UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period
ended: September 30, 2002 Commission file number: 1-12639
------------------ -------
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
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(Exact name of registrant as specified in its charter)
Maryland 94-3254883
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 Crescent Court, Suite 1350, Dallas, Texas 75201
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(Address of principal executive offices) (Zip Code)
214-871-5131
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(Registrant's telephone number, including area code)
N/A
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(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. X Yes No
----- ----
The number of shares outstanding of registrant's $0.01 par value common
stock, as of the close of business on November 6, 2002: 1,000 shares.
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
THIRD QUARTER 2002 REPORT ON FORM 10-Q
TABLE OF CONTENTS
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Balance Sheets
September 30, 2002 and December 31, 2001.......................................................3
Unaudited Statements of Income
Nine months ended September 30, 2002 and 2001..................................................4
Unaudited Statements of Income
Three months ended September 30, 2002 and 2001.................................................5
Unaudited Statement of Stockholders' Equity
Nine months ended September 30, 2002...........................................................6
Unaudited Statements of Cash Flows
Nine months ended September 30, 2002 and 2001..................................................7
Notes to Unaudited Financial Statements........................................................8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.................................................10
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................15
Item 4. Controls and Procedures.......................................................................15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................16
Item 5. Other Information.............................................................................16
Item 6. Exhibits and Current Reports on Form 8-K......................................................16
Signature..............................................................................................17
Certifications.........................................................................................18
2
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
BALANCE SHEETS
September 30, 2002 and December 31, 2001
(Unaudited)
(dollars in thousands, except per share data)
September 30, December 31,
ASSETS 2002 2001
----------- -----------
Residential mortgage loans, net $ 939,453 $ 933,168
Cash and cash equivalents 22,623 18,702
Due from affiliates 54,140 56,622
Accrued interest receivable 3,906 4,138
Foreclosed real estate, net -- 99
----------- -----------
TOTAL ASSETS $ 1,020,122 $ 1,012,729
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Due to affiliates $ 1,039 $ 638
Accounts payable and accrued liabilities 192 237
----------- -----------
Total Liabilities 1,231 875
----------- -----------
Commitments and contingencies -- --
Stockholders' Equity:
Preferred stock, 9 1/8% noncumulative exchangeable series A, par value
$0.01 per share, liquidation preference $500,000, 30,000,000 shares
authorized, 20,000,000 shares issued and outstanding 500,000 500,000
Common stock, par value $0.01 per share, 30,000,000 shares authorized,
1,000 shares issued and outstanding -- --
Additional paid-in capital 500,000 500,000
Retained earnings 18,891 11,854
----------- -----------
Total Stockholders' Equity 1,018,891 1,011,854
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,020,122 $ 1,012,729
=========== ===========
See accompanying notes to unaudited financial statements.
3
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
STATEMENTS OF INCOME
Nine Months Ended September 30, 2002 and 2001
(Unaudited)
(in thousands)
2002 2001
---- ----
INTEREST INCOME
Residential mortgage loans $ 43,893 $ 52,690
Less: servicing fee expense (2,704) (2,734)
-------- --------
41,189 49,956
Short-term investments 268 663
-------- --------
Interest income, net of servicing fee expense 41,457 50,619
NONINTEREST EXPENSE
Director fees 66 65
Professional fees 111 57
Foreclosed real estate operations, net (1) (64)
Other 25 38
-------- --------
Total noninterest expense 201 96
-------- --------
NET INCOME 41,256 50,523
Preferred stock dividends 34,219 34,219
-------- --------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 7,037 $ 16,304
======== ========
See accompanying notes to unaudited financial statements.
4
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
STATEMENTS OF INCOME
Three Months Ended September 30, 2002 and 2001
(Unaudited)
(in thousands)
2002 2001
---- ----
INTEREST INCOME
Residential mortgage loans $ 14,563 $ 16,638
Less: servicing fee expense (918) (895)
-------- --------
13,645 15,743
Short-term investments 94 217
-------- --------
Interest income, net of servicing fee expense 13,739 15,960
NONINTEREST EXPENSE
Director fees 6 51
Professional fees 26 20
Foreclosed real estate operations, net -- (17)
Other 3 6
-------- --------
Total noninterest expense 35 60
-------- --------
NET INCOME 13,704 15,901
Preferred stock dividends 11,406 11,406
-------- --------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 2,298 $ 4,494
======== ========
See accompanying notes to unaudited financial statements.
