Item 1. Business
General and Business Overview
We are a financial services company headquartered in San Mateo, California. On October 3, 2002, we adopted a Plan of Dissolution and Stockholder Liquidity (the “Plan”). The Plan contemplated that we, under applicable provisions of the Delaware General Corporation Law, would:
• dispose of all of our assets, including all of the assets of the Bank;
• pay all of our debts and liabilities and make reasonable provision for any contingent liabilities;
• distribute the remaining proceeds from our asset sales to our stockholders; and
• dissolve.
As a result of the adoption of the Plan, we adopted liquidation basis accounting effective September 30, 2002.
During the fourth quarter of 2003, our Board amended the Plan to become a plan of partial liquidation (the “Amended Plan”) under which we are completing the liquidation of the assets and satisfaction of the liabilities of the Bank remaining after the Bank’s September 30, 2003 dissolution, distributed a major portion of the proceeds to our stockholders through a series of cash distributions, and continue to operate BVAC, our wholly-owned automobile finance subsidiary. When we adopted the Amended Plan, we discontinued our use of liquidation basis accounting and re-adopted going concern basis accounting effective October 1, 2003.
Among the factors considered by our Board in deciding to engage in a partial liquidation rather than a complete liquidation were:
• Adverse market conditions in the auto finance sector, which caused our Board to conclude that the near-term sale of BVAC to a third party, or distribution of the stock of BVAC to our stockholders, as contemplated by the Plan, would not be the best method of maximizing stockholder value;
• A determination that our remaining tax net operating loss carryforwards could be more fully utilized by continuing to operate BVAC beyond the third quarter of 2005; and
• The opportunity to obtain greater corporate and financial flexibility than we would have if we were operating as a dissolving corporation.
In accordance with the Amended Plan, we redeemed $63.5 million of our 9.76% Cumulative Capital Securities (the “Capital Securities”) on December 31, 2003, and redeemed the remaining $22.0 million of these Capital Securities on June 30, 2004 and, between December 31, 2003 and December 31, 2004, distributed $311.0 million in cash to our stockholders, or $47.25 per share after adjustments to reflect the retroactive effect of the 1-for-10 reverse stock split of our common stock effective June 30, 2004.
At December 31, 2004, we had assets of $423.3 million, liabilities of $319.1 million and stockholders’ equity of $104.2 million. Refer to “Forward-Looking Statements - Cash Distributions” for comments about future cash distributions.
Auto Finance
BVAC is a Southern California-based auto finance company engaged in the indirect financing of automobile purchases by individuals. Of the auto contracts BVAC purchased in 2004, 93% were originated by manufacturer-franchised dealerships and the remaining 7% were originated by independent dealerships; 52% were contracts on new vehicles and 48% were contracts on used vehicles. BVAC purchases auto contracts from approximately 7,000 automobile dealers in 33 states with limited recourse to the dealer.
BVAC has historically positioned itself in the market as a premium priced lender for well-qualified borrowers seeking extended-term financing and/or higher advance rates than those generally offered by traditional lenders. This
strategy has enabled BVAC to establish a loyal dealership network by satisfying a unique niche within the indirect auto finance market that large commercial banks and captive finance companies have not served well. Recently, BVAC has begun leveraging this established reputation with its dealers to broaden its array of auto financing programs available to prime credit quality borrowers.
BVAC places a strong emphasis on borrower stability, credit quality and debt serviceability. With Fair, Isaac & Co., or “FICO,” credit scores that averaged 739 in 2004, BVAC’s borrower base is largely comprised of prime credit quality borrowers. BVAC currently offers financing terms to 96 months and typically finances an amount in excess of a dealer’s wholesale value of a vehicle. During 2004, the term to maturity on auto contracts purchased by BVAC averaged 83 months and the loan-to-value ratio averaged 125%. The average loan amount financed by BVAC was $29,400.
Since the liquidation of the Bank, BVAC has operated as an independent finance company, rather than a portfolio-lending unit of the Bank, purchasing auto contracts primarily for sale or securitization, and servicing these auto contracts. BVAC has a $350.0 million revolving warehouse credit facility to fund its purchases of contracts, and periodically sells or securitizes auto contracts in order to pay down the facility and maintain available borrowing capacity. BVAC retains the servicing obligation on the contracts that it sells or securitizes, which provides us with a source of fee income over the life of the contracts. At December 31, 2004, BVAC had $298.8 million outstanding under this credit facility to purchase auto contracts. On February 17, 2005, BVAC issued $232.1 million of auto receivable backed notes and repaid $217.8 million of borrowings on the credit facility.
BVAC’s headquarters and operations center is located in Covina, California. The operations center manages the underwriting of contracts and supports its dealer relationships. It also houses BVAC’s servicing and collections activities involving more than 28,000 accounts representing $571 million of managed contracts as of December 31, 2004. BVAC also administers lease customer re-marketing and asset disposition activities in its operations center for the auto lease portfolio that we assumed from the Bank and are liquidating. In 2004, BVAC completed a geographical expansion that was initiated in late 2002, expanding into a total of 33 states from its established presence in 17 states, primarily in the West, Midwest and Florida. In 2003, BVAC entered seven Mid-Atlantic states including Maryland, New Jersey, North Carolina, Pennsylvania, South Carolina, Tennessee and Virginia. In 2004, BVAC entered nine additional states including Alabama, Connecticut, Delaware, Kansas, Kentucky, Maine, Massachusetts, New Hampshire and Oklahoma.
Liquidating Portfolio
As of December 31, 2004, our ongoing business consisted solely of the indirect automobile financing conducted by BVAC. Our only other activity is the continuing liquidation of the assets we assumed from the Bank. The following descriptions are provided to reflect the outstanding balances of these assets at December 31, 2004. All outstanding balances at December 31, 2004 are classified as held-for-sale.
Auto Leases - Auto leases totaled $10.0 million, net of accumulated depreciation, impairment charges and valuation allowances at December 31, 2004, and represented 2.4% of our consolidated assets. We ceased purchasing auto leases in June 2000. The auto leases are accounted for as operating leases and the lease assets are capitalized and depreciated to their estimated residual value over the term of the leases. At December 31, 2003, auto leases totaled $66.7 million.
Other Loans - At December 31, 2004, our other loans consisted of asset-based and franchise loans. During 2004, sales, as well as loan payoffs and amortization, reduced our other loans to $0.9 million at December 31, 2004 from $12.1 million at December 31, 2003.
Real Estate Owned - At December 31, 2004, our real estate owned totaled $3.4 million and consisted of foreclosed commercial properties.
Funding Activities
In addition to BVAC’s warehouse credit facility, we have one other borrowing, representing the remaining balance of a structured financing secured by the contractual cash flows from our auto lease portfolio. This borrowing totaled $1.9 million at December 31, 2004.
Debt
As of December 31, 2004, we had no other outstanding debt beyond the aforementioned warehouse credit facility and the structured financing. At December 31, 2003, we had $24.8 million of outstanding debt represented by 9.76% Junior Subordinated Deferrable Interest Debentures (the “Junior Debentures”) that we issued to Bay View Capital I, a Delaware business trust we sponsored. The Junior Debentures supported the $22.0 million of outstanding 9.76% Capital Securities that were issued by Bay View Capital I. Effective December 31, 2003, in accordance with the requirements of Financial Accounting Standards Board Financial Interpretation No. 46, “Consolidation of Variable Interest Entities, as revised,” we deconsolidated Bay View Capital I and the Capital Securities. As a result of this deconsolidation, the debt reflected in our consolidated financial statements as of December 31, 2003 reflected the Junior Debentures instead of the Capital Securities.
During the second quarter of 2004, we redeemed the remaining $22.0 million of outstanding Capital Securities and the underlying $24.8 million of outstanding Junior Debentures.
Competition
Automobile financing is provided by a number of competing entities, including captive finance affiliates of automobile manufacturers, commercial banks, independent finance companies, thrifts and credit unions. Many of BVAC’s competitors have greater financial resources and capitalization, greater access to existing and newly emerging capital markets, better economies of scale and more favorable cost of funds than BVAC does. The captive finance affiliates of the automobile manufacturers have historically offered varying amounts of below-market financing to automobile purchasers to increase automobile sales volume. A number of our competitors also offer automobile purchasers and dealerships with additional forms of financing, including auto leasing and dealer inventory floor plan financing, which BVAC does not provide. We believe that BVAC competes primarily on the basis of the relative uniqueness of the extended term and over-advance features of its products. Accordingly, BVAC may not be able to compete successfully against these competitors.
Economic Conditions, Government Policies and Legislation
During periods of economic slowdown, delinquencies and losses from defaults and repossessions may increase. Decreased demand for automobiles and, therefore, BVAC’s automobile financing volumes, may also occur during periods of economic slowdown. Decreased demand for automobiles may also depress values of used automobiles, which weakens the collateral values of BVAC’s auto contracts. Depressed values of used automobiles during periods of economic slowdown may reduce the value of repossessed and off-lease vehicles and may require greater reserves and could result in greater losses for us. Sustained periods of increased delinquencies and losses from defaults and repossessions could adversely affect BVAC’s financial position, results of operations and liquidity by limiting its ability to enter into future securitizations or sales of its auto contracts.
BVAC’s profitability is also dependent on the interest rate spread it earns on auto contracts, the difference between the interest earned on its fixed rate auto contracts and the rate it pays on its floating rate borrowings, and the price it receives for the fixed rate contracts that are securitized or sold. BVAC monitors interest rates and utilizes derivative instruments to economically hedge interest rate volatility, however, market interest rates are highly sensitive to many factors that are beyond BVAC’s control, such as inflation, recession and unemployment and the impact of future changes in domestic and foreign economic conditions that BVAC cannot predict.
Supervision and Regulation
General
We are subject to regulation, supervision and licensing under various federal, state and local statutes, ordinances and regulations, including the Sarbanes-Oxley Act of 2002, the Office of Foreign Assets Control and the USA Patriot Act. We are required to comply with the laws of those states in which we conduct operations. We believe that we are in compliance in all material respects with these laws and regulations.
Our common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As such, we are subject to the information, proxy solicitation, insider trading and other requirements and restrictions of the Exchange Act. Our common stock trades on the New York Stock Exchange (“NYSE”) under the ticker symbol “BVC.”
Until the Bank’s dissolution, we and the Bank were subject to extensive regulation intended primarily for the protection of depositors and the federal deposit insurance fund and not for the benefit of our stockholders. Upon the Bank’s dissolution, we ceased to be a registered bank holding company and are no longer subject to such regulation.
Consumer Protection Laws
Numerous federal and state consumer protection laws and related regulations impose substantial requirements upon lenders and servicers involved in consumer finance, such as BVAC. These laws include the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Federal Trade Commission Act, the Fair Credit Reporting Act, the Gramm-Leach-Bliley Act, the Magnuson-Moss Warranty Act, Board of Governors of the Federal Reserve System’s Regulations B and Z, states’ adaptations of the Uniform Consumer Credit Code and of the Uniform Commercial Code, state and federal privacy laws and state motor vehicle retail installment sales acts and other similar laws. These laws, among other things, require us to provide certain disclosures to applicants, prohibit misleading advertising and protect against discriminatory financing or unfair credit and collection practices. The Truth-in-Lending Act and Regulation Z promulgated thereunder require disclosure of, among other things, the payment schedule, the finance charge, the amount financed, the total of payments and the annual percentage rate charged on each retail installment contract. The Equal Credit Opportunity Act prohibits creditors from discriminating against credit applicants (including retail installment contract obligors) on the basis of specific enumerated criteria. Creditors are also required to make certain disclosures regarding consumer rights and advise consumers whose credit applications are not approved. The holder in due course rules of the Federal Trade Commission provide for the preservation of the consumer’s claims and defenses when a consumer obligation is assigned to a holder. Some state laws impose finance charge ceilings and other restrictions on consumer transactions and require contract disclosures in addition to those required under federal law. These requirements impose specific statutory liabilities upon creditors who fail to comply with their provisions. In some cases these provisions, if violated, could affect BVAC’s ability to enforce the contracts it purchases.
Employees
At December 31, 2004, we had a total of 125 employees on a full-time equivalent basis, consisting of both full-time and permanent part-time employees, as follows:
Our employees are not represented by any unions or covered by any collective bargaining agreements. We consider our relations with our employees to be satisfactory.
Executive Officers of the Registrant
The following table sets forth certain information regarding our executive officers:
(1) Mr. Catalano has submitted his resignation effective April 8, 2005.
The business experience of each of our executive officers is as follows:
Mr. Cooper has served as a Director, President and Chief Executive Officer of Bay View Capital Corporation since October 2002. He joined us in May 2001, initially serving as Executive Vice President and Chief Credit Officer. Previously, he served as Executive Vice President and Chief Credit Officer at Lone Star Bank of Dallas. Prior to joining Lone Star Bank, he was Senior Vice President of Loan Administration at Compass Bank in Dallas from 1996 to 2000. Mr. Cooper has more than 30 years of experience in the banking industry, including 13 years experience as a bank examiner with the FDIC.
Mr. Chatterjee has served as President and Chief Executive Officer of BVAC and as Executive Vice President and Director of Retail Operations of Bay View Capital Corporation since September 2004. Prior to joining us, he served as Executive Vice President, Head of Consumer Lending, at AmSouth Bancorp from 1997 to 2002 and U.S. Bancorp from 1995 to 1997. Mr. Chatterjee has over 17 years of consumer lending experience and has served as a member of the Automobile Finance Committee of the Consumer Bankers Association for more than 10 years.
Mr. Catalano, Senior Vice President, became our General Counsel and Corporate Secretary in December 2002. Mr. Catalano joined us in 1993 and served as Assistant General Counsel from 2000 to 2002. Previously, he served as Senior Vice President and Assistant General Counsel of American Savings and Loan, Stockton California.
Mr. Okubo, Executive Vice President, has served as our Chief Financial Officer since November 2002. Mr. Okubo joined us in 1996 and has held various financial management positions, including Treasurer from June 2001 and as Controller of the Bank from 1998 to 2001. Previously, he served as Executive Vice President and Chief Financial Officer of Home Federal Savings of San Francisco from 1993 to 1996.
Ms. Soukiassian, Senior Vice President, was promoted to General Auditor in November 2002. Previously, she served as our Director of Corporate Projects from 1998 to 2002. Prior to joining us, she held management positions with KPMG Peat Marwick, LLP in Los Angeles from 1996 to 1998.
There is no family relationship among the above officers. All executive officers serve at the discretion of the Board of Directors.
Item 2.
Item 2. Properties
At December 31, 2004, we occupied three offices including our corporate headquarters office and had an additional two offices that we have vacated, and are subleasing, under operating lease agreements expiring at various dates through the year 2012. In most instances, these lease arrangements include options to renew or extend the lease at market rates. We also own leasehold improvements, furniture and equipment at our offices, all of which are used in our business activities.
Item 3.
Item 3. Legal Proceedings
On August 29, 2003, Financial Security Assurance Inc. (“FSA”) filed a complaint against us and the Bank in the United States District Court for the Southern District of New York. The complaint, as amended, alleges breaches of representations and warranties or indemnity obligations with regard to a number of loans that served as collateral for two securitizations involving us and/or a former subsidiary, Bay View Franchise Mortgage Acceptance Company, that were effected in 1998 and 2000. FSA guaranteed certain payments in connection with these securitizations. We vigorously deny any liability to FSA and have asserted numerous defenses to each of FSA’s claims. We have also filed counterclaims against FSA.
We are also a party to various other legal actions arising in the normal course of our business.
After consultation with counsel, we do not currently expect that the resolution of these legal actions will have a material adverse effect on our consolidated financial condition, results of operations or cash flows.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the three months ended December 31, 2004.
Part II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
Our common stock is traded on the NYSE under the stock symbol “BVC.” On June 24, 2004, our stockholders approved a 1-for-10 reverse stock split of the issued and outstanding shares of our common stock. The reverse stock split became effective on June 30, 2004. Accordingly, all shares outstanding and per share amounts are presented on a post-reverse stock split basis for all periods reported. At December 31, 2004, 6,593,860 shares of our common stock were outstanding, and held by 1,516 stockholders of record. During 2004, we distributed $7.25 per share in cash to our common stockholders - $2.50 per share on June 30, 2004, $2.50 per share on September 30, 2004 and $2.25 per share on December 31, 2004. On December 31, 2003, we distributed $40.00 per share in cash to our common stockholders. The effect of these distributions is reflected in the following tables that set forth quarterly closing stock price activity for 2004 and 2003:
Item 6.
