UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No.: 0-21137
R&G FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Puerto Rico 66-0532217
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
280 Jesus T. Pinero Avenue
Hato Rey, San Juan, Puerto Rico 00918
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(Address of Principal (Zip Code)
Executive Offices)
Registrant's telephone number, including area code: (787) 758-2424
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
Class B Common Stock New York Stock Exchange
(par value $.01 per share)
Securities registered pursuant to Section 12(g) of the Act:
Series A-D Noncumulative Perpetual Monthly Income Preferred Stock
(liquidation value $25 per share and par value $.01 per share)
--------------------------------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether Registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2). Yes [X] No [ ]
The aggregate value of the 18,482,423 shares of Class B Common Stock of the
Registrant issued and outstanding on such date, which excludes 1,003,863 shares
held by all directors and officers of the Registrant as a group, was
approximately $438.2 million. This figure is based on the last known trade price
of $23.71 per share of the Registrant's Class B Common Stock on June 28, 2002.
Number of shares of Class B Common Stock outstanding as of February 28, 2003:
19,486,286 (Does not include 14,553,056 shares of Class A Common Stock which are
exchangeable into shares of Class B Common Stock at the option of the holder.)
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents incorporated by reference and
the Part of the Form 10-K into which the document is incorporated:
(1) Portions of the Annual Report to Stockholders for the fiscal year ended
December 31, 2002 are incorporated into Parts II and IV.
(2) Portions of the definitive proxy statement for the Annual Meeting of
Stockholders are incorporated into Part III.
PART I
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
A number of the presentations and disclosures in this Form 10-K,
including any statements preceded by, followed by or which include the words
"may," "could," "should," "will," "would," "hope," "might," "believe," "expect,"
"anticipate," "estimate," "intend," "plan," "assume" or similar expressions
constitute forward-looking statements.
These forward-looking statements, implicitly and explicitly, include
the assumptions underlying the statements and other information with respect to
our beliefs, plans, objectives, goals, expectations, anticipations, estimates,
intentions, financial condition, results of operations, future performance and
business, including our expectations and estimates with respect to our revenues,
expenses, earnings, return on equity, return on assets, efficiency ratio, asset
quality and other financial data and capital and performance ratios.
Although we believe that the expectations reflected in our
forward-looking statements are reasonable, these statements involve risks and
uncertainties that are subject to change based on various important factors
(some of which are beyond our control). The following factors, among others,
could cause our financial performance to differ materially from our goals,
plans, objectives, intentions, expectations and other forward-looking
statements:
- the strength of the United States economy in general and the
strength of the regional and local economies within Puerto
Rico and Florida;
- the effects of, and changes in, trade, monetary and fiscal
policies and laws, including interest rate policies of the
Board of Governors of the Federal Reserve System;
- inflation, interest rate, market and monetary fluctuations;
- our timely development of new products and services in a
changing environment, including the features, pricing and
quality of our products and services compared to the products
and services of our competitors;
- the willingness of users to substitute competitors' products
and services for our products and services;
- the impact of changes in financial services policies, laws and
regulations, including laws, regulations and policies
concerning taxes, banking, securities and insurance, and the
application thereof by regulatory bodies;
- technological changes;
- changes in consumer spending and savings habits; and
- regulatory or judicial proceedings.
If one or more of the factors affecting our forward-looking information
and statements proves incorrect, then our actual results, performance or
achievements could differ materially from those expressed in, or implied by,
forward-looking information and statements contained in this Form 10-K.
2
Therefore, we caution you not to place undue reliance on our forward-looking
information and statements.
We do not intend to update our forward-looking information and
statements, whether written or oral, to reflect change. All forward-looking
statements attributable to us are expressly qualified by these cautionary
statements.
ITEM 1: BUSINESS
GENERAL
THE COMPANY
R&G Financial Corporation ("R&G Financial" or the "Company") is a
Puerto Rico chartered, financial holding company that operates R&G Mortgage
Corp. ("R&G Mortgage"), the second largest mortgage company in Puerto Rico, R-G
Premier Bank of Puerto Rico ("Premier Bank"), a Puerto Rico commercial bank, and
Crown Bank, a Federal Savings Bank ("Crown Bank") (Premier Bank and Crown Bank
hereinafter collectively referred to as "banking subsidiaries" of R&G
Financial). Through R&G Mortgage, the Company also operates The Mortgage Store
of Puerto Rico, Inc. ("The Mortgage Store"), a Puerto Rico mortgage company, and
through Crown Bank, the Company operates Continental Capital Corp.
("Continental"), a mortgage banking company doing business in New York, New
Jersey, Connecticut, Florida and North Carolina. The Company also operates Home
& Property Insurance Corp., a Puerto Rico insurance agency, and R-G Investments
Corporation, a Puerto-Rico licensed broker-dealer registered with the National
Association of Securities Dealers ("NASD").
On June 7, 2002, R&G Financial, through its wholly-owned subsidiary R&G
Acquisition Holdings Corporation ("RAC"), a Florida corporation, acquired The
Crown Group, Inc., a Florida corporation, and its wholly-owned savings bank
subsidiary, Crown Bank, for an aggregate of $100.0 million in cash. Crown Bank,
operates in the Tampa-St. Petersburg-Clearwater and Orlando metropolitan areas
through 15 full-service offices.
The Orlando market is one of the fastest growing markets in Florida,
both generally and for Hispanics in particular (mainly Puerto Rican), and
provides the Company with what management believes is a cost effective way to
access the Hispanic markets in the United States, while providing a strong
platform for further expansion in Florida. Crown Bank's balance sheet is
complimentary to that of the Company and is predominantly secured by real
estate. In addition, the acquisition will allow the Company to access lower cost
funding in Florida as compared to Puerto Rico.
The Company is currently in its 31st year of operations and operates
its business through its subsidiaries. The Company is primarily engaged in
providing a full range of banking services, including commercial banking
services, corporate real estate and business lending, residential construction
lending, consumer lending and credit cards, offering a diversified range of
deposit products and, to a lesser extent, trust and investment services through
its private banking department and its broker-dealer. The Company is also
engaged in a range of real estate secured lending activities, including the
origination, servicing, purchase and sale of mortgages on single-family
residences, the securitization and sale of various mortgage-backed and related
securities and the holding and financing of mortgage loans and mortgage-backed
and related securities for sale or investment and the purchase and sale of
servicing rights associated with such mortgage loans.
The Company was organized in 1972 as R&G Mortgage Corp. and completed
its initial public offering in 1996, following its reorganization as a bank
holding company. As of December 31, 2002, the Company had total assets of $6.3
billion, total deposits of $2.8 billion and stockholders' equity of $662.2
3
million. At December 31, 2002, the Company operated 29 bank branches, mainly
located in the northeastern section of Puerto Rico, 15 bank branches in the
continental United States, located in Florida, 42 mortgage offices in Puerto
Rico and 5 mortgage offices in the United States, located in New York, North
Carolina and Florida.
The Company has generally sought to achieve long-term financial
strength and profitability by increasing the amount and stability of its net
interest income and non-interest income. The Company has sought to implement
this strategy by: (1) emphasizing the growth of its mortgage banking activities,
including the origination and sale of mortgage loans, and growing its loan
servicing operation; (2) expanding its retail banking franchise in order to
achieve increased market presence and to increase core deposits; (3) enhancing
its net interest income by increasing its loans held for investment,
particularly single-family residential loans, and investment securities; (4)
developing new business relationships through an increased emphasis on
commercial real estate and commercial business lending; (5) diversifying its
retail products and services, including an increase in consumer loan
originations; (6) meeting the banking needs of its customers through, among
other things, the offering of trust and investment services and insurance
products; (7) expanding its operations in the United States; and, (8)
emphasizing controlled growth, while pursuing a variety of acquisition
opportunities when appropriate.
The senior management of the Company is comprised of five executives
with an average of over 28 years of experience in the financial services
industry. Victor J. Galan is the Company's Chairman and Chief Executive Officer,
positions he has held since the Company's incorporation in 1996. Mr. Galan is
also the founder and Chairman of R&G Mortgage, a position he has held since
1972. Ramon Prats is the Company's President and Vice Chairman, positions he has
held since 2001 and 1996, respectively. Mr. Prats formerly was Executive Vice
President of R&G Mortgage, a position he held since 1980. Joseph Sandoval was
recently promoted to Executive Vice President and he has also been the Company's
Chief Financial Officer since 1997. Previously, Mr. Sandoval was an accountant
with a predecessor to PriceWaterhouseCoopers LLP. Mario Ruiz has been with R&G
Financial subsidiaries since 1990 and is presently Executive Vice President of
Premier Bank. Mr. Ruiz previously served in various capacities for R&G Mortgage
and The Mortgage Store. Steven Velez has been with R&G Mortgage since 1989 and
is presently Executive Vice President of R&G Mortgage.
During the past year, the Company participated in several financing
transactions. During March 2002, the Company issued 2,760,000 shares of the
Company's 7.25% Monthly Income Preferred Stock, Series D, for aggregate net
proceeds of $66.6 million. In April 2002 and December 2002, RAC formed R&G
Capital Trust I and R&G Capital Trust II, respectively, Delaware and Connecticut
business trusts, which issued $25.0 million and $10.0 million, respectively, of
trust preferred securities in private placements. Such securities are included
within notes payable in the Company's Consolidated Statements of Financial
Condition. The Company has guaranteed certain obligations of RAC to R&G Capital
Trust I related to the payment of interest by RAC on the trust preferred
securities and the eventual redemption of the trust preferred securities at
maturity.
In August 2002, the Company completed an offering of 4,025,000 shares
of its Class B Common Stock, comprised of 2,525,000 shares offered by the
Company and 1,500,000 shares offered by Victor J. Galan, the Company's Chairman
and Chief Executive Officer. The aggregate net proceeds to the Company from the
offering were $45.2 million. The Company did not receive any proceeds from the
sale of shares by Mr. Galan.
Effective July 12, 2002, the Company began trading its Class B Common
Stock on the New York Stock Exchange under the symbol "RGF." At such time, the
Company voluntarily delisted its Class B Common Stock from trading on The Nasdaq
National Market.
4
The Company's principal executive offices are located at 280 Jesus T.
Pinero Avenue, San Juan, Puerto Rico 00918 and its telephone number is (787)
758-2424.
BANKING OPERATIONS
General. The Company provides a full range of banking services through
its banking subsidiaries, including residential, commercial and personal loans
and a diversified range of deposit products. Premier Bank also provides private
banking, trust and other financial services to its customers.
R&G Financial's banking business consists principally of holding
deposits from the general public and using them, together with funds obtained
from other sources, to originate and purchase loans secured primarily by
residential real estate, and to purchase mortgage-backed and other securities.
To a lesser extent, but with increasing emphasis over the past few years, R&G
Financial also originates construction loans and loans secured by commercial
real estate, as well as consumer and personal loans and commercial business
loans. Such loans offer higher yields, are generally for shorter terms and offer
the Company an opportunity to provide a greater range of financial services to
its customers. Premier Bank also offers trust services through its trust
department. To date, Premier Bank has engaged in business solely in Puerto Rico.
Crown Bank conducts business from its Florida locations, and Continental
originates retail construction and commercial loans in New York, New Jersey,
Connecticut, North Carolina and Florida.
Residential Loans. At December 31, 2002, R&G Financial's loans
receivable, net, totaled $2.8 billion, which represented 44.0% of R&G
Financial's $6.3 billion of total assets. At such date, all but $250,000 of R&G
Financial's loans receivable were held by its banking subsidiaries. R&G
Financial's loan portfolio historically has had a substantial amount of loans
secured by first mortgage liens on existing single-family residences. At
December 31, 2002, $1.5 billion, or 52.0% of R&G Financial's total loans held
for investment, consisted of such loans, of which all but $3.1 million consisted
of conventional loans.
Construction Loans. At December 31, 2002, retail construction loans
amounted to $104.1 million, or 3.6% of R&G Financial's total loans held for
investment, while commercial construction and land acquisition loans amounted to
$302.4 million in the aggregate, or 10.5% of total loans held for investment.
R&G Financial intends to continue to increase its involvement in single-family
residential construction lending. Such loans afford the Company the opportunity
to increase the interest rate sensitivity of its loan portfolio.
Commercial Loans. R&G Financial also originates mortgage loans secured
by commercial real estate, primarily office buildings, retail stores, warehouses
and general purpose industrial space. At December 31, 2002, $582.1 million, or
20.2% of R&G Financial's total loans held for investment, consisted of such
loans. Finally, R&G Financial also offers commercial business loans, including
working capital lines of credit, inventory and accounts receivable loans,
equipment financing (including equipment leases), term loans, insurance premium
loans and loans guaranteed by the Small Business Administration and various
consumer loans. At December 31, 2002, consumer loans, which are largely secured
by real estate and deposits, amounted to $200.9 million, or 7.0% of total loans
held for investment, and commercial business loans amounted to $152.7 million,
or 5.3% of total loans held for investment.
5
MORTGAGE BANKING
Originations. The Company is the second largest mortgage loans
originator and servicer of mortgage loans on single family residences in Puerto
Rico. R&G Mortgage is primarily engaged in the business of originating first and
second mortgage loans on single-family residential properties secured by real
estate. R&G Mortgage also originates residential mortgage loans through The
Mortgage Store, its wholly-owned subsidiary. Pursuant to agreements entered into
between R&G Mortgage and Premier Bank, non-conforming conventional single-family
residential loans and consumer loans secured by real estate are also originated
by R&G Mortgage for portfolio retention by Premier Bank. Premier Bank retains
most of the nonconforming conventional single-family residential loans because
these loans generally do not satisfy resale guidelines of purchasers in the
secondary mortgage market, primarily because of size (in the case of "jumbo"
loans) or other underwriting technicalities (mostly related to documentation
requirements) at the time of origination. Jumbo loans may be packaged and sold
in the secondary market, while loans with underwriting technicalities may be
cured through payment experience and subsequently sold. Management believes that
these loans are essentially of the same credit quality as conforming loans.
During the years ended December 31, 2002, 2001 and 2000, R&G Financial
originated a total of $2.0 billion, $1.8 billion and $1.1 billion of residential
mortgage loans, respectively. These aggregate originations include loans
originated by R&G Mortgage directly for Premier Bank of $811.8 million, $664.8
million and $451.4 million during the years ended December 31, 2002, 2001 and
2000, respectively, or 41%, 36% and 43%, respectively, of total originations.
The loans originated by R&G Mortgage for Premier Bank are comprised primarily of
conventional residential loans and, to a lesser extent, residential construction
loans and consumer loans secured by real estate.
Continental has historically originated residential FHA/VA as well as
conventional conforming mortgage loans from all its offices, and interim
construction loans to builders from its North Carolina office, retaining 5% and
selling the balance to a non-affiliated bank. As a subsidiary of Crown Bank,
Continental plans on continuing this business, as well as originating commercial
loans and retail construction loans in New York in fiscal 2003. Crown Bank
intends to retain the commercial and retail construction loans in its portfolio.
Servicing. R&G Financial's servicing portfolio has grown significantly
over the past several years. During the second quarter of 2002, the Company
acquired a servicing portfolio of $2.6 billion as part of its acquisition of
Crown Bank. At December 31, 2002, R&G Financial's servicing portfolio totaled
$11.0 billion and consisted of a total of 158,659 loans. These amounts include
R&G Mortgage's servicing portfolio, totaling $7.2 billion, Crown Bank's
servicing portfolio, totaling $3.3 billion, and Continental's servicing
portfolio, totaling $470.1 million, at December 31, 2002. At December 31, 2002,
R&G Financial's servicing portfolio included $1.1 billion of loans serviced for
Premier Bank and $100.9 million of loans serviced for Crown Bank, or 10.3% and
0.9%, respectively, of the total servicing portfolio. Substantially all of the
mortgage loans in R&G Financial's servicing portfolio are secured by
single-family residences. R&G Financial generally retains the servicing function
with respect to the loans which have been securitized and sold.
Securitizations. R&G Financial pools Federal Housing Administration,
the "FHA," and Veterans Administration, the "VA," loans into mortgage-backed
securities which are guaranteed by the Government National Mortgage Association,
the "GNMA." These securities are sold to securities broker-dealers and other
investors in Puerto Rico. Conventional loans may either be sold directly to
agencies such as the Federal National Mortgage Association, the "FNMA," and the
Federal Home Loan Mortgage Corporation, the "FHLMC," or to private investors, or
may be pooled into FNMA or FHLMC mortgage-backed securities, which are generally
sold to investors. During the years ended December 31, 2002, 2001 and 2000, R&G
Financial sold $1.2 billion, $1.1 billion and $637.8 million of loans,
respectively, as part
6
of its mortgage banking activities, which includes loans securitized and sold,
but does not include loans originated for Premier Bank or loans securitized for
other institutions.
REGULATION
The Company operates its businesses under a variety of federal, state
and Puerto Rico laws and rules. As a financial holding company, it is subject to
the rules of the Board of Governors of the Federal Reserve System and the Office
of the Puerto Rico Commissioner of Financial Institutions, the "OCFI." Among
other things, the Company is required to meet minimum capital requirements, and
its activities are limited to those that are determined to be financial in
nature or incidental or complimentary to a financial activity.
Premier Bank is subject to extensive regulation and examination by the
Federal Deposit Insurance Corporation, or "FDIC," and by the OCFI, and Crown
Bank is subject to extensive regulation and supervision by the Office of Thrift
Supervision, or "OTS." This regulation and supervision establishes a
comprehensive framework of activities in which the Company's banking
subsidiaries can engage. In addition, the FDIC and the OTS are required to take
"prompt corrective action" if a given bank does not meet its minimum capital
requirements. The FDIC and the OTS have established five capital tiers to
implement this requirement, from "well capitalized" to "critically
undercapitalized." A bank's capital tier will depend on various capital measures
and other qualitative factors and will subject it to specific requirements. As
of December 31, 2002, Premier Bank and Crown Bank met the capital measures for
being "well capitalized" under the regulations.
The Company's mortgage banking business is subject to the rules of the
FHA, VA, GNMA, FNMA, FHLMC and the Department of Housing and Urban Development
with respect to originating, processing, selling and servicing mortgage loans.
In addition to these rules, the Company's Puerto Rico mortgage banks are
subject to the rules of the OCFI and Continental is subject to the rules of the
OTS. Among other things, all of these rules prohibit discrimination, establish
underwriting guidelines, require credit reports, fix maximum loan amounts and,
in some cases, fix maximum interest rates.
LENDING ACTIVITIES FROM BANKING OPERATIONS
General. At December 31, 2002, R&G Financial's loans receivable, net
totaled $2.8 billion, which represented 44.0% of R&G Financial's $6.3 billion of
total assets. At December 31, 2002, all but $250,000 of R&G Financial's loans
receivable, net were held by its banking subsidiaries. The principal category of
loans in R&G Financial's portfolio are conventional loans which are secured by
first liens on single-family residences. Conventional residential real estate
loans are loans which are neither insured by the FHA nor partially guaranteed by
the VA. At December 31, 2002, all but $3.1 million of R&G Financial's first
mortgage single-family residential loans consisted of conventional loans. The
other principal categories of loans in R&G Financial's loans receivable, net
portfolio are second mortgage residential real estate loans, construction loans,
commercial real estate loans, commercial business loans and consumer loans.
7
Loan Portfolio Composition. The following table sets forth the
composition of R&G Financial's loan portfolio by type of loan at the dates
indicated. Except as noted in the footnotes to the table, all of the loans are
held by banking subsidiaries of R&G Financial.