5
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
STATEMENT OF STOCKHOLDERS' EQUITY
Nine Months Ended September 30, 2002
(Unaudited)
(dollars in thousands)
Additional Total
Preferred Common Paid-in Retained Stockholders'
Stock Stock Capital Earnings Equity
----- ----- ------- -------- ------
BALANCE AT DECEMBER 31, 2001 $500,000 $ -- $500,000 $ 11,854 $1,011,854
Net income -- -- -- 41,256 41,256
Dividends paid on 9 1/8% noncumulative
exchangeable preferred stock, series A -- -- -- (34,219) (34,219)
-------- -------- -------- -------- ----------
BALANCE AT SEPTEMBER 30, 2002 $500,000 $ -- $500,000 $ 18,891 $1,018,891
======== ======== ======== ======== ==========
See accompanying notes to unaudited financial statements.
6
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2002 and 2001
(Unaudited)
(in thousands)
2002 2001
---- ----
OPERATING ACTIVITIES:
Net income $ 41,256 $ 50,523
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of purchase discounts and premiums, net 3,213 2,043
Interest capitalized on negatively amortizing loans -- (60)
Gain on sales of foreclosed real estate, net (1) (64)
Decrease (increase) in due from affiliates 259 (44)
Decrease in accrued interest receivable 1,446 1,527
Decrease in accounts payable and accrued liabilities (45) (19)
Increase in due to affiliates 401 363
--------- ---------
Net cash provided by operating activities 46,529 54,269
INVESTING ACTIVITIES:
Purchase of mortgage loans (427,422) (263,618)
Mortgage loan principal repayments 420,147 259,357
Purchase of accrued interest receivable (1,214) (971)
Proceeds from sales of foreclosed real estate 100 648
--------- ---------
Net cash used in investing activities (8,389) (4,584)
FINANCING ACTIVITIES:
Preferred stock dividends paid (34,219) (34,219)
--------- ---------
Net cash used in financing activities (34,219) (34,219)
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 3,921 15,466
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 18,702 8,526
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 22,623 $ 23,993
========= =========
Supplemental disclosure of cash flow information:
Non-cash investing activities:
Mortgage loan principal increase (decrease) for timing difference
between principal repayments received by servicer and related cash
received by Company during the period $ 2,223 $ (19,532)
See accompanying notes to unaudited financial statements.
7
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
(1) Basis of Presentation
The accompanying financial statements of California Federal Preferred
Capital Corporation (the "Company") were prepared in accordance with
accounting principles generally accepted in the United States of America
for interim financial information and the requirements of Regulation S-X,
Article 10 and therefore do not include all disclosures necessary for
complete financial statements. In the opinion of management, all
adjustments have been made that are necessary for a fair presentation of
the financial position and results of operations and cash flows as of and
for the periods presented. All such adjustments are of a normal recurring
nature. The results of operations for the nine months ended September 30,
2002 are not necessarily indicative of the results that may be expected for
the entire fiscal year or any other interim period. Certain amounts from
prior periods have been reclassified to conform with the current period's
presentation.
The accompanying financial statements should be read in conjunction with
the financial statements included in the Company's Annual Report on Form
10-K for the year ended December 31, 2001. All terms used but not defined
elsewhere herein have meanings ascribed to them in the Company's Annual
Report on Form 10-K.
As the Company's common stock is wholly owned by California Federal Bank
(the "Bank"), earnings per share data is not presented.
