ITEM 1. BUSINESS - -----------------
GENERAL
Bay View Capital Corporation (the "Company" or "BVCC"), a Delaware corporation, is a diversified financial services company incorporated in 1989. The Company has been focused on the diversification of its asset origination activities and expects to continue this process prospectively (see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Strategic Overview" for further discussion of these diversification efforts). The Company's principal business activities consist of three operating platforms: a Banking Platform, a Consumer Finance Platform and a Commercial Finance Platform. The Company operates these platforms through its wholly owned subsidiaries (i) Bay View Bank ("BVB" or the "Bank"), a federally chartered capital stock savings bank, (ii) Bay View Acceptance Corporation ("BVAC"), a Nevada corporation operating as a consumer finance company originating prime motor vehicle loans through its wholly owned subsidiaries, Bay View Credit ("BVC"), formerly California Thrift & Loan ("CTL"), and Ultra Funding, Inc. ("Ultra"), and (iii) Concord Growth Corporation ("CGC"), a California corporation operating as a commercial finance company, including its asset-based lending division, Bay View Financial Corporation ("BVFC"). The Company is also the holding company for Bay View Securitization Corporation ("BVSC"), a Delaware corporation formed for the purpose of issuing asset-backed securities through a trust and Regent Financial Corporation ("Regent"), a California corporation providing item processing services.
Effective January 2, 1998, the Company acquired America First Eureka Holdings, Inc. ("AFEH") and its wholly owned subsidiary, EurekaBank, a Federal Savings Bank. At December 31, 1997, AFEH had $2.3 billion in assets and 36 retail banking branches operating throughout the San Francisco Bay Area.
BAY VIEW BANK
BVB is a federally chartered capital stock savings bank incorporated in 1911 and is the basis of the Company's Banking Platform. In 1986, BVB converted from a mutual to a stock association, and in 1989, became a wholly owned subsidiary of the Company. In 1997, the Bank changed its name from Bay View Federal Bank to Bay View Bank. BVB is a member of the Federal Home Loan Bank of San Francisco ("FHLBSF").
At December 31, 1997, BVB had 27 branches serving primarily the San Francisco Bay Area. Its principal business consists of attracting deposits from the general public and using those deposits, together with borrowings and other funds, to fund the activities of the Banking, Consumer Finance and Commercial Finance Platforms. All of the mortgage loans originated by BVB are secured by properties located in California, primarily Northern California. BVB originates both fixed rate and adjustable rate loans. BVB has shifted the concentration of its real estate loan portfolio to adjustable rate mortgages ("ARMs"), which are sensitive to fluctuations in market interest rates. The majority of these loans are secured by multifamily residential properties. BVB also originates real estate loans secured by commercial and industrial properties. During 1996, BVB discontinued its single family mortgage lending activity.
BAY VIEW ACCEPTANCE CORPORATION
BVAC, formed in 1997, is the Company's Consumer Finance Platform and is a subsidiary of BVB. BVAC's wholly owned subsidiaries are Bay View Credit and Ultra Funding, Inc.
Bay View Credit (formerly California Thrift & Loan) - ---------------------------------------------------
CTL was acquired by the Company effective June 1, 1996 in a business combination accounted for as a purchase. CTL was an FDIC-insured industrial loan company incorporated under the laws of the State of California. Effective December 31, 1997, CTL ceased accepting deposits (and is therefore no longer regulated as
a depository institution) and was renamed Bay View Credit. In conjunction with this reorganization, BVC now operates as a consumer finance company. All references to this subsidiary from this point forward will reflect its new name, Bay View Credit.
Based in Covina, California, BVC operates 10 offices throughout California and the Western United States offering primarily motor vehicle financing. Its business niche strategy is to originate prime motor vehicle loans at yields which are generally above those offered by conventional financing sources (such as commercial banks) while applying its traditional underwriting criteria on a case-by-case basis to mitigate any potential loan losses. BVC underwrites and purchases both new and used fixed rate prime motor vehicle loans.
Ultra Funding, Inc. - -------------------
Ultra was formed during 1997 and effective October 1, 1997 acquired the origination capabilities and certain assets of Ultra Funding, Ltd. ("Ultra Funding") of Austin, Texas. From November 1996 through October 1997, the Company had a strategic alliance with Ultra Funding whereby the Company had a right of first refusal to purchase all of the motor vehicle installment contracts originated by Ultra Funding which met the Company's underwriting criteria. Ultra operates one office in Austin, Texas and originates fixed rate new and used prime motor vehicle loans.
CONCORD GROWTH CORPORATION
The Company created its Commercial Finance Platform through the acquisition of EXXE Data Corporation ("EXXE") and its wholly owned subsidiary, Concord Growth Corporation on March 17, 1997. Subsequent to the acquisition, EXXE was merged into CGC and liquidated and CGC became a first-tier stand-alone subsidiary of the Company. The acquisition was accounted for as a purchase effective April 1, 1997. CGC, based in San Mateo, California, offers factoring, warehouse and re- discount lines, and Bay View Financial Corporation, a division of CGC based in Encino, California, offers asset-based lending. CGC and BVFC operate 11 loan production offices throughout the United States.
LENDING ACTIVITIES
BAY VIEW BANK
Residential Lending - -------------------
Multifamily Mortgage Loans (five or more units). At December 31, 1997, loans secured by multifamily residential real estate totaled $1.03 billion, representing approximately 42.6% of the Company's consolidated loan portfolio. In general, these loans were originated as ARMs with terms of 30 years, although some of these loans have monthly payments calculated on a 30-year amortization period with a balloon payment due at maturity, typically 15 years. The majority of the ARMs originated by BVB prior to 1996 were indexed to the Eleventh District Cost of Funds Index ("COFI"). During 1996, management re-directed its business lending practices and BVB moved away from COFI as its index for ARMs. Currently, BVB utilizes the London Interbank Offered Rate ("LIBOR") and prime rate as its variable interest rate indices for the majority of its new originations.
BVB generally does not lend more than 75% of the appraised value of multifamily residences on a first mortgage loan. The property's net income available for loan payments is also a limiting factor on the approved loan amount for multifamily residences. Properties securing multifamily loans are required to generate cash flow sufficient to cover loan payments and other property expenditures.
Single Family Mortgage Loans (one to four units). At December 31, 1997, single family loans totaled $550.5 million, representing 22.9% of the Company's consolidated loan portfolio. Generally, ARMs secured by single family residential properties have terms of 30 years. During 1996, BVB discontinued its single family loan origination operations.
Commercial Real Estate Lending - ------------------------------
At December 31, 1997, loans secured by commercial real estate totaled $348.8 million, representing 14.5% of the Company's consolidated loan portfolio. Substantially all of BVB's commercial real estate loans are ARMs. ARMs secured by commercial real estate are generally made upon the same terms and conditions as ARMs secured by multifamily residences.
Most of BVB's commercial real estate loans consist of loans secured by improved property such as office buildings, warehouses and retail sales facilities. A majority of these loans are in amounts ranging from $250,000 to $1 million. BVB generally does not originate commercial real estate loans which have a loan-to-value ("LTV") ratio exceeding 70%. The property's cash flow available for loan payments is a limiting factor on the approved loan amount. Properties securing commercial real estate loans are required to generate cash flow sufficient to cover loan payments and other property expenditures.
Commercial real estate lending entails significant additional risks compared to single family residential mortgage lending. Income producing property loans may involve large loan balances to single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by commercial real estate properties is typically dependent on the successful operation of the properties, as well as favorable conditions in the real estate market or the economy in general.
Underwriting Policies and Procedures - Real Estate Loans - --------------------------------------------------------
BVB originates multifamily and commercial real estate loans through internal loan production personnel. As part of the loan underwriting process, staff appraisers or qualified independent appraisers inspect and appraise the property that would secure the loan. A loan underwriter analyzes the merits of the loan based on information obtained relative to the borrower and property (i.e., income, credit history, assets, liabilities, cash flows and the value of the real property as stated on the appraisal report). Loans are then approved at various levels of authority depending upon the amount and type of loan.
BVB requires the American Land Title Association form of title insurance on all loans secured by real property and requires that fire and extended coverage casualty insurance in amounts sufficient to rebuild or replace the improvements at current replacement costs be maintained on all properties securing the loans. BVB also requires flood insurance for properties in flood hazard zones to protect the property securing its interest. Consistent with regional industry practices, BVB does not necessarily require earthquake insurance as part of its general underwriting practices, however, BVB may require mudslide, earthquake and/or other hazard insurance depending on the location of the property.
Consumer Lending - ----------------
At December 31, 1997, home equity and other consumer loans totaled $121.7 million, representing 5.1% of the Company's consolidated loan portfolio. Approximately $67.1 million of this balance is comprised of a portfolio of home equity loans acquired by BVB in August 1997.
Business Lending - ----------------
BVB offers business lending products (i.e., business loans, credit lines and term loans) and other services in order to expand BVB's customer base and make BVB more competitive in the community banking environment. As of December 31, 1997, BVB's business loan portfolio was not material in relation to its other lending.
BAY VIEW CREDIT
Motor Vehicle Lending - ---------------------
At December 31, 1997, motor vehicle loans totaled $160.7 million, representing 6.7% of the Company's consolidated loan portfolio. BVC underwrites and purchases high quality, fixed rate loans on both new and used prime motor vehicles on a non-recourse basis, currently with Fair, Isaac Credit Bureau ("FICO") scores averaging 700. BVC's typical motor vehicle loan customer desires a higher relative loan amount and/or longer term than is offered by many automobile financing sources. In return for the flexibility of the product it offers, management expects to continue to charge interest rates of 200 to 300 basis points over the rates typically offered by traditional sources of motor vehicle financing such as banks and captive finance companies. Management's primary focus is on the credit quality of the customer rather than the value of the collateral, and BVC will accordingly finance the full retail sales price of the automobile plus taxes, licensing fees, insurance, dealer preparation fees and extended warranty. BVC uses available technology, including a custom credit scoring system, to process approval decisions typically within three hours of receipt of information from a dealer.
BVC began offering 84-month motor vehicle loan financing in December 1994. Prior to this, the typical motor vehicle loan had a term of 48 to 72 months. Management believes that 84-month financing allows it to further distinguish its motor vehicle loan product without significantly increasing charge-offs or delinquencies.
Management initially anticipated periodic sales of its motor vehicle loans to BVSC and their subsequent securitization. During the first quarter of 1997, $253 million of BVC's motor vehicle loans were sold and securitized, with the premium from the sale recorded as part of purchase accounting. The transaction enabled the Company to significantly reduce the goodwill associated with the BVC acquisition and return an additional $26 million of capital for redeployment during the first quarter of 1997. In addition, a gain of $925,000 was realized from the sale representing the improvement in the fair value of the motor vehicle loans due to a change in market interest rates between the acquisition date and the sale date.
In conjunction with the Company's May 1997 announcement of the acquisition of AFEH and its wholly owned subsidiary, EurekaBank, as discussed elsewhere herein, the Company discontinued the sale and securitization of BVC's motor vehicle loans. This acquisition, which closed on January 2, 1998, is expected to provide the Company with an enhanced and expanded lower cost funding base for its higher yielding Consumer and Commercial Finance Platforms.
Other Consumer Lending - ----------------------
At December 31, 1997, BVC's portfolio of other consumer financing loans totaled $18.7 million, representing 0.8% of the Company's consolidated loan portfolio. This lending activity was discontinued in November 1996.
Mortgage Loans, Revolving Credit Lines and Real Estate Participations - ---------------------------------------------------------------------
BVC had historically maintained a portfolio of mortgage loans, revolving credit lines and real estate loan participations. The mortgage loan portfolio was primarily comprised of first and second deeds of trust secured by single family residences. Effective September 30, 1997, all of BVC's mortgage and real estate loan participations (approximately $99.7 million) were sold to BVB at their book value, which approximated fair value.
Commercial Equipment Leasing - ----------------------------
Prior to December 1996, BVC offered fixed-rate commercial equipment leases principally in the state of California. In December 1996, BVC sold its entire commercial equipment leasing portfolio for $60 million in cash. This sale enabled BVC to return $15 million of capital to the Company for redeployment on December 31, 1996.
ULTRA FUNDING INC.
At December 31, 1997, Ultra's loan portfolio, comprised entirely of motor vehicle loans, totaled $126.1 million, representing 5.2% of the Company's consolidated loan portfolio. These loans are serviced by BVC.
Ultra originates high quality, fixed rate loans on both new and used motor vehicles on a non-recourse basis, currently with FICO scores averaging 670. Ultra's motor vehicle loan product is more traditional than that of BVC with the corresponding yields approximately 200 to 300 basis points lower than BVC's motor vehicle loan yields.
CONCORD GROWTH CORPORATION
At December 31, 1997, CGC's loan portfolio serviced for BVB, comprised entirely of commercial loans, totaled $54.1 million, representing 2.2% of the Company's consolidated loan portfolio. CGC, including its asset-based lending division, BVFC, comprises the Company's Commercial Finance Platform.
SECURITIES INVESTMENT ACTIVITIES
The Company's securities investment activities primarily involve the purchase and sale of mortgage-backed securities ("MBS") by BVB. BVB purchases securities when high quality loan production is not available. The portfolio consists primarily of MBS issued by the Federal Home Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA") and Government National Mortgage Association ("GNMA").
Securities are classified as held to maturity or available for sale. The Company does not maintain a trading portfolio. Securities in the held to maturity category consist of securities purchased for long-term investment in order to enhance the Company's ongoing stream of net interest income and core earnings. Securities deemed held to maturity are classified as such because the Company has both the intent and ability to hold the securities to maturity. Securities purchased which may be sold prior to maturity are designated as available for sale at the time of purchase.
As part of the Company's strategic objectives, management is de-emphasizing the less profitable aspects of its business such as wholesale investment activities (which is primarily comprised of a large MBS portfolio funded by borrowings from the FHLBSF). As a result, BVB sold $20.5 million of its MBS in 1997, $57.6 million in 1996 and $103.4 million in 1995. There were no MBS purchased in 1997, 1996 or 1995.
RETAIL DEPOSIT ACTIVITIES
BAY VIEW BANK
BVB attracts both short-term and long-term deposits from the general public by offering a wide range of deposit products and services. BVB, through its branch network, provides its banking customers with the following services:
. Money market accounts . Savings and checking accounts . Certificates of deposit . Individual retirement accounts . 24-hour automated teller machines (STAR(R) System and Plus(R) Network)
Enhancing the value of BVB's retail branch franchise remains one of the Company's primary objectives. BVB plans to continue to expand its retail banking presence in Northern California through internal growth, new product development and the acquisition or purchase of deposits from other institutions. This objective led to the Company's acquisition of EurekaBank, which was announced in May 1997 and completed on January 2, 1998. Including EurekaBank, BVB's retail deposit franchise is now the largest of any financial institution operating exclusively in the San Francisco Bay Area.
Throughout 1997, BVB continued to emphasize the development and marketing of its transaction account products, and as a result BVB has increased its percentage of lower-cost transaction accounts in relation to total retail customer deposits (excluding BVB brokered deposits at December 31, 1997 and excluding BVC transaction accounts at December 31, 1996) to 34.6% at December 31, 1997 compared with 30.3% and 21.3% at December 31, 1996 and 1995, respectively.
BAY VIEW CREDIT
BVC's customer deposits were primarily comprised of thrift certificates, which were similar to certificates of deposits with the exception that they were callable at par plus accrued interest. When thrift certificates were purchased by customers, BVC reserved the right to repurchase the certificates at any time upon thirty days notice. Utilizing this call provision, BVC redeemed the higher cost component (higher than BVB's incremental borrowing cost) of these deposits at face value (approximately $267 million) as of December 31, 1996. The remainder of the BVC customer deposits (which were lower in cost than BVB's incremental borrowing cost) were sold to BVB in June 1997.
BORROWING ACTIVITIES
The Company's borrowing activities are primarily conducted by BVB. The Federal Home Loan Bank ("FHLB") System functions in a reserve credit capacity for savings institutions. As a member, BVB is required to own capital stock in the FHLBSF and has the authority to apply for advances from the FHLBSF utilizing FHLBSF capital stock, qualifying mortgage loans and MBS as collateral.
The FHLBSF offers a full range of borrowing programs on its advances with terms of up to ten years at competitive market rates. A prepayment penalty is usually imposed for early repayment of FHLBSF advances. BVB is also a member of the Federal Reserve System ("Federal Reserve") and may borrow from the Federal Reserve Bank of San Francisco. Thrifts are required to utilize their FHLBSF borrowing capacity before borrowing from the Federal Reserve.
BVB also utilizes borrowings under reverse repurchase agreements with securities dealers and the FHLBSF. Reverse repurchase agreements are sales of securities owned by BVB to securities dealers with a commitment by BVB to repurchase such securities for a predetermined price at a future date.
