SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number 33-76930
TELEBANC FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 13-3759196
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1111 NORTH HIGHLAND STREET, ARLINGTON, VIRGINIA 22201
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (703) 247-3700.
Securities registered pursuant to Section 12(b) of the Act:
(Not applicable)
Securities registered pursuant to Section 12(g) of the Act:
(Not applicable)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (ss. 229.405 of this chapte\\r) is not contained
herein, and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. [ X ]
Based upon the closing price of the registrant's common stock as of
March 19, 1998, the aggregate market value of the voting stock held by
non-affiliates of the registrant is $45.1 million.*
The number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date is:
Class: Common Stock, par value $.01 per share.
Outstanding at March 19, 1998: 2,242,494 shares.
DOCUMENTS INCORPORATED BY REFERENCE:
PART III:
Portions of the definitive proxy statement for the 1998 Annual Meeting
of Shareholders, if filed before April 30, 1998.
- ----------------
* Solely for purposes of this calculation, all executive officers and
directors of the registrant, Employee Stock Ownership Plan and all
shareholders reporting beneficial ownership of more than 5% of the
registrant's common stock are considered to be affiliates. This reference
to affiliate status is not necessarily a conclusive determination for other
purposes.
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
TeleBanc Financial Corporation (the "Company" or "TeleBanc"), with
headquarters in Arlington, Virginia, had total assets of $1.1 billion at the end
of 1997. TeleBanc was organized by its majority stockholder, MET Holdings
Corporation ("MET Holdings"), to become, in March 1994, the parent savings and
loan holding company for TeleBank ("the Bank"), a federally chartered savings
bank. In February 1997, TeleBanc acquired TeleBanc Capital Markets, Inc.
("TCM"), a registered investment advisor, funds manager, and broker-dealer
specializing in mortgages and mortgage-related securities. In June 1997, the
Company formed TeleBanc Capital Trust I ("TCT"), which in turn sold shares of
trust preferred securities, Series A, for a total of $10.0 million in a private
placement. All references to the Company include the business of the Bank, TCM,
and TCT. Financial and other data as of and for all periods prior to March 1994
represent the consolidated data of the Bank only. Prior to March 1996, the Bank
was formerly known as Metropolitan Bank for Savings, F.S.B.
The Company's revenues are derived principally from interest income on
loans, mortgage-backed and related securities, and interest and dividends on
investment securities and interest-bearing deposits. The Company's principal
expenses are interest expense on deposits and borrowings and operating expenses,
such as compensation and employee benefits. The Company's net income also may be
offset by gains or losses on hedging transactions and other trading account
gains or losses as part of the Company's asset/liability management strategies.
Funds for these activities are provided by deposits, borrowings, principal
repayments on outstanding loans and mortgage-backed and related securities, and
sales of investment securities held for trading.
The Bank, through its wholly owned subsidiary TeleBanc Servicing
Corporation ("TSC"), funded 50% of the capital commitment for two new entities,
AGT Mortgage Services, LLC ("AGT") and AGT PRA, LLC ("AGT PRA"). AGT services
performing loans and administers workouts for troubled or defaulted loans for a
fee. Management ceased operation of AGT on July 31, 1997. The primary business
of AGT PRA is its investment in Portfolio Recovery Associates, LLC ("PRA"). PRA
acquires and collects delinquent consumer debt obligations for its own
portfolio.
Since 1994, TeleBanc has raised approximately $61.8 million through the
sale of capital stock and warrants and the issuance of subordinated notes and
trust preferred securities. In the second quarter of 1994, TeleBanc completed
its initial public offering, raising $4.6 million through the sale of common
stock and an additional $17.3 million through the issuance of subordinated notes
with warrants. Upon the completion of this offering, the Company invested $15
million of the proceeds as capital of the Bank. In February 1997, the Company
consummated the sale of $29.9 million of units to investment partnerships
managed by Conning & Company, CIBC WG Argosy Merchant Fund 2, LLC, General
American Life Insurance Company, the Progressive Corporation, and The
Northwestern Mutual Life Insurance Company and the purchase of the assets of
Arbor Capital Partners, Inc., which was majority owned by MET Holdings, through
the issuance of 162,461 shares of TeleBanc common stock and a $500,000 cash
payment. The units consist of convertible preferred stock and senior
subordinated notes with warrants. In June 1997, the Company formed TCT, which in
turn sold shares of trust preferred securities, Series A, for a total of $10.0
million in a private placement.
1
<PAGE>
MARKET AREA AND COMPETITION
From its office in Arlington, Virginia, the Company has a customer base
in all 50 states and the District of Columbia. As a result of the Company's
direct marketing strategy for deposits and reliance upon the secondary market to
purchase mortgage loans and mortgage-backed and related securities, the Company
competes on a nationwide basis for deposits and investments in residential
mortgage products. Generally, the Company faces substantial competition for
deposits from thrifts, commercial banks, credit unions, and other institutions
providing retail investment opportunities. The ability of the Company to attract
and retain deposits depends on its ability to provide an investment opportunity
meeting the requirements of investors as to rate of return, liquidity, risk, and
other factors, as well as on the perception of depositors as to the convenience
and quality of its services. Competition in residential mortgage investing comes
primarily from commercial banks, thrift institutions, and purchasers of mortgage
products in the secondary market. The Company competes for residential mortgage
investments principally on the basis of bid price and for loans on the basis of
interest rate, fees it charges, and loan types offered.
LENDING ACTIVITIES
GENERAL. The Company's lending activities consist primarily of the
purchases of whole loans and mortgage-backed and related securities rather than
the production and origination of loans, which entails greater overhead
expenses, commonly found in a traditional thrift or community bank.
LOAN PORTFOLIO COMPOSITION. The Company's net loans receivable totaled
$540.7 million at December 31, 1997, or 49.1%, of total assets at that date. At
December 31, 1997, $547.7 million, or 98.8%, of the total gross loan portfolio,
consisted of one-to-four family residential mortgage loans. Prior to 1990, the
Company originated a limited number of loans for the purchase or construction of
multifamily and commercial real estate. As part of the Company's general
operating strategy and in response to risks associated with multifamily and
commercial real estate lending and prevailing economic conditions, the Company
has substantially reduced its purchases and originations of such loans. At
December 31, 1997, multifamily, commercial, and mixed use real estate loans
amounted to $5.3 million, or 1.0%, of the Company's total loan portfolio. The
loan portfolio also included home equity lines of credit and loans secured by
savings deposits in the amount of $869,000, or 0.2%, of the Company's total loan
portfolio at December 31, 1997.
2
<PAGE>
The following table sets forth information concerning the Company's
loan portfolio in dollar amounts and in percentages, by type of loan.
<TABLE>
<CAPTION>
AT DECEMBER 31,
------------------------------------
1997 % 1996 %
---- ---- ---- ---
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Real estate loans:
One- to four-family fixed-rate.................... $ 211,287 38.11% $142,211 38.59%
One- to four-family adjustable-rate............... 336,470 60.69 217,352 58.97
Multifamily....................................... 1,447 0.26 1,516 0.41
Commercial real estate............................ 3,033 0.55 4,017 1.09
Mixed use real estate............................. 856 0.15 1,180 0.32
Land.............................................. 463 0.08 781 0.21
--------- ------ -------- ------
Total real estate loans.......................... 553,556 99.84 367,057 99.59
--------- ------ -------- ------
Consumer and other loans:
Lease financing................................... -- -- -- --
Home equity lines of credit and
second mortgage loans............................. 564 0.10 1,208 0.33
Other (1)......................................... 305 0.06 305 0.03
---------------- -------- ------
Total consumer and other loans.................... 869 0.16 1,513 0.41
---------------- -------- ------
Total loans....................................... $ 554,425 100.00% $368,570 100.00%
========= ======= ======== ======
Deduct:
Non accrual/cost recovery......................... (155) (182)
Deferred loan fees................................ (34) (42)
Deferred discounts on loans....................... (9,938) (13,750)
Allowance for loan losses......................... (3,594) (2,957)
------------- ----------
Total................................................ (13,721) (16,749)
------------- ----------
Loans receivable, net................................ $ 540,704 $ 351,821
============= ==========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
AT DECEMBER 31,
-------------------------------------------------------
1995 % 1994 % 1993 %
---- --- ---- --- ---- --
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family fixed-rate.................... $ 105,750 39.91% $ 67,449 42.54% $ 44,450 43.06%
One- to four-family adjustable-rate............... 148,928 56.20 79,701 50.27 50,708 49.14
Multifamily....................................... 1,286 0.49 1,114 0.70 932 0.90
Commercial real estate............................ 4,553 1.72 4,385 2.77 5,912 5.73
Mixed use real estate............................. 1,792 0.68 1,953 1.23 -- --
Land.............................................. 384 0.14 387 0.24 16 0.02
--------- ------- --------- ------ --------- ------
Total real estate loans.......................... 262,693 99.14 154,989 97.75 102,018 98.85
--------- ------- --------- ------ --------- ------
Consumer and other loans:
Lease financing................................... -- -- -- -- 17 0.02
Home equity lines of credit and
second mortgage loans............................. 2,202 0.83 3,395 2.14 1,007 0.98
Other (1)......................................... 79 0.08 168 0.11 151 0.15
--------- ------- --------- ------ --------- ------
Total consumer and other loans.................... 2,281 0.86 3,563 2.25 1,175 1.15
--------- ------- --------- ------ --------- ------
Total loans....................................... $ 264,974 100.00% $ 158,552 100.00% $ 103,193 100.00%
========= ======= ========= ====== ========= ======
Deduct:
Non accrual/cost recovery......................... -- -- --
Deferred loan fees................................ (42) (50) (68)
Deferred discounts on loans....................... (14,129) (2,835) (1,431)
Allowance for loan losses......................... (2,311) (925) (835)
------- ------ ------
Total................................................ (16,482) (3,810) (2,334)
------- ------ ------
Loans receivable, net................................ $248,492 $154,742 $100,859
========= ========= ========
</TABLE>
- ------------
(1) Includes primarily loans secured by deposit accounts in the Bank, and to a
lesser extent, unsecured consumer credit.
3
<PAGE>
MATURITY OF LOAN PORTFOLIO. The following table sets forth certain
information at December 31, 1997 regarding the dollar amount of loans maturing
in the Company's portfolio, including scheduled repayments of principal, based
on contractual terms to maturity. Demand loans, loans having no stated schedule
of repayments and no stated maturity, and overdrafts are reported as due within
one year. The table below does not include any estimate of prepayments, which
may significantly shorten the average life of a loan and may cause the Company's
actual repayment experience to differ from that shown below.
<TABLE>
<CAPTION>
DUE IN ONE DUE IN ONE DUE AFTER
YEAR OR LESS TO FIVE YEARS FIVE YEARS TOTAL
------------ ------------- ---------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Real estate loans:
One- to four-family fixed-rate........... $ 1,402 $ 6,878 $ 203,007 $ 211,287
One- to four-family adjustable-rate...... 11 12,634 323,825 336,470
Multifamily.............................. -- 1,114 333 1,447
Mixed use................................ 110 300 446 856
Commercial real estate................... 453 252 2,328 3,033
Land..................................... -- -- 463 463
Consumer and other loans:
Home equity lines of credit and
second mortgage loans.................. -- 544 20 564
Other.................................... -- -- 305 305
--------- --------- --------- ------------
Total.................................. $ 1,976 $ 21,722 $530,727 $ 554,425
========= ========= ======== ============
</TABLE>
The following table sets forth as of December 31, 1997 the dollar
amount of the loans maturing subsequent to December 31, 1998 allocated between
those with fixed interest rates and those with adjustable interest rates.
<TABLE>
<CAPTION>
FIXED RATES ADJUSTABLE RATES TOTAL
----------- ---------------- -----
(IN THOUSANDS)
<S> <C> <C> <C>
Real estate loans:
One- to four-family........................................ $209,885 $336,459 $ 546,344
Multifamily................................................ 1,270 177 1,447
Mixed use.................................................. 746 -- 746
Commercial real estate..................................... 537 2,043 2,580
Land....................................................... 463 -- 463
Consumer and other loans:
Home equity lines of credit and second
mortgage loans........................................... 21 543 564
Other...................................................... 81 224 305
---------- ---------- -----------
Total.................................................... $ 213,003 $ 339,446 $ 552,449
=========== =========== ===========
</TABLE>
Scheduled contractual principal repayments of loans may not reflect the
actual life of such assets. The average life of loans may be substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Company the right to declare a conventional
loan immediately due and payable in the event, among other things, that the
borrower sells the property. The average life of mortgage loans tends to
increase, however, when current mortgage loan market rates are substantially
higher than rates on existing mortgage loans and, conversely, decreases when
rates on existing mortgage loans are substantially higher than current mortgage
loan market rates.
ORIGINATION, PURCHASE, AND SALE OF LOANS. Consistent with the Company's
strategy of minimizing operating expenses, the Company emphasizes the purchase
of loans rather than direct
4
<PAGE>
originations. The Company purchased $342.9 million, $183.1 million, $145.9
million, $85.4 million, and $33.4 million of loans during the years ended
December 31, 1997, 1996, 1995, 1994, and 1993, respectively. The Company's
mortgage loan originations totaled $0, $462,000, $2.7 million, $4.3 million, and
$1.8 million in the years ended December 31, 1997, 1996, 1995, 1994, and 1993,
respectively.
Approximately 54.4% of the Company's loan portfolio is
serviced by other lenders for which the Company pays a fee ranging from a
minimum of 25 basis points of the principal balance of the loan per annum to a
maximum of $12 per month per loan. The institutions servicing loans for the
Company, among other things, collect and remit loan payments, maintain escrow
accounts, inspect properties, and administer foreclosures when necessary.
The Company sells whole loans to institutional investors and,
accordingly, is a Fanie Mae seller/servicer and a Federal Home Loan Mortgage
Corporation ("FHLMC") servicer. The majority of loans sold have consisted of
long-term, fixed-rate mortgage loans sold to Fannie Mae.
The Company generally sells such loans with servicing retained.
The following table shows loan origination, purchase, sale, and
repayment activity of the Company during the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Total loans receivable at beginning of period........... $ 351,821 $ 248,492 $ 154,742
Loans purchased:
Real estate loans:
One- to four-family variable rate.................... 256,545 128,171 98,065
One- to four-family fixed rate....................... 86,331 53,915 47,845
Multi-Family ........................................ -- 1,000 --
Mixed-used........................................... -- -- --
Commercial real estate............................... -- -- --
Consumer and other loans............................. -- -- --
----------- ----------- ---------
Total loans purchased.............................. 342,876 183,086 145,910
Loans originated:
Real estate loans:
One- to four-family variable rate.................... -- -- --
One- to four-family fixed rate....................... -- 25 80
Commercial real estate............................... -- -- --
Land ................................................ -- 400 --
Home equity lines of credit and second mortgage loans... -- 37 2,644
----------- ----------- -----------
Total loans originated............................. -- 462 2,724
----------- ----------- -----------
Total loans purchased and originated............... 342,876 183,548 148,634
Loans sold.............................................. 39,656 18,829 6,192
Loans securitized....................................... 21,017 8,275 2,794
Loan repayments......................................... 95,127 50,221 32,755
----------- ----------- -----------
Total loans sold, securitized, and repaid............ 155,800 77,325 41,741
Net change - TBFC ESOP Note Receivable ................. -- (65) --
Net change in deferred discounts and loan fees.......... 3,820 (379) (11,286)
Net transfers to REO ................................... (1,454) (1,513) (471)
Net provision for loan losses........................... (637) (646) (1,386)
Cost Recovery/Contra Assets ............................ 27 (41) --
Other loan debits/HELOC advances ....................... 51 (250) --
------- -------- -------
Increase (decrease) in total loans receivable........... 188,883 103,329 93,750
------- -------- -------
Net loans receivable at end of period................... $ 540,704 $ 351,821 $ 248,492
======= ======== =======
</TABLE>
The Company's loan purchases during 1997 increased $159.8 million from
fiscal year 1996 as the Company continued to expand the Bank's operations.
During fiscal 1997 and 1996, the Company's loan purchases involved purchases of
whole loans in the secondary market, principally
5
<PAGE>
from private investors. The Company's loan purchases during fiscal year 1997
included purchases of 92 pools with approximately 2,900 loans. The Company's
loan purchases during fiscal year 1996 included purchases of 35 pools with
approximately 1,253 loans and minimal loan originations consistent with the
Company's operating strategy. The Company's loan purchases during fiscal year
1995 included purchases of 26 pools with approximately 1,200 loans and minimal
loan originations consistent with the Company's operating strategy.
ONE-TO-FOUR FAMILY RESIDENTIAL LENDING. No mortgage loans were
originated during 1997. In 1996, the Company originated $25,000 of loans secured
by one-to-four-family residential properties, excluding home equity lines of
credit, in accordance with Fannie Mae and FHLMC underwriting guidelines for
terms up to 30 years. It is the Company's policy to make one-to-four-family
mortgage loans with up to a 95% loan-to-value ratio, if private mortgage
insurance is obtained on the portion of the principal amount in excess of 80% of
the appraised value.
MULTIFAMILY AND COMMERCIAL REAL ESTATE LENDING. Since 1990, the Company
has not actively pursued multifamily and commercial real estate lending or loans
secured by undeveloped land and has substantially reduced originations of such
loans. As of December 31, 1997, multifamily, mixed use, commercial real estate,
and land loans amounted to $5.8 million, or 1.05%, of the Company's total loan
portfolio.
CONSUMER AND OTHER LENDING. The Company does not emphasize consumer or
other loans, but from time to time, originates such loans as an accommodation to
its customers or purchases such loans as part of larger loan packages. Such
lending primarily includes home equity lines of credit and loans secured by
savings deposits. However, the Company did not originate any consumer or other
loans during 1997. During 1996, the Company originated $37,000 in consumer loans
and $305,000 in other loans. At December 31, 1997, consumer and other loans
totaled $305,000, or 0.06%, of the Company's total loan portfolio. At December
31, 1997, total outstanding home equity lines of credit and second mortgage
loans amounted to $564,000, or 0.10%, of the Company's total loan portfolio.
CRA LENDING ACTIVITIES. The Bank participates in various community
development programs in an effort to meet its responsibilities under the CRA.
The Bank has now committed to invest up to $500,000 in an investment tax credit
fund that qualifies for CRA purposes.
In 1995, the federal financial regulatory agencies promulgated a final
rule revising the regulations that implement the CRA. The revised regulations
outline special evaluations for wholesale institutions. The Bank believes that
it meets the definition of a wholesale institution and that it serves the credit
needs of the entire nation.
6
<PAGE>
MORTGAGE-BACKED AND RELATED SECURITIES, AND SECONDARY MARKET ACTIVITIES
The Company maintains a significant portion of mortgage-backed
securities, primarily in the form of privately insured mortgage pass-through
securities, as well as Government National Mortgage Association ("GNMA"), Fannie
Mae, and FHLMC participation certificates, and securities issued by other
nonagency organizations. GNMA certificates are guaranteed as to principal and
interest by the full faith and credit of the United States, while Fannie Mae and
FHLMC certificates are each guaranteed by their respective agencies.
Mortgage-backed securities generally entitle the Company to receive a pro rata
portion of the cash flows from an identified pool of mortgages. The Company has
also invested in collateralized mortgage obligations ("CMOs") which are
securities issued by special purpose entities generally collateralized by pools
of mortgage-backed securities. The cash flows from such pools are segmented and
paid in accordance with a predetermined priority to various classes of
securities issued by the entity. The Company's CMOs are senior tranches
collateralized by federal agency securities or whole loans. In the fourth
quarter of 1995, the Company reclassified the existing held-to-maturity
mortgage-backed security portfolio to available-for-sale. The following table
sets forth the activity in the Company's mortgage-backed securities
held-to-maturity portfolio during the periods indicated.
In 1997, the Company acquired certain trading securities. Trading
securities are bought and held principally for the purpose of selling them in
the near term. Securities purchased for trading are carried at market value with
the corresponding unrealized gains and losses being recognized by credits and
charges to income. The Company had $21.1 million classified as trading
securities at December 31, 1997. No securities were classified as trading
securities at and prior to December 31, 1996. For the period ending December 31,
1997, the Company recognized approximately $564,000 in realized gains from the
sale of trading assets and approximately $640,000 in unrealized appreciation of
trading assets.
7
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
1997 1996 1995
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Mortgage-backed and related securities at beginning
of period (not including available for sale and trading)... $ -- $ -- $ 221,005
Purchases:
Pass-through securities.................................. -- -- 55,110
CMOs..................................................... -- -- 5,235
FNMA..................................................... -- -- --
GNMA..................................................... -- -- --
FHLMC.................................................... -- -- --
Acquired in exchange for loans............................. -- -- (10,465)
Sales (1).................................................. -- -- (18,813)
Repayments................................................. -- -- (39,155)
Transfer to held for sale.................................. -- -- (212,917)
--------------------------------------------
Mortgage-backed and related securities at
end of period (not including available for sale and trading). $ -- $ -- $ --
=============================================
</TABLE>
The following table sets forth the activity in the Company's
mortgage-back securities available for sale portfolio during the period
indicated.
<TABLE>
<CAPTION>
-------------------------------------------------
1997 1996 1995
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Mortgage-backed and related securities at beginning
of period ................................................. $ 184,743 $ 234,835 $15,459
Purchases:
Pass-through securities.................................. 39,400 109,600 13,183
CMOs..................................................... 218,836 30,053 --
FNMA..................................................... 2,115 12,102 2,634
GNMA..................................................... 32,200 30,687 --
FHLMC.................................................... 4,649 14,194 12,810
Transfer from held to maturity............................. -- -- 212,917
Sales (1).................................................. (117,047) (185,703) (15,755)
Repayments................................................. (45,304) (61,805) (6,024)
Transfer to trading........................................ -- -- (1,650)
Provision for losses on securities............................ -- (22) --
Mark to market ............................................... (389) 826 811
FASB 122 servicing ........................................... -- (24) --
-------------------------------------------------
Mortgage-backed and related securities at
end of period ............................................... $ 319,203 $184,743 $ 234,835
=================================================
</TABLE>
- ------------------------
(1) Includes mortgage-backed securities on which call options have been
exercised.
8
<PAGE>
The following table sets forth the scheduled maturities, carrying
values, and current yields for the Company's portfolio of mortgage-backed
securities at December 31, 1997:
<TABLE>
<CAPTION>
AFTER ONE BUT AFTER FIVE BUT
WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS
--------------- ----------------- ----------------
BALANCE WEIGHTED BALANCE WEIGHTED BALANCE WEIGHTED
DUE YIELD DUE YIELD DUE YIELD
--- ----- --- ----- --- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Private issuer $ -- --% $ 2,621 6.44% $ 6,021 8.84%
Collateralized mortgage obligations -- -- -- -- -- --
Agencies 939 6.26 623 6.75 -- --
------ ---- ------- ---- ------- ----
$ 939 6.26% $ 3,244 6.50% $ 6,021 8.84%
====== ==== ======= ==== ======= =====
<CAPTION>
AFTER TEN YEARS TOTALS
--------------- ------------------
BALANCE WEIGHTED BALANCE WEIGHTED
DUE YIELD DUE YIELD
--- ----- --- -----
<S> <C> <C> <C> <C>
Private issuer $145,417 8.78% $154,059 8.74%
Collateralized mortgage obligations 139,578 6.90 139,578 6.90
Agencies 24,004 6.90 25,566 6.87
-------- ---- -------- ----
$308,999 7.78% $319,203 7.79%
======== ==== ======== ====
</TABLE>
9
<PAGE>
In May 1996, the Company formed AGT, a 50% owned subsidiary which
services loans for both the Bank and third parties. The Company entered into a
loan servicing agreement with AGT on May 1, 1996, whereby AGT is paid a fee of
$8 to $100 per loan per month depending upon the type of loan and whether it is
performing or non-performing. AGT also receives a fee in its capacity as Master
Servicer for the Company's subserviced portfolio and is reimbursed for any
direct collection expenses including attorney fees, repair costs, etc. The
Company ceased operation of AGT on July 31, 1997. For the period ending December
31,1997, the Company incurred a loss in equity investment in AGT of
approximately $640,000.
Most of the loans sold by the Company are sold on a servicing retained
basis. Servicing includes collecting and remitting loan payments, holding escrow
funds for the payment of real estate taxes, contacting delinquent mortgagors, in
some cases advancing to the investor interest when the mortgage is delinquent,
supervising foreclosures in the event of unremedied defaults and generally
administering the loans. Under loan servicing contracts, the Company receives
servicing fees that are withheld from the monthly payments made to investors.
The Company's aggregate loan servicing fees amounted to $942,000, $790,000, and
$126,000 in 1997, 1996, and 1995, respectively.
The following table sets forth information regarding the Company's loan
servicing portfolio at the dates shown.
<TABLE>
<CAPTION>
AT DECEMBER 31,
----------------------------------------------------------------------------
1997 1996 1995
----------------------- ----------------------- -----------------------
PERCENT PERCENT PERCENT
OF OF OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
------ ----- ------ ----- ------ -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Loans owned and serviced by
the Company....................... $ 252,945 45.6 % $ 164,745 44.7% $ 161,625 61.0%
Loans owned by the Company
and serviced by others............ 301,500 54.4 203,853 55.3 103,349 39.0
--------- ------- ----------- ------ --------- -----
Total loans owned by the
Company......................... $ 554,425 100.0 % $ 368,598 100.0% $ 264,974 100.0%
=========== ======= =========== ====== =========== =====
Loans serviced for others............ $ 57,682 $ 45,856 $ 18,196
</TABLE>
NON-PERFORMING, DELINQUENT, AND OTHER PROBLEM ASSETS
GENERAL. It is management's policy to monitor continually the Company's
loan portfolio to anticipate and address potential and actual delinquencies.
Valuations are periodically performed by management and an allowance for losses
on REO is established by a charge to operations if the fair value of the
property has changed.
NONPERFORMING ASSETS. Nonperforming assets consist of loans on which
interest is no longer accrued, loans which have been restructured in order to
allow the borrower to maintain control of the collateral, real estate acquired
by foreclosure, real estate upon which deeds in lieu of foreclosure have been
accepted and real estate owned which has been classified as In-Substance
Foreclosure ("ISF"). Restructured loans and real estate owned have been written
down to estimated fair value, based upon estimates of cash flow expected from
the underlying collateral and appropriately discounted.
10
<PAGE>
The following table sets forth information with respect to the
Company's non-accrual loans, REO and ISF, and troubled debt restructuring
("TDRs") at the dates indicated. Since December 1993, the Company no longer
classifies ISF loans as REO.
<TABLE>
<CAPTION>
AT DECEMBER 31,
----------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Loans accounted for on a
non-accrual basis:
Real estate loans:
One- to four-family................ $ 10,359 $ 8,979 $ 4,526 $ 1,296 $ 1,570
Commercial real estate............. 568 1,217 261 702 902
Land............................... -- -- -- -- --
Construction....................... -- -- -- -- --
Home equity lines of credit and
second mortgage loans.............. -- 54 136 41 47
Other................................ -- -- -- 27 35
----------- ----------- ----------- ----------- -----------
Total................................... $ 10,927 $ 10,250 $ 4,923 $ 2,066 $ 2,554
=========== =========== =========== =========== ===========
Accruing loans which are contractu-
ally past due 90 days or more:
Real estate loans:
One- to four-family................ $ -- $ -- $ 230 $ -- $ --
----------- ----------- ------------ ----------- -----------
Total................................... $ -- $ -- $ 230 $ -- $ --
=========== =========== ============ =========== ===========
Total of non-accrual and 90 days
past due loans......................... $ 10,927 $ 10,250 $ 5,153 $ 2,066 $ 2,554
=========== =========== =========== =========== ===========
REO:
One- to four-family.................. $ 681 $ 1,300 $ 421 $ 98 $ 194
Commercial real estate............... -- -- -- 206 665
Land................................. -- -- 582 581 582
----------- ----------- ----------- ----------- -----------
681 1,300 1,003 885 1,441
Loss allowance for REO............... -- (65) (213) (92) (221)
----------- ----------- ----------- ------------ -----------
Total REO, net..................... 681 1,235 790 793 1,220
----------- ----------- ----------- ----------- -----------
Total non-performing assets, net........ $ 11,608 $ 11,485 $ 5,943 2,859 $ 3,774
=========== =========== =========== =========== ===========
Total non-performing assets, net,
as a percentage of total assets...... 1.05% 1.83% 1.07% 0.7% 1.7%
=========== =========== =========== ============ ===========
Total loss allowance as a percentage
of total non-performing assets,
gross................................ 30.96% 26.30% 39.53% 34.45% 26.43%
=========== =========== =========== ============ ===========
TDRs .................................. $ 425 $ 435 $ 365 $ 688 $ 413
=========== =========== =========== ============ ===========
</TABLE>
During 1997, non-performing assets increased by $123,000 or 1.1%. This
increase is attributed to the $188.9 million, or 53.6%, growth in the overall
loan portfolio. In accordance with the Company's policy, management actively
monitors the non-performing assets.