(2) Residential Mortgage Loans, Net
At September 30, 2002 and December 31, 2001, residential mortgage loans,
net, consisted of the following (in thousands):
September 30, December 31,
2002 2001
--------- ---------
1-4 unit residential mortgage loans $ 937,147 $ 932,683
Purchase discounts and premiums, net 9,840 8,073
Allowance for loan losses (7,534) (7,588)
--------- ---------
Total residential mortgage loans, net $ 939,453 $ 933,168
========= =========
Residential mortgage loans consist primarily of adjustable rate mortgages
("ARMs"), which adjust periodically based on changes in various indices
including the FHLB Eleventh District Cost of Funds, the one-year Treasury
rate, the six-month Treasury rate, and the average of interbank offered
rates for six month U.S. dollar denominated deposits in the London market
("LIBOR"). Certain types of residential mortgage loans contain an option
for the mortgagor to convert the ARM to a fixed rate loan for the remainder
of the term. Included in residential mortgage loans are hybrid ARMs, which
have an initial three or five-year fixed rate period, followed by annual
interest rate adjustments. As of September 30, 2002 and December 31, 2001,
approximately 68% and 61%, respectively, of residential mortgage loans
consisted of such hybrid ARMs.
(3) Dividends
Holders of Series A Preferred Shares (as defined herein) are entitled to
receive, if, when and as authorized and declared by the Board of Directors
of the Company out of funds legally available, noncumulative dividends at a
rate of 9 1/8% per annum of the initial liquidation preference ($25.00 per
share). Dividends on the Series A Preferred Shares, if authorized and
declared, are payable quarterly in arrears on the last day of March, June,
September and December. Dividends paid during the nine month period ended
September 30, 2002 and 2001 to the holders of the Series A Preferred Shares
totalled approximately $34.2 million.
Dividends on common stock are paid if, when and as authorized and declared
by the Board of Directors out of funds legally available after all
preferred dividends have been paid. There were no common stock dividends
paid during the nine months ended September 30, 2002 or 2001.
8
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
(4) Related Party Transactions
The Company entered into a servicing agreement with First Nationwide
Mortgage Corporation ("FNMC") pursuant to which FNMC performs the actual
servicing of the residential mortgage loans held by the Company in
accordance with normal industry practice (the "Servicing Agreement"). The
Servicing Agreement can be terminated without cause with at least 30 days
prior written notice to FNMC and payment to FNMC of a termination fee equal
to 2% of the outstanding principal balances of the loans. The servicing fee
ranges from 0.25% to 0.50% per year of the outstanding principal balances.
Servicing fee expense paid totalled $2.7 million for each of the nine
months ended September 30, 2002 and 2001, respectively. FNMC is also
entitled to a 1% disposition fee on the aggregate proceeds obtained in the
sale of a defaulted residential mortgage loan. The Company recorded such
disposition fees totalling approximately $5,000 during the nine months
ended September 30, 2001. No such fees were recorded during the nine months
ended September 30, 2002. These disposition fees are included in other
noninterest expense in the accompanying statements of income.
In its capacity as servicer, FNMC holds mortgage loan payments received on
behalf of the Company in a custodial account at the Bank. The balance of
this account totalled approximately $54.1 million and $56.6 million at
September 30, 2002 and December 31, 2001, respectively, and is included in
due from affiliates. Substantially all of such payments were passed through
to the Company in October 2002 and January 2002, respectively, as provided
in the Servicing Agreement. At September 30, 2002 and December 31, 2001,
trust funds of approximately $2.7 million and $1.4 million, respectively,
representing escrows received from borrowers, were on deposit in a trust
account at the Bank and are not included in the accompanying financial
statements.
As of September 30, 2002 and December 31, 2001, the Company owed the Bank
approximately $1,039,000 and $638,000, respectively, in connection with the
settlement of loans purchased from the Bank, advances related to foreclosed
real estate and expenses incurred by the Company to be reimbursed to the
Bank. These amounts were paid to the Bank during October 2002 and January
2002, respectively.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements. This Report contains forward-looking statements,
within the meaning of the Private Securities Litigation Reform Act of 1995, that
pertain to our future operating results. Words such as "anticipate," "believe,"
"expect," "intend," and other similar expressions are intended to identify these
statements. Forward-looking statements are not historical facts and are
inherently subject to significant business, economic and competitive
uncertainties and contingencies, many of which are beyond our control. Our
actual results could differ materially from those in the forward-looking
statements due to such factors as (i) the Company's dependence upon the
operations of its affiliated servicer and upon the financial condition and
operations of its parent, California Federal Bank; (ii) regulatory restrictions
on the Company's operations; (iii) interest rate changes; (iv) declines in real
estate values and increases in uncollected or uncollectable mortgage loans; (v)
the concentration of the Company's portfolio in loans secured by residential
properties located in California; (vi) the inclusion of high balance mortgage
loans in the Company's portfolio; (vii) changes made by the Company's Board of
Directors in the Company's investment and operating policies and strategies,
including whether or not to incur indebtedness; and (viii) failure to qualify as
a real estate investment trust for federal income tax purposes. These factors
are discussed in greater detail in our 10-K for 2001, under the heading
"Business - Factors That May Affect Future Results." We assume no obligation to
update any of our forward-looking statements.