Item 6. Selected Financial Data - Five-Year Financial Information
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
INDEX
Strategic Overview
Restatement
Liquidation of the Bank
Auto Finance
Critical Accounting Policies
Accounting Changes and Recent Accounting Pronouncements
Results of Operations
Going Concern Basis
Results of Operations - Year ended December 31, 2004
Results of Operations - Three Months ended December 31, 2003
Liquidation Basis
Changes in Net Assets in Liquidation - Nine Months ended September 30, 2003
Changes in Net Assets in Liquidation - Three Months ended December 31, 2002
Going Concern Basis
Results of Operations - Nine Months ended September 30, 2002
Balance Sheet Analysis
Cash and Cash Equivalents
Restricted Cash
Retained Interests in Securitizations
Auto Installment Contracts and Other Loans
Deposits
Borrowings
Liquidity and Capital Resources
Contractual Obligations
Stock Repurchase Program
Impact of Inflation and Changing Prices
Strategic Overview
Bay View Capital Corporation (the “Company,” “we,” “us” or “our”) is a financial services company headquartered in San Mateo, California, whose primary subsidiary, Bay View Acceptance Corporation (“BVAC”), is an automobile finance company engaged in indirect purchases of retail automobile installment contracts originated by manufacturer-franchised and independent dealers in connection with the sale of new and used automobiles. BVAC generates revenue through its investment in auto contracts, and the subsequent securitization or sale and servicing of these auto contracts.
Restatement
During the Company’s year-end audit and Sarbanes-Oxley Section 404 review, the Company determined that it should have recognized a total of $0.4 million of unrealized after-tax losses on certain derivative instruments. As described in Note 21 to the consolidated financial statements, “Selected Quarterly Results of Operations (Unaudited),” at Item 8, such restatements increased our reported net losses for the first, second, third and fourth quarters of 2004.
Liquidation of the Bank
On October 3, 2002, we adopted a Plan of Dissolution and Stockholder Liquidity (the “Plan”). The Plan contemplated that we, under applicable provisions of the Delaware General Corporation Law, would dispose of all of our assets, including all of the assets of Bay View Bank, N.A. (the “Bank”); pay all of our debts and liabilities and make reasonable provision for any contingent liabilities; distribute the remaining proceeds from our asset sales to our stockholders; and dissolve. As a result of the adoption of the Plan, we adopted liquidation basis accounting effective September 30, 2002.
During the fourth quarter of 2003, our Board amended the Plan to become a plan of partial liquidation (the “Amended Plan”) under which we are completing the liquidation of the assets and the satisfaction of the liabilities of the Bank remaining after the Bank’s September 30, 2003 dissolution, distributed a major portion of the proceeds to our stockholders through a series of cash distributions, and continue to operate BVAC. When we adopted the Amended Plan, we discontinued our use of liquidation basis accounting and re-adopted going concern basis accounting effective October 1, 2003. With the Bank’s dissolution on September 30, 2003, its remaining assets and liabilities were transferred to us, as the Bank’s sole stockholder, and we ceased to be a bank holding company and, along with our subsidiaries, were no longer subject to supervision, examination and regulation by the Board of Governors of the Federal Reserve System (the “FRB”), the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.
Among the factors considered by our Board in deciding to engage in a partial liquidation rather than a complete liquidation were:
• Adverse market conditions in the auto finance sector, which caused our Board to conclude that the near-term sale of BVAC to a third party, or distribution of the stock of BVAC to our stockholders, as contemplated by the Plan, would not be the best method of maximizing stockholder value;
• A determination that our remaining tax net operating loss carryforwards could be more fully utilized by continuing to operate BVAC beyond the third quarter of 2005; and
• The opportunity to obtain greater corporate and financial flexibility than we would have if we were operating as a dissolving corporation.
In accordance with the Amended Plan, we redeemed $63.5 million of our 9.76% Cumulative Capital Securities (the “Capital Securities”) on December 31, 2003, and redeemed the remaining $22.0 million of these Capital Securities on June 30, 2004 and, between December 31, 2003 and December 31, 2004, have distributed $311.0 million in cash to our stockholders, or $47.25 per share after the adjustments to reflect the retroactive effect of the 1-for-10 reverse stock split of our common stock effective June 30, 2004.
At December 31, 2004, we had assets of $423.3 million, liabilities of $319.1 million and stockholders’ equity of $104.2 million. Refer to “Forward-Looking Statements - Cash Distributions” for comments about future cash distributions.
Auto Finance
BVAC is a Southern California-based auto finance company engaged in the indirect financing of automobile purchases by individuals. Of the auto contracts BVAC purchased in 2004, 93% were originated by manufacturer-
franchised dealerships and the remaining 7% were originated by independent dealerships; 52% were contracts on new vehicles and 48% were contracts on used vehicles. BVAC purchases auto contracts from approximately 7,000 automobile dealers in 33 states with limited recourse to the dealer.
BVAC has historically positioned itself in the market as a premium priced lender for well-qualified borrowers seeking extended-term financing and/or higher advance rates than those generally offered by traditional lenders. This strategy has enabled BVAC to establish a loyal dealership network by satisfying a unique niche within the indirect auto finance market that large commercial banks and captive finance companies have not served well. Recently, BVAC has begun leveraging this established reputation with its dealers to broaden its array of auto financing programs available to prime credit quality borrowers.
BVAC places a strong emphasis on borrower stability, credit quality and debt serviceability. With Fair, Isaac & Co., or “FICO,” credit scores that averaged 739 in 2004, BVAC’s borrower base is largely comprised of prime credit quality borrowers. BVAC currently offers financing terms to 96 months and typically finances an amount in excess of a dealer’s wholesale value of a vehicle. During 2004, the term to maturity on auto contracts purchased by BVAC averaged 83 months and the loan-to-value ratio averaged 125%. The average loan amount financed by BVAC was $29,400.
Since the liquidation of the Bank, BVAC has operated as an independent finance company, rather than a portfolio-lending unit of the Bank, purchasing auto contracts for sale or securitization, and servicing these auto contracts. BVAC has a $350.0 million revolving warehouse credit facility to fund its purchases of contracts, and periodically sells or securitizes auto contracts in order to pay down the facility and maintain available borrowing capacity. BVAC retains the servicing obligation on the contracts that it sells or securitizes, which provides us with a source of fee income over the life of the contracts. At December 31, 2004, BVAC had $298.8 million outstanding under this credit facility to purchase auto contracts. On February 17, 2005, BVAC issued $232.1 million of auto receivable backed notes and repaid $217.8 million of borrowings on the credit facility.
BVAC’s headquarters and operations center is located in Covina, California. The operations center manages the underwriting of contracts and supports its dealer relationships. It also houses BVAC’s servicing and collections activities involving more than 28,000 accounts representing $571 million of managed contracts as of December 31, 2004. BVAC also administers lease customer re-marketing and asset disposition activities in its operations center for the auto lease portfolio that we assumed from the Bank and are liquidating. In 2004, BVAC completed a geographical expansion that was initiated in late 2002, expanding into a total of 33 states from its established presence in 17 states, primarily in the West, Midwest and Florida. In 2003, BVAC entered seven Mid-Atlantic states including Maryland, New Jersey, North Carolina, Pennsylvania, South Carolina, Tennessee and Virginia. In 2004, BVAC entered nine additional states including Alabama, Connecticut, Delaware, Kansas, Kentucky, Maine, Massachusetts, New Hampshire and Oklahoma.
Critical Accounting Policies
We have identified the most critical accounting policies upon which our financial status depends. We determined the critical policies by considering accounting principles that involve the most complex or subjective decisions or assessments. We have identified our most critical accounting policies to be those related to loan sales and retained interests in securitizations, allowance for credit losses, investment in operating lease assets, income taxes, and derivative instruments.
Going Concern vs. Liquidation Basis Accounting
For the period September 30, 2002 through September 30, 2003, we used liquidation basis accounting under which assets were carried at estimated net realizable values and all estimated future liabilities associated with carrying out the Plan were accrued. Future revenues and expenses of an operating nature were recognized in income and expense when realized.
With our adoption of the Amended Plan, we discontinued our use of liquidation basis accounting and re-adopted going concern basis accounting, and re-established our stockholders’ equity effective October 1, 2003. In connection with our re-adoption of going concern basis of accounting, we recognized $0.7 million of pre-tax expense and $1.1 million of additions to stockholders’ equity, and recorded the following adjustments:
• Goodwill: Re-established the $1.8 million of goodwill related to our acquisition of BVAC’s predecessor entity, CTL, Inc., that existed prior to our adoption of liquidation basis accounting;
• Premium on investment in BVAC: Reversed $10.0 million of premium over the book value of BVAC, which was recorded as deferred gain under liquidation basis accounting, and restored the historical cost basis in our equity investment in BVAC;
• Auto contracts: Reversed unrealized gains that were recorded under liquidation basis accounting and restored the lower of cost or market valuation;
• Mortgage-backed securities: Restored fair value accounting for these available-for-sale securities;
• Accrued liabilities: Reversed $1.7 million of accruals related to certain severance and occupancy costs that were recorded under liquidation basis accounting and adopted Statement No. 146 accounting for costs associated with disposal activities; and
• Stockholders’ equity: Restored stockholders’ equity as of October 1, 2003
See Note 2 to the Consolidated Financial Statements, “Summary of Significant Accounting Policies - Liquidation Basis,” under Item 8. “Financial Statements and Supplementary Data” for further discussion of the significant accounting policies that were applicable, under liquidation basis accounting, during the period September 30, 2002 through September 30, 2003.
Loan Sales and Retained Interests in Securitizations
BVAC has periodically transferred a portion of its warehouse inventory of auto contracts held-for-sale to trusts that, in turn, issue asset-backed securities to investors. We have structured these transactions as sales in accordance with Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” and recognized a gain on the sale of the auto contracts to the trusts - which represents the difference between the sum of sale proceeds, net of transaction costs, and cash deposited into a securitization trust account in order to enhance the credit rating of the asset-backed securities and the sum of our net carrying value of the auto contracts and the present value of future excess cash flow anticipated to be distributed to us by the trust over the life of the asset-backed securities - and an asset which is referred to as a “retained interest” in the securitization.
The retained interest is comprised of the cash initially deposited into the securitization trust account and the present value of the future excess cash flow anticipated to be distributed to us by the trust over the life of the asset-backed securities. These estimated future cash flows - which are comprised of interest income received on the auto contracts less interest paid to investors in the asset-backed securities, credit losses and trust expenses - are initially retained by the trust to build the trust cash account to pre-designated levels and provide further credit enhancement. Once the pre-designated levels of cash are attained, the trust distributes the excess cash flow to BVAC. In recording the gain on sale and the retained interest, we have made assumptions in calculating the present value of the future excess cash flow anticipated to be distributed to us by the trust over the life of the asset-backed securities and recording the retained interest.
We designate retained interests as available-for-sale and carry them at fair value. Our retained interests are subordinate to investor interests in the related asset-backed securities, their value is subject to credit and prepayment risks in the pool of underlying auto contracts. We are not aware of an active secondary market for our retained interests and, accordingly, estimate the fair value of our retained interests by calculating the present value of the future excess cash flow anticipated to be received, using management’s best estimates of key valuation assumptions including credit losses, prepayment speeds and discount rates commensurate with the underlying risks in the anticipated future cash flow.
The following table sets forth the significant assumptions used in the valuation of our retained interests as of December 31, 2004:
Changes in the above assumptions due to differing actual experience or market conditions could affect the value of our retained interests.
Allowance for Credit Losses
The allowance for credit losses on auto contracts held-for-investment is established through a provision charged to expense and maintained at a level that we believe is sufficient to cover estimated probable losses in this loan portfolio. We consider BVAC’s portfolio of auto contracts to be comprised of relatively small balance, homogeneous receivables and, accordingly, determines its allowance for credit losses in accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies.” The allowance for credit losses is evaluated and adjusted on a quarterly basis.
In determining the level of the allowance for credit losses, we evaluate BVAC’s auto contracts held-for-investment using two methodologies. The primary methodology is based upon an analysis of BVAC’s historical loss experience using a “vintage” analysis of its past purchases of auto contracts from which BVAC predicts probable losses that are inherent in its portfolio of auto contracts held-for-investment. Under this method, BVAC’s historical credit loss experience is stratified by quarter and correlated with the related auto contracts that have been similarly stratified by the number of quarters that have elapsed since date of purchase. This credit loss data is derived from “static pool” information that has been internally collected on the historical loss experience of BVAC’s portfolio of managed auto contracts. BVAC defines managed auto contracts as the sum of its warehouse inventory of auto contracts receivable plus auto contracts that have been securitized and/or sold with servicing retained by BVAC. We also use a secondary method for evaluating the sufficiency of the allowance for credit losses. This secondary method, a “roll rate” analysis, projects the migration of quarter-end auto contracts held-for-investment from current
payment status through 30-, 60- and 90-day delinquent status to charge-off and correlates this projection with loss reserve factors.
These methodologies incorporate quantitative as well as qualitative factors, including historical loss experience changes in underwriting practices, changes in the credit quality of contracts and an assessment of economic conditions.
Investment in Operating Lease Assets
We purchased auto leases, which are accounted for as operating leases, from March 1998 through June 2000. These purchases were recorded as fixed assets and are being depreciated on a straight-line basis over the respective lease terms to the estimated residual values of the leases. This depreciation and other related expenses, including the amortization of initial direct costs that are deferred and amortized over the lease term, are classified as noninterest expense. Lease payments received are recorded as noninterest income.
In accordance with the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we perform a quarterly impairment analysis of our long-lived assets, including our auto leases. A lease is considered impaired if its gross future undiscounted cash flows are less than the net book value of the lease. The net book value of the lease is defined as the original capitalized cost of the vehicle, including initial direct capitalized costs, less the cumulative amount of depreciation recorded against the vehicle and the cumulative amount of amortization of the initial direct capitalized costs recorded since the inception of the lease and less any impairment charges recorded-to-date on that lease.
In determining gross future undiscounted cash flows, we contract with Automotive Lease Guide, commonly referred to as ALG, to provide updated estimates of the residual value of the underlying vehicles comprising our portfolio of auto leases at the end of their lease terms, assuming that the vehicles are in average condition. This information is obtained from ALG on a quarterly basis. We then estimate the probability of one of three lease payoff scenarios occurring: (i.) the vehicle will be purchased by the lessee prior to the end of the lease term, (ii.) the vehicle will be purchased by the lessee at the end of the lease term, either at a discount or at the full contractual residual amount, or (iii.) the vehicle will be returned by the lessee at the end of the lease term. These probabilities are estimated using a number of factors, including our experience-to-date and industry experience.
Using the projected ALG residual values combined with our experience-to-date relative to our realization of projected ALG residual values, we reduce the projected ALG residual values to reflect our experience-to-date. This experiential analysis, along with the probabilities of each of the three disposition scenarios discussed above occurring, enables us to determine a probability-weighted gross future undiscounted cash flow for each vehicle lease. For those leases where the gross future undiscounted cash flows are less than net book value, the lease is considered impaired.
For those leases considered impaired, we then estimate the fair value of the lease. The fair value is determined by calculating the present value of the future estimated cash flows again assuming the probabilities of each of the three disposition scenarios. The present value is calculated using current market interest rates, which are similar to the original contract lease rates. For those impaired leases where the estimated fair value is less than the net book value, an impairment charge is recorded for the difference. Annual depreciation expense associated with those leases that have reduced residual values is recomputed over the remaining term of the lease.
Income Taxes
We file consolidated federal income tax returns in which our taxable income or loss is combined with that of our subsidiaries. Consolidated, combined and separate company state tax returns are filed in certain states, as applicable, including California. Each subsidiary’s share of income tax expense (benefit) is based on the amount that would be payable (receivable) if separate returns were filed.