During the years ended December 31, 1997, 1996, 1995, and 1994,
interest income of approximately $739,000, $789,000, $365,000, and $113,000,
respectively, would have been recorded on non-accruing loans had they been
performing in accordance with their terms. No interest on non-accruing loans was
included in income during the years ended December 31, 1997, 1996, 1995, and
1994. TDRs are loans to which the Company has granted certain concessions taking
into consideration among other things the borrower's financial difficulty. The
objective of the Company in granting these concessions, through a modification
of terms, is to maximize the recovery of its investment. Such modifications of
terms may include reduction in stated rate, extension of maturity at a more
favorable rate, and/or reduction of accrued interest. TDRs with concessions
totaled approximately $ 425,000, $435,000, $365,000, and $688,000 at December
31, 1997, 1996, 1995, and 1994, respectively. TDRs continue to be closely
monitored by the Company due to their inherent risk characteristics. Interest
income recorded on TDRs in 1997, 1996, 1995, and 1994 was approximately $28,000,
$28,000, $45,000, and $9,000, respectively.
11
<PAGE>
Loans which are not classified as non-accrual, past due 90 days or more
or TDRs, but where known information about possible credit problems of borrowers
caused management to have serious doubts as to the ability of the borrowers to
comply with present loan repayment terms and may result in disclosure as
non-accrual, past due 90 days or more or TDRs are considered potential problem
loans. At December 31, 1997, loans still accruing interest, but identified by
management as potential problem loans aggregated $2.5 million. The majority of
these loans, identified as "special mention" loans, include a $2.3 million pool
of single family, non-performing loans which are performing in accordance with a
bankruptcy plan.
ALLOWANCE FOR LOAN LOSSES. In originating and purchasing loans, the
Company recognizes that credit losses will be experienced and that the risk of
loss will vary with, among other things, the type of loan, the creditworthiness
of the borrower over the term of the loan, general economic conditions, and in
the case of a secured loan, the quality of the security for the loan. It is
management's policy to maintain an adequate allowance for loan losses based on,
among other things, the Company's and the industry's historical loan loss
experience, evaluation of economic conditions, and regular reviews of
delinquencies and loan portfolio quality. The Company increases its allowance
for loan losses by charging provisions for possible loan losses against the
Company's income.
The Company's methodology for establishing the allowance for loan
losses takes into consideration probable losses that have been identified in
connection with specific loans as well as losses in the loan portfolio that have
not been identified but can be expected to occur. General allowances are
established by management and approved by the Board of Directors. These
allowances are reviewed monthly based on an assessment of risk in the Company's
loan portfolio as a whole taking into consideration the composition and quality
of the portfolio, delinquency trends, current charge-off and loss experience,
the state of the real estate market and general economic conditions. Additional
provisions for losses on loans may be made to bring the allowance to a level
deemed adequate. Additionally, the Company's internal audit consultants have
established an independent internal loan review program which is followed by
bank personnel.
In general, the Company adds provisions to its allowance for loan
losses in amounts equal to 0.20% of one-to-four family mortgages, 0.50% for home
equity lines of credit and second trusts, 1.0% of multifamily and mixed use real
estate loans and 2.0% of commercial and land loans. During 1997, the Company
recorded a $637,000 net increase in the allowance for loan losses in relation to
the $188.9 million increase in the loan portfolio. Of this increase in the
allowance for loan losses, 100% of the amount related to the general valuation
allowance ("GVA").
As of December 31, 1997, total loans receivable include four pools of
credit enhanced one-to-four family mortgage loans totaling $41.7 million, or
7.5%, of total loans outstanding. Two of these pools totaling $28.3 million have
a credit reserve from the seller equal to 2.5% of the unpaid principal balance
at the time of the purchase available to offset any losses. Another pool,
totaling $7.3 million, has an indemnification whereby the seller must repurchase
any loan that become more than four payments past due at any time during the
life of the loan. The final pool, totaling $6.1 million, has a credit reserve
equal to approximately 10.0% of the unpaid principal balance at the time of
acquisition. Management believes that the combination of the Company's loan loss
allowance, net credit discount, and credit enhancement on certain loan pools are
adequate to cover potential losses.
Information regarding movements in the provision for loan losses during
the five year period ending December 31, 1997 is incorporated herein by
reference to the section titled "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Earnings Performance --
Provision for Loan and Security Losses" included in this Form 10-K.
12
<PAGE>
The following table sets forth at December 31, 1997 the aggregate
carrying value of the Company's assets classified as substandard, doubtful,
loss, and special mention according to type.
<TABLE>
<CAPTION>
TOTAL SPECIAL
SUBSTANDARD DOUBTFUL LOSS CLASSIFIED MENTION
----------- -------- ---- ---------- -------
(IN THOUSANDS)
Loans:
<S> <C> <C> <C> <C> <C>
One- to four-family.................. $ 10,359 $ -- $ 443 $ 10,802 $ 2,257
Commercial real estate............... 283 285 67 635 249
Land................................. -- -- -- -- --
Home equity lines of credit and
second mortgage.................... -- -- -- -- --
----------- -------- ---------- ----------- ---------
Total loans............................. $ 10,642 $ 285 $ 510 $ 11,437 $ 2,506
=========== ========= ========== =========== =========
REO:
One- to four-family.................. $ 681 $ -- $ -- $ 681 $ --
----------- -------- ---------- ----------- ---------
Total REO............................... 681 -- -- 681 --
----------- -------- ---------- ----------- ---------
Total................................... $ 11,323 $ 285 $ 510 $ 12,118 $ 2,506
=========== ========= ========== =========== =========
</TABLE>
As a result of the declines in regional real estate market values and
the significant losses experienced by many financial institutions, there has
been a greater level of scrutiny by regulatory authorities of the loan
portfolios of financial institutions undertaken as part of the examination of
the institution by the FDIC, OTS, and other state and federal regulators.
Although the Company believes it has established its existing allowances for
losses in accordance with generally accepted accounting principles, there can be
no assurance that regulators, in reviewing the Company's loan portfolio, will
not request the Company to increase its allowance for losses, thereby negatively
affecting the Company's financial condition and earnings.
13
<PAGE>
The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any other category.
<TABLE>
<CAPTION>
AT DECEMBER 31,
-------------------------------------------------------------------------------
1997 1996 1995
------------------------- ------------------------- --------------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH LOANS IN EACH CH
CATEGORY TO CATEGORY TO CATEGORY TO O
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS S
------ ------------- ------ ------------- ------ ------------- -
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family..... $ 3,271 98.80% $ 2,529 97.56% $ 1,939 96.11%
Multifamily............. 15 0.26 15 0.41 13 0.49
Commercial real estate.. 286 0.55 373 1.09 281 1.72
Mixed use............... 9 0.15 12 0.32 18 0.68
Land.................... 8 0.08 8 0.21 8 0.14
Lease financing........... -- -- -- -- -- --
Home equity lines of
credit and second
mortgage loans.......... 5 0.16 20 0.41 28 0.83
Other consumer............ -- -- -- -- 24 0.03
--------- ----------- --------- ------- -------- ------
Total allowance for
loan losses............. $ 3,594 100.00% $ 2,957 100.00% $ 2,311 100.00%
========= ======= ========= ======== ======== =======
<CAPTION>
-----------------------------------------------------
1994 1993
------------------------- ---------------------------
PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ------------- ------ ------------
<S> <C> <C> <C> <C>
Real estate loans:
One- to four-family..... $ 667 92.81% $ 468 92.20%
Multifamily............. 11 0.70 9 0.90
Commercial real estate.. 273 2.77 329 5.73
Mixed use............... -- 1.23 -- --
Land.................... 8 0.24 1 0.02
Lease financing........... -- -- 3 0.02
Home equity lines of
credit and second
mortgage loans.......... 16 2.14 5 0.98
Other consumer............ 14 0.11 20 0.15
--------- ----- --------- ------
Total allowance for
loan losses............. $ 989 100.00% $ 835 100.00%
========= ======= ========= ========
</TABLE>
14
<PAGE>
Included in the above amounts are specific reserves totaling $510,000,
$579,000, $392,000, $201,000, and $240,000, at December 31, 1997, 1996, 1995,
1994, and 1993, respectively, related to loans classified as loss.
REO. REO is initially recorded at estimated fair value less selling
costs. Fair value is defined as the estimated amount in cash or cash-equivalent
value of other consideration that a real estate parcel would yield in a current
sale between a willing buyer and a willing seller. Subsequent to foreclosure,
REO is periodically evaluated by management and an allowance for loss is
established if the estimated fair value of the property, less estimated costs to
sell, declines.
As of December 31, 1997, all of the Company's REO consisted of
one-to-four family real estate.
INVESTMENT SECURITIES
The following table sets forth the cost basis and fair value of the
Company's investment portfolio at the dates indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31,
1997 1996 1995
-------------------- ------------------- ------------
COST FAIR COST FAIR COST FAIR
BASIS VALUE BASIS VALUE BASIS VALUE
----- ----- ----- ----- ----- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Investment Securities:
Held to maturity:
Corporate debt................. $ -- $ -- $ -- $ -- $ -- $ --
Margin account ................ -- -- 18 18 -- --
Other investments.............. -- -- 1 1 -- --
Available for sale:
Municipal bonds................ 7,327 7,681 7,325 7,507 12,360 12,712
Corporate debt................. 18,536 19,575 22,525 23,569 22,850 23,987
Obligations of U.S.
government agencies.......... 22,147 22,505 31,139 31,272 3,359 3,359
Other Investments.............. 25,536 25,553 -- -- -- --
Certificate of Deposits ....... 499 499 499 499 -- --
-------- --------- --------- -------- ------- -------
Subtotal............................ 74,045 75,813 61,505 62,866 38,569 40,058
Securities purchased under
agreements to resell........... -- -- 1,730 1,730 -- --
Equity securities:
Stock in FHLB Atlanta.......... 10,000 10,000 7,300 7,300 5,275 5,275
Stock in FHLMC ................ 5,000 4,950 5,000 4,988 -- --
Stock in FNMA .................. 8,000 8,375 8,000 8,232 -- --
Other corporate stock ......... 2,038 2,099 1,011 1,011 -- --
-------- --------- --------- --------- -------- ---------
Total.......................... $ 99,083 $101,237 $ 84,546 $ 86,127 $ 43,844 $ 45,333
======== ======== ========= ========= ======== =========
</TABLE>
15
<PAGE>
The following table sets forth the scheduled maturities, carrying
values, and current yields for the Company's investment portfolio of debt
securities at December 31, 1997 (dollars in thousands):
<TABLE>
<CAPTION>
AFTER ONE BUT AFTER FIVE BUT
WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS
-------------------- ---------------------- --------------------
BALANCE WEIGHTED BALANCE WEIGHTED BALANCE WEIGHTED
DUE YIELD DUE YIELD DUE YIELD
--- ----- --- ----- --- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Municipal bonds (a) $ -- --% $ 577 6.35% $ 3,692 6.50%
Corporate debt -- -- -- -- 7,675 6.95
Certificates of Deposit -- -- 499 6.92 -- --
Obligations of U.S. Government Agencies 539 5.95 -- -- -- --
Other Investments 324 5.84 25,054 5.69 175 7.50
Equities -- -- -- -- -- --
--------- ------ -------- ------ -------- ------
$ 863 5.91% $ 26,130 5.73% $ 11,542 6.81%
========= ====== ======== ====== ======== ======
<CAPTION>
AFTER TEN YEARS TOTALS
------------------ ------------------
BALANCE WEIGHTED BALANCE WEIGHTED
DUE YIELD DUE YIELD
--- ----- --- -----
<S> <C> <C> <C> <C>
Municipal bonds (a) $ 3,412 9.67% $ 7,681 7.90%
Corporate debt 11,900 6.59 19,575 6.73
Certificates of Deposit -- -- 499 6.92
Obligations of U.S. Government Agencies 21,966 6.18 22,505 6.17
Other Investments -- -- 25,553 5.70
Equities 25,424 6.42 25,424 6.42
-------- ------ --------- ------
$ 62,702 6.55% $ 101,237 6.36%
======== ====== ========= ======
</TABLE>
- -----------------
(a) Yields on tax exempt obligations are computed on a tax equivalent basis.
16
<PAGE>
DEPOSITS AND OTHER SOURCES OF FUNDS
Deposits in the Bank as of December 31, 1997 were represented by the various
categories described below:
<TABLE>
<CAPTION>
PERCENT
OF TOTAL
TERM CATEGORY BALANCE DEPOSITS
---- -------- ------- --------
(In thousands)
<S> <C> <C>
None Checking Accounts $ 761 0.15%
None Money Market Accounts 122,185 23.40%
None Passbook Accounts 665 0.13%
Certificates of Deposit
3-month Fixed-Term, Fixed-Rate 949 0.18%
6-month Fixed-Term, Fixed-Rate 4,414 0.84%
12-month Fixed-Term, Fixed-Rate 54,604 11.41%
18-month Fixed-Term, Fixed-Rate 8,312 1.59%
2-year Fixed-Term, Fixed-Rate 60,490 11.63%
30-month Fixed-Term, Fixed-Rate 136,599 26.12%
3-year Fixed-Term, Fixed-Rate 23,404 4.48%
4-year Fixed-Term, Fixed-Rate 603 0.12%
5-year Fixed-Term, Fixed-Rate 94,804 18.15%
7-year Fixed-Term, Fixed-Rate 4,303 0.82%
10-year Fixed-Term, Fixed-Rate 5,128 0.98%
----------- -------
Total $ 522,221 100.00%
=========== =======
</TABLE>
17
<PAGE>
The following table sets forth the change in dollar amount of deposits
in the various types of accounts offered by the Company between the dates
indicated:
<TABLE>
<CAPTION>
BALANCE BALANCE
AT PERCENTAGE AT PERCENTAGE
DECEMBER 31, OF INCREASE DECEMBER 31, OF
ACCOUNTS 1997 DEPOSITS (DECREASE) 1996 DEPOSITS
-------- ---------- ---------------- ---------- --------------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Passbook.............................. $ 665 0.13% $ (1,093) $ 1,758 0.45%
Money market.......................... 122,185 23.40 12,350 109,835 28.13
Checking.............................. 761 0.15 452 309 0.08
Certificates of deposit............... 398,610 76.32 120,026 278,584 71.34
---------- ------ --------- --------- ------
Total............................ $ 522,221 100.00% $ 131,735 $ 390,486 100.00%
========== ====== ========= ========= ======
<CAPTION>
BALANCE
AT PERCENTAGE
INCREASE DECEMBER 31, OF
ACCOUNTS (DECREASE) 1995 DEPOSITS
-------- ---------- --------------- ---------
<S> <C> <C> <C>
Passbook.............................. $ (262) $ 2,020 0.66%
Money market.......................... 34,103 75,732 24.71
Checking.............................. (1,439) 1,748 0.57
Certificates of deposit............... 51,584 227,000 74.06
--------- --------- -------
Total............................ $ 83,986 $ 306,500 100.00%
========= ========= =======
</TABLE>
18
<PAGE>
The following table sets forth certificates of deposit and money market
accounts in the Company classified by rates at the dates indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31,
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
0 - 1.99%..................................................... $ 5 $ 5,235 $ --
2 - 3.99%..................................................... -- 148 --
4 - 5.99%..................................................... 231,048 210,481 141,750
6 - 7.99%..................................................... 289,046 170,056 158,375
8 - 9.99%..................................................... 696 1,709 1,817
10 - 11.99%................................................... -- 790 790
----------- ----------- -----------
$ 520,795 $ 388,419 $ 302,732
=========== =========== ===========
</TABLE>
The following table indicates the amount of the Company's certificates
of deposit of $100,000 or more by time remaining until maturity as of December
31, 1997.
<TABLE>
<CAPTION>
CERTIFICATES
OF DEPOSIT
----------
(IN THOUSANDS)
<S> <C>
Three months or less........................................ $ 3,379
Three through six months.................................... 3,174
Six through twelve months................................... 11,779
Over twelve months.......................................... 29,208
----------
Total....................................................... $ 47,540
==========
</TABLE>
BORROWINGS
Although deposits are the Company's primary source of funds, the
Company also utilizes borrowings from the FHLB of Atlanta and securities sold
under agreements to repurchase as alternative funding sources. As a member of
the FHLB System, which, among other things, functions in a reserve credit
capacity for savings institutions, the Company is required to own capital stock
in the FHLB of Atlanta and is authorized to apply for advances on the security
of such stock and certain of its home mortgages and other assets (principally
securities which are obligations of, or guaranteed by, the United States of
America) provided certain creditworthiness standards have been met. See
"Regulation."
As of December 31, 1997 the Company had outstanding advances of $200.0
million from the FHLB of Atlanta at interest rates ranging from 5.45% to 5.89%
and at a weighted average rate of 5.66%.
19
<PAGE>
The Company also borrows funds by entering into sales of securities
under agreements to repurchase the same securities with nationally recognized
investment banking firms. The securities are held in custody by the investment
banking firms with which the Company enters into the repurchase agreement.
Repurchase agreements are treated as borrowings by the Company and are secured
by designated fixed and variable rate securities. The proceeds of these
transactions are used to meet cash flow or asset/liability matching needs of the
Company. The following table sets forth certain information regarding repurchase
agreements for the dates indicated:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Weighted average balance during the year...................... $ 117,431 $ 68,920 $ 97,692
Weighted average interest rate during the year................ 5.76% 5.77% 6.29%
Maximum month-end balance during the year..................... $ 279,909 $ 97,416 $ 119,507
Mortgage-backed securities underlying
the agreements as of the end of the year:
Carrying value, including accrued interest................. $ 104,736 $ 22,856 $ 103,590
Estimated market value........................................ $ 104,696 $ 22,804 $ 103,891
Agencies:
Carrying value, including accrued interest................. $ 190,820 $ 38,562 $ 10,499
Estimated market value..................................... $ 190,804 $ 38,621 $ 10,594
</TABLE>
20
<PAGE>
The following table sets forth information regarding the weighted
average interest rates and the highest and average month end balances of the
Company's borrowings.
<TABLE>
<CAPTION>
AT OR AT OR
FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996
--------------------------------------------------- ---------------------------------------------------
WEIGHTED MAXIMUM WEIGHTED AVERAGE WEIGHTED MAXIMUM WEIGHTED AVERAGE
ENDING AVERAGE AMOUNT AT AVERAGE WEIGHTED ENDING AVERAGE AMOUNT AT AVERAGE WEIGHTED
CATEGORY BALANCE RATE MONTH-END BALANCE AVERAGE RATE BALANCE RATE MONTH-END BALANCE AVERAGE RATE
- -------- ------- ---- ---------- ------- ------------ ------- ------- --------- ------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Advances from the FHLB of
Atlanta............. $200,000 5.71% $200,000 $160,749 5.66% $144,800 5.94% $ 154,500 $120,633 5.91%
Securities sold under
agreement to repurchase $279,909 5.91% $279,909 $117,431 5.76% $ 57,581 5.69% $ 97,416 $ 68,920 5.77%
<CAPTION>
AT OR
FOR THE YEAR ENDED
DECEMBER 31, 1995
------------------------------------------------
WEIGHTED MAXIMUM WEIGHTED AVERAGE
ENDING AVERAGE AMOUNT AT AVERAGE WEIGHTED
CATEGORY BALANCE RATE MONTH-END BALANCE AVERAGE RATE
- -------- ------- -------- --------- ------- ------------
<S> <C> <C> <C> <C> <C>
Advances from the FHLB of
Atlanta............. $105,500 5.87% $ 106,800 $ 104,110 6.06%
Securities sold under
agreement to repurchase $ 93,905 6.06% $ 119,507 $ 97,692 6.29%
</TABLE>
21
<PAGE>
PROPERTIES
During 1997, the Bank operated from the Company's headquarters located
at 1111 North Highland Street, Arlington, Virginia 22201 and the Company
operated from an office that it subleases from Danzinger and Danzinger, a law
firm, in New York for approximately $24,000 per year.
SUBSIDIARIES
During the second quarter of 1996, the Bank through its wholly owned
subsidiary TeleBanc Servicing Corporation ("TSC") funded 50% of the capital
commitment to AGT Mortgage Services, LLC ("AGT"). AGT services performing loans
and workouts for troubled or defaulted loans for a fee. The Company ceased
operation of AGT on July 31, 1997. The Bank also provided in the second quarter
of 1996, 50% of the capital commitment to AGT PRA, LLC ("AGT PRA"). The primary
business of AGT PRA is its investment in Portfolio Recovery Associates, LLC
("PRA"). PRA acquires and collects delinquent consumer debt obligations for its
own portfolio.
In February 1997, TeleBanc acquired TeleBanc Capital Markets, Inc.
("TCM"), a registered investment advisor, funds manager, and broker-dealer
specializing in mortgages and mortgage-related securities. In June 1997, the
Company formed TeleBanc Capital Trust I ("TCT"), which in turn sold shares of
trust preferred securities, Series A, for a total of $10.0 million in a private
placement.
EMPLOYEES
At December 31, 1997, the Company had approximately 58 full-time
employees. Management considers its relations with its employees to be
excellent. The Bank's employees are not represented by any collective bargaining
group.
REGULATION
GENERAL
The Company, as a savings and loan holding company, and the Bank, as a
federally chartered savings bank, are subject to extensive regulation,
supervision and examination by the OTS as their primary federal regulator. The
Bank also is subject to regulation, supervision and examination by the Federal
Deposit Insurance Corporation (the "FDIC") and as to certain matters by the
Board of Governors of the Federal Reserve System (the "Federal Reserve Board").
See "Management's Discussion and Analysis" and "Notes to Consolidated Financial
Statements" as to the impact of certain laws, rules and regulations on the
operations of the Company and the Bank. Set forth below is a description of
certain recent regulatory developments.
As discussed in Management's Discussion and Analysis, in September
1996, legislation (the "1996 legislation") was enacted to address the
undercapitalization of the SAIF, of which the Bank is a member. As a result of
the 1996 legislation, the FDIC imposed a one-time special assessment of 0.657%
on deposits insured by the SAIF as of March 31, 1995. The Bank incurred a
one-time charge of $1.7 million (before taxes) to pay for the special assessment
based upon its level of SAIF deposits as of March 31, 1995. After the SAIF was
deemed to be recapitalized, the Bank's deposit insurance premiums to the SAIF
were reduced as of September 30, 1996. The Bank expects that its future deposit
insurance premiums will continue to be lower than the premiums it paid prior to
the recapitalization.
The 1996 legislation also contemplates the merger o the saif with the
Bank Insurance Fund (the "BIF"), which generally insures desposits in national
and state-chartered banks. The combined deposit insurance fund, which would be
formed no earlier than January 1, 1999, would insure deposits at all FDIC
Insured despository institutions. As a condition to the combined insurance fund,
22
<PAGE>
however, the 1996 legislation contemplates that no insured depository
institution would be chartered as a savings association (such as TeleBank).
Several proposals for abolishing the federal thrift charter were introduced in
Congress during 1997 in bills addressing financial services modernization,
including a proposal from the Treasury Department developed pursuant to
requirements of the 1996 legislation. While no legislation was passed in 1997,
financial modernization legislation continues to be discussed by Congress. In
the most recent proposal introduced in Congress, the thrift charter would be
preserved, but the OTS would become a division of the Office of the Comptroller
of the Currency, the agency that regulates national banks, and thrifts would
become subject to national bank branching rules. In addition, the legislation
would require thrifts to hold 10% of their assets in home mortgages, and only
mortgage-backed securities backed by residential mortgages originated by the
thrift would count towards meeting this threshold. The Company does not believe
that the proposed changes to the thrift charter or the change in OTS status
would have a material effect on its operations, however, the Company is unable
to predict what form any final legislation will take. If final legislation is
passed abolishing the federal thrift charter, TeleBank could be required to
convert its federal charter to either a national bank charter, a new federal
type of bank charter or a state depository institution charter.
The legislation currently being discussed in Congress also would
subject the Company to regulation by the Federal Reserve Board. Regulation by
the Federal Reserve Board could subject the Company to capital requirements that
are not currently applicable to holding companies under OTS regulation, and may
result in limitations on the type of business activities in which the Company
may engage at the holding company level, which business activities currently are
not restricted.
Various proposals were introduced in Congress in 1997 to permit the
payment of interest on required reserve balances, and to permit savings
institutions and other regulated financial institutions to pay interest on
business demand accounts. While this legislation appears to have strong support
from many constituencies, the Company is unable to predict whether such
legistation will be enacted.
During 1997, the OTS continued its comprehensive review of its
regulations to eliminate duplicative, unduly burdensome, and unnecessary
regulations. The OTS revised or has proposed revising regulations addressing
electronic banking operations, capital distributions, liquidity requirements,
deposit accounts, and application processing. The proposal on electronic banking
operations would expand the services that TeleBank can provide electronically by
permitting savings institutions to engage in any activity through electronic
means that they may conduct through more traditional delivery mechanisms,
including opening new deposit accounts and the establishment of loan accounts.
The proposal also would allow savings institutions to market and sell electronic
capacities and by-products to third parties if the capacities and by-products
are acquired or developed in good faith as part of providing financial services.
The recently proposed revisions to the OTS capital distribution
regulation would conform the definition of "capital distribution" to the
definition used in the OTS prompt corrective action regulations, and would
delete the three classifications of institutions. Under the proposal, there
would be no specific limitation on the amount of permissible capital
distributions, but the OTS could disapprove a capital distribution if the
institution would not be at least adequately capitalized under the OTS prompt
correction action regulations following the distribution, if the distribution
raised safety or soundness concerns, or if the distribution violated a
prohibition contained in any statute, regulation, or agreement between the
institution and the OTS, or a condition imposed on the institution by the OTS.
The OTS would consider the amount of the distribution when determining whether
it raised safety or soundness concerns.
The recently adopted revisions to the OTS liquidity requirements
lowered the minimum liquidity requirement for a federal savings institution from
5% to 4%, but made clear that an institution must maintain sufficient liquidity
to ensure its safe and sound operation. The revisions also added certain
mortgage-related securities and mortgage loans to the types of assets that can
be used to meet liquidity requirements, and provided alternatives for measuring
compliance with the requirements.
23
<PAGE>
ITEM 2. PROPERTIES
Reference is made to the information set forth under the caption
"Properties" under Item 1. Business of this Annual Report on Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than ordinary
routine litigation incidental to its business, to which the Company or any of
its subsidiaries is a party or of which any of their property is the subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of TeleBanc stockholders during the
fourth quarter of the fiscal year ended December 31, 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Common Stock is currently traded "over-the-counter" under the symbol "TBFC".
The following table sets forth the closing high and low bid prices for the
Common Stock of the periods indicated.
Initial offering $6.125
1996 High Low
- ---- ---- ---
1st quarter $ 8.00 $ 7.50
2nd quarter $ 9.75 $ 8.00
3rd quarter $10.00 $8.875
4th quarter $13.25 $ 9.75
1997
- ----
1st quarter $17.00 $12.00
2nd quarter $17.50 $12.50
3rd quarter $19.00 $15.75
4th quarter $18.75 $17.50
No dividends were paid in 1996 and 1997. The closing per share bidprice of the
Common Stock on December 31, 1997 was $17.75. The approximate number of holders
of record of the Company's common stock at December 31, 1997 was less than 300.
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
SELECTED FINANCIAL DATA
Years ended December 31,
<S> <C> <C> <C> <C> <C>
(Dollars in thousands, except per share data) 1997 1996 1995 1994 1993
Interest income $ 59,301 $ 45,800 $ 40,511 $ 22,208 $ 16,667
Interest expense 46,063 34,815 31,946 17,513 11,828
Net interest income 13,238 10,985 8,565 4,695 4,839
Provision for loan losses 921 919 1,722 492 211
Non-interest income 4,093 2,756 3,777 175 1,157
General and administrative expenses 9,042 8,375 5,561 3,503 2,997
Other non-interest operating expenses 1,100 700 679 153 739
Income before income taxes and cumulative
effect of change in accounting principle 6,268 3,747 4,380 722 2,049
Income tax expense 1,657 1,195 1,660 182 842
Cumulative effect of change in
accounting principle -- -- -- -- 170
Net income $ 3,671 $ 2,552 $ 2,720 $ 540 $ 1,377
Earnings per share:
Basic $ 1.68 $ 1.25 $ 1.33 $ 0.31 $ 1.06
Diluted $ 1.49 $ 1.16 $ 1.33 $ 0.31 $ 1.06
At December 31,
Total assets $ 1,100,352 $ 647,965 $ 553,943 $427,292 $ 220,301
Loans receivable, net 540,704 351,821 248,492 154,742 100,859
Mortgage-backed securities (a) 340,313 184,743 234,385 236,464 80,782
Investment securities (a) 91,237 78,826 40,058 12,444 18,110
Deposits 522,221 390,486 306,500 212,411 113,132
Advances from the FHLB 200,000 144,800 105,500 96,000 61,000
Securities sold under agreements to repurchase 279,909 57,581 93,905 79,613 29,642
Total stockholders equity 45,824 24,658 21,565 17,028 12,378
Financial ratios:
Return on average
Total assets 0.45% 0.61%(c) 0.53% 0.17% 0.61%
Stockholders' equity 9.17% 16.50%(c) 14.10% 3.17% 11.79%
Average stockholders'
equity to average total assets 4.92% 3.70% 3.77% 5.27% 5.20%
Total general and administrative expenses
to total assets 0.82% 1.03%(c) 1.00% 0.82% 1.36%
Number of (b):
Deposit accounts 25,507 16,506 12,919 8,564 2,932
Full-time equivalent employees 58 39 30 29 18
Total assets per employee (b) $ 18,972 $ 16,614 $ 18,465 $ 14,734 $ 12,239
</TABLE>
(a) Includes available for sale, held to maturity, held for sale, and trading.
