<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO _________
COMMISSION FILE NUMBER: __________
HIGHLAND BANCORP, INC.
(Exact name of Registrant as specified in its Charter)
DELAWARE 95-4654552
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
601 SOUTH GLENOAKS BOULEVARD, BURBANK, CALIFORNIA 91502
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 848-4265
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.01 PAR VALUE
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ____
---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of March 23, 1998, the aggregate market value of the Common Stock held by
non-affiliates of the Registrant was $36,988,151. Shares of Common Stock held
by each executive officer and director and each person owning more than 5% of
the outstanding Common Stock of the Registrant have been excluded in that such
persons may be deemed to be affiliates of the Registrant. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes. The number of shares of Common Stock of the Registrant outstanding as
of March 23, 1998 was 2,322,687.
The following documents are incorporated by reference herein:
------------------------------------------------------------
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders to be held on April 22, 1998 are incorporated by reference into
Part III herein.
<PAGE>
Discussions of certain matters contained in this Annual Report on Form 10-K
may constitute forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 (the "Reform Act"), and as such may
involve risks and uncertainties. These forward-looking statements relate to,
among other things, expectations of the business environment in which Highland
(as defined below) operates, projections of future performance, perceived
opportunities in the market and statements regarding Highland's mission and
vision. Highland's actual results, performance, or achievements may differ
significantly from the results, performance, or achievements expressed or
implied in such forward-looking statements. For discussion of the factors that
might cause such a difference, see "Item 1. Business-Factors that May Affect
Future Results."
PART I
ITEM 1. BUSINESS
GENERAL
Highland Bancorp, Inc. ("Highland") is a corporation organized under the
laws of the State of Delaware on September 29, 1997 for the primary purpose of
becoming the holding company of Highland Federal Bank, a Federal Savings Bank
(the "Bank"). On December 16, 1997, after obtaining the necessary stockholder
and regulatory approvals, Highland and the Bank effected a reorganization
whereby each issued and outstanding share of Common Stock, $1.00 stated value,
of the Bank was converted into one share of Common Stock, $0.01 par value, of
Highland, and the Bank became a wholly-owned subsidiary of Highland
(collectively, the "Reorganization"). See "Item 4. Submission of Matters to a
Vote of Security Holders." Highland is registered as a savings and loan holding
company under applicable federal law and regulations.
The Bank is a federally chartered and insured savings bank which was
organized in 1968 as a federal mutual savings and loan association and converted
in 1982 to a federal stock savings and loan association. In 1989, the Bank
changed its name from Highland Federal Savings and Loan Association to its
present name, Highland Federal Bank, a Federal Savings Bank.
The Bank provides financial services through seven offices located in
communities within Los Angeles County, California, including two offices in the
South Bay area and five offices spread out across the San Gabriel Valley,
Northern Los Angeles and Santa Monica. See "Market Area and Competition." The
Bank's lending activity focuses on originating multi-family residential mortgage
loans, commercial real estate loans and construction loans principally in
Southern California. The Bank's lending and investment activities are funded
primarily through deposits derived from the Bank's branch network and through
borrowings from the Federal Home Loan Bank ("FHLB") System. The principal
executive offices of Highland and the Bank are located at 601 South Glenoaks
Boulevard, Burbank, California 91502, and its telephone number at that address
is (818) 848-4265. Highland's stock is traded on the Nasdaq National Market
under the trading symbol "HBNK."
At December 31, 1997, Highland had total consolidated assets of a $549.6
million, total consolidated deposits of $363.7 million and total consolidated
stockholders' equity of $41.5 million. Highland's principal sources of funds
have been and are expected to be dividends paid by the Bank. There are legal
and contractual limitations that are imposed on the amount of fees and dividends
that may be paid by the Bank to Highland. See "Business-Supervision and
Regulation-Regulation of the Bank."
At and for the year ending December 31, 1997, the financial information and
discussion contained in this Report on Form 10-K reflect the operations of
Highland. Prior periods presented in this Report on Form 10-K reflect the
operations of the Bank. Therefore, all information, including financial
statements and tables for periods prior to the Reorganization, presented in this
Annual Report and the financial statements attached hereto assume that the
Reorganization was effective at the beginning of the periods presented. Unless
otherwise stated or indicated, all references to "Highland" or "the Bank"
include their respective subsidiaries on a combined basis.
2
<PAGE>
LENDING ACTIVITIES
LOAN PORTFOLIO AND ORIGINATION
- ------------------------------
Highland's lending strategy is to focus primarily on niches in real estate
lending in its market areas that management believes are currently not generally
targeted by traditional lenders. While niche lending markets generally entail
greater credit risks, management believes that borrowers in these markets are
also generally willing to pay the higher rates required to compensate Highland
for the increased risk and higher costs associated with such loans. Highland's
lending activities focus primarily on origination of multi-family residential
mortgage loans, commercial real estate loans and construction loans principally
in Highland's market areas. Highland's lending and investment activities are
funded primarily through deposits derived from the Bank's branch network and
through borrowings from the FHLB.
Loan Portfolio Composition. Highland's loan portfolio consists primarily
of first trust deed loans secured by one-to-four family residential properties,
multi-family residential properties (five or more units) and commercial
properties. At the end of 1996, Highland discontinued its lending operations
related to the originating of loans secured by one-to-four family residential
properties. At December 31, 1997, Highland had total gross loans outstanding of
$444.7 million, which included $64.5 million of one-to-four family residential
mortgage loans, $214.5 million of multi-family mortgage loans, $154.7 million of
commercial real estate loans, $10.5 million of construction and land loans and
$0.5 million of consumer loans.
The following table sets forth information concerning the composition of
Highland's loan portfolio at the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31
-------------------------------------------------------------------------------
1997 1996 1995
----------------------- ---------------------- ---------------------
PERCENT PERCENT PERCENT
OF TOTAL OF TOTAL OF TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
-------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Real estate(1):
One- to four-family........... $ 64,558 14.52% $ 82,436 21.42% $ 99,724 30.82%
Multi-family.................. 214,462 48.23 180,940 47.00 127,073 39.27
Commercial.................... 154,717 34.79 116,389 30.23 88,326 27.30
Construction and land......... 10,465(2) 2.35 3,954(2) 1.03 7,543 2.33
Consumer......................... 493 0.11 1,244 0.32 923 0.28
-------- -------- -------- -------- -------- --------
Total loans............... 444,695 100.00% 384,963 100.00% 323,589 100.00%
======== ======== ========
Less:
Undisbursed loan
funds....................... 6,653 1,439 1,066
Deferred loan fees, net....... 1,957 2,303 2,473
Allowance for loan
losses...................... 8,848 7,676 7,056
-------- -------- --------
Total loans, net.......... $427,237 $373,545 $312,994
======== ======== ========
<CAPTION>
----------------------------------------------
1994 1993
-------------------- --------------------
PERCENT PERCENT
OF TOTAL OF TOTAL
AMOUNT LOANS AMOUNT LOANS
-------- -------- -------- --------
<C> <C> <C> <C>
Real estate(1):
One- to four-family........... $ 96,742 33.98% $112,292 37.70%
Multi-family.................. 92,931 32.64 98,892 33.21
Commercial.................... 91,937 32.29 81,213 27.27
Construction and land......... 2,316 0.81 4,491 1.51
Consumer......................... 780 0.28 933 0.31
-------- -------- -------- --------
Total loans............... 284,706 100.00% 297,821 100.00%
========= ========
Less:
Undisbursed loan
funds....................... 197 376
Deferred loan fees, net....... 2,654 2,906
Allowance for loan
losses...................... 8,832 5,142
-------- --------
Total loans, net.......... $273,023 $289,397
======== ========
</TABLE>
___________________
(1) Consists of loans receivable less participations and unamortized premiums
or discounts.
(2) Includes construction loans of $7,355,900, $0 and $1,875,000 for one- to
four-family, multi-family and commercial projects, respectively, at
December 31, 1997 and $0, $650,000 and $1,605,000 respectively, at December
31, 1996. Highland had no construction loans prior to 1995.
3
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Loan Maturity. The following table sets forth the final contractual
maturities of Highland's gross loans at December 31, 1997:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
-----------------------------------------------------------------------------------
ONE MORE THAN MORE THAN MORE THAN MORE THAN MORE
YEAR OR 1 YEAR TO 3 YEARS TO 5 YEARS TO 10 YEARS TO THAN TOTAL
LESS 3 YEARS 5 YEARS 10 YEARS 20 YEARS 20 YEARS LOANS
-------- --------- ---------- ---------- ----------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Real estate:
One- to four-family......... $ 109 $ 80 $ 1,285 $ 4,291 $ 10,314 $ 48,479 $ 64,558
Multi-family................ 433 7,680 5,924 21,078 159,373 19,974 214,462
Commercial.................. 247 3,499 5,812 28,437 105,761 10,961 154,717
Construction and land....... 6,996 2,669 70 142 588 -- 10,465
Consumer...................... 300 50 27 116 -- -- 493
-------- --------- ---------- ---------- ----------- -------- ---------
Total amount due......... $ 8,085 $ 13,978 $ 13,118 $ 54,064 $ 276,036 $ 79,414 $ 444,695
======== ========= ========== ========== =========== ======== =========
</TABLE>
The following table sets forth, as of December 31, 1997, the dollar amounts
of gross loans receivable that are contractually due after December 31, 1998 and
whether such loans have fixed or adjustable interest rates:
<TABLE>
<CAPTION>
DUE AFTER DECEMBER 31, 1998
-------------------------------------------
FIXED(1) ADJUSTABLE TOTAL
---------- ------------ -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Real estate:
One- to four-family............... $ 55,540 $ 8,909 $ 64,449
Multi-family...................... 51,268 162,761 214,029
Commercial........................ 51,230 103,240 154,470
Construction and land............. 398 3,071 3,469
Consumer............................ 193 -- 193
---------- ------------ -----------
Total loans receivable......... $ 158,629 $ 277,981 $ 436,610
========== ============ ===========
</TABLE>
______________
(1) Includes fixed-rate three-year rollover loans.
Loan Origination and Sale. Prior to 1994, substantially all of Highland's
loan originations were generated on a retail basis through the Bank's branch
offices. In mid-1994, management of Highland adopted a new loan origination
strategy and hired new loan officers, who rely on a network of loan brokers
operating throughout Southern California for sources of loan applications. The
loan officers operate primarily in certain of the Bank's branch offices and
three loan processing centers located in Orange County, San Diego County and
Sacramento. Management believes that Highland's new loan origination strategy
is not only a more cost-effective means of originating loans, but also affords
Highland improved access to potential loan transactions and greater geographic
diversification in Southern California in its loan portfolio. Management
believes that Highland's lending specializations, service-oriented approach,
timely decision making process and competitive fee structure provide incentives
for brokers to do business with Highland.
In late 1996, Highland decided to cease origination of sub-prime loans
secured by one-to-four family residential properties. This decision was made
because Highland believed that cost associated with the origination of such
loans was higher relative to its other lending areas, and that competition for
such product was intensifying.
From time to time, Highland may sell loans in order to achieve its
asset/liability objectives. During 1997, Highland sold loans totaling $4.3
million which consisted of $1.5 million of single-family loans, $1.9 million of
multi-family loans and $0.9 million of commercial real estate loans. During
1996, Highland sold $12.5 million of single-family loans designated as
available-for-sale.
4
<PAGE>
The following table sets forth Highland's loan originations by category and
purchases, sales and principal repayments of loans for the periods indicated:
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Beginning balance................ $373,545 $312,994 $273,023 $289,397 $315,684
-------- -------- -------- -------- --------
Loans originated:
Real Estate:
One- to four-family......... 257 11,451 18,423 8,063 13,930
Multi-family................ 53,997 62,634 48,160 12,590 15,198
Commercial.................. 53,324 36,632 15,587 21,126 10,105
Construction and land....... 10,068 606 5,502 -- 732
Consumer......................... 977 1,149 1,352 3,740 1,458
-------- -------- -------- -------- --------
Total loans originated...... 118,623 112,472 89,024 45,519 41,423
Loans purchased.................. 396 7,690 -- -- 2,248
-------- -------- -------- -------- --------
Total....................... 119,019 120,162 89,024 45,519 43,671
-------- -------- -------- -------- --------
Less:
Principal repayments........... 58,159 44,068 42,988 60,012 59,192
Sales of loans................. 4,262 12,527 7,257 3,053 1,990
Other net changes(1)........... 2,906 3,016 (1,192) (1,172) 8,776
-------- -------- -------- -------- --------
Total loans................. $427,237 $373,545 $312,994 $273,023 $289,397
======== ======== ======== ======== ========
</TABLE>
_____________________
(1) Other net changes includes changes in allowance for loan losses, deferred
loan fees, loans in process and unamortized premiums and discounts.
LOAN SERVICING. Loan servicing is centralized at Highland's corporate
headquarters. In addition to servicing loans owned by Highland, Highland is
servicing $5.5 million of loans originated by it but subsequently sold to other
institutions.
Highland's loan servicing operations are intended to provide prompt
customer service and accurate and timely information for account follow-up,
financial reporting and management review. Following the funding of an approved
loan, loan data is entered into Highland's data processing system, which
provides monthly billing statements, tracks payment performance, and effects
agreed upon interest rate adjustments on loans. Regular loan service efforts
include payment processing and collection follow-up, as well as tracking the
performance of additional borrower obligations with respect to the maintenance
of casualty insurance coverage, payment of property taxes and senior liens, if
any, and periodically requesting required information, including current
borrower and property financial and operating statements. When payments are not
received by their contractual due date, collection efforts begin on the
fifteenth day of delinquency with a telephone contact, and proceed to written
notices that begin with reminders of the borrower's payment obligation and
progress to an advice that a notice of default may be forthcoming. Accounts
delinquent more than 30 days are generally transferred to the Bank's Asset
Management Department which, following a review of the account and management
approval, implements a collection or restructure plan or a foreclosure or note
sale strategy, and evaluates any potential loss exposure on the asset. Highland
will generally send a notice of intention to foreclose after 30 days of
delinquency.
UNDERWRITING PROCESS. The lending activities of Highland are guided by the
basic lending policies established by the Board of Directors. Each loan must
meet minimum underwriting criteria established in Highland's lending policies
and must fit within Highland's strategies for yield and portfolio enhancement.
Highland's underwriting procedures require, among other things, a thorough
analysis of the borrower's financial condition and the debt coverage ratio of
income-producing properties in various interest rate scenarios (utilizing a
fully indexed interest rate). The policies also emphasize geographic and
product diversification.
For all newly originated loans, upon receipt of a completed loan
application from a prospective borrower, a credit report is ordered and, if
necessary, additional financial information is requested. An independent
appraisal is required on every property securing a loan and additionally, an
internal field review appraisal is conducted for every loan with a principal
balance in excess of $700,000. In addition, the Appraisal Department conducts a
review of appraisals on selected loan files, which have constituted at least 50%
of all loans originated since June 1994. Also, for all multi-family residential
and
5
<PAGE>
commercial real estate loans, the responsible loan officer inspects the property
and, if the transaction involves a loan over $1.0 million, the property is
inspected by either the President, Chief Lending Officer or Chief Credit Officer
of the Bank. The Board of Directors of the Bank reviews and approves annually
the independent appraisers used by the Bank and the Bank's appraisal policy.
Subject to the above standards, the Board of Directors of the Bank has
authorized the following persons to approve new loans involving total liability
of the borrower (new loans plus old loans) of the following amounts: all income
property loans up to $2,000,000 require the approval of at least two members of
the Loan Committee (consisting of the President, Chief Lending Officer and
Branch Administrator), and all loans which bring the total aggregate
indebtedness of a borrower to an amount in excess of $2,000,000 require the
additional approval of at least two outside directors.
Multi-family Residential Lending. Highland originates loans secured by
multi-family residential properties (five units and greater). Pursuant to the
Bank's underwriting policies, a multi-family residential ARM loan may only be
made in an amount up to 75% of the appraised value of the underlying property in
a sale transaction and 70% on refinancings. In addition, Highland generally
requires a minimum debt service ratio (the ratio of net earnings on a property
to debt service) of 1.15, based on the fully indexed loan rate.
Loans secured by multi-family residential properties are generally larger
and involve a greater degree of risk than one- to four-family residential loans.
The liquidation value of commercial and multi-family properties may be adversely
affected by risks generally incident to interests in real property, including
changes or continued weakness in general or local economic conditions and/or
specific industry segments; declines in real estate values; declines in rental,
room or occupancy rates; increases in interest rates, real estate and personal
property tax rates and other operating expenses (including energy costs); the
availability of refinancing; changes in governmental rules, regulations and
fiscal policies, including rent control ordinances, environmental legislation,
taxation and other factors beyond the control of the borrower or the lender.
Because of this, Highland considers the borrower's experience in owning and
managing similar properties and Highland's lending experience with the borrower.
Commercial Real Estate Lending. Highland focuses on originating loans
secured by commercial real estate, such as retail centers, small office and
light industrial buildings and other mixed use commercial properties. Highland
will, from time to time, make a loan secured by a special purpose property such
as a restaurant or motel. Pursuant to Highland's underwriting policies,
commercial real estate loans may be made in amounts up to the lesser of 70% of
the appraised value of the property or the sales price. These loans may be made
with terms up to 30 years. Highland's underwriting standards and procedures are
similar to those applicable to its multi-family residential loans, whereby
Highland considers the net operating income of the property and requires a debt
service coverage ratio of at least 1.15, based on a fully indexed rate.
Loans secured by commercial real estate properties involve the same
additional risks as discussed above with respect to multi-family residential
loans. Because of this, Highland considers the borrower's experience in owning
and managing similar properties and Highland's lending experience with the
borrower. Highland's underwriting policies require that the borrower is able to
demonstrate strong management skills and the ability to maintain the property's
current income.
Construction And Rehabilitation Lending. On a limited basis, Highland
originates loans for the development and rehabilitation of property in its
market areas. Highland's construction loans primarily have been made to finance
the rehabilitation of apartment buildings and the construction of one- to four-
family residential properties or released properties. These loans are generally
adjustable rate with maturities of 18 months or less. Highland's policies
provide that construction loans may be made in amounts up to 75% of the
appraised value of the property. As of December 31, 1997, Highland had $9.2
million of construction loans (less undisbursed loan funds of $6.3 million),
which amounted to 0.2% of Highland's total loan portfolio. In addition to the
lending risks discussed above with respect to multi-family residential and
commercial real estate loans, construction loans also present risks associated
with the accuracy of the initial estimate of the property's value upon
completion and its actual value, as well as timely completion of construction
activities for the allotted costs. These risks can be affected by a variety of
factors, including the oversight of the project, localized costs for labor and
materials, and the weather.
6
<PAGE>
CREDIT ADMINISTRATION
- ---------------------
The Chief Credit Officer provides independent oversight to the lending
function. The Chief Credit Officer reports to the President and has access to
the Board of Directors through the Audit Committee of the Board, including
holding quarterly meetings with the Audit Committee unaccompanied by other
members of management.
Underwriting criteria are set forth in the Lending Policy Manual, taking
into account the types of lending engaged in by Highland. In light of high
levels of historic losses in certain lending categories, Highland's underwriting
criteria have been revised to reduce the levels of certain types of
originations, including residential hotels near Downtown Los Angeles, and
special purpose commercial real estate loans. In addition, the Chief Credit
Officer and other members of management have established new information systems
which management believes have, among other things, resulted in more timely
identification of, and development of dispositions plans for, problem assets.
CREDIT REVIEW AND LOAN CLOSING OVERSIGHT. The Chief Credit Officer and the
Credit Review Department monitor all loans for exceptions to loan policies by
reviewing each loan before approval is received and assigning a loan risk rating
to each proposed credit. Credit Review Department staff also monitor the
accuracy of loan risk ratings (as described below) on an ongoing basis by
reviewing Highland's management information systems on existing loans.
The Loan Closing Administration Department, in conjunction with the Credit
Review Department, monitors loans for exceptions to loan policies after approval
has been obtained but before funding. If documentation exceptions are noted,
the exceptions are required to be cured prior to funding. Loan Closing
Administration staff track and monitor all exceptions until resolved.
ASSET QUALITY RATINGS. Highland's asset risk rating system is intended to
provide timely identification of potential loan problems in the portfolio and to
identify potential areas for modification in Highland's lending policies and
procedures. The risk rating system assigns loans to six categories ranging from
"pass" to "loss." There are two designations in the "pass" category called
"pass" and "watch," which consist of credits found to be of acceptable risk.
Loans in this category are generally performing in accordance with their terms,
have significant net operating income and are protected by the paying capacity
of the borrower and/or by the value of the collateral. When a loan shows signs
of potential weaknesses that may affect repayment of the loan or the collateral,
the loan is reclassified "special mention." A loan which has further
deterioration and exhibits defined weaknesses in the borrower's capacity to
repay is reclassified "substandard." Loans that exhibit signs of questionable
repayment are classified "doubtful" and loans that show signs of partial or full
loss are subject to a specific loss allocation.
The Internal Asset Review Committee ("IARC") is responsible for reviewing
and approving asset classifications and the adequacy of the allowance for loan
losses. The IARC meets monthly and reports its findings and recommendations for
risk ratings of assets, potential problem assets and changes in ratings of
previously classified assets to the Board of Directors on a monthly basis. The
IARC consists of the Chief Credit Officer, Chief Executive Officer, Chief
Lending Officer, Chief Financial Officer and Senior Vice President for Loan
Administration.
The Chief Credit Officer reviews, on a periodic basis, various segments of
the loan portfolio and makes periodic reports to senior management, internal and
external auditors and regulatory agencies to facilitate an objective assessment
of the overall asset quality, risks and trends of asset categories. The Chief
Credit Officer also meets periodically with the Audit Committee of the Board in
order to provide an added degree of independence to his analyses and
recommendations.
TROUBLED ASSET MANAGEMENT. All classified assets, special mention and
watch-list credits are generally reported to IARC monthly, through Asset
Classification Reports ("AC Reports"). These reports are prepared by the Loan
Administration and Internal Asset Review Departments and, in addition to
identifying problem loans, specify corrective strategies and dates for
accomplishing the strategies.
When evaluating the AC Reports, management determines if specific reserves
should be set up on impaired loans, depending on the nature of the problem and
the underlying collateral. If there is erosion in either the borrower's cash
flow or underlying collateral value, prompt action is taken to protect
Highland's position. Such actions may include taking additional collateral,
obtaining further guaranties, declaring a default and accelerating the loan, and
such other legal remedies as may be available to Highland pursuant to the loan
documents in order to take control of the collateral. The AC Reports are
summarized on the Troubled Asset Report, which is used to monitor the activity
of credits both in terms of changing loan
7
<PAGE>
balances and forecasting based on risk ratings and dispositions. Furthermore,
the Troubled Asset Report and AC Report are provided to the IARC for review and
analysis, and ultimately to the Board of Directors in monthly Board packages.
Concentrations of Credit. Under federal law, the Bank's ability to make
aggregate loans to one borrower is limited to 15% of unimpaired capital and
surplus (as of December 31, 1997 this amount was $6.6 million) plus an
additional 10% of unimpaired capital and surplus if a loan is secured by readily
marketable collateral (defined to include only certain financial instruments and
gold bullion), although management generally does not make loans in excess of
$2.0 million. The Bank's largest single loan was for approximately $1.9 million
at December 31, 1997. As of December 31, 1997, the Bank had five lending
relationships which exceeded $2.0 million in aggregate indebtedness. These
lending relationships are comprised of a number of separate multi-family
residential loans to long-time borrowers of the Bank. All such loans were
performing and were not classified at December 31, 1997.
NONPERFORMING ASSETS
- --------------------
The following table sets forth the amounts of nonaccrual loans, real estate
owned ("REO") and troubled debt restructurings ("TDRs") at the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31,
---------------------------------------------------
1997 1996 1995 1994 1993
---------- -------- --------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Nonaccrual loans:
Real estate:
One-to-four family.................................... $ 1,951 $ 474 $ 1,506 $ 1,964 $ 422
Multi-family......................................... 1,584 1,320 2,181 4,826 4,918
Commercial........................................... 913 1,653 1,496 2,248 4,212
Construction and land............................... -- -- -- -- 459
Consumer................................................. 37 8 37 -- --
------- ------- ------- -------- -------
Total............................................... 4,485 3,455 5,220 9,038 10,011
REO......................................................... 1,543 1,400 2,966 6,791 9,169
------- ------- ------- ------- -------
Total nonperforming assets.......................... $ 6,028 $ 4,855 $ 8,186 $15,829 $19,180
======= ======= ======= ======= =======
TDRs........................................................ $ 4,642 $ 7,428 $ 9,377 $ 8,877 $ 7,567
======= ======= ======= ======= =======
Allowance for loan losses as a percent
of gross loans receivable (1)............................ 2.02% 2.00% 2.18% 3.10% 1.73%
Allowance for loan losses as a percent
of total nonperforming loans............................. 197.28% 222.24% 135.20% 97.72% 51.36%
Nonperforming loans as a percent of
gross loans receivable (1)............................... 1.01% 0.90% 1.61% 3.17% 3.36%
Nonperforming assets as a percent of
total assets............................................. 1.10% 0.99% 1.78% 3.41% 4.28%
</TABLE>
______________________
(1) Gross loans receivable includes loans receivable less loan participations
and unamortized premiums and discounts.
Nonaccrual Loans. Loans are automatically placed on nonaccrual status
when principal or interest payments are past due greater than 90 days (no loans
past due greater than 90 days are still on accrual status). At December 31,
1997, Highland had 28 loans on nonaccrual status consisting of thirteen one-to-
four family residential loans, eight multi-family residential loans, five
commercial real estate loans and two consumer loans. Interest income foregone
by Highland on nonaccrual loans compared to the original terms of such loans
during 1997 and 1996 totaled $396,000 and $692,000, respectively.
Real Estate Owned. Highland's general policy is to initiate foreclosure
proceedings when loans are more than 30 days past due. Some loans that are more
than 30 days past due are never actually foreclosed upon, however, because the
borrower brings the account current before a formal notice of default is filed.
Assets classified as REO include properties upon which Highland has foreclosed
on the borrower's real estate collateral or a deed has been offered in lieu of
foreclosure. At December 31, 1997, Highland's REO portfolio totaled $1.5
million, consisting of two SFR properties, six multi-family residential
properties and two commercial real estate properties. No properties are valued
at more than $400,000.
8
<PAGE>
Troubled Debt Restructurings. A TDR is a loan on which Highland has
reduced the rate of interest to a below-market rate or has forgiven all or part
of the interest income or part of the principal balance of the loan due to the
borrower's financial condition, including reduced cash flow, reduced collateral
value or other conditions that impair the borrower's ability to repay the loan
according to the original terms. At December 31, 1997, Highland had 16 loans
classified as TDRs. Interest income foregone by Highland on TDRs compared to the
original terms of such loans during 1997 and 1996 totaled $179,000 and $261,000,
respectively.
Classified Assets. The Internal Asset Review and Credit Review
Departments periodically review segments of Highland's loan portfolio and assign
to each loan a classification according to Highland's risk rating system.
Classified assets (consisting of nonaccrual loans, loans graded as substandard
or lower and REO) at December 31, 1997 and December 31, 1996 were $13.5 million
and $15.7 million, respectively. At December 31, 1997, classified assets
consisted of 60 loans and 10 REO properties. Six classified loans totaling $3.5
million had net principal balances in excess of $500,000 at December 31, 1997,
and no REO properties exceeded $500,000 at such date.
Delinquent Loans. The following tables set forth loans delinquent 30-59
days and 60-89 days in the loan portfolio as of the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997 AT DECEMBER 31, 1996 AT DECEMBER 31, 1995
-------------------------- ----------------------------- -------------------------
30-59 DAYS 60-89 DAYS 30-59 DAYS 60-89 DAYS 30-59 DAYS 60-89 DAYS
PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL
BALANCE BALANCE BALANCE BALANCE BALANCE BALANCE
OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS
------------ ----------- ------------ ---------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Real Estate:
One-to-four family............. $ 364 $ 272 $ 1,640 $ 1,779 $ 385 $ 30
Multi-family................... 202 704 2,069 1,577 1,104 802
Commercial..................... 285 1,321 512 213 1,735 606
Construction and land.......... -- -- -- -- -- --
Consumer............................ -- -- -- -- -- --
------- ------- --------- -------- ------- -------
Total.......................... $ 851 $ 2,297 $ 4,221 $ 3,569 $ 3,224 $ 1,438
======= ======= ========= ======== ======= =======
Delinquent loans to total loans(1).. 0.20% 0.54% 1.10% 0.93% 1.00% 0.44%
</TABLE>
(1) Total loans includes loans receivable less loan participations and
unamortized premiums and discounts.
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in its loan portfolio and the general economy. The allowance is
increased by provisions charged against earnings and reduced by net loan
chargeoffs. Loans are charged off when they are deemed to be uncollectible, or
partially charged off when portions of a loan are deemed to be uncollectible.
Recoveries are generally recorded only when cash payments are received.
In determining the adequacy of the allowance, management initially
considers the allowances specifically allocated to individual impaired loans,
and next considers the level of general loss allowances deemed appropriate for
the balance of the portfolio based on factors including levels of problem loans,
general portfolio trends relative to asset and portfolio size, asset categories,
potential credit concentrations, nonaccrual loan levels, historical loss
experience, risks associated with changes in economic and business conditions,
and other factors. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review Highland's allowance for
loan loses. Such agencies may require Highland to make additional provisions
for loan losses based upon judgments which differ from those of management.
9
<PAGE>
The following table sets forth information regarding Highland's allowance
for loan losses at the dates and for the periods indicated:
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1997 1996 1995 1994 1993
--------- -------- -------- --------- -----------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Balance at beginning of period.................... $ 7,676 $ 7,056 $ 8,832 $ 5,142 $ 3,053
Provision for loan losses......................... 5,164 3,930 5,221 13,536 6,758
Chargeoffs:
Real estate loans:
One-to-four family......................... 432 590 1,196 867 1,895
Multi-family............................... 2,650 1,925 4,936 7,278 2,031
Commercial................................. 895 785 1,616 1,229 338
Construction and land...................... 13 21 164 472 405
Consumer...................................... 2 2 -- -- --
-------- -------- -------- -------- --------
Total...................................... 3,992 3,323 7,912 9,846 4,669
Recoveries........................................ -- 13 915 -- --
-------- -------- -------- -------- --------
Balance at end of period.......................... $ 8,848 $ 7,676 $ 7,056 $ 8,832 $ 5,142
======== ======== ======== ======== ========
</TABLE>
Highland made provisions for loan losses during 1993 and 1994 at
historically high levels and loan chargeoffs during these years exceeded the
allowance at the beginning of each such year, primarily due to the worsening of
economic conditions in Highland's market areas and declines in real estate
values during these years. As the level of nonaccrual loans and foreclosed
loans began decreasing in 1995 and 1996, Highland's provision for loan losses
also decreased during these years. Highland's increased provision for 1997
compared with 1996 reflects moderate increases in the levels of loan chargeoffs
and nonaccrual loans during 1997. Nonaccrual loans decreased from $5.2 million
at the beginning of 1996 to $3.5 million at the beginning of 1997, then
increased to $4.5 million at December 31, 1997. However, classified assets
declined to $13.5 million at December 31, 1997 from $15.7 million at December
31, 1996, while the allowance for loan losses as a percentage of total
nonperforming loans decreased from 222.24% at December 31, 1996 to 197.28% at
December 31, 1997.
