<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, 1999
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: 0-29668
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 24, 2000, the aggregate market value of the Common Stock held by
non-affiliates of the Registrant was $46,441,771. 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 24, 2000 was 4,243,474.
The following documents are incorporated by reference herein:
------------------------------------------------------------
Portions of the Registrant's Proxy Statement for the 2000 Annual Meeting of
Stockholders, which will be filed within 120 days of the fiscal year ended
December 31, 1999, are incorporated by reference into Part III herein
<PAGE>
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform
Act"), relating to, among other things, future cash dividends and future
earnings levels, which are subject to risks and uncertainties that could cause
actual results, performance, or achievements to differ materially. These risks
and uncertainties include economic conditions, interest rates, changes in
government regulation and monetary policy, competition and other factors. For a
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 (the
"Reorganization"). Highland is registered as a savings and loan holding company
under applicable federal law and regulations.
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."
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 "Item 1. Business-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.
At December 31, 1999, Highland had total consolidated assets of a $654.8
million, total consolidated deposits of $413.6 million and total consolidated
stockholders' equity of $48.2 million. Highland's principal sources of funds
have been and are expected to be dividends paid by the Bank. There are legal
limitations that are imposed on the amount of fees and dividends that may be
paid by the Bank to Highland. See "Item 1. Business-Supervision and Regulation-
Limitation on Capital Distributions."
At and for the years ending December 31, 1999 and 1998, 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 primarily involve 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, 1999, Highland had total gross loans outstanding of
$559.2 million, which included $34.0 million of one-to-four family residential
mortgage loans, $277.2 million of multi-family mortgage loans, $236.1 million of
commercial real estate loans, $11.1 million of construction and land loans and
$0.8 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
----------------------------------------------------------------------------
1999 1998 1997
---------------------- ------------------------- -----------------------
Percent of Percent of Percent of
Total Total Total
Amount Loans Amount Loans Amount Loans
---------- ---------- ---------- ----------- ---------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate(1):
One- to four-family.... $ 34,013 6.08% $ 46,622 9.37% $ 64,558 14.52%
Multi-family........... 277,204 49.57 243,892 48.98 214,462 48.23
Commercial............. 236,100 42.22 194,596 39.08 154,717 34.79
Construction and 11,076 1.98 12,146 2.44 10,465 2.35
land(2)
Consumer.................. 835 0.15 666 0.13 493 0.11
-------- ------- -------- ------- -------- -------
Total loans......... 559,228 100.00% 497,922 100.00% 444,695 100.00%
======= ======= =======
Less:
Undisbursed loan
funds............... 1,415 3,179 6,653
Deferred loan fees, net 172 1,140 1,957
Allowance for loan
losses.............. 11,951 9,909 8,846
---------- ------------- -------------
Total loans, net $545,690 $483,694 $427,237
========== ============= =============
</TABLE>
<TABLE>
<CAPTION>
At December 31
-------------------------------------------------
1996 1995
------------------- ---------------------------
Percent Percent
of Total of Total
Amount Loans Amount Loans
---------- --------- ----------- ------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate(1):
One- to four-family.... $ 82,436 21.42% $ 99,724 30.82%
Multi-family........... 180,940 47.00 127,073 39.27
Commercial............. 116,389 30.23 88,326 27.30
Construction and 3,954 1.03 7,543 2.33
land(2)
Consumer.................. 1,244 0.32 923 0.28
-------- ------- -------- -------
Total loans......... 384,963 100.00% 323,589 100.00%
======= =======
Less:
Undisbursed loan
funds............... 1,439 1,066
Deferred loan fees, net 2,303 2,473
Allowance for loan
losses.............. 7,676 7,056
--------- ---------
Total loans, net $373,545 $312,994
========= =========
</TABLE>
___________________
(1) Consists of loans receivable less participations and unamortized premiums
or discounts.
(2) Includes construction loans of $3,594,000, $0 and $7,208,000 for one- to
four-family, multi-family and commercial projects, respectively, at
December 31, 1999, $5,786,000, $0 and $5,150,000 for one- to four-family,
multi-family and commercial projects, respectively, at December 31, 1998,
$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 for one- to four-family, multi-family and commercial
projects, respectively, at December 31, 1996. Highland had no construction
loans in 1995.
3
<PAGE>
Loan Maturity. The following table sets forth the final contractual
maturities of Highland's gross loans at December 31, 1999:
<TABLE>
<CAPTION>
At December 31, 1999
------------------------------------------------------------------------------------
One More More More More More
Year or than than than than than Total
Less 1 Year to 3 Years to 5 Years to 10 Years to 20 Years Loans
3 Years 5 Years 10 Years 20 Years
---------- ---------- ---------- ------------ ----------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Real estate:
One- to four-family........... $ 111 $ 506 $ 748 $ 1,883 $ 8,961 $21,804 $ 34,013
Multi-family.................. 3,256 3,712 4,215 53,529 189,922 22,570 277,204
Commercial.................... 1,443 1,850 5,561 91,799 132,608 2,839 236,100
Construction and land......... 8,213 2,117 220 231 295 -- 11,076
Consumer......................... 740 -- 28 67 -- -- 835
--------- -------- --------- --------- ---------- ---------- -----------
Total amount due........... $13,763 $8,185 $10,772 $147,509 $331,786 $47,213 $559,228
========= ======== ========= ========= ========== ========== ===========
</TABLE>
The following table sets forth, as of December 31, 1999, the dollar
amounts of gross loans receivable that are contractually due after December 31,
2000 and whether such loans have fixed or adjustable interest rates:
<TABLE>
<CAPTION>
Due after December 31, 2000
--------------------------------------------
Fixed Adjustable Total
---------- ---------------- -----------
(Dollars in thousands)
<S> <C> <C> <C>
Real estate:
One- to four-family............... $ 28,795 $ 5,107 $ 33,902
Multi-family...................... 78,727 195,221 273,948
Commercial........................ 104,496 130,161 234,657
Construction and land............. 816 2,047 2,863
Consumer.............................. 95 -- 95
------------- -------------- -------------
Total loans receivable........ $212,929 $332,536 $545,465
============= ============== =============
</TABLE>
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 California for sources of loan applications. The loan
officers operate primarily in certain of the Bank's branch offices and in
offices located in Los Angeles County, Orange County and San Diego County.
Management believes that Highland's current 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 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 1999, Highland sold $6.1 million in
commercial real estate loans. During 1998, Highland sold $9.0 million of
multi-family loans. 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.
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,
----------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------- ---------- ---------- ---------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Beginning balance............... $ 483,694 $427,237 $373,545 $312,994 $273,023
--------------- ------------ ------------ ------------ ------------
Loans originated:
Real Estate:
One- to four-family..... -- 600 257 11,451 18,423
Multi-family............ 71,878 74,412 53,997 62,634 48,160
Commercial.............. 80,150 65,515 53,324 36,632 15,587
Construction and land... 13,446 14,317 10,068 606 5,502
Consumer and commercial...... 440 983 977 1,149 1,352
--------------- ------------ ------------ ------------ ------------
Total loans originated.. 165,914 155,827 118,623 112,472 89,024
Loans purchased................. 9,222 -- 396 7,690 --
--------------- ------------ ------------ ------------ ------------
Total................... 175,136 155,827 119,019 120,162 89,024
--------------- ------------ ------------ ------------ ------------
Less:
Principal repayments......... 102,853 88,056 58,159 44,068 42,988
Sales of loans............... 6,116 8,958 4,262 12,527 7,257
Other net changes(1)......... 4,171 2,356 2,906 3,016 (1,192)
--------------- ------------ ------------ ------------ ------------
Total loans............. $ 545,690 $483,694 $427,237 $373,545 $312,994
=============== ============ ============ ============ ============
</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 $2.8 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 borrower information, including current
borrower and property financial and operating statements. When payments are not
received by their contractual due date, collection efforts generally 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 managed by the Bank's Collection
Department which, following a review of the account, implements a collection or
restructure plan or a foreclosure or note sale strategy, and initiates an
appraisal or other evaluation of the asset in order to assess the need for a
specific valuation allowance or chargeoff. 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.
Highland's underwriting procedures require, among other things, analysis of the
borrower's financial condition and the debt coverage. The policies also
emphasize geographic and product diversification.
5
<PAGE>
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. An internal field
review appraisal is conducted for every loan with a principal balance in excess
of $1.0 million. In addition, the Appraisal Department conducts a desk review of
appraisals on loans with a principal balance of at least $500,00 but less than
$1.0 million, and other selected new loan files. In total, field or desk reviews
have been performed on over 25% of all loans originated since June 1994. Also,
for all multi-family residential and commercial real estate loans, the
responsible loan officer visits the property and, if the transaction involves a
loan over $1.0 million, the property is visited 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 $2.0 million require the approval of at least two of the
following officers (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 $2.0 million 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). The Bank's
underwriting policies provide that a multi-family residential loan may only be
made in an amount up to 75% of the appraised value of the underlying property.
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. These risks
include 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 also make a loan secured by a special purpose property such as a restaurant
or motel. Highland's underwriting policies provide that commercial real estate
loans may be made in amounts up to 75% of the appraised value of the property.
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. 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. Highland originates loans for the
development and rehabilitation of property in its market areas on a limited
basis. Highland's construction loans primarily have been made to finance the
rehabilitation of apartment buildings and the construction of residential and
commercial 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, 1999, Highland had $10.8 million of construction loans (less undisbursed
loan funds of $1.4 million), which amounted to 1.93% 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
6
<PAGE>
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.
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, including requirements for borrower financial
statements, appraisals, and debt coverage ratios, are set forth in the Lending
Policy Manual, and take 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, special purpose commercial real estate loans and certain
geographic concentrations. Revisions to underwriting criteria will occur in
response to market conditions.
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 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. 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, Treasurer, Controller and Senior
Vice President for Loan Administration (ex officio).
The Chief Credit Officer reviews, on a periodic basis, various segments of
the loan portfolio and makes periodic reports to senior management and the Board
of Directors 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"). The Loan Administration and Internal
Asset Review Departments prepare these reports.
7
<PAGE>
When evaluating the AC Reports, management determines if specific
allowances 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 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, 1999 this amount was $7.2 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). The Bank, however, generally does not make loans in excess of
$4.0 million. The Bank's largest single loan was for approximately $3.4 million
at December 31, 1999. The Bank had 11 loans over $2 million totaling $28.4
million at year end 1999. Also, as of December 31, 1999, the Bank had six
additional lending relationships which exceeded $2.0 million in aggregate
indebtedness. These lending relationships are comprised principally 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, 1999.
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,
-----------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
----------------- ------------------ ---------------- --------------- ---------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Nonaccrual loans:
Real estate:
One-to-four family................... $ 505 $ 526 $ 1,951 $ 474 $ 1,506
Multi-family......................... -- 1,379 1,584 1,320 2,181
Commercial........................... 1,502 423 913 1,653 1,496
Consumer.............................. -- 37 37 8 37
----------------- ------------------ --------------- --------------- ---------------
Total................................ 2,007 2,365 4,485 3,455 5,220
REO.................................... -- 630 1,543 1,400 2,966
----------------- ------------------ --------------- --------------- ---------------
Total nonperforming assets........... $ 2,007 $ 2,995 $ 6,028 $ 4,855 $ 8,186
================= ================== =============== ============== ===============
TDRs................................... $ 2,143 $ 3,017 $ 4,642 $ 7,428 $ 9,377
================= ================== =============== ============== ===============
Allowance for loan losses as a percent
of gross loans receivable (1)......... 2.14% 2.01% 2.02% 2.00% 2.18%
Allowance for loan losses as a percent
of total nonperforming loans.......... 595.46% 418.99% 197.28% 222.24% 135.20%
Nonperforming loans as a percent of
gross loans receivable (1)............ 0.41% 0.48% 1.02% 0.90% 1.61%
Nonperforming assets as a percent of
total assets.......................... 0.31% 0.50% 1.10% 0.99% 1.78%
</TABLE>
______________________
(1) Gross loans receivable includes loans receivable less loan participations,
undisbursed loan funds 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, 1999,
Highland had eight loans on nonaccrual status consisting of four one-to-four
family residential loans, no multi-family residential loans, and four commercial
real estate loans. Total interest income foregone by Highland on nonaccrual
loans compared to the original terms of such loans at December 31, 1999 and 1998
totaled $230,000 and $193,000, respectively.
8
<PAGE>
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 or enters into a workout plan 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, 1999, Highland
held no REO properties.
Troubled Debt Restructurings("TDR"). 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. Generally, Highland is not creating any new
TDR's. At December 31, 1999, Highland had nine loans classified as TDRs.
Interest income foregone by Highland on TDRs compared to the original terms of
such loans during 1999 and 1998 totaled $89,000 and $121,000, respectively.
Interest rates on TDR's range from 7.0% to 12.75% at December 31, 1999.
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, 1999 and December 31, 1998 were $10.8 million and $9.5
million, respectively. At December 31, 1999, classified assets consisted of 60
loans and no REO properties. Six classified loans totaling $3.4 million had net
principal balances in excess of $500,000 at December 31, 1999.
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, 1999 At December 31, 1998 At December 31, 1997
-------------------------- ---------------------------- -----------------------------
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
------------ ------------ ------------ ------------- ------------ --------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real Estate:
One-to-four family........... $ 675 $ 259 $ 597 $ 552 $ 364 $ 272
Multi-family................. 722 -- 584 384 202 704
Commercial................... 455 16 313 -- 285 1,321
Consumer............................. -- -- 5 -- -- --
------------ ------------- ------------ ------------- ------------- --------------
Total........................ $ 1,852 $ 275 $ 1,499 $ 936 $ 851 $ 2,297
============= ============= ============ ============= ============= ==============
Delinquent loans to total loans(1)... 0.33% 0.05% 0.30% 0.19% 0.20% 0.54%
</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 income 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,
----------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---------------- ----------------- ---------------- ---------------- ---------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Balance at beginning of year......... $ 9,909 $8,848 $7,676 $7,056 $8,832
Provision for loan losses............ 2,518 3,315 5,164 3,930 5,221
Chargeoffs:
Real estate loans:
One-to-four family.............. 24 91 432 590 1,196
Multi-family.................... 496 1,144 2,650 1,925 4,936
Commercial...................... 29 968 895 785 1,616
Construction and land........... -- 47 13 21 164
Consumer........................... 20 4 2 2 --
---------------- ----------------- ---------------- ---------------- ---------------
Total........................... 569 2,254 3,992 3,323 7,912
Recoveries........................... 93 -- -- 13 915
---------------- ----------------- ---------------- ---------------- ---------------
Balance at end of year............... $ 11,951 $ 9,909 $ 8,848 $ 7,676 $ 7,056
================ ================= ================ ================ ===============
</TABLE>
Highland made provisions for loan losses during 1995 at a relatively high
level and loan chargeoffs during that year exceeded the allowance at the
beginning of the year, primarily due to the continuing poor economic conditions
in Highland's market areas and depressed real estate values during that year. As
the level of nonaccrual loans and foreclosed loans continued 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
slight increases in the levels of loan chargeoffs and nonaccrual loans during
1997. Highland's provision for losses for 1998 and 1999 were reduced in line
with improving asset quality. Nonaccrual loans increased from $3.5 million at
the beginning of 1997 to $4.5 million at the beginning of 1998, then decreased
to $2.4 million at December 31, 1998 and $2.0 million at December 31, 1999.
Classified assets increased modestly to $10.8 million at December 31, 1999 after
declining to $9.5 million at December 31, 1998 from $13.5 million at December
31, 1997, while the allowance for loan losses as a percentage of total
nonperforming loans increased from 197.28% at December 31, 1997 to 418.99% at
December 31, 1998 and 595.46% at December 31, 1999.
Highland's allowance for loan losses was $11,951,000 at December 31, 1999.
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,
- ------------------------------------------------------------------------------------------------------------------------------------
1999 1998 1997
-------------------------------- ------------------------------ --------------------------------
Percent of Percent of Percent of
Loans in Loans Loans in
Percent of Each Percent of in Each Percent of 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..... $ 460 3.85% 6.06% $ 607 6.13% 9.37% $ 905 10.23% 14.52%
Multi-family........... 6,379 53.37 49.70 5,531 55.81 48.98 5,337 60.32 48.23
Commercial............. 4,719 39.49 42.39 3,446 34.78 39.08 2,312 26.13 34.79
Construction and land.. 323 2.70 1.75 238 2.40 2.44 183 2.07 2.35
Consumer.................. 70 0.59 0.10 87 0.88 0.13 111 1.25 0.11
------- ------ ------ ------ ------ ------ ------ ------ ------
Total............... $11,951 100.00% 100.00% $9,909 100.00% 100.00% $8,848 100.00% 100.00%
======= ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------------------------------------------------
1996 1995
---------------------------------------- --------------------------------------------
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... $ 958 12.48% 21.42% $1,411 20.00% 30.82%
Multi-family.......... 4,686 61.05 47.00 3,443 48.80 39.27
Commercial............ 1,898 24.73 30.23 2,093 29.66 27.30
Construction and land. 134 1.74 1.03 92 1.30 2.33
Consumer................. -- -- 0.32 17 0.24 0.28
-------- ------ ------ ------ ------- --------
Total.............. $7,676 100.00% 100.00% $7,056 100.00% 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 "Item 1. Supervision and 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 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
11
<PAGE>
Investment Committee (either the President, Chief Financial Officer or
Treasurer) 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, 1999, Highland held $2.0 million in U.S. agency securities.
Highland's mortgage-backed securities ("MBS") portfolio consists of seasoned
fixed-rate and balloon MBSs, longer-term fixed-rate securities and adjustable-
rate securities. At December 31, 1999, substantially 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 $65.4 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, 1999 At December 31, 1998 At December 31, 1997
------------------------- ------------------------ -------------------------
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...... $ 1,998 $ 1,824 $ 3,996 $ 3,999 $ 15,481 $ 15,459
Mortgage-backed securities............... 65,371 63,502 49,401 49,375 34,400 34,176
--------- ---------- --------- ---------- ---------- ----------
Total debt securities............. $ 67,369 $ 65,326 $ 53,397 $ 53,374 $ 49,881 $ 49,635
========= ========== ========= ========== ========== ==========
Securities held-to-maturity:
Mortgage-backed securities............... $ 8,943 $ 8,622 $ 11,926 $ 11,877 $ 15,419 $ 15,263
========= ========== ========= ========== ========== ==========
</TABLE>
The contractual maturities of debt securities held-to-maturity and
available-for-sale at December 31, 1999 were as follows:
<TABLE>
<CAPTION>
Held-to-maturity Available-for-sale
----------------------------- -----------------------------
Amortized Estimated Amortized Estimated
cost fair value cost fair value
--------- ---------- --------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Due from one year to five years........ $ -- $ -- $ 5,714 $ 5,630
Due from five to ten years............. 8,943 8,622 21,827 21,276
Due after ten years.................... -- -- 39,828 38,420
--------- ---------- --------- ---------
Total.............................. $ 8,943 $ 8,622 $ 67,369 $ 65,326
========= ========== ========= =========
</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.
