<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM 10-K/A
------------------------
AMENDMENT NO. 2 TO ANNUAL REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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 (IRS EMPLOYER
OF INCORPORATION ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
1111 NORTH HIGHLAND STREET
ARLINGTON, VIRGINIA 22201
(703) 247-3700
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
(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:
Common Stock
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of 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
30, 1999, the aggregate market value of the voting stock held by non-affiliates
of the registrant is $730.4 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 $0.01 PER SHARE
OUTSTANDING AT MARCH 30, 1999: 12,610,599 SHARES
DOCUMENTS INCORPORATED BY REFERENCE
None.
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<PAGE> 2
PART I
ITEM 1. BUSINESS
TeleBanc Financial Corporation ("Telebanc" or the "Company") is a savings
and loan holding company organized under the laws of Delaware in 1994.
We provide high value financial products and services primarily over the
internet. We offer a wide range of FDIC-insured and other banking products and
services with significantly higher rates and lower fees than traditional banks
with brick-and-mortar branches.
We have been providing branchless banking for ten years using electronic
delivery channels. With the advent of the internet, we have positioned ourselves
to exploit its low cost distribution, increased functionality and broader reach.
We believe that the low costs associated with delivering our products and
services over the internet provide us with significant cost advantages over
traditional banks that must support branch networks.
Currently, approximately 60% of our customer contacts occur over the
internet. Using our secure, comprehensive and customer friendly web site
(www.telebankonline.com), individuals can open an account, transfer funds
between accounts, view account balances, pay bills and compare our premium rates
to national averages. Customers can deposit funds using direct deposit, wire or
U.S. mail, and can withdraw cash from over 430,000 automated teller machines on
the Cirrus(R) network worldwide. To support our products and services and build
customer loyalty, we strive to provide superior customer service through our
24-hour call centers. We also offer a wide array of complementary products,
including residential mortgage loans and fixed annuities, through mutually
beneficial alliances with other companies that provide these products directly.
Our comprehensive marketing plan targets customers in all 50 states who
value the convenience and premium rates of our high value products. The four
main initiatives of our marketing plan are national advertising through print,
radio and online media, marketing alliances with popular web sites such as
Yahoo! and E-Loan, affinity partnerships with national organizations such as
Sam's Club and programs where our existing customers refer new customers to us.
As of December 31, 1998, we had approximately 50,000 customer accounts, $2.3
billion in total assets and $1.1 billion in retail deposits. During 1998, our
retail deposits and customer accounts grew 119% and 133%.
Our executive offices are located at 1111 North Highland Street, Arlington,
Virginia 22201, telephone (703) 247-3700. Our web site address is located at
www.telebankonline.com.
LENDING ACTIVITIES
GENERAL. We purchase whole loans and mortgage-backed and related
securities rather than produce or originate loans.
LOAN PORTFOLIO COMPOSITION. At December 31, 1998, our net loans receivable
totaled $904.8 million, or 39.6% of total assets. As of the same date, $897.2
million, or 97.5%, of the total gross loan portfolio, consisted of one- to
four-family residential mortgage loans. Prior to 1990, we originated a limited
number of loans for the purchase or construction of multifamily and commercial
real estate. However, as part of our general operating strategy and in response
to risks associated with multifamily and commercial real estate lending and
prevailing economic conditions, we stopped originating and purchasing such
loans. At December 31, 1998, multifamily, commercial, and mixed-use real estate
loans amounted to $13.1 million, or 1.4%, of our total loan portfolio. The loan
portfolio also included second trust residential mortgages, home equity lines of
credit, automobile loans and loans secured by savings deposits totaling $8.7
million, or 0.9%, of our total loan portfolio at December 31, 1998.
The following table presents information concerning our loan portfolio in
dollar amounts and in percentages, by type of loan.
2
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<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------------------------------------------------------------
1998 % 1997 % 1996 % 1995
-------- ------ -------- ------ -------- ------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family
fixed-rate............... $466,850 50.76% $211,287 38.11% $142,211 38.59% $105,750
One- to four-family
adjustable-rate.......... 430,319 46.79 336,470 60.69 217,352 58.97 148,928
Multifamily................. 3,223 0.35 1,447 0.26 1,516 0.41 1,286
Commercial real estate...... 8,916 0.97 3,033 0.55 4,017 1.09 4,553
Mixed use real estate....... 929 0.10 856 0.15 1,180 0.32 1,792
Land........................ 316 0.03 463 0.08 781 0.21 384
-------- ------ -------- ------ -------- ------ --------
Total real estate
loans............. 910,553 99.00 553,556 99.84 367,057 99.59 262,693
-------- ------ -------- ------ -------- ------ --------
Consumer and other loans:
Lease financing............. 554 0.06 -- -- -- -- --
Home equity lines of credit
and second mortgage
loans.................... 5,895 0.64 564 0.10 1,208 0.33 2,202
Other (1)................... 2,758 0.30 305 0.06 305 0.08 79
-------- ------ -------- ------ -------- ------ --------
Total consumer and
other loans....... 9,207 1.00 869 0.16 1,513 0.41 2,281
-------- ------ -------- ------ -------- ------ --------
Total loans......... 919,760 100.00% 554,425 100.00% 368,570 100.00% 264,974
-------- ------ -------- ------ -------- ------ --------
Deduct:
Deferred discounts on
loans.................... (9,989) (9,938) (13,568) (14,129)
Allowance for loan losses... (4,766) (3,594) (2,957) (2,311)
Other....................... (151) (189) (224) (42)
-------- -------- -------- --------
Total............... (14,906) (13,721) (16,749) (16,482)
-------- -------- -------- --------
Loans receivable, net....... $904,854 $540,704 $351,821 $248,492
======== ======== ======== ========
<CAPTION>
AT DECEMBER 31,
----------------------------
% 1994 %
------ -------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Real estate loans:
One- to four-family
fixed-rate............... 39.91% $ 67,449 42.54%
One- to four-family
adjustable-rate.......... 56.20 79,701 50.27
Multifamily................. 0.49 1,114 0.70
Commercial real estate...... 1.72 4,385 2.77
Mixed use real estate....... 0.68 1,953 1.23
Land........................ 0.14 387 0.24
------ -------- ------
Total real estate
loans............. 99.14 154,989 97.75
------ -------- ------
Consumer and other loans:
Lease financing............. -- -- --
Home equity lines of credit
and second mortgage
loans.................... 0.83 3,395 2.14
Other (1)................... 0.03 168 0.11
------ -------- ------
Total consumer and
other loans....... 0.86 3,563 2.25
------ -------- ------
Total loans......... 100.00% 158,552 100.00%
------ -------- ------
Deduct:
Deferred discounts on
loans.................... (2,835)
Allowance for loan losses... (925)
Other....................... (50)
--------
Total............... (3,810)
--------
Loans receivable, net....... $154,742
========
</TABLE>
- ---------------
(1) Includes primarily loans secured by deposit accounts in Telebank, and to a
lesser extent, unsecured consumer credit.
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MATURITY OF LOAN PORTFOLIO. The following table shows, as of December 31,
1998, the dollar amount of loans maturing in our portfolio in the time periods
indicated. This information includes scheduled principal repayments, based on
the loans' contractual maturities. We report demand loans, loans with no stated
repayment schedule and no stated maturity, and overdrafts as due within one
year. The table below does not include any estimate of prepayments. Prepayments
may significantly shorten the average life of a loan and may cause our 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..... $4,853 $15,944 $446,053 $466,850
One- to four-family
adjustable-rate................. 521 9,940 419,858 430,319
Multifamily........................ 1,954 987 282 3,223
Mixed use.......................... -- -- 929 929
Commercial real estate............. 15 693 8,208 8,916
Land............................... -- 316 -- 316
Consumer and other loans:
Home equity lines of credit and
second mortgage loans........... -- 766 5,129 5,895
Other.............................. 172 3,140 -- 3,312
------ ------- -------- --------
Total......................... $7,515 $31,786 $880,459 $919,760
====== ======= ======== ========
</TABLE>
The following table shows, as of December 31, 1998, the dollar amount of
our loans that mature after December 31, 1999. We have allocated these loans
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......................... $461,997 $429,798 $891,795
Multifamily................................. 987 282 1,269
Mixed use................................... 753 176 929
Commercial real estate...................... 4,507 4,394 8,901
Land........................................ 316 -- 316
Consumer and other loans:
Home equity lines of credit and second
mortgage loans........................... 4,721 1,174 5,895
Other....................................... 2,248 892 3,140
-------- -------- --------
Total.................................. $475,529 $436,716 $912,245
======== ======== ========
</TABLE>
Scheduled principal repayments set forth in loan contracts may not reflect
the actual life of the loans. Prepayments may cause the average life of loans to
be substantially less than their contractual terms. In addition, some loans
contain due-on-sale clauses, which give us the right to declare a conventional
loan immediately due and payable in the event, among other things, that the
borrower sells the property. However, if market interest rates on current
mortgage loans climb to a level substantially higher than rates on loans that we
own, the average life of our loans tends to increase. Conversely, the average
life of our mortgage loans tends to decrease when market interest rates on
current loans fall substantially below rates on loans that we own.
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<PAGE> 5
Origination, Purchase, and Sale of Loans.
The following table shows our loan purchases and originations during the
periods indicated.
<TABLE>
<CAPTION>
LOAN LOAN
PURCHASES ORIGINATIONS
--------- ------------
(IN THOUSANDS)
<S> <C> <C>
1998........................................................ $518,000 $ --
1997........................................................ 342,900 --
1996........................................................ 183,100 462
1995........................................................ 145,900 2,700
1994........................................................ 85,400 4,300
</TABLE>
Additionally, during 1998, we acquired approximately $150.0 million in
loans through our merger with DFC.
The following table shows our loan origination, purchase, sale, and
repayment activity during the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Total loans receivable at beginning of period...... $540,704 $351,821 $248,492
Loans purchased:
One- to four-family variable rate............. 299,817 256,545 128,171
One- to four-family fixed rate................ 330,477 86,331 53,915
Multi-Family.................................. 1,959 -- 1,000
Commercial.................................... 8,941 -- --
Consumer and other loans...................... 26,910 -- --
-------- -------- --------
Total loans purchased.................... 668,104 342,876 183,086
Loans originated:
Real estate loans:
One- to four-family fixed rate................ -- -- 25
Land.......................................... -- -- 400
Home equity lines of credit and second mortgage
loans............................................ -- -- 37
-------- -------- --------
Total loans originated................... -- -- 462
-------- -------- --------
Total loans purchased and originated..... 668,104 342,876 183,548
Loans sold......................................... 20,622 39,656 18,829
Loans securitized.................................. -- 21,017 8,275
Loan repayments.................................... 280,151 94,945 50,221
-------- -------- --------
Total loans sold, securitized, and
repaid................................. 300,773 155,618 77,325
Net change in deferred discounts and loan fees..... (611) 3,638 (444)
Net transfers to REO............................... (1,923) (1,454) (1,513)
Net provision for loan losses...................... (1,174) (637) (646)
Cost Recovery/Contra Assets........................ -- 27 (41)
Other loan debits/HELOC advances................... 527 51 (250)
-------- -------- --------
Increase (decrease) in total loans receivable...... 364,150 188,883 103,329
-------- -------- --------
Net loans receivable at end of period.............. $904,854 $540,704 $351,821
======== ======== ========
</TABLE>
During fiscal 1998 and 1997, we purchased whole loans in the secondary
market, principally from private investors. In 1998, we purchased 171 pools with
2,472 loans. We purchased 92 pools with 2,900 loans in 1997. In 1996, we
purchased 35 pools with 1,253 loans and originated a minimal number of loans.
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We did not originate any loans during 1998 or 1997. From time to time we
may originate consumer loans as an accommodation to our customers or purchase
such loans as part of larger loan packages.
Under existing master loan servicing contracts, we receive servicing fees
that we withhold from the monthly payments we make to the loan holders. Our
aggregate loan servicing fee income amounted to $1.0 million, $942,000 and
$790,000 in 1998, 1997 and 1996, respectively.
On August 1, 1998, mortgage loans which were serviced in-house were
transferred to Dovenmuehle Mortgage, Inc., pursuant to a subservicing agreement
dated May 6, 1998. While we continue to earn servicing fee income, we pay
Dovenmuehle Mortgage, Inc., a flat fee ranging from $6 to $7 per loan per month.
At December 31, 1998, Dovenmuehle Mortgage, Inc., serviced $217.4 million, or
23.6%, of our gross loan portfolio and $135.2 million in mortgage loans that we
had previously serviced for others. The remainder of our loan portfolio is
serviced by other lenders, who perform the functions described above. To receive
this service, we pay a fee ranging from a minimum of $6 per loan per month to a
maximum of 79 basis points of the principal balance of the loan per annum.
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 invests in loans or other
investments secured by affordable housing for low- or moderate-income
individuals and has committed to invest up to $500,000 in a low-income housing
tax credit fund that qualifies as a community development loan under the CRA.
Senior management of Telebank serves on the board of directors of non-profit
organizations whose purpose is to promote community development. We also provide
loan servicing for Habitat for Humanity of Northern Virginia, Inc., a non-profit
organization whose purpose is to create decent, affordable housing for those in
need.
In 1995, the federal financial regulatory agencies revised the regulations
that implement the CRA. The revised regulations set forth specific types of
evaluations for wholesale banks, which are those that are not in the business of
extending home mortgage, small business, small farm, or consumer loans to retail
customers. Satisfaction of a wholesale bank's responsibilities under the CRA are
measured by various criteria including the number and amount of community
development loans, qualified investments, or community development services, and
the use of innovative or complex community development services, qualified
investments, or community development loans. The Bank has been approved as a
wholesale bank.
The OTS is expected to issue shortly guidance on how a financial
institution which conducts business over the internet is to comply with CRA
obligations. This guidance may impact the way in which the Bank currently meets
its obligations under the CRA.
MORTGAGE-BACKED AND RELATED SECURITIES
We maintain a significant portfolio of mortgage-backed securities,
primarily in the following forms:
- privately insured mortgage pass-through securities
- Government National Mortgage Association ("GNMA") participation
certificates
- Fannie Mae participation certificates
- Freddie Mac participation certificates
- securities issued by other non-agency organizations
Principal and interest on GNMA certificates are guaranteed by the full
faith and credit of the United States. Fannie Mae and Freddie Mac certificates
are each guaranteed by their respective agencies. Mortgage-backed securities
generally entitle us to receive a pro rata portion of the cash flows from an
identified pool of mortgages. We also invest in collateralized mortgage
obligations ("CMOs"). CMOs are securities issued by special purpose entities
generally collateralized by pools of mortgage-backed securities. The cash flows
from these pools are segmented and paid in accordance with a predetermined
priority to various classes of securities issued by the entity. Our CMOs are
senior tranches collateralized by federal agency securities or whole loans. Over
98% of our CMO portfolio is comprised of securities with a triple "A" rating.
Similar to mortgage-backed pass-through securities, our CMO portfolio has an
average maturity date in excess of 10 years. However, the nature of the CMO
bonds acquired, primarily sequential pay bonds, provides for more
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<PAGE> 7
predictable cashflows than the mortgage-backed securities. This reduces the
duration risk, extension risk and price volatility of the CMO compared to
mortgage-backed pass-through securities and thus allows us to target liabilities
with shorter durations.
The following table shows the activity in our mortgage-backed securities
available-for-sale portfolio during the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
---------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Mortgage-backed and related securities at
beginning of period........................... $ 319,203 $ 184,743 $ 234,835
Purchases:
Pass-through securities....................... 22,776 39,400 109,600
CMOs.......................................... 1,092,487 218,836 30,053
Fannie Mae.................................... 8,405 2,115 12,102
GNMA.......................................... 5,890 32,200 30,687
Freddie Mac................................... 11,759 4,649 14,194
Other......................................... 19,586 -- --
Sales(1)........................................ (294,161) (117,047) (185,703)
Repayments...................................... (174,398) (45,304) (61,805)
Transfer to trading............................. (332) -- --
Mark to market adjustment to reflect fair value
of portfolio.................................. 948 (389) 780
---------- --------- ---------
Mortgage-backed and related securities at end of
period........................................ $1,012,163 $ 319,203 $ 184,743
========== ========= =========
</TABLE>
- ---------------
(1) Includes mortgage-backed securities on which call options have been
exercised.
In 1997, we began to acquire mortgage-backed and related securities for
trading purposes. We buy and hold trading securities principally for the purpose
of selling them in the near term. We carry these securities at market value with
unrealized gains and losses recognized in income. At December 31, 1998 and 1997,
we held $29.6 million and $21.1 million of trading securities, respectively. No
securities were classified as trading securities at December 31, 1996. For the
periods ending December 31, 1998 and 1997, we recognized approximately $569,000
and $564,000, respectively, in realized gains from the sale of trading assets
and approximately ($612,000) and $640,000, respectively, in unrealized
depreciation or appreciation of trading assets.
The following table shows the scheduled maturities, carrying values, and
current yields for our portfolio of mortgage-backed and related securities, both
available-for-sale and trading, at December 31, 1998:
<TABLE>
<CAPTION>
AFTER ONE BUT AFTER FIVE BUT
WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS AFTER TEN YEARS TOTALS
------------------ ------------------ ------------------ --------------------- ---------------------
BALANCE WEIGHTED BALANCE WEIGHTED BALANCE WEIGHTED BALANCE WEIGHTED BALANCE WEIGHTED
DUE YIELD DUE YIELD DUE YIELD DUE YIELD DUE YIELD
------- -------- ------- -------- ------- -------- ---------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Private issuer....... $403 38.73% $2,961 7.31% $8,867 8.95% $ 124,447 8.11% $ 136,678 8.24%
Collateralized
mortgage
obligations........ 12 -- -- -- 4,135 6.42 889,296 6.75 893,443 6.75
Agencies............. -- -- -- -- 108 7.57 11,518 6.16 11,626 6.17
---- ----- ------ ---- ------- ---- ---------- ---- ---------- ----
$415 37.61% $2,961 7.31% $13,110 8.14% $1,025,261 6.91% $1,041,747 6.94%
</TABLE>
NONPERFORMING, DELINQUENT AND OTHER PROBLEM ASSETS
GENERAL. We continually monitor our loan portfolio so that we will be able
to anticipate and address potential and actual delinquencies. Generally, we
perform annual valuations on real estate owned ("REO"). If
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<PAGE> 8
the fair value of a property has changed, we establish an allowance for losses
on REO by recognizing an operating expense.
NONPERFORMING ASSETS. Nonperforming assets consist of the following:
- loans on which we no longer accrue interest
- troubled debt restructurings ("TDRs"), which are loans that have been
restructured in order to allow the borrower to retain possession of the
collateral
- real estate acquired by foreclosure
- real estate upon which deeds in lieu of foreclosure have been accepted
We write down restructured loans and REO to estimated fair value, based on
estimates of the cash flow we expect to receive from the underlying collateral.
The following table presents information about our non-accrual loans, REO
and TDRs at the dates indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31,
-------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Loans accounted for on a non-accrual basis:
Real estate loans:
One-to four-family.................... $ 7,727 $10,359 $ 8,979 $4,526 $1,296
Commercial real estate................ 372 568 1,217 261 702
Land.................................. 316 -- -- -- --
Home equity lines of credit and second
mortgage loans........................ 255 -- 54 136 41
Other.................................... 205 -- -- -- 27
------- ------- ------- ------ ------
Total...................................... 8,875 10,927 10,250 4,923 2,066
------- ------- ------- ------ ------
Accruing loans which are contractually past
due 90 days or more:
Real estate loans:
One-to four-family.................... -- -- -- 230 --
------- ------- ------- ------ ------
TDRs....................................... -- 425 435 365 688
------- ------- ------- ------ ------
Total of non-accrual, 90 days past due
loans and TDRs........................... 8,875 11,352 10,685 5,518 2,754
------- ------- ------- ------ ------
REO:
One-to four-family....................... 1,460 681 1,300 421 98
Commercial real estate................... -- -- -- -- 206
Land..................................... -- -- -- 582 581
------- ------- ------- ------ ------
1,460 681 1,300 1,003 885
Loss allowance for REO..................... -- -- (65) (213) (92)
------- ------- ------- ------ ------
Total REO, net................... 1,460 681 1,235 790 793
------- ------- ------- ------ ------
Total non-performing assets, net........... $10,335 $12,033 $11,920 $6,308 $3,547
======= ======= ======= ====== ======
Total non-performing assets, net, as a
percentage of total assets............... 0.45% 1.09% 1.84% 1.14% 0.83%
======= ======= ======= ====== ======
Total loss allowance as a percentage of
total non-performing loans, net.......... 53.70% 31.66% 27.67% 41.88% 35.91%
======= ======= ======= ====== ======
</TABLE>
During 1998, our non-performing assets decreased by $1.7 million or 14.1%.
As a matter of policy, we actively monitor our non-performing assets.
During the years ended December 31, 1998, 1997, 1996, 1995 and 1994, if our
non-accruing loans had been performing in accordance with their terms, we would
have recorded interest income of approximately
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<PAGE> 9
$597,000, $739,000, $789,000, $365,000 and $113,000, respectively. However, we
did not recognize any interest income on non-accruing loans during these years.
TDRs are loans that have been restructured and to which we have granted
concessions in order to allow the borrower to retain possession of the
collateral. We take into consideration, among other things, the borrower's
financial difficulty. In granting these concessions, our goal is to maximize our
recovery from the investment by modifying its terms. These modifications may
include the following:
- reducing the stated rate
- extending maturity at a more favorable rate
- reducing the accrued interest
TDRs totaled approximately $0, $425,000, $435,000, $365,000, and $688,000
at December 31, 1998, 1997, 1996, 1995 and 1994, respectively. We recorded
approximately $0, $28,000, $28,000, $45,000 and $9,000 in interest income on
TDRs in 1998, 1997, 1996, 1995 and 1994, respectively. We monitor TDRs closely
because they are inherently risky.
In some cases, information we know about a borrower's possible credit
problems may cause us to have serious doubts about the borrower's ability to
repay under the loan's present terms, even if that loan is not classified as
non-accrual, past due 90 days or more or a TDR. We consider these loans
potential problem loans. At December 31, 1998, loans that we had identified as
potential problem loans that were still accruing interest approximated $822,000.
The majority of these loans, identified as "special mention" loans, include
non-residential loans that were delinquent but had not yet been placed on
non-accrual.
ALLOWANCE FOR LOAN LOSSES. We recognize that, from time to time, we will
experience credit losses as a normal effect of owning loans. We believe the risk
of credit loss varies with, among other things, the following:
- the type of loan
- the creditworthiness of the borrower over the term of the loan
- general economic conditions
- in the case of a secured loan, the quality of the security for the loan
Our policy is to maintain an adequate allowance for loan losses based on,
among other things, the following:
- our historical loan loss experience
- regular reviews of delinquencies and loan portfolio quality
- the industry's historical loan loss experience for similar asset types
- evaluation of economic conditions
We increase our allowance for loan losses when we estimate that losses have
been incurred by charging provisions for possible loan losses against income.
Charge-offs reduce the allowance when losses are confirmed.
In establishing the allowance for loan losses, we set up specific
allowances for probable losses that we have identified on specific loans.
Additionally, we provide general allowance for estimated expected losses in the
remainder of the loan portfolio. The allowances established by management are
subject to review and approval by the Company's Board of Directors. Each month,
we review the allowance for adequacy, based on our assessment of the risk in our
loan portfolio as a whole, considering the following factors:
- the composition and quality of the portfolio
- delinquency trends
- current charge-off and loss experience
- the state of the real estate market
- general economic conditions
9
<PAGE> 10
During 1998, we recorded a net increase of $1.2 million in the allowance
for loan losses. The increase resulted from a provision of $905,000, $723,000
from the acquisition of DFC, offset by net charge-offs of $457,000. As of
December 31, 1998, total allowance for loan losses equaled $4.8 million, of
which $449,000 represents reserves established by management for probable losses
on specific loans.
The general allowance is computed based on an assessment of performing
loans. Each month, the performing loan portfolio is stratified by asset type
(one- to four-family, commercial, consumer, etc.) and a range of expected loss
ratios is applied to each type of loan. Expected loss ratios range between 20
basis points and 200 basis points depending upon asset type, loan-to-value ratio
and current market and economic conditions. The expected loss ratios are based
on historical loss experience, adjusted to reflect industry loss experience as
published by the Office of Thrift Supervision. We believe that an adjustment was
appropriate in estimating the losses inherent in the loan portfolio due to the
fact that the Bank purchases, rather than originates in house, the majority of
its loans and the limited amount of historical loss experience to date.
Also considered in the reserve computation is the positive impact of loans
acquired that have a seller or third party credit enhancement. Reserves are not
provided for loans in which the credit enhancement amount exceeds the amount of
reserves that would otherwise be required. We have purchased certain loans with
an expectation that all contractual payments of the loan will not be collected.
Discounts attributable to credit issues are tracked separately and are not
included as a component of the allowance for loan losses.
The level of provision recorded for 1998 was based upon the level of
charge-offs, the significant growth in the portfolio and the $15.0 million
increase in commercial mortgage and home equity loans from the DFC acquisition.
As of December 31, 1998, total loans receivable included nine pools of
credit-enhanced one- to four-family mortgage loans totaling $43.1 million, or
4.7%, of total gross loans outstanding. One of these pools, totaling $22.2
million, has a credit reserve from the seller equal to 2.3% of the unpaid
principal balance at the time of purchase to offset any losses. Three pools,
totaling $13.0 million, have certain recourse whereby the seller must repurchase
any loan that becomes more than 90 days past due at any time during the life of
the loan. The five remaining pools, which total $7.9 million, have other forms
of credit enhancement, including letters of credit and offsetting cash reserves
designed to protect us from credit losses. We believe that the combination of
our loan loss allowance, net credit discount and credit enhancement on certain
loan pools is adequate to cover estimated losses. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
We believe that we have established our existing loss allowances in
accordance with generally accepted accounting principles. However, in reviewing
our loan portfolio, regulators may request that we increase our allowance for
losses. Such an increase would negatively affect our financial condition and
earnings.
The following table allocates the allowance for loan losses by loan
category at the dates indicated. This allocation does not necessarily restrict
the use of the allowance to absorb losses in any other category. The table also
shows the percentage of total loans that each loan category represents.
10
<PAGE> 11
<TABLE>
<CAPTION>
AT DECEMBER 31,
---------------------------------------------------------------------------------
1998 1997 1996 1995
---------------------- ---------------------- ---------------------- ------
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......... $4,089 97.55% $3,271 98.80% $2,529 97.56% $1,939
Multifamily................. 32 0.35 15 0.26 15 0.41 13
Commercial real estate...... 520 0.97 286 0.55 373 1.09 281
Mixed use................... 9 0.10 9 0.15 12 0.32 18
Land........................ 6 0.03 8 0.08 8 0.21 8
Lease financing............... 16 0.06 -- -- -- -- --
Home equity lines of credit
and second mortgage loans... 57 0.64 5 0.16 20 0.41 28
Other consumer................ 37 0.30 -- -- -- -- 24
------ ------- ------ ------ ------ ------- ------
Total allowance for
loan losses....... $4,766 100.00% $3,594 100.00% $2,957 100.00% $2,311
====== ======= ====== ====== ====== ======= ======
<CAPTION>
AT DECEMBER 31,
--------------------------------------
1995 1994
------------- ----------------------
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......... 96.11% $667 92.81%
Multifamily................. 0.49 11 0.70
Commercial real estate...... 1.72 273 2.77
Mixed use................... 0.68 -- 1.23
Land........................ 0.14 8 0.24
Lease financing............... -- -- --
Home equity lines of credit
and second mortgage loans... 0.83 16 2.14
Other consumer................ 0.03 14 0.11
------- ---- -------
Total allowance for
loan losses....... 100.00% $989 100.00%
======= ==== =======
</TABLE>
11
<PAGE> 12
The above amounts include specific reserves totaling $449,000, $510,000,
$579,000, $392,000, and $201,000, at December 31, 1998, 1997, 1996, 1995 and
1994, respectively, related to loans classified as loss.
The following table shows the activity in our allowance for loan losses
during the periods indicated.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C>
Allowance for loan losses at the beginning of the
year................................................. $3,594 $2,957 $2,311 $ 989 $ 835
Charge-offs:
Real estate loans.................................... (463) (304) (409) (406) (522)
Other consumer....................................... (76) -- (28) -- --
Other loans.......................................... (17) -- -- -- --
------ ------ ------ ------ -----
Total charge-offs............................ (556) (304) (437) (406) (522)
Recoveries:
Real estate loans.................................... 13 13 148 6 184
Other consumer....................................... 81 7 16 -- --
Other loans.......................................... 5 -- -- -- --
------ ------ ------ ------ -----
Total recoveries............................. 99 20 164 6 184
Net Charge-offs........................................ (457) (254) (273) (400) (338)
Loan loss allowance acquired in the merger with DFC.... 724 -- -- -- --
Additions charged to operations........................ 905 921 919 1,722 492
------ ------ ------ ------ -----
Allowance for loan losses at the beginning of the
year................................................. $4,766 $3,594 $2,957 $2,311 $ 989
</TABLE>
REO. We initially record REO at estimated fair value less selling costs.
Fair value is defined as the estimated amount that a real estate parcel would
yield in a current sale between a willing buyer and a willing seller. Subsequent
to foreclosure, management periodically reviews REO and establishes an allowance
if the estimated fair value of the property, less estimated costs to sell,
declines.
As of December 31, 1998, all of our REO consisted of one- to four-family
real estate loans.
INVESTMENT SECURITIES
The following table shows the cost basis and fair value of our investment
portfolio other than mortgage-backed securities at the dates indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31,
------------------------------------------------------------
1998 1997 1996
------------------- ------------------ -----------------
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.................... $ -- $ -- $ -- $ -- $ 19 $ 19
Available for sale:
Municipal bonds..................... 15,750 16,028 7,327 7,681 7,325 7,507
Corporate debt...................... 154,534 153,205 18,536 19,575 22,525 23,569
Obligations of U.S. government
agencies......................... 26,661 27,992 22,147 22,505 31,139 31,272
Asset backed........................ 1,095 1,119 -- -- -- --
Other investments................... 7,814 7,632 26,035 26,052 499 499
-------- -------- ------- -------- ------- -------
Subtotal.............................. 205,854 205,976 74,045 75,813 61,507 62,866
Securities purchased under
agreements to resell............. -- -- -- -- 1,730 1,730
Equity securities:
Stock in Federal Home Loan Bank,
Atlanta.......................... 25,175 25,175 10,000 10,000 7,300 7,300
Preferred stock in Freddie Mac...... 5,000 4,988 5,000 4,950 5,000 4,988
Preferred stock in Fannie Mae....... 8,000 8,394 8,000 8,375 8,000 8,232
Other corporate stock............... 937 1,000 2,038 2,099 1,011 1,011
-------- -------- ------- -------- ------- -------
Total....................... $244,966 $245,533 $99,083 $101,237 $84,548 $86,127
======== ======== ======= ======== ======= =======
</TABLE>
12
<PAGE> 13
The following table shows the scheduled maturities, carrying values, and
current yields for our investment portfolio of debt securities at December 31,
1998:
<TABLE>
<CAPTION>
AFTER ONE BUT AFTER FIVE BUT
WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS
------------------ ------------------ ------------------
WEIGHTED WEIGHTED WEIGHTED
BALANCE AVERAGE BALANCE AVERAGE BALANCE AVERAGE
DUE YIELD DUE YIELD DUE YIELD
------- -------- ------- -------- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Municipal bonds(a).......... $145 4.28% $ 836 5.10% $ 989 6.24%
Asset backed................ -- -- 774 7.70 -- --
Corporate debt.............. -- -- -- -- 5,288 6.86
Certificates of deposit..... -- -- 499 6.92 -- --
Obligations of U.S.
government agencies....... -- -- 14,060 7.66 -- --
Equities.................... -- -- -- -- -- --
Other investments........... -- -- -- -- 368 7.50
---- ---- ------- ---- ------ ----
$145 4.28% $16,169 7.51% $6,645 6.80%
==== ==== ======= ==== ====== ====
<CAPTION>
AFTER TEN YEARS TOTALS
------------------- -------------------
WEIGHTED WEIGHTED
BALANCE AVERAGE BALANCE AVERAGE
DUE YIELD DUE YIELD
-------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Municipal bonds(a).......... $ 14,058 7.63% $ 16,028 7.38%
Asset backed................ 345 7.27 1,119 7.57
Corporate debt.............. 147,917 6.24 153,205 6.26
Certificates of deposit..... -- -- 499 6.92
Obligations of U.S.
government agencies....... 13,932 6.13 27,992 6.91
Equities.................... 14,382 5.40 14,382 5.40
Other investments........... 6,765 5.15 7,133 5.27
-------- ---- -------- ----
$197,399 6.23% $220,358 6.34%
======== ==== ======== ====
</TABLE>
- ---------------
(a) Yields on tax exempt obligations are computed on a tax equivalent basis.
13
<PAGE> 14
DEPOSITS AND OTHER SOURCES OF FUNDS
The following table presents information about the various categories of
Telebank deposits as of December 31, 1998.
The following table shows the dollar changes in our various types of
deposit accounts between the dates indicated:
<TABLE>
<CAPTION>
AVERAGE AVERAGE AVERAGE
BALANCE BALANCE BALANCE
AT PERCENTAGE AT PERCENTAGE AT PERCENTAGE
DECEMBER 31, OF AVERAGE DECEMBER 31, OF AVERAGE DECEMBER 31, OF
ACCOUNTS 1998 DEPOSITS RATE 1997 DEPOSITS RATE 1996 DEPOSITS
- -------- ------------ ---------- ------- ------------ ---------- ------- ------------ ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Passbook............. $ 459 0.06% 3.00% $ 551 0.13% 3.00% $ 1,613 0.45%
Money market......... 140,506 17.60 4.70 101,226 23.40 5.26 100,758 28.13
Checking............. 1,985 0.25 3.81 630 0.15 -- 283 0.08
Certificates of
deposit............ 600,781 75.26 5.93 330,234 76.32 6.24 255,562 71.34
Brokered callable
certificates of
deposit............ 54,491 6.83 6.16 -- -- -- -- --
---------- ------ ----- -------- ------ ---- -------- ------
Total........ $ 798,222 100.00% $432,641 100.00% $358,216 100.00%
========== ====== ======== ====== ======== ======
<CAPTION>
AVERAGE
ACCOUNTS RATE
- -------- -------
<S> <C>
Passbook............. 3.00%
Money market......... 5.10
Checking............. --
Certificates of
deposit............ 6.28
Brokered callable
certificates of
deposit............ --
----
Total........
</TABLE>
The following table classifies our certificates of deposit and money market
accounts by rate at the dates indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31,
----------------------------------
1998 1997 1996
---------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
0 - 1.99%............................... $ 5 $ 5 $ 5,235
2 - 3.99%............................... 424 -- 148
4 - 5.99%............................... 756,618 231,048 210,481
6 - 7.99%............................... 440,711 289,046 170,056
8 - 9.99%............................... 793 696 1,709
10 - 11.99%............................... 44 -- 790
12 - 20%.................................. 24 -- --
---------- -------- --------
$1,198,619 $520,795 $388,419
========== ======== ========
</TABLE>
The following table classifies the amount of our large certificates of
deposit ($100,000 or more) by time remaining until maturity, as of December 31,
1998.
<TABLE>
<CAPTION>
CERTIFICATES
OF DEPOSIT
--------------
(IN THOUSANDS)
<S> <C>
Three months or less........................................ $ 31,867
Three through six months.................................... 21,052
Six through twelve months................................... 36,530
Over twelve months.......................................... 108,023
--------
Total............................................. $197,472
========
</TABLE>
14
<PAGE> 15
BORROWINGS
Although deposits are our primary source of funds, we also borrow from the
Federal Home Loan Bank ("FHLB") of Atlanta and sell securities under agreements
to repurchase to acquire additional funding. We are a member of the FHLB system,
which, among other things, functions in a reserve credit capacity for savings
institutions. This membership requires us to own capital stock in the FHLB of
Atlanta. It also authorizes us to apply for advances on the security of FHLB
stock and various home mortgages and other assets -- principally securities that
are obligations of, or guaranteed by, the United States of America -- provided
we meet certain creditworthiness standards.
As of December 31, 1998 our outstanding advances from the FHLB of Atlanta
totaled $472.5 million at interest rates ranging from 5.13% to 5.73% and at a
weighted average rate of 5.19%.
We also borrow funds by selling securities to nationally recognized
investment banking firms under agreements to repurchase the same securities. The
investment banking firms hold the securities in custody. We treat repurchase
agreements as borrowings and secure them with designated fixed and variable rate
securities. We use the proceeds of these transactions to meet our cash flow or
asset/liability matching needs. The following table presents information
regarding repurchase agreements for the dates indicated:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Weighted average balance during the year.................... $259,846 $117,431 $68,920
Weighted average interest rate during the year.............. 5.69% 5.76% 5.77%
Maximum month-end balance during the year................... $519,078 $279,909 $97,416
Private issuer mortgage-backed securities underlying the
agreements as of the end of the year:
Carrying value, including accrued interest................ $441,323 $104,736 $22,856
Estimated market value.................................... $438,955 $104,696 $22,804
Agencies underlying the agreements as of the end of the
year:
Carrying value, including accrued interest................ $ -- $190,820 $38,562
Estimated market value.................................... $ -- $190,804 $38,621
</TABLE>
The following table sets forth information regarding the weighted average
interest rates and the highest and average month end balances of our borrowings.
15
<PAGE> 16
<TABLE>
<CAPTION>
AT OR AT OR
FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997
--------------------------------------------------------- -------------------------------
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..... $472,500 5.19% $478,000 $219,487 5.49% $200,000 5.86% $200,000
Securities sold under
agreement to
repurchase.......... $401,100 5.52% $519,078 $259,846 5.69% $279,909 6.10% $279,909
<CAPTION>
AT OR AT OR
FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996
----------------------- ---------------------------------------------------------
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..... $160,749 5.66% $144,800 5.56% $154,500 $120,633 5.91%
Securities sold under
agreement to
repurchase.......... $117,431 5.76% $ 57,581 5.69% $ 97,416 $68,920 5.77%
</TABLE>
16
<PAGE> 17
EMPLOYEES
At December 31, 1998, we had 96 full-time employees and 25 part-time
employees. Management considers its relations with its employees to be
excellent. Our employees are not represented by any collective bargaining group.
REGULATION
Telebanc, 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.
TeleBanc Capital Markets, Inc., a wholly owned subsidiary of Telebanc, is a
registered broker-dealer under the Securities Exchange Act of 1934. As such,
TeleBanc Capital Markets, Inc. is regulated by the SEC.
TeleBanc Insurance Services, Inc., a subsidiary of Telebanc, is required to
be licensed in each state where it sells insurance products and is subject to
the regulatory requirements of these states. Currently, TeleBanc Insurance is
licensed in six states.
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. The 1996 Legislation contemplates the
merger of the SAIF with the Bank Insurance Fund (the "BIF"), which generally
insures deposits in national and state-chartered banks. 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 1998 in bills addressing financial services
modernization of the 1996 Legislation. While no legislation was enacted in 1998,
financial modernization legislation continues to be discussed by Congress. If
final legislation is passed abolishing the federal thrift charter, Telebank
could be required to convert its federal charter to a national bank charter, a
new federal type of bank charter or a state depository institution charter, and
the Company could be subject to regulation by the Federal Reserve Board or
another agency, and could be subject to capital requirements that are not
currently applicable to holding companies under OTS regulation.
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 1998, the
Company leased approximately 1,400 square feet of office space in Los Angeles,
California as a small business development office. The lease expires in 2003.
Also during 1998, the Company became the lessee of an office in Gibbsboro, New
Jersey through its acquisition of Direct Financial Corporation. This office
consists of approximately 8,000 square feet and is leased until 2000.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than ordinary
routine litigation incidental to its business, to which the Company or any of
its subsidiaries is a party or of which any of their property is the subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders during
the fourth quarter of the year ended December 31, 1998.
17
<PAGE> 18
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Common Stock has been quoted on the Nasdaq Market National Market under
the symbol "TBFC" since July 22, 1998. Prior to that time, the common stock was
traded in the over-the-counter market under the same symbol. The following table
sets forth the high and low closing sale prices for the Common Stock for the
periods indicated.
<TABLE>
<CAPTION>
HIGH LOW
------- -------
<S> <C> <C>
1997
1st quarter............................................ $ 8.500 $ 6.000
2nd quarter............................................ $ 8.750 $ 6.250
3rd quarter............................................ $ 9.500 $ 7.750
4th quarter............................................ $ 9.375 $ 8.500
1998
1st quarter............................................ $10.625 $ 8.500
2nd quarter............................................ $14.000 $ 9.000
3rd quarter (July 1, 1998 through July 21, 1998)....... $19.750 $13.000
3rd quarter (July 22, 1998 through September 30,
1998)............................................... $24.750 $12.375
4th quarter............................................ $35.625 $ 8.125
</TABLE>
No dividends were paid in 1997 and 1998. The closing per share price of the
Common Stock on December 31, 1998 was $34.00. The approximate number of holders
of record of the Company's Common Stock at March 17, 1999 was 66.
18
<PAGE> 19
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Interest income................... $ 100,110 $ 59,301 $ 45,800 $ 40,511 $ 22,208
Interest expense.................. 80,305 46,063 34,815 31,946 17,513
---------- ---------- -------- -------- --------
Net interest income............. 19,805 13,238 10,985 8,565 4,695
Provision for loan losses......... 905 921 919 1,722 492
Non-interest income............... 7,564 4,093 2,756 3,777 175
Non-interest expenses:
Selling, general and
administrative expenses...... 19,819 9,042 8,375 5,561 3,503
Other non-interest operating
expenses..................... 2,259 1,100 700 679 153
---------- ---------- -------- -------- --------
Income before income tax expense
and minority interest........... 4,386 6,268 3,747 4,380 722
Income tax expense................ 1,649 1,657 1,195 1,660 182
Minority interest in
subsidiary(1)................... 1,362 394 -- -- --
---------- ---------- -------- -------- --------
Net income........................ 1,375 4,217 2,552 2,720 540
Preferred stock dividend(1)....... 2,112(2) 546 -- -- --
---------- ---------- -------- -------- --------
Net income available to common
stockholders(1).............. $ (737)(2) $ 3,671 $ 2,552 $ 2,720 $ 540
========== ========== ======== ======== ========
Earnings per share(1):
Basic........................... $ (0.09)(2) $ 0.84 $ 0.62 $ 0.66 $ 0.16
Diluted......................... $ (0.09)(2) $ 0.57 $ 0.58 $ 0.66 $ 0.16
Weighted average shares:
Basic........................... 7,840 4,383 4,099 4,099 3,498
Diluted......................... 7,840 7,411 4,406 4,104 3,498
STATEMENT OF FINANCIAL CONDITION
DATA:
Total assets...................... $2,283,341 $1,100,352 $647,965 $553,943 $427,292
Loans receivable, net............. 904,854 540,704 351,821 248,492 154,742
Mortgage-backed securities(3)..... 1,041,747 340,313 184,743 234,385 236,464
Investment securities............. 220,358 91,237 78,826 40,058 12,444
Retail savings and certificates of
deposit......................... 1,142,385 522,221 390,486 306,500 212,411
Advances from the FHLB............ 472,500 200,000 144,800 105,500 96,000
Securities sold under agreements
to repurchase................... 404,435 279,909 57,581 93,905 79,613
Trust preferred securities(4)..... 35,385 9,572 -- -- --
Total stockholders' equity........ 113,435 45,824 24,658 21,565 17,028
OTHER FINANCIAL AND OPERATING
DATA:
Return on average total assets.... 0.10% 0.52% 0.42%(5) 0.53% 0.17%
Return on average stockholders'
equity.......................... 2.07% 10.53% 11.46%(5) 14.10% 3.17%
SG&A expenses to total assets..... 0.87% 0.82% 1.29%(5) 1.00% 0.82%
Number of deposit accounts........ 50,835 21,817 16,506 12,919 8,564
CAPITAL RATIOS OF TELEBANK:
Core............................ 5.57% 5.06% 5.08% 5.31% 6.27%
Tangible........................ 5.57% 5.06% 5.07% 5.36% 6.35%
Total capital................... 13.40% 11.91% 10.41% 11.74% 15.96%
</TABLE>
19
<PAGE> 20
- ---------------
(1) Minority interest reflects expense related to payments on trust preferred
securities issued by TeleBanc Capital Trust I and TeleBanc Capital Trust II.
TeleBanc Capital Trust I and TeleBanc Capital Trust II are business trusts
formed for the purpose of issuing trust preferred securities and investing
the proceeds in subordinated debentures issued by TeleBanc.