DEBT
At December 31, 1997, the Company had approximately $150 million of debt outstanding. This debt is comprised of $100 million in 9.125% subordinated notes issued in August 1997 and $50 million in 8.42% senior debentures issued in May 1996.
COMPETITION
BAY VIEW BANK
BVB faces strong competition both in originating loans and in attracting deposits. Competition in originating multifamily and commercial real estate mortgage loans comes primarily from other savings institutions, commercial banks and mortgage bankers located in the San Francisco Bay Area. BVB competes for mortgage loans principally on the basis of interest rates, types of products, loan fees charged and the quality of customer service it provides to borrowers. Competition in attracting deposits comes primarily from other savings institutions, commercial banks, brokerage firms, mutual funds, credit unions and other types of investment companies. The ability of BVB to attract and retain deposits depends on a number of factors which include:
. Interest rates offered on deposit products . Fees . Types of deposit products . Convenient office locations . Advertising . Automated teller machines (ATMs) . Quality customer service
BVB has ATMs located throughout the San Francisco Bay Area which provide 24- hour cash availability to its customers. BVB also participates in the STAR System and the Plus Network, which link BVB ATMs with those of a number of major financial institutions. This linkage provides customers with cash availability worldwide.
BVB also has a wholly owned subsidiary, MoneyCare, Inc., which offers uninsured investment products, such as mutual funds and annuities, providing BVB's customers with additional choices and products that meet their individual investment needs.
BAY VIEW CREDIT AND ULTRA FUNDING, INC.
BVC and Ultra have experienced increased competition for their motor vehicle loan programs. This competition comes primarily from large, well-capitalized lending institutions and finance companies. Management intends to build origination and purchase volumes through more competitive loan pricing and further improvements in products, service and marketing. It also intends to expand origination capability and market share through geographic expansion, strategic alliances with other consumer finance companies and additional business acquisitions, as warranted.
CONCORD GROWTH CORPORATION
CGC has also experienced intense competition from other commercial finance companies competing for market share. This competition has translated to lower yields. Management has countered this impact by expanding the asset-based lending segment of the business by adding personnel with significant industry experience, relocating the asset-based business to Southern California, one of the top asset-based lending markets in the country, and adding new and enhanced products to the Commercial Finance Platform's product array.
SUPERVISION AND REGULATION
GENERAL
The Company, together with its subsidiaries, is subject to extensive examination, supervision and regulation by the Office of Thrift Supervision ("OTS") and the Federal Deposit Insurance Corporation ("FDIC").
Applicable regulations govern, among other things, BVB's lending and investment powers, the types of deposit and/or loan accounts it is permitted to offer, the types of business in which it may engage and requirements for regulatory capital. The Company is also subject to the regulations of the Board of Governors of the Federal Reserve System with respect to required reserves and certain other matters.
The Company is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings institution subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.
BAY VIEW BANK
Federal Regulation of Savings Institutions. The OTS has extensive authority over the operations of savings institutions. As part of this authority, BVB is required to file periodic reports with the OTS and the FDIC. The OTS has extensive enforcement authority over all savings institutions and their holding companies, including BVB and the Company, and their affiliated parties such as directors, officers, agents and other persons providing services to the institution or holding company.
Insurance of Accounts and Regulation by the FDIC. BVB is a member of the Savings Association Insurance Fund ("SAIF"), which is administered by the FDIC. BVB's deposits are insured up to applicable limits by the FDIC. As insurer, the FDIC has adopted a risk-based deposit insurance system that assesses deposit insurance premiums for all FDIC-insured banks and thrifts according to the level of risk involved in an institution's activities. An institution's risk category is based upon whether the institution is classified as "well capitalized", "adequately capitalized" or "undercapitalized" and within each risk category there are three subcategories based upon an institution's risk classification. BVB's current assessment rate is approximately 6.48 basis points.
The FDIC is authorized to increase assessment rates, on a semiannual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF-insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. In addition, the FDIC may impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC.
Regulatory Capital Requirements. Federally insured savings institutions such as BVB are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings institutions. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual institutions on a case-by-case basis. At December 31, 1997, BVB was deemed "well capitalized" under current capital regulations and exceeded its fully phased-in regulatory capital requirements.
In August 1993, the OTS issued a final rule for the calculation of an interest rate risk component for institutions with a greater than "normal" (i.e., greater than 2%) level of interest rate risk exposure. Currently, the OTS has deferred implementation of the interest rate risk component. At December 31, 1997, if the interest rate risk component regulation had been implemented, BVB would not have been subject to an interest rate risk capital deduction for risk-based capital purposes.
Limitations on Dividends and Other Capital Distributions. The retained earnings of BVB are substantially restricted based on certain laws and regulations relating to the payment of dividends. Federal regulations impose various restrictions or requirements on institutions with respect to their ability to pay dividends or make other distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the equity account.
Generally, Tier I institutions, which are institutions that before and after the proposed distribution meet or exceed their capital requirements, may, after the receipt of no objection by the OTS, make capital distributions during any calendar year equal to the greater of 100% of net income on a year-to-date basis plus 50% of the amount by which the institution's tangible core or risk-based capital exceeds its respective fully phased-in capital requirement, as measured at the beginning of the calendar year, or 75% of its net income for the most recent four quarter period. BVB meets the requirements for a Tier I institution.
Federal Reserve System. The Federal Reserve requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts). At December 31, 1997, BVB was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements imposed by the OTS.
Federal Home Loan Bank System. BVB is a member of the FHLBSF, one of 12 regional FHLBs. Each FHLB serves as a reserve or central bank for its members within its assigned geographic region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLBSF are required to be fully secured by sufficient collateral as determined by the FHLBSF. In addition, all long-term advances are restricted to providing funds for residential home financing.
BAY VIEW CREDIT
BVC was subject to supervision and regulation by the Department of Corporations of the State of California and, as a federally insured depository institution, by the FDIC. In addition, BVC was also subject to regulation in Arizona, Colorado, Illinois, Nevada, New Mexico, Oregon and Texas as a result of its operations in those states. The Company began implementing a significant restructuring of BVC in late 1996 which culminated in BVC being de-regulated effective December 31, 1997 and converted to a consumer finance company. As a subsidiary of BVAC, a wholly owned subsidiary of BVB, BVC is subject to supervision and regulation by the OTS.
OTHER SUBSIDIARIES
BVSC, a wholly owned subsidiary of BVCC, is a Delaware corporation formed in 1997 for the purpose of issuing asset-backed securities through a trust. BVSC purchased, and subsequently securitized, approximately $253 million of motor vehicle loans from BVC in January 1997. The Company subsequently ceased its securitization activities in conjunction with the announcement of the EurekaBank acquisition.
Regent, a wholly owned subsidiary of BVCC, is a California corporation engaged in providing item processing services for BVB and other financial institutions.
MoneyCare, a wholly owned subsidiary of BVB, sells uninsured investment products, such as mutual funds and annuities, through an arrangement with a registered broker-dealer. MoneyCare receives commissions on the sales of such products. BVB stresses cross-selling to improve profitability and solidify customer relationships.
BVB has two other subsidiaries: Bay View Auxiliary Corporation and Bay View Acceptance Corporation. Bay View Auxiliary Corporation acts as trustee under deeds of trust originated through BVB's loan activity. BVAC is the parent Corporation for BVC and Ultra.
EMPLOYEES
At December 31, 1997, the Company's principal entities had a total of 640 employees on a full-time equivalent ("FTE") basis as follows:
The Company's employees are not represented by any collective bargaining groups. The Company considers its relations with its employees to be good.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the executive officers of the Registrant.
The business experience of each of the executive officers of the Company is as follows:
Mr. Sondker has served as a Director, President and Chief Executive Officer of the Company since 1995. Previously, he served as President and Chief Executive Officer of Independence One Bank of California, FSB, a subsidiary of Michigan National Corporation. From 1985 to 1990, he was the President and Chief Executive Officer of La Jolla Bank & Trust Company. Prior to 1985, Mr. Sondker held executive and management positions with a community bank holding company in Kansas City, Missouri.
Mr. Arnold, Executive Vice President, has served as Director of Sales and Banking Administration since 1997. Prior to joining the Company, he served as an Executive Vice President of First Interstate Bank and was responsible for all branch banking activities in Northern California. Prior to joining First Interstate in 1990, he held executive and management positions at Security Pacific Bank in a career that spanned over thirty years.
Mr. Buckley, Executive Vice President, has served as Director of Credit Administration since 1995 and Manager of Credit Administration and Asset Management since 1994. He joined the Company in September 1993. Previously, he served at Bank of America in various capacities from 1985 to 1993. His last position was Vice President and Regional Credit Administrator for the Real Estate Industries Division at Bank of America.
Mr. Flax, Executive Vice President, has served as General Counsel of BVB since 1985 and has served in various capacities since 1980. He has served as General Counsel and Corporate Secretary of the Company since
its formation in 1989. Before joining BVB, he was a trial attorney in private practice in San Francisco from 1976 to 1980.
Mr. Heaberlin, Executive Vice President, has served as Chief Financial Officer of the Company since 1995 and Chief Operating Officer of BVB since 1997. Previously, he served as Senior Vice President and Chief Financial Officer for First California/Mortgage Service America. During 1993 and 1994, he was Executive Vice President and Treasurer of ITT Residential Capital Corporation. Prior to ITT, he was the financial executive for various entities including Bowery Bank, Exchange National Bank of Chicago, Financial Corporation of Santa Barbara and Numerica Financial. He has over 20 years experience in commercial banking, savings banks and the financial services industry. Mr. Heaberlin is a Certified Public Accountant.
Mr. Reed, Executive Vice President, has served as Director of Management Information Systems and Loan Servicing since 1997. Previously, he served as Chief Information Officer for Weyerhaeuser and WMC Mortgage Corporation. He has over 30 years of corporate management, information technology and servicing experience and has held senior management positions with Technology Management Corporation, American Savings Bank and Home Savings of America / HF Ahmanson.
There is no family relationship among the above officers. All executive officers serve at the pleasure of the Board of Directors.
ITEM 2.
ITEM 2. PROPERTIES - --------------------
As of December 31, 1997, the Company and its subsidiaries occupied 56 offices and the Company's administrative corporate office under operating lease arrangements expiring at various dates through 2012. BVB owns the property in which one of its branches is located. In 1996, the Company sold its corporate office complex and entered into an operating lease arrangement for new facilities. Also in 1996, BVC's corporate office complex was sold and BVC relocated its administrative offices.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS - ---------------------------
See Note 19 of the Consolidated Financial Statements at Item 8.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - -------------------------------------------------------------
The following was submitted for a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended December 31, 1997.
(a) Special Meeting of Shareholders of the Company held on October 23, 1997 to consider the proposal to approve the adoption of the Agreement and Plan of Merger dated May 8, 1997 by and among the Company, America First Eureka Holdings, Inc., America First Financial Fund 1987-A Limited Partnership and America First Capital Associates Limited Partnership Five. The vote on the proposal was as follows:
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - -------------------------------------------------------------------------------
The Company's common stock is traded on the Nasdaq National Market. The Company's common stock symbol was changed to BVCC from BVFS in May 1997. At December 31, 1997, there were 12,070,474 shares of the Company's common stock outstanding, as adjusted for a 2 for 1 stock split in the form of a 100% stock dividend paid in June 1997 (the "Stock Split"), which were owned by 1,854 shareholders of record.
The following is a summary of quarterly stock price activity and dividends declared for 1997 and 1996 (amounts have been adjusted for the Stock Split):
The ability of the Company to pay dividends may be limited by certain regulatory restrictions. See "Supervision and Regulation - Limitations on Dividends and Other Capital Distributions" at Item 1 and Note 14 of the Consolidated Financial Statements at Item 8.
The following is a summary of year-end values for 1997 and 1996.
The following is a summary of selected financial ratios, excluding special mention items, for 1997 and 1996. See also Item 6
ITEM 6. SELECTED FINANCIAL DATA - FIVE-YEAR FINANCIAL INFORMATION (INCLUDING - ------------------------------------------------------------------------------ BVC EFFECTIVE JUNE 1, 1996, CGC EFFECTIVE APRIL 1, 1997 AND ULTRA EFFECTIVE - --------------------------------------------------------------------------- OCTOBER 1, 1997) - ----------------
(1) The selected other information is based upon data as of the end of, and for the respective years, except that average assets, average intangible assets and average equity have been calculated by averaging the relevant month-end amounts for each respective year.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and - -------------------------------------------------------------------------- Results of Operations - ---------------------
INDEX
STRATEGIC OVERVIEW
The Company is a diversified financial services company which operates from three distinct business platforms:
. A Banking/Depository/Wholesale Platform ("Banking Platform"), which is comprised primarily of mortgage loans, home equity loans and MBS.
. A Consumer Finance Platform, which is comprised of motor vehicle loans originated by BVC and Ultra.
. A Commercial Finance Platform, which is comprised of the factoring, re- discount and warehouse lending activities of CGC and the asset-based lending activities of BVFC, a division of CGC.
THE COMPANY'S MISSION STATEMENT
To build a diversified financial services company by investing in niche businesses with risk-adjusted returns that enhance shareholder value.
THE COMPANY'S STRATEGY
The Company's strategy is to continue expanding net interest margin. In order to realize this objective, management is pursuing a strategy that encompasses the following:
. Replacing lower yielding mortgage loans with consumer and commercial assets with higher risk-adjusted returns, shorter maturities and less sensitivity to interest rate fluctuations.
. Enhancing BVB's deposit base by reducing higher cost deposits and expanding lower cost transaction accounts by emphasizing relationship banking and capitalizing on cross-sell opportunities with customers.
. De-emphasizing the less profitable elements of the Company's activities by ceasing residential mortgage loan originations and reducing BVB's wholesale activities.
. Maintaining the capital of BVB at or above the minimum "well-capitalized" (as defined for bank regulatory purposes) level and returning any excess capital to the Company.
. Redeploying such excess capital in businesses intended to generate assets with higher risk-adjusted returns than those typically provided by mortgage loans.
BANKING PLATFORM STRATEGIES
The Banking Platform's strategic focus is designed to expand the retail deposit franchise by focusing on the growth of "transaction accounts" (i.e. checking, savings and money market) instead of higher cost certificates of deposit as a source of financing and to reduce wholesale activities.
Change in Name to Bay View Bank - -------------------------------
Marking its transition from a traditional savings bank to a community bank, Bay View Federal Bank changed its name to Bay View Bank, effective March 17, 1997.
Acquisition of America First Eureka Holdings, Inc. and EurekaBank - -----------------------------------------------------------------
The Company completed its acquisition of America First Eureka Holdings, Inc. and its wholly owned subsidiary, EurekaBank, a Federal Savings Bank, on January 2, 1998. Pursuant to the Merger Agreement, the Company paid $90 million in cash and $210 million in stock (8,076,923 shares of the Company's common stock) to America First Financial Fund 1987-A Limited Partnership, the sole shareholder of AFEH, for a total purchase price of $300 million. The number of shares issued was based on the average value of the Company's stock for the 20 full trading days ending on the fifth business day prior to the merger closing date. Based on the average value of $34.3031 during this period, pursuant to the Merger Agreement, the number of shares issued was determined by dividing the $210 million stock portion of the purchase price by $26.00 per share.
The acquisition of AFEH will be accounted for as a purchase effective January 2, 1998. The amount of goodwill to be recorded as of the merger date is expected to be $98 million which will be amortized on a straight-line basis over 20 years and which excludes core deposit intangibles estimated at $12 million. This goodwill amount represents the preliminary estimate of the excess of the purchase price over the fair value of net assets acquired and liabilities assumed based on information available as of this date. No assurance can be given that the final goodwill amount will not be more or less than the estimated amount.
The following represents selected financial data for the Company as of December 31, 1997 and selected pro forma financial data for the Company combined with EurekaBank, reflecting the impact of the acquisition as of December 31, 1997:
EurekaBank will initially operate under its own name. The Company anticipates that by May 31, 1998, the systems and products of EurekaBank and BVB will be fully integrated at which time all EurekaBank branches will convert to BVB branches. The combined entity will have 56 full service branches and will represent the largest deposit franchise of any financial institution operating exclusively in the San Francisco Bay Area.
The acquisition is expected to be accretive on a tangible cash earnings basis, as defined in Item 5, in 1998. The Company expects to incur during 1998 approximately $5.0 million ($2.9 million after tax) representing costs associated with integrating EurekaBank into the Company, including training, systems and operations integration and costs for transitional personnel.
CONSUMER FINANCE PLATFORM STRATEGIES
The Consumer Finance Platform is comprised of motor vehicle loans originated by Bay View Acceptance Corporation and its wholly owned subsidiaries, Bay View Credit and Ultra Funding, Inc.
Bay View Credit - ---------------
In late 1996, the Company's management began implementing a significant restructuring of BVC's balance sheet. The following is a summary of the actions taken:
. Sale of entire equipment leasing portfolio of $60 million.
