================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
For the quarterly period ended SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
__________ TO __________
Commission File Number 1-13578
DOWNEY FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
Delaware 33-0633413
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3501 JAMBOREE ROAD, NEWPORT BEACH, CA 92660
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (949) 854-0300
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ---------------------------------
COMMON STOCK, $0.01 PAR VALUE NEW YORK STOCK EXCHANGE
PACIFIC EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
At September 30, 2002, 28,022,722 shares of the Registrant's Common Stock,
$0.01 par value were outstanding.
================================================================================
DOWNEY FINANCIAL CORP.
SEPTEMBER 30, 2002 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I
ITEM 1. FINANCIAL INFORMATION.............................................. 1
Consolidated Balance Sheets........................................ 1
Consolidated Statements of Income.................................. 2
Consolidated Statements of Comprehensive Income.................... 3
Consolidated Statements of Cash Flows.............................. 4
Notes To Consolidated Financial Statements......................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................. 13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......... 42
ITEM 4. CONTROLS AND PROCEDURES............................................ 42
PART II
ITEM 1. LEGAL PROCEEDINGS.................................................. 43
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.......................... 43
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................... 43
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIY HOLDERS............... 43
ITEM 5. OTHER INFORMATION.................................................. 43
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................... 43
SIGNATURES ..................................................................45
i
PART I
ITEM 1. - FINANCIAL INFORMATION
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31, September 30,
(Dollars in Thousands, Except Per Share Data) 2002 2001 2001
-------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash .......................................................................... $ 135,493 $ 106,079 $ 103,000
Federal funds ................................................................. 16,702 37,001 2,401
-------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents .................................................. 152,195 143,080 105,401
U.S. Treasury securities, agency obligations and other investment
securities available for sale, at fair value ............................... 267,243 402,355 296,204
Municipal securities held to maturity, at amortized cost (estimated
fair value of $6,372 at September 30, 2002, $6,373 at
December 31, 2001 and $6,533 at September 30, 2001) ........................ 6,387 6,388 6,549
Loans held for sale, at lower of cost or fair value ........................... 665,587 499,024 373,489
Mortgage-backed securities available for sale, at fair value .................. 1,019,030 118,981 4,562
Loans receivable held for investment .......................................... 10,000,420 9,514,408 9,534,438
Investments in real estate and joint ventures ................................. 40,371 38,185 38,043
Real estate acquired in settlement of loans ................................... 15,441 15,366 11,870
Premises and equipment ........................................................ 113,258 111,762 106,488
Federal Home Loan Bank stock, at cost ......................................... 116,041 113,139 111,649
Mortgage servicing rights, net ................................................ 46,912 56,895 37,507
Other assets .................................................................. 75,197 85,447 90,094
-------------------------------------------------------------------------------------------------------------------------------
$ 12,518,082 $ 11,105,030 $ 10,716,294
===============================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits ...................................................................... $ 9,056,932 $ 8,619,566 $ 8,868,782
Federal Home Loan Bank advances and other borrowings .......................... 1,869,789 1,522,712 927,427
Accounts payable and accrued liabilities ...................................... 618,068 67,431 67,392
Deferred income taxes ......................................................... 62,680 41,425 34,218
-------------------------------------------------------------------------------------------------------------------------------
Total liabilities .......................................................... 11,607,469 10,251,134 9,897,819
-------------------------------------------------------------------------------------------------------------------------------
Company obligated mandatorily redeemable capital securities of subsidiary trust
holding solely junior subordinated debentures
of the Company ("Capital Securities") ...................................... 120,000 120,000 120,000
STOCKHOLDERS' EQUITY:
Preferred stock, par value of $0.01 per share; authorized 5,000,000
shares; outstanding none ................................................... -- -- --
Common stock, par value of $0.01 per share; authorized 50,000,000
shares; issued 28,235,022 shares at September 30, 2002 and 28,213,048
shares at December 31, 2001 and September 30, 2001 ......................... 282 282 282
Additional paid-in capital .................................................... 93,792 93,400 93,400
Accumulated other comprehensive income (loss) ................................. 274 (239) 897
Retained earnings ............................................................. 704,978 640,453 603,896
Treasury stock, at cost, 212,300 shares at September 30, 2002 ................. (8,713) -- --
-------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity ................................................. 790,613 733,896 698,475
-------------------------------------------------------------------------------------------------------------------------------
$ 12,518,082 $ 11,105,030 $ 10,716,294
===============================================================================================================================
See accompanying notes to consolidated financial statements.
1
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data) 2002 2001 2002 2001
----------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans receivable ................................................. $ 150,987 $ 187,867 $ 459,712 $ 604,449
U.S. Treasury securities and agency obligations .................. 2,190 3,727 7,386 12,259
Mortgage-backed securities ....................................... 287 62 2,503 277
Other investments ................................................ 1,460 2,040 5,146 7,912
----------------------------------------------------------------------------------------------------------------------------------
Total interest income .......................................... 154,924 193,696 474,747 624,897
----------------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Deposits ......................................................... 59,598 107,033 188,354 336,220
Borrowings ....................................................... 15,314 10,176 45,226 53,700
Capital securities ............................................... 3,040 3,040 9,122 9,122
----------------------------------------------------------------------------------------------------------------------------------
Total interest expense ......................................... 77,952 120,249 242,702 399,042
----------------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME .............................................. 76,972 73,447 232,045 225,855
PROVISION FOR LOAN LOSSES ........................................ 471 791 812 1,274
----------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses ............ 76,501 72,656 231,233 224,581
----------------------------------------------------------------------------------------------------------------------------------
OTHER INCOME, NET
Loan and deposit related fees .................................... 11,848 13,274 34,762 37,640
Real estate and joint ventures held for investment, net .......... 2,407 746 6,420 2,438
Secondary marketing activities:
Loan servicing loss, net ....................................... (18,963) (11,771) (35,168) (22,854)
Net gains (losses) on sales of loans and mortgage-backed
securities ................................................... (971) 4,234 22,126 15,383
Net gains on sales of mortgage servicing rights ................ -- 87 306 758
Net gains on sales of investment securities ...................... -- 3 209 242
Other ............................................................ 913 497 2,034 1,759
----------------------------------------------------------------------------------------------------------------------------------
Total other income (loss), net ................................. (4,766) 7,070 30,689 35,366
----------------------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSE
Salaries and related costs ....................................... 29,067 24,943 86,819 72,860
Premises and equipment costs ..................................... 7,916 6,628 22,803 18,713
Advertising expense .............................................. 1,066 939 3,692 3,242
Professional fees ................................................ 91 2,432 888 4,613
SAIF insurance premiums and regulatory assessments ............... 765 786 2,313 2,259
Other general and administrative expense ......................... 7,474 5,981 20,035 17,293
----------------------------------------------------------------------------------------------------------------------------------
Total general and administrative expense ....................... 46,379 41,709 136,550 118,980
----------------------------------------------------------------------------------------------------------------------------------
Net operation of real estate acquired in settlement of loans ..... 110 110 79 2
Amortization of excess cost over fair value of branch acquisitions 111 116 336 344
----------------------------------------------------------------------------------------------------------------------------------
Total operating expense ........................................ 46,600 41,935 136,965 119,326
----------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES ....................................... 25,135 37,791 124,957 140,621
Income taxes ..................................................... 10,631 16,025 52,830 59,536
----------------------------------------------------------------------------------------------------------------------------------
NET INCOME ..................................................... $ 14,504 $ 21,766 $ 72,127 $ 81,085
==================================================================================================================================
PER SHARE INFORMATION
BASIC ............................................................ $ 0.52 $ 0.77 $ 2.56 $ 2.87
==================================================================================================================================
DILUTED .......................................................... $ 0.52 $ 0.77 $ 2.56 $ 2.86
==================================================================================================================================
CASH DIVIDENDS DECLARED AND PAID ................................. $ 0.09 $ 0.09 $ 0.27 $ 0.27
==================================================================================================================================
Weighted average diluted shares outstanding ...................... 28,132,199 28,278,485 28,229,288 28,274,894
==================================================================================================================================
See accompanying notes to consolidated financial statements.
2
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------
(In Thousands) 2002 2001 2002 2001
------------------------------------------------------------------------------------------------------------------------
NET INCOME ............................................................ $ 14,504 $ 21,766 $ 72,127 $ 81,085
------------------------------------------------------------------------------------------------------------------------
OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAXES (BENEFITS)
Unrealized gains (losses) on securities available for sale:
U.S. Treasury securities, agency obligations and other investment
securities available for sale, at fair value ..................... 104 973 (441) 1,513
Mortgage-backed securities available for sale, at fair value ...... 774 9 1,698 64
Less reclassification of realized gains included in net income .... -- (2) (121) (139)
Unrealized gains (losses) on cash flow hedges:
Net derivative instruments ........................................ (3,383) (3,052) (7,008) (2,330)
Less reclassification of realized losses included in net income ... 2,543 575 6,385 1,102
------------------------------------------------------------------------------------------------------------------------
Total other comprehensive income (loss), net of income taxes (benefits) 38 (1,497) 513 210
------------------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME .................................................. $ 14,542 $ 20,269 $ 72,640 $ 81,295
========================================================================================================================
See accompanying notes to consolidated financial statements.
3
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
-------------------------------
(In Thousands) 2002 2001
-----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ................................................................................ $ 72,127 $ 81,085
Adjustments to reconcile net income to net cash used for operating activities:
Depreciation and amortization .......................................................... 45,302 37,402
Provision for losses on loans, real estate acquired in settlement of loans, investments
in real estate and joint ventures, mortgage servicing rights and other assets ........ 34,912 21,376
Net gains on sales of loans and mortgage-backed securities, mortgage servicing rights,
investment securities, real estate and other assets .................................. (27,677) (18,255)
Interest capitalized on loans (negative amortization) .................................. (20,917) (36,633)
Federal Home Loan Bank stock dividends ................................................. (2,902) (5,293)
Loans originated for sale ................................................................. (4,131,463) (3,210,267)
Proceeds from sales of loans held for sale, including those sold
via mortgage-backed securities ......................................................... 4,036,188 3,071,593
(Increase) decrease in other, net ......................................................... 19,712 (2,979)
-----------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities ...................................... 25,282 (61,971)
-----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of:
U.S. Treasury securities, agency obligations and other investment securities
available for sale ................................................................... 88,541 24,052
Wholly owned real estate and real estate acquired in settlement of loans ............... 26,036 8,426
Proceeds from maturities of U.S. Treasury securities, agency obligations
and other investment securities available for sale ..................................... 426,205 340,715
Purchase of:
U.S. Treasury securities, agency obligations and other investment securities
available for sale ................................................................... (381,730) (351,619)
Mortgage-backed securities available for sale .......................................... (503,874) --
Loans receivable held for investment ................................................... (31,204) (94,980)
Premises and equipment ................................................................. (15,878) (14,615)
Originations of loans receivable held for investment (net of refinances of $606,919 for the
nine months ended September 30, 2002 and $557,183 for the nine months ended ............
September 30, 2001) .................................................................... (2,697,856) (1,807,057)
Principal payments on loans receivable held for investment and mortgage-backed
securities available for sale .......................................................... 2,263,744 2,218,148
Net change in undisbursed loan funds ...................................................... 53,694 (8,946)
Investments in real estate held for investment ............................................ (15,965) (5,573)
Other, net ................................................................................ 3,600 3,526
-----------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities ...................................... (784,687) 312,077
-----------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
4
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Nine Months Ended
September 30,
-----------------------------
(In Thousands) 2002 2001
-------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits ..................................................... $ 437,366 $ 786,093
Proceeds from Federal Home Loan Bank advances and other borrowings ........... 4,325,258 2,040,850
Repayments of Federal Home Loan Bank advances and other borrowings ........... (3,978,181) (3,091,995)
Purchase of treasury stock ................................................... (8,713) --
Proceeds from exercise of stock options ...................................... 392 161
Cash dividends ............................................................... (7,602) (7,617)
-------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities ......................... 768,520 (272,508)
-------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents ......................... 9,115 (22,402)
Cash and cash equivalents at beginning of period ............................. 143,080 127,803
-------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................................... $ 152,195 $ 105,401
=============================================================================================================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest ................................................................ $ 243,440 $ 404,885
Income taxes ............................................................ 21,992 59,016
Supplemental disclosure of non-cash investing:
Loans transferred to held for investment from held for sale ............... 2,475 4,287
Loans transferred from held for investment to wholly owned real estate .... -- 15,688
Mortgage-backed securities available for sale, purchased and not settled .. 510,224 --
Loans exchanged for mortgage-backed securities ............................ 3,401,952 2,525,816
Real estate acquired in settlement of loans ............................... 20,245 17,588
Loans to facilitate the sale of real estate acquired in settlement of loans 10,778 8,156
=============================================================================================================
See accompanying notes to consolidated financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE (1) - BASIS OF FINANCIAL STATEMENT PRESENTATION
In the opinion of Downey Financial Corp. and subsidiaries ("Downey," "we,"
"us" and "our"), the accompanying consolidated financial statements contain all
adjustments (consisting of only normal recurring accruals) necessary for a fair
presentation of Downey's financial condition as of September 30, 2002, December
31, 2001 and September 30, 2001, the results of operations and comprehensive
income for the three months and nine months ended September 30, 2002 and 2001,
and changes in cash flows for the nine months ended September 30, 2002 and 2001.
Certain prior period amounts have been reclassified to conform to the current
period presentation.
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial statements and are in compliance with the
instructions for Form 10-Q and therefore do not include all information and
footnotes necessary for a fair presentation of financial condition, results of
operations, comprehensive income and cash flows. The following information under
the heading Management's Discussion and Analysis of Financial Condition and
Results of Operations is written with the presumption that the interim
consolidated financial statements will be read in conjunction with Downey's
Annual Report on Form 10-K for the year ended December 31, 2001, which contains
among other things, a description of the business, the latest audited
consolidated financial statements and notes thereto, together with Management's
Discussion and Analysis of Financial Condition and Results of Operations as of
December 31, 2001 and for the year then ended. Therefore, only material changes
in financial condition and results of operations are discussed in the remainder
of Part I.
NOTE (2) - EARNINGS PER SHARE
Earnings per share is calculated on both a basic and diluted basis. Basic
earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted from issuance of
common stock that then shared in earnings.
The following table presents a reconciliation of the components used to
derive basic and diluted earnings per share for the periods indicated.
Three Months Ended September 30,
--------------------------------------------------------------------------
2002 2001
--------------------------------------------------------------------------
Weighted Weighted
Average Average
Net Shares Per Share Net Shares Per Share
(Dollars in Thousands, Except Per Share Data) Income Outstanding Amount Income Outstanding Amount
----------------------------------------------------------------------------------------------------------------------------
Basic earnings per share $14,504 28,092,920 $0.52 $21,766 28,212,575 $0.77
Effect of dilutive stock options -- 39,279 -- -- 65,910 --
----------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $14,504 28,132,199 $0.52 $21,766 28,278,485 $0.77
============================================================================================================================
Nine Months Ended September 30,
--------------------------------------------------------------------------
2002 2001
--------------------------------------------------------------------------
Weighted Weighted
Average Average
Net Shares Per Share Net Shares Per Share
(Dollars in Thousands, Except Per Share Data) Income Outstanding Amount Income Outstanding Amount
----------------------------------------------------------------------------------------------------------------------------
Basic earnings per share $72,127 28,179,585 $2.56 $81,085 28,211,100 $2.87
Effect of dilutive stock options -- 49,703 -- -- 63,794 0.01
----------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $72,127 28,229,288 $2.56 $81,085 28,274,894 $2.86
============================================================================================================================
6
NOTE (3) - BUSINESS SEGMENT REPORTING
The following table presents the operating results and selected financial
data by major business segments for the periods indicated.