December 31,
-----------------------------------------------------------------------------------
2002 2001 2000
------------------------ ------------------------- ------------------------
Amount Percent Amount Percent Amount Percent
----------- ------- ----------- ------- ---------- -------
(Dollars in Thousands)
Residential real estate -
first mortgage ................ $ 1,500,572 52.05% $ 1,006,073 52.59% $1,005,033 58.43%
Residential real estate -
second mortgage ............... 40,429 1.40 33,321 1.74 27,419 1.59
Retail construction ............. 104,075 3.61 50,767 2.65 47,698 2.77
Commercial construction
and land acquisition(1) ....... 302,411 10.49 221,537 11.58 137,640 8.00
Commercial real estate .......... 582,114 20.19 340,139 17.78 270,459 15.72
Commercial business ............. 152,743 5.30 79,909 4.18 59,120 3.44
Consumer loans:
Loans secured by deposits ..... 28,070 0.97 26,176 1.37 26,926 1.57
Real estate secured
consumer loans .............. 68,156 2.36 83,509 4.37 100,357 5.83
Unsecured consumer loans ...... 104,715 3.63 71,507 3.74 45,563 2.65
----------- ----- ----------- ------ ---------- ------
Total loans receivable ...... 2,883,285 100.00% 1,912,938 100.00% 1,720,615 100.00%
----------- ------ ----------- ------ ---------- ------
Less:
Allowance for loan losses ..... (32,676) (17,428) (11,600)
Loans in process .............. (90,432) (92,935) (78,163)
Deferred loan fees ............ (45) 20 909
Unearned interest ............. (443) (207) (85)
----------- ----------- ----------
(123,596) (110,550) (88,939)
----------- ----------- ----------
Loans receivable, net(2) ...... $ 2,759,689 $ 1,802,388 $1,631,276
=========== =========== ==========
December 31,
-----------------------------------------------------
1999 1998
------------------------- -----------------------
Amount Percent Amount Percent
---------- ------- ------- -------
Residential real estate - first mortgage.......... $1,099,843 68.47% $735,795 66.87%
Residential real estate - second mortgage.......... 13,029 0.81 18,634 1.69
Retail construction................................ 38,950 2.42 23,280 2.12
Commercial construction and land acquisition(1).... 61,037 3.80 15,353 1.39
Commercial real estate............................. 204,155 12.71 117,151 10.65
Commercial business................................ 54,231 3.38 46,532 4.23
Consumer loans:
Loans secured by deposits....................... 20,539 1.28 17,225 1.56
Real estate secured consumer loans.............. 76,944 4.79 85,055 7.73
Unsecured consumer loans........................ 37,653 2.34 41,381 3.76
---------- ------ --------- ------
Total loans receivable........................ 1,606,381 100.00% 1,100,406 100.00%
---------- ------ --------- ------
Less:
Allowance for loan losses....................... (8,971) (8,055)
Loans in process................................ (33,526) (18,170)
Deferred loan fees.............................. (437) (166)
Unearned interest............................... (440) (347)
---------- ----------
(43,374) (26,738)
---------- ----------
Loans receivable, net(2)........................ $1,563,007 $1,073,668
========== ==========
-----------------
(1) Includes $250,000, $665,000, $1.2 million, $545,000 and $249,000 of
loans held by R&G Mortgage at December 31, 2002, 2001, 2000, 1999 and
1998, respectively.
(2) Does not include mortgage loans held for sale of $258.7 million, $236.4
million, $95.7 million, $77.3 million and $117.1 million at December
31, 2002, 2001, 2000, 1999 and 1998, respectively, of R&G Mortgage.
8
Contractual Principal Repayments and Interest Rates. The following
table sets forth certain information at December 31, 2002 regarding the dollar
amount of loans maturing in R&G Financial's total loan portfolio based on the
contractual terms to maturity. Loans having no stated schedule of repayments and
no stated maturity are reported as due in one year or less.
Due 1-5 Due 5 or more
years after years after
Due 1 year December 31, December 31,
or less 2002 2002 Total(1)
---------- ------------ ------------- ------------
(In Thousands)
Residential real estate................... $ 117,341 $ 78,907 $ 1,344,753 $ 1,541,001
Retail construction....................... 103,141 460 474 104,075
Commercial real estate(2)................. 377,182 346,502 160,841 884,525
Commercial business....................... 81,068 47,623 24,052 152,743
Consumer:
Loans on savings....................... 16,043 11,779 248 28,070
Real estate secured consumer loans..... 8,413 11,975 47,768 68,156
Unsecured consumer loans............... 49,054 46,619 9,042 104,715
--------- ---------- ------------ -----------
Total(3).................................. $ 752,242 $ 543,865 $ 1,587,178 $ 2,883,285
========= ========== ============ ===========
-----------------------
(1) Amounts have not been reduced for the allowance for loan losses, loans
in process, deferred loan fees or unearned interest.
(2) Includes $302.4 million of commercial construction and land acquisition
loans.
(3) Does not include mortgage loans held for sale.
The following table sets forth the dollar amount of total loans at
December 31, 2002 which have fixed interest rates or which have floating or
adjustable interest rates.
Floating or
Fixed rate adjustable-rate Total
---------- --------------- -----------
(In Thousands)
Residential real estate................... $1,527,896 $ 13,105 $ 1,541,001
Retail construction....................... 62,099 41,976 104,075
Commercial real estate(1)................. 252,805 631,720 884,525
Commercial business....................... 79,547 73,196 152,743
Consumer:
Loans on savings....................... 28,070 -- 28,070
Real estate secured consumer loans..... 61,680 6,476 68,156
Unsecured consumer loans............... 104,715 -- 104,715
---------- --------- -----------
Total..................................... $2,116,812 $ 766,473 $ 2,883,285
========== ========= ===========
---------------------
(1) Includes $302.4 million of commercial construction and land acquisition
loans.
Scheduled contractual amortization of loans does not reflect the
expected term of R&G Financial's loan portfolio. The average life of loans is
substantially less than their contractual terms because of prepayments and
due-on-sales clauses, which give R&G Financial the right to declare a
conventional loan immediately due and payable in the event, among other things,
that the borrower sells the real property subject to the mortgage and the loan
is not repaid. The average life of mortgage loans
9
tends to increase when current mortgage loan rates are higher than rates on
existing mortgage loans and, conversely, decrease when rates on existing
mortgage loans are lower than current mortgage loan rates (due to refinancing of
adjustable-rate and fixed-rate loans at lower rates). Under the latter
circumstance, the weighted average yield on loans decreases as higher-yielding
loans are repaid or refinanced at lower rates.
Origination, Purchases and Sales of Loans. The following table sets
forth loan originations, purchases and sales from banking operations for the
periods indicated.
Year Ended December 31,
------------------------------------------------
2002 2001 2000
------------------------------------------------
(Dollars in Thousands)
Loan originations:
Loans originated by R&G Mortgage:
Residential mortgages................................... $ 764,115 $625,798 $ 378,398
Commercial mortgages.................................... -- -- --
Residential construction................................ 45,026 29,353 29,063
Consumer loans.......................................... 2,632 9,658 43,943
------------- ---------- -----------
Total loans originated by R&G Mortgage................ 811,773 664,809 451,404
------------- ---------- -----------
Other loans originated:
Residential real estate (1)............................. 26,163 -- --
Commercial real estate.................................. 357,718 213,215 150,329
Commercial business..................................... 62,965 59,074 48,060
Construction and development (2)........................ 143,356 171,026 127,473
Consumer loans:
Loans on deposit........................................ 40,061 48,730 45,474
Real estate secured consumer loans...................... 4,191 -- --
Unsecured consumer loans................................ 90,431 63,702 32,517
------------- ---------- -----------
Total other loans originated.......................... 724,885 555,747 403,853
------------- ---------- -----------
Loans purchased......................................... 236,181 61,359 128,824
------------- ---------- -----------
Total loans originated and purchased.................. 1,772,839 1,281,915 984,081
------------- ---------- -----------
Loans sold.............................................. (35,311) (130,716) (105,653)
Loan participations sold................................ (43,301) (52,886) --
Loan principal reductions............................... (691,013) (486,410) (359,760)
------------- ---------- -----------
Net increase before other items, net.................... 1,003,214 611,903 518,668
Loans acquired in connection with acquisition of
Crown Bank.......................................... 486,958 -- --
Loans securitized and transferred to mortgage-backed
securities.......................................... (534,656) (421,645) (410,453)
------------- ---------- -----------
Net increase in loans................................... $ 955,516 $ 190,258 $ 108,215
============= ========== ===========
----------------------
(1) All of such loans were conventional loans.
(2) Includes $32.1 million and $34.6 million originated by Continental in
2002 and 2001, respectively.
R&G Financial, through its banking subsidiaries, originates for both
investment and sale mortgage loans secured by residential real estate (secured
by both first and second mortgage liens) as well as construction loans (for
residential real estate), commercial real estate loans, commercial business
loans and consumer loans.
R&G Mortgage assists Premier Bank in meeting its loan production
targets and goals by, among other things, (i) advertising, promoting and
marketing to the general public; (ii) interviewing prospective borrowers and
conducting the initial processing of the requisite loan applications, consistent
with Premier Bank's underwriting guidelines; and (iii) providing personnel and
facilities with respect to the execution of loan agreements approved by Premier
Bank. R&G Mortgage performs the foregoing loan origination
10
services on behalf of Premier Bank with respect to residential mortgage loans,
some commercial real estate loans and construction loans. R&G Mortgage receives
from Premier Bank 75% of the applicable loan origination fee with respect to
loans originated by R&G Mortgage on behalf of Premier Bank. During the years
ended December 31, 2002, 2001 and 2000, R&G Mortgage received $11.6 million,
$10.3 million and $8.1 million, respectively, of loan origination fees with
respect to loans originated by R&G Mortgage on behalf of Premier Bank. These
fees are eliminated in consolidation in R&G Financial's Consolidated Financial
Statements. See "- Regulation - R&G Financial - Limitations on Transactions with
Affiliates."
R&G Financial originates commercial real estate, commercial business
and consumer loans. Applications for commercial real estate, commercial business
and unsecured consumer loans are taken at all branch offices of the Company's
banking subsidiaries, and may be approved by lending officers of each banking
subsidiary within designated limits which are established and modified from time
to time to reflect an individual's expertise and experience. All loans in excess
of an individual's designated limits are referred to an officer with the
requisite authority. In addition, Premier Bank's Management Credit Committee is
authorized to approve all loans not exceeding $5.0 million, and the Executive
Committee of the Board of Directors is authorized to approve all loans exceeding
$5.0 million. In the case of Crown Bank, all loans over $1 million require
approval by Crown Bank's Credit Committee and Board of Directors. Management of
R&G Financial believes that its relatively centralized approach to approving
loan applications ensures strict adherence to its underwriting guidelines, while
still allowing the Company to approve loan applications on a timely basis.
R&G Financial also purchases conventional loans secured by first liens
on single-family residential real estate from unrelated financial institutions.
Such loan purchases are underwritten pursuant to the same guidelines as direct
loan originations. During the years ended December 31, 2002, 2001 and 2000,
Premier Bank purchased $236.2 million, $61.4 million and $128.8 million of
loans, respectively. Crown Bank did not purchase any such loans during the years
ended December 31, 2002, 2001 and 2000.
During the years ended December 31, 2001 and 2000, loans sold from
banking operations were $130.7 million and $105.7 million, respectively. These
loans, which were primarily nonconforming loans at the time of origination, were
generally sold in packages in privately negotiated transactions with FNMA and
FHLMC or other private parties.
R&G Mortgage services all loans held in Premier Bank's portfolio
(including single-family residential loans retained by Premier Bank, commercial
real estate, commercial business and consumer loans (although R&G Mortgage does
not actually acquire such servicing rights)). In addition, Premier Bank
processes payments on all loans serviced by R&G Mortgage on behalf of Premier
Bank. Finally, R&G Mortgage renders securitization services with respect to the
pooling of some of Premier Bank's mortgage loans into mortgage-backed
securities. See "- Mortgage Banking Activities."
Single-Family Residential Real Estate Loans. R&G Financial historically
has had a substantial portion of its lending activities in the origination of
loans secured by first mortgage liens on existing single-family residences. At
December 31, 2002, $1.5 billion or 52.0% of R&G Financial's total loans held for
investment consisted of such loans, of which all but $3.1 million consisted of
conventional loans. Premier Bank's first mortgage single-family residential
loans consist exclusively of fixed-rate loans with terms of between 15 and 30
years. As evidenced by this statistic, the Puerto Rico residential mortgage
market has not been receptive to long-term adjustable rate mortgage loans.
11
R&G Financial's first mortgage single-family residential loans
typically do not exceed 80% of the appraised value of the security property.
Pursuant to underwriting guidelines adopted by its Board of Directors, R&G
Financial may lend up to 95% of the appraised value of the property securing a
first mortgage single-family residential loan provided it is with private
mortgage insurance with respect to the top 25% of the loan.
The Company also originates loans secured by second mortgages on
single-family residential properties. At December 31, 2002, $40.4 million or
1.4% of R&G Financial's total loans held for investment consisted of second
mortgage loans on single-family residential properties. R&G Financial offers
such second mortgage loans in amounts up to $125,000 for a term not to exceed 15
years. The loan-to-value ratio of second mortgage loans generally is limited to
75% of the property's appraised value (including the first mortgage).
Construction Loans. At December 31, 2002, retail construction ("spot")
loans amounted to $104.1 million or 3.6% of R&G Financial's total loans held for
investment, while commercial construction and land acquisition loans amounted to
$302.4 million or 10.5% of total loans held for investment.
Premier Bank and Crown Bank offer "spot" loans to individual borrowers
for the purpose of constructing single-family residences. Substantially all of
the Company's construction lending to individuals is originated on a
construction/permanent mortgage loan basis. Construction/permanent loans are
made to individuals who hold a contract with a general contractor acceptable to
the Company to construct their personal residence. The construction phase of the
loan provides for monthly payments on an interest only basis at a designated
fixed rate for the term of the construction period, which generally does not
exceed nine months. Thereafter, the permanent loan is made at then market rates,
provided that such rate shall not be more than 2% greater than the interim
construction rate. In the case of Premier Bank, R&G Mortgage's construction loan
department approves the proposed contractors and administers the loan during the
construction phase. The Company's construction/permanent loan program has been
successful due to its ability to offer borrowers a single closing and,
consequently, reduced costs.
R&G Financial also originates construction loans to developers to
develop single family residential properties. At December 31, 2002, R&G
Financial had residential construction loans to develop single-family residences
with an aggregate principal balance of $208.2 million. Commitments for future
funding included in such amount approximate $49.8 million. In addition, R&G
Financial had loans to develop commercial properties with an aggregate principal
balance of $42.8 million. All loans are performing in accordance with their
terms at December 31, 2002.
In addition to the foregoing, at December 31, 2002, R&G Financial had
land acquisition loans with an aggregate balance of $50.4 million, which were
made in connection with projects to construct single-family residences. R&G
Financial and the financial institution which made the interim construction loan
have entered into an agreement pursuant to which R&G Financial is to be paid a
percentage of the proceeds from each home as it is released upon construction
and sale. R&G Financial expects to make the permanent construction loan on some
of these projects. Premier Bank has also made a working capital/pre-development
loan with an outstanding principal balance of $1.0 million at December 31, 2002
which is secured by land.
R&G Financial intends to continue to increase their involvement in
single-family residential construction lending. Such loans afford the Company
the opportunity to increase the interest rate sensitivity of its loan portfolio.
Construction lending is generally considered to involve a higher level of
12
risk as compared to permanent single-family residential lending, due to the
concentration of principal in a limited number of loans and borrowers and the
effects of general economic conditions on real estate developers and managers.
Moreover, a construction loan can involve additional risks because of the
inherent difficulty in estimating both a property's value at completion of the
project and the estimated costs (including interest) of the project. The nature
of these loans is such that they are generally more difficult to evaluate and
monitor. The Company has taken steps to minimize the foregoing risks by, among
other things, limiting its construction lending primarily to residential
properties. In addition, the Company has adopted underwriting guidelines which
impose stringent loan-to-value, debt service and other requirements for loans
which are believed to involve higher elements of credit risk and by working with
builders with whom it has established relationships or knowledge thereof. At
December 31, 2002, $1.5 million of R&G Financial's retail construction loans
were classified as non-performing. As of such date, no commercial construction
or land acquisition loans were non-performing.
Commercial Real Estate Loans. The Company also originates mortgage
loans secured by commercial real estate. At December 31, 2002, $582.1 million or
20.2% of R&G Financial's total loans held for investment consisted of such
loans. At December 31, 2002, $29.4 million of R&G Financial's commercial
real estate loans were classified as nonperforming.
Commercial real estate loans of the Company are primarily secured by
office buildings, retail stores, warehouses and general purpose industrial
space. Although terms vary, commercial real estate loans generally are amortized
over a period of 7 to 15 years in Premier Bank and 10 to 20 years in Crown Bank,
and have maturity dates of 5 to 7 years in Premier Bank and 3 to 10 years in
Crown Bank. R&G Financial generally originates these loans with interest rates
which adjust monthly in accordance with a designated prime rate plus a margin,
which generally is negotiated at the time of origination. Such loans will have a
floor but no ceiling on the amount by which the rate of interest may adjust over
the loan term. Loan-to-value ratios on the Company's commercial real estate
loans are currently limited to 80% or lower. As part of the criteria for
underwriting commercial real estate loans, R&G Financial generally requires a
debt coverage ratio (the ratio of net cash from operations before payment of
debt service to debt service) of 1.20 or more. It is also the Company's policy
to seek additional protection to mitigate any weaknesses identified in the
underwriting process. Additional coverage may be provided through mortgage
insurance, secondary collateral and/or personal guarantees from the principals
of the borrower.
Commercial real estate lending entails different and significant risks
when compared to single-family residential lending because such loans typically
involve large loan balances to single borrowers and because the payment
experience on such loans is typically dependent on the successful operation of
the project or the borrower's business. These risks can also be significantly
affected by supply and demand conditions in the local market for apartments,
offices, warehouses or other commercial space. R&G Financial attempts to
minimize its risk exposure by limiting the extent of its commercial lending
generally. In addition, the Company imposes stringent loan-to-value ratios,
requires conservative debt coverage ratios, and continually monitors the
operation and physical condition of the collateral. Although the Company has
begun to increase its emphasis on commercial real estate lending, management
does not currently anticipate that the commercial real estate loans portfolio
will grow significantly as a percentage of the total loan portfolio.
Commercial Business Loans. The Company offers commercial business
loans, including working capital lines of credit, inventory and accounts
receivable loans, equipment financing (including equipment leases), term loans,
insurance premiums loans and loans guaranteed by the Small Business
Administration. Depending on the collateral pledged to secure the extension of
credit, maximum loan to value ratios are 75% or less, with exceptions permitted
to a maximum of 80%. Loan terms may vary
13
from one to 15 years. The interest rates on such loans are generally variable
and are indexed to a designated prime rate, plus a margin. The Company also
generally obtains personal guarantees from the principals of the borrowers. At
December 31, 2002, commercial business loans amounted to $152.7 million or 5.3%
of total loans held for investment. Although the Company has begun to increase
its emphasis on commercial business lending, management does not currently
anticipate that its portfolio of commercial business loans will grow
significantly as a percentage of the total loan portfolio.
Consumer Loans. R&G Financial also originates real estate secured
consumer loans. Such loans generally have shorter terms and higher interest
rates than other mortgage loans. At December 31, 2002, $200.9 million or 7.0% of
R&G Financial's total loans held for investment consisted of consumer loans.
This amount is comprised mostly of real estate secured consumer loans (which in
the case of Premier Bank are originated by R&G Mortgage) and deposit accounts,
but the Company also offers credit cards and other unsecured consumer loans.
Most of the Company's consumer loans are secured and have been primarily
obtained through newspaper advertising, although loans are also obtained from
existing and walk-in customers. Although R&G Financial has begun to increase the
emphasis on consumer lending, management does not currently anticipate that its
portfolio of consumer loans will grow significantly as a percentage of the total
loan portfolio.
R&G Financial currently offers loans secured by deposit accounts, which
amounted to $28.1 million at December 31, 2002. Such loans are originated
generally for up to 90% of the account balance, with a hold placed on the
account restricting the withdrawal of the account balance. R&G Financial offers
real estate secured loans in amounts up to 75% of the appraised value of the
property, including the amount of any existing prior liens. Real estate secured
consumer loans generally have a maximum term of 10 years, which may be extended
at management's sole discretion in certain circumstances, and an interest rate
which is set at a fixed rate based on market conditions. The loans are secured
with a first or second mortgage on the property, including loans where another
institution holds the first mortgage. At December 31, 2002, real estate secured
consumer loans totaled $68.2 million. At December 31, 2002, credit card
receivables, all held by Premier Bank, totaled $43.3 million.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. In addition, consumer lending collections are dependent
on the borrower's continuing financial stability, and thus are more likely to be
adversely effected by job loss, divorce, illness and personal bankruptcy. In
many cases, any repossessed collateral for a defaulted consumer loan will not
provide an adequate source of repayment of the outstanding loan balance because
of improper repair and maintenance of the underlying security. The remaining
deficiency may not warrant further substantial collection efforts against the
borrower. At December 31, 2002, $5.3 million of consumer loans were classified
as non-performing, of which $4.5 million were secured by real estate.