(2) Pursuant to a conversion agreement dated May 15, 1998, 29,900 of our
outstanding shares of preferred stock converted to 2,399,479 shares of
common stock upon consummation of our July 1998 equity offering. In
addition, upon the conversion, we issued a special dividend in the amount of
119,975 shares of common stock to the holders of the preferred stock. In
connection with the special dividend, we recorded a $1.7 million
nonrecurring, non-cash charge related to the additional preferred stock
dividend payable in common stock, based on the fair market value of the
common stock at the time the dividend was paid.
(3) Includes mortgage-backed securities available-for-sale and trading.
(4) Consists of trust preferred securities of TeleBanc Capital Trust I and
TeleBanc Capital Trust II. See Note 14 to the consolidated financial
statements.
(5) Includes one-time pre-tax charge of $1.7 million, $1.1 million after tax, to
recapitalize the Savings Association Insurance Fund. Without 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 0.61%, 16.50% and 1.03%.
20
<PAGE> 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We provide high value financial products and services primarily over the
internet. By avoiding the costs of brick-and-mortar branches, we offer
significantly higher rates and lower fees on our FDIC-insured and other banking
products and services than traditional banks. Our branchless structure allows us
to deliver these services worldwide through the convenient anytime, anywhere
access of the internet, telephone and automated teller machines, or ATMs.
Our revenue consists of interest income and, to a lesser degree,
non-interest income, which includes income primarily from services and gains on
the sale of loans and securities. Our net interest income is the difference
between the rates of interest earned on our loans and other interest-earning
assets and the rates of interest paid on our deposits and borrowed funds. An
indicator of an institution's profitability is its net interest margin or net
yield on interest-earning assets, which is its annualized net interest income
divided by the average balance of interest-earning assets. 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.
Our asset acquisition strategy is to purchase pools of one- to four-family
first lien mortgages and mortgage-related securities. We do not currently
originate loans. We believe that by purchasing a seasoned and geographically
diverse mortgage loan portfolio, we reduce expenses related to loan acquisition
and are better able to actively manage our credit quality risk.
We actively monitor our 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. To this end, we have established an asset-liability committee
and implemented a risk measurement guideline employing market value of equity
and gap methodologies and other measures. In an effort to manage interest rate
exposure, we use various hedging techniques such as caps, floors, interest rate
swaps, futures and financial options.
In 1998, we implemented a strategy to build the "Telebank" brand name by
expanding the marketing of our high value financial products, superior customer
service and anytime, anywhere convenience. We believe that associating our brand
name with our services and delivery channels will enable us to attract a growing
number of customers who are increasingly relying on alternative channels for the
delivery of their financial services. In pursuing this strategy, we increased
our marketing expenditures significantly to implement a targeted, national
advertising campaign and marketing initiative. We plan to continue this strategy
to further strengthen the "Telebank" brand. See "-- Results of
operations -- Year ended December 31, 1998 compared to year ended December 31,
1997 -- Non-interest expenses".
DIRECT FINANCIAL CORPORATION ACQUISITION
On August 10, 1998, we acquired Direct Financial Corporation, the thrift
holding company of Premium Bank, F.S.B. This acquisition presented an
opportunity to acquire a financial services company employing a direct marketing
strategy similar to ours. Premium Bank operated from a single branch in New
Jersey, and its deposit base was concentrated in the mid-Atlantic region of the
United States. We are using Premium Bank's former office as a back-up call
center and operations center pending a final systems conversion of Premium Bank,
expected to be completed in June 1999. We paid approximately $22.3 million cash
in the transaction. At the time of the acquisition, Direct Financial Corporation
had $307.1 million in deposits and 19,263 accounts.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
INTEREST INCOME. Total interest income increased by $40.8 million, or
68.8%, to $100.1 million for the year ended December 31, 1998 from $59.3 million
for the year ended December 31, 1997. A portion of this increase was caused by a
$16.8 million increase in interest income from mortgage-backed and related
securities. This increase in income from mortgage-backed and related securities
is primarily volume-related, as we increased our securities portfolio
significantly in 1998 following the completion of our securities offerings and
the acquisition of Direct Financial Corporation. We also increased our mortgage
loan portfolio, which gener-
21
<PAGE> 22
ated a $16.5 million, or 47.6%, increase in interest income on mortgage loans to
$51.2 million in 1998 from $34.7 million in 1997. The increase in the portfolio
of interest-earning assets was slightly offset as a result of a decline in the
yield on our interest-earning assets to 7.28% during 1998 from 7.70% during
1997, primarily due to overall declines in market interest rates during the
year. Additionally, interest income from investment securities available for
sale increased by $4.2 million during 1998 reflecting an $83.7 million increase
in the average balance of such securities, slightly offset by a 0.09% decrease
in the yield.
INTEREST EXPENSE. Total interest expense increased by $34.2 million from
$46.1 million in 1997 to $80.3 million in 1998, an increase of 74.2%. This
increase is almost entirely volume-driven, as the average interest cost of
liabilities decreased during 1998. The significant increase in retail deposits
during 1998 caused interest expense on retail deposits to increase $19.0
million, or 73.4%, from $25.9 million in 1997 to $44.9 million in 1998. The cost
of our interest-bearing liabilities decreased from 6.21% in 1997 to 6.08% in
1998, due to declining interest rates during 1998. We saw the majority of this
decrease in our short-term borrowings, while the cost of our deposits declined
only two basis points from 6.00% to 5.98%. Also during 1998, we initiated a
brokered callable certificate of deposit program. The average balance of these
deposits was $54.5 million in 1998, and the average rate paid was 6.68%.
LOAN LOSS PROVISION. The provision for loan losses is the annual cost of
providing an allowance for estimated losses in the loan portfolio. The provision
reflects management's judgment as to the reserve necessary to absorb loan losses
based upon our assessment of a number of factors, including delinquent loan
trends and historical loss experience, current economic conditions, the mix of
loans in our portfolio, and our internal credit review process.
The provision is determined in part by applying a range of expected loss
ratios to the applicable type of loan. Expected loss ratios range between 0.2%
and 2.0% depending upon asset type, loan to value and current market and
economic conditions. The expected loss ratios are based on historical loss
experience adjusted upward to reflect industry loss experience for similar asset
types.
Also considered in the calculation of the loan loss provision is the
positive impact of loans acquired that have seller or third party credit
enhancements. Reserves are not provided for loans in which the credit
enhancements amount exceeds the amount of reserves that would otherwise be
required. As of December 31, 1998, $43.1 million of loans contained credit
enhancements which did not require additional reserves. In addition, we have
purchased certain loans with an expectation that all contractual payments of the
loans will not be collected. Discounts attributable to credit issues are tracked
separately, netted against the loan balance, and not included as a component of
the allowance for loan losses.
As a result of management's loan loss allowance process, the provision for
loan losses decreased slightly to $905,000 for the year ended December 31, 1998,
compared to $921,000 for the year ended December 31, 1997.
The primary factor impacting the amount of the 1998 loan loss provision was
the significant increase in the loan portfolio. Asset quality, as demonstrated
by net charge-offs as a percentage of average loan balances of 0.07% and 0.06%
for 1998 and 1997 remained stable. Other factors affecting the allowance and
provision amounts, including the expected loss ratios and the impact of credit
enhancements and recourse arrangements, remained relatively unchanged from 1997
to 1998 and did not significantly change the amount of the loan loss provision.
The total loan loss allowance at December 31, 1997 was $3.6 million, or 0.66% of
total loans outstanding. Total loan loss allowance as a percentage of total
non-performing loans was 53.7% as of December 31, 1998, compared to 31.7% as of
December 31, 1997.
NON-INTEREST INCOME. Total non-interest income increased by $3.5 million
to $7.6 million for the year ended December 31, 1998, from $4.1 million for the
year ended December 31, 1997, an increase of 85.4%. This increase in
non-interest income consisted primarily of $3.5 million of gains on sales of
mortgage-backed and investment securities during 1998, compared to gains of $1.0
million in 1997, as well as $2.1 million from gain on sale of loans held for
sale, compared to $1.1 million in 1997. The increase in the gain on sale of
loans in 1998 reflects the sale of primarily home equity loans. In 1998,
non-interest income totaled 7.0% of total revenue, compared to 6.5% in 1997.
Total revenue is comprised of total interest income and total non-interest
income.
22
<PAGE> 23
NON-INTEREST EXPENSES. Total non-interest expenses increased substantially
during 1998 to $22.1 million, compared to $10.1 million in 1997, an increase of
$12.0 million, or 118.8%. In 1998, we implemented a strategy of increasing
marketing expenses associated with brand building that seeks to establish
Telebank as the premier national provider of high-value banking products. This
strategy resulted in the $4.0 million increase in advertising and marketing
expenses to $4.6 million in 1998 from $600,000 in 1997. For 1999, we anticipate
our marketing strategy will result in significantly greater increases in
marketing expenses. In addition, compensation costs increased $2.9 million, or
59.2%, from $4.9 million for the year ended December 31, 1997, to $7.8 million
for the year ended December 31, 1998, as a result of hiring additional
personnel.
Other non-interest expenses increased $1.2 million to $2.3 million during
the year ended December 31, 1998 from $1.1 million during the year ended
December 31, 1997, primarily as a result of the amortization of goodwill
resulting from the Direct Financial Corporation acquisition in August 1998.
INCOME TAX EXPENSE. Income tax expense for the year ended December 31,
1998 was $1.6 million, compared with $1.7 million for the year ended December
31, 1997. Telebanc's effective tax rate for 1998 was 37.6%, compared to 26.4%
for 1997. The effective tax rate increased largely as a result of goodwill
acquired in the Direct Financial Corporation acquisition, since goodwill
amortization expense is not deductible for tax purposes.
NET INCOME. Net income for the year ended December 31, 1998 decreased $2.8
million to $1.4 million from $4.2 million for the year ended December 31, 1997,
a decrease of 66.7%. Net income in 1998 consisted primarily of $19.8 million in
net interest income and $7.6 million in non-interest income, which was offset by
$22.1 million in non-interest expenses, $905,000 in provision for loan losses,
and $1.6 million in income tax expense. Net income available to common
stockholders which decreased $4.4 million, or 118.9%, from 1997, to a loss of
$737,000 in 1998, includes a non-cash charge totaling $1.7 million, related to a
one-time dividend paid to the holders of our preferred stock in the form of
119,975 shares of common stock. We paid this dividend upon conversion of 29,900
outstanding shares of preferred stock to 2,399,479 shares of common stock. We
based the $1.7 million charge related to the special dividend on the fair market
value of the common stock on the date we paid the dividend.
Our net interest margin decreased from 1.73% in 1997 to 1.42% in 1998. This
decline reflects falling interest rates and increased competition for
high-yielding mortgage products.
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 remained substantially
unchanged at $921,000 for the year ended December 31, 1997, compared to $919,000
for the year ended December 31, 1996. The ratio of net charge-offs to net
average loans outstanding during 1997 was 0.06%, compared to 0.10% during 1996.
Total loan loss allowance as a percentage of total non-performing loans was
31.7% as of December 31, 1997, compared to 27.7% 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 we recognized $1.2 million of non-interest income as
gain on trading securities during 1997. In addition, we recognized an $864,000
decline in equity investment primarily attributable
23
<PAGE> 24
to the write-off of the equity investment by Telebank in AGT Mortgage Services,
which had provided our 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 $1.0 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, we incurred a one-time
$1.7 million assessment to recapitalize the Savings Association Insurance Fund.
Other non-interest expenses increased $400,000 to $1.1 million during the
year ended December 31, 1997 from $700,000 during the year ended December 31,
1996, an increase of 57.1%, primarily as a result of 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. Our 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 $1.6
million to $4.2 million from $2.6 million for the year ended December 31, 1996,
an increase of 61.5%. Net income for 1997 consisted primarily of $13.2 million
in net interest income, $3.3 million in net gain on the sale of trading
securities, 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. Net income
available to common stockholders 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%.
24
<PAGE> 25
QUARTERLY RESULTS
The following table sets forth our selected unaudited quarterly financial
data for each of the eight quarters in the two-year period ended December 31,
1998. The consolidated financial data presented below have been prepared on a
basis consistent with our audited consolidated financial statements and, in the
opinion of management, include all adjustments, consisting of normal recurring
accruals, necessary for a fair presentation of this information. This
information should be read in conjunction with our consolidated financial
statements and notes beginning on page 36. 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,
1997 1997 1997 1997 1998 1998 1998 1998
--------- -------- --------- -------- --------- -------- --------- --------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Interest income.................. $12,837 $15,275 $14,821 $16,368 $18,071 $18,581 $27,632 $35,826
Interest expense................. 9,878 11,865 11,548 12,772 14,477 15,276 21,979 28,573
------- ------- ------- ------- ------- ------- ------- -------
Net interest income.......... $ 2,959 $ 3,410 $ 3,273 $ 3,596 $ 3,594 $ 3,305 $ 5,653 $ 7,253
Provision for loan losses........ 243 308 120 250 250 75 300 280
Non-interest income.............. 607 1,244 1,084 1,158 1,947 1,104 1,832 2,681
Selling, general and
administrative expenses........ 1,897 2,251 2,078 2,816 3,889 3,441 5,666 6,823
Other non-interest operating
expenses....................... 208 202 260 430 315 487 586 871
------- ------- ------- ------- ------- ------- ------- -------
Income before income taxes
and minority interest...... $ 1,218 $ 1,893 $ 1,899 $ 1,258 $ 1,087 $ 406 $ 933 $ 1,960
Income tax expense............... 355 618 709 (25) 475 51 389 734
Minority interest(1)............. -- 67 285 42 176 176 439 571
------- ------- ------- ------- ------- ------- ------- -------
Net income................... $ 863 $ 1,208 $ 905 $ 1,241 $ 436 $ 179 $ 105 $ 655
Preferred stock dividends.... 60 162 162 162 162 162 1,788(2) --
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss) available
to common stockholders..... $ 803 $ 1,046 $ 743 $ 1,079 $ 274 $ 17 $(1,683)(2) $ 655
Other comprehensive income(3).... (1,165) 2,443 (24) (612) 262 (1,109) 8,579 (8,593)
------- ------- ------- ------- ------- ------- ------- -------
Comprehensive income............. $ (362) $ 3,489 $ 719 $ 467 $ 536 $(1,092) $ 6,896 $(7,938)
======= ======= ======= ======= ======= ======= ======= =======
Basic earnings per share......... $ 0.19 $ 0.24 $ 0.16 $ 0.24 $ 0.06 $ 0.00 $ (0.17)(2) $ 0.05
Diluted earnings per share....... 0.15 0.16 0.11 0.16 0.05 0.00 (0.17)(2) 0.05
</TABLE>
- ---------------
(1) Minority interest reflects expense related to payments on trust preferred
securities issued by TeleBanc Capital Trust I and TeleBanc Capital Trust II.
(2) Includes $1.7 million non-recurring, non-cash charge related to the
additional preferred stock dividend payable in common stock, based on the
fair market value of the common stock at the time such dividend was paid.
The charge reduced net income available to common stockholders by the same
amount and diluted earnings per share in the third quarter of 1998 by $0.18
per share.
(3) Other comprehensive income is comprised of unrealized gains and losses on
available-for-sale securities.
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<PAGE> 26
During the second quarter of 1998, we focused on maintaining stable asset
levels and sufficient liquidity in anticipation of our acquisition of Direct
Financial Corporation in August 1998. As a result, our interest income and
selling, general and administrative expenses remained relatively steady, as
compared to the first quarter of 1998. In the third quarter of 1998, the
completion of our equity and trust preferred offerings and our acquisition of
Direct Financial Corporation resulted in a substantial increase in our asset
size.
Other comprehensive income represents unrealized gains and losses on
securities that we consider available for sale. We experienced wide swings in
other comprehensive income during the third and fourth quarters of 1998, due
primarily to increased volatility in the fixed-income market.
FINANCIAL CONDITION
Total assets increased by $1.2 billion to $2.3 billion at December 31, 1998
from $1.1 billion at December 31, 1997, an increase of 109.1%. The growth in
total assets is primarily the result of a $693.0 million increase in
mortgage-backed securities and a $364.1 million increase in loans receivable.
The primary sources of funds for this growth in assets were deposits, borrowings
and capital raised through our 1998 equity offering and trust preferred
offering.
Loans receivable, net and loans receivable held-for-sale, increased $364.1
million to $904.8 million at December 31, 1998 from $540.7 million at December
31, 1997, an increase of 67.3%. The increase reflects whole loan purchases of
$668.1 million, offset in part by $280.2 million of principal repayments and
$20.6 million of loans sold in 1998. During 1997, we recorded whole loan
purchases of $342.9 million, offset in part by $94.9 million of principal
repayments and $60.7 million of loans sold.
Mortgage-backed securities available-for-sale increased $693.0 million to
$1.0 billion at December 31, 1998 from $319.2 million at December 31, 1997, an
increase of 217.1%. Investment securities available-for-sale increased $129.2
million to $220.4 million at December 31, 1998 from $91.2 million at December
31, 1997, an increase of 141.7%. We hold these investment securities for
liquidity purposes, and the increases in these categories of assets are
consistent with the overall growth of our assets in 1998.
Retail deposits increased $620.2 million to $1.1 billion at December 31,
1998 from $522.2 million at December 31, 1997, an increase of 118.8%, largely as
a result of our continued targeted marketing efforts to attract new customers
and deposit accounts. During the year ended December 31, 1998, we credited
approximately $42.2 million of interest to retail deposit accounts, and deposits
exceeded withdrawals by $577.9 million, resulting in the net overall increase in
deposits.
Federal Home Loan Bank, or FHLB, advances increased $272.5 million to
$472.5 million at December 31, 1998, from $200.0 million at December 31, 1997,
an increase of 136.3%. Other borrowings, composed primarily of securities sold
under agreements to repurchase, increased $124.5 million to $404.4 million at
December 31, 1998 from $279.9 million at December 31, 1997, an increase of
44.5%. At December 31, 1998, subordinated debt, net of original issue discount,
consisting of the 9.5% senior subordinated debentures issued in February 1997
and the 11.5% subordinated debentures issued in the second quarter of 1994,
totaled $29.9 million. Additionally, we issued $67.1 million of callable
certificates of deposit during 1998 as relatively cost-effective borrowings with
hedging properties that improve our overall interest rate risk position.
In June 1997, we formed TeleBanc Capital Trust I, which sold an aggregate
of $10.0 million in shares of trust preferred securities, series A, with an
annual dividend rate of 11.0% payable semi-annually, beginning in December 1997,
callable beginning December 2007. In July 1998, we formed TeleBanc Capital Trust
II, which sold an aggregate of $27.5 million in shares of trust preferred
securities, series A, with an annual dividend rate of 9.0% payable quarterly,
beginning in September 1998, callable beginning September 2003.
Stockholders' equity increased $67.6 million to $113.4 million at December
31, 1998 from $45.8 million at December 31, 1997. The increase is primarily the
result of the receipt of approximately $70.0 million in net proceeds from the
issuance of common stock in July and August 1998. This increase was offset by
net income during 1998 of $1.4 million, less preferred stock dividends of $2.1
million. Additionally, our unrealized gain on securities available for sale
decreased to $1.9 million
26
<PAGE> 27
at December 31, 1998. Upon consummation of the July 1998 common stock offering,
29,900 outstanding shares of preferred stock converted to 2,399,479 shares of
common stock. In addition, upon the conversion, we issued 119,975 shares of
common stock as a special dividend to the holders of the preferred stock. The
dividend had a value of $1.7 million, based on the fair market value of the
common stock on the date the dividend was paid.
LIQUIDITY
Liquidity represents our 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 our ongoing obligations. We have historically met our
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. We believe that we will be able to renew or replace our funding
sources at then-existing market rates, which may be higher or lower than current
rates. Pursuant to applicable Office of Thrift Supervision, or OTS, regulations,
Telebank is required to maintain an average liquidity ratio of 4.0% of certain
borrowings and its deposits, which requirement it fully met during 1998. Prior
to November 24, 1997, this requirement was 5.0%, which Telebank fully met during
1996 and 1997.
In the third quarter of 1998, we raised capital through our common stock
offering, in which we sold 5,175,000 shares of common stock to the public at an
offering price of $14.50. We also raised $27.5 million in the third quarter of
1998 through TeleBanc Capital Trust II's sale of 1,100,000 shares of 9.0% trust
preferred securities, series A. We are using the net proceeds of both offerings
to fund continued growth.
We seek 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, time deposit
accounts and accounts that maintain a relatively high balance provide a
relatively stable source of funding. At December 31, 1998, our average retail
account balance was approximately $22,000, and our average customer maintained
1.7 accounts. Savings and transactional deposits increased $91.8 million to
$215.4 million during the year ended December 31, 1998, an increase of 74.3%.
Retail certificates of deposit increased $528.4 million to $927.0 million during
the year ended December 31, 1998, an increase of 132.6%. During 1998, we also
began to offer callable certificates of deposit, which totaled $67.1 million at
December 31, 1998.
We also rely on borrowed funds, such as FHLB advances and securities sold
under agreements to repurchase, to provide liquidity. Total borrowings increased
$397.0 million to $876.9 million at December 31, 1998, an increase of 82.7%. At
December 31, 1998, Telebank had approximately $667.3 million in additional
borrowing capacity.
At December 31, 1998, we had outstanding $31.0 million face amount of
subordinated debentures. In addition, at the same date, we also had outstanding
$37.5 million face amount of junior subordinated debentures held by our trust
preferred subsidiaries. Additionally, from January 1, 1998 through July 28,
1998, we had outstanding $15.3 million of preferred stock, which converted to
2,399,479 shares of common stock upon consummation of our 1998 common stock
offering. We paid $373,000 in cash dividends on the preferred stock during 1998.
Our aggregate annual interest expense on the subordinated debentures and junior
subordinated debentures is $7.0 million.
Subject to the approval of the OTS and compliance with federal regulations,
Telebank pays a dividend to Telebanc semi-annually in an amount equal to the
aggregate debt service and dividend obligations. Under current OTS capital
distribution regulations, as long as Telebank meets the OTS capital requirements
before and after the payment of dividends, Telebank may pay dividends to us
without prior OTS approval in an amount equal to the net income to date over the
calendar year, plus retained net income over the preceding two years. In
addition, the OTS has discretion to prohibit any otherwise permitted capital
distribution on general safety and soundness grounds, and we must give 30 days'
advance notice to the OTS of all capital distributions, during which time it may
object to any proposed distribution. As of December 31, 1998, Telebank had
approximately $21.7 million available for payment of dividends under applicable
restrictions without regulatory approval. Under the terms of the indenture
pursuant to which the 11.5% subordinated debentures were issued and the terms of
the
27
<PAGE> 28
9.5% subordinated debentures, Telebanc currently is required to maintain, on an
unconsolidated basis, liquid assets in an amount equal to or greater than $7.0
million, which represents 100% of the aggregate interest expense for one year on
our outstanding subordinated debentures and junior subordinated debentures. We
had $10.0 million in liquid assets as of December 31, 1998.
