<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
------------------------
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
--------------- ---------------
COMMISSION FILE NUMBER 33-13646
WESTCORP
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------
<TABLE>
<S> <C>
CALIFORNIA 51-0308535
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
23 PASTEUR, IRVINE, CALIFORNIA 92618-3816
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE: (714) 727-1000
------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
<S> <C>
COMMON STOCK $1 PAR VALUE NEW YORK STOCK EXCHANGE
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports, and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
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]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of February 27, 1998:
COMMON STOCK, $1.00 PAR VALUE -- $174,199,867
The number of shares outstanding of the issuer's class of common stock as
of February 27, 1998:
COMMON STOCK, $1.00 PAR VALUE -- 26,282,949
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the 1997 Annual Meeting of
Shareholders to be held April 30, 1998, are incorporated by reference into Part
III.
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<PAGE> 2
WESTCORP AND SUBSIDIARIES
TABLE OF CONTENTS
PART I
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 44
Item 3. Legal Proceedings........................................... 44
Item 4. Submission of Matters to a Vote of Security Holders......... 44
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 44
Item 6. Selected Financial Data..................................... 45
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 46
Item 7A. Quantitative and Qualitative Disclosure about Market Risk... 57
Item 8. Financial Statements and Supplementary Data................. 60
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................. 60
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 60
Item 11. Executive Compensation...................................... 60
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 60
Item 13. Certain Relationships and Related Transactions.............. 60
PART IV
Item 14. Financial Statement Schedules, Exhibits, and Reports on Form
8-K....................................................... 60
</TABLE>
i
<PAGE> 3
PART I
ITEM 1. BUSINESS
OVERVIEW
Westcorp (the "Company"), a California corporation, is a diversified
financial services holding company providing automobile ("consumer") lending
programs through WFS Financial Inc ("WFS") and residential real estate lending,
retail banking and commercial banking through Western Financial Bank, formerly
Western Financial Bank, F.S.B. (the "Bank"). The Company owns all the capital
stock of the Bank, its principal subsidiary. The Bank owns 83.7% of the capital
stock of WFS. See Subsidiaries.
In 1982, the Company acquired Evergreen Savings and Loan Association
("Evergreen"), a California-licensed savings and loan association, which became
a wholly-owned subsidiary of the Company. Evergreen's name was ultimately
changed to Western Financial Savings Bank. In 1992, Western Financial Savings
Bank converted to a federal charter and added F.S.B. to its name. In 1996,
Western Financial Savings Bank, F.S.B. changed its name to Western Financial
Bank, F.S.B. to more accurately reflect the addition of a broad array of new
products and services. In 1997, Western Financial Bank, F.S.B. changed its name
to Western Financial Bank.
The Bank is subject to examination and comprehensive regulation by the
Office of Thrift Supervision ("OTS") and the Federal Deposit Insurance
Corporation ("FDIC"). It is further subject to certain regulations of the Board
of Governors of the Federal Reserve System ("FRS") which governs reserves
required to be maintained against deposits and other matters. The Bank is also a
member of the Federal Home Loan Bank of San Francisco ("FHLB"), one of twelve
regional banks for federally insured savings and loan associations and banks
comprising the FHLB System. The FHLB System is under the supervision of the
Federal Housing Finance Board. WFS and certain other subsidiaries of the Bank
are further regulated by various departments or commissions of the states in
which it does business.
The types of loans which the Company may originate are primarily defined by
federal statutes and regulations. The Company's strategy has been to focus on
and expand its two principal lines of business -- consumer lending and mortgage
lending. The Company expanded its consumer lending operations to 40 states at
February 28, 1998. Additionally, the Company continued its transition to
becoming a full-service financial institution, which included the expansion of
the products and services offered by the mortgage banking, commercial banking
and retail banking divisions of the Company.
The Company competes in the prime and non-prime auto finance industry. Its
strategy is to purchase automobile loans from new and used car dealers,
securitize those loans through underwritten public sales of securities and
retain the right to service them. In order to achieve this strategy, the Company
focuses on developing and maintaining strong relationships with its dealers
through frequent and substantial personal interaction.
The Company's business plan for mortgage lending is to originate or
purchase loans, and to sell or securitize them in the secondary market and
retain the servicing rights thereon. While maintaining its traditional focus on
traditional mortgage lending, the Company has concentrated on developing and
offering additional products to meet the special needs of customers who do not
qualify for conventional mortgages. The Company originated and purchased loans
secured by residential real estate through its mortgage offices in 7 states at
February 28, 1998.
In addition to its two principal lines of business, the Company continues
to focus on retail banking. In its retail banking operations, the Company serves
the needs of individuals and small businesses by establishing "relationship
banking" and offering a range of products, such as demand deposits and money
market accounts and by expanding its alternative delivery channels, such as
automated teller machines ("ATMs").
The Company has continued expansion of its commercial banking operations
which commenced operations in 1996. The Company targets small and medium-sized
businesses in southern California, offering
1
<PAGE> 4
loans, lines of credit and trade finance services, as well as account analysis,
cash management and other commercial depository services.
Management believes that the Company and its clients are best served by
strengthening the Company's focus on its ability to cross-sell products and
services to its current client base. This focus includes developing a common
identity, while maximizing point of sale and cross-selling opportunities. The
Company also solicits additional potential customers through strategic direct
mail programs. The Company's target markets are the individual consumer and
small and medium-sized businesses, to which the Company intends to offer
"relationship banking," focused on proactive customer service.
The following table sets forth the loan origination, purchase and sale
activity of the Company for the periods indicated.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Loans originated:
Consumer loans
Automobile(1)................... $2,285,279 $2,121,689 $1,527,649 $1,177,031 $ 820,218
Other........................... 52,074 35,867 28,647 14,529 16,538
---------- ---------- ---------- ---------- ----------
Total consumer loans............ 2,337,353 2,157,556 1,556,296 1,191,560 836,756
Mortgage loans:
Existing property............... 2,303,331 1,240,652 481,441 621,416 795,154
Construction.................... 17,078 10,207 5,697 18,853 33,511
Equity.......................... 8,177 8,857 4,136 35,692 76,863
---------- ---------- ---------- ---------- ----------
Total mortgage loans............ 2,328,586 1,259,716 491,274 675,961 905,528
Commercial......................... 74,325 8,632
---------- ---------- ---------- ---------- ----------
Total loans originated............... 4,740,264 3,425,904 2,047,570 1,867,521 1,742,284
Loans purchased:
Mortgage loans on existing
property........................ 6,166 213 252 45,373 210
---------- ---------- ---------- ---------- ----------
Total loans purchased................ 6,166 213 252 45,373 210
Loans sold or securitized:
Automobile loans................... 2,190,000 2,090,000 1,480,000 842,000 777,500
Mortgage loans..................... 1,974,423 992,582 304,242 541,923 803,992
---------- ---------- ---------- ---------- ----------
Total loans sold or securitized...... 4,164,423 3,082,582 1,784,242 1,383,923 1,581,492
Principal reductions(2).............. 444,080 357,507 269,483 334,627 529,683
---------- ---------- ---------- ---------- ----------
Increase (decrease) in total loans... $ 137,927 $ (13,972) $ (5,903) $ 194,344 $ (368,681)
========== ========== ========== ========== ==========
</TABLE>
- ---------------
(1) Includes automobile loans purchased from automobile dealers.
(2) Includes scheduled payments, prepayments and chargeoffs.
At December 31, 1997, the Company's loan portfolio totalled $1.9 billion,
of which 13% were automobile loans, 82% were loans secured by real property used
primarily for residential purposes, 2% were commercial loans and 3% were other
consumer loans. The Company's loan portfolio totalled $1.7 billion at December
31, 1996, of which 13% were automobile loans, 82% were loans secured by real
property used primarily for residential purposes, 1% were commercial loans and
4% were other consumer loans. At December 31, 1997, the Company serviced $3.5
billion of consumer loans and $4.9 billion of mortgage loans for the benefit of
others. At December 31, 1996, the Company serviced $2.8 billion of consumer
loans and $4.4 billion of mortgage loans for the benefit of others. The
Company's revenues are derived primarily from interest earned on loans and from
servicing income. Interest on deposits and borrowings, provisions for loan
losses, and general and administrative expenses are the Company's major expense
items.
2
<PAGE> 5
The following table sets forth the composition of the Company's loan
portfolio by type of loan, including loans held for sale, as of the dates
indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------------------------
1997 1996 1995 1994
-------------------- -------------------- -------------------- ----------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT
---------- ------- ---------- ------- ---------- ------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Consumer loans:
Automobile.............. $ 253,455 13.6% $ 267,715 15.4% $ 353,345 20.2% $ 507,772
Other................... 57,758 3.1 67,484 3.9 33,092 1.9 16,246
---------- ----- ---------- ----- ---------- ----- ----------
311,213 16.7 335,199 19.3 386,437 22.1 524,018
Less: unearned
discounts............... 22,225 1.2 33,768 2.0 38,628 2.2 82,762
---------- ----- ---------- ----- ---------- ----- ----------
Total consumer
loans............... 288,988 15.5 301,431 17.3 347,809 19.9 441,256
Mortgage loans:
Loans on existing
property.............. 1,529,764 81.9 1,419,177 82.0 1,393,983 79.9 1,298,037
Construction loans...... 15,835 0.8 5,501 0.3 8,469 0.5 19,813
---------- ----- ---------- ----- ---------- ----- ----------
Total mortgage
loans............... 1,545,599 82.7 1,424,678 82.3 1,402,452 80.4 1,317,850
Less: undisbursed loan
proceeds................ 6,711 0.4 2,359 0.1 4,672 0.3 7,614
---------- ----- ---------- ----- ---------- ----- ----------
Total mortgage
loans............... 1,538,888 82.3 1,422,319 82.2 1,397,780 80.1 1,310,236
---------- ----- ---------- ----- ---------- ----- ----------
Commercial loans.......... 41,668 2.2 7,867 0.5
---------- ----- ---------- ----- ---------- ----- ----------
Total loans........... $1,869,544 100.0% $1,731,617 100.0% $1,745,589 100.0% $1,751,492
========== ===== ========== ===== ========== ===== ==========
Loan serviced for the
benefit of others:
Consumer loans.......... $3,459,272 41.3% $2,812,637 38.8% $1,894,944 33.9% $1,208,674
Mortgage loans.......... 4,917,712 58.7 4,436,789 61.2 3,688,730 66.1 1,656,811
---------- ----- ---------- ----- ---------- ----- ----------
Total loans serviced
for the benefit of
others.............. $8,376,984 100.0% $7,249,426 100.0% $5,583,674 100.0% $2,865,485
========== ===== ========== ===== ========== ===== ==========
<CAPTION>
DECEMBER 31,
------------------------------
1994 1993
------- --------------------
PERCENT AMOUNT PERCENT
------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Consumer loans:
Automobile.............. 29.0% $ 251,751 16.2%
Other................... 0.9 55,905 3.6
----- ---------- -----
29.9 307,656 19.8
Less: unearned
discounts............... 4.7 27,972 1.8
----- ---------- -----
Total consumer
loans............... 25.2 279,684 18.0
Mortgage loans:
Loans on existing
property.............. 74.1 1,260,670 81.0
Construction loans...... 1.1 31,684 2.0
----- ---------- -----
Total mortgage
loans............... 75.2 1,292,354 83.0
Less: undisbursed loan
proceeds................ 0.4 14,890 1.0
----- ---------- -----
Total mortgage
loans............... 74.8 1,277,464 82.0
----- ---------- -----
Commercial loans..........
----- ---------- -----
Total loans........... 100.0% $1,557,148 100.0%
===== ========== =====
Loan serviced for the
benefit of others:
Consumer loans.......... 42.2% $1,009,941 46.5%
Mortgage loans.......... 57.8 1,160,485 53.5
----- ---------- -----
Total loans serviced
for the benefit of
others.............. 100.0% $2,170,426 100.0%
===== ========== =====
</TABLE>
SEGMENT INFORMATION
LENDING -- GENERAL
The Company's primary sources of revenue are net interest income and
noninterest income. Net interest income is the difference between the income
earned on interest earning assets and the interest paid on interest bearing
liabilities. Noninterest income includes contractual servicing fees earned by
servicing loans for the benefit of others, retained residual interest on sold
loans, and additional fees related to servicing, such as late charges and
prepayment fees, fees related to the sales of investment products such as mutual
funds and annuities, gains on loans sold, insurance commission income and other
fee income for deposits and various other products.
Net interest income is affected by the difference between yields earned by
the Company on its interest earning assets and the rates paid on its interest
bearing liabilities (interest rate spread), and the relative amounts of the
Company's
3
<PAGE> 6
interest earning assets and interest bearing liabilities. The following table
presents information relative to the average balances and interest rates of the
Company for the periods indicated.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------ ------------------------------ ------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- -------- ------ ---------- -------- ------ ---------- -------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest earning assets:
Other investments........... $ 133,416 $ 7,612 5.71% $ 107,866 $ 5,969 5.53% $ 99,062 $ 5,662 5.72%
Investment securities....... 132,197 7,376 5.58 138,184 7,620 5.51 118,926 6,551 5.51
Mortgage-backed
securities................ 936,026 68,055 7.27 786,925 57,471 7.30 653,850 47,486 7.26
Total loans:
Consumer loans............ 415,226 65,985 15.89 409,255 65,542 16.01 416,949 60,953 14.62
Mortgage loans(1)......... 1,552,392 119,859 7.72 1,366,509 105,682 7.73 1,336,080 101,441 7.59
Commercial................ 19,090 1,645 8.62 1,093 104 9.50
---------- -------- ----- ---------- -------- ----- ---------- -------- -----
Total interest earning
assets...................... 3,188,347 270,532 8.49 2,809,832 242,388 8.63 2,624,867 222,093 8.46
Noninterest earning assets:
Amounts due from trusts..... 233,241 140,067 79,721
Retained interests in
securitized assets........ 141,008 84,949 53,115
Capitalized servicing
rights.................... 33,591 26,922 8,103
Premises and equipment and
real estate owned......... 97,371 87,159 81,804
Other assets................ 131,331 125,941 30,453
Less: allowance for loan
losses.................... 37,409 41,157 40,771
---------- ---------- ----------
Total......................... $3,787,480 $3,233,713 $2,837,292
========== ========== ==========
Interest bearing liabilities:
Deposits.................... $1,945,520 107,078 5.50 $1,761,319 99,091 5.63 $1,751,539 101,364 5.79
Securities sold under
agreements to
repurchase................ 308,573 17,376 5.63 299,211 15,491 5.18 325,926 18,834 5.78
FHLB advances and other
borrowings................ 339,110 21,809 6.43 245,908 15,397 6.26 131,700 9,911 7.53
Subordinated debentures..... 166,924 14,807 8.87 104,619 9,215 8.81 104,088 9,170 8.81
---------- -------- ----- ---------- -------- ----- ---------- -------- -----
Total interest bearing
liabilities................. 2,760,127 161,070 5.84 2,411,057 139,194 5.77 2,313,253 139,279 6.02
Noninterest bearing
liabilities:
Amounts held on behalf of
trustee................... 318,621 178,754 135,083
Other liabilities........... 379,482 335,597 175,645
Shareholders' equity.......... 329,250 308,305 213,311
---------- ---------- ----------
Total......................... $3,787,480 $3,233,713 $2,837,292
========== -------- ----- ========== -------- ----- ========== -------- -----
Net interest income and
interest rate spread........ $109,462 2.65% $103,194 2.86% $ 82,814 2.44%
======== ===== ======== ===== ======== =====
Net yield on average interest
earning assets.............. 3.43% 3.67% 3.16%
===== ===== =====
</TABLE>
- ---------------
(1) For the purposes of these computations, nonaccruing loans are included in
the average loan amounts outstanding.
4
<PAGE> 7
The following table sets forth the changes in net interest income
attributable to (i) changes in volume (change in average portfolio volume
multiplied by prior period average rate), (ii) changes in rates (change in
weighted average interest rate multiplied by prior period average portfolio
balance), and (iii) the combined effect of changes in rates and volume (change
in weighted average interest rate multiplied by change in average portfolio
balance).
<TABLE>
<CAPTION>
1997 COMPARED TO 1996 1996 COMPARED TO 1995
------------------------------------ -------------------------------------
RATE/ RATE/
VOLUME RATE VOLUME TOTAL VOLUME RATE VOLUME TOTAL
------- ------- ------ ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income:
Other investments................ $ 1,412 $ 194 $ 37 $ 1,643 $ 503 $ (9) $ (187) $ 307
Investment securities............ (329) 96 (11) (244) 1,061 83 (75) 1,069
Mortgage-backed securities....... 10,884 (236) (64) 10,584 9,661 65 259 9,985
Total loans:
Consumer loans................. 955 (491) (21) 443 (1,124) 5,295 418 4,589
Mortgage loans................. 14,368 (136) (55) 14,177 2,309 1,736 196 4,241
Commercial loans............... 1,709 (9) (159) 1,541 104 104
------- ------- ----- ------- ------- ------- ------- -------
Total interest earning assets...... $28,999 $ (582) $(273) 28,144 $12,410 $ 7,170 $ 715 20,295
======= ======= ===== ======= ======= =======
Interest expense:
Deposits......................... $10,370 $(2,290) $ (93) 7,987 $ 566 $(5,079) $ 2,240 (2,273)
Securities sold under agreements
to repurchase.................. 484 1,346 55 1,885 (1,544) (489) (1,310) (3,343)
FHLB advances.................... 5,834 418 160 6,412 8,599 (1,449) (1,664) 5,486
Subordinated debentures.......... 5,489 63 40 5,592 46 (1,955) 1,954 45
------- ------- ----- ------- ------- ------- ------- -------
Total interest bearing
liabilities...................... $22,177 $ (463) $ 162 21,876 $ 7,667 $(8,972) $ 1,220 (85)
======= ======= ===== ------- ======= ======= ======= -------
Net change in net interest
income........................... $ 6,268 $20,380
======= =======
</TABLE>
5
<PAGE> 8
The increase in interest income, interest expense and net interest income
was the result of the increase in mortgage loans, mortgage-backed securities,
deposits and loans receivable as well as generally higher interest rates for
borrowed funds.
The Company's ability to maintain a positive spread during periods of
fluctuating interest rates is determined principally by the maturities and
repricing mechanisms of its interest earning assets and interest bearing
liabilities. Synchronizing the repricing of an institution's assets and
liabilities to minimize interest rate risk is commonly referred to as gap
management. Negative gap occurs when an institution's liabilities reprice more
rapidly than its assets and positive gap occurs when an institution's assets
reprice more rapidly than its liabilities.
The Company's asset/liability management strategy is to match its loan and
investment products with interest bearing liabilities having similar repricing
characteristics and durations. This strategy includes originating adjustable
rate loans, matching loans with liabilities that have similar repricing and
maturity characteristics, matching fixed rate loans held in the portfolio with
advances from the FHLB, selling fixed rate loans and utilizing financial
instrument agreements. These agreements are used by the Company solely to manage
interest rate risk within its portfolio and include interest rate swaps, caps,
options, floors and forward agreements. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Asset/Liability
Management."
As a result of the Company's practice of matching its rate sensitive
liabilities with rate sensitive assets, the Company had an overall positive gap
of 10.71% at December 31, 1997, with positive gaps of 24.56% for assets and
liabilities having an interest rate maturity of less than three months, 7.49%
for assets and liabilities having an interest rate maturity of less than one
year and 9.47% for assets and liabilities having an interest rate maturity of
three years or less. At December 31, 1997, 78% of the Company's interest earning
assets had interest rate maturities of three years or less with 49% having
maturities of less than three months.
The Company maintained an overall positive gap by having interest sensitive
assets that adjusted to fluctuations in interest rates during 1997 almost as
frequently as its interest sensitive liabilities adjusted. The Company's ability
to maintain a positive gap may be significantly affected by, among other
factors, (i) a large percentage of interest earning assets based on a market
lagging index, (ii) interest earning assets and interest bearing liabilities
repricing at different times, (iii) interest rate caps and floors imposed on its
assets, (iv) interest rates on assets and liabilities responding differently to
economic, market and competitive factors, (v) high interest rate levels
adversely affecting lending markets in general and (vi) low interest rate levels
increasing the difficulty of originating adjustable rate mortgage loans ("ARMs")
and (vii) increasing loan prepayments, where such amounts may be reinvested at
lower interest rates.
The following table illustrates the projected interest rate maturities,
based upon certain assumptions regarding the major asset and liability
categories of the Company at December 31, 1997. Prepayment and decay assumptions
for loans and savings accounts were developed using both the Company's own
prepayment experience and industry averages. For the Company's mortgage loans,
the prepayment assumptions range from 10% to 30% of loans prepaying per year
depending upon the interest rate, type of loan and contractual repricing terms.
For passbook and money market deposit accounts, the Company uses a rate of 20%
to 40% decay per year depending upon the characteristics of each type of
account. The interest rate sensitivity of the Company's assets and liabilities
illustrated in the following table could vary substantially if different
assumptions were used or if actual experience differs from the assumptions set
forth. Although the Company's investment
6
<PAGE> 9
securities and mortgage-backed securities are classified as available for sale,
they are presented in the repricing categories based on their respective stated
maturities adjusted for any appropriate prepayment assumptions.
<TABLE>
<CAPTION>
INTEREST RATE SENSITIVITY ANALYSIS AT DECEMBER 31, 1997
------------------------------------------------------------------------
WITHIN 3 MONTHS 1 YEAR TO 3 YEARS TO AFTER 5
3 MONTHS TO 1 YEAR 3 YEARS 5 YEARS YEARS TOTAL
---------- --------- --------- ---------- --------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest earning assets:
Investment securities....... $ (54) $ 81,467 $ 10,563 $ 29,971 $ 1,462 $ 123,409
Other investments........... 99,436 210 99,646
Mortgage-backed
securities................ 317,739 91,274 179,290 124,050 229,095 941,448
Consumer loans(1)........... 44,958 74,363 113,043 49,868 6,756 288,988
Mortgage loans:
Adjustable rate(2)........ 958,395 153,378 1,111,773
Fixed rate(2)............. 17,395 65,803 103,441 76,125 155,227 417,991
Construction(2)............. 9,124 9,124
Commercial(2)............... 41,668 41,668
---------- --------- --------- --------- --------- ----------
Total interest earning
assets.................... 1,488,661 466,495 406,337 280,014 392,540 3,034,047
Interest bearing
liabilities:
Deposits:
Passbook/statement
accounts(3)............ 4,480 8,650 8,753 21,883
Money market deposit
accounts(3)............ 11,604 44,137 85,394 141,135
Certificate accounts(4)... 714,202 860,800 145,487 22,479 1,742,968
FHLB advances(4)............ 8 70,037 6,610 6,626 1,690 84,971
Securities sold under
agreements to
repurchase(4)............. 287,071 287,071
Subordinated
debentures(4)............. 239,195 239,195
Other borrowings(4)......... 191,182 623 75 191,880
---------- --------- --------- --------- --------- ----------
Total interest bearing
liabilities............... 1,208,547 984,247 246,319 29,105 240,885 2,709,103
---------- --------- --------- --------- --------- ----------
Excess interest earning
assets (liabilities)...... 280,114 (517,752) 160,018 250,909 151,655 324,944
Effect of hedging
activities................ 465,000 (100,000) (215,000) (150,000)
---------- --------- --------- --------- --------- ----------
Hedged excess (deficit)..... $ 745,114 $(517,752) $ 60,018 $ 35,909 $ 1,655 $ 324,944
========== ========= ========= ========= ========= ==========
Cumulative excess........... $ 745,114 $ 227,362 $ 287,380 $ 323,289 $ 324,944 $ 324,944
========== ========= ========= ========= ========= ==========
Cumulative difference as a
percentage of total
interest earning assets... 24.56% 7.49% 9.47% 10.66% 10.71% 10.71%
</TABLE>
- ---------------
(1) Based on contractual maturities adjusted by the Company's historical
prepayment rate.
(2) Based on interest rate repricing adjusted for projected prepayments.
(3) Based on assumptions established by the OTS.
(4) Based on contractual maturity.
THE BUSINESS OF WFS
AUTOMOBILE LENDING
The Company and its predecessors and affiliates have purchased and
originated automobile loans since 1972. During 1995, the Company combined the
operations of the Company's consumer finance division and the Bank's
subsidiaries, Westcorp Financial Services, Inc., WFS Financial Auto Loans, Inc.
("WFAL") and WFS Financial Auto Loans 2, Inc. ("WFAL2") to create WFS. WFS
Investments, Inc. was created in 1996
7
<PAGE> 10
and is also a subsidiary of WFS. Primarily, automobile loans are underwritten
and purchased from approved new and used automobile dealers on a nonrecourse
basis ("indirect loan") or, on a limited basis, are underwritten and originated
directly with consumers ("direct loan"). Marketing is performed by business
development representatives through personal calls to automobile dealers as well
as referrals. The Company believes that the creation and maintenance of close
personal relationships with automobile dealers is a major factor in promoting
the growth and sustaining the quality of its automobile loan portfolio.
All loans originated or purchased by the Company are reviewed to ensure
proper documentation and adherence to underwriting guidelines. The Company does
not have minimum or maximum maturity requirements; however, automobile loans
with less than three years maturity or more than six years maturity are seldom
purchased due to low customer demand. Each automobile loan is fully amortizing
and provides for level payments over the term of the loan with the portion of
principal and interest of each level payment determined on the simple interest
method or on the basis of the sum of the months digits method (also known as the
Rule of 78s). The interest rates charged on automobile loans are primarily
determined by the risk inherent in the borrower as determined by the Company's
underwriting criteria.
The Company generally lends to the applicant an amount not to exceed the
sum of the dealer's cost, taxes, license fees, and other miscellaneous costs.
Additional advances over the sum of such costs may be made under certain
circumstances with increasing levels of management review based on the
creditworthiness of the applicant. For used automobiles, the amount loaned
generally does not exceed the wholesale value for the automobile plus related
expenses and any approved additional advances.
The following table below presents a summary of the Company's automobile
lending production volumes.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
New automobiles........................................ $ 417,075 $ 441,529 $ 367,638
Used automobiles....................................... 1,868,204 1,680,160 1,160,011
---------- ---------- ----------
Total volume................................. $2,285,279 $2,121,689 $1,527,649
========== ========== ==========
Prime.................................................. $1,245,027 $1,129,314 $ 936,429
Non-Prime.............................................. 1,040,252 992,375 591,220
---------- ---------- ----------
Total volume................................. $2,285,279 $2,121,689 $1,527,649
========== ========== ==========
</TABLE>
AUTOMOBILE LOAN SERVICING
The Company services all of the automobile loans it purchases, both those
held by the Company and those sold in securitization transactions. These
servicing activities include collecting payments and protecting its interest in
the collateral. As part of these activities, the Company also earns other
miscellaneous fees, primarily late charges. Payment collection includes pursuing
delinquent accounts, most of which are cured promptly. If not, the Company
repossesses and sells the collateral in accordance with the terms of the loan
and statutory guidelines. Deficiency balances are charged off against the
allowance for loan losses. After chargeoff, the Company pursues collection of
deficiency balances subject to applicable law.
ASSET-BACKED MARKET ACTIVITIES
The Company regularly sells automobile loans in the asset-backed market
while retaining the servicing rights thereon. The Company has securitized its
automobile loans using an off-balance sheet structure which utilizes a separate
trust for each transaction. Automobile loan securitization provides a stable
source of funding, minimizes interest rate risk on the loans sold, enhances
return on assets and improves the capital position of the Company. The loans are
sold in publicly underwritten securitization transactions in which the Company
continues to service such loans. The securities issued, since the first
securitization transaction in 1985, have been rated "AAA" by Standard & Poor's
Rating Services, a division of McGraw-Hill, Inc. ("S&P") and "Aaa" by Moody's
Investors Service, Inc. ("Moody's"), their highest rating categories due to
8
<PAGE> 11
both the structure of the transaction and as a result of third party credit
enhancement provided by Financial Security Assurance, Inc.
These securitizations are structured to be treated as sales without
recourse under generally accepted accounting principles ("GAAP"), thereby
removing the automobile loans sold from the Company's balance sheet. The Company
retains a residual interest in the excess interest which represents the excess
of the underlying interest rate on the pool of automobile loans sold over the
sum of the pass-through rate on the securities, credit losses, administrative
expenses and contractual servicing fees. The valuation and recognition of the
residual interest is affected by actual credit loss and prepayment history,
discount rate assumptions and other factors.
The Company securitized $2.2 billion and $2.1 billion of automobile loans
during 1997 and 1996, respectively. At December 31, 1997 and 1996, $184 million
and $186 million, respectively, of automobile loans were held for sale, pending
securitization.
IMPROVE OPERATING EFFICIENCIES
In 1996, the Company began implementing cost saving initiatives through the
automation and centralization of its front-end application processing system and
back office activities. These initiatives were taken to give the Company the
necessary tools for profitable future growth and were completed in 1997. The
front-end application processing system provides the Company with the ability to
route applications to the appropriate prime or non-prime credit analyst. It also
insures adherence to the Company's established underwriting guidelines through
concurrence at the appropriate level. The front-end application system has
increased the efficiency in processing and approving applications at a lower
cost.
Additionally, the Company has completed the centralization of its back
office activities which include customer service, records management, asset
recovery and remarketing. By removing these functions from the field offices,
production personnel are better able to focus on origination activities. These
initiatives are also designed to reduce the Company's overall operating costs.
To continue to improve operational efficiencies, the Company announced a
restructuring plan on February 10, 1998 which consolidated offices and reduced
staff. In the first quarter, the Company consolidated 15 prime lending dealer
centers and 44 non-prime lending branch offices in the western United States
into 12 regional business centers and 15 satellite offices. Each location will
buy the full spectrum of prime and non-prime credit from dealers through a
single sales and marketing approach which will provide enhanced service and is
designed to increase volume. The restructuring plan will result in a one-time
pre-tax accounting charge for the first quarter ended March 31, 1998 of
approximately $9.0 million or $0.20 per diluted share. The plan, once fully
implemented, is designed to save up to $12.0 million or $0.26 per diluted share
annually in expenses.
BANK OPERATIONS
REAL ESTATE LENDING
The Company's primary real estate lending focus is on conventional single
family residential loans, alternative mortgage products ("AMPs") and home equity
loans. Other components of real estate lending operations include multifamily
residential loans and loan servicing. The Company also holds a small portfolio
of non-residential real estate loans.
The Company's single family residential products are marketed and
distributed through wholesale branches. The real estate lending network has
offices in 7 states at February 28, 1998 that service individuals, real estate
brokers and agents assisting property buyers, mortgage brokers, homebuilders and
thrifts. As of December 31, 1997, 81.6% of the dollar amount of mortgage loans
owned by the Company related to borrowers or properties located in California.
Of all mortgage loans originated during the year, based on dollar amount, 63.3%
were originated in California.
9
<PAGE> 12
The Company's total mortgage loan portfolio (including those held for sale)
consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------
1997 1996
------------------- -------------------
AMOUNT % AMOUNT %
---------- ----- ---------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Single family residential loans:
First trust deeds................................ $1,062,208 69.0% $ 908,741 63.9%
Second trust deeds............................... 48,393 3.1 55,778 3.9
---------- ----- ---------- -----
1,110,601 72.1 964,519 67.8
Multifamily residential loans...................... 410,139 26.7 453,425 31.9
Construction loans................................. 15,835 1.0 5,501 0.4
Other.............................................. 9,024 0.6 1,233 0.1
---------- ----- ---------- -----
1,545,599 100.4 1,424,678 100.2
Less: undisbursed loan proceeds.................... 6,711 0.4 2,359 0.2
---------- ----- ---------- -----
Total mortgage loans..................... $1,538,888 100.0% $1,422,319 100.0%
========== ===== ========== =====
</TABLE>
Mortgage loan originations are primarily generated by employees in the
Company's wholesale network. These employees receive commissions based on the
total volume of loans originated in accordance with the Company's product
pricing and underwriting standards, and do not have any underwriting authority.
The Company has established criteria for the brokers from whom it will accept
loan referrals. The commissioned employees responsible for originations also
endeavor to increase the number of brokers approved by the Company. The Company
undertakes a significant review of a potential broker before accepting any loan
applications from the broker. This analysis include reviewing the broker's
license and financial statements; performing a search for criminal offenses;
ensuring that the broker has the appropriate regulatory Veteran's Administration
("VA")/Federal Housing Administration ("FHA") approvals; and contacting
references. In addition, the broker must sign a wholesale broker agreement and
personally guarantee all representations and warranties in the agreement. All of
this documentation must be reviewed and approved by the Wholesale Lending
Manager. The Company regularly reviews a sample of its mortgage loans to ensure
compliance with its underwriting guidelines and with federal and state
regulations.
The Company originates fixed rate loans, ARMs without negative amortization
and ARMs with potential negative amortization. By diversifying its loan
portfolio among three types of loan products, the Company reduces its overall
risk exposure, increases its flexibility in asset/liability management and
provides greater loan origination opportunities. The following table sets forth
information on the amount of fixed rate mortgage loans and ARMs, net of
undisbursed loan proceeds, in the Company's portfolio.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------
1997 1996
------------------- -------------------
AMOUNT % AMOUNT %
---------- ----- ---------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Fixed rate loans................................... $ 417,991 27.2% $ 290,814 20.4%
Adjustable rate loans:
Negative amortization............................ 707,431 46.0 831,701 58.5
Without negative amortization.................... 413,466 26.8 299,804 21.1
---------- ----- ---------- -----
Total mortgage loans..................... $1,538,888 100.0% $1,422,319 100.0%
========== ===== ========== =====
</TABLE>
MORTGAGE LOAN SERVICING
Mortgage loan servicing includes collecting payments and related servicing
income and protecting the Company's and investors' interest in the underlying
collateral. Additional fees and charges related to loan servicing include
prepayment fees, late charges, assumption fees and other miscellaneous fees. The
loan servicing group collects mortgage payments from borrowers and remits
payments to investors such as the Federal National Mortgage Association ("FNMA")
and the Federal Home Loan Mortgage Company
10
<PAGE> 13
("FHLMC"). The loan servicing group earns a servicing fee on all loans serviced
for others. In addition, this group services $1.5 billion in loans owned by the
Company at December 31, 1997. During 1996, the Company purchased rights to
service $1.1 billion of single family residential loans for $9.9 million. The
Company did not purchase rights to service single family loans in 1997. These
rights, known as purchased mortgage servicing rights ("PMSRs"), allow the
Company to receive servicing income related to the servicing of these loans, in
addition to the servicing retained on loans sold from its own portfolio. The
purchase price of PMSRs is capitalized and amortized over the expected life of
the underlying loans.
