ITEM 1. BUSINESS - -----------------
GENERAL
Bay View Capital Corporation (the "Company" or "BVCC"), a Delaware corporation, is a savings and loan holding company incorporated in 1989. The Company has been focused on the diversification of its asset origination activities during 1996 and expects to continue this process prospectively (see Management's Discussion and Analysis of Financial Condition and Results of Operations "Strategic Overview" for further discussion of these diversification efforts). Currently, the Company's principal business activities consist of the operation of i) a bank through its wholly owned subsidiary, Bay View Federal Bank, a Federal Savings Bank ("BVFB") and ii) a consumer finance company through its wholly owned subsidiary, California Thrift & Loan, an industrial loan company ("CTL"). The Company is also the holding company for Bay View Securitization Corporation ("BVSC"), a Delaware corporation formed for the purpose of issuing asset-backed securities through a trust.
Bay View Federal Bank - ---------------------
BVFB is a federally chartered capital stock savings bank incorporated in 1911. In 1986, BVFB converted from a mutual to a stock association. In 1989, BVFB became a wholly owned subsidiary of the Company. BVFB is a member of the Federal Home Loan Bank of San Francisco ( the "FHLBSF").
BVFB has 26 banking centers serving primarily the San Francisco Bay Area and its principal business consists of attracting deposits from the general public and using those deposits, together with borrowings and other funds, to originate loans secured by real estate. All of the mortgage loans originated by BVFB are secured by properties located in California, primarily Northern California. BVFB originates both fixed rate and adjustable rate loans. Since 1983, BVFB has shifted the concentration of its real estate loan portfolio to adjustable rate mortgages ("ARMs"), which are sensitive to fluctuations in market interest rates. The majority of these loans are secured by multifamily residential properties. BVFB also originates real estate loans secured by commercial and industrial properties. During 1996, BVFB discontinued its single family mortgage lending activity.
California Thrift & Loan - ------------------------
CTL was acquired by the Company effective June 1, 1996 in a business purchase combination and is an FDIC-insured industrial loan company incorporated under the laws of the State of California. CTL has 19 offices throughout California and the western United States, and offers automobile and other consumer financing. Its business strategy is to originate consumer loans at yields which are generally above those offered by conventional financing sources (such as commercial banks) while applying its traditional underwriting criteria on a case-by-case basis to mitigate any potential loan losses. CTL underwrites and purchases both new and used fixed-rate motor vehicle loans and consumer installment contracts. The Company began implementing a planned restructuring of CTL in late 1996. This restructuring, when completed, may also include converting CTL to a "pure" finance company subject to supervision and regulation only by the Commissioner of Corporations of the State of California.
LENDING ACTIVITIES
Bay View Federal Bank
Residential Lending - -------------------
Multifamily Mortgage Loans (five or more units). At December 31, 1996, loans secured by multifamily residential real estate totaled $1.03 billion, representing 50.0% of BVFB's total loan portfolio at that date. In general, these loans were originated as ARMs with terms of 30 years, although some of these loans have monthly payments calculated on a 30-year amortization period with a balloon payment due at maturity, typically 15 years. The majority of the ARMs originated by BVFB prior to 1996 are indices to the Eleventh District Cost of Funds ("COFI"). During 1996, management re-directed its business lending practices and BVFB is moving away from COFI as its index for ARMs. Currently, BVFB utilizes the London Interbank Offered Rate ("LIBOR") and prime rate as its variable interest rate indices for the majority of its new originations.
BVFB generally does not lend more than 75% of the appraised value of multifamily residences on a first mortgage loan. The property's net income available for loan payments is also a limiting factor on the approved loan amount for multifamily residences. Properties securing multifamily loans are required to generate cash flow sufficient to cover loan payments and other property expenditures.
Single Family Mortgage Loans (one to four units). At December 31, 1996, single family loans totaled $610.6 million and represented 29.5% of BVFB's total loan portfolio at that date. Generally, ARMs secured by single family residential properties have terms of 30 years. During 1996, BVFB de-emphasized its focus on single family mortgage lending and discontinued its loan origination operations.
Commercial Real Estate Lending - ------------------------------
At December 31, 1996, loans secured by commercial real estate totaled $367.1 million, representing 17.7% of BVFB's total loan portfolio at that date. Substantially all of the BVFB's commercial loans are ARMs. ARMs secured by commercial real estate are generally made upon the same terms and conditions as ARMs secured by multifamily residences. Currently, BVFB utilizes the LIBOR and prime rate as its variable interest rate indexes for the majority of its new originations.
Most of BVFB's commercial real estate loans consist of loans secured by improved property such as office buildings, warehouses and retail sales facilities. A majority of these loans are in amounts ranging from $250,000 to $1 million. BVFB generally does not originate commercial real estate loans which exceed an LTV of 70%. The property's cash flow available for loan payments is a limiting factor on the approved loan amount. Properties securing commercial real estate loans are required to generate cash flow sufficient to cover loan payments and other property expenditures.
Commercial real estate lending entails significant additional risks compared to single family residential mortgage lending. Income producing property loans may involve large loan balances to single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by commercial real estate properties is typically dependent on the successful operation of the properties, as well as to adverse conditions in the real estate market or the economy in general.
Consumer Lending - ----------------
BVFB engages in consumer lending, primarily by making home equity loans and auto loans. In November 1996, BVFB entered into a strategic alliance with Ultra Funding, Ltd. ("Ultra"), a Texas limited partnership, under which BVFB has sole first right of refusal to purchase all of the motor vehicle installment contracts originated by Ultra subject to established underwriting criteria. These auto receivables are serviced by CTL and are anticipated to be securitized by BVSC on a periodic basis together with the future production from CTL. Management expects Ultra to be a significant component (current production approximates $3 million to $4 million per month) of its expanding consumer finance strategy. At December 31, 1996, the consumer loan portfolio of BVFB totaled $57.8 million, representing 2.8% of its total loan portfolio at that date. See "California Thrift & Loan-Motor Vehicle Loans" below with regard to the Company's strategy to securitize and sell its current assets as well as future production.
Business Lending - ----------------
During 1995, BVFB introduced a new product line designed for small and medium-sized businesses. Business loan products (i.e., business loans, credit lines and term loans) and other services are being offered in order to expand BVFB's customer base and make BVFB more competitive in the community banking environment. As of December 31, 1996, BVFB's business loan portfolio was not material in relation to its other lending.
Underwriting Policies and Procedures - ------------------------------------
BVFB originates real estate loans through internal loan production personnel. As part of the loan underwriting process, staff appraisers or qualified independent appraisers inspect and appraise the property that would secure the loan. A loan underwriter analyzes the merits of the loan based on information obtained relative to the borrower and property (i.e., income, credit history, assets, liabilities, cash flows and the value of the real property as stated on the appraisal report). Loans are then approved at various levels of authority depending upon the amount and type of loan.
BVFB requires the American Land Title Association form of title insurance on all loans secured by real property and requires that fire and extended coverage casualty insurance in amounts sufficient to rebuild or replace the improvements at current replacement costs be maintained on all properties securing the loans. BVFB also requires flood insurance for properties in flood hazard zones to protect the property securing its interest. Consistent with regional industry practices, BVFB does not necessarily require earthquake insurance as part of its general underwriting practices, however, BVFB may require mudslide, earthquake and/or other hazard insurance depending on the location of the property.
Sales and Servicing of Real Estate Loans - ----------------------------------------
BVFB has historically sold (none in 1996 or 1995) whole real estate loans and participation interests in real estate loans. BVFB generally sells real estate loans and loan participations for cash equal to the unpaid principal amount of the loans or loan participation, based upon yields currently required in the secondary market. This may result in a gain or loss on the sale. When loans are sold, BVFB typically retains the responsibility for collecting and remitting loan payments, inspecting the properties securing the loans, making certain that monthly principal and interest payments and real estate tax payments are made on behalf of borrowers, and otherwise servicing the loans. BVFB receives a fee for performing these services.
California Thrift & Loan
Motor Vehicle Loans - -------------------
At December 31, 1996, motor vehicle loans totaled $286.3 million, representing 67.8% of CTL's total loan portfolio at that date. CTL underwrites and purchases fixed rate loans on both new and used motor vehicles on a non- recourse basis. CTL's typical motor vehicle loan customer desires a higher relative loan amount and/or longer term than is offered by many automobile financing sources. In return for the flexibility of the product it offers, management expects to continue to charge interest rates of 200 to 300 basis points over the rates typically offered by traditional sources of motor vehicle financing such as banks and captive finance companies. Management's primary focus is on the credit quality of the customer rather than the value of the collateral, and CTL will accordingly finance the full retail sales price of the automobile plus taxes, licensing fees, insurance, dealer preparation fees and extended warranty. CTL uses available technology, including a custom credit scoring system, to process approval decisions typically within three hours of receipt of information from a dealer.
CTL began to offer its motor vehicle loan products to an increased number of selected used car dealerships in 1994. Prior to this, the amount of motor vehicle loan business derived from used car dealerships was not significant. CTL began offering 84-month motor vehicle loan financing in December 1994. Prior to this, the typical motor vehicle loan had a term of 48 to 72 months. Management believes that 84-month financing will allow it to further distinguish its motor vehicle loan product without significantly increasing charge-offs or delinquencies.
The Company's business strategy for CTL is focused on expanding its asset origination capabilities and increasing the velocity of its capital utilization through sales of its auto loans and subsequent securitization of the auto loans by BVSC which will return a large portion of CTL's capital to the Company.
Other Consumer Financing - ------------------------
At December 31, 1996, other consumer financing loans totaled $30.5 million, representing 7.3% of CTL's total loan portfolio at that date. This activity was discontinued in November 1996. CTL underwrites and purchases installment contracts for larger home enhancement products such as organs, pianos and spas. Like motor vehicle loans, installment contract financing usually comes to CTL from dealers of the financed products. CTL will also make unsecured direct loans and loans secured by personal property, but these loans comprise an insignificant portion of CTL's loan portfolio. Management applies the same credit criteria to other consumer financing as it applies to motor vehicle lending.
Mortgage Loans, Revolving Credit Lines and Real Estate Participations - ---------------------------------------------------------------------
At December 31, 1996, CTL's portfolio of mortgage loans, revolving credit lines, and real estate loan participations totaled $105.3 million representing 24.9% of its total loan portfolio. The loan portfolio is primarily comprised of first and second deeds of trust secured by single family residences. Almost all of CTL's home equity loans are fixed-rate term loans, with maturities of up to 15 years. CTL's revolving credit lines (home equity lines of credit) are variable-rate loans, which are tied to the prime rate. CTL's real estate loan participations were purchased from and serviced by one unrelated party in 1996 and 1995. All of the real estate securing these loans is located in California.
CTL generally adheres to a maximum loan-to-value ratio of 75% at the time of origination, supported by a thorough appraisal process. Therefore, management has been willing to make loans to borrowers whose credit history or financial condition might not qualify under conventional mortgage underwriting and secondary market requirements.
CTL's typical loan customer is a borrower who seeks to reduce monthly debt payments. Exceptions to CTL's 75% loan-to-value criteria are small consumer- based real estate-secured loans such as credit lines under $35,000, which are primarily underwritten to applicants based on creditworthiness.
Commercial Equipment Leasing - ----------------------------
Prior to December 1996, CTL offered fixed-rate commercial equipment leases principally in the state of California. In December 1996, CTL sold its entire commercial equipment leasing portfolio and the related servicing obligations to a local financial institution without recourse.
SECURITIES ACTIVITIES
The Company's securities activities are primarily conducted by BVFB. BVFB purchases securities when high quality loan production is not available. The securities portfolio is categorized into two general components: (i) investment securities; and (ii) mortgage-backed securities. The investment securities portfolio mainly consists of government agency notes and debentures. The mortgage-backed securities portfolio mainly consists of securities issued by the Federal Home Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA") and Government National Mortgage Association ("GNMA").
Securities are classified as held-to-maturity or available-for-sale. BVFB does not maintain a trading portfolio. Securities in the held-to-maturity category consist of securities purchased for long-term investment in order to enhance BVFB's ongoing stream of net interest income and core earnings. Securities deemed held-to-maturity are classified as such because BVFB has both the intent and ability to hold the securities to maturity. Securities purchased which may be sold prior to maturity are designated as available-for-sale at the time of purchase.
As part of the Company's strategic objectives, management is de-emphasizing the less profitable aspects of its business such as wholesale investment activities. As a result, BVFB sold approximately $55 million of its MBS available-for-sale in 1996. There were no additional mortgage-backed securities purchased in 1996.
RETAIL DEPOSIT ACTIVITIES
Bay View Federal Bank
BVFB attracts both short-term and long-term deposits from the general public by offering a wide range of deposit products and services. BVFB, through its banking centers network, provides its banking customers with the following services:
. Savings and checking accounts . Certificates of deposit . Individual retirement accounts . 24-hour automated teller machines (STAR System and CIRRUS System Network)
Enhancing the value of BVFB's retail branch franchise remains one of Management's primary objectives. BVFB plans to continue to expand its retail banking presence in Northern California through internal growth, new product development and the acquisition or purchase of deposits from other institutions. During 1995, BVFB began offering a variety of deposit and related banking services designed for small businesses, including specialized checking. In 1996, BVFB continued to emphasize the development and marketing of its transaction account products, and as a result has successfully increased its percentage of transaction accounts in relation to total customer deposits to more than 30% which has contributed to lower cost of funds.
California Thrift & Loan
CTL's customer deposits are primarily comprised of thrift certificates which are similar to certificates of deposits with the exception that they are callable at par plus accrued interest. When thrift certificates are purchased by customers, CTL has, as thrift certificates have been issued, reserved the right to repurchase the certificates at any time upon thirty days notice. Utilizing this call provision, CTL redeemed the higher cost component (higher than BVFB's incremental borrowing cost) of these deposits at face value (approximately $267 million) as of December 31, 1996.
The remainder of the CTL customer deposits (which are lower cost than BVFB's incremental borrowing cost) will be sold to BVFB. An application for the approval of the sale of these deposits to BVFB has been filed with the Office of Thrift Supervision. The sale is anticipated to be completed during the first quarter of 1997.
BORROWING ACTIVITIES
The Company's borrowing activities are primarily conducted by BVFB. The Federal Home Loan Bank ("FHLB") System functions in a reserve credit capacity for savings institutions. As a member, BVFB is required to own capital stock in the FHLBSF and has the authority to apply for advances from the FHLBSF utilizing FHLBSF capital stock, qualifying mortgage loans and mortgage-backed securities as collateral.
The FHLBSF offers a full range of borrowing programs on its advances with terms of up to ten years at competitive market rates. A prepayment penalty is usually imposed for early repayment of FHLBSF advances. BVFB is also a member of the Federal Reserve System ("Federal Reserve") and may borrow from the Federal Reserve Bank of San Francisco. Thrifts are required to utilize their FHLBSF borrowing capacity before borrowing from the Federal Reserve.
BVFB also utilizes borrowings under reverse repurchase agreements with securities dealers and the FHLBSF. Reverse repurchase agreements are sales of securities owned by BVFB to security dealers with a commitment by BVFB to repurchase such securities for a predetermined price at a future date.
COMPETITION
Bay View Federal Bank
BVFB faces strong competition both in originating loans and in attracting deposits. Competition in originating multi-family and commercial real estate mortgage loans comes primarily from other savings institutions, commercial banks and mortgage bankers located in the San Francisco Bay Area. BVFB competes for mortgage loans principally on the basis of interest rates, types of products, loan fees charged and the quality of customer service it provides to borrowers. Competition in attracting deposits comes primarily from other savings institutions, commercial banks, brokerage firms, mutual funds, credit unions and other types of investment companies. The ability of BVFB to attract and retain deposits depends on a number of factors which include:
. Interest rates offered on deposit products . Fees . Types of deposit products . Convenient office locations . Advertising . Automated teller machines (ATMs) . Quality customer service
BVFB has ATMs located throughout the San Francisco Bay Area which provide 24-hour cash availability to its customers. BVFB also participates in the STAR System and the CIRRUS System Network, which link BVFB ATMs with those of a number of major financial institutions. This linkage provides customers with cash availability across the United States.
BVFB also has a wholly owned subsidiary, MoneyCare, Inc., which offers uninsured investment products such as mutual funds and annuities which provide BVFB's customers with additional choices and products that meet their individual investment needs.
California Thrift & Loan
CTL has experienced increased competition, particularly for its motor vehicle loan programs. This competition comes primarily from large well- capitalized lending institutions and finance companies. Management intends to build origination and purchase volumes through more competitive loan pricing and further improvements in service, marketing and product flexibility. It also intends to expand origination capability and market share through geographic expansion and additional business acquisitions, as warranted.
SUPERVISION AND REGULATION
Bay View Capital Corporation
General. The Company, together with its subsidiaries, is subject to extensive examination, supervision and regulation by the OTS and the Federal Deposit Insurance Corporation (the "FDIC"). Applicable regulations govern, among other things, BVFB's lending and investment powers, the types of accounts it is permitted to offer, the types of business in which it may engage and requirements for regulatory capital. The Company is also subject to the regulations of the Board of Governors of the Federal Reserve System with respect to required reserves and certain other matters.