CAPITAL
As of December 31, 1998, 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.
The following table sets forth Telebank's regulatory capital levels as of
December 31, 1998 in relation to the regulatory requirements in effect at that
date. The information below reflects only the regulatory capital of Telebank and
does not give effect to additional available capital of its parent Telebanc. See
Note 4 to the consolidated financial statements.
<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, 1997:
Core Capital...................... $ 52,617 5.06% $41,606 4.0% $ 52,008 5.0%
Tangible Capital.................. 52,608 5.06 15,602 1.5 N/A N/A
Tier I Capital.................... 52,617 11.25 N/A N/A 28,057 6.0
Total Capital..................... 55,701 11.91 37,409 8.0 46,761 10.0
As of December 31, 1998:
Core Capital...................... $122,871 5.57% $88,310 4.0% $110,388 5.0%
Tangible Capital.................. 122,871 5.57 33,116 1.5 N/A N/A
Tier I Capital.................... 122,871 12.95 N/A N/A 56,934 6.0
Total Capital..................... 127,179 13.40 75,913 8.0 94,891 10.0
</TABLE>
RATE/VOLUME TABLE
The following table allocates the period-to-period changes in our various
categories of interest income and expense between changes due to (1) 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 (2) changes in rate, calculated by multiplying changes in rate
by the prior year's volume. Changes due to changes in rate-volume, which is
calculated as the change in rate multiplied by changes in volume, have been
allocated proportionately between changes in volume and changes in rate.
28
<PAGE> 29
<TABLE>
<CAPTION>
1997 VS. 1996 1998 VS. 1997
--------------------------- ---------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
--------------------------- ---------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ----- ------ ---- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net............. $12,732 $(1,092) $11,640 $17,102 $ (665) $16,437
Interest-bearing deposits......... 68 (29) 39 8 13 21
Mortgage-backed and related
securities available for
sale........................... 373 (682) (309) 18,433 (1,605) 16,828
Investment securities available
for sale....................... 809 8 817 5,358 (62) 5,296
Federal funds sold................ 54 2 56 (84) 3 (81)
Investment in FHLB stock.......... 153 1 154 247 18 265
Trading account................... 1,124 -- 1,124 495 (142) 353
------- ------- ------- ------- ------- -------
Total interest-earning
assets.................. $15,313 $(1,792) $13,521 $41,559 $(2,440) $39,119
======= ======= ======= ======= ======= =======
Interest-bearing liabilities:
Savings deposits.................. $ 1,111 $ 454 $ 1,565 $ 1,784 $ (38) $ 1,746
Time deposits..................... 3,315 (279) 3,036 17,666 (354) 17,312
Brokered callable certificates of
deposit........................ -- -- -- 3,638 -- 3,638
FHLB advances..................... 2,400 796 3,196 3,475 (338) 3,137
Other borrowings.................. 2,838 (466) 2,372 7,289 (81) 7,208
Subordinated debt................. 1,207 (128) 1,079 288 (41) 247
------- ------- ------- ------- ------- -------
Total interest-bearing
liabilities............. $10,871 $ 377 $11,248 $34,140 $ (852) $33,288
------- ------- ------- ------- ------- -------
Change in net interest income....... $ 4,442 $(2,169) $ 2,273 $ 7,419 $(1,588) $ 5,831
======= ======= ======= ======= ======= =======
</TABLE>
29
<PAGE> 30
AVERAGE BALANCE TABLE
The following table presents consolidated average balance sheet data,
income and expense and related interest yields and rates for each of the three
years in the period ended December 31, 1998. The table also presents information
for the periods indicated with respect to net interest margin, an indicator of
an institution's profitability. Another indicator is net interest spread, which
is the difference between the weighted average yield earned on interest-earning
assets and weighted average rate paid on interest-bearing liabilities. Interest
income includes the incremental tax benefit of tax exempt income.
<TABLE>
<CAPTION>
1996 1997
--------------------------------- ---------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
BALANCE INC./EXP. YIELD/COST BALANCE INC./EXP. YIELD/COST
-------- --------- ---------- -------- --------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net........................ $279,038 $23,089 8.28% $441,819 $34,729 7.86%
Interest-bearing deposits.................... 6,612 420 6.24 7,865 459 5.84
Mortgage-backed and related securities,
available for sale......................... 221,656 17,955 8.10 226,064 17,646 7.81
Investment securities, available for sale.... 61,169 3,959 6.47 73,649 4,776 6.49
Federal funds sold........................... 842 44 5.22 1,844 100 5.37
Investment in FHLB stock..................... 6,229 451 7.25 8,338 605 7.25
Trading account.............................. -- -- -- 12,581 1,124 8.81
-------- ------- -------- -------
Total interest-earning assets.......... $575,546 $45,918 7.98% $772,160 $59,439 7.70%
-------- ------- -------- -------
Non-interest earning assets................... 26,929 41,465
-------- --------
Total assets........................... $602,475 $813,625
======== ========
Interest-bearing liabilities:
Retail deposits.............................. $358,216 $21,357 5.96% $432,641 $25,958 6.00%
Brokered callable certificates of deposit.... -- -- -- -- -- --
FHLB advances................................ 120,678 6,689 5.54 160,681 9,885 6.07
Other borrowings............................. 68,154 4,569 6.70 117,515 6,941 5.83
Subordinated debt, net....................... 17,250 2,200 12.75 27,434 3,279 11.95
-------- ------- -------- -------
Total interest-bearing liabilities..... $564,298 $34,815 6.14% $738,271 $46,063 6.21%
-------- ------- -------- -------
Non-interest-bearing liabilities.............. 15,900 25,719
-------- --------
Total liabilities...................... $580,198 $763,990
-------- --------
Trust preferred securities.................... -- $ 9,597
Total stockholders' equity............. 22,277 40,038
-------- --------
Total liabilities and stockholders'
equity................................ $602,475 $813,625
======== ========
Excess of interest-earning assets over
interest-bearing liabilities/net interest
income....................................... $ 11,248 $11,103 $ 33,889 $13,376
======== ======= ======== =======
Net interest spread........................... 1.84% 1.49%
====== ======
Net interest margin (net yield on
interest-earning assets)..................... 1.94 1.73
====== ======
Ratio of interest-earning assets to
interest-bearing liabilities................. 101.99 104.59
====== ======
<CAPTION>
1998
-----------------------------------
AVERAGE INTEREST AVERAGE
BALANCE INC./EXP. YIELD/COST
---------- --------- ----------
(Dollars in thousands)
<S> <C> <C> <C>
Interest-earning assets:
Loans receivable, net........................ $ 663,913 $51,166 7.71%
Interest-bearing deposits.................... 7,993 480 5.92
Mortgage-backed and related securities,
available for sale......................... 492,077 34,474 7.01
Investment securities, available for sale.... 157,381 10,072 6.40
Federal funds sold........................... 346 19 5.53
Investment in FHLB stock..................... 11,651 870 7.47
Trading account.............................. 19,760 1,477 7.47
---------- -------
Total interest-earning assets.......... $1,353,121 $98,558 7.28%
---------- -------
Non-interest earning assets................... 52,841
----------
Total assets........................... $1,405,962
==========
Interest-bearing liabilities:
Retail deposits.............................. $ 753,352 $45,016 5.98%
Brokered callable certificates of deposit.... 54,491 3,638 6.68
FHLB advances................................ 219,487 13,022 5.85
Other borrowings............................. 242,412 14,149 5.76
Subordinated debt, net....................... 29,880 3,526 11.80
---------- -------
Total interest-bearing liabilities..... $1,299,622 $79,351 6.08%
---------- -------
Non-interest-bearing liabilities.............. 19,312
----------
Total liabilities...................... $1,318,934
----------
Trust preferred securities.................... $ 20,599
Total stockholders' equity............. 66,429
----------
Total liabilities and stockholders'
equity................................ $1,405,962
==========
Excess of interest-earning assets over
interest-bearing liabilities/net interest
income....................................... $ 53,499 $19,207
========== =======
Net interest spread........................... 1.20%
======
Net interest margin (net yield on
interest-earning assets)..................... 1.42
======
Ratio of interest-earning assets to
interest-bearing liabilities................. 104.12
======
</TABLE>
30
<PAGE> 31
INTEREST RATE SENSITIVITY MANAGEMENT
The following is intended to address the disclosures required by Item 7A,
Quantitative and Qualitative Disclosures about Market Risk.
We actively monitor our 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 risk management function is responsible for measuring,
monitoring and controlling market risk and communicating risk limits in
connection with our asset/liability management activities and trading.
Our strategies are intended to stabilize our net interest margin and its
exposure to market risk under a variety of changes in interest rates. By
actively managing the maturities of our interest-sensitive assets and
liabilities, we seek to maintain a relatively consistent net interest margin and
mitigate much of the interest rate risk associated with such assets and
liabilities.
Management uses a risk management process that allows risk-taking within
specific limits. To this end, we have established an asset-liability committee
and implemented a risk measurement guideline employing market value of equity
and gap methodologies and other measures.
The asset-liability committee establishes the policies and guidelines for
the management of our assets and liabilities. The committee's policy is directed
toward reducing the variability of the market value of our equity under a wide
range of interest rate environments. Fair value of equity represents the net
fair value of our financial assets and liabilities, including off-balance sheet
hedges. We monitor the sensitivity of changes in the fair value of equity with
respect to various interest rate environments and report regularly to the
asset/liability committee. Effective fair value management maximizes net
interest income while constraining the changes in the fair value of equity with
respect to changes in interest rates to acceptable levels. The model calculates
a benchmark fair value of equity for current market conditions.
We use sensitivity analysis to evaluate the rate and extent of changes to
our fair value of equity under various market environments. In preparing
simulation analyses, we break down the aggregate investment portfolio into
discrete product types that share similar properties, such as fixed or
adjustable rate, similar coupon and similar age. Under this analysis, we
calculate net present value of expected cashflows for interest sensitive assets
and liabilities under various interest rate scenarios. In conducting this
sensitivity analysis, the model considers all assets, liabilities and
off-balance sheet hedges, including whole loan mortgages, mortgage-backed
securities, mortgage derivatives, corporate bonds, and interest rate swaps,
caps, floors and options. The range of interest rate scenarios evaluated
encompasses significant changes to current market conditions. By this process,
we subject our interest rate sensitive assets and liabilities to substantial
market stress and evaluate the fair value of equity resulting from various
market scenarios. The asset-liability committee reviews the results of these
stress tests and establishes appropriate strategies to promote continued
compliance with established guidelines.
Management measures the efficiency of its asset/liability management
strategies by analyzing, on a quarterly basis, Telebank's theoretical fair value
of equity and the expected effect of changes in interest rates. The board of
directors establishes limits within which such changes in the fair value of
equity are to be maintained in the event of changes in interest rates.
We calculated a theoretical fair value of equity in response to a
hypothetical change in market interest risk. The model addresses the exposure to
Telebank of its market sensitive non-trading financial instruments. The model
excludes Telebank's trading portfolio, which, based on management's analysis,
has an immaterial impact on Telebank's fair value of equity. A hypothetical
instantaneous 1.0% rise in interest rates would cause the fair value of equity
to decrease by 9.0%.
Every method of market value sensitivity analysis contains inherent
limitations and express and implied assumptions that can affect the resulting
calculations. For example, each interest rate scenario reflects unique
prepayment and repricing assumptions. In addition, this analysis offers a static
view of assets, liabilities and hedges held as of December 31, 1998 and makes no
assumptions regarding transactions we might enter into in response to changing
market conditions.
Telebank's primary interest risk is the exposure to increasing interest
rates. We manage our exposure to increasing interest rates, principally changes
in three-month LIBOR associated with the cost of our deposits and advances from
the Federal Home
31
<PAGE> 32
Loan Bank of Atlanta, by entering into related interest rate swap and cap
agreements. These instruments contain principally the same terms and notional
balance as the related designated liabilities.
We employ various techniques to implement the asset/liability committee's
strategies directed toward managing the variability of the fair value of equity
by controlling the relative sensitivity of market value of interest-earning
assets and interest-bearing liabilities. The sensitivity of changes in market
value of assets and liabilities is affected by factors, including the level of
interest rates, market expectations regarding future interest rates, projected
related loan prepayments and the repricing characteristics of interest-bearing
liabilities. We use hedging techniques to reduce the variability of fair value
of equity and its overall interest rate risk exposure over a one- to seven-year
period.
We also monitor our assets and liabilities by examining the extent to which
such assets and liabilities are interest rate sensitive and by monitoring the
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. Our current asset-liability management strategy
is to maintain an evenly matched one- to five-year gap giving effect to hedging,
but depending on market conditions and related circumstances, a positive or
negative one- to five-year gap of up to 20% may be acceptable. Inclusive of our
hedging activities, our one-year gap at December 31, 1998 was (3.4)%. Our
hedge-affected one- to five-year gap at such date was (11.4)%.
We used the following assumptions to prepare our gap table at December 31,
1998. Non-amortizing investment securities are shown in the period in which they
contractually mature. Investment securities that contain embedded options such
as puts or calls are shown in the period in which that security is currently
expected to be put or called or to mature. The table assumes that fully indexed,
adjustable-rate, residential mortgage loans and mortgage-backed securities
prepay at an annual rate between 25% and 35%, based on estimated future
prepayment rates for comparable market benchmark securities and our prepayment
history. The table also assumes that fixed-rate, current-coupon residential
loans and mortgage-backed securities prepay at an annual rate of between 20% and
25%. The above assumptions were adjusted up or down on a pool-by-pool basis to
model the effects of product type, coupon rate, rate adjustment frequency,
lifetime cap, net coupon reset margin and periodic rate caps upon prevailing
annual prepayment rates. Time deposits are shown in the period in which they
contractually mature, and savings deposits are shown to reprice immediately. The
interest rate sensitivity of our assets and liabilities could vary substantially
if different assumptions were used or if actual experience differs from the
assumptions used.
32
<PAGE> 33
The following table sets forth our gap at December 31, 1998.
<TABLE>
<CAPTION>
REPRICING REPRICING REPRICING REPRICING
BALANCE AT WITHIN WITHIN WITHIN IN
DECEMBER 31, PERCENT 0-3 4-12 1-5 MORE THAN
1998 OF TOTAL MONTHS MONTHS YEARS 5 YEARS
------------ -------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net............... $ 904,854 40.92% $ 154,771 $ 305,557 $ 337,540 $106,986
Mortgage-backed securities,
available for sale and trading.... 1,041,747 47.10 69,134 220,375 394,455 357,783
Investment securities available for
sale and FHLB stock............... 245,533 11.10 52,116 6,484 59,273 127,660
Federal funds sold and interest
bearing deposits.................. 19,401 0.88 -- 1,940 17,461 --
---------- ------ --------- --------- --------- --------
Total interest-earning assets......... $2,211,535 100.00% $ 276,021 $ 534,356 $ 808,729 $592,429
---------- ====== ========= ========= ========= ========
Non-interest-earning assets:.......... 71,806
----------
Total assets........................ $2,283,341
==========
Interest-bearing liabilities:
Savings deposits.................... $ 215,402 10.18% $ -- $ 21,540 $ 193,862 $ --
Time deposits....................... 994,068 46.97 43,306 526,935 351,882 71,945
FHLB advances....................... 472,500 22.33 332,500 134,000 6,000 --
Other borrowings.................... 404,435 19.11 401,100 3,335 -- --
Subordinated debt................... 29,855 1.41 -- 29,855 -- --
---------- ------ --------- --------- --------- --------
Total interest-bearing
liabilities....................... $2,116,260 100.00% $ 776,906 $ 715,665 $ 551,744 $ 71,945
---------- ====== ========= ========= ========= ========
Non-interest-bearing liabilities...... 18,261
----------
Total liabilities................... $2,134,521
----------
Total trust preferred............... 35,385
Stockholders' equity................ 113,435
----------
Total liabilities and stockholders'
equity............................ $2,283,341
==========
Periodic gap.......................... $(500,885) $(181,309) $ 256,985 $520,484
========= ========= ========= ========
Cumulative gap........................ $(500,885) $(682,194) $(425,209) $ 95,275
========= ========= ========= ========
Cumulative gap to total assets........ (21.9)% (29.9)% (18.6)% 4.2%
Cumulative gap to total assets hedge
affected............................ 6.8% (3.4)% (11.4)% 4.2%
</TABLE>
33
<PAGE> 34
IMPACT OF INFLATION AND CHANGING PRICES
The impact inflation has on us is different from the impact on an
industrial company because substantially all of our assets and liabilities are
monetary in nature, and interest rates and inflation rates do not always move in
concert. We believe that the impact of inflation on financial results depends
upon our 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 our operating expenses. The actual effect of inflation on our
net interest income, however, would depend on the extent to which we were able
to maintain a spread between the average yield on our interest-earning assets
and the average cost of our interest-bearing liabilities, which would depend to
a significant extent on our asset-liability sensitivity. As discussed above, we
seek to manage the relationship between interest-sensitive assets and
liabilities to protect against wide interest rate fluctuations, including those
resulting from inflation. The effect of inflation on our results of operations
for the past three years has been minimal.
YEAR 2000 READINESS DISCLOSURE STATEMENT
In 1997, we began year 2000 planning, following the five steps recommended
by the Federal Financial Institutions Examination Council. We have completed
phases focused on awareness and assessment and continue to update the results of
these phases for new information received. Currently, the renovation phase,
which consists of implementing changes and monitoring vendor renovation, and the
validation phase, which consists of testing renovated systems, are underway. We
are monitoring vendors for software updates and final compliance certification
statements and have received certifications from all of our vendors. Some
vendors, however, have continued to update their products to correct year 2000
issues even after certifying that they are year 2000 compliant, indicating that
these certifications may not be final. As a result, following the receipt of the
final certification statements relating to those systems identified as mission
critical in the assessment phase, we internally validate such certifications
through testing. To date, we have identified no significant year 2000 issues
through our testing of mission critical systems. Our mission critical systems
include the deposit processing system, general ledger system and internet
banking applications. We are substantially complete with renovation, validation
and implementation of all mission critical systems. As of April 6, 1999, we have
completed 100% of our remediation efforts and 75% of the testing of our mission
critical systems.
Our steady growth over the past several years has required that we
continually upgrade our systems; we do not anticipate that we will incur
material costs related to our year 2000 remediation efforts. We have analyzed
the impact of year 2000 issues on our non-information technology systems such as
embedded chips necessary for proper operation of mechanical systems and have
concluded that these issues do not present a significant risk to our operations.
To date, we have not hired any outside consultants to address the year 2000
issue, and few upgrades have been accelerated due to the year 2000 issue. We
estimate that we have spent approximately $25,000 on upgrades related to our
year 2000 remediation efforts, with an additional $75,000 expected to be spent
before the year 2000.
The majority of our loans are serviced by a large company that uses the
same system as several of the largest loan servicers in the United States and
that is expected to be year 2000 compliant. We are currently monitoring this
servicer's year 2000 plan and testing. However, approximately 38% of our loans
are serviced by smaller loan servicers whose systems may not be year 2000
compliant. If these systems were to fail, principal and interest payments on the
loans serviced by these servicers could be delayed, and we would lose interest
income that we would normally earn on these funds. We have developed a
contingency plan to address this loan servicing issue specifically. Under the
contingency plan, we have notified these servicers that if we have not received
confirmation of compliance by March 31, 1999, we will begin transferring
servicing of these loans to servicers who are known to be year 2000 compliant.
We hope to complete any such transfers that are necessary by June 30, 1999.
Based upon current information, we do not anticipate costs associated with
the year 2000 issue to have a material financial impact. There may, however, be
interruptions or other limitations of financial and operating systems'
functionality and we may incur additional costs to avoid such inter-
34
<PAGE> 35
ruptions or limitations. Our expectations about future costs associated with the
year 2000 issue are subject to uncertainties that could cause actual results to
have a greater financial impact than currently anticipated. Factors that could
influence the amount and timing of future costs include:
- our success in identifying systems and programs that contain two-digit
year codes;
- the nature and amount of programming required to upgrade or replace each
of the affected programs;
- the rate and magnitude of related labor and consulting costs; and
- our success in addressing the year 2000 issues with third-parties with
which we do business.
CHANGES IN ACCOUNTING PRINCIPLES
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities ("SFAS 133"). The statement establishes accounting and
reporting standards requiring that every derivative instrument, including
derivative instruments embedded in other contracts, be recorded in the balance
sheet as either an asset or liability measured at fair value. SFAS 133 requires
that changes in the derivative instrument's fair value be recognized currently
in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative instrument's gains and
losses to offset related results on the hedged item in the income statement and
requires that a company formally document, designate and assess the
effectiveness of transactions that receive hedge accounting treatment.
SFAS 133 is effective for fiscal years beginning after June 15, 1999,
although a company may implement the statement as of the beginning of any fiscal
quarter after issuance, that is, fiscal quarters beginning June 16, 1998 and
after. SFAS 133 cannot be applied retroactively. SFAS 133 must be applied to (a)
derivative instruments and (b) certain derivative instruments embedded in hybrid
contracts that were issued, acquired or substantively modified after December
31, 1997 and, at our election, before January 1, 1998.
We plan to adopt SFAS 133 as of January 1, 2000 but have not yet quantified
the impact of adopting SFAS 133 on our financial statements. However, the
statement could increase volatility in earnings and other comprehensive income.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5, Reporting on the Cost of Start-up Activities
("SOP 98-5"), which is effective for fiscal years beginning after December 18,
1998. The statement requires that the cost of start-up activities be expensed as
incurred rather than capitalized, with initial application reported as the
cumulative effect of a change in accounting principle, as described in
Accounting Principles Board Opinion Number 20, Accounting Changes. As of
December 31, 1998, we carried on our books approximately $740,000 of capitalized
start-up costs, relating primarily to the establishment of TeleBanc Insurance
Services, Inc., or Telebanc Insurance. We intend to implement SOP 98-5 on
January 1, 1999, and, as a result, will recognize this amount, net of tax, as an
expense classified as the cumulative effect of a change in accounting principle.