Mortgage loan borrowers are provided a grace period before a late charge is
assessed. Delinquent customers are promptly contacted by the Company. If
delinquencies are not cured promptly, the Company takes those steps required by
law to perfect its interest in the collateral. This process generally includes
recording a notice of default and a trustee's sale of the property. The Company
disposes of foreclosed property as expeditiously as possible while seeking to
maximize sale proceeds. Due to legal restrictions and other factors, the Company
generally does not pursue a deficiency judgment through a judicial foreclosure.
Single Family Residential Loans
The single family (1-4 units) mortgage loans enable borrowers to purchase,
refinance or improve residential property. Loans are originated primarily
through wholesale distribution channels. The Company has substantially increased
its volume of fixed rate real estate loans for sale in the secondary market. The
Company believes that its current network of mortgage banking offices is
sufficient to handle a substantial increase in origination volume without a
proportional increase in costs. As part of its real estate lending operations,
the Company obtains forward financing commitments, which are then used to fund
all conforming originations. These secondary market real estate loan sales
enable the Company to leverage its capital efficiently, lock in interest rate
spreads, minimize interest rate risk, increase servicing fee income and limit
credit loss exposure on real estate loans sold.
The Company originates both ARMs and fixed rate first trust deed loans
secured by single family residences. These loans generally do not exceed
$400,000 in original principal amount. The Company has established lending
limits based on the amount of the loan compared to the property's value ("LTV").
The Company will finance loans for the purchase of owner occupied single family
residences for up to 95% of the market value based on the lesser of the purchase
price or appraised value of the property. Private mortgage insurance on the
unpaid balance in excess of 75% of the property's value is required on loans
with an LTV exceeding 80% at origination as long as the LTV is greater than 80%.
The cost of this insurance is paid by the borrower during the term of the loan.
Single family residential loans are typically made for terms of up to 30 years
and are amortized on a monthly basis with level payments of principal and
interest due each month, subject to periodic adjustments in the case of ARMs.
Interest rates offered by the Company are regularly reviewed and adjusted
and generally reflect prevailing competitive terms. Loan demand and availability
of credit affect these market conditions. Loan origination fees are a volatile
source of income varying with the volume and type of loans made and with
competitive conditions in the mortgage markets. The interest rates on adjustable
rate mortgage loans are adjusted monthly, quarterly, semiannually or annually,
at a rate typically between 2.25% to 3.50% above a specified index. The Company
originates loans using the London Interbank Offer Rate ("LIBOR"), the 11th
District Cost of Funds Index ("COFI") published by the FHLB, Treasury indices
and the Federal Cost of Funds Index. Initial interest rates and adjustment
periods are set based on prevailing market conditions and, from time to time,
have included initial rates below those which would prevail under the general
terms of the loan. Negative amortization ARM loans are underwritten based on the
fully indexed rate. At December 31, 1997, $46.4 million of the Bank's portfolio
of $1.1 billion in ARM loans had yet to adjust to a fully-indexed rate.
ARM loans are also designed with limits on the amount the interest rate may
change in a given period and with maximum lifetime interest rates, or caps, to
stimulate greater customer acceptance while maintaining the desired interest
rate flexibility. The interest rates on ARMs generally can increase or decrease
no more than 3% to 6% over the life of the loan. All ARMs are assumable by
qualified buyers at the interest rate then in effect on the loan, in some cases
with the payment of an assumption fee, but the maximum upward or
11
<PAGE> 14
downward interest rate adjustment over the life of the assumed loan is reset at
the time of assumption. On ARMs without negative amortization, the maximum
change in interest rate per period may be limited to 2% or less on certain loan
programs. On ARMs with negative amortization, the amount of any interest due in
excess of the monthly payment is capitalized by adding it to the principal
balance of the loan resulting in an increased principal balance. The monthly
payment on ARMs with negative amortization is adjusted annually, subject to a
7.5% maximum increase. At the end of each five-year interval throughout the life
of the loan (or sooner if the outstanding loan amount reaches a dollar figure
specified by the terms of the loan, generally no greater than 125% of the
original loan amount), adjustments are made regardless of the 7.5% cap to fully
amortize the loan over the remaining term. At December 31, 1997, the total
amount of negative amortizing adjustable loans totalled $707 million.
The Company requires title insurance which insures the priority of its
liens on loans made that are secured by real property, and may require
additional title endorsements to standard policies as necessary to protect its
security in the property encumbered. Fire and extended coverage must be
maintained in amounts at least equal to the replacement costs of structures and
improvements on all properties serving as security for its loans. If the
borrower fails to obtain or maintain the required insurance, the Company has the
right to obtain, and add the premium for, such insurance to the principal
balance of the loan. The Company also requires flood insurance on properties
that are within areas defined as having a special flood hazard.
Alternative Mortgage Products
AMPs are marketed to "sub-prime" borrowers who would not normally qualify
under conventional FNMA and FHLMC guidelines, primarily due to past credit
problems, instability of income, debt coverage ratios in excess of traditional
limits or an inability to sufficiently document income. AMPs are originated
through the Company's wholesale branches as well as through a specialized
division established to originate AMPs called WestWorks. The senior management
of the WestWorks division conducts the loan sale activity for the company for
the AMPs products as well as designing and administering the product for use in
the wholesale branches.
AMP product lines include 15 and 30 year fixed rate programs and ARMs tied
to the LIBOR index. The principal amount of loans is capped at $500,000. AMP
interest rates are higher than rates for conventional conforming financing, with
spreads ranging from 250 to 400 basis points over the typical conventional
conforming loans. AMP loans generally are sold within 60 days of origination to
investors, with the servicing rights released. At December 31, 1997, the
weighted average interest rate for a fixed-rate AMP loan secured by a first deed
of trust was 10.67% and the weighted average interest rate for an adjustable
rate AMP loan secured by a first deed of trust was 9.74%. The Company also
collects discount and/or origination points on each AMP loan as well as
miscellaneous loan fees.
In order to ensure credit quality and salability, all AMP loans are
reviewed by the WestWorks corporate credit department. Tiered approval
authorities have been established in both the wholesale branches and WestWorks
Regional Operations Centers. In addition, prior to funding, each appraisal is
reviewed by an in-house appraiser or an outside appraiser approved by the
Company to assure collateral requirements are being met. Post funding audits are
performed on a monthly basis to ensure that the loans meet investor's criteria,
with any deficiencies noted as well as corrective measures taken. Continuous
education, training and testing are given to all AMP personnel by the WestWorks
division to ensure that acceptable standards of expertise are maintained.
Collection practices for AMPs loans are more aggressive than those for
conventional loans. The WestWorks credit staff currently reviews each AMP loan
for compliance with underwriting standards. As the Company obtains more
experience with this product, the WestWorks credit staff expects the review to
be carried out on random samples of loans at less than 100%.
During the year, the Company originated $174 million of AMPs, compared to
$22.0 million during 1996. The Company expects this growth to continue into 1998
although no assurance can be given that such growth will continue at current
rates.
12
<PAGE> 15
Secondary Market Activities
Mortgage loans originated or purchased by the Company are either held in
its portfolio or sold in the secondary market. As the Company has become more
active in the secondary market, it has sold FHA and VA loans, as well as other
conforming and nonconforming loans to FNMA, FHLMC and other established
conduits. With the exception of FHA and VA loans which are sold servicing
released, the Company retains the servicing rights to these loans and earns
servicing income therefrom. These sales are generally without recourse, thereby
removing the mortgage loans sold from the Company's balance sheet. During 1997,
the Company sold $2.0 billion of mortgage loans in the secondary market compared
to $993 million during 1996. The Company's portfolio of mortgage loans held for
sale, consisting of single family loans, totalled $574 million at December 31,
1997 and $273 million at December 31, 1996.
Multifamily Residential Loans
Since 1991, the Company has not focused on multifamily residential loan
originations. Most of the multifamily originations were made to refinance or
restructure loans currently in the portfolio, to facilitate loans for the
disposition of real estate owned or to fund Community Reinvestment Act ("CRA")
loans. See Supervision and Regulation -- The Company -- Community Reinvestment
Act for further discussion. However, based on improved market conditions in this
sector, the Company has reentered this market on a limited basis in 1997. During
1997, the Company originated $15.5 million in multifamily residential loans, of
which $5.6 million, or 36%, was for sales of real estate acquired through
foreclosure and real estate acquired for investment or development ("REO"), $6.0
million, or 39%, was for the funding of CRA loans, and the remainder is related
to loans that were refinanced or restructured. During 1996, the Company
originated $11.9 million in multifamily residential loans, of which $7.9
million, or 66% was for the sale of REO.
Construction Loans
On a limited basis, the Company originates construction loans primarily for
single family owner-occupied residences. These included loans for the
acquisition and development of unimproved property to be used for residential
purposes. During 1997, the Company originated $17.1 million in construction
loans. At December 31, 1997, the Company's construction loans totalled $15.8
million (of which $6.7 million has not been disbursed). Such loans represent
less than 1% of the Company's total assets.
The construction loan portfolio generally consists of loans with terms
ranging from 12 to 18 months with adjustable interest rates equal to 1.5% to
5.75% above the prime rate. Advances are generally made to cover actual
construction costs and include a reserve for paying the stated interest due on
the loan.
RETAIL BANKING
The Company's retail banking operations are conducted through 26 retail
banking offices located in California. Historically, the Company has focused on
certificates of deposit as the primary source of funding for its lending
operations. The Company continues on its strategy to lower its overall cost of
funds by becoming the primary bank for its customers and attracting funds
through demand deposit accounts and money market accounts, loan and investment
products.
The target market for these products is comprised of four categories: (i)
existing certificates of deposit and savings customers; (ii) automobile loan
customers generated through WFS; (iii) mortgage customers; and (iv) potential
consumer and small business customers.
The Company will continue to pursue its target market and simultaneously
expand into other areas. Core deposit growth represents the retail banking
division's top priority. The Company added small business deposit accounts and
business money market accounts to its line of product offerings. The Company
targets these products to small and middle market businesses generally with $10
million and under in annual gross sales and is aggressively pursuing the
personal banking relationships of the principals and employees of such
businesses.
The success in increasing core deposits is expected to continue to reduce
the Company's overall cost of funds. Since the introduction of demand deposit
accounts in the second quarter of 1996, core deposit balances
13
<PAGE> 16
(demand deposit, money market and savings accounts) increased to $193 million as
of December 31, 1997 compared to $73.2 million as of December 31, 1996. This
amount represents less than 10% of the Company's total deposits, and provides a
significant opportunity to materially increase the core to total deposit ratio.
At December 31, 1997, the Company's deposits in checking accounts, savings
accounts, certificates of deposits and money market accounts totalled $2.0
billion.
COMMERCIAL BANKING
The Company continues to focus its commercial banking operations in the
Orange, Los Angeles and San Diego County metropolitan areas, operating through
the Irvine headquarters office. The Company targets companies with sales of $10
million to $100 million and cross-sells products to the owners and management as
well as their employees. In addition, the Company offers private banking
services to individuals. In general, the commercial banking business focuses on
the southern California region, allowing the Company to differentiate itself
from its competition by providing high quality services, local relationship
management and fast turnaround time on loan decisions through experienced
employees.
The Company offers its commercial customers a full array of deposit and
loan products which are priced competitively and designed specifically for the
customer. Deposit products include money market deposits, business checking and
certificates of deposits delivered either through direct contact or cash
management products. Loan products include lines of credit, term loans, asset
based loans and credit lines, real estate related loans and trade finance
services, as well as consumer loans and lines of credit made available to
company owners, management and employees. Deposit products are generally priced
on a floating rate basis, based on the prime rate or LIBOR rate. Fixed rates are
utilized to a limited degree.
The Company manages credit quality by having each loan reviewed for
approval by a credit committee comprised of the Bank's President, Chairman of
the Board and Executive Vice President -- Commercial Banking. In addition,
account officers are directly assigned to specific accounts to stay in close
contact with the customer. Such contact allows for greater opportunity to
cross-sell products, as well as for observing and continually evaluating the
customer for potential credit problems.
At December 31, 1997, $70.6 million were committed to commercial banking
customers for various commercial loan products of which $41.7 million were
outstanding.
ASSET QUALITY
OVERVIEW
Nonperforming assets, loan delinquency and loan losses are considered key
measures of asset quality by the Company. Asset quality, in turn, affects the
determination of the allowance for loan losses. In addition to nonperforming
assets and loan delinquency levels, valuation allowances for estimated losses on
loans and real estate are also determined by taking into consideration general
economic conditions in the markets the Company serves, historical loss
experience, individual loan reviews and the level of assets relative to
reserves.
AUTOMOBILE LOAN QUALITY
During 1997, the Company substantially increased its servicing and
collections staff in response to the increased number of automobile loans
serviced from the non-prime segment of the credit quality market, which requires
more attention, and the overall increase in the servicing portfolio from
expansion.
During the early stages of delinquency, the Company utilizes an automated
telephone dialing system ("autodialer") to aid in the servicing and collections
process. The Company substantially increased the capacity of its autodialers
during 1997. The Company utilizes the autodialer to initiate contact with
delinquent obligors. If the early collection efforts do not result in a
satisfactory resolution of the delinquent account, then the account is forwarded
to the appropriate collection specialist. In addition, if contact is not made
with the customer within 48 hours of the initial autodialer effort, the account
is automatically sent to a collection specialist for review.
14
<PAGE> 17
If satisfactory payment arrangements are not made or complied with, the
automobile is generally repossessed within 60 to 90 days of the date of initial
delinquency, subject to compliance with the applicable law. The Company uses
independent contractors to perform repossessions. The automobile remains in the
custody of the Company for 15 days (or longer if required by applicable law) to
provide the obligor with the opportunity to redeem the automobile loan. If after
the redemption period the delinquency is not cured, the Company writes down the
vehicle to fair value. After the redemption period expires, the Company prepares
the automobile for sale. The Company sells substantially all of its automobiles
through wholesale auto auctions at the best price possible, subject to
applicable law. The Company rarely provides the financing on repossessions sold.
The Company uses centralized remarketing departments to sell its repossessed
vehicles. The remarketing departments are responsible for transportation of the
vehicle to wholesale auction houses, reconditioning and repairs, when necessary
and tracking vehicles until they are sold. Once the vehicle is sold, any
deficiency balances are then charged off. At December 31, 1997, the total amount
of repossessed vehicles managed by the Company was $9.7 million or 0.26% of the
total serviced automobile portfolio compared with $6.1 million or 0.20% of the
total serviced automobile portfolio at December 31, 1996.
After chargeoff, the Company will seek collection on deficiency balances
through its centralized loss recovery center ("ARC"). The ARC will first attempt
to collect directly from the obligor with its in-house collection staff. If
efforts are not successful, the ARC will seek a deficiency judgment through a
small claims court procedure, where available, or an attorney employed by the
Company takes formal judicial action against customers with deficiency balances
in excess of that which may be brought in a small claims court proceeding. In
some cases, particularly when the likelihood of recovery is remote, the account
is assigned to a collection agency for final resolution. Additionally, the ARC
will attempt to obtain vehicles that could not be found for repossession by skip
tracing to locate the vehicle. The ARC also monitors payment plans on those
obligors that have filed for bankruptcy. If the obligor is not following the
payment plan stipulated by the courts, then the ARC will seek a judgment for
dismissal or discharge, or will seek to repossess the vehicle.
It is the Company's policy to charge off all automobile loans once they
become 120 days past due, including those that are not in compliance with the
court ordered bankruptcy plan and whether or not the automobile has been
repossessed or sold by that date. Therefore, the Company continues to accrue
interest on automobile loans until they are charged off. At the time an
automobile loan is charged off, all accrued but unpaid interest which has been
previously included as income is reversed by charging the allowance for credit
losses. No assurance can be given that the future performance of the automobile
loans purchased by the Company will be similar to that disclosed in the
following tables.
15
<PAGE> 18
The following table sets forth information with respect to the delinquency
of the Company's portfolio of automobile loans serviced.
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------------------------
1997 1996 1995
----------------------- ----------------------- -----------------------
NUMBER OF NUMBER OF NUMBER OF
AUTOMOBILE AUTOMOBILE AUTOMOBILE
LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT
---------- ---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Automobile loans
serviced(1)................ 408,958 $3,680,817 341,486 $3,046,585 258,665 $2,209,594
======= ========== ======= ========== ======= ==========
Period of delinquency(2)
31 - 59 days............... 6,605 $ 54,450 4,511 $ 38,173 2,180 $ 18,557
60 - 89 days............... 2,161 18,652 1,305 11,470 690 6,143
90 days or more............ 918 7,762 567 5,144 308 2,701
------- ---------- ------- ---------- ------- ----------
Total automobile loans
delinquent................. 9,684 $ 80,864 6,383 $ 54,787 3,178 $ 27,401
======= ========== ======= ========== ======= ==========
Delinquencies for automobile
loans as a percentage of
number and amount of
automobile loans
outstanding................ 2.37% 2.20% 1.87% 1.80% 1.23% 1.24%
======= ========== ======= ========== ======= ==========
</TABLE>
- ---------------
(1) Includes delinquency information relating to automobile loans which are
owned by the Company which have been sold and securitized but are serviced
by the Company.
(2) The period of delinquency is based on the number of days payments are
contractually past due.
The following table sets forth information with respect to actual loss
experience of the Company's portfolio of automobile loans serviced and includes
automobile loan loss information relating to automobile loans which are owned by
the Company and contracts which have been sold and securitized but are serviced
by the Company.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Portfolio
Automobile loans serviced at end of period
(net of unearned add-on interest)(1).................. $3,680,817 $3,046,585 $2,209,594
========== ========== ==========
Average during period (net of unearned add-on
interest)(1).......................................... $3,383,570 $2,627,622 $1,886,359
========== ========== ==========
Gross chargeoffs of automobile loans during period....... $ 136,773 $ 86,464 $ 48,999
Recoveries of automobile loans charged off in prior
periods............................................... 34,634 25,946 18,715
---------- ---------- ----------
Net chargeoffs........................................... $ 102,139 $ 60,518 $ 30,284
========== ========== ==========
Net chargeoffs as a percent of average automobile loans
outstanding during period............................. 3.02% 2.30% 1.61%
========== ========== ==========
</TABLE>
- ---------------
(1) Includes loan loss information for loans sold that were originated and
serviced by the Company.
The increase in loss experience in 1997 is primarily due to a shift in
product mix from prime to non-prime automobile loans. Other factors that
management believes has also affected losses include increased competition and
increased personal bankruptcies.
16
<PAGE> 19
REAL ESTATE LOAN QUALITY
The Company has established procedures to assist in the effective
identification, measurement and rehabilitation of delinquent and other problem
loans. An integral part of this process is the Internal Asset Review Department
("IAR"). IAR performs an independent review function to measure risk with the
Company's asset portfolio. IAR reviews and classifies assets as Pass, Special
Mention, Substandard, Doubtful or Loss. Substandard assets have one or more
defined weaknesses and are characterized by the distinct possibility that the
Company may sustain some loss unless the deficiencies are corrected. Doubtful
assets have a higher possibility of loss than substandard assets. Special
mention assets are assets not falling in the foregoing categories, but which
have apparent weaknesses or potential weaknesses deserving management's close
attention.
The following table sets forth the delinquency percentages relative to the
dollar amounts of the Company's total mortgage portfolio, including loans held
for sale, for the past five years.
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------
1997 1996 1995 1994 1993
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Period of Delinquency:
Two payments (31-59 days)................ 0.55% 0.34% 0.57% 0.56% 0.40%
Three payments (60-89 days).............. 0.10 0.14 0.40 0.09 0.42
Four or more payments (90 days or
more)................................. 0.80 1.03 0.89 1.11 1.31
</TABLE>
The following table of mortgage delinquencies over 60 days by loan type
highlights the fact that real estate loan related delinquencies have stabilized
over the past three years.
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
AMOUNT AMOUNT AMOUNT
PAST DUE PAST DUE PAST DUE
OVER % OF OVER % OF OVER % OF
60 DAYS CATEGORY 60 DAYS CATEGORY 60 DAYS CATEGORY
-------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Single family................ $12,993 1.17% $15,266 1.55% $15,185 1.63%
Multifamily.................. 938 0.22 1,756 0.38 2,908 0.62
Construction................. 220 2.79 107 1.56
------- ---- ------- ---- ------- ----
$14,151 0.90% $17,022 1.17% $18,200 1.29%
======= ==== ======= ==== ======= ====
</TABLE>
NONPERFORMING ASSETS
The Company's total nonperforming assets ("NPAs") decreased $6.1 million to
$26.9 million at December 31, 1997 compared to $33.0 million at December 31,
1996 and $29.2 million at December 31, 1995. NPAs as a percentage of total
assets decreased by 0.3% for 1997 compared to 1996. At December 31, 1997, NPAs
represented 0.7% of total assets. NPAs represented 1.0% and 0.9% of total assets
at December 31, 1996 and 1995, respectively. Real estate markets have become
strong throughout California and have been relatively stable throughout the
United States, although weaknesses still exist in certain sectors of the market.
NPAs consist of nonperforming loans ("NPLs") and REO. REO is carried at
lower of cost or fair value less estimated disposition costs. NPLs are defined
as all nonaccrual loans, which include mortgage loans 90 days or more past due
and impaired loans where full collection of principal and interest is not
reasonably assured. When a loan is designated as nonaccrual, all previously
accrued but unpaid interest is reversed. At December 31, 1997, 1996 and 1995,
interest on nonperforming loans excluded from interest income was $0.8 million,
$1.0 million, and $0.8 million, respectively.
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect all amounts
due according to the contractual terms of the loan agreement. The Company
measures impairment based on, among other factors, the fair value of the loan's
collateral. Changes in the fair value of loans are recorded through the
allowance for loan losses. At December 31, 1997
17
<PAGE> 20
and 1996, impaired loans were $4.8 million and $6.9 million, respectively. The
following table classifies NPLs into significant categories:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
-------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Loans placed on nonaccrual..................... $14,979 $14,052
Impaired loans................................. 4,806 6,887
------- -------
$19,785 $20,939
======= =======
</TABLE>
Single family loans accounted for 69% of total NPAs at December 31, 1997
while multifamily loans accounted for 29%, although no single loan or series of
such loans predominate. The decrease in total NPAs is the result of improving
asset quality and stabilization of market values. The following tables show the
roll forward and migration of NPLs and REO since December 31, 1995:
<TABLE>
<CAPTION>
SINGLE
FAMILY MULTIFAMILY MULTIFAMILY
TOTAL 1-4 UNITS 5-36 UNITS 37+ UNITS CONSTRUCTION
-------- --------- ----------- ----------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
NONPERFORMING LOANS
Balance December 31, 1995............. $ 18,400 $ 9,934 $ 5,993 $ 2,366 $ 107
New nonperforming loans............. 35,910 24,454 6,948 4,508
REO................................. (20,112) (11,633) (6,754) (1,618) (107)
Cures and payoffs................... (12,550) (8,407) (2,860) (1,283)
Chargeoffs.......................... (709) (709)
-------- -------- ------- ------- -----
Balance December 31, 1996............. 20,939 13,639 3,327 3,973 --
New nonperforming loans............. 24,674 19,878 3,062 1,180 554
REO................................. (16,605) (11,739) (3,685) (1,181)
Cures and payoffs................... (7,941) (6,464) (1,346) (106) (25)
Chargeoffs.......................... (1,230) (1,060) (170)
Transfers........................... (52) (945) 893
-------- -------- ------- ------- -----
Balance December 31, 1997............. $ 19,785 $ 13,309 $ 2,251 $ 3,866 $ 359
======== ======== ======= ======= =====
REAL ESTATE ACQUIRED THROUGH
FORECLOSURE
Balance December 31, 1995............. $ 10,828 $ 7,234 $ 2,911 $ 683
New REO............................. 26,889 15,505 11,299 85
Sales............................... (21,478) (11,715) (9,763)
Writedowns.......................... (4,176) (1,846) (1,932) (398)
-------- -------- ------- ------- -----
Balance December 31, 1996............. 12,063 9,178 2,515 370
New REO............................. 27,021 15,113 10,622 $ 1,181 105
Sales............................... (26,489) (17,906) (7,317) (1,181) (85)
Writedowns.......................... (5,475) (1,237) (4,127) (111)
-------- -------- ------- ------- -----
Balance December 31, 1997............. $ 7,120 $ 5,148 $ 1,693 $ -- $ 279
======== ======== ======= ======= =====
</TABLE>
ALLOWANCE FOR LOAN LOSSES
The Company decreased its allowance for loan losses to $33.8 million at
December 31, 1997, compared to $40.2 million at December 31, 1996. The decrease
in 1997 was primarily due to the stabilization in the asset quality of the
Company's loan portfolio. The allowance for loan losses and related provisions
are determined by considering loan volumes, loan sales, prepayments, loss
trends, levels of NPLs and management's analysis of
18
<PAGE> 21
market conditions and other relevant factors. The following table sets forth the
activity in the allowance for loan losses.
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of period..................... $ 40,211 $ 39,260 $ 41,323
Chargeoffs:
Mortgage loans................................... (6,850) (5,678) (6,358)
Consumer loans................................... (15,956) (15,580) (12,829)
-------- -------- --------
(22,806) (21,258) (19,187)
Recoveries:
Mortgage loans................................... 66 2,010 189
Consumer loans................................... 4,303 5,158 4,565
-------- -------- --------
4,369 7,168 4,754
-------- -------- --------
Net chargeoffs..................................... (18,437) (14,090) (14,433)
Transfers from the allowance for real estate
losses........................................... 800
Business acquisition adjustments(1)................ (791) 1,470 100
Provision for loan losses.......................... 12,851 13,571 11,470
-------- -------- --------
Balance at end of period........................... $ 33,834 $ 40,211 $ 39,260
======== ======== ========
Ratio of net chargeoffs during the period to
average loans
outstanding during the period.................... 0.93% 0.79% 0.82%
</TABLE>
- ---------------
(1) Adjustments related to the acquisition of The Hammond Company and its
subsidiaries were $686 thousand, $1.47 million and $100 thousand at December
31, 1997, 1996 and 1995 respectively.
The allowance for loan loss by loan category was as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------
1997 1996
---------------------- ----------------------
LOANS LOANS
IN EACH IN EACH
CATEGORY CATEGORY
AS A % OF AS A % OF
TOTAL TOTAL
ALLOWANCE LOANS ALLOWANCE LOANS
--------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Consumer......................... $ 6,787 15.5% $ 7,648 17.4%
Single family residential........ 8,952 60.4 12,321 51.1
Multifamily residential.......... 16,111 21.9 20,242 31.0
Commercial....................... 1,984 2.2 0.5
------- ----- ------- -----
$33,834 100.0% $40,211 100.0%
======= ===== ======= =====
</TABLE>
The allowance for real estate losses was established to absorb potential
losses in the REO portfolio. Provisions for real estate losses are charged to
real estate operations. Changes in the allowance for real estate losses were as
follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------
1997 1996 1995
---- ---- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of period...................... $784 $784 $1,684
Provision for real estate losses.................... (100)
Chargeoffs, net
Transfers to the allowance for loan losses.......... (800)
---- ---- ------
Balance at end of the year.......................... $784 $784 $ 784
==== ==== ======
</TABLE>
19
<PAGE> 22
INVESTMENT SECURITIES
The Company's investment securities portfolio consists primarily of United
States Agency and Treasury securities and is classified as available for sale.
Accordingly, the portfolio is reported at fair value with unrealized gains and
losses being reflected as a separate component of shareholders' equity. This
portfolio is maintained primarily for liquidity purposes in accordance with
regulatory requirements. The Company also holds FHLB stock, which is carried at
cost, as required by its affiliation with the FHLB System. All of the Company's
investment securities held to maturity were reclassified to available for sale
in 1997. See Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Results of Operations -- Other Noninterest Income for
further discussion. In 1996, the Company held other investments which include
investment securities. At December 31, 1997, the weighted average interest rate
of the Company's investment securities portfolio was 5.74% for securities with
maturities of up to one year, 5.94% for securities with maturities greater than
one year up to five years, 4.8% for securities with maturities greater than five
years up to ten years, 5.35% for securities with maturities greater than ten
years. The following table summarizes the Company's investment securities at the
dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest bearing deposits with other
financial institutions.................... $ 15,510 $ 510 $ 689 $ 563 $ 796
Other short-term investments................ 84,136 62,798 126,227 145,391 137,162
Investment securities:
U.S. Treasury securities and obligations
of other U.S Government agencies and
corporations -- available for sale..... 121,714 140,806 130,052 111,677 114,050
U.S. Treasury securities and obligations
of other U.S Government agencies and
corporations -- held to maturity....... 1,504 1,506
Obligations of states and political
subdivisions........................... 1,532 1,513 3,441 3,062 3,527
FHLB stock................................ 25,762 31,967 29,624 24,474 17,566
Corporate bonds -- below investment
grade.................................. 400
Other..................................... 163 25 25 25 25
-------- -------- -------- -------- --------
$248,817 $239,123 $291,564 $285,192 $273,526
======== ======== ======== ======== ========
</TABLE>
The following table sets forth the stated maturities of the Company's
investment securities at December 31, 1997.
<TABLE>
<CAPTION>
UP TO ONE YEAR FIVE YEARS TEN YEARS NO STATED
ONE YEAR TO FIVE YEARS TO TEN YEARS OR MORE MATURITY
-------- ------------- ------------ --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest bearing deposits with other
financial institutions.............. $ 15,510
Other short-term investments.......... 84,136
Investment securities:
U.S. Treasury securities and
obligations of other U.S
Government agencies and
corporations..................... 81,165 $40,549
Obligations of states and political
subdivisions..................... $1,009 $523
FHLB stock............................ $25,762
Other................................. 25 138
-------- ------- ------ ---- -------
$180,836 $40,549 $1,009 $523 $25,900
======== ======= ====== ==== =======
Weighted average interest rate........ 5.74% 5.94% 4.80% 5.35% 5.67%
</TABLE>
20
<PAGE> 23
MORTGAGE-BACKED SECURITIES
The Company invests in mortgage-backed securities ("MBS") to generate net
interest income, to manage its mix of assets and liabilities and to invest in
certain low-income housing programs designed to provide affordable access to the
housing market. In 1997, the Company has reclassified all of the portfolio as
available for sale and accounts for it at fair value with unrealized gains or
losses being reported as a separate component of shareholders' equity. See
Management's Discussion and Analysis of Financial Condition And Results of
Operations -- Results of Operations -- Other Noninterest Income. In 1996, the
Company had a portion of its MBS portfolio as held to maturity and accounted for
that portion using amortized cost. The following table summarizes the Company's
MBS portfolio by issuer.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Held to maturity securities:
GNMA certificates.................................... $346,098
FNMA participation certificates...................... 84,005
FHLMC participation certificates..................... 7,358
Other................................................ 1,201
--------
$438,662
========
Available for sale securities:
GNMA certificates.................................... $786,942 $321,776
FNMA participation certificates...................... 143,451 71,983
FHLMC participation certificates..................... 8,125 17,127
Other................................................ 2,930
-------- --------
$941,448 $410,886
======== ========
</TABLE>
The carrying value of the MBS available for sale is equal to its estimated
market value of $941 million and has a weighted average interest rate of 7.28%
at December 31, 1997. The Company's MBS portfolio had maturities of ten years or
greater at December 31, 1997, although payments are generally received monthly
throughout the life of these securities.
FUNDING SOURCES
The Company employs various sources to fund its operations, including
deposits, securitizations, commercial paper, advances from the FHLB, repurchase
agreements, subordinated debentures and other borrowings. The sources used vary
depending on such factors as rates paid, maturities, and the impact on capital.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Capital Resources and Liquidity".
DEPOSITS
The Company attracts both short-term and long-term deposits from the
general public, commercial enterprises and institutions by offering a variety of
accounts and rates. The Company offers regular passbook accounts, various money
market accounts, demand deposit accounts, fixed interest rate certificates with
varying maturities and individual retirement accounts. In 1997, the retail
banking division continued its strategy to lower overall cost of funds. This
strategy involved becoming the primary bank for its customers by providing
checking accounts, money market accounts, ATMs, debit cards, overdraft
protection and alternative investments (primarily mutual funds and annuities).
The Company's deposits are obtained primarily from the areas surrounding its
banking offices in California.
21
<PAGE> 24
The following table sets forth the amount of the Company's deposits by type
at the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
No minimum term:
Demand deposit accounts.... $ 46,579 $ 30,069
Passbook accounts.......... 21,883 42,532 $ 65,293 $ 104,085 $ 162,185
Money market deposit
accounts................ 124,442 438 602 801 1,149
Noninterest bearing
deposits................ 62,510 39,032
Certificate accounts:
Certificates (30 days to
five years)............. 1,490,866 1,481,847 1,462,649 1,335,805 1,026,671
IRA........................ 214,640 231,535 224,931 192,091 167,053
Brokered deposits............ 39,976 48,489
---------- ---------- ---------- ---------- ----------
$2,000,896 $1,873,942 $1,753,475 $1,632,782 $1,357,058
========== ========== ========== ========== ==========
</TABLE>
The variety of deposits offered by the Company has allowed it to remain
competitive in obtaining funds and to respond with flexibility to changes in
customer demand and competitive pressures. Generally, the Company, as other
financial institutions, has become more subject to short-term fluctuations in
deposit flows as customers have become more interest rate conscious. The ability
of the Company to attract and maintain deposits and control its cost of funds
has been, and will continue to be, significantly affected by money market
conditions.
The Company's average certificate accounts outstanding are summarized
below.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1996
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Average certificate accounts outstanding............ $1,782,967 $1,674,658
Average interest rate paid.......................... 5.8% 5.8%
</TABLE>
Deposit accounts, subject to certain FDIC attribution rules, are insured by
the FDIC up to $100,000 per customer. The Company's maturities of certificate
accounts greater than or equal to $100,000 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Three months or less................................... $163,336 $153,186
Over three months through six months................... 65,135 50,065
Over six months through one year....................... 128,081 121,067
Over one year through three years...................... 49,546 76,168
Over three years....................................... 9,471 5,780
-------- --------
$415,569 $406,266
======== ========
</TABLE>
SECURITIZATION
The Company employs a hedging and securitization strategy to leverage its
capital efficiently, lock in interest rate spreads and materially reduce its
interest rate risk while also limiting its credit loss exposure on automobile
loans sold. Securitization enables the Company to sell automobile loans on a
regular basis while continuing to receive servicing fees and to use the proceeds
from such sales to purchase additional automobile loans.
Between December 1985 and December 1997, the Company sold, in 40
transactions, approximately $10.0 billion of automobile loans in publicly
underwritten securitization transactions. The first issue was rated
22
<PAGE> 25
AA by Standard & Poor's Rating Service, a division of McGraw-Hill, Inc. ("S&P")
and Aa by Moody's Investor Service, Inc. ("Moody's") and all 39 issues since
that time were rated AAA by S&P and Aaa by Moody's, their highest rating
categories, as a result of the structure of the transactions and the quality of
the automobile loans securitized or the credit enhancement provided by Financial
Security Assurance Inc. ("FSA"). In all of its securitization transactions, the
Company continues to service the automobile loans sold. Each transaction is
independent of all others, with no cross-collateralization or cross-default
provisions applicable. Each securitization transaction with a maturity date
prior to the date hereof has been paid in full on or before its contracted final
maturity date and no recourse has been made to FSA on any transaction.
