<PAGE> 1
Filed Pursuant to Rule 424(b)(4)
Registration Statement No. 333-11589
PROSPECTUS
$75,000,000
(LOGO) FIRST FINANCIAL CARIBBEAN
FIRST FINANCIAL CARIBBEAN CORPORATION
7.84% SENIOR NOTES DUE 2006
---------------------
Interest on the Notes will be payable semi-annually on April 10 and October
10 of each year, commencing April 10, 1997. The Notes will have no sinking fund
provisions. The Notes will be redeemable as a whole or in part, at the option of
the Company, at any time or from time to time, at a redemption price equal to
the greater of (i) 100% of their principal amount and (ii) the sum of the
present values of the remaining scheduled payments of principal and interest
thereon discounted to the date of redemption on a semiannual basis (assuming a
360-day year consisting of twelve 30-day months) at the Treasury Yield (as
defined herein) plus 25 basis points, plus in each case accrued interest to the
date of redemption.
The Notes are general unsecured and unsubordinated obligations of the
Company and will rank on a parity with any existing and future senior unsecured
indebtedness of the Company. The Notes will be effectively subordinated,
however, to all secured indebtedness of the Company as well as existing and
future obligations of the Company's subsidiaries.
The Notes will be issued only in book-entry form through the facilities of
The Depository Trust Company (the "Depository"). Interests in the Notes will be
shown in, and transfer thereof will be effected only through, records maintained
by the Depository and its participants. Except as provided herein, Notes in
definitive form will not be issued. See "Description of Notes -- Book-Entry
System."
---------------------
FOR A DISCUSSION OF CERTAIN MATERIAL FACTORS THAT SHOULD BE CONSIDERED IN
CONNECTION WITH AN INVESTMENT IN THE NOTES, SEE "RISK FACTORS" BEGINNING ON PAGE
6.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, THE OFFICE OF THE COMMISSIONER OF FINANCIAL
INSTITUTIONS OF PUERTO RICO OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION, THE OFFICE OF THE
COMMISSIONER OR ANY STATE SECURITIES COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
---------------------
THE ATTORNEY GENERAL OF THE STATE OF NEW YORK HAS NOT PASSED ON OR ENDORSED THE
MERITS OF THIS OFFERING. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
PRICE TO UNDERWRITING DISCOUNT PROCEEDS TO
PUBLIC(1) AND COMMISSIONS(2) COMPANY(1)(3)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Note.................................... 100% 1.75% 98.25%
- -----------------------------------------------------------------------------------------------------------
Total....................................... $75,000,000 $1,312,500 $73,687,500
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
</TABLE>
(1) Plus accrued interest, if any, from October 10, 1996.
(2) The Company has agreed to indemnify the Underwriter against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(3) Before deducting expenses payable by the Company, estimated at $400,000.
---------------------
The Notes are offered by the Underwriter when, as and if delivered to and
accepted by the Underwriter and subject to various prior conditions, including
the right to reject orders in whole or in part. It is expected that delivery of
the Notes will be made against payment of immediately available funds through
the facilities of the Depository, in book entry form only on or about October
10, 1996.
---------------------
BT SECURITIES CORPORATION
---------------------
THE DATE OF THIS PROSPECTUS IS OCTOBER 7, 1996.
<PAGE> 2
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE NOTES AT LEVELS
ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING,
IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
---------------------
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
There is incorporated herein by reference the following documents of the
Company heretofore filed by it with the Securities and Exchange Commission (the
"Commission"): Annual Report on Form 10-K for the year ended December 31, 1995,
Quarterly Reports on Form 10-Q for the quarters ended March 31 and June 30,
1996, and Current Reports on Form 8-K dated March 20, 1996 and September 11,
1996.
All documents filed by the Company pursuant to Section 13(a), 13(c), 14 or
15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
subsequent to the date of this Prospectus and prior to the termination of the
offering made hereby shall be deemed to be incorporated by reference into this
Prospectus and to be a part hereof from the date of the filing of such
documents. Any statement contained herein or in a document incorporated or
deemed to be incorporated by reference herein shall be deemed to be modified or
superseded for purposes of this Prospectus to the extent that a statement
contained herein or in any other subsequently filed document which also is or is
deemed to be incorporated by reference herein, modifies or supersedes such
statement. Any such statement so modified or superseded shall not be deemed,
except as so modified or superseded, to constitute a part of this Prospectus.
The Company will provide without charge to each person, including a
beneficial owner, to whom this Prospectus is delivered, upon written or oral
request of any such person, a copy of any or all of the documents incorporated
herein by reference (other than exhibits to such documents unless such exhibits
are specifically incorporated by reference into such documents). Requests for
such copies should be directed to First Financial Caribbean Corporation,
Attention: Secretary, 570 Lexington Avenue, New York, New York 10022, telephone:
(212) 759-7127.
---------------------
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Exchange
Act and, in accordance therewith, files reports and other information with the
Commission. Information as of particular dates concerning its directors and
officers and any material interest of such persons in transactions with the
Company is disclosed in proxy statements distributed to stockholders filed with
the Commission. The Company has filed with the Commission a registration
statement on Form S-3 (herein, together with all amendments, schedules and
exhibits thereto, referred to as the "Registration Statement") under the
Securities Act of 1933, as amended (the "Securities Act"), with respect to the
securities offered hereby. This Prospectus does not contain all the information
set forth in such Registration Statement, certain parts of which are omitted in
accordance with the rules and regulations of the Commission. Statements
contained herein concerning the provisions of documents are necessarily
summaries of such documents, and each statement is qualified in its entirety by
reference to the copy of the applicable document filed with the Commission. For
further information, reference is hereby made to the Registration Statement and
all such reports, proxy statements and other information filed by the Company,
which can be inspected and copied at the public reference facilities maintained
by the Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549,
and at the public reference facilities in the Commission's regional offices
located at Suite 1400, Northwestern Atrium Center, 500 West Madison Street,
Chicago, Illinois 60661, and Suite 1300, 7 World Trade Center, 13th Floor, New
York, New York 10048. Copies of such material can also be obtained from the
Public Reference Section of the Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549, at prescribed rates. Reports and other information concerning the
Company may also be inspected at the National Association of Securities Dealers,
Inc., 1735 K Street, Washington, D.C.
After the termination of the offering of the Notes to which this Prospectus
relates, the Company will provide without charge to each investor (including a
beneficial owner) in such Notes, upon written or oral request of any such
person, copies of its Annual Reports on Form 10-K filed with the Commission
(other than exhibits to such Annual Reports unless such exhibits are
specifically incorporated by reference into such Annual Reports). Requests for
such copies should be directed to First Financial Caribbean Corporation,
Attention: Secretary, 570 Lexington Avenue, New York, New York 10022, telephone:
(212) 759-7127.
2
<PAGE> 3
PROSPECTUS SUMMARY
The following summary, which is presented herein solely to furnish limited
introductory information regarding the Company and the offering, is qualified in
its entirety by, and should be read in conjunction with, the more detailed
information and the financial statements (including the notes thereto) appearing
elsewhere in this Prospectus or incorporated by reference herein.
THE COMPANY
The Company, together with its wholly-owned subsidiaries, is primarily
engaged in a wide range of mortgage banking activities, including the
origination, servicing, purchase and sale of mortgages on single-family
residences, the issuance and sale of various mortgage-backed securities, the
holding and financing of mortgage loans and mortgage-backed securities for sale
or investment, the purchase and sale of servicing rights associated with such
mortgage loans and, to a lesser extent, the origination of construction loans
and loans secured by commercial real estate (the "Mortgage Banking Business").
FFCC is the leading mortgage banking institution in Puerto Rico in terms of the
volume of origination of first mortgage loans on single-family residences. The
Company's Mortgage Banking Business is principally conducted through two
operating units: Doral Mortgage Corporation ("Doral Mortgage"), a wholly-owned
subsidiary of the Company, and HF Mortgage Bankers Division ("HF Division"), a
division of the Company. The Company is also engaged in the savings and loan
business through Doral Federal Savings Bank ("Doral Federal"), a federal savings
and loan association which was acquired by FFCC in September 1993. References
herein to the "Company" or "FFCC" shall be deemed to refer to the Company and
its consolidated subsidiaries, unless the context requires otherwise.
The Company is an approved seller/servicer for the Federal Home Loan
Mortgage Corporation ("FHLMC") and the Federal National Mortgage Association
("FNMA"), an approved issuer for the Government National Mortgage Association
("GNMA") and an approved servicer under the GNMA, FNMA and FHLMC mortgage-backed
securities programs. FFCC is also qualified to originate mortgage loans insured
by the Federal Housing Administration ("FHA") and guaranteed by the Veterans
Administration ("VA"). Prior to the acquisition of Doral Federal, substantially
all of the Company's revenues were derived from its Mortgage Banking Business.
Substantially all of FFCC's Mortgage Banking Business is conducted in
Puerto Rico, where it operates through 18 branch offices, 15 of which are
operated by Doral Mortgage. Doral Mortgage also operates two branches in Miami
and Orlando, Florida.
The Company's strategy is to increase its volume of loan originations and
its servicing portfolio as well as to maximize net interest income. The Company
seeks to increase its volume of loan originations by emphasizing quality
customer service and maintaining the most extensive system of branch offices of
any mortgage banking institution in Puerto Rico. The Company strives to increase
its servicing portfolio by relying primarily on internal loan originations and
supplementing such originations with wholesale purchases of loans and mortgage
servicing rights from third parties. The Company has traditionally emphasized
the origination of 15-year and 30-year conventional and FHA-insured ("FHA
loans") or VA-guaranteed ("VA loans") mortgage loans on single-family
residences. The Company relies on net interest income for a more significant
portion of its earnings than mortgage banking companies generally do. The
Company seeks to maximize net interest income by holding mortgage-backed
securities, primarily GNMA securities, for longer periods prior to sale than
most mortgage banking companies. This strategy has the effect of reducing the
Company's overall effective tax rate because the interest on GNMA securities
backed by Puerto Rico mortgages is tax exempt under Puerto Rico law. The Company
also seeks to increase net interest income by funding and holding for investment
through Doral Federal mortgage loans and mortgage-backed securities.
The Company's thrift subsidiary, Doral Federal, operates through two
branches in the San Juan metropolitan area, which serve primarily as
deposit-taking operations, since to date most loans held in Doral Federal's loan
portfolio have been originated pursuant to the Master Loan Production Agreement
with the Company. See "BUSINESS OF THE COMPANY -- Other Lending and Investment
Activities -- Lending
3
<PAGE> 4
Activities of Doral Federal and Real Estate Owned." Doral Federal has
experienced rapid growth since its acquisition by the Company, increasing from
$13.1 million in assets as of September 10, 1993 to $209 million in assets as of
June 30, 1996. As of June 30, 1996, Doral Federal had total deposits and net
worth of $142 million and $17.3 million, respectively. The Company intends to
commit substantial management and financial resources to continue to increase
the assets of Doral Federal by increasing the amount of loans funded and held by
Doral Federal as well as to increase its deposit base and branch network.
Although no assurance can be given, the Company expects that as Doral Federal
continues to increase the amount of its interest earning assets, the net
interest income earned by Doral Federal will continue to increase as well as the
relative contribution of Doral Federal to the consolidated earnings of the
Company.
During the second quarter of 1996, the Company organized a new subsidiary,
AAA Financial Services Corporation ("AAA Financial"), to operate as a securities
broker dealer. AAA Financial commenced operations on September 12, 1996. While
AAA Financial will engage in a general securities business, it is expected to
initially concentrate on the sale of Puerto Rico tax exempt GNMA securities and
other Puerto Rico securities. AAA Financial commenced operations from a single
branch in the San Juan metropolitan area and is expected to employ approximately
20 persons by the end of 1996.
FFCC's principal executive office is located at 1159 Franklin D. Roosevelt
Avenue, San Juan, Puerto Rico 00920, and its telephone number is (787) 749-7100.
THE OFFERING
Securities Offered............ $75,000,000 aggregate principal amount of 7.84%
Senior Notes due 2006.
Maturity Date................. October 10, 2006.
Interest Payment Dates........ April 10 and October 10 of each year,
commencing April 10, 1997.
Optional Redemption........... The Company has the option to redeem the Notes
at any time or from time to time, in whole or
in part, at the redemption price set forth
herein, together with accrued interest. See
"DESCRIPTION OF NOTES -- Optional Redemption".
Mandatory Redemption.......... None.
Certain Covenants............. The Indenture will contain certain covenants
that, among other things, limit the ability of
the Company and its subsidiaries to incur
additional Indebtedness or issue Disqualified
Stock (as defined herein), make Restricted
Payments (as defined herein), engage in certain
transactions with affiliates, effect certain
asset dispositions, create restrictions on the
ability of subsidiaries to pay dividends or to
make certain other distributions, create
certain liens and encumbrances and allow its
subsidiaries to issue or sell certain classes
of stock. The Indenture will also limit the
Company's ability to consolidate or merge with,
or transfer all or substantially all of its
assets to, another person. See "DESCRIPTION OF
NOTES -- Certain Covenants" and
"-- Consolidations, Mergers and Sales of Assets
by the Company."
Ranking....................... The Notes will be general unsecured and
unsubordinated obligations of the Company
ranking pari passu in right of payment to all
existing and future senior unsecured
indebtedness of the Company, including the
claims of general creditors of the Company, but
will be effectively subordinated to all secured
indebtedness of the Company as well as existing
and future obligations of the Company's
subsidiaries, including Doral Mortgage and
Doral Federal.
4
<PAGE> 5
Book-Entry Registration....... Upon issuance, the Notes will be represented by
one or more Global Notes (as defined herein)
deposited with the Depositary (as defined
herein) and registered in the name of the
Global Note Holder (as defined herein). So long
as the Global Note Holder is the registered
owner of any Notes, the Global Note Holder will
be considered the sole holder under the
Indenture of any Notes evidenced by the Global
Notes. Except under the limited circumstances
set forth herein, owners of beneficial
interests in Global Notes will not be entitled
to have Notes represented by such Global Notes
registered in their names and will not receive
or be entitled to receive physical delivery of
Notes in definitive form. A beneficial owner of
Notes evidenced by Global Notes will not be
considered the owner or holder thereof under
the Indenture for any purpose. See "DESCRIPTION
OF NOTES -- Book Entry; Delivery and Form."
Use of Proceeds............... The net proceeds from the sale of the Notes
offered hereby will be used to repay certain
existing indebtedness of the Company and for
general corporate purposes, including possible
acquisitions. Pending such use, the proceeds
may be temporarily invested in short-term
investments. See "USE OF PROCEEDS."
RISK FACTORS
See "Risk Factors" for a discussion of certain factors that should be
considered carefully by prospective purchasers of the Notes.
5
<PAGE> 6
RISK FACTORS
Prospective investors should consider carefully the following factors, as
well as the other information contained in this Prospectus or incorporated by
reference herein, before making an investment in the Notes.
INTEREST RATE FLUCTUATIONS; CYCLICAL NATURE OF MORTGAGE BANKING INDUSTRY
Changes in interest rates can have a variety of effects on the Company's
business. In particular, changes in interest rates affect the volume of mortgage
loan originations and acquisitions, the interest rate spread on the Company's
portfolio of loans and mortgage-backed securities, the amount of gain on sale of
loans and the value of the Company's loan servicing portfolio.
Lower interest rates tend to increase demand for mortgage loans for home
purchases, as well as the demand for refinancing of existing mortgages. Higher
interest rates make it more difficult for potential borrowers to purchase
residential properties and to qualify for mortgage loans and reduce demand for
refinance loans. As a result, higher interest rates may adversely affect the
volume of loan originations and income related to mortgage production. A
substantial portion of the Company's total mortgage loan originations has
consistently been comprised of refinancing loans. For the six months ended June
30, 1996 and the years ended December 31, 1995, 1994 and 1993, refinancing
activity represented approximately 48%, 41%, 59% and 80%, respectively, of the
Company's total dollar volume of mortgage loans originated. Although the Company
has increased home purchase originations, a significant future increase in
mortgage interest rates in Puerto Rico would adversely affect the Company's
business if it results in a significant decrease in refinancing of first
mortgage loans.
Changes in prevailing long-term market interest rates between the time the
Company commits to or establishes an interest rate on a mortgage loan and the
time commitments to purchase the mortgage loan are obtained or the loan is sold
affect FFCC's gain or loss on the sale of such mortgage loan. The Company uses
forward commitments and other hedging techniques in an attempt to reduce its
exposure to changes in interest rates pending the sale of such mortgage loans.
There can be no assurance that the hedging techniques will be successful. To the
extent they are not successful, the Company's profitability may be adversely
affected. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- Assets and Liabilities."
In addition, the market value of and income from the Company's loan
servicing portfolio may also be affected by interest rate fluctuations.
Specifically, the market value of and earnings from the Company's loan servicing
portfolio may be adversely affected as mortgage interest rates decline and loan
prepayments increase as a result of increased refinancing activity. Conversely,
a rising interest rate environment tends to positively affect the market value
of and income from the Company's loan servicing portfolio by reducing
prepayments and extending the average life of the Company's mortgage loan
servicing portfolio. See "BUSINESS OF THE COMPANY -- Mortgage Banking
Business -- Loan Servicing."
Another important element of the Company's revenues and earnings, net
interest income (interest earned less interest expenses), is directly related to
the difference (the "spread") between the interest rates at which the Company
originates mortgage loans and the interest rates on the Company's borrowings to
finance loans prior to sale. Generally, short-term interest rates are lower than
long-term interest rates and the Company benefits from the difference on the
spread during the time mortgage loans and mortgage-backed securities are held
pending sale. Increases in short-term rates relative to long-term rates could
reduce the spread and thereby adversely affect the Company's net income. A
greater proportion of the Company's net income has generally been composed of
net interest income than is typical of mortgage banking institutions in the
United States. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- Results of Operations for the Three Years ended
December 31, 1995, 1994 and 1993 -- Net Interest Income."
Doral Federal, the Company's thrift subsidiary, is also affected by changes
in interest rates. In certain interest rate environments, Doral Federal may face
greater competition in attracting deposits. In addition, since most of Doral
Federal's loans held for investment have fixed rates and because interest on
deposits will
6
<PAGE> 7
rise more quickly in a rapidly rising interest rate environment than the
composition of Doral Federal's loan portfolio, the net interest income of Doral
Federal could be adversely affected in such an environment. See "BUSINESS OF THE
COMPANY -- Other Lending and Investment Activities".
ECONOMIC CONDITIONS IN PUERTO RICO AND PHASE-OUT OF SECTION 936 TAX BENEFITS
During 1995 and the first six months of 1996, approximately 98% of the
mortgage loans originated and acquired by the Company's mortgage banking
activities, were secured by real estate located in Puerto Rico. In addition, at
December 31, 1995 and June 30, 1996, approximately 98% of loans receivable held
for investment by Doral Federal were secured by real estate located in Puerto
Rico. Any significant adverse economic developments in Puerto Rico could result
in a decrease in the volume of mortgage loans originated by FFCC or an increase
in defaults or delinquencies on mortgage loans that are serviced by FFCC or held
by FFCC pending sale in the secondary mortgage market, thereby reducing the
resale value of such mortgage loans. Any such decline in the Puerto Rico economy
could also result in an increase in the level of nonperforming assets held by
Doral Federal.
Section 936 of the U.S. Internal Revenue Code ("Section 936"), has
historically provided incentives for U.S. corporations to invest in Puerto Rico
by granting a credit to qualifying corporations ("936 Corporations") against a
portion of the U.S. income tax payable from the active conduct of a trade or
business in Puerto Rico and 100% of certain qualifying investment income derived
in Puerto Rico. Section 936 together with complementary Puerto Rico laws has
provided incentives for 936 Corporations and financial intermediaries receiving
funds from 936 Corporations to invest in mortgage loans and mortgage-backed
securities originated in Puerto Rico. Thus, Section 936 has helped to create a
pool of lower cost funds in Puerto Rico that the Company has historically used
to fund mortgage loans and mortgage-backed securities. On August 20, 1996, the
Small Business Job Protection Act of 1996 (the "Small Business Job Protection
Act") was signed into law. The Small Business Job Protection Act provides for
the elimination of the special U.S. federal income tax benefits available under
Section 936 to U.S. corporations operating and investing in Puerto Rico. The Act
repeals Section 936, subject to a ten-year grandfather rule for 936 Corporations
that were engaged in the active conduct of a trade or business on October 13,
1995 and that qualified for and elected the benefits of Section 936 for the
corporation's taxable year which includes such date. During the grandfather
period, the amount of income that will benefit from the credit available under
Section 936 derived from the active conduct of a trade or business will be
subject to varying caps. The credit available for investment income will not be
subject to the grandfather rule and will be eliminated effective for taxable
years beginning after December 31, 1995 but in no event prior to July 1, 1996.
While the final impact of a repeal of Section 936 cannot be determined at
this time, the repeal of Section 936 could have an adverse effect on the general
economic condition of Puerto Rico, the Company's predominant service area, by
reducing incentives for investment in Puerto Rico. Any such adverse effect on
the general economy of Puerto Rico could lead to an increase in mortgage
delinquencies and a reduction in the level of residential construction and
demand for mortgage loans. The elimination of Section 936, particularly the
elimination of the credit for investment income, could also lead to a decrease
in the amount of funds invested in the Puerto Rico financial market by 936
Corporations ("936 Funds"), thereby increasing funding costs and decreasing
liquidity for Puerto Rico mortgage products. The magnitude of the impact of any
such changes on the Company's profitability or financial condition cannot be
determined at this time. Management believes that the principal impact of the
loss of 936 Funds will be a moderate increase in the Company's funding costs.
The Company, however, has taken steps to attempt to reduce the impact of any
such adverse changes by diversifying its sources of funding and identifying
additional investors for its mortgage products. See "MANAGEMENTS DISCUSSION AND
ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- Liquidity and
Capital Resources." During recent periods, the disparity between the cost of 936
Funds and other sources of funding, such as the Euro-dollar market, has
decreased, thereby possibly reducing the adverse effect that the loss of such
funding may have on the profitability of the Company. In addition, any adverse
effect on liquidity should be ameliorated by the fact that during 1994, 1995 and
the first six months of 1996, 936 Corporations have not been active investors in
mortgage-backed securities.
7
<PAGE> 8
POSSIBLE CHANGES IN FAVORABLE PUERTO RICO TAX LAWS
FFCC currently benefits from Puerto Rico tax laws. Of particular importance
is the current income tax exemption available under Puerto Rico law for interest
on FHA loans and VA loans secured by residential property located in Puerto Rico
and GNMA securities backed by such mortgage loans. As a result of this
exemption, FFCC has been able to sell tax-exempt Puerto Rico GNMA
mortgage-backed securities to local investors at higher prices than those at
which comparable instruments would be sold in the mainland United States. This
exemption has also permitted the Company to reduce its effective tax rate, since
a significant portion of its net interest income is tax exempt. From time to
time, the government of Puerto Rico has examined whether the existing tax
exemption for interest received on FHA loans and VA loans should be modified or
repealed. There can be no assurance that such exemption will not be modified or
repealed in the future. Any such action could adversely affect FFCC's gain on
sale of mortgage loans and increase its effective tax rate, thereby adversely
affecting FFCC's profitability. See "BUSINESS OF THE COMPANY -- Mortgage Banking
Business -- Puerto Rico Secondary Mortgage Market and Favorable Tax Treatment."
FEDERAL PROGRAMS
The business and profitability of FFCC depend, to a large degree, on its
ability to sell mortgage loans to investors in the secondary mortgage market at
prices that are higher than the prices at which FFCC originates or purchases
such loans. The growth of the secondary mortgage market is attributable in large
part to programs maintained by the FNMA, FHLMC and GNMA. In addition, part of
the Company's business is affected significantly by the continuation of various
programs administered by the FHA for the United States Department of Housing and
Urban Development ("HUD"), which insures mortgage loans, and the VA, which
partially guarantees mortgage loans. Any discontinuation of, or significant
reduction in, the various programs administered by FNMA, FHLMC, GNMA, FHA or VA
could have a material adverse effect on the Company's operations. See "Mortgage
Banking Business -- Sale of Loans; Issuance of Mortgage Backed Securities"
herein.
POSSIBLE CHANGES IN PREVAILING REGULATORY STRUCTURE AND STATUS
The Company is subject to the rules and regulations of, and supervision by,
several Federal and Puerto Rico entities, including the Office of Thrift
Supervision (the "OTS"), FNMA, FHLMC, GNMA, FHA, VA, HUD and the Commissioner of
Financial Institutions of Puerto Rico (the "Office of the Commissioner"), with
respect to, among other things, licensing requirements, establishment of maximum
interest rates, required disclosure to customers and the origination,
processing, underwriting, selling and securitizing of mortgage loans, Although
the Company believes that it is in compliance in all material respects with
applicable Federal and Puerto Rico laws, rules and regulations, there can be no
assurance that more restrictive laws or rules will not be adopted in the future,
which could make compliance more difficult or expensive, restrict the Company's
ability to originate or sell mortgage loans or sell mortgage-backed securities,
further limit or restrict the amount of interest and other fees earned from the
origination of loans, or otherwise adversely affect the business or prospects of
the Company.
In addition, the Company is considering the possibility of converting Doral
Federal into a commercial bank, which would subject the Company to the
provisions of the Bank Holding Company Act of 1956. As a bank holding company,
FFCC would be subject to certain regulatory restrictions, such as those relating
to regulatory capital requirements and minimum leverage ratios, not currently
applicable to it. See "BUSINESS OF THE COMPANY -- Regulation -- Savings and Loan
Operations -- Possible Conversion and Regulation under the Federal Bank Holding
Company Act."
EFFECTIVE SUBORDINATION TO CREDITORS OF SUBSIDIARIES OF THE COMPANY
The Company's assets include its stock holdings of Doral Mortgage and Doral
Federal, the principal subsidiaries of the Company. Since the Company does not
own the assets of Doral Mortgage and Doral Federal, holders of the Notes are not
creditors of such subsidiaries. Accordingly, the Company's rights and the rights
of its creditors, including the holders of the Notes, to receive assets of Doral
Mortgage, Doral Federal or
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<PAGE> 9
any other subsidiary of the Company upon a liquidation or receivership of any
such subsidiary will be effectively subordinated to the claim of the creditors
of such subsidiary.
DELINQUENCY, FORECLOSURE AND OTHER CREDIT RISKS
From the time that the Company funds the mortgage loans it originates or
acquires to the time it sells them or packages them into mortgage-backed
securities, the Company is generally at risk for any mortgage loan defaults.
Once the Company sells the mortgage loans it originates or acquires or packages
them into mortgage-backed securities, generally the risk of loss from mortgage
loan defaults and foreclosures passes to the purchaser or insurer of the
mortgage loans. The degree of risk associated with servicing mortgage loans
following their sale or packaging into mortgage-backed securities is dependent
on the extent to which the servicing arrangement is on a non-recourse or
recourse basis. In recourse servicing, the servicer agrees to share the credit
risk with the owner of the mortgage loans, such as FNMA or FHLMC or with an
insurer or guarantor. Losses on recourse servicing occur primarily when
foreclosure sale proceeds of the property underlying a defaulted mortgage are
less than the outstanding principal balance and accrued interest of such
mortgage loan and the cost of holding and disposing of such underlying property.
At June 30, 1996 and December 31, 1995 and 1994, the Company was servicing
mortgage loans with an aggregate principal amount of $73 million, $85 million
and $112 million, respectively, on a recourse basis. During the years ended
December 31, 1995 and 1994 and the six months ended June 30, 1996, losses
incurred due to recourse servicing were not material.
In the ordinary course of business, the Company makes certain
representations and warranties to the purchasers and insurers of mortgage loans
and to the purchasers of servicing rights. If a mortgage loan defaults and there
has been a breach of these representations or warranties, the Company may become
liable for the unpaid principal and interest on the defaulted mortgage loan. In
such case, which would primarily arise as the result of fraudulent
representation made to the Company in the loan origination or acquisition
process, the Company may be required to repurchase the mortgage loan and bear
any subsequent loss on the mortgage loans. During 1995, 1994, and the first six
months of 1996, the impact of loans repurchased by the Company as the result of
any such fraudulent representations was not material.
The Company is also affected by mortgage loan delinquencies and defaults on
mortgage loans that it services. Under certain types of servicing contracts,
even when mortgage loan payments are delinquent, the servicer must forward all
or part of the scheduled payments to the owner of the mortgage loans. Also, to
protect their liens on mortgage properties, owners of mortgage loans usually
require the servicer to advance mortgage and hazard insurance and tax payments
on schedule even though sufficient escrow funds may not be available. The
servicer will ultimately be reimbursed by the mortgage owner or from liquidation
proceeds for payments advanced that the servicer is unable to recover from the
mortgagor. However, in the interim, the servicer must absorb the cost of funds
advanced during the time the advance is outstanding. Furthermore, the servicer
must bear the increased cost of attempting to collect on delinquent and
defaulted mortgage loans. Although these increased costs are somewhat offset
through the receipt of late fees and the reimbursement of certain direct
expenses out of foreclosure proceeds, management believes that increased
delinquencies and defaults generally increase the costs of the servicing
function. In addition, if a default is not cured, the mortgage loan will be
prepaid as a result of foreclosure proceedings. As a consequence, the Company is
required to forego servicing income from the time such loans become delinquent.
In general, economic slowdowns or recessions expose the Company to increased
delinquency and default risks. See "BUSINESS OF THE COMPANY -- Mortgage Banking
Business -- Loan Servicing".
Doral Federal holds loans for investment in its portfolio that involve a
degree of credit risk. During the six months ended June 30, 1996, the Company
increased its allowance for loan losses as a result of the growth in this
portfolio and increases in the amount of home equity and personal loans secured
by mortgages held by Doral Federal for which Doral Federal generally provides
higher allowances. While management believes that the current allowance for loan
losses is adequate, the Company intends to increase its allowance in the future
as required. However, in the event of higher than expected defaults on those
loans, the Company's results of operations would be adversely affected. See
"BUSINESS OF THE COMPANY -- Other Lending and Investment Activities" and
"-- Nonperforming Assets and Allowance for Loan Losses."
9
<PAGE> 10
ABSENCE OF A PUBLIC MARKET FOR THE NOTES
There is currently no trading market for the Notes. The Company does not
intend to apply for listing of the Notes on any national securities exchange or
automated quotation service. The Company has been advised by the Underwriter
that it currently intends to make a market in the Notes; however, the
Underwriter is not obligated to do so and may discontinue any such market making
at any time without notice. No assurance can be given as to the development or
liquidity of any trading market for the Notes or as to the prices at which the
Notes may trade in such market.
USE OF PROCEEDS
The net proceeds to be received from the sale of the Notes offered hereby
are estimated at approximately $73,287,500. The net proceeds from the sale of
the Notes will be used by the Company to repay approximately $17.7 million in
indebtedness owed by the Company under a five-year senior servicing secured loan
facility (the "Servicing Secured Facility") granted pursuant to a multi-bank
syndicated credit agreement (the "Syndicated Credit Agreement") managed by
Bankers Trust Company, the proceeds of which were used to finance the mortgage
servicing assets of the Company and for general working capital purposes ($14.3
million of which amortizes over a five year period ending on June 30, 2000 and
$3.4 million of which amortizes over a five year period ending on June 30, 2001;
and bears interest at a variable rate equal to either the one, two or three
month London Interbank Offered Rate plus 225 basis points, adjusted every month,
two months or three months, as applicable) and for general corporate purposes
which may include (i) making capital contributions to Doral Federal, AAA
Financial and other subsidiaries of the Company; (ii) financing of the mortgage
servicing assets of the Company; and (iii) funding possible acquisitions of
mortgage banking and other financial institutions. Pending such use, the
proceeds may be temporarily invested in short-term investments. The Company has
no current agreements or understandings regarding any possible acquisitions, but
will consider acquisition opportunities as they arise.
10
<PAGE> 11
CAPITALIZATION
The following table sets forth the unaudited indebtedness and
capitalization of the Company at June 30, 1996 on an actual basis and as
adjusted to give effect to the issuance of the Notes offered hereby and the
application of the proceeds therefrom, including the repayment of $15.3 million
of the Servicing Secured Facility outstanding as of June 30, 1996. In addition
to the indebtedness of the Company reflected below, at June 30, 1996, the
Company had other indebtedness consisting of deposits ($136.5 million) and
FHLB-NY borrowings ($15.4 million) incurred in the ordinary course of business.
See "BUSINESS OF THE COMPANY -- Funding." This table should be read in
conjunction with the Consolidated Financial Statements and related notes
included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1996
----------------------------
ACTUAL AS ADJUSTED(1)
-------- -----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Short-term borrowings
Loans payable............................................ $199,158 $ 199,158
Short-term portion of notes payable(1)................... 24,863 21,038
Short-term portion of securities sold under agreements
to repurchase......................................... 369,965 369,965
-------- --------
Total short-term borrowings...................... $593,986 $ 590,161
======== ========
Long-term borrowings
Long-term portion of notes payable(1).................... $ 46,860 $ 35,385
Long-term portion of securities sold under agreements
to repurchase......................................... 20,000 20,000
Convertible Subordinated Debentures(2)................... 10,000 10,000
Senior Notes offered hereby.............................. -- 75,000
-------- --------
Total long-term borrowings....................... $ 76,860 $ 140,385
======== ========
Stockholders' equity
Common Stock, $1.00 par value, 20,000,000 shares
authorized; 9,125,092 shares issued and
outstanding(3)........................................ $ 9,125 $ 9,125
Paid-in capital.......................................... 38,673 38,673
Retained earnings........................................ 92,368 92,368
Treasury Stock at par value, 14,000 shares............... (14) (14)
Unrealized loss on securities available for sale......... (301) (301)
Unearned compensation under employment contracts......... (145) (145)
-------- --------
Total stockholders' equity....................... $139,706 $ 139,706
======== ========
</TABLE>
- ---------------
(1) Of the Servicing Secured Facility being repaid with the proceeds of the
Notes, $3.825 million is included as short-term portion of notes payable
and $11.475 million is included as long-term portion of notes payable.
(2) Represents $10 million of 8.25% Convertible Subordinated Debentures due
January 1, 2006 (the "Convertible Subordinated Debentures") which are
convertible into shares of Common Stock at a conversion price of $17.50 per
share subject to certain adjustments in certain events. Approximately $8.2
million of the Convertible Subordinated Debentures are immediately
convertible into shares of Common Stock. The remaining $1.8 million of
Convertible Subordinated Debentures may not be converted into shares of
Common Stock prior to January 1, 1999.
(3) Does not include up to 571,428 shares of Common Stock issuable upon
conversion of the Subordinated Convertible Debentures outstanding as of
June 30, 1996.
11
<PAGE> 12
SELECTED FINANCIAL DATA
The following table sets forth certain selected consolidated financial and
operating data for the Company on a historical basis as of and for the six-month
periods ended June 30, 1996 and 1995, and for each of the five years in the
period ended December 31, 1995. This information should be read in conjunction
with the Consolidated Financial Statements and related notes thereto included
elsewhere herein. Financial information for the six-month periods ended June 30,
1996 and 1995 is derived from unaudited financial statements, which, in the
opinion of management, include all adjustments (consisting only of normal
recurring accruals) necessary for a fair presentation of the results for such
periods. Results for the six-month period ended June 30, 1996 are not
necessarily indicative of results for the full year.
<TABLE>
<CAPTION>
SIX MONTHS
ENDED JUNE 30, YEAR ENDED DECEMBER 31,
----------------------- --------------------------------------------------------------
1996 1995 1995 1994 1993 1992 1991
---------- ---------- ---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues............................. $ 52,019 $ 43,986 $ 91,837 $ 72,043 $ 70,228 $ 49,804 $ 39,430
Interest expense..................... 21,818 20,184 43,380 23,252 9,710 9,270 12,303
Loan origination costs and
administrative and general
expenses........................... 15,526 12,699 26,396 30,046 29,597 24,118 17,407
Income before income taxes........... 14,675 11,103 22,061 18,745 30,921 16,416 9,720
Income taxes......................... 1,288 1,536 2,500 2,530 9,601 3,371 2,987
Income before cumulative effect...... 13,387 19,560 16,215 21,320 13,045 6,733
Cumulative effect.................... -- -- -- 1,215 -- -- --
Net income........................... 13,387 9,567 19,560 17,430 21,320 13,045 6,733
Cash dividends paid.................. 2,911 2,114 4,374 3,943 3,142 2,182 1,620
BALANCE SHEET DATA:
Mortgage loans held for sale......... 263,818 190,645 245,484 263,773 262,515 128,814 83,288
Mortgage-backed securities held for
trading............................ 389,136 395,356 407,941 319,204 125,716 124,967 123,656
Securities held to maturity.......... 112,637 72,776 77,945 66,804 6,530 -- --
Securities available for sale........ 7,438 -- 14,579 -- -- -- --
Loans receivable, net................ 86,686 52,583 51,355 34,809 9,561 -- --
Mortgage notes receivable, net....... -- -- -- -- -- 7,282 23,917
Total assets......................... 989,164 831,279 917,922 768,019 486,431 320,972 270,949
Loans payable and securities sold
under agreements to repurchase..... 589,123 590,713 598,436 569,436 335,994 227,179 210,548
Notes payable........................ 71,723 31,870 51,682 17,055 -- -- --
Deposit accounts..................... 136,512 88,700 95,740 66,471 26,451 -- --
Stockholders' equity................. 139,706 97,892 129,017 90,496 76,945 58,467 36,041
PER SHARE DATA:(1)
Net Income:
Primary............................ 1.49 1.32 2.65 2.46 3.15 2.35 1.26
Fully diluted(2)................... 1.41 1.26 2.53 2.30 2.81 2.06 1.25
Cash dividends:
Common Stock....................... 0.32 0.28 0.58 0.52 0.40 0.30 0.2625
Series A Preferred Stock(2)........ 0.3825 0.525 1.05 1.05 1.05 1.05 0.525
Weighted average shares outstanding:
Primary............................ 9,020,462 7,198,324 7,307,946 6,942,734 6,614,854 5,321,600 5,135,206
Fully diluted...................... 9,679,136 7,576,964 7,760,135 7,576,964 7,516,964 6,347,392 5,411,744
OPERATING DATA:
Mortgage loans originated(3)....... 378,000 245,000 559,000 760,434 1,432,448 693,723 360,400
Mortgaged loans purchased(4)....... 46,000 44,000 77,000 63,400 1,000 29,000 48,000
Loan servicing portfolio........... $2,930,000 $2,541,000 $2,668,000 $2,644,000 $2,375,000 $1,700,000 $1,400,000
RATIO OF EARNINGS TO FIXED
CHARGES(5)......................... 1.66x 1.54x 1.50x 1.78x 4.03x 2.72x 1.78x
OTHER SUPPLEMENTAL DATA
Consolidated EBITDA(6)............. $6,215 $11,284 $22,063 $16,524 $30,817 $18,196 $11,364
Adjusted Consolidated EBITDA(7).... $8,791 -- $27,826 -- -- -- --
Ratio of Adjusted Consolidated
EBITDA to Adjusted Consolidated
Interest Expense(7).............. 2.44x -- 4.26x -- -- -- --
</TABLE>
12
<PAGE> 13
- ---------------
(1) Adjusted to reflect two-for-one stock split effective December 10, 1993.
(2) The Series A Preferred Stock was issued in July 1991 and redeemed on May 10,
1996.
(3) Excludes loans purchased from third parties.
(4) Composed exclusively of FHA/VA loans.
(5) For purposes of calculating the ratio of earnings to fixed charges, earnings
consist of income before income taxes, plus fixed charges. Fixed charges
represent interest expense on all indebtedness plus the portion of rental
expense that is representative of the interest factor.
(6) For a definition of the term Consolidated EBITDA see "DESCRIPTION OF
NOTES -- Certain Definitions" herein.
Since the major portion of the Company's interest expense is incurred
to finance mortgage loans and mortgage-backed securities, which generate
interest income, and since interest income and interest expense on such
loans are generated simultaneously, the Company believes that Consolidated
EBITDA is a more meaningful measure of its debt service ability because the
interest expense component of Consolidated EBITDA excludes funding
liabilities incurred to finance the Company's mortgage loan and
mortgage-backed securities inventory. In addition, Consolidated EBITDA
deducts from net income certain non-cash contributions to net income and
adds back to net income certain non-cash charges.
Set forth below is a computation of Consolidated EBITDA for the periods
presented:
<TABLE>
<CAPTION>
SIX MONTHS
ENDED JUNE 30, YEAR ENDED DECEMBER 31,
----------------- -----------------------------------------------
1996 1995 1995 1994 1993 1992 1991
------- ------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Net Income..................................... $13,387 $ 9,567 $19,560 $17,431 $21,320 $13,044 $ 6,773
------- ------- ------- ------- ------- ------- -------
Depreciation and amortization.................. 862 774 1,765 1,534 698 519 433
Amortization of excess servicing fees
receivable................................... 629 441 988 567 161 28 0
Amortization of mortgage servicing rights...... 467 274 562 730 492 506 560
Amortization of cost in excess of fair value of
net assets acquired.......................... 188 188 376 358 255 247 247
Amortization of unearned compensation under
employment contracts......................... 48 32 64 65 300 235 157
Allowance for loan losses...................... 366 166 352 300 1,012 715 166
Additions to excess servicing fees
receivable................................... (7,683) (1,194) (2,639) (5,859) (3,103) (550) 0
Originated mortgage servicing rights........... (4,593) (550) (2,600) 0 0 0 0
Amortization of debt issue cost................ 231 50 372 83 81 81 81
Taxes.......................................... 1,288 1,536 2,500 2,530 9,601 3,371 2,987
Effect of change in accounting principle....... 0 0 0 (1,215) 0 0 0
Interest on debt, excluding "Permitted
Indebtedness"................................ 1,025 0 763 0 0 0 0
------- ------- ------- ------- ------- ------- -------
Total adjustments to net income........ (7,172) 1,717 2,503 (907) 9,497 5,152 4,631
------- ------- ------- ------- ------- ------- -------
Consolidated EBITDA.................... $ 6,215 $11,284 $22,063 $16,524 $30,817 $18,196 $11,364
======= ======= ======= ======= ======= ======= =======
</TABLE>
The Company has included information concerning Consolidated EBITDA
here because it is used by certain investors as a measure of the Company's
ability to service its debt. Consolidated EBITDA is not a measure of
financial performance under generally accepted accounting principles and
should not be considered as an alternative to net income as a measure of
operating performance or to cash flows from operating activities as a
measure of liquidity.
(7) For definitions of the terms Consolidated EBITDA and Consolidated Interest
Expense see "DESCRIPTION OF NOTES -- Certain Definitions" herein. Adjusted
Consolidated EBITDA and Adjusted Consolidated Interest Expense give effect
to the sale of the Notes offered hereby and the application of the net
proceeds therefrom to retire approximately $15.3 million of the Servicing
Secured Facility outstanding as of June 30, 1996, as if such transaction
had occurred on the first day of each period presented. Both Adjusted
Consolidated EBITDA and Adjusted Consolidated Interest Expense reflect an
assumed interest rate of 8.5% per annum on the Notes, or $6.4 million and
$3.2 million for the year ended December 31, 1995, and the six months ended
June 30, 1996, respectively, and that no interest or income is received
during such period on the portion of the proceeds of the Notes not used to
retire the Servicing Secured Facility.
13
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
FFCC experienced significant growth in its business from 1991 to 1993,
reaching record levels in 1993 as a result of the historically low levels of
interest rates and the increased demand for refinancing loans. Mortgage
production decreased in 1995 and 1994, as compared to 1993, as a result of
decreased demand for refinancing loans. FFCC, nevertheless, continued to be the
leading originator of mortgage loans in Puerto Rico, in terms of the volume of
originations of first mortgages on single family residences. The volume of loans
originated and purchased by FFCC was approximately $636 million, $824 million,
$1.44 billion, $724 million and $408 million for the years ended December 31,
1995, 1994, 1993, 1992 and 1991, respectively.
The increases in 1992 and 1993 were primarily due to declines in mortgage
interest rates which declined to their lowest levels in decades during 1993,
thereby stimulating demand for both refinancing loans and loans to finance the
acquisition of new and existing residential units. The decrease in 1994 as
compared to 1993 is attributable to rising interest rates causing a lower level
of loan originations, decreased refinancing activity and increased competition.
The decrease in 1995 as compared to 1994 was the result of continued reduced
demand for mortgage loans, especially refinancing loans. Refinancing loans
comprised 41% of loan originations in 1995 compared to 59% and 80% in 1994 and
1993, respectively.
During 1992 and 1993, the Company's strategy was to increase its servicing
portfolio through internal originations. As a result of the high volume of loans
originated in those years, the Company was not active in the wholesale loan
purchase market during 1992 and 1993. The Company became active again in the
Puerto Rico wholesale mortgage loan purchase market during the second quarter of
1994 in order to diversify its sources of loan production and compensate for the
decrease in volume caused by higher interest rates and increased competition.