. Redemption and transfer of customer deposits.
. Sale and securitization of $253 million of the motor vehicle loan portfolio.
Sale of Equipment Leasing Portfolio
BVC signed a definitive agreement during 1996 for the sale of its entire equipment leasing portfolio for cash. The leases sold aggregated $60 million and this transaction closed in December, 1996. The proceeds from this transaction slightly exceeded the value established during the purchase accounting valuation process. This sale, combined with other restructuring efforts outlined herein, enabled BVC to return $15 million of capital to the Company on December 31, 1996 for redeployment.
Reduction of High Cost Customer Deposits
BVC's customer deposits were primarily comprised of thrift certificates which were similar to certificates of deposit with the exception that they were callable at par plus accrued interest. When thrift certificates were purchased by customers, BVC reserved the right to repurchase the certificates at any time upon thirty days notice. Utilizing this call provision, BVC redeemed the higher cost component (higher than BVB's incremental borrowing cost) of these deposits at face value (approximately $267 million) as of December 31, 1996. The remainder of the BVC customer deposits (which were lower in cost than BVB's incremental borrowing cost) were sold to BVB in June 1997.
Sale and Securitization of Motor Vehicle Loan Portfolio
In January 1997, BVC sold $253 million of its motor vehicle loan portfolio to BVSC, a Delaware corporation formed for the purpose of issuing asset-backed securities through a trust. The motor vehicle loan portfolio was recorded at its fair value upon acquisition assuming that such loans would be securitized and sold. As a result, the only gain recorded on the sale and securitization was relating to the changes in the market interest rates between the acquisition date of BVC and the sale and securitization of the loans. In conjunction with the decision to securitize the motor vehicle loan portfolio, management entered into certain hedges which materially insulated the purchase accounting valuation from movements in interest rates.
In January 1997, $253 million of motor vehicle receivable-backed securities were issued through a trust. Capital Markets Assurance Corporation provided credit enhancement for this transaction. The Company ceased its securitization activities in conjunction with the announcement of the EurekaBank acquisition.
Ultra Funding, Inc. - -------------------
A significant source of the Consumer Finance Platform's loan purchases has been a strategic alliance that began in November 1996 with Ultra Funding, an originator of prime motor vehicle loans, whereby the Company had a right of first refusal to purchase all of the motor vehicle installment contracts originated by Ultra Funding which met the Company's underwriting criteria. Effective October 1, 1997, the Company, through its newly created subsidiary, Ultra Funding, Inc., acquired the origination capabilities and certain assets of Ultra Funding.
Strategic Alliances - -------------------
In January 1998, the Company announced the formation of a strategic alliance with Onyx Acceptance Corporation ("Onyx") whereby the Company will purchase motor vehicle loans originated by Onyx.
In March 1998, the Company announced agreements with Lendco Financial Services ("Lendco") to purchase motor vehicle operating leases from Lendco. The agreements also provide the Company with
an option to acquire Lendco.
These strategic alliances are consistent with management's strategy to continue expanding the Company's net interest margin by focusing on generating assets in the Consumer and Commercial Finance Platforms with higher risk-adjusted yields.
COMMERCIAL FINANCE PLATFORM STRATEGIES
The Commercial Finance Platform is comprised of CGC's asset-based lending and factoring, warehouse and re-discount lines. CGC's corporate vision is to become a preeminent nationwide provider of asset-based lending, factoring and warehouse and re-discount lines to small and middle market companies. Management believes that meaningful expansion opportunities exist due to the highly fragmented nature of the segment of the commercial finance industry serving small to medium size companies.
Asset-Based Lending - -------------------
CGC's asset-based lending includes credit secured by accounts receivable, inventory, machinery and equipment and real estate. At December 31, 1997, these loan products represented approximately 75% of the Commercial Platform's loan portfolio and had average yields approximating 17%.
In December 1997, the Company announced an expansion of the Commercial Finance Platform including the formation of a new asset-based lending group known as Bay View Financial Corporation. BVFC, a division of CGC, is located in Southern California, one of the top asset-based lending markets in the country. This expansion represents a significant step in achieving the Company's goal of establishing a $200-300 million nationwide asset-based lending platform.
Factoring, Warehouse and Re-Discount Lines - ------------------------------------------
CGC's lending includes accounts receivable factoring, warehouse and re- discount lines. At December 31, 1997, these loan products represented approximately 25% of the Commercial Platform's loan portfolio and had average yields approximating 39%.
CAPITAL REDEPLOYMENT STRATEGIES
Stock Repurchase Program - ------------------------
The Company's outstanding shares of common stock at December 31, 1997 and 1996 were 12,070,474 shares and 13,349,270 shares, respectively. The decrease in the number of outstanding shares was attributable to the repurchase of shares in 1997 partially offset by the exercise of stock options. As a result of the stock repurchases, weighted average shares outstanding (including dilutive potential common shares) used for earnings per diluted share calculations decreased to 13,203,000 shares for 1997 from 13,900,000 shares for 1996.
In January 1997, the Company approved a repurchase program of $25 million to redeploy its excess capital and in May 1997, an additional $25 million was approved. During 1997, the Company repurchased 1,399,000 shares of its common stock at an average price of $28.48 per share. In December 1997, the Company's Board of Directors rescinded the remaining share repurchase authorization in order to explore opportunities to use the stock's "currency value" for potential future acquisitions which may be accounted for as a pooling-of-interests.
Since the inception of the stock repurchase program in late 1995, the Company has repurchased nearly 3 million shares at an average cost of $21.81 per share. This represents over 20% of the shares outstanding at December 31, 1995. In January 1998, the Company's treasury shares were reissued in conjunction with the acquisition of AFEH.
Other Capital Strategies - ------------------------
On August 28, 1997, the Company issued $100 million in subordinated notes. The notes are unsecured obligations of the Company and are subordinated in right of payment to all existing and future senior indebtedness, as defined, of the Company. The notes mature on August 15, 2007, and are callable upon a change of control, within 180 days of the occurrence of the change, at the option of the Company and upon certain other events. The issuance has a stated coupon rate of 9.125% and yields 9.225%.
The Company expects to continue utilizing this capital pool to pursue accretive acquisition opportunities to expand its Consumer and Commercial Finance Platforms. Management will also continue to explore the acquisition of other potential high quality, niche origination capabilities, as well as opportunities to further enhance BVB's deposit franchise.
RESULTS OF OPERATIONS
Consolidated net income was $14.0 million, or $1.06 per diluted share, for the year ended December 31, 1997 as compared with $11.0 million, or $0.79 per diluted share, for 1996, and a net loss of $4.7 million, or $0.32 per share, for 1995. Operating results for 1997 included $5.6 million (after tax) in special mention items, primarily related to EurekaBank acquisition-related expenses. Operating results for 1996 included $6.8 million (after tax) in special mention items, primarily relating to a one-time special assessment to recapitalize the Savings Association Insurance Fund as well as other offsetting special mention items. Operating results for 1996 also included the benefit associated with the $253 million of motor vehicle loans which were sold and securitized in January 1997. Operating results for 1995 included $11.3 million (after tax) in special mention items. See "Special Mention Items" elsewhere herein for further discussion.
Core earnings (net income excluding special mention items) were $19.6 million, or $1.48 per diluted share for 1997, as compared with $17.7 million, or $1.28 per diluted share, for 1996 and $6.6 million, or $0.45 per share, for 1995.
The following table reconciles net income (loss) to core earnings for the years indicated:
(1) 1996 includes an estimated $4.2 million in earnings (after tax) associated with the $253 million of motor vehicle loans which were sold and securitized in January 1997. (2) Core earnings are calculated excluding special mention items. See "Special Mention Items" for further discussion. Core earnings are not a measure of performance under generally accepted accounting principles and should not be considered as an alternative to net income (loss) as an indicator of the Company's operating performance. Core earnings are included herein as management believes they are a useful tool for investors and analysts in assessing the Company's performance and trends excluding the impact of such items. These measures may not be comparable to similarly titled measures reported by other companies.
The increases in earnings and earnings per diluted share over prior years were due to a continued expansion of net interest margin as well as the impact of share repurchases. Net interest margin for 1997 was 2.86% as
compared with 2.57% for 1996 and 1.86% for 1995. This improvement reflects the continued strategic shift in the Company's balance sheet from commodity oriented, real estate-based assets with lower risk-adjusted yields and higher prepayment risk to consumer and commercial loans with higher risk-adjusted yields, shorter maturities and lower prepayment risk.
EARNINGS BY BUSINESS PLATFORM
Net earnings (loss), by business platform, are summarized as follows for the years indicated:
(1) The Consumer Finance Platform was created with the acquisitions of BVC in June 1996 and Ultra in October 1997, and the Commercial Finance Platform was created with the acquisition of CGC in April 1997. (2) 1996 includes an estimated $4.2 million in earnings (after tax) associated with the $253 million of motor vehicle loans which were sold and securitized in January 1997.
Core earnings, by business platform, are summarized as follows for the years indicated:
(1) The Consumer Finance Platform was created with the acquisitions of BVC in June 1996 and Ultra in October 1997, and the Commercial Finance Platform was created with the acquisition of CGC in April 1997. (2) 1996 includes an estimated $4.2 million in earnings (after tax) associated with the $253 million of motor vehicle loans which were sold and securitized in January 1997. (3) See definition and discussion of core earnings included elsewhere herein.
TANGIBLE CASH EARNINGS
Tangible cash earnings are based on core earnings for each period and exclude charges related to the amortization of intangibles and the Employee Stock Ownership Plan ("ESOP").
Tangible cash earnings are summarized as follows for the years indicated:
(1) See definition and discussion of core earnings included elsewhere herein.
NET INTEREST INCOME AND MARGIN BY BUSINESS PLATFORM
Consolidated net interest income was $87.3 million for the year ended December 31, 1997 as compared with $81.0 million for 1996 and $55.9 million for 1995. The consolidated net interest margin for 1997 was 2.86% as compared with 2.57% for 1996 and 1.86% for 1995.
This improvement in the consolidated net interest margin over prior years was primarily due to lower funding costs due to a decrease in the cost of retail deposits, continued originations and purchases of higher yielding assets by the Consumer and Commercial Finance Platforms and the Banking Platform's purchase of $70 million in home equity loans in 1997. This impact was partially offset by additional interest expense associated with the subordinated debt issued in 1997 and the senior debt issued in 1996.
Consolidated net interest income and margin, by business platform, is summarized as follows for the years indicated:
(1) The Consumer Finance Platform was created with the acquisitions of BVC in June 1996 and Ultra in October 1997, and the Commercial Finance Platform was created with the acquisition of CGC in April 1997. (2) 1996 includes an estimated $7.3 million in incremental interest income (pre tax) associated with the $253 million of motor vehicle loans which were sold and securitized in January 1997.
Banking Platform - ----------------
The Banking Platform's 1997 net interest margin was 2.45%, as compared with a net interest margin 2.36% for 1996 and 1.86% for 1995. The 9 basis point improvement in net interest margin for 1997 was primarily due to a lower cost of funds throughout the year as well as the purchase of home equity loans. The 50 basis point improvement in net interest margin for 1996 was primarily due to higher yields on mortgage loans combined with a lower cost of deposits.
Consumer Finance Platform - -------------------------
The Consumer Finance Platform's 1997 net interest margin was 5.54%. This compares with a net interest margin of 5.80% in 1996. The decrease in the net interest margin from 1996 was primarily due the impact of securitizing the $253 million motor vehicle loan portfolio in January 1997 as well as continued originations by Ultra which are at yields lower than those of BVC.
Commercial Finance Platform - ---------------------------
The Commercial Finance Platform's 1997 net interest margin was 19.05%. This platform was created as a result of the Company's acquisition of CGC effective April 1, 1997.
Average Balance Sheet. The following table sets forth certain information relating to the Company's consolidated statements of financial condition and reflects the average yields on interest-earning assets and average rates paid on interest-bearing liabilities for the years indicated. Such yields and rates are derived by dividing interest income or expense by the average balances of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown.
(1) Average loan balances include nonaccrual loans. Nonaccrual loans were $11.0 million, $16.1 million and $10.8 million at December 31, 1997, 1996 and 1995, respectively. (2) Loan interest income and yields include the amortization of deferred loan origination costs, net of fees, of $187,000, $1.4 million and $452,000 for the years ended December 31, 1997, 1996 and 1995, respectively. (3) Average balances and yields for securities available for sale are based on historical amortized cost balances and do not include any unrealized gains or losses. (4) Interest expense for borrowings includes interest expense on interest rate swaps of $2.8 million, $2.6 million and $40,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
INTEREST INCOME
Interest Income on Loans Receivable - -----------------------------------
Interest income on loans receivable was $197.9 million for the year ended December 31, 1997 as compared with $192.4 million for 1996 and $155.9 million for 1995.
Interest income on loans receivable, by business platform, is summarized as follows for the years indicated:
(1) The Consumer Finance Platform was created with the acquisitions of BVC in June 1996 and Ultra in October 1997, and the Commercial Finance Platform was created with the acquisition of CGC in April 1997. (2) 1996 includes an estimated $7.3 million in incremental interest income (pre tax) associated with the $253 million of motor vehicle loans which were sold and securitized in January 1997.
Banking Platform
Loan yields for 1997 and 1996 were the same at 7.88%. This is a result of the average monthly COFI for 1997 approximating 1996. A substantial portion of the Banking Platform's ARMs reprice to COFI on a monthly basis. The decrease in interest income on loans is due to a slight decrease in the average loan balance.
Loan yields increased by 40 basis points from 1995 to 1996. The average monthly COFI for the year ended December 31, 1996, which impacted ARMs, increased by 16 basis points. The average loan balances for 1996 and 1995 were essentially the same at $2.07 billion and $2.08 billion, respectively.
Consumer Finance Platform
The decrease in motor vehicle loan yields to 10.46% for 1997 as compared with 10.91% in 1996 was primarily due to the sale of the $253 million motor vehicle loan portfolio in January 1997 to BVSC. The sale of these loans was offset partially by current year loan activity, including Ultra originations and purchases which were at lower average yields than the motor vehicle loans originated by BVC.
Commercial Finance Platform
The commercial loan yield for 1997 was 24.20%. This platform was created as a result of the acquisition of CGC effective April 1, 1997.
Interest Income on Mortgage-backed Securities - ---------------------------------------------
Interest income on the Company's MBS was $34.3 million for the year ended December 31, 1997 as compared with $42.1 million for 1996 and $54.2 million for 1995. The decrease in interest income on MBS was primarily attributable to lower average balances resulting from sales and principal amortization. There were no MBS purchased in 1997, 1996 or 1995 consistent with management's strategy to restructure the balance sheet and de-emphasize the Company's wholesale investment and borrowing activities.
Interest and Dividends on Investments - -------------------------------------
Interest and dividend income from the Company's investment portfolio was $10.0 million for the year ended December 31, 1997 as compared with $7.2 million for 1996 and $6.4 million for 1995. The increase in interest and dividend income on investments was primarily due to the impact of higher average balances and yields on investments.
INTEREST EXPENSE
Interest Expense on Customer Deposits - -------------------------------------
Interest expense on the Company's customer deposits was $76.5 million for the year ended December 31, 1997 as compared with $100.2 million for 1996 and $93.4 million for 1995. The decrease in interest expense in 1997 as compared with 1996 was a result of lower average customer deposit balances, a lower cost of retail deposits and the redemption of the higher-cost component of BVC deposits (approximately $267 million) at year-end 1996.
The decrease in the Company's cost of retail deposits was primarily due to favorable repricing of certificates of deposit and an increase in transaction accounts which are at lower rates than certificates of deposit. The cost of retail deposits at December 31, 1997 for BVB was 4.71%, which included the retail deposits of BVC sold to BVB in June 1997. BVB's cost of retail deposits was 24 basis points below COFI at December 31, 1997 and 1996 as compared with 12 basis points above COFI at December 31, 1995. BVB's cost of retail deposits was higher at December 31, 1997, as compared to the average cost for the year of 4.64%, due to the impact of brokered certificates of deposit held at year-end and a transaction account promotion conducted during the fourth quarter of 1997. Transaction accounts for BVB as a percentage of total retail deposits increased to 34.6% at December 31, 1997 as compared to 30.3% and 21.3% at December 31, 1996 and 1995, respectively.
The increase in interest expense on customer deposits from 1995 to 1996 was primarily due to the acquisition of BVC effective June 1996.
BVB's cost of retail deposits compared to COFI is summarized as follows:
Interest Expense on Borrowings - ------------------------------
Interest expense on the Company's borrowings was $78.4 million for the year ended December 31, 1997 as compared with $60.5 million for 1996 and $67.1 million for 1995.