In 1990, the Company began to securitize its automobile loans using an
off-balance sheet structure which utilizes a separate grantor trust for each
transaction. These securitizations were structured to be treated as sales
without recourse, thereby removing the automobile loans sold from the balance
sheet of the Company. The Company retained a residual interest in the excess
interest which represented the excess amount of the underlying interest on the
pool of automobile loans sold over the amount of interest payable on the
securities and the amount of credit losses, administrative expenses and
contractual servicing fees. The Company securitized $1.5 billion and $842
million of automobile loans using this structure during 1995 and 1994,
respectively.
In 1996, the Company began using an owner trust structure, issuing both
collateralized notes and pass-through certificates. Securitizations using the
owner trust structure are also treated as sales without recourse. The Company
retains the servicing of the automobile loans sold to the owner trust and
receives excess interest from the automobile loans sold. The owner trust
structure enables the Company to maximize the residual return from a
securitization transaction by more closely matching the yield paid to the
investor to the yield curve existing at the time the securitization transaction
is consummated. The Company securitized $2.2 billion and $2.1 billion of
automobile loans using this structure during 1997 and 1996, respectively.
The Company derives multiple benefits from the securitization of automobile
loans, including a stable source of low cost funding, reduction of interest rate
and credit risk for sold automobile loans, enhanced return on assets and
regulatory compliance.
BORROWINGS AND OTHER SOURCES OF FUNDS
The Company's other sources of funds include issuing commercial paper and
obtaining advances from the FHLB, selling securities under agreements to
repurchase and other borrowings as well as loan repayments and cash generated
from operations. The Company selects from among these funding alternatives based
on the timing and duration of its cash needs, as well as the costs, maturities
and other requirements of each funding source.
The FHLB system functions in a reserve capacity for savings institutions.
As a member, the Company is required to own capital stock in the FHLB and is
authorized to apply for advances from the FHLB on security of such stock and on
certain residential mortgage loans. The Bank has been preapproved for advances
up to 25% of its assets, based on remaining availability under credit facilities
established by the Bank with the FHLB, with 24 hours notice. Such borrowings may
be made pursuant to several different programs offered from time to time by the
FHLB. Additional funds are available subject to additional collateral and other
requirements. Each credit program has its own interest rate, which may be fixed
or variable, and range of maturities. The FHLB prescribes the acceptable uses to
which advances pursuant to each program may be put, as well as limitations on
the sizes of advances and repayment provisions.
At December 31, 1997 and 1996, the Company had $171 million and $25.0
million of commercial paper outstanding, respectively, with a weighted average
interest rate of 6.0% for both years. The maximum amount of commercial paper
outstanding at any month-end was $399 million and $398 million during 1997 and
1996, respectively. The average amount of commercial paper outstanding during
1997 and 1996 was $178 million and $163 million, respectively.
Savings associations such as the Bank also have authority to borrow from
the Federal Reserve System ("FRS") "discount window". FRS regulations require
these institutions to exhaust all reasonable alternative
23
<PAGE> 26
sources of funds, including FHLB sources, before borrowing from the FRS. Federal
regulations have been promulgated which connect CRA performance with access to
long term advances from FHLB to member institutions. The Bank received a
"satisfactory" rating in its most recent CRA evaluation.
SUBORDINATED CAPITAL DEBENTURES
In 1993 and 1997, the Company, through the Bank, issued $125 million of
8.5% and $150 million of 8.875% Subordinated Capital Debentures due 2003 and
2007, respectively, of which $239 million is currently outstanding. In addition
to being a funding source, the Bank is permitted to include these Debentures in
supplementary capital for purposes of determining compliance with risk-based
capital requirements. See "Business -- Supervision and Regulation -- Regulatory
Capital Requirements."
SUBSIDIARIES
WESTERN FINANCIAL BANK
The Bank is a federally chartered and insured savings bank. The Bank
provides diversified financial services through real estate, commercial and
related lending programs, depository accounts and investment services. The Bank
has retail banking and mortgage banking offices in 7 states at February 28,
1998. Substantially all of the Company's operations are conducted through the
Bank and its subsidiaries. The Bank's subsidiaries are WFS (which in turn owns
all of the stock of WFAL, WFAL2 and WFSII), WFIA, RECON, WCS, Westhrift and
THCMB. On July 1, 1997, WESTFIN, became a direct subsidiary of the Company. Each
of these entities are described in detail below.
WFS FINANCIAL INC
WFS is in the business of consumer finance and operates in 40 states at
February 28, 1998. Each of its offices are licensed to the extent required by
law to conduct business in each respective state. WFS was created in 1995 by the
combination of the Bank's automobile lending operations and the Bank's
subsidiaries, Westcorp Financial Services, Inc., WFAL and WFAL2. The Company
owns an 83.7% interest in WFS. The remaining interest is traded on the National
Association of Securities Dealers Automated Quotation System ("NASDAQ") under
the ticker symbol "WFSI." During 1997, WFS originated $2.3 billion of automobile
loans. The loans which WFS originates are generally sold in securitized
offerings by its subsidiaries WFAL and WFAL2. See "Business -- The Business of
WFS -- Automobile Lending."
WFS FINANCIAL AUTO LOANS, INC.
WFAL is a wholly owned, limited purpose subsidiary of WFS. WFAL was
organized primarily for the purpose of purchasing automobile loans from WFS and
securitizing such loans in the asset-backed market. A total of four
securitization transactions totalling $2.2 billion were completed during 1997.
WFS FINANCIAL AUTO LOANS 2, INC.
WFAL2 is a wholly owned, limited purpose subsidiary of WFS. WFAL2 was
organized primarily for the purpose of purchasing automobile loans from WFS, and
securitizing such loans in the asset-backed market and engaging in other
asset-backed financing transactions. WFAL2 did not engage in any such activities
in 1997.
WFS INVESTMENTS, INC ("WFSII")
WFSII is a wholly owned, limited purpose subsidiary of WFS. WFSII was
incorporated for the purpose of purchasing ownership interests in owner trusts
in connection with securitization transactions. WFSII is limited by its Articles
of Incorporation from engaging in any business activities not incidental or
necessary to its stated purpose.
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WESTFIN INSURANCE AGENCY, INC. ("WFIA")
WFIA is a California based insurance agency which acts as an agent for
independent insurers in providing property and casualty insurance coverage on
collateral, primarily automobiles, securing loans made by the Company,
collateral protection insurance and other noncredit related life and disability
programs. WFIA's revenues consist of commissions received on policies sold to
customers.
WESTERN RECONVEYANCE COMPANY, INC. ("RECON")
RECON is a California corporation which acts primarily as the trustee under
trust deed loans made by the Company and is not a significant source of revenues
or expenses.
WESTERN CONSUMER SERVICES, INC. ("WCS")
WCS conducts real estate development activities through two California
limited liability companies ("LLC"). The purpose of the LLC's is to acquire,
develop and ultimately sell single family residences. The Company's interest
includes a participating share of the profits realized upon the sale of each
unit.
WCS also owns two branch locations of the Company. These properties can not
be treated as branch premises for regulatory purposes since the Bank does not
occupy at least 25% of the premises, consistent with OTS guidelines. The Bank is
required to hold risk-based capital against its investment in WCS.
WESTHRIFT LIFE INSURANCE COMPANY ("WESTHRIFT")
Westhrift, an Arizona corporation, is engaged in the business of reinsuring
credit life and credit disability insurance offered to borrowers of the Company
and underwritten by an independent insurer. The credit life insurance policies
provide for full payment to the Company of the insured's financial obligation in
the event of the insured's death. The credit disability insurance policies
provide for payment to the Company of an insured's financial obligation during a
period of disability resulting from illness or physical injury. Westhrift has a
Certificate of Authority from the California Insurance Commissioner authorizing
it to conduct insurance business in California. At December 31, 1997, credit
life and disability insurance in force was $7.0 million.
For Arizona statutory purposes, Westhrift is required to maintain reserves
for losses on credit life and credit disability policies. Westhrift's aggregate
reserves for credit life and credit disability policies at December 31, 1997
were $0.6 million. The aggregate reserves are computed in accordance with
commonly accepted actuarial standards consistently applied, and are based on
actuarial assumptions which are in accordance with or stronger than those called
for in policy provisions. The policies reinsured are underwritten by the
independent insurer for no more than the amount that the insured owes to the
Company, not to exceed $25 thousand per loan. Westhrift also maintains a $0.5
million deposit in accordance with California statutory deposit requirements.
Westhrift does not engage in any business except with respect to customers of
the Company and WFS.
THE HAMMOND COMPANY, THE MORTGAGE BANKERS ("THCMB")
An 80% interest in The Hammond Company ("THC") and its subsidiaries was
acquired by the Company on December 21, 1995. On June 19, 1996 the Company
acquired the remaining 20% of THC. On August 13, 1996, THC was merged into its
subsidiary The Hammond Company, The Mortgage Bankers ("THCMB"). In late 1996,
the Company combined all of THCMB, except for its VA and California Housing
Finance Authority ("CHFA") mortgage lending, with the Company's Mortgage Banking
Division, as the retail mortgage arm of the Company. During 1997, THCMB was
involved in the origination and sale of CHFA and VA mortgage loans. THCMB is not
a significant source of revenues or expenses.
WESTCORP INVESTMENTS, INC. ("WII")
WII is a limited-purpose, wholly owned subsidiary of the Company. WII was
incorporated in California on February 9, 1996 for the purpose of purchasing an
ownership interest in an owner trust created for a WFS
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automobile loan securitization transaction. WII is limited by its Articles of
Incorporation from engaging in any business activities not incidental or
necessary to its stated purpose.
WESTFIN SECURITIES CORPORATION ("WESTFIN")
WestFin Securities Corporation, formerly known as Western Financial
Investments, Inc. ("WFI"), began operations in 1994 as a licensed broker-dealer
selling mutual funds and variable annuities to the general public. In order to
also participate in the underwriting of certain securities, (of which WESTFIN is
currently only a financial advisor) Western Financial Investments, Inc. changed
its name to WestFin Securities Corporation in July 1997 and was made a direct
subsidiary of the Company. Prior to this change, WFI was a subsidiary of the
Bank.
WESTRAN SERVICES CORP. ("WESTRAN")
Westran is a California corporation which provides travel related services
for the Company and its subsidiaries. It is not a significant source of revenues
or expenses for the Company.
COMPETITION
The Company faces strong competition in both its lending and deposit
gathering activities. The Company believes it can differentiate itself from its
competition based on product pricing, the high degree of quality and
professionalism in the services it provides and through long-standing
relationships with borrowers, real estate brokers, automobile dealers and retail
deposit customers.
WFS faces strong competition in the purchase of automobile dealer generated
automobile loans from competitors including automobile manufacturer finance
subsidiaries, consumer finance companies, commercial banks, and credit unions.
WFS competes for the purchase of such loans on the basis of price and the level
of service provided to its dealers, including its promptness in processing and
approving automobile applications submitted by the dealer.
Competition in originating mortgage loans comes primarily from other
savings and loan associations, commercial banks and mortgage bankers. The
Company competes for mortgage loans principally on the basis of the interest
rates and loan fees it charges, the types of loans it originates and the quality
of services it provides borrowers and real estate brokers.
The greatest competition for deposits comes from other savings and loan
associations, money market funds, commercial banks, credit unions, thrift and
loan associations, corporate and government securities and mutual funds. Many of
the nation's largest savings and loan associations and other depository
institutions are headquartered or have branches in the areas where the Company
primarily conducts its business. The "Riegle-Neal Interstate Banking and Branch
Efficiency Act of 1994" legislated broader interstate banking authority to
financial institutions. At this time, the Company does not know the full extent
of the impact, if any, this Act might have on the Company. The Company competes
for deposits primarily on the basis of interest rates paid and quality of
service provided to its customers. The Company does not rely on any individual,
group or entity for a material portion of its deposits.
Competition in the commercial banking business comes primarily from other
commercial banks with a presence in the same geographic area. In general, many
commercial banks are more sizable institutions with larger lending capacity and
a lower cost of funds than the Company. However, the Company, because of the
experience of the individuals it has recruited, plans to differentiate itself
based on outstanding relationship management as well as on its ability to
provide quick credit decisions, competitive interest rates and competitive
pricing on loans, deposits and other services.
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TAXATION
FEDERAL INCOME TAXES
The Company and its subsidiaries file a calendar year consolidated federal
income tax return. All entities included on the consolidated financial
statements are included in the consolidated tax return.
The Bank is a savings and loan association for federal tax purposes. Prior
to 1996, savings and loan associations satisfying certain conditions were
permitted under the Internal Revenue Code ("IRC") to establish reserves for bad
debts and to make annual additions to these reserves which qualified as
deductions from income. However, in 1996 new legislation was enacted which
eliminated the reserve method of accounting for bad debts for tax purposes for
savings and loan associations. The repeal of the reserve method is effective for
tax years beginning after December 31, 1995. Savings and loan associations are
now subject to the same tax laws regarding bad debt reserves as banks. A bank
which qualifies as a "small bank" may still be allowed to use the reserve method
of accounting for bad debts, but may only calculate its addition to the reserve
using the experience method, not the percentage of taxable income method. A bank
which qualifies as a "large bank" is not allowed to use the reserve method and
is only allowed amounts which are specifically charged off to be taken as a tax
deduction. The Bank is considered a "large bank" for federal income tax purposes
and, therefore, is required to use the specific charge off method for deducting
bad debts for federal income tax purposes.
The tax reserves for bad debts which were added after 1987 and which still
exist as of the date of this change, are required to be recaptured into income
ratably over a period of six years starting with the first taxable year after
1995. However, savings and loan associations which meet the "residential loan
requirement" will be allowed to defer the recapture of their reserves for up to
two years. In order to meet the residential loan requirement, the principal
amount of residential loans made by a savings and loan association must equal or
exceed the average principal amount of the residential loans made by the savings
and loan association during the six most recent tax years beginning before 1996.
The tax reserves related to pre-1988 additions to the reserves, are not required
to be recaptured into income as a result of this legislation. The balance of the
Bank's post-1987 reserve as of December 31, 1997, which will be required to be
recaptured into income is $17 million. The Bank met the residential loan
requirement for 1997 and, thus, has postponed recapture of its post-1987
reserves for this year. Beginning in 1998, the Bank will be required to
recapture approximately $2.8 million into taxable income for each of the next
six years.
Prior to the legislation discussed above, the Bank, if it met certain
criteria, was permitted to compute its addition to the bad debt reserve on loans
using one of the following two methods: (i) the percentage of taxable income
method; or (ii) the experience method. The Bank has used whichever method has
provided the maximum tax deduction in the past. A savings and loan association
which utilized the percentage of taxable income method is subject to recapture
taxes on such reserves if it makes certain distributions to its stockholders.
Dividends may be paid without the imposition of any tax on the Bank if the
amounts paid as dividends do not exceed the Bank's current or accumulated
earnings and profits as calculated for federal income tax purposes. Dividends
paid in excess of current and accumulated earnings and profits, stock
redemption's and other distributions with respect to stock, are deemed to be
made from the bad debt reserve for qualifying real property loans, to the extent
that this reserve exceeds the amount that could have accumulated under the
experience method. The amount of tax that would be payable upon any distribution
which is treated as having been made from the bad debt reserve for qualifying
real property loans are also deemed to have been paid from the reserve to the
extent thereof. Management does not contemplate making distributions that will
create taxable income, but assuming a 35% tax rate, distributions to
stockholders which are treated as having been made from the bad debt reserve for
qualifying real property loans could result in a federal recapture tax which is
approximately equal to one-half of the amount of such distributions. Despite the
new laws regarding tax bad debt reserves, to the extent that the Bank has not
recaptured its reserves into income as discussed above, and makes distributions
deemed to have been made from their remaining reserves, the Bank would still be
subject to the recapture tax discussed above.
The Company will be subject to the alternative minimum tax if such tax is
larger than the regular federal tax otherwise payable. Generally, alternative
minimum taxable income is a taxpayer's regular taxable income,
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increased by the taxpayer's tax preference items for the year and adjusted by
computing certain deductions in a special manner which negates the acceleration
of such deductions under the regular federal tax. This amount is then reduced by
an exemption amount and is subject to tax at a 20% rate. In the past, the
Company has not generally paid alternative minimum tax and does not expect that
they will in the current year.
Currently the Company and its subsidiaries are under examination by the
Internal Revenue Service for the tax years ended December 31, 1993 and 1994.
Management does not anticipate any significant changes based upon these
examinations.
CALIFORNIA FRANCHISE TAX AND OTHER STATE PROVISIONS
At the end of 1997, the Company and subsidiaries had a tax presence in
approximately 35 states. However, the majority of the activity of the group and
the resulting income should be taxed as California source income, with minor
amounts apportioned or allocated outside California.
The California franchise tax applicable to the financial corporations is
higher than the rate of tax applicable to nonfinancial corporations because it
includes an amount "in lieu" of local personal property and business license
taxes paid by nonfinancial corporations, but not generally paid by financial
corporations. For taxable years ending after December 31, 1995, the tax rate for
a financial corporation is equal to the tax rate on a regular corporation plus
2%, or 11.3%. For income years beginning after January 1, 1997, the California
regular corporate tax rate was reduced to 8.84% resulting in a tax rate of
10.84%.
Under California law, a savings and loan association may determine its bad
debt deduction using one of two methods. The first method allows a deduction for
debts which become wholly or partially worthless during the tax year (i.e., the
specific charge off method). The second method allows a reasonable addition to a
reserve to be deducted. A reasonable addition can be calculated using an
experience ratio, or may be determined by management to be greater than the
experience ratio, but not greater than the amount deducted for regulatory and
financial statement purposes, and not greater than 1% of outstanding loans at
year end. The Bank generally determines its California bad debt deduction using
an experience ratio. California has not yet conformed to the federal repeal of
the reserve method of accounting for bad debts for a savings and loan
association, but may do so in the future.
The Company and its subsidiaries compute their taxable income for
California purposes an a unitary basis, or as if they were one business unit,
and file one combined California franchise tax return (excluding Westhrift). The
California returns of the Company and subsidiaries for the tax years 1990
through 1993 were examined by the Franchise Tax Board. A claim for refund is
still pending. All other issues for those years have been settled.
SUPERVISION AND REGULATION
GENERAL
The adoption of Financial Institutions Reform, Recovery and Enforcement Act
of 1989 ("FIRREA") substantially restructured the regulatory framework in which
the Company and the Bank operate. In December 1991, the Federal Deposit
Insurance Corporation Improvement Act ("FDICIA") was enacted. FDICIA requires
specified regulatory agencies to adopt regulations having broad application to
insured financial institutions such as the Bank. In 1994, the Riegle Community
Development and Regulatory Improvement Act of 1994 ("RCDA") was adopted, which
modified several of the requirements initiated by FDICIA. In addition, the
Deposit Insurance Fund Act (the "Fund Act") has further modified certain of
these requirements.
Set forth below is a discussion of the statutory and regulatory framework
for the Company and the Bank as affected by FIRREA, FDICIA, RCDA and the Fund
Act and the regulations promulgated thereunder. However, to the extent that the
following information describes statutory or regulatory provisions, it is
qualified in its entirety by reference to the particular statutory and
regulatory provisions. Any change in the applicable law or regulation or in the
policies of various regulatory authorities may have a material effect on the
business and prospects of the Company and the Bank.
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WESTCORP
The Savings and Loan Holding Company Act
Westcorp, by virtue of its ownership of the Bank, is a savings and loan
holding company within the meaning of the Home Owners' Loan Act ("HOLA"), as
amended by FIRREA. Savings and loan holding companies and their savings
association subsidiaries are extensively regulated under federal laws.
As a savings and loan holding company registered with the OTS, the Company
is subject to its regulations, examination and reporting requirements. The
Company is a "unitary" savings and loan holding company within the meaning of
regulations promulgated by the OTS, and as a result the Company is virtually
unrestricted in the types of business activities in which it may engage,
provided the Bank continues to meet the Qualified Thrift Lender test under HOLA.
Although the Company intends to remain a unitary savings and loan holding
company, if it acquires one or more insured institutions and operates them as
separate subsidiaries rather than merging them with the Bank, or if certain
other circumstances not currently applicable to the Company arise, the Company
would be treated as a "multiple" savings and loan holding company and could
cause additional regulatory restrictions to be imposed on the Company. The
Company does not anticipate that those circumstances will arise unless such
institutions are acquired pursuant to a supervisory acquisition and the insured
subsidiaries meet the Qualified Thrift Lender test.
HOLA prohibits a savings and loan holding company, without prior approval
of the OTS, from controlling any other savings association or savings and loan
holding company.
Additionally, FIRREA empowers the OTS to take substantive action when it
determines that there is reasonable cause to believe that the continuation by a
savings and loan holding company of any particular activity constitutes a
serious risk to the financial safety, soundness, or stability of that holding
company's subsidiary savings association. Thus, FIRREA confers on the OTS
oversight authority for all holding company affiliates, not just the Bank.
Specifically, the OTS may, as necessary: (i) limit the payment of dividends by
the Bank; (ii) limit transactions between the Bank, the holding company and the
subsidiaries or affiliates of either; and (iii) limit any activities of the
holding company that might create a serious risk that the liabilities of the
holding company and its affiliates may be imposed on the Bank. Any such limits
may be issued in the form of regulations, or a directive having the effect of a
cease and desist order.
Savings association subsidiaries of a savings and loan holding company are
limited by HOLA in the type of activities and investments in which they may
participate if the investment and/or activity involves an affiliate. In general,
savings association subsidiaries of a savings and loan holding company are
subject to Sections 23A and 23B of the Federal Reserve Act ("FRA") in the same
manner and to the same extent as if the savings association were a member bank
of the Federal Reserve System, as well as being subject to similar regulations
adopted by the OTS. Section 23A of the FRA puts certain quantitative
limitations, based upon a percentage of the savings association's capital stock
and surplus, on certain transactions between a bank or its subsidiary and an
affiliate, including transactions involving (i) loans or extensions of credit to
the affiliate; (ii) the purchase of or investment in securities issued by an
affiliate; (iii) purchase of certain assets from an affiliate; (iv) the
acceptance of securities issued by an affiliate as security for a loan or
extension of credit to any person; or (v) the issuance of a guarantee,
acceptance or letter of credit on behalf of an affiliate. The Board of Governors
of the Federal Reserve System (the "Board") has revised the definition of
capital stock and surplus for purposes of Section 23A to conform that definition
to that used by the Board in calculating the limits in Regulation O for insider
lending and by the Office of the Comptroller of the Currency ("OCC") in
calculating the limit on loans by a national bank to a single borrower. The
revised definition will permit subordinated debt that qualifies for inclusion in
Tier 2 capital to be included.
In addition, under Section 23B, transactions between a bank or its
subsidiary and an affiliate must meet certain qualitative limitations. Such
transactions must be on terms at least as favorable to the bank or its
subsidiary as transactions with unaffiliated companies.
Section 11 of the HOLA, as amended by FIRREA, also specifically prohibits a
savings association subsidiary of the savings and loan holding company from
making a loan or extension of credit to an affiliate unless that affiliate is
engaged only in activities permitted to bank holding companies under Section
4(c) of
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the Bank Holding Company Act or from purchasing or investing in the securities
of any affiliate (other than a subsidiary of the savings association). The OTS
regulations, consistent with the provisions of Sections 23A and 23B, exclude
transactions between a savings association and its subsidiaries from the
limitations of those sections, but those regulations also define certain
subsidiaries to be affiliates and subject to the requirements of those sections.
At the present time, none of the Bank's subsidiaries are within the definition
of an affiliate for purposes of those regulations.
Amendments made by FIRREA and FDICIA require that savings associations
comply with the requirements of FRA Sections 22(g) and 22(h), and FRS Regulation
O promulgated thereunder, in the same manner as member banks, with respect to
loans to executive officers, directors and principal shareholders. The RCDA
permits loans secured by a first lien on an executive officer's residence to be
made without prior approval of the board of directors of the financial
institution. As a matter of policy, the Company does not make loans to executive
officers, directors or principal shareholders.
THE BANK
California Savings Association Law
As a federally chartered institution, the Bank's investments and
borrowings, loans, issuance of securities, payments of interest and dividends,
establishment of branch offices and all other aspects of its operations are
subject to the exclusive jurisdiction of the OTS, to the exclusion of the
California Financial Code or regulations of the California Commissioner of
Financial Institutions. The OTS has adopted regulations to the effect that State
laws pertaining to the operations of federal savings associations and their
operating subsidiaries are preempted.
Federal Home Loan Bank System
The Bank, as a member of the FHLB, is required to own capital stock in the
FHLB in an amount at least equal to the greater of 1% of the aggregate
outstanding balance of its loans secured by residential real property or 5% of
the sum of advances outstanding plus committed FHLB commercial paper lines. The
Bank is in compliance with this requirement.
Since the adoption of FIRREA, the dividends which the Bank has received on
its FHLB stock have been significantly reduced as a result of requirements
imposed by FIRREA on the FHLB System. Each bank in the FHLB System is required
to transfer a certain portion of its reserves and undivided profits to the
Resolution Funding Corporation ("RFC"), the entity established to raise funds to
resolve troubled thrifts, to fund a portion of the interest and the principal on
RFC bonds and other obligations. Also, each bank in the FHLB System is required
to transfer a percentage of its annual net earnings to the Affordable Housing
Program, as defined in FIRREA. This amount, as of January 1, 1996, is a minimum
of 10% of the annual net income of each bank in the FHLB System.
Insurance of Accounts
The FDIC administers two separate deposit insurance funds for financial
institutions: (i) the Savings Association Insurance Fund ("SAIF"), which insures
the deposits of associations that were insured by the Federal Savings and Loan
Insurance Corporation ("FSLIC") prior to the enactment of FIRREA, and (ii) the
Bank Insurance Fund ("BIF"), which insures the deposits of institutions that
were insured by the FDIC prior to FIRREA. Commencing in 1989, the deposits of
the Bank became insured through the SAIF to the maximum amount permitted by law
(currently $100,000).
During 1997 the Bank was required to pay insurance premiums of $1.0
million. FDICIA required the FDIC to implement a risk-based assessment system
under which an institution's premiums are based on the FDIC's determination of
the relative risk the condition of such institution poses to its insurance fund.
In response, the FDIC adopted a final rule, effective January 1, 1994. Under
this rule, each insured institution is classified as "well capitalized,"
"adequately capitalized" or "undercapitalized," using definitions substantially
the same as those adopted with respect to the "prompt corrective action" rules
adopted by the regulatory
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agencies under FDICIA. See "Prompt Corrective Regulatory Action." Within each of
these classifications, the FDIC has created three risk categories into which an
institution may be placed, based upon the supervisory evaluations of the
institution's primary federal financial institution regulatory agency and the
FDIC. These three categories consist of those institutions deemed financially
sound, those with demonstrated weakness that could result in significant
deterioration of the institution and risk of loss to the FDIC, and those which
pose a substantial probability of loss to the FDIC. Each of these nine
assessment categories for SAIF insured institutions such as the Bank is assigned
an assessment rate. Under the regulations, an institution is precluded from
disclosing the risk-based assessment category to which it has been assigned.
Pursuant to the provisions of FIRREA, the FDIC adopted a significant
reduction in the insurance premiums to be paid by those financial institutions,
primarily commercial banks, whose deposits are insured under the BIF. For BIF
insured institutions, the assessment rate ranged from 0 to 27 basis points per
annum of the institution's deposit assessment base, with a minimum premium of
$2,000 per year, while for SAIF insured institutions it ranged from 23 to 31
basis points per annum. The Fund Act, signed into law by President Clinton on
September 30, 1996, provides for elimination of the differential in premiums. In
addition, the Fund Act authorized a one-time special assessment of 65.7 basis
points of SAIF-assessable deposits as of March 31, 1995, to be paid by SAIF
insured institutions to recapitalize the SAIF. On November 27, 1996, the FDIC
collected from the Bank a special assessment of $11.6 million. As a result of
the special assessment required by the Fund Act, the SAIF was capitalized at the
target Designated Reserve Ratio ("DRR") of 1.25% of estimated insured deposits
on October 1, 1996. Therefore, the FDIC lowered the rates on assessments paid to
the SAIF, while simultaneously widening the spread between the lowest and
highest rates, to avoid collecting more than needed to maintain the DRR, and to
improve the effectiveness of the risk-based system. Effective October 1, 1996,
for all SAIF insured institutions other than SAIF-member savings associations,
the assessment rate ranged from 0 to 27 basis points per annum. On January 1,
1997, the adjusted rates became effective for all institutions including the
Bank. A special interim rate schedule of 18 to 27 basis points per annum was
also established for SAIF-member savings associations for the period of October
1, 1996, to January 1, 1997, reflecting the fact that assessments paid to the
Financing Corporation ("FICO") are included in the SAIF rates for these
institutions during that interval. The Fund Act separated, effective January 1,
1997, the FICO assessment from the SAIF assessment. Excess assessments collected
under the prior assessment schedule will be refunded or credited with interest.
The Fund Act also provides for the eventual merger of the BIF and SAIF funds on
January 1, 1999, provided that legislation is adopted which will eliminate the
federal thrift charter.
FIRREA established a five year moratorium on conversions from the SAIF to
the BIF. The Resolution Trust Corporation Completion Act ("RTCCA"), enacted on
December 17, 1993, extended this moratorium until the date on which the SAIF
first meets the reserve ratio designed for it. The Fund Act provides that the
moratorium will now terminate on the earlier of January 1, 2000 or when the bank
and savings association charters are united and the BIF and SAIF are merged.
There are several exceptions to this moratorium. Most importantly, a SAIF member
may convert to a bank charter if the resulting bank remains a SAIF member during
the term of the moratorium. Additionally, conversions to a bank charter can take
place during the moratorium if: (i) it affects only an "insubstantial" portion
of an institution's total deposits and is approved by the FDIC; (ii) it results
from the acquisition of a troubled institution that is in default or in danger
of default and is approved by the FDIC; or (iii) it results from a merger or
consolidation of a bank and a savings association and is approved by the FDIC or
the OCC, as well as by the FRS. While these are proposals pending in Congress to
eliminate the thrift charter and merge the BIF and SAIF, the Company can provide
no assurance as to whether such proposals will be enacted.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined
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by the FDIC. Management is aware of no existing circumstances which could result
in termination of the Bank's deposit insurance.
Liquidity Requirements
Under OTS regulations, the Bank is required to maintain an average daily
balance of liquid assets (cash, certain time deposits, bankers' acceptances and
specified United States government, state or federal agency obligations and
certain corporate debt obligations and commercial paper) equal to at least 4% of
its average daily balance of net withdrawal accounts and borrowings payable on
demand or in one year or less. If at any time the Bank's liquid assets do not at
least equal (on an average daily basis for any quarter) the amount required by
these regulations, the Bank would be subject to various OTS enforcement
procedures, including monetary penalties. At December 31, 1997, the percentage
was 9.11%. Thus, the Bank was in compliance with these requirements. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Capital Resources and Liquidity."
Brokered Deposits
In June 1992, the FDIC issued regulations under FDICIA that provide for
differential regulation relating to brokered deposits based on capital adequacy.
Institutions are divided into categories of "well capitalized," "adequately
capitalized" and "undercapitalized." Only "well capitalized" institutions may
continue to accept brokered deposits without restriction. The RCDA affirmatively
excludes well capitalized institutions from the definition of deposit brokers,
thereby eliminating the need for well capitalized institutions to register as
deposit brokers.
At December 31, 1997, the Bank met the capital requirements of a well
capitalized association as defined by the regulation. At that date, the Bank
held $40.0 million of brokered deposits.
Regulatory Capital Requirements
The HOLA, as amended by FIRREA, mandates that the OTS promulgate capital
regulations which provide capital standards no less stringent than the capital
standards applicable to national banks.
The HOLA and the OTS regulation require savings associations to maintain
"core capital" in an amount not less than 3% of adjusted total assets. Core
capital is defined in the OTS capital regulations as including, among other
things, (i) common shareholder's equity (including retained earnings); (ii) a
certain portion of the association's qualifying supervisory goodwill; (iii)
noncumulative perpetual preferred stock and related surplus; and (iv)
capitalized servicing rights ("CSR") and purchased credit card relationships
("PCCRs") meeting certain valuation requirements. The maximum amount of CSRs and
PCCRs which can be included in core capital and tangible capital may not exceed,
in the aggregate, an amount equal to 50% of the institutions core capital, with
PCCRs limited to 25% of core capital. At December 31, 1997, the Bank had $37.4
million of CSRs, but held no PCCRs. Of the CSRs held by the Bank, $3.2 million
are in excess of the amount which may be included within the Bank's core
capital.
The regulations of the OCC, the principal national bank regulator, require
a minimum core capital requirement of 3% of adjusted total assets for national
banks with a composite 1 rating (the highest rating available) under the
Capital, Asset Quality, Management, Earnings, Liquidity, Sensitivity toward
market risk ("CAMELS") rating system for national banks and substantially higher
core capital requirements for lower rated national banks. Most national banks
are required to maintain core capital of 4% to 5% under this regulation. Because
HOLA generally requires that the capital standards applicable to savings
institutions be "no less stringent" than those applicable to national banks,
there is a high likelihood that the OTS will impose substantially equivalent
requirements, and in April 1991, the OTS proposed to modify the 3% of adjusted
total assets core capital requirement in the same manner. Under the OTS
proposal, only savings associations rated composite CAMELS 1 will be permitted
to operate at the regulatory minimum core capital ratio of 3%. For all other
savings associations, the minimum core capital ratio will be 3% plus at least an
additional 100 to 200 basis points, which thus will increase the core capital
ratio requirement to 4% to 5% (or more) of adjusted total assets. In determining
the amount of additional core capital any savings institution will be required
to
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maintain, the OTS will assess both the quality of risk management systems and
the level of overall risk in each individual savings association through the
supervisory process on a case-by-case basis. The OTS has not yet issued a final
rule. The OTS capital regulations already permit the OTS to impose a higher
individual minimum capital requirement on a case-by-case basis. The Bank is not
currently subject to any such requirement. The Bank's core capital ratio at
December 31, 1997 was 9.48%.
A savings association must maintain "Tangible Capital" in an amount not
less than 1.5% of adjusted total assets. "Tangible Capital" means core capital
less any intangible assets (including supervisory goodwill), plus CSRs and PCCRs
to the extent includable in core capital as described above. At December 31,
1997, the Bank's tangible capital was 9.48%.