12
<PAGE>
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, 1999,
certificates of deposit constituted 78.9% 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 deposit pricing and
convenience 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 breakdown 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,
1999 1998 1997
---------- ---------- -----------
(Dollars in thousands)
<S> <C> <C> <C>
Deposits sold....................................... $ -- $ -- $ (101,843)
Net deposits (withdrawals).......................... 6,697 5,532 62,351
Interest credited on deposit accounts............... 18,875 18,837 18,249
---------- ---------- -----------
Total increase (decrease) in deposit accounts....... $25,572 $24,369 $ (21,243)
========== ========== ===========
</TABLE>
At December 31, 1999, Highland had $98.1 million in non-brokered
certificate accounts in amounts of $100,000 or more, consisting of 779 accounts,
maturing as follows:
<TABLE>
<CAPTION>
Weighted
Average
Maturity Period Amount Rate
------------------------ ---------- -------------
(Dollars in thousands)
<S> <C> <C>
Three months or less.................. $ 21,272 5.01%
Over three through six months......... 21,696 5.11
Over six through 12 months............ 42,544 5.53
Over 12 months........................ 12,544 5.79
---------- ---------
Total............................ $ 98,056 5.36%
========== =========
</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,
-----------------------------------------------------------------------------
1999 1998
-------------------------------------- -------------------------------------
Percent of Percent of
Total Weighted Total Weighted
Average Average Average Average Average Average
Balance/(1)/ Deposits Rate Balance/(1)/ Deposits Rate
-------------------------------------- -------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Money market savings accounts..... $ 38,184 9.33% 4.03% $ 34,683 9.07% 3.79%
Passbook accounts................. 20,603 5.03 2.23 21,327 5.58 2.30
NOW accounts...................... 21,248 5.19 2.14 18,613 4.87 1.72
<CAPTION>
1997
-------------------------------------
Percent of
Total Weighted
Average Average Average
Balance/(1)/ Deposits Rate
-------------------------------------
<S> <C> <C> <C>
Money market savings accounts..... $ 24,135 6.55% 3.62%
Passbook accounts................. 24,639 6.68 2.42
NOW accounts...................... 19,522 5.30 1.71
</TABLE>
13
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C>
Noninterest-bearing accounts......... 9,410 2.30 -- 9,789 2.56
------------------------- ---------------------
Total............................ 89,445 21.85 2.74 84,412 22.08
Certificate accounts:
Less than six months............. 3,678 0.90 3.61 6,290 1.64
Over six through 12 months....... 174,256 42.56 4.22 172,522 45.10
Over 12 through 24 months........ 83,548 20.40 6.77 65,315 17.07
Over 24 months................... 25,784 6.30 6.36 20,195 5.28
IRA/KEOGH........................ 32,743 8.00 5.05 33,785 8.83
------------------------- ---------------------
Total certificate accounts.... 320,009 78.15 5.14 298,107 77.92
------------------------- ---------------------
Total average deposits........ $ 409,454 100.00% 4.61% $ 382,519 100.00%
========================= =====================
<CAPTION>
<S> <C> <C> <C> <C>
Noninterest-bearing accounts......... -- 9,107 2.47 --
------------------------
Total............................ 2.59 77,403 21.00 2.33
Certificate accounts:
Less than six months............. 4.45 1,708 0.46 4.62
Over six through 12 months....... 6.03 108,936 29.56 6.61
Over 12 through 24 months........ 4.56 110,581 30.00 4.97
Over 24 months................... 6.09 27,674 7.51 6.28
IRA/KEOGH........................ 5.61 42,277 11.47 5.48
------------------------
Total certificate accounts.... 5.41 291,176 79.00 5.67
------------------------
Total average deposits........ 4.94% $ 368,579 100.00% 4.97%
========================
</TABLE>
(1) Average balances are based on average month-end balances during the period.
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, 1999:
<TABLE>
<CAPTION>
Period to Maturity from December 31, 1999
--------------------------------------------------------------------------
Less than One to Two to Three to Four to
One Year Two Three Four Five
Years Years Years Years
---------- ----------- ------------ ----------- -------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Certificate accounts:
0 to 3.99%............. $ 10,402 - - - -
4.00 to 5.99%.......... 259,020 30,758 7,922 4,489 2,191
6.00 to 8.00%.......... 6,071 1,079 2,546 161 1,683
---------- ----------- ------------ ----------- -------------
Total.......... 275,493 31,837 10,468 4,650 3,874
========== =========== ============ =========== =============
<CAPTION>
At December 31,
-----------------------------------------
1999 1998 1997
-----------------------------------------
<S>
Certificate accounts: <C> <C> <C>
0 to 3.99%............. $ 10,402 $ 7,022 $ --
4.00 to 5.99%.......... 304,380 262,756 246,590
6.00 to 8.00%.......... 11,540 27,042 47,435
---------- ---------- ----------
Total.......... $ 326,322 $ 296,820 $ 294,025
========== ========== ==========
</TABLE>
Borrowings
- ----------
From time to time, Highland obtains 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. At December 31, 1999,
the maximum amount available to the Bank was $229.2 million, of which $50.3
million was unused. During 1999, Highland increased its net borrowings by
$28.0 million. At December 31, 1999, Highland had $178.9 million in outstanding
advances from the FHLB and total other borrowings of $5 million. These
borrowings mature between 2000 and 2008, however, $15.0 million of five year
FHLB advances are callable quarterly beginning in 2000 and $5.0 million of ten
year FHLB advances are callable quarterly beginning in 2003. The interest rates
payable by Highland on its FHLB and other borrowings at December 31, 1999 range
from 4.80% to 6.33%.
The following table sets forth certain information regarding Highland's
borrowed funds at the dates and for the periods indicated:
14
<PAGE>
<TABLE>
<CAPTION>
At or For the Years Ended December 31,
---------------------------------------------------
1999 1998 1997
----------- ------------ -----------
(Dollars in thousands)
<S> <C> <C> <C>
FHLB advances:
Average balance outstanding......................... $149,694 $131,081 $ 95,979
Maximum amount outstanding at any month-end
during the period.............................. $178,900 $150,900 $135,000
Balance outstanding at end of period................ $178,900 $150,900 $135,000
Weighted average interest rate during the period.... 5.58% 5.90% 6.17%
Weighted average interest rate at end of period..... 5.74% 5.52% 6.07%
Other borrowings:
Average balance outstanding......................... $ 9,900 $ 6,000 $ --
Maximum amount outstanding at any month-end
during the period.............................. $ 10,000 $ 10,000 $ --
Balance outstanding at end of period................ $ 5,000 $ 10,000 $ --
Weighted average interest rate during the period.... 5.60% 5.52% --
Weighted average interest rate at end of period..... 6.02% 5.52% --
</TABLE>
15
<PAGE>
SUPERVISION AND REGULATION
General
- -------
Financial institution holding companies and insured depository institutions
are extensively regulated under both federal and state law. Set forth below is
a summary description of certain laws and regulations, which relate to the
operation of Highland and its subsidiaries. The following description does not
purport to be complete and is qualified in its entirety by reference to the
applicable laws and regulations.
Highland Bancorp, Inc., as a savings and loan holding company, is required
to file certain reports with, and otherwise comply with the rules and
regulations of, the OTS under the Home Owners' Loan Act, as amended (the
"HOLA"). In addition, the activities of the Bank are governed by the HOLA and
the Federal Deposit Insurance Act ("FDIA").
The Bank is subject to extensive regulation, examination, and supervision
by the OTS, as its primary federal regulator, and the FDIC, as the insurer of
customer deposits. The Bank must file reports with the OTS and the FDIC
concerning its activities and financial condition. In addition, the Bank must
obtain various regulatory approvals prior to conducting certain types of
business or entering into selected transactions; e.g. acquisitions of other
financial institutions. The OTS and / or the FDIC conduct periodic examinations
of the Bank's safety and soundness, its operations (including technology
utilization), and its compliance with applicable laws and regulations, including
the Community Reinvestment Act ("CRA"), the Real Estate Settlement Procedures
Act ("RESPA"), and the Bank Secrecy Act ("BSA"). These examinations are
primarily conducted for the protection of the SAIF, and are not intended to
provide any assurance to investors in Highland's common stock.
The regulatory structure provides the supervisory authorities with
extensive discretion across a wide range of Highland's operations, including but
not limited to:
. Loss allowance adequacy
. Capital requirements
. Credit classification
. Limitation or prohibition of dividends
. Assessment levels for deposit insurance and examination costs
. Permissible branching
Any change in regulatory requirements or policies, whether by the OTS, the
FDIC, the FRB, or Congress, could have a material adverse impact on Highland.
16
<PAGE>
Holding Company Regulation
- --------------------------
Highland is a non-diversified unitary savings & loan holding company within
the meaning of the HOLA. As such, Highland will generally not be restricted
under existing laws as to the types of business activities in which it may
engage, provided that the Bank continues to be a qualified thrift lender
("QTL"). However, a number of potential laws are being debated in Congress
which could significantly alter the business and regulatory environment in which
Highland and its subsidiaries may operate (See "Item 1. Supervision and
Regulation-Financial Industry Reform Legislation").
Upon any nonsupervisory acquisition by Highland of another savings
institution or savings bank which meets the QTL test and is deemed to be a
savings institution by the OTS, Highland could then become a multiple savings &
loan holding company (if the acquired institution is maintained as a separate
subsidiary), and would then be subject to extensive limitations on the types of
business activities in which it could engage. The HOLA limits the activities of
a multiple savings & loan holding company and its non-FDIC insured subsidiaries
primarily to those activities permissible for bank holding companies under
Section 4(c)(8) of the Bank Holding Company Act ("BHCA") and certain other
activities authorized by OTS regulations.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from:
1) acquiring more than 5% of the voting stock of another savings
institution or holding company thereof, without prior written approval
of the OTS;
2) acquiring or retaining, with certain exceptions, more than 5% of a
nonsubsidiary company engaged in activities other than those permitted
by the HOLA;
3) acquiring or retaining control of a depository institution that is not
insured by the FDIC.
In evaluating applications by holding companies to acquire savings
institutions, the OTS must consider the financial and managerial resources and
future prospects of the company and the institution involved, the effect of the
acquisition on the risk to the deposit insurance funds, the convenience and
needs of the community, and competitive factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, subject to two exceptions:
(A) the approval of interstate supervisory acquisitions by savings and
loan holding companies and
(B) the acquisition of a savings institution in another state if the laws
of the state of the target savings institution specifically permit
such acquisitions. The states vary in the extent to which they permit
interstate savings & loan holding company acquisitions.
Although savings & loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions, as described below. The Bank must notify the OTS 30 days
before declaring any dividend to Highland. In addition, the financial impact of
a holding company on its subsidiary institution is a matter that is evaluated by
the OTS in its examination of the safety and soundness of the insured depository
institution. The OTS also has authority to order cessation of activities or
divestiture of holding company subsidiaries deemed to pose a threat to the
safety and soundness of the insured depository institution.
Capital Requirements and Capital Categories.
- --------------------------------------------
FIRREA Capital Requirements. OTS capital regulations, as mandated by the
Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"),
require savings institutions to meet three minimum capital standards (as defined
by applicable regulations):
17
<PAGE>
. a 1.5% tangible capital ratio
. a 3.0% leverage (core) capital ratio
. an 8.0% risk-based capital ratio
The capital standards applicable to savings institutions must be no less
stringent than those for national banks. In addition, the prompt corrective
action ("PCA") standards discussed below also establish, in effect, the
following minimum standards:
. a 2.0% tangible capital ratio
. a 4.0% leverage (core) capital ratio (3.0% for institutions receiving
the highest regulatory rating under the CAMELS rating system)
. a 4.0% Tier One risk based capital ratio
The OTS also has the authority, after giving the affected institution
notice and an opportunity to respond, to establish specific minimum capital
requirements for a single institution which are higher than the general industry
minimum requirements presented above. The OTS can take this action upon a
determination that a higher minimum capital requirement is appropriate in light
of an institution's particular circumstances.
Tangible capital is composed of:
. common stockholders' equity (including retained earnings)
. certain noncumulative perpetual preferred stock and related earnings
. minority interests in equity accounts of consolidated subsidiaries
Less:
. intangible assets other than certain asset servicing rights
. investments in and loans to subsidiaries engaged in activities as
principal, not permissible for a national bank
. deferred tax assets as defined under Statement of Financial Accounting
Standards ("SFAS") Number 109 - "Accounting for Income Taxes" in
excess of certain thresholds
Core capital consists of tangible capital plus various adjustments for
certain intangible assets. At December 31, 1999 and 1998, the Bank's tangible
capital was equivalent to its core capital, as the Bank did not maintain any
qualifying adjustments. In general, total assets calculated for regulatory
capital purposes exclude those assets deducted from capital in determining the
applicable capital ratio.
The risk based capital standard for savings institutions requires the
maintenance of Tier One capital (core capital) and total capital (defined as
core capital plus supplementary capital) to risk weighted assets of 4.0% and
8.0%, respectively. In determining the amount of an institution's risk weighted
assets, all assets, including certain off balance sheet positions, are
multiplied by a risk weight of 0.0% to 100.0%, as assigned by OTS regulations
based upon the amount of risk perceived as inherent in each type of asset. The
components of supplementary capital include:
. cumulative preferred stock
. long term perpetual preferred stock
. mandatory convertible securities
. certain subordinated debt
. intermediate preferred stock
. the general allowance for loan and lease losses, subject to a limit of
1.25% of risk weighted assets
Overall, the amount of supplementary capital included as part of total
capital cannot exceed 100.0% of core capital.
18
<PAGE>
As disclosed in Note 17 to Highland's audited Consolidated Financial
Statements, at December 31, 1999, the Bank exceeded all minimum regulatory
capital requirements.
FDICIA PCA Regulations. The Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") dictated that the OTS implement a system
requiring regulatory sanctions against institutions that are not adequately
capitalized, with the sanctions growing more severe the lower institution's
capital. The OTS has established specific capital ratios under the PCA
Regulations for five separate capital categories:
. well capitalized
. adequately capitalized
. under capitalized
. significantly under capitalized
. critically undercapitalized
Under the OTS regulations implementing FDICIA, an insured depository
institution will be classified in the following categories based, in part, on
the following capital measures:
Well Capitalized
----------------
Total risk based capital ratio of at least 10.0%
Tier One risk based capital ratio of at least 6.0%
Leverage ratio of at least 5.0%
Adequately Capitalized
----------------------
Total risk based capital ratio of at least 8.0%
Tier One risk based capital ratio of at least 4.0%
Leverage ratio of at least 4.0%
Under Capitalized
-----------------
Total risk based capital ratio of less than 8.0%
Tier One risk based capital ratio of less than 4.0%
Leverage ratio of less than 4.0%
Significantly Under Capitalized
-------------------------------
Total risk based capital ratio of less than 6.0%
Tier One risk based capital ratio of less than 3.0%
Leverage ratio of less than 3.0%
Critically Under Capitalized
----------------------------
Tangible capital of less than 2.0%
An institution that, based upon its capital levels, is classified on one of
the top three categories may be regulated as though it were in the next lower
capital category if the appropriate federal banking agency, after notice and an
opportunity for hearing, determines that the operation or status of the
institution warrants such treatment. There are numerous mandatory supervisory
restrictions on the activities of under capitalized institutions. An
institution that is under capitalized must submit a capital restoration plan to
the OTS that the OTS may approve only if it determines that the plan is likely
to succeed in restoring the institution's capital and will not appreciably
increase the risks to which the institution is exposed. In addition, the
institution's performance under the capital restoration plan must be guaranteed
by every company that controls the institution. Under capitalized institutions
may not acquire an interest in any company, open a new branch office, or engage
in a new line of business without OTS or FDIC approval. An under capitalized
institution is also limited in its ability to increase average assets, accept
brokered deposits, pay management fees, set deposit rates, and make capital
distributions. Additional restrictions apply to significantly and critically
under capitalized institutions. In addition, the OTS maintains extensive
discretionary sanctions which may be applied to under capitalized institutions,
including the issuance of a capital directive and the replacement of senior
executive officers and directors.
19
<PAGE>
As disclosed in Note 17 to the Highland's Consolidated Financial
Statements, at December 31, 1999, the Bank met the requirements to be classified
as a "well capitalized" institution under PCA regulations.
Safety and Soundness Standards
- ------------------------------
In addition to the PCA provisions discussed above based on an institution's
regulatory capital ratios, FDICIA contains several measures intended to promote
early identification of management problems at depository institutions and to
ensure that regulators intervene promptly to require corrective action by
institutions with inadequate operational and managerial controls. The OTS has
established minimum standards in this regard related to:
. internal controls, information systems, and internal audit systems
. loan documentation
. credit underwriting
. asset growth
. income
. compensation, fees and benefits
If the OTS determines that an institution fails to meet any of these
minimum standards, the agency may require the institution to submit to the
agency an acceptable plan to achieve compliance with the standard. In the event
the institution fails to submit an acceptable plan within the time allowed by
the agency or fails in any material respect to implement an accepted plan, the
agency must, by order, require the institution to correct the deficiency and may
implement a series of supervisory sanctions.
Effective October 1, 1996, the federal banking agencies (including the OTS)
promulgated safety and soundness regulations and accompanying interagency
compliance guidelines on asset quality and earnings standards. These guidelines
provide six standards for establishing and maintaining a system to identify
problem assets and prevent those assets from deteriorating. The institution
should:
1) conduct periodic asset quality reviews to identify problem assets
2) estimate the inherent losses in those assets and establish reserves
that are sufficient to absorb estimated losses
3) compare problem asset totals to capital
4) take appropriate corrective action to resolve problem assets
5) consider the size and potential risks of material asset concentrations
6) provide periodic asset reports with adequate information for
management and the board of directors to assess the level of asset
risk
These guidelines also set forth standards for evaluating and monitoring
earnings and for ensuring that earnings are sufficient for the maintenance of
adequate capital and reserves. If the institution fails to comply with a safety
and soundness standard, the appropriate federal banking agency may require the
institution to submit a compliance plan. Failure to submit a compliance plan or
to implement an accepted plan may result in enforcement action.
Potential Enforcement Actions
- -----------------------------
The OTS has primary enforcement responsibility over savings institutions
and maintains the authority to bring actions against the institution and all
institution affiliated parties, as defined under the applicable regulations, for
unsafe or unsound practices in conducting their businesses or for violations of
any law, rule, regulation, condition imposed in writing by the agency, or any
written agreement with the agency. Enforcement actions may include the
imposition of a conservator or receiver, the issuance of a cease and desist
order that can be judicially enforced, the termination of insurance of deposits
(in the case of the Bank), the imposition of civil money penalties, the issuance
of directives to increase capital, the issuance of formal and informal
agreements, the issuance of removal or prohibition orders against institution
affiliated parties, and the imposition of restrictions under the PCA provisions
of FDICIA. Federal law also establishes criminal penalties for certain
violations. Additionally, a holding
20
<PAGE>
company's inability to serve as a source of strength to its subsidiary financial
institutions could serve as an ancillary basis for regulatory action against the
holding company. Neither Highland, the Bank, or any subsidiaries thereof are
currently subject to any enforcement actions.