Real Estate
(In Thousands) Banking Investment Elimination Totals
-------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 2002
Net interest income .............................. $ 76,960 $ 12 $ -- $ 76,972
Provision for loan losses ........................ 471 -- -- 471
Other income (loss) .............................. (7,507) 2,741 -- (4,766)
Operating expense ................................ 46,439 161 -- 46,600
Net intercompany income (expense) ................ 100 (100) -- --
-------------------------------------------------------------------------------------------------------------------
Income before income taxes ....................... 22,643 2,492 -- 25,135
Income taxes ..................................... 9,607 1,024 -- 10,631
-------------------------------------------------------------------------------------------------------------------
Net income .................................. $ 13,036 $ 1,468 $ -- $ 14,504
===================================================================================================================
AT SEPTEMBER 30, 2002
Assets:
Loans and mortgage-backed securities ........ $ 11,685,037 $ -- $ -- $ 11,685,037
Investments in real estate and joint ventures -- 40,371 -- 40,371
Other ....................................... 828,500 4,090 (39,916) 792,674
-------------------------------------------------------------------------------------------------------------------
Total assets .............................. 12,513,537 44,461 (39,916) 12,518,082
-------------------------------------------------------------------------------------------------------------------
Equity ........................................... $ 790,613 $ 39,916 $ (39,916) $ 790,613
===================================================================================================================
THREE MONTHS ENDED SEPTEMBER 30, 2001
Net interest income (loss) ....................... $ 73,473 $ (26) $ -- $ 73,447
Provision for loan losses ........................ 791 -- -- 791
Other income ..................................... 5,987 1,083 -- 7,070
Operating expense ................................ 40,071 1,864 -- 41,935
Net intercompany income (expense) ................ 92 (92) -- --
-------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (benefit) ...... 38,690 (899) -- 37,791
Income taxes (benefit) ........................... 16,389 (364) -- 16,025
-------------------------------------------------------------------------------------------------------------------
Net income (loss) ........................... $ 22,301 $ (535) $ -- $ 21,766
===================================================================================================================
AT SEPTEMBER 30, 2001
Assets:
Loans and mortgage-backed securities ........ $ 9,912,489 $ -- $ -- $ 9,912,489
Investments in real estate and joint ventures -- 38,043 -- 38,043
Other ....................................... 797,775 1,629 (33,642) 765,762
-------------------------------------------------------------------------------------------------------------------
Total assets .............................. 10,710,264 39,672 (33,642) 10,716,294
-------------------------------------------------------------------------------------------------------------------
Equity ........................................... $ 698,475 $ 33,642 $ (33,642) $ 698,475
===================================================================================================================
Real Estate
(In Thousands) Banking Investment Elimination Totals
-------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2002
Net interest income .............................. $ 232,015 $ 30 $ -- $ 232,045
Provision for loan losses ........................ 812 -- -- 812
Other income ..................................... 23,358 7,331 -- 30,689
Operating expense ................................ 136,338 627 -- 136,965
Net intercompany income (expense) ................ 279 (279) -- --
-------------------------------------------------------------------------------------------------------------------
Income before income taxes ....................... 118,502 6,455 -- 124,957
Income taxes ..................................... 50,185 2,645 -- 52,830
-------------------------------------------------------------------------------------------------------------------
Net income .................................. $ 68,317 $ 3,810 $ -- $ 72,127
===================================================================================================================
NINE MONTHS ENDED SEPTEMBER 30, 2001
Net interest income .............................. $ 225,843 $ 12 $ -- $ 225,855
Provision for loan losses ........................ 1,274 -- -- 1,274
Other income ..................................... 31,943 3,423 -- 35,366
Operating expense ................................ 115,924 3,402 -- 119,326
Net intercompany income (expense) ................ 273 (273) -- --
-------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (benefit) ...... 140,861 (240) -- 140,621
Income taxes (benefit) ........................... 59,632 (96) -- 59,536
-------------------------------------------------------------------------------------------------------------------
Net income (loss) ........................... $ 81,229 $ (144) $ -- $ 81,085
===================================================================================================================
7
NOTE (4) - MORTGAGE SERVICING RIGHTS
The following table summarizes the activity in our mortgage servicing
rights and related allowance for the periods indicated and other related
financial data.
Three Months Ended
-------------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 2002 2002 2002 2001 2001
------------------------------------------------------------------------------------------------------------------------------------
Gross balance at beginning of period ............. $ 81,100 $ 74,914 $ 65,630 $ 61,651 $ 55,848
Additions ........................................ 9,304 10,156 14,997 15,300 10,294
Amortization ..................................... (4,120) (3,253) (2,916) (2,956) (2,495)
Sales of mortgage servicing rights ............... -- -- (35) (4,916) (582)
Impairment write-down ............................ (2,579) (717) (2,762) (3,449) (1,414)
------------------------------------------------------------------------------------------------------------------------------------
Gross balance at end of period ............... 83,705 81,100 74,914 65,630 61,651
------------------------------------------------------------------------------------------------------------------------------------
Allowance balance at beginning of period ......... 21,329 6,333 8,735 24,144 13,706
Provision for (reduction of) impairment .......... 18,043 15,713 360 (11,960) 11,852
Impairment write-down ............................ (2,579) (717) (2,762) (3,449) (1,414)
------------------------------------------------------------------------------------------------------------------------------------
Allowance balance at end of period ........... 36,793 21,329 6,333 8,735 24,144
------------------------------------------------------------------------------------------------------------------------------------
Total mortgage servicing rights, net ......... $ 46,912 $ 59,771 $ 68,581 $ 56,895 $ 37,507
====================================================================================================================================
Estimated fair value (1) ......................... $ 46,986 $ 59,771 $ 70,532 $ 58,047 $ 37,507
Weighted average expected life (in months) ....... 39 61 87 82 59
Custodial account earnings rate .................. 2.06% 3.82% 4.61% 4.36% 2.85%
Weighted average discount rate ................... 8.19 9.10 9.13 9.16 9.21
====================================================================================================================================
AT PERIOD END
Mortgage loans serviced for others:
Total ........................................ $ 7,502,157 $ 6,962,403 $ 6,408,812 $ 5,805,811 $ 5,458,970
With capitalized mortgage servicing rights:(1)
Amount ................................... 7,355,700 6,807,306 6,196,137 5,379,513 5,078,088
Weighted average interest rate ........... 6.71% 6.80% 6.85% 6.97% 7.19%
====================================================================================================================================
Custodial escrow balances ........................ $ 21,628 $ 13,044 $ 6,103 $ 10,596 $ 15,415
====================================================================================================================================
Nine Months Ended
September 30,
------------------------------
(In Thousands) 2002 2001
-----------------------------------------------------------------------------------
Gross balance at beginning of period ............. $ 65,630 $ 46,214
Additions ........................................ 34,457 29,091
Amortization ..................................... (10,289) (6,857)
Sales of mortgage servicing rights ............... (35) (2,910)
Impairment write-down ............................ (6,058) (3,887)
-----------------------------------------------------------------------------------
Gross balance at end of period ............... 83,705 61,651
-----------------------------------------------------------------------------------
Allowance balance at beginning of period ......... 8,735 5,483
Provision for impairment ......................... 34,116 22,548
Impairment write-down ............................ (6,058) (3,887)
-----------------------------------------------------------------------------------
Allowance balance at end of period ........... 36,793 24,144
-----------------------------------------------------------------------------------
Total mortgage servicing rights, net ......... $ 46,912 $ 37,507
===================================================================================
(1) The estimated fair value may exceed book value for certain asset strata and
excluded loans sold or securitized prior to 1996 and loans temporarily
sub-serviced without capitalized mortgage servicing rights.
Key assumptions, which vary due to changes in market interest rates and are
used to determine the fair value of our mortgage servicing rights, include:
expected prepayment speeds, which impact the average life of the portfolio; the
earnings rate on custodial accounts, which impact the value of custodial
accounts; and the discount rate used in valuing future cash flows. The following
table summarizes the estimated changes in the fair value of our mortgage
servicing rights for changes in those assumptions individually and in
combination associated with an immediate 100 basis point increase or decrease in
market rates. Also summarized is the earnings impact associated with provisions
to or reductions in the valuation allowance for mortgage servicing rights.
Impairment is measured on a disaggregated basis based upon the predominant risk
8
characteristics of the underlying mortgage loans such as term and coupon.
Certain stratum may have impairment, while other stratum may not. Therefore,
changes in overall fair value may not equal provisions to or reductions in the
valuation allowance.
The sensitivity analysis in the table below is hypothetical and should be
used with caution. As the figures indicate, changes in fair value based on a 100
basis point variation in assumptions generally cannot be easily extrapolated
because the relationship of the change in the assumptions to the change in fair
value may not be linear. Also, in this table, the effect that a change in a
particular assumption may have on the fair value is calculated without changing
any other assumptions. In reality, changes in one factor may result in changes
in another, which might magnify or counteract the sensitivities.
Expected Value of
Prepayment Custodial Discount
(Dollars in Thousands) Speeds Accounts Rate Combination
-----------------------------------------------------------------------------------------------------------
Increase rates 100 basis points:
Increase (decrease) in fair value (1) ........ $ 38,181 $ 2,435 $ (1,150) $ 36,990
Reduction of (increase in) valuation allowance 36,793 2,509 (1,076) 36,793
Decrease rates 100 basis points:
Increase (decrease) in fair value (2) ........ (19,849) (2,435) 1,209 (21,973)
Reduction of (increase in) valuation allowance (19,775) (2,361) 1,283 (21,899)
===========================================================================================================
(1) The weighted-average expected life is 81 months.
(2) The weighted-average expected life is 21 months.
The following table presents a breakdown of the components of our loan
servicing income (loss) during the periods indicated.
Three Months Ended
-------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
---------------------------------------------------------------------------------------------------------------------
Income from servicing operations .......... $ 3,200 $ 3,349 $ 2,688 $ 2,477 $ 2,576
Amortization of MSRs ...................... (4,120) (3,253) (2,916) (2,956) (2,495)
(Provision for) reduction of impairment ... (18,043) (15,713) (360) 11,960 (11,852)
---------------------------------------------------------------------------------------------------------------------
Total loan servicing income (loss), net $(18,963) $(15,617) $ (588) $ 11,481 $(11,771)
=====================================================================================================================
Nine Months Ended
September 30,
--------------------------
(In Thousands) 2002 2001
-----------------------------------------------------------------------
Income from servicing operations .......... $ 9,237 $ 6,551
Amortization of MSRs ...................... (10,289) (6,857)
Provision for impairment .................. (34,116) (22,548)
-----------------------------------------------------------------------
Total loan servicing loss, net $(35,168) $(22,854)
=======================================================================
NOTE (5) - ACCOUNTING FOR DERIVATIVES AND HEDGING ACTIVITIES
DERIVATIVES
We offer short-term interest rate lock commitments to help us attract
potential home loan borrowers. The commitments guarantee a specified interest
rate for a loan if our underwriting standards are met, but do not obligate the
potential borrower. Accordingly, a certain number of commitments never become
loans and merely expire. The residential one-to-four unit rate lock commitments
we ultimately expect to result in loans and sell in the secondary market are
treated as derivatives. Consequently, as derivatives, the hedging of the
expected rate lock commitments do not qualify for hedge accounting. Associated
fair value adjustments to the notional amount of the expected rate lock
commitments are recorded in current earnings under net gains (losses) on sales
of loans and mortgage-backed securities with an offset to the balance sheet in
either other assets, or accounts payable and accrued liabilities. Fair values
for the notional amount of expected rate lock
9
commitments are based on observable market prices acquired from third parties.
The carrying amount of loans held for sale includes a basis adjustment to the
loan balance at funding resulting from the change in fair value of the rate lock
derivative from the date of commitment to the date of funding. At September 30,
2002, we had a notional amount of expected rate lock commitments identified to
sell as part of our secondary marketing activities of $892 million, with an
estimated fair value gain of $12.1 million, of which $6.9 million was associated
with mortgage servicing rights.
HEDGING ACTIVITIES
As part of our secondary marketing activities, we typically utilize
short-term forward sale and purchase contracts--derivatives--that mature in less
than one year to offset the impact of changes in market interest rates on the
value of our residential one-to-four unit expected rate lock commitments and
loans held for sale. We do not generally enter into derivative transactions for
purely speculative purposes. Contracts designated to loans held for sale are
accounted for as cash flow hedges because these contracts have a high
correlation to the price movement of the loans being hedged (within a range of
80% - 125%). The measurement approach for determining the ineffective aspects of
the hedge is established at the inception of the hedge. Changes in fair value of
the notional amount of forward sale contracts not designated to loans held for
sale and the ineffectiveness of hedge transactions that are not perfectly
correlated are recorded in net gains (losses) on sales of loans and
mortgage-backed securities. Changes in fair value of the notional amount of
forward sale contracts designated as cash flow hedges for loans held for sale
are recorded in other comprehensive income, net of tax, provided cash flow hedge
requirements are met. The offset to these changes in fair value of the notional
amount of forward sale contracts are recorded in the balance sheet as either
other assets, or accounts payable and accrued liabilities. The amounts recorded
in accumulated other comprehensive income will be recognized in the income
statement when the hedged forecasted transactions settle. We estimate that all
of the related unrealized gains or losses in accumulated other comprehensive
income will be reclassified into earnings within the next three months. Fair
values for the notional amount of forward sale contracts are based on observable
market prices acquired from third parties. At September 30, 2002, the notional
amount of forward sale contracts amounted to $1.7 billion, with an estimated
fair value loss of $15.7 million, of which $659 million were designated as cash
flow hedges. The notional amount of forward purchase contracts amounted to $165
million, with an estimated fair value gain of $0.7 million that partially
offsets the loss on our forward sale contracts not designated to loans held for
sale.
We have not discontinued any designated derivative instruments associated
with loans held for sale due to a change in the probability of settling a
forecasted transaction.
The following table shows the impact from non-qualifying hedges and the
ineffectiveness of cash flow hedges on net gains (losses) on sales of loans and
mortgage-backed securities (i.e., SFAS 133 effect), as well as the impact to
other comprehensive income (loss) from qualifying cash flow transactions. Also
shown is the notional amount of expected rate lock commitment derivatives for
loans originated for sale, loans held for sale and the notional amounts for
their associated hedging derivatives (i.e., forward sale contracts).
Three Months Ended
-------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
------------------------------------------------------------------------------------------------------------------------------------
Net gains (losses) on non-qualifying hedge transactions ....... $ (2,663) $ (390) $ 4,864 $ (3,834) $ (1,149)
Net losses on qualifying cash flow hedge transactions:
Unrealized hedge ineffectiveness .......................... -- -- -- -- (27)
Less reclassification of realized hedge ineffectiveness ... -- -- -- -- 27
------------------------------------------------------------------------------------------------------------------------------------
Total net gains (losses) recognized in sales of loans and
mortgage-backed securities (SFAS 133 effect) .......... (2,663) (390) 4,864 (3,834) (1,149)
Other comprehensive income (loss) ............................. (840) (1,138) 1,355 501 (2,477)
====================================================================================================================================
NOTIONAL AMOUNT AT PERIOD END
Non-qualifying hedge transactions:
Expected rate lock commitments ............................ $ 892,429 $ 503,359 $ 235,099 $ 269,315 $ 422,606
Associated forward sale contracts ......................... 1,024,586 501,292 230,660 278,319 404,177
Associated forward purchase contracts ..................... 165,000 3 -- -- 53
Qualifying cash flow hedge transactions:
Loans held for sale, at lower of cost or fair value ....... 665,587 381,465 388,468 499,024 373,489
Associated forward sale contracts ......................... 659,305 378,238 392,099 508,706 369,335
====================================================================================================================================
10
Nine Months Ended
September 30,
---------------------------
(In Thousands) 2002 2001
-------------------------------------------------------------------------------------------
Net gains (losses) on non-qualifying hedge transactions ....... $ 1,811 $ (2,130)
Net losses on qualifying cash flow hedge transactions:
Unrealized hedge ineffectiveness .......................... -- (467)
Less reclassification of realized hedge ineffectiveness ... -- 467
-------------------------------------------------------------------------------------------
Total net gains (losses) recognized in sales of loans and
mortgage-backed securities (SFAS 133 effect) .......... 1,811 (2,130)
Other comprehensive loss ...................................... (623) (1,228)
===========================================================================================
NOTE (6) - INCOME TAXES
Downey and its wholly owned subsidiaries file a consolidated federal income
tax return and various state income and franchise tax returns on a calendar year
basis. The Internal Revenue Service and state taxing authorities have examined
Downey's tax returns for all tax years through 1997. Tax years subsequent to
1997 remain open to review. Downey's management believes it has adequately
provided for potential exposure to issues that may be raised in the years open
to review.
NOTE (7) - CURRENT ACCOUNTING ISSUES
Statement of Financial Accounting Standards No. 142. Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS
142"), applies to all acquired intangible assets whether acquired singularly, as
part of a group, or in a business combination. SFAS 142 supersedes APB Opinion
No. 17, "Intangible Assets," and carries forward provisions in Opinion 17
related to internally developed intangible assets. SFAS 142 changes the
accounting for goodwill from an amortization method to an impairment-only
approach. Goodwill should no longer be amortized, but instead tested for
impairment at least annually at the reporting unit level. The accounting
provisions are effective for fiscal years beginning after December 31, 2001. Our
intangible assets and goodwill are related to branch acquisitions and not within
the scope of SFAS 142. We recognized an unidentified intangible asset for branch
acquisitions because the fair value of the liabilities assumed exceeded the fair
value of the assets acquired. However, Statement of Financial Accounting
Standards No. 147, "Acquisitions of Certain Financial Institutions, an amendment
of FASB Statements No. 72 and 144 and FASB Interpretation No. 9," which was
issued on October 1, 2002, states that assets of this nature which meet the
definition of a business combination will be accounted for using the
impairment-only approach (see discussion below).
