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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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(Mark One)
|X| Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the fiscal year ended December 31, 2000.
|X| Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from ______________ to
______________.
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Commission File Number 1-13578
DOWNEY FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
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3501 Jamboree Road, Newport Beach, California 92660
(Address of principal executive offices) (Zip Code)
I.R.S. Employer Identification No.: 33-0633413
Registrant's telephone number, including area code: (949) 854-0300
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE
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Common Stock, $0.01 par value New York Stock Exchange
Pacific Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing sale price of its Common Stock on
February 28, 2001, on the New York Stock Exchange was $923,319,826.
At February 28, 2001, 28,211,048 shares of the Registrant's Common Stock,
$0.01 par value were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's Proxy
Statement to be filed with the Securities and Exchange Commission in connection
with the Annual Meeting of Stockholders to be held April 25, 2001 are
incorporated by reference in Part III hereof.
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TABLE OF CONTENTS
ITEM PAGE
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PART I
1. BUSINESS.......................................................... 1
General........................................................ 1
Banking Activities............................................. 2
Lending Activities........................................... 2
Loan and Mortgage-Backed Securities Portfolio.............. 3
Residential Real Estate Lending............................ 3
Secondary Marketing and Loan Servicing Activities.......... 5
Commercial Real Estate and Multi-Family Lending............ 6
Construction Lending....................................... 6
Commercial Lending......................................... 6
Consumer Lending........................................... 6
Investment Activities........................................ 7
Deposit Activities........................................... 7
Borrowing Activities......................................... 7
Capital Securities........................................... 8
Asset/Liability Management................................... 8
Earnings Spread.............................................. 8
Insurance Agency Activities.................................. 9
Real Estate Investment Activities.............................. 9
Competition.................................................... 9
Employees...................................................... 10
Regulation..................................................... 10
General...................................................... 10
Regulation of Downey......................................... 10
Regulation of the Bank....................................... 12
Regulation of DSL Service Company............................ 19
Taxation....................................................... 20
Factors That May Affect Future Results......................... 20
2. PROPERTIES........................................................ 22
Branches....................................................... 22
Electronic Data Processing..................................... 22
3. LEGAL PROCEEDINGS................................................. 22
4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS................... 22
PART II
5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS............................................ 23
6. SELECTED FINANCIAL DATA........................................... 24
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS...................................... 26
Overview....................................................... 26
Results of Operations.......................................... 28
Net Interest Income......................................... 28
Provision for Loan Losses................................... 30
Other Income................................................ 31
Loan and Deposit Related Fees............................ 31
Real Estate and Joint Ventures Held for Investment....... 31
Secondary Marketing Activities .......................... 32
Other Category........................................... 32
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TABLE OF CONTENTS
ITEM PAGE
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PART II----(CONTINUED)
Operating Expenses.......................................... 32
Provision for Income Taxes.................................. 32
Business Segment Reporting.................................. 33
Banking.................................................. 33
Real Estate Investment................................... 34
Financial Condition............................................ 35
Loans and Mortgage-Backed Securities........................ 35
Investment Securities....................................... 38
Investments in Real Estate and Joint Ventures............... 39
Deposits.................................................... 41
Borrowings.................................................. 43
Capital Securities.......................................... 44
Asset/Liability Management and Market Risk.................. 44
Problem Loans and Real Estate............................... 48
Non-Performing Assets.................................... 48
Delinquent Loans......................................... 50
Allowance for Losses on Loans and Real Estate............ 52
Capital Resources and Liquidity............................. 57
Regulatory Capital Compliance............................... 58
Current Accounting Issues................................... 59
Sale of Subsidiary.......................................... 61
8. FINANCIAL STATEMENTS.............................................. 62
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES........................... 108
PART III
10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................ 108
11. EXECUTIVE COMPENSATION............................................ 108
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT..................................................... 108
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................... 108
PART IV
14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K.................................................... 108
SIGNATURES ................................................................111
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PART I
Certain matters discussed in this Annual Report may constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 (the "Reform Act") and, as such, may involve risks
and uncertainties. These forward-looking statements relate to, among other
things, expectations of the business environment in which Downey Financial Corp.
("Downey," "we," "us" and "our") operates, projections of future performance,
perceived opportunities in the market and statements regarding Downey's mission
and vision. Downey's actual results, performance or achievements may differ
significantly from the results, performance or achievements expressed or implied
in such forward-looking statements. For discussion of the factors that might
cause such a difference, see Business--Factors That May Affect Future Results on
page 20.
ITEM 1. BUSINESS
GENERAL
We were incorporated in Delaware on October 21, 1994. On January 23, 1995,
after we obtained necessary stockholder and regulatory approvals, we acquired
100% of the issued and outstanding capital stock of Downey Savings and Loan
Association (the "Bank") and the Bank's stockholders became holders of our
stock. Downey was thereafter funded by the Bank and presently operates as the
Bank's holding company. Our stock is traded on the New York Stock Exchange and
Pacific Exchange under the trading symbol "DSL."
The Bank was formed in 1957 as a California-licensed savings and loan
association and converted to a federal charter in 1995. As of December 31, 2000,
it conducts its business through 114 retail deposit branches, including 49
full-service in-store branches. Residential loans are originated by residential
loan officers who work out of 46 of the Bank's California retail deposit
branches. Residential loan officers also originate residential loans through the
Internet from two California call centers. Wholesale loans submitted by mortgage
brokers are originated from six California loan origination centers, two of
which are located in or by a Bank office.
The Bank is regulated or affected by the following governmental entities
and laws:
o As a federally chartered savings association, the Bank's activities
and investments are generally governed by the Home Owners' Loan Act,
as amended, and regulations and policies of the Office of Thrift
Supervision (the "OTS").
o The Bank and Downey are subject to the primary regulatory and
supervisory jurisdiction of the OTS.
o As a federally insured depository institution, the Bank is regulated
and supervised by the Federal Deposit Insurance Corporation (the
"FDIC") with respect to some of its activities and investments.
o The Bank is a member of the Federal Home Loan Bank (the "FHLB") of San
Francisco, which is one of the 12 regional banks for federally insured
depository institutions comprising the Federal Home Loan Bank System.
o The Bank's savings deposits are insured through the Savings
Association Insurance Fund ("SAIF") of the FDIC, an instrumentality of
the United States government.
o The Bank is regulated by the Federal Reserve with respect to reserves
the Bank is required to maintain against deposits and other matters.
General economic conditions, the monetary and fiscal policies of the
federal government and the regulatory policies of governmental authorities
significantly influence our operations. Additionally, interest rates on
competing investments and general market interest rates influence our deposit
flows and the costs we incur on interest-bearing liabilities, which represents
our cost of funds. Similarly, market interest rates and other factors that
affect the supply of and demand for housing and the availability of funds affect
our loan volume and our yields on loans and mortgage-backed securities.
Our primary business is banking and we are also involved in real estate
investments, each of which we discuss further below.
1
BANKING ACTIVITIES
Our primary business is banking. Our banking activities focus on:
o attracting funds from the general public and institutions; and
o originating and investing in loans, primarily residential real estate
mortgage loans, investment securities and mortgage-backed securities.
These mortgage-backed securities include mortgage pass-through securities issued
by other entities and securities issued or guaranteed by government-sponsored
enterprises like the Federal National Mortgage Association, the Federal Home
Loan Mortgage Corporation and the Government National Mortgage Association.
Our primary sources of revenue from our banking business are:
o interest we earn on loans, investment securities and mortgage-backed
securities;
o fees we earn in connection with loans and deposits;
o gains on sales of our loans, investment securities and mortgage-backed
securities; and
o income we earn on loans and mortgage-backed securities we service for
investors.
Our principal expenses in connection with our banking business are:
o interest we incur on our interest-bearing liabilities, including
deposits, borrowings and capital securities; and
o general and administrative costs.
Our primary sources of funds from our banking business are:
o deposits;
o principal and interest payments on our loans and mortgage-backed
securities;
o proceeds from sales of our loans and mortgage-backed securities; and
o borrowings and capital securities.
Scheduled payments we receive on our loans and mortgage-backed securities are a
relatively stable source of funds. However, the funds we receive from deposits
and prepayment of loans and mortgage-backed securities vary widely. Below is a
detailed discussion of our banking activities.
LENDING ACTIVITIES
Historically, our lending activities have primarily emphasized our
origination of first mortgage loans secured by residential properties and retail
neighborhood shopping centers. To a lesser extent, our lending activities have
emphasized our origination of real estate loans secured by multi-family and
commercial and industrial properties, including office buildings, land and other
properties with income producing capabilities. In addition, we have provided
construction loan financing for single family and multi-family residential
properties and commercial retail neighborhood shopping center projects. These
construction loan financings have included loans to joint ventures, which were
being engaged in by DSL Service Company, a wholly owned subsidiary of the Bank,
with other participants. We also originate loans to businesses through our
commercial banking operations.
We originate automobile loans directly through our branch network. We also
conducted an indirect auto-lending program through our purchase of new or used
automobile sales contracts from auto dealers in California and other western
states. Downey Auto Finance Corp., a previous wholly owned subsidiary of the
Bank, operated this indirect auto-lending program, but was sold in February
2000. For more information, see Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition--Sale of
Subsidiary on page 61.
Our primary focus will continue to be our origination of:
o adjustable rate single family mortgage loans, including subprime loans
which carry higher interest rates; and
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o consumer loans.
We will also continue our secondary marketing activities of originating and
selling single family loans to various investors.
For more information, see below under the caption entitled Secondary
Marketing and Loan Servicing Activities on page 5. For additional information on
the composition of our loan and mortgage-backed securities portfolio, see
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Financial Condition--Loans and Mortgage-Backed Securities on page
35.
LOAN AND MORTGAGE-BACKED SECURITIES PORTFOLIO
We carry loans receivable held for investment at cost. Our net loans
receivable are adjusted for amortization of premiums and accretion of discounts
which are recognized in interest income using the interest method. Our
investments in mortgage-backed securities represent participating interests in
pools of first mortgage loans originated and serviced by the issuers of the
securities. We carry mortgage-backed securities held to maturity at unpaid
principal balances, which are adjusted for unamortized premiums and unearned
discounts. We amortize premiums and discounts on mortgage-backed securities by
using the interest method over the remaining period to contractual maturity,
adjusted for anticipated prepayments.
We identify loans that may be sold before their maturity. In our balance
sheets, we classify these as loans held for sale and record them at the lower of
amortized cost or market value. We recognize net unrealized losses on these
loans, if any, in a valuation allowance by making charges to our income.
We carry mortgage-backed securities available for sale at fair value. We
report net unrealized gains or losses on these securities net of income taxes in
stockholders' equity and as a separate component of our other comprehensive
income until realized.
The residential mortgage loans we originate typically have contractual
maturities at origination of 15 to 40 years. To limit the interest rate risk
associated with these 15- to 40-year maturities, we, among other things,
principally originate adjustable rate mortgages for our own loan portfolio. We
originate fixed rate loans with the intention to sell the majority of them in
the secondary market on a non-recourse basis for cash. However, we occasionally
originate fixed rate loans for our own portfolio to facilitate the sale of real
estate we acquire in settlement of loans or which meet specific yield and other
approved guidelines. For more information, see Asset/Liability Management on
page 8. In addition, the average term of these fixed rate mortgage loans we
originate for our own portfolio historically has been significantly shorter than
their contractual maturity due to loan payoffs as a result of home sales or
refinancings and prepayments.
RESIDENTIAL REAL ESTATE LENDING
Our primary lending activity is our origination of mortgage loans secured
by single family residential properties consisting of one-to-four units located
primarily in California. We provide these mortgage loans for borrowers to
purchase residences or to refinance their existing mortgages at lower rates or
upon different terms. Our primary strategy is to originate adjustable rate
mortgages for our portfolio of loans we hold for investment. For more
information, see Asset/Liability Management on page 8. We also originate
residential fixed rate mortgage loans to meet consumer demand, but we intend to
sell the majority of these loans in the secondary market, rather than hold them
in our portfolio. We may, however, place residential fixed rate loans in our
portfolio of loans held for investment if these fixed rate loans are funded with
long-term funds to mitigate interest rate risk. In addition, we originate a
small volume of fixed rate loans for our own investment if they meet specific
yield and other approved guidelines or to facilitate our sale of real estate
acquired in settlement of loans. For more information, see Secondary Marketing
and Loan Servicing Activities on page 5.
Our adjustable rate mortgages generally:
o 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 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
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o limit interest rate adjustments to 1% per adjustment period for those
that adjust semi-annually and 2% per adjustment period for those that
adjust annually.
Most of our adjustable rate mortgages adjust monthly instead of
semi-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, which
adjust annually; and
o allow for negative amortization, which is the addition to loan
principal of accrued interest that exceeds the required monthly loan
payments.
Regarding negative amortization, if a loan incurs significant negative
amortization, then there is an increased risk that the market value of the
underlying collateral on the loan would be insufficient to satisfy fully the
outstanding principal and interest. We currently impose a limit on the amount of
negative amortization, so that the principal plus the added amount cannot exceed
110% of the original loan amount. In the past, the limit was 125% on loans with
an original loan-to-value ratio of 80% or less. A loan-to-value ratio is the
ratio of the principal amount of the loan to the appraised value at origination
of the property securing the loan. At year-end 2000, loans with the higher limit
on negative amortization represented about one-third of our adjustable rate
one-to-four unit residential portfolio. We permit adjustable rate mortgages to
be assumed by qualified borrowers.
During 2000, approximately 87% of our one-to-four unit residential real
estate loans were obtained by our wholesale loan representatives but originated
through outside mortgage brokers. We pay our wholesale loan representatives on a
commission basis. We consider the compensation we pay outside mortgage brokers
when we set the overall price of our mortgage loan products. These mortgage
brokers do not operate from our offices and are not our employees. Our retail
loan account representatives generated approximately 13% of our one-to-four unit
residential loans during 2000. We compensate our retail loan account
representatives located in our call centers on a salary basis plus a fixed
amount per loan they originate. Retail loan account representatives located in
our branch offices are compensated on a commission only basis. Retail loan
account representatives typically receive loan referrals from real estate
agents, builders and customers. Our call centers receive loan referrals from
retail advertising and other sources, including over the Internet.
We require that our residential real estate loans be approved at various
levels of management, depending upon the amount of the loan. On a single family
residential loan we originate for our portfolio, the maximum amount we generally
will lend is $1 million. Our average loan size, however, is much lower. In 2000,
our average loan size was $260,210. We generally make loans with loan-to-value
ratios not exceeding 80%. We will make loans with loan-to-value ratios of over
80%, but not exceeding 97% of the value of the property, if the borrower obtains
private mortgage insurance to reduce the effective loan-to-value ratio to
between 70% to 78%, consistent with secondary marketing requirements. In
addition, we require that borrowers obtain hazard insurance for all residential
real estate loans covering the lower of the loan amount or the replacement value
of the residence.
In our approval process for the loans we originate or purchase, we assess
both the value of the property securing the loan and the applicant's ability to
repay the loan. Loan underwriters analyze the loan application and the property
involved. Qualified appraisers on our staff or outside appraisers establish the
value of the collateral through the use of full appraisals or alternative
valuation formats that meet regulatory requirements. Appraisal reports prepared
by outside appraisers are selectively reviewed by our staff appraisers or by
approved fee appraisers. We also obtain information about the applicant's
income, financial condition, employment and credit history. Typically, we will
verify an applicant's credit information for loans originated by our retail loan
representatives. For loans submitted from outside mortgage brokers, we require
the mortgage broker to obtain, review and verify the applicant's credit
information and employment. In addition, in underwriting and qualifying the loan
applicant, we obtain credit information about the applicant and perform other
underwriting tests of these broker-originated loans.
On our adjustable rate mortgages we offer with incentive interest rates, we
qualify applicants:
o for loan programs with no negative amortization at the higher of:
o the initial incentive interest rate; or
o the fully indexed interest rate.
o for loan programs that include negative amortization and are owner
occupied, at the minimum qualifying interest rate of 7.50%.
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o for loan programs that include negative amortization and are non-owner
occupied, at the minimum qualifying interest rate of 7.75%.
Late in 1996, we began offering one-to-four unit residential loans to
borrowers who have or, in the case of purchases, will have equity in their homes
but whose credit rating contains exceptions which preclude them from qualifying
for lower or better market interest rates and terms. We refer to these lower
grade credits, which we characterize as "A-," "B" and "C" loans, as subprime
loans in our loan portfolio. Our subprime loans are characterized by lower
loan-to-value ratios and higher average interest rates than higher credit grade
loans or "A" loans. We believe these lower credit grade borrowers represent an
opportunity for us to earn a higher net return for the risks we assume. We have
developed specific underwriting guidelines for each classification of subprime
credit and qualify these applicants at the fully indexed rate. For further
information, see Regulation--Regulation of the Bank--Regulatory Capital
Requirements on page 13.
SECONDARY MARKETING AND LOAN SERVICING ACTIVITIES
As part of our secondary marketing activities, we originate some
residential real estate adjustable rate mortgages and fixed rate mortgages,
which we intend to sell. Accordingly, we classify these loans as held for sale
and carry them at the lower of cost or market. These loans are secured by first
liens on one-to-four unit residential properties and generally have maturities
of 30 years or less.
Generally, we use various hedging programs to manage the interest rate risk
of our fixed rate mortgage origination process. For further information, see
Asset/Liability Management on page 8.
We believe that servicing loans for others can be an important
asset/liability management tool because it produces operating results which, in
response to changes in market interest rates, tend to move opposite to changes
in net interest income. Because adjustable rate mortgages take longer to adjust
to market interest rates, net interest income associated with these loans is
expected to decline in periods of rising interest rates and increase in periods
of falling rates. In contrast, the value of a loan servicing portfolio normally:
o increases as interest rates rise and loan prepayments decrease; and
o declines as interest rates fall and loan prepayments increase.
In addition, increased levels of servicing activities and the opportunity to
offer our other financial services in servicing loans for others can provide us
with additional income with minimal additional overhead costs.
Depending upon market pricing for servicing, we sell loans either servicing
retained or servicing released. When we sell loans servicing retained, we record
gains or losses from these loans at the time of sale. We calculate gains or
losses from our sale as the difference between the net sales proceeds and the
allocated basis of the loans sold. We capitalize mortgage servicing rights we
acquire through either our purchase or origination of mortgage loans we intend
to sell with servicing rights retained. We allocate the total cost of the
mortgage loans designated for sale to both the mortgage servicing rights and to
the mortgage loans without mortgage servicing rights based on their relative
fair values. We disclose our mortgage servicing rights in our financial
statements and include them as a component of the gain on sale of loans. We
recognize impairment losses on the mortgage servicing rights through a valuation
allowance and record any associated provision as a component of loan servicing
fees. At December 31, 2000, our mortgage servicing rights totaled $41 million.
We may exchange loans we originate for sale with government agencies for
mortgage-backed securities collateralized by these loans. Our cost for the
exchange, a monthly guaranty fee, is expressed as a percentage of the unpaid
principal balance and is deducted from interest income. We can use the
securities we receive to collateralize various types of our borrowings at rates
that frequently are more favorable than rates on other types of liabilities and
also carry a lower risk-based capital requirement than whole loans. We carry
these mortgage-backed securities available for sale at fair value. However, we
record no gain or loss on the exchange in our statement of income until the
securities are sold to a third party. Before we sell these securities to third
parties, we show all changes in fair value as a separate component of
stockholders' equity as accumulated other comprehensive income, net of income
taxes.
5
COMMERCIAL REAL ESTATE AND MULTI-FAMILY LENDING
We have provided permanent loans secured by retail neighborhood shopping
centers and multi-family properties. Our major loan officers conduct our
commercial real estate and multi-family lending activities. We compensate these
officers on a salary basis.
Commercial real estate and multi-family loans generally entail additional
risks as compared to single family residential mortgage lending. We subject each
loan, including loans to facilitate the sale of real estate we own, to our
underwriting standards, which generally include:
o our evaluation of the creditworthiness and reputation of the borrower;
and
o the amount of the borrower's equity in the project as determined on
the basis of appraisal, sales and leasing information on the property
and cash flow projections.
To protect the value of the security for our loan, we require borrowers to
maintain casualty insurance for the loan amount or replacement cost. In
addition, for non-residential loans in excess of $500,000, we require the
borrower to obtain comprehensive general liability insurance. All commercial
real estate loans we originate must be approved by at least two of our officers,
one of whom must be the originating loan account officer and the other a
designated officer with appropriate loan approval authority.
CONSTRUCTION LENDING
We have provided construction loan financing for single family and
multi-family residential properties and commercial real estate projects, like
retail neighborhood shopping centers. Our major loan officers principally
originate these loans. We generally make construction loans at floating interest
rates based upon the prime or reference rate of a major commercial bank.
Generally, we require a loan-to-value ratio of 75% or less on construction
lending and we subject each loan to our underwriting standards.
Construction loans involve risks different from completed project lending
because we advance loan funds based upon the security of the completed project
under construction. If the borrower defaults on the loan, then we may have to
advance additional funds to finance the project's completion before the project
can be sold. Moreover, construction projects are affected by uncertainties
inherent in estimating:
o construction costs;
o potential delays in construction time;
o market demand; and
o the accuracy of the estimate of value on the completed project.
When providing construction loans, we require the general contractor to,
among other things, carry contractor's liability insurance equal to specific
prescribed minimum amounts, carry builder's risk insurance and have a blanket
bond against employee misappropriation.
COMMERCIAL LENDING
We originate commercial loans and revolving lines of credit and issue
standby letters of credit for our middle market commercial customers. We offer
the various credit products on both a secured and unsecured basis with interest
rates being either fixed or variable. Our portfolio emphasis is toward secured,
floating rate credit facilities. Our commercial banking group directs these
activities and focuses on our long-term, relationship-based customers. We also
utilize our retail branch network as a source of commercial customers, with the
lending to these customers being typically managed by the branch manager. We
believe our commercial borrowers are desirable because these borrowers generally
have lower cost deposit accounts.
CONSUMER LENDING
Until its sale in February 2000, we originated fixed rate automobile loans
through an indirect lending program of Downey Auto Finance Corp. which used
preapproved automobile dealers to finance consumer purchases of new and used
automobiles. For additional information regarding Downey Auto Finance Corp., see
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Financial Condition--Sale of Subsidiary on page 61.
6
In addition, the Bank originates direct automobile loans, home equity loans
and lines of credit, and other consumer loan products. Before we make a consumer
loan, we assess the applicant's ability to repay the loan and, if applicable,
the value of the collateral securing the loan. The risk involved with home
equity loans and lines of credit is similar to the risk involved with
residential real estate loans. We offer customers a credit card through a third
party, who extends the credit and services the loans made to our customers.
INVESTMENT ACTIVITIES
Federal and state regulations require the Bank to maintain a specified
minimum amount of liquid assets invested in particular short-term obligations
and other securities. For additional information regarding liquidity
requirements and the Bank's compliance with the liquidity requirements, see
Regulation--Regulation of the Bank--Liquidity Requirements on page 19 and
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Financial Condition--Capital Resources and Liquidity on page 57. As
a federally chartered savings association, the Bank's ability to make other
securities investments is prescribed under the OTS regulations and the Home
Owners' Loan Act. The Bank's authorized officers make investment decisions
within guidelines established by the Bank's Board of Directors. The Bank manages
these investments in an effort to produce the highest yield, while at the same
time maintaining safety of principal, minimizing interest rate risk and
complying with applicable regulations.
We carry securities held to maturity at amortized cost. We adjust these
costs for amortization of premiums and accretion of discounts, which we
recognize as interest income using the interest method. We carry securities
available for sale at fair value. We exclude unrealized holding gains and
losses, or valuation allowances established for net unrealized losses, from our
earnings and report them as a separate component of our stockholders' equity as
accumulated other comprehensive income, net of income taxes, unless the security
is deemed other than temporarily impaired. If the security is determined to be
other than temporarily impaired, we charge the amount of the impairment to
operations. For further information on the composition of our investment
portfolio, see Management's Discussion and Analysis of Financial Condition and
Results of Operations--Financial Condition--Investment Securities on page 38.
DEPOSIT ACTIVITIES
We prefer to use deposits as our principal source of funds for supporting
our lending activities, because the cost of these funds generally is less than
that of borrowings or other funding sources with comparable maturities. We
traditionally have obtained our savings deposits primarily from areas
surrounding the Bank's California branch offices. However, we occasionally raise
some retail deposits through Wall Street activities.
General economic conditions affect deposit flows. Funds may flow from
depository institutions such as savings associations into direct vehicles like
government and corporate securities or other financial intermediaries. Our
ability to attract and retain deposits will continue to be affected by money
market conditions and prevailing interest rates. Generally, state or federal
regulation does not restrict interest rates we pay on deposits.
In 1996, we began establishing full-service branch facilities in selected
supermarket locations throughout California. Each in-store branch offers a full
range of financial services including checking and savings accounts as well as
residential and consumer loans.
When consistent with our maintenance of appropriate capital levels, we may
consider opportunities to augment our retail branch system and deposit base
through our acquisition of selected branches or deposits.
For further information, see Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition--Deposits on
page 41.
BORROWING ACTIVITIES
Our principal source of funds has been and continues to be deposits we
raise through our retail branch system. At various times, however, we have
utilized other sources to fund our loan origination and other business
activities. We have at times relied upon our borrowings from the FHLB of San
Francisco as an additional source of funds. The FHLB of San Francisco makes
advances to us through several different credit programs it offers.
From time to time, we obtain additional sources of funds by selling some of
our securities and mortgage loans under agreements to repurchase. These reverse
repurchase agreements are generally short-term and are
7
collateralized by our mortgage-backed or investment securities and our mortgage
loans. We only deal with investment banking firms that are recognized as primary
dealers in U.S. government securities or major commercial banks in connection
with these reverse repurchase agreements. In addition, we limit the amounts of
our borrowings from any single institution.
For further information, see Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition--Borrowings
on page 43.
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. Of the $115 million of net proceeds, we invested $108
million as additional common stock of the Bank thereby increasing the Bank's
regulatory core/tangible capital by that same amount. The balance of the net
proceeds have been used for general corporate purposes. For further information
regarding our capital securities, see Note 19 on page 93 of Notes to
Consolidated Financial Statements.
ASSET/LIABILITY MANAGEMENT
Savings institutions are affected by interest rate risks to the degree that
their interest-bearing liabilities, consisting principally of customer deposits,
FHLB advances, other borrowings and capital securities, mature or reprice on a
different basis than their interest-earning assets, which consist predominantly
of intermediate or long-term real estate loans. While having liabilities that on
average mature or reprice more frequently than assets may be beneficial in times
of declining interest rates, this asset/liability structure may result in
declining net earnings during periods of rising interest rates. One of our
principal objectives is to manage the effects of adverse changes in interest
rates on our interest income while maintaining our asset quality and an
acceptable interest rate spread. To improve the rate sensitivity and maturity
balance of our interest-earning assets and liabilities, we have emphasized the
origination of loans with adjustable interest rates or relatively short
maturities. Loans with adjustable interest rates have the beneficial effect of
allowing the yield on our assets to increase during periods of rising interest
rates, although these loans have contractual limitations on the frequency and
extent of interest rate adjustments.
For further information see Lending Activities on page 2 and Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Financial Condition--Asset/Liability Management and Market Risk on
page 44.
EARNINGS SPREAD
We determine our net interest income or the interest rate spread by
calculating the difference between:
o the yield we earn on our interest-earning assets like loans,
mortgage-backed securities and investment securities; and
o the cost we pay on our interest-bearing liabilities like deposits,
borrowings and capital securities.
Our net interest income is also determined by the relative dollar amounts of our
interest-earning assets and interest-bearing liabilities.
Our effective interest rate spread, which reflects the relative level of
our interest-earning assets to our interest-bearing liabilities, equals:
o the difference between interest income on our interest-earning assets
and interest expense on our interest-bearing liabilities, divided by
o our average interest-earning assets for the period.
For information regarding our net income and the components thereof and for
management's analysis of our financial condition and results of operations, see
Management's Discussion and Analysis of Financial Condition and Results of
Operations beginning on page 26. For information regarding the return on our
assets and other selected financial data see Selected Financial Data on page 24.
8
INSURANCE AGENCY ACTIVITIES
Downey Affiliated Insurance Agency was incorporated on January 25, 1995, as
Downey's wholly owned subsidiary. We capitalized Downey Affiliated Insurance
Agency on February 24, 1995 with $400,000. In the 1995 second quarter, Downey
Affiliated Insurance Agency commenced operations at which time representatives
of Downey Affiliated Insurance Agency were available in our branches to offer
annuity products. During 1996, Downey Affiliated Insurance Agency began offering
forced-placed casualty insurance policies on mortgage loans and stopped offering
annuity products. The offering of forced-placed casualty insurance policies
ceased in April 1999.
REAL ESTATE INVESTMENT ACTIVITIES
In addition to our primary business of banking, which has been described
above, we are also involved in real estate investment activities, which are
conducted primarily through DSL Service Company, a wholly owned subsidiary of
the Bank. DSL Service Company is a diversified real estate development company
which was established in 1966 as a neighborhood shopping center and residential
tract developer, as well as the general contractor for the Bank's branch
locations. Today its capabilities include development, construction and property
management activities relating to its portfolio of projects primarily within
California, but also in Arizona. In addition to DSL Service Company developing
its own real estate projects, it associates with other qualified developers to
engage in joint ventures. The primary revenue sources of our real estate
investment activities include net rental income and gains from the sale of real
estate investments. The primary expenses of our real estate investment
activities are interest expense and general and administrative expense.
Before Congress passed the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA"), the Bank conducted real estate development
and joint venture operations directly, in addition to operations conducted
through DSL Service Company. Since FIRREA, however, the Bank's ability to engage
in new real estate development and joint venture activities and to retain its
existing real estate investments was curtailed dramatically. In addition, these
activities may be economically unfeasible for the Bank because of the capital
requirements FIRREA imposes on these activities. FIRREA requires, with some
limited exceptions, a savings institution like the Bank to exclude from the
Bank's regulatory capital:
o the Bank's investments in, and extensions of credit to, real estate
subsidiaries like DSL Service Company; and
o the Bank's direct equity investments in real estate development and
joint venture operations.
FIRREA also prohibits the Bank from making new investments in real estate
development and joint venture operations.
The Bank is required to deduct the full amount of its investment in DSL
Service Company in calculating its applicable ratios under the core, tangible
and risk-based capital standards. Savings associations generally may invest in
service corporation subsidiaries, like DSL Service Company, to the extent of 2%
of the association's assets, plus up to an additional 1% of assets for
investments which serve primarily community, inner-city or community development
purposes. In addition, "conforming loans" by the Bank to DSL's joint venture
partnerships are limited to 50% of the Bank's risk-based capital. "Conforming
loans" are those generally limited to 80% of appraised value, bear a market rate
of interest and require payments sufficient to amortize the principal balance of
the loan. We are in compliance with each of these investment limitations.
To the extent Downey or a subsidiary of Downey, other than the Bank or its
subsidiaries, makes real estate investments, the above-mentioned capital
deductions and limitations do not apply as they only pertain to the specific
investments by savings associations or their subsidiaries.
For further information, see Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition--Investments
in Real Estate and Joint Ventures on page 39.
COMPETITION
We face competition both in attracting deposits and in making loans. Our
most direct competition for deposits has historically come from other savings
institutions and from commercial banks located in our principal market areas,
including many large financial institutions based in other parts of the country
or their subsidiaries. In addition, we face additional significant competition
for investors' funds from short-term money market securities
9
and other corporate and government securities. Our ability to attract and retain
savings deposits depends, generally, on our ability to provide a rate of return,
liquidity and risk comparable to that offered by competing investment
opportunities and the appropriate level of customer service.
We experience competition for real estate loans principally from other
savings institutions, commercial banks, mortgage banking companies and insurance
companies. We compete for loans principally through our interest rates and loan
fees we charge and our efficiency and quality of services we provide borrowers
and real estate brokers.
EMPLOYEES
At December 31, 2000, we had approximately 1,294 full-time employees and
489 part-time employees. We provide our employees with health and welfare
benefits and a retirement and savings plan. Additionally, we offer qualifying
employees participation in our stock purchase plan. Our employees are not
represented by any union or collective bargaining group, and we consider our
employee relations to be good.
REGULATION
GENERAL
Federal and state law extensively regulates savings and loan holding
companies and savings associations. This regulation is intended primarily for
the protection of our depositors and the SAIF and not for the benefit of our
stockholders. In the following information, we describe some of the regulations
applicable to us and the Bank. We do not claim this discussion is complete and
qualify our discussion in its entirety by reference to applicable statutory or
regulatory provisions.
REGULATION OF DOWNEY
General. We are a savings and loan holding company. We are subject to
regulatory oversight by the OTS. Thus, we are required to register and file
reports with the OTS and are regulated and examined by the OTS. In addition, the
OTS has enforcement authority over us, which also permits the OTS to restrict or
prohibit our activities that it determines to be a serious risk to the Bank.
Activities Restrictions. As a savings and loan holding company with only
one savings and loan association subsidiary, we generally are not limited by OTS
activity restrictions, provided the Bank satisfies the qualified thrift lender
test or meets the definition of a domestic building and loan association in the
Internal Revenue Code. If we acquire control of another savings association as a
separate subsidiary of Downey, we would become a multiple savings and loan
holding company. As a multiple savings and loan holding company, our activities,
other than the activities of the Bank or any other SAIF-insured savings
association, would become subject to restrictions applicable to bank holding
companies unless these other savings associations were acquired in a supervisory
acquisition and each also satisfies the qualified thrift lender test or meets
the definition of a domestic building and loan association. Furthermore, if we
were in the future to sell control of the Bank to any other company, such
company would not succeed to our grandfathered status as a unitary thrift
holding company and would be subject to the same business activity restrictions
as a bank holding company. For more information, see Recent Legislation on page
11 and Regulation of the Bank--Qualified Thrift Lender Test on page 15.
On October 27, 2000, the OTS issued a proposed rule that would require some
savings and loan holding companies to notify the OTS 30 days before undertaking
certain significant new business activities. As proposed, holding companies
would have to give the OTS advance notice of:
o the incurrence of debt, when combined with all other transactions by
the company or any subsidiaries other than the thrift during the past
12 months, increases non-thrift liabilities by 5 percent or more; and
non-thrift liabilities, after the debt transaction, equal 50 percent
or more of the company's consolidated core capital;
o an asset acquisition or series of such transactions by the company or
non-thrift subsidiary during the past 12 months that involves assets
other than cash, cash equivalents and securities or other obligations
guaranteed by the U.S. Government and exceeds 15 percent of the
company's consolidated assets; and
10
o any transaction that, when combined with all other transactions during
the past 12 months, reduces the company's capital by 10 percent or
more.