(b) At end of period. (c) Excludes SAIF assessment.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information contained in this section should be read in conjunction with the
Company's 1997 Consolidated Financial Statements and Notes thereto. In addition,
this Annual Report, which includes Management's Discussion and Analysis,
contains certain forward-looking information. This information includes the
plans and objectives of management for future operations and financial
objectives, loan portfolio growth, and availability of funds. This
forward-looking information is subject to the inherent uncertainties in
predicting future results and conditions. Certain factors that could cause
actual results and conditions to differ materially from those projected in the
forward-looking information are set forth below in the Interest Rate Sensitivity
Management section. Other factors that could cause actual results to differ
materially include the uncertainties of economic, competitive and market
conditions, and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions underlying the
forward-looking information included herein are reasonable, any of the
assumptions could be inaccurate and therefore, there can be no assurance that
the forward-looking information included herein will prove to be accurate.
Therefore, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives and plans
of the Company will be achieved.
INTRODUCTION
TeleBanc Financial Corporation ("TeleBanc" or the "Company") was
organized by its majority stockholder, MET Holdings Corporation ("MET
Holdings"), to become, in March 1994, the parent savings and loan holding
company for TeleBank ("the Bank"), a federally chartered savings bank. In
February 1997, TeleBanc acquired TeleBanc Capital Markets, Inc. ("TCM"), a
registered investment advisor, funds manager, and broker-dealer specializing in
mortgages and mortgage-related securities. In June 1997, the Company formed
TeleBanc Capital Trust I ("TCT"), which in turn sold shares of trust preferred
securities, Series A, for a total of $10.0 million in a private placement. All
references to the Company include the business of the Bank, TCM, and TCT.
Financial and other data as of and for all periods prior to March 1994 represent
the consolidated data of the Bank only. Prior to March 1996, the Bank was known
as Metropolitan Bank for Savings, F.S.B.
Since 1994, TeleBanc has raised approximately $61.8 million through the
sale of capital stock and warrants and the issuance of subordinated notes and
trust preferred securities. In the second quarter of 1994, TeleBanc completed
its initial public offering, raising $4.6 million through the sale of common
stock and an additional $17.3 million through the issuance of subordinated notes
with warrants. Upon the completion of this offering, the Company invested $15
million of the proceeds as capital of the Bank. In February 1997, the Company
consummated the sale of $29.9 million of units to investment partnerships
managed by Conning & Company, CIBC WG Argosy Merchant Fund 2, LLC, the
Progressive Corporation, and The Northwestern Mutual Life Insurance Company and
the purchase of the assets of Arbor Capital Partners, Inc., which was majority
owned by MET Holdings, through the issuance of 162,461 shares of TeleBanc common
stock and a $500,000 cash payment. The units consist of convertible preferred
stock and senior
24
<PAGE>
subordinated notes with warrants. For the period ending December 31, 1997, the
Company invested $15.3 million in the Bank and $3.0 million in TCM.
Overall growth in assets and deposits reflects the Company's efforts to
invest and leverage the capital proceeds. At December 31, 1997, TeleBanc
reported total assets of $1.1 billion, total deposits of $522.2 million, and
stockholders' equity of $45.8 million, compared to $220.3 million, $113.1
million, and $12.4 million, respectively, at December 31, 1993.
Since 1989, the Bank has been developing an operating strategy that
seeks to minimize general and administrative expenses through more efficient
deposit gathering, borrowing, and asset generation. From its headquarters in
Arlington, Virginia, the Company attracts deposit accounts such as certificates
of deposit, money market accounts, and interest checking accounts through a
targeted direct marketing program. Unlike traditional financial institutions,
the Company pursues a "branchless" marketing strategy and thus interacts with
its customers primarily through the telephone, internet, mail, and fax. Company
representatives utilize a sophisticated computer software system to market and
process deposits, build a customer database for future products, and provide
quality service. Other funding sources for the Company include borrowings from
the Federal Home Loan Bank of Atlanta ("FHLB"), securities sold under agreements
to repurchase, and subordinated debt.
The Company's asset acquisition strategy is focused on investing in
one-to-four unit, single-family mortgages and mortgage backed securities
purchased in the secondary market rather than to originate loans. The Company
seeks to manage interest rate risk through matching the maturities of its
deposit solicitations and borrowings as compared with its asset purchases and
the use of certain hedging techniques in order to operate profitably in various
interest rate environments.
In the first quarter of 1998, TeleBanc announced that it had signed a
definitive merger agreement to acquire (the "DFC Acquisition") Direct Financial
Corporation ("DFC"). DFC is the parent holding company of Premium Bank, a
federal savings bank headquartered in New Jersey. At December 31, 1997, DFC
reported total assets of $326.1 million, loans receivable, net of $187.2
million, total deposits of $273.9 million and total stockholders' equity of
$12.3 million. TeleBanc will pay $12 for each share of Direct Financial common
stock or common stock equivalent. The transaction is valued at approximately
$26.4 million. The DFC Acquisition is expected to be consummated in the second
quarter of 1998, subject to DFC stockholder and regulatory approvals.
Also in January 1998, TeleBanc signed a definitive acquisition
agreement whereby MET Holdings will sell substantially all of its assets,
including approximately 1,433,081 shares of TeleBanc Common Stock owned by MET
Holdings, and assign substantially all of its liabilities, to TeleBanc.
Immediately following consummation of the acquisition, MET Holdings will
dissolve and distribute its remaining assets and liabilities to its
stockholders, assuming such dissolution is approved by the requisite number of
stockholders of MET Holdings and TeleBanc.
Given the ever-increasing competitive financial services environment,
the Company has adopted a plan to establish the Bank as a leading brand name in
direct banking. The Company intends to focus on higher growth rates and
therefore anticipates increased associated expenses, including marketing,
compensation, and technology costs, for
25
<PAGE>
the next two years. The Bank's core competency has been to incorporate
technology to operate at a significantly lower cost structure than its
competitors and to use a portion of the expense differential to offer higher
value savings products. The Bank has also evolved from using national rate
surveys as the primary means of attracting deposits to developing sophisticated,
multiple channel marketing strategies. These strategies are building brand
identity, franchise value, and savings patterns that mirror the favorable
deposit structure of a traditional savings bank without the corresponding
infrastructure expense. Management believes this commitment to expansion
directly associated with brand building is necessary to establish the preeminent
direct banking franchise.
The following financial review presents management's analysis of the
consolidated financial condition and results of operations of TeleBanc and
should be read together with the consolidated financial statements and
accompanying notes.
INTEREST RATE SENSITIVITY MANAGEMENT
The Company actively monitors the sensitivity of its assets and
liabilities to various interest rate environments due to repricing in future
time periods. Effective interest rate sensitivity management seeks to ensure
that net interest income is protected from the impact of changes in interest
rates. The risk management function is responsible for the measurement,
monitoring, and control of market risk and the communication of risk limits
throughout the Company in connection with its asset-liability management
activities and trading.
The Company's strategies are intended to stabilize the Company's exposure
to market risk and net interest rate spread under a variety of changes in
interest rates. In an effort to manage growth effectively, the Company
undertakes a slow and steady path to leverage its capital and invest in
interest-earning assets. This growth is funded by raising deposits and incurring
debt including FHLB advances and securities sold under agreements to repurchase
("repos"). The Company's deposit gathering strategy tends to rely on higher
yielding interest checking accounts, money market accounts, and certificates of
deposit accumulated through the Bank's branchless banking telephone and mail
operations, rather than relying on extensive branch networks which require
higher overhead. Similarly, the Company tends to invest its funds in assets
purchased in the secondary market rather than incurring overhead for extensive
loan origination operations. As a result, the Company's interest rate spread is
lower than that of traditional financial institutions. By actively managing the
maturities of its interest-sensitive assets and liabilities, the Company seeks
to maintain relatively consistent interest rate spreads and mitigate much of the
interest rate risk associated with such assets and liabilities.
Management utilizes a risk management process that allows risk-taking
within well defined limits which can be used to create and enhance shareholder
value through the effective employment of risk capital. To this end, the Company
has established an Asset-Liability Committee ("ALCO") and implemented a
measurement of risk using "market value of equity"and "gap" methodologies and
other measures.
ALCO establishes the policies and guidelines for the management of the
Company's assets and liabilities. The ALCO meets a minimum of eight times each
year and its membership is composed of individuals from the Company and two
members of the Board of Directors. The ALCO policy is directed toward reducing
the variability of the market value of its equity under a wide range of interest
rate environments. Fair value of equity (FVE) represents the
26
<PAGE>
net fair value of the company's financial assets and liabilities, including
off-balance sheet hedges. The Company monitors the sensitivity of changes in its
fair value of equity with respect to various interest rate environments and
reports regularly to ALCO. Effective fair value management maximizes net
interest income while constraining the changes in the fair value of equity with
respect to changes in interest rates to acceptable levels. The model calculates
a benchmark FVE for current market conditions.
The Company utilizes sensitivity analysis to evaluate the rate and
extent of changes to its FVE under various market environments. In preparing
simulation analysis, the Company breaks down the aggregate investment portfolio
into discrete product types that share similar properties, such as fixed- or
adjustable rate, similar coupon, and similar age. In the model, each product
type exhibits different projected cashflows (i.e. prepayment assumptions). Under
this analysis, the net present value of expected cashflows for interest
sensitive assets and liabilities are calculated under various interest rate
scenarios. In conducting this sensitivity analysis, the model considers all
asset, liability, and off-balance sheet hedges, including whole loan mortgages,
mortgage-backed securities, mortgage derivatives, corporate bonds, interest rate
swaps, caps, floors, and options. The range of interest rate scenarios evaluated
encompasses significant changes to current market conditions. By this process,
the Company subjects its interest rate sensitive assets and liabilities to
substantial market stress and evaluates the FVE resulting from various market
scenarios. ALCO reviews the results of these stress tests and establishes
appropriate strategies to promote continued compliance with established
guidelines.
Management measures the efficiency of its asset/liability management
strategies by analyzing, on a quarterly basis, the Bank's theoretical FVE and
the expected effect of changes in interest rates. The Board of Directors
establishes limits within which such changes in FVE are to be maintained in the
event of changes in interest rates.
The Company calculates a theoretical FVE in response to a hypothetical
change in market interest risk. The model addresses the exposure to the Bank of
its market sensitive (i.e. interest rates) non-trading financial instruments.
The model excludes the Bank's trading portfolio, which based on management's
analysis, has an immaterial impact on the Bank's FVE. A hypothetical
instantaneous move upward of 100 basis points would cause FVE to decrease by
7.7%.
Every method of market value sensitivity analysis contains inherent
limitations and express and implied assumptions that can affect the resulting
calculations. For example, each interest rate scenario reflects unique
prepayment and repricing assumptions. In addition, this analysis offers a static
view of assets, liabilities, and hedges held as of December 31, 1997 and makes
no assumptions regarding transactions the Company might take in response to
changing market conditions.
The Company employs various hedging techniques to implement ALCO
strategies directed toward managing the variability of the FVE by controlling
the relative sensitivity of market value of interest-earning assets and
interest-bearing liabilities. The sensitivity of changes in market value of
assets and liabilities is affected by such factors as the level of interest
rates, market expectations regarding future interest rates, projected related
loan prepayments, and the repricing characteristics of interest bearing
liabilities.
27
<PAGE>
The Company utilizes hedging techniques to reduce the variability of
FVE and its overall interest rate risk exposure over a one-to-seven year period.
A policy adopted by the Company's Board of Directors prohibits management from
speculative purchases or sales of futures, options, stripped mortgage-backed
securities, or other mortgage derivative products.
Interest rate swaps, caps, swaptions, floors, collars, financial
options, and other mortgage derivative products are used to manage
interest rate exposure by hedging certain assets and liabilities and are not
used for speculative purposes. The Company's interest rate spread was 1.49%,
1.84%, and 1.72% for 1997, 1996, and 1995, respectively. The Company's yield on
interest-earning assets for such periods was 1.73%, 1.94%, and 1.88%,
respectively. Since the initial public offering in May 1994, the Company has
steadily grown in both assets and liabilities, with average interest earning
assets growing from $206.9 million for the quarter ended March 31, 1994 to
$772.2 million for the year ended December 31, 1997, and average interest
bearing liabilities growing from $206.1 million to $738.3 million over the same
period. The Company's ongoing strategy is to maintain a relatively stable
interest rate margin and interest rate spread.
The Company also monitors its assets and liabilities by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring interest rate sensitivity "gap." An asset or liability is said to be
interest rate sensitive within a specific period if it will mature or reprice
within that period. The interest rate sensitivity gap is defined as the
difference between the amount of interest-earning assets maturing or repricing
within a specific time period and the amount of interest-bearing liabilities
maturing or repricing within the same time period. A gap is considered positive
when the amount of interest rate sensitive assets exceeds the amount of interest
rate sensitive liabilities and is considered negative when the amount of
interest rate sensitive liabilities exceeds the amount of interest rate
sensitive assets. Generally, during a period of rising interest rates, a
negative gap would adversely affect net interest income while a positive gap
would result in an increase in net interest income; conversely, during a period
of falling interest rates, a negative gap would result in an increase in net
interest income and a positive gap would adversely affect net interest income.
The Company's current asset-liability management strategy is to maintain an
evenly matched one-to-five year gap giving effect to hedging, but depending on
market conditions and related circumstances, a positive or negative one-to-five
year gap of up to 20% may be acceptable. Inclusive of the Company's hedging
activities, the Company's one-year gap at December 31, 1997 is 5.35%. The
Company's hedge-effected one-to-five year gap at such date is (6.36)%.
The following assumptions were used by management in order to prepare
the Company's gap table set forth on the next page. Non-amortizing investment
securities are shown in the period in which they contractually mature.
Investment securities which contain embedded options such as puts or calls are
shown in the period in which that security is currently expected to be put or
called or to mature. The table assumes that fully-indexed, adjustable-rate,
residential mortgage loans and mortgage-backed securities prepay at an annual
rate between 10% and 15%, based on estimated future prepayment rates for
comparable market benchmark securities and the Company's prepayment history. The
table also assumes that fixed rate, current-coupon residential loans prepay at
an annual rate of between 10% and 15%. The above assumptions were adjusted up or
down on a pool by pool basis to model the effects of product type, coupon rate,
rate adjustment frequency, lifetime cap, net coupon reset margin, and periodic
rate caps upon prevailing
28
<PAGE>
annual prepayment rates. Time deposits are shown in the period in which they
contractually mature, and savings deposits are shown to reprice immediately. The
interest rate sensitivity of the Company's assets and liabilities could vary
substantially if different assumptions were used or if actual experience differs
from the assumptions used. Certain shortcomings are inherent in the method of
analysis presented in the gap table. Although certain assets and liabilities may
have similar maturities or periods of repricing, they may react in different
degrees to changes in market interest rates. The interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types of assets and liabilities may lag
behind changes in market interest rates. Certain assets, such as adjustable-rate
mortgages, have features which restrict changes in interest rates on a
short-term basis and over the life of the assets. In the event of a change in
interest rates, prepayment rates would likely deviate significantly from those
assumed in calculating the table. The ability of many borrowers to service their
debt may decease in the event of an interest rate increase.
<TABLE>
<CAPTION>
Repricing Repricing Repricing
Within Within Within Repricing
Balance Percent 0-3 4-12 1-5 Over
<S> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands) December 31, 1997 of Total Months Months Years 5 Years
Interst-earning assets:
Loans receivable, net $ 540,704 50.43% $ 62,981 $ 174,892 $204,997 $ 97,834
Investment securities
available for sale, interest
bearing accounts & FHLB stock 91,237 8.51 15,158 638 61,934 13,507
Mortgage backed securities
available for sale and trading 340,313 31.74 127,191 104,601 61,715 46,805
Federal funds sold & interest
bearing deposits 99,991 9.32 99,991 -- -- --
Total interest-earning assets $1,072,245 100.00% $ 305,321 $ 280,131 $328,647 $158,146
Non-interest earning assets: 28,107
Total assets $1,100,352
Interest-bearing liabilities:
Savings deposits $ 123,611 11.98% $ 123,611 $ -- $ -- $ --
Time deposits 398,610 38.63 23,414 102,348 266,838 6,010
FHLB advances 200,000 19.39 200,000 -- -- --
Other borrowings 279,909 27.13 279,909 -- -- --
Subordinated debt 29,614 2.87 -- -- 12,937 16,677
Total interest-bearing liabilities $1,031,744 100.00% $ 626,934 $ 102,348 $279,775 $ 22,687
Non-interest bearing liabilities 13,212
Total liabilities $1,044,956
Total trust preferred 9,572
Stockholders' equity 45,824
Total liabilities and
stockholders equity $1,100,352
Periodic repricing difference
(periodic gap) $(321,613) $ 177,783 $ 48,872 $135,459
Cumulative repricing difference
(cumulative gap) $(321,613) $ (143,830) $ (94,958) $ 40,501
Cumulative gap to total assets (29.23)% (13.07)% (8.63)% 3.68%
Cumulative gap to total assets
hedge affected (a) (10.81)% 5.35% (6.36)% 3.68%
</TABLE>
(a) The hedge effected cumulative gap to total assets reflects the effect of
hedging instruments on the Company's gap at December 31, 1997. For purposes of
determining the effect of such hedging instruments, interest rate swap
agreements are treated as part of the hedged liability; hence, the cash flows
from the swap and the hedged asset or liability are netted and the resulting
cash flows are used in the gap calculation. Interest rate cap agreements also
are
29
<PAGE>
treated as part of the hedged asset or liability and weighted the market's
estimate of the likelihood the cap strike will be met or exceeded. The net cash
flows are used in the gap calculations.
FINANCIAL CONDITION
The Company's total assets increased by $452.0 million or 69.8% from
$648.0 million at December 31, 1996 to $1.1 billion at December 31, 1997. Growth
in assets is attributable to increases in mortgage-backed securities and loans
receivable. The primary sources of funds for this growth in assets were deposits
and borrowings.
Loans receivable, net and loans receivable held for sale increased
$188.9 million or 53.7%, from $351.8 million at December 31, 1996 to $540.7
million at December 31, 1997. The increase reflects whole loan purchases of
$343.2 million offset by $95.1 million of principal repayments and $60.7 million
of loans sold in 1997. In the past year, the Company focused its efforts on
expanding its direct loan acquisition program. As a result, the Company has
significantly improved its ability to source, price, and close whole loans.
During 1996, the Company recorded whole loan purchases of $103.1 million offset
by $50.2 million of principal repayments and $27.1 million of loans sold. In the
second quarter of 1996, the Company reevaluated its loan investment strategy.
The Company determined that the probable sale of loans, subsequent to a
restructuring or credit enhancement, would add value to the portfolio. Pursuant
to this strategy, the Company created a loans held for sale category with a
one-time transfer of loans from the investment portfolio that have
characteristics that make them susceptible to sale after restructuring, credit
enhancement, or other improvements. Loans held for sale are recorded at the
lower of cost or market. The Company maintains loans held for sale and loans
held for investment categories.
Mortgage-backed securities, available-for-sale, increased $134.5
million, or 72.8%, from $184.7 million at December 31, 1996 to $319.2 million at
December 31, 1997. Investment securities, available for sale, increased $12.4
million, or 15.7%, from $78.8 million at December 31, 1996 to $91.2 million at
December 31, 1997. These securities are held for liquidity purposes and
increased along with the growth of assets of the Bank in 1997.
Deposits increased $131.7 million, or 33.7%, from $390.5 million at
December 31, 1996 to $522.2 million at December 31, 1997, largely as a result of
the Company's continued marketing efforts to attract money market and
certificate of deposit accounts. During fiscal year 1997, approximately $25.9
million of interest was credited to the accounts while deposits exceeded
withdrawals by $105.8 million, resulting in a net change of $131.7 million.
During 1997, the Company completed a systems conversion to an integrated
platform for marketing, deposit operations, and accounting/finance. The new
system will support future growth and improve the Company's ability to launch
new products. To prepare for the systems upgrade, management controlled growth
of deposits in an effort to focus on the conversion process and minimize the
impact to new customers. The Company relied on FHLB advances and other
borrowings to support asset growth. .
FHLB advances increased $55.2 million, or 38.1%, from $144.8 million at
December 31, 1996 to $200.0 million at December 31, 1997. Other borrowings,
composed of securities sold under agreements to repurchase, increased $222.3
million, or 385.9%, from $57.6 million at December 31, 1996 to $279.9 million at
December 31, 1997. For the year ended 1997, subordinated debt, net of original
issue discount, was $29.6 million, which includes the 9.5% senior
30
<PAGE>
subordinated debt raised in February 1997 and the 11.5% subordinated debt raised
in the second quarter of 1994. In June 1997, the Company formed TCT, which in
turn sold shares of trust preferred securities, Series A, for a total of $10.0
million in a private placement. The trust preferred securities have an annual
dividend rate of 11.0% payable semi-annually, beginning in December 1997. These
transactions reflect the Company's ability to utilize alternate sources of
funding in order to support asset growth.
Stockholders' equity increased $21.1 million to $45.8 million at
December 31, 1997 from $24.7 million at December 31, 1996. The increase reflects
the issuance of $15.3 million of 4% convertible preferred stock, $1.5 million
stock issuance in exchange for Arbor's assets, $4.6 million in net income, and
an unrealized gain for the year on securities available for sale of $642,000,
net of taxes, which increases the Company's stockholders' equity, but does not
impact the statement of operations. The consolidated average balance sheets
along with income and expense and related interest yields and rates at December
31, 1997 and for each of the preceding three fiscal years are shown below. The
table also presents information for the periods indicated with respect to the
difference between the weighted average yield earned on interest-earning assets
and weighted average rate paid on interest-bearing liabilities, or "interest
rate spread," which savings institutions traditionally use as an indicator of
profitability. Another indicator of an institution's profitability is its "net
yield on interest-earning assets," which is its net interest income divided by
the average balance of interest-earning assets. Net interest income is affected
by the interest rate spread and by the relative amounts of interest earning
assets and interest-bearing liabilities. As discussed above, the Company's
operating strategy results in lower spreads and margins than other comparable
financial institutions, but the Company believes lower net interest income is
mitigated by savings in general and administrative expenses.
<TABLE>
<CAPTION>
1997 1996 1995
Balance Average Interest Average Average Interest Average Average Interest Average
(Dollars in thousands) December 31, 1997 Balance Inc./Exp. Yield/Cost Balance Inc./Exp.Yield/Cost Balance Inc./Exp.Yield/Cost
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net(a) $ 540,704 $441,819 $34,729 7.86% $279,038 $23,089 8.28% $201,737 $17,726 8.80%
Mortgage-backed &
related securities -- -- -- -- -- -- -- 233,728 18,614 7.96
Investment securities (b) 54,241 16,203 1,064 6.48 12,841 871 6.79 13,627 990 7.274
Mortgage-backed &
related securities, AFS 319,203 226,064 17,646 7.81 221,656 17,955 8.10 19,138 1,597 8.35
Investment securities, AFS (c) 91,237 73,649 4,776 6.49 61,169 3,959 6.47 25,516 2,071 8.12
Federal funds sold 45,750 1,844 100 5.37 842 44 5.22 810 49 6.05
Trading account 21,110 12,581 1,124 8.81 -- -- -- 1,932 166 8.59
Total interest-earning
assets $1,072,245 $772,160 $59,439 7.70% $575,546 $45,918 7.98% $496,488 $41,213 8.31%
Non-interest earning assets 28,107 41,465 26,929 15,388
Total assets $1,100,352 $813,625 $602,475 $511,876
Interest-bearing liabilities:
Savings deposits $ 123,611 $120,901 $ 6,380 5.28% $ 99,346$ 4,815 4.85% $ 41,387$ 2,111 5.10%
Time deposits 398,610 311,740 19,578 6.28 258,870 16,542 6.39 223,745 14,922 6.67
FHLB advances 200,000 160,681 9,885 6.07 120,678 6,689 5.54 94,718 5,985 6.32
Other borrowings 279,909 117,515 6,941 5.83 68,154 4,569 6.70 107,330 6,839 6.37
Subordinated debt, net 29,614 27,434 3,279 11.95 17,250 2,200 12.75 17,250 2,089 12.11
Total interest-bearing
liabilities $1,031,744 $738,271 $46,063 6.21% $564,298 $34,815 6.14% $484,430 $31,9466.59%
Non-interest-bearing
liabilities 13,212 25,719 15,900 8,150
Total liabilities $1,044,956 $763,990 $580,198 $492,580
Total Trust Preferred 9,572 9,597 -- --
Stockholders' equity 45,824 40,038 22,277 19,296
Total liabilities and
stockholders' equity $1,100,352 $813,625 $602,475 $511,876
Excess of interest-earning
assets over interest-
bearing liabilities/
net interest income/
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
interest rate spread $ 40,501 $ 33,889 $13,376 1.49% $ 11,248 $11,103 1.84%$ 12,058$ 9,267 1.72%
Net yield on interest
earning assets 1.73% 1.94% 1.87%
Ratio of interest-earning
assets to interest-bearing
liabilities 104.59% 101.99% 102.49%
</TABLE>
(a) Includes mortgages held for sale and investment. (b) Includes
interest-bearing deposits, repurchase agreements, investment securities held to
maturity, and FHLB stock. (c) Interest income and average yields on municipal
bonds are presented on a tax equivalent basis.
LIQUIDITY MANAGEMENT AND FUNDING
Liquidity is a company's ability to maintain sufficient cash flows to
fund operations and meet existing and future obligations, including maturing
liabilities, loan commitments, and depositors' withdrawals. The asset portion of
the balance sheet provides liquidity through short-term investments and
maturities and repayments of loans and investment securities. Other sources of
asset liquidity include sales of loans or securities.
Liquidity is provided through the Company's ability to attract and
maintain sufficient deposits and to access available funding markets. Federal
regulations require that the Bank maintain an average of 5.00% liquidity ratio
in relation to certain borrowings and the deposit base. The Bank exceeded the
requirement throughout 1997 and 1996.
The Company continues to enhance the core deposit base through its
branchless marketing strategy that targets individual savers who deposit an
average of $21,000. Management is developing new deposit products, such as an
interest checking account, responsive to our customers needs and cross marketing
these services, which should provide stable funding sources in future periods.
In an effort to decrease the costs associated with new accounts, the Company
attracted several new affinity groups including the National Council of Senior
Citizens. Members of the affinity groups receive increased benefits including
higher rates and lower minimum balances.
The following table shows the changes in deposits for each of the prior
periods:
<TABLE>
<CAPTION>
Years ended December 31,
(Dollars in thousands) 1997 1996 1995
<S> <C> <C> <C>
Balance at beginning of period $390,486 $306,500 $212,411
Deposits in excess of (less than)
withdrawals 105,777 62,629 76,866
Interest credited on deposits 25,958 21,357 17,223
Balance at end of period $522,221 $390,486 $306,500
</TABLE>
Management believes that liquidity of bank deposits coupled with FDIC
insurance will continue to encourage depositors to maintain significant portions
of their funds in insured depository accounts. Management also believes that a
high level of service and convenience coupled with a growing acceptance of
electronic and branchless banking will allow the Company to compete efficiently
and effectively against other FDIC insured banks and other non-bank financial
institutions. Savings deposits increased $11.7 million, or 10.5%, and
certificate of deposit accounts increased $120.0 million, or 43.1% during 1997.
The Company also relies upon borrowed funds to provide a source of
liquidity at attractive interest rates. Total borrowings increased $277.5
million, or 137.1%, during 1997. Advances from the FHLB increased $55.2 million,
or 38.1%, during the period largely as a result of attractive interest rates and
due to the various products offered by the
32
<PAGE>
FHLB to member institutions. Advances are collateralized by specific liens on
mortgage loans in accordance with an "Advances, Specific Collateral Pledge and
Security Agreement", which requires the Company to maintain qualified collateral
equal to 120 to 160 percent of the Company's advances. Accordingly, the Company
increased single-family residential mortgage loan collateral to the FHLB to
$255.8 million during the year. Additional borrowings from the FHLB are
contingent upon the Company providing the appropriate collateral. Repurchase
agreements increased $222.3 million, or 386.1%, during 1997. Principally,
mortgage-backed securities are pledged as collateral for the repurchase
agreements. As of December 31, 1997, the Bank had approximately $154.0 million
in additional borrowing capacity.
As of December 31 1997, the Company had approximately $31.0 million of
face amount of subordinated notes with warrants. The subordinated debt
represents a very stable, although relatively expensive, source of funds. At
December 31, 1997, subordinated debt, net was $29.6 million. In addition to the
subordinated debt, the Company also had outstanding $10.0 million face amount of
11.0% trust preferred securities and $16.2 million face amount of 4.0%
cumulative preferred stock at December 31, 1997. The annual cost to service the
subordinated debt and trust preferred securities is $4.4 million and the annual
dividend requirement on the cumulative preferred stock is $648,000. Subject to
regulatory approval, the Bank will dividend this balance to the Company to
service the debt. There are various regulatory limitations on the extent to
which federally chartered savings institutions may pay dividends. Also, savings
institution subsidiaries of holding companies generally are required to provide
their OTS Regional Director with no less than 30 days' advance notice of any
proposed declaration on the institution's stock. Under terms of the indenture
pursuant to which the subordinated notes were issued, the Company presently is
required to maintain, on an unconsolidated basis, liquid assets in an amount
equal to or greater than $3.3 million, which represents 100% of the aggregate
interest expense for one year on the subordinated debt. The Company had $48.6
million in liquid assets at December 31, 1997.
CAPITAL ADEQUACY
The Company's stockholders' equity at December 31, 1997, was $45.8
million. This represents a $21.2 million, or 85.8%, increase from the prior
year. The increase reflects the issuance of $15.3 million of 4% convertible
preferred stock, $1.6 million stock issuance in exchange for Arbor's assets,
$4.2 million in net income and an unrealized gain for the year on securities
available for sale of $642,000, net of taxes, which increases the Company's
stockholders' equity, but does not impact the statement of operations. See Note
2 of the Consolidated Financial Statements.
The Bank meets all current and fully phased-in capital requirements as
adjusted for the changes which are effective to the computation of risk-based
capital and core capital at December 31, 1997.
The required and actual amounts and ratios of capital pertaining to the
Bank as of December 31, 1997 are set forth as follows (dollars in thousands):
<TABLE>
<CAPTION>
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes: Action Provisions:
Amount Ratio Amount Ratio Amount Ratio
As of December 31, 1997:
Total Capital (to risk
<S> <C> <C> <C> <C> <C> <C>
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
weighted assets) $55,701 11.91% _$37,409 _8.0% _$46,761 _10.0%
Core Capital (to adjusted
tangible assets) $52,617 5.06% _$41,606 _4.0% _$52,008 _5.0%
Tangible Capital (to
tangible assets) $52,608 5.06% _$15,602 _1.5% N/A N/A
Tier I Capital (to
risk weighted assets) $52,617 11.25% N/A N/A _$28,057 _6.0%
As of December 31, 1996:
Total Capital (to risk
weighted assets) $34,104 10.41% _$26,205 _8.0% _$32,756 _10.0%
Core Capital (to adjusted
tangible assets) $31,726 5.08% _$24,999 _4.0% _$31,248 _5.0%
Tangible Capital (to
tangible assets) $31,711 5.07% _$9,374 _1.5% N/A N/A
Tier I Capital (to
risk weighted assets) $31,726 9.69% N/A N/A _$19,654 _6.0%
</TABLE>
EARNINGS PERFORMANCE
Comparison of Operating Results for the Years Ended December 31, 1997 , 1996,
and 1995
NET INCOME. Net income for fiscal year 1997 was $3.7 million compared to $2.6
million for fiscal year 1996. Net income for the year ended December 31, 1997
consisted primarily of $12.3 million in net interest income, $3.3 million in net
gains on the sale of loans held for sale, mortgage-backed and investment
securities, and trading assets offset by $10.1 million in non-interest expenses,
$921,000 in provision for loan losses, and $1.7 million in income tax expenses.
For fiscal year 1997, the Company's return on average assets and return on
average equity was 0.45% and 9.17%, respectively. The Company's return on
average assets and return on average equity has historically declined in years
of capital raising. Based on 2,833,036 weighted average shares of common stock
issued and outstanding as well as potentially dilutive securities, diluted
earnings per share was $1.49.
Net income decreased by $168,000, or 6.2%, from $2.7 million in fiscal
year 1995, to $2.6 million in fiscal year 1996. Net income for 1996 includes the
effect of a one-time $1.7 million, before tax, assessment to recapitalize the
Savings Association Insurance Fund ("SAIF"). Without such assessment, net income
would have been $3.6 million. Net income for the year ended December 31, 1996
consisted primarily of $11.0 million in net interest income, $1.8 million in net
gains on the sale of loans held for sale and mortgage-backed and investment
securities offset by $9.1 million in non-interest expenses, $919,000 in
provision for loan losses, and $1.2 million in income tax expenses. For fiscal
year 1996, the Company's return on average assets and return on average equity
was 0.42% and 11.46%, respectively. Based on 2,203,075 weighted average shares
of common stock issued and outstanding as well as potentially dilutive
securities, diluted earnings per share was $1.16.
NET INTEREST INCOME. Net interest income is the principal source of a financial
institution's income stream and represents the spread between interest and fee
income generated from earning assets and the interest expense paid on deposits
and borrowed funds. Fluctuations in interest rates as well as volume and
composition changes in interest-earning assets and interest-bearing liabilities
materially affect net interest income.
Net interest income increased by $2.2 million, or 20.0%, from $11.0
million to $13.2 million for the years ended December 31, 1996 and 1997,
respectively. Interest rate spreads decreased from 1.84% to 1.49% for the years
34
<PAGE>
ended December 31, 1996 and 1997, respectively. The decrease in spreads reflects
a 28 basis point decline in the yield of interest earning assets and a 7 basis
point increase in the costs of interest-bearing liabilities. The decline in
yield reflects a decrease in loan yield due to a larger loan held for sale
portfolio and an increase in costs associated with hedging instruments used to
reduce interest rate risk matched against the deposit portfolio resulting in
higher costs. Average interest-earning assets and liabilities were $772.2
million and $738.3 million, respectively, for 1997 compared to $575.5 million
and $564.3 million, respectively, for 1996.
Net interest income increased $2.4 million, or 27.9%, from $8.6 million
to $11.0 million for the years ended December 31, 1995 and 1996, respectively.
Interest rate spreads increased to 1.84% from 1.72% for the years ended December
31, 1996 and 1995, respectively. For 1995, average interest-earning assets and
liabilities were $ $496.5 million and $484.4 million, respectively.
The following table allocates the period-to-period changes in the
Company's various categories of interest income and expense between changes due
to changes in volume (calculated by multiplying the change in average volume of
the related interest-earning asset or interest-bearing liability category by the
prior year's rate) and due to changes in rate (changes in rate multiplied by
prior year's volume). Changes due to changes in rate-volume (change in rate
multiplied by changes in volume) have been allocated proportionately between
changes in volume and changes in rate.
<TABLE>
<CAPTION>
1997 vs. 1996 1996 vs. 1995
Increase (Decrease) Due to Increase (Decrease) Due to
(Dollars in thousands) Volume Rate Total Volume Rate Total
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net (a) $ 12,732 $ (1,092) $ 11,640 $ 6,333 $ (968) $ 5,365
Mortgage-backed and
related securities -- -- -- (9,307) (9,307) (18,614)
Investment securities (b) 220 (27) 193 16 (134) (118)
Mortgage-backed and related securities
available for sale 373 (682) (309) 16,404 (45) 16,359
Investment securities
available for sale (c) 809 8 817 2,194 (305) 1,889
Federal funds sold 54 2 56 2 (8) (6))
Trading account 562 562 1,124 17 (185) (168)
Total interest-earning assets $14,750 $(1,229) $ 13,521 $15,659 $ (10,952) $ 4,707
Interest-bearing liabilities:
Savings deposits $ 1,111 $ 454 $ 1,565 $ 2,803 $ (100) $ 2,703
Time deposits 3,315 (279) 3,036 2,208 (596) 1,612
FHLB advances 2,400 796 3,196 972 (292) 680
Other borrowings 2,838 (466) 2,372 (1,778) (446) (2,224)
Subordinated debt 1,207 (128) 1,079 -- 112 112
Total interest-bearing liabilities 10,871 377 11,248 4,205 (1,322) 2,883
Change in net interest income $3,879 $ (1,606) $ 2,273 $ 11,454 $ (9,630) $ 1,824
</TABLE>
(a) Includes mortgage and other loans. (b) Includes interest-bearing deposits,
repurchase agreements, investment securities held to maturity, and FHLB stock.
(c) Interest income and average yields on municipal bonds, included in
investment securities, are presented on a tax equivalent basis.
INTEREST INCOME. Total interest income increased $13.5 million, or 29.5%, from
$45.8 million for the year ended December 31, 1996 to $59.3 million for the year
ended December 31, 1997. Interest income on mortgage and other loans increased
$11.6 million or 50.4%. The increase is largely attributed to the $162.8 million
increase in average loan
35
<PAGE>
balance. Interest income on mortgage-backed securities held-to-maturity and
available-for-sale decreased by $309,000, or 1.7%, from $18.0 million at
December 31, 1996 to $17.6 million at December 31, 1997 largely as a result of a
29 basis point decline in the yield.
Total interest income increased $5.3 million, or 13.1%, from $40.5
million for the year ended December 31, 1995 to $45.8 million for the year ended
December 31, 1996. Interest income on mortgage and other loans increased $5.4
million or 30.5%. The increase is largely attributed to the $77.3 million
increase in average loan balance. Interest income on mortgage-backed securities
held-to-maturity and available-for-sale decreased by $2.2 million, or 10.9%,
from $20.2 million at December 31, 1995 to $18.0 million at December 31, 1996
largely as a result of a $31.2 million decline in average mortgage backed
securities held-to-maturity and available-for-sale.
INTEREST EXPENSE. Total interest expense increased by $11.2 million, or 32.3%,
from $34.8 million for the year ended December 31, 1996 to $46.1 million for the
year ended December 31, 1997. The increase is attributable to a $174.0 million
increase in interest bearing liabilities coupled with a 7 basis point increase
in interest costs. Total interest expense increased by $2.9 million, or 9.1%,
from $31.9 million for the year ended December 31, 1995 to $34.8 million for the
year ended December 31, 1996. The increase is attributable to a $79.9 million
increase in interest bearing liabilities offset by a 45 basis point decline in
interest costs.
PROVISION FOR LOAN LOSSES. The provision for loan losses is the annual cost of
providing an allowance for estimated losses in the loan portfolio. The allowance
reflects management's judgment as to the level considered appropriate to absorb
such losses based upon a review of factors including delinquent loan trends,
historical loss experience, economic conditions, loan portfolio mix and the
Company's internal credit review process.
Total provisions for loan losses increased by $2,000, or 0.2% from
$919,000 for the year ended December 31, 1996 to $921,000 for the year ended
December 31, 1997. The stable level of provision expenses during 1997 is
attributed to the low level of net charge-offs. The total loan loss allowance as
of December 31, 1997 and 1996 was $3.6 million and $3.0 million respectively,
which was 0.67% and 0.80% of total loans outstanding, respectively. Total loan
loss allowance as a percentage of total non-performing loans was 31.4% as of
December 31, 1997 as compared to 26.3% as of December 31, 1996.
The Company's strategy of purchasing loans in the secondary market has
provided management with the ability to acquire certain assets at discounts. As
of December 31, 1997, the Company reported a total net discount of $10.2
million. These discounts are only taken into income as the balance of the loans
receivable are repaid.
Total loans receivable as of December 31, 1997 include four pools of
credit enhanced one-to-four family mortgage loans totaling $41.7 million or 7.5%
of total loans outstanding. Two of these pools totaling $28.3 million have a
credit reserve from the seller equal to 2.5% of the unpaid principal balance at
the time of the purchase available to offset any losses. Another pool, totaling
$7.3 million, has an indemnification whereby the seller must repurchase any loan
that become more than four payments past due at any time during the life of the
loan. The final pool, totaling $6.1 million, has a credit reserve equal to
approximately 10.0% of the unpaid balance at the time of the acquisition.
36
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $2,957 $2,311 $ 989 $ 835 $659
Loans charged off, net of recoveries:
Real estate loans:
One-to-four family (283) (273) -- (338) (19)
Land -- -- -- -- (1)
Other:
Other -- -- (400) -- (15)
Total charge-offs (283) (273) (400) (338) (35)
Provision for loan losses 921 919 1,722 492 211
Balance at end of period $3,595 $2,957 $2,311 $ 989 $835
Ratio of net charge-offs to net average
loans outstanding during the period 0.06% 0.10% 0.14% 0.24% 0.03%
</TABLE>
NON-INTEREST INCOME. Total non-interest income increased by $1.3 million, or
46.4%, from $2.8 million for fiscal year 1996 to $4.1 million for fiscal year
1997. With the addition of trading assets, the Company recognized non-interest
income of $1.2 million. Gains on loans held for sale increased $274,000. Gains
on sales of mortgage-backed securities and investment totaled $982,000. Loan
fees, service charges and other decreased $188,000, which includes loan fees and
other income of $829,000, TCM commission income of $572,000 and a equity loss of
$642,000 for the write-off of the Bank's investment in AGT Mortgage Services
("AGT"). AGT serviced performing and non-performing loans for a fee. Given lower
than anticipated non-performing loan levels, AGT did not achieve adequate
economies of scale to generate sufficient revenue. Accordingly, management
decided to cease operations of AGT on July 31, 1997.
Total non-interest income declined by $1.0 million, or 26.3%, from $3.8
million for fiscal year 1995 to $2.8 million for fiscal year 1996. Loan fees and
service charges increased $756,000 due to fees collected on $2.8 million in
purchased mortgage servicing rights. Gains on loans held for sale increased
$642,000. Gains on sales of mortgage-backed securities and investments totaled
$935,000.
NON-INTEREST EXPENSES. Total non-interest expenses increased $1.0 million, or
11.0%, from $9.1 million for fiscal year 1996 to $10.1 million for fiscal year
1997. Non-interest expenses are composed of general and administrative expenses
and other non-interest expenses. General and administrative expenses increased
$600,000, or 7.1%, from $8.4 million for the year ended December 31, 1996 to
$9.0 million for the year ended December 31, 1997. The slight increase is
primarily attributed to the $1.2 million increase in compensation which was
offset by the effect of a one-time $1.7 million assessment to recapitalize the
SAIF which was recognized in fiscal year 1996. Compensation expenses reflect an
increase of 19 employees from the prior year including the compensation expenses
for TCM employees. Other administrative costs increased $1.1 million to
accommodate the growing deposit base and increased marketing expenses associated
with building a brand identity and enhancing franchise value. As in previous
years, it is the Company's compensation policy to pay a combination of salary
and incentive based compensation consisting of bonuses tied to the overall
Company's performance and individual performances consistent with the improved
performance of the Company. Bonuses increased from $1.1 million for 1996 to $1.5
million for 1997. General and administrative expenses net of bonuses and the
SAIF assessment as a percentage of total assets was 0.69% and 0.86% for the
years ended
37
<PAGE>
December 31, 1997 and 1996, respectively. General and administrative expenses
net of the SAIF assessment as a percentage of total assets were 0.69% and 1.03%
for the years ended December 31, 1997 and 1996, respectively. Other non-interest
expense increased $1.1 million, or 36.7%, from $3.0 million at December 31, 1996
to $4.1 million at December 31, 1997. This increase is attributable to a
$375,000 increase in advertising expense in conjunction with the marketing plan,
$150,000 increase in amortization of purchased mortgage servicing rights,
$228,000 increase in office occupancy, and $350,000 increase in other operating
expenses.
Total non-interest expenses increased $2.9 million, or 46.8%, from $6.2
million for fiscal year 1995 to $9.1 million for fiscal year 1996. Non-interest
expenses are composed of general and administrative expenses and other
non-interest expenses. General and administrative expenses increased $2.8
million, or 50.0%, from $5.6 million for the year ended December 31, 1995 to
$8.4 million for the year ended December 31, 1996. The increase is primarily
attributed to the effect of a one-time $1.7 million assessment to recapitalize
the SAIF, a $660,000 increase in compensation, employee benefits, and $483,000
in federal insurance premium and overall administrative costs for a higher
deposit base. As in previous years, it is the Company's compensation policy to
pay a combination of salary and incentive based compensation consisting of
bonuses tied to the overall Company's performance and individual performances.
Consistent with the improved performance of the Company net of SAIF assessment,
bonuses increased to $1.1 million for 1996 from $775,000 for 1995. Bonuses were
$1.1 million and $745,000 for the year ended December 31, 1996 and 1995,
respectively. General and administrative expenses net of bonuses and the SAIF
assessment as a percentage of total assets was 0.86% and 0.87% for the years
ended December 31, 1996 and 1995, respectively. General and administrative
expenses net of the SAIF assessment as a percentage of total assets was 1.03%
and 1.00% for the years ended December 31, 1996 and 1995, respectively. Other
non-interest expense increased $21,000, or 3.1%, from $679,000 at December 31,
1995 to $700,000 at December 31, 1996. The slight increase is attributable to a
$213,000 increase in amortization of purchased mortgage servicing rights offset
by a $192,000 decline in real estate owned expenses.
INCOME TAX EXPENSE. Income tax expense is computed upon, and generally varies
proportionally with, earnings before income tax expense adjusted for non-taxable
income and non-deductible expenses.
The effective tax rate for the year ended December 31, 1997 was 26.4%
compared to 31.9% for 1996. The income tax expense for the year ended December
31, 1997 was $1.7 million as compared with $1.2 million for the year ended
December 31, 1996. The effective tax rate decreased largely as a result of an
increase in municipal bond interest.
The effective tax rate for the year ended December 31, 1996 was 31.9%
compared to 37.9% for 1995. The income tax expense for the year ended December
31, 1996 was $1.2 million as compared with $1.7 million for the year ended
December 31, 1995. The effective tax rate decreased largely as a result of a
decrease in municipal bond interest.
IMPACT OF INFLATION AND CHANGING PRICES
Since interest rates and inflation rates do not always move in concert,
the effect of inflation on financial institutions may not necessarily be the
same as on other businesses. A bank's asset and liability structure differs
38
<PAGE>
significantly from that of industrial companies in that virtually all assets and
liabilities are of a monetary nature. Management believes that the impact of
inflation on financial results depends upon the Company's ability to manage
interest rate sensitivity and, by such management, reduce the inflationary
impact upon performance. Interest rates do not necessarily move in the same
direction, or in the same magnitude, as the prices of other goods and services.
As discussed above, management seeks to manage the relationship between interest
sensitive assets and liabilities in order to protect against wide interest rate
fluctuations, including those resulting from inflation.
YEAR 2000
The Company utilizes and is dependent upon data processing systems and
software to conduct its business. The data processing systems include various
software packages licensed to the Company by outside vendors and a client server
core processing system which are run on in-house computer networks. In 1997, the
Company initiated a review and assessment of all hardware and software to
confirm that it will function properly in the year 2000. The Company's core
processing software vendor and the majority of the vendors which have been
contacted have indicated that their hardware and/or software are Year 2000
compliant. Testing will be performed for compliance. While there may be some
additional expenses incurred during the next two years, Year 2000 compliance is
not expected to have a material effect on the Company's consolidated financial
statements.
NEW GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
Statement of Financial Accounting Standards Nos. 130 and 131,
"Reporting Comprehensive Income" and "Disclosures about Segments of an
Enterprise and Related Information," respectively, were issued in June 1997.
SFAS 130 requires that certain financial activity typically disclosed in
shareholders' equity be reported in the financial statements as an adjustment to
net income in determining comprehensive income. SFAS 131 requires the reporting
of selected segmented information in quarterly and annual reports. The Company
does not anticipate any material financial impact from the implementation of
SFAS Nos. 130 and 131.
39
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Item 9 is not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instruction G of the Form 10-K, such information
shall be filed as an amendment no later than 120 days from December 31, 1997.
ITEM 11. EXECUTIVE COMPENSATION
Pursuant to General Instruction G of the Form 10-K, such information
shall be filed as an amendment no later than 120 days from December 31, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Pursuant to General Instruction G of the Form 10-K, such information
shall be filed as an amendment no later than 120 days from December 31, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to General Instruction G of the Form 10-K, such information
shall be filed as an amendment no later than 120 days from December 31, 1997.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) The following consolidated financial statements of registrant
and its subsidiary and report of independent auditors are included in Item 8
hereof.
Report of Independent Auditors.
Consolidated Statements of Financial Condition - December 31, 1997 and
1996.
Consolidated Statements of Operations - Years Ended December 31, 1997,
1996, and 1995.
Consolidated Statements of Changes in Stockholders' Equity - Years
Ended December 31, 1997, 1996, and 1995.
40
<PAGE>
Consolidated Statements of Cash Flows - Years Ended December 31, 1997,
1996, and 1995.
Notes to Consolidated Financial Statements.
(a)(2) All schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable and therefore have
been omitted.
(a)(3) The following exhibits are either filed with this Report or are
incorporated herein by reference:
3.1(a) Amended and Restated Certificate of Incorporation of the Company.*
3.1(b) Certificate of Designation****
3.2 Bylaws of the Company.****
4.1 Specimen certificate of shares of Common Stock.***
4.2 Indenture, dated as of June 9, 1997, between the Coporation and
Wilmington Trust Company, as debenture trustee.*
4.3 Form of Certificate of Exchange Junior Subordinated Debentures.*
4.4 Amended and Restated Declaration of Trust of TeleBanc Capital Trust
I dated as of June 9, 1997.*
4.5 Form of Exchange Capital Security Certificate.*
4.6 Exchange Guarantee Agreement by the Corporation for the benefit of
the holders of Exchange Capital Securities.*
4.7 Registration Rights Agreement, dated June 5, 1997, among the
Corporation, TeleBanc Capital Trust I, and the Initial Purchaser.*
4.8 Liquidated Damages Agreement, dated June 9, 1997, among the
Corporation, TeleBanc Capital Trust I, and the Initial Purchaser.*
10.1 1994 Stock Option Plan.***
10.2 Tax Allocation Agreement, dated April 7, 1994, between the Bank and
the Company.**
10.3 Unit Purchase Agreement, dated as of February 19, 1997, among the
Company and the Purchasers identified therein. ****
10.4 Amended and Restated Acquisition Agreement, dated as of February 19,
1997, among the Company, Arbor Capital Partners, Inc., MET Holdings,
Inc., and William M. Daugherty. ****
10.5 1997 Stock Option Plan*****
11 Statement regarding computation of per share earnings.
13 1997 Annual Report to Stockholders, portions of which have been
incorporated by reference into this Form 10-K.
21 Subsidiaries of the Registrant.
99.1 Independent auditor's report of Arthur Andersen LLP .
- ------------------
* Incorporated by reference to the Company's registration statement on Form
S-4/A (File 33-340399) filled with the SEC on December 8, 1997.
** Incorporated by reference herein to pre-effective Amendment No. 1 to the
Company's registration statement on Form S-1 (File No. 33-76930) filed
with the SEC on May 3, 1994.
*** Incorporated by reference herein to the Company's registration statement
on Form S-1 (File No. 33-76930) filed with the SEC on March 25, 1994.
**** Incorporated by reference herein from the Company's Current Report on Form
8-K, as filed with the SEC on March 17, 1997.
***** Incorporated by reference herein from Exhibit D to the Corporation's
definitive proxy materials which were filed as Exhibit 99.3 to the
Corporation's Annual Report on Form 10-K for the year ended December 31,
1996, attached to the prospectus as Appendix I.
41
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized as of the 30th day of
March, 1996.
TELEBANC FINANCIAL CORPORATION
------------------------------
Registrant
By: /s/ Mitchell H. Caplan
----------------------
Mitchell H. Caplan
President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated as of March 30, 1996.
Signature Title
--------- -----
/s/ David A. Smilow Chairman of the Board & CEO
- ------------------------- (principal executive officer)
David A. Smilow
/s/ Mitchell H. Caplan President, Vice Chairman
- ------------------------- and Director
Mitchell H. Caplan
/s/ Aileen Lopez Pugh Executive Vice President and
- ------------------------- Chief Financial Officer/Treasurer
Aileen Lopez Pugh (principal financial and accounting officer)
/s/ David DeCamp Director
- ------------------------
David DeCamp
/s/ Arlen W. Gelbard Director
- ------------------------
Arlen W. Gelbard
/s/ Dean C. Kehler Director
- ------------------------
Dean C. Kehler
/s/ Steven F. Piaker Director
- ------------------------
Steven F. Piaker
/s/ Mark Rollinson Director
- ------------------------
Mark Rollinson
<PAGE>
/s/ Michael A. Smilow Director
- ------------------------
Michael A. Smilow
<PAGE>
INDEX TO FINANCIALS
Report of Independent Auditors.
Consolidated Statements of Financial Condition - December 31, 1997 and
1996.
Consolidated Statements of Operations - Years Ended December 31, 1997,
1996, and 1995.
Consolidated Statements of Changes in Stockholders' Equity - Years
Ended December 31, 1997, 1996, and 1995.
Consolidated Statements of Cash Flows - Years Ended December 31, 1997,
1996, and 1995.
Notes to Consolidated Financial Statements.
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Sequentially
Numbered
Exhibit No. Exhibit Page
----------- ------- ----
<S> <C>
3.1(a) Amended and Restated Certificate of Incorporation of the
Company.*
3.1(b) Certificate of Designation****
3.2 Bylaws of the Company.****
4.1 Specimen certificate of shares of Common Stock.***
4.2 Indenture, dated as of June 9, 1997, between the Coporation
and Wilmington Trust Company, as debenture trustee.*
4.3 Form of Certificate of Exchange Junior Subordnates Debentures.
4.4 Amended and Restated Declaration of Trust of TeleBanc Capital
Trust I dated as of June 9, 1997.
4.5 Form of Exchange Capital Security Certificate.*
4.6 Exchange Guarantee Agreement by the Corporation for the
benefit of the holders of Exchange Capital Securities.
4.7 Registration Rights Agreement, dated June 5, 1997, among the
Corporation, TeleBanc Capital Trust I, and the Initial
Purchaser.
4.8 Liquidated Damages Agreement, dated June 9, 1997, among the
Corporation, TeleBanc Capital Trust I, and the Initial
Purchaser.
10.1 1994 Stock Option Plan.***
10.2 Tax Allocation Agreement, dated April 7, 1994, between the
Bank and the Company.**
10.3 Unit Purchase Agreement, dated as of February 19, 1997, among
the Company and the Purchasers identified therein. ****
10.4 Amended and Restated Acquisition Agreement, dated as of
February 19, 1997, among the Company, Arbor Capital Partners,
Inc., MET Holdings, Inc., and William M. Daugherty. ****
10.5 1997 Stock Option Plan.****
11 Statement regarding computation of per share earnings.
13 1997 Annual Report to Stockholders, portions of which have
been incorporated by reference into this Form 10-K.
21 Subsidiaries of the Registrant.
99.1 Independent auditor's report of Arthur Andersen LLP
</TABLE>
* Incorporated by reference to the Company's registration statement on Form
S-4 (File 33-340399) filded with the SEC on December 8, 1997.
** Incorporated by reference to pre-effective Amendment No. 1 to the
Company's registration statement on Form S-1 (File No. 33-76930) filed
with the SEC on May 3, 1994.
*** Incorporated by reference to the Company's registration statement on Form
S-1 (File No. 33-76930) filed with the SEC on March 25, 1994.
**** Incorporated by reference from the Company's Current Report on Form 8-K,
as filed with the SEC on March 17, 1997.
***** Incorporated by reference herein from Exhibit D to the Corporation's
definitive proxy materials which were filed as Exhibit 99.3 to the
Corporation's Annual Report on Form 10-K for the year ended December 31,
1996, attached to the prospectus as Appendix I.
TELEBANC FINANCIAL CORPORATION
EXHIBIT 11
SCHEDULE OF COMPUTATION OF NET INCOME PER SHARE
-----------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
-------------------------------------
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1996
---- ----
BASIC
-----
<S> <C> <C>
Net income for basic earnings per common share $ 3,671 $ 2,552
Weighted average number of common shares outstanding
during the year 2,191 2,050
Basic earnings per common share $ 1.68 $ 1.25
DILUTED
-------
Net income for diluted earngings per share $ 4,217 $ 2,552
Weighted average number of shares used in calculating
diluted earngings per share 2,191 2,050
Add incremental shares representing:
Dilutive shares issuable upon exercise of stock options
and warrants 642 153
--------- ----------
Weighted average number of shares used in calculating
fully diluted income per share 2,833 2,203
Fully diluted income per common share $ 1.49 $ 1.16
</TABLE>
<TABLE>
<CAPTION>
SELECTED FINANCIAL DATA
Years ended December 31,
<S> <C> <C> <C> <C> <C>
(Dollars in thousands, except per share data) 1997 1996 1995 1994 1993
Interest income $ 59,301 $ 45,800 $ 40,511 $ 22,208 $ 16,667
Interest expense 46,063 34,815 31,946 17,513 11,828
Net interest income 13,238 10,985 8,565 4,695 4,839
Provision for loan losses 921 919 1,722 492 211
Non-interest income 4,093 2,756 3,777 175 1,157
General and administrative expenses 9,042 8,375 5,561 3,503 2,997
Other non-interest operating expenses 1,100 700 679 153 739
Income before income taxes and cumulative
effect of change in accounting principle 6,268 3,747 4,380 722 2,049
Income tax expense 1,657 1,195 1,660 182 842
Cumulative effect of change in
accounting principle -- -- -- -- 170
Net income $ 3,671 $ 2,552 $ 2,720 $ 540 $ 1,377
Earnings per share:
Basic $ 1.68 $ 1.25 $ 1.33 $ 0.31 $ 1.06
Diluted $ 1.49 $ 1.16 $ 1.33 $ 0.31 $ 1.06
At December 31,
Total assets $ 1,100,352 $ 647,965 $ 553,943 $427,292 $ 220,301
Loans receivable, net 540,704 351,821 248,492 154,742 100,859
Mortgage-backed securities (a) 340,313 184,743 234,385 236,464 80,782
Investment securities (a) 91,237 78,826 40,058 12,444 18,110
Deposits 522,221 390,486 306,500 212,411 113,132
Advances from the FHLB 200,000 144,800 105,500 96,000 61,000
Securities sold under agreements to repurchase 279,909 57,581 93,905 79,613 29,642
Total stockholders equity 45,824 24,658 21,565 17,028 12,378
Financial ratios:
Return on average
Total assets 0.45% 0.61%(c) 0.53% 0.17% 0.61%
Stockholders' equity 9.17% 16.50%(c) 14.10% 3.17% 11.79%
Average stockholders'
equity to average total assets 4.92% 3.70% 3.77% 5.27% 5.20%
Total general and administrative expenses
to total assets 0.82% 1.03%(c) 1.00% 0.82% 1.36%
Number of (b):
Deposit accounts 25,507 16,506 12,919 8,564 2,932
Full-time equivalent employees 58 39 30 29 18
Total assets per employee (b) $ 18,972 $ 16,614 $ 18,465 $ 14,734 $ 12,239
</TABLE>
(a) Includes available for sale, held to maturity, held for sale, and trading.
(b) At end of period. (c) Excludes SAIF assessment.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The information contained in this section should be read in conjunction with the
Company's 1997 Consolidated Financial Statements and Notes thereto. In addition,
this Annual Report, which includes Management's Discussion and Analysis,
contains certain forward-looking information. This information includes the
plans and objectives of management for future operations and financial
objectives, loan portfolio growth, and availability of funds. This
forward-looking information is subject to the inherent uncertainties in
predicting future results and conditions. Certain factors that could cause
actual results and conditions to differ materially from those projected in the
forward-looking information are set forth below in the Interest Rate Sensitivity
Management section. Other factors that could cause actual results to differ
materially include the uncertainties of economic, competitive and market
conditions, and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions underlying the
forward-looking information included herein are reasonable, any of the
assumptions could be inaccurate and therefore, there can be no assurance that
the forward-looking information included herein will prove to be accurate.
Therefore, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives and plans
of the Company will be achieved.
INTRODUCTION
TeleBanc Financial Corporation ("TeleBanc" or the "Company") was
organized by its majority stockholder, MET Holdings Corporation ("MET
Holdings"), to become, in March 1994, the parent savings and loan holding
company for TeleBank ("the Bank"), a federally chartered savings bank. In
February 1997, TeleBanc acquired TeleBanc Capital Markets, Inc. ("TCM"), a
registered investment advisor, funds manager, and broker-dealer specializing in
mortgages and mortgage-related securities. In June 1997, the Company formed
TeleBanc Capital Trust I ("TCT"), which in turn sold shares of trust preferred
securities, Series A, for a total of $10.0 million in a private placement. All
references to the Company include the business of the Bank, TCM, and TCT.
Financial and other data as of and for all periods prior to March 1994 represent
the consolidated data of the Bank only. Prior to March 1996, the Bank was known
as Metropolitan Bank for Savings, F.S.B.
Since 1994, TeleBanc has raised approximately $61.8 million through the
sale of capital stock and warrants and the issuance of subordinated notes and
trust preferred securities. In the second quarter of 1994, TeleBanc completed
its initial public offering, raising $4.6 million through the sale of common
stock and an additional $17.3 million through the issuance of subordinated notes
with warrants. Upon the completion of this offering, the Company invested $15
million of the proceeds as capital of the Bank. In February 1997, the Company
consummated the sale of $29.9 million of units to investment partnerships
managed by Conning & Company, CIBC WG Argosy Merchant Fund 2, LLC, the
Progressive Corporation, and The Northwestern Mutual Life Insurance Company and
the purchase of the assets of Arbor Capital Partners, Inc., which was majority
owned by MET Holdings, through the issuance of 162,461 shares of TeleBanc common
stock and a $500,000 cash payment. The units consist of convertible preferred
stock and senior
2
<PAGE>
subordinated notes with warrants. For the period ending December 31, 1997, the
Company invested $15.3 million in the Bank and $3.0 million in TCM.
Overall growth in assets and deposits reflects the Company's efforts to
invest and leverage the capital proceeds. At December 31, 1997, TeleBanc
reported total assets of $1.1 billion, total deposits of $522.2 million, and
stockholders' equity of $45.8 million, compared to $220.3 million, $113.1
million, and $12.4 million, respectively, at December 31, 1993.
Since 1989, the Bank has been developing an operating strategy that
seeks to minimize general and administrative expenses through more efficient
deposit gathering, borrowing, and asset generation. From its headquarters in
Arlington, Virginia, the Company attracts deposit accounts such as certificates
of deposit, money market accounts, and interest checking accounts through a
targeted direct marketing program. Unlike traditional financial institutions,
the Company pursues a "branchless" marketing strategy and thus interacts with
its customers primarily through the telephone, internet, mail, and fax. Company
representatives utilize a sophisticated computer software system to market and
process deposits, build a customer database for future products, and provide
quality service. Other funding sources for the Company include borrowings from
the Federal Home Loan Bank of Atlanta ("FHLB"), securities sold under agreements
to repurchase, and subordinated debt.
The Company's asset acquisition strategy is focused on investing in
one-to-four unit, single-family mortgages and mortgage backed securities
purchased in the secondary market rather than to originate loans. The Company
seeks to manage interest rate risk through matching the maturities of its
deposit solicitations and borrowings as compared with its asset purchases and
the use of certain hedging techniques in order to operate profitably in various
interest rate environments.
In the first quarter of 1998, TeleBanc announced that it had signed a
definitive merger agreement to acquire (the "DFC Acquisition") Direct Financial
Corporation ("DFC"). DFC is the parent holding company of Premium Bank, a
federal savings bank headquartered in New Jersey. At December 31, 1997, DFC
reported total assets of $326.1 million, loans receivable, net of $187.2
million, total deposits of $273.9 million and total stockholders' equity of
$12.3 million. TeleBanc will pay $12 for each share of Direct Financial common
stock or common stock equivalent. The transaction is valued at approximately
$26.4 million. The DFC Acquisition is expected to be consummated in the second
quarter of 1998, subject to DFC stockholder and regulatory approvals.
Also in January 1998, TeleBanc signed a definitive acquisition
agreement whereby MET Holdings will sell substantially all of its assets,
including approximately 1,433,081 shares of TeleBanc Common Stock owned by MET
Holdings, and assign substantially all of its liabilities, to TeleBanc.
Immediately following consummation of the acquisition, MET Holdings will
dissolve and distribute its remaining assets and liabilities to its
stockholders, assuming such dissolution is approved by the requisite number of
stockholders of MET Holdings and TeleBanc.
Given the ever-increasing competitive financial services environment,
the Company has adopted a plan to establish the Bank as a leading brand name in
direct banking. The Company intends to focus on higher growth rates and
therefore anticipates increased associated expenses, including marketing,
compensation, and technology costs, for
3
<PAGE>
the next two years. The Bank's core competency has been to incorporate
technology to operate at a significantly lower cost structure than its
competitors and to use a portion of the expense differential to offer higher
value savings products. The Bank has also evolved from using national rate
surveys as the primary means of attracting deposits to developing sophisticated,
multiple channel marketing strategies. These strategies are building brand
identity, franchise value, and savings patterns that mirror the favorable
deposit structure of a traditional savings bank without the corresponding
infrastructure expense. Management believes this commitment to expansion
directly associated with brand building is necessary to establish the preeminent
direct banking franchise.
The following financial review presents management's analysis of the
consolidated financial condition and results of operations of TeleBanc and
should be read together with the consolidated financial statements and
accompanying notes.
INTEREST RATE SENSITIVITY MANAGEMENT
The Company actively monitors the sensitivity of its assets and
liabilities to various interest rate environments due to repricing in future
time periods. Effective interest rate sensitivity management seeks to ensure
that net interest income is protected from the impact of changes in interest
rates. The risk management function is responsible for the measurement,
monitoring, and control of market risk and the communication of risk limits
throughout the Company in connection with its asset-liability management
activities and trading.
The Company's strategies are intended to stabilize the Company's exposure
to market risk and net interest rate spread under a variety of changes in
interest rates. In an effort to manage growth effectively, the Company
undertakes a slow and steady path to leverage its capital and invest in
interest-earning assets. This growth is funded by raising deposits and incurring
debt including FHLB advances and securities sold under agreements to repurchase
("repos"). The Company's deposit gathering strategy tends to rely on higher
yielding interest checking accounts, money market accounts, and certificates of
deposit accumulated through the Bank's branchless banking telephone and mail
operations, rather than relying on extensive branch networks which require
higher overhead. Similarly, the Company tends to invest its funds in assets
purchased in the secondary market rather than incurring overhead for extensive
loan origination operations. As a result, the Company's interest rate spread is
lower than that of traditional financial institutions. By actively managing the
maturities of its interest-sensitive assets and liabilities, the Company seeks
to maintain relatively consistent interest rate spreads and mitigate much of the
interest rate risk associated with such assets and liabilities.
Management utilizes a risk management process that allows risk-taking
within well defined limits which can be used to create and enhance shareholder
value through the effective employment of risk capital. To this end, the Company
has established an Asset-Liability Committee ("ALCO") and implemented a
measurement of risk using "market value of equity"and "gap" methodologies and
other measures.
ALCO establishes the policies and guidelines for the management of the
Company's assets and liabilities. The ALCO meets a minimum of eight times each
year and its membership is composed of individuals from the Company and two
members of the Board of Directors. The ALCO policy is directed toward reducing
the variability of the market value of its equity under a wide range of interest
rate environments. Fair value of equity (FVE) represents the
4
<PAGE>
net fair value of the company's financial assets and liabilities, including
off-balance sheet hedges. The Company monitors the sensitivity of changes in its
fair value of equity with respect to various interest rate environments and
reports regularly to ALCO. Effective fair value management maximizes net
interest income while constraining the changes in the fair value of equity with
respect to changes in interest rates to acceptable levels. The model calculates
a benchmark FVE for current market conditions.
The Company utilizes sensitivity analysis to evaluate the rate and
extent of changes to its FVE under various market environments. In preparing
simulation analysis, the Company breaks down the aggregate investment portfolio
into discrete product types that share similar properties, such as fixed- or
adjustable rate, similar coupon, and similar age. In the model, each product
type exhibits different projected cashflows (i.e. prepayment assumptions). Under
this analysis, the net present value of expected cashflows for interest
sensitive assets and liabilities are calculated under various interest rate
scenarios. In conducting this sensitivity analysis, the model considers all
asset, liability, and off-balance sheet hedges, including whole loan mortgages,
mortgage-backed securities, mortgage derivatives, corporate bonds, interest rate
swaps, caps, floors, and options. The range of interest rate scenarios evaluated
encompasses significant changes to current market conditions. By this process,
the Company subjects its interest rate sensitive assets and liabilities to
substantial market stress and evaluates the FVE resulting from various market
scenarios. ALCO reviews the results of these stress tests and establishes
appropriate strategies to promote continued compliance with established
guidelines.
Management measures the efficiency of its asset/liability management
strategies by analyzing, on a quarterly basis, the Bank's theoretical FVE and
the expected effect of changes in interest rates. The Board of Directors
establishes limits within which such changes in FVE are to be maintained in the
event of changes in interest rates.
The Company calculates a theoretical FVE in response to a hypothetical
change in market interest risk. The model addresses the exposure to the Bank of
its market sensitive (i.e. interest rates) non-trading financial instruments.
The model excludes the Bank's trading portfolio, which based on management's
analysis, has an immaterial impact on the Bank's FVE. A hypothetical
instantaneous move upward of 100 basis points would cause FVE to decrease by
7.7%.
Every method of market value sensitivity analysis contains inherent
limitations and express and implied assumptions that can affect the resulting
calculations. For example, each interest rate scenario reflects unique
prepayment and repricing assumptions. In addition, this analysis offers a static
view of assets, liabilities, and hedges held as of December 31, 1997 and makes
no assumptions regarding transactions the Company might take in response to
changing market conditions.
The Company employs various hedging techniques to implement ALCO
strategies directed toward managing the variability of the FVE by controlling
the relative sensitivity of market value of interest-earning assets and
interest-bearing liabilities. The sensitivity of changes in market value of
assets and liabilities is affected by such factors as the level of interest
rates, market expectations regarding future interest rates, projected related
loan prepayments, and the repricing characteristics of interest bearing
liabilities.
5
<PAGE>
The Company utilizes hedging techniques to reduce the variability of
FVE and its overall interest rate risk exposure over a one-to-seven year period.
A policy adopted by the Company's Board of Directors prohibits management from
speculative purchases or sales of futures, options, stripped mortgage-backed
securities, or other mortgage derivative products.
Interest rate swaps, caps, swaptions, floors, collars, financial
options, and other mortgage derivative products are used to manage
interest rate exposure by hedging certain assets and liabilities and are not
used for speculative purposes. The Company's interest rate spread was 1.49%,
1.84%, and 1.72% for 1997, 1996, and 1995, respectively. The Company's yield on
interest-earning assets for such periods was 1.73%, 1.94%, and 1.88%,
respectively. Since the initial public offering in May 1994, the Company has
steadily grown in both assets and liabilities, with average interest earning
assets growing from $206.9 million for the quarter ended March 31, 1994 to
$772.2 million for the year ended December 31, 1997, and average interest
bearing liabilities growing from $206.1 million to $738.3 million over the same
period. The Company's ongoing strategy is to maintain a relatively stable
interest rate margin and interest rate spread.
The Company also monitors its assets and liabilities by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring interest rate sensitivity "gap." An asset or liability is said to be
interest rate sensitive within a specific period if it will mature or reprice
within that period. The interest rate sensitivity gap is defined as the
difference between the amount of interest-earning assets maturing or repricing
within a specific time period and the amount of interest-bearing liabilities
maturing or repricing within the same time period. A gap is considered positive
when the amount of interest rate sensitive assets exceeds the amount of interest
rate sensitive liabilities and is considered negative when the amount of
interest rate sensitive liabilities exceeds the amount of interest rate
sensitive assets. Generally, during a period of rising interest rates, a
negative gap would adversely affect net interest income while a positive gap
would result in an increase in net interest income; conversely, during a period
of falling interest rates, a negative gap would result in an increase in net
interest income and a positive gap would adversely affect net interest income.
The Company's current asset-liability management strategy is to maintain an
evenly matched one-to-five year gap giving effect to hedging, but depending on
market conditions and related circumstances, a positive or negative one-to-five
year gap of up to 20% may be acceptable. Inclusive of the Company's hedging
activities, the Company's one-year gap at December 31, 1997 is 5.35%. The
Company's hedge-effected one-to-five year gap at such date is (6.36)%.
The following assumptions were used by management in order to prepare
the Company's gap table set forth on the next page. Non-amortizing investment
securities are shown in the period in which they contractually mature.
Investment securities which contain embedded options such as puts or calls are
shown in the period in which that security is currently expected to be put or
called or to mature. The table assumes that fully-indexed, adjustable-rate,
residential mortgage loans and mortgage-backed securities prepay at an annual
rate between 10% and 15%, based on estimated future prepayment rates for
comparable market benchmark securities and the Company's prepayment history. The
table also assumes that fixed rate, current-coupon residential loans prepay at
an annual rate of between 10% and 15%. The above assumptions were adjusted up or
down on a pool by pool basis to model the effects of product type, coupon rate,
rate adjustment frequency, lifetime cap, net coupon reset margin, and periodic
rate caps upon prevailing
6
<PAGE>
annual prepayment rates. Time deposits are shown in the period in which they
contractually mature, and savings deposits are shown to reprice immediately. The
interest rate sensitivity of the Company's assets and liabilities could vary
substantially if different assumptions were used or if actual experience differs
from the assumptions used. Certain shortcomings are inherent in the method of
analysis presented in the gap table. Although certain assets and liabilities may
have similar maturities or periods of repricing, they may react in different
degrees to changes in market interest rates. The interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types of assets and liabilities may lag
behind changes in market interest rates. Certain assets, such as adjustable-rate
mortgages, have features which restrict changes in interest rates on a
short-term basis and over the life of the assets. In the event of a change in
interest rates, prepayment rates would likely deviate significantly from those
assumed in calculating the table. The ability of many borrowers to service their
debt may decease in the event of an interest rate increase.
<TABLE>
<CAPTION>
Repricing Repricing Repricing
Within Within Within Repricing
Balance Percent 0-3 4-12 1-5 Over
<S> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands) December 31, 1997 of Total Months Months Years 5 Years
Interst-earning assets:
Loans receivable, net $ 540,704 50.43% $ 62,981 $ 174,892 $204,997 $ 97,834
Investment securities
available for sale, interest
bearing accounts & FHLB stock 91,237 8.51 15,158 638 61,934 13,507
Mortgage backed securities
available for sale and trading 340,313 31.74 127,191 104,601 61,715 46,805
Federal funds sold & interest
bearing deposits 99,991 9.32 99,991 -- -- --
Total interest-earning assets $1,072,245 100.00% $ 305,321 $ 280,131 $328,647 $158,146
Non-interest earning assets: 28,107
Total assets $1,100,352
Interest-bearing liabilities:
Savings deposits $ 123,611 11.98% $ 123,611 $ -- $ -- $ --
Time deposits 398,610 38.63 23,414 102,348 266,838 6,010
FHLB advances 200,000 19.39 200,000 -- -- --
Other borrowings 279,909 27.13 279,909 -- -- --
Subordinated debt 29,614 2.87 -- -- 12,937 16,677
Total interest-bearing liabilities $1,031,744 100.00% $ 626,934 $ 102,348 $279,775 $ 22,687
Non-interest bearing liabilities 13,212
Total liabilities $1,044,956
Total trust preferred 9,572
Stockholders' equity 45,824
Total liabilities and
stockholders equity $1,100,352
Periodic repricing difference
(periodic gap) $(321,613) $ 177,783 $ 48,872 $135,459
Cumulative repricing difference
(cumulative gap) $(321,613) $ (143,830) $ (94,958) $ 40,501
Cumulative gap to total assets (29.23)% (13.07)% (8.63)% 3.68%
Cumulative gap to total assets
hedge affected (a) (10.81)% 5.35% (6.36)% 3.68%
</TABLE>
(a) The hedge effected cumulative gap to total assets reflects the effect of
hedging instruments on the Company's gap at December 31, 1997. For purposes of
determining the effect of such hedging instruments, interest rate swap
agreements are treated as part of the hedged liability; hence, the cash flows
from the swap and the hedged asset or liability are netted and the resulting
cash flows are used in the gap calculation. Interest rate cap agreements also
are
7
<PAGE>
treated as part of the hedged asset or liability and weighted the market's
estimate of the likelihood the cap strike will be met or exceeded. The net cash
flows are used in the gap calculations.
FINANCIAL CONDITION
The Company's total assets increased by $452.0 million or 69.8% from
$648.0 million at December 31, 1996 to $1.1 billion at December 31, 1997. Growth
in assets is attributable to increases in mortgage-backed securities and loans
receivable. The primary sources of funds for this growth in assets were deposits
and borrowings.
Loans receivable, net and loans receivable held for sale increased
$188.9 million or 53.7%, from $351.8 million at December 31, 1996 to $540.7
million at December 31, 1997. The increase reflects whole loan purchases of
$343.2 million offset by $95.1 million of principal repayments and $60.7 million
of loans sold in 1997. In the past year, the Company focused its efforts on
expanding its direct loan acquisition program. As a result, the Company has
significantly improved its ability to source, price, and close whole loans.
During 1996, the Company recorded whole loan purchases of $103.1 million offset
by $50.2 million of principal repayments and $27.1 million of loans sold. In the
second quarter of 1996, the Company reevaluated its loan investment strategy.
The Company determined that the probable sale of loans, subsequent to a
restructuring or credit enhancement, would add value to the portfolio. Pursuant
to this strategy, the Company created a loans held for sale category with a
one-time transfer of loans from the investment portfolio that have
characteristics that make them susceptible to sale after restructuring, credit
enhancement, or other improvements. Loans held for sale are recorded at the
lower of cost or market. The Company maintains loans held for sale and loans
held for investment categories.
Mortgage-backed securities, available-for-sale, increased $134.5
million, or 72.8%, from $184.7 million at December 31, 1996 to $319.2 million at
December 31, 1997. Investment securities, available for sale, increased $12.4
million, or 15.7%, from $78.8 million at December 31, 1996 to $91.2 million at
December 31, 1997. These securities are held for liquidity purposes and
increased along with the growth of assets of the Bank in 1997.
Deposits increased $131.7 million, or 33.7%, from $390.5 million at
December 31, 1996 to $522.2 million at December 31, 1997, largely as a result of
the Company's continued marketing efforts to attract money market and
certificate of deposit accounts. During fiscal year 1997, approximately $25.9
million of interest was credited to the accounts while deposits exceeded
withdrawals by $105.8 million, resulting in a net change of $131.7 million.
During 1997, the Company completed a systems conversion to an integrated
platform for marketing, deposit operations, and accounting/finance. The new
system will support future growth and improve the Company's ability to launch
new products. To prepare for the systems upgrade, management controlled growth
of deposits in an effort to focus on the conversion process and minimize the
impact to new customers. The Company relied on FHLB advances and other
borrowings to support asset growth. .
FHLB advances increased $55.2 million, or 38.1%, from $144.8 million at
December 31, 1996 to $200.0 million at December 31, 1997. Other borrowings,
composed of securities sold under agreements to repurchase, increased $222.3
million, or 385.9%, from $57.6 million at December 31, 1996 to $279.9 million at
December 31, 1997. For the year ended 1997, subordinated debt, net of original
issue discount, was $29.6 million, which includes the 9.5% senior
8
<PAGE>
subordinated debt raised in February 1997 and the 11.5% subordinated debt raised
in the second quarter of 1994. In June 1997, the Company formed TCT, which in
turn sold shares of trust preferred securities, Series A, for a total of $10.0
million in a private placement. The trust preferred securities have an annual
dividend rate of 11.0% payable semi-annually, beginning in December 1997. These
transactions reflect the Company's ability to utilize alternate sources of
funding in order to support asset growth.
Stockholders' equity increased $21.1 million to $45.8 million at
December 31, 1997 from $24.7 million at December 31, 1996. The increase reflects
the issuance of $15.3 million of 4% convertible preferred stock, $1.5 million
stock issuance in exchange for Arbor's assets, $4.6 million in net income, and
an unrealized gain for the year on securities available for sale of $642,000,
net of taxes, which increases the Company's stockholders' equity, but does not
impact the statement of operations. The consolidated average balance sheets
along with income and expense and related interest yields and rates at December
31, 1997 and for each of the preceding three fiscal years are shown below. The
table also presents information for the periods indicated with respect to the
difference between the weighted average yield earned on interest-earning assets
and weighted average rate paid on interest-bearing liabilities, or "interest
rate spread," which savings institutions traditionally use as an indicator of
profitability. Another indicator of an institution's profitability is its "net
yield on interest-earning assets," which is its net interest income divided by
the average balance of interest-earning assets. Net interest income is affected
by the interest rate spread and by the relative amounts of interest earning
assets and interest-bearing liabilities. As discussed above, the Company's
operating strategy results in lower spreads and margins than other comparable
financial institutions, but the Company believes lower net interest income is
mitigated by savings in general and administrative expenses.
<TABLE>
<CAPTION>
1997 1996 1995
Balance Average Interest Average Average Interest Average Average Interest Average
(Dollars in thousands) December 31, 1997 Balance Inc./Exp. Yield/Cost Balance Inc./Exp.Yield/Cost Balance Inc./Exp.Yield/Cost
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net(a) $ 540,704 $441,819 $34,729 7.86% $279,038 $23,089 8.28% $201,737 $17,726 8.80%
Mortgage-backed &
related securities -- -- -- -- -- -- -- 233,728 18,614 7.96
Investment securities (b) 54,241 16,203 1,064 6.48 12,841 871 6.79 13,627 990 7.274
Mortgage-backed &
related securities, AFS 319,203 226,064 17,646 7.81 221,656 17,955 8.10 19,138 1,597 8.35
Investment securities, AFS (c) 91,237 73,649 4,776 6.49 61,169 3,959 6.47 25,516 2,071 8.12
Federal funds sold 45,750 1,844 100 5.37 842 44 5.22 810 49 6.05
Trading account 21,110 12,581 1,124 8.81 -- -- -- 1,932 166 8.59
Total interest-earning
assets $1,072,245 $772,160 $59,439 7.70% $575,546 $45,918 7.98% $496,488 $41,213 8.31%
Non-interest earning assets 28,107 41,465 26,929 15,388
Total assets $1,100,352 $813,625 $602,475 $511,876
Interest-bearing liabilities:
Savings deposits $ 123,611 $120,901 $ 6,380 5.28% $ 99,346$ 4,815 4.85% $ 41,387$ 2,111 5.10%
Time deposits 398,610 311,740 19,578 6.28 258,870 16,542 6.39 223,745 14,922 6.67
FHLB advances 200,000 160,681 9,885 6.07 120,678 6,689 5.54 94,718 5,985 6.32
Other borrowings 279,909 117,515 6,941 5.83 68,154 4,569 6.70 107,330 6,839 6.37
Subordinated debt, net 29,614 27,434 3,279 11.95 17,250 2,200 12.75 17,250 2,089 12.11
Total interest-bearing
liabilities $1,031,744 $738,271 $46,063 6.21% $564,298 $34,815 6.14% $484,430 $31,9466.59%
Non-interest-bearing
liabilities 13,212 25,719 15,900 8,150
Total liabilities $1,044,956 $763,990 $580,198 $492,580
Total Trust Preferred 9,572 9,597 -- --
Stockholders' equity 45,824 40,038 22,277 19,296
Total liabilities and
stockholders' equity $1,100,352 $813,625 $602,475 $511,876
Excess of interest-earning
assets over interest-
bearing liabilities/
net interest income/
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
interest rate spread $ 40,501 $ 33,889 $13,376 1.49% $ 11,248 $11,103 1.84%$ 12,058$ 9,267 1.72%
Net yield on interest
earning assets 1.73% 1.94% 1.87%
Ratio of interest-earning
assets to interest-bearing
liabilities 104.59% 101.99% 102.49%
</TABLE>
(a) Includes mortgages held for sale and investment. (b) Includes
interest-bearing deposits, repurchase agreements, investment securities held to
maturity, and FHLB stock. (c) Interest income and average yields on municipal
bonds are presented on a tax equivalent basis.
LIQUIDITY MANAGEMENT AND FUNDING
Liquidity is a company's ability to maintain sufficient cash flows to
fund operations and meet existing and future obligations, including maturing
liabilities, loan commitments, and depositors' withdrawals. The asset portion of
the balance sheet provides liquidity through short-term investments and
maturities and repayments of loans and investment securities. Other sources of
asset liquidity include sales of loans or securities.
Liquidity is provided through the Company's ability to attract and
maintain sufficient deposits and to access available funding markets. Federal
regulations require that the Bank maintain an average of 5.00% liquidity ratio
in relation to certain borrowings and the deposit base. The Bank exceeded the
requirement throughout 1997 and 1996.
The Company continues to enhance the core deposit base through its
branchless marketing strategy that targets individual savers who deposit an
average of $21,000. Management is developing new deposit products, such as an
interest checking account, responsive to our customers needs and cross marketing
these services, which should provide stable funding sources in future periods.
In an effort to decrease the costs associated with new accounts, the Company
attracted several new affinity groups including the National Council of Senior
Citizens. Members of the affinity groups receive increased benefits including
higher rates and lower minimum balances.
The following table shows the changes in deposits for each of the prior
periods:
<TABLE>
<CAPTION>
Years ended December 31,
(Dollars in thousands) 1997 1996 1995
<S> <C> <C> <C>
Balance at beginning of period $390,486 $306,500 $212,411
Deposits in excess of (less than)
withdrawals 105,777 62,629 76,866
Interest credited on deposits 25,958 21,357 17,223
Balance at end of period $522,221 $390,486 $306,500
</TABLE>
Management believes that liquidity of bank deposits coupled with FDIC
insurance will continue to encourage depositors to maintain significant portions
of their funds in insured depository accounts. Management also believes that a
high level of service and convenience coupled with a growing acceptance of
electronic and branchless banking will allow the Company to compete efficiently
and effectively against other FDIC insured banks and other non-bank financial
institutions. Savings deposits increased $11.7 million, or 10.5%, and
certificate of deposit accounts increased $120.0 million, or 43.1% during 1997.
The Company also relies upon borrowed funds to provide a source of
liquidity at attractive interest rates. Total borrowings increased $277.5
million, or 137.1%, during 1997. Advances from the FHLB increased $55.2 million,
or 38.1%, during the period largely as a result of attractive interest rates and
due to the various products offered by the
10
<PAGE>
FHLB to member institutions. Advances are collateralized by specific liens on
mortgage loans in accordance with an "Advances, Specific Collateral Pledge and
Security Agreement", which requires the Company to maintain qualified collateral
equal to 120 to 160 percent of the Company's advances. Accordingly, the Company
increased single-family residential mortgage loan collateral to the FHLB to
$255.8 million during the year. Additional borrowings from the FHLB are
contingent upon the Company providing the appropriate collateral. Repurchase
agreements increased $222.3 million, or 386.1%, during 1997. Principally,
mortgage-backed securities are pledged as collateral for the repurchase
agreements. As of December 31, 1997, the Bank had approximately $154.0 million
in additional borrowing capacity.