Holding Company Regulations. The Company is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings institution subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.
Bay View Federal Bank
Federal Regulation of Savings Institutions. The OTS has extensive authority over the operations of savings institutions. As part of this authority, BVFB is required to file periodic reports with the OTS and the FDIC. The OTS has extensive enforcement authority over all savings institutions and their holding companies, including BVFB and the Company, and their affiliated parties such as directors, officers, agents and other persons providing services to the institution or holding company.
Insurance of Accounts and Regulation by the FDIC. BVFB is a member of the Savings Association Insurance Fund ("SAIF"), which is administered by the FDIC. BVFB's deposits are insured up to applicable limits by the FDIC. As insurer, the FDIC has adopted a risk-based deposit insurance system that assesses deposit insurance premiums for all FDIC-insured banks and thrifts according to the level of risk involved in an institution's activities. An institution's risk category is based upon whether the institution is classified as "well capitalized," "adequately capitalized" or "undercapitalized" and within each risk category there are three subcategories.
The FDIC is authorized to increase assessment rates, on a semiannual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF-insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. In addition, the FDIC may impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC.
Disparity Between BIF and SAIF Insurance Premiums. Federal law requires that the FDIC maintain the reserve level of both the SAIF and the Bank Insurance Fund ("BIF") at a level equal to 1.25% of insured deposits. The reserves are funded through the payment of insurance premiums by the insured institutional members of each fund. As a result of the BIF reaching the designated reserve ratio, effective in the third quarter of 1995, the FDIC revised the assessment matrix for BIF-insured institutions to provide a range of .04% to .31%. The matrix was further revised, effective January 1996, to provide a range of 0% to .27%, with a minimum annual assessment of $2,000 for more than 90% of all BIF members.
During the third quarter of 1996, federal legislation to recapitalize and fully fund the Savings Association Insurance Fund was signed into law. Customer deposits for BVFB are SAIF-insured, and as a result of the legislation BVFB was required to pay a one-time special assessment of $11.7 million pre-tax ($6.7 million after tax or $.97 per share). The legislation had no effect on CTL, as its deposits are insured under the Bank Insurance Fund.
Pursuant to this legislation, premiums on SAIF-insured deposits for BVFB will be reduced in 1997 from the previously anticipated 23 basis points to approximately 6.48 basis points which will translate into lower annual deposit costs in 1997. The estimated annual savings associated with these lower premiums will be approximately $2.7 million based on the level of deposits for BVFB at December 31, 1996.
Regulatory Capital Requirements. Federally insured savings institutions such as BVFB are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings institutions. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual institutions on a case-by-case basis. At December 31, 1996, the Bank was deemed "well capitalized" under current capital regulations and exceeded its fully phased-in regulatory capital requirements.
In August 1993, the OTS issued a final rule for the calculation of an interest rate risk component for institutions with a greater than normal (i.e., greater than 2%) level of interest rate risk exposure. Currently, the OTS has deferred implementation of the interest rate risk component. At December 31, 1996, if the interest risk component regulation had been implemented, BVFB would not have been subject to an interest rate risk capital deduction for risk-based capital purposes.
Limitations on Dividends and Other Capital Distributions. The retained earnings of BVFB are substantially restricted based on certain laws and regulations relating to the payment of dividends. Federal regulations impose various restrictions or requirements on institutions with respect to their ability to pay dividends or make other distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the equity account.
Generally, Tier I institutions, which are institutions that before and after the proposed distribution meet or exceed their capital requirements, may, after the receipt of no objection by the regulators, make capital distributions during any calendar year equal to the greater of 100% of net income on a year- to-date basis plus 50% of the amount by which the institutions tangible core or risk-based capital exceeds its respective fully
phased-in capital requirement, as measured at the beginning of the calendar year, or 75% of its net income for the most recent four quarter period. BVFB meets the requirements for a Tier I institution.
Federal Reserve System. The Federal Reserve requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts). At December 31, 1996, BVFB was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements imposed by the OTS.
Federal Home Loan Bank System. BVFB is a member of the FHLBSF, one of 12 regional FHLBs. Each FHLB serves as a reserve or central bank for its members within its assigned geographic region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLBSF are required to be fully secured by sufficient collateral as determined by the FHLBSF. In addition, all long-term advances are restricted to providing funds for residential home financing.
California Thrift & Loan
CTL is subject to supervision and regulation by the Commissioner of Corporations of the State of California (the "Commissioner") and, as a Federally insured depository institution, by the FDIC. In addition, CTL is subject to regulation in Arizona, Colorado, Illinois, Nevada, New Mexico, Oregon and Texas as a result of its operations in those states. The Company began implementing a significant restructuring of CTL in late 1996. This restructuring, when completed, may also include converting CTL to a "pure" finance company subject to supervision and regulation by the Commissioner only.
CALIFORNIA LAW
The thrift and loan business conducted by CTL is governed by the California Industrial Loan Law and the rules and regulations of the Commissioner, which, among other things, regulate the issuance of certain thrift investment certificates as well as the collateral requirements and maximum maturities of the various types of loans that are permitted to be made by California-chartered industrial loan companies (also called thrift and loan companies).
Subject to restrictions imposed by California law, CTL is permitted to make secured and unsecured consumer and non-consumer loans. The maximum term for repayment of loans made by thrift and loan companies ranges up to 40 years depending upon the type of collateral and priority of secured position, if any. Although non-consumer secured loans of fewer than 10 years may generally be repaid in unequal periodic payments, consumer loans must generally be repaid in substantially equal periodic payments. California law limits lending activities outside of California by thrift and loan companies to no more than 40% of total assets.
California law contains extensive requirements for the diversification of the loan portfolios of thrift and loan companies. A thrift and loan with outstanding investment certificates may not, among other things, place more than 25% of its loans or other obligations in loans or obligations which are secured only partially, but not primarily, by real property; may not make any one loan secured primarily by improved real property which exceeds 20% of its paid-up and unimpaired capital stock and surplus not available for dividends (10% for unimproved property); may not lend an amount in excess of 5% of its paid-up and unimpaired capital stock and surplus not available for dividends upon the security of the stock of any one corporation; may not make loans to, or hold the obligations of, any one person as primary obligor in an aggregate principal amount exceeding 20% of its paid-up and unimpaired capital stock and surplus not available for dividends (5% if the loans are unsecured); may
not have outstanding leases which exceed 20% of the thrift's aggregate receivables; and may have no more than 70% of its total assets consisting of loans which have remaining terms to maturity in excess of seven years and are secured solely or primarily by real property. Loans that are for the purchase or refinance of residential property, are salable in the secondary market and are owned by the company for less than 90 days are considered to have a remaining term less than seven years for this purpose. Any loan insured by a federal or state agency is also deemed to have a term of less than seven years for this purpose. Management believes that CTL can maintain compliance with such regulatory requirements by managing the mix of its assets and loans without any material adverse impact on earnings or liquidity.
A thrift and loan generally may not make any loan to, or hold an obligation of, any of its directors or officers or any director or officer of its holding company or affiliates, except in specified cases and subject to regulation by the Commissioner. A thrift and loan also may not make any loan to, or hold any obligation of, any of its stockholders or any stockholder of its holding company or affiliates, except that this prohibition does not apply to persons who own less than 10% of the stock of a holding company or affiliates which are listed on a national securities exchange.
A thrift and loan is subject to certain leverage limitations which are not generally applicable to commercial banks or savings and loan associations, but these are generally preempted by stricter federal rules. The Commissioner may limit the amount of brokered deposits a thrift and loan may have outstanding. The limit on CTL's brokered deposits is $100 million.
Thrift and loan companies are not permitted to borrow, except by the sale of thrift investment certificates, in an amount exceeding 300% of tangible net worth, surplus and undivided profits without the Commissioner's prior consent. All sums borrowed in excess of 150% of tangible net worth, surplus and undivided profits must be unsecured borrowings or, if secured, approved in advance by the Commissioner, and be included as thrift investment certificates for purposes of computing the maximum amount of certificates a thrift and loan may issue. However, collateralized Federal Home Loan Bank advances are excluded for this test of secured borrowings and are not specifically limited by California law.
Under California law, thrift and loan companies are generally limited to investments, other than loans, that are legal investments for commercial banks. Current policy of the Commissioner prohibits investment in subsidiary companies. California commercial banks are prohibited from investing an amount exceeding 15% of stockholders' equity in the securities of any one issuer, except for specified obligations of the United States, California and local governments and agencies. A thrift and loan company may acquire real property only in satisfaction of debts previously contracted, pursuant to certain foreclosure transactions or as may be necessary for the transaction of its business, in which case such investment is limited to one-third of a thrift and loan's paid- in capital stock and surplus not available for dividends. Management believes it is in compliance with these requirements.
The California Industrial Loan Law allows a thrift and loan to increase its secondary capital by issuing interest-bearing capital notes in the form of subordinated notes and debentures. Such notes are not deposits and are not insured by the FDIC or any other governmental agency, and generally are required to have a maturity of at least seven years, and are subordinated to thrift investment certificate holders, general creditors and secured creditors of the issuing thrift.
Although investment authority and other activities that may be engaged in by CTL generally are prescribed under the California Industrial Loan Law, certain federal laws may limit CTL's ability to engage in certain activities that otherwise are authorized under the California Industrial Loan Law. See "Federal Law" below.
FEDERAL LAW
CTL's thrift investment certificates are insured by the Bank Insurance Fund (the "BIF") administered by the FDIC to the full extent by law. As an insurer of deposits, the FDIC issues regulations, conducts examinations, requires the filing of reports and generally supervises the operations of institutions to which it provides deposit insurance. The FDIC is also the federal agency charged with regulating state-chartered banks that are not members of the Federal Reserve System. For this purpose, CTL is considered to be a state-chartered bank. The approval or non-objection of the FDIC is required prior to any merger, consolidation or acquisition of control of CTL, and prior to the establishment or relocation of a branch office facility of CTL. An acquirer may be deemed to control CTL if it holds, directly or indirectly or acting in concert with others, 10% or more of a class of voting stock of CTL. This supervision and regulation is intended primarily for the protection of depositors.
FDIC Insurance Assessments and Regulatory Capital. All FDIC-insured institutions pay semi-annual assessments against deposit balances. CTL paid 23 cents per $100 of deposits effective January 1, 1994 based on its "well- capitalized" status. The FDIC reduced deposit insurance premium rates to 4 cents per $100 of deposits effective June 1, 1995, and then reduced the annual deposit insurance premium to a flat $2,000 effective January 1, 1996. CTL's capital ratios at December 31, 1996 placed it in the "well capitalized" category.
Brokered Deposits and Benefit Plan Deposits. An undercapitalized bank cannot accept, renew, or roll over deposits obtained through a deposit broker, and may not solicit deposits by offering interest rates that are more than 75 basis points higher than market rates. Banks that are adequately capitalized but not well capitalized must obtain a waiver from the FDIC in order to accept, renew or roll over brokered deposits, and even if a waiver is granted may not solicit deposits, through a broker or otherwise, by offering interest rates that exceed market rates by more than 75 basis points. Similarly, the ability to accept benefit plan deposits with pass-through deposit insurance (for each plan beneficiary) is tied to capitalization levels. CTL is well capitalized, and therefore may accept brokered deposits and benefit plan deposits free from these restrictions.
Fair Lending Laws. The Federal government announced a policy of strict enforcement of laws that prohibit discrimination against protected groups in lending and require banking institutions to serve the credit needs of their communities. Federal regulations seek to measure whether a retail institution, such as CTL, is adequately serving the credit needs of low and moderate income communities in its markets. Management believes that CTL's lending practices and other policies fully comply with current law.
Restrictions on Activities. Under FDIC regulations, CTL may not engage as principal in any activities that are not permissible for national banks and their subsidiaries unless (i) CTL meets the applicable FDIC capital standards described above, and (ii) the FDIC has determined that the activity would pose no significant risk to the BIF. The types of consumer finance, real property lending (including second mortgage lending) and equipment leasing activities conducted by CTL have been determined by the Office of the Comptroller of the Currency to be permissible activities for national banks.
CTL is prohibited, under both federal and state laws, from engaging in certain tying arrangements in connection with an extension of credit, sale or lease of property or provision of services. For example, with certain exceptions, CTL may not require a customer to obtain other services provided by CTL and may not require the customer to promise not to obtain other services from a competitor as a condition to an extension of credit or reduced consideration for credit to the customer.
In addition, federal law imposes restrictions on transactions between CTL and its affiliates. All such transactions, including leases and service contracts, must be on terms and under circumstances that are substantially the same, or at least as favorable to CTL, as those prevailing at the time for comparable transactions involving non-affiliated companies. Affiliate transactions are also subject to certain quantitative limits.
OTHER SUBSIDIARIES
Previously, the Company had invested in real estate with various joint venture partners for the development of single family homes through Regent Financial Corporation, a subsidiary of the Company, and Bay View Financial Corporation ("BVFC"), a subsidiary of BVFB. BVFC is a wholly owned service corporation subsidiary of BVFB with the power to engage generally in service corporation activities, and has three subsidiaries: Bay View Auxiliary Corporation, Bay Counties Insurance Agency, Inc. and Carquinez Reserve, Inc. During 1993, the Company curtailed its participation in real estate joint ventures and sold off all of its related interests in these type of ventures. The Company has no current plans to re-enter this type of business. At present, these subsidiaries of BVFB are principally inactive and were insignificant to the Company's operations during 1996 and 1995.
MoneyCare, Inc. ("MoneyCare"), a wholly owned subsidiary of BVFB, is also a service corporation. The primary activity of MoneyCare is to sell uninsured investment products such as mutual funds and annuities under an arrangement with CoreLink Financial Inc. MoneyCare receives commissions on sales of such products. BVFB stresses cross-selling to improve profitability and solidify customer relationships.
EMPLOYEES
At December 31, 1996, the Company had a total of 576 employees on a full- time equivalent ("FTE") basis (383 FTE at BVFB and 193 FTE at CTL). The Company's employees are not represented by any collective bargaining groups. The Company considers its relations with its employees to be good.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the executive officers of the Registrant.
The business experience of each of the executive officers of the Company is as follows:
Mr. Sondker has been a Director, President and Chief Executive Officer of the Company since 1995. He joined BVFB in August 1995 as President and Chief Executive Officer. Previously, he served as President and Chief Executive Officer of Independence One Bank of California, FSB, a subsidiary of Michigan National Corporation. From 1985 to 1990, he was the President and Chief Executive Officer of La Jolla Bank & Trust Company. Prior to 1985, Mr. Sondker held executive and management positions with a community bank holding company in Kansas City, Missouri.
Mr. Flax has been Executive Vice President and General Counsel of BVFB since 1985 and has served in various capacities since 1980. He has served as Executive Vice President, General Counsel and Corporate Secretary of the Company since its formation. Before joining BVFB, he was a trial attorney in private practice in San Francisco from 1976 to 1980.
Mr. Heaberlin has been Executive Vice President and Chief Financial Officer since November 1995. Previously, he served as Senior Vice President and Chief Financial Officer for First California/Mortgage Service America. During 1993 and 1994, he was Executive Vice President and Treasurer of ITT Residential Capital Corporation. Prior to ITT, he was Executive Vice President for Numerica Financial Corporation, a multi-bank holding company located in Manchester, New Hampshire. He has over 20 years experience in commercial banking, savings banks and the financial services industry. Mr. Heaberlin is a Certified Public Accountant.
Mr. Buckley has been Senior Vice President and Director of Credit Administration since January 1995 and Manager of Credit Administration and Asset Management since June 1994. He joined BVFB in September 1993. Previously, he served at Bank of America in various capacities from 1985 to 1993. His last position was Vice President and Regional Credit Administrator for the Real Estate Industries Division at Bank of America.
Ms. Hart has been Senior Vice President and Director of Banking Centers since January 1995 and Asset Management Manager of BVFB since 1992. She was a Portfolio Manager with HomeFed Bank from 1991 to 1992, and was with the Bank of New England from 1990 to 1991 as a Group Leader of Controlled Loans. From 1988 to 1990, she was with American Savings Bank as a Senior Asset Manager, and from 1986 to 1988, she was Director of Asset Quality for the FHLBSF.
There is no family relationship among the above officers. All executive officers serve at the pleasure of the Board of Directors.
ITEM 2.

ITEM 2. PROPERTIES - --------------------
As of December 31, 1996, BVFB occupies 25 of its 26 banking centers and the administrative corporate office for the Company under operating lease arrangements expiring at various dates through 2012. BVFB owns the property in which one of its banking centers is located. In 1996, the Company sold its corporate office complex and entered into an operating lease arrangement for new facilities.
As of December 31, 1996, CTL occupies 19 offices under operating lease arrangements expiring on various dates through 2006. In 1996, CTLs corporate office complex was sold and CTL relocated its administrative offices.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS - ---------------------------
See Note 19 of the Consolidated Financial Statement Notes at Item 8.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - -------------------------------------------------------------
No matter was submitted for a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended December 31, 1996.