FINANCIAL HIGHLIGHTS
The following information is presented as of September 30, 2002 and 2001 and for
the nine and three months ended September 30, 2002 and 2001 (dollars in
thousands):
2002 2001
---- ----
Statements of Income - Nine Months Ended September 30
Net interest income $ 41,457 $ 50,619
Net income $ 41,256 $ 50,523
Average yield on mortgage loans 5.48% 6.69%
Statements of Income - Three Months Ended September 30
Net interest income $ 13,739 $ 15,960
Net income $ 13,704 $ 15,901
Average yield on mortgage loans 5.46% 6.31%
Balance Sheet as of September 30
Residential mortgage loans, net $ 939,453 $ 953,065
Total assets $1,020,122 $1,016,865
Total stockholders' equity $1,018,891 $1,016,865
OVERVIEW
The Company's principal business objective is to acquire, hold and manage
residential mortgage loans that will generate net income for distribution to
stockholders. The Company currently intends to invest in residential mortgage
loans only. The Company's current policy prohibits the acquisition of any
mortgage loan, which is delinquent at the time of the proposed acquisition or
which meets certain criteria for non-performance during the preceding 12 months.
The Company currently expects that substantially all of the residential mortgage
loans to be acquired will be conventional or hybrid adjustable rate loans;
however, the Company may from time to time acquire fixed interest rate
residential mortgage loans. The Company anticipates it will continue to acquire
all of its residential mortgage loans from the Bank or affiliates of the Bank as
whole loans secured by first mortgages or deeds of trust on 1-4 unit residential
real estate properties, although mortgage loans may be acquired from
unaffiliated third parties. The Company may from time to time acquire fixed rate
or variable rate mortgage-backed securities issued or guaranteed by agencies of
the federal government or government sponsored agencies. The mortgage loans
underlying the mortgage-backed securities will be secured by single-family
residential, multifamily or commercial real estate properties located throughout
the United States.
10
On January 31, 1997, the Company commenced its operations upon the initial
public offering of 20,000,000 shares of the Company's 9 1/8% Noncumulative
Exchangeable Preferred Stock, Series A (the "Series A Preferred Shares"), which
raised $500 million. The Series A Preferred Shares are traded on the New York
Stock Exchange under the trading symbol "CFP." Concurrent with the sale of the
Series A Preferred Shares, the Bank contributed additional capital of $500
million to the Company. All common shares are held by the Bank.
RESULTS OF OPERATIONS
Nine months ended September 30, 2002 versus nine months ended September 30, 2001
Net Income. The Company reported net income for the nine months ended September
30, 2002 of $41.3 million compared with net income of $50.5 million for the
corresponding period in 2001. This decrease in 2002 compared with 2001 is
attributable to a decrease in net interest income.
During each of the nine month periods ended September 30, 2002 and 2001, the
Company declared and paid dividends of $34.2 million on the outstanding Series A
Preferred Shares. Net income available to the common stockholder for the nine
months ended September 30, 2002 and 2001 totalled $7.0 million and $16.3
million, respectively. No common stock dividends were paid during the nine
months ended September 30, 2002 and 2001.