Premiums for Deposit Insurance
- ------------------------------
Legislation was enacted on September 30, 1996 to address the disparity in
bank and thrift deposit insurance premiums. This legislation imposed a
requirement on all SAIF members, including the Bank, to fully recapitalize the
SAIF by paying a one time special assessment of approximately 65.7 basis points
on all assessable deposits as of March 31, 1995. This one time special
assessment resulted in the Bank recording an additional $2.5 million in FDIC
insurance expense during its quarter ended September 30, 1996.
The FDIC currently assesses its premiums based upon the insured
institution's position on two factors:
1) The institution's capital category under PCA regulations
2) The institution's supervisory category as determined by the FDIC based
upon supervisory information provided by the institution's primary
federal regulator and other information deemed pertinent by the FDIC.
The supervisory categories are:
Group A: financially sound with only a few minor weaknesses
Group B: demonstrates weaknesses that could result in significant
deterioration
Group C: poses a substantial probability of loss
Annual SAIF assessment rates as of January 1, 1999 were as follows:
Assessment Rates Effective January 1, 2000 *
---------------------------------------------
<TABLE>
<CAPTION>
Group A Group B Group C
------- ------- -------
<S> <C> <C> <C>
Well Capitalized 0 3 17
Adequately Capitalized 3 10 24
Under Capitalized 10 24 27
</TABLE>
*Assessment figures are expressed in terms of cents per $100 of assessed
deposits.
During the quarter ended December 31, 1999, the Bank was not assessed any
SAIF insurance premiums under the above schedule.
In addition to the deposit insurance premiums presented in the above table,
SAIF insured institutions must also pay FDIC premiums related to the servicing
of Financing Corporation ("FICO") bonds which were issued to help fund the
federal government costs associated with the savings and loan problems of the
late 1980's. At January 1, 2000, the Bank's premium rate for the FICO related
payments was 2.12 basis points of assessable deposits per annum. During the
second fiscal quarter of 2000, the premium rate is expected to be 2.08 basis
points.
The Budget Act passed by Congress prohibits the FDIC from setting premiums
under the above risk based schedule above the amount needed to meet the
designated reserve ratio (currently 1.25%). The latest statistics released by
the FDIC indicate that both the SAIF and the Bank Insurance Fund ("BIF")
maintain reserve ratios in excess of the designated ratio. Legislation is being
evaluated by Congress which might, among other events, merge the SAIF and BIF,
and thereby present a potential impact upon the Bank's deposit insurance
premiums. Highland cannot predict what legislation will be approved, if any,
and what the impact of such legislation might be upon Highland.
Branching
- ---------
21
<PAGE>
Branching
- ---------
OTS regulations permit nationwide branching by federally chartered savings
institutions to the extent allowed by federal statute. This permits federal
savings institutions to establish interstate networks and to geographically
diversity their loan portfolios and lines of business. The OTS authority
preempts any state law purporting to regulate branching by federal savings
institutions. At this time, Highland's management has no plans to establish
physical branches outside of California, although the Bank does serve customers
domiciled outside of California via alternative delivery channels such as
telephone, mail, and ATM networks.
Transactions With Related Parties
- ---------------------------------
The Bank's authority to engage in transactions with related parties or
"affiliates" (e.g. any company that controls or is under common control with an
institution, including Highland and any non-savings institution subsidiaries) 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 10% of the capital and surplus of the savings institution. The
aggregate amount of covered transactions with all 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 provides 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. In addition, savings institutions
are prohibited from lending to any affiliate that is engaged in activities that
are not permissible for bank holding companies and 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
10% shareholders, as well as entities such persons control, is governed by
Section 22(g) and 22(h) of the FRA and Regulation O thereunder. Among other
things, such loans are required to be made on terms substantially the same as
those offered to unaffiliated individuals and to not involve more than the
normal risk of repayment. Regulation O also places individual and aggregate
limits on the types and amounts of loans the Bank may make to such persons
based, in part, on the Bank's capital position, and requires certain board
approval procedures to be followed.
Community Reinvestment Act
- --------------------------
The Community Reinvestment Act ("CRA") requires each savings institution,
as well as certain other lenders, to identify and delineate the communities
served through and by the institution's offices and to affirmatively meet the
credit needs of its delineated communities and to market the types of credit the
institution is prepared to extend within such communities. The CRA also
requires the OTS to assess the performance of the institution in meeting the
credit needs of its communities and to take such assessment into consideration
in reviewing applications for mergers, acquisitions, and other transactions. An
unsatisfactory CRA rating may be the basis for denying such an application.
Performance is assessed on the basis of 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 connection with its assessment
of CRA performance, the OTS assigns a rating of "outstanding," "satisfactory,"
"needs improvement" or "substantial noncompliance." Based on its most recent
examination, the Bank received a "satisfactory" rating.
Qualified Thrift Lender Test
- ----------------------------
The qualified thrift lender ("QTL") test requires that, in at least nine
out of every twelve months, at least 65% of a savings institution's "portfolio
assets", as defined, must be invested in a limited list of qualified thrift
investments, including residential mortgages and qualifying mortgage backed
securities. Portfolio assets for the QTL test consist of tangible assets minus
(i) assets utilized to satisfy liquidity requirements (subject to certain
limitations), and (ii) the value of property used by the institution to conduct
its business.
In 1996, the Economic Growth and Regulatory Paperwork Reduction Act
("EGRPRA") was adopted, amending the QTL test requirements to allow educational
loans, small business loans, and credit card loans to count as qualified thrift
assets without limit. The EGRPRA also amended the QTL requirements to allow
loans for
22
<PAGE>
personal, family, or household purposes to count as qualified thrift assets in
the reporting category limited to 20.0% of portfolio assets. Finally, EGRPRA
provided that as an alternative to the QTL test, thrifts such as the Bank may
choose to comply with the Internal Revenue Service's domestic building and loan
tax code test. A savings institution which fails the QTL test is subject to
certain operating restrictions and may be required to convert to a bank charter.
As of December 31, 1999, the Bank maintained 66.7% of its portfolio assets in
qualified thrift investments and therefore met the QTL test.
Limitation on Capital Distributions
- -----------------------------------
OTS regulations impose limitations upon all capital distributions by
savings institutions, such as cash dividends, payments to repurchase or
otherwise acquire its shares, payments to shareholders of another institution in
a cash-out merger and other distributions charged against capital. The OTS
recently adopted an amendment to these capital distribution limitations. Under
the new rule, a savings association in certain circumstances may be required to
file an application and await approval from the OTS prior to making a capital
distribution, may be required to file a notice 30 days prior to the capital
distribution, or may be permitted to make the capital distribution without
notice or application to the OTS.
An application is required (1) if the savings association is not eligible
for expedited treatment of its other applications under OTS regulations; (2) the
total amount of all of capital distributions (including the proposed capital
distribution) for the applicable calendar year exceeds net income for that year
to date plus retained net income for the preceding two years; (3) the savings
association would not be at least adequately capitalized, under the prompt
corrective action regulations of the OTS following the distribution; or (4) the
savings association's proposed capital distribution would violate a prohibition
contained in any applicable statute, regulation, or agreement between the
savings association and the OTS (or the FDIC), or violate a condition imposed on
the savings association in an OTS-approved application or notice.
A notice of a capital distribution is required if a savings association is
not required to file an application, but: (1) would not be well capitalized
under the prompt corrective action regulations of the OTS following the
distribution; (2) the proposed capital distribution would reduce the amount of
or retire any part of the Association's common or preferred stock or retire any
part of debt instruments such as notes or debentures included in capital (other
than regular payments required under a debt instrument approved by the OTS); or
(3) the savings association is a subsidiary of a savings and loan holding
company.
If neither the savings association nor the proposed capital distribution
meet any of the above listed criteria, no application or notice is required for
the savings association to make the proposed capital distribution. 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.
Liquidity
- ---------
Federal regulations currently require savings institutions to maintain, for
each calendar month, an average daily balance of liquid assets (including cash,
certain time deposits, bankers' acceptances, certain mortgage-related
securities, certain mortgage loans with the security of a first lien on
residential property, and specified United States Government, state, or federal
agency obligations) equal to at least 4% of either (i) the average daily balance
of its net withdrawable accounts plus short-term borrowings (the "liquidity
base") during the preceding calendar quarter or (ii) the amount of the liquidity
base at the end of the preceding calendar quarter. This liquidity requirement
may be changed from time to time by the OTS Director to an amount within a range
of 4% to 10% of such accounts and borrowings depending upon economic conditions
and the deposit flows of savings institutions. In addition, savings
institutions must comply with a general non-quantitative requirement to maintain
a safe and sound level of liquidity. For the calculation period including
December 31, 1999, the liquidity ratio of the Bank exceeded regulatory
requirements.
Restrictions On Investments And Loans
- -------------------------------------
23
<PAGE>
In addition to those restrictions presented above in reference to the
Liquidity and QTL Test requirements of federal savings institutions, OTS
regulations do not permit the Bank to invest directly in equity securities, non
investment grade debt securities, or real estate (other than real estate used
for the institution's offices and facilities). Indirect equity investment in
real estate through a subsidiary is permissible, but is subject to certain
limitations and deductions from regulatory capital. Highland's management
intends to refrain from real estate investment in development activity for the
foreseeable future.
Savings institutions are generally subject to the same loans to one
borrower limitations that are applicable to national banks. With certain
limited exceptions, the maximum amount that a savings institution may lend to
one borrower (including certain related persons or entities of such borrower) is
equal to 15% of the savings institution's unimpaired capital and unimpaired
surplus, plus an additional 10% for loans fully secured by readily marketable
collateral. Real estate is not included within the definition of "readily
marketable collateral" for this purpose. The term "unimpaired capital and
unimpaired surplus" is defined as an institution's regulatory capital, plus that
portion of an institution's general valuation allowances that is not includable
in the institution's regulatory capital. At December 31, 1999, the maximum
amount which the Bank could lend to any one borrower (including related persons
and entities) other than for loans secured by readily marketable collateral
under the current loans to one borrower limit was $7.2 million.
The OTS and other federal banking agencies have jointly adopted uniform
rules on real estate lending and related Interagency Guidelines for Real Estate
Lending Policies (the "Guidelines"). The uniform rules require that
institutions adopt and maintain comprehensive written policies for real estate
lending. The policies must reflect consideration of the Guidelines and must
address relevant lending procedures, such as loan to value limitations, loan
administration procedures, portfolio diversification standards and
documentation, and approval and reporting requirements. Although the uniform
rules do not impose specific maximum loan to value ratios, the related
Guidelines state that such ratio limits established by individual institutions'
boards of directors generally should not exceed levels set forth in the
Guidelines, which range from a maximum of 65% for loans secured by unimproved
land to 85% for improved property. No limit is set for single family residence
loans, but the Guidelines state that such loans equal to or exceeding a 90% loan
to value ratio should have private mortgage insurance or some form of credit
enhancement. The Guidelines further permit a limited amount of loans that do
not conform to these criteria.
Aggregate loans secured by non-residential real property are generally
limited to 400% of an institution's total capital, as defined. Because of its
high portfolio concentration in commercial real estate loans at December 31,
1999, the Bank had $13.9 million of additional non-residential lending capacity
under the 400% of capital test.
Classification of Assets
- ------------------------
Savings institutions are required to classify their assets on a regular
basis, to establish appropriate allowances for losses, and to report the results
of such classifications quarterly to the OTS. A savings institution is also
required to set aside adequate valuation allowances, and to establish
liabilities for off balance sheet items, such as letters of credit, when a loss
becomes probable and estimable. The OTS has the authority to review the
institution's classification of its assets and to determine whether additional
assets must be classified, or whether the institution's allowances must be
increased. Such instruction by the OTS to increase valuation allowances could
have a material impact upon both the Bank's reported income and financial
condition.
Assets are classified into one of five categories:
1) Pass. These assets present no apparent weakness of deficiency.
2) Special Mention. These assets present weaknesses or deficiencies
deserving continued monitoring and heightened management attention.
3) Substandard. These assets, or portions thereof, possess well-defined
weaknesses which could jeopardize the timely liquidation of the asset
or the realization of the collateral at values at least equal to
Highland's investment in the asset. These assets are therefore
characterized by the possibility that the institution will sustain
some loss if the deficiencies are not corrected. Highland classifies
all real estate acquired through foreclosure as substandard.
24
<PAGE>
4) Doubtful. These assets, or portions thereof, present probable loss of
principal, but the amount of loss, if any, is subject to the outcome
of future events which are not fully determinable at the time of
classification.
5) Loss. These assets, or portions thereof, present quantified losses to
the institution. The institution must either establish a specific
reserve for the amount of loss or charge off a like amount of the
asset.
In December 1993, the federal banking agencies issued an interagency policy
statement on the allowance for loan and lease losses ("ALLL") which among other
things, establishes certain benchmark ratios of loan loss reserves to criticized
and classified assets (defined at those categorized as other than "Pass").
Highland's internal credit policy is to comply with this policy statement and to
maintain adequate reserves for estimable losses. However, the determination of
estimable losses is by nature an uncertain practice, and hence no assurance can
be given that Highland's losses will prove adequate to cover future losses.
Federal Home Loan Bank System
- -----------------------------
The Federal Home Loan Banks ("FHLB's") provide a comprehensive credit
facility to member institutions. As a member of the FHLB of San Francisco, the
Bank is required to own capital stock in the FHLB. The Bank was in compliance
with this requirement, with a $8.9 million investment in FHLB-San Francisco
capital stock at December 31, 1999. FHLB advances must be secured by specific
types of collateral, including various types of mortgage loans and investment
securities. It is the policy of the Bank's management to maintain an excess of
collateral at the FHLB-San Francisco at all times to serve as a ready source of
additional liquidity.
Federal Reserve System.
- -----------------------
The FRB requires savings institutions to maintain, on a recurring cycle
basis, non interest bearing reserves against certain deposit accounts (primarily
deposit accounts that may be accessed by writing unlimited checks). The amount
of required reserves are calculated according to a formula updated periodically
by the FRB, while such requirement must be met on an average balance basis
during each two-week measurement cycle. The Bank was in compliance with these
reserve requirements for the cycle which included December 31, 1999. The
balances maintained to meet the FRB reserve requirements may be used to satisfy
the liquidity requirements imposed by the OTS.
Legislation is currently being debated which could permit the payment of
interest on reserve balances maintained at the FRB. Another component of this
legislation is the potential elimination of restrictions governing the payment
of interest on certain types of checking accounts (primarily corporate
accounts). Highland's management is unable to predict what, if any, legislation
might eventually be passed and the potential impact of such legislation upon
Highland.
The Bank is subject to many regulations promulgated by the FRB, including,
but not limited to:
. Regulation B: Equal Credit Opportunity Act
. Regulation D: Reserve Requirements
. Regulation E: Electronic Funds Transfer
. Regulation F: Limitations On Correspondent Institution Credit
Exposure
. Regulation Z: Truth In Lending Act
. Regulation CC: Expedited Funds Availability Act
. Regulation DD: Truth In Savings Act
Federal Securities Laws
- -----------------------
Highland's common stock is registered with the SEC under Section 12(g) of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Highland
is subject to periodic reporting requirements, proxy solicitation rules, insider
trading restrictions, tender offer rules, and other requirements under the
Exchange Act. In addition,
25
<PAGE>
certain activities of Highland, its executive officers, and directors are
covered under the Securities Act of 1933, as amended (the "Securities Act").
Non Banking regulation
- ----------------------
Under various federal, state, and local environmental laws and regulations,
a current or previous owner or operator of real property may be liable for the
costs of removal or remediation of hazardous substances on, under, or in such
property. In addition, any person or entity which arranges for the disposal or
treatment of hazardous substances may also be liable for the costs of removal or
remediation of hazardous substances at the disposal or treatment facility. Such
laws and regulations often impose liability regardless of fault, and liability
has been interpreted to be joint and several unless the harm is divisible and
there is a reasonable basis for allocation of responsibility. Pursuant to these
laws and regulations, under certain circumstances, a lender may become liable
for the environmental liabilities associated with its borrowers' properties, if,
among other things, it either forecloses or participates in the management of
its borrowers' operations, hazardous substance handling, or disposal activity.
Although the Comprehensive Environmental Response, Compensation, and
Liability Act of 1980 ("CERCLA") and certain state counterparts provide
exemptions for secured lenders such as the Bank, the scope of such exemptions is
limited. In addition, CERCLA and certain state counterparts impose a statutory
lien, which may be prior to the Bank's interest securing a loan, for certain
costs incurred in connection with removal or remediation of hazardous
substances. Other laws and regulations may also require the removal or
remediation of hazardous substances located on a property before such property
may be sold or transferred.
The Bank incorporates environmental review into its loan approval process,
at times requiring a Phase I environmental audit (which generally involves a
physical inspection without sampling) or a Phase II environmental audit (which
generally involves sampling), with such audits performed by independent
environmental engineers or consultants. Despite these efforts, there can be no
assurances that the Bank will be successful in identifying all potential
environmental liabilities that may exist with respect to real estate securing
its loans or real estate acquired by the Bank through foreclosure. In addition,
the Bank may be impacted by environmental liabilities created in the future
through borrower activities on properties securing real estate loans.
The Bank is aware of certain properties underlying its loans which may
present the potential requirement for environmental remediation, including that
stemming from underground storage tanks, asbestos, and lead paint. Although the
Bank is not aware of any environmental liability relating to these properties
which would have a material adverse effect on its business or results of
operations, there can be no assurance that the costs of any required removal or
remediation would not be material to the value of the subject properties, impact
the Bank's willingness to foreclose on such properties, or adversely affect the
Bank's ability to sell such properties following potential future foreclosure.
Highland is also impacted by bankruptcy laws, which have been a recent
topic of federal legislative discussion.
Taxation.
- ---------
General - Under a tax sharing agreement, Highland files consolidated
federal and California tax returns for itself and its subsidiary on a fiscal
year basis under the accrual method of accounting. In general, Highland is
subject to taxation in a manner similar to other like financial institutions.
Highland is subject to a 34.0% federal income tax rate on taxable income up to
$10 million, and a 35.0% rate applied against taxable income in excess of that
threshold. For California franchise tax purposes, savings and loans are taxed
as "financial corporations" at a rate of 10.84%, versus an 8.84% general
corporate rate, because of exemptions from certain state and local taxes.
Highland is also subject to the corporate Alternative Minimum Tax ("AMT").
Highland also pays certain fees, not classified as taxes for financial reporting
purposes, to the State of Delaware as a Delaware holding company not earning
income in that state.
Tax Bad Debt Reserves - Effective for taxable years beginning after 1995,
legislation enacted in 1996 repealed, for federal purposes, the reserve method
of accounting for bad debts for thrift institutions. While thrifts
26
<PAGE>
qualifying as "small banks" (as defined) may continue to use the experience
method, Highland Federal, deemed a "large bank" (as defined), is required to use
the specific charge-off method. In addition, the legislation enacted in 1996
contains certain income recapture provisions which are discussed below.