The increase in interest expense on borrowings was due to higher average balances arising from a decrease in average customer deposits as well as the impact of the $100 million in subordinated notes issued in August 1997 (9.6% all-in cost) and the $50 million in senior debentures issued in May 1996 (8.9% all-in cost).
The decrease in interest expense on borrowings between 1996 and 1995 was primarily due to lower average balances arising from lower borrowing requirements consistent with the level of interest-earning assets maintained, combined with the prepayment of higher cost borrowings in late 1995. Interest expense on borrowings for 1996 reflects the impact of the prepayment of $190 million of higher cost borrowings in the fourth quarter of 1995 which were replaced with short-term lower cost borrowings. In conjunction with the prepayment of these borrowings, the Company entered into interest rate swap agreements to provide interest rate risk
protection for the short-term lower cost borrowings by matching the floating interest rate characteristics and lengthening their maturities.
The following table sets forth the changes in net interest income due to changes in the rate and volume of the Company's interest-earning assets and interest-bearing liabilities. Rate and volume changes are calculated excluding nonperforming assets. Changes in rate and volume (changes in weighted average interest rate multiplied by average portfolio balance), which cannot be segregated, have been allocated proportionately to the change in rate and the change in volume.
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans was $2.0 million for the year ended December 31, 1997 as compared with $1.9 million for 1996 and $4.3 million for 1995. The decreases in 1997 and 1996 were due to continued improvements in the credit quality of the portfolio, as evidenced by the significant decline in nonperforming assets to $15.8 million at December 31, 1997 from $24.3 million at December 31, 1996 and $38.8 million at December 31, 1995. Additionally, the decrease in 1997 is also due to recoveries of approximately $1.8 million received during the year and credited to the allowance for losses on loans. See the "Allowance for Losses on Loans" section below for a more detailed discussion.
NONINTEREST INCOME
Noninterest income was $12.8 million for the year ended December 31, 1997 as compared with $8.6 million for 1996 and $6.1 million for 1995, which included losses on the sale of securities of $800,000 and $2.5 million in 1996 and 1995, respectively. There was no net gain or loss on securities sold in 1997.
The increase in noninterest income in 1997 as compared with 1996 is due to an increase in loan fees attributable to commercial finance assets due to the acquisition of CGC effective April 1, 1997. Also, in January 1997, BVC sold $253 million of motor vehicle loans to BVSC and recognized a gain of $925,000 representing the improvement in the fair value of the loans as a result in changes in market interest rates between the acquisition date and the sale date.
During 1996, BVB sold $57.6 million in MBS and recognized a loss of $507,000. Also, in conjunction with the anticipated securitization of BVC's auto loan portfolio, during the fourth quarter of 1996, BVC entered into a short sale of Treasury securities to hedge the valuations from movements in interest rates. A loss of $293,000 was recorded in the fourth quarter of 1996 associated with this short sale of Treasury securities. During 1995, BVB sold $103.4 million in MBS and recognized a loss of $2.5 million. BVB's interest rate risk profile was favorably impacted by the sale of these securities.
NONINTEREST EXPENSE
General and Administrative Expenses - -----------------------------------
General and administrative expenses were $71.9 million for the year ended December 31, 1997 as compared with $59.0 million for 1996 and $57.0 million for 1995. General and administrative expenses for 1997 included $8.8 million in special mention items, primarily EurekaBank acquisition-related expenses. General and administrative expenses for 1996 included $6.1 million in special mention items, primarily related to systems conversion, sublease loss accruals and long-term incentive expenses. General and administrative expenses for 1995 included $9.6 million in special mention items, primarily related to the write- down due to the sale of the Company's corporate office complex and severance payments. See "Special Mention Items" elsewhere herein for further discussion.
General and administrative expenses, by principal entity, are summarized as follows for the years indicated:
(1) The Consumer Finance Platform was created with the acquisitions of BVC in June 1996 and Ultra in October 1997, and the Commercial Finance Platform was created with the acquisition of CGC in April 1997.
The increase in consolidated general and administrative expenses for 1997 was primarily attributable to the acquisitions of CGC and Ultra in 1997 and BVC in 1996 as well as a higher level of special mention items. Additionally, general and administrative expenses for BVC have declined (on an annualized basis) during the period subsequent to acquisition due to the termination of certain employee functions, the impact of the sale of the entire leasing portfolio and the continued implementation of cost reduction opportunities. The decrease in general and administrative expenses for the Company and BVB in 1996 was due to a decrease in special mention items as well as lower compensation and benefits expense and the impact of other cost reduction initiatives.
Consolidated core general and administrative expenses, excluding special mention items, were $63.1 million for the year ended December 31, 1997 as compared with $52.8 million for 1996 and $47.4 million for 1995. Core general and administrative expenses, by principal entity, are summarized as follows for the years indicated:
(1) The Consumer Finance Platform was created with the acquisitions of BVC in June 1996 and Ultra in October 1997, and the Commercial Finance Platform was created with the acquisition of CGC in April 1997. (2) Consolidated core general and administrative expenses are calculated excluding special mention items. See "Special Mention Items" for further discussion. Core general and administrative expenses are not a measure of performance under generally accepted accounting principles and should not be considered as an alternative to consolidated general and administrative expenses as an indicator of the Company's operating performance. Core general and administrative expenses are included herein as management believes they are a useful tool for investors and analysts in assessing the Company's performance and trends excluding the impact of such items.
The increases in consolidated core general and administrative expenses for 1997 and 1996 were primarily attributable to the acquisitions of CGC and Ultra in 1997 and BVC in 1996.
Consolidated general and administrative expenses as a percentage of consolidated average assets (including securitized assets) were 2.16% for the year ended December 31, 1997 as compared with 1.84% for both 1996 and 1995. The increase in the general and administrative expense ratio over the prior years was primarily due to the acquisition of the Commercial Finance Platform.
Consolidated core general and administrative expenses, excluding special mention items, as a percentage of consolidated average assets (including securitized assets) were 1.90% for the year ended December 31, 1997 as compared with 1.65% for 1996 and 1.53% for 1995. The ratio of core general and administrative expenses to average assets (including securitized assets), by business platform, is summarized as follows for the years indicated:
(1) The Consumer Finance Platform was created with the acquisitions of BVC in June 1996 and Ultra in October 1997, and the Commercial Finance Platform was created with the acquisition of CGC in April 1997. (2) See definition and discussion of core general and administrative expenses included elsewhere herein.
The consolidated efficiency ratio was 71.9% for the year ended December 31, 1997 as compared with 64.8% and 88.3% for 1996 and 1995, respectively. The increase in the consolidated efficiency ratio is also due to the impact of the acquisitions of the Consumer and Commercial Finance Platforms as well as special mention items.
The consolidated core efficiency ratio, excluding special mention items, was 61.8% for the year ended December 31, 1997 as compared with 58.0% and 73.5% for 1996 and 1995, respectively.
SAIF Recapitalization Assessment - --------------------------------
Federal legislation to recapitalize and fully fund the Savings Association Insurance Fund was signed into law on September 30, 1996. Customer deposits for BVB are SAIF-insured, and as a result of the legislation, BVB was required to pay a one-time special assessment of $11.7 million pre tax ($6.7 million after tax, or $0.485 per share) in the third quarter of 1996. The legislation had no direct effect on BVC, as its deposits were insured under the Bank Insurance Fund.
Pursuant to this legislation, premiums on SAIF-insured deposits for BVB were reduced in 1997 which translated into lower annual deposit insurance costs.
Income and Expenses from Real Estate Owned - ------------------------------------------
Income from operations of real estate owned and net provision/recovery of losses on real estate owned was $1.1 million for the year ended December 31, 1997 as compared with $4.9 million for 1996 and $332,000 for 1995. The decrease in 1997 from 1996, as well as the increase from 1995 to 1996, were primarily due to gains from the sale of, and higher income received from, real estate owned in
Amortization and Write-down of Intangibles - ------------------------------------------
The amortization and write-down of intangible assets was $4.1 million for the year ended December 31, 1997 as compared with $2.6 million for 1996 and $3.9 million for 1995. The increase in amortization for 1997 was due to the amortization of goodwill related to the BVC, CGC and Ultra acquisitions.
The amortization and write-down of intangibles for 1995 includes core deposit premiums of $854,000, which were written-off due to an impairment in the value of core deposit premiums attributable to higher than expected decay rates in the customer deposits acquired. The balance of the core deposit premiums was subsequently amortized over the remaining useful life. Additionally, during the fourth quarter of 1995, BVB decided to sell or exchange certain of its acquired branches for which goodwill was recorded in 1981. Based on the offers received and management's estimates of the undiscounted future cash flows, the remaining unamortized goodwill was written-off because management believed that the goodwill could no longer be assured of recovery. As a result, goodwill of $758,000 was written-off in the fourth quarter of 1995.
INCOME TAXES
Income tax expense was $9.2 million for the year ended December 31, 1997 as compared with $8.3 million for 1996. The income tax benefit was $708,000 for the year ended December 31, 1995. The effective tax rate for 1997 was 39.7% compared with 43.0% for 1996. The decrease in the effective tax rate for 1997 is primarily due to benefits resulting from enterprise zone tax credits as well as the finalization of recent tax audits.
EXTRAORDINARY ITEM
As part of its asset/liability management strategy to reduce interest rate risk exposure, during the fourth quarter of 1995, the Company prepaid $45.0 million of its short-term FHLBSF advances. In addition, the Company committed to prepay an additional $145.0 million of its short-term FHLBSF advances in February 1996. As a result, the Company incurred a prepayment charge of $2.5 million (net of applicable income taxes). In accordance with Generally Accepted Accounting Principles, the prepayment penalties were reported as an extraordinary charge (net of applicable income taxes). Although the amount of the charge reduced the Company's earnings at the time the debt was extinguished, management believes that the Company's future earnings were enhanced by such actions. For further discussion of the Company's asset/liability management strategies, see "Asset and Liability Management".
SPECIAL MENTION ITEMS
The net income (loss) for the periods indicated below contained certain items which deserve special mention and which were excluded from net income (loss) to arrive at core earnings.
1997 Special Mention Items - --------------------------
The impact of special mention items during the year ended December 31, 1997 was a net expense of $9.6 million ($5.6 million after tax, or $0.42 per diluted share).
. $7.7 million in charges related to the acquisition of EurekaBank including: . $6.2 million in related systems, operations and reengineering integration projects. . $1.1 million payment to the senior debt holders. The $50 million senior debt, issued in May 1996, contained certain covenants, including restrictions on stock repurchases. In conjunction with the proposed acquisition of EurekaBank announced in May 1997, the Company negotiated covenant modifications with the senior debt holders to allow the repurchase of additional shares of stock. . $450,000 write-off of deferred expenses related to a shelf registration statement on Form S-3 for $500 million of automobile receivable-backed securities filed with the Securities and Exchange Commission in November 1996. With the Company's decision in 1997 to cease securitization of motor vehicle loans, the Company wrote-off the remaining unamortized expenses. . $1.2 million in charges related to the expansion and reorganization of CGC and BVC. . $1.0 million in incremental costs related to the Company's issuance of $100 million subordinated debt in August. The debt proceeds were intended for corporate funding purposes, including funding for the EurekaBank acquisition. The incremental costs represent the effective cost of the debt in excess of the estimated reinvestment rate of the debt proceeds for the period prior to the EurekaBank acquisition. . $800,000 expense accrual for long-term incentive plan awards due to an increase in the Company's stock price. . $415,000 recovery related to a real estate joint venture previously written- off. . $650,000 benefit associated with the decision to remain with Fiserv (the current data processor for BVB and EurekaBank) and the corresponding reversal of an accrual for the termination of BVB's data processing contract discussed below.
The Company has incurred a total of $7.7 million in expenses related to the EurekaBank acquisition ($4.5 million after tax, or $0.34 per diluted share). The Company had previously disclosed that it expected to incur pre-merger expenses of $5 million ($2.9 million after tax, or $0.22 per diluted share). This amount exceeds the original estimate primarily due to expenses related to the Bank's systems conversion to EurekaBank's Fiserv - Pittsburgh systems platform. The decision to convert the Bank to EurekaBank's platform was made subsequent to the acquisition announcement and therefore not contemplated in the original estimate.
1996 Special Mention Items - --------------------------
The impact of special mention items for the year ended December 31, 1996 was a net expense of $11.8 million ($6.8 million after tax, or $0.49 per diluted share).
. $11.7 million SAIF recapitalization assessment. . $4.8 million gain from the sale of and income received from certain real estate owned properties. . $2.4 million contribution to pre tax net income resulting from purchase accounting valuations associated with the BVC assets being held for sale. . $2.8 million accrual for termination of data processing contracts and write- down of computer hardware relating to the Company's long-term information services technology agreement with BISYS. . $1.3 million loss accrual for lease obligations in excess of related sublease rentals resulting from unfavorable lease agreement terms. . $1.2 million expense accrual for long-term incentive plan awards.
. $800,000 loss on sale of MBS and short sale of Treasury securities. . $500,000 additional write-down due to the sale of the Company's corporate office complex which closed in 1996. The Company had provided a write-down of $7.1 million on this property in 1995. . $350,000 write-off of core deposit intangibles and fixed assets due to a branch closure. . $300,000 accrual for downsizing loan operations, relocation of administrative functions and other items.
1995 Special Mention Items - --------------------------
The impact of special mention items for the year ended December 31, 1995, incurred primarily during the fourth quarter, was a net expense of $19.0 million ($11.3 million after tax, or $0.77 per share).
. $7.6 million write-down related to the corporate office complex, fixed assets and refurbishment expenses. . $2.0 million related to a provision for loan losses on one loan and write- down related to foreclosed properties. . $4.4 million prepayment penalties on FHLBSF advances. . $3.8 million related to impairment of intangible assets and capitalized excess servicing and other special mention items. . $1.2 million related to charges for severance payments arising from workforce reductions and pension plans.
BALANCE SHEET ANALYSIS
The Company's total assets at December 31, 1997 and 1996 were $3.2 billion and $3.3 billion, respectively.
SECURITIES INVESTMENT
The Company's securities investment activities are primarily conducted by BVB. BVB has historically purchased (no significant purchases in 1997 or 1996) securities to maintain appropriate interest-earning asset levels when sufficient high quality loan production was not available. The majority of the securities purchased are high quality MBS, primarily issued by FHLMC, FNMA, GNMA and Student Loan Mortgage Association ("SLMA"). Since MBS are collateralized by mortgages, these assets qualify under the OTS regulations requiring BVB to hold certain levels of mortgage-related assets. The Company also invests in investment securities such as U.S. government agency notes and debentures and other short-term securities.
The composition of the Company's investment securities portfolio at carrying value is summarized as follows as of the dates indicated:
The composition of the Company's MBS portfolio is summarized as follows as of the dates indicated:
The principal balances of MBS sold were $20.5 million, $57.6 million and $103.4 million for the years ended December 31, 1997, 1996 and 1995, respectively. During 1996, the Company sold $57.6 million of MBS including $2.6 million of MBS which were scheduled to mature within three months of sale. The $2.6 million
MBS was sold from the held to maturity portfolio and the remainder of $55.0 million was from the available for sale portfolio. The Company does not maintain a trading portfolio. There were no purchases of MBS during 1997, 1996 or 1995.
In November 1995, the Financial Accounting Standards Board ("FASB") issued "A Guide to Implementation of Statement of Financial Accounting Standards No. 115 ("SFAS 115") on Accounting for Certain Investments in Debt and Equity Securities - - Questions and Answers" ("Special Report"). The Special Report was issued as an aid in understanding and implementing SFAS 115. For companies that adopted SFAS 115 in financial statements issued prior to the issuance of this Special Report, if the effects of initially adopting this implementation guidance resulted in reclassification of securities between categories, the Special Report requires that such transfers be accounted for as transfers in accordance with SFAS 115. As a result, concurrent with the initial adoption of this implementation guidance, the Company reassessed the appropriateness of the classifications of all securities held at that time and, in December 1995, reclassified $147.7 million in mortgage-backed securities from held to maturity to available for sale. The transfer of the MBS was recorded at a fair value of $146.0 million with $981,000 of unrealized losses (net of tax) recorded as a separate component of stockholders' equity.
The unrealized loss on securities available for sale included in stockholders' equity was $72,000 and $713,000 (net of tax) at December 31, 1997 and 1996, respectively.
LOANS AND REAL ESTATE OWNED
Loan Portfolio Composition - --------------------------
The composition of the Company's loan portfolio (before deductions for net deferred loan origination fees, premiums and discounts and allowance for loan losses) is summarized as follows as of the dates indicated. Except as shown below, the Company did not have any loan concentrations that exceeded 10% of total loans as of December 31, 1997. The Company also did not have any loan concentrations which may result in uncertainties materially impacting its future operations.