A savings institution's investments in, and extensions of credit to, a
subsidiary engaged in any activities not permissible for national banks
("nonincludable subsidiaries") generally are deducted from the institution's
core capital and tangible capital in determining compliance with capital
standards. This deduction is not required for investments in, and extensions of
credit to, a subsidiary engaged solely in mortgage banking, to certain
subsidiaries which are themselves insured depository institutions or, unless the
FDIC determines otherwise in the interests of safety and soundness, to a
subsidiary which engages in such impermissible activities solely as agent for
its customers. Effective July 1, 1996, the Bank is required to deduct from its
core and tangible capital its investments in WCS (both equity and extensions of
credit), as WCS is engaged in residential real estate activities not permitted
by national banks. At December 31, 1997, the amount excluded from the Bank's
core and tangible capital was $10.2 million.
As of December 31, 1997, the Bank's core capital was $356 million,
exceeding the Bank's regulatory requirement by $243 million. The Bank's tangible
capital at December 31, 1997 was $356 million, exceeding the applicable
regulatory requirement by $299 million.
The risk-based component of the capital standards requires that an
association have total capital equal to 8.0% of risk-weighted assets. The OTS
risk-based capital regulation provides that for assets sold as to which any
recourse liability is retained (including on-balance sheet assets related to the
assets sold which are at risk) a savings association must hold capital as a part
of its risk-based capital requirement equal to the lesser of (i) the amount of
that recourse liability or (ii) the risk-weighted capital requirement for assets
sold off-balance sheet as though the assets had not been sold. In addition, in
the former instance, when calculating the Bank's risk-based capital ratio (a)
the value of those on balance sheet assets which are subject to recourse, to the
extent of that recourse liability ("fully capitalized assets"), is deducted from
the Bank's total capital and (b) neither the risk-weighted value of the asset
sold off-balance sheet nor the amount of the fully capitalized assets is
included in the Bank's total risk-weighted assets. The Bank's risk-based capital
requirement at December 31, 1997 included $345 million due to its recourse
liability relating to grantor and owner trust financings, including fully
capitalized assets.
The RCDA requires the federal banking agencies, including the OTS, to
review their risk-based capital recourse rules, and to adopt new rules for
assets sold with low levels of recourse to ensure that the risk-based capital
held for such assets does not exceed the contractual maximum recourse liability
retained by the institution upon the sale of those assets. The federal banking
agencies, including the OTS have adopted such regulations. As the existing OTS
low level recourse regulations were already consistent with those called for by
the RCDA, the OTS regulations discussed in the preceding paragraph were not
modified. Accordingly, these regulations will not affect the Bank.
Also in response to the RCDA, the federal banking agencies, including the
OTS, have adopted regulations pertaining to the amount of risk-based capital
which must be held upon the sale, with recourse, of qualifying small business
loans. Under these regulations, a well capitalized institution, such as the
Bank, upon the sale of loans which meet the criteria for loans to small
business, as defined by the Small Business Administration, needs to maintain
capital only against the amount of recourse retained, provided a reserve is
established, under GAAP, for that recourse liability. In addition, the maximum
amount of recourse retained under this regulation may not exceed 15% of the
Bank's total capital. The effect of this regulation is to substantially reduce
the amount of risk-based capital which must be maintained upon the sale of
qualifying small business loans.
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The Bank's total risk-weighted assets are determined by taking the sum of
the products obtained by multiplying each of the Bank's assets and certain
off-balance sheet items by a designated risk-weight. Before an off-balance sheet
item can be assigned a risk-weight, it must be converted to an on balance sheet
credit equivalent amount.
Four risk-weight categories exist for on balance sheet assets. The four
risk-weighted categories are zero percent (generally cash and securities issued
by or backed by the full faith and credit of the United States), twenty percent
(generally US government backed mortgage securities), fifty percent (generally
qualifying mortgage loans and mortgage backed securities not within lower
categories) and one hundred percent (all other assets).
Before a risk-weight category can be applied to a consolidated off-balance
sheet item, such item must be converted into a credit-equivalent amount by
multiplying its face amount by whichever of four credit conversion factors is
appropriate. There is a one hundred percent conversion of direct credit
substitutes, and net assets sold under an agreement to repurchase; a fifty
percent conversion factor for transaction-related contingencies and the unused
portions of nonexempt loan commitments; a twenty percent conversion for
trade-related contingencies, such as commercial letters of credit; and a zero
percent conversion for the unused portion of exempt loan commitments and unused,
unconditionally cancellable retail credit card lines. Interest rate contracts
have special credit equivalent amounts equal to the sum of their current credit
exposure plus their potential credit exposure. The risk-weight category to be
applied to such amounts in determining the credit risk component would depend on
the obligor, but in no event would be higher than fifty percent risk-weight. As
of December 31, 1997 the Bank's total risk-weighted assets equaled $5.2 billion.
In addition to regulations pertaining to risk-based capital for interest
rate risk, FDICIA also requires the adoption of risk-based capital regulations
regarding excessive exposure to concentration of credit risk and the risks
associated with nontraditional activities. The OTS individual minimum capital
regulations include these factors as additional grounds upon which the OTS could
impose such requirements. The regulations do not set specific standards, but
leave it to the discretion of the OTS to impose additional capital requirements
on a case by case basis. The RCDA requires the federal banking agencies to add
the size and activities of an institution to that list of factors which may
justify the need for additional risk-based capital. Under the RCDA the federal
banking agencies are not to cause undue reporting burdens in connection with
such regulations. The OTS has not yet proposed new regulations in response to
this law.
Total capital, as defined by OTS regulations, is core capital plus
supplementary capital (supplementary capital cannot exceed 100% of core capital)
less direct equity investments not permissible to national banks (subject to a
phase-in schedule), reciprocal holdings of depository institution capital
investments, and that portion of land loans and nonresidential construction
loans in excess of 80% loan-to-value ratio. Supplementary capital is comprised
of three elements: (i) permanent capital instruments not included in core
capital; (ii) maturing capital instruments; and (iii) general valuation loan and
lease loss allowance.
The Bank currently has $107 million (excluding discount and issuance costs)
of its 8.5% Debentures and $150 million of its 8.875% Debentures (excluding
discounts and issuance costs) outstanding. Pursuant to the approval from the OTS
to treat those debentures as supplementary capital, subsequent to January 1,
1999 the amount of those debentures which may be included as supplementary
capital may not exceed 40% of the Bank's total capital, until January 1, 1999 at
which time the inclusion reverts back to one-third of the Bank's total capital.
At December 31, 1997, the Debentures then outstanding represented 39.8% of the
Bank's total capital. Consistent with the OTS capital regulations, the amount of
the 8.5% Debentures which may be included as supplementary capital will decrease
at the rate of 20% of the amount originally outstanding per year (net of
redemptions), commencing on July 1, 1998 and the amount of the 8.875% debentures
which may be included as supplementary capital will decrease at the rate of 20%
of the amount originally outstanding per year (net of redemptions), commencing
on August 1, 2002. The Bank's total capital at December 31, 1997 was $640
million and its risk-based capital ratio was 12.24%.
As required by the provisions of FDICIA, the OTS has adopted an interest
rate risk component to its capital rules. The new rule establishes a method for
determining an appropriate level of capital to be held by savings associations
subject to the supervision of the OTS, such as the Bank, against interest rate
risk
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("IRR"). The new rule generally provides that if a savings association's IRR,
calculated in accordance with the rule, exceeds a specified percentage, the
savings association must deduct from its total capital an IRR component when
calculating its compliance with the risk-based capital requirement.
Specifically, the rule provides that a savings association's IRR is to be
determined by the decline in that association's Net Portfolio Value ("NPV")
(i.e., the value of the association's assets as determined in accordance with
the provisions of the rule) resulting from a 200 basis point change in market
interest rates (increase or decrease, whichever results in a lower NPV) divided
by the NPV prior to that change. If that result is a decrease of greater than
2%, the association must deduct from its total capital an amount equal to
one-half of the decline in its NPV in excess of 2% of its NPV prior to the
interest rate change (the "IRR component"). The reduction of an association's
total risk-based capital is effective on the first day of the third quarter
following the reporting date of the information used to make the required
calculations. The rule also contains provisions (i) reducing the IRR component
if the association reduces its IRR by the end of the quarter following the
reporting date and (ii) permitting the OTS to waive or defer the IRR component
on a showing that the association has made meaningful steps to reduce or control
its interest rate risk. The OTS has postponed the effective date as of which an
IRR component will be required to be deducted from a savings association's
capital to permit the OTS to review the interest rate risk regulations currently
being promulgated by the other federal banking agencies for their respective
institutions. Even were the rule currently being applied, the Bank would not be
required to reduce its total capital by an IRR component, and does not
anticipate being required to do so during 1998.
Any savings association that fails any of the capital requirements is
subject to possible enforcement actions by the OTS or the FDIC. Such actions
could include a capital directive, a cease and desist order, civil money
penalties, the establishment of restrictions on an association's operations and
the appointment of a conservator or receiver. The OTS's capital regulation
provides that such actions, through enforcement proceedings or otherwise, could
require one or more of a variety of corrective actions. The OTS must prohibit
asset growth by any institution that is in violation of the foregoing minimum
capital requirements, and must require any such institution to comply with a
capital directive issued by the OTS. See "Prompt Corrective Regulatory Action."
In summary, the Bank exceeded the current minimum requirements for core
capital, tangible capital and risk-weighted capital as of December 31, 1997.
Prompt Corrective Regulatory Action
FDICIA requires each applicable agency and the FDIC to take prompt
corrective action to resolve the problems of insured depository institutions
that fall below certain capital ratios. Such action must be accomplished at the
least possible long-term cost to the appropriate deposit insurance fund.
In connection with such action, each agency must promulgate regulations
defining the following five categories in which an insured depository
institution will be placed, based on the adequacy of its regulatory capital
level: well-capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized. The critically
undercapitalized level cannot be set lower than 2% of total assets or higher
than 65% of the required minimum leverage capital level. In addition to the
various capital levels, FDICIA allows an institution's primary federal
regulatory agency to treat an institution as if it were in the next lower
category if that agency (i) determines (after notice and an opportunity for
hearing) that the institution is in an unsafe or unsound condition or (ii) deems
the institution to be engaged in an unsafe or unsound practice.
At each successive downward level of capital, institutions are subject to
more restrictions and regulators are given less flexibility in deciding how to
deal with the bank or thrift. For example, undercapitalized institutions will be
subject to asset growth restrictions and will be required to obtain prior
approval for acquisitions, branching and engaging in new lines of business. For
significantly undercapitalized institutions, the appropriate agency must require
the institution to sell shares in order to raise capital, must restrict interest
rates offered by the institution, and must restrict transactions with affiliates
unless, in each case, the agency determines that such actions would not further
the purposes of the prompt corrective action system. In
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addition, for critically undercapitalized institutions, the agency must require
prior agency approval for any transaction outside the ordinary course of
business, and the institution must be placed in receivership or conservatorship
unless the appropriate agency and FDIC make certain affirmative findings
regarding the viability of the institution (which findings must be reviewed
every 90 days).
FDICIA prohibits any insured institution (regardless of its capitalization
category) from making capital distributions to anyone or paying management fees
to any persons having control of the institution if, after such transaction, the
institution would be undercapitalized. Any undercapitalized institution must
submit an acceptable capital restoration plan to the appropriate agency within
45 days of becoming undercapitalized.
A capital restoration plan will be acceptable only if each company having
control over an undercapitalized institution guarantees that the institution
will comply with the capital restoration plan until the institution has been
adequately capitalized on an average during each of four consecutive calendar
quarters and provides adequate assurances of performance. The aggregate
liability of such guarantee is limited to the lesser of (i) an amount equal to
5% of the institution's total assets at the time the institution became
undercapitalized or (ii) the amount which is necessary to bring the institution
into compliance with all capital standards applicable with respect to such
institution as of the time the institution fails to comply with its capital
restoration plan.
The OTS, in conjunction with the other federal financial institution
regulatory agencies, adopted regulations defining the five categories of
capitalization and implementing a framework of supervisory actions, including
those described above, applicable to savings institutions in each category. The
regulations provide that a savings association will be deemed to be (i) "well
capitalized" if it has a total risk-based capital ratio of 10% or greater, a
Tier 1 (i.e., core) risk-based capital ratio of 6% or greater, a leverage ratio
of 5% or greater and is not subject to any OTS order or directive to meet and
maintain a specific capital level for any capital measure; (ii) "adequately
capitalized" if it has a total risk-based capital ratio of 8% or greater; has a
Tier 1 risk-based capital ratio of 4% or greater and has either (a) a leverage
ratio of 4% or greater or (b) a leverage ratio of 3% or greater and is rated
composite 1 under the CAMELS rating system in the most recent examination of the
institution; (iii) "undercapitalized" if it has a total risk-based capital ratio
that is less than 8%, has a Tier 1 risk-based capital ratio that is less than
4%, has a leverage ratio that is less than 4% or, if rated composite 1 under the
CAMELS rating system in the most recent examination of the institution, has a
leverage ratio that is less than 3%; (iv) "significantly undercapitalized" if it
has a total risk-based capital ratio that is less than 6%, a Tier 1 risk-based
capital ratio that is less than 3% or a leverage ratio that is less than 3%; and
(v) "critically undercapitalized" if it has a ratio of tangible equity to total
assets that is equal to or less than 2%. At December 31, 1997, the Bank met the
capital requirements of a "well capitalized" institution, as its total
risk-based capital ratio was 12.24%, its Tier 1 risk-based capital ratio was
6.74% and its leverage ratio was 9.43%.
Loans to One Borrower
Under the HOLA as amended by FIRREA, the loans to one borrower limitations
for national banks apply to all savings associations in the same manner and to
the same extent as they do to national banks. Thus, savings associations
generally are not permitted to make loans to a single borrower in excess of 15%
to 25% of the savings associations' unimpaired capital and unimpaired surplus
(depending upon the type of loan and the collateral provided therefore), except
that a savings association may make loans to one borrower in excess of such
limits under one of the following circumstances: (i) for any purpose, in any
amount not to exceed $500,000; (ii) to develop domestic residential housing
units, in an amount not to exceed the lesser of $30.0 million or 30% of the
savings association's unimpaired capital and unimpaired surplus, provided that
the association receives the written approval of the OTS to do so (which
approval the Bank has not sought) and certain other conditions are satisfied; or
(iii) to finance the sale of real property which it owns as a result of
foreclosure, providing that no new funds are advanced. In addition, further
restrictions on a savings association's loans to one borrower authority may be
imposed by the OTS if necessary to protect the safety and soundness of the
savings association. At December 31, 1997, 15% of the Bank's unimpaired capital
and unimpaired surplus for loans to one borrower purposes was $63.7 million. The
largest amount outstanding at December 31, 1997 to one borrower (and related
entities) was $11.5 million.
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Equity Risk Investment Limitations
The Bank generally is not authorized to make equity investments other than
investments in subsidiaries. A savings association may not acquire a new
subsidiary or engage in a new activity through an existing subsidiary without
giving 30 days prior notice to the OTS and the FDIC, and must conduct the
activities of the subsidiary in accordance with the regulations and orders of
the OTS. Under certain circumstances, the OTS also may order a savings
association to divest its interest in, terminate the activities of, or take
other corrective measures with respect to, an existing subsidiary.
The Bank's aggregate investment in service corporation subsidiaries was
$11.7 million and its equity investments in operating subsidiaries was $182
million as of December 31, 1997.
Qualified Thrift Lender Test
A Qualified Thrift Lender ("QTL") test was enacted as a part of FIRREA, and
was modified by FDICIA and the Economic Growth and Regulatory Paperwork
Reduction Act ("EGRPRA"). An association that fails to become or remain a QTL
must either (i) convert to a bank subject to the banking regulations or (ii) be
subject to severe restrictions, including being forbidden to invest in or
conduct any activity that is not permissible to both a savings association and a
national bank, and certain other restrictions on branching, advances from its
Federal Home Loan Bank, and dividends. For a three year period after an
association fails to meet its QTL requirements, the association is forbidden
from retaining any investment or continuing any activity not permitted for a
national bank and must repay promptly all FHLB advances. In addition, companies
that control savings associations that fail the QTL test must, within one year
of such failure, become a bank holding company subject to the Bank Holding
Company Act.
Under the existing QTL requirements, a savings association's "qualified
thrift investments" must equal not less than 65% of the association's "portfolio
assets" measured on a monthly basis, in 9 of every 12 consecutive months.
Savings associations have the option of substituting compliance with the IRC
"domestic building and loan association" ("DBLA") test for compliance with the
amended QTL requirements. Qualified thrift investments include: (i) all loans or
mortgage-backed securities held by an association which are secured or relate to
domestic residential or manufactured housing; (ii) investments in educational,
small business, credit card, and credit card account loans; and (iii) FHLB stock
and certain obligations of the FDIC and related entities. Certain other
investments are included as qualified thrift investments, but are limited to 20%
of an association's portfolio assets, including (i) 50% of residential mortgage
loans sold by an association within 90 days of their origination, (ii)
investments in subsidiaries which derive at least 80% of their revenue from
domestic residential or manufactured housing, (iii) subject to certain
limitations, 200% of investments relating to "starter homes" or housing and
community facilities in "credit-needy areas," (iv) consumer loans in the
aggregate of not more than 20% of portfolio assets, and (v) FHLMC and FNMA
stock. Portfolio assets are total assets less goodwill and other intangible
assets, the value of the association's facilities and the association's liquid
assets maintained to meet its liquidity requirements (but not over 20% of its
total assets).
At December 31, 1997 the Bank's percentage of qualified thrift investments
to portfolio assets was 81%. The Company anticipates that the Bank will continue
to remain a QTL.
Dividend Regulations
The OTS has adopted regulations limiting the amount of capital
distributions a savings association may make. The regulation divides savings
associations into three tiers; those which meet all of the fully phased-in
capital requirements of the OTS both before and after the proposed distribution
(Tier 1 Associations), those which meet all of the current capital requirements
both before and after the proposed distribution (Tier 2 Associations), and those
which fail to meet one or more of the current capital requirements (Tier 3
Associations). A Tier 1 Association may make capital distributions in an amount
equal to the greater of (i) 100% of its net income for the current calendar year
to the date of capital distribution, plus the amount that would reduce by
one-half its "surplus capital ratio" (the amount by which the association's
total capital-to-risk-weighted assets ratio exceeds its fully phased-in
requirement of 8%) at the beginning of the current calendar year (i.e., at the
end of the preceding calendar year), or (ii) 75% of its net income over the most
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recent four-quarter period preceding the quarter in which the capital
distribution is to be made. A Tier 2 Association may make capital distributions
of up to 75% of its net income over the past four-quarter period. A Tier 3
Association may not make any capital distribution without the prior
authorization of the OTS. Although Tier 1 and Tier 2 Associations do not need to
obtain prior approval to make a capital distribution which complies with the
requirements of the OTS regulation, the savings association must file a notice
with the OTS at least 30 days in advance of the date on which the distribution
is to be made. The OTS has proposed that savings associations which are not
subsidiaries of holding companies may make distributions without advance notice
to the OTS. The OTS has the authority, under the regulation, to preclude a
savings association from making capital distributions, notwithstanding its
qualification to do so on the above tests, if the OTS determines that the
savings association is in need of more than normal supervision, or if the
proposed distribution will constitute an unsafe or unsound practice given the
condition of the savings association. In addition, a Tier 1 Association deemed
to be in need of more than normal supervision by the OTS may be downgraded to a
Tier 2 or Tier 3 Association as a result of such determination. A savings
association may also apply to the OTS for approval to make a capital
distribution even though it does not meet the above tests, or for an amount
which exceeds the amount permitted by the express terms of the regulation.
In addition, another OTS regulation pertaining to holding companies
requires that the OTS be given a 30 day advance notice before a savings
association subsidiary pays a dividend to its holding company. The notice
described above can also constitute the notice for this purpose, if so
designated.
The Bank is a Tier 1 Association. As of the date hereof, under the
limitations of the OTS capital distributions regulation, the Bank may pay
dividends up to the greater of 100% of its net income since January 1, 1997 plus
50% of its surplus capital or 75% of its net income over the four-quarter period
ending December 31, 1997. However, the Bank is also subject to certain
limitations on the payment of dividends by the terms of the indenture for its
8.5% and 8.875% Debentures, which limitations are more severe than the OTS
capital distribution regulations. Under the most restrictive of those
limitations, the greatest capital distribution which the Bank could currently
make is $85.6 million for the fourth quarter of 1997. During 1997, the Company
made an additional investment in the Bank of $15.0 million which increased the
availability of a capital distribution. In 1996, the available capital
distribution was $51.0 million. The Company received dividends from the Bank
during 1997 in the aggregate amount of $46.4 million.
Community Reinvestment Act
CRA was passed by Congress in 1977 as a means to encourage each financial
institution to help meet the credit needs of the communities it served,
including low- to moderate-income neighborhoods. Depository institutions were
required to:
- Delineate their community by describing their primary lending area;
- List the types of credit available;
- Maintain a CRA statement and lobby poster (CRA Notice); and
- Complete an annual review of the CRA statement by the Board of Directors.
In 1989, additional regulations were passed which amended or expanded the
CRA requirements improving public awareness of the activities of financial
institutions and making it possible to better quantify the performance of
individual banks. These changes included:
- The power of regulatory institutions to deny branch applications on CRA
grounds;
- Increased compliance requirements including documenting affirmative steps
to develop and maintain an effective CRA program; and
- FIRREA which required the regulators to prepare a written CRA evaluation,
which after July 1, 1990, must be made public within 30 business days
after the institution receives its final examination report, including a
public rating of the financial institution's CRA performance.
The CRA regulation was changed again effective July 1, 1995, when the
regulatory agencies consisting of the OCC, Board of Governors of the Federal
Reserve System (the "Board"), FDIC and OTS passed a joint final rule. This
amended regulation established a uniform framework and criteria by which the
agencies could assess an institution's record of helping to meet the credit
needs of its community, including low- and
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moderate-income neighborhoods, consistent with safe and sound operations, and
provided for consideration of the agencies assessment when reviewing certain
applications. Commonly referred to as the New CRA, the regulation establishes
certain performance standards under which the Company is to be examined.
Periodically, the OTS will review the Company's performance and publish a
"Community Reinvestment Act Performance Evaluation". The revised examination
procedures provide for an evaluation under the lending, investment and service
tests.
As required by the new CRA regulation, the Company has identified eleven
Primary Metropolitan Statistical Areas ("PMSA's") and Metropolitan Statistical
Areas ("MSA's") in the state of California as its assessment area(s). These
geographic markets contain the Company's retail banking offices and are
representative of where the Company accepts deposits from its customer base. The
Company has been notified that it will be audited under the new regulation in
the first half of 1998. The revised examination procedures will focus on
performance rather than process. The new system will evaluate the degree to
which the institution is providing (i) loans, (ii) branches and other services,
and (iii) investments to low and moderate income areas. Under the new
regulation, the Company could seek to be assessed on its CRA performance under a
strategic plan prepared by the association and approved by the OTS. This would
take the place of the three tests mentioned above. The new regulation also
emphasized the importance of an institution's CRA performance in the corporate
application process, and seeks to make the regulation more enforceable.
The Company has elected to be audited under the Lending Test, Investment
Test and Service Test and does not believe that its performance under the new
CRA regulation will differ materially from its performance under the previously
existing CRA regulations. Following the scheduled audit the Company will receive
an updated performance evaluation which will be made public in each branch
office.
Classification of Assets
The OTS has adopted a classification system for problem assets of insured
institutions. Problem assets are classified as "special mention," "substandard,"
"doubtful" or "loss," depending on the presence of certain characteristics. An
asset will be considered "special mention" when assets do not currently expose a
savings association to a sufficient degree of risk to warrant classification but
possess credit deficiencies or potential weaknesses deserving management's close
attention; an asset is "substandard" if it is inadequately protected by the
current capital and paying capacity of the obligor or by the collateral pledged,
if any. Assets classified as "doubtful" have all of the weaknesses inherent in
those classified "substandard," with the added characteristic that the
weaknesses make "collection or liquidation in full," on the basis of currently
existing facts, conditions and values, "highly questionable and improbable."
Assets classified as "loss" are those considered "uncollectible" and of such
little value that their continuance as assets without the establishment of a
specific loss reserve is not warranted. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Asset
Quality -- Allowance for Loan Losses."
Insured institutions are required to classify their own assets and to
establish general valuation allowances (reserves) where appropriate. Assets
classified as substandard or doubtful may be reviewed by the OTS examiner and
valuation allowances may be required to be increased subject to review by the
OTS Regional Director. For the portion of assets classified as loss, the OTS
permits 100% of the amount classified to be charged off or the establishment of
a specific valuation allowance.
The OTS has revised its asset classification scheme. The OTS removed the
specific description of assets classified as "substandard," "doubtful" and
"loss" from the regulatory text, and is now providing such descriptions in
guidance, as is the practice of the federal banking regulatory agencies. As of
December 31, 1997 the Bank had established allowances for loan and real estate
losses of $34.6 million.
Insurance Operations
The insurance subsidiaries of the Bank are subject to regulation and
supervision in the jurisdictions in which they do business. The method and
extent of such regulation varies, but the insurance laws of most states
establish agencies with broad regulatory and supervisory powers. These powers
relate primarily to the establishment of solvency standards which must be met
and maintained, the licensing of insurers and their
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agents, the nature and amount of investments, approval of policy forms and
rates, and the form and content of required financial statements. The Bank,
through its insurance subsidiaries, is also subject to various state laws and
regulations covering extraordinary dividends, transactions with insurance
subsidiaries and other matters. The Bank is in compliance with these state laws
and regulations.
Investment Powers
Pursuant to the Interagency Guidelines for Real Estate Lending Policies,
the Bank is required to have lending policies consistent with the guidelines,
including as to loan portfolio management considerations, underwriting standards
and loan administration. In particular, the regulation establishes supervisory
LTV limits for real property secured loans. Each insured institution is to set
its own policy with respect to LTV, but those LTV limits are not to exceed the
LTV limits of the guidelines, except as specifically permitted by the
guidelines. Generally, the LTV limits are as follows: for raw land, 65%; for
land development, 75%; for construction of 1 to 4 family residential housing,
85%, and 80% for other construction loans; and for improved property, 85%. Loans
secured by owner occupied 1 to 4 family residences are not subject to a
supervisory LTV limit, except that any such loan with a LTV ratio of greater
than 90% at origination requires either private mortgage insurance or other
readily marketable collateral. The Bank's LTV standards are consistent with
these supervisory limitations. In addition, the OTS and the other federal
banking agencies have adopted uniform real estate appraisal guidelines which
require the board of directors of financial institutions to adopt appraisal and
evaluation programs which will cover the selection of appraisers, monitoring
their activities, require needed independence from the real estate transaction
at issue, establish criteria for reports, formats and the use thereof.
The EGRPRA expanded the small business and agricultural lending authority
of federal associations. Federal associations can make total loans secured by
business or agricultural real estate in amounts up to 400% of capital, and can
make additional secured and unsecured loans to businesses and farms in total
amounts up to 20% of total assets, provided that amounts in excess of 10% of
assets may only be used for "small business loans." The OTS also no longer
aggregates commercial loans made by a savings association's service corporation
with commercial loans made by the savings association itself for purposes of the
statutory 10% of assets limitation.
In addition, the EGRPRA amended section 5 of the HOLA to conform and
clarify that federal savings associations may engage in credit card lending
without a percentage of assets investment limitation, as OTS has maintained. The
EGRPRA also amended HOLA section 5 to permit federal associations to make
education loans without investment restriction, as opposed to the previous limit
of 5% of total assets.
Pass-Through Investments
A federal savings association may invest in entities, such as limited
partnerships and mutual funds, that hold only assets, and engage only in
activities, permissible for federal savings associations. A savings association
does not have to give advance notice to the OTS if the pass-through investment
satisfies the following: (1) the savings association does not invest more than
15% of its total capital in one company; (2) the book value of the association's
aggregate pass-through investment does not exceed 50% of its total capital after
making the investment; (3) its investment would not give it direct or indirect
control of the company; (4) its liability is limited to the amount of its
investment; and (5) the company falls into one of the following categories: (i)
a limited partnership; (ii) an open-end mutual fund; (iii) a closed-end
investment trust; (iv) a limited liability company; or (v) an entity which is
invested in primarily to use the company's services (e.g. data processing). A
savings association must provide 30 day's advance written notice to OTS before
making any pass-through investment that does not meet these standards. Loans
that a savings association makes to an entity in which it has made a
pass-through equity investment will be subject to the loans to one borrower rule
in the same manner as loans by a savings association to any third party. A
thrift's investment in its operating subsidiaries is not subject to these
restrictions. The Bank does not currently have any pass-through investments.
40
<PAGE> 43
Accounting Requirements
The OTS has a statement of policy which provides guidance regarding the
proper classification of, and accounting for, securities held for investment,
sale and trading. Securities held for investment, sale or trading may be
differentiated based upon an institution's desire to earn an interest yield
(held for investment), to realize a holding gain from assets held for indefinite
periods of time (held for sale), or to earn a dealer's spread between the bid
and asked prices (held for trading). Critical to the proper classification of
accounting for securities as investments is the intent and ability of an
institution to hold the securities until maturity. A positive intent to hold to
maturity, not just a current lack of intent to dispose, is necessary for
securities acquired to be considered to be held for investment purposes.
Securities held for investment purposes may be accounted for at amortized cost
while securities held for sale are to be accounted for at the lower of cost or
market and securities held for trading are to be accounted for at market. The
Bank believes that its investment activities have been and will continue to be
conducted in accordance with the requirements of OTS policies and generally
accepted accounting principles.
The Federal Financial Institutions Examination Council determined in August
of 1993 that all federal financial institution regulatory agencies must adopt
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," for fiscal years commencing
on or after January 1, 1994. Under SFAS No. 115, savings associations will be
required to recognize unrealized gains and losses on "available for sale"
securities when measuring shareholders' equity. The OTS has determined that SFAS
No. 115 will not be used as a component in core capital or as a part of
supplementary capital. The Company recognized an increase in shareholders'
equity of approximately $186 thousand at December 31, 1995 as a result of SFAS
No. 115. For additional information see the Consolidated Financial Statements.
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" was issued by the Financial Accounting
Standards Board in June 1996. SFAS No. 125 established standards for the
recognition and measurement of transactions involving transfers of financial
assets. SFAS No. 125 adopts a financial components approach which, after a
transfer of financial assets, requires recognition of assets which continue to
be controlled by the transferor and derecognition of assets for which control
has been surrendered. SFAS No. 125 is to be applied prospectively to
transactions occurring after January 1, 1997. Transactions prior to adoption are
not affected. The adoption of SFAS No. 125 is not expected to have a material
impact on the financial condition or results of operations of the Company
arising from the securitization activities of WFS.
Annual Examinations
FDICIA significantly reduces regulatory discretion by mandating the
appropriate federal financial institution regulatory agency to conduct a full
scope, on-site examination of each insured depository institution every twelve
months. The Bank's last annual examination ended on July 16, 1997.
FDIC Back-Up Enforcement Authority
The FDIC has the statutory authority under FDICIA to direct an insured
institution's principal regulator to take enforcement action, and to take that
action itself if the principal regulator fails to act timely, or in an emergency
situation.
Financial Reporting
FDICIA requires insured institutions to submit independently audited annual
reports to the FDIC and the other appropriate regulated agencies. These publicly
available reports must include: (i) annual financial statements prepared in
accordance with generally accepted accounting principles and such other
disclosure requirements as required by the FDIC or the appropriate agencies;
(ii) a report, signed by the chief executive officer and the chief financial
officer or chief accounting officer of the institution which contains
statements, attested to by independent auditors, about the adequacy of internal
controls and procedures for financial
41
<PAGE> 44
reporting . Insured institutions such as the Bank are required to monitor these
activities through an independent audit committee.
FDICIA also directs the FDIC to develop with other appropriate agencies a
method for insured depository institutions to provide supplemental disclosure of
the estimated fair market value of assets and liabilities, to the extent
feasible and practicable, in any balance sheet, financial statement, report of
condition or any other report of any insured depository institution.
Standards for Safety and Soundness
FDICIA, as amended by the RCDA, requires the federal banking regulatory
agencies to prescribe, by regulation or guidelines, standards for all insured
depository institutions and depository institution holding companies relating
to: (i) internal controls, information systems and audit systems; (ii) loan
documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v)
asset growth; and (vi) compensation, fees and benefits. In addition, the federal
banking regulatory agencies are required to prescribe standards relating to
asset quality, earnings and stock valuation as they determine to be appropriate.
The OTS, in conjunction with the federal banking regulatory agencies, has
adopted a final regulation and Interagency Guidelines Prescribing Standards for
Safety and Soundness to meet the amended FDICIA requirements. In general, the
guidelines are designed to identify emerging safety and soundness problems and
ensure that such action is taken to address those concerns before they pose a
risk to the deposit insurance fund. The guidelines call for each insured
institution to have policies, procedures and systems appropriate to its size and
the nature of its assets and liabilities which address the specific criteria
identified in the guidelines for each of the six items identified above. The
guidelines do not set any specific numerical targets or minimum requirements.
In the event the OTS determines that a savings association has failed to
satisfy the safety and soundness standards called for by the guidelines, the OTS
may, upon requisite notice, require such association to submit a compliance plan
that sets forth the steps it will take and the time frame required to correct
the deficiency. If the association fails to comply with the OTS request, the OTS
may then issue a notice of intent to issue an order (or in an appropriate case
an immediate order, subject to appeal by the association) requiring that
association to correct a safety and soundness deficiency or to take or refrain
from other actions.
OTS Prohibitions
The OTS prohibits directors, officers, and natural persons having the power
to control the management or policies of savings associations from receiving,
directly, or indirectly, any commission, fee or other compensation in connection
with the procurement of any loan by the savings association or a subsidiary of
the savings association. This regulation does not apply to holding companies and
holding company affiliates of savings associations. Therefore, this regulation
does not apply to the Company, but does apply to the Bank.
Furthermore, the OTS prohibits directors, officers, employees, persons
having the power to control management or policies of savings associations, and
other persons who perform fiduciary duties for savings associations, from
advancing their own personal or business interests, or those of others with whom
they have a personal business relationship, at the expense of the institutions
they serve. Generally, a person will not be deemed to be advancing his, her or
its interests at the expense of the institution if the transaction complies with
sections 23A and 23B of the FRA, Regulation O, or the OTS' safe harbor
provision. Likewise, the rule does not prohibit an executive officer, director
or principal shareholder from receiving a loan from the association which they
serve under certain circumstances.