35
<PAGE> 36
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to "Interest Rate Sensitivity Management" in Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................... 37
Consolidated Statement of Financial Condition -- As of
December 31, 1998 and 1997................................ 38
Consolidated Statements of Operations and Comprehensive
Income -- For the Years Ended December 31, 1998, 1997 and
1996...................................................... 39
Consolidated Statements of Changes in Stockholders'
Equity -- For the Years Ended December 31, 1998, 1997 and
1996...................................................... 40
Consolidated Statements of Cash Flows -- For the Years Ended
December 31, 1998, 1997 and 1996.......................... 41
Notes to Consolidated Financial Statements.................. 43
</TABLE>
36
<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 statements of financial
condition of TeleBanc Financial Corporation (a Delaware Corporation) and
subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of operations and comprehensive income, stockholders' equity, and
cash flows for each of the three years ended December 31, 1998. 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, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Vienna, Virginia
February 10, 1999
37
<PAGE> 38
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $ 26,282 $ 92,156
Trading securities.......................................... 29,584 21,110
Federal Home Loan Bank stock................................ 25,175 10,000
Investment securities available-for-sale.................... 220,358 91,237
Mortgage-backed securities available-for-sale............... 1,012,163 319,203
Loans receivable held for sale.............................. 117,928 149,086
Loans receivable, net....................................... 786,926 391,618
Other assets................................................ 64,925 25,942
---------- ----------
Total assets................................................ $2,283,341 $1,100,352
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Retail deposits............................................. $1,142,385 $ 522,221
Brokered callable certificates of deposit................... 67,085 --
Advances from the Federal Home Loan Bank of Atlanta......... 472,500 200,000
Securities sold under agreements to repurchase and other
borrowings................................................ 404,435 279,909
Subordinated debt, net...................................... 29,855 29,614
Other liabilities........................................... 18,261 13,212
---------- ----------
Total liabilities........................................... 2,134,521 1,044,956
Corporation-Obligated Mandatorily Redeemable Capital
Securities of Subsidiary Trust Holding Solely Junior
Subordinated Debentures of the Corporation................ 35,385 9,572
Commitments and contingencies............................... -- --
Stockholders' equity:
4% Cumulative Preferred Stock, $0.01 par value, 500,000
shares authorized
Series A, 0 and 18,850 issued and outstanding at December
31, 1998 and 1997...................................... -- 9,634
Series B, 0 and 4,050 issued and outstanding at December
31, 1998 and 1997...................................... -- 2,070
Series C, 0 and 7,000 issued and outstanding at December
31, 1998 and 1997...................................... -- 3,577
Common stock, $0.01 par value, 29,500,000 shares authorized;
12,388,242 and 4,458,322 issued and outstanding at
December 31, 1998 and 1997................................ 123 44
Additional paid-in capital.................................. 103,194 16,205
Unearned ESOP shares........................................ (2,578) --
Retained earnings........................................... 10,819 11,556
Unrealized gain on securities available for sale, net of
tax....................................................... 1,877 2,738
---------- ----------
Total stockholders' equity.................................. 113,435 45,824
---------- ----------
Total liabilities and stockholders' equity.................. $2,283,341 $1,100,352
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
38
<PAGE> 39
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Interest income:
Loans..................................................... $ 51,197 $34,729 $23,089
Mortgage-backed and related securities.................... 34,474 17,646 17,955
Investment securities..................................... 9,951 5,702 4,690
Trading securities........................................ 2,861 1,124 --
Other..................................................... 1,627 100 66
-------- ------- -------
Total interest income............................... 100,110 59,301 45,800
Interest expense:
Retail deposits........................................... 44,913 25,958 21,357
Brokered callable certificates of deposit................. 3,638 -- --
Advances from the Federal Home Loan Bank of Atlanta....... 13,022 9,885 6,689
Repurchase agreements and other borrowings................ 15,204 6,941 4,569
Subordinated debt......................................... 3,528 3,279 2,200
-------- ------- -------
Total interest expense.............................. 80,305 46,063 34,815
-------- ------- -------
Net interest income................................. 19,805 13,238 10,985
Provision for loan losses................................... 905 921 919
-------- ------- -------
Net interest income after provision for loan
losses.............................................. 18,900 12,317 10,066
-------- ------- -------
Non-interest income:
Gain on sale of available for sale securities............. 3,536 982 935
Gain on sale of loans..................................... 2,088 1,148 874
(Loss) gain on trading securities......................... (43) 1,204 --
Income (loss) on equity investments....................... 531 (1,138) (274)
Fees, service charges, and other.......................... 1,452 1,897 1,221
-------- ------- -------
Total non-interest income........................... 7,564 4,093 2,756
Non-interest expenses:
Selling, general and administrative expenses:
Compensation and employee benefits........................ 7,779 4,909 3,690
Advertising and marketing................................. 4,634 606 93
Special SAIF assessment................................... -- -- 1,671
Other..................................................... 7,406 3,527 2,921
-------- ------- -------
Total general and administrative expenses........... 19,819 9,042 8,375
Other non-interest expenses:
Net operating cost of real estate acquired through
foreclosure............................................. 336 278 238
Amortization of goodwill and other intangibles............ 1,923 822 462
-------- ------- -------
Total other non-interest expenses....................... 2,259 1,100 700
-------- ------- -------
Total non-interest expenses......................... 22,078 10,142 9,075
-------- ------- -------
Income before income tax expense and minority
interest............................................... 4,386 6,268 3,747
Income tax expense.......................................... 1,649 1,657 1,195
Minority interest in subsidiary............................. 1,362 394 --
-------- ------- -------
Net income.......................................... $ 1,375 $ 4,217 $ 2,552
Preferred stock dividends................................... 2,112 546 --
-------- ------- -------
Net (loss) income available to common
stockholders........................................ $ (737) $ 3,671 $ 2,552
======== ======= =======
Other comprehensive income, before tax:
Unrealized holding gain on securities arising during the
period.................................................. 1,331 1,251 1,088
Less: reclassification adjustment for gains included in
net income.............................................. (3,536) (982) (882)
-------- ------- -------
Other comprehensive income, before tax.................. (2,205) 269 206
Income tax expense related to reclassification adjustment
for gains on sale of securities......................... 1,344 373 335
-------- ------- -------
Other comprehensive income, net of tax.................. (861) 642 541
-------- ------- -------
Comprehensive income.................................... $ (1,598) $ 4,313 $ 3,093
======== ======= =======
Earnings per share:
Basic..................................................... $ (0.09) $ 0.84 $ 0.62
Diluted................................................... $ (0.09) $ 0.57 $ 0.58
</TABLE>
See accompanying notes to consolidated financial statements.
39
<PAGE> 40
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED
GAINS
(LOSSES)
ON
ADDITIONAL AVAILABLE-
PREFERRED COMMON PAID-IN UNEARNED RETAINED FOR-SALE
STOCK STOCK CAPITAL ESOP SHARES EARNINGS SECURITIES TOTAL
--------- ------ ---------- ----------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCES AT DECEMBER 31, 1995................. $ -- $ 40 $ 14,637 $ -- $ 5,333 $ 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................. -- 40 14,637 -- 7,885 2,096 24,658
Net income.................................... -- -- -- -- 4,217 -- 4,217
Common stock issued........................... -- 4 1,568 -- -- -- 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 44 16,205 -- 11,556 2,738 45,824
Net income.................................... -- -- -- -- 1,375 -- 1,375
Common stock issued........................... -- 54 69,994 -- -- -- 70,048
Dividends on 4% cumulative preferred stock.... -- 1 1,738 -- (2,112) -- (373)
Conversion of 4% cumulative preferred stock to
common stock................................ (15,281) 24 15,257 -- -- -- --
Unearned ESOP shares.......................... -- -- -- (2,578) -- -- (2,578)
Unrealized gain on available for sale
securities, net of tax effect............... -- -- -- -- -- (861) (861)
-------- ---- -------- ------- ------- ------- --------
BALANCES AT DECEMBER 31, 1998................. $ -- $123 $103,194 $(2,578) $10,819 $ 1,877 $113,435
======== ==== ======== ======= ======= ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
40
<PAGE> 41
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................................... $ 1,375 $ 4,217 $ 2,552
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Minority interest................................. 1,362 394 --
Equity in (income) losses of subsidiaries......... (531) 1,129 274
Depreciation, amortization, and discount
accretion....................................... 1,197 (1,038) (1,516)
Provision for loan losses......................... 905 921 919
Provision for losses on foreclosed real estate.... -- 19 78
Other gains and losses, net....................... (86) (1,624) (1,011)
Deferred income tax provision..................... (3,004) (445) (224)
Proceeds from sales, repayments and maturities of
loans held-for-sale............................. 69,762 60,145 27,865
Purchases of loans held-for-sale.................. (2,297) (72,804) (91,943)
Net realized gains on available-for-sale
securities, loans held-for-sale and trading..... (4,105) (2,613) (935)
Purchases of trading assets....................... (623,913) (100,630) --
Proceeds from sales, repayments and maturities of
trading assets.................................. 616,110 80,990 --
Increase in accrued interest receivable........... (7,089) (1,492) (2,220)
Increase in accrued expenses and other
liabilities..................................... 1,113 345 3,730
Increase in other assets.......................... (18,296) (3,373) (2,433)
Interest credited to deposits..................... 45,023 25,958 21,361
----------- --------- ---------
Net cash (used in) provided by operating
activities................................... 77,526 (9,901) (43,503)
----------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash received from business acquisition.......... 10,347 -- --
Net increase in loans held to maturity, net of loans
received in business acquisition.................. (281,603) (269,036) (90,717)
Loans extended to Employee Stock Ownership Plan...... (2,578) -- --
Equity investments in subsidiaries................... (1,687) (1,736) (2,359)
Purchases of available-for-sale securities, net of
securities received in business acquisition....... (1,286,948) (395,675) (356,882)
Proceeds from sales of available-for-sale
securities........................................ 379,166 144,718 220,293
Proceeds from maturities of and principal payments on
available-for-sale securities..................... 214,466 197,036 201,547
Net sales (purchases) of premises and equipment, net
of premises and equipment received in business
acquisition....................................... (2,070) 110 (842)
Proceeds from sale of foreclosed real estate......... 978 1,563 1,156
----------- --------- ---------
Net cash used in investing activities........... (969,929) (323,020) (27,804)
----------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
41
<PAGE> 42
<TABLE>
<CAPTION>
1998 1997 1996
----------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits, net of deposits received in
business acquisition.............................. 335,136 105,777 62,625
Advances from Federal Home Loan Bank of Atlanta...... 1,201,577 322,000 273,500
Payments on advances from Federal Home Loan Bank of
Atlanta........................................... (929,077) (266,800) (234,200)
Net increase (decrease) in securities sold under
agreements to repurchase.......................... 124,526 222,328 (36,324)
Net increase in other borrowed funds, net of
borrowings received in business acquisition....... 241 13,028 --
Proceeds from the issuance of trust preferred
securities, net................................... 25,813 9,572 --
Proceeds from the issuance of common stock and
preferred stock................................... 71,787 16,853 --
Dividend paid on Trust Preferred securities.......... (1,362) (394) --
Dividends paid on preferred stock.................... (2,112) (546) --
----------- --------- ---------
Net cash provided by financing activities....... 826,529 421,818 65,601
----------- --------- ---------
Net (decrease) increase in cash and cash equivalents... (65,874) 88,897 (5,706)
Cash and cash equivalents at beginning of period....... 92,156 3,259 8,965
----------- --------- ---------
Cash and cash equivalents at end of period............. $ 26,282 $ 92,156 $ 3,259
=========== ========= =========
SUPPLEMENTAL INFORMATION:
Interest paid on deposits and borrowed funds......... $ 74,701 $ 45,440 $ 32,660
Income taxes paid.................................... 999 2,473 972
Gross unrealized (loss) gain on marketable securities
available-for-sale................................ (1,389) 873 795
Tax effect of gain on available-for-sale
securities........................................ 528 231 254
Transfer from loans to REO........................... 1,923 1,454 1,513
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES:
Additional common stock, totaling 119,975 shares, was
issued upon conversion of 29,900 shares of 4%
Cumulative Preferred Stock.
</TABLE>
The Company purchased all of the capital stock of DFC for $22.3 million, in
a merger transaction consummated on August 10, 1998. The total fair value of
assets acquired was $333.7 million and total fair value of liabilities assumed
was $315.4 million.
See accompanying notes to consolidated financial statements.
42
<PAGE> 43
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") and TeleBanc Capital Markets, Inc. ("TCM"). The Bank is a federally
chartered savings bank that provides deposit accounts insured by the Federal
Deposit Insurance Corporation ("FDIC") to customers nationwide. TCM is a funds
manager and registered broker-dealer. TeleBanc Capital Trust I ("TCT I") and
TeleBanc Capital Trust II ("TCT II") are business trusts 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"), owns 100% of TeleBanc Insurance Services
("TBIS"), which was formed in May 1998 to offer co-branded insurance products.
In 1997, TSC funded 50% of the capital commitment for two entities, AGT Mortgage
Services, LLC ("AGT") and AGT PRA, LLC ("AGT PRA"). AGT, which ceased operation
on July 31, 1997, serviced performing loans and administered workouts for
troubled or defaulted loans for a fee. The primary business of AGT PRA is its
two-thirds investment in Portfolio Recovery Associates, LLC ("PRA"). PRA
acquires and collects delinquent consumer debt obligations for its own
portfolio.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Telebank, TCM, TCT I, TCT II and TSC. All significant intercompany transactions
and balances are eliminated in consolidation. The investment in AGT PRA is
accounted for under the equity method. The Company's net equity investment in
AGT PRA at December 31, 1998 totaled approximately $4.0 million. During 1998,
1997 and 1996, Telebank recorded $526,000, ($487,000), and ($155,000) in
earnings/(loss) from its investment in AGT PRA, respectively.
On June 22, 1998, the Board of Directors of the Company approved the
distribution of a 100% stock dividend on its outstanding common stock, par value
$0.01 (the "Common Stock"). The effect of the stock dividend has been
retroactively applied in the Consolidated Financial Statements for all periods
presented.
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, loans receivable 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
that 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 or deductions 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 and
non-interest-bearing deposits, certificates of deposit, funds due from banks,
and federal funds sold with original maturities of three months or less. The
Company is required to maintain an overnight balance of $2.4 million in its
account with the Federal Reserve Bank of Richmond. As of December 31, 1998, the
Company had $18.1 million of interest-bearing deposits that were held at other
depository institutions.
43
<PAGE> 44
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.
During 1997 and 1998, the Company held no investment or mortgage-backed
securities that it classified as held-to-maturity.
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 realized and unrealized gains and losses
recognized by credits or charges to non-interest income. The Company had $29.6
million and $21.1 million classified as trading securities at December 31, 1998
and 1997, respectively. For the years ending December 31, 1998, 1997 and 1996,
the Company recognized $569,000, $564,000 and $0, respectively, in realized
gains from the sale of trading assets, as well as ($612,000), $640,000 and $0,
respectively, in unrealized depreciation or appreciation of trading assets. All
other securities not included in the trading category 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 from
held-to-maturity is recognized as a separate component of stockholders' equity,
net of tax effect. Dividend and interest income is 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 consist of mortgages that management has the intent and
ability to hold for the foreseeable future or until maturity or pay-off. These
loans 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.
Certain loans have been purchased by the Company with an expectation that
all contractual payments of the loan will not be collected. Discounts
attributable to credit issues are tracked separately, netted against the loan
balance, and are not included as a component of allowance for loan losses.
Discounts are accreted on a level yield basis only to the extent they are
expected to be realized.
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. The allowance for loan losses represents management's estimate
of losses that have occurred as of the respective reporting date.
In determining the level of the allowance, the Bank has established both
specific and general allowances. The amount of specific reserves is determined
through a loan-by-loan analysis of non-performing loans and larger dollar
non-single-family mortgage loans.
The general allowance is computed based on an assessment of performing
loans. Each month, the performing loan portfolio is stratified by asset type
(one- to four-family, commercial, consumer, etc.) and a range of expected loss
ratios is applied to each type of loan. Expected loss ratios range between 0.2%
and 2.0% depending upon asset type, loan-to-value ratio and current market and
economic conditions. The expected loss ratios are based on historical loss
experience adjusted to reflect industry loss experience. We also believe that an
adjustment is appropriate, at the present time, in estimating the losses
inherent in the loan portfolio due to
44
<PAGE> 45
the fact that the Bank purchases, rather than originates in house, the majority
of its loans and the limited amount of historical loss experience to date.
Nonperforming Assets
Nonperforming assets consist of loans for which interest is no longer being
accrued, troubled loans that have been restructured in order to increase the
opportunity to collect amounts due on the loan and real estate acquired in
settlement of loans. 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 at least ninety days past due, as well as other loans considered
uncollectable, are placed on nonaccrual status. Payments received on nonaccrual
loans are 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 acquisition costs are deferred and the
net fee or cost 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. Discounts on loans held for sale are recognized as part of the loss
or gain upon sale and not amortized or accreted, respectively.
Real Estate Acquired through Foreclosure and Held for Sale
Real estate properties acquired through foreclosure and held for sale are
recorded at fair value less estimated selling costs at acquisition. Fair value
is determined by appraisal or other appropriate method of valuation. Losses
estimated at the time of acquisition are charged to the allowance for loan
losses. Management performs periodic valuations and establishes an allowance for
losses 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 bases. 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
The Company uses interest rate swaps, caps, floors and futures 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. These instruments are used
primarily to hedge specific assets and liabilities. For interest rate swaps, the
net interest received or paid is treated as an adjustment to the interest income
or expense related to the hedged assets or obligations in the period in which
such amounts are due.
In order to be eligible for hedge accounting treatment, high correlation
must be probable at the inception of the hedge transaction and must be
maintained throughout the hedge period. Upon the sale or disposition of the
hedged item, the hedging instrument is marked-to-market with changes recorded in
the income statement. Any gain or loss that is incurred upon termination of a
hedging instrument is added to the carrying value of the
45
<PAGE> 46
hedged item and amortized over its remaining life. Premiums and fees associated
with interest rate caps are amortized to interest income or expense on a
straight-line basis over the lives of the contracts. For instruments that are
not designated or do not qualify as hedges, realized and unrealized gains and
losses are recognized in the income statement as gain or loss on trading
securities in the period during which they are incurred.
Other Assets
Other assets include purchased loan servicing rights, premiums paid on
interest rate caps, and prepaid assets. The Bank services loans totaling $245.0
million as of December 31, 1998, which underlie 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, 1998,
amortization expense of loan servicing rights was $925,000. 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, 1998, the amortized cost and fair value
of the loan servicing rights were $2.4 million. No valuation allowance was
recognized at December 31, 1998. Effective January 1, 1997, the Company adopted
Statement of Financial Accounting Standards No. 125, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS
125"), as amended by Statement of Financial Accounting Standards No. 127,
Deferral of the Effective Date of Certain Provisions of FASB Statement No.
125 -- An Amendment of FASB Statement No. 125 ("SFAS 127"). The implementation
of SFAS 125 did not have a material impact on the Company's financial position.
Federal Home Loan Bank Stock
The Federal Home Loan Bank ("FHLB") stock is carried at its amortized cost
of $25.2 and $10.0 million as of December 31, 1998 and 1997, respectively.
Advertising Costs
The Company's policy is to expense advertising costs when incurred. For the
years ended December 31, 1998, 1997, and 1996, the Company incurred advertising
expense of $4.6 million, $606,000, and $93,000, respectively.
Effects of Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 130, Reporting Comprehensive
Income ("SFAS No. 130"), effective for fiscal years beginning after December 15,
1997. This statement 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. The Company
adopted SFAS No. 130 effective January 1, 1998. As a result, comprehensive
income for the periods ending December 31, 1998 and 1997 is reported in the
Consolidated Statement of Operations.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, Disclosures about Segments of an Enterprise and Related
Information("SFAS No. 131"), effective for fiscal years beginning after December
15, 1997. This statement requires entities to disclose selected information
regarding "reportable segments," which are defined as material operating
segments, and certain enterprise-wide information in quarterly and annual
reports. Segment disclosures are unnecessary, because only one operating segment
meets the materiality test to be considered a reportable segment. As of December
31, 1998, the Bank, considered one segment, accounted for approximately 97.5% of
the Company's combined total assets and approximately 96.0% of the Company's
combined 1998 revenues. As of December 31, 1998, the Company's other operating
segment, TCM, was not sufficiently material to be considered a reportable
segment, as defined by SFAS No. 131. In 1998, the Company did not earn
significant revenue from foreign sources and did not
46
<PAGE> 47
hold a material amount of long-lived assets in foreign countries. Additionally,
the Company does not rely on any one source for a significant portion of its
revenue.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No.
133"). The statement establishes accounting and reporting standards requiring
that every derivative instrument, including derivative instruments embedded in
other contracts, be recorded in the balance sheet as either an asset or
liability measured at fair value. SFAS No. 133 requires that changes in the
derivative instrument's fair value be recognized currently in earnings unless
specific hedge accounting criteria are met. Special accounting for qualifying
hedges allows a derivative instrument's gains and losses to offset related
results on the hedged item in the income statement and requires that a company
formally document, designate and assess the effectiveness of transactions that
receive hedge accounting treatment. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999, although a company may implement the statement as
of the beginning of any fiscal quarter after issuance, that is, fiscal quarters
beginning June 16, 1998 and after. SFAS No. 133 cannot be applied retroactively.
SFAS No. 133 must be applied to (a) derivative instruments and (b) certain
derivative instruments embedded in hybrid contracts that were issued, acquired,
or substantively modified after December 31, 1997 and, at the Company's
election, before January 1, 1998. We plan to adopt SFAS No. 133 as of January 1,
2000 but have not yet quantified the impact of adopting SFAS No. 133 on our
financial statements. However, the statement could increase volatility in
earnings and other comprehensive income.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5, Reporting on the Cost of Start-up
Activities("SOP 98-5"), which is effective for fiscal years beginning after
December 15, 1998. The statement requires that the cost of start-up activities
be expensed as incurred rather than capitalized, with initial application
reported as the cumulative effect of a change in accounting principle, as
described in Accounting Principles Board Opinion Number 20, Accounting Changes.
As of December 31, 1998, the Company carries on its books approximately $740,000
of capitalized start-up costs, relating primarily to the establishment of TBIS.
The Company intends to implement SOP 98-5 on January 1, 1999, and, as a result,
will recognize this amount, net of tax, as an expense classified as the
cumulative effect of a change in accounting principle.
Reclassifications
Certain reclassifications of the 1997 and 1996 financial statements have
been made to conform to the 1998 presentation.