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - -------------------------------------------------------------------------------
The Company's common stock (symbol: BVFS) is traded on the NASDAQ National Market. At December 31, 1996, there were 6,674,635 shares of the Company's common stock outstanding, which were owned by 1,441 shareholders of record. The following is a summary of year-end values for 1996 and 1995.
The following is a summary of selected financial ratios excluding special mention items and SAIF recapitalization assessment for 1996 and fourth quarter nonrecurring charges for 1995. See also Item 6

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - -------------------------------------------------------------------------- RESULTS OF OPERATION - --------------------
INDEX
STRATEGIC OVERVIEW ------------------
The Company has been aggressively restructuring and diversifying its operations since late 1995. The following is an overview of the principal strategies being pursued and the most significant actions implemented thus far.
THE COMPANY'S MISSION STATEMENT
To build a diversified financial services company by investing in and creating niche lending generating companies that originate high yielding assets and maximizing per share market value.
THE COMPANY'S CAPITAL STRATEGY
In order to realize the Company's objectives, management is pursuing a capital strategy that encompasses the following:
1. To de-emphasize the less profitable elements of the Company's subsidiaries.
2. To return the capital of subsidiaries in excess of the regulatory "well capitalized" requirement to the Company.
3. To redeploy excess capital to generate a more profitable, risk-based return or repurchase shares.
4. To increase the velocity of capital utilization.
BAY VIEW FEDERAL BANK STRATEGIES
BVFB has 26 branches servicing primarily the San Francisco Bay Area. Its principal business consists of attracting deposits from the general public and using those deposits, together with borrowings, to originate loans secured by real estate. Historically, BVFB's performance has been negatively impacted by weak retail asset origination (primarily COFI-based, commodity oriented mortgage products), high general and administrative expenses and also unfavorable interest rate risk exposure. In addition, BVFB had purchased mortgage-backed securities ("MBS") when high quality loan production was not available.
In 1996, management redirected BVFB's strategic focus to concentrate on enhancing the deposit franchise and (beginning in late 1995) the restructuring of the wholesale (MBS/borrowings) portion of the balance sheet. As a result, transaction accounts as a percentage of total deposits increased to 30.3% at December 31, 1996 from approximately 20% at year-end 1995. In addition, BVFB prepaid a significant portion of its high cost borrowings and also sold certain MBS from its available-for-sale portfolio to mitigate its interest rate risk exposure. At December 31, 1996, BVFB had entered into interest rate swaps with notional amounts of $421 million which provide interest rate risk protection by matching the floating interest rate risk of its balance sheet. Including the effect of interest rate swaps, interest rate risk sensitivity estimated by management (as measured by the change in the net portfolio value of equity as a percentage of the present value of assets from an immediate 200 basis point increase/decrease in interest rates) was 1.15% and 0.79% at December 31, 1996 and 1995, respectively, as compared to 3.02% at December 31, 1994.
CALIFORNIA THRIFT & LOAN STRATEGIES
CTL is the Company's consumer finance subsidiary which underwrites and purchases primarily high quality, high yielding auto loans and has successfully carved out a niche in the increasingly competitive auto finance industry. The Company acquired CTL in June 1996 and the acquisition was accounted for under the purchase accounting method. It is currently headquartered in Covina, California and operates 19 offices throughout California and western United States.
The Company's focus at CTL is to capture asset values and increase the velocity of capital utilization. As a result, the Company's management began implementing a significant restructuring of CTL's balance sheet in late 1996. The following summarizes the status of those actions.
Sale of Equipment Leasing Portfolio - -----------------------------------
CTL signed a definitive agreement for the sale of its entire equipment leasing portfolio for cash. The leases sold aggregated $60 million and this transaction closed in December, 1996. The proceeds from this transaction slightly exceeded the value established during the purchase accounting valuation process. This sale combined with other restructuring efforts outlined herein enabled CTL to return $15 million of capital to the Company for redeployment on December 31, 1996.
Reduction of High Cost Customer Deposits - ----------------------------------------
CTL's customer deposits are primarily comprised of thrift certificates which are similar to certificates of deposit with the exception that they are callable at par plus accrued interest. When thrift certificates are purchased by customers, CTL reserves the right to repurchase the certificates at any time upon thirty days notice. Utilizing this call provision, CTL redeemed the higher cost component (higher than BVFB's incremental borrowing cost) of these deposits at face value (approximately $267 million) as of December 31, 1996.
The remainder of the CTL customer deposits (which are lower cost than BVFB's incremental borrowing cost) will be sold to BVFB. An application for the approval of the sale of these deposits to BVFB has been filed with the OTS. The sale is anticipated to be completed during the first quarter of 1997 and will allow CTL to further return approximately $8 million of capital to the Company.
Sale and Securitization of Auto Loan Portfolio - ----------------------------------------------
CTL intends to sell a portion of its auto loan portfolio to BVSC, a Delaware corporation formed for the purpose of issuing asset-backed securities through a trust. The sale of the auto loans is expected to enable CTL to return approximately $25 million of capital to the Company.
The premium arising from the sale of the auto loan portfolio has been recorded as part of the purchase accounting valuations related to the June 1996 acquisition of CTL. In conjunction with the decision to securitize the auto loan portfolio, management entered into certain hedges which materially insulated the purchase accounting valuation from movements in interest rates.
In November 1996, BVSC filed with the Securities and Exchange Commission ("SEC") a shelf registration statement on Form S-3 for $500 million of automobile receivable-backed securities. The shelf registration statement was declared effective by the SEC and in January 1997, $253 million of such securities were issued pursuant to this shelf registration. Capital Markets Assurance Corporation provided credit enhancement of this initial transaction.
BVFB has entered into a strategic alliance with Ultra Funding, Ltd., a Texas limited partnership, to purchase motor vehicle installment contracts ("auto receivables") originated by Ultra. These auto receivables are serviced by CTL and are anticipated to be securitized on a periodic basis together with the future production from CTL. Management expects Ultra to be a significant component (current production approximates $3 - $4 million per month) of its expanding consumer finance strategy.
The actions described above are consistent with the Company's capital strategy to increase the velocity of capital utilization, de-emphasize less profitable activities and return the capital of subsidiaries in excess of the regulatory "well capitalized" requirement to the Company. The Company expects to utilize the estimated $48 million of capital being returned by CTL to aggressively pursue accretive acquisition opportunities and/or repurchase additional shares. See discussion on "Capital Redeployment Strategies".
CAPITAL REDEPLOYMENT STRATEGIES
Stock Repurchase Program - ------------------------
The Company's outstanding shares of common stock at December 31, 1996 and 1995 were 6,674,635 shares and 7,101,590 shares, respectively. The decrease in the number of outstanding shares was primarily attributable to the repurchase of 495,000 shares in 1996 partially offset by the exercise of stock options. As a result of the stock repurchases, weighted average shares outstanding (including certain common stock equivalents) used for earnings per share calculations has decreased from 7,293,492 shares for 1995 to 6,949,919 shares for 1996, a decrease of approximately 4.9%. The Company's share repurchases during 1995 and 1996 completed its previously announced intention to repurchase 800,000 shares of common stock. These shares were repurchased at an average cost of $31.97.
In January 1997, the Company approved a further repurchase program of $25 million to further redeploy its excess capital. This authorization should enable the Company to repurchase approximately 475,000 shares (based on most recent share price of $52.875) bringing the aggregate repurchases to approximately 1.3 million shares or 17.5% of the 7.4 million shares outstanding when the initial share repurchase program was approved.
Acquisition of EXXE Data Corporation/Concord Growth Corporation - ---------------------------------------------------------------
In January 1997, the Company signed a definitive agreement to acquire EXXE Data Corporation ("EXXE") and its wholly owned nationwide commercial finance subsidiary, Concord Growth Corporation ("CGC"). Under the terms of the definitive agreement, holders of EXXE capital stock, warrants and options will receive an initial aggregate payment of $19.8 million at closing and will be entitled to potential future payments, dependent on the future financial performance of CGC, of up to $34 million.
The Company estimates that the first full year EPS enhancement from this transaction will approximate $.14 per share or $.05 (50%+) more than the estimated $.09 per share benefit that which would be achieved from utilizing the $19.8 million to repurchase shares of the Company's common stock. The closing payment of $19.8 million constitutes approximately 9.4 times the estimated initial year net income for CGC. Cash basis EPS enhancement from this transaction, which excludes the amortization of goodwill arising from the transaction, is estimated at $.30 for the first full year of operations or more than 300% better than that which would be achieved by utilizing the $19.8 million to repurchase the Company shares. When measured against the first full year cash basis EPS, the closing payment of $19.8 million represents approximately 6.2 times the initial year earnings estimate for CGC. The Company expects, for the twelve months following the completion of the CGC acquisition, that consumer and commercial finance activities will contribute approximately 20% of the Company's consolidated profits.
The acquisition of EXXE/CGC will be accounted for as a purchase and is expected to be completed during March 1997. Subject to the approval of EXXE shareholders, the purchase price is currently estimated to exceed the fair value of the net assets acquired by $16.5 million which the Company anticipates amortizing over a 15 year period. CGC is expected to be a stand-alone subsidiary of the Company.
Other Capital Strategies - ------------------------
The Company has estimated that capital of $48 million would be returned from CTL in connection with the sales of CTL's auto loans and the subsequent securitization of such assets by BVSC and balance sheet restructuring of CTL. The capital returned from CTL when combined with excess capital available at BVFB and excess cash at the Company would approximate more than $80 million.
The Company is currently contemplating the issuance of commercial paper and the issuance of subordinated notes by BVFB. The commercial paper issuance would be utilized as a funding alternative for CGC, CTL and certain BVFB assets. The subordinated notes would be utilized to expand BVFB's Tier II regulatory capital and reduce Tier I capital. Management estimates that these actions combined with 1997 earnings will enable the Company to generate at least $40 million of additional capital for redeployment.
The EXXE/CGC acquisition and the $25 million share repurchase will redeploy roughly $50 million of the $80 million currently available. Following the completion of these transactions, the Company estimates that at least $70 million of capital remains available for redeployment during 1997.
The Company expects to continue utilizing this capital pool to aggressively pursue accretive acquisition opportunities to expand its commercial and consumer finance platforms. Management will also continue to explore the acquisition of other potential high quality niche origination capabilities, as well as opportunities to further enhance the BVFB deposit franchise. These acquisition activities are likely to be combined with further future share repurchases.
ACQUISITION OF CALIFORNIA THRIFT & LOAN
On June 14, 1996, the Company acquired CTL Credit, Inc. ("CTL Credit"), a Delaware corporation and the holding company for CTL. In connection with the acquisition, CTL Credit was liquidated with its assets transferred to and liabilities assumed by the Company, and CTL became a stand-alone subsidiary of the Company and a sister bank to BVFB.
The Company acquired all of the outstanding common stock of CTL Credit for $18.00 per share, or total cash consideration of approximately $62 million, which was funded with existing cash and borrowings. During May 1996, the Company issued $50 million in Senior Debentures yielding 8.42% (all-in cost was 8.91% annualized), and $26 million of the proceeds were used to finance the CTL Credit acquisition. The residual proceeds of the debt offering will be utilized for future accretive acquisitions or other business purposes deemed to enhance shareholder value, such as the repurchase of the Company's common stock, if warranted (see "Capital Redeployment Strategies").
The CTL Credit acquisition has been accounted for as a purchase effective June 1, 1996. Under the purchase accounting method, the purchase price is allocated to assets acquired and liabilities assumed based on their estimated fair values at the time of consummation of the transaction. Based on initial estimates performed in association with the June 30, 1996 interim financial statements, aggregate costs exceeded the estimated fair value of net assets acquired (i.e., goodwill) by $18.4 million. Subsequent market data and analysis has determined that the realizable value of the acquired assets is higher than the initial estimates, specifically the value attributable to certain assets positioned for securitization or sale. Given the revised estimates, goodwill has been adjusted to $7.0 million and is being amortized on a straight-line basis over a period of seven years.
The following table summarizes the revised purchase accounting valuation and related adjustments as compared to the initial estimates performed for the June 30, 1996 interim financial statements. The revised purchase price allocations are based on estimates of the fair value of the net assets acquired given available information and may be subject to further adjustment in accordance with the guidelines established under Accounting Principles Board Opinion No. 16 "Business Combinations".
SIGNIFICANT PURCHASE PRICE ALLOCATION ASSUMPTIONS
The significant assumptions utilized in association with the purchase accounting valuations as of the date of acquisition are as follows:
A. The estimated fair value of loans held for investment was determined by discounting the applicable cash flows at the market rate as of the effective date of the acquisition. The market rate represents the corresponding yield that a willing buyer would receive as a result of the sale of similar loans issued to borrowers of similar credit risk. The applicable cash flows represent the projected loan payments, net of estimated prepayments based on historical experience and published data for similar loans. Fair values of loans held for sale are based on prices for similar loans in the secondary market. The initial estimate of the fair value of the loan portfolio was based on carrying amounts. The adjustment was based on fair values that management expects to realize from the sale of such loans.
B. The adjustment to real estate owned represents a write-down based on a revised evaluation of the fair value less estimated costs to sell.
C. The adjustment to fixed assets is based on a revised estimate of the proceeds from the sale of the building (sale closed in December 1996) used as the corporate headquarters of CTL.
D. The adjustment to other liabilities represents reserves established for costs to be incurred from terminating lease obligations, data processing activities and CTL's employee automobile program. The adjustment also includes costs associated with termination and integration of certain employee functions.
E. No adjustment has been made for valuations associated with the deposit portfolio. It was assumed that these liabilities will be sold to BVFB or retired at face value as selective assets are sold or securitized.
F. The adjustment related to deferred taxes represents the tax impact of all purchase accounting adjustments by applying enacted statutory taxes applicable to future years. This adjustment effectively represents the estimated future tax consequences associated with these purchase price valuations.
RESULTS OF OPERATIONS
The Company reported consolidated net income of $11.0 million or $1.58 per share for the year ended December 31, 1996 (including CTL effective June 1, 1996) as compared to a consolidated net loss of $4.7 million or $0.64 per share for the year ended December 31, 1995 and consolidated net income of $14.5 million or $2.02 per share for the year ended December 31, 1994. Operating results for 1996 included a one-time charge of $6.7 million or $0.97 per share ($11.7 million pre-tax) relating to a special assessment to recapitalize the Savings Association Insurance Fund. Operating results for 1995 included certain nonrecurring charges of $11.3 million after tax ($18.0 million pre-tax) related to performance impediments which were eliminated to improve the Company's future profitability and enhance shareholder value. Excluding the impact of the SAIF recapitalization assessment in 1996 and the nonrecurring charges in 1995, the increase in earnings for 1996 over 1995 was primarily due to an improvement in net interest margin and lower general and administrative expenses as discussed further elsewhere herein.
SPECIAL MENTION ITEMS - ---------------------
Net income for the year ended December 31, 1996 contained certain items which deserve special mention. The impact of these items on full year 1996 earnings was a net decrease of $52,000 or $0.01 per share.
First Quarter 1996 (pretax) - ------------------
The net impact of the following items on first quarter 1996 results was a net improvement of $109,000 after tax or $0.01 per share.
- - $800,000 gain from the sale of and income received from certain real estate owned properties.
- - $350,000 write-off of core deposit intangibles and fixed assets due to a branch closure.
- - $260,000 loss resulting from the sale of approximately $24 million of mortgage-backed securities from the available-for-sale portfolio.
Second Quarter 1996 (pretax) - -------------------
The net impact of the following items on second quarter 1996 results was a net decrease of approximately $89,000 after tax or $0.01 per share.
- - $770,000 gain from the sale of and income received from certain real estate owned properties.
- - $500,000 additional write-down due to the sale of the corporate office complex which closed in the third quarter of 1996. The Company had provided a write-down of $7.1 million on this property in 1995.
- - $425,000 write-down related to certain computer hardware and software. The computer-related write-down was directly related to the Company's decision to enter into a long-term information services technology agreement with BISYS Group, Inc.
Third Quarter 1996 (pretax) - ------------------
The net impact of the following items on third quarter 1996 results was a net decrease of $72,000 after tax or $0.01 per share.
- - $3.2 million gain from the sale of and income received from certain real estate owned properties.
- - $2.0 million accrual for termination of data processing contracts and an additional write-down for computer hardware relating to the Company's long- term information services technology agreement with BISYS Group, Inc.
- - $1.4 million of enhanced profitability resulting from purchase accounting valuations associated with the CTL assets being held-for-sale.
- - $1.3 million loss accrual for lease obligations in excess of related sublease rentals resulting from unfavorable lease agreement terms.
- - $1.2 million expense accrual for long-term incentive plan awards.
- - $210,000 accrual for downsizing loan operations and relocation of administrative functions.
Fourth Quarter 1996 (pretax) - -------------------
The net impact of the following items on fourth quarter 1996 results completely offset each other.
- - $1.0 million of enhanced profitability resulting from purchase accounting valuations associated with the CTL assets being held-for-sale.
- - $538,000 loss on sale of mortgage-backed securities and short sale of Treasury securities.
- - $400,000 additional accrual for the termination of data processing contracts which was finalized during the fourth quarter of 1996.