Highland's allowance for loan losses was $8.8 million at December 31, 1997.
The determination of this allowance requires the use of estimates and
assumptions regarding the risks inherent in individual loans and the loan
portfolio in its entirety. While management believes that these estimates and
assumptions are reasonable, there can be no assurances that they will not prove
incorrect in the future. The actual amount of future provisions that may be
required cannot be determined as of the date hereof, and such provisions may
exceed the amounts of past provisions.
10
<PAGE>
The following tables set forth Highland's percent of allowance for loan
losses to total allowance for loan losses and the percent of loans to total
loans in each of the categories listed at the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31,
---------------------------------------------------------------------------------------------------
1997 1996 1995
--------------------------------- -------------------------------- ------------------------------
PERCENT OF PERCENT PERCENT
LOANS IN OF LOANS OF LOANS
PERCENT OF EACH PERCENT OF IN EACH PERCENT OF IN EACH
ALLOWANCE CATEGORY ALLOWANCE CATEGORY ALLOWANCE CATEGORY
TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
------ --------- ---------- ------ --------- -------- ------ --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate:
One-to-four family........ $ 905 10.23% 14.52% $ 958 12.48% 21.42% $1,411 20.00% 30.82%
Multi-family.............. 5,337 60.32 48.23 4,686 61.05 47.00 3,443 48.80 39.27
Commercial................ 2,312 26.13 34.79 1,898 24.73 30.23 2,093 29.66 27.30
Construction and land..... 183 2.07 2.35 134 1.74 1.03 92 1.30 2.33
Consumer.................. 111 1.25 0.11 -- -- 0.32 17 0.24 0.28
------ ------ ------ ------ ------ ------ ------ ------ ------
Total.................. $8,848 100.00% 100.00% $7,676 100.00% 100.00% $7,056 100.00% 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31,
------------------------------------------------------------------------
1994 1993
-------------------------------- ----------------------------------
PERCENT OF PERCENT OF
PERCENT OF LOANS IN PERCENT OF LOANS IN
ALLOWANCE EACH ALLOWANCE EACH
TO TOTAL CATEGORY TO TO TOTAL CATEGORY TO
AMOUNT ALLOWANCE TOTAL LOANS AMOUNT ALLOWANCE TOTAL LOANS
------ --------- ---------- ------ --------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Real estate:
One- to four-family..................... $1,637 18.53% 33.98% $ 849 16.51% 37.70%
Multi-family............................ 5,306 60.08 32.64 2,139 41.60 33.21
Commercial.............................. 1,793 20.30 32.29 1,976 38.43 27.27
Construction and land................... 84 0.95 0.81 165 3.21 1.51
Consumer................................... 12 0.14 0.28 13 0.25 0.31
------ ------ ------ ------ ------ ------
Total................................ $8,832 100.00% 100.00% $5,142 100.00% 100.00%
====== ====== ====== ====== ====== ======
</TABLE>
INVESTMENT ACTIVITIES
- ---------------------
Federally chartered savings institutions such as the Bank are authorized to
invest in various types of liquid assets, including U.S. Treasury obligations,
securities of various federal agencies, certificates of deposit of insured banks
and savings institutions, bankers' acceptances, repurchase agreements and
federal funds. Subject to various restrictions, federally chartered savings
institutions may also invest their assets in commercial paper, investment-grade
corporate debt securities and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly. Additionally, the Bank must maintain minimum
levels of investment as liquid assets under the regulations of the Office of
Thrift Supervision ("OTS"). See "Supervision and Regulation-Federal Savings
Institution Regulation-Liquidity." Historically, the Bank has maintained liquid
assets above the minimum OTS requirements and at a level considered to be
adequate to meet its normal daily activities.
The investment policy of Highland, as established by the Board of
Directors, attempts to provide for and maintain liquidity, generate a favorable
return on investments without incurring undue interest rate and credit risk, and
complement Highland's lending activities. Specifically, Highland's policies
generally limit investments to government and federal agency-backed securities
and other non-government guaranteed securities, including corporate debt
obligations, that are investment grade. Highland's policies provide the
authority to invest in mortgage-backed securities guaranteed by the U.S.
government
11
<PAGE>
and agencies thereof. Highland's policies provide that all investment purchases
between $3.0 million and $10.0 million must be approved by two officers of the
Investment Committee (either the President, Chief Financial Officer or Chief
Lending Officer) while all investment purchases exceeding $10.0 million require
the approval of two officers of the Investment Committee and two outside
directors of the Asset/Liability Committee and must be ratified by the Board of
Directors.
At December 31, 1997, Highland held $15.5 million in U.S. Treasury and
agency securities. Highland's mortgage-backed security ("MBS") portfolio
consists of seasoned fixed-rate and balloon MBSs, longer-term fixed-rate
securities and adjustable-rate securities. At December 31, 1997, all of
Highland's MBSs were insured or guaranteed by either the Federal National
Mortgage Association, Federal Home Loan Mortgage Corporation or Government
National Mortgage Association, including a cost basis of $34.4 million in MBSs
available-for-sale. Investments in MBSs involve a risk that actual prepayments
will be greater than estimated prepayments over the life of the security, which
may require adjustments to the amortization of any premium or accretion of any
discount relating to such instruments thereby reducing the net yield on such
securities. There is also reinvestment risk associated with the cash flows from
such securities. In addition, the market value of such securities may be
adversely affected by changes in interest rates.
The following tables set forth the carrying values and estimated fair
values of Highland's investment portfolio at the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997 AT DECEMBER 31, 1996 AT DECEMBER 31, 1995
----------------------- ------------------------ ------------------------
AMORTIZED ESTIMATED AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
----------- ---------- ---------- ---------- ----------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Securities available-for-sale:
U.S. Treasury and agency securities......... $ 15,481 $ 15,459 $ 2,982 $ 2,968 $ 2,972 $ 2,960
Mortgage-backed securities.................. 34,400 34,176 34,431 34,070 41,438 40,914
--------- --------- -------- -------- -------- --------
Total debt securities................... $ 49,881 $ 49,635 $ 37,413 $ 37,038 $ 44,410 $ 43,874
========= ========= ======== ======== ======== =========
<CAPTION>
AT DECEMBER 31, 1997 AT DECEMBER 31, 1996 AT DECEMBER 31, 1995
----------------------- ------------------------ ------------------------
AMORTIZED ESTIMATED AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
----------- ---------- ---------- ---------- ----------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Securities held-to-maturity:
Mortgage-backed securities.................. $ 15,419 $ 15,263 $ 17,969 $ 17,493 $ 20,787 $ 20,558
========= ========= ======== ======== ======== =========
</TABLE>
12
<PAGE>
The contractual maturities of debt securities held-to-maturity and
available-for-sale at December 31, 1997 were as follows:
<TABLE>
<CAPTION>
HELD-TO-MATURITY AVAILABLE-FOR-SALE
------------------------------ ----------------------------
AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST FAIR VALUE COST FAIR VALUE
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Due from one year to five years..................... $ -- $ -- $ 29,900 $ 29,714
Due from five to ten years.......................... 2,711 2,677 11 11
Due after ten years................................. 12,708 12,586 19,970 19,910
--------- -------- --------- ----------
Total........................................... $ 15,419 $ 15,263 $ 49,881 $ 49,635
========= ======== ========= ==========
</TABLE>
SOURCES OF FUNDS
GENERAL
- -------
Deposits, loan repayments and prepayments, proceeds from the sales of
loans, cash flows generated from operations and FHLB advances are the primary
sources of Highland's funds for use in lending, investing and for other general
purposes.
DEPOSITS
- --------
Highland offers a variety of deposit accounts with a range of interest
rates and terms. Highland's deposits consist of checking accounts, money market
accounts, passbook accounts and certificates of deposit. At December 31, 1997,
certificates of deposit constituted 80.8% of total deposits. The flow of
deposits is influenced significantly by general economic conditions, changes in
money market rates, prevailing interest rates and competition. Highland's
deposits are obtained predominantly from the areas in which the Bank's branch
offices are located. Highland relies primarily on customer service, aggressive
marketing and cross-selling to customers and prospects to attract and retain
these deposits. However, market interest rates and products, and rates offered
by competing financial institutions significantly affect Highland's ability to
grow and retain deposits. See Note 6 of the Notes to Consolidated Financial
Statements for a discussion of the type of deposits accounts offered by
Highland. Highland does not currently accept brokered deposits.
The following table represents the deposit activity of Highland for the
periods indicated:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
------------ ------------ ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Deposits sold............................................. $(101,843) $ -- $ --
Net deposits (withdrawals)................................ 62,351 (11,846) (16,506)
Interest credited on deposit accounts..................... 18,249 18,068 18,539
--------- -------- --------
Total increase (decrease) in deposit accounts............. $ (21,243) $ 6,222 $ 2,033
========= ======== ========
</TABLE>
13
<PAGE>
At December 31, 1997, Highland had $71.1 million in non-brokered
certificate accounts in amounts of $100,000 or more, consisting of 578 accounts,
maturing as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
MATURITY PERIOD AMOUNT RATE
------------------------------------------------- ----------- ------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Three months or less............................. $ 12,014 5.37%
Over three through six months.................... 16,652 5.68
Over six through 12 months....................... 30,525 5.81
Over 12 months................................... 11,951 6.00
--------- -------
Total...................................... $ 71,142 5.74%
========= =======
</TABLE>
The following table sets forth the distribution of Highland's average
deposit accounts for the periods indicated and the weighted average interest
rates on each category of deposits presented:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------------
1997 1996 1995
---------------------------------- -------------------------------- -----------------------------
PERCENT OF PERCENT OF PERCENT OF
TOTAL WEIGHTED TOTAL WEIGHTED TOTAL WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE(1) DEPOSITS RATE BALANCE(1) DEPOSITS RATE BALANCE(1) DEPOSITS RATE
-------- ---------- -------- ------- ---------- -------- ------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Money market savings
accounts.................. $ 24,135 6.55% 3.62% $ 23,281 6.21% 2.92% $ 25,874 6.80% 3.01%
Passbook accounts.......... 24,639 6.68 2.42 32,222 8.59 2.65 38,168 10.03 3.34
NOW accounts............... 19,522 5.30 1.71 24,453 6.52 1.42 24,847 6.53 1.94
Noninterest-bearing
accounts.................. 9,107 2.47 -- 9,143 2.43 -- 6,727 1.77 --
-------- ------ ---- -------- ----- ---- -------- ----- ----
Total.................. 77,403 21.00 2.33 89,099 23.75 2.16 95,616 25.13 2.65
Certificate accounts:
Less than six months... 1,708 0.46 4.62 6,907 1.84 3.49 3,164 0.83 3.73
Over six through 12
months................ 108,936 29.56 6.31 83,074 22.15 5.00 138,355 36.35 5.57
Over 12 through 24
months................ 110,581 30.00 4.97 100,613 26.82 6.19 41,598 10.93 5.41
Over 24 months......... 27,674 7.51 6.28 28,138 7.50 6.30 32,132 8.44 5.84
IRA/KEOGH.............. 42,277 11.47 5.48 67,305 17.94 5.60 69,742 18.32 5.81
-------- ------ ---- -------- ----- ---- -------- ----- ----
Total certificate
accounts........... 291,176 79.00 5.67 286,037 76.25 5.66 284,991 74.87 5.61
-------- ------ ---- -------- ----- ---- -------- ----- ----
Total average
deposits........... $368,579 100.00% 4.97% $375,136 100.00% 4.82% $380,607 100.00% 4.87%
======== ====== ==== ======== ====== ==== ======== ====== ====
</TABLE>
(1) Average balances are based on average month-end balances during the period.
14
<PAGE>
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1997.
<TABLE>
<CAPTION>
PERIOD TO MATURITY FROM DECEMBER 31, 1997 AT DECEMBER 31,
------------------------------------------------------- --------------------------------
ONE TO TWO TO THREE FOUR TO
LESS THAN TWO THREE TO FOUR FIVE
ONE YEAR YEARS YEARS YEARS YEARS 1997 1996 1995
------------ --------- -------- --------- ------------- ---------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Certificate accounts:
0 to 4.00%................ $ -- $ -- $ -- $ -- $ -- $ -- $ 10 $ 1,998
4.01 to 6.00%............. 222,041 21,303 2,649 268 329 246,590 246,933 186,168
6.01 to 8.00%............. 20,622 17,252 5,845 1,515 2,201 47,435 53,598 97,311
------------ --------- -------- --------- ------------- ---------- -------- ---------
Total............. $ 242,663 $ 38,555 $ 8,494 $ 1,783 $2,530 $ 294,025 $300,541 $285,477
============ ========= ======== ========= ============= ========== ======== =========
</TABLE>
BORROWINGS
- ----------
From time to time, Highland has obtained advances from the FHLB as an
alternative to deposit funds and may make greater use of such funds in the
future as part of its operating strategy. These advances are collateralized
primarily by certain of Highland's mortgage loans and MBSs and secondarily by
Highland's investment in capital stock of the FHLB. Such advances are made
pursuant to several different credit programs, each of which has its own
interest rate and range of maturities. The maximum amount that FHLB will advance
to member institutions, including Highland, fluctuates from time to time in
accordance with the policies of the OTS and the FHLB. During 1997, Highland
increased its borrowings by a net of $72.5 million. At December 31, 1997,
Highland had $135.0 million in outstanding advances from the FHLB and no other
borrowings. Of these borrowings, $61.5 million mature in 1998, $49.0 million
mature in 1999, $9.5 million mature in 2000 and $15.0 million mature in 2002.
The interest rates payable by Highland on its borrowings at December 31, 1997
range from 5.30% to 8.29%.
The following table sets forth certain information regarding Highland's
borrowed funds at the dates and for the periods indicated:
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
------------- ---------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
FHLB advances:
Average balance outstanding.......................... $ 95,979 $39,563 $51,734
Maximum amount outstanding at any month-end
during the period.............................. $135,000 $62,500 $61,500
Balance outstanding at end of period................. $135,000 $62,500 $39,500
Weighted average interest rate during the period..... 6.17% 5.96% 5.44%
Weighted average interest rate at end of period...... 6.07% 6.19% 5.70%
</TABLE>
15
<PAGE>
SUPERVISION AND REGULATION
General
- -------
Upon completion of the Reorganization in December 1997, Highland became a
savings and loan holding company within the meaning of the Savings and Loan
Holding Company Act. As such, Highland registered with, and is subject to the
regulation, examination, supervision and reporting requirements of the Office of
Thrift Supervision ("OTS").
The Bank is subject to extensive regulation, examination and supervision by
the OTS, as its chartering agency, and by the Federal Deposit Insurance
Corporation ("FDIC"), as the insurer of its deposits. The Bank is a member of
the Federal Home Loan Bank ("FHLB") System and its deposit accounts are insured
up to applicable limits by the Savings Association Insurance Fund ("SAIF") of
the FDIC. The Bank is required to file reports with the OTS and the FDIC
concerning its activities and financial condition, in addition to obtaining
regulatory approvals prior to entering into certain transactions such as mergers
with, or acquisitions of, other financial institutions. There are periodic
examinations by the OTS and the FDIC to test the Bank's compliance with various
regulatory requirements. These types of regulation and supervision establish a
comprehensive framework of activities in which an institution such as the Bank
may engage, and are intended primarily for the protection of the insurance fund
and depositors. This structure also gives the regulatory authorities extensive
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. Any change in such policies, or in the regulatory structure or the
statutes or regulations applicable to the Bank, whether by the OTS, the FDIC or
the Congress, could have a material adverse impact on the Bank and its
operations.
Certain of the regulatory requirements applicable to Highland and the Bank
are summarized below or elsewhere herein. The descriptions of statutory
provisions and regulations applicable to savings institutions and their holding
companies set forth herein do not purport to be complete descriptions of such
statutes and regulations or their actual or potential effects on Highland and
the Bank, and are qualified in their entirety by reference to such statutes and
regulations.
Regulation of Highland
- ----------------------
Highland is a unitary savings and loan holding company within the meaning
of the Home Owners' Loan Act of 1933, as amended ("HOLA"). As such, Highland
will be required to be registered with the OTS and will be subject to OTS
regulations, examinations, supervision and reporting requirements. Among other
things, the OTS has enforcement authority which permits the OTS to restrict or
prohibit activities that are determined to be a serious risk to the subsidiary
savings institution.
Restrictions on Activities. There are generally no restrictions on the
types of activities of a unitary savings and loan holding company. However, if
the subsidiary savings institution of such a holding company fails to meet the
qualified thrift lender ("QTL") test set forth in the Financial Institutions
Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), then such unitary
holding company also will become subject to the activities restrictions
applicable to multiple savings and loan holding companies and, unless the
savings institution requalifies as a QTL within one year thereafter, will have
to register as, and become subject to the restrictions applicable to, a bank
holding company.
If Highland were to acquire control of another savings institution, other
than through merger or other business combination with the Bank, Highland would
thereupon become a multiple savings and loan holding company. Except under
limited circumstances, the activities of Highland and any of its subsidiaries
(other than the Bank or other subsidiary savings institutions) would thereafter
be subject to further extensive limitations. In general, such holding company
would be limited primarily to activities permissible for bank holding companies
under the Bank Holding Company Act (the "BHC Act") and other activities in which
multiple savings and loan companies were authorized by regulation to engage as
of March 5, 1987.
Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the OTS: (i) control of any other savings institution or savings and loan
holding company or substantially all the assets thereof; or (ii) more than five
percent (5%) of the voting shares of a savings institution or holding company
thereof which is not a subsidiary. Except with the prior approval of the OTS, no
director or
16
<PAGE>
officer of a savings and loan holding company or person owning or controlling by
proxy or otherwise more than twenty-five percent (25%) of such company's stock,
may acquire control of any savings institution, other than a subsidiary savings
institution, or of any other savings and loan holding company.
The OTS may only approve acquisitions resulting in the formation of a
multiple savings and loan holding company which controls savings institutions in
more than one state if: (i) the multiple savings and loan holding company
involved controls a savings institution which operated a home or branch office
located in the state of the institution to be acquired as of March 5, 1987; (ii)
the acquiror is authorized to acquire control of the savings institution
pursuant to the emergency acquisition provisions of the Federal Deposit
Insurance Act (the "FDI Act"); or (iii) the statutes of the state in which the
institution to be acquired is located specifically authorize a savings
association chartered by such state to be acquired by a savings association
chartered by the state where the acquiring entity is located (or by a holding
company that controls such a state-chartered savings association).
Regulation of the Bank
- ----------------------
Business Activities. The activities of federal savings institutions, such
as the Bank, are governed by the HOLA and, in certain respects, the FDI Act, and
the regulations issued by the various federal banking agencies to implement
these statutes. These laws and regulations delineate the nature and extent of
the activities in which federal savings institutions such as the Bank may
engage. In particular, many types of lending authority for federal savings
institutions, e.g., commercial, non-residential real property loans and consumer
loans, are limited to a specified percentage of the institution's capital or
assets.
Loans to One Borrower. Under the HOLA, savings institutions are generally
subject to the national bank limit on loans to one borrower. Generally, this
limit is fifteen percent (15%) of the Bank's unimpaired capital and surplus plus
an additional ten percent (10%) of unimpaired capital and surplus, if such loan
is secured by readily-marketable collateral, which is defined to include certain
financial instruments and gold bullion, although management generally does not
make loans in excess of $2.0 million. At December 31, 1997, the Bank's largest
aggregate amount of loans to one borrower was $4.0 million and the second
largest borrower had an aggregate balance of $3.2 million.
QTL Test. The HOLA requires savings institutions to meet a qualified thrift
lender ("QTL") test. Under the QTL test, a savings institution is required to
maintain at least 65% of its "portfolio assets" (total assets less: (i)
specified liquid assets up to 20% of total assets; (ii) intangibles, including
goodwill; and (iii) the value of property used to conduct business) in certain
"qualified thrift investments" (primarily residential mortgages and related
investments, including certain mortgage-backed and related securities) for at
least nine months out of each 12-month period. A savings institution that fails
the QTL test must either convert to a bank charter or operate under certain
restrictions. As of December 31, 1997, the Bank maintained 68.6% of its
portfolio assets in qualified thrift investments and, therefore, met the QTL
test. Recent legislation has expanded the extent to which education loans,
credit card loans and small business loans may be considered as "qualified
thrift investments."
Nonresidential Real Estate Loans. OTS regulations impose limitations on the
Bank's ability to make loans secured by nonresidential real estate, which
includes commercial real estate but does not include multi-family residential
real estate. Under the OTS regulations, an institution such as the Bank would be
limited to holding loans on the security of nonresidential real estate to a
maximum of 400% of total capital. In the case of the Bank, 400% of total capital
equaled $170.8 million at December 31, 1997. As of such date, the Bank held
$155.6 million in nonresidential real estate loans. The Bank may in the future
sell or participate out new or existing loans in this category in order to
maintain compliance with the limit. The OTS regulations permit lending in excess
of the prescribed limit if the OTS finds that such lending "will not present a
significant risk to the safe and sound operation of the association and is
consistent with prudent operating practices." There can be no assurance that the
OTS would make such a finding in the case of the Bank.
Limitations on Capital Distributions. OTS regulations impose limitations on
all capital distributions by savings institutions such as the Bank. Capital
distributions include cash dividends to stockholders (such as Highland),
payments to repurchase or otherwise acquire shares, payments to stockholders of
another institution in a cash-out merger and other
17
<PAGE>
distributions charged against capital. In general, the Bank may not declare or
pay a cash dividend on its capital stock if the effect of such action would
cause the Bank to fail to meet one or more of its regulatory capital
requirements.
Under the OTS regulations, a savings association that meets its 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 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 December 31, 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 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 was not owned by a holding
company, would no longer 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.
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable deposit accounts plus short-
term borrowings. OTS regulations also require each savings institution to
maintain an average daily balance of short-term liquid assets at a specified
percentage (currently 1%) of the total of its net withdrawable deposit accounts
and borrowings payable in one year or less. Monetary penalties may be imposed
for failure to meet these liquidity requirements. The Bank's average liquidity
ratio for the month of December 1997 was 14.84%, which exceeded the then
applicable requirements.
Assessments. Savings institutions are required by regulation to pay
assessments to the OTS to fund the agency's operations. The general assessment,
paid on a semi-annual basis, is computed upon the savings institution's total
assets including consolidated subsidiaries, as reported in the Bank's latest
quarterly Thrift Financial Report. The assessments paid by the Bank for 1997 and
1996 totaled $109,850 and $105,100, respectively.
Activities of Subsidiaries. A savings association seeking to establish a
new subsidiary, acquire control of an existing company or conduct a new activity
through a subsidiary must provide 30 days' prior notice to the FDIC and the OTS
and conduct any activities of the subsidiary in accordance with regulations and
orders of the OTS. The OTS has the power to require a savings association to
divest any subsidiary or terminate any activity conducted by a subsidiary that
the OTS determines to pose a serious threat to the financial safety, soundness
or stability of the savings association or to be otherwise inconsistent with
sound banking practices.
Branching. OTS regulations permit federally chartered savings institutions
to branch nationwide under certain conditions. Generally, federal savings
institutions may establish interstate networks and geographically diversify
their loan portfolios and lines of business. The OTS authority preempts any
state law purporting to regulate branching by federal savings institutions.
18
<PAGE>
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" such as Highland (i.e., any
company that controls or is under common control with an institution) is limited
by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A limits
the aggregate amount of covered transactions with any individual affiliate to
ten percent (10%) of the capital and surplus of the savings institution and also
limits the aggregate amount of transactions with all affiliates to 20% of the
savings institution's capital and surplus. Certain transactions with affiliates
are required to be secured by collateral in an amount and of a type described in
Section 23A and the purchase of low-quality assets from affiliates is generally
prohibited. Section 23B generally requires that certain transactions with
affiliates, including loans and asset purchases, must be on terms and under
circumstances, including credit standards, that are substantially the same or at
least as favorable to the institution as those prevailing at the time for
comparable transactions with non-affiliated companies. Notwithstanding Sections
23A and 23B, savings institutions are prohibited from lending to any affiliate
that is engaged in activities that are not permissible for bank holding
companies under Section 4(c) of the BHC Act. Further, no savings institution may
purchase the securities of any affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors and
ten percent (10%) stockholders, as well as entities controlled by such persons,
is currently governed by Sections 22(g) and 22(h) of the FRA, and Regulation O
thereunder. Among other things, these regulations require that such loans be
made on terms and conditions substantially the same as those offered to
unaffiliated individuals and not involve more than the normal risk of repayment.
Regulation O also places individual and aggregate limits on the amount of loans
the Bank may make to such persons based, in part, on the Bank's capital
position, and requires certain board approval procedures be followed. The OTS
regulations, with certain minor variances, apply Regulation O to savings
institutions.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring action
against all "institution-affiliated parties," including stockholders, and any
attorneys, appraisers and accountants who knowingly or recklessly participate in
wrongful action likely to have an adverse effect on an insured institution.
Depending on the severity of the unsafe or unsound practice or violation,
enforcement actions may include a requirement that the Bank file a capital
restoration plan, a requirement that the Bank take additional actions to comply
with the capital restoration plan, the issuance of a cease and desist order, the
issuance of a capital directive, the imposition of civil money penalties on the
Bank and certain affiliated parties, the imposition of such operating
restrictions as the OTS deems appropriate at the time, such other actions by the
OTS as it may be authorized or required to take under applicable statutes and
regulations and, under certain circumstances, the appointment of a conservator
or receiver for the Bank. In the event of a liquidation of the Bank, the
interests of the holders of the Bank Common Stock will be subordinate to the
interests of, among others, creditors of the Bank, including depositors.
Historically, with few exceptions, equity holders of financial institutions such
as the Bank have not obtained any recovery for their investment following the
appointment of a conservator or a receiver. Civil penalties cover a wide range
of violations and can amount to $25,000 per day, or $1 million per day in
especially egregious cases. Under the FDI Act, the FDIC has the authority to
recommend to the Director of the OTS that enforcement action be taken with
respect to a particular savings institution. If action is not taken by the
Director, the FDIC has authority to take such action under certain
circumstances. Federal and state law also establish criminal penalties for
certain violations.
Standards for Safety and Soundness. The FDI Act requires each federal
banking agency to prescribe for all insured depository institutions standards
relating to, among other things, internal controls, information systems and
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, compensation, fees and benefits and such other
operational and managerial standards as the agency deems appropriate. The
federal bank regulatory agencies have adopted final regulations and Interagency
Guidelines Establishing Standards for Safety and Soundness (the "Guidelines") to
implement these safety and soundness standards. The Guidelines set forth the
safety and soundness standards that the agencies use to identify and address
problems at insured depository institutions before capital becomes impaired. The
Guidelines address internal controls and information systems, internal audit
system, credit underwriting, loan documentation, interest rate risk exposure,
asset growth, asset quality, earnings and compensation, fees and benefits. If
the appropriate federal banking agency determines that an institution fails to
meet any standard prescribed by the Guidelines, the agency may require the
institution to submit to the agency an acceptable plan to achieve compliance
with the standard, as required by the FDI Act. The final regulation establishes
deadlines for the submission and review of such safety and soundness compliance
plans.
19
<PAGE>
Capital Requirements. The OTS capital regulations require savings
institutions to meet three capital standards: a 1.5% tangible capital standard,
a 3% leverage (core capital) ratio and an 8% risk-based capital standard. Core
capital is defined as common stockholders' equity (including retained earnings),
certain noncumulative perpetual preferred stock and related surplus, minority
interests in equity accounts of consolidated subsidiaries less intangibles other
than certain purchased mortgage servicing rights ("PMSRs") and credit card
relationships. The OTS regulations also require that, in meeting the leverage
ratio, tangible and risk-based capital standards, institutions generally must
deduct investments in and loans to subsidiaries engaged in activities not
permissible for a national bank. In addition, the OTS's prompt corrective action
regulations provide that a savings institution that has a leverage capital ratio
of less than 4% (3% for institutions receiving the highest rating under the
applicable regulatory examination rating system) will be deemed to be
"undercapitalized" and may be subject to certain restrictions.
The risk-based capital standard for savings institutions requires the
maintenance of total capital (which is defined as core capital and supplementary
capital) to risk-weighted assets of 8%. In determining the amount of risk-
weighted assets, all assets, including certain off-balance sheet assets, are
multiplied by a risk-weight of 0% to 100%, as assigned by the OTS capital
regulation based on the risks the OTS believes are inherent in the type of
asset. The components of core capital are equivalent to those utilized for
purposes of determining the leverage ratio. The components of supplementary
capital currently include cumulative preferred stock, long-term perpetual
preferred stock, mandatory convertible securities, subordinated debt and
intermediate preferred stock and, within specified limits, the allowance for
loan and lease losses. Overall, the amount of supplementary capital included as
part of total capital cannot exceed 100% of core capital.
As of December 31, 1997, the Bank's tangible capital ratio was 6.85%, its
leverage ratio was 6.85% and its ratio of total capital to risk-weighted assets
was 10.65%.
The OTS has incorporated an interest rate risk component in its regulatory
capital rule. The final interest rate risk rule also adjusts the risk-weighting
for certain mortgage derivative securities. Under the revised rule, savings
institutions with "above normal" interest rate risk exposure would be subject to
a deduction from total capital for purposes of calculating their risk-based
capital requirements. An institution's interest rate risk is measured by the
decline in net portfolio value of its assets (i.e., the difference between
incoming and outgoing discounted cash flows from assets, liabilities and off-
balance sheet contracts) that would result from a hypothetical 200-basis point
increase or decrease in market interest rates divided by the estimated economic
value of the bank's assets, as calculated in accordance with guidelines set
forth by the OTS. An institution whose measured interest rate risk exposure
exceeds 2% must deduct an interest rate component in calculating its total
capital under the risk-based capital rule. The interest rate risk components is
an amount equal to one-half of the difference between an institution's measured
interest rate risk and 2%, multiplied by the estimated economic value of the
bank's assets. That dollar amount is deducted from total capital in calculating
compliance with the risk-based capital requirement. Under the rule, there is a
lag between the reporting date of an institution's financial data and the
effective date for the new capital requirement based on that data. An
institution with assets of less than $300 million and risk-based capital ratios
in excess of 12% is not subject to the interest rate risk component, unless the
OTS determines otherwise. The rule also provides that the Director of the OTS
may waive or defer a bank's interest rate risk component on a case-by-case
basis. In August 1995, the OTS indicated that it intends to delay implementation
of its automatic capital deduction for interest rate risk pending the testing of
an OTS appeals process and to provide an opportunity to assess any further
guidance from the other three federal banking agencies regarding their planned
implementation of a capital deduction. This delay is still in effect and, based
on the Bank's asset/liability structure, the Bank would not have been subject to
an interest rate risk capital requirement at December 31, 1997.
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
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<PAGE>
be adversely affected by activities or condition of its holding company,
affiliates, subsidiaries or other persons with which it has significant business
relationships. The Bank is not subject to any such individual minimum regulatory
capital requirement.
Prompt Corrective Regulatory Action. Provisions of the FDI Act enacted in
1991 require each federal banking agency, including the OTS, to take prompt
corrective action to resolve the problems of insured depository institutions,
including but not limited to those that fall below one or more prescribed
minimum capital ratios. The FDI Act requires each federal banking agency to
promulgate regulations defining the following five categories in which an
insured depository institution will be placed, based on the level of its capital
ratios. The regulations establish five categories of capital classification:
"well capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." Under the regulations, an
institution's risk-based capital, leverage capital and tangible capital ratios
are used to determine the institution's capital classification. At December 31,
1997, the Bank exceeded the capital requirements of a well capitalized
institution under applicable OTS regulations.
In general, the prompt corrective action regulations prohibit 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 (as defined) 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 rollover
brokered deposits.
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.
Insurance of Deposits Accounts. The Bank's deposit accounts are insured by
the SAIF, as administered by the FDIC, up to the maximum amount permitted by
law. Insurance of deposits may be terminated by the FDIC upon a finding that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the institution's
primary regulator.
The FDIC charges an annual assessment for the insurance of deposits based
on the risk a particular institution poses to its deposit insurance fund. Under
this system as of December 31, 1995, SAIF members paid within a range of 23
cents to 31 cents per $100 of domestic deposits, depending upon the
institution's risk classification. This risk classification is based on an
institution's capital group and supervisory subgroup assignment. On September
30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996
(the "Funds Act") which, among other things, imposed a special one-time
assessment on SAIF-member institutions, including the Bank, to recapitalize the
SAIF at the designated reserve level of 1.25% as of October 1, 1996. As required
by the Funds Act, the FDIC imposed a special assessment of 65.7 basis points on
SAIF assessable deposits held as of March 31, 1995, payable November 27, 1996
(the "SAIF Special Assessment"). The SAIF Special Assessment was recognized by
the Bank as an expense in the quarter ended September 30, 1996 and is generally
tax deductible. The SAIF Special Assessment recorded by the Bank amounted to
$2.5 million on a pre-tax basis and $1.7 million on an after-tax basis.
The Bank pays its normal deposit insurance premium as a member of the SAIF
ranging from 0 to 27 cents per $100 of domestic deposits. In addition, the Bank
also pays an amount equal to approximately 6.2 cents per $100 of domestic
deposits toward the retirement of the Financing Corporation bonds ("Fico Bonds")
issued in the 1980s to assist in the recovery of the savings and loan industry.
Members of the Bank Insurance Fund ("BIF"), by contrast, pay, in addition to
their normal deposit insurance premium, approximately 1.3 cents per $100 of
domestic deposits. Under the Funds Act, the FDIC also is not permitted to
establish SAIF assessment rates that are lower than comparable BIF assessment
rates. Beginning no later than January 1, 2000, the rate paid to retire the
Fico Bonds will be equal for members of the BIF and the SAIF. The
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Act also provides for the merging of the BIF and the SAIF by January 1, 1999
provided there are no financial institutions still chartered as savings
associations at that time. Should the insurance funds be merged before January
1, 2000, the rate paid by all members of this new fund to retire the Fico Bonds
would be equal.
The Bank's SAIF assessment rate for the year ended December 31, 1997 varied
between a low rate of 6.2 basis points and a high rate of 9.3 basis points per
year, and the aggregate premium paid for 1997 was $299,000. The Bank's annual
assessment rate at December 31, 1997 was 6.2 basis points.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon
a finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule order or condition imposed by the FDIC or the
OTS. Management knows of no practice, condition or violation that might lead to
termination of deposit insurance.
Thrift Rechartering Legislation
- -------------------------------
The Funds Act provides that the BIF and SAIF will merge on January 1, 1999,
if there are no savings associations, as defined in the Funds Act, in existence
on that date. Pursuant to that legislation, the Department of the Treasury in
May 1997 recommended in a report to Congress that the separate charters for
thrifts and banks be abolished. Various proposals to eliminate the federal
thrift charter, create a uniform financial institutions charter, conform holding
company regulation and abolish the OTS have been introduced in Congress. Such
proposals would require federal thrifts, such as the Bank, to convert their
charters to national or state commercial bank charters. The Treasury Department
has been studying the development of a common charter for federal savings
associations and commercial banks. In the event that the thrift charter is
eliminated by January 1, 1999, the Funds Act 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 Highland and the Bank because,
among other things, the regulatory, capital and accounting treatment for
national and state banks and savings associations differs in certain significant
respects. Highland 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 Highland and the
Bank.
Federal Home Loan Bank System
- -----------------------------
The Bank is a member of the Federal Home Loan Bank System consisting of 12
regional Federal Home Loan Banks, which each provide a central credit facility,
primarily for member institutions. The Bank, as a member of the FHLB, is
required to acquire and hold shares of capital stock in the FHLB in an amount at
least equal to 1% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year, or 5% of
its advances (borrowings) from the FHLB, whichever is greater. The Bank was in
compliance with this requirement with an investment in FHLB stock at December
31, 1997 of $6.75 million. FHLB advances must be secured by specified types of
collateral and all long-term advances may only be obtained for the purpose of
providing funds for residential housing finance.
The regional Federal Home Loan Banks are required to provided funds for the
resolution of insolvent thrifts and contribute funds for affordable housing
programs. These requirements could reduce the amount of dividends that these
institutions pay to their members and could also result in higher rates of
interest on FHLB advances. For the years ended December 31, 1997, 1996 and 1995,
dividends from the FHLB to the Bank amounted to approximately $293,000, $177,000
and $170,000, respectively. If dividends were reduced, or interest on future
FHLB advances increased, the Bank's income would likely also be reduced.
Further, there can be no assurance that the impact of recent or future
legislation on the FHLBs will not also cause a decrease in the value of the FHLB
stock held by the Bank.
Federal Reserve System
- ----------------------
Regulations of the Board of Governors of the Federal Reserve System (the
"Federal Reserve Board") require savings institutions to maintain noninterest-
earning reserves against their transaction accounts (primarily NOW and regular
checking accounts). The Federal Reserve Board regulations generally require that
reserves be maintained against aggregate transaction accounts as follows: for
accounts aggregating $47.8 million or less (subject to adjustment by the Federal
Reserve
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Board) the reserve requirement is 3%; and for accounts greater than $47.8
million, the reserve requirement is $1.3 million plus 10% (subject to adjustment
by the Federal Reserve Board between 8% and 14%) against that portion of total
transaction accounts in excess of $47.8 million. The first $4.7 million of
otherwise reservable balances (subject to adjustments by the Federal Reserve
Board) are exempted from the reserve requirements. The Bank is in compliance
with the foregoing requirements. Because required reserves must be maintained in
the form of either vault cash, a noninterest-bearing account at a Federal
Reserve Bank or a pass-through account as defined by the Federal Reserve Board,
the effect of this reserve requirement is to reduce the Bank's interest-earning
assets. FHLB System members are also authorized to borrow from the Federal
Reserve "discount window," but Federal Reserve Board regulations require
institutions to exhaust all FHLB sources before borrowing from a Federal Reserve
Bank.
Year 2000 Compliance
- --------------------
In May 1997, the Federal Financial Institutions Examination Council issued
an interagency statement to the chief executive officers of all federally
supervised financial institutions regarding Year 2000 project management
awareness. It is expected that unless financial institutions address the
technology issues relating to the coming of the year 2000, there could be major
disruptions in the operations of financial institutions. The statement provides
guidance to financial institutions, providers of data services, and all
examining personnel of the federal banking agencies regarding the year 2000
problem. The federal banking agencies intend to conduct year 2000 compliance
examinations, and the failure to implement a year 2000 program may be seen by
the federal banking agencies as an unsafe and unsound banking practice. In
addition, federal banking agencies will be taking into account year 2000
compliance programs when analyzing applications and may deny an application
based on year 2000 related issues. See "Item 1. Business-Factors That May
Affect Future Results-Year 2000."
Highland is implementing a process for identifying, prioritizing, modifying
or replacing systems that may be affected by the Year 2000 issue. Highland is
also monitoring the adequacy of the processes and progress of third-party
vendors of systems that may be affected by the Year 2000 issue. Year 2000 costs
are expensed as incurred and approximately $2,000 was expensed in 1997.
Highland currently estimates that its Year 2000 project, including costs
incurred in 1997 and through the year 2000, may cost approximately $50,000.
Community Reinvestment Act Developments
- ---------------------------------------
The Bank is subject to certain fair lending requirements and reporting
obligations involving home mortgage lending operations and Community
Reinvestment Act ("CRA") activities. The CRA generally requires the federal
banking agencies to evaluate the record of financial institutions in meeting the
credit needs of their local communities, including low- and moderate-income
neighborhoods. In addition to substantial penalties and corrective measures
that may be required for a violation of certain fair lending laws, the federal
banking agencies may take compliance with such laws and CRA into account when
regulating and supervising other activities. In May 1995, the federal bank
regulatory agencies, including the OTS, issued final regulations which changed
the manner in which they measure an institution's compliance with its CRA
obligations. The final regulations adopt a performance-based evaluation system
which bases CRA ratings on an institution's actual lending, service and
investment performance rather than the extent to which the institution conducts
needs assessments, documents community outreach or complies with other
procedural requirements.
In addition, under the final regulations, an institution's size and
business strategy will determine the type of CRA examination that it will
receive. Large, retail-oriented institutions will be examined using a
performance-based lending, investment and service test. Small institutions will
be examined using a streamlined approach. Wholesale and limited purpose
institutions will be examined under a community development test. All
institutions have the option of being evaluated under a strategic plan
formulated with community input and pre-approved by the applicable bank
regulatory agency.
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MARKET AREA AND COMPETITION
Highland faces substantial competition for its deposits, fee services and
loans throughout its market areas from commercial banks, other savings and loan
institutions, thrift and loan associations, credit unions, insurance companies,
real estate financing conduits, money market and mutual funds and other
investment alternatives. Highland faces competition throughout its market areas
from local institutions, which have a large presence in Highland's market areas,
as well as out-of-state financial institutions which have offices in Highland's
market areas. Many of these institutions may enjoy a competitive advantage over
Highland in terms of prior business relationships with potential borrowers or
customers; more accessible branch office locations; the ability to offer a
broader range of services; more favorable pricing alternatives or higher
interest rates on deposits; and a lower operating cost structure.
In order to compete with these other institutions with respect to deposits
and fee services, Highland relies principally upon local promotional activities,
personal relationships established by officers, directors and employees of
Highland and specialized services tailored to meet the individual needs of
Highland's customers. In addition, at those three branches which serve
communities with large Hispanic populations and the one branch which serves a
large Asian population, Highland provides bilingual employees.
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The following table sets forth the locations, transaction deposits and
other information relating to the branches of the Bank as of December 31, 1997:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
---------------------------
TRANSACTION
DATE BRANCH DEPOSITS (1) NUMBER OF
BRANCH NAME OPENED (IN THOUSANDS) ACCOUNTS
--------------- ----------- --------------- -----------
<S> <C> <C> <C>
Highland Park...... 1/6/69 $15,221 4,649
San Gabriel........ 12/1/74 9,465 1,755
Atwater............ 8/1/79 9,146 2,381
Palos Verdes....... 1/1/81 11,680 1,478
Burbank............ 3/1/82 10,839 1,721
Torrance........... 2/1/88 4,381 1,074
Santa Monica....... 4/1/89 8,921 1,441
--------------- -----------
$69,653 14,499
</TABLE>
_________________________
(1) Transaction deposits include Passbook Accounts, NOW Accounts, and Money
Market Accounts.
In the lending area, Highland focuses on niche market segments that
management believes are currently not aggressively targeted by traditional
lenders. Niche lending markets targeted by management include real estate loans
secured by multi-family residential and commercial properties. Competitors in
these lending areas have included thrift and loan associations, real estate
financing conduits, smaller insurance companies and, to a lesser extent, banks
and other savings and loan institutions. In addition, due to Highland's loan
origination strategy involving the accessing of loan applications through
independent loan brokers, Highland encounters competition with other potential
lenders for the services of loan brokers. Management believes that Highland's
lending specializations, service-oriented approach and timely decision-making
process provide incentives for brokers to do business with Highland. Due to
Highland's niche lending strategy, if one or more larger traditional lenders
elects, either directly or indirectly through a subsidiary, to pursue
aggressively the origination of the types of niche loans that Highland currently
targets, Highland could be exposed to significant declines in its loan
originations. Such a development would have a significant adverse effect on
Highland's ability to increase or even maintain the level of its loan portfolio
which would, in turn, have significant adverse effects on Highland's results of
operations.
EMPLOYEES
At December 31, 1997, Highland had 110 full-time equivalent employees.
None of Highland's employees are covered by a collective bargaining agreement.
Management believes its employee relations are satisfactory. Highland maintains
a comprehensive employee benefits program providing, among other benefits,
hospitalization and major medical insurance, long- and short-term disability
insurance and life insurance. Highland also offers qualifying employees the
opportunity to participate in a qualified plan under section 401(k) of the
Internal Revenue Code, as amended.
SUBSIDIARY ACTIVITIES
On December 16, 1997, after obtaining the necessary stockholder and
regulatory approvals, Highland and the Bank effected a reorganization whereby
each issued and outstanding share of Common Stock, $1.00 stated value, of the
Bank was converted into one share of Common Stock, $0.01 par value, of Highland,
and the Bank became a wholly-owned subsidiary of Highland. The Bank is
Highland's only subsidiary.
25
<PAGE>
The Bank has two subsidiaries, HFS Corporation and HI-FED Insurance Agency.
HFS Corporation, a wholly owned subsidiary of the Bank, acts as the trustee for
deeds of trust on behalf of the Bank. At December 31, 1997, the assets of HFS
Corporation totaled $239,000.
HI-FED Insurance Agency acts as the Bank's representative for placing fire
insurance coverage for the Bank's mortgage loans in the event the borrower is
unable or unwilling to provide their own insurance. Alternative investment
products sold to deposit customers in the branches are also included in the
operations of HI-FED Insurance Agency. At December 31, 1997, the total assets of
HI-FED Insurance were $292,000 and its operations were not material to the
consolidated financial condition or consolidated results of operations of
Highland.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The following is a discussion of certain factors that may affect Highland's
financial condition and results and operations, and should be considered in
evaluating Highland.
Economic Conditions and Geographic Concentration. Highland's operations
------------------------------------------------
are concentrated primarily in Southern California. As a result of this
geographic concentration, Highland's results depend largely upon economic
conditions in Southern California and Los Angeles in particular, which have been
relatively volatile over the past several years. While the Southern California
economy recently has exhibited positive economic and employment trends, there is
no assurance that such trends will continue. A deterioration in economic
conditions could have material adverse impact on the quality of Highland's loan
portfolio and the demand for its products and services.
Interest Rates. Highland anticipates that should interest rate levels
--------------
increase somewhat during 1998 relative to 1997, its net interest margin would
decrease somewhat in 1998 relative to 1997 because Highland has a one-year
interest rate sensitivity "gap" which is liability sensitive. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations-
Management of Interest Rate Risk." If interest rates vary substantially from
present levels, however, Highland's results may differ materially from the
results currently anticipated. Changes in interest rates will influence net
interest income, the growth of loans, investments and deposits, and affect the
rates received on loans and investment securities and paid on deposits.
Government Regulation and Monetary Policy. The banking industry is subject
-----------------------------------------
to extensive federal and state supervision and regulation. Significant new laws
or changes in, or repeals of, existing laws may cause Highland's results to
differ materially. Further, federal monetary policy, particularly as
implemented through the Federal Reserve System, significantly affects credit
conditions for Highland, primarily through open market operations in United
States government securities, the discount rate for bank borrowings and bank
reserve requirements, and a material change in these conditions would be likely
to have a material impact on Highland's results.
Competition. The banking and financial services business in Highland's
-----------
market areas are highly competitive. The increasingly competitive environment is
a result primarily of changes in regulation, technology and product delivery
systems, and the accelerating pace of consolidation among financial services
providers. The results of Highland may differ if circumstances affecting the
nature or level of competition change.
Credit Quality. A significant source of risk arises from the possibility
--------------
that losses will be sustained because borrowers, guarantors and related parties
may fail to perform in accordance with the terms of their loans. Highland has
adopted underwriting and credit monitoring procedures and credit policies,
including the establishment and review of the allowance for credit losses, that
management believes are appropriate to minimize this risk by assessing the
likelihood of nonperformance, tracking loan performance and diversifying
Highland's credit portfolio. Such policies and procedures, however, may not
prevent unexpected losses that could materially adversely affect Highland's
results.
Year 2000. Like most financial organizations, Highland has many computer
---------
systems that identify dates using only the last two digits of the year. These
systems must be prepared to distinguish dates such as 1900 from 2000. Computer
system failures due to processing errors potentially arising from calculations
using Year 2000 dates are a known risk. Highland has established processes to
identify, prioritize, renovate or replace systems that may be affected by Year
2000
26
<PAGE>
dates. To date, Highland has completed an inventory of all systems and
determined which processes are most critical to supporting customer transaction
processing and providing customer services. Highland is currently in the process
of identifying the progress of third-party vendors of systems which may be
affected by the Year 2000 issue. This process is targeted for completion by the
end of 1998, with compliance testing and installation processes to be completed
during 1999. However, third-party vendor dependency, including government
entities, may impact Highland's efforts to successfully complete Year 2000
compliance for all systems in a timely fashion.
Other Risks. From time to time, Highland details other risks with respect
-----------
to its business and/or financial results in its filings with the OTS.
27
<PAGE>
ITEM 2. PROPERTIES
Highland and the Bank conduct business through an administrative and full-
service office located in Burbank, California and six other full service branch
offices. Highland believes that its current facilities are adequate to meet the
present and immediately foreseeable needs of Highland and the Bank. The
following table presents certain information concerning Highland's leased and
owned properties:
<TABLE>
<CAPTION>
ORIGINAL YEAR
LEASED OR LEASED OR DATE OF LEASE
LOCATION OWNED ACQUIRED EXPIRATION(1)
- ----------------------- ---------- ------------- ------------------
<S> <C> <C> <C>
CORPORATE OFFICE/BURBANK Owned June 1985 N/A
601 S. Glenoaks Boulevard
Burbank, CA 91502
ATWATER Owned August 1979 N/A
3355 Glendale Boulevard
Los Angeles, CA 90039
HIGHLAND PARK Leased January 1969 September 2001
6301 North Figueroa Street
Los Angeles, CA 90042
PALOS VERDES Leased May 1990 August 2000
20 Miraleste Plaza
Palos Verdes, CA 90274
SAN GABRIEL Owned December 1976 N/A
835 E. Las Tunas Drive
San Gabriel, CA 91776
SANTA MONICA Leased April 1989 January 1999
1101 Montana Avenue
Santa Monica, CA 90403
TORRANCE Leased February 1988 October 2002
25345 Crenshaw Boulevard
Torrance, CA 90505
</TABLE>
____________________
(1) Lease expiration dates do not take into account available options to renew.
ITEM 3. LEGAL PROCEEDINGS
During the ordinary course of its business, Highland is involved in various
legal proceedings and litigation. While no assurance can be given as to the
likelihood of an unfavorable outcome of any such litigation or the estimated
amount of potential loss, if any, based upon currently available information,
Highland does not believe that the outcome of such litigation will have a
material adverse effect upon the operations or financial condition of Highland.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 11, 1997, a special meeting of the shareholders of the Bank
(the "Special Meeting") was held. At the Special Meeting, the shareholders of
the Bank approved a proposal to adopt a Plan of Reorganization and Agreement
of Merger pursuant to which the Bank would become a wholly-owned subsidiary of
Highland (the "Reorganization"). No matters were considered at the Special
Meeting by shareholders of Highland. At the Special Meeting, holders of the
Bank's common stock were eligible to vote on the Reorganization. There were
2,314,137 shares eligible to vote. The results of the voting are set forth
below.
28
<PAGE>
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN
---------- -------- ---------
<S> <C> <C> <C>
REORGANIZATION 1,787,473 4,225 5,700
</TABLE>
29
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Upon Highland's Reorganization effected on December 16, 1997, the Common
Stock of Highland began to trade on the Nasdaq National Market under the symbol
"HBNK." Prior to the reorganization, the Common Stock of the Bank traded on the
Nasdaq Small-Cap Market from October 16, 1995 and on the Nasdaq National Market
from December 29, 1995 under the symbol "HBNK." Sandler O'Neill & Partners, L.P.
and Herzog, Heine, Geduld, Inc. act as market makers of Highland's Common Stock.
The high and low sales prices by quarter for trades on the Nasdaq National
Market during 1997 and 1996 of the Common Stock of the Bank (through December
15, 1997) and Highland (beginning December 16, 1997) are set forth in the table
below. The closing sales price of Highland Common Stock on the Nasdaq National
Market was $32.75 per share on December 31, 1997.
<TABLE>
<CAPTION>
1997
-------- -------
High Low
-------- -------
<S> <C> <C>
Fourth Quarter.......... $33.13 $31.25
Third Quarter........... $31.00 $25.00
Second Quarter.......... $25.75 $20.50
First Quarter........... $24.00 $17.50
1996
-------- -------
High Low
-------- -------
Fourth Quarter.......... $17.50 $14.25
Third Quarter........... $16.25 $14.25
Second Quarter.......... $17.00 $16.00
First Quarter........... $17.00 $14.50
</TABLE>
The Bank paid a cash dividend of $.50 per share of Common Stock in each of
June 1992, December 1992 and December 1993, and a cash dividend of $.40 per
share of Common Stock in June 1993. The Bank paid no dividends during 1994,
1995, 1996 or 1997, and Highland has paid no dividends since its organization.
As of March 23, 1998, there were approximately 751 stockholders of record of
Highland's Common Stock.
30
<PAGE>
ITEM 6. SUMMARY SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The following tables present selected consolidated financial and other data
of Highland as of and for each of the years in the five years ended December 31,
1997. The information below should be read in conjunction with, and is qualified
in its entirety by, the more detailed information included elsewhere in this
Annual Report, including Highland's Consolidated Financial Statements and notes
thereto.
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ----------- ---------- ----------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
SELECTED FINANCIAL CONDITION DATA:
Total assets.......................... $549,638 $489,902 $459,961 $463,753 $488,369
Securities available-for-sale(1)...... 49,635 37,038 43,874 39,669 --
Securities held-to-maturity(1)........ 15,419 17,969 20,787 98,370 110,008
Loans receivable, net(2).............. 427,237 373,545 312,994 273,023 289,397
Deposits.............................. 363,678 384,921 378,699 376,666 347,927
FHLB advances......................... 135,000 62,500 39,500 61,500 65,425
Stockholders' equity(3)............... 41,512 34,863 34,091 20,962 28,801
Book value per share.................. 17.91 15.18 14.85 18.97 26.06
Loans originated and purchased during
period.............................. 119,019 120,162 89,024 45,519 43,671
SELECTED OPERATING DATA:
Interest income....................... $ 44,629 $ 39,638 $ 38,699 $ 37,476 $ 40,907
Interest expense...................... 24,224 20,426 21,387 17,801 17,611
------------ ------------ ------------- ------------- -------------
Net interest income................ 20,405 19,212 17,312 19,675 23,296
Provision for loan losses............. 5,164 3,930 5,221 13,536 6,758
------------ ------------ ------------- ------------- -------------
Net interest income after
provision for loan losses......... 15,241 15,282 12,091 6,139 16,538
Noninterest income.................... 3,924 2,167 1,579 979 1,169
Noninterest expense:
General and administrative
expense........................... 9,863 15,694 12,960 13,685 14,611
Net cost of operations of
real estate acquired
through foreclosure............... 555 928 2,306 3,173 1,140
------------ ------------ ------------- ------------- -------------
Total noninterest expense.......... 10,418 16,622 15,266 16,858 15,751
------------ ------------ ------------- ------------- -------------
Earnings (loss) before income
tax expense (benefit) and
cumulative effect of change
in accounting principle........... 8,747 827 (1,596) (9,740) 1,956
Income tax expense (benefit).......... 2,624 162 (617) (3,355) 846
Cumulative effect of change
in accounting principle.............. -- -- -- -- 409
------------ ------------ ------------- ------------- -------------
Net earnings (loss)................ $ 6,123 $ 665 $ (979) $ (6,385) $ 1,519
============ ============ ============= ============= =============
Basic earnings (loss) per
share before cumulative effect
of change in accounting
principle............................ $ 2.66 $ 0.29 $ (0.86) $ (5.78) $ 1.00
============ ============ ============= ============= =============
Diluted earnings (loss) per
share before cumulative effect
of change in accounting
principle............................ $ 2.58 $ 0.29 $ (0.86) $ (5.78) $ 1.00
============ ============ ============= ============= =============
Cash dividends per share.............. -- -- -- -- $ 0.90
============ ============ ============= ============= =============
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995 1994 1993
------- ------- ------ ------- ------
<S> <C> <C> <C> <C> <C>
SELECTED FINANCIAL RATIOS AND OTHER DATA (4):
PERFORMANCE RATIOS:
Return on average assets............................................. 1.20% 0.15% (0.21)% (1.40)% 0.36%
Return on average equity............................................. 16.17 1.93 (4.41) (24.33) 5.19
Average equity to average assets..................................... 7.44 7.56 4.76 5.74 6.85
Interest rate spread (5)............................................. 4.14 4.45 4.16 4.75 5.71
Net interest margin (6).............................................. 4.33 4.60 4.11 4.71 5.84
General and administrative expense to average assets (7)............. 1.94 3.43 2.82 2.99 3.42
REGULATORY CAPITAL RATIOS (8):
Tangible capital..................................................... 6.9% 7.2% 7.5% 4.8% 6.4%
Leverage capital..................................................... 6.9 7.2 7.5 4.8 6.4
Risk-based capital................................................... 10.7 11.3 13.6 8.2 10.5
ASSET QUALITY RATIOS:
Nonperforming loans (9) as a percent of gross loans (10)............. 1.01% 0.90% 1.61% 3.17% 3.36%
Nonperforming assets (11) as a percent of total assets............... 1.10 0.99 1.78 3.41 4.28
Allowance for loan losses as a percent of total assets............... 1.61 2.00 2.18 3.10 1.73
Allowance for loan losses as a percent of total
nonperforming loans (9).......................................... 197.28 222.24 135.20 97.72 51.36
Classified assets as a percent of stockholder's equity and
allowance for loan losses........................................ 26.90 36.87 53.82 107.55 88.74
NUMBER OF FULL-SERVICE CUSTOMER FACILITIES.............................. 7 11 11 11 11
</TABLE>
_________________________
(1) Highland adopted Statement of Financial Accounting Standards ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity Securities," as
of January 1, 1994. Prior to the adoption of SFAS No. 115, Highland did
not report separately its securities held-to-maturity. Therefore, for
purposes of this presentation, all securities have been reported at
December 31, 1993 as held-to-maturity securities.
(2) The allowance for loan losses at December 31, 1997, 1996, 1995, 1994, and
1993 was $8.8 million, $7.7 million, $7.1 million, $8.8 million and $5.1
million, respectively.
(3) Stockholders' equity amounts at December 31, 1997, 1996, 1995 and 1994 are
net of unrealized holding losses on securities available-for-sale of
$162,000, $247,000, $354,000 and $1,453,000, respectively, pursuant to SFAS
No. 115.
(4) Regulatory capital ratios and asset quality ratios are end-of-period
ratios. With the exception of end-of-period ratios, all ratios are based
on average daily balances during 1997, 1996 and 1995 and average monthly
balances during 1994 and 1993 and are annualized where appropriate.
(5) Represents the difference between the weighted average yield on interest-
earning assets and the weighted average cost of interest-bearing
liabilities.
(6) Represents net interest income as a percent of average interest-earning
assets.
(7) Excludes net cost of operation of REO and losses on sale of investments.
(8) For definitions and further information relating to the regulatory capital
requirements of the Bank, see "Supervision and Regulation-Federal Savings
Institutions Regulation-Capital Requirements."
(9) Nonperforming loans consist of nonaccrual loans. It is Highland's policy
to cease accruing interest on all loans 90 days or more past due.
(10) Gross loans receivable excludes participation loan balances and unamortized
discounts.
(11) Nonperforming assets consist of nonperforming loans and REO.
32
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following presents management's discussion and analysis of the
consolidated financial condition and results of operations of Highland as of and
for the years ended December 31, 1997, 1996, and 1995. The discussion should be
read in conjunction with Highland's Consolidated Financial Statements and Notes
thereto appearing elsewhere in this Report on Form 10-K.
Discussions of certain matters under this caption constitute "forward-
looking statements" under the Reform Act which involve risks and uncertainties.
Highland's actual results may differ significantly from the results discussed in
such forward-looking statements. Factors that might cause such a difference
include but are not limited to economic conditions, competition in the
geographic and business areas in which Highland conducts its operations,
fluctuations in interest rates, credit quality and government regulation. For
additional information concerning these factors, see "Item 1. Business-Factors
That May Affect Future Results."
RESULTS OF OPERATIONS
OVERVIEW
- --------
Highland's principal business involves the origination of loans primarily
secured by income-producing real estate, located predominately in Southern
California. While such lending has provided Highland with interest-earning
assets with generally higher yields compared with those of most banks and
savings institutions, Highland has also incurred generally higher loan
origination and servicing costs and provisions for credit losses and REO expense
than such institutions. Highland operates in the State of California, with most
activity in Southern California, which over the past several years has
experienced both a recession and a significant decline in property values. These
factors contributed to higher levels of nonperforming assets and associated
costs (including provisions for loan losses ands REO expense) over the past
three years.
Highland recorded net earnings of $6.1 million in 1997, compared with $0.7
million in 1996. Pre-tax earnings for 1996 included non-recurring charges of
$2.5 million for the SAIF special assessment and $0.5 million relating to
Highland's defined benefit pension plan. Net earnings for 1997 include a one-
time gain of $2.0 million from the sale of four retail branches with deposits
totaling $101.8 million. The improved net earnings in 1997 were principally
attributable to a decrease in noninterest expense of $6.2 million, partially
offset by an increase in the provision for loan losses of $1.2 million. Highland
recorded net earnings of $0.7 million in 1996, compared with a net loss of $1.0
million in 1995, despite nonrecurring charges of $3.0 million in 1996. The
improved net earnings in 1996 were principally attributable to an improvement in
Highland's net interest margin to 4.60% for 1996 from 4.11% in 1995 and to a
reduction in provisions for loan losses and REO expense in 1996 relative to
1995. Provisions for loan losses and REO expense in 1996 were $3.9 million and
$0.9 million, respectively, compared with $5.2 million and $2.3 million,
respectively, in 1995.
33
<PAGE>
The changes in Highland's principal income and expense items are
highlighted in the following table of condensed statements of operations:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
INCREASE/ INCREASE/
1997 1996 (DECREASE) 1996 1995 (DECREASE)
---------- -------- ---------- -------- ------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total interest income................... $44,629 $39,638 $ 4,991 $39,638 $38,699 $ 939
Total interest expense.................. 24,224 20,426 3,798 20,426 21,387 (961)
---------- -------- --------- -------- ------- -----------
Net interest income (loss).............. 20,405 19,212 1,193 19,212 17,312 1,900
Provision for loan losses............... 5,164 3,930 1,234 3,930 5,221 (1,291)
Total noninterest income (loss)......... 3,924 2,167 1,757 2,167 1,579 588
Total general & administrative expense.. 9,863 15,694 (5,831) 15,694 12,960 2,734
Total net cost of operation of real
estate acquired through foreclosure. 555 928 (373) 928 2,306 (1,378)
---------- -------- --------- -------- ------- -----------
Income (loss) before income taxes....... 8,747 827 7,920 827 (1,596) 2,423
Provision (benefit) for income taxes.... 2,624 162 2,462 162 (617) 779
---------- -------- --------- -------- ------- -----------
Net Income (loss)..................... $ 6,123 $ 665 $ 5,458 $ 665 $ (979) $ 1,644
========== ======== ========= ======== ======= ===========
</TABLE>
NET INTEREST INCOME
The following table sets forth condensed average balance sheet information
relating to Highland for the periods indicated together with interest income and
yields earned on average interest-bearing assets and interest expense and rates
paid on average interest-bearing liabilities. Management does not believe that
the use of average monthly balances instead of average daily balances has caused
any material difference in the information presented.
34
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------
1997 1996 1995
--------------------------------- ----------------------------- ---------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE INTEREST YIELD/ AVERAGE INTEREST YIELD/ AVERAGE INTEREST YIELD/
BALANCE (1) COST BALANCE (1) COST BALANCE (1) COST
----------- --------- -------- --------- --------- --------- ------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Loans(2).............................. $392,139 $40,022 10.21% $341,890 $35,251 10.31% $286,979 $30,223 10.53%
Mortgage-related securities(3)........ 50,833 3,001 5.90 57,599 3,379 5.87 123,120 7,781 6.32
Investments........................... 28,639 1,606 5.61 18,379 1,008 5.48 11,451 695 6.07
----------- -------- -------- ---------- --------- ---------- --------
Total interest-earning assets.... 471,611 44,629 9.46 417,868 39,638 9.49 421,550 38,699 9.18
Noninterest-earning assets............ 37,405 39,385 38,587
----------- ---------- ----------
Total Assets..................... $509,016 $457,253 $460,137
=========== ========== ==========
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Money market savings accounts......... $ 24,135 873 3.62 $ 23,281 680 2.92 $ 25,874 779 3.01
Passbook accounts..................... 24,639 596 2.42 32,222 853 2.65 38,168 1,276 3.34
NOW accounts.......................... 19,552 333 1.71 24,453 347 1.42 24,847 482 1.94
Certificate accounts.................. 291,176 16,509 5.67 286,037 16,188 5.66 284,991 16,002 5.61
FHLB advances and other
borrowings......................... 95,979 5,913 6.16 39,563 2,358 5.96 52,379 2,848 5.44
----------- -------- ---------- --------- ---------- --------
Total interest-bearing liabilities.... 455,481 24,224 5.32 405,556 20,426 5.04 426,259 21,387 5.02
Noninterest-bearing liabilities....... 15,664 17,143 11,961
Stockholders' Equity.................. 37,871 34,554 21,917
----------- ---------- ----------
Total Liabilities and
Stockholders' Equity............... $509,016 $457,253 $460,137
=========== ========== ==========
Net interest income................... $20,405 $19,212 $17,312
======== =========== ==========
Interest rate spread(4)............... 4.14% 4.45% 4.16%
Net interest margin(5)................ 4.33% 4.60% 4.11%
Ratio of average interest-earning
assets to average interest-bearing
liabilities.......................... 103.54% 103.04% 98.90%
</TABLE>
______________________
(1) Includes loan fees of $286,000, $696,000 and $570,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
(2) Loans include nonaccrual loans.
(3) Includes securities available-for-sale and unamortized discounts and
premiums.
(4) Interest rate spread represents the difference between the yields on
interest-earning assets and rates paid on interest-bearing liabilities.
(5) Net interest margin represents net interest income divided by average
interest-earning assets.
Highland's primary source of revenue is net interest income. Highland's net
interest income is affected by (i) the difference between the yields received on
interest-earning assets, such as loans, mortgage-backed securities and other
investments, and interest rates paid on interest-bearing liabilities (referred
to as the "interest rate spread"), which consist of deposits and borrowings, and
(ii) the relative amounts of interest-earning assets and interest-bearing
liabilities. When interest-earning assets equal or exceed interest-bearing
liabilities, any positive interest rate spread will generate net interest
income; if interest-bearing liabilities exceed interest-earning assets, Highland
may incur a decline in net interest income even when the interest rate spread is
positive. For 1997, Highland's ratio of interest-earning assets to interest-
bearing liabilities was 103.54%.
The following table represents the extent to which changes in interest
rates and changes in the volume of interest-earning assets and interest-bearing
liabilities have affected Highland's interest income and expense during the
periods indicated. Information is provided for each major component of
interest-earning assets and interest-bearing liabilities with
35
<PAGE>
respect to: (i) changes attributable to changes in volume (changes in volume
multiplied by prior rate); (ii) changes attributable to rate (changes in rate
multiplied by prior volume); and (iii) the net change. The changes attributable
to both volume and rate have been allocated proportionately to the change due to
volume and the change due to rate.
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996
COMPARED TO YEAR COMPARED TO YEAR
ENDED DECEMBER 31, 1996 ENDED DECEMBER 31, 1995
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
---------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
---------------------------------------------------------------------
VOLUME RATE NET VOLUME RATE NET
---------- ------- ------ -------- --------- ------------------
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME:
Loans..................................... $5,132 $(361) $4,771 $ 5,674 $ (646) $ 5,028
Mortgage-related securities............... (399) 21 (378) (3,879) (523) (4,402)
Investments............................... 575 23 598 386 (73) 313
Other assets.............................. -- -- -- -- -- --
---------- ------ ------- -------- --------- -------------------
Total interest income on interest-earning
assets................................. 5,308 (317) 4,991 2,181 (1,242) 939
---------- ------ ------- -------- --------- -------------------
INTEREST EXPENSE:
Deposits.................................. (326) 569 243 (390) (81) (471)
FHLB Advances and other borrowings........ 3,473 82 3,555 (745) 255 (490)
---------- ------ ------- -------- --------- -------------------
Total interest expense on interest-bearing
liabilities............................ 3,147 651 3,798 (1,135) 174 (961)
---------- ------ ------- -------- --------- -------------------
Increase (decrease) in net interest income $2,161 $(968) $1,193 $ 3,316 $(1,416) $ 1,900
========== ====== ======= ======== ========= ===================
</TABLE>
Net interest income totaled $20.4 million in 1997 compared with $19.2
million in 1996. Interest income for 1997 was $44.6 million, compared to $39.6
million for 1996, an increase of $5.0 million. This increase was primarily the
result of an increase in the average volume of loans receivable, which increased
by $51.1 million during 1997 compared to 1996, resulting in an increase in
interest income of $5.1 million offset by a decrease in the average volume of
mortgage-backed securities of $6.8 million during 1997 compared to 1996,
resulting in a decrease in interest income of $0.4 million. The increase in
volume of loans receivable was offset in part by a decrease in the average yield
on loans receivable, which declined to 10.21% over this period from 10.31%,
while the average yield on mortgage-backed securities increased to 5.90% over
the period from 5.87%. The decrease in the average yield on loans receivable was
due principally to lower rates on adjustable-rate loans originated in 1997 and
1996 compared to rates on Highland's existing fixed-rate portfolio. Further,
interest income on Highland's investment portfolio for 1997 increased by $0.6
million compared to 1996. The average yield on interest earning assets decreased
to 9.46% for 1997 compared to 9.49% for 1996 as a result of higher levels of
liquidity related to the sale of four retail deposit branches and the
origination of loans at generally lower rates than the average for the loan
portfolio. The cost of interest-bearing liabilities increased to 5.32% during
1997 compared to 5.04% during 1996 as a result of the increase in FHLB advances
to fund the sale of the four branches. This resulted in a decrease in Highland's
annualized net interest margin to 4.33% for 1997 from 4.60% for 1996.
Interest expense for 1997 was $24.2 million, compared to $20.4 million for
1996, an increase of $3.8 million. This increase was due primarily to increased
volumes of interest-bearing liabilities during 1997 compared to 1996 and an
increase in FHLB advances, the highest-rate liability, increased as a percentage
of total interest-bearing liabilities. The average interest rate paid on average
interest-bearing deposits increased to 5.07% for 1997 from 4.94% for 1996, as
the average volume on interest-bearing deposits decreased by $5.1 million to
$360.9 million during 1997 from $366.0 million during 1996. In addition, the
average volume of FHLB borrowings increased by $56.2 million, contributing to an
increase in
36
<PAGE>
interest expense on such borrowings to $5.9 million for 1997 from $2.4 million
for 1996. For further information on funding sources, see "Item 1. Business-
Sources of Funds."
Net interest income totaled $19.2 million in 1996 compared with $17.3
million in 1995. Interest income for 1996 was $39.6 million, compared to $38.7
million for 1995, an increase of $0.9 million. This increase was primarily the
result of an increase in the average volume of loans receivable, which increased
by $54.9 million during 1996 compared to 1995, resulting in an increase in
interest income of $5.0 million offset by decrease in the average volume of
mortgage-backed securities of $65.5 million during 1996 compared to 1995,
resulting in a decrease in interest income of $3.9 million. The increase in
volume of loans receivable was offset in part by a decrease in the average yield
on loans receivable, which declined to 10.31% over this period from 10.53%,
while the average yield on mortgage-backed securities decreased to 5.87% over
the period from 6.32%. The decrease in the average yield on loans receivable was
due principally to lower rates on adjustable-rate loans originated in 1996
compared to rates on Highland's existing fixed-rate portfolio, while the
decrease in the average yield on the mortgage-backed securities portfolio was
due primarily to the repricing of adjustable-rate securities (specifically
securities tied to the one-year constant treasury index) within the mortgage-
backed securities portfolio. New loan originations and purchases during 1996
increased to $120.2 million, compared to $89.0 million in 1995, as loans, the
highest-yielding asset, increased as a percentage of total interest-earning
assets to 81.82% during 1996 from 68.08% during 1995. This change, combined with
a general decline in levels of nonaccrual loans helped to increase the average
yield on interest-earning assets to 9.49% for 1996 compared to 9.18% for 1995.
The cost of interest-bearing liabilities increased only slightly to 5.04% during
1996 compared to 5.02% during 1995, resulting in an increase in Highland's
annualized net interest margin to 4.60% for 1996 from 4.11% for 1995.
Interest expense for 1996 was $20.4 million, compared to $21.4 million for
1995, a decrease of $961,000 or 4.5%. This decrease was due primarily to
decreased volumes of interest-bearing liabilities during 1996 compared to 1995.
The average interest rate paid on average interest-bearing deposits decreased to
4.94% for 1996 from 4.96% for 1995, as the average volume on interest-bearing
deposits also decreased by $7.9 million to $366.0 million during 1996 from
$373.9 million during 1995. In addition, the average volume of FHLB borrowings
declined by $12.8 million, contributing to a decrease in interest expense on
such borrowings to $2.4 million for 1996 from $2.8 million for 1995. For further
information on funding sources, see "Item 1. Business-Sources of Funds."
Nonperforming assets consist of nonaccrual loans and REO. Nonaccrual loans
reduce the overall yield on Highland's loan portfolio (and therefore, Highland's
actual interest rate spread and net interest margin) since the outstanding
principal balances are included in the average balances of loans when
calculating the yield on the portfolio, even though interest is not accrued on
these loans. In addition, REO is not an interest-earning asset, which adversely
impacts the ratio of Highland's interest-earning assets to interest-bearing
liabilities. Any income related to REO is included in the net cost of operations
of REO rather than interest income. Also, nonaccrual loans and REO have a cost
to carry, as those assets are funded by interest-bearing liabilities.
Nonperforming assets were $6.0 million at December 31, 1997 compared with
$4.9 million at December 31, 1996 and $8.2 million at December 31, 1995.
Management expects that Highland's net interest income in future periods would
benefit from decreases in nonperforming assets and would be adversely affected
if the levels of nonperforming assets increases. In addition, net interest
income may be adversely affected by certain shifts in the relative holdings of
various types of interest-earning assets.
PROVISION FOR LOAN LOSSES
Highland maintains an allowance for loan losses in order to provide for
estimated, probable losses associated with its loan portfolio. The provision for
loan losses is charged against income and is applied to the allowance for loan
losses.
Management periodically assesses the adequacy of the allowance for loan
losses by reference to many factors which may be weighted differently at
different times depending upon prevailing conditions. These factors include
general portfolio trends relative to asset and portfolio size, asset categories,
potential credit, concentrations, nonaccrual loan levels, historical loss
experience, and risks associated with changes in economic and business
conditions.
37
<PAGE>
Highland's provisions for loan losses were $5.2 million, $3.9 million and
$5.2 million for the years ended December 31, 1997, 1996, and 1995,
respectively. Highland's increased provision for 1997 compared with 1996
reflects moderate increases in the levels of loan chargeoffs and nonaccrual
loans during 1997. Nonaccrual loans increased to $4.5 million at December 31,
1997 from $3.5 million at December 31, 1996. However, classified assets declined
to $13.5 million at December 31, 1997 from $15.7 million at December 31, 1996,
while aggregate delinquent loans and loans past due less than 90 days decreased
to $7.6 million and $3.1 million, respectively, at December 31, 1997 from $11.2
million and $7.8 million, respectively, at December 31, 1996. Highland's reduced
provision for 1996 compared to 1995 reflects improvements in asset quality
during 1996. Nonaccrual loans declined to $3.5 million at December 31, 1996 from
$5.2 million at December 31, 1995. In addition, classified assets declined to
$15.7 million at December 31, 1996 from $22.2 million at December 31, 1995, and
aggregate delinquent loans and loans past due 30-89 days increased slightly to
$11.2 million and $7.8 million, respectively, at December 31, 1996 from $9.9
million and $4.7 million, respectively, at December 31, 1995. While management
believes that the current allowance for loan losses is adequate to absorb the
known and inherent risks in the loan portfolio, no assurances can be given that
economic conditions which may adversely affect Highland's market areas or other
circumstances will not result in increases in problem loans and future loan
losses, which losses may not be covered completely by the current allowance and
may require provisions for loan losses in excess of past provisions, which would
have an adverse effect on Highland's financial condition and results of
operations. See "Item 1. Business-Nonperforming Assets."
NONINTEREST INCOME
Noninterest income for 1997 was $3.9 million, including a $2.0 million
branch sale gain, compared to $2.2 million for 1996. This decrease in
noninterest income, excluding the branch sale gain, was due primarily to gains
of $0.4 million from the sale of approximately $13 million of mortgage loans in
1996. Noninterest income for 1996 increased by $0.6 million to $2.2 million from
$1.6 million for 1995. This increase was due primarily to a $0.4 million
increase in gains on sale of mortgage loans during the 1996 period and to
moderate increases in service charge income and collections.
NONINTEREST EXPENSE
Noninterest expense consists of REO expense and general and administrative
expense. Noninterest expense for 1997 decreased by $6.2 million to $10.4 million
from $16.6 million for 1996. Net cost of operations of REO (comprised of
provisions for REO losses, losses (gains) on sale of REO and certain
administrative expenses, including appraisal, evaluation and legal expenses,
inspection fees and net operating expenses) declined to $555,000 during 1997
from $928,000 during 1996 principally due to a higher percentage of losses on
impaired assets being charged against loan loss allowances versus REO losses
than in prior years. General and administrative expense decreased during 1997 to
$9.9 million from $15.7 million for 1996 (which includes payment of the SAIF
special assessment of $2.5 million in the third quarter of 1996 and to a
$500,000 expense associated with a change in the assumptions related to
Highland's defined benefit pension plan). As a result, the ratio of general and
administrative expenses to average assets decreased to 1.94% during 1997,
compared to 3.43% during 1996. Excluding the effects of the SAIF special
assessment and additional pension expense, Highland's ratio of general and
administrative expense to average assets in 1996 would have been 2.77%.
Noninterest expense for 1996 increased by $1.3 million from $15.3 million for
1995. Net cost of operation of REO (comprised of provisions for REO losses,
losses (gains) on sale of REO and certain administrative expenses, including
appraisal, evaluation and legal expenses, inspection fees and net operating
expenses) declined to $928,000 during 1996 from $2.3 million during 1995
principally due to lower levels of REO activity in 1996. However, general and
administrative expense increased during 1996 to $15.7 million from $13.0 million
for 1995, reflecting payment of the SAIF special assessment of $2.5 million and
to a $500,000 expense associated with Highland's defined benefit pension plan.
As a result, the ratio of general and administrative expenses to average assets
increased to 3.43% during 1996, compared to 2.82% during 1995. Excluding the
SAIF special assessment and additional pension expense, Highland's ratio of
general and administrative expense to average assets in 1996 would have been
2.77%.
38
<PAGE>
INCOME TAXES
The provision (benefit) for income taxes for 1997, 1996, and 1995 was $2.6
million, $0.2 million and ($0.6 million), respectively. Highland's combined,
effective federal and state income tax rates for 1997, 1996 and 1995 were 30.0%,
19.6% and (38.7%), respectively. Highland's statutory federal and state income
tax rates for 1997, 1996 and 1995 were approximately 41% in each year. The
effective income tax rates differ from the statutory income tax rates in each
year principally due either to the provision of an allowance (in 1995) for state
deferred income tax benefits on the recognition of such benefits (in 1996) or
the utilization of valuation reserves for state deferred income tax benefits (in
1997). Highland had valuation allowances for state deferred income tax benefits
of $0.2 million, $1.3 million and $1.0 million at December 31, 1997, 1996 and
1995, respectively. Utilization of the valuation allowance may result in lower
than expected effective income tax rates in future periods.
FINANCIAL CONDITION
COMPARISON OF FINANCIAL CONDITION FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
Total assets at December 31, 1997 increased to $549.6 million, or 12.2%,
from $490.0 million at December 31, 1996, due mainly to increased levels of
loans receivable. Loans receivable increased by $53.7 million during 1997 as a
result of $119.0 million of loan originations, which more than offset
amortization and prepayment of loans. Highland's cash and cash equivalents
decreased to $26.4 million at December 31, 1997 from $33.7 million at December
31, 1996, due primarily to the funding of the branch sales.
Total liabilities at December 31, 1997 were $508.1 million, compared to
$455.0 million at December 31, 1996. This increase was due primarily to an
increase in FHLB advances to $135.0 million at December 31, 1997 from $62.5
million at December 31, 1996, partially offset by a decrease in deposits of
$21.2 million over this period (due to the sale of four retail branches with
deposits of $101.8 million). Stockholders' equity at December 31, 1997 was $41.5
million, compared to $34.9 million at December 31, 1996.
COMPARISON OF FINANCIAL CONDITION FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
- --------------------------------------------------------------------------------
Total assets at December 31, 1996 were $490.0 million, compared to $460.0
million at December 31, 1995. Highland's cash and cash equivalents decreased to
$33.7 million at December 31, 1996 from $52.8 million at December 31, 1995, due
primarily by increased uses of cash to fund mortgage loans. Loans receivable
increased by $60.6 million during 1996 as a result of increased efforts by
Highland to expand its lending markets within Southern California.
Total liabilities at December 31, 1996 were $455.0 million, compared to
$425.9 million at December 31, 1995. This increase was due primarily to an
increase in FHLB advances from $39.5 million at December 31, 1995 to $62.5
million at December 31, 1996 in addition to an increase in deposits of $6.2
million over this period. Stockholders' equity at December 31, 1996 was $34.9
million, compared to $34.1 million at December 31, 1995.
LIQUIDITY
- ---------
The maintenance of an appropriate level of liquid resources to meet not
only regulatory requirements but also to provide the liquidity necessary to fund
the institution's business activities and obligations is an important element in
the successful management of Highland. Federal regulations currently require
that, for each calendar quarter, savings institutions maintain an average daily
balance of cash and cash equivalents, and certain marketable securities which
are not committed, equal to 4% of net withdrawable accounts and borrowings due
in one year or less. Under FIRREA, the percentage of assets which must
constitute liquid assets will be determined by the OTS, but may be set at no
less than 4% and no more than 10% of the obligations of the institution on
withdrawable accounts and borrowings due in one year or less. At December 31,
1997, Highland's liquidity ratio was 15.0%, compared to 11.1% and 7.2% at
December 31, 1996 and 1995, respectively. Highland's liquidity ratio may vary
from time to time, depending upon savings flows, future loan fundings, operating
needs and general economic conditions.
39
<PAGE>
New loan originations and purchases totaled $119.0 million for 1997,
compared to $120.2 million for 1996 and $89.0 million in 1995. Highland received
cash repayments and prepayments of approximately $48.5 million during 1997,
compared to $44.1 million for 1996 and $43.0 million in 1995. Such payments,
together with an increase of $72.5 million in FHLB advances and cash flow from
operations, were sufficient to fund all of Highland's lending activities during
1997.
Highland is permitted to borrow from the FHLB, in addition to other
sources, both to meet short-term liquidity requirements and for longer-term
needs. During 1997, Highland had net borrowings of $72.5 million of FHLB
advances, compared to net repayments of $29.5 million during 1996. At December
31, 1997, Highland's outstanding borrowings from the FHLB totaled $135.0
million, compared to $62.5 million at December 31, 1996. See "Item 1, Business-
Funding Sources."
Highland's liquidity potential is supported by additional borrowing
capacity available to it from the FHLB. Highland is currently authorized to
borrow up to 35% of its assets from the FHLB ($192.4 million at December 31,
1997). FHLB advances are collateralized by pledges of qualifying real estate
loan collateral. At December 31, 1997, Highland had $135.0 million of FHLB
advances outstanding. Highland also has available a $5 million unsecured line of
credit with an unaffiliated Bank, all of which was available at December 31,
1997.
MANAGEMENT OF INTEREST RATE RISK
- --------------------------------
The principal objectives of Highland's interest rate risk management
function are to evaluate the interest rate risk included in certain balance
sheet accounts and in the balance sheet as a whole, determine the level of risk
appropriate given Highland's business focus, operating environment, capital and
liquidity requirements and performance objectives, and manage such risk
consistent with Board approved guidelines. Through such management, Highland
seeks to reduce the vulnerability of its operations to changes in interest
rates. Highland monitors its interest rate risk as such risk relates to its
operating strategies. The Bank's Board of Directors has established an
Asset/Liability Committee, whose members include the Chairman of the Board, two
other outside directors and the Bank's President and Chief Financial Officer,
and which is supported by other members of senior management. The
responsibilities of the Committee, which meets quarterly, include reviewing the
Bank's asset/liability policies and interest rate risk position and reporting
trends to the Board of Directors on a quarterly basis. The extent of movements
in interest rates is an uncertainty which could have a negative impact on the
earnings of Highland.
Highland's fixed rate mortgage loan portfolio at December 31, 1997
consisted of approximately $115 million of loans, or 26% of the total loan
portfolio. Such loans do not bear interest rates which vary with market interest
rates or Highland's cost of funds. In addition, the loan portfolio contained
approximately $59 million, or 13%, of fixed rate, three-year rollover loans
(loans which the interest reprices every three years to either a prevailing
mortgage rate or a rate tied to COFI) at December 31, 1997. As of such date,
these loans carried a weighted interest rate margin of 396 basis points. Such
loans could represent a source of risk to Highland if interest rates were to
increase significantly over a short period. However, Highland believes that
certain contractual features, such as generally higher interest rates than those
of other lenders, provide some protection from the effects of rate increases.
Conversely, if rates were to decline significantly over a short period, Highland
has other features such as prepayment penalties on many of these loans which
provide some protection.
Highland's remaining loan portfolio as of December 31, 1997 consisted of
approximately $271 million, or 61%, of adjustable rate mortgage loans, with
interest rates that vary based on COFI, a lagging market index or six-month
LIBOR, a current market index. COFI loans represented 79% of the total
adjustable rate mortgage loans while LIBOR loans totalled 21%. At December 31,
1997, these loans had a weighted interest rate margin of 415 basis points, and
featured interest rate floors of 9.3% and interest rate ceilings of 14.2%. These
loans generally have annual caps of 200 basis points and lifetime caps of 500
basis points. Accordingly, interest rates and the resulting cost of funds
increases in a rapidly rising interest rate environment could exceed the cap
levels on these loans and have a negative impact on Highland's net interest
income. However, during a declining rate environment, Highland benefits
primarily due to the effect of the lagging market index, which results in
interest income declining at a slower rate than interest expense.
During 1997, Highland utilized the following strategies to manage interest
rate risk: (i) originating primarily adjustable-rate new loans for the
portfolio, (ii) purchasing principally adjustable-rate mortgage-backed
securities and short-
40
<PAGE>
term investment securities and (iii) attempting to reduce the overall interest
rate sensitivity of liabilities by emphasizing core and longer-term deposits, in
addition to lengthening the maturity of Highland's FHLB advances.
Gap Analysis. The matching of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities are "interest rate
sensitive" and by monitoring an institution's interest rate sensitivity "gap."
An asset or liability is said to be interest rate sensitive within a specific
time period if it will mature or reprice within that time period. The interest
rate sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
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 the amount of interest rate sensitive assets. During a
period of rising interest rates, therefore, a negative gap would theoretically
tend to adversely affect net interest income, while a positive gap would tend to
result in an increase in net interest income. Conversely, during a period of
falling interest rates, a negative gap position would theoretically tend to
result in an increase in net interest income while a positive gap would tend to
affect net interest income adversely.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1997 which are
anticipated by Highland, based upon certain assumptions, to reprice or mature in
each of the future time periods shown. Except as stated below, the amount of
assets and liabilities shown which reprice or mature during a particular period
were determined in accordance with the earlier of term to repricing or the
contractual maturity of the asset or liability. The table is intended to provide
an approximation of the projected repricing of assets and liabilities at
December 31, 1997, on the basis of contractual maturities, anticipated
prepayments, and scheduled rate adjustments within a three-month period and
subsequent selected time intervals. The loan amounts in the table reflect
principal balances expected to be redeployed and/or repriced as a result of
contractual amortization and anticipated prepayments of adjustable-rate loans
and fixed-rate loans, and as a result of contractual rate adjustments on
adjustable- rate loans. For loans on residential properties, adjustable-rate
loans and fixed-rate loans are projected to prepay at rates between 4% and 21%
annually. Mortgage-backed securities are projected to prepay at rates between
10% and 35% annually. Savings account deposits, such as money market savings
accounts, passbook accounts and negotiable order of withdrawal ("NOW") accounts,
are all assumed to reprice immediately, and so are allocated to the shortest
period (three months or less) for purposes of the table.
41
<PAGE>
<TABLE>
<CAPTION>
MORE THAN MORE MORE
3 MONTHS THAN THAN 1 MORE NON
3 MONTHS TO 6 MONTHS YEAR TO THAN INTEREST
OR LESS 6 MONTHS TO 1 YEAR 5 YEARS 5 YEARS SENSITIVE TOTAL
----------- ---------- ---------- -------- --------- ---------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Cash and cash equivalents.................... $ 4,000 $ 90 $ -- $ -- $ -- $ 22,330 $ 26,420
Investment securities, net................... 1,903 2,023 6,651 26,511 27,966 -- 65,054
Loans receivable............................. 187,161 116,893 34,739 78,931 21,808 -- 439,532
Noninterest-earning assets less
allowance for loan losses, deferred
loan fees and loans in process............ -- -- -- -- -- 18,632 18,632
----------- ---------- ---------- --------- -------- ---------- ----------
Total Assets............................ 193,064 119,006 41,390 105,442 49,774 40,962 549,638
----------- ---------- ---------- --------- -------- ---------- ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Money market savings accounts................ 20,719 -- -- -- -- -- 20,719
Passbook accounts............................ 21,716 -- -- -- -- -- 21,716
NOW accounts................................. 18,680 -- -- -- -- 8,565 27,245
Certificate accounts......................... 60,623 65,316 116,738 51,321 -- -- 293,998
FHLB advances................................ 25,000 11,500 25,000 73,500 -- -- 135,000
Noninterest-bearing liabilities.............. -- -- -- -- -- 9,448 9,448
Stockholders' Equity......................... -- -- -- -- -- 41,512 41,512
----------- ---------- ---------- --------- -------- ---------- ----------
Total Liabilities and Stockholders'
Equity.................................... 146,738 76,816 141,738 124,821 -- 59,525 549,638
----------- ---------- ---------- --------- -------- ---------- ==========
Interest rate sensitivity gap................ $ 46,326 $ 42,190 $(100,348) $(19,379) $49,774 $(18,563)
=========== ========== ========== ========= ======== ==========
Cumulative interest rate sensitivity gap..... $ 46,326 $ 88,516 $ (11,832) $(31,211) $18,563 --
=========== ========== ========== ========= ======== ==========
Interest rate sensitivity gap as a percent of
total assets................................ 8.43% 7.68% (18.26)% (3.53)% 9.06% (3.38)%
=========== ========== ========== ========= ======== ===========
Cumulative interest rate sensitivity gap as
a percent of total assets................... 8.43% 16.11% (2.15)% (5.68)% 3.38% --
----------- ---------- ---------- --------- -------- ----------
</TABLE>
Certain shortcomings are inherent in the method of analysis presented in
the foregoing table. For example, money market, passbook and NOW account deposit
liabilities, most of which are allocated to the shortest period in the table
(three months or less), are not expected in most scenarios to actually reprice
within this time frame. Also, many of Highland's adjustable rate loans are
indexed to the 11th district cost of funds, an index which has been historically
slower to reprice than other indices.
In addition, although certain assets and liabilities are assumed to have
similar maturities or periods to repricing, they may actually react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable-rate loans, have
features which restrict the degree of changes in interest rates both on a short-
term basis and over the life of the asset. Most of Highland's adjustable-rate
loans may not adjust downward below their initial rate (the "floor interest
rate"), with increases generally limited to maximum adjustments of 2% per year
and 5% for the life of the loan. Further, in the event of a significant change
in interest rates, prepayment and early withdrawal levels would likely deviate
materially from those assumed in calculating the table. Finally, the ability of
many borrowers to service their adjustable-rate loans may decrease in the event
of a significant interest rate increase.
Net Portfolio Value. Highland's interest rate sensitivity is monitored
by management through the use of an internally generated model which estimates
the change in net portfolio value ("NPV") over a range of interest rate
scenarios. NPV is the present value of expected cash flows from assets,
liabilities and off-balance sheet contracts. The NPV Ratio, in any interest rate
scenario, is defined as the NPV in that scenario divided by the market value of
assets in the same scenario.
42
<PAGE>
The Sensitivity Measure is the decline in the NPV Ratio, in basis points, caused
by a 2% increase or decrease in rates, whichever produces a larger decline. The
higher an institution's Sensitivity Measure, the greater is considered to be its
exposure to interest rate risk. The OTS also produces a similar analysis using
its own model, based upon data submitted on the Bank's quarterly Thrift
Financial Reports.
As of December 31, 1997, the Bank's Sensitivity Measure, as measured by the
OTS, was negative 137 basis points. As of the same date, the Sensitivity Measure
as measured by Highland was negative 201 basis points. Highland compares the
results from the OTS and from its internally generated results and provides the
Board of Directors with a comparison to determine if there is any additional
risk.
As is the case with the gap table, certain shortcomings are inherent in the
methodology used in the above interest rate-risk measurements. Modeling changes
in NPV requires the making of certain assumptions which may tend to oversimplify
the manner in which actual yields and costs respond to changes in market
interest rates. First, the models assume that the composition of the Bank's
interest sensitive assets and liabilities existing at the beginning of a period
remains constant over the period being measured. Second, the models assume that
a particular change in interest rates is reflected uniformly across the yield
curve regardless of the duration to maturity or repricing of specific assets and
liabilities. Accordingly, although the NPV measurements and net interest income
models provide an indication of Highland's interest rate risk exposure at a
particular point in time, such measurements are not intended to and do not
provide a precise forecast of the effect of changes in market interest rates on
Highland's net interest income and will differ from actual results.
CAPITAL RESOURCES
- -----------------
At December 31, 1997, the Bank exceeded all of its regulatory capital
requirements and was considered "well capitalized." The following table sets
forth the Bank's regulatory capital ratios at December 31, 1997 and December 31,
1996 (see also Note 16 of the Notes to Consolidated Financial Statements):
<TABLE>
<CAPTION>
MINIMUM
DECEMBER 31, 1997 DECEMBER 31, 1996 REQUIREMENT
------------------ ----------------- -----------
<S> <C> <C> <C>
Tangible Capital........ 6.9% 7.2% 1.5%
Leverage Capital........ 6.9% 7.2% 3.0%
Risk-based Capital...... 10.7% 11.3% 8.0%
</TABLE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCUSSION ABOUT MARKET RISK
The information required herein is incorporated by reference from "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" of Highland's 1997 Annual Report filed in this form 10-K. At
December 31, 1997, Highland did not hold any derivative financial instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Highland's consolidated financial statements begin on page F-1 of this
report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On March 3, 1997, the Bank dismissed Grant Thornton LLP ("Grant") as its
independent auditors. The reports of Grant on the financial statements of the
Bank for fiscal years ending December 31, 1996 and 1995 did not contain an
adverse opinion, or a disclaimer of opinion, and were not qualified or modified
as to uncertainty, audit scope or accounting principles. The authority to change
independent auditors was provided by the Audit Committee of the Board of
Directors of the Bank at their meeting of February 19, 1997.
43
<PAGE>
In connection with its audits for the two most recent fiscal years, and
through March 3, 1997, there have been no disagreements with Grant on any matter
of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure. The Bank requested that Grant furnish a letter
addressed to the Office of Thrift Supervision stating that it agrees with the
above statements. A copy of such letter, dated March 5, 1997, has been filed as
Exhibit 16 to the Bank's Current Report on Form 8-K filed March 7, 1997.
On March 3, 1997, the Bank engaged the firm of KPMG Peat Marwick LLP as its
independent auditors for the fiscal year ended December 31, 1997 and KPMG Peat
Marwick LLP remained the independent auditors of Highland after the
Reorganization.
44
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning Highland's directors and executive officers is
incorporated herein by reference from the section entitled "ELECTION OF
DIRECTORS" of Highland's definitive Proxy Statement to be filed pursuant to
Regulation 14A within 120 days after the end of the last fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by
reference from the section entitled "EXECUTIVE COMPENSATION" of Highland's
definitive Proxy Statement to be filed pursuant to Regulation 14A within 120
days after the end of the last fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning the security ownership of certain beneficial owners
and management is incorporated by reference from the sections entitled "SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" in Highland's definitive
Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the
end of the last fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
45
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are included in this report at the page
numbers indicated.
<TABLE>
<CAPTION>
1. Financial Statements and Schedules Page No.
---------------------------------- --------
<S> <C>
Independent Auditor's Reports............................................ F-1, F-2
Consolidated Statements of Financial Condition as of December 31,
1997 and 1996............................................................ F-3
Consolidated Statements of Operations for the Years ended December 31,
1997, 1996 and 1995...................................................... F-4
Consolidated Statements of Shareholders' Equity for the Years ended
December 31, 1997, 1996 and 1995......................................... F-6
Consolidated Statements of Cash Flows for the Years ended
December 31, 1997, 1996 and 1995......................................... F-7
Notes to Consolidated Financial Statements............................... F-10
</TABLE>
2. All financial statement schedules are omitted because of the
absence of the conditions under which they are required to be
provided or because the required information is included in the
financial statements listed above and/or related notes.
3. Exhibits
--------
(i) Executive Compensation Plans and Arrangements:
---------------------------------------------
The following is a summary of Highland's executive
compensation plans and arrangements which are required to be
filed as exhibits to this Report on Form 10-K:
Exhibit
Number Description of Exhibit
- ------ ----------------------
10.1 Highland Federal Bank 1994 Stock Option and Performance Share Award
Plan, including forms of Stock Option Agreement and Performance Share
Award and Restricted Stock Agreement, filed as Exhibit 10.1 to the S-4
Registration Statement (as defined below) and incorporated herein by
reference.
10.2 Highland Federal Bank Profit Sharing Plan and Trust, filed as Exhibit
10.2 to the S-4 Registration Statement and incorporated herein by
reference.
10.3 Form of Change of Control Employment Agreement between the Bank and
each of Stephen N. Rippe, Gary P. Warren, Anthony L. Frey and Ellen B.
Geiger.
10.4 Form of Indemnification Agreement between the Bank and Members of the
Board of Directors of the Bank.
10.5 Retirement Agreement between the Bank and Ben Karmelich, dated June
19, 1986, and Amendment No. 1 to Retirement Agreement, dated March 16,
1988.
46
<PAGE>
(ii) Exhibit Index:
-------------
Exhibit
Number Description of Exhibit
- ------ ----------------------
2.1 Plan of Reorganization and Agreement of Merger, filed as Exhibit A to
the Proxy Statement/Prospectus included in the Registration Statement
on Form S-4 (File No. 333-38911) filed by the Registrant with the
Commission on October 28, 1997 (the "S-4 Registration Statement") and
incorporated herein by reference.
3.1 Certificate of Incorporation of the Registrant, filed as Exhibit 3.1
to the S-4 Registration Statement and incorporated herein by
reference.
3.2 Bylaws of the Registrant, filed as Exhibit 3.2 to the S-4 Registration
Statement and incorporated herein by reference.
4.0 Form of Stock Certificate of the Registrant, filed as Exhibit 4.1 to
the S-4 Registration Statement and incorporated herein by reference.
10.1 Highland Federal Bank 1994 Stock Option and Performance Share Award
Plan, including forms of Stock Option Agreement and Performance Share
Award and Restricted Stock Agreement, filed as Exhibit 10.1 to the S-4
Registration Statement and incorporated herein by reference.
10.2 Highland Federal Bank Profit Sharing Plan and Trust, filed as Exhibit
10.2 to the S-4 Registration Statement and incorporated herein by
reference.
10.3 Form of Change of Control Employment Agreement between the Bank and
each of Stephen N. Rippe, Gary P. Warren, Anthony L. Frey and Ellen B.
Geiger.
10.4 Form of Indemnification Agreement between the Bank and Members of the
Board of Directors of the Bank.
10.5 Retirement Agreement between the Bank and Ben Karmelich, dated June
19, 1986, and Amendment No. 1 to Retirement Agreement, dated March 16,
1988.
16.0 Letter of Grant Thornton LLP, dated March 5, 1997.
11.0 Statement re Computation of Per Share Earnings is included in the
Consolidated Statements of Operations and Notes to Consolidated
Financial Statements of the Registrant which are attached hereto.
21.0 Subsidiaries of the Registrant. The only subsidiary of the Registrant
is Highland Federal Bank, a Federal Savings Bank.
23.0 Consent of KPMG Peat Marwick LLP.
27.0 Financial Data Schedule.
(b) Reports on Form 8-K
-------------------
The Registrant filed one report on Form 8-K during the fourth
quarter of 1997. The report, filed on December 18, 1997 under "Item 5.
Other," related to the automatic succession of the Registrant to the
Exchange Act reporting obligations of the Bank in connection with the
reorganization of the Bank into a holding company form of
organization.
(c) Exhibits Required by Item 601 of Regulation S-K
-----------------------------------------------
See Item 14(a)(3)(i) above.
(d) Additional Financial Statements
-------------------------------
Not applicable.
47
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 30th day of
March, 1998.
HIGHLAND BANCORP, INC.
By: /s/ STEPHEN N. RIPPE
-----------------------------
Stephen N. Rippe, President
March 30, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ RICHARD J. CROSS Dated: March 30, 1998
- ----------------------------
Richard J. Cross
Chairman of the Board and Director
Dated:
- ----------------------------
Woodrow De Witt, Director
/s/ WILLIAM G. DYESS Dated: March 30, 1998
- ----------------------------
William G. Dyess, Director
/s/ ANTHONY L. FREY Dated: March 30, 1998
- ----------------------------
Anthony L. Frey
Executive Vice President, Chief
Financial Officer
(Principal Accounting Officer)
/s/ BEN KARMELICH Dated: March 30, 1998
- ----------------------------
Ben Karmelich, Director
/s/ RICHARD O. OXFORD Dated: March 30, 1998
- ----------------------------
Richard O. Oxford, Director
Dated:
- ----------------------------
George Piercy, Director
/s/ STEPHEN N. RIPPE Dated: March 30, 1998
- ----------------------------
Stephen N. Rippe
President, Chief Executive
Officer and Director
(Principal Executive Officer)
/s/ SHIRLEY E. SIMMONS Dated: March 30, 1998
- ----------------------------
Shirley E. Simmons
Vice Chairman of the Board
and Director
48
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Highland Bancorp, Inc.:
We have audited the accompanying consolidated statement of financial condition
of Highland Bancorp, Inc. and subsidiaries (the Company) as of December 31, 1997
and the related consolidated statements of operations, shareholders' equity and
cash flows for the year then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated 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 1997 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Highland Bancorp, Inc. and subsidiaries as of December 31, 1997 and the results
of their operations and their cash flows for the year then ended in conformity
with generally accepted accounting principles.
/S/ KPMG PEAT MARWICK LLP
Los Angeles, California
January 23, 1998
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
----------------------------
Board of Directors
Highland Bancorp, Inc.:
We have audited the accompanying consolidated statement of financial condition
of Highland Bancorp, Inc. and subsidiaries (the Company) as of December 31,
1996, and the related consolidated statements of operations, shareholders'
equity and cash flows for the years ended December 31, 1996 and 1995. These
consolidated financial statements are the responsibility of the Company'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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Highland Bancorp,
Inc. and subsidiaries as of December 31, 1996, and the consolidated results of
their operations and their consolidated cash flows for the years ended December
31, 1996 and 1995, in conformity with generally accepted accounting principles.
/s/ Grant Thornton LLP
Los Angeles, California
January 28, 1997
F-2
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------------------------
ASSETS 1997 1996
------------------- -------------------
<S> <C> <C>
Cash and cash equivalents $ 26,420 33,714
Securities available-for-sale (cost of $49,881 in 1997 and $37,414
in 1996) 49,635 37,038
Securities held-to-maturity (fair value of $15,263 in 1997 and
$17,493 in 1996) 15,419 17,969
Loans receivable, net of allowance for loan losses of $8,848 in 1997
and $7,678 in 1996 427,237 373,545
Real estate acquired through foreclosure 1,543 1,400
Federal Home Loan Bank stock, at cost 6,750 3,125
Accrued interest receivable 3,789 3,404
Premises and equipment, net 7,599 8,311
Deferred income taxes, net 4,819 4,463
Other assets 6,427 6,933
------------------- -------------------
$ 549,638 489,902
=================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $ 363,678 384,921
FHLB advances 135,000 62,500
Accounts payable and other liabilities 6,961 7,417
Income taxes payable 2,487 201
------------------- -------------------
Total liabilities 508,126 455,039
------------------- -------------------
Commitments and contingencies
Shareholders' equity - partially restricted:
Preferred stock. Authorized, 1,000,000 shares of $.01 stated
value, no shares issued -- --
Common stock. Authorized, 8,000,000 shares of $.01 stated value;
issued and outstanding 2,318,437 shares in 1997 and 2,295,983
shares in 1996 23 23
Additional paid-in capital 16,144 15,703
Retained earnings 25,507 19,384
Net unrealized holding loss on securities available-for-sale, net
of tax (162) (247)
------------------- -------------------
Total shareholders' equity 41,512 34,863
------------------- -------------------
$ 549,638 489,902
=================== ===================
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Interest income:
Loans $ 40,022 35,251 30,223
Securities:
Available-for-sale 3,581 3,210 7,146
Held-to-maturity 1,026 1,177 1,330
------------------- ------------------- -------------------
Total interest income 44,629 39,638 38,699
------------------- ------------------- -------------------
Interest expense:
Deposits 18,311 18,068 18,539
FHLB advances and other borrowings 5,913 2,358 2,848
------------------- ------------------- -------------------
Total interest expense 24,224 20,426 21,387
------------------- ------------------- -------------------
Net interest income 20,405 19,212 17,312
Provision for losses on loans 5,164 3,930 5,221
------------------- ------------------- -------------------
Net interest income after provision for
losses on loans 15,241 15,282 12,091
------------------- ------------------- -------------------
Noninterest income:
Gain on sale of loans 118 441 86
Net gain on sale of securities 20 15 9
Gain on sales of branches 2,014 -- --
Other 1,772 1,711 1,484
------------------- ------------------- -------------------
Total noninterest income 3,924 2,167 1,579
------------------- ------------------- -------------------
</TABLE>
(Continued)
F-4
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations, Continued
(Dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Noninterest expense:
General and administrative expense:
Compensation and benefits $ 5,552 6,556 6,472
Occupancy and equipment 1,290 2,175 2,100
FDIC deposit insurance premium 299 1,003 1,087
FDIC deposit insurance premium - special
assessment -- 2,548 --
Service bureau and related equipment rental 568 730 640
Other 2,154 2,682 2,661
------------------- ------------------- -------------------
Total general and administrative expense
9,863 15,694 12,960
Net cost of operation of real estate acquired
through foreclosure 555 928 2,306
------------------- ------------------- -------------------
Total noninterest expense 10,418 16,622 15,266
------------------- ------------------- -------------------
Earnings (loss) before income taxes 8,747 827 (1,596)
Income taxes (benefit) 2,624 162 (617)
------------------- ------------------- -------------------
Net earnings (loss) $ 6,123 665 (979)
=================== =================== ===================
Basic net earnings (loss) per share $ 2.66 .29 (.86)
=================== =================== ===================
Diluted net earnings (loss) per share $ 2.58 .29 (.86)
=================== =================== ===================
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Years ended December 31, 1997, 1996 and 1995
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
NET UNREALIZED
HOLDING LOSS ON
SECURITIES TOTAL
ADDITIONAL RETAINED AVAILABLE-FOR- SHAREHOLDERS'
CAPITAL STOCK PAID-TO CAPITAL EARNINGS SALE, NET OF TAX EQUITY
------------- --------------- -------- ---------------- ------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $ 11 2,706 19,698 (1,453) 20,962
Stock offering 12 12,997 -- -- 13,009
Net loss -- -- (979) -- (979)
Change in net unrealized holding loss on
securities available-for-sale, net of tax -- -- -- 1,099 1,099
------------ ------------ --------- ---------- --------
Balance at December 31, 1995 23 15,703 18,719 (354) 34,091
Net earnings -- -- 665 -- 665
Change in net unrealized holding loss on
securities available-for-sale, net of tax -- -- -- 107 107
------------ ------------ --------- ---------- --------
Balance at December 31, 1996 23 15,703 19,384 (247) 34,863
Net earnings -- -- 6,123 -- 6,123
Exercise of common stock options -- 243 -- -- 243
Retirement of common stock -- (185) -- -- (185)
Issuance of performance shares -- 383 -- -- 383
Change in net unrealized holding loss on
securities available-for-sale, net of tax -- -- -- 85 85
------------ ------------ --------- ---------- --------
Balance at December 31, 1997 $ 23 16,144 25,507 (162) 41,512
============ ============ ========= ========== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
---------------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) $ 6,123 665 (979)
Adjustments to reconcile net earnings (loss) to
net cash provided by operating activities:
Gain on sale of loans (118) (441) (86)
Gain on sale of securities available-for-sale (20) (15) (9)
Gain on sale of branches (2,014) -- --
Net (gain) loss on sale of real estate
acquired through foreclosure (90) (330) 296
Increase in net deferred tax asset (427) (19) (5,524)
Amortization of premiums on securities 301 312 1,030
Depreciation 690 665 727
Federal Home Loan Bank stock dividend (249) (135) (130)
Deferred direct loan origination fees and
costs, net (346) (169) (182)
Amortization of deferred compensation expense 255 -- --
Provision for losses on loans 5,164 3,930 5,221
Provision for losses on real estate acquired
through foreclosure 310 264 669
Increase (decrease) in accrued interest
receivable (385) (342) 406
Decrease in recoverable income taxes -- -- 7,211
Decrease (increase) in other assets 759 752 (2,288)
Increase (decrease) in accounts payable and
other liabilities (456) 3,060 193
Increase (decrease) in income taxes payable 2,286 (3,113) 3,314
------------------- ------------------- -------------------
Net cash provided by operating
activities 11,783 5,084 9,869
------------------- ------------------- -------------------
</TABLE>
(Continued)
F-7
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
---------------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Cash flows from investing activities:
Purchases of securities available-for-sale $ (32,426) (7,652) (9,332)
Sales and maturities of securities
available-for-sale 19,744 14,452 81,059
Principal payments on investment securities
held-to-maturity 2,474 2,718 2,295
(Increase) decrease in Federal Home Loan Bank
stock (3,376) 317 915
(Purchases) sales of premises and equipment 22 (954) (770)
Costs capitalized on real estate acquired
through foreclosure (205) -- --
Proceeds from the sale of real estate acquired
through foreclosure 7,082 6,872 19,788
Proceeds from the sale of loans 3,445 12,527 7,257
Purchases of loans (396) (7,690) --
Net increase in loans receivable (68,769) (73,948) (69,109)
------------------- ------------------- -------------------
Net cash provided by (used in)
investing activities (72,405) (53,358) 32,103
------------------- ------------------- -------------------
Cash flows from financing activities:
Decrease in deposits from sale of branches (103,857) -- --
Net increase in deposits 84,627 6,222 2,032
Net borrowings (repayments) from the Federal
Home Loan Bank 72,500 23,000 (22,000)
Proceeds from stock offering -- -- 13,009
Retirement of common stock (185) -- --
Common stock options exercised 243 -- --
------------------- ------------------- -------------------
Net cash (used in) provided by
financing activities 53,328 29,222 (6,959)
------------------- ------------------- -------------------
Increase (decrease) in cash and cash
equivalents (7,294) (19,052) 35,013
Cash and cash equivalents at beginning of year 33,714 52,766 17,753
------------------- ------------------- -------------------
Cash and cash equivalents at end of year $ 26,420 33,714 52,766
=================== =================== ===================
</TABLE>
(Continued)
F-8
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Supplemental disclosures of cash flow
information:
Interest paid $ 23,906 19,983 21,435
Income taxes paid, net 863 695 1,592
=================== =================== ===================
Supplemental disclosure of noncash investing and
financing activities:
Acquisition of real estate in settlement of
loans $ 9,688 5,240 15,667
Loans made in conjunction with real estate
sales 3,574 3,625 6,416
=================== =================== ===================
</TABLE>
See accompanying notes to consolidated financial statements.
F-9
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1997, 1996 and 1995
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
During 1997, Highland Bancorp, Inc. (the Company) was established to serve
as a holding corporation for Highland Federal Bank and its wholly owned
subsidiaries, H.F.S. Corporation and Hi-Fed Insurance Agency (collectively
referred to as the Bank). The accounting and reporting policies of the
Company and the Bank conform to generally accepted accounting principles
and the prevailing practices within the savings and loan industry.
Highland Federal Bank obtained regulatory and shareholder approval to
reorganize into a holding company structure to provide greater flexibility
for meeting future financial and competitive needs. As a result of the
reorganization, which occurred on December 16, 1997, each share of the
Bank's $1.00 par value common stock was converted into one share of $0.01
par value common stock of Highland Bancorp, Inc. Consequently, the Bank
became a wholly owned subsidiary of Highland Bancorp, Inc.
In December 1997, the Bank contributed $4.0 million in capital to Highland
Bancorp, Inc. as part of the reorganization into a holding company
structure. The Bank's regulatory capital was reduced by the amount of this
contribution at December 31, 1997.
The Bank is a Federally chartered savings bank primarily engaged in the
business of attracting deposits from the general public and using such
deposits, together with borrowings and other funds, to make mortgage loans
secured by residential and other real estate. Bank revenues are derived
principally from interest on real estate loans and investments and other
fees. The major expense of the Bank is interest paid on deposits and
borrowings. Bank operations and net interest income are affected by general
economic conditions and by the monetary and fiscal policies of the Federal
government. Lending activities are affected by the demand for mortgage and
other types of financing which is, in turn, affected primarily by interest
rates and other factors affecting the supply of housing and the
availability of funds. Deposit flows and cost of funds are influenced by
interest rates on competing investments and by general market interest
rates.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Material estimates that are particularly susceptible to significant change
in the near term relate to the determination of the allowance for loan
losses and the valuation of real estate. Management believes that the
allowances established on loans and real estate are adequate. While
management uses available information to recognize losses on loans and real
estate, future additions to the allowances may be necessary based on
changes in economic conditions. In addition, various regulatory agencies,
as an integral part of their examination process, periodically review the
Company's allowance for losses on loans and real estate. Such agencies may
require the Company to recognize additions to the allowances based on their
judgments about information available to them at the time of their
examination.
F-10
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The Company is required to carry its available-for-sale securities and real
estate acquired in settlement of loans at the lower of cost or fair value
or, in certain cases, at fair value. Fair value estimates are made at a
specific point in time based upon relevant market information and other
information about the asset. Such estimates related to the investment
securities portfolios include published bid prices or bid quotations
received from securities dealers. Fair value estimates for real estate
acquired in settlement of loans is determined by current appraisals and,
where no active market exists for a particular property, discounting a
forecast of expected cash flows at the rate commensurate with the risk
involved.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of the Company include the accounts
of the Company, the Bank and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in
consolidation. Certain prior years' data have been reclassified to conform
to current year presentation.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include
cash, Federal funds sold, time certificates of deposit and other deposits
with maturities of three months or less. Generally, Federal funds are sold
for a one-day period.
SECURITIES
Securities include U.S. government obligations, corporate securities and
other debt securities. The Company classifies its securities in two
categories: available-for-sale and held-to-maturity. Available-for-sale
securities are measured at fair value, with net unrealized gains and losses
reported as a separate component of shareholders' equity. Held-to-maturity
securities are carried at cost, adjusted for premiums or discounts which
are amortized or accreted and recognized in interest income using the
interest method over the period to maturity. Held-to-maturity securities
are classified as such because the Company has the ability and management
has the intent to hold them to maturity. Available-for-sale securities are
debt and equity securities not classified as held-to-maturity. These
securities are reported at fair value, with unrealized gains and losses
excluded from earnings and reported as a separate component of
shareholders' equity (net of tax effects). Premiums or discounts on
mortgage-backed securities are amortized over the remaining contractual
maturity, adjusted for anticipated prepayments using the interest method.
The amortized cost or carrying value of the specific security sold is used
to compute the gain or loss on the sale of securities.
LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans receivable are stated at unpaid principal balances, less allowance
for loan losses and net deferred loan origination fees.
Loans are placed on nonaccrual status when a loan becomes 90 days past due
as to interest or principal unless the loan is both well secured and in
process of collection. Loans are also placed on nonaccrual status when the
full collection of interest or principal becomes uncertain. When a loan is
placed on nonaccrual status, the accrued and unpaid interest receivable is
reversed. Thereafter, interest collected on the loan is accounted for on
the cash collection or cost recovery method until qualifying for return to
accrual status. Generally, a loan may be returned to accrual status when
all delinquent principal and interest are brought current in accordance
with the terms of the loan agreement and certain performance criteria have
been met.
F-11
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The Company maintains an allowance for loan losses at a level considered by
management adequate to cover probable losses on loans. The allowance for
loan losses is increased by charges to income and decreased by charge-offs
(net of recoveries). Management's periodic evaluation of the adequacy of
the allowance is based on the Company's past loan loss experience, known
and inherent risks in the portfolio, adverse situations that may affect the
borrower's ability to repay, estimated value of any underlying collateral,
and current and prospective economic conditions. Although management uses
the best information available to make these estimates, future adjustments
to the allowance may be necessary due to economic, operating, regulatory
and other conditions that may be beyond the Company's control. In addition,
various regulatory agencies, as an integral part of their examination
process, periodically review the Company's allowance for loan losses. Such
agencies may require the Company to recognize additions to the allowance
based on judgments different from those of management.
Uncollectible interest on loans that are contractually past due is charged
off or an allowance is established based on management's periodic
evaluation. The allowance is established by a charge to interest income
equal to all interest previously accrued, and income is subsequently
recognized only to the extent cash payments are received until, in
management's judgment, the borrower's ability to make periodic interest and
principal payments is back to normal, in which case the loan is returned to
accrual status.
The Company considers a loan to be impaired when it is deemed probable that
the Company will be unable to collect all amounts due (both principal and
interest) according to the contractual terms of the loan agreement. The
Company selects the measurement method for determining impairment on a
loan-by-loan basis, except that collateral-dependent loans for which
foreclosure is probable are measured at the fair value of the collateral.
The Company measures impairment of a restructured loan by discounting the
total expected cash flows using the loan's effective rate of interest in
the original loan agreement. Cash receipts on impaired loans receivable are
applied to principal and interest in accordance with the terms of the loan.
LOAN ORIGINATION AND COMMITMENT FEES
The Company recognizes loan origination fees as an adjustment of the loan's
yield over the life of the loan by the interest method, which results in a
constant rate of return. Certain direct costs of originating the loan are
recognized over the life of the loan as a reduction of the yield rather
than as an expense when incurred.
Generally, loan commitment fees are deferred and recognized as an
adjustment of yield by the interest method over the related loan life or,
if the commitment expires unexercised, recognized in income upon expiration
of the commitment.
The amortization of deferred loan fees is discontinued when the loan is
placed on nonaccrual status.
F-12
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
REAL ESTATE ACQUIRED THROUGH FORECLOSURE
The Company records real estate acquired through foreclosure or deed in
lieu of foreclosure at the fair value at the time of foreclosure, less
estimated selling costs. The fair value of foreclosed property is based
upon a current appraisal. Declines in value from the periodic valuation of
foreclosed properties are charged against operating expenses and included
in the allowance for other real estate owned in the period in which they
are identified. Required developmental costs associated with foreclosed
property under construction are capitalized and considered in determining
the fair value of the property. Operating expenses of such properties, net
of related income, and gains and losses on their disposition are included
in noninterest expense.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost, less accumulated depreciation
and amortization. Depreciation is computed using the straight-line basis
over the estimated useful lives of the assets. Leasehold improvements are
amortized over the life of the lease or the service lives of the
improvements, whichever is shorter.
EARNINGS (LOSS) PER SHARE
As of December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128), and has
restated all prior period earnings (loss) per share data.
SFAS No. 128 simplifies the standards for computing and presenting earnings
per share (EPS) as previously prescribed by Accounting Principles Board
opinion No. 15, "Earnings per Share." SFAS No. 128 replaces primary EPS
with basic EPS and fully diluted EPS with diluted EPS. 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 from issuance of common stock
that then shared in earnings. The following table reconciles the weighted
average shares of common stock outstanding used in the basic EPS
computation to that used in the diluted EPS computation. There is no
difference in the earnings used in the two computations.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------------------------------------------
1997 1996 1995
SHARES SHARES SHARES
------------------- ------------------- -------------------
<S> <C> <C> <C>
Basic EPS - weighted average number of shares
used in computation 2,299,042 2,295,983 1,138,082
Effect of dilutive securities - incremental
shares from outstanding common stock options 69,981 9,811 --
------------------- ------------------- -------------------
Diluted EPS - weighted average number of shares
used in computation 2,369,023 2,305,794 1,138,082
=================== =================== ===================
</TABLE>
At December 31, 1997 and 1996, there were no shares which had an
antidilutive effect on earnings per share. At December 31, 1995, there were
6,096 shares which were excluded from the table above since such shares
were antidilutive.
F-13
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
INCOME TAXES
Provisions for income taxes are based on amounts reported in the
consolidated statements of income. Deferred taxes are computed on the
liability method of accounting for income taxes. Deferred income taxes are
recognized for the tax consequences of temporary differences by applying
enacted statutory tax rates applicable to future years to differences
between the financial statement carrying amounts and the tax bases of
existing assets and liabilities. The effect on deferred taxes from a change
in tax rates is recognized in income in the period that includes the
enactment date.
STOCK-BASED COMPENSATION
Prior to January 1, 1996, the Company accounted for its stock option plan
in accordance with the provisions of Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. As such, compensation expense would be recorded on the
date of grant only if the current market price of the underlying stock
exceeded the exercise price. On January 1, 1996, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," which permits entities to recognize as expense
over the vesting period the fair value of all stock-based awards on the
date of grant. Alternatively, SFAS No. 123 also allows entities to continue
to apply the provisions of APB Opinion No. 25 and provide pro forma net
income and pro forma earnings per share disclosures for employee stock
option grants made in 1995 and future years as if the fair-value-based
method defined in SFAS No. 123 had been applied. The Company has elected to
continue to measure compensation cost related to stock options following
the provisions of APB Opinion No. 25 and provide the pro forma disclosure
provisions of SFAS No. 123.
MORTGAGE SERVICING RIGHTS
The Company adopted Statement of Financial Accounting Standard (SFAS) No.
122, "Accounting for Mortgage Servicing Rights," as of January 1, 1996.
SFAS No. 122 requires companies that sell or securitize mortgage loans with
servicing rights retained to allocate the total cost of the mortgage loans
to the mortgage servicing rights and the loans based upon their relative
fair values. SFAS No. 122 further requires that capitalized mortgage
servicing rights be evaluated for impairment based upon the fair value of
these rights. SFAS No. 122 was superseded by SFAS No. 125 effective January
1, 1997.
The Company adopted, effective January 1, 1997, SFAS No. 125, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities." This statement provides accounting and reporting standards
for transfers of financial assets and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a financial-components approach that focuses on control.
Under that approach, after a transfer of financial assets, an entity
recognizes the financial assets and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has
been surrendered and derecognizes liabilities when extinguished. This
statement provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings.
The effect of adopting this statement did not have a material effect on the
Company's consolidated financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 130, "Reporting Comprehensive Income." Comprehensive income represents
the change in equity of the Company during a period from transactions and
other events and circumstances from nonowner sources. It includes all
changes in equity during the period except those resulting from investments
by owners and
F-14
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
distributions to owners. SFAS No. 130 establishes standards for reporting
and display of comprehensive income and its components in a full set of
general purpose financial statements. SFAS No. 130 requires all components
of comprehensive income, which are required to be recognized under
accounting standards, to be reported in a financial statement that is
displayed in equal prominence with the other financial statements. SFAS No.