The Bank's base-year reserve balance of $4.2 million, for which income
taxes were not provided due to tax legislation in effect during prior periods,
may have to be recaptured into taxable income if:
The Bank ceases to be a "bank" or "thrift" under applicable Internal
Revenue Service ("IRS") definitions (which include restrictions on asset
mix), or
upon the occurrence of certain events, such as distribution to
shareholders in excess of the Bank's current and accumulated earnings and
profits, redemption of shares, or upon a partial or complete liquidation.
If such reserves are recaptured into taxable income, taxes will have to be
provided. Under California regulations, bad debt deductions are available in
computing franchise taxes using a three or six year average loss experience
method.
Net Operating Losses - Federal law limits the carryback period for net
operating losses ("NOL") to two years, with a carryforward period of 20 years.
California does not permit net operating loss carrybacks to prior tax years, but
does permit such losses to be carried forward, generally for five tax years and
only for 50.0% of the net operating losses.
Accounting and Regulation - Federally supervised banks and savings
associations are required to report deferred tax assets and liabilities in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 109. A
reconciliation of Highland's deferred tax assets and liabilities is included in
Note 9 to its audited Consolidated Financial Statements.
Current federal banking rules limit the amount of deferred tax assets that
are allowable in computing an institution's regulatory capital. Deferred tax
assets that can be realized for taxes paid in prior carryback years and from
future reversals of existing taxable temporary differences are generally not
limited. Deferred tax assets that can only be recognized through future taxable
earnings are limited for regulatory capital purposes to the lesser of:
1) The amount that can be realized within one year of the quarter end
report date, based upon projected taxable income for that year
2) 10.0% of Tier One regulatory capital, as defined by applicable
regulations
The amount of any deferred tax assets in excess of this limit would be excluded
from both Tier One regulatory capital and total regulatory assets under
regulatory capital calculations.
Recent Tax Legislation and Rulings - The Tax Court recently determined that
certain direct loan origination expenses were capital in nature, and therefore
should be deducted over the life of the related asset rather than at the time
incurred as ordinary and necessary expenses under Section 162 of the Internal
Revenue Code. If this Tax Court decision is not overturned on appeal or via
Congressional legislation, Highland will experience additional economic cost, as
expenses paid for in cash on a current basis would be deducted only over a
number of years, potentially up to 40 years, depending upon the terms of the
associated loan.
Financial Services Modernization Legislation
- --------------------------------------------
On November 12, 1999, President Clinton signed into law the Gramm-Leach-
Bliley Act of 1999 (the "Financial Services Modernization Act"). The Financial
Services Modernization Act repeals the two affiliation provisions of the Glass-
Steagall Act: Section 20, which restricted the affiliation of Federal Reserve
Member Banks with firms "engaged principally" in specified securities
activities; and Section 32, which restricts officer, director, or employee
interlocks between a member bank and any company or person "primarily engaged"
in specified securities activities. In addition, the Financial Services
Modernization Act also contains provisions that expressly preempt any
27
<PAGE>
state law restricting the establishment of financial affiliations, primarily
related to insurance. The general effect of the law is to establish a
comprehensive framework to permit affiliations among commercial banks, insurance
companies, securities firms, and other financial service providers by revising
and expanding the Bank Holding Company Act of 1956 ("BHCA") framework to permit
a holding company system to engage in a full range of financial activities
through a new entity known as a "Financial Holding Company." "Financial
activities" is broadly defined to include not only banking, insurance, and
securities activities, but also merchant banking and additional activities that
the Federal Reserve Board, in consultation with the Secretary of the Treasury,
determines to be financial in nature, incidental to such financial activities,
or complementary activities that do not pose a substantial risk to the safety
and soundness of depository institutions or the financial system generally.
The Financial Services Modernization Act provides that no company may
acquire control of an insured savings association after May 4, 1999, unless that
company engages, and continues to engage, only in the financial activities
permissible for a Financial Holding Company, unless grandfathered as a unitary
savings and loan holding company. The Financial Institution Modernization Act
grandfathers any company that was a unitary savings and loan holding company on
May 4, 1999 (or becomes a unitary savings and loan holding company pursuant to
an application pending on that date). Such a company may continue to operate
under present law as long as the company continues to meet the two tests: it can
control only one savings institution, excluding supervisory acquisitions, and
each such institution must meet the QTL test. It further requires that a
grandfathered unitary savings and loan holding company must continue to control
at least one savings association, or a successor institution, that it controlled
on May 4, 1999.
The Financial Services Modernization Act also permits national banks to
engage in expanded activities through the formation of financial subsidiaries. A
national bank may have a subsidiary engaged in any activity authorized for
national banks directly or any financial activity, except for insurance
underwriting, insurance investments, real estate investment or development, or
merchant banking, which may only be conducted through a subsidiary of a
Financial Holding Company. Financial activities include all activities permitted
under new sections of the BHCA or permitted by regulation.
While Highland and the Bank do not believe that the Financial Services
Modernization Act will have a material adverse effect on the operations of
Highland and the Bank in the near-term, to the extent that the act permits
banks, securities firm, and insurance companies to affiliate, the financial
services industry may experience further consolidation. The Financial Services
Modernization Act is intended to grant to community banks certain powers as a
matter of right that larger institutions have accumulated on an ad hoc basis and
which unitary savings and loan holding companies already possess. Nevertheless,
this act results in an increase of competition that the Company and the Bank
face from larger institutions and other types of companies offering financial
products, many of which may have substantially more financial resources than the
Company and the Bank. In addition, because the Company may only be acquired by
other unitary savings and loan holding companies or Financial Holding Companies,
the legislation may have an anti-takeover effect by limiting the number of
potential acquirors or by increasing the costs of an acquisition transaction by
a bank holding company that has not made the election to be a Financial Holding
Company under the new legislation.
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
28
<PAGE>
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.
The following table sets forth the locations, transaction deposits and
other information relating to the branches of the Bank as of December 31, 1999:
<TABLE>
<CAPTION>
At December 31, 1998
Transaction Number of
Date Branch Deposits (1) Transaction Total Deposits Number of
Branch Name Opened (In thousands) Accounts (In thousands) Total Accounts
- ----------------------- -------------- ---------------- ------------- --------------- --------------
<S> <C> <C> <C> <C> <C>
Highland Park............. 1/6/69 $ 19,945 3,986 $ 78,278 5,690
San Gabriel............... 12/1/74 11,530 1,615 85,920 3,635
Atwater................... 8/1/79 10,776 2,053 40,070 3,005
Palos Verdes.............. 1/1/81 15,354 1,387 46,370 2,225
Burbank................... 3/1/82 10,061 1,347 65,625 2,709
Torrance.................. 2/1/88 5,520 909 38,280 1,608
Santa Monica.............. 4/1/89 14,111 1,296 59,076 2,211
---------------- ------------- --------------- --------
$ 87,297 12,593 $413,619 21,083
================ ============= =============== ========
</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, 1999, Highland had 103 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
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, 1999, the assets of HFS
Corporation totaled $268,000.
29
<PAGE>
The Bank's alternative investment program, which targets deposit customers
in the branches, is included in the operations of HI-FED Insurance Agency. This
activity contributed $237,000 in commission revenues for 1999. Also, 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. Commissions on insurance sales are
not material to the consolidated results of Highland. At December 31, 1999,
the total assets of HI-FED Insurance were $662,000.
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 located in Southern California and are concentrated in Los Angeles County.
Although management has diversified the Bank's loan portfolio into Northern
California, Arizona and Nevada, a majority of the Bank's credits remain
concentrated in Southern California. As a result of this geographic
concentration, Highland's results depend largely upon economic conditions in
these areas, which have been relatively volatile over the past decade. While
the Southern California economy has recently exhibited significant improved
trends in employment, construction, and real estate valuation, there is no
assurance such economic performance will continue. A deterioration in economic
conditions in Los Angeles County and Southern California could have a material
adverse impact on the quality of Highland's loan portfolio and the demand for
its products and services.
Interest Rates. By nature, all financial institutions are impacted by
--------------
changing interest rates, due to the impact of such upon the demand for new
loans, and the prepayment speeds and the credit profiles of existing loans, and
the rates received on loans and securities and the rates paid on deposits and
borrowings. As presented under Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations", Highland is financially exposed
to both parallel shifts in general market interest rates (with upward shifts
having a negative impact on the Company) and to changes in the relative pricing
of the term structure of general market interest rates to the extent this
impacts Highland's pricing of its interest sensitive assets and liabilities.
Government Regulation and Monetary Policy. The financial services industry
-----------------------------------------
is subject to extensive federal and state supervision and regulation.
Significant new laws, changes in existing laws, or repeals of present laws could
cause Highland's financial results to materially differ from past results.
Further, federal monetary policy, particularly as implemented through the
Federal Reserve System, significantly affects credit conditions for Highland.
Competition. The financial services business in Highland's market areas is
-----------
highly competitive, and is becoming more so due to technological advances,
changes in the regulatory environment, and the accelerating pace of
consolidation among financial services providers. Many of Highland's
competitors are much larger in total assets and market capitalization, have
greater access to capital and funding, and offer a broader array of financial
services. In light of this environment, there can be no assurance that Highland
will be able to compete effectively. The results of Highland may materially
differ in future periods depending upon the nature or level of competition.
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 control this risk by assessing the
likelihood of non performance, tracking loan performance, and diversifying the
credit portfolio. Such policies and procedures may not, however, prevent
unexpected losses that could have a material adverse effect on Highland's
results. For example, relatively few of the real properties securing Highland's
real estate loan portfolio are covered by earthquake insurance, which has
generally been unavailable, significantly limited in scope, or not affordable to
many of Highland's borrowers. Highland is also exposed to credit risk from
multiple other specific and systemic factors, not all of which are within the
Highland's ability to influence or control.
30
<PAGE>
Other Risks. From time to time, Highland details other risks with respect
-----------
to its business and/or financial results with the SEC.
31
<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 Leased June 1985 August 2003
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 2005
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 2004
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 Highland.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
32
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of Highland trades on the Nasdaq National Market under the
symbol "HBNK." The high and low closing sales prices by quarter for trades on
the Nasdaq National Market during 1999 and 1998 of Highland and cash dividends
paid during each quarter are set forth in the table below. The closing sales
price of Highland Common Stock on the Nasdaq National Market was $19.00 per
share on December 31, 1999. The sales prices and dividends have been
retroactively adjusted for the two-for-one stock split effected in the form of a
100% stock dividend in May 1999.
<TABLE>
<CAPTION>
1999
-------------------------------------
------- -------- ---------------
High Low Cash Dividends
------- -------- ---------------
<S> <C> <C> <C>
Fourth Quarter.............. $19.75 $17.63 $0.0625
Third Quarter............... $19.50 $18.13 $0.0625
Second Quarter.............. $20.63 $18.25 $0.0625
First Quarter............... $18.63 $15.75 $0.0625
1998
-------------------------------------
High Low Cash Dividends
------- ---------- ---------------
Fourth Quarter.................. $18.06 $15.75 $0.0625
Third Quarter................... $21.28 $18.94 $0.0625
Second Quarter.................. $21.75 $18.75 $0.1250
First Quarter................... $19.25 $16.63 --
</TABLE>
As of March 24, 2000, there were approximately 770 stockholders of record
of Highland's Common Stock.
33
<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,
1999. 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. The per share data has been retroactively adjusted for the
two-for-one stock split effected in the form of a 100% stock dividend in May
1999.
<TABLE>
<CAPTION>
At or For the Years Ended December 31,
-------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- ----------- ---------- -----------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Selected Financial Condition Data:
Total assets..................................... $ 654,778 $ 604,803 $ 549,638 $ 489,902 $ 459,961
Securities available-for-sale.................... 65,326 53,374 49,635 37,038 43,874
Securities held to maturity...................... 8,943 11,926 15,419 17,969 20,787
Loans receivable, net(1)......................... 545,690 483,694 427,237 373,545 312,994
Deposits......................................... 413,619 388,047 363,678 384,921 378,699
FHLB advances.................................... 178,900 150,900 135,000 62,500 39,500
Stockholders' equity(2).......................... 48,207 43,439 41,512 34,863 34,091
Book value per share............................. 11.36 9.96 8.96 7.59 7.43
Loans originated and purchased during period..... 175,136 155,827 119,019 120,162 89,024
Selected Operating Data:
Interest income.................................. $ 55,546 $ 51,217 $ 44,629 $ 39,638 $ 38,699
Interest expense................................. 27,793 26,981 24,224 20,426 21,387
---------- ---------- ---------- ---------- ----------
Net interest income........................... 27,753 24,236 20,405 19,212 17,312
Provision for loan losses........................ 2,518 3,315 5,164 3,930 5,221
---------- ---------- ---------- ---------- ----------
Net interest income after provision for
loan losses............................... 25,235 20,921 15,241 15,282 12,091
Noninterest income............................... 2,505 3,378 3,924 2,167 1,579
Noninterest expense:
General and administrative expense............ 10,797 9,636 9,863 15,694 12,960
Net (income) cost of operations of real estate
acquired through foreclosure.............. (197) (19) 555 928 2,306
---------- ---------- ---------- ---------- ----------
Total noninterest expense..................... 10,600 9,617 10,418 16,622 15,266
---------- ---------- ---------- ---------- ----------
Income (loss) before income tax
expense (benefit)......................... 17,140 14,682 8,747 827 (1,596)
Income tax expense (benefit)..................... 7,095 6,090 2,624 162 (617)
---------- ---------- ---------- ---------- ----------
Net income (loss)............................. $ 10,045 $ 8,592 $ 6,123 $ 665 $ (979)
========== ========== ========== ========== ==========
Basic earnings (loss) per share.................. $ 2.31 $ 1.88 $ 1.33 $ 0.15 $ (0.43)
========== ========== ========== ========== ==========
Diluted earnings (loss) per share................ $ 2.25 $ 1.80 $ 1.29 $ 0.15 $ (0.43)
========== ========== ========== ========== ==========
Cash dividends per share......................... $ 0.25 $ 0.25 -- -- --
========== ========== ========== ========== ==========
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
At or For the Years Ended December 31,
------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- ------- -------- ----------
<S> <C> <C> <C> <C> <C>
Selected Financial Ratios and Other Data (3):
Performance Ratios:
Return on average assets 1.60% 1.50% 1.20% 0.15% (0.21)%
Return on average equity....................................... 21.76 19.72 16.17 1.93 (4.41)
Dividend payout ratio.......................................... 10.82 13.26 -- -- --
Average equity to average assets............................... 7.38 7.59 7.44 7.56 4.76
Interest rate spread (4)....................................... 4.37 4.23 4.14 4.45 4.16
Net interest margin (5)........................................ 4.66 4.50 4.33 4.60 4.11
General and administrative expense to average assets (6)....... 1.72 1.68 1.94 3.43 2.82
Regulatory Capital Ratios (7):
Tangible capital............................................... 7.5% 7.0% 6.9% 7.2% 7.5%
Leverage capital............................................... 7.5 7.0 6.9 7.2 7.5
Risk-based capital............................................. 10.5 10.4 10.7 11.3 13.6
Asset Quality Ratios:
Nonperforming loans (8) as a percent of gross loans (9)........ 0.36% 0.48% 1.02% 0.90% 1.61%
Nonperforming assets (10) as a percent of total assets......... 0.31 0.50 1.10 0.99 1.78
Allowance for loan losses as a percent of total assets......... 1.83 1.64 1.61 1.57 1.54
Allowance for loan losses as a percent of total
nonperforming loans (8).................................... 595.46 418.99 197.28 222.24 135.20
Classified assets as a percent of stockholder's equity and
allowance for loan losses.................................. 18.16 18.22 26.90 36.87 53.82
Number of full-service customer facilities........................ 7 7 7 11 11
</TABLE>
_________________________
(1) The allowance for loan losses at December 31, 1999, 1998, 1997, 1996 and
1995 was $12.0 million, $9.9 million, $8.8 million, $7.7 million and $7.1
million, respectively.
(2) Stockholders' equity amounts at December 31, 1999, 1998, 1997, 1996 and
1995 are net of unrealized holding losses on securities available-for-sale
of $1,348,000, $15,000, $162,000, $247,000 and $354,000, respectively,
pursuant to SFAS No. 115.
(3) 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.
(4) Represents the difference between the weighted average yield on interest-
earning assets and the weighted average cost of interest-bearing
liabilities.
(5) Represents net interest income as a percent of average interest-earning
assets.
(6) Excludes net cost of operation of REO and losses on sale of investments.
(7) For definitions and further information relating to the regulatory capital
requirements of the Bank, see "Item 1. Supervision and Regulation-Capital
Requirements and Capital Categories."
(8) Nonperforming loans consist of nonaccrual loans. It is Highland's policy
to cease accruing interest on all loans 90 days or more past due.
(9) Gross loans receivable excludes participation loan balances and unamortized
discounts.
(10) Nonperforming assets consist of nonperforming loans and REO.
35
<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, 1999, 1998, and 1997. 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.
This discussion and analysis contains certain statements which constitute
"forward-looking statements" under the Private Securities Litigation Reform Act
of 1995, relating to, among other things, future cash dividends, and future
earnings levels, which are subject to risks and uncertainties that could cause
actual results, performance, or achievements to differ materially. These risks
and uncertainties include economic conditions, interest rates, changes in
government regulation and monetary policy, 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 decade has experienced
relatively volatile economic conditions, including fluctuations in property
values. While the Southern California economy has shown significant improvement
since 1997, there is no assurance that this improved performance will continue.
These factors contributed to higher levels of nonperforming assets and
associated costs (including provisions for loan losses and REO expense) during
1997 when compared to 1998 and 1999.
Highland recorded net income of $10.0 million in 1999, compared with $8.6
million in 1998. Net interest income before provision for losses on loans
increased by $3.5 million, and provision for losses decreased by $0.8 million.
These positive variances were only partially offset by a $1.0 million increase
in non-interest expenses. Highland recorded net income of $8.6 million in 1998,
compared with $6.1 million in 1997. Non-interest income for 1998 included $1.2
million related to the sale of the headquarters building, while 1997 included
$2.0 million in gains on the sales of four branches. The improvement in net
income was principally due to a $5.7 million increase in net interest income
after provision for loan losses, offset by the reduction in other income
discussed above, and $3.5 million in additional income tax provision for 1998
compared to 1997.
36
<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/
1999 1998 (Decrease) 1998 1997 (Decrease)
------- ------- --------- ------- ------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Statement of Income and Comprehensive
Income Data:
Total interest income..................... $55,546 $51,217 $4,329 $51,217 $44,629 $ 6,588
Total interest expense.................... 27,793 26,981 812 26,981 24,224 2,757
------- ------- -------- ------- ------- ---------
Net interest income....................... 27,753 24,236 3,517 24,236 20,405 3,831
Provision for loan losses................. 2,518 3,315 (797) 3,315 5,164 (1,849)
Total noninterest income.................. 2,505 3,378 (873) 3,378 3,924 (546)
Total general & administrative expense.... 10,797 9,636 1,161 9,636 9,863 (227)
Total net (income) cost of operation of
real estate acquired through foreclosure. (197) (19) (178) (19) 555 (574)
------- ------- -------- ------- ------- ---------
Income before income taxes................ 17,140 14,682 2,458 14,682 8,747 5,935
Income taxes.............................. 7,095 6,090 1,005 6,090 2,624 3,466
------- ------- -------- ------- ------- ---------
Net income.......................... $10,045 $ 8,592 $1,453 $ 8,592 $ 6,123 $ 2,469
======= ======= ======== ======= ======= =========
</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.
37
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------------------------------------
1999 1998 1997
----------------------------- --------------------------- --------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
-------- -------- ------- ------- -------- ------- -------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Loans(1)(2)....................... $506,760 $50,411 9.95% $446,764 $45,917 10.28% $392,139 $40,022 10.21%
Mortgage-related securities(3).... 69,899 4,212 6.03 56,699 3,318 5.85 50,833 3,001 5.90
Investments(4).................... 18,728 923 4.93 35,136 1,982 5.64 28,639 1,606 5.61
-------- -------- -------- ------- -------- -------- ------
Total interest-earning assets 595,387 55,546 9.33 538,599 51,217 9.51 471,611 44,629 9.46
Noninterest-earning assets........ 32,232 35,054 37,405
-------- -------- --------
Total Assets................. $627,619 $573,653 $509,016
======== ======== ========
Liabilities and Stockholders'
Equity:
NOW accounts...................... $ 21,248 454 2.14 $ 18,613 321 1.72 $ 19,552 333 1.71
Passbook accounts................. 20,603 460 2.23 21,327 492 2.30 24,639 596 2.42
Money market savings accounts..... 38,184 1,541 4.03 34,683 1,314 3.79 24,135 873 3.62
Certificate accounts.............. 320,009 16,438 5.14 298,107 16,788 5.63 291,176 16,509 5.67
-------- -------- -------- ------- -------- -------- ------
Total interest-bearing deposits 400,044 18,893 4.72 372,730 18,915 5.07 359,502 18,311 5.09
FHLB advances and other
borrowings..................... 159,571 8,900 5.58 137,903 8,066 5.85 95,979 5,913 6.16
-------- -------- -------- ------- -------- -------- ------
Total interest-bearing liabilities 559,615 27,793 4.97 510,633 26,981 5.28 455,481 24,224 5.32
Noninterest-bearing deposits 9,410 9,789 9,107
Other noninterest-bearing
liabilities.................... 12,430 9,669 6,557
Stockholders' Equity.............. 46,164 43,562 37,871
Total Liabilities and
-------- -------- --------
Stockholders' Equity........... $627,619 $573,653 $509,016
======== ======== ========
Net interest income............... 27,753 24,236 20,405
======= ======= =======
Interest rate spread(5)........... 4.36% 4.23% 4.14%
Net interest margin(6)............ 4.66% 4.50% 4.33%
Ratio of interest-earning assets
to interest-bearing liabilities... 106.39% 105.48% 103.54%
</TABLE>
______________________
(1) Interest includes loan fees of $328,000, $669,000 and $286,000 and
prepayment fees of $855,000, $554,000 and $240,000 for the years ended
December 31, 1999, 1998 and 1997, respectively.
(2) Loans include nonaccrual loans.
(3) Includes mortgage securities available-for-sale and held-to-maturity net of
unamortized discounts and premiums.
(4) Includes interest-bearing cash and cash equivalents.
(5) Interest rate spread represents the difference between the yields on
interest-earning assets and rates paid on interest-bearing liabilities.
(6) 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 (1) 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,
which consist of deposits and borrowings, and (2) 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 1999, Highland's ratio of
average interest-earning assets to average interest-bearing liabilities was
106.39%. For 1998, this ratio was 105.48%.
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 respect to: (1)
changes attributable to changes in volume (changes in volume multiplied by prior
rate); (2) changes attributable to rate (changes in rate multiplied by prior
volume); and (3) the net change. The
38
<PAGE>
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, 1999 December 31, 1998
Compared to Year Compared to Year
Ended December 31, 1998 Ended December 31, 1997
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...................................... $ 6,006 $ (1,512) $ 4,494 $5,612 $ 283 $5,895
Mortgage-related securities................ 793 101 894 343 (26) 317
Investments................................ (834) (225) (1,059) 366 10 376
-------- -------- ------- -------- ------ -------
Total interest income on interest-earning
assets.................................. 5,965 (1,636) 4,329 6,321 267 6,588
-------- -------- ------- -------- ------ -------
Interest Expense:
Deposits................................... 1,332 (1,354) (22) 671 (67) 604
FHLB Advances and other borrowings......... 1,242 (408) 834 2,466 (313) 2,153
-------- -------- ------- -------- ------ -------
Total interest expense on interest-bearing
liabilities............................. 2,574 (1,762) 812 3,137 (380) 2,757
-------- -------- ------- -------- ------ -------
Increase (decrease) in net interest income. $ 3,391 $ 126 $ 3,517 $3,184 $ 647 $3,831
======== ======== ======= ======== ====== =======
</TABLE>
Net interest income totaled $27.8 million in 1999, compared with $24.2
million in 1998, an increase of $3.5 million, and resulted primarily from a
volume variance of $6.0 million in interest income on loans, offset by a total
volume variance of $2.6 million in interest bearing liabilities, as rate
variances in interest-earning assets and interest-bearing liabilities totaled
only $0.1 million. Interest income for 1999 was $55.5 million, compared to
$51.2 million for 1998, an increase of $4.3 million. This increase was
primarily the result of an increase in the average volume of loans receivable,
which increased by $60.0 million during 1999 compared to 1998 resulting in a
positive volume variance in interest income of $6.0 million. The average yield
on loans receivable decreased to 9.95% over this period from 10.28% for 1998.
This rate decrease resulted in a negative $1.5 million rate variance in interest
income. The decrease in the average yield on loans receivable is attributable
principally to relatively lower rates charged on new loans and payoffs of older
higher-yielding loans, partially offset by continued high levels of interest
income related to loan prepayments in both 1999 and 1998. Loan principal
amortization and payoffs were $102.9 million during 1999, compared to $83.8
million for 1998. This resulted in the recognition of prepayment fee income of
$855,000 for 1999, compared to $554,000 for 1998. Amortization of deferred
loan fees in 1999 totaled $328,000, compared to $669,000 in 1998. The increase
in loan prepayments did not result in accelerated amortization of deferred loan
fees for the 1999 periods when compared to 1998, because Highland has been
collecting fewer fees on its new loan production. Management anticipates that
the yields earned on Highland's loan portfolio may continue to decrease if the
levels of loan prepayments and related prepayment penalties, decline.
Additionally, in 1999 and 1998, Highland has recognized interest income related
to the amortization of a deep discount on a pool of real estate loans purchased
in late 1996. These loans, which all matured in early 1999, resulted in $328,000
and $623,000 in discount amortization on this pool of loans during 1999 and
1998, respectively. These fees contributed six basis points and 14 basis points,
for 1999 and 1998, respectively, to the yield on loans earned by Highland.
Highland does not anticipate the acquisition of any similar pools of loans in
the future that would have such an enhanced yield. At December 31, 1999 and
1998, the contractual yield on Highland's total loan portfolio was 9.39% and
9.54%, respectively, excluding loan origination fee and discount amortization
and loan prepayment fee income.
39
<PAGE>
The average volume on mortgage-backed securities increased by $13.2
million, resulting in a positive volume variance in interest income of $0.8
million, while the yield on these mortgage-backed securities increased to 6.03%
over the period from 5.85%, which created a $0.1 million positive variance.
Interest income on Highland's investment portfolio for 1999 decreased by $1.1
million compared to 1998, principally attributable to a $16.4 million, or 42.7%,
decrease in the average portfolio volume. The average yield on total interest
earning assets decreased to 9.33% for 1999 compared to 9.51% for 1998 as a
result of rate decreases in all categories of earning assets.
Interest expense for 1999 was $27.8 million, compared to $27.0 million for
1998, an increase of $0.8 million. This increase was due entirely to a $49.0
million increase of total interest-bearing liabilities during 1999 compared to
1998, which contributed a $2.6 million volume related variance. The average
balance of FHLB and other borrowings increased by $21.7 million, contributing to
a volume related variance in interest expense on such borrowings of $1.2 million
for 1999 compared to 1998, while the average balance in interest-bearing
deposits increased by $27.3 million, which resulted in a $0.7 million volume
variance. The positive volume variances for deposits and other borrowings were
partially offset by a negative rate variance of $0.4 million, as the overall
cost of all interest bearing liabilities decreased to 4.97% for 1999 compared to
5.28% for 1998. The average interest rate paid on interest-bearing deposits
decreased to 4.72% for 1999 from to 5.07% for 1998, while the average rate paid
on other borrowings decreased to 5.58% from 5.85% for 1998. For further
information on funding sources, see "Item 1. Business-Sources of Funds."
Net interest income totaled $24.2 million in 1998, compared with $20.4
million in 1997. Interest income for 1998 was $51.2 million, compared to $44.6
million for 1997, an increase of $6.6 million. This increase was primarily the
result of an increase in the average volume of loans receivable, which increased
by $54.6 million during 1998 compared to 1997 resulting in an increase in
interest income of $5.6 million. The average yield on loans receivable increased
slightly to 10.28% over this period from 10.21% for 1997. This rate increase
contributed $0.3 million to the increase in interest income. The increase in the
average yield on loans receivable is attributable principally to increased
levels of interest income related to loan prepayments in 1998 compared to 1997.
Loan principal amortization and payoffs were $83.8 million during 1998, compared
to $48.5 million for 1997. This resulted in the recognition of prepayment fee
income of $554,000 for 1998, compared to $240,000 for 1997. The increase in loan
prepayments also resulted in accelerated amortization of deferred loan fees for
the 1998 periods when compared to 1997. Without prepayment income and fee
amortization related to payoffs in the portfolio during 1998, Highland would
have experienced a negative rate variance in interest on loans. Additionally,
for both 1997 and 1998, Highland has recognized interest income related to the
amortization of a deep discount on a pool of real estate loans purchased in late
1996. These loans will all mature in early 1999. Without the $623,000 discount
amortization on this pool of loans during 1998, the yield earned by Highland
would have been reduced by approximately 14 basis points for the year.
The average volume on mortgage-backed securities increased by $5.9 million,
resulting in an increase in related interest income of $0.3 million, while the
yield on these mortgage-backed securities decreased to 5.85% over the period
from 5.90%, which created a small ($26,000) negative variance. Interest income
on Highland's investment portfolio for 1998 increased by $0.4 million compared
to 1997, attributable almost entirely to an increase in portfolio volume. The
average yield on interest earning assets increased to 9.51% for 1998 compared to
9.46% for 1997 as a result of volume increases in all categories of investments,
and the positive rate variance for the loan portfolio due to the acceleration of
payoffs.
Interest expense for 1998 was $27.0 million, compared to $24.2 million for
1997, an increase of $2.8 million. This increase was due entirely to a $55.2
million increase of interest-bearing liabilities during 1998 compared to 1997,
which contributed a $3.1 million volume related variance. The average volume of
FHLB and other borrowings increased by $41.9 million, contributing to a volume
related variance in interest expense on such
40
<PAGE>
borrowings of $2.5 million for 1998 compared to 1997, while the average balance
in interest-bearing deposits increased by $12.8 million, which resulted in a
$0.7 million volume variance. The positive volume variances for deposits and
other borrowings were slightly offset by a negative rate variance of $0.4
million, as the overall cost of all interest bearing liabilities decreased to
5.28% for 1998 compared to 5.32% in 1997. The average interest rate paid on
interest-bearing deposits decreased to 5.07% for 1998 from 5.09% for 1997, while
the average rate paid on other borrowings decreased to 5.85% from 6.16% for
1997. 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 $2.0 million at December 31, 1999 compared with
$3.0 million at December 31, 1998 and $6.0 million at December 31, 1997.
Management expects that Highland's net interest income in future periods would
continue to benefit from relatively low levels 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.
Highland's provisions for loan losses were $2.5 million in 1999, $3.3
million in 1998 and $5.2 million in 1997. Highland's reduced provision for 1999
compared to 1998 reflects improvements in asset quality during 1999. Nonaccrual
loans declined to $2.0 million at December 31, 1999 from $2.4 million at
December 31, 1998. In addition, aggregate delinquent loans and loans past due
30-89 days decreased to $4.1 million and $2.1 million, respectively, at December
31, 1999 from $4.8 million and $2.4 million, respectively, at December 31, 1998.
Chargeoffs against Highland's allowance for loan losses decreased to $0.6
million in 1999 from $2.3 million in 1998. Total classified assets increased
slightly to $10.8 million at December 31, 1999 from $9.5 million at December 31,
1998 and was 1.6% of total assets for both years.
Highland's reduced provision for 1998 compared to 1997 reflects
improvements in asset quality during 1998. Nonaccrual loans declined to $2.4
million at December 31, 1998 from $4.5 million at December 31, 1997. In
addition, classified assets declined to $9.5 million at December 31, 1998 from
$13.5 million at December 31, 1997, and aggregate delinquent loans and loans
past due 30-89 days decreased to $4.8 million and $2.4 million, respectively, at
December 31, 1998 from $7.6 million and $3.1 million, respectively, at December
31, 1997. Chargeoffs against the allowance for loan losses decreased by $1.7
million, in 1998 compared to 1997, a reduction of 43.5%.
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
41
<PAGE>
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 1999 decreased by $0.9 million to $2.5 million from
$3.4 million for 1998. Highland recognized a $0.3 million gain related to the
settlement in 1999 of disputed utility liens and charges against previously
foreclosed real estate, while a $1.2 million gain on the sale of Highland's
headquarters building was recognized in 1998. Excluding the utility lien
settlement in 1999 and the gain on the building sale in 1998, noninterest income
was unchanged between the two years.
Noninterest income for 1998 decreased by $0.5 million to $3.4 million from
$3.9 million for 1997. A $1.2 million gain on the sale of Highland's
headquarters building was recognized during 1998. Excluding the building sales
gain in 1998 and the $2.0 million gain on sale of branches realized in 1997,
noninterest income increased by $0.3 million between the two years, due
principally to an increase of $0.2 million in gains on sales on loans.
Noninterest Expense
Noninterest expense consists of REO expense and general and administrative
expense. Noninterest expense for 1999 increased by $1.0 million to $10.6
million, compared to $9.6 million for 1998. General and administrative expense
increased by $1.2 million for 1999, due to the recognition of $1.2 million in
additional compensation expense related to the exercise of certain executives'
stock options with a tax-offset cash bonus during the year. The ratio of
general and administrative expenses to average assets increased to 1.72% during
1999, compared to 1.68% during 1998, as a result of this additional compensation
charge. Net cost of operation of REO is 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. Highland had net income from operations of REO of $197,000 during
1999 and $19,000 during 1998, reflecting in both years low levels of REO
holdings and dispositions at little cost or net gain to the Company.
Noninterest expense for 1998 decreased by $0.8 million from $10.4 million
for 1997. Net income from operation of REO was $19,000 for 1998, compared to
$0.5 million of net cost during 1997 principally due to lower levels of REO
activity in 1998. General and administrative expense decreased slightly during
1998 to $9.6 million from $9.9 million for 1997, reflecting a full year of
reduced costs associated with the 1997 sales of four branches, offset by
increases related to a computer service bureau conversion. As a result, the
ratio of general and administrative expenses to average assets decreased to
1.68% during 1998, compared to 1.94% during 1997.
Income Taxes
The provision for income taxes was $7.1 million in 1999, $6.1 million in
1998 and $2.6 million in 1997, respectively. Highland's combined, effective
federal and state income tax rates was 41.4% in 1999, 41.5% in 1998 and 30.0% in
1997, respectively. Highland's statutory federal and state income tax rates was
approximately 41.4% in each year. The effective income tax rates differ from the
statutory income tax rates in 1997 principally due to the utilization of
valuation reserves for state deferred income tax benefits. Highland had
valuation allowances for state deferred income tax benefits of $0.2 million at
December 31, 1997.
42
<PAGE>
FINANCIAL CONDITION
Comparison of Financial Condition for the Years Ended December 31, 1999 and 1998
- --------------------------------------------------------------------------------
Total assets at December 31, 1999 were $654.8 million, compared to $604.8
million at December 31, 1998. Loans receivable increased by $62.0 million
during 1999, reflecting the $165.9 million in new loan originations and $9.2
million in loan purchases, offset by $109.0 million in loan sales, payoffs and
normal principal amortization. Cash and cash equivalents decreased by $21.5
million, principally to fund loans originated and purchased late in the year,
while total securities increased by $9.0 million. Other assets were all
relatively unchanged for the year.
Total liabilities at December 31, 1999 were $606.6 million, compared to
$561.4 million at December 31, 1998, an increase of $45.2 million. This growth
was split almost evenly between an increase in FHLB advances of $28.0 million
and an increase in deposits of $25.6 million over this period, offset partially
by a $5.0 million reduction in securities sold under agreements to repurchase.
Stockholders' equity at December 31, 1999 was $48.2 million, compared to $43.4
million at December 31, 1998, as the Company's net income of $10.0 million was
partially offset by a net increase of $2.1 million in common shares held in
treasury, a $1.3 million increase in accumulated other comprehensive loss
related to securities available-for-sale and $1.1 million of dividends paid on
common stock.
Comparison of Financial Condition for the Years Ended December 31, 1998 and 1997
- --------------------------------------------------------------------------------
Total assets at December 31, 1998 were $604.8 million, compared to $549.6
million at December 31, 1997. Loans receivable increased by $56.5 million
during 1998, reflecting the $155.8 million in new loan originations, offset by
$92.8 million in loan sales, payoffs and normal principal amortization.
Premises and equipment decreased by $5.3 million, reflecting the sale of the
headquarters building, offset by increases in computer equipment related to the
Company's computer conversion. Cash, investments, and other assets were all
relatively unchanged.
Total liabilities at December 31, 1998 were $561.4 million, compared to
$508.1 million at December 31, 1997. This growth was split almost evenly between
an increase in FHLB advances and other borrowings of $25.9 million and an
increase in deposits of $24.4 million over this period. Stockholders' equity at
December 31, 1998 was $43.4 million, compared to $41.5 million at December 31,
1997, as the Company's net income of $8.6 million was offset by the purchase of
150,000 common shares held in treasury for $5.8 million and dividends paid on
common stock of $1.1 million.
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,
1999, the Bank's most recent quarterly average liquidity ratio was 13.6%,
compared to 15.7% and 15.0% for the comparable 1998 and 1997 periods,
respectively. Highland's liquidity ratio may vary from time to time, depending
upon savings flows, future loan fundings, operating needs and general economic
conditions.