At December 31, 2004, we had deferred tax assets of $21.2 million, consisting of net deferred tax assets of $42.7 million less a valuation allowance of $21.5 million. This valuation allowance was established in consideration of our projected future net income available to realize the deferred tax assets under the Amended Plan in years after 2004. The realization of deferred tax assets is dependent upon our ability to generate future taxable income.
Derivative Instruments
We use derivative instruments to reduce our exposure to interest rate risk embedded in our fixed-rate auto contracts which are funded by floating-rate financing. Rising interest rates reduce the net interest spread produced by our auto contracts, a primary component of our profitability, as well as the economic value of our inventory of auto contracts. Additionally, under the terms of our warehouse credit facility, the indenture trustee maintains derivative instruments to provide interest rate risk protection to our lenders. We account for these derivative instruments in accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivatives and Hedging Activities.”
Refer to “Balance Sheet Analysis” - “Borrowings, Warehouse Credit Facility” for additional comments about the derivative instruments maintained under the terms of our warehouse credit facility.
Statement No. 133 establishes accounting and reporting standards for derivative instruments and requires that derivative instruments (including certain derivative instruments embedded in other contracts) be recorded in the statement of financial condition as either an asset or liability measured at its fair value. Statement No. 133 further dictates that the accounting treatment for gains or losses from changes in the derivative instrument’s fair value is contingent on whether the derivative instrument qualifies as a hedge under the standard. Risk management instruments must qualify and be designated as hedges upon their inception and must be effective in substantially reducing the risk arising from the asset or liability identified as exposing the Company to risk throughout the hedge period in order to receive hedge accounting treatment. To qualify as hedges, among other things, risk management instruments must be linked to specific assets or liabilities or pools of similar assets or liabilities. If the derivative instrument does not qualify as a hedge, the gains or losses are reported in the consolidated statement of income when they occur. If the derivative instrument qualifies and is designated as a hedge under the standard, depending on the type of risk being hedged, the gains and losses are either reported in the consolidated statement of income, offsetting the fair value change in the hedged item, or reported as accumulated other comprehensive income in the equity section of the consolidated statement of financial condition. If a hedged asset or liability is sold or paid off before maturity of the hedging derivative, the derivative is closed out or settled, and any net settlement amount upon the close-out or termination of the derivative is recognized in earnings. The standard requires that an entity formally document, designate and assess the effectiveness of transactions that receive hedge accounting.
Our derivative instruments outstanding at December 31, 2004 were comprised of interest rate swap contracts and interest rate caps. In accordance with Statement No. 133, these derivative instruments are accounted for as assets or liabilities and recorded at fair value. Because these derivatives do not meet specific high correlation tests required to use hedge accounting, changes in fair values are charged or credited to earnings.
Prior to our re-adoption of going concern basis accounting, we accounted for changes in the market value of derivative instruments using liquidation basis accounting. Changes in the market value of these derivative instruments were reflected in our consolidated statements of net assets in liquidation under pre-tax loss from operations, while offsetting changes in the market value of underlying auto contracts were included in changes in estimated values of assets and liabilities. Refer to Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Asset/Liability Management
Interest rate risk, the fluctuation of market interest rates, impacts the value of our fixed-rate auto contracts. It also impacts the net interest income component of our earnings because BVAC funds the purchase of fixed-rate auto contracts with its warehouse credit facility, which is a floating-rate facility. The rate on the warehouse facility, a revolving purchase facility, is tied to the one-month Libor rate as well as commercial paper rates and subject to frequent adjustments.
Fixed-rate Auto Contracts
BVAC purchases these fixed-rate auto contracts primarily for sale or for on- or off-balance sheet securitization. Investors in these securitization or whole loan sale transactions require a yield that is commensurate with prevailing market interest rates. The prices offered by investors in these transactions reflect prevailing market interest rates at the time of these transactions, which creates interest rate risk for us during the period BVAC warehouses, or owns, these fixed-rate auto contracts. Accordingly, our earnings are affected by changes in prevailing market interest rates. Rising market interest rates generally reduce the value of BVAC’s fixed-rate auto contracts.
Net Interest Income
BVAC funds purchases of fixed-rate auto contracts with its floating-rate warehouse credit facility. While BVAC owns these contracts, we earn net interest income, which is defined as the amount by which interest income earned on the contracts exceeds the interest paid on BVAC’s warehouse credit facility. Changes in prevailing market interest rates produce corresponding changes in the cost of BVAC’s floating-rate warehouse credit facility thereby creating interest rate risk. Rising market interest rates generally increase the interest expense we incur on BVAC’s warehouse credit facility, thereby reducing the net interest income we earn.
To protect us from interest rate risk, we may use various derivative financial instruments, including interest rate swap contracts, to protect the market value of BVAC’s warehouse inventory of auto contracts and the net interest income produced by its warehouse inventory. The market value of these derivative instruments is designed to respond inversely to the market value of BVAC’s warehouse inventory resulting from changes in prevailing market interest rates. We may enter into these agreements as BVAC purchases auto contracts; and the agreements may be closed out at the time the underlying auto contracts are securitized or sold.
At December 31, 2004, we had outstanding swap contracts with a total notional amount of $145.0 million under which we pay a fixed interest rate of 3.16% and receive a floating interest rate of 2.37%. These contracts mature from May 2005 to May 2008. At December 31, 2004, we had an unrealized gain of $0.4 million in our swap contracts and estimate that an increase in market interest rates of 100 and 200 basis points would have resulted in an approximate unrealized gain of $2.4 million and $4.6 million, respectively, while a decrease in interest rates of 100 basis points would have resulted in an approximate unrealized loss of $2.4 million.
Warehouse Credit Facility
As discussed above, auto contracts pledged to secure borrowings under BVAC’s warehouse credit facility bear fixed interest rates while amounts borrowed under BVAC’s warehouse credit facility bear a floating interest rate. To provide protection to the Note Purchasers from interest rate risk embedded in the fixed-rate auto contracts that have been transferred to the trust, the trust enters into out-of-the-money, interest rate cap contracts, containing the terms and conditions required by the Note Purchasers. Refer to “Balance Sheet Analysis” - “Borrowings, Warehouse Credit Facility” for additional comments about these interest rate cap contracts maintained under the terms of our warehouse line of credit.
Derivative financial instruments involve, to varying degrees, elements of credit risk. Credit risk is defined as the possibility of sustaining a loss because a counterparty to a financial instrument failed to perform in accordance with the terms of the contract. Refer to “Critical Accounting Policies, Derivatives” for comments about the accounting for our derivative instruments.
The following table provides information about the Company’s interest rate-sensitive financial instruments by expected maturity date as of December 31, 2004 (dollars in thousands):
Item 8.
Item 8. Financial Statements and Supplementary Data
Bay View Capital Corporation and Subsidiaries
Consolidated Statements of Financial Condition
See notes to consolidated financial statements.
Bay View Capital Corporation and Subsidiaries
Consolidated Statements of Operations and Comprehensive Loss
See notes to consolidated financial statements.
Bay View Capital Corporation and Subsidiaries
Consolidated Statements of Changes in Net Assets in Liquidation (Liquidation Basis)
See notes to consolidated financial statements.
Bay View Capital Corporation and Subsidiaries
Consolidated Statement of Operations and Comprehensive Income
Bay View Capital Corporation and Subsidiaries
Consolidated Statement of Operations and Comprehensive Income (continued)
See notes to consolidated financial statements.
Bay View Capital Corporation and Subsidiaries
Consolidated Statements of Stockholders’ Equity and Net Assets in Liquidation
See notes to consolidated financial statements.
Bay View Capital Corporation and Subsidiaries
Consolidated Statements of Cash Flows
Bay View Capital Corporation and Subsidiaries
Consolidated Statements of Cash Flows (continued)
See notes to the consolidated financial statements.
Bay View Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
Note 1. Basis of Presentation
Bay View Capital Corporation (the “Company,” “we,” “us” or “our”) is a financial services company headquartered in San Mateo, California.
The accompanying consolidated financial statements include the accounts of the Company, a Delaware corporation, and our wholly owned subsidiaries: Bay View Acceptance Corporation (“BVAC”), a Nevada corporation, along with its subsidiaries, Bay View Receivables Corporation, a Delaware corporation and Bay View Transaction Corporation, a Delaware corporation; and our subsidiaries, Bay View Securitization Corporation, a Delaware corporation; Bay View Capital I, a Delaware business trust; FMAC Insurance Services, a Delaware corporation; FMAC 2000-A Holding Company, a California corporation; FMAC Franchise Receivables Corporation, a California corporation; Bay View Commercial Finance Group, a California corporation; XBVBKRS, Inc., a California corporation; MoneyCare, Inc., a California corporation; Bay View Auxiliary Corporation, a California corporation; and Bay View Bank, N.A. (the “Bank”), a national bank which was dissolved effective September 30, 2003. All significant intercompany accounts and transactions have been eliminated.
The consolidated financial statements as of December 31, 2004 and 2003 and for the year ended December 31, 2004, the three months ended December 31, 2003 and the nine months ended September 30, 2002 have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), on a going concern basis. The consolidated financial statements for the nine months ended September 30, 2003 and for the three months ended December 31, 2002 have been prepared, in accordance with GAAP, under liquidation basis accounting.
On June 30, 2004, the Company effected a 1-for-10 reverse stock split of the issued and outstanding shares of the Company’s common stock, and as a result, the number of issued shares was reduced from 65,910,689 shares prior to the reverse stock split to 6,590,461 shares following the reverse stock split, including an adjustment for fractional shares. The Company’s issued common stock totaled 6,597,303 shares at December 31, 2004. The reverse stock split did not impact the par value of the common stock, which remains at $0.01 per share. Accordingly, the aggregate value of the issued common stock on the Company’s balance sheet was reduced by reclassifying the cumulative par value of the eliminated shares of common stock to additional paid-in capital. All shares outstanding and per share amounts are presented on a post-reverse stock split basis for all periods reported.
Plan of Dissolution and Stockholder Liquidity
On October 3, 2002, a special meeting of the Company’s stockholders was held to vote on the Company’s proposed plan of dissolution and stockholder liquidity (“the Plan”) and the sale of the Bank’s retail banking assets to U.S. Bank. Both of these proposals were approved by a majority of the common stockholders. As a result of these approvals and the close of the U.S. Bank transaction on November 1, 2002, the Company adopted liquidation basis accounting effective September 30, 2002 in accordance with GAAP. Accordingly, assets were valued at their estimated net realizable values and liabilities included accruals for estimated costs associated with carrying out the Plan. In accordance with liquidation basis accounting, our stockholders’ equity was transferred to net assets in liquidation. Our net assets in liquidation totaled $410.1 million at December 31, 2002 or $64.30 in net assets in liquidation per outstanding share based on 6,374,716 diluted shares in liquidation.
The Plan outlined the steps necessary to liquidate the Company, including the sale of the Bank’s retail banking assets to U.S. Bank. Following the sale, the remaining assets of the Company were to be sold in an orderly manner and the liabilities and expenses were to be paid, including the outstanding debt of both the Company and the Bank and the Capital Securities. Once these transactions were completed, the Company would distribute the net proceeds of the asset sales to its stockholders.
On November 1, 2002, the Company completed the U.S. Bank transaction. At the closing of the transaction, U.S. Bank paid the Bank the sum of: (i) a 14% deposit premium (based on the average daily balances of deposits for the 30 calendar days ending on the business day prior to the closing date) plus $5.0 million, or approximately $463.7 million; (ii) the principal amount of the loans acquired of approximately $337.2 million less a loan loss reserve of approximately $2.2 million; (iii) the net book value of real property and personal property utilized by the branches and improvements thereto and other assets assumed of approximately $15.2 million and (iv) the face amount of coins and currency of approximately $9.8 million. The Bank paid to U.S. Bank at the closing an amount equal to the deposits being assumed by U.S. Bank of approximately $3.3 billion, less the amounts payable by U.S. Bank to the Bank as described above.
The Company and the Bank obtained regulatory approvals necessary for the early redemption of their outstanding debt securities in the fourth quarter of 2002. The Company’s $100.0 million of 9.125% Subordinated Notes were redeemed at the applicable price of par plus a premium of 4.563% on November 29, 2002 and the Bank’s $50.0 million of 10% Subordinated Notes were redeemed at par on December 9, 2002.
After receiving the required regulatory approvals, the Company paid the accrued distributions and interest of $24.5 million on the Capital Securities on December 31, 2002.
The Company initially recorded pre-tax income totaling $266.5 million related to the mark-to-market adjustments in its assets and liabilities in connection with its adoption of liquidation basis accounting for the quarter ended September 30, 2002. The valuation adjustments primarily consisted of the following:
• $463.7 million deposit premium, which was calculated as 14% of non-brokered retail deposits based on October average deposit levels plus $5.0 million pursuant to the agreement with U.S. Bank;
• $91.0 million reduction in goodwill related to the deposits being sold;
• $37.0 million mark-to-market reduction related to loan balances reflecting the Company’s estimated net realizable value of its remaining loan portfolios under an accelerated timeline to sell such loans pursuant to the plan of dissolution and stockholder liquidity;
• $51.1 million in charges related to the sale of the Company’s retail banking assets including $26.6 million in severance payments, $12.7 million in investment banking and other professional fees, and $11.8 million in net accruals for closed facilities and other contracts and settlements;
• $8.8 million in charges related to the prepayment of the Company’s and the Bank’s Subordinated Notes including a $4.2 million write-off of issuance costs and $4.6 million in prepayment penalties;
• $4.9 million write-off of franchise loan securitization residual assets; and
• $3.7 million write-off of unamortized issuance costs on the Capital Securities in anticipation of these securities being called in 2003.
The Company recorded an additional $6.0 million and $2.8 million net pre-tax adjustments related to mark-to-market valuation of its assets and liabilities for the first nine months of 2003 and the quarter ended December 31, 2002, respectively. The valuation adjustments were primarily due to decreases in the market value of the auto lease and the loan portfolio.
Plan of Partial Liquidation
Because of changing market conditions in the auto finance sector, we believed that the near-term sale or distribution of the stock of BVAC to stockholders was no longer the best method of achieving maximum stockholder value. Accordingly, during the fourth quarter of 2003, the Company’s Board of Directors amended the Plan and converted it to a plan of partial liquidation (the “Amended Plan”) under which the Company will complete the liquidation of the assets and satisfaction of the liabilities it assumed from the Bank after the Bank’s September 30, 2003 dissolution, distribute the proceeds to its stockholders through a series of cash distributions, and continue to operate BVAC on an ongoing basis. In accordance with the Amended Plan, the Company distributed $40.00 per share in cash to common stockholders on December 30, 2003. The Company intends to make further distributions of the proceeds to its stockholders through a series of cash distributions.
The decision to engage in a partial liquidation and continue to operate BVAC on an ongoing basis, warranted the termination of our use of the liquidation basis of accounting. Effective October 1, 2003, the Company discontinued the use of the liquidation basis of accounting and re-adopted the going concern basis of accounting. Accordingly, the Company re-established its stockholders’ equity effective October 1, 2003. For the period from September 30, 2002 through September 30, 2003, the Company used the liquidation basis of accounting.
In connection with its re-adoption of the going concern basis of accounting, we recognized $0.7 million of pre-tax expense and $1.1 million of additions to stockholders’ equity, recording the following adjustments -
• Goodwill: Re-established the $1.8 million of goodwill that existed prior to our adoption of the liquidation basis of accounting; this goodwill related to our acquisition of BVAC’s predecessor entity, California Thrift & Loan
• Premium on investment in BVAC: Reversed $10.0 million of premium over the book value of BVAC, which was recorded as deferred gain under the liquidation basis of accounting, restoring the historical cost basis in our equity investment in BVAC
• Installment contracts: Reversed unrealized gains which were recorded under the liquidation basis of accounting and restored the lower of cost or market valuation
• Mortgage-backed securities: Restored Statement No. 115 available-for-sale accounting
• Accrued liabilities: Reversed $1.7 million of accruals related to certain severance and occupancy costs which were recorded under the liquidation basis of accounting
• Stockholders’ equity: Restored stockholders’ equity as of October 1, 2003
In accordance with the Amended Plan, the Company made an initial cash distribution of $263.2 million, or $40.00 per share to its stockholders on December 30, 2003. The Company also paid cash distributions of $2.50 per share at June 30, 2004, $2.50 per share at September 30, 2004 and $2.25 per share at December 31, 2004 for a total of $47.8 million.