130 does not require a specific presentation format, but will require the
Company to display an amount representing total comprehensive income for
the periods in the financial statements. SFAS No. 130 is effective for both
interim and annual periods beginning after December 15, 1997.
Implementation of SFAS No. 130 will not have a material effect on the
Company's financial condition or results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 establishes standards
for the way public business enterprises are to report information about
operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes
standards for related disclosures about products and services, geographic
areas and major customers. SFAS No. 131 supersedes numerous requirements in
a previously issued statement, SFAS No. 14, "Financial Reporting for
Segments of a Business Enterprise," but retains the requirements to report
information about major customers. SFAS No. 131 is effective for financial
statements for periods beginning after December 15, 1997. Implementation of
SFAS No. 131 will not have a material effect on the Company's financial
condition or results of operations.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits" (SFAS No. 132). This
statement standardizes the disclosure requirements for defined benefits
plans and recommends a parallel format for presenting information about
pensions and other postretirement benefits. This statement is effective for
fiscal years beginning after December 15, 1997. Implementation of SFAS No.
132 will not have a material effect on the Company's financial condition or
results of operations.
(2) SECURITIES
The amortized cost, gross unrealized gains and losses, and estimated fair
values of the Company's available-for-sale and held-to-maturity securities
as of December 31, 1997 and 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
AMORTIZED GROSS UNREALIZED ESTIMATED
-------------------------------------------
COST GAINS LOSSES FAIR VALUE
------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
1997:
Securities available-for-sale:
U.S. Treasury and agency
securities $ 15,481 4 26 15,459
Mortgage-backed securities 34,400 24 248 34,176
------------------- ------------------- ------------------- -------------------
$ 49,881 28 274 49,635
=================== =================== =================== ===================
Securities held-to-maturity
mortgage-backed securities $ 15,419 -- 156 15,263
=================== =================== =================== ===================
</TABLE>
F-15
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
<TABLE>
<CAPTION>
AMORTIZED GROSS UNREALIZED ESTIMATED
-------------------------------------------
COST GAINS LOSSES FAIR VALUE
------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
1996:
Securities available-for-sale:
U.S. Treasury and agency
securities $ 2,982 -- 14 2,968
Mortgage-backed securities 34,432 64 426 34,070
------------------- ------------------- ------------------- -------------------
$ 37,414 64 440 37,038
=================== =================== =================== ===================
Securities held-to-maturity-
mortgage-backed securities $ 17,969 -- 476 17,493
=================== =================== =================== ===================
</TABLE>
The weighted average yields of U.S. Treasury and equity securities earned
during 1997, 1996 and 1995 were 6.4%, 5.5% and 6.1%, respectively. The
weighted average yield of mortgage-backed securities was 5.9%, 5.9% and
6.6% and during 1997, 1996 and 1995, respectively.
Proceeds and realized gains and losses on sales of securities
available-for-sale for the years ended December 31 are summarized as
follows (in thousands):
<TABLE>
<CAPTION>
PROCEEDS GAINS LOSSES
------------------- ------------------- -------------------
<S> <C> <C> <C>
1997 $ 2,033 20 --
1996 4,645 15 --
1995 72,960 341 332
=================== =================== ===================
</TABLE>
The contractual maturities of securities held-to-maturity and
available-for-sale at December 31, 1997 were as follows (in thousands):
<TABLE>
<CAPTION>
HELD-TO-MATURITY AVAILABLE-FOR-SALE
------------------------------------------- -------------------------------------------
AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE
------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
U.S. Treasury and agency
securities:
Due in less than one year $ -- -- 2,992 2,983
Due from one year to five
years -- -- 12,489 12,476
Due from five to ten years -- -- -- --
Due after ten years -- -- -- --
------------------- ------------------- ------------------- -------------------
$ -- -- 15,481 15,459
=================== =================== =================== ===================
</TABLE>
F-16
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) LOANS RECEIVABLE
Loans receivable are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------------------- -------------------
<S> <C> <C>
Trust deed loans collateralized by real estate:
1-4 family residential properties $ 64,558 82,436
Multifamily 214,462 180,940
Commercial 154,717 116,389
Construction and land 10,465 3,954
Consumer loans 493 1,244
------------------- -------------------
444,695 384,963
Less:
Loans in process 6,653 1,439
Deferred origination fees, net 1,957 2,303
Allowance for loan losses 8,848 7,676
------------------- -------------------
Loans receivable, net $ 427,237 373,545
=================== ===================
</TABLE>
The Company serviced loans for others in the approximate amounts of $5.5
million and $5.0 million at December 31, 1997 and 1996, respectively.
The Company had impaired loans of $9.1 million and $10.9 million at
December 31, 1997 and 1996, respectively. The average recorded investment
in impaired loans during 1997 and 1996 was $11.8 million and $12.3 million,
respectively. The total allowance for loan losses related to impaired loans
was $1.3 million and $2.6 million at December 31, 1997 and 1996,
respectively. Interest income recognized on impaired loans of $627,000,
$861,000 and $1,000,000 was recognized for cash payments received in 1997,
1996 and 1995, respectively.
The Company had no loans 90 days past due and still accruing interest at
December 31, 1997 and 1996.
The amounts below approximate the balance of loans which have been placed
on nonaccrual status and the interest that would have been earned had the
loans been performing (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Principal balance $ 4,485 3,455 5,220
Foregone interest 396 692 788
=================== =================== ===================
</TABLE>
F-17
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Restructured loans for which interest has been reduced or suspended totaled
approximately $4.6 million, $7.4 million and $9.4 million at December 31,
1997, 1996 and 1995, respectively. Interest income that would have been
recorded under the original terms of such loans and the interest income
actually recognized for the years ended December 31 are summarized as
follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Interest income that would have been recorded $ 596 887 796
Interest income recognized (417) (626) (576)
------------------- ------------------- -------------------
Interest income foregone $ 179 261 220
=================== =================== ===================
</TABLE>
A summary of the activity in the allowance for loan losses for the years
ended December 31 is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Allowance for loan losses at beginning of year $ 7,676 7,056 8,832
Provision for losses 5,164 3,930 5,221
Losses charged against the allowance (3,992) (3,323) (7,912)
Recoveries -- 13 915
------------------- ------------------- -------------------
Allowance for loan losses at end of year $ 8,848 7,676 7,056
=================== =================== ===================
</TABLE>
(4) REAL ESTATE ACQUIRED THROUGH FORECLOSURE
Real estate acquired through foreclosure for years ended December 31 is as
follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------------------- -------------------
<S> <C> <C>
Real estate acquired through foreclosure $ 1,628 1,400
Less allowance for losses (85) --
------------------- -------------------
$ 1,543 1,400
=================== ===================
</TABLE>
F-18
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
A summary of the change in the allowance for possible losses on real estate
acquired through foreclosure for the years ended December 31 is summarized
as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Balance at beginning of year $ -- -- --
Provision charged to expense 310 264 669
Charge-offs (225) (264) (669)
------------------- ------------------- -------------------
Balance at end of year $ 85 -- --
=================== =================== ===================
</TABLE>
Components of the Company's net cost of operation of real estate acquired
through foreclosure for the years ended December 31 are as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Gains on sales $ (253) (399) (305)
Losses on sales 163 69 619
Provision for losses 310 264 669
Operating costs while owned 335 994 1,323
------------------- ------------------- -------------------
$ 555 928 2,306
=================== =================== ===================
</TABLE>
(5) PREMISES AND EQUIPMENT
Premises and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------------------------
1997 1996
------------------- -------------------
<S> <C> <C>
Office buildings $ 6,683 $ 6,682
Leasehold improvements 1,026 1,623
Furniture, fixtures, equipment and vehicles 1,575 1,647
Land 1,936 1,936
------------------- -------------------
11,220 11,888
Less accumulated depreciation and amortization (3,621) (3,577)
------------------- -------------------
Premises and equipment net $ 7,599 $ 8,311
=================== ===================
</TABLE>
F-19
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) DEPOSITS
Deposits at December 31 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------------------- -------------------
<S> <C> <C>
NOW accounts $ 27,217 33,038
Passbook accounts 21,716 29,224
Money Market Checking and Savings 20,720 22,118
Certificates of deposit 294,025 300,541
------------------- -------------------
$ 363,678 384,921
=================== ===================
</TABLE>
As of December 31, 1997, certificate accounts are scheduled to mature as
follows (in thousands):
<TABLE>
<CAPTION>
YEAR OF MATURITY AMOUNT
------------------------------------------ -------------------
<S> <C>
1998 $ 242,663
1999 38,555
2000 8,494
Thereafter 4,313
-------------------
$ 294,025
===================
</TABLE>
The aggregate amount of jumbo certificates of deposit with a balance equal
to or greater than $100,000 was $71.1 million and $56.2 million at December
31, 1997 and 1996, respectively.
The amount of interest expense per deposit category for the years ended
December 31 is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
NOW accounts $ 333 347 482
Money market checking and savings accounts 873 680 779
Passbook accounts 596 853 1,276
Certificates of deposit 16,509 16,188 16,002
------------------- ------------------- -------------------
$ 18,311 18,068 18,539
=================== =================== ===================
</TABLE>
(7) FHLB ADVANCES
FHLB advances represent secured obligations with the Federal Home Loan Bank
(FHLB), at various rates and terms. FHLB advances are secured by mortgage
loans and mortgage-backed securities.
F-20
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Mortgage loans and mortgage-backed securities with a carrying value of
$243.5 million and $294.1 million, have been pledged to secure these
advances at December 31, 1997 and 1996, respectively. Advances at December
31, 1997 have the following maturity dates: $61.5 million in 1998, $49.0
million in 1999, $9.5 million in 2000 and $15.0 million in 2002. Interest
rates range from 5.30% to 8.29%.
The following table approximates the maximum month-end balance outstanding,
average daily balance outstanding, average rates paid during the year and
the average rates on the balance at December 31 for FHLB advances (dollars
in thousands):
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Maximum month-end balance $ 135,000 62,500 61,500
Average daily balance 95,979 39,563 51,734
Average rates paid 6.17% 5.96% 5.44%
Average rates on balance at year-end 6.07% 6.19% 5.70%
Balance at year-end $ 135,000 62,500 39,500
=================== =================== ===================
</TABLE>
(8) INCOME TAXES
Significant components of the Company's deferred tax assets and liabilities
as of December 31 are approximated as follows (dollars in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Deferred tax assets:
Depreciation $ 24 143 107
Book over tax reserve for loan losses 3,334 3,511 3,231
Deferred compensation 2,094 1,765 1,014
Installment sale 246 249 249
Allowance for losses 993 1,003 1,003
Nonaccrual interest 85 89 357
Unrealized loss on securities available-for-sale 101 170 182
Real estate owned - allowances 139 -- 558
Discount to facilitate sale of real estate owned 457 239 251
Net operating loss carryforward -- 467 297
Mark to market for loans 482 -- --
Other 10 51 57
------------------- ------------------- -------------------
Deferred tax asset 7,965 7,687 7,306
Valuation allowance (223) (1,334) (1,012)
------------------- ------------------- -------------------
Total deferred tax assets 7,742 6,353 6,294
------------------- ------------------- -------------------
</TABLE>
F-21
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Deferred tax liabilities:
Accrued interest $ 48 115 128
State franchise tax 408 220 215
Tax over book deferred loan fees 1,380 287 301
FHLB dividends 1,087 965 885
Mark to market for loans -- 303 267
------------------- ------------------- -------------------
Total deferred tax liabilities 2,923 1,890 1,796
------------------- ------------------- -------------------
Net deferred tax asset $ 4,819 4,463 4,498
=================== =================== ===================
</TABLE>
A summary of the provision for income taxes (benefit) for the years ended
December 31 is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Current taxes:
Federal $ 3,073 987 4,904
State (22) 2 2
------------------- ------------------- -------------------
3,051 989 4,906
------------------- ------------------- -------------------
Deferred taxes:
Federal 109 (748) (5,570)
State 575 (79) 47
------------------- ------------------- -------------------
684 (827) (5,523)
------------------- ------------------- -------------------
Change in the valuation allowance (1,111) -- --
------------------- ------------------- -------------------
$ 2,624 162 (617)
=================== =================== ===================
</TABLE>
A reconciliation of the Federal statutory income tax rate to the effective
income tax rate for the years ended December 31 is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Statutory Federal tax rate 34.0% 34.0% (34.0)%
Officers' life insurance (.9) (8.9) --
State income taxes, net of Federal benefit 6.3 (10.9) --
Change in the valuation allowance (12.7) -- --
Other 3.3 5.4 (4.7)
------------------- ------------------- -------------------
30.0% 19.6% (38.7)%
=================== =================== ===================
</TABLE>
F-22
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Deferred tax assets are initially recognized for net operating loss and
differences between the financial statement carrying amount and the tax
bases of assets and liabilities which will result in future deductible
amounts. A valuation allowance is then established to reduce that deferred
tax asset to the level at which "it is more likely than not" that the tax
benefits will be realized. A taxpayer's ability to realize the tax benefits
of deductible temporary differences and net operating loss carryfowards
depends on having sufficient taxable income of an appropriate character
within the carryback and carryforward periods. Sources of taxable income
that may allow for the realization of tax benefits include (i) taxable
income in the current year or prior years that is available through
carryback, (ii) future taxable income that will result from the reversal of
existing taxable temporary differences and (iii) future taxable income
generated by future operations. Based on the Company's projected taxable
earnings, management believes it is more likely than not that the Company
will realize the benefit of the existing net deferred tax asset at December
31, 1997.
At December 31, 1997, approximately $4,202,000 of accumulated retained
earnings have qualified as tax bad debt deductions for which no provision
for Federal income taxes has been made. If in the future these amounts are
used for any purpose other than to absorb loan losses, including
distributions in liquidation, a tax liability will be imposed at the
current corporate rate. It is not contemplated that such amounts will be
used in any manner which will create a Federal income tax liability.
(9) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
These financial instruments include commitments to extend credit, including
unfunded lines of credit. Those instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount
recognized in the consolidated statements of financial condition. The
contractual amounts of those instruments reflect the extent of involvement
the Company has in particular classes of financial instruments.
(10) COMMITMENTS AND CONTINGENCIES
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments as the Company
uses the same lending policies for these instruments as it does for the
loan portfolio. The Company has outstanding commitments to fund loans of
approximately $25.5 million and $7.6 million at December 31, 1997 and 1996,
respectively. These commitments expire within approximately 90 days and
provide for variable rates of interest. The Company also has unfunded
construction loan commitments in the amount of approximately $6.3 million
and $1.3 million at December 31, 1997 and 1996, respectively.
F-23
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
COMMITMENTS
The Company leases its branch operation premises under various operating
leases and certain automobiles. The leases expire at varying periods
through the year 2002. At December 31, 1997, the minimum rental commitments
under all noncancelable leases with initial or remaining terms of more than
one year are approximated as follows (in thousands):
<TABLE>
<CAPTION>
YEAR AMOUNT
--------------------------------------- -------------------
<S> <C>
1998 $ 372
1999 258
2000 235
2001 172
2002 74
-------------------
Total minimum payments required $ 1,111
===================
</TABLE>
Included in occupancy and equipment expense for 1997, 1996 and 1995 are
rental expenses for premises and equipment of approximately $614,000,
$875,000 and $1,056,000, respectively. Included in other expenses for 1997,
1996 and 1995 are auto lease expenses of approximately $22,000, $23,000 and
$26,000, respectively. Office leases provide for certain cost-of-living
increases and require the Company to pay for property taxes, insurance and
maintenance expenses.
CONTINGENCIES
The Company is also involved in certain other litigation concerning various
transactions entered into during the normal course of business. Management
does not believe that the settlement of such litigation will have a
material effect on the Company.
(11) OTHER NONINTEREST INCOME
Components of the Company's other noninterest income for the years ended
December 31 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Late charges and collection fees $ 93 192 227
Retail branch fees (including ATM) 1,099 1,105 571
Dividends on FHLB stock 293 177 170
Other 287 237 516
------------------- ------------------- -------------------
Total noninterest income - other $ 1,772 1,711 1,484
=================== =================== ===================
</TABLE>
F-24
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(12) PREFERRED AND COMMON STOCK
The Company has authorized 1,000,000 shares of preferred stock. The Board
has the authority to issue the preferred stock in one or more series, and
to fix the designations, rights, preferences, privileges, qualifications
and restrictions, including dividend rights, conversion rights, voting
rights, rights of redemption, liquidation preferences and sinking fund
terms, any or all of which may be greater than the rights of the common
stock.
(13) EMPLOYEES' PROFIT SHARING AND RETIREMENT PLANS
As of January 1, 1995, the Company converted its noncontributory employee
profit sharing retirement plan to a contributory plan. Under the new plan,
the first 6% or less of a participant's compensation contributed is matched
at 50% by the Company. All employees of the Company who have completed one
year of service and have reached 21 years of age can participate in the
plan. Under the previous plan, contributions were discretionary, and were
determined annually by the Company's Board of Directors based on the
Company's net earnings. The contributions charged against operating results
were approximately $89,000, $69,000 and $66,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
The Company also funds a Supplemental Executive Retirement Plan (SERP) and
a Split Dollar Insurance Program (SDIP) for the benefit of certain
employees and former employees of the Company who were employed by the
Company in 1986 and before. The SERP calls for a defined benefit to be paid
to certain employees and former employees, while the SDIP provides a
benefit to certain employees and former employees based upon the values of
specific insurance policies less Company funding costs. As of December 31,
1997 and 1996, the Company had recorded liabilities of $3.7 million and
$3.9 million, respectively. The total related compensation cost was
approximately $157,000, $1,009,000 and $174,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
The following table sets forth the SERP's funded status and amounts
recognized in the Company's consolidated statements of financial condition:
<TABLE>
<CAPTION>
DECEMBER 31
-------------------------------------------
1997 1996
------------------- -------------------
<S> <C> <C>
Actuarial present value of benefit obligations:
Vested benefit obligation $ 2,602 2,683
Nonvested benefit obligation 69 36
------------------- -------------------
Accumulated benefit obligations $ 2,671 2,719
=================== ===================
Projected benefit obligation for service rendered to date $ 2,671 2,719
Plan assets, at fair value 4,401 4,083
------------------- -------------------
Excess of plan assets over projected benefit obligations
$ 1,730 1,364
=================== ===================
</TABLE>
F-25
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Net pension cost includes the following components:
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------------------------
1997 1996
------------------- -------------------
<S> <C> <C>
Service cost - benefits earned during the period $ 10 9
Interest cost on projected benefit obligation 135 61
Service cost - benefits earned in prior periods -- 878
Net amortization and deferral (372) (261)
------------------- -------------------
Net periodic pension cost $ (227) 687
=================== ===================
</TABLE>
The discount rate used to determine the actuarial present value of the
benefit obligations was 7.0% as of December 31, 1997 and 1996.
(14) STOCK-BASED COMPENSATION
During 1994, the Company adopted a Stock Option and Performance Share Award
Plan (the Plan), which provides for the grant of options and performance
share awards to key employees as designated by the Board of Directors and
for the automatic grant of stock options to nonemployee directors. The
aggregate number of common stock outstanding and available for issuance
pursuant to the exercise of options or the grant of awards is 300,000
shares.
Option grants to employees and nonemployee directors will be at prices at
least equal to the market price of the Company's stock on the effective
date of the grant. The terms of awards and vesting requirements for
employee options are determined by the Board of Directors. All such options
will expire after ten years from the grant date. Each option granted to a
nonemployee director has a term of five years from the grant date and is
exercisable only if such director has been a nonemployee director for at
least three years. In addition, such options will not be exercisable prior
to six months after the date of grant.
The terms and conditions of performance share awards are determined by the
Board of Directors.
On April 16, 1997, 18,000 shares of stock with a fair value of $382,500
were issued as performance shares to certain key employees. These shares
will be fully vested as of January 1, 1999. In connection with the issuance
of these shares, $255,000 has been charged to compensation expense for the
year ended December 31, 1997.
F-26
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
A summary of the status of the Company's fixed stock option plan as of
December 31, 1997 and 1996 and changes for each of the years in the three-
year period ended December 31, 1997 is presented below:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
------------------- -------------------
<S> <C> <C>
Outstanding at December 31, 1994 42,500 $ 16.00
Stock options canceled (25,000) 16.00
Stock options granted 69,000 13.65
-------------------
Outstanding at December 31, 1995 86,500 14.13
Stock options granted 46,000 16.38
-------------------
Outstanding at December 31, 1996 132,500 14.91
Stock options granted 123,500 21.53
Stock options exercised (18,300) 13.31
-------------------
Outstanding at December 31, 1997 237,700 18.47
=================== ===================
</TABLE>
The following information applied to options outstanding at December 31,
1997:
<TABLE>
<S> <C>
Number outstanding 237,700
Range of exercise prices $12.00 to $23.25
Weighted-average exercise price $18.47
Weighted-average remaining life 7.83 years
</TABLE>
In August 1995, amendments were made to reprice 25,000 certain options from
$16 per share to the price of $12.
The Company applies APB Opinion 25 in accounting for its stock-based
compensation plan. Accordingly, no compensation cost has been recognized
for its stock options. Had compensation cost been recognized based upon the
fair value of the options at the grant date consistent with the methodology
specified in SFAS No. 123, the Company's net earnings and net earnings per
share at December 31, 1997, 1996 and 1995 would have been (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Net earnings (loss) as reported $ 6,123 665 (979)
Net earnings (loss) pro forma 5,666 588 (1,182)
Basic earnings (loss) per share as reported 2.66 .29 (.86)
Basic earnings (loss) per share pro forma 2.46 .26 (1.04)
Diluted earnings (loss) per share as reported 2.58 .29 (.86)
Diluted earnings (loss) per share pro forma 2.39 .26 (1.04)
=================== =================== ===================
</TABLE>
F-27
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The per share weighted-average fair value of stock options granted during
1997, 1996 and 1995 was $7.03, $7.37 and $7.93, respectively, on the date
of grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions: 1997 - volatility of 19.0%, no expected
dividends, risk-free interest rate of 6.7% and an expected life of 5 years;
1996 - volatility of 39.1%, no expected dividends, risk-free interest rate
of 6.7% and an expected life of 5 years; 1995 volatility of 54.2%, no
expected dividends, risk-free interest rate of 6.4% and an expected life of
5 years.
During the initial phase-in period, the effects of applying SFAS No. 123
for these pro forma disclosures are not likely to be representative of the
effects on reported income for future years as options vest over several
years and additional awards are generally made each year.
(15) OTHER NONINTEREST EXPENSE
Components of the Company's other noninterest expense for the years ended
December 31 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Legal fees $ 329 416 410
Advertising 161 124 94
Stationery and printing 251 264 235
Telephone expense 136 168 158
Insurance expense 270 315 349
Audit and accounting 150 299 239
Other 857 1,096 1,176
------------------- ------------------- -------------------
Total other noninterest expense $ 2,154 2,682 2,661
=================== =================== ===================
</TABLE>
(16) RESTRICTIONS ON CASH DIVIDENDS; REGULATORY CAPITAL REQUIREMENTS
Under Federal banking law, dividends declared by savings banks in any
calendar year may, upon the approval of the Office of Thrift Supervision
(OTS), equal the greater of (i) 100% of its net earnings to date during the
calendar year plus the amount that would reduce by one-half its "surplus
capital ratio" (as defined) at the beginning of the calendar year; or (ii)
75% of its net earnings for the previous four quarters.
The Company and the Bank are 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 Company's consolidated financial
statements. Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Company and the Bank must meet specific
capital guidelines that involve quantitative measures of the Company and
the Bank's assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Company and the
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings and other
factors.
F-28
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios
(set forth in the table below) of total and Tier I capital (as defined in
the regulations) to risk-weighted assets (as defined) and of Tier I capital
(as defined) to average assets (as defined). Management believes that, as
of December 31, 1997, the Company and the Bank meet all capital adequacy
requirements to which it is subject.
As of December 31, 1997, the most recent notification from the Office of
Thrift Supervision categorized the Bank as well capitalized under the
regulatory framework for prompt corrective actions. To be categorized as
well capitalized the Bank must maintain minimum total risk-based, Tier I
risk-based and Tier I leveraged ratios as set forth in the following table.
There are no conditions or events since that notification that management
believes have changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the
table (in thousands). There was no deduction from capital for interest-rate
risk in 1997 and 1996.
<TABLE>
<CAPTION>
TO BE WELL CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE ACTION
ACTUAL ADEQUACY PURPOSES PROVISIONS
------------------- ------------------- ------------------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
--------- -------- --------- -------- --------------------- ---------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1997:
Risk-Based Capital $ 42,702 10.65% $ 32,068 8.0% $ 40,085 10.0%
Tier I Risk-Based Capital 37,679 9.40 16,034 4.0 24,051 6.0
Leverage Capital 37,679 6.85 21,989 4.0 27,486 5.0
Tangible Capital 37,679 6.85 8,246 1.5 8,246 1.5
========= ======== ========= ======== ===================== =========
As of December 31, 1996:
Risk-Based Capital $ 39,111 11.27% $ 27,774 8.0% $ 34,718 10.0%
Tier I Risk-Based Capital 35,110 10.12 13,887 4.0 20,831 6.0
Leverage Capital 35,110 7.17 19,556 4.0 24,457 5.0
Tangible Capital 35,110 7.17 7,337 1.5 7,337 1.5
========= ======== ========= ======== ===================== =========
</TABLE>
At December 31, 1997, Highland Bancorp, Inc. has $4.0 million of capital
which is not included in the above table.
(17) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The consolidated financial statements include various estimated fair value
information. Such information, which pertains to the Company's financial
instruments, does not purport to represent the aggregate net fair value of
the Company. Fair values have been estimated using data that management
considered best available, as generally provided in the Company's
Regulatory Reports, and estimation methodologies deemed suitable for the
pertinent category of financial instrument. Further, the fair value
estimates are based on various assumptions, methodologies and subjective
considerations, which vary widely among different financial institutions
and which are subject to change. The carrying amounts are the amounts at
which the financial instruments are reported in the financial statements.
F-29
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Changes in the assumptions or methodologies used to estimate fair value may
materially affect the estimated amounts. Also, management is concerned that
there may not be reasonable comparability between institutions due to the
wide range of permitted assumptions and methodologies in the absence of
active markets. This lack of uniformity gives rise to a high degree of
subjectivity in estimating financial instrument fair values.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments, for which it is practicable to
estimate that value.
CASH AND CASH EQUIVALENTS
The carrying amount is a reasonable estimate of fair value.
SECURITIES
The fair values of securities is based on quoted market prices or dealer
quotes.
LOANS RECEIVABLE
For certain homogeneous categories of loans, such as some residential
mortgages and other consumer loans, fair value is estimated using the
quoted market prices for securities backed by similar loans, adjusted for
differences in loan characteristics. The fair value of other types of loans
is estimated by discounting the future cash flows using the current rates
at which similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities.
DEPOSIT LIABILITIES
The fair value of demand deposits, savings accounts and certain money
market deposits is the amount payable on demand at the reporting date. The
fair value of fixed-maturity certificates of deposit is estimated using the
rates currently offered for deposits of similar remaining maturities.
FHLB ADVANCES
Rates currently available to the Company for debt with similar terms and
remaining maturities are used to estimate fair value of existing debt.
F-30
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
ACCRUED INTEREST RECEIVABLE AND PAYABLE
The carrying amount approximates fair value because of the short maturity
of these items.
The estimated fair values of the Company's financial instruments are as
follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------------------------- -------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 26,420 26,420 33,714 33,714
Securities available-for-sale 49,635 49,635 37,038 37,038
Securities held-to-maturity 15,419 15,263 17,969 17,493
Loans receivable 427,237 433,965 373,545 380,569
Accrued interest receivable 3,789 3,789 3,404 3,404
Financial liabilities:
Deposits 363,678 364,980 384,921 386,676
FHLB advances 135,000 134,801 62,500 62,798
Accrued interest payable 1,024 1,024 51 51
========== ========== ========== ==========
</TABLE>
(18) YEAR 2000
Many computer systems, including most of those used by the Company,
identify dates using only the last two digits of the year. These systems
are unable to distinguish between dates in the year 2000 and dates in the
year 1900. That inability (referred to as the "Year 2000 issue"), if not
addressed, could cause these systems to fail or provide incorrect
information after December 31, 1999 or when using dates after December 31,
1999. This in turn could have a material adverse impact on the Company and
its ability to process customer transactions or provide customer services.
The Company has implemented a process for identifying, prioritizing and
modifying or replacing systems that may be affected by the Year 2000 issue.
The Company is also monitoring the adequacy of the processes and progress
of third party vendors of systems that may be affected by the Year 2000
issue. While the Company believes its process is designed to be successful,
because of the complexity of the Year 2000 issue, it is possible that the
Company's efforts or those of third party vendors will not be
satisfactorily completed in a timely fashion. In addition, the Company
interacts with a number of other entities, including government entities.
The failure of these entities to address the Year 2000 issue could
adversely affect the Company.
The Company currently estimates that its Year 2000 project, including costs
incurred in 1997 and through the year 2000, may cost approximately $50,000.
These costs include estimates for employee compensation on the project
team, consultants, hardware and software lease expense and depreciation of
equipment purchased as part of the project. Year 2000 costs are expensed as
incurred and approximately $2,000 has been expensed in 1997.
As the Company progresses in addressing the Year 2000 issue, estimates of
costs could change, including as a result of the failure of third party
vendors to address the Year 2000 issue in a timely fashion.