The Bank's primary sources of liquidity are deposits, principal and
interest payments (including prepayments) on its loan and investment portfolios,
FHLB advances and other borrowings, and cash from operations (retained
earnings). The primary uses of funds include loan disbursements, loan
purchases, customer deposit withdrawals, purchases of new investments, dividends
and treasury share repurchases. Highland has funded most of its growth from
1997 through 1999 through financing activities, including net growth in
borrowings and deposits, rather than through retained earnings.
43
<PAGE>
New loan originations and purchases totaled $175.1 million for 1999,
compared to $155.8 million for 1998 and $119.0 million for 1997. Highland
received cash repayments and prepayments of approximately $102.9 million during
1999, compared to $83.8 million for 1998 and $48.5 million for 1997. Such
payments, together with increases in FHLB advances and securities sold under
agreements to repurchase, along cash flow from operations, were sufficient to
fund all of Highland's lending activities during 1999 and 1998.
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 1999, Highland had net additional borrowings of $28.0 million of
FHLB advances, compared to net borrowings of $15.9 million during 1998. At
December 31, 1999, Highland's outstanding borrowings from the FHLB totaled
$178.9 million, compared to $150.9 million at December 31, 1998. 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 ($229.3 million at December 31,
1999). FHLB advances are collateralized by pledges of qualifying real estate
loan collateral. At December 31, 1999, Highland had $178.9 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,
1999.
The liquidity of the parent company, Highland Bancorp, Inc., is dependent
on several factors, including the payment of cash dividends by its subsidiary,
Highland Federal Bank, or the ability to obtain borrowings. Without dividends
from Highland Federal Bank, Highland Bancorp, Inc. must rely solely on existing
cash and cash equivalents, which total $0.2 million at December 31, 1999, or on
the ability to obtain borrowings to pay existing current liabilities and future
operating expenses. The parent company's liquidity requirements are currently
limited to shareholder dividends when declared, and certain incidental
expenditures related to corporate obligations. The parent company currently has
no separate operations from the subsidiary Bank.
Asset/Liability Management and Interest Rate Risk
- --------------------------------------------------
Interest rate risk ("IRR") and credit risk constitute the two greatest
sources of financial exposure for insured financial institutions. For a
discussion of Highland's credit risk, please see "Provision for Loan Losses".
IRR represents the impact that changes in absolute and relative levels of
general market interest rates might have upon Highland's net interest income,
results of operations, and theoretical liquidation value, also called net
portfolio value ("NPV"). Interest rate changes impact income and NPV in many
ways, including effects upon the yields generated by variable rate assets, the
cost of deposits and other sources of funds, the exercise of options embedded in
various financial instruments, and customer demand for and market supply of
different financial assets and liabilities.
In order to manage IRR, Highland has established an Asset Liability
Management Committee ("ALCO"). ALCO is responsible for managing the Company's
financial assets and liabilities in a manner which balances profitability, IRR,
and various other risks including liquidity. ALCO operates under policies and
within risk limits prescribed by and reviewed and approved by the Board of
Directors.
The primary objective of Highland's IRR management program is to maximize
net income while controlling IRR exposure to within prudent levels. Financial
institutions are subject to IRR whenever assets and liabilities mature or
reprice at different times (gap risk), against different indices (basis risk),
for different terms (yield curve risk), or are subject to various embedded
options, such as the right of mortgage borrowers to refinance their loans when
general market interest rates decline. Decisions to control or accept IRR are
analyzed with a consideration of the probable occurrence of future interest rate
changes. Stated another way, IRR management encompasses the evaluation of the
likely additional return associated with an incremental change in the IRR
profile of Highland. For example, having liabilities that mature or reprice
faster than assets can be beneficial when interest rates decline, but may be
detrimental when interest rates rise. Assessment of potential changes in market
interest rates and the relative financial impact to income and NPV is used by
Highland to help quantify and manage IRR. As with credit risk, the complete
elimination of IRR would curtail Highland's profitability, as Highland generates
a
44
<PAGE>
return, in part, through effective risk management. Highland's exposure to IRR
as of December 31, 1999 was within the limits established by the Board of
Directors.
Highland monitors its interest rate risk using various analytical methods
that include:
. internal income simulation and financial forecasting analysis
. NPV analysis, produced both internally by Highland and obtained
externally from the OTS Net Portfolio Value Model
. other analyses and management reports.
A common, if analytically limited, measure of financial institution IRR is
the institution's "static gap." Static gap is the difference between the amount
of assets and liabilities (adjusted for off balance sheet positions) which are
expect to mature or reprice within a specific time period. A static gap is
considered positive when the amount of interest sensitive assets exceeds the
amount of interest rate sensitive liabilities in a given time period or
cumulatively through that time period, and is considered negative when the
amount of interest rate sensitive liabilities exceeds the amount of interest
sensitive assets maturing or repricing within a given or cumulative period.
At December 31, 1999, Highland's cumulative one-year and three-year static
gaps, based upon contractual repricing and maturities, (ignoring prepayments and
other non-contractual adjustments) were (9.01)% and (7.09)%, respectively, of
total interest earning assets. These figures suggest that the Bank's net
interest income would decline somewhat if rates were to increase and would
increase similarly if rates were to decline.
The following table presents the maturity and rate sensitivity of interest-
earning assets and interest-bearing liabilities as of December 31, 1999. The
"static gap" figures in the table below reflect the estimated difference between
the amount of interest-earning assets and interest-bearing liabilities that are
contractually scheduled to mature or reprice (whichever occurs first) during
future periods:
45
<PAGE>
<TABLE>
<CAPTION>
More than More than More than
3 Months 1 Year 3 Years to More than Noninterest
3 Months to to 3 Years 5 Years 5 Years Sensitive
or less 1 Year Total
-------- --------- --------- --------- --------- ----------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Assets:
Cash and cash equivalents................. $ 1,000 $ -- $ -- $ -- $ -- $ 6,231 $ 7,231
Investment securities, net................ -- -- -- -- 2,000 -- 2,000
Fixed rate mortgage backed securities..... 3,252 5,960 9,410 9,244 36,054 -- 63,920
Adjustable rate mortgage backed
securities............................... 40 122 358 407 9,315 -- 10,242
Premiums (discounts) and unrealized
gains (losses) on securities............. -- -- -- -- -- (1,893) (1,893)
Fixed rate residential loans.............. 1,203 2,341 4,396 3,465 17,607 -- 29,012
Adjustable rate residential loans......... 3,202 1,904 -- -- -- -- 5,106
Fixed rate multifamily loans.............. 12,532 15,130 23,782 10,896 16,693 -- 79,033
Adjustable rate multifamily loans......... 143,935 52,787 174 308 -- -- 197,204
Fixed rate commercial real estate loans 13,254 21,107 37,895 15,755 19,302 -- 107,313
Adjustable rate commercial real estate
loans.................................... 101,126 28,465 -- -- -- -- 129,591
Fixed rate land and construction loans.... 701 574 188 28 20 -- 1,511
Adjustable rate land and construction 619
loans.................................... 1,851 2,097 1,046 2,616 -- 8,229
Fixed rate consumer and other loans....... 418 331 21 22 43 -- 835
Allowance for loan losses, deferred
loan fees and loans in process........... -- -- -- -- -- (12,144) (12,144)
Other noninterest-earning assets.......... -- -- -- -- -- 27,588 27,588
--------- --------- -------- -------- -------- -------- ---------
Total Assets 282,514 130,818 77,270 40,744 103,650 19,782 654,778
--------- --------- -------- -------- -------- -------- ---------
Liabilities and Shareholders' Equity:
Money market savings accounts............. 36,596 -- -- -- -- -- 36,596
Passbook accounts......................... 19,959 -- -- -- -- -- 19,959
NOW accounts.............................. 22,774 -- -- -- -- 7,968 30,742
Certificate accounts...................... 66,791 208,723 42,285 8,523 -- -- 326,322
FHLB advances and other borrowings........ 35,000 82,500 22,400 44,000 -- -- 183,900
Noninterest-bearing liabilities........... -- -- -- -- -- 9,052 9,052
Shareholders' equity...................... -- -- -- -- -- 48,207 48,207
--------- --------- -------- -------- -------- -------- ---------
Total Liabilities and Shareholders'
Equity................................. 181,120 291,223 64,685 52,523 -- 65,227 654,778
--------- --------- -------- -------- -------- -------- =========
Interest rate sensitivity gap............. $ 101,394 $(160,405) $ 12,585 $(11,779) $103,650 $(45,445)
========= ========= ======== ======== ======== ========
Cumulative interest rate sensitivity gap.. $ 101,394 $ (59,011) $(46,426) $(58,205) $ 45,445 --
========= ========= ======== ======== ======== ========
Interest rate sensitivity gap as a
percent of total assets.................. 15.49% (24.50)% 1.92% (1.80)% 15.83% (6.94)%
========= ========= ======== ======== ======== ========
Cumulative interest rate sensitivity
gap as a percent of total assets......... 15.49% (9.01)% (7.09)% (8.89)% 6.94% --
--------- -------- -------- -------- -------- --------
</TABLE>
Static gap analysis such as that presented above fails to capture material
components of IRR, and therefore provides only a limited, point in time view of
the Company's IRR exposure. Simulating multiple interest rate scenarios to
analyze the financial impacts of various changes in general market interest
rates is a more effective measure of IRR because it incorporates specific
assumptions and factors not considered in static gap analysis. The assumptions
and factors which are by definition excluded from the static gap analysis
encompass:
46
<PAGE>
. prepayments on assets, which are very significant to Highland due its large
balance of mortgage loans and related securities
. how rate movements and the shape of the Treasury curve affect borrower
prepayment behavior
. that all loans and deposit repricing at a given time will not adjust to the
same degree or by the same magnitude
. that the nature of rate changes for assets and liabilities in the over one-
year category have a greater long-term economic impact than those for shorter
term assets and liabilities
. transaction deposit accounts do not have scheduled repricing dates or
contractual maturities, and therefore may respond to interest rate changes
differently than other financial instruments
. potential company and competitor strategic and operating responses to changes
in absolute and relative interest rate levels
. the financial impact of options embedded in various financial instruments
such as callable bonds and putable borrowings
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. 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, 1999, the Bank's Sensitivity Measure, as measured by the
OTS, was 147 basis points. As of the same date, the Sensitivity Measure as
measured by the Company was 240 basis points. The Company 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.
47
<PAGE>
Year 2000 Issues (THIS CONSTITUTES A "YEAR 2000 READINESS DISCLOSURE" UNDER THE
YEAR 2000 INFORMATION AND READINESS DISCLOSURE ACT)
The Year 2000 Issue concerns the potential impact of historic computer
software code that only utilizes two digits to represent the calendar year (e.g.
"99" for 1999"). Software so developed, and not corrected, could produce
inaccurate or unpredictable results commencing upon January 1, 2000, when
current and future dates present a lower two digit year number than dates in the
prior century. Highland, similar to most financial services providers, is
significantly subject to the potential impact of the Year 2000 Issue due to the
nature of financial information. Potential impacts to Highland may arise from
software, computer hardware, and other equipment both within Highland's direct
control and outside of Highland's ownership, yet with which Highland
electronically or operationally interfaces.
In order to address the Year 2000 Issue, Highland developed and implemented
a five phase plan divided into the following major components:
. awareness
. assessment
. renovation
. validation
. implementation
Highland has experienced no Year 2000 operating problems or issues through
February 29, 2000. The Company's management plans to continue to monitor its
business and data processing related activities to insure that any Year 2000
processing issues are identified and addressed. Because all Highland's critical
computer systems are written and maintained by outside vendors, the direct costs
incurred by Highland for Year 2000 issues have been less than if Highland had to
utilize its own personnel to modify or rewrite computer software. Highland spent
approximately $95,000 in 1999 and $75,000 in 1998, primarily indirect labor to
oversee planning and testing for Year 2000, and spent $2,000 in 1997. Highland
has not noted any significant impacts of Year 2000 issues on its customers, and
continues to believe this poses no material risk to the Bank.
Capital Resources
- -----------------
At December 31, 1999, 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, 1999 and December 31,
1998 (see also Note 17 of the Notes to Consolidated Financial Statements):
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998 Minimum Requirement
----------------- ----------------- -------------------
<S> <C> <C> <C>
Tangible Capital..................... 7.50% 7.01% 1.50%
Leverage Capital..................... 7.50% 7.01% 4.00%
Risk-based Capital................... 10.45% 10.38% 8.00%
</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."
48
<PAGE>
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
NONE
49
<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 sections entitled "ELECTION OF
DIRECTORS" and "COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF
1934" 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 "SECURITIES OWNERSHIP OF 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
50
<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>
<S> <C>
1. Financial Statements and Schedules Page No.
Independent Auditors' Report............................................ F-1
Consolidated Statements of Financial Condition as of December
31,1999 and 1998........................................................ F-2
Consolidated Statements of Income and Comprehensive Income for the Years
ended December 31, 1999, 1998 and 1997.................................. F-3
Consolidated Statements of Shareholders' Equity for the Years ended
December 31, 1999, 1998 and 1997........................................ F-4
Consolidated Statements of Cash Flows for the Years ended
December 31, 1999, 1998 and 1997........................................ F-5
Notes to Consolidated Financial Statements.............................. F-7
</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 Bancorp, Inc. 1994 Stock Option and Performance Share Award
Plan, as Amended and Restated.
10.2 Highland Federal Bank Profit Sharing Plan and Trust.
10.3 Form of Change of Control Employment Agreement between the Bank and
each of Stephen N. Rippe, Gary P. Warren 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.
51
<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.
4.1 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 Bancorp Inc. 1994 Stock Option and Performance Share Award
Plan, as Amended and Restated, filed as Exhibit 99.1 to Registration
Statement on Form S-8 (File No. 333-57725) filed by the Registrant
with the Commission on June 25, 1998 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 and Ellen B. Geiger, filed as
Exhibit 10.3 to Registrant's Annual Report on Form 10-K for the year
ended December 31, 1997, Commission File No. 0-29668 (the "1997 10-K")
and incorporated herein by reference.
10.4 Form of Indemnification Agreement between the Bank and Members of the
Board of Directors of the Bank, filed as Exhibit 10.4 to the 1997 10-K
and incorporated herein by reference.
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, filed as Exhibit 10.5 to the 1997 10-K and incorporated herein
by reference.
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 included herein.
21.0 Subsidiaries of the Registrant.
23.1 Consent of KPMG LLP.
27.0 Financial Data Schedule.
(b) Reports on Form 8-K
-------------------
The Registrant did not file any reports on Form 8-K during the
fourth quarter of 1999.
(c) Exhibits Required by Item 601 of Regulation S-K
See Item 14(a)(3)(i) above.
(d) Additional Financial Statements
-------------------------------
Not applicable.
52
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities and
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 27th day of
March, 2000.
HIGHLAND BANCORP, INC.
By: /s/ STEPHEN N. RIPPE
---------------------------
Stephen N. Rippe, President
March 27, 2000
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 27, 2000
- --------------------------
Richard J. Cross
Chairman of the Board and Director
/s/ WOODROW De WITT Dated: March 27, 2000
- --------------------------
Woodrow De Witt, Director
/s/ WILLIAM DYESS Dated: March 27, 2000
- --------------------------
William Dyess, Director
/s/ RICHARD O. OXFORD Dated: March 27, 2000
- --------------------------
Richard O. Oxford, Director
/s/ GEORGE PIERCY Dated: March 27, 2000
- --------------------------
George Piercy, Director
/s/ STEPHEN N. RIPPE Dated: March 27,2000
- --------------------------
Stephen N. Rippe,
President, Chief Executive Officer
and Director (Principal Executive Officer)
/s/ SHIRLEY E. SIMMONS Dated: March 27,2000
- --------------------------
Shirley E. Simmons
Vice Chairman of the Board and Director
/s/ KELLY A. ANDREWS Dated: March 27, 2000
- --------------------------
Senior Vice President, Treasurer
(Principal Financial Officer)
/s/ STEPHEN D. COOPER Dated: March 27, 2000
- --------------------------
Senior Vice President, Controller
(Principal Accounting Officer)
53
<PAGE>
Independent Auditors' Report
The Board of Directors and Shareholders
Highland Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition
of Highland Bancorp, Inc. and subsidiaries as of December 31, 1999 and 1998 and
the related consolidated statements of income and comprehensive income, changes
in shareholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1999. 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 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, 1999 and 1998 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999 in conformity with generally accepted
accounting principles.
