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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
For the quarterly period ended March 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
__________ TO __________
Commission File Number 1-13578
DOWNEY FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0633413
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3501 JAMBOREE ROAD, NEWPORT BEACH, CA 92660
(Address of principal executive office (Zip Code)
Registrant's telephone number, including area code (949) 854-0300
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ---------------------------------
COMMON STOCK, $0.01 PAR VALUE NEW YORK STOCK EXCHANGE
PACIFIC EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No__
At March 31, 2002, 28,213,048 shares of the Registrant's Common Stock,
$0.01 par value were outstanding.
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DOWNEY FINANCIAL CORP.
MARCH 31, 2002 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION.................................................... 1
Consolidated Balance Sheets...................................... 1
Consolidated Statements of Income................................ 2
Consolidated Statements of Comprehensive Income.................. 3
Consolidated Statements of Cash Flows............................ 4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS............................... 6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................. 12
PART II
OTHER INFORMATION........................................................ 36
Item 6 Exhibits and Reports on Form 8-K...................... 36
i
PART I - FINANCIAL INFORMATION
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
March 31, December 31, March 31,
(Dollars in Thousands, Except Per Share Data) 2002 2001 2001
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ASSETS
Cash .......................................................................... $ 120,000 $ 106,079 $ 114,316
Federal funds ................................................................. 28,800 37,001 7,601
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Cash and cash equivalents ................................................. 148,800 143,080 121,917
U.S. Treasury securities, agency obligations and other investment securities
available for sale, at fair value ......................................... 248,322 402,355 255,891
Municipal securities held to maturity, at amortized cost (estimated
fair value of $6,373 at March 31, 2002 and December 31, 2001 and
$6,534 at March 31, 2001) ................................................. 6,388 6,388 6,550
Mortgage loans purchased under resale agreements .............................. 10,000 -- --
Loans held for sale, at lower of cost or fair value ........................... 388,468 499,024 446,264
Mortgage-backed securities available for sale, at fair value .................. 90,803 118,981 5,842
Loans receivable held for investment .......................................... 9,608,842 9,514,408 9,820,116
Investments in real estate and joint ventures ................................. 26,384 38,185 18,690
Real estate acquired in settlement of loans ................................... 11,917 15,366 11,634
Premises and equipment ........................................................ 111,465 111,762 104,138
Federal Home Loan Bank stock, at cost ......................................... 114,842 113,139 108,223
Mortgage servicing rights, net ................................................ 68,581 56,895 35,717
Other assets .................................................................. 78,189 85,447 96,120
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$ 10,913,001 $ 11,105,030 $ 11,031,102
==============================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits ...................................................................... $ 8,598,890 $ 8,619,566 $ 8,708,275
Federal Home Loan Bank advances ............................................... 1,320,386 1,522,705 1,457,046
Other borrowings .............................................................. -- 7 145
Accounts payable and accrued liabilities ...................................... 62,282 67,431 64,138
Deferred income taxes ......................................................... 43,821 41,425 32,906
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Total liabilities ......................................................... 10,025,379 10,251,134 10,262,510
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Company obligated mandatorily redeemable capital securities of subsidiary trust
holding solely junior subordinated debentures of the Company
("Capital Securities") .................................................... 120,000 120,000 120,000
STOCKHOLDERS' EQUITY
Preferred stock, par value of $0.01 per share; authorized 5,000,000 shares;
outstanding none .......................................................... -- -- --
Common stock, par value of $0.01 per share; authorized 50,000,000 shares;
outstanding 28,213,048 shares at March 31, 2002 and December 31, 2001
and 28,211,048 shares at March 31, 2001 ................................... 282 282 282
Additional paid-in capital .................................................... 93,400 93,400 93,374
Accumulated other comprehensive income (loss) ................................. (1,288) (239) 1,182
Retained earnings ............................................................. 675,228 640,453 553,754
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Total stockholders' equity ................................................ 767,622 733,896 648,592
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$ 10,913,001 $ 11,105,030 $ 11,031,102
==============================================================================================================================
See accompanying notes to consolidated financial statements.