- - $80,000 net expense arising from the impact of the sale of the leasing portfolio partially offset by refunds of FDIC insurance premiums.
The decrease in net income in 1995 compared with 1994 was primarily attributable to lower net interest income, nonrecurring charges relating to losses on the sale of mortgage-backed securities available-for-sale, severance payments relating to workforce reductions, fixed assets written-off, write-down of corporate office complex, write-down of intangibles and prepayment penalties on FHLBSF advances.
NET INTEREST INCOME
Net interest income was $81.0 million for the year ended December 31, 1996 as compared to $55.9 million and $66.9 million for the years 1995 and 1994, respectively. The increase in net interest income for 1996 as compared to 1995 was primarily due to an improvement in net interest margin for BVFB which increased to 2.38% in 1996 from 1.86% in 1995 and also the impact of the acquisition of CTL. The decrease in net income in 1995 from 1994 was primarily attributable to a lower net interest margin, which declined to 1.86% in 1995 from 2.34% in 1994. The following table summarizes net interest income (excluding intercompany interest income/expense) for each of the years indicated:
Bay View Capital Corporation - ----------------------------
The net interest expense for BVCC in 1996 consists primarily of interest expense on $50 million of 8.42% senior debentures (all-in cost 8.91% annualized) issued in May 1996.
Bay View Federal Bank - ---------------------
BVFB's 1996 net interest margin was 2.38%, an increase of 52 basis points as compared to net interest margin of 1.86% for 1995. The improvement in net interest margin was primarily due to lower cost of funds related to retail deposits.
The cost of retail deposits at December 31, 1996 was 4.60%, 24 basis points below COFI of 4.84%. The cost of retail deposits decreased by 64 basis points as compared to December 31, 1995. The decrease in the cost of retail deposits was primarily due to favorable repricing of certificates of deposit and an increase in transaction accounts which are at lower rates than certificates of deposit. As of December 31, 1996, transaction accounts as a percentage of total deposits increased to 30.3% from 21.3% and 22.2% at December 31, 1995 and 1994, respectively. The following table is a summary of cost of retail deposits for BVFB versus COFI as of December 31 for each of the years indicated:
A significant portion of BVFB's adjustable rate loan portfolio is indexed to COFI which typically lags market interest rate movements. Generally, BFVB's net interest margin is favorably affected during periods of declining interest rates as the cost of BVFB's interest-bearing liabilities may adjust to market rates more quickly than the yield on its interest-earning assets. Conversely, during periods of rising interest rates, BVFB's net interest margin is unfavorably affected by this lag factor. The Federal Reserve began increasing the discount rate and/or federal funds rates in 1994 and as a result, the general interest rate environment was higher in 1996 as compared to 1995. The net interest margin in 1996 for BVFB was adversely affected by the movements in the
COFI as a result of the rising interest rates and BVFB's exposure to interest rate movements. However, the decrease in the cost of retail deposits more than offset the unfavorable impact of COFI in 1996 which resulted in an improvement in BVFB's net interest margin. Management actions in late 1995 and early 1996 which significantly reduced BVFB's exposure to interest rates also benefited the net interest margin during 1996 (see "Asset and Liability Management" for further discussion).
The net interest margin was lower in 1995 as compared to 1994 primarily due to this lag factor compounded by higher cost of retail deposits and BVFB's exposure to interest rate movements.
California Thrift & Loan - ------------------------
CTL's 1996 net interest margin was 5.10%. As discussed elsewhere herein, the Company began implementing a significant restructuring of CTL's balance sheet in late 1996 which included a sale of its entire equipment leasing portfolio, reduction of high cost customer deposits, sale of its auto loan portfolio and subsequent securitization by BVSC.
Average Balance Sheet. The following table sets forth certain information relating to the Company's consolidated statements of financial condition and reflects the average yields on interest-earning assets and average rates paid on interest-bearing liabilities for the years indicated. Such yields and rates are derived by dividing interest income or expense by the average balances of interest-earning assets of interest-bearing liabilities, respectively, for the periods shown. The yields for the periods indicated include the amortization of deferred loan origination fees, net of costs, which were considered adjustments to yield.
(1) Interest expense for borrowings includes interest expense on interest rate swaps of $2.6 million, $40,000 and $80,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
(2) Average balances and yields for securities available-for-sale are based on historical amortized cost balances.
INTEREST INCOME
INTEREST INCOME ON LOANS RECEIVABLE
Interest income on loans was $192.4 million for the year ended December 31, 1996 as compared to $155.9 million and $131.8 million for the years 1995 and 1994, respectively. The following table is a summary of interest income on loans:
Bay View Federal Bank - ---------------------
The increase in yields on loans for BVFB of 31 basis points between 1996 and 1995 was primarily due to the repricing of a significant portion of loans indexed to the COFI and to a lesser extent, the one-year Treasury note. The average monthly COFI for the years ended December 31, 1996 and 1995, which impacted BVFB's adjustable rate mortgages, increased by 16 basis points. The average loan balances for 1996 and 1995 were essentially the same at $2.07 billion and $2.08 billion, respectively. The average monthly COFI for the years ended December 31, 1995 and 1994, which impacted BVFB's adjustable rate mortgages, increased by 101 basis points. However, this increase was partially offset by slower repricing of loans which adjust other than on a monthly basis and a higher amortization of SFAS 91 deferred fees due to higher level of loan prepayments.
California Thrift & Loan - ------------------------
The interest income on loans for CTL primarily relates to interest income on auto loans, mortgage loans, revolving lines of credit, and indirect equipment leases. The interest income on loans for CTL includes the amortization of purchase accounting valuation adjustments for loans held for investment. The yields on loans for CTL remained essentially the same since acquisition date. In December 1996, CTL sold its entire leasing portfolio of $60 million for cash.
INTEREST INCOME ON MORTGAGE-BACKED SECURITIES
Interest income on MBS was $42.1 million for the year ended December 31, 1996 as compared to $54.2 million and $61.1 million for the years ended December 31, 1995 and 1994, respectively. All of the interest income on MBS was related to BVFB only. The decrease in interest income on MBS was primarily attributable to lower average balances resulting from principal amortization and sale of MBS available-for-sale in 1996 and 1995. The sale of MBS was due to management's strategic focus on restructuring the wholesale balance sheet and reduction of interest rate risk exposure. There were no MBS purchased in 1996 and 1995.
INTEREST AND DIVIDENDS ON INVESTMENTS
Interest and dividend income from the Company's investment portfolio was $7.2 million for the year ended December 31, 1996 as compared to $6.4 million and $4.4 million for the years 1995 and 1994, respectively. The interest and dividend income from CTL was $761,000 for the period since acquisition date. Excluding CTL, the investment income for BVFB remained essentially the same for 1996 and 1995. The increase in investment income from 1994 to 1995 was primarily due to higher average investment balances.
INTEREST EXPENSE
INTEREST EXPENSE ON CUSTOMER DEPOSITS
Interest expense on customer deposits was $100.2 million for the year ended December 31, 1996 as compared to $93.4 million and $66.4 million for the years ended December 31, 1995 and 1994, respectively. The following table summarizes interest expense on deposits:
Bay View Federal Bank - ---------------------
The decrease in the cost of retail deposits was primarily due to favorable repricing of certificates of deposit and an increase in transaction accounts which are at lower rates than certificates of deposit. As of December 31, 1996, transaction accounts as a percentage of total deposits increased to 30.23% from 21.3% and 22.2% at December 31, 1995 and 1994, respectively. The average balances of retail deposits decreased from $1.81 billion in 1995 to $1.71 billion in 1996. However, average transaction accounts increased from $367 million to $439 million.
The increase in interest expense from 1994 to 1995 was primarily due to higher average rates and customer deposit balances primarily in certificates of deposit.
California Thrift & Loan - ------------------------
The cost of deposits for CTL remained essentially unchanged since June 1, 1996, the acquisition date. CTL redeemed the higher cost component (higher than BVFB's incremental borrowing cost) of these deposits at face value (approximately $267 million) at year-end 1996.
INTEREST EXPENSE ON BORROWINGS
The following table summarizes interest expense on borrowings:
The decrease in interest expense on borrowings for BVFB was primarily due to lower average balances arising from lower borrowing requirements consistent with the level of interest-earning assets maintained. Also, in the fourth quarter of 1995 and first quarter of 1996, BVFB prepaid $190 million of high cost borrowings and replaced them with short-term lower cost borrowings. In conjunction with the prepayment of these borrowings, BVFB entered into interest rate swap agreements to provide interest rate risk protection for the short-term lower cost borrowings by matching the floating interest rate characteristics and lengthening their maturities. The lower average balances in 1996 are consistent with management's strategy to de-emphasize the wholesale balance sheet and enhance the retail deposit franchise.
During May 1996, the Company issued $50 million in Senior Debentures yielding 8.42% (all-in cost was 8.91% annualized) and $26 million of the proceeds were used to finance the acquisition of CTL.
The following table sets forth the changes in net interest income due to changes in the rate and volume of the Company's interest-earning assets and interest-bearing liabilities. The variances include the impact of CTL beginning June 1, 1996. Rate and volume changes are calculated excluding nonperforming assets. Changes in rate and volume (changes in weighted average interest rate multiplied by average portfolio balance), which cannot be segregated, have been allocated proportionately to the change in rate and the change in volume.
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans was $1.9 million for the year ended December 31, 1996 as compared to $4.3 million and $2.4 million for the years 1995 and 1994, respectively. See the Allowance for Losses on Loans section below for a more detailed discussion.
NONINTEREST INCOME
Noninterest income was $8.6 million, $6.1 million and $7.5 million for the years 1996, 1995 and 1994 which includes losses on securities of $0.8 million for 1996, $2.5 million for 1995, and $1.1 million for 1994. The following table summarizes noninterest income:
Excluding the loss on securities, noninterest income for BVFB remained relatively flat between 1996 and 1995. During 1996, total mortgage-backed securities sold from the available-for-sale portfolio were $55.0 million and aggregated a loss of $507,000. BVFB's interest rate risk profile has been favorably impacted by the sale of these securities. At December 31, 1996, the remaining balance of mortgage-backed securities available-for-sale was $84.4 million and the unrealized loss was $1.2 million or 1.5%.
In conjunction with the pending securitization of CTL's auto loan portfolio, during the fourth quarter of 1996, CTL entered into a short sale of Treasury securities to hedge the valuations from movements in interest rates. A loss of $293,000 in accordance with generally accepted accounting principles was recorded in the fourth quarter associated with this short sale of Treasury securities.
NONINTEREST EXPENSE
GENERAL AND ADMINISTRATIVE EXPENSE
The following table is a summary of the major categories of general and administrative expenses (including special mention items) for each of the years indicated (including CTL effective June 1, 1996).
Bay View Capital Corporation and Bay View Federal Bank - ------------------------------------------------------
General and administrative expenses for BVCC in 1996 includes a higher allocation of expenses from BVFB as compared to prior years due to an increase in activity relating to redeployment of capital as discussed elsewhere herein. General and administrative expenses for BVFB in 1996 included the special mention items discussed below which totaled $6.1 million. Excluding these special mention items and including the normalization of deposit insurance premiums (due to impact of SAIF legislation), general and administrative expenses for BVCC and BVFB combined for 1996 would have been approximately $40.4 million as compared to the previously indicated annualized threshold of less than $42 million. The following is a summary of special mention items in 1996.
- - $2.8 million accrual for termination of existing data processing contracts and a write-down for computer hardware and software relating to the Company's new long-term information services technology agreement with BISYS Group, Inc.
- - $1.3 million loss accrual for lease obligations in excess of related sublease rentals resulting from unfavorable lease agreement terms.
- - $1.2 million expense accrual for long-term incentive plan awards.
- - $500,000 additional write-down due to the sale of the corporate office complex which closed in the third quarter of 1996. The Company had provided a write-down of $7.1 million on this property in 1995.
- - $310,000 accrual for downsizing loan operations and relocation of administrative functions.
General and administrative expenses in 1995 included the following special mention items which totaled $10.8 million:
- - $7.1 million write-down due to the pending sale of the corporate office complex.
- - $2.8 million severance payment relating to workforce reductions.
- - $866,000 write-off relating to fixed asset disposals.
Excluding special mention items, general and administrative expenses for 1996 were lower than 1995 primarily due to lower compensation and benefit expense and other cost reduction initiatives. General and administrative expenses for 1995 (excluding special mention items) and 1994 were essentially the same.
California Thrift & Loan - ------------------------
General and administrative expenses for CTL have declined during the period subsequent to acquisition due to the termination of certain employee functions, impact of the sale of the entire leasing portfolio and the continued implementation of cost reduction opportunities.
The following table summarizes general and administrative expenses and efficiency ratios exclusive of special mention items:
SAIF RECAPITALIZATION ASSESSMENT
Federal legislation to recapitalize and fully fund the Savings Association Insurance Fund was signed into law on September 30, 1996. Customer deposits for BVFB are SAIF-insured, and as a result of the legislation, BVFB was required to pay a one-time special assessment of $11.7 million pre-tax ($6.7 million after tax or $.97 per share). The legislation had no effect on CTL, as its deposits are insured under the Bank Insurance Fund.
Pursuant to this legislation, premiums on SAIF-insured deposits for BVFB will be reduced in 1997 from the previously anticipated 23 basis points to 6.48 basis points which will translate into lower annual deposit costs in 1997. The estimated annual savings associated with this lower premium will be approximately $2.7 million based on the level of deposits for BVFB at December 31, 1996.
INCOME AND EXPENSES FROM REAL ESTATE OWNED
Income from operations of real estate owned was $4.8 million for the year ended December 31, 1996 as compared to $1.1 million and $95,000 for the years 1995 and 1994, respectively. The increase was primarily due to gains from the sale of and higher income received from real estate owned properties (see discussion of special mention items included elsewhere herein). There were no significant changes in the provision for losses on real estate owned.
The increase in income from real estate owned operations during 1995 as compared to 1994 was primarily due to income received from one large property foreclosed upon in April 1995. Prior to foreclosure, the income received was reported as interest income on loans.
AMORTIZATION AND WRITE-DOWN OF INTANGIBLES
The following table summarizes the amortization and write-down of intangibles:
Bay View Federal Bank - ---------------------
The amortization and write-down of intangibles in 1996 includes core deposit intangible write-offs of $274,000 due to a decision to close one of BVFB's branches. During the fourth quarter of 1995, core deposit premiums of $854,000 were written-off due to an impairment in the value of core deposit premiums attributable to higher than expected decay rates in the customer deposits acquired. The balance of the core deposit premiums was subsequently amortized over the remaining useful life.
During the fourth quarter of 1995, BVFB decided to sell or exchange certain of its acquired branches for which goodwill was recorded in 1981. Based on the offers received and management's estimates of the undiscounted future cash flows, the remaining unamortized goodwill was written-off because management believes that the goodwill could no longer be assured of recovery. As a result, goodwill of $758,000 was written-off in the fourth quarter of 1995.
California Thrift & Loan - ------------------------
The amortization of the intangible assets of CTL was due to the amortization of goodwill arising from the excess of the purchase price over the fair value of net assets acquired.
INCOME TAXES
The effective tax rates for 1996, 1995 and 1994 were 43.0%, (24.8%) and 35.0%, respectively. The decrease in the effective tax rate in 1995 was due to the net loss of BVFB partially offset by the net income of the Company and a subsidiary of BVFB.
Income tax expense for 1994 was reduced by $2.1 million to reflect a revision of the Company's estimated tax liabilities resulting from a tentative agreement with the Internal Revenue Service for the taxable years 1987 through 1989. The agreement resolved certain disputed savings and loan industry tax issues which the Company was contesting.
EXTRAORDINARY ITEM
As part of its asset/liability management strategy to reduce interest rate risk exposure, during the fourth quarter of 1995, the Company prepaid $45.0 million of its short-term FHLBSF advances. In addition, the Company committed to prepay an additional $145.0 million of its short-term FHLBSF advances in February 1996. As a result, the Company incurred a prepayment charge of $2.5 million (net of applicable income taxes). In accordance with generally accepted accounting principles, the prepayment penalties were reported as an extraordinary charge (net of applicable income taxes). There were no prepayment penalties in 1994. Although the amount of the charge reduced the Company's earnings at the time the debt was extinguished, management believes that the Company's future earnings will be enhanced by such actions. For further discussion of the Company's asset/liability management strategies, see "Asset/Liability Management".
BALANCE SHEET ANALYSIS
The Company's total assets at December 31, 1996 and 1995 were $3.3 billion and $3.0 billion, respectively. The increase in total assets was primarily due to the acquisition of CTL which had total assets of $464 million at December 31, 1996.
The total assets of BVFB were the same at $3.0 billion at December 31, 1996 and 1995, respectively. The total assets of BVFB at year-end 1996 included a line of credit of $163.2 million to CTL. Excluding the intercompany line of credit, total assets of BVFB have declined from 1995 primarily due to decreases in mortgage-backed securities resulting from sales of mortgage-backed securities and principal paydowns. The level of assets in 1996 is consistent with BVFB's strategic focus to enhance the retail deposit franchise and restructure (beginning in late 1995) the wholesale (MBS/borrowings) portion of the balance sheet.