3. BUSINESS ACQUISITIONS
Effective August 10, 1998, the Company acquired Direct Financial
Corporation ("DFC"), a regional savings and loan holding company, and its wholly
owned subsidiary, Premium Bank F.S.B., a federal savings bank ("Premium Bank"),
in a merger transaction for approximately $22.3 million in cash (the "DFC
Acquisition"). This transaction has been accounted for under the purchase method
of accounting. The Company recorded the excess of the purchase price over the
estimated fair value of the net tangible assets acquired, as well as the direct
costs of the DFC Acquisition, as goodwill. The Company plans to amortize
goodwill over a period of 15 years using the straight-line method. At December
31, 1998, goodwill totaled $17.5 million, net of accumulated amortization of
$584,000. Operating results of DFC have been included with those of the Company
from the closing date.
47
<PAGE> 48
The following pro forma combined financial information presents the
historical results of operations of the Company and DFC for the years ended
December 31, 1997 and 1998, with pro forma adjustments as if DFC had been
acquired as of the beginning of the periods presented. The pro forma information
presented is not necessarily indicative of what the results of operations
actually would have been if the transaction had occurred on the date indicated,
or of future results of operations.
<TABLE>
<CAPTION>
1998 1997
-------- -------
(UNAUDITED)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Interest income............................................. $113,394 $82,450
Interest expense............................................ 91,502 64,344
-------- -------
Net interest income....................................... 21,892 18,106
Provision for loan losses................................... 1,106 1,377
Non-interest income......................................... 7,671 4,533
Non-interest expense:
Selling, general and administrative expenses.............. 24,807 12,510
Other non-interest expense................................ 2,907 2,473
-------- -------
Income before income tax, minority interest and preferred
dividend.................................................. 743 6,279
Income tax expense.......................................... 625 2,128
Minority interest........................................... 1,362 394
-------- -------
Net income from continuing operations before nonrecurring
charges directly attributable to the transaction and
preferred dividend........................................ $ (1,244) $ 3,757
Preferred dividend.......................................... 2,112 546
-------- -------
Net income available to common stockholders................. $ (3,356) $ 3,211
======== =======
Other comprehensive income.................................. (861) 708
-------- -------
Comprehensive income........................................ $ (4,217) $ 3,919
======== =======
Earnings per share:
Basic..................................................... $ (0.43) $ 0.73
Diluted................................................... $ (0.43)(a) $ 0.51
</TABLE>
- ---------------
(a) The impact of the Company's outstanding options, warrants, and convertible
preferred stock is antidilutive for the year ended December 31, 1998.
In April 1998, the Company purchased and assumed substantially all of the
assets and liabilities of MET Holdings Corporation ("MET") in accordance with
the Amended and Restated Acquisition Agreement between MET and the Company (the
"Agreement"), dated as of March 17, 1998. Thereafter, MET dissolved. Pursuant to
the Agreement, MET sold substantially all of its assets, including 2,866,162
shares of Common Stock owned by MET, and assigned substantially all of its
liabilities to the Company in exchange for 2,876,162 shares of Common Stock,
which shares were distributed to the shareholders of MET upon MET's dissolution.
The Company accounted for this transaction under the purchase method of
accounting and recorded the excess of the purchase price over the estimated fair
value of the net tangible assets acquired as goodwill. Goodwill from this
transaction totaled $275,000 at December 31, 1998, net of accumulated
amortization of $12,000. The Company amortizes this goodwill using the
straight-line method over a period of 15 years.
4. 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
48
<PAGE> 49
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, 1998, that the Bank meets all capital
adequacy requirements to which it is subject. As of December 31, 1998 and 1997,
the Office of Thrift Supervision 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 following table. There are no
conditions or events since that notification that management believes have
changed the institution's category.
The Bank's actual capital amounts and ratios are presented in the table
below (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, 1998:
Core Capital (to adjusted tangible
assets)........................... $122,871 5.57% > $88,310 >4.0% > $110,388 >5.0%
Tangible Capital (to tangible
assets)........................... $122,871 5.57% > $33,116 >1.5% N/A N/A
Tier I Capital (to risk weighted
assets)........................... $122,871 12.95% N/A N/A > $ 56,934 >6.0%
Total Capital (to risk weighted
assets)........................... $127,179 13.40% > $75,913 >8.0% > $ 94,891 >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
asset)............................ $ 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>
49
<PAGE> 50
5. INVESTMENT SECURITIES
The cost basis and estimated fair values of available-for-sale investment
securities other than mortgage-backed securities at December 31, 1998 and 1997,
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>
1998:
Due within one year:
Municipal bonds........................ $ 145 $ -- $ -- $ 145
Due within one to five years:
Agency notes........................... 13,282 778 -- 14,060
Municipal bonds........................ 835 1 -- 836
Asset backed........................... 758 16 -- 774
Certificate of deposit................. 499 -- -- 499
Due within five to ten years:
Corporate debt......................... 4,981 307 -- 5,288
Municipal bonds........................ 980 9 -- 989
Other investments...................... 500 -- (132) 368
Due after ten years:
Corporate debt......................... 149,552 734 (2,369) 147,917
Equities............................... 13,937 457 (12) 14,382
Municipal bonds........................ 13,790 268 -- 14,058
Agency notes........................... 13,379 553 -- 13,932
Asset backed........................... 337 8 -- 345
Other investments...................... 6,815 1 (51) 6,765
-------- ------ ------- --------
$219,790 $3,132 $(2,564) $220,358
======== ====== ======= ========
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
Certificates 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>
The proceeds from sale and gross realized gains and losses on investment
securities available for sale that were sold in 1998 were $85.7 million, $1.3
million, and $8,000, respectively. 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,
50
<PAGE> 51
$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.
6. 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 fluctuates
according to current interest rate conditions and prepayments. Fair value is
estimated using quoted market prices. For illiquid securities, market prices are
estimated by obtaining market price quotes on similar liquid securities and
adjusting the price to reflect differences between the two securities, such as
credit risk, liquidity, term, coupon, payment characteristics, and other
information.
The amortized cost basis and estimated fair values of mortgage-backed
securities available-for-sale at December 31, 1998 and 1997, 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>
1998:
Due within one year:
Private issuer...................... $ 391 $ 12 $ -- $ 403
Due within one to five years:
Private issuer...................... 2,971 -- (10) 2,961
Due within five to ten years:
Agencies............................ 109 -- (1) 108
Collateralized mortgage
obligations...................... 4,110 25 -- 4,135
Private issuer...................... 8,560 389 (82) 8,867
Due after ten years:
Agencies............................ 11,154 48 (4) 11,198
Private Issuer...................... 107,159 2,790 (335) 109,614
Collateralized mortgage
obligations...................... 875,209 1,650 (1,982) 874,877
---------- ------ ------- ----------
$1,009,663 $4,914 $(2,414) $1,012,163
========== ====== ======= ==========
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
========== ====== ======= ==========
</TABLE>
The Company pledged $439.0 million and $104.7 million of private issuer
mortgage-backed securities as collateral for repurchase agreements at December
31, 1998 and 1997, respectively. The proceeds from sale and
51
<PAGE> 52
gross realized gains and losses on mortgage-backed securities available for sale
that were sold in 1998 were $294.8 million, $2.4 million, and $113,000,
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.
7. LOANS RECEIVABLE
Loans receivable at December 31, 1998 and 1997 are summarized as follows
(in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
First mortgage loans (principally conventional):
Secured by one- to four-family residences................. $897,168 $547,757
Secured by commercial real estate......................... 8,916 3,033
Secured by mixed-use property............................. 929 856
Secured by five or more dwelling units.................... 3,224 1,447
Secured by land........................................... 316 463
-------- --------
Total first mortgage loans.................................. 910,553 553,556
Other loans:
Home equity and second mortgage loans..................... 5,895 564
Other..................................................... 3,312 305
-------- --------
Total loans................................................. 919,760 554,425
Less:
Net deferred loan origination fees........................ (13) (34)
Unamortized discounts, net................................ (9,989) (9,938)
Other..................................................... (138) (155)
-------- --------
909,620 544,298
Less: allowance for loan losses............................. (4,766) (3,594)
-------- --------
Net loans receivable........................................ $904,854 $540,704
======== ========
</TABLE>
The mortgage loans are located primarily in California, New Jersey, and New
York according to the following percentages 24.8%, 10.4%, and 8.0%,
respectively. As of December 31, 1998, the mortgage loan portfolio consisted of
variable rate loans of $436.3 million, or 47.6%, and fixed rate loans of $480.1
million, or 52.4%. The weighted average maturity of mortgage loans secured by
one- to four-family residences is 291 months as of December 31, 1998. The unpaid
principal balance of mortgage loans owned by the Company but serviced by other
companies was $919.8 million and $301.5 million at December 31, 1998 and 1997,
respectively. Loans past due ninety days or more, and therefore on non-accrual
status at December 31, 1998 and 1997, are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
------ -------
<S> <C> <C>
First mortgage loans:
Secured by one- to four-family residences................. $7,727 $10,802
Secured by commercial real estate......................... 372 635
Home equity and second mortgage loans....................... 255 --
Other....................................................... 521 --
------ -------
Total............................................. $8,875 $11,437
====== =======
</TABLE>
The interest accrual balance for each loan that enters non-accrual is
reversed from income. If all non-performing loans had been performing during
1998, 1997, and 1996, the Bank would have recorded $597,000, $739,000 and
$789,000, respectively, in additional interest income. There were no commitments
to lend additional funds to these borrowers as of December 31, 1998 and 1997.
52
<PAGE> 53
Activity in the allowance for loan losses for the years ended December 31,
1998, 1997, and 1996 is summarized as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Balance, beginning of the year........................... $3,594 $2,957 $2,311
Provision for loan losses................................ 905 921 919
Loan loss allowance acquired in merger with DFC.......... 724 -- --
Charge-offs, net......................................... (457) (284) (273)
------ ------ ------
Balance, end of year..................................... $4,766 $3,594 $2,957
====== ====== ======
</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, 1998 and 1997
(in thousands):
<TABLE>
<CAPTION>
AMOUNT
TOTAL AMOUNT OF OR RECORDED
RECORDED INVESTMENT SPECIFIC INVESTMENT NET OF
DESCRIPTION OF LOANS IN IMPAIRED LOANS RESERVES SPECIFIC RESERVES
- -------------------- ------------------- --------- -----------------
<S> <C> <C> <C>
1998:
Impaired loans:
Commercial real estate................... $ 667 $ 351 $ 316
One- to four-family...................... 7,880 1,095 6,785
Other.................................... 776 67 709
------- ------ ------
Total.......................... $ 9,323 $1,513 $7,810
======= ====== ======
Restructured loans:
Commercial real estate................... $ -- $ -- $ --
One- to four-family...................... -- -- --
------- ------ ------
Total.......................... $ -- $ -- $ --
======= ====== ======
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
======= ====== ======
</TABLE>
The average recorded investment in impaired loans, as of December 31, 1998,
1997, and 1996 was $1.4 million, $2.3 million and $2.2 million, 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
53
<PAGE> 54
Company's method for non-accrual loans, payments received on impaired loans is
recognized as interest income or applied to principal when it is doubtful that
full payment will be collected.
8. REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS
Real estate acquired through foreclosure at December 31, 1998 and December
31, 1997 was $1.5 million and $681,000, respectively.
9. LOANS SERVICED FOR OTHERS
Mortgage loans master 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, 1998 and 1997 are
summarized as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Mortgage loans underlying pass-through securities:
Federal Home Loan Mortgage Corporation.................... $110,162 $148,269
Federal National Mortgage Association..................... 106,006 135,973
-------- --------
Subtotal.................................................. 216,168 284,242
-------- --------
Mortgage loan portfolio serviced for:
Other investors........................................... 28,855 44,702
-------- --------
Total............................................. $245,023 $328,944
======== ========
</TABLE>
Custodial escrow balances held in connection with the foregoing loans
serviced were approximately $740,000 and $120,000 at December 31, 1998 and 1997,
respectively.
Included in other assets is purchased mortgage servicing rights of $2.4
million and $3.3 million as of December 31, 1998 and 1997, respectively.
10. DEPOSITS
The Bank initiates deposits directly with customers through contact on the
internet, the phone, the mail, and walk-in at its headquarters. Deposits at
December 31, 1998 and 1997 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
RATE AT
DECEMBER 31 AMOUNT PERCENT
----------- --------------------- ---------------
1998 1997 1998 1997 1998 1997
---- ---- ---------- -------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
Demand accounts, non-interest-bearing... --% --% $ 5,605 $ 761 0.46% 0.15%
Demand accounts, interest-bearing....... 3.81 -- 4,721 -- 0.39 --
Money market............................ 4.70 5.26 204,551 122,185 16.91 23.39
Passbook savings........................ 3.00 3.00 525 665 0.04 0.13
Certificates of deposit................. 5.93 6.24 926,983 398,610 76.65 76.33
Brokered callable certificates of
deposit............................... 6.16 -- 67,085 -- 5.55 --
---------- -------- ------ ------
Total......................... $1,209,470 $522,221 100.00% 100.00%
========== ======== ====== ======
</TABLE>
54
<PAGE> 55
Certificates of deposit and money market accounts, classified by rates as
of December 31, 1998 and 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
AMOUNT 1998 1997
- ------ ---------- --------
<S> <C> <C>
0 - 1.99%........................... $ 5 $ 5
2 - 3.99%........................... 424 --
4 - 5.99%........................... 756,618 231,048
6 - 7.99%........................... 440,711 289,046
8 - 9.99%........................... 793 696
10 - 11.99%.......................... 44 --
12 - 20%............................. 24 --
---------- --------
Total...................... $1,198,619 $520,795
========== ========
</TABLE>
At December 31, 1998, scheduled maturities of certificates of deposit and
money market accounts are as follows (in thousands):
<TABLE>
<CAPTION>
LESS THAN 1-2 2-3 3-4 4-5 5+
ONE YEAR YEARS YEARS YEARS YEARS YEARS TOTAL
--------- -------- ------- ------- ------- ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
0 - 1.99%.................. $ 5 $ -- $ -- $ -- $ -- $ -- $ 5
2 - 3.99%.................. 424 -- -- -- -- -- 424
4 - 5.99%.................. 642,358 53,613 41,260 940 17,354 1,093 756,618
6 - 7.99%.................. 161,520 110,448 31,567 29,920 37,569 69,687 440,711
8 - 9.99%.................. 469 284 -- 40 -- -- 793
10 - 11.99%................. 44 -- -- -- -- -- 44
12 - 20%.................... 24 -- -- -- -- -- 24
-------- -------- ------- ------- ------- ------- ----------
$804,844 $164,345 $72,827 $30,900 $54,923 $70,780 $1,198,619
======== ======== ======= ======= ======= ======= ==========
</TABLE>
The aggregate amount of certificates of deposit with denominations greater
than or equal to $100,000 was $197.5 million and $47.5 million at December 31,
1998 and 1997, respectively.
Interest expense on deposits for the years ended December 31, 1998, 1997,
and 1996 is summarized as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Money market................................................ $ 7,961 $ 6,353 $ 4,740
Passbook savings............................................ 16 27 59
Checking.................................................... 46 -- --
Certificates of deposit..................................... 36,890 19,578 16,558
Brokered callable certificates of deposit................... 3,638 -- --
------- ------- -------
Total............................................. $48,551 $25,958 $21,357
======= ======= =======
</TABLE>
Accrued interest payable on deposits at December 31, 1998 and 1997 was $3.4
million and $728,000, respectively.
55
<PAGE> 56
11. ADVANCES FROM THE FHLB OF ATLANTA
Advances to the Bank from the FHLB of Atlanta at December 31, 1998 and 1997
were as follows (dollars in thousands):
<TABLE>
<CAPTION>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
1998 INTEREST RATE 1997 INTEREST RATE
-------- ------------- -------- -------------
<S> <C> <C> <C> <C>
1998.................................. $ -- --% $ 71,000 6.02%
1999.................................. 466,500 5.19 129,000 5.77
2000.................................. 6,000 5.30 -- --
2001.................................. -- -- -- --
-------- ---- -------- ----
Total............................ $472,500 5.19% $200,000 5.86%
======== ==== ======== ====
</TABLE>
All advances are floating rate advances and adjust daily to the Federal
Funds Rate or quarterly or semi-annually to the London InterBank Offering Rate
("LIBOR") rate. In 1998 and 1997, 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, 1998 and 1997, 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 $647.6
million and $259.9 million at December 31, 1998 and 1997, 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.
12. 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>
1998 1997
-------- --------
<S> <C> <C>
Weighted average balance during the year (calculated on a
daily basis).............................................. $259,846 $117,431
Weighted average interest rate during the year (calculated
on a daily basis)......................................... 5.69% 5.76%
Maximum month-end balance during the year................... $519,078 $279,909
Balance at year-end......................................... $401,100 $279,909
Mortgage-backed securities underlying the agreements as of
the end of the year:
Carrying value, including accrued interest................ $441,323 $295,556
Estimated market value.................................... $438,955 $295,500
</TABLE>
The securities sold under the repurchase agreements at December 31, 1998
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 were to fail, the Company may incur an accounting loss for
the excess collateral posted with the counterparty. As of December 31, 1998,
there were no counterparties with which the Company's amount at risk exceeded
10% of the Company's stockholders' equity.
56
<PAGE> 57
As of December 31, 1998, the Company carried borrowings of approximately
$3.3 million that were secured by a pool of loans owned by the Company. Under
the borrowing agreement, which expires in August 1999, the Company may not sell
or otherwise transfer the pledged assets.
13. 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 two shares each of Telebanc
Common Stock. The notes are subordinated to all senior indebtedness of the
Company and 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
690,000 warrants was $948,750, which resulted in an original issue discount on
the subordinated debt in the amount of $899,288. 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 $3.8281.
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 396,176 detachable
warrants, $16.2 million in 4.0% convertible preferred stock, par value $0.01
(the "Preferred Stock"), and rights to 411,126 contingent warrants. The senior
subordinated notes, which are subordinated to all senior indebtedness of the
Company, 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, each of
which entitles the bearer to purchase two shares of Common Stock, are
exercisable at $4.75 with an expiration date of February 28, 2005. The Preferred
Stock, which consisted of Series A Voting Convertible Preferred Stock, Series B
Nonvoting Convertible Preferred Stock, and Series C Nonvoting Convertible
Preferred Stock, converted to 2,399,479 shares of Common Stock upon consummation
of the Company's Equity Offering on July 28, 1998. The contingent warrants, each
of which entitles the bearer to purchase two shares of Common Stock, 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 $0.005 until an internal rate of return of 25% is reached. The
annual interest expense to service the senior subordinated notes is $1.3
million. The Company paid $2.1 million and $546,000 in dividends on the
preferred stock in 1998 and 1997, respectively.
14. TRUST PREFERRED SECURITIES
In June 1997, the Company formed TCT 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. TCT 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, which are subordinated to the 11.5% subordinated notes and the 9.5%
subordinated notes, 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 were used for general corporate purposes, including to fund Bank
operations and the creation and expansion of its financial service and product
operations.
57
<PAGE> 58
In July 1998, the Company formed TCT II, a business trust formed solely for
the purpose of issuing capital securities. TCT II sold, at par, 1,100,000 shares
of Beneficial Unsecured Securities, Series A, (the "BLUS(SM)"), with a
liquidation amount of $25, for a total of $27.5 million and invested the net
proceeds in the Company's 9.0% Junior Subordinated Deferrable Interest
Debentures, Series A. The BLUS(SM), which are subordinated to the 11.5%
subordinated notes and the 9.5% subordinated notes, mature in 2028 and have an
annual dividend rate of 9.0%, payable quarterly, beginning in September 1998.
The net proceeds were used for general corporate purposes, which include funding
the Company's continued growth and augmenting working capital.
15. STOCKHOLDERS' EQUITY
As of December 31, 1998, the authorized capital stock of the Company
consisted of 29.5 million shares of Common Stock and 500,000 shares of Preferred
Stock. In July and August 1998, the Company sold 5,175,000 shares of Common
Stock to the public at an offering price of $14.50 (the "Equity Offering").
Simultaneously, pursuant to a conversion agreement dated May 15, 1998, the
Company's 29,900 outstanding shares of Preferred Stock converted to 2,399,479
shares of Common Stock, upon consummation of the Equity Offering on July 28,
1998. In addition, upon the conversion, the Company issued a special dividend in
the amount of 119,975 shares of Common Stock to the holders of the Preferred
Stock.
16. 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, 1998, 1997, and 1996 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
7,840,214 at December 31, 1998, 4,382,910 at December 31, 1997 and 4,099,000 at
December 31, 1996. 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, 1998
-------------------------------------
INCOME SHARES PER SHARE AMOUNT
------- ------ ----------------
<S> <C> <C> <C>
Net income....................................... $ 1,375
Less: preferred stock dividends.................. (2,112)
-------
Basic earnings per share
Income available to common shareholders.......... $ (737) 7,840 $(0.09)
======= ====== ======
Options issued to management..................... -- 866
Warrants......................................... -- 757
Convertible preferred stock...................... 2,112 1,368
------- ------
Diluted earnings per share....................... $ 1,375 10,831 $(0.09)(a)
======= ====== ======
</TABLE>
58
<PAGE> 59
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997
------------------------------------
INCOME SHARES PER SHARE AMOUNT
------ ------ ----------------
<S> <C> <C> <C>
Net income......................................... $4,217
Less: preferred stock dividends.................... (546)
------
Basic earnings per share
Income available to common shareholders............ $3,671 4,383 $0.84
====== ===== =====
Options issued to management....................... -- 510
Warrants........................................... -- 501
Convertible preferred stock........................ 546 2,017
------ -----
Diluted earnings per share......................... $4,217 7,411 $0.57
====== ===== =====
</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 4,099 $0.62
====== ===== =====
Options issued to management....................... -- 182
Warrants........................................... -- 125
------ -----
Diluted earnings per share......................... $2,552 4,406 $0.58
====== ===== =====
</TABLE>
- ---------------
(a) The impact of the Company's outstanding options, warrants, and convertible
preferred stock is antidilutive for the year ended December 31, 1998.
17. INCOME TAXES
Income tax expense for the years ended December 31, 1998, 1997, and 1996 is
summarized as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Current: Federal......................................... $1,706 $1,881 $1,194
State.................................................. 164 221 225
------ ------ ------
1,870 2,102 1,419
Deferred: Federal........................................ (196) (398) (78)
State.................................................. (25) (47) (146)
------ ------ ------
(221) (445) (224)
Total: Federal........................................... 1,510 1,483 1,116
State.................................................. 139 174 79
------ ------ ------
$1,649 $1,657 $1,195
====== ====== ======
</TABLE>
A reconciliation of the statutory Federal income tax rate to the Company's
effective income tax rate for the years ended December 31, 1998, 1997, and 1996
is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<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................................................... (4.7) (5.8) (3.6)
Amortization of goodwill.................................... 9.8 -- --
Other....................................................... (5.7) (6.0) (2.7)
---- ---- ----
37.6% 26.4% 31.9%
==== ==== ====
</TABLE>
59
<PAGE> 60
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, 1998 and 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
DEFERRED TAX LIABILITIES:
Purchase accounting premium............................... $ -- $ (75)
Depreciation.............................................. (185) (44)
Tax reserve in excess of base year........................ (101) (134)
Tax effect of securities available-for-sale adjustment to
fair value (notes 5 and 6)............................. (1,181) (722)
FHLB stock dividends...................................... (129) (129)
Other..................................................... (23) (89)
------- -------
Total............................................. (1,619) (1,193)
DEFERRED TAX ASSETS:
Reserves for loan losses.................................. 1,875 1,293
Acquisition of DFC........................................ 2,770 --
Other..................................................... 12 80
------- -------
Total............................................. 4,657 1,373
------- -------
Net deferred tax asset (liability)........................ $ 3,038 $ 180
======= =======
</TABLE>
18. FINANCIAL INSTRUMENTS
The Company is party to a variety of interest rate caps, floors, swaps and
futures to manage interest rate exposure. The Company enters into interest rate
swap 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
interest rate swaps are specifically designated to specific liabilities or, to a
lesser extent, assets at their acquisition. The net payments 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 swap agreements for the years ended December 31, 1998 and
1997 are summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Weighted average fixed rate payments............... 6.04% 6.15%
Weighted average original term..................... 4.2yrs 4.6yrs
Weighted average variable rate obligation.......... 5.43% 5.81%
Notional amount.................................... $355,000 $205,000
</TABLE>
The counterparties to the interest rate swap agreements described above are
Goldman Sachs, Merrill Lynch, NationsBank, Nomura, and Salomon Brothers. As of
December 31, 1998, the Company had no credit risk associated with any of the
aforementioned counterparties. The interest rate swap agreements described above
required the Company to post cash of approximately $9.8 million as collateral.
The Company enters into interest rate cap agreements to hedge outstanding
mortgage loans, mortgage-backed securities, 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.
Premiums paid for
60
<PAGE> 61
the caps are amortized into expense based on the term of the cap. 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
4.0%................................ July 1992 $ 10,000 July 1999
4.4%................................ September 1998 $250,000 November 2000
4.4%................................ September 1998 $400,000 October 2000
5.0%................................ September 1998 $300,000 October 2000
5.5%................................ September 1998 $150,000 September 2000
5.5%................................ September 1998 $150,000 September 1999
6.0%................................ September 1998 $150,000 September 2000
6.0%................................ September 1998 $150,000 September 1999
6.0%................................ October 1996 $ 20,000 October 1999
6.1%................................ December 1998 $225,000 December 1999
6.1%................................ December 1998 $225,000 December 1999
6.5%................................ August 1998 $ 50,000 August 2003
7.0%................................ January 1997 $ 10,000 January 2002
7.5%................................ July 1997 $ 25,000 July 1999
8.0%................................ July 1997 $ 25,000 July 2000
8.0%................................ June 1997 $ 25,000 June 2000
10.0%................................ April 1995 $ 10,000 January 2002
</TABLE>
The counterparties to the interest rate cap agreements described above are
Goldman Sachs, Lehman Brothers, Merrill Lynch, NationsBank, Nomura, Salomon
Brothers, and UBS. As of December 31, 1998, the associated credit risk with the
aforementioned counterparties was $3.6 million, $366,000, $68,000, $1.8 million,
$11,000, $203,000, and $353,000, respectively. The credit risk is attributable
to the unamortized cap premium and any amounts due from the counterparty as of
December 31, 1998.
As of December 31, 1998, the Company was party to four interest rate caps
and one interest rate floor that were not designated as hedges. Realized and
unrealized gains and losses on these instruments have been recognized in the
income statement as gain or loss on trading securities. The following table
summarizes the Company's interest rate cap and floor agreements that were not
designated as hedges as of December 31, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
EFFECTIVE NOTIONAL MATURITY
DATE BALANCE DATE
----------- -------- --------
<S> <C> <C> <C>
Cap Strike Rate
7.00%................................. May 1998 $50,000 May 2001
7.25%................................. May 1998 $50,000 May 2001
7.50%................................. May 1998 $25,000 May 2002
7.75%................................. August 1998 $25,000 May 2003
Floor Strike Rate
5.00%................................. August 1998 $25,000 May 2001
</TABLE>
The counterparties to the interest rate cap and floor agreements described
above are Lehman Brothers and Salomon Brothers. As of December 31, 1998, the
associated credit risk with the aforementioned counterparties was $128,000 and
$276,000, respectively. The total amortization expense for premiums on all
interest rate caps and floors was $1.6 million, $777,000 and $638,000 for the
years ended December 31, 1998, 1997, and 1996, respectively.
61
<PAGE> 62
19. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS
The fair value information for financial instruments that is provided below
is based on the requirements of Statement of Financial Accounting Standards No.
107, Disclosure About Fair Value of Financial Instruments ("SFAS No. 107") and
does not represent the aggregate net fair value of the Bank. Much of the
information used to determine fair value is subjective and judgmental in nature.
Therefore, fair value estimates, especially for less marketable securities, may
vary. In addition, the amounts actually realized or paid upon settlement or
maturity could be significantly different. 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.
INTEREST RATE CAPS -- Fair value is based on quotes received from
third parties.
LOANS RECEIVABLE -- For certain residential mortgage loans, fair value
is estimated using quoted market prices for similar types of products. The
fair value of certain other types of loans is estimated using quoted market
prices for securities backed by similar loans. The fair value for loans
that 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.
62
<PAGE> 63
The fair value of financial instruments as of December 31, 1998 and 1997 is
as follows (in thousands):
<TABLE>
<CAPTION>
1998 1998 1997 1997
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
---------- ---------- -------- --------
<S> <C> <C> <C> <C>
ASSETS:
Cash and cash equivalents.................. $ 26,282 $ 26,282 $ 92,156 $ 92,156
Investment securities available-for-sale... 220,358 220,358 91,237 91,237
Mortgage-backed securities
available-for-sale...................... 1,012,163 1,012,163 319,203 319,203
Loans receivable........................... 904,854 935,167 540,704 562,270
Trading.................................... 29,584 29,584 21,110 21,110
Caps....................................... 6,354 8,363 1,386 477
LIABILITIES:
Retail deposits............................ $1,142,385 $1,088,921 $522,221 $524,022
Brokered callable certificates of
deposit................................. 67,085 66,360 -- --
Advances from the FHLB Atlanta............. 472,500 472,500 200,000 200,000
Securities sold under agreements to
repurchase.............................. 404,435 404,435 279,909 279,909
Subordinated debt, net..................... 29,855 30,810 29,614 30,953
Trust preferred............................ 35,385 35,385 9,572 10,000
Off-balance sheet instruments.............. -- (8,648) -- (1,818)
Commitments to purchase loans.............. -- 298 -- --
</TABLE>
20. DISTRIBUTIONS
The Bank is subject to certain restrictions on the amount of dividends it
may declare without prior regulatory approval. At December 31, 1998,
approximately $21.7 million of retained earnings was available for dividend
declaration.
21. EMPLOYEE STOCK OWNERSHIP PLAN
The Company sponsors an Employee Stock Ownership Plan ("ESOP"). All
employees of the Company who meet limited qualifications participate in the
ESOP. Under the ESOP, the Company contributes to a separate trust fund
maintained exclusively for the benefit of those employees who have become
participants. The ESOP has borrowed from the Company and used the proceeds to
acquire Company stock. The ESOP shares initially were pledged as collateral for
its debt to the Company. As the debt is repaid, shares are released from
collateral and allocated to active employees, based on the proportion of debt
service paid in the year. The Company accounts for its ESOP in accordance with
Statement of Position 93-6. Accordingly, the shares pledged as collateral are
reported as unearned ESOP shares in the statement of financial position. As
shares are released from collateral, the Company reports compensation expense
equal to the current market price of the shares. As of December 31, 1998 and
1997, the ESOP owned 434,945 and 261,094 shares, respectively, of the Company's
stock, with approximately 223,000 and 196,536 shares allocated, respectively. As
of December 31, 1998 and 1997, the fair value of unearned shares held by the
ESOP was $7.2 million and $573,000, respectively. Compensation expense was
$391,000, $247,000 and $224,000 for the years ended December 31, 1998, 1997, and
1996, respectively.
22. STOCK BASED COMPENSATION
In 1998, the Company authorized and issued 959,710 options to directors,
officers and employees to purchase 959,710 shares of Telebanc Common Stock at
prices ranging from $9.75 to $14.50. In 1997, directors, officers and employees
were issued 698,402 options to purchase 698,402 shares of Telebanc Common Stock
at prices ranging from $1.33 to $6.75. As of December 31, 1998 and 1997, 904,797
and 598,248 of the options outstanding, respectively, were vested at exercise
prices ranging from $1.33 to $14.50. The maximum term for the outstanding
options is 10 years. At the discretion of management, options are
63
<PAGE> 64
assigned a vesting period of five years, with 20% of options vesting at the end
of each year, or four years, with 20% of options vesting on the grant date and
the remaining 80% vesting ratably over the 4 years. As of December 31, 1998, the
total number of authorized options was 2,708,929. The options' exercise price
was the market value of the stock at the date of issuance.
<TABLE>
<CAPTION>
1998 1997 1996
------------------- ------------------- -------------------
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.............. 1,330 $ 4.86 704 $3.45 542 $3.26
Granted....................................... 960 $12.53 698 $6.26 162 $4.09
Exercised..................................... 46 $ 5.93 34 $3.26 -- --
Forfeited..................................... 106 $ 7.34 38 $5.70 -- --
Expired....................................... -- $ -- -- $ -- -- $ --
----- ----- -----
Outstanding at end of year.................... 2,138 $ 8.20 1,330 $4.86 704 $3.45
===== ===== =====
Options exercisable at year-end............... 905 $ 5.84 598 $4.03 360 $3.45
===== ===== =====
Weighted avg. fair value of options granted
during the year............................. $ 4.81 $1.75 $1.31
</TABLE>
The following table summarizes information about fixed options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING (000'S) OPTIONS EXERCISABLE (000'S)
-------------------------------------- ---------------------------
WEIGHTED
AVG.
REMAINING WEIGHTED WEIGHTED
CONTRACTUAL AVG. AVG.
RANGE OF NUMBER LIFE EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING (YEARS) PRICE EXERCISABLE PRICE
- --------------- ----------- ----------- -------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Less than $5.00..................... 690 6.04 $ 3.32 535 $ 3.24
$5.00 -- $7.49...................... 513 8.15 $ 6.75 189 $ 6.75
$7.50 -- $9.99...................... 373 9.07 $ 9.75 71 $ 9.75
$10.00 -- $12.49.................... -- -- -- -- --
$12.50 -- $14.99.................... 562 9.81 $14.50 110 $14.50
----- ---
Less than $5.00 -- $14.99........... 2,138 8.07 $ 8.20 905 $ 5.84
===== ===
</TABLE>
Because the method of accounting required by SFAS No. 123 has not been
applied to options granted prior to January 1996, 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 Black Scholes option pricing model with the following weighted average
assumptions for grants; risk-free interest rates of 4.71 percent, 5.08 percent
and 5.25 percent for 1998, 1997, and 1996, respectively; expected life of 5
years in 1998 and 10 years in 1997 and 1996 for all options granted; expected
volatility of 81.6 percent, 25.0 percent and 23 percent for 1998, 1997, and
1996, respectively.
64
<PAGE> 65
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
12/31/98 12/31/97 12/31/96
---------- ---------- ----------
<S> <C> <C> <C>
Net income (loss):
As reported............................ $ (737) $3,671 $2,552
Pro forma.............................. $(2,061) $2,629 $2,409
Basic earnings per share:
As reported............................ $ (0.09) $ 0.84 $ 0.62
Pro forma.............................. $ (0.26) $ 0.60 $ 0.59
Diluted earnings per share:
As reported............................ $ (0.09) $ 0.57 $ 0.58
Pro forma.............................. $ (0.26) $ 0.43 $ 0.55
</TABLE>
23. 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, 1998, the Company was obligated under three operating
leases for office space with original terms ranging from three to ten years. Net
rent expense under operating leases was approximately $333,000, $238,000 and
$142,000 for the years ended December 31, 1998, 1997, and 1996, respectively.
The projected minimum rental payments under the terms of the lease are as
follows:
<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31, AMOUNT
- ------------ ----------
<S> <C>
1999........................................................ 419,000
2000........................................................ 382,000
2001........................................................ 294,000
2002........................................................ 297,000
2003........................................................ 185,000
2004 and thereafter......................................... 95,000
----------
$1,672,000
==========
</TABLE>
As of December 31, 1998, the Company had commitments to purchase $53.3
million of mortgage loans.
65
<PAGE> 66
24. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)
STATEMENTS OF FINANCIAL CONDITION
($ IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
-------- --------
<S> <C> <C>
ASSETS
Cash........................................................ $ 4,941 $ 5,401
Investment securities available-for-sale.................... 2,468 4,186
Mortgage-backed securities available-for-sale............... 3,651 26,219
Loans receivable, net....................................... -- 566
Loan receivable held for sale............................... 2,089 6,367
Trading..................................................... -- 14,011
Equity in net assets of subsidiary.......................... 162,859 58,976
Deferred charges............................................ 1,291 1,460
Other assets................................................ 7,154 4,806
-------- --------
Total assets........................................... $184,453 $121,992
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Subordinated debt........................................... $ 68,515 $ 39,614
Securities sold under agreements to repurchase.............. -- 33,555
Accrued interest payable.................................... 751 1,037
Taxes payable and other liabilities......................... 1,752 1,962
-------- --------
Total liabilities...................................... 71,018 76,168
-------- --------
Stockholders' Equity Preferred Stock........................ -- 15,281
Common Stock................................................ 123 44
Additional Paid in Capital.................................. 103,194 16,205
Unearned ESOP Shares........................................ (2,578) --
Retained earnings........................................... 10,819 11,556
Unrealized gain/loss on securities available-for-sale....... 1,877 2,738
-------- --------
Total stockholders' equity.................................. 113,435 45,824
-------- --------
Total liabilities and stockholders' equity............. $184,453 $121,992
======== ========
</TABLE>
66
<PAGE> 67
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
($ IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Interest income............................................. $ 2,777 $ 2,683 $ 531
Interest expense............................................ 4,311 4,352 2,163
------- ------- -------
Net interest loss........................................... (1,534) (1,669) (1,632)
Non interest income......................................... 383 13 133
Total selling, general and administrative expenses.......... 3,214 1,288 1,393
Other non-interest expenses................................. 285 195 127
------- ------- -------
Net loss before equity in net income of subsidiaries and
income taxes.............................................. (4,650) (3,139) (3,019)
Equity in net income of subsidiaries........................ 4,200 5,668 6,716
Income taxes................................................ (1,825) (1,688) 1,145
Preferred stock dividends................................... 2,112 546 --
------- ------- -------
Net income.................................................. (737) 3,671 2,552
Other comprehensive income, net of tax...................... (861) 642 541
------- ------- -------
Comprehensive income........................................ $(1,598) $ 4,313 $ 3,093
======= ======= =======
</TABLE>
67
<PAGE> 68
STATEMENTS OF CASH FLOWS
($ IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 1,375 $ 4,217 $ 2,552
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed earnings of subsidiaries........ (4,200) (5,668) (4,426)
Purchases of loans held for sale........................ (2,622) (6,367) --
Proceeds from sales of loans held for sale.............. 4,388 -- --
Proceeds from maturities of and principal payments on
loans held for sale.................................. 2,512 -- --
Net (increase) in trading securities.................... 14,011 (14,011) --
(Increase) decrease in other assets..................... (5,077) (4,227) (686)
Increase in accrued expenses and other liabilities...... (258) 2,223 267
-------- -------- ---------
Net cash provided by operating activities................. 10,129 (23,833) (2,293)
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in loan to Employee Stock
Ownership Plan....................................... (2,578) -- (65)
Net increase in loans................................... 566 (261) --
Net (increase) decrease in equity investments........... (97,736) (19,178) 2,074
Purchases of available-for-sale securities.............. (25,476) (92,862) (100,574)
Proceeds from sale of available-for-sale securities..... 36,873 80,159 11,103
Proceeds from maturities of and principal payments on
available-for-sale securities........................ 12,791 1,158 76,910
Net sales (purchases) of premises and equipment......... (50) -- (37)
-------- -------- ---------
Net cash (used in) provided by investing activities....... (75,610) (30,984) (10,589)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in securities sold under agreements to
repurchase........................................... (33,555) 20,724 12,831
Increase in subordinated debt........................... 28,901 23,028 --
Increase in common stock and additional paid in
capital.............................................. 71,787 16,853 --
Dividends paid on common and preferred stock............ (2,112) (546) --
-------- -------- ---------
Net cash provided by financing activities................. 65,021 60,059 12,831
-------- -------- ---------
Net increase (decrease) in cash and cash equivalents...... (460) 5,242 (51)
Cash and cash equivalents at beginning of period.......... 5,401 159 210
-------- -------- ---------
Cash and cash equivalents at end of period................ $ 4,941 $ 5,401 $ 159
======== ======== =========
SUPPLEMENTAL INFORMATION:
Interest paid on borrowed funds......................... 4,597 3,734 2,074
</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 $0 and $992,000 to Telebanc for subordinated interest expense
payments for the years ended December 31, 1998 and 1997, respectively.
68
<PAGE> 69
25. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Condensed quarterly financial data for the years ended December 31, 1998
and 1997 is shown as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1998 1998 1998 1998
--------- -------- ------------- ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Interest income................................ $18,071 $18,581 $27,632 $35,826
Interest expense............................... 14,477 15,276 21,979 28,573
------- ------- ------- -------
Net interest income.......................... 3,594 3,305 5,653 7,253
Provision for loan and lease losses............ 250 75 300 280
Non-interest income............................ 1,947 1,104 1,832 2,681
General and administrative expenses............ 3,889 3,441 5,666 6,823
Other non-interest operating expenses.......... 315 487 586 871
------- ------- ------- -------
Income before income taxes and minority
interest................................... 1,087 406 933 1,960
Income tax expense............................. 475 51 389 734
Minority interest in subsidiary................ 176 176 439 571
------- ------- ------- -------
Net income..................................... 436 179 105 655
Preferred stock dividends...................... 162 162 1,788 --
------- ------- ------- -------
Net income available to common
stockholders............................... 274 17 (1,683) 655
Other comprehensive income..................... 262 (1,109) 8,579 (8,593)
------- ------- ------- -------
Comprehensive income........................... $ 536 $(1,092) $ 6,896 $(7,938)
======= ======= ======= =======
Basic earnings per share....................... $ 0.06 $ 0.00 $ (0.17)(1) $ 0.05
Diluted earnings per share..................... $ 0.05 $ 0.00 $ (0.17)(1) $ 0.05
</TABLE>
<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 available to common
stockholders............................ 803 1,046 743 1,079
Other comprehensive income................... (1,165) 2,443 (24) (612)
------- ------- ------- -------
Comprehensive income......................... $ (362) $ 3,489 $ 719 $ 467
======= ======= ======= =======
Basic earnings per share..................... $ 0.19 $ 0.24 $ 0.16 $ 0.24
Diluted earnings per share................... $ 0.15 $ 0.16 $ 0.11 $ 0.16
</TABLE>
- ---------------
(1) Reflects a $1.7 million nonrecurring, noncash charge related to the
additional Preferred Stock dividend payable in Common Stock, based on the
fair market value of the Common Stock at the time such dividend was paid.
The charge reduced net income available to common stockholders by the same
amount and diluted earnings per share in the third quarter of 1998 by $0.18
per share.
69
<PAGE> 70
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.............................. 37 Chairman of the Board of Directors
Mitchell H. Caplan........................... 41 Vice Chairman of the Board of Directors,
Chief Executive Officer and President
Aileen Lopez Pugh............................ 31 Executive Vice President and Chief Financial
Officer
Laurence P. Greenberg........................ 37 Executive Vice President and Chief Marketing
Officer
Stephen G. Dervenis.......................... 34 Executive Vice President, Chief Executive
Officer of TCM
Michael Opsahl............................... 36 Executive Vice President and Chief Credit
Officer
Sang-Hee Yi.................................. 34 Executive Vice President and Chief Operating
Officer
Ross C. Atkinson............................. 30 Executive Vice President and Chief Information
Officer
Arlen W. Gelbard............................. 41 Executive Vice President and General Counsel
David R. DeCamp.............................. 40 Director
Dean C. Kehler............................... 42 Director
Marcia Myerberg.............................. 54 Director
Steven F. Piaker............................. 36 Director
Mark Rollinson............................... 63 Director
</TABLE>
David A. Smilow, a founder and Chairman of the Company, will continue to
reduce his operational role at the Company and, in 1999, is expected to focus
exclusively, in his capacity as non-executive chairman, on long term strategic
initiatives and asset liability management.
Mr. 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 1985 until
September 1990, Mr. Caplan was an associate of the law firm of Shearman and
Sterling, where he represented and advised private and public commercial
institutions.
Aileen Lopez Pugh has served as Executive Vice President and Chief
Financial Officer of the Company and Telebank since August 1994. Prior to
joining management of the Company and Telebank, Ms. Pugh served as a director of
the Company 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. Prior to 1993, Ms. Pugh was an
auditor with KPMG Peat Marwick.
Laurence P. Greenberg has served as Executive Vice President and Chief
Marketing Officer of the Company and Telebank since 1995. 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
70
<PAGE> 71
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 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.
Stephen G. Dervenis has served as Executive Vice President of the Company,
as well as Chief Executive Officer of TCM, since June 1998. From October 1997 to
June 1998, Mr. Dervenis served as Director of Amortizing and Emerging Assets
Securitization at Barclays Capital in New York. From April 1994 to September
1997, Mr. Dervenis served as a Managing Director of Furman Selz, and from
January 1993 to March 1994, as a Vice President at J.P. Morgan, both in New
York.
Michael Opsahl has served as Executive Vice President and Chief Credit
Officer of the Company, Telebank, and TCM, or their predecessors since 1990. He
is 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 Federal Home Loan Mortgage Corporation. Mr. Opsahl
is the brother-in-law of Mr. Smilow.