As of December 31 1997, the Company had approximately $31.0 million of
face amount of subordinated notes with warrants. The subordinated debt
represents a very stable, although relatively expensive, source of funds. At
December 31, 1997, subordinated debt, net was $29.6 million. In addition to the
subordinated debt, the Company also had outstanding $10.0 million face amount of
11.0% trust preferred securities and $16.2 million face amount of 4.0%
cumulative preferred stock at December 31, 1997. The annual cost to service the
subordinated debt and trust preferred securities is $4.4 million and the annual
dividend requirement on the cumulative preferred stock is $648,000. Subject to
regulatory approval, the Bank will dividend this balance to the Company to
service the debt. There are various regulatory limitations on the extent to
which federally chartered savings institutions may pay dividends. Also, savings
institution subsidiaries of holding companies generally are required to provide
their OTS Regional Director with no less than 30 days' advance notice of any
proposed declaration on the institution's stock. Under terms of the indenture
pursuant to which the subordinated notes were issued, the Company presently is
required to maintain, on an unconsolidated basis, liquid assets in an amount
equal to or greater than $3.3 million, which represents 100% of the aggregate
interest expense for one year on the subordinated debt. The Company had $48.6
million in liquid assets at December 31, 1997.
CAPITAL ADEQUACY
The Company's stockholders' equity at December 31, 1997, was $45.8
million. This represents a $21.2 million, or 85.8%, increase from the prior
year. The increase reflects the issuance of $15.3 million of 4% convertible
preferred stock, $1.6 million stock issuance in exchange for Arbor's assets,
$4.2 million in net income and an unrealized gain for the year on securities
available for sale of $642,000, net of taxes, which increases the Company's
stockholders' equity, but does not impact the statement of operations. See Note
2 of the Consolidated Financial Statements.
The Bank meets all current and fully phased-in capital requirements as
adjusted for the changes which are effective to the computation of risk-based
capital and core capital at December 31, 1997.
The required and actual amounts and ratios of capital pertaining to the
Bank as of December 31, 1997 are set forth as follows (dollars in thousands):
<TABLE>
<CAPTION>
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes: Action Provisions:
Amount Ratio Amount Ratio Amount Ratio
As of December 31, 1997:
Total Capital (to risk
<S> <C> <C> <C> <C> <C> <C>
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
weighted assets) $55,701 11.91% _$37,409 _8.0% _$46,761 _10.0%
Core Capital (to adjusted
tangible assets) $52,617 5.06% _$41,606 _4.0% _$52,008 _5.0%
Tangible Capital (to
tangible assets) $52,608 5.06% _$15,602 _1.5% N/A N/A
Tier I Capital (to
risk weighted assets) $52,617 11.25% N/A N/A _$28,057 _6.0%
As of December 31, 1996:
Total Capital (to risk
weighted assets) $34,104 10.41% _$26,205 _8.0% _$32,756 _10.0%
Core Capital (to adjusted
tangible assets) $31,726 5.08% _$24,999 _4.0% _$31,248 _5.0%
Tangible Capital (to
tangible assets) $31,711 5.07% _$9,374 _1.5% N/A N/A
Tier I Capital (to
risk weighted assets) $31,726 9.69% N/A N/A _$19,654 _6.0%
</TABLE>
EARNINGS PERFORMANCE
Comparison of Operating Results for the Years Ended December 31, 1997 , 1996,
and 1995
NET INCOME. Net income for fiscal year 1997 was $3.7 million compared to $2.6
million for fiscal year 1996. Net income for the year ended December 31, 1997
consisted primarily of $12.3 million in net interest income, $3.3 million in net
gains on the sale of loans held for sale, mortgage-backed and investment
securities, and trading assets offset by $10.1 million in non-interest expenses,
$921,000 in provision for loan losses, and $1.7 million in income tax expenses.
For fiscal year 1997, the Company's return on average assets and return on
average equity was 0.45% and 9.17%, respectively. The Company's return on
average assets and return on average equity has historically declined in years
of capital raising. Based on 2,833,036 weighted average shares of common stock
issued and outstanding as well as potentially dilutive securities, diluted
earnings per share was $1.49.
Net income decreased by $168,000, or 6.2%, from $2.7 million in fiscal
year 1995, to $2.6 million in fiscal year 1996. Net income for 1996 includes the
effect of a one-time $1.7 million, before tax, assessment to recapitalize the
Savings Association Insurance Fund ("SAIF"). Without such assessment, net income
would have been $3.6 million. Net income for the year ended December 31, 1996
consisted primarily of $11.0 million in net interest income, $1.8 million in net
gains on the sale of loans held for sale and mortgage-backed and investment
securities offset by $9.1 million in non-interest expenses, $919,000 in
provision for loan losses, and $1.2 million in income tax expenses. For fiscal
year 1996, the Company's return on average assets and return on average equity
was 0.42% and 11.46%, respectively. Based on 2,203,075 weighted average shares
of common stock issued and outstanding as well as potentially dilutive
securities, diluted earnings per share was $1.16.
NET INTEREST INCOME. Net interest income is the principal source of a financial
institution's income stream and represents the spread between interest and fee
income generated from earning assets and the interest expense paid on deposits
and borrowed funds. Fluctuations in interest rates as well as volume and
composition changes in interest-earning assets and interest-bearing liabilities
materially affect net interest income.
Net interest income increased by $2.2 million, or 20.0%, from $11.0
million to $13.2 million for the years ended December 31, 1996 and 1997,
respectively. Interest rate spreads decreased from 1.84% to 1.49% for the years
12
<PAGE>
ended December 31, 1996 and 1997, respectively. The decrease in spreads reflects
a 28 basis point decline in the yield of interest earning assets and a 7 basis
point increase in the costs of interest-bearing liabilities. The decline in
yield reflects a decrease in loan yield due to a larger loan held for sale
portfolio and an increase in costs associated with hedging instruments used to
reduce interest rate risk matched against the deposit portfolio resulting in
higher costs. Average interest-earning assets and liabilities were $772.2
million and $738.3 million, respectively, for 1997 compared to $575.5 million
and $564.3 million, respectively, for 1996.
Net interest income increased $2.4 million, or 27.9%, from $8.6 million
to $11.0 million for the years ended December 31, 1995 and 1996, respectively.
Interest rate spreads increased to 1.84% from 1.72% for the years ended December
31, 1996 and 1995, respectively. For 1995, average interest-earning assets and
liabilities were $ $496.5 million and $484.4 million, respectively.
The following table allocates the period-to-period changes in the
Company's various categories of interest income and expense between changes due
to changes in volume (calculated by multiplying the change in average volume of
the related interest-earning asset or interest-bearing liability category by the
prior year's rate) and due to changes in rate (changes in rate multiplied by
prior year's volume). Changes due to changes in rate-volume (change in rate
multiplied by changes in volume) have been allocated proportionately between
changes in volume and changes in rate.
<TABLE>
<CAPTION>
1997 vs. 1996 1996 vs. 1995
Increase (Decrease) Due to Increase (Decrease) Due to
(Dollars in thousands) Volume Rate Total Volume Rate Total
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net (a) $ 12,732 $ (1,092) $ 11,640 $ 6,333 $ (968) $ 5,365
Mortgage-backed and
related securities -- -- -- (9,307) (9,307) (18,614)
Investment securities (b) 220 (27) 193 16 (134) (118)
Mortgage-backed and related securities
available for sale 373 (682) (309) 16,404 (45) 16,359
Investment securities
available for sale (c) 809 8 817 2,194 (305) 1,889
Federal funds sold 54 2 56 2 (8) (6))
Trading account 562 562 1,124 17 (185) (168)
Total interest-earning assets $14,750 $(1,229) $ 13,521 $15,659 $ (10,952) $ 4,707
Interest-bearing liabilities:
Savings deposits $ 1,111 $ 454 $ 1,565 $ 2,803 $ (100) $ 2,703
Time deposits 3,315 (279) 3,036 2,208 (596) 1,612
FHLB advances 2,400 796 3,196 972 (292) 680
Other borrowings 2,838 (466) 2,372 (1,778) (446) (2,224)
Subordinated debt 1,207 (128) 1,079 -- 112 112
Total interest-bearing liabilities 10,871 377 11,248 4,205 (1,322) 2,883
Change in net interest income $3,879 $ (1,606) $ 2,273 $ 11,454 $ (9,630) $ 1,824
</TABLE>
(a) Includes mortgage and other loans. (b) Includes interest-bearing deposits,
repurchase agreements, investment securities held to maturity, and FHLB stock.
(c) Interest income and average yields on municipal bonds, included in
investment securities, are presented on a tax equivalent basis.
INTEREST INCOME. Total interest income increased $13.5 million, or 29.5%, from
$45.8 million for the year ended December 31, 1996 to $59.3 million for the year
ended December 31, 1997. Interest income on mortgage and other loans increased
$11.6 million or 50.4%. The increase is largely attributed to the $162.8 million
increase in average loan
13
<PAGE>
balance. Interest income on mortgage-backed securities held-to-maturity and
available-for-sale decreased by $400,000, or 2.2%, from $18.0 million at
December 31, 1996 to $17.6 million at December 31, 1997 largely as a result of a
29 basis point decline in the yield.
Total interest income increased $5.3 million, or 13.1%, from $40.5
million for the year ended December 31, 1995 to $45.8 million for the year ended
December 31, 1996. Interest income on mortgage and other loans increased $5.4
million or 30.5%. The increase is largely attributed to the $77.3 million
increase in average loan balance. Interest income on mortgage-backed securities
held-to-maturity and available-for-sale decreased by $2.2 million, or 10.9%,
from $20.2 million at December 31, 1995 to $18.0 million at December 31, 1996
largely as a result of a $31.2 million decline in average mortgage backed
securities held-to-maturity and available-for-sale.
INTEREST EXPENSE. Total interest expense increased by $11.3 million, or 32.5%,
from $34.8 million for the year ended December 31, 1996 to $46.1 million for the
year ended December 31, 1997. The increase is attributable to a $174.0 million
increase in interest bearing liabilities coupled with a 7 basis point increase
in interest costs. Total interest expense increased by $2.9 million, or 9.1%,
from $31.9 million for the year ended December 31, 1995 to $34.8 million for the
year ended December 31, 1996. The increase is attributable to a $79.9 million
increase in interest bearing liabilities offset by a 45 basis point decline in
interest costs.
PROVISION FOR LOAN LOSSES. The provision for loan losses is the annual cost of
providing an allowance for estimated losses in the loan portfolio. The allowance
reflects management's judgment as to the level considered appropriate to absorb
such losses based upon a review of factors including delinquent loan trends,
historical loss experience, economic conditions, loan portfolio mix and the
Company's internal credit review process.
Total provisions for loan losses increased by $2,000, or 0.2% from
$919,000 for the year ended December 31, 1996 to $921,000 for the year ended
December 31, 1997. The stable level of provision expenses during 1997 is
attributed to the low level of net charge-offs. The total loan loss allowance as
of December 31, 1997 and 1996 was $3.6 million and $3.0 million respectively,
which was 0.67% and 0.80% of total loans outstanding, respectively. Total loan
loss allowance as a percentage of total non-performing loans was 31.0% as of
December 31, 1997 as compared to 26.3% as of December 31, 1996.
The Company's strategy of purchasing loans in the secondary market has
provided management with the ability to acquire certain assets at discounts. As
of December 31, 1997, the Company reported a total net discount of $10.2
million. These discounts are only taken into income as the balance of the loans
receivable are repaid.
Total loans receivable as of December 31, 1997 include four pools of
credit enhanced one-to-four family mortgage loans totaling $41.7 million or 7.5%
of total loans outstanding. Two of these pools totaling $28.3 million have a
credit reserve from the seller equal to 2.5% of the unpaid principal balance at
the time of the purchase available to offset any losses. Another pool, totaling
$7.3 million, has an indemnification whereby the seller must repurchase any loan
that become more than four payments past due at any time during the life of the
loan. The final pool, totaling $6.1 million, has a credit reserve equal to
approximately 10.0% of the unpaid balance at the time of the acquisition.
14
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $2,957 $2,311 $ 989 $ 835 $659
Loans charged off, net of recoveries:
Real estate loans:
One-to-four family (283) (273) -- (338) (19)
Land -- -- -- -- (1)
Other:
Other -- -- (400) -- (15)
Total charge-offs (283) (273) (400) (338) (35)
Provision for loan losses 921 919 1,722 492 211
Balance at end of period $3,595 $2,957 $2,311 $ 989 $835
Ratio of net charge-offs to net average
loans outstanding during the period 0.06% 0.10% 0.14% 0.24% 0.03%
</TABLE>
NON-INTEREST INCOME. Total non-interest income increased by $1.3 million, or
46.4%, from $2.8 million for fiscal year 1996 to $4.1 million for fiscal year
1997. With the addition of trading assets, the Company recognized non-interest
income of $1.2 million. Gains on loans held for sale increased $274,000. Gains
on sales of mortgage-backed securities and investment totaled $982,000. Loan
fees, service charges and other decreased $188,000, which includes loan fees and
other income of $829,000, TCM commission income of $572,000 and a equity loss of
$642,000 for the write-off of the Bank's investment in AGT Mortgage Services
("AGT"). AGT serviced performing and non-performing loans for a fee. Given lower
than anticipated non-performing loan levels, AGT did not achieve adequate
economies of scale to generate sufficient revenue. Accordingly, management
decided to cease operations of AGT on July 31, 1997.
Total non-interest income declined by $1.0 million, or 26.3%, from $3.8
million for fiscal year 1995 to $2.8 million for fiscal year 1996. Loan fees and
service charges increased $756,000 due to fees collected on $2.8 million in
purchased mortgage servicing rights. Gains on loans held for sale increased
$642,000. Gains on sales of mortgage-backed securities and investments totaled
$935,000.
NON-INTEREST EXPENSES. Total non-interest expenses increased $1.0 million, or
11.0%, from $9.1 million for fiscal year 1996 to $10.1 million for fiscal year
1997. Non-interest expenses are composed of general and administrative expenses
and other non-interest expenses. General and administrative expenses increased
$600,000, or 7.1%, from $8.4 million for the year ended December 31, 1996 to
$9.0 million for the year ended December 31, 1997. The slight increase is
primarily attributed to the $1.2 million increase in compensation which was
offset by the effect of a one-time $1.7 million assessment to recapitalize the
SAIF which was recognized in fiscal year 1996. Compensation expenses reflect an
increase of 19 employees from the prior year including the compensation expenses
for TCM employees. Other administrative costs increased $1.1 million to
accommodate the growing deposit base and increased marketing expenses associated
with building a brand identity and enhancing franchise value. As in previous
years, it is the Company's compensation policy to pay a combination of salary
and incentive based compensation consisting of bonuses tied to the overall
Company's performance and individual performances consistent with the improved
performance of the Company. Bonuses increased from $1.1 million for 1996 to $1.5
million for 1997. General and administrative expenses net of bonuses and the
SAIF assessment as a percentage of total assets was 0.69% and 0.86% for the
years ended
15
<PAGE>
December 31, 1997 and 1996, respectively. General and administrative expenses
net of the SAIF assessment as a percentage of total assets were 0.69% and 1.03%
for the years ended December 31, 1997 and 1996, respectively. Other non-interest
expense increased $1.1 million, or 36.7%, from $3.0 million at December 31, 1996
to $4.1 million at December 31, 1997. This increase is attributable to a
$375,000 increase in advertising expense in conjunction with the marketing plan,
$150,000 increase in amortization of purchased mortgage servicing rights,
$228,000 increase in office occupancy, and $350,000 increase in other operating
expenses.
Total non-interest expenses increased $2.9 million, or 46.8%, from $6.2
million for fiscal year 1995 to $9.1 million for fiscal year 1996. Non-interest
expenses are composed of general and administrative expenses and other
non-interest expenses. General and administrative expenses increased $2.8
million, or 50.0%, from $5.6 million for the year ended December 31, 1995 to
$8.4 million for the year ended December 31, 1996. The increase is primarily
attributed to the effect of a one-time $1.7 million assessment to recapitalize
the SAIF, a $660,000 increase in compensation, employee benefits, and $483,000
in federal insurance premium and overall administrative costs for a higher
deposit base. As in previous years, it is the Company's compensation policy to
pay a combination of salary and incentive based compensation consisting of
bonuses tied to the overall Company's performance and individual performances.
Consistent with the improved performance of the Company net of SAIF assessment,
bonuses increased to $1.1 million for 1996 from $775,000 for 1995. Bonuses were
$1.1 million and $745,000 for the year ended December 31, 1996 and 1995,
respectively. General and administrative expenses net of bonuses and the SAIF
assessment as a percentage of total assets was 0.86% and 0.87% for the years
ended December 31, 1996 and 1995, respectively. General and administrative
expenses net of the SAIF assessment as a percentage of total assets was 1.03%
and 1.00% for the years ended December 31, 1996 and 1995, respectively. Other
non-interest expense increased $21,000, or 3.1%, from $679,000 at December 31,
1995 to $700,000 at December 31, 1996. The slight increase is attributable to a
$213,000 increase in amortization of purchased mortgage servicing rights offset
by a $192,000 decline in real estate owned expenses.
INCOME TAX EXPENSE. Income tax expense is computed upon, and generally varies
proportionally with, earnings before income tax expense adjusted for non-taxable
income and non-deductible expenses.
The effective tax rate for the year ended December 31, 1997 was 26.4%
compared to 31.9% for 1996. The income tax expense for the year ended December
31, 1997 was $1.7 million as compared with $1.2 million for the year ended
December 31, 1996. The effective tax rate decreased largely as a result of an
increase in municipal bond interest.
The effective tax rate for the year ended December 31, 1996 was 31.9%
compared to 37.9% for 1995. The income tax expense for the year ended December
31, 1996 was $1.2 million as compared with $1.7 million for the year ended
December 31, 1995. The effective tax rate decreased largely as a result of a
decrease in municipal bond interest.
IMPACT OF INFLATION AND CHANGING PRICES
Since interest rates and inflation rates do not always move in concert,
the effect of inflation on financial institutions may not necessarily be the
same as on other businesses. A bank's asset and liability structure differs
16
<PAGE>
significantly from that of industrial companies in that virtually all assets and
liabilities are of a monetary nature. Management believes that the impact of
inflation on financial results depends upon the Company's ability to manage
interest rate sensitivity and, by such management, reduce the inflationary
impact upon performance. Interest rates do not necessarily move in the same
direction, or in the same magnitude, as the prices of other goods and services.
As discussed above, management seeks to manage the relationship between interest
sensitive assets and liabilities in order to protect against wide interest rate
fluctuations, including those resulting from inflation.
YEAR 2000
The Company utilizes and is dependent upon data processing systems and
software to conduct its business. The data processing systems include various
software packages licensed to the Company by outside vendors and a client server
core processing system which are run on in-house computer networks. In 1997, the
Company initiated a review and assessment of all hardware and software to
confirm that it will function properly in the year 2000. The Company's core
processing software vendor and the majority of the vendors which have been
contacted have indicated that their hardware and/or software are Year 2000
compliant. Testing will be performed for compliance. While there may be some
additional expenses incurred during the next two years, Year 2000 compliance is
not expected to have a material effect on the Company's consolidated financial
statements.
NEW GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
Statement of Financial Accounting Standards Nos. 130 and 131,
"Reporting Comprehensive Income" and "Disclosures about Segments of an
Enterprise and Related Information," respectively, were issued in June 1997.
SFAS 130 requires that certain financial activity typically disclosed in
shareholders' equity be reported in the financial statements as an adjustment to
net income in determining comprehensive income. SFAS 131 requires the reporting
of selected segmented information in quarterly and annual reports. The Company
does not anticipate any material financial impact from the implementation of
SFAS Nos. 130 and 131.
17
<PAGE>
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 1997 and 1996
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996
Assets
<S> <C> <C>
Cash and cash equivalents $ 92,156 $ 3,259
Trading securities 21,110 --
Investment securities available-for-sale 91,237 78,826
Mortgage-backed securities available-for-sale 319,203 184,743
Loans receivable held for sale 149,086 166,064
Loans receivable, net 391,618 185,757
Other assets 35,942 29,316
Total assets 1,100,352 647,965
Liabilities and Stockholders' Equity
Deposits 522,221 390,486
Advances from the Federal Home
Loan Bank of Atlanta 200,000 144,800
Securities sold under agreements to repurchase 279,909 57,581
Subordinated debt, net 29,614 16,586
Other liabilities 13,212 13,854
Total liabilities 1,044,956 623,307
Corporation--Obligated Mandatorily Redeemable
Capital Securities of Subsidiary Trust
Holding Solely Junior Subordinated
Debentures of the Corporation 9,572 --
Commitments and contingencies -- --
Stockholders' equity:
4% Cumulative Preferred Stock, $0.01 par value,
500,000 shares authorized
Series A, 18,850 issued and outstanding 9,634 --
Series B, 4,050 issued and outstanding 2,070 --
Series C, 7,000 issued and outstanding 3,577 --
Common stock, $0.01 par value, 8,500,000 shares authorized;
2,229,161 and 2,049,500 issued and outstanding at
December 31,1997 and 1996 22 20
Additional paid-in capital 16,207 14,637
Retained earnings 11,576 7,905
Unrealized gain on securities
available for sale, net of tax 2,738 2,096
Total stockholders' equity 45,824 24,658
Total liabilities and stockholders' equity $1,100,352 $647,965
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 1997, 1996, and 1995
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(Dollars in thousands, except per share data) 1997 1996 1995
Interest income:
Loans $34,729 $23,089 $ 17,726
Mortgage-backed and related securities 17,646 17,955 20,205
Investment securities 5,702 4,690 2,347
Trading securities 1,124 -- --
Other 100 66 233
Total interest income 59,301 45,800 40,511
Interest expense:
Deposits 25,958 21,357 17,033
Advances from the Federal Home
Loan Bank of Atlanta 9,885 6,689 5,985
Repurchase agreements 6,941 4,569 6,839
Subordinated debt 3,279 2,200 2,089
Total interest expense 46,063 34,815 31,946
Net interest income 13,238 10,985 8,565
Provision for loan losses 921 919 1,722
Net interest income after
provision for loan losses 12,317 10,066 6,843
Non-interest income:
Gain on sale of available for sale securities 982 935 3,412
Gain on sale of loans 1,148 874 232
Gain on trading securities 1,204 -- --
Fees, service charges, and other 759 947 133
Total non-interest income 4,093 2,756 3,777
Non-interest expenses:
General and administrative expenses:
Compensation and employee benefits 4,909 3,690 3,030
SAIF assessment -- 1,671 --
Other 4,133 3,014 2,531
Total general and administrative expenses 9,042 8,375 5,561
Other non-interest expenses:
Net operating cost of real estate
acquired through foreclosure 278 238 430
Amortization of goodwill and other intangibles 822 462 249
Total other non-interest expenses 1,100 700 679
Total non-interest expenses 10,142 9,075 6,240
Income before income tax expense and
minority interest 6,268 3,747 4,380
Income tax expense 1,657 1,195 1,660
Minority interest in subsidiary 394 -- --
Net income $ 4,217 $ 2,552 $ 2,720
Preferred stock dividends 546 -- --
Net income available to common stockholders $ 3,671 $ 2,552 $ 2,720
Earnings per share:
Basic $ 1.68 $ 1.25 $ 1.33
Diluted $ 1.49 $ 1.16 $ 1.33
</TABLE>
See accompanying notes to consolidated financial statements.
19
<PAGE>
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the years ended
December 31, 1997, 1996, and 1995
<TABLE>
<CAPTION>
Unrealized
Gains (Losses)
Additional on Available-
Preferred Common Paid-in Retained for-Sale
(Dollars in thousands) Stock Stock Capital Earnings Securities Total
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1994 $-- $20 $14,637 $2,633 $ (262) $17,028
Net income -- -- -- 2,720 -- 2,720
Unrealized gain on available-for-
sale securities,
net of tax effect -- -- -- -- 1,817 1,817
Balances at December 31, 1995 $-- $20 $14,637 $5,353 $1,555 $21,565
Net income -- -- -- 2,552 -- 2,552
Unrealized gain on available-for-
sale securities,
net of tax effect -- -- -- -- 541 541
Balances at December 31, 1996 $-- $20 $14,637 $7,905 $2,096 $24,658
Net income -- -- -- 4,217 -- 4,217
Common stock issued -- 2 1,570 -- -- 1,572
Issuance of 4% cumulative
preferred stock, Series A 9,634 -- -- -- -- 9,634
Issuance of 4% cumulative
preferred stock, Series B 2,070 -- -- -- -- 2,070
Issuance of 4% cumulative
preferred stock, Series C 3,577 -- -- -- -- 3,577
Dividends on 4% cumulative
preferred stock -- -- -- (546) -- (546)
Unrealized gain on available
for sale securities, net of
tax effect -- -- -- -- 642 642
------- --- ------- ------- ------ -------
Balances at December 31, 1997 $15,281 $22 $16,207 $11,576 $2,738 $45,824
------- --- ------- ------- ------ -------
</TABLE>
See accompanying notes to consolidated financial statements.
20
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 1997,
1996, and 1995
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996 1995
Cash flows from operating activities:
<S> <C> <C> <C>
Net income $ 4,611 $ 2,552 $ 2,720
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Equity in losses of subsidiaries 1,129 274 --
Depreciation, amortization, and discount accretion (1,038) (1,516) (2,153)
Provision for loan losses 921 919 1,722
Provision for losses on foreclosed real estate 19 78 213
Other gains and losses, net (1,624) (1,011) (153)
Deferred income tax provision (445) (224) (559)
Proceeds from sales of loans held for sale 60,145 27,865 --
Purchases of loans held for sale (72,804) (91,943) --
Net realized gains on available-for sale securities,
loans held for sale and trading (2,613) (935) (3,412)
Purchases of trading assets (100,630) -- --
Proceeds from sale of trading assets 80,990 -- --
Increase in accrued interest receivable (1,492) (2,220) (4,954)
Increase in accrued expenses and other liabilities 345 3,730 2,693
Increase in other assets (3,373) (2,433) (80)
Interest credited to deposits 25,958 21,361 17,033
Net cash (used in) provided
by operating activities (9,901) (43,503) 13,070
Cash flows from investing activities:
Net increase in loans (269,036) (90,717) (98,439)
Equity investments in subsidiaries (1,736) (2,359) --
Purchases of available-for-sale securities (395,675) (356,882) (122,785)
Proceeds from sale of available-for-sale securities 144,718 220,293 71,084
Proceeds from maturities of and principal
payments on available-for-sale securities 197,036 201,547 39,646
Net sales (purchases) of premises and equipment 110 (842) (537)
Proceeds from sale of foreclosed real estate 1,563 1,156 --
Net cash used in investing activities (323,020) (27,804) (111,031)
Cash flows from financing activities:
Net increase in time deposits 105,777 62,625 77,056
Increase in advances from FHLB 322,000 273,500 59,000
Payments on advances from FHLB (266,800) (234,200) (49,500)
Net increase (decrease) in securities sold
under agreements to repurchase 222,328 (36,324) 14,292
Net increase in other borrowed funds 13,028 -- --
Issuance of trust preferred stock, net 9,572 -- --
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
Issuance of preferred and common stock and
<S> <C>
additional paid in capital 16,853 -- --
Interest paid to minority interest in subsidiary (394) -- --
Dividends paid on common and preferred stock (546) -- --
Net cash provided by financing activities 421,818 65,601 100,848
Net increase (decrease) in cash and cash equivalents 88,897 (5,706) 2,887
Cash and cash equivalents at beginning of period 3,259 8,965 6,078
Cash and cash equivalents at end of period $ 92,156 $ 3,259 $ 8,965
(Dollars in thousands) 1997 1996 1995
Supplemental information:
Interest paid on deposits and borrowed funds $45,440 $32,660 $29,852
Income taxes paid 2,473 972 950
Gross unrealized gain (loss) on
marketable securities available-for-sale 873 795 2,926
Tax effect of gain (loss) on
available-for-sale securities 231 254 1,109
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
TeleBanc Financial Corporation ("TeleBanc" or the "Company") is a savings and
loan holding company organized under the laws of Delaware in 1994. The primary
business of the Company is the activities conducted by TeleBank (the "Bank"),
formerly known as Metropolitan Bank for Savings, F.S.B., TeleBanc Capital
Markets, Inc. ("TCM"), formerly known as Arbor Capital Partners, Inc. ("Arbor"),
and TeleBanc Capital Trust I ("TCT"). The Bank is a federally chartered savings
bank, which provides deposit accounts insured by the Federal Deposit Insurance
Corporation ("FDIC") to customers nationwide. TCM is a registered investment
advisor, funds manager, and broker-dealer. TCT is a business trust formed for
the purpose of issuing capital securities and investing the proceeds in junior
subordinated debentures issued by the Company. The Bank, through its
wholly-owned subsidiary TeleBanc Servicing Corporation ("TSC"), funded 50% of
the capital commitment for two new entities, AGT Mortgage Services, LLC ("AGT")
and AGT PRA, LLC ("AGT PRA"). AGT services performing loans and administers
workouts for troubled or defaulted loans for a fee.Management ceased operation
of AGT on July 31, 1997. The primary business of AGT PRA is its investment in
Portfolio Recovery Associates, LLC ("PRA"). PRA acquires and collects delinquent
consumer debt obligations for its own portfolio. The net equity investment in
AGT PRA at December 31, 1997 is $2.1 million.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
TeleBank, TCM, TCT, and TSC, a wholly owned subsidiary of the bank. All
significant intercompany transactions and balances are eliminated in
consolidation. The investment in AGT PRA is accounted for under the equity
method.
BASIS OF FINANCIAL STATEMENT PRESENTATION
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosures of contingent assets and
liabilities, and revenues and expenses for the period. Actual results could
differ significantly from those estimates. Material estimates for which a change
is reasonably possible in the near-term relate to the determination of the
allowance for loan losses, the fair value of investments and mortgage-backed
securities available-for-sale, loan receivables held for sale, trading
securities, and the valuation of real estate acquired in connection with
foreclosures and mortgage servicing rights. In addition, the regulatory agencies
which supervise the financial services industry periodically review the Bank's
allowance for losses on loans. This review, which is an integral part of their
examination process, may result in additions to the allowance for loan losses
based on judgments with regard to available information provided at the time of
their examinations.
23
<PAGE>
CASH AND CASH EQUIVALENTS
Cash and cash equivalents are composed of interest-bearing deposits,
certificates of deposit, funds due from banks, and federal funds sold with
original maturities of three months or less.
INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES
The Company generally classifies its debt and marketable equity securities in
one of three categories: held-to-maturity, trading, or available-for-sale. In
December 1995, the Company reclassified the existing held-to-maturity investment
and mortgage-backed securities portfolios as available-for-sale.
Trading securities are bought and held principally for the purpose of selling
them in the near term. Securities purchased for trading are carried at market
value with the corresponding unrealized gains and losses being recognized by
credits or charges to income. The Company had $21.1 million classified as
trading securities at December 31, 1997. No securities were classified as
trading securities at December 31, 1996. For the period ending December 31,
1997, the Company recognized $564,000 in realized gains from the sale of trading
assets and $640,000 in unrealized appreciation of trading assets. All other
securities not included in held-to-maturity or trading are classified as
available-for-sale. Available-for-sale securities are recorded at fair value.
Unrealized gains and losses on available-for-sale securities, net of the related
tax effects, are reported as a separate component of stockholders' equity until
realized. A decline in market value of any available-for-sale asset below its
cost, that is deemed other than temporary, is charged to earnings, resulting in
the establishment of a new cost basis for the asset. Transfers of securities
into the available-for-sale category are recorded at fair value at the date of
the transfer. Any unrealized gain or loss at the date of transfer is recognized
as a separate component of stockholders' equity, net of tax effect. Dividend and
interest income are recognized when earned. Realized gains and losses for
securities classified as available-for-sale and trading are included in earnings
and are derived using the specific identification method for determining the
cost of the security sold.
LOANS HELD FOR SALE
Mortgages acquired by the Company and intended for sale in the secondary market
are carried at lower of cost or estimated market value in the aggregate. The
market value of these mortgage loans is determined by obtaining market quotes
for loans with similar characteristics.
LOANS RECEIVABLE
Loans receivable consists of mortgages that management has the intent and
ability to hold for the foreseeable future or until maturity or pay-off and are
carried at amortized cost adjusted for charge-offs, the allowance for loan
losses, any deferred fees or costs on purchased or originated loans, and
unamortized premiums or discounts on purchased loans. The loan portfolio is
reviewed by the Company's management to set provisions for estimated losses on
loans which are charged to earnings in the current period. In this review,
particular attention is paid to delinquent loans and loans in the process of
foreclosure. The allowance and provision for loan losses are based on several
factors, including continuing examinations and appraisals of the loan portfolio
by management, examinations by supervisory authorities, continuing reviews of
problem loans and overall portfolio quality, analytical reviews of loan loss
experience in relation to outstanding loans, and management's judgment with
respect to economic conditions and its impact on the loan portfolio.
24
<PAGE>
NONPERFORMING ASSETS
Nonperforming assets consist of loans for which interest is no longer being
accrued, loans which have been restructured in order to increase the opportunity
to collect amounts due on the loan, real estate acquired through foreclosure and
real estate upon which deeds in lieu of foreclosure have been accepted. Interest
previously accrued but not collected on nonaccrual loans is reversed against
current income when a loan is placed on nonaccrual status. Accretion of deferred
fees is discontinued for nonaccrual loans. All loans past due ninety days, as
well as other loans considered uncollectible, are placed on non-accrual status.
Interest received on nonaccrual loans is recognized as interest income or
applied to principal when it is doubtful that full payment will be collected.
LOAN AND COMMITMENT FEES, DISCOUNTS AND PREMIUMS
Loan fees and certain direct loan origination costs are deferred and the net fee
or cost is recognized into interest income using the interest method over the
contractual life of the loans. Premiums and discounts on loans receivable are
amortized or accreted, respectively, into income using the interest method over
the remaining period to contractual maturity and adjusted for anticipated
prepayments. Premiums and discounts on loans held for sale are recognized as
part of the loss or gain upon sale and not amortized or accreted, respectively.
REAL ESTATE ACQUIRED THROUGH FORECLOSURE AND HELD FOR SALE
Real estate properties acquired through foreclosure and held for sale are
recorded at fair value less estimated selling costs at acquisition. Fair value
is determined by appraisal or other appropriate method of valuation. Losses
estimated at the time of acquisition are charged to the allowance for loan
losses. Valuations are periodically performed by management and an allowance for
losses is established through a charge to income if the carrying value of a
property exceeds its estimated fair value less selling costs.
DEFERRED FINANCING COSTS
Deferred financing costs related to the issuance of the subordinated notes have
been capitalized and are being amortized using the interest method over the life
of the subordinated notes.
INCOME TAXES
Effective January 1, 1993, the Bank adopted the provisions of Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS No.
109"). Under the asset and liability method of SFAS No. 109, deferred tax assets
and liabilities are recognized for the future tax consequences attributable to
temporary differences between the financial statement carrying amounts of
existing assets and their respective tax basis. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled.
FINANCIAL INSTRUMENTS
Interest rate swaps and caps are used by the Company in the management of its
interest-rate risk. The Company is generally exposed to rising interest rates
because of the nature of the repricing of rate-sensitive assets as compared with
rate-sensitive liabilities. The objective of these financial instruments is to
match estimated repricing periods of rate-sensitive assets and liabilities to
reduce interest rate exposure. These instruments are used only to hedge specific
assets and liabilities and are not used for speculative purposes. In order to be
eligible for hedge accounting treatment, high
25
<PAGE>
correlation must be probable at the inception of the hedge and must be
maintained throughout the hedge period. Once high correlation ceases, any gain
or loss on the hedge, up to the time high correlation ceased, should be
recognized to the extent the results of the hedging instrument were not offset
by the effects of interest rate changes on the hedged item. Upon the sale or
disposition of the hedged item, the hedging instrument should be
marked-to-market with changes recorded in the income statement. The net interest
received or paid on these contracts is treated as an adjustment to the interest
expense related to the hedged obligations in the period in which such amounts
are due. Premiums and fees associated with interest rate caps are amortized to
interest expense on a straight-line basis over the lives of the contracts.
OTHER ASSETS
Other assets include purchased loan servicing rights, premiums paid on interest
rate caps, and prepaid assets. The Bank services the loans underlying these
servicing rights. The cost of the loan servicing rights is amortized in
proportion to, and over the period of, the estimated net servicing income. For
the period ending December 31, 1997, amortization expense of loan servicing
rights was $547,000. Impairment of mortgage servicing rights is assessed based
on the fair value of those rights. Fair values are estimated using discounted
cash flows based on a current market interest rate. For purposes of measuring
impairment, the rights are stratified based on mortgage product types. The
amount of impairment recognized is the amount by which the capitalized mortgage
servicing rights exceed their fair value in aggregate. As of December 31, 1997,
the amortized cost and fair value of the loan servicing rights were $3.3 million
and $3.4 million, respectively. No valuation allowance was recognized at
December 31, 1997. Effective January 1, 1997, the Company adopted Statement of
Financial Accounting Standards No. 125, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities ("SFAS 125"), as amended
by Statement of Financial Accounting Standards No. 127, Deferral of the
Effective Date of Certain Provisions of FASB Statement No. 125--An Amendment of
FASB Statement No. 125 ("SFAS 127"). The implementation of SFAS 125 did not have
a material impact on the company's final position.
COMMITMENTS AND CONTINGENT LIABILITIES
In managing the Company's interest-rate risk, the Company utilizes financial
derivatives in the normal course of business. These products consist primarily
of interest rate cap and swap agreements. Financial derivatives are employed to
assist in the management and/or reduction of interest rate risk for the Company
and can effectively alter the interest sensitivity of segments of the balance
sheet for specified periods of time. The Company accounts for interest rate swap
agreements and cap agreements as hedges of debt issuances, deposit balances, and
investment in loan portfolio to which such agreements have been specifically
designated. Cash remittances due or received pursuant to these agreements are
reported as adjustments to interest expense on an accrual basis. Any premiums
paid in conjunction with these interest rate swap and interest rate cap
agreements are amortized as additional interest expense on a straight-line basis
over the term of these agreements. Any gain or loss upon early termination of
these instruments would be deferred and amortized as an adjustment to interest
expense over the term of the applicable interest rate agreement.
26
<PAGE>
RECLASSIFICATIONS
Certain reclassifications of the 1996 and 1995 financial statements have been
made to conform to the 1997 presentation.
3. CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory-and possibly additional discretionary-actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of total and Tier I
capital to risk-weighted assets and of Tier I capital to average assets.
Management believes, as of December 31, 1997, that the Bank meets all capital
adequacy requirements to which it is subject. As of December 31, 1997 and 1996,
the OTS categorized the Bank as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized the Bank
must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage
ratios as set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Bank's actual capital amounts and ratios are presented in the table below
($ in thousands):
<TABLE>
<CAPTION>
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes: Action Provisions:
Amount Ratio Amount Ratio Amount Ratio
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1997:
Total Capital (to risk greater than greater than greater than greater than
weighted assets) $55,701 11.91% $37,409 8.0% $46,761 10.0%
Core Capital (to adjusted greater than greater than greater than greater than
tangible assets) $52,617 5.06% $41,606 4.0% $52,008 5.0%
Tangible Capital (to greater than greater than
tangible assets) $52,608 5.06% $15,602 1.5% N/A N/A
Tier I Capital (to greater than greater than
risk weighted assets) $52,617 11.25% N/A N/A $28,057 6.0%
As of December 31, 1996:
Total Capital (to risk greater than greater than greater than greater than
weighted assets) $34,104 10.41% $26,205 8.0% $32,756 10.0%
Core Capital (to adjusted greater than greater than greater than greater than
tangible assets) $31,726 5.08% $24,999 4.0% $31,248 5.0%
Tangible Capital (to greater than greater than
tangible assets) $31,711 5.07% $9,374 1.5% N/A N/A
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Tier I Capital (to
risk weighted asset) $31,726 9.69% N/A N/A _$19,654 _6.0%
</TABLE>
On August 8, 1996, the OTS terminated the May 1993 Supervisory Agreement with
TeleBank subsequent to the completion of a full scope safety and soundness
examination of the Bank.
4. INVESTMENT SECURITIES
The cost basis and estimated fair values of investment securities
available-for-sale at December 31, 1997 and 1996, by contractual maturity, are
shown below (in thousands):
<TABLE>
<CAPTION>
Gross Gross
Amortized unrealized unrealized Estimated
cost gains losses fair values
<S> <C> <C> <C> <C>
1997:
Due within one year:
Agency notes $ 539 $ -- $ -- $ 539
Other investments 323 1 -- 324
Due within one to five years:
Municipal bonds 565 12 -- 577
Other investments 25,038 16 -- 25,054
Certificate of deposit 499 -- -- 499
Due within five to ten years:
Corporate debt 7,433 242 -- 7,675
Municipal bonds 3,562 130 -- 3,692
Other investments 175 -- -- 175
Due after ten years:
Agency notes 21,608 398 (40) 21,966
Equities 15,038 436 (50) 15,424
Corporate debt 11,103 797 -- 11,900
Municipal bonds 3,200 212 -- 3,412
$89,083 $2,244 $(90) $91,237
1996:
Due within one year:
Repurchase agreement $ 1,730 $ -- $ -- $ 1,730
Margin account 18 -- -- 18
Due within one to five years:
Corporate debt 2,000 -- (10) 1,990
Agency notes 988 1 -- 989
Municipal bonds 565 3 -- 568
Certificate of deposit 499 -- -- 499
Due within five to ten years:
Corporate debt 7,436 61 -- 7,497
Municipal bonds 3,560 27 -- 3,587
Due after ten years:
Agency notes 30,151 132 -- 30,283
Equities 14,011 220 -- 14,231
Corporate debt 13,089 994 -- 14,083
Municipal bonds 3,200 151 -- 3,351
$77,247 $1,589 $(10) $78,826
</TABLE>
28
<PAGE>
The proceeds from sale and gross realized gains and losses on investment
securities available for sale that were sold in 1997 were $25.9 million,
$423,000, and $34,000, respectively. The proceeds from sale and gross realized
gains and losses on investment securities available for sale that were sold in
1996 were $25.1 million, $311,000, and $153,000, respectively. The proceeds from
sale and gross realized gains and losses on investment securities available for
sale that were sold in 1995 were $24.1 million, $1.1 million, and $52,000,
respectively.
5. MORTGAGE-BACKED AND RELATED SECURITIES
Mortgage-backed and related securities represent participating interests in
pools of long-term first mortgage loans originated and serviced by the issuers
of the securities. The Company has also invested in collateralized mortgage
obligations ("CMOs") which are securities issued by special purpose entities
generally collateralized by pools of mortgage-backed securities. The Company's
CMOs are senior tranches collateralized by federal agency securities or whole
loans. The fair value of mortgage-backed and related securities fluctuate
according to current interest rate conditions and prepayments. Fair value is
estimated using quoted market prices. For illiquid securities, market prices are
estimated by obtaining market price quotes on similar liquid securities and
adjusting the price to reflect differences between the two securities, such as
credit risk, liquidity, term, coupon, payment characteristics, and other
information. The amortized cost basis and estimated fair values of
mortgage-backed securities available-for-sale at December 31, 1997 and 1996, by
contractual maturity, are shown as follows (in thousands):
<TABLE>
<CAPTION>
Gross Gross
Amortized unrealized unrealized Estimated
cost gains losses fair values
<S> <C> <C> <C> <C>
1997: Due within one year:
Agencies $ 939 $ -- $ -- $ 939
Due within one to five years:
Agencies 627 2 (6) 623
Private issuer 2,643 -- (22) 2,621
Due within five to ten years:
Private issuer 5,982 39 -- 6,021
Due after ten years:
Agencies 23,907 124 (27) 24,004
Private Issuer 143,889 2,971 (1,443) 145,417
Collateralized mortgage
obligations 139,663 536 (621) 139,578
$317,650 $3,672 $ (2,119) $319,203
1996:
Due within one to five years:
Private issuer $ 4,172 $ -- $ (56) $ 4,116
Due within five to ten years:
Private issuer 8,262 75 -- 8,337
Collateralized mortgage
obligations 371 -- (3) 368
Due after ten years:
Private issuer 132,791 1,367 -- 134,158
Collateralized mortgage
obligations 24,896 461 -- 25,357
Agency certificates 12,310 97 -- 12,407
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
$182,802 $2,000 $ (59) $184,743
</TABLE>
The Company pledged $104.1 million and $61.4 million of private issuer
mortgage-backed securities as collateral for repurchase agreements at December
31, 1997 and 1996, respectively. The proceeds from sale and gross realized gains
and losses on mortgage-backed securities available for sale that were sold in
1997 were $112.4 million, $845,000, and $253,000, respectively. The proceeds
from sale and realized gains and losses on mortgage-backed securities available
for sale that were sold in 1996 were $185.2 million, $1.4 million, and $707,000
respectively. The proceeds from sale and realized gains and losses on
mortgage-backed securities available for sale that were sold in 1995 were $39.7
million, $1.6 million, and $3,000, respectively.
6. LOANS RECEIVABLE
Loans receivable at December 31, 1997 and 1996 are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
First mortgage loans (principally conventional):
Secured by one-to-four family residences $547,734 $359,563
Secured by commercial real estate 3,009 4,017
Secured by mixed-use property 856 1,180
Secured by five or more dwelling units 1,447 1,516
Secured by land 378 781
553,424 367,057
Less:
Net deferred loan origination fees (34) (42)
Unamortized discounts, net (9,938) (13,750)
Total first mortgage loans 543,452 353,265
Other loans:
Home equity and second mortgage loans 541 1,208
Other 305 305
544,298 354,778
Less: allowance for loan losses (3,594) (2,957)
Net loans receivable $540,704 $351,821
</TABLE>
The mortgage loans are located primarily in California, New York, and Virginia
according to the following percentages 15.1%, 13.3%, and 7.4%, respectively. As
of December 31, 1997, the mortgage loan portfolio consisted of variable rate
loans of $335.2 million or 62% and fixed rate loans of $205.5 million, or 38%.
The weighted average maturity of mortgage loans secured by one to four family
residences is 266 months as of December 31, 1997. The unpaid principal balance
of mortgage loans owned by the Company but serviced by other companies was
$301.5 million and $203.9 million at December 31, 1997 and 1996, respectively.
Loans past due ninety days or more, and therefore on non-accrual status at
December 31, 1997 and 1996, are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
First mortgage loans:
Secured by one-to-four family residences $ 10,802 $ 8,979
Secured by commercial real estate 635 1,217
Home equity and second mortgage loans 0 54
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Total $11,437 $10,250
</TABLE>
The interest accrual balance for each loan that enters non-accrual is reversed
from income. If all nonperforming loans had been performing during 1997, 1996,
and 1995, the Bank would have recorded $739,000, $789,000, and $365,000,
respectively, in additional interest income. There were no commitments to lend
additional funds to these borrowers as of December 31, 1997 and 1996.
Activity in the allowance for loan losses for the years ended December 31, 1997,
1996, and 1995 is summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Balance, beginning of the year $2,957 $2,311 $ 989
Provision for loan losses 921 919 1,722
Charge-offs, net (284) (273) (400)
Balance, end of year $3,594 $2,957 $2,311
</TABLE>
According to Statement of Financial Accounting Standards No. 114, Accounting by
Creditors for Impairment of a Loan, ("SFAS No. 114"), a loan is considered
impaired when, based upon current information and events, it is probable that a
creditor will be unable to collect all amounts due according to the contractual
terms of the loan agreement. The term "all amounts due" includes both the
contractual interest and principal payments of a loan as scheduled in the loan
agreement. The Company has determined that once a loan becomes 90 or more days
past due, collection of all amounts due is no longer probable and is therefore
considered impaired. The amount of impairment is measured based upon the fair
value of the underlying collateral and is reflected through the creation of a
valuation allowance. The table below presents impaired loans as of December 31,
1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
Amount
Total Amount of of recorded
recorded investment specific investment net of
Description of Loans in impaired loans reserves specific reserves
<S> <C> <C> <C>
1997: Impaired loans:
Commercial real estate $ 635 $ 248 $ 387
One-to-four family 10,802 1,760 9,042
Total $ 11,437 $ 2,008 $ 9,429
Restructured loans:
Commercial real estate $ 248 $ - $ 248
One-to-four family 177 - 177
Total $ 425 $ - $ 425
1996:
Impaired loans:
Commercial real estate $ 1,217 $ 318 $ 899
One-to-four family 9,033 1,492 7,541
Total $ 10,250 $ 1,810 $ 8,440
Restructured loans:
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Commercial real estate $ 251 $ 8 $ 243
One-to-four family 184 0 184
Total $ 435 $ 8 $ 427
</TABLE>
The average recorded investment in impaired loans, with identified losses, as of
December 31, 1997, 1996, and 1995 was $2.3 million, $2.2 million, and $2.0
million, respectively. The related amount of interest income the Company would
recognize as additional interest income for the years ended December 31, 1997,
1996, and 1995 was $739,000, $789,000, and $365,000, respectively. The Company's
charge-off policy for impaired loans is consistent with its charge-off policy
for other loans; impaired loans are charged-off when, in the opinion of
management, all principal and interest due on the impaired loan will not be
fully collected. Consistent with the Company's method for non-accrual loans,
interest received on impaired loans is recognized as interest income or applied
to principal when it is doubtful that full payment will be collected.
7. REAL ESTATE ACQUIRED THROUGH FORECLOSURE
Real estate acquired through foreclosure at December 31, 1997 and December 31,
1996 was $681,000 and $1.2 million, respectively. Activity in the allowance for
real estate losses for the years ended December 31, 1997, 1996, and 1995 is
summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Balance, beginning of year $ 65 $ 213 $ 92
Provision for real estate losses 19 77 256
Charge-offs (84) (225) (135)
Balance, end of year $ - $ 65 $ 213
</TABLE>
8. LOANS SERVICED FOR OTHERS
Mortgage loans serviced by the Bank for others are not included in the
accompanying consolidated statements of financial condition because the related
loans are not owned by the Company or any of its subsidiaries. The unpaid
principal balances of these loans at December 31, 1997 and 1996 are summarized
as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Mortgage loans underlying pass-through securities:
Federal Home Loan Mortgage Corporation $ 2,140 $ 2,843
Federal National Mortgage Association 28,417 11,548
Subtotal $ 30,557 $ 14,391
Mortgage loan portfolio serviced for:
Other investors 27,125 31,465
Total $ 57,682 $ 45,856
</TABLE>
32
<PAGE>
Custodial escrow balances held in connection with the foregoing loans serviced
were approximately $120,000 and $84,000 at December 31, 1997 and 1996,
respectively. Included in other assets is purchased mortgage servicing rights of
$3.3 million and $2.8 million as of December 31, 1997 and 1996, respectively.
9. DEPOSITS
The Bank initiates deposits directly with customers through contact on the
phone, the mail, and walk-in at its headquarters. On May 2, 1996, TeleBanc
entered into an agreement to assume certain deposit liabilities with First
Commonwealth Savings Bank FSB ("First Commonwealth"), First Commonwealth
Financial Corp., and John York, Jr. Pursuant to this agreement, TeleBanc assumed
certain brokered and telephone solicited deposits accounts of First Commonwealth
which had a current balance of approximately $53.1 million as of April 30, 1996.
In the deposit assumption, First Commonwealth paid TeleBanc the amount of the
deposit liabilities assumed, plus the amount of the deposit liabilities (less
certain renewals) multiplied by 0.25 percent. Deposits at December 31, 1997 and
1996 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
Weighted
average rate at
December 31 Amount Percent
1997 1996 1997 1996 1997 1996
<S> <C> <C> <C> <C> <C>
Demand accounts,
non interest-
bearing --% --% $ 761 $ 309 0.2% --%
Money market 5.26 5.10 122,185 109,835 23.4 28.1
Passbook savings 3.00 3.00 665 1,758 0.1 0.5
Certificates of
deposit 6.24 6.28 398,610 278,584 76.3 71.4
Total $ 522,221 $ 390,486 100.0% 100.0%
</TABLE>
Certificates of deposit and money market accounts, classified by rates as of
December 31, 1997 and 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
Amount 1997 1996
<S> <C> <C>
0 - 1.99% $ 5 $ 5,235
2 - 3.99% -- 148
4 - 5.99% 231,048 210,481
6 - 7.99% 289,046 170,056
8 - 9.99% 696 1,709
10 - 11.99% -- 790
Total $ 520,795 $ 388,419
</TABLE>
At December 31, 1997, scheduled maturities of certificates of deposit and money
market accounts are as follows (in thousands):
<TABLE>
<CAPTION>
Less than 1-2 2-3 3-4 4-5 5+
one year years years years years years Total
<S> <C> <C> <C> <C> <C> <C> <C>
0 - 1.99% $ 5 $ -- $ -- $ -- $ -- $ -- $ 5
2 - 3.99% -- -- -- -- -- -- --
4 - 5.99% 209,547 17,708 2,217 1,126 362 88 231,048
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C>
6 - 7.99% 37,687 124,905 97,079 13,550 9,849 5,976 289,046
8 - 9.99% 578 -- 82 -- 36 -- 696
10 - 11.99% -- -- -- -- -- -- --
$ 247,817 $142,613 $ 99,378 $ 14,676 $ 10,247 $ 6,064 $ 520,795
</TABLE>
The aggregate amount of certificates of deposit with denominations greater than
or equal to $100,000 was $47.5 million and $45.1 million at December 31, 1997
and 1996, respectively. Interest expense on deposits for the years ended
December 31, 1997, 1996, and 1995 is summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Money market $ 6,353 $ 4,740 $ 2,036
Passbook savings 27 59 78
Certificates of deposit 19,578 16,558 14,919
Total $25,958 $21,357 $17,033
</TABLE>
Accrued interest payable on deposits at December 31, 1997 and 1996 was $728,000
and $667,000, respectively.
10. ADVANCES FROM THE FHLB OF ATLANTA
Advances to the Bank from the FHLB of Atlanta at December 31, 1997 and 1996 were
as follows (dollars in thousands):
<TABLE>
<CAPTION>
Weighted Weighted
average average
1997 interest rate 1996 interest rate
<S> <C> <C> <C>
1996 $ -- -- % $ -- 5.52 %
1997 -- -- 64,800 5.56
1998 71,000 5.61 41,000 5.53
1999 129,000 5.69 39,000 5.60
Total $200,000 5.66% $144,800 5.56%
</TABLE>
All advances, except for $2.0 million which matured in November of 1996, are
floating rate advances and adjust quarterly or semi-annually to the London
InterBank Offering Rate ("LIBOR") rate. In 1997 and 1996, the advances were
collateralized by a specific lien on mortgage loans in accordance with an
"Advances, Specific Collateral Pledge and Security Agreement" with the FHLB of
Atlanta, executed September 10, 1980. Under this agreement, the Bank is required
to maintain qualified collateral equal to 120 to 160 percent of the Bank's FHLB
advances, depending on the collateral type. As of December 31, 1997 and 1996,
the Company secured these advances with an assignment of specific mortgage loan
collateral from its loan and mortgage-backed security portfolio. These
one-to-four family whole first mortgage loans and securities pledged as
collateral totaled approximately $ 259.9 million and $ 186.1 million at December
31, 1997 and 1996, respectively. The Company is required to be a member of the
FHLB System and to maintain an investment in the stock of the FHLB of Atlanta at
least equal to the greater of 1 percent of the unpaid principal balance of its
residential mortgage loans or 1 percent of 30 percent of its total assets or
1/20th of its outstanding advances from the FHLB.
11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
34
<PAGE>
Information concerning borrowings under fixed and variable rate coupon
repurchase agreements is summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Weighted average balance during the year $117,431 $68,920
Weighted average interest rate during the year 5.76% 5.77%
Maximum month-end balance during the year $279,909 $97,416
Balance at year-end $279,909 $57,581
Private issuer mortgage-backed securities underlying
the agreements as of the end of the year:
Carrying value, including accrued interest $295,556 $61,418
Estimated market value $295,500 $61,426
</TABLE>
The securities sold under the repurchase agreements at December 31, 1997 are due
in less than one year. The Company enters into sales of securities under
agreements to repurchase the same securities. Repurchase agreements are
collateralized by fixed and variable rate mortgage-backed securities or
investment grade securities. Repurchase agreements are treated as financings,
and the obligations to repurchase securities sold are reflected as a liability
in the balance sheet. The dollar amount of securities underlying the agreement
remains in the asset accounts. The securities underlying the agreements are
physical and book entry securities and the brokers retain possession of the
securities collateralizing the repurchase agreements. If the counterparty in a
repurchase agreement was to fail, the Company may incur an accounting loss for
the excess collateral posted with the counterparty. As of December 31, 1997,
Lehman Brothers Inc. represents the only counterparty with which the Company's
amount at risk exceeded 10% of the Company's stockholders' equity. The amount of
risk at December 31, 1997 with Lehman Brothers Inc. was $5.1 million with a
weighted average maturity of 47 days.
12. SUBORDINATED DEBT
In May and June 1994, the Company issued 15,000 units of subordinated debt at a
price of $15.0 million and 2,250 units at a price of $2.3 million, respectively.
The units each consist of $1,000 of 11.5% subordinated notes due in 2004 and 20
detachable warrants to purchase one share each of TeleBanc common stock. The
notes may not be redeemed prior to May 1, 1999. The notes are redeemable at the
option of the Company after May 1, 1999, at an initial redemption price of
105.75% of the principal amount plus accrued interest with the redemption price
declining to 104.60%, 103.45%, 102.30%, and 101.15% annually each year
thereafter. Interest is payable semi-annually on May 1 and November 1,
commencing November 1, 1994. The indenture, among other things, restricts the
ability of the Company under certain circumstances to incur additional
indebtedness, limits cash dividends and other capital distributions by the
Company, requires the maintenance of a reserve equal to 100% of the Company's
annual interest expense on all indebtedness, restricts disposition of the Bank
or its assets, and limits transactions with affiliates. The annual interest
expense to service the subordinated debt is $2.0 million.