The amount of loans purchased from third parties was approximately $77 million,
$63 million, $1 million, $29 million and $48 million for the years ended
December 31, 1995, 1994, 1993, 1992 and 1991, respectively. The Company believes
that the purchase of mortgage loans is a low cost method of increasing mortgage
loan production that complements retail loan originations. Purchases of loans
from third parties are generally limited to FHA and VA loans.
The Company entered the savings and loan industry in September 1993 through
the acquisition of all the outstanding stock of Doral Federal, which formerly
operated under the name of Catano Federal Savings Bank. Doral Federal operates
through two branches in Puerto Rico. During the year ended December 31, 1994,
Doral Federal contributed only $205,000 to the consolidated net income of the
Company as a result of the incurrence of expenses associated with creating the
infrastructure necessary to support bank growth. For the year ended December 31,
1995, Doral Federal's net income increased to $1.5 million, reflecting a
substantial increase in interest earning assets. Doral Federal increased its
assets from $86.4 million as of December 31, 1994 to $160.4 million as of
December 31, 1995. This growth was funded largely through increases in
certificate of deposit accounts, non-interest bearing deposits from affiliated
companies, advances from the Federal Home Loan Bank of New York ("FHLB-NY") and
the private placement of five year notes secured by FHLB-NY letters of credit
with 936 Corporations electing the benefits of Section 936.
FFCC's results of operations are primarily influenced by: (i) the direction
of interest rates; (ii) the level of demand for mortgage credit, which is
affected by such external factors as the level of interest rates and the
strength of the economy in Puerto Rico; and (iii) the relationship between
mortgage interest rates and the costs of funds.
14
<PAGE> 15
The principal components of FFCC's revenues are: (i) mortgage loan sales
and fees; (ii) net interest income; (iii) servicing income; (iv) gain on sale of
servicing rights; and (v) other income.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
----------------- ---------------------------
1996 1995 1995 1994 1993
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Mortgage loan sales and fees..................... $13,422 $ 3,705 $13,529 $10,573 $35,230
Interest income.................................. 32,600 30,918 61,907 46,508 23,775
Interest expense................................. 21,818 20,184 43,380 23,252 9,710
Net interest income.............................. 10,782 10,734 18,527 23,256 14,065
Servicing income................................. 5,697 5,441 10,577 11,448 8,627
Gain on sale of servicing rights................. 0 3,623 5,205 3,003 2,378
Other income..................................... 300 299 620 511 218
</TABLE>
RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1995, 1994 AND
1993.
Net Income. The Company's net income for the year ended December 31, 1995
increased to $19.6 million compared to $17.4 million for 1994. Consolidated
results include the operations of Doral Federal, which was acquired by the
Company in September 1993. Doral Federal contributed approximately $1.5 million
to the Company's consolidated net earnings in 1995, compared to $205,000 for
1994. Consolidated results for 1995 reflect the adoption by the Company as of
April 1, 1995 of Statement of Financial Accounting Standards ("SFAS") No. 122,
"Accounting for Mortgage Servicing Rights." Additional net income of
approximately $1.5 million was realized for the year ended December 31, 1995 as
a result of the adoption of SFAS No. 122. Since SFAS No. 122 does not permit
retroactive application, the results for 1995 are not directly comparable to
prior years. See "New Accounting Standards" herein. Results for 1994 include a
one time benefit of $1.2 million from the cumulative effect of the adoption of
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities"
as of January 1, 1994. This pronouncement requires the Company to carry its
mortgage-backed securities inventory at market value. Any gains or losses from
market fluctuations are reflected in the Company's results from operations.
Revenues from Mortgage Loan Sales and Fees. As part of its mortgage
banking business, FFCC sells substantially all of the loans that it originates,
except for certain mortgage loans originated by Doral Federal, which are
generally held until maturity. When FFCC sells mortgage loans and
mortgage-backed securities, it realizes a gain or loss which is equal to the
difference between FFCC's carrying cost and the selling price of the loans sold,
net of commitment fees paid. Net gain or loss on sale of loans is affected by
interest rate fluctuations on fixed-rate loans and securities, as well as by the
tax status of interest on mortgage loans under Puerto Rico income tax statutes.
See "RISK FACTORS -- Interest Rate Fluctuations; Cyclical Nature of Mortgage
Banking Industry" and "-- Possible Changes in Favorable Puerto Rico Tax Laws."
Substantially, all the mortgage loans originated by FFCC are fixed interest rate
loans.
Revenues from mortgage loan sales and fees increased by 28% during 1995,
compared to a decrease of 70% in 1994 and an increase of 43% in 1993. The
increase for 1995 was primarily due to the adoption SFAS No. 122 during the
second quarter of 1995, which had the effect of increasing mortgage loans sales
and fees by approximately $2.6 million. SFAS No. 122 has the effect of
increasing the gain on the sale of mortgage loans by requiring that the carrying
costs of mortgage loans be reduced by a proportion of the fair value of the
related mortgage servicing rights. The decrease in 1994 was due to interest rate
increases resulting in a lower level of loan originations, lower gains on the
sale of mortgage loans and pressures on pricing as a result of increased
competition. The increase for 1993 was the result of increased volume of loan
originations due to a sharp decline in interest rates and increased gains on
sale of mortgage loans, as a result of favorable market conditions which
permitted the Company to obtain better prices on sales of mortgage loans and
mortgage-backed securities.
The total volume of loans originated and purchased was approximately $636
million for the year ended December 31, 1995, compared to $824 million for the
prior year. Demand for mortgage loans, especially refinancing loans, continued
lower during 1995, notwithstanding a decrease in interest rates during 1995. The
increase in prevailing interest rates during 1994 significantly decreased the
unusually high refinancing activity
15
<PAGE> 16
experienced during 1993. Refinancing loans comprised 41% of production for 1995
versus 59% in 1994 and 80% in 1993. During 1995, decreased demand for mortgage
loans in the Puerto Rico market led to increased competition among mortgage
bankers and banks to attract prospective borrowers. FFCC, however, continues to
be the largest originator of mortgage loans in Puerto Rico. In 1995, the Company
issued $366 million of GNMA mortgage-backed securities to rank No. 1 in Puerto
Rico and No. 31 in the USA in such issuances according to the "Mortgage
Marketplace."
During 1995, the Company continued its program of pooling non-conforming
conventional loans into collateralized mortgage obligations ("CMOs") to be
issued by grantor trusts for sale to investors. Mortgage loan sales and fees
reflect pretax profits of approximately $253,000, $463,000 and $3.5 million for
the years ended December 31, 1995, 1994 and 1993, respectively, in connection
with the pooling and sale of approximately $75 million, $101 million and $115
million, respectively, in conventional non-conforming mortgage loans to various
grantor trusts. While the Company anticipates that it will enter into similar
transactions in the future, especially with non-conforming loans, the frequency
of such transactions and future gains related thereto, if any, will be dependent
on then existing market conditions.
Sales of mortgages loans made during 1995 resulted in the recording of
approximately $2.6 million of excess servicing fee receivable compared to $5.8
million and $3 million in 1994 and 1993, respectively. FFCC capitalizes as an
asset any excess servicing fees receivable on loans sold with servicing rights
retained whenever the stated servicing fee rate is materially higher than the
servicing fee normally permitted by FNMA or FHLMC. The excess servicing fee
receivable represents the discounted present value of the excess of the interest
rate on the loan over a normal servicing fee and the interest required to be
paid to investors. The excess servicing fee receivable is recognized at the time
of sale of the related loan as an adjustment to the resulting gain or loss on
sale of the loan and is recorded in the accompanying Consolidated Statement of
Income and Retained Earnings under "Mortgage loan sales and fees" even though
such amount is received by the Company over the life of the loan.
The amortization of excess servicing fees is based on the amount and timing
of estimated future cash flows. See Note 2 to the Notes to Consolidated
Financial Statements. Amortization of such excess servicing fees for each of the
years ended December 31, 1995, 1994 and 1993 was approximately $988,000,
$570,000 and $160,000, respectively. The amortization of excess servicing fee
receivable is recorded as a reduction of servicing income.
For the years ended December 31, 1995 and 1993, increases in mortgage loan
sales and fees were net of losses on options on futures contracts used for
hedging purposes in the amounts of $5.4 million and $1.4 million, respectively,
while in 1994 such hedging activities produced gains in the amount of $2.2
million, thereby increasing mortgage loan sales and fees by the same amount.
Net Interest Income. Net interest income is the difference between the
interest income earned on mortgage loans and mortgage-backed securities held for
trading and for investment, and the interest paid by FFCC on the short-term
warehousing lines of credit with commercial banks, repurchase agreements,
gestation lines of credit, and advances and deposits (in the case of Doral
Federal) and other financing arrangements used to finance the carrying of such
loans and mortgage-backed securities. The conditions that affect net interest
income from period to period include the relationship between prevailing
mortgage rates and the prime rate, the London Interbank Bid Rate for deposit of
U.S. dollars ("LIBID"), the cost of 936 Funds, interest rates on fixed-rate
loans and the Company's average holding period before mortgage loans are sold.
In each year since FFCC's inception, interest income earned by FFCC on its
mortgage loans and mortgage-backed securities has exceeded interest expense on
FFCC's short-term borrowings and other financing arrangements. Net interest
income decreased by approximately 20% from 1994 to 1995, and increased by
approximately 65% from 1993 to 1994. The decrease in net interest income
reflects lower interest spreads, primarily from mortgage banking operations, as
mortgage interest rates declined more rapidly than short-term interest rates
payable on warehousing and repurchase agreements lines of credit and the other
funding vehicles used to finance such assets. The Company's weighted average
interest rate spread was approximately 250 basis points during 1995 as compared
with approximately 385 basis points and 411 basis points during 1994 and 1993,
respectively. The decrease also reflects additional interest costs incurred in
16
<PAGE> 17
connection with borrowings not directly related to interest earning assets,
including a servicing secured bank term loan and ten-year convertible
subordinated debentures. See "Liquidity and Capital Resources." The decrease in
the interest rate spread from 1993 to 1994 was due to higher short-term
borrowing costs. The Company has been able to continue to maintain a positive
interest spread due to, among other things, the origination of higher yielding
mortgages and the funding of mortgage loans held by Doral Federal through lower
costing deposits and the availability of low cost 936 Funds. As of December 31,
1995, approximately $49.5 million ($18.5 million of such deposits are not
reflected in the Consolidated Financial Statements of the Company because of
inter-company eliminations) or 43% of total deposits held at Doral Federal of
non-interest bearing accounts, were comprised primarily of servicing accounts
and corporate demand accounts maintained by the Company and its affiliates.
Doral Federal contributed approximately $4.3 million or 23% of the
consolidated net interest income of the Company for the year ended December 31,
1995 compared to $2.1 million or 9% for the year ended December 31, 1994. This
increase reflects an increase in average interest earning assets from $70.8
million for the year ended December 31, 1994 to $106.8 million for the year
ended December 31, 1995 and the maintenance of an average interest rate spread
of 407 basis points for 1995 compared to 430 basis points for 1994.
Net interest income has generally represented a greater proportion of the
Company's total net income than that of typical mortgage banking institutions.
This results primarily from the fact that the Company is able to finance a
substantial portion of the mortgage loans that it originates with lower cost
funds and holds mortgage-backed securities, mainly GNMA certificates, for longer
periods of time prior to sale than is customary for mortgage bankers in the
United States, in order to maximize the interest produced by these securities.
During the year ended December 31, 1995, the Company held mortgage loans and
mortgage-backed securities for an average period of 352 days prior to sale as
compared to 212 days for the year ended December 31, 1994. This increase in the
amount of days mortgage loans and mortgage-backed securities were held prior to
sale was due principally to a decision made by the Company in the first quarter
of 1994 to increase its level of holding of mortgage-backed securities for
future sale and to maximize the interest income produced by these securities
prior to sale, a substantial portion of which is tax-exempt to the Company under
Puerto Rico law. The result was to increase the Company's net interest income
and its level of assets held for sale, while decreasing the Company's effective
tax rate.
Increases in prevailing interest rates from the time the Company originates
a mortgage loan to the time it is sold in the secondary market may lead to
reductions in the value of the Company's portfolio of mortgage loans and
mortgage-backed securities, thereby reducing gain on sale of mortgage loans.
Interest rate fluctuations can also adversely affect the Company's net interest
income. FFCC attempts to manage these risks through the use of various hedging
techniques, including the purchase of listed put options on various instruments.
There can be no assurance that such hedging techniques will be successful. To
the extent they are not, the Company's profitability could be adversely
affected.
Loan Servicing Fees. Loan servicing fees represent revenues earned by FFCC
for administering mortgage loans. FFCC's loan servicing fees depend on the type
of mortgage loan being serviced and ranges from 0.25% to 0.50% of the declining
outstanding principal amount of such loan. The size of FFCC's loan servicing
portfolio and the amount of its servicing fees have increased substantially
since FFCC's inception as a result of increases in loan originations and the
size of its servicing portfolio. Loan servicing fees, however, decreased 8% from
1994 to 1995. Servicing fees had increased 33% from 1993 to 1994 and 20% from
1992 to 1993. The decrease in loan servicing income during 1995 was due
primarily to sales during 1995 and the last quarter of 1994 of mortgage
servicing rights aggregating approximately $512 million. Increases in the amount
of loan servicing fees for 1994 and 1993 were primarily due to increases in the
principal amount of loans serviced as compared to prior years. The mortgage
servicing portfolio was approximately $2.67 billion at December 31, 1995,
basically the same level that existed as of December 31, 1994. At December 31,
1995, less than 2% of the Company's servicing portfolio was related to mortgages
originated outside Puerto Rico (all of which were originated in Florida).
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During 1995, total amortization of mortgage servicing rights ("MSRs")
amounted to $562,054 versus $730,059 for 1994. Amortization of MSRs is included
as a component of "Other Expenses" in the Company's financial statements. The
Company's traditional strategy has been to increase the size of its servicing
portfolio through internal originations. However, during 1994, the Company
reentered the wholesale loan market by purchasing mortgage loans from third
parties as a means of compensating for the decrease in volume. This strategy has
proven to be effective in the past. During the years ended December 31, 1995 and
1994 the Company capitalized $8.2 million and $581,130, respectively, of MSRs.
The amount of principal prepayments on mortgage loans serviced by the
Company was $160 million, $281 million and $537 million for the years ended
December 31, 1995, 1994 and 1993, respectively. This represented approximately
6%, 11% and 26% of the aggregate principal amount of mortgage loans serviced
during such periods and the average size of the loans prepaid was $37,800,
$41,800 and $54,600, respectively. Principal prepayments declined during 1995
and 1994 as a result of decreased refinancing activity following the refinance
boom of 1993.
Increases in prepayment rates over anticipated levels adversely affect a
mortgage company's revenues and liquidity by increasing the amortization rates
for MSRs and excess servicing fees receivable as well as requiring the Company
to recognize an impairment over and above scheduled amortization. Amortization
and impairment of MSRs have the effect of reducing servicing income. To date,
the primary means used by the Company to reduce the sensitivity of its servicing
fee income to changes in interest and prepayment has been the development of a
strong internal retail origination network that has allowed the Company to
increase or maintain the size of its servicing portfolio even during periods of
high prepayment. The portion of the Company's mortgage servicing portfolio
consisting of MSRs that were originated by the Company prior to the adoption of
SFAS No. 122, and therefore is not reflected as an asset on the Company's
Financial Statements, is not subject to amortization or impairment.
Gain on Sale of Servicing Rights. During the years ended December 31,
1995, 1994 and 1993, the Company sold servicing rights of $310 million, $202
million and $199 million, respectively, realizing pretax gains of approximately
$5.2 million, $3.0 million and $2.4 million, respectively. While the Company's
strategy is to continue to increase the size of its servicing portfolio by
retaining the servicing rights to the mortgage loans it originates, the Company
may continue to sell servicing rights in the future when market conditions are
favorable.
Other Income and Expenses. Other income increased 21% in 1995 as compared
to 1994, and 134% from 1993 to 1994. The increases during 1995 and 1994 were due
primarily to increased fees earned by Doral Federal.
Aggregate expenses in 1995 increased by $16.5 million compared to the same
period for 1994, as a result of higher interest expense associated with the
financing of the Company's mortgage loans and mortgage-backed securities
portfolios. Telephone and advertising expense decreased 19% and 41%,
respectively, over 1994 levels as a result of cost containment measures
implemented by management commencing in 1994 in connection with the reduction in
volume of mortgage loan originations.
For 1994 compared to 1993 aggregate expenses increased by approximately
36%. This increase reflected increases in interest, telephone and rent expenses
of 139%, 21% and 39%, respectively, as compared to 1993. Professional services,
rent and telephone expenses increases were attributable to the growth
experienced by the Company in both personnel and asset size. Employee costs in
1994 reflected approximately $1.75 million in voluntary reductions taken by the
Chief Executive Officer in salary and incentive compensation.
Puerto Rico Income Taxes. The Puerto Rico maximum statutory corporate
income tax rate is 42%. Such maximum rate was reduced to 39% for taxable years
commencing after June 30, 1995. For 1995, the effective income tax rate of FFCC
was 11.33% as compared to 16.3% for 1994 and 31.0% for 1993. The decrease in
effective tax rates for 1995 and 1994 compared to 1993 was mainly due to the
increase in holdings of tax exempt GNMA mortgage-backed securities. The decrease
for 1995 also reflects a tax deduction for the value of shares previously
granted under employment agreements.
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<PAGE> 19
The lower effective tax rates (as compared to the maximum statutory rate)
experienced by FFCC, especially those experienced in 1995 and 1994, reflect the
fact that the portion of the net interest income derived from certain FHA and VA
mortgage loans secured by property located in Puerto Rico and on GNMA securities
backed by such mortgage loans is exempt from income tax under Puerto Rico law.
Income tax savings to FFCC attributable to this exemption amounted to
approximately $4.6 million, $5.4 million and $2.7 million for the years ended
December 31, 1995, 1994 and 1993, respectively. Note 21 to the Company's
Consolidated Financial Statements includes a reconciliation of the provision for
income taxes to the amount computed by applying the applicable Puerto Rico
statutory tax rates to income before taxes.
RESULTS OF OPERATIONS FOR SIX MONTHS ENDED JUNE 30, 1996 AND 1995
The Company's net income for the six months ended June 30, 1996 increased
to $13.4 million, compared to $9.6 million for the corresponding period in 1995.
For the six-month period ended June 30, 1996, Doral Federal contributed
approximately $1.2 million in net income compared to $574,000 for the six months
ended June 30, 1995. Results for the first six months of 1996 reflect the
adoption by the Company as of April 1, 1995 of SFAS No. 122. Additional net
income of approximately $2.8 million was realized for the six months ended June
30, 1996, compared to $320,000 for the six-month period ended June 30, 1995,
from the adoption of SFAS No. 122. During the first six months of 1996, the
Company did not sell any mortgage servicing rights, while in the comparable
period of 1995 the Company had gains on sales of servicing rights of
approximately $3.6 million.
Revenues from mortgage loan sales and fees increased 262% to $13.4 million
from $3.7 million a year ago. This increase was due to a higher volume of loan
originations and higher loan sales and fees. The increase also reflected hedging
gains of approximately $4.4 million for the first six months of 1996, compared
to hedging losses of $3.3 million for the first six months of 1995. Hedging
gains reflect the increase in interest rates experienced during the period. The
total volume of loans originated and purchased was approximately $424 million
for the six-month period ended June 30, 1996, compared to approximately $289
million for the six-month period ended June 30, 1995. The increase of 47% in
loan originations and purchases was the result of increased demand for
refinancing loans. Refinancing loans comprised 48% of production in the first
six months of 1996 compared with 39% for the same period in 1995. Mortgage loan
sales and fees also reflect approximately $4.6 million of additional gains on
sale of mortgage loans as the result of the adoption of SFAS No. 122.
Net interest income increased by approximately $48,000 for the six-month
period ended June 30, 1996 versus the comparable period of 1995. The weighted
average interest rate spread was 266 basis points during the six months ended
June 30, 1996 compared to 302 basis points for the comparable period of 1995.
Doral Federal contributed approximately $3.2 million and $1.8 million to the
consolidated net interest income of the Company for the six month periods ended
June 30, 1996 and 1995, respectively.
Loan servicing income increased 5% to $5.7 million for the six-month period
ended June 30, 1996, compared to $5.4 million for the same period in 1995.
Amortization of excess servicing fee receivable for each of the six-month
periods ended June 30, 1996 and 1995 was approximately $629,000 and $441,000,
respectively. The amortization of excess servicing fees receivable is recorded
as a reduction of servicing income. For the six-month periods ended June 30,
1996 and 1995, amortization of mortgage servicing rights was $467,000 and
$274,000, respectively. Amortization of servicing rights is recorded as a
component of "Other Expenses."
Aggregate expenses for the six-month period ended June 30, 1996 increased
by $4.5 million compared to the same period for 1995, primarily because of
higher interest expense associated with the financing of the Company's mortgage
loans and mortgage-backed securities portfolios and additional interest expense
of $1 million attributable to financing costs not directly related to interest
earning assets. Loan origination, general and administrative expenses increased
by $2.8 million compared to the same period for 1995, due to investments in
increasing loan origination capacity.
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LIQUIDITY AND CAPITAL RESOURCES
The Company's cash requirements arise from loan originations and purchases,
repayments of debt upon maturity, payments of operating and interest expenses,
servicing advances and loan repurchases. The Company's primary sources of
liquidity are sales in the secondary mortgage market of the loans it originates
and purchases, short term borrowings under warehouse, gestation and repurchase
agreement lines of credit secured by pledges of its loans and mortgage-backed
securities (in most cases until such loans are sold and the lenders repaid) and
revenues from operations. In the past, the Company has also relied on
privately-placed debt financings and public offerings of preferred and common
stock. Doral Federal, the Company's thrift subsidiary, also relies on deposits,
borrowings from the FHLB-NY as well as term notes backed by letters of credit of
the FHLB-NY.
Total liabilities were approximately 6.08 and 6.12 times stockholders'
equity at June 30, 1996 and December 31, 1995, respectively. The Company's
decreased leverage at June 30, 1996 reflects a net increase in stockholders'
equity of $10.7 million and an increase in liabilities of $60.6 million,
primarily as a result of an increase in deposit accounts held by Doral Federal.
The interim Consolidated Statement of Cash Flows reflects the working
capital needs of the Company. Operating activities provided approximately $10.1
million of net cash during the six-month period ended June 30, 1996, compared to
approximately $22.9 million in the comparable period of 1995. Mortgage loan
originations for the six-month period ended June 30, 1996 increased by 47% as
compared to the 1995 period. Increased originations resulted in increased sales
of mortgage-backed securities and loans held for sale during the period. FFCC
held mortgage loans (including mortgage loans converted into mortgage-backed
securities) prior to sale for an average period of approximately 267 days for
the six-month period ended June 30, 1996 and 352 days during the year ended
December 31, 1995. The decrease in days was due to increased sales of
mortgage-backed securities held for trading.
Investing activities used cash of approximately $83.9 million during the
six-month period ended June 30, 1996, due primarily to origination of loans
receivable and purchases of securities held to maturity of approximately $41.2
million and $40.2 million, respectively. The Company capitalized $5.8 million of
mortgage servicing rights during the first half of 1996 related to the adoption
of SFAS No. 122 and mortgage loan purchases from third parties.
During the first six months of 1996, financing activities provided
approximately $63.4 million of net cash, primarily due to additional deposits
amounting to approximately $40.8 million received by Doral Federal, the
Company's thrift subsidiary, and an increase of approximately $20 million in
notes payable, of which approximately $15 million represent term notes issued by
Doral Federal.
Servicing agreements relating to the mortgage-backed securities programs of
FNMA, FHLMC and GNMA and certain other investors and mortgage loans sold to
certain other purchasers, require FFCC to advance funds to make scheduled
payments of principal, interest, taxes and insurance, if such payments have not
been received from the borrowers. FFCC generally recovers funds advanced
pursuant to these arrangements within 30 days. During the six-month period ended
June 30, 1996, the monthly average amount of funds advanced by the Company under
such servicing agreements was approximately $5.9 million.
During the six-month period ended June 30, 1996, the Company collected an
average of approximately $950,000 per month in net servicing fees, including
late charges. At June 30, 1996 and December 31, 1995, the servicing portfolio
amounted to approximately $2.9 billion and $2.7 billion, respectively. The
Company may, from time to time, determine to sell portions of its servicing
portfolio and to purchase servicing rights from third parties.
FFCC expects that it will continue to have adequate liquidity and financing
arrangements to finance its operations. The Company will continue to explore
alternative and supplementary methods of financing its operations, including
both debt and equity financing. There can be no assurance, however, that the
Company will be successful in consummating any such transactions.
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For additional information regarding the funding sources of the Company see
"BUSINESS OF THE COMPANY -- Funding."
ASSETS AND LIABILITIES
At June 30, 1996, total assets were $989 million compared to $918 million
at December 31, 1995. This increase was due primarily to a net increase of $34.7
million and $35.4 million in securities held to maturity and loans receivable,
respectively, at Doral Federal. As of June 30, 1996, Doral Federal had $209
million in assets, compared to $160 million at December 31, 1995. Total
liabilities were $849 million at June 30, 1996, compared to $789 million at
December 31, 1995. This increase was largely the result of an increase in
deposit accounts at Doral Federal. At June 30, 1996, Doral Federal's deposit
accounts totaled $142 million, compared to $114 million at December 31, 1995.
Deposit accounts include $28.1 million in non-interest bearing demand deposits
representing escrow funds and other servicing accounts from First Financial's
servicing operations. The increase in deposits is primarily due to the offering
of competitive interest rates and increased market recognition achieved by Doral
Federal.
The Company's Mortgage Banking Business is subject to the risk that future
changes in interest rates may adversely affect the value of the Company's
portfolio of mortgage loans and mortgage-backed securities. Interest rate
fluctuations may also adversely affect net interest income. FFCC attempts to
reduce these risks through forward commitments and other hedging techniques.
The Company does not generally hedge conventional loans in the pipeline or
in the process of origination because the Company does not generally permit
customers to lock-in an interest rate prior to closing. Instead the interest
rates on loans are generally fixed at closing based on a certain spread over a
prevailing rate that adjusts weekly. For FNMA and FHLMC conforming loans and
FNMA and FHLMC mortgage-backed securities, the Company seeks to sell or obtain
commitments for the purchase of such loans or mortgage-backed securities
following the funding of such loans. These loans are normally sold to
institutional investors or to FNMA and FHLMC. To the extent the Company does
engage in offerings of mortgage products which lock-in the interest rate until
the closing date, it attempts to obtain forward commitments at the time it fixes
the rates for the loans. Non-conforming conventional loans are normally sold in
bulk to local financial institutions or packaged into collateralized mortgage
obligations. The sale of non-conforming conventional loans normally takes longer
than the sale of conforming mortgage loans. Accordingly, the Company attempts to
manage this interest rate risk through the purchase of listed options on U.S.
treasuries, as well as the purchase of option contracts in the over-the-counter
market on other interest rate sensitive instruments.
In the case of GNMA securities, the Company normally holds such securities
for longer periods prior to sale to maximize its net interest income and to take
advantage of the tax exempt status of the interest on such securities under
Puerto Rico law. Prices for GNMA certificates in Puerto Rico tend to be more
stable than on the mainland U.S. because the tax exempt status of interest paid
on these securities under Puerto Rico law makes them more attractive to retail
investors. This relative stability of prices for Puerto Rico GNMA securities
allows the Company to carry out a less aggressive hedging strategy to attempt to
protect the value of these assets than what might otherwise be required. The
Company seeks to protect itself from interest rate risk associated with its
inventory of GNMA securities by purchasing listed options on treasury bond
futures contracts and other interest rate sensitive instruments, as well as
purchasing options on U.S. GNMA securities in the over-the-counter market. The
Company has in place long-term repurchase agreements secured by GNMA
certificates with a principal amount of approximately $24.4 million. The Company
does not obtain forward commitments or otherwise hedge such GNMA securities
because they are financed pursuant to long-term repurchase agreements. The
Company has the right to substitute GNMA certificates subject to the repurchase
agreements with similar GNMA certificates at any time.
Contracts designated as trading hedges are marked-to-market monthly with
the resulting gains and losses charged to operations. Changes in the market
value of such contracts that qualify as hedges of existing assets and
liabilities are recognized as an adjustment to the value of the asset or
liability being hedged. Investment in such options is increased or decreased in
relation to interest rates changes and other market factors.
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The operations of the Company are also subject to interest rate risk
because its interest earning assets and interest-bearing liabilities reprice at
different times and varying amounts. FFCC's loans held for sale and
mortgage-backed securities held for trading inventories are fixed rate
interest-earning assets that are not subject to repricing (except for
replacement of assets through repayments, sales and new originations) while the
short-term borrowings used to finance these positions normally reprice
quarterly. To protect against major fluctuations in short-term interest rates,
the Company purchases listed put and call options and sells call options on
financial instruments, including Eurodollars contracts. This policy attempts to
ensure a relatively stable short-term cost of funds. With respect to the loans
receivable held by Doral Federal, Doral Federal attempts to obtain long-term
deposits and other long-term debt financing and/or advances from the FHLB-NY and
term notes backed by FHLB-NY letters of credit.
In the future, FFCC may use alternative hedging techniques including
futures, options or other hedge vehicles to help mitigate interest rate and
market risk. However, there can be no assurance that any of the above hedging
techniques will be successful. To the extent they are not successful, the
Company's profitability may be adversely affected. For the six months ended June
30, 1996, the Company experienced hedging gains of $4.4 million, while for the
six-month period ended June 30, 1995, the Company experienced hedging losses of
$3.3 million.
NEW ACCOUNTING STANDARDS
In June, 1996, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." SFAS No. 125 establishes accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities based on the consistent application of the
financial components approach. This approach requires the recognition of
financial assets and servicing assets that are controlled by the reporting
entity, the derecognition of financial assets when control is surrendered, and
the derecognition of liabilities when they are extinguished. Specific criteria
are established for determining when control has been surrendered in the
transfer of financial assets.
Liabilities and derivatives incurred or obtained by transferors in
conjunction with the transfer of financial assets are required to be measured at
fair value, if practicable. Servicing assets and other retained interests in
transferred assets are required to be measured by allocating the previous
carrying amount between the assets sold, if any, and the interest that is
retained, if any, based on the relative fair values of the assets at the date of
the transfer. Servicing assets retained are subsequently subject to amortization
and assessment for impairment.
SFAS No. 125 is effective for transfers and servicing of financial assets
and extinguishment of liabilities occurring after December 31, 1996. It is to be
applied prospectively; earlier or retroactive application is not permitted.
Management is currently evaluating the impact, if any, of the adoption of SFAS
No. 125 on the Company's financial statements.
In March 1995, FASB issued SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed." SFAS No. 121
establishes accounting standards for the impairment of long-lived assets,
certain identifiable intangibles and goodwill related to those assets, to be
held and used. Under SFAS No. 121, long-lived assets and certain identifiable
intangibles to be held and used must be reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. In performing the review for recoverability, an estimate of
the future cash flows expected to result from the use of the asset and its
eventual disposition must be made. If the sum of the future cash flows
(undiscounted and without interest charges) is less than the carrying amount of
the asset, an impairment loss is recognized.
Application of SFAS No. 121 is required for financial statements for fiscal
years beginning after December 15, 1995. Based on presently available
information, management believes that the application of SFAS No. 121 in future
years should not have a material adverse effect on the Company's financial
condition or results of operations.
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RECENT DEVELOPMENTS
Market Trends. Demand for mortgage loans and prices for mortgage loans and
mortgage-backed securities are sensitive to changes in interest rates. During
the second quarter of 1996 interest rates generally increased. To the extent
interest rates were to continue to increase during 1996, demand and prices for
mortgage loans and mortgage-backed securities could be adversely affected,
thereby adversely impacting mortgage loan originations and gain on sale of
mortgage loans. An increase in prevailing interest rates could also adversely
impact the Company's net interest income. Interest rates, however, decreased
during the early part of the third quarter of 1996 which should have a favorable
impact on the volume of mortgage loan originations and prices for mortgage loans
and mortgage-backed securities should this trend continue.
In order to further diversify its available loan products, during the
latter part of 1995 and the first half of 1996, the Company began to offer home
equity and personal loans secured by mortgages. These loans, which are secured
by first or second mortgage liens, generally have lower balances (between
$10,000 and $40,000), shorter maturities (between five to ten years) and bear
higher interest rates. The Company sells these loans, other than such loans
funded and retained by Doral Federal, to local financial institutions, or
packages them into collateralized mortgage obligations. When the Company sells
these loans, it normally retains the right to receive, as a servicing fee,
interest payable on the loan above a specified rate. The present value of the
servicing fee income to be received over the life of the loan over and above the
typical servicing fee payable on conforming conventional loans is recognized on
the Company's income statement as a component of sale of the mortgage loan and
is reflected as an asset on the Company's balance sheet as excess servicing fees
receivable. As the volume of originations of this type of loan product
increases, the amount of excess servicing fees receivable reflected on the
financial statements of the Company will increase.
Mortgage interest rates on non-government guaranteed mortgage loans in
Puerto Rico were deregulated effective April 1996. Management believes that this
deregulation may result in an increase in loan originations by expanding the
market of potential borrowers. The deregulation of interest rates in Puerto Rico
may also have a positive impact on the Company's net interest income by allowing
the Company to originate higher yielding mortgage loans.
New Broker-Dealer Subsidiary. During the second quarter of 1996, the
Company organized a new securities broker-dealer subsidiary, AAA Financial,
which commenced operations on September 12, 1996. The new broker-dealer
subsidiary commenced operations from a single branch in the San Juan
metropolitan area and is expected to employ 20 persons by the end of 1996. While
the new subsidiary will engage in a general securities business, it is expected
to initially concentrate on the sale of Puerto Rico tax exempt GNMA securities
and other Puerto Rico securities.
Repeal of Section 936. For a discussion of the repeal of Section 936 and
its possible impact on the Company, see "RISK FACTORS -- Economic Conditions in
Puerto Rico and Phase-out of Section 936 Tax Benefits" and "BUSINESS OF THE
COMPANY -- Mortgage Banking Business -- Puerto Rico Secondary Mortgage Market
and Favorable Tax Treatment."
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BUSINESS OF THE COMPANY
GENERAL
The Company, together with its wholly-owned subsidiaries, is primarily
engaged in the Mortgage Banking Business. FFCC is the leading mortgage banking
institution in Puerto Rico in terms of the volume of origination of first
mortgage loans on single-family residences. The Company's Mortgage Banking
Business is principally conducted through two operating units: Doral Mortgage, a
wholly-owned subsidiary of the Company, and HF Division, a division of the
Company. The Company also owns Doral Federal, a federal savings and loan
association which was acquired by FFCC in September 1993 and operates through
two branches in Puerto Rico. The Company has also established AAA Financial, a
new broker-dealer subsidiary, which commenced operations on September 12, 1996.
The Company is an approved seller/servicer for FHLMC and FNMA, an approved
issuer for GNMA and an approved servicer under the GNMA, FNMA and FHLMC
mortgage-backed securities programs. FFCC is also qualified to originate
mortgage loans insured by FHA and guaranteed by VA. Prior to the acquisition of
Doral Federal, substantially all of the Company's revenues were derived from its
Mortgage Banking Business. See "-- Mortgage Banking Business -- Sale of Loans;
Issuance of Mortgage Backed Securities" herein.
Prior to 1992, FFCC's Mortgage Banking Business was conducted exclusively
in Puerto Rico and currently is conducted in Puerto Rico through 18 branches, 15
of which are operated by Doral Mortgage. Since March 1992, Doral Mortgage has
opened branch offices in Orlando and Miami, Florida. The Florida offices are
staffed by seven employees and originated approximately $7 million and $11
million in mortgage loans during the six months ended June 30, 1996 and the year
ended December 31, 1995, respectively.
The Company's strategy is to increase its volume of loan originations and
its servicing portfolio as well as to maximize net interest income. The Company
seeks to increase its volume of loan originations by emphasizing quality
customer service and maintaining the most extensive system of branch offices of
any mortgage banking institution in Puerto Rico. The Company strives to increase
its servicing portfolio by relying primarily on internal loan originations and
supplementing such originations with wholesale purchases of loans and mortgage
servicing rights from third parties. The Company has traditionally emphasized
the origination of 15-year and 30-year conventional and FHA-insured or
VA-guaranteed mortgage loans on single-family residences. The Company relies on
net interest income for a more significant portion of its earnings than mortgage
banking companies generally do. The Company seeks to maximize net interest
income by holding mortgage-backed securities, primarily GNMA securities, for
longer periods prior to sale than most mortgage banking companies. This strategy
has the effect of reducing the Company's overall effective tax rate because the
interest on GNMA securities backed by Puerto Rico mortgages is tax exempt under
Puerto Rico law. The Company also seeks to increase net interest income by
funding and holding for investment through Doral Federal mortgage loans and
mortgage-backed securities.
The Company's thrift subsidiary, Doral Federal, operates through two
branches in the San Juan metropolitan area, which serve primarily as
deposit-taking operations, since to date most loans have been originated
pursuant to the Master Loan Production Agreement with the Company. See "Other
Lending and Investment Activities -- Lending Activities of Doral Federal and
Real Estate Owned" herein. Doral Federal has experienced rapid growth since its
acquisition by the Company, increasing from $13.1 million in assets as of
September 10, 1993 to $209 million in assets as of June 30, 1996. To date, this
growth has been funded primarily through increases in certificate of deposit
accounts and non-interest bearing deposits consisting primarily of corporate and
custodial accounts. As of June 30, 1996, Doral Federal had total deposits and
net worth of $142 million and $17.3 million, respectively. Custodial accounts
associated with the Company's servicing portfolio, commercial demand deposit
accounts of the Company and certificates of deposits accounts constituted
approximately 20%, 9% and 57%, respectively, of Doral Federal's total deposit
accounts. The Company intends to commit substantial management and financial
resources to continue to increase the assets, deposit base and branch network of
Doral Federal.
The business and profitability of FFCC depend, to a large degree, on its
ability to sell mortgage loans to investors in the secondary mortgage market at
prices that are higher than the prices at which FFCC originates
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or purchases such loans. The growth of the secondary mortgage market is
attributable in large part to programs maintained by the FNMA, FHLMC and GNMA.
In addition, part of the Company's business is affected significantly by the
continuation of various programs administered by the FHA for HUD, which insures
mortgage loans, and the VA, which partially guarantees mortgage loans. Any
discontinuation of, or significant reduction in, the various programs
administered by FNMA, FHLMC, GNMA, FHA or VA could have a material adverse
effect on the Company's operations. See "-- Mortgage Banking Business -- Sale of
Loans; Issuance of Mortgage Backed Securities" herein.
The Company is subject to the rules and regulations of, and supervision by,
several Federal and Puerto Rico entities, including the OTS, FNMA, FHLMC, GNMA,
FHA, VA, HUD and the Office of the Commissioner, with respect to, among other
things, licensing requirements, establishment of maximum interest rates,
required disclosure to customers and the origination, processing, underwriting,
selling and securitizing of mortgage loans. See "Regulation" herein. Doral
Federal's operations are subject to regulation by the OTS and the Federal
Deposit Insurance Corporation ("FDIC"). FFCC's operations in the state of
Florida are subject to supervision by the Florida Department of Banking and
Finance. In addition, the Company's operations are affected by Federal and
Puerto Rico laws and regulations designed to promote economic development in
Puerto Rico, particularly the various Puerto Rico Industrial Incentives Acts
(the "Industrial Incentives Acts") and Section 936. See "-- Mortgage Banking
Business -- Puerto Rico Secondary Mortgage Market and Favorable Tax Treatment"
herein.
MORTGAGE BANKING BUSINESS
Loan Origination and Purchase of Mortgages. FFCC has the most extensive
system of branch offices for originating mortgages loans of any mortgage banking
institution in Puerto Rico. HF Division operates two branches in the San Juan
Metropolitan area. Doral Mortgage operates 15 branches throughout Puerto Rico
and two small branch offices in the State of Florida. Centro Hipotecario, Inc.,
a wholly-owned subsidiary of the Company, operates an additional branch in the
San Juan metropolitan area.
FFCC originates both (a) conventional mortgages on single-family
residences, which generally (i) are insured by private mortgage insurers or (ii)
do not exceed 80% of the appraised value of the mortgaged property, and (b) VA
loans and FHA loans. VA loans and FHA loans qualify for inclusion in the
mortgage-backed securities program sponsored by GNMA. A portion of the
conventional loans are conforming loans which qualify for inclusion in guarantee
programs sponsored by FNMA or FHLMC. The Company also originates construction
loans for owner-occupied single-family residences and other real estate
developments and mortgage loans on commercial properties. Construction loans and
mortgage loans on commercial properties constituted approximately 3% and 1% of
the total dollar volume of loans originated and purchased by the Company for the
six months ended June 30, 1996 and the year ended December 31, 1995,
respectively.
While the Company makes available a wide variety of mortgage products
designed to respond to consumer needs and competitive conditions, it currently
emphasizes 15-year and 30-year conventional first mortgages and 15-year and
30-year FHA loans and VA loans. Substantially all the loans are fixed rate
mortgages. The average loan size for FHA/VA mortgage loans and conventional
mortgage loans was approximately $66,700 and $57,600, respectively, for the year
ended December 31, 1995.
The Company also offers second mortgages. During 1995, second mortgages
constituted less than 2% of the total loans originated by the Company. The
maximum loan-to-appraised value ratio on second mortgages permitted by the
Company is 80% (including the amount of any first mortgage).
Commencing in 1995, the Company has intensified its offering of home equity
or personal loans secured by mortgages up to $40,000. These loans are generally
made for debt consolidation, home improvements, refinancing or other personal
credit needs. These loans are generally secured by first or second mortgages on
single-family residences, are payable within five to ten years and provide for
higher interest rates than typical conventional mortgages. During the six months
ended June 30, 1996 and the year ended December 31, 1995 the Company originated
approximately $38 million and $10 million of such loans, respectively.
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<PAGE> 26
Loan origination activities performed by FFCC include soliciting,
completing and processing mortgage loan applications and preparing and
organizing the necessary loan documentation. Loan applications are examined for
compliance with underwriting criteria and, if all requirements are met, FFCC
issues a commitment to the prospective borrower specifying the amount of the
loan and the loan origination fees, discount points and closing costs to be paid
by the borrower or seller and the date on which the commitment expires.
FFCC purchases FHA loans and VA loans from Doral Mortgage and other
mortgage bankers for resale to institutional investors in the form of GNMA
securities. The Company's strategy is to increase its servicing portfolio
primarily through internal originations through its branch network. However, in
1994, in order to diversify its sources of loan production, the Company
reentered the wholesale mortgage loan market. The amount of loans purchased from
third parties was approximately $77 million, $63 million, $1 million, $29
million, and $48 million for the years ended December 31, 1995, 1994, 1993,
1992, and 1991, respectively. All loans purchased consisted of FHA and VA loans.
In addition to loan originations through its retail branch network and
purchases from third parties, the Company originates mortgage loans referred to
it by approved mortgage brokers. The mortgage broker receives a fee payable at
closing by the borrower for its services. Approximately, $15 million and $10
million of mortgage loans were originated through mortgage brokers for the
six-month period ended June 30, 1996 and the year ended December 31, 1995,
respectively. Purchases of loans from other mortgage bankers in the wholesale
loan market as well as origination of mortgage loans through loan brokers
provides the Company with a source of low cost production that allows the
Company to efficiently increase the size of its servicing portfolio.
The following table sets forth the number and dollar amount of the
Company's mortgage loan originations for the periods indicated:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
------------------- ------------------------------------------------------
1996 1995 1995 1994 1993 1992 1991
-------- -------- -------- -------- ---------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT AVERAGE INITIAL LOAN BALANCES)
<S> <C> <C> <C> <C> <C> <C> <C>
FHA/VA LOANS:(1)
Number of Loans........... 2,078 2,052 4,016 7,037 8,364 3,224 2,182
Volume of Loans........... $145,378 $130,212 $267,909 $433,748 $ 532,654 $207,239 $132,005
Percent of Total Volume... 38% 58% 48% 57% 37% 30% 37%
CONVENTIONAL AND OTHER
LOANS:(2)
Number of Loans........... 5,068 1,693 5,059 6,285 12,658 7,637 4,856
Volume of Loans........... $232,880 $ 93,019 $291,537 $326,698 $ 899,794 $486,484 $228,411
Percent of Total Volume... 62% 42% 52% 43% 63% 70% 63%
TOTAL LOANS:
Number of Loans(3)........ 7,146 3,745 9,075 13,322 21,022 10,861 7,038
Volume of Loans(4)........ $378,258 $223,231 $559,446 $760,446 $1,432,448 $693,723 $360,416
AVERAGE INITIAL LOAN
BALANCE:
FHA/VA Loans.............. $ 70,000 $ 63,400 $ 66,700 $ 61,600 $ 63,700 $ 64,300 $ 60,500
Conventional and other
Loans(2)................ $ 45,900 $ 54,900 $ 57,600 $ 52,000 $ 71,100 $ 63,700 $ 47,000
REFINANCINGS(5)........... 48% 39% 41% 59% 80% 67% 67%
</TABLE>
- ---------------
(1) Excludes loans purchased from third parties.