1
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Income
Three Months Ended
March 31,
-----------------------------
(Dollars in Thousands, Except Per Share Data) 2002 2001
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INTEREST INCOME
Loans receivable .................................................... $160,277 $212,762
U.S. Treasury securities and agency obligations ..................... 3,033 4,410
Mortgage-backed securities .......................................... 1,274 128
Other investments ................................................... 1,814 2,666
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Total interest income ........................................... 166,398 219,966
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INTEREST EXPENSE
Deposits ............................................................ 68,359 114,801
Borrowings .......................................................... 15,053 25,962
Capital securities .................................................. 3,041 3,041
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Total interest expense .......................................... 86,453 143,804
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NET INTEREST INCOME ................................................. 79,945 76,162
PROVISION FOR LOAN LOSSES ........................................... 1,447 52
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Net interest income after provision for loan losses ............. 78,498 76,110
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OTHER INCOME, NET
Loan and deposit related fees ....................................... 11,518 10,230
Real estate and joint ventures held for investment, net ............. 2,997 1,000
Secondary marketing activities:
Loan servicing loss, net ........................................ (588) (8,185)
Net gains on sales of loans and mortgage-backed securities ...... 16,201 2,187
Net gains on sales of mortgage servicing rights ................. 294 --
Net gains on sales of investment securities ......................... 190 125
Other ............................................................... 741 656
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Total other income, net ......................................... 31,353 6,013
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OPERATING EXPENSE
Salaries and related costs .......................................... 29,437 23,271
Premises and equipment costs ........................................ 7,133 6,043
Advertising expense ................................................. 1,044 1,176
Professional fees ................................................... 564 577
SAIF insurance premiums and regulatory assessments .................. 786 732
Other general and administrative expense ............................ 6,211 5,339
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Total general and administrative expense ........................ 45,175 37,138
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Net operation of real estate acquired in settlement of loans ........ (58) (2)
Amortization of excess of cost over fair value of branch acquisitions 111 114
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Total operating expense ......................................... 45,228 37,250
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INCOME BEFORE INCOME TAXES .......................................... 64,623 44,873
Income taxes ........................................................ 27,309 19,009
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NET INCOME ..................................................... $ 37,314 $ 25,864
=====================================================================================================
PER SHARE INFORMATION
BASIC ............................................................... $ 1.32 $ 0.92
=====================================================================================================
DILUTED ............................................................. $ 1.32 $ 0.91
=====================================================================================================
CASH DIVIDENDS DECLARED AND PAID .................................... $ 0.09 $ 0.09
=====================================================================================================
Weighted average diluted shares outstanding ......................... 28,271,172 28,275,184
=====================================================================================================
See accompanying notes to consolidated financial statements.
2
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Three Months Ended
March 31,
----------------------
(In Thousands) 2002 2001
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Net income ................................................................. $ 37,314 $ 25,864
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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 .......................... (1,356) 693
Mortgage-backed securities available for sale, at fair value ............ (938) 33
Less reclassification of realized gains included in net income .......... (110) (72)
Unrealized losses on cash flow hedges:
Net derivative instruments .............................................. (517) (1,323)
Less reclassification of realized losses included in net income ......... 1,872 1,164
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Total other comprehensive income (loss), net of income taxes (benefits) .... (1,049) 495
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COMPREHENSIVE INCOME ....................................................... $ 36,265 $ 26,359
====================================================================================================
See accompanying notes to consolidated financial statements.
3
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three Months Ended
March 31,
---------------------------
(In Thousands) 2002 2001
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CASH FLOWS FROM OPERATING ACTIVITIES
Net income .............................................................................. $ 37,314 $ 25,864
Adjustments to reconcile net income to net cash used for operating activities:
Depreciation and amortization ........................................................ 14,990 9,947
Provision for losses on loans, real estate acquired in settlement of loans,
investments in real estate and joint ventures, mortgage servicing rights
and other assets ................................................................... 818 8,593
Net gains on sales of loans and mortgage-backed securities, mortgage servicing rights,
investment securities, real estate and other assets ................................ (18,066) (3,178)
Net change in interest capitalized on loans (negative amortization) .................. 13,860 (21,886)
Federal Home Loan Bank stock dividends ............................................... (1,703) (1,867)
Loans originated for sale ............................................................... (1,266,430) (796,801)
Proceeds from sales of loans held for sale, including those sold
via mortgage-backed securities ....................................................... 1,381,086 595,743
Other, net .............................................................................. (29,458) (2,757)
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Net cash provided by (used for) operating activities .................................... 132,411 (186,342)
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CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of:
U.S. Treasury securities, agency obligations and other investment
securities available for sale ...................................................... 68,628 10,017
Wholly owned real estate and real estate acquired in settlement of loans ............. 16,827 2,528
Proceeds from maturities of U.S. Treasury securities, agency obligations
and other investment securities available for sale ................................... 156,530 202,765
Purchase of:
U.S. Treasury securities, agency obligations and other investment
securities available for sale ...................................................... (74,710) (160,945)
Mortgage loans under resale agreements ............................................... (10,000) --
Loans receivable held for investment ................................................. (30) (250)
Premises and equipment ............................................................... (3,562) (3,087)
Originations of loans receivable held for investment (net of refinances of
$183,227 at March 31, 2002 and $146,113 at March 31, 2001) ........................... (850,588) (522,091)
Principal payments on loans receivable held for investment and mortgage-backed
securities available for sale ........................................................ 786,137 563,420
Net change in undisbursed loan funds .................................................... 8,030 (12,250)
Proceeds from (investments in) real estate held for investment .......................... 950 (1,668)
Other, net .............................................................................. 638 215
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Net cash provided by investing activities ............................................... 98,850 78,654
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See accompanying notes to consolidated financial statements.
4
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
Three Months Ended
March 31,
---------------------------
(In Thousands) 2002 2001
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CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits .......................................... $ (20,676) $ 625,586
Proceeds from Federal Home Loan Bank advances ................................ 1,316,200 498,500
Repayments of Federal Home Loan Bank advances ................................ (1,518,519) (1,019,802)
Net decrease in other borrowings ............................................. (7) (79)
Proceeds from exercise of stock options ...................................... -- 135
Cash dividends ............................................................... (2,539) (2,538)
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Net cash provided by (used for) financing activities ......................... (225,541) 101,802
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Net increase (decrease) in cash and cash equivalents ......................... 5,720 (5,886)
Cash and cash equivalents at beginning of period ............................. 143,080 127,803
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CASH AND CASH EQUIVALENTS AT END OF PERIOD ................................... