<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM 10-K/A
------------------------
AMENDMENT NO. 5 TO ANNUAL REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
COMMISSION FILE NUMBER: 33-76930
------------------------
TELEBANC FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 13-3759196
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION ORGANIZATION) IDENTIFICATION NO.)
1111 NORTH HIGHLAND STREET 22201
ARLINGTON, VIRGINIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
</TABLE>
(703) 247-3700
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 has (1) 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 (Section 299.405 of this chapter) is not contained herein,
and will not be contained, to the best of the 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
None.
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<PAGE> 2
This fifth amendment (the "Amendment") to the Annual Report of TeleBanc
Financial Corporation (the "Company") on Form 10-K/A is being filed to reflect
the amendment and restatement of the following items of the Company's Annual
Report on Form 10-K filed with the Securities and Exchange Commission (the
"Commission") on March 31, 1998: Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations and Item 11, Executive
Compensation. The Amendment also reflects certain non-material conforming
changes to and the restatement of all of the remaining items of the Company's
Annual Report on Form 10-K filed in amendments on April 2, 1998, April 30, 1998,
May 14, 1998 and May 15, 1998.
PART I
ITEM 1. BUSINESS
GENERAL
The Company, headquartered in Arlington, Virginia, had total assets of $1.1
billion at the end of 1997. The Company was organized in January 1994 by its
majority stockholder, MET Holdings Corporation ("MET Holdings"), to become the
parent savings and loan holding company for TeleBank, a federally chartered
savings bank ("TeleBank"). In February 1997, the Company 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 I"), 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 TeleBank, TCM, and TCT I. Financial and other data as of and for all
periods prior to March 1994 represent the consolidated data of TeleBank only.
Prior to March 1996, TeleBank was 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.
TeleBank, 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, the Company 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, the Company completed
its initial public offering, raising $4.6 million through the sale of common
stock, par value $.01 per share (the "Common Stock"), and an additional $17.3
million through the issuance of subordinated notes with warrants. Upon the
completion of the initial public offering, the Company invested $15.0 million of
the proceeds as capital of TeleBank. In February 1997, the Company consummated
the sale of $29.9 million of units of serial preferred stock and notes to two
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., an entity which was
majority-owned by MET Holdings, through the issuance of 162,461 shares of 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
1
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TCT I, which sold in a private placement shares of trust preferred securities,
Series A, for a total of $10.0 million, which proceeds were used to invest in
11.0% Junior Subordinated Deferrable Interest Debentures, Series A (the "TCT I
Junior Subordinated Debentures") issued by the Company.
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 entail 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> 4
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 % 1995 % 1994
-------- ------ -------- ------ -------- ------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
One-to-four family fixed-rate........ $211,287 38.11% $142,211 38.59% $105,750 39.91% $ 67,449
One-to-four family adjustable-rate... 336,470 60.69 217,352 58.97 148,928 56.20 79,701
Multifamily.......................... 1,447 0.26 1,516 0.41 1,286 0.49 1,114
Commercial real estate............... 3,033 0.55 4,017 1.09 4,553 1.72 4,385
Mixed use real estate................ 856 0.15 1,180 0.32 1,792 0.68 1,953
Land................................. 463 0.08 781 0.21 384 0.14 387
-------- ------ -------- ------ -------- ------ --------
Total real estate loans....... 553,556 99.84 367,057 99.59 262,693 99.14 154,989
-------- ------ -------- ------ -------- ------ --------
Consumer and other loans:
Lease financing...................... -- -- -- -- -- -- --
Home equity lines of credit and
second mortgage loans.............. 564 0.10 1,208 0.33 2,202 0.83 3,395
Other (1)............................ 305 0.06 305 0.08 79 0.03 168
-------- ------ -------- ------ -------- ------ --------
Total consumer and other
loans....................... 869 0.16 1,513 0.41 2,281 0.86 3,563
-------- ------ -------- ------ -------- ------ --------
Total loans................... $554,425 100.00% $368,570 100.00% $264,974 100.00% $158,552
======== ====== ======== ====== ======== ====== ========
Deduct:
Non accrual/cost recovery............ (155) (182) -- --
Deferred loan fees................... (34) (42) (42) (50)
Deferred discounts on loans.......... (9,938) (13,568) (14,129) (2,835)
Allowance for loan losses............ (3,594) (2,957) (2,311) (925)
-------- -------- -------- --------
Total......................... (13,721) (16,749) (16,482) (3,810)
-------- -------- -------- --------
Loans receivable, net.................. $540,704 $351,821 $248,492 $154,742
======== ======== ======== ========
<CAPTION>
AT DECEMBER 31,
----------------------------
% 1993 %
------ -------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Real estate loans:
One-to-four family fixed-rate........ 42.54% $ 44,450 43.06%
One-to-four family adjustable-rate... 50.27 50,708 49.14
Multifamily.......................... 0.70 932 0.90
Commercial real estate............... 2.77 5,912 5.73
Mixed use real estate................ 1.23 -- --
Land................................. 0.24 16 0.02
------ -------- ------
Total real estate loans....... 97.75 102,018 98.85
------ -------- ------
Consumer and other loans:
Lease financing...................... -- 17 0.02
Home equity lines of credit and
second mortgage loans.............. 2.14 1,007 0.98
Other (1)............................ 0.11 151 0.15
------ -------- ------
Total consumer and other
loans....................... 2.25 1,175 1.15
------ -------- ------
Total loans................... 100.00% $103,193 100.00%
====== ======== ======
Deduct:
Non accrual/cost recovery............ --
Deferred loan fees................... (68)
Deferred discounts on loans.......... (1,431)
Allowance for loan losses............ (835)
--------
Total......................... (2,334)
--------
Loans receivable, net.................. $100,859
========
</TABLE>
- ---------------
(1) Includes primarily loans secured by deposit accounts in TeleBank, and to a
lesser extent, unsecured consumer credit.
3
<PAGE> 5
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 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.
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<PAGE> 6
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 Federal National Mortgage Association ("Fannie 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............................................ 94,945 50,221 32,755
-------- -------- --------
Total loans sold, securitized, and repaid........ 155,618 77,325 41,741
Net change -- TBFC ESOP Note Receivable.................... -- (65) --
Net change in deferred discounts and loan fees............. 3,638 (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 TeleBank's operations.
During fiscal 1997 and 1996, the Company's loan purchases involved purchases of
whole loans in the secondary market, principally from private investors. The
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<PAGE> 7
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. TeleBank participates in various community
development programs in an effort to meet its responsibilities under the
Community Reinvestment Act (the "CRA"). TeleBank 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.
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
6
<PAGE> 8
following table sets forth the activity in the Company's mortgage-backed
securities held-to-maturity portfolio during the periods indicated.
<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
Fannie Mae............................................ -- -- --
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-backed securities available for sale portfolio during the period
indicated.
<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.................................................... $ 184,743 $ 234,835 $ 15,459
Purchases:
Pass-through securities................................ 39,400 109,600 13,183
CMOs................................................... 218,836 30,053 --
Fannie Mae............................................. 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.
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> 9
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
-------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<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>
In May 1996, the Company formed AGT, a 50% owned subsidiary which services
loans for both TeleBank and unaffiliated 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............................ $252,925 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>
8
<PAGE> 10
NONPERFORMING, 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 real estate owned ("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 REO which has been classified as In-Substance Foreclosure ("ISF").
Restructured loans and REO have been written down to estimated fair value, based
upon estimates of cash flow expected from the underlying collateral and
appropriately discounted.
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 contractually 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>
9
<PAGE> 11
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, of 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 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.
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 of the Company. 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 becomes more than four payments past due at any time during the
life
10
<PAGE> 12
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. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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)
<S> <C> <C> <C> <C> <C>
Loans:
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 Federal Deposit Insurance Corporation (the "FDIC"), Office of Thrift
Supervision (the "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.
11
<PAGE> 13
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 1994
---------------------- ---------------------- ---------------------- ------
PERCENT OF PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT
------ ------------- ------ ------------- ------ ------------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <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% $667
Multifamily................. 15 0.26 15 0.41 13 0.49 11
Commercial real estate...... 286 0.55 373 1.09 281 1.72 273
Mixed use................... 9 0.15 12 0.32 18 0.68 --
Land........................ 8 0.08 8 0.21 8 0.14 8
Lease financing............. -- -- -- -- -- -- --
Home equity lines of credit
and second mortgage loans... 5 0.16 20 0.41 28 0.83 16
Other consumer................ -- -- -- -- 24 0.03 14
------ ------ ------ ------ ------ ------ ----
Total allowance for loan
losses...................... $3,594 100.00% $2,957 100.00% $2,311 100.00% $989
====== ====== ====== ====== ====== ====== ====
<CAPTION>
AT DECEMBER 31,
--------------------------------------
1994 1993
------------- ----------------------
PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO
TOTAL LOANS AMOUNT TOTAL LOANS
------------- ------ -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Real estate loans:
One- to four-family......... 92.81% $468 92.20%
Multifamily................. 0.70 9 0.90
Commercial real estate...... 2.77 329 5.73
Mixed use................... 1.23 -- --
Land........................ 0.24 1 0.02
Lease financing............. -- 3 0.02
Home equity lines of credit
and second mortgage loans... 2.14 5 0.98
Other consumer................ 0.11 20 0.15
------ ---- ------
Total allowance for loan
losses...................... 100.00% $835 100.00%
====== ==== ======
</TABLE>
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.
12
<PAGE> 14
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 Federal Home Loan Bank,
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 Fannie Mae................ 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>
13
<PAGE> 15
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:
<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
------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<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.
14
<PAGE> 16
DEPOSITS AND OTHER SOURCES OF FUNDS
Deposits in TeleBank as of December 31, 1997 were represented by the
various categories described below:
<TABLE>
<CAPTION>
PERCENT OF
TERM CATEGORY BALANCE TOTAL DEPOSITS
---- -------- -------------- --------------
(IN THOUSANDS)
<S> <C> <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, 949 0.18%
Fixed-Rate
6-month Fixed-Term, 4,414 0.84%
Fixed-Rate
12-month Fixed-Term, 59,604 11.41%
Fixed-Rate
18-month Fixed-Term, 8,312 1.59%
Fixed-Rate
2-year Fixed-Term, 60,490 11.59%
Fixed-Rate
30-month Fixed-Term, 136,599 26.16%
Fixed-Rate
3-year Fixed-Term, 23,404 4.48%
Fixed-Rate
4-year Fixed-Term, 603 0.12%
Fixed-Rate
5-year Fixed-Term, 94,804 18.15%
Fixed-Rate
7-year Fixed-Term, 4,303 0.82%
Fixed-Rate
10-year Fixed-Term, 5,128 0.98%
Fixed-Rate
-------- ------
Total $522,221 100.00%
======== ======
</TABLE>
15
<PAGE> 17
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 INCREASE
ACCOUNTS 1997 DEPOSITS (DECREASE) 1996 DEPOSITS (DECREASE)
-------- ------------ ---------- ---------- ------------ ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Passbook........................ $ 665 0.13% $ (1,093) $ 1,758 0.45% $ (262)
Money market.................... 122,185 23.40 12,350 109,835 28.13 34,103
Checking........................ 761 0.15 452 309 0.08 (1,439)
Certificates of deposit......... 398,610 76.32 120,026 278,584 71.34 51,584
-------- ------ -------- -------- ------ -------
Total................. $522,221 100.00% $131,735 $390,486 100.00% $83,986
======== ====== ======== ======== ====== =======
<CAPTION>
BALANCE
AT PERCENTAGE
DECEMBER 31, OF
ACCOUNTS 1995 DEPOSITS
-------- ------------ ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Passbook........................ $ 2,020 0.66%
Money market.................... 75,732 24.71
Checking........................ 1,748 0.57
Certificates of deposit......... 227,000 74.06
-------- ------
Total................. $306,500 100.00%
======== ======
</TABLE>
16
<PAGE> 18
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 Federal Home Loan Bank ("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%.
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>
17
<PAGE> 19
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
ENDING AVERAGE AMOUNT AT AVERAGE WEIGHTED ENDING AVERAGE AMOUNT AT
CATEGORY BALANCE RATE MONTH-END BALANCE AVERAGE RATE BALANCE RATE MONTH-END
-------- -------- -------- --------- -------- ------------ -------- -------- ---------
(DOLLARS IN THOUSANDS)
<S> <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
Securities sold under
agreement to
repurchase......... $279,909 5.91% $279,909 $117,431 5.76% $ 57,581 5.69% $ 97,416
<CAPTION>
AT OR AT OR
FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 1996 DECEMBER 31, 1995
----------------------- ---------------------------------------------------------
WEIGHTED AVERAGE WEIGHTED MAXIMUM WEIGHTED AVERAGE
AVERAGE WEIGHTED ENDING AVERAGE AMOUNT AT AVERAGE WEIGHTED
CATEGORY BALANCE AVERAGE RATE BALANCE RATE MONTH-END BALANCE AVERAGE RATE
-------- -------- ------------ -------- -------- --------- -------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Advances from the
FHLB of Atlanta.... $120,633 5.91% $105,500 5.87% $106,800 $104,110 6.06%
Securities sold under
agreement to
repurchase......... $ 68,920 5.77% $ 93,905 6.06% $119,507 $ 97,692 6.29%
</TABLE>
18
<PAGE> 20
SUBSIDIARIES
During the second quarter of 1996, through TSC, TeleBank funded 50% of the
capital commitment to 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. TeleBank also provided in the second quarter of 1996, 50% of the
capital commitment to AGT PRA. The primary business of AGT PRA is its investment
in PRA. PRA acquires and collects delinquent consumer debt obligations for its
own portfolio.
In February 1997, TeleBanc acquired TCM, a registered investment advisor,
funds manager and broker-dealer specializing in mortgages and mortgage-related
securities. In June 1997, the Company formed TCT I, which sold shares of trust
preferred securities, Series A in a private placement, for a total of $10.0
which proceeds were used to invest in the TCT I Junior Subordinated Debentures.
EMPLOYEES
At December 31, 1997, the Company had approximately 58 full-time employees.
Management considers its relations with its employees to be excellent.
TeleBank's employees are not represented by any collective bargaining group.
REGULATION
General
The Company, as a savings and loan holding company, and TeleBank, as a
federally chartered savings bank, are subject to extensive regulation,
supervision and examination by the OTS as their primary federal regulator.
TeleBank also is subject to regulation, supervision and examination by 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
of Financial Condition and Results of Operations" and the Company's Consolidated
Financial Statements and the Notes thereto included elsewhere in this Annual
Report as to the impact of certain laws, rules and regulations on the operations
of the Company and TeleBank. Set forth below is a description of certain recent
regulatory developments.
In September 1996, legislation (the "1996 Legislation") was enacted to
address the undercapitalization of the Savings Association Insurance Fund (the
"SAIF"), of which TeleBank 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. TeleBank 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,
TeleBank's deposit insurance premiums to the SAIF were reduced as of September
30, 1996. TeleBank 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 of the SAIF with the Bank
Insurance Fund (the "BIF"), which generally insures deposits 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 depository institutions. As a condition to the combined insurance fund,
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 U.S. Department of the Treasury developed pursuant
to requirements of the 1996 Legislation. While no legislation was enacted 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. The
19
<PAGE> 21
Company, however, 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 legislation will
be enacted.
During 1997, the OTS continued its comprehensive review of its regulations
to eliminate duplicative, unduly burdensome, and unnecessary regulations. The
OTS has 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.
ITEM 2. PROPERTIES
The Company leases its principal office located at 1111 North Highland
Street, Arlington, Virginia 22201. The Company leases approximately 19,000
square feet in that location. The lease expires in 2005. During 1997, the
Company also operated from an office that it subleases from Danzinger and
Danzinger, a law firm, in New York.
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.
20
<PAGE> 22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's 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 sale prices for the Common
Stock for the periods indicated.
Initial offering $6.125
<TABLE>
<CAPTION>
HIGH LOW
------ -------
<S> <C> <C>
1996
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
</TABLE>
No dividends were paid in 1996 and 1997. The closing per share bid price 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>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1997 1996 1995 1994 1993
---------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
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
Selling, 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
Minority interest........................................ 394 -- -- -- --
Preferred stock dividend................................. 546 -- -- -- --
Net income available to common stockholders.......... $ 3,671 $ 2,552 $ 2,720 $ 540 $ 1,377
Earnings per share:
Basic.................................................. $ 1.68 $ 1.25 $ 1.33 $ 0.31 $ 1.06
Diluted................................................ $ 1.14 $ 1.16 $ 1.33 $ 0.31 $ 1.06
Weighted average shares:
Basic.................................................. 4,383 4,099 4,099 3,498 2,599
Diluted................................................ 7,411 4,406 4,104 3,498 2,599
</TABLE>
21
<PAGE> 23
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1997 1996 1995 1994 1993
---------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Statement of Financial Condition Data:
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(1)............................ 319,203 184,743 234,385 236,464 80,782
Investment securities(1)................................. 91,237 78,826 40,058 12,444 18,110
Retail savings and certificates of deposit............... 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
Trust preferred securities(2)............................ 9,572 -- -- -- --
Total stockholders equity................................ 45,824 24,658 21,565 17,028 12,378
Other Financial and Operating Data:
Return on average total assets........................... 0.45% 0.61%(3) 0.53% 0.17% 0.61%
Return on average stockholders' equity................... 9.17% 16.50%(3) 14.10% 3.17% 11.79%
S,G&A expenses to total assets........................... 0.82% 1.03%(3) 1.00% 0.82% 1.36%
Number of deposit accounts............................... 21,817 16,506 12,919 8,564 2,932
Capital Ratios of TeleBank:
Core................................................... 5.06% 5.08% 5.31% 6.27% 5.39%
Tangible............................................... 5.06 5.07 5.36 6.35 5.38
Total capital.......................................... 11.91 10.41 11.74 15.96 14.75
</TABLE>
- ---------------
(1) Includes available-for-sale, held-to-maturity, held-for-sale, and trading.
(2) Consists of 10,000 shares of Company-Obligated Mandatorily Redeemable
Capital Securities of a subsidiary trust, TCT I. TCT I is a business trust
formed for the purpose of issuing capital securities and investing the
proceeds in the TCT I Junior Subordinated Debentures issued by the Company.
See Note 12 to Consolidated Financial Statements.
(3) Excludes one-time pre-tax charge of $1.7 million ($1.1 million after tax) to
recapitalize the SAIF. Giving effect to the charge, return on average
assets, return on average stockholders' equity, and selling, general and
administrative expenses to total assets for 1996 were 0.42%, 11.4% and
1.29%, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company has adopted a branchless banking strategy through which it
offers financial products and services to customers nationwide using alternative
delivery platforms, including telephone, Internet, automatic teller machines,
facsimile and mail. Prior to its acquisition by members of present management in
1989, the Company operated as a traditional community savings bank. In 1989,
management changed the Company's growth strategy using direct marketing to offer
high value financial products and services, which generally offer higher
interest rates or lower fees than those offered by traditional financial
institutions.
The Company primarily generates revenue in the form of net interest income
and, to a lesser degree, non-interest income which includes fees and commissions
for services and gains on the sale of assets. Net interest income is the
"spread" or difference between the rates of interest earned on its loans and
other interest-earning assets, and the rates of interest paid on its deposits
and borrowed funds. Fluctuations in interest rates as well as volume and
composition changes in interest-earning assets and interest-bearing liabilities
may materially affect net interest income.
The Company's asset acquisition strategy is to purchase pools of mortgages
secured by one-to-four family residences and mortgage-related securities. The
Company does not currently originate loans. The Company believes that by
purchasing a seasoned and geographically diverse loan portfolio, it reduces
expenses related to loan origination, and is able to actively manage credit
quality risk.
22
<PAGE> 24
TeleBank manages its interest rate risk by analyzing the maturities and
repricing of its deposits and other sources of funding, and seeking to match the
maturities of these instruments with the maturities of the assets in its loan
portfolio. In an effort to manage interest rate exposure, TeleBank uses various
hedging techniques such as interest rate swaps, caps, swaptions, floors, collars
and financial options. TeleBank actively monitors its interest rate sensitivity
in a variety of interest rate environments.
The Company plans to build the "TeleBank" franchise identity based on its
high value savings and investment and other financial products, superior
customer service and anywhere, anytime convenience. The Company believes that
associating its brand name with its services and delivery channels will enable
it to capture the growing market of customers who are increasingly relying on
alternative channels for the delivery of their financial services. In pursuing
this strategy, the Company plans to increase significantly its marketing
expenditures for the foreseeable future to implement a targeted, national
advertising campaign and marketing initiative.
DFC ACQUISITION
Consistent with its operating strategy, the Company has signed an agreement
to acquire Direct Financial Corporation ("DFC"), a thrift holding company, and
its federally chartered savings bank subsidiary, Premium Bank, F.S.B., in a
transaction expected to be consummated in the summer of 1998, subject to
regulatory approval. The Company is acquiring DFC because DFC has employed a
direct marketing strategy similar to that of the Company, and thus presents the
opportunity for the Company to acquire the deposits and customers of a financial
institution without acquiring significant infrastructure. DFC currently operates
from a single branch in New Jersey located approximately 30 miles outside of
Philadelphia, Pennsylvania, and its customer and deposit base is concentrated in
the mid-Atlantic region of the United States. The Company does not intend to
retain any significant portion of DFC's employees and intends to close DFC's
single branch location. DFC also originates residential mortgage loans, although
the Company intends to discontinue mortgage loan origination upon its
acquisition of DFC. DFC also offers credit cards to its customers through a
relationship with First Data Resources and Card Management Services. In 1998, in
reliance upon DFC's existing credit card relationships, the Company also intends
to offer its customers a co-branded credit card.
RESULTS OF OPERATIONS
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Interest Income. Total interest income increased by $13.5 million to $59.3
million for the year ended December 31, 1997 from $45.8 million for the year
ended December 31, 1996, an increase of 29.5%. This increase is due primarily to
the $11.6 million increase in interest income on mortgages and other loans, an
increase of 50.4% in 1997, principally due to a significant increase in the
average loan balance during the period. Interest income on mortgage-backed and
related securities decreased slightly to $17.6 million at December 31, 1997 from
$18.0 million at December 31, 1996 largely as a result of a decline in the
yield.
Interest Expense. Total interest expense increased by $11.3 million to
$46.1 million for the year ended December 31, 1997 from $34.8 million for the
year ended December 31, 1996, an increase of 32.5%. The increase is attributable
to both an increase in interest-bearing liabilities and a slight increase in the
average interest rate paid.
Loan Loss Provision. The provision for loan losses is the annual cost of
providing an allowance for estimated losses in the loan portfolio, and reflects
management's judgment as to the reserve necessary to absorb loan losses based
upon the Company's assessment of a number of factors, including its delinquent
loan trends and historical loss experience, current and anticipated economic
conditions, the mix of loans in the Company's portfolio, and the Company's
internal credit review process. The provision for loan losses remained
substantially unchanged at $921,000 for the year ended December 31, 1997,
compared to $919,000 for the year ended December 31, 1996, despite a significant
increase in the loan portfolio primarily because the Company historically has
experienced a low level of net charge-offs due in part to its focus on
residential mortgage assets. The ratio of net charge-offs to net average loans
outstanding during 1997 was 0.06%,
23
<PAGE> 25
compared to 0.10% during 1996. Total loan loss allowance as a percentage of
total non-performing loans was 31.0% as of December 31, 1997, compared to 26.3%
as of December 31, 1996.
Non-interest Income. Total non-interest income increased by $1.3 million to
$4.1 million for the year ended December 31, 1997, from $2.8 million for the
year ended December 31, 1996, an increase of 46.4%. Non-interest income
increased primarily because the Company recognized $1.2 million of non-interest
income as gain on trading securities during 1997. In addition, the Company
recognized an $864,000 decline in equity investment primarily attributable to
the write-off of the equity investment by TeleBank in AGT, which had provided
loan servicing services for a fee and ceased operations in July 1997.
Non-interest Expenses. Total non-interest expenses, principally selling,
general and administrative expenses, increased $1.1 million to $10.1 million for
the year ended December 31, 1997, from $9.1 million for the year ended December
31, 1996, an increase of 11.0%. Selling, general and administrative expenses
increased $600,000 to $9.0 million during 1997 from $8.4 million during 1996, an
increase of 7.1%, primarily as a result of a $1.2 million increase in
compensation and employee benefits in 1997. During 1996, the Company incurred a
one-time $1.7 million assessment to recapitalize the SAIF. Other general and
administrative expenses increased $1.1 million, principally as a result of
increased marketing expenses to support a growing deposit base and the building
of brand identity.
Other non-interest expenses increased $1.1 million to $4.1 million during
the year ended December 31, 1997 from $3.0 million during the year ended
December 31, 1996, an increase of 36.7%, primarily as a result of increased
advertising expenses, increased office occupancy costs and an increased
amortization of purchased mortgage servicing rights.
Income Tax Expense. Income tax expense for the year ended December 31, 1997
was $1.7 million, compared with $1.2 million for the year ended December 31,
1996. The Company's effective tax rate for 1997 was 26.4%, compared to 31.9% for
1996. The effective tax rate decreased largely as a result of an increase during
1997 in interest earned on municipal bonds, which generally were tax-exempt.
Net Income. Net income for the year ended December 31, 1997 increased $1.1
million to $3.7 million from $2.6 million for the year ended December 31, 1996,
an increase of 42.3%. 1997 net income consisted primarily of $12.3 million in
net interest income, $3.3 million in net gain on the sale of trading securities,
principally loans held for sale, and mortgage-backed and investment securities,
which was offset by $10.1 million in non-interest expenses, $921,000 in
provision for loan losses, and $1.7 million in income tax expense. The Company's
return on average assets and return on average equity for the year ended
December 31, 1997 were 0.45% and 9.17%, respectively.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Interest Income. Total interest income increased by $5.3 million to $45.8
million for the year ended December 31, 1996 from $40.5 million for the year
ended December 31, 1995, an increase of 13.1%. The increase is due primarily to
a $5.4 million increase in interest income on mortgages and other loans, an
increase of 30.5% in 1996, principally due to a $77.3 million increase in the
average loan balance during the period. Interest income on mortgage-backed
securities held-to-maturity and available-for-sale decreased to $18.0 million at
December 31, 1996 from $20.2 million at December 31, 1995 largely as a result of
a decline in average balances.
Interest Expense. Total interest expense increased by $2.9 million to $34.8
million for the year ended December 31, 1996 from $31.9 million for the year
ended December 31, 1995, an increase of 9.1%. The increase is attributable to an
increase in interest-bearing liabilities, offset in part by a decline in
interest cost.
Loan Loss Provision. The provision for loan losses declined to $919,000 for
the year ended December 31, 1996, compared to $1.7 million for the year ended
December 31, 1995, despite a significant increase in the size of the loan
portfolio, primarily because the Company experienced a low level of actual net
charge-offs due in part to its focus on residential mortgage assets. The total
loan loss allowance as of December 31, 1996 was $3.0 million from $2.3 million
at December 31, 1995, which were 0.80% and 0.90% of total loans
24
<PAGE> 26
outstanding at such dates, respectively. Total loan loss allowance as a
percentage of total non-performing loans was 26.3% as of December 31, 1996,
compared to 43.4% as of December 31, 1995.
Non-interest Income. Total non-interest income declined by $1.0 million to
$2.8 million for the year ended December 31, 1996, from $3.8 million for the
year ended December 31, 1995, a decrease of 26.3%. Fees, service charges and
other income increased by $756,000 in 1996, in large part as a result of fees
collected on $2.8 million in purchased mortgage servicing rights, and gain on
loans held for sale increased by $642,000 in 1996, which were primarily offset
by an $870,000 decrease in mortgage-backed securities available for sale, a
$924,000 decrease in investment securities available for sale and a $628,000
decrease in trading account income.
Non-interest Expenses. Total non-interest expenses increased $2.9 million
to $9.1 million for the year ended December 31, 1996 from $6.2 million for the
year ended December 31, 1995, an increase of 46.8%. Selling, general and
administrative expenses increased $2.8 million to $8.4 million for the year
ended December 31, 1996 from $5.6 million for the year ended December 31, 1995,
an increase of 50%, primarily because of the $1.7 million one-time SAIF
assessment incurred in 1996. In addition, compensation and employee expenses
increased by $660,000 as a result of adding employees and higher
performance-based bonuses, the TeleBank federal deposit insurance premium
increased by $483,000, and administrative expenses generally increased as a
result of an increased deposit base.
Other non-interest expenses increased slightly because of an increase in
amortization of purchased mortgage servicing rights, offset by a decline in REO
expense.
Income Tax Expense. Income tax expense for the year ended December 31, 1996
was $1.2 million, compared with $1.7 million for the year ended December 31,
1995. The Company's effective tax rate for the year ended December 31, 1996 was
31.9%, compared to 37.9% for the year ended December 31, 1995.
Net Income. Net income for the year ended December 31, 1996 decreased
$168,000 to $2.6 million from $2.7 million for the year ended December 31, 1995,
a decrease of 6.2%. Net income for the year ended December 31, 1996 included the
one-time $1.7 million SAIF assessment. Excluding the one-time assessment, 1996
net income would have been $3.6 million. Net income consisted primarily of $11.0
million in net interest income and $1.8 million in net gain on the sale of
trading securities, principally loans held for sale and mortgage-backed and
investment securities, which was offset by $9.1 million in non-interest
expenses, $919,000 in provision for loan losses, and $1.2 million in income tax
expense. The Company's return on average assets and return on average equity for
the year ended December 31, 1996 were 0.42% and 11.46%, respectively. Earnings
per share, on a fully diluted basis, were $1.16 for 1996.
25
<PAGE> 27
QUARTERLY RESULTS
The following table sets forth certain selected unaudited quarterly
financial data of the Company for each of the eight quarters in the two year
period ended December 31, 1997. The consolidated financial data presented below
have been prepared on a basis consistent with the Company's audited Consolidated
Financial Statements included elsewhere in this Annual Report and, in the
opinion of management, include all adjustments (consisting of normal recurring
accruals) necessary for a fair presentation of such information. This
information should be read in conjunction with the Company's audited
Consolidated Financial Statements and the Notes thereto included elsewhere in
this Annual Report. The operating results for any quarter are not necessarily
indicative of results for any future period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996 1997 1997 1997 1997
--------- -------- --------- -------- --------- -------- --------- --------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Interest income................. $11,131 $11,364 $11,871 $11,433 $12,837 $15,275 $14,821 $16,368
Interest expense................ 8,357 8,449 9,034 8,975 9,878 11,865 11,548 12,772
------- ------- ------- ------- ------- ------- ------- -------
Net interest income... 2,774 2,915 2,837 2,458 2,959 3,410 3,273 3,596
Provision for loan losses....... 419 200 125 175 243 308 120 250
Non-interest income............. 605 291 540 1,320 607 1,244 1,084 1,158
SG&A............................ 1,679 1,749 3,287 1,660 1,897 2,251 2,078 2,816
Other non-interest operating
expenses...................... 300 81 247 71 208 202 260 430
------- ------- ------- ------- ------- ------- ------- -------
Income before income taxes and
minority interest............. 981 1,176 (282) 1,872 1,218 1,893 1,899 1,258
Income tax expense.............. 332 417 (220) 667 355 618 709 (25)
Minority interest in
subsidiary.................... -- -- -- -- -- 67 285 42
------- ------- ------- ------- ------- ------- ------- -------
Net income...................... 649 759 (62) 1,205 863 1,208 905 1,241
Preferred stock dividends....... -- -- -- -- 60 162 162 162
Net income available to common
stockholders.................. $ 649 $ 759 $ (62) $ 1,205 $ 803 $ 1,046 $ 743 $ 1,079
======= ======= ======= ======= ======= ======= ======= =======
Basic earnings per share........ $ 0.32 $ 0.37 $ (0.03) $ 0.59 $ 0.38 $ 0.48 $ 0.33 $ 0.48
Diluted earnings per share...... 0.31 0.36 (0.03) 0.52 0.30 0.31 0.22 0.31
</TABLE>
The Company's quarterly results of operations may be subject to significant
fluctuations due to several factors, including interest rate fluctuations,
economic factors, the level of marketing expenditures to implement the Company's
growth strategy, the performance of the Company's loan portfolio and other
interest-earning assets, retention and growth of deposits, and other factors.