Statement of Financial Accounting Standards No. 143. Statement of Financial
Accounting Standards No. 143, "Accounting for Asset Retirement Obligations"
("SFAS 143"), addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. SFAS 143 is effective for financial statements issued
for fiscal years beginning after June 15, 2002. It is anticipated that the
financial impact of SFAS 143 will not have a material effect on Downey.
Statement of Financial Accounting Standards No. 144. Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS 144"), addresses financial accounting and reporting
for the impairment or disposal of long-lived assets. SFAS 144 supersedes SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," and the accounting and reporting provisions of APB
Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of a business segment. SFAS
144 also eliminates the exception to consolidation for a subsidiary for which
control is likely to be temporary. The provisions of SFAS 144 are effective for
financial statements issued for fiscal years beginning after December 15, 2001,
and interim periods within those fiscal years. The provisions of SFAS 144
generally are to be applied prospectively.
Statement of Financial Accounting Standards No. 145. Statement of Financial
Accounting Standards No. 145, "Rescission of SFAS Statements No. 4, 44, and 64,
Amendment of SFAS Statement No. 13, and Technical Corrections" ("SFAS 145"),
updates, clarifies and simplifies existing accounting pronouncements. SFAS 145
rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt."
SFAS 145 amends SFAS No. 13, "Accounting for Leases," to eliminate an
inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. The provisions of SFAS
145 related to SFAS No. 4 and SFAS No. 13 are effective for fiscal years
beginning and transactions occurring after
11
May 15, 2002, respectively. It is anticipated that the financial impact of SFAS
145 will not have a material effect on Downey.
Statement of Financial Accounting Standards No. 146. Statement of Financial
Accounting Standards No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities" ("SFAS 146"), requires Downey to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan. SFAS 146 replaces Emerging Issues
Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The provisions of SFAS 146 are to be
applied prospectively to exit or disposal activities initiated after December
31, 2002.
Statement of Financial Accounting Standards No. 147. Statement of Financial
Accounting Standards No. 147, "Acquisitions of Certain Financial Institutions,
an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9"
("SFAS 147"), addresses the financial accounting and reporting for the
acquisition of all or part of a financial institution, except for a transaction
between two or more mutual enterprises. SFAS 147 removes acquisitions of
financial institutions, other than transactions between two or more mutual
enterprises, from the scope of Statement of Financial Accounting Standards No.
72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions,"
("SFAS 72"), and Financial Accounting Standards Board Interpretation No. 9,
"Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a
Similar Institution Is Acquired in a Business Combination Accounted for by the
Purchase Method," and requires that those transactions be accounted for in
accordance with Statement of Financial Accounting Standards No. 141, "Business
Combinations," and SFAS 142. Thus, the requirement in SFAS 72 to recognize, and
subsequently amortize, any excess of the fair value of liabilities assumed over
the fair value of tangible and identifiable intangible assets acquired as an
unidentifiable intangible asset no longer applies to acquisitions within the
scope of SFAS 147. Consequently, Downey will cease amortizing the remaining
excess cost over fair value of branch acquisitions and subject this asset to
annual impairment testing. Downey will also restate previously issued financial
statements back to January 1, 2002, when SFAS 142 was applied. For the third
quarter of 2002, our amortization of excess cost over fair value of branch
acquisitions was $0.1 million and as of September 30, 2002, this asset totaled
$3 million. For the first nine months of 2002, our amortization was $0.3
million.
SFAS 147 also provides guidance on the accounting for the impairment or
disposal of acquired long-term customer-relationship intangible assets of
financial institutions such as depositor- and borrower-relationship intangible
assets and credit cardholder intangible assets. Those intangible assets are
subject to the same undiscounted cash flow recoverability test and impairment
loss recognition and measurement provisions that SFAS 144 requires for other
long-lived assets that are held and used. The provisions of SFAS 147 are
effective on October 1, 2002.
The following table shows the impact to net income on both an absolute and
per share basis for the restatement that will be made in fourth quarter 2002
pursuant to SFAS 147.
Three Months Ended Nine Months Ended
-------------------------------------------- -----------------
September 30, June 30, March 31, September 30,
(In Thousands, Except Per Share Data) 2002 2002 2002 2002
-------------------------------------------------------------------------------------- -----------------
NET INCOME AS ORIGINALLY REPORTED
Amount ...................... $ 14,504 $ 20,309 $ 37,314 $ 72,127
Basic earnings per share .... 0.52 0.72 1.32 2.56
Diluted earnings per share .. 0.52 0.72 1.32 2.56
====================================================================================== =================
NET INCOME RESTATED FOR SFAS 147
Amount ...................... $ 14,568 $ 20,375 $ 37,378 $ 72,321
Basic earnings per share .... 0.52 0.72 1.32 2.56
Diluted earnings per share .. 0.52 0.72 1.32 2.56
====================================================================================== =================
12
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain statements under this caption may constitute "forward-looking
statements" under the Private Securities Litigation Reform Act of 1995 which
involve risks and uncertainties. Our actual results may differ significantly
from the results discussed in such forward-looking statements. Factors that
might cause such a difference include, but are not limited to, economic
conditions, competition in the geographic and business areas in which we conduct
our operations, fluctuations in interest rates, credit quality and government
regulation.
OVERVIEW
Our net income for the third quarter of 2002 totaled $14.5 million or $0.52
per share on a diluted basis, compared to $21.8 million or $0.77 per share in
the third quarter of 2001. During the current quarter, 212,300 shares of common
stock were repurchased at an average price per share of $41.04, leaving $41
million of the $50 million authorization available for future share repurchases.
The decline in our net income between third quarters was primarily due to a
larger addition to the valuation allowance for mortgage servicing rights. The
addition was reflected within the category of loan servicing loss and was
necessary due to an approximate 120 basis point decline in long-term interest
rates, which resulted in an increase in the projected rate at which loans
serviced for others are expected to prepay, thereby shortening their expected
average life. In addition, the decline in long-term interest rates also reduced
the expected value of associated custodial accounts. The pre-tax addition during
the third quarter was $18.0 million, up from $11.9 million in the year-ago third
quarter. Excluding the valuation allowances, our net income in the current
quarter would have been $24.9 million, down $3.7 million or 12.9% from the
adjusted year-ago level. This decline reflected a decrease of $5.7 million in
adjusted net income from our banking operations, partially offset by a $2.0
million increase in net income from real estate investment activities which
benefited from higher gains from sales. The decline in our adjusted net income
from banking operations was primarily due to the following:
o a $7.3 million or 40.9% decline in other income primarily due to:
o a $5.3 million unfavorable change in net gains from the sales of
loans and mortgage servicing rights and
o a $1.4 million decline in loan and deposit related fees due
primarily to lower loan prepayment fees; and
o a $6.4 million or 15.9% increase in operating expense due to higher
costs associated with the increased number of branch locations and
higher loan origination activity.
These items were partially offset by a $3.5 million or 4.7% increase in net
interest income, due to higher interest-earning assets, and a $0.3 million
decline in provision for loan losses.
For the first nine months of 2002, our net income totaled $72.1 million or
$2.56 per share on a diluted basis, compared to $81.1 million or $2.86 per share
for the first nine months of 2001. The decline between nine-month periods
reflected lower net income from our banking operations and was primarily due to
higher valuation provisions associated with mortgage servicing rights.
For the third quarter of 2002, our return on average assets was 0.51% and
our return on average equity was 7.41%. For the first nine months of 2002, our
return on average assets was 0.87% and our return on average equity was 12.51%.
Our single family loan originations totaled a record $2.832 billion in the
third quarter of 2002, up 42.4% from the $1.988 billion we originated in the
third quarter of 2001 and 29.9% above the $2.179 billion we originated in the
previous quarter. Of the current quarter total, $1.032 billion represented
originations of loans for portfolio, of which $150 million represented subprime
credits. In addition to single family loans, we originated $43 million of other
loans in the quarter.
At quarter end, our assets totaled $12.5 billion, up 16.8% from a year ago.
Included in the total were $1.0 billion of 30-year fixed rate mortgage-backed
securities purchased in late September, of which about half were funded by
quarter end with short-term borrowings, while the other half settles in
mid-October. These securities were purchased due to a net interest spread of
over 3% given the steepness in the yield curve. However, these securities were
sold in early October due to interest rate volatility and the potential adverse
impact market interest rate changes could have on the carrying value of the
investment. Approximately $1.0 million was earned on these securities while
owned, virtually all of which will be recognized in the fourth quarter.
13
Our deposits totaled $9.1 billion, up 2.1% from a year ago. During the
quarter, we opened one new traditional and seven new in-store branches, bringing
our total branches at quarter end to 156, of which 85 were in-store. A year ago,
branches totaled 134, of which 67 were in-store.
Our non-performing assets increased $5 million during the quarter to $89
million or 0.71% of total assets (0.77% excluding the previously mentioned
mortgage-backed securities purchased in late September but sold in early
October). Residential non-performers increased $9 million during the quarter, of
which $6 million was associated with subprime loans. That increase was partially
offset by a $4 million decline in commercial real estate non-performers due to a
short-pay that was accepted in full consideration of the loan obligation.
At September 30, 2002, our primary subsidiary, Downey Savings and Loan
Association, F.A. (the "Bank") exceeded all regulatory capital tests, with
capital-to-asset ratios of 6.36% for both tangible and core capital and 13.65%
for risk-based capital. These capital levels are significantly above the "well
capitalized" standards defined by the federal banking regulators of 5% for core
and tangible capital and 10% for risk-based capital.
CRITICAL ACCOUNTING POLICIES
We have established various accounting policies which govern the
application of accounting principles generally accepted in the United States of
America in the preparation of our financial statements. Our significant
accounting policies are described in Downey's Annual Report on Form 10-K for the
year ended December 31, 2001. Certain accounting policies require us to make
significant estimates and assumptions which have a material impact on the
carrying value of certain assets and liabilities, and we consider these to be
critical accounting policies. The estimates and assumptions we use are based on
historical experience and other factors, which we believe to be reasonable under
the circumstances. Actual results could differ significantly from these
estimates and assumptions which could have a material impact on the carrying
value of assets and liabilities at the balance sheet dates and our results of
operations for the reporting periods.
We believe the following are critical accounting policies that require the
most significant estimates and assumptions that are particularly susceptible to
significant change in the preparation of our financial statements:
o Allowance for losses on loans and real estate. For further
information, see Financial Condition--Problem Loans and Real
Estate--Allowance for Losses on Loans and Real Estate on page 36.
o Valuation of mortgage servicing rights. For further information, see
Note 4 on page 8 of Notes to Consolidated Financial Statements.
14
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is the difference between the interest and dividends
earned on loans, mortgage-backed securities and investment securities
("interest-earning assets") and the interest paid on deposits, borrowings and
capital securities ("interest-bearing liabilities"). The spread between the
yield on interest-earning assets and the cost of interest-bearing liabilities
and the relative dollar amounts of these assets and liabilities principally
affects net interest income.
Our net interest income totaled $77.0 million in the third quarter of 2002,
up $3.5 million or 4.8% from the same period last year. The increase between
third quarters reflected higher interest-earning asset levels. Our
interest-earning assets averaged $10.9 billion during the quarter, up 5.6% from
the year-ago level. The effective interest rate spread averaged 2.83% in the
current quarter, slightly below 2.85% a year ago.
For the first nine months of 2002, net interest income totaled $232.0
million, up $6.2 million or 2.7% from a year ago. The increase reflected both a
higher effective interest rate spread and higher interest-earning asset levels.
The following table presents for the periods indicated the total dollar
amount of:
o interest income from average interest-earning assets and the resultant
yields; and
o interest expense on average interest-bearing liabilities and the
resultant costs, expressed as rates.
The table also sets forth our net interest income, interest rate spread and
effective interest rate spread. The effective interest rate spread reflects the
relative level of interest-earning assets to interest-bearing liabilities and
equals:
o the difference between interest income on interest-earning assets and
interest expense on interest-bearing liabilities, divided by
o average interest-earning assets for the period.
The table also sets forth our net interest-earning balance--the difference
between the average balance of interest-earning assets and the average balance
of total deposits, borrowings and capital securities--for the periods indicated.
We included non-accrual loans in the average interest-earning assets balance. We
included interest from non-accrual loans in interest income only to the extent
we received payments and to the extent we believe we will recover the remaining
principal balance of the loans. We computed average balances for the quarter
using the average of each month's daily average balance during the periods
indicated.
15
Three Months Ended September 30,
----------------------------------------------------------------------------
2002 2001
----------------------------------------------------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in Thousands) Balance Interest Rate Balance Interest Rate
--------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Loans ........................................... $ 10,475,813 $ 150,987 5.77% $ 9,893,414 $ 187,867 7.60%
Mortgage-backed securities ...................... 32,601 287 3.52 4,951 62 5.01
Investment securities ........................... 387,325 3,650 3.74 420,635 5,767 5.44
--------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets ................. 10,895,739 154,924 5.69 10,319,000 193,696 7.51
Non-interest-earning assets ....................... 392,952 354,634
--------------------------------------------------------------------------------------------------------------------------------
Total assets .................................... $ 11,288,691 $ 10,673,634
================================================================================================================================
Transaction accounts:
Non-interest-bearing checking ................... $ 301,169 $ -- -- % $ 313,665 $ -- -- %
Interest-bearing checking (a) ................... 414,909 323 0.31 406,779 501 0.49
Money market .................................... 114,544 487 1.69 93,388 648 2.75
Regular passbook ................................ 3,222,127 18,566 2.29 1,184,206 9,426 3.16
--------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts .................... 4,052,749 19,376 1.90 1,998,038 10,575 2.10
Certificates of deposit ........................... 4,766,674 40,222 3.35 6,929,044 96,458 5.52
--------------------------------------------------------------------------------------------------------------------------------
Total deposits .................................. 8,819,423 59,598 2.68 8,927,082 107,033 4.76
Borrowings ........................................ 1,396,414 15,314 4.35 805,879 10,176 5.01
Capital securities ................................ 120,000 3,040 10.14 120,000 3,040 10.14
--------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and capital securities 10,335,837 77,952 2.99 9,852,961 120,249 4.84
Other liabilities ................................. 169,552 131,469
Stockholders' equity .............................. 783,302 689,204
--------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity ...... $ 11,288,691 $ 10,673,634
================================================================================================================================
Net interest income/interest rate spread .......... $ 76,972 2.70% $ 73,447 2.67%
Excess of interest-earning assets over deposits,
borrowings and capital securities ............... $ 559,902 $ 466,039
Effective interest rate spread .................... 2.83 2.85
================================================================================================================================
Nine Months Ended September 30,
----------------------------------------------------------------------------
2002 2001
----------------------------------------------------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in Thousands) Balance Interest Rate Balance Interest Rate
--------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Loans ........................................... $ 10,161,564 $ 459,712 6.03% $ 10,043,997 $ 604,449 8.02%
Mortgage-backed securities ...................... 73,283 2,503 4.55 6,121 277 6.03
Investment securities ........................... 412,504 12,532 4.06 450,942 20,171 5.98
--------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets ................. 10,647,351 474,747 5.95 10,501,060 624,897 7.93
Non-interest-earning assets ....................... 394,442 357,013
--------------------------------------------------------------------------------------------------------------------------------
Total assets .................................... $ 11,041,793 $ 10,858,073
================================================================================================================================
Transaction accounts:
Non-interest-bearing checking ................... $ 293,964 $ -- -- % $ 285,427 $ -- -- %
Interest-bearing checking (a) ................... 421,894 1,065 0.34 404,065 1,633 0.54
Money market .................................... 112,830 1,497 1.77 90,869 1,903 2.80
Regular passbook ................................ 2,875,959 52,502 2.44 942,245 23,369 3.32
--------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts .................... 3,704,647 55,064 1.99 1,722,606 26,905 2.09
Certificates of deposit ........................... 4,929,779 133,290 3.61 6,968,361 309,315 5.93
--------------------------------------------------------------------------------------------------------------------------------
Total deposits .................................. 8,634,426 188,354 2.92 8,690,967 336,220 5.17
Borrowings ........................................ 1,373,979 45,226 4.40 1,254,497 53,700 5.72
Capital securities ................................ 120,000 9,122 10.14 120,000 9,122 10.14
--------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and capital securities 10,128,405 242,702 3.20 10,065,464 399,042 5.30
Other liabilities ................................. 144,425 129,714
Stockholders' equity .............................. 768,963 662,895
--------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity ...... $ 11,041,793 $ 10,858,073
================================================================================================================================
Net interest income/interest rate spread .......... $ 232,045 2.75% $ 225,855 2.63%
Excess of interest-earning assets over deposits,
borrowings and capital securities ............... $ 518,946 $ 435,596
Effective interest rate spread .................... 2.91 2.87
================================================================================================================================
(a) Included amounts swept into money market deposit accounts.