The total value of the 345,000 warrants was $948,750 which resulted in an
original issue discount on the subordinated debt in the amount of $899,289. The
original issue discount is amortized on a level yield basis over the life of the
debt.
35
<PAGE>
The warrants became transferable on November 27, 1994 and are exercisable on or
after May, 27, 1995. The exercise price of each warrant is $7.65625.
On February 28, 1997, the Company sold $29.9 million of units in the form of 4%
convertible preferred stock and 9.5% senior subordinated notes and warrants to
investment partnerships managed by Conning & Co., CIBC Wood Gundy Argosy
Merchant Fund 2, LLC, The Progressive Corporation, and The Northwestern Mutual
Life Insurance Company. Upon the sale of the units, representatives from the
Conning partnerships and the CIBC Merchant Fund were appointed to the Company's
Board. The units consist of $13.7 million in 9.5% senior subordinated notes with
198,088 detachable warrants, $16.2 million in 4.0% convertible preferred stock,
and rights to 205,563 contingent warrants. The senior subordinated notes are due
on March 31, 2004 and stipulate increases over time in interest rates subsequent
to March 31, 2002 from 9.5% up to 15.25%. The warrants are exercisable at $9.50
with an expiration date of February 28, 2005. The preferred stock consists of
Series A Voting Convertible Preferred Stock, Series B Nonvoting Convertible
Preferred Stock, and Series C Nonvoting Convertible Preferred Stock and is
convertible to 1,199,743 shares of common stock. Series A and Series B shares
may be converted at any time into fully-paid and non-assessable shares of Voting
Common Stock. Series C shares may be converted at any time to Series A or Series
B shares or at any time into fully-paid and non-assessable nonvoting common
stock. The aforementioned preferred stock has no liquidation preferences. The
contingent warrants may be exercised upon a change of control or at any time
after February 19, 2002 ("Exercise Event"). If the Company's annual internal
rate of return is less than 25% at the time of an Exercise Event, unit holders
may exercise the contingent warrants for $0.01 until an internal rate of return
of 25% is reached. The annual interest expense to service the senior
subordinated notes is $1.3 million and the annual dividend requirement on the
preferred stock is $648,000.
In June 1997, the Company formed TeleBanc Capital Trust I, which in turn sold,
at par, 10,000 shares of trust preferred securities, Series A, liquidation
amount of $1,000, for a total of $10,000,000 in a private placement. TeleBanc
Capital Trust I is a business trust formed for the purpose of issuing capital
securities and investing the proceeds in junior subordinated debentures issued
by the company. The trust preferred securities mature in 2027 and have an annual
dividend rate of 11.0%, or $1.1 million, payable semi-annually, beginning in
December 1997. The net proceeds will be used, for general corporate purposes,
including to fund Bank operations and the creation and expansion of its
financial service and product operations.
13. EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 "Earnings per Share" ("SFAS 128"),
effective December 15, 1997. This statement specifies the computation,
presentation, and disclosure requirements for earnings per share ("EPS") for
entities with publicly held common stock or potential common stock.
Basic earnings per common share, as required by SFAS 128, is computed by
dividing adjusted net income by the total of the weighted average number of
common shares outstanding during the respective periods. Diluted earnings per
common share for the years ended December 31, 1997, 1996, and 1995 were
determined on the assumptions that the
36
<PAGE>
dilutive options and warrants were exercised upon issuance. The options and
warrants are deemed to be dilutive if (a) the average market price of the
related common stock for a period exceeds the exercise price or (b) the security
to be tendered is selling at a price below that at which it may be tendered
under the option or warrant agreement and the resulting discount is sufficient
to establish an effective exercise price below the market price of the common
stock obtainable upon exercise. The Company's year to date weighted average
number of common shares outstanding was 2,191,455 at December 31, 1997 and
2,049,500 at December 31, 1996 and 1995. For diluted earnings per share
computation, weighted average shares outstanding also include potentially
dilutive securities.
<TABLE>
<CAPTION>
EPS Calculation
Income Shares Per Share Amount
-----------------------------------------------------------------------
For the Year Ended December 31, 1997
-----------------------------------------------------------------------
<S> <C> <C> <C>
Net income $ 4,216,826
less: preferred stock dividends (546,182)
-----------------------
Basic earnings per share
Income available to common shareholders $ 3,670,644 2,191,455 $ 1.68
=======================
Options issued to management -- 224,145
Warrants -- 250,410
Convertible preferred stock 546,182 167,026
----------------------- -----------------------
Diluted earnings per share $ 4,216,826 2,833,036 $ 1.49
======================= ======================= =======================
For the Year Ended December 31, 1996
-----------------------------------------------------------------------
Basic earnings per share
Net income $ 2,552,044 2,049,500 $ 1.25
=======================
Options issued to management -- 91,031
Warrants -- 62,544
Diluted earnings per share $ 2,552,044 2,203,075 $ 1.16
======================= ======================= =======================
For the Year Ended December 31, 1995
-----------------------------------------------------------------------
Basic earnings per share
Net income $ 2,719,875 2,049,500 $ 1.33
=======================
Options issued to management -- 2,694
Diluted earnings per share $ 2,719,875 2,052,194 $ 1.33
======================= ======================= =======================
</TABLE>
14. INCOME TAXES
Income tax expense for the years ended December 31, 1997, 1996, and 1995 is
summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Current: Federal $ 1,881 $ 1,194 $ 2,038
State 221 225 181
-------------------------------------
2,102 1,419 2,219
Deferred: Federal (398) (78) (474)
State (47) (146) (85)
-------------------------------------
(445) (224) (559)
Total: Federal 1,483 1,116 1,564
State 174 79 96
-------------------------------------
$ 1,657 $ 1,195 $1,660
</TABLE>
37
<PAGE>
A reconciliation of the statutory Federal income tax rate to the Company's
effective income tax rate for the years ended December 31, 1997, 1996, and 1995
is as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal income tax at statutory rate 34.0% 34.0% 34.0%
State taxes, net of federal benefit 4.2 4.2 4.2
Municipal bond interest, net of
disallowed interest expense (5.8) (3.6) (7.0)
Other (6.0) (2.7) 6.7
-----------------------------------
26.4% 31.9% 37.9%
</TABLE>
Deferred income taxes result from temporary differences in the recognition of
income and expense for tax versus financial reporting purposes. The sources of
these temporary differences and the related tax effects for the years ended
December 31, 1997 and 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------ -------
<S> <C> <C>
Deferred Tax Liabilities:
Acquired Loan Servicing Rights $ - $ (12)
Purchase Accounting Premium (75) (40)
Depreciation (44) (17)
Tax Reserve in Excess of Base Year (134) (93)
Tax Effect of Securities Available-for-sale
Adjustment to Fair Value (notes 4 and 5) (722) (1,030)
FHLB Stock Dividends (129) (168)
Other (89) (52)
---------------------
Total (1,193) $(1,412)
Deferred Tax Assets:
General Reserves & Real Estate Owned Losses 1,293 819
Other 80 20
--------------------
Total 1,373 839
Net Deferred Tax Asset (Liability) $ 180 $ (573)
</TABLE>
The Company has a tax bad debt base year reserve of $264,000 for which income
taxes have not been provided. Certain distributions or transactions may cause
the Bank to recapture its tax bad debt base year reserve, resulting in taxes of
$100,000. In addition, the Bank has entered into a tax sharing agreement with
TeleBanc under which it is allocated its share of income tax expense or benefit
based on its portion of consolidated income or loss.
15. FINANCIAL INSTRUMENTS
The Company is party to a variety of interest rate caps and swaps to manage
interest rate exposure. In general, the Company enters into agreements to assume
fixed-rate interest payments in exchange for variable market-indexed interest
payments. The effect of these agreements is to lengthen short-term variable
liabilities into longer term fixed-rate liabilities or to shorten long-term
fixed rate assets into short-term variable rate assets. The net costs of these
38
<PAGE>
agreements are charged to interest expense or interest income, depending on
whether the agreement is designated to hedge a liability or an asset.
Interest rate exchange agreements for the years ended December 31, 1997 and 1996
are summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Weighted average fixed rate payments 6.15% 5.97%
Weighted average original term 4.6 yrs 5.0 yrs
Weighted average variable rate obligation 5.81% 5.62%
Notional Amount $ 205,000 $ 130,000
</TABLE>
The Company enters into interest rate cap agreements to hedge outstanding FHLB
advances and repurchase agreements. Under the terms of the interest rate cap
agreements, the Company generally would receive an amount equal to the
difference between 3 month LIBOR or 6 month LIBOR and the cap's strike rate,
multiplied by the notional amount. The interest rate cap agreements are
summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Effective Notional Maturity
Cap Strike Rate Date Balance Date
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
4% July 1992 $10,000 July 1999
6% October 1996 $20,000 October 1999
7% January 1997 $10,000 January 2002
7% January 1995 $10,000 July 1998
7.5% July 1997 $25,000 July 1999
8% July 1997 $25,000 July 2000
8% June 1997 $25,000 June 2000
9% December 1994 $14,000 December 1998
10% April 1995 $10,000 January 2002
</TABLE>
The counterparties to the interest rate cap agreements are Goldman Sachs, Lehman
Brothers, Merrill Lynch, NationsBank, Nomura, Salomon Brothers, and UBS. As of
December 31, 1997, the associated credit risk with the aforementioned
counterparties are $332,000, $104,000, $117,000, $66,000, $30,000, $132,000, and
$605,000, respectively. The credit risk is attributable to the unamortized cap
premium and any amounts due from the counterparty as of December 31,1997. The
total amortization expense for premiums on interest rate caps was $777,000,
$638,000, and $213,000 for the years ended December 31, 1997, 1996, and 1995,
respectively.
16. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS
The fair value information for financial instruments, which is provided below,
is based on the requirements of Statement of Financial Accounting Standards No.
107, Disclosure About Fair Value of Financial Instruments ("SFAS No. 107") and
does not represent the aggregate net fair value of the Bank. Much of the
information used to determine fair value is subjective and judgmental in nature,
therefore, fair value estimates, especially for less marketable securities, may
vary. In addition, the amounts actually realized or paid upon settlement or
maturity could be significantly different.
39
<PAGE>
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument for which it is reasonable to estimate that
value:
CASH AND INTEREST-BEARING DEPOSITS - Fair value is estimated to be carrying
value.
FEDERAL FUNDS SOLD - Fair value is estimated to be carrying value.
SECURITIES PURCHASED UNDER AGREEMENT TO RESELL - Fair value is estimated to be
carrying value.
INVESTMENT SECURITIES - Fair value is estimated by using quoted market prices
for most securities. For illiquid securities, market prices are estimated by
obtaining market price quotes on similar liquid securities and adjusting the
price to reflect differences between the two securities, such as credit risk,
liquidity, term coupon, payment characteristics, and other information.
MORTGAGE-BACKED AND RELATED SECURITIES - Fair value is estimated using quoted
market prices. For illiquid securities, market prices are estimated by obtaining
market price quotes on similar liquid securities and adjusting the price to
reflect differences between the two securities, such as credit risk, liquidity,
term coupon, payment characteristics, and other information.
LOANS RECEIVABLE - For certain residential mortgage loans, fair value is
estimated using quoted market prices for similar types of products. The fair
value of other certain types of loans is estimated using quoted market prices
for securities backed by similar loans.
The fair value for loans which could not be reasonably established using the
previous two methods was estimated by discounting future cash flows using
current rates for similar loans.
Management adjusts the discount rate to reflect the individual characteristics
of the loan, such as credit risk, coupon, term, payment characteristics, and the
liquidity of the secondary market for these types of loans.
DEPOSITS - For passbook savings, checking and money market accounts, fair value
is estimated at carrying value. For fixed maturity certificates of deposit, fair
value is estimated by discounting future cash flows at the currently offered
rates for deposits of similar remaining maturities.
ADVANCES FROM THE FHLB OF ATLANTA - For adjustable rate advances, fair value is
estimated at carrying value. For fixed rate advances, fair value is estimated by
discounting future cash flows at the currently offered rates for fixed-rate
advances of similar remaining maturities.
40
<PAGE>
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE - Fair value is estimated using
carrying value. The securities are repriced on a semiannual basis.
SUBORDINATED DEBT - For subordinated debt, fair value is estimated using quoted
market prices.
OFF-BALANCE SHEET INSTRUMENTS - The fair value of interest rate exchange
agreements is the net cost to the Company to terminate the agreement as
determined from market quotes. The fair value of financial instruments as of
December 31, 1997 and 1996 is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1997 1996 1996
Carrying Fair Carrying Fair
Value Value Value Value
--------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents 92,156 92,156 3,259 3,259
Investment securities
available-for-sale 91,237 91,237 78,826 78,826
Mortgage-backed securities
available-for-sale 319,203 319,203 184,743 184,743
Loans receivable 540,704 562,270 351,821 365,401
Trading 21,110 21,110 -- --
Liabilities:
Deposits $ 522,221 $ 524,022 $390,486 $ 393,820
Advances from the FHLB Atlanta 200,000 200,000 144,800 144,800
Securities sold under agreements
to repurchase 279,909 279,909 57,581 57,581
Subordinated debt, net 29,614 30,953 16,586 16,625
Trust preferred 9,572 10,000 -- --
Off-balance sheet instruments -- $ (1 ,342) -- $ 1,684
Commitments to purchase loans -- -- --
</TABLE>
17. DISTRIBUTIONS
The Bank is subject to certain restrictions on the amount of dividends it may
declare without prior regulatory approval. At December 31, 1997, approximately
$10.6 million of retained earnings were available for dividend declaration.
18. EMPLOYEE STOCK OWNERSHIP PLAN
The Company sponsors an Employee Stock Ownership Plan ("ESOP"). All full-time
employees of the Company who meet limited qualifications participate in the
ESOP. Under the ESOP, the Company contributes cash to a separate trust fund
maintained exclusively for the benefit of those employees who have become
participants. Participants will have shares of TeleBanc common stock, valued at
market value, allocated to their personal plan accounts based on a uniform
percentage of wages. At December 31, 1997 and 1996, the Company carried a
$305,000 note receivable from the ESOP which was collateralized by the Company's
common stock. The ESOP owned 67,600 shares of the Company's stock with
approximately 39,000 and 32,000 shares vested at December 31, 1997 and 1996,
respectively. The Company's
41
<PAGE>
contribution to the ESOP, which is reflected in compensation expense, was
$247,000, $224,000 and $210,000 for the years ended December 31, 1997, 1996, and
1995, respectively.
19. STOCK BASED COMPENSATION
In 1997, the Company authorized and issued 349,201 options to directors,
officers and employees to purchase 349,201 shares of TeleBanc common stock at
prices ranging from $2.66 to $13.50. In 1996, officers and employees were issued
80,500 options to purchase 80,500 shares of TeleBanc common stock at prices
ranging from $7.75 to $8.875. As of December 31, 1997 and 1996, 299,124 and
180,438 of the shares,respectively, were vested at exercise prices ranging from
$2.66 to $12.50. The maximum term for the outstanding options is 10 years. As of
December 31, 1997, the total number of authorized options is 901,431. The
options' exercise price was the market value of the stock at the date of
issuance.
<TABLE>
<CAPTION>
1997 1996 1995
Options Shares Weighted Avg. Shares Weighted Avg. Shares Weighted Avg.
(000's) Exercise Price (000's) Exercise Price (000's) Exercise Price
------- -------------- ------- -------------- ------- --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 352 $6.89 271 $6.51 242 $6.64
Granted 349 $12.51 81 $8.17 32 $5.50
Exercised 17 $6.52 - - - -
Forfeited 19 $11.40 - - 3 $6.13
Outstanding at end of year 665 $9.72 352 $6.89 271 $6.51
Options exercisable at year-end 299 $8.06 180 $6.69 110 $6.55
Weighted avg. fair value of options $3.49 $2.61 $1.81
granted
</TABLE>
The following table summarizes information about fixed options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding (000's) Options Exercisable (000's)
Range of Exercise Prices Number Weighted Avg. Weighted Avg. Number Exercisable Weighted Avg.
Outstanding Remaining Exercise Price Exercise Price
Contractual Life
(Years)
<S> <C> <C> <C> <C> <C>
Less than $5.00 24 9.2 $2.66 5 $2.66
$5.00 - $7.49 255 6.5 $6.55 202 $6.57
$7.50 - $9.99 74 8.3 $8.21 30 $8.21
$10.00 - $12.49 - - - - -
$12.50 - $14.99 312 9.2 $13.23 62 $13.23
--- ---
Less than $5.00 - $14.99 665 8.0 $9.72 299 $8.06
=== ===
</TABLE>
Because the method of accounting required by SFAS No. 123 has not been applied
to options granted prior to January 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years. The fair
value of each option grant is estimated on the date of grant using the Roll
Geske option pricing model with the
42
<PAGE>
following weighted average assumptions for grants; risk-free interest rates of
5.08 percent, 5.25 percent and 6.00 percent for 1997, 1996, and 1995,
respectively; expected life of 10 years for all options granted in 1997, 1996,
and 1995; expected volatility of 25 percent, 23 percent, and 16 percent for
1997, 1996, and 1995 respectively. The Company accounts for this plan under APB
No. 25, under which no compensation cost has been recognized. Had compensation
cost for the plan been determined consistent with SFAS No. 123, the Company's
net income and net income per share would have been reduced to the following pro
forma amounts:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
12/31/97 12/31/96 12/31/95
-------- -------- --------
<S> <C> <C> <C>
Net income:
As reported $ 3,671 $ 2,552 $ 2,720
Pro forma $ 2,629 $ 2,409 $ 2,684
Basic earnings per share:
As reported $ 1.68 $ 1.25 $ 1.33
Pro forma $ 1.20 $ 1.18 $ 1.31
Diluted earnings per share:
As reported $ 1.49 $ 1.16 $ 1.33
Pro forma $ 1.12 $ 1.09 $ 1.31
</TABLE>
20. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company has various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying consolidated financial statements. The principal commitments of the
Company are as follows:
At December 31, 1997, the Company was obligated under an operating lease for
office space with an original term of ten years. Net rent expense under
operating leases was approximately $238,000, $142,000, and $127,000 for the
years ended December 31, 1997, 1996, and 1995, respectively.
The projected minimum rental payments under the terms of the lease are as
follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
Years ending
December 31, Amount
- ---------------------------------------------------------------------------------------------------
<S> <C>
1998 $ 190,000
1999 165,000
2000 166,000
2001 167,000
2002 168,000
- ---------------------------------------------------------------------------------------------------
2003 and thereafter 267,000
$ 1,123,000
- ---------------------------------------------------------------------------------------------------
</TABLE>
As of December 31, 1997, the Company had commitments to purchase $24.0 million
of mortgage loans.
43
<PAGE>
The Company self-insures for a portion of health insurance expenses paid by the
Company as a benefit to its employees. At December 31, 1997 and 1996, there was
no reserve needed for incurred but not reported claims under this insurance
arrangement.
21. SUBSEQUENT EVENTS
In the first quarter of 1998, TeleBanc signed a definitive merger agreement (the
"DFC Acquisition") to acquire Direct Financial Corporation ("DFC"). DFC is the
parent holding company of Premium Bank, a federal savings bank headquartered in
New Jersey. At December 31, 1997, DFC reported total assets of $326.1 million,
loans receivable, net of $187.2 million, total deposits of $273.9 million and
total stockholders' equity of $12.3 million. TeleBanc will pay $12 for each
share of Direct Financial common stock or common stock equivalent. The
transaction is valued at approximately $26.4 million. The DFC Acquisition is
expected to be consummated in the second quarter of 1998, subject to DFC
stockholder and regulatory approvals.
Also in January 1998, TeleBanc announced that it had signed a definitive
acquisition agreement whereby MET Holdings will sell substantially all of its
assets, including approximately 1,433,081 shares of TeleBanc Common Stock owned
by MET Holdings, and assign substantially all of its liabilities, to TeleBanc.
Immediately following consummation of the acquisition, MET Holdings will
dissolve and distribute its remaining assets and liabilities to its
stockholders, assuming such dissolution is approved by the requisite number of
stockholders of MET Holdings and TeleBanc.
22. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)
Statements of Financial Condition
($ in thousands)
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------
1997 1996
--------- --------
<S> <C> <C>
Assets:
Cash $ 5,401 $ 159
Investment securities available-for-sale 4,186 4,132
Mortgage-backed securities
available-for-sale 26,219 14,086
Loans receivable, net 566 305
Loan receivable held for sale 6,367 --
Trading 14,011 --
Equity in net assets of subsidiary 58,976 34,130
Deferred charges 1,460 940
Other assets 4,806 1,099
--------- --------
Total assets $ 121,992 $ 54,851
Liabilities and Stockholders' Equity
Liabilities:
</TABLE>
44
<PAGE>
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------
1997 1996
--------- --------
<S> <C> <C>
Subordinated debt $ 39,614 $ 16,586
Securities sold under agreements
to repurchase 33,555 12,831
Accrued interest payable 1,037 357
Taxes payable and other liabilities 1,962 419
--------- --------
Total liabilities $ 76,168 $ 30,193
--------- --------
Stockholders' Equity
Preferred Stock $ 15,281 $ --
Common Stock 22 20
Additional Paid in Capital 16,207 14,637
Retained earnings 11,576 7,905
Unrealized gain/loss on
securities available-for-sale 2,738 2,096
--------- --------
Total stockholders' equity 45,824 24,658
--------- --------
Total liabilities and stockholders' equity $121,992 $ 54,851
<CAPTION>
STATEMENTS OF OPERATIONS
($ in thousands)
December 31,
----------------------------------------------------------------
1997 1996 1995
--------- -------- -------
<S> <C> <C> <C>
Interest income $ 2,683 $ 531 $ 429
Interest expense 4,352 2,163 2,111
Net interest loss (1,669) (1,632) (1,682)
Non interest income 13 133 92
Total general and
administrative expenses 1,288 1,393 1,046
Non interest expenses 195 127 126
Net loss before equity in
net income of subsidiary
and income taxes (3,139) (3,019) (2,762)
Equity in net income
of subsidiary 5,668 6,716 4,434
Income taxes (1,688) 1,145 (1,048)
Preferred stock dividend 546 -- --
Net income $ 3,671 $ 2,552 $ 2,720
<CAPTION>
STATEMENTS OF CASH FLOWS
Year ended December 31,
-----------------------------------------------------
(Dollars in thousands) 1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 4,217 $ 2,552 $ 2,720
Adjustments to reconcile net income to
net cash provided by operating activities:
Equity in undistributed earnings of subsidiaries (5,668) (4,426) (4,434)
Purchases of loans held for sale (6,367) -- --
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------
(Dollars in thousands) 1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Net (increase) in trading securities (14,011) -- --
(Increase) decrease in other assets (4,227) (686) 38
Increase in accrued expenses and other liabilities 2,223 267 122
Net cash provided by operating activities (23,833) (2,293) (1,554)
Cash flows from investing activities:
Net (increase) decrease in loan to Employee Stock
Ownership Plan -- (65) 60
Net increase in loans (261) -- --
Net (increase) decrease in equity investments (19,178) 2,074 2,089
Purchases of available-for-sale securities (92,862) (100,574) (20,771)
Proceeds from sale of available-for-sale securities 80,159 11,103 5,170
Proceeds from maturities of and principal payment
on available-for-sale securities 1,158 76,910 14,619
Net sales (purchases) of premises and equipment - (37) (21)
Net cash (used in) provided by investing activities (30,984) (10,589) 1,146
Cash flows from financing activities:
Net increase in securities sold under agreements
to repurchase 20,724 12,831 --
Increase in subordinated debt 23,028 -- --
Increase in common stock and additional paid in capital 16,853 -- --
Dividends paid on common and preferred stock (546) -- --
Net cash provided by financing activities 60,059 12,831 --
Net increase (decrease) in cash and cash equivalents 5,242 (51) (408)
Cash and cash equivalents at beginning of period 159 210 618
Cash and cash equivalents at end of period $ 5,401 $ 159 $ 210
</TABLE>
TeleBanc Financial Corporation commenced activities on January 27, 1994, the
effective date of its formation as a holding company of the Bank. The Bank paid
dividends of $992,000 and $2.2 million to TeleBanc for subordinated interest
expense payments for the years ended December 31, 1997 and 1996, respectively.
22. SELECTED QUARTERLY FINANCIAL DATA (unaudited)
Condensed quarterly financial data for the years ended December 31, 1997 and
1996 is shown as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Three months ended
Mar. 31, June 30, Sept. 30, Dec. 31,
(Dollars in thousands except per share data) 1997 1997 1997 1997
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest income $12,837 $15,275 $14,821 $16,368
Interest expense 9,878 11,865 11,548 12,772
</TABLE>
46
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Net interest income 2,959 3,410 3,273 3,596
Provision for loan and lease losses 243 308 120 250
Non-interest income 607 1,244 1,084 1,158
General and administrative expenses 1,897 2,251 2,078 2,816
Other non-interest operating expenses 208 202 260 430
Income before income taxes
and minority interest 1,218 1,893 1,899 1,258
Income tax expense 355 618 709 (25)
Minority interest in subsidiary - 67 285 42
Net income 863 1,208 905 1,241
Preferred stock dividends 60 162 162 162
Net income after preferred stock dividends $ 803 $ 1,046 $ 743 $ 1,079
Basic earnings per share $ 0.38 $ 0.48 $ 0.33 $ 0.48
Diluted earnings per share $ 0.35 $ 0.44 $ 0.30 $ 0.40
- -----------------------------------------------------------------------------------------------------------------------------
Three months ended
Mar. 31, June 30, Sept. 30, Dec. 31,
(Dollars in thousands except per share data) 1996 1996 1996 1996
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest income $11,131 $11,364 $11,871 $11,433
Interest expense 8,357 8,449 9,034 8,975
Net interest income 2,774 2,915 2,837 2,458
Provision for loan and lease losses 419 200 125 175
Non-interest income 605 291 540 1,320
General and administrative expenses 1,679 1,749 3,287 1,660
Other non-interest operating expenses 300 81 247 71
Income before income taxes 981 1,176 (282) 1,872
Income tax expense 332 417 (220) 667
Net income $ 649 $ 759 $ (62) $ 1,205
Basic earnings per share $ 0.32 $ 0.37 $ (0.03) $ 0.59
Diluted earnings per share $ 0.31 $ 0.36 $ (0.03) $ 0.52
</TABLE>
SUBSIDIARIES OF REGISTRANT
--------------------------
JURISDICTION OF
---------------
NAME OF SUBSIDIARY INCORPORATION
TeleBank United States
TeleBanc Capital Markets United States
TeleBanc Servicing Corporation United States
TeleBanc Capital Trust I United States
AGT Mortgage Services United States
AGT-PRA United States
Report of Independent Public Accountants
To the Board of Directors and Stockholders
of TeleBanc Financial Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheets of TeleBanc
Financial Corporation (a Delaware Corporation) and subsidiaries as of December
31, 1997 and 1996, and the related consolidated statements of income,
stockholders' equity, and cash flows for the years then ended. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of TeleBanc Financial Corporation
and subsidiaries as of December 31, 1997 and 1996, and the results of its
operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.
/s/ Arthur Andersen LLP
Vienna, VA
February 20, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000920986
<NAME> TeleBanc Financial Corp
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 2,165
<INT-BEARING-DEPOSITS> 44,241
<FED-FUNDS-SOLD> 45,750
<TRADING-ASSETS> 21,110
<INVESTMENTS-HELD-FOR-SALE> 410,440
<INVESTMENTS-CARRYING> 406,735
<INVESTMENTS-MARKET> 3,705
<LOANS> 544,298
<ALLOWANCE> 3,594
<TOTAL-ASSETS> 1,100,352
<DEPOSITS> 522,221
<SHORT-TERM> 479,909
<LIABILITIES-OTHER> 13,212
<LONG-TERM> 29,614
9,572
15,281
<COMMON> 22
<OTHER-SE> 30,521
<TOTAL-LIABILITIES-AND-EQUITY> 838,533
<INTEREST-LOAN> 34,729
<INTEREST-INVEST> 0
<INTEREST-OTHER> 24,572
<INTEREST-TOTAL> 59,301
<INTEREST-DEPOSIT> 25,958
<INTEREST-EXPENSE> 20,105
<INTEREST-INCOME-NET> 13,238
<LOAN-LOSSES> 921
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 10,142
<INCOME-PRETAX> 6,268
<INCOME-PRE-EXTRAORDINARY> 6,268
<EXTRAORDINARY> 0
<CHANGES> 2,597
<NET-INCOME> 3,671
<EPS-PRIMARY> 1.68
<EPS-DILUTED> 1.49
<YIELD-ACTUAL> 1.73
<LOANS-NON> 11,437
<LOANS-PAST> 5,273
<LOANS-TROUBLED> 425
<LOANS-PROBLEM> 11,437
<ALLOWANCE-OPEN> 3,310
<CHARGE-OFFS> 304
<RECOVERIES> 20
<ALLOWANCE-CLOSE> 3,594
<ALLOWANCE-DOMESTIC> 3,084
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 3,084
</TABLE>