The OTS also prohibits directors or officers of savings associations,
persons having the power to control the management or policies of savings
associations and other persons who owe a fiduciary duty to savings associations
from taking advantage of corporate opportunities belonging to their savings
association or its subsidiaries. A corporate opportunity will be deemed to
belong to the savings association if: (i) it is within the corporate powers of
the savings association or its subsidiary; and (ii) the opportunity is of
present or potential practical advantage to the savings association, directly or
through its subsidiary. The OTS will deem a person
42
<PAGE> 45
not to have taken advantage of a corporate opportunity belonging to the savings
association if a disinterested and independent majority of the savings
association's board of directors, after receiving a full and fair presentation
of the matter, rejected the opportunity as a matter of sound business judgement.
WFS
WFS is an operating subsidiary of the Bank. WFS purchases automobile loans
from new and used car dealers and makes installment loans to individual
consumers, secured, in both instances, by automobiles and light duty trucks. WFS
purchased automobile loans in 40 states at February 28, 1998. WFS is licensed in
each state in which it operates as a consumer finance lender by a state
licensing agency in each such state. As such, it is subject to audit and
examination by the applicable state agencies for these states, as well as being
subject to examination and supervision by the OTS and the FDIC. WFS engages
local counsel familiar with the applicable consumer finance and auto finance,
licensing and titling laws and regulations of each of the states in which it has
offices and from which it purchases automobile loans to the extent it purchases
automobile loans from states in which it has no office. WFS will continue to do
so as to each of the states in which WFS intends to purchase automobile loans.
At December 31, 1997, and as of the date hereof, WFS is in compliance with the
licensing and operating laws and regulations applicable to each of its offices
in these states.
Numerous federal and state consumer protection laws and regulations impose
requirements applicable to the automobile loans purchased and serviced by WFS.
Among these enactment's are the federal Truth-in-Lending Act, the Federal Trade
Commission Act, the Fair Credit Billing Act, the Fair Credit Reporting Act, the
Equal Credit Opportunity Act, the Fair Debt Collection Practices Act and the
California Rees-Levering Act and similar retail installment sales laws and
similar laws of other states in which WFS originates automobile loans. Most of
the states in which WFS is originating automobile loans have statutes or
regulations pertaining to the repossession and sale process WFS must follow when
seeking to recover on a defaulted automobile loan. Generally, WFS must follow
those requirements with precision to ensure its ability to maximize its recovery
on a defaulted automobile loan. In addition, some states, such as Texas, have
consumer protection laws which limit the assets WFS may reach in order to
recover on any deficiency following repossession and sale of the vehicle which
secures a defaulted automobile loans.
As an operating subsidiary of the Bank, WFS is precluded by regulations of
the OTS from engaging in any business activity which the Bank could not itself
undertake. All of its current business activities are permitted activities for
the Bank. Also, as an operating subsidiary of the Bank, the Bank is required to
retain ownership of at least a majority of the voting stock of WFS. WFS may not
engage in any new business activity nor may it acquire a business from a third
party, even if such business activities are permitted to the Bank and thereby to
WFS, until the Bank has first given notice thereof to the FDIC and to the OTS.
EMPLOYEES
At December 31, 1997, the Company had 2,549 full-time and 76 part-time
employees. None of these employees is represented by a collective bargaining
unit or union and the Company and its subsidiaries believe they have good
relations with their respective personnel.
FORWARD-LOOKING STATEMENTS
The preceding Business section contains certain "forward-looking"
statements within the meaning of the Private Securities Litigation Reform Act of
1995 which provides a new "safe harbor" for certain forward-looking statements.
This Annual Report on Form 10-K contains forward-looking statements which
reflect the Company's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties, including those identified below, which could cause actual
results to differ materially from historical results or those anticipated. The
forward-looking terminology such as "believe", "expect", "design", "anticipate",
"intend", "may", "will", "should", "estimate", "continue", and/or the negative
thereof or other comparable expressions which indicate future events and trends
identify forward-looking statements. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of their
dates. The Company undertakes no obligation to publicly
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<PAGE> 46
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise. The following factors could cause
actual results to differ materially from historical results or those
anticipated: (1) the level of demand for consumer, mortgage and commercial
loans, which is affected by such external factors as the level of interest
rates, the strength of the various segments of the economy, debt burden held by
the consumer and demographics of the Company's lending markets; (2) the
direction of interest rates; (3) fluctuations between interest rates and the
cost of funds; (4) federal and state regulation of the Company's operations; (5)
competition within the financial services industry; (6) the availability and
cost of securitization transactions; (7) continued dealer and broker
relationships and (8) the impact of the automobile lending operations
restructure.
ITEM 2. PROPERTIES
At December 31, 1997, the Company owned 23 properties in California and one
property in Texas and leases additional properties at various locations in other
states.
The executive offices are located at 23 Pasteur Road, Irvine, California.
The remaining owned and leased properties are used as branch offices, finance
company offices, dealer centers, and mortgage banking offices. At December 31,
1997, the net book value of property and leasehold improvements was
approximately $65.4 million. The Company leases space at seven locations from
companies controlled by a major shareholder. For further information see "Item
13 -- Certain Relationships and Related Transactions".
ITEM 3. LEGAL PROCEEDINGS
The Company is involved as a party to certain legal proceedings incidental
to its business. Management believes that the outcome of such proceedings will
not have a material effect upon the Company's financial condition, results of
operations and cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE BY QUARTER
The common stock of the Company has been publicly traded since 1986 and is
currently traded on the New York Stock Exchange ("NYSE"), identified by the
symbol, WES. The following table illustrates the high and low prices by quarter
in 1997 and 1996, as reported by NYSE, which prices are believed to represent
actual transactions:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
HIGH LOW HIGH LOW
---- --- ---- ---
<S> <C> <C> <C> <C>
First Quarter............................................... $22 7/8 $14 1/2 $18 11/16 $16 3/16
Second Quarter.............................................. 19 13 1/4 19 17/32 17 5/8
Third Quarter............................................... 22 7/8 17 15/16 21 7/8 17
Fourth Quarter.............................................. 23 1/2 15 5/8 23 7/8 20 1/4
</TABLE>
There were approximately 1,800 shareholders of Westcorp common stock at
December 31, 1997. The number of shareholders was determined by the number of
record holders, including the number of individual participants, in security
position listings.
DIVIDENDS
The Company paid cash dividends of $0.40, $0.39 and $0.34 per share for the
years ended December 31, 1997, 1996 and 1995, respectively. The Company declared
a stock dividend of 5% in 1996 and 1995. The 1996
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<PAGE> 47
and 1995 dividends and earning per share and share amounts have been
retroactively adjusted to give effect of the 1996 and 1995 5% stock dividends.
On January 29, 1998, the Company declared a quarterly cash dividend of $0.10 per
share for shareholders of record as of February 10, 1998 and paid on February
23, 1998.
The Company is not restricted by regulation or agreement in its ability to
pay dividends.
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED SUMMARY OF INCOME
Interest income................. $ 270,532 $ 242,388 $ 222,093 $ 143,639 $ 157,946
Interest expense................ 161,070 139,194 139,279 88,766 101,203
----------- ----------- ----------- ----------- -----------
Net interest income........... 109,462 103,194 82,814 54,873 56,743
Provision for loan losses....... 12,851 13,571 11,470 13,033 22,584
----------- ----------- ----------- ----------- -----------
Net interest income after
provision for loan
losses..................... 96,611 89,623 71,344 41,840 34,159
Noninterest income.............. 218,038 181,264 105,660 85,932 73,839
Noninterest expense............. 241,454 203,646 115,433 95,133 83,625
----------- ----------- ----------- ----------- -----------
Income before income taxes and
extraordinary loss............ 73,195 67,241 61,571 32,639 24,373
Income taxes.................... 31,287 28,095 25,235 13,819 10,386
----------- ----------- ----------- ----------- -----------
Income before minority
interest...................... 41,908 39,146 36,336 18,820 13,987
Minority interest in earnings of
subsidiaries.................. 5,120 7,349 2,908
----------- ----------- ----------- ----------- -----------
Income before extraordinary
loss.......................... 36,788 31,797 33,428 18,820 13,987
Extraordinary loss, net of
applicable income tax benefit
of $811(1).................... (1,113)
----------- ----------- ----------- ----------- -----------
Net income...................... $ 36,788 $ 31,797 $ 33,428 $ 18,820 $ 12,874
=========== =========== =========== =========== ===========
OTHER SELECTED FINANCIAL DATA
Book value per share(2)......... $ 13.27 $ 12.23 $ 11.54 $ 8.32 $ 8.09
Weighted average number of
shares and common share
equivalents -- diluted........ 26,351,144 26,199,537 25,917,018 25,531,182 22,966,693
Income before extraordinary
item.......................... $ 1.40 $ 1.21 $ 1.29 $ 0.74 $ 0.61
Extraordinary loss due to
redemption of subordinated
debentures.................... (0.05)
----------- ----------- ----------- ----------- -----------
Net income per
share -- diluted(2)........... $ 1.40 $ 1.21 $ 1.29 $ 0.74 $ 0.56
=========== =========== =========== =========== ===========
Dividends per share(2).......... $ 0.40 $ 0.39 $ 0.34 $ 0.27 $ 0.17
Dividend payout ratio........... 28.6% 32.2% 26.4% 36.5% 30.4%
</TABLE>
- ---------------
(1) During the third quarter of 1993, the Bank redeemed its 11% Subordinated
Capital Debentures due 1999 at a loss.
(2) Gives effect to the issuance of 4.3 million shares of common stock in 1993
and a 5% stock dividends in 1994, 1995 and 1996.
45
<PAGE> 48
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED SUMMARY FINANCIAL
CONDITION
Assets:
Cash and other assets.............. $ 794,464 $ 514,756 $ 333,232 $ 234,936 $ 247,018
Loans:
Consumer(1)..................... 288,988 301,431 347,809 441,256 230,351
Mortgage(2)..................... 1,538,888 1,422,319 1,397,780 1,310,236 1,326,797
Commercial(2)................... 41,668 7,867
Mortgage-backed securities......... 941,448 849,548 852,552 470,669 94,567
Investments and time deposits...... 123,409 239,124 291,564 285,192 273,526
---------- ---------- ---------- ---------- ----------
Total assets............... $3,728,865 $3,335,045 $3,222,937 $2,742,289 $2,172,259
========== ========== ========== ========== ==========
Liabilities:
Deposits........................... $2,000,896 $1,873,942 $1,753,475 $1,632,782 $1,357,058
FHLB advances and other
borrowings...................... 563,922 569,357 655,100 545,652 276,896
Amounts held on behalf of
trustee......................... 488,653 393,449 341,693 216,204 182,905
Other liabilities.................. 57,910 47,058 48,605 31,488 29,863
---------- ---------- ---------- ---------- ----------
Total liabilities.......... 3,111,381 2,883,806 2,798,873 2,426,126 1,846,722
Subordinated debt.................. 239,195 104,917 104,360 103,851 120,422
Minority interest in equity of
subsidiaries.................... 29,538 28,392 21,965
Shareholders' equity............... 348,751 317,930 297,739 212,312 205,115
---------- ---------- ---------- ---------- ----------
Total liabilities and
shareholders' equity..... $3,728,865 $3,335,045 $3,222,937 $2,742,289 $2,172,259
========== ========== ========== ========== ==========
OTHER SELECTED FINANCIAL
DATA
Average assets....................... $3,787,480 $3,233,713 $2,837,292 $2,162,141 $2,279,393
Return on average assets............. 1.01% 0.98% 1.18% 0.87% 0.56%
Average shareholders' equity......... $ 329,250 $ 308,305 $ 213,311 $ 208,178 $ 182,999
Return on average shareholders'
equity............................. 11.17% 10.31% 13.51% 9.04% 7.04%
Equity-to-assets ratio............... 9.35% 9.53% 9.24% 7.74% 9.44%
Originations:
Consumer loans..................... $2,337,353 $2,157,556 $1,556,296 $1,191,560 $ 836,756
Mortgage loans..................... 2,328,586 1,259,716 491,274 675,961 905,528
Commercial loans................... 74,325 8,632
---------- ---------- ---------- ---------- ----------
Total originations......... $4,740,264 $3,425,904 $2,047,570 $1,867,521 $1,742,284
========== ========== ========== ========== ==========
Interest rate spread................. 2.65% 2.86% 2.44% 2.18% 2.48%
</TABLE>
- ---------------
(1) Net of unearned discount.
(2) Net of undisbursed loan proceeds.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSES OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Consolidated Financial Statements and notes thereto and other information
included or incorporated by reference herein.
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<PAGE> 49
OVERVIEW
During 1997, the Company focused on automobile and mortgage lending and
retail and commercial banking. The Company originated automobile loans totalling
$2.3 billion in 1997 compared to $2.1 billion in 1996. The 7.7% increase was due
to increased production in newer office locations and greater market penetration
in existing office locations. At February 28, 1998, the Company operated its
automobile lending operations in 40 states.
Mortgage loan production during 1997 increased to $2.3 billion compared to
$1.3 billion during 1996. The 77% increase in real estate loan originations was
the result of a strong refinancing environment resulting from lower interest
rates and the Company's success in expanding its wholesale mortgage markets.
During 1997, sales and securitizations of loans in the secondary market
totalled $4.2 billion compared to $3.1 billion in 1996. This included sales or
securitizations of $2.2 billion of consumer loans compared to $2.1 billion in
1996 and sales of $2.0 billion of mortgage loans compared to $993 million in
1996. Secondary market activity is primarily a function of origination levels
and market conditions. Loans serviced for the benefit of others increased 16% to
$8.4 billion at December 31, 1997 compared to $7.2 billion at December 31, 1996
and consisted of $3.5 billion of consumer loans and $4.9 billion of mortgage
loans.
At December 31, 1997, nonperforming assets totalled $26.9 million, or 0.7%
of total assets, compared to $33.0 million, or 1.0% of total assets, at December
31, 1996. At December 31, 1997, loans past due 60 days or more as a percentage
of total loans in the Company's consumer and real estate loan portfolios were
1.1% and 0.9%, respectively, compared to 0.9% and 1.2% at December 31, 1996.
The Company currently exceeds all regulatory capital requirements. At
December 31, 1997, the Bank's FDICIA regulatory capital ratios for Tier 1 and
risk-based capital were 6.74% and 12.24% respectively. The Bank's FIRREA
regulatory capital ratios for tangible, core and risk-based capital were 9.48%,
9.48% and 12.24%, respectively.
RESULTS OF OPERATIONS
GENERAL
The Company's primary sources of revenue are net interest income and
noninterest income. Net interest income is the difference between the income
earned on interest earning assets and the interest paid on interest bearing
liabilities. Noninterest income includes, among other things, contractual
servicing fees earned by servicing loans for the benefit of others, retained
interests on sold loans and additional fees related to servicing, such as late
charges and prepayment fees, fees related to the sales of investment products
such as mutual funds and annuities, gains on loans sold, insurance commission
income and other fee income for deposits and various other products. Other
significant factors that affect the Company's income are asset quality,
origination levels of real estate, commercial and automobile loans, other
miscellaneous income, noninterest expenses and income taxes.
The Company's net income was $36.8 million for the year ended December 31,
1997, compared to $31.8 million for the year ended December 31, 1996 and $33.4
million for the year ended December 31, 1995. The increases in net income for
the years ended December 31, 1997 and 1996 compared to 1995 are attributable to
continued sales and securitizations in the secondary market, expanded real
estate lending operations and an improving real estate market. These activities
have resulted in increased net interest income, noninterest income, and lower
provisions for loan losses.
Net income was primarily affected by the following factors:
- Net interest income increased resulting from an increase in
mortgage-backed securities and real estate loans.
- Automobile lending income increased primarily due to an increase in the
overall servicing portfolio.
- Mortgage banking income increased as a result of increased loan
origination and an increase in the real estate loan servicing portfolio.
47
<PAGE> 50
- Investment and mortgage-backed securities gains increased due to the sale
of $283 million of mortgage backed securities available for sale.
- Several noninterest expense categories increased primarily as a result of
expansion of operations in the automobile lending, mortgage banking and
commercial banking businesses.
ASSET/LIABILITY MANAGEMENT
Asset/liability management is the process of measuring and controlling
interest rate risk through matching the maturity and repricing characteristics
of interest earning assets with those of interest bearing liabilities. The
Company's approach to asset/liability management includes originating adjustable
rate loans, securitizing loans with liabilities that have similar repricing and
maturity characteristics, matching fixed rate loans held in the portfolio with
advances from the FHLB, selling fixed rate loans and using other financial
instrument agreements.
Average interest rates on the Company's interest earning assets,
particularly its consumer and mortgage loan portfolios, have decreased compared
to 1996. The December 31, 1997 yield on interest earning assets of 8.5% remained
relatively constant compared to 8.6% and 8.5% for the years ended 1996 and 1995.
Mortgage loans were comprised of fixed-rate loans (which are generally sold
to investors) and adjustable rate products. The yields on the adjustable rate
loans are primarily indexed to COFI. COFI was 5.0% in December 1997, compared to
4.8% in December 1996 and 5.1% in December 1995. The yield on the Company's real
estate loan portfolio, which represents the majority of the Company's interest
earning assets, remained fairly constant for the year ended December 31, 1997 at
7.7%, compared with 7.7% and 7.6% for the years ended December 31, 1996 and
1995, respectively. Consumer loan rates were 15.9% for the year ended December
31, 1997 compared to 16.0% and 14.6% for the years ended December 31, 1996 and
1995, respectively.
Average interest costs on the Company's interest bearing liabilities
remained constant at 5.8% for the year ended December 31, 1997 and the
comparable period of 1996.
The overall interest rate spread for the Company was 2.7% during 1997
compared to 2.9% and 2.4% during 1996 and 1995, respectively. The net yield on
average interest earning assets for the period ending December 31, 1997 was 3.4%
compared to 3.7% and 3.2% for the comparable periods of 1996 and 1995,
respectively.
During 1997, average interest earning assets were $3.2 billion compared to
$2.8 billion in 1996 and $2.6 billion in 1995. The increases were primarily
attributable to increases in the Company's mortgage-backed securities and
mortgage loan portfolios. The Company invests in mortgage-backed securities to
generate additional net interest income as well as to manage the interest rate
risk characteristics of its balance sheet. The average mortgage-backed
securities portfolio increased $149 million for 1997. The increase in mortgage
loan portfolio was attributable to increased originations of mortgage loans. The
average mortgage loan portfolio increased $186 million in 1997.
Average interest bearing liabilities totalled $2.8 billion during 1997
compared to $2.4 billion in 1996 and $2.3 billion in 1995. These increases were
due primarily to increasing the deposit base to fund the larger asset base.
Average deposits, which represent over 70% of the Company's average interest
bearing liabilities, were $1.9 billion at December 31, 1997, compared to $1.8
billion at December 31, 1996 and 1995. Average interest bearing liabilities as a
percentage of average interest earning assets totalled 86.1% at December 31,
1997, compared to 87.0% in 1996 and 89.6% in 1995. For additional information on
the Company's interest sensitive assets, see "Business -- Lending -- General".
On a limited basis, the Company also manages interest rate risk through
financial instrument agreements. The Company uses interest rate swaps, options,
caps, floors and forward agreements as part of its hedging strategy to reduce
the sensitivity of its assets to changes in interest rates. These instruments
are carried at, and included as part of, the basis of the underlying assets. The
Company's interest rate swaps consist of
48
<PAGE> 51
agreements to pay fixed-rate interest and receive floating-rate interest at
specified intervals based on an agreed notional amount, a specified index and
settlement on a net basis. The Company minimizes the effect of changes in
interest rates on loans held for sale by entering into forward agreements that
protect the hedged assets from changes in interest rates. The Company has
entered into or committed to interest rate caps and swaps as hedges against
market value changes in designated portions of its mortgage-backed securities
portfolio. At December 31, 1997, caps with notional amounts totalling $365
million and a swap of $50 million were outstanding. The cap agreements have
strike rates from 6.0% to 7.5% with expiration dates ranging from 2001 to 2004.
The swap has a pay rate of 5.9% and expires in December 2002. The Company uses
only counterparties with high credit ratings and further reduces its risk by
avoiding any significant concentration with any single counterparty. Master
netting agreements are arranged or collateral is obtained through physical
delivery of, or rights to, securities to minimize the Company's exposure to
credit losses in the event of nonperformance by counterparties to financial
instruments.
At December 31, 1997, caps with notional amounts totalling $365 million and
a swap of $50 million were outstanding. At December 31, 1996, caps with notional
amounts totalling $150 million and a swap of $50 million were outstanding.
The Company's hedging strategy for its loan production includes the use of
forward agreements. The Company enters into these agreements in numbers and
amounts which generally correspond to the principal amount of the sale and/or
securitization transactions. The market value of these forward agreements
responds inversely to the market value changes of the underlying loans. Because
of this inverse relationship, the Company can effectively lock in its gain
and/or gross interest rate spread at the time of the hedge transaction. Gains
and losses relative to these agreements are deferred and recognized in full at
the time of loan sale and/or securitization as an adjustment to the gain or loss
on the sale of loans. The Company uses only highly rated counterparties and
further reduces its risk by avoiding any material concentration with a single
counterparty. Credit exposure is limited to those agreements with a positive
fair value and only to the extent of that fair value. At December 31, 1997, the
Company held forward agreements with a notional amount outstanding of $608
million.
The impact of such caps, floors and options on net interest income was a
reduction in net interest income of $2.0 million for the year ending December
31, 1997 and $1.4 million for the year ended December 31, 1996.
ASSET QUALITY
Nonperforming assets, loan delinquency, and loan losses are considered key
measures of asset quality by the Company. Asset quality, in turn, affects the
determination of the allowance for loan losses. In addition to nonperforming
assets and loan delinquency levels, valuation allowances for estimated losses on
loans and real estate owned are also determined by taking into consideration
general economic conditions in the markets the Company serves, historical loss
experience, individual loan reviews and the level of assets relative to
reserves.
LOAN QUALITY
The Company's total NPAs decreased $6.1 million, or 18.5%, to $26.9 million
at December 31, 1997 compared to $33.0 million at December 31, 1996. At December
31, 1997, NPAs represented 0.7% of total assets compared to 1.0% at December 31,
1996. See "Business -- Asset Quality Nonperforming Assets."
NPAs consist of NPLs and REO. REO is carried at lower of cost or fair value
less estimated disposition costs. NPLs are defined as all loans on nonaccrual,
which include mortgage loans 90 days or more past due or impaired loans where
full collection of principal and interest is not reasonably assured. When a loan
is designated as nonaccrual, all previously accrued but unpaid interest is
reversed. Interest on nonperforming loans excluded from interest income was $0.8
million at December 31, 1997 compared to $1.0 million and $0.8 million at
December 31, 1996 and 1995, respectively.
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect all amounts
due according to the contractual terms of the loan agreement. The Company
measures impairment based on, among other factors, the fair value of the loan's
collateral.
49
<PAGE> 52
Changes in the fair value of loans are recorded through the allowance for loan
losses. At December 31, 1997 and December 31, 1996, impaired loans were $4.8
million and $6.9 million, respectively.
Real estate loans past due 60 days or more at December 31, 1997 totalled
$14.2 million, or 0.9% of total real estate loans compared to $17.0 million, or
1.2% at December 31, 1996. See "Business -- Asset Quality -- Real Estate Loan
Quality." Consumer loans past due 60 days or more at December 31, 1997 totalled
$3.2 million, or 1.1% of total consumer loans compared to $2.5 million, or 0.9%
of total consumer loans at December 31, 1996. See "Business -- The Business of
WFS -- Automobile Lending -- Automobile Loan Quality."
Allowance For Loan Losses
The Company's allowance for loan losses was $33.8 million at December 31,
1997 compared to $40.2 million at December 31, 1996 and $39.3 million at
December 31, 1995. The allowance for loan losses and related provisions are
determined by considering loan volumes, loan sales, prepayments, loss trends,
levels of NPLs and management's analysis of market conditions, individual loan
reviews, levels of assets to reserves and other relevant factors. The allowance
for loan losses is reduced by net chargeoffs and increased by the provision for
loan losses. For the year ended December 31, 1997, the provision for loan losses
totalled $12.9 million compared to $13.6 million and $11.5 million for the years
ended December 31, 1996 and 1995, respectively. Net chargeoffs for the years
ended December 31, 1997, 1996 and 1995 were $18.4 million, $14.1 million and
$14.4 million, respectively. See "Business -- Asset Quality -- Allowance for
Loan Losses." The Company believes that the allowance for loan losses is
currently adequate to absorb potential losses in the portfolio. While the
Company's portfolio consists primarily of single family loans, no single loan,
borrower or series of such loans comprise a significant portion of the total
portfolio. The provision and allowance for loan losses are indicative of loan
volumes, loss trends and management's analysis of market conditions.
The allowance for real estate losses remained constant at $0.8 million at
December 31, 1997 and 1996. The allowance for real estate losses is charged with
writedowns of foreclosed assets or changes in estimated fair value occurring
subsequent to foreclosure. No later than at the time of foreclosure, individual
properties are written down to estimated fair value and the allowance for loan
losses is charged. Management believes that the allowance for real estate losses
is currently adequate to absorb potential losses in the foreclosed
50
<PAGE> 53
portfolio. The following table presents summarized data relative to the
allowances for loan and real estate losses.
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1997 1996
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Total loans(1)........................................ $1,869,544 $1,731,617
Allowance for loan losses............................. 33,834 40,211
Allowance for real estate losses...................... 784 784
Loans past due 60 days or more........................ 17,312 19,546
Nonperforming loans................................... 19,785 20,939
Nonperforming assets (2).............................. 26,905 33,002
Allowance for loan losses as a percent of:
Total loans (2)..................................... 1.8% 2.3%
Loans past due 60 days or more...................... 195.4 205.7
Nonperforming loans................................. 171.0 192.0
Total allowance for loan losses and REO losses as a
percent of nonperforming assets..................... 128.7 124.2
Nonperforming loans as a percent of total loans....... 1.1 1.2
Nonperforming assets as a percent of total assets..... 0.7 1.0
</TABLE>
- ---------------
(1) Loans net of unearned discounts and undisbursed loan proceeds.
(2) Nonperforming loans and real estate owned.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is affected by the difference between yields earned by
the Company on its interest earning assets and the rates paid on its interest
bearing liabilities (interest rate spread), and the relative amounts of the
Company's interest earning assets and interest bearing liabilities. Net interest
income totalled $109 million in 1997 compared to $103 million and $82.8 million
in 1996 and 1995, respectively. The increase in net interest income for the year
ended December 31, 1997 compared to 1996 and 1995 was attributable to the
increase in mortgage-backed securities as well as the increase in loans held on
balance sheet.
As the Company sells or securitizes its on-balance sheet loans, revenue
previously recognized as net interest income will, upon sale or securitization,
be recognized as noninterest income. Noninterest income from automobile loans is
recorded as a component of automobile lending income and servicing income from
single family residential loans is recorded as a component of mortgage banking
income.
The total interest rate spread decreased 21 basis points for 1997, compared
to 1996 due to a decrease of 14 basis points in the yield on interest earning
assets while the cost of funds increased by 7 basis points.
The decrease in income on interest earning assets for 1997, compared to
1996 was affected by a 12 basis point decrease in the yield on the consumer loan
portfolio, which is due to a more favorable interest rate market and increased
competition in the non-prime market.
The increase in the cost of funds was affected by a 45 basis point increase
in securities sold under agreements to repurchase, a 17 basis point increase in
the rate paid on FHLB advances and other borrowings, and a 6 basis point
increase in the rate paid on subordinate debentures offset by a 13 basis point
decrease in the rate paid on deposits for 1997 compared to 1996.
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<PAGE> 54
NONINTEREST INCOME
Automobile Lending Income
The Company originates and sells automobile loans with servicing rights
retained in the asset-backed market. The Company purchased $2.3 billion of
automobile loans in 1997 compared to $2.1 billion in 1996. Noninterest income
from automobile lending includes gains from the sale of loans, loan servicing
income net of amortization of retained interests in securitized assets ("RISA"),
and other related income such as document fees and late charges. For the year
ended December 31, 1997, automobile lending generated income of $176 million
compared to $153 million and $91.2 million for the years ended December 31, 1996
and 1995, respectively.
Automobile lending is summarized as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
-------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Gains on sale of automobile loans........... $ 39,945 $ 42,121 $19,367
Loan servicing income....................... 100,647 79,623 50,478
Other fee income............................ 35,600 31,355 21,355
-------- -------- -------
$176,192 $153,099 $91,200
======== ======== =======
</TABLE>
Gain on sale of automobile loans fluctuates as a result of changes in the
gross interest rate spread of automobile loans securitized, the amount of dealer
participation paid, changes in credit loss assumptions and the effect of hedging
activities. The gross interest rate spread is affected by product mix, general
market conditions and overall market interest rates. The risks inherent in
interest rate fluctuations, however, are substantially reduced through hedging
activities. See "-- Asset/Liability Management."
Net loan servicing income increased to $101 million for the year ended
December 31, 1997 compared to $79.6 million and $50.5 million for 1996 and 1995,
respectively. The increases resulted from increased loans serviced by the
Company. The Company serviced automobile loans both owned and those sold and
serviced for the benefit of others, of $3.8 billion at December 31, 1997, $3.1
billion at December 31, 1996 and $2.2 billion at December 31, 1995.
Other fee income, consisting primarily of documentation fees, late charges
and deferment fees, increased to $35.6 million during 1997 compared to $31.4
million and $21.4 million in 1996 and 1995, respectively, representing increases
of 14% and 47%, respectively. These increases in other fee income are related to
the increase in the number of automobile loans purchased and serviced.
Mortgage Banking Income
The Company originates first trust deed loans secured by single family
residences primarily for sale in the secondary market. During 1997, the Company
originated $2.3 billion compared to $1.3 billion in 1996. Income from mortgage
banking includes gains on the sale of loans, loan servicing income net of
amortization of capitalized servicing, and other income which primarily consists
of late charges.
As shown in the following table, total mortgage banking income was $24.5
million, $18.0 million and $3.2 million, for the years ended December 31, 1997,
1996 and 1995, respectively.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Net gains (losses) from sale of mortgage
loans....................................... $18,945 $10,095 $(1,944)
Loan servicing income......................... 3,284 5,988 3,925
Other......................................... 2,311 1,963 1,178
------- ------- -------
$24,540 $18,046 $ 3,159
======= ======= =======
</TABLE>
52
<PAGE> 55
Gains on sales of mortgage loans for 1997 totalled $18.9 million compared
to $10.1 million and losses of $2.0 million for the years ended December 31,
1996 and 1995, respectively. The increase in gain on sale of mortgage loans is a
result of an increase in the volume of loan sales which rose to $2.0 billion for
the year ended December 31, 1997 compared to $993 million and $304 million for
the comparable periods in 1996 and 1995, respectively. The significant increase
in 1997 is largely due to the increase in origination volume which creates the
availability of loans available for sale. Mortgage loans held for sale increased
from $273 million at December 31, 1996 to $529 million at December 31, 1997.
Net loan servicing income totalled $3.3 million, $6.0 million and $3.9
million for the years ended December 31, 1997, 1996 and 1995, respectively. The
decrease in servicing income was due to increased capitalized servicing rights
amortization resulting from increased prepayment experience. At December 31,
1997, the Company serviced, including loans owned and those serviced for the
benefit of others, mortgage loans of $6.4 billion compared to $5.9 billion and
$5.1 billion at December 31, 1996 and 1995, respectively.
Other Noninterest Income
Other noninterest income consists primarily of investment and
mortgage-backed securities gains and losses, insurance income and real estate
operations. The Company had investment and mortgage-backed securities gains of
$8.0 million for the year ended December 31, 1997 compared to a loss of $1.6
million in 1996 and a gain of $1.8 million in 1995. The increase in gain in 1997
was primarily due to the sale of $283 million of MBS available for sale which
resulted in a gain of $6.3 million. The Company reclassified all of its
investment securities and MBS held to maturity to available for sale at October
1, 1997. The reclassification was due to a change in the Company's intent to
potentially realize a holding gain from assets held for an indefinite period of
time (available for sale) as opposed to holding the assets in order to earn an
interest yield (held to maturity). Insurance income, which totalled $6.5
million, $12.9 million and $8.8 million for the years ended December 31, 1997,
1996 and 1995, includes premiums and commissions earned on insurance and
insurance-related products, including credit life and collateral protection
insurance. Sales of mutual funds and annuities totalled $1.8 million in 1997 and
$1.4 million in 1996. The Company also charges fees in connection with products
and services provided by its retail banking and commercial banking operations.
Real estate operations include the costs of managing and disposing of
foreclosed real estate as well as the gains and losses realized upon
disposition. In addition, real estate operations include the gains and losses
relative to the operation of joint ventures. Total real estate operations income
for 1997 was $811 thousand compared to losses of $2.4 million and $267 thousand
for 1996 and 1995, respectively. The income generated in 1997 was primarily the
result of sales of foreclosed assets at prices in excess of their carrying
values.
NONINTEREST EXPENSES
Noninterest expenses, which consist of salaries and employee benefits,
occupancy, data processing, insurance and other miscellaneous expenses increased
to $241 million in 1997 compared to $204 million in 1996 and $115 million in
1995. Salaries and employee benefits increased primarily due to expansion of
operations in both the automobile lending (which was completed in 1997) and
mortgage and commercial banking businesses. The increase in miscellaneous
expenses was primarily attributable to an increase in the number of loans
serviced, automation and centralization programs and expansion into additional
states. In addition, insurance expense for the year ended December 31, 1996
included a pretax charge of $11.6 million related to the accrual for the
one-time assessment of Savings Association Insurance Fund recapitalization. The
ratio of noninterest expenses to average serviced assets was 2.0% in 1997
compared to 2.2% in 1996 and 1.8% in 1995.
The Company announced a restructuring plan on February 10, 1998 which
consolidated offices and reduced staff for its automobile lending subsidiary. In
the first quarter, the Company consolidated 15 prime lending dealer centers and
44 non-prime lending branch offices in the western United States into 12
regional business centers and 15 satellite offices. Each location will buy the
full spectrum of prime and non-prime credit from dealers through a single sales
and marketing approach which will provide enhanced service and is
53
<PAGE> 56
designed to increase volume. The restructuring plan will result in a one-time
pre-tax accounting charge for the first quarter ended March 31, 1998 of
approximately $9.0 million or $0.20 per diluted share. The plan, once fully
implemented, is designed to save up to $12.0 million or $0.26 per diluted share
annually in expenses.
INCOME TAXES
The Company's effective tax rate was 42.7% for the year ended December 31,
1997 compared to 41.8% and 41.0% for the years ended December 31, 1996 and 1995,
respectively.