Note 2. Summary of Significant Accounting Policies
Going Concern Basis
The Company’s reported financial position as of December 31, 2004 and 2003, and its results of operations for the year ended December 31, 2004, the three-month period ended December 31, 2003 and the nine-month period ended September 30, 2002 have been prepared on a going concern basis. The following is a description of the significant accounting policies applicable to these financial statements.
Basis of Financial Presentation and Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures 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. Material estimates particularly susceptible to possible changes in the near term relate to the determination of the allowance for credit losses, the investment in operating lease assets, retained interests in securitizations and deferred tax assets.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and highly liquid financial instruments, with maturities of 90 days or less at the time of purchase, that are readily convertible into cash and are so near their maturity that they present insignificant risk of changes in value.
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 with banks.
Restricted Cash
Restricted cash includes cash collateral provided to counterparties to BVAC’s hedging contracts to meet margin requirements, cash collateral provided to cure potential borrowing base deficiencies on BVAC’s warehouse credit facility, cash payments received from our customers that are in-transit to trust accounts for BVAC’s auto securitization trusts, cash collateral pledged to secure a letter of credit, and cash collateral pledged in connection with financing secured by the Company’s auto lease portfolio cash flows as well as cash collateral pledged in connection with the Company’s servicing of a multi-family loan pool and other contractual obligations.
Securities
Securities are identified as either available-for-sale or held-to-maturity at purchase and 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. 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 securities, using the specific identification method. Historically, unrealized losses on securities were realized and charged against earnings when it was determined that a decline in value which was other than temporary had occurred.
Discounts and premiums on securities are amortized into interest income using a method approximating the effective interest method over the estimated life of the security, adjusted for actual prepayments.
Loans and Leases
The Company continues to purchase auto contracts through BVAC but ceased all other loan production activities during the fourth quarter of 2002.
Auto Contracts
Auto contracts purchased by the Company are designated as either held-for-sale or held-for-investment.
Auto contracts held-for-sale are classified as such because the Company does not intend to hold these contracts to maturity. Auto contracts designated as held-for-sale are recorded at cost including premiums paid to dealers, and deferred fees and costs, and are subsequently carried at the lower of cost or estimated fair value. Estimated fair value for these contracts is based on prices for similar contracts in the secondary whole loan or securitization markets. Net unrealized losses, if any, are recognized through a valuation allowance by charges to earnings. When a contract held-for-sale is either charged-off or paid off, unamortized dealer premiums, and deferred fees and costs are written off against noninterest income.
All other auto contracts are designated as held-for-investment and are recorded at cost
including premiums paid to dealers, and deferred fees and costs. The dealer premiums, and deferred fees and costs are capitalized at the time the loan is granted. The Company recognizes these dealer premiums, and deferred fees and costs as yield adjustments over the life of the related contracts using an amortization method approximating the effective interest method. When a contract is charged-off, sold or paid off, unamortized dealer premiums, and deferred fees and costs are written off against interest income at that time.
Auto contracts transferred from the held-for-sale portfolio to the held-for-investment portfolio are recorded at the lower of cost or estimated fair value upon transfer.
Nonperforming auto contracts are defined as contracts which are 90 days or more delinquent as to principal and interest payments unless the principal and interest are well secured and in the process of collection. The Company charges off auto contracts and reverses related accrued interest receivable when the contracts become 120 days delinquent. The Company may also designate contracts which are less than 90 days delinquent as nonperforming when the full collection of principal and/or interest is doubtful. The Company generally recognizes interest income on impaired contracts on a cash basis when received.
Other Loans
Prior to September 30, 2002, the Company originated or purchased single-family, multi-family and commercial real estate loans, home equity loans and lines of credit, franchise loans, asset-based loans, factoring loans and commercial leases. The Company ceased its single-family loan origination operations in 1996. Loans and leases that were originated or purchased were identified as either held-for-sale or held-for-investment. Loans and leases held-for-investment were recorded at cost including premiums or discounts, deferred fees and costs and the allowance for credit losses. Loans and leases classified as held-for-sale primarily consisted of franchise loans. Loans and leases classified as held-for-sale were carried at the lower of cost or market on an aggregate basis for each loan and lease
type. Market value for these loans and leases was based on prices for similar loans and leases in the secondary whole loan or securitization markets or estimates of proceeds to be obtained through a workout and payoff. Interest on loans and leases was accrued as income to the extent considered collectible. Loans and leases classified as held-for-investment were carried at amortized cost and were not adjusted to the lower of cost or market because the Company had the ability and the intent to hold these loans and leases for the foreseeable future. Generally, interest accruals on loans and leases 90 days or more past due were discontinued. Interest income on nonaccrual loans and leases was generally recognized on a cash basis when received.
The Company charged fees for originating loans and leases at the time the loan or lease was granted. The origination fees were recognized, net of certain direct costs where applicable, as a yield adjustment over the life of the related loan or lease using the effective interest method or an approximate equivalent if not materially different. Amortization of net deferred origination fees was discontinued on nonperforming loans and leases. When a loan or lease paid off, unamortized net deferred origination fees were included in interest income at that time. When a loan or lease was sold, unamortized net deferred origination fees were included in the gain or loss on the sale.
Impairment of a loan occurs when, based on current information and events, it was probable that the Company was unable to collect all amounts due according to the contractual terms of the loan agreement. The Company considered nonperforming loans and troubled debt restructurings as impaired loans. Nonperforming loans were defined as loans 90 days or more delinquent as to principal and interest payments unless the principal and interest were well secured and in the process of collection. The Company also designated loans less than 90 days delinquent as nonperforming when the full collection of principal and/or interest was doubtful. Troubled debt restructurings were loans which were modified based upon interest rate concessions and/or payment concessions. Homogeneous loans were collectively evaluated on an aggregate basis for impairment. The Company historically considered its single-family residential and home equity loans as homogeneous loans. Impaired loans were measured based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical equivalent, at the loan’s observable market price or the fair value of the collateral if the loan was collateral dependent. Impaired real estate-based loans were generally measured based on the fair value of the collateral because they were collateral dependent. The Company generally recognized interest income on impaired loans on a cash basis when received.
Charge-offs were recorded on impaired loans through September 30, 2002 for the difference between the valuation of the loan and the recorded investment, net of any specific allowance. In determining charge-offs for specific loans, management evaluated the creditworthiness and financial status of the borrower and also analyzed cash flows and current property appraisals.
Allowance for Credit Losses
The allowance for credit losses on auto contracts held-for-investment is established through a provision charged to expense and maintained at a level that the Company believes is sufficient to cover estimated probable losses in this loan portfolio. The Company considers BVAC’s portfolio of auto contracts to be comprised of relatively small balance, homogeneous receivables and, accordingly, determines its allowance for credit losses in accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies.” The allowance for credit losses is evaluated and adjusted on a quarterly basis.
In determining the level of the allowance for credit losses, the Company evaluates BVAC’s auto contracts held-for-investment using two methodologies. The primary methodology is based upon an analysis of BVAC’s historical loss experience using a “vintage” analysis of its past purchases of auto contracts from which BVAC predicts probable losses that are inherent in its portfolio of auto contracts held-for-investment. Under this method, the Company’s historical credit loss experience is stratified by quarter and correlated with the related auto contracts that have been similarly stratified by the number of quarters that have elapsed since date of purchase. This credit loss data is derived from “static pool” information that has been internally collected on the historical loss experience of the BVAC’s portfolio of managed auto contracts. The Company defines managed auto contracts as the sum of BVAC’s warehouse inventory of auto contracts receivable plus auto contracts that have been securitized and/or sold with
servicing retained by BVAC. The Company also uses a secondary method for evaluating the allowance for credit losses. This secondary method, a “roll rate” analysis, projects the migration of quarter-end auto contracts held-for-investment from current payment status through 30- , 60- and 90-day delinquent status to charge-off and correlates this projection with loss reserve factors.
These methodologies incorporate quantitative as well as qualitative factors, including historical loss experience, changes in underwriting practices, changes in the credit quality of contracts and an assessment of economic conditions.
Loan Sales and Retained Interests in Securitizations
BVAC has periodically transferred a portion of its warehouse inventory of auto contracts held-for-sale to trusts that, in turn, issue asset-backed securities to investors. The Company has structured these transactions as sales in accordance with Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” and recognized a gain on the sale of the auto contracts to the trusts - which represents the difference between the sum of sale proceeds, net of transaction costs, and cash deposited into a securitization trust account in order to enhance the credit rating of the asset-backed securities and the sum of the Company’s net carrying value of the auto contracts and the present value of future excess cash flow anticipated to be distributed to us by the trust over the life of the asset-backed securities - and an asset which is referred to as a “retained interest” in the securitization.
The retained interest is comprised of the cash initially deposited into the securitization trust account and the present value of the future excess cash flow anticipated to be distributed to the Company by the trust over the life of the asset-backed securities. These estimated future cash flows - which are comprised of interest income received on the auto contracts less interest paid to investors in the asset-backed securities, credit losses and trust expenses - are initially retained by the trust to build the trust cash account to pre-designated levels and provide further credit enhancement. Once the pre-designated levels of cash are attained, the trust distributes the excess cash flow to BVAC. In recording the gain on sale and the retained interest, the Company has made assumptions in calculating the present value of the future excess cash flow anticipated to be distributed to the Company by the trust over the life of the asset-backed securities and recording the retained interest.
The Company designates retained interests as available-for-sale and carries them at fair value. Retained interests are subordinate to investor interests in the related asset-backed securities, their value is subject to credit and prepayment risks in the pool of underlying auto contracts. The Company is not aware of an active secondary market for retained interests and, accordingly, estimates the fair value of its retained interests by calculating the present value of the future excess cash flow anticipated to be received, using management’s best estimates of key valuation assumptions including credit losses, prepayment speeds and discount rates commensurate with the underlying risks in the anticipated future cash flow. Changes in these assumptions due to differing actual experience or market conditions could affect the value of the Company’s retained interests.
During 2002, the Company wrote off the balance of its retained interests in franchise loan securitizations totaling $4.9 million upon its adoption of liquidation basis accounting. There were no impairment charges related to retained interests during 2004 and 2003. The Company recorded impairment charges relating to retained interests of $12.6 million for the year ended December 31, 2002.
Loan Sales and Servicing
Prior to adopting Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” the Company recorded servicing assets, in accordance with Statement of Financial Accounting Standards No. 125, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” for the present value of any retained interest in a transferred asset representing servicing fees net of related costs. Retained interests in excess of such servicing fees were recorded on a net present value basis and classified as available-for-sale securities at fair value. There were no servicing assets at December 31, 2004. The balance of these assets was $0.1 million at December 31, 2003. There were no impairment charges for 2004 and 2003. Amortization of servicing assets and any related impairments are included in noninterest income and noninterest expense, respectively, as the associated servicing revenue is received and expenses are incurred.
Gains or losses on the securitizations and/or sales of loans and leases were recorded in earnings at the time of the transaction when control over the loans and leases was surrendered and consideration other than beneficial interests in the loans and leases was received.
Investment in Operating Lease Assets
The Company purchased and/or originated auto leases characterized as operating leases from March 1998 through June 2000. The asset was recorded as a fixed asset and depreciated on a straight-line basis over the lease term to its estimated residual value. This depreciation and other related expenses, including the amortization of initial direct costs that are deferred and amortized over the lease term, are classified as noninterest expense. Lease payments received are recorded as noninterest income. Lease asset balances were $37.3 million and $139.4 million at December 31, 2004 and 2003, respectively. Accumulated depreciation and amortization related to the lease assets totaled $27.3 million and $72.7 million at December 31, 2004 and 2003, respectively. At December 31, 2004, future minimum lease payments to be received by the Company under operating leases were $1.7 million for the year ending December 31, 2005.
The Company performs a quarterly impairment analysis of its automobile operating lease portfolio in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which the Company adopted effective January 1, 2002. There was no financial statement impact upon adoption of Statement No. 144. A lease is considered impaired if its gross future undiscounted cash flows are less than the net book value of the lease. The net book value of the lease is defined as the original capitalized cost of the automobile, including initial direct capitalized costs, less the cumulative amount of depreciation recorded against the automobile and the cumulative amount of amortization of the initial direct capitalized costs recorded since the inception of the lease and less any impairment charges recorded-to-date on that lease.
In determining gross future undiscounted cash flows, the Company contracts with Automotive Lease Guide, commonly referred to as ALG, to provide estimates of the residual value of the underlying vehicles at the end of their lease terms assuming that the vehicles are in average condition. The Company then estimates the probability that (i.) the automobiles will be purchased by the lessee prior to the end of the lease term, (ii.) the automobile will be purchased by the lessee at the end of the lease term, either at a discount or at the full contractual residual amount, or (iii.) the automobile will be returned at the end of the lease term. These probabilities are estimated using a number of factors, including the Company’s experience-to-date and industry experience.
Using the projected ALG residual values, the Company’s experience-to-date relative to the projected ALG residual values (for example, for vehicle classes where actual amounts realized were less than what ALG had projected, the Company reduces the projected ALG residual values to equal the Company’s experience-to-date), and the probabilities of each of the three disposition scenarios discussed above occurring, the Company determines a probability-weighted gross future undiscounted cash flow for each automobile lease. For those leases where the gross future undiscounted cash flows are less than net book value, the lease is considered impaired.
For those leases considered impaired, the Company then estimates the fair value of the lease. The fair value is determined by calculating the present value of the future estimated cash flows again assuming the probabilities of each of the three disposition scenarios. The present value is calculated using current market rates, which the Company estimates as the original contract lease rate. An impairment charge is then recorded for the difference between the carrying value and the estimated fair value. There were no impairment charges recorded for the year ended December 31, 2004. The Company recorded impairment charges of $8.5 million for the year ended December 31, 2003. At December 31, 2004, there were no vehicles in the Company’s auto lease portfolio that were considered impaired under Statement No. 144. At December 31, 2004 and 2003, the Company had allowances of $6.1 million and $18.0 million, respectively, for impairment and additional monthly depreciation charges, net of losses, against its automobile operating lease portfolio.
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. The difference upon foreclosure, if any, is charged to earnings for adverse changes in the fair value of the property. Prior to September 2002, the difference upon foreclosure, if any, was charged-off against the allowance for losses on loans and leases. Revenues and other expenses associated with real estate owned are realized and reported as a component of noninterest expense when incurred.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis over the estimated useful lives for each of the various asset categories. These useful lives range from two to ten years.
Intangible Assets
Goodwill and other intangible assets were written off as of September 30, 2002 with the adoption of liquidation basis accounting. The goodwill and core deposit intangibles associated with the deposits sold to U.S. Bank were realized in anticipation of the close of that transaction. As a result of the Company’s re-adoption of going concern basis accounting as of October 1, 2003, goodwill of $1.8 million was re-established in BVAC related to the acquisition of California Thrift & Loan in 1996. As required by the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” which the Company adopted as of January 1, 2002, this goodwill is tested for impairment annually.
During 2002, the Company recorded $18.9 million in impairment charges, net of taxes, for goodwill related to three of the Company’s commercial lending businesses which was not expected to be realized upon the disposition of these businesses. As required by the transitional provisions of Statement No. 142, the impairment loss was measured and recorded as of the date of adoption and recognized as the cumulative effect of a change in accounting principle as of January 1, 2002.
Prior to September 30, 2002, core deposit premiums arose from the purchase of deposits and were amortized using an accelerated method over the estimated life of the deposit base acquired, generally eight to ten years. The Company continually evaluated the periods of amortization to determine whether later events and circumstances warranted revised estimates. In addition, the market value of core deposit premiums was re-evaluated on an annual basis to assess if any impairment existed and to determine the carrying value that was eligible to be included as a component of regulatory capital. Goodwill was amortized to expense on a straight-line basis over periods of up to 20 years. On a periodic basis, the Company reviewed its goodwill for events or changes in circumstances that indicated that the estimated undiscounted future cash flows from these acquisitions was less than the carrying amount of the goodwill. If it became probable that impairment existed, a reduction in the carrying amount was recognized.