Exempt from the notice requirement would be any holding company with
consolidated subsidiary thrift assets of less than 20 percent of total assets or
consolidated holding company capital of at least 10 percent. The OTS could
object to or conditionally approve an activity or transaction if it finds a
material risk to the safety and soundness and stability of the thrift. The
review period could be extended an additional 30 days if necessary.
The OTS proposal also would codify current practices and the factors
relevant to a holding company's need for capital. To determine the need for and
level of an explicit holding company capital requirement, the OTS will look at
overall risk at the thrift and the consolidated entity, their tangible and
equity capital, whether the holding company's debt-to-capital ratio is rising,
what investments or activities are funded by debt, its cash flow, how much the
holding company relies on dividends from its subsidiary thrift to service debt
or fulfill other obligations, earnings volatility and the thrift's standing in
the corporate structure.
The comment period for the proposed rule was extended to February 9, 2001.
It is not possible at this time to predict the impact of the proposed rule on
our financial condition or results of operation.
Restrictions on Acquisitions. We must obtain approval from the OTS before
acquiring control of any other SAIF-insured association. The OTS generally
prohibits these types of acquisitions if they result in a multiple savings and
loan holding company controlling savings associations in more than one state.
However, the OTS permits interstate acquisitions if the acquisition is
authorized by specific state authorization or a supervisory acquisition of a
failing savings association.
Federal law generally provides that no "person," acting directly or
indirectly or through or in concert with one or more other persons, may acquire
"control" of a federally insured savings association unless the person gives at
least 60 days written notice to the OTS. The OTS then has the opportunity to
disapprove the proposed acquisition. In addition, no company may acquire control
of this type of an institution without prior OTS approval. These provisions also
prohibit, among other things, any director or officer of a savings and loan
holding company, or any individual who owns or controls more than 25% of the
voting shares of a savings and loan holding company, from acquiring control of
any savings association not a subsidiary of the savings and loan holding
company, unless the acquisition is approved by the OTS.
Recent Legislation. On November 12, 1999, the Gramm-Leach-Bliley Act of
1999 (the "Financial Services Modernization Act") was signed into law. The
Financial Services Modernization Act repeals the two affiliation provisions of
the Glass-Steagall Act:
o Section 20, which restricted the affiliation of Federal Reserve member
banks with firms "engaged principally" in specified securities
activities; and
o Section 32, which restricts officer, director or employee interlocks
between a member bank and any company or person "primarily engaged" in
specified securities activities.
In addition, the Financial Services Modernization Act contains provisions
that expressly preempt any state law restricting the establishment of financial
affiliations, primarily related to insurance. The general effect of the law is
to establish a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms and other financial service
providers by revising and expanding the Bank Holding Company Act framework to
permit a holding company to engage in a full range of financial activities
through a new entity known as a "Financial Holding Company." "Financial
activities" is broadly defined to include not only banking, insurance and
securities activities, but also merchant banking and additional activities that
the Federal Reserve Board, in consultation with the Secretary of the Treasury,
determines to be financial in nature, related or incidental to such financial
activities, or complementary activities that do not pose a substantial risk to
the safety and soundness of depository institutions or the financial system
generally.
The Financial Services Modernization Act provides that no company may
acquire control of an insured savings association, unless that company engages,
and continues to engage, only in the financial activities permissible for a
Financial Holding Company, unless grandfathered as a unitary savings and loan
holding company. The Financial Institution Modernization Act grandfathers any
company that was a unitary savings and loan holding company on May 4, 1999 or
became a unitary savings and loan holding company pursuant to an application
pending on that date. Downey is a grandfathered unitary savings and loan holding
company and we
11
may continue to operate under present law as long as we continue to control only
the Bank and the Bank continues to meet the qualified thrift lender test.
We do not believe that the Financial Services Modernization Act will have a
material adverse effect on our operations in the near-term. However, to the
extent that the act permits banks, securities firms and insurance companies to
affiliate, the financial services industry may experience further consolidation.
The Financial Services Modernization Act is intended to grant to community banks
certain powers as a matter of right that larger institutions have accumulated on
an ad hoc basis and which unitary savings and loan holding companies, such as
Downey, already possess. Nevertheless, this act may have the result of
increasing the amount of competition that we face from larger institutions and
other types of companies offering financial products, many of which may have
greater financial resources than we do. In addition, the Financial Services
Modernization Act may have an anti-takeover effect because it may tend to limit
the range of potential acquirers of Downey to other savings and loan holding
companies and Financial Holding Companies.
REGULATION OF THE BANK
General. The OTS and the FDIC extensively regulate the Bank because the
Bank is a federally chartered, SAIF-insured savings association. The Bank must
ensure that its lending activities and its other investments comply with various
statutory and regulatory requirements. The Bank is also regulated by the Federal
Reserve.
The OTS, in conjunction with the FDIC, regularly examines the Bank and
prepares reports for the Bank's Board of Directors to consider with respect to
any deficiencies the OTS or the FDIC finds in the Bank's operations. Federal and
state laws also regulate the relationship between the Bank and its depositors
and borrowers, especially in matters regarding the ownership of savings accounts
and the form and content of mortgage documents used by the Bank.
The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition. In addition, the Bank must obtain regulatory
approvals before entering into some transactions like mergers with or
acquisitions of other financial institutions. This regulation and supervision
establishes a comprehensive framework of activities in which an institution may
engage and is intended primarily for the protection of the SAIF and our
depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in regulations, whether by the OTS, the FDIC
or the Congress, could have a material adverse impact on us, the Bank and our
operations.
Insurance of Deposit Accounts. The SAIF, as administered by the FDIC,
insures the Bank's deposit accounts up to the maximum amount permitted by law.
The FDIC may terminate insurance of deposits upon a finding that the
institution:
o has engaged in unsafe or unsound practices;
o is in an unsafe or unsound condition to continue operations; or
o has violated any applicable law, regulation, rule, order or condition
imposed by the FDIC or the institution's primary regulator.
The FDIC charges an annual assessment for the insurance of deposits based
on the risk a particular institution poses to its deposit insurance fund. Under
this system as of December 31, 2000, SAIF members paid within a range of 0 cents
to 27 cents per $100 of domestic deposits, depending upon the institution's risk
classification. This risk classification is based on an institution's capital
group and supervisory subgroup assignment.
The Bank also pays, in addition to its normal deposit insurance premium as
a member of the SAIF, an amount equal to approximately 0.0212% of insured
deposits toward the retirement of the Financing Corporation bonds (known as FICO
Bonds) issued in the 1980s to assist in the recovery of the savings and loan
industry. These assessments will continue until the FICO Bonds mature in 2017.
12
Regulatory Capital Requirements. The Bank must meet regulatory capital
standards to be deemed in compliance with OTS capital requirements. OTS capital
regulations require savings associations to meet the following three capital
standards:
o tangible capital equal to 1.5% of total adjusted assets;
o leverage capital, or "core capital," equal to 3% of total adjusted
assets for institutions such as the Bank; and
o risk-based capital equal to 8.0% of total risk-based assets.
A savings association with a greater than "normal" level of interest rate
exposure must deduct an interest rate risk component in calculating its total
capital for purposes of determining whether it meets its risk-based capital
requirement. Interest rate exposure is measured, generally, as equal to:
o the decline in an institution's net portfolio value that would result
from a 200 basis point increase or decrease in market interest rates,
whichever would result in a lower net portfolio value, divided by
o the estimated economic value of the savings association's assets.
The interest rate risk component a savings association must deduct from its
total capital is equal to:
o one-half of the difference between an institution's measured exposure
and "normal" interest rate risk exposure, which the OTS defines as 2%,
multiplied by
o the estimated economic value of the institution's assets.
In August 1995, the OTS indefinitely delayed implementation of its interest
rate risk regulation. However, based on the asset/liability structure of the
Bank, at December 31, 2000, the Bank would not have been required to deduct an
interest rate risk component in calculating its total risk-based capital had
OTS's interest rate risk regulation been in effect.
The OTS views its capital regulation requirements as minimum standards, and
it expects most institutions to maintain capital levels well above the minimum.
In addition, the OTS regulations provide that the OTS may establish minimum
capital levels higher than those provided in the regulations for individual
savings associations, upon a determination that the savings association's
capital is or may become inadequate in view of its circumstances. The OTS
regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others:
o a savings association has a high degree of exposure to interest rate
risk, prepayment risk, credit risk, concentration of credit risk,
other risks arising from nontraditional activities, or similar risks
or a high proportion of off-balance sheet risk;
o a savings association is growing, either internally or through
acquisitions, at a rate that presents supervisory issues; or
o a savings association may be adversely affected by activities or
condition of its holding company, affiliates, subsidiaries or other
persons, or savings associations with which it has significant
business relationships.
The Bank is not required to meet any individual minimum regulatory capital
requirement. At December 31, 2000, the Bank's regulatory capital exceeded all
minimum regulatory capital requirements.
As a result of a number of federally insured financial institutions
extending their risk selection standards to attract lower credit quality
accounts due to their having higher interest rates and fees, the federal banking
regulatory agencies jointly issued Interagency Guidelines on Subprime Lending in
March 1999. In addition, expanded guidelines were issued by the agencies on
January 31, 2001. Subprime lending involves extending credit to individuals with
less than perfect credit histories.
The agencies' guidelines consider subprime lending a high-risk activity
that is unsafe and unsound if the risks associated with subprime lending are not
properly controlled. Specifically, the 2001 guidelines direct examiners to
13
expect regulatory capital one and one-half to three times higher than that
typically set aside for prime assets for institutions that:
o have subprime assets equal to 25% or higher of Tier 1 capital, or
o have subprime portfolios experiencing rapid growth or adverse
performance trends, are administered by inexperienced management, or
have inadequate or weak controls.
Our subprime portfolio, pursuant to our definition, represented 250% of
Tier 1 capital as of year-end 2000. Any requirement for us to maintain
additional regulatory capital as a result of our activities in subprime lending
could have an adverse affect on our future prospects and operations and may
restrict our ability to grow. If we are unable to comply with any new capital
requirements imposed upon regulatory examination, we may be subject to the
prompt corrective action regulations of the OTS. Although we believe we maintain
appropriate controls and regulatory capital for our subprime activities, we
cannot determine whether, or to what extent, additional capital requirements
will be imposed on us after periodic examinations by the OTS.
The Home Owners' Loan Act permits savings associations not in compliance
with the OTS capital standards to seek an exemption from penalties or sanctions
for noncompliance. The OTS will grant an exemption only if the savings
association meets strict requirements. In addition, the OTS must deny the
exemption in some circumstances. If the OTS does grant an exemption, the savings
association still may be exposed to enforcement actions for other violations of
law or unsafe or unsound practices or conditions.
Prompt Corrective Action. The OTS's prompt corrective action regulation
requires the OTS to take mandatory actions and authorizes the OTS to take
discretionary actions against a savings association that falls within
undercapitalized capital categories specified in the regulation.
The regulation establishes five categories of capital classification:
o "well capitalized;"
o "adequately capitalized;"
o "undercapitalized;"
o "significantly undercapitalized;" and
o "critically undercapitalized."
The regulation uses an institution's risk-based capital, leverage capital and
tangible capital ratios to determine the institution's capital classification.
At December 31, 2000, the Bank exceeded the capital requirements of a well
capitalized institution under applicable OTS regulations.
Loans-to-One-Borrower. Savings associations generally are subject to the
lending limits applicable to national banks. With limited exceptions, the
maximum amount that a savings association or a national bank may lend to any
borrower, including some related entities of the borrower, at one time may not
exceed:
o 15% of the unimpaired capital and surplus of the institution, plus
o an additional 10% of unimpaired capital and surplus if the loans are
fully secured by readily marketable collateral.
Savings associations are additionally authorized to make loans to one
borrower, for any purpose:
o in an amount not to exceed $500,000; or
o by order of the Director of OTS, in an amount not to exceed the lesser
of $30,000,000 or 30% of unimpaired capital and surplus to develop
residential housing, provided:
o the purchase price of each single-family dwelling in the
development does not exceed $500,000;
14
o the savings association is in compliance with its capital
requirements;
o the loans comply with applicable loan-to-value requirements; and
o the aggregate amount of loans made under this authority does not
exceed 15% of unimpaired capital and surplus.
At December 31, 2000, the Bank's loans-to-one-borrower limit was $112
million based upon the 15% of unimpaired capital and surplus measurement.
Qualified Thrift Lender Test. The OTS requires savings associations to meet
a qualified thrift lender test. The qualified thrift lender test may be met
either by maintaining a specified level of assets in qualified thrift
investments as specified in the Home Owners' Loan Act or by meeting the
definition of a "domestic building and loan association." Qualified thrift
investments are primarily residential mortgages and related investments,
including some mortgage-related securities. The required percentage of
investments under the Home Owners' Loan Act is 65% of assets while the Internal
Revenue Code requires investments of 60% of assets. An association must be in
compliance with the qualified thrift lender test or the definition of domestic
building and loan association on a monthly basis in nine out of every 12 months.
Associations failing to meet the qualified thrift lender test are generally
allowed only to engage in activities permitted for both national banks and
savings associations.
The FHLB also relies on the qualified thrift lender test. A savings
association will only enjoy full borrowing privileges from an FHLB if the
savings association is a qualified thrift lender. As of December 31, 2000, the
Bank was in compliance with its qualified thrift lender test requirement and met
the definition of a domestic building and loan association.
Affiliate Transactions. Transactions between a savings association and its
"affiliates" are quantitatively and qualitatively restricted under the Federal
Reserve Act. Affiliates of a savings association include, among other entities,
the savings association's holding company and companies that are under common
control with the savings association.
In general, a savings association or its subsidiaries are limited in their
ability to engage in "covered transactions" with affiliates:
o to an amount equal to 10% of the association's capital and surplus, in
the case of covered transactions with any one affiliate; and
o to an amount equal to 20% of the association's capital and surplus, in
the case of covered transactions with all affiliates.
In addition, a savings association and its subsidiaries may engage in covered
transactions and other specified transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction"
includes:
o a loan or extension of credit to an affiliate;
o a purchase of investment securities issued by an affiliate;
o a purchase of assets from an affiliate, with some exceptions;
o the acceptance of securities issued by an affiliate as collateral for
a loan or extension of credit to any party; or
o the issuance of a guarantee, acceptance or letter of credit on behalf
of an affiliate.
15
In addition, under the OTS regulations:
o a savings association may not make a loan or extension of credit to an
affiliate unless the affiliate is engaged only in activities
permissible for bank holding companies;
o a savings association may not purchase or invest in securities of an
affiliate other than shares of a subsidiary;
o a savings association and its subsidiaries may not purchase a
low-quality asset from an affiliate;
o covered transactions and other specified transactions between a
savings association or its subsidiaries and an affiliate must be on
terms and conditions that are consistent with safe and sound banking
practices; and
o with some exceptions, each loan or extension of credit by a savings
association to an affiliate must be secured by collateral with a
market value ranging from 100% to 130%, depending on the type of
collateral, of the amount of the loan or extension of credit.
The OTS regulations generally exclude all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve decides to treat these
subsidiaries as affiliates. The regulations also require savings associations to
make and retain records that reflect affiliate transactions in reasonable detail
and provides that specified classes of savings associations may be required to
give the OTS prior notice of affiliate transactions.
Capital Distribution Limitations. OTS regulations impose limitations upon
all capital distributions by savings associations, like cash dividends, payments
to repurchase or otherwise acquire its shares, payments to shareholders of
another institution in a cash-out merger and other distributions charged against
capital. The OTS recently adopted an amendment to these capital distribution
limitations. Under the new rule, a savings association in some circumstances
may:
o be required to file an application and await approval from the OTS
before it makes a capital distribution;
o be required to file a notice 30 days before the capital distribution;
or
o be permitted to make the capital distribution without notice or
application to the OTS.
The OTS regulations require a savings association to file an application if:
o it is not eligible for expedited treatment of its other applications
under OTS regulations;
o the total amount of all of capital distributions, including the
proposed capital distribution, for the applicable calendar year
exceeds its retained net income for that year to date plus retained
net income for the preceding two years;
o it would not be at least adequately capitalized, under the prompt
corrective action regulations of the OTS following the distribution;
or
o the association's proposed capital distribution would violate a
prohibition contained in any applicable statute, regulation or
agreement between the savings association and the OTS, or the FDIC, or
violate a condition imposed on the savings association in an
OTS-approved application or notice.
In addition, a savings association must give the OTS notice of a capital
distribution if the savings association is not required to file an application,
but:
o would not be well capitalized under the prompt corrective action
regulations of the OTS following the distribution;
o the proposed capital distribution would reduce the amount of or retire
any part of the savings association's common or preferred stock or
retire any part of debt instruments like notes or debentures
16
included in capital, other than regular payments required under a debt
instrument approved by the OTS; or
o the savings association is a subsidiary of a savings and loan holding
company.
If neither the savings association nor the proposed capital distribution
meet any of the above listed criteria, the OTS does not require the savings
association to submit an application or give notice when making the proposed
capital distribution. The OTS may prohibit a proposed capital distribution that
would otherwise be permitted if the OTS determines that the distribution would
constitute an unsafe or unsound practice.
Privacy. Under the Financial Services Modernization Act, federal banking
regulators are required to adopt rules that will limit the ability of banks and
other financial institutions to disclose non-public information about consumers
to nonaffiliated third parties. Federal banking regulators issued final rules on
May 10, 2000. Pursuant to those rules, financial institutions must provide:
o initial notices to customers about their privacy policies, describing
the conditions under which they may disclose nonpublic personal
information to nonaffiliated third parties and affiliates;
o annual notices of their privacy policies to current customers; and
o a reasonable method for customers to "opt out" of disclosures to
nonaffiliated third parties.
The rules were effective November 13, 2000, but compliance is optional until
July 1, 2001. These privacy provisions will affect how consumer information is
transmitted through diversified financial companies and conveyed to outside
vendors. Although it is not possible at this time to assess the impact of the
privacy provisions on our financial condition or results of operations, we do
not believe that the Privacy provisions will have a material adverse impact on
our operations in the near term.
Consumer Protection Rules - Sale of Insurance Products. In December 2000,
pursuant to the requirements of the Financial Services Modernization Act, the
federal bank and thrift regulatory agencies adopted consumer protection rules
for the sale of insurance products by depository institutions. The rule is
effective on April 1, 2001. The final rule applies to any depository institution
or any person selling, soliciting, advertising or offering insurance products or
annuities to a consumer at an office of the institution or on behalf of the
institution. Before an institution can complete the sale of an insurance product
or annuity, the regulation requires oral and written disclosure that such
product:
o is not a deposit or other obligation of, or guaranteed by, the
depository institution or its affiliate;
o is not insured by the FDIC or any other agency of the United States,
the depository institution or its affiliate; and
o has certain risks in investment, including the possible loss of value.
Finally, the depository institution may not condition an extension of
credit:
o on the consumer's purchase of an insurance product or annuity from the
depository institution or from any of its affiliates, or
o on the consumer's agreement not to obtain, or a prohibition on the
consumer from obtaining, an insurance product or annuity from an
unaffiliated entity.
The rule also requires formal acknowledgement from the consumer that
disclosures were received.
In addition, to the extent practicable, a depository institution must keep
insurance and annuity sales activities physically segregated from the areas
where retail deposits are routinely accepted from the general public.
17
Safeguarding Confidential Customer Information. In January 2000, the
banking agencies adopted guidelines requiring financial institutions to
establish an information security program to:
o identify and assess the risks that may threaten customer information;
o develop a written plan containing policies and procedures to manage
and control these risks;
o implement and test the plan; and
o adjust the plan on a continuing basis to account for changes in
technology, the sensitivity of customer information, and internal or
external threats to information security.
Each institution may implement a security program appropriate to its size and
complexity and the nature and scope of its operations.
The guidelines outline specific security measures that institutions should
consider in implementing a security program. A financial institution must adopt
those security measures determined to be appropriate. The guidelines require the
board of directors to oversee an institution's efforts to develop, implement and
maintain an effective information security program and approve written
information security policies and programs. The guidelines are effective July 1,
2001.
Activities of Subsidiaries. A savings association seeking to establish a
new subsidiary, acquire control of an existing company or conduct a new activity
through a subsidiary must provide 30 days prior notice to the FDIC and the OTS
and conduct any activities of the subsidiary in compliance with regulations and
orders of the OTS. The OTS has the power to require a savings association to
divest any subsidiary or terminate any activity conducted by a subsidiary that
the OTS determines to pose a serious threat to the financial safety, soundness
or stability of the savings association or to be otherwise inconsistent with
sound banking practices.
Community Reinvestment Act and the Fair Lending Laws. Savings associations
have a responsibility under the Community Reinvestment Act and related
regulations of the OTS to help meet the credit needs of their communities,
including low- and moderate-income neighborhoods. In addition, the Equal Credit
Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in
their lending practices on the basis of characteristics specified in those
statutes. An institution's failure to comply with the provisions of the
Community Reinvestment Act could, at a minimum, result in regulatory
restrictions on its activities and the denial of applications. In addition, an
institution's failure to comply with the Equal Credit Opportunity Act and the
Fair Housing Act could result in the OTS, other federal regulatory agencies as
well as the Department of Justice taking enforcement actions.
Federal Home Loan Bank System. The Bank is a member of the FHLB system.
Among other benefits, each FHLB serves as a reserve or central bank for its
members within its assigned region. Each FHLB is financed primarily from the
sale of consolidated obligations of the FHLB system. Each FHLB makes available
loans or advances to its members in compliance with the policies and procedures
established by the Board of Directors of the individual FHLB.
As an FHLB member, the Bank is required to own capital stock in an FHLB in
an amount equal to the greater of:
o 1% of its aggregate outstanding principal amount of its residential
mortgage loans, home purchase contracts and similar obligations at the
beginning of each calendar year;
o 5% of its FHLB advances or borrowings; or
o $500.
The Bank's required investment in FHLB stock, based on December 31, 2000
financial data, was $99 million. At December 31, 2000, the Bank had $106 million
of FHLB stock.
18
Liquidity Requirements. Under OTS regulations, a savings association is
required to maintain an average daily balance of liquid assets. These liquid
assets include cash, some time deposits and savings accounts, bankers'
acceptances, some government obligations and other investments. The OTS requires
a savings association to maintain an average daily balance of liquid assets in
each calendar quarter of not less than 4% of either:
o its liquidity base, which consists of some net withdrawable accounts
plus short-term borrowings, as of the end of the preceding calendar
quarter; or
o the average daily balance of its liquidity base during the preceding
quarter.
The OTS may change this liquidity requirement from time to time to any
amount between 4% and 10%, depending upon factors, including economic conditions
and savings flows of all savings associations. The Bank maintains liquid assets
in compliance with these regulations. The OTS may impose monetary penalties upon
an institution for violations of liquidity requirements.
Federal Reserve System. The Federal Reserve requires all depository
institutions to maintain non- interest-bearing reserves at specified levels
against their transaction accounts and non-personal time deposits. These
transaction accounts include checking, NOW and Super NOW checking accounts. The
balances a savings association maintains to meet the reserve requirements
imposed by the Federal Reserve may be used to satisfy the liquidity requirements
that are imposed by the OTS. At December 31, 2000, the Bank was in compliance
with these requirements.
REGULATION OF DSL SERVICE COMPANY
DSL Service Company is licensed as a real estate broker under the
California Real Estate Law and as a contractor with the Contractors State
License Board. Thus, the real estate investment activities of DSL Service
Company, including development, construction and property management activities
relating to its portfolio of projects, are governed by a variety of laws and
regulations. Changes in the laws and regulations or their interpretation by
agencies and the courts occur frequently. DSL Service Company must comply with
various federal, state and local laws, ordinances, rules and regulations
concerning zoning, building design, construction, hazardous waste and similar
matters. Environmental laws and regulations also affect the operations of DSL
Service Company, including regulations pertaining to availability of water,
municipal sewage treatment capacity, land use, protection of endangered species,
population density and preservation of the natural terrain and coastlines. These
and other requirements could become more restrictive in the future, resulting in
additional time and expense in connection with DSL Service Company's real estate
activities.
With regard to environmental matters, the construction products industry is
regulated by federal, state and local laws and regulations pertaining to several
areas including human health and safety and environmental compliance. The
Comprehensive Environmental Response, Compensation and Liability Act of 1980, as
amended by the Superfund Amendments and Reauthorization Act of 1986, as well as
analogous laws in some states, create joint and several liability for the cost
of cleaning up or correcting releases to the environment of designated hazardous
substances. Among those who may be held jointly and severally liable are:
o those who generated the waste;
o those who arranged for disposal;
o those who owned or operated the disposal site or facility at the time
of disposal; and
o current owners.
In general, this liability is imposed in a series of governmental
proceedings initiated by the government's identification of a site for initial
listing as a "Superfund site" on the National Priorities List or a similar state
list and the government's identification of potentially responsible parties who
may be liable for cleanup costs. None of the DSL Service Company's project sites
are listed as a "Superfund site."
In addition, California courts have imposed warranty-like responsibility
upon developers of new housing for defects in structure and the housing site,
including soil conditions. This responsibility is not necessarily dependent upon
a finding that the developer was negligent.
19
As a licensed entity, DSL Service Company is also examined and supervised
by the California Department of Real Estate and the Contractors State License
Board.
TAXATION
Federal. A savings institution is taxed like other corporations for federal
income tax purposes, though savings institutions have historically enjoyed
favorable treatment under the Internal Revenue Code in determining their
deductions for bad debts.
Savings institutions are required to comply with income tax statutes and
regulations similar to those applicable to large commercial banks. The Bank's
bad debt deduction is determined under the specific charge-off method, which
allows the Bank to take an income tax deduction for these loans only when they
have been determined to be wholly or partially worthless.
In addition to the regular corporate income tax, corporations might be
required to pay an alternative minimum tax. This tax is computed at 20% of the
corporation's regular taxable income, after taking some adjustments into
account. This alternative tax applies to corporations to the extent that it
exceeds a corporation's regular tax liability.
A corporation that incurs alternative minimum tax generally is entitled to
take this tax as a credit against its regular tax in later years to the extent
that the corporation's regular tax liability in these later years exceeds the
corporation's alternative minimum tax.
State. The Bank uses California's financial corporation income tax rate to
compute its California franchise tax liability. This rate is higher than the
California non-financial corporation income tax rate because the financial
corporation income tax rate reflects an amount "in lieu" of local personal
property and business license taxes that are paid by non-financial corporations,
but not by banks or other financial corporations. The financial corporation
income tax rate was 10.84% for both 2000 and 1999.
The Bank files a California franchise tax return on a combined reporting
basis. Other state income and franchise tax returns are filed on a
separate-entity basis in Arizona, Colorado, Idaho, Oregon and Utah. The Bank
anticipates that additional state income and franchise tax returns will be
required in future years as its lending business is expanded nationwide.
The Internal Revenue Service and state taxing authorities have examined our
tax returns for all tax years through 1995 and are currently reviewing returns
filed for the 1996 tax year. The Bank made a payment of $10.7 million during
2000 to settle federal tax claims related to the sale and leaseback of computer
equipment in 1990. This amount had been previously reflected in the Bank's tax
accrual, and therefore had no adverse impact upon current year earnings. In
addition, the Bank's management believes it has adequately provided for
potential exposure with regard to other issues in the years currently under
examination. Our tax years subsequent to 1996 remain open to review by federal
and state tax authorities.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The following discusses certain factors which may affect our financial
results and operations and should be considered in evaluating Downey.
Economic Conditions and Geographic Concentrations. Downey is headquartered
in and its operations are concentrated in California. As a result of this
geographic concentration, our results depend largely upon economic conditions in
the state. Leading business forecasters and economists predict that economic
growth may slow substantially from 2000. A significant contributor to the
projected 2001 slowdown is California's current energy crisis. The expected hike
in energy rates could impede growth by reducing business investment and consumer
spending within the state. Other issues facing the state's economy are potential
job losses as California "dot.com" companies continue to reduce their workforce.
A deterioration in economic conditions could have a material adverse impact on
the quality of our loan and real estate portfolios and the demand for our
products and services.
Interest Rates. We anticipate that short-term interest rate levels will
likely decline in 2001, and if interest rates vary substantially from present
levels, our results may differ materially from current levels. Changes in
interest rates will influence the growth of loans, investments and deposits and
affect the rates received on loans and investment securities and paid on
deposits. Changes in interest rates also affect the value of our recorded
20
mortgage servicing rights on loans we service for others, generally increasing
in value as interest rates rise and declining as interest rates fall. If
interest rates were to increase significantly, the economic feasibility of real
estate investment activities also could be adversely affected.
Government Regulation and Monetary Policy. The financial services industry
is subject to extensive federal and state supervision and regulation.
Significant new laws or changes in, or repeals of, existing laws may cause our
results to differ materially. Further, federal monetary policy, particularly as
implemented through the Federal Reserve System, significantly affects credit
conditions for Downey, primarily through open market operations in United States
government securities, the discount rate for borrowings and reserve
requirements, and a material change in these conditions would be likely to have
a material impact on our results.
Competition. The banking and financial services business in our market
areas is highly competitive. The increasingly competitive environment is a
result primarily of changes in regulation, changes in technology and product
delivery systems, and the accelerating pace of consolidation among financial
services providers. Our results may differ if circumstances affecting the nature
or level of competition change.
Credit Quality. A significant source of risk arises from the possibility
that losses will be sustained because borrowers, guarantors and related parties
may fail to perform in accordance with the terms of their loans. We have adopted
prudent underwriting and loan quality monitoring systems, procedures and credit
policies, including the establishment and review of the allowance for loan
losses, that management believes are appropriate to minimize this risk by
tracking loan performance, assessing the likelihood of nonperformance and
diversifying our loan portfolio. Such policies and procedures, however, may not
prevent unexpected losses that could materially adversely affect our results.
21
ITEM 2. PROPERTIES
BRANCHES
The corporate offices of Downey, the Bank and DSL Service Company are
located at 3501 Jamboree Road, Newport Beach, California 92660. Part of that
corporate facility houses a branch office of the Bank. Certain departments
(warehousing, record retention, etc.) are located in other owned and leased
facilities in Orange County, California. The majority of our administrative
operations, however, are located in our corporate headquarters.
At December 31, 2000, we had 114 branches. We owned the building and land
occupied by 56 of our branches and we owned one branch building on leased land.
We operate branches in 57 locations (including 49 in-store locations) with
leases or licenses expiring at various dates through October 2010, with options
to extend the term.
The net book value of our owned branches, including the one on leased land,
totaled $82 million at December 31, 2000 and the net book value of our leased
branch offices totaled $2 million at December 31, 2000. The net book value of
our furniture and fixtures, including electronic data processing equipment, was
$20 million at December 31, 2000.
For additional information regarding our offices and equipment, see Note 1
on page 69 and Note 9 on page 85 of Notes to Consolidated Financial Statements.
ELECTRONIC DATA PROCESSING
We utilize a mainframe computer system with use of various third-party
vendors' software for retail deposit operations, loan servicing, accounting and
loan origination functions, including our operations conducted over the
Internet. The net book value of our electronic data processing equipment,
including personal computers and software, was $12 million at December 31, 2000.
ITEM 3. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
No matters were submitted to shareholders during the fourth quarter of
2000.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the New York Stock Exchange ("NYSE") and the
Pacific Exchange ("PCX") with the trading symbol "DSL." At February 28, 2001, we
had approximately 873 stockholders of record (not including the number of
persons or entities holding stock in nominee or street name through various
brokerage firms) and 28,211,048 outstanding shares of common stock.
The following table sets forth for the quarters indicated the range of high
and low sale prices per share of our common stock as reported on the NYSE
Composite Tape.
2000 1999
-----------------------------------------------------------------------
4th 3rd 2nd 1st 4th 3rd 2nd 1st
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
-------------------------------------------------------------------------------------------
High ........ $60.88 $40.94 $33.00 $21.44 $22.94 $24.13 $23.00 $25.75
Low ......... 33.13 29.94 20.44 18.75 19.06 19.81 18.13 18.25
End of period 55.00 39.50 28.98 21.25 20.19 20.13 21.94 18.31
===========================================================================================
During 2000, we paid quarterly cash dividends totaling $0.36 per share,
aggregating $10.1 million compared to $0.35 per share, aggregating $9.9 million
during 1999. On February 23, 2001, we paid a $0.09 per share quarterly cash
dividend, aggregating $2.5 million.
We may pay additional dividends out of funds legally available therefor at
such times as the Board of Directors determines that dividend payments are
appropriate. The Board of Directors' policy is to consider the declaration of
dividends on a quarterly basis.
The payment of dividends by the Bank to Downey is subject to OTS
regulations. For further information regarding these regulations see
Business--Regulation--Regulation of the Bank--Capital Distribution Limitations
on page 16.