Asset Quality. When a borrower fails to make a required payment on a
loan, R&G Financial attempts to cure the deficiency by contacting the borrower
and seeking payment. Contacts are generally made between the 10th and 15th day
after a payment is due. In most cases, deficiencies are cured promptly. If a
delinquency extends beyond 15 days, the loan and payment history is reviewed and
efforts are made to collect the loan. While R&G Financial generally prefers to
work with borrowers to resolve such problems, when the account becomes 90 days
delinquent in the case of mortgage loans, R&G Financial does institute
foreclosure or other proceedings, as necessary, to minimize any potential loss.
In the case of consumer loans, the Company refers the file for collection action
after 60 days.
Loans secured by real estate are placed on non-accrual status when, in
the judgment of management, the probability of collection of interest is deemed
to be insufficient to warrant further accrual. When such a loan is placed on
non-accrual status, previously accrued but unpaid interest is
14
deducted from interest income. As a matter of policy, R&G Financial does not
accrue interest on loans past due 90 days or more which are secured by real
estate. The Company generally takes the same position in the case of consumer
loans.
Real estate acquired by the Company as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold.
Pursuant to a statement of position ("SOP 92-3"), which provides guidance on
determining the balance sheet treatment of foreclosed assets in annual financial
statements, there is a rebuttable presumption that foreclosed assets are held
for sale and such assets are recommended to be carried at the lower of fair
value minus estimated costs to sell the property, or cost (generally the balance
of the loan on the property at the date of acquisition). After the date of
acquisition, all costs incurred in maintaining the property are expensed and
costs incurred for the improvement or development of such property are
capitalized up to the extent of their net realizable value. The Company's
accounting for its real estate owned complies with the guidance set forth in
SOP 92-3.
15
The following table sets forth the amounts and categories of R&G
Financial's non-performing assets at the dates indicated. R&G Financial did not
have any troubled debt restructurings at any of the periods presented. Except as
otherwise indicated in the footnotes to the table, the non-performing assets are
assets of banking subsidiaries of the Company.
December 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------ ------- -------
(Dollars in Thousands)
Non-accruing loans:
Residential real estate(1)..................... $43,281 $50,358 $79,234 $47,413 $32,973
Residential construction....................... 1,512 871 487 478 441
Commercial real estate......................... 29,375 16,945 11,881 9,005 6,463
Commercial business............................ 2,197 3,105 1,414 1,255 3,224
Consumer unsecured............................. 802 303 1,186 802 1,358
Other.......................................... -- -- -- 61 67
------- ------- ------- ------- --------
Total........................................ 77,167 71,582 94,202 59,014 44,526
------- ------- ------- ------- --------
Accruing loans greater than 90 days delinquent:
Residential real estate........................ 104 -- -- -- --
Residential construction....................... -- -- -- -- --
Commercial real estate......................... -- -- -- -- --
Commercial business............................ 261 462 420 63 61
Consumer....................................... 667 428 360 274 357
------- ------- ------- ------- --------
Total accruing loans greater than
90 days delinquent......................... 1,032 890 780 337 418
------- ------- ------- ------- --------
Total non-performing loans................... 78,199 72,472 94,982 59,351 44,944
------- ------- ------- ------- --------
Real estate owned, net of reserves................ 15,544(2) 10,061 9,056 5,852 4,041
Other repossessed assets.......................... 292 362 583 466 237
------- ------- ------- ------- --------
15,836 10,423 9,639 6,318 4,278
------- ------- ------- ------- --------
Total non-performing assets $94,035 $82,895 $104,621 $65,669 $49,222
======= ======= ======== ======= ========
Total non-performing loans as a
percentage of total loans(3) 2.71% 3.79% 5.52% 3.66% 4.08%
======= ======= ======== ======= ========
Total non-performing assets as a
percentage of total assets 1.50% 1.78% 2.96% 2.26% 2.41%
======= ======= ======== ======= ========
----------------------
(1) Includes $4.5 million, $5.8 million, $6.2 million, $6.1 million and $5.3
million consumer loans, respectively, held by Premier Bank secured by
first and second mortgages on residential real estate at December 31,
2002, 2001, 2000, 1999 and 1998, respectively. Also includes $6.5
million, $7.3 million, $17.6 million, $5.9 million and $4.3 million
residential real estate loans secured by first mortgages held by R&G
Mortgage at December 31, 2002, 2001, 2000, 1998 and 1998, respectively.
(2) Real estate owned, net of reserves, acquired in connection with the
acquisition of Crown Bank in 2002 amounted to $5.1 million.
(3) Non-performing loans at December 31, 2002 exclude $45.9 million
non-performing residential mortgage loans sold during 2002, and include
$13.2 million non-performing loans acquired in connection with the
acquisition of Crown Bank in June 2002. While the ratio of non-performing
loans to total loans decreased from 3.79% to 2.71% from December 31, 2001
to December 31, 2002, the ratio was nevertheless larger than it would
otherwise have been due to securitizations from the loan portfolio, which
reduced the amount of loans considered in the calculation of the ratio.
Without giving effect to loan securitizations, at December 31, 2002 and
2001, the ratio of non-performing loans to total loans would have been
1.98% and 2.75%, respectively.
16
Non-performing loans amounted to $78.2 million at December 31, 2002, as
compared to $72.5 million at December 31, 2001. The increase in the aggregate
amount of non-performing loans during 2002 is due primarily to $13.2 million of
non-performing loans (primarily commercial real estate) acquired in connection
with the acquisition of Crown Bank in June 2002. Non-performing loans at
December 31, 2002 exclude $45.9 million of residential mortgage loans sold
during 2002. An aggregate of $43.4 million or 55.5% of non-performing loans held
at December 31, 2002 consisted of residential mortgage loans. Because of the
nature of the collateral, R&G Financial has historically recognized a low level
of loan charge-offs. R&G Financial's aggregate charge-offs amounted to 0.41%
during 2002, as compared to 0.32% during 2001. Although loan delinquencies have
historically been higher in Puerto Rico than in the United States, loan
charge-offs have historically been lower than in the United States.
Non-performing residential loans decreased by $7.0 million or 13.8%
from December 31, 2001 to December 31, 2002. The average loan balance on
non-performing mortgage loans amounted to $58,000 at December 31, 2002. As of
such date, 391 loans with an aggregate balance of $25.0 million (including 135
consumer loans secured by real estate with an aggregate balance of $2.6 million)
were in the process of foreclosure. The total delinquency ratio (including loans
past due less than 90 days) on residential mortgages of banking subsidiaries,
excluding consumer loans secured by real estate, decreased from 6.40% in 2001 to
4.13% in 2002. The Company's loss experience on such portfolio has been minimal
over the last several years.
Non-performing commercial real estate loans increased by $12.4 million
or 73.4% from $16.9 million at December 31, 2001 to $29.4 million at December
31, 2002. A substantial amount of the increase in non-performing commercial real
estate loans is attributable to non-performing commercial real estate loans
acquired in connection with the acquisition of Crown Bank in 2002. The number of
loans delinquent over 90 days amounted to 145 loans at December 31, 2002, with
an average balance of $203,000. The largest non-performing commercial real
estate loan as of December 31, 2002 had a balance of $1.8 million.
Non-performing commercial business loans consist of 84 loans. Such
loans include 14 loans with an aggregate balance of $1.0 million which are 90%
guaranteed by the Small Business Administration, 38 commercial leases amounting
to $765,000 and 32 other commercial business loans with an aggregate balance of
$669,000. These loans have a combined average loan size of $29,000. The largest
non-performing commercial business loan as of December 31, 2002 had a $786,000
balance.
At December 31, 2002, R&G Financial's five largest loans-to-one
borrower and their related entities amounted to $30.9 million, $24.7 million,
$24.3 million, $23.7 million and $23.1 million. All of such loan concentrations
were performing at December 31, 2002.
At December 31, 2002, R&G Financial's allowance for loan losses totaled
$32.7 million, which represented a $15.2 million or 87.5% increase from the
level maintained at December 31, 2001. The allowance for loan losses at December
31, 2002 includes $7.5 million of acquired reserves in connection with the
acquisition of Crown Bank in June 2002. At December 31, 2002, R&G Financial's
allowance represented approximately 1.13% of the total loan portfolio and 41.79%
of total non-performing loans, as compared to 0.91% and 24.05% at December 31,
2001. The increase in the allowance for loan losses reflected the increase in
R&G Financial's commercial real estate and construction loan portfolio.
Allowance for Loan Losses. It is the policy of the Company to maintain
an allowance for estimated losses on loans based on a number of quantitative and
qualitative factors, including levels and trends of past due and nonaccrual
loans, levels and trends in asset classifications, change in volume and mix of
loans and collateral values. Quantitative factors used to assess the adequacy
of the allowance for loan losses are established based upon management's
assessment of the credit risk in the portfolio, historical loan loss experience
and our loan underwriting policies as well as management's judgment and
experience. Provisions for loan losses are provided on both a specific and
general basis. Specific and general valuation allowances are increased by
provisions charged to expense and decreased by charge-offs of loans, net of
recoveries. Specific allowances are provided for impaired loans for which the
expected loss is measurable. General valuation allowances are provided based on
a formula which incorporates the factors discussed above. R&G Financial
periodically reviews the assumptions and formula by which additions are made to
the specific and general valuation allowances for losses in an effort to refine
such allowances in light of the current status of the factors described above.
Although management believes that it uses the best information
available to make such determinations, future adjustments to the allowance may
be necessary, and net earnings could be significantly affected, if circumstances
differ substantially from the assumptions used in making the initial
determinations. Our amount of future losses is susceptible to changes in
economic, operating and other conditions, including changes in interest rates,
that may be beyond our control and future losses may exceed current estimates.
Premier Bank's and Crown Bank's Internal Asset Review Committee undertakes a
monthly evaluation of the adequacy of the allowance for loan losses, which is
reviewed and approved at least quarterly by the Board of Directors. We provide
an allowance to absorb losses that are both probable and reasonably quantifiable
as well as for those that are not specifically identified but can be reasonably
estimated.
17
The following table sets forth an analysis of R&G Financial's allowance
for loan losses during the periods indicated, of which $32.4 million is
maintained against the loan portfolios of the banking subsidiaries at December
31, 2002:
At and For the Year Ended December 31,
----------------------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
Balance at beginning of period ................ $ 17,428 $ 11,600 $ 8,971 $ 8,056 $ 6,772
---------- ---------- ---------- ---------- ----------
Charge-offs:
Residential real estate .................... 959 72 38 17 73
Construction ............................... -- -- -- -- --
Commercial real estate ..................... 3,263 1,090 468 353 --
Commercial business ........................ 3,547 2,899 1,539 1,548 1,485
Consumer ................................... 3,924 2,566 1,940 2,518 4,455
Other ...................................... -- -- -- 4 --
---------- ---------- ---------- ---------- ----------
Total charge-offs ........................ 11,693 6,627 3,985 4,440 6,013
---------- ---------- ---------- ---------- ----------
Recoveries:
Residential real estate .................... 135 -- -- -- --
Commercial real estate ..................... 15 11 80 69 --
Commercial business ........................ 709 131 381 332 20
Consumer ................................... 599 382 402 429 313
Other ...................................... -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Total recoveries ......................... 1,458 524 863 830 333
---------- ---------- ---------- ---------- ----------
Net charge-offs ............................... 10,235 6,103 3,122 3,610 5,680
---------- ---------- ---------- ---------- ----------
Transferred reserves from R&G Mortgage ........ -- 806 -- -- --
---------- ---------- ---------- ---------- ----------
Allowance for loan losses acquired
in acquisitions(1) ......................... 7,463 -- -- -- 364
---------- ---------- ---------- ---------- ----------
Provision for losses on loans ................. 18,020 11,125 5,751 4,525 6,600
---------- ---------- ---------- ---------- ----------
Balance at end of period ...................... $ 32,675 $ 17,428 $ 11,600 $ 8,971 $ 8,056
========== ========== ========== ========== ==========
Allowance for loan losses as a percent of total
loans outstanding .......................... 1.13% 0.91% 0.67% 0.55% 0.74%
========== ========== ========== ========== ==========
Allowance for loan losses as a percent of
non-performing loans ....................... 41.79% 24.05% 12.21% 15.11% 17.92%
========== ========== ========== ========== ==========
Ratio of net charge-offs to average loans
outstanding ................................ 0.41% 0.32% 0.17% 0.25% 0.55%
========== ========== ========== ========== ==========
---------------------------------
(1) Relates to acquired reserves in connection with the acquisition of Crown
Bank in 2002 and Fajardo Federal in 1998.
18
The following table sets forth information concerning the allocation of
R&G Financial's allowance for loan losses by loan category at the dates
indicated.
December 31,
---------------------------------------------------------------------------------------
2002 2001 2000
---------------------------------------------------------------------------------------
Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------- ------------ ------- ------------- --------- -------------
(Dollars in Thousands)
Residential real estate........ 2,982 9.13% $2,496 14.32% $ 1,278 11.02%
Construction................... 1,522 4.66 800 4.59 432 3.72
Commercial real estate......... 17,114 52.37 7,371 42.29 4,880 42.07
Commercial business............ 4,104 12.56 2,253 12.93 1,321 11.39
Consumer....................... 6,954 21.28 4,508 25.87 3,689 31.80
------- ------ ------- ------ --------- ------
Total.......................... $32,676 100.00% $17,428 100.00% $ 11,600 100.00%
======= ====== ======= ====== ========= ======
December 31,
---------------------------------------------------------------------
2002 2001
--------------------------------------------------------------------
Percent of Percent of
Loans in Each Loans in Each
Category to Category to
Amount Total Loans Amount Total Loans
------------- ----------- ------- ------------
(Dollars in Thousands)
Residential real estate................... $1,419 15.82% $1,272 15.79%
Construction.............................. 186 2.07 46 0.57
Commercial real estate.................... 3,258 36.32 2,655 32.96
Commercial business....................... 1,063 11.85 1,033 12.82
Consumer.................................. 3,045 33.94 3,049 37.86
------ ------ ------ ------
Total..................................... $8,971 100.00% $8,055 100.00%
====== ====== ====== ======
The allowance for loan losses reflects management's judgment of the
level of allowance adequate to absorb estimated credit losses inherent in R&G
Financial's loan portfolio. The Board of Directors of R&G Financial approved a
policy formulated by management for a systematic analysis of the adequacy of the
allowance. The major elements of the policy consist of: (1) a monthly analysis
of reserve amounts at Premier Bank (quarterly at Crown Bank); (2) approval by
the Board of Directors of each banking subsidiary of the periodic analysis; and
(3) division of the reserve into specific allocation and unspecified reserve
portions. The analysis is based on management's assessment of the historic rate
of losses in addition to concentration, segmentation, regional economic
conditions, non-performing loan and asset levels, past due status, composition
of the portfolio, and other factors.
Specific Allocations. All classified loans are evaluated for loss
portions or potential loss exposure. The evaluation occurs at the time the loan
is classified and on a regular basis (at least every 360 days) thereafter. This
evaluation is documented in the Internal Asset Review Report relating to a
specific loan. Specific allocation of reserves considers the value of
collateral, the financial condition of the borrower, and industry and current
economic trends.
General Allowances. Management realizes that an institution's past
loss history should be considered in evaluating the inherent loss potential of
the loan portfolio. Consequently, management has deemed it prudent to develop
and implement a migration analysis for the determination of inherent loss
potential for both its homogeneous and non-homogeneous loan portfolios.
Homogeneous loan categories consist of one-to-four family residential mortgages
and consumer loans. Commercial business and commercial real estate loans less
than $500,000 are also treated as homogeneous loans for asset review purposes.
Homogeneous loans are analyzed on a group or pool basis for evaluating credit
quality and impairment under FASB's SFAS No 5. Non-homogeneous loan categories
consist of all other commercial business and commercial real estate loans.
These assets are reviewed individually for the purpose of evaluating credit
quality and impairment under FASB's SFAS No. 114. The migration loss percentage
factors used for each risk class or grade for both homogeneous and
non-homogeneous loan categories are based on the results of a 3 year migration
analysis.
General allowances are derived for consumer lending utilizing
historical loss factors derived through migration analysis and adjusting for
current trends, economic conditions and portfolio behavioral characteristics.
Consumer lending poses more inherent risks than one-to-four family residential
lending and, consequently, the loss factors are higher. Because of the Company's
limited loss history for one-to-four family residential loans in Crown Bank,
general allowances for Crown Bank are derived utilizing historical industry loss
factors, also adjusted for management's assessment of the qualitative factors
presented above. Loss factors are applied based upon delinquency status with
higher loss factors applied as the number of days past due increases.
MORTGAGE BANKING ACTIVITIES
Loan Originations, Purchases and Sales. During the years ended December
31, 2002, 2001 and 2000, R&G Financial originated a total of $2.0 billion, $1.8
billion and $1.1 billion of residential mortgage loans, respectively. These
aggregate originations include loans originated by R&G Mortgage directly for
Premier Bank of $811.8 million, $664.8 million and $451.4 million during the
years ended December 31, 2002, 2001 and 2000, respectively, of such
originations, or 41%, 36% and 43%, respectively, of total originations. The
loans originated by R&G Mortgage for Premier Bank are comprised primarily of
conventional residential loans and, to a lesser extent, consumer loans secured
by real estate.
R&G Financial is engaged to a significant extent in the origination of
FHA-insured and VA-guaranteed single-family residential loans which are
primarily securitized into GNMA mortgage-backed securities and sold to
institutional and/or private investors in the secondary market. During the years
ended December 31, 2002, 2001 and 2000, R&G Financial originated $365.2 million,
$482.7 million and $307.1 million, respectively, of FHA/VA loans, which
represented 18.6%, 26.4% and 29.2%, respectively, of total loans originated
during such respective periods.
19
R&G Financial also originates conventional single-family residential
loans which are either insured by private mortgage insurers or do not exceed 80%
of the appraised value of the mortgaged property. During the years ended
December 31, 2002, 2001 and 2000, R&G Financial originated $1.6 billion, $1.3
billion and $699.7 million, respectively, of conventional single-family
residential mortgage loans. Substantially all conforming conventional
single-family residential loans are securitized and sold in the secondary
market, while a substantial portion of non-conforming conventional single-family
residential loans are originated by R&G Mortgage (either directly or through The
Mortgage Store) on behalf of Premier Bank and either held by Premier Bank in its
portfolio or subsequently securitized by R&G Mortgage and/or sold in the
secondary market from time to time.
Non-conforming loans generally consist of loans which, primarily
because of size or other underwriting technicalities (mostly related to
documentation requirements) which may be cured through seasoning, do not satisfy
the guidelines for resale of FNMA, FHLMC, GNMA and other private secondary
market investors at the time of origination. Management believes that these
loans are essentially of the same credit quality as conforming loans. In
connection with mortgage operations, during the years ended December 31, 2002,
2001 and 2000, non-conforming conventional loans represented approximately 54%,
48% and 53%, respectively, of R&G Financial's total volume of mortgage loans
originated, most of which were originated by R&G Mortgage on behalf of Premier
Bank. During the years ended December 31, 2002, 2001 and 2000, 94.1%, 94.1% and
83.8% of loans originated by R&G Mortgage on behalf of Premier Bank consisted of
single-family residential loans during such respective periods. R&G Mortgage
originates single-family residential, construction and commercial real estate
loans on behalf of Premier Bank pursuant to the terms of a Master Production
Agreement between R&G Mortgage and Premier Bank. See "- Lending Activities from
Banking Operations - Origination, Purchase and Sale of Loans."