Income Taxes
The Company files consolidated federal income tax returns in which its taxable income or loss is combined with that of its subsidiaries. Consolidated, combined and separate company state tax returns are filed in certain states, as applicable, including California. Each subsidiary’s share of income tax expense (benefit) is based on the amount which would be payable (receivable) if separate returns were filed.
The Company’s income tax provisions are based upon income taxes payable for the current period as well as current period changes in deferred income taxes. Deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory income tax 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 income taxes for a change in tax rates is recognized through the provision for income taxes during the period of enactment.
Liquidation Reserve
The liquidation reserve represents a liability for estimated severance, costs related to facilities closures, estimated litigation settlements and related legal costs and other costs associated with the completion of remaining liquidating activities arising from the Company’s adoption of the Amended Plan during the fourth quarter of 2003, and its resultant re-adoption of going concern basis accounting as of October 1, 2003. The liquidation reserve is accounted for in accordance with Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.”
At December 31, 2004, the remaining balance of the liquidation reserve was $8.9 million including accruals for severance, facilities, and litigation and other costs of $1.3 million, $6.0 million and $1.5 million, respectively. The following table sets forth balances and activity in the liquidation reserve as of and for the periods indicated:
Derivative Instruments
The Company uses derivative instruments to reduce its exposure to interest rate risk embedded in BVAC’s fixed-rate auto contracts which are funded by floating-rate financing. Rising interest rates reduce the net interest spread produced by the auto contracts, a primary component of our profitability, as well as the economic value of the inventory of auto contracts. Additionally, under the terms of BVAC’s warehouse credit facility, the indenture trustee maintains derivative instruments to provide interest rate risk protection to BVAC’s lenders. We account for these derivative instruments in accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivatives and Hedging Activities.”
Statement No. 133 establishes accounting and reporting standards for derivative instruments and requires that derivative instruments (including certain derivative instruments embedded in other contracts) be recorded in the statement of financial condition as either an asset or liability measured at its fair value. Statement No. 133 further dictates that the accounting treatment for gains or losses from changes in the derivative instrument’s fair value is contingent on whether the derivative instrument qualifies as a hedge under the standard. Derivative instruments must qualify and be designated as hedges upon their inception and must be effective in substantially reducing the risk arising from the asset or liability identified as exposing the Company to risk throughout the hedge period in order to receive hedge accounting treatment. To qualify as hedges, among other things, derivative instruments must be linked to specific assets or liabilities or pools of similar assets or liabilities. If the derivative instrument does not qualify as a hedge, the gains or losses are reported in the consolidated statement of income when they occur. If the derivative instrument qualifies and is designated as a hedge under the standard, depending on the type of risk being hedged, the gains and losses are either reported in the consolidated statement of income, offsetting the fair value change in the hedged item, or reported as accumulated other comprehensive income in the equity section of the consolidated statement of financial condition. If a hedged asset or liability is sold or paid off before maturity of the hedging derivative, the derivative is closed out or settled, and any net settlement amount upon the close-out or termination of the derivative is recognized in earnings. The standard requires that an entity formally document, designate and assess the effectiveness of transactions that receive hedge accounting.
The Company’s derivative instruments outstanding at December 31, 2004 were comprised of interest rate swap contracts and interest rate caps. In accordance with Statement No. 133, these derivative instruments are accounted for as assets or liabilities and recorded at fair value. Because these derivatives were not formally designated as hedges, which is required to use hedge accounting, changes in fair values are charged or credited to earnings.
In using derivative instruments, the Company is exposed to potential losses (credit risk) in the event of nonperformance by the counterparties to the agreements. The Company manages the credit risk associated with derivative instruments by adhering to a strict counterparty selection process and by establishing maximum exposure limits with individual counterparties.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” amends Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” and provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also amends required disclosures about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.
Statement No. 123 established financial accounting and reporting standards for stock-based compensation plans, including employee stock purchase plans, stock options and restricted stock. Statement No. 123 encourages all entities to adopt a fair value method of accounting for stock-based compensation plans, whereby compensation cost is measured at the grant date based upon the fair value of the award and is realized as an expense over the service or vesting period. However, Statement No. 123 also allowed an entity to continue to measure compensation cost for these plans using the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.”
The Company accounts for stock-based awards to employees and directors using the intrinsic value method of accounting in accordance with Accounting Principles Board Opinion (“APB”) No. 25. Under the intrinsic value method, compensation cost is generally the excess, if any, of the quoted market price of the stock at the grant or other measurement date over the exercise price. The Company adopted the disclosure requirements of Statement No. 148 as of December 31, 2002.
Compensation expense of $2.0 million was recorded in 2002 based on APB 25. There was no compensation expense recorded under APB 25 for the year ended December 31, 2004 and the three months ended December 31, 2003. Had compensation expense related to the Company’s stock option awards to employees and directors been determined under the fair value method prescribed under Statement No. 123, it would have recorded an additional $2.0 million of expense in 2002. Pro forma calculations of the net loss and loss per share are set forth in the table below for the periods indicated:
Earnings (Loss) Per Share
From September 30, 2002 through September 30, 2003, the Company reported its results using liquidation basis accounting, under which earnings per share information is not presented. Accordingly, the earnings (loss) per share information set forth below is for reporting periods where the Company used going concern basis accounting to report its results of operations.
Basic earnings (loss) per share is calculated by dividing net earnings or loss for the period by the weighted-average common shares outstanding for that period; there is no adjustment to the number of outstanding shares for potential dilutive instruments, such as stock options. Diluted earnings (loss) per share takes into account the potential dilutive impact of such instruments and uses the average share price for the period in determining the number of incremental shares to add to the weighted-average number of shares outstanding. For the year ended December 31, 2004 and the three months ended December 31, 2003, weighted-average dilutive potential common shares of 9,389 and 39,068 respectively, related to shares issuable upon the exercise of options were not included in the computation because they were anti-dilutive solely as a result of the Company’s net loss for the respective periods. For the year ended December 31, 2004 and the three months ended December 31, 2003, there were potential common shares of 84,100 and 86,730, respectively, related to shares issuable upon the exercise of options that could potentially dilute basic earnings per share in the future that were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the respective periods.
The following table illustrates the calculation of basic and diluted earnings (loss) per share for the periods indicated:
Accounting Changes and Recent Accounting Pronouncements
In March 2004, the FASB Emerging Issues Task Force (EITF) released Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-1 provides guidance for determining whether impairment for certain debt and equity investments is other-than-temporary and the measurement of an impaired loss. Certain disclosure requirements of EITF 03-1 were adopted in 2003 and the Company has complied with the new disclosure requirements in its consolidated financial statements. The recognition and measurement requirements of EITF 03-1 were initially effective for reporting periods beginning after June 15, 2004. In September 2004, the FASB Staff issued FASB Staff Position (“FSP”) EITF 03-1-1 that delayed the
effective date for certain measurement and recognition guidance contained in EITF 03-1. The FSP requires that entities continue to apply previously existing “other-than-temporary” guidance until a final consensus is reached. Management does not anticipate that issuance of a final consensus will materially impact the Company’s financial condition or results of operations.
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123-R, “Share-Based Payments,” a revision to Statement No. 123. Statement No. 123-R requires that a public entity measure the cost of equity based service awards based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period, usually the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. A public entity will initially measure the cost of liability based service awards based on its current fair value; the fair value of that award will be re-measured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period. Statement No. 123-R eliminates the alternative to use the intrinsic value method of accounting under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” that was provided in Statement No. 123 as originally issued. Adoption of Statement No. 123-R is required for fiscal periods beginning after June 15, 2005. The Company is evaluating Statement No. 123-R but does not expect adoption to have a material impact on its financial condition, results of operations or cash flows.
Reclassifications
In addition to the reclassifications discussed above, certain other reclassifications have been made to prior year balances in order to conform to the current year presentation.
Liquidation Basis
The following is a description of the significant accounting policies applicable to the Company’s valuation of assets and liabilities under liquidation basis accounting for the period September 30, 2002 through September 30, 2003. Only those policies that are different from going concern basis are included.
Basis of Financial Presentation and Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts of assets and liabilities as reported in the consolidated statement of net assets (liquidation basis) and disclosures 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. Material estimates particularly susceptible to possible changes in the near term relate to the determination of the mark-to-market adjustments on loans and leases, investment in operating lease assets and deferred tax assets.
Securities
All securities were classified as available-for-sale and reported at net realizable value. Valuations were determined from published information or quotes by registered securities brokers. Securities for which quotes were not readily available were valued based on the present value of estimated future cash flows. Adjustments to net realizable value, if any, were recorded on a quarterly basis in earnings through the adjustment for liquidation basis. Interest on securities continued to be accrued as income to the extent considered collectible.
Loans and Leases
All loans and leases were classified as held-for-sale and reported at net realizable value. Net realizable value for these loans and leases was based on existing external bids from sales contracts or letters of intent or prices for similar loans and leases in the secondary whole loan or securitization markets or estimates of proceeds to be obtained through a workout and payoff. Declines in net realizable value, if any, were recorded on a quarterly basis as a charge
through the adjustment for liquidation basis. Accounting policies for interest income and loan fee recognition, classification and accounting treatment of impaired loans, including nonperforming loans and troubled debt restructurings were unchanged from going concern basis accounting.
Allowance for Loan and Lease Losses
Under liquidation basis accounting, loans were designated as held-for-sale and carried at the lower of cost or net realizable value. Upon adoption of the liquidation basis accounting, effective September 30, 2002, the balance of the existing allowance for loan and lease losses was reallocated to individual loans and leases and groups of homogeneous loans as a mark-to-market allowance on such loans; a separate allowance for credit losses was not maintained.
Real Estate Owned
Real estate owned was recorded at net realizable value as of the date of foreclosure. The difference upon foreclosure between book value and net realizable value, if any, was expensed to adjustment for liquidation basis. Adjustments to net realizable value, if any, were recorded on a quarterly basis as a charge through the adjustment for liquidation basis. Revenues and other expenses associated with real estate owned were recognized and reported as a component of noninterest expense when incurred.
Premises and Equipment
Premises and equipment were stated at cost less accumulated depreciation and amortization. This is considered to approximate net realizable value in accordance with liquidation basis accounting. Depreciation and amortization were computed on a straight-line basis over the estimated useful lives for each of the various asset categories. These useful lives range from two to ten years.
Intangible Assets
Goodwill and other intangible assets were written off as of September 30, 2002 with the adoption of liquidation basis accounting. The goodwill and core deposit intangibles associated with the deposits sold to U.S. Bank were realized in anticipation of the close of that transaction. The goodwill related to the Company’s commercial business units, including Asset-Based Lending, Factored Receivables and Commercial Leasing, was written off as current estimated fair values of those businesses were below book value based on bids from interested buyers of the businesses.
Deferred Gain
The deferred gain represented the estimated after-tax gain anticipated from the future sale of the Company’s auto finance business. As this transaction was not under contract or assured, the estimated after-tax gain was not recognized, but rather was recorded as a deferred gain.
Reserve for Estimated Costs during the Period of Liquidation
The reserve for estimated costs during the period of liquidation includes severance payments and costs related to facility closures, investment banking and other professional fees and estimated litigation expense and settlements. These expense accruals were reviewed for adequacy on a quarterly basis. Changes to the accruals, if necessary, were charged to earnings as changes in estimated values of assets and liabilities.
At December 31, 2002, the reserve for estimated costs during the period of liquidation was $44.0 million, including accruals for severance and facilities of $29.0 million and $9.4 million, respectively. At December 31, 2003, the balance of the liquidation reserve was $11.6 million, including accruals for severance and facilities of $2.0 million and $6.4 million, respectively.
Note 3. Restatement of Consolidated Financial Statements as of and for the Three Months ended December 31, 2003
Subsequent to the issuance of our consolidated financial statements as of and for the three months ended December 31, 2003, we determined that we incorrectly applied FASB Statement No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases,” to our auto finance subsidiary’s portfolio of auto contracts
held-for-sale for the three-month period that began October 1, 2003, when we re-adopted the going concern basis of accounting, and ended December 31, 2003. As a result, we have restated our going concern basis consolidated financial statements as of and for the three months ended December 31, 2003 to eliminate the recognition of amortization expense related to premiums and deferred origination costs and fees associated with auto contracts held-for-sale. The restatement increased total assets and net income as of and for the three months ended December 31, 2003 by $182 thousand.
On June 30, 2004, we effected a 1-for-10 reverse stock split of the issued and outstanding shares of the Company’s common stock. As a result, the Company’s issued common stock was reduced from 65,910,689 shares prior to the reverse stock split to 6,590,461 shares following the reverse stock split, including an adjustment for fractional shares. Our restated consolidated financial statements also include adjustments to reflect this reverse stock split. Accordingly, all shares outstanding and per share amounts are presented herein on a post-reverse stock split basis for all periods reported.
Except as set forth above, we have not updated the disclosures contained herein to reflect any events that have occurred after the Original Filing. The following table shows the impact of the restatement on net income and basic and diluted earnings per share for the three months ended December 31, 2003:
Note 4. Regulatory Matters
Effective September 30, 2003, the Company completed the dissolution of the Bank. On that date, the Company assumed specified assets and liabilities of the Bank. As a result, the Company ceased to be a bank holding company and, along with its subsidiaries, was no longer subject to supervision, examination and regulation by the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency or the Federal Deposit Insurance Corporation.
Note 5. Retained Interests in Securitizations
Retained interests in securitizations were classified as available-for-sale at December 31, 2004 and 2003. The Company did not maintain a trading portfolio during 2004 and 2003. The following tables set forth the activity in the Company’s retained interests in securitizations for the periods indicated:
Retained interest values are subject to credit, prepayment, and interest rate risks on the underlying auto contracts. The following table illustrates the significant assumptions utilized in the valuation of retained interests as of the dates indicated:
At December 31, 2004, the fair value of the Bay View 2002-LJ-1 and 2003-LJ-1 retained interests as a result of immediate 10% and 20% adverse changes in significant assumptions would have decreased as follows:
The Company securitized and sold $193.3 million and $453.2 million of auto installment contracts during 2003 and 2002, respectively. The Company retained interests in these securitizations with initial balances of $9.5 million and $23.2 million for 2003 and 2002, respectively. During 2003, BVAC called its Bay View 1999-LJ-1 and 2000-LJ-1 automobile receivable backed notes and repurchased auto contracts from the asset-backed bond trusts with par values of $21.8 million and $33.8 million and average coupon rates of 12.52% and 10.25%, respectively.
Note 6. Mortgage-backed Securities and Other Securities
At December 31, 2004, the Company’s entire mortgage-backed and other securities portfolio had either matured or been sold. At December 31, 2003, the portfolio totaled $6.1 million and consisted of $5.3 million of mortgage-backed securities issued by Fannie Mae, $0.6 million of CMOs and $0.2 million of asset-backed securities. All mortgage-backed and other securities were classified as available-for-sale at December 31, 2003. The weighted-average yield on mortgage-backed securities classified as available-for-sale at December 31, 2003 was 6.21%. Adjustable-rate mortgage-backed securities totaled $0.6 million at December 31, 2003.
Proceeds from sales of mortgage-backed and asset-backed securities classified as available-for-sale during 2004, 2003 and 2002 were $5.6 million, $15.2 million and $257.3 million, respectively. Gains or losses we recognized on these sales were insignificant during 2004 and 2003. Gross gains of $1.1 million were realized on these sales during 2002.
Note 7. Auto Installment Contracts and Other Loans
The following table sets forth the Company’s portfolio of auto contracts and other loans as of the dates indicated:
During 2004, the Company completed the sale of $33.5 million of loans and received an additional $112.8 million of loan repayments. These loan sales and repayments, totaling $146.3 million, were comprised of $135.4 million of auto contracts, $5.5 million of franchise loans, $4.8 million of business loans and $0.6 million of asset-based loans. During 2003, the Company sold or securitized $339.8 million of loans and received an additional $129.6 million of loan repayments. These loan sales, securitizations and repayments totaled $469.4 million and included $319.5 million of auto contracts, $91.5 million of asset-based loans, $33.4 million of franchise loans, $10.8 million of syndicated loans, $7.0 million of commercial real estate loans, $3.9 million of multi-family mortgage loans and $3.3 million of business loans, factored receivables and commercial leases.