23
ITEM 6. SELECTED FINANCIAL DATA
(Dollars in Thousands, Except Per Share Amounts) 2000 1999 1998 1997 1996
------------------------------------------------------------------------------------------------------------------------------------
INCOME STATEMENT DATA:
Total interest income .......................................... $ 784,360 $ 533,751 $ 440,404 $ 420,418 $ 346,360
Total interest expense ......................................... 521,885 326,273 266,057 266,260 211,765
------------------------------------------------------------------------------------------------------------------------------------
Net interest income ........................................ 262,475 207,478 174,347 154,158 134,595
Provision for loan losses ...................................... 3,251 11,270 3,899 8,640 9,137
------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses ........ 259,224 196,208 170,448 145,518 125,458
------------------------------------------------------------------------------------------------------------------------------------
Other income, net:
Loan and deposit related fees .............................. 30,089 20,097 15,645 10,921 7,435
Real estate and joint ventures held for investment, net .... 8,798 19,302 22,363 14,222 8,241
Secondary marketing activities:
Loan servicing fees ...................................... (3,628) 1,672 259 1,276 1,415
Net gains on sales of loans and mortgage-backed securities 3,297 14,806 6,462 2,675 1,543
Net gains (losses) on sales of investment securities ....... (106) 288 68 -- 4,473
Gain on sale of subsidiary (1) ............................. 9,762 -- -- -- --
Other ...................................................... 2,342 3,113 2,556 6,094 2,092
------------------------------------------------------------------------------------------------------------------------------------
Total other income, net .................................. 50,554 59,278 47,353 35,188 25,199
------------------------------------------------------------------------------------------------------------------------------------
Operating expense:
General and administrative expense ......................... 136,189 144,382 115,890 99,556 86,460
SAIF special assessment (2) ................................ -- -- -- -- 24,644
Net operation of real estate acquired in settlement of loans 818 19 260 1,184 2,567
Amortization of excess of cost over fair value of net assets
acquired.................................................. 462 474 510 532 532
------------------------------------------------------------------------------------------------------------------------------------
Total operating expense .................................. 137,469 144,875 116,660 101,272 114,203
------------------------------------------------------------------------------------------------------------------------------------
Net income (1) (2) ............................................. $ 99,251 $ 63,804 $ 57,973 $ 45,234 $ 20,704
PER SHARE DATA:
Earnings per share--Basic (1) (2) .............................. $ 3.52 $ 2.27 $ 2.06 $ 1.61 $ 0.74
Earnings per share--Diluted (1) (2) ............................ 3.51 2.26 2.05 1.61 0.74
Book value per share at end of period .......................... 22.15 18.91 17.08 15.32 13.95
Stock price at end of period ................................... 55.00 20.19 25.44 27.08 17.80
Cash dividends paid ............................................ 0.36 0.35 0.32 0.30 0.29
SELECTED FINANCIAL RATIOS:
Effective interest rate spread ................................. 2.66% 2.88% 3.08% 2.83% 2.96%
Return on average assets (1) (2) ............................... 0.97 0.85 0.98 0.79 0.43
Return on average equity (1) (2) ............................... 17.17 12.70 12.71 11.07 5.33
Dividend payout ratio .......................................... 10.22 15.44 15.33 18.69 39.35
LOAN ACTIVITY:
Loans originated ............................................... $ 5,218,368 $7,132,486 $4,071,262 $2,329,266 $1,583,784
Loans and mortgage-backed securities purchased ................. 18,828 49,669 7,463 35,828 30,296
Loans and mortgage-backed securities sold ...................... 1,662,600 2,386,958 1,740,416 557,511 166,503
BALANCE SHEET SUMMARY (END OF PERIOD):
Total assets ................................................... $10,893,863 $9,407,540 $6,270,419 $5,835,825 $5,198,157
Loans and mortgage-backed securities ........................... 10,084,353 8,746,063 5,788,365 5,366,396 4,729,846
Investments and cash equivalents ............................... 439,968 299,698 215,086 221,201 222,255
Deposits ....................................................... 8,082,689 6,562,761 5,039,733 4,869,978 4,173,102
Borrowings ..................................................... 1,978,572 2,122,780 703,720 483,735 595,345
Capital securities ............................................. 120,000 120,000 -- -- --
Stockholders' equity ........................................... 624,636 532,418 480,566 430,346 391,571
Loans serviced for others ...................................... 3,964,462 2,923,778 1,040,264 612,529 576,044
AVERAGE BALANCE SHEET DATA:
Assets ......................................................... $10,217,371 $7,501,228 $5,918,507 $5,693,869 $4,789,648
Loans .......................................................... 9,514,978 6,937,342 5,345,380 5,174,767 4,269,136
Deposits ....................................................... 7,290,850 5,697,292 5,102,045 4,588,320 3,892,981
Stockholders' equity ........................................... 577,979 502,412 456,237 408,473 388,187
24
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
(Dollars in Thousands, Except Per Share Amounts) 2000 1999 1998 1997 1996
------------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS:
Average stockholders' equity to average assets ................. 5.66% 6.70% 7.71% 7.17% 8.10%
Bank only--end of period (3):
Core and tangible capital .................................. 6.42 6.27 6.83 6.61 6.56
Risk-based capital ......................................... 12.94 12.14 12.88 12.64 12.66
SELECTED ASSET QUALITY DATA (END OF PERIOD):
Total non-performing assets .................................... $ 54,974 $ 39,194 $ 27,419 $ 52,120 $ 62,027
Non-performing assets as a percentage of total assets .......... 0.50% 0.42% 0.44% 0.89% 1.19%
Allowance for loan losses:
Amount ..................................................... $ 34,452 $ 38,342 $ 31,517 $ 32,092 $ 30,094
As a percentage of non-performing loans .................... 76.63% 116.25% 140.86% 76.96% 66.84%
====================================================================================================================================
(1) In 2000, a $5.6 million after-tax gain was recognized from the sale of
Downey Auto Finance Corp. Excluding the gain, 2000 net income would have
been $93.6 million or $3.33 per share on a basic basis and $3.32 per share
on a diluted basis, the return on average assets would have been 0.92% and
the return on average equity would have been 16.20%.
(2) In 1996, savings associations such as the Bank were assessed a one-time
charge for purposes of recapitalizing the SAIF. Excluding the SAIF special
assessment, 1996 net income would have been $34.7 million or $1.23 per
share on both a basic and diluted basis, the return on average assets would
have been 0.73% and the return on average equity would have been 8.95%.
(3) For more information regarding these ratios, see Management's Discussion
and Analysis of Financial Condition and Results of Operations--Financial
Condition--Regulatory Capital Compliance on page 58.
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements under this caption 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. For additional information concerning these factors, see
Business--Factors that May Affect Future Results on page 20.
OVERVIEW
Our net income for 2000 totaled a record $99.2 million or $3.51 per share
on a diluted basis. Included in the results was a $5.6 million after-tax gain
from the sale of our indirect automobile finance subsidiary in February 2000.
Excluding the gain, our net income for the year would have been $93.6 million or
$3.32 per share on a diluted basis, up 46.8% from $63.8 million or $2.26 per
share in 1999.
The increase in our adjusted net income between years was due to higher net
income from our banking operations, as net income from our real estate
investment activities declined $5.6 million to $4.4 million due primarily to
lower net gains from sales of properties. On an adjusted basis, net income from
our banking operations increased $35.4 million or 65.8% to $89.2 million due to
the following:
o net interest income increased $54.4 million or 26.2% due to an
increase in average interest-earning assets as our effective interest
rate spread declined;
o provision for loan losses declined by $8.0 million due primarily to
lower growth in our loan portfolio than a year ago and the sale of our
indirect automobile finance subsidiary; and
o operating expense declined by $7.1 million due to lower general and
administrative costs primarily associated with residential lending
activities and the sale of our indirect automobile finance subsidiary.
Our efficiency ratio (the percentage of our net interest income and
other income excluding income from real estate investment activities
and investment securities gains or losses used to cover our general
and administrative costs) improved from 58.4% in 1999 to 46.2% in
2000.
Those favorable items were partially offset by a $8.1 million decline in other
income, as an increase of $10.0 million in loan and deposit related fees were
unable to offset the following:
o a $11.5 million decline in net gains on sales of loans and
mortgage-backed securities due to a lower volume of loans being sold;
and
o a $3.6 million loss in loan servicing fees compared to income of $1.7
million in 1999. Our current year loss resulted from a $6.1 million
addition to the valuation allowance for mortgage servicing rights due
to an increase in expected prepayments from the drop in late 2000 in
mortgage interest rates.
For 2000, our return on average assets was 0.97% and our return on average
equity was 17.17%. Excluding the gain on sale of subsidiary, our adjusted
returns were 0.92% on average assets and 16.20% on average equity. Both these
performance ratios compare favorably to 1999 when our return on average assets
was 0.85% and our return on average equity was 12.70%.
Our assets increased $1.5 billion or 15.8% during 2000 to $10.9 billion at
year-end, following a record 50.0% increase during 1999. Assets expanded in 2000
primarily from loan growth. Our single family loan originations decreased from
$6.7 billion in 1999 to $5.0 billion in 2000, of which $1.7 billion were
originated for sale in the secondary market. Of the current year's total, $405
million represented originations for portfolio of subprime credits as part of
our continuing strategy to enhance the portfolio's net yield. In addition to
single family loans, we originated $254 million of other loans during the year,
including $115 million of construction and land loans and $57 million of
automobile loans.
We funded our asset growth with deposits that increased 23.2% to $8.1
billion at December 31, 2000.
Non-performing assets totaled $55 million at December 31, 2000, up from $39
million a year ago. This increase was due primarily to a rise in residential
non-performers, of which $11 million was in the subprime
26
category. When measured as a percentage of total assets, our non-performing
assets rose from 0.42% at year-end 1999 to 0.50% at year-end 2000.
At December 31, 2000, the Bank exceeded all three regulatory capital tests,
with capital-to-asset ratios of 6.42% in tangible and core capital and 12.94% in
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. For further information,
see Business--Regulation--Regulation of the Bank--Insurance of Deposit Accounts
on page 12, Financial Condition--Investments in Real Estate and Joint Ventures
on page 39 and Financial Condition--Regulatory Capital Compliance on page 58.
27
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 was $262.5 million in 2000, up $55.0 million or
26.5% from 1999 and $88.1 million or 50.5% greater than 1998. The 2000
improvement over 1999 primarily reflected an increase in average earning assets
as our effective interest rate spread declined. Our average earning assets
increased by $2.7 billion or 37.3% to $9.9 billion. Our effective interest rate
spread averaged 2.66% in 2000, down from 2.88% in 1999 and 3.08% in 1998. The
decline in the effective interest rate spread primarily reflected a higher
proportion of earning assets in the current year being funded with higher cost
certificates of deposit and borrowings thereby resulting in the cost of funds
increasing more rapidly than the yield on earning assets. To a lesser extent,
the sale of our indirect automobile lending subsidiary also contributed to the
decline in the effective interest rate spread, as the loan yield on that
portfolio was higher than the yield on our remaining loan portfolio.
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 year using
the average of each month's daily average balance during the periods indicated.
28
2000 1999 1998
--------------------------------------------------------------------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
(Dollars in Thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
------------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Loans ............................. $ 9,514,978 $760,538 7.99% $6,937,342 $519,006 7.48% $5,345,380 $421,942 7.89%
Mortgage-backed securities ........ 15,959 1,060 6.64 26,361 1,638 6.21 42,075 2,780 6.61
Investment securities ............. 346,192 22,762 6.57 232,746 13,107 5.63 276,139 15,682 5.68
------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets .... 9,877,129 784,360 7.94 7,196,449 533,751 7.42 5,663,594 440,404 7.78
Non-interest-earning assets .......... 340,242 304,779 254,913
------------------------------------------------------------------------------------------------------------------------------------
Total assets ...................... $10,217,371 $7,501,228 $5,918,507
====================================================================================================================================
Transaction accounts:
Non-interest-bearing checking ..... $ 209,221 $ -- -- % $ 165,271 $ -- -- % $ 129,469 $ -- -- %
Interest-bearing checking (1) ..... 381,269 3,520 0.92 336,604 3,517 1.04 292,279 3,142 1.08
Money market ...................... 89,495 2,544 2.84 95,282 2,641 2.77 94,792 2,626 2.77
Regular passbook .................. 796,212 27,841 3.50 767,238 26,224 3.42 531,492 17,102 3.22
------------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts ....... 1,476,197 33,905 2.30 1,364,395 32,382 2.37 1,048,032 22,870 2.18
Certificates of deposit .............. 5,814,653 345,398 5.94 4,332,897 224,382 5.18 4,054,013 225,467 5.56
------------------------------------------------------------------------------------------------------------------------------------
Total deposits .................... 7,290,850 379,303 5.20 5,697,292 256,764 4.51 5,102,045 248,337 4.87
Borrowings ........................... 2,118,497 130,419 6.16 1,175,704 64,161 5.46 292,044 17,720 6.07
Capital securities ................... 120,000 12,163 10.14 52,903 5,348 10.14 -- -- --
------------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and
capital securities ............... 9,529,347 521,885 5.48 6,925,899 326,273 4.71 5,394,089 266,057 4.93
Other liabilities .................... 110,045 72,917 68,181
Stockholders' equity ................. 577,979 502,412 456,237
------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity ............. $10,217,371 $7,501,228 $5,918,507
====================================================================================================================================
Net interest income/interest rate
spread ............................ $262,475 2.46% $207,478 2.71% $174,347 2.85%
Excess of interest-earning assets over
deposits, borrowings and capital
securities ........................ $ 347,782 $ 270,550 $ 269,505
Effective interest rate spread ....... 2.66 2.88 3.08
====================================================================================================================================
(1) Includes amounts swept into money market deposit accounts.
29
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 years 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 yearly average balances computed using the average of
each month's daily average balance during the periods indicated.
2000 Versus 1999 1999 Versus 1998
Changes Due To Changes Due To
-------------------------------------------------------------------------------------
Rate/ Rate/
(In Thousands) Volume Rate Volume Net Volume Rate Volume Net
--------------------------------------------------------------------------------------------------------------------------
Interest income:
Loans ........................... $192,842 $35,500 $13,190 $241,532 $125,663 $(22,036) $(6,563) $97,064
Mortgage-backed securities ...... (646) 113 (45) (578) (1,038) (166) 62 (1,142)
Investment securities ........... 6,389 2,196 1,070 9,655 (2,465) (131) 21 (2,575)
--------------------------------------------------------------------------------------------------------------------------
Change in interest income ..... 198,585 37,809 14,215 250,609 122,160 (22,333) (6,480) 93,347
--------------------------------------------------------------------------------------------------------------------------
Interest expense:
Transaction accounts:
Interest-bearing checking (1) . 466 (409) (54) 3 476 (88) (13) 375
Money market .................. (161) 68 (4) (97) 14 1 -- 15
Regular passbook .............. 990 604 23 1,617 7,586 1,064 472 9,122
--------------------------------------------------------------------------------------------------------------------------
Total transaction accounts .. 1,295 263 (35) 1,523 8,076 977 459 9,512
Certificates of deposit ......... 76,733 32,998 11,285 121,016 20,897 (19,376) (2,606) (1,085)
--------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 78,028 33,261 11,250 122,539 28,973 (18,399) (2,147) 8,427
Borrowings ...................... 51,433 8,927 5,898 66,258 53,612 (1,781) (5,390) 46,441
Capital securities .............. 6,815 -- -- 6,815 -- -- 5,348 5,348
--------------------------------------------------------------------------------------------------------------------------
Change in interest expense .... 136,276 42,188 17,148 195,612 82,585 (20,180) (2,189) 60,216
--------------------------------------------------------------------------------------------------------------------------
Change in net interest income ...... $ 62,309 $(4,379) $(2,933) $ 54,997 $ 39,575 $ (2,153) $(4,291) $33,131
==========================================================================================================================
(1) Includes amounts swept into money market deposit accounts.
PROVISION FOR LOAN LOSSES
Provision for loan losses was $3.3 million in 2000, down from $11.3 million
in 1999 and $3.9 million in 1998. The decrease in our provision for loan losses
in 2000 is due primarily to lower growth in our loan portfolio than a year ago
and the previously mentioned sale of the indirect automobile finance subsidiary.
For further information, see Financial Condition--Problem Loans and Real
Estate--Allowance for Losses on Loans and Real Estate on page 52.
30
OTHER INCOME
Our total other income was $50.6 million in 2000, down from $59.3 million
in 1999 but up from $47.4 million in 1998. Other income in 2000 included a $9.8
million pre-tax gain associated with our sale of the indirect automobile finance
subsidiary. Excluding that gain, our other income declined by $18.5 million in
2000 primarily due to:
o a $11.5 million decline in net gains on sales of loans and
mortgage-backed securities;
o a $10.5 million decline in income from real estate investment
activities; and
o a $3.6 million loss in loan servicing fees compared to income of $1.7
million in 1999.
Those declines were partially offset by a $10.0 million increase in our loan and
deposit related fees. Below is a further discussion of the major other income
categories.
LOAN AND DEPOSIT RELATED FEES
Loan and deposit related fees totaled $30.1 million in 2000, up from $20.1
million in 1999 and $15.6 million in 1998. Our loan related fees increased by
$6.1 million or 57.9% in 2000 due primarily to higher prepayment fees, while our
deposit related fees increased by $3.9 million or 40.6% due primarily to a $2.6
million increase in fees from automated teller machines.
The following table presents a breakdown of loan and deposit related fees
during the periods indicated.
(In Thousands) 2000 1999 1998
--------------------------------------------------------------------------------
Loan related fees ............................. $16,722 $10,589 $ 7,225
Deposit related fees .......................... 13,367 9,508 8,420
--------------------------------------------------------------------------------
Total loan and deposit related fees ....... $30,089 $20,097 $15,645
================================================================================
REAL ESTATE AND JOINT VENTURES HELD FOR INVESTMENT
Income from our real estate and joint ventures held for investment totaled
$8.8 million in 2000, down from $19.3 million in 1999 and $22.4 million in 1998.
The table below sets forth the key components comprising our income from
real estate and joint venture operations during the periods indicated.
(In Thousands) 2000 1999 1998
------------------------------------------------------------------------------------------------
Operations, net:
Rental operations, net of expenses ............................... $2,572 $ 3,822 $ 3,723
Equity in net income from joint ventures ......................... 3,224 5,352 9,203
Interest from joint venture advances ............................. 887 1,256 1,584
------------------------------------------------------------------------------------------------
Total operations, net ......................................... 6,683 10,430 14,510
Net gains on sales of wholly owned real estate ...................... 2,981 5,206 2,557
Reduction of (provision for) losses on real estate and joint ventures (866) 3,666 5,296
------------------------------------------------------------------------------------------------
Income from real estate and joint ventures held for investment .. $8,798 $19,302 $22,363
================================================================================================
Our income from real estate held for investment decreased by $10.5 million
due to several factors. First, our net gains from sales declined by $4.5 million
to $6.1 million. Of the decline, $2.3 million was related to joint venture
projects reported in the category equity in net income from joint ventures.
Second, we provided $0.9 million in 2000 to our allowance for losses on real
estate and joint ventures, while in 1999 our allowance was reduced by $3.7
million. Finally, net rental income declined by $1.3 million due to fewer
properties owned.
31
For additional information, see Financial Condition--Investments in Real
Estate and Joint Ventures on page 39, Financial Condition--Problem Loans and
Real Estate--Allowance for Losses on Loans and Real Estate on page 52 and Note 7
of Notes to Consolidated Financial Statements on page 80.
SECONDARY MARKETING ACTIVITIES
Sales of loans and mortgage-backed securities we originated decreased in
2000 to $1.7 billion from $2.4 billion in 1999 but were the same as in 1998. Net
gains associated with these sales totaled $3.3 million in 2000, down from $14.8
million in 1999 and $6.5 million in 1998. The net gains included $18.5 million
in 2000, $29.3 million in 1999 and $7.3 million in 1998 related to the
capitalization of mortgage servicing rights.
A loss of $3.6 million was recorded in loan servicing fees from our
portfolio of loans serviced for others during 2000, compared to income of $1.7
million in 1999 and $0.3 million in 1998. The loss in 2000 reflects an increase
of $6.1 million in the valuation allowance for mortgage servicing rights due to
an increase in expected prepayments from the drop in mortgage interest rates in
late 2000. At December 31, 2000, we serviced $4.0 billion of loans for others,
compared to $2.9 billion at December 31, 1999 and $1.0 billion at December 31,
1998.
For additional information concerning mortgage servicing rights, see Note
11 of Notes to Consolidated Financial Statements on page 86.
OTHER CATEGORY
The all other category of other income totaled $2.3 million in 2000, down
from $3.1 million in 1999 and $2.6 million in 1998.
OPERATING EXPENSES
Our operating expenses totaled $137.5 million in 2000, down from $144.9
million in 1999 and up from $116.7 million in 1998. The current year decrease
was due to lower general and administrative expense, which declined by $8.2
million or 5.7%. That decline was primarily due to lower costs associated with
our residential lending activities and the sale of our indirect automobile
finance subsidiary.
The following table presents a breakdown of key components comprising
operating expense during the periods indicated.
(In Thousands) 2000 1999 1998
---------------------------------------------------------------------------------------------------
Salaries and related costs .......................................... $ 82,522 $ 86,163 $ 66,152
Premises and equipment costs ........................................ 23,220 20,617 16,834
Advertising expense ................................................. 4,786 8,595 5,954
Professional fees ................................................... 3,319 2,502 2,867
SAIF insurance premiums and regulatory assessments .................. 2,626 3,937 3,832
Other general and administrative expense ............................ 19,716 22,568 20,251
---------------------------------------------------------------------------------------------------
Total general and administrative expense ........................ 136,189 144,382 115,890
Net operation of real estate acquired in settlement of loans ........ 818 19 260
Amortization of excess of cost over fair value of net assets acquired 462 474 510
---------------------------------------------------------------------------------------------------
Total operating expense ......................................... $137,469 $144,875 $116,660
===================================================================================================
PROVISION FOR INCOME TAXES
Our effective tax rate for 2000 was 42.4%, compared to 42.3% in 1999 and
42.7% in 1998. See Note 1 on page 69 and Note 18 on page 91 of Notes to
Consolidated Financial Statements for a further discussion of income taxes and
an explanation of the factors which impact Downey's effective tax rate.
32
BUSINESS SEGMENT REPORTING
The previous sections of the Results of Operations discussed our
consolidated results. The purpose of this section is to present data on the
results of operations of our two business segments--banking and real estate
investment. For a description of these business segments and the accounting
policies used, see Business on page 1 and Note 1 on page 69 and Note 26 on page
102 of Notes to Consolidated Financial Statements.
The following table presents by business segment our net income for 2000,
1999 and 1998, followed by a discussion of the results of operations of each
segment.
(In Thousands) 2000 (1) 1999 1998 (2)
-----------------------------------------------------------------------------------
Banking net income .................................. $94,822 $53,796 $46,736
Real estate investment net income ................... 4,429 10,008 11,237
-----------------------------------------------------------------------------------
Total net income ................................. $99,251 $63,804 $57,973
====================================================================================
(1) Banking includes a $5.6 million after-tax gain related to the sale of
subsidiary.
(2) The net income impact of a settlement with a former joint venture partner
totaled $4.8 million, of which $1.9 million was in banking and $2.9 million
was in real estate investment.
BANKING
Net income from our banking operations totaled $94.8 million in 2000, up
from $53.8 million in 1999 and $46.7 million in 1998. The previously mentioned
sale of our indirect automobile finance subsidiary benefited our net income from
banking operations by $5.6 million. Excluding the gain, our net income from
banking operations would have increased during 2000 by $35.4 million or 65.8%.
The increase in our adjusted 2000 net income reflected several factors. Net
interest income increased $54.4 million or 26.2% due to an increase in our
average earning assets as our effective interest rate spread declined. Also
contributing to the increase between years were decreases of $8.0 million in
provision for loan losses and $7.1 million in operating expense. These decreases
were primarily associated with the sale of our indirect automobile finance
subsidiary as well as lower loan origination volumes and costs associated with
residential lending activities. These favorable items were partially offset by a
decline of $8.1 million in adjusted other income. The decline in adjusted other
income was primarily due to lower net gains/losses on sales of loans and
mortgage-backed securities and loan servicing fees which more than offset higher
loan and deposit related fees.
The table below sets forth banking operational results and selected
financial data for the periods indicated.
(In Thousands) 2000 (1) 1999 1998
----------------------------------------------------------------------------------
Net interest income .................... $ 262,232 $ 207,784 $ 174,967
Provision for loan losses .............. 3,251 11,270 3,918
Other income:
Gain on sale of subsidiary ......... 9,762 -- --
All other .......................... 31,644 39,755 24,617
Operating expense ...................... 135,996 143,081 113,954
Net intercompany income (expense) ...... 397 393 (107)
----------------------------------------------------------------------------------
Income before income taxes ............. 164,788 93,581 81,605
Income taxes ........................... 69,966 39,785 34,869
----------------------------------------------------------------------------------
Net income .......................... $ 94,822 $ 53,796 $ 46,736
==================================================================================
AT DECEMBER 31:
Assets:
Loans and mortgage-backed securities $10,084,353 $8,746,063 $5,788,365
Other ............................... 806,201 654,745 464,097
----------------------------------------------------------------------------------
Total assets ...................... 10,890,554 9,400,808 6,252,462
----------------------------------------------------------------------------------
Equity ................................. $ 624,636 $ 532,418 $ 480,566
==================================================================================
(1) Includes a $5.6 million after-tax gain related to the sale of subsidiary.
33
REAL ESTATE INVESTMENT
Net income from our real estate investment operations totaled $4.4 million
in 2000, down from $10.0 million in 1999 and $11.2 million in 1998. The decline
was primarily attributed to lower net gains on sales and to an increase to
valuation allowances in the current year compared to a reduction in valuation
allowances in 1999. Also contributing to the decline was a lower level of net
rental income due to fewer properties being owned.
The table below sets forth real estate investment operational results and
selected financial data for the periods indicated.
(In Thousands) 2000 1999 1998
--------------------------------------------------------------------------------
Net interest income (expense) .................. $ 243 $ (306) $ (620)
Reduction of loan losses ....................... -- -- (19)
Other income ................................... 9,148 19,523 22,736
Operating expense .............................. 1,473 1,794 2,706
Net intercompany income (expense) .............. (397) (393) 107
--------------------------------------------------------------------------------
Income before income taxes ..................... 7,521 17,030 19,536
Income taxes ................................... 3,092 7,022 8,299
--------------------------------------------------------------------------------
Net income .................................. $ 4,429 $10,008 $11,237
--------------------------------------------------------------------------------
AT DECEMBER 31:
Assets:
Investments in real estate and joint ventures $17,641 $42,172 $49,447
Other ....................................... 3,584 7,399 9,841
--------------------------------------------------------------------------------
Total assets .............................. 21,225 49,571 59,288
--------------------------------------------------------------------------------
Equity ......................................... $17,916 $42,839 $41,331
================================================================================
For a further discussion regarding income from real estate investment, see
Other Income--Real Estate and Joint Ventures Held For Investment on page 31, and
for information regarding related assets, see Financial Condition--Investments
in Real Estate and Joint Ventures on page 39.
34
FINANCIAL CONDITION
LOANS AND MORTGAGE-BACKED SECURITIES
Loans and mortgage-backed securities, including those we hold for sale,
totaled $10.1 billion or 92.6% of assets at December 31, 2000. This represents
an increase of $1.3 billion or 15.3% from year-end 1999. The increase represents
a higher level of loans held for investment, primarily one-to-four unit
residential loans.
Our loan originations, including loans purchased, totaled $5.2 billion in
2000, down from $7.2 billion in 1999 but up from $4.1 billion in 1998. This
current year decrease primarily reflects a decline in originations of
one-to-four unit residential loans. Of the $5.0 billion of one-to-four unit
residential loans we originated, approximately 65% or $3.3 billion were for
portfolio, while the balance was originated for sale in the secondary market.
Our origination of subprime loans totaled $492 million in 2000, down from $1.2
billion in 1999.
The table below presents information regarding interest rates and fees
collected on loans originated during the periods indicated.
(Dollars in Thousands) 2000 1999 1998 1997 1996
----------------------------------------------------------------------------------------------------------------
Average interest rate on new loans .................... 6.10% 5.92% 6.45% 6.04% 6.06%
Total loan origination costs (net of fees) and premiums
(net of discounts) deferred during the year ....... $34,797 $53,181 $30,621 $11,505 $4,525
================================================================================================================
We originate one-to-four unit residential adjustable rate mortgages both
with and without loan origination fees. In adjustable rate mortgage transactions
for which we charge no origination fees, we receive a larger margin over the
index to which the loan pricing is tied than in those in which we charge fees.
In addition, a prepayment fee on these loans is generally required if prepaid
within the first three years. This trend towards loans with no origination fees
has generally resulted in deferrable loan origination costs exceeding loan
origination fees.
Residential one-to-four unit adjustable rate mortgage originations,
including loans purchased, were $3.5 billion during 2000, down from $4.4 billion
in 1999 but up from $1.4 billion in 1998. Refinancing activities related to
residential one-to-four unit loans, including new loans to refinance existing
loans which we or other lenders originated, constituted 42% of originations
during the year compared to 63% during 1999 and 71% during 1998. Refinancing
activities decreased from $4.2 billion in 1999 to $2.1 billion in 2000 as a
higher interest rate environment existed throughout most of the year. In
addition, the majority of residential originations were adjustable rate
mortgages tied to the FHLB Eleventh District Cost of Funds Index ("COFI"), an
index which lags the movement in market interest rates. For the year, 86% of
one-to-four unit originations for investment represented monthly adjusting COFI
rate mortgages which provide for negative amortization, 11% represented COFI
rate mortgages which reprice every six months but do not provide for negative
amortization, with the balance represented by a variety of other pricing terms.
At December 31, 2000, $6.9 billion of our one-to-four unit adjustable rate
mortgages were subject to negative amortization of which $148 million
represented the amount of negative amortization added to the unpaid loan
balance. For further information, see Business--Banking Activities--Lending
Activities--Residential Real Estate Lending on page 3.
Our origination of commercial real estate loans, including loans purchased,
totaled $24 million in 2000, compared to $10 million in 1999 and $11 million in
1998. Originations of loans secured by multi-family properties, including loans
purchased, totaled $1 million in both 2000 and 1999, compared to $15 million in
1998.
During 2000, we originated $99 million of construction loans, principally
for entry level and first time move-up residential tracts. This compares to $149
million in 1999 and $112 million in 1998. Our origination of land development
loans totaled $17 million in 2000, compared to $57 million in 1999 and $48
million in 1998.
Origination of non-mortgage commercial loans decreased to $19 million in
2000 from $25 million in 1999 but were up from $6 million in 1998. A substantial
majority of these originations represented secured loans.
Origination of automobile loans totaled $57 million in 2000, compared to
$234 million in 1999 and $175 million in 1998. Prior to 2000, the majority of
these originations represented our indirect lending program that was conducted
by Downey Auto Finance Corp., a former subsidiary, whereby loans to finance the
purchase of new or used automobiles were obtained through preapproved automobile
dealers. For further information regarding Downey Auto Finance Corp., see Sale
of Subsidiary on page 61.
35
At December 31, 2000, we had commitments to fund loans amounting to $694
million, of which $239 million were one-to-four unit residential loans being
originated for sale in the secondary market, as well as undrawn lines of credit
of $81 million and loans in process of $67 million. We believe our current
sources of funds will enable us to meet these obligations while exceeding all
regulatory liquidity requirements.
The following table sets forth the origination, purchase and sale activity
relating to our loans and mortgage-backed securities during the periods
indicated.
(In Thousands) 2000 1999 1998 1997 1996
---------------------------------------------------------------------------------------------------------------------------
INVESTMENT PORTFOLIO:
Loans originated:
Loans secured by real estate:
Residential one-to-four units:
Adjustable ......................................... $ 2,831,596 $ 3,102,810 $ 943,736 $ 1,384,442 $1,026,812
Adjustable - subprime .............................. 395,911 1,182,552 372,286 218,399 33,030
---------------------------------------------------------------------------------------------------------------------------
Total adjustable ................................. 3,227,507 4,285,362 1,316,022 1,602,841 1,059,842
Fixed .............................................. 9,167 262,923 192,436 22,265 33,073
Fixed - subprime ................................... -- 12,238 6,020 2,786 545
Residential five or more units:
Adjustable ......................................... -- 247 875 4,600 17,409
Fixed .............................................. 678 -- 13,229 -- 2,253
---------------------------------------------------------------------------------------------------------------------------
Total residential ................................ 3,237,352 4,560,770 1,528,582 1,632,492 1,113,122
Commercial real estate .............................. 23,720 10,063 10,363 7,830 1,548
Construction ........................................ 98,330 149,143 111,534 80,014 71,678
Land ................................................ 16,530 56,851 48,357 20,295 10,468
Non-mortgage:
Commercial .......................................... 18,504 24,948 6,376 14,336 11,835
Automobile .......................................... 56,576 233,948 175,193 259,040 200,966
Other consumer ...................................... 38,136 54,489 28,274 25,988 14,226
---------------------------------------------------------------------------------------------------------------------------
Total loans originated ............................. 3,489,148 5,090,212 1,908,679 2,039,995 1,423,843
Real estate loans purchased:
One-to-four units ..................................... 9,178 36,317 4,343 32,241 223
One-to-four units - subprime .......................... 8,595 12,912 1,833 2,243 --
Other (1) ............................................. 1,055 440 1,287 1,344 --
---------------------------------------------------------------------------------------------------------------------------
Total real estate loans purchased ................... 18,828 49,669 7,463 35,828 223
---------------------------------------------------------------------------------------------------------------------------
Total loans originated and purchased .............. 3,507,976 5,139,881 1,916,142 2,075,823 1,424,066
Loan repayments .......................................... (1,981,802) (1,823,585) (1,855,157) (1,130,357) (832,713)
Other net changes (2) .................................... (291,935) (36,794) (34,145) (319,183) (39,978)
---------------------------------------------------------------------------------------------------------------------------
Net increase in loans held for investment ............. 1,234,239 3,279,502 26,840 626,283 551,375
---------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO:
Residential, one-to-four units:
Originated whole loans ................................ 1,642,046 2,028,402 2,162,583 289,271 159,941
Originated whole loans - subprime ..................... 87,174 13,872 -- -- --
Loans transferred from (to) the investment portfolio .. 54,993 42,570 (3,056) 290,558 1,791
Originated whole loans sold ........................... (687,512) (999,594) (1,130,303) (467,989) (135,426)
Loans exchanged for mortgage-backed securities ........ (970,319) (1,387,364) (608,831) (89,522) (26,452)
Other net changes ..................................... (10,815) (9,263) (8,111) (83) (48)
---------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for sale ...... 115,567 (311,377) 412,282 22,235 (194)
---------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities, net:
Received in exchange for loans ........................ 970,319 1,387,364 608,831 89,522 26,452
Purchased ............................................. -- -- -- -- 30,073
Sold .................................................. (975,088) (1,387,364) (610,113) (89,522) (31,077)
Repayments ............................................ (7,031) (9,936) (15,129) (12,560) (15,661)
Other net changes ..................................... 284 (491) (742) 592 (596)
---------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in mortgage-backed securities
available for sale ............................... (11,516) (10,427) (17,153) (11,968) 9,191
---------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for sale and
mortgage-backed securities available for sale .... 104,051 (321,804) 395,129 10,267 8,997
---------------------------------------------------------------------------------------------------------------------------
Total net increase in loans and
mortgage-backed securities ....................... $ 1,338,290 $ 2,957,698 $ 421,969 $ 636,550 $ 560,372
===========================================================================================================================
(1) Primarily five or more unit residential loans except for $1.1 million of
construction loans in 2000 and $0.6 million of commercial real estate loans
in 1998.
(2) Primarily includes borrowings against and repayments of lines of credit and
construction loans, changes in loss allowances, loans transferred to or
from real estate acquired in settlement of loans or from (to) the held for
sale portfolio, and interest capitalized on loans (negative amortization).
Also included in 2000 was $367 million of net automobile loans sold as part
of the sale of subsidiary.
36
The following table sets forth the composition of our loan and
mortgage-backed securities portfolio at the dates indicated. At December 31,
2000, approximately 93% of our real estate loans were secured by real estate
located in California, principally in Los Angeles, Orange, Santa Clara, San
Diego and San Mateo counties.
December 31,
----------------------------------------------------------------
(In Thousands) 2000 1999 1998 1997 1996
------------------------------------------------------------------------------------------------------------------------
INVESTMENT PORTFOLIO:
Loans secured by real estate:
Residential one-to-four units:
Adjustable .................................. $ 7,200,400 $5,644,883 $3,721,728 $4,190,160 $3,840,862
Adjustable - subprime ....................... 1,726,526 1,620,624 580,232 245,749 32,715
Fixed ....................................... 454,838 510,516 325,454 168,315 172,328
Fixed - subprime ............................ 17,388 18,777 8,719 3,321 543
------------------------------------------------------------------------------------------------------------------------
Total one-to-four units .................. 9,399,152 7,794,800 4,636,133 4,607,545 4,046,448
Residential five or more units:
Adjustable .................................. 14,203 15,889 18,617 29,246 43,050
Fixed ....................................... 5,257 5,166 21,412 9,032 13,857
Commercial real estate:
Adjustable .................................. 37,374 37,419 39,360 87,604 158,656
Fixed ....................................... 127,230 110,908 101,430 114,821 101,953
Construction .................................. 118,165 176,487 127,761 70,865 66,651
Land .......................................... 26,880 67,631 44,859 25,687 21,177
Non-mortgage:
Commercial .................................... 21,721 26,667 28,293 26,024 22,136
Automobile (1) ................................ 39,614 399,789 357,988 342,326 202,186
Other consumer ................................ 60,653 49,344 41,894 47,735 47,281
------------------------------------------------------------------------------------------------------------------------
Total loans held for investment ............. 9,850,249 8,684,100 5,417,747 5,360,885 4,723,395
Increase (decrease) for:
Undisbursed loan funds ........................ (72,328) (125,159) (108,414) (64,884) (49,250)
Net deferred costs and premiums ............... 79,109 67,740 31,021 18,088 11,663
Allowance for losses .......................... (34,452) (38,342) (31,517) (32,092) (30,094)
------------------------------------------------------------------------------------------------------------------------
Total loans held for investment, net ........ 9,822,578 8,588,339 5,308,837 5,281,997 4,655,714
------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO, NET:
Loans held for sale:
One-to-four units ............................. 251,014 122,133 447,382 35,100 12,865
One-to-four units - subprime .................. 558 13,872 -- -- --
------------------------------------------------------------------------------------------------------------------------
Total loans held for sale ................... 251,572 136,005 447,382 35,100 12,865
Mortgage-backed securities available for sale:
Adjustable .................................... 6,050 7,700 10,996 17,751 23,620
Fixed ......................................... 4,153 14,019 21,150 31,548 37,647
------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed securities available
for sale ................................. 10,203 21,719 32,146 49,299 61,267
------------------------------------------------------------------------------------------------------------------------
Total loans held for sale and mortgage-backed
securities available for sale ............ 261,775 157,724 479,528 84,399 74,132
------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities .. $10,084,353 $8,746,063 $5,788,365 $5,366,396 $4,729,846
========================================================================================================================
(1) The decline during 2000 primarily reflected the sale of subsidiary.
At December 31, 2000, our residential one-to-four units subprime portfolio
consisted of approximately 71% A-, 23% B and 6% C loans. At year end, 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 December 31, 2000, reflected an unrealized loss of $65,000, or $37,000 net of
income taxes. The current year-end unrealized loss, less the associated tax
effect, is reflected within a separate component of other comprehensive income
(loss) until realized.
37
The table below sets forth the scheduled contractual maturities of our loan
and mortgage-backed securities portfolio at December 31, 2000.
Within 1-2 2-3 3-5 5-10 10-15 Beyond
(In Thousands) 1 Year Years Years Years Years Years 15 Years Total
---------------------------------------------------------------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units:
Adjustable (1) ........ $ 61,539 $ 66,956 $ 72,850 $165,506 $559,374 $852,933 $7,148,326 $ 8,927,484
Fixed (1) ............. 7,751 8,399 9,103 20,548 68,432 102,251 506,756 723,240
Five or more units:
Adjustable ............ 279 304 330 746 2,502 3,771 6,271 14,203
Fixed ................. 206 221 237 525 1,672 2,350 46 5,257
Commercial real estate:
Adjustable ............ 2,185 2,402 2,639 6,086 21,324 2,738 -- 37,374
Fixed ................. 13,044 14,203 15,464 35,167 49,352 -- -- 127,230
Construction - adjustable 118,165 -- -- -- -- -- -- 118,165
Land:
Adjustable ............ 20,520 5,474 -- -- -- -- -- 25,994
Fixed ................. 70 77 84 193 462 -- -- 886
Non-mortgage:
Commercial ................ 20,188 892 641 -- -- -- -- 21,721
Automobile ................ 9,264 10,158 11,138 9,054 -- -- -- 39,614
Other consumer (2) ........ 4,148 4,587 5,074 4,156 42,688 -- -- 60,653
---------------------------------------------------------------------------------------------------------------------
Total loans ............. 257,359 113,673 117,560 241,981 745,806 964,043 7,661,399 10,101,821
Mortgage-backed securities, net 4,262 118 127 286 939 1,379 3,092 10,203
---------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-
backed securities ....... $261,621 $113,791 $117,687 $242,267 $746,745 $965,422 $7,664,491 $10,112,024
=====================================================================================================================
(1) Includes loans held for sale.
(2) Includes home equity line of credit loans which are interest only, with
balances due at the end of the term. All or part of the outstanding
balances may be paid off at any time during the term without penalty.
At December 31, 2000, the maximum amount the Bank could have loaned to any
one borrower, and related entities, under regulatory limits was $112 million, or
$187 million for loans secured by readily marketable collateral, compared to
$100 million or $167 million for loans secured by readily marketable collateral
at year-end 1999. We do not expect that these regulatory limitations will
adversely impact our proposed lending activities during 2001.
INVESTMENT SECURITIES
The following table sets forth the composition of our investment securities
portfolio at the dates indicated.
December 31,
------------------------------------------------
(In Thousands) 2000 1999 1998 1997 1996
--------------------------------------------------------------------------------------------------------
Federal funds ........................................ $ 19,601 $ 1 $ 33,751 $ 6,095 $ 6,038
U.S. Treasury and agency securities available for sale 284,102 171,823 116,061 159,398 141,999
Corporate bonds available for sale ................... 21,513 -- -- -- --
Municipal bonds held to maturity ..................... 6,550 6,728 6,764 6,885 6,997
--------------------------------------------------------------------------------------------------------
Total investment securities ...................... $331,766 $178,552 $156,576 $172,378 $155,034
========================================================================================================
38
At December 31, 2000, the maturities of our investment securities and the
weighted average yield of those securities were as follows.
After 1 Year
1 Year or Less Through 5 Years After 5 Years Total
--------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
(Dollars in Thousands) Amount Yield Amount Yield Amount Yield Amount Yield
---------------------------------------------------------------------------------------------------------------------
Federal funds ..................... $19,601 3.36% $ -- -- % $ -- -- % $ 19,601 3.36%
U.S. Treasury and agency securities 5,008 6.51 279,094 6.60 -- -- 284,102 6.60
Corporate bonds available for sale -- -- 21,513 7.41 -- -- 21,513 7.41
Municipal bonds (1) ............... -- -- -- -- 6,550 5.90 6,550 5.90
---------------------------------------------------------------------------------------------------------------------
Total ........................ $24,609 4.00% $300,607 6.66% $6,550 5.90% $331,766 6.45%
=====================================================================================================================
(1) Yield on a fully tax-equivalent basis is 10.35%.
INVESTMENTS IN REAL ESTATE AND JOINT VENTURES
DSL Service Company participates as an owner of, or a partner in, a variety
of real estate development projects, principally retail neighborhood shopping
center developments, most of which are located in California. For additional
information regarding the location of these real estate investments see Note 7
of Notes to the Consolidated Financial Statements on page 80. We have completed
and substantially leased most of the real estate development projects--with a
weighted average occupancy of 82% for retail neighborhood shopping centers at
December 31, 2000. At December 31, 2000, the Bank had outstanding loans of $23
million to these joint ventures.
In its joint ventures, DSL Service Company is entitled to interest on its
equity invested in the project on a priority basis after third-party debt and
shares profits and losses with the developer partner, generally on an equal
basis. DSL Service Company has obtained personal guarantees from the principals
of the developer partners in a number of the joint ventures and generally
requires the developer partner to secure any outstanding obligations to the
joint venture, like its portion of operating losses, when the partner is unable
to satisfy such obligations on a current basis. Partnership equity or deficit
accounts are affected by current period results of operations, additional
partner advances, partnership distributions and partnership liquidations.
As of December 31, 2000, DSL Service Company was involved with three joint
venture partners. These partners were operators of three retail neighborhood
shopping centers, a commercial building, three residential housing development
projects, of which two are substantially completed, and vacant land held for
sale. DSL Service Company has seven wholly owned retail neighborhood shopping
centers located in California and Arizona.
39
The following table sets forth the condensed balance sheets of DSL Service
Company's joint ventures by property type at December 31, 2000, on a historical
cost basis. For one of the joint venture investments, DSL Service Company
established a valuation allowance totaling $2 million as the carrying value of
the associated property exceeded its fair market value. For further information
regarding the establishment of loss allowances, see Problem Loans and Real
Estate--Allowance for Losses on Loans and Real Estate on page 52.
Retail
Neighborhood
Shopping
(Dollars in Thousands) Centers Commercial Residential Total
--------------------------------------------------------------------------------------------------------------
ASSETS
Cash ....................................................... $ 190 $ 825 $1,167 $ 2,182
Projects under development ................................. -- -- 6,879 6,879
Completed projects ......................................... 15,317 5,151 -- 20,468
Other assets ............................................... 874 568 32 1,474
--------------------------------------------------------------------------------------------------------------
$16,381 $6,544 $8,078 $31,003
==============================================================================================================
LIABILITIES AND EQUITY
Liabilities:
Notes payable to the Bank .............................. $19,245 $ -- $4,153 $23,398
Notes payable to others ................................ -- 4,282 -- 4,282
Other .................................................. 3,131 324 1,300 4,755
Equity (deficit):
DSL Service Company (1) ................................ (606) 930 2,174 2,498
Allowance for losses recorded by DSL Service Company (2) 1,505 -- -- 1,505
Other partners' (2) .................................... (6,894) 1,008 451 (5,435)
--------------------------------------------------------------------------------------------------------------
Net equity (deficit) ................................ (5,995) 1,938 2,625 (1,432)
--------------------------------------------------------------------------------------------------------------
$16,381 $6,544 $8,078 $31,003
==============================================================================================================
Number of joint venture projects ........................... 3 2 3 8
==============================================================================================================
(1) We included in these amounts interest-bearing joint venture advances with
priority interest payments from joint ventures to DSL Service Company.
(2) The aggregate other partners' deficit of $5 million represents their equity
interest in the accumulated retained earnings (deficit) of the respective
joint ventures. Those results include not only the net profit on sales and
the operating results of the real estate assets, but depreciation expense
and funding costs as well. Except for any secured financing which has been
obtained, DSL Service Company has provided all other financing. As part of
our internal asset review process, we compare the fair value of the joint
venture real estate assets to the secured notes payable to the Bank and
others and DSL Service Company's equity investment. To the extent the fair
value of the real estate assets is less than the aggregate of those
amounts, we make a provision to create a valuation allowance. The allowance
at December 31, 2000 totaled $2 million.
40
The following table sets forth by property type our investments in real
estate and related allowances for losses at December 31, 2000.
Retail
Neighborhood
(Dollars in Thousands) Residential Shopping Centers Land Total
------------------------------------------------------------------------------------------------
Investment in wholly owned projects ..... $ -- $8,874 (1) $ 6,872 (2) $15,746
Investment in California Affordable
Housing Fund ......................... 889 -- -- 889
Allowance for losses .................... -- (430) (1,062) (1,492)
------------------------------------------------------------------------------------------------
Net investment in real estate projects $ 889 $8,444 $ 5,810 $15,143
================================================================================================
Number of projects ...................... 1 7 8 16
================================================================================================
(1) Includes seven free-standing stores that are part of neighborhood shopping
centers totaling $1 million and which we counted as one project.
(2) Includes three properties totaling $6 million.
Real estate investments entail risks similar to those our construction and
commercial lending activities present. In addition, California courts have
imposed warranty-like responsibility upon developers of new housing for defects
in structure and the housing site, including soil conditions. This
responsibility is not necessarily dependent upon a finding that the developer
was negligent. Owners of real property also may incur liabilities with respect
to environmental matters, including financial responsibility for clean-up of
hazardous waste or other conditions, under various federal and state laws.
DEPOSITS
Our deposits increased $1.5 billion or 23.2% in 2000 and totaled $8.1
billion at December 31, 2000. Our certificates of deposit increased $1.5 billion
or 30.1%, while our lower-rate transaction accounts--i.e., checking, regular
passbook and money market--were virtually unchanged. Within transaction
accounts, our total checking accounts (non-interest and interest bearing)
increased $74 million or 13.0%. That increase, however, was essentially offset
by declines in regular passbook and money market accounts, as depositors
transferred funds into higher-yielding certificates of deposit. Of the total
increase in our deposits, $12 million was associated with 10 new branches we
opened during 2000.
41
The following table sets forth the amount of deposits by classification at
the dates indicated.
December 31,
-----------------------------------------------------------------
2000 1999 1998
-----------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
(Dollars in Thousands) Rate Amount Rate Amount Rate Amount
------------------------------------------------------------------------------------------------------
Transaction accounts:
Non-interest-bearing checking . -- % $ 244,311 -- % $ 182,165 -- % $ 155,267
Interest-bearing checking (1) . 0.78 395,640 1.00 383,973 1.00 317,452
Money market .................. 2.88 89,408 2.91 95,947 2.92 98,389
Regular passbook .............. 3.41 754,127 3.62 827,854 3.36 666,954
------------------------------------------------------------------------------------------------------
Total transaction accounts .. 2.12 1,483,486 2.46 1,489,939 2.30 1,238,062
Certificates of deposit:
Less than 3.00% ............... 2.41 6,357 2.47 8,717 2.62 25,126
3.00-3.49 ..................... 3.45 25 3.02 16 3.01 593
3.50-3.99 ..................... 3.97 384 3.92 3,786 3.88 51,474
4.00-4.49 ..................... 4.19 26,916 4.32 210,127 4.39 428,316
4.50-4.99 ..................... 4.82 80,844 4.78 939,858 4.80 668,204
5.00-5.99 ..................... 5.71 1,901,166 5.56 3,623,632 5.53 2,421,333
6.00-6.99 ..................... 6.63 4,558,730 6.07 284,984 6.06 204,065
7.00 and greater .............. 7.02 24,781 7.32 1,702 7.24 2,560
------------------------------------------------------------------------------------------------------
Total certificates of deposit 6.33 6,599,203 5.39 5,072,822 5.26 3,801,671
------------------------------------------------------------------------------------------------------
Total deposits ............ 5.56% $8,082,689 4.72% $6,562,761 4.53% $5,039,733
======================================================================================================
(1) Includes amounts swept into money market deposit accounts.
The following table shows at December 31, 2000 our certificates of deposit
maturities by interest rate category.
Less
Than 4.00% - 4.50% - 5.00% - 6.00% - 7.00% Percent
(Dollars in Thousands) 4.00% 4.49% 4.99% 5.99% 6.99% and Greater Total (1) of Total
-------------------------------------------------------------------------------------------------------------
Within 3 months ....... $6,216 $25,706 $61,804 $ 488,051 $ 863,100 $13,602 $1,458,479 22.10%
3 to 6 months ......... 72 1,018 12,818 291,800 1,529,257 2,444 1,837,409 27.84
6 to 12 months ........ 249 155 1,784 1,059,402 1,589,153 8,505 2,659,248 40.30
12 to 24 months ....... 213 23 1,043 46,130 567,193 230 614,832 9.32
24 to 36 months ....... -- 14 1,661 12,734 5,280 -- 19,689 0.30
36 to 60 months ....... 18 -- 1,734 3,047 4,747 -- 9,546 0.14
Over 60 months ........ -- -- -- -- -- -- -- --
-------------------------------------------------------------------------------------------------------------
Total ............. $6,768 $26,916 $80,844 $1,901,164 $4,558,730 $24,781 $6,599,203 100.00%
=============================================================================================================
(1) Includes jumbo ($100,000 and over) certificates of deposit of $496 million
with maturities of 3 months or less, $653 million with maturities of 3 to 6
months, $981 million with maturities of 6 to 12 months and $196 million
with a remaining term of over 12 months.
42
BORROWINGS
At December 31, 2000, borrowings totaled $2.0 billion, down from $2.1
billion at year-end 1999 but up from $704 million at year-end 1998. The decrease
in 2000 primarily occurred in advances from the FHLB.
The following table sets forth information concerning our FHLB advances and
other borrowings at the dates indicated.
December 31,
----------------------------------------------------------
(Dollars in Thousands) 2000 1999 1998 1997 1996
-----------------------------------------------------------------------------------------------------------------
Federal Home Loan Bank advances ..................... $1,978,348 $2,122,407 $695,012 $352,458 $386,883
Other borrowings:
Reverse repurchase agreements ................... -- -- -- 34,803 --
Commercial paper ................................ -- -- -- 83,811 198,113
Real estate notes ............................... 224 373 8,708 12,663 10,349
-----------------------------------------------------------------------------------------------------------------
Total borrowings .............................. $1,978,572 $2,122,780 $703,720 $483,735 $595,345
=================================================================================================================
Weighted average rate on borrowings during the period 6.16% 5.46% 6.07% 6.07% 5.98%
Total borrowings as a percentage of total assets .... 18.16 22.56 11.22 8.29 11.45
=================================================================================================================
The following table sets forth certain information with respect to our
short-term borrowings.
(Dollars in Thousands) 2000 1999 1998
--------------------------------------------------------------------------------------------------------------
FHLB advances with original maturities less than one year:
Balance at end of year ............................................. $1,475,000 $1,590,500 $120,000
Average balance outstanding during the year ........................ 1,601,732 616,199 38,393
Maximum amount outstanding at any month-end during the year ........ 1,942,000 1,590,500 120,000
Weighted average interest rate during the year ..................... 6.38% 5.42% 5.96%
Weighted average interest rate at the end of year .................. 6.55 5.88 5.36
Securities sold under agreement to repurchase:
Balance at end of year ............................................. $ -- $ -- $ --
Average balance outstanding during the year ........................ 753 1,987 1,877
Maximum amount outstanding at any month-end during the year ........ 39,250 24,875 50,088
Weighted average interest rate during the year ..................... 6.10% 5.42% 5.90%
Weighted average interest rate at the end of year .................. -- -- --
Commercial paper sold:
Balance at end of year ............................................. $ -- $ -- $ --
Average balance outstanding during the year ........................ -- -- 30,589
Maximum amount outstanding at any month-end during the year ........ -- -- 103,749
Weighted average interest rate during the year ..................... -- % -- % 6.32%
Weighted average interest rate at the end of year .................. -- -- --
Total short-term borrowings:
Total average short-term borrowings outstanding during the year .... $1,602,485 $ 618,186 $ 70,859
Total weighted average rate on short-term borrowings during the year 6.38% 5.42% 6.11%
==============================================================================================================
43
At year-end 2000, total intermediate and long-term advances were $503
million, down from $532 million at December 31, 1999. The weighted average rate
on our intermediate and long-term FHLB advances at year-end 2000 was 5.39%.
The following table sets forth the associated maturities at December 31,
2000.
(In Thousands)
--------------------------------------------------------------
2001 .............................................. $ 16,293
2002 .............................................. 55,921
2003 .............................................. 134
2004 .............................................. --
2005 .............................................. 1,000
Thereafter ........................................ 430,000
--------------------------------------------------------------
Total intermediate and long-term FHLB advances $503,348
===============================================================
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, including the amortization of deferred
issuance costs, on our capital securities was $12.2 million for 2000. For
further information regarding our capital securities, see Note 19 on page 93 of
Notes to Consolidated Financial Statements.
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 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 Asset/Liability Management Committee is responsible for implementing
the interest rate risk management policy which sets forth limits established by
the Board of Directors of acceptable changes in net interest income and net
portfolio value from specified changes in interest rates. The OTS defines net
portfolio value as the present value of expected net cash flows from existing
assets minus the present value of expected net cash flows from existing
liabilities plus the present value of expected cash flows from existing
off-balance sheet contracts. Our Asset/Liability Management Committee reviews,
among other items, economic conditions, the interest rate outlook, the demand
for loans, the availability of deposits and borrowings, and our current
operating results, liquidity, capital and interest rate exposure. In addition,
our Asset/Liability Management Committee monitors asset and liability maturities
and repricing characteristics on a regular basis and performs various
simulations and other analyses to determine the potential impact of various
business strategies in controlling interest rate risk and the potential impact
of those strategies upon future earnings under various interest rate scenarios.
Based on these reviews, our Asset/Liability Management Committee formulates a
strategy that is intended to implement the objectives set forth in our business
plan without exceeding the net interest income and net portfolio value limits
set forth in our interest rate risk policy.
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
December 31, 2000, as well as other information regarding the repricing and
maturity difference 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
44
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.
December 31, 2000
-------------------------------------------------------------------------
Within 7 - 12 2 - 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) $ 229,409 $ 55,169 $ 153,475 $ 69 $ -- $ 438,122
Loans and mortgage-backed securities:
Loans secured by real estate:
Residential:
Adjustable ..............................(2) 8,653,459 216,643 120,994 -- -- 8,991,096
Fixed ...................................(2) 287,289 29,294 173,780 121,947 118,581 730,891
Commercial real estate ....................(2) 47,024 12,053 99,919 886 1,721 161,603
Construction ..............................(2) 54,527 -- -- -- -- 54,527
Land ......................................(2) 19,652 9 67 801 -- 20,529
Non-mortgage loans:
Commercial ................................(2) 16,275 -- -- -- -- 16,275
Consumer ..................................(2) 68,539 7,472 23,218 -- -- 99,229
Mortgage-backed securities .................. 10,203 -- -- -- -- 10,203
-------------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities .... 9,156,968 265,471 417,978 123,634 120,302 10,084,353
-------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets ............... $9,386,377 $ 320,640 $ 571,453 $ 123,703 $120,302 $10,522,475
===============================================================================================================================
Transaction accounts:
Non-interest-bearing checking ................. $ 244,311 $ -- $ -- $ -- $ -- $ 244,311
Interest-bearing checking .....................(3) 395,640 -- -- -- -- 395,640
Money market ..................................(4) 89,408 -- -- -- -- 89,408
Regular passbook ..............................(4) 754,127 -- -- -- -- 754,127
-------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts .................. 1,483,486 -- -- -- -- 1,483,486
Certificates of deposit ..........................(1) 3,295,888 2,659,248 644,067 -- -- 6,599,203
-------------------------------------------------------------------------------------------------------------------------------
Total deposits ................................ 4,779,374 2,659,248 644,067 -- -- 8,082,689
Borrowings ....................................... 1,484,993 6,517 57,062 430,000 -- 1,978,572
Capital securities ............................... -- -- -- -- 120,000 120,000
-------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and
capital securities .......................... $6,264,367 $ 2,665,765 $ 701,129 $ 430,000 $120,000 $10,181,261
===============================================================================================================================
Excess (shortfall) of interest-earning assets over
deposits, borrowings and capital securities ... $3,122,010 $(2,345,125) $(129,676) $(306,297) $ 302 $ 341,214
Cumulative gap ................................... 3,122,010 776,885 647,209 340,912 341,214
Cumulative gap - as a % of total assets:
December 31, 2000 ............................. 28.66% 7.13% 5.94% 3.13% 3.13%
December 31, 1999 ............................. 21.29 10.20 4.97 1.92 2.35
December 31, 1998 ............................. 23.84 7.48 9.07 3.40 4.00
===============================================================================================================================
(1) Based upon contractual maturity and repricing date.
(2) Based upon contractual maturity, repricing date and projected repayment and
prepayments of principal.
(3) Includes amounts swept into money market deposit accounts and is subject to
immediate repricing.
(4) Subject to immediate repricing.
Our six-month gap at December 31, 2000 was a positive 28.66%. This means
that more interest-earning assets reprice within six months than total deposits,
borrowings and capital securities. This compares to a positive six-month gap of
21.29% at December 31, 1999 and 23.84% at December 31, 1998. 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. We originated and
purchased approximately $3.4 billion during 2000, $4.7 billion during 1999 and
$1.5 billion during 1998 of loans and mortgage-backed securities with adjustable
interest rates or maturities of five years or less. These loans represented
approximately 97% during 2000, 92% during 1999 and 80% during 1998 of all loans
and mortgage-backed securities originated and purchased for investment during
these periods.
45
At December 31, 2000, 98% of our interest-earning assets mature, reprice or
are estimated to prepay within five years, compared to 97% at December 31, 1999
and 98% at December 31, 1998. At December 31, 2000, loans held for investment
and mortgage-backed securities with adjustable interest rates represented 91% of
those portfolios. During 2001, we will continue to offer residential fixed rate
loan products to our customers to meet customer demand. We primarily originate
fixed rate loans for sale in the secondary market and price them accordingly to
create loan servicing income and to increase opportunities for originating
adjustable rate mortgages. However, we may originate fixed rate loans for
investment when funded with long-term funds to mitigate interest rate risk and
small volumes to facilitate the sale of real estate acquired through foreclosure
or that meet certain yield and other approved guidelines. See Business--Banking
Activities--Lending Activities--Secondary Marketing and Loan Servicing
Activities on page 5.
We are better protected against rising interest rates with a positive
six-month gap. However, we remain subject to possible interest rate spread
compression, which would adversely impact our net interest income if interest
rates rise. This is primarily due to the lag in repricing of the indices to
which our adjustable rate loans and mortgage-backed securities are tied, as well
as the repricing frequencies and periodic interest rate caps on these adjustable
rate loans and mortgage-backed securities. The amount of such interest rate
spread compression would depend upon the frequency and severity of such interest
rate fluctuations.
In addition to measuring interest rate risk via a gap analysis, we
establish limits on, and measure the sensitivity of, our net interest income and
net portfolio value to changes in interest rates. Changes in interest rates are
defined as instantaneous and sustained movements in interest rates in 100 basis
point increments. We utilize an internally maintained asset/liability management
simulation model to make the calculations which, for net portfolio value, is
calculated on a discounted cash flow basis. First, we estimate our net interest
income for the next twelve months and the current net portfolio value assuming
no change in interest rates from those at period end. Once the base case has
been estimated, we make calculations for each of the defined changes in interest
rates, to include any associated differences in the anticipated prepayment speed
of loans. We then compare those results against the base case to determine the
estimated change to net interest income and net portfolio value due to the
changes in interest rates. The following are the estimated impacts to net
interest income and net portfolio value from various instantaneous, parallel
shifts in interest rates based upon our asset and liability structure as of
year-ends 2000 and 1999. Since we base these estimates upon numerous
assumptions, like the expected maturities of our interest-bearing assets and
liabilities and the shape of the period-end interest rate yield curve, our
actual sensitivity to interest rate changes could vary significantly if actual
experience differs from those assumptions used in making the calculations.
2000 1999
-------------------------------------------------------------
Percentage Change in Percentage Change in
-------------------------------------------------------------
Change in Interest Rates Net Interest Net Portfolio Net Interest Net Portfolio
(In Basis Points) Income(1) Value (2) Income (1) Value (2)
-----------------------------------------------------------------------------------------------
+200 .................. (7.5)% (3.0)% (13.8)% (9.7)%
+100 .................. (3.4) 0.9 (6.8) (1.5)
(100) ................. 0.7 (4.8) 3.9 (2.2)
(200) ................. 2.1 (9.9) 7.1 (4.3)
===============================================================================================
(1) The percentage change in this column represents net interest income for 12
months in a stable interest rate environment versus the net interest income
in the various rate scenarios.
(2) The percentage change in this column represents the net portfolio value of
the Bank in a stable interest rate environment versus the net portfolio
value in the various rate scenarios.
46
The following table shows our financial instruments that are sensitive to
changes in interest rates, categorized by expected maturity, and the
instruments' fair values at December 31, 2000. This data differs from that in
the gap table as it does not incorporate the repricing characteristics of assets
and liabilities. Rather, it only reflects contractual maturities adjusted for
anticipated prepayments. Market risk sensitive instruments are generally defined
as on and off balance sheet derivatives and other financial instruments.
Expected Maturity Date at December 31, 2000 (1)
--------------------------------------------------------------------------------------------------
Total Fair
(Dollars in Thousands) 2001 2002 2003 2004 2005 Thereafter Balance Value
------------------------------------------------------------------------------------------------------------------------------------
Investment securities .......... $ 278,097 $ 85,931 $ 24,707 $ 9,904 $ 32,933 $ 6,550 $ 438,122 $ 438,106
Average interest rate ....... 6.62% 6.21% 6.92% 6.66% 6.81% 5.90% 6.56%
Loans held for sale ............ 251,572 -- -- -- -- -- 251,572 254,545
Average interest rate ....... 8.29% -- % -- % -- % -- % -- % 8.29%
Mortgage-backed securities
available for sale .......... 5,371 942 747 596 479 2,068 10,203 10,203
Average interest rate ....... 6.91% 7.75% 7.74% 7.73% 7.72% 7.70% 7.29%
Loans held for investment:
Loans secured by real estate:
Residential:
Adjustable ............... 2,265,459 2,448,067 1,790,709 908,947 476,854 1,100,502 8,990,538 9,104,257
Average interest rate .. 8.42% 8.40% 8.36% 8.31% 8.23% 8.19% 8.35%
Fixed .................... 61,593 52,947 46,157 40,291 35,257 243,632 479,877 481,616
Average interest rate .. 7.88% 7.86% 7.85% 7.83% 7.82% 7.81% 7.83%
Other ..................... 81,649 64,015 27,637 28,852 8,934 25,572 236,659 243,585
Average interest rate .... 9.11% 8.86% 8.79% 8.86% 8.94% 8.97% 8.95%
Non-mortgage:
Commercial ................ 12,049 4,018 208 -- -- -- 16,275 16,979
Average interest rate .... 10.12% 10.37% 9.86% -- % -- % -- % 10.18%
Consumer .................. 16,226 11,283 7,683 64,037 -- -- 99,229 100,533
Average interest rate .... 9.95% 10.07% 10.19% 10.24% -- % -- % 10.17%
Interest bearing advances to
joint ventures .............. 12,339 -- -- -- -- -- 12,339 12,339
Average interest rate ....... 4.32% -- % -- % -- % -- % -- % 4.32%
MSR's and loan servicing
portfolio (2) ............... 9,006 7,993 6,827 5,751 4,823 6,331 40,731 43,168
------------------------------------------------------------------------------------------------------------------------------------
Total interest-sensitive assets $2,993,361 $2,675,196 $1,904,675 $1,058,378 $559,280 $1,384,655 $10,575,545 $10,705,331
====================================================================================================================================
Transaction accounts:
Non-interest-bearing checking $ 44,623 $ 36,473 $ 29,811 $ 24,366 $ 19,916 $ 89,122 $ 244,311 $ 244,311
Interest-bearing checking (3) 72,263 59,064 48,276 39,459 32,252 144,326 395,640 395,640
Money market ................ 16,330 13,348 10,910 8,917 7,288 32,615 89,408 89,408
Regular passbook ............ 137,740 112,581 92,019 75,212 61,474 275,101 754,127 754,127
------------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts . 270,956 221,466 181,016 147,954 120,930 541,164 1,483,486 1,483,486
Average interest rate .... 2.12% 2.12% 2.12% 2.12% 2.12% 2.12% 2.12%
Certificates of deposit ........ 5,955,136 614,832 19,689 4,746 4,800 -- 6,599,203 6,619,453
Average interest rate ....... 6.34% 6.30% 5.57% 5.43% 6.10% -- % 6.33%
Borrowings ..................... 1,491,510 55,928 134 -- 1,000 430,000 1,978,572 1,978,808
Average interest rate ....... 6.55% 4.93% 5.76% -- % 8.75% 5.42% 6.26%
Capital securities ............. -- -- -- -- -- 120,000 120,000 122,400
Average interest rate ....... -- % -- % -- % -- % -- % 10.00% 10.00%
------------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and
capital securities .......... $7,717,602 $ 892,226 $ 200,839 $ 152,700 $126,730 $1,091,164 $10,181,261 $10,204,147
====================================================================================================================================
(1) Expected maturities are contractual maturities adjusted for prepayments of
principal. We use a number of assumptions to estimate fair values and
expected maturities. For assets, we base expected maturities upon
contractual maturity, projected repayments and prepayments of principal.
The prepayment experience reflected herein is based on our historical
experience. Our average projected constant prepayment rate ("CPR") is 10.8%
on our fixed-rate and 24.0% on our adjustable rate mortgage portfolio for
interest-earning assets, excluding investment securities, which do not have
prepayment features. For deposit liabilities, in accordance with standard
industry practice and our own historical experience, we have applied "decay
factors," used to estimate deposit runoff, of 20.0% per year. The actual
maturities of these instruments could vary substantially if future
prepayments differ from our historical experience.
(2) Includes mortgage servicing rights acquired prior to January 1, 1996 when
Downey began capitalizing the asset.
(3) Includes amounts swept into money market deposit accounts.
47
The following table sets forth the interest rate spread between our
interest-earning assets and interest-bearing liabilities at the dates indicated.
December 31,
-------------------------------------
2000 1999 1998 1997 1996
---------------------------------------------------------------------------------
Weighted average yield:
Loans and mortgage-backed securities 8.45% 7.67% 7.72% 7.95% 7.77%
Federal Home Loan Bank stock ....... 5.52 5.60 5.44 5.88 6.45
Investment securities .............. 6.45 6.12 5.40 5.63 6.02
---------------------------------------------------------------------------------
Earning assets yield ............. 8.36 7.62 7.65 7.87 7.71
---------------------------------------------------------------------------------
Weighted average cost:
Deposits ........................... 5.56 4.72 4.53 5.00 4.86
Borrowings:
Federal Home Loan Bank advances .. 6.26 5.77 5.47 6.11 5.80
Other borrowings ................. 6.79 7.88 8.69 6.15 5.60
---------------------------------------------------------------------------------
Total borrowings ............. 6.26 5.99 5.51 6.12 5.73
Capital securities ................. 10.00 10.00 -- -- --
---------------------------------------------------------------------------------
Combined funds cost .............. 5.75 5.05 4.66 5.11 4.97
---------------------------------------------------------------------------------
Interest rate spread ......... 2.61% 2.57% 2.99% 2.76% 2.74%
=================================================================================
The year-end weighted average yield on our loan portfolio increased to
8.45% at December 31, 2000, from 7.67% at year-end 1999. The weighted average
rate on new loans originated during 2000 was 6.10%, compared to 5.92% during
1999 and 6.45% during 1998. At December 31, 2000, our adjustable rate mortgage
portfolio of single family residential loans, including mortgage-backed
securities, totaled $9.0 billion with a weighted average rate of 8.47%, compared
to $7.3 billion with a weighted average rate of 7.52% at December 31, 1999 and
$4.3 billion with a weighted average rate of 7.53% at December 31, 1998.
PROBLEM LOANS AND REAL ESTATE
NON-PERFORMING ASSETS
Non-performing assets consist of loans on which we have ceased the accrual
of 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. Non-performing assets totaled $55 million at December 31, 2000,
compared to $39 million at December 31, 1999 and $27 million at December 31,
1998. The increase in our non-performing assets during 2000 was primarily
attributed to a rise in residential non-performers of which $8.4 million was in
the subprime category. Of the total, real estate acquired in settlement of
loans, net of allowances, represented $10 million at December 31, 2000, up from
$6 million at December 31, 1999 and $4 million at December 31, 1998. When
measured as a percentage of total assets, our non-performing assets rose to
0.50% at year-end 2000, compared to 0.42% at year-end 1999 and 0.44% at year-end
1998.
48
The following table summarizes our non-performing assets at the dates
indicated.
December 31,
------------------------------------------------
(Dollars in Thousands) 2000 1999 1998 1997 1996
-------------------------------------------------------------------------------------------------------
Non-accrual loans:
Residential one-to-four units ................... $20,746 $15,590 $15,571 $20,816 $22,885
Residential one-to-four units - subprime ........ 22,296 13,914 1,975 -- --
Other ........................................... 1,708 3,477 4,829 20,883 22,136
-------------------------------------------------------------------------------------------------------
Total non-accrual loans ....................... 44,750 32,981 22,375 41,699 45,021
Troubled debt restructure - below market rate (1) ... 206 -- -- -- --
Real estate acquired in settlement of loans ......... 9,942 5,899 4,475 9,626 16,078
Repossessed automobiles ............................. 76 314 569 795 928
-------------------------------------------------------------------------------------------------------
Total non-performing assets ...................... $54,974 $39,194 $27,419 $52,120 $62,027
=======================================================================================================
Allowance for loan losses (2):
Amount .......................................... $34,452 $38,342 $31,517 $32,092 $30,094
As a percentage of non-performing loans ......... 76.63% 116.25% 140.86% 76.96% 66.84%
Non-performing assets as a percentage of total assets 0.50 0.42 0.44 0.89 1.19
=======================================================================================================
(1) Represents a single one-to-four unit residential loan.
(2) Allowance for loan losses does not include the allowance for real estate
and real estate acquired in settlement of loans.
It is our policy to take appropriate, timely and aggressive action when
necessary to resolve non-performing assets. When resolving problem loans, it is
our policy to determine collectibility under various circumstances which are
intended to result in our maximum financial benefit. We accomplish this by
either working with the borrower to bring the loan current or by foreclosing and
selling the asset. We perform ongoing reviews of loans that display weaknesses
and maintain adequate loss allowances on the loans. For a discussion on our
internal asset review policy, refer to Allowance for Losses on Loans and Real
Estate on page 52.
All but $7.2 million of our non-performing assets at December 31, 2000 were
located in California.
We evaluate the need for appraisals for non-performing assets on a periodic
basis. We will generally obtain a new appraisal when we believe that there may
have been an adverse change in the property operations or in the economic
conditions of the geographic market of the property securing our loans. Our
policy is to obtain new appraisals at least annually for major real estate
acquired in settlement of loans. Throughout 2000, we obtained new appraisals for
non-performing loans and real estate acquired in settlement of loans.
Non-Accrual Loans. It is our general policy to account for a loan as
non-accrual when the loan becomes 90 days delinquent or when collection of
interest appears doubtful. In a number of cases, loans may remain on accrual
status past 90 days when we determine that continued accrual is warranted
because the loan is well-secured and in process of collection. As of December
31, 2000, we had no loans 90 days or more delinquent which remained on accrual
status. We reverse and charge against interest income any interest previously
accrued with respect to non-accrual loans. We recognize interest income on
non-accrual loans to the extent that we receive payments and to the extent that
we believe we will recover the remaining principal balance of the loan. We
restore these loans to an accrual status only if all past due payments are made
by the borrower and the borrower has demonstrated the ability to make future
payments of principal and interest. At December 31, 2000, non-accrual loans
aggregating $14 million were less than 90 days delinquent relative to their
contractual terms. Additional loans aggregating $1 million were not
contractually past due, but were deemed non-accrual due to management's
assessment of the borrower's ability to pay.
Troubled Debt Restructurings. We consider a restructuring of a debt a
troubled debt restructuring when we, for economic or legal reasons related to
the borrower's financial difficulties, grant a concession to the borrower that
we would not otherwise grant. Troubled debt restructurings may include changing
repayment terms, reducing the stated interest rate or reducing the amounts of
principal and/or interest due or extending the maturity date. The restructuring
of a loan is intended to recover as much of our investment as possible and to
achieve the
49
highest yield possible. At December 31, 2000 we had less than $1 million of
troubled debt restructurings on accrual status representing a single one-to-four
unit residential loan.
Real Estate Acquired in Settlement of Loans. Real estate acquired in
settlement of loans consists of real estate acquired through foreclosure or
deeds in lieu of foreclosure and totaled $10 million at December 31, 2000.
DELINQUENT LOANS
When a borrower fails to make required payments on a loan and does not cure
the delinquency within 60 days, we normally record a notice of default to
commence foreclosure proceedings, so long as we have given any required prior
notice to the borrower. If the loan is not reinstated within the time permitted
by law for reinstatement, which is normally five business days prior to the date
set for the non-judicial trustee's sale, we may then sell the property at a
foreclosure sale. If we have elected to pursue a non-judicial foreclosure, we
are not permitted under applicable law to obtain a deficiency judgment against
the borrower, even if the security property is insufficient to cover the balance
owed. At these foreclosure sales, we generally acquire title to the property.
At December 31, 2000, loans delinquent 30 days or more as a percentage of
total loans was 0.66%, up from 0.58% at year-end 1999 and 0.65% at year-end
1998. The increase primarily occurred in our residential one-to-four unit
categories. As a percentage of its loan category, residential one-to-four units
increased from 0.40% at year-end 1999 to 0.46% at year-end 2000, while subprime
residential one-to-four units increased from 1.15% at year-end 1999 to 1.68% at
year-end 2000. A higher incidence of delinquency is expected on these subprime
loans as these borrowers have a history of delinquencies for which we charge
higher interest rates to compensate for that risk. In addition, the
loan-to-value ratio on these loans is generally lower thereby providing more
equity protection against loss. The increase in our residential one-to-four unit
categories was partially offset by a decline in our delinquent automobile loans
attributed to the sale of our indirect automobile finance subsidiary.
50
The following table indicates the amounts of our past due loans at the
dates indicated.
December 31,
----------------------------------------------------------------------------
2000 1999
----------------------------------------------------------------------------
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 .................... $12,400 $ 8,611 $15,246 $36,257 $ 8,630 $3,889 $12,793 $25,312
One-to-four units - subprime ......... 7,300 7,658 14,427 29,385 7,867 3,069 7,935 18,871
Five or more units ................... -- -- -- -- -- -- -- --
Commercial real estate ................. -- -- -- -- -- -- -- --
Construction ........................... -- -- -- -- -- -- -- --
Land ................................... -- -- -- -- -- -- -- --
--------------------------------------------------------------------------------------------------------------------------
Total real estate loans .............. 19,700 16,269 29,673 65,642 16,497 6,958 20,728 44,183
Non-mortgage:
Commercial ............................. -- -- -- -- -- -- -- --
Automobile ............................. 393 26 151 570 4,758 674 717 6,149
Other consumer ......................... 98 29 246 373 679 42 114 835
--------------------------------------------------------------------------------------------------------------------------
Total delinquent loans ............... $20,191 $16,324 $30,070 $66,585 $21,934 $7,674 $21,559 $51,167
==========================================================================================================================
Delinquencies as a percentage of total loans 0.20% 0.16% 0.30% 0.66% 0.25% 0.09% 0.24% 0.58%
==========================================================================================================================
1998 1997
----------------------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units .................... $ 9,841 $6,014 $12,832 $28,687 $12,099 $4,101 $18,579 $34,779
One-to-four units - subprime ......... 244 784 947 1,975 185 -- -- 185
Five or more units ................... -- -- 155 155 -- 222 -- 222
Commercial real estate ................. -- -- -- -- -- -- 279 279
Construction ........................... -- -- -- -- -- -- -- --
Land ................................... -- -- -- -- -- -- -- --
--------------------------------------------------------------------------------------------------------------------------
Total real estate loans .............. 10,085 6,798 13,934 30,817 12,284 4,323 18,858 35,465
Non-mortgage:
Commercial ............................. -- -- -- -- -- -- -- --
Automobile ............................. 4,650 888 1,048 6,586 4,167 981 961 6,109
Other consumer ......................... 334 45 344 723 218 54 533 805
--------------------------------------------------------------------------------------------------------------------------
Total delinquent loans ............... $15,069 $7,731 $15,326 $38,126 $16,669 $5,358 $20,352 $42,379
==========================================================================================================================
Delinquencies as a percentage of total loans 0.26% 0.13% 0.26% 0.65% 0.31% 0.10% 0.38% 0.79%
==========================================================================================================================
1996
------------------------------------
Loans secured by real estate:
Residential:
One-to-four units .................... $14,519 $5,502 $18,549 $38,570
One-to-four units - subprime ......... 198 -- -- 198
Five or more units ................... -- -- -- --
Commercial real estate ................. -- -- -- --
Construction ........................... -- -- -- --
Land ................................... -- -- 566 566
-----------------------------------------------------------------------------------
Total real estate loans .............. 14,717 5,502 19,115 39,334
Non-mortgage:
Commercial ............................. -- -- -- --
Automobile ............................. 2,080 328 274 2,682
Other consumer ......................... 158 15 181 354
-----------------------------------------------------------------------------------
Total delinquent loans ............... $16,955 $5,845 $19,570 $42,370
===================================================================================
Delinquencies as a percentage of total loans 0.36% 0.12% 0.41% 0.89%
===================================================================================
(1) All 90 day or greater delinquencies are on non-accrual status and we report
them as part of non-performing assets.
51
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. A key component to our evaluation is
our internal asset review process.
Our Internal Asset Review Department conducts independent reviews to
evaluate the risk and quality of all our assets. Our Internal Asset Review
Committee is responsible for the review and classification of assets. The
Internal Asset Review Committee members include the Chief Internal Asset Review
Officer, Chief Executive Officer, Chief Financial Officer, Chief Lending
Officer, General Counsel, Director of Compliance/Risk Management, Credit
Administrator and Chief Appraiser. The Internal Asset Review Committee meets
quarterly to review and to determine asset classifications and to recommend any
changes to asset valuation allowances. With the exception of payoffs or asset
sales, the classification of an asset, once established, can be removed or
upgraded only upon approval of the Internal Asset Review Committee. The Chief
Internal Asset Review Officer reports quarterly to the Audit Committee of the
Board of Directors regarding overall asset quality, the adequacy of valuation
allowances on classified assets and our adherence to policies and procedures
regarding asset classification and valuation.
We adhere to an internal asset review system and loss allowance methodology
designed to provide for timely recognition of problem assets and adequate
general valuation allowances to cover asset losses. Our current asset monitoring
process includes the use of asset classifications to segregate the assets,
largely loans and real estate, into various risk categories. We use the various
asset classifications as a means of measuring risk for determining the valuation
allowance at a point in time. We currently use a six grade system to classify
our assets. The current grades are:
o pass;
o watch;
o special mention;
o substandard;
o doubtful; and
o loss.
We consider substandard, doubtful and loss assets "classified assets" for
regulatory purposes. A brief description of these classifications follows:
o The pass classification represents a level of credit quality which
contains no well-defined deficiency or weakness.
o The watch classification is used to identify an asset that currently
contains no well-defined deficiency or weakness, but it is determined
to be desirable to closely monitor the asset--e.g., loans to
facilitate the sale of real estate acquired in settlement of loans.
This category may also be used for assets upgraded from lower
classifications where continuing monitoring is deemed appropriate.
o A special mention asset does not currently expose us to a sufficient
degree of risk to warrant an adverse classification, but does possess
a correctable deficiency or potential weakness deserving management's
close attention.
o Substandard assets have a well-defined weakness or weaknesses. They
are characterized by the distinct possibility that we will sustain
some loss if we do not correct the deficiencies.
o An asset classified doubtful has all the weaknesses inherent in those
classified substandard with the added characteristic that the
weaknesses make collection or liquidation in full, on the basis of
currently existing facts, conditions and values, highly questionable
and improbable. We consider doubtful to be a temporary classification
until resolution of pending weakness issues enables us to more clearly
define the potential for loss.
o That portion of an asset classified as loss is considered
uncollectible and of so little value that its continuance as an asset,
without establishment of a specific valuation allowance, is not
warranted. A loss classification does not mean that an asset has
absolutely no recovery or salvage value, but rather it is not
reasonable to defer writing off or providing for all or a portion of
an impaired asset even though
52
partial recovery may be effected in the future. We will generally
classify as loss the balance of the asset that is greater than the net
fair value of the asset unless we can expect payment from another
source. Therefore, the amount of an asset classified as loss reflects
the total of specific valuation allowances established for the
particular asset. Specific valuation allowances are not includable in
determining the Bank's total regulatory capital.
The OTS has the authority to require us to change our asset
classifications. If the change results in an asset being classified in whole or
in part as loss, a specific allowance must be established against the amount so
classified or that amount must be charged off. OTS guidelines set forth
quantitative benchmarks as a starting point for the determination of appropriate
levels of general valuation allowances. The OTS directs its examiners to rely on
management's estimates of adequate general valuation allowances if the Bank's
process for determining adequate allowances is deemed to be sound.
Our policy is to provide an allowance for losses on loans and real estate
when it is probable that the value of the asset has been impaired and the loss
can be reasonably estimated. To comply with this policy, we have established a
monitoring system that requires at least an annual review of all assets in
excess of $5 million and a semiannual review of all assets considered adversely
classified or criticized. The monitoring system requires a review of current
operating statements, an evaluation of the property's current and past
performance, an evaluation of the borrower's ability to repay and the
preparation of a discounted cash flow analysis. Based on the results of the
review, we may require a new appraisal.
We utilize the asset classifications from our internal asset review process
in the following manner to determine the amount of our allowances:
o General valuation allowances: This element relates to assets with no
well-defined deficiency or weakness (i.e., assets classified pass or
watch) and takes into consideration loss that is imbedded within the
portfolio but has not yet been realized. Generally, we believe that
borrowers are impacted by events well in advance of a lender's
knowledge that may ultimately result in loan default and eventual
loss. Examples of such loss-causing events would be borrower job loss,
divorce or medical crisis in the case of single family residential and
consumer loans, or loss of a major tenant in the case of commercial
real estate loans. General valuation allowances are determined by
applying factors that take into consideration past loss experience and
asset duration for each major asset type to the associated asset
balance.
o Allocated allowances: This element relates to assets with well-defined
deficiencies or weaknesses (i.e., assets classified special mention,
substandard, doubtful or loss). We calculate on an ongoing basis loss
by credit classification for each major asset type. Factors based upon
those loss statistics are applied against current classified asset
balances to determine the amount of allocated allowances. Included in
these allowances are those amounts associated with assets where it is
probable that the value of the asset has been impaired and the loss
can be reasonably estimated. If we determine the net fair value of the
asset exceeds our carrying value, a specific allowance is recorded for
the amount of that difference.
o Unallocated allowance: This element 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.
Our provision for loan losses was $3.3 million in 2000, down $8.0 million
from 1999. Although the provision for loan losses exceeded our net loan
charge-offs by $1.9 million, the allowance for loan losses declined by $3.9
million to $34.5 million at December 31, 2000. The decline in the allowance
reflected a decrease of $3.6 million in general valuation allowances to $27.0
million due primarily to a reduction of $5.5 million associated with the sale of
the indirect automobile finance subsidiary which more than offset an increase
related to increases in one-to-four unit residential loans. Allocated allowances
declined by $0.2 million of which $0.3 million was associated with the
subsidiary sale. There was no change in the unallocated allowance of $2.8
million. During 1999, our provision for loan losses exceeded net loan
charge-offs by $6.8 million resulting in an increase in the allowance for loan
losses to $38.3 million at December 31, 1999. The allowance increase reflected
an increase of $6.2 million in general valuation allowances to $30.6 million due
primarily to the increase during the year in the overall one-to-four unit
residential loan portfolio, while allocated allowances increased $0.6 million to
$4.9 million due primarily to an increase in loans classified substandard. There
was no change in the unallocated allowance.
53
The following table is a summary of the activity in our allowance for loan
losses during the years indicated.
(In Thousands) 2000 1999 1998 1997 1996
------------------------------------------------------------------------------------
Balance at beginning of period $38,342 $31,517 $32,092 $30,094 $27,943
Provision .................... 3,251 11,270 3,899 8,640 9,137
Charge-offs .................. (1,749) (5,535) (7,372) (7,773) (7,660)
Recoveries ................... 419 1,090 2,898 1,131 674
Transfers (1) ................ (5,811) -- -- -- --
------------------------------------------------------------------------------------
Balance at end of period ..... $34,452 $38,342 $31,517 $32,092 $30,094
====================================================================================
(1) Reduction in 2000 was due to the sale of subsidiary.
Net loan charge-offs were $1.3 million in 2000, down from $4.4 million in
1999 and $4.5 million in 1998. The decline in net loan charge-offs in 2000
primarily reflected a decline of $3.3 million in net charge-offs of automobile
loans due to the previously mentioned sale of subsidiary, partially offset by a
$0.1 million increase in net charge-offs of one-to-four unit residential loans.
54
The following table presents gross charge-offs, gross recoveries and net
charge-offs by category of loan during the periods indicated.
(Dollars in Thousands) 2000 1999 1998 1997 1996
-------------------------------------------------------------------------------------------------------
Gross loan charge-offs:
Loans secured by real estate:
Residential:
One-to-four units (1) ...................... $ 419 $ 393 $ 1,035 $2,389 $5,098
One-to-four units - subprime ................ 316 187 -- -- --
Five or more units .......................... -- -- 68 -- 102
Commercial real estate ........................ -- -- -- -- --
Land .......................................... -- -- -- -- --
Non-mortgage:
Commercial .................................... -- -- -- -- 115
Automobile .................................... 832 4,795 6,118 5,109 2,096
Other consumer ................................ 182 160 151 275 249
-------------------------------------------------------------------------------------------------------
Total gross loan charge-offs ................ 1,749 5,535 7,372 7,773 7,660
-------------------------------------------------------------------------------------------------------
Gross loan recoveries:
Loans secured by real estate:
Residential:
One-to-four units ........................... 19 -- 125 224 116
One-to-four units - subprime ................ -- -- -- -- --
Five or more units .......................... -- -- -- -- --
Commercial real estate ........................ 250 250 1,610 261 250
Land .......................................... -- -- -- -- --
Non-mortgage:
Commercial .................................... -- -- -- -- --
Automobile .................................... 136 831 1,159 641 305
Other consumer ................................ 14 9 4 5 3
-------------------------------------------------------------------------------------------------------
Total gross loan recoveries ................. 419 1,090 2,898 1,131 674
-------------------------------------------------------------------------------------------------------
Net loan charge-offs:
Loans secured by real estate:
Residential:
One-to-four units ........................... 400 393 910 2,165 4,982
One-to-four units - subprime ................ 316 187 -- -- --
Five or more units .......................... -- -- 68 -- 102
Commercial real estate ........................ (250) (250) (1,610) (261) (250)
Land .......................................... -- -- -- -- --
Non-mortgage:
Commercial .................................... -- -- -- -- 115
Automobile .................................... 696 3,964 4,959 4,468 1,791
Other consumer ................................ 168 151 147 270 246
-------------------------------------------------------------------------------------------------------
Total net loan charge-offs .................. $1,330 $4,445 $ 4,474 $6,642 $6,986
=======================================================================================================
Net loan charge-offs as a percentage of average loans 0.01% 0.06% 0.08% 0.13% 0.16%
=======================================================================================================
(1) Includes amounts associated with the January 1994 Northridge earthquake of
$1.0 million in 1996.
55
The allocation of the allowance for loan losses at the dates indicated is
as shown in the following table.
December 31,
-------------------------------------------------------------------------------------------------
2000 1999 1998
-------------------------------------------------------------------------------------------------
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 ........ $15,254 $7,655,238 0.20% $12,913 $6,155,399 0.21% $11,244 $4,047,182 0.28%
One-to-four units-subprime 10,157 1,743,914 0.58 9,876 1,639,401 0.60 3,055 588,951 0.52
Five or more units ....... 146 19,460 0.75 184 21,055 0.87 401 40,029 1.00
Commercial real estate ..... 2,935 164,604 1.78 2,439 148,327 1.64 2,632 140,790 1.87
Construction ............... 1,390 118,165 1.18 2,075 176,487 1.18 1,508 127,761 1.18
Land ....................... 332 26,880 1.24 843 67,631 1.25 568 44,859 1.27
Non-mortgage:
Commercial ................. 442 21,721 2.03 334 26,667 1.25 218 28,293 0.77
Automobile (1) ............. 269 39,614 0.68 6,259 399,789 1.57 8,344 357,988 2.33
Other consumer ............. 727 60,653 1.20 619 49,344 1.25 747 41,894 1.78
Not specifically allocated .... 2,800 -- -- 2,800 -- -- 2,800 -- --
---------------------------------------------------------------------------------------------------------------------------------
Total loans held for
investment ............ $34,452 $9,850,249 0.35% $38,342 $8,684,100 0.44% $31,517 $5,417,747 0.58%
=================================================================================================================================
1997 1996
------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units ........ $13,396 $4,358,475 0.31% $12,960 $4,013,190 0.32%
One-to-four units-subprime 1,256 249,070 0.50 281 33,258 0.84
Five or more units ....... 314 38,278 0.82 517 56,907 0.91
Commercial real estate ..... 4,112 202,425 2.03 6,956 260,609 2.67
Construction ............... 847 70,865 1.20 773 66,651 1.16
Land ....................... 331 25,687 1.29 466 21,177 2.20
Non-mortgage:
Commercial ................. 196 26,024 0.75 236 22,136 1.07
Automobile ................. 8,016 342,326 2.34 4,303 202,186 2.13
Other consumer ............. 824 47,735 1.73 802 47,281 1.70
Not specifically allocated .... 2,800 -- -- 2,800 -- --
--------------------------------------------------------------------------------------------
Total loans held for
investment ............ $32,092 $5,360,885 0.60% $30,094 $4,723,395 0.64%
============================================================================================
(1) The decline during 2000 primarily reflects the sale of subsidiary.
Impaired Loans. We consider a loan to be impaired when, based upon current
information and events, we believe it is probable that we will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. We carry impaired loans at either the present value of expected
future cash flows discounted at the loan's effective interest rate or at the
loan's observable market price or the net fair value of the collateral securing
the loan. Impaired loans exclude large groups of smaller balance homogeneous
loans that we collectively evaluate for impairment. For us, loans we
collectively review for impairment include all single family loans and
performing multi-family and non-residential loans having principal balances of
less than $5 million.
In determining impairment, we consider large non-homogeneous loans with the
following characteristics: non-accrual loans, debt restructurings and performing
loans which exhibit, among other characteristics, high loan-to-value ratios or
delinquent taxes. We base the measurement of collateral dependent impaired loans
on the fair value of the loan's collateral. We value non-collateral dependent
loans based on a present value calculation of expected future cash flows,
discounted at the loan's effective rate. We generally use cash receipts on
impaired loans not performing according to contractual terms to reduce the
carrying value of the loan, unless we believe we will recover the remaining
principal balance of the loan. We include impairment losses in the allowance for
loan losses through a charge to provision for loan losses. We include
adjustments to impairment losses due to changes in the fair value of the
collateral of impaired loans in provision for loan losses. Upon disposition of
an impaired loan, we record loss of principal through a charge-off to the
allowance for loan losses. At December 31, 2000, the recorded investment in
loans for which we have recognized impairment totaled $14 million, up from $13
million at December 31, 1999. The total allowance for losses related to these
loans was $1 million for both
56
December 31, 2000 and 1999. During 2000, the total interest recognized on the
impaired portfolio was $2.9 million, compared to $1.9 million in 1999. For
further information regarding impaired loans, see Note 6 of the Notes to
Consolidated Financial Statements on page 78.
A summary of the activity in the allowance for loan losses associated with
impaired loans is shown below for the years indicated. We have recorded
provisions and reductions to the allowance associated with changes in
classification of loans as impaired and reductions due to loan principal
payments.
(In Thousands) 2000 1999 1998 1997 1996
-----------------------------------------------------------------------------------
Balance at beginning of period $ 797 $ 810 $1,301 $4,402 $5,292
Provision (reduction) ........ 3 (13) (491) (3,101) (890)
Charge-offs .................. -- -- -- -- --
Recoveries ................... -- -- -- -- --
-----------------------------------------------------------------------------------
Balance at end of period ..... $ 800 $ 797 $ 810 $1,301 $4,402
===================================================================================
The following table is a summary of the activity in our allowance for real
estate and joint ventures held for investment during the years indicated. The
provision reductions in all years were, in general, due to a continuing
improvement in the real estate market which favorably impacted the valuation of
certain neighborhood shopping center investments and to a reduction in the
investment in certain joint venture investments.
(In Thousands) 2000 1999 1998 1997 1996
-----------------------------------------------------------------------------
Balance at beginning of period $2,131 $ 7,717 $21,244 $30,071 $34,338
Provision (reduction) ........ 866 (3,666) (5,296) (3,190) (3,306)
Charge-offs .................. -- (1,920) (8,231) (5,637) (1,035)
Recoveries ................... -- -- -- -- 74
-----------------------------------------------------------------------------
Balance at end of period ..... $2,997 $ 2,131 $ 7,717 $21,244 $30,071
=============================================================================
In addition to losses charged against the allowance for loan losses, we
have recorded losses on real estate acquired in settlement of loans by direct
write-off to net operations of real estate acquired in settlement of loans and
against an allowance for losses specifically established for these assets. As of
September 30, 1999, we are no longer maintaining an allowance for real estate
acquired in settlement of loans as we record the related individual assets at
the lower of cost or fair value.
The following table is a summary of the activity of our allowance for real
estate acquired in settlement of loans during the years indicated.
(In Thousands) 2000 1999 1998 1997 1996
-------------------------------------------------------------------------------
Balance at beginning of period $-- $ 533 $ 839 $ 1,078 $ 1,217
Provision (reduction) ........ 412 (45) 455 1,107 1,658
Charge-offs .................. (442) (488) (761) (1,346) (1,797)
Recoveries ................... 30 -- -- -- --
-------------------------------------------------------------------------------
Balance at end of period ..... $-- $-- $ 533 $ 839 $ 1,078
===============================================================================
CAPITAL RESOURCES AND LIQUIDITY
Our sources of funds include deposits, advances from the FHLB and other
borrowings; proceeds from the sale of real estate, loans and mortgage-backed
securities; 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.
57
Our primary sources of funds generated during 2000 were from:
o principal repayments--including prepayments, but excluding our
refinances of our existing loans--on loans and mortgage-backed
securities of $1.8 billion; and
o a net deposit inflow of $1.5 billion, all of which was in certificates
of deposit.
We used these funds primarily to originate loans held for investment of $3.3
billion.
To the extent 2001 deposit growth falls short of satisfying ongoing
commitments to fund maturing and withdrawable deposits, repay borrowings, fund
existing and future loans and make investments, continue branch improvement
programs and maintain regulatory liquidity requirements, we will utilize
borrowing arrangements with the FHLB and other sources. At December 31, 2000, we
had commitments to fund loans amounting to $694 million, undisbursed loan funds
and unused lines of credit of $148 million, and other contingent liabilities of
$2 million. We believe our current sources of funds will enable us to meet these
obligations while maintaining our liquidity at appropriate levels.
The principal measure of liquidity in the savings and loan industry is the
regulatory ratio of cash and eligible investments to the sum of withdrawable
savings and borrowings due within one year. Federal regulators reduced the
minimum liquidity ratio in 1997 from 5% to 4%. At December 31, 2000, the Bank's
ratio was 4.3%, compared to 4.2% at December 31, 1999, and 4.0% at December 31,
1998.
Downey currently has liquid assets, including due from Bank--interest
bearing balances, of $18 million and can obtain further funds by means of
dividends from subsidiaries, subject to certain limitations, or issuance of
further debt or equity.
REGULATORY CAPITAL COMPLIANCE
The core and tangible capital ratios were 6.42% and the risk-based capital
ratio was 12.94% at December 31, 2000. These levels are up slightly from
comparable ratios of 6.27% for core and tangible capital and 12.14% for
risk-based capital at December 31, 1999, and continue to exceed the "well
capitalized" standards of 5.00% for core capital and 10.00% for risk-based
capital, as defined by regulation. During 2000, the amount of the Bank's
non-includable investment in real estate required to be deducted from regulatory
capital was reduced by $28 million due primarily to DSL Service Company's return
of $32 million of capital to the Bank associated with the sale of certain real
estate investments.
58
The following table is a reconciliation of the Bank's stockholder's equity
to federal regulatory capital as of December 31, 2000.
Tangible Capital Core Capital Risk-Based Capital
------------------- ------------------ --------------------
(Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------------------------------------------------------------------------
Stockholder's equity ................................ $722,829 $722,829 $722,829
Adjustments:
Deductions:
Investment in subsidiary, primarily real estate . (17,230) (17,230) (17,230)
Goodwill ........................................ (3,607) (3,607) (3,607)
Non-permitted mortgage servicing rights ......... (4,073) (4,073) (4,073)
Additions:
Unrealized gains on securities available for sale (687) (687) (687)
General loss allowance - investment in DSL
Service Company .............................. 483 483 483
Allowance for loan losses,
net of specific allowances (1) ................ -- -- 34,129
-----------------------------------------------------------------------------------------------------------------------------
Regulatory capital .................................. 697,715 6.42% 697,715 6.42% 731,844 12.94%
Well capitalized requirement ........................ 162,896 1.50 (2) 542,985 5.00 565,601 10.00 (3)
-----------------------------------------------------------------------------------------------------------------------------
Excess $534,819 4.92% $154,730 1.42% $166,243 2.94%
=============================================================================================================================
(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 12.34%.
CURRENT ACCOUNTING ISSUES
Statement of Financial Accounting Standards No. 140. In September 2000, the
Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities - a replacement of FASB Statement No. 125,"
which revises the standards for accounting for securitizations and other
transfers of financial assets and collateral and requires certain disclosures.
Although it replaces FASB Statement No. 125, it carries over most of statement
125's provisions without reconsideration.
The accounting provisions are effective for fiscal years beginning after
March 15, 2001. The reclassification and disclosure provisions are effective for
fiscal years beginning after December 15, 2000. It is not anticipated that the
financial impact of this statement will have a material effect on Downey.
Statement of Financial Accounting Standards No. 133. In June 1998, the
Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including a number of derivative instruments embedded in other
contracts, collectively referred to as derivatives, and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If specific conditions are met, a derivative may be specifically
designated as:
o a hedge of the exposure to changes in the fair value of a recognized
asset or liability or an unrecognized firm commitment;
o a hedge of the exposure to variable cash flows of a forecasted
transaction; or
o a hedge of the foreign currency exposure of a net investment in a
foreign operation, an unrecognized firm commitment, an available for
sale security or a foreign-currency-denominated forecasted
transaction.
Under SFAS 133, an entity that elects to apply hedge accounting is required
to establish at the inception of the hedge the method it will use for assessing
the effectiveness of the hedging derivative and the measurement
59
approach for determining the ineffective aspect of the hedge. Those methods must
be consistent with the entity's approach to managing risk.
This statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000.
As part of our secondary marketing activities, we utilize forward sale and
purchase derivative contracts to hedge the value of loans originated for sale
against adverse changes in interest rates. At December 31, 2000, sales contracts
amounted to approximately $150 million. These contracts have a high correlation
to the price movement of the loans being hedged. There is no recognition of
unrealized gains and losses on these contracts in the balance sheet or statement
of income. When the related loans are sold, the deferred gains or losses from
these contracts are recognized in the statement of income as a component of net
gains or losses on sales of loans and mortgage-backed securities.
On January 1, 2001, we adopted SFAS 133, and at that time, designated those
sales contracts as cash flow derivative instruments in accordance with the
requirements of the new standard. These cash flow derivative instruments hedge
the variability of forecasted cash flows attributable to interest rate risk.
Cash flow hedges are accounted for by recording the value of the derivative
instrument on the balance sheet as either an asset or liability with a
corresponding offset recorded in other comprehensive income within stockholders'
equity, net of tax. Amounts are reclassified from other comprehensive income to
the income statement in the period the hedged cash flow occurs. Derivative gains
and losses not considered effective in hedging the change in expected cash flows
of the hedged item are recognized immediately in the income statement.
With the implementation of SFAS 133, we recorded after-tax transition
amounts associated with establishing the fair values of the derivative
instruments and hedged items on the balance sheet as an increase of $36,000 to
net income and a reduction of $388,000 in other comprehensive income.
(In Thousands) 2001
---------------------------------------------------------------------------------
SUMMARY OF TRANSITION ADJUSTMENT AT JANUARY 1:
BALANCE SHEET
ASSETS
Other assets .............................................. $ 244
Deferred income tax benefit ............................... 260
---------------------------------------------------------------------------------
$ 504
=================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued liabilities $ 856
Accumulated other comprehensive loss - unrealized losses on
derivative instruments ................................... (388)
Retained earnings ......................................... 36
---------------------------------------------------------------------------------
$ 504
=================================================================================
STATEMENT OF INCOME
Cumulative effect of a change in accounting principle ....... $ 62
Income taxes ................................................ 26
---------------------------------------------------------------------------------
Net income ................................................ $ 36
=================================================================================
The transition adjustment will be presented as a cumulative effect
adjustment as described in Accounting Principles Board Opinion No. 20,
Accounting Changes, in our 2001 financial statements. The transition amounts
were determined based on the interpretive guidance issued to date by the
Financial Accounting Standards Board. The Financial Accounting Standards Board
continues to issue interpretive guidance which could require changes in our
application of the standard and adjustment to the transition amounts. We will
continue to hedge as we have previously done; however, SFAS 133, as applied to
our risk management strategies, may increase or decrease reported net income and
stockholders' equity prospectively, depending on future levels of interest rates
and other variables affecting the fair values of derivative instruments and
hedged items, but will have no effect on cash flows or the overall economics of
the transactions. For further information regarding current accounting issues,
see Note 1 of the Notes to Consolidated Financial Statements on page 69.