While R&G Financial makes available a wide variety of mortgage products
designed to respond to consumer needs and competitive conditions, it currently
emphasizes 15-year and 30-year conventional first mortgages and 15-year and
30-year FHA loans and VA loans. Substantially all of such loans consist of
fixed-rate mortgages. R&G Financial also offers second mortgage loans up to
$125,000 with a maximum term of 15 years. The maximum loan-to-appraised value
ratio on second mortgage loans permitted by R&G Financial is generally 75%
(including the amount of any first mortgage). In addition, R&G Financial also
offers real estate secured consumer loans up to $60,000 with a maximum term of
15 years. The maximum loan-to-appraised value ratio on real estate secured
consumer loans permitted by R&G Financial is generally 80%. R&G Financial will
secure such loans with either a first or second mortgage on the property.
The Company's loan origination activities in Puerto Rico are conducted
out of R&G Mortgage offices and mortgage banking centers, and in the continental
United States, mainly through loan officers and solicitors, out of Crown Bank's
branches and Continental's mortgage offices. Residential mortgage loan
applications are attributable to walk-in customers, existing customers and
advertising and promotion, referrals from real estate brokers and builders, loan
solicitors and mortgage brokers.
Loan origination activities performed by the Company include
soliciting, completing and processing mortgage loan applications and preparing
and organizing the necessary loan documentation. Loan applications are examined
for compliance with underwriting criteria and, if all requirements are met, the
Company issues a commitment to the prospective borrower specifying the amount of
the loan and the loan origination fees, points and closing costs to be paid by
the borrower or seller and the date on which the commitment expires.
R&G Mortgage also purchases FHA loans and VA loans from other mortgage
bankers for resale to institutional investors and other investors in the form of
GNMA mortgage-backed securities. R&G Mortgage's strategy is to increase its
servicing portfolio primarily though internal originations through its
20
branch network and, to a lesser extent, purchases from third parties. Purchases
of loans from other mortgage bankers in the wholesale loan market are generally
limited to FHA loans and VA loans and such purchases provide R&G Mortgage with a
source of low cost production that allows R&G Mortgage to continue to increase
the size of its servicing portfolio. R&G Mortgage purchased $21.9 million, $29.3
million and $145.9 million of loans from third parties during the years ended
December 31, 2002, 2001 and 2000, respectively.
The following table sets forth loan originations, purchases and sales
from its mortgage banking business by R&G Financial for the periods indicated.
Year Ended December 31,
------------------------------------------------
2002 2001 2000
---------- ---------- ----------
(Dollars in Thousands)
Loans Originated For Premier Bank:
Conventional loans(1):
Number of loans ......................... 7,182 6,355 4,929
Volume of loans ......................... $ 809,141 $ 655,151 $ 407,461
FHA/VA loans:
Number of loans ......................... -- -- --
Volume of loans ......................... -- -- --
Consumer loans(2):
Number of loans ......................... 133 485 1,807
Volume of loans ......................... $ 2,632 $ 9,658 $ 43,943
Total loans:
Number of loans ......................... 7,315 6,840 6,736
Volume of loans ......................... $ 811,773 $ 664,809 $ 451,404
Percent of total volume ................. 41% 36% 38%
Loans Originated For Third Parties:
Conventional loans(1):
Number of loans ......................... 7,123 6,791 3,377
Volume of loans ......................... $ 782,782 $ 679,190 $ 292,283
FHA/VA loans:
Number of loans ......................... 3,537 4,823 3,241
Volume of loans ......................... $ 365,172 $ 482,721 $ 307,128
Total loans:
Number of loans ......................... 10,660 11,614 6,618
Volume of loans ......................... $1,147,954 $1,161,911 $ 599,411
Percent of total volume ................. 58% 63% 50%
---------- ---------- ----------
Total loan originations ............. $1,959,727 $1,826,720 $1,050,815
========== ========== ==========
Loans Purchased For R&G Mortgage:
Number of loans ......................... 283 371 1,627
Volume of loans(3) ...................... $ 21,890 $ 29,342 $ 145,881
Percent of total volume ................. 1% 1% 12%
---------- ---------- ----------
Total loan originations and purchases $1,981,617 $1,856,062 $1,196,696
========== ========== ==========
21
Year Ended December 31,
-----------------------------------------------------
2002 2001 2000
----------- ----------- ----------
(Dollars in Thousands)
Loans Sold To Third Parties(4):
Conventional loans(1):
Number of loans ......................... 7,114 6,124 3,937
Volume of loans ......................... $ 794,869 $ 603,542 $ 332,930
FHA/VA loans:
Number of loans ......................... 2,668 3,365 4,167
Volume of loans ......................... $ 369,449 $ 513,366 $ 367,868
Total loans:
Number of loans ......................... 9,782 9,489 8,104
Volume of loans(3) ...................... $ 1,164,318 $ 1,116,908 $ 700,798
----------- ------------ -----------
Percent of total volume ................. 59% 60% 59%
Adjustments:
Loans originated for Premier Bank .......... $ (811,773) $ (664,809) $ (451,404)
Loan amortization .......................... (44,200) (31,802) (18,544)
----------- ----------- ------------
Net (decrease) increase in loans ............. $ (38,674) $ 42,543 $ 25,950
=========== ============ =========
Average Initial Loan Origination Balance:
Premier Bank:
Conventional loans(1) ................... $ 113 $ 103 $ 83
FHA/VA loans ............................ -- -- --
Third Parties:
Conventional loans(1) ................... $ 110 $ 100 $ 87
FHA/VA loans ............................ 103 100 95
Total
Conventional loans(1) ................... $ 111 $ 102 $ 84
FHA/VA loans ............................ 103 100 95
Refinancings(5):
Premier Bank ............................... 50% 57% 56%
Third Parties .............................. 56% 50% 29%
-------------------
(1) Includes non-conforming loans.
(2) All of such loans were secured by real estate.
(3) Includes $21.8 million, $27.1 million and $63.0 million of loans
purchased from another institution, and securitized and sold to the
same financial institution during 2002, 2001 and 2000, respectively.
(4) Includes loans converted into mortgage-backed securities.
(5) As a percent of the total dollar volume of mortgage loans originated by
R&G Mortgage for Premier Bank (excluding consumer loans) or third
parties, as the case may be. In the case of Premier Bank, refinancings
do not necessarily represent refinancings of loans previously held by
Premier Bank.
All loan originations, regardless of whether originated through the
Company or purchased from third parties, must be underwritten in accordance with
R&G Financial's underwriting criteria, including loan-to-appraised value ratios,
borrower income qualifications, debt ratios and credit history, investor
requirements, necessary insurance and property appraisal requirements. R&G
Financial's underwriting standards also comply with the relevant guidelines set
forth by HUD, VA, FNMA, FHLMC, bank regulatory authorities, private mortgage
investment conduits and private mortgage insurers, as applicable.
22
The Company's underwriting personnel, while operating out of its loan offices,
make underwriting decisions independent of the Company's mortgage loan
origination personnel.
Typically, when a mortgage loan is originated, the borrower pays an
origination fee. These fees are generally in the range of 0% to 7% of the
principal amount of the mortgage loan, and are payable at the closing of such
loan. The Company receives these fees on mortgage loans originated through its
retail branches. The Company may charge additional fees depending upon market
conditions and regulatory considerations as well as the Company's objectives
concerning mortgage loan origination volume and pricing. The Company incurs
certain costs in originating mortgage loans, including overhead, out-of-pocket
costs and, in some cases, where the mortgage loans are subject to a purchase
commitment from private investors, related commitment fees. The volume and type
of mortgage loans and of commitments made by investors vary with competitive and
economic conditions (such as the level of interest rates and the status of the
economy in general), resulting in fluctuations in revenues from mortgage loan
originations. Generally accepted accounting principles ("GAAP") require that
general operating expenses incurred in originating mortgage loans be charged to
current expense. Direct origination costs and origination income must be
deferred and amortized using the interest method, until the repayment or sale of
the related mortgage loans. Historically, the value of servicing rights which
result from R&G Financial's origination activities has exceeded the net costs
attributable to such activities.
R&G Financial customarily sells most of the loans that it originates,
except for those originated on behalf of Premier Bank pursuant to a Master
Production Agreement with R&G Mortgage. See "-Lending Activities from Banking
Operations - Origination, Purchases and Sales of Loans." During the years ended
December 31, 2002, 2001 and 2000, R&G Financial sold $1.2 billion, $1.1 billion
and $637.8 million of loans, respectively, which includes loans securitized and
sold but does not include loans originated by R&G Mortgage on behalf of Premier
Bank or loans securitized for other institutions. With respect to such loan
sales, $253.1 million or 21.7%, $375.1 million or 33.6% and $270.8 million or
42.5% consisted of GNMA-guaranteed mortgage-backed securities of FHA loans or VA
loans packaged into pools of $1 million or more ($2.5 million to $5 million for
GNMA serial notes) by R&G Mortgage. These securities were sold directly either
through R-G Investments Corporation, R&G Financial's broker-dealer, Premier
Bank's Trust Department, or indirectly through securities broker-dealers.
Conforming conventional loans originated or purchased by the Company
are generally sold directly to FNMA, FHLMC or private investors for cash or are
grouped into pools of $1 million or more in aggregate principal balance and
exchanged for FNMA or FHLMC-issued mortgage-backed securities, which the Company
sells to securities broker-dealers. In connection with any such exchanges, the
Company pays guarantee fees to FNMA and FHLMC. The issuance of mortgage-backed
securities provides R&G Financial with flexibility in selling the mortgages
which it originates or purchases and also provides income by increasing the
value and marketability of the loans. Mortgage loans that do not conform to
GNMA, FNMA or FHLMC requirements (so-called "non-conforming loans") are
generally originated on behalf of Premier Bank by R&G Mortgage and either
retained in Premier Bank's portfolio, sold to financial institutions or other
private investors.
While R&G Financial's exchanges of mortgage loans into agency
securities and sales of mortgage loans are generally made on a non-recourse
basis, the Company also engages in the sale or exchange of mortgage loans on a
recourse basis. In the past, recourse sales often involved the sale of
non-conforming loans to FNMA, FHLMC and local financial institutions. R&G
Financial estimates the fair value of the retained recourse obligation at the
time mortgage loans are sold. At December 31, 2002, R&G Financial had loans in
its servicing portfolio with provisions for recourse in the principal amount of
approximately $762.3 million, as compared to $552.4 million and $680.5 million
as of December 31, 2001 and 2000, respectively. Of the recourse loans existing
at December 31, 2002,
23
approximately $378.1 million in principal amount consisted of loans sold to FNMA
and FHLMC and converted into mortgage-backed securities of such agencies, and
approximately $384.2 million in principal amount consisted of non-conforming
loans sold to other financial institutions and/or private investors. As of
December 31, 2002, R&G Financial had reserves for possible losses related to its
recourse obligations of $1.8 million. Historical losses on recourse obligations
have not been significant.
Loan Servicing. R&G Financial acquires servicing rights through its
mortgage loan originations (including originations on behalf of Premier Bank)
and purchases from third parties. The Company generally retains the rights to
service mortgage loans sold, which it has originated or purchased, and receives
the related servicing fees. Loan servicing includes collecting principal and
interest and remitting the same to the holders of the mortgage loans or
mortgage-backed securities to which such mortgage loan relates, holding escrow
funds for the payment of real estate taxes and insurance premiums, contacting
delinquent borrowers, supervising foreclosures in the event of unremedied
defaults and generally administering the loans. The Company receives annual loan
servicing fees ranging from 0.25% to 0.50% of the declining outstanding
principal balance of the loans serviced plus any late charges. In general, the
Company's servicing agreements are terminable by the investor for cause without
penalty or after payment of a termination fee ranging from 0.5% to 1.0% of the
outstanding principal balance of the loans being serviced.
R&G Financial's servicing portfolio has grown significantly over the
past several years. During the second quarter of 2002, the Company acquired a
servicing portfolio of $2.6 billion as part of its acquisition of Crown Bank. At
December 31, 2002, R&G Financial's servicing portfolio totaled $11.0 billion and
consisted of a total of 158,659 loans. These amounts include R&G Mortgage's
servicing portfolio totaling $7.2 billion, Crown Bank's servicing portfolio
totaling $3.3 billion and Continental's servicing portfolio totaling $470.1
million at December 31, 2002. At December 31, 2002, R&G Financial's servicing
portfolio included $1.1 billion of loans serviced for Premier Bank and $100.9
million of loans serviced for Crown Bank, or 10.3% and 0.9%, respectively, of
the total servicing portfolio. Substantially all of the mortgage loans in R&G
Financial's servicing portfolio are secured by single (one-to-four) family
residences. At December 31, 2002, approximately 65.4% of R&G Financial's
mortgage servicing portfolio is comprised of mortgages secured by real estate
located in Puerto Rico.
R&G Mortgage services all loans held in Premier Bank's loan portfolio
(including single-family residential loans retained by Premier Bank and certain
commercial real estate loans), although R&G Mortgage does not actually acquire
such servicing rights. Once loans are sold, Premier Bank retains the servicing
rights to such loans; R&G Mortgage continues to service the loans on behalf of
Premier Bank. Premier Bank pays R&G Mortgage servicing fees with respect to the
loans serviced by R&G Mortgage on behalf of Premier Bank. In addition, Premier
Bank processes payments of all loans originated by R&G Mortgage on behalf of
Premier Bank. In connection therewith, R&G Mortgage pays Premier Bank a fee
equal to between $0.50 and $1.00 per loan. See "- Regulation - R&G Financial -
Limitations on Transactions with Affiliates."
R&G Financial's mortgage loan servicing portfolio is subject to
reduction by reason of normal amortization, prepayments and foreclosure of
outstanding mortgage loans. Additionally, R&G Financial may sell mortgage loan
servicing rights from time to time.
24
The following table sets forth certain information regarding the total
loan servicing portfolio of R&G Financial for the periods indicated.
Year Ended December 31,
---------------------------------------------------------
2002 2001 2000
------------ ----------- ------------
(Dollars in Thousands)
Composition of Servicing Portfolio at End of
Period:
Conventional and other mortgage loans(1) ... $ 8,035,208 $ 4,070,074 $ 3,447,383
FHA/VA loans ............................... 2,956,736 3,154,497 3,186,676
------------ ------------ ------------
Total servicing portfolio ................ $ 10,991,944 $ 7,224,571 $ 6,634,059
============ ============ ============
Activity in the Servicing Portfolio:
Beginning servicing portfolio .............. $ 7,224,571 $ 6,634,059 $ 6,177,511
Add: Loan originations and purchases ...... 2,204,275 1,887,582 1,280,898
Servicing of portfolio loans acquired(2) 4,325,499 4,936 31,404
Less: Sale of servicing rights(3) .......... (229,587) (211,603) (213,959)
Run-offs(4) .......................... (2,532,814) (1,090,403) (641,795)
------------ ------------ ------------
Ending servicing portfolio ................. $ 10,991,944 $ 7,224,571 $ 6,634,059
============ ============ ============
Number of loans serviced ................... 158,659 113,070 110,874
Average loan size .......................... $ 69 $ 64 $ 60
Average servicing fee rate ................. 0.508% 0.499% 0.483%
-------------------
(1) Includes non-conforming loans.
(2) Includes $2.6 billion acquired in connection with the acquisition of
Crown Bank in June 2002.
(3) Includes loans sold, servicing released, by Continental totaling $229.6
million, $211.6 million and $172.9 million in 2002, 2001 and 2000,
respectively.
(4) Run-off refers to regular amortization of loans, prepayments and
foreclosures.
The following table sets forth certain information at December 31, 2002
regarding the number of, and aggregate principal balance of, the mortgage loans
serviced by R&G Financial for its loan portfolio and for third parties at
various mortgage interest rates.
At December 31, 2002
-----------------------------------------------------------------------------------------------
Portfolio Loans Serviced Total Loans
Loans Serviced or Third Parties Serviced
------------------------------------------------------------------------------------------------
Aggregate Aggregate Aggregate
Number of Principal Number of Principal Number of Principal
Loans Balance Loans Balance Loans Balance
--------- ------------ --------- ---------- --------- -----------
(Dollars in Thousands)
Mortgage Interest Rate
Less than 7.00% 4,470 556,425 37,285 3,187,295 41,755 3,743,720
7.00% - 7.49% 2,970 352,258 32,128 2,451,576 35,098 2,803,834
7.50% - 7.99% 1,691 158,507 31,574 2,011,642 33,265 2,170,149
8.00% - 8.49% 769 63,841 15,317 878,645 16,086 942,486
8.50% - 8.99% 867 50,385 14,438 692,413 15,305 742,798
9.00% - 9.49% 334 17,859 5,272 219,128 5,606 236,987
9.50% - 9.99% 398 14,744 4,187 133,528 4,585 148,272
10.00% - 10.49% 113 5,830 1,626 57,187 1,739 63,017
10.50% - 10.99% 259 7,473 1,231 41,212 1,490 48,685
11.00% or more 122 3,286 3,608 88,710 3,730 91,996
------ ---------- ------- ---------- ------- -----------
11,993 $1,230,608 146,666 $9,761,336 158,659 $10,991,944
====== ========== ======= ========== ======= ===========
25
The amount of principal prepayments on mortgage loans serviced by R&G
Financial was $287.2, $180.3 million and $176.3 million for the years ended
December 31, 2002, 2001 and 2000, respectively. This represented approximately
3.1%, 2.5% and 2.7% of the aggregate principal amount of mortgage loans serviced
during such periods. The primary means used by R&G Mortgage to reduce the
sensitivity of its servicing fee income to changes in interest and prepayment
rates is the development of a strong internal origination capability that has
allowed R&G Financial to continue to increase the size of its servicing
portfolio even in times of high prepayments.
Servicing agreements relating to the mortgage-backed securities
programs of FNMA, FHLMC and GNMA, and certain other investors, require R&G
Financial to advance funds to make scheduled payments of principal, interest,
taxes and insurance, if such payments have not been received from the borrowers.
During the years ended December 31, 2002, 2001 and 2000, the monthly average
amount of funds advanced by R&G Financial under such servicing agreements was
$24.4 million, $7.4 million and $5.8 million, respectively. Funds advanced by
R&G Financial pursuant to these arrangements are generally recovered by R&G
Financial within 30 days.
In connection with its loan servicing activities, R&G Financial holds
escrow funds for the payment of real estate taxes and insurance premiums with
respect to the mortgage loans it services. At December 31, 2002, R&G Financial
held $224.4 million of such escrow funds, $116.3 million of which were deposited
in Premier Bank, $103.8 million of which were deposited in Crown Bank and $4.3
million of which were deposited with other financial institutions. The escrow
funds lower the overall cost of funds, while the escrow funds deposited with
other financial institutions serve as part of R&G Financial's compensating
balances which permit the Company to borrow funds from such institutions
(pursuant to certain warehouse lines of credit) at rates that are lower than
would otherwise apply. See "- Sources of Funds - Borrowings."
The degree of risk associated with a mortgage loan servicing portfolio
is largely dependent on the extent to which the servicing portfolio is
non-recourse or recourse. In non-recourse servicing, the principal credit risk
to the servicer is the cost of temporary advances of funds. In recourse
servicing, the servicer agrees to share credit risk with the owner of the
mortgage loans such as FNMA or FHLMC or with an insurer or guarantor. Losses on
recourse servicing occur primarily when foreclosure sale proceeds of the
property underlying a defaulted mortgage are less than the then outstanding
principal balance and accrued interest of such mortgage loan and the cost of
holding and disposing of such underlying property. At December 31, 2002, R&G
Financial was servicing mortgage loans with an aggregate principal amount of
$762.3 million on a recourse basis. During the last three years, losses incurred
due to recourse servicing have not been significant.
R&G Financial's general strategy is to retain the servicing rights
related to the mortgage loans it originates and purchases. Nevertheless, there
is a market for servicing rights, which are generally valued in relation to the
present value of the expected income stream generated by the servicing rights.
Among the factors which influence the value of a servicing portfolio are
servicing fee rates, loan balances, loan types, loan interest rates, the
expected average life of the underlying loans (which may be reduced through
foreclosure or prepayment), the value of escrow balances, delinquency and
foreclosure experience, servicing costs, servicing termination rights of
permanent investors and any recourse provisions. Although the Company may on
occasion consider future sales of a portion of its servicing portfolio,
management does not anticipate sales of servicing rights to become a significant
part of its operations.