The Company anticipates that its operating expenses, principally marketing and
compensation expenses, will increase significantly for the foreseeable future.
If the Company's net interest income in any quarter does not increase
correspondingly, the Company's results of operations for that quarter would be
materially adversely affected. Accordingly, the Company does not believe that
quarter-to-quarter comparisons of the results of operations are meaningful and
the results of operations in any particular quarter should not be relied upon as
necessarily indicative of future performance.
26
<PAGE> 28
FINANCIAL CONDITION
The Company's total assets increased by $452.0 million to $1.1 billion at
December 31, 1997 from $648.0 million at December 31, 1996, an increase of
69.8%. The growth in total assets is primarily the result of a $188.9 million
increase in loans receivable and a $134.5 million increase in mortgage-backed
securities. 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 to $540.7 million at December 31, 1997 from $351.8 million at December
31, 1996, an increase of 53.7%. The increase reflects whole loan purchases of
$342.9 million, offset in part by $95.1 million of principal repayments and
$60.7 million of loans sold in 1997. During 1996, the Company recorded whole
loan purchases of $183.1 million, offset in part by $50.2 million of principal
repayments and $27.1 million of loans sold. In mid-1996, as part of a change in
its loan investment strategy, the Company reclassified certain loans as "loans
held-for-sale." Loans held-for-sale generally are susceptible to sale after
restructuring or credit enhancement and are recorded at the lower of cost or
market.
Mortgage-backed securities available-for-sale increased $134.5 million to
$319.2 million at December 31, 1997 from $184.7 million at December 31, 1996, an
increase of 72.8%. Investment securities available-for-sale increased $12.4
million to $91.2 million at December 31, 1997 from $78.8 million at December 31,
1996, an increase of 15.7%. These securities are held for liquidity purposes and
the increases in these categories of assets is consistent with the overall
growth of the Company's assets in 1997.
Deposits increased $131.7 million to $522.2 million at December 31, 1997
from $390.5 million at December 31, 1996, an increase of 33.7%, largely as a
result of the Company's continued targeted marketing efforts to attract money
market accounts and certificates of deposit ("CDs"). During the year ended
December 31, 1997, approximately $25.9 million of interest was credited to
deposit accounts and deposits exceeded withdrawals by $105.8 million, resulting
in the net overall increase in deposits. During 1997, the Company completed a
systems conversion to an integrated platform for marketing, deposit operations,
and accounting and finance, to support future growth and the introduction of new
products and services.
FHLB advances increased $55.2 million to $200.0 million at December 31,
1997, from $144.8 million at December 31, 1996, an increase of 38.1%. Other
borrowings, composed of securities sold under agreements to repurchase,
increased $222.3 million to $279.9 million at December 31, 1997 from $57.6
million at December 31, 1996, an increase of 385.9%. At December 31, 1997,
subordinated debt, net of original issue discount, consisting of the 9.5% Senior
Subordinated Debentures of the Company (the "9.5% Subordinated Debentures")
issued in February 1997, and the 11.5% Subordinated Debentures of the Company
(the "11.5% Subordinated Debentures" and, together with the 9.5% Subordinated
Debentures, the "Subordinated Debentures") issued by the Company in the second
quarter of 1994, totaled $29.6 million. In June 1997, the Company formed TCT I
for the purpose of offering and selling in a private placement an aggregate of
$10.0 million in shares of Capital Securities, Series A, which have an annual
dividend rate of 11.0% payable semi-annually, beginning in December 1997.
Stockholders' equity increased $21.1 million to $45.8 million at December
31, 1997 from $24.7 million at December 31, 1996. The increase is the result of
the receipt of $15.3 million in proceeds from the issuance of the Series A
Voting Convertible Preferred Stock (the "Series A Preferred Stock"), Series B
Nonvoting Convertible Preferred Stock and Series C Nonvoting Convertible
Preferred Stock (collectively, the "Preferred Stock") in February 1997, the
receipt of $1.5 million from the issuance of 162,461 shares of Common Stock in
February 1997 in exchange for the assets of Arbor Capital Partners Inc., a
former affiliate of the Company, $4.6 million in net income, and an unrealized
gain on securities available for sale of $642,000, net of taxes, in 1997, which
increased the Company's stockholders' equity, but did not impact the Company's
results of operations.
27
<PAGE> 29
LIQUIDITY
Liquidity represents the Company's ability to raise funds to support asset
growth, fund operations and meet obligations, including deposit withdrawals,
maturing liabilities, and other payment obligations, to maintain reserve
requirements and to otherwise meet its ongoing obligations. During the past
three years, the Company has met its liquidity needs primarily through financing
activities, consisting principally of increases in core deposit accounts,
maturing short-term investments, loans and repayments of investment securities,
and to a lesser extent, sales of loans or securities. The Company believes that
it will be able to renew or replace its funding sources at then-existing market
rates, which may be higher or lower than current rates. Pursuant to applicable
OTS regulations, TeleBank is required to maintain an average liquidity ratio of
5.0% of certain borrowings and its deposits, which requirement it fully met
during 1997 and 1996. Effective November 24, 1997, this requirement has been
lowered to 4.0%.
The Company seeks to maintain a stable funding source for future periods in
part by attracting core deposit accounts, which are accounts that tend to be
relatively stable even in a changing interest rate environment. Typically,
accounts that maintain a relatively high balance and time deposit accounts
provide a relatively stable source of funding. At December 31, 1997, the average
account balance at TeleBank was $24,000, and the average customer maintained 1.6
accounts with TeleBank, which the Company believes are relatively high
statistics compared to the customer and account base at most traditional
depository institutions. Savings deposits increased $11.7 million to $123.6
million during the year ended December 31, 1997, an increase of 10.5%. CDs
increased $120.0 million to $398.6 million during the year ended December 31,
1997, an increase of 43.1%.
The following table shows the changes in deposits for each of the periods
indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of period............. $212,411 $306,500 $390,486
Deposits in excess of withdrawals.......... 76,866 62,629 105,777
Interest credited on deposits.............. 17,223 21,357 25,958
-------- -------- --------
Balance at end of period................... $306,500 $390,486 $522,221
======== ======== ========
</TABLE>
The Company also relies upon borrowed funds to provide liquidity. The
Company's total borrowings increased $277.5 million to $479.9 million at
December 31, 1997, an increase of 137.1%. Advances from the FHLB increased $55.2
million to $200.0 million during 1997, an increase of 38.1%. Securities sold
under agreements to repurchase increased $222.3 million to $279.9 million at
December 31, 1997, an increase of 386.1%. At December 31, 1997, TeleBank had
approximately $154.0 million in additional borrowing capacity.
At December 31, 1997, the Company had outstanding approximately $31.0
million face amount of Subordinated Debentures. In addition, at the same date,
the Company also had outstanding $10.0 million face amount of the TCT I Junior
Subordinated Debentures and $16.2 million of Preferred Stock. The Company's
aggregate annual interest expense on the Subordinated Debentures and the TCT I
Junior Subordinated Debentures is $4.4 million and the annual dividend payment
on the cumulative Preferred Stock is $648,000. Subject to the approval of the
OTS and compliance with federal regulations, TeleBank pays a dividend to the
Company semi-annually in an amount equal to the aggregate debt service and
dividend obligations. Under the terms of the indenture pursuant to which the
11.5% Subordinated Debentures were issued and the terms of the TCT I Junior
Subordinated Debentures, 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
both the 11.5% Subordinated Debentures and the TCT I Junior Subordinated
Debentures. The Company had $48.6 million in liquid assets at December 31, 1997.
CAPITAL
At December 31, 1997, TeleBank was in compliance with all of its regulatory
capital requirements and its capital ratios exceeded the ratios for "well
capitalized" institutions under OTS regulations.
28
<PAGE> 30
The following table sets forth TeleBank's regulatory capital levels at
December 31, 1997 in relation to the regulatory requirements in effect at that
date. The information below is based upon the Company's understanding of the
regulations and interpretations currently in effect and may be subject to
change.
<TABLE>
<CAPTION>
REQUIRED TO BE WELL
REQUIRED FOR CAPITALIZED UNDER
CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------- ------------------ -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- --------- ------ --------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1996:
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
Total Capital (to risk weighted assets)...... 34,104 10.41% > 26,205 >8.0% > 32,756 >10.0%
As of December 31, 1997:
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
Total Capital (to risk weighted assets)...... 55,701 11.91% > 37,409 >8.0% > 46,761 >10.0%
</TABLE>
29
<PAGE> 31
RATE/VOLUME TABLE
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>
1996 VS. 1995 1997 VS. 1996
----------------------------- ---------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
----------------------------- ---------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------- -------- -------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net(1)............. $ 6,333 $ (968) $ 5,365 $12,732 $(1,092) $11,640
Mortgage-backed and related
securities........................ (9,307) (9,307) (18,614) -- -- --
Investment securities(2)............. 16 (134) (118) 220 (27) 193
Mortgage-backed and related
securities available for sale..... 16,404 (45) 16,359 373 (682) (309)
Investment securities available for
sale(3)........................... 2,194 (305) 1,889 809 8 817
Federal funds sold................... 2 (8) (6) 54 2 56
Trading account...................... 17 (185) (168) 562 562 1,124
------- -------- -------- ------- ------- -------
Total interest-earning
assets..................... $15,659 $(10,952) $ 4,707 $14,750 $(1,229) $13,521
======= ======== ======== ======= ======= =======
Interest-bearing liabilities:
Savings deposits..................... $ 2,803 $ (100) $ 2,703 $ 1,111 $ 454 $ 1,565
Time deposits........................ 2,208 (596) 1,612 3,315 (279) 3,036
FHLB advances........................ 972 (292) 680 2,400 796 3,196
Other borrowings..................... (1,778) (446) (2,224) 2,838 (466) 2,372
Subordinated debt.................... -- 112 112 1,207 (128) 1,079
------- -------- -------- ------- ------- -------
Total interest-bearing
liabilities................ 4,205 (1,322) 2,883 10,871 377 11,248
------- -------- -------- ------- ------- -------
Change in net interest income.......... $11,454 $ (9,630) $ 1,824 $ 3,879 $(1,606) $ 2,273
======= ======== ======== ======= ======= =======
</TABLE>
- ---------------
(1) Includes mortgage and other loans.