60
SALE OF SUBSIDIARY
On February 29, 2000, the Bank sold its indirect automobile finance
subsidiary, Downey Auto Finance Corp., to Auto One Acceptance Corp., a
subsidiary of California Federal Bank and recognized a pre-tax gain from the
sale of $9.8 million. At December 31, 1999, Downey Auto Finance Corp. had loans
totaling $366 million and total assets of $373 million. The proceeds from the
sale have provided additional capital to further the growth of our residential
lending business.
61
ITEM 8. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Report.................................... 63
Consolidated Balance Sheets..................................... 64
Consolidated Statements of Income............................... 65
Consolidated Statements of Comprehensive Income................. 66
Consolidated Statements of Stockholders' Equity................. 66
Consolidated Statements of Cash Flows........................... 67
Notes to Consolidated Financial Statements...................... 69
62
KPMG
355 South Grand Avenue
Los Angeles, CA 90071
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Downey Financial Corp.:
We have audited the accompanying consolidated balance sheets of Downey Financial
Corp. and subsidiaries ("Downey") as of December 31, 2000 and 1999, and the
related consolidated statements of income, comprehensive income, stockholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 2000. These consolidated financial statements are the
responsibility of Downey's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Downey Financial
Corp. and subsidiaries as of December 31, 2000 and 1999, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States of America.
/s/ KPMG LLP
Los Angeles, California
January 17, 2001
63
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
--------------------------
(Dollars in Thousands, Except Per Share Data) 2000 1999
-------------------------------------------------------------------------------------------------------------
ASSETS
Cash ........................................................................... $ 108,202 $ 121,146
Federal funds .................................................................. 19,601 1
-------------------------------------------------------------------------------------------------------------
Cash and cash equivalents .................................................. 127,803 121,147
U.S. Treasury securities, agency obligations and other investment securities
available for sale, at fair value .......................................... 305,615 171,823
Municipal securities held to maturity, at amortized cost (estimated market value
of $6,534 at December 31, 2000, and $6,710 at December 31, 1999) ........... 6,550 6,728
Loans held for sale, at lower of cost or market ................................ 251,572 136,005
Mortgage-backed securities available for sale, at fair value ................... 10,203 21,719
Loans receivable held for investment ........................................... 9,822,578 8,588,339
Investments in real estate and joint ventures .................................. 17,641 42,172
Real estate acquired in settlement of loans .................................... 9,942 5,899
Premises and equipment ......................................................... 104,178 107,978
Federal Home Loan Bank stock, at cost .......................................... 106,356 102,392
Mortgage servicing rights, net ................................................. 40,731 34,263
Other assets ................................................................... 90,694 69,075
-------------------------------------------------------------------------------------------------------------
$10,893,863 $ 9,407,540
=============================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits ....................................................................... $ 8,082,689 $ 6,562,761
Federal Home Loan Bank advances ................................................ 1,978,348 2,122,407
Other borrowings ............................................................... 224 373
Accounts payable and accrued liabilities ....................................... 54,236 45,682
Deferred income taxes .......................................................... 33,730 23,899
-------------------------------------------------------------------------------------------------------------
Total liabilities .......................................................... 10,149,227 8,755,122
-------------------------------------------------------------------------------------------------------------
Company obligated mandatorily redeemable capital securities of subsidiary trust
holding solely junior subordinated debentures of the Company
("Capital Securities") ..................................................... 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;
outstanding 28,205,741 shares at December 31, 2000, and 28,148,409
shares at December 31, 1999 ................................................ 282 281
Additional paid-in capital ..................................................... 93,239 92,385
Accumulated other comprehensive income (loss) - unrealized gains (losses)
on securities available for sale ........................................... 687 (1,568)
Retained earnings .............................................................. 530,428 441,320
-------------------------------------------------------------------------------------------------------------
Total stockholders' equity ................................................. 624,636 532,418
-------------------------------------------------------------------------------------------------------------
$10,893,863 $ 9,407,540
=============================================================================================================
See accompanying notes to consolidated financial statements.
64
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Income
Years Ended December 31,
-----------------------------------------
(Dollars in Thousands, Except Per Share Data) 2000 1999 1998
--------------------------------------------------------------------------------------------------------------------------
Interest income:
Loans receivable ....................................................... $ 760,538 $ 519,006 $ 421,942
U.S. Treasury securities and agency obligations ........................ 13,387 8,025 7,078
Mortgage-backed securities ............................................. 1,060 1,638 2,780
Other investments ...................................................... 9,375 5,082 8,604
--------------------------------------------------------------------------------------------------------------------------
Total interest income ............................................... 784,360 533,751 440,404
--------------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits ............................................................... 379,303 256,764 248,337
Borrowings ............................................................. 130,419 64,161 17,720
Capital securities ..................................................... 12,163 5,348 --
--------------------------------------------------------------------------------------------------------------------------
Total interest expense .............................................. 521,885 326,273 266,057
--------------------------------------------------------------------------------------------------------------------------
Net interest income .................................................... 262,475 207,478 174,347
Provision for loan losses .................................................. 3,251 11,270 3,899
--------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses .................... 259,224 196,208 170,448
--------------------------------------------------------------------------------------------------------------------------
Other income, net:
Loan and deposit related fees .......................................... 30,089 20,097 15,645
Real estate and joint ventures held for investment, net:
Operations, net ..................................................... 6,683 10,430 14,510
Net gains on sales of wholly owned real estate ...................... 2,981 5,206 2,557
(Provision for) reduction of losses on real estate and joint ventures (866) 3,666 5,296
Secondary marketing activities:
Loan servicing fees ................................................. (3,628) 1,672 259
Net gains on sales of loans and mortgage-backed securities .......... 3,297 14,806 6,462
Net gains (losses) on sales of investment securities ................... (106) 288 68
Gain on sale of subsidiary ............................................. 9,762 -- --
Other .................................................................. 2,342 3,113 2,556
--------------------------------------------------------------------------------------------------------------------------
Total other income, net ............................................. 50,554 59,278 47,353
--------------------------------------------------------------------------------------------------------------------------
Operating expense:
Salaries and related costs ............................................. 82,522 86,163 66,152
Premises and equipment costs ........................................... 23,220 20,617 16,834
Advertising expense .................................................... 4,786 8,595 5,954
Professional fees ...................................................... 3,319 2,502 2,867
SAIF insurance premiums and regulatory assessments ..................... 2,626 3,937 3,832
Other general and administrative expense ............................... 19,716 22,568 20,251
--------------------------------------------------------------------------------------------------------------------------
Total general and administrative expense ............................ 136,189 144,382 115,890
--------------------------------------------------------------------------------------------------------------------------
Net operation of real estate acquired in settlement of loans ........... 818 19 260
Amortization of excess of cost over fair value of net assets acquired .. 462 474 510
--------------------------------------------------------------------------------------------------------------------------
Total operating expense ............................................. 137,469 144,875 116,660
--------------------------------------------------------------------------------------------------------------------------
Income before income taxes ................................................. 172,309 110,611 101,141
Income taxes ............................................................... 73,058 46,807 43,168
--------------------------------------------------------------------------------------------------------------------------
Net income ............................................................. $ 99,251 $ 63,804 $ 57,973
==========================================================================================================================
PER SHARE INFORMATION:
Basic .................................................................. $ 3.52 $ 2.27 $ 2.06
==========================================================================================================================
Diluted ................................................................ $ 3.51 $ 2.26 $ 2.05
==========================================================================================================================
Cash dividends declared and paid ....................................... $ 0.36 $ 0.35 $ 0.32
==========================================================================================================================
Weighted average diluted shares outstanding ............................ 28,225,551 28,175,537 28,176,243
==========================================================================================================================
See accompanying notes to consolidated financial statements.
65
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Years Ended December 31,
------------------------------------
(In Thousands) 2000 1999 1998
-----------------------------------------------------------------------------------------------------------------------
Net income ..................................................................... $ 99,251 $ 63,804 $ 57,973
-----------------------------------------------------------------------------------------------------------------------
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 ............................ 2,032 (1,874) 1,104
Mortgage-backed securities available for sale, at fair value .............. 173 (281) (422)
Less reclassification of realized gains (losses) included in net income ... (50) 166 39
-----------------------------------------------------------------------------------------------------------------------
Total other comprehensive income (loss), net of income taxes (benefits) ..... 2,255 (2,321) 643
-----------------------------------------------------------------------------------------------------------------------
Comprehensive income ........................................................... $ 101,506 $ 61,483 $ 58,616
=======================================================================================================================
Consolidated Statements of Stockholders' Equity
Accumulated
Additional Other
Common Paid-in Comprehensive Retained
(Dollars in Thousands, Except Per Share Data) Stock Capital Income (Loss) Earnings Total
-------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 .................... $ 268 $ 45,954 $ 110 $ 384,014 $ 430,346
Cash dividends, $0.32 per share .................. -- -- -- (8,889) (8,889)
Stock dividend ................................... 13 45,702 -- (45,732) (17)
Exercise of stock options ........................ -- 510 -- -- 510
Unrealized gains on securities available for sale -- -- 643 -- 643
Net income ....................................... -- -- -- 57,973 57,973
-------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 .................... 281 92,166 753 387,366 480,566
Cash dividends, $0.35 per share .................. -- -- -- (9,850) (9,850)
Exercise of stock options ........................ -- 219 -- -- 219
Unrealized losses on securities available for sale -- -- (2,321) -- (2,321)
Net income ....................................... -- -- -- 63,804 63,804
-------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1999 .................... 281 92,385 (1,568) 441,320 532,418
Cash dividends, $0.36 per share .................. -- -- -- (10,143) (10,143)
Exercise of stock options ........................ 1 854 -- -- 855
Unrealized gains on securities available for sale -- -- 2,255 -- 2,255
Net income ....................................... -- -- -- 99,251 99,251
-------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 2000 .................... $ 282 $ 93,239 $ 687 $ 530,428 $ 624,636
=========================================================================================================================
See accompanying notes to consolidated financial statements.
66
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended December 31,
---------------------------------------
(In Thousands) 2000 1999 1998
--------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income ................................................................... $ 99,251 $ 63,804 $ 57,973
Adjustments to reconcile net income to net cash used for operating activities:
Depreciation and amortization ............................................. 32,957 22,427 16,660
Provision for (recovery of) losses on loans, real estate acquired in
settlement of loans, investments in real estate and joint ventures and
other assets ............................................................ 4,527 7,640 (1,017)
Net gains on sales of loans and mortgage-backed securities, investment
securities, real estate and other assets ................................ (10,111) (27,086) (20,365)
Gain on sale of subsidiary ................................................ (9,762) -- --
Interest capitalized on loans (negative amortization) ..................... (72,641) (29,429) (18,953)
Federal Home Loan Bank stock dividends .................................... (7,522) (2,941) (2,728)
Loans originated for sale .................................................... (1,729,220) (2,042,274) (2,162,583)
Proceeds from sales of:
Loans held for sale ....................................................... 586,728 935,485 1,130,164
Mortgage-backed securities available for sale ............................. 963,712 1,386,151 608,158
Increase in other, net ....................................................... (27,160) (12,829) (5,294)
--------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities ........................... (169,241) 300,948 (397,985)
--------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities: Proceeds from sales of:
Subsidiary, net ........................................................... 379,234 -- --
U.S. Treasury securities, agency obligations and other
investment securities available for sale ................................ 29,645 67,195 60,319
Loans held for investment ................................................. 99,751 50,856 --
Wholly owned real estate and real estate acquired in settlement
of loans ................................................................ 38,707 25,863 14,035
Federal Home Loan Bank stock .............................................. 17,516 -- --
Proceeds from maturities of U.S. Treasury securities, agency obligations
and other investment securities available for sale ........................ 22,000 -- 10,001
Purchase of:
U.S. Treasury securities, agency obligations and other investment
securities available for sale ........................................... (181,905) (126,403) (25,000)
Loans receivable held for investment ...................................... (18,828) (49,669) (7,463)
Federal Home Loan Bank stock .............................................. (13,958) (50,021) (2,617)
Loans receivable originated held for investment (net of refinances of $165,148
at December 31, 2000, $145,316 at December 31, 1999 and
$120,638 at December 31, 1998) ............................................ (3,317,104) (4,938,395) (1,854,801)
Principal payments on loans receivable held for investment and
mortgage-backed securities available for sale ............................. 1,823,685 1,688,205 1,830,492
Net change in undisbursed loan funds ......................................... (59,588) 38,154 43,222
Investments in real estate held for investment ............................... (1,356) (10,712) (4,074)
Other, net ................................................................... (8,334) (14,655) (10,147)
--------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities ........................... (1,190,535) (3,319,582) 53,967
--------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
67
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
Years Ended December 31,
-----------------------------------------
(In Thousands) 2000 1999 1998
-----------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase in deposits .................................................... $ 1,519,928 $ 1,523,028 $ 169,755
Net decrease in securities sold under agreements to repurchase .............. -- -- (34,803)
Proceeds from Federal Home Loan Bank advances ............................... 6,059,445 7,166,737 857,200
Repayments of Federal Home Loan Bank advances ............................... (6,203,504) (5,739,342) (514,646)
Net decrease in other borrowings ............................................ (149) (8,335) (87,766)
Proceeds from issuance of capital securities, net ........................... -- 115,063 --
Proceeds from exercise of stock options ..................................... 855 219 510
Cash dividends .............................................................. (10,143) (9,850) (8,889)
-----------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities ...................................... 1,366,432 3,047,520 381,361
-----------------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents ...................................... 6,656 28,886 37,343
Cash and cash equivalents at beginning of period ............................... 121,147 92,261 54,918
-----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period ..................................... $ 127,803 $ 121,147 $ 92,261
=============================================================================================================================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest .................................................................. $ 511,943 $ 325,769 $ 266,407
Income taxes .............................................................. 73,744 22,064 52,784
Supplemental disclosure of non-cash investing:
Loans transferred from (to) held for investment to (from) held for sale ..... 54,993 42,570 (3,056)
Loans exchanged for mortgage-backed securities .............................. 970,319 1,387,364 608,831
Real estate acquired in settlement of loans ................................. 18,389 11,263 14,958
Loans to facilitate the sale of real estate acquired in settlement of loans . 6,896 6,501 14,084
=============================================================================================================================
See accompanying notes to consolidated financial statements.
68
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
For the Years Ended December 31, 2000, 1999 and 1998
(1) Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements of Downey Financial Corp. and
subsidiaries ("Downey") include all accounts of Downey Financial Corp. and
the consolidated accounts of all subsidiaries, including Downey Savings and
Loan Association, F.A. (the "Bank"). All significant intercompany balances
and transactions have been eliminated.
Business
Downey provides a full range of financial services to individual and
corporate customers. Downey is subject to competition from other financial
institutions. Downey is subject to the regulations of certain governmental
agencies and undergoes periodic examinations by those regulatory
authorities.
Basis of Financial Statement Presentation
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. In preparing the consolidated
financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities as
of the dates of the balance sheets and the results of operations for the
reporting periods. Actual results could differ significantly from those
estimates.
Material estimates that are particularly susceptible to significant change
in the near term relate to the determination of the allowances for losses
on loans, real estate and mortgage servicing rights ("MSRs"). Management
believes that the allowances established for losses on loans, real estate
and MSRs are adequate. While management uses available information to
recognize losses on loans, real estate and MSRs, future additions to the
allowances may be necessary based on changes in economic conditions. In
addition, various regulatory agencies, as an integral part of their
examination process, periodically review Downey's allowances for losses on
loans, real estate and MSRs. Such agencies may require Downey to recognize
additions to the allowances based on their judgments about information
available to them at the time of their examination.
Downey is required to carry its loans held for sale portfolio,
mortgage-backed and investment securities available for sale portfolio,
real estate acquired in settlement of loans, real estate held for
investment or under development and MSRs at the lower of cost or fair value
or in certain cases, at fair value. Fair value estimates are made at a
specific point in time based upon relevant market information and other
information about the asset. Such estimates related to the mortgage-backed
and investment securities portfolios include published bid prices or bid
quotations received from securities dealers. Fair value estimates for real
estate acquired in settlement of loans and real estate held for investment
or under development is determined by current appraisals and, where no
active market exists for a particular property, discounting a forecast of
expected cash flows at a rate commensurate with the risk involved.
Cash and Cash Equivalents
For purposes of the statements of cash flows, cash and cash equivalents
include cash on hand, amounts due from banks, certificates of deposit with
maturities three months or less and federal funds sold. Generally, federal
funds are purchased and sold for one-day periods.
69
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Mortgage-Backed Securities Purchased Under Resale Agreements, U.S. Treasury
Securities and Agency Obligations, Other Investment Securities, Municipal
Securities and Mortgage-Backed Securities
Downey has established written guidelines and objectives for its investing
activities. At the time of purchase of a mortgage-backed security purchased
under resale agreement, U.S. Treasury security and agency obligation, other
investment security, municipal security or a mortgage-backed security,
management of Downey designates the security as either held to maturity,
available for sale or held for trading based on Downey's investment
objectives, operational needs and intent. Downey then monitors its
investment activities to ensure that those activities are consistent with
the established guidelines and objectives.
Held to Maturity. Securities held to maturity are carried at cost, adjusted
for amortization of premiums and accretion of discounts which are
recognized in interest income using the interest method. Mortgage-backed
securities represent participating interests in pools of long-term first
mortgage loans originated and serviced by the issuers of the securities.
Mortgage-backed securities held to maturity are carried at unpaid principal
balances, adjusted for unamortized premiums and unearned discounts.
Premiums and discounts on mortgage-backed securities are amortized using
the interest method over the remaining period to contractual maturity,
adjusted for anticipated prepayments. It is the positive intent of Downey,
and Downey has the ability, to hold these securities until maturity as part
of its portfolio of long-term, interest-earning assets. If the cost basis
of these securities is determined to be other than temporarily impaired,
the amount of the impairment is charged to operations.
Available for Sale. Securities available for sale are carried at fair
value. Premiums and discounts are amortized using the interest method over
the remaining period to contractual maturity and, in the case of
mortgage-backed securities, adjusted for anticipated prepayments.
Unrealized holding gains and losses, or valuation allowances established
for net unrealized losses, are excluded from earnings and reported as a
separate component of stockholders' equity as accumulated other
comprehensive income, net of income taxes, unless the security is deemed
other than temporarily impaired. If the security is determined to be other
than temporarily impaired, the amount of the impairment is charged to
operations.
Realized gains and losses on the sale of securities available for sale,
determined using the specific identification method and recorded on a trade
date basis, are reflected in earnings.
Held for Trading. Securities held for trading are carried at market value.
Realized and unrealized gains and losses are reflected in earnings.
Loans Held for Sale
Downey identifies those loans which foreseeably may be sold prior to
maturity. These loans have been classified as held for sale in the
Consolidated Balance Sheets and are recorded at the lower of amortized cost
or market value. In response to unforeseen events such as changes in
regulatory capital requirements, liquidity shortfalls, changes in the
availability of sources of funds and excess loan demand by borrowers that
could not be controlled immediately by loan price changes, Downey may sell
loans which had been held for investment. In such occurrences, the loans
are transferred at amortized cost and the lower of cost or market method is
then applied.
Gains or Losses on Sales of Loans and Mortgage Servicing Assets
Gains or losses on sales of loans are recognized at the time of sale and
are determined by the difference between the net sales proceeds and the
allocated basis of the loans sold. Downey capitalizes MSRs acquired through
either the purchase or origination of mortgage loans for sale or
securitization with servicing rights retained. The total cost of the
mortgage loans designated for sale is allocated to the MSRs and the
mortgage loans without the MSRs based on their relative fair values. The
MSRs are included as a component of gain on sale of loans. The MSRs are
amortized in proportion to and over the estimated period of net servicing
income. Such amortization is reflected as a component of loan servicing
fees.
70
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
The MSRs are periodically reviewed for impairment based on their fair
value. The fair value of the MSRs, for the purposes of impairment, is
measured using a discounted cash flow analysis based on market-adjusted
discount rates and anticipated prepayment speeds. Market sources are used
to determine prepayment speeds, the net cost of servicing per loan, and
inflation, default and interest rates for mortgages.
The Company capitalizes and measures impairment on a disaggregated basis
based on the following predominant risk characteristics of the underlying
mortgage loans: fixed-rate mortgage loans by loan term and coupon rate
(less than 7%, 150 basis point increments between 7% and 10%, and greater
than 10%), and loan term for adjustable rate mortgages. Impairment losses
are recognized through a valuation allowance for each impaired stratum,
with any associated provision recorded as a component of loan servicing
fees.
Derivative Financial Instruments
As part of its secondary marketing activities, Downey utilizes forward sale
contracts to hedge the value of loans originated for sale against adverse
changes in interest rates. These contracts have a high correlation to the
price movement of the loans being hedged. There is no recognition of
unrealized gains and losses on these contracts in the balance sheet or
statement of income. When the related loans are sold, the deferred gains or
losses from these contracts are recognized in the statement of income as a
component of net gains or losses on sales of loans and mortgage-backed
securities.
Loans Receivable Held for Investment
Loans receivable are recorded at cost, net of discounts and premiums,
undisbursed loan proceeds, net deferred fees and costs and the allowance
for loan losses.
Interest income on loans is accrued based on the outstanding principal
amount of loans using the interest method. Discounts and premiums on loans
are amortized to income using the interest method over the remaining period
to contractual maturity. The amortization of discounts into income is
discontinued on loans that are contractually ninety days past due or when
collection of interest appears doubtful.
Loan origination fees and related incremental direct loan origination costs
are deferred and amortized to income using the interest method over the
contractual life of the loans, adjusted for actual prepayments. Fees
received for a commitment to originate or purchase a loan or group of loans
are deferred and, if the commitment is exercised, recognized over the life
of the loan as an adjustment of yield or, if the commitment expires
unexercised, recognized as income upon expiration of the commitment. The
amortization of deferred fees and costs is discontinued on loans that are
contractually ninety days past due or when collection of interest appears
doubtful.
Accrued interest on loans that are contractually ninety days or more past
due or when collection of interest appears doubtful is generally reversed
and charged against interest income. Income is subsequently recognized only
to the extent cash payments are received and the principal balance is
expected to be recovered. Such loans are restored to an accrual status only
if the loan is brought contractually current and the borrower has
demonstrated the ability to make future payments of principal and interest.
Allowance for Loan Losses
The allowance for loan losses is maintained at an amount management deems
adequate to cover inherent losses. Downey has implemented and adheres to an
internal asset review system and loan loss allowance methodology designed
to provide for the detection of problem assets and an adequate allowance to
cover loan losses. In determining the allowance for loan losses related to
specific major loans (loans over $5 million), management evaluates its
allowance on an individual loan basis, including an analysis of the
creditworthiness, cash flows and financial status of the borrower, and the
condition and the estimated value of the collateral. Downey reviews all
loans under $5 million by analyzing their performance and
71
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
composition of their collateral as a whole, because of the relatively
homogeneous nature of the portfolios. Given the above evaluations, 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 loans with no well-defined deficiency or
weakness and are determined by applying against such loans factors for each
major loan category that consider past loss experience and loan duration.
Allocated allowances relate to loans with well-defined deficiencies or
weaknesses and are generally determined by loss factors that consider past
loss experience for such loans or are determined by the excess of the
recorded investment in the loan over the fair value of the collateral,
where appropriate. The unallocated allowance is more subjective and is
reviewed quarterly to take into consideration estimation errors and other
factors such as prevailing and forecasted economic conditions.
Downey considers a loan to be impaired when, based upon current information
and events, it believes it is probable that Downey will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. In determining impairment, Downey considers large
non-homogeneous loans with the following characteristics: non-accrual
loans, debt restructurings and performing loans which exhibit, among other
characteristics, high loan-to-value ratios or delinquent taxes. Downey
bases the measurement of collateral dependent impaired loans on the fair
value of the loan's collateral. Non-collateral dependent loans are valued
based on a present value calculation of expected future cash flows,
discounted at the loan's effective rate. Cash receipts on impaired loans
not performing according to contractual terms are generally used to reduce
the carrying value of the loan, unless Downey believes it will recover the
remaining principal balance of the loan. Impairment losses are included in
the allowance for loan losses through a charge to provision for loan
losses. Adjustments to impairment losses due to changes in the fair value
of collateral of impaired loans are included in provision for loan losses.
Upon disposition of an impaired loan, loss of principal, if any, is
recorded through a charge-off to the allowance for loan losses.
In the opinion of management, and in accordance with the loan loss
allowance methodology, the present allowance is considered adequate to
absorb estimable and probable loan losses. Additions to the allowances are
reflected in current operations. Charge-offs to the allowance are made when
the loan is considered uncollectible or is transferred to real estate
owned. Recoveries are credited to the allowance.
For regulatory capital purposes, the Bank's general allowance for loan
losses is included to a limit of 1.25% of regulatory risk-weighted assets.
Loan Servicing
Downey services mortgage loans for investors. Fees earned for servicing
loans owned by investors are reported as income when the related mortgage
loan payments are collected. Loan servicing costs are charged to expense as
incurred.
Investment in Real Estate and Joint Ventures
Real estate held for investment or under development is held at the lower
of cost (less accumulated depreciation) or fair value. Costs, including
interest, of holding real estate in the process of development or
improvement are capitalized, whereas costs relating to holding completed
property are expensed. An allowance for losses is established by a charge
to operations if the carrying value of a property exceeds its fair value,
including the consideration of disposition costs.
Downey utilizes the equity method of accounting for investments in
non-controlled joint ventures and the consolidation method for investments
in controlled joint ventures. All intercompany profits are eliminated.
Income from the sale of real estate is recognized principally when title to
the property has passed to the buyer, minimum down payment requirements are
met and the terms of any notes received by Downey satisfy continuing
investment requirements. At the time of sale, costs are relieved from real
estate projects on a relative sales value basis and charged to operations.
72
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Real Estate Acquired in Settlement of Loans
Real estate acquired through foreclosure is initially recorded at fair
value (net of an allowance for estimated selling costs and delinquent
property taxes) on the date of foreclosure and a writedown is recorded or a
valuation allowance is established for any subsequent declines in fair
value. All legal fees and direct costs, including foreclosure and other
related costs, are expensed as incurred.
Premises and Equipment
Buildings, leasehold improvements and furniture, fixtures and equipment are
carried at cost, less accumulated depreciation and amortization. Buildings
and furniture, fixtures and equipment are depreciated using the
straight-line method over the estimated useful lives of the assets. The
cost of leasehold improvements is being amortized using the straight-line
method over the shorter of the estimated useful life of the asset or the
terms of the related leases.
Impairment of Long-Lived Assets
Downey reviews long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying
amount of an asset to future net cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the
assets exceed the fair value of the assets. Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs to
sell.
Securities Sold Under Agreements to Repurchase
Downey enters into sales of securities under agreements to repurchase
("reverse repurchase agreements"). Reverse repurchase agreements are
treated as financing arrangements and, accordingly, the obligations to
repurchase the securities sold are reflected as liabilities in Downey's
consolidated financial statements. The securities collateralizing reverse
repurchase agreements are delivered to several major national brokerage
firms who arranged the transactions. These securities are reflected as
assets in Downey's consolidated financial statements. The brokerage firms
may loan such securities to other parties in the normal course of their
operations and agree to return the identical securities to Downey at the
maturity of the agreements.
Income Taxes
Downey applies the asset and liability method of accounting for income
taxes. The asset and liability method recognizes deferred income taxes for
the tax consequences of "temporary differences" by applying enacted
statutory tax rates applicable to future years to differences between the
financial statement carrying amounts and the tax bases of existing assets
and liabilities. The effect on deferred taxes of a change in tax rates is
recognized in income in the period that includes the enactment date.
Deferred tax assets are to be recognized for temporary differences that
will result in deductible amounts in future years and for tax carryforwards
if, in the opinion of management, it is more likely than not that the
deferred tax assets will be realized.
Stock Option Plan
Downey records compensation expense on the date of grant only if the
current market price of the underlying stock exceeded the exercise price
rather than recognizing as expense over the vesting period the fair value
of all stock-based awards on the date of grant. However, Downey provides
pro forma net income and pro forma net income per share disclosures for
employee stock option grants made since 1995 as if the fair-value of all
stock-based awards as of the grant date are recognized as expense over the
vesting period.
73
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Per Share Information
Two earnings per share ("EPS") measures are presented. Basic EPS 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 EPS 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.
Current Accounting Pronouncement
Statement of Financial Accounting Standards No. 140. In September 2000, the
Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities - a replacement of FASB
Statement No. 125," which revises the standards for accounting for
securitizations and other transfers of financial assets and collateral and
requires certain disclosures. Although it replaces FASB Statement No. 125,
it carries over most of statement 125's provisions without reconsideration.
The accounting provisions are effective for fiscal years beginning after
March 15, 2001. The reclassification and disclosure provisions are
effective for fiscal years beginning after December 15, 2000. It is not
anticipated that the financial impact of this statement will have a
material effect on Downey.
Statement of Financial Accounting Standards No. 133. In June 1998, the
Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met, a
derivative may be specifically designated as (a) a hedge of the exposure to
changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment, (b) a hedge of the exposure to variable cash
flows of a forecasted transaction or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available for sale security or a
foreign-currency-denominated forecasted transaction.
Under SFAS 133, an entity that elects to apply hedge accounting is required
to establish at the inception of the hedge the method it will use for
assessing the effectiveness of the hedging derivative and the measurement
approach for determining the ineffective aspect of the hedge. Those methods
must be consistent with the entity's approach to managing risk.
This statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000. It is not anticipated that the financial
impact of this statement will have a material impact on Downey.
As part of secondary marketing activities, Downey utilizes forward sale and
purchase derivative contracts to hedge the value of loans originated for
sale against adverse changes in interest rates. At December 31, 2000, sales
contracts amounted to approximately $150 million. These contracts have a
high correlation to the price movement of the loans being hedged. There is
no recognition of unrealized gains and losses on these contracts in the
balance sheet or statement of income. When the related loans are sold, the
deferred gains or losses from these contracts are recognized in the
statement of income as a component of net gains or losses on sales of loans
and mortgage-backed securities.
On January 1, 2001, Downey adopted SFAS 133, and at that time, designated
those sales contracts as cash flow derivative instruments in accordance
with the requirements of the new standard. These cash flow derivative
instruments hedge the variability of forecasted cash flows attributable to
interest rate risk.
74
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Cash flow hedges are accounted for by recording the value of the derivative
instrument on the balance sheet as either an asset or liability with a
corresponding offset recorded in other comprehensive income within
stockholders' equity, net of tax. Amounts are reclassified from other
comprehensive income to the income statement in the period the hedged cash
flow occurs. Derivative gains and losses not considered effective in
hedging the change in expected cash flows of the hedged item are recognized
immediately in the income statement.
With the implementation of SFAS 133, Downey recorded after-tax transition
amounts associated with establishing the fair values of the derivative
instruments and hedged items on the balance sheet as an increase of $36,000
to net income and a reduction of $388,000 in other comprehensive income.
(In Thousands) 2001
-----------------------------------------------------------------------------
Summary of transition adjustment at January 1:
Balance Sheet
Assets
Other assets .............................................. $ 244
Deferred income tax benefit ............................... 260
-----------------------------------------------------------------------------
$ 504
=============================================================================
Liabilities and Stockholders' Equity
Accounts payable and accrued liabilities .................. $ 856
Accumulated other comprehensive loss - unrealized losses on
derivative instruments ................................... (388)
Retained earnings ......................................... 36
-----------------------------------------------------------------------------
$ 504
=============================================================================
Statement of Income
Cumulative effect of a change in accounting principle ....... $ 62
Income taxes ................................................ 26
-----------------------------------------------------------------------------
Net income ................................................ $ 36
=============================================================================
The transition adjustment will be presented as a cumulative effect
adjustment as described in Accounting Principles Board Opinion No. 20,
Accounting Changes, in Downey's 2001 financial statements. The transition
amounts were determined based on the interpretive guidance issued to date
by the Financial Accounting Standards Board. The Financial Accounting
Standards Board continues to issue interpretive guidance which could
require changes in Downey's application of the standard and adjustment to
the transition amounts. Downey will continue to hedge as previously done;
however, SFAS 133, as applied to our risk management strategies, may
increase or decrease reported net income and stockholders' equity
prospectively, depending on future levels of interest rates and other
variables affecting the fair values of derivative instruments and hedged
items, but will have no effect on cash flows or the overall economics of
the transactions.
(2) Business Combination
During 1988, the Bank acquired Butterfield Savings and Loan Association,
FSA ("Butterfield") from the Federal Savings and Loan Insurance Corporation
("FSLIC") in a FSLIC assisted acquisition.
Concurrent with the acquisition, the Bank and the FSLIC entered into an
assistance agreement ("Butterfield Assistance Agreement") that provides for
the indemnification of the Bank against losses incurred on the disposal of
certain defined covered assets and the settlement of certain unreserved
preacquisition liabilities or contingencies reduced by tax benefits
associated with those expenses as defined. Additionally, the FSLIC agreed
to provide yield maintenance assistance on certain covered assets at the
Federal Home
75
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Loan Bank ("FHLB") Eleventh District Cost of Funds Index ("COFI"). All such
amounts received are nontaxable under the Internal Revenue Code.
All assets subject to the Butterfield Assistance Agreement were sold or
repurchased by the Federal Deposit Insurance Corporation ("FDIC") on
December 29, 1995. By its terms, the Butterfield Assistance Agreement
terminated on March 31, 1997.
The Butterfield Assistance Agreement provides broad authority to the FDIC
to conduct audits. A compliance audit was completed by the FDIC for the
period July 1, 1993 to June 30, 1996. A final post termination audit of the
Butterfield Assistance Agreement by the FDIC remains to be completed.
(3) U.S. Treasury Securities, Agency Obligations and Other Investment
Securities Available for Sale
The amortized cost and estimated market value of U.S. Treasury securities,
agency obligations and other investment securities available for sale are
summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In Thousands) Cost Gains Losses Value
--------------------------------------------------------------------------------
U.S. Treasury and agency securities $283,132 $ 1,069 $ 99 $284,102
Corporate securities .............. 21,212 301 -- 21,513
--------------------------------------------------------------------------------
December 31, 2000 ................. $304,344 $ 1,370 $ 99 $305,615
================================================================================
U.S. Treasury and agency securities
at December 31, 1999 ............ $174,223 $ -- $ 2,400 $171,823
================================================================================
At December 31, 2000, $283 million in amortized cost and $284 million in
estimated market value of these investment securities contain call
provisions. The call dates range from January 5, 2001 to June 2, 2002.