The market value of, and earnings from, R&G Financial's mortgage loan
servicing portfolio may be adversely affected if mortgage interest rates decline
and mortgage loan prepayments increase. In a period of declining interest rates
and accelerated prepayments, income generated from the Company's
26
mortgage loan servicing portfolio may also decline. Conversely, as mortgage
interest rates increase, the market value of the Company's mortgage loan
servicing portfolio may be positively affected. See Note 1 to R&G Financial's
Notes to Consolidated Financial Statements for a discussion of SFAS No. 140 and
the treatment of servicing rights, incorporated by reference into Item 8 hereof.
Mortgage Loan Delinquencies and Foreclosures. The following table shows
the delinquency statistics for R&G Financial's servicing portfolio at the dates
indicated.
Year Ended December 31,
-----------------------------------------------------------------------------------
2002 2001 2000
------------------------ ------------------------- ----------------------
Percent of Percent of Percent of
Number of Servicing Number of Servicing Number of Servicing
Loans Portfolio Loans Portfolio Loans Portfolio
--------- --------- --------- ---------- --------- ----------
Loans delinquent for:
30-59 days................. 5,708 3.60% 5,995 5.30% 5,336 4.81%
60-89 days................. 1,696 1.07 1,746 1.54 1,547 1.40
90 days or more............ 3,298 2.08 2,678 2.37 2,300 2.07
------ ---- ------ ---- ----- ----
Total delinquencies(1)... 10,702 6.75% 10,419 9.21% 9,183 8.28%
====== ==== ====== ==== ===== ====
Foreclosures pending(2)....... 2,199 1.39% 2,056 1.82% 1,845 1.66%
====== ==== ===== ==== ===== ====
--------------------
(1) Includes at December 31, 2002 an aggregate of $80.2 million of delinquent
loans serviced for Premier Bank, or 0.73% of the total servicing
portfolio, $9.3 million of delinquent loans held by Crown Bank, or 0.08%
of the total servicing portfolio, and $14.4 million of delinquent loans
held in R&G Mortgage's portfolio.
(2) At December 31, 2002, Premier Bank had foreclosures pending on $17.4
million of loans being serviced by R&G Mortgage, which constituted 0.16%
of the servicing portfolio. Crown Bank had foreclosures pending on
$843,000 million of loans it is servicing for its own portfolio, and R&G
Mortgage had foreclosures pending on $4.1 million of loans it is
servicing for its own portfolio at December 31, 2002.
While delinquency rates in Puerto Rico are generally higher than in the
mainland United States, these rates are not necessarily indicative of future
foreclosure rates or losses on foreclosures. Real estate owned as a result of
foreclosures ("REO") related to R&G Financial's mortgage banking business arise
primarily through foreclosure on mortgage loans repurchased from investors
either because of breach of representations or warranties or pursuant to
recourse arrangements. As of December 31, 2002, 2001 and 2000, R&G Financial
held REO related to servicing activities with a book value of approximately $9.6
million, $3.0 million and $1.3 million, respectively, including $1.6 million
related to Crown Bank at December 31, 2002. Sales of REO resulted in losses to
R&G Financial of $1,474,000 and $442,000 during the years ended December 31,
2002 and 2001, respectively, and gains of $168,000 for the year ended December
31, 2000. There is no liquid secondary market for the sale of R&G Financial's
REO.
With respect to mortgage loans securitized through GNMA programs, the
Company is fully insured as to principal by the FHA and VA against foreclosure
loans. As a result of these programs, foreclosure on these loans had generated
no loss of principal as of December 31, 2002. Currently, Crown Bank only
services conventional loans, as opposed to FHA/VA loans. R&G Mortgage, however,
incurs about $3,000 per loan foreclosed in interest and legal charges during the
time between payment by R&G Mortgage and FHA or VA reimbursement. For the years
ended December 31, 2002, 2001 and 2000, total expenses related to FHA or VA
loans foreclosed amounted to $797,000, $337,000 and $235,000, respectively.
Although FNMA and FHLMC are obligated to reimburse the Company for principal and
interest payments advanced by the Company as a servicer (except for recourse
servicing), the funding of
27
delinquent payments or the exercise of foreclosure rights involves costs to the
Company which may not be recouped. Such nonrecouped expenses have to date been
immaterial.
Any significant adverse economic developments could result in an
increase in defaults or delinquencies on mortgage loans that are serviced by the
Company or held by the Company pending sale in the secondary mortgage market,
thereby reducing the resale value of such mortgage loans.
INVESTMENT ACTIVITIES
General. R&G Financial's securities portfolio is managed by investment
officers in accordance with a comprehensive written investment policy which
addresses strategies, types and levels of allowable investments and which is
reviewed and approved annually by the respective Boards of Directors of the
Company's banking subsidiaries and R&G Mortgage. The management of the
securities portfolio is set in accordance with strategies developed by Interest
Rate Risk, Budget and Investments Committee ("IRRBICO") of each banking
subsidiary.
As discussed under "- Mortgage Banking Activities," R&G Mortgage is
primarily engaged in the origination of mortgage loans and the securitization of
such loans into mortgage-backed and related securities and the subsequent sale
of such securities to securities broker-dealers and other investors in the
secondary market. As a result of R&G Mortgage's securitization activities, R&G
Mortgage maintains a substantial portfolio of GNMA mortgage-backed securities.
At December 31, 2002, R&G Mortgage held GNMA and FHLMC mortgage-backed
securities with a fair value of $26.1 million which are classified as held for
trading. Such securities generally remain in R&G Mortgage's portfolio for
between 90 and 180 days. In addition, as of such date, R&G Mortgage held tax-
exempt GNMA mortgage-backed securities with a fair value of $345.2 million,
which are classified as available for sale. At December 31, 2002, R&G Mortgage's
CMO interest-only residuals and interest only strips, which are classified as
available for sale, had an amortized cost of $22.2 million and a fair value of
$22.2 million.
Under Premier Bank's and Crown Bank's Investment Policies, the
Company's banking subsidiaries generally invest in U.S. Treasury obligations
(with a maturity up to five years), U.S. Agency obligations, FNMA, GNMA and
FHLMC mortgage-backed certificates, investment grade municipal obligations (with
a maturity of up to five years), bankers' acceptances and Federal Home Loan Bank
("FHLB") notes (with a maturity of up to five years), investment grade
commercial paper (with a maturity of up to 9 months), federal funds (with a
maturity of six months or less), certificates of deposit in other financial
institutions (including Eurodollar deposits), repurchase agreements (with a
maturity of six months or less), investment grade corporate bonds (with a
maturity of five years or less) and certain mortgage-backed derivative
securities (with a weighted average life of less than ten years).
At December 31, 2002, the securities portfolios of the Company's
banking subsidiaries include $40.4 million of securities held for investment,
consisting principally of $6.3 million of GNMA mortgage-backed securities, $6.4
million of FHLMC and FNMA mortgage backed securities, and $27.6 million of
Puerto Rico Government obligations and other Puerto Rico securities, all held by
Premier Bank. In addition, at December 31, 2002, the securities portfolios of
the Company's banking subsidiaries classified as available for sale had a fair
value of $2.2 billion, consisting principally of $117.8 million of GNMA
mortgage-backed securities, $1.0 billion of FHLMC and FNMA mortgage-backed
securities, $84.3 million of FHLB stock, $459.5 million of CMOs, $10.6 million
of CMO interest-only residuals and interest only strips, $70.8 million corporate
debt obligations and $411.6 million of U.S. Government and Agency securities. A
substantial amount of securities held by Premier Bank are tax-exempt.
28
Premier Bank's Treasury Department from time to time conducts certain
trading. At December 31, 2002, securities for trading held by Premier Bank
totaled $48.7 million, consisting of FHLMC mortgage-backed securities.
At December 31, 2002, $607.3 million or 22.4% of R&G Financial's
mortgage-backed and investment securities were pledged to secure various
obligations of R&G Financial (excluding repurchase agreements).
The following table presents certain information regarding the
composition and period to maturity of R&G Financial's securities portfolio held
to maturity as of the dates indicated below. All of such securities are assets
of the Company's banking subsidiaries, except as otherwise indicated in the
footnotes below.
December 31,
--------------------------------------------------------------
2002 2001
--------------------------- --------------------------------
Weighted Weighted
Carrying Market Average Carrying Market Average
Value Value Yield Value Value Yield
-------- ------ -------- -------- ------ --------
(Dollars in Thousands)
Mortgage-backed securities:
GNMA(1)
Due within one year........... $ -- $ -- --% $ -- $ -- --%
Due from one-five years....... -- -- -- -- -- --
Due from five-ten years....... 5,457 5,513 5.82 7,180 7,111 5.82
Due over ten years............ 33,521 34,091 6.30 37,043 37,092 6.49
FNMA
Due within one year........... -- -- -- -- -- --
Due from one-five years....... -- -- -- -- -- --
Due from five-ten years....... -- -- -- -- -- --
Due over ten years............ 6,327 6,698 7.06 7,594 7,910 7.05
FHLMC
Due within one year........... -- -- -- -- -- --
Due from one-five years....... -- -- -- -- -- --
Due from five-ten years....... -- -- -- -- -- --
Due over ten years............ 102 102 5.55 128 125 5.59
Investment securities:
United States Government and
Agencies obligations
Due within one year......... 997 997 1.75 -- -- --
Due from one-five years..... 1,500 1,500 2.38 -- -- --
Puerto Rico Government
and Agencies obligations
Due within one year......... -- -- -- -- -- --
Due from one-five years..... 26,586 26,804 5.40 12,691 12,731 4.99
Due from five-ten years..... 1,000 1,005 5.05 10,896 11,059 6.00
Due over ten years.......... -- -- -- -- -- --
Other
Due within one year......... -- -- -- -- -- --
Due from one-five years..... 100 100 6.20 100 100 6.20
Due from five-ten years..... -- -- -- -- -- --
Due over ten years.......... -- -- -- -- -- --
-- -- --
Total securities held for
investment................ $75,791 $76,810 5.98% $75,632 $76,128 6.16%
======= ======= ==== ======= ======= =====
(1) Includes $32.7 million held by R&G Financial at the parent company level at
December 31, 2002.
29
December 31,
---------------------------------
2000
---------------------------------
Weighted
Carrying Market Average
Value Value Yield
-------- ------ --------
(Dollars in Thousands)
Mortgage-backed securities:
GNMA
Due within one year.................. $ 2 $ 3 10.00%
Due from one-five years.............. -- -- --
Due from five-ten years.............. 8,865 8,605 5.79
Due over ten years................... 1,845 1,766 6.17
FNMA
Due within one year.................. -- -- --
Due from one-five years.............. -- -- --
Due from five-ten years.............. -- -- --
Due over ten years................... 8,947 9,145 7.08
FHLMC
Due within one year.................. -- -- --
Due from one-five years.............. -- -- --
Due from five-ten years.............. -- -- --
Due over ten years................... 160 154 6.16
Investment securities:
Puerto Rico Government and Agencies
obligations
Due within one year................ -- -- --
Due from one-five years............ 1,948 1,948 5.88
Due from five-ten years............ 1,755 1,755 5.98
Due over ten years................. -- -- --
Other
Due within one year................ -- -- --
Due from one-five years............ -- -- --
Due from five-ten years............ -- -- --
Due over ten years -- -- --
------- ------- -----
Total securities held for
investment....................... $23,522 $23,376 6.34%
======= ======= =====
30
The following table presents certain information regarding the
composition and period to maturity of R&G Financial's held for trading and
available for sale mortgage-backed and investment securities portfolio as of the
dates indicated below.
December 31,
---------------------------------------------------------------------------------
2002 2001
------------------------------------- -------------------------------------
Weighted Weighted
Amortized Fair Average Amortized Average
Cost Value Yield Cost Fair Value Yield
---------- ----- -------- --------- ---------- -------
(Dollars in Thousands)
Mortgage-backed securities available for sale:
GNMA
Due within one year...................... -- -- --% $ -- $ -- --%
Due from one-five years.................. -- -- -- 50 50 8.49
Due from five-ten years.................. 16,515 16,759 6.34 11,053 11,172 5.97
Due over ten years....................... 440,767 446,339 5.33 513,508 511,639 6.50
FNMA mortgage-backed securities
Due within one year...................... -- -- -- -- -- --
Due from one-five years.................. -- -- -- -- -- --
Due from five-ten years.................. 370 390 6.50 538 549 6.50
Due over ten years....................... 258,805 269,367 6.72 266,495 270,936 7.24
FHLMC mortgage-backed securities
Due within one year...................... 2 2 8.72 -- -- --
Due from one-five years.................. 20 21 9.04 73 74 8.93
Due from five-ten years.................. 889 935 5.91 1,265 1,292 6.60
Due over ten years....................... 738,041 756,228 6.46 435,662 437,026 6.74
Collateralized mortgage obligations
(CMO'S)
Due within one year...................... -- -- -- -- -- --
Due from one-five years.................. 17,178 17,288 4.74 -- -- --
Due from five-ten years.................. 31,571 32,219 5.48 27,212 27,316 6.05
Due over ten years....................... 404,981 409,830 5.40 202,546 202,468 5.98
CMO residuals and other mortgage-backed
securities
Due within one year...................... 112 112 8.08 -- -- --
Due from one-five years.................. 10,862 12,496 12.56 9,897 9,627 15.00
Due from five-ten years.................. 20,102 20,263 14.71 9,239 10,797 8.08
Due over ten years....................... -- -- -- -- -- --
Investment securities available for sale:
U.S. Government & Agencies
Due within one year...................... -- -- -- 9,600 9,807 5.78
Due from one-five years.................. 263,632 267,896 3.90 156,522 157,408 4.82
Due from five-ten years.................. 137,756 143,695 5.82 307,110 310,938 6.21
Due over ten years....................... -- -- -- -- -- --
Municipal debt obligations
Due over ten years....................... 4,884 4,879 4.57 -- -- --
Corporate debt obligations
Due within one year...................... 3,205 3,367 6.63 -- -- --
Due from one-five years.................. 52,779 55,283 6.54 53,637 54,503 6.53
Due from five-ten years.................. 2,979 2,385 7.76 -- -- --
Due over ten years....................... 9,805 9,809 6.89 -- -- --
Mortgage securities portfolio
mutual fund.............................. 3,266 2,964 4.21 -- -- --
FHLB stock................................. 84,337 84,337 5.42 66,077 66,077 5.20
Other...................................... 49 49 -- -- -- --
---------- ---------- ------- ---------- ---------- -----
$2,502,908 $2,556,913 5.84% $2,070,484 $2,081,679 6.42%
========== ========== ======= ========== ========== =====
Securities held for trading:
GNMA certificates.......................... 9,281 9,741 4.86% $ 18,152 $ 18,152 5.80%
FHLMC certificates......................... 62,550 65,016 7.18 73,687 75,796 7.29
---------- ---------- ------- ---------- ---------- -----
$ 71,831 $ 74,757 6.89% $ 91,839 $ 93,948 6.99%
========== ========== ======= ========== ========== =====
31
December 31,
------------------------------------------
2000
------------------------------------------
Weighted
Amortized Fair Average
Cost Value Yield
---------- ---------- --------
Mortgage-backed securities available for sale
GNMA
Due within one year................................... $ -- $ -- --%
Due from one-five years............................... 26 26 8.50
Due from five-ten years............................... 10,492 10,419 5.68
Due over ten years.................................... 584,419 576,869 6.62
FNMA mortgage-backed securities
Due within one year................................... -- -- --
Due from one-five years............................... -- -- --
Due from five-ten years............................... 634 634 6.50
Due over ten years.................................... 98,779 99,968 7.15
FHLMC mortgage-backed securities
Due within one year................................... 13 13 9.00
Due from one-five years............................... 132 130 8.94
Due from five-ten years............................... 1,587 1,587 6.61
Due over ten years.................................... 434,865 437,227 7.26
CMO residuals and other mortgage-backed
securities
Due within one year................................... -- -- --
Due from one-five years............................... 10,710 10,190 12.00
Due from five-ten years............................... -- -- --
Due over ten years.................................... 10,688 13,037 8.08
Investment securities available for sale
U.S. Government & Agencies
Due within one year................................... 8,500 8,446 5.48
Due from one-five years............................... 192,763 193,298 6.26
Due from five-ten years............................... 114,881 115,352 7.30
Due over ten years.................................... -- -- --
Corporate debt obligations
Due within one year................................... -- -- --
Due from one-five years............................... -- -- --
Due from five-ten years............................... 5,097 5,202 6.80
Due over ten years.................................... -- -- --
FHLB stock.............................................. 45,973 45,973 7.30
---------- ---------- ----
$1,519,559 $1,518,371 6.96%
========== ========== ====
Securities held for trading:
GNMA certificates....................................... $ 11,630 $ 12,038 7.28%
FHLMC certificates...................................... -- -- --
---------- ---------- ----
$ 11,630 $ 12,038 7.28%
========== ========== ====
A substantial portion of R&G Financial's securities are held in
mortgage-backed securities. Mortgage-backed securities (which also are known as
mortgage participation certificates or pass-through certificates) represent a
participation interest in a pool of single-family or multi-family mortgages, the
principal and interest payments on which are passed from the mortgage
originators, through intermediaries (generally U.S. Government agencies and
government sponsored enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as R&G Financial. Such
U.S. Government agencies and government sponsored enterprises, which guarantee
the payment of principal and interest to investors, primarily include the FHLMC,
the FNMA and the GNMA.
The FHLMC is a public corporation chartered by the U.S. Government and
owned by the 12 Federal Home Loan Banks and federally-insured savings
institutions. The FHLMC issues participation
32
certificates backed principally by conventional mortgage loans. The FHLMC
guarantees the timely payment of interest and the ultimate return of principal
within one year. The FNMA is a private corporation chartered by the U.S.
Congress with a mandate to establish a secondary market for conventional
mortgage loans. The FNMA guarantees the timely payment of principal and interest
on FNMA securities. FHLMC and FNMA securities are not backed by the full faith
and credit of the United States, but because the FHLMC and the FNMA are U.S.
Government-sponsored enterprises, these securities are considered to be among
the highest quality investments with minimal credit risks. The GNMA is a
government agency within HUD which is intended to help finance
government-assisted housing programs. GNMA securities are backed by FHA-insured
and VA-guaranteed loans, and the timely payment of principal and interest on
GNMA securities are guaranteed by the GNMA and backed by the full faith and
credit of the U.S. Government. Because the FHLMC, the FNMA and the GNMA were
established to provide support for low- and middle-income housing, there are
limits to the maximum size of loans that qualify for these programs. To
accommodate larger-sized loans, and loans that, for other reasons, do not
conform to the agency programs, a number of private institutions have
established their own home-loan origination and securitization programs.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
characteristics of the underlying pool of mortgage, i.e., fixed-rate or
adjustable-rate, as well as prepayment risk, are passed on to the certificate
holder. The life of a mortgage-backed pass-through security thus approximates
the life of the underlying mortgages. Mortgage-backed securities generally
increase the quality of R&G Financial's assets by virtue of the insurance or
guarantees that back them, are more liquid than individual mortgage loans and
may be used to collateralize borrowings or other obligations of R&G Financial.
R&G Financial's securities portfolio includes CMOs. CMOs have been
developed in response to investor concerns regarding the uncertainty of cash
flows associated with the prepayment option of the underlying mortgagor and are
typically issued by government agencies, government sponsored enterprises and
special purpose entities, such as trusts, corporations or partnerships,
established by financial institutions or other similar institutions. A CMO can
be collateralized by loans or securities which are insured or guaranteed by the
FNMA, the FHLMC or the GNMA. In contrast to pass-through mortgage-backed
securities, in which cash flow is received pro rata by all security holders, the
cash flow from the mortgages underlying a CMO is segmented and paid in
accordance with a predetermined priority to investors holding various CMO
classes. By allocating the principal and interest cash flows from the underlying
collateral among the separate CMO classes, different classes of bonds are
created, each with its own stated maturity, estimated average life, coupon rate
and prepayment characteristics.