Sang-Hee Yi has served as Executive Vice President and Chief Operating
Officer of the Company and Telebank since April 1996, she is 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.
Ross C. Atkinson has served as Executive Vice President and Chief
Information Officer of the Company and Telebank since June 1998, he is
responsible for the strategic direction of all information processing,
communication systems and operations. From 1997 until June 1998, Mr. Atkinson
served as a principal consultant with Platinum Technology, Inc., a database
systems and information management software provider. From 1991 through 1996,
Mr. Atkinson served as a systems engineer for Electronic Data Systems.
Arlen W. Gelbard has served as Executive Vice President and General Counsel
of the Company and Telebank since June 1998. From 1982 until June 1998, Mr.
Gelbard was a member of the law firm of Hofheimer Gartlir & Gross, LLP, New
York, where he specialized in transactional real estate, lending, leasing,
foreclosures and workouts. Prior to joining management of the Company, from
April 1996 to June 1998, Mr. Gelbard served as a director, as well as Chairman
of the Compensation Committees of the Company and Telebank.
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.
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 Oppenheimer Corp., a
subsidiary of CIBC, 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 in August 1995.
He is also a director of Global Crossing Ltd and Booth Creek Ski Group, Inc.
Marcia Myerberg has served as a director of the Company and Telebank since
May 1998. Ms. Myerberg has been Chief Executive Officer of Myerberg & Company,
L.P., an investment banking firm specializing in the mortgage-backed securities
markets, since February 1994. Prior to her current position, from March 1989 to
February 1994, Ms. Myerberg was a Senior Managing Director of The Bear Stearns
Companies, Inc. From July 1985 to February 1989, she was a Director of Salomon
Brothers, Inc., and from November 1979 to June 1985 she was the Senior Vice
President-Corporate Finance and Treasurer of Federal Home Loan Mortgage
Corporation.
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
71
<PAGE> 72
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").
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
AWARDS
------------
ANNUAL COMPENSATION SECURITIES
--------------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS(#) COMPENSATION($)(1)
- --------------------------- ---- --------- -------- ------------ ------------------
<S> <C> <C> <C> <C> <C>
David A. Smilow....................... 1998 $229,000 $250,000 200,000 $16,000
Chairman of the Board 1997 205,000 200,000 200,000 15,000
1996 205,000 188,000 -- 15,000
Mitchell H. Caplan.................... 1998 229,000 250,000 200,000 16,000
Vice Chairman, Chief Executive 1997 205,000 200,000 200,000 15,000
Officer and President 1996 205,000 188,000 -- 15,000
Aileen Lopez Pugh..................... 1998 100,000 130,000 60,000 16,000
Executive Vice President and 1997 79,500 100,000 20,000 15,000
Chief Financial Officer 1996 75,000 60,000 30,000 13,500
Laurence P. Greenberg................. 1998 100,000 130,000 60,000 16,000
Executive Vice President and 1997 79,500 100,000 50,000 15,000
Chief Marketing Officer 1996 75,000 85,000 10,000 15,000
Stephen G. Dervenis................... 1998 87,500 245,000 25,000 16,000
Executive Vice President
</TABLE>
- ---------------
(1) The total amounts shown for each of the years presented represent dollar
value of contributions made by the Company to its Employee Stock Ownership
Plan for the account of the Named Executive Officer.
72
<PAGE> 73
STOCK OPTIONS GRANTS IN 1998
The following table contains information with respect to options to
purchase Common Stock granted to the Named Executive Officers in 1998. All
options were granted under the Company's 1994, 1997 or 1998 Stock Option Plans.
The Company has not granted any SARs.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS OPTION TERM(1)
----------------------------------------------- -----------------------
PERCENT POTENTIAL REALIZABLE
OF TOTAL VALUE AT ASSUMED
NUMBER OF OPTIONS ANNUAL RATES OF STOCK
SECURITIES GRANTED TO EXERCISE PRICE APPRECIATION
UNDERLYING EMPLOYEES OR BASE FOR OPTION TERM
OPTIONS IN FISCAL PRICE EXPIRATION -----------------------
NAME GRANTED(#) YEAR ($/SH) DATE 5%($) 10%($)
- ---- ---------- ---------- -------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
David A. Smilow......................... 200,000(2) 20.8% $14.50 10/23/08 $1,823,794 $4,621,853
Mitchell H. Caplan...................... 200,000(2) 20.8 14.50 10/23/08 1,823,794 4,621,853
Aileen Lopez Pugh....................... 60,000(3) 6.3 9.75 1/27/08 367,903 932,339
Laurence P. Greenberg................... 60,000(3) 6.3 9.75 1/27/08 367,903 932,339
Stephen G. Dervenis..................... 25,000(2) 2.6 14.50 10/23/08 227,974 577,732
</TABLE>
- ---------------
(1) The dollar amounts under these columns are the result of calculations at the
5% and 10% assumed annual growth rates mandated by the rules and regulations
promulgated by the Commission and, therefore, are not intended to forecast
possible future appreciation, if any, in the Common Stock price.
(2) The options vested 20% upon grant on October 23, 1998, and 20% vests ratably
on each of the next four anniversaries of the grant.
(3) The options vested 20% upon grant on January 27, 1998 and 20% vests ratably
on each of the next four anniversaries of the grant.
The following table sets forth information with respect to outstanding
options held by the Named Executive Officers at December 31, 1998.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED-
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT FY-END AT FY-END($)(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
David A. Smilow(2).............. 26,666 $74,998 304,064 280,000 $8,690,072 $6,390,000
Mitchell H. Caplan(2)........... -- -- 330,730 280,000 9,416,721 6,390,000
Aileen Lopez Pugh(3)............ -- -- 56,000 74,000 1,610,625 1,915,000
Laurence P. Greenberg(4)........ -- -- 46,000 84,000 1,266,750 2,164,500
Stephen G. Dervenis(5).......... -- -- 5,000 20,000 97,500 390,000
</TABLE>
- ---------------
(1) Based on last reported sale price of the Common Stock on December 31, 1998
of $34.00 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 85,234 shares of Common Stock with an exercise price of $3.0625 and
options to purchase 125,496 shares of Common Stock with an exercise price
equal to $3.5625. The options expire in April 2004. Also Messrs. Smilow and
Caplan were each granted options to purchase 200,000 shares of Common Stock
on February 28, 1997 with an exercise price of $6.75 and an expiration date
of February 28, 2007. On October 23, 1998, Messrs. Smilow and Caplan were
each granted options to purchase 200,000 shares of Common Stock, with an
exercise price of $14.50 and an expiration date of October 23, 2008. For
each of these grants, 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 130,000 options to Ms. Pugh: 10,000
options granted on April 28, 1994 with an exercise price of $3.0625, 10,000
options granted on February 15, 1995 with an exercise price of $2.75, 30,000
options granted on February 15, 1996 with an exercise price of $3.875,
20,000 options granted on February 15, 1997 with an exercise price of $6.75
and 60,000 options granted on
73
<PAGE> 74
January 27, 1998 with an exercise price of $9.75. The options expire in
April 2004, February 2005, February 2006, February 2007 and January 2008,
respectively. The options vested 20% upon grant, and 20% vest ratably on
each of the next four anniversaries of the grant.
(4) The Company has granted a total of 130,000 options to Mr. Greenberg: 10,000
options granted on February 15, 1995 with an exercise price of $2.75, 10,000
options granted on February 15, 1996 with an exercise price of $3.875,
50,000 options granted on February 15, 1997 with an exercise price of $6.75
and 60,000 options granted on January 27, 1998 with an exercise price of
$9.75. The options expire in February 2005, February 2006, February 2007 and
January 2008, respectively. The options vested 20% upon grant, and 20% vest
ratably on each of the next four anniversaries of the grant.
(5) The Company granted 25,000 options to Mr. Dervenis on October 23, 1998 with
an exercise price of $14.50 and an expiration date of October 23, 2008. 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 $3,000 per director annually.
Non-employee directors of Telebank receive $12,000 per director annually. In
addition, non-employee directors are reimbursed for travel costs and other
out-of-pocket expenses incurred in attending meetings.
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 $3.0625 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 36,000 in the aggregate are vested. In October 1998, the Company granted
to each of Messrs. Kehler and Piaker options to acquire 20,000 shares of Common
Stock, of which options to acquire 8,000 in the aggregate are vested. Also in
October 1998, the Company granted Ms. Myerberg options to acquire 10,000 shares
of Common Stock, none of which options are vested. As of the date of this Annual
Report, options to acquire 120,000 shares of Common Stock held in the aggregate
by such directors are outstanding.
INTERLOCKS AND INSIDER PARTICIPATIONS
CIBC Oppenheimer, an affiliate of CIBC WGArgosy Merchant Fund 2, LLC, of
which Mr. Kehler is a managing director, served as an underwriter for the
Company's Equity Offering and Trust Preferred Offering in July and August 1998.
CIBC Oppenheimer earned underwriters' fees totaling $2.3 million in connection
with the offerings.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock (the "Voting Securities") as of March
30, 1999 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, 1998, (iii) the Chief
Executive Officer and the Named Executive Officers, and (iv) all directors and
executive officers as a group. Except as otherwise noted, each beneficial owner
has sole investment and voting power with respect to the listed shares.
74
<PAGE> 75
SECURITY OWNERSHIP OF THE COMPANY'S SECURITIES
<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 David A. Smilow(2) 1,655,350 12.71%
Mitchell H. Caplan(3) 879,277 6.74
Aileen Lopez Pugh(4) 116,961 *
Laurence P. Greenberg(5) 87,907 *
Stephen G. Dervenis(6) 5,700 *
David R. DeCamp(7) 19,000 *
Dean C. Kehler(8) 686,590 5.40
Marcia Myerberg -- --
Steven F. Piaker(9) 4,000 *
Mark Rollinson(10) 20,500 *
CIBC WG Argosy Merchant Fund 2 LLC(8) 682,590 5.37
Conning & Company(11) 772,589 6.08
General American Mutual Holding company(12) 967,614 7.60
PC Investment Company(13) 867,866 6.82
Directors and Executive Officers as a group (9
individuals)(14) 3,475,285 25.24
TeleBanc Financial Corporation Employee Stock
Ownership Plan(15) 495,445 3.91
</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) 1,153,954 of Mr. Smilow's shares are held by D. Aron LLC, a limited
liability company of which Mr. Smilow is the managing member, and 50,036
shares are held directly by Mr. Smilow. Includes 354,064 shares of Common
Stock issuable upon exercise of options and 64,200 shares issuable upon
exercise of warrants exercisable within 60 days of this filing and 33,096
shares of Common Stock held by the ESOP and allocated to Mr. Smilow's
account. Excludes 288,944 shares held by D. Aron LLC over which Mr. Smilow
does not have voting or dispositive power and 412,349 shares of Common
Stock and warrants to acquire 50,000 shares of Common Stock held by the
ESOP (excluding the shares allocated to his account), of which Mr. Smilow
is a trustee.
(3) Includes 380,730 shares of Common Stock issuable upon exercise of options
and 46,000 shares issuable upon exercise of warrants exercisable within 60
days of this filing and 15,809 shares of Common Stock held by the ESOP and
allocated to Mr. Caplan's account. Excludes 429,636 shares of Common Stock
and warrants to acquire 50,000 shares of Common Stock held by the ESOP
(excluding the shares allocated to his account), of which Mr. Caplan is a
trustee. Mr. Caplan disclaims beneficial ownership of warrants to acquire
23,000 shares of Common Stock listed above.
(4) Includes 88,000 shares of Common Stock issuable upon exercise of options
and 12,200 shares of Common Stock issuable upon exercise of warrants
exercisable within 60 days of this filing and 7,481 shares of Common Stock
held by the ESOP and allocated to Ms. Pugh's account.
(5) Includes 80,000 shares of Common Stock issuable upon exercise of options
exercisable within 60 days of this filing and 7,507 shares of Common Stock
held by the ESOP and allocated to Mr. Greenberg's account.
(6) Includes 5,000 shares of Common Stock issuable upon exercise of options
exercisable within 60 days of the date of this filing.
(7) Includes 17,000 shares of Common Stock issuable upon exercise of options
exercisable within 60 days of this filing. Mr. DeCamp's address is Grubb &
Ellis, 1717 Pennsylvania Avenue, N.W., Suite 250, Washington, D.C. 20006.
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<PAGE> 76
(8) Mr. Kehler is the designated director for CIBC WG Argosy Merchant Fund 2
LLC ("CIBC Merchant Fund"), which, according to a Schedule 13G filed on
February 16, 1999, directly holds 589,840 shares of Common Stock and 92,750
shares of Common Stock issuable upon exercise of warrants exercisable
within 60 days of this filing. Mr. Kehler is a partner of CIBC Merchant
Fund and disclaims beneficial ownership of such shares. Mr. Kehler's
beneficial ownership interest includes 4,000 shares of Common Stock
issuable upon exercise of options exercisable within 60 days of December
31, 1998, which are not part of CIBC's holdings. Mr. Kehler's address is
c/o CIBC Oppenheimer, 425 Lexington Avenue, 3rd Floor, New York, New York
10017.
(9) Represents Common Stock issuable upon exercise of options exercisable
within 60 days of this filing. Mr. Piaker is the designated director for
Conning & Company and serves as its Senior Vice President. Mr. Piaker does
not exercise voting or investment control over the shares held by Conning &
Company. Mr. Piaker's address is c/o Conning & Company, City Place II, 185
Asylum Street, Hartford, Connecticut 06103.
(10) Includes 12,000 shares of Common Stock issuable upon exercise of options
exercisable within 60 days of this filing. Mr. Rollinson's address is P.O.
Box 826, Leesburg, Virginia 22075.
(11) According to a Schedule 13G filed on February 16, 1999, Conning Insurance
Capital Limited Partnership III ("CICLP III") beneficially owns 671,975
shares of Common Stock. Conning Insurance Capital International Partners
III, L.P. ("CICIP III") beneficially owns 100,614 shares of Common Stock.
The Company understands that CICLP III and CICIP III collectively own
92,750 shares of Common Stock issuable upon exercise of warrants
exercisable within 60 days of the date of this filing. Conning & Company
controls the general partner of each of CICLP III and CICIP III. The
address of Conning & Company is City Place II, 185 Asylum Street, Hartford,
Connecticut 06103.
(12) According to a Schedule 13G filed on February 16, 1999, General American
Life Insurance Company ("General American"), an indirect subsidiary of
General American Mutual Holding Company directly holds 168,525 shares of
Common Stock and 26,500 shares of Common Stock issuable upon exercise of
warrants exercisable within 60 days of this filing. General American Mutual
Holding Company indirectly controls Conning & Company and may be deemed to
beneficially own all of the shares held by CICLP III and CICIP III.
Accordingly, the shares held by Conning & Company are also included in the
table above. The address of General American is 700 Market Street, St.
Louis, Missouri 63101.
(13) PC Investment Company holds 749,940 shares of Common Stock, as well as
117,926 shares of Common Stock issuable upon exercise of warrants
exercisable within 60 days of this filing. The address of PC Investment
Company is 401 Theodore Freund Avenue, Rye, New York 10580.
(14) Includes 944,794 shares of Common Stock issuable upon exercise of options
and 215,150 shares of Common Stock issuable upon exercise of warrants
exercisable within 60 days of this filing. Excludes 381,552 shares of
Common Stock (except for any shares allocable to the accounts of Messrs.
Smilow, Caplan and Greenberg and Ms. Pugh) and warrants to acquire 50,000
shares of Common Stock exercisable within 60 days of December 31, 1998,
held by the ESOP, of which Messrs. Smilow and Caplan act as trustees.
(15) Includes 50,000 shares of Common Stock issuable upon exercise of warrants
exercisable within 60 days of December 31, 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
CIBC Oppenheimer, an affiliate of CIBC WG Argosy Merchant Fund 2, LLC, of
which Mr. Kehler is a managing director, served as an underwriter for the
Company's Equity Offering and Trust Preferred Offering in July and August 1998.
CIBC Oppenheimer earned underwriters' fees totaling $2.3 million in connection
with the offerings.
Prior to resigning from the Board of Directors and joining the Company as
general counsel, Mr. Gelbard served as a partner of Hofheimer, Gartlir & Gross,
LLC, which performed legal services for the Company. During 1998, Hofheimer,
Gartlir & Gross, LLC, received approximately $106,000 in legal fees and expenses
for work performed through June 30, 1998.
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<PAGE> 77
The Company paid $204,000 in consulting fees to Myerberg & Company, of
which Ms. Myerberg is the Chief Executive Officer, in connection with the
establishment of an agreement to purchase funding notes collateralized by
consumer loans.
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 beginning on page 34 hereof.
Report of Independent Public Accountants.
Consolidated Statements of Financial Condition -- December 31, 1998
and 1997.
Consolidated Statements of Operations -- Years Ended December 31,
1998, 1997, and 1996.
Consolidated Statements of Changes in Stockholders' Equity -- Years
Ended December 31, 1998, 1997, and 1996.
Consolidated Statements of Cash Flows -- Years Ended December 31,
1998, 1997, and 1996.
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
- ------- -------
<C> <S>
3.1 Amended and Restated Certificate of Incorporation of the
Company (incorporated herein by reference to Exhibit 3.1(a)
to the Company's Registration Statement on Form S-2, File
No. 333-52871)
3.2 Bylaws of the Company (incorporated by herein reference 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 herein by reference 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 herein by reference 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 herein by reference to Exhibit 4.5 to
the Company's Registration Statement on Form S-1, dated
March 25, 1994, File No. 33-76930)
4.4 Declaration of Trust of TeleBanc Capital Trust II, dated May
22, 1998 (incorporated herein by reference to the Company's
Registration Statement on Form S-2, File No. 333-52871)
4.5 Form of Certificate of Exchange Junior Subordinated
Debentures (incorporated herein by reference 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 herein by
reference to Exhibit 3.4 to the Company's Registration
Statement on Form S-4, dated December 8, 1997, File No.
333-40399)
</TABLE>
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<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT
- ------- -------
<C> <S>
4.7 Amended and Restated Trust Agreement of TeleBanc Capital
Trust II, dated July 31, 1998 (incorporated herein by
reference to Exhibit 4.5 to Amendment No. 1 to the Company's
Registration Statement on Form S-2, dated July 2, 1998, File
No. 333-53689)
4.8 Form of Exchange Capital Security Certificate (incorporated
herein by reference to Exhibit 4.6 to the Company's
Registration Statement on Form S-4, dated December 8, 1997,
File No. 333-40399)
4.9 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 herein by reference to
Exhibit 10.1 to the Company's Registration Statement on Form
S-1, dated March 25, 1994, File No. 33-76930)
10.2* 1997 Stock Option Plan (incorporated herein by reference 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* 1998 Stock Incentive Plan (incorporated herein by reference
to the Company's Registration Statement on Form S-2, File
No. 333-52871)
10.4 Employee Stock Ownership Plan of the Company (incorporated
herein by reference to the Company's Registration Statement
on Form S-2, File No. 333-52871)
10.5 Agreement and Plan of Merger by and between the Company and
Direct Financial Corporation, dated January 14, 1998
(amended pursuant to the First Amendment to Agreement and
Plan of Merger dated May 29, 1998 and filed as Exhibit 10.14
incorporated by reference hereto)
10.6 Registration Rights Agreement, dated June 5, 1997, among the
Company, TeleBanc Capital Trust I and the Initial Purchaser
(incorporated herein by reference to Exhibit 4.8 to the
Company's Registration Statement on Form S-4, dated December
8, 1997, File No. 333-40399)
10.7 Unit Purchase Agreement, dated February 19, 1997, among the
Company and the Purchasers identified therein (incorporated
herein by reference to Exhibit 10.1 to the Company's Current
Report on 8-K, dated March 17, 1997)
10.8 Amended and Restated Acquisition Agreement, dated February
19, 1997, among the Company, Arbor Capital Partners, Inc.,
MET Holdings, Inc., and William M. Daughtery (incorporated
herein by reference to Exhibit 10.2 to the Company's Current
Report on 8-K, dated March 17, 1997)
10.9 Liquidated Damages Agreement, dated June 9, 1997, by and
among the Company, TeleBanc Capital Trust I, and the Initial
Purchaser (incorporated herein by reference to Exhibit 4.9
to the Company's Registration Statement on Form S-4, dated
December 8, 1997, File No. 333-40399)
10.10 Tax Allocation Agreement, dated April 7, 1994, between
TeleBank and Company (incorporated herein by reference 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)
10.11 Indenture dated June 9, 1997, between the Company and
Wilmington Trust Company, as debenture trustee (incorporated
herein by reference to the Company's Registration Statement
on Form S-4, dated December 8, 1997, File No. 333-40399)
10.12 Form of Indenture between the Company and Wilmington Trust
Company as Trustee (incorporated herein by reference to
Exhibit 4.3 to the Company's Registration Statement on Form
S-1, dated March 25, 1994, File No. 33-76930)
10.13 Conversion Agreement dated May 15, 1998 by and among the
Company and certain investors named therein (incorporated
herein by reference to the Company's Registration Statement
on Form S-2, File No. 333-52871)
</TABLE>
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<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT
- ------- -------
<C> <S>
10.14 First Amendment to Agreement and Plan of Merger (filed as
Exhibit 10.5 hereto) by and among the Company, Direct
Financial Corporation and TBK Acquisition Corp., dated May
29, 1998 (incorporated herein by reference to the Company's
Registration Statement on Form S-2, File No. 333-52871)
10.15** Consultation Agreement with Marsha Myerberg.
10.16** Amended and Restated Acquisition Agreement with MET Holdings
Corporation and TeleBanc Financial Corporation dated March
17, 1998.
21** Subsidiaries of the Company
27.1** Financial Data Schedule
</TABLE>
- ---------------
* Indicates compensatory plan or arrangement.
** Previously filed.
(b) Reports on Form 8-K
On August 25, 1998, the Company reported to the Securities and Exchange
Commission on Form 8-K under Item 2, Acquisition or Disposition of Assets, that
on August 10, 1998, the Company had acquired DFC and its wholly-owned
subsidiary, Premium Bank. Included in the filing was the Agreement and Plan of
Merger dated January 14, 1998, as amended by the First Amendment to the
Agreement and Plan of Merger, dated May 29, 1998. The Company amended the Form
8-K and filed the financial statements required under Item 7, Required Financial
Statements, on October 26, 1998.
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<PAGE> 80
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
TELEBANC FINANCIAL CORPORATION
(Registrant)
By: /s/ SANG HAN
------------------------------------
Sang Han
Controller and Acting Chief
Financial Officer