(2) Includes second mortgage loans and non-conforming loans (conventional loans
that do not qualify for inclusion in the guarantee programs sponsored by
FNMA or FHLMC).
(3) Includes 961, 421, 834, 898 and 61, of loans funded by Doral Federal
pursuant to the Master Loan Production Agreement for the six months ended
June 30, 1996 and 1995 and the years ended
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<PAGE> 27
December 31, 1995, 1994 and 1993, respectively. See "-- Other Lending and
Investment Activities -- Lending Activities of Doral Federal and Real
Estate Owned" herein.
(4) Includes $41.2 million, $20.2 million, $52.3 million, $26.3 million and $4.9
million, principal amount of loans funded by Doral Federal pursuant to the
Master Loan Production Agreement for the six months ended June 30, 1996 and
1995 and the years ended December 31, 1995, 1994 and 1993, respectively.
See "-- Other Lending and Investment Activities -- Lending Activities of
Doral Federal and Real Estate Owned" herein.
(5) As a percentage of the total dollar volume of loans originated.
A substantial proportion of the Company's total mortgage loan originations
has consistently been comprised of refinancing loans. Demand for refinancing
loans has traditionally been high in Puerto Rico because this product is often
used as a vehicle for debt consolidation. For the six months ended June 30, 1996
and the years ended December 31, 1995, 1994 and 1993, refinancing activity
represented approximately 48%, 41%, 59% and 80%, respectively, of the Company's
total dollar volume of mortgage loans originated. The high level of refinancings
during 1993 was principally due to a decline in average mortgage interest rates
which stimulated demand for refinancing of existing mortgage loans. The decrease
in refinancing activity during 1994 compared to 1993 was due to the rise in
interest rates experienced during the second half of 1994. The continued
decrease in refinance loans during 1995 reflected the continued weakness in
demand for this product following the unusually high refinance activity
experienced during 1993. A significant future increase in mortgage interest
rates in Puerto Rico could adversely affect the Company's business if it results
in a significant decrease in refinancing of first mortgage loans. In recent
years, the Company, primarily through its HF Division, has increased relations
with realtors and developers in order to increase home purchase loan
originations. The Company believes that by increasing its home purchase
originations it may offset, in part, the adverse effects that increasing
interest rates or lower demand for refinancing loans could have on overall
mortgage loan production.
For the six months ended June 30, 1996 and the years ended December 31,
1995, 1994 and 1993, non-conforming conventional loans represented approximately
52%, 45%, 28% and 15%, respectively, of the Company's total volume of mortgage
loans originated.
All loan originations, regardless of whether originated through the retail
network, obtained through mortgage brokers or purchased from third parties, must
be underwritten in accordance with the Company's underwriting criteria,
including loan-to-value ratios, borrower income qualifications, debt ratios and
credit history, investor requirements, and insurance and property appraisal
requirements. The Company's underwriting standards also comply with the relevant
guidelines set forth by HUD, VA, FNMA, FHLMC, federal savings and loan
regulatory authorities, private mortgage investment conduits and private
mortgage insurers, as applicable. The Company's underwriting personnel, while
operating out of loan offices, make underwriting decisions independent of the
Company's mortgage loan origination personnel. Under the Company's quality
control plan, the Company reverifies a portion of the mortgage loans funded each
month, to provide reasonable assurance that the Company's underwriting standards
have been satisfied. The selection of mortgage loans for reverification is done
on a sampling basis to provide quality control coverage for all mortgage loan
programs and appraisers. In addition, the Company reconfirms employment status,
the source of down payment and other key items.
Typically, when a mortgage loan is originated through the Company's retail
branches, the borrower is required to pay an origination fee to the Company.
These fees range from 0% to 6% of the principal amount of the mortgage loan, and
are payable at the closing of such loan. The Company may also charge discount
points depending upon market conditions and regulatory considerations as well as
the Company's objectives concerning mortgage loan origination volume and
pricing. The Company incurs certain costs in originating mortgage loans,
including overhead, out-of-pocket costs and, in some cases, where the mortgage
loans are subject to a purchase commitment from private investors, related
commitment fees. The volume and type of mortgage loans and of commitments made
by investors vary with competitive and economic conditions, resulting in
fluctuations in revenues from mortgage loan originations. Generally Accepted
Accounting
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<PAGE> 28
Principles ("GAAP") require that general operating expenses incurred in
originating mortgage loans be charged to current expense. Direct origination
costs and origination income must be deferred and amortized using the interest
method, until the repayment or sale of the related mortgage loans.
Loan Servicing. The Company's principal source of servicing rights is
mortgage loan originations and purchases from third parties. When FFCC sells the
mortgage loans it has originated or purchased, it generally retains the rights
to service such loans and receives the related servicing fees. Loan servicing
includes collecting principal and interest and remitting the same to the holders
of the mortgage loans or mortgage-backed securities to which such mortgage loan
relates, holding escrow funds for the payment of real estate taxes and insurance
premiums, contacting delinquent borrowers, supervising foreclosures in the event
of unremedied defaults and generally administering the loans. FFCC receives
annual loan servicing fees ranging from 0.25% to 0.50% of the declining
principal amount of the loans serviced plus any late charges. In general, FFCC's
servicing agreements are terminable by the investor for cause.
Servicing rights represent a contractual right and not a beneficial
ownership interest in the underlying mortgage loans. Failure to service the
loans in accordance with contract requirements may lead to a termination of the
servicing rights and the loss of future servicing fees. There has been no
termination of servicing rights by any mortgage loan owners because of the
failure by the Company to service in accordance with its contractual
obligations.
At June 30, 1996 and December 31, 1995, approximately $246.7 million and
$267.5 million, respectively, or 8% and 10%, respectively, of the Company's
total servicing portfolio consisted of mortgage loans securitized by the Company
and sold to grantor trusts or other mortgage conduits such as REMICs. The
insurance company insuring the senior certificates issued by such grantor trusts
and other conduits may terminate the Company's servicing rights if, among other
things: (i) the Company becomes ineligible or losses its rights as an approved
servicer for GNMA, FNMA or FHLMC; (ii) the number of loans included in the trust
which are delinquent 90 days or more (including properties acquired upon
foreclosure) exceeds 8% of the aggregate outstanding principal balance of the
mortgage loans included in the trust; (iii) realized losses with respect to
mortgage loans included in the trust exceeds certain thresholds on an annual
basis (1% of the outstanding balance of mortgage loans) and on a cumulative
basis over various periods of time (ranging from 0.45% to 4.00% of the original
principal balance of loans in the trusts).
In addition to the foregoing, with respect to all mortgage loans funded by
Doral Federal after October 1, 1995, Doral Federal may terminate the Company's
servicing rights without cause upon notice to the Company.
The Company's mortgage loan servicing portfolio is subject to reduction by
reason of normal amortization, prepayments and foreclosure of outstanding
mortgage loans. Additionally, the Company may sell mortgage loan servicing
rights from time to time to other institutions if market conditions are
favorable.
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<PAGE> 29
The following table sets forth certain information regarding the total loan
servicing portfolio of FFCC for the periods indicated:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
----------------------- --------------------------------------------------------------
1996 1995 1995 1994 1993 1992 1991
---------- ---------- ---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
COMPOSITION OF SERVICING
PORTFOLIO AT PERIOD END:
FHA and VA Mortgage Loans..... $1,261,438 $ 984,343 $1,117,296 $1,062,108 $ 955,624 $ 851,853 $ 858,261
Conventional and Other
Mortgage Loans(1)........... 1,669,256 1,556,958 1,550,964 1,581,418 1,420,031 885,571 554,745
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total Servicing
Portfolio............... $2,930,694 $2,541,301 $2,668,260 $2,643,526 $2,375,655 $1,737,424 $1,413,006
========= ========= ========= ========= ========= ========= =========
BEGINNING SERVICING
PORTFOLIO................... $2,668,260 $2,643,526 $2,643,526 $2,375,655 $1,737,424 $1,413,006 $1,193,067
ADD:
Loans Funded and
Purchased(2)................ 423,560 266,797 678,330 823,834 1,433,448 722,723 408,400
LESS:
Servicing Sales Transferred... $ -- 208,000 310,000 202,000 198,700 53,400 51,460
Run-off(3).................... 161,126 161,022 343,596 353,963 596,517 344,905 137,001
---------- ---------- ---------- ---------- ---------- ---------- ----------
ENDING SERVICING PORTFOLIO.... $2,930,694 $2,541,301 $2,668,260 $2,643,526 $2,375,655 $1,737,424 $1,413,006
========= ========= ========= ========= ========= ========= =========
SELECTED DATA REGARDING
MORTGAGE LOANS SERVICED:
Number of Loans............... 59,655 50,513 54,993 52,515 48,272 39,562 34,897
Weighted Average Interest
Rate........................ 8.41% 8.30% 8.43% 8.21% 8.15% 9.09% 10.06%
Weighted Average Maturity
(months).................... 206 185 181 192 226 204 224
Weighted Average Servicing Fee
Rate........................ .3843 .3933 .3831 .3945 .4195 .4040 .4242
DELINQUENT MORTGAGE LOANS AND
PENDING FORECLOSURES AT
PERIOD END:(4)
60-89 days past due........... 1.52% 1.63% 1.78% 1.53% 1.49% 1.39% 2.01%
90 days or more past due...... 2.08% 1.79% 2.22% 1.48% 1.62% 1.55% 2.26%
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total delinquencies........... 3.60% 3.42% 4.00% 3.01% 3.11% 2.94% 4.27%
========= ========= ========= ========= ========= ========= =========
Foreclosures Pending.......... 1.00% 1.10% 1.04% 1.19% 1.21% 1.44% 1.47%
========= ========= ========= ========= ========= ========= =========
</TABLE>
- ---------------
(1) Includes $108.8 million, $39.9 million, $73.7 million, $26 million and $4.7
million of loans serviced for Doral Federal for the six months ended June
30, 1996 and 1995 and the years ended December 31, 1995, 1994 and 1993,
respectively, which represented 3.71%, 1.57%, 2.76%, 0.98% and 0.20% of the
total servicing portfolio as of such date.
(2) Loans funded and purchased represent that portion of loans originated or
purchased with respect to which the servicing rights were retained by the
Company. For 1995 and 1991, there is also included $42.3 million and $49.2
million, respectively, of servicing rights acquired in bulk from third
parties.
(3) Run-off refers to regular amortization of loans, prepayments and
foreclosures.
(4) Expressed as a percentage of the total number of loans serviced.
Substantially all of the mortgage loans in the Company's servicing
portfolio are secured by single (one-to-four) family residences. Substantially
all of FFCC's mortgage servicing portfolio is composed of mortgages secured by
real estate in Puerto Rico. At June 30, 1996 and December 31, 1995, less than 2%
of the Company's mortgage servicing portfolio related to mortgages secured by
real property outside Puerto Rico (all of which were secured by real property
located in the State of Florida).
The amount of principal prepayments on mortgage loans serviced by the
Company was $103 million for the first six months of 1996 and $160 million, $281
million and $537 million for the years ended December 31, 1995, 1994 and 1993,
respectively. This represented approximately 7%, 6%, 11% and 26% of the
aggregate principal amount of mortgage loans serviced during such periods and
the average size of the loans prepaid
29
<PAGE> 30
were $37,900, $37,800, $41,800 and $54,600, respectively. Principal prepayments
declined during 1995 and 1994 as a result of decreased refinancing activity
following the refinance boom of 1993. The primary means used by the Company to
reduce the sensitivity of its servicing fee income to changes in interest and
prepayment rates is the development of a strong internal origination capability
that has allowed the Company to continue to increase the size of its servicing
portfolio even in times of high prepayments.
Servicing agreements relating to the mortgage-backed securities programs of
FNMA, FHLMC and GNMA, and certain other investors, require FFCC to advance funds
to make scheduled payments of principal, interest, taxes and insurance, if such
payments have not been received from the borrowers. During the first six months
of 1996 and the year ended December 31, 1995, the monthly average amount of
funds advanced by FFCC under such servicing agreements was approximately $5.9
million and $4.7 million, respectively. Funds advanced by FFCC pursuant to these
arrangements are generally recovered by FFCC within 30 days.
The degree of risk associated with a mortgage loan servicing portfolio is
largely dependent on the extent to which the servicing portfolio is non-recourse
or recourse. In non-recourse servicing, the principal credit risk to the
servicer is the cost of temporary advances of funds. In recourse servicing, the
servicer agrees to share credit risk with the owner of the mortgage loans such
as FNMA or FHLMC or with an insurer or guarantor. Losses on recourse servicing
occur primarily when foreclosure sale proceeds of the property underlying a
defaulted mortgage are less than the then outstanding principal balance and
accrued interest of such mortgage loan and the cost of holding and disposing of
such underlying property. At June 30, 1996 and December 31, 1995 and 1994, the
Company was servicing mortgage loans with an aggregate principal amount of $73
million, $85 million and $112 million, respectively, on a recourse basis. During
the last five years, losses incurred due to recourse servicing have not been
material.
In the ordinary course of business, the Company makes certain
representations and warranties to purchasers and insurers of mortgage loans and
to the purchasers of servicing rights. In connection with any purchases by the
Company of servicing rights, the Company is also exposed to liability as a
successor to third party originators' representations and warranties. If a loan
defaults and there has been a breach of representations and warranties, the
Company may become liable for the unpaid principal and interest on defaulted
loans. In such a case, the Company may be required to repurchase the mortgage
loan and bear any subsequent loss on the mortgage loan. During 1995, 1994 and
the six months ended June 30, 1996, the impact of loans repurchased as a result
of borrower misrepresentations was not material.
FFCC's servicing rights provide a significant continuing source of income
for FFCC. There is a market in Puerto Rico for servicing rights, which are
generally valued in relation to the present value of the expected income stream
generated by the servicing rights. Among the factors which influence the value
of a servicing portfolio are servicing fee rates, loan balances, loan types,
loan interest rates, expected average life of underlying loans (which may be
reduced through foreclosure or prepayment), the value of escrow balances,
delinquency and foreclosure experience, servicing costs, servicing termination
rights of permanent investors, and any recourse provisions. During the years
ended December 31, 1995, 1994 and 1993, FFCC sold servicing rights on $310
million, $202 million, and $199 million, respectively, of mortgage loans. No
such sales were made during the first six months of 1996. While the Company's
general strategy is to increase the size of its servicing portfolio by retaining
the servicing rights related to the mortgage loans it originates and purchases,
FFCC may from time to time sell additional portions of its servicing portfolio
when market conditions are favorable.
The market value of, and earnings from, the Company's mortgage loan
servicing portfolio may be adversely affected if mortgage interest rates decline
and mortgage loan prepayments increase. In a period of declining interest rates
and accelerated prepayments, servicing income generated from the Company's
mortgage loan servicing portfolio may also decline through increased
amortization and the recognition of impairment of servicing rights. Conversely,
as mortgage interest rates increase, the market value of the Company's mortgage
loan servicing portfolio may be positively affected. Increases in the rate of
delinquencies and foreclosures on mortgage loans tend to increase the costs
associated with administering mortgage loans.
30
<PAGE> 31
HRU, Inc. provides mailing and electronic data processing services for
FFCC's mortgage servicing and earns fees from FFCC based on the volume of
mortgage loans serviced. Such fees are determined at fair market value and
amounted to approximately $421,000, $860,000, $726,000 and $617,000 for the six
months ended June 30, 1996 and for the years ended December 31, 1995, 1994 and
1993, respectively. FFCC owns 33% of HRU, Inc.
Foreclosure Experience and Real Estate Owned. While delinquency rates in
Puerto Rico are generally higher than in the mainland United States, these rates
are not necessarily indicative of future foreclosure rates or losses on
foreclosures. Moreover, because substantially all the mortgage loans in its
servicing portfolio are serviced on a non-recourse basis, foreclosure losses in
connection with the Company's Mortgage Banking Business are generally the
responsibility of the investors or insurer and not of the Company. Real estate
owned as a result of foreclosures ("REO") related to the Company's Mortgage
Banking Business arises primarily through foreclosure on mortgage loans
repurchased from investors either because of breach of representations or
warranties or pursuant to recourse arrangements. As of June 30, 1996 and
December 31, 1995 and 1994, FFCC held REO with a book value of approximately
$2.3 million, $2.1 million and $2.1 million, respectively. Sales of REO resulted
in net losses to FFCC of approximately $117,000 for the six months ended June
30, 1996 and $145,000, $473,000 and $1.05 million for the years ended December
31, 1995, 1994 and 1993, respectively. There is no liquid secondary market for
the sale of the Company's REO.
In addition to the REO held by the Company, a real estate partnership, in
which the Company owns a 15% interest and in which members of management are
investors, held REO with a book value of approximately $1.8 million as of June
30, 1996. The REO was part of $4.7 million of REO that was sold by the Company
to the partnership in December 1990. Of the $4.7 million purchase price,
$600,000 was paid in cash and $4.1 million was paid in notes of the partnership.
The Company sold $2.8 million of such notes to a financial institution with
recourse to the Company. As of June 30, 1996, the unpaid balance of the notes
held by the Company and the notes sold with recourse was $756,000 and $1.2
million, respectively.
With respect to mortgage loans securitized through GNMA programs, the
Company is fully insured as to principal by the FHA against foreclosure loss,
while the VA guarantee is subject to a limitation which is generally equal to
25% to 50% of the principal amount of the loan, up to a maximum ranging from
$22,500 to $50,750, depending upon the amount of the loan. As a result of these
programs, foreclosure on these loans had generated no loss of principal as of
June 30, 1996. FFCC, however, incurs about $2,200 per loan foreclosed in
interest and legal charges during the time between payment by FFCC and FHA or VA
reimbursement. For the six months ended June 30, 1996 and the years ended
December 31, 1995, 1994 and 1993 total expenses related to FHA or VA loans
foreclosed amounted to $30,000, $75,000, $464,000, and $158,000, respectively.
Although FNMA and FHLMC are obligated to reimburse the Company for principal and
interest payments advanced by the Company as a servicer (except for recourse
servicing), the funding of delinquent payments or the exercise of foreclosure
rights involves costs to the Company which may not be recovered. Such
nonrecovered expenses have been immaterial to date.
Any significant adverse economic developments in Puerto Rico, FFCC's
primary service area, could result in an increase in defaults or delinquencies
on mortgage loans that are serviced by FFCC or held by FFCC pending sale in the
secondary mortgage market, thereby reducing the resale value of such mortgage
loans and increasing the costs of administering loans.
Sale of Loans; Issuance of Mortgage-Backed Securities. FFCC customarily
sells most of the loans that it originates, except for those originated by Doral
Federal, which are generally held until maturity, utilizing different sales
channels described below. FFCC issues GNMA-guaranteed mortgage-backed
securities, which involve the packaging of FHA loans or VA loans into pools of
$1 million or more ($2.5 million to $5 million for serial notes) for sale
primarily to broker-dealers in Puerto Rico. During the six months ended June 30,
1996 and the year ended December 31, 1995, FFCC issued approximately $186
million and $366 million, respectively, in GNMA-guaranteed mortgage-backed
securities.
Certain GNMA-guaranteed mortgage-backed securities sold by FFCC are in the
form of GNMA serial notes. GNMA serial notes are sold in pools of $2.5 million
to $5 million. Such pools are composed solely of FHA loans or VA loans
originated in Puerto Rico. GNMA securities issued under the serial note program
are
31
<PAGE> 32
structured into packages consisting of notes of different yields and maturities,
which range from 1 to 30 years and have an average maturity of 12 years, taking
into account historical experience with prepayments of the underlying mortgages.
The rates on the serial notes or GNMA pools must be 1/2 of 1% less than the
rates on the mortgages comprising the pool. Upon completion of the necessary
processing, the GNMA-guaranteed mortgage-backed securities are offered to the
public through securities broker-dealers. During six months ended June 30, 1996
and the year ended December 31, 1995, FFCC issued GNMA serial notes totalling
approximately $153 million and $284 million, respectively.
With respect to loans securitized through GNMA programs, the Company is
insured against foreclosure losses by HUD with respect to FHA loans or partially
guaranteed against foreclosure loss by the VA (at present, generally 25% to 50%
of the loan, up to a maximum amount ranging from $22,500 to $50,750, depending
upon the amount of the loan). According to the applicable VA guidelines, the
maximum amount of a VA loan originated in Puerto Rico is presently $203,000.
According to applicable FHA guidelines, the maximum amount of a FHA loan ranges
from $78,660 to $152,000, depending on the municipality where the mortgaged
property is located.
Conforming conventional loans originated or purchased by FFCC are either
sold directly to FNMA, FHLMC or private investors for cash or are grouped into
pools of $1 million or more in aggregate principal balance and exchanged for
FNMA or FHLMC-issued mortgage-backed securities, which FFCC sells to securities
broker-dealers. In connection with any such exchanges, the Company pays
guarantee fees to FNMA and FHLMC. The issuance of mortgage-backed securities
provides FFCC with flexibility in selling the mortgage loans that it originates
or purchases and also provides income by increasing the value and marketability
of such loans.
Mortgage loans that do not conform to GNMA, FNMA or FHLMC requirements
(so-called non-conforming loans) are sold to financial institutions or other
private investors or are securitized into "private label" mortgage-backed
securities through grantor trusts or other mortgage conduits that either are
organized by the Company or third parties and sold through broker-dealers. Each
issue of mortgage-backed securities normally consists of several classes of
senior, subordinate and residual certificates. The residual certificates
evidence a right to receive payments on the mortgage loans after payment of all
required amounts on the senior and subordinate certificates are made. To date,
credit enhancement, in the form of an insurance policy and subordination, has
generally been used to increase the credit rating of the senior certificates and
thereby improve their marketability. During the six months ended June 30, 1996
and the year ended December 31, 1995, the Company securitized approximately $37
million and $75 million, respectively, aggregate principal amount of
non-conforming mortgage loans. Financial Security Assurance, Inc. ("FSA")
insured approximately $35 million and $70 million of senior certificates issued
in connection with such securitization transactions during the six months ended
June 30, 1996 and the year ended December 31, 1995, respectively. Subject to
market conditions, the Company contemplates entering into similar securitization
transactions in the future. As part of its arrangement with FSA, the Company has
agreed to retain and pledge to FSA the residual certificates issued by the
respective trusts. The Company also generally retains the subordinate
certificates issued in such transactions. As of June 30, 1996 and December 31,
1995, the Company held approximately $13.4 million and $13.1 million,
respectively, in subordinate certificates and $9.1 million and $8.8 million,
respectively, in residual certificates issued in securitization transactions
involving the Company. Currently a liquid secondary market for subordinate or
residual certificates does not exist in Puerto Rico. The value of residual
certificates represents the present value of expected future distributions on
such certificates over the life of the trusts and is subject to substantial
fluctuations as a result of changes in prevailing interest rates. In October
1995, the Company entered into a one-year credit facility with a local financial
institution to finance its portfolio of subordinate certificates. As of June 30,
1996, the outstanding principal amount of such financing was approximately $13.2
million and bore interest at an average rate of 8.36% per annum.
The relative emphasis on the origination of FHLMC and FNMA conforming loans
versus FHA and VA loans and non-conforming loans is dependent on market
conditions, the relative pricing and return on origination of the different
types of mortgage loans and the maximum loans amounts for the various types of
loans.
32
<PAGE> 33
While the Company's exchanges of mortgage loans into agency securities and
sales of mortgage loans are generally made on a non-recourse basis, the Company
also engages in the sale or exchange of mortgage loans on a recourse basis. In
the past, recourse sales often involved sale of non-conforming loans to local
financial institutions. Recourse sales have decreased in recent years, in part
due the securitization of non-conforming loans into private label
mortgage-backed securities and increased sales channels that allow the Company
to sell non-conforming loans to investors on a non-recourse basis. The Company
estimates the fair value of the retained recourse obligation at the time
mortgage loans are sold. The Company has not provided a reserve or allowance for
losses in the Company's financial statements for these recourse obligations
because the Company has historically been successful in reselling repurchased
loans for at least their carrying costs. Accordingly, as of June 30, 1996, the
Company did not deem it necessary to establish reserves for possible losses
related to recourse obligations. At June 30, 1996 and December 31, 1995, the
Company had loans in its servicing portfolio with provisions for recourse in the
principal amount of approximately $73 million and $85 million, respectively, as
compared to $112 million as of December 31, 1994. Of these recourse loans,
approximately $15 million and $16 million, respectively, in principal amount
consisted of loans sold to FNMA and FHLMC into securities of such agencies, and
approximately $58 million and $69 million principal amount, respectively,
consisted of non-conforming loans sold to other private investors. At June 30,
1996 existing commitments to sell loans to FHLMC aggregated $15 million and were
on a non-recourse basis.
In addition to the sale of the "private label" mortgage-backed securities
referred to above, the Company has, from time to time, sold mortgage-backed
securities in bulk to local broker-dealers or financial institutions. These
mortgage-backed securities are normally converted into collateralized mortgage
obligations by the purchasers and sold in the local Puerto Rico market.
From time to time, the Company may sell mortgage-backed securities subject
to put arrangements. Pursuant to these arrangements, the Company grants the
purchaser of the mortgage-backed securities a put option that grants the buyer
the right to sell, and obligates the Company to buy, the securities at a future
date at a negotiated price. Sales of securities with puts are accounted for as
sales or borrowings based on an assessment of the probability that the put
option will be exercised. If, on the transaction date, the Company determines
that it is probable that the put option will not be exercised, the transaction
is accounted for as a sale. Conversely, if it is determined that it is probable
that the put option will be exercised, the transaction will be accounted for as
a secured borrowing. As of June 30, 1996, the Company had outstanding $89.4
million in mortgage-backed securities sold subject to put arrangements, which
expire in varying amounts from January 1997 through April 1999, all of which
were accounted for as sales.
Market Interest Rates and Net Interest Income. A greater proportion of the
Company's net income has generally been composed of net interest income than is
typical of mortgage banking institutions in the mainland United States. This is
primarily due to the fact that the Company has traditionally held mortgage loans
and mortgage-backed securities, particularly GNMA certificates, for longer
periods prior to sale than mortgage banking institutions generally do. For the
six months ended June 30, 1996 and the year ended December 31, 1995, the Company
held mortgage loans (including mortgage-backed securities) prior to sale for an
average period of 267 days and 352 days, respectively, as compared to 212 days
for the year ended December 31, 1994. The increase in the number of days
mortgage loans and mortgage-backed securities were held during 1995 was
primarily due to the decision of the Company to hold tax exempt FHA and VA
mortgages and GNMA securities, for longer periods prior to sale, to maximize tax
exempt net interest income produced by these instruments.
Puerto Rico regulatory requirements and the operation of the GNMA serial
note program in Puerto Rico also tend to increase the period during which
mortgage loans are held prior to sale. In order to be able to fund the
origination of mortgage loans with tax-advantaged 936 Funds (see "Puerto Rico
Secondary Mortgage Market and Favorable Tax Treatment" below), mortgages
qualifying for favorable tax treatment must be segregated and separately funded
from non-qualifying mortgages. This requirement, together with the fact that the
GNMA serial note pools consist of a minimum of $2.5 million principal amount of
mortgage loans as compared to $1 million for other GNMA programs, obligates the
Company to hold mortgage loans and mortgage-backed securities for longer periods
prior to sale in order to assemble such pools.
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<PAGE> 34
Changes in prevailing market interest rates between the time FFCC funds a
mortgage loan and the time the mortgage loan or mortgage-backed security is sold
to permanent investors could reduce FFCC's net interest income on mortgage loans
held prior to sale and gains from the sale of loans, thereby reducing FFCC's net
income. FFCC attempts to manage these risks by securing commitments for future
delivery or engaging in managed hedging transactions such as those described
under "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- Assets and Liabilities" herein.
Interest Rate Management. The Company's Mortgage Banking Business is
subject to the risk that future changes in interest rates may adversely affect
the value of the Company's portfolio of mortgage loans and mortgage-backed
securities. Interest rate fluctuations may also adversely affect net interest
income. FFCC attempts to minimize these risks through the use of forward
commitments and other hedging techniques. For a more detailed discussion of such
risks and the techniques used by the Company to attempt to mitigate such risks
see "MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- Assets and Liabilities" herein.
Puerto Rico Secondary Mortgage Market and Favorable Tax Treatment. In
general, the Puerto Rico market for mortgage-backed securities is an extension
of the United States market with respect to pricing, rating of the investment
instruments, and other matters. However, the Puerto Rico secondary mortgage
market has historically benefitted from certain incentives provided by United
States and Puerto Rico tax laws. Section 936, which has provided certain of
these incentives, was repealed on August 20, 1996, subject to a ten-year
grandfather period, as discussed below.
Under the Industrial Incentives Acts, certain investment income earned by
qualified manufacturing entities or service enterprises ("Exempt Companies") is
exempt from Puerto Rico income tax. The Industrial Incentive Acts also encourage
investment in Puerto Rico by allowing Exempt Companies to reduce the otherwise
applicable 10% tax (the "Tollgate Tax") on distributions to shareholders by
investing their exempt industrial development income ("IDI") in Puerto Rico for
fixed periods of time, generally from five years to ten years. Investment income
that qualifies for this exemption includes interest on certain mortgage loans
and interest on funds of Exempt Companies ("936 Funds") placed with eligible
institutions in Puerto Rico (primarily savings and loan associations, commercial
banks and registered broker-dealers), provided such funds are invested in
certain "eligible activities" as defined in regulations promulgated by the
Office of the Commissioner, including certain mortgage loans and mortgage-backed
securities and warehousing loans to finance the origination of mortgage loans.
Most Exempt Companies are United States corporations which operate in
Puerto Rico under Section 936. Corporations that meet certain requirements and
elect the benefits of Section 936 ("Section 936 Corporations") are entitled to
credit against their United States corporate income tax a portion of such tax
attributable to (i) income derived from the active conduct of a trade or
business within Puerto Rico or from the sale or exchange of substantially all
assets used in the active conduct of such trade or business ("Active Business
Income") and (ii) qualified possession source investment income ("QPSII"). QPSII
includes interest derived from mortgage loans secured by real property located
in Puerto Rico and mortgage-backed securities consisting of such mortgage loans
as well as interest on deposits with financial institutions which in turn use
such funds to finance the origination of certain qualifying eligible activities
that include mortgage loans and other qualifying assets. The credit provided by
QPSII has favorably affected FFCC's net interest income by helping create a pool
of lower-cost funds that FFCC can access through financial intermediaries such
as banks and broker-dealers and use to fund mortgage loans and mortgage-backed
securities pending sale. The credit provided for QPSII also tends to increase
the demand for Puerto Rico mortgage loans and mortgage-backed securities by
providing incentives for 936 Corporations and financial intermediaries to invest
in certain mortgage loans and mortgage backed securities originated in Puerto
Rico.
The Omnibus Budget Reconciliation Act of 1993 amended various provisions of
Section 936. The amendments (the "OBRA Amendments"), which are generally
effective for taxable years beginning after December 31, 1993, permit a taxpayer
to compute the tax credit available under Section 936 (the "936 Credit") as
under prior law but limit the amount of credit allowed with respect to Active
Business Income under one of two alternatives to be selected at the option of
the taxpayer. Under the first alternative,
34
<PAGE> 35
the limit is equal to a fixed percentage of the amount of tax credit allowable
under prior law (the "Fixed Percentage Method"). This fixed percentage commenced
at 60% for taxable years beginning in 1994 and is reduced by 5% per year until
1998. For taxable years beginning in 1998, such percentage would be 40%. Under
the second alternative (the "Economic Activity Method"), which is based on the
amount of economic activity conducted by the taxpayer in Puerto Rico, the credit
may not exceed the sum of the following three components: (i) 60% of the
qualified possession wages and the allocable fringe benefits paid by the
taxpayer, (ii) applicable percentages of certain depreciation deductions claimed
for regular tax purposes by the taxpayer with respect to qualified tangible
property and (iii) a portion of the possession income taxes paid by the taxpayer
except where the taxpayer uses the profit-split method for determining its
income. The OBRA Amendments did not limit the 100% credit available under
Section 936 for QPSII.
On August 20, 1996, the Small Business Job Protection Act, which provides
for the repeal of Section 936, was signed into law. 936 Corporations that were
engaged in the active conduct of trade or business on October 13, 1995 and that
qualified for and elected the benefits of Section 936 for the corporation's
taxable year which includes such date will have the benefit of a ten-year
grandfather rule. Under the grandfather rule, the amount of Active Business
Income eligible for the 936 Credit will be subject to certain caps that will
vary depending upon whether the 936 Corporation computed its 936 Credit under
the Economic Activity Method or under the Fixed Percentage Method. The credit
available for QPSII will not be subject to the grandfather rule and will be
eliminated with respect to amounts received or accrued for taxable years
commencing after December 31, 1995 but no earlier than July 1, 1996.
While the final impact of the repeal of Section 936 cannot be determined at
this time, the repeal of Section 936 could have an adverse effect on the general
economic condition of Puerto Rico, the Company's predominant service area, by
reducing incentives for investment in Puerto Rico. Any such adverse effect on
the general economy of Puerto Rico could lead to an increase in mortgage
delinquencies and a reduction in the level of residential construction and
demand for mortgage loans. The elimination of Section 936, particularly the
elimination of the credit for QPSII, could also lead to a decrease in the amount
of 936 Funds invested in Puerto Rico financial assets by 936 Corporations,
thereby increasing funding costs and decreasing liquidity in the Puerto Rico
financial market. The magnitude of the impact of any such changes on the
Company's profitability or financial condition cannot be determined at this
time. Management believes that the principal impact of the loss of 936 Funds
will be a moderate increase in the Company's funding costs. The Company has
taken steps to attempt to reduce the impact of any such adverse changes by
diversifying its sources of funding and identifying additional investors for its
mortgage products. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS -- Liquidity and Capital Resources." During
recent periods, the disparity between the cost of 936 Funds and other sources of
funding, such as the Euro-dollar market, has decreased, thereby possibly
reducing the adverse effect that the loss of such funding may have on the
profitability of the Company. In addition, any adverse effect in liquidity
should be ameliorated by the fact that during 1994, 1995 and the first six
months of 1996, 936 Corporations have not been active investors in
mortgage-backed securities.
In addition to the foregoing incentives, interest derived from FHA loans or
VA loans secured by real property in Puerto Rico originated after June 30, 1983,
and, under certain circumstances, on or before February 15, 1973, and from GNMA
certificates consisting of such mortgages, is exempt from Puerto Rico income
tax. FHA and VA mortgage loans are also exempt from Puerto Rico gift and estate
taxes. Individuals who are bona fide residents of Puerto Rico are also not
subject to United States federal income tax on income from Puerto Rico sources,
including interest income derived from mortgage loans originated in Puerto Rico
whose mortgagors are residents of Puerto Rico. The exemption for interest earned
on FHA loans, VA loans and GNMA certificates tends to increase the demand for
these products and the price the Company may obtain upon their sale. From time
to time, the government of Puerto Rico has examined whether the existing tax
exemption for FHA and VA loans and GNMA securities should be modified or
repealed. There can be no assurance that the tax exempt treatment of interest on
FHA and VA loans will not be reviewed or modified in the future.
Any change in Puerto Rico's political status could result in the
elimination or modification of these tax benefits described above. See "THE
COMMONWEALTH OF PUERTO RICO -- Relationship of Puerto
35
<PAGE> 36
Rico with the United States" for a description of legislation introduced into
the House of Representatives regarding the holding of a referendum on the
political status of Puerto Rico.
OTHER LENDING AND INVESTMENT ACTIVITIES
Lending Activities of Doral Federal and Real Estate Owned. The Company,
through Doral Federal, originates for investment mortgage loans secured by
residential real estate, including personal loans up to $40,000 secured by first
or second mortgages. To a lesser extent, Doral Federal also originates
development and construction loans and loans secured by commercial real estate.
Prior to being acquired by the Company in September 1993, Doral Federal also
engaged in unsecured consumer and commercial lending and finance leases. Doral
Federal is considering beginning to offer such products again on a limited
basis.
At June 30, 1996, December 31, 1995 and 1994, loans held for investment
which were originated as part of the Company's other lending activities through
Doral Federal, totaled $86.7 million, $51.4 million and $34.8 million,
respectively, and 97%, 72% and 85%, respectively, of such loans were secured by
mortgages on owner-occupied single-family residences. While Doral Federal has
nationwide lending authority as a federal savings association, substantially all
of its loans are secured by real property located in Puerto Rico. At June 30,
1996 and December 31, 1995, 98% and 99%, respectively, of the mortgage loans
held for investment by Doral Federal were secured by property located in Puerto
Rico. At June 30, 1996, the largest loan held for investment by Doral Federal
was $645,000 and the maximum aggregate amount of loans that Doral Federal could
make to a single borrower under OTS regulations was $2.6 million. The Company
anticipates continued growth in Doral Federal's portfolio of loans held for
investment.
In addition to its portfolio of loans held for investment, Doral Federal
maintains a portfolio of mortgage loans held for sale consisting entirely of
first mortgage loans secured by residential properties. As of June 30, 1996 and
December 31, 1995, Doral Federal held mortgage loans available for sale of $30.0
million and $31.7 million, respectively. Such mortgage loans are recorded in the
financial statements of the Company at the lower of cost or market value.
In connection with FFCC's acquisition of Doral Federal, Doral Federal
entered into a Master Loan Production Agreement with the Company whereby the
Company agreed to help the thrift meet its stated production goals by, among
other things, (1) advertising, promoting and marketing to the general public,
(2) interviewing prospective borrowers and initial processing of loan
applications, consistent with Doral Federal's underwriting guidelines, and (3)
providing personnel and facilities with respect to the execution of loan
agreements. In the future, Doral Federal may determine to engage in direct
mortgage loan originations through its branch network.
For mortgage loans originated prior to October 1, 1995, Doral Federal had
in effect a Master Purchase, Servicing and Collection Agreement (the "Master
Purchase Agreement") with the Company providing for the sale by Doral Federal to
the Company of the servicing rights to all first and second mortgage loans
secured by residential properties, all loans secured by commercial real estate,
all commercial business loans, consumer and any other loans secured by mortgages
and forming a part of Doral Federal's loan portfolio (the "Doral Federal
Loans"). The Master Purchase Agreement further provides that the Company,
exclusively, will service the Doral Federal Loans according to a fee schedule
contained in the Master Purchase Agreement. The fee schedule provides that the
purchase price of the servicing rights with respect to the Doral Federal Loans
is a percentage of the outstanding principal amount of such Doral Federal Loans.
For Doral Federal Loans originated after October 1, 1995, the Master
Purchase Agreement was substituted with a Master Servicing and Collection
Agreement (the "Master Servicing Agreement") whereby Doral Federal will
contractually agree to service all Doral Federal Loans originated after the date
of the Master Servicing Agreement. Under the Master Servicing Agreement, FFCC
will not, however, purchase the intangible right to service such Doral Federal
Loans. The Company is entitled to receive a servicing fee equal to 50 basis
points of the outstanding principal amount of the Doral Federal Loans being
serviced. Doral Federal retains the right to terminate the Company's servicing
rights, without cause, upon notice to the Company.
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<PAGE> 37
The following table set forth certain information regarding the Company's
loans held for investment as part of its other lending activities through Doral
Federal as of the dates indicated:
<TABLE>
<CAPTION>
JUNE 30, PERCENT DECEMBER 31, PERCENT DECEMBER 31, PERCENT
1996 OF TOTAL 1995 OF TOTAL 1994 OF TOTAL
-------- -------- ------------ -------- ------------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Construction loans............ $ 2,694 3% $ 2,637 5% $ 1,061 3%
Residential mortgage loans.... 50,183 57 29,481 57 23,293 66
Commercial real estate........ 13,742 16 9,205 18 2,044 6
Consumer -- Secured by
mortgage.................... 17,806 20 7,362 14 6,283 18
Consumer -- other............. 523 1 324 (1) 1,009 3
Other(2):..................... 2,892 3 2,971 13 1,560 4
-------- --- ------------ --- ------------ ---
Gross loans(3)(4)........... 87,840 100% 51,980 100% 35,250 100%
-------- ------------ ------------
Less:
Unearned interest and
deferred loan fees....... (648) (383) (13)
Allowance for loan losses... (506) (242) (428)
-------- ------------ ------------
(1,154) (625) (441)
-------- ------------ ------------
Loans receivable, Net(5).... $ 86,686 $ 51,355 $ 34,809
======= ========== ==========
</TABLE>
- ---------------
(1) Less than one percent.
(2) Includes commercial loans, loans on savings deposits, leases and loans
secured with land.
(3) Sum of the columns may not add up to the totals due to rounding.
(4) Excludes residential mortgage loans held for sale by Doral Federal of $30.0
million and $31.7 million as of June 30, 1996 and December 31, 1995,
respectively.
(5) Net of deferred loan fees resulting from the sale of servicing rights to
affiliates which are eliminated in the preparation of the Company's
Consolidated Financial Statements.
Doral Federal originates adjustable and fixed interest rate loans. However,
given traditional consumer preferences in Puerto Rico for fixed rate mortgage
loans, Doral Federal's principal product, the Company does not anticipate
significant growth in adjustable rate mortgages. At June 30, 1996 and December
31, 1995 approximately 4% and 7%, respectively, of Doral Federal's loans held
for investment were adjustable rate loans. The adjustable rate loans have
interest rate adjustment limitations and are generally tied to the prime rate.
Future market factors may affect the correlation of the interest rate adjustment
with the rate Doral Federal pays on the short-term deposits that have primarily
funded these loans.
The following information indicates as of June 30, 1996, with respect to
the Company's loans held for investment through Doral Federal, the time periods
during which fixed rates loans mature and adjustable rate loans reprice:
<TABLE>
<CAPTION>
FIXED RATE LOANS ADJUSTABLE RATE LOANS
------------------------------------------ -----------------------------------------
BOOK TERM OF DATE OF BOOK
TERM TO MATURITY VALUE RATE ADJUSTMENT VALUE
--------------------------- ------- --------------------------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
1 month - 1 year $ 1,306 1 month - 1 year $1,971
1 year - 3 years 3,060 Non-performing --
3 years - 5 years 284 ------
5 years - 10 years 27,431 $1,971
10 years - 20 years 14,911 ======
Over 20 years 37,964
Non-performing 913
-------
$85,869
=======
</TABLE>
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<PAGE> 38
Nonperforming Assets and Allowance for Loan Losses. Nonperforming assets
("NPAs") consist of loans on a non-accrual basis and other real estate owned.
Doral Federal's policy is to place all loans 90 days or more past due on
non-accrual basis, at which point a reserve for all unpaid interest previously
accrued is established. Interest income is recognized when the borrower makes a
payment, and the loan will return to an accrual basis when it is no longer 90 or
more days delinquent and collectability is reasonably assured. Mortgage loans
held for sale as part of the Company's Mortgage Banking Business are normally
only placed on a non-accrual basis upon commencement of foreclosure proceedings
(which normally occurs within six to eight months following default). For the
six months ended June 30, 1996 and the years ended December 31, 1995 and 1994,
the Company would have recognized $167,000, $211,000 and $287,000, respectively,
in additional interest income had all delinquent loans owned by the Company been
accounted for on an accrual basis. See "-- Regulation -- Savings and Loan
Operations -- Doral Federal -- Classification of Assets" for additional
information regarding classified assets of Doral Federal.
The following table sets forth information with respect to the Company's
non-accrual loans, REO and other nonperforming assets as of June 30, 1996 and
December 31, 1995 and 1994.
<TABLE>
<CAPTION>
DECEMBER 31,
JUNE 30, -----------------
1996 1995 1994
------------- ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Mortgage Banking Business(1):
Non-accrual loans(2)............................... $ 1,250 $1,250 $4,260
Other real estate owned............................ 2,251 2,085 2,029
Other nonperforming assets(3)...................... 892 893 448
Other Lending Activities through Doral Federal(4):
Non-accrual loans.................................. 913 949 459
Other real estate owned............................ -- -- 87
Total NPAs as a percentage of loans receivable, net
and other real estate owned..................... 1.1% 1.8% 1.6%
Ratio of allowance for loan receivables to
nonperforming loans............................. 55.42% 25.50% 93.25%
</TABLE>
- ---------------
(1) Includes mortgage loans held for sale and real estate owned related to the
Company's Mortgage Banking Business. Consists primarily of construction and
commercial loans.
(2) Of the amounts shown $1.25 million, $1.25 million and $2.9 million
represented loans that were required to be repurchased by a non-affiliated
Puerto Rico government institution at par on a non-recourse basis as of
June 30, 1996 and December 31, 1995 and 1994, respectively.
(3) This amount refers to a mortgage loan to a real estate partnership to which
the Company previously sold REO. This loan is included in "Mortgage-backed
securities and investments held to maturity" in the Company's financial
statements. See "-- Mortgage Banking Business -- Foreclosure Experience and
Real Estate Owned."