The FDIC has issued a statement of policy which states, among other
things, that mortgage derivative products (including CMOs and CMO residuals)
which possess average life or price volatility in excess of a benchmark fixed
rate 30-year mortgage-backed pass-through security are "high-risk mortgage
securities," are not suitable investments for depository institutions, and if
considered "high risk" at purchase must be carried in the institution's trading
account or as assets held for sale, and must be marked to market on a regular
basis. In addition, if a security was not considered "high risk" at purchase but
was later found to be "high risk" based on the tests, it may remain in the
held-to-maturity portfolio as long as the institution has positive intent to
hold the security to maturity and has a documented plan in place to manage the
high risk. At December 31, 2002, CMOs, and interest-only securities and
residuals of the Company's banking subsidiaries, which had a fair value of
$10.7 million, were designated as "high-risk mortgage securities" and classified
as available for sale.
33
SOURCES OF FUNDS
General. R&G Financial will consider various sources of funds to fund
its investment and lending activities and evaluates the available sources of
funds in order to reduce R&G Financial's overall funding costs. Deposits,
reverse repurchase agreements, warehouse lines of credit, notes payable, FHLB
advances, subordinated capital notes and sales, maturities and principal
repayments on loans and securities have been the major sources of funds for use
in R&G Financial's lending and investing activities and for other general
business purposes.
Deposits. Deposits are the major sources of funds for R&G Financial's
lending and other investment purposes. Consumer and commercial deposits are
attracted principally from within the Company's primary market area through the
offering of a broad selection of deposit instruments, including passbook, NOW
and Super NOW, checking and commercial checking and certificates of deposit
ranging in terms from 7 days to 10 years. Included among these deposit products
are $991.5 million of certificates of deposit with balances of $100,000 or more,
which amounted to 35.4% of R&G Financial's total deposits at December 31, 2002.
Deposit account terms vary according to the minimum balance required, the time
periods the funds must remain on deposit and the interest rate, among other
factors.
The Company attempts to price its deposits in order to promote deposit
growth. The Company regularly evaluates its internal costs of funds, surveys
rates offered by competing institutions, reviews cash flow requirements for
lending and liquidity and executes rate changes when deemed appropriate. The
Company does not obtain funds through brokers on a regular basis, although at
December 31, 2002, the Company held $200.5 million of deposits acquired from
money desks in the United States.
The principal methods currently used by the Company to attract deposit
accounts include offering a wide variety of services and accounts and
competitive interest rates. The Company utilizes traditional marketing methods
to attract new customers and savings deposits, including advertising.
The following table presents for the banking subsidiaries the average
balance of each deposit type and the average rate paid on each deposit type for
the periods indicated.
December 31,
--------------------------------------------------------------------------------
2002 2001 2000
---------------------- ---------------------- ----------------------
Average Average Average
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
---------- ------- ---------- ------- ---------- -------
(Dollars in Thousands)
Passbook...................... $ 283,497 2.84% $ 131,729 3.55% $ 113,660 3.73%
NOW and Super NOW accounts.... 360,596 2.84 188,545 3.75 134,573 3.93
Checking...................... 78,626 -- 43,621 -- 40,455 --
Commercial checking(1)........ 266,869 -- 165,541 -- 110,937 --
Certificates of deposit....... 1,481,449 4.18 1,289,193 5.98 1,106,294 6.43
---------- ---------- ----------
Total deposits............. $2,471,037 3.58% $1,818,629 4.89% $1,505,919 5.36%
========== ====== ========== ====== ========== ======
------------------
(1) Includes $220.0 million, $101.9 million and $91.8 million of escrow funds
of the Company at December 31, 2002, 2001 and 2000, respectively,
maintained with the Company's banking subsidiaries.
34
The following table sets forth the maturities of certificates of
deposit having principal amounts of $100,000 or more at December 31, 2002.
Amount
--------------
(In Thousands)
Certificates of deposit maturing:
Three months or less........................................... $ 106,818
Over three through six months.................................. 163,818
Over six through twelve months................................. 130,678
Over twelve months............................................. 590,191
-----------
Total..................................................... $ 991,505
===========
Borrowings. R&G Financial's business requires continuous access to
various funding sources, both short and long-term. R&G Mortgage's primary source
of short-term funds is through sales of securities to investment dealers under
agreements to repurchase ("reverse repurchase agreements"). The Company also
uses reverse repurchase agreements to fund a majority of its investment
securities portfolio.
In a reverse repurchase agreement transaction, R&G Financial will
generally sell a mortgage-backed security agreeing to repurchase either the same
or a substantially identical security on a specified later date (generally not
more than 90 days) at a price less than the original sales price. The difference
in the sale price and purchase price is the cost of the use of the proceeds. The
mortgage-backed securities underlying the agreements are delivered to the
dealers who arrange the transactions. For agreements in which R&G Financial has
agreed to repurchase substantially identical securities, the dealers may sell,
loan or otherwise dispose of R&G Financial's securities in the normal course of
their operations; however, such dealers or third party custodians safe-keep the
securities which are to be specifically repurchased by R&G Financial. Reverse
repurchase agreements represent a competitive cost funding source for R&G
Financial. Nevertheless, R&G Financial is subject to the risk that the lender
may default at maturity and not return the collateral. The amount at risk is the
value of the collateral which exceeds the balance of the borrowing. In order to
minimize this potential risk, R&G Financial only deals with large, established
investment brokerage firms when entering into these transactions.
Reverse repurchase transactions are accounted for as financing
arrangements rather than as sales of such securities, and the obligations to
repurchase such securities is reflected as a liability in R&G Financial's
Consolidated Financial Statements. As of December 31, 2002, R&G Financial had
$1.5 billion of reverse repurchase agreements outstanding, with a weighted
average interest rate of 3.16%.
R&G Financial's loan originations are also funded by borrowings under
various warehouse lines of credit provided by various commercial banks
("Warehouse Lines"). At December 31, 2002, R&G Financial was permitted to borrow
under such Warehouse Lines up to $278.4 million, $168.0 million of which was
drawn upon and outstanding as of such date. The Warehouse Lines are used by R&G
Financial to fund loan commitments and must generally be repaid within 180 days
after the loan is closed or when payment from the sale of the funded loan is
received, whichever occurs first. Until such sale closes, the Warehouse Lines
provide that the funded loan is pledged to secure the outstanding borrowings.
The Warehouse Lines are also collateralized by a general assignment of mortgage
payments receivable and an assignment of certain mortgage servicing rights.
Certain of these warehousing lines of credit impose restrictions with respect to
the maintenance of minimum levels of net worth and working capital and
limitations on the amount of indebtedness and dividends which may be declared.
Management of R&G Financial believes that as of December 31, 2002, it was in
compliance with all of such covenants and restrictions and does not anticipate
that such covenants and restrictions will limit its operations.
35
The interest rate on funds borrowed pursuant to the Warehouse Lines is
based on Libor rates plus a negotiated amount. By maintaining compensating
balances, R&G Financial is able to borrow funds under the Warehouse Lines at a
lower interest rate than would otherwise apply. These compensating balances are
comprised of a portion of the escrow accounts maintained by R&G Financial for
principal and interest payments and related tax and insurance payments on loans
its services. At December 31, 2002, the weighted average interest rate being
paid by R&G Financial under its Warehouse Lines amounted to 2.51%.
Although R&G Financial's primary sources of funds are deposits, it also
borrows funds on both a short and long-term basis. The Company obtains both
fixed-rate and variable-rate short-term and long-term advances from the FHLB of
New York and Atlanta through its banking subsidiaries upon the security of
certain of their residential first mortgage loans, securities and cash deposits,
provided certain standards related to the credit-worthiness of the banking
subsidiaries have been met. FHLB advances are available for general business
purposes to expand lending and investing activities. Advances from the FHLB are
made pursuant to several different credit programs, each of which has its own
interest rate and range of maturities. At December 31, 2002, the Company had
access to $1.7 billion in advances from the FHLB and had $940.7 million
outstanding as of such date, which mature at various dates commencing in January
1, 2003 through March 2, 2011 and have a weighted average interest rate of
4.23%. At December 31, 2002, the Company had pledged investment securities and
loans aggregating $1.2 billion to the FHLB as collateral for the advances. The
Company maintains collateral with the FHLB in excess of applicable requirements
in order to facilitate any necessary future borrowings.
The following table sets forth certain information regarding the
short-term borrowings of R&G Financial at or for the dates indicated.
At or For the Year Ended
December 31,
------------------------------------------
2002 2001 2000
---------- ---------- --------
(Dollars in Thousands)
Securities sold under agreements to repurchase:
Average balance outstanding .................................. $1,437,089 $1,035,814 $756,351
Maximum amount outstanding at any month-end during the
period ..................................................... 1,602,394 1,396,939 838,202
Balance outstanding at end of period ......................... 1,489,758 1,396,939 827,749
Average interest rate during the period ...................... 3.56% 4.77% 6.57%
Average interest rate at end of period ....................... 3.16% 3.47% 6.75%
Notes Payable:
Average balance outstanding .................................. $ 256,158 $ 233,462 $186,748
Maximum amount outstanding at any month-end during the
period ..................................................... 196,330 258,301 161,533
Balance outstanding at end of period ......................... 194,607 195,587 138,858
Average interest rate during the period ...................... 2.65% 4.88% 6.23%
Average interest rate at end of period ....................... 2.55% 3.04% 7.55%
FHLB of New York advances:
Average balance outstanding .................................. 698,170 444,422 438,276
Maximum amount outstanding at any month-end during the
period ..................................................... 940,725 523,000 510,500
Balance outstanding at end of period ......................... 940,725 464,125 505,000
Average interest rate during the period ...................... 4.51% 5.36% 6.34%
Average interest rate at end of period ....................... 4.23% 4.87% 6.42%
36
TRUST AND INVESTMENT SERVICES
R&G Financial also provides trust and investment services through
Premier Bank's Trust Department. Services offered include custodial services,
the administration of IRA accounts and the sale to investors of mortgage-backed
securities guaranteed by GNMA. As of December 31, 2002, Premier Bank's Trust
Department administered trust accounts with aggregate assets of $272.8 million
as of such date. Premier Bank receives fees dependent upon the level and type of
service provided. The administration of Premier Bank's Trust Department is
performed by the Trust Committee of the Board of Directors of Premier Bank.
BROKER-DEALER AND INSURANCE SERVICES
Beginning in the first quarter of 2002, R&G Financial's wholly-owned
licensed broker-dealer subsidiary, R-G Investments Corporation commenced
operations. R-G Investments Corporation is a NASD registered broker-dealer which
offers fixed-income and other investment products to its clients, including
customers of sister subsidiaries R&G Mortgage and Premier Bank. The Company
began insurance operations in November 2000 with its acquisition of Home &
Property Insurance Corp., a Puerto Rico insurance agency which provides
insurance policies principally on residential properties to R&G Financial's
customers and, to a lesser extent, other parties. R-G Investments Corporation
and Home & Property Insurance Corp. contributed $8.3 million of revenues,
representing 2.9% of total revenues, for the year ended December 31, 2002. For
additional information, see Note 26 to R&G Financial's Notes to Consolidated
Financial Statements, incorporated by reference into Item 8 hereof.
PERSONNEL
As of December 31, 2002, R&G Financial (on a consolidated basis) had
1,996 full-time employees and 101 part-time employees. The employees are not
represented by a collective bargaining agreement and R&G Financial believes that
it has good relations with its employees.
REGULATION
Set forth below is a brief description of certain laws and regulations
which, together with the descriptions of laws and regulations contained
elsewhere herein, are deemed material to an investor's understanding of the
extent to which R&G Financial and its subsidiary companies are regulated. The
description of these laws and regulations, as well as descriptions of laws and
regulations contained elsewhere herein, does not purport to be complete and is
qualified in its entirety by reference to applicable laws and regulations.
THE COMPANY
General. R&G Financial is a registered financial holding company
pursuant to the Bank Holding Company Act of 1956, as amended (the "BHCA"). R&G
Financial, as a financial holding company, is subject to regulation and
supervision by the Federal Reserve Board and the OCFI. R&G Financial is required
to file annually a report of its operations with, and is subject to examination
by, the Federal Reserve Board and the OCFI.
BHCA Activities and Other Limitations. The BHCA prohibits a bank
holding company from acquiring direct or indirect ownership or control of more
than 5% of the voting shares of any bank, or increasing such ownership or
control of any bank, without prior approval of the Federal Reserve Board.
37
No approval under the BHCA is required, however, for a bank holding company
already owning or controlling 50% of the voting shares of a bank to acquire
additional shares of such bank.
The BHCA also prohibits a bank holding company, with certain
exceptions, from acquiring more than 5% of the voting shares of any company that
is not a bank and from engaging in any business other than banking or managing
or controlling banks. Under the BHCA, the Federal Reserve Board is authorized to
approve the ownership of shares by a bank holding company in any company, the
activities of which the Federal Reserve Board has determined to be so closely
related to banking or to managing or controlling banks as to be a proper
incident thereto. In making such determinations, the Federal Reserve Board is
required to weigh the expected benefit to the public, such as greater
convenience, increased competition or gains in efficiency, against the possible
adverse effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interest or unsound banking practices.
The Federal Reserve Board has by regulation determined that certain
activities are closely related to banking within the meaning of the BHCA. These
activities include operating a mortgage company, such a R&G Mortgage, finance
company, credit card company, factoring company, trust company or savings
association; performing certain data processing operations; providing limited
securities brokerage services; acting as an investment or financial advisor;
acting as an insurance agent for certain types of credit-related insurance;
leasing personal property on a full-payout, non-operating basis; providing tax
planning and preparation services; operating a collection agency; and providing
certain courier services. The Federal Reserve Board also has determined that
certain other activities, including real estate brokerage and syndication, land
development, property management and underwriting of life insurance not related
to credit transactions, are not closely related to banking and a proper incident
thereto.
Limitations on Transactions with Affiliates. Transactions between
financial institutions and any affiliate are governed by Sections 23A and 23B of
the Federal Reserve Act. The Federal Reserve Board has also recently issued
Regulation W, which codifies prior regulations under Sections 23A and 23B of the
Federal Reserve Act and provides interpretative guidance with respect to
affiliate transactions. Affiliates of a financial institution include, among
other entities, the financial institution's holding company (such as R&G
Financial) and companies that are under common control with the financial
institution. In general, subject to certain specified exemptions, a financial
institution or its subsidiaries are limited in their ability to engage in
"covered transactions" with affiliates: (i) to an amount equal to 10% of the
financial institution's capital and surplus, in the case of covered transactions
with any one affiliate; and (ii) to an amount equal to 20% of the financial
institution's capital and surplus, in the case of covered transactions with all
affiliates.
In addition, a financial institution and its subsidiaries may engage in
covered transactions and other specified transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
financial institution or its subsidiary, as those prevailing that the time for
comparable transactions with nonaffiliated companies. A "covered transaction"
includes: (i) a loan or extension of credit to an affiliate; (ii) a purchase of,
or an investment in, securities issued by an affiliate; (iii) a purchase of
assets from an affiliate, with some exceptions; (iv) the acceptance of
securities issued by an affiliate as collateral for a loan or extension of
credit to any party; and (v) the issuance of a guarantee, acceptance or letter
of credit on behalf of an affiliate.
In addition, under Regulation W: (i) a financial institution may not
purchase a low-quality asset from an affiliate; (ii) covered transactions and
other specified transactions between a financial institution or its subsidiaries
and an affiliate must be on terms and conditions that are consistent with safe
and sound banking practices; and (iii) with some exceptions, each loan or
extension of credit by a financial institution to an affiliate must be secured
by collateral with a market value ranging from 100% to 130%, depending on the
type of collateral, of the amount of the loan or extension of credit.
38
Regulation W exempts from the quantitative limits and collateral
requirements transactions between "sister banks." The sister bank exemption
covers transactions between a bank and a FDIC insured depository institution if
the same company controls 80% or more of the voting securities of the bank and
the depository institution. In addition, an operating subsidiary of a FDIC
depository institution is treated as part of the depository institution, for
purposes of the definition.
In addition, Sections 22(h) and (g) of the Federal Reserve Act place
restrictions on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a greater than 10% stockholder of a financial institution, and certain
affiliated interests of either, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the financial
institution's loans to one borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus). Section 22(h) also requires that
loans to directors, executive officers and principal stockholders be made on
terms substantially the same as offered in comparable transactions to other
persons unless the loans are made pursuant to a benefit or compensation program
that (i) is widely available to employees of the institution and (ii) does not
give preference to any director, executive officer or principal stockholder, or
certain affiliated interests of either, over other employees of the savings
institutions. Section 22(h) also requires prior board approval for certain
loans. In addition, the aggregate amount of extensions of credit by a financial
institution to all insiders cannot exceed the institution's unimpaired capital
and surplus. Furthermore, Section 22(g) places additional restrictions on loans
to executive officers.
R&G Mortgage and Premier Bank are parties to various agreements which
address how each would conduct itself in specifically delineated affiliated
transactions (the "Affiliated Transaction Agreements"). The Affiliated
Transaction Agreements include a Master Purchase, Servicing and Collections
Agreement (the "Master Purchase Agreement"), a Master Custodian Agreement, a
Master Production Agreement, a Securitization Agreement and a Data Processing
Computer Service Agreement. The terms of these agreements were negotiated at
arm's length on the basis that they are substantially the same, or at least as
favorable to Premier Bank, as those prevailing for comparable transactions with,
or involving, other nonaffiliated companies.
Pursuant to the Master Production Agreement, Premier Bank, on a monthly
basis, determines its loan production targets and goals (the "Loan Production
Goals") and R&G Mortgage assists Premier Bank to reach its Loan Production Goals
by, among other things: (i) advertising, promoting and marketing to the general
public; (ii) interviewing prospective borrowers and initial processing of loan
applications, consistent with Premier Bank's underwriting guidelines and Loan
Production Goals previously established; and (iii) providing personnel and
facilities with respect to the execution of any loan agreement approved by
Premier Bank. In exchange for these services, Premier Bank remits to R&G
Mortgage a percentage of the processing or originating fees charged to the
borrowers under loan agreements, as set forth in the agreements. See "-Lending
Activities from Banking Operations - Originations, Purchases and Sales of
Loans."
Until January 1, 2001, the Master Purchase Agreement provided for the
sale by Premier Bank to R&G Mortgage of the servicing rights to all first and
second mortgage loans secured by residential properties which become part of
Premier Bank's loan portfolio once the related loans are sold. Effective January
1, 2001, Premier Bank retains servicing rights on loans sold or secured into
mortgage backed securities. R&G Mortgage services all other loans held in
Premier Bank's loan portfolio (including single-family residential loans
retained by Premier Bank and certain commercial real estate loans), although R&G
Mortgage does not actually acquire such servicing rights. The Master Purchase
Agreement further provides that R&G Mortgage exclusively will service such loans
and that Premier Bank will process payments of such loans, all according to a
fee schedule. See " - Mortgage Banking Activities - Loan Originations, Purchases
and Sales of Loans."
39
Under the Securitization Agreement, R&G Mortgage renders securitization
services with respect to the pooling of some of Premier Bank's mortgage loans
into mortgage-backed securities. With respect to securitization services
rendered, Premier Bank pays a securitization fee of 25 basis points. The Master
Custodian Agreement provides that Premier Bank shall be the custodial agent for
R&G Mortgage of certain documentation related to the issuance by R&G Mortgage of
GNMA, FNMA or FHLMC mortgage-backed certificates. In consideration of these
services, Premier Bank receives a fee for each mortgage note included in a
mortgage-backed certificate per year for which it acts as custodian, as set
forth in the agreement. See "- Mortgage Banking Activities - Loan Originations,
Purchases and Sales of Loans."
Capital Requirements. The Federal Reserve Board has adopted capital
adequacy guidelines pursuant to which it assesses the adequacy of capital in
examining and supervising a bank holding company and in analyzing applications
to it under the BHCA. The Federal Reserve Board capital adequacy guidelines
generally require bank holding companies to maintain total capital equal to 8%
of total risk-adjusted assets, with at least one-half of that amount consisting
of Tier I or core capital and up to one-half of that amount consisting of Tier
II or supplementary capital. Tier I capital for bank holding companies generally
consists of the sum of common stockholders' equity and perpetual preferred stock
(subject in the case of the latter to limitations on the kind and amount of such
stocks which may be included as Tier I capital), less goodwill and, with certain
exceptions, intangibles. Tier II capital generally consists of hybrid capital
instruments; perpetual preferred stock which is not eligible to be included as
Tier I capital; term subordinated debt and intermediate-term preferred stock;
and, subject to limitations, general allowances for loan losses. Assets are
adjusted under the risk-based guidelines to take into account different risk
characteristics, with the categories ranging from 0% (requiring no additional
capital) for assets such as cash to 100% for the bulk of assets which are
typically held by a bank holding company, including multi-family residential and
commercial real estate loans, commercial business loans and consumer loans.