16
Changes in our net interest income are a function of both changes in rates
and changes in volumes of interest-earning assets and interest-bearing
liabilities. The following table sets forth information regarding changes in our
interest income and expense for the periods indicated. For each category of
interest-earning assets and interest-bearing liabilities, we have provided
information on changes attributable to:
o changes in volume--changes in volume multiplied by comparative period
rate;
o changes in rate--changes in rate multiplied by comparative period
volume; and
o changes in rate/volume--changes in rate multiplied by changes in
volume.
Interest-earning asset and interest-bearing liability balances used in the
calculations represent quarterly average balances computed using the average of
each month's daily average balance during the period indicated.
Three Months Ended September 30, Nine Months Ended September 30,
2002 Versus 2001 2002 Versus 2001
Changes Due To Changes Due To
----------------------------------------------------------------------------------------------
Rate/ Rate/
(In Thousands) Volume Rate Volume Net Volume Rate Volume Net
------------------------------------------------------------------------------------------------------------------------------------
Interest income:
Loans ........................... $ 11,059 $(45,274) $ (2,665) $(36,880) $ 7,075 $(150,056) $ (1,756) $(144,737)
Mortgage-backed securities ...... 346 (18) (103) 225 3,039 (68) (745) 2,226
Investment securities ........... (457) (1,803) 143 (2,117) (1,719) (6,472) 552 (7,639)
------------------------------------------------------------------------------------------------------------------------------------
Change in interest income ..... 10,948 (47,095) (2,625) (38,772) 8,395 (156,596) (1,949) (150,150)
------------------------------------------------------------------------------------------------------------------------------------
Interest expense:
Transaction accounts:
Interest-bearing checking (1) . 10 (184) (4) (178) 72 (613) (27) (568)
Money market .................. 147 (251) (57) (161) 460 (697) (169) (406)
Regular passbook .............. 16,222 (2,603) (4,479) 9,140 47,959 (6,168) (12,658) 29,133
------------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts .. 16,379 (3,038) (4,540) 8,801 48,491 (7,478) (12,854) 28,159
Certificates of deposit ......... (30,102) (37,990) 11,856 (56,236) (90,490) (120,906) 35,371 (176,025)
------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits (13,723) (41,028) 7,316 (47,435) (41,999) (128,384) 22,517 (147,866)
Borrowings ...................... 7,418 (1,348) (932) 5,138 5,052 (10,189) (3,337) (8,474)
Capital securities .............. -- -- -- -- -- -- -- --
------------------------------------------------------------------------------------------------------------------------------------
Change in interest expense .... (6,305) (42,376) 6,384 (42,297) (36,947) (138,573) 19,180 (156,340)
------------------------------------------------------------------------------------------------------------------------------------
Change in net interest income ....... $ 17,253 $ (4,719) $ (9,009) $ 3,525 $ 45,342 $ (18,023) $(21,129) $ 6,190
====================================================================================================================================
(1) Included amounts swept into money market deposit accounts.
PROVISION FOR LOAN LOSSES
Provision for loan losses totaled $0.5 million in the current quarter, down
$0.3 million from the year-ago third quarter. The allowance for loan losses was
$35 million at September 30, 2002, compared to $36 million at year-end 2001. Net
charge-offs totaled $1.4 million in the third quarter of 2002, compared to less
than $0.1 million a year ago. The increase from a year ago primarily reflects a
$1.2 million charge-off in the current quarter of a commercial real estate loan
for which a short-pay was accepted in full consideration of the loan.
For the first nine months of 2002, provision for loan losses was $0.8
million and net charge-offs were $2.1 million. That compares to a provision for
loan losses of $1.3 million and net charge-offs of $0.7 million in the year-ago
period. For further information regarding our allowance for loan losses, see
Financial Condition--Problem Loans and Real Estate--Allowance for Losses on
Loans and Real Estate on page 36.
17
OTHER INCOME
A loss of $4.8 million was recognized in our total other income for the
third quarter of 2002, compared to income of $7.1 million in the year-ago third
quarter. The $11.8 million unfavorable change between third quarters primarily
reflected:
o a $7.2 million increase in the loss on our loan servicing activity due
primarily to a larger addition to the valuation allowance for mortgage
servicing rights, as the fair value of those rights dropped in the
current quarter due to an approximate 120 basis point decline in
long-term interest rates;
o a $5.3 million unfavorable change in net gains (losses) on sales of
loans and mortgage-backed securities and mortgage servicing rights;
and
o a $1.4 million decline in loan and deposit related fees, due primarily
to a $2.9 million decline in loan prepayment fees.
Partially offsetting those declines was a $1.7 million increase in income from
real estate held for investment due to higher gains from sales.
For the first nine months of 2002, total other income was $30.7 million,
down $4.7 million from a year ago, primarily reflecting a $12.3 million increase
in the loss from loan servicing and a $2.9 million decrease in loan and deposit
related fees. Those items were partially offset by a $6.3 million increase in
net gains (losses) on sales of loans and mortgage-backed securities and mortgage
servicing rights, and a $4.0 million increase in income from real estate and
joint ventures held for investment. Below is a further discussion of the major
other income categories.
LOAN AND DEPOSIT RELATED FEES
Loan and deposit related fees totaled $11.8 million in the third quarter of
2002, down $1.4 million from a year ago. Our loan related fees were down $2.8
million between third quarters, due primarily to a decline in loan prepayment
fees. This decline was partially offset by a $1.3 million or 28.6% increase in
our deposit related fees, primarily due to higher fees from our checking
accounts.
The following table presents a breakdown of loan and deposit related fees
during the quarterly periods indicated.
Three Months Ended
---------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
---------------------------------------------------------------------------------------------------------------
Loan related fees:
Prepayment fees ...................... $ 3,523 $ 4,140 $ 4,686 $ 5,475 $ 6,384
Other fees ........................... 2,366 1,992 2,167 2,477 2,257
Deposit related fees:
Automated teller machine fees ........ 2,051 1,668 1,543 1,670 1,671
Other fees ........................... 3,908 3,596 3,122 3,224 2,962
---------------------------------------------------------------------------------------------------------------
Total loan and deposit related fees $11,848 $11,396 $11,518 $12,846 $13,274
===============================================================================================================
18
For the nine months of 2002, loan and deposit related fees totaled $34.8
million, down $2.9 million from the same period of 2001. The decrease reflected
a $6.0 million decline in loan prepayment fees, as deposit related fees were up
$2.9 million.
The following table presents a breakdown of loan and deposit related fees
during the year-to-date periods indicated.
Nine Months Ended
September 30,
---------------------
(In Thousands) 2002 2001
-----------------------------------------------------------------
Loan related fees:
Prepayment fees ...................... $12,349 $18,364
Other fees ........................... 6,525 6,287
Deposit related fees:
Automated teller machine fees ........ 5,262 4,854
Other fees ........................... 10,626 8,135
-----------------------------------------------------------------
Total loan and deposit related fees $34,762 $37,640
=================================================================
REAL ESTATE AND JOINT VENTURES HELD FOR INVESTMENT
Income from our real estate and joint ventures held for investment totaled
$2.4 million in the third quarter of 2002, up $1.7 million from a year ago. The
favorable change reflected increases of $1.7 million in net gains from sales.
The gains primarily related to joint venture projects and were reported in the
category of equity in net income from joint ventures.
The following table sets forth the key components comprising our income
from real estate and joint venture operations during the quarterly periods
indicated.
Three Months Ended
------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
---------------------------------------------------------------------------------------------------------------------------
Rental operations, net of expenses ..................... $ 269 $ 521 $ 823 $ 1,026 $ 259
Equity in net income from joint ventures ............... 1,634 1,001 745 212 12
Interest from joint venture advances ................... 306 304 111 83 101
Net gains on sales of wholly owned real estate ......... 99 8 -- 127 --
(Provision for) reduction of losses on real estate and
joint ventures ...................................... 99 (818) 1,318 (1) 374
---------------------------------------------------------------------------------------------------------------------------
Total income from real estate and joint ventures held
for investment, net ............................... $ 2,407 $ 1,016 $ 2,997 $ 1,447 $ 746
===========================================================================================================================
For the first nine months of 2002, income from real estate and joint
ventures held for investment totaled $6.4 million, up $4.0 million from the same
period of 2001 due primarily to sales activity.
The following table sets forth the key components comprising our income
from real estate and joint venture operations during the year-to-date periods
indicated.
Nine Months Ended
September 30,
-------------------
(In Thousands) 2002 2001
------------------------------------------------------------------------------------------------
Rental operations, net of expenses ......................................... $1,613 $1,219
Equity in net income from joint ventures ................................... 3,380 524
Interest from joint venture advances ....................................... 721 385
Net gains on sales of wholly owned real estate ............................. 107 2
Reduction of losses on real estate and joint ventures ...................... 599 308
------------------------------------------------------------------------------------------------
Total income from real estate and joint ventures held for investment, net $6,420 $2,438
================================================================================================
19
SECONDARY MARKETING ACTIVITIES
A loss of $19.0 million was recorded in loan servicing from our portfolio
of loans serviced for others during the third quarter of 2002, $7.2 million
higher than the loss of $11.8 million in the year-ago period. The higher loss
primarily reflected a larger addition to the valuation allowance for mortgage
servicing rights, $18.0 million in the current quarter, compared to $11.9
million a year ago. The current quarter valuation addition was associated with
the deterioration in fair value of our mortgage servicing rights due to the
approximate 120 basis point decline in long-term interest rates, which resulted
in an increase in the projected rate at which loans serviced for others are
expected to prepay, thereby shortening their expected average life. In addition,
the decline in long-term interest rates also reduced the expected value of
custodial accounts. At September 30, 2002, we serviced loans for others of $7.5
billion, compared to $5.8 billion at December 31, 2001, and $5.5 billion at
September 30, 2001.
The following table presents a breakdown of the components of our loan
servicing income (loss) during the quarterly periods indicated.
Three Months Ended
----------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
----------------------------------------------------------------------------------------------------------------------------
Income from servicing operations .......... $ 3,200 $ 3,349 $ 2,688 $ 2,477 $ 2,576
Amortization of MSRs ...................... (4,120) (3,253) (2,916) (2,956) (2,495)
(Provision for) reduction of impairment ... (18,043) (15,713) (360) 11,960 (11,852)
----------------------------------------------------------------------------------------------------------------------------
Total loan servicing income (loss), net $(18,963) $(15,617) $ (588) $11,481 $(11,771)
============================================================================================================================
For the first nine months of 2002, a loss of $35.2 million was recorded in
loan servicing, compared to a loss of $22.9 million from the same period of
2001, due to a larger addition to the valuation allowance for mortgage servicing
rights.
The following table presents a breakdown of the components of our loan
servicing loss during the year-to-date periods indicated.
Nine Months Ended
September 30,
---------------------------
(In Thousands) 2002 2001
--------------------------------------------------------------
Income from servicing operations . $ 9,237 $ 6,551
Amortization of MSRs ............. (10,289) (6,857)
Provision for impairment ......... (34,116) (22,548)
--------------------------------------------------------------
Total loan servicing loss, net $(35,168) $(22,854)
==============================================================
For further information regarding mortgage servicing rights, see Notes To
Consolidated Financial Statements--Note (4)--Mortgage Servicing Rights on page
8.
20
Sales of loans and mortgage-backed securities increased in the third
quarter of 2002 to a record $1.564 billion from $1.120 billion a year ago. A
loss of $1.0 million was recognized in the current quarter, compared to income
of $4.2 million a year ago. Included in the current quarter loss was a $2.7
million loss associated with the SFAS 133 impact of valuing derivatives
associated with the sale of loans. Excluding the SFAS 133 loss, a gain of $1.7
million or 0.11% of loans sold was realized. This result is below recent
quarters due, in part, to lower values of mortgage servicing rights being
recognized on loans sold servicing retained, given the decline that occurred in
long-term interest rates between the time the fixed rate was committed to the
borrower and when we sold the loan. Net losses in the current quarter included
the capitalization of mortgage servicing rights totaling $9.3 million, compared
to $10.3 million a year ago.
The following table presents a breakdown of the components of our net gains
(losses) on sales of loans and mortgage-backed securities during the quarterly
periods indicated.
Three Months Ended
----------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
----------------------------------------------------------------------------------------------------------------------------
Mortgage servicing rights .................... $ 9,304 $10,156 $14,997 $15,299 $10,294
All other components excluding SFAS 133 ...... (7,612) (2,870) (3,660) (4,416) (4,911)
SFAS 133 ..................................... (2,663) (390) 4,864 (3,834) (1,149)
----------------------------------------------------------------------------------------------------------------------------
Total net gains (losses) on sales of loans
and mortgage-backed securities ......... $ (971) $ 6,896 $16,201 $ 7,049 $ 4,234
============================================================================================================================
Total as percent of loans and
mortgage-backed securities sold .......... (0.06)% 0.63% 1.17% 0.48% 0.38%
============================================================================================================================
For the first nine months of 2002, net gains on sales of loans and
mortgage-backed securities totaled $22.1 million, up $6.7 million from the same
period of 2001.
The following table presents a breakdown of the components of our net gains
on sales of loans and mortgage-backed securities during the year-to-date periods
indicated.
Nine Months Ended
September 30,
---------------------------
(In Thousands) 2002 2001
-------------------------------------------------------------------
Mortgage servicing rights ............. $ 34,457 $ 29,091
All other components excluding SFAS 133 (14,142) (11,578)
SFAS 133 .............................. 1,811 (2,130)
-------------------------------------------------------------------
Total net gains on sales of loans
and mortgage-backed securities .. $ 22,126 $ 15,383
===================================================================
Total as percent of loans and
mortgage-backed securities sold ... 0.55% 0.50%
===================================================================
21
OPERATING EXPENSE
Our operating expense totaled $46.6 million in the current quarter, up $4.7
million or 11.1% from the third quarter of 2001. That increase was due primarily
to higher general and administrative costs associated with an increased number
of branch locations and higher loan origination activity.
The following table presents a breakdown of key components comprising
operating expense during the quarterly periods indicated.
Three Months Ended
--------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
-----------------------------------------------------------------------------------------------------------------
Salaries and related costs ................. $29,067 $28,315 $29,437 $27,075 $24,943
Premises and equipment costs ............... 7,916 7,754 7,133 7,303 6,628
Advertising expense ........................ 1,066 1,582 1,044 1,168 939
Professional fees .......................... 91 233 564 839 2,432
SAIF insurance premiums and regulatory
assessments ............................. 765 762 786 792 786
Other general and administrative expense ... 7,474 6,350 6,211 6,339 5,981
-----------------------------------------------------------------------------------------------------------------
Total general and administrative expense 46,379 44,996 45,175 43,516 41,709
Net operation of real estate acquired in
settlement of loans ..................... 110 27 (58) 237 110
Amortization of excess cost over fair value
of branch acquisitions ................ 111 114 111 113 116
-----------------------------------------------------------------------------------------------------------------
Total operating expense ............... $46,600 $45,137 $45,228 $43,866 $41,935
=================================================================================================================
For the first nine months of 2002, operating expenses totaled $137.0
million, up $17.6 million or 14.8% from the same period of 2001, and also
reflected higher costs associated with the increased number of branch locations
and higher loan origination activity.
The following table presents a breakdown of key components comprising
operating expense during the year-to-date periods indicated.
Nine Months Ended
September 30,
----------------------
(In Thousands) 2002 2001
------------------------------------------------------------------------------------------
Salaries and related costs ....................................... $ 86,819 $ 72,860
Premises and equipment costs ..................................... 22,803 18,713
Advertising expense .............................................. 3,692 3,242
Professional fees ................................................ 888 4,613
SAIF insurance premiums and regulatory assessments ............... 2,313 2,259
Other general and administrative expense ......................... 20,035 17,293
------------------------------------------------------------------------------------------
Total general and administrative expense ..................... 136,550 118,980
Net operation of real estate acquired in settlement of loans ..... 79 2
Amortization of excess cost over fair value of branch acquisitions 336 344
------------------------------------------------------------------------------------------
Total operating expense ...................................... $136,965 $119,326
==========================================================================================
PROVISION FOR INCOME TAXES
Income taxes for the third quarter totaled $10.6 million, resulting in an
effective tax rate of 42.3%, compared to $16.0 million and 42.4% for the like
quarter of a year ago. Our effective tax rate was 42.3% for the first nine
months of both 2002 and 2001. For further information regarding income taxes,
see Notes to Consolidated Financial Statements--Note (6)--Income Taxes on page
11.