/s/ KPMG LLP
Los Angeles, California
January 19, 2000
F-1
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
(Dollar amounts in thousands, except share amounts)
<TABLE>
<CAPTION>
December 31
----------------------------
Assets 1999 1998
---- ----
<S> <C> <C>
Cash and cash equivalents $ 7,231 28,776
Securities available-for-sale (cost of $67,369 in 1999 and $53,397
in 1998) 65,326 53,374
Securities held-to-maturity (fair value of $8,622 in 1999 and
$11,877 in 1998) 8,943 11,926
Loans receivable, net of allowance for loan losses of $11,951 in
1999 and $9,909 in 1998 545,690 483,694
Real estate acquired through foreclosure, net -- 630
Federal Home Loan Bank stock, at cost 8,945 7,545
Accrued interest receivable 4,402 4,205
Premises and equipment, net 2,147 2,300
Deferred income taxes, net 1,580 4,475
Other assets 10,514 7,878
-------- -------
$654,778 604,803
======== =======
Liabilities and Shareholders' Equity
Liabilities:
Deposits $413,619 388,047
FHLB advances 178,900 150,900
Securities sold under agreements to repurchase 5,000 10,000
Accounts payable and other liabilities 8,782 10,416
Income taxes payable 270 2,001
-------- -------
Total liabilities 606,571 561,364
-------- -------
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 4,662,987 shares in 1999 and 4,662,348 shares
in 1998 47 47
Additional paid-in capital 15,518 16,255
Retained earnings 41,909 32,952
Treasury shares (419,513 shares in 1999 and 300,000 shares
in 1998, at cost) (7,919) (5,800)
Accumulated other comprehensive loss - unrealized losses on
securities available-for-sale (1,348) (15)
-------- -------
Total shareholders' equity 48,207 43,439
-------- -------
$654,778 604,803
======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
(Dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
Year ended December 31
------------------------------------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Interest income:
Loans $50,411 45,917 40,022
Securities available-for-sale 4,540 4,479 3,581
Securities held-to-maturity 595 821 1,026
------- ------ ------
Total interest income 55,546 51,217 44,629
------- ------ ------
Interest expense:
Deposits 18,893 18,915 18,311
FHLB advances and other borrowings 8,900 8,066 5,913
------- ------ ------
Total interest expense 27,793 26,981 24,224
------- ------ ------
Net interest income 27,753 24,236 20,405
Provision for losses on loans 2,518 3,315 5,164
------- ------ ------
Net interest income after provision for losses on loans 25,235 20,921 15,241
------- ------ ------
Noninterest income:
Gain on sale of building -- 1,170 --
Gain on sale of loans 169 276 118
Net gain on sale of securities available-for-sale -- 12 20
Gain on sales of branches -- -- 2,014
Other 2,336 1,920 1,772
------- ------ ------
Total noninterest income 2,505 3,378 3,924
------- ------ ------
Noninterest expense:
General and administrative expense:
Compensation and benefits 6,796 5,684 5,552
Occupancy and equipment 1,210 1,024 1,290
FDIC deposit insurance premium 238 224 299
Service bureau and related equipment rental 682 755 568
Other 1,871 1,949 2,154
------- ------ ------
Total general and administrative expenses 10,797 9,636 9,863
(Income) cost of operation of real estate acquired through
foreclosure (197) (19) 555
------- ------ ------
Total noninterest expense 10,600 9,617 10,418
------- ------ ------
Income before income taxes 17,140 14,682 8,747
Income taxes 7,095 6,090 2,624
------- ------ ------
Net income 10,045 8,592 6,123
------- ------ ------
Other comprehensive income:
Unrealized (losses) gains on securities available-for-sale (2,020) 245 101
Reclassification adjustment for gains (loss) included in income -- (22) 28
Income tax (benefit) expense on other comprehensive income (687) 76 44
------- ------ ------
Other comprehensive (loss) income, net of tax (1,333) 147 85
------- ------ ------
Comprehensive income $ 8,712 8,739 6,208
======= ====== ======
Basic net earnings per share $ 2.31 1.89 1.33
======= ====== ======
Diluted net earnings per share $ 2.25 1.80 1.29
======= ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity
Years ended December 31, 1999, 1998 and 1997
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Accumulated
Additional Common other Total
Common paid-in Retained shares held comprehensive shareholders'
stock capital earnings in treasury income (loss) equity
------ ---------- -------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $47 15,679 19,384 -- (247) 34,863
Net income -- -- 6,123 -- -- 6,123
Exercise of common stock options -- 243 -- -- -- 243
Retirement of common stock -- (185) -- -- -- (185)
Issuance of performance shares -- 383 -- -- -- 383
Other comprehensive income, net of tax -- -- -- -- 85 85
--- ------ ------ ------ ------ ------
Balance at December 31, 1997 47 16,120 25,507 -- (162) 41,512
Net income -- -- 8,592 -- -- 8,592
Exercise of common stock options -- 135 -- -- -- 135
Purchase of treasury shares -- -- -- (5,800) -- (5,800)
Dividends paid on common stock -- -- (1,147) -- -- (1,147)
Other comprehensive income, net of tax -- -- -- -- 147 147
--- ------ ------ ------ ------ ------
Balance at December 31, 1998 47 16,255 32,952 (5,800) (15) 43,439
Net income -- -- 10,045 -- -- 10,045
Exercise of common stock options -- (1,668) -- 1,917 -- 249
Purchase of treasury shares -- -- -- (4,036) -- (4,036)
Dividends paid on common stock -- -- (1,088) -- -- (1,088)
Issuance of stock options -- 931 -- -- -- 931
Other comprehensive income, net of tax -- -- -- -- (1,333) (1,333)
--- ------ ------ ------ ------ ------
Balance at December 31, 1999 $47 15,518 41,909 (7,919) (1,348) 48,207
=== ====== ====== ====== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Year ended December 31
---------------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 10,045 8,592 6,123
Adjustments to reconcile net income to net cash provided by
operating activities:
Gain on sale of loans (169) (276) (118)
Gain on sale of securities available-for-sale -- (12) (20)
Gain on sale of building -- (1,170) --
Gain on sale of branches -- -- (2,014)
Net gain on sale of real estate acquired through foreclosure (169) (262) (90)
Decrease (increase) in net deferred tax asset 3,582 (735) 576
Amortization of premiums on securities 146 294 301
Depreciation 496 559 690
Federal Home Loan Bank stock dividend (407) (399) (249)
Deferred direct loan origination fees and costs, net (968) (817) (346)
Amortization of deferred compensation expense -- 128 255
Provision for losses on loans 2,518 3,315 5,164
Provision for losses on real estate acquired through foreclosure -- 108 310
Increase in accrued interest receivable (197) (416) (385)
Increase in other assets (2,636) (576) (244)
(Decrease) increase in accounts payable and other liabilities (1,634) 1,008 (456)
(Decrease) increase in income taxes payable (1,731) (486) 2,286
-------- ------- --------
Net cash provided by operating activities 8,876 8,855 11,783
-------- ------- --------
Cash flows from investing activities:
Purchases of securities available-for-sale (32,083) (51,156) (32,426)
Sales and maturities of securities available-for-sale 18,038 47,443 19,744
Principal payments on investment securities held-to-maturity 2,910 3,408 2,474
Increase in Federal Home Loan Bank stock (993) (396) (3,376)
(Purchases) sales of premises and equipment (343) 8,357 22
Net costs capitalized on real estate acquired through foreclosure (171) (313) (205)
Proceeds from the sale of real estate acquired through foreclosure 1,048 2,862 7,082
Proceeds from the sale of loans 6,285 9,234 4,380
Purchases of loans (9,222) -- (396)
Net increase in loans receivable (60,518) (69,395) (69,704)
-------- ------- --------
Net cash used in investing activities (75,049) (49,956) (72,405)
-------- ------- --------
</TABLE>
(Continued)
F-5
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Year ended December 31
---------------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Cash flows from financing activities:
Decrease in deposits from sale of branches $ -- -- (103,857)
Net increase in deposits 25,572 24,369 84,627
Net borrowings from the Federal Home Loan Bank 28,000 15,900 72,500
(Decrease) increase in securities sold under agreements to repurchase (5,000) 10,000 --
Repurchase of common stock for treasury (4,036) (5,800) --
Retirement of common stock -- -- (185)
Dividends paid on common stock (1,088) (1,147) --
Common stock options exercised 1,180 135 243
-------- ------ --------
Net cash provided by financing activities 44,628 43,457 53,328
-------- ------ --------
(Decrease) increase in cash and cash equivalents (21,545) 2,356 (7,294)
Cash and cash equivalents at beginning of year 28,776 26,420 33,714
-------- ------ --------
Cash and cash equivalents at end of year $ 7,231 28,776 26,420
======== ====== ========
Supplemental disclosures of cash flow information:
Interest paid $ 28,004 27,474 23,906
Income taxes paid, net 5,491 6,835 863
======== ====== ========
Supplemental disclosure of noncash investing and financing activities:
Acquisition of real estate in settlement of loans $ 425 3,402 9,688
Loans made in conjunction with real estate sales 347 1,924 3,574
======== ====== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
(1) Summary of Significant Accounting Policies
Highland Bancorp, Inc. (the Company) was established in 1997 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.
All stock and per-share information, including that of prior periods, has
been restated to reflect the Company's 2 for 1 stock split, effected as a
100% stock dividend, in May 1999.
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.
(a) 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.
(b) 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.
(Continued)
F-7
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
(c) Securities
Securities include U.S. Treasury securities, U.S. government agency
obligations and mortgage-backed securities. The Company classifies its
securities in two categories: held-to-maturity and available-for-sale.
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 estimated remaining life of
the security. 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
measured at fair value, with net unrealized gains and losses reported as
a component of the accumulated other comprehensive loss caption of
shareholders' equity. 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.
(d) 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 in management's judgment, the borrower's ability to make periodic
interest and principal payments is back to normal.
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.
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
(Continued)
F-8
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
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.
(e) 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) 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.
(g) 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.
(h) Earnings per Share
Two types of earnings per share (EPS), basic and diluted, are presented
in the consolidated statements of income and comprehensive income. Basic
EPS excludes dilution and is computed by dividing income available to
common shareholders 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 that then shared in income.
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, as
(Continued)
F-9
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
restated to reflect the 2 for 1 stock split, effected in the form of a
100% stock dividend, paid on May 14, 1999 to shareholders of record as of
May 3, 1999. There is no difference in the income used in the two
computations.
<TABLE>
<CAPTION>
Year ended December 31
----------------------------------------
1999 1998 1997
shares shares shares
-------- --------- ---------
<S> <C> <C> <C>
Basic EPS - weighted-average number of shares
used in computation 4,346,270 4,556,584 4,598,084
Effect of dilutive securities - incremental
shares from outstanding common stock options 108,702 222,588 139,962
--------- --------- ---------
Diluted EPS - weighted-average number of shares
used in computation 4,454,972 4,779,172 4,738,046
========= ========= =========
</TABLE>
At December 31, 1999 and 1998, there were 96,000 and 98,000 stock
options, respectively, which were excluded from the effect of dilutive
securities in the table above since such shares were antidilutive.
(i) Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred taxes
from a change in tax rates is recognized in income in the period that
includes the enactment date.
(j) 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
(Continued)
F-10
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
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.
(k) Comprehensive Income
Comprehensive income consists of net income and net unrealized gains
(losses) on securities and is presented in the consolidated statements of
income and comprehensive income.
(l) Segment Reporting
Management of the Company has determined that it is engaged in only one
segment, providing certain banking services to its customers, including
real estate lending funded primarily by deposits and other borrowings.
(m) Interest-Rate Swaps
The Company enters into selected interest-rate swap agreements for the
purpose of asset/liability management. An interest-rate swap agreement
is a contractual agreement to exchange, or "swap" a series of interest-
rate payments over a specified period, based upon a common underlying
notional amount. These payments are typically an exchange of fixed
interest-rate cash flows for floating-rate cash flows. The objective is
the synthetic alteration of the nature of or the risk characteristics of
the underlying asset or liability. The agreements are accounted for on
the accrual basis of accounting for interest rate swaps whereby the net
amount to be received or paid under the swap agreement is accrued through
each settlement date of the swap as part of the income or expense from
the underlying asset or liability. The fair value of these swap
agreements are not currently recognized as an asset or liability in the
financial statements and are considered to be "off-balance-sheet"
financial instruments.
(n) Use of Estimates
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 include the determination of the allowance for
loan losses and the valuation of real estate and fair value estimates
related to investment securities, which are made at a specific point in
time based upon relevant market information and other information about
the asset.
(o) Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities (SFAS
No. 133). This statement establishes
(Continued)
F-11
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
accounting and reporting standards for derivative instruments and hedging
activities. This statement is effective for fiscal years beginning after
June 15, 2000. The Company does not believe that the implementation will
have a significant impact on the Company's financial position, net income
or comprehensive income.
(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, 1999 and 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
Gross unrealized
Amortized -------------------------- Estimated
cost Gains Losses fair value
--------- ----- ------ ----------
<S> <C> <C> <C> <C>
1999:
Securities available-for-sale:
U.S. Treasury and agency
securities $ 1,998 -- 174 1,824
Mortgage-backed securities 65,371 2 1,871 63,502
------- ------ ----- ------
$67,369 2 2,045 65,326
======= ====== ===== ======
Securities held-to-maturity -
mortgage-backed securities $ 8,943 -- 321 8,622
======= ====== ===== ======
<CAPTION>
Gross unrealized
Amortized -------------------------- Estimated
cost Gains Losses fair value
--------- ----- ------ ----------
<S> <C> <C> <C> <C>
1998:
Securities available-for-sale:
U.S. Treasury and agency
securities $ 3,996 3 -- 3,999
Mortgage-backed securities 49,401 142 168 49,375
------- ------ ----- ------
$53,397 145 168 53,374
======= ====== ===== ======
Securities held-to-maturity -
mortgage-backed securities $11,926 2 51 11,877
======= ====== ===== ======
</TABLE>
The weighted-average yields of U.S. Treasury and agency securities earned
during 1999, 1998 and 1997 were 6.3%, 5.6% and 6.4%, respectively. The
weighted-average yield of mortgage-backed securities was 6.0%, 5.9% and
5.9% during 1999, 1998 and 1997, respectively.
(Continued)
F-12
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
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>
1999 $ -- -- --
1998 7,959 15 3
1997 2,033 20 --
====== ====== ======
</TABLE>
The contractual maturities of securities available-for-sale (excluding
mortgage-backed securities) at December 31, 1999 were as follows (in
thousands):
<TABLE>
<CAPTION>
Available-for-sale
----------------------------------
Amortized Estimated
cost fair value
--------- ----------
<S> <C> <C>
Due after ten years $1,998 1,824
====== =====
</TABLE>
(3) Loans Receivable
Loans receivable are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Trust deed loans collateralized by real estate:
1-4 family residential properties $ 34,013 46,622
Multifamily 277,204 243,892
Commercial 236,100 194,596
Construction and land 11,076 12,146
Consumer loans 835 666
-------- -------
559,228 497,922
Less:
Loans in process (1,415) (3,179)
Deferred origination fees, net (172) (1,140)
Allowance for loan losses (11,951) (9,909)
-------- ------
Loans receivable, net $545,690 483,694
======== =======
</TABLE>
The Company serviced loans for others in the approximate amounts of $2.8
million and $4.1 million at December 31, 1999 and 1998, respectively.
The Company had impaired loans of $5.3 million and $7.9 million at
December 31, 1999 and 1998, respectively. The average recorded investment
in impaired loans during 1999 and 1998 was $7.3 million
(Continued)
F-13
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
and $10.5 million, respectively. The total allowance for loan losses related to
impaired loans was $0.6 million and $1.2 million at December 31, 1999 and 1998,
respectively. Interest income recognized on impaired loans of $388,000, $648,000
and $627,000 was recognized for cash payments received in 1999, 1998 and 1997,
respectively.
The Company had no loans 90 days past due and still accruing interest at
December 31, 1999 and 1998.
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>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Principal balance $2,007 2,365 4,485
Foregone interest 230 193 396
====== ===== =====
</TABLE>
Restructured loans for which interest has been reduced or suspended totaled
approximately $2.1 million, $3.2 million and $4.8 million at December 31,
1999, 1998 and 1997, 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>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Interest income that would have been recorded $ 271 769 596
Interest income recognized (182) (648) (417)
----- ---- ----
Interest income foregone $ 89 121 179
===== ==== ====
</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>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Allowance for loan losses at beginning of year $ 9,909 8,848 7,676
Provision for losses 2,518 3,315 5,164
Losses charged against the allowance (569) (2,254) (3,992)
Recoveries 93 -- --
------- ------ ------
Allowance for loan losses at end of year $11,951 9,909 8,848
======= ====== ======
</TABLE>
F-14
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
(4) Real Estate Acquired through Foreclosure
Real estate acquired through foreclosure for the years ended December 31 is
as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Real estate acquired through foreclosure $ -- 744
Less allowance for losses -- (114)
----- ----
$ -- 630
===== ====
</TABLE>
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>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Balance at beginning of year $ 114 85 --
Provision charged to expense -- 108 310
Charge-offs (114) (79) (225)
----- --- ----
Balance at end of year $ -- 114 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>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Gains on sales $(170) (304) (253)
Losses on sales 1 42 163
Provision for losses -- 108 310
Operating (income) costs while owned (28) 135 335
----- ---- ----
$(197) (19) 555
===== ==== ====
</TABLE>
(Continued)
F-15
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
(5) Premises and Equipment
Premises and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31
------------------
1999 1998
---- ----
<S> <C> <C>
Office buildings $ 1,064 1,064
Leasehold improvements 1,033 1,026
Furniture, fixtures, equipment and vehicles 2,318 2,129
Land 210 210
------- ------
4,625 4,429
Less accumulated depreciation and amortization (2,478) (2,129)
------- ------
Premises and equipment, net $ 2,147 2,300
======= ======
</TABLE>
In August 1998, the Company sold its Burbank headquarters building, which
had a net carrying value of $5.6 million, to a real estate investment
company for a gross sales price of $9.8 million. The transaction included a
five-year leaseback agreement between the buyer and the Bank. Under the
applicable sale/leaseback accounting rules, the Company deferred $2.4
million of the gain and recognized $1.2 million as noninterest income.
(6) Deposits
Deposits at December 31 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
NOW accounts $ 30,742 30,303
Passbook accounts 19,959 21,041
Money market checking and savings 36,596 39,883
Certificates of deposit 326,322 296,820
-------- -------
$413,619 388,047
======== =======
</TABLE>
(Continued)
F-16
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
As of December 31, 1999, certificate accounts are scheduled to mature as
follows (in thousands):
<TABLE>
<CAPTION>
Year of maturity Amount
----------------------------- --------
<S> <C>
2000 $275,493
2001 31,837
2002 10,468
Thereafter 8,524
--------
$326,322
========
</TABLE>
The aggregate amount of certificates of deposit with a balance equal to or
greater than $100,000 was $99.0 million and $83.5 million at December 31,
1999 and 1998, respectively.
The amount of interest expense per deposit category for the years ended
December 31 is as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
NOW accounts $ 454 321 333
Passbook accounts 460 492 596
Money market checking and savings 1,541 1,314 873
Certificates of deposit 16,438 16,788 16,509
------- ------ ------
$18,893 18,915 18,311
======= ====== ======
</TABLE>
In 1999 the Company entered into two interest-rate swap agreements to manage
the interest-rate risk associated with its certificate of deposit accounts.
The agreements that the Company entered into are structured to synthetically
alter or change the nature or risk characteristics of one financial
instrument to that of another financial instrument, such as a fixed-rate
certificate of deposit to a variable rate. Both swap agreements have
notational amounts of $10.0 million and mature in 2004. The Company pays a
fixed rate of interest of 5.71% and 5.90%, respectively, and earns interest
based on the six month LIBOR rate, adjusted periodically. For the year ended
December 31, 1999, the Company realized a net expense of $50,000. These
instruments are currently accounted for under the accrual/settlement method
of accounting, whereby the net amount to be received or paid under the swap
agreement is accrued through each settlement date of the swap as part of the
income or expense from the underlying asset or liability to which the swap
is designated.
(Continued)
F-17
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
(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.
Mortgage loans, U.S. Treasury and agency securities and mortgage-backed
securities with a carrying value of $284.5 million and $232.9 million have
been pledged to secure these advances at December 31, 1999 and 1998,
respectively. Interest rates range from 4.80% to 6.33% at December 31, 1999.
As of December 31, 1999, the contractual maturities of the FHLB advances are
as follows (in thousands):
<TABLE>
<CAPTION>
Year of maturity Amount
----------------------------- --------
<S> <C>
2000 $ 97,500
2001 20,000
2002 12,400
2003 25,000
2004 19,000
2008 5,000
--------
$178,900
========
</TABLE>
As of December 31, 1999, $20 million of these advances can be called by the
FHLB as follows: $15 million of five-year advances beginning in 2000 and $5
million of ten-year advances beginning in 2003.
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
----------------------------------
1999 1998 1997
-------- ------- -------
<S> <C> <C> <C>
Maximum month-end balance $178,900 150,900 135,000
Average daily balance 149,694 131,081 95,979
Average rates paid 5.58% 5.90% 6.17%
Average rates on balance at year-end 5.74% 5.52% 6.07%
Balance at year-end 178,900 150,900 135,000
======== ======= =======
</TABLE>
(8) Securities Sold under Agreements to Repurchase
At December 31, 1999, securities sold under agreements to repurchase totaled
$5,000,000 and carried a weighted-average interest rate of 6.02%. These
agreements mature in 2000. The securities underlying these agreements were
mortgage-backed securities with a carrying value of $5.6 million and a
market value at year-end of $5.4 million. The securities underlying these
agreements are held by a custodian bank until the maturity of the agreement.