Single-family residential first mortgage loans which are not past-due (90 days
or more) or non-performing and which have been made in accordance with prudent
underwriting standards are assigned a 50% level in the risk-weighing system, as
are certain privately-issued mortgage-backed securities representing indirect
ownership of such loans. Off-balance sheet items also are adjusted to take into
account certain risk characteristics.
In addition to the risk-based capital requirements, the Federal Reserve
Board requires bank holding companies to maintain a minimum leverage capital
ratio of Tier I capital to total assets of 3.0%. Total assets for this purpose
does not include goodwill and any other intangible assets and investments that
the Federal Reserve Board determines should be deducted from Tier I capital. The
Federal Reserve Board has announced that the 3.0% Tier I leverage capital ratio
requirement is the minimum for the top-rated bank holding companies without any
supervisory, financial or operational weaknesses or deficiencies or those which
are not experiencing or anticipating significant growth. Other bank holding
companies are expected to maintain Tier I leverage capital ratios of at least
4.0% to 5.0% or more, depending on their overall condition.
R&G Financial is in compliance with the above-described Federal Reserve
Board regulatory capital requirements.
Financial Support of Affiliated Institutions. Under Federal Reserve
Board policy, R&G Financial will be expected to act as a source of financial
strength to its banking subsidiaries and to commit resources to support them in
circumstances when it might not do so absent such policy. The legality and
precise scope of this policy is unclear, however, in light of recent judicial
precedent. In addition, any capital loans by a bank holding company to a
subsidiary bank are subordinate in right of payment to deposits and to certain
other indebtedness of such subsidiary bank. In the event of a bank holding
company's bankruptcy, any commitment by the bank holding company to a federal
bank regulatory
40
agency to maintain the capital of a subsidiary bank will be assumed by the
bankruptcy trustee and entitled to a priority of payment.
RECENT LEGISLATION
USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001
was enacted in response to the terrorist attacks in New York, Pennsylvania and
Washington, D.C. which occurred on September 11, 2001. The Patriot Act is
intended is to strengthen U.S. law enforcement's and the intelligence
communities' abilities to work cohesively to combat terrorism on a variety of
fronts. The potential impact of the Patriot Act on financial institutions of all
kinds is significant and wide ranging. The Patriot Act contains sweeping
anti-money laundering and financial transparency laws and imposes various
regulations, including standards for verifying client identification at account
opening, and rules to promote cooperation among financial institutions,
regulators and law enforcement entities in identifying parties that may be
involved in terrorism or money laundering.
Financial Services Modernization Legislation. The Gramm-Leach-Bliley
Act, signed into law on November 12, 1999, revises and expands the existing
provisions of the BHCA by including a new section that permits a bank holding
company to elect to become a financial holding company, which may engage in a
full range of financial activities. The qualification requirements and the
process for a bank holding company that elects to be treated as a financial
holding company requires that all the subsidiary banks controlled by the bank
holding company at the time of election to become a financial holding company
must be and remain at all times well capitalized and well managed. R&G Financial
applied for and became a financial holding company in 2000.
Financial holding companies may engage, directly or indirectly, in any
activity that is determined to be (i) financial in nature, (ii) incidental to
such financial activity, or (iii) complementary to a financial activity and
which does not pose a substantial risk to the safety and soundness of depository
institutions or the financial system generally. The Gramm-Leach-Bliley Act
specifically provides that the following activities have been determined to be
"financial in nature": (a) lending, trust and other banking activities; (b)
insurance activities; (c) financial or economic advice or services; (d) pooled
investments; (e) securities underwriting and dealing; (f) existing bank holding
company domestic activities; (g) existing bank holding company foreign
activities and (h) merchant banking activities.
In addition, the Gramm-Leach-Bliley Act specifically gives the Federal
Reserve Board the authority, by regulation or order, to expand the list of
"financial" or "incidental" activities, but requires consultation with the U.S.
Treasury, and gives the Federal Reserve Board authority to allow a financial
holding company to engage in any activity that is "complementary" to a financial
activity and does not "pose a substantial risk to the safety and soundness of
depository institutions or the financial system generally."
Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed
into law the Sarbanes-Oxley Act of 2002 ("SOA"). The stated goals of the SOA are
to increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties at publicly traded companies and to
protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities laws.
The SOA is the most far-reaching U.S. securities legislation enacted in
some time. The SOA generally applies to all companies, both U.S. and non-U.S.,
that file or are required to file periodic reports with the Securities and
Exchange Commission ("SEC"), under the Securities Exchange Act of 1934
("Exchange Act"). Given the extensive SEC role in implementing rules relating to
many of the SOA's new requirements, the final scope of these requirements
remains to be determined.
41
The SOA includes very specific additional disclosure requirements and
new corporate governance rules, requires the SEC and securities exchanges to
adopt extensive additional disclosure, corporate governance and other related
rules and mandates further studies of specified issues by the SEC and the
Comptroller General. The SOA represents significant federal involvement in
matters traditionally left to state regulatory systems, such as the regulation
of the accounting profession, and to state corporate law, such as the
relationship between a board of directors and management and between a board of
directors and its committees.
The SOA addresses, among other matters: (i) audit committees; (ii)
certification of financial statements by the chief executive officer and the
chief financial officer; (iii) the forfeiture of bonuses or other
incentive-based compensation and profits from the sale of an issuer's securities
by directors and senior officers in the twelve month period following initial
publication of any financial statements that later require restatement; (iv) a
prohibition on insider trading during pension plan black out periods; (v)
disclosure of off-balance sheet transactions; (vi) a prohibition on personal
loans to directors and officers; (vii) expedited filing requirements for Forms
4's; (viii) disclosure of a code of ethics and filing a Form 8-K for a change or
waiver of such code; (ix) "real time" filing of periodic reports; (x) the
formation of a public accounting oversight board; (xi) auditor independence; and
(xii) various increased criminal penalties for violations of securities laws.
The SOA contains provisions which became effective upon enactment on
July 30, 2002 and provisions which will become effective from within 30 days to
one year from enactment. The SEC has been delegated the task of enacting rules
to implement various provisions with respect to, among other matters, disclosure
in periodic filings pursuant to the Exchange Act.
BANKING SUBSIDIARIES
General. Premier Bank is incorporated under the Puerto Rico Banking Act
of 1933, as amended (the "Puerto Rico Banking Law") and is subject to extensive
regulation and examination by the OCFI, the FDIC and certain requirements
established by the Federal Reserve Board. Crown Bank is subject to extensive
regulation by the OTS and the FDIC. The federal and Puerto Rico laws and
regulations which are applicable to banks and thrift institutions regulate,
among other things, the scope of their business, their investments, their
reserves against deposits, the timing of the availability of deposited funds and
the nature and amount of and collateral for certain loans. There are periodic
examinations by the aforementioned regulatory authorities to test Premier Bank's
and Crown Bank's compliance with various regulatory requirements. This
regulation and supervision establishes a comprehensive framework of activities
in which an institution can engage and is intended primarily for the protection
of the insurance fund and depositors. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such regulation, whether by
the OCFI, the FDIC, the OTS or the U.S. Congress or Puerto Rico legislature
could have a material adverse impact on R&G Financial and its operations.
FDIC Insurance Premiums. The banking subsidiaries of the Company
currently pay deposit insurance premiums to the FDIC based on a risk-based
assessment system established by the FDIC for all Savings Association Insurance
Fund ("SAIF") member institutions, such as Crown Bank and Bank Insurance Fund
("BIF") member institutions, such as Premier Bank. Under applicable regulations,
institutions are assigned to one of three capital groups which is based solely
on the level on an institution's capital: "well capitalized," "adequately
capitalized" and "undercapitalized." These three groups are then divided into
three subgroups which reflect varying levels of supervisory concern, from those
which are considered to be healthy to those which are considered to be of
substantial supervisory
42
concern. The matrix so created results in nine assessment risk classifications,
with rates ranging from .0% for well capitalized, healthy institutions to .27%
for undercapitalized institutions with substantial supervisory concerns. Each of
Premier Bank and Crown Bank was classified as a "well-capitalized" institution
as of December 31, 2002.
The FDIC may terminate the deposit insurance of any insured depository
institution, including Premier Bank or Crown Bank, if it determines after a
hearing that the institution has engaged or is engaging in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations, or has
violated any applicable law, regulation, order or any condition imposed by an
agreement with the FDIC. It also may suspend deposit insurance temporarily
during the hearing process for the permanent termination of insurance, if the
institution has no tangible capital. If insurance of accounts is terminated, the
accounts at the institution at the time of the termination, less subsequent
withdrawals, shall continue to be insured for a period of six months to two
years, as determined by the FDIC. Management is aware of no existing
circumstances which would result in termination of Premier Bank's or Crown
Bank's deposit insurance.
From time to time, new laws are proposed that, if enacted, could have
an effect on the financial institutions industry. For example, deposit insurance
reform legislation has recently been introduced in Congress that would: (i)
merge the Bank Insurance Fund and the SAIF; (ii) increase the current deposit
insurance coverage limit for insured deposits to $130,000 and index future
coverage limits to inflation; (iii) increase deposit insurance coverage limits
for municipal deposits; (iv) double deposit insurance coverage limits for
individual retirement accounts; and (v) replace the current fixed 1.25
designated reserve ratio with a reserve range of 1-1.5%, giving the FDIC
discretion in determining a level adequate within this range. If any of these
proposals eventually become law, they could have an effect on R&G Financial's
operations and the way it conducts business.
Capital Requirements. The FDIC has promulgated regulations and adopted
a statement of policy regarding the capital adequacy of state-chartered banks
which, like Premier Bank, will not be members of the Federal Reserve System.
These requirements are substantially similar to those adopted by the Federal
Reserve Board regarding bank holding companies, as described above.
The FDIC's capital regulations establish a minimum 3.0% Tier I leverage
capital requirement for the most highly-rated state-chartered, non-member banks,
with an additional cushion of at least 100 to 200 basis points for all other
state-chartered, non-member banks, which effectively increases the minimum Tier
I leverage ratio for such other banks to 4.0% to 5.0% or more. Under the FDIC's
regulation, the highest-rated banks are those that the FDIC determines are not
anticipating or experiencing significant growth and have well diversified risk,
including no undue interest rate risk exposure, excellent asset quality, high
liquidity, good earnings and, in general, which are considered a strong banking
organization and are rated composite 1 under the Uniform Financial Institutions
Rating System. Leverage or core capital is defined as the sum of common
stockholders' equity (including retained earnings), noncumulative perpetual
preferred stock and related surplus, and minority interests in consolidated
subsidiaries, minus all intangible assets other than certain qualifying
supervisory goodwill and certain purchased mortgage servicing rights.
The FDIC also requires that banks meet a risk-based capital standard.
The risk-based capital standard for banks requires the maintenance of total
capital (which is defined as Tier I capital and supplementary (Tier 2) capital)
to risk weighted assets of 8%. In determining the amount of risk-weighted
assets, all assets, plus certain off balance sheet assets, are multiplied by a
risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in
the type of asset or item. The components of Tier I capital are equivalent to
those discussed above under the 3% leverage capital standard. The components of
supplementary capital include certain perpetual preferred stock, certain
mandatory
43
convertible securities, certain subordinated debt and intermediate preferred
stock and general allowances for loan and lease losses. Allowance for loan and
lease losses includable in supplementary capital is limited to a maximum of
1.25% of risk-weighted assets. Overall, the amount of capital counted toward
supplementary capital cannot exceed 100% of core capital. At December 31, 2002,
Premier Bank met each of its capital requirements.
The FDIC and the other federal banking agencies have published a joint
policy statement that describes the process the banking agencies will use to
measure and assess the exposure of a bank's net economic value to changes in
interest rates. The FDIC and other federal banking agencies have also adopted a
joint policy statement on interest rate risk policy. Because market conditions,
bank structure, and bank activities vary, the agencies concluded that each bank
needs to develop its own interest rate risk management program tailored to its
needs and circumstances. The policy statement describes prudent principles and
practices that are fundamental to sound interest rate risk management, including
appropriate board and senior management oversight and a comprehensive risk
management process that effectively identifies, measures, monitors and controls
risks.
Under OTS capital regulations, an institution is well capitalized if it
has a total risk-based capital ratio of at least 10.0%, a Tier 1 risk-based
capital ratio of at least 6.0% and a leverage ratio of at least 5.0%. An
institution is adequately capitalized if it has a total risk-based capital ratio
of at least 8.0%, a Tier 1 risk-based capital ratio of at least 4.0% and a
leverage ratio of at least 4.0% (or 3.0% if it has a composite rating of "1" and
is not experiencing or anticipating significant growth). The regulation also
establishes three categories for institutions with lower ratios:
undercapitalized, significantly undercapitalized and critically
undercapitalized. At December 31, 2002, Crown Bank met the capital requirements
of a "well capitalized" institution under applicable OTS regulations.
OTS capital regulations also require savings associations to meet three
additional capital standards: (i) tangible capital equal to at least 1.5% of
total adjusted assets, (ii) leverage capital (core capital) equal to 4.0% of
total adjusted assets, and (iii) risk-based capital equal to 8.0% of total
risk-weighted assets. These capital requirements are viewed as minimum standards
by the OTS, and most institutions are expected to maintain capital levels well
above the minimum. In addition, the OTS regulations provide that minimum capital
levels higher than those provided in the regulations may be established by the
OTS for individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its circumstances.
Crown Bank is not subject to any such individual minimum regulatory capital
requirement and Crown Bank's regulatory capital exceeded all minimum regulatory
capital requirements as of December 31, 2002.
Activities and Investments. The activities and equity investments of
FDIC-insured, state-chartered banks (which under the Federal Deposit Insurance
Act includes banking institutions incorporated under the laws of Puerto Rico)
are generally limited to those that are permissible for national banks. Under
regulations dealing with equity investments, an insured state bank generally may
not directly or indirectly acquire or retain any equity investment of a type, or
in an amount, that is not permissible for a national bank. An insured state bank
is not prohibited from, among other things, (i) acquiring or retaining a
majority interest in a subsidiary or (ii) acquiring or retaining the voting
shares of a depository institution if certain requirements are met. In addition,
an insured state-chartered bank may not, directly, or indirectly through a
subsidiary, engage as "principal" in any activity that is not permissible for a
national bank unless the FDIC has determined that such activities would pose no
risk to the insurance fund of which it is a member and the bank is in compliance
with applicable regulatory capital requirements. Any insured state-chartered
bank directly or indirectly engaged in any activity that is not permitted for a
national bank must cease the impermissible activity.
44
Puerto Rico Banking Law. As a commercial bank organized under the laws
of the Commonwealth, Premier Bank is subject to supervision, examination and
regulation by the OCFI pursuant to the Puerto Rico Banking Law.
The Puerto Rico Banking Law requires that at least ten percent (10%) of
the yearly net income of Premier Bank be credited annually to a reserve fund.
This apportionment shall be done every year until the reserve fund shall be
equal to the sum of Premier Bank's paid-in common and preferred stock capital.
As of December 31, 2002, Premier Bank had credited $17.4 million to such reserve
fund.
The Puerto Rico Banking Law also provides that when the expenditures of
a bank are greater than the receipts, the excess of the former over the latter
shall be charged against the undistributed profits of such bank, and the
balance, if any, shall be charged against the reserve fund, as a reduction
thereof. If there is no reserve fund sufficient to cover such balance in whole
or in part, the outstanding amount shall be charged against the capital account
and no dividend shall be declared until said capital has been restored to its
original amount and the reserve fund to 20% of the original capital. In
addition, every bank is required by the Puerto Rico Banking Law to maintain a
legal reserve which shall not be less than 20% of its demand liabilities, except
government deposits (federal, state and municipal) which are secured by actual
collateral. The reserve is required to be made up of any of the following
instruments or any combination of them: (i) legal tender of the United States;
(ii) checks on banks or trust companies located in any part of Puerto Rico, to
be presented for collection during the day following that on which they are
received; (iii) money deposited in other banks provided said deposits are
authorized by the Commissioner, subject to immediate collection; and (iv)
federal funds sold and securities purchased under agreements to resell, provided
such funds are repaid on or prior to the close of the next business day.
Under the Puerto Rico Banking Law, Premier Bank is permitted to make
loans to any one person, firm, partnership or corporation, up to an aggregate
amount of fifteen percent (15%) of the paid-in capital and reserve fund of
Premier Bank, plus 15% of 50% of undistributed earnings for "well capitalized"
institutions. As of December 31, 2002, the legal lending limit for Premier Bank
under these provisions was approximately $38.5 million. If such loans are
secured by collateral worth at least twenty-five percent (25%) more than the
amount of the loan, the aggregate maximum amount may reach one-third of the
paid-in capital of Premier Bank, plus its reserve fund. The legal lending limit
for Premier Bank for loans secured by collateral with at least 25% more than the
amount of the loan was approximately $85.5 million. Premier Bank's maximum
extension of credit to any one borrower was $36.4 million at December 31, 2002,
which is fully secured with collateral with a "loan to value" ratio of less than
80%. There are no restrictions on the amount of loans to subsidiaries of banks,
or loans that are secured by mortgages by real estate, or loans that are wholly
secured by bonds, securities and other evidences of indebtedness of the United
States or the Commonwealth, or by current debt bonds, not in default, of
municipalities or instrumentalities of the Commonwealth. Loans to non-banking
affiliates of Premier Bank, are subject however to the lending limitations set
forth in Sections 23A and 23B of the Federal Reserve Act and the new Regulation
W. The Puerto Rico Banking Law also authorizes Premier Bank to conduct certain
financial and related activities directly or through subsidiaries. The Puerto
Rico Banking Law also prohibits Puerto Rico banks from making loans secured by
their own stock, and from purchasing their own stock, unless such purchase is
necessary to prevent losses because of a debt previously contracted in good
faith. The stock so purchased must be sold in a private or public sale within
one year from the date of purchase. Premier Bank may repurchase its own stock
for the purpose of reducing its capital, subject to the approval of the OCFI.
The rate of interest that Premier Bank may charge on mortgage and other
types of loans to individuals in Puerto Rico is subject to Puerto Rico's usury
laws. Such laws are administered by the Financing Board, which consists of the
Commissioner of Financial Institutions, the President of the Government
Development Bank, the Chairman of the Planning Board and the Puerto Rico
Secretaries of
45
Commerce, Treasury and Consumer Affairs and three representatives from the
private sector. The Financing Board promulgates regulations which specify
maximum rates on various types of loans to individuals. The Financing Board
eliminated the regulations that set forth the maximum interest rates that could
be charged on consumer loans, mortgage loans and commercial loans. The
origination charges on residential mortgage loans may not exceed 6% of the loan
amount.
Regulatory Enforcement Authority. Applicable banking laws include
substantial enforcement powers available to federal and Puerto Rico banking
regulators. This enforcement authority includes, among other things, the ability
to assess civil money penalties, to issue cease-and-desist or removal orders and
to initiate injunctive actions against banking organizations and
institution-affiliated parties, as defined. In general, these enforcement
actions may be initiated for violations of laws and regulations and unsafe or
unsound practices. Other actions or inactions may provide the basis for
enforcement action, including misleading or untimely reports filed with
regulatory authorities.
Regulations Applicable to Crown Bank. Crown Bank is subject to the
lending limits applicable to national banks. With limited exceptions, the
maximum amount that a savings association or a national bank may lend to any
borrower, including related entities of the borrower, at one time may not exceed
15% of the unimpaired capital and surplus of the institution, plus an additional
10% of unimpaired capital and surplus for loans fully secured by readily
marketable collateral. At December 31, 2002, Crown Bank's loans-to-one-borrower
limit was $11.9 million based upon the 15% of unimpaired capital and surplus
measurement. At December 31, 2002, Crown Bank's largest single lending
relationship had an outstanding balance of $10.5 million, and consisted of six
loans secured by real estate with an aggregate balance of $10.1 million and a
working capital line of credit with a balance of $419,000, each of which was
performing in accordance with its terms.