CAPITAL RESOURCES AND LIQUIDITY
The Company and its subsidiaries have multiple sources of funds generated
through its operations. Primary sources of funds include deposits, loan
principal and interest payments received, sales of real estate loans and
automobile loans, sales of and payments on mortgage-backed securities and the
maturity or sale of investment securities. Prepayments on loans and
mortgage-backed securities and deposit inflows and outflows are affected
significantly by interest rates, real estate sales activity and general economic
conditions. See "Business -- Funding Sources."
Other sources of funds include a commercial paper facility totalling $400
million, repurchase agreements and FHLB advances. FHLB advances outstanding at
December 31, 1997 totalled $85 million. The Company's unused line of credit at
December 31, 1997 totalled $472 million. Reverse repurchase agreements
outstanding at December 31, 1997 totalled $287 million and currently represent
an inexpensive source of short-term liquidity.
The Company uses its funds to meet its business needs, which include
funding new and maturing certificates of deposit, savings, money market and
demand deposit withdrawals, repaying borrowings, funding loan and investment
commitments, meeting operating expenses and maintaining minimum regulatory
liquidity and capital levels. OTS regulations require the Company, as a savings
association, to maintain a specified level of liquid assets such as cash and
short-term U.S. government and other qualifying securities. Such liquid assets
must not be less than 4.0% for December 1997 and 5.0% for December 1996 of the
Company's average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. At December 31, 1997 and 1996, such
ratios were 9.1% and 7.4%, respectively.
During the year ended December 31, 1997, net cash used in operating
activities were $108 million compared to net cash provided by operating
activities of $28.1 million and $37.5 million for the years ended December 31,
1996 and 1995, respectively. The major component of cash flows related to
operating activities were cash inflows or outflows due to net change in loans
held for sale. There was a net outflow of $195 million for the year ended
December 31, 1997 compared to a net inflow of $122 million and a net outflow of
$46.7 million for the years ended December 31, 1996 and 1995, respectively.
Net cash used in investing activities for the year ended December 31, 1997
was $195 million compared to $129 million and $568 million for the years ended
December 31, 1996 and 1995, respectively. The major component that affected the
net cash used in investing activities was due to purchases of mortgage-backed
securities available for sale of $582 million for the year ended December 31,
1997 compared to $300 million and $398 million for the years ended December 31,
1996 and 1995, respectively. The sales of mortgage-backed securities provided
for proceeds of $394 million for the year ended December 31, 1997 compared to
$198 million and $203 million for the years ended December 31, 1996 and 1995,
respectively.
The Company's net cash provided by financing activities during the years
ended December 31, 1997, 1996 and 1995 were $338 million, $76 million and $427
million, respectively. The following financing activities provided the primary
services of cash for the Company: increase in deposits, short-term borrowings
and subordinated debentures.
The Bank is a federally chartered savings bank. As such, it is subject to
certain minimum capital requirements imposed by FIRREA and FDICIA. FDICIA
separates all financial institutions into one of five capital categories: "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," and "critically undercapitalized." In order to be considered
"well capitalized," an institution must
54
<PAGE> 57
have a total risk-based capital ratio of 10% or greater, a Tier 1 (i.e., core)
risk-based capital ratio of 6% or greater, a leverage ratio of 5% or greater and
not be subject to any OTS order. The Bank currently meets all of the
requirements of a "well capitalized' institution. Its regulatory capital
position at December 31, 1997 for this purpose, was as follows:
<TABLE>
<CAPTION>
TIER 1
TANGIBLE RISK-BASED RISK-BASED
CAPITAL CORE CAPITAL CAPITAL CAPITAL
-------- ------------ ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
DECEMBER 31, 1997
Actual Capital:
Amount...................................... $355,650 $355,650 $352,123 $639,937
Capital ratio............................... 9.48% 9.48% 6.74% 12.24%
FIRREA minimum required capital:
Amount...................................... $ 56,249 $112,498 N/A $418,115
Capital ratio............................... 1.50% 3.00% N/A 8.00%
Excess...................................... $299,401 $243,152 N/A $221,822
FDICIA well capitalized required capital:
Amount...................................... N/A $188,574 $313,587 $522,644
Capital ratio............................... N/A 5.00% 6.00% 10.00%
Excess...................................... N/A $167,076 $ 38,536 $117,293
DECEMBER 31, 1996
Actual Capital:
Amount...................................... $348,938 $348,938 $348,938 $467,563
Capital ratio............................... 10.53% 10.53% 8.14% 10.91%
FIRREA minimum required capital:
Amount...................................... $ 49,707 $ 99,414 N/A $342,915
Capital ratio............................... 1.50% 3.00% N/A 8.00%
Excess...................................... $299,231 $249,524 N/A $124,648
FDICIA well capitalized required capital:
Amount...................................... N/A $166,838 $257,187 $428,644
Capital ratio............................... N/A 5.00% 6.00% 10.00%
Excess...................................... N/A $182,100 $ 91,751 $ 38,919
</TABLE>
55
<PAGE> 58
The following table reconciles the Bank's capital in accordance with GAAP
to the Bank's tangible, core and risk-based capital as of December 31, 1997 and
1996:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Bank shareholder's equity-GAAP basis........................ $345,426 $337,958
Adjustment: Unrealized gains under SFAS 115................. (5,858) (1,083)
Less: non-permissible activities (1)...................... (10,222) (13,135)
Add: minority interest in equity of subsidiaries.......... 29,538 28,061
Less: disallowed capitalized servicing rights............. (3,234) (2,863)
-------- --------
Total tangible and core capital............................. 355,650 348,938
Adjustments for risk-based capital:
Subordinated debentures(2)................................ 256,311 106,559
General loan valuation allowance(3)....................... 31,503 36,298
Less: fully capitalized assets............................ (3,527) (24,232)
-------- --------
Risk-based capital........................................ $639,937 $467,563
======== ========
</TABLE>
- ---------------
(1) Does not include minority interest in joint venture subsidiaries.
(2) Excludes capitalized discounts and issue costs.
(3) Limited to 1.25% of risk-weighted asset.
As a member of the FHLB, the Bank is required to maintain a specified ratio
of cash, short-term United States government and other qualifying securities to
net withdrawable accounts and borrowings payable in a year or less. The required
liquidity ratio is currently 4%. The Bank has maintained liquidity in excess of
the required amount in 1997.
EFFECT OF INFLATION AND CHANGING PRICES
Unlike many industrial companies, substantially all of the assets and
liabilities of the Company are monetary in nature. As a result, interest rates
have a more significant effect on the Company's performance than the general
level of inflation. See "Management's Discussion and Analyses of Financial
Condition and Results of Operations -- Results of Operations -- Asset/Liability
Management."
YEAR 2000
Many computer systems process transactions based on two digits representing
the year of transaction (i.e., "97" for 1997), rather than the full four digits.
These computer systems may not operate properly when the last two digits become
"00", as will occur on January 1, 2000. In some cases a date after December 31,
1999 will cause a computer to stop operating, while in other cases incorrect
output may result. The problem could affect a wide variety of automated
information systems, such as mainframe applications, personal computers,
communications systems, and other information systems utilized by the Company.
The Company initiated the process of preparing its computer systems and
applications for the year 2000 in July 1997. This process involves modifying or
replacing certain hardware and software maintained by the Company as well as
communicating with external service providers to ensure that they are taking the
appropriate action to remedy their year 2000 issues. Management expects to have
substantially modified all of the systems and applications by the end of 1998
and completed testing by the third quarter of 1999 and believes its level of
preparedness is appropriate.
Based on currently available information, management does not anticipate
that the cost to address the Year 2000 issues will have a material adverse
impact on the Company's financial condition, results of operations or cash
flows.
56
<PAGE> 59
CURRENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, Reporting Comprehensive Income". This statement is effective with the
year-end 1998 financial statements; however, a total for comprehensive income is
required in the financial statements of interim periods beginning with the first
quarter of 1998. Reclassification of financial statements for earlier periods
provided for comparative purposes is required. This Statement establishes
standards for reporting and displaying comprehensive income and its components
in the financial statements. It requires that a company classify items of other
comprehensive income, as defined by accounting standards, by their nature (e.g.,
unrealized gains or losses on securities available for sale and retained
interests in securitized assets) in a financial statement with the same
prominence as other financial statements, but does not require a specific format
for that statement. The Company is in the process of determining its preferred
format. The accumulated balance of their comprehensive income is to be displayed
separately from retained earnings and additional paid-in capital in the equity
section of the Consolidated Statements of Financial Condition.
In June 1997, the FASB issued "SFAS No. 131, Disclosure about Segments of
an Enterprise and Related Information." This Statement provides guidance for the
way public enterprises report information about operating segments in annual
financial statements and requires selected information about operating segments
in annual financial statements and in interim financial reports. It also
requires certain related disclosures about products and services, geographic
areas and major customers. The segment and other information disclosures are
required for the year ended December 31, 1998. In the initial year of
application, comparative information for earlier years is to be restated.
FORWARD LOOKING STATEMENTS
The preceding Management Discussion and Analysis of Financial Condition and
Results of Operation section contains certain "forward-looking" statements
within the meaning of the Private Securities Litigation Reform Act of 1995 which
provides a new "safe harbor" for certain forward-looking statements. This Annual
Report on Form 10-K contains forward-looking statements which reflect the
Company's current views with respect to future events and financial performance.
These forward-looking statements are subject to certain risks and uncertainties,
including those identified below, which could cause actual results to differ
materially from historical results or those anticipated. The forward-looking
terminology such as "believe", "expect", "design", "anticipate", "intend",
"may", "will", "should", "estimate", "continue", and/or the negative thereof or
other comparable expressions thereof or other comparable expressions which
indicate future events and trends identify forward-looking statements. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of their dates. The Company undertakes no obligation to
publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise. The following factors could cause
actual results to differ materially from historical results or those
anticipated: (1) the level of demand for consumer, mortgage and commercial
loans, which is affected by such external factors as the level of interest
rates, the strength of the various segments of the economy, debt burden held by
the consumer and demographics of the Company's lending markets; (2) the
direction of interest rates; (3) fluctuations between interest rates and the
cost of funds; (4) federal and state regulation of the Company's operations; (5)
competition within the financial services industry; (6) the availability and
cost of securitization transactions; (7) continued dealer and broker
relationships and (8) the impact of the automobile lending operations
restructure.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Credit risk and interest rate risk are the primary risks facing the
Company. The Company relies upon loan review and an adequate loan loss reserve
in order to address credit risk (see Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Asset/Liability Management).
The Company's Asset/Liability committee is responsible for the management
of interest rate risk. This committee closely monitors interest rate risk and
recommends policy for managing this risk. The primary measurement tool for
evaluating this risk is the use of interest rate shock analysis. This analysis
simulates the
57
<PAGE> 60
effects of an instantaneous and sustained change in interest rates (in
increments of 100 basis points) on the Company's assets and liabilities and
measures the resulting increase or decrease to the net present value ("NPV") of
the Company's assets and liabilities. Another important measurement of the
Company's interest rate risk is its "GAP". GAP is defined as the difference
between the amount of interest sensitive assets that reprice versus the amount
of interest-sensitive liabilities that also reprice within a defined period of
time. For the Company, more interest rate sensitive liabilities than assets are
repricing in the shorter maturity buckets and more interest rate sensitive
assets then liabilities are repricing in the longer maturity buckets. In
general, an increase in interest rates would more adversely affect the Company's
NPV than would a decrease in interest rates improve the Company's NPV. As of
December 31, 1997, a 200 basis point increase in interest rates would decrease
the Company's NPV by 11% whereas a 200 basis point decline in interest rates
would increase NPV by 3%. It should be noted that shock analysis is objective
but not entirely realistic in that it assumes an instantaneous and isolated set
of events. The following table summarizes the maturity GAP position of the
Company at December 31, 1997.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
-----------------------------------------------------------
UP TO UP TO AFTER 5
3 MONTHS 1 YEAR 5 YEARS YEARS TOTAL
---------- --------- --------- --------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Total interest earning assets......... $1,488,661 $ 466,495 $ 686,351 $ 392,540 $3,034,047
Total interest bearing liabilities.... 1,208,547 984,247 275,424 240,885 2,709,103
---------- --------- --------- --------- ----------
Excess interest earning assets
(liabilities)....................... 280,114 (517,752) 410,927 151,655 324,944
---------- --------- --------- --------- ----------
Effect of hedging activities.......... 465,000 (315,000) (150,000)
---------- --------- --------- --------- ----------
Hedged excess......................... $ 745,114 $(517,752) $ 95,927 $ 1,655 $ 324,944
========== ========= ========= ========= ==========
Cumulative excess..................... $ 745,114 $ 227,362 $ 323,289 $ 324,944 $ 324,944
========== ========= ========= ========= ==========
Cumulative difference as a percentage
of total interest earning assets.... 24.56% 7.49% 10.66% 10.71% 10.71%
Gap ratio............................. 1.23 0.47 2.49 1.63 1.12
</TABLE>
The Company utilizes a variety of means in order to manage interest rate
risk including originating adjustable rate loans, securitizing loans with
liabilities that have similar repricing and maturity characteristics, matching
fixed rate loans held in the portfolio with FHLB advances and selling fixed rate
loans. The Company hedges its MBS portfolio with interest rate caps and swaps.
Also, as an originator of fixed rate mortgage loans, the Company enters into MBS
forward agreements in order to limit the risk of a change in interest rates
related to its pipeline of mortgage loans. Similarly, the Company utilizes
two-year Treasury securities forward agreements in order to limit interest rate
risk related to automobile loans prior to their inclusion in securitization
transactions.
The following table provides information about the Company's derivative
financial instruments and other financial instruments used that are sensitive to
changes in interest rates. For loans, securities and liabilities with
contractual maturities, the table presents principal cash flows and related
weighted average interest rates by contractual maturities as well as the
Company's historical experience of the impact of interest rate fluctuations on
the prepayment of real estate loans, automobile loans and mortgage-backed
securities. For core deposits (e.g., Passsbook, Money Market and interest
bearing-demand deposits) that have no contractual maturity, the table presents
principal cash flows and, as applicable, related weighted average interest rates
based on the Company's historical experience, management's judgment and
statistical analysis, as applicable, concerning their most likely withdrawal
behaviors.
58
<PAGE> 61
For interest rate swaps and interest rate caps, the table presents notional
amounts and, as applicable, weighted average interest rates by contractual
maturity date. Notional amounts are used to calculate the contractual payments
to be exchanged under the contracts.
<TABLE>
<CAPTION>
FAIR
VALUE
DECEMBER 31,
1998 1999 2000 2001 2002 THEREAFTER TOTAL 1997
---------- -------- -------- -------- ------- ---------- ---------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
RATE SENSITIVE ASSETS:
Fixed interest rate
loans................... $ 178,218 $123,511 $ 92,159 $ 74,214 $50,967 $159,756 $ 678,825 $ 714,750
Average interest rate... 11.67% 11.77% 11.61% 11.34% 10.26% 8.34% 10.75%
Variable interest rate
loans................... $ 223,831 $141,067 $106,259 $ 79,739 $60,064 $579,759 $1,190,719 $1,205,669
Average interest rate... 8.28% 8.42% 8.39% 8.37% 8.36% 7.72% 8.04%
Fixed interest rate
securities.............. $ 309,255 $ 97,502 $ 92,716 $ 89,282 $65,716 $230,785 $ 885,256 $ 899,160
Average interest rate... 6.60% 7.85% 7.62% 7.31% 7.62% 7.79% 7.30%
Variable interest rate
securities.............. $ 37,085 $ 33,016 $ 30,109 $ 26,762 $22,738 $129,537 $ 279,247 $ 280,940
Average interest rate... 6.07% 6.04% 6.08% 6.11% 6.10% 6.06% 6.07%
RATE SENSITIVE
LIABILITIES:
Passbook deposits......... $ 13,130 $ 5,252 $ 3,501 $ 21,883 $ 21,475
Average interest rate... 2.45% 2.45% 2.45% 2.45%
Money market and interest
bearing demand
deposits................ $ 51,255 $ 43,239 $ 46,641 $ 141,135 $ 138,502
Average interest rate... 4.09% 4.13% 3.04% 3.76%
Certificates of
deposits................ $1,443,757 $207,720 $ 52,546 $ 555 $38,383 $ 7 $1,742,968 $1,743,453
Average interest rate... 5.71% 5.83% 6.44% 5.64% 6.01% 6.06% 5.75%
Fixed interest rate
borrowings.............. $ 526,732 $ 8,820 $ 520 $ 61 $ 6,520 $247,446 $ 790,099 $ 807,529
Average interest rate... 5.69% 7.65% 7.80% 7.07% 8.20% 8.71% 6.68%
Variable interest rate
borrowings.............. $ 13,018 $ 13,018 $ 13,305
Average interest rate... 6.85% 6.85%
RATE SENSITIVITY
DERIVATIVE FINANCIAL
INSTRUMENTS:
Pay variable interest rate
swaps................... $50,000 $ 50,000 $ 802
Average pay rate........ 5.91% 5.91% 5.91% 5.91% 5.91% 5.91%
Average receive rate.... 5.90% 5.90% 5.90% 5.90% 5.90% 5.90%
Interest rate caps
purchased............... $100,000 $65,000 $200,000 $ 365,000 $ 6,087
Average strike rate..... 6.25% 6.50% 6.75% 6.57%
</TABLE>
59
<PAGE> 62
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company'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
PART III
Certain information required by Part III is omitted from this report, as
the Company will file a definitive proxy statement (the "Proxy Statement")
within 120 days after the end of its fiscal year pursuant to Regulation 14A of
the Securities Exchange Act of 1934 for its Annual Meeting of Stockholders to be
held April 30, 1998 and the information included therein is incorporated herein
by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors appears under the caption "Election of
Directors" in the Proxy Statement and is incorporated herein by reference.
Information regarding executive officers appears under the caption "Executive
Officers Who Are Not Directors" in the Proxy Statement and is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation appears under the caption
"Compensation of Executive Officers" in the Proxy Statement and is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and
management appears under the caption "Security Ownership of Management Directors
and Nominees" in the Proxy Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions
appears under the caption "Certain Transactions Between Management and the
Company or its Subsidiaries" in the Proxy Statement and is incorporated herein
by reference.
PART IV
ITEM 14. FINANCIAL STATEMENT SCHEDULES, EXHIBITS, AND REPORTS ON FORM 8-K
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT:
(1) FINANCIAL STATEMENTS
The following consolidated financial statements and report of
independent auditors of the Company and subsidiaries are included in
this Report commencing on page F-1.
Report of Independent Auditors
Consolidated Statements of Financial Condition at December 31, 1997
and 1996
Consolidated Statements of Income for the years ended December 31,
1997, 1996, and 1995.
Consolidated Statements of Changes in Shareholders' Equity for the
years ended December 31, 1997, 1996, and 1995.
60
<PAGE> 63
Consolidated Statements of Cash Flows for the years ended December 31, 1997,
1996, and 1995.
Notes to Consolidated Financial Statements.
(2) FINANCIAL STATEMENT SCHEDULES
Schedules to the consolidated financial statements are omitted
because the required information is inapplicable or the information
is presented in the Company's consolidated financial statements or
related notes.
(3) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
3.1 Certificate of Incorporation(a)
3.2 Bylaws(a)
4.1 Indenture dated as of June 17, 1993 issued by Western
Financial Bank, formerly Western Financial Savings Bank,
F.S.B., with respect to $125,000,000 in aggregate principal
amount of 8.5% Subordinated Capital Debentures due 2003(b)
4.2 Indenture dated as of June 25, 1997 issued by Western
Financial Bank, formerly Western Financial Bank, F.S.B.,
with respect to $150,000,000 in aggregate principal amount
of 8.875% Subordinated Capital Debentures due 2007(c)
10.1 Westcorp Incentive Stock Option Plan(d)
10.2 Westcorp Employee Stock Ownership and Salary Savings Plan(a)
10.3 Westcorp 1991 Stock Option Plan(e)
10.4 WFS Financial Inc ("WFS") 1996 Incentive Stock Option
Plan(f)
10.5 Westcorp Employee Stock Ownership and Salary Saving Plan(g)
10.6 Employment Agreements(h)(i)(j)(k)
22.1 Subsidiaries of Westcorp
23.1 Consent of Independent Auditors
27 Financial Data Schedule
</TABLE>
- ---------------
(a) Exhibits previously filed with Westcorp Registration Statement on Form S-4
(File No. 33-34286), filed April 11, 1990, incorporated herein by reference
under Exhibit Numbers indicated.
(b) Exhibit previously filed with Western Financial Bank, formerly Western
Financial Savings Bank, F.S.B., Offering Circular with the OTS, dated June
17, 1993 (will be provided to the SEC upon request).
(c) Exhibit previously filed with Western Financial Bank, formerly Western
Financial Bank, F.S.B., Offering Circular with the OTS, dated July 25, 1997
(will be provided to the SEC upon request).
(d) Exhibit previously filed with Westcorp Registration Statement on Form S-1
(File No. 33-04295), filed May 2, 1986, incorporated herein by reference
under Exhibit Number indicated.
(e) Exhibit previously filed with Westcorp Registration Statement on Form S-8
(File No. 33-43898), filed December 11, 1991, incorporated herein by
reference under the Exhibit Number indicated.
(f) Exhibit previously filed with WFS Registration Statement on Form S-8 (File
No. 33-07485), filed July 3, 1996, incorporated herein by reference under
the Exhibit Number indicated. Amendment No. 1 dated as of November 13, 1997
filed with the WFS Registration Statement on Form S-8 (File No. 333-040121,
incorporated herein by reference under Exhibit Number indicated.
(g) Exhibit previously filed with Westcorp Registration Statement on Form S-8
(File No. 333-11039) and the related Form 11K (File No. 001-09910), filed
August 29, 1996 and June 28, 1996, respectively, incorporated herein by
reference under the Exhibit Number indicated.
61
<PAGE> 64
(h) Employment Agreement, in letter form, dated January 11, 1996 between the
Bank and Donald H. Kasle (will be provided to the SEC upon request).
(i) Employment Agreement, in letter form, dated March 11, 1997 between the
registrant and Andrey R. Kosovych (will be provided to the SEC upon
request).
(j) Employment Agreement, dated February 27, 1998 between WFS and Joy Schaefer
(will be provided to the SEC and/or the OTS upon request).
(k) Employment Agreements, dated February 27, 1998 between the registrant and
WFS and Lee A. Whatcott (will be provided to the SEC and/or the OTS upon
request).
(b) REPORT ON FORM 8-K
None
62
<PAGE> 65
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
WESTCORP
By: /s/ ERNEST S. RADY
------------------------------------
Ernest S. Rady
Chairman of the Board
President and Chief Executive
Officer
Dated: March 16, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following on behalf of the registrant in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ ERNEST R. RADY Chairman of the Board, March 16, 1998
- -------------------------------------------------------- President and Chief,
Ernest S. Rady Executive Officer
/s/ ANDREY R. KOSOVYCH Vice Chairman March 16, 1998
- --------------------------------------------------------
Andrey R. Kosovych
Director
- --------------------------------------------------------
Judith M. Bardwick
Director
- --------------------------------------------------------
William J. Crawford
/s/ STANLEY E. FOSTER Director March 16, 1998
- --------------------------------------------------------
Stanley E. Foster
/s/ CHARLES E. SCRIBNER Director March 16, 1998
- --------------------------------------------------------
Charles E. Scribner
Director
- --------------------------------------------------------
Howard C. Reese
/s/ LEE A. WHATCOTT Senior Vice President March 16, 1998
- -------------------------------------------------------- (Principal Financial and
Lee A. Whatcott Accounting Officer) and
Chief Financial Officer
</TABLE>
63
<PAGE> 66
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
WESTCORP AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORT OF INDEPENDENT AUDITORS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
REPORT OF INDEPENDENT AUDITORS.............................. F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Statements of Financial Condition at December
31, 1997 and 1996......................................... F-3
Consolidated Statements of Income for the years ended
December 31, 1997, 1996 and 1995.......................... F-4
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1997, 1996 and 1995...... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995.......................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 67
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Westcorp
We have audited the consolidated financial statements of Westcorp and
Subsidiaries listed in the accompanying Index to Consolidated Financial
Statements (Item 14(a)). These financial statements are the responsibility of
Westcorp's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements listed in the accompanying Index
to Consolidated Financial Statements (Item 14(a)) present fairly, in all
material respects, the consolidated financial position of Westcorp and
Subsidiaries at December 31, 1997 and 1996 and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Los Angeles, California
February 9, 1998
F-2
<PAGE> 68
WESTCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1996
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
ASSETS
Cash........................................................ $ 73,783 $ 75,070
Interest bearing deposits with other financial
institutions.............................................. 15,510 510
Other short-term investments................................ 84,136 62,798
Investment securities held to maturity (fair value 1996:
$1,493)................................................... 1,504
Investment securities available for sale.................... 123,409 142,344
Mortgage-backed securities held to maturity (fair value
1996: $442,229)........................................... 438,662
Mortgage-backed securities available for sale............... 941,448 410,886
Loans receivable, net of allowance for loan losses (1997:
$33,834; 1996: $40,211)................................... 1,126,322 1,232,235
Loans held for sale......................................... 712,554 458,973
Amounts due from trusts..................................... 295,123 191,469
Retained interests in securitized assets.................... 181,177 121,597
Capitalized servicing rights................................ 37,417 28,640
Premises and equipment, net................................. 89,791 82,137
Real estate owned, net...................................... 6,336 11,279
Federal Home Loan Bank stock................................ 25,762 31,967
Other assets................................................ 16,097 44,974
---------- ----------
$3,728,865 $3,335,045
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits.................................................... $2,000,896 $1,873,942
Securities sold under agreements to repurchase.............. 287,071 287,412
Short-term borrowings....................................... 191,880 55,945
Federal Home Loan Bank advances............................. 84,971 226,000
Amounts held on behalf of trustee........................... 488,653 393,449
Other liabilities........................................... 57,910 47,058
---------- ----------
3,111,381 2,883,806
SUBORDINATED DEBENTURES..................................... 239,195 104,917
MINORITY INTEREST IN EQUITY OF SUBSIDIARIES................. 29,538 28,392
SHAREHOLDERS' EQUITY
Common stock, par value $1.00 per share; authorized
45,000,000 shares; issued and outstanding 26,278,593
shares in 1997 and 25,996,618 shares in 1996.............. 26,279 25,997
Paid-in capital............................................. 185,187 185,742
Retained earnings........................................... 131,427 105,108
Unrealized gains on securities available for sale and
retained interests in securitized assets, net of tax...... 5,858 1,083
---------- ----------
348,751 317,930
---------- ----------
$3,728,865 $3,335,045
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 69
WESTCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C> <C>
Interest income:
Loans, including fees................................. $ 187,489 $ 171,328 $ 162,394
Mortgage-backed securities............................ 68,055 57,471 47,486
Investment securities................................. 7,376 7,620 6,551
Other................................................. 7,612 5,969 5,662
----------- ----------- -----------
TOTAL INTEREST INCOME................................... 270,532 242,388 222,093
Interest expense:
Deposits.............................................. 107,078 99,091 101,364
Federal Home Loan Bank advances and other
borrowings......................................... 36,616 24,612 19,081
Securities sold under agreements to repurchase........ 17,376 15,491 18,834
----------- ----------- -----------
TOTAL INTEREST EXPENSE.................................. 161,070 139,194 139,279
----------- ----------- -----------
NET INTEREST INCOME..................................... 109,462 103,194 82,814
Provision for loan losses............................... 12,851 13,571 11,470
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES..... 96,611 89,623 71,344
Noninterest income:
Automobile lending.................................... 176,192 153,099 91,200
Mortgage banking...................................... 24,540 18,046 3,159
Investment and mortgage-backed securities gains
(losses)........................................... 8,026 (1,620) 1,829
Insurance income...................................... 6,454 12,905 8,837
Real estate operations................................ 811 (2,428) (267)
Rental operations..................................... (1,182) (378) (307)
Miscellaneous......................................... 3,197 1,640 1,209
----------- ----------- -----------
TOTAL NONINTEREST INCOME................................ 218,038 181,264 105,660
Noninterest expenses:
Salaries and employee benefits........................ 137,741 110,494 64,844
Occupancy............................................. 15,851 11,030 6,747
Insurance............................................. 1,760 16,382 5,766
Miscellaneous......................................... 86,102 65,740 38,076
----------- ----------- -----------
TOTAL NONINTEREST EXPENSES.............................. 241,454 203,646 115,433
----------- ----------- -----------
INCOME BEFORE INCOME TAXES.............................. 73,195 67,241 61,571
Income taxes............................................ 31,287 28,095 25,235
----------- ----------- -----------
INCOME BEFORE MINORITY INTEREST......................... 41,908 39,146 36,336
Minority interest in earnings of subsidiaries........... 5,120 7,349 2,908
----------- ----------- -----------
NET INCOME.............................................. $ 36,788 $ 31,797 $ 33,428
=========== =========== ===========
NET INCOME PER COMMON SHARE AND
COMMON SHARE EQUIVALENTS -- BASIC.................... $ 1.41 $ 1.23 $ 1.30
=========== =========== ===========
NET INCOME PER COMMON SHARE AND
COMMON SHARE EQUIVALENTS -- DILUTED................... $ 1.40 $ 1.21 $ 1.29
=========== =========== ===========
Weighted average number of common shares and common
share equivalents -- basic............................ 26,165,678 25,910,548 25,650,705
=========== =========== ===========
Weighted average number of common shares and common
share equivalents -- diluted.......................... 26,351,144 26,199,537 25,917,018
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 70
WESTCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
UNREALIZED
COMMON STOCK GAINS
-------------------- (LOSSES)
PAID-IN RETAINED NET OF
SHARES PAR VALUE CAPITAL EARNINGS TAX(1) TOTAL
---------- --------- -------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE JANUARY 1, 1995........... 23,145,640 $23,146 $102,376 $ 92,788 $(5,998) $212,312
Stock options exercised......... 260,485 260 1,906 2,166
Stock dividend.................. 1,157,294 1,157 10,416 (11,573)
Cash dividends.................. (8,692) (8,692)
Issuance of subsidiary common
stock........................ 52,341 52,341
Net income...................... 33,428 33,428
Change in unrealized gains on
securities available for
sale, net of tax............. 6,184 6,184
---------- ------- -------- -------- ------- --------
BALANCE DECEMBER 31, 1995......... 24,563,419 24,563 167,039 105,951 186 297,739
Stock options exercised......... 134,017 134 923 1,057
Stock dividend.................. 1,233,742 1,234 21,285 (22,519)
Employee Stock Ownership and
Salary Savings Plan stock
contribution................. 65,440 66 1,115 1,181
Cash dividends.................. (10,121) (10,121)
Purchase of subsidiary stock.... (4,620) (4,620)
Net income...................... 31,797 31,797
Change in unrealized gains on
securities available for
sale, net of tax............. 897 897
---------- ------- -------- -------- ------- --------
BALANCE DECEMBER 31, 1996......... 25,996,618 25,997 185,742 105,108 1,083 317,930
Stock options exercised......... 116,605 117 940 1,057
Employee Stock Ownership and
Salary Savings Plan stock
contribution................. 165,370 165 2,728 2,893
Cash dividends.................. (10,469) (10,469)
Purchase of subsidiary stock.... (4,223) (4,223)
Net income...................... 36,788 36,788
Change in unrealized gains on
securities available for sale
and retained interests in
securitized assets, net of
tax.......................... 4,775 4,775
---------- ------- -------- -------- ------- --------
BALANCE DECEMBER 31, 1997......... 26,278,593 $26,279 $185,187 $131,427 $ 5,858 $348,751
========== ======= ======== ======== ======= ========
</TABLE>
- ---------------
(1) Includes securities available for sale and retained interests in securitized
assets.
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 71
WESTCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 36,788 $ 31,797 $ 33,428
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Provision for loan losses................................. 12,851 13,571 11,470
Depreciation and amortization............................. 17,113 10,803 10,411
Amortization of capitalized servicing rights.............. 9,541 5,768 3,814
(Gain) loss on sale of investment securities and
mortgage-backed securities.............................. (8,026) 1,620 (1,829)
Gain on sale of loans..................................... (58,889) (32,025) (17,346)
Gain on sale of capitalized servicing rights.............. (1,496) (915)
Gain on disposition of real estate owned.................. (4,382) (2,116) (3,719)
Stock Contribution to Employee Stock Ownership and Salary
Savings Plans........................................... 1,181
Net change in loans receivable.............................. 72,204 (108,351) 57,925
Net change in loans held for sale........................... (194,692) 122,433 (46,680)
Net change in retained interests in securitized assets...... (58,809) (43,552) (34,620)
Disposition of real estate owned............................ 30,278 22,617 17,583
Other, net.................................................. 39,582 5,276 7,030
--------- --------- ---------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES......... (107,937) 28,107 37,467
INVESTING ACTIVITIES
Investment securities held to maturity:
Purchases................................................. (1,667)
Investment securities available for sale:
Purchases................................................. (29,976) (42,809) (37,271)
Proceeds from sale........................................ 1,915
Proceeds from maturities.................................. 53,000 33,000 26,000
Mortgage-backed securities held to maturity:
Purchases................................................. (934) (1,336) (241,518)
Payments received on mortgage-backed securities........... 47,502 72,959 44,143
Mortgage-backed securities available for sale:
Purchases................................................. (581,753) (299,683) (397,935)
Proceeds from sale........................................ 393,599 197,531 202,970
Payments received on mortgage-backed securities........... 60,403 31,840 14,271
Increase in capitalized servicing rights.................... (23,871) (20,562) (20,266)
Proceeds from sale of capitalized servicing rights.......... 7,049 5,972
Additions to premises and equipment......................... (22,585) (22,156) (11,182)
Purchases of FHLB stock..................................... (18,817) (4,114) (6,842)
Proceeds from sale of FHLB stock............................ 25,022 1,771 1,692
Increase in amounts due from trusts......................... (103,654) (81,238) (41,604)
--------- --------- ---------
NET CASH USED IN INVESTING ACTIVITIES....................... (195,015) (128,577) (467,542)
FINANCING ACTIVITIES
Increase in deposits........................................ 126,954 120,467 120,693
(Decrease) increase in securities sold under agreements to
repurchase................................................ (341) (66,612) 107,950
(Decrease) increase in FHLB advances, net................... (141,029) 34,000 103,000
Increase (decrease) in short-term borrowings................ 135,935 (56,385) (98,248)
Increase in amounts held on behalf of trustee............... 95,204 51,756 125,489
Increase in subordinated debentures......................... 133,505
Increase in minority interests.............................. 1,410 6,427 21,965
Proceeds from issuance of common stock...................... 1,057 1,057 2,166
Issuance of subsidiary common stock......................... 52,341
Purchase of subsidiary common stock......................... (4,223) (4,620)
Cash dividends.............................................. (10,469) (10,121) (8,692)
--------- --------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES................... 338,003 75,969 426,664
--------- --------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ 35,051 (24,501) (3,411)
Cash and equivalents at beginning of period................. 138,378 162,879 166,290
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 173,429 $ 138,378 $ 162,879
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest.................................................... $ 156,852 $ 138,400 $ 139,563
Income taxes................................................ 5,738 18,322 28,050
SUPPLEMENTAL DISCLOSURES OF NONCASH TRANSACTIONS:
Acquisition of real estate acquired through foreclosure..... $ 20,953 $ 26,889 $ 32,200
Unrealized gains on securities available for sale and
retained interests in securitized assets, net of tax...... 4,775 897 594
Investment securities and mortgage-backed securities held to
maturity transferred to available for sale................ 395,411
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 72
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The accompanying consolidated financial statements
include the accounts of Westcorp ("the Company"), its wholly-owned subsidiaries,
Westran Services Corp., Westcorp Investments, Inc., WestFin Securities
Corporation and Western Financial Bank, formerly Western Financial Bank, F.S.B.