Banking Platform
A major portion of the Banking Platform's loan portfolio consists of loans collateralized by income-producing properties, all of which are located in California, principally Northern California. Construction loans have been insignificant. During 1996, BVB discontinued its single family mortgage loan originations. The Company believes that income property lending affords an opportunity to receive interest income at yields higher than those obtainable from single.
family lending. Nevertheless, loans on income properties, particularly nonresidential properties, generally present a higher risk than do single family residential loans due to the sensitivity of the underlying property to changes in economic conditions. Management takes such risks into account when it establishes the loan rates, underwriting standards, loss allowances and decisions regarding portfolio mix.
ARMs comprise a significant portion of BVB's loan portfolio. The interest rates on ARMs may periodically rise or fall (generally based on monthly or semi- annual adjustment periods) in accordance with an independent index. At December 31, 1997, the ARM portfolio was primarily comprised of loans whose interest rates were tied to COFI, the one-year Constant Maturity Treasury Index and the six-month LIBOR rate.
Consumer Finance Platform
The Consumer Finance Platform's loan portfolio consists of prime motor vehicle loans originated by BVC and Ultra as well as motor vehicle loans purchased from Ultra Funding, Ltd. prior to the Company's acquisition of Ultra effective October 1, 1997.
Commercial Finance Platform
The Commercial Finance Platform's loan portfolio consists of commercial loans originated by CGC related to asset-based and transaction lending.
The percentage of mortgage loans to total loans for each of the years in the five-year period beginning with the period ended December 31, 1997 was 80.0%, 84.7%, 98.3%, 98.5% and 98.0%, respectively. The percentage of motor vehicle and other consumer loans to total loans for each of the years in the five-year period beginning with the period ended December 31, 1997 was 17.8%, 15.3%, 1.7%, 1.5% and 2.0%, respectively. The percentage of commercial loans to total loans at December 31, 1997 was 2.2%.
The composition of the Company's fixed and adjustable rate loan portfolios (before deductions for net deferred loan fees, premiums and discounts, and allowance for loan losses) is summarized as follows as of the dates indicated:
Loan Originations and Purchases - -------------------------------
Loans originated and purchased are summarized as follows for each of the years indicated:
(1) The Consumer Finance Platform was created with the acquisitions of BVC in June 1996 and Ultra in October 1997, and the Commercial Finance Platform was created with the acquisition of CGC in April 1997.
The shift in the Company's loan origination and purchase activity for 1997 as compared with 1996 and 1995 is consistent with management's strategy to de- emphasize mortgage activity and focus on consumer and commercial assets with higher risk-adjusted yields. Further, management's strategy is to supplement its loan production with purchases of loans with higher risk-adjusted yields than real estate loans.
Credit Quality - --------------
The Company defines nonperforming assets ("NPAs") as nonperforming loans, defaulted mortgage-backed securities, real estate owned and other repossessed assets. The Company defines nonperforming loans as loans 90 days or more delinquent (excluding accruing loans delinquent 90 days or more) and loans less than 90 days delinquent designated as nonperforming when the Company determines that the full collection of principal and/or interest is doubtful. Nonperforming assets are placed on nonaccrual status. Troubled debt restructurings ("TDRs") are real estate loans that have been modified (due to borrower financial difficulties) to allow a stated interest rate and/or a monthly payment rate lower than those prevailing in the market.
Overall credit quality has continued to improve as evidenced by significant declines in NPAs. The Company's NPAs and TDRs are summarized as follows as of the dates indicated:
NPAs and NPAs as a percentage of consolidated total assets, by business platform, are summarized as follows as of the dates indicated:
Loans delinquent 60 days or more and loans delinquent 60 days or more as a percentage of consolidated loans, by business platform, are summarized as follows as of the dates indicated:
(1) The Consumer Finance Platform was created with the acquisitions of BVC in June 1996 and Ultra in October 1997, and the Commercial Finance Platform was created with the acquisition of CGC in April 1997.
Allowance for Losses on Loans - -----------------------------
The Company conducts an ongoing review of its asset categories to assess the adequacy of the allowance for loan losses which are maintained at levels that management believes are sufficient to cover estimated possible losses in the portfolios. In determining the necessary level of the allowance for loan losses, management considers prevailing and anticipated economic conditions, historical loss experience, the levels of classified, nonperforming and delinquent assets, weighting by property type, loan portfolio trends and other factors.
The allowance for losses at December 31, 1997 was $38.5 million as compared with $36.4 million at December 31, 1996 (including approximately $7.4 million related to loans held for sale) and $30.9 million at December 31, 1995. The increase in the allowance over prior years was due to a combination of factors including reserves for the Commercial Finance Platform acquired effective April 1997, the expansion of the Consumer Finance Platform and approximately $5.6 million in reserves established in connection with the $70 million home equity portfolio purchased in August 1997.
The allowance for losses as a percentage of NPAs, gross loans and total assets is summarized as follows as of the dates indicated:
The changes in the allowance for losses on loans are summarized as follows for the years indicated:
(1) The Consumer Finance Platform was created with the acquisitions of BVC in June 1996 and Ultra in October 1997, and the Commercial Finance Platform was created with the acquisition of CGC in April 1997.
Management believes that the allowance for loan losses is adequate to cover estimated losses in its asset portfolios, although there can be no assurance in this regard. Future adjustments may be necessary and earnings could be significantly adversely affected if circumstances differ substantially from the assumptions used in making such determinations. Management will continue to monitor the adequacy of the allowance for losses related to problem assets. Management monitors the impact of the economic environment on its lending activities on a periodic basis. If real estate markets weaken in future periods, no assurance can be given that the Company's future loss experience will approximate its current estimates. In addition, various regulatory agencies review the Company's allowance for losses as an integral part of their examination process. Such agencies may require the Company to recognize additions to this allowance based on their judgment relating to information available to them at the time of their examination.
CUSTOMER DEPOSITS
As a primary part of the Company's business, deposits are gathered for purposes of funding loans and purchasing securities. A summary of customer deposits follows:
Increasing the value of its retail branch franchise is one of management's primary objectives. Management believes that a gradual expansion of its retail deposit base, particularly transaction accounts in Northern California, will enhance its results of operations by lowering its cost of funds, increasing fee income and expanding opportunities for cross-selling products and services, although there can be no assurance in this regard. Throughout 1997 and 1996, management continued to emphasize the development and marketing of new products and as a result has successfully increased its percentage of transaction accounts in relation to total retail deposits which has contributed to lower cost of funds. Transaction accounts as a percentage of total retail deposits, and excluding BVC deposits at December 31, 1996, increased to 34.6% at December 31, 1997 as compared with 30.3% and 21.3% at December 31, 1996 and 1995, respectively.
Included in total customer deposits at December 31, 1996 were deposits held by BVC, primarily comprised of thrift certificates which were similar to certificates of deposit with the exception that they were callable at par plus accrued interest. When thrift certificates were purchased by customers, BVC reserved the right to repurchase the certificates at any time upon thirty days notice. Utilizing this call provision, BVC redeemed the higher cost component (higher than BVB's incremental borrowing cost) of these deposits at face value (approximately $267 million) at December 31, 1996. The remainder of the BVC customer deposits (which were lower cost than BVB's incremental borrowing cost) were sold to BVB in June 1997.
Retail certificates of deposit of $100,000 or more, by time remaining until maturity, were as follows:
BORROWINGS
The Company utilizes collateralized advances from the FHLBSF for purposes of funding loans. In addition, the Company utilizes other borrowings, on a collateralized and noncollateralized basis, such as securities sold under agreements to repurchase (also known as reverse repurchase agreements).
In August 1997, the Company issued $100 million in subordinated notes with a stated coupon of 9.125% and a yield of 9.225% (all-in cost was 9.62% annualized). In May 1996, the Company issued $50 million in senior debentures yielding 8.42% (all-in cost was 8.91% annualized).
The Company's borrowings are summarized as follows:
The increases in borrowings at December 31, 1997 was primarily due to a decrease in customer deposits. In late 1995, management redirected BVB's strategic focus to restructure the wholesale borrowings in conjunction with the enhancement of its retail deposit franchise. In the fourth quarter of 1995 and the first quarter of 1996, BVB prepaid $190 million of short-term high cost borrowings and replaced them with short-term lower cost borrowings. In conjunction with the prepayment of these borrowings, the Company entered into interest rate swap agreements to provide interest rate risk protection for the short-term lower cost borrowings by matching the floating interest rate characteristics and lengthening their maturities.
The Company's short-term borrowings are summarized as follows:
The following table sets forth the maximum outstanding balance for each type of short-term borrowing at any month end during 1997, 1996 and 1995, and the average balances and weighted average interest rates on short-term borrowings for 1997, 1996 and 1995:
LIQUIDITY AND REGULATORY CAPITAL
Liquidity
The Company's primary sources of funds include: . Cash flows from operations . Loan and MBS repayments . Customer deposits . Advances from the FHLBSF . Reverse repurchase agreements
The Company uses its liquidity resources principally as follows: . Originations and purchases of loans . Funding the withdrawal of certificates of deposits and other deposit products . Repayment and/or refinance of maturing FHLBSF advances and reverse repurchase agreements
The Company expects the foregoing sources of funds will satisfy its liquidity requirements. However, to the extent that the Company seeks to make additional acquisitions, it may be required to seek additional sources of outside financing.
OTS regulations require savings institutions to maintain a specified liquidity ratio (presently 4.00%) of cash and securities to total customer deposits and borrowings due in one year or less. Historically, BVB has maintained its liquid assets above the minimum requirements imposed by the OTS regulations and at a level believed adequate to meet requirements imposed by the OTS regulations and at a level believed adequate to meet requirements of normal banking activities, repayment of maturing debt and potential deposit outflows. BVB maintained liquidity ratios of 5.42% and 5.39% for the months ended December 31, 1997 and 1996, respectively.
REGULATORY CAPITAL
BVB's regulatory capital at December 31, 1997 exceeded the minimum requirements of each OTS regulatory capital standard on a fully phased-in basis as follows:
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires each Federal banking agency, including the OTS, to implement prompt corrective actions for under capitalized institutions that it regulates. Under capital guidelines enacted by FDICIA, BVB met the criteria for the "well capitalized" standard at December 31, 1997 as follows:
YEAR 2000
The Year 2000 issue arises from computer programs that were written using two digits rather than four to define the applicable year. As a result, computer programs with time-sensitive software may have a difficult time distinguishing between the year 2000 and the year 1900, causing potential disruptions of operations, including among other things, potential miscalculations or inability to process transactions.
The majority of the Company's EDP processing capabilities are either currently provided by third party vendors or are on systems that are in the process of converting to third party vendors. Contracts with each of these vendors require that the vendor be Year 2000 compliant. The Company continues to monitor these vendors' progress towards Year 2000 compliance. Additionally, the Company is evaluating all internal systems for potential Year 2000 compliance issues. The Company currently estimates that its total internal and external costs associated with making these internal systems Year 2000 compliant will be approximately $750,000 which will be funded through operating cash flows.
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income", which requires that an enterprise report, any major components and as a single total, the change in its net assets during the period from nonowner sources; and Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures About Segments of an Enterprise and Related Information", which establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas, and major customers. Adoption of these statements will not impact the Company's consolidated financial position, results of operations or cash flow, and any effect will be limited to the form and content of its disclosures. Both statements are effective for fiscal years beginning after December 15, 1997, with earlier application permitted.
IMPACT OF INFLATION AND CHANGING PRICES
The Company's consolidated financial statements presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time, due to the fact that almost all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than general levels of inflation. Interest rates do not necessarily move in the same direction or magnitude as the prices of goods and services.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - --------------------------------------------------------------------
ASSET AND LIABILITY MANAGEMENT
The objective of the Company's asset/liability management activities is to improve earnings by adjusting the type and mix of assets and liabilities to effectively address changing conditions and risks. Through overall management of its balance sheet and by controlling various risks, the Company seeks to optimize its financial returns within safe and sound parameters. The Company's operating strategies for attaining this objective include:
. Managing net interest margin through appropriate risk/return pricing of assets and liabilities. . Increasing retail deposits as a percentage of interest-bearing liabilities and reducing the Company's cost of funds. . Utilizing the Company's strong capital position to boost the earnings power through acquisition of quality assets with higher risk-adjusted yields. . Controlling noninterest expense and enhancing noninterest income, utilizing improved information systems to facilitate the analysis of the profitability of individual business units and products. . Utilizing interest rate swap agreements and other hedging strategies to reduce exposure to fluctuations in interest rates. . Enhancing internal analysis capability for measuring, evaluating and monitoring risk.
INTEREST RATE RISK
Financial institutions are subject to interest rate risk to the degree that interest-bearing liabilities reprice or mature on a different basis and at different times than interest-earning assets. The Company's strategy has been to reduce the sensitivity of its earnings to interest rate fluctuations by more closely matching the effective maturities or repricing characteristics of its assets and liabilities. Certain assets and liabilities, however, may react in different degrees to changes in market interest rates. Further, interest rates on certain types of assets and liabilities may fluctuate prior to changes in market interest rates, while rates on other types may lag behind. Additionally, certain assets, such as ARMs, have features, including payment and rate caps, which restrict changes in their interest rates. The Company considers the anticipated effects of these factors when implementing its interest rate risk management objectives.
The Company pursues balance sheet strategies that should, in the long run, mitigate its exposure to rising interest rates. The Company also considers other strategies to minimize the variability of the net interest margin including off-balance sheet activities. The Company has initiated numerous actions which significantly reduced the Company's exposure to fluctuations in interest rates. These actions are discussed as follows.
Interest Rate Swaps - -------------------
The Company uses interest rate swap agreements to reduce the interest rate fluctuation risk related to certain assets and liabilities. Interest rate swaps involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying notional amounts. At December 31, 1997 and 1996, the Company was party to interest rate swap agreements with notional principal amounts of $449 million and $421 million, respectively, which involve the receipt of floating interest rates (based on 3-month LIBOR) and payment of fixed interest rates on the underlying notional amounts.
During the fourth quarter of 1995, the Company prepaid $45 million of its short-term high cost borrowings. In addition, the Company committed to prepay another $145 million of its short-term high cost borrowings in February 1996. As a result, the Company incurred a prepayment charge of $2.5 million (net of applicable income taxes). In conjunction with the prepayment of these borrowings, the Company entered into interest rate swap agreements with notional principal amounts of $200 million. The impact of these actions was a reduction of the Company's interest rate risk exposure by prepaying its short-term high cost borrowings and replacing the
prepayments with short-term lower cost borrowings. The interest rate swap agreements were used to provide interest rate risk protection for the short-term borrowings by matching the floating interest rate characteristics and lengthening their maturities.
Sale of MBS - -----------
During 1997 and 1996 the Company sold $20.5 million and $57.6 million of fixed rate MBS. The purpose of the sales was to reduce the Company's exposure to interest rate increases. Additionally, during the fourth quarter of 1995 the Company reclassified $148 million of its MBS from held to maturity to available for sale as a result of adopting the implementation guide to SFAS 115. This reclassification allowed the Company to position these securities for potential sale, which assisted in the reduction of its interest rate risk exposure without tainting its remaining held to maturity portfolio.
Hedging Issuance of Subordinated Debt - -------------------------------------
During 1997, the Company entered into $105 million in Treasury rate lock agreements to hedge the anticipated issuance of subordinated debt. These agreements guaranteed a stated rate of interest for a stated period of time and the Company paid the difference between the lock rate and the effective treasury rate on the settlement date. In conjunction with the Treasury rate lock agreements, approximately $307,000 was deferred and recognized as an adjustment of interest expense over the life of the subordinated debt.
Hedging Auto Loans Pending Securitization - -----------------------------------------
As discussed elsewhere herein, in conjunction with the decision to sell BVC's auto loans and their subsequent securitization by BVSC, management entered into a short sale of Treasury securities that materially insulated the purchase accounting valuations from movements in interest rates. The short sale transaction was paired-off in December 1996 with a loss of $293,000 recorded as a loss on securities. At December 31, 1996, a Treasury rate lock transaction with a notional principal amount of $210 million was entered into to hedge the auto loans pending sale by BVC and securitization by BVSC.
INTEREST RATE SENSITIVITY
The Company's interest rate risk policies are established and monitored by its Asset/Liability Committee ("ALCO"). The ALCO reviews the sensitivity of the Company's net interest income and market value of equity to interest rate changes. The objective of the Company's ALCO activities is to improve earnings by adjusting the types of assets and liabilities to effectively address changing conditions and risks. Management believes that its asset/liability activities have improved earnings within safe and sound parameters.
In measuring interest rate sensitivity, the Company uses simulation modeling to estimate the potential effects of movements in interest rates. Interest rate sensitivity analysis measures the Company's interest rate risk by computing estimated market value of equity ("MVE") based on the net present value of cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. MVE is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 400 basis point increase or decrease in market interest rates.
The following table presents BVB's projected change in MVE, with and without interest rate swaps, for the various basis points ("bp") rate shock levels at December 31, 1997. All market risk sensitive instruments presented in this table are held to maturity or available for sale. The Company has no trading securities.