(2) Includes interest-bearing deposits, repurchase agreements, investment
securities held to maturity, and FHLB stock.
(3) Interest income and average yields on municipal bonds, included in
investment securities, are presented on a tax equivalent basis.
30
<PAGE> 32
YIELD TABLE
The following table presents certain consolidated balance sheet data,
income and expense and related interest yields and rates at December 31, 1997,
and for each of the preceding three years as set forth 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 is traditionally used as an indication of the profitability of a
savings institution. 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.
<TABLE>
<CAPTION>
1995 1996
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE 1997
BALANCE INC./EXP YIELD/COST BALANCE INC./EXP YIELD/COST BALANCE
-------- -------- ---------- -------- -------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net............ $201,737 $17,726 8.80% $279,038 $23,089 8.28% $ 540,704
Mortgage-backed and related
securities..................... 233,728 18,614 7.96 -- -- -- --
Investment securities............ 13,627 990 7.27 12,841 871 6.79 54,241
Mortgage-backed and related
securities, available for
sale........................... 19,138 1,597 8.35 221,656 17,955 8.10 319,203
Investment securities, available
for sale....................... 25,516 2,071 8.12 61,169 3,959 6.47 91,237
Federal funds sold............... 810 49 6.05 842 44 5.22 45,750
Trading account.................. 1,932 166 8.59 -- -- -- 21,110
-------- ------- ------ -------- ------- ------ ----------
Total interest-earning
assets................... $496,488 $41,213 8.31% $575,546 $45,918 7.98% $1,072,245
-------- ------- ------ -------- ------- ------ ----------
Non-interest earning assets........ 15,388 26,929 28,107
-------- -------- ----------
Total assets............... $511,876 $602,475 $1,100,352
======== ======== ==========
Interest-bearing liabilities:
Savings deposits................. $ 41,387 $ 2,111 5.10% $ 99,346 $ 4,815 4.85% $ 123,611
Time deposits.................... 223,745 14,922 6.67 258,870 16,542 6.39 398,610
Brokered callable certificates of
deposit........................ -- -- -- -- -- -- --
FHLB advances.................... 94,718 5,985 6.32 120,678 6,689 5.54 200,000
Other borrowings................. 107,330 6,839 6.37 68,154 4,569 6.70 279,909
Subordinated debt, net........... 17,250 2,089 12.11 17,250 2,200 12.75 29,614
-------- ------- ------ -------- ------- ------ ----------
Total interest-bearing
liabilities.............. $484,430 $31,946 6.59% $564,298 $34,815 6.14% $1,031,744
-------- ------- ------ -------- ------- ------ ----------
Non-interest-bearing liabilities... 8,150 15,900 13,212
-------- -------- ----------
Total liabilities.......... $492,580 $580,198 $1,044,956
Trust preferred securities......... -- -- 9,572
Total stockholders'
equity................... 19,296 22,277 45,824
-------- -------- ----------
Total liabilities and
stockholders' equity..... $511,876 $602,475 $1,100,352
======== ======== ==========
Excess of interest-earning assets
over interest-bearing
liabilities/net interest
income........................... $ 12,058 $ 9,267 $ 11,248 $11,103 $ 40,501
======== ======= ======== ======= ==========
Net interest spread................ 1.72% 1.84%
====== ======
Net interest margin(1)............. 1.87% 1.94%
====== ======
Ratio of interest-earning assets to
interest-bearing liabilities..... 102.49% 101.99%
====== ======
<CAPTION>
1997
AVERAGE INTEREST AVERAGE
BALANCE INC./EXP. YIELD/COST
-------- --------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Interest-earning assets:
Loans receivable, net............ $441,819 $34,729 7.86%
Mortgage-backed and related
securities..................... -- -- --
Investment securities............ 16,203 1,064 6.48
Mortgage-backed and related
securities, available for
sale........................... 226,064 17,646 7.81
Investment securities, available
for sale....................... 73,649 4,776 6.49
Federal funds sold............... 1,844 100 5.37
Trading account.................. 12,581 1,124 8.81
-------- ------- ------
Total interest-earning
assets................... $772,160 $59,439 7.70%
-------- ------- ------
Non-interest earning assets........ 41,465
--------
Total assets............... $813,625
========
Interest-bearing liabilities:
Savings deposits................. $120,901 $ 6,380 5.28%
Time deposits.................... 311,740 19,578 6.28
Brokered callable certificates of
deposit........................ -- -- --
FHLB advances.................... 160,681 9,885 6.07
Other borrowings................. 117,515 6,941 5.83
Subordinated debt, net........... 27,434 3,279 11.95
-------- ------- ------
Total interest-bearing
liabilities.............. $738,271 $46,063 6.21%
-------- ------- ------
Non-interest-bearing liabilities... 25,719
--------
Total liabilities.......... $763,990
Trust preferred securities......... 9,597
Total stockholders'
equity................... 40,038
--------
Total liabilities and
stockholders' equity..... $813,625
========
Excess of interest-earning assets
over interest-bearing
liabilities/net interest
income........................... $ 33,889 $13,376
======== =======
Net interest spread................ 1.49%
======
Net interest margin(1)............. 1.73%
======
Ratio of interest-earning assets to
interest-bearing liabilities..... 104.59%
======
</TABLE>
- ---------------
(1) Net interest margin is the ratio of annualized net interest income to
average interest-earning assets.
31
<PAGE> 33
As a result of the Company's strategy of offering high value savings and
investment products through alternative distribution channels, the Company's
interest rate spread is lower than that of traditional depository institutions.
The Company's interest rate spread was 1.49%, 1.84%, and 1.72% for 1997, 1996,
and 1995, respectively. The Company's net interest margin on interest-earning
assets for such periods was 1.73%, 1.94%, and 1.87%, respectively.
INTEREST RATE SENSITIVITY MANAGEMENT
The Company actively monitors its net interest rate sensitivity position.
Effective interest rate sensitivity management seeks to ensure that net interest
income and the market value of equity are protected from the impact of changes
in interest rates.
The Company employs an interest rate risk management process that allows
risk-taking within well-defined limits. The Company has implemented a risk
measurement guideline employing "market value of equity" and "gap' methodologies
and other measures. By actively managing the maturities of its interest-
sensitive assets and liabilities, the Company seeks to maintain relatively
consistent net interest spreads and mitigate much of the interest rate risk
associated with such assets and liabilities.
The Company's policy seeks to reduce the variability of the market value of
its equity in a variety of interest rate environments. The Company uses the
concept of fair value of equity (FVE), which represents the net fair value of
the Company's financial assets and liabilities, including off-balance sheet
hedges, and monitors the sensitivity of changes in its FVE with respect to
various interest rate environments. The Company seeks to maximize net interest
income, while limiting changes in the FVE within changing interest rate
environments to prescribed levels deemed acceptable by the Company. The Company
utilizes sensitivity analysis to evaluate the rate and extent of changes to its
FVE in various market environments.
The Company utilizes interest rate swaps, caps, swaptions, floors, collars,
financial options and other mortgage derivative products to reduce the
variability of FVE and its overall interest rate risk exposure. The Company's
Board of Directors prohibits the use of the aforementioned financial instruments
for speculative purposes.
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.
32
<PAGE> 34
The following table sets forth an interest rate sensitivity analysis for
the Company at December 31, 1997.
<TABLE>
<CAPTION>
REPRICING REPRICING REPRICING REPRICING
BALANCE AT WITHIN WITHIN WITHIN MORE
DECEMBER 31, PERCENT 0-3 4-12 1-5 THAN
1997 OF TOTAL MONTHS MONTHS YEARS 5 YEARS
------------ -------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net...... $ 540,704 50.43% $ 62,981 $ 174,892 $204,997 $ 97,834
Mortgage-backed securities,
available for sale and
trading................. 340,313 31.74 127,191 104,601 61,715 46,805
Investment securities
available for sale,
interest-bearing
accounts and FHLB
stock................... 91,237 8.51 15,158 638 61,934 13,507
Federal funds sold and
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 16,667
---------- ------ --------- --------- -------- --------
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(1)... (10.81)% 5.35% (6.36)% 3.68%
</TABLE>
- ---------------
(1) The hedge effected cumulative gap to total assets includes 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 treated as part of the hedged asset or liability and
weighted by the market's estimate of the likelihood the cap strike will be
met or exceeded. The estimated net cash flows are used in the gap
calculations.
Shortcomings are inherent in gap analysis since certain assets and
liabilities may not move proportionately as interest rates change. Based on the
Company's projected December 31, 1997 simulation analysis, and
33
<PAGE> 35
excluding TeleBank's trading portfolio, the Company estimates that a
hypothetical instantaneous 100 basis point rise in rates would cause FVE to
decrease by 7.70%.
IMPACT OF INFLATION AND CHANGING PRICES
The impact of inflation on the Company is different from the impact on an
industrial company because substantially all of the assets and liabilities of
the Company are monetary in nature and interest rates and inflation rates do not
always move in concert. A bank's asset and liability structure differs
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. The most direct impact of an extended period of
inflation would be to increase interest rates and to place upward pressure on
the operating expenses of the Company. However, the actual effect of inflation
on the net interest income of the Company would depend on the extent to which
the Company was able to maintain a spread between the average yield on
interest-earning assets and the average cost of interest-bearing liabilities,
which would depend to a significant extent on its asset-liability sensitivity.
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. The effect
of inflation on the Company's results of operations for the past three years has
been minimal.
YEAR 2000 ISSUES
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. Although the Company may
incur additional expenses during the next two years to confirm Year 2000
compliance and to remedy problems, if any, the Company does not anticipate that
such expenditures will be material or that Year 2000 compliance will otherwise
have a material effect on the Company's financial condition or results of
operations.
CHANGES IN ACCOUNTING PRINCIPLES
Statement of Financial Accounting Standards ("SFAS") No. 130 "Reporting
Comprehensive Income" and SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information" were issued in June 1997. SFAS 130 requires
that certain financial activity typically disclosed in stockholders' 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 implemented
SFAS No. 130 effective for the first quarter of 1998 and will implement SFAS No.
131 effective for the year ending December 31, 1998. The Company does not
anticipate any material financial impact from the implementation of SFAS Nos.
130 and 131.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to "Interest Rate Sensitivity" in Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations.