Savings associations must also meet a qualified thrift lender, or
"QTL," test, which test may be met either by maintaining a specified level of
assets in qualified thrift investments as specified by the Home Owners Loan Act
of 1933, or HOLA, or by meeting the definition of a "domestic building and loan
association" under the Internal Revenue Code of 1986, as amended, or the "Code."
Qualified thrift investments are primarily residential mortgages and related
investments, including mortgage related securities. The required percentage of
investments under the HOLA is 65% of assets while the Code requires investments
of 60% of assets. An association must be in compliance with the QTL test or the
definition of domestic building and loan association on a monthly basis in nine
out of every 12 months. Associations that fail to meet the QTL test will
generally be prohibited from engaging in any activity not permitted for both a
national bank and a savings association. As of December 31, 2002, Crown Bank was
in compliance with its QTL requirement.
Community Reinvestment Act and the Fair Lending Laws. Premier Bank and
Crown Bank have a responsibility under the Community Reinvestment Act and
related regulations to help meet the credit needs of their communities,
including low- and moderate-income neighborhoods. In addition, the Equal Credit
Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in
their lending practices on the basis of characteristics specified in those
statutes. An institution's failure to comply with the provisions of the
Community Reinvestment Act could, at a minimum, result in regulatory
restrictions on its activities and the denial of applications. In addition, an
institution's failure to comply with the Equal Credit Opportunity Act and the
Fair Housing Act could result in the applicable federal regulatory agencies
and/or the Department of Justice taking enforcement actions against the
institution. Based on their most recent examinations, Premier Bank and Crown
Bank each received a satisfactory rating with respect to its performance
pursuant to the Community Reinvestment Act.
Federal Home Loan Bank System. Premier Bank and Crown Bank are members
of the FHLB system. Among other benefits, each FHLB serves as a reserve or
central bank for its members within its
46
assigned region. Each FHLB is financed primarily from the sale of consolidated
obligations of the FHLB system. Each FHLB makes available loans or advances to
its members in compliance with the policies and procedures established by the
board of directors of the individual FHLB. As an FHLB member, Premier Bank and
Crown Bank are required to own capital stock in an FHLB in an amount equal to
the greater of: (i) 1% of its aggregate outstanding principal amount of its
residential mortgage loans, home purchase contracts and similar obligations at
the beginning of each calendar year; or (ii) 5% of its FHLB advances or
borrowings. At December 31, 2002, Premier Bank and Crown Bank each met the
required investment in FHLB stock, with each holding $78.2 million and $6.2
million of the FHLB of New York and FHLB of Atlanta stock, respectively.
Federal Reserve System. The Federal Reserve Board requires all
depository institutions to maintain noninterest bearing reserves at specified
levels against their transaction accounts (primarily checking, NOW, and Super
NOW checking accounts) and non personal time deposits. At December 31, 2002,
Premier Bank and Crown Bank were in compliance with these requirements.
MORTGAGE BANKING SUBSIDIARIES
The mortgage banking business conducted by R&G Mortgage, The Mortgage
Store and Continental is subject to the rules and regulations of FHA, VA, FNMA,
FHLMC and GNMA with respect to originating, processing, selling and servicing
mortgage loans and the issuance and sale of mortgage-backed securities. Those
rules and regulations, among other things, prohibit discrimination and establish
underwriting guidelines which include provisions for inspections and appraisals,
require credit reports on prospective borrowers and fix maximum loan amounts
and, with respect to VA loans, fix maximum interest rates. Moreover, lenders are
required annually to submit to FNMA, FHA, FHLMC, GNMA and VA audited financial
statements, and each regulatory entity has its own financial requirements. The
affairs of these subsidiaries are also subject to supervision and examination by
FNMA, FHA, FHLMC, GNMA, HUD and VA at all times to assure compliance with the
applicable regulations, policies and procedures. Mortgage origination activities
are subject to, among others, the Equal Credit Opportunity Act, Federal
Truth-in-Lending Act and the Real Estate Settlement Procedures Act and the
regulations promulgated thereunder.
Mortgage loan production activities are subject to the Federal
Truth-in-Lending Act and Regulation Z promulgated thereunder. The
Truth-in-Lending Act contains disclosure requirements designed to provide
consumers with uniform, understandable information with respect to the terms and
conditions of loans and credit transactions in order to give them the ability to
compare credit terms. The Truth-in-Lending Act provides consumers a three day
right to cancel certain credit transactions, including any refinance mortgage or
junior mortgage loan on a consumer's primary residence.
The mortgage subsidiaries are required to comply with the Equal Credit
Opportunity Act of 1974, as amended ("ECOA"), and Regulation B promulgated
thereunder, which prohibit creditors from discriminating against applicants on
the basis of race, color, sex, age or marital status, and restrict creditors
from obtaining certain types of information from loan applicants. It also
requires certain disclosures by lenders regarding consumer rights and requires
lenders to advise applicants of the reasons for any credit denial. In instances
where the applicant is denied credit or the rate or charge for loan increases as
a result of information obtained from a consumer credit agency, another statute,
The Fair Credit Reporting Act of 1970, as amended, requires the lenders to
supply the applicant with the name and address of the reporting agency.
The Federal Real Estate Settlement Procedures Act ("RESPA") imposes,
among other things, limits on the amount of funds a borrower can be required to
deposit with the mortgage subsidiaries in any escrow account for the payment of
taxes, insurance premiums or other charges.
47
R&G Mortgage and The Mortgage Store are also subject to regulation by
the OCFI, with respect to, among other things, licensing requirements and the
record-keeping, examination and reporting requirements of the Puerto Rico
Mortgage Banking Institutions Law (the "Mortgage Banking Law"). R&G Mortgage and
The Mortgage Store are licensed by the OCFI as a mortgage banking institution in
Puerto Rico. Such authorization to act as a mortgage banking institution must be
renewed as of January 1 of each year. In the past, neither R&G Mortgage nor The
Mortgage Store has not had any difficulty in renewing its authorization to act
as a mortgage banking institution, and management is unaware of any existing
practices, conditions or violations which would result in either company being
unable to receive such authorization in the future.
The Mortgage Banking Law requires the prior approval of the OCFI for
the acquisition of control of any mortgage banking institution licensed under
the Mortgage Banking Law. For purposes of the Mortgage Banking Law, the term
"control" means the power to direct or influence decisively, directly or
indirectly, the management or policies of a mortgage banking institution. The
Mortgage Banking Law provides that a transaction that results in the holding of
less than 10% of the outstanding voting securities of a mortgage banking
institution shall not be considered a change of control. Pursuant to the
Mortgage Banking Law, upon receipt of notice of a proposed transaction that may
result in change of control, the OCFI is obligated to make such inquires as it
deems necessary to review the transaction. Under the Mortgage Banking Law, the
determination of the OCFI whether or not to authorize a proposed change of
control is final and non-appealable.
As is the case with Premier Bank, the rate of interest that R&G
Mortgage and The Mortgage Store may charge on mortgage loans to individuals is
subject to Puerto Rico's usury laws. Such laws are administered by the Financing
Board which promulgates regulations that specify maximum rates on various types
of loans to individuals. Regulation 26-A promulgated by the Financing Board
fixes the maximum rate (which is adjusted on a weekly basis) which may be
charged on residential first mortgage loans.
WEBSITE ACCESS TO COMPANY REPORTS
The Company makes available free of charge on its website at
www.rgonline.com its annual, quarterly and current reports, and all amendments
to those reports, as soon as reasonably practicable after the Company files
these materials with, or furnishes them to, the SEC.
ITEM 2: PROPERTIES.
The Company's principal executive office is located at 280 Jesus T.
Pinero Avenue, Hato Ray, San Juan, Puerto Rico 00918. At December 31, 2002, we
operated our subsidiaries mostly through leased facilities. All of our
subsidiaries except Crown Bank and Continental, conduct business in Puerto Rico.
Premier Bank operates from 29 offices, R&G Mortgage operates from 34 offices,
Crown Bank operates from 15 offices located in the State of Florida, The
Mortgage Store operates from eight offices, Home & Property Insurance Corp.
operates from one office, R-G Investments Corporation operates from three
offices and Continental operates from five offices located in the States of New
York, North Carolina and Florida.
ITEM 3: LEGAL PROCEEDINGS.
The Company is not involved in any pending legal proceedings other than
nonmaterial legal proceedings occurring in the ordinary course of business.
48
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
Not applicable.
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The information required herein is incorporated by reference from page
98 of the Registrant's 2002 Annual Report.
ITEM 6: SELECTED FINANCIAL DATA.
The information required herein is incorporated by reference from pages
33 to 36 of the Registrant's 2002 Annual Report.
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The information required herein is incorporated by reference from pages
37 to 56 of the Registrant's 2002 Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required herein is incorporated by reference from pages
49 to 54 of the Registrant's 2002 Annual Report.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required herein is incorporated by reference from pages
57 to 96 of the Registrant's 2002 Annual Report.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required herein is incorporated by reference from pages
3 to 6 and 9 of the Registrant's Proxy Statement dated March 31, 2003 ("Proxy
Statement").
ITEM 11: EXECUTIVE COMPENSATION.
The information required herein is incorporated by reference from pages
10 to 15 of the Registrant's Proxy Statement.
49
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required herein is incorporated by reference from pages
8 to 9 of the Registrant's Proxy Statement.
EQUITY COMPENSATION PLAN INFORMATION
The following table presents information on the Company's equity
compensation plans at December 31, 2002.
(c)
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
(a) (b) FUTURE ISSUANCE UNDER
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION
BE ISSUED UPON EXERCISE PRICE OF OUTSTANDING PLANS (EXCLUDING
OF OUTSTANDING OPTIONS, OPTIONS, WARRANTS AND SECURITIES REFLECTED IN
PLAN CATEGORY WARRANTS AND RIGHTS RIGHTS COLUMN (a))
------------- ----------------------- ------------------------- -----------------------
Equity compensation plans approved by
security holders........................... 187,480 12.03 13,240
Equity compensation plans not approved by
security holders........................... -- --
------- ------
Total................. 187,480 13,240
======= ======
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required herein is incorporated by reference from pages
11 to 12 of the Registrant's Proxy Statement.
ITEM 14: CONTROLS AND PROCEDURES.
Within the 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer along with our Executive Vice President
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures pursuant to the Exchange Act Rule 13a-14.
Based upon that evaluation, our Chief Executive Officer along with our
Executive Vice President and Chief Financial Officer concluded that our
disclosure controls and procedures are effective in timely alerting us to
material information relating to us (including our consolidated subsidiaries)
required to be included in our periodic SEC filings. There have been no
significant changes in our internal controls or in other factors which could
significantly affect these controls subsequent to the date we carried out our
evaluation.
Disclosure controls and procedures are controls and other procedures
that are designed to ensure that information required to be disclosed by us in
the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by us in the reports that we file under the Exchange Act is
accumulated and communicated to our management, including our Chief Executive
Officer and Executive Vice President and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure.
50
PART IV
ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Documents Filed as Part of this Report
(1) The following financial statements are incorporated by
reference from Item 8 hereof (see Exhibit 13):
Independent Auditors' Report.
Consolidated Statements of Financial Condition as of December 31, 2002
and 2001.
Consolidated Statements of Income for the Years Ended December 31,
2002, 2001 and 2000.
Consolidated Statements of Cash Flows for the Years Ended December 31,
2002, 2001 and 2000.
Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended December 31, 2002, 2001 and 2000.
Notes to Consolidated Financial Statements.
(2) All schedules for which provision is made in the applicable
accounting regulation of the SEC are omitted because of the
absence of conditions under which they are required or because
the required information is included in the consolidated
financial statements and related notes thereto.
(3) The following exhibits are filed as part of this Form 10-K,
and this list includes the Exhibit Index.
No. Description
--- -----------
2.1 Amended and Restated Agreement and Plan of Merger by and between R&G
Financial Corporation, R-G Premier Bank of Puerto Rico and R-G Interim
Premier Bank, dated as of September 27, 1996 (1)
2.2.0 Agreement and Plan of Reorganization among R&G Financial Corporation,
R&G Acquisition Holdings Corporation, The Crown Group, Inc. and Crown
Bank, a Federal Savings Bank dated as of December 19, 2001 (2)
2.2.1 Amendment No. 2 to Agreement and Plan of Reorganization among R&G
Financial Corporation, R&G Acquisition Holdings Corporation, The Crown
Group, Inc. and Crown Bank, a Federal Savings Bank dated as of February
27, 2002 (3)
3.1.0 Certificate of Incorporation of R&G Financial Corporation (4)
3.1.1 Certificate of Amendment to Certificate of Incorporation of R&G
Financial Corporation (4)
3.1.2 Amended and Restated Certificate of Incorporation of R&G Financial
Corporation (5)
3.1.3 Certificate of Amendment to Amended and Restated Certificate of
Incorporation of R&G Financial Corporation (6)
3.1.4 Second Certificate of Amendment to Amended and Restated Certificate of
Incorporation of R&G Financial Corporation (15)
3.1.5 Certificate of Resolution designating the terms of the Series A
Preferred Stock (7)
3.1.6 Certificate of Resolution designating the terms of the Series B
Preferred Stock (8)
3.1.7 Certificate of Designation for Series C Preferred Stock (12)
3.1.8 Certificate of Designation for Series D Preferred Stock (13)
3.2 Bylaws of R&G Financial Corporation (4)
51
4.0 Form of Stock Certificate of R&G Financial Corporation (4)
4.1 Form of Series A Preferred Stock Certificate of R&G Financial
Corporation (9)
4.2 Form of Series B Preferred Stock Certificate of R&G Financial
Corporation (10)
4.3 Form of Series C Preferred Stock Certificate of R&G Financial
Corporation (11)
4.4 Form of Series D Preferred Stock Certificate of R&G Financial
Corporation (14)
10.1 Master Purchase, Servicing and Collection Agreement between R&G
Mortgage Corporation and R-G Premier Bank of Puerto Rico dated February
16, 1990, as amended on April 1, 1991, December 1, 1991, February 1,
1994 and July 1, 1994 (4)
10.2 Master Custodian Agreement between R&G Mortgage Corporation and R-G
Premier Bank of Puerto Rico dated February 16, 1990, as amended on June
27, 1996 (4)
10.3 Master Production Agreement between R&G Mortgage and R-G Premier Bank
of Puerto Rico dated February 16, 1990, as amended on August 30, 1991
and March 31, 1995 (4)
10.4 Data Processing Computer Service Agreement between R&G Mortgage and R-G
Premier Bank of Puerto Rico dated December 1, 1994 (4)
10.5 Securitization Agreement by and between R&G Mortgage and R-G Premier
Bank of Puerto Rico, dated as of July 1, 1995 (4)
10.6 R&G Financial Corporation Stock Option Plan (4)(*)
10.7 Guarantee Agreement between R&G Financial Corporation, R&G Acquisition
Holdings Corporation and Wilmington Trust as Guarantee Trustee with
respect to the Capital Securities issued by R&G Capital Trust I, dated
as of April 10, 2002 (16)
13.0 2002 Annual Report to Stockholders
21.0 Subsidiaries of the Registrant - Reference is made to "Item 1.
Business" for the required information
-----------------
(1) Incorporated by reference from the Registration Statement on Form S-4
(Registration No. 333-13199) filed by the Registrant with the
Securities and Exchange Commission ("SEC") on October 1, 1996.
(2) Incorporated by reference from the Registrant's Current Report on Form
8-K filed with the SEC on December 20, 2001.
(3) Incorporated by reference from the Registrant's Current Report on Form
8-K filed with the SEC on February 28, 2002.
(4) Incorporated by reference from the Registration Statement on Form S-1
(Registration No. 333-06245) filed by the Registrant with the SEC on
June 18, 1996, as amended.
(5) Incorporated by reference from the Registrant's Current Report on Form
8-K filed with the SEC on November 19, 1999.
(6) Incorporated by reference from the Registrant's Current Report on Form
8-K filed with the SEC on June 12, 2001.
(7) Incorporated by reference from the Registrant's Current Report on Form
8-K filed with the SEC on August 31, 1998.
(8) Incorporated by reference from the Registrant's Form 10-K filed with
the SEC on April 13, 2000.
(9) Incorporated by reference from the Registrant's Registration Statement
on Form S-3 (Registration No. 333-60923) filed with the SEC on August
7, 1998.
(10) Incorporated by reference from the Registrant's Registration Statement
on Form S-3 (Registration No. 333-90463) filed with the SEC on November
5, 1999.
(11) Incorporated by reference from the Registrant's Registration Statement
on Form S-3 (File No. 333-55834) filed with the SEC on February 16,
2001.
(12) Incorporated by reference from the Registrant's Form 10-K filed with
the SEC on April 2, 2001.
(13) Incorporated by reference from the Registrant's Current Report on Form
8-K filed with the SEC on March 7, 2002.
52
(14) Incorporated by reference from the Registrant's Registration Statement
on Form S-3 (File No. 333-81214) filed with the SEC on January 22,
2002.
(15) Incorporated by reference from the Registrant's Current Report on Form
8-K filed with the SEC on June 18, 2002.
(16) Incorporated by reference from the Registrant's Form 10-Q filed with
the SEC on November 14, 2002.
(*) Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K.
The Registrant filed the following Reports on Form 8-K during the
quarter ended December 31, 2002:
(1) Form 8-K filed on October 17, 2002 with an attached press
release announcing the Registrant's earnings for the third
quarter and nine months ended September 30, 2002.
(2) Form 8-K filed on November 14, 2002, in conjunction with the
filing of the Registrant's Form 10-Q for the quarter ended
September 30, 2002, containing the certification required
pursuant to Section 906 of the Sarbanes-Oxley Act.
53
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.
R&G FINANCIAL CORPORATION
March 31, 2003 By: /s/ Victor J. Galan
------------------------------
Victor J. Galan
Chairman of the Board and
Chief Executive 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.
/s/ Victor J. Galan March 31, 2003
--------------------------------------------
Victor J. Galan
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
/s/ Ramon Prats March 31, 2003
--------------------------------------------
Ramon Prats
Vice Chairman of the Board and
President
/s/ Joseph R. Sandoval March 31, 2003
--------------------------------------------
Joseph R. Sandoval
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
/s/ Ana M. Armendariz March 31, 2003
--------------------------------------------
Ana M. Armendariz
Director and Treasurer
/s/ Enrique Umpierre-Suarez March 31, 2003
--------------------------------------------
Enrique Umpierre-Suarez
Director and Secretary
/s/ Victor L. Galan Fundora March 31, 2003
--------------------------------------------
Victor J. Galan Fundora
Director
/s/ Laureno Carus Abarca March 31, 2003
--------------------------------------------
Laureno Carus Abarca
Director
/s/ Eduardo McCormack March 31, 2003
--------------------------------------------
Eduardo McCormack
Director
/s/ Gilberto Rivera-Arrega March 31, 2003
--------------------------------------------
Gilberto Rivera-Arreaga
Director
/s/ Benigno R. Fernandez March 31, 2003
--------------------------------------------
Benigno R. Fernandez
Director
/s/ Ileana M. Colon-Carlo March 31, 2003
--------------------------------------------
Ileana M. Colon-Carlo
Director
/s/ Roberto Gorbea March 31, 2003
--------------------------------------------
Roberto Gorbea
Director
CERTIFICATIONS
I, Victor J. Galan, certify that:
1. I have reviewed this annual report on Form 10-K of R&G Financial
Corporation;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual 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 annual report (the "Evaluation Date");
and
(c) Presented in this annual 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 the registrant's board of directors (or persons
performing the equivalent functions):
(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 weaknesses 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
annual report whether 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.
Date: March 31, 2003
/s/ Victor J. Galan
--------------------------
Victor J. Galan
Chairman of the Board and
Chief Executive Officer
I, Joseph R. Sandoval, certify that:
1. I have reviewed this annual report on Form 10-K of R&G Financial
Corporation;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual 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 annual report (the "Evaluation Date");
and
(c) Presented in this annual 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 the registrant's board of directors (or persons
performing the equivalent functions):
(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 weaknesses 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
annual report whether 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.
Date: March 31, 2003
/s/ Joseph R. Sandoval
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Joseph R. Sandoval
Executive Vice President and
Chief Financial Officer