The change in MVE as a percentage of the present value of assets from an immediate 200 bp increase in interest rates was 0.59% and 1.15% at December 31, 1997 and 1996, respectively.
The computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Company may undertake in response to changes in interest rates. Certain shortcomings are inherent in the method of analysis presented in the computation of MVE. Actual values may differ from those projections set forth in the table, should market conditions vary from assumptions used in the preparation of the table.
To measure the Company's interest rate sensitivity, a cumulative gap measure can also be used to assess the impact of potential changes in interest rates on net interest income. The repricing gap represents the net position of assets and liabilities subject to repricing in specified time periods. Assets and liabilities are categorized according to the expected repricing time frames based on management's judgment. A cumulative gap measure alone cannot be used to evaluate interest rate sensitivity because interest rate changes do not affect all categories of assets and liabilities equally or simultaneously.
The following table sets forth information regarding asset and liability repricing for the Company as of December 31, 1997:
(1) Based on assumed annual prepayment and amortization rates which approximate the Company's historical experience.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(1) Substantially restricted.
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying financial statements include the consolidated accounts of Bay View Capital Corporation, a holding company incorporated in Delaware (the "Company" or "BVCC"), and its wholly owned subsidiaries: Bay View Bank ("BVB"), Bay View Acceptance Corporation ("BVAC") and its wholly owned subsidiaries, Bay View Credit ("BVC"), formerly California Thrift & Loan ("CTL") and Ultra Funding, Inc. ("Ultra"), Concord Growth Corporation ("CGC"), Bay View Securitization Corporation ("BVSC"), a Delaware corporation and Regent Financial Corporation ("Regent"), a California corporation. All significant intercompany accounts and transactions have been eliminated. As used herein, the terms "Company" or "BVCC" refer to the Company and its consolidated subsidiaries unless otherwise indicated.
Nature of Operations
The Company is a diversified financial services company headquartered in San Mateo, California. BVB is a federally chartered capital stock savings bank with 27 full-service community banking centers throughout the San Francisco Bay Area. BVC and Ultra operate as consumer finance companies throughout California, Texas and the Western United States. CGC operates as a commercial finance company throughout the United States. BVSC was formed for the purpose of issuing asset-backed securities through a trust. Regent provides item processing services.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash equivalents consist of highly liquid financial instruments, with maturities of 90 days or less at the time of purchase, that are readily convertible into cash and have insignificant interest rate risk.
Loans Receivable
Loans receivable originated or purchased by the Company are identified as either held for sale or held for investment at, or soon after, origination or purchase and are recorded at cost net of discounts, deferred loan origination fees, and allowance for loan losses as applicable. Loans receivable held for investment are carried at amortized cost and are not adjusted to the lower of cost or market because management intends and the Company has the ability, to hold these loans to maturity. Interest is accrued as income only to the extent considered collectible. Generally, the Company discontinues interest accruals on loans 90 days or more past due. Interest income on nonaccrual loans is measured on a cash basis. Loans classified as held for sale are carried at the lower of cost or market on an aggregate basis by property type. Market value for these loans is based on prices for similar loans in the secondary loan market.
The Company charges fees for originating loans at the time the loan is granted. The Company recognizes these loan origination fees, net of certain direct costs, as a yield adjustment over the life of the related loan using the interest method. Amortization of net deferred loan origination fees are discontinued on nonperforming loans. When a loan is sold or paid off, any unamortized net loan origination fees are included in income at that time.
Statement of Financial Accounting Standards No. 114 ("SFAS 114"), "Accounting by Creditors for Impairment of a Loan" as amended by Statement of Financial Accounting Standards No. 118 ("SFAS 118"), "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures" was effective January 1, 1995. A loan is impaired when, based on current information and events, it is probable that the Company is unable to collect all amounts due according to the contractual terms of the loan agreement. The Company considers nonperforming loans and troubled debt restructurings as impaired loans. Nonperforming loans are defined as loans 90 days or more delinquent (excluding accruing loans delinquent 90 days or more) and loans less than 90 days delinquent when the Company determines that full collection of principal and interest is doubtful. Troubled debt restructurings are loans which have been modified based on interest rate concessions and/or payment concessions. SFAS 114 is not applicable to large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment. The Company considers its single family residential and consumer loans as homogeneous loans for purposes of the application of SFAS 114.
Charge-offs are recorded when the measure of the impaired loan is less than the recorded investment in the loan. In determining charge-offs for specific loans, management evaluates its loans on an individual basis that includes assessing the creditworthiness and financial status of the borrower and analyzing cash flows and current property appraisals. SFAS 114 requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The Company's impaired loans are measured based on the fair value of the collateral because they are collateral dependent.
SFAS 118 allows a creditor to use existing methods for recognizing interest income on an impaired loan. The Company recognizes interest income on impaired loans on a cash basis.
Allowance for Loan Losses
Allowances for loan losses are maintained at levels that management deems adequate to cover estimated losses and are continually reviewed and adjusted. The Company adheres to an internal asset review system and an established loan loss reserve methodology. Management evaluates factors such as the prevailing and anticipated economic conditions, historic loss experiences, composition of the loan portfolio by property type, levels and trends of classified loans and loan delinquencies in assessing overall valuation allowance levels to be maintained.
While management uses currently available information to provide for losses on loans, additions to the allowance may be necessary based on new information and/or future economic conditions. When the property collateralizing a delinquent mortgage loan is foreclosed on by the Company and transferred to real estate owned, the difference between the loan balance and the fair value of the property less estimated selling costs is charged-off against the allowance for loan losses.
Loan Sales and Servicing
In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 125 ("SFAS 125"), "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement establishes standards under which, after a
transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. Under SFAS 125, the Company records a servicing asset for the present value of the retained interest in a transferred asset representing servicing fees net of related costs. Any retained interest in excess of such servicing fees is recorded on a net present value basis as an available for sale security and stated at fair value. SFAS 125 was effective, on a prospective basis, for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996. Prior to January 1, 1997, when a participating interest in loans sold had an average contractual interest rate, adjusted for normal servicing fees, which was different than the agreed upon yield to the purchaser, the sales price was adjusted by the present value of the differential for the estimated remaining life of the loans (capitalized excess servicing). Any resulting net premium or discount is amortized to interest income over the estimated remaining life of the loans based on a methodology that approximates the effective interest yield method. The aggregate amount of unamortized premiums arising from loan sales was $1.2 million and $575,000 at December 31, 1997 and 1996, respectively and is included as other assets. At December 31, 1997, there was no impairment relating to servicing assets. Amortization of servicing assets and any related impairments are included in noninterest income as incurred. Gains or losses on the sale of loans are recognized at the time of sale.
Securities
Statement of Financial Accounting Standards No. 115 ("SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities" establishes the classification of investments into three categories: held to maturity, available for sale and trading. Securities classified as held to maturity are recorded at amortized cost because management intends and the Company has the ability to hold these securities to maturity. Securities classified as available for sale are reported at fair value. Fair value for these securities is obtained principally from published information or quotes by registered securities brokers. Securities for which quotes are not readily available are valued based on the present value of discounted estimated future cash flows. The Company does not have a trading portfolio.
Securities are identified as either available for sale or held to maturity at, or soon after, purchase and are accounted for accordingly. Net unrealized gains and losses on securities available for sale are excluded from earnings and reported net of applicable income taxes as a separate component of stockholders' equity until realized. Gains and losses on sales of securities are recorded in earnings at the time of sale and are determined by the difference between the net sale proceeds and the amortized cost of the security, using the specific identification method.
Discounts and premiums on securities are amortized using a method approximating the interest method over the estimated life of the security, adjusted for actual prepayments. Interest on securities is accrued as income only to the extent considered collectible.
In November 1995, the FASB issued "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities Questions and Answers" ("Special Report"). The Special Report was issued as an aid in understanding and implementing SFAS 115. For companies that adopted SFAS 115 prior to the issuance of this Special Report and the effects of adoption resulted in reclassification of securities between categories, the guidance stipulated that the transfers should be accounted for in accordance with SFAS 115. As a result, concurrent with the initial adoption of the Special Report, the Company reassessed the appropriateness of its classifications for all securities held at that time and, in December 1995, reclassified $147.7 million in mortgage-backed securities from held to maturity to available for sale. The transfer was recorded at a fair value of $146.0 million with $981,000 of unrealized losses (net of tax) recorded as a separate component of stockholders' equity.
Real Estate Owned
Real estate owned is comprised of property acquired through foreclosure and is recorded at the lower of cost (i.e., net loan value) or fair value less estimated costs to sell, as of the date of foreclosure. Thereafter, specific valuation allowances are established for adverse changes in the fair value of the underlying assets.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on the straight-line basis over the estimated useful lives for each of the various asset categories.
Intangibles
Core deposit premiums arise from the acquisition of deposits and are amortized on a straight-line basis over the estimated life of the deposit base acquired, generally eight years. The Company continually evaluates the periods of amortization to determine whether later events and circumstances warrant revised estimates. In addition, the market value of core deposit premiums is established on an annual basis to evaluate the recoverability of its carrying value for inclusion as a component of regulatory capital.
Goodwill represents the excess of cost over the fair value of net assets acquired. Goodwill is amortized to expense over a period no greater than the estimated remaining life of the long-term interest-earning assets acquired. If the assets acquired do not include a significant amount of long-term interest- earning assets, goodwill is amortized over a period that does not exceed the estimated remaining life of the existing customer deposit base. Goodwill is amortized on a straight-line basis over a period of up to 15 years. If it becomes probable that the estimated undiscounted future cash flows will be less than the carrying amount of goodwill, a reduction in the carrying amount is recognized.
Impairment of Long-Lived Assets
Long-lived assets and certain identifiable intangibles to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss for long-lived assets and identifiable intangibles that management expects to hold and use are based on the fair value of the asset. Long-lived assets and certain identifiable intangibles to be disposed of are reported at the lower of carrying amount or fair value less cost to sell.
Securities Sold Under Agreements to Repurchase
The Company enters into sales of securities under agreements to repurchase (reverse repurchase agreements) which are considered financing activities. The obligations to repurchase the securities are reflected as liabilities, and the related underlying securities for the agreements, which are pledged as collateral and held by the counterparties, are included in the Company's securities portfolio as recorded assets.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The effect on deferred taxes for a change in tax rates is recognized in income during the period of enactment.
Derivative Financial Instruments
The Company uses interest rate derivative financial instruments (e.g., swaps and treasury rate locks) primarily to hedge mismatches in the rate and maturity of loans and their funding sources and reduce interest rate risk on anticipated transactions. These instruments serve to reduce rather than increase the Company's exposure to movements in interest rates. At the inception of the hedge, the Company identifies an individual asset, liability, or anticipated transaction or an identifiable group of essentially similar assets or liabilities that expose the Company to interest rate risk at the consolidated or subsidiary level. Interest rate derivatives are accounted for by the deferral or accrual method only if they are designated as a hedge and are expected to be and are effective in substantially reducing interest rate risk arising from the assets, liabilities or anticipated transactions identified as exposing the Company to risk. Treasury rate locks must meet specific correlation tests (i.e., the change in their fair values must be within 80 to 120 percent of the opposite change in the fair values of the anticipated transactions). For interest rate swaps, their notional amount, interest rate index and life must closely match the related terms of the hedged assets or liabilities. If periodic assessment indicates derivatives no longer provide an effective hedge, the derivatives are closed out or settled; previously unrecognized hedge results, and the net settlement upon close-out or termination that offset changes in value of the hedged asset or liability are deferred and amortized over the life of the asset or liability with excess amounts recognized in noninterest income.
Amounts payable or receivable for interest rate swaps are accrued with the passage of time, the effect of which is included in the interest income or expense reported on the hedged asset or liability. If a hedged asset or liability settles before maturity of the hedging interest rate derivatives, the derivatives are closed out or settled, and previously unrecognized hedge results and the net settlement upon close-out or termination are accounted for as part of the gains and losses on the hedged asset or liability. If interest rate derivatives used in an effective hedge are closed out or terminated before the hedged item settles, previously unrecognized hedge results and the net settlement upon close-out or termination are deferred and amortized over the life of the hedged asset or liability.
When an anticipated transaction occurs, the derivatives hedging the anticipated transaction are closed out or settled, and previously unrecognized hedge results and the net settlement upon close-out or termination are deferred and amortized over the life of the hedged asset or liability. If the anticipated transaction is a sale of assets, the derivatives hedging the anticipated transaction are closed out or settled, and previously unrecognized hedge results and the net settlement upon close-out or termination are accounted for as part of the gains and losses on the sale of the hedged asset. If the anticipated transaction does not occur, the derivatives hedging the anticipated transaction are closed out or settled, and are accounted for as gains and losses on the hedge.
The Company is also exposed to loss of future interest differential payments (credit risk) in the event of nonperformance by the counterparties to the interest rate exchange agreements. The Company manages the credit risk of its interest rate exchange agreements by maintaining exposure limits and adhering to a strict counterparty selection process. The Company does not anticipate nonperformance by the other parties.
Stock-Based Compensation
The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion ("APB") No. 25 "Accounting for Stock Issued to Employees".
Earnings (Loss) Per Share
In March 1997, the FASB issued Statement of Financial Accounting Standards No. 128, "Measurement of Earnings Per Share" ("SFAS 128"). SFAS 128 replaces Primary and Fully Diluted Earnings Per Share ("EPS") with Basic EPS and Diluted EPS for fiscal years ending after December 15, 1997. Basic EPS is calculated by dividing net earnings for the period by the weighted-average common shares outstanding for that period. There is no adjustment to the number of outstanding shares for dilutive instruments, such as stock options. Diluted EPS takes into account the dilutive impact of such instruments and uses the average share price for the period in determining the number of incremental shares to add to the weighted average number of shares outstanding.
All prior period earnings per share amounts have been restated to reflect the adoption of SFAS 128. The basic and diluted loss per share for 1995 were calculated using the weighted average number of shares outstanding, excluding the impact of dilutive potential common shares.
The calculation of basic and diluted earnings per share is summarized as follows:
Recent Accounting Pronouncements
In June 1997, the FASB issued Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income," which requires that an enterprise report any major components and as a single total, the changes in its assets during the period from nonowner sources; and Statement of Financial Accounting Standard No. 131, "Disclosures About Segments of an Enterprise and Related Information," which establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas, and major customers. Adoption of these statements will not materially impact the Company's consolidated financial position, results of operations or cash flows, and any effect will be limited to the form and content of its disclosures. Both statements are effective for fiscal years beginning after December 15, 1997, with earlier application permitted. Management has not yet determined its operating segments approach to SFAS 131.
Reclassification
Certain reclassifications have been made to the prior year balances in order to conform to the current year presentation.
NOTE 2. MERGER-RELATED ACTIVITY
California Thrift & Loan
Effective June 1, 1996, the Company acquired all the outstanding stock of CTL Credit, Inc. and its wholly owned subsidiary California Thrift & Loan for cash.
CTL was an FDIC-insured California industrial loan company with a specific focus on consumer lending. The acquisition was accounted for using the purchase method of accounting in accordance with APB No. 16, "Business Combinations". In an acquisition accounted for as a purchase, the purchase price is allocated to assets acquired and liabilities assumed based on their estimated fair values at the time of consummation of the transaction.
The Company issued $50 million of 8.42% Senior Debentures in May 1996 of which a portion was used to partially finance the acquisition.
The aggregate acquisition purchase price of approximately $62 million exceeded the estimated fair value of net assets acquired by approximately $7 million and is being amortized on a straight-line basis over seven years. Results of operations for the acquired entity have been included in the Company's consolidated financial statements commencing as of the effective date of acquisition.
Effective December 31, 1997, CTL was de-regulated and renamed Bay View Credit. BVC is a subsidiary of BVAC, a subsidiary of BVB. All references to this subsidiary from this point forward will reflect its new name, Bay View Credit.
Concord Growth Corporation
The Company completed its acquisition of EXXE Data Corporation ("EXXE") and its wholly owned commercial finance subsidiary, Concord Growth Corporation, on March 17, 1997. At the close of the transaction, EXXE became a stand-alone subsidiary of the Company. Subsequent to the close of the transaction, EXXE was merged into CGC and liquidated and CGC became a first-tier stand-alone subsidiary of the Company. The former holders of EXXE capital stock, warrants and options received an initial aggregate payment of $19.8 million and will be entitled to potential future cash payments, of up to $34 million, depending upon the financial performance of CGC. The acquisition was accounted for as a purchase effective April 1, 1997. The aggregate costs exceeded the fair value of the net assets acquired by approximately $21 million, which was recorded as goodwill and which is being amortized on a straight-line basis over a 15-year period.
Ultra Funding, Inc.