34
<PAGE> 36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................... 36
Consolidated Statement of Financial Condition -- As of
December 31, 1997 and 1996................................ 37
Consolidated Statements of Operations -- For the Years Ended
December 31, 1997, 1996 and 1995.......................... 38
Consolidated Statements of Changes in Stockholders'
Equity -- For the Years Ended December 31, 1997, 1996 and
1995...................................................... 39
Consolidated Statements of Cash Flows -- For the Years Ended
December 31, 1997, 1996 and 1995.......................... 40
Notes to Consolidated Financial Statements.................. 41
</TABLE>
35
<PAGE> 37
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 each of the three years ended December
31, 1997. 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 each of the three years ended December
31, 1997, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Vienna, VA
May 11, 1998
36
<PAGE> 38
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1997 AND 1996
ASSETS
<TABLE>
<CAPTION>
1997 1996
---------- --------
(DOLLARS IN THOUSANDS)
<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.
37
<PAGE> 39
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
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................................................. $ 1.14 $ 1.16 $ 1.33
</TABLE>
See accompanying notes to consolidated financial statements.
38
<PAGE> 40
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
UNREALIZED GAINS
ADDITIONAL (LOSSES) ON
PREFERRED COMMON PAID-IN RETAINED AVAILABLE-FOR-SALE
STOCK STOCK CAPITAL EARNINGS SECURITIES TOTAL
--------- ------ ---------- -------- ------------------ -------
(DOLLARS IN THOUSANDS)
<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.
39
<PAGE> 41
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
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 loss 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 -- --
Increase in Issuance of preferred and common stock and
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
========= ========= =========
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.
40
<PAGE> 42
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.
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
41
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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.
42
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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
43
<PAGE> 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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.
44
<PAGE> 46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Bank's actual capital amounts and ratios are presented in the table
below (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
------- ------ ---------- ------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31, 1997:
Total Capital (to risk 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 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
======= ====== ==== =======
</TABLE>
45
<PAGE> 47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUES
--------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
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>
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.
46
<PAGE> 48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
-------- ------ ------- --------
$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.
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.
47
<PAGE> 49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
------- -------
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.
48
<PAGE> 50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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:
Commercial real estate............................... $ 251 $ 8 $ 243
One-to-four family................................... 184 -- 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
49
<PAGE> 51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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>
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
50
<PAGE> 52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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> <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
------ -------- --------
<C> <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
--------- -------- ------- ------- ------- ------ --------
<C> <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
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.
51
<PAGE> 53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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> <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
1/20 of its outstanding advances from the FHLB.
11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
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.
52
<PAGE> 54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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. 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, General American Life Insurance Company, 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.
53
<PAGE> 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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.
EPS CALCULATION
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997
-------------------------------------------
INCOME SHARES PER SHARE AMOUNT
---------- --------- ----------------
<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........................ -- 255,135
Warrants............................................ -- 250,410
Convertible preferred stock......................... 546,182 1,008,575
---------- --------- -----
Diluted earnings per share.......................... $4,216,826 3,705,575 $1.14
========== ========= =====
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1996
-------------------------------------------
INCOME SHARES PER SHARE AMOUNT
---------- --------- ----------------
<S> <C> <C> <C>
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
========== ========= =====
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1995
-------------------------------------------
INCOME SHARES PER SHARE AMOUNT
---------- --------- ----------------
<S> <C> <C> <C>
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>
54
<PAGE> 56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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>
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 and 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
55
<PAGE> 57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
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......................... 4.6yrs 5.0yrs
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
DATE BALANCE DATE
------------- -------- -------------
<S> <C> <C> <C>
Cap Strike Rate
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
56
<PAGE> 58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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.
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
</TABLE>
57
<PAGE> 59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
1997 1997 1996 1996
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- -------- -------- --------
<S> <C> <C> <C> <C>
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 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.
58
<PAGE> 60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
1997 1996 1995
------------------ ------------------ ------------------
WEIGHTED WEIGHTED WEIGHTED
AVG. AVG. AVG.
SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE
OPTIONS (000'S) PRICE (000'S) PRICE (000'S) 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 granted... $ 3.49 $2.61 $1.81
</TABLE>
The following table summarizes information about fixed options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING (000'S)
------------------------------------ OPTIONS EXERCISABLE
WEIGHTED (000'S)
AVG. ----------------------
REMAINING WEIGHTED WEIGHTED
CONTRACTUAL AVG. AVG.
RANGE OF EXERCISE NUMBER LIFE EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING (YEARS) PRICE EXERCISABLE PRICE
----------------- ----------- ----------- -------- ----------- --------
<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 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............................ $ 1.14 $ 1.16 $ 1.33
Pro forma.............................. $ 0.86 $ 1.09 $ 1.31
</TABLE>
59
<PAGE> 61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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 $26.4 million. The DFC Acquisition is
expected to be consummated in the summer of 1998, subject to DFC stockholder and
regulatory approvals.
Also in January 1998, TeleBanc announced that it had signed a definitive
acquisition agreement whereby MET Holdings will sell substantially all of its
assets, including approximately 1,433,081 shares of TeleBanc Common Stock owned
by MET Holdings, and assign substantially all of its liabilities, to TeleBanc.
Immediately following consummation of the acquisition, MET Holdings will
dissolve and distribute its remaining assets and liabilities to its
stockholders, assuming such dissolution is approved by the requisite number of
stockholders of MET Holdings and TeleBanc.
60
<PAGE> 62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
22. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)
STATEMENTS OF FINANCIAL CONDITION
($ IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1996
-------- -------
<S> <C> <C>
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:
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 $54,851
======== =======
</TABLE>
61
<PAGE> 63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF OPERATIONS
($ IN THOUSANDS)
<TABLE>
<CAPTION>
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
</TABLE>
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1997 1996 1995
-------- --------- --------
(DOLLARS IN THOUSANDS)
<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) -- --
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
</TABLE>
62
<PAGE> 64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1997 1996 1995
-------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
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.
23. 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
---------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1997 1997 1997 1997
--------- -------- ------------- ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<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
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......................... $ 0.30 $ 0.31 $ 0.22 $ 0.31
</TABLE>
63
<PAGE> 65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1996 1996 1996 1996
--------- -------- ------------- ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<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>
64
<PAGE> 66
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table lists the current directors, executive officers and
certain key employees of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
David A. Smilow........................ 36 Chairman of the Board of Directors
Mitchell H. Caplan..................... 40 Vice Chairman of the Board of Directors
Chief Executive Officer and President
Aileen Lopez Pugh...................... 30 Executive Vice President, Chief
Financial Officer
Laurence Greenberg..................... 36 Executive Vice President, Chief
Marketing Officer
Michael Opsahl......................... 35 Executive Vice President, Chief Credit
Officer
Sang-Hee Yi............................ 34 Executive Vice President, Chief
Operating Officer
David R. DeCamp........................ 38 Director
Arlen W. Gelbard....................... 40 Director
Dean C. Kehler......................... 41 Director
Steven F. Piaker....................... 35 Director
Mark Rollinson......................... 62 Director
</TABLE>
DAVID A. SMILOW has served as the Chairman of the Board of Directors since
March 1994 and as Chief Executive Officer of the Company from March 1994 to
April 1998. He has also served as the Chairman of the Board of Directors of
TeleBank since January 1994 and as Chief Risk Management Officer of TeleBank
since February 1996. Prior to January 1994, Mr. Smilow served as President of
TeleBank. Mr. Smilow also serves as President of TCM. Mr. Smilow is the
brother-in-law of Mr. Opsahl.
MITCHELL H. CAPLAN has served as the Vice Chairman of the Board of
Directors and President of the Company since January 1994 and has served as
Chief Executive Officer of the Company since April 1998. Mr. Caplan has also
served as Vice Chairman, President and Chief Executive Officer of TeleBank since
January 1994. Mr. Caplan also serves as Vice President of TCM. From 1990 until
December 1993, Mr. Caplan was a member of the law firms of Danziger & Caplan and
Zuckerman & Gore, where he represented and advised private and public commercial
institutions.
AILEEN LOPEZ PUGH has served as Executive Vice President, Chief Financial
Officer and Treasurer of the Company and TeleBank since August 1994. Prior to
joining management of the Company and TeleBank, Ms. Pugh served as a director
from April 1993 to August 1994. From December 1993 to May 1994, she served as a
consultant to MET Holdings in connection with the organization of the Company
and its initial public offering.
LAURENCE GREENBERG has served as Executive Vice President and Chief
Marketing Officer of the Company and TeleBank since 1995 where he is responsible
for developing and implementing the Company's marketing strategy and overseeing
the call center and deposit operations functions. From October 1994 to 1995, Mr.
Greenberg served as Senior Vice President of Marketing. Prior to joining
management of the Company and TeleBank, Mr. Greenberg served as consultant to
TeleBank between April and September 1994. From 1993 to April 1994, Mr.
Greenberg was a Senior Associate at T.H. Land Research Group, Inc., a
65
<PAGE> 67
marketing research company serving direct marketing companies. From 1989 to
1993, Mr. Greenberg was a Marketing Manager for specialty publications with
Capital Cities/ABC, Inc.
MICHAEL OPSAHL has served as Executive Vice President and Chief Credit
Officer since 1990, responsible for the development of the loan acquisition
process, including the acquisition and pricing of loans and the swapping of
purchased loan pools for mortgage-backed securities. Prior to joining the
Company, Mr. Opsahl served as a trading assistant at the FHLMC. Mr. Opsahl is
the brother-in-law of Mr. Smilow.
SANG-HEE YI has served as Executive Vice President and Chief Operating
Officer since April 1996, responsible for operations and regulatory compliance.
Prior to serving in her current position, Ms. Yi served as the compliance
officer of the Company. From 1986 to April 1994, she was a federal thrift
regulator at the OTS.
DAVID R. DECAMP has served as a director of the Company since its formation
in March 1994 and as a director of TeleBank since July 1992. Mr. DeCamp is a
Senior Vice President of Grubb & Ellis, a commercial real estate broker. From
1988 to 1996, Mr. DeCamp was a commercial real estate broker with Cassidy &
Pinkard, Inc. Mr. DeCamp is the Chairman of the Audit and Compliance Committees
of the Company and TeleBank, respectively.
ARLEN W. GELBARD has served as a director of the Company and TeleBank since
April 1996. Mr. Gelbard is a member of the law firm of Hofheimer Gartlir &
Gross, LLP, New York, New York where he has specialized in transactional real
estate, lending, leasing, foreclosures and workouts since 1982. Mr. Gelbard is
the Chairman of the Compensation Committees of the Company and TeleBank,
respectively. On June 30, 1998, Mr. Gelbard will join the Company as its General
Counsel and resign his position as a director of the Company.