(4) Includes mortgage loans and REO of Doral Federal.
The Mortgage Banking Business' other real estate owned arises primarily
through foreclosure on mortgage loans repurchased from investors, either because
of breach of representations or warranties or pursuant to recourse arrangements.
The Company believes that the value of the REO reflected on its financial
statements represent a reasonable estimate of the properties' fair value, net of
cost of sales. During the past five years, the impact of loans repurchased as
the result of breach of representations or warranties or pursuant to recourse
arrangements has not been material.
The provision for loan losses relating to loans held by Doral Federal was
$506,000 as of June 30, 1996 as compared to $242,000 as of December 31, 1995.
The increase in the allowance was primarily the result of the increase in the
size of the loan portfolio and an increase in the amount of home equity and
consumer loans secured by mortgages for which Doral Federal provides a higher
allowance.
The percentage of the allowance for loan losses to nonperforming loans held
for investment will not remain constant due to the nature of Doral Federal's
portfolio of mortgage loans, which are primarily collateralized by real estate.
The collateral for each nonperforming mortgage loan is analyzed by Doral Federal
to determine potential loss exposure, and in conjunction with other factors,
this loss exposure contributes to
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<PAGE> 39
the overall assessment of the adequacy of the allowance for loan losses. On an
on-going basis, management monitors the loan portfolio and evaluates the
adequacy of the allowance for loan losses. In determining the adequacy of the
allowance for loan losses, management considers such factors as historical loan
loss experience, known problem loans, evaluations made by bank regulatory
authorities, assessment of economic conditions and other appropriate data to
identify the risks in the loan portfolio. Loans deemed by management to be
uncollectible are charged to the allowance for loan losses. Recoveries on loans
previously charged off are credited to the allowance. Provisions for loan losses
are charged to expense and credited to the allowance in amounts deemed
appropriate by management based upon its evaluation of the known and inherent
risks in the loan portfolio. While management believes that the current
allowance for loan losses is sufficient, future additions to the allowance may
be necessary. The following table summarizes certain information regarding the
Company's allowance for loan losses related to loans held for investment by
Doral Federal and losses on other real estate owned for both Doral Federal and
the Mortgage Banking Business for the periods indicated.
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
------------- --------------------
1996 1995 1995 1994 1993
----- ----- ----- ----- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
REAL ESTATE HELD FOR SALE:
Balance at beginning of period.................... $ 356 $ 356 $ 356 $ 525 $400
Provision for losses.............................. 117 -- -- -- 100
Losses charged to the allowance................... (117) -- -- (169) --
Other............................................. -- -- -- -- 25
----- ----- ----- ----- ----
Balance at end of period.......................... $ 356 $ 356 $ 356 $ 356 $525
===== ===== ===== ===== ====
ALLOWANCE FOR LOAN RECEIVABLES(1):
Balance at beginning of period.................... $ 242 $ 428 $ 428 $ 234 $516
Provision for loan losses......................... 270 70 110 168 23
Recoveries........................................ 2 5 7 26 --
Losses charged to the allowance................... (8) (192) (303) -- (305)
----- ----- ----- ----- ----
Balance at end of period.......................... $ 506 $ 311 $ 242 $ 428 $234
===== ===== ===== ===== ====
</TABLE>
- ---------------
(1) Relates to loans held for investment by Doral Federal, which the Company
acquired in September 1993.
Other Investment Activities. As a result of the Company's mortgage
securitization activities, the Company maintains a substantial portfolio of
mortgage-backed securities held for trading. At June 30, 1996, the Company held
mortgage-backed securities held for trading with a fair value of $389.1 million,
approximately $355.5 million of which consisted of GNMA and other tax-exempt
mortgage-backed securities. These tax-exempt securities are generally held by
the Company for longer periods prior to sale in order to maximize the tax-exempt
interest received thereon.
As of June 30, 1996, the Company also held approximately $112.6 million of
securities and other investments which are classified as held to maturity
because the Company had the intent and ability to hold these securities until
maturity. Of this amount, approximately $52.6 million were held by Doral
Federal. The $59.1 million in securities classified as held to maturity included
as part of the Company's Mortgage Banking Business consist of tax exempt
GNMA-backed collateralized mortgage obligations. The holding of these securities
until maturity is consistent with the Company's strategy to maximize tax exempt
interest income. The Company does not believe that the holding of these
securities will have an adverse effect on the liquidity of the Company because
it believes that it will be able to obtain continuous financing for these
securities under its existing credit facilities or pursuant to deposits, in the
case of securities owned by Doral Federal.
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<PAGE> 40
The following table provides certain information regarding the composition
of the Company's mortgage-backed securities and other investments held to
maturity as of the dates indicated below.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------
JUNE 30, 1996 1995 1994
---------------------- --------------------- ----------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
--------- -------- --------- ------- --------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
MORTGAGE-BACKED
SECURITIES:
CMO certificates of
non-affiliated
issuers........... $ 59,138(1) $ 59,195 $59,248(1) $59,521 $42,052(1) $42,175
GNMA................. 21,618 21,720 10,745 10,919
FHLMC................ -- -- 4,600 4,470
FNMA................. -- -- 7,748 7,310
DEBT SECURITIES:
Federal Home Loan
Bank Notes........ 23,984 23,984 4,999 4,995 9,972 9,712
U.S. Treasury Notes
and Bills......... 7,005 6,987 2,061 2,065 1,984 1,949
OTHER INVESTMENTS:
Mortgage notes
receivables....... 892 892 892 892 448 448
-------- -------- ------- ------- ------- -------
Total........ $ 112,637 $112,778 $77,945 $78,392 $66,804 $66,064
======== ======== ======= ======= ======= =======
</TABLE>
- ---------------
(1) Includes approximately $4.8 million of interest only certificates.
The following table provides information on the contractual or expected
maturities (in the case of mortgage-backed securities) of the Company's
mortgage-backed securities and investments held to maturity as of June 30, 1996:
<TABLE>
<CAPTION>
MORTGAGE-
BACKED DEBT
SECURITIES SECURITIES
----------------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Less than 1 year............................................. $ -- $ 22,941
After 1 year through 5 years................................. 19,720 8,940
After 5 years through 10 years............................... 22,794 --
After 10 years............................................... 38,242 --
----------------- ----------
Total.............................................. $80,756 $ 31,881
============= =======
</TABLE>
The aggregate gross unrealized holding gains and losses for the Company's
mortgage-backed securities and investments held to maturity as of the dates
indicated are detailed below:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------
JUNE 30, 1996 1995 1994
---------------------- ---------------------- ----------------------
MORTGAGE- MORTGAGE- MORTGAGE-
BACKED DEBT BACKED DEBT BACKED DEBT
SECURITIES SECURITIES SECURITIES SECURITIES SECURITIES SECURITIES
--------- ---------- --------- ---------- --------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Gross unrealized holding
gains....................... $ 301 9 481 4 $ 397 $ --
Gross unrealized holding
losses...................... 142 27 34 4 843 295
</TABLE>
As of June 30, 1996, Doral Federal also held approximately $7.4 million in
FNMA, FHLMC and GNMA mortgage-backed securities that are classified as available
for sale. As of June 30, 1996, gross unrealized holding gains with respect to
such securities equalled approximately $10,000 while gross unrealized
40
<PAGE> 41
losses equalled approximately $311,000. The contractual maturity of the
securities available for sale at June 30, 1996 is generally over ten years.
PROPOSED BROKER-DEALER ACTIVITIES
During the second quarter of 1996, the Company organized a new subsidiary,
AAA Financial, which commenced operations on September 12, 1996. While AAA
Financial will engage in a general securities business, it is expected to
initially concentrate on the sale of Puerto Rico tax exempt GNMA securities and
other Puerto Rico securities. AAA Financial will commence operations from a
single branch in the San Juan metropolitan area and is expected to employ
approximately 20 persons by the end of 1996.
FUNDING
BORROWING ARRANGEMENTS RELATING TO MORTGAGE BANKING OPERATIONS. Except as
noted below with respect to GNMA securities, historically, a period of two to
four months has normally elapsed between the origination of a mortgage loan by
FFCC and its sale to permanent investors. The Company often holds GNMA
certificates for longer periods to take advantage of tax exempt interest income
on such certificates while conforming loans that qualify for the mortgage-backed
securities programs of FNMA and FHLC are normally sold within 60 days of
origination.
Prior to issuance of GNMA or other mortgage-backed certificates, FFCC's
mortgage loans are funded almost entirely by borrowings under warehousing lines
of credit or other financing agreements such as pre-sale, gestation facilities
and repurchase agreements, with financial institutions. FFCC principal short
term facilities include the Syndicated Credit Agreement, warehousing lines of
credit with three local commercial banks and pre-sale, gestation or repurchase
facilities with three affiliates of major U.S. brokerage houses. Pre-sale or
gestation facilities generally permit the Company to obtain more favorable
financing rates once mortgage loans been assigned to a pool but prior to
securitization. These facilities also generally allow for the financing of
mortgage-backed securities upon issuance. Typically, FFCC finances between 90%
and 95% of the principal amount of its mortgage loans and secures advances under
its lines of credit by pledging such loans and the servicing agreements relating
thereto to such banks or financial institutions, a practice commonly referred to
as "warehousing." The percentage of principal amount will range from 90% for
conventional mortgages (one bank will only lend up to 80% of the principal
amount of conventional mortgages) to 95% for FHA and VA loans. The rates of
interest FFCC pays under its warehousing lines of credit fluctuate depending
upon changes in the lender's cost of funds. FFCC warehousing lines of credit are
generally terminable at the discretion of the lender.
FFCC pays interest on its lines of credit at floating rates which vary with
market conditions. The interest rates on these lines of credit have been lower
than the interest rates which FFCC earns on the mortgage loans pledged to secure
such financing. Amounts borrowed under lines of credit are payable upon demand
and are usually repaid after FFCC packages such mortgage loans into GNMA, FNMA
or FHLMC certificates and receives the proceeds from the sale of such
certificates or the financing of such securities under repurchase agreements.
FFCC also obtain short-term financing through repurchase agreements with
financial institutions and investment banking firms. Under these agreements,
FFCC sells GNMA, FNMA or FHLMC-guaranteed mortgage-backed securities and, to a
lesser extent, private label mortgage-backed securities, and simultaneously
agrees to repurchase them at a future date at a fixed price. FFCC uses the
proceeds of such sales to repay borrowings under its bank warehousing lines of
credit. The effective cost of funds under repurchase agreements is typically
lower than the costs of funds borrowed under FFCC's warehousing lines of credit.
FFCC's continued use of repurchase agreements will depend upon the cost of
repurchase agreements relative to the cost of borrowing under lines of credit
from banks.
Commencing in 1993, the Company made a strategic decision to diversify its
sources of funding and to obtain funding from sources outside of Puerto Rico. As
of June 30, 1996, the Company's credit facilities included three pre-sale or
gestation facilities with affiliates of major U.S. brokerage houses and a
syndicated multi-bank credit facility described below. Obtaining credit from
financial institutions located outside Puerto
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<PAGE> 42
Rico generally permits the Company to obtain larger lines of credit and reduces
its dependence on tax advantaged funding available in the local market.
On June 30, 1995, as part of its strategy to continue to diversify its
sources of funding, FFCC entered into a Syndicated Credit Agreement with six
banks which, as amended, provides for three credit facilities totaling up to
$125 million. The credit facilities were structured by Bankers Trust Company, as
administrative and syndicate agent. The three facilities included: (i) a $100
million secured one-year revolving warehousing credit facility to finance
residential mortgage loans and mortgage-backed securities; (ii) a $7 million
secured one-year revolving credit facility to provide financing for receivables
and working capital needs; and (iii) a $18 million five-year senior secured term
loan facility (of which $15.3 million had been drawn as of June 30, 1996 and the
remaining $2.7 million of the commitment expired), secured with a portion of the
Company's servicing portfolio, to finance the acquisition of additional
servicing rights and general working capital purposes. The amounts available
under the Syndicated Credit Agreement are subject to a borrowing base which
consists of mortgage loans and mortgage-backed securities for the first
facility, receivables relating to servicing advances and real estate owned for
the second facility and mortgage servicing rights for the third facility.
On June 28, 1996, the Syndicated Credit Agreement was amended in order to,
among other things, extend for additional one year periods the warehousing and
revolving credit facilities as well as to provide an additional $5 million
non-revolving servicing secured term facility with a final maturity of June 30,
2001.
As of September 30, 1996, the outstanding amount of all servicing secured
advances totalled $17.7 million. Such advances will be paid from the proceeds of
the Notes offered hereby and such facility will be terminated.
During 1995, the Company also entered into a Debenture Purchase Agreement
dated September 25, 1995, as amended and restated as of December 15, 1995 (the
"Debenture Purchase Agreement") with BanPonce Corporation ("BanPonce") a bank
holding company headquartered in San Juan, Puerto Rico, providing for the
issuance and sale to BanPonce of up to $10,000,000 of Convertible Subordinated
Debentures in a private placement transaction. Approximately $6.6 million of
Convertible Subordinated Debentures were issued on September 25, 1995 and the
remaining $3.4 million were issued on December 22, 1995. The Convertible
Subordinated Debentures are convertible into shares of common stock at a
conversion price of $17.50 per share, subject to adjustment in certain events.
In order to facilitate the receipt of all required regulatory approvals,
approximately $1.8 million of the Convertible Subordinated Debentures are not
convertible into shares of Common Stock prior to January 1, 1999. The
Convertible Subordinated Debentures are subordinated to all existing and future
senior debt (as defined in the Debenture Purchase Agreement) of the Company. If
the entire $8.2 million of the Convertible Subordinated Debentures that are
immediately convertible into shares of Common Stock were converted, they would
equal 466,262 shares, or approximately 4.99% of the Company's total outstanding
shares of Common Stock as of December 31, 1995, as adjusted for the conversion
of such Convertible Subordinated Debentures.
Under the terms of the Debenture Purchase Agreement, BanPonce also obtained
the right to acquire up to 200,000 additional shares of Common Stock at a price
of $17.50 per share (subject to adjustment in certain events) to the extent that
the shares of Common Stock issued or issuable upon conversion of all the
Debentures (including the Convertible Subordinated Debentures that are not
immediately convertible) represent less than the 5% of the Company's fully
diluted outstanding shares of Common Stock.
FUNDING ARRANGEMENTS RELATING TO SAVINGS AND LOAN OPERATIONS. Deposits and
borrowings, consisting of FHLB-NY advances and term notes, are the primary
sources of Doral Federal's funds for use in its lending, investment and other
business activities. In addition, Doral Federal obtains funds in the form of
loan repayments and income from operations as well as capital contributions from
FFCC. FFCC made capital contributions of $8.5 million in Doral Federal during
1995. Loan repayments are a relatively stable source of funds while net increase
in deposits are significantly influenced by general interest rates and money
market conditions.
Deposits have been the principal source of funds for Doral Federal's
lending activities. At June 30, 1996, Doral Federal held $142 million in
deposits at a weighted average interest rate cost of 3.64%. Doral Federal offers
passbook savings accounts, checking accounts, NOW accounts and fixed interest
rate certificate accounts with varying maturities. A substantial portion of
Doral Federal's deposits consist of non-interest
42
<PAGE> 43
bearing wholesale deposit accounts such as corporate and custodial accounts. At
June 30, 1996, $41.3 million or approximately 29% of Doral Federal's total
deposits consisted of non-interest bearing accounts. Approximately 80% of such
amount related to corporate and custodial accounts of the Company and its
affiliates. This amount includes approximately $5.1 million in corporate
accounts of the Company and its affiliates which are eliminated in the
preparation of the Company's Consolidated Financial Statements. Corporate
accounts of the Company as well as escrow and custodial accounts related to the
Company's Mortgage Banking Business represent a stable source of low cost
funding for Doral Federal. For additional information regarding the
characteristics of Doral Federal's deposit accounts, refer to Note 19 of the
Company's Audited Consolidated Financial Statements.
Doral Federal may also obtain funding through collateralized borrowings
directly from the Federal Home Loan Bank of New York (the "FHLB-NY") and through
borrowings secured by FHLB-NY letters of credit, up to a maximum of 30% of total
assets. Such advances or letter of credit reimbursement obligations must be
secured by qualifying assets with a market value equal to between 105% and 115%
of the outstanding obligation. At June 30, 1996, Doral Federal had $15.4 million
in outstanding advances from the FHLB-NY at a weighted average interest rate
cost of 6.28%.
Doral Federal is licensed as an Eligible Depository Institution ("EDI")
with the Office of the Commissioner and as such is authorized to accept 936
Funds directly from 936 Corporations. As of June 30, 1996, Doral Federal had
issued approximately $33.1 million in five year term notes that were sold to 936
Corporations. Such term notes have maturities ranging from October, 2000 to
April, 2001 and bear interest at a weighted average annual interest rate of
6.01%. Approximately $28.1 million of such term notes bear interest a fixed
rate. With respect to the $5.0 million of term notes that bears interest at a
fluctuating rate, the Company has effectively fixed the rate on such notes by
entering into an interest rate swap agreement with a major brokerage firm.
Because of Doral Federal's status as an EDI, the interest received on the term
notes issued by Doral Federal is tax exempt when received by a 936 Corporation.
Because of such favorable tax treatment, the interest rates on such notes are
less than what otherwise would be obtained by Doral Federal. The term notes
contain interest "gross-up" provisions that provide for a prospective adjustment
on the interest rates on the notes to a fixed rate equal to 100% of the LIBID,
as of the adjustment date, on the remaining term of the notes, in the event of
an advance change in the tax treatment of the interest received on the Notes
under Section 936. As a result of the recent elimination of QPSII in connection
with the repeal of Section 936, the interest rate on such term notes will be
increased commencing in October of 1996. The ability to continue to raise
additional long term funding through the issuance of term notes to 936
Corporation may be adversely affected by the repeal of the tax benefits
available under Section 936. Notwithstanding the repeal of Section 936, 936
Corporations will continue to have an incentive under Puerto Rico law to invest
in term notes with maturities of five years to avoid payment of the otherwise
applicable tollgate tax. See "-- Mortgage Banking Business-Puerto Rico Secondary
Mortgage Market and Favorable Tax Treatment" for a description of the benefits
available under Section 936 and the Puerto Rico Industrial Incentive Acts.
From time to time, Doral Federal may also obtain funding through the use of
repurchase agreements with brokerage firms and other financial institutions. As
of June 30, 1996, Doral Federal did not have any outstanding borrowings under
repurchase agreements.
PUERTO RICO INCOME TAXES
FFCC is subject to Puerto Rico income taxes. On October 31, 1994, the
Government of Puerto Rico enacted a new comprehensive internal revenue act known
as the Puerto Rico Internal Revenue Code of 1994 (the "PRIRC"). Most changes
affecting corporations are effective for taxable years commencing after June 30,
1995. While the PRIRC incorporates many of the provisions of the prior tax law,
it also provides for various amendments and changes from prior law.
Among the most important changes introduced by the PRIRC were (i) a
reduction in the maximum marginal statutory corporate tax rate from 42% to 39%,
(ii) the elimination of the deduction for bad debt expense arising from the use
of the reserve method for bad debt reserve and the related prorated recapture of
the outstanding balance of the reserve existing as of June 30, 1995 over a four
year period and (iii) optional use of a new method of accelerated depreciation
for capital assets purchased during taxable years beginning after June 30, 1995.
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<PAGE> 44
The Company is also subject to an alternative minimum tax of 22% on its
alternative minimum tax net income. In computing the Company's alternative
minimum tax net income its interest expense deduction will be reduced in the
same proportion that its exempt obligations (including FHA loans, VA loans and
GNMA securities) bear to its total assets. Therefore, to the extent that the
Company holds FHA loans or VA loans and other exempt obligations, it may be
subject to the payment of the 22% alternative minimum tax.
Under PRIRC, corporations are not permitted to file consolidated returns
with their subsidiaries and affiliates. Effective for taxable year commencing
after June 30, 1995, FFCC is entitled to a 100% dividend received deduction on
dividends received from Doral Mortgage or any other Puerto Rico corporation
subject to tax under PRIRC. No dividends received deduction is available for
dividends received from U.S. corporations such as Doral Federal. Effective July
1, 1995, the PRIRC also provided for the elimination of the existing 29%
withholding tax applicable on interest paid to non-resident corporations and
individuals as well as a reduction of the withholding tax applicable to
dividends payable to non-resident corporations and individuals from 25% to 10%.
The Company does not believe that the changes implemented by the PRIRC will
have a material adverse affect on the business or financial condition of the
Company.
UNITED STATES INCOME TAXES
FFCC and Doral Mortgage are corporations organized under the laws of Puerto
Rico. Accordingly, FFCC and Doral Mortgage are subject generally to United
States income tax only on their income, if any, from sources within the United
States. Prior to 1992, the Company did not earn any income that was subject to
United States income tax. However, in March 1992, Doral Mortgage opened a branch
in Florida. Accordingly, Doral Mortgage is subject to both Florida income and
franchise taxes and federal income tax on income effectively connected with the
conduct of the trade or business of this branch. In addition, the United States
may impose a branch profits tax of 30% in the event that profits from the
Florida branch are repatriated to Puerto Rico. Both the Federal tax as well as
the branch profit tax may be claimed as a tax credit in Puerto Rico, subject to
certain limitations.
Doral Federal, as a federal savings association, is also subject to U.S.
income taxes. It will be entitled to a foreign tax credit for a portion of
income taxes paid to the Puerto Rico Treasury Department. Doral Federal has also
elected to qualify for the benefits provided under Section 936 which allows an
income tax credit for a portion of the U.S. income taxes attributable to the
earnings derived from sources within Puerto Rico. See "Mortgage Banking
Business -- Puerto Rico Secondary Mortgage Market and Favorable Tax Treatment"
for a description of Section 936.
EMPLOYEES
At June 30, 1996, FFCC employed 774 persons, of whom 456 were
administrative personnel, 94 were loan originators, 91 were involved in
processing of loan applications (including quality control auditors), 17 were
loan underwriters, and 116 were involved in loan servicing activities. None of
FFCC's employees is represented by a labor union and FFCC considers its employee
relations to be excellent.
REGULATION -- MORTGAGE BANKING BUSINESS
The Company's Mortgage Banking Business is subject to the rules and
regulations of FHA, VA, FNMA, FHLMC and GNMA with respect to originating,
processing, selling and servicing mortgage loans and the issuance and sale of
mortgage-backed securities. Those rules and regulations, among other things,
prohibit discrimination and establish underwriting guidelines which include
provisions for inspections and appraisals, require credit reports on prospective
borrowers and fix maximum loan amounts, and with respect to VA loans, fix
maximum interest rates. Moreover, lenders such as the Company are required
annually to submit to FNMA, FHA, FHLMC, GNMA, HUD and VA audited financial
statements, and each regulatory entity has its own financial requirements. The
Company's affairs are also subject to supervision and examination by FNMA, FHA,
FHLMC, GNMA, HUD and VA at all times to assure compliance with the applicable
regulations, policies and procedures. Mortgage origination activities are
subject to, among others, the Equal
44
<PAGE> 45
Credit Opportunity Act, Federal Truth-in-Lending Act and the Real Estate
Settlement Procedures Act and the regulations promulgated thereunder which,
among other things, prohibit discrimination and require the disclosure of
certain basic information to mortgagors concerning credit terms and settlement
costs. The Company is also subject to regulation by the Office of the
Commissioner, with respect to, among other things, licensing requirements and
establishment of maximum interest rates. Although the Company believes that it
is in compliance in all material respects with applicable Federal and Puerto
Rico laws, rules and regulations, there can be no assurance that more
restrictive laws or rules will not be adopted in the future, which could make
compliance more difficult or expensive, restrict the Company's ability to
originate or sell mortgage loans or sell mortgage-backed securities, further
limit or restrict the amount of interest and other fees earned from the
origination of loans, or otherwise adversely affect the business or prospects of
the Company.
FFCC is licensed by the Office of the Commissioner as a mortgage banking
institution in Puerto Rico. Such authorization to act as a mortgage banking
institution must be renewed as of January 1 of each year. In the past, FFCC has
not had any difficulty in renewing its authorization to act as a mortgage
banking institution, and management is unaware of any existing practices,
conditions or violations which would result in FFCC being unable to receive such
authorization in the future. FFCC operations in the State of Florida are subject
to supervision by the Florida Department of Banking and Finance.
Section 5 of the Puerto Rico Mortgage Banking Institutions Law (the
"Mortgage Banking Law") requires the prior approval of the Office of the
Commissioner for the acquisition of control of any mortgage banking institution
licensed under the Mortgage Banking Law. For purposes of the Mortgage Banking
Law, the term "control" means the power to direct or influence decisively,
directly or indirectly, the management or policies of a mortgage banking
institution. The Mortgage Banking Law provides that a transaction that results
in the holding of less than 10% of the outstanding voting securities of a
mortgage banking institution shall not be considered a change of control.
Pursuant to Section 5 of the Mortgage Banking Law, upon receipt of notice of a
proposed transaction that may result in change of control, the Office of the
Commissioner is obligated to make such inquiries as he deems necessary to review
the transaction. Under the Mortgage Banking Law, the determination of the Office
of the Commissioner whether or not to authorize a proposed change of control is
final and non-appealable.
REGULATION -- SAVINGS AND LOAN OPERATIONS
The Company
As a result of the acquisition of Doral Federal in September 1993, FFCC
became a savings and loan holding company ("SLHC"), subject to the restrictions
and requirements of the Home Owners' Loan Act, as amended (the "HOLA"). FFCC is
registered as an SLHC with the Director (the "Director") of the Office of Thrift
Supervision (the "OTS") and is subject to the various requirements of Sections
10 and 11 of the HOLA and the regulations thereunder, including examination,
supervision and reporting requirements. Of particular importance, is the
requirement that a subsidiary savings association give the Director at least 30
days' advance notice of the proposed declaration by its directors of dividends
on its stock. Any such dividend declared within the 30-day notice period, or
declared without giving such notice, is invalid. Payment of cash dividends by a
savings association on shares of its capital stock is also subject to the
limitations on capital distributions imposed by the OTS. See
"Regulation -- Savings and Loan Operations -- Doral Federal -- Dividends."
Federal law and OTS regulations place certain limits on the types of
activities in which a SLHC and its subsidiaries may engage. However, in general,
these activity restrictions do not apply to a holding company that controls only
one savings and loan association, provided such association meets the "qualified
thrift lender" test, which generally requires an association to have 65% of its
portfolio assets in "qualified thrift investments" for nine months out of the
immediately preceding 12 months. For Puerto Rico-based institutions, these
investments include, among other things, home mortgages, mortgage-backed
securities, and personal loans. In the event a SLHC's subsidiary savings
association does not hold sufficient "qualified thrift assets" to meet the
"qualified thrift lender test", a SLHC may be deemed for regulatory purposes to
become a bank holding company. In such event, a SLHC would become subject to
certain activity restrictions. In
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<PAGE> 46
addition, any savings association subsidiary would be subject to the activity
and branching restrictions applicable to national banks, including the
application of the statutes and regulations governing the payment of dividends
by a national bank in the same manner and to the same extent as though it were a
national bank. Under the National Bank Act, national banks are only permitted to
pay dividends out of "net profits" (as defined therein) subject to the
requirement that a certain portion of net profits must be carried periodically
to the bank's surplus fund until the surplus fund shall equal its common
capital. Capital may not be used to pay dividends. Doral Federal currently is in
compliance with the "qualified thrift lender" test and expects to continue to
comply with this requirement.
With certain specific exceptions, a SLHC is prohibited from acquiring more
than 5% of the "voting shares" of a savings association that is not a
subsidiary, or of another SLHC that is not a subsidiary. An association which is
a subsidiary of a SLHC is prohibited from or subject to restrictions upon
engaging in certain transactions involving its affiliates under the provisions
of Sections 23A and 23B of the Federal Reserve Act, which are made applicable to
savings associations under the HOLA. In general, the term "affiliate" with
respect to such subsidiary savings association would include the SLHC, its
subsidiaries and companies controlled by it, and would also include a bank
subsidiary of a savings association, but not a non-bank subsidiary thereof
(unless a contrary determination were made by the OTS pursuant to Section 23A as
to such non-bank subsidiary).
Because of the Company's status as a SLHC, owners of the Common Stock are
subject to certain restrictions and disclosure obligations under various federal
laws, including the Change in Bank Control Act (the "Control Act") and the
Savings and Loan Holding Company Act (the "SLHCA"). Regulations pursuant to the
Control Act and the SLHCA generally require prior OTS approval for an
acquisition of control of an insured institution (as defined) or holding company
thereof by any person (or persons acting in concert). Control is deemed to exist
if, among other things, a person (or persons acting in concert) acquires more
than 25% of any class of voting stock of an insured institution or holding
company thereof. Control is presumed to exist subject to rebuttal, if a person
(or persons acting in concert) acquires more than 10% of any class of voting
stock or 25% of any class of nonvoting stock and is subject to any of the
"control factors" set forth in such regulations. The control factors relate,
among other matters, to the percentage of such company's debt or equity owned by
the person (or persons acting in concert), agreements giving the person (or
persons acting in concert) influence over a material aspect of the company's
management or policies, and the number of seats on the board of directors of the
company held by the person (or persons acting in concert). One of the "control
factors" is a holder's status as one of the two largest holders of any class of
voting stock. The concept of acting in concert is very broad and also is subject
to certain rebuttable presumptions, including among others, that relatives,
business partners, management officials, affiliates and others are presumed to
be acting in concert with each other and their businesses. This regulatory
requirement may have the effect of discouraging takeover attempts against the
Company and may limit the ability of persons, other than Company directors duly
authorized by the Company's board of directors, to solicit or exercise proxies,
or otherwise exercise voting rights, in connection with matters submitted to a
vote of the Company's stockholders.
Doral Federal
General. Doral Federal is a federal savings association. Accordingly, its
investments, borrowing, lending, issuance of securities, establishment of branch
offices and all other aspects of its operation are subject to the jurisdiction
of the OTS.
As a creditor and financial institution, Doral Federal is subject to
certain regulations promulgated by the Federal Reserve Board including, without
limitations, Regulation B (Equal Credit Opportunity Act), Regulation DD (The
Truth in Savings Act), Regulation E (Electronic Funds Transfer Act), Regulation
F (Limits on Exposure to Other Banks), Regulation Z (Truth in Lending Act),
Regulation CC (Expedited Funds Availability Act), Regulation X (Real Estate
Settlement Procedures Act), Regulation BB (Community Reinvestment Act) and
Regulations C (Home Mortgage Disclosure Act). As a real property lender and as
owner of real property, including real estate owned, pursuant to foreclosure,
financial institutions, including Doral Federal, may also be subject to
potential liability under various statutes and regulations applicable to
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<PAGE> 47
property owners generally, including statutes and regulations relating to the
environmental condition of real property.
As an Eligible Depository Institution licensed to receive 936 Funds
directly from 936 Corporations, Doral Federal is subject to an annual license
renewal and certain regulations promulgated by the Office of the Commissioner.
The regulations are designed to require that 936 Funds received by Doral Federal
are channelled into investments that promote employment, production and income
in Puerto Rico.
Capital Requirements. FIRREA established capital standards for savings
associations, including three capital requirements: a "leverage limit" or "core
capital requirement," a "tangible capital requirement" and a "risk-based capital
requirement." FIRREA required the Director to promulgate regulations to
prescribe and maintain uniform capital standards for all savings associations.
Pursuant to FIRREA, these capital standards must be no less stringent than the
capital standards applicable to national banks. Current capital requirements are
discussed below.
An institution is required by statute to maintain tangible capital of not
less than 1.5% of adjusted total assets. "Tangible Capital" consists of core
capital less any intangible assets, plus a limited amount of purchased mortgage
servicing rights ("PMSR") valued in accordance with OTS regulations. Any PMSR
over this limit would generally be deducted in calculating tangible capital.
The Leverage Limit requires savings associations to maintain "core capital"
of not less than 3% of adjusted total assets. The Director has proposed
revisions to the Capital Regulations to provide that only those savings
associations rated a composite of 1 under the OTS MACRO rating system will be
permitted to operate at or near the minimum statutory requirements of 3% of
adjusted total assets, while all other associations are required to meet a
minimum core capital requirement of at least 100 to 200 basis points above the
3% minimum core capital requirement. In determining the amount of additional
capital required, the OTS has indicated that it assesses both the quality of
risk management systems and the level of overall risk in each individual
association. "Core capital" generally includes common stockholders' equity
(including retained earnings), non cumulative perpetual preferred stock and any
related surplus and minority interests in the equity accounts of fully
consolidated subsidiaries. Intangible assets (other than purchased mortgage
servicing rights includable as tangible capital and purchased credit card
relationship) must be deducted from core capital. At June 30, 1996, Doral
Federal had approximately $369,000 of intangible assets that were required to be
deducted from core and tangible capital. Excess servicing fees receivable
("ESFR") are not considered intangibles and are therefore fully includable in
capital calculations. Up to 50% of core capital may consist of purchased
mortgage servicing rights valued at the lower of 90% of fair market value, 90%
of original cost or the amortized book value as determined under GAAP. Doral
Federal did not have any PMSR or ESFR in its tangible or core capital at June
30, 1996.
The risk-based capital requirement provides that the book value asset will
be adjusted to reflect the degree of credit risk associated with such asset. The
risk-based capital guidelines require the maintenance of capital against
off-balance sheet items, including assets sold with recourse, as well as assets
that are reported on the institution's financial statements. After determination
of an association's qualifying total capital, total risk-weighted assets are
ascertained. Under these guidelines, an association's balance sheet assets and
credit equivalent amounts of off-balance sheet items, such as letters of credit
and outstanding loan commitments, are assigned to one of several broad risk
categories, and the aggregate dollar amount of each category is then multiplied
by the risk weight associated with that category. The resulting weighted values
from each of the categories are then added together to determine the total
risk-weighted assets that comprise the denominator of the risk-based capital
ratio. The OTS regulations assign single family residential mortgage loans and
certain "qualifying multifamily mortgage loans" to the fifty percent (50%)
risk-weight category.
The risk-based capital requirement generally requires savings associations
to maintain "total capital" equal to 8% of risk-weighted assets. For purposes of
the risk-based capital requirement, "total capital" means core capital (as
described above) plus "supplementary capital" (as described below), provided
that the amount of supplementary capital may not exceed the amount of core
capital, less certain assets. Supplementary capital, includes, among other
things, general allowances for loan losses up to a maximum of 1.25% of
risk-weighted assets. Under the risk-based capital requirements, certain assets
must be excluded from total
47
<PAGE> 48
capital. At June 30, 1996, Doral Federal had approximately $369,000 of
intangible assets that were required to be deducted from capital.
At June 30, 1996, Doral Federal complied with each of the then current
tangible capital, core capital, and risk-based capital requirements. In the
event that Doral Federal fails to satisfy any applicable capital requirements,
Doral Federal may be subject to sanctions, and its operations may be subject to
severe regulatory restrictions and limitations. Set forth below is a description
of Doral Federal's actual capital levels relative to its regulatory capital
requirements as of June 30, 1996:
<TABLE>
<CAPTION>
AMOUNT RATIO(1)
------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
TANGIBLE CAPITAL:
Capital position.... $17,188 8.2%
Capital
requirement....... 3,134 1.5
------- --------
Tangible capital
excess............ $14,054 6.7%
======= ========
<CAPTION>
AMOUNT RATIO(1)
------- --------
<S> <C> <C>
(DOLLARS IN THOUSANDS)
CORE CAPITAL:
Capital position.... $17,188 8.2%
Capital
requirement(2).... 6,269 3.0
------- --------
Core capital
excess............ $10,919 5.2%
======= ========
<CAPTION>
AMOUNT RATIO(1)
------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
RISK-BASED CAPITAL:
Capital position.... $17,641 19.9%
Capital
requirement....... 7,068 8.0
------- --------
Risk-based capital
excess............ $10,573 11.9%
======= ========
</TABLE>
- ---------------
(1) Ratio of capital to adjusted total assets for tangible and core capital and
ratio of capital to risk-weighted assets for risk-based capital.
(2) See discussion below for additional requirements imposed by the Federal
Deposit Insurance Corporation Improvement Act of 1991.
FDICIA. Under the Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA") federal banking regulators must take prompt corrective action in
respect of depository institutions that do not meet minimum capital
requirements. The FDICIA and regulations thereunder establish five capital
tiers: "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized," and "critically undercapitalized." A
depository institution is deemed well capitalized if it maintains a leverage
ratio of at least 5%, a risk-based Tier I capital ratio of at least 6% and a
risk-based Total capital ratio of at least 10% and is not subject to any written
agreement or directive to meet a specific capital level. A depository
institution is deemed adequately capitalized if it is not well capitalized but
maintains a leverage ratio of at least 4% (or at least 3% if given the highest
examination rating and not experiencing or anticipating significant growth), a
risk-based Tier I capital ratio of at least 4% and a risk-based Total capital
ratio of at least 8%. A depository institution is deemed undercapitalized if it
fails to meet the standards for adequately capitalized institutions (unless it
is deemed significantly or critically undercapitalized). An institution is
deemed significantly undercapitalized if it has a leverage ratio of less than
3%, a risk-based Tier I capital ratio of less than 3% or a risk-based Total
capital ratio of less than 6%. An institution is deemed critically
undercapitalized if it has tangible equity equal to 2% or less of total assets.
A depository institution may be deemed to be in a capitalized category that is
lower than is indicated by its actual capital position if it receives a less
than satisfactory examination rating in any one of four categories.
At June 30, 1996, Doral Federal was well capitalized. An institution's
capital category, as determined by applying the prompt corrective action
provisions of law, may not constitute an accurate representation of the overall
financial condition or prospects of Doral Federal and should be considered in
conjunction with other available information regarding the Doral Federal's
financial condition and results of operations.
FDICIA generally prohibits a depository institution from making any capital
distribution (including payment of a dividend) or paying any management fee to
its holding company if the depository institution would thereafter be
undercapitalized. In addition, undercapitalized depository institutions are
subject to growth limitations and are required to submit capital restoration
plans. The federal banking agencies may not accept a capital plan without
determining, among other things, that the plan is based on realistic assumptions
and is likely to succeed in restoring the depository institution's capital. If a
depository institution fails to submit an acceptable plan, it is treated as if
it is significantly undercapitalized. Significantly undercapitalized depository
institutions may be subject to a number of requirements and restrictions,
including orders to sell sufficient voting stock to become adequately
capitalized, requirements to reduce total assets and cessation of
48
<PAGE> 49
receipt of deposits from correspondent banks. Critically undercapitalized
depository institutions are subject to appointment of a receiver or conservator.
Enforcement Provisions. FIRREA includes enforcement provisions that are
applicable to all depository institutions, including savings institutions.
FIRREA extended the enforcement authority of bank regulatory agencies to
"institution-affiliated parties". The term includes: (i) directors, officers,
employees, agents, and controlling stockholders; (ii) persons required to file a
change-in-control notice; (iii) certain persons who participate in the affairs
of the savings institution (which include stockholders, consultants, and joint
venture partners); and (iv) independent contractors (including attorneys,
appraisers, and accountants) who knowingly or recklessly cause or participate in
a violation, breach of duty or unsafe practice likely to cause a loss to the
savings institution. FIRREA includes significantly increased penalties for
violations of cease-and-desist orders and other regulations. At the same time,
requirements for the issuance of such orders have been lessened.
Payment of Dividends. Doral Federal's payment of dividends is subject to
the limitations of the capital distribution regulations promulgated by the OTS.
The OTS' regulation determines a savings association's ability to pay dividends,
make stock repurchases, or make other types of capital distributions, according
to the institution's capital position. The rule establishes "safe-harbor"
amounts of capital distributions that institutions can make after providing
notice to the OTS, without constituting an unsafe or unsound practice.
Associations that do not meet their capital requirements can make distributions
with the prior approval of the OTS.
For associations such as Doral Federal, that meet all applicable capital
requirements, the safe-harbor amount is the greater of (a) 75% of net income for
the prior four quarters, or (b) the sum of (i) the current year's net income and
(ii) the amount that causes the excess of any component of the association's
total capital to be less than only one-half of such excess at the beginning of
the year; provided, however, that the association must continue to satisfy
applicable capital requirements after the distribution.
Deposit Insurance. Doral Federal's deposits are insured to the fullest
extent of the law by the Savings Association Insurance Fund ("SAIF"), which is
managed by the FDIC. As a result, the FDIC has certain regulatory and
enforcement authority over Doral Federal. The FDICIA required the FDIC to
implement a risk-based assessment system, under which an institution's
assessment will be based on the probability that the deposit insurance fund will
incur a loss with respect to the institution, the likely amount of any such
loss, and the revenue needs of the deposit insurance fund. Under this system,
the FDIC established premium rates for SAIF insured institutions which until
1995 were within a range from 0.23% to 0.31% based upon their capital ratios and
supervisory evaluation. Doral Federal's insurance premium assessment was set at
0.23% effective January 1, 1994.
The FDIC revised the premium schedule for Bank Insurance Fund ("BIF")
insured banks, effective in the third quarter of 1995, to provide a range of
.04% to .31% of deposits (as compared to the former range of .23% to .31% of
deposits for both BIF and SAIF insured institutions) in anticipation of the BIF
achieving its statutory reserve ratio. Effective January 1, 1996, the schedule
was further revised to provide a range of 0% to .27% with a minimum annual
premium of $2,000. The lower premiums did not apply to SAIF members. At the time
of such action, the FDIC noted that the SAIF would likely not be adequately
recapitalized until 2002, absent a substantial increase in premium rates or the
imposition of special assessments or other significant developments such as a
merger of the SAIF and the BIF. As a result of this disparity, SAIF members
could be placed at a significant competitive disadvantage to BIF members due to
higher costs for deposits insurance.
In order to help eliminate this disparity and any competitive disadvantage
due to disparate deposit insurance premium schedules, legislation to
recapitalize the SAIF was enacted on September 30, 1996. The legislation
provides for a one-time assessment to be imposed on all deposits assessed at the
SAIF rates, as of March 31, 1995, in order to recapitalize the SAIF. It also
provides for the merger of the BIF and the SAIF on January 1, 1999 provided no
savings associations then exist. The special assessment rate is currently
anticipated to be .66% and will be payable by November 29, 1996. Based upon
Doral Federal's level of SAIF deposits at March 31, 1995, and assuming a special
assessment of .66%, Doral Federal's assessment would be approximately $590,000.
Following the special assessment, and based upon Doral Federal's capital level
and
49
<PAGE> 50
supervisory rating, Doral Federal's deposit insurance premiums are expected to
decrease for future periods. While SAIF rates are expected to be reduced by this
legislation they are not anticipated to be equalized with BIF rates as a result
of the continuing assessment payable by SAIF members to repay obligations issued
by a federally chartered corporation to provide financing for resolving the
thrift crisis in the 1980s.
Classification of Assets. Savings associations are required to review
their assets on a regular basis and, if warranted, classify them as
"substandard," "doubtful," or "loss." Adequate valuation allowances, consistent
with GAAP, are required to be established for classified assets. If any assets
are classified as substandard or doubtful, the association must establish a
prudent general allowance for possible future loan losses with respect thereto.
If an asset, or a portion thereof, is classified as a loss, the association must
either establish a specific valuation allowance equal to the amount classified
as loss or charge off such amount. In addition, a savings association is
required to set aside adequate valuation allowances to the extent that any
affiliate possesses assets which pose a risk to the savings and loan
association. The association's OTS Regional Director has the authority to
approve, disapprove or modify the classification and amount established as an
allowance pursuant to such classification. In addition, a savings association is
required to record as liabilities off balance sheet items, such as letters of
credit, when the loss becomes probable and estimable.
The following table sets forth information with respect to Doral Federal's
classified assets as of June 30, 1996:
<TABLE>
<CAPTION>
AT JUNE 30, 1996
--------------------------------------------
SUBSTANDARD DOUBTFUL LOSS TOTAL
----------- -------- ---- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
REAL ESTATE LOANS:
One to four family.......................... $ 365 $0 $ 1 $ 366
Commercial.................................. 451 0 0 451
Consumer -- secured by mortgage............. 141 0 42 183
REO........................................... 0 0 0 0
Consumer loans -- unsecured................... 0 0 14 14
Other......................................... 0 0 2 2
--
----------- ---- ------
Total classified assets............. $ 957 $0 $59 $1,016
========= ======= === ======
</TABLE>
Proposed Banking Legislation. Various legislation, including proposals to
overhaul the bank regulatory system, expand bank and bank holding company powers
and limit the investments that a depository institution may make with insured
funds, is from time to time introduced in Congress. The Company cannot determine
the ultimate effect that such potential legislation, if enacted, or implementing
regulations, would have upon its financial condition or results of operations.
Possible Conversion and Regulation under the Federal Bank Holding Company Act
From time to time, legislation has been introduced in the United States
Congress that would require, by no later than January 1, 1998, that all
federally chartered savings associations, such as Doral Federal, either convert
to a national bank, state bank or state savings association or liquidate. Any
institution not converted by such date would become a national bank by operation
of law. Under such proposed legislation, the OTS would be abolished and its
functions transferred to the other Federal banking agencies.