Effective October 1, 1997, the Company, through its newly formed subsidiary, Ultra Funding, Inc., acquired the origination capabilities and certain assets of Ultra Funding, Ltd. of Austin, Texas. The purchase price exceeded the fair value of net assets acquired by approximately $400,000, which is being amortized on a straight-line basis over a 7-year period.
America First Eureka Holdings, Inc.
The Company completed its acquisition of America First Eureka Holdings, Inc. ("AFEH") and its wholly owned subsidiary EurekaBank, a Federal Savings Bank, on January 2, 1998. Pursuant to the Merger Agreement, the Company paid $90 million in cash and $210 million in stock (8,076,923 shares of the Company's common stock) to America First Financial Fund 1987-A Limited Partnership, the sole shareholder of AFEH, for a total purchase price of $300 million. The number of shares issued was based on the average value of the Company's common stock for the 20 full trading days ending on the fifth business day prior to the merger closing date. Based on the average value of $34.3031 during this period, pursuant to the Merger Agreement, the number of shares issued was determined by dividing the $210 million stock portion of the purchase price by $26.00 per share.
The acquisition of AFEH will be accounted as a purchase effective January 2, 1998. The amount of goodwill to be recorded as of the merger date is expected to be $98 million which will be amortized on a straight-line basis over 20 years and which excludes core deposit intangibles estimated at $12 million. This goodwill amount represents the preliminary estimate of the excess of the acquisition costs over the fair value of assets acquired and liabilities assumed based on information available as of this date. No assurance can be given that the final goodwill amount will not be more or less than the estimated amount.
NOTE 3. CASH AND CASH EQUIVALENTS
The Company's cash and cash equivalents are summarized as follows:
Generally, the Company's banking depositories either pay interest on deposits or apply an imputed interest credit to deposit balances which is used as an offset to charges for banking services rendered. The Company has no compensating balance arrangements or lines of credit with banks. Cash balances for BVB required to be held at the Federal Reserve Bank totaled approximately $1.4 million and $5.5 million at December 31, 1997 and 1996, respectively. There were no similar cash balance reserve requirements for BVC.
NOTE 4. INVESTMENT SECURITIES
The Company's investment securities are summarized as follows:
The Company's debt security held to maturity at December 31, 1997 has a weighted average yield of 6.40% and matures in 2000. The weighted average yield of investment securities available for sale and held to maturity at December 31, 1996 was 5.29% and 6.67%, respectively.
There were no sales of investment securities during 1997, 1996 and 1995. The Company's investment in Federal Home Loan Mortgage Corporation ("FHLMC") notes and debentures of $10.0 million was called at par in 1997 and the Company's FHLMC preferred stock of $1.0 million was redeemed by FHLMC at book value in 1997.
In conjunction with the securitization of BVC's auto loan portfolio in January of 1997, BVC entered into a short sale of Treasury securities during the fourth quarter of 1996 to hedge the valuations from movements in interest rates. A loss of $293,000 was recorded in the fourth quarter of 1996 associated with the close out of this short sale of Treasury securities.
NOTE 5. MORTGAGE-BACKED SECURITIES
The Company's mortgage-backed securities are summarized as follows:
The weighted average yields of mortgage-backed securities ("MBS") available for sale and held to maturity at December 31, 1997 were 6.84% and 6.44%, respectively. The weighted average yields of MBS available for sale and held to maturity at December 31, 1996 were 6.61% and 6.44%, respectively.
There were no adjustable rate MBS as of December 31, 1997. At December 31, 1996, the amount of adjustable rate MBS was $664,000. The Company uses MBS as full or partial collateral for borrowings. The total amount of pledged MBS at December 31, 1997 and 1996 was $455.7 million and $560.0 million, respectively.
Proceeds from sales of MBS available for sale during 1997 were $20.5 million. Gross gains of $13,000 and gross losses of $13,000 were realized on those sales. There were no sales of MBS held to maturity during 1997. Proceeds from sales of MBS available for sale during 1996 were $54.5 million. Gross gains of $411,000 and gross losses of $918,000 were realized on those sales. Proceeds from the sale of MBS held to maturity (scheduled to mature within three months from sale date) during 1996 was $2.6 million and there was no gain or loss on this sale. Proceeds from sales of MBS available for sale during 1995 were $101.2 million. Gross gains of $688,000 and gross losses of $2.9 million were realized on those sales.
The following table sets forth the remaining contractual terms to maturity of the Company's MBS portfolio as of December 31, 1997:
NOTE 6. LOANS RECEIVABLE
The Company originates loans for the purpose of enabling borrowers to purchase or refinance multifamily (five or more units) and nonresidential real estate through its wholly owned subsidiary, BVB. During 1996, management re-directed its business lending practices and de-emphasized its focus on single family real estate lending. As a result, the Company discontinued its loan origination operations for those specific products. BVB's loans receivable are primarily secured by real property located in Northern California with the heaviest concentration in the counties of San Mateo, San Francisco and Santa Clara. Although BVB has a diversified loan portfolio, the geographic concentration of its borrowers implies a dependence on the regional economy and local real estate markets. The loan portfolio for BVC and Ultra consist primarily of motor vehicle loans, while CGC's loan portfolio consists of loans secured by receivables and equipment. BVC's motor vehicle loans were classified as held for sale at December 31, 1996, because they were subsequently sold to BVSC for securitization.
The Company's loans receivable, which includes loans held for sale, are summarized as follows:
During the first quarter of 1997, $253 million of BVC's motor vehicle loans were sold and securitized. The BVC motor vehicle loan portfolio was recorded at its fair value upon acquisition assuming that such loans would be securitized and sold. As a result the $925,000 gain recorded on the sale was related to the change in market interest rates between the acquisition date of BVC and the sale and securitization of the loans. At December 31, 1997, BVC is servicing $145 million of these motor vehicle loans. The Company discontinued the sale and securitization of BVC's motor vehicle loans in conjunction with the announcement of the EurekaBank acquisition in May 1997.
BVB has historically sold (none in 1997 or 1996) mortgage loans to the secondary market and usually retained responsibility for servicing the loans. At December 31, 1997, 1996 and 1995, BVB serviced participating interests in loans sold of $372.0 million, $412.4 million, and $466.5 million, respectively.
The Company has agreed to modifications of certain multifamily and nonresidential mortgage loans. The modifications have taken the form of interest rate concessions, and/or payment concessions. Such loan modifications are considered troubled debt restructurings (see Note 1) and are entered into with the objective of maximizing the Company's long-term recovery of the investment in the loan when a
borrower is experiencing financial difficulties. The Company has no commitments to lend additional funds to borrowers whose loans were so modified. In the aggregate, the Company's investment in troubled debt restructurings (excluding troubled debt restructurings classified as nonaccrual loans) was $731,000 and $509,000 at December 31, 1997 and 1996, respectively. Interest income with respect to these loans, under their original terms, as well as actual interest recognized, was not significant in 1997 or 1996. Under their original terms, interest income with respect to these would have been $1.1 million in 1995, while actual interest recognized by the Company on these modified loans was $1.1 million in 1995.
At December 31, 1997 and 1996, nonaccrual loans totaled $11.0 million and $16.1 million, respectively. Interest on nonaccrual loans that was not recorded in income was $209,000, $735,000 and $623,000 for the years ended December 31, 1997, 1996, and 1995, respectively. Actual interest recognized by the Company on these nonaccrual loans was not significant in 1997, 1996 or 1995. At December 31, 1997, the Company had no commitments to lend additional funds to these borrowers.
The average investment in impaired loans during 1997 and 1996 was $13.9 million and $15.1 million, respectively. Impaired loans recorded in accordance with SFAS 114 consist of nonperforming loans (see Note 1) and troubled debt restructurings and are summarized as follows:
The changes in the Company's allowance for loan losses are summarized as follows:
Allowance for loan losses was provided for all impaired loans at December 31, 1997 and 1996. The portion of the total allowance for loan losses that was attributable to impaired loans was $1.7 million and
$1.9 million at December 31, 1997 and 1996, respectively. Provision for loan losses, charge-offs and recoveries relating to impaired loans were $2.0 million, $8.4 million and $1.8 million for the year ended December 31, 1997, respectively, $1.9 million, $6.4 million and $0.6 million for the year ended December 31, 1996, respectively, and $4.3 million, $4.9 million and $1.5 million for the year ended December 31, 1995, respectively.
To facilitate the sale of real estate loans, the Company has in the past occasionally offered a recourse guaranty on loans sold whereby the Company agreed to repurchase or substitute loans that became 90 days delinquent. In addition, the Company on occasion subordinated its retained participation interest in sold loans. At December 31, 1997 and 1996, the Company had outstanding recourse and subordination contingencies relating to principal of $50.9 million and $54.3 million, respectively, on sold mortgage loans.
At December 31, 1997 and 1996, mortgage loans aggregating $1.24 billion and $1.13 billion respectively, were pledged as collateral for advances from the FHLBSF.
NOTE 7. PREMISES AND EQUIPMENT
The Company's premises and equipment are summarized as follows:
During the fourth quarter of 1995, the Company recorded a charge of $7.1 million to adjust the carrying amount of the land and building of its San Mateo, California corporate office complex to its estimated fair value less costs to sell as a result of its decision to pursue a sale of the complex. The Company recorded additional charges of $500,000 as a result of the sale of the complex in September 1996. During 1996, the Company wrote off $1.2 million of computer hardware equipment as a result of new specifications relating to the Company's long-term information services technology agreement with an outside data processing services vendor. Depreciation and amortization expense for the years ended December 31, 1997, 1996 and 1995 was $3.0 million, $2.2 million and $3.1 million, respectively.
NOTE 8. INTANGIBLE ASSETS
The Company's intangible assets are summarized as follows:
During the fourth quarter of 1995, core deposit premiums of $854,000 were written-off for the year ended December 31, 1995 resulting from an impairment in the value of core deposit premiums that was attributable to higher than expected decay rates in the customer deposits acquired. The balance of core deposit premiums was subsequently amortized over its remaining useful life. Amortization expense for core deposit premiums was $2.1 million, $2.0 million and $1.9 million for the years ended December 31, 1997, 1996 and 1995, respectively.
During the fourth quarter of 1995, BVB explored the sale and/or exchange of certain of its acquired branches which had purchased goodwill dating from 1981. Based on offers received and management's estimate of undiscounted future cash flows, it was determined that the recovery of the goodwill associated with these branches was no longer recoverable and related unamortized goodwill of $758,000 was written off in 1995. Amortization expense for goodwill was $2.0 million, $581,000 and $396,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
NOTE 9. CUSTOMER DEPOSITS
The Company's customer deposits are summarized as follows:
Noninterest bearing deposits were $27.2 million and $24.6 million as of December 31, 1997 and 1996, respectively. Customer deposits at December 31, 1997 included certificates of deposit scheduled to mature as follows:
Interest expense on customer deposits, by deposit type, is summarized as follows (including BVC effective June 1, 1996):
At year-end 1996, BVC redeemed approximately $267 million of customer deposits at face value. In June 1997, BVC sold substantially all of its remaining deposits to BVB.
NOTE 10. ADVANCES FROM THE FEDERAL HOME LOAN BANK OF SAN FRANCISCO
At December 31, 1997 and 1996, BVB had the following advances outstanding with the following maturities and rates:
FHLBSF advances at December 31, 1997 included $5 million of borrowings maturing in 1998 at interest rates that reset monthly based on the Eleventh District Cost of Funds Index and $20 million of borrowings maturing in 2001 at interest rates that reset semi-annually based on the 6-month LIBOR rate. FHLBSF advances were collateralized by loans and MBS totaling $1.7 billion at both December 31, 1997 and 1996.
BVB is a member of the Federal Home Loan Bank System. As a member, BVB is required to purchase stock in the FHLBSF at an amount equal to the greater of 1% of BVB's residential mortgage loans or 5% of outstanding FHLBSF advances. The stock is purchased at par value ($100 per share) and shares of stock held in excess of the minimum requirement may be sold back to the FHLBSF at par value. BVB records its investment in FHLBSF stock at cost (par value). At December 31, 1997, BVB's investment was $58.5 million and its minimum required investment was $55.5 million. At December 31, 1997, BVC's investment in FHLBSF stock was $2.5 million. The stock is pledged as collateral for advances from the FHLBSF. The FHLBSF generally declares quarterly stock dividends. The amount of FHLBSF dividends recorded in income during the years ended December 31, 1997, 1996 and 1995 was $3.4 million, $2.5 million, and $2.2 million, respectively.
As part of its asset/liability management strategy to reduce interest rate risk exposure, the Company prepaid $45 million of its advances from the FHLBSF, and during the fourth quarter of 1995, committed to prepay $145 million of its FHLBSF advances in February 1996. Accordingly, the Company incurred a prepayment charge of $2.5 million (net of applicable income taxes) in connection with the early retirement of FHLBSF advances which was reported as an extraordinary item in 1995.
NOTE 11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase are effectively borrowings secured by mortgage-backed securities. The securities sold under the terms of these agreements are safekept for the Company by the registered primary securities dealers who arrange the transactions. Borrowings under reverse repurchase agreements at December 31, 1997 and 1996 were $90.1 million and $210.6 million, respectively. The weighted average interest rate on reverse repurchase agreements at December 31, 1997 and 1996 were 5.76% and 5.53%, respectively.
These borrowings have maturities of one year or less and are collateralized by mortgage-backed securities aggregating $93.6 million and $218.2 million respectively, at December 31, 1997 and 1996. The contractually required market values of the collateral may range up to 106% of the borrowings. The market value of the mortgage-backed securities collateralizing such borrowings at December 31, 1997 and 1996 was $95.5 million and $218.7 million, respectively.
NOTE 12. NOTES AND DEBENTURES
On August 28, 1997, the Company issued $100 million in subordinated notes registered under the Securities Act of 1933, as amended (the "Securities Act"). The notes are unsecured obligations of the Company and are subordinated in right of payment to all existing and future senior indebtedness, as defined, of the Company. The notes mature on August 15, 2007, with a call provision upon a change of control, within 180 days of the occurrence of the change, or upon the occurrence of certain other events, at the option of the Company. The issuance has a stated coupon of 9.125% and yields 9.225%. The all-in cost of the subordinated debt is approximately 9.6%. The Company may use the net proceeds for general corporate purposes, which may include, among other things, the repayment of outstanding indebtedness, investments in or extensions of credit to its subsidiaries and the financing of acquisitions such as EurekaBank. Interest expense on the subordinated notes for the year ended December 31, 1997 was $3.2 million.
On May 28, 1996, the Company issued $50 million of 8.42% senior debentures, which were not registered under the Securities Act, in a private placement under Section 4 (2) of the Securities Act. A portion of the proceeds were used to finance the acquisition of BVC. The senior debentures, which have an all-in cost of approximately 8.9%, are due June 1, 1999. In conjunction with the acquisition of
EurekaBank, the Company negotiated covenant modifications with the senior debenture holders during 1997 to allow the repurchase of additional shares of common stock in exchange for a payment of approximately $1.1 million. Interest expense on the senior debentures was $4.5 million for 1997 and $2.6 million for 1996.
NOTE 13. INCOME TAXES
The Company and its subsidiaries file consolidated federal income tax returns in which the taxable income or loss of the Company is combined with that of its subsidiaries. Each subsidiary's share of income tax expense (benefit) is based on the amount which would be payable if separate returns were filed. The Company's consolidated income tax expense (benefit), before extraordinary items, is summarized as follows:
Current and deferred income taxes, included in other assets (liabilities), are summarized as follows:
The differences between the effective tax rates and the federal statutory rates are summarized as follows:
The components of the net deferred tax assets are summarized as follows:
In accordance with SFAS 109, a deferred tax liability has not been recognized for the bad debt reserves of the Company which arose in the tax years which began prior to December 31, 1987. At December 31, 1997 and 1996, the amount of these reserves was approximately $17.0 million. The amount of unrecognized deferred tax liability at December 31, 1997 and 1996 was approximately $6.1 million. The deferred tax liability could be recognized if in the future there is a change in federal tax law, certain distributions are made with respect to the stock of the savings institution, or the bad debt reserves are used for any purpose other than absorbing bad debt losses.
During 1996, the Company and the Internal Revenue Service ("IRS") reached a final agreement to resolve certain disputed issues related to the taxable years 1987 through 1989. The principal disputed issues related to various savings and loan industry tax issues for which the Company had previously provided deferred taxes. During 1997 the Company realized the benefit resulting from the finalization of these tax audits as well enterprise zone tax credits.
The acquisition of BVC during 1996 increased deferred income tax liabilities by $7.3 million with subsequent adjustments in 1997 increasing deferred income tax assets by $800,000. The acquisition of CGC during 1997 increased deferred income tax assets by $4.8 million.