F-31
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(19) QUARTERLY FINANCIAL INFORMATION (UNAUDITED SEE ACCOMPANYING ACCOUNTANTS'
REPORT)
(Dollars in thousands, except for share and common stock closing prices)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1997 1997 1997 1997
----------- ----------- ------------- ------------
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
Interest income $ 10,671 10,756 11,358 11,844
Interest expense 5,641 5,778 6,395 6,410
Net interest income 5,030 4,978 4,963 5,434
Provision for losses on loans 1,800 924 1,230 1,210
Net interest income after provision for loan losses 3,230 4,054 3,733 4,224
Total noninterest income 1,565 425 1,306 628
Net cost of operation of real estate acquired
through foreclosure 101 33 246 175
General and administrative expenses 2,838 2,524 2,309 2,192
Income before taxes 1,856 1,922 2,484 2,485
Income tax expenses 565 569 745 745
Net earnings 1,291 1,353 1,739 1,740
Basic earnings per share .56 .59 .76 .75
Diluted earnings per share .55 .58 .73 .72
Closing prices for common stock:
High 24.00 25.75 31.00 33.125
Low 17.50 20.50 25.00 31.25
=========== =========== ============= ============
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1996 1996 1996 1996
----------- ----------- ------------- ------------
<S> <C> <C> <C> <C>
Year ended December 31, 1996:
Interest income $ 9,543 9,925 9,876 10,294
Interest expense 5,036 4,778 5,181 5,431
Net interest income 4,507 5,147 4,695 4,863
Provision for losses on loans 501 1,030 1,429 970
Net interest income after provision for loan losses 4,006 4,117 3,266 3,893
Total noninterest income 519 602 503 543
Net cost (income) of operation of real estate acquired
through foreclosure 470 464 40 (46)
General and administrative expenses 3,169 3,528 6,075 2,923
Income (loss) before taxes 886 727 (2,346) 1,559
Income tax benefit 285 238 (768) 407
Net earnings (loss) 601 489 (1,578) 1,152
Basic earnings (loss) per share .26 .21 (.68) .50
Diluted earnings (loss) per share .26 .21 (.68) .50
Closing prices for common stock:
High 17.00 17.00 16.25 17.50
Low 14.50 16.00 14.25 14.25
=========== =========== ============= ============
</TABLE>
F-32
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(20) PARENT COMPANY CONDENSED FINANCIAL INFORMATION
This information should be read in conjunction with the other notes to the
consolidated financial statements. The following are the condensed
financial statements for Highland Bancorp, Inc. (Parent Company only) as of
December 31, 1997 and for the year ended December 31, 1997:
<TABLE>
<CAPTION>
DECEMBER 31,
STATEMENT OF FINANCIAL CONDITION 1997
- ------------------------------------------------------------------------------------------ --------------
(In thousands)
<S> <C>
Assets:
Cash and cash equivalents $ 121
Receivable from Highland Federal Bank 3,800
Investment in Highland Federal Bank 37,524
Other assets 79
------------
$ 41,524
============
Liabilities and shareholders' equity:
Other liabilities $ 12
Shareholders' equity 41,512
------------
$ 41,524
============
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
STATEMENT OF OPERATIONS 1997
- ------------------------------------------------------------------------------------------ --------------
(In thousands)
<S> <C>
Other expense $ (12)
Equity in earnings of Highland Federal Bank 6,135
------------
Net earnings $ 6,123
============
</TABLE>
F-33
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
STATEMENT OF CASH FLOWS 1997
- ------------------------------------------------------------------------------------------ --------------
(In thousands)
<S> <C>
Cash flows from operating activities:
Net earnings $ 6,123
Adjustments to reconcile net earnings to cash used by operating activities:
Equity in earnings of Highland Federal Bank (6,135)
Increase in other assets (79)
Increase in other liabilities 12
-----------
Net cash used by operating activities (79)
Cash flows from financing activities dividend from Highland Federal Bank 200
-----------
Net increase in cash and cash equivalents 121
Cash and cash equivalents, beginning of year --
-----------
Cash and cash equivalents, end of year $ 121
===========
</TABLE>
F-34
<PAGE>
(ii) Exhibit Index:
-------------
Exhibit
Number Description of Exhibit
- ------ ----------------------
2.1 Plan of Reorganization and Agreement of Merger, filed as Exhibit A to
the Proxy Statement/Prospectus included in the Registration Statement
on Form S-4 (File No. 333-38911) filed by the Registrant with the
Commission on October 28, 1997 (the "S-4 Registration Statement") and
incorporated herein by reference.
3.1 Certificate of Incorporation of the Registrant, filed as Exhibit 3.1
to the S-4 Registration Statement and incorporated herein by
reference.
3.2 Bylaws of the Registrant, filed as Exhibit 3.2 to the S-4 Registration
Statement and incorporated herein by reference.
4.0 Form of Stock Certificate of the Registrant, filed as Exhibit 4.1 to
the S-4 Registration Statement and incorporated herein by reference.
10.1 Highland Federal Bank 1994 Stock Option and Performance Share Award
Plan, including forms of Stock Option Agreement and Performance Share
Award and Restricted Stock Agreement, filed as Exhibit 10.1 to the S-4
Registration Statement and incorporated herein by reference.
10.2 Highland Federal Bank Profit Sharing Plan and Trust, filed as Exhibit
10.2 to the S-4 Registration Statement and incorporated herein by
reference.
10.3 Form of Change of Control Employment Agreement between the Bank and
each of Stephen N. Rippe, Gary P. Warren, Anthony L. Frey and Ellen B.
Geiger.
10.4 Form of Indemnification Agreement between the Bank and Members of the
Board of Directors of the Bank.
10.5 Retirement Agreement between the Bank and Ben Karmelich, dated June
19, 1986, and Amendment No. 1 to Retirement Agreement, dated March 16,
1988.
16.0 Letter of Grant Thornton LLP, dated March 5, 1997.
11.0 Statement re Computation of Per Share Earnings is included in the
Consolidated Statements of Operations and Notes to Consolidated
Financial Statements of the Registrant which are attached hereto.
21.0 Subsidiaries of the Registrant. The only subsidiary of the Registrant
is Highland Federal Bank, a Federal Savings Bank.
23.0 Consent of KPMG Peat Marwick LLP.
27.0 Financial Data Schedule.
(b) Reports on Form 8-K
-------------------
The Registrant filed one report on Form 8-K during the fourth
quarter of 1997. The report, filed on December 18, 1997 under "Item 5.
Other," related to the automatic succession of the Registrant to the
Exchange Act reporting obligations of the Bank in connection with the
reorganization of the Bank into a holding company form of
organization.
(c) Exhibits Required by Item 601 of Regulation S-K
-----------------------------------------------
See Item 14(a)(3)(i) above.
(d) Additional Financial Statements
-------------------------------
Not applicable.
<PAGE>
EXHIBIT 10.3
FORM OF CHANGE OF CONTROL EMPLOYMENT AGREEMENT
----------------------------------------------
This Change of Control Employment Agreement (hereinafter referred to as
"Agreement") is entered into effective as of ,199 (hereinafter referred
-------- --
to as "Effective Date") by and between Highland Federal Bank, FSB (hereinafter
referred to as "Bank") and ______________ (hereinafter referred to as
"Executive").
W I T N E S S E T H
-------------------
WHEREAS, in order to ensure the successful management of the Bank, the Bank
desires to avail itself of the experience, skills, abilities and knowledge of
Executive;
WHEREAS, should the possibility of a Change of Control (as defined below)
arise, the Board of Directors of the Bank (hereinafter referred to as "Board")
believes it imperative that the Bank and the Board be able to rely upon the
Executive to continue in Executive's position, and that the Bank be able to
receive and rely upon the Executive's advice, if it requests such advice, as to
the best interests of the Bank, without concern that Executive might be
distracted by the personal uncertainties and risks created by the possibility of
a Change of Control;
WHEREAS, should the possibility of a Change of Control arise, in addition
to the Executive's regular duties, the Executive may be called upon to assist in
the assessment of such possible Change of Control, to advise management and the
Board as to whether such Change of Control would be in the best interests of the
Bank and to take such other actions as the Board might determine to be
appropriate;
WHEREAS, the Bank desires to continue to avail itself of the skill,
knowledge and experience of Executive to ensure the successful management of the
business of the Bank should the Board agree to enter into a Change of Control
and the employment of the Executive is materially adversely altered or not
continued by the acquiring financial institution or individuals following the
closing of such Change of Control; and
WHEREAS, the Agreement was duly reviewed, fixed, stated, approved and
authorized for and on behalf of the Bank by action of
<PAGE>
the Board.
NOW, THEREFORE, IN CONSIDERATION OF the mutual covenants, terms and
conditions hereinafter set forth, the sufficiency of which is acknowledged, the
parties hereto covenant and agree as follows:
1. DEFINITIONS.
-----------
As used in this Agreement:
1.1 Change of Control. "Change of Control" means (i) a merger where the
-----------------
Bank is not the surviving entity; (ii) a consolidation where the Bank is not the
surviving entity; (iii) a transfer to another entity of all or substantially all
of the assets of the Bank; (iv) an acquisition by a person (which term includes
an entity or an individual) or persons acting as a group of more than fifty
percent (50%) of the then outstanding shares of the Bank that are held by a
person or group of persons (whether or not acting in concert) not the holder of
more than fifty percent (50%) of the shares of the Bank on the Effective Date;
or (v) during any period of twenty-four (24) consecutive months, individuals who
at the beginning of such period were members of the Board (the "Incumbent
Board") shall cease to constitute a majority of the Board or the board of
directors of any successor to the Bank, provided that any individual becoming a
director subsequent to the beginning of such period whose election or nomination
for election was approved by a vote of least seventy-five percent (75%) of the
directors compromising the Incumbent Board shall, for purposes hereof, be
considered as though such individual were a member of the Incumbent Board.
1.2 Good Reason. "Good Reason" means (i) the Executive's then current
-----------
level of annual base salary is reduced; or (ii) there is any reduction in the
employee benefit coverage provided to the Executive (including pension, profit
sharing, deferred compensation, life insurance and health insurance, but not
including incentive bonuses) from the coverage levels in effect immediately
prior to the Change of Control, unless the Bank provides substantially
equivalent employee benefits to the Executive; or (iii) the Executive suffers a
material diminution in Executive's title, position, reporting relationship,
responsibilities, authority or offices; or (iv) there is a
-2-
<PAGE>
relocation of the Executive's principal business office by more than fifty (50)
miles from its existing location; or (v) the Bank fails to obtain assumption of
any employment agreement relating to Executive by any successor or assign of the
Bank; provided, however, that termination by the Executive for Good Reason must
be made in good faith.
2. EMPLOYMENT OF EXECUTIVE.
-----------------------
This Agreement is not intended to alter or otherwise change the current
employment relationship between Executive and the Bank except as stated herein.
3. DUTIES.
------
3.1 General. Executive shall serve as _______________________________
-------
_____________________________, subject to the powers by law vested in the Board
and in the Bank's shareholders.
3.2 Performance. Executive shall devote substantially all of
-----------
Executive's full energies, interest, abilities and productive time to the
business of the Bank.
4. CHANGE OF CONTROL.
-----------------
4.1 General. In the event that (i) a Change of Control occurs during
-------
the employment of the Executive and (ii) (a) the Executive's position is either
eliminated or materially changed or (b) the Executive terminates or resigns
Executive's employment for a Good Reason, the Executive shall receive eighteen
(18) months of the Executive's then current annual salary in full and complete
satisfaction of any and all rights which Executive may enjoy hereunder. Said
amount shall not reduce or otherwise affect Executive's rights, if any, to
exercise any stock options vested prior to such termination. The Executive may
choose to receive said amount in a lump sum or in quarterly payments.
4.2 Continuation of Health Insurance Upon Termination. If the Bank
-------------------------------------------------
terminates the employment of Executive upon a Change of Control as provided
above, the Bank will issue notice of continuation of health insurance pursuant
to federal law (including COBRA), and will pay Executive the equivalent eighteen
(18) months' continuation of such benefits.
-3-
<PAGE>
4.3 Notice of Good Reason by Executive to Bank. Notwithstanding anything
------------------------------------------
to the contrary contained herein, Executive shall not be deemed to have
terminated or resigned Executive's employment for Good Reason unless (i) the
Executive shall give written notice to the Bank not later than thirty (30) days
prior to the effective date of such termination for Good Reason and within six
(6) months after the date the Executive first becomes entitled to terminate for
Good Reason on account of the event(s) forming the basis for such termination,
setting forth in specific detail the basis for such termination for Good Reason;
and (ii) the Bank shall not, within thirty (30) days after receipt of such
notice, take actions reasonably acceptable to the Executive to remedy the
circumstances leading to the termination for Good Reason.
4.4 Termination Prior to a Change of Control. Notwithstanding anything to
----------------------------------------
the contrary contained herein, in the event of termination of employment of
Executive prior to a Change of Control (provided that such termination is not
due solely to a Change of Control that is expected to occur in the future),
Executive shall not receive the benefits of Sections 4.1 and 4.2. Nothing herein
shall prevent the Executive from exercising any stock options vested prior to
such termination.
4.5 Termination for Cause. The provisions of subsection (b) of Section
---------------------
563.39 of the OTS Regulations as in effect on the Effective Date are hereby made
a part of this Agreement and are incorporated herein by this reference thereto.
4.6 Regulatory Limitation. Any payments made to Executive pursuant to this
---------------------
Agreement, or otherwise, are subject to and conditioned upon their compliance
with 12 U.S.C. /S/1828(k) and any regulations promulgated thereunder, including
without limitation Part 359 of the FDIC Regulations.
5. MISCELLANEOUS.
-------------
5.1 Term. The term of this Agreement shall commence on the Effective Date
----
and shall continue until the fifth anniversary of the Effective Date
(hereinafter referred to as "Expiration Date"). At any time during the twelve
months preceding the Expiration Date or the expiration date of any extended term
of this Agreement, the Board may extend the term of this Agreement for
-4-
<PAGE>
additional terms.
5.2 Notice. Any and all notices and other communications hereunder shall be
------
in writing and shall be deemed to have been duly given when delivered personally
or forty-eight (48) hours after being mailed, certified or registered mail,
return receipt requested, postage prepaid, to the addresses as may from time to
time be designated by the parties hereto in writing.
5.3 Time. Time is of the essence in the performance of this Agreement with
----
respect to each and every provision of this Agreement in which time is a factor.
5.4 Entire Agreement. This Agreement sets forth the entire agreement between
----------------
Executive and the Bank pertaining to the subject matter hereof, fully supersedes
any and all prior agreements or understandings between Executive and any other
persons on behalf of the Bank pertaining to the subject matter hereof and no
change or modification of or addition, amendment or supplement to this Agreement
shall be valid unless set forth in writing and signed and dated by Executive and
the Bank.
5.5 Further Assurances. Executive and the Bank, without the necessity of any
------------------
further consideration, agree to execute and deliver such other documents and
take such other actions as may be necessary to consummate more effectively the
purposes and subject matter of this Agreement.
5.6 Applicable Law; Severability. The existence, validity, construction and
----------------------------
operational effect of this Agreement, any and all of these covenants,
agreements, representations, warranties, terms and conditions, and the rights
and obligations of Executive and the Bank hereunder shall be determined in
accordance with federal law, including without limitation the regulations of the
Office of Thrift Supervision. Any provision of this Agreement which may be
prohibited by law or otherwise held invalid shall be ineffective only to the
extent of such prohibition or invalidity and shall not invalidate or otherwise
render ineffective any or all of the remaining provisions of this Agreement.
5.7 Controversy. In the event of any controversy, claim, or dispute between
-----------
Executive and the Bank arising out of or relating to this Agreement, the
prevailing party shall be entitled
-5-
<PAGE>
to recover as costs from the non-prevailing party reasonable expenses,
including, but not by way of limitation, attorneys' fees and costs and
accountant's fees and costs.
5.8 Arbitration. Any dispute regarding any aspect of this Agreement,
-----------
including but not limited to its formation, performance or breach ("arbitrable
dispute"), shall be submitted to arbitration in Los Angeles County, California,
before a single experienced employment arbitrator licensed to practice law in
California and selected in accordance with the Employment Dispute Resolution
Rules of the American Arbitration Association, as the exclusive forum for
resolving such claims or dispute. The arbitrator shall not have authority to
modify or change the Agreement in any respect. The prevailing party in any such
arbitration shall be awarded its costs, expenses, and actual attorneys' fees and
costs incurred in connection with the arbitration. The Bank and Executive shall
each be responsible for payment of one-half the amount of the arbitrator's
fee(s). The arbitrator's decision and/or award will be fully enforceable and
subject to an entry of judgment by the Superior Court of the State of California
for the County of Los Angeles. Should any party to this Agreement hereafter
institute any legal action or administrative proceeding against the other with
respect to any claim waived by this Agreement or pursue any arbitrable dispute
by any method other than arbitration, the responding party shall recover from
the initiating party all damages, costs, expenses, and attorneys' fees incurred
as a result of such action.
5.9 Headings and Gender. The section headings used in this Agreement are
-------------------
intended solely for the convenience of reference and shall not in any way or
manner amplify, limit, modify or otherwise be used in the interpretation of any
of the provisions of this Agreement, and the masculine, feminine or neuter
gender and the singular or plural number shall be deemed to include the others
whenever the context so indicates or requires.
5.10 Successors. The covenants, agreements, representations, warranties,
----------
terms and conditions contained in this Agreement shall be binding upon and inure
to the benefit of the heirs, beneficiaries, representatives, successors and
assigns of
-6-
<PAGE>
Executive and the Bank, provided, however, that Executive may not assign any or
all of Executive's rights or duties hereunder except upon the prior written
consent of the Board in its sole and absolute discretion.
IN WITNESS WHEREOF, this Agreement is entered into effective as of the
Effective Date.
----------------------------
HIGHLAND FEDERAL BANK, FSB
By:
------------------------
Its:
------------------------
-7-
<PAGE>
EXHIBIT 10.4
INDEMNIFICATION AGREEMENT
--------------- ---------
THIS INDEMNIFICATION AGREEMENT ("Agreement") is made as of this day of
by and between HIGHLAND FEDERAL BANK, A Federal Savings Bank, ("Bank"),
and ______________ ("Indemnitee").
WITNESSETH:
Whereas the Bank and Indemnitee recognize the increasing difficulty
-------
in obtaining directors' and officers' liability insurance, and the general
reductions in the coverage of such insurance; and
Whereas the Bank and Indemnitee further recognize the substantial
-------
increase in corporate litigation in general, subjecting officers and directors
to expensive litigation risks at the same time as the availability and coverage
of liability insurance has been severely limited; and
Whereas Indemnitees and other officers and directors of the Bank may
-------
not be willing to continue to serve as officers and directors without additional
protection; and
Whereas the Bank desires to attract and retain the services of highly
-------
qualified individuals, such as Indemnitee, to serve as officers and directors of
the Bank and to indemnify its officers and directors so as to provide them with
the maximum protection permitted by law; and
Now, Therefore, the Bank and Indemnitee hereby agree as follows:
Whereas Bank and Indemnitee acknowledge and agree that any such
indemnification is subject to the provisions of Section 545.121 of the OTS
Regulations.
1. Indemnification.
---------------
(a) Third Party Proceedings. The Bank shall indemnify Indemnitee if
----- ----- -----------
Indemnitee is or was a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (other than an action by or in the
right of the Bank) by reason of the fact that Indemnitee is or was a director,
officer, employee or agent of the Bank or any subsidiary of the Bank, or by
reason of any action or inaction on the part of Indemnitee while an officer,
director or employee of the Bank or any subsidiary of the Bank, or by reason of
the fact that Indemnitee is or was serving at the request of the Bank as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, against expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement (if such settlement is
approved in advance by the Bank, which approval shall not be withheld
unreasonably) actually and reasonably incurred by Indemnitee in connection with
such action, suit or proceeding if a majority of the disinterested directors of
the Bank determine that Indemnitee was acting in good faith within the scope of
his or her employment or authority as he or she could reasonably have perceived
it under the circumstances and for a purpose he or she could reasonably have
believed under the circumstances was in the best interests of the Bank or its
members and, with respect to any criminal action or proceeding, had no
reasonable cause to
<PAGE>
Page 2
believe Indemnitee's conduct was unlawful. The termination of any action, suit
or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo
contendere or its equivalent, shall not, of itself, create a presumption that
Indemnitee did not act in good faith within the scope of his or her employment
or authority and in a manner which Indemnitee reasonably believed to be in or
not opposed to the best interests of the Bank, and, with respect to any criminal
action or proceeding, had reasonable cause to believe that Indemnitee's conduct
was unlawful.
(b) Proceedings By or in the Right of the Bank. The Bank shall
----------- -- -- -- --- ----- -- --- ----
indemnify Indemnitee if Indemnitee is or was a party or is threatened to be made
a party to any threatened, pending or completed action or suit by or in the
right of the Bank or any subsidiary of the Bank to procure a judgment in its
favor by reason of the fact that Indemnitee is or was a director, officer,
employee or agent of the Bank or any subsidiary of the Bank, or by reason of any
action or inaction on the part of Indemnitee while an officer, director or
employee of the Bank or any of its subsidiaries, or by reason of the fact that
Indemnitee is or was serving at the request of the Bank as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise, against expenses (including attorneys' fees) and, to the
fullest extent permitted by law, amounts paid in settlement, in each case to the
extent actually and reasonably incurred by Indemnitee in connection with the
defense or settlement of such action or suit if a majority of the disinterested
directors of the Bank determine that Indemnitee was acting in good faith within
the scope of his or her employment or authority as he or she could reasonably
have perceived it under the circumstances and for a purpose he or she could
reasonably have believed under the circumstances was in the best interests of
the Bank or its members, except that no indemnification shall be made in
respect of any claim, issue or matter as to which Indemnitee shall have been
adjudged to be liable to the Bank in the performance of Indemnitee's duty to the
Bank and its shareholders unless and only to the extent that the court in which
such action or suit is or was pending shall determine upon application that, in
view of all the circumstances of the case, Indemnitee is fairly and reasonably
entitled to indemnify for expenses and then only to the extent that the court
shall determine.
(c) Mandatory Payment of Expenses. To the extent that Indemnitee has
--------- ------- -- --------
been successful in a final judgment on the merits in the defense of any action,
suit or proceeding referred to in Subsections (a) and (b) of this Section 1 or
in defense of any claim, issue or matter therein, Indemnitee shall be
indemnified against costs and all other expenses (including attorney's fees)
actually and reasonably incurred by Indemnitee in connection therewith.
(d) Deposition or Hearing. The Bank shall indemnify Indemnitee for
---------- -- -------
any costs or expenses incurred in connection with Indemnitee's testimony at any
deposition or hearing held in connection with a proceeding in which the Bank, or
any of its agents, including Indemnitee, is, or is threatened to be made, a
party.
2. Agreement to Serve. In consideration of the protection afforded by
--------- -- -----
this Agreement, if Indemnitee is a director of the Bank he agrees to serve at
least for the balance of the current term as a director and not to resign
voluntarily during such period without the written consent of a majority of the
Board of Directors. If Indemnitee is an officer of the Bank not serving under an
employment contract, he agrees to serve in such capacity at least for the
balance of the current fiscal year of the Bank and not to resign voluntarily
during such period without the written consent of a majority of the Board of
Directors. Following the applicable period set forth above, Indemnitee agrees to
continue to serve in such capacity at the will of the Bank (or under separate
Agreement, if such agreement exists) so long as he is duly appointed or elected
and qualified in accordance with the applicable provisions of the
<PAGE>
Page 3
Bylaws of the Bank or any subsidiary of the Bank or until such time as he
tenders his resignation in writing. Nothing contained in this Agreement is
intended to create in Indemnitee any right to continued employment.
3. Expenses; Indemnification Procedure.
-------- --------------- ---------
(a) Advancement of Expenses. If a majority of the directors of the
----------- -- --------
Bank concludes that, in connection with any civil or criminal action, suit or
proceeding referenced in Section 1(a) or (b) hereof, Indemnitee ultimately may
become entitled to indemnification under this Agreement, the directors may
authorize advancement of all expenses incurred by Indemnitee in connection with
such civil or criminal action, suit or proceeding (but not amounts actually paid
in settlement of any such action, suit or proceeding). Indemnitee hereby
undertakes to repay such amounts advanced only if, and to the extent that, it
shall ultimately be determined that Indemnitee is not entitled to be indemnified
by the Bank as provided herein. The advances to be made hereunder shall be paid
by the Bank to Indemnitee within forty-five (45) days following delivery of a
written request herefor by Indemnitee to the Bank, subject to any required board
of directors determination and the non-objection of the OTS to such
indemnification or advances.
(b) Notice/Cooperation by Indemnitee. Indemnitee shall give the Bank
------ ----------- -- ----------
notice in writing as soon as practicable of any claim made against Indemnitee
for which indemnification will or could be sought under this Agreement;
provided, however, that a delay in giving the Bank such notice shall not, unless
the Bank is subjected to liability or expense thereby, affect Indemnitee's right
to indemnification pursuant to the terms of this Agreement. Notice to the Bank
shall be directed to the Chief Executive Officer of the Bank at the address
shown on the signature page of this Agreement (or such other address as the Bank
shall designate in writing to Indemnitee). Notice shall be deemed received three
business days after the date postmarked if sent by domestic certified or
registered mail, properly addressed; otherwise, notice shall be deemed received
only when such notice shall actually have been received by the Bank. In
addition, Indemnitee shall give the Bank such information and cooperation as it
may reasonably require and as shall be within Indemnitee's power.
(c) OTS Notice. Notwithstanding anything to the contrary contained in
--- ------
this Agreement, no indemnification or advances provided for in Section 1 and
this Section 3 shall be made unless the Bank gives the Office of Thrift
Supervision (the "OTS") at least 60 days' notice of its intention to make such
indemnification or advances. Such notice shall state the facts on which the
civil or criminal action, suit or proceeding arose, the terms of any settlement,
and any disposition of the action by a court. Such notice, a copy thereof, and a
certified copy of the resolution containing any required determination by the
board of directors shall be sent to the District Director of the OTS, who shall
properly acknowledge receipt thereof. The notice period shall run from the date
of such receipt. Not such indemnification or advance shall be made if the
Director of the OTS advises the Bank in writing, within such notice period, of
its objection therto.
(d) Procedure. Any indemnification and advances provided for in
Section 1 and this Section 3 shall be made no later than forty-five (45) days
after receipt of the written request of Indemnitee, subject to any required
board of directors determination and the non-objection of the OTS to such
indemnification or advances. If a claim under this Agreement, under any statute,
or under any provision of the Bank's Articles of Incorporation or Bylaws
providing for indemnification, is not paid in full by the Bank within forty-five
(45) days after a written request for repayment thereof has first been received
by the Bank, subject to any required board of directors determination and the
non-objection of the OTS to such indemnification or advances. Indemnitee may,
but need not, at any time thereafter bring an
<PAGE>
Page 4
action against the Bank to recover the unpaid amount of the claim and, subject
to Section 12 of this Agreement, Indemnitee shall also be entitled to be paid
for the expenses (including attorneys' fees) of bringing such action. It shall
be a defense to any such action (other than an action brought to enforce a claim
for expenses incurred in connection with any action, suit or proceeding in
advance of its final disposition) that indemnification would be unlawful because
Indemnitee has not met the statutorily or regulatorily prescribed standards of
conduct which make it permissible under applicable law for the Bank to indemnify
Indemnitee for the amount claimed, but the burden of proving such defense shall
be on the Bank and Indemnitee shall be entitled to receive interim payment of
expenses pursuant to Section 3(a) hereof unless and until such defense may be
finally adjudicated by court order or judgment from which no further right of
appeal exists. It is the parties' intention that if the Bank contests
Indemnitee's right to indemnification, the question of Indemnitee's right to
indemnification shall be for the court to decide, and neither the failure of the
Bank (including its Board of Directors, any committee or subgroup of the Board
of Directors, independent legal counsel, or its stockholders) to have made a
determination that indemnification of Indemnitee is proper in the circumstances,
nor an actual determination by the Bank (including its Board of Directors, any
committee or subgroup of the Board of Directors, independent legal counsel, or
its stockholders) that indemnification is not proper in the circumstances, shall
create any legal presumption that indemnification would, under the
circumstances, be permitted or prohibited by applicable law or the terms of this
Agreement.
(e) Notice to Insurers. If, at the time of the receipt of a notice of
------ -- --------
a claim pursuant to Section 3(b) hereof, the Bank has director and officer
liability insurance, in effect, the Bank shall give prompt notice of the
commencement of such proceeding to the insurers in accordance with the
procedures set forth in the respective policies. The Bank shall thereafter take
all necessary or desirable action to cause such insurers to pay, on behalf of
the Indemnitee, all amounts payable as a result of such proceeding in accordance
with the terms of such policies.
(f) Selection of Counsel. In the event the Bank shall be obligated
--------- -- -------
under Section 3(a) hereof to pay the expenses of any proceeding against
Indemnitee, the Bank, if appropriate, shall be entitled to assume the defense of
such proceeding, with counsel approved by Indemnitee, upon the delivery to
Indemnitee of written notice of its election so to do. After deliver of such
notice, approval of such counsel by Indemnitee and the retention of such counsel
by the Bank, the Bank will not be liable to Indemnitee under this Agreement for
any fees of counsel subsequently incurred by Indemnitee with respect to the same
proceeding, provided that (i) Indemnitee shall have the right to employ his or
her counsel in any such proceeding at Indemnitee's expense; and (ii) if (A) the
employment of counsel by Indemnitee has been previously authorized by the Bank,
or (B) Indemnitee shall have reasonably concluded that there may be a conflict
of interest between the Bank and Indemnitee in the conduct of any such defense
or (C) the Bank shall not, in fact, have employed counsel to assume the defense
of such proceeding, then the fees and expenses of Indemnitee's counsel shall be
borne by the Bank.
4. Additional Indemnification Rights;
---------- --------------- ------
Nonexclusivity.
--------------
(a) Scope. The provisions of this Agreement shall be construed in
-----
conformity with the Bank's intention to agree to indemnify the Indemnitee to the
fullest extent permitted by applicable law, as amended from time to time,
notwithstanding that the form or manner of such indemnification might not be
authorized specifically by the other provisions of this Agreement, the Bank's
Certificate of Incorporation, the Bank's Bylaws or by statute or regulation.
<PAGE>
Page 5
(b) Nonexclusivity. The indemnification provided by this Agreement
--------------
shall not be deemed exclusive of any rights to which Indemnitee may be entitled
under the Bank's Certificate of Incorporation, its Bylaws, any other agreement,
any vote of stockholders or disinterested directors, the corporation laws of the
State of California or Delaware federal law or regulation, or otherwise, both as
to action in Indemnitee's official capacity and as to action in another capacity
while holding such office. Notwithstanding the foregoing or anything to the
contrary contained herein, the Bank shall not indemnify Indemnitee or obtain
insurance with respect to Indemnitee or others other than in accordance with
Section 545.121 of the OTS Regulations. The indemnification provided under this
agreement shall continue as to Indemnitee for any action taken or not taken
while serving in an indemnified capacity even though he or she may have ceased
to serve in such capacity at the time of any action, suit or other covered
proceeding.
5. Officer and Director Liability Insurance. The Bank shall, from time to
----------------------------------------
time, make the good faith determination whether or not it is practicable for the
Bank to obtain and maintain a policy or policies of insurance providing the
officers and directors of the Bank with coverage for losses from certain covered
acts or types of acts, or to ensure the Bank's performance of its
indemnification obligations under this Agreement or otherwise. Among other
considerations, the Bank will weigh the costs of obtaining such insurance
coverage against the protection afforded by such coverage. In all policies of
director and officer liability insurance, Indemnitee shall be named as an
insured in such manner as to provide Indemnitee the same rights and benefits as
are accorded to the most favorably insured of the Bank's directors, if
Indemnitee is a director; or of the Bank's officers, if Indemnitee is not a
director of the Bank but is an officer; of the Company's key employees, if
Indemnitee is not an officer or director but is a key employee. Notwithstanding
the foregoing, the Bank shall have no obligation to obtain or maintain such
insurance if the Bank determines in good faith that such insurance is not
reasonably available, if the premium costs for such insurance are
disproportionate to the amount of coverage provided, if the coverage provided by
such insurance is limited by exclusions so as to provide an insufficient benefit
relative to the cost thereof, or if Indemnitee is covered by similar insurance
maintained by a subsidiary or parent of the Bank. Notwithstanding anything to
the contrary contained herein, the Bank shall not obtain insurance that provides
for a payment of losses of Indemnitee incurred as a consequence of his or her
willful or criminal misconduct.