SECURITIES
The Company's securities activities are primarily conducted by BVFB. BVFB has historically purchased (no significant purchases in 1996 and 1995) securities to maintain appropriate interest-earning asset levels when sufficient high quality loan production was not available. The majority of the securities purchased are high quality MBS, primarily issued by FHLMC, FNMA, GNMA and Student Loan Mortgage Association ("SLMA"). Since MBS are collateralized by mortgages, these assets qualify under the OTS regulations requiring BVFB to hold certain levels of mortgage-related assets. The Company also invests in investment securities such as FHLMC and FNMA notes and debentures and other short-term securities.
The following table reflects the composition of the Company's investment securities portfolio as of the dates indicated:
The following table reflects the composition of BVFB's MBS securities portfolio as of the dates indicated:
The principal balances of MBS purchased and sold for the years ended December 31, 1996, 1995, and 1994 were as follows:
In November 1995, the Financial Accounting Standards Board ("FASB") issued "A Guide to Implementation of Statement of Financial Accounting Standards No. 115 ("SFAS 115") on Accounting for Certain Investments in Debt and Equity Securities - Questions and Answers" ("Special Report"). The Special Report was issued as an aid in understanding and implementing SFAS 115. For companies that adopted SFAS 115 in financial statements issued prior to the issuance of this Special Report, if the effects of initially adopting this implementation guidance resulted in reclassification of securities between categories, the Special Report requires that such transfers be accounted for as transfers in accordance with SFAS 115. As a result, concurrent with the initial adoption of this implementation guidance, the Company reassessed the appropriateness of the classifications of all securities held at that time and, in December 1995, reclassified $147.7 million in mortgage-backed securities from held-to-maturity to available-for-sale. The transfer of the MBS was recorded at a fair value of $146.0 million with $981,000 of unrealized losses (net of tax) recorded as a separate component of stockholders' equity.
The unrealized loss on securities available-for-sale included in stockholders' equity at December 31, 1996 and 1995 was $0.7 million (net of tax). During 1996, the Company sold $57.6 million of MBS including $2.6 million of MBS which were scheduled to mature within three months of sale. The $2.6 million MBS was sold from the held-to-maturity portfolio and the remainder of $55.0 million was from the available-for-sale portfolio. BVFB does not maintain a trading portfolio.
LOANS AND REAL ESTATE OWNED
Loan Portfolio Composition
The following table shows the composition of the Company's loan portfolio (before deductions for net deferred loan origination fees, discounts and allowance for loan losses) by type of loan at the dates indicated. Except as shown below, the Company did not have any loan concentrations that exceeded 10% of total loan as of December 31, 1996. The Company also did not have any loan concentrations which may result in uncertainties materially impacting its future operations.
Bay View Federal Bank - ---------------------
A major portion of the BVFB's loan portfolio consists of loans collateralized by income-producing properties, all of which are located in California, principally Northern California. Construction loans have been insignificant. During 1996, BVFB de-emphasized its focus on single family mortgage lending and discontinued its loan origination operations for this category. The Company believes that income property lending affords an opportunity to receive interest income at yields higher than those obtainable from single family lending. Nevertheless, loans on income properties, particularly nonresidential properties, generally present a higher risk than do single family residential loans due to the sensitivity of the underlying property to changes in economic conditions. Management takes such risks into account when it establishes the loan rates, underwriting standards, loss allowances and decisions regarding portfolio mix.
California Thrift & Loan - ------------------------
The loan portfolio for CTL consists primarily of consumer loans. As described elsewhere herein, management began implementing a significant restructuring of CTL's balance sheet in late 1996. The entire leasing portfolio was sold in December 1996. In addition, CTL sold $253 million of its auto loan portfolio to BVSC in January 1997 which was subsequently securitized and sold by BVSC. These actions are consistent with the Company's capital strategy to increase the velocity of capital utilization, de-emphasize less profitable activities and return the capital of subsidiaries in excess of the regulatory "well capitalized" requirement to the Company. The following table shows the composition of the Company's fixed and adjustable rate loan portfolios (before deductions for net unearned loan origination fees, discounts and allowance for loan losses):
The interest rates on the Company's adjustable rate loans may periodically rise or fall (generally based on monthly or semi-annual adjustment periods) in accordance with an independent index. The indices most commonly used by BVFB are the Federal Home Loan Bank's Eleventh District Cost of Funds Index, the one- year Constant Maturity Treasury Index and the 6-month LIBOR rate.
Loan Originations, Purchases and Sales
For each of the years indicated, loans originated, purchased and sold were as follows:
Bay View Federal Bank - ---------------------
Loans originated by BVFB in 1996 were primarily multifamily mortgages indexed to LIBOR. Loans originated in 1995 consisted of single family and multifamily mortgages indexed to COFI and the one-year Treasury rate. The increase in loan purchases in 1996 as compared to 1995 and 1994 was primarily due to management's strategy to supplement its loan production with purchases of higher yielding loans.
California Thrift & Loan - ------------------------
Loans originated by CTL in 1996 were primarily auto loans. As discussed elsewhere herein, CTL sold $253 million of its auto loans in January 1997 to BVSC which were subsequently securitized and sold by BVSC. The $59.8 million of loans sold in 1996 consisted of CTL's entire leasing portfolio.
Delinquent, Nonaccrual and Restructured Loans
Credit quality has continued to improve as evidenced by the decline in nonperforming assets and delinquencies. A summary of trends in credit quality follows:
Loans Delinquent 60 Days or More - --------------------------------
Loans delinquent 60 days or more as a percentage of gross loan portfolio by property type were as follows:
Nonperforming Assets, Troubled Debt Restructures and Real Estate Owned - ----------------------------------------------------------------------
The Company defines nonperforming assets as loans 90 days or more delinquent (excluding accruing loans delinquent 90 days or more), loans less than 90 days delinquent designated as nonperforming when the Company determines that the full collection of principal and/or interest is doubtful, defaulted mortgage-backed securities, real estate owned, and other repossessed assets. Nonperforming assets are placed on nonaccrual status.
Troubled debt restructures are real estate loans that have been modified (due to borrower financial difficulties) to allow a stated interest rate and/or a monthly payment rate lower than those prevailing in the market. As of December 31, 1996 and 1995, all such restructured loans were performing in accordance with their modified terms. The following is a summary of nonperforming assets:
Management actively seeks to return nonperforming assets to performing status or expediently dispose of foreclosed assets at their fair value. During 1996, 1995 and 1994, sales of real estate owned were $26.5 million, $19.3 million and $22.9 million, respectively.
The following table sets forth nonaccrual loans, accruing loans delinquent 90 days or more and troubled debt restructures. The Company accrues interest on loans delinquent more than 90 days when the loans are considered to be well secured and in the process of collection.
ALLOWANCE FOR LOAN LOSSES
The Company conducts an ongoing review of its asset categories to assess the adequacy of allowance for loan losses, which are maintained at levels the Company believes are sufficient to cover potential losses. In determining the level of allowance, the Company considers prevailing and anticipated economic conditions, historical loss experience, the levels of classified, nonperforming and delinquent assets, weighing by property type, loan portfolio trends and other factors.
Management periodically reviews specific loans and other real estate related assets on an individual basis. Such evaluation includes an analysis of creditworthiness, cash flows, financial status of the borrower and the estimated fair value of the underlying collateral. The Company provides for losses on individual assets when its investment in the asset is not expected to be fully collectible or realizable. The following is a summary of activity of the Company's allowance on loans for the years indicated (including CTL effective June 1, 1996):
The percentage of mortgage loans to total loans for each of the years in the five-year period ended December 31, 1996 was 84.7%, 98.3%, 98.5%, 98.1% and 97.4%, respectively. The percentage of consumer loans to total loans for each of the years in the five-year period ended December 31, 1996 was 15.3%, 1.7%, 1.5%, 1.9% and 2.6%, respectively.
A summary of allowance for losses is as follows:
Note: The allowance for losses on loans held for sale has been included in the lower of cost or market measurement of the carrying value of loans held for sale.
Provision for loan losses
Provisions for loan losses are recorded to maintain the level of allowance that management believes is adequate to cover estimated losses. The provision for losses on loans was $1.9 million, $4.3 million and $2.4 million for 1996, 1995 and 1994, respectively.
Bay View Federal Bank - ---------------------
The provision for losses on loans was $1.8 million, $4.3 million and $2.4 million, respectively. The decrease in the provision for losses on loans in 1996 as compared to 1995 was attributable to the improvement in the credit quality of the loan portfolio. The higher provision for loan losses in 1995 was primarily due to a higher level of nonperforming assets and provision for losses on one large loan classified as a troubled debt restructuring due to management's decision to accelerate the disposal of this asset.
California Thrift & Loan - ------------------------
The CTL allowance for loan losses included the allowance for loans held for investment and loans held for sale. The allowance for loans held for sale reflects management's intention to securitize auto loans which have been classified as held for sale and recorded at estimated realizable value consistent with purchase accounting. As a result, the allowance for losses on loans held for sale has been included in the lower of cost or market measurement of the carrying value of loans held for sale. The allowance for losses on loans held for sale will be included in the carrying value as the auto loan portfolio is sold and securitized by BVSC.
Management believes that it uses appropriate information to make loss determinations and considers its allowances for losses at December 31, 1996 and 1995 to be adequate to cover losses from loan and real estate related assets. However, future adjustment in the level of allowance for loan losses may be necessary and earnings could be significantly affected, if circumstances differ substantially from the assumptions used in making such determinations.
Management monitors the impact of the economic environment on its lending activities on a periodic basis. If real estate markets weaken in future periods, no assurance can be given that the Company's future loss experience will approximate its current estimates. In addition, various regulatory agencies review the Company's allowance for losses as an integral part of their examination process. Such agencies may require the Company to recognize additions to this allowance based on their judgment relating to information available to them at the time of their examinations.
RETAIL CUSTOMER DEPOSITS
As a primary part of the Company's business, deposits are gathered for purposes of funding loans and purchasing securities. A summary of the retail customer deposits (excluding intercompany accounts) follows:
Bay View Federal Bank - ---------------------
Increasing the value of its retail branch franchise is one of management's primary objectives. BVFB believes that a gradual expansion of its retail deposit base, particularly transaction accounts in Northern California, will enhance its core earnings by lowering its cost of funds, increasing fee income and expanding opportunities for cross-selling products and services. Throughout 1996, BVFB continued to emphasize the development and marketing of new products and as a result has successfully increased its percentage of transaction accounts in relation to total deposits which has contributed to lower cost of funds. Transaction accounts as a percentage of total deposits increased to 30.23% at December 31, 1996 from 21.3% and 22.2% at December 31, 1995 and 1994, respectively.
California Thrift & Loan - ------------------------
The customer deposits are primarily comprised of thrift certificates which are similar to certificates of deposit with the exception that they are callable at par plus accrued interest. When thrift certificates are purchased by customers, CTL has, as thrift certificates have been issued, reserved the right to repurchase the certificates at any time upon thirty days notice. Utilizing this call provision, CTL redeemed the higher cost component (higher than BVFB's incremental borrowing cost) of these deposits at face value (approximately $267 million) at December 31, 1996.
The remainder of the CTL customer deposits (which are lower cost than BVFB's incremental borrowing cost) will be sold to BVFB. An application for the approval of the sale of these deposits to BVFB has been filed with the Office of Thrift Supervision.
Customer deposits of $100,000 or more by time remaining until maturity as of December 31, 1996 were as follows:
BORROWINGS
The Company utilizes collateralized advances from the FHLBSF for purposes of funding loans. In addition, the Company utilizes other borrowings, on a collateralized and noncollateralized basis, such as securities sold under agreements to repurchase (also known as reverse repurchase agreements). The following table sets forth certain information as to the Companys borrowings as of the dates indicated:
As discussed elsewhere herein, in 1996, management redirected BVFB's strategic focus to restructure the wholesale borrowings (beginning in late 1995) in conjunction with the enhancement of its retail deposit franchise. The average balances for borrowings at BVFB decreased from $1.05 billion in 1995 to $977.7 million in 1996. In the fourth quarter of 1995 and the first quarter of 1996, BVFB prepaid $190 million of high cost borrowings and replaced them with short-term lower cost borrowings. In conjunction with the prepayment of these borrowings, the Company entered into interest rate swap agreements to provide interest rate risk protection for the short-term lower cost borrowings by matching the floating interest rate characteristics and lengthening their maturities. The increase in borrowings at December 31, 1996 as compared to 1995 was due to borrowings from the FHLBSF used to fund the redemption of CTL's high cost thrift certificates as discussed elsewhere herein.
BVFB is a member of the FHLBSF. As such, BVFB must purchase stock in the FHLBSF equal to the greater of 1% of residential mortgage loans or 5% of its borrowings. As of December 31, 1996 and 1995, the investment in FHLBSF stock amounted to $49.6 million and $39.5 million, respectively. BVFB expects to continue to utilize collateralized advances from the FHLBSF as a source of funding. Advances can be fixed or variable rate, with maturities staggered in accordance with the Company's asset/liabilities management strategies.
In May 1996, the Company issued $50 million in Senior Debentures yielding 8.42% (all-in cost was 8.91% annualized) and $26 million of the proceeds were used to finance the acquisition of CTL. The residual proceeds of the debt offering will be utilized for future accretive acquisitions or other business purposes to enhance shareholder value, such as the repurchase of the Company's common stock, if warranted. (See "Capital Redeployment Strategies")
ASSET AND LIABILITY MANAGEMENT
GENERAL
The objective of the Company's asset/liability management activities is to improve earnings by adjusting the type and mix of assets and liabilities to effectively address changing conditions and risks. Through overall management of its balance sheet and by controlling various risks, the Company seeks to optimize its financial returns within safe and sound parameters. The Company's operating strategies for attaining this objective include:
. Managing net interest margin through appropriate risk/return pricing of assets and liabilities . Utilizing interest rate swap agreements and other hedging strategies to reduce exposure to fluctuations in interest rates . Controlling noninterest expense and enhancing noninterest income, utilizing improved information systems to facilitate the analysis of the profitability of individual business units and products . Increasing retail deposits as a percentage of interest-bearing liabilities and reducing the Company's cost of funds . Utilizing the Company's strong capital position to boost the earnings power through acquisition of higher yielding assets . Enhancing internal analysis capability for measuring, evaluating and monitoring risk
INTEREST RATE RISK
Financial institutions are subject to interest rate risk to the degree that interest-bearing liabilities reprice or mature on a different basis and at different times than interest-earning assets. The Company's strategy has been to reduce the sensitivity of its earnings to interest rate fluctuations by more closely matching the effective maturities or repricing characteristics of its assets and liabilities. Certain assets and liabilities, however, may react in different degrees to changes in market interest rates. Further, interest rates on certain types of assets and liabilities may fluctuate prior to changes in market interest rates, while rates on other types may lag behind. Additionally, certain assets, such as adjustable rate mortgages, have features, including payment and rate caps, which restrict changes in their interest rates. The Company considers the anticipated effects of these factors when implementing its interest rate risk management objectives.
The Company pursues balance sheet strategies that should, in the long run, mitigate its exposure to rising interest rates. The Company also considers other strategies to minimize the variability of the net interest margin including off-balance sheet activities. The Company uses principally interest rate swap agreements to reduce the interest rate fluctuation risk related to certain assets and liabilities. Interest rate swaps involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying notional amounts. The Company has initiated numerous actions in late 1995 and 1996 which significantly reduced the Company's exposure to fluctuations in interest rates. These actions include:
Sale of mortgage-backed securities - ----------------------------------
In 1996, the Company sold $55 million of fixed rate mortgage-backed securities available-for-sale. The purpose of the sale was to reduce the Company's exposure to interest rate increases. During the fourth quarter of 1995 the Company reclassified $148 million of its mortgage-backed securities from held-to-maturity to available-for-sale as a result of adopting the implementation guide to SFAS 115. This reclassification allowed the Company to position these securities for potential sale, which assisted in the reduction of its interest rate risk exposure without tainting its remaining held-to-maturity portfolio.
Interest Rate Swaps - -------------------
As of December 31, 1996, the Company was party to interest rate swap agreements with notional principal amounts of $421 million, which involve the receipt of floating interest rates (based on 3-month LIBOR) and payment of fixed interest rates on the underlying notional amounts. During the fourth quarter of 1995, the Company prepaid $45 million of its short-term high cost borrowings. In addition, the Company committed to prepay another $145 million of its short- term high cost borrowings in February 1996. As a result, the Company incurred a prepayment charge of $2.5 million (net of applicable income taxes). In conjunction with the prepayment of these borrowings, the Company entered into interest rate swap agreements with notional principal amounts of $200 million. The impact of these actions was a reduction of the Company's interest rate risk exposure by prepaying its short-term high cost borrowings and replacing the prepayments with short-term lower cost borrowings. The interest rate swap agreements were used to provide interest rate risk protection for the short-term borrowings by matching the floating interest rate characteristics and lengthening their maturities.