There were no loan securitizations during 2004. The Company securitized and sold approximately $193.3 million and $453.2 million of auto contracts during 2003 and 2002, respectively. Gains of $0.8 million and $11.8 million were recognized on the 2003 and 2002 securitizations, respectively. The Company retained servicing responsibilities and subordinated interests in these securitizations. The Company’s retained interests are subordinate to investors’ interests. However, investors and the securitization trusts have no recourse to the Company’s other assets for failure of debtors to pay when due.
The Company serviced participating interests in auto contracts that it securitized and/or sold of $250.2 million at December 31, 2004 and $405.1 million at December 31, 2003.
The total of impaired loans and leases, consisting entirely of nonaccrual auto contracts and other loans, were $1.0 million and $7.1 million at December 31, 2004 and 2003, respectively. Interest on nonaccrual auto contracts and other loans that was not recorded in income was $342 thousand for the year ended December 31, 2004, $1.6 million for 2003 and $5.9 million for 2002. Cash interest that we recognized on these nonaccrual auto contracts and other loans was not significant in 2004, 2003 or 2002. At December 31, 2004, we had no commitments to lend additional funds to these borrowers. The average investment in impaired auto contracts and other loans was $1.3 million for the year ended December 31, 2004, $11.0 million for 2003 and $63.2 million for 2002.
The following table sets forth information on delinquent loans (loans delinquent 60 days or more) and net charge-offs on the Company’s managed loan portfolio of auto contracts, franchise and other loans serviced by the Company:
(1)
Through September 30, 2003, charge-offs and recoveries were recorded as mark-to-market valuation adjustments in accordance with liquidation basis accounting. Subsequent to the Company’s re-adoption of going concern basis accounting, net chargeoffs of auto contracts and other loans held-for-sale are charged against noninterest income while net chargeoffs of auto contracts held-for-investment are charged against the allowance for credit losses.
(2)
Includes off-balance sheet amounts associated with securitized auto contracts and loans sold servicing-released.
(3)
Includes $5.2 million and $1.1 million of net charge-offs from off-balance sheet auto contracts and contracts held-for-sale, respectively, for 2004; includes $6.3 million and $0.6 million of net charge-offs from off-balance sheet auto contracts and contracts held-for-sale, respectively, for 2003.
The following table sets forth the activity in the allowance for credit losses on auto contracts and other loans held-for-investment as of and for the periods indicated:
Effective September 30, 2002, the Company adopted liquidation basis accounting under which its loans and leases were carried at their net realizable value. Accordingly, the balance of the allowance for credit losses was reallocated as mark-to-market adjustments to individual loans and leases and groups of homogeneous loans in liquidation. On October 1, 2003, the Company re-adopted going concern basis accounting. From October 1, 2003 to
May 31, 2004, the Company’s auto contracts were classified as held-for-sale and were carried at the lower of cost or market.
Beginning in the second quarter of 2004, the Company has designated a portion of its auto contracts as held-for-investment. Accordingly, the Company has re-established an allowance for credit losses on auto contracts held-for-investment that represents management’s estimate of inherent credit losses that have occurred as of the date of the financial statements.
Note 8. Premises and Equipment
The following table sets forth premises and equipment as of the dates indicated:
Depreciation and amortization expense related to premises and equipment totaled $0.3 million, $0.5 million and $3.1 million for the years ended December 31, 2004, 2003 and 2002, respectively.
Note 9. Accounting for Goodwill and Other Intangible Assets
Upon re-adoption of going concern basis accounting, the Company re-established goodwill of $1.8 million in BVAC related to its acquisition of California Thrift & Loan in 1996.
As of January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” which requires that certain goodwill and intangible assets with indefinite useful lives be tested for impairment at least annually rather than amortized. As of January 1, 2002, the Company ceased the amortization of existing goodwill.
The Company completed the first and second steps of the transitional goodwill impairment test as of June 30, 2002 and September 30, 2002, respectively. As a result, the Company recorded $18.9 million in impairment charges, net of taxes, for goodwill not expected to be realized upon the disposition of its Asset-Based Lending, Factored Receivables and Commercial Leasing businesses. As required by the transitional provisions of Statement No. 142, the impairment loss was measured and recorded as of the date of adoption and recognized as the cumulative effect of a change in accounting principle as of January 1, 2002. At December 31, 2004 and 2003, management determined that there was no impairment of goodwill.
Note 10. Deposits
During 2002, U.S. Bank acquired the Bank’s retail deposits, totaling $3.3 billion, in connection with the sale of the Bank’s retail banking assets.
Note 11. Borrowings
During the second quarter of 2004, BVAC secured a $350.0 million floating-rate, revolving warehouse credit facility to replace a maturing $250.0 million facility originally obtained in 2003. The facility is jointly provided by two lenders including a commercial paper conduit affiliated with one of the lenders (the “Note Purchasers”). The facility is for a term of 364 days and matures on June 25, 2005. The interest rate on a portion of the facility is indexed to asset-backed commercial paper rates; the balance of the facility is indexed to the 1 month Libor rate. BVAC draws on the facility to purchase and finance its existing inventory of auto contracts. Substantially all auto contracts retained by BVAC are pledged as collateral for the credit facility. Under the terms of the facility, BVAC draws on the facility by transferring auto contracts to a special purpose entity, a statutory trust, which issues notes to the Note Purchasers. BVAC periodically securitizes or sells auto contracts in order to pay down the line of credit and maintain borrowing capacity.
At December 31, 2004, $298.8 million was outstanding under this facility with an all-in cost of 3.34%. These borrowings were secured by $314.5 million of auto contracts. The facility contains various performance triggers and default covenants requiring that BVAC maintain certain cumulative credit loss, delinquency and other financial ratios. As of December 31, 2004, all such financial and performance ratios were within required levels.
On December 31, 2001, the Company completed a structured financing of its auto lease cash flows and recorded $136.5 million in other borrowings. Since the Company ceased its purchases of auto leases in June 2000, the contractual auto lease cash flows have been decreasing monthly and are scheduled to conclude in December 2005. The transaction was treated as a sale for tax purposes that allowed the Company to capture expiring net operating loss carryforwards and partially reverse the related valuation allowance on deferred tax assets. At December 31, 2004, the balance of the borrowing was $1.9 million. The effective cost of the borrowing for 2004 was 2.00%.
During 2003, the Company adopted FASB Financial Interpretation No. 46, “Consolidation of Variable Interest Entities,” and accordingly, deconsolidated Bay View Capital I. As a result, the 9.76% Capital Securities of Bay View Capital I were no longer reflected on the Company’s Consolidated Statement of Financial Condition while the underlying 9.76% Junior Subordinated Deferrable Interest Debentures (the “Junior Debentures”), which were acquired by Bay View Capital I, was reflected as borrowings. On June 30, 2004, the Company redeemed the remaining $22.0 million of Junior Debentures and recovered its $2.8 million equity investment in Bay View Capital I through a settlement of its liability with the Trustee. See Note 13.
Note 12. Notes and Debentures
On August 18, 1999, the Bank issued $50.0 million in Subordinated Notes. The Subordinated Notes were unsecured obligations of the Bank and were subordinated in right of payment to all existing and future senior indebtedness, as defined, of the Bank. The Subordinated Notes were to mature on August 31, 2009, with a call provision at our option any time after August 31, 2002 at par. The issuance had a stated coupon of 10.00%. The all-in cost of the Subordinated Notes was 10.57%. A portion of the proceeds was dividended to the Company and used to partially finance the acquisition of Franchise Mortgage Acceptance Company. On December 9, 2002, the Bank redeemed the entire $50.0 million of its outstanding Subordinated Notes. Interest expense on the Subordinated Notes was $4.9 million for the year ended December 31, 2002.
On August 28, 1997, the Company issued $100.0 million in Subordinated Notes registered under the Securities Act of 1933, as amended. The Subordinated Notes were unsecured obligations of the Company and were subordinated in right of payment to all existing and future senior indebtedness, as defined, of the Company. The Subordinated Notes were to mature on August 15, 2007, with a call provision effective on or after August 15, 2002 or, at any time upon a change of control or the occurrence of certain other events, at our option, at various premiums through August 15, 2005 and at par thereafter. The issuance had a stated coupon of 9.125% and was issued at a discount to yield 9.225%. The all-in cost of the Subordinated Notes was 9.62%. A portion of the proceeds was used to partially finance the acquisition of America First Eureka Holdings, Inc., which the Company acquired in January 1998. On November 29, 2002, the Company prepaid the entire $100.0 million of its outstanding Subordinated Notes at a premium of 4.563%. Interest expense on the Subordinated Notes was $8.6 million for the year ended December 31, 2002.
Note 13. Capital Securities
On December 21, 1998, the Company issued $90.0 million in Capital Securities through Bay View Capital I (the “Trust”). The Capital Securities paid quarterly cumulative cash distributions at an annual rate of 9.76% of the liquidation value of $25 per share. The Capital Securities represented undivided beneficial interests in the Trust. The Company owned all of the issued and outstanding common securities of the Trust. Proceeds from the offering and from the issuance of common securities were invested by the Trust in the Company’s 9.76% Junior Debentures due December 31, 2028 with an aggregate principal amount of $92.8 million. The primary asset of the Trust was the Junior Debentures. The Company fully and unconditionally guaranteed the obligations of the Trust with respect to the Capital Securities to the extent provided in the Guarantee Agreement. Proceeds were used to repay the Company’s $50.0 million Senior Debentures and the balance for general corporate purposes. The all-in cost of the Capital Securities was 9.95%. Prior to the dissolution of the Bank, the Capital Securities had the added benefit of qualifying as Tier 1 capital for regulatory capital purposes.
In September of 2000, the Company entered into an agreement with the FRB that required the Company to obtain their approval prior to disbursing any dividends associated with the Capital Securities. Beginning with the third quarter of 2000, the Company began deferring distributions of the quarterly dividends in accordance with the terms of the Capital Securities. During this deferral period, distributions to which holders are entitled continued to accrue at an annual rate of 9.76% of the liquidation amount of $25 per Capital Security, plus accumulated additional distributions at the same rate, compounded quarterly, on any unpaid distributions (to the extent permitted by law).
In December of 2002, the Company received approval from the FRB to pay the cumulative distributions on its Capital Securities. On December 31, 2002, the Company paid the cumulative deferred distributions, interest on the deferred distributions and the current quarterly distribution. The total amount paid per share as of December 31, 2002 was $6.10 for the 10 quarterly distributions plus $0.715 in accrued interest. Subsequent quarterly distributions remained subject to FRB approval until the dissolution of the Bank, as of September 2003, when the Company ceased to be a bank holding company and was no longer subject to supervision, examination and regulation by the FRB. Dividend expense on the Capital Securities was $1.1 million, $8.8 million and $10.6 million for the years ended December 31, 2004, 2003 and 2002, respectively. Effective July 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. ” Implementation of Statement No. 150 resulted in the reclassification of the Capital Securities from their prior classification as a “mezzanine” item to liabilities and required the Company to reflect the dividend expense on the Capital Securities as interest on borrowings.
During the third quarter of 2003, the Company completed an offer of optional redemption of the Capital Securities at a price of $25 per Capital Security plus accrued and unpaid distributions through the date of redemption. Holders of the Capital Securities elected to redeem 184,903 shares, or approximately 5.14% of the outstanding Capital Securities, under the offer that expired on September 8, 2003. An additional $63.5 million, or approximately 74%, of the outstanding Capital Securities was redeemed on December 31, 2003. These redemptions reduced the outstanding Capital Securities from $90.0 million at December 31, 2002 to $22.0 million at December 31, 2003. On June 30, 2004, the Company redeemed the remaining $22.0 million of the outstanding Capital Securities.
Note 14. Income Taxes
The following table sets forth the Company’s consolidated income tax expense (benefit) for the
periods indicated:
At December 31, 2004, the Company had recorded an estimate of contingent tax liabilities of $4.2 million. Management does not believe a material change in this estimate will occur within the next twelve months. If and when these contingent tax liabilities are ultimately paid, it could have a significant impact on the cash flows or liquidity of the Company.
The following table sets forth the reconciliation between the federal statutory income tax rate and the effective income tax rate for the periods indicated. The table reflects the inclusion of dividends on Capital Securities in the determination of income (loss) before income tax expense (benefit):
Stockholders’ equity or net assets in liquidation were credited with a tax benefit associated with the exercise of stock options of $0.2 million for 2002. For the years ended December 31, 2004 and 2003, there was no such tax benefit. Stockholders’ equity or net assets in liquidation were charged a tax associated with certain adjustments recorded to convert from the liquidation basis to going concern basis accounting, of $0.6 million for the year ended December 31, 2003.
The following table sets forth the components of net deferred tax assets as of the dates indicated:
The valuation allowance on deferred tax assets, which was $21.5 million as of December 31, 2003, was unchanged as of December 31, 2004. In the determination of deferred tax assets, net of the valuation allowance, the Company considered the projected future net income available to absorb the realization of deferred tax assets. Under the Company’s prior plan of complete liquidation, the determination of deferred tax assets was limited to consideration of projected future net income through September 30, 2005, which was the projected final liquidation date of the Company.
The Company recorded an income tax benefit of $2.5 million for the year ended December 31, 2004 compared to an income tax benefit of $6.4 million for 2003 and an income tax provision of $176.9 million for 2002. The Company’s effective tax rate was 39.2% for 2004 compared to 56.2% for 2003 and 72.1% for 2002. The Company’s 2004 effective rate differs from the 35.0% federal statutory tax rate primarily due to state income and franchise taxes.
For the year ended December 31, 2002, as a result of the Company’s Plan, income tax expense included the effect of establishing a valuation allowance of $21.5 million on the realizability of deferred tax assets in years after 2002. The realizability of deferred tax assets and the related valuation allowance were based on total projected future income through the final liquidation of the Company. During 2002, the Company also recorded a deferred tax benefit of $2.3 million on the cumulative effect of the change in accounting principle, which is presented net of this tax benefit. During 2002, the Company realized approximately $138.0 million of its net deferred tax assets primarily as a result of the Company’s sale of its retail banking assets to U.S. Bank and other asset sale transactions.
At December 31, 2004, the federal net operating loss carryforwards were $127.9 million, of which $58.4 million will expire in 2020 and $69.5 million will expire in 2023. The Company has federal alternative minimum tax credits of $3.9 million. These credits can be carried forward indefinitely to reduce future regular tax.
Effective for the 2002 and 2003 tax years, California tax law suspended deductions for net operating loss carryforwards. As a result, the 2002 current state tax provision has no utilization of California net operating loss carryforwards; for 2003, the Company generated an additional California net operating loss, and for 2004, the Company utilized California net operating loss carryforwards. At December 31, 2004, the California net operating loss carryforwards were $41.7 million, of which $24.8 million will expire in 2012, and $16.9 million will expire in 2013.
Note 15. Stock Options
As of December 31, 2004, the Company had five employee stock option plans and three non-employee director stock option plans. The employee stock option plans were as follows: the “Amended and Restated 1986 Stock Option and Incentive Plan,” the “Amended and Restated 1995 Stock Option and Incentive Plan,” the “1998-2000 Performance Stock Plan (the “2001 Plan”),” the “1999 FMAC Stock Option, Deferred Stock and Restricted Stock Plan,” and the “2001 Stock Option and Incentive Plan,” which authorize the issuance of 175,943, 250,000, 40,000, 27,058 and 320,000 shares of common stock, respectively. The non-employee director stock option plans were as follows: the “Amended and Restated 1989 Non-Employee Director Stock Option and Incentive Plan,” the “1998 Non-Employee Director Stock Option and Incentive Plan,” and the “2001 Non-Employee Director Stock Option Plan,” which authorize the issuance of up to 55,000, 20,000, and 50,000 shares of common stock, respectively.
Excluding options for 347,700 shares granted in 2001 that were issued with exercise prices below the then current market value, the exercise price for the purchase of shares subject to a stock option at the date of grant generally may not be less than 100% of the market value of the shares covered by the option on that date. Options generally vest over periods ranging from 6 months to 3 years and expire over periods ranging from 6 years to 13 years. The Company’s stock options generally cancel automatically 90 days after termination of employment and, notwithstanding any other provisions of our stock option plans, all outstanding stock options will automatically cancel on the final record date.