("the Bank"), and the Bank's subsidiaries including WFS Financial Inc ("WFS") of
which the Bank owns 83.7%. All significant intercompany accounts and
transactions have been eliminated upon consolidation. Certain prior year amounts
have been reclassified to conform with the current year's presentation.
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 amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Nature of Operations: The Company is a financial services holding company
which specializes in automobile lending, retail banking, mortgage banking,
commercial banking and other related services.
Cash and Cash Equivalents: Cash and cash equivalents include cash,
interest-bearing deposits with other financial institutions and other short-term
investments which have no material restrictions as to withdrawal or usage.
Investment Securities and Mortgage-Backed Securities Held to Maturity: The
Company reclassified all of its held to maturity portfolio to available for sale
as of October 1, 1997. At December 31, 1996, these securities are carried at
their amortized cost. Unrealized holding gains and losses are not recognized in
the financial statements until realized or until a decline in fair value below
cost is deemed to be other than temporary. The method used in determining the
cost of investments sold is specific identification.
Investment Securities and Mortgage-Backed Securities Available for
Sale: Investments and mortgage-backed securities intended to be held for an
indefinite period of time but which may be sold in response to events reasonably
expected in the foreseeable future are classified as available for sale and
carried at fair value. Unrealized holding gains and losses on such investments
are recorded as a separate component of shareholders' equity, net of income
taxes. Any decline in the fair value of the investments which is deemed to be
other than temporary is charged against current earnings. The method used in
determining the cost of investments sold is specific identification.
The Company has entered into or committed to interest rate caps, swaps and
forward agreements as hedges against market value changes in designated portions
of its mortgage-backed securities and loans held for sale portfolios and to
manage interest rate risk exposure on its available for sale securities. These
financial instruments are also recorded at fair value and are included in the
basis of the designated available for sale securities and loans held for sale.
The interest rate differential to be paid or received is accrued and included as
part of interest income, thereby adjusting the overall yield on securities or
loans for which management is attempting to reduce its exposure to interest rate
risk. Recognition of unrealized gains and losses on these contracts are deferred
and amortized into interest income over the shorter of the remaining life of the
derivative instrument or the expected life of the associated asset. When the
related mortgage-backed securities or loans are sold, settled or terminated, the
deferred gains or losses from these contracts are recognized in the Statements
of Income as a component of automobile lending income, mortgage banking income
and investment and mortgage-backed securities gains and losses.
Allowance for Loan Losses: The allowance for loan losses for loans
receivables is maintained at a level believed adequate by management to absorb
potential losses in the loan portfolios. Management's determination of the
adequacy of the allowance is based on an evaluation of the portfolio, past loan
loss experience, current economic conditions, volume, growth and composition of
the loan portfolio, and other relevant factors. The allowance is increased by
provisions for loan losses charged against income.
F-7
<PAGE> 73
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Loans Held for Sale: Loans held for sale are stated at the lower of
aggregate amortized cost or market. The carrying amount of the specific loan
pools sold is used to compute gains or losses. Market value is based on
prevailing market quotes for real estate loans and discounted cash flow
calculations for consumer loans.
Sales of Loans and Securitized Assets and Capitalized Servicing
Rights: Certain mortgage and consumer loans are originated and sold to investors
with servicing rights retained by the Company. The Company does not retain any
direct recourse with respect to the automobile loans securitized. As part of the
automobile loan sale, the trustee reimburses the Company for borrowing costs
incurred between the cut-off of the loans and the closing date of the sale.
Gain on sale of automobile loans represents the present value of the
estimated future earnings to be received from the excess spread created in the
securitization transactions less prepaid dealer commission, issuance costs, and
the effect of hedging activities. These retained interests in securitized assets
("RISA") are capitalized and amortized over the expected repayment life of the
underlying automobile loans. The Company evaluates quarterly the carrying value
of its RISA in light of the actual repayment experience of the underlying
automobile loans and makes adjustments to reduce the carrying value, if
appropriate. Servicing income and amortization of RISA are included in
automobile lending income in noninterest income in the Consolidated Statements
of Income.
Gain on sale of mortgage loans represents the difference between the
allocated cost basis of loans sold and proceeds from sale, which includes the
carrying value of capitalized servicing rights ("CSR") created as a result of
the sale. The carrying value of the CSR assets represent an allocation of the
cost basis of loans sold between the CSR and the loans based upon their relative
fair value at the date the loans are originated or purchased. The fair value of
CSR is calculated by estimating future servicing revenues, including servicing
fees, late charges, other ancillary income, and float benefit, less the actual
cost to service loans. The amortization of the CSR is a component of mortgage
banking income in noninterest income over the period of, and in proportion to,
the expected repayment term of the underlying loans. CSR is evaluated for
impairment based on the excess of the carrying amount of the CSR over their fair
value. See Note 7 for additional disclosure related to the RISA and CSR.
Nonaccrual Loans: Nonaccrual loans are loans on which accrual of interest
has been suspended. Interest is suspended on all real estate loans when, in
management's judgement, the interest will not be collectible in the normal
course of business or when the loan is 90 days or more past due or full
collection of principal is not assured. When a loan is placed on nonaccrual,
interest accrued is reversed against interest income. Interest income is
suspended on all loans, except consumer loans. On these loans, interest
continues to accrue until the loan is charged off, which occurs automatically
after the loan is past due 120 days, whereupon all accrued interest is also
charged off.
Amounts Due From Trusts/Amounts Held on Behalf of Trustee: Servicing income
earned by the Company for which the Company has not yet received repayment from
the trust is reported as amounts due from trusts. As servicer of securitized
automobile loans, the Company holds and remits funds collected from the
borrowers on behalf of the trustee. These amounts are reported as amounts held
on behalf of the trustee.
Premises and Equipment: Premises and equipment are recorded at cost and are
depreciated over their estimated useful lives principally using the
straight-line method for financial reporting and accelerated methods for tax
purposes. Leasehold improvements are amortized over the lives of the respective
leases or the service lives of the improvements, whichever is shorter.
Real Estate Owned: Real estate acquired through foreclosure is recorded at
the lower of cost or fair value less estimated costs to sell. Costs of holding
this real estate, and related gains and losses on disposition, are credited or
charged to real estate operations as incurred. These values are periodically
reviewed and write-downs are recorded, if appropriate.
F-8
<PAGE> 74
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Real estate owned is carried net of an allowance for potential losses which
is maintained at a level believed by management to be adequate to absorb any
potential losses in the portfolio. Management's determination of the adequacy of
the allowance is based on an evaluation of the past loss experience, current
economic conditions, selling costs and other relevant factors.
Interest Income and Fee Income: Interest income on real estate and certain
consumer loans is earned using the effective yield method and classified on the
balance sheets as part of other assets to the extent not collected. Certain
consumer loans use the sum of the months digits method, which approximates the
interest method.
The Company defers loan origination and commitment fees and certain loan
origination costs. The net amount is amortized as an adjustment to the related
loan's yield over the contractual life of the related loans. Commitment fees
based on a percentage of a customer's unused line of credit are recognized over
the commitment period. Fees for other services are recorded as income when
earned.
Insurance Commissions: Commissions on insurance policies sold are
recognized as income over the life of the policies.
Insurance Premiums: Premiums for life and accident/health insurance
policies are recognized as income over the term of the insurance contract.
Income Taxes: The Company files consolidated federal and state tax returns
with all of its subsidiaries except for Westhrift, which files a separate state
tax return.
Net Income Per Common Share: SFAS No. 128, "Earnings Per Share", was issued
by the Financial Accounting Standards Board ("FASB") in February 1997 and
adopted on December 31, 1997. Under the provisions of SFAS No. 128, primary and
fully diluted earnings per share were replaced with basic and diluted earnings
per share in an effort to simplify the computation of these measures and align
them more closely with the methodology used internationally. Basic earnings per
share is calculated by dividing net income available to common stockholders by
the weighted average number of common share outstanding and does not include the
impact of any potentially dilutive common stock equivalents. The diluted
earnings per share calculation method is similar to the previously required
fully diluted earnings per share method and is arrived at by dividing net income
by the weighted average number of shares outstanding, adjusted for the dilutive
effect of outstanding stock options. For purposes of comparability, all prior
period earnings per share data has been restated.
Current Accounting Pronouncements: In June 1997, the FASB issued "SFAS No.
130, Reporting Comprehensive Income". This statement is effective with the
year-end 1998 financial statements; however, a total for comprehensive income is
required in the financial statements of interim periods beginning with the first
quarter of 1998. Reclassification of financial statements for earlier periods
provided for comparative purposes is required. This Statement establishes
standards for reporting and displaying comprehensive income and its components
in the financial statements. It requires that a company classify items of other
comprehensive income, as defined by accounting standards, by their nature (e.g.,
unrealized gains or losses on securities available for sale and retained
interests in securitized assets) in a financial statement with the same
prominence as other financial statements, but does not require a specific format
for that statement. The Company is in the process of determining its preferred
format. The accumulated balance of comprehensive income is to be displayed
separately from retained earnings and additional paid-in capital in the equity
section of the consolidated statements of financial condition.
In June 1997, the FASB issued "SFAS No. 131, Disclosure about Segments of
an Enterprise and Related Information." This Statement provides guidance for the
way public enterprises report information about operating segments in annual
financial statements and requires selected information about operating
F-9
<PAGE> 75
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
segments in annual financial statements and in interim financial reports. It
also requires certain related disclosures about products and services,
geographic areas and major customers. The segment and other information
disclosures are required for the year ended December 31, 1998. In the initial
year of application, comparative information for earlier years is to be
restated.
NOTE 2 -- INVESTMENT SECURITIES HELD TO MATURITY
There were no investment securities held to maturity at December 31, 1997.
Investment securities held to maturity at December 31, 1996 all had maturities
within one to five years and consisted of the following:
<TABLE>
<CAPTION>
1996
---------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAIN LOSS FAIR VALUE
--------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of
other U.S. Government agencies and
corporations.................................. $1,504 $11 $1,493
------ ------- --- ------
$1,504 $11 $1,493
====== ======= === ======
</TABLE>
NOTE 3 -- INVESTMENT SECURITIES AVAILABLE FOR SALE
Investment securities available for sale consisted of the following at
December 31:
<TABLE>
<CAPTION>
1997
---------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAIN LOSS FAIR VALUE
--------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of
other U.S. Government agencies and
corporations.................................. $121,716 $418 $420 $121,714
Obligations of states and political
subdivisions.................................. 1,511 21 1,532
Other........................................... 163 163
-------- ---- ---- --------
$123,390 $439 $420 $123,409
======== ==== ==== ========
</TABLE>
<TABLE>
<CAPTION>
1996
---------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAIN LOSS FAIR VALUE
--------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of
other U.S. Government agencies and
corporations.................................. $141,981 $1,175 $140,806
Obligations of states and political
subdivisions.................................. 1,512 $1 1,513
Other........................................... 79 54 25
-------- -- ------ --------
$143,572 $1 $1,229 $142,344
======== == ====== ========
</TABLE>
F-10
<PAGE> 76
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
At December 31, 1997, the stated maturities of the Company's investment
securities available for sale were as follows:
<TABLE>
<CAPTION>
ONE YEAR TO FIVE YEARS TEN YEARS
UP TO ONE YEAR FIVE YEARS TO TEN YEARS OR MORE
------------------- ------------------- ------------------ -----------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE COST VALUE
--------- ------- --------- ------- --------- ------ --------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities
and obligations of
other U.S. Government
agencies and
corporations........... $81,430 $81,165 $40,286 $40,549
Obligations of states and
political
subdivisions........... $1,002 $1,009 $509 $523
Other.................... 163 163
------- ------- ------- ------- ------ ------ ---- ----
$81,593 $81,328 $40,286 $40,549 $1,002 $1,009 $509 $523
======= ======= ======= ======= ====== ====== ==== ====
</TABLE>
The Company did not sell any investment securities available for sale in
1997. Proceeds from the sale of investment securities available for sale
totalled approximately $1.9 million in 1996. The Company had gross realized
gains of $139 thousand in 1996 and had no gross realized losses.
NOTE 4 -- MORTGAGE-BACKED SECURITIES HELD TO MATURITY
There were no mortgage-backed securities held to maturity at December 31,
1997. Mortgage-backed securities held to maturity at December 31, 1996 had
maturities of ten years or more, although payments are generally received
monthly throughout the life of these securities, and consisted of the following:
<TABLE>
<CAPTION>
1996
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
GNMA certificates............................... $346,098 $5,447 $2,497 $349,048
FNMA participation certificates................. 84,005 394 84,399
FHLMC participation certificates................ 7,358 223 7,581
Other participation certificates................ 1,201 1,201
-------- ------ ------ --------
$438,662 $6,064 $2,497 $442,229
======== ====== ====== ========
</TABLE>
F-11
<PAGE> 77
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 5 -- MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE
Mortgage-backed securities available for sale consisted of the following at
December 31:
<TABLE>
<CAPTION>
1997
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
GNMA certificates............................... $778,302 $12,710 4,070 $786,942
FNMA participation certificates................. 142,572 972 93 143,451
FHLMC participation certificates................ 8,188 42 105 8,125
Other........................................... 2,912 54 36 2,930
-------- ------- ------ --------
$931,974 $13,778 4,304 $941,448
======== ======= ====== ========
</TABLE>
<TABLE>
<CAPTION>
1996
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
GNMA certificates............................... $318,505 $5,206 $1,935 $321,776
FNMA participation certificates................. 72,214 61 292 71,983
FHLMC participation certificates................ 17,092 118 83 17,127
-------- ------ ------ --------
$407,811 $5,385 $2,310 $410,886
======== ====== ====== ========
</TABLE>
Proceeds from the sale of mortgage-backed securities available for sale
totalled approximately $394 million and $198 million in 1997 and 1996,
respectively. The Company had gross realized gains of $8.5 million and $1.6
million in 1997 and 1996, respectively, and gross realized losses of $487
thousand and $3.1 million in 1997 and 1996, respectively.
During 1997, the Company transferred mortgage-backed securities held to
maturity with an amortized cost of $395 million with an unrealized gain of $7.0
million to mortgage-backed securities available for sale. The reclassification
was due to a change in the Company's intent to potentially realize a holding
gain from assets held for an indefinite period of time (available for sale) as
opposed to holding the assets in order to earn an interest yield (held to
maturity).
The Company's mortgage-backed securities available for sale all had
maturities at December 31, 1997 and 1996, of ten years or more, although
payments are generally received monthly throughout the life of these securities.
The Company has issued certain mortgage-backed securities that include
recourse provisions. Subject to certain limitations, the Company is required,
for the life of the loans, to repurchase the buyer's interest in individual
loans on which foreclosure proceedings have been completed. Securities with
recourse issued by the Company had a total outstanding balance of $159 million
and $178 million at December 31, 1997 and 1996, respectively.
The Company has provided for possible losses that may occur as a result of
its recourse obligations. The maximum remaining exposure under these recourse
provisions at December 31, 1997 and 1996 was $88.7 million and $98.7 million,
respectively. The Company has pledged $13.6 million and $15.2 million of
mortgage-backed securities as collateral under these recourse provisions at
December 31, 1997 and 1996, respectively.
F-12
<PAGE> 78
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 6 -- NET LOANS RECEIVABLE
Net loans receivable consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Real Estate:
Mortgage.......................................... $1,529,764 $1,419,177
Construction...................................... 15,835 5,501
---------- ----------
1,545,599 1,424,678
Less: undisbursed loan proceeds..................... (6,711) (2,359)
---------- ----------
1,538,888 1,422,319
Consumer:
Automobile loans.................................. 253,455 267,715
Other............................................. 57,758 67,484
Unearned discounts................................ (22,225) (33,768)
---------- ----------
288,988 301,431
Commercial.......................................... 41,668 7,867
---------- ----------
1,869,544 1,731,617
Allowance for loan losses........................... (33,834) (40,211)
Net deferred loan costs (fees)...................... 3,166 (198)
---------- ----------
1,838,876 1,691,208
Less: loans held for sale
Mortgage.......................................... 529,026 272,670
Consumer.......................................... 183,528 186,303
---------- ----------
712,554 458,973
---------- ----------
$1,126,322 $1,232,235
========== ==========
</TABLE>
Loans serviced by the Company for the benefit of others totalled
approximately $8.4 billion and $7.2 billion at December 31, 1997 and 1996,
respectively. These amounts are not included in the Consolidated Statements of
Financial Condition.
Changes in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of year............................... $ 40,211 $ 39,260 $ 41,323
Provision for loan losses.................................. 12,851 13,571 11,470
Chargeoffs................................................. (22,806) (21,258) (19,187)
Recoveries................................................. 4,369 7,168 4,754
Transfers from the allowance for real estate losses........ 800
Business acquisition adjustment............................ (791) 1,470 100
-------- -------- --------
Balance at end of year..................................... $ 33,834 $ 40,211 $ 39,260
======== ======== ========
</TABLE>
NOTE 7 -- SECURITIZED ASSETS AND CAPITALIZED SERVICING RIGHTS
Statement of Financial Accounting Standards ("SFAS") No. 125 requires that,
following a transfer of financial assets, an entity must recognize the assets it
controls and the liabilities it has incurred, and
F-13
<PAGE> 79
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
derecognize assets for which control has been surrendered and liabilities that
have been extinguished. SFAS No. 125 defines two separate financial assets
retained at the time of securitization or sale, RISA which represents the excess
spread created from securitization or sale, and CSR which represents the benefit
derived from retaining the rights to service loans securitized or sold. The
Company did not recognize any CSR as of December 31, 1997 or 1996 with respect
to securitized automobile loans. Previous accounting guidance did not separately
distinguish these rights.
Retained Interests in Securitized Assets
RISA capitalized upon securitization of automobile loans represents the
present value of the estimated future earnings to be received by the Company
from the excess spread created in securitization transactions. Excess spread is
the difference between the coupon rate of the automobile loans sold and the
interest rate paid to the investors less contractually specified servicing and
guarantor fees.
Prepayment and credit loss assumptions are utilized to project future
excess spread and are based upon historical experience. Credit losses are
estimated using a cumulative loss rate estimated by management to reduce the
likelihood of asset impairment. All assumptions used are evaluated each quarter
and adjusted, if appropriate, to reflect actual performance of the automobile
loans.
Future earnings are discounted at a rate management believes to be
representative of market at the time of securitization. The balance of the RISA
is amortized against actual excess spread income earned on a monthly basis over
the expected repayment life of the underlying automobile loans. Similar to
available for sale securities, RISAs are marked to market each quarter. Market
value changes are calculated by discounting the excess spread using a current
market discount rate. Any changes in the market value of the RISA is reported as
a separate component of shareholders' equity as an unrealized gain or loss, net
of applicable taxes.
The following table presents the activity of the RISA:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Beginning balance.......................... $121,597 $ 78,045 $ 43,426
Additions.................................. 112,230 104,071 78,506
Amortization............................... (53,421) (60,519) (43,887)
Change in unrealized gains on RISA......... 771
-------- -------- --------
Ending balance............................. $181,177 $121,597 $ 78,045
======== ======== ========
</TABLE>
When initially valuing the RISA, the Company establishes an off-balance
sheet allowance for expected future credit losses. The allowance is based upon
historical experience and management's estimate of future performance regarding
credit losses and includes an unallocated amount to reduce the likelihood of
impairment of the RISA. The amount is reviewed periodically and adjustments are
made if actual experience or other factors indicate that future performance may
differ from management's prior expectations.
The following table presents the estimated future undiscounted retained
interest earnings to be received from securitizations. Estimated future
undiscounted RISA earnings are calculated by taking the difference between the
coupon rate of the automobile loans sold and the certificate rate paid to the
investors, less the contractually specified servicing fee of 1.0% and guarantor
fees, after giving effect to estimated prepayments and assuming no losses. To
arrive at the RISA, this amount is reduced by the off-balance sheet allowance
established for potential future losses and by discounting to present value.
Prior to the adoption of SFAS No. 125, the Company reduced excess spread by the
actual cost to service automobile loans instead of the
F-14
<PAGE> 80
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
contractually specified servicing fee. The actual cost to service automobile
loans is now included in the computation of the CSR.
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
(DOLLARS IN
THOUSANDS)
<S> <C>
Estimated net undiscounted RISA earnings.................... $ 438,190
Off-balance sheet allowance for losses...................... (236,796)
Discount to present value................................... (20,217)
----------
Retained interests in securitized assets.................... $ 181,177
==========
Outstanding balance of automobile loans sold through
securitizations........................................... $3,449,590
Off-balance sheet allowance for losses as a percent of
automobile loans sold through securitization.............. 6.86%
</TABLE>
The Company believes that the off-balance sheet allowance for losses is
currently adequate to absorb potential losses in the sold portfolio. Had SFAS
125 been in effect at December 31, 1996, the off-balance sheet allowance for
losses as a percent of automobile loans sold through securitizations would have
been 8.03%.
Capitalized Servicing Rights
Capitalized servicing rights consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Purchased mortgage servicing rights...................... $14,695 $20,994
Originated mortgage servicing rights..................... 26,161 9,051
Impairment allowance for mortgage servicing rights....... (3,439) (1,405)
------- -------
$37,417 $28,640
======= =======
</TABLE>
The Company retains the rights to service most loans securitized or sold.
CSR assets represent an allocation of the cost basis of loans sold between the
CSR and the loans based upon their relative fair value at the date the loans are
originated or purchased. The fair value of CSR is calculated by estimating
future servicing revenues, including servicing fees, late charges, other
ancillary income, and float benefit, less the actual cost to service loans.
For the year ended December 31, 1997, the Company capitalized servicing
rights totalling $23.9 million compared to $20.6 million in 1996. The mortgage
servicing rights are included in capitalized servicing rights and the
amortization is a component of mortgage banking income in noninterest income.
The fair value of the CSR was $42.8 million and $38.3 million at December
31, 1997 and December 31, 1996, respectively. Fair value was determined based on
the present value of estimated future earnings. Significant assumptions were
based upon prepayment, default, servicing cost and discount rate. For the
purpose of estimated fair value, CSR are stratified on the basis of loan type,
loan coupon and loan term.
CSR are evaluated for impairment based on the excess of the carrying amount
of the CSR over their fair value.
Amortization of capitalized servicing rights are reflected as a component
of mortgage banking income in noninterest income. Amortization expense for the
year ended December 31, 1997 was $9.5 million, compared to $5.8 million for the
year ended December 31, 1996.
F-15
<PAGE> 81
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 8 -- PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Land................................................... $ 24,496 $ 20,468
Buildings and improvements............................. 56,106 57,662
Furniture and equipment................................ 46,290 35,132
Automobiles and airplanes.............................. 6,916 2,049
-------- --------
133,808 115,311
Less: accumulated depreciation......................... 44,017 33,174
-------- --------
$ 89,791 $ 82,137
======== ========
</TABLE>
NOTE 9 -- NONPERFORMING ASSETS
Nonperforming loans consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Unimpaired loans placed on nonaccrual.................... $14,979 $14,052
Impaired loans........................................... 4,806 6,887
------- -------
$19,785 $20,939
======= =======
</TABLE>
Interest forgone on nonaccrual loans was $0.8 million, $1.0 million and
$0.8 million for the years ended December 31, 1997, 1996 and 1995, respectively.
The following table presents a breakdown of impaired loans and the
impairment allowance related to impaired loans at December 31:
<TABLE>
<CAPTION>
1997 1996
------ ------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Recorded investment with allowance......................... $6,343 $7,090
Less: impairment allowance................................. 1,537 1,678
------ ------
4,806 5,412
Recorded investment without allowance...................... 1,475
------ ------
$4,806 $6,887
====== ======
</TABLE>
For the years ended December 31, 1997 and 1996, average impaired loans were
$5.7 million and $9.1 million, respectively. For the years ended December 31,
1997 and 1996, the Company recognized $1.5 million and $1.0 million,
respectively, of interest income on impaired loans, all of which was recognized
on a cash basis.
Real estate owned consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Real estate acquired through foreclosure.................. $7,120 $12,063
Less: allowance for losses................................ 784 784
------ -------
$6,336 $11,279
====== =======
</TABLE>
F-16
<PAGE> 82
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Changes in the allowance for real estate losses were as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------
1997 1996 1995
----- ----- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of year.......................... $784 $784 $1,684
Provision for real estate losses...................... (100)
Transfers to the allowance for loan losses............ (800)
---- ---- ------
Balance at end of year................................ $784 $784 $ 784
==== ==== ======
</TABLE>
NOTE 10 -- ACCRUED INTEREST RECEIVABLE
Accrued interest receivable consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Interest on loans receivable............................. $10,887 $ 8,665
Interest on securities................................... 7,256 7,125
Interest on other........................................ 4 4
------- -------
$18,147 $15,794
======= =======
</TABLE>
Accrued interest receivable at December 31, 1997 and 1996 are included in
other assets in the Consolidated Statements of Financial Condition.
NOTE 11 -- DEPOSITS
Deposits consisted of the following at December 31:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE RATE
FOR THE YEAR
ENDED
1997 1997 1996
------------ ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Demand deposit accounts................ 1.2% $ 46,579 $ 30,069
Passbook accounts...................... 2.3 21,883 42,532
Money market deposit accounts.......... 4.6 124,442 438
Certificate accounts................... 5.8 1,705,506 1,713,382
Brokered certificate accounts.......... 5.8 39,976 48,489
Noninterest bearing deposits........... 62,510 39,032
---------- ----------
$2,000,896 $1,873,942
========== ==========
</TABLE>
The aggregate amount of deposits in denominations greater than or equal to
$100,000 at December 31, 1997 and 1996 was $418 million and $411 million,
respectively.
F-17
<PAGE> 83
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Scheduled maturities of certificate accounts as of December 31, 1997 are as
follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE RATE AMOUNT
------------ -----------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Six months or less.................................... 5.7% $ 885,886
More than six months through one year................. 5.8 516,625
More than one year through three years................ 6.0 261,535
More than three years through ten years............... 5.9 41,460
----------
$1,705,506
==========
</TABLE>
Interest expense on deposits consisted of the following for the year ended
December 31:
<TABLE>
<CAPTION>
1997 1996 1996
-------- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Demand deposit accounts..................... $ 399 $ 335
Passbook accounts........................... 746 1,414 $ 2,367
Money market deposit accounts............... 2,181 14 20
Certificate accounts........................ 101,085 97,180 98,977
Brokered certificate accounts............... 2,667 148
-------- ------- --------
$107,078 $99,091 $101,364
======== ======= ========
</TABLE>
Accrued interest payable on deposits at December 31, 1997 and 1996 was $955
thousand and $445 thousand, respectively, which is included in other liabilities
in the Consolidated Statements of Financial Condition.
The following table summarizes certificate accounts by interest rate within
maturity categories at December 31:
<TABLE>
<CAPTION>
1997
-----------------------------------------------------------------------------
1998 1999 2000 2001 2002 THEREAFTER TOTAL
---------- -------- ------- ------- ------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
0% - 3.99% $ 1,034 $ 21 $2,514 $ 3,569
4.00% - 5.99% 1,115,388 156,868 $20,702 $ 400 $12,272 1,305,630
6.00% - 7.99% 286,063 51,404 32,540 155 26,112 7 396,281
8.00% - 9.99% 26 26
---------- -------- ------- ------- ------- ------ ----------
$1,402,511 $208,293 $53,242 $ 555 $38,384 $2,521 $1,705,506
========== ======== ======= ======= ======= ====== ==========
</TABLE>
<TABLE>
<CAPTION>
1996
-----------------------------------------------------------------------------
1997 1998 1999 2000 2001 THEREAFTER TOTAL
---------- -------- ------- ------- ------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
0% - 3.99% $ 1,407 $ 15 $ 1,422
4.00% - 5.99% 988,275 $248,597 11,366 $ 2,446 $ 745 $ 62 1,251,491
6.00% - 7.99% 306,473 118,237 7,865 27,673 460,248
8.00% - 9.99% 197 24 221
---------- -------- ------- ------- ------- ------ ----------
$1,296,352 $366,858 $19,246 $30,119 $ 745 $ 62 $1,713,382
========== ======== ======= ======= ======= ====== ==========
</TABLE>
F-18
<PAGE> 84
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 12 -- SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Balance at end of period............................... $287,071 $287,412
Balance at end of period, including accrued interest... 287,714 287,991
Estimated fair value at end of period.................. 293,323 287,933
Average amount outstanding during the period........... 308,573 299,211
Maximum amount outstanding at any given month-end
during the period.................................... 417,688 403,871
Weighted average interest rate during the period....... 5.6% 5.2%
Weighted average interest rate at end of period........ 5.9% 5.5%
</TABLE>
Mortgage-backed securities available for sale sold under reverse repurchase
agreements were delivered to dealers who arranged the transactions. The dealers
may have sold, loaned, or otherwise disposed of such securities to other parties
in the normal course of their operations, and have agreed to resell to the
Company substantially identical securities at the maturities of the agreements.
The agreements at December 31, 1997 mature within 30 days. The agreements at
December 31, 1996 mature with terms between 30 to 90 days. Average amounts are
computed based upon daily ending balances.
NOTE 13 -- SHORT-TERM BORROWINGS
The Company has a letter of credit supporting the Company's commercial
paper facility with the Federal Home Loan Bank ("FHLB"). It is collateralized by
eligible real estate loans and mortgage backed securities described in Note 14,
Federal Home Loan Bank advances, with an approved letter of credit of up to $400
million in 1997 and 1996, and a weighted average interest rate of 6.0% at
December 31, 1997 and 1996. The maximum amount of commercial paper outstanding
at any month-end during 1997 and 1996 was $399 million and $398 million,
respectively and the average amount of commercial paper outstanding, during 1997
and 1996 was $178 million and $163 million respectively, with a weighted average
interest rate of 5.7% and 5.4% at December 31, 1997 and 1996, respectively. The
Company's commercial paper generally matures within 30 days from the issuance
date.
The Company has two lines of credit with a bank which has a maximum
availability of $19.5 million and a line of credit with a maximum availability
of $25.0 million at December 31, 1997 and 1996, respectively. The lines of
credit have an interest rate tied to the FHLB Reference Rate. The $4.5 million
line of credit matures in September 1998 and the $15.0 million line of credit
matures in December 1998. At December 31, 1996, the line of credit had a
maturity at June 30, 1997 with an interest rate tied to the FHLB Reference Rate
plus 0.5%.
The components of short-term borrowings are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1997 1996
---------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Commercial paper, net of discount (1997, $536.4
thousand; 1996, $41.7 thousand........................ $170,973 $24,958
Lines of credit......................................... 17,518 25,000
Other................................................... 3,389 5,987
-------- -------
$191,880 $55,945
======== =======
</TABLE>
F-19
<PAGE> 85
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 14 -- FEDERAL HOME LOAN BANK ADVANCES
Advances from the FHLB are collateralized with eligible real estate loans
and mortgage-backed securities. The FHLB letter of credit disclosed in Note
13 -- Short-Term Borrowings is also pledged with the same collateral. The FHLB
advances and the FHLB letter of credit are collateralized with mortgage loans
totalling $642 million and $454 million at December 31, 1997 and 1996,
respectively, and mortgage-backed securities totalling $67.0 million and $178
million at December 31, 1997 and 1996, respectively.
Information as to interest rates and maturities on the advances from the
FHLB as of December 31 are as follows:
<TABLE>
<CAPTION>
1997 1996
-------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Range of interest rates............................ 6.0%-8.2% 5.7%-8.2%
Weighted average interest rate..................... 6.3% 6.3%
Year due:
1997............................................. $142,000
1998............................................. $70,000 70,000
1999............................................. 6,500 6,500
2000.............................................
2001.............................................
2002............................................. 6,500 6,500
Thereafter....................................... 1,971 1,000
-------- --------
$84,971 $226,000
======== ========
</TABLE>
The Company had a credit availability of approximately $472 million with
the FHLB at December 31, 1997.
NOTE 15 -- SUBORDINATED DEBENTURES
Subordinated capital debentures of the Company ("subordinated debentures")
totalled $239 million at December 31, 1997 and $105 million at December 31,
1996, net of discount and issuance costs (1997, $5.3 million; 1996, $2.4
million). The subordinated debentures are unsecured and consist of two issuances
with outstanding balances of $93 million with an interest rate of 8.5% due in
2003 and $146 million with an interest rate of 8.875% due in 2007. They are
redeemable, in whole or in part, at the option of the Company, on or after July
1, 2000 and August 1, 2004, respectively, both at 100% of the principal amount
being redeemed plus accrued interest as of the date of redemption. For
regulatory purposes, the subordinated debentures are included as part of the
Bank's supplementary capital, subject to certain limitations.
F-20
<PAGE> 86
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 16 -- COMMITMENTS AND CONTINGENCIES
Future minimum payments under noncancellable operating leases on premises
and equipment with terms of one year or more were as follows at December 31:
<TABLE>
<CAPTION>
1997
----------------------
(DOLLARS IN THOUSANDS)
<S> <C>
1998...................................... $ 7,309
1999...................................... 6,018
2000...................................... 4,630
2001...................................... 2,936
2002...................................... 862
Thereafter................................ 1,054
-------
$22,809
=======
</TABLE>
These agreements include, in certain cases, various renewal options and
contingent rental agreements. Rental expense for premises and equipment amounted
to $7.8 million, $5.5 million and $3.2 million in 1997, 1996 and 1995,
respectively.