DEAN C. KEHLER has served as a director of the Company and TeleBank since
March 1997. Mr. Kehler has been a Managing Director of CIBC Wood Gundy
Securities, a subsidiary of CIBC World Markets, and co-head of the High Yield
Group since August 1995. From February 1990 to August 1995, Mr. Kehler was a
founding partner and Managing Director of The Argosy Group, L.P., which was
acquired by CIBC Wood Gundy Securities in August 1995.
STEVEN F. PIAKER has served as a director of the Company and TeleBank since
March 1997. Since January 1997, Mr. Piaker has been a Senior Vice President of
Conning & Company, a provider of asset management, private equity capital,
corporate finance services and research to the insurance and financial services
industries, which he joined in 1994. From September 1992 to June 1994, Mr.
Piaker served as a Senior Vice President of Conseco, Inc. where he was involved
in company-sponsored leveraged buyouts and private placements in the insurance
industry.
MARK ROLLINSON has served as a director of the Company since its formation
in March 1994 and as a director of TeleBank since 1992. He has been a
self-employed attorney in Leesburg, Virginia, for the past ten years.
MESSRS. KEHLER and Piaker were elected to the Board of Directors of the
Company pursuant to a provision in the Certificate of Designation of the
Preferred Stock (the "Certificate of Designation").
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<PAGE> 68
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION
The following table sets forth the compensation paid and earned during the
periods indicated by the Company and TeleBank to the executive officers of the
Company (the "Named Executive Officers") for services rendered to the Company in
all capacities. The Company has not granted any stock appreciation rights
("SARs").
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
--------------------------- ------------
SECURITIES
UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS (#) COMPENSATION ($)(1)
--------------------------- ---- --------- -------- ------------ -------------------
<S> <C> <C> <C> <C> <C>
David A. Smilow....................... 1997 $205,000 $200,000 100,000 $15,000
Chairman of the Board 1996 205,000 188,000 -- 15,000
1995 205,000 150,000 -- 15,000
Mitchell H. Caplan.................... 1997 205,000 200,000 100,000 15,000
Vice Chairman, Chief Executive 1996 205,000 188,000 -- 15,000
Officer and President 1995 205,000 150,000 -- 15,000
Aileen Lopez Pugh..................... 1997 79,500 100,000 10,000 13,913
Executive Vice President, 1996 75,000 60,000 15,000 13,500
Chief Financial Officer 1995 75,000 60,000 5,000 13,500
</TABLE>
- ---------------
(1) The total amounts shown for each of the years presented represent dollar
value of contributions made by the Company to its Employee Stock Ownership
Plan for the account of the Named Executive Officer.
STOCK OPTIONS GRANTS IN 1997
The following table contains information with respect to options to
purchase Common Stock granted to the Named Executive Officers in 1997. All
options were granted under the Company's 1994 or 1997 Stock Option Plan. The
Company has not granted any SARs.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS OPTION TERM (1)
- ------------------------------------------------------------------------------------------- ---------------------------
PERCENT POTENTIAL REALIZABLE VALUE
OF TOTAL AT ASSUMED ANNUAL RATES
NUMBER OF OPTIONS OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES EXERCISE TERM
OPTIONS IN FISCAL OR BASE EXPIRATION ---------------------------
NAME GRANTED (#) YEAR PRICE ($/SH) DATE 5% ($) 10% ($)
---- --------------------- ---------------- ------------ ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
David A. Smilow...... 100,000(2) 35.0% $13.50 2/28/07 $849,008 $2,151,552
Mitchell H. Caplan... 100,000(2) 35.0 13.50 2/28/07 849,008 2,151,552
Aileen Lopez Pugh.... 10,000(3) 3.5 13.50 2/15/07 84,901 215,155
</TABLE>
- ---------------
(1) The dollar amounts under these columns are the result of calculations at the
5% and 10% assumed annual growth rates mandated by the rules and regulations
promulgated by the Commission and, therefore, are not intended to forecast
possible future appreciation, if any, in the Common Stock price.
(2) The options vested 20% upon grant on February 28, 1997, and 20% vests
ratably on each of the next four anniversaries of the grant.
(3) The options vested 20% upon grant on February 15, 1997 and 20% vests ratably
on each of the next four anniversaries of the grant.
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<PAGE> 69
None of the Named Executive Officers exercised stock options during 1997.
The following table sets forth information with respect to outstanding options
held by the Named Executive Officers at December 31, 1997.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED-
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FY-END(#) AT FY-END($)(1)
---------------------------- ----------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
David A. Smilow........................... 104,292 101,073 $1,014,696 $572,424
Mitchell H. Caplan........................ 104,292 101,073 1,014,696 572,424
Aileen Lopez Pugh......................... 16,000 19,000 163,375 148,500
</TABLE>
- ---------------
(1) Based on last reported sale price of the Common Stock on December 31, 1997
of $17.75 per share and applicable per share exercise price for the options.
(2) On April 28, 1994, Messrs. Smilow and Caplan were each granted options to
purchase 42,617 shares of Common Stock with an exercise price of $6.125 and
options to purchase 62,478 shares of Common Stock with an exercise price
equal to $7.125. The options expire in April 2004. The options vested 20%
upon grant, and 20% vests ratably on each of the next four anniversaries of
the grant. Also Messrs. Smilow and Caplan were each granted options to
purchase 100,000 shares of Common Stock on February 28, 1997 with an
exercise price of $13.50 and an expiration date of February 28, 2007. The
options vested 20% upon grant, and 20% vest ratably on each of the next four
anniversaries of the grant.
(3) The Company has granted a total of 35,000 options to Ms. Pugh: 5,000 options
granted on April 28, 1994 with an exercise price of $6.125, 5,000 options
granted on February 15, 1995 with an exercise price of $5.50, 15,000 options
granted on February 15, 1996 with an exercise price of $7.75 and 10,000
options granted on February 15, 1997 with an exercise price of $13.50. The
options expire in April 2004, February 2005, February 2006 and February
2007, respectively. The options vested 20% upon grant, and 20% vest ratably
on each of the next four anniversaries of the grant.
COMPENSATION OF DIRECTORS
Non-employee directors of the Company receive $750 for each Board of
Directors and committee meeting attended, up to an aggregate of $3,000 per
director annually. Non-employee directors of TeleBank receive $750 for each
Board of Directors or committee meeting attended up to an aggregate of $12,000
per director annually. In addition, non-employee directors are reimbursed for
travel costs and other out-of-pocket expenses incurred in attending such
meeting.
As additional compensation for services provided to the Company, in May
1994, the Company granted to each of Messrs. DeCamp and Rollinson options to
acquire 10,000 shares of Common Stock, at an exercise price of $3.063 per share.
As of the date of this Annual Report, these options are fully vested. Mr.
Rollinson has exercised options to acquire 10,000 shares of Common Stock. In
August 1996, the Company granted to each of Messrs. DeCamp, Gelbard and
Rollinson options to acquire 20,000 shares of Common Stock, of which options to
acquire 24,000 in the aggregate are vested. As of the date of this Annual
Report, options to acquire 70,000 shares of Common Stock held in the aggregate
by such directors are outstanding.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following tables set forth certain information regarding the beneficial
ownership of the Company's Common Stock and Series A Preferred Stock
(collectively, the "Voting Securities") as of March 31, 1998 by (i) any person
known to the Company to be the beneficial owner of more than 5% of any class of
the Company's Voting Securities, (ii) each director and person nominated to be a
director as of December 31, 1997, (iii) the Chief Executive Officer and the
Named Executive Officers, and (iv) all directors and executive
68
<PAGE> 70
officers as a group. Except as otherwise noted, each beneficial owner has sole
investment and voting power with respect to the listed shares.
SECURITY OWNERSHIP OF THE COMPANY'S SECURITIES
<TABLE>
<CAPTION>
PERCENTAGE OF
AMOUNT AND CLASS OUTSTANDING/
NATURE OF COMPANY'S
BENEFICIAL VOTING
TITLE OF CLASS NAME OF BENEFICIAL OWNER OWNERSHIP SECURITIES(1)
-------------- ------------------------ ---------- ------------------
<S> <C> <C> <C>
Series A Preferred Stock Conning Insurance Capital Limited
Partnership III(2)................... 4,719 25.03%/6.31%
Conning Insurance Capital
International Partners III,
L.P.(3).............................. 667 3.54%/*
General American Life Insurance
Company(4)........................... 1,539 8.16%/2.06%
PC Investment Company(5)............. 6,925 36.74%/9.27%
The Northwestern Mutual Life
Insurance Company(6)................. 5,000 26.53%/6.69%
</TABLE>
- ---------------
* Less than 1%.
(1) Each share of Series A Preferred Stock has approximately 40.12519 votes,
based on its conversion into an equivalent number of shares of Common Stock.
Accordingly, the percentages reflected include (i) the percentage of Series
A Preferred Stock outstanding and (ii) the percentage of the Company's
Voting Securities beneficially owned, giving effect to the voting rights
held by the owners of Series A Preferred Stock.
(2) The address of Conning Insurance Capital Limited Partnership III is c/o
Conning & Company, City Place II, 185 Asylum Street, Hartford, Connecticut
06103
(3) The address of Conning Insurance Capital International Partners III is c/o
Conning & Company, City Place II, 185 Asylum Street, Hartford, Connecticut
06103.
(4) The address of General American Life Insurance Company is 700 Market Street,
St. Louis, Missouri 63101.
(5) The address of PC Investment Company is 401 Theodore Freund Avenue, Rye, New
York 60580.
(6) The address of The Northwestern Mutual Life Insurance Company is 720 East
Wisconsin Avenue, Milwaukee, Wisconsin 53202.
69
<PAGE> 71
<TABLE>
<CAPTION>
AMOUNT
AND NATURE PERCENTAGE
OF OF
TITLE BENEFICIAL CLASS
OF CLASS NAME OF BENEFICIAL OWNER(1) OWNERSHIP OUTSTANDING
-------- --------------------------- ---------- -----------
<S> <C> <C> <C>
Common Stock MET Holdings Corporation(2)......................... 1,433,081 63.9%
David A. Smilow(3).................................. 155,290 6.9%
Mitchell H. Caplan(4)............................... 142,698 6.0%
David R. DeCamp(5).................................. 10,000 *
Arlen W. Gelbard(6)................................. 4,000 *
Dean C. Kehler(7)................................... 280,876 11.1%
Steven F. Piaker(8)................................. 224,139 9.1%
Mark Rollinson(9)................................... 12,000 *
Aileen Lopez Pugh(10)............................... 29,300 1.3%
Directors and Executive Officers as a group (9
individuals)(11).................................. 927,628 29.3%
TeleBanc Financial Corporation Employee Stock
Ownership Plan(12)................................ 75,525 3.4%
</TABLE>
- ---------------
* Less than 1%.