Net Interest Income. The Company reported interest income, net of servicing fee
expense, for the nine months ended September 30, 2002 of $41.5 million, a
decrease of $9.1 million from the $50.6 million reported for the nine month
period ended September 30, 2001. This decrease in interest income is attributed
to a lower average yield on the residential mortgage loan portfolio. The lower
yield of 5.48% on residential mortgage loans during the nine month period ended
September 30, 2002 as compared to the 6.69% yield for the same period in 2001 is
primarily due to the effect of the variable rate loans at lower rates. The
average outstanding balance of residential mortgage loans during the nine month
period ended September 30, 2002 was $6.8 million higher than during the same
period in 2001. Interest income, net of servicing fee expense, during the nine
months ended September 30, 2002 is comprised of $41.2 million ($43.9 million
gross interest less $2.7 million servicing fee expense) from residential
mortgage loans and $268,000 from short-term investments, representing an average
yield after servicing fees on residential mortgage loans of 5.48% and on earning
assets of 5.38%, based on average outstanding asset balances of $1,002.1 million
and $1,027.1 million, respectively. Interest income, net of servicing fee
expense, during the nine months ended September 30, 2001 is comprised of $50.0
million ($52.7 million gross interest less $2.7 million servicing fee expense)
from residential mortgage loans and $663,000 from short-term investments,
representing an average yield after servicing fees on residential mortgage loans
of 6.69% and on earning assets of 6.64%, based on average outstanding asset
balances of $995.3 million and $1,017.1 million, respectively.
The computation of the average yield on residential mortgage loans and on
earning assets is based on daily average outstanding asset balances that include
nonaccruing loans and the amount of principal payments collected by FNMC but not
yet remitted to the Company, which is included in due from affiliates on the
balance sheets.
Provision for Loan Losses. The Company recorded no provision for loan losses in
either of the nine month periods ended September 30, 2002 and 2001. The
determination to record no provision for loan losses during these periods is the
result of management's evaluation of the adequacy of the allowance for loan
losses based on, among other things, the Bank's and the Company's past loan loss
experience, known and inherent risks in the residential mortgage loan portfolio,
adverse situations that have occurred but are not yet known and that may affect
the borrower's ability to repay, the estimated value of the underlying
collateral, and economic conditions.
Three months ended September 30, 2002 versus three months ended September 30,
2001
Net Income. The Company reported net income for the three months ended September
30, 2002 of $13.7 million compared with net income of $15.9 million for the
corresponding period in 2001. This decrease in 2002 compared with 2001 is
attributable to a decrease in net interest income.
During each of the three month periods ended September 30, 2002 and 2001, the
Company declared and paid dividends of $11.4 million on the outstanding Series A
Preferred Shares. Net income available to the common stockholder for the three
months ended September 30, 2002 and 2001 totalled $2.3 million and $4.5 million,
respectively. No common stock dividends were paid during the three months ended
September 30, 2002 and 2001.
11
Net Interest Income. The Company reported interest income, net of servicing fee
expense, for the three months ended September 30, 2002 of $13.6 million, a
decrease of $2.1 million from the $15.7 million reported for the three month
period ended September 30, 2001. This decrease in interest income is attributed
to a lower average yield on the residential mortgage loan portfolio. The lower
yield of 5.46% on residential mortgage loans during the three month period ended
September 30, 2002 as compared to the 6.31% yield for the same period in 2001 is
primarily due to the repricing of variable rate loans at lower rates during 2002
and the purchase of new loans at lower current market rates. The average
outstanding balance of residential mortgage loans during the three month period
ended September 30, 2002 was $1.3 million higher than during the same period in
2001. Interest income, net of servicing fee expense, during the three months
ended September 30, 2002 is comprised of $13.6 million ($14.6 million gross
interest less $918,000 servicing fee expense) from residential mortgage loans
and $94,000 from short-term investments, representing an average yield after
servicing fees on residential mortgage loans of 5.46% and on earning assets of
5.36%, based on average outstanding asset balances of $999.5 million and
$1,026.0 million, respectively. Interest income, net of servicing fee expense,
during the three months ended September 30, 2001 is comprised of $15.7 million
($16.6 million gross interest less $895,000 servicing fee expense) from
residential mortgage loans and $217,000 from short-term investments,
representing an average yield after servicing fees on residential mortgage loans
of 6.31% and on earning assets of 6.22%, based on average outstanding asset
balances of $998.2 million and $1,025.6 million, respectively.
The computation of the average yield on residential mortgage loans and on
earning assets is based on daily average outstanding asset balances that include
nonaccruing loans and the amount of principal payments collected by FNMC but not
yet remitted to the Company, which is included in due from affiliates on the
balance sheets.