The Company's outstanding commercial, mortgage loan commitments and
mortgage loans sold with recourse were as follows at December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Commercial letter of credit and unused lines of credit
provided............................................. $ 68,214 $ 40,293
======== ========
Commitments to fund mortgage loans
Fixed rate loans..................................... $202,674 $ 89,477
Variable rate loans.................................. 43,643 32,106
-------- --------
$246,317 $121,583
======== ========
Commitments to sell mortgage loans..................... $537,621 $320,794
======== ========
Mortgage loans sold with recourse...................... $131,359 $171,639
======== ========
</TABLE>
The Company has pledged certain assets relative to amounts held on behalf
of trustees as follows at December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
FNMA participation certificates........................ $105,790 $115,959
FHLMC participation certificates....................... 14,596
GNMA certificates...................................... 397,214 175,376
Residential second mortgages........................... 44,748 55,521
Multifamily first mortgages............................ 70,714 75,478
-------- --------
$618,466 $436,930
======== ========
</TABLE>
The Company is also involved as a party to certain legal proceedings
incidental to its business. Management of the Company believes that the outcome
of such proceedings will not have a material effect upon its business or
financial condition, results of operations or cash flows.
F-21
<PAGE> 87
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 17 -- EARNINGS PER SHARE
SFAS No. 128, "Earnings Per Share," was issued by the Financial Accounting
Standards Board ("FASB") in February, 1997 and adopted on December 31, 1997.
Under the provisions of SFAS No. 128, primary and fully diluted earnings per
share were replaced with basic and diluted earnings per share in an effort to
simplify the computation of these measures and align them more closely with the
methodology used internationally. Basic earnings per share is calculated by
dividing net income available to common stockholders by the weighted average
number of common share outstanding and does not include the impact of any
potentially dilutive common stock equivalents. The diluted earnings per share
calculation method is similar to the previously required fully diluted earnings
per share method and is arrived at by dividing the weighted average number of
shares outstanding, adjusted for the dilutive effect of outstanding stock
options. For purposes of comparability, all prior period earnings per share data
has been restated.
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
1997 1996 1995
-------------- -------------- --------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
BASIC
Net income.................................. $ 36,788 $ 31,797 $ 33,428
=========== =========== ===========
Average common shares outstanding........... 26,165,678 25,910,548 25,650,705
=========== =========== ===========
Net income per common share -- basic........ $ 1.41 $ 1.23 $ 1.30
=========== =========== ===========
DILUTED
Net income.................................. $ 36,788 $ 31,797 $ 33,428
=========== =========== ===========
Average common shares outstanding........... 26,165,678 25,910,548 25,650,705
Stock option adjustment..................... 185,466 288,989 266,313
----------- ----------- -----------
Average common shares outstanding........... 26,351,144 26,199,537 25,917,018
=========== =========== ===========
Net income per common share -- diluted...... $ 1.40 $ 1.21 $ 1.29
=========== =========== ===========
</TABLE>
Options to purchase 257,500 and 2,000 shares of common stock at December
31, 1997 and 1996, respectively, were not included in the computation of diluted
earnings per share because the options' exercise price was greater than the
average market price of the common share, and therefore, the effect would be
antidilutive. The weighted average exercise price at December 31, 1997 and 1996
was $18.72 and $22.75, respectively, for the options outstanding. There were no
antidilutive options at December 31, 1995. The 1995 basic and dilutive average
common shares outstanding and earnings per share have been retroactively
adjusted for the 1996 5% stock dividend.
NOTE 18 -- STOCK OPTIONS
In 1991, the Company reserved 3,150,000 shares of common stock for future
issuance to certain employees under an incentive stock option plan ("the Plan").
There were 1,605,297 share available for future grants at December 31, 1997. The
options may be exercised, within five to seven years after the date of grant.
Additionally, the weighted average life of the options at December 31, 1997 was
3.2 years and the exercise price of the options outstanding at December 31, 1997
ranged from $7.37 to $22.75 per share.
F-22
<PAGE> 88
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
At December 31, 1997, there were 983,157 exercisable stock options under
the plan. Stock option activity is summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
SHARES EXERCISE PRICE
-------- --------------
<S> <C> <C>
Outstanding at January 1, 1995...................... 843,188 $ 8.04
Issued............................................ 30,975 11.57
Exercised......................................... (274,724) 11.53
Cancelled......................................... (30,611) 8.23
-------- ------
Outstanding at December 31, 1995.................... 568,828 8.26
Issued............................................ 470,958 17.30
Exercised......................................... (139,711) 8.71
Cancelled......................................... (5,869) 10.95
-------- ------
Outstanding at December 31, 1996.................... 894,206 13.10
Issued............................................ 348,000 18.09
Exercised......................................... (116,605) 11.86
Cancelled......................................... (142,444) 15.32
-------- ------
Outstanding at December 31, 1997.................... 983,157 $15.07
======== ======
</TABLE>
In 1996, the Company's subsidiary, WFS, reserved 550,000 share of common
stock for future issuance to certain employees under an incentive stock option
plan ("the Plan"). In 1997, WFS reserved an additional 550,000 share of common
stock for future issuance under the Plan which is currently subject to
shareholder approval. There were 320,675 shares available for future grants at
December 31, 1997. The options may be exercised within five to seven years after
the date of grant. Additionally, the weighted average life of the options at
December 31, 1997 was 5.0 years and the exercise price of the options
outstanding at December 31, 1997 ranged from $13.00 to $18.00 per share.
At December 31, 1997, there were 325,215 exercisable stock options under
the Plan. Stock option activity for WFS is summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
SHARES EXERCISE PRICE
------- --------------
<S> <C> <C>
Outstanding at January 1, 1996
Issued............................................. 519,569 $18.00
Exercised..........................................
Cancelled..........................................
------- ------
Outstanding at December 31, 1996..................... 519,569 18.00
Issued............................................. 343,498 13.14
Exercised.......................................... (24,443) 18.00
Cancelled.......................................... (83,742) 17.58
------- ------
Outstanding at December 31, 1997..................... 754,882 $15.83
======= ======
</TABLE>
Effective January 1, 1996 the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation." SFAS No. 123 provides for companies to recognize
compensation expense associated with stock-based compensation plans over the
anticipated service period based on the fair value of the award on the date of
grant. However, SFAS No. 123 allows companies to continue to measure
compensation costs prescribed by Accounting Principles Board Opinion ("APB") No.
25, "Accounting for Stock Issued to
F-23
<PAGE> 89
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Employees." Companies electing to continue accounting for stock-based
compensation plans under APB No. 25 must make pro forma disclosures of net
income and earnings per share as if SFAS No. 123 has been adopted if the fair
value of the options has material impact on earnings. The Company has continued
to account for stock-based compensation plans under APB No. 25.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's and WFS' stock options have characteristics
significantly different from those traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing model does not necessarily provide a reliable
single measure of the fair value of its employee stock options.
The Company's fair value of options granted in 1997, 1996 and 1995 was
estimated at the date of grant using a Black-Scholes option pricing model with
the following assumptions:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Risk-free interest rate......................... 5.7% 6.2% 6.2%
Volatility factor............................... 0.41 0.30 0.30
Expected option life............................ 5 years 5 years 5 years
</TABLE>
The Company's weighted average fair value of options granted during 1997,
1996, and 1995 was $2.39, $1.49 and $0.39, respectively.
The WFS fair value of options granted in 1997, 1996, and 1995 was estimated
at the date of grant using a Black-Scholes option pricing model with the
following assumptions:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Risk-free interest rate......................... 5.7% 6.2% 6.2%
Volatility factor............................... 0.57 0.30 0.30
Expected option life............................ 7 years 5 years 5 years
</TABLE>
The weighted average fair value of options granted during 1997, 1996 and
1995 was $8.26, $6.82 and $6.82, respectively.
The impact of applying SFAS No. 123 in 1997, 1996 and 1995 is immaterial to
the financial statements of the Company.
NOTE 19 -- REGULATORY CAPITAL
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") and the regulations promulgated thereunder established certain
minimum levels of regulatory capital for savings institutions supervised by the
Office of Thrift Supervision ("OTS"). The Bank must follow specific capital
guidelines stipulated by the OTS which involve quantitative measures of the
Bank's assets, liabilities and certain off-balance sheet items as calculated
under regulatory accounting practices. An institution that fails to comply with
its regulatory capital requirements must obtain OTS approval of a capital plan
and can be subject to a capital directive and certain restrictions on its
operations which could have a direct material effect on the Bank's financial
statements.
At December 31, 1997 and 1996, the Bank's most recent notification from the
OTS categorized the Bank as "well capitalized" under the prompt corrective
action ("PCA") regulations adopted by the OTS pursuant to the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"). To be categorized as
F-24
<PAGE> 90
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
"well capitalized," the Bank must maintain minimum capital ratios as set forth
in the table below. The Bank's capital is subject to review by federal
regulators for the components, amounts, risk weighting classifications and other
factors. There are no conditions or events since December 31, 1997 that
management believes have changed the Bank's category.
The following table summarizes the Bank's actual capital and required
capital as of December 31, 1997 and 1996:
<TABLE>
<CAPTION>
TIER 1
TANGIBLE RISK-BASED RISK-BASED
CAPITAL CORE CAPITAL CAPITAL CAPITAL
-------- ------------ ------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
DECEMBER 31, 1997
Actual Capital:
Amount....................................... $355,650 $355,650 $352,123 $639,937
Capital ratio................................ 9.48% 9.48% 6.74% 12.24%
FIRREA minimum required capital:
Amount....................................... $ 56,249 $112,498 N/A $418,115
Capital ratio................................ 1.50% 3.00% N/A 8.00%
Excess....................................... $299,401 $243,152 N/A $221,822
FDICIA well capitalized required capital:
Amount....................................... N/A $188,574 $313,587 $522,644
Capital ratio................................ N/A 5.00% 6.00% 10.00%
Excess....................................... N/A $167,076 $ 38,536 $117,293
DECEMBER 31, 1996
Actual Capital:
Amount....................................... $348,938 $348,938 $348,938 $467,563
Capital ratio................................ 10.53% 10.53% 8.14% 10.91%
FIRREA minimum required capital:
Amount....................................... $ 49,707 $ 99,414 N/A $342,915
Capital ratio................................ 1.50% 3.00% N/A 8.00%
Excess....................................... $299,231 $249,524 N/A $124,648
FDICIA well capitalized required capital:
Amount....................................... N/A $166,838 $257,187 $428,644
Capital ratio................................ N/A 5.00% 6.00% 10.00%
Excess....................................... N/A $182,100 $ 91,751 $ 38,919
</TABLE>
F-25
<PAGE> 91
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The following table reconciles the Bank's capital in accordance with
generally accepted accounting principles ("GAAP") to the Bank's tangible, core
and risk-based capital as of December 31, 1997 and 1996:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Bank shareholder's equity -- GAAP basis................ $345,426 $337,958
Adjustment: Unrealized gains under SFAS 115............ (5,858) (1,083)
Less: Non-permissible activities at required
phase-in.......................................... (10,222) (13,135)
Add: Minority interest in equity of subsidiaries..... 29,538 28,061
Less: Disallowed capitalized servicing rights........ (3,234) (2,863)
-------- --------
Total tangible and core capital........................ 355,650 348,938
Adjustments for risk-based capital:
Subordinated debentures(1)........................... 256,311 106,559
General loan valuation allowance(2).................. 31,503 36,298
Less: Fully capitalized assets....................... (3,527) (24,232)
-------- --------
Risk-based capital................................... $639,937 $467,563
======== ========
</TABLE>
- ---------------
(1) Excludes capitalized discounts and issue costs.
(2) Limited to 1.25% of risk-weighted assets.
NOTE 20 -- DIVIDENDS
The Company paid cash dividends of $0.40, $0.39 and $0.34 per share for the
years ended December 31, 1997, 1996 and 1995, respectively. The Company declared
a stock dividend of 5% in 1996 and 1995. The 1996 and 1995 dividends and
earnings per share and share amounts have been retroactively adjusted to give
effect of the 1996 and 1995 5% stock dividends. On January 29, 1998, the Company
declared a quarterly cash dividend of $0.10 per share for shareholders of record
as of February 10, 1998, and paid on February 23, 1998.
NOTE 21 -- PENSION PLAN
The Company has an Employee Stock Ownership and Salary Savings Plan
("Pension Plan"), which covers essentially all full-time employees who have
completed one year of service. Contributions to the Pension Plan are
discretionary and determined by the Board of Directors within limits set forth
under the Employment Retirement Income Security Act of 1974. Contributions to
the Pension Plan are fully expensed in the year to which the contribution
applies.
The Company's contribution to the Pension Plan amounted to $2.4 million,
$3.4 million and $2.4 million in 1997, 1996 and 1995, respectively.
F-26
<PAGE> 92
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 22 -- INCOME TAXES
Income tax expense consisted of the following for the year ended December
31:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal................................... $ 7,792 $ 4,169 $23,860
State..................................... 2,488 1,362 7,849
------- ------- -------
10,280 5,531 31,709
Deferred:
Federal................................... 15,387 17,394 (5,628)
State..................................... 5,620 5,170 (846)
------- ------- -------
21,007 22,564 (6,474)
------- ------- -------
$31,287 $28,095 $25,235
======= ======= =======
</TABLE>
A reconciliation of total tax provisions and the amounts computed by
applying the statutory federal income tax rate of 35% to income before taxes is
as follows for the year ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Tax at statutory rate....................... $25,618 $23,534 $21,550
State tax (net of Federal tax benefit)...... 5,270 4,246 3,685
Other....................................... 399 315
------- ------- -------
$31,287 $28,095 $25,235
======= ======= =======
</TABLE>
Deferred taxes reflect the net tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Amounts previously reported as
current and deferred income tax expense have been restated. Such changes to the
components of the expense occur because all tax alternatives available to the
Company are not known for a number of months subsequent to year-end.
F-27
<PAGE> 93
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Significant components of the Company's deferred tax assets and liabilities
are as follows at December 31:
DEFERRED TAX POSITION
ASSETS/(LIABILITIES)
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Loan loss reserves................................... $ 6,936 $ 9,383
State tax deferred benefit........................... 3,939 1,857
Deferred compensation accrual........................ 3,211 2,594
Tax basis difference -- marketable securities........ 1,295 1,229
Other, net........................................... 4,110 2,596
-------- --------
19,491 17,659
Deferred tax liabilities:
Loan fee income deferred for tax purposes............ (4,335) (3,968)
FHLB dividends....................................... (4,608) (4,007)
Accelerated depreciation for tax purposes............ (565) (874)
Loan costs........................................... (1,638) (2,098)
SFAS 115 deferred taxes.............................. (4,404) (1,323)
Asset securitization income recognized for book
purposes.......................................... (28,662) (10,700)
Originated Mortgage service rights................... (7,941) (2,670)
Other, net........................................... (3,414) (3,501)
-------- --------
(55,567) (29,141)
-------- --------
$(36,076) $(11,482)
======== ========
</TABLE>
F-28
<PAGE> 94
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 23 -- BUSINESS SEGMENT DATA
In addition to its principal operations in banking, the Company conducts a
significant amount of automobile lending as presented below at December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Revenues:
Automobile lending................... $ 230,489 $ 207,514 $ 135,199
Banking operations................... 96,246 76,846 52,253
Operating profit:
Automobile lending................... 54,143 66,420 51,130
Banking operations................... 21,641 3,114 10,440
General corporate expenses........... (2,589) (2,293) 1
---------- ---------- ----------
Pretax income.......................... $ 73,195 $ 67,241 $ 61,571
========== ========== ==========
Identifiable assets:
Automobile lending................... $ 878,160 $ 675,572 $ 583,588
Banking operations................... 2,835,718 2,646,758 2,635,193
General corporate assets............. 14,987 12,715 4,017
---------- ---------- ----------
Total assets........................... $3,728,865 $3,335,045 $3,222,798
========== ========== ==========
</TABLE>
The automobile lending operations involve the purchase, origination, sale
and servicing of automobile loans. The banking operations include activities
normally associated with retail banking, mortgage banking, commercial banking
and other ancillary services. The revenues for each segment are generated
through lending and related activities from unaffiliated customers.
NOTE 24 -- FINANCIAL INSTRUMENT AGREEMENTS
The Company uses interest rate swaps, purchased options, forward
agreements, floors and caps to minimize its exposure to interest rate risk. The
fair value of these agreements may vary substantially with changes in interest
rates. At December 31, the Company's portfolio of such agreements consisted of
the following:
<TABLE>
<CAPTION>
1997
----------------------
NOTIONAL CREDIT
AMOUNT EXPOSURE
---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Interest rate swaps................................... $ 50,000 $ 802
Interest rate caps.................................... 365,000 6,087
Forward agreements.................................... 607,621
---------- ------
$1,022,621 $6,889
========== ======
</TABLE>
<TABLE>
<CAPTION>
1996
----------------------
NOTIONAL CREDIT
AMOUNT EXPOSURE
---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Interest rate swaps................................... $ 50,000 $1,490
Interest rate caps.................................... 150,000
Forward agreements.................................... 390,794 56
---------- ------
$ 590,794 $1,546
========== ======
</TABLE>
F-29
<PAGE> 95
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Notional amounts do not represent amounts exchanged by parties and, thus,
are not a measure of the Company's exposure to loss through its use of these
agreements. The amounts exchanged are determined by reference to the notional
amounts and the other terms of the agreements.
The Company's interest rate swaps consist of agreements with other parties
to exchange, at specified intervals, the difference between fixed rate and
floating rate interest amounts calculated by reference to an agreed notional
amount and a specified index. The Company pays a fixed interest rate and
receives a floating interest rate on all of its interest rate swaps. At December
31, 1997 and 1996, the terms of the Company's interest rate swaps were to pay a
weighted average fixed rate of 5.9% in each year, and to receive a weighted
average variable rate of 5.9% and 5.6%, respectively, maturing in 2002 with
collateral requirement of 1.6% to 3.0%. Variable interest rates may change in
the future.
The Company purchases interest rate caps to effectively remove lifetime
interest rate caps on mortgage-backed securities, to hedge interest rate
fluctuations on assets available for sale and to limit the erosion of net
interest income under increases in interest rates. The interest rate cap
agreements have strike rates from 6.0% to 7.5% with expiration dates ranging
from 2001 to 2004 as of December 31, 1997 and 7.5% to 8.0% with expiration dates
ranging from 1999 to 2003 as of December 31, 1996.
The Company's hedging strategy for its loan production includes the use of
forward agreements. The Company enters into these agreements in numbers and
amounts which generally correspond to the principal amount of the sale and/or
securitization transactions. The market value of these forward agreements
responds inversely to the market value changes of the underlying loans. Because
of this inverse relationship, the Company can effectively lock in its gross
interest rate spread at the time of the hedge transaction. Gains and losses
relative to these agreements are deferred and recognized in full at the time of
loan sale and/or securitization as an adjustment to the gain or loss on the sale
of loans. The Company uses only highly rated counterparties and further reduces
its risk by avoiding any material concentration with a single counterparty.
Credit exposure is limited to those agreements with a positive fair value and
only to the extent of that fair value. At December 31, 1997, the Company held
forward agreements with a notional amount outstanding of $608 million.
The current credit exposure under these agreements is limited to the fair
value of the agreements with a positive fair value at the reporting date. Master
netting agreements are arranged or collateral is obtained through physical
delivery of, or rights to, securities to minimize the Company's exposure to
credit losses in the event of nonperformance by counterparties to financial
instruments. The Company also minimizes its counterparty risk by entering into
agreements only with highly rated counterparties.
NOTE 25 -- FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair Values of Financial Instruments: Fair value information about
financial instruments, whether or not recognized in the balance sheet, for which
it is practicable to estimate that value, are reported using quoted market
prices. In cases where quoted market prices are not available, fair values are
based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and in many cases, could not be realized in immediate settlement of the
instrument. Fair values for certain financial instruments and all non-financial
instruments are not required to be disclosed. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Company.
F-30
<PAGE> 96
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents and other short-term investments: The carrying
amounts reported in the balance sheet for cash and short-term instruments
approximate those assets' fair values.
Investment securities and mortgage-backed securities: Fair values for
investment securities are based on quoted market prices, where available. If
quoted market prices are not available, fair values are based on quoted market
prices of comparable instruments.
Loans receivable (including held for sale): The fair values for loans are
estimated using discounted cash flow analyses, using interest rates currently
being offered for loans with similar terms to borrowers of similar credit
quality.
Retained interest in securitized assets: The fair value of retained
interest in securitized assets is based on discounted cash flow calculations.
Capitalized servicing rights: The fair values are estimated using
discounted cash flows based on a current market interest rate. These cash flows
generally include servicing fees, float income from payments and escrow
accounts, servicing costs, foreclosure costs and interest expense for funds
advanced.
Interest rate swaps: Interest rate swaps are carried at fair value as
hedges of available for sale securities. The fair value is determined by
obtaining market quotes from brokers.
Interest rate options, floors and caps: The carrying amount comprises the
unamortized premiums paid for the contracts. The fair value is estimated by
obtaining market quotes from brokers.
Forward agreements: The carrying amount comprises the amount of the gain or
loss deferred on expired agreements. The fair value is estimated by obtaining
market quotes from brokers.
Loan Commitments (including fixed and variable): The fair values of the
loan commitments are based on quoted market prices of similar loans sold in the
secondary market.
Deposits: The fair values disclosed for demand deposit accounts, passbook
accounts, certificate accounts, brokered certificate accounts and certain types
of money market accounts are, by definition, equal to the amount payable on
demand at the reporting date (i.e., their carrying amounts). Fair values for
fixed-rate certificates of deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on certificates
of deposit to a schedule of aggregated expected monthly maturities on time
deposits.
Securities sold under agreements to repurchase: The fair value is estimated
by using discounted cash flow analyses, based on the Company's current
incremental borrowing rates for similar types of borrowing arrangements.
Short-term borrowings: The carrying amounts of the commercial paper and the
lines of credit with a bank approximate their fair values.
Federal Home Loan Bank advances: The fair value is estimated by using
discounted cash flow analyses, based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
Amounts held on behalf of trustee: The carrying amounts reported in the
balance sheet approximate fair value.
Subordinated debentures: The fair values of the subordinated debentures are
estimated using discounted cash flow analyses, based on the current incremental
borrowing rates for similar types of borrowing arrangements.
F-31
<PAGE> 97
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The estimated fair values of the Company's financial instruments are as
follows at December 31:
<TABLE>
<CAPTION>
1997 1996
----------------------- -----------------------
CARRYING FAIR CARRYING FAIR
AMOUNTS VALUE AMOUNTS VALUE
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents..................... $ 89,293 $ 89,293 $ 75,580 $ 75,580
Other short-term investments.................. 84,136 84,136 62,798 62,798
Investment securities and mortgage-
backed securities.......................... 1,057,968 1,057,968 988,110 993,458
Loans receivable (including held for sale).... 1,872,710 1,920,419 1,731,419 1,775,141
Retained interests in securitized assets...... 181,177 181,177 121,597 121,597
Capitalized servicing rights.................. 37,417 42,768 28,640 38,257
Financial instrument agreements held for
purposes other than trading:
Interest rate swaps........................... 802 802 1,490 1,490
Interest rate options, floors and caps........ 6,087 6,087 3,796 2,004
Forward agreements............................ (2,174) 56
Fixed rate loan commitments................... 202,674 203,864 89,477 89,486
Variable rate loan commitments................ 43,643 43,756 32,106 32,305
Financial liabilities:
Deposits...................................... $2,000,896 $1,986,353 $1,873,942 $1,873,898
Securities sold under agreements to
repurchase................................. 287,071 293,323 287,412 287,933
Short-term borrowings......................... 191,880 196,121 55,945 55,945
Federal Home Loan Bank advances............... 84,971 86,849 226,000 226,410
Amounts held on behalf of trustee............. 488,653 488,653 393,449 393,449
Subordinated debentures....................... 239,195 244,481 104,917 112,154
</TABLE>
NOTE 26 -- WESTCORP (PARENT COMPANY ONLY) FINANCIAL INFORMATION
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Assets
Cash............................................... $ 3,433 $ 9,155
Investment in subsidiaries......................... 347,834 343,374
Other.............................................. 17,334 1,675
-------- --------
$368,601 $354,204
======== ========
Liabilities and shareholders' equity
Other liabilities.................................. $ 19,850 $ 36,274
-------- --------
19,850 36,274
Shareholders' equity................................. 348,751 317,930
-------- --------
$368,601 $354,204
======== ========
</TABLE>
F-32
<PAGE> 98
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Income
Interest income (expense)................... $(1,473) $ 20 $ 9
Dividends from subsidiaries................. 46,366 5,000 21,500
Other....................................... 9 (1) 1,128
------- ------- -------
44,902 5,019 22,637
Noninterest expenses.......................... 1,156 1,816 1,016
------- ------- -------
Income before income taxes and equity in net
income of subsidiaries...................... 43,746 3,203 21,621
Income tax expense (benefit).................. (1,099) (669) 49
------- ------- -------
Income before equity in net income of
subsidiaries................................ 44,845 3,872 21,572
Equity in undistributed net income (loss) of
subsidiaries................................ (8,057) 27,925 11,856
------- ------- -------
NET INCOME.................................... $36,788 $31,797 $33,428
======= ======= =======
</TABLE>
F-33
<PAGE> 99
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income................................. $ 36,788 $ 31,797 $ 33,428
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses................ (104)
Depreciation and amortization............ 343 6,262
Amortization of goodwill................. 84
Contribution to employee stock option
plan.................................. 1,181
Equity in undistributed net income of
subsidiaries.......................... 8,057 (27,925) (11,856)
Other, net............................... (2,415) 10,106 415
-------- -------- --------
NET CASH PROVIDED BY OPERATING
ACTIVITIES............................... 42,773 21,421 21,967
INVESTMENT ACTIVITIES
Infusion of capital to subsidiary.......... (15,000) (60,400) (2,000)
Net increase investment in subsidiaries.... 7,522
Purchases of investment securities
available for sale....................... (12,434)
Addition to premises and equipment......... 698 (9,021)
-------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES...... (19,214) (69,421) (2,000)
FINANCING ACTIVITIES
(Decrease) increase in short-term
borrowings............................... (15,382) 25,000
Purchase of subsidiary stock............... (4,487)
Dividends paid............................. (10,469) (10,121) (8,692)
Proceeds from issuance of common stock..... 1,057 1,057 2,166
-------- -------- --------
NET CASH (USED IN) PROVIDED BY FINANCING
ACTIVITIES............................... (29,281) 15,936 (6,526)
-------- -------- --------
(DECREASE) INCREASE IN CASH................ (5,722) (32,064) 13,441
Cash and cash equivalents at beginning of
year..................................... 9,155 41,219 27,778
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR... $ 3,433 $ 9,155 $ 41,219
======== ======== ========
</TABLE>
F-34
<PAGE> 100
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 27 -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations for
the years ended December 31, 1997 and 1996. Certain quarterly amounts have been
adjusted to conform with the year-end presentation.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
--------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
--------- ------- ------------- ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
1997
Interest income.................................... $62,530 $68,558 $ 71,300 $68,144
Interest expense................................... 36,481 40,033 42,176 42,380
------- ------- -------- -------
Net interest income.............................. 26,049 28,525 29,124 25,764
Provision for loan losses.......................... (4,371) (2,602) (2,223) (3,655)
Noninterest expense................................ (5,457) (5,718) (9,584) (2,657)
------- ------- -------- -------
Income before income taxes....................... 16,221 20,205 17,317 19,452
Income taxes....................................... 6,814 8,573 7,268 8,632
------- ------- -------- -------
Income before minority interest.................... 9,407 11,632 10,049 10,820
Minority interest in earnings of subsidiaries...... 1,511 1,747 1,121 741
------- ------- -------- -------
Net income....................................... $ 7,896 $ 9,885 $ 8,928 $10,079
======= ======= ======== =======
Net income per common share -- diluted............. $ 0.30 $ 0.38 $ 0.34 $ 0.38
======= ======= ======== =======
1996
Interest income.................................... $59,081 $58,847 $ 61,231 $63,229
Interest expense................................... 36,224 32,634 34,082 36,254
------- ------- -------- -------
Net interest income.............................. 22,857 26,213 27,149 26,975
Provision for loan losses.......................... (5,600) (1,454) (3,097) (3,420)
Noninterest income (expenses)...................... 2,387 (3,101) (14,349) (7,319)
------- ------- -------- -------
Income before income taxes....................... 19,644 21,658 9,703 16,236
Income taxes....................................... 8,074 9,090 4,237 6,694
------- ------- -------- -------
Income before minority interest.................... 11,570 12,568 5,466 9,542
Minority interest in earnings of subsidiaries...... 1,722 1,894 1,987 1,746
------- ------- -------- -------
Net income....................................... $ 9,848 $10,674 $ 3,479 $ 7,796
======= ======= ======== =======
Net income per common share -- diluted............. $ 0.37 $ 0.41 $ 0.13 $ 0.30
======= ======= ======== =======
</TABLE>
F-35
<PAGE> 101
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<S> <C> <C>
3.1 Certificate of Incorporation(a)
3.2 Bylaws(a)
4.1 Indenture dated as of June 17, 1993 issued by Western
Financial Bank, formerly Western Financial Savings Bank,
F.S.B., with respect to $125,000,000 in aggregate principal
amount of 8.50% Subordinated Capital Debentures due 2003(b)
4.2 Indenture dated as of June 25, 1997 issued by Western
Financial Bank, formerly Western Financial Savings Bank,
F.S.B., with respect to $150,000,000 is aggregate principal
amount of 8.875% Subordinated Capital Debentures due 2007(c)
10.1 Westcorp Incentive Stock Option Plan(d)
10.2 Westcorp Employee Stock Ownership and Salary Savings Plan(a)
10.3 Westcorp 1991 Incentive Stock Option Plan(e)
10.4 WFS Financial Inc ("WFS") 1996 Incentive Stock Option
Plan(f)
10.5 Westcorp Employee Stock Ownership and Salary Savings Plan(g)
10.6 Employment Agreements(h)(i)(j)(k)
22.1 Subsidiaries of Westcorp
23.1 Consent of Independent Auditors
27 Financial Data Schedule
</TABLE>
- ---------------
(a) Exhibits previously filed with Westcorp Registration Statement on Form S-4
(File No. 33-34286), filed April 11, 1990 incorporated herein by reference
under Exhibit Numbers indicated.
(b) Exhibit previously filed with Western Financial Bank, formerly Western
Financial Savings Bank, F.S.B. Offering Circular with the OTS, dated June
17, 1993 (will be provided to the SEC upon request).
(c) Exhibit previously filed with Western Financial Bank, formerly Western
Financial Bank, F.S.B. Offering Circular with the OTS, dated July 25, 1997
(will be provided to the SEC upon request).
(d) Exhibit previously filed with Westcorp Registration Statement in Form S-1
(File No. 33-04295), filed May 2, 1986, incorporated herein by reference
under Exhibit Number indicated.
(e) Exhibit previously filed with Westcorp Registration Statement on Form S-8
(File No. 33-43898), filed December 11, 1991, incorporated herein by
reference under the Exhibit Number indicated.
(f) Exhibit previously filed with WFS Registration Statement on Form S-8 (File
No. 33-07485), filed July 3, 1996, incorporated herein by reference under
the Exhibit Number indicated. Amendment No. 1 dated as of November 13, 1997
filed with the WFS Registration Statement on Form S-8 (File No. 333-40121),
incorporated herein by reference under the Exhibit Number indicated.
(g) Exhibit previously filed with Westcorp Registration Statement on Form S-8
(File No. 333-11039) and the related Form 11-K (File No. 001-09910, filed
August 29, 1996 and June 28, 1996, respectively, incorporated herein by
reference under the Exhibit Number indicated.
(h) Employment Agreement, in letter form, dated January 11, 1996 between the
Bank and Donald H. Kasle (will be provided to the SEC upon request).
(i) Employment Agreement, in letter form, dated March 11, 1997 between the
registrant and Audrey R. Kosovych (will be provided to the SEC upon
request).
(j) Employment Agreement, dated February 27, 1998 between WFS and Joy Schaefer
(will be provided to the SEC and/or the OTS upon request).
(k) Employment Agreements, dated February 27, 1998 between the registrant and
WFS and Lee A. Whatcott (will be provided to the SEC and/or the OTS upon
request).
<PAGE> 1
EXHIBIT 22.1
SUBSIDIARIES OF WESTCORP
Western Financial Bank, a Federal Savings Bank
WFS Financial Inc, a California corporation
WFS Financial Auto Loans, Inc., a California corporation
WFS Financial Auto Loans 2, Inc., a California corporation
WFS Investments, Inc., a California corporation
Western Consumer Services, Inc., a California corporation
WestFin Insurance Agency, Inc., a California corporation
Western Reconveyance Company, Inc., a California corporation
WestFin Securities Corporation, a California corporation
Westhrift Life Insurance Company, an Arizona corporation
Westran Services Corp., a California corporation
Westcorp Investments, Inc., a California corporation
The Hammond Company, The Mortgage Bankers, a California corporation
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Forms S-8 No. 33-04295, No. 33-43898 and No. 333-11039) pertaining to the
Incentive Stock Option Plan of Westcorp, the Westcorp 1991 Incentive Stock
Option Plan and the Westcorp Employee Stock Ownership and Salary Savings Plan,
respectively, and in the related prospectus of our report dated February 9,
1998, with respect to the consolidated financial statements of Westcorp included
in the Annual Report (Form 10-K) for the year ended December 31, 1997.
ERNST & YOUNG LLP
Los Angeles, California
March 12, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 157,919
<INT-BEARING-DEPOSITS> 15,510
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,064,857
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 1,869,544
<ALLOWANCE> 33,834
<TOTAL-ASSETS> 3,728,865
<DEPOSITS> 2,000,896
<SHORT-TERM> 478,951
<LIABILITIES-OTHER> 576,101
<LONG-TERM> 324,166
0
0
<COMMON> 26,279
<OTHER-SE> 322,472
<TOTAL-LIABILITIES-AND-EQUITY> 3,728,865
<INTEREST-LOAN> 187,489
<INTEREST-INVEST> 75,431
<INTEREST-OTHER> 7,612
<INTEREST-TOTAL> 270,532
<INTEREST-DEPOSIT> 107,078
<INTEREST-EXPENSE> 161,070
<INTEREST-INCOME-NET> 109,462
<LOAN-LOSSES> 12,851
<SECURITIES-GAINS> 8,026
<EXPENSE-OTHER> 241,454
<INCOME-PRETAX> 73,195
<INCOME-PRE-EXTRAORDINARY> 36,788
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 36,788
<EPS-PRIMARY> 1.41<F1>
<EPS-DILUTED> 1.40<F2>
<YIELD-ACTUAL> 3.6
<LOANS-NON> 19,785
<LOANS-PAST> 1,068
<LOANS-TROUBLED> 16,792
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 40,211
<CHARGE-OFFS> 22,806
<RECOVERIES> 4,369
<ALLOWANCE-CLOSE> 33,834
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
<FN>
<F1>For Purposes of This Exhibit, Primary means "Basic EPS" as prescribed by
Statement of Financial Accounting Standards No. 128.
<F2>For Purposes of This Exhibit, Diluted means "Diluted EPS" as prescribed by
Statement of Financial Accounting Standards No. 128.
</FN>
</TABLE>