Existing savings and loan holding companies, such as the Company, would
become bank holding companies subject to supervision and examination by the
Federal Reserve Board (the "Federal Reserve") under the Bank Holding Company Act
of 1956 (the "BHCA"). The BHCA and Federal Reserve regulations promulgated
thereunder generally place limitations on the types of activities in which a
bank holding company and its subsidiaries may engage. In general, such
activities must be banking services or activities so closely related to the
business of banking as to be a proper incident thereto. Regulation K promulgated
by the Federal Reserve, generally grants bank holding companies and their
subsidiaries somewhat broader powers with respect to activities conducted
"outside the United States" than with respect to activities conducted within the
United States. For purposes of Regulation K, Puerto Rico is considered to be
outside the United States.
50
<PAGE> 51
Notwithstanding the foregoing, under the provisions of the proposed legislation,
any savings and loan holding company that becomes a bank holding company as a
result of such act would be grandfathered from the bank holding company activity
restrictions described above, provided that: (i) any former savings association
subsidiary continues to meet the "qualified thrift lender test;" (ii) the former
savings subsidiary continues to limit its activities to those permissible under
its former federal thrift charter; and (iii) the holding company does not
acquire any additional FDIC insured depository institution. At this time,
certain aspects of the proposed legislation remain unresolved and no assurances
can be given as to whether or in what form the legislation will be enacted or
its effect on Doral Federal or the Company.
Independent of the requirements of any pending legislation, the Company is
currently considering the possibility of converting Doral Federal into a Puerto
Rico chartered commercial bank as a result of the reduction in the 936 Credit
introduced by the OBRA Amendments as well as the repeal of Section 936 as part
of the Small Business Job Protection Act. To the extent that the income earned
by Doral Federal is not fully covered by the 936 Credit, Doral Federal would be
subject to double taxation on its income earned in Puerto Rico since it is
generally not entitled to a credit under Puerto Rico tax law for federal income
taxes paid with respect to income earned in Puerto Rico. In addition, dividends
payable by a United States corporation, such as Doral Federal, to a Puerto Rico
corporation, such as the Company, are not entitled to any dividends received
deduction and are subject to taxation as ordinary income at the normal statutory
tax rates. Conversion to a Puerto Rico chartered commercial bank would address
both issues since dividends received by a Puerto Rico corporation from a Puerto
Rico chartered commercial bank are subject to a 100% dividends received
deduction. In addition, a Puerto Rico chartered commercial bank is not subject
to U.S. federal income taxes on its income from sources within Puerto Rico.
In addition to the activity restrictions discussed above, the BHCA also
imposes various other restrictions on bank holding companies and their
subsidiaries. Many of these restrictions are similar to those currently imposed
on the Company under the SLHCA. For example, the BHCA contains change of control
provisions similar to those contained in the SLHCA. See "Regulation -- Savings
and Loan Operations -- The Company." Sections 23A and 23B of the Federal Reserve
Act also apply in the same manner to bank holding companies and their
subsidiaries as to savings and loan holding companies.
As a bank holding company, the Company would, however, be subject to
certain additional regulatory restrictions that are not otherwise applicable to
savings and loan holding companies. For example, unlike savings and loan holding
companies, bank holding companies are subject to certain regulatory capital
requirements. Under the Federal Reserve's risk-based capital guidelines, a bank
holding company must maintain a ratio of total capital (the "Total Capital") to
risk-weighted assets (including certain off-balance sheet items, such as standby
letters of credit) equal to 8%. At least half of the Total Capital is to be
comprised of common equity, retained earnings, minority interests in
consolidated subsidiaries, noncumulative perpetual preferred stock and a limited
amount of cumulative perpetual preferred stock, less goodwill and less certain
intangible assets discussed below ("Tier 1 capital"). The remainder may consist
of a limited amount of subordinated debt, other preferred stock, certain other
instruments, and a limited amount of loan and lease loss reserves ("Tier 2
capital").
In addition, the Federal Reserve has established minimum leverage ratio
guidelines for bank holding companies. These guidelines provide for a minimum
ratio of Tier 1 capital to average quarterly assets of 3% for bank holding
companies that meet certain specified criteria, including that they have the
highest regulatory rating. All other bank holding companies are required to
maintain a leverage ratio of 3% plus an additional cushion of at least 100 to
200 basis points. The guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets. Furthermore, the guidelines
indicate that the Federal Reserve will continue to consider a "tangible Tier 1
leverage ratio" (deducting all intangibles) and other indication of capital
strength in evaluating proposals for expansion or new activities. The tangible
Tier 1 leverage ratio is the ratio of a banking organization's Tier 1 capital,
less all intangibles, to total assets, less all intangibles.
51
<PAGE> 52
The Federal Reserve has adopted regulations with respect to risk-based and
leverage capital ratios that require most intangibles, including core deposit
intangibles, to be deducted from Tier 1 capital. The regulations, however,
permit the inclusion of a limited amount of intangibles related to PMSR and
purchased credit card receivables. The Federal Reserve has also decided to
exclude from regulatory capital the amount of net unrealized gains and losses on
securities available-for-sale, except the net unrealized losses of equity
securities with readily determinable fair values.
The Federal Reserve has issued a policy statement that provides that
insured banks and bank holding companies should generally pay dividends only out
of current operating earnings. In addition, under Federal Reserve policy, a bank
holding company is expected to act as a source of financial strength to each of
its subsidiary banks and to commit resources to support each subsidiary bank.
This support may be required at times, when absent such policy, the bank holding
company might not otherwise provide such support.
The Company believes that if it were to become subject to the provisions of
the BHCA it would be in compliance with all of the above regulatory and capital
requirements and would be able to continue to conduct its Mortgage Banking
Business as presently conducted.
The conversion of Doral Federal into a Puerto Rico chartered bank would
also subject Doral Federal to supervision and examination by the Office of the
Commissioner and to the provisions of the Puerto Rico Banking Act and the
regulations promulgated thereunder. The Company does not believe that the
application of such laws or regulations would have a material adverse effect on
the manner in what Doral Federal currently conducts its operations.
In addition to the possible conversion of Doral Federal into a Puerto Rico
commercial bank and the possible application of the BHCA to the Company's
operations, the Company may, in the future, consider other changes in corporate
structure or organization that could result in the transfer of all or a part of
the Company's Mortgage Banking Business to Doral Federal or a subsidiary of
Doral Federal. Any such reorganization could subject the Company to additional
regulatory requirements.
REGULATION -- NEW BROKER-DEALER OPERATIONS
AAA Financial is registered as a broker-dealer with the Securities and
Exchange Commission ("SEC") and the Office of the Commissioner. AAA Financial is
also a member of the National Association of Securities Dealers (the "NASD"). As
a registered broker-dealer, it is subject to regulation by the SEC, the NASD and
the Office of the Commissioner in matters relating to the conduct of its
securities business, including record keeping and reporting requirements,
supervision and licensing of employees and obligations to customers.
In particular, AAA Financial is subject to the SEC's net capital rules,
which specify minimum net capital requirements for registered broker-dealers and
are designed to ensure that broker-dealers maintain adequate regulatory capital
in relation to their liabilities and the size of their customer business.
MARKET AREA AND COMPETITION
Prior to March 1992, Puerto Rico was FFCC's exclusive service area.
Although Doral Mortgage has since opened branch offices in Orlando and Miami,
Florida, Puerto Rico remains the Company's predominant service area accounting
for 98% of the Company's loan originations for the six months ended June 30,
1996 and the years ended December 31, 1995 and 1994. Within Puerto Rico, FFCC's
primary market area is the metropolitan San Juan area, which accounted for
approximately 45% and 47% of FFCC loan originations in 1995 and 1994,
respectively. The competition in Puerto Rico for the origination of mortgages is
substantial. Competition comes not only from other mortgage bankers, but also
from major banks and savings and loan associations. There are approximately 37
mortgage banks, two savings institutions and 21 commercial banks operating in
Puerto Rico, including affiliates of banks headquartered in the United States,
Canada and Spain. The Company competes principally by offering loans with
competitive features, by emphasizing the quality of its service and pricing its
range of products at competitive rates.
52
<PAGE> 53
MANAGEMENT
DIRECTORS
Set forth below is certain information with respect to the Directors of the
Company:
<TABLE>
<CAPTION>
DIRECTOR
NAME PRINCIPAL OCCUPATION AND OTHER INFORMATION SINCE
- --------------------------------- ---------------------------------------------------- --------
<S> <C> <C>
Salomon Levis(1)................. Chairman of the Board and Chief Executive Officer of 1988
the Company since February 1990; Chairman of the
Board Doral Mortgage and Doral Federal; President
and Chief Executive Officer of the Company
(1989-1991); Chairman of the Board, Doral Mortgage
(1988-1990); President and Chief Operating
Officer, Doral Mortgage (1985-1988); President of
RSC Corp., a wholly-owned subsidiary of the
Company (1979-1988). Age 53.
Richard F. Bonini................ Senior Executive Vice President of the Company since 1976
1988, Chief Financial Officer since April 1996 and
Secretary of the Company since December 1991;
Director and Secretary of Doral Federal since
September 1993; Secretary of Doral Mortgage for
more than the past five years; Consultant to
Culbro Corporation (1989- 1990); Senior Vice
President, Culbro Corporation and Vice President
of the Company (1976-1988); Director Search
Capital Group (automobile financing). Age 57.
Edgar M. Cullman, Jr.(2)......... President, Culbro Corporation since 1984; Executive 1988
Vice President, Culbro Corporation (1983-1984);
President, General Cigar & Tobacco Co.
(1980-1983); Director, Culbro Corporation. Age 50.
Frederick M. Danziger(2)......... Of-Counsel, Latham & Watkins (attorneys) from 1988
December 1995 to present. Member, Mudge Rose
Guthrie Alexander & Ferdon (attorneys) from July
1974 to September 30, 1995; Director, Culbro
Corporation, Monro Muffler/Brake, Inc., Ryan
Instruments, L.P. (general partner), Bloomingdale
Properties, Inc. (investments and real estate) and
Centaur Communications Ltd. Age 56.
John L. Ernst(2)................. Chairman of the Board and President of Bloomingdale 1989
Properties, Inc., since September 1984; Director,
Culbro Corporation. Age 56.
Zoila Levis(1)................... President of the Company since August 12, 1991; 1991
Executive Vice President of the Company from January
1, 1990 to August 11, 1991; President of Z. Levis
Assoc. (real estate development) from January 1,
1985 to December 31, 1989. Age 49.
</TABLE>
53
<PAGE> 54
<TABLE>
<CAPTION>
DIRECTOR
NAME PRINCIPAL OCCUPATION AND OTHER INFORMATION SINCE
- --------------------------------- ---------------------------------------------------- --------
<S> <C> <C>
A. Brean Murray.................. Chairman of the Board and Chief Executive Officer of 1994
Brean Murray, Foster Securities Inc., an
investment banking firm for more than the past
five years; Director, American Asset Management
(money management), BMI Capital Corp. (money
management), Blyth Holdings Inc. (money
management) and Search Capital Group (automobile
financing). Age 59.
Victor M. Pons, Jr............... Attorney in private practice since 1992; Chief 1994
Justice of the Supreme Court, Commonwealth of Puerto
Rico (1985-1992). Age 61.
</TABLE>
- ---------------
(1) Zoila Levis is the sister of Salomon Levis.
(2) Edgar M. Cullman, Jr. and John L. Ernst are cousins. Frederick M. Danziger
is the brother-in-law of Edgar M. Cullman, Jr.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following information is supplied with respect to the executive
officers of the Company who do not serve on the Company's Board of Directors.
There are no arrangements or understandings pursuant to which any of such
executive officers was selected as an officer, and none of such executive
officers is related to any other director or executive officer of the Company by
blood, marriage or adoption, except that Mario S. Levis is the nephew of Salomon
Levis and Zoila Levis.
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION
NAME DURING THE PAST FIVE YEARS AGE
- -------------------------- -------------------------------------------------------------- ---
<S> <C> <C>
Luis A. Alvarado.......... Executive Vice President of the Company since 1985; Chief 48
Financial Officer of the Company from 1985 to April 1996;
President of Doral Federal from September 1993 until April
1996; Senior Vice President and Controller of the Company
(1980-1985).
Ernesto Carattini......... President of HF Division since September 1995; Executive Vice 48
President of Doral Mortgage for more than five years prior
thereto.
Mario S. Levis............ Executive Vice President of the Company since September 1995; 33
Executive Vice President of Doral Mortgage. Vice President
and Treasurer of the Company since December 1991; Senior
Executive Trader of the Company since 1988. Trader, Merrill
Lynch Pierce Fenner & Smith Incorporated (1987-1988).
Ricardo Melendez.......... Vice President and Controller since October 1995; Chief 37
Financial Officer of Doral Federal from September 1993 to July
1995; Senior Assistant to CEO and CFO of the Corporation
from May 1991 to September 1993; Audit Manager and Senior
Auditor Price Waterhouse since July 1986 to May 1991.
Frederick Teed............ Executive Vice President -- Banking Operations since March 1, 38
1996; Federal Thrift Regulator, Office of Thrift Supervision,
Department of the Treasury, for more than five years prior
thereto.
Edison Velez.............. President of Doral Mortgage since September 1995; Senior Vice 34
President of Doral Mortgage for more than five years prior
thereto.
</TABLE>
54
<PAGE> 55
THE COMMONWEALTH OF PUERTO RICO
GENERAL
Puerto Rico, the fourth largest of the Caribbean islands, is located
approximately 1,600 miles southeast of New York, New York and 1,000 miles
southeast of Miami, Florida. It is approximately 100 miles long and 35 miles
wide. The population of Puerto Rico for 1990, as determined by the United States
Census Bureau, was approximately 3.6 million as compared to 3.2 million in 1980.
According to estimates of the Puerto Rico Planning Board, the population of
Puerto Rico increased to 3.7 million in fiscal 1995. The Puerto Rico Planning
Board estimates that the San Juan metropolitan area has a population in excess
of 1.0 million.
RELATIONSHIP OF PUERTO RICO WITH THE UNITED STATES.
The Constitution of Puerto Rico was drafted by a popularly elected
constitutional convention, overwhelmingly approved in a special referendum and
approved "as a compact" by the United States Congress and the President,
becoming effective upon proclamation of the Governor of Puerto Rico on July 25,
1952. Puerto Rico's relationship to the United States under the compact is
referred to herein as "commonwealth status." The United States and Puerto Rico
share a common defense, market and currency. Puerto Rico exercises virtually the
same control over its internal affairs as a state government does. The people of
Puerto Rico are citizens of the United States, but do not vote in national
elections and are represented in Congress by a Resident Commissioner who has a
voice in the House of Representatives but only limited voting rights. Most
federal taxes, except those such as social security taxes which are imposed by
mutual consent, are not levied in Puerto Rico. No federal income tax is
collected from Puerto Rico residents on ordinary income earned from sources
within Puerto Rico, except for Federal employees who are subject to taxes on
their salaries. Corporations organized under the laws of Puerto Rico are treated
as foreign corporations for federal income tax purposes. For many years there
have been two major views in Puerto Rico with respect to the island's
relationship to the United States, one essentially favoring the existing
commonwealth status and the other favoring statehood.
On November 14, 1993, a plebiscite was held in Puerto Rico to allow
eligible voters an opportunity to express their preference between statehood,
Commonwealth (with certain changes) and independence for Puerto Rico. The
Commonwealth status obtained the most votes, receiving 48.6% of the votes cast,
and statehood and independence received 46.3% and 4.4% of the votes casts,
respectively.
On March 6, 1996, legislation was introduced in the United States House of
Representatives providing for a three-stage process to resolve permanently
Puerto Rico's political relationship with the United States. The proposed
legislation ("H.R. 3024") would have allowed residents of Puerto Rico to choose
full self government (either integration into the United States leading to
statehood or separate sovereignty in the form of independence, including free
association with the United States, via bilateral treaty) or Commonwealth. The
proposed legislation provided for three referenda to be held in Puerto Rico
starting not later than 1998. Failure to settle on full self government after
the three-referenda process would have resulted in the retention of the current
Commonwealth status.
H.R. 3024 was withdrawn prior to being voted upon by the full House of
Representatives. While a similar bill was later introduced it was not acted upon
prior to the adjournment of the 104th Congress on October 4, 1996. No assurance
can be given as to whether or in what form similar legislation may be introduced
in the next Congress.
A change in the political status of Puerto Rico could result in
modifications to or elimination of the Puerto Rico laws providing favorable tax
treatment for investment in Puerto Rico mortgages and, therefore, could have a
material adverse effect on gain on sales from mortgage loans and mortgage-backed
securities, particularly tax-exempt GNMA mortgage-backed securities, and the
financial performance of FFCC. See "BUSINESS OF THE COMPANY -- Puerto Rico
Secondary Mortgage Market and Favorable Tax Treatment" herein. It is not
possible to predict to what extent, if any, such adverse effects would be offset
by possible beneficial aspects of a change in status.
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THE ECONOMY
Puerto Rico has established policies and programs directed at the
development of manufacturing and the expansion and modernization of the island's
infrastructure. The investment of funds by mainland United States, foreign and
local entities in new factories has been stimulated by selective tax exemption,
development loans, and other financial and tax incentives. Infrastructure
expansion and modernization have been to a large extent financed by bonds and
notes issued by the Commonwealth, its public corporations and municipalities.
Economic progress has been aided by significant increases in the levels of
education and occupational skills of the island's population. The percentage of
the college-age population enrolled in institutions of higher learning has
increased from 16.8% in 1970 to 36.8% in 1993.
The economy of Puerto Rico is closely integrated with that of the mainland
United States. During the fiscal year ended June 30, 1995, approximately 89% of
Puerto Rico's exports went to the United States mainland, which was also the
source of approximately 65% of Puerto Rico's imports. For the fiscal year ended
June 30, 1995, Puerto Rico experienced a positive adjusted merchandise trade
balance of $4.6 billion.
The economy of Puerto Rico is dominated by the manufacturing and service
sectors. The manufacturing sector has experienced a basic change over the years
as a result of increased emphasis on higher wage, high technology industries
such as pharmaceuticals and electronics. The service sector also plays a major
role in the economy. It ranks second only to manufacturing in contribution to
the gross domestic product and leads all sectors in providing employment. In
recent years, the service sector has experienced significant growth in response
to the expansion of the manufacturing sector.
Gross product increased from $22.8 billion ($19.3 billion in 1987 prices)
for fiscal 1991 to $28.4 billion ($21.2 billion in 1987 prices) for fiscal 1995,
an increase of 24.4% (10% in 1987 prices). Since fiscal 1985, personal income,
both aggregate and per capita, has increased consistently each fiscal year. In
fiscal 1995, aggregate personal income was $27 billion ($22.5 billion in 1987
prices) and personal income per capita was $7,296 ($6,074 in 1987 prices).
Average employment increased from 977,000 in fiscal 1991 to 1,051,300 in fiscal
1995. Average unemployment decreased from 15.2% in fiscal 1991 to 13.8% in
fiscal 1995.
Future growth in the Puerto Rico economy will depend on several factors
including the condition of the United States economy, the relative stability in
the price of oil imports, the exchange value of the U.S. dollars and the level
of interest rates and changes to existing tax incentive legislation as discussed
below.
The Small Business Job Protection Act, which was signed into law on August
20, 1996, provides for the repeal of Section 936. The elimination of the
benefits of Section 936, without the substitution of another fiscal incentive to
attract investment to Puerto Rico, could have an adverse effect on the future
growth of the Puerto Rico economy. At this point, the Company cannot predict the
impact of the repeal of Section 936 on the economy of Puerto Rico. See "RISK
FACTORS -- Economic Conditions in Puerto Rico and Phase-out of Section 936 Tax
Benefits."
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DESCRIPTION OF NOTES
The Notes are to be issued under an Indenture, to be dated as of October
10, 1996 (the "Indenture"), between the Company and Bankers Trust Company, as
Trustee (the "Trustee"). A copy of the Indenture is filed as an exhibit to the
Registration Statement. The following summaries of certain provisions of the
Indenture do not purport to be complete and are subject to, and are qualified in
their entirety by reference to, all the provisions of the Indenture, including
the definitions therein of certain terms. The definitions of certain capitalized
terms used in the following summary are set forth below under "-- Certain
Definitions."
GENERAL
The Notes will be unsecured senior indebtedness of the Company, will be
limited to $75,000,000 aggregate principal amount, and will mature on October
10, 2006. The Notes will bear interest at the rate per annum shown on the front
cover of this Prospectus from October 10, 1996 or from the most recent interest
payment date to which interest has been paid or provided for, payable
semiannually on April 10 and October 10 of each year, commencing on April 10,
1997, to Persons in whose name the Notes are registered at the close of business
on the preceding March 25 or September 25, as the case may be. Principal of, and
premium, if any, and interest on the Notes will be payable at the offices or
agencies of the Company in the City of New York. In addition, payment of
interest may, at the option of the Company, be made by check mailed to the
Person entitled thereto to such Person's address as it appears in the Securities
Register.
BOOK-ENTRY SYSTEM
The Notes will be issued in the form of registered global notes (the
"Global Notes") that will be deposited with, or on behalf of, The Depository
Trust Company, New York, New York (the "Depositary") and registered in the name
of the Depositary's nominee. Unless and until exchanged in whole or in part for
Notes in certificated registered form, the Global Notes may not be transferred
except as a whole by the Depositary to another nominee of the Depositary or to a
successor depositary or a nominee of such successor.
Upon the issuance of the Global Notes, the Depositary will credit on its
book-entry registration and transfer system the principal amount of the notes
represented by the Global Notes to accounts of participant institutions that
have accounts with the Depositary. The accounts to be credited shall be
designated by the Underwriter, dealers or agents. Owners of beneficial interest
in the Global Notes that are not participants or Persons that may hold through
participants but desire to purchase, sell or otherwise transfer ownership of the
Notes by book-entry on the records of the Depositary may do so only through
participants and Persons that may hold through participants. Because the
Depositary can only act on behalf of participants and Persons that may hold
through participants, the ability of an owner of a beneficial interest in the
Global Notes to pledge Notes to Persons that do not participate in the
book-entry and transfer system of the Depositary, or otherwise take actions in
respect to such Notes, may be limited. In addition, the laws of some states
require that certain purchasers of securities take physical delivery of such
securities in definitive form. Such limits and such laws may impair the ability
to transfer or pledge beneficial interests in the Global Notes.
So long as the Depositary, or its nominee, is the registered owner of the
Global Notes, the Depositary or such nominee, as the case may be, will be
considered the sole owner or holder of the Notes represented by the Global Notes
for all purposes under the Indenture. Except as set forth below, owners of
beneficial interests in the Global Notes will not be entitled to have Notes
represented by the Global Notes registered in their names, will not receive or
be entitled to receive physical delivery of Notes in definite form and will not
be considered the owners or Holders thereof under the Indenture.
Accordingly, each Person owning a beneficial interest in the Global Notes
must rely on the procedures of the Depositary and, if such Person is not a
participant, on the procedures of the participant through which such Person owns
its interest, to exercise any rights of a Holder of Notes under the Indenture or
such Global Notes. The Company understands that, under existing industry
practice, in the event the Company requests any action of Holders of Notes, or
an owner of a beneficial interest in the Global Notes desires to take any action
that the Depositary, as the Holder of such Global Notes, is entitled to take,
the Depositary would authorize the participants to take such action and that the
participants would authorize beneficial owners
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owning through such participants to take such action or would otherwise act upon
the instructions of beneficial owners owning through them.
Principal and interest payments on Notes registered in the name of the
Depositary or its nominee will be made to the Depositary or its nominee, as the
case may be, as the registered owner of the Global Notes. None of the Company,
the Trustee, any paying agent or the registrar for the Notes will have any
responsibility or liability for any aspect of the records relating to or
payments made on account of beneficial interests in the Global Notes or for
maintaining, supervising or reviewing any records relating to such beneficial
interests.
The Depositary has advised the Company and the Trustee that its current
practice upon receipt of any payment of principal, premium, if any, or interest,
if any, is immediately to credit the accounts of the participants with such
payment in amounts proportionate to their respective holdings in principal
amount of beneficial interest in the Global Notes as shown in the records of the
Depositary. Payments by participants to owners of beneficial interests in the
Global Notes held through such participants will be governed by standing
instructions and customary practices, as is now the case with securities held
for the accounts of customers registered in "street name", and will be the
responsibility of such participants. Owners of beneficial interests in the
Global Notes that hold through the Depositary under a book-entry format (as
opposed to holding certificates directly) may experience some delay in the
receipt of interest payments since the Depositary will forward payments to its
participants, which in turn will forward them to Persons that hold through
participants or such owners.
If the Depositary is at any time unwilling or unable to continue as
depositary and a successor depositary is not appointed by the Company or the
Depositary within ninety days, the Company will issue Notes in definitive form
in exchange for the Global Notes. In addition, the Company may at any time and
in its sole discretion determine not to have the Notes represented by the Global
Notes and, in such event, the Company will issue Notes in definitive form in
exchange for the Global Notes. In either instance, an owner of a beneficial
interest in the Global Notes will be entitled to have Notes equal in principal
amount to such beneficial interest registered in its name and will be entitled
to physical delivery of such Notes in definitive form. Notes so issued in
definitive form will be issued in denominations of $1,000 and integral multiples
thereof and will be issued in registered form only, without coupons.
The Depositary has advised the Company and the Underwriters as follows: The
Depositary is a limited-purpose trust company organized under the New York
Banking Law, a "banking organization" within the meaning of the New York Banking
Law, a member of the Federal Reserve System, a "clearing corporation" within the
meaning of the New York Uniform Commercial Code and a "clearing agency"
registered pursuant to the provisions of Section 17A of the Exchange Act. The
Depositary was created to hold securities of participants and to facilitate the
clearance and settlement of securities transactions among the participants in
deposited securities through electronic book-entry changes in accounts of the
participants, thereby eliminating the need for physical movement of securities
certificates. Participants include securities brokers and dealers (including the
Underwriter), banks, trust companies, clearing corporations and certain other
organizations, some of which (and/or their representatives) own the Depositary.
Access to the Depositary's book-entry system is also available to others such as
banks, brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a participant, either directly or indirectly
("indirect participants"). Persons who are not participants may beneficially own
securities held by the Depositary only through participants or indirect
participants. The rules applicable to the Depositary and the participants are on
file with the Commission. The Depositary agrees with and represents to its
participants that it will administer its book-entry system in accordance with
its rules and bylaws and requirements of law.
OPTIONAL REDEMPTION
The Notes will be redeemable as a whole or in part, at the option of the
Company at any time, and from time to time, at a redemption price equal to the
greater of (i) 100% of their principal amount and (ii) the sum of the present
values of the remaining scheduled payments of principal and interest thereon
discounted to the date of redemption on a semiannual basis (assuming a 360-day
year consisting of twelve 30-day months) at the Treasury Yield plus 25 basis
points, plus in each case accrued interest to the date of redemption.
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"Treasury Yield" means, with respect to any redemption date, the rate per
annum equal to the semiannual equivalent yield to maturity of the Comparable
Treasury Issue, assuming a price for the Comparable Treasury Issue (expressed as
a percentage of its principal amount) equal to the Comparable Treasury Price for
such redemption date.
"Comparable Treasury Issue" means the United States Treasury security
selected by the Independent Investment Banker as having a maturity comparable to
the remaining term of the Notes that would be utilized, at the time of selection
and in accordance with customary financial practice, in pricing new issues of
corporate debt securities of comparable maturity to the remaining term of the
Notes. "Independent Investment Banker" means BT Securities Corporation or, if
such firm is unwilling or unable to select the Comparable Treasury Issue, an
independent investment banking institution of national standing appointed by the
Company.
"Comparable Treasury Price" means, with respect to any redemption date, (i)
the average of the bid and asked prices for the Comparable Treasury Issue
(expressed in each case as a percentage of its principal amount) on the third
business day preceding such redemption date, as set forth in the daily
statistical release (or any successor release) published by the Federal Reserve
Bank of New York and designated "Composite 3:30 p.m. Quotations for U.S.
Government Securities" or (ii) if such release (or any successor release) is not
published or does not contain such prices on such business day, the Reference
Treasury Dealer Quotation for such redemption date, in each case, as calculated
by the Company. "Reference Treasury Dealer Quotation" means the average of the
bid and asked prices for the Comparable Treasury Issue (expressed in each case
as a percentage of its principal amount) quoted in writing to the Company and
the Trustee by such Reference Treasury Dealer at 5:00 p.m. on the third business
day preceding such redemption date. The Company will provide the Trustee with an
officers' certificate setting forth the redemption price prior to 11:00 a.m. on
the second business day preceding such redemption date.
"Reference Treasury Dealer" means BT Securities Corporation, and its
respective successors; provided, however, that if the foregoing shall cease to
be a primary U.S. Government securities dealer in New York City (a "Primary
Treasury Dealer"), the Company shall substitute therefore another Primary
Treasury Dealer.
Holders of Notes to be redeemed will receive notice thereof by first-class
mail at least 30 and not more than 60 days prior to the date fixed for
redemption.
In the case of any partial redemption, selection of the Notes for
redemption will be made by the Trustee on a pro rata basis, by lot or by such
other method as the Trustee in its sole discretion shall deem to be fair and
appropriate, although no Note of $1,000 in original principal amount or less
shall be redeemed in part. If any Note is to be redeemed in part only, the
notice of redemption relating to such Note shall state the portion of the
principal amount thereof to be redeemed. A new Note in principal amount equal to
the unredeemed portion thereof will be issued in the name of the Holder thereof
upon cancellation of the original Note.
RANKING
The Notes will be senior unsecured indebtedness of the Company, ranking
senior to all subordinated indebtedness of the Company and pari passu with all
other existing and future senior unsecured indebtedness of the Company.
CERTAIN COVENANTS
The Indenture contains, among others, the following covenants:
Limitation on Company and Subsidiary Indebtedness and Disqualified Stock
The Company will not, and will not permit any of its Subsidiaries, directly
or indirectly to, create, incur, assume, become liable for or guarantee the
payment of (collectively, "incur") any Indebtedness or issue or become obligated
with respect to any Disqualified Stock unless at the time of such event and
after giving pro forma effect thereto (including the application of the
proceeds, if any, thereof) (i) the Consolidated Interest Coverage Ratio of the
Company is greater than 3.0 to 1.0, (ii) no Event of Default, or event which,
after
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notice or lapse of time or both, would become an Event of Default, shall have
occurred and be continuing, and (iii) such Indebtedness is not Restricted
Indebtedness.
The limitations contained in the previous paragraph will not apply to (i)
Permitted Indebtedness, (ii) Refinancing Indebtedness and (iii) Indebtedness
owed to and held by the Company or a Subsidiary; provided, however, that any
subsequent issuance or transfer of Capital Stock which results in any such
Subsidiary ceasing to be a Subsidiary or any subsequent transfer of such
Indebtedness (other than to the Company or another Subsidiary) shall be deemed
in each case, to constitute the incurrence of such Indebtedness by the Company.
Limitation on Restricted Payments
The Company will not, and will not permit any of its Subsidiaries to,
directly or indirectly, make any Restricted Payment unless (i) at the time of
and after giving effect to the proposed Restricted Payment, no Event of Default,
or event which, after notice or lapse of time or both, would become an Event of
Default, shall have occurred and be continuing; and (ii) at the time of and
after giving effect to the proposed Restricted Payment, the aggregate amount of
all Restricted Payments made after the date of original issuance of the Notes
shall not exceed the sum of (a) 50% of the aggregate Consolidated Net Income
(or, in the case of a Consolidated Net Loss, minus 100% of such Loss) of the
Company for the period (taken as one accounting period) commencing on October 1,
1996 to and including the last day of the fiscal quarter ended immediately prior
to the date of the proposed Restricted Payment, plus (b) the aggregate net
proceeds, including the fair market value of property other than cash (as
determined by the Board of Directors, whose determination shall be conclusive
and evidenced by a Board Resolution filed with the Trustee), received by the
Company from the issuance or sale (other than to a Subsidiary) after the date of
original issuance of the Notes, of (A) shares of its Capital Stock (other than
Disqualified Stock) or (B) Indebtedness of the Company which has been converted
into or exchanged for shares of its Capital Stock (other than Disqualified
Stock) plus (c) $15,000,000.
The provisions of the previous paragraph shall not be deemed to prohibit
(i) the payment of any dividend within 60 days after the date of declaration
thereof, if at such declaration date such declaration complied with the
provisions of the Indenture, (ii) the redemption, repurchase or other
acquisition or retirement of any shares of any class of Capital Stock of the
Company or of any Subsidiary in exchange for (including any such exchange
pursuant to the exercise of a conversion right or privilege in connection with
which cash is paid in lieu of the issuance of fractional shares or scrip), or
out of the proceeds of a substantially concurrent issue and sale (other than to
a Subsidiary) of, other shares of Capital Stock (other than Disqualified Stock)
of the Company, or (iii) the declaration or payment of any dividend payable
exclusively in shares of Capital Stock (other than Disqualified Stock) of the
Company.
The Restricted Payments described in clauses (ii) and (iii) of the previous
paragraph shall not be applied to reduce the amount available under clause (ii)
of the first paragraph of this "Limitation on Restricted Payments" covenant, nor
shall the proceeds from any issuance and sale of Capital Stock referred to in
such clause (ii) be included in "aggregate net proceeds" for purposes of
subclause (ii)(b) of the first paragraph of this "Limitation on Restricted
Payments" covenant. The payment of dividends under clause (i) of the previous
paragraph shall not reduce the amount available under clause (ii) of such first
paragraph, but the amount available under such clause (ii) shall be reduced when
such dividends are declared.
Limitation on Liens
The Company will not, nor will it permit any Subsidiary to, at any time
create, assume, guarantee or suffer to exist any Indebtedness of the Company or
any Subsidiary secured by any Lien (other than a Permitted Lien) on any
Property, shares of Capital Stock or Indebtedness of the Company or of any
Subsidiary, whether now owned or acquired after the date of the Indenture,
without in any such case effectively providing, concurrently with the creation,
assumption or guarantee of such Indebtedness, that the Notes shall, so long as
any such other Indebtedness shall be so secured (and, if the Company shall so
determine, any other existing indebtedness (or Indebtedness thereafter in
existence) created, assumed or guaranteed by the Company or any Subsidiary), be
secured by any such Lien equally and ratably with or prior to any and all other
Indebtedness thereby secured.
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Limitation on Dividends and Other Payment Restrictions Affecting Subsidiaries
The Company will not, and will not permit any Subsidiary to, create or
otherwise cause or suffer to exist or become effective any consensual
encumbrance or restriction of any kind, on the ability of any Subsidiary to (i)
pay dividends or make any other distributions on its Capital Stock; (ii) pay any
Indebtedness owed to the Company or any other Subsidiary; (iii) make loans,
advances or capital contributions to the Company or any other Subsidiary; or
(iv) sell, lease or transfer any of its property or assets to the Company or any
other Subsidiary. The foregoing limitations shall not apply to encumbrances or
restrictions existing under or by reason of (a) any encumbrances or restrictions
pursuant to an agreement in effect on the date of the Indenture, (b) any
restrictions, with respect to a Person that is not a Subsidiary on the date of
the Indenture, under any agreement in existence at the time such Person becomes
a Subsidiary (unless such agreement was entered into in connection with, or in
contemplation of, such Person becoming a Subsidiary on or after the date of the
Indenture), (c) any restrictions existing under any agreement that amends,
refinances or replaces the agreement containing restrictions described in the
foregoing clauses (a) and (b) and this clause (c), provided that the terms and
conditions of any such restrictions are no less favorable to the Holders of the
Notes than those under the agreement so amended, refinanced or replaced, (d)
customary non-assignment or sublease provisions of any lease governing a
leasehold interest of any Subsidiary, (e) those imposed by applicable law or
regulation, (f) those imposed by an agreement with a regulatory authority, and
(g) any restrictions with respect to a Subsidiary imposed pursuant to an
agreement which has been entered into for the sale or disposition of all or
substantially all of the Capital Stock or assets of such Subsidiary.
Limitation on Sales of Assets
The Company shall not, and shall not permit any Subsidiary to, directly or
indirectly, effect any Asset Disposition unless the Company or such Subsidiary,
as the case may be, receives consideration for such Asset Disposition at least
equal to the fair market value of the property or other assets sold or disposed
(as determined by the Board of Directors, whose determination shall be
conclusive and evidenced by a Board Resolution filed with the Trustee). The
restrictions contained in this section shall not apply to or prevent the
consolidation or merger of a Wholly Owned Subsidiary with, or a conveyance or
transfer of its properties and assets as an entirety or substantially as an
entirety to, the Company or another then existing Wholly Owned Subsidiary.
Transactions with Affiliates
The Company will not, and will not permit any Subsidiary to, enter into or
be a party to any material transaction or arrangement or series of transactions
or arrangements with any Affiliate (including, without limitation, the purchase
from, sale to, or exchange of assets or property with, or the rendering of any
service by or for, any Affiliate and excluding any transaction or arrangement
between the Company and any Wholly-Owned Subsidiary or between Wholly-Owned
Subsidiaries), unless (i) such transaction or arrangement is entered into
pursuant to the reasonable requirement of the Company's or such Subsidiary's
existing or proposed business, upon fair and reasonable terms no less favorable
to the Company or such Subsidiary than it would obtain in a comparable
arm's-length transaction with a person other than an Affiliate, and (ii) with
respect to a transaction or arrangement or series of related transactions or
arrangements involving aggregate value in excess of $2,000,000, such transaction
is approved by a majority of the members of the Board of Directors having no
personal stake in such transaction or arrangement as evidenced by a Board
Resolution filed with the Trustee, provided that the provisions of clause (ii)
shall not be applicable to transactions or arrangements between the Company and
HRU, Inc.
Limitation on Capital Stock of Subsidiaries
The Company will not (i) sell, pledge, hypothecate or otherwise convey or
dispose of any Capital Stock of a Subsidiary or (ii) permit a Subsidiary to
issue or sell any Capital Stock or other equity interest to any Person (other
than to the Company or to a Wholly-Owned Subsidiary of the Company); provided
that the foregoing restrictions shall not apply (x) to any such sale,
disposition or issuance which does not exceed $5,000,000 in fair market value
(as determined in good faith by the Company), (y) to the issuance and sale of
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nonvoting, nonconvertible preferred stock of any Subsidiary, provided that the
aggregate liquidation or stated value of all such nonvoting, nonconvertible
preferred stock does not exceed 5% of the Consolidated Net Tangible Assets of
the Company and (z) to the issuance or sale of qualifying shares to a director.
Line of Business
The Company and its Subsidiaries shall continue to engage in the business
of mortgage banking and lending, servicing mortgage loans and other financial
services (including banking, consumer finance and broker-dealer operations and
any other activity that would be permissible for a federal savings association,
a national or Puerto Rico chartered commercial bank or a bank or savings and
loan holding company) as their principal business.
Consolidations, Mergers and Sales of Assets by the Company
The Company may not consolidate with or merge into any other Person or
convey, transfer or lease all or substantially all of its Property to any
Person, nor shall the Company permit any Person to consolidate with or merge
into the Company or convey, transfer or lease all or substantially all of its
Property to the Company unless (i) the Person formed by such consolidation or
into which the Company is merged or the Person to which the Property of the
Company is so conveyed, transferred or leased shall be a corporation,
partnership or trust organized and existing under the laws of the United States,
any State thereof, the Commonwealth of Puerto Rico or the District of Columbia
and shall expressly assume the payment of the principal of (and premium, if any)
and interest on the Notes and the performance of the other covenants of the
Company under the Indenture; (ii) immediately after giving effect to such
transaction, no Event of Default, and no event which, after notice or lapse of
time or both, would become an Event of Default, shall have occurred and be
continuing; (iii) immediately after giving effect to such transaction, such
Person would be able to incur $1.00 in additional indebtedness under the
"Limitation on Company and Subsidiary Indebtedness and Disqualified Stock"
covenant (assuming the applicability of such provision to such Person in the
event that such Person is not the Company); (iv) immediately after giving effect
to such transaction, such Person shall have a Consolidated Net Worth equal to or
greater than the Consolidated Net Worth of the Company immediately prior to such
transaction; and (v) the Company has delivered to the Trustee an Officers'
Certificate and an Opinion of Counsel each stating that such consolidation,
merger, conveyance, transfer or lease and any supplemental indenture relating
thereto comply with the Indenture and that all conditions precedent under the
Indenture have been complied with.
CERTAIN DEFINITIONS
"Affiliate" of any specified Person means any other Person (i) directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person; (ii) which beneficially owns 10% or more of
the Voting Stock of such specified Person; or (iii) 10% or more of the Voting
Stock (or in the case of a Person which is not a corporate entity, 10% of the
equity interest) of which is owned by such specified Person or a subsidiary
thereof. For the purposes of this definition, "control" when used with respect
to any specified Person means the power to direct the management and policies of
such Person, directly or indirectly, whether through the ownership of voting
securities, by contract or otherwise; and the terms "controlling" and
"controlled" have meanings correlative to the foregoing.
"Asset Disposition" means any sale, lease, transfer or other disposition
(or series of related sales, leases, transfers or dispositions) of property or
other assets (each referred to for the purposes of this definition as a
"disposition") by the Company or any of its Subsidiaries (other than (i) a
disposition by a Subsidiary to the Company or by the Company or a Subsidiary to
a Wholly Owned Subsidiary, (ii) a disposition of any asset, including without
limitation, loans, mortgage-backed securities, Servicing Assets and other
securities, in the ordinary course of business and (iii) a disposition of
property or other assets having a fair market value (as determined in good faith
by the Company) of not more than $1,500,000. For purposes of this definition,
the term "Asset Disposition" shall include any disposition by means of a merger,
consolidation or similar transaction unless such merger, consolidation or
similar transaction is not in violation of the provisions described under the
"Consolidation, Merger and Sale of Assets" covenant.
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"Board of Directors" means either the board of directors of the Company or
any duly authorized committee of that board.
"Board Resolution" means a copy of a resolution certified by the Secretary
or an Assistant Secretary of the Company to have been duly adopted by the Board
of Directors and to be in full force and effect on the date of such
certification, and delivered to the Trustee.
"Capital Stock" of any Person means any and all shares, interests,
participations or other equivalents in the equity interest (however designated)
in such Person and any rights (including debt securities convertible into an
equity interest), warrants or options to acquire an equity interest in such
Person.
"Capitalized Lease Obligation" means any obligation to pay rent or other
amounts under a lease of (or other agreement conveying the right to use) real or
personal property that is required to be classified and accounted for as a
capital lease obligation under GAAP, and, for the purposes of this Indenture,
the amount of such obligation at any date shall be the capitalized amount
thereof at such date, determined in accordance with such principles.
"Consolidated EBITDA" means, with respect to the Company for any period,
(i) the sum of, without duplication, the amount for such period, taken as a
single accounting period, of (a) Consolidated Net Income, (b) Consolidated
Non-cash Charges, (c) Consolidated Interest Expense and (d) Consolidated Income
Tax Expense, less (ii) Consolidated Non-cash Net Income Contributions.
"Consolidated Income Tax Expense" means, with respect to the Company for
any period, the provision for federal, state, local and foreign income taxes of
the Company and its Subsidiaries for such period as determined on a consolidated
basis in accordance with GAAP.
"Consolidated Interest Coverage Ratio" means, with respect to the Company,
the ratio of the aggregate amount of Consolidated EBITDA of the Company for the
four full fiscal quarters for which financial information in respect thereof is
available immediately preceding the date of the transaction (for purposes of
this definition, the "Transaction Date") giving rise to the need to calculate
the Consolidated Interest Coverage Ratio (such four full fiscal quarter period
being referred to herein for purposes of this definition as the "Four Quarter
Period") to the aggregate amount of Consolidated Interest Expense of the Company
for the Four Quarter Period. In addition to and without limitation of the
foregoing, for purposes of this definition "Consolidated EBITDA" and
"Consolidated Interest Expense" shall be calculated after giving effect on a pro
forma basis for the period of such calculation to, without duplication, (a) the
incurrence of any Indebtedness of the Company or its Subsidiaries during the
period commencing on the first day of the Four Quarter Period to and including
the Transaction Date (for purposes of this definition, the "Reference Period"),
including, without limitation, the incurrence of the Indebtedness giving rise to
the need to make such calculation (and the application of the net proceeds
thereof), as if such incurrence (and application) occurred on the first day of
the Reference Period, (b) an adjustment to eliminate or include, as the case may
be, the Consolidated EBITDA and Consolidated Interest Expense of such Person
directly or indirectly attributable to assets which are the subject of any
acquisition, which gives rise to the need to make such calculation occurring
during the Reference Period, as if such acquisition occurred on the first day of
the Reference Period and (c) the retirement of Indebtedness during the Reference
Period which cannot thereafter be reborrowed under the agreement pursuant to
which it was incurred occurring as if retired on the first day of the Reference
Period. For purposes of calculating "Consolidated Interest Expense" for this
"Consolidated Interest Coverage Ratio," interest on Indebtedness incurred during
the Four Quarter Period under any revolving credit facility which can be
borrowed and repaid without reducing the commitments thereunder shall be the
actual interest during the Four Quarter Period. Furthermore, in calculating
"Consolidated Interest Expense" for purposes of determining the denominator (but
not the numerator) of this "Consolidated Interest Coverage Ratio", (i) interest
on outstanding Indebtedness determined on a fluctuating basis as of the
Transaction Date and which will continue to be so determined thereafter shall be
deemed to have accrued at a fixed rate per annum equal to the rate of interest
on such Indebtedness in effect on the Transaction Date, (ii) if interest on any
Indebtedness actually incurred on the Transaction Date may optionally be
determined at an interest rate based upon a factor of a prime or similar rate, a
eurocurrency interbank offered rate, or other money market rates, then the
interest rate in effect on the Transaction Date will be deemed to have been in
effect during the Reference Period, and
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(iii) notwithstanding clauses (i) and (ii) above, interest on Indebtedness
determined on a fluctuating basis, to the extent such interest is covered by
agreements relating to Interest Rate Protection Obligations, shall be deemed to
have accrued at the rate per annum resulting after giving effect to the
operation of such agreements. If the Company or its Subsidiaries directly or
indirectly guaranteed Indebtedness of a third person, the above clauses shall
give effect to the incurrence of such guaranteed Indebtedness as if the Company
or its Subsidiary had directly incurred or otherwise assumed such guaranteed
Indebtedness.