Hedging Auto Loans Pending Securitization - -----------------------------------------
As discussed elsewhere herein, in conjunction with the decision to sell CTL's auto loans and their subsequent securitization by BVSC, management entered into a short sale of Treasury securities that has materially insulated the purchase accounting valuations from movements in interest rates. The short sale transaction was paired-off in December 1996 with a loss of $293,000 recorded as a loss on securities. At December 31, 1996, a Treasury rate lock transaction with a notional principal amount of $210 million was entered into to hedge the auto loans pending sale by CTL and securitization by BVSC.
INTEREST RATE SENSITIVITY
The Company's interest rate risk policies are established and monitored by its Asset/Liability Committee ("ALCO"). The ALCO reviews the sensitivity of the Company's net interest income and market value of equity to interest rate changes. The objective of the Company's ALCO activities is to improve earnings by adjusting the types of assets and liabilities to effectively address changing conditions and risks. Management believes that its asset/liability activities have improved earnings within safe and sound parameters. To measure the Company's interest rate sensitivity, a cumulative gap measure can be used to assess the impact of potential changes in interest rates on the net interest income. The repricing gap represents the net position of assets and liabilities subject to repricing in specified time periods. Assets and liabilities are categorized according to the expected repricing time frames based on management's judgment. A cumulative gap measure alone cannot be used to evaluate interest rate sensitivity because interest rate changes do not affect all categories of assets and liabilities equally or simultaneously. In measuring interest rate sensitivity, the Company also uses simulation modeling to estimate the potential effects of movements in interest rates. Interest rate risk sensitivity estimated by management, as measured by the change in the net portfolio value of equity as a percentage of the present value of assets from an immediate 200 basis point increase/decrease in interest rates, was 1.15% and 0.79% at December 31, 1996 and 1995 as compared to 3.02% at December 31, 1994. Interest rate sensitivity from a 200 basis point increase/decrease in interest rates for CTL was 0.54% at December 31, 1996.
Market Value of Equity ("MVE") - ------------------------------
The following analysis compares the market value of equity for BVFB with and without interest rate swaps for the indicated basis points ("bp") market shift scenarios at December 31, 1996:
Bay View Federal Bank - ---------------------
The following table sets forth information regarding asset and liability repricing as of December 31, 1996:
(1) Net of nonperforming assets (2) Investments and mortgage-backed securities are at amortized cost (3) Based on assumed annual prepayment and amortization rates which approximate the Company's historical experience
California Thrift & Loan - ------------------------
The following table sets forth information regarding asset and liability repricing as of December 31, 1996:
(1) Investments are at amortized cost (2) Net of nonperforming assets (3) Based on assumed annual prepayment and amortization rates which approximate the Company's historical experience
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
The Company's primary sources of funds include:
. Customer deposits . Advances from the FHLBSF . Reverse repurchase agreements . Loan and mortgage-backed securities repayments
The Company uses its liquidity resources principally as follows:
. Origination and purchases of mortgage loans . Funding the withdrawal of certificates of deposits and other deposit products . Repayment and/or refinance of maturing FHLBSF advances and reverse repurchase agreements
The Company expects to fund, repay and/or refinance, on a timely basis, its commitments, short-term and long-term liabilities. During 1996, cash flows from operating activities totaled $83 million. Cash flows from investing activities totaled $220 million, primarily from the sale and principal repayments of MBS and net loan repayments. Cash outflows from financing activities totaled $240 million primarily due to redemption of CTL thrift certificates and net deposit outflows offset by borrowings from the FHLBSF and reverse repurchase agreements.
The following table sets forth the period ending balances for the Company's short-term borrowings and the weighted average interest rates:
The following table sets forth the maximum outstanding balance of each type of short-term borrowings at any month-end during 1996, 1995 and 1994, and the average balances and weighted average interest rates on short-term borrowings for 1996, 1995 and 1994:
OTS regulations require savings institutions to maintain a specified liquidity ratio (presently 5.00%) of cash and specified securities to total customer deposits and borrowings due in one year or less. Historically, BVFB has maintained its liquid assets above the minimum requirements imposed by the OTS regulations and at a level believed adequate to meet requirements imposed by the OTS regulations and at a level believed adequate to meet requirements of normal banking activities, repayment of maturing debt and potential deposit outflows. BVFB maintained liquidity ratios of 5.39% and 5.26% for the months ended December 31, 1996 and 1995, respectively.
CAPITAL RESOURCES
See also "Strategic Overview" discussion.
BAY VIEW FEDERAL BANK
BVFB's regulatory capital at December 31, 1996 and 1995 exceeded the minimum requirements of each regulatory capital standard, both in effect on such dates and on a fully phased in basis. The fully phased-in capital ratios became effective in 1996 whereas the total amount of nonqualifying investments in subsidiaries is required to be fully deducted in its entirety from regulatory capital. Regulatory capital ratios of BVFB were as follows:
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires each Federal banking agency, including the OTS, to implement prompt corrective actions for institutions that it regulates. Under capital guidelines enacted by FDICIA, BVFB met the criteria for the "well capitalized" standard at December 31, 1996 as follows:
CALIFORNIA THRIFT AND LOAN
Under capital guidelines enacted by FDICIA, CTL met the criteria for the "well capitalized" standard at December 31, 1996 as follows:
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1996, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 125 ("SFAS 125") "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS 125 establishes standards for when transfers of financial assets, including those with continuing involvement by the transferor, should be considered a sale. SFAS 125 also establishes standards for when a liability should be considered extinguished. This statement was initially to be fully effective for transactions relating to the transfers of assets and extinguishment of liabilities occurring after December 31, 1996; however, in December 1996, the FASB reconsidered certain provisions of SFAS 125 and issued Statement of Financial Accounting Standards No. 127 "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125" to defer, for one year, the effective date of implementation for transactions related to repurchase agreements, dollar-roll repurchase agreements, securities lending and similar transactions. The financial statement impact of adopting this standard is not expected to be material to the Company.
IMPACT OF INFLATION AND CHANGING PRICES
The Company's consolidated financial statements presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time, due to the fact that almost all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than general levels of inflation. Interest rates do not necessarily move in the same direction or magnitude as the prices of goods and services.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - -----------------------------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
* Substantially restricted
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
The acquisition of California Thrift & Loan involved the following (see note 2):
The accompanying notes are an integral part of these consolidated financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying financial statements include the consolidated accounts of Bay View Capital Corporation, a holding company incorporated in Delaware (the "Company" or "BVCC"), and its wholly owned subsidiaries: Bay View Federal Bank, a Federal Savings Bank ("BVFB"), California Thrift & Loan, a California industrial loan company ("CTL") and Bay View Securitization Corporation, a Delaware corporation ("BVSC"). All significant intercompany accounts and transactions have been eliminated. As used herein, the terms "Company" or "BVCC" refer to the Company and its consolidated subsidiaries unless otherwise indicated.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash equivalents consist of highly liquid financial instruments, with maturities of 90 days or less at the time of purchase, that are readily convertible into cash and have insignificant interest rate risk.
Loans Receivable
Loans receivable originated or purchased by the Company are identified as either held for sale or held for investment at, or soon after, origination or purchase and are recorded at cost net of discounts, deferred loan origination fees, and allowance for loan losses as applicable. Loans receivable held for investment are carried at amortized cost and are not adjusted to the lower of cost or market because management intends and the Company has the ability, to hold these loans to maturity. Interest is accrued as income only to the extent considered collectible. Generally, the Company discontinues interest accruals on loans 90 days or more past due. Interest income on nonaccrual loans is measured on a cash basis. Loans classified as held for sale are carried at the lower of cost or market on an aggregate basis by property type. Market value for these loans is based on prices for similar loans in the secondary loan market.
The Company charges fees for originating loans at the time the loan is granted. The Company recognizes these loan origination fees, net of certain direct costs, as a yield adjustment over the life of the related loan using the interest method. Amortization of net deferred loan origination fees are discontinued on nonperforming loans. When a loan is sold or paid off, any unamortized net loan origination fees are included in income at that time.
Statement of Accounting Standards No. 114 ("SFAS 114"), "Accounting by Creditors for Impairment of a Loan" as amended by Statement of Financial Accounting Standards No. 118 ("SFAS 118"), "Accounting by Creditors for Impairment of a loan - Income Recognition and Disclosures" was effective January 1, 1995. A loan is impaired when, based on current information and events, it is
probable that the Company is unable to collect all amounts due according to the contractual terms of the loan agreement. The Company considers nonperforming loans and troubled debt restructurings as impaired loans. Nonperforming loans are defined as loans 90 days or more delinquent (excluding accruing loans delinquent 90 days or more) and loans less than 90 days delinquent when the Company determines that full collection of principal and interest is doubtful. Troubled debt restructurings are loans which have been modified based on interest rate concessions and/or payment concessions. SFAS 114 is not applicable to large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment. The Company considers its consumer loans as homogeneous loans for purposes of the application of SFAS 114.
Charge-offs are recorded when the measure of the impaired loan is less than the recorded investment in the loan. In determining charge-offs for specific loans, management evaluates its loans on an individual basis that includes assessing the creditworthiness and financial status of the borrower and analyzing cash flows and current property appraisals. SFAS 114 requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The Company's impaired loans are measured based on the fair value of the collateral because they are collateral dependent. At December 31, 1996, there were $16.6 million of impaired loans.
SFAS 118 allows a creditor to use existing methods for recognizing interest income on an impaired loan. The Company recognizes interest income on impaired loans on a cash basis.
Allowance for Loan Losses
Allowances for loan losses are maintained at levels that management deems adequate to cover estimated losses and are continually reviewed and adjusted. The Company adheres to an internal asset review system and an established loan loss reserve methodology. Management evaluates factors such as the prevailing and anticipated economic conditions, historic loss experiences, composition of the loan portfolio by property type, levels and trends of classified loans and loan delinquencies in assessing overall valuation allowance levels to be maintained.
While management uses currently available information to provide for losses on loans, additions to the allowance may be necessary based on new information and/or future economic conditions. When the property collateralizing a delinquent mortgage loan is foreclosed on by the Company and transferred to real estate owned, the difference between the loan balance and the fair value of the property less estimated selling costs is charged-off against the allowance for loan losses.
Loan Sales and Servicing
Gains or losses on the sale of loans are recognized at the time of sale. When a participating interest in loans sold had an average contractual interest rate, adjusted for normal servicing fees, which was different than the agreed upon yield to the purchaser, the sales price was adjusted by the present value of the differential for the estimated remaining life of the loans. Any resulting net premium or discount is amortized to interest income over the estimated remaining life of the loans based on a methodology that approximates the effective interest yield method. The aggregate amount of unamortized premiums arising from loan sales (capitalized excess servicing) is included as other assets. Capitalized excess servicing fees are periodically reviewed for impairment based on their fair values in accordance with Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights". The fair value of the capitalized excess servicing, for the purposes of impairment, is
measured using a discounted cash flow analysis based on the Company's estimated annual cost of servicing, the market prepayment rates, and the market discount rates. At December 31, 1996, there was no impairment relating to capitalized excess servicing fees. Amortization of capitalized excess servicing fees and any related impairments are included in noninterest income as incurred.
Securities
Statement of Financial Accounting Standards No. 115 ("SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities" establishes the classification of investments into three categories: held-to-maturity, available-for-sale and trading. Securities classified as held-to-maturity are recorded at amortized cost because management intends and the Company has the ability to hold these securities to maturity. Securities classified as available-for-sale are reported at fair value. Fair value for these securities is obtained principally from published information or quotes by registered securities brokers. Securities for which quotes are not readily available are valued based on the present value of discounted estimated future cash flows. The Company does not have a trading portfolio.
Securities are identified as either available-for-sale or held-to-maturity at, or soon after, purchase and are accounted for accordingly. Net unrealized gains and losses on securities available-for-sale are excluded from earnings and reported net of applicable income taxes as a separate component of stockholders' equity until realized. Gains and losses on sales of securities are recorded in earnings at the time of sale and are determined by the difference between the net sale proceeds and the amortized cost of the security, using specific identification.
Discounts and premiums on securities are amortized using a method approximating the interest method over the estimated life of the security, adjusted for actual prepayments. Interest on securities is accrued as income only to the extent considered collectible.
In November 1995, the Financial Accounting Standards Board issued "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities Questions and Answers" ("Special Report"). The Special Report was issued as an aid in understanding and implementing SFAS 115. For companies that adopted SFAS 115 prior to the issuance of this Special Report and the effects of adoption resulted in reclassification of securities between categories, the guidance stipulated that the transfers should be accounted for in accordance with SFAS 115. As a result, concurrent with the initial adoption of the Special Report, the Company reassessed the appropriateness of its classifications for all securities held at that time and, in December 1995, reclassified $147.7 million in mortgage-backed securities from held to maturity to available-for-sale. The transfer was recorded at a fair value of $146.0 million with $981,000 of unrealized losses (net of tax) recorded as a separate component of stockholders' equity.
Real Estate Owned
Real estate owned is comprised of property acquired through foreclosure and is recorded at the lower of cost (i.e., net loan value) or fair value less estimated costs to sell, as of the date of foreclosure. Thereafter, specific valuation allowances are established for adverse changes in the fair value of the underlying assets.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on the straight-line basis over the estimated useful lives for each of the various asset categories.
Intangibles
Core deposit premiums arise from the acquisition of deposits and are amortized on a straight-line basis over the estimated life of the deposit base acquired, generally eight years. The Company continually evaluates the periods of amortization to determine whether later events and circumstances warrant revised estimates. In addition, the market value of core deposit premiums is established on an annual basis to evaluate the recoverability of its carrying value for inclusion as a component of regulatory capital.
Goodwill represents the excess of cost over the fair value of net assets acquired. Goodwill is amortized to expense over a period no greater than the estimated remaining life of the long-term interest-earning assets acquired. If the assets acquired do not include a significant amount of long-term interest- earning assets, goodwill is amortized over a period that does not exceed the estimated remaining life of the existing customer deposit base. Goodwill is amortized on a straight-line basis over a period of up to 7 years. If it becomes probable that the estimated undiscounted future cash flows will be less than the carrying amount of goodwill, a reduction in the carrying amount is recognized.
Impairment of Long-Lived Assets
Long-lived assets and certain identifiable intangibles to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss for long-lived assets and identifiable intangibles that management expects to hold and use are based on the fair value of the asset. Long-lived assets and certain identifiable intangibles to be disposed of are reported at the lower of carrying amount or fair value less cost to sell.
Securities Sold Under Agreements to Repurchase
The Company enters into sales of securities under agreements to repurchase (reverse repurchase agreements) which are considered financing activities. The obligations to repurchase the securities are reflected as liabilities, and related underlying securities for the agreements are included in the Company's securities portfolio as recorded assets.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The effect on deferred taxes for a change in tax rates is recognized in income during the period of enactment.
Derivative Financial Instruments
The Company uses certain derivative financial instruments to manage interest rate risk, principally interest rate exchange agreements (swaps, caps and collars). The Company does not hold any derivative financial instruments for trading purposes. The Company uses interest rate swap agreements as part of its overall asset/liability management in order to reduce its exposure to interest rate fluctuation risk. The agreements involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying notional amounts. Net interest income (expense), resulting from the differential between exchanging floating and fixed rate interest payments, is recorded on a current basis. Notional principal amounts are often used to express the volume of interest rate swap transactions, but the amounts potentially subject to loss are much smaller. The Company is exposed to loss of future interest differential payments (credit risk) in the event of nonperformance by the counterparties to the interest rate exchange agreements. The Company manages the credit risk of its interest rate exchange agreements by maintaining exposure limits and adhering to a strict counterparty selection process. The Company does not anticipate nonperformance by the other parties.
Stock Based Compensation
The Company accounts for stock based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion (APB) No. 25 "Accounting for Stock Issued to Employees".
Earnings (Loss) Per Share
Earnings per share for 1996 and 1994 were calculated using weighted average number of common shares outstanding including common stock equivalents (primarily outstanding stock options). Loss per share for 1995 was calculated using the weighted average number of common shares outstanding. The average number of shares outstanding (including common stock equivalents) for 1996 and 1994 were 6,949,919 and 7,180,880 shares, respectively. The average number of shares outstanding for 1995 was 7,293,492. The Company's fully diluted earnings per share does not differ materially from its primary earnings per share, therefore, it has not been separately reported.
Reclassification
Certain reclassifications have been made to the prior year balances in order to conform to the current year presentation.
NOTE 2. ACQUISITION OF CTL
Effective June 1, 1996, the Company acquired all the outstanding stock of CTL Credit, Inc. and its wholly owned subsidiary California Thrift & Loan ("CTL") for cash.
CTL is an FDIC insured California industrial loan company with a specific focus on consumer lending. The acquisition was accounted for using the purchase method of accounting in accordance with APB No. 16, "Business Combinations". Under this method of accounting, the acquisition purchase price of approximately $62 million was allocated to assets acquired and liabilities assumed based on their estimated fair values as of the effective date of acquisition.
In conjunction with the transaction, the Company issued $50 million of 8.42% Senior Debentures in May 1996 of which a portion was used to partially finance the acquisition.
The aggregate cost of the acquisition exceeded the estimated fair value of net assets acquired by approximately $7 million and is being amortized on a straight-line basis over seven years. Results of operations for the acquired entity have been included in the Company's consolidated financial statements commencing as of the effective date of acquisition.