22
BUSINESS SEGMENT REPORTING
The previous discussion and analysis of the Results of Operations pertained
to our consolidated results. This section discusses and analyzes the results of
operations of our two business segments--banking and real estate investment. For
further information regarding business segments, see Notes To Consolidated
Financial Statements--Note (3)--Business Segment Reporting on page 7.
The following table presents by business segment our net income for the
periods indicated.
Three Months Ended
-----------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
--------------------------------------------------------------------------------------------------------------------------
Banking net income ..................... $13,036 $19,724 $35,557 $38,225 $22,301
Real estate investment net income (loss) 1,468 585 1,757 871 (535)
--------------------------------------------------------------------------------------------------------------------------
Total net income .................... $14,504 $20,309 $37,314 $39,096 $21,766
==========================================================================================================================
Nine Months Ended
September 30,
--------------------------
2002 2001
--------------------------------------------------------------------------
Banking net income ..................... $68,317 $81,229
Real estate investment net income (loss) 3,810 (144)
--------------------------------------------------------------------------
Total net income .................... $72,127 $81,085
==========================================================================
BANKING
Net income from our banking operations for the third quarter of 2002
totaled $13.0 million, down $9.3 million or 41.5% from $22.3 million in the
third quarter of 2001. The decrease between third quarters primarily reflected a
larger addition to the valuation allowance for mortgage servicing rights. The
addition was reflected within the category of loan servicing loss and was
necessary due to the approximate 120 basis point decline in long-term interest
rates, which resulted in an increase in the projected rate at which loans
serviced for others are expected to prepay, thereby shortening their expected
average life. In addition, the decline in long-term interest rates also reduced
the expected value of associated custodial accounts. The pre-tax addition during
the third quarter was $18.0 million, up from $11.9 million in the year-ago third
quarter. Excluding the valuation allowances, our net income from banking
operations in the current quarter would have been $23.4 million, down $5.7
million or 19.6% from the adjusted year-ago level. The decline in our adjusted
net income from banking operations was primarily due to the following:
o a $7.3 million or 40.9% decrease in other income primarily due to:
o a $5.3 million unfavorable change in net gains from the sales of
loans and mortgage servicing rights and
o a $1.4 million decrease in loan and deposit related fees due
primarily to lower loan prepayment fees; and
o a $6.4 million or 15.9% increase in operating expense due to higher
costs associated with the increased number of branch locations and
higher loan origination activity.
These items were partially offset by a $3.5 million or 4.7% increase in net
interest income due to higher interest-earning assets, and a $0.3 million
decline in provision for loan losses.
23
The following table sets forth our banking operational results and selected
financial data for the quarterly periods indicated.
Three Months Ended
------------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
-------------------------------------------------------------------------------------------------------------------------
Net interest income .................... $ 76,960 $ 75,115 $ 79,940 $ 79,730 $ 73,473
Provision for (reduction of) loan losses 471 (1,106) 1,447 1,290 791
Other income (loss) .................... (7,507) 2,803 28,062 31,397 5,987
Operating expense ...................... 46,439 44,893 45,006 43,680 40,071
Net intercompany income ................ 100 86 93 96 92
-------------------------------------------------------------------------------------------------------------------------
Income before income taxes ............. 22,643 34,217 61,642 66,253 38,690
Income taxes ........................... 9,607 14,493 26,085 28,028 16,389
-------------------------------------------------------------------------------------------------------------------------
Net income .......................... $ 13,036 $ 19,724 $ 35,557 $ 38,225 $ 22,301
=========================================================================================================================
AT PERIOD END
Assets:
Loans and mortgage-backed securities $ 11,685,037 $ 10,286,033 $ 10,088,113 $ 10,132,413 $ 9,912,489
Other ............................... 828,500 840,416 819,407 966,942 797,775
-------------------------------------------------------------------------------------------------------------------------
Total assets ...................... 12,513,537 11,126,449 10,907,520 11,099,355 10,710,264
-------------------------------------------------------------------------------------------------------------------------
Equity ................................. $ 790,613 $ 787,306 $ 767,622 $ 733,896 $ 698,475
=========================================================================================================================
For the first nine months of 2002, our net income from banking operations
totaled $68.3 million, down $12.9 million from the same period a year ago due
primarily to the larger addition to the valuation allowance for mortgage
servicing rights.
The following table sets forth our banking operational results for the
year-to-date periods indicated.
Nine Months Ended
September 30,
------------------------
(In Thousands) 2002 2001
------------------------------------------------------
Net interest income ...... $232,015 $225,843
Provision for loan losses 812 1,274
Other income ............. 23,358 31,943
Operating expense ........ 136,338 115,924
Net intercompany income .. 279 273
------------------------------------------------------
Income before income taxes 118,502 140,861
Income taxes ............. 50,185 59,632
------------------------------------------------------
Net income ............ $ 68,317 $ 81,229
======================================================
24
REAL ESTATE INVESTMENT
Net income from our real estate investment operations totaled $1.5 million
in the third quarter of 2002, compared to a net loss of $0.5 million in the
year-ago quarter. The favorable change was primarily attributed to higher gains
from sales, which increased $1.7 million, and lower operating expenses, as the
year-ago quarter included expense pertaining to litigation matters associated
with certain joint venture partners.
The following table sets forth real estate investment operational results
and selected financial data for the quarterly periods indicated.
Three Months Ended
------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) ................. $ 12 $ 13 $ 5 $ (15) $ (26)
Other income .................................. 2,741 1,299 3,291 1,773 1,083
Operating expense ............................. 161 244 222 186 1,864
Net intercompany expense ...................... 100 86 93 96 92
------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (benefit) ... 2,492 982 2,981 1,476 (899)
Income taxes (benefit) ........................ 1,024 397 1,224 605 (364)
------------------------------------------------------------------------------------------------------------------------
Net income (loss) .......................... $ 1,468 $ 585 $ 1,757 $ 871 $ (535)
========================================================================================================================
AT PERIOD END
Assets:
Investment in real estate and joint ventures $ 40,371 $ 40,283 $ 26,384 $ 38,185 $ 38,043
Other ...................................... 4,090 1,919 4,060 2,003 1,629
------------------------------------------------------------------------------------------------------------------------
Total assets ............................. 44,461 42,202 30,444 40,188 39,672
------------------------------------------------------------------------------------------------------------------------
Equity ........................................ $ 39,916 $ 38,448 $ 24,963 $ 34,513 $ 33,642
========================================================================================================================
For the first nine months of 2002, our net income from real estate
investment operations totaled $3.8 million, a favorable change from a loss of
$0.1 million from the same period a year ago due primarily to sales activity and
lower operating expenses, as the year-ago quarter included expense pertaining to
litigation matters associated with certain joint venture partners.
The following table sets forth our real estate investment operational
results for the year-to-date periods indicated.
Nine Months Ended
September 30,
------------------------
(In Thousands) 2002 2001
---------------------------------------------------------------------
Net interest income ....................... $ 30 $ 12
Other income .............................. 7,331 3,423
Operating expense ......................... 627 3,402
Net intercompany expense .................. 279 273
---------------------------------------------------------------------
Income (loss) before income taxes (benefit) 6,455 (240)
Income taxes (benefit) .................... 2,645 (96)
---------------------------------------------------------------------
Net income (loss) ...................... $ 3,810 $ (144)
=====================================================================
Our investment in real estate and joint ventures amounted to $40 million at
September 30, 2002, compared to $38 million at both December 31, 2001 and
September 30, 2001.
For information on valuation allowances associated with real estate and
joint venture loans, see Financial Condition--Problem Loans and Real
Estate--Allowances for Losses on Loans and Real Estate on page 36.
25
FINANCIAL CONDITION
LOANS AND MORTGAGE-BACKED SECURITIES
Total loans and mortgage-backed securities, including those we hold for
sale, increased $1.4 billion during the third quarter to a total of $11.7
billion or 93.3% of assets at September 30, 2002. The increase primarily
resulted from the purchase of $1.0 billion of 30-year fixed rate mortgage-backed
securities available for sale purchased in late September, of which about half
were funded by quarter end with short-term borrowings, while the other half
settles in mid-October. These securities were purchased due to a net interest
spread of over 3% given the steepness in the yield curve. However, these
securities were sold in early October due to interest rate volatility and the
potential adverse impact market interest rate changes could have on the carrying
value of the investment. Also contributing to the increase in loans and
mortgage-backed securities was a higher level of loans held for investment in
the residential one-to-four units adjustable category. Given the continued low
interest rate environment and borrower preference for fixed rate loans, our
annualized prepayment speed in the current quarter remained high at 36%,
compared to 39% a year ago and 38% during the previous quarter.
The following table sets forth loans originated, including purchases, for
investment and for sale during the periods indicated.
Three Months Ended Nine Months Ended
---------------------------------------------- September 30,
September 30, June 30, September 30, ---------------------------
(In Thousands) 2002 2002 2001 2002 2001
------------------------------------------------------------------------------------------- ---------------------------
Loans originated for investment:
Residential one-to-four units:
Adjustable .......................... $1,028,635 $1,109,982 $ 867,271 $3,126,680 $2,318,955
Fixed ............................... 3,473 3,940 4,445 11,779 19,411
Other .................................. 42,576 119,970 56,554 208,298 129,010
------------------------------------------------------------------------------------------- ---------------------------
Total loans originated for investment 1,074,684 1,233,892 928,270 3,346,757 2,467,376
Loans originated for sale (1) ............. 1,799,673 1,065,360 1,116,589 4,131,463 3,210,267
------------------------------------------------------------------------------------------- ---------------------------
Total loans originated ................. $2,874,357 $2,299,252 $2,044,859 $7,478,220 $5,677,643
------------------------------------------------------------------------------------------- ---------------------------
(1) Residential one-to-four unit loans, primarily fixed.
Originations of residential one-to-four unit loans totaled a record $2.832
billion in the third quarter of 2002, of which $1.032 billion or 36% were for
portfolio, with the balance for sale in the secondary market. This was 29.9%
higher than the $2.179 billion we originated in the second quarter of 2002, and
42.4% higher than the $1.988 billion we originated in the year-ago third
quarter. Of the current quarter originations for portfolio, $150 million
represented originations of subprime credits as part of our continuing strategy
to enhance the portfolio's net yield. During the current quarter, 78% of our
residential one-to-four unit originations represented refinancing transactions.
This is up from the previous quarter level of 67% and the year-ago third quarter
level of 72%. In addition to single family loans, we originated $43 million of
other loans in the current quarter.
During the current quarter, loan originations for investment consisted
primarily of adjustable rate mortgages which provide for negative amortization
and are tied to COFI or the 12-month moving average of the annual yields on
actively traded U.S. Treasury securities adjusted to a constant maturity of one
year ("MTA"), indexes which lag behind the movement in market interest rates.
For the quarter, 52% of portfolio originations represented monthly adjusting
COFI rate mortgages, 23% represented monthly adjusting MTA rate mortgages, while
20% represented adjustable rate loans where the initial rate is fixed for the
first three years.
Our adjustable rate mortgages:
o generally begin with an incentive interest rate, which is an interest
rate below the current market rate, that adjusts to the applicable
index plus a defined spread, subject to periodic and lifetime caps,
after one, three, six or twelve months;
o generally provide that the maximum interest rate we can charge
borrowers cannot exceed the incentive rate by more than six to nine
percentage points, depending on the type of loan and the initial rate
offered; and
o limit interest rate adjustments, for loans that adjust both the
interest rate and payment amount simultaneously, to 1% per adjustment
period for those that adjust semi-annually and 2% per adjustment
period for those that adjust annually.
26
Most of our adjustable rate mortgages adjust the interest rate monthly and
the payment amount annually. These monthly adjustable rate mortgages:
o have a lifetime interest rate cap, but no specified periodic interest
rate adjustment cap;
o have a periodic cap on changes in required monthly payments; and
o allow for negative amortization, which is the addition to loan
principal of accrued interest that exceeds the required monthly loan
payments.
If a loan incurs significant negative amortization, the loan-to-value ratio
could increase which creates an increased risk that the fair value of the
underlying collateral on the loan would be insufficient to satisfy fully the
outstanding principal and interest. A loan-to-value ratio is the ratio of the
principal amount of the loan to the lower of the sales price or appraised value
of the property securing the loan at origination. We currently impose a limit on
the amount of negative amortization. The principal plus the negative
amortization cannot exceed 125% of the original loan amount, except for subprime
loans and loans with loan-to-value ratios of greater than 80% wherein the
borrower has obtained private mortgage insurance to reduce the effective
loan-to-value ratio to between 67% and 80%. In those two instances, the
principal plus negative amortization cannot exceed 110% of the original loan
amount.
At September 30, 2002, $7.3 billion or 77% of the adjustable rate mortgages
in our loan portfolio were subject to negative amortization, of which $128
million represented the amount of negative amortization included in the loan
balance. The amount of negative amortization is $18 million or 12.3% below the
June 30, 2002 level.
We also continue to originate residential fixed interest rate mortgage
loans to meet consumer demand, but we intend to sell the majority of these
loans. We sold through our secondary marketing activities a record $1.564
billion of loans and mortgage-backed securities in the third quarter of 2002,
compared to $1.093 billion in the previous quarter and $1.120 billion in the
third quarter of 2001. All were secured by residential one-to-four unit
property, and at September 30, 2002, loans held for sale totaled $666 million.
At September 30, 2002, our unfunded loan application pipeline totaled $2.9
billion. Within that pipeline, we had commitments to borrowers for short-term
interest rate locks of $1.3 billion, of which $1.2 billion were related to
residential one-to-four unit loans being originated for sale in the secondary
market. Furthermore, at September 30, 2002, we had commitments to purchase loans
of $294 million, loans in process of $92 million and undrawn lines and letters
of credit of $92 million. We believe our current sources of funds will enable us
to meet these obligations.
27
The following table sets forth the origination, purchase and sale activity
relating to our loans and mortgage-backed securities during the quarterly
periods indicated.
Three Months Ended
-------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT PORTFOLIO
Loans originated:
Loans secured by real estate:
Residential one-to-four units:
Adjustable .............................................. $ 675,280 $ 868,022 $ 515,686 $ 382,772 $ 459,897
Adjustable - subprime ................................... 123,263 148,876 107,334 82,561 100,025
Adjustable - fixed for 3-5 years ........................ 181,439 85,679 365,043 418,979 307,349
Adjustable - fixed for 3-5 years - subprime ............. 24,851 133 -- -- --
------------------------------------------------------------------------------------------------------------------------------------
Total adjustable residential one-to-four units ........ 1,004,833 1,102,710 988,063 884,312 867,271
Fixed ................................................... 3,373 3,940 4,336 1,577 3,294
Fixed - subprime ........................................ -- -- -- 211 1,103
Residential five or more units ........................... -- -- -- -- --
------------------------------------------------------------------------------------------------------------------------------------
Total residential ..................................... 1,008,206 1,106,650 992,399 886,100 871,668
Commercial real estate ................................... 557 -- -- 133 --
Construction ............................................. 17,418 65,030 13,672 32,025 27,649
Land ..................................................... -- 37,820 18,542 5,153 4,870
Non-mortgage:
Commercial ............................................... 8,000 600 1,361 4,006 8,440
Automobile ............................................... 64 329 376 275 957
Other consumer ........................................... 16,537 16,191 11,801 9,896 7,965
------------------------------------------------------------------------------------------------------------------------------------
Total loans originated .................................. 1,050,782 1,226,620 1,038,151 937,588 921,549
Real estate loans purchased:
One-to-four units .......................................... 21,485 6,459 30 -- 48
One-to-four units - subprime ............................... 2,417 813 -- -- --
Other (1) .................................................. -- -- -- -- 6,673
------------------------------------------------------------------------------------------------------------------------------------
Total real estate loans purchased ........................ 23,902 7,272 30 -- 6,721
------------------------------------------------------------------------------------------------------------------------------------
Total loans originated and purchased .................... 1,074,684 1,233,892 1,038,181 937,588 928,270
Loan repayments ............................................... (927,653) (950,438) (942,811) (945,582) (968,918)
Other net changes (2) ......................................... 6,943 (45,850) (936) (12,036) (24,333)
------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for investment ....... 153,974 237,604 94,434 (20,030) (64,981)
------------------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO
Residential one-to-four units:
Originated whole loans ..................................... 1,792,091 1,060,399 1,264,559 1,610,470 1,115,345
Loans purchased ............................................ 7,582 4,961 1,871 3,201 1,244
Loans transferred to the investment portfolio .............. (460) (1,401) (614) (3,167) (1,108)
Originated whole loans sold ................................ (280,786) (132,614) (156,206) (181,632) (129,237)
Loans exchanged for mortgage-backed securities ............. (1,232,826) (943,883) (1,225,243) (1,290,355) (991,232)
Other net changes .......................................... (3,105) (594) (789) (404) (530)
Capitalized basis adjustment (3) ........................... 1,626 6,129 5,866 (12,578) 2,447
------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for sale ........... 284,122 (7,003) (110,556) 125,535 (3,071)
------------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities, net:
Received in exchange for loans ............................. 1,232,826 943,883 1,225,243 1,290,355 991,232
Sold ....................................................... (1,283,100) (960,840) (1,225,243) (1,290,355) (991,232)
Purchased .................................................. 1,014,098 -- -- 115,597 --
Repayments ................................................. (4,258) (18,950) (26,553) (773) (686)
Other net changes .......................................... 1,342 3,226 (1,625) (405) 14
------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in mortgage-backed securities
available for sale ...................................... 960,908 (32,681) (28,178) 114,419 (672)
------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for sale and
mortgage-backed securities available for sale ........... 1,245,030 (39,684) (138,734) 239,954 (3,743)
------------------------------------------------------------------------------------------------------------------------------------
Total net increase (decrease) in loans and mortgage-backed
securities .............................................. $ 1,399,004 $ 197,920 $ (44,300) $ 219,924 $ (68,724)
====================================================================================================================================
(1) Included one commercial loan for the three months ended September 30, 2001.