Provision for Loan Losses. The Company recorded no provision for loan losses in
either of the three month periods ended September 30, 2002 and 2001. The
determination to record no provision for loan losses during these periods is the
result of management's evaluation of the adequacy of the allowance for loan
losses based on, among other things, the Bank's and the Company's past loan loss
experience, known and inherent risks in the residential mortgage loan portfolio,
adverse situations that have occurred but are not yet known and that may affect
the borrower's ability to repay, the estimated value of the underlying
collateral, and economic conditions.
RESIDENTIAL MORTGAGE LOANS
The Company reinvests principal collections in additional residential mortgage
loans purchased from either the Bank or its affiliates on a periodic basis.
It is the Company's policy to place a loan on nonaccrual when a borrower is 90
days or more delinquent. There were no accruing loans contractually past due 90
days or more at September 30, 2002 or December 31, 2001.
The following table reflects residential mortgage loans with past due principal
and interest payments as of September 30, 2002 and December 31, 2001:
September 30, 2002 December 31, 2001
------------------ -----------------
Principal Balance Percent Principal Balance Percent
(in thousands) Of Total Loans (in thousands) of Total Loans
-------------- -------------- -------------- --------------
30 to 59 days past due $ 775 0.08% $1,593 0.17%
60 to 89 days past due -- -- 1,397 0.15
90 days or more past due 968 0.10 2,214 0.24
------- ---- ------ ----
$ 1,743 0.18% $5,204 0.56%
======= ==== ====== ====
ALLOWANCE FOR LOAN LOSSES
As of September 30, 2002, the Company has allocated $148,000 of its allowance
for loan losses against specific problem loans, with the remaining $7.4 million
available to absorb potential loan losses from the entire residential mortgage
loan portfolio. The Company deems its allowance for loan losses as of September
30, 2002 to be adequate. Although the Company believes that it has sufficient
allowances to absorb losses which currently exist in the portfolio, the amount
is
12
subject to continuing review based on quality indicators, industry and
geographic concentrations, changes in business conditions, and other external
factors such as competition, legal and regulatory requirements. The Company will
continue to periodically reassess the adequacy of the allowance for loan losses.
The following table reflects the activity in the Company's allowance for loan
losses for the nine months ended September 30, 2002 and 2001 (in thousands):
2002 2001
---- ----
Balance - January 1 $ 7,588 $ 7,641
Provision for loan losses -- --
Recoveries (charge-offs), net (54) 13
-- ------- -------
Balance - September 30 $ 7,534 $ 7,654
======= =======
The Company's allowance coverage ratio (allowance for loan losses to loans) at
September 30, 2002 and December 31, 2001 was .80% and .81%, respectively.
INTEREST RATE RISK
The Company's income consists primarily of interest payments on residential
mortgage loans. The Company anticipates that most of its residential mortgage
loans will bear interest at adjustable rates. If there is a decline in interest
rates (as measured by the indices upon which the interest rates of the
residential mortgage loans are based), then the Company will experience a
decrease in income available to be distributed to its stockholders. In such an
interest rate environment the Company may experience an increase in prepayments
on its residential mortgage loans and may find it more difficult to purchase
additional residential mortgage loans bearing rates sufficient to support
payment of the dividends on the Series A Preferred Shares. In addition, certain
residential mortgage loan products which the Company holds will allow borrowers
in such an interest rate environment to convert an adjustable rate mortgage to a
fixed rate mortgage, thus "locking in" a lower fixed interest rate. Because the
dividend rate on the Series A Preferred Shares is fixed, there can be no
assurance that an interest rate environment in which there is a significant
decline in interest rates would not adversely affect the Company's ability to
pay such dividends.