The identical securities will be repurchased by the Bank.
(Continued)
F-18
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
The average outstanding balance of securities sold under agreements to
repurchase was $9.9 million in 1999. The weighted-average interest rate was
5.60%, and the maximum amount outstanding was $10,000,000.
(9) 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>
1999 1998 1997
------ ---- ----
<S> <C> <C> <C>
Deferred tax assets:
Depreciation $ 207 198 140
Allowance for loan losses 4,712 3,883 4,215
Deferred compensation 1,839 2,211 2,141
Installment sale -- --
Unrealized loss on securities available-for-sale 1,065 10 84
Real estate owned - allowances 192 191 142
Discount to facilitate sale of real estate owned (783) (637) (356)
Net operating loss carryforward 32 32 --
Mark to market for loans -- 1,683 496
AMT credit carryforward 21 21 21
Other 780 767 38
------ ----- -----
Deferred tax asset 8,065 8,359 6,921
Valuation allowance (223) (223) (223)
------ ----- -----
Total deferred tax assets 7,842 8,136 6,698
------ ----- -----
Deferred tax liabilities:
Accrued interest 30 50 49
State franchise tax 94 122 311
Tax over book deferred loan fees 2,708 2,187 1,411
FHLB dividends 1,492 1,302 1,111
Mark to market for loans 1,938 -- --
------ ----- -----
Total deferred tax liabilities 6,262 3,661 2,882
------ ----- -----
Net deferred tax asset $1,580 4,475 3,816
====== ===== =====
</TABLE>
(Continued)
F-19
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
A summary of the provision for income taxes (benefit) for the years ended
December 31 is as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Current taxes:
Federal $2,393 6,696 3,073
State 1,143 3 (22)
------ ------ ------
3,536 6,699 3,051
------ ------ ------
Deferred taxes:
Federal 3,098 (2,204) 109
State 461 1,595 575
------ ------ ------
3,559 (609) 684
------ ------ ------
Change in the valuation allowance -- -- (1,111)
------ ------ ------
$7,095 6,090 2,624
====== ====== ======
</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>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Statutory federal tax rate 35.0% 35.0% 34.0%
Officers' life insurance 0.2 (1.9) (.9)
State income taxes, net of federal benefit 6.1 7.1 6.3
Change in the valuation allowance -- -- (12.7)
Other 0.1 1.3 3.3
---- ---- -----
41.4% 41.5% 30.0%
==== ==== =====
</TABLE>
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 carryforwards
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
income, management believes it is more
(Continued)
F-20
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
likely than not that the Company will realize the benefit of the existing
net deferred tax asset at December 31, 1999.
At December 31, 1999, approximately $4.2 million 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.
(10) 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.
(11) 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 $20.2 million and $31.8 million at December 31, 1999 and
1998, 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 $1.4 million
and $7.5 million at December 31, 1999 and 1998, respectively.
(a) Commitments
The Company leases its branch operation premises under various
operating leases. The leases expire at varying periods through the year
2005. Approximately $1.8 million of these lease commitments will be
charged against deferred gain on the sale of the Company's headquarters
building. At December 31, 1999, 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>
2000 $ 806
2001 777
2002 689
2003 438
2004 56
Thereafter 27
------
$2,793
======
</TABLE>
(Continued)
F-21
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
Included in occupancy and equipment expense for 1999, 1998 and 1997 are
rental expenses for premises and equipment of approximately $498,000,
$474,000 and $614,000, respectively. Included in other expenses for
1999, 1998 and 1997 are auto lease expenses of approximately $0, $7,000
and $22,000, respectively. Office leases provide for certain cost-of-
living increases and require the Company to pay for property taxes,
insurance and maintenance expenses.
(b) 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.
(12) Other Noninterest Income
Components of the Company's other noninterest income for the years ended
December 31 are as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Late charges $ 197 165 93
Retail branch fees (including ATM) 913 911 1,099
Dividends on FHLB stock 416 415 293
Commissions on alternative investments 269 302 48
Other 541 127 239
------ ----- -----
Total noninterest income - other $2,336 1,920 1,772
====== ===== =====
</TABLE>
(13) 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.
(14) Employees' Profit Sharing and Retirement Plans
The Company has a contributory employee profit sharing retirement plan.
Under the 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. The contributions charged against operating
results were approximately $124,000, $107,000 and $89,000 for the years
ended December 31, 1999, 1998 and 1997, 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
(Continued)
F-22
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
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, 1999 and 1998, the Company had recorded liabilities of $3.6
million and $3.6 million, respectively. The total compensation (credit) cost
related to the SERP and the SDIP was approximately $(73,000), ($91,000) and
$157,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
A summary of the changes in the SERP's benefit obligation and plan assets
follows:
<TABLE>
<CAPTION>
1999 1998
------ -----
<S> <C> <C>
Change in benefit obligations:
Obligation at beginning of year $2,574 2,671
Service cost 12 11
Interest cost 171 167
Benefits paid (293) (275)
------ -----
Obligation at year-end 2,464 2,574
------ -----
Change in plan assets:
Fair value of plan assets at beginning of year 4,957 4,401
Increase in cash surrender value of asset 535 507
Employer contribution 324 324
Benefits paid (293) (275)
------ -----
Fair value of plan assets at end of year 5,523 4,957
------ -----
Funded status $3,059 2,383
====== =====
</TABLE>
Net pension credit related to the SERP includes the following components:
<TABLE>
<CAPTION>
December 31
-----------------
1999 1998
---- ----
<S> <C> <C>
Service cost - benefits earned during the period $ 12 11
Interest cost on projected benefit obligation 171 167
Net amortization and deferral (425) (395)
----- ----
Net periodic pension credit $(242) (217)
===== ====
</TABLE>
The discount rate used to determine the actuarial present value of the
benefit obligations was 7.0% as of December 31, 1999 and 1998.
(Continued)
F-23
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
(15) Stock-Based Compensation
During 1994, the Company adopted a Stock Option and Performance Share Award
Plan (the Plan). The Plan, which was amended in 1998, 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. Under the plan, the aggregate number of
common stock outstanding and available for issuance pursuant to the
exercise of options or the grant of awards was 800,000 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, 36,000 shares of stock with a fair value of $382,500
were issued as performance shares to certain key employees. These shares
were fully vested as of January 1, 1999. In connection with the issuance of
these shares, $-0- and $127,500 has been charged to compensation expense
for the years ended December 31, 1999 and 1998, respectively.
A summary of the status of the Company's fixed stock option plan as of
December 31, 1999 and 1998 and changes for each of the years in the three-
year period ended December 31, 1999 is presented below:
<TABLE>
<CAPTION>
Weighted-average
Shares exercise price
-------- ----------------
<S> <C> <C>
Outstanding at December 31, 1996 265,000 $ 7.46
Stock options granted 247,000 10.77
Stock options exercised (36,600) 6.66
--------
Outstanding at December 31, 1997 475,400 9.24
Stock options granted 98,000 21.12
Stock options exercised (35,404) 9.24
Stock options canceled (2,666) 10.63
--------
Outstanding at December 31, 1998 535,330 11.40
Stock options granted 120,000 17.81
Stock options exercised (151,100) 8.33
Stock options canceled (28,500) 13.72
--------
Outstanding at December 31, 1999 475,730 13.86
========
</TABLE>
(Continued)
F-24
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
The following information applied to options outstanding at December 31,
1999:
<TABLE>
<CAPTION>
Number Range of
outstanding exercise prices
----------- ----------------
<S> <C>
94,000 $ 6.00 to $ 8.19
177,730 $10.63 to $11.63
204,000 $17.81 to $21.50
------- ----------------
475,730
=======
</TABLE>
At December 31, 1999, the weighted-average exercise price was $13.86 and
the weighted-average remaining life was 6.4 years for the Company's
outstanding options.
At December 31, 1999, the Company had 65,166 shares available for grants in
the fixed stock option plan. 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 when originally
issued. In 1999, $931,000 of stock option compensation expense was recorded
as a result of the exercise of certain executives' stock options originally
issued in prior years, with a tax-offset cash bonus, representing the
difference between the option exercise price and the stock price on the
dates these options were exercised. 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 income and net
income per share at December 31, 1999, 1998 and 1997 would have been (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
1999 1998 1997
------- ----- -----
<S> <C> <C> <C>
Net income as reported $10,045 8,592 6,123
Net income pro forma 9,462 8,151 5,666
Basic earnings per share as reported 2.31 1.89 1.33
Basic earnings per share pro forma 2.18 1.79 1.23
Diluted earnings per share as reported 2.25 1.80 1.29
Diluted earnings per share pro forma 2.12 1.71 1.20
</TABLE>
The per share weighted-average fair value of stock options granted during
1999, 1998 and 1997 was $7.08, $9.32 and $3.51, respectively, on the date
of grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions: 1999 - volatility of 32.0%, no expected
dividends, risk-free interest rate of 6.34% and expected life of 5 years;
1998 - volatility of 43.3%, no expected dividends, risk-free interest rate
of 5.5% and expected life of 5 years; 1997 - volatility of 19.0%, no
expected dividends, risk-free interest rate of 6.7% and an expected life of
5 years.
(Continued)
F-25
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
(16) Other Noninterest Expense
Components of the Company's other noninterest expense for the years ended
December 31 are as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Legal fees $ 132 312 329
Advertising 94 93 161
Stationery and printing 172 213 251
Telephone expense 113 144 136
Insurance expense 182 210 270
Audit and accounting 275 175 150
Other 903 802 857
------ ----- -----
Total other noninterest expense $1,871 1,949 2,154
====== ===== =====
</TABLE>
(17) 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 income 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 income 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.
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, 1999, the Company and the Bank meet all capital adequacy
requirements to which it is subject.
As of December 31, 1999, 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.
(Continued)
F-26
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
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 1999 and 1998.
<TABLE>
<CAPTION>
Minimum to be well
capitalized under
Minimum for capital prompt corrective
Actual adequacy purposes action provisions
----------------- ------------------- ------------------
Amount Percent Amount Percent Amount Percent
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999:
Risk-based capital $55,961 10.45% $42,827 8.0% $53,534 10.0%
Tier I risk-based capital 49,212 9.19% 21,414 4.0% 32,120 6.0%
Leverage capital 49,212 7.50% 26,259 4.0% 32,824 5.0%
Tangible capital 49,212 7.50% 9,847 1.5% N/A N/A
======= ===== ======= === ======= ====
As of December 31, 1998:
Risk-based capital $48,182 10.38% $37,137 8.0% $46,421 10.0%
Tier I risk-based capital 42,344 9.12 18,568 4.0 27,853 6.0
Leverage capital 42,344 7.01 24,151 4.0 30,189 5.0
Tangible capital 42,344 7.01 9,057 1.5 N/A N/A
======= ===== ======= === ======= ====
</TABLE>
The Bank's regulatory capital ratios are based upon the shareholder's
equity of the Bank adjusted as provided for in the capital regulations of
the OTS. At December 31, 1999 and 1998, Highland Bancorp, Inc. has $0.3
million and $1.1 million of shareholders' equity, respectively, which is
not included in the above table.
(18) 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.
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.
(Continued)
F-27
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
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.
(a) Cash and Cash Equivalents
The carrying amount is a reasonable estimate of fair value.
(b) Securities
The fair values of securities are based on quoted market prices or
dealer quotes.
(c) 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.
(d) 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.
(e) 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) Accrued Interest Receivable and Payable
The carrying amount approximates fair value because of the short
maturity of these items.
(Continued)
F-28
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
The estimated fair values of the Company's financial instruments are as
follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
----------------------------------- ---------------------------------
Carrying Fair Carrying Fair
amount value amount value
------------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 7,231 7,231 28,776 28,776
Securities available-for-sale 65,326 65,326 53,374 53,374
Securities held-to-maturity 8,943 8,622 11,926 11,877
Loans receivable 545,690 569,888 483,694 507,903
Accrued interest receivable 4,402 4,402 4,205 4,205
Financial liabilities:
Deposits 413,619 412,380 388,047 389,822
FHLB advances and other
borrowings 183,900 181,128 160,900 161,670
Accrued interest payable 319 319 593 593
</TABLE>
(19) Quarterly Financial Information (Unaudited)
(Dollars in thousands, except per share amounts and common stock closing
prices)
<TABLE>
<CAPTION>
Three months ended
----------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
1999 1999 1999 1999
--------------- ----------- ------------- ------------
<S> <C> <C> <C> <C>
Year ended December 31, 1999:
Interest income $13,593 13,600 14,081 14,272
Interest expense 6,682 6,805 7,198 7,108
Net interest income 6,911 6,795 6,883 7,164
Provision for losses on loans 718 600 600 600
Net interest income after provision for losses on
loans 6,193 6,195 6,283 6,564
Total noninterest income 469 667 666 703
Net (income) cost of operation of real estate
acquired through foreclosure (3) (80) (69) (45)
General and administrative expenses 2,496 3,541 2,182 2,578
Income before taxes 4,169 3,401 4,836 4,734
Income tax 1,721 1,408 2,003 1,963
Net income 2,448 1,993 2,833 2,771
Basic earnings per share 0.56 0.45 0.65 0.65
Diluted earnings per share 0.54 0.44 0.63 0.64
Closing prices for common stock:
High 18.63 20.63 19.50 19.75
Low 15.75 18.25 18.13 17.63
======= ====== ====== ======
</TABLE>
(Continued)
F-29
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
Three months ended
-------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
1998 1998 1998 1998
------------ ----------- ------------- --------------
<S> <C> <C> <C> <C>
Year ended December 31, 1998:
Interest income $12,241 12,532 12,926 13,518
Interest expense 6,528 6,671 6,950 6,832
Net interest income 5,713 5,861 5,976 6,686
Provision for losses on loans 940 860 790 725
Net interest income after provision for losses on
loans 4,773 5,001 5,186 5,961
Total noninterest income 779 483 1,622 494
Net (income) cost of operation of real estate
acquired through foreclosure 15 (126) 123 (31)
General and administrative expenses 2,258 2,317 2,375 2,686
Income before taxes 3,279 3,293 4,310 3,800
Income tax 1,355 1,365 1,780 1,590
Net income 1,924 1,928 2,530 2,210
Basic earnings per share 0.41 0.41 0.55 0.50
Diluted earnings per share 0.40 0.39 0.53 0.48
Closing prices for common stock:
High 19.25 21.75 21.28 18.06
Low 16.63 18.75 18.94 15.75
======= ====== ====== ======
</TABLE>
(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, 1999 and 1998 and for the years then ended (dollars in
thousands):
<TABLE>
<CAPTION>
December 31
-----------------------------
Statements of Financial Condition 1999 1998
-------------------------------------------------------------- -------- --------
<S> <C> <C>
Assets:
Cash and cash equivalents $ 180 1,055
Investment in Highland Federal Bank 47,865 42,329
Other assets 193 154
------- ------
$48,238 43,538
======= ======
Liabilities and shareholders' equity:
Payable to Highland Federal Bank $ 31 99
Shareholders' equity 48,207 43,439
------- ------
$48,238 43,538
======= ======
</TABLE>
(Continued)
F-30
<PAGE>
HIGHLAND BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
Year ended December 31
---------------------------------------
Statements of Operations 1999 1998
- --------------------------------------------------------------------- --------- ---------
<S> <C> <C>
Interest income $ 19 --
Other expense (112) (66)
Dividends received from Highland Federal Bank 4,200 4,000
Equity in undistributed income of Highland Federal Bank 5,938 4,658
------- ------
Net income $10,045 8,592
======= ======
<CAPTION>
Year ended December 31
--------------------------------------
Statements of Cash Flows 1999 1998
- --------------------------------------------------------------------- ----------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $10,045 8,592
Adjustments to reconcile net income to cash used by operating
activities:
Equity in undistributed income of Highland Federal Bank (5,938) (4,658)
Decrease in receivable from Highland Federal Bank -- 3,800
Increase in other assets (39) (75)
(Decrease) increase in other liabilities (68) 87
------- ------
Net cash used by operating activities 4,000 7,746
------- ------
Cash flows from financing activities:
Common stock options exercised 249 135
Common stock dividends paid (1,088) (1,147)
Repurchase of treasury shares (4,036) (5,800)
------- ------
Net cash used by financing activities (4,875) (6,812)
------- ------
Net (decrease) increase in cash and cash equivalents (875) 934
Cash and cash equivalents, beginning of year 1,055 121
------- ------
Cash and cash equivalents, end of year $ 180 1,055
======= ======
</TABLE>
F-31
<PAGE>
(ii) Exhibit Index:
-------------
Exhibit
Number Description of Exhibit
- ------ ----------------------
21.0 Subsidiaries of the Registrant.
23.1 Consent of KPMG LLP.
27.0 Financial Data Schedule.
54
<PAGE>
EXHIBIT 21.0
SUBSIDIARIES OF REGISTRANT
--------------------------
Highland Federal Bank, a Federal Savings Bank organized under the laws of the
United States
HFS Corporation, a corporation organized under the laws of California
HI-FED Insurance Agency, a corporation organized under the laws of California
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Highland Bancorp, Inc.:
We consent to incorporation by reference in the registration statements (Nos.
333-45515 and 333-57725) on Form S-8 of Highland Bancorp, Inc. of our report
dated January 19, 2000, relating to the consolidated statements of financial
condition of Highland Bancorp, Inc. and subsidiaries as of December 31, 1999 and
1998 and the related consolidated statements of income and comprehensive income,
shareholders' equity and cash flows for each of the years in the three-year
period ended December 31,1999, which report appears in the December 31, 1999
Annual Report on Form 10-K of Highland Bancorp, Inc.
/s/ KPMG LLP
Los Angeles, California
March 29, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 5,764
<INT-BEARING-DEPOSITS> 1,288
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 65,326
<INVESTMENTS-CARRYING> 8,943
<INVESTMENTS-MARKET> 8,622
<LOANS> 557,641
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<DEPOSITS> 413,619
<SHORT-TERM> 5,000
<LIABILITIES-OTHER> 9,052
<LONG-TERM> 178,900
0
0
<COMMON> 47
<OTHER-SE> 48,160
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<INTEREST-LOAN> 50,411
<INTEREST-INVEST> 5,135
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 55,546
<INTEREST-DEPOSIT> 18,893
<INTEREST-EXPENSE> 27,793
<INTEREST-INCOME-NET> 27,753
<LOAN-LOSSES> 2,518
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 10,600
<INCOME-PRETAX> 17,140
<INCOME-PRE-EXTRAORDINARY> 10,045
<EXTRAORDINARY> 0
<CHANGES> 0
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<EPS-BASIC> 2.31
<EPS-DILUTED> 2.25
<YIELD-ACTUAL> 4.66
<LOANS-NON> 2,007
<LOANS-PAST> 0
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<LOANS-PROBLEM> 6,659
<ALLOWANCE-OPEN> 9,909
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<ALLOWANCE-CLOSE> 11,951
<ALLOWANCE-DOMESTIC> 11,951
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 2,768
</TABLE>