(2) Primarily included borrowings against and repayments of lines of credit and
construction loans, changes in loss allowances, loans transferred to real
estate acquired in settlement of loans or from (to) the held for sale
portfolio, and the change in interest capitalized on loans (negative
amortization).
(3) Reflected the change in fair value of the rate lock derivative from the
date of commitment to the date of funding.
28
The following table sets forth the composition of our loan and
mortgage-backed securities portfolio at the quarter ends indicated.
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT PORTFOLIO
Loans secured by real estate:
Residential one-to-four units:
Adjustable ........................................ $ 6,746,906 $ 6,590,943 $ 6,279,350 $ 6,365,149 $ 6,564,971
Adjustable - subprime ............................. 1,345,644 1,357,098 1,365,817 1,424,656 1,513,047
Adjustable - fixed for 3-5 years .................. 1,313,391 1,271,031 1,294,855 999,528 626,958
Adjustable - fixed for 3-5 years - subprime ....... 64,808 48,835 57,844 66,760 75,526
Fixed ............................................. 225,701 260,934 295,228 334,384 375,533
Fixed - subprime .................................. 9,629 11,982 13,099 15,303 17,421
------------------------------------------------------------------------------------------------------------------------------------
Total residential one-to-four units ........... 9,706,079 9,540,823 9,306,193 9,205,780 9,173,456
Residential five or more units:
Adjustable ........................................ 4,693 4,952 5,920 6,055 6,199
Fixed ............................................. 3,737 3,775 4,230 5,124 5,290
Commercial real estate:
Adjustable ........................................ 39,553 40,200 40,650 40,900 41,987
Fixed ............................................. 38,112 41,522 69,691 71,609 100,493
Construction ........................................ 110,125 124,318 78,202 84,942 99,161
Land ................................................ 53,885 62,182 36,303 22,028 21,121
Non-mortgage:
Commercial .......................................... 17,792 17,371 21,182 22,017 22,762
Automobile .......................................... 14,475 17,667 20,902 24,529 29,109
Other consumer ...................................... 54,779 50,101 48,067 50,908 53,243
------------------------------------------------------------------------------------------------------------------------------------
Total loans held for investment ................... 10,043,230 9,902,911 9,631,340 9,533,892 9,552,821
Increase (decrease) for:
Undisbursed loan funds .............................. (99,309) (106,557) (65,813) (61,280) (62,880)
Net deferred costs and premiums ..................... 91,379 85,926 80,622 77,916 79,540
Allowance for losses ................................ (34,880) (35,834) (37,307) (36,120) (35,043)
------------------------------------------------------------------------------------------------------------------------------------
Total loans held for investment, net .............. 10,000,420 9,846,446 9,608,842 9,514,408 9,534,438
------------------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO, NET
Loans held for sale:
Residential one-to-four units ....................... 662,292 379,796 392,928 509,350 371,237
Capitalized basis adjustment (1) .................... 3,295 1,669 (4,460) (10,326) 2,252
------------------------------------------------------------------------------------------------------------------------------------
Total loans held for sale ......................... 665,587 381,465 388,468 499,024 373,489
Mortgage-backed securities available for sale:
Adjustable .......................................... 3,385 58,122 73,792 101,562 4,562
Fixed ............................................... 1,015,645 -- 17,011 17,419 --
------------------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed securities available for sale 1,019,030 58,122 90,803 118,981 4,562
------------------------------------------------------------------------------------------------------------------------------------
Total loans held for sale and mortgage-backed
securities available for sale ................. 1,684,617 439,587 479,271 618,005 378,051
------------------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities ........ $11,685,037 $10,286,033 $10,088,113 $10,132,413 $ 9,912,489
====================================================================================================================================
(1) Reflected the change in fair value of the rate lock derivative from the
date of commitment to the date of funding.
We carry loans for sale at the lower of cost or fair value. At September
30, 2002, no valuation allowance was required as the fair value exceeded book
value on an aggregate basis.
At September 30, 2002, our residential one-to-four units subprime portfolio
consisted of approximately 85% "A-" credit, 13% "B" credit and 2% "C" credit
loans. At September 30, 2002, the average loan-to-value ratio at origination for
these loans was approximately 75%.
We carry mortgage-backed securities available for sale at fair value which,
at September 30, 2002, reflected an unrealized gain of $1.6 million. The current
quarter-end unrealized gain, less the associated tax effect, is reflected within
a separate component of other comprehensive income until realized.
29
DEPOSITS
At September 30, 2002, our deposits totaled $9.1 billion, up $188 million
or 2.1% from the year-ago level, and up $366 million or 4.2% from the previous
quarter. Compared to the year-ago period, our lower-rate transaction
accounts--i.e., checking, money market and regular passbook--increased $2.1
billion, almost double the year-ago level, which was partially offset by a
decrease in our certificates of deposit of $1.9 billion or 28.6%. As depositors
seemed more interested in liquidity given the relatively low level of interest
rates, they moved monies from certificates of deposit to transaction accounts,
primarily regular passbook accounts. At September 30, 2002, the average deposit
size of our traditional branches was $105 million, while the average size of our
in-store branches was $19 million, or $21 million excluding the 18 new in-store
branches opened within the past 12 months.
The following table sets forth information concerning our deposits and
weighted average rates paid at the quarter ends indicated.
September 30, 2002 June 30, 2002 March 31, 2002 December 31, 2001 September 30, 2001
--------------------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average
(Dollars in Thousands) Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount
---------------------------------------------------------------------------------------------------------------------------
Transaction accounts:
Non-interest-bearing
checking ............ -- % $ 312,338 -- % $ 295,788 -- % $ 312,962 -- % $ 263,165 -- % $ 327,335
Interest-bearing
checking (1) ........ 0.25 410,095 0.25 418,310 0.25 436,612 0.35 423,776 0.42 403,134
Money market .......... 1.64 113,746 1.80 114,618 1.82 112,646 2.01 108,747 2.29 97,548
Regular passbook ...... 2.04 3,413,891 2.42 3,082,356 2.57 2,789,500 2.46 2,131,048 2.96 1,308,959
---------------------------------------------------------------------------------------------------------------------------
Total transaction
accounts .......... 1.71 4,250,070 1.99 3,911,072 2.05 3,651,720 1.92 2,926,736 2.00 2,136,976
Certificates of deposit:
Less than 3.00% ....... 2.36 1,942,296 2.50 1,764,986 2.45 1,467,532 2.41 970,854 2.41 39,217
3.00-3.49 ............. 3.36 1,213,176 3.33 1,258,969 3.29 1,080,673 3.20 458,511 3.26 379,901
3.50-3.99 ............. 3.88 664,344 3.84 588,142 3.84 527,613 3.84 532,634 3.83 508,383
4.00-4.49 ............. 4.25 376,386 4.25 563,298 4.23 830,142 4.22 892,517 4.22 888,123
4.50-4.99 ............. 4.80 492,254 4.80 456,618 4.76 495,530 4.76 555,885 4.73 815,711
5.00-5.99 ............. 5.41 66,452 5.43 74,154 5.21 356,605 5.30 921,510 5.36 1,883,498
6.00 and greater ...... 6.26 51,954 6.26 73,319 6.32 189,075 6.37 1,360,919 6.46 2,216,973
---------------------------------------------------------------------------------------------------------------------------
Total certificates of
deposit ........... 3.30 4,806,862 3.41 4,779,486 3.66 4,947,170 4.54 5,692,830 5.24 6,731,806
---------------------------------------------------------------------------------------------------------------------------
Total deposits .... 2.55% $9,056,932 2.77% $8,690,558 2.98% $8,598,890 3.65% $8,619,566 4.46% $8,868,782
===========================================================================================================================
(1) Included amounts swept into money market deposit accounts.
BORROWINGS
During the current quarter, our borrowings increased $456 million to $1.9
billion, due to increases in FHLB advances of $274 million and securities sold
under agreements to repurchase of $182 million. This increased level of
borrowing was used to purchase approximately one-half of the $1.0 billion of
mortgage-backed securities, which were purchased late in September but sold in
early October.
The following table sets forth information concerning our FHLB advances and
other borrowings at the quarter ends indicated.
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 2002 2002 2002 2001 2001
------------------------------------------------------------------------------------------------------------------------------
Federal Home Loan Bank advances ................ $1,687,431 $ 1,413,607 $ 1,320,386 $1,522,705 $ 927,398
Securities sold under agreements to repurchase . 182,358 -- -- -- --
Other borrowings ............................... -- -- -- 7 29
------------------------------------------------------------------------------------------------------------------------------
Total borrowings ............................ $1,869,789 $ 1,413,607 $ 1,320,386 $1,522,712 $ 927,427
==============================================================================================================================
Weighted average rate on borrowings during
the period ................................. 4.35% 4.59% 4.28% 4.31% 5.01%
Total borrowings as a percentage of total assets 14.94 12.70 12.10 13.71 8.65
==============================================================================================================================
30
CAPITAL SECURITIES
On July 23, 1999, we issued $120 million in capital securities through
Downey Financial Capital Trust I. The capital securities pay quarterly
cumulative cash distributions at an annual rate of 10.00% of the liquidation
value of $25 per share. Interest expense on our capital securities, including
the amortization of deferred issuance costs, was $3.0 million for the third
quarter of 2002, and $9.1 million for the first nine months of 2002.
ASSET/LIABILITY MANAGEMENT AND MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
interest rates. Our market risk arises primarily from interest rate risk in our
lending and deposit taking activities. This interest rate risk primarily occurs
to the degree that our interest-bearing liabilities reprice or mature on a
different basis--generally more rapidly--than our interest-earning assets. Since
our earnings depend primarily on our net interest income, which is the
difference between the interest and dividends earned on interest-earning assets
and the interest paid on interest-bearing liabilities, one of our principal
objectives is to actively monitor and manage the effects of adverse changes in
interest rates on net interest income while maintaining asset quality. Our
primary strategy to manage interest rate risk is to emphasize the origination of
adjustable rate mortgages or loans with relatively short maturities. Interest
rates on adjustable rate mortgages are primarily tied to COFI and MTA.
In addition to the market risk associated with our lending and deposit
taking activities, we also have market risk associated with our secondary
marketing activities. Changes in mortgage interest rates, primarily fixed rate
mortgages, impact the fair value of loans held for sale as well as our
off-balance sheet commitments where we have committed to an interest rate with a
potential borrower for a loan we intend to sell (known as an interest rate lock
commitment derivative). Our objective is to hedge against fluctuations in
interest rates through use of forward sale and purchase contracts with
government-sponsored enterprises and whole loan sale contracts with various
parties. These contracts are typically obtained at the time the interest rate
lock commitments are made. Therefore, as interest rates fluctuate, the changes
in the fair value of our interest rate lock commitments and loans held for sale
tend to be offset by changes in the fair value of the hedge contracts. Although
we continue to hedge as previously done, SFAS 133, as applied to our risk
management strategies, may increase or decrease reported net income and
stockholders' equity, depending on levels of interest rates and other variables
affecting the fair values of derivative instruments and hedged items, but will
have no effect on the overall economics of the transactions. We currently do not
enter into hedging contracts for speculative purposes.
Changes in mortgage interest rates also impact the value of our mortgage
servicing rights. Rising interest rates typically result in slower prepayment
speeds on the loans being serviced for others which increase the value of
mortgage servicing rights. Declining interest rates typically result in faster
prepayment speeds which decrease the value of mortgage servicing rights.
Currently, we do not hedge our mortgage servicing rights against that risk.
There has been no significant change in our market risk since December 31,
2001.
31
One measure of our exposure to differential changes in interest rates
between assets and liabilities is shown in the following table, which sets forth
the repricing frequency of our major asset and liability categories as of
September 30, 2002, as well as other information regarding the repricing and
maturity differences between our interest-earning assets and total deposits,
borrowings and capital securities in future periods. We refer to these
differences as "gap." We have determined the repricing frequencies by reference
to projected maturities, based upon contractual maturities as adjusted for
scheduled repayments and "repricing mechanisms"--provisions for changes in the
interest and dividend rates of assets and liabilities. We assume prepayment
rates on substantially all of our loan portfolio based upon our historical loan
prepayment experience and anticipated future prepayments. Repricing mechanisms
on a number of our assets are subject to limitations, such as caps on the amount
that interest rates and payments on our loans may adjust, and accordingly, these
assets do not normally respond to changes in market interest rates as completely
or rapidly as our liabilities. The interest rate sensitivity of our assets and
liabilities illustrated in the following table would vary substantially if we
used different assumptions or if actual experience differed from the assumptions
set forth.
September 30, 2002
------------------------------------------------------------------------------
Within 7 - 12 1 - 5 6 - 10 Over Total
(Dollars in Thousands) 6 Months Months Years Years 10 Years Balance
-----------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Investment securities and FHLB stock ..........(1) $ 241,988 $ 45,819 $ 113,490 $ 5,076 $ -- $ 406,373
Loans and mortgage-backed securities: .........(2)
Loans secured by real estate:
Residential:
Adjustable .............................. 8,451,276 297,630 841,852 -- -- 9,590,758
Fixed ................................... 687,370 49,348 107,514 7,250 1,510 852,992
Commercial real estate .................... 37,312 3,726 17,407 14,451 2,256 75,152
Construction .............................. 45,379 -- -- -- -- 45,379
Land ...................................... 23,369 9 66 779 -- 24,223
Non-mortgage loans:
Commercial ................................ 9,422 -- -- -- -- 9,422
Consumer .................................. 57,271 3,120 7,690 -- -- 68,081
Mortgage-backed securities .................. 1,019,030 -- -- -- -- 1,019,030
-----------------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities .... 10,330,429 353,833 974,529 22,480 3,766 11,685,037
-----------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets ............... $10,572,417 $ 399,652 $1,088,019 $ 27,556 $ 3,766 $12,091,410
===================================================================================================================================
Transaction accounts:
Non-interest-bearing checking ................. $ 312,338 $ -- $ -- $ -- $ -- $ 312,338
Interest-bearing checking .....................(3) 410,095 -- -- -- -- 410,095
Money market ..................................(4) 113,746 -- -- -- -- 113,746
Regular passbook ..............................(4) 3,413,891 -- -- -- -- 3,413,891
-----------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts .................. 4,250,070 -- -- -- -- 4,250,070
Certificates of deposit ..........................(1) 2,419,199 1,103,111 1,284,552 -- -- 4,806,862
-----------------------------------------------------------------------------------------------------------------------------------
Total deposits ................................ 6,669,269 1,103,111 1,284,552 -- -- 9,056,932
Borrowings ....................................... 729,439 69,700 611,650 459,000 -- 1,869,789
Capital securities ............................... -- -- -- -- 120,000 120,000
-----------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and
capital securities .......................... $ 7,398,708 $ 1,172,811 $1,896,202 $ 459,000 $ 120,000 $11,046,721
===================================================================================================================================
Excess (shortfall) of interest-earning assets over
deposits, borrowings and capital securities ... $ 3,173,709 $ (773,159) $ (808,183) $ (431,444) $ (116,234) $ 1,044,689
Cumulative gap ................................... 3,173,709 2,400,550 1,592,367 1,160,923 1,044,689
Cumulative gap - as a percent of total assets:
September 30, 2002 ............................ 25.35% 19.18% 12.72% 9.27% 8.35%
December 31, 2001 ............................. 12.01 4.76 7.91 4.71 3.86
September 30, 2001 ............................ 17.55 7.07 8.93 4.93 3.85
===================================================================================================================================
(1) Based upon contractual maturity and repricing date.