Pro Forma Financial Information
The following unaudited pro forma financial information assumes the acquisition occurred as of the beginning of 1995. The disclosed results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisition been made as of the beginning of 1995 or of the results which may occur in the future.
The following table reflects the combined historical results of operations for BVCC and CTL after giving effect to the amortization of fair value and other purchase accounting adjustments recorded in connection with the acquisition of CTL. Such adjustments include the revaluation of assets held-for-sale, the capitalization of goodwill and other intangibles, and specific expense accruals and reserves for acquisition-related costs and contingencies.
The following pro forma historical results for the years ended December 31, 1996, and 1995 have been adjusted to include amortization of the aforementioned adjustments for the full periods presented which was calculated based on appropriate methods and periods of benefit as determined by management.
NOTE 3. CASH AND CASH EQUIVALENTS
(1) Intercompany depository accounts have been eliminated.
Generally, the Company's banking depositories either pay interest on deposits or apply an imputed interest credit to deposit balances which is used as an offset to charges for banking services rendered. The Company has no compensating balance arrangements or lines of credit with banks. Cash balances for BVFB required to be held at the Federal Reserve Bank totaled approximately $5.5 million and $5.7 million at December 31, 1996 and 1995, respectively. There were no similar cash balance reserve requirements for CTL.
NOTE 4. INVESTMENT SECURITIES
A summary of the Company's investment securities is as follows:
The weighted average yield of investment securities available-for-sale and held-to-maturity at December 31, 1996 was 5.29% and 6.67%, respectively. The weighted average yield of investment securities available-for-sale and held-to- maturity at December 31, 1995 was 7.19% and 6.58%, respectively.
There were no sales of investment securities during 1996 and 1995. During 1994, proceeds from sales of investment securities available-for-sale were $5.3 million and gross gains of $171,000 were realized on those sales.
In conjunction with the pending securitization of CTL's auto loan portfolio, during the fourth quarter of 1996, CTL entered into a short sale of Treasury securities to hedge the valuations from movements in interest rates. A loss of $293,000 in accordance with generally accepted principles was recorded in the fourth quarter associated with this short sale of Treasury securities.
The following table sets forth the contractual maturities and amortized cost of the Company's investment securities as of December 31, 1996:
The Company's investment in FHLMC preferred stock of $1.01 million has no scheduled maturity and is redeemable in whole or in part after June 30, 1997 at the option of FHLMC.
NOTE 5. MORTGAGE-BACKED SECURITIES
A summary of the Company's mortgage-backed securities is as follows:
The weighted average yield of mortgage-backed securities available-for-sale and held-to-maturity at December 31, 1996 was 6.61% and 6.44%, respectively. The weighted average yield of mortgage-backed securities available-for-sale and held-to-maturity at December 31, 1995 was 6.72% and 6.58%, respectively.
Adjustable rate mortgage-backed securities included above totaled $664,000 at December 31, 1996 and $725,000 at December 31, 1995. The Company uses mortgage-backed securities as full or partial collateral for borrowings. The total amount of pledged mortgage-backed securities at December 31, 1996 and 1995 was $560.0 million and $551.1 million, respectively.
Proceeds from sales of mortgage-backed securities ("MBS") available-for- sale during 1996 were $54.5 million. Gross gains of $411,000 and gross losses of $918,000 were realized on those sales. Proceeds from the sale of MBS held- to-maturity (scheduled to mature three months from sale date) during 1996 was $2.6 million and there was no gain or loss on this sale. Proceeds from sales of mortgage-backed securities available-for-sale during 1995 were $101.2 million. Gross gains of $688,000 and gross losses of $2.9 million were realized on those sales. There were no sales of mortgage-backed securities in 1994.
The following table sets forth the remaining contractual terms to maturity of the Company's mortgage-backed securities portfolio as of December 31, 1996 which is held exclusively by BVFB:
NOTE 6. LOANS RECEIVABLE
The Company originates loans for the purpose of enabling borrowers to purchase or refinance multifamily (five or more units) and nonresidential real estate through its wholly owned subsidiary, BVFB. During 1996, management re- directed its business lending practices whereas it de-emphasized its focus on single family real estate lending. As a result, the Company discontinued its loan origination operations for those specific products. BVFB's loans receivable are primarily secured by real property located in Northern California with the heaviest concentration in the counties of San Mateo, San Francisco and Santa Clara. Although BVFB has a diversified loan portfolio, the geographic concentration of its borrowers implies a dependence on the regional economy and local real estate markets. The loan portfolio for CTL consists primarily of consumer loans. CTL's auto loans are classified as held-for-sale because they are expected to be sold to BVSC for subsequent securitization. The following is a summary of the Company's loans receivable which includes loans held-for-sale at December 31, 1996:
BVFB has historically sold (none in 1996 and 1995) mortgage loans to the secondary market and usually retained responsibility for servicing the loans. At December 31, 1996, 1995 and 1994, BVFB serviced participating interests in loans sold of $412.4 million, $466.5 million, and $541.0 million, respectively.
The Company has agreed to modifications of certain multifamily and nonresidential mortgage loans. The modifications have taken the form of interest rate concessions, and/or payment concessions. Such loan modifications are considered troubled debt restructurings (see Note 1) and are entered into with the objective of maximizing the Company's long-term recovery of the investment in the loan when a borrower is experiencing financial difficulties. The Company has no commitments to lend additional funds to borrowers whose loans were so modified. In the aggregate, the Company's investment in troubled debt restructurings (excluding troubled debt restructurings classified as nonaccrual loans) was $509,000 and $15.6 million at December 31, 1996 and 1995, respectively. Under their original terms, interest income with respect to these loans would not have been significant in 1996 and would have been
$1.1 million in 1995 and $863,000 in 1994. Actual interest recognized by the Company on these modified loans was not significant in 1996 and was $1.1 million in 1995 and $920,000 in 1994.
At December 31, 1996 and 1995, nonaccrual loans totaled $16.1 million and $10.8 million, respectively. Interest on nonaccrual loans that was not recorded in income was $735,000, $623,000 and $2.8 million for years ended December 31, 1996, 1995, and 1994, respectively. Actual interest recognized by the Company on these nonaccrual loans was not significant in 1996 or 1995. At December 31, 1996, the Company had no commitments to lend additional funds to these borrowers.
The average investment in impaired loans during 1996 and 1995 was $15.1 million and $38.5 million, respectively. Impaired loans recorded in accordance with SFAS 114 consist of nonperforming loans (see Note 1) and troubled debt restructurings as follows:
The following table summarizes the changes in the allowance for loan losses for the periods indicated (including CTL effective June 1, 1996):
Allowance for loan losses was provided for all impaired loans at December 31, 1996 and 1995. The portion of the total allowance for loan losses that was attributable to impaired loans was $1.9 million and $5.1 million at December 31, 1996 and 1995, respectively. Provision for loan losses, charge-offs and recoveries relating to impaired loans were $1.9 million, $6.4 million and $0.6 million for the year
ended December 31, 1996 and $4.3 million, $4.9 million and $1.5 million for the year ended December 31, 1995, respectively.
To facilitate the sale of real estate loans, the Company has in the past occasionally offered a recourse guaranty on loans sold whereas the Company agreed to repurchase or substitute loans that became 90 days delinquent. In addition, the Company on occasion subordinated its retained participation interest in sold loans. At December 31, 1996 and 1995, the Company had outstanding recourse and subordination contingencies relating to principal of $54.3 million and $56.0 million, respectively, on sold mortgage loans.
At December 31, 1996 and 1995, mortgage loans aggregating $1.13 billion and $1.24 billion respectively, were pledged as collateral for advances from the FHLBSF.
NOTE 7. PREMISES AND EQUIPMENT
During the fourth quarter of 1995, the Company recorded a charge of $7.1 million to adjust the carrying amount of the land and building of its San Mateo, California corporate office complex to its estimated fair value less costs to sell as a result of its decision to pursue a sale of the complex. The Company recorded additional charges of $500,000 as a result of the sale of the complex in September 1996. During 1996, the Company wrote off $1.2 million of computer hardware equipment as a result of new specifications relating to the Company's long-term information services technology agreement with an outside data processing services vendor. Depreciation and amortization expense for the years ended December 31, 1996, 1995 and 1994 was $2.2 million, $3.1 million and $3.1 million, respectively.
NOTE 8. INTANGIBLE ASSETS
Core deposit premiums of $274,000 were written off during 1996 due to a branch closure. During the fourth quarter of 1995, core deposit premiums of $854,000 were written-off for the year ended December 31, 1995 resulting from an impairment in the value of core deposit premiums that was attributable to higher than expected decay rates in the customer deposits acquired. The balance of core deposit premiums was subsequently amortized over its remaining useful life. There were no core deposit premiums written off during 1994. Amortization expense for core deposit premiums was $1.8 million, $1.9 million and $2.0 million for the years ended December 31, 1996, 1995 and 1994, respectively.
During the fourth quarter of 1995, BVFB explored the sale and/or exchange of certain of its acquired branches which had purchased goodwill dating from 1981. Based on offers received and management's estimate of undiscounted future cash flows, it was determined that the recovery of the goodwill associated with these branches was no longer recoverable. Correspondingly, related unamortized goodwill of $758,000 was written off in 1995. Amortization expense for goodwill was $581,000 for the year ended December 31, 1996 and $396,000 for each of the years ended December 31, 1995 and 1994.
NOTE 9. CUSTOMER DEPOSITS
(1) Intercompany deposit accounts have been eliminated
Noninterest bearing deposits were $24.6 million and $13.3 million as of December 31, 1996 and 1995, respectively. Customer deposits at December 31, 1996 included certificates of deposit scheduled to mature as follows:
Interest expense on customer deposits by deposit type is as follows (including CTL effective June 1, 1996):
(1) Intercompany amounts have been eliminated
NOTE 10. ADVANCES FROM THE FEDERAL HOME LOAN BANK OF SAN FRANCISCO
At December 31, 1996 and 1995, BVFB had the following advances outstanding with the following maturities and rates:
FHLBSF advances at December 31, 1996 included $25 million of borrowings maturing in 1997 and 1998 at interest rates that reset monthly based on the Eleventh District Cost of Funds Index and $20 million of borrowings maturing in 2001 at interest rates that reset semi-annually based on the 6-month LIBOR rate. The advances were collateralized by loans and mortgage-backed securities totaling $1.70 billion and $1.61 billion at December 31, 1996 and 1995, respectively.
BVFB is a member of the Federal Home Loan Bank System. As a member, BVFB is required to purchase stock in the FHLBSF at an amount equal to the greater of 1% of BVFB's residential mortgage loans or 5% of outstanding FHLBSF advances. The stock is purchased at par value ($100 per share) and shares of stock held in excess of the minimum requirement may be sold back to the FHLBSF at par value. BVFB records its investment in FHLBSF stock at cost (par value). At December 31, 1996, BVFB's investment was $49.6 million and its minimum required investment was $48.9 million. The stock is pledged as collateral for advances from the FHLBSF. The FHLBSF generally declares quarterly stock dividends. The amount of FHLBSF dividends recorded in income during the years ended December 31, 1996, 1995 and 1994 was $2.5 million, $2.2 million, and $2.3 million, respectively.
As part of its asset/liability management strategy to reduce interest rate risk exposure, the Company prepaid $45 million of its advances from the FHLBSF, and during the fourth quarter of 1995, committed to prepay $145 million of its FHLBSF advances in February 1996. Accordingly, the Company incurred a prepayment charge of $2.5 million (net of applicable income taxes) in connection with the early retirement of FHLBSF advances which was reported as an extraordinary item in 1995.
NOTE 11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase are effectively borrowings secured by mortgage-backed securities. The securities sold under the terms of these agreements are safekept for the Company by the registered primary securities dealers who arrange the transactions. Borrowings under reverse repurchase agreements at December 31, 1996 and 1995 were $210.6 million and $166.7 million, respectively. The weighted average interest rate on reverse repurchase agreements at December 31, 1996 and 1995 were 5.53% and 6.13%, respectively.
These borrowings have maturities of one year or less and are collateralized by mortgage-backed securities aggregating $218.2 million and $172.2 million respectively, at December 31, 1996 and 1995.
The contractually required market values of the collateral may range up to 106% of the borrowings. The market value of the mortgage-backed securities collateralizing such borrowings at December 31, 1996 and 1995 was $218.7 million and $174.8 million, respectively.
NOTE 12. SENIOR DEBENTURES
In May 1996, Bay View Capital Corporation issued $50 million of Senior Debentures of which a portion was used to partially finance the acquisition of CTL. The Senior Debentures are due June 1, 1999 and pay interest semi-annually at a rate of 8.42%.
NOTE 13. INCOME TAXES
The Company files consolidated federal tax returns with its wholly owned subsidiaries. Income tax expense (benefit) before extraordinary items is summarized as follows for the years ended December 31:
Following is a summary of current and deferred income taxes included in other assets (liabilities):
The differences between the effective tax rates and the federal statutory rates were as follows:
The components of the net deferred tax assets as of December 31, 1996 and 1995 were as follows:
In accordance with SFAS 109, a deferred tax liability has not been recognized for the bad debt reserves of the Company which arose in the tax years which began prior to December 31, 1987. At December 31, 1996 and 1995, the amount of these reserves was approximately $17.0 million.
The amount of unrecognized deferred tax liability at December 31, 1996 and 1995 was approximately $6.1 million. The deferred tax liability could be recognized if in the future there is a change in federal tax law, certain distributions are made with respect to the stock of the savings institution, or the bad debt reserves are used for any purpose other than absorbing bad debt losses.
During 1996, the Company and the Internal Revenue Service ("IRS") reached a final agreement to resolve certain disputed issues related to the taxable years 1987 through 1989. The principal disputed issues related to various savings and loan industry tax issues for which the Company had previously provided deferred taxes.
As a result of reaching a tentative agreement in 1994, the Company reduced its 1994 income tax expense by approximately $2.1 million. The reduction in 1994 income tax expense represented an adjustment to the Company's current and deferred tax liabilities (including the estimated effect of the IRS agreement on the Company's California franchise tax returns).
The acquisition of CTL during 1996 increased deferred income tax liabilities by $7.3 million.
NOTE 14. STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL REQUIREMENTS
Federal legislation to recapitalize and fully fund the Savings Association Insurance Fund ("SAIF") was signed into law on September 30, 1996. Customer deposits for BVFB are SAIF-insured, and as a result of the legislation BVFB was required to pay a one-time special assessment of $11.7 million pre-tax ($6.7 million after tax or $.97 per share). The legislation had no effect on CTL, as its deposits are insured under the Bank Insurance Fund.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, BVFB and CTL must meet specific capital guidelines that involve quantitative measures of BVFB's or CTL's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. BVFB's and CTL's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Failure to meet minimum capital requirements can initiate certain mandatory, and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements.
Bay View Federal Bank - ---------------------
The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") provides definitions of regulatory capital (tangible capital, core capital and risk-based capital) and methods of calculating the minimum requirement for each type of capital. The tangible capital requirement is 1.5% of tangible assets. The core capital requirement is 3.0% of tangible assets plus qualifying intangibles. The risk-based capital requirement is 8.0% of risk-weighted assets. At December 31, 1996, BVFB's fully phased-in regulatory capital exceeds the minimum requirements of each regulatory capital standard in effect on such date as follows:
The following table is a reconciliation of BVFB's capital (excluding unrealized loss on securities available-for-sale, net of tax benefit) under Generally Accepted Accounting Principles ("GAAP") with its regulatory capital at December 31, 1996:
The Federal Deposit Insurance Corporation Improvement Act of 1991 required each federal banking agency to implement prompt corrective actions for institutions that it regulates. In response to this requirement, the Office of Thrift Supervision adopted final rules, effective December 19, 1992, based on FDICIA's five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.
The regulations provide that a savings institution is well capitalized if its Tier II risk-based capital ratio is 10% or greater, its Tier I risk-based capital ratio is 6% or greater, its leverage ratio is 5% or greater, and the institution is not subject to a capital directive. As used herein, Tier II risk-based capital ratio means the ratio of Tier II risk-based capital to risk- weighted assets, Tier I capital ratio means the ratio of core capital to risk- weighted assets, and leverage ratio means the ratio of core capital to adjusted total assets, in each case as calculated in accordance with current OTS capital regulations. As of December 31, 1996 and 1995, the most recent notification from the OTS categorized BVFB as well capitalized. There are no conditions or events since that notification that management believes have changed BVFB's category.
Under capital guidelines enacted by FDICIA, BVFB met the criteria for the "well capitalized" standard at December 31, 1996 and 1995 as follows:
Currently, the OTS has deferred implementation of the interest rate risk component for institutions with a greater than "normal" (i.e. greater than 2%) level of interest rate risk exposure. As of December 31, 1996, if the interest rate risk component regulation had been implemented, BVFB would not have been subject to an interest rate risk capital deduction for risk-based capital purposes.