"Consolidated Interest Expense" means, with respect to the Company for any
period, without duplication, the sum of (i) the interest expense of the Company
and its Subsidiaries with respect to Indebtedness other than Permitted
Indebtedness and Refinancing Indebtedness (other than Indebtedness under the
Indenture and the Convertible Subordinated Debentures and Refinancing
Indebtedness thereon) for such period as determined on a consolidated basis in
accordance with GAAP, excluding the amortization of fees related to the issuance
of the Notes, but including, without limitation, (a) any amortization of debt
discount, (b) the net cost under Interest Rate Protection Obligations (including
any amortization of discounts), (c) the interest portion of any deferred payment
obligation which in accordance with GAAP is required to be reflected on an
income statement, (d) all commissions, discounts and other fees and charges owed
with respect to letters of credit and bankers' acceptance financing, and (e) all
accrued interest and (ii) the interest component of Capitalized Lease
Obligations paid, accrued and/or scheduled to be paid or accrued by the Company
and its Subsidiaries during such period as determined on a consolidated basis in
accordance with GAAP.
"Consolidated Net Income" or "Consolidated Net Loss" means, with respect to
the Company for any period, the consolidated net income (or loss) of the Company
and its Subsidiaries for such period as determined in accordance with GAAP
consistently applied adjusted, to the extent included in calculating such net
income, by excluding, without duplication, (i) all extraordinary gains or losses
(net of fees and expenses relating to the transaction giving rise thereto) and
the non-recurring cumulative effect of accounting charges, (ii) the portion of
net income (or loss) of the Company and its Subsidiaries allocable to minority
interests in unconsolidated Persons to the extent that cash dividends or
distributions have not actually been received by the Company, (iii) net income
(or loss) of any Person combined with the Company or its Subsidiaries on a
"pooling of interests" basis attributable to any period prior to the date of
combination, (iv) any gain or loss realized upon the termination of any employee
pension benefit plan, on an after-tax basis, (v) gains (net of fees and expenses
relating to the transaction giving rise thereto) or losses in respect of any
Asset Dispositions by the Company or its Subsidiaries, on an after-tax basis and
(vi) the net income of any Subsidiary of the Company to the extent that the
declaration of dividends or similar distributions by that Subsidiary of that
income is not at the time permitted, directly or indirectly, by operation of the
terms of its charter or any agreement, instrument, judgment, decree, order,
statute, rule or governmental regulations applicable to that Subsidiary or its
stockholders.
"Consolidated Net Tangible Assets" means, as of any date of determination,
the sum of the amounts that would appear on a consolidated balance sheet of any
Person and its subsidiaries as the total assets (less accumulated depreciation
and amortization, allowances for doubtful receivables, other applicable reserves
and other properly deductible items) of such Person and its subsidiaries,
determined on a consolidated basis in accordance with GAAP, after giving effect
to purchase accounting and after deducting therefrom, to the extent otherwise
included, the amounts of (without duplication): (i) the excess of cost over fair
market value of assets or businesses acquired; (ii) any reevaluation or other
write-up in book value of assets subsequent to the last day of the fiscal
quarter of such Person immediately preceding the date of the Indenture as a
result of a change in the method of valuation in accordance with GAAP; and (iii)
unamortized debt discount and expenses, other unamortized deferred charges,
goodwill, patents, trademarks, service marks, trade names, copyrights, licenses,
organization or developmental expenses and other intangible items (if included
in total assets).
"Consolidated Net Worth" means the total stockholders' equity (exclusive of
any Disqualified Capital Stock) of any Person and its subsidiaries determined on
a consolidated basis in accordance with GAAP.
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"Consolidated Non-cash Charges" means, with respect to the Company for any
period, the aggregate depreciation, amortization (including amortization of
excess servicing fees receivable, cost in excess of fair value of net assets
acquired, amortization of debt issuance costs and mortgage servicing rights) and
other non-cash expenses (including, without limitation, allowance for loan and
lease losses, non-cash reserves and non-cash charges) of the Company and its
Subsidiaries reducing Consolidated Net Income of the Company and its
Subsidiaries for such period, determined on a consolidated basis in accordance
with GAAP.
"Consolidated Non-cash Net Income Contributions" means, with respect to the
Company for any period, the additions to excess servicing fees receivable and
the increase in originated mortgage servicing rights (OMSR) of the Company and
its Subsidiaries for such period, determined on a consolidated basis in
accordance with GAAP.
"Convertible Subordinated Debentures" means the 8.25% Convertible
Subordinated Debentures due January 1, 2006 issued pursuant to the Debenture
Purchase Agreement, dated as of September 25, 1995, as amended and restated as
of December 15, 1995, between the Company and Banponce Corporation, a Puerto
Rico corporation.
"Disqualified Stock" means any Capital Stock that, by its terms (or by the
terms of any security into which it is convertible or for which it is
exchangeable), or upon the happening of any event, matures or is mandatorily
redeemable, pursuant to a sinking fund obligation or otherwise, or is redeemable
at the option of the holder thereof, in whole or in part, on or prior to October
10, 2006.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as may be approved by a significant segment of the accounting
profession of the United States, as in effect from time to time.
"Holder" means a Person in whose name a Note is registered in the Security
Register.
"Indebtedness" of any Person means (i) any liability of such Person (a) for
borrowed money, (b) secured by any Lien, (c) evidenced by a bond, note,
debenture or similar instrument (including a purchase money instrument), other
than a trade payable or current liability arising in the ordinary course of
business, (d) created or arising under any conditional sale or other title
retention agreement, (e) which is a "take-or-pay" obligation, (f) for the
payment of money relating to a Capitalized Lease Obligation, (g) for
reimbursement in respect of letters of credit but only to the extent that the
letters of credit do not support an obligation of such Person already included
in Indebtedness or which would constitute Permitted Indebtedness of such Person,
or (h) under Interest Rate Protection Agreements (other than Interest Rate
Protection Agreements relating to or in connection with Permitted Indebtedness);
(ii) any liability of others described in the preceding clause (i) that the
Person has guaranteed or that is otherwise its legal liability; and (iii) any
amendment, supplement, modification, deferral, renewal, extension or refunding
of any liability of the types referred to in clauses (i) and (ii) above, but
excluding contingent recourse obligations or contingent recourse liabilities
related to the Company's mortgage servicing portfolio or mortgage servicing
rights of the Company and its Subsidiaries and obligations as a servicer under
mortgage servicing agreements to make advances on mortgage loans in advance of
receipt of payment from the underlying obligors. Notwithstanding the foregoing,
any securities issued in a securitization by a special purpose trust on similar
entity to which mortgage loans or mortgage-backed securities have been sold or
otherwise transferred by or on behalf of the Company or any Subsidiary of the
Company or by any person to which the Company or any Subsidiary shall have sold
mortgage loans or mortgage-backed securities in connection with such
securitization transaction shall not be treated as Indebtedness regardless of
whether such securities are treated as indebtedness for tax purposes.
"Interest Rate Protection Agreement" of any Person means any interest rate
swap agreement, interest rate collar agreement, option or future contract or
other similar agreement or arrangement designed to protect such Person or any of
its subsidiaries against fluctuations in interest rates.
"Lien" means, with respect to any Property, any mortgage, lien, pledge,
charge, security interest or encumbrance of any kind in respect of such
Property. For purposes of this definition, a Person shall be deemed
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to own subject to a Lien any Property which it has acquired or holds subject to
the interest of a vendor or lessor under any conditional sale agreement, capital
lease or other title retention agreement relating to such Property.
"Permitted Indebtedness" means (i) Indebtedness of the Company and its
Subsidiaries outstanding immediately following the issuance of the Notes and the
application of the proceeds thereof; (ii) deposit liabilities of any Subsidiary,
the deposits of which are insured by the Federal Deposit Insurance Corporation
or any successor agency to the fullest extent permitted by law; (iii)
Indebtedness of the Company or any Subsidiary incurred in the ordinary course of
business pursuant to overdraft facilities; (iv) Indebtedness of the Company or
any Subsidiary to the Federal Home Loan Bank of New York or any successor
thereto incurred in the ordinary course of business and secured by mortgage
loans, mortgage-backed securities or other permitted collateral (including term
notes payable to private investors collateralized by letters of credit issued by
the Federal Home Loan Bank of New York); (v) Indebtedness of the Company or any
Subsidiary incurred in the ordinary course of business and secured by mortgage
loans, mortgage-backed securities, asset-backed securities or Servicing Assets
(other than term facilities secured by Servicing Assets) or any other type of
security in the case of AAA Financial, including commercial paper notes that are
credit enhanced pursuant to credit facilities which are secured by any such
assets; (vi) Indebtedness of the Company or any Subsidiary under any mortgage
loan repurchase agreements or securities repurchase agreements entered into in
the ordinary course of business; (vii) Indebtedness of the Company or any
Subsidiary under, or incurred to finance or settle, any put obligation entered
into in the ordinary course of business in connection with the sale or financing
of mortgage loans or mortgage-backed securities; and (viii) Indebtedness of the
Company or any Subsidiary under Interest Rate Protection Agreements related to
or in connection with (i) through (vii) above.
"Permitted Liens" means (i) any purchase money Lien on any Property
acquired after the date of the Indenture by the Company or any Subsidiary or
constructed or improved after the date of the Indenture by the Company or any
Subsidiary to secure or provide for the payment of all or a part of the purchase
price thereof, or any Indebtedness incurred to finance the purchase thereof or
cost of construction or cost of improvement of such property; provided that (a)
such Liens shall not extend to any other Property of the Company or any
Subsidiary, and (b) any Indebtedness secured by any such Lien shall not exceed
an amount equal to 100% of the lesser of the purchase price or fair market value
at the time of acquisition of the Property (the amount to be determined in good
faith by the Company); (ii) all Liens on Property of the Company or any
Subsidiary existing on the date of the Indenture; (iii) Liens created in
connection with property taxes and assessments or governmental charges or levies
and Liens securing claims of mechanics and materialmen in the ordinary course of
business; (iv) Liens in favor of the Company or a Subsidiary securing
Indebtedness of a Subsidiary; (v) Liens on Property existing at the time of
acquisition thereof (including acquisition through merger or consolidation);
provided that (a) such Liens shall not extend to any other Property of the
Company or any Subsidiary, and (b) such Liens shall not have been created,
incurred or assumed in contemplation of such Property being acquired by the
Company or any Subsidiary; (vi) Liens securing the Notes; (vii) Liens incidental
to the conduct of business or the ownership of properties (including
warehousemen's and attorneys' liens and statutory landlord's liens and liens to
secure the deposit of public funds or trust funds in the case of Doral Federal);
(viii) Liens arising by reason of any judgment, decree or order of any court, so
long as such Lien is adequately bonded, any appropriate legal proceedings which
may have been duly initiated for the review of such judgment, decree or order
shall not have been finally terminated and the period within which such
proceedings may be initiated shall not have expired; (ix) Liens securing
Indebtedness referred to in clauses (i) and (iii)-(viii) of the definition of
"Permitted Indebtedness" above; (x) Liens securing residential mortgage
servicing assets; (xi) Liens in favor of Financial Security Assurance or other
insurance or credit enhancement provider on residual certificates or interests
of mortgage trusts; and (xii) any extension, renewal or replacement (or
successive extensions, renewals or replacements), in whole or in part, of any
Lien referred to in the foregoing subparagraphs (i) through (xi); provided that
any of the foregoing are limited to the same Property subject to, and securing
no more Indebtedness than, the Lien so extended, renewed or replaced.
"Person" means any individual, corporation, limited liability company,
limited or general partnership, joint venture, association, joint stock company,
trust, unincorporated organization or government or any agency or political
subdivision thereof.
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"Property" of any Person means all types of real, personal, tangible,
intangible or mixed property owned by such Person whether or not included in the
most recent consolidated balance sheet of such Person and its subsidiaries under
GAAP.
"Refinancing Indebtedness" means Indebtedness that refunds, refinances or
extends any Indebtedness of the Company or its Subsidiaries outstanding on the
date of the Indenture or other Indebtedness permitted to be incurred by the
Company or its Subsidiaries pursuant to the terms of the Indenture, but only to
the extent that (i) such newly incurred Indebtedness is subordinated to the
Notes to the same extent as the Indebtedness being refunded, refinanced or
extended; (ii) the Refinancing Indebtedness is scheduled to mature either (a) no
earlier than the Indebtedness being refunded, refinanced or extended, or (b)
after the Stated Maturity of the Notes; (iii) the portion, if any, of the
Refinancing Indebtedness that is scheduled to mature on or prior to the Stated
Maturity of the Notes has a weighted average life to maturity at the time such
Refinancing Indebtedness is incurred that is equal to or greater than the
weighted average life to maturity of the portion of the Indebtedness being
refunded, refinanced or extended that is scheduled to mature on or prior to the
Stated Maturity of the Notes; (iv) such Refinancing Indebtedness is in an
aggregate principal amount that is equal to or less than the sum of (a) the
aggregate principal amount then outstanding under the Indebtedness being
refunded, refinanced or extended, (b) the amount of accrued and unpaid interest,
if any, on such Indebtedness being refunded, refinanced or extended and (c) the
amount of customary fees, expenses and costs related to the incurrence of such
Refinancing Indebtedness; and (v) such Refinancing Indebtedness is incurred by
the same Person that initially incurred the Indebtedness being refunded,
refinanced or extended, except that (a) the Company may incur Refinancing
Indebtedness to refund, refinance or extend Indebtedness of any Subsidiary and
(b) any Subsidiary may incur Refinancing Indebtedness to refund, refinance or
extend Indebtedness of any other Subsidiary.
"Restricted Indebtedness" means any Indebtedness that (i) is subordinated
in right of payment to the Notes; and (ii) requires any principal payment,
redemption payment or sinking fund payment thereon, in whole or in part, to be
made on or prior to the Stated Maturity of the Notes; provided that any
Indebtedness which qualifies as Refinancing Indebtedness shall not be deemed to
constitute Restricted Indebtedness.
"Restricted Investment" shall mean any investment in, loan or advance to,
guarantee on behalf of, directly or indirectly, or other transfer of assets to
(i) any Person, whether in corporate, partnership or other legal form, in which
the Company or any of its Subsidiaries holds a 50% or less interest; or (ii) any
Subsidiary that is subject to restrictions, direct or indirect, on the
declaration or payment of dividends or similar distributions, or the making of
intercompany loans or advances, by that Subsidiary to the Company or to any
other Subsidiary under the terms of its certificate of incorporation or any
agreement, instrument, judgment, order, decree, statute (other than Puerto Rico
or any State corporate law or any equivalent restriction relating to federal
savings associations or commercial banks), rule or governmental regulation
binding upon such Subsidiary.
"Restricted Payment" means (i) any declaration or payment of any dividend
or other distribution on Capital Stock of the Company or any of its Subsidiaries
(other than wholly-owned Subsidiaries), other than dividends or distributions
payable in Capital Stock (other than Disqualified Stock) or options, warrants or
other rights to acquire Capital Stock (other than Disqualified Stock); (ii) any
redemption, purchase requirement, or other acquisition for value (other than
value represented by Capital Stock (other than Disqualified Stock) or options,
warrants or other rights to acquire Capital Stock (other than Disqualified
Stock)) of the Capital Stock of the Company or any of its Subsidiaries (other
than wholly-owned Subsidiaries); (iii) the making of any principal payment on,
or the purchase, defeasance, repurchase, redemption or other acquisition or
retirement for value, prior to any scheduled maturity, scheduled repayment or
scheduled sinking fund payment, of any Indebtedness of the Company which is
subordinated in right of payment to the Notes other than (a) with the proceeds
from the incurrence of Refinancing Indebtedness related thereto or (b) in
exchange for Capital Stock (other than Disqualified Stock) or options, warrants
or other rights to acquire Capital Stock (other than Disqualified Stock) or (c)
with respect to Convertible Subordinated Debentures; or (iv) any Restricted
Investment.
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"Security Register" means the register maintained in the office or agency
designated pursuant to the Indenture in which, subject to such reasonable
regulations as it may prescribe, the Company shall provide for the registration
of Notes and transfer of Notes.
"Servicing Assets" means, at any time, the portfolio of outstanding
residential mortgage loans with respect to which the Company has direct
servicing rights.
"Stated Maturity" when used with respect to any Note or any installment of
interest thereon, means the date specified in such Note as the fixed date on
which the principal of such Note or such installment of interest is due and
payable.
A "subsidiary" of any Person means (i) a corporation a majority of whose
Voting Stock is at the time, directly or indirectly, owned by such Person, by
one or more subsidiaries of such Person or by such Person and one or more
subsidiaries of such Person or (ii) any other Person in which such Person,
directly or indirectly, at the date of determination thereof, has (x) at least a
majority ownership interest or (y) the power to elect or direct the election of
a majority of the directors or other governing body of such Person.
"Subsidiary" means any subsidiary of the Company.
"Trust Indenture Act" means the Trust Indenture Act of 1939 as in force on
the date the Indenture is executed.
"U.S. Government Obligations" means securities which are (i) direct
obligations of the United States of America for the payment of which its full
faith and credit is pledged; or (ii) obligations of a Person controlled or
supervised by and acting as an agency or instrumentality of the United States of
America, the timely payment of which is unconditionally guaranteed as a full
faith and credit obligation by the United States of America, which, in either
case, are not callable or redeemable at the option of the issuer thereof, and
shall also include a depositary receipt issued by a bank or trust company as
custodian with respect to any such U.S. Government Obligation or a specific
payment of interest on or principal of any such U.S. Government Obligation held
by such custodian for the account of the holder of a depositary receipt;
provided, that (except as required by law) such custodian is not authorized to
make any deduction from the amount payable to the holder of such depositary
receipt from any amount received by the custodian in respect of the U.S.
Government Obligation or the specific payment of interest on or principal of the
U.S. Government Obligation evidenced by such depositary receipt.
"Voting Stock" means, with respect to any Person, securities of any class
or classes of Capital Stock in such Person entitling the holders thereof
(whether at all times or only so long as no senior class of stock has voting
power by reason of any contingency) to vote in the election of members of the
Board of Directors or other governing body of such Person.
"Wholly-Owned Subsidiary" means a Subsidiary of which all issued and
outstanding Capital Stock (other than directors' qualifying shares) is owned
beneficially and of record by the Company and/or one or more Wholly-Owned
Subsidiaries of the Company.
EVENTS OF DEFAULT
The following will be Events of Default under the Indenture: (i) failure to
pay principal of or premium, if any, on any Note when due or to pay any
redemption price; (ii) failure to pay any interest on any Note when due,
continuing for 30 days; (iii) failure to perform any other covenant of the
Company or breach by the Company of any warranty in the Indenture, continuing
for 60 days in each case after written notice as provided in the Indenture; (iv)
failure of the Company or any Subsidiary to pay the principal of any
Indebtedness for money borrowed with a principal amount then outstanding in
excess of $10,000,000, individually or in the aggregate, when such Indebtedness
becomes due and payable at its final maturity and such failure shall continue
after any applicable grace period specified in the agreement relating to such
Indebtedness; or any default on any such Indebtedness which results in such
Indebtedness becoming due and payable prior to its final maturity; (v) certain
undischarged or unbonded final judgments for the payment of money in excess of
$10,000,000 against the Company; and (vi) certain events of bankruptcy,
insolvency or reorganization.
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Subject to the provisions of the Indenture and the Trust Indenture Act relating
to the duties of the Trustee in case an Event of Default shall occur and be
continuing, the Trustee will be under no obligation to exercise any of its
rights or powers under the Indenture at the request or direction of any of the
Holders, unless such Holders shall have offered to the Trustee reasonable
indemnity. Subject to such provisions for the indemnification of the Trustee,
the Holders of a majority in aggregate principal amount of the Notes then
outstanding will have the right to direct the time, method and place of
conducting any proceeding for any remedy available to the Trustee or exercising
any trust or power conferred on the Trustee.
If an Event of Default shall occur and be continuing, either the Trustee or
the Holders of at least 25% in principal amount of the Notes then outstanding
may accelerate the maturity of all Notes; provided, however, that after such
acceleration, but before a judgment or decree based on acceleration, the Holders
of a majority in principal amount of Notes then outstanding may, under certain
circumstances, rescind and annul such acceleration if all Events of Default
other than the non-payment of accelerated principal have been cured or waived as
provided in the Indenture. For information as to waiver of defaults, see
"-- Modification and Waiver."
The Indenture provides that no Holder of a Note may pursue any remedy under
the Indenture unless the Trustee shall have failed to act after notice of an
Event of Default and request by Holders of at least 25% in principal amount of
the Notes then outstanding and the offer to the Trustee of indemnity
satisfactory to it; provided that such provision does not affect the right to
sue for enforcement of any overdue payment on the Notes.
The Company will be required to furnish to the Trustee annually a statement
as to the performance by the Company of certain of its obligations under the
Indenture and as to any default in such performance.
MODIFICATION AND WAIVER
Modifications and amendments of the Indenture may be made by the Company
and the Trustee with the consent of the Holders of a majority in aggregate
principal amount of the Notes then outstanding; provided, however, that no such
modification or amendment may, without the consent of the Holder of each Note
affected thereby, (i) change the maturity date of the principal of, or any
installment of interest on, any Note; (ii) reduce the principal amount of, or
the premium or interest on, any Note; (iii) change the place or currency of
payment of principal of, or premium or interest on, any Note; (iv) impair the
right to institute suit for the enforcement of any payment on or with respect to
any Note; (v) reduce the above-stated percentage of Notes necessary to modify or
amend the Indenture; or (vi) reduce the percentage of aggregate principal amount
of Notes necessary for waiver of compliance with certain provisions of the
Indenture or for waiver of certain defaults.
The Holders of a majority in aggregate principal amount of the Notes then
outstanding may waive compliance by the Company with certain provisions of the
Indenture. The Holders of a majority in aggregate principal amount of the Notes
then outstanding may waive any past default under the Indenture, except (i) a
default in the payment of principal, premium or interest; and (ii) a default
with respect to certain other provisions.
DEFEASANCE AND DISCHARGE OF INDENTURE
The Company may discharge any and all obligations in respect of the Notes
then outstanding if (i) all such Notes mature within one year or are to be
called for redemption within one year; (ii) the Company irrevocably deposits
with the Trustee, in trust, money in United States Dollars and/or U.S.
Government Obligations sufficient, in the opinion of a nationally recognized
firm of independent public accountants, to pay the principal of and premium, if
any, and each installment of interest, if any, on the Notes then outstanding to
maturity or redemption, as the case may be; and (iii) certain other conditions
are satisfied.
The Company may omit to comply with certain restrictive covenants that are
described in the Indenture and any such omission will not be deemed to be a
default or an Event of Default under the Indenture and Notes upon irrevocable
deposit with the Trustee, in trust, of money in United States Dollars and/or
U.S.
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Government Obligations which through the payment of interest thereon and
principal thereof in accordance with their terms will provide, not later than
one day before the due date of any payment, money in an amount sufficient in the
opinion of a nationally recognized firm of independent public accountants to pay
the principal of and premium, if any, and each installment of interest, if any,
on the Notes then outstanding. The obligations under the Indenture, other than
with respect to the covenants described in the preceding sentence, and the
Events of Default under the Indenture, other than the Events of Default relating
to such covenants, shall remain in full force and effect. Such trust may only be
established if, among other things, (a) the Company has delivered to the Trustee
an opinion of counsel to the effect that the deposit and related defeasance
would not cause the Holders of the Notes to recognize gain or loss for United
States Federal income tax purposes; (b) the Notes, if then listed on any
securities exchange, will not be delisted as a result of such deposit; (c) no
Event of Default shall have occurred or be continuing (A) on the date of such
deposit, or (B) insofar as certain events of bankruptcy, insolvency, or
reorganization are concerned, at any time during the period ending on the 123rd
day after the date of such deposit (it being understood that this condition
shall not be deemed satisfied until the expiration of such period); (d) such
defeasance or covenant defeasance will not result in the trust arising from such
deposit being in violation of the Investment Company Act of 1940, as amended;
and (3) certain other conditions are satisfied.
THE TRUSTEE
Bankers Trust Company is to be the Trustee under the Indenture and has been
appointed by the Company as Registrar and Paying Agent with respect to the
Notes.
The Trustee is an affiliate of BT Securities Corporation, which is acting
as underwriter for the Notes, and is the administrative and syndicate agent and
a lender under the Syndicated Credit Agreement. The Trustee and its banking
affiliates may have other banking relationships with the Company in the ordinary
course of business.
The Trust Indenture Act imposes certain limitations on the right of the
Trustee, as a creditor of the Company, to obtain payment of claims in certain
cases, or to realize on certain property received in respect to any such claim
as security or otherwise. The Trustee will be permitted to engage in other
transactions; provided, however, if it acquires any conflicting interest within
the meaning of Section 310 of the Trust Indenture Act, it must generally either
eliminate such conflict or resign.
In the case an Event of Default shall occur (and shall not be cured), the
Trustee will be required to use the degree of care of a prudent person in the
conduct of its own affairs in the exercise of its powers.
GOVERNING LAW
The Indenture and the Notes will be governed by and construed in accordance
with the laws of the State of New York, without regard to the principals of
conflicts of law.
CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of the material U.S. federal income tax
consequences of the acquisition, ownership and disposition of Notes by a U.S.
Holder (as defined below). The Summary is based upon laws, regulations, rulings
and judicial decisions now in effect, all of which are subject to change
(possibly on a retroactive basis). This summary deals only with initial
purchasers of Notes at the issue price that are U.S. Holders and that will hold
Notes as capital assets. The discussion does not cover all aspects of U.S.
federal income taxation that may be relevant to, or the actual tax effect that
any of the matters described herein will have on, the acquisition, ownership or
disposition of Notes by particular investors, and does not address state, local,
foreign or other tax laws. In particular, this summary does not discuss all of
the tax considerations that may be relevant to certain types of investors
subject to special treatment under the U.S. federal income tax laws (such as
banks, insurance companies, investors liable for the alternative minimum tax,
individual retirement accounts and other tax-deferred accounts, tax-exempt
organizations, dealers in securities or currencies, investors that will hold the
Notes as part of straddles, hedging transactions or conversion
70
<PAGE> 71
transactions for federal tax purposes or investors whose functional currency is
not the U.S. Dollar) and does not discuss the consequences to a holder under
state, local or foreign tax laws. Prospective investors are advised to consult
their own tax advisors regarding the federal, state, local and other tax
considerations of holding and disposing of the Notes.
As used herein, the term "U.S. Holder" means a beneficial owner of Notes
that is (i) a citizen or resident of the United States for U.S. federal income
tax purposes, (ii) a corporation created or organized under the laws of the
United States or any State thereof (including the District of Columbia) or (iii)
a person or entity that is otherwise subject to U.S. federal income tax on a net
income basis in respect of income derived from the Notes.
The following summary is based on the Internal Revenue Code of 1986, as
amended (the "Code"), existing and proposed regulations thereunder, published
rulings and court decisions, all as currently in effect and all subject to
change at any time, perhaps with retroactive effect.
STATED INTEREST
Interest paid on a Note will be taxable to a U.S. Holder as ordinary income
at the time it is received or accrued, depending on the holder's method of
accounting for tax purposes. Interest paid by the Company on the Notes generally
will constitute income from sources outside the United States. Prospective
investors should consult their tax advisors concerning the applicability of the
source of income rules to income attributable to the Notes.
PURCHASE, SALE, EXCHANGE, RETIREMENT AND REDEMPTION OF THE NOTES
In general, a U.S. Holder's tax basis in a Note will equal the price paid
for the Note. A U.S. Holder generally will recognize gain or loss on the sale,
exchange, retirement, redemption or other disposition of a Note (or portion
thereof) equal to the difference between the amount of cash and the fair market
value of any property received on such disposition and the U.S. Holder's tax
basis in the Note (or portion thereof). Except to the extent attributable to
accrued but unpaid interest, gain or loss recognized on such disposition of a
Note will be capital gain or loss and will be long-term capital gain or loss if
the Note was held for more than one year. Any such gain will generally be U.S.
source income.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Payments of interest and principal on, and the proceeds of sale or other
disposition of Notes payable to a U.S. Holder may be subject to information
reporting requirements, and backup withholding at a rate of 31% may apply to
such payments unless such holder (a) is a corporation or comes within certain
other exempt categories and, when required, demonstrates this fact, or (b)
provides a correct taxpayer identification number, certifies as to no loss of
exemption from backup withholding and otherwise complies with applicable
requirements of the backup withholding rules. Any amount paid as backup
withholding will be creditable against the holder's U.S. federal income tax
liability. A U.S. Holder that provides an incorrect taxpayer identification
number may be subject to penalties imposed by the Code. U.S. Holders should
consult their tax advisors as to their qualification for exemption from backup
withholding and the procedure for obtaining such an exemption.
EFFECT OF PUERTO RICO WITHHOLDING TAXES
If payments on the Notes are subject to Puerto Rico withholding taxes, U.S.
Holders will be treated as having actually received the amount of Puerto Rico
taxes withheld by the Company with respect to a Note and then having paid over
such withheld taxes to the Puerto Rico taxing authorities. Subject to certain
limitations, a U.S. Holder would generally be entitled to a credit against the
U.S. federal income tax liability, or a deduction in computing its U.S. federal
taxable income, for any Puerto Rico income taxes withheld by the Company.
Prospective investors should consult their tax advisors as to the U.S. federal
income tax consequences of Puerto Rico withholding taxes and the availability of
a foreign tax credit or deduction.
71
<PAGE> 72
CERTAIN PUERTO RICO INCOME TAX CONSEQUENCES
The following discussion of certain Puerto Rico income tax consequences to
holders of Notes with respect to the acquisition, ownership and disposition of
the Notes is based upon laws, regulations, rulings and decisions now in effect,
all of which are subject to change. The discussion below does not purport to
deal with all aspects of Puerto Rico taxation that may be relevant to particular
investors. Prospective investors are advised to consult their own tax advisors
regarding the Puerto Rico income tax consequences of the acquisition, ownership
and disposition of the Notes and the applicability of the income and withholding
tax provisions described below.
PAYMENTS TO NON-RESIDENT HOLDERS OF THE NOTES
Under the PRIRC, interest on Notes received by a holder of the Notes who is
(i) not a U.S. citizen and not a resident of Puerto Rico or (ii) a foreign
corporation or partnership (i.e., not organized under the laws of Puerto Rico)
not engaged in a trade or business in Puerto Rico or (iii) a foreign trust
(each, a "Non-Resident Holder") will be exempt from Puerto Rico income and
withholding tax, except in the case of any such Non-Resident Holder that may be
regarded as a "related person" with respect to the Company. For this purpose, a
"related person" generally will be one that directly or indirectly owns 50% or
more in value of the stock of the Company.
On September 13, 1996, legislation was enacted which, among other things,
amended the PRIRC to provide that interest on bonds and other evidence of
indebtedness of residents of Puerto Rico, whether individuals or corporations,
received by United States citizens non-residents of Puerto Rico is sourced
outside of Puerto Rico and therefore, exempt from Puerto Rico income and
withholding taxes.
SALE OF NOTES BY A NON-RESIDENT NOTEHOLDER
Any gain realized by a Non-Resident Holder from the sale or exchange of
Notes outside Puerto Rico will not be subject to Puerto Rico income taxation.
72
<PAGE> 73
UNDERWRITING
BT Securities Corporation is acting as underwriter (the "Underwriter") of
the Notes. Subject to the terms and conditions set forth in an underwriting
agreement (the "Underwriting Agreement"), the Underwriter has agreed to
purchase, and the Company has agreed to sell to it, $75,000,000 aggregate
principal amount of Notes.
The Underwriting Agreement provides that the obligations of the Underwriter
are subject to the approval of certain legal matters by counsel and various
other conditions. The nature of the Underwriter's obligations is such that it is
committed to purchase all of the above Notes if any are purchased. The
Underwriter proposes to offer the Notes directly to the public at the offering
price set forth on the cover page of this Prospectus and to certain dealers at
such price less a concession not in excess of 1.25% of the principal amount of
the Notes.
The Notes are a new issue of securities with no established trading market.
The Underwriter has advised the Company that it intends to make a market in the
Notes but the Underwriter is not obligated to do so and may discontinue market
making at any time without notice. No assurance can be given as to the liquidity
of the trading market for the Notes.
The Underwriting Agreement provides that the Company will indemnify the
Underwriter against certain liabilities, including liabilities under the Act, or
will contribute to payments that the Underwriter may be required to make in
respect thereof.
Bankers Trust Company, an affiliate of BT Securities Corporation, is the
trustee with respect to the Notes and administrative and syndicate agent and a
lender under an existing Syndicated Credit Agreement with the Company. See
"DESCRIPTION OF THE NOTES -- The Trustee."
LEGAL MATTERS
Certain legal matters with respect to the validity of the Notes offered
hereby will be passed upon for the Company by Pietrantoni Mendez & Alvarez, San
Juan, Puerto Rico. Certain legal matters in connection with the Notes will be
passed upon for the Underwriter by Cahill Gordon & Reindel, New York, New York.
Pietrantoni Mendez & Alvarez will rely on the opinion of Cahill Gordon & Reindel
as to certain matters of New York law.
EXPERTS
The financial statements as of December 31, 1995 and 1994 and for each of
the three years in the period ended December 31, 1995 included in this
Prospectus have been so included in reliance on the report of Price Waterhouse,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
73
<PAGE> 74
FIRST FINANCIAL CARIBBEAN CORPORATION AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
CONSOLIDATED ANNUAL AUDITED FINANCIAL STATEMENTS
Report of Independent Accountants..................................................... F-2
Financial Statements
Consolidated Balance Sheet as of December 31, 1995 and 1994......................... F-3
Consolidated Statement of Income and Retained Earnings for the years ended December
31, 1995, 1994, and 1993......................................................... F-4
Consolidated Statement of Changes in Capital Stock for the years ended December 31,
1995, 1994 and 1993.............................................................. F-5
Consolidated Statement of Cash Flows for the years ended December 31, 1995, 1994 and
1993............................................................................. F-6
Notes to Consolidated Financial Statements.......................................... F-8
INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheet as of June 30, 1996 and December 31, 1995.................. F-36
Consolidated Statement of Income and Retained Earnings for the quarter ended and the
six months ended June 30, 1996 and June 30, 1995.................................... F-37
Consolidated Statement of Cash Flows for the six months ended June 30, 1996 and June
30, 1995............................................................................ F-38
Notes to Consolidated Financial Statements............................................ F-39
</TABLE>
All financial schedules have been omitted because they are not applicable
or because the required information is shown in the financial statements or
notes thereto.
F-1
<PAGE> 75
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of
First Financial Caribbean Corporation
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income and retained earnings, of changes in capital
stock and of cash flows present fairly, in all material respects, the financial
position of First Financial Caribbean Corporation and its subsidiaries at
December 31, 1995 and 1994, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1995, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
As discussed in Note 2 to the consolidated financial statements, the
Company adopted the provisions of the Financial Accounting Standards Board
Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage
Servicing Rights, an amendment of FASB Statement No. 65," effective April 1,
1995.
Price Waterhouse
Certified Public Accountants
(of Puerto Rico)
License No 10 Expires Dec. 1, 1998
Stamp 1327038 of the P.R. Society of
Certified Public Accountants has been
affixed to the file copy of this report
San Juan, Puerto Rico
February 2, 1996
F-2
<PAGE> 76
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1995 1994
------------ ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents......................................... $ 59,871,646 $ 35,916,125
Mortgage loans held for sale, net................................. 245,484,255 263,773,383
Mortgage-backed securities held for trading....................... 407,941,495 319,203,574
Securities held to maturity....................................... 77,945,425 66,804,426
Securities available for sale..................................... 14,578,997 --
Loans receivable, net............................................. 51,355,258 34,808,938
Accounts receivable and mortgage servicing advances, net.......... 9,591,627 7,086,045
Accrued interest receivable....................................... 8,155,028 7,874,551
Mortgage servicing rights......................................... 11,164,065 3,543,032
Excess servicing fees receivable.................................. 10,407,297 8,756,589
Property, leasehold improvements and equipment, net............... 6,504,725 7,466,980
Cost in excess of fair value of net assets acquired............... 6,526,131 6,609,402
Real estate held for sale, net.................................... 2,084,541 2,115,911
Prepaid and other assets.......................................... 6,311,571 4,060,368
------------ ------------
Total assets............................................ $917,922,061 $768,019,324
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Loans payable..................................................... $234,706,497 $265,705,957
Securities sold under agreements to repurchase.................... 363,728,000 303,730,017
Deposit accounts.................................................. 95,740,441 66,471,111
Notes payable..................................................... 51,682,156 17,055,480
Advances from Federal Home Loan Bank of N.Y....................... 10,407,111 419,245
Convertible Subordinated Debentures............................... 10,000,000 --
Accounts payable and other liabilities............................ 17,376,204 17,792,644
Income tax payable................................................ 388,041 2,571,773
Deferred tax liability............................................ 4,877,068 3,776,899
------------ ------------
Total liabilities....................................... 788,905,518 677,523,126
------------ ------------
Commitments and contingencies (Note 25)...........................
------------ ------------
Stockholders' equity:
10.5% Cumulative Convertible Preferred Stock, Series A, $1 par
value, 2,000,000 shares authorized;
108,397 shares issued and outstanding (1994 -- 204,329)
(liquidating preference of $10 per share,
aggregating $1,083,970)...................................... 108,397 204,329
Common stock, $1 par value, 10,000,000 shares authorized;
8,884,170 shares issued and outstanding
(1994 -- 7,182,306).......................................... 8,884,170 7,182,306
Paid-in capital................................................. 38,329,800 16,674,402
Retained earnings............................................... 81,892,300 66,706,435
------------ ------------
129,214,667 90,767,472
Unrealized gain on securities available for sale.................. 8,856 --
Treasury stock at par value, 14,000 shares........................ (14,000) (14,000)
Unearned compensation under employment contracts.................. (192,980) (257,274)
------------ ------------
Total stockholders' equity.............................. 129,016,543 90,496,198
------------ ------------
Total liabilities and stockholders' equity.............. $917,922,061 $768,019,324
=========== ===========
</TABLE>
The accompanying notes are an integral part of this statement.
F-3
<PAGE> 77
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED STATEMENT OF INCOME AND RETAINED EARNINGS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Interest income................................................. $61,907,114 $46,507,972 $23,774,659
Mortgage loan sales and fees.................................... 13,528,534 10,572,734 35,230,405
Servicing income................................................ 10,576,826 11,447,772 8,627,024
Gain on sale of servicing rights................................ 5,204,933 3,003,459 2,378,000
Other income.................................................... 619,923 510,705 218,123
----------- ----------- -----------
91,837,330 72,042,642 70,228,211
----------- ----------- -----------
Expenses:
Interest........................................................ 43,380,148 23,251,898 9,710,091
Employee cost................................................... 6,471,059 6,000,632 7,194,699
Taxes, other than payroll and income taxes...................... 1,150,416 847,856 768,048
Maintenance..................................................... 654,354 712,627 615,503
Advertising..................................................... 2,474,638 4,205,312 4,620,177
Professional services........................................... 2,867,316 3,658,557 3,611,639
Telephone....................................................... 1,682,412 2,076,049 1,719,687
Rent............................................................ 2,096,979 2,004,023 1,444,866
Other........................................................... 8,999,491 10,540,576 9,622,256
----------- ----------- -----------
69,776,813 53,297,530 39,306,966
----------- ----------- -----------
Income before income taxes and cumulative effect of change in
accounting principle............................................ 22,060,517 18,745,112 30,921,245
----------- ----------- -----------
Income taxes:
Current......................................................... 1,400,044 2,092,696 7,141,681
Deferred........................................................ 1,100,169 436,899 2,460,000
----------- ----------- -----------
2,500,213 2,529,595 9,601,681
----------- ----------- -----------
Income before cumulative effect of change in accounting
principle....................................................... 19,560,304 16,215,517 21,319,564
Cumulative effect of change in accounting principle -- adoption of
SFAS 115, net of deferred income taxes of $880,000.............. -- 1,215,000 --
----------- ----------- -----------
Net income............................................... 19,560,304 17,430,517 21,319,564
Retained earnings at beginning of year............................ 66,706,435 53,219,178 35,041,903
Less cash dividends:
Convertible preferred stock $1.05 per share................... 187,639 325,045 496,948
Common stock $.58 per share (1994 -- $.52; 1993 -- $.40 per
share)...................................................... 4,186,800 3,618,215 2,645,341
----------- ----------- -----------
Retained earnings at end of year.................................. $81,892,300 $66,706,435 $53,219,178
============ ============ ============
Earnings per share:
Primary:
Income before cumulative effect of change in accounting
principle..................................................... $ 2.65 $ 2.29 $ 3.15
Cumulative effect of change in accounting principle............. -- .17 --
----------- ----------- -----------
Net income............................................... $ 2.65 $ 2.46 $ 3.15
============ ============ ============
Fully diluted:
Income before cumulative effect of change in accounting
principle..................................................... $ 2.53 $ 2.14 $ 2.81
Cumulative effect of change in accounting principle............. -- .16 --
----------- ----------- -----------
Net income............................................... $ 2.53 $ 2.30 $ 2.81
============ ============ ============
</TABLE>
The accompanying notes are an integral part of this statement.
F-4
<PAGE> 78
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN CAPITAL STOCK
<TABLE>
<CAPTION>
PREFERRED COMMON PAID-IN TREASURY
STOCK STOCK CAPITAL STOCK
--------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Balance at December 31, 1992................... $ 510,895 $3,284,587 $20,258,555 $ (7,000)
Stock split on December 10, 1993............... -- 3,381,069 (3,374,069) (7,000)
Shares converted............................... (96,482) 96,482 -- --
--------- ---------- ----------- --------
Balance at December 31, 1993................... 414,413 6,762,138 16,884,486 (14,000)
Shares converted............................... (210,084) 420,168 (210,084) --
--------- ---------- ----------- --------
Balance at December 31, 1994................... 204,329 7,182,306 16,674,402 (14,000)
Shares issued on December 11, 1995............. -- 1,510,000 21,751,330 --
Shares converted............................... (95,932) 191,864 (95,932)
--------- ---------- ----------- --------
Balance at December 31, 1995................... $ 108,397 $8,884,170 $38,329,800 $(14,000)
======== ========= ========== ========
</TABLE>
The accompanying notes are an integral part of this statement.