(2) Based upon contractual maturity, repricing date and projected repayment and
prepayments of principal.
(3) Included amounts swept into money market deposit accounts and is subject to
immediate repricing.
(4) Subject to immediate repricing.
32
Our six-month gap at September 30, 2002 was a positive 25.35%. This means
that more interest-earning assets mature or reprice within six months than total
deposits, borrowings and capital securities. This compares to a positive
six-month gap of 12.01% at December 31, 2001 and 17.55% at September 30, 2001.
We continue to pursue our strategy of emphasizing the origination of
adjustable rate mortgages. For the twelve months ended September 30, 2002, we
originated and purchased for investment $4.3 billion of adjustable rate loans
which represented virtually all of the loans we originated and purchased for
investment during the period.
At September 30, 2002 and 2001, essentially all of our interest-earning
assets mature, reprice or are estimated to prepay within five years, compared to
99% at December 31, 2001. At September 30, 2002, loans held for investment with
adjustable interest rates represented 92% of the portfolio. During the third
quarter of 2002, we continued to offer residential fixed rate loan products to
our customers primarily for sale in the secondary market. We price and originate
fixed rate mortgage loans for sale into the secondary market to increase
opportunities to originate adjustable rate mortgages and to generate fees and
servicing income. We also originate fixed rate loans for portfolio to facilitate
the sale of real estate acquired in settlement of loans and which meet specific
yield and other approved guidelines.
At September 30, 2002, $9.8 billion or 92% of our total loan portfolio,
consisted of adjustable rate loans, construction loans, and loans with a due
date of five years or less, compared to $9.3 billion or 91% at December 31,
2001, and $9.1 billion or 92% at September 30, 2001.
The following table sets forth the interest rate spread between our
interest-earning assets and interest-bearing liabilities at the quarter ends
indicated.
September 30, June 30, March 31, December 31, September 30,
2002 2002 2002 2001 2001
----------------------------------------------------------------------------------------------------------------
Weighted average yield:
Loans and mortgage-backed securities 6.00% 6.01% 6.45% 7.15% 7.68%
Federal Home Loan Bank stock ....... 2.87 5.56 5.30 5.31 6.00
Investment securities .............. 3.12 3.44 3.43 3.54 5.18
----------------------------------------------------------------------------------------------------------------
Interest-earning assets yield .... 5.90 5.93 6.35 6.98 7.59
----------------------------------------------------------------------------------------------------------------
Weighted average cost:
Deposits ........................... 2.55 2.77 2.98 3.65 4.46
Borrowings:
Federal Home Loan Bank advances .. 3.95 4.32 4.63 3.73 4.70
Other borrowings ................. 2.02 -- -- 7.88 7.88
----------------------------------------------------------------------------------------------------------------
Total borrowings .............. 3.76 4.32 4.63 3.73 4.70
Capital securities ................. 10.00 10.00 10.00 10.00 10.00
----------------------------------------------------------------------------------------------------------------
Combined funds cost .............. 2.84 3.07 3.28 3.74 4.55
----------------------------------------------------------------------------------------------------------------
Interest rate spread .......... 3.06% 2.86% 3.07% 3.24% 3.04%
================================================================================================================
The period-end weighted average yield on our loan portfolio declined to
6.00% at September 30, 2002, down from 7.15% at December 31, 2001 and 7.68% at
September 30, 2001. At September 30, 2002, our adjustable rate mortgage
portfolio of single family residential loans, including mortgage-backed
securitites, totaled $9.6 billion with a weighted average rate of 5.94%,
compared to $9.0 billion with a weighted average rate of 7.11% at December 31,
2001, and $8.8 billion with a weighted average rate of 7.68% at September 30,
2001.
PROBLEM LOANS AND REAL ESTATE
NON-PERFORMING ASSETS
Non-performing assets consist of loans on which we have ceased accruing
interest (which we refer to as non-accrual loans), loans restructured at a below
market rate, real estate acquired in settlement of loans and repossessed
automobiles. Our non-performing assets increased $5 million during the quarter
to $89 million or 0.71% of total assets (0.77% excluding the mortgage-backed
securities of $1.0 billion purchased in late September but were sold in early
October). Residential non-performers increased $9 million during the quarter, of
which $6 million was associated with subprime loans. That increase was partially
offset by a $4 million decline in commercial real estate non-performers due to a
short-pay that was accepted in full consideration of the loan.
33
The following table summarizes our non-performing assets at the quarter
ends indicated.
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 2002 2002 2002 2001 2001
---------------------------------------------------------------------------------------------------------------------------
Non-accrual loans:
Residential one-to-four units ................... $36,068 $33,827 $43,934 $43,210 $29,266
Residential one-to-four units - subprime ........ 36,304 31,540 33,169 31,166 31,076
Other ........................................... 823 4,305 4,589 2,668 2,927
---------------------------------------------------------------------------------------------------------------------------
Total non-accrual loans ........................ 73,195 69,672 81,692 77,044 63,269
Troubled debt restructure - below market rate (1) ... 203 203 203 203 204
Real estate acquired in settlement of loans ......... 15,441 13,528 11,917 15,366 11,870
Repossessed automobiles ............................. 15 16 19 19 28
---------------------------------------------------------------------------------------------------------------------------
Total non-performing assets ..................... $88,854 $83,419 $93,831 $92,632 $75,371
===========================================================================================================================
Allowance for loan losses:
Amount .......................................... $34,880 $35,834 $37,307 $36,120 $35,043
As a percentage of non-performing loans ......... 47.52% 51.28% 45.55% 46.76% 55.21%
Non-performing assets as a percentage of total assets 0.71 0.75 0.86 0.83 0.70
===========================================================================================================================
(1) Represented one residential one-to-four unit loan.
DELINQUENT LOANS
Loans delinquent 30 days or more as a percentage of total loans declined
slightly during the quarter to 0.90% at September 30, 2002, from 0.91% at June
30, 2002, and 0.96% a year ago. In our 60-89 non-mortgage commercial category,
we had an increase of $1.2 million due to one loan, which paid-off after
September 30, 2002.
34
The following table indicates the amounts of our past due loans at the
quarter ends indicated.
September 30, 2002 June 30, 2002
--------------------------------------------------------------------------------------
30-59 60-89 90+ 30-59 60-89 90+
(Dollars in Thousands) Days Days Days (1) Total Days Days Days (1) Total
-----------------------------------------------------------------------------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units .................... $17,835 $10,454 $25,487 $ 53,776 $20,531 $ 6,461 $27,472 $ 54,464
One-to-four units - subprime ......... 11,606 6,565 22,275 40,446 10,694 3,308 24,228 38,230
Five or more units ................... -- -- -- -- -- -- -- --
Commercial real estate ................. -- -- -- -- -- -- -- --
Construction ........................... -- -- -- -- -- -- -- --
Land ................................... -- -- -- -- -- -- -- --
-----------------------------------------------------------------------------------------------------------------------------------
Total real estate loans .............. 29,441 17,019 47,762 94,222 31,225 9,769 51,700 92,694
Non-mortgage:
Commercial ............................. -- 1,235 548 1,783 -- -- 428 428
Automobile ............................. 126 9 26 161 190 13 54 257
Other consumer ......................... 147 36 249 432 314 132 180 626
-----------------------------------------------------------------------------------------------------------------------------------
Total delinquent loans ............... $29,714 $18,299 $48,585 $ 96,598 $31,729 $ 9,914 $52,362 $ 94,005
===================================================================================================================================
Delinquencies as a percentage of total loans 0.28% 0.17% 0.45% 0.90% 0.31% 0.10% 0.50% 0.91%
===================================================================================================================================
March 31, 2002 December 31, 2001
--------------------------------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units .................... $19,454 $ 6,360 $34,724 $ 60,538 $19,170 $12,797 $33,449 $ 65,416
One-to-four units - subprime ......... 13,653 4,175 25,797 43,625 13,159 9,104 20,958 43,221
Five or more units ................... -- -- -- -- -- -- -- --
Commercial real estate ................. -- -- -- -- -- -- -- --
Construction ........................... -- -- -- -- -- -- -- --
Land ................................... -- -- -- -- -- -- -- --
-----------------------------------------------------------------------------------------------------------------------------------
Total real estate loans .............. 33,107 10,535 60,521 104,163 32,329 21,901 54,407 108,637
Non-mortgage:
Commercial ............................. -- -- 637 637 -- -- 1,163 1,163
Automobile ............................. 138 14 79 231 174 85 46 305
Other consumer ......................... 142 57 185 384 356 62 173 591
-----------------------------------------------------------------------------------------------------------------------------------
Total delinquent loans ............... $33,387 $10,606 $61,422 $105,415 $32,859 $22,048 $55,789 $110,696
===================================================================================================================================
Delinquencies as a percentage of total loans 0.33% 0.11% 0.61% 1.05% 0.33% 0.22% 0.55% 1.10%
===================================================================================================================================
September 30, 2001
------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units .................... $18,515 $ 8,165 $25,131 $ 51,811
One-to-four units - subprime ......... 11,212 8,569 21,649 41,430
Five or more units ................... -- -- -- --
Commercial real estate ................. -- -- -- --
Construction ........................... -- -- -- --
Land ................................... -- -- -- --
---------------------------------------------------------------------------------------
Total real estate loans .............. 29,727 16,734 46,780 93,241
Non-mortgage:
Commercial ............................. -- -- 1,290 1,290
Automobile ............................. 269 54 80 403
Other consumer ......................... 253 38 264 555
---------------------------------------------------------------------------------------
Total delinquent loans ............... $30,249 $16,826 $48,414 $ 95,489
=======================================================================================
Delinquencies as a percentage of total loans 0.30% 0.17% 0.49% 0.96%
=======================================================================================
(1) All 90 day or greater delinquencies are on non-accrual status and reported
as part of non-performing assets.
35
ALLOWANCE FOR LOSSES ON LOANS AND REAL ESTATE
We maintain a valuation allowance for losses on loans and real estate to
provide for losses inherent in those portfolios. The adequacy of the allowance
is evaluated quarterly by management to maintain the allowance at levels
sufficient to provide for inherent losses.
We adhere to an internal asset review system and loss allowance methodology
designed to provide for timely recognition of problem assets and an adequate
valuation allowance to cover asset losses. The amount of the allowance is based
upon the summation of general valuation allowances, allocated allowances and an
unallocated allowance. General valuation allowances relate to assets with no
well-defined deficiency or weakness and takes into consideration loss that is
imbedded within the portfolio but has not yet been realized. Allocated
allowances relate to assets with well-defined deficiencies or weaknesses.
Included in both these allowances are those amounts associated with assets where
it is probable that the recorded value of the asset has declined and the loss
can be reasonably estimated. If we determine the carrying value of our asset
exceeds its net fair value and no alternative payment source exists, then a
specific allowance is recorded for the amount of that difference. The
unallocated allowance is more subjective and is reviewed quarterly to take into
consideration estimation errors and economic trends that are not necessarily
captured in determining the general valuation and allocated allowances.
Allowances for losses on all assets were $37 million at September 30, 2002,
compared to $39 million at December 31, 2001, and $38 million at September 30,
2001.
In the current quarter, our provision for loan losses totaled $0.5 million
and net loan charge-offs totaled $1.4 million, resulting in a decrease in the
allowance for loan losses to $35 million at September 30, 2002. The current
quarter decline in the allowance reflected a decrease of $1.5 million in
allocated allowances to $5.4 million due primarily to a $1.2 million charge-off
of a commercial real estate loan for which a short-pay was accepted in full
consideration of the loan. General valuation allowances increased $0.5 million
and there was no change in our unallocated allowance of $2.8 million.
The following table summarizes the activity in our allowance for loan
losses during the quarterly periods indicated.
Three Months Ended
-----------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
-----------------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $35,834 $37,307 $36,120 $35,043 $34,301
Provision (reduction) ........ 471 (1,106) 1,447 1,290 791
Charge-offs .................. (1,450) (387) (276) (316) (198)
Recoveries ................... 25 20 16 103 149
-----------------------------------------------------------------------------------------------------------------------------
Balance at end of period ..... $34,880 $35,834 $37,307 $36,120 $35,043
=============================================================================================================================
Since year-end 2001, our allowance for loan losses declined by $1.2
million, as general valuation allowances declined by $1.1 million and allocated
allowances declined by $0.1 million.
The following table summarizes the activity in our allowance for loan
losses during the year-to-date periods indicated.
Nine Months Ended
September 30,
------------------------------
(In Thousands) 2002 2001
-----------------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 36,120 $ 34,452
Provision .................... 812 1,274
Charge-offs .................. (2,113) (1,032)
Recoveries ................... 61 349
----------------------------------------------------------------
Balance at end of period ..... $ 34,880 $ 35,043
================================================================
36
The following table presents gross charge-offs, gross recoveries and net
charge-offs by category of loan during the periods indicated.
Three Months Ended Nine Months Ended
--------------------------------------------------------------------- September 30,
September 30, June 30, March 31, December 31, September 30, ---------------------
(Dollars in Thousands) 2002 2002 2002 2001 2001 2002 2001
------------------------------------------------------------------------------------------------------- ---------------------
GROSS LOAN CHARGE-OFFS
Loans secured by real estate:
Residential:
One-to-four units .......... $ 113 $ 197 $ 125 $ 108 $ 25 $ 435 $ 422
One-to-four units - subprime 69 63 17 70 60 149 274
Five or more units ......... -- -- -- -- -- -- --
Commercial real estate ...... 1,188 -- -- -- -- 1,188 --
Construction ................ -- -- -- -- -- -- --
Land ........................ -- -- -- -- -- -- --
Non-mortgage:
Commercial .................. -- -- -- -- -- -- --
Automobile .................. 3 33 52 51 26 88 146
Other consumer .............. 77 94 82 87 87 253 190
------------------------------------------------------------------------------------------------------- ---------------------
Total gross loan charge-offs 1,450 387 276 316 198 2,113 1,032
------------------------------------------------------------------------------------------------------- ---------------------
GROSS LOAN RECOVERIES
Loans secured by real estate:
Residential:
One-to-four units .......... -- -- 9 1 86 9 266
One-to-four units - subprime -- -- -- 100 61 -- 66
Five or more units ......... -- -- -- -- -- -- --
Commercial real estate ...... -- -- -- -- -- -- 1
Construction ................ -- -- -- -- -- -- --
Land ........................ -- -- -- -- -- -- --
Non-mortgage:
Commercial .................. -- -- -- -- -- -- --
Automobile .................. 21 16 5 -- -- 42 4
Other consumer .............. 4 4 2 2 2 10 12
------------------------------------------------------------------------------------------------------- ---------------------
Total gross loan recoveries 25 20 16 103 149 61 349
------------------------------------------------------------------------------------------------------- ---------------------
NET LOAN CHARGE-OFFS
Loans secured by real estate:
Residential:
One-to-four units .......... 113 197 116 107 (61) 426 156
One-to-four units - subprime 69 63 17 (30) (1) 149 208
Five or more units ......... -- -- -- -- -- -- --
Commercial real estate ...... 1,188 -- -- -- -- 1,188 (1)
Construction ................ -- -- -- -- -- -- --
Land ........................ -- -- -- -- -- -- --
Non-mortgage:
Commercial .................. -- -- -- -- -- -- --
Automobile .................. (18) 17 47 51 26 46 142
Other consumer .............. 73 90 80 85 85 243 178
------------------------------------------------------------------------------------------------------- ---------------------
Total net loan charge-offs . $ 1,425 $ 367 $ 260 $ 213 $ 49 $ 2,052 $ 683
======================================================================================================= =====================
Net loan charge-offs as a
percentage of average loans 0.05% 0.01% 0.01% 0.01% -- % 0.03% 0.01%
======================================================================================================= =====================
37
The following table indicates our allocation of the allowance for loan
losses to the various categories of loans at the quarter ends indicated.