Residential mortgage loans which have interest rates that adjust monthly based
upon the FHLB Eleventh District Cost of Funds limit payment changes to no more
than 7.5% of the payment amount per year. This may lead to monthly payments
which are less than the amount necessary to amortize the loan to maturity at the
interest rate in effect for any particular month. In the event that the monthly
payment is not sufficient to pay interest accruing on the loan during the month,
this deficiency is added to the loan's principal balance (i.e., negative
amortization). The total outstanding principal balance for a particular loan is
generally not allowed to exceed 125% of the original loan amount as a result of
negative amortization. Every five years and at any time the loan reaches its
maximum amount, the loan payment is recalculated to the payment sufficient to
repay the unpaid balance in full at the maturity date. Approximately $84.9
million and $115.2 million of the residential mortgage loans held by the Company
at September 30, 2002 and December 31, 2001, respectively, had the potential to
negatively amortize, while approximately $3.1 million and $8.6 million of the
residential mortgage loans had negatively amortized such that the current
principal balance of the loan exceeded the original principal balance at
September 30, 2002 and December 31, 2001, respectively. The current principal
balance exceeded the original principal balance on those loans by approximately
$109,000 and $264,000 as of September 30, 2002 and December 31, 2001,
respectively. If there is an increase in interest rates on such residential
mortgage loans (as measured by the indices upon which the interest rates of the
residential mortgage loans are based), where such increase in the interest rate
does not coincide with a corresponding adjustment of the borrower's monthly
payment, the Company may experience a decrease in cash available to be
distributed to its common stockholder.
SIGNIFICANT CONCENTRATION OF CREDIT RISK
Certain geographic regions of the United States from time to time may experience
natural disasters or weaker regional economic conditions and housing markets
and, consequently, may experience higher rates of loss and delinquency on
residential mortgage loans generally. Any concentration of the residential
mortgage loans in such a region may present risks in addition to those generally
present with respect to residential mortgage loans.
13
The Company's exposure to geographic concentrations directly affects the credit
risk of the residential mortgage loans within the portfolio. The following table
shows the residential mortgage loan portfolio by geographical area as of
September 30, 2002:
Book Value
(in thousands) Percent
-------------- -------
California $ 721,241 76.96%
Illinois 25,346 2.70
Colorado 23,945 2.55
Florida 23,583 2.52
Texas 18,151 1.94
Washington 13,180 1.41
Maryland 12,819 1.37
Nevada 12,260 1.31
New York 11,943 1.27
Missouri 11,354 1.21
Other states (30 states and Washington, D.C.;
no state has more than 1%) 63,325 6.76
--------- ------
$ 937,147 100.00%
========= ======
The 77% of the Company's total residential mortgage loan portfolio comprised of
loans secured by residential real estate properties located in California may be
subject to a greater risk of default than other comparable residential mortgage
loans in the event of natural hazards or other adverse conditions in California
that may affect the ability of residential property owners in California to make
payments of principal and interest on underlying mortgages. There is evidence of
deterioration in some real estate markets, especially in northern California. As
of September 30, 2002, 41% of the Company's total residential mortgage loan
portfolio was comprised of loans secured by properties located in northern
California.
LIQUIDITY RISK MANAGEMENT
The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all of the Company's financial commitments and to
capitalize on opportunities for the Company's business expansion. In managing
liquidity, the Company takes into account various legal limitations placed on a
Real Estate Investment Trust ("REIT"). See " --Other Matters."
The Company's principal liquidity needs are to maintain the current portfolio
size through the acquisition of additional residential mortgage loans and to pay
dividends on the Series A Preferred Shares. The acquisition of additional
residential mortgage loans is funded with the proceeds obtained from repayment
of principal balances by individual mortgagees. The payment of dividends on the
Series A Preferred Shares will be made from legally available funds, principally
arising from the operating activities of the Company. The Company's cash flows
from operating activities principally consist of the collection of interest on
the residential mortgage loans. The Company does not have and does not
anticipate having any material capital expenditures.
In order to remain qualified as a REIT, the Company must distribute annually at
least 90% of its REIT taxable income, as provided for under the Internal Revenue
Code ("IRC"), to its common and preferred stockholders. The Company currently
expects to distribute dividends annually to satisfy these REIT requirements.
The Company anticipates that cash and cash equivalents on hand and the cash flow
from the residential mortgage loans will provide adequate liquidity for its
operating, investing and financing needs.
As presented in the accompanying statement of cash flows, the primary sources of
funds during the nine months ended September 30, 2002 were $46.5 million
provided by operating activities and $420.1 million provided by mortgage loan
principal repayments. The primary uses of funds were $427.4 million in purchases
of mortgage loans and $34.2 million in preferred stock dividends paid.