The amortized cost and estimated market value of U.S. Treasury securities,
agency obligations and other investment securities available for sale at
December 31, 2000, by contractual maturity, are shown below.
Amortized Market
(In Thousands) Cost Value
---------------------------------------------------------------------------
Due in one year or less ................. $ 5,000 $ 5,008
Due after one year through five years (1) 299,344 300,607
---------------------------------------------------------------------------
Total ................................... $304,344 $305,615
===========================================================================
(1) No investment matures beyond five years.
Proceeds, gross realized gains and losses on the sales of U.S. Treasury
securities, agency obligations and other investment securities available
for sale are summarized as follows:
(In Thousands) 2000 1999 1998
---------------------------------------------------------------------------
Proceeds ............ $29,645 $67,195 $60,319
===========================================================================
Gross realized gains $ 4 $ 288 $ 68
===========================================================================
Gross realized losses $ 110 $ -- $ --
===========================================================================
Net unrealized gains on investment securities available for sale were
recognized in stockholders' equity as accumulated other comprehensive
income in the amount of $1.3 million, or $0.7 million net of income
76
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
taxes, at December 31, 2000, compared to net unrealized losses of $2.4
million, or $1.4 million net of income taxes, at December 31, 1999.
(4) Loans and Mortgage-Backed Securities Purchased Under Resale Agreements and
Other Investment Securities Held to Maturity
Loans and Mortgage-Backed Securities Purchased Under Resale Agreements
There were no outstanding loans or mortgage-backed securities purchased
under resale agreements at December 31, 2000 or 1999. The average interest
rate and balance of such transactions was 6.70% and $3 million,
respectively, during 2000 and 5.16% and $4 million, respectively, during
1999. There was no amount outstanding at any month-end during 2000 and
1999.
Municipal Securities Held to Maturity
The amortized cost and estimated market value of municipal securities held
to maturity are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In Thousands) Cost Gains Losses Value
--------------------------------------------------------------------------
December 31, 2000 $6,550 $ -- $ 16 $6,534
==========================================================================
December 31, 1999 $6,728 $ -- $ 18 $6,710
==========================================================================
All of the investment at December 31, 2000 and all but $30,000 of the
investment in 1999 represents an industrial revenue bond on which the
interest income is not subject to federal income taxes and matures in 2015.
(5) Mortgage-Backed Securities Available for Sale
The amortized cost and estimated market value of the mortgage-backed
securities available for sale are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In Thousands) Cost Gains Losses Value
----------------------------------------------------------------------------
December 31, 2000:
FHLMC certificates .... $ 4,182 $ -- $ 29 $ 4,153
Non-agency certificates 6,086 6 42 6,050
----------------------------------------------------------------------------
Total .............. $10,268 $ 6 $ 71 $10,203
============================================================================
December 31, 1999:
GNMA certificates ..... $ 5,112 $ 100 $ 1 $ 5,211
FNMA certificates ..... 125 3 -- 128
FHLMC certificates .... 8,936 -- 257 8,679
Non-agency certificates 7,897 10 206 7,701
----------------------------------------------------------------------------
Total .............. $22,070 $ 113 $ 464 $21,719
============================================================================
Net unrealized losses on mortgage-backed securities available for sale were
recognized in stockholders' equity as accumulated other comprehensive
income in the amount of $65,000, or $37,000 net of income taxes, at
December 31, 2000. At December 31, 1999, net unrealized losses were
recognized in
77
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
stockholders' equity as accumulated other comprehensive income in the
amount of $350,000, or $202,000 net of income taxes.
Proceeds, gross realized gains and losses on the sales of mortgage-backed
securities available for sale are summarized as follows:
(In Thousands) 2000 1999 1998
---------------------------------------------------------------------------
Proceeds ............ $ 963,712 $1,386,151 $ 608,158
===========================================================================
Gross realized gains $ 4,788 $ 14,017 $ 3,490
===========================================================================
Gross realized losses $ 5,690 $ 2,504 $ 3,814
===========================================================================
(6) Loans Receivable
Loans receivable are summarized as follows:
December 31,
---------------------------
(In Thousands) 2000 1999
------------------------------------------------------------------------------------
Held for investment:
Loans secured by real estate:
Residential:
One-to-four units ............................. $ 7,655,238 $ 6,155,399
One-to-four units - subprime .................. 1,743,914 1,639,401
Five or more units ............................ 19,460 21,055
Commercial real estate .......................... 164,604 148,327
Construction .................................... 118,165 176,487
Land ............................................ 26,880 67,631
Non-mortgage:
Commercial ...................................... 21,721 26,667
Automobile ...................................... 39,614 399,789
Other consumer .................................. 60,653 49,344
------------------------------------------------------------------------------------
Total loans receivable held for investment .... 9,850,249 8,684,100
Less:
Undisbursed loan funds .......................... (72,328) (125,159)
Net deferred costs and premiums ................. 79,109 67,740
Allowance for estimated losses .................. (34,452) (38,342)
------------------------------------------------------------------------------------
Total loans receivable held for investment, net $ 9,822,578 $ 8,588,339
====================================================================================
Held for sale:
Loans secured by residential one-to-four units ..... $ 251,572 $ 136,005
====================================================================================
Over 93% of the real estate securing Downey's loans is located in
California.
78
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
A summary of activity in the allowance for loan losses for loans receivable
held for investment during 2000, 1999 and 1998 follows:
Not
Real Other Specifically
(In Thousands) Estate Commercial Automobile Consumer Allocated Total
--------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 ........... $ 20,256 $ 196 $ 8,016 $ 824 $ 2,800 $ 32,092
Provision for (reduction of) loan losses (1,480) 22 5,287 70 -- 3,899
Charge-offs ............................ (1,103) -- (6,118) (151) -- (7,372)
Recoveries ............................. 1,735 -- 1,159 4 -- 2,898
--------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 ........... 19,408 218 8,344 747 2,800 31,517
Provision for loan losses .............. 9,252 116 1,879 23 -- 11,270
Charge-offs ............................ (580) -- (4,795) (160) -- (5,535)
Recoveries ............................. 250 -- 831 9 -- 1,090
--------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 ........... 28,330 334 6,259 619 2,800 38,342
Provision for loan losses .............. 2,350 108 517 276 -- 3,251
Charge-offs ............................ (735) -- (832) (182) -- (1,749)
Recoveries ............................. 269 -- 136 14 -- 419
Transfers (1) .......................... -- -- (5,811) -- -- (5,811)
--------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 ........... $ 30,214 $ 442 $ 269 $ 727 $ 2,800 $ 34,452
==============================================================================================================
(1) Reduction in 2000 was due to the sale of subsidiary.
Net charge-offs represented 0.01%, 0.06% and 0.08% of average loans for
2000, 1999 and 1998, respectively.
All impaired loans at December 31, 2000 and 1999 were secured by commercial
real estate. The following table presents impaired loans with specific
allowances and the amount of such allowances and impaired loans without
specific allowances.
Net Specific Net
(In Thousands) Carrying Value Allowance Balance
---------------------------------------------------------------------------
December 31, 2000:
Loans with specific allowances .. $ -- $ -- $ --
Loans without specific allowances 13,841 -- 13,841
---------------------------------------------------------------------------
Total impaired loans ............ $13,841 $ -- $13,841
===========================================================================
December 31, 1999:
Loans with specific allowances .. $ -- $ -- $ --
Loans without specific allowances 13,049 -- 13,049
---------------------------------------------------------------------------
Total impaired loans ............ $13,049 $ -- $13,049
===========================================================================
The average recorded investment in impaired loans totaled $13 million in
both 2000 and 1999. During 2000, total interest recognized on the impaired
loan portfolio was $2.9 million, compared to $1.9 million in 1999 and $2.0
million in 1998.
The combined weighted average interest yield on loans receivable held for
investment and sale was 8.45% and 7.67% as of December 31, 2000 and 1999,
respectively, and averaged 7.99%, 7.48% and 7.89% during 2000, 1999 and
1998, respectively.
79
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
The aggregate amount of non-accrual loans receivable that are contractually
past due 90 days or more as to principal or interest, in the foreclosure
process, restructured, or upon which interest collection is doubtful were
$45 million and $33 million as of December 31, 2000 and 1999, respectively.
At December 31, 2000 we had less than $1 million of troubled debt
restructurings on accrual status representing a single one-to-four unit
residential loan.
Interest due on non-accrual loans, but excluded from interest income, was
approximately $1.8 million for 2000, $1.1 million for 1999 and $0.5 million
for 1998.
Downey has had, and expects in the future to have, transactions in the
ordinary course of business with executive officers, directors and their
associates ("related parties") on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for
comparable transactions with other non-related parties. In the opinion of
management, those transactions neither involve more than the normal risk of
collectibility nor present any unfavorable features. At December 31, 2000,
the Bank had extended loans to two of its directors and their associates
totaling $23 million. At December 31, 1999, the Bank had extended loans to
one director and his associates totaling $27 million. All such loans are
performing in accordance with their loan terms. Presented below is a
summary of activity with respect to such loans for the years ending
December 31, 2000 and 1999:
(In Thousands) 2000 1999
---------------------------------------------------------------------------
Balance at beginning of period $ 26,657 $ 25,763
Additions .................... 632 4,149
Repayments ................... (4,222) (3,255)
---------------------------------------------------------------------------
Balance at end of period ..... $ 23,067 $ 26,657
===========================================================================
(7) Investments in Real Estate and Joint Ventures
Investments in real estate and joint ventures are summarized as follows:
December 31,
(In Thousands) 2000 1999
--------------------------------------------------------------------------------------
Gross investments in real estate (1) ......................... $ 23,948 $ 46,715
Accumulated depreciation ..................................... (7,313) (7,127)
Allowance for estimated losses ............................... (1,492) (2,131)
--------------------------------------------------------------------------------------
Investments in real estate ................................. 15,143 37,457
--------------------------------------------------------------------------------------
Investments in and interest bearing advances to joint ventures 4,003 4,715
Joint venture valuation allowance ............................ (1,505) --
--------------------------------------------------------------------------------------
Investments in joint ventures .............................. 2,498 4,715
--------------------------------------------------------------------------------------
Total investments in real estate and joint ventures ........ $ 17,641 $ 42,172
======================================================================================
(1) Includes $0.9 million invested in low income housing.
80
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
The table set forth below describes the type, location and amount invested
in real estate and joint ventures, net of specific valuation allowances of
$3 million and general valuation allowances of less than $1 million, at
December 31, 2000:
(In Thousands) California Arizona Other Total
----------------------------------------------------------------------------------------------------
Shopping centers ..................................... $ 1,916 $ 6,351 $ -- $ 8,267
Office buildings ..................................... 702 -- -- 702
Residential .......................................... 3,063 -- -- 3,063
Land ................................................. 5,524 109 459 6,092
----------------------------------------------------------------------------------------------------
Total real estate before general valuation allowance $ 11,205 $ 6,460 $ 459 18,124
General valuation allowance .......................... (483)
----------------------------------------------------------------------------------------------------
Net investment in real estate and joint ventures ..... $ 17,641
====================================================================================================
A summary of real estate and joint venture operations included in Downey's
results of operations follows:
(In Thousands) 2000 1999 1998
-------------------------------------------------------------------------------------------------
Wholly owned operations:
Rental operations:
Rental income .......................................... $ 3,617 $ 4,950 $ 5,189
Costs and expenses ..................................... (1,045) (1,128) (1,466)
-------------------------------------------------------------------------------------------------
Net rental operations ................................ 2,572 3,822 3,723
Net gains on sales of real estate ......................... 2,981 5,206 2,557
Reduction of losses on real estate ........................ 639 2,266 5,081
-------------------------------------------------------------------------------------------------
Total wholly owned operations .......................... 6,192 11,294 11,361
-------------------------------------------------------------------------------------------------
Joint venture operations:
Equity in net income from joint ventures .................. 3,224 5,352 9,203
Reduction of (provision for) losses provided by DSL Service
Company ................................................ (1,505) 1,400 215
-------------------------------------------------------------------------------------------------
Net joint venture operations ........................... 1,719 6,752 9,418
Interest from joint venture advances ........................ 887 1,256 1,584
-------------------------------------------------------------------------------------------------
Total joint venture operations ............................ 2,606 8,008 11,002
-------------------------------------------------------------------------------------------------
Total .................................................. $ 8,798 $ 19,302 $ 22,363
=================================================================================================
81
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Activity in the allowance for losses on real estate and investments in
joint ventures for 2000, 1999 and 1998 is as follows:
Real Estate Commercial Residential
Held for Real Estate Real Estate Investments
or Under Held for Held for In Joint
(In Thousands) Development Investment Investment Ventures Total
------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 ................ $ 5,829 $ 2,021 $ 11,767 $ 1,627 $ 21,244
Provision for (reduction of) estimated losses 33 (427) (4,687) (215) (5,296)
Charge-offs ................................. (1,151) -- (7,080) -- (8,231)
Recoveries .................................. -- -- -- -- --
------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 ................ 4,711 1,594 -- 1,412 7,717
Reduction of estimated losses ............... (1,741) (525) -- (1,400) (3,666)
Charge-offs ................................. (1,908) -- -- (12) (1,920)
Recoveries .................................. -- -- -- -- --
------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 ................ 1,062 1,069 -- -- 2,131
Provision for (reduction of) estimated losses -- (639) -- 1,505 866
Charge-offs ................................. -- -- -- -- --
Recoveries .................................. -- -- -- -- --
------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 ................ $ 1,062 $ 430 $ -- $ 1,505 $ 2,997
============================================================================================================
82
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Condensed financial information of joint ventures reported on the equity
method is as follows:
Condensed Combined Balance Sheets - Joint Ventures
December 31,
---------------------
(In Thousands) 2000 1999
----------------------------------------------------------------------------------
Assets
Cash ..................................................... $ 2,182 $ 1,870
Projects under development ............................... 6,879 12,523
Completed projects ....................................... 20,468 25,155
Other assets ............................................. 1,474 2,903
----------------------------------------------------------------------------------
$ 31,003 $ 42,451
==================================================================================
Liabilities and Equity
Liabilities:
Notes payable to the Bank .............................. $ 23,398 $ 34,697
Notes payable to others ................................ 4,282 3,230
Other .................................................. 4,755 6,175
Equity (deficit):
DSL Service Company (1) ................................ 2,498 4,715
Allowance for losses recorded by DSL Service Company (2) 1,505 --
Other partners' (2) .................................... (5,435) (6,366)
----------------------------------------------------------------------------------
Net deficit .......................................... (1,432) (1,651)
----------------------------------------------------------------------------------
$ 31,003 $ 42,451
==================================================================================
(1) Included in these amounts are interest-bearing joint venture advances
with priority interest payments from joint ventures to DSL Service
Company.
(2) The aggregate other partners' deficit of $5 million and $6 million at
December 31, 2000 and 1999, respectively, represents their equity
interest in the accumulated retained earnings (deficit) of the
respective joint ventures. Those results include not only the net
profit on sales and the operating results of the real estate assets,
but depreciation expense and funding costs as well. Except for any
secured financing which has been obtained, DSL Service Company has
provided all other financing. As part of Downey's internal asset
review process, the fair value of the joint venture real estate assets
is compared to the secured notes payable to the Bank and others and
DSL Service Company's investment. To the extent the fair value of the
real estate assets is less than the aggregate of those amounts, a
provision is made to create a valuation allowance. The allowance at
December 31, 2000 totaled $2 million.
83
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Condensed Combined Statements of Operations - Joint Ventures
(In Thousands) 2000 1999 1998
-----------------------------------------------------------------------------------
Real estate sales:
Sales ...................................... $ 32,237 $ 40,096 $ 59,095
Cost of sales .............................. (26,021) (31,770) (39,261)
-----------------------------------------------------------------------------------
Net gains on sales ........................ 6,216 8,326 19,834
-----------------------------------------------------------------------------------
Rental operations:
Rental income .............................. 3,849 5,825 6,252
Operating expenses ......................... (901) (2,192) (2,409)
Interest, depreciation and other expenses .. (3,131) (4,236) (5,271)
-----------------------------------------------------------------------------------
Net loss on rental operations ............. (183) (603) (1,428)
-----------------------------------------------------------------------------------
Net income .................................... 6,033 7,723 18,406
Less other partners' share of net income ...... 2,809 2,371 9,203
-----------------------------------------------------------------------------------
DSL Service Company's share of net income ..... 3,224 5,352 9,203
Reduction of (provision for) losses provided by
DSL Service Company ......................... (1,505) 1,400 215
-----------------------------------------------------------------------------------
DSL Service Company's share of net income ..... $ 1,719 $ 6,752 $ 9,418
===================================================================================
(8) Real Estate Acquired in Settlement of Loans
Real estate acquired in settlement of loans is recorded at the lower of
cost or fair value on an individual asset basis.
The type and amount of real estate acquired in settlement of loans is
summarized as follows:
December 31,
---------------
(In Thousands) 2000 1999
---------------------------------------------------------------------------
Residential one-to-four units ..................... $6,651 $4,973
Residential one-to-four units - subprime .......... 3,291 926
---------------------------------------------------------------------------
Total real estate acquired in settlement of loans $9,942 $5,899
===========================================================================
A summary of net operation of real estate acquired in settlement of loans
included in Downey's results of operations follows:
(In Thousands) 2000 1999 1998
------------------------------------------------------------------------------------------------
Net gains on sales ............................................ $ (669) $ (704) $(1,417)
Net operating expense ......................................... 1,075 768 1,222
Provision for (reduction of) estimated losses ................. 412 (45) 455
------------------------------------------------------------------------------------------------
Net operations of real estate acquired in settlement of loans $ 818 $ 19 $ 260
================================================================================================
84
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Activity in the allowance for estimated losses on real estate acquired
through foreclosure for 2000, 1999 and 1998 is as follows:
(In Thousands) 2000 1999 1998
---------------------------------------------------------------------------
Balance at beginning of period ................. $-- $ 533 $ 839
Provision for (reduction of) real estate losses 412 (45) 455
Charge-offs .................................... (442) (488) (761)
Recoveries ..................................... 30 -- --
---------------------------------------------------------------------------
Balance at end of period ....................... $-- $-- $ 533
===========================================================================
(9) Premises and Equipment
Premises and equipment are summarized as follows:
December 31,
----------------------
(In Thousands) 2000 1999
---------------------------------------------------------------------------
Land .................................... $ 24,626 $ 23,653
Building and improvements ............... 91,361 90,591
Furniture, fixtures and equipment ....... 67,331 64,693
Construction in progress ................ 769 18
Other ................................... 62 62
---------------------------------------------------------------------------
Total premises and equipment .......... 184,149 179,017
Accumulated depreciation and amortization (79,971) (71,039)
---------------------------------------------------------------------------
Total premises and equipment, net ..... $ 104,178 $ 107,978
===========================================================================
Downey has commitments under long term operating leases, principally for
building space and land. Lease terms generally cover a five-year period.
Rental expense was $2.3 million in 2000, $2.1 million in 1999 and $1.7
million in 1998. The following table summarizes future minimum rental
commitments under noncancelable leases.
(In Thousands)
---------------------------------------------------------------------------
2001 ......... $2,247
2002 ......... 1,725
2003 ......... 1,264
2004 ......... 588
2005 ......... 646
Thereafter (1) 769
---------------------------------------------------------------------------
Total future lease commitments $7,239
===========================================================================
(1) There are no lease commitments beyond the year 2010 though options to
renew at that time are available.
85
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
(10) Federal Home Loan Bank Stock
The Bank's required investment in FHLB stock, based on December 31, 2000
financial data, was $99 million. The investment in FHLB stock amounted to
$106 million and $102 million at December 31, 2000 and 1999, respectively.
(11) Mortgage Servicing Rights
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of mortgage
loans serviced for others was $4.0 billion at December 31, 2000 and $2.9
billion at December 31, 1999.
Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in demand deposits, were $8 million and $5 million
at December 31, 2000 and 1999, respectively.
A summary of activity in mortgage servicing rights and the allowance for
mortgage servicing rights during 2000, 1999 and 1998 as well as the
estimated fair value of mortgage servicing rights at each period end are as
follows:
(In Thousands) 2000 1999 1998
----------------------------------------------------------------------------
Gross balance at beginning of period ... $ 34,266 $ 8,256 $ 2,161
Additions .............................. 18,510 29,271 7,276
Amortization ........................... (5,968) (3,051) (653)
Sale of servicing ...................... -- -- (17)
Impairment write-down .................. (594) (210) (511)
----------------------------------------------------------------------------
Gross balance at end of period ...... 46,214 34,266 8,256
----------------------------------------------------------------------------
Allowance balance at beginning of period 3 464 206
Provision for (reduction of) impairment 6,074 (251) 769
Impairment write-down .................. (594) (210) (511)
----------------------------------------------------------------------------
Allowance balance at end of period .. 5,483 3 464
----------------------------------------------------------------------------
Mortgage servicing rights, net ...... $ 40,731 $ 34,263 $ 7,792
============================================================================
Estimated fair value (1) ............... $ 41,826 $ 37,048 $ 7,844
============================================================================
(1) The estimated fair value exceeded book value for certain asset
stratum. Excludes loans sold or securitized prior to 1996 without
capitalized mortgage servicing rights.
The unpaid principal balances of mortgage loans serviced for others with
capitalized mortgage servicing rights was $3.8 billion at December 31, 2000
and $2.7 billion at December 31, 1999. The weighted average interest rate
on the associated loans was 7.56% at December 31, 2000 and 7.23% at
December 31, 1999.
The components of loan servicing fees included in Downey's results of
operations are summarized as follows:
(In Thousands) 2000 1999 1998
------------------------------------------------------------------------
Income from servicing operations ...... $ 8,414 $ 4,472 $ 1,681
Amortization of MSRs .................. (5,968) (3,051) (653)
(Provision for) reduction of impairment (6,074) 251 (769)
------------------------------------------------------------------------
Loan servicing fees ................... $(3,628) $ 1,672 $ 259
========================================================================
86
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
(12) Other Assets
Other assets are summarized as follows:
December 31,
-----------------
(In Thousands) 2000 1999
---------------------------------------------------------------------------
Accounts receivable .......................... $ 2,406 $ 3,338
Accrued interest receivable:
Loans ...................................... 61,131 43,240
Mortgage-backed securities ................. 60 123
Investment securities ...................... 6,206 3,360
Prepaid expenses ............................. 14,210 12,362
Excess of purchase price over fair value of
assets acquired and liabilities assumed, net 3,608 4,070
Repossessed automobiles, net ................. 76 314
Other ........................................ 2,997 2,268
---------------------------------------------------------------------------
Total other assets ......................... $90,694 $69,075
===========================================================================
(13) Deposits
Deposits are summarized as follows:
December 31,
---------------------------------------------
2000 1999
---------------------------------------------
Weighted Weighted
Average Average
(Dollars in Thousands) Rate Amount Rate Amount
---------------------------------------------------------------------------------
Transaction accounts:
Non-interest-bearing checking . -% $ 244,311 -% $ 182,165
Interest-bearing checking (1) . 0.78 395,640 1.00 383,973
Money market .................. 2.88 89,408 2.91 95,947
Regular passbook .............. 3.41 754,127 3.62 827,854
---------------------------------------------------------------------------------
Total transaction accounts . 2.12 1,483,486 2.46 1,489,939
Certificates of deposit:
Less than 3.00% ............... 2.41 6,357 2.47 8,717
3.00-3.49 ..................... 3.45 25 3.02 16
3.50-3.99 ..................... 3.97 384 3.92 3,786
4.00-4.49 ..................... 4.19 26,916 4.32 210,127
4.50-4.99 ..................... 4.82 80,844 4.78 939,858
5.00-5.99 ..................... 5.71 1,901,166 5.56 3,623,632
6.00-6.99 ..................... 6.63 4,558,730 6.07 284,984
7.00 and greater .............. 7.02 24,781 7.32 1,702
---------------------------------------------------------------------------------
Total certificates of deposit 6.33 6,599,203 5.39 5,072,822
---------------------------------------------------------------------------------
Total deposits .............. 5.56% $8,082,689 4.72% $6,562,761
=================================================================================
(1) Includes amounts swept into money market accounts.
87
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was $2.3 billion and $1.7 billion at December 31,
2000 and 1999, respectively.
At December 31, 2000, scheduled maturities of certificates of deposit are
as follows:
Weighted
(Dollars in Thousands) Average Rate Amount
---------------------------------------------------------------------------
2001 ..... 6.34% $5,955,136
2002 ..... 6.30 614,832
2003 ..... 5.57 19,689
2004 ..... 5.43 4,746
2005 ..... 6.10 4,800
Thereafter - --
---------------------------------------------------------------------------
Total 6.33% $6,599,203
===========================================================================
The weighted average cost of deposits averaged 5.20%, 4.51% and 4.87%
during 2000, 1999 and 1998, respectively.
As of December 31, 2000 and 1999 public funds of approximately $5 million
and $3 million, respectively, are secured by mortgage loans with a carrying
value of approximately $7 million and $5 million at December 31, 2000 and
1999, respectively.
Interest expense on deposits by type is summarized as follows:
(In Thousands) 2000 1999 1998
---------------------------------------------------------------------------
Interest-bearing checking (1) .. $ 3,520 $ 3,517 $ 3,142
Money market ................... 2,544 2,641 2,626
Regular passbook ............... 27,841 26,224 17,102
Certificate accounts ........... 345,398 224,382 225,467
---------------------------------------------------------------------------
Total deposit interest expense $379,303 $256,764 $248,337
===========================================================================
(1) Includes amounts swept into money market accounts.
Accrued interest on deposits, which is included in accounts payable and
accrued liabilities, was $3 million at December 31, 2000 and $2 million at
December 31, 1999.
88
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
(14) Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase are summarized as follows:
(Dollars in Thousands) 2000 1999 1998
--------------------------------------------------------------------------------------------
Balance at year end ....................................... $ -- $ -- $ --
Average balance outstanding during the year ............... 753 1,987 1,877
Maximum amount outstanding at any month-end during the year 39,250 24,875 50,088
Weighted average interest rate during the year ............ 6.10% 5.42% 5.90%
Weighted average interest rate at year end ................ - - -
============================================================================================
The securities collateralizing these transactions were delivered to major
national brokerage firms who arranged the transactions. Securities sold
under agreements to repurchase generally mature within 30 days of the
various dates of sale.
(15) Federal Home Loan Bank Advances
FHLB advances are summarized as follows:
(Dollars in Thousands) 2000 1999 1998
-----------------------------------------------------------------------------------------------------
Balance at year end ....................................... $1,978,348 $2,122,407 $ 695,012
Average balance outstanding during the year ............... 2,117,787 1,169,474 247,521
Maximum amount outstanding at any month-end during the year 2,460,276 2,122,407 695,012
Weighted average interest rate during the year ............ 6.15% 5.44% 5.85%
Weighted average interest rate at year end ................ 6.26 5.77 5.47
As of year end secured by:
Loans receivable ........................................ $2,222,863 $2,395,599 $ 789,588
=====================================================================================================
In addition to the collateral securing existing advances, Downey had an
additional $779 million in loans available as collateral for any future
advances as of December 31, 2000.
FHLB advances have the following maturities at December 31, 2000:
(In Thousands)
---------------------------------------------------------------------------
2001 ..... $1,491,293
2002 ..... 55,921
2003 ..... 134
2004 ..... --
2005 ..... 1,000
Thereafter 430,000
---------------------------------------------------------------------------
Total .. $1,978,348
===========================================================================
89
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
(16) Commercial Paper
Commercial paper borrowings are summarized as follows:
(Dollars in Thousands) 2000 1999 1998
-------------------------------------------------------------------------------------------
Balance at year end ....................................... $ -- $ -- $ --
Average balance outstanding during the year ............... -- -- 30,589
Maximum amount outstanding at any month-end during the year -- -- 103,749
Weighted average interest rate during the year ............ -% -% 6.32%
Weighted average interest rate at end of year ............. - - -
===========================================================================================
The commercial paper program was discontinued during 1998.
(17) Other Borrowings
Other borrowings are summarized as follows:
December 31,
--------------
(Dollars In Thousands) 2000 1999
---------------------------------------------------------------------------------------
Long-term notes payable to banks, secured by real estate and mortgage
loans with a carrying value of $669 at December 31, 2000, bearing
interest rates of 7.88% to 9.88% .................................... $224 $373
=======================================================================================
Other borrowings have the following maturities at December 31, 2000:
(In Thousands)
---------------------------------------------------------------------------
2001 ..... $ 186
2002 ..... 7
2003 ..... --
2004 ..... --
2005 ..... --
Thereafter 31
---------------------------------------------------------------------------
Total .. $ 224
===========================================================================
90
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
(18) Income Taxes
Current income taxes payable were $4 million and $12 million at December
31, 2000 and 1999, respectively.
Deferred tax liabilities (assets) are comprised of the following temporary
differences between the financial statement carrying amounts and the tax
basis of assets:
December 31,
---------------------
(In Thousands) 2000 1999
---------------------------------------------------------------------------------
Deferred tax liabilities:
Tax reserves in excess of base year .................. $ 22,115 $ 21,904
Mortgage servicing rights, net of allowances ......... 17,783 14,818
FHLB stock dividends ................................. 11,588 8,197
Deferred loan fees ................................... 6,882 5,344
Depreciation on premises and equipment ............... 2,093 2,737
Equity in joint ventures ............................. 1,724 --
Unrealized gains on investment securities ............ 519 --
---------------------------------------------------------------------------------
Total deferred tax liabilities .................... 62,704 53,000
---------------------------------------------------------------------------------
Deferred tax assets:
Loan valuation allowances, net of bad debt charge-offs (16,172) (18,017)
California franchise tax ............................. (5,651) (3,959)
Real estate and joint venture valuation allowances ... (2,734) (2,180)
Deferred compensation ................................ (2,289) (1,895)
Other deferred income items .......................... (2,056) (1,217)
Unrealized losses on investment securities ........... -- (1,183)
Mark to market adjustment on loans held for sale ..... (72) (357)
Equity in joint ventures ............................. -- (293)
---------------------------------------------------------------------------------
Total deferred tax assets ......................... (28,974) (29,101)
Deferred tax assets valuation allowance ................. -- --
---------------------------------------------------------------------------------
Net deferred tax liability .............................. $ 33,730 $ 23,899
=================================================================================
91
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Income taxes (benefits) are summarized as follows:
(In Thousands) 2000 1999 1998
---------------------------------------------------------------------------
Federal:
Current ..................... $ 48,714 $ 18,382 $ 38,474
Deferred .................... 5,567 19,821 (5,848)
---------------------------------------------------------------------------
Total federal income taxes $ 54,281 $ 38,203 $ 32,626
===========================================================================
State:
Current ..................... $ 16,214 $ 8,186 $ 10,955
Deferred .................... 2,563 418 (413)
---------------------------------------------------------------------------
Total state income taxes . $ 18,777 $ 8,604 $ 10,542
===========================================================================
Total:
Current ..................... $ 64,928 $ 26,568 $ 49,429
Deferred .................... 8,130 20,239 (6,261)
---------------------------------------------------------------------------
Total income taxes ....... $ 73,058 $ 46,807 $ 43,168
===========================================================================
A reconciliation of income taxes (benefits) to the expected statutory
federal corporate income taxes follows:
2000 1999 1998
--------------------------------------------------------------
(Dollars in Thousands) Amount Percent Amount Percent Amount Percent
----------------------------------------------------------------------------------------------------------------
Expected statutory income taxes ............... $ 60,308 35.0% $ 38,714 35.0% $ 35,399 35.0%
California franchise tax, net of federal income
tax benefit ................................. 12,206 7.1 7,606 6.9 6,880 6.8
Increase (decrease) resulting from:
Amortization of goodwill .................... 162 0.1 166 0.2 253 0.3
Interest on municipal bonds ................. (99) (0.1) (105) (0.1) (107) (0.1)
Other ....................................... 481 0.3 426 0.3 743 0.7
----------------------------------------------------------------------------------------------------------------
Income taxes .................................. $ 73,058 42.4% $ 46,807 42.3% $ 43,168 42.7%
================================================================================================================
Downey made income tax payments, net of refunds, amounting to $73.7
million, $22.1 million and $52.8 million in 2000, 1999 and 1998,
respectively.
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 1995 and are
currently reviewing returns filed for the 1996 tax year. Downey made a
payment of $10.7 million during the year to settle federal tax claims
related to the sale and leaseback of computer equipment in 1990. This
amount had been previously reflected in Downey's tax accrual, and therefore
had no adverse impact upon current year earnings. In addition, Downey's
management believes it has adequately provided for potential exposure with
regard to other tax issues in the years currently under examination. Tax
years subsequent to 1996 remain open to review by federal and state tax
authorities.
92
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
(19) Capital Securities
On July 23, 1999, Downey, through Downey Financial Capital Trust I (the
"Trust"), issued $120 million in 10.00% capital securities. The capital
securities, which were sold in a public underwritten offering, pay
quarterly cumulative cash distributions at an annual rate of 10.00% of the
liquidation value of $25 per share and are recorded as interest expense by
Downey. The capital securities represent undivided beneficial interests in
the Trust, which was established by Downey for the purpose of issuing the
capital securities. Downey owns all of the issued and outstanding common
securities of the Trust. Proceeds from the offering and from the issuance
of common securities were invested by the Trust in 10.00% Junior
Subordinated Deferrable Interest Debentures due September 15, 2029 issued
by Downey (the "Junior Subordinated Debentures"), with an aggregate
principal amount of $124 million. The sole asset of the Trust is the Junior
Subordinated Debentures. The obligations of the Trust with respect to the
securities are fully and unconditionally guaranteed by Downey. The payment
of distributions on the capital securities may be deferred if Downey defers
payments of interest on the junior subordinated debentures. Downey will
have the right, on one or more occasions, to defer payments of interest on
the junior subordinated debentures for up to 20 consecutive quarterly
periods. During the time Downey defers interest payments, interest on the
junior subordinated debentures will continue to accrue and distributions on
the capital securities will continue to accumulate and the deferred
interest and deferred distributions will themselves accrue interest at an
annual rate of 10.00%, compounded quarterly, to the extent permitted by
applicable law. Downey may redeem, in whole or in part, the junior
subordinated debentures before their maturity at a redemption price of 100%
of their principal amount plus accrued and unpaid interest on or after July
23, 2004.