6. Severability. Nothing in this Agreement is intended to require or shall
------------
be construed as requiring the Bank to do or fail to do any act in violation of
federal law or regulation or California or Delaware law. The Bank's inability,
pursuant to court order to perform its obligations under this Agreement shall
not constitute a breach of this Agreement. The provisions of this Agreement
shall be severable as provided in this Section 6. If this Agreement or any
portion hereof shall be invalidated on any ground by any court of competent
jurisdiction, then the Bank shall nevertheless indemnify Indemnitee to the full
extent permitted by any applicable portion of this Agreement that shall not have
been invalidated, and the balance of this Agreement not so invalidated shall be
enforceable in accordance with its terms.
7. Exceptions. Any other provision herein to the contrary notwithstanding,
----------
the Bank shall not be obligated pursuant to the terms of this Agreement:
(a) Excluded Acts. To indemnify Indemnitee for any acts or omissions
-------------
or transactions from which a director may not be relieved of liability under the
Bank's Certificate of Incorporation; or
<PAGE>
Page 6
(b) Claims Initiated by Indemnitee. To indemnify or advance expenses
------------------------------
to Indemnitee with respect to proceedings or claims initiated or brought
voluntarily by Indemnitee and not by way of defense, except with respect to
proceedings brought in the Bank's name or behalf, or to establish or enforce a
right of indemnification under this Agreement or any other statute or law or
otherwise as required under Chapter 3 of the California General Corporation Law,
but such indemnification or advancement of expenses may be provided by the Bank
in specific cases if the Board of Directors has approved the initiation or
bringing of such suit; or
(c) Lack of Good Faith. To indemnify Indemnitee for any expense
------------------
incurred by the Indemnitee with respect to any proceeding instituted by
Indemnitee to enforce or interpret this Agreement, if a court of competent
jurisdiction determines that the material assertions made by the Indemnitee in
such proceeding were not made in good faith or were frivolous; or
(d) Insured Claims. To indemnify Indemnitee for expenses or
--------------
liabilities of any type whatsoever (including, but not limited to, judgments,
fines, ERISA excise taxes or penalties, and amounts paid in settlement) which
have been paid directly to Indemnitee by an insurance carrier under a policy of
officers' and directors' liability insurance maintained by the Bank; or
(e) Claims Under Section 16(b). To indemnify Indemnitee for expenses
--------------------------
and the payment of profits arising from the purchase and sale by Indemnitee of
securities in violation of Section 16(b) of the Securities Exchange Act of 1934,
as amended, or any similar successor statute.
8. Federal Deposit Insurance Act. The indemnification provided for in
-----------------------------
Section 1 of this Agreement is subject to and qualified by 12 U.S.C. /S/1821(k).
9. Construction of Certain Phrases.
-------------------------------
(a) For purpose of this Agreement, references to the "Bank" shall
include, in addition to the resulting corporation any constituent corporation
(including any constituent of a constituent) absorbed in a consolidation or
merger which, if its separate existence had continued, would have had power and
authority to indemnify its directors, officers and employees or agents, so that
if Indemnitee is or was a director, officer, employee or agent of such
constituent corporation, or is or was serving at the request of such constituent
corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, Indemnitee shall stand in
the same position under the provisions of this Agreement with respect to the
resulting or surviving corporation as Indemnitee would have with respect to such
constituent corporation if its separate existence had continued.
(b) For purposes of this Agreement, references to "other enterprises"
shall include employee benefit plans; references to "fines" shall include any
excise taxes assessed on Indemnitee with respect to an employee benefit plan;
and references to "serving at the request of the Bank" shall include any service
as a director, officer, employee or agent of the Bank which imposes duties on,
or involves services by, such director, officer, employee or agent with respect
to an employee benefit plan, its participants, or beneficiaries; and if
Indemnitee acted in good faith and in a manner Indemnitee reasonably believed to
be in the interest of the participants and beneficiaries of an employee benefit
plan, Indemnitee shall be deemed to have acted in a manner "not opposed to the
best interests of the Bank" as referred to in this Agreement.
<PAGE>
Page 7
10. Counterparts. This Agreement may be executed in one or more
------------
counterparts, each of which shall constitute an original.
11. Successors and Assigns. This Agreement shall be binding upon the Bank
---------- --- -------
and its successors and assigns, and shall inure to the benefit of Indemnitee and
Indemnitee's estate, heirs, legal representatives and assigns.
12. Attorneys' Fees. In the event that any action is instituted by
---------- ----
Indemnitee under this Agreement to enforce or interpret any of the terms hereof,
Indemnitee shall be entitled to be paid all costs and expenses, including
reasonable attorneys' fees, incurred by Indemnitee in connection with such
action except to the extent that, as a part of such action, a court of competent
jurisdiction determines that the material assertions made by Indemnitee as a
basis for such action were not made in good faith or were frivolous. In the
event of an action instituted by or in the name of the Bank under this Agreement
or to enforce or interpret any of the terms of this Agreement, Indemnitee shall
be entitled to be paid all court costs and expenses, including attorney's fees,
incurred by Indemnitee in defense of such action (including with respect to
Indemnitee's counterclaims and cross-claims made in such action), except to the
extent that, as part of such action, the court determines that Indemnitee's
material defenses to such action were made in bad faith or were frivolous.
13. Notice. Except as otherwise provided for in this Agreement, all
notices, requests, demands and other communications under this Agreement shall
be in writing and shall be deemed duly given (i) if delivered by hand and
receipted for by the party addressed on the date of such receipt, or (ii) if
mailed by domestic certified or registered mail with postage prepaid, on the
third business day after the date postmarked. Addresses for notice to either
party are shown on the signature page of this Agreement, or as subsequently
modified by written notice.
<PAGE>
Page 8
14. Consent to Jurisdiction. The Bank and Indemnitee each hereby
------- -- ------------
irrevocably consent to the jurisdiction of the courts of the State of California
for all purposes in connection with any action or proceeding with arise out of
or relates to this Agreement.
15. Choice of Law. This Agreement shall be governed by and its provisions
------ -- ---
construed in accordance with the laws of the United States, including without
limitation the laws, rules and regulations applicable to federally chartered
savings banks, except that, to the extent that this Agreement shall be deemed to
be governed by state law, this Agreement shall be governed by and its provisions
construed in accordance with the laws of the State of Delaware, except to the
extent any California statute shall expressly apply to the exclusion of Delaware
law, in which case California law shall apply.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
-- ------- -------
of the date first above written.
<PAGE>
EXHIBIT 10.5
AGREEMENT
---------
THIS AGREEMENT made as of the 19th day of June, 1986, (hereinafter the
"Effective Date") by and between HIGHLAND FEDERAL SAVINGS AND LOAN ASSOCIATION,
a corporation organized and existing under and by virtue of the laws of the
State of California (hereinafter the "Company") and BEN KARMELICH (hereinafter
the "Employee"), amends, restates and supersedes a prior Agreement between the
parties, which shall be of no further force and effect.
W I T N E S S E T H:
-------------------
WHEREAS, it is the desire of the Company to provide benefits for the Employee
or his survivors upon his retirement or death in order to provide incentives to
the Employee for his continued employment with the Company; and
WHEREAS, the Company by action of its Board of Directors the 19th day of
June, 1986, has duly authorized the adoption and execution of this Agreement.
NOW, THEREFORE, in consideration of the foregoing and the continued
employment of the Employee with the Company, it is mutually agreed as follows:
<PAGE>
ARTICLE I
DEFINITIONS
1.1 The words "Anniversary Date" shall mean the anniversary of the Effective
Date of this Agreement in each and every year subsequent thereto.
1.2 The word "Beneficiary" shall mean any person who receives or is
designated to receive payment of any benefit under the terms of this Agreement
on the death of the Employee.
1.3 The word "Company" shall mean HIGHLAND FEDERAL SAVINGS AND LOAN
ASSOCIATION or any successor corporation or business organization.
1.4 The Employee is "Disabled" when he has been unable to perform his normal
duties of employment with the Company for a period of six (6) continuous months
(as defined in the Company's disability insurance policy covering the Employee,
as from time to time in effect, or as defined in the policy last maintained if
there is not one then in effect, or if none, as determined under the Chubb
United Insurance Company policy most commonly purchased as of the date of the
commencement of the purported disability).
1.5 Any Beneficiary designation heretofore filed by the Employee with the
Company under the superseded Agreement shall govern the payment of any benefits
hereunder unless and until a subsequent designation is filed with the Company.
2
<PAGE>
ARTICLE II
DEFERRED INCOME CREDITS
2.1 For each full year, to a maximum of four (4), subsequent to the Effective
Date, during which the Employee remains in the employ of the Company, the
Employee will be credited with "deferred income" in an amount equal to the sum
of the following:
(1) The Employee's salary deferral of $12,272.00 per annum out of the
otherwise payable annual compensation, if any, due to the Employee (hereinafter
"deferred salary"); and
(2) An additional amount on each Anniversary Date in an amount equal to
a percentage of the total amount of the deferred income credited to the Employee
as of the previous Anniversary Date equal to interest at the rate of seven
percent (7%) per annum (hereinafter "deferred interest").
2.2 For purposes of this Article II, the Employee shall be considered to be
in the employ of the Company during:
(a) Any period in which the Employee is absent with the consent of the
Company; or
(b) Any period during which the Employee is employed by any subsidiary
of the Company.
3
<PAGE>
ARTICLE III
RETIREMENT BENEFITS
3.1 The annual benefit payable to the Employee under this Agreement shall be
Ninety-Two Thousand Forty Dollars ($92,040) per annum, payable in like amounts
for fifteen (15) years, in monthly or other convenient installments of one-
twelfths (1/12ths) or proper portions of the annual amount, without interest.
3.2 In the event of the retirement of the Employee from the employ of the
Company on or after ten (10) years from the Effective Date (or such earlier date
as shall be specified by the Board of Directors of the Company) (hereinafter
"retirement date") the annual amount of retirement benefits shall be payable to
the Employee commencing thirty (30) days from his retirement date.
3.3 In the event of the termination of employment with the Company by the
Employee prior to his Retirement Date (other than reason of the Employee
---------------
becoming disabled or dying), the Employee shall receive the greater of (a) his
deferred income as of the date of his termination, or (b) the product of twenty-
five percent (25%) times the number of full years (not exceeding four (4)) that
the Employee is credited with deferred compensation times his annual retirement
benefit (hereinafter "adjusted retirement benefit"). If his deferred income is
greater as of such date, it shall be paid to him in six (6) equal monthly
installments without interest commencing the first day of the
4
<PAGE>
month following his termination. If the adjusted retirement benefit is greater,
his annual retirement benefit shall be paid to him commencing on the date that
would have been his retirement date, over fifteen (15) years in monthly or other
convenient installments of one-twelfth (1/12) the retirement benefit, or proper
portions thereof, without interest.
Notwithstanding the foregoing, in the event a Change of Ownership occurs
prior to the Employee's termination of service, any benefit payable to the
Employee's termination of service, any benefit payable to the Employee under (b)
above shall be computed, if more favorable to the Employee, by substituting for
"twenty-five percent (25%) times the number of full years (not exceeding four
(4)) that the Employee is credited with deferred salary" the words "one hundred
percent (100%) times". A Change of Ownership shall have occurred on the date
when:
a. More than 50% of the then outstanding shares of the Company are held by
a person or group of persons (whether or not acting in concert) not the
holder of more than 50% of the shares on the Effective Date;
b. Any person or group of persons (whether or not acting in concert) holds
more than 50% of the shares of the Company then outstanding;
c. The Company is declared bankrupt or insolvent or makes an assignment
for the benefit of its creditors;
d. The Company is in material breach of any contract, agreement, law or
regulation;
5
<PAGE>
e. The Company merges with or becomes a subsidiary of another company and
is not the surviving entity or issues more than 50% of its then
outstanding shares in connection with such a transaction and is the
surviving entity.
Notwithstanding the foregoing, no payment shall be made to the Employee
which would subject the Company or Employee to any tax under IRS Section 280G.
6
<PAGE>
ARTICLE IV
DEATH BENEFITS
4.1 In the event of the death of the Employee prior to his termination of
employment, retirement date, or disability, his beneficiary shall be entitled to
receive (a) a single cash payment of Five Thousand Dollars ($5,000), plus (b)
the greater in present value of (i) the benefit described at Paragraph 3.3
determined as if the Employee had terminated his employment on the day
immediately prior to his death; or (ii) the retirement benefits or adjusted
retirement benefits payable to the Employee under Paragraph 3.1 of this
Agreement, in monthly or other convenient installments, of one-twelfth (1/12th)
or the proper portion of the annual retirement benefits, without interest,
commencing thirty (30) days after the date of the Employee's death and
continuing for fifteen (15) years, but reduced by ten percent (10%) for each
year less than ten (10) from the Effective Date to the date of death; or (iii)
the benefit described at Paragraph 5.1 determined as if the Employee had become
disabled on the day immediately prior to his death, payable as described
therein.
4.2 In the event of the death of the Employee after the commencement of
retirement benefit payments under any provision of Article III or V, his
beneficiary shall be entitled to continue to receive the remainder of the
installments of retirement benefits or adjusted retirement benefits otherwise
payable to the Employee, and no more; provided, however, that his
7
<PAGE>
beneficiary shall receive a single additional payment of the amount described at
Paragraph 4.1(a).
4.3 Beneficiaries shall be designated by the Employee from time to time in
such manner as the Company shall require. The Employee shall have the right to
change the beneficiary of any death benefits from time to time by filing notice
and any necessary forms indicating such change with the Company. Any beneficiary
entitled to receive payment of benefits shall have a like right to designate
beneficiaries unless successor beneficiaries were designated by the Employee, in
which case they may only designate further successors. No designation of
beneficiary shall be valid unless in writing signed by the Employee, dated, and
filed with and acknowledged by the Company. Beneficiaries may be changed without
the consent of any prior beneficiaries; provided that the consent of the
Employee's spouse must be obtained to the naming of any primary beneficiary
other than the spouse. If the Employee fails to designate a beneficiary or
successor beneficiary or if there is no beneficiary or successor beneficiary
surviving at his death or the death of the last properly designated beneficiary
or successor, benefits payable shall be paid to the following, in the order
named:
(a) Surviving spouse of the Employee;
(b) Descendents per stirpes of the Employee;
(c) Executor or administrator of the Employee; or
(d) Next of kin of the Employee as provided by the intestacy
laws of the State of California in effect at the time of the event requiring
determination in the order named in such laws.
8
<PAGE>
The Employee's spouse shall be deemed to have designated him as the
beneficiary of any community property interest she may have in all benefits
hereunder if she shall predecease the Employee, unless a different beneficiary
designation is signed by the spouse and Employee, dated, and filed with and
accepted by the Company in writing.
9
<PAGE>
ARTICLE V
DISABILITY BENEFITS
5.1 In the event of the disability of the Employee prior to the
termination of his employment or retirement date, he shall be entitled to
receive his annual retirement benefit for fifteen (15) years (payable in monthly
or other convenient installments, without interest) commencing on the date that
would have been his retirement date had he remained with the Company until such
date; provided, however, that such amount shall be reduced by ten percent (10%)
for each year less than ten (10) from the Effective Date to the date of
commencement of disability; but in no event shall he receive less than the
benefit described at Paragraph 3.3 determined as if the Employee had terminated
his employment on the day immediately prior to his disability commencement.
10
<PAGE>
ARTICLE VI
NONASSIGNABILITY
6.1 This Agreement may not be assigned by the Employee or by the Company
without the consent of the Employee, provided that in the event that
substantially all the assets of the Company are sold or transferred to a
successor corporation or business organization and such successor shall assume
the obligations of the Company hereunder, then the Company may assign this
Agreement without the consent of the Employee.
6.2 No benefits under this Agreement shall be subject in any manner to be
anticipated, alienated, sold, transferred, assigned, pledged, encumbered or
charged by the Employee or any beneficiary, and any attempt by the Employee to
so anticipate, alienate, sell, transfer, assign, pledge, encumber or charge the
same shall be void; nor shall any such benefits in any manner be liable for or
subject to the debts, contracts, liabilities, engagements or torts of the
Employee.
11
<PAGE>
ARTICLE VII
MISCELLANEOUS
7.1 Nothing herein contained shall be construed as giving the Employee the
right to be retained in the service of the Company or shall in any way affect
the right of the Company to control the Employee and to terminate the
employment of the Employee at any time. In the event, but only in the event,
that the Employee is requested by the Board of Directors and agrees in writing
to continue in the employ of the Company after his retirement date, the
retirement benefits otherwise payable to him or his beneficiary shall be
increased by an amount determined by the Company to be sufficient to provide the
Employee at his actual retirement with benefits of an equal value, using rates
approved by the Board of Directors, and the retirement benefits otherwise
payable to the Employee shall be deferred until such actual retirement.
7.2 The Company may insure the life of the Employee as an officer or
employee for such amount as it may deem necessary or advisable to implement the
foregoing provisions and to provide financial reimbursement for the loss of the
Employee. The Company shall name itself as beneficiary of all policies of life
insurance, shall pay all premiums on such insurance, and shall be the sole owner
of such policies. The Employee agrees to submit to any examination which may be
requested by the Company for the purpose of obtaining such insurance. Neither
the Employee nor his beneficiaries shall have any right, title or interest in
any
12
<PAGE>
such policies or the proceeds thereof. Provided, however, if the Employee and
the Corporation agree, such policy may be "split-dollared" between the Company
and the Employee. If such an arrangement is made, then for so long as such
"split-dollared" insurance is in effect, there shall be no death benefits
payable as provided under Article IV hereof, and all obligations of the Company
hereunder shall cease as of the Employee's Death. If such a policy is issued,
there shall be no changes made with respect to such policy (such as ownership,
beneficiary, or discontinuance of premium payments) without the prior written
approval of the Employee. In its sole discretion, the Company may satisfy any
and all obligations hereunder to the Employee or his beneficiaries by purchasing
and assigning an annuity policy from an insurance company licensed to do
business in the State of California providing for the payment of the benefits
otherwise payable hereunder. Upon any such assignment, all rights to payment
hereunder shall cease and neither the Employee nor his beneficiaries shall have
any further rights hereunder.
7.3 If any provision of this Agreement is held invalid or unenforceable,
such invalidity or unenforceability shall not affect any other provisions, and
this Agreement shall be construed and enforced as if such provision had not been
included.
7.4 This Agreement shall be binding on the Company and its successors and
assigns and the Employee, his successors and beneficiaries.
7.5 This Agreement shall be construed in accordance with the laws of the
State of California.
13
<PAGE>
7.6 Nothing created herein shall be deemed to create a trust of any kind
or create any fiduciary relationship. Funds set aside or invested hereunder
shall continue for all purposes to be a part of the general funds of the Company
and no person other than the Company shall, by virtue of the provisions hereof,
have any interest in such funds. Title to and beneficial ownership of any
assets, whether insurance policies, cash or investments, which the Company may
set aside to meet its obligations hereunder, shall at all times remain in the
Company. To the extent that the Employee acquires a right to receive payments
from the Company hereunder, such right shall be no greater than the right of any
unsecured general creditor of the Company.
7.7 If the Company is unable, within seven (7) years after any benefit
becomes due to the Employee or his beneficiary, to authorize payment because the
identity or whereabouts of such person cannot, after the exercise of due
diligence, be ascertained, the Company may direct that such benefit be forfeited
and all liability for the payment thereof shall terminate.
7.8 In the event that the Company shall, prior to distribution to the
Employee or his beneficiary of all amounts due him, terminate the Employee's
employment by reason of the commission of any illegal act intended by him to be
detrimental to the Company, the Employee's participation hereunder shall
forthwith terminate, and any interest he shall have (other than his deferred
salary, to the extent a like amount has not already been paid) whether or not
otherwise vested and whether or not due him or his beneficiary, shall be
forfeited.
14
<PAGE>
7.9 All benefits forfeited by reason of termination prior to vesting,
misdeeds, disappearance, or otherwise, shall remain the property of the Company.
7.10 The books and records to be maintained for the purposes of this
program shall be maintained by the officers and employees of the Company at its
expense and subject to the supervision and control of the Board of Directors.
All expenses of administration, including the expenses of maintaining books and
records and general administrative expenses, shall be paid by the Company.
7.11 Any amounts payable hereunder shall not be deemed salary or other
compensation to the Employee for the purpose of computing benefits to which he
may be entitled under any vacation, health, welfare, profit sharing or pension
plan or other arrangement of the Company for the benefit of its general
employees.
7.12 The program described herein may be amended in whole or in part from
time to time by the Board of Directors of the Company. The Employee and any
persons claiming any interest hereunder shall be bound by such amendments;
provided that no amendment shall deprive the Employee, without his consent, of
the interest he would be entitled to hereunder were his employment terminated at
the time of amendment. Notice of every such amendment shall be given in writing
to the Employee or his designated beneficiary if he is deceased.
7.13 Before making any payment or distribution to the Employee or a
beneficiary, the Company may deduct such amounts
15
<PAGE>
as, in its sole discretion, it deems proper to satisfy obligations owed to it by
the Employee or to protect itself against liability for or on account of debt,
succession, inheritance, income, and other taxes or liabilities of similar
import, and out of money so deducted, discharge any such obligations or
liabilities.
IN WITNESS WHEREOF, HIGHLAND FEDERAL SAVINGS AND LOAN ASSOCIATION, by its
duly authorized officers, and BEN KARMELICH have caused this Agreement to be
executed as of the date and year first above written.
"COMPANY"
-------
HIGHLAND FEDERAL SAVINGS AND
LOAN ASSOCIATION
By /s/ James B. Johnston
-----------------------------
Its James B. Johnston, Secretary
----------------------------
By /s/ Kelly Andrews
-----------------------------
Its Kelly Andrews
Senior Vice President
----------------------------
"EMPLOYEE"
--------
/s/ Ben Karmelich
--------------------------------
BEN KARMELICH
16
<PAGE>
DESIGNATION OF BENEFICIARY
Employee's Name KARMELICH BEN SR.
----------------------------------------------------------
(Last) (First) (Middle)
Beneficiary's Name KARMELICH MARIE A.
-------------------------------------------------------
(Last) (First) (Middle)
Beneficiary's Address 19 LA VISTA VERDE, RANCHO PALOS VERDES, CA 90274
----------------------------------------------------------
Contingent Beneficiary SONS: JOHN, BEN JR, MARK, AND BRIAN KARMELICH
--------------------------------------------------------
The undersigned hereby designates the first beneficiary named as his
beneficiary with respect to any interest the undersigned may have at his death
under all deferred compensation Agreements, as amended from time to time. The
undersigned understands that the beneficiary named herein may be changed at any
time by notifying the Company in writing. If the first beneficiary named is not
living at the time of the undersigned's death, the undersigned hereby designates
the contingent beneficiary hereinabove named as beneficiary of any interest of
the undersigned.
IN WITNESS WHEREOF, the undersigned has executed this designation this 20
day of Nov., 1986.
/s/ Ben Karmelich
----------------------------------
Employee
----------------------------------
Employee's Spouse
*If the employee who signs this form is married and designates a person other
than his spouse as beneficiary, the employee's spouse must approve such
designation by also signing this designation.
<PAGE>
Effective October 1, 1987
Mr. Ben Karmelich
- --------------------
- --------------------
Re: Amendment to Deferred Compensation Agreement
--------------------------------------------
Dear Mr. Karmelich:
Effective June 19, 1986, you and Highland Federal Savings & Loan
Association (the "Company") entered into an Agreement providing for certain
deferred compensation benefits to you. The purpose of this letter is to reflect
an amendment to that Agreement effective October 1, 1987 (the "Amendment Date"),
as follows:
1. Paragraph 2.1(1) of the Agreement is amended to reflect the fact that
as of the Amendment Date, your annual deferred salary shall be increased by
$6,764. per annum.
2. Paragraph 3.1 of the Agreement is amended to reflect the fact that as
of the Amendment Date, your annual benefit shall be increased by $38,040.
3. Retirement, Disability and Death Benefits payable under the Agreement
shall be adjusted to correspond with the foregoing, and prorated to reflect any
partial deferral of salary consistent with our intent to provide you with a new
Anniversary Date for the incremental benefits provided for under this Agreement.
If the above is a correct statement of our agreed Amendment, please sign
and return the enclosed copy of this letter.
Very truly yours,
HIGHLAND FEDERAL SAVINGS
& LOAN ASSOCIATION
By /s/ Kelly Andrews
---------------------
KELLY ANDREWS
ACCEPTED & AGREED Senior Vice President
/s/ Ben Karmelich
- -----------------
Ben Karmelich
<PAGE>
HIGHLAND FEDERAL SAVINGS & LOAN ASSOCIATION
OF LOS ANGELES
6301 North Figueroa Street
Los Angeles, California 90042
March 16, 1988
Mr. Ben Karmelich
6301 North Figueroa Street
Los Angeles, CA 90042
Re: Amendment to Agreement Dated June 19, 1986
------------------------------------------
Dear Mr. Karmelich:
Effective June 19, 1986, you and Highland Federal Savings & Loan
Association (the "Company") entered into an Agreement (the "Agreement")
providing for certain deferred compensation, retirement, disability and death
benefits. The purpose of this letter is to reflect an amendment to the Agreement
which became effective October 1, 1987 (the "Amendment Date"), as follows:
1. Section 2.1(1) of the Agreement provides for an annual salary
deferral of $12,272 per annum for each of the four years commencing June 19,
1986. The Agreement is amended to reflect that there will be an additional
annual salary deferral of $6,754 per annum (the "Additional Salary Deferral"),
for each of the four years commencing on the Amendment Date.
2. The current annual benefit payable to you under the Agreement is
$92,040 (the "Current Benefit"). The annual benefit payable to you under the
Agreement represented by the Additional Salary Deferral shall be $38,040 (the
"Additional Benefit"). The Additional Benefit shall be payable at the times and
on the terms the Current Benefit is payable to you, except that for the purpose
of determining the amount of the Additional Benefit payable from time to time,
the "Effective Date" shall be the Amendment Date, and all determinations of the
amount of the Additional Benefit payable to you (or your beneficiary) upon your
retirement, termination of employment, death or disability shall be separately
determined based on the amount of the Additional Salary Deferral and number of
years
<PAGE>
Mr. Ben Karmelich
March 16, 1988
Page 2
elapsed since the Amendment Date as of the date of such event.
3. Section 3.3 of the Agreement is hereby amended to delete the words
"prior to his Vesting Date" from the first sentence of such section.
If the foregoing correctly states the terms of our amendment to the
Agreement, please execute and return the enclosed copy of this letter.
Very truly yours,
HIGHLAND FEDERAL SAVINGS & LOAN
ASSOCIATION OF LOS ANGELES
By: /s/ James B. Johnston
--------------------------
James B. Johnston,
Executive Vice President
AGREED TO AND ACCEPTED THIS
18 DAY OF MARCH, 1988:
/s/ Ben Karmelich
- -----------------
Ben Karmelich
<PAGE>
Effective January 2, 1989
Mr. Ben Karmelich
- -----------------
- -----------------
Re: Amendment to Deferred Compensation Agreement
--------------------------------------------
Dear Mr. Karmelich:
Effective June 19, 1986, you and Highland Federal Savings & Loan
Association (the "Company") entered into an Agreement providing for certain
deferred compensation benefits to you. The purpose of this letter is to reflect
an amendment to that Agreement effective January 2, 1989 (the "Amendment Date"),
as follows:
1. Paragraph 2.1(1) of the Agreement is amended to reflect the fact that
as of the Amendment Date, your annual deferred salary shall be increased by
$1,533 per annum.
2. Paragraph 3.1 of the Agreement is amended to reflect the fact that as
of the Amendment Date, your annual benefit shall be increased by $8,620.
3. Retirement, Disability and Death Benefits payable under the Agreement
shall be adjusted to correspond with the foregoing, and prorated to reflect any
partial deferral of salary consistent with our intent to provide you with a new
Anniversary Date for the incremental benefits provided for under this Amendment.
If the above is a correct statement of our agreed Amendment, please sign
and return the enclosed copy of this letter.
Very truly yours,
HIGHLAND FEDERAL SAVINGS
& LOAN ASSOCIATION
By /s/ Kelly Andrews
-----------------------
KELLY ANDREWS
ACCEPTED & AGREED Chief Financial Officer
/s/ Ben Karmelich
- -----------------
Ben Karmelich
<PAGE>
EXHIBIT 16.0
[LETTERHEAD OF GRANT THORNTON]
March 5, 1997
Office of Thrift Supervision
Information Services
Attention: Pam Stuckey
1700 G street NW
Washington, DC 20552
Re: Highland Federal Bank, FSB
Dear Sir or Madam:
We have read Item 4 of the Form 8-K of Highland Federal Bank, FSB dated March 3,
1997. With respect to Item 4 paragraph (a) of that Form 8-K, we agree with the
statements contained therein.
With respect to Item 4 paragraph (b), we do not have sufficient knowledge for us
to comment on this statement.
Very truly yours,
/s/ Grant Thornton LLP
<PAGE>
EXHIBIT 23.0
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Highland Bancorp, Inc.
We consent to incorporation by reference in the registration statement (No.
333-45515) on Form S-8 of Highland Bancorp, Inc. of our report dated January 23,
1998, relating to the consolidated statement of financial condition of Highland
Bancorp, Inc. and subsidiaries as of December 31, 1997 and the related
consolidated statements of operations, shareholders' equity and cash flows for
the year ended December 31, 1997, which report appears in the December 31, 1997
Annual Report on Form 10-K of Highland Bancorp, Inc.
KPMG Peat Marwick LLP
Los Angeles, California
March 27, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9 EXHIBIT 27
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 26,420
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 49,635
<INVESTMENTS-CARRYING> 15,419
<INVESTMENTS-MARKET> 15,263
<LOANS> 427,237
<ALLOWANCE> 8,848
<TOTAL-ASSETS> 549,638
<DEPOSITS> 363,678
<SHORT-TERM> 61,500
<LIABILITIES-OTHER> 9,448
<LONG-TERM> 73,500
0
0
<COMMON> 23
<OTHER-SE> 41,489
<TOTAL-LIABILITIES-AND-EQUITY> 549,638
<INTEREST-LOAN> 40,022
<INTEREST-INVEST> 4,607
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 44,629
<INTEREST-DEPOSIT> 18,311
<INTEREST-EXPENSE> 24,224
<INTEREST-INCOME-NET> 20,405
<LOAN-LOSSES> 5,164
<SECURITIES-GAINS> 20
<EXPENSE-OTHER> 10,418
<INCOME-PRETAX> 8,747
<INCOME-PRE-EXTRAORDINARY> 8,747
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,123
<EPS-PRIMARY> 2.66
<EPS-DILUTED> 2.58
<YIELD-ACTUAL> 9.46
<LOANS-NON> 4,485
<LOANS-PAST> 0
<LOANS-TROUBLED> 4,642
<LOANS-PROBLEM> 4,311
<ALLOWANCE-OPEN> 7,676
<CHARGE-OFFS> 3,992
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 8,848
<ALLOWANCE-DOMESTIC> 8,848
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 6,590
</TABLE>