September 30, 2002 June 30, 2002 March 31, 2002
------------------------------------------------------------------------------------------------
Gross Allowance Gross Allowance Gross Allowance
Loan Percentage Loan Percentage Loan Percentage
Portfolio to Loan Portfolio to Loan Portfolio to Loan
(Dollars in Thousands) Allowance Balance Balance Allowance Balance Balance Allowance Balance Balance
-----------------------------------------------------------------------------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units ........... $17,951 $ 8,285,998 0.22% $17,291 $8,122,908 0.21% $18,566 $7,869,433 0.24%
One-to-four units - subprime 8,873 1,420,081 0.62 8,697 1,417,915 0.61 9,755 1,436,760 0.68
Five or more units .......... 63 8,430 0.75 65 8,727 0.74 76 10,150 0.75
Commercial real estate ........ 1,448 77,665 1.86 2,905 81,722 3.55 3,367 110,341 3.05
Construction .................. 1,292 110,125 1.17 1,459 124,318 1.17 920 78,202 1.18
Land .......................... 665 53,885 1.23 769 62,182 1.24 446 36,303 1.23
Non-mortgage:
Commercial .................... 634 17,792 3.56 596 17,371 3.43 511 21,182 2.41
Automobile .................... 127 14,475 0.88 250 17,667 1.42 292 20,902 1.40
Other consumer ................ 1,027 54,779 1.87 1,002 50,101 2.00 574 48,067 1.19
Not specifically allocated ....... 2,800 -- -- 2,800 -- -- 2,800 -- --
-----------------------------------------------------------------------------------------------------------------------------------
Total loans held for investment $34,880 $10,043,230 0.35% $35,834 $9,902,911 0.36% $37,307 $9,631,340 0.39%
===================================================================================================================================
December 31, 2001 September 30, 2001
----------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units ........... $19,033 $7,699,061 0.25% $16,598 $7,567,462 0.22%
One-to-four units - subprime 9,633 1,506,719 0.64 10,385 1,605,994 0.65
Five or more units .......... 84 11,179 0.75 86 11,489 0.75
Commercial real estate ........ 1,848 112,509 1.64 2,262 142,480 1.59
Construction .................. 1,005 84,942 1.18 1,164 99,161 1.17
Land .......................... 274 22,028 1.24 262 21,121 1.24
Non-mortgage:
Commercial .................... 573 22,017 2.60 650 22,762 2.86
Automobile .................... 277 24,529 1.13 196 29,109 0.67
Other consumer ................ 593 50,908 1.16 640 53,243 1.20
Not specifically allocated ....... 2,800 -- -- 2,800 -- --
---------------------------------------------------------------------------------------------------
Total loans held for investment $36,120 $9,533,892 0.38% $35,043 $9,552,821 0.37%
===================================================================================================
At September 30, 2002, the recorded investment in loans for which we
recognized impairment totaled $13 million, unchanged from December 31, 2001, but
down from $15 million at September 30, 2001. The allowance for losses related to
these loans was $1 million at September 30, 2002, December 31, 2001 and
September 30, 2001. During the third quarter of 2002, total interest recognized
on the impaired loan portfolio was $0.3 million.
The following table summarizes the activity in our allowance for loan
losses associated with impaired loans during the quarterly periods indicated.
Three Months Ended
---------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
-----------------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 2,203 $ 2,356 $ 759 $ 1,210 $ 782
Provision (reduction) ........ (268) (153) 1,597 (451) 428
Charge-offs .................. (1,188) -- -- -- --
Recoveries ................... -- -- -- -- --
-----------------------------------------------------------------------------------------------------------------------------
Balance at end of period ..... $ 747 $ 2,203 $ 2,356 $ 759 $ 1,210
=============================================================================================================================
For the first nine months of 2002, total interest recognized on the
impaired loan portfolio was $1.0 million.
38
The following table summarizes the activity in our allowance for loan
losses associated with impaired loans during the year-to-date periods indicated.
Nine Months Ended
September 30,
--------------------------
(In Thousands) 2002 2001
-----------------------------------------------------------
Balance at beginning of period $ 759 $ 800
Provision .................... 1,176 410
Charge-offs .................. (1,188) --
Recoveries ................... -- --
-----------------------------------------------------------
Balance at end of period ..... $ 747 $ 1,210
===========================================================
The following table summarizes the activity in our allowance for real
estate and joint ventures held for investment during the quarterly periods
indicated.
Three Months Ended
-------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2002 2002 2002 2001 2001
---------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 1,851 $ 1,033 $ 2,690 $ 2,689 $ 3,063
Provision (reduction) ........ (99) 818 (1,318) 1 (374)
Charge-offs .................. -- -- (339) -- --
Recoveries ................... -- -- -- -- --
---------------------------------------------------------------------------------------------------------
Balance at end of period ..... $ 1,752 $ 1,851 $ 1,033 $ 2,690 $ 2,689
=========================================================================================================
The following table summarizes the activity in our allowance for real
estate and joint ventures held for investment during the year-to-date periods
indicated.
Nine Months Ended
September 30,
------------------------
(In Thousands) 2002 2001
-----------------------------------------------------------
Balance at beginning of period $ 2,690 $ 2,997
Reduction .................... (599) (308)
Charge-offs .................. (339) --
Recoveries ................... -- --
-----------------------------------------------------------
Balance at end of period ..... $ 1,752 $ 2,689
===========================================================
CAPITAL RESOURCES AND LIQUIDITY
Our sources of funds include deposits, advances from the FHLB and other
borrowings; proceeds from the sale of loans, mortgage-backed securities and real
estate; payments of loans and mortgage-backed securities and payments for and
sales of loan servicing; and income from other investments. Interest rates, real
estate sales activity and general economic conditions significantly affect
repayments on loans and mortgage-backed securities and deposit inflows and
outflows.
Our primary sources of funds generated in the third quarter of 2002 were
from:
o principal repayments--including prepayments, but excluding refinances
of our existing loans--on loans and mortgage-backed securities of $664
million;
o a net increase in FHLB advances and other borrowings of $456 million;
o an increase in deposits of $366 million; and
o maturities of U.S. Treasury securities, agency obligations and other
investment securities available for sale of $157 million.
39
We used these funds for the following purposes:
o to originate and purchase loans held for investment, excluding
refinances of our existing loans, of $780 million;
o to purchase mortgage-backed securities available for sale of $504
million;
o to increase our loans held for sale a net $284 million; and
o to purchase U.S. Treasury securities, agency obligations and other
investment securities available for sale of $131 million.
Our principal source of liquidity is our ability to utilize borrowings, as
needed. Our primary source of borrowings is the FHLB. At September 30, 2002, our
FHLB borrowings totaled $1.7 billion, representing 13.5% of total assets. We
currently are approved by the FHLB to borrow up to 40% of total assets to the
extent we provide qualifying collateral and hold sufficient FHLB stock. That
approved limit would have permitted us, as of quarter end, to borrow an
additional $3.3 billion. To the extent deposit growth over the remainder of 2002
falls short of satisfying ongoing commitments to fund maturing and withdrawable
deposits, repay maturing borrowings, fund existing and future loans, make
investments, and continue branch improvement programs, we will utilize our FHLB
borrowing arrangement or possibly other sources. As of September 30, 2002, we
had commitments to borrowers for short-term rate locks of $1.3 billion,
undisbursed loan funds and unused lines and letters of credit of $184 million,
and other contingent liabilities of $3 million. We believe our current sources
of funds enable us to meet our obligations while maintaining liquidity at
appropriate levels.
Another measure of liquidity in the savings and loan industry is the ratio
of cash and eligible investments to the sum of withdrawable savings and
borrowings due within one year. The Bank's ratio was 4.6% at September 30, 2002,
4.3% at December 31, 2001 and 4.1% at September 30, 2001.
The holding company currently has liquid assets, including due from
Bank--interest bearing balances, of $67 million and can obtain further funds by
means of dividends from subsidiaries, subject to certain limitations, or
issuance of further debt or equity.
On July 24, 2002, the Board of Directors of Downey authorized a share
repurchase program of up to $50 million of Downey's common stock. To fund this
program, the Bank paid a special $50 million dividend during the third quarter
to the holding company. The shares will be repurchased from time-to-time in open
market transactions. The timing, volume and price of purchases will be made at
the discretion of Downey, and will also be contingent upon Downey's overall
financial condition, as well as market conditions in general. During the third
quarter of 2002, 212,300 shares were repurchased at an average price of $41.04.
Stockholders' equity totaled $791 million at September 30, 2002, up from
$734 million at December 31, 2001 and $698 million at September 30, 2001.
40
REGULATORY CAPITAL
Our core and tangible capital ratios were both 6.36% and our risk-based
capital ratio was 13.65%. The Bank's capital ratios exceed the "well
capitalized" standards of 5.00% for core capital and 10.00% for risk-based
capital, as defined by regulation.
The following table is a reconciliation of the Bank's stockholder's equity
to federal regulatory capital as of September 30, 2002.
Tangible Capital Core Capital Risk-Based Capital
---------------------- ---------------------- ---------------------
(Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------------------------------------------------------------------------
Stockholder's equity ................................. $839,077 $839,077 $839,077
Adjustments:
Deductions:
Investment in subsidiary, primarily real estate .. (39,201) (39,201) (39,201)
Excess cost over fair value of branch acquisitions (2,814) (2,814) (2,814)
Non-permitted mortgage servicing rights .......... (4,691) (4,691) (4,691)
Additions:
Unrealized losses on securities available for sale (274) (274) (274)
General loss allowance - investment in DSL
Service Company ............................... 265 265 265
Allowance for loan losses,
net of specific allowances (1) ................ - - 34,299
-----------------------------------------------------------------------------------------------------------------------------
Regulatory capital ................................... 792,362 6.36% 792,362 6.36% 826,661 13.65%
Well capitalized requirement ......................... 186,905 1.50 (2) 623,017 5.00 605,784 10.00(3)
-----------------------------------------------------------------------------------------------------------------------------
Excess ............................................... $605,457 4.86% $169,345 1.36% $220,877 3.65%
-----------------------------------------------------------------------------------------------------------------------------
(1) Limited to 1.25% of risk-weighted assets.
(2) Represents the minimum requirement for tangible capital, as no "well
capitalized" requirement has been established for this category.
(3) A third requirement is Tier 1 capital to risk-weighted assets of 6.00%,
which the Bank met and exceeded with a ratio of 13.08%.
41
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding quantitative and qualitative disclosures about
market risk see Financial Condition--Asset/Liability Management and Market Risk
on page 31.
ITEM 4. - CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, Downey carried out an
evaluation, under the supervision and with the participation of Downey's
management, including Downey's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of Downey's disclosure
controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that Downey's disclosure controls and procedures are effective in timely
alerting them to material information relating to Downey required to be included
in Downey's periodic Securities and Exchange Commission filings. There has been
no significant changes in Downey's internal controls or in other factors that
could significantly affect these controls subsequent to the evaluation date.
42
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
We have been named as a defendant in legal actions arising in the ordinary
course of business, none of which, in the opinion of management, is material.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5 - OTHER INFORMATION
None.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
Exhibit
Number Description
-------- -------------
3.1 (2) Certificate of Incorporation of Downey Financial Corp.
3.2 (1) Bylaws of Downey Financial Corp.
4.1 (4) Junior Subordinated Indenture dated as of July 23, 1999 between
Downey Financial Corp. and Wilmington Trust Company as Indenture
Trustee.
4.2 (4) 10% Junior Subordinated Debenture due September 15, 2029,
Principal Amount $123,711,350.
4.3 (4) Certificate of Trust of Downey Financial Capital Trust I, dated as
of May 25, 1999.
4.4 (4) Trust Agreement of Downey Financial Capital Trust I, dated May 25,
1999.
4.5 (4) Amended and Restated Trust Agreement of Downey Financial Capital
Trust I, between Downey Financial Corp., Wilmington Trust Company and
the Administrative Trustees named therein, dated as of July 23, 1999.
4.6 (4) Certificate Evidencing Common Securities of Downey Financial
Capital Trust I, 10% Common Securities.
4.7 (4) Certificate Evidencing Capital Securities of Downey Financial
Capital Trust I, 10% Capital Securities (Global Certificate).
4.8 (4) Common Securities Guarantee Agreement of Downey Financial Corp.
(Guarantor), dated July 23, 1999.
4.9 (4) Capital Securities Guarantee Agreement of Downey Financial Corp.
and Wilmington Trust Company, dated as of July 23, 1999.
10.1 (3) Downey Savings and Loan Association, F.A. Employee Stock Purchase
Plan (Amended and Restated as of January 1, 1996).
43
(A) Exhibits (Continued)
Exhibit
Number Description
-------- -------------
10.2 (3) Amendment No. 1, Downey Savings and Loan Association, F.A.
Employee Stock Purchase Plan. Amendment No. 1, Effective and Adopted
January 22, 1997.
10.3 (3) Downey Savings and Loan Association, F.A. Employees' Retirement
and Savings Plan (October 1, 1997 Restatement).
10.4 (3) Amendment No. 1, Downey Savings and Loan Association, F.A.
Employees' Retirement and Savings Plan (October 1, 1997 Restatement)
Amendment No. 1, Effective and Adopted January 28, 1998.
10.5 (3) Trust Agreement for Downey Savings and Loan Association, F.A.
Employees' Retirement and Savings Plan, Effective October 1, 1997
between Downey Savings and Loan Association, F.A. and Fidelity
Management Trust Company.
10.6 (2) Downey Savings and Loan Association 1994 Long-Term Incentive Plan
(as amended).
10.7 (1) Asset Purchase Agreement among Butterfield Savings and Loan
Association, FSA, Mortgage Investment, Inc., Property Management
Service, Inc. and Butterfield Capital Corporation, dated September 1,
1988.
10.8 (1) Assistance Agreement between and among the Federal Savings and
Loan Insurance Corporation, Butterfield Savings and Loan Association,
FSA and Downey Savings and Loan Association, dated September 29, 1988
(confidential treatment requested due to contractual prohibition
against disclosure).
10.9 (1) Merger of Butterfield Savings and Loan Association, FSA, into
Downey Savings and Loan Association, dated September 29, 1989.
10.10(1) Founder Retirement Agreement of Maurice L. McAlister, dated
December 21, 1989.
10.11(5) Amendment No. 1, Founders Retirement Agreement of Maurice L.
McAlister, dated December 21, 1989. Amendment No. 1, Effective and
Adopted July 26, 2000.
10.12(1) Founder Retirement Agreement of Gerald H. McQuarrie, dated
December 21, 1989.
10.13 (6) Deferred Compensation Program.
10.14 (6) Director Retirement Benefits.
99.1 Certification of Chief Executive Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
(1) Filed as part of Downey's Registration Statement on Form 8-B/A filed
January 17, 1995.
(2) Filed as part of Downey's Registration Statement on Form S-8 filed February
3, 1995.
(3) Filed as part of Downey's report on Form 10-K filed March 16, 1998.
(4) Filed as part of Downey's report on Form 10-Q filed November 2, 1999.
(5) Filed as part of Downey's report on Form 10-Q filed August 2, 2000.
(6) Filed as part of Downey's report on Form 10-K filed March 7, 2001.
We will furnish any or all of the non-confidential exhibits upon payment of a
reasonable fee. Please send request for exhibits and/or fee information to:
44
Downey Financial Corp.
3501 Jamboree Road
Newport Beach, California 92660
Attention: Corporate Secretary
(B) 1) Form 8-K filed July 8, 2002, with respect to the election of James H.
Hunter as a new Board of Director.
2) Form 8-K filed July 17, 2002, with respect to a press release
reporting its results of operations during the three and six months
ended June 30, 2002.
3) Form 8-K filed August 16, 2002, with respect to a press release
reporting monthly selected financial data for the thirteen months
ended July 31, 2002.
4) Form 8-K filed September 18, 2002, with respect to a press release
reporting monthly selected financial data for the thirteen months
ended August 31, 2002.
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.
DOWNEY FINANCIAL CORP.
Date: October 31, 2002 /s/ Daniel D. Rosenthal
-----------------------------------------------------
Daniel D. Rosenthal
President and Chief Executive Officer
Date: October 31, 2002 /s/ Thomas E. Prince
-----------------------------------------------------
Thomas E. Prince
Executive Vice President and Chief Financial Officer
45
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Daniel D. Rosenthal, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Downey Financial Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: October 31, 2002 /s/ Daniel D. Rosenthal
-----------------------------------------------------
Daniel D. Rosenthal
President and Chief Executive Officer
46
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Thomas E. Prince, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Downey Financial Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: October 31, 2002 /s/ Thomas E. Prince
-----------------------------------------------------
Thomas E. Prince
Executive Vice President and Chief Financial Officer
47