14
OTHER MATTERS
As of September 30, 2002, the Company was in full compliance with the REIT tax
rules and believes that it will continue to qualify as a REIT under the
provisions of the IRC. The Company calculates:
a. its Qualified REIT Assets, as defined in the Code, to be 97% of its total
assets, as compared to the Federal tax requirements that at least 75% of
its total assets must be Qualified REIT assets; and
b. that 99% of its revenue qualifies for the 75% source of income test and
100% of its revenue qualifies for the 95% source of income test under the
REIT rules.
The Company also met all REIT requirements regarding the ownership of its stock
and anticipates meeting the annual distribution requirements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in reported market risks faced by the
Company since the Company's report in Item 7A of its Form 10-K for the year
ended December 31, 2001.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's Exchange Act
reports is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and that such information is accumulated
and communicated to the Company's management, including its Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure.
Within 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer along with the
Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-14. Based upon the foregoing, the Company's Chief
Executive Officer along with the Company's Chief Financial Officer concluded
that the Company's disclosure controls and procedures are effective. There have
been no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls subsequent to the date
the Company completed its evaluation.
15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not the subject of any material litigation. None of Company, the
Bank or any of its affiliates is currently involved in, nor, to the Company's
knowledge, is currently threatened with, any material litigation with respect to
the residential mortgage loans included in the portfolio other than routine
litigation arising in the ordinary course of business, most of which is covered
by liability insurance.
ITEM 5. OTHER INFORMATION
On May 21, 2002, Golden State Bancorp, Inc., a Delaware corporation and indirect
parent of the Company, Citigroup, Inc., a Delaware corporation, and Mercury
Merger Sub, Inc., a Delaware corporation and subsidiary of Citigroup, Inc.,
entered into an Agreement and Plan of Merger. This Agreement provides for, among
other things, the merger of Golden State Bancorp, Inc. with and into Mercury
Merger Sub, Inc. with Mercury Merger Sub, Inc. as the surviving corporation. On
October 28, 2002 Citigroup, Inc. received Federal Reserve Board approval for
this merger. On October 29, 2002 the OTS approved the related merger of the Bank
with and into Citibank (West), FSB (in formation). The mergers are expected to
close during the fourth quarter of 2002.
ITEM 6. EXHIBITS AND CURRENT REPORTS ON FORM 8-K
(a) Exhibits:
3.1 Amended and Restated Charter of the Registrant (Incorporated by
reference to Exhibit 3.1 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1997).
3.2 By-laws of the Registrant, as amended (Incorporated by reference
to Exhibit 3(b) to Amendment No. 2 to the Registrant's
Registration Statement on Form S-11 (File No. 333-11609).
99.1 Certification of Periodic Report by Gerald J. Ford.
99.2 Certification of Periodic Report by Richard H. Terzian.
(b) Reports on Form 8-K:
No Current Reports on Form 8-K were filed during the quarter ended
September 30, 2002.
16
SIGNATURE
Pursuant to the requirements 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.
California Federal Preferred Capital Corporation
/s/ Richard H. Terzian
--------------------------------------------------------------
By: Richard H. Terzian
Executive Vice President, Chief Financial Officer and Director
(Signing on behalf of the Registrant and as the Principal
Financial Officer)
November 6, 2002
17
CERTIFICATIONS
CERTIFICATION BY CHAIRMAN AND CHIEF EXECUTIVE OFFICER
I, Gerald J. Ford, certify that:
1. I have reviewed this quarterly report on Form 10-Q of California
Federal Preferred Capital Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant is made known to
us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weakness in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Gerald J. Ford
-----------------------------------------
By: Gerald J. Ford
Chairman and Chief Executive Officer
November 4, 2002
18
CERTIFICATION BY CHIEF FINANCIAL OFFICER
I, Richard H. Terzian, certify that:
1. I have reviewed this quarterly report on Form 10-Q of California
Federal Preferred Capital Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant is made known to
us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weakness in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Richard H. Terzian
---------------------------------
By: Richard H. Terzian
Chief Financial Officer
November 4, 2002
19