F-5
<PAGE> 79
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1995 1994 1993
------------- ------------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income.................................... $ 19,560,304 $ 17,430,517 $ 21,319,564
------------- ------------- ---------------
Adjustments to reconcile net income to net
cash (used) provided by operating
activities:
Depreciation and amortization.............. 1,764,500 1,533,750 698,300
Amortization of excess servicing fees
receivable............................... 988,082 566,668 160,785
Amortization of cost in excess of fair
value of net assets acquired............. 376,158 358,097 255,476
Amortization of mortgage servicing
rights................................... 562,054 730,059 492,000
Gain on sale of mortgage servicing
rights................................... (5,204,933) (3,003,459) (2,378,000)
Cumulative effect of change in accounting
principle................................ -- (1,215,000) --
Allowances for losses...................... 352,000 299,523 1,012,500
Origination and purchases of mortgage loans
held for sale............................ (583,659,000) (797,582,000) (1,432,448,000)
Principal repayments and sales of mortgage
loans held for sale...................... 282,477,731 216,918,548 620,387,650
Purchases of mortgage-backed securities
held for trading......................... (72,124,000) (265,025,000) (182,883,000)
Principal repayments and sales of
mortgage-backed securities held for
trading.................................. 357,461,000 653,479,000 860,471,000
Increase in accrued interest receivable.... (280,477) (3,853,140) (18,979)
(Decrease) increase in loans payable....... (94,089,007) 72,911,782 98,215,950
Increase in loans payable related to
securities sold not yet purchased........ 22,089,547 -- --
Increase (decrease) in interest payable.... 382,912 788,079 (149,082)
Increase in securities sold under
agreements to repurchase................. 59,997,983 160,530,375 14,444,412
(Decrease) increase in accounts payable and
other liabilities........................ (799,352) (21,838,018) 3,480,563
(Decrease) increase in income tax
payable.................................. (2,183,732) (1,177,206) 3,365,157
Deferred tax provision..................... 1,100,169 436,899 2,460,000
Amortization of unearned compensation under
employment contracts..................... 64,294 64,294 299,952
------------- ------------- ---------------
Total adjustments..................... (30,724,071) 14,923,251 (12,133,316)
------------- ------------- ---------------
Net cash (used) provided by operating
activities.......................... (11,163,767) 32,353,768 9,186,248
------------- ------------- ---------------
Cash flows from investing activities:
Redemption of certificates of deposit......... -- -- 2,500,000
Purchases of securities held to maturity...... (10,789,000) (61,789,000) (6,127,850)
Principal repayments of securities held to
maturity................................... 3,207,857 799,896 --
Origination of loans receivables.............. (52,341,000) (26,252,000) --
Principal repayments of loans receivable...... 4,060,159 836,792 756,275
Decrease in mortgage notes receivable......... -- -- 6,763,184
(Decrease) increase in accounts receivable and
mortgage servicing advances................ (2,857,582) 8,112,720 (958,587)
Additions to excess servicing fees
receivable................................. (2,638,790) (5,859,312) (3,103,139)
Purchase of property, leasehold improvements
and equipment.............................. (802,245) (3,229,537) (2,981,977)
Payments of contingent purchase price of
subsidiary................................. (292,887) (430,929) (985,900)
</TABLE>
F-6
<PAGE> 80
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1995 1994 1993
------------- ------------- ---------------
<S> <C> <C> <C>
Proceeds from disposal of real estate held for
sale....................................... 1,616,911 3,163,069 4,363,585
Acquisition of real estate held for sale...... (1,585,541) (2,350,675) (3,699,118)
Increase in mortgage servicing rights......... (8,207,139) (581,130) (14,943)
Proceeds from sale of mortgage servicing
rights..................................... 5,228,985 3,306,286 2,378,000
Cash resulting from acquisition of subsidiary,
net of purchase price...................... -- -- 227,000
(Increase) decrease in prepaid and other
assets..................................... (2,251,203) (591,019) 166,963
------------- ------------- ---------------
Net cash used by investing
activities.......................... (67,651,475) (84,864,839) (716,507)
------------- ------------- ---------------
Cash flows from financing activities:
Increase in deposits.......................... 29,269,330 40,020,265 18,141,846
Decrease in loans payable related to mortgage
notes receivable........................... -- -- (3,845,899)
Proceeds from convertible subordinated
debentures................................. 10,000,000 -- --
Proceeds from issuance of common stock, net... 23,261,330 -- --
Proceeds (repayment) of advances from Federal
Home Loan Bank............................. 9,987,866 (2,012,134) (1,003,621)
Increase in notes payable..................... 34,626,676 17,055,480 --
Dividends declared and paid................... (4,374,439) (3,943,260) (3,142,289)
------------- ------------- ---------------
Net cash provided by financing
activities.......................... 102,770,763 51,120,351 10,150,037
------------- ------------- ---------------
Net increase (decrease) in cash and cash
equivalents................................... 23,955,521 (1,390,720) 18,619,778
Cash and cash equivalents at beginning of
year.......................................... 35,916,125 37,306,845 18,687,067
------------- ------------- ---------------
Cash and cash equivalents at end of year........ $ 59,871,646 $ 35,916,125 $ 37,306,845
============ ============ ==============
Supplemental Schedule of Noncash Investing and
Financing Activities:
Noncash financing activities-conversion of
preferred stock............................ $ 959,320 $ 2,100,840 $ 964,820
============ ============ ==============
On September 10, 1993, the Company acquired all
of the outstanding capital stock of Doral
Federal Savings Bank (formerly Catano Federal
Savings Bank) for $1,200,000 (including
transaction costs). In conjunction with the
acquisition, liabilities were assumed as
follows:
Fair value of assets acquired................. -- -- $ 13,073,000
Cash paid..................................... -- -- 1,200,000
------------- ------------- ---------------
Liabilities assumed............................. -- -- $ 11,873,000
============ ============ ==============
Supplemental Cash Flow Information:
Cash used to pay interest..................... $ 43,000,000 $ 22,460,000 $ 9,561,000
============ ============ ==============
Cash used to pay income taxes................. $ 3,360,000 $ 3,260,000 $ 3,780,000
============ ============ ==============
</TABLE>
The accompanying notes are an integral part of this statement.
F-7
<PAGE> 81
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- REPORTING ENTITY
The consolidated financial statements include the accounts of First
Financial Caribbean Corporation and its wholly-owned subsidiaries ("FFCC" or the
"Company"), Doral Mortgage Corporation ("Doral"), RSC Corp. ("RSC"), Centro
Hipotecario, Inc. and Doral Federal Savings Bank ("Doral Federal"). All
significant intercompany accounts and transactions have been eliminated in
consolidation.
On September 10, 1993, the Company acquired all of the outstanding common
stock of Doral Federal Savings Bank at a price of approximately $1,200,000. This
acquisition was accounted for using the purchase method of accounting. The
consolidated statement of income and retained earnings for the year ended
December 31, 1993 includes the results of operations of Doral Federal from
September 10, 1993. Proforma results of operations for 1993 as though the
acquisition had been made at the beginning of such period are substantially
similar to actual results of operations for the periods and therefore is not
presented.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company is primarily engaged in the origination, purchase and sale of
FHA, VA and conventional first and second mortgage loans and in providing and/or
arranging for interim financing for the construction of residences and other
types of real estate developments in Puerto Rico and selected markets in
Florida. The Company, in combination with its subsidiaries, services FHA
insured, VA guaranteed and conventional mortgage loans pooled for issuance of
Government National Mortgage Association (GNMA), Federal National Mortgage
Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC) backed
securities and collateralized mortgage obligations certificates issued by
grantor trusts established by the Company (CMO Certificates). It also services
loans for private investors. The Company also originates loans for investment
and provides banking services through a federal savings bank that operates two
branches located in Puerto Rico.
The preparation of financial statements in conformity with generally
accepted accounting principles requires the use of management's estimates. The
following summarizes the more significant accounting policies used by the
Company.
ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES
In January 1994, the Company adopted Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"). This statement requires the Company to classify and
account for investments on equity securities that have readily determinable fair
values and all investments in debt securities as follows:
Debt securities that the Company has the positive intent and ability
to hold to maturity are classified as held-to-maturity and reported at
amortized cost.
Debt and equity securities that are bought and held principally for
the purpose of selling them in the near term are classified as trading and
reported at fair value, with unrealized gains and losses included in
earnings. Mortgage-backed securities held for sale in conjunction with
mortgage banking activities must be classified as trading securities.
Debt and equity securities not classified as either held-to-maturity
or trading are classified as available- for-sale and reported at fair
value, with unrealized gains and losses excluded from earnings and reported
in a separate component of stockholders' equity.
The adoption of this standard resulted in the recognition of a gross
unrealized gain of approximately $2.5 million as of January 1, 1994 ($1,215,000
net of approximately $880,000 in taxes and approximately $405,000 of related
expenses). Unrealized gains and losses on holdings of trading securities after
January 1, 1994, are included in earnings as a component of mortgage loan sales
and fees.
F-8
<PAGE> 82
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In December 1995, the Company used the one-time opportunity provided in the
Special Report "A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities" ("The Guide") issued by the
Financial Accounting Standards Board ("FASB"), to reassess the appropriateness
of classifications of all of the securities held by the Company as of the date
the Guide was issued. As a result of such reassessment, the Company transferred
approximately $15 million from the "held to maturity" category to the "available
for sale" category. As provided in the Guide, such transfer was recorded at fair
value and resulted in the recording of an unrealized gain of approximately
$9,000 in the stockholders' equity. Also, approximately $18 million was
transferred from the "trading category" to the "held to maturity category". This
transfer did not have any effect in current earnings or stockholders' equity
because transferred securities were already at fair value.
Mortgage-backed securities held for trading
Mortgage-backed securities held for trading are recorded at fair value.
Changes in fair value are recorded currently in income.
Securities held to maturity
Securities held to maturity are recorded at amortized cost.
Securities available-for-sale
Securities available-for-sale are recorded at fair value, with unrealized
gains and losses excluded from earnings and reported in a separate component of
stockholders' equity.
Mortgage loans held for sale
Mortgage loans held for sale are recorded at the lower of cost or market
computed on an aggregate portfolio basis.
LOANS RECEIVABLE
Loans receivable are held by Doral Federal principally for investment
purposes. These consist of residential first and second mortgages, commercial
and consumer loans with maturity dates ranging from one to twenty years.
Loans receivable are presented at the unpaid balance, less unearned
interest and allowance for loan losses. Unearned interest on commercial and
consumer loans is amortized using a method which results in a uniform level rate
of return on the principal amounts outstanding.
ALLOWANCES FOR LOSSES
Allowances for losses provide for estimated losses on mortgage loans held
for sale, loans receivable, accounts receivable and real estate held for sale
based upon a review of the loan portfolio, loss experience, economic conditions
and other pertinent factors.
The Company estimates the fair value of the retained recourse obligation of
loans sold at the time of sale. Ordinarily the amounts involved are minimal
insofar as the recourse obligations are met by substituting loans. The Company
has generally been able to rehabilitate and resell the reacquired loans for at
least their carrying amount. Accordingly, a reserve for possible losses arising
from recourse obligations has not been deemed necessary.
F-9
<PAGE> 83
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
EXCESS SERVICING FEES RECEIVABLE
The Company sells substantially all of the mortgage loans it produces
(other than those originated by Doral Federal) and retains the related servicing
rights. These servicing rights entitle the Company to a future stream of cash
flows based on the outstanding principal balance of the mortgage loans and the
contractual servicing fee. Gains and losses on sales of such loans are adjusted
to reflect as income or loss servicing fees that vary from normal servicing fee
rates set by federally sponsored secondary market makers. Accordingly, the
Company has recorded, as excess servicing fees receivable, amounts equal to the
present value of servicing fees to be received in future years in excess of
normal rates based upon the estimated lives of the loans and using long-term
interest rates that reflect the risks of the assets. The adjustment results in a
receivable that is realized through receipt of the excess service fees over
time. The Company evaluates periodically the net realizable value of its excess
servicing fees receivable based on the present value of the estimated remaining
future excess servicing fees revenue, using the same discount rate used to
calculate the original excess servicing fees receivable asset. Any impairment in
the value of the excess servicing fees receivable due to actual and anticipated
prepayment experience, is recognized currently as a reduction of excess
servicing fees receivable. The resulting excess servicing fees receivable is
amortized over the estimated life using a method approximating the level-yield
method. The amortization is recorded as a reduction of servicing income.
MORTGAGE SERVICING RIGHTS
In April 1995, the Company adopted Statement of Financial Accounting
Standards No. 122, "Accounting for Mortgage Servicing Rights, an amendment of
FASB No. 65, ("SFAS 122"). This statement changed the accounting for servicing
rights related to loans originated by an entity. Previously, the Company
followed the guidance provided by SFAS 65 which, among other things, prohibited
the recognition of servicing rights related to loans originated by an entity.
SFAS 122 requires that a portion of the cost of originating a mortgage loan be
allocated to the mortgage servicing right. The allocation is based on the
aggregate fair value of the loan and the related servicing right taken as a
whole. To determine the fair value of the servicing rights, the Company uses the
market prices of comparable servicing sale contracts.
SFAS 122 also requires that all mortgage servicing rights be evaluated for
impairment. In determining servicing value impairment, mortgage servicing rights
were disaggregated into their predominant risk characteristic. The Company has
determined that risk characteristic to be interest rate. For purposes of
measuring impairment, mortgage servicing rights are stratified by pool on the
basis of interest rates. An impairment is recognized whenever the prepayment
pattern of the mortgage pool indicates that the fair value of the related
mortgage servicing rights is less than its carrying amount. An impairment is
recognized by charging such excess to income. The Company determined that no
reserve for impairment was required as of December 31, 1995.
The adoption of this standard had the effect of increasing net income and
mortgage loan sales and fees by approximately $1,500,000 and $2,600,000,
respectively, for the year ended December 31, 1995, and increasing capitalized
servicing rights at December 31, 1995 by approximately $4,150,000. If the
Company had not adopted SFAS 122, earnings per share would have been
approximately $2.44 and $2.33, on a primary and fully diluted basis,
respectively, for the year ended December 31, 1995. SFAS 122 prohibits
retroactive application, therefore, mortgage servicing rights related to loans
originated prior to April 1, 1995 continue to be unrecognized in the Company's
financial statements.
Purchased mortgage servicing rights are initially recorded at the lower of
cost or present value of estimated future net servicing income stream. The
amount capitalized is amortized in proportion to, and over the period of,
estimated net servicing income. Amortization is adjusted prospectively to
reflect changes in prepayment experience. Any unamortized balance related to
rights sold is charged to income at time of sale.
F-10
<PAGE> 84
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
COST IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED
The cost in excess of fair value of net assets acquired is amortized on the
straight-line basis over their estimated useful lives (30-year period for
acquisitions made before Doral Federal and a 10-year period for the acquisition
of Doral Federal).
REAL ESTATE HELD FOR SALE
The Company acquires real estate through foreclosures. These properties are
held for sale and are stated at the lower of fair value, minus estimated costs
to sell, or cost.
PROPERTY, LEASEHOLD IMPROVEMENTS AND EQUIPMENT
Property, leasehold improvements and equipment are carried at cost.
Depreciation and amortization are provided on the straight-line method over the
estimated useful lives of the assets or the terms of the leases, if shorter, for
leasehold improvements. These range from five to ten years.
INCOME AND EXPENSE RECOGNITION
Loan origination fees and related direct loan origination costs are
deferred and amortized to income as an adjustment of the yield throughout the
life of the related mortgage loan. Such fees and costs related to mortgage loans
held for sale are deferred and recognized in income as a component of gain on
sale of mortgage loans when the related loans are sold or securitized.
SALE OF SECURITIES WITH PUT ARRANGEMENTS
From time to time the Company may sell mortgage-backed securities and
mortgage loans with put arrangements. Pursuant to these arrangements the Company
grants the buyer a put option that allows the buyer to sell the securities back
to the Company at a negotiated price. The accounting treatment for these
transactions (as a borrowing or a sale) is based on an assessment of the
probability that the put option will be exercised. If on the transaction date,
management determines that it is probable that the put option will be exercised,
the transaction is accounted for as a borrowing. If it is not judged probable
that the put option will be exercised, the transaction is accounted for as a
sale.
The premium collected on such put and any gain on the mortgage loans sold
are deferred until the negotiated net option period expires. When a transaction
is initially recorded as a sale but exercise of the put option later becomes
probable, the Company accrues any losses expected upon the exercise of the put
option and periodically adjusts the estimated loss accrual.
INTEREST RATE RISK MANAGEMENT
The Company has various mechanisms to reduce its exposure to interest rate
fluctuations, as these affect the value of its portfolio and the prices of newly
generated loans, loans to be originated and sales with put options.
The Company may enter into financial derivatives such as future contracts
or options.
The cost of unexpired options, net of premiums collected on written
options, is capitalized as part of the carrying cost of the mortgage loans and
charged to income when these expire. Unrealized net gains or losses on unexpired
options positions are considered as part of the lower cost or market evaluation
made for mortgage loans.
F-11
<PAGE> 85
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LOAN SERVICING
The Company pools FHA insured and VA guaranteed mortgages for issuance of
GNMA mortgage-backed securities. Conventional loans are pooled and issued as
FNMA or FHLMC mortgage-backed securities and CMO certificates as well as sold in
bulk to investors. Mortgages included in the resulting GNMA, FNMA and FHLMC
pools, CMO certificates and certain pools of conventional loans sold to
investors are serviced by the Company. The Company is required to advance funds
to make scheduled payments to investors, if payments due have not been received
from the mortgagors. At December 31, 1995, accounts receivable include advances
to investors of approximately $5,340,000 (1994 -- $3,100,000).
The Company is also required to foreclose on loans in the event of default
by the mortgagor. Mortgage loan servicing fees, which are based on a percentage
of the principal balances of the mortgages serviced, are credited to income as
mortgage payments are collected.
SALES OF MORTGAGE SERVICING RIGHTS
The Company recognizes gain or loss on the sale of mortgage servicing
rights when the sales contract is executed, all regulatory related approvals are
obtained and the title and all risks and rewards of ownership have been
irrevocably transferred to the buyer.
INCOME TAXES
The Company follows an asset and liability approach that requires the
recognition of deferred tax liabilities and assets for the expected future tax
consequences of temporary differences between the carrying amounts and the tax
bases of other assets and liabilities. A valuation allowance is recognized for
any deferred tax asset for which, based on management's evaluation, it is more
likely than not (a likelihood of more than 50%) that some portion or all of the
deferred tax asset will not be realized.
ACCOUNTING FOR IMPAIRMENT OF A LOAN
In January 1995, the Company adopted Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan." This
statement requires that impaired loans that are within the scope of the
statement be measured based on the present value of expected future cash flows
discounted at the loan's effective interest rate or, as a practical expedient,
at the loan's observable market price or the fair value of the collateral if the
loan is collateral dependent.
The adoption of this statement had no effect on the Company's results of
operations or financial position.
STATEMENT OF CASH FLOWS
Cash and cash equivalents include cash in banks, overnight deposits and
certificates of deposit (1995 -- $25,099,000 and 1994 -- $330,000) and other
highly liquid securities with an original maturity of three months or less.
F-12
<PAGE> 86
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1995, other highly liquid securities include $30,473,141 of
securities purchased under agreements to resell as follows:
<TABLE>
<CAPTION>
AMOUNT MATURITY
----------- -----------------
<S> <C> <C>
PaineWebber Inc. of Puerto Rico....................... $ 4,016,193 January 2, 1996
BP Capital Markets, Inc............................... 2,004,448 January 2, 1996
BP Capital Markets, Inc............................... 1,000,000 January 2, 1996
PaineWebber Inc. of Puerto Rico....................... 10,650,000 January 23, 1996
PaineWebber Inc. of Puerto Rico....................... 10,600,000 January 23, 1996
CS First Boston Corporation........................... 2,202,500 February 22, 1996
-----------
$30,473,141
===========
</TABLE>
EARNINGS PER SHARE
Primary net income per share is determined by dividing net income, after
deducting preferred stock dividends, by the weighted average number of common
stock outstanding during the period considering the dilutive effect of
restricted stock awards.
Fully diluted net income per share has been computed based on the
assumption that all of the shares of convertible preferred stock and convertible
subordinated debentures are converted into common stock, and after giving
retroactive effect to the elimination of interest expense, net of income taxes,
applicable to the convertible subordinated debentures.
On October 25, 1993, the Company declared a two for one stock split on its
shares of common stock outstanding. The stock split was effected in the form of
a stock dividend of one additional share of common stock for each share of
common stock held on record date of November 22, 1993. As a result, 3,381,069
shares of common stock were issued on December 10, 1993. As a result of the
stock split referred to above, each outstanding share of the Company's Series A
Preferred Stock became convertible into two shares of common stock at a
conversion price of $5 per share.
The number of shares of common stock used for computing the primary and
fully diluted earnings per share was as follows:
<TABLE>
<CAPTION>
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Primary............................................... 7,307,945 6,942,734 6,614,854
Fully diluted......................................... 7,760,135 7,576,964 7,576,964
</TABLE>
FAIR VALUE OF FINANCIAL INSTRUMENTS
The reported fair values of financial instruments are based on a variety of
factors. For a substantial portion of financial instruments, fair values
represent quoted market prices for identical or comparable instruments. In a few
other cases, fair values have been estimated based on assumptions concerning the
amount and timing of estimated future cash flows and assumed discount rates
reflecting varying degrees of risk. Accordingly, the fair values may not
represent actual values of the financial instruments that could have been
realized as of year end or that will be realized in the future.
ACCOUNTING FOR STOCK-BASED COMPENSATION
In October, 1995, the FASB issued Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). This
statement, which the Company must adopt for transactions entered into in the
fiscal years that begin after December 15, 1995, establishes financial
accounting and reporting standards for stock-based employee compensation plans.
Those plans include all arrangements by which employees receive shares of stock
or other equity instruments of the employer or the
F-13
<PAGE> 87
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
employer incurs liabilities to employees in amounts based on the price of the
employee's stock. Examples are: stock purchase plan, stock options, restricted
stock and stock appreciation rights. This statement defines a fair value based
method of accounting for an employee stock option and encourages all entities to
adopt that method of accounting for all of their employee stock compensation
plans. However, it also allows an entity to continue to measure compensation
cost for those plans using the intrinsic value based method of accounting
prescribed by APB Opinion No. 25.
No transactions of the nature covered by SFAS 123 have been made,
therefore, disclosure of monetary nature is not deemed appropriate.
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF
LIABILITIES
In June, 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities". SFAS No. 125
establishes accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on the consistent
application of the financial components approach. This approach requires the
recognition of financial assets and servicing assets that are controlled by the
reporting entity, the derecognition of financial assets when control is
surrendered, and the derecognition of liabilities when they are extinguished.
Specific criteria are established for determining when control has been
surrendered in the transfer of financial assets.
Liabilities and derivatives incurred or obtained by transferors in
conjunction with the transfer of financial assets are required to be measured at
fair value, if practicable. Servicing assets and other retained interests in
transferred assets are required to be measured by allocating the previous
carrying amount between the assets sold, if any, and the interest that is
retained, if any, based on the relative fair values of the assets at the date of
the transfer. Servicing assets retained are subsequently subject to amortization
and assessment for impairment.
SFAS No. 125 is effective for transfers and servicing of financial assets
and extinguishment of liabilities occurring after December 31, 1996. It is to be
applied prospectively; earlier or retroactive application is not permitted.
Management is currently evaluating the impact, if any, of the adoption of SFAS
No. 125 in the Company's financial statements.
OTHER
Certain amounts reflected in the 1994 and 1993 consolidated financial
statements have been reclassified to conform to the presentation for 1995.
NOTE 3 -- COST IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED
Doral and RSC were acquired in December 1986, these transactions were
accounted for by the purchase method of accounting resulting in $1,620,000 of
cost in excess of the fair value of net assets acquired. The terms of the
Company's purchase agreement require additional pay-outs to the former
stockholder over a ten-year period ending in 1996. The additional pay-outs are
contingent payments under the purchase agreements, and are accounted for as
additional cost over the fair value of assets acquired. The amount of such
pay-outs is determined based on a percentage ranging from 1/16% to 1/4% of the
aggregate principal amount of mortgage loans closed. The deferred pay-out
portion has been discounted using an imputed interest rate of 8%.
F-14
<PAGE> 88
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The changes in cost in excess of fair value of net assets acquired are
shown below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
Balance at beginning of period................. $6,609,402 $6,536,570 $5,535,146
Contingent payments under Doral purchase
agreement.................................... 292,887 430,929 985,900
Acquisition of Doral Federal Savings Bank...... -- -- 271,000
Amortization expense........................... (376,158) (358,097) (255,476)
---------- ---------- ----------
Balance at end of period....................... $6,526,131 $6,609,402 $6,536,570
========= ========= =========
</TABLE>
Total accumulated amortization relating to cost in excess of fair value of
net assets acquired amounted to $3,351,660, $2,975,502 and $2,617,405 at
December 31, 1995, 1994 and 1993, respectively.
NOTE 4 -- REGULATORY REQUIREMENTS
The Company is a U.S. Department of Housing and Urban Development (HUD)
approved, non supervised mortgagee and is required to maintain an excess of
current assets over current liabilities and minimum net worth, as defined by the
various regulatory agencies. The Company is also required to maintain fidelity
bonds and errors and omission's insurance coverages based on the balance of its
servicing portfolio.
As a result of the acquisition of Doral Federal, the Company became legally
a savings and loan holding company ("SLHC") subject to the restrictions and
requirements of the Home Owners' Loan Act of 1933, as amended (the "HOLA"). As
SLHC, the Company was registered with the Director of the Office of Thrift
Supervision (the "OTS") and is subject to various requirements of the HOLA,
including examination, supervision and reporting requirements. Federal law and
OTS regulations place certain limits on the types of activities in which an SLHC
and its subsidiaries may engage. However, in general, these restrictions do not
apply to a holding company that controls only one savings and loan association,
provided such association meets the "qualified thrift lender" test which
generally requires the association to have 65% of its portfolio assets in
"qualified thrift investments." For Puerto Rico based institutions, these
investments include, among other things, home mortgages, mortgage-backed
securities, and personal loans. Doral Federal is also subject to certain
regulatory capital requirements.
The Company is in compliance with these regulatory requirements.
NOTE 5 -- MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1995 1994
------------ ------------
<S> <C> <C>
Mortgage Loans:
Conventional loans..................................... $138,433,518 $194,208,574
FHA/VA loans........................................... 101,627,975 60,275,811
Construction and commercial loans...................... 5,422,762 9,288,998
------------ ------------
$245,484,255 $263,773,383
============ ============
</TABLE>
F-15
<PAGE> 89
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1995, the aggregate amortized cost and approximate market
value of these loans are as follows:
<TABLE>
<CAPTION>
AMORTIZED GROSS UNREALIZED GROSS UNREALIZED APPROXIMATE
COST HOLDING GAINS HOLDING LOSSES MARKET VALUE
- ------------ ---------------- ---------------- ------------
<S> <C> <C> <C>
$245,484,255 $4,158,015 $ (4,142,708) $245,499,562
============ ========== ===========
</TABLE>
Proceeds from sales of mortgage loans held for sale and mortgage-backed
securities held for trading during 1995 was approximately $725,236,000
(1994 -- $774,313,000). Gross gains of $42,472,000 (1994 -- $56,010,000) and
gross losses of $27,362,000 (1994 -- $41,452,000) were realized on those sales.
At December 31, 1995, construction and commercial loans include a loan of
approximately $1,250,000 on which the accrual of interest income had been
discontinued. The Company is contractually entitled to transfer this loan to a
non-related financial institution on a non-recourse basis. If this loan had been
accruing interest, additional interest income would have been realized of about
$125,000.
NOTE 6 -- MORTGAGE-BACKED SECURITIES HELD FOR TRADING
Mortgage-backed securities held for trading consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1995 1994
------------ ------------
<S> <C> <C>
Mortgage-backed securities:
CMO certificates...................................... $157,535,436 $158,252,188
GNMA.................................................. 242,327,525 152,494,112
FHLMC................................................. 7,091,819 7,217,040
FNMA.................................................. 986,715 1,240,234
------------ ------------
$407,941,495 $319,203,574
=========== ===========
</TABLE>
CMO certificates include the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1995 1994
------------ ------------
<S> <C> <C>
Certificates of other issuers........................... $135,572,829 $137,824,467
Residual certificates, CMO's established by the
Company............................................... 8,826,552 9,355,934
Subordinated certificates, CMO's established by the
Company............................................... 13,136,055 11,071,787
------------ ------------
$157,535,436 $158,252,188
=========== ===========
</TABLE>
At December 31, 1995, CMO certificates include approximately $14,094,000 of
interest only certificates.
Net unrealized holding gains on trading securities included in earnings for
the year ended December 31, 1995 amounted to approximately $4,864,000
(1994 -- Net unrealized holdings losses of $1,485,000).
The Insurance and Indemnity Agreements (the "Agreements") covering certain
financial guaranty insurance policies that insure the payment of senior
certificates issued by CMO grantors trusts established by the Company, provide,
among other things, that the Company cannot sell, transfer or pledge the
residual certificates issued by the trusts (amounting to approximately
$5,700,000) without the insurance company approval because the residual
certificates are pledged as collateral to the insurance company.
F-16
<PAGE> 90
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7 -- SECURITIES HELD TO MATURITY
Securities held to maturity consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1995 1994
------------------------- -------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Mortgage backed securities:
CMO certificates of other
issuers........................ $59,248,183 $59,520,647 $42,052,074 $42,175,115
GNMA.............................. 10,744,705 10,918,536 -- --
FHLMC............................. -- -- 4,600,372 4,469,976
FNMA.............................. -- -- 7,747,202 7,308,743
Debt securities:
Federal Home Loan Bank Notes...... 4,999,354 4,995,300 9,972,150 9,712,450
U.S. Treasury Notes............... 1,997,436 2,001,880 1,984,296 1,949,360
U.S. Treasury Bills............... 63,075 63,360 -- --
Other investments:
Mortgage notes receivables........ 892,672 892,672 448,332 448,332
----------- ----------- ----------- -----------
$77,945,425 $78,392,395 $66,804,426 $66,063,976
=========== =========== =========== ===========
</TABLE>
Management has the intent to hold these securities and believes it has the
ability to hold them to maturity by obtaining continuing financing under its
existing credit facilities. In addition, part of the above securities are held
by Doral Federal which has the ability to finance these securities with
deposits, advances from Federal Home Loan Bank of N.Y. and other long-term
funding sources.
At December 31, 1995, CMO certificates include approximately $4,800,000 of
interest only certificates.
At December 31, 1995, held to maturity securities include approximately
$2,500,000 pledged to secure public funds deposited in Doral Federal.
Contractual maturities of securities held to maturity at December 31, 1995
are as follows:
<TABLE>
<CAPTION>
MBS DEBT SECURITIES
----------- ---------------
<S> <C> <C>
Within one year............................................ -- $ 7,952,537
After 1 year through five years............................ $12,487,500 --
After 5 years through 10 years............................. 12,483,350 --
After 10 years............................................. 45,022,038 --
----------- ---------------
$69,992,888 $ 7,952,537
========== ===========
</TABLE>
Aggregate gross unrealized holding gains and losses are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------
MBS DEBT SECURITIES
----------------------- -----------------------
1995 1994 1995 1994
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Gross unrealized holding gains........ $ 480,644 $ 397,026 $ 4,730 $ --
========= ========= ========= =========
Gross unrealized holding losses....... $ 34,350 $ 842,839 $ 4,054 $ 294,637
========= ========= ========= =========
</TABLE>
F-17
<PAGE> 91
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- SECURITIES AVAILABLE FOR SALE
At December 31, 1995, securities available for sale consists of:
<TABLE>
<CAPTION>
FAIR VALUE AMORTIZED COST
----------- --------------
<S> <C> <C>
FNMA..................................................... $ 7,132,358 $ 7,164,471
FHLMC.................................................... 4,381,228 4,413,676
GNMA..................................................... 3,065,411 2,991,994
----------- --------------
$14,578,997 $ 14,570,141
========== ===========
</TABLE>
Aggregate gross unrealized holding gains and losses are as follows:
<TABLE>
<S> <C>
Gross unrealized holding gains............................................. $95,406
=======
Gross unrealized holding losses............................................ $86,550
=======
</TABLE>
The contractual maturity of the securities available for sale at December
31, 1995 is over ten years.
There were no sales of such securities during the year ended December 31,
1995.
NOTE 9 -- LOANS RECEIVABLE
Loans receivable consist of:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Construction loans...................................... $ 2,637,523 $ 1,060,528
Residential mortgage loans.............................. 29,480,931 23,292,969
Commercial real estate.................................. 9,204,612 2,044,120
Consumers -- secured by mortgage........................ 7,361,606 6,283,092
Consumers -- other...................................... 323,744 1,008,704
Loans on savings deposits............................... 1,939,912 956,212
Commercial.............................................. 698,367 392,940
Leases.................................................. 3,283 27,727
Land secured............................................ 330,345 183,896
----------- -----------
Gross loans............................................. 51,980,323 35,250,188
----------- -----------
Less:
Unearned interest and deferred loan fees.............. (382,894) (13,204)
Reserve for loan losses............................... (242,171) (428,046)
----------- -----------
(625,065) (441,250)
----------- -----------
Total loans................................... $51,355,258 $34,808,938
========== ==========
</TABLE>
As of December 31, 1995, Doral Federal had loans amounting to approximately
$949,000 on which the accrual of interest income had been discontinued. If these
loans had been accruing interest, the additional interest income realized would
have been approximately $86,000.
Doral Federal originates adjustable and fixed interest rate loans. The
adjustable rate loans have interest rate adjustment limitations and are
generally tied to various market indexes. Future market factors may affect
F-18
<PAGE> 92
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the correlation of the interest rate adjustment with the rate Doral Federal pays
on the short-term deposits that have primarily funded these loans. At December
31, 1995, the composition of loans receivable was as follows:
<TABLE>
<CAPTION>
ADJUSTABLE RATES
FIXED RATES -------------------------------------
- ------------------------------------- TERM TO DATE
TERM TO MATURITY BOOK VALUE OF RATE ADJUSTMENT BOOK VALUE
- ---------------------- ----------- ---------------------- -----------
<S> <C> <C> <C>
1 month -- 1 year $ 1,985,637 1 month -- 1 year $ 3,527,605
1 year -- 3 years 1,590,101 Non-performing 82,475
-----------
3 years -- 5 years 4,616,212
5 years -- 10 years 11,744,621 $ 3,610,080
==========
10 years -- 20 years 15,487,877
More than 20 years 12,078,938
Non-performing 866,857
-----------
$48,370,243
==========
</TABLE>
NOTE 10 -- ALLOWANCES FOR LOSSES
The changes in the allowances for losses were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
Accounts receivable and mortgage servicing
advances:
Balance at beginning of period................... $1,563,701 $1,446,563 $1,283,925
Provision for losses............................. 242,000 132,000 889,500
Losses charged to the allowance.................. -- (14,862) (726,862)
---------- ---------- ----------
Balance at end of period......................... $1,805,701 $1,563,701 $1,446,563
========== ========== ==========
Real estate held for sale:
Balance at beginning of period................... $ 356,035 $ 525,000 $ 400,000
Provision for losses............................. -- -- 100,000
Losses charged to the allowance.................. -- (168,965) --
Other............................................ -- -- 25,000
---------- ---------- ----------
Balance at end of period......................... $ 356,035 $ 356,035 $ 525,000
========== ========== ==========
Reserve for bank loan losses:
Balance at beginning of period................... $ 428,046 $ 234,200 $ 516,200
Provision for loan losses........................ 110,000 167,523 23,000
Recoveries....................................... 6,810 26,323 --
Losses charged to the allowance.................. (302,685) -- (305,000)
---------- ---------- ----------
Balance at end of period......................... $ 242,171 $ 428,046 $ 234,200
========== ========== ==========
</TABLE>
F-19
<PAGE> 93
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11 -- EXCESS SERVICING FEES RECEIVABLE
The changes in excess servicing fees receivable are shown below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1995 1994 1993
----------- ---------- ----------
<S> <C> <C> <C>
Balance at beginning of period.................... $ 8,756,589 $3,463,945 $ 521,591
Additions......................................... 2,638,790 5,859,312 3,103,139
Amortization
Scheduled.................................... (988,082) (566,668) (160,785)
Unscheduled.................................. -- -- --
----------- ---------- ----------
Balance at end of period.......................... $10,407,297 $8,756,589 $3,463,945
=========== ========== ==========
</TABLE>
There was no impairment of excess servicing fees receivable during any of
the above periods.
NOTE 12 -- PROPERTY, LEASEHOLD IMPROVEMENTS AND EQUIPMENT
Property, leasehold improvements and equipment consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1995 1994
----------- -----------
<S> <C> <C>
Office furniture and equipment.............................. $ 6,076,902 5,984,310
Leasehold improvements...................................... 4,634,187 4,243,689
Automobiles................................................. 262,428 287,211
Real estate under rental agreements......................... 73,660 73,660
Office building............................................. 413,982 406,815
----------- -----------
11,461,159 10,995,685
Less -- Accumulated depreciation and amortization......... (4,956,434) (3,528,705)
----------- -----------
$ 6,504,725 7,466,980
=========== ===========
</TABLE>
NOTE 13 -- MORTGAGE SERVICING RIGHTS
The changes in mortgage servicing rights are shown below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1995 1994 1993
----------- ---------- ----------
<S> <C> <C> <C>
Balance at beginning of period................ $ 3,543,032 $3,994,788 $4,416,955
Capitalization of rights...................... 7,901,308 581,130 69,833
Rights sold................................... (24,052) (302,827) --
Rights purchased.............................. 305,831 -- --
Impairments................................... -- -- --
Amortization:
Scheduled................................... (562,054) (730,059) (492,000)
Unscheduled................................. -- -- --
----------- ---------- ----------
Balance at end of period...................... $11,164,065 $3,543,032 $3,994,788
========== ========= =========
</TABLE>
Acquisitions in 1993 include $54,980 of mortgage servicing rights related
to the acquisition of Doral Federal. The Company's servicing portfolio amounted
to approximately $2,668,000,000 and $2,644,000,000 at December 31, 1995 and
1994, respectively, including $85,170,000 and $112,000,000 respectively, of
loans sold with recourse which are not government guaranteed or insured.
F-20
<PAGE> 94
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During the years ended December 31, 1995, 1994 and 1993, the Company sold
rights to service loans, amounting to approximately $310,000,000, $202,000,000
and $198,700,000, respectively. During the year ended December 31, 1995, the
Company purchased rights to service loans amounting to approximately
$40,000,000. No mortgage servicing rights were purchased in 1994 and 1993.
The carrying amount of mortgage servicing rights approximates its fair
value.
NOTE 14 -- ACCOUNTS PAYABLE AND OTHER LIABILITIES
Accounts payable and other liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1995 1994
----------- -----------
<S> <C> <C>
Amounts retained on mortgage loans, generally paid
within 5 days......................................... $ 3,516,973 $ 3,044,286
Customer mortgages and closing expenses payable......... 1,756,931 1,235,655
Deferred compensation plan.............................. 1,982,142 2,416,948
Incentive compensation payable.......................... 2,162,867 3,302,446
Accrued expenses and other payables..................... 7,957,291 7,793,309
----------- -----------
$17,376,204 $17,792,644
========== ==========
</TABLE>
NOTE 15 -- LOANS PAYABLE
At December 31, 1995 and 1994, the Company had several mortgage warehousing
lines of credit and gestation or presale facilities totaling $525,000,000 and
$367,000,000, respectively. Advances under these facilities are secured by loans
held for inclusion in GNMA, FNMA and FHLMC pools or for sale to financial
investors.
Loans payable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1995 1994
------------ ------------
<S> <C> <C>
Loans payable resulting from use of warehousing lines of
credit and gestation or presale facilities. At various
variable rates averaging 6.77% and 7.17% at December 31,
1995 and 1994, respectively, and other financing
arrangements............................................ $171,616,950 265,705,957
Amount payable in connection with securities previously
sold under put arrangement, due January 1996, at 7.5%,
collateralized by GNMA mortgage-backed securities....... 41,000,000 --
Securities sold not yet purchased ($19,962,047 at 7.5% and
$2,127,500 at variable rates -- 5.5% -- at December 31,
1995), due dates ranging from December 1996 to August
2000.................................................... 22,089,547 --
------------ ------------
$234,706,497 265,705,957
=========== ===========
</TABLE>
Maximum borrowings outstanding at any month-end during 1995 and 1994 were
$280,000,000 and $283,000,000, respectively. The approximate average outstanding
borrowings during the periods were $223,000,000 and $149,000,000, respectively.
The weighted average interest rate of such borrowings, computed on a monthly
basis, was 7.15% in 1995 and 5.70% in 1994.
On June 30, 1995, FFCC entered into a Syndicated Credit Agreement (the
"Syndicated Credit Agreement") with six banks providing for three credit
facilities totaling up to $125 million. The credit
F-21
<PAGE> 95
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
facilities were structured by Bankers Trust Company, as administrative and
syndicate agent. The three facilities include: (i) a $100 million secured
one-year revolving warehousing credit facility to finance residential mortgage
loans and mortgage-backed securities; (ii) a $7 million secured one-year
revolving credit facility to provide financing for receivables and working
capital needs; and (iii) a $18 million five-year senior secured term loan,
secured with a portion of the Company's servicing portfolio, to finance the
acquisition of additional servicing rights and general working capital purposes.
The amounts available under the Syndicate Credit Agreement are subject to a
borrowing base which consists of mortgage loans and mortgage-backed securities
for the first facility, receivables relating to servicing advances and real
estate owned for the second facility and mortgage servicing rights for the third
facility. Loans payable include advances from the warehousing credit facility.
Advances from the other two facilities are included in notes payable. The
existing warehousing credit facilities, the Syndicated Credit Agreement and
other financing arrangements require the Company to maintain certain capital
ratios and to comply with other requirements. At December 31, 1995, the Company
was in compliance with these requirements. At December 31, 1995 the scheduled
aggregate annual maturities of loans payable were approximately as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
---------------------------------------------------------------------
<S> <C>
1996................................................................. $222,596,297
1997................................................................. 9,982,700
2000................................................................. 2,127,500
------------
$234,706,497
===========
</TABLE>
NOTE 16 -- SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Company sells mortgage-backed securities and mortgage loans under
agreements to repurchase. At December 31, 1995 and 1994, the Company had several
repurchase agreement lines of credit, totaling $617,000,000 and $560,000,000,
respectively. At December 31, 1995 and 1994, the Company had a liability of
$363,728,000 and $303,730,017, respectively, relating to such agreements at
interest rates ranging from 5.09% to 6.95% in 1995 and 3.77% to 6.75% in 1994.
These agreements mature at various dates as follows:
DECEMBER 31, 1995:
<TABLE>
<CAPTION>
APPROXIMATE
MARKET AND BOOK
REPURCHASE VALUE OF UNDERLYING
TYPE OF SECURITY LIABILITY SECURITIES
------------------------------------------------------ ------------ -------------------
<S> <C> <C>
GNMA(1)............................................... $143,475,000 $ 152,157,723
FHLMC(1).............................................. 6,917,000 7,091,819
FNMA(1)............................................... 1,001,000 986,515
CMO Certificates(1)................................... 126,630,000 148,223,489
------------ -------------------
278,023,000 308,459,546
------------ -------------------
GNMA(2)............................................... 39,998,000 42,541,205
CMO Certificates(2)................................... 25,554,000 29,707,699
------------ -------------------
65,552,000 72,248,904
------------ -------------------
GNMA(3)............................................... 5,014,000 5,708,786
------------ -------------------
CMO Certificates(4)................................... 15,139,000 17,767,400
------------ -------------------
$363,728,000 $ 404,184,636
=========== =============
</TABLE>
F-22
<PAGE> 96
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1994:
<TABLE>
<CAPTION>
APPROXIMATE
MARKET AND BOOK
REPURCHASE VALUE OF UNDERLYING
TYPE OF SECURITY LIABILITY SECURITIES
------------------------------------------------------ ------------ -------------------
<S> <C> <C>
GNMA(1)............................................... $ 90,648,904 $ 98,448,093
FHLMC(1).............................................. 4,360,352 4,995,961
CMO Certificates(1)................................... 144,785,836 166,578,950
------------ -------------------
239,795,092 270,023,004
------------ -------------------
GNMA(2)............................................... 9,399,101 10,461,432
CMO Certificates(2)................................... 14,662,910 16,719,287
------------ -------------------
24,062,011 27,180,719
------------ -------------------
GNMA(5)............................................... 37,058,246 42,735,912
FHLMC(5).............................................. 979,260 1,240,234
FNMA(5)............................................... 1,835,408 2,221,079
------------ -------------------
39,872,914 46,197,225
------------ -------------------
$303,730,017 $ 343,400,948
=========== =============
</TABLE>
- ---------------
(1) Term up to 30 days
(2) Term over 30 days to 120 days
(3) Term over 120 days to 1 year
(4) Term between 3 to 5 years
(5) Term between 5 to 8 years
Maximum borrowings outstanding at any month-end during 1995 and 1994 under
the agreements to repurchase were $389,000,000 and $353,000,000, respectively.
The approximate average borrowings outstanding during the periods were
$368,000,000 and $302,000,000, respectively. The weighted average interest rate
of such borrowings, computed on a monthly basis was 5.90% in 1995 and 4.33% in
1994.