The Company is a legal entity separate and distinct from BVFB. The Company's principal source of funds on an unconsolidated basis is expected dividends from its wholly owned subsidiaries. Dividends declared by BVFB to the Company were $0 in 1996, $29.4 million in 1995 and $4.4 million in 1994. There are various statutory and regulatory limitations on the extent to which BVFB can pay dividends to, make investments in or loans to, or otherwise supply funds to the Company. Based on the current financial status of BVFB, the Company believes that such limitations and restrictions will not impair the Company's ability to continue to pay the current level of dividends.
California Thrift & Loan - ------------------------
As of December 31, 1996, the most recent notification from the FDIC categorized CTL as well capitalized. There are no conditions or events since that notification that management believes have changed CTL's category. CTL's capital ratios at December 31, 1996 are as follows:
CTL declared and paid a dividend of $15 million in 1996 to return excess capital to the Company.
NOTE 15. STOCK REPURCHASE PROGRAM
During 1995, the Company's Board of Directors authorized a stock repurchase program enabling the Company to purchase up to 600,000 shares of the Company's common stock which was subsequently increased in 1996 to a total of 800,000 shares authorized for repurchase. As of December 31, 1996, the Company had completed its previously announced stock buy back of 800,000 shares (305,000 shares in 1995 and 495,000 in 1996) which were repurchased at an average cost of $31.97.
On January 22, 1997, the Company announced that its Board of Directors has authorized the repurchase of an additional $25 million of shares of the Company's common stock.
NOTE 16. STOCK OPTIONS
The Company has adopted the "Amended and Restated 1986 Stock Option and Incentive Plan" and the "1995 Stock Option and Incentive Plan" which authorize the issuance of up to 879,715 and 500,000 shares of common stock, respectively. The Company has also adopted a Non-Employee Director Stock Option Plan which authorizes the issuance of up to 275,000 additional shares of common stock. The stock option plans were approved by the Company's stockholders.
At December 31, 1996, the Company had outstanding non-qualified options for all three plans with expiration dates from 1997 to 2006, as follows:
Statement of Financial Accounting Standard (SFAS) No. 123 Pro Forma Disclosure
The Company accounts for its stock option grants in accordance with APB Opinion No. 25 "Accounting for Stock Issued to Employees". Had compensation cost been recorded based on SFAS No. 123, the Company's net income (loss) and earnings (loss) per share would have been as follows:
The fair value of options granted was estimated as of the date of grant based on the Black-Scholes option pricing model given the following weighted- average assumptions.
The following table summarizes information about stock options outstanding at December 31, 1996:
NOTE 17. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) thrift plan under which an employee with one or more years of service may contribute from 2% to 15% of base salary to the plan. The Company will match an employee's contribution up to 100% of the first 6% of the employee's base salary, depending on the employee's length of service. The Company's contributions for the years ended December 31, 1996, 1995 and 1994 were $435,000, $483,000, and $526,000 respectively.
Effective December 31, 1995, the Company modified its non-qualified defined benefit retirement plan for non-employee members of its Board of Directors and terminated its non-qualified supplemental retirement plan for executive officers (collectively, the "Plans"). As of December 31, 1996, the Company had a $1.1 million liability to certain non-employee members of its Board of Directors payable in 33,057 shares of the Company's common stock in satisfaction of the retirement plan liability. Such shares were repurchased in the market and are held in treasury and restricted as to issuance until paid out. The liability is included in additional paid in capital. As of December 31, 1996, the Company had a $2.0 million liability to certain retired Directors and executive officers (relating to the remaining benefits owed pursuant to the terminated supplemental retirement plan for executive officers).
The pension liability in the Consolidated Statements of Financial Condition at December 31, 1995 was $4.5 million, which represented the expected payout to participants upon termination of the Plans. The benefits were based on years of service and the participants' compensation. The amounts charged to income for the pension benefits, including the charges relating to the modification and termination of these plans, during 1996, 1995 and 1994 were $42,000, $637,000, and $860,000, respectively.
Net pension cost for these Plans included the following components for 1994:
The Company has an ESOP covering all regular full-time and part-time employees who have completed one year of employment. The Company borrowed $6.0 million from a financial institution which it in turn lent to the ESOP to purchase shares of the Company's common stock in the open market. At December 31, 1996 and 1995, the ESOP held 157,095 and 176,589 shares, respectively, of the Company's common stock. The interest rate paid by the Company on the ESOP debt is based on 90% of the prime rate. Total interest expense incurred on the ESOP debt was $362,000, $407,000 and $352,000, respectively, for the years ended December 31, 1996, 1995 and 1994. The interest expense recorded by the Company was $289,000, $254,000, and $199,000, for the years ended December 31, 1996, 1995 and 1994, respectively. The Company makes periodic contributions to the ESOP primarily to enable the ESOP to pay interest expense and administrative costs not covered by cash dividends received by the ESOP on its shares of the Company's common stock. Contributions from the Company to the ESOP on a cash basis totaled $674,000 for 1996, $609,000 for 1995, and $508,000 for 1994.
NOTE 18. DERIVATIVE FINANCIAL INSTRUMENTS
Interest Rate Exchange Agreements (Swaps)
At December 31, 1996 and 1995 the Company was party to interest rate swap agreements with notional principal amounts of $421.0 million and $150.0 million, respectively. The information presented below is based on interest rates at December 31, 1996 and 1995. To the extent that rates change, variable interest rate information will change. The following schedule represents the maturities and weighted average interest rates for swap agreements outstanding as of December 31, 1996:
The following schedule represents the maturities and weighted average interest rates for swap agreements outstanding as of December 31, 1995:
The interest rate swaps at December 31, 1996 and 1995 were collateralized by loans and mortgage-backed securities totaling $10.4 million and $14.6 million, respectively. The effect of interest rate swap agreements for the years ended December 31, 1996, 1995 and 1994 was to increase interest expense by $2.6 million, $40,000, and $80,000, respectively.
Treasury Rate Lock Agreement
At December 31, 1996, CTL entered into a $210 million treasury rate lock agreement to hedge its auto loan portfolio pending sale to BVSC and subsequent securitization and sale of asset-backed securities by BVSC. The treasury rate lock agreement guarantees a stated interest rate for a stated period of time and CTL will receive/pay the difference between the lock rate and the effective treasury rate on settlement date. Gains and losses on the hedge are deferred and recognized in income upon settlement of the hedge or sale of the underlying assets being hedged.
NOTE 19. COMMITMENTS AND CONTINGENCIES
Banking Center Premises
In 1980, the Company sold a building which formerly housed its headquarters for $3.45 million, and, concurrent with the sale, leased back the entire building under a twenty-year lease which has been accounted for as a capital lease. The Company occupies a minor portion of this building and receives sublease rental income from the major portion, and is responsible for all operating and maintenance expenses associated with the building. Sublease rentals totaled $389,000, $385,000, and $389,000 during the years ended December 31, 1996, 1995 and 1994, respectively. During the years ended December 31, 1996, 1995 and 1994, depreciation on the capital lease was $303,000 for each year. Accumulated depreciation at December 31, 1996 and 1995 was $2.9 million and $2.6 million, respectively.
Certain banking center locations and the Company's administrative corporate office are leased by the Company under operating type lease arrangements expiring at various dates through 2012. Lease rental expense for the years ended December 31, 1996, 1995 and 1994 totaled $3.5 million, $2.4 million, and $2.5 million, respectively.
Future minimum payments under lease obligations at December 31, 1996 are included in the following table:
Mortgage Loans
As of DECEMBER 31, 1996 the Company had outstanding commitments to originate $7.4 million of mortgage loans. The Company has outstanding recourse and subordination contingencies relating to $54.3 million of sold loans at December 31, 1996 (see Note 6).
Litigation
The Company is involved as plaintiff or defendant in various legal actions arising in the normal course of business. In the opinion of management, after consultation with counsel, the resolution of these legal actions will not have a material adverse effect on the Company's consolidated financial condition or results of operations.
NOTE 20. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Company using market information and valuation methodologies considered appropriate. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The fair value estimates presented herein are based on pertinent information available to the Company as of December 31, 1996 and 1995. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
(1) Carrying amounts are net of allowance for losses (2) Intercompany accounts have been eliminated
The Company believes the carrying amounts of cash and cash equivalents and investment in stock of the FHLBSF are reasonable estimates of their fair values. The fair values of investment securities and mortgage-backed securities were based on published market prices or quotes obtained from independent registered securities brokers.
The estimated fair value of loans receivable held for investment was determined by discounting the projected cash flows using current interest rates at which similar loans would be made to borrowers of similar credit risk. Prepayment estimates were based on historical experience and published data for similar loans. Fair values for loans available-for-sale are based on prices for similar loans in the secondary loan market. The estimated fair value of capitalized excess servicing represents the present value of the discounted cash flows on the sold loans less the Company's cost to service such loans.
The fair value of transactions accounts (demand deposits, savings accounts and money market accounts) is the amount payable on demand and is assumed to equal the carrying amount. The fair value of fixed maturity deposits for BVFB was estimated using the rates currently offered for certificates of deposit with similar remaining maturities and for CTL at carrying amount due to the call feature.
Rates currently available to the Company for debt with similar terms and remaining maturities were used to estimate the fair value of existing debt, including advances from the FHLBSF, securities sold under agreements to repurchase and Senior Debentures.
The unrealized loss on interest rate swaps is the estimated amount that the Company would receive or pay to terminate the swap agreements at the reporting date, taking into account current interest rates and the current creditworthiness of the swap counterparties. The unrealized gain on the Treasury rate lock is the estimated amount that the Company would receive to terminate the agreement with the counterparty.
NOTE 21. PARENT COMPANY FINANCIAL INFORMATION
The Company and its subsidiaries file consolidated Federal income tax returns in which the taxable income or loss of the Company is combined with that of its subsidiaries. The Company's share of income tax expense is based on the amount which would be payable if separate returns were filed. Accordingly, the Company's equity in the net income of its subsidiaries (distributed and undistributed) is excluded from the computation of the provision for income taxes for financial statement purposes.
The Parent Company's statements of financial condition and related statements of operations and cash flows are as follows:
STATEMENTS OF FINANCIAL CONDITION
STATEMENTS OF OPERATIONS
STATEMENTS OF CASH FLOWS
NOTE 22. SELECTED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
(1) Including CTL effective June 1, 1996 (2) Includes SAIF recapitalization assessment (see note 14)
NOTE 23. SIGNIFICANT FOURTH QUARTER 1995 ADJUSTMENTS
The following significant fourth quarter adjustments were recorded in the 1995 Consolidated Statement of Operations:
NOTE 24. SUBSEQUENT EVENTS
On January 21, 1997, the Company executed a definitive agreement to acquire EXXE Data Corporation ("EXXE") and its wholly owned subsidiary Concord Growth Corporation ("CGC"), a nationwide commercial finance company. The acquisition will be accounted for as a purchase and is expected to be completed during March 1997. Under the terms of the definitive agreement, shareholders of EXXE capital stock, warrants and options will receive an initial aggregate payment of $19.8 million at closing and will be entitled to potential future payments, dependent on the future financial performance of CGC, of up to $34 million. The transaction is subject to the approval of EXXE shareholders and all applicable regulatory authorities.
On January 24, 1997, the Company securitized and sold $253 million of asset-backed securities through its wholly owned subsidiary BVSC pursuant to a previously filed shelf registration statement on Form S-3 for $500 million of automobile receivable-backed securities. The securities consisted of 6.29% Class A-1 Automobile Receivable Backed Certificates in aggregate principal amount of $200,979,000, 6.59% Class A-2 Automobile Receivable Backed Certificates in the aggregate principal amount of $52,245,989, and other Interest Only Automobile Receivable Backed Certificates that will not receive distributions of principal. The premium arising from the sale of the automobile loans has been recorded as part of the purchase accounting valuations related to the acquisition of CTL. A gain of approximately $900,000 will be realized in the income statement due to the improvement in the fair value of the automobile loans as a result of changes in market interest rates between June 1, 1996 and the sale of the automobile loans on January 24, 1997. The underlying automobile loans collaterizing the certificates will be serviced by CTL.
(1) Includes Bay View Securitization Corporation and Regent Financial Corporation, wholly owned subsidiaries of the Company, which are not material for separate financial statement disclosure for the periods presented.
(1) Reflects operating results beginning on June 1, 1996, the effective date of acquisition.
(2) Includes Bay View Securitization Corporation and Regent Financial Corporation, wholly owned subsidiaries of the Company, which are not material for separate financial statement disclosure for the periods presented.
(1) Reflects cash flows beginning on June 1, 1996, the effective date of acquisition.
(2) Includes Bay View Securitization Corporation and Regent Financial Corporation, wholly owned subsidiaries of the Company, which are not material for separate financial statement disclosure for the periods presented.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of Bay View Capital Corporation:
We have audited the accompanying consolidated statements of financial condition of Bay View Capital Corporation and subsidiaries (the "Company") as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of Bay View Capital Corporation and subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
Our audits were conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The supplemental consolidating schedules of financial information on pages 93 - 96 are presented for the purpose of additional analysis of the basic consolidated financial statements rather than to present the financial position, results of operations, and cash flows of the individual companies, and are not a required part of the basic consolidated financial statements. These schedules are the responsibility of the Company's management. Such schedules have been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, are fairly stated in all material respects when considered in relation to the basic consolidated financial statements taken as a whole.
/s/ Deloitte & Touche LLP
San Francisco, California January 24, 1997
ITEM 9.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------
Information concerning Executive Officers of the Company is contained under the heading "Executive Officers of the Registrant" on page 14 herein. Information concerning directors of the Registrant is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 22, 1997, a copy of which will be filed not later than 120 days after the close of the fiscal year. The compensation report and performance graph included in the Proxy Statement pursuant to Items 402(k) and 402(l) of Regulation S-K are specifically not incorporated by reference herein.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION - --------------------------------
Information concerning executive compensation is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 22, 1997, a copy of which will be filed not later than 120 days after the close of the fiscal year. The compensation report and performance graph included in the Proxy Statement pursuant to Items 402(k) and 402(l) of Regulation S-K are specifically not incorporated by reference herein.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 22, 1997, a copy of which will be filed not later than 120 days after the close of the fiscal year.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------
Information concerning certain relationships and transactions is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 22, 1997, a copy of which will be filed not later than 120 days after the close of the fiscal year.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------
All financial statement schedules have been omitted as the required information is not applicable or has been included in the Notes to Consolidated Financial Statements.
(a) (3) Exhibits: - ------------------
(References to Prior Filings)
3a Filed as exhibit 4.1 to the Registrant's Registration Statement on Form S-8 filed July 26, 1991 (File No. 33-41924) 3b Filed as exhibit I to the Registrant's Current Report on Form 8-K filed January 10, 1994 (File No. 0-17901) 4a Filed as exhibit 4.3 to the Registrant's Registration Statement on Form S-8 filed July 26, 1991 (File No. 33-41924) 4b Filed as exhibit I to the Registrant's Registration Statement on Form 8 filed March 9, 1993 (the second amendment to a Form 8-A filed August 6, 1990)(File no. 0-17901) 4c Filed as exhibit 3 to the Registrant's Registration Statement on Form 8 filed March 9, 1993 (the second amendment to a Form 8-A filed August 6, 1990)(File no. 0-17901) 4d Filed as exhibit 2 to the Registrant's Registration Statement on Form 8 filed March 9, 1993 (the second amendment to a Form 8-A filed August 6, 1990)(File no. 0-17901) 10a-c Filed as exhibits 10.6 to 10.8 respectively, to the Registrant's Annual Report on Form 10-K filed March 30, 1993 for the year ended December 31, 1992 (File No. 0-17901) 10d Filed as exhibit 4 to the Registrant's Registration Statement on Form S-8 filed August 11, 1995 (File No. 33-95724) 10e Filed as exhibit 4.4 to the Registrant's Registration Statement on Form S-8 filed July 26, 1991 (File No. 33-41924)
All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K.
(b) Reports on Form 8-K: - -------------------------
The Company did not file any Current Reports on Form 8-K during the quarter ended December 31, 1996.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DATE: February 18, 1997 BAY VIEW CAPITAL CORPORATION
By: /s/ David A. Heaberlin ---------------------------- David A. Heaberlin Executive Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
By: /s/ Edward H. Sondker By: /s/ John R. McKean --------------------- ------------------ Edward H. Sondker, Director John R. McKean President and Chief Executive Officer Chairman of the Board
Date: February 18, 1997 Date: February 18, 1997
By: /s/ Paula R. Collins By:/s/ Roger K. Easley ---------------------- ------------------- Paula R. Collins, Director Roger K. Easley, Director
Date: February 18, 1997 Date: February 18, 1997
By: /s/ Thomas M. Foster By: /s/ Richard J. Quinlan -------------------- ----------------------- Thomas M. Foster, Director Richard J. Quinlan, Director
Date: February 18, 1997 Date: February 18, 1997
By: /s/ Robert L. Witt By: /s/ Robert M. Greber ------------------ --------------------- Robert L. Witt, Director Robert M. Greber, Director
Date: February 18, 1997 Date: February 18, 1997
By: /s/ Angelo J. Siracusa By: /s/ W. Blake Winchell ----------------------- --------------------- Angelo J. Siracusa, Director W. Blake Winchell, Director
Date: February 18, 1997 Date: February 18, 1997