Downey invested $108 million of the $115 million of net proceeds from the
sale of the Junior Subordinated Debentures (net of underwriting discounts
and commissions and other offering expenses) as additional common stock of
the Bank thereby increasing the Bank's regulatory core / tangible capital
by that amount. The balance of the net proceeds have been used for general
corporate purposes.
93
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
(20) Stockholders' Equity
Regulatory Capital
Downey is not subject to any regulatory capital requirements. However, the
Bank is subject to regulation by the Office of Thrift Supervision ("OTS")
which has adopted regulations ("Capital Regulations") that contain a
capital standard for savings institutions. The Bank is in compliance with
the Capital Regulations at December 31, 2000 and 1999.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------- ----------------- -----------------
(Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio
--------------------------------------------------------------------------------------------------------------
2000
Risk-based capital
(to risk-weighted assets) $731,844 12.94% $452,480 8.00% $565,601 10.00%
Core capital
(to adjusted assets) .... 697,715 6.42 325,791 3.00 542,985 5.00
Tangible capital
(to adjusted assets) .... 697,715 6.42 162,896 1.50 -- - (1)
Tier I capital
(to risk-weighted assets) 697,715 12.34 -- - (1) 339,360 6.00
--------------------------------------------------------------------------------------------------------------
1999
Risk-based capital
(to risk-weighted assets) $623,863 12.14% $410,955 8.00% $513,693 10.00%
Core capital
(to adjusted assets) .... 585,909 6.27 280,382 3.00 467,304 5.00
Tangible capital
(to adjusted assets) .... 585,909 6.27 140,191 1.50 -- - (1)
Tier I capital
(to risk-weighted assets) 585,909 11.41 -- - (1) 308,216 6.00
==============================================================================================================
(1) Ratio is not specified under capital regulations.
Capital Distributions
The OTS rules impose certain limitations regarding stock repurchases and
redemptions, cash-out mergers and any other distributions charged against
an institution's capital accounts. The payment of dividends by the Bank is
subject to OTS regulations. Inasmuch as the Bank is owned by a holding
company, the Bank is required to provide the OTS with a notice before
payment of any dividend. Prior OTS approval is required, however, to the
extent the Bank would not be considered adequately capitalized under the
prompt corrective action regulations of the OTS following the distribution
or the amount of the dividend exceeds the Bank's retained net income for
that year to date plus retained net income for the preceding two years.
As of December 31, 2000, the Bank had the capacity to declare a dividend
totaling $193 million without obtaining prior OTS approval.
Stock Dividend
On April 22, 1998, the Board of Directors declared a five percent stock
dividend on Downey's common stock payable on May 22, 1998 to stockholders
of record on May 7, 1998. The stock dividend resulted in the issuance of
1,337,271 shares and the par value of the common stock remained at $0.01.
Accordingly,
94
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
$13,000 and $45.7 million were transferred from retained earnings to common
stock and additional paid-in-capital, respectively. All share and per share
data, including stock option plan information, have been restated to
reflect this distribution.
Employee Stock Option Plans
During 1994, the Bank adopted and the stockholders approved the Downey
Savings and Loan Association 1994 Long Term Incentive Plan (the "LTIP").
The LTIP provides for the granting of stock appreciation rights, restricted
stock, performance awards and other awards. The LTIP specifies an
authorization of 434,110 shares (adjusted for stock dividends and splits)
of the Bank's common stock available for issuance under the LTIP. Effective
January 23, 1995, Downey Financial Corp. and the Bank executed an amendment
to the LTIP by which Downey Financial Corp. adopted and ratified the LTIP
such that shares of Downey Financial Corp. shall be issued upon exercise of
options or payment of other awards, for which payment is to be made in
stock, in lieu of the Bank's common stock.
During 2000 and 1999, no shares were granted under the LTIP, while in 1998,
120,335 shares were granted.
Options outstanding under the LTIP at December 31, 2000 and 1999 are
summarized as follows:
Outstanding Options
-------------------
Number Average
of Option
Shares Price
---------------------------------------------------------------------------
December 31, 1997 143,886 $ 13.40
Options granted . 120,335 25.44
Options exercised (38,567) 13.26
Options canceled (6,203) 13.39
---------------------------------------------------------------------------
December 31, 1998 219,451 20.03
Options granted . -- --
Options exercised (16,633) 13.16
Options canceled (2,068) 13.39
---------------------------------------------------------------------------
December 31, 1999 200,750 20.66
Options granted . -- --
Options exercised (57,332) 14.91
Options canceled -- --
---------------------------------------------------------------------------
December 31, 2000 143,418 $ 22.96
===========================================================================
Under the LTIP, options are exercisable over vesting periods specified in
each grant and, unless exercised, the options terminate between five or ten
years from the date of the grant. Further, under the LTIP, the option price
shall at least equal or exceed the fair market value of such shares on the
date the options are granted.
At December 31, 2000, 143,418 were outstanding at a weighted average
remaining contractual life of six years, of which 71,214 options were
exercisable at a weighted average option price per share of $20.45 and
127,722 shares were available for future grants under the LTIP. At December
31, 1999 and 1998, options of 100,344 and 78,439, respectively, were
exercisable at a weighted average option price per share of $16.30 and
$13.26, respectively.
Downey measures its employee stock-based compensation arrangements under
the provisions of APB 25. Accordingly, no compensation expense has been
recognized for the stock option plan. Had compensation expense for Downey's
stock option plan been determined based on the fair value at the grant date
for
95
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
previous awards, Downey's net income and income per share would have been
reduced to the pro forma amounts indicated below:
(In Thousands, Except Per Share Data) 2000 1999 1998
---------------------------------------------------------------------------
Net income:
As reported ............. $99,251 $63,804 $57,973
Pro forma ............... 99,172 63,611 57,954
Earnings per share - Basic:
As reported ............. $3.52 $2.27 $2.06
Pro forma ............... 3.52 2.26 2.06
Earnings per share - Diluted:
As reported ............. 3.51 2.26 2.05
Pro forma ............... 3.51 2.26 2.05
===========================================================================
The weighted average fair value at date of grant of options granted was
$7.77 during 1998. The fair value of options at date of grant was estimated
using the Black-Scholes model with the following weighted average
assumptions:
2000 (1) 1999 (1) 1998
---------------------------------------------------------------------------
Expected life (years) - - 3.11
Interest rate ....... -% -% 4.65%
Volatility .......... - - 40.31
Dividend yield ...... - - 1.23
===========================================================================
(1) No options were granted during the period.
(21) Earnings Per Share
A reconciliation of the components used to derive basic and diluted
earnings per share for 2000, 1999 and 1998 follows:
Net Weighted Average Per Share
(Dollars in Thousands, Except Per Share Data) Income Shares Outstanding Amount
------------------------------------------------------------------------------------------
2000:
Basic earnings per share ....... $99,251 28,177,152 $3.52
Effect of dilutive stock options -- 48,399 0.01
------------------------------------------------------------------------------------------
Diluted earnings per share ..... $99,251 28,225,551 $3.51
==========================================================================================
1999:
Basic earnings per share ....... $63,804 28,144,851 $2.27
Effect of dilutive stock options -- 30,686 0.01
------------------------------------------------------------------------------------------
Diluted earnings per share ..... $63,804 28,175,537 $2.26
==========================================================================================
1998:
Basic earnings per share ....... $57,973 28,111,855 $2.06
Effect of dilutive stock options -- 64,388 0.01
------------------------------------------------------------------------------------------
Diluted earnings per share ..... $57,973 28,176,243 $2.05
==========================================================================================
96
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
(22) Employee Benefit Plans
Retirement and Savings Plan
In August 1993, Downey amended its profit sharing plan so that it qualifies
as a profit sharing and savings plan under Section 401(k) of the Internal
Revenue Code (the "Plan"), covering substantially all salaried employees.
Under the Plan, employee contributions are partially matched by Downey.
Downey's matching contribution is equal to 25% of an employee's pretax
contributions which do not exceed 4% of the employee's annual compensation.
In addition, Downey makes an annual retirement contribution based on
Downey's net income and the employee's age, vested years of service and
salary. Downey's contributions to the Plan totaled $2.0 million for 2000,
compared to $1.9 million in both 1999 and 1998.
During 1995, Downey approved the implementation of a Deferred Compensation
Plan for key management employees and directors. The Deferred Compensation
Plan is considered to be an essential element in a comprehensive
competitive benefits package designed to attract and retain individuals who
contribute to the success of Downey. Participants are eligible to defer
compensation on a pre-tax basis, including director fees, and earn a
competitive interest rate on the amounts deferred. Currently, 66 management
employees and seven directors are eligible to participate in the program.
During 2000, 23 management employees and one director elected to defer
compensation pursuant to the plan. Downey's expense related to the Deferred
Compensation Plan has been less than $0.1 million each year since
inception.
Group Benefit Plan
Downey provides certain health and welfare benefits for active employees
under a cafeteria plan (the "Benefit Plan") as defined by section 125 of
the Internal Revenue Code. Under the Benefit Plan, employees make
appropriate selections as to the type of benefits and the amount of
coverage desired. The benefits are provided through insurance companies and
other health organizations and are funded by contributions from Downey,
employees and retirees and include deductibles, co-insurance provisions and
other limitations. Downey's expense for health and welfare benefits was
$3.9 million, $3.6 million and $3.1 million in 2000, 1999 and 1998,
respectively.
(23) Commitments and Contingencies
Litigation
Downey has 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.
Financial Instruments with Off-Balance-Sheet Risk
Downey is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers
and to reduce its own exposure to fluctuations in interest rates. These
financial instruments include commitments to originate fixed and variable
rate mortgage loans, commitments to sell or purchase loans and
mortgage-backed securities, letters of credit, lines of credit and loans in
process. The contract or notional amounts of those instruments reflect the
extent of involvement Downey has in particular classes of financial
instruments.
Downey uses the same credit policies in making commitments to originate
loans, lines of credit and letters of credit as it does for
on-balance-sheet instruments. For commitments to originate fixed rate
loans, the contract amounts represent exposure to loss from market
fluctuations as well as credit loss. To hedge adverse changes from market
fluctuations, Downey utilizes forward sale and purchase derivative
contracts that mature in less than one year. Downey controls the credit
risk of its commitments to originate fixed rate loans through credit
approvals, limits and monitoring procedures.
97
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
The following is a summary of commitments and contingent liabilities:
December 31,
-------------------
(In Thousands) 2000 1999
----------------------------------------------------------------------------------
Commitments to sell loans and mortgage-backed securities ... $149,898 $210,092
Commitments to purchase investment securities .............. -- 15,000
Commitments to purchase loans and mortgage-backed securities -- 13,992
Commitments to originate loans:
Adjustable .............................................. 454,782 422,145
Fixed ................................................... 239,415 184,695
Undisbursed loan funds and unused lines of credit .......... 148,304 209,414
Standby letters of credit and other contingent liabilities . 2,446 2,423
==================================================================================
Commitments to sell or purchase loans and mortgage-backed securities are
used as part of Downey's secondary marketing activities. These contracts
have a high correlation to the price movement on loans which provides a
hedge against adverse changes in interest rates.
Commitments to originate fixed and variable rate mortgage loans are
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a
fee. Since some of the commitments may expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements. The credit risk involved in issuing lines and letters of
credit requires the same creditworthiness evaluation as that involved in
extending loan facilities to customers. Downey evaluates each customer's
creditworthiness on a case-by-case basis. Undisbursed loan funds and unused
lines of credit include home equity lines of credit and funds not
disbursed, but committed to construction and commercial lending by the
Bank.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party.
Downey receives collateral to support commitments for which collateral is
deemed necessary. The most significant categories of collateral include
real estate properties underlying mortgage loans, liens on personal
property and cash on deposit with Downey. At December 31, 2000, the extent
of collateral supporting mortgage and other loans varied from nothing to
100% of the maximum credit exposure.
In connection with its interest rate risk management, Downey may enter into
interest rate exchange agreements ("swap contracts") with certain national
investment banking firms under terms that provide mutual payment of
interest on the outstanding notional amount of the swap. The effect of
these swaps serve to reduce Downey's interest rate risk between repricing
assets and liabilities. At December 31, 2000, no swap contracts were
outstanding.
(24) Risk Management
Derivative financial instruments are utilized to minimize the effect of
future fluctuations in interest rates as part of our secondary marketing
activities. Downey utilizes forward sale and purchase contracts to hedge
the value of loans designated for sale against adverse changes in interest
rates. These contracts are used to secure an agreed upon price at a future,
fixed delivery or receipt settlement date and the contracts mature in less
than one year. Gains or losses are recognized at the time the contracts
mature and are recorded as a component of gains on sales of loans and
mortgage-backed securities. At December 31, 2000, forward sales contracts
to hedge loans designated for sale amounted to $150 million. These
contracts expose Downey to credit risk in the event of nonperformance by
the other parties--primarily government-sponsored enterprises such as
Federal National Mortgage Association or Federal Home Loan Mortgage
Corporation --to such agreements. This risk consists primarily of the
termination value of
98
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
agreements where Downey is in a favorable position. Downey controls the
credit risk associated with its other parties to the various derivative
agreements through credit review, exposure limits and monitoring
procedures. Downey does not anticipate nonperformance by the other parties.
(25) Fair Value of Financial Instruments
Fair value estimates are made at a specific point in time based upon
relevant market information and other information about the financial
instrument. The estimates do not necessarily reflect the price Downey might
receive if it were to sell at one time its entire holding of a particular
financial instrument. Because no active market exists for a significant
portion of Downey's financial instruments, fair value estimates are based
upon the following methods and assumptions, some of which are subjective in
nature. Changes in assumptions could significantly affect the estimates.
Cash, Federal Funds Sold and Securities Purchased Under Resale Agreements
The carrying amounts reported in the balance sheet for these items
approximate fair value.
Investment Securities Including U.S. Treasuries and Mortgage-Backed
Securities
Fair value is based upon bid prices published in financial newspapers or
bid quotations received from securities dealers.
Loans Receivable
For residential mortgage loans, fair value is estimated based upon market
prices obtained from readily available market quote systems. The remaining
portfolio was segregated into those loans with variable rates of interest
and those with fixed rates of interest. For non-residential variable rate
loans which reprice frequently, fair values approximate carrying values.
For non-residential fixed rate loans, fair values are based on discounting
future contractual cash flows using the current rate offered for such loans
with similar remaining maturities and credit risk. The amounts so
determined for each category of loan are reduced by the associated
allowance for loan losses which thereby takes into consideration changes in
credit risk.
Interest-Bearing Advances to Joint Ventures
The carrying amounts approximate fair value as the interest earned is based
upon a variable rate.
Federal Home Loan Bank Stock
The carrying amounts approximate fair value.
Mortgage Servicing Rights
The fair value of MSRs related to loans serviced for others is determined
by computing the present value of the expected net servicing income from
the portfolio.
Deposits
The fair value of deposits with no stated maturity such as regular passbook
accounts, money market accounts and checking accounts, is the carrying
amount reported in the balance sheet. The fair value of deposits with a
stated maturity such as certificates of deposit is based on discounting
future contractual cash flows by the current rate offered for such deposits
with similar remaining maturities.
99
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Borrowings
For short-term borrowings, fair value approximates carrying value. The fair
value of long-term borrowings is based on their interest rate
characteristics. For variable rate borrowings, fair values approximate
carrying values. For fixed rate borrowings, fair value is based on
discounting future contractual cash flows by the current rate paid on such
borrowings with similar remaining maturities.
Capital Securities
Fair value is based upon closing stock price published in financial
information services or newspapers.
Off-Balance-Sheet Financial Instruments
Outstanding commitments to sell loans and mortgage-backed securities,
commitments to purchase mortgage-backed securities, standby letters of
credit and other contingent liabilities, unused lines of credit,
commitments to originate loans and mortgage-backed securities are
essentially carried at zero with a fair value of less than $1 million. See
Note 23 on page 97, for information concerning the notional amount of such
financial instruments.
100
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Based on the above methods and assumptions, the following table presents
the estimated fair value of Downey's financial instruments:
December 31, 2000 December 31, 1999
-------------------------------------------------
Carrying Estimated Carrying Estimated
(In Thousands) Amount (1) Fair Value Amount (1) Fair Value
-----------------------------------------------------------------------------------------------------------------------
Assets:
Cash .............................................................. $ 108,202 $ 108,202 $ 121,146 $ 121,146
Federal funds ..................................................... 19,601 19,601 1 1
U.S. Government and agency obligations and other
investment securities available for sale ....................... 305,615 305,615 171,823 171,823
Municipal securities held to maturity ............................. 6,550 6,534 6,728 6,710
Loans held for sale ............................................... 251,572 254,545 136,005 136,298
Mortgage-backed securities available for sale ..................... 10,203 10,203 21,719 21,719
Loans receivable held for investment: Loans secured by real estate:
Residential:
Adjustable ................................................. 8,990,538 9,104,257 7,319,949 7,308,374
Fixed ...................................................... 479,877 481,616 536,884 533,673
Other ........................................................ 236,659 243,585 269,833 276,140
Non-mortgage loans:
Commercial ................................................... 16,275 16,979 17,259 17,912
Consumer ..................................................... 99,229 100,533 444,414 453,425
Interest-bearing advances to joint ventures ....................... 12,339 12,339 15,613 15,613
Federal Home Loan Bank stock ...................................... 106,356 106,356 102,392 102,392
MSRs and loan servicing portfolio (2) ............................. 40,731 43,168 34,263 38,807
Liabilities:
Deposits:
Transaction accounts ........................................... 1,483,486 1,483,486 1,489,939 1,489,939
Certificates of deposit ........................................ 6,599,203 6,619,453 5,072,822 5,025,389
Borrowings ........................................................ 1,978,572 1,978,808 2,122,780 2,055,493
Capital securities ................................................ 120,000 122,400 120,000 102,000
=======================================================================================================================
(1) The carrying amount of loans is stated net of undisbursed loan funds,
unearned fees and discounts and allowances for losses.
(2) Includes mortgage servicing rights acquired prior to January 1, 1996
when Downey began capitalizing the asset.
101
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
(26) Business Segment Reporting
Downey views its business as consisting of two reportable business
segments--banking and real estate investment. The accounting policies of
the segments are the same as those described in Note 1, Summary of
Significant Accounting Policies on page 69. Downey evaluates performance
based on the net income generated by each segment. Internal expense
allocations between segments are independently negotiated and, where
possible, service and price is measured against comparable services
available in the external marketplace.
The following describes the two business segments.
Banking
The principal business activities of this segment are attracting funds from
the general public and institutions and originating and investing in loans,
primarily residential real estate mortgage loans, mortgage-backed
securities and investment securities.
This segment's primary sources of revenue are interest earned on mortgage
loans and mortgage-backed securities, income from investment securities,
gains on sales of loans and mortgage-backed securities, fees earned in
connection with loans and deposits and income earned on its portfolio of
loans and mortgage-backed securities serviced for investors.
This segment's principal expenses are interest incurred on interest-bearing
liabilities, including deposits and borrowings, and general and
administrative costs.
Real Estate Investment
Real estate development and joint venture operations are conducted
principally through the Bank's wholly owned service corporation subsidiary,
DSL Service Company. However, Downey Financial Corp. owned one investment
in land which it purchased from DSL Service Company at fair value in 1995
and sold in 1999.
DSL Service Company participates as an owner of, or a partner in, a variety
of real estate development projects, principally retail neighborhood
shopping center developments, most of which are located in California. Most
of the real estate development projects have been completed and are
substantially leased.
In its joint ventures, DSL Service Company is entitled to interest on its
equity invested in the project on a priority basis after third-party debt
and shares profits and losses with the developer partner, generally on an
equal basis. Partnership equity (deficit) accounts are affected by current
period results of operations, additional partner advances, partnership
distributions and partnership liquidations.
This segment's primary sources of revenue are net rental income and gains
from the sale of real estate investment assets. This segment's principal
expenses are interest expense and general and administrative expense.
102
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Operating Results and Assets
The following presents the operating results and selected financial data by
major business segments for 2000, 1999 and 1998:
Real Estate
(In Thousands) Banking Investment Elimination Totals
-------------------------------------------------------------------------------------------------------
Year ended December 31 2000:
Net interest income .................... $ 262,232 $ 243 $ -- $ 262,475
Provision for loan losses .............. 3,251 -- -- 3,251
Other income ........................... 41,406 9,148 -- 50,554
Operating expense ...................... 135,996 1,473 -- 137,469
Net intercompany income (expense) ...... 397 (397) -- --
-------------------------------------------------------------------------------------------------------
Income before income tax expense ....... 164,788 7,521 -- 172,309
Income tax expense ..................... 69,966 3,092 -- 73,058
-------------------------------------------------------------------------------------------------------
Net income .......................... $ 94,822 $ 4,429 $ -- $ 99,251
=======================================================================================================
Assets at December 31 2000:
Loans and mortgage-backed securities $ 10,084,353 $ -- $ -- $ 10,084,353
Real estate held for investment ..... -- 17,641 -- 17,641
Other ............................... 806,201 3,584 (17,916) 791,869
-------------------------------------------------------------------------------------------------------
Total assets ..................... 10,890,554 21,225 (17,916) 10,893,863
-------------------------------------------------------------------------------------------------------
Equity ................................. $ 624,636 $ 17,916 $ (17,916) $ 624,636
=======================================================================================================
Year ended December 31 1999:
Net interest income (expense) .......... $ 207,784 $ (306) $ -- $ 207,478
Provision for loan losses .............. 11,270 -- -- 11,270
Other income ........................... 39,755 19,523 -- 59,278
Operating expense ...................... 143,081 1,794 -- 144,875
Net intercompany income (expense) ...... 393 (393) -- --
-------------------------------------------------------------------------------------------------------
Income before income tax expense ....... 93,581 17,030 -- 110,611
Income tax expense ..................... 39,785 7,022 -- 46,807
-------------------------------------------------------------------------------------------------------
Net income .......................... $ 53,796 $ 10,008 $ -- $ 63,804
=======================================================================================================
Assets at December 31 1999:
Loans and mortgage-backed securities $ 8,746,063 $ -- $ -- $ 8,746,063
Real estate held for investment ..... -- 42,172 -- 42,172
Other ............................... 654,745 7,399 (42,839) 619,305
-------------------------------------------------------------------------------------------------------
Total assets ..................... 9,400,808 49,571 (42,839) 9,407,540
-------------------------------------------------------------------------------------------------------
Equity ................................. $ 532,418 $ 42,839 $ (42,839) $ 532,418
=======================================================================================================
Year ended December 31 1998:
Net interest income (expense) .......... $ 174,967 $ (620) $ -- $ 174,347
Provision for (reduction of) loan losses 3,918 (19) -- 3,899
Other income ........................... 24,617 22,736 -- 47,353
Operating expense ...................... 113,954 2,706 -- 116,660
Net intercompany income (expense) ...... (107) 107 -- --
-------------------------------------------------------------------------------------------------------
Income before income tax expense ....... 81,605 19,536 -- 101,141
Income tax expense ..................... 34,869 8,299 -- 43,168
-------------------------------------------------------------------------------------------------------
Net income .......................... $ 46,736 $ 11,237 $ 57,973
=======================================================================================================
Assets at December 31 1998:
Loans and mortgage-backed securities $ 5,788,365 $ -- $ -- $ 5,788,365
Real estate held for investment ..... -- 49,447 -- 49,447
Other ............................... 464,097 9,841 (41,331) 432,607
-------------------------------------------------------------------------------------------------------
Total assets ..................... 6,252,462 59,288 (41,331) 6,270,419
-------------------------------------------------------------------------------------------------------
Equity ................................. $ 480,566 $ 41,331 $ (41,331) $ 480,566
=======================================================================================================
103
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
(27) Selected Quarterly Financial Data (Unaudited)
Selected quarterly financial data are presented below by quarter for the
years ended December 31, 2000 and 1999:
December 31, September 30, June 30, March 31,
(In Thousands, Except Per Share Data) 2000 2000 2000 2000
-------------------------------------------------------------------------------------------------------
Total interest income ............................... $209,775 $204,370 $192,700 $177,515
Total interest expense .............................. 140,838 137,160 129,135 114,752
-------------------------------------------------------------------------------------------------------
Net interest income ............................... 68,937 67,210 63,565 62,763
Provision for loan losses ........................... 511 1,007 942 791
-------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 68,426 66,203 62,623 61,972
Total other income .................................. 7,545 12,065 9,467 21,477
Total operating expense ............................. 36,344 32,476 32,924 35,725
-------------------------------------------------------------------------------------------------------
Income before income taxes .......................... 39,627 45,792 39,166 47,724
Income taxes ....................................... 16,632 19,454 16,684 20,288
-------------------------------------------------------------------------------------------------------
Net income .......................................... $ 22,995 $ 26,338 $ 22,482 $ 27,436
=======================================================================================================
Net income per share:
Basic ............................................. $ 0.81 $ 0.94 $ 0.80 $ 0.97
Diluted ........................................... 0.81 0.93 0.80 0.97
=======================================================================================================
Market range:
High bid .......................................... $ 60.88 $ 40.94 $ 33.00 $ 21.44
Low bid ........................................... 33.13 29.94 20.44 18.75
End of period ..................................... 55.00 39.50 28.98 21.25
=======================================================================================================
December 31, September 30, June 30, March 31,
1999 1999 1999 1999
-------------------------------------------------------------------------------------------------------
Total interest income ............................... $161,244 $136,404 $122,209 $113,894
Total interest expense .............................. 104,962 85,361 71,012 64,938
-------------------------------------------------------------------------------------------------------
Net interest income ............................... 56,282 51,043 51,197 48,956
Provision for loan losses ........................... 3,253 2,838 2,798 2,381
-------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 53,029 48,205 48,399 46,575
Total other income .................................. 18,406 16,271 13,259 11,342
Total operating expense ............................. 37,092 35,805 35,521 36,457
-------------------------------------------------------------------------------------------------------
Income before income taxes .......................... 34,343 28,671 26,137 21,460
Income taxes ........................................ 14,507 12,109 11,079 9,112
-------------------------------------------------------------------------------------------------------
Net income .......................................... $ 19,836 $ 16,562 $ 15,058 $ 12,348
=======================================================================================================
Net income per share:
Basic ............................................. $ 0.71 $ 0.59 $ 0.53 $ 0.44
Diluted ........................................... 0.70 0.59 0.53 0.44
=======================================================================================================
Market range:
High bid .......................................... $ 22.94 $ 24.13 $ 23.00 $ 25.75
Low bid ........................................... 19.06 19.81 18.13 18.25
End of period ..................................... 20.19 20.13 21.94 18.31
=======================================================================================================
104
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
(28) Parent Company Financial Information
Downey Financial Corp. was incorporated in Delaware on October 21, 1994. On
January 23, 1995, after obtaining necessary stockholder and regulatory
approvals, Downey Financial Corp. acquired 100% of the issued and
outstanding capital stock of the Bank, and the Bank's stockholders became
stockholders of Downey Financial Corp. The transaction was accounted for in
a manner similar to a pooling-of-interests under generally accepted
accounting principles. Downey Financial Corp. was thereafter funded by a
$15 million dividend from the Bank. Condensed financial statements of
Downey Financial Corp. only are as follows:
Condensed Balance Sheets
December 31,
-------------------
(In Thousands) 2000 1999
---------------------------------------------------------------------------
Assets
Cash ................................ $ 11 $ 7
Due from Bank - interest bearing .... 17,635 12,686
Investment in subsidiaries:
Bank .............................. 722,829 636,213
Downey Financial Capital Trust I .. 3,711 3,711
Downey Affiliated Insurance Agency 202 204
Real estate held for investment ..... -- --
Other assets ........................ 5,028 5,016
---------------------------------------------------------------------------
$749,416 $657,837
===========================================================================
Liabilities and Stockholders' Equity
Junior subordinated debentures ...... $123,711 $123,711
Accounts payable and accrued expenses 1,069 1,708
---------------------------------------------------------------------------
Total liabilities ................. 124,780 125,419
Stockholders' equity ................ 624,636 532,418
---------------------------------------------------------------------------
$749,416 $657,837
===========================================================================
105
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Condensed Statements of Income and Other Comprehensive Income
Years Ended December 31,
------------------------------------
(In Thousands) 2000 1999 1998
--------------------------------------------------------------------------------------------------------
Income:
Dividends from the Bank ....................................... $ 21,985 $ 5,011 $ 9,537
Interest income ............................................... 933 1,635 374
Other income .................................................. 59 104 60
--------------------------------------------------------------------------------------------------------
Total income ............................................... 22,977 6,750 9,971
--------------------------------------------------------------------------------------------------------
Expense:
Interest expense .............................................. 12,163 5,353 --
Provision for (reduction of) losses on real estate ............ -- (1,720) 24
General and administrative expense ............................ 816 896 793
--------------------------------------------------------------------------------------------------------
Total expense .............................................. 12,979 4,529 817
--------------------------------------------------------------------------------------------------------
Income before income taxes and equity in undistributed
net income of subsidiaries .................................... 9,998 2,221 9,154
Income tax benefit .............................................. 4,895 1,162 157
--------------------------------------------------------------------------------------------------------
Income before equity in undistributed net income
of subsidiaries ............................................... 14,893 3,383 9,311
Equity in undistributed net income of subsidiaries .............. 84,358 60,421 48,662
--------------------------------------------------------------------------------------------------------
Net income .................................................... 99,251 63,804 57,973
--------------------------------------------------------------------------------------------------------
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 .. 2,032 (1,874) 1,104
Mortgage-backed securities available for sale, at fair value 173 (281) (422)
Less reclassification of realized gains (losses)
included in net income ................................... (50) 166 39
--------------------------------------------------------------------------------------------------------
Total other comprehensive income (loss), net of
income taxes (benefits) .................................... 2,255 (2,321) 643
--------------------------------------------------------------------------------------------------------
Comprehensive income .......................................... $ 101,506 $ 61,483 $ 58,616
========================================================================================================
106
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements----(Continued)
Condensed Statements of Cash Flows
Years Ended December 31,
------------------------------------
(In Thousands) 2000 1999 1998
------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income ............................................ $ 99,251 $ 63,804 $ 57,973
Equity in undistributed net income of subsidiaries .... (84,358) (60,421) (48,662)
Provision for (recovery of) losses on real estate ..... -- (1,720) 24
Increase (decrease) in liabilities .................... (639) 1,449 134
Other, net ............................................ (13) 1,022 807
------------------------------------------------------------------------------------------------
Net cash provided by operating activities .......... 14,241 4,134 10,276
------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital contribution to the Bank ...................... -- (107,600) --
Increase in due from Bank - interest bearing .......... (4,949) (4,165) (1,886)
Sales of wholly owned real estate ..................... -- 2,201 --
------------------------------------------------------------------------------------------------
Net cash used for investing activities ............. (4,949) (109,564) (1,886)
------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Issuance of junior subordinated debentures ............ -- 115,063 --
Exercise of stock options ............................. 855 219 510
Dividends on common stock ............................. (10,143) (9,850) (8,889)
Other ................................................. -- -- (17)
------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities (9,288) 105,432 (8,396)
------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents .... 4 2 (6)
Cash and cash equivalents at beginning of period ........ 7 5 11
------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period .............. $ 11 $ 7 $ 5
================================================================================================
(29) Sale of Subsidiary
On February 29, 2000, Downey Savings and Loan Association, F.A. sold its
indirect automobile finance subsidiary, Downey Auto Finance Corp., to Auto
One Acceptance Corp., a subsidiary of California Federal Bank and
recognized a pre-tax gain from the sale of $9.8 million. As of December 31,
1999, Downey Auto Finance Corp. had loans totaling $366 million and total
assets of $373 million. The proceeds of the sale provided additional
capital to further the growth of our residential lending business.
107
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Downey Financial Corp. intends to file with the Securities and Exchange
Commission a definitive proxy statement (the "Proxy Statement") pursuant to
Regulation 14A, which will involve the election of directors, within 120 days of
the end of the year covered by this Form 10-K. Information regarding directors
of Downey Financial Corp. will appear under the caption "Election of Directors"
in the Proxy Statement for the Annual Meeting of Stockholders to be held on
April 25, 2001, and is incorporated herein by reference. Information regarding
executive officers of Downey Financial Corp. will appear under the caption
"Executive Officers" in the Proxy Statement and is incorporated herein by this
reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation will appear under the caption
"Executive Compensation" in the Proxy Statement and is incorporated herein by
this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information to be included under the captions "Securities Ownership of
Certain Beneficial Owners and Management" in the Proxy Statement is incorporated
herein by this reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information to be included under the caption "Certain Relationships and
Related Transactions" in the Proxy Statement is incorporated herein by this
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements.
These documents are listed in the Index to Consolidated Financial
Statements under Item 8.
2. Financial Statement Schedules.
Financial Statement Schedules have been omitted because they are not
applicable or the required information is shown in the Consolidated
Financial Statements or Notes thereto.
(b) Reports on Form 8-K during the last quarter of 2000.
None.
108
(c) 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).
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).
109
(c) Exhibits (Continued)
Exhibit
Number Description
------- -----------
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 Deferred Compensation Program.
10.14 Director Retirement Benefits.
22 Subsidiaries.
23 Consent of Independent Auditors.
27 Financial Data Schedule (Only filed as part of the EDGAR version).
(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.
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:
Downey Financial Corp.
3501 Jamboree Road
Newport Beach, California 92660
Attention: Corporate Secretary
110
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.
By: /s/ DANIEL D. ROSENTHAL
-------------------------------------
Daniel D. Rosenthal
President and Chief Executive Officer
Director
DATED: March 7, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
Chairman of the Board March 7, 2001
------------------------- Director
Maurice L. McAlister
/s/ CHERYL E. OLSON Vice Chairman of the Board March 7, 2001
------------------------- Director
Cheryl E. Olson
/s/ DANIEL D. ROSENTHAL President and March 7, 2001
------------------------- Chief Executive Officer
Daniel D. Rosenthal Director
/s/ THOMAS E. PRINCE Executive Vice President March 7, 2001
------------------------- Chief Financial Officer
Thomas E. Prince (Principal Financial and
Accounting Officer)
/s/ MICHAEL ABRAHAMS Director March 7, 2001
-------------------------
Michael Abrahams
/s/ DR. PAUL KOURI Director March 7, 2001
-------------------------
Dr. Paul Kouri
/s/ BRENT MCQUARRIE Director March 7, 2001
-------------------------
Brent McQuarrie
/s/ LESTER C. SMULL Director March 7, 2001
-------------------------
Lester C. Smull
/s/ SAM YELLEN Director March 7, 2001
-------------------------
Sam Yellen
111