At December 31, 1995, securities sold under agreements to repurchase are
classified by dealer as follows:
<TABLE>
<CAPTION>
APPROXIMATE
MARKET VALUE OF
BALANCE OF BORROWING UNDERLYING SECURITIES
-------------------- ---------------------
<S> <C> <C>
Lehman Brothers Puerto Rico, Inc................... $ 78,762,000 $ 88,308,589
BP Capital Markets, Inc............................ 129,545,000 146,783,397
PaineWebber, Inc. of Puerto Rico................... 48,009,000 53,632,665
Merrill Lynch Government Securities of
Puerto Rico, SA.................................. 46,706,000 49,291,901
Bear Stearns Securities Corp....................... 31,235,000 32,655,279
Bankers Trust Caribe Capital Markets, Inc.......... 29,471,000 33,512,805
------------ ------------
Total.................................... $363,728,000 $ 404,184,636
============ ============
</TABLE>
F-23
<PAGE> 97
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17 -- NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1995 1994
----------- -----------
<S> <C> <C>
Demand note payable at 9% interest, collateralized by CMO
certificates.............................................. $ 1,000,000 3,250,000
Unsecured medium term notes, payable at interest rates
ranging from 9.50% to 13.63%, due December 31, 1996....... 1,590,000 3,170,000
Unsecured notes payable at 9% interest rate, final payment
dates ranging from August, 1996 to September 1998......... 5,915,480 6,095,480
Note payable to bank, collateralized by CMO certificates, at
8.50% interest rate and due on October 16, 1996........... 9,776,676 --
Term-notes payable to private investors, collateralized by
stand-by letters of credit issued by the Federal Home Loan
Bank of New York:
at 5.55% maturing on October 13, 2000.................. 8,100,000 --
at variable rate (5.00% at December 31, 1995) maturing
on November 17, 2000................................. 5,000,000 --
at 5.23% maturing on November 27, 2000................. 5,000,000 --
Loan payable to Bank, collateralized by mortgage servicing
rights held by the Company, at variable rate (8.125% at
December 31, 1995) maturing on June 30, 2000.............. 15,300,000 --
Due to Bank................................................. -- 4,540,000
----------- -----------
$51,682,156 17,055,480
=========== ===========
</TABLE>
At December 31, 1995, the scheduled aggregate annual maturities of notes
payable were approximately as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------------------------------------------------------
<S> <C>
1996.................................................................... $15,307,156
1997.................................................................... 2,190,000
1998.................................................................... 785,000
2000.................................................................... 33,400,000
-----------
$51,682,156
==========
</TABLE>
NOTE 18 -- CONVERTIBLE SUBORDINATED DEBENTURES
The Company entered into a Debenture Purchase Agreement (the "Debenture
Agreement") with BanPonce Corporation ("BanPonce"), providing for the issuance
and sale to BanPonce of up to $10 million of the Company's 8.25% Convertible
Subordinated Debentures due January 1, 2006 (the "Subordinated Convertible
Debentures"). The Subordinated Convertible Debentures are convertible into
shares of common stock of the Company at a conversion price of $17.50 per share,
subject to adjustments in certain events. Approximately $6.6 million and $3.4
million of Subordinated Convertible Debentures were issued on September 25 and
December 22, 1995, respectively. The Subordinated Convertible Debentures are
subordinated to all existing and future senior debt of the Company (as defined
in the Debenture Agreement). Under the Debenture Agreement, BanPonce has the
right to acquire up to 200,000 additional shares of the Company's common stock
at a price of $17.50 per share (subject to adjustment in certain events) to the
extent that its investment in the Company is reduced below 5% on a fully-diluted
basis. Such right to acquire
F-24
<PAGE> 98
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the additional shares expires on June 30, 1999 and is subject to termination
upon the occurrence of certain corporate events involving the acquisition of the
Company.
NOTE 19 -- DEPOSIT ACCOUNTS
At December 31, deposits and their weighted average interest rates are
summarized as follows:
<TABLE>
<CAPTION>
1995 1994
------------------ ------------------
AMOUNT % AMOUNT %
----------- ---- ----------- ----
<S> <C> <C> <C> <C>
Regular savings.................................. $10,271,981 3.68 $ 5,621,092 2.99
NOW accounts..................................... 2,046,765 3.35 2,788,200 3.14
Non interest-bearing deposits.................... 31,094,992 -- 23,774,402 --
Certificates of deposit.......................... 52,326,703 6.12 34,287,417 5.56
----------- ---- ----------- ----
$95,740,441 3.20 $66,471,111 2.73
========== ==== ========== ====
</TABLE>
At December 31, 1995 certificates of deposit over $100,000 in the aggregate
amounted to $12,253,574. A summary of certificates of deposit by maturity as of
December 31 follows:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Within one year............................................. $40,465,351 $10,591,820
One to three years.......................................... 5,252,095 18,853,486
Three and thereafter........................................ 6,609,257 4,842,111
----------- -----------
$52,326,703 $34,287,417
=========== ===========
</TABLE>
A summary of certificates of deposit by interest rate at December 31, 1995
follows:
<TABLE>
<CAPTION>
RATE AMOUNT
------------------------------------------------------------------------ -----------
<S> <C>
2.9% or less............................................................ $ 16,323
From 3.00% to 3.99%..................................................... 5,000
From 4.00% to 4.99%..................................................... 1,443,679
From 5.00% to 5.99%..................................................... 22,095,190
From 6.00% to 6.99%..................................................... 19,595,638
From 7.00% to 7.99%..................................................... 9,080,873
From 8.00% to 8.99%..................................................... 90,000
-----------
Total......................................................... $52,326,703
===========
</TABLE>
At December 31, 1995, Doral Federal has deposits from officers, directors,
employees and major stockholders of the Company amounting to approximately
$1,100,000 (1994 -- $1,400,000).
The Company as a servicer of loans is required to maintain certain balances
on behalf of the borrowers, called escrow funds. At December 31, 1995, escrow
funds amounted to approximately $35,377,000 (1994 -- $32,125,000), of which
$27,430,000 were deposited with Doral Federal (1994 -- $21,132,000). The
remaining escrow funds, $7,947,000 (1994 -- $10,993,000), were deposited with
other banks and therefore excluded from the Company's assets and liabilities.
F-25
<PAGE> 99
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 20 -- ADVANCES FROM THE FEDERAL HOME LOAN BANK
At December 31, 1995, advances from the Federal Home Loan Bank of New York
("FHLB") consist of the following:
<TABLE>
<S> <C>
7.76% due on August 21, 1996............................................ $ 407,111
6.307% due on July 21, 2000............................................. 5,000,000
6.445% due on July 17, 2002............................................. 5,000,000
-----------
Total......................................................... $10,407,111
===========
</TABLE>
At December 31, 1995, the Company had qualified collateral, in the form of
first mortgage notes and mortgage-backed securities with a carrying value of
$38,462,085 which were pledged to secure advances from the FHLB and stand-by
letters of credit issued by the FHLB as collateral for the term-notes.
NOTE 21 -- INCOME TAXES
Under the provisions of Law No. 38 of May 20, 1983, the Company is exempt
from the payment of Puerto Rico income taxes on the interest earned on mortgages
on residential properties located in Puerto Rico which were executed after June
30, 1983, and are insured or guaranteed pursuant to the provisions of the
National Housing Act of June 27, 1934, as amended, and pursuant to the
Provisions of the Servicemen's Readjustment Act of 1944, as amended. As a
result, net interest income has generally represented a greater proportion of
the Company's total net income than that of a typical non-Puerto Rican mortgage
banking institution. The Company holds exempt loans and mortgage-backed
securities for periods of time prior to sale in order to maximize the tax exempt
interest produced by these securities and loans.
Doral Federal, as a federally chartered financial institution operating in
Puerto Rico, is subject to U.S. Federal income taxes. Doral Federal has filed an
election under Section 936 of the U.S. Internal Revenue Code, whereby a
possession tax credit is allowed for part of the federal income taxes
attributable to income from operations in Puerto Rico. The mortgage banking
operation of the Company conducted through Puerto Rico corporations are not
subject to United States income tax for business carried out in Puerto Rico.
Substantially all of the Company's mortgage banking operations are conducted in
Puerto Rico, therefore, the amount of U.S. income taxes with respect to such
operations is not significant.
Consolidated tax returns are not permitted under the Puerto Rico Income Tax
Law, therefore, income tax returns are filed individually by each Company.
F-26
<PAGE> 100
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The provision for income taxes differs from amounts computed by applying
the applicable Puerto Rico statutory tax rate to income before taxes. A
reconciliation of the difference follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------
1995 1994 1993
------------------------- ------------------------- -------------------------
<S> <C> <C> <C> <C> <C> <C>
Income before income
taxes.................. $22,060,517 $20,840,112 $30,921,245
</TABLE>
<TABLE>
<CAPTION>
% OF PRETAX % OF PRETAX % OF PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Tax at statutory rates... $ 9,265,417 42.0 $ 8,752,847 42.0 $12,986,923 42.0
Tax effect of exempt
interest
income -- net.......... (4,590,485) (20.8) (5,435,541) (26.1) (2,717,262) (8.8)
Tax effect of capital
gains.................. (510,588) (2.5) (471,920) (1.5)
Tax effect of
amortization of
goodwill, other non-
deductible expenses and
other.................. (281,246) (1.3) 602,877 2.9 745,856 2.4
Tax effect of shares
issued under employment
contracts.............. (1,893,473) (8.6) (941,916) (3.1)
----------- ----------- ----------- ----------- ----------- -----------
Provision for income
taxes.................. $ 2,500,213 11.3 $ 3,409,595 16.3 $ 9,601,681 31.0
============ ========== ============ ========== ============ ==========
</TABLE>
At December 31, the components of the net deferred tax liability are:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Deferred tax liabilities resulting from:
Untaxed income............................................ $(6,460,876) $(3,700,899)
Deferred costs............................................ (1,986,637) (2,139,000)
----------- -----------
(8,447,513) (5,839,899)
----------- -----------
Deferred tax assets:
Unrealized losses......................................... 1,108,105 1,266,000
Deferred income........................................... 1,539,361 --
Net operating loss........................................ 922,979 797,000
----------- -----------
3,570,445 2,063,000
----------- -----------
Net deferred tax liability.................................. $(4,877,068) $(3,776,899)
========== ==========
</TABLE>
Deferred income tax expense for the year ended December 31, 1994 amounted
to $1,316,899 of which $436,899 is presented as current and $880,000 is shown as
part of the cumulative effect of change in accounting principle.
At December 31, 1995 Doral had net operating losses available to offset
future taxable Puerto Rico source income amounting to approximately $2,365,000
expiring in 2001.
NOTE 22 -- RELATED PARTY TRANSACTIONS
Mortgage loans held for sale include approximately $460,000 of loans to
various officers of the Company at prevailing interest rates (1994 -- $280,000).
F-27
<PAGE> 101
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company paid a computer service bureau, in which it holds a 33%
interest, $860,000, $726,000 and $617,000 for services rendered during the years
ended December 31, 1995, 1994 and 1993, respectively. At December 31, 1995 and
1994, the Company's equity in this service bureau was not significant.
The Company has a 15% interest in a real estate partnership amounting to
approximately $135,000 and which is carried at cost because of its lack of
materiality. At December 31, 1995 and 1994, mortgage-backed securities and
investments held to maturity include approximately $890,000 and $450,000,
respectively due from the Partnership. In addition, at December 31, 1995 and
1994, accounts receivable includes approximately $480,000 and $510,000,
respectively, due from the Partnership.
NOTE 23 -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers
and to reduce its own exposure to fluctuations in interest rates. These
financial instruments include commitments to extend credit and sell
mortgage-backed securities and loans, and options on futures contracts. Those
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the statement of financial position.
The contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments. The
Company's exposure to credit losses in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. The Company
uses the same credit policies in making commitments as it does for on-balance
sheet instruments. At December 31, 1995, commitments to extend credit to
individuals for residential mortgages amounted to approximately $14 million and
commitments to sell mortgage-backed securities and loans amounted to
approximately $44 million. Management believes that the Company has the ability
to meet these commitments and that no loss will result from the same.
Commitments to extend credit are agreements to lend to a customer as long as the
conditions established in the contract are met. Commitments generally have fixed
expiration dates or other termination clauses.
Since many of the commitments are expected to expire without being drawn
upon, the total commitment amounts do not necessarily represent future cash
requirements.
The Company evaluates each customer's credit worthiness on a case-by-case
basis. The amount of collateral, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation of the
counterparty. A geographic concentration exists within the Company's mortgage
loans portfolio since most of the Company's business activity is with customers
located in Puerto Rico.
The Company controls the credit risk of its future contracts through credit
approvals, limits and monitoring procedures. Options on future contracts confer
the right from sellers to buyer to take a future position at a stated price.
Risks arise from the possible inability of counterparts to meet the terms of
their contracts and from movements in securities values and interest rates.
Collateral for securities purchased under agreements to resell is kept by the
seller under custody agreements. Collateral for securities sold under agreements
to repurchase is kept by the purchaser.
NOTE 24 -- PENSION AND COMPENSATION PLANS
The Company has a noncontributory target benefit pension plan ("the Plan").
The Plan generally covers all full time Company employees that have completed
one year of service and have attained age 21.
Under the Plan, the Company contributes annually the funding amount which
is projected to be necessary to fund the target benefit. The target benefit is
based on years of service and the employees'
F-28
<PAGE> 102
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
compensation, as defined in the Plan. The Company has the right to terminate the
Plan at any time. Upon termination, all amounts credited to the participants'
accounts will become 100% vested.
Contributions to the Plan during the years ended December 31, 1995, 1994
and 1993 amounted to approximately $640,000, $700,000 and $503,000,
respectively. Plan assets consist principally of mortgage loans and
mortgage-backed securities.
The Company has unfunded deferred incentive compensation arrangements (the
"Deferred Compensation") with certain employees. The Deferred Compensation is
determined as a percentage of net income arising from the mortgage banking
activities, as defined, and is payable to participants after a five-year vesting
period. The expense for the years ended December 31, 1995 and 1993 amounted to
approximately $62,000 and $885,000, respectively. For the year ended December
31, 1994 there was no deferred compensation expense.
The Company also has incentive compensation arrangements with certain
employees payable currently. The incentive payments are based on the amount of
consolidated net income in excess of established return on stockholders' equity,
as defined in the agreements and mortgage loans closed (1993). The expense under
these arrangements for the years ended December 31, 1995, 1994 and 1993 amounted
to approximately $2,415,000, $2,721,000 and $7,866,000, respectively.
NOTE 25 -- COMMITMENTS AND CONTINGENCIES
The Company has several noncancellable operating leases for office
facilities expiring through 2005. Total minimum rental commitments for leases in
effect at December 31, 1995 are as follows:
<TABLE>
<CAPTION>
YEAR AMOUNT
----------------------------------------------------------------------- ----------
<S> <C>
1996................................................................... $1,756,000
1997................................................................... 1,187,000
1998................................................................... 647,000
1999................................................................... 239,000
2000................................................................... 156,000
2001 and thereafter.................................................... 394,000
</TABLE>
Total rental expense for the years ended December 31, 1995, 1994 and 1993
amounted to approximately $2,100,000, $2,000,000 and $1,445,000, respectively.
The Company is subject to legal proceedings and claims which have arisen in
the ordinary course of its business and have not been finally adjudicated. These
actions, when finally concluded and determined, will not, in the opinion of
management, have a material adverse effect upon the financial position or
results of operations of the Company.
From time to time the Company may sell mortgage-backed securities and
mortgage loans with put options. At December 31, 1995, the amount outstanding
under these arrangements amounted to approximately $25,000,000, expiring in July
1996. If the put option is exercised, the Company would have to buy back this
amount at the original sale price, adjusted for prepayments. As part of its
hedging program, the Company includes the risks associated with its put
arrangements.
The Company has a commitment to sell approximately $40,000,000 of 5.5% GNMA
mortgage-backed securities with a one-year put option.
Legislation has been proposed by the U.S. Congress that would, among other
matters, recapitalize the FDIC Savings Association Insurance Fund (the "SAIF").
The proposed legislation provides for a one-time assessment to be imposed on all
SAIF-insured deposits as of March 31, 1995, in order to recapitalize the SAIF
and eliminate the disparity of insurance premiums with the Bank Insurance Fund
(the "BIF"). Under such proposed legislation, the SAIF and the BIF would be
merged effective January 1, 1998. The special
F-29
<PAGE> 103
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
assessment rate is anticipated to be between .70% to .90% of deposits and would
be payable in early 1996. Based upon Doral Federal's deposits at March 31, 1995
and assuming a special assessment of .90%, Doral Federal's assessment would be
approximately $861,000 on a pre-tax basis.
As part of the ongoing federal budget negotiations, various proposals have
been made that provide for the repeal of Section 936 of the U.S. Internal
Revenue Code ("Section 936"). While the final impact of any such proposals
cannot be determined at this time, the repeal of Section 936 could have an
adverse effect on the general economic condition of Puerto Rico, the Company's
predominant service area. The repeal of Section 936 could also raise funding
costs, reduce demand for mortgage loans and mortgage-backed securities in Puerto
Rico and would likely increase the effective tax rate of Doral Federal. In
recent years, the Company has taken steps to attempt to reduce any adverse
impact from the repeal of Section 936 by diversifying its sources of funding and
identifying additional investors for its mortgage products.
NOTE 26 -- CAPITAL STOCKS AND PAID-IN CAPITAL
The Company has a Restricted Stock Plan (the "Restricted Stock Plan") and a
Stock Option Plan. The Restricted Stock Plan provides for the granting of up to
250,000 shares of common stock to selected officers at no cost. At December 31,
1995 and 1994, the number of shares awarded and issued under the Restricted
Stock Plan was 177,806 shares, including 88,903 shares issued on December 10,
1993 as result of the stock split. The terms of the Restricted Stock Plan permit
the imposition of restrictions ranging from one to five years on the sale or
disposition of the shares issued. The Stock Option Plan provides for selected
officers and key employees to purchase up to 300,000 shares of common stock at
prices equal to the fair market value on date of grant. No options have been
awarded.
The Company's 10.5% Cumulative Convertible Preferred Stock Series A, has a
liquidation preference of $10 per share plus accrued dividends and is
convertible at the option of the holder into two shares of common stock at a
conversion price of $5 per share. It is redeemable in whole or part at the
option of the Company on or after January 1, 1995 and on or prior to December
31, 1996 at $11 per share, and thereafter, at redemption prices declining to a
minimum of $10.30 per share on January 1, 2002. Dividends are cumulative from
the date of issue and are payable quarterly.
Present regulations limit the amount of dividends that Doral Federal may
pay. Payment of such dividends is prohibited if, among other things, the effect
of such payment would be to cause the capital of Doral Federal to fall below the
regulatory capital requirements.
The Company is prohibited under the Debenture Agreement mentioned in Note
18 from paying dividends on any capital stock (other than dividends payable in
capital stock or in stock rights), when an event of default under such agreement
exist or, if the amount of dividends payable by the Company together with the
aggregate amount of dividends paid and other capital distributions made since
June 1, 1995, exceed an amount defined in the Debenture Agreement. In addition,
the Company cannot pay dividends if it fails to maintain specified minimum
levels of net worth, net earnings to debt service and dividends ratios, and
certain other financial ratios, specified under the Debenture Agreement, the
Syndicated Credit Agreement mentioned in Note 15, and other financing
agreements.
NOTE 27 -- SUPPLEMENTAL INCOME STATEMENT INFORMATION
Employee costs and other expenses are shown in the Consolidated Statement
of Income and Retained Earnings net of direct loan origination costs. Pursuant
to SFAS-91 direct loan origination costs are capitalized as part of the carrying
cost of mortgage loans and are offset against mortgage loan sales and fees when
the
F-30
<PAGE> 104
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
loans are sold. Without the application of SFAS-91, employee costs and other
expenses would have been as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Employee costs.................................. $24,395,306 $28,537,321 $35,822,728
=========== =========== ===========
Other expenses.................................. $12,042,064 $12,802,432 $12,824,650
=========== =========== ===========
</TABLE>
Set forth below is a breakdown of direct loan origination costs that were
capitalized as part of the carrying cost of mortgage loans inventory or offset
against mortgage loan sales and fees.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Offset against mortgage loan sales and fees............. $16,398,038 $21,008,323 $29,220,886
Capitalized as part of loan inventory................... 5,093,940 5,093,940 2,609,537
-------- -------- --------
$21,491,978 $26,102,263 $31,830,423
======== ======== ========
</TABLE>
NOTE 28 -- DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and fair values of the
Company's financial instruments at December 31, 1995 and 1994. FASB Statement
No. 107, Disclosures about Fair Value of Financial Instruments, defines the fair
value of a financial instrument as the amount at which the instruments could be
exchanged in a current transaction between willing parties, other than in a
forced or liquidation sale. Significant differences can arise between the fair
value and carrying amount of financial instruments that are recognized at
historical cost amounts.
<TABLE>
<CAPTION>
1995 1994
--------------------- ---------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents........................... $ 59,872 $ 59,872 $ 35,916 $ 35,916
Mortgage loans held for sale........................ 245,484 245,500 263,773 264,652
Mortgage-backed securities held for trading......... 407,941 407,941 319,204 319,204
Securities held to maturity......................... 77,945 78,392 66,804 66,064
Securities available for sale....................... 14,579 14,579 -- --
Loans receivable.................................... 51,355 51,355 34,809 34,809
Accounts receivable and mortgage servicing
advances......................................... 9,592 9,592 7,086 7,086
Accrued interest receivable......................... 8,155 8,155 7,875 7,875
Excess servicing fees receivable.................... 10,407 10,407 8,757 8,757
-------- -------- -------- --------
$885,330 $ 885,793 $744,224 $ 744,363
======== ======== ======== ========
</TABLE>
F-31
<PAGE> 105
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
1995 1994
--------------------- ---------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Financial liabilities:
Loans payable....................................... $234,707 $ 234,707 $265,706 $ 265,706
Securities sold under agreements to repurchase...... 363,728 363,728 303,730 303,730
Deposit accounts.................................... 95,740 95,740 66,471 66,471
Notes payable....................................... 51,682 51,682 17,055 17,055
Advances from FHLB.................................. 10,407 10,407 419 419
Payables and accrued liabilities.................... 17,376 17,376 17,793 17,793
Convertible Subordinated Debentures................. 10,000 10,000 -- --
Income tax payable.................................. 5,265 5,265 6,349 6,349
-------- -------- -------- --------
$788,905 $ 788,905 $677,523 $ 677,523
======== ======== ======== ========
</TABLE>
The following notes summarize the major methods and assumptions used in
estimating the fair values of financial instruments:
Cash and cash equivalents: valued at the carrying amounts in the
consolidated balance sheet. The carrying amounts are reasonable estimates
of fair value due to the short period to maturity. This approach applies to
cash and cash equivalents, accounts receivable and mortgage servicing
advances, accrued interest receivables and the majority of short-term
financial liabilities.
Excess servicing fees receivable: valued based on the present value
of the estimated remaining future excess servicing fee revenue.
Derivatives: fair value is estimated as the amounts that the Company
would receive or pay to terminate the contracts at the reporting date,
taking into account the current unrealized gains or losses of open
contracts. Market or dealer quotes are available for many derivatives;
otherwise, pricing or valuation models are applied to current market
information to estimate fair value.
Mortgage loans held for sale, mortgage-backed securities held for
trading, securities held to maturity and securities
available-for-sale: valued at quoted market prices if available. For
securities without quoted prices, fair values represent quoted market
prices for comparable instruments. In a few other cases, fair values have
been estimated based on assumptions concerning the amount and timing of
estimated future cash flows and assumed discount rates reflecting varying
degrees of risk.
Loans receivable: valued on the basis of estimated future principal
and interest cash flows, discounted at various rates. Loan prepayments are
assumed to occur at rates experienced in previous periods when interest
rates were at levels similar to current levels, adjusted for any
differences in interest rate outlook. Future cash flows for homogeneous
categories of loans, such as residential mortgage loans, are estimated on a
portfolio basis and discounted at current rates offered for similar loan
terms to new borrowers with similar credit profiles. Quoted market prices
for securities backed by similar loans, adjusted for different loan
characteristics, are also used in estimating fair value.
Deposit accounts: for demand deposits and deposits with no defined
maturities, fair value is taken to be the amount payable on demand at the
reporting date. The fair values of fixed-maturity deposits, including
certificates of deposit, is estimated using rates currently offered for
deposits of similar remaining maturities. The value of long-term
relationships with depositors is not taken into account in estimating the
fair values disclosed.
F-32
<PAGE> 106
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Loans payable and securities sold under agreements to repurchase: The
carrying amounts are reasonable estimates of fair values due to short
period to maturity.
Notes payable, advances from FHLB and convertible subordinated
debentures: The carrying amounts are reasonable estimates of fair values
due to recent issuance date.
NOTE 29 -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Financial data showing results of the 1995 and 1994 quarters is presented
below. These results are unaudited. In the opinion of management all adjustments
necessary for a fair presentation have been included:
<TABLE>
<CAPTION>
QUARTERS
-------------------------------------------
1ST 2ND 3RD 4TH
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
1995
Revenue................................... $20,710 $23,277 $23,365 $24,487
Net income................................ 3,430 6,137 4,928 5,065
Net income per share:
Primary................................ .47 .84 .68 .66
Fully diluted.......................... .45 .81 .65 .62
1994
Revenue................................... $15,074 $18,967 $17,864 $20,138
Income before cumulative effect of
change in accounting principle....... 3,307 4,785 3,882 4,242
Cumulative effect of change in
accounting principle -- adoption of
SFAS 115, net of deferred taxes of
$880................................. 1,215 -- -- --
------- ------- ------- -------
Net income $ 4,522 $ 4,785 $ 3,882 $ 4,242
======= ======= ======= =======
Net income per share:
Primary:
Income before cumulative effect of
change in accounting principle....... $ .47 $ .68 $ .54 $ .59
Cumulative effect of change in
accounting principle................. .18 -- -- --
------- ------- ------- -------
$ .65 $ .68 $ .54 $ .59
======= ======= ======= =======
Fully diluted:
Income before cumulative effect of
change in accounting principle....... $ .44 $ .63 $ .51 $ .56
Cumulative effect of change in
accounting principle................. .16 -- -- --
------- ------- ------- -------
$ .60 $ .63 $ .51 $ .56
======= ======= ======= =======
</TABLE>
F-33
<PAGE> 107
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 30 -- RISK MANAGEMENT ACTIVITIES
The Company's principal objective in holding derivatives and certain other
financial instruments is the management of interest rate risk arising out of its
portfolio holdings and related borrowings. Risk management activities are aimed
at optimizing realization on sales of mortgage loans and/or mortgage-backed
securities and net interest income, given levels of interest rate risk
consistent with the Company's business strategies.
Asset/liability risk management activities are conducted in the context of
Company's sensitivity to interest rate changes. This sensitivity arises due to
changes in the value of mortgage loans held for sale and mortgage-backed
securities held for trading from the time such assets are originated to the time
these are sold. In addition interest-bearing liabilities reprice more frequently
than interest-earning assets and, therefore, the Company is affected by the
interrelationships between long-term and short-term interest rates.
To achieve its risk management objective, the Company uses a combination of
derivative financial instruments, particularly, futures and options, as well as
other types of contracts such as forward sales commitments.
As part of the interest rate risk management at December 31, 1995, the
Company, as a purchaser, had unexpired options where it had the right to sell
bonds and GNMA contracts for a notional amount of $450,000,000. It also has
rights to buy bonds and GNMA contracts for a notional amount of $160,000,000. As
a writer or seller of options, the Company had unexpired options where it had
the obligations to sell bonds and GNMA contracts for a notional amount of
$250,000,000, and obligations to buy bonds and GNMA contracts for a notional
amount of $190,000,000. In addition, at December 31, 1995 the Company had
approximately $44 million of forward commitments to sell mortgage-backed
securities and loans.
Generally the options have expired without being exercised. During the
years ended December 31, 1995, 1994 and 1993 net gains (net losses) from these
transactions, designated as hedges, amounted to approximately ($5,400,000),
$2,172,000, and ($1,367,000), respectively. These amounts are presented as part
of mortgage loan sales and fees. At December 31, 1995, mortgage loans held for
sale includes capitalized costs of unexpired options of approximately
$2,300,000. At December 31, 1995, unrealized net losses on open positions
related to unexpired options, including capitalized costs, amounted to
approximately $2,700,000.
The credit risk of futures contracts is limited, due to daily cash
settlement of the net change in value of open contracts with the exchange in
which the instrument is traded. Forwards have a greater degree of credit risk,
depending on the types of counterparts involved, as daily cash settlements are
not required. Options are contracts that grant the purchaser, for a premium
payment, the right to either purchase from or sell to the writer of the option a
financial instrument at a specified price within a specified period of time or
on a specified date.
The risk that counterparts to both derivative and cash instruments might
default on their obligations is monitored on an ongoing basis. To manage the
level of credit risk the Company deals with counterparts of good credit
standing, enters into master netting agreements whenever possible and, when
appropriate, obtains collateral. Master netting agreements incorporate rights of
set off that provide for the net settlement of subject contracts with the same
counterpart in the event of default.
All derivative financial instruments are subject to market risk, the risk
that future changes in market conditions may make an instrument less valuable or
more onerous. For example, fluctuations in market prices and interest rates
change the market value of the instruments. If the instruments are recognized at
market value, these changes directly affect reported income. Exposure to market
risk is managed in accordance with risk limits set by senior management by
buying or selling instruments or entering into offsetting positions.
The Company enters into rate swap agreements in managing its interest rate
exposure. Interest rate swap agreements generally involve the exchange of fixed
and floating rate interest payment obligations without the exchange of the
underlying principal.
F-34
<PAGE> 108
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1995, the Company had outstanding an interest rate swap
agreement with an investment banker to change the Company's interest rate
exposure. The agreement is for a notional principal amount of $5,000,000
covering the Company's interest rate exposure of a $5,000,000 floating rate
term-note. This agreement ends at the time the related obligation matures. The
interest rate to be received is 87% of the three-months LIBOR rate minus .125%
(4.95% at December 31, 1995) and the interest rate to be paid is 4.92%.
Non-performance by the counterparty will expose the Company to an interest rate
risk.
F-35
<PAGE> 109
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS OF DOLLARS EXCEPT FOR SHARE INFORMATION)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1996 1995
------------ ------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS
Cash and cash equivalents........................................... $ 49,341 $ 59,872
Mortgage loans held for sale, net................................... 263,818 245,484
Mortgage-backed securities held for trading......................... 389,136 407,941
Securities held to maturity......................................... 112,637 77,945
Securities available for sale....................................... 7,438 14,579
Loans receivable, net............................................... 86,686 51,355
Accounts receivable and mortgage servicing advances, net............ 12,626 9,592
Accrued interest receivable......................................... 9,245 8,155
Mortgage servicing rights........................................... 16,515 11,164
Excess servicing fees receivable.................................... 17,462 10,407
Property, leasehold improvements and equipment, net................. 6,548 6,505
Cost in excess of fair value of net assets acquired................. 6,552 6,526
Real estate held for sale, net...................................... 2,251 2,085
Prepaid and other assets............................................ 8,909 6,312
-------- --------
Total Assets.............................................. $989,164 $917,922
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Loans payable....................................................... $199,158 $234,707
Securities sold under agreements to repurchase...................... 389,965 363,728
Deposit accounts.................................................... 136,512 95,740
Notes payable....................................................... 71,723 51,682
Advances from Federal Home Loan Bank of N.Y......................... 15,401 10,407
Convertible Subordinated Debentures................................. 10,000 10,000
Accounts payable and other liabilities.............................. 21,019 17,376
Income tax payable.................................................. 183 388
Deferred tax liability.............................................. 5,497 4,877
-------- --------
Total liabilities......................................... 849,458 788,905
======== ========
Commitments and contingencies
-------- --------
Stockholders' equity:
10.5% Cumulative Convertible Preferred Stock, Series A, $1.00 par
value, 2,000,000 shares authorized; no shares outstanding
(1995 -- 108,397).............................................. -- 108
Common stock, $1.00 par value, 20,000,000 shares authorized;
9,125,092 shares issued and outstanding (1995 -- 8,884,170).... 9,125 8,884
Paid-in capital................................................... 38,673 38,331
Retained earnings................................................. 92,368 81,892
-------- --------
140,166 129,215
Unrealized (loss) gain on securities available for sale........... (301) 9
Treasury stock at par value, 14,000 shares........................ (14) (14)
Unearned compensation under employment contracts.................. (145) (193)
-------- --------
Total stockholders' equity................................ 139,706 129,017
-------- --------
Total liabilities and stockholders equity................. $989,164 $917,922
======== ========
</TABLE>
The accompanying notes are an integral part of this statement.
F-36
<PAGE> 110
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED STATEMENT OF INCOME AND RETAINED EARNINGS
(IN THOUSANDS OF DOLLARS, EXCEPT FOR PER SHARE DATA)
UNAUDITED
<TABLE>
<CAPTION>
SIX-MONTH
QUARTER ENDED PERIOD ENDED
----------------- -----------------
JUNE JUNE JUNE JUNE
30, 30, 30, 30,
1996 1995 1996 1995
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues:
Mortgage loans sales and fees........................... 6,539 $ 1,210 $13,422 $ 3,705
Servicing income........................................ 2,946 2,752 5,697 5,441
Interest income......................................... 16,353 15,544 32,600 30,918
Gain on sale of servicing rights........................ -- 3,623 -- 3,623
Rental and other income................................. 146 148 300 299
------- ------- ------- -------
25,984 23,277 52,019 43,986
------- ------- ------- -------
Expenses:
Interest................................................ 10,826 10,404 21,818 20,184
Employee cost, net (See Note g)......................... 1,946 1,300 4,533 3,872
Taxes, other than payroll and income taxes.............. 236 287 483 523
Maintenance............................................. 163 162 290 298
Advertising............................................. 800 539 1,624 994
Professional services................................... 706 679 1,387 1,377
Telephone............................................... 448 444 920 855
Rent.................................................... 515 517 1,047 1,019
Other, net (See Note g)................................. 3,219 1,799 5,242 3,761
------- ------- ------- -------
18,859 16,131 37,344 32,883
------- ------- ------- -------
Income before income taxes................................ 7,125 7,146 14,675 11,103
Income taxes:
Current................................................. 231 59 668 59
Deferred................................................ (140) 950 620 1,477
------- ------- ------- -------
91 1,009 1,288 1,536
------- ------- ------- -------
Net Income................................................ 7,034 6,137 13,387 9,567
Retained earnings at beginning of period.................. 86,885 69,153 81,892 66,706
Less cash dividends paid:
Convertible preferred stock.......................... -- 48 14 97
Common stock......................................... 1,551 1,083 2,897 2,017
------- ------- ------- -------
Retained earnings at the end of period.................... $92,368 $74,159 $92,368 $74,159
======= ======= ======= =======
Net Income per share:
Primary................................................. $ 0.77 $ 0.84 $ 1.49 $ 1.32
Fully Diluted........................................... $ 0.74 $ 0.81 $ 1.41 $ 1.26
</TABLE>
The accompanying notes are an integral part of this statement.
F-37
<PAGE> 111
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
SIX-MONTH PERIOD ENDED
JUNE 30,
------------------------
1996 1995
--------- ---------
(UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................................ $ 13,387 $ 9,567
--------- ---------
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of excess servicing fee receivable....................................... 629 441
Amortization of cost in excess of fair value of net assets acquired................... 188 188
Amortization of mortgage servicing rights............................................. 467 274
Depreciation and amortization......................................................... 862 774
Gain on sale of servicing rights...................................................... -- (3,623)
Allowances for losses................................................................. 366 166
Origination and purchases of mortgage loans held for sale............................. (382,391) (268,769)
Principal repayment and sales of loans held for sale.................................. 219,267 164,190
Purchases of mortgage-backed securities held for trading.............................. (56,887) (64,262)
Principal repayments and sales of mortgage-backed securities held for trading......... 220,483 165,818
Increase in interest receivable....................................................... (1,090) (533)
Decrease in loans payable............................................................. (35,548) (73,805)
Increase in loans payable related to securities sold not yet purchased................ -- 19,835
Increase in interest payable.......................................................... 2,048 293
Increase in securities sold under agreements to repurchase............................ 26,237 75,162
Increase (decrease) in payables and accrued liabilities............................... 1,595 (1,739)
Decrease in income tax payable........................................................ (205) (2,572)
Deferred tax provision................................................................ 620 1,477
Amortization of unearned compensation under employment contracts...................... 48 32
--------- ---------
Total adjustments................................................................. (3,311) 13,347
--------- ---------
Net cash provided by operating activities......................................... 10,076 22,914
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage-backed securities and investments held to maturity................ (40,154) (10,841)
Principal repayments of investments held to maturity.................................... 5,462 5,584
Origination of loans receivable......................................................... (41,169) (20,166)
Principal repayments of loans receivable................................................ 5,838 2,392
Principal repayments and sales of securities available for sale......................... 6,831 --
Increase in accounts receivable and mortgage servicing advances......................... (3,401) (3,614)
Additions to excess servicing fee receivable............................................ (7,683) (1,194)
Purchase of property, leasehold improvements and equipment.............................. (906) (153)
Additions to cost in excess of fair value of net assets acquired........................ (214) (155)
Proceeds from disposal of real estate held for sale..................................... 572 1,159
Acquisition of real estate held for sale................................................ (739) (1,368)
Increase in mortgage servicing rights................................................... (5,817) (2,116)
Proceeds from sale of servicing rights.................................................. -- 3,708
Increase in other assets................................................................ (2,597) (2,963)
--------- ---------
Net cash used by investing activities............................................. (83,977) (29,727)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in notes payable............................................................... 20,041 14,900
Increase in deposits.................................................................... 40,771 22,229
Dividends declared and paid............................................................. (2,911) (2,114)
Increase (repayment) of advances from FHLB.............................................. 4,994 (6)
Proceeds from issuance of common stock.................................................. 475 --
--------- ---------
Net cash provided by financing activities......................................... 63,370 35,009
--------- ---------
Net (decrease) increase in cash and cash equivalents.................................... (10,531) 28,196
Cash and cash equivalents at beginning of period........................................ 59,872 35,916
--------- ---------
Cash and cash equivalents at end of period.............................................. $ 49,341 $ 64,112
========= =========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Noncash financing activities-conversion of preferred stock.............................. $ 216 $ 230
========= =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash used to pay interest............................................................... $ 19,770 $ 19,891
========= =========
Cash used to pay income taxes........................................................... $ 874 $ 3,965
========= =========
</TABLE>
The accompanying notes are an integral part of this statement.
F-38
<PAGE> 112
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
a. The Consolidated Financial Statements (unaudited) include the accounts
of First Financial Caribbean Corporation and its wholly-owned subsidiaries
("FFCC" or the "Company"), Doral Mortgage Corporation ("Doral"), RSC Corp.
("RSC"), Centro Hipotecario, Inc. and Doral Federal Savings Bank ("Doral
Federal"). All significant intercompany accounts and transactions have been
eliminated in consolidation. The Consolidated Financial Statements (unaudited)
have been prepared in conformity with the accounting policies stated in the
Company's Annual Audited Financial Statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1995, and should be read in
conjunction with the Notes to the Consolidated Financial Statements appearing in
that report. All adjustments (consisting only of normal recurring accruals)
which are, in the opinion of management, necessary for a fair presentation of
results for the interim periods have been reflected.
b. The results of operations for the quarter and six-month period ended
June 30, 1996 are not necessarily indicative of the results to be expected for
the full year.
c. Cash dividends per share paid for the quarter and six-month period ended
June 30, 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
SIX-MONTH
QUARTER ENDED PERIOD ENDED
JUNE 30, JUNE 30,
--------------- ----------------
1996 1995 1996 1995
----- ------- ------- ------
<S> <C> <C> <C> <C>
Series A Preferred Stock......................... $0.12 $0.2625 $0.3825 $0.525
Common Stock..................................... $0.17 $ 0.15 $ 0.32 $ 0.28
</TABLE>
All outstanding shares of Series A Preferred Stock were redeemed on May 10,
1996.
d. At June 30, 1996, escrow funds include approximately $28.1 million
deposited with Doral Federal Savings Bank ("Doral Federal"). These funds are
included in the Company's financial statements. Escrow funds also include
approximately $7.9 million deposited with other banks which are excluded from
the Company's assets and liabilities.
e. Certain reclassifications of prior years' data have been made to conform
to 1996 classifications.
f. The number of average shares of common stock used for computing the
primary and fully diluted net income per share was as follows:
<TABLE>
<CAPTION>
SIX-MONTH
QUARTER ENDED PERIOD ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
1996 1995 1996 1995
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Primary................................. 9,092,942 7,211,514 9,020,462 7,198,324
Fully diluted........................... 9,683,394 7,576,964 9,679,136 7,576,964
</TABLE>
g. Employee costs and other expenses are shown in the Consolidated
Statement of Income and Retained Earnings net of direct loan origination costs
that, pursuant to SFAS No. 91, are capitalized as part of the carrying cost of
mortgage loans and are offset against mortgage loan sales and fees when the
loans are sold. Employee costs would have been $7.5 million and $6.5 million,
respectively, for the quarters ended June 30, 1996 and 1995, and $15.1 million
and $12.2 million, respectively, for the six-month periods ended June 30, 1996
and 1995, except for the application of SFAS No. 91. Other expenses would have
been $3.9 million and $2.8 million, respectively, for the quarters ended June
30, 1996 and 1995, and $7.4 million and $5.5 million, respectively, for the
six-month periods ended June 30, 1996 and 1995, except for the application of
SFAS No. 91.
F-39
<PAGE> 113
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Set forth below is a breakdown of direct loan origination costs that were
deferred pursuant to SFAS No. 91.
<TABLE>
<CAPTION>
SIX-MONTH
QUARTER ENDED PERIOD ENDED
JUNE 30, JUNE 30,
--------------- -----------------
1996 1995 1996 1995
------ ------ ------- -------
<S> <C> <C> <C> <C>
Employee Costs.............................................. $5,516 $5,226 $10,536 $ 8,354
Other Costs................................................. 715 975 2,150 1,806
------ ------ ------- -------
$6,231 $6,201 $12,686 $10,160
====== ====== ======= =======
</TABLE>
h. On May 12, 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage
Servicing Rights" ("SFAS No. 122"), an amendment to SFAS No. 65. The Company
elected to adopt this standard for its financial statement reporting in the
second quarter of 1995. SFAS No. 122 prohibits retroactive application.
Accordingly, the Company's financial statement reporting for the first quarter
of 1995 was accounted for under the original SFAS No. 65 and the results for the
six-month period ended June 30, 1996 are not directly comparable to the results
for the six-month period ended June 30, 1995 with respect to this specific
matter.
For the quarter and six-month period ended June 30, 1996, the Company
realized additional net income of approximately $1.8 million and $2.8 million,
respectively (representing $2.9 million and $4.6 million of gross revenues,
respectively) from the adoption of SFAS No. 122, compared to additional net
income of $320,000 ($550,000 of gross revenues, respectively) for the quarter
and six-month period ended June 30, 1995. If the Company had not adopted SFAS
No. 122 in the second quarter of 1995, the Company would have reported a net
income of approximately $5.2 million for the second quarter of 1996 ($0.58 and
$0.55 per common share on a primary and fully-diluted basis, respectively) and
$10.5 million for the six-month period ended June 30, 1996 ($1.16 and $1.11 per
common share on a primary and fully-diluted basis, respectively).
SFAS No. 122 requires that part of the cost of originating a mortgage loan
be allocated to the mortgage servicing right based on its fair value relative to
the aggregate fair value of the loan and the related servicing right taken as a
whole. To determine the fair value of the servicing rights pursuant to SFAS No.
122, the Company used the market prices under comparable servicing sale
contracts.
SFAS No. 122 also requires that all capitalized mortgage servicing rights
be evaluated for impairment based on the excess of the carrying amount of
mortgage servicing rights over their fair value. For purposes of measuring
impairment, capitalized mortgage servicing rights are stratified pool by pool on
the basis of interest rates. An impairment is recognized whenever the prepayment
pattern of the mortgage pool shows that the fair value of the related
capitalized servicing rights is less than its carrying amounts. An impairment is
recognized by charging such excess to income. The Company determined that no
reserve for impairment was required for the six-month period ended June 30,
1996.
F-40
<PAGE> 114
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- ------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON IS AUTHORIZED TO GIVE ANY INFORMATION
OR TO MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED OR INCORPORATED BY
REFERENCE IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY
OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY IN ANY
JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR IN WHICH
THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO
ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER
THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
---------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Incorporation Of Certain Documents By
Reference........................... 2
Available Information................. 2
Prospectus Summary.................... 3
Risk Factors.......................... 6
Use Of Proceeds....................... 10
Capitalization........................ 11
Selected Financial Data............... 12
Management's Discussion And Analysis
Of Financial Condition And Results
Of Operations....................... 14
Business Of The Company............... 24
Management............................ 53
The Commonwealth Of Puerto Rico....... 55
Description Of Notes.................. 57
Certain U.S. Federal Income Tax
Considerations...................... 70
Certain Puerto Rico Income Tax
Consequences........................ 72
Underwriting.......................... 73
Legal Matters......................... 73
Experts............................... 73
Index To Financial Statements......... F-1
</TABLE>
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- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
$75,000,000
FIRST FINANCIAL
CARIBBEAN CORPORATION
(LOGO) FFCC
7.84% SENIOR NOTES
DUE 2006
------------------------
PROSPECTUS
------------------------
BT SECURITIES CORPORATION
October 7, 1996
- ------------------------------------------------------
- ------------------------------------------------------