(1) Unless otherwise indicated, the address of each beneficial owner listed
above is c/o TeleBanc Financial Corporation, 1111 North Highland Street,
Arlington, Virginia 22201.
(2) MET Holdings is the predecessor savings and loan holding company of
Metropolitan Bank for Savings, F.S.B. ("Metropolitan Bank"). MET Holdings
organized the Company so that it could become, in March 1994, the holding
company for Metropolitan Bank as part of the Company's initial public
offering of debt and equity securities in 1994. Metropolitan Bank was
renamed "TeleBank" in March 1996, and is a wholly owned subsidiary of the
Company. The address of MET Holdings is 405 Park Avenue, Suite 1104, New
York, New York 10022.
(3) Includes options to acquire 129,365 shares of Common Stock which are
exercisable within 60 days of April 30, 1998. Mr. Smilow also holds
significant ownership positions in the outstanding securities of MET
Holdings. See "-- Security Ownership of the Company's Parent by
Management."
(4) Comprised of options to acquire 142,698 shares of Common Stock which are
exercisable within 60 days of April 30, 1998. Mr. Caplan also holds
significant ownership positions in the outstanding securities of MET
Holdings. See "-- Security Ownership of Company's Parent by Management."
(5) Includes options to acquire 9,000 shares of Common Stock which are
exercisable within 60 days of April 30, 1998.
(6) Comprised of options to acquire 4,000 shares of Common Stock which are
exercisable within 60 days of April 30, 1998.
(7) Dean C. Kehler is the designated director for CIBC WG Argosy Merchant Fund
2, LLC, which holds the interest set forth above. Mr. Kehler disclaims any
beneficial ownership in such interest.
(8) Steven F. Piaker is the designated director for Conning Insurance Capital
Limited Partnership III, and Conning Insurance Capital International
Partners III, L.P., which collectively hold the beneficial interests set
forth above. Mr. Piaker disclaims any beneficial ownership in such
interests.
(9) Includes options to acquire 4,000 shares of Common Stock which are
exercisable within 60 days of April 30, 1998.
(10) Includes options to acquire 16,000 shares of Common Stock which are
exercisable within 60 days of April 30, 1998 and warrants for 6,200 shares
of Common Stock.
(11) Includes options to acquire 305,063 shares of Common Stock which are
exercisable within 60 days of April 30, 1998.
70
<PAGE> 72
SECURITY OWNERSHIP OF THE COMPANY'S PARENT BY MANAGEMENT
The following table sets forth certain information as of December 31, 1997
with respect to the beneficial ownership by the management of the Company of
equity securities of the Company's parent, MET Holdings. MET Holdings has four
classes of equity securities, Class A Common Stock, Class B Common Stock, 6%
Class A Serial Preferred Stock ("Class A Serial Preferred Stock") and 6% Class B
Serial Preferred Stock ("Class B Serial Preferred Stock"). No shares of Class A
Serial Preferred Stock have been issued. The Class A Serial Preferred Stock and
Class B Serial Preferred Stock have certain limited voting rights. Unless
otherwise required by law, the Class B Common Stock is non-voting.
<TABLE>
<CAPTION>
NAME EQUITY SECURITY OWNED PERCENT OF CLASS
---- --------------------- ----------------
<S> <C> <C>
David A. Smilow.......................... 4,091 (Class A Common Stock)(1) 41.5%
1,641 (Class B Common Stock)(1) 26.5
2,091 (Class B Serial Preferred Stock)(1) 42.2
Mitchell H. Caplan....................... 985 (Class A Common Stock)(2) 9.9
1,053 (Class B Common Stock)(2) 17.0
1,079 (Class B Serial Preferred Stock)(1) 21.8
Michael A. Smilow........................ 110 (Class A Common Stock) 1.1
117 (Class B Common Stock) 1.9
Directors and Executive Officers......... 5,186 (Class A Common Stock) 52.6
of the Company as a group................ 2,811 (Class B Common Stock) 49.8
(9 individuals).......................... 3,170 (Class B Serial Preferred Stock) 63.9
</TABLE>
- ---------------
(1) Includes 3,252 shares of Class A Common Stock, 980 shares of Class B Common
Stock and 893 shares of Class B Serial Preferred Stock, with respect to
which Mr. D. Smilow shares beneficial ownership with his wife and children.
(2) Includes 645 shares of Class A Common Stock, 655 shares of Class B Common
Stock and 1,079 shares of Class B Serial Preferred Stock, with respect to
which Mr. Caplan shares beneficial ownership.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In February 1997, the Company consummated 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 Common Stock and a $500,000 cash payment.
Messrs. D. Smilow and Caplan are shareholders of MET Holdings.
During 1997 the Company engaged Hofheimer Gartlir & Gross, LLP, of which
Mr. Gelbard is a member, on various matters. Additionally, CIBC Wood Gundy
Securities, of which Mr. Kehler is Managing Director, acted as placement agent
for the Company's private placement of trust preferred securities in June 1997
and invested in the securities through certain of its merchant funds. See
"Business -- General."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) The following consolidated financial statements of the Company and
its subsidiaries and report of independent auditors are included in Item 8 on
page 34 hereof.
Report of Independent Public Accountants.
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.
71
<PAGE> 73
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 Annual Report or
are incorporated herein by reference:
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT
----------- -------
<S> <C>
3.1(a) Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference herein to Exhibit 3.1 to
the Company's Registration Statement on Form S-4, dated
December 8, 1997, File No. 333-40399)
3.1(b) Certificate of Designations (incorporated by reference
herein to Exhibit 3 the Company's Current Report on Form
8-K, dated March 17, 1997)
3.2 Bylaws of the Company (incorporated by reference herein to
Exhibit 3.2, to the Company's Annual Report on Form 10-K for
the year ended December 31, 1996, dated March 31, 1997)
4.1 Specimen certificate evidencing shares of Common Stock of
the Company (incorporated by reference herein to Exhibit 4.1
to the Company's Registration Statement on Form S-1, dated
March 25, 1994, File No. 33-76930)
4.2 Form of warrant for the purchase of shares of Common Stock,
issued in connection with the Unit Purchase Agreement, dated
February 19, 1997, among the Company and the Purchasers
identified therein (incorporated by reference herein to
Exhibit 10.1 to the Company's Current Report on Form 8-K,
dated March 17, 1997)
4.3 Form of warrant for the purchase of shares of Common Stock,
issued in connection with the units of warrants and
subordinated debt sold in the Company's initial public
offering (incorporated by reference herein to Exhibit 4.5 to
the Company's Registration Statement on Form S-1, dated
March 25, 1994, File No. 33-76930)
4.5 Form of Certificate of Exchange Junior Subordinated
Debentures (incorporated by reference herein to Exhibit 4.3
to the Company's Form 10-K/A for the year ended December 31,
1997, dated April 2, 1998)
4.6 Amended and Restated Declaration of Trust of TeleBanc
Capital Trust I, dated June 9, 1997 (incorporated by
reference herein to Exhibit 3.4 to the Company's
Registration Statement on Form S-4, dated December 8, 1997,
File No. 333-40399)
4.7 Form of Exchange Capital Security Certificate (incorporated
by reference herein to Exhibit 4.6 to the Company's
Registration Statement on Form S-4, dated December 8, 1997,
File No. 333-40399)
4.8 Exchange Guarantee Agreement by the Company for the benefit
of the holders of Exchange Capital Securities (incorporated
herein by reference to Exhibit 4.7 to the Company's
Registration Statement on Form S-4, dated December 8, 1997,
File No. 333-40399)
10.1* 1994 Stock Option Plan (incorporated by reference herein to
Exhibit 10.1 to the Company's Registration Statement on Form
S-1, dated March 25, 1994, File No. 33-76930)
</TABLE>
72
<PAGE> 74
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT
----------- -------
<S> <C>
10.2* 1997 Stock Option Plan (incorporated by reference herein to
Exhibit D to the Company's definitive proxy materials which
were filed as Exhibit 99.3 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1996, dated March
31, 1997)
10.3 Registration Rights Agreement, dated June 5, 1997, among the
Company, TeleBanc Capital Trust I and the Initial Purchaser
(incorporated by reference herein to Exhibit 4.8 to the
Company's Registration Statement on Form S-4, dated December
8, 1997, File No. 333-40399)
10.4 Unit Purchase Agreement, dated February 19, 1997, among the
Company and the Purchasers identified therein (incorporated
by reference herein to Exhibit 10.1 to the Company's Current
Report on 8-K, dated March 17, 1997)
10.5 Amended and Restated Acquisition Agreement, dated February
19, 1997, among the Company, Arbor Capital Partners, Inc.,
MET Holdings, Inc., and William M. Daughtery (incorporated
by reference herein to Exhibit 10.2 to the Company's Current
Report on 8-K, dated March 17, 1997)
10.6 Liquidated Damages Agreement, dated June 9, 1997, by and
among the Company, TeleBanc Capital Trust I, and the Initial
Purchaser (incorporated by reference herein to Exhibit 4.9
to the Company's Registration Statement on Form S-4, dated
December 8, 1997, File No. 333-40399)
10.7 Tax Allocation Agreement, dated April 7, 1994, between
TeleBank and Company (incorporated by reference herein to
Exhibit 10.3 to Amendment No. 1 to the Company's
Registration Statement on Form S-1, dated May 3, 1994, File
No. 33-76930)
10.8 Indenture dated June 9, 1997, between the Company and
Wilmington Trust Company, as debenture trustee (incorporated
by reference herein to the Company's Registration Statement
on Form S-4, dated December 8, 1997, File No. 333-40399)
10.9 Form of Indenture between the Company and Wilmington Trust
Company as Trustee (incorporated by reference herein to
Exhibit 4.3 to the Company's Registration Statement on Form
S-1, dated March 25, 1994, File No. 33-76930)
11 Statement regarding calculation of net income per share
(incorporated by reference herein to Exhibit 11 to Amendment
No. 4 on Form 10-K/A to the Company's Annual Report on Form
10-K, dated May 15, 1998)
21 Subsidiaries of the Company (incorporated by reference
herein to Exhibit 21 to Amendment No. 4 on Form 10-K/A to
the Company's Annual Report on Form 10-K, dated May 15,
1998)
</TABLE>
- ---------------
* Indicates compensatory plan or arrangement.
73
<PAGE> 75
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amendment to its
Annual Report on Form 10-K to be signed on its behalf by the undersigned,
thereunto duly authorized.
TELEBANC FINANCIAL CORPORATION
/s/ AILEEN LOPEZ PUGH
--------------------------------------
Aileen Lopez Pugh
Executive Vice President, Chief
Financial Officer
June 3, 1998
74