All of the stock option plans define a change in control as including a sale of all or substantially all of the Company’s assets, and all of the stock option plans provide for the automatic acceleration of the exercisability of stock options in the event of a change in control with the exception of the 2001 Plan. The 2001 Plan provides for the acceleration of the exercisability of stock options in such circumstances as the stock option committee of the Board of Directors determines to be appropriate. On August 6, 2002, the stock option committee determined that the consummation of the sale of the Bank’s retail banking assets constituted a change in control for purposes of the 2001 Plan and recommended to the Board of Directors the acceleration of the exercisability of the stock options under the 2001 Plan in order that all option holders would be treated equally. On October 3, 2002, the Board of Directors authorized such acceleration as of that date. Subsequently, the stock option plans were treated as variable plans based on APB 25. As of December 31, 2002, the acceleration of the exercisability of stock options resulting from the change in control for all other plans had an insignificant impact on the Company’s financial statements.
The following table sets forth the stock options available for grant as of December 31, 2004:
At December 31, 2004, the Company had outstanding options under the plans with expiration dates ranging from the year 2005 through 2014, as set forth in the following table:
The following table sets forth information about stock options outstanding at December 31, 2004:
Statement of Financial Accounting Standards No. 123 Pro Forma Disclosure
The Company adopted Statement No. 123 effective January 1, 1996, but continues to account for employee and director stock-based compensation plans under the intrinsic value method prescribed by APB 25. Statement No. 123 requires that stock-based compensation to parties other than employees and directors be accounted for under the fair value method. No compensation cost has been recognized for the stock option awards to employees and directors in 2004, 2003 and 2002, except as discussed above. The weighted-average fair value of options granted to employees and directors were $11.99 and $23.10 in 2004 and 2002, respectively. There were no options granted during 2003. See Note 2 for a pro forma calculation of net income (loss) and earnings (loss) per share had compensation cost related to the Company’s stock option awards been determined under the fair value method.
The fair value of options granted was estimated as of the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
(1)
The expected risk-free interest rate was calculated using a term commensurate with the expected life of the options.
Note 16. Employee Benefit Plans
On July 22, 2002, the Company’s Board of Directors approved the termination, effective as of September 30, 2002 and subject to regulatory approval, of the qualified, noncontributory defined benefit retirement plan (the “Eureka Plan”) that the Company assumed in its acquisition of America First Eureka Holdings. The Eureka Plan was in a frozen status and no additional benefits had been accrued since January 1, 1994. In November 2003, the Company received a favorable determination from the Internal Revenue Service to proceed with the termination. As of December 31, 2003, the Company accrued $0.9 million related to its liabilities to the Eureka Plan and the costs associated with the termination. As of December 31, 2003, the plan assets approximated $1.5 million. In January 2004, and as part of the termination process, the Company purchased an annuity at a cost of $2.4 million from a third party annuity provider to provide benefits for all remaining Eureka Plan participants. The termination process is in compliance with the relevant regulations of the Department of Labor.
The following tables set forth the funded status of the Eureka Plan and related net periodic benefits cost for the year prior to the termination:
As of December 31, 2004, 3,443 shares of the Company’s common stock were held in treasury under the Company’s non-qualified defined benefit retirement plan for non-employee members of its Board of Directors. These shares were previously repurchased in the open market at a cost of $0.6 million to be distributed to certain non-employee members of the Company’s Board of Directors. As of December 31, 2004, the Company had $0.2 million included in other liabilities for the remaining benefits owed to certain current and retired executive officers pursuant to a terminated non-qualified supplemental retirement plan for executive officers and $1.0 million in other liabilities for postretirement health care benefits owed to certain retired employees, officers and directors pursuant to a terminated retiree health plan.
Effective October 31, 2002, the Company’s Board of Directors approved the termination of the Company’s Employee Stock Ownership Plan (“ESOP”). All participants were fully vested as of October 1, 2002. Before the termination, the Company borrowed from a financial institution and in turn lent it to the ESOP to purchase shares of the Company’s common stock in the open market. As of December 2002, the ESOP debt was fully paid. Interest expense of the ESOP debt amounted to $7,000 for the year ended December 31, 2002. The ESOP held 36,144 shares of the Company’s common stock at December 31, 2003. During the second quarter of 2004, these shares were distributed to participants. All fractional shares were paid in cash. Prior to the termination, the Company made periodic contributions to the ESOP to enable the ESOP to pay principal, interest expense and administrative costs not covered by cash dividends received by the ESOP on its unallocated shares of the Company’s common stock. The Company made cash contributions to the ESOP of $1.1 million for the year ended December 31, 2002. All shares of common stock held by the ESOP were treated as outstanding shares in calculating both basic and diluted earnings per share. ESOP-related compensation expense of $0.5 million was recorded for the year ended December 31, 2002.
The Company has a 401(k) thrift plan under which an employee with three or more months of service may contribute from 2% to 15% of base salary to the plan. The amount of base salary deferred is not subject to federal or state income taxes at the time of deferral. After one year of service, 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 contribution was $0.3 million, $0.4 million and $1.9 million for the years ended December 31, 2004, 2003 and 2002, respectively.
Note 17. Derivative Instruments
The Company uses derivatives to modify interest rate characteristics of certain assets or liabilities to hedge its exposure to interest rate fluctuations, reducing the effects these fluctuations might have on associated cash flows or values. Derivative financial instruments involve, to varying degrees, elements of credit risk. Credit risk is defined as the possibility of sustaining a loss because counterparties to the financial instrument fail to perform in accordance with the terms of the contract.
As a result of the Company’s re-adoption of going concern basis accounting effective October 1, 2003 and the use of accounting prescribed by Statement No. 133, the Company’s derivative instruments are being carried at fair value, with changes in such fair value charged or credited to earnings. Prior to the Company’s re-adoption of going concern basis accounting, it accounted for changes in the market value of derivative instruments using liquidation basis accounting. Accordingly, changes in the fair value of these derivative instruments were reflected in the consolidated statements of net assets in liquidation under pre-tax loss from operations, while offsetting changes in the market value of underlying auto contracts were included in changes in estimated values of assets and liabilities.
The Company was a party to “fixed-for-floating” interest rate swaps with notional principal amounts of $145.0 million and $133.0 million at December 31, 2004 and 2003, respectively. The interest rate swaps mature at various dates between May 2005 and May 2008. During 2004, the Company paid a fixed interest rate of 2.51% and received a floating interest rate of 1.46%. During 2003, the Company paid a fixed interest rate of 2.29% and received a floating interest rate of 1.18%. Interest rate swaps increased interest expense by $1.8 million and $0.3 million for the years ended December 31, 2004 and 2003, respectively. To record its interest rate swaps at their fair value, as required by Statement No. 133, the Company recognized gains of $2.1 million during 2004 and losses of $1.6 million during 2003.
As discussed in Note 11, BVAC draws on its warehouse credit facility by transferring auto contracts to a special purpose entity, a statutory trust, which issues notes to its two lenders including a commercial paper conduit affiliated with one of the lenders (the “Note Purchasers”). Under the terms of the facility, the trust enters into out-of-the-money, interest rate cap contracts, containing terms and conditions required by the Note Purchasers, to provide protection to the Note Purchasers from interest rate risk embedded in the fixed-rate auto contracts that have been transferred to the trust. BVAC incurs the cost of these interest rate caps. The notional balance of these amortizing interest rate caps is maintained by the trust to coincide with the outstanding balance of the underlying auto contracts. At December 31, 2004, the notional amount of these interest rate caps was $281.3 million. The contracts mature between May 2008 and October 2010; the strike rates on the contracts, which are indexed to the 1 month Libor rate, range between 5.50% and 6.25%. At December 31, 2004, the interest rate caps had a fair value of $0.7 million. For the year ended December 31, 2004, the Company recognized $0.7 million of unrealized losses on interest rate caps. The fair value of the interest rate caps is included in other assets.
Note 18. Commitments and Contingencies
Premises
At December 31, 2004, the Company occupied three offices including its corporate headquarters office and had an additional two offices that have been vacated, and are subleasing, under operating lease agreements expiring at various dates through the year 2012. In most instances, these lease arrangements include options to renew or extend the lease at market rates.
The Company is a party to lease agreements for two former Bay View Franchise Mortgage Acceptance Company offices, both of which were subleased at December 31, 2004.
Rental expense was $1.2 million for the year ended December 31, 2004, $1.2 million for 2003 and $9.1 million for 2002. Sublease rental income totaled $18,000 for the year ended December 31, 2004, $186,000 for 2003 and $567,000 for 2002.
Future minimum payments under noncancellable lease obligations are summarized below. These payments have not been reduced to reflect approximately $2.3 million in sublease rental income from existing sublease rental arrangements through the year 2008.
Included in the table above are future minimum lease payments of $15.1 million related to the Company’s liquidating activities. At December 31, 2004, the Company had accrued $6.0 million for future rent payments net of estimated sublease income as facilities costs as described in Note 2.
Loans
At December 31, 2004 and 2003, the Company had contingent liabilities of $14.5 million and $14.4 million, respectively, related to a standby letter of credit that the Bank had provided on bonds issued by a community housing development in Northern California. This letter of credit has been secured by a cash deposit of a corresponding amount which is included in restricted cash. The Company had no outstanding lending commitments at December 31, 2004 and 2003. There were no outstanding recourse and subordination contingencies at December 31, 2004 and 2003.
Litigation
On August 29, 2003, Financial Security Assurance Inc. (“FSA”) filed a complaint against the Company and the Bank in the United States District Court for the Southern District of New York. The complaint, as amended, alleges breaches of representations and warranties or indemnity obligations with regard to a number of loans that served as collateral for two securitizations involving the Company and/or a former subsidiary, Bay View Franchise Mortgage Acceptance Company that were effected in 1998 and 2000. FSA guaranteed certain payments in connection with these securitizations. The Company vigorously denies any liability to FSA and has asserted numerous defenses to each of FSA’s claims. The Company has also filed counterclaims against FSA.
The Company is a party to various other legal actions arising in the normal course of business.
After consultation with counsel, the Company does not currently expect that the resolution of these legal actions will have a material adverse effect on the Company’s consolidated financial condition, results of operations or cash flows.
Note 19. 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.” Fair value estimates, methods and assumptions, set forth below for the Company’s financial instruments, are made solely to comply with the requirements of Statement No. 107 and should be read in conjunction with the Company’s consolidated financial statements and related notes.
The Company has determined the estimated fair value amounts by using market information and valuation methodologies that it considers 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 or has realized 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. For all of these reasons, the aggregation of the fair values presented herein does not represent, and should not be construed to represent, their underlying value.
The following methods and assumptions have been used to estimate the fair value of each class of financial instrument for which it was practicable to estimate the value:
Cash and cash equivalents: This category includes cash and deposits due from depository institutions and money market funds. The cash equivalents were readily convertible to known amounts of cash or are so near their maturity that they present insignificant risk of changes in value. For these short-term financial instruments, the carrying amount approximated fair value.
Securities: The fair values of investment securities and retained interests in loan securitizations were estimated by discounting future cash flows using a discount rate commensurate with the risks involved. The fair value of mortgage-backed securities was based on published market prices or quotes obtained from independent registered securities brokers.
Auto contracts and other loans: The fair value of auto contracts and other loans was based on prices for similar loans in the secondary whole loan or securitization markets with similar credit terms and remaining maturities. Prepayment estimates were based on historical experience for similar loans.
Borrowings: Borrowings include BVAC’s floating rate warehouse credit facility and a structured financing of the Company’s auto lease cash flows which mature within one year of December 31, 2004. For such borrowings, the carrying amount approximates fair value.
Junior Subordinated Deferrable Interest Debentures: The carrying value of the Junior Subordinated Deferrable Interest Debentures, which were redeemed on June 30, 2004, in connection with the Company’s redemption of the remaining Capital Securities, approximated fair value at December 31, 2003.
Interest rate swaps: The fair value of 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.
Interest rate caps: The fair value of interest rate caps is the estimated amount that the Company would receive or pay to terminate the cap agreements at the reporting date, taking into account current interest rates and the current creditworthiness of the cap counterparties.
Limitations: The fair value estimates presented herein were based on pertinent information available to the Company as of December 31, 2004 and 2003. 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.
The following table sets forth the estimated fair values of the Company’s financial instruments as of the dates indicated:
Note 20. Segment and Related Information
The Company considers its auto finance business to be its sole line of business. Prior to the Company’s adoption of the Plan on September 30, 2002, the Company had two operating segments that were referred to as business platforms. The platforms were determined primarily based upon the characteristics of interest-earning assets and their respective distribution channels and reflect the way that the Company monitored, measured and evaluated its primary business activities. The platforms were comprised of: a Retail Platform which was comprised of single-family real estate loans, home equity loans and lines of credit, auto contracts and leases, mortgage-backed securities and other investments, and consumer banking products and services; and a Commercial Platform which was comprised of multi-family and commercial real estate loans, franchise loans, franchise asset-backed securities, asset-based loans, syndicated loans, factored receivables and commercial leases, and business banking products and services.
The Company evaluated the performance of its segments based upon contribution by platform. Contribution by platform is defined as each platform’s net interest income and noninterest income less each platform’s allocated provision for losses on loans and leases, direct general and administrative expenses, including certain expense allocations, and other noninterest expense, including the amortization of intangible assets.
In computing net interest income by platform, the interest expense associated with the warehouse lines, which were used primarily to fund franchise loans held-for-sale, was allocated directly to the Commercial Platform. The interest expense associated with remaining funding sources, including dividends associated with the 9.76% Capital Securities, was allocated to each platform on a pro-rata basis determined by the relative amount of average interest-bearing liabilities, excluding warehouse lines, that were required to fund the platform’s interest-earning assets.
The Retail Platform incurred the direct general and administrative expenses related to operating the Company’s branch network, which served primarily to generate deposits used to fund interest-earning assets in the Retail and Commercial Platforms. A portion of these direct general and administrative expenses was allocated to the Commercial Platform based upon the relative amount of average interest-bearing liabilities that were required to fund the platform’s interest-earning assets.
All indirect general and administrative expenses not specifically identifiable with, or allocable to, the Company’s business platforms were included in indirect corporate overhead. Indirect corporate overhead included expenses associated with our administrative and support functions. Liquidation adjustments recorded during the third quarter of 2002 in connection with the Company’s adoption of liquidation basis accounting effective September 30, 2002 were not allocated to the Company’s business platforms.
The following table sets forth each platform’s contribution for the period indicated. The table also sets forth the reconciliation of total contribution by platform to consolidated net income for the period indicated. Reconciling items generally included indirect corporate overhead, liquidation and valuation adjustments for 2002 and income taxes.
Note 21. Selected Quarterly Results of Operations (Unaudited)
During the Company’s year-end audit and Sarbanes-Oxley Section 404 review, the Company determined that it should have recognized a total of $0.4 million of unrealized after-tax losses on certain derivative instruments. As described in Note 11, BVAC maintains, through an affiliated special purpose trust entity, a $350.0 million revolving receivables warehouse facility. Under the terms of this facility, the special purpose trust entity maintains interest rate caps to protect the holders of interest in the trust from interest rate risk in fixed-rate automobile installment contracts transferred to the trust. While BVAC pays the costs associated with the required interest rate caps, the special purpose trust entity owns the required interest rate caps and has pledged the benefits thereof to an indenture trustee for the benefit of the secured parties of such trust. BVAC considered the cost of the interest rate caps to be a cost of its warehouse facility, and as such, the cost was deferred and amortized as a cost of the warehouse facility. Subsequently it was determined that the Company should have recognized the interest rate caps as its derivative instruments and recorded them at fair value with changes in the fair value recognized in earnings in accordance with Statement No. 133. In light of this information, the Company adjusted the carrying value of these interest rate caps to fair value at each of the quarter-ends in 2004 and recognized an unrealized loss on the interest rate caps. This resulted in revised earnings for the quarters ended March 31, June 30 and September 30, 2004. The Company intends to restate its previously reported consolidated financial statements for the first, second and third quarters of 2004 that were previously reported in its Quarterly Reports on Form 10-Q in addition to its consolidated financial statements for the fourth quarter of 2004 that were previously furnished in a Current Report on Form 8-K dated January 28, 2005 (collectively, the “2004 Quarterly Statements”). The 2004 Quarterly Statements will correct the manner in which the Company accounted for the aforementioned interest rate cap contracts. The aggregate effect of the restatements is to increase the Company’s net loss by $430 thousand, or $0.06 per share.