The net operating loss ("NOL") carryforwards from the acquisition of CGC are $1.1 million and will expire in 2011. These NOL carryforwards are subject to the Separate Return Loss Years ("SRLY") rules which may limit their usage depending upon the revenue generated by CGC on a standalone basis. Accordingly, a valuation allowance was established against these NOL carryforwards since the likelihood of recognition does not meet the more likely than not criteria of Statement of Financial Accounting Standards 109.
NOTE 14. STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL REQUIREMENTS
Federal legislation to recapitalize and fully fund the Savings Association Insurance Fund ("SAIF") was signed into law on September 30, 1996. Customer deposits for BVB are SAIF-insured, and as a result of the legislation BVB was required to pay a one-time special assessment of $11.7 million pre tax ($6.7 million after tax or $.485 per share). The legislation had no direct effect on BVC, as its deposits were insured under the Bank Insurance Fund.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, BVB must meet specific capital guidelines that involve quantitative measures of BVB's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. BVB's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Failure to meet minimum capital requirements can initiate certain mandatory, and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements.
Bay View Bank
The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") provides definitions of regulatory capital (tangible capital, core capital and risk-based capital) and methods of calculating the minimum requirement for each type of capital. The tangible capital requirement is 1.5% of tangible assets. The core capital requirement is 3.0% of tangible assets plus qualifying intangibles. The risk-based capital requirement is 8.0% of risk-weighted assets. BVB's fully phased-in regulatory capital exceeded the minimum requirements of each regulatory capital standard in effect at December 31, 1997 and 1996 and is summarized as follows:
The reconciliation of BVB's capital (excluding unrealized loss on securities available for sale, net of tax benefit) under Generally Accepted Accounting Principles ("GAAP") with its regulatory capital is summarized as follows:
The Federal Deposit Insurance Corporation Improvement Act of 1991 required each federal banking agency to implement prompt corrective actions for under capitalized institutions that it regulates. In response to this requirement, the Office of Thrift Supervision adopted final rules, effective December 19, 1992, based on FDICIA's five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.
The regulations provide that a savings institution is well capitalized if its Total risk-based capital ratio is 10% or greater, its Tier I risk-based capital ratio is 6% or greater, its leverage ratio is 5% or greater, and the institution is not subject to a capital directive. As used herein, Total risk-based capital ratio means the ratio of Total risk-based capital to risk-weighted assets, Tier I capital ratio means the ratio of core capital to risk-weighted assets, and leverage ratio means the ratio of core capital to adjusted total assets, in each case as calculated in accordance with current OTS capital regulations. As of December 31, 1997 and 1996, the most recent notification from the OTS categorized BVB as well capitalized. There are no conditions or events since that notification that management believes have changed BVB's category.
Under capital guidelines enacted by FDICIA, BVB met the criteria for the "well capitalized" standard and is summarized as follows:
Currently, the OTS has deferred implementation of the interest rate risk component for institutions with a greater than "normal" (i.e. greater than 2%) level of interest rate risk exposure. As of December 31, 1997, if the interest rate risk component regulation had been implemented, BVB would not have been subject to an interest rate risk capital deduction for risk-based capital purposes.
The Company is a legal entity separate and distinct from BVB. The Company's principal source of funds on an unconsolidated basis is expected dividends from its wholly owned subsidiaries. Dividends declared by BVB to the Company were $13.0 million in 1997, $0 in 1996, and $29.4 million in 1995. There are various statutory and regulatory limitations on the extent to which BVB can pay dividends to, make investments in or loans to, or otherwise supply funds to the Company. Based on the current financial status of BVB, the Company believes that such limitations and restrictions will not impair the Company's ability to continue to pay the current level of dividends.
Bay View Credit
Effective December 31, 1997, BVC was de-regulated. BVC is a subsidiary of BVAC, which is a subsidiary of BVB. Accordingly, BVC had no regulatory capital requirements at December 31, 1997.
As of December 31, 1996, the most recent notification from the FDIC categorized BVC as well capitalized. BVC's capital ratios at December 31, 1997 were as follows:
BVC declared and paid a dividend of $15 million in 1996 to return excess capital to the Company.
NOTE 15. STOCK REPURCHASE PROGRAM
During 1995, the Company's Board of Directors authorized a stock repurchase program enabling the Company to purchase up to 1,200,000 shares (all share amounts effected for stock split) of the Company's common stock which was subsequently increased in 1996 to a total of 1,600,000 shares authorized for repurchase. As of December 31, 1996, the Company had completed its previously announced stock buy back of 1,600,000 shares (600,000 shares in 1995 and 1,000,000 shares in 1996) which were repurchased at an average cost of $15.99.
In January 1997, the Company's Board of Directors authorized the repurchase of $25 million in shares of the Company's common stock and in May 1997 an additional $25 million was approved. During 1997, the Company repurchased 1,399,000 shares of its common stock at an average price of $28.48. In December 1997, the Company's Board of Directors rescinded the remaining share repurchase authorization. In January 1998, the Company's treasury shares were reissued in conjunction with the acquisition of AFEH discussed in Note 2.
NOTE 16. STOCK OPTIONS
As of December 31, 1997, the Company had three stock option plans: the "Amended and Restated 1986 Stock Option and Incentive Plan", the "1995 Stock Option and Incentive Plan" and the "1989 Non-Employee Director Stock Option Plan", which authorize the issuance of up to 1,759,430, 2,000,000 and 550,000 shares of common stock, respectively. The plans provide for the grant of a variety of long-term incentive awards to directors, officers and employees as a means of enhancing and encouraging the recruitment and retention of those individuals on whom the continued success of the Company most depends. The exercise price for the purchase of shares subject to a stock option at the date of grant generally may not be less than 100% of the market value of the shares covered by the option on that date and the options generally vest over a periods ranging from 6 months to 3 years.
The following table summarizes the stock options available for grant as of December 31, 1997:
At December 31, 1997, the Company had outstanding options for all three plans with expiration dates from 1998 to 2007, as follows:
The following table summarizes information about stock options outstanding at December 31, 1997:
Statement of Financial Accounting Standard (SFAS) 123 Pro Forma Disclosure
The Company accounts for its stock option grants in accordance with APB Opinion No. 25 "Accounting for Stock Issued to Employees". Had compensation cost been recorded based on the fair value method of SFAS 123, the Company's net income and earnings per diluted share would have been as follows:
The fair value of options granted was estimated as of the date of grant based on the Black-Scholes option pricing model given the following weighted-average assumptions.
NOTE 17. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) thrift plan under which an employee with one or more years of service may contribute from 2% to 15% of base salary to the plan. The Company will match an employee's contribution up to 100% of the first 6% of the employee's base salary, depending on the employee's length of service. The Company's contributions for the years ended December 31, 1997, 1996 and 1995 were $1.4 million, $435,000, and $483,000 respectively.
Effective December 31, 1995, the Company modified its non-qualified defined benefit retirement plan for non-employee members of its Board of Directors and terminated its non-qualified supplemental retirement plan for executive officers (collectively, the "Plans"). As of December 31, 1997, the Company had a $1.1 million liability to certain non-employee members of its Board of Directors payable in 66,114 shares of the Company's common stock in satisfaction of the retirement plan liability. Such shares were
repurchased in the market and are held in treasury and restricted as to issuance until paid out. The liability is included in additional paid-in capital. As of December 31, 1997, the Company had a $1.7 million liability to certain retired Directors and executive officers (relating to the remaining benefits owed pursuant to the terminated supplemental retirement plan for executive officers) recorded as other liabilities.
The Company has an ESOP covering all regular full-time and part-time employees who have completed one year of employment. The Company borrowed $6.0 million from a financial institution which it in turn lent to the ESOP to purchase shares of the Company's common stock in the open market. At December 31, 1997 and 1996, the ESOP held 275,286 and 314,196 shares, respectively, of the Company's common stock. The interest rate paid by the Company on the ESOP debt is based on 90% of the prime rate. Total interest expense incurred on the ESOP debt was $316,000, $362,000 and $407,000 for the years ended December 31, 1997, 1996 and 1995, respectively. The interest expense recorded by the Company was $224,000, $289,000, and $254,000, for the years ended December 31, 1997, 1996 and 1995, respectively. The Company makes periodic contributions to the ESOP primarily to enable the ESOP to pay interest expense and administrative costs not covered by cash dividends received by the ESOP on its shares of the Company's common stock. Contributions from the Company to the ESOP on a cash basis totaled $649,000 for 1997, $674,000 for 1996, and $609,000 for 1995.
NOTE 18. DERIVATIVE FINANCIAL INSTRUMENTS
Interest Rate Exchange Agreements (Swaps)
At December 31, 1997 and 1996 the Company was party to interest rate swap agreements with a notional principal amount of $449.3 and $421.0 million, respectively. The information presented below is based on interest rates at December 31, 1997 and 1996. To the extent that rates change, variable interest rate information will change. The maturities and weighted average interest rates for swap agreements outstanding as of December 31, 1997 are summarized as follows:
The maturities and weighted average interest rates for swap agreements outstanding as of December 31, 1996 are summarized as follows:
The interest rate swaps at December 31, 1997 and 1996 were collateralized by loans and mortgage-backed securities totaling $9.1 million and $10.4 million, respectively. The effect of interest rate swap agreements for the years ended December 31, 1997, 1996 and 1995 was to increase interest expense by $2.8 million, $2.6 million, and $40,000, respectively.
Hedging Issuance of Subordinated Debt
During 1997, the Company entered into $105 million in Treasury rate lock agreements to hedge the anticipated issuance of subordinated debt. These agreements guaranteed a stated rate of interest for a stated period of time and the Company paid the difference between the lock rate and the effective treasury rate on the settlement date. In conjunction with the Treasury rate lock agreements, approximately $307,000 was deferred and will be recognized as an adjustment of net interest expense over the life of the subordinated debt.
Hedging Auto Loans Pending Securitization
As discussed in Note 4, in conjunction with the decision to sell BVC's motor vehicle loans and their subsequent securitization by BVSC, management entered into a short sale of Treasury securities that has materially insulated the purchase accounting valuations from movements in interest rates. The short sale transaction was paired-off in December 1996 with a loss of $293,000 recorded as a loss on securities. At December 31, 1996, a Treasury rate lock agreement with a notional principal amount of $210 million was entered into to hedge the motor vehicle loans sale pending sale by BVC and securitization by BVSC.
NOTE 19. COMMITMENTS AND CONTINGENCIES
Banking Center Premises
In 1980, the Company sold a building which formerly housed its headquarters for $3.45 million, and, concurrent with the sale, leased back the entire building under a twenty-year lease which has been accounted for as a capital lease. The Company occupies a minor portion of this building and receives sublease rental income from the major portion, and is responsible for all operating and maintenance expenses associated with the building. Sublease rentals totaled $670,000, $389,000, and $385,000 during the years ended December 31, 1997, 1996 and 1995, respectively. During the years ended December 31, 1997, 1996 and 1995, depreciation on the capital lease was $303,000 for each year. Accumulated depreciation at December 31, 1997 and 1996 was $3.2 million and $2.9 million, respectively.
As of December 31, 1997, the Company and its subsidiaries occupied 56 offices and the Company's administrative corporate office under operating lease arrangements expiring at various dates through 2012. BVB owns the property in which one of its branches is located. In 1996, the Company sold its corporate office complex and entered into an operating lease arrangement for new facilities. Also in 1996, BVC's corporate office complex was sold and BVC relocated its administrative offices. Lease rental expense for the years ended December 31, 1997, 1996 and 1995 totaled $5.6 million, $3.5 million, and $2.4 million, respectively.
Future minimum payments under lease obligations, including approximately $2.0 million to be recovered from sublease rental arrangements through 2001, are summarized as follows:
Mortgage Loans
As of December 31, 1997 the Company had outstanding commitments to originate $10.9 million of mortgage loans. The Company has outstanding recourse and subordination contingencies relating to $50.9 million of sold loans at December 31, 1997 (see Note 6).
Litigation
The Company is involved as plaintiff or defendant in various legal actions arising in the normal course of business. In the opinion of management, after consultation with counsel, the resolution of these legal actions will not have a material adverse effect on the Company's consolidated financial condition or results of operations.
NOTE 20. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Company using market information and valuation methodologies considered appropriate. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The fair value estimates presented herein are based on pertinent information available to the Company as of December 31, 1997 and 1996. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
(1) Carrying amounts are net of allowance for losses
The Company believes the carrying amounts of cash and cash equivalents and investment in stock of the FHLBSF are reasonable estimates of their fair values. The fair values of investment securities and mortgage-backed securities were based on published market prices or quotes obtained from independent registered securities brokers.
The estimated fair value of loans receivable held for investment was determined by discounting the projected cash flows using current interest rates at which similar loans would be made to borrowers of similar credit risk. Prepayment estimates were based on historical experience and published data for similar loans. Fair values for loans available for sale are based on prices for similar loans in the secondary loan market.
The fair value of transactions accounts (demand deposits, savings accounts and money market accounts) is the amount payable on demand and is assumed to equal the carrying amount. The fair value of fixed maturity deposits for BVB was estimated using the rates currently offered for certificates of deposit with similar remaining maturities.
Rates currently available to the Company for debt with similar terms and remaining maturities were used to estimate the fair value of existing debt, including advances from the FHLBSF, securities sold under agreements to repurchase, and senior debentures and subordinated notes.
The unrealized loss on interest rate swaps is the estimated amount that the Company would receive or pay to terminate the swap agreements at the reporting date, taking into account current interest rates and the current creditworthiness of the swap counterparties. The unrealized gain on the Treasury rate lock is the estimated amount that the Company would receive to terminate the agreement with the counterparty.
NOTE 21. PARENT COMPANY FINANCIAL INFORMATION
The Parent Company's condensed statements of financial condition and related condensed statements of operations and cash flows are as follows:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
CONDENSED STATEMENTS OF OPERATIONS
CONDENSED STATEMENTS OF CASH FLOWS
NOTE 22. SELECTED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
NOTE 23. SIGNIFICANT FOURTH QUARTER 1995 ADJUSTMENTS
The following significant fourth quarter adjustments were recorded in the 1995 Consolidated Statement of Operations:
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of Bay View Capital Corporation:
We have audited the accompanying consolidated statements of financial condition of Bay View Capital Corporation and subsidiaries (the "Company") as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of Bay View Capital Corporation and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
San Francisco, California January 26, 1998
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------------------------------------------------------------------------ FINANCIAL DISCLOSURE - --------------------
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------
Information concerning Executive Officers of the Company is contained under the heading "Executive Officers of the Registrant" on page 13 herein. Information concerning directors of the Registrant and compliance with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934 by the Registrant's directors, executive officers and beneficial owners of greater than ten percent of the Company's equity securities is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 28, 1998, a copy of which will be filed not later than 120 days after the close of the fiscal year. The compensation report and performance graph included in the Proxy Statement pursuant to Items 402(k) and 402(l) of Regulation S-K are specifically not incorporated by reference herein.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION - --------------------------------
Information concerning executive compensation is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 28, 1998, a copy of which will be filed not later than 120 days after the close of the fiscal year. The compensation report and performance graph included in the Proxy Statement pursuant to Items 402(k) and 402(l) of Regulation S-K are specifically not incorporated by reference herein.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------------------------------------------------------------------------
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 28, 1998, a copy of which will be filed not later than 120 days after the close of the fiscal year.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------
Information concerning certain relationships and transactions is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 28, 1998, a copy of which will be filed not later than 120 days after the close of the fiscal year.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------
All financial statement schedules have been omitted as the required information is not applicable or has been included in the Notes to Consolidated Financial Statements.
(a) (3) Exhibits: - ------------------
All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K.
(b) Reports on Form 8-K: - -------------------------
The Company did not file any Current Reports on Form 8-K during the quarter ended December 31, 1997.
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.
DATE: March 30, 1998 BAY VIEW CAPITAL CORPORATION By:/s/ David A. Heaberlin ----------------------- David A. Heaberlin Executive Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
By: /s/ John R. McKean By: /s/ Edward H. Sondker ------------------ --------------------- John R. McKean Edward H. Sondker, Director Chairman of the Board President and Chief Executive Officer
Date: March 30, 1998 Date: March 30, 1998
By: /s/ Paula R. Collins By: /s/ George H. Krauss ---------------------- --------------------- Paula R. Collins, Director George H. Krauss, Director
Date: March 30, 1998 Date: March 30, 1998
By:/s/ Roger K. Easley By: /s/ Stephen T. McLin ------------------- --------------------- Roger K. Easley, Director Stephen T. McLin, Director
Date: March 30, 1998 Date: March 30, 1998
By: /s/ Thomas M. Foster By: /s/ Angelo J. Siracusa -------------------- ----------------------- Thomas M. Foster, Director Angelo J. Siracusa, Director
Date: March 30, 1998 Date: March 30, 1998
By: /s/ Robert M. Greber By: /s/ W. Blake Winchell --------------------- --------------------- Robert M. Greber, Director W. Blake Winchell, Director
Date: March 30, 1998 Date: March 30, 1998