(1) Earnings per share is computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share amounts may not equal the annual amount. This is caused by rounding and the averaging effect of the number of share equivalents outstanding throughout the year, which changes with the market price of the common stock.
The following table summarizes the changes in loss before income tax benefit, net loss, basic and diluted loss per share and total assets from amounts previously reported in the Company’s Quarterly Reports on Form 10-Q and its Current Report on Form 8-K dated January 28, 2005:
(1)
Represents year-to-date adjustment to total assets.
Note 22. Subsequent Events
On February 17, 2005, the Company, through Bay View 2005-LJ-1 Owner Trust, issued $232.1 million of auto receivable backed notes payable. The issue was comprised of five classes of notes, Classes A-1 through A-4, and Class I which is an interest only security. The notes have a weighted-average stated coupon of 4.19% and final maturities ranging between February 27, 2006 and May 25, 2012. The notes are insured as to the timely payment of principal and interest and they contain a call provision that grants the Company the option of calling the notes at any time after the aggregate balance of receivables has been reduced to 15% of the original pool of receivables. Proceeds from the issuance of the notes were used to repay $217.8 million of borrowings on the Company’s revolving warehouse credit facility.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of
Bay View Capital Corporation
We have audited the accompanying statement of financial condition of Bay View Capital Corporation and subsidiaries as of December 31, 2004, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity and cash flows for the year then ended. 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 audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bay View Capital Corporation and subsidiaries at December 31, 2004, and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Bay View Capital Corporation and subsidiaries internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated April 4, 2005 expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting.
/s/ Grant Thornton LLP
San Francisco, California
April 4, 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Bay View Capital Corporation and Subsidiaries:
We have audited the accompanying consolidated statement of financial condition of Bay View Capital Corporation and Subsidiaries (the “Company”) as of December 31, 2003, and the related consolidated statements of operations and comprehensive income (loss) and of stockholders’ equity for the period from October 1, 2003 to December 31, 2003 and for the period from January 1, 2002 to September 30, 2002, the consolidated statements of changes in net assets in liquidation for the period from January 1, 2003 to September 30, 2003 and for the period from September 30, 2002 to December 31, 2002, and the consolidated statements of cash flows for the years ended December 31, 2003 and 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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.
As discussed in Note 1 to the consolidated financial statements, the stockholders of the Company approved a plan of liquidation on October 3, 2002, and the Company commenced liquidation effective September 30, 2002. As a result, the Company changed its basis of accounting from the going concern basis to the liquidation basis effective September 30, 2002. As further discussed in Note 1 to the consolidated financial statements, the Board of Directors of the Company approved a change of the plan of liquidation on October 23, 2003. As a result, the Company changed its basis of accounting from the liquidation basis to the going concern basis effective October 1, 2003.
In our opinion, such consolidated financial statements present fairly, in all material respects, (1) the financial position of the Bay View Capital Corporation and Subsidiaries at December 31, 2003, (2) the results of their operations for the period from October 1, 2003 to December 31, 2003 and for the period from January 1, 2002 to September 30, 2002, (3) the changes in their net assets in liquidation for the period from January 1, 2003 to September 30, 2003 and for the period from September 30, 2002 to December 31, 2002, and (4) their cash flows for the years ended December 31, 2003 and 2002, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, effective January 1, 2002, the Company changed its method of accounting for previously recognized goodwill and intangible assets to conform to Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”
As discussed in Note 3 to the consolidated financial statements, the accompanying 2003 consolidated financial statements have been restated.
/s/ Deloitte Touche LLP
San Francisco, California
March 12, 2004
(August 13, 2004 as to Note 3)
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of December 31, 2004. Our disclosure controls and procedures are designed to ensure that information we are required to disclose in the reports we file under the Exchange Act is recorded, processed, summarized and reported on a timely basis in accordance with generally accepted accounting principles in the United States (“GAAP”) and without material misstatement.
Based on such evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of December 31, 2004, because of the material weaknesses in our internal control over financial reporting described in this Item 9A, our disclosure controls and procedures were not effective as of December 31, 2004 in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file under the Exchange Act.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over our financial reporting as that term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.
Our internal control over financial reporting is a process designed under the supervision of our Chief Executive Officer and our Chief Financial Officer to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external reporting purposes in accordance with GAAP.
Under the supervision of and with the participation of our Chief Executive Officer and our Chief Financial Officer, our management has conducted a review, evaluation and assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004, using the criteria set forth for effective internal control over financial reporting as described in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In accordance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), our management makes the following assertions:
• Management has implemented a process to monitor and assess both the design and operating effectiveness of our internal control over financial reporting.
• Because of its inherent limitations, a system of internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness as to future financial reporting periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or a combination of control deficiencies, that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. As of December 31, 2004, we had three material weaknesses in our internal control over financial reporting that were communicated to us by our independent auditors; therefore, our internal control over financial reporting was not effective. A description of the three material weaknesses is as follows:
• Our internal controls intended to ensure the proper accounting for derivatives (interest rate cap contracts) maintained by a special purpose trust in connection with a $350 million warehouse credit facility provided to the Company’s wholly owned subsidiary, Bay View Acceptance Corporation (“BVAC”), were not operating effectively. We determined that we should account for the derivatives in accordance with Statement of Financial Accounting Standards 133 (“SFAS 133”), Accounting for Derivatives and Hedging Activities. Under SFAS 133, we are now recognizing the value of the derivatives as an asset and record them at fair value, with any changes in fair value recognized in earnings. We previously accounted for the derivatives as a debt issuance cost of BVAC’s warehouse credit facility, which was amortized into the results of operations.
• The above weakness reflects that a continuing weakness exists, as reported in a Form 8-K Current Report dated July 26, 2004, relating to insufficient qualified accounting personnel to identify and resolve complex accounting issues on a timely basis and lack of appropriate resources resulting in insufficient supervision and review of our financial reporting process.
• The Company was unable to assess the effectiveness of the internal controls of two of BVAC’s third-party service organizations. The service organizations’ processes are an integral part of BVAC’s auto installment loan process, which is part of our internal control over financial reporting, specifically as to the existence and valuation of auto installment contracts, interest and fee income. The control deficiency did not result in a misstatement in our historical consolidated financial statements; however, it could result in a misstatement of auto installment contracts, interest and fee income that would result in a material misstatement to our annual or interim financial statements that might not be prevented or detected in a timely manner.
A report of management’s assessment of the design and effectiveness of our internal control over financial reporting is included. Grant Thornton LLP, an independent registered public accounting firm, audited the effectiveness of our internal control over financial reporting as of December 31, 2004 based on criteria established by COSO. The report of Grant Thornton LLP dated April 4, 2005 is included below.
Remediation Efforts Related to the Material Weakness in Internal Control over Financial Reporting
At the direction and under the supervision of our Audit Committee, which held meetings on March 30, 2005, April 4, 2005, April 5, 2005 and April 8, 2005, we are undertaking the following actions to resolve the material weaknesses:
• Commence an immediate and ongoing review of all loan arrangements that involve derivative instruments;
• Conduct a quarterly review of all accounting policies that are relevant to proposed new or modified activities we contemplate undertaking;
• Retain qualified independent advisors to provide guidance as it relates to complex accounting principles and commensurately evaluate the appropriate staff size and composition in our accounting and financial reporting areas;
• Continue our efforts to have BVAC’s outside service organizations obtain SAS 70 Type II reports; and
• Continue to conduct frequent periodic substantive testing to verify the accuracy of BVAC’s auto installment contract principal balances, interest and fee income.
Our Form 8-K Current Report dated April 1, 2005 reported our loss before taxes, net loss, basic loss per share, diluted loss per share and total assets as originally reported, the adjustments required in accordance with SFAS 133 and our loss before taxes, net loss, basic loss per share, diluted loss per share and total assets in accordance with GAAP. We intend to restate our financial statements on Form 10-Q for the first, second and third quarters of 2004 and for the fourth quarter of 2004 as reported in a Form 8-K Current Report dated January 28, 2005.
Our Audit Committee has also retained KPMG LLP, our internal auditors, to assist the Audit Committee in its oversight of the corrective actions.
Changes in Internal Control over Financial Reporting
Because of the material weaknesses described above in Management’s Report on Internal Control Over Financial Reporting, during 2005 we are undertaking the actions described above. There have been no other changes to our internal control over financial reporting since October 1, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Report of Independent Registered Public Accounting Firm on Management’s Assessment of the Effectiveness of Internal Control over Financial Reporting and the Effectiveness of Internal Control over Financial Reporting
To the Shareholders and Board of Directors of
Bay View Capital Corporation and Subsidiaries
We have audited management’s assessment, included in the accompanying Report of Management on Internal Control over Financial Reporting, that Bay View Capital Corporation and subsidiaries (the Company) did not maintain an effective internal control over financial reporting as of December 31, 2004, because of the effect of material weaknesses identified in management’s assessment based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. We have identified the following material weaknesses that have been included as material weaknesses in management’s assessment:
i) As of December 31, 2004, the Company’s internal control did not maintain effective control over a derivative instrument. Specifically, the derivative instrument overstated as a result of errors caused by management using an incorrect application of accounting principles generally accepted in the United States of America and incorrectly recorded the amount as a debt issuance cost. The Company did not have effective review and approval controls to prevent or detect these errors on a timely basis. This control deficiency resulted in the restatement of the Company’s interim consolidated financial statements for 2004. Additionally, this control deficiency could result in a misstatement of the derivative instrument and the related change in fair value that would result in a material misstatement to annual or interim financial statements that would not be prevented or detected. Accordingly, management believes that this control deficiency constitutes a material weakness.
ii) As of December 31, 2004, the Company’s internal control over the financial reporting process is not operating effectively due to insufficient qualified accounting personnel to identify and resolve accounting issues and lack of appropriate resources resulting in insufficient supervision and review of the financial reporting process. Accordingly, management believes that this control deficiency constitutes a material weakness.
iii) As of December 31, 2004, the Company did not maintain effective control over the effectiveness of controls at two third-party service organizations. The service organizations’ processes are an integral part of the Company’s auto installment loan process. Such processes are considered part of the Company’s internal control over financial reporting specifically as to the existence and valuation of auto installment loan contracts and related interest and fee income. Management was unable to assess the effectiveness of controls over financial reporting at the service organizations. Management’s inability to obtain evidence about the effectiveness of controls over financial reporting at the service organizations represents a control deficiency. This control deficiency did not result in a misstatement to the Company’s historical consolidated financial statements; however, it could result in a misstatement of auto installment loan contracts and related interest and fee income that would result in a material misstatement to annual or interim financial statements that would not be prevented or detected. Accordingly, management believes that this control deficiency constitutes a material weakness.
These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2004 consolidated financial statements, and this report does not affect our report dated April 4, 2005 on those consolidated financial statements.
In our opinion, management’s assessment that the Company did not maintain effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We do not express an opinion or any other form of assurance on management’s statements included in this Item 9A, Controls and Procedures, other than those statements included under Report of Management on Internal Control over Financial Reporting.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition of Bay View Capital Corporation and subsidiaries as of December 31, 2004, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for the year then ended and our report dated April 4, 2005 expressed an unqualified opinion on those consolidated financial statements.
/s/ Grant Thornton LLP
San Francisco, California
April 4, 2005
Item 9B.
Item 9B. Other Information
None.
Part III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information concerning our executive officers, our directors and compliance with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) by our directors, executive officers and beneficial owners of 10% or greater of our equity securities is incorporated herein by reference from our Definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 26, 2005. The compensation report and performance graph included in the Definitive Proxy Statement pursuant to Items 402(k) and 402(l) of Regulation S-K are specifically not incorporated by reference herein.
We have adopted a Code of Ethical Conduct that applies to our directors, executive officers, employees and others acting on our behalf, including our principal executive officer, principal financial and accounting officer, and any other person performing similar functions. A copy of the Code of Ethical Conduct is filed in this Report as Exhibit 14.
Item 11.
Item 11. Executive Compensation
Information concerning executive compensation is incorporated herein by reference from our Definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 26, 2005. The compensation report and performance graph included in the Definitive 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 and Related Stockholder Matters
Information concerning security ownership of certain beneficial owners and management and the Equity Compensation Plans table are incorporated herein by reference from our Definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 26, 2005.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions is incorporated herein by reference from our Definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 26, 2005.
Item 14.
Item 14. Principal Accountant Fees and Services
Information concerning principal accounting fees and services is incorporated herein by reference from our Definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 26, 2005.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) and (2):
Our Financial Statements and Supplementary Data contained in Item 8 are filed as part of this report. All financial statement schedules have been omitted as the required information is not applicable or has been included in our financial statements and related notes.
(a) (3):
Exhibits are listed in the table below.
(References to Prior Filings)
3a
Filed as exhibit 3 to the Registrant’s Quarterly Report on Form 10-Q filed August 13, 2004 for the quarterly period ended June 30, 2004 (File No. 0-14879)
3b
Filed as exhibit 99.1 to the Registrant’s Current Report on Form 8-K filed March 29, 2005 (File No. 001-14879)
4a
Filed as exhibit 4.1 to the Registrant’s Annual Report on Form 10-K filed March 24, 2000 for the year ended December 31, 1999 (File No. 0-14879)
10a
Filed as exhibit 10.a to the Registrant’s Quarterly Report on Form 10-Q filed November 9, 2004 for the quarter ended September 30, 2004 (File No. 0-14879)
10b-d
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)
10e
Filed as exhibit 4 to the Registrant’s Registration Statement on Form S-8 filed August 11, 1995 (File No. 33-95724)
10f
Filed as exhibits 10 to 10.2, respectively, to the Registrant’s Quarterly Report on Form 10-Q filed November 12, 1999 for the quarterly period ended September 30, 1999 (File No. 0-14879)
10g
Filed as exhibit 4.4 to the Registrant’s Registration Statement on Form S-8 filed July 26, 1991 (File No. 33-41924)
10h
Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1996, as amended on Form 10-K/A on June 27, 1997 (File No. 0-17901)
10i
Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1996, as amended on Form 10-K/A on June 27, 1997 (File No. 0-17901)
10j
Filed as an appendix to the Registrant’s Definitive Proxy Statement on Schedule 14-A filed April 20, 1998 (File No. 0-17901)
10k
Filed as exhibit 10.4 to the Registrant’s Annual Report on Form 10-K filed on March 24, 2000 for the year ended December 31, 1999 (File No. 0-14879)
10l
10n Filed as exhibit 10 to the Registrant’s Registration Statement on Form S-8 filed September 27, 2001 (File No. 333-70372)
10m
Filed as exhibit 10 to the Registrant’s Registration Statement on Form S-8 filed September 27, 2001 (File No. 333-70362)
10n
Filed as exhibits 10.1 and 10.2, respectively, to the Registrant’s Annual Report on Form 10-K filed March 19, 2003 for the year ended December 31, 2002 (File No. 0-14879)
All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K.
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.
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/ Robert B. Goldstein
By: /s/ Charles G. Cooper
Robert B. Goldstein
Charles G. Cooper, Director
Chairman of the Board
President and Chief Executive Officer
(Principal Executive Officer)
Date: April 15, 2005
Date: April 15, 2005
By: /s/ Roger K. Easley
By: /s/ Thomas M. Foster
Roger K. Easley, Director
Thomas M. Foster, Director
Date: April 15, 2005
Date: April 15, 2005
By: /s/ Joel E. Hyman
By: /s/ John W. Rose
Joel E. Hyman, Director
John W. Rose, Director
Date: April 15, 2005
Date: April 15, 2005
By: /s/ Frederick W. Dreher
Frederick W. Dreher, Director
Date: April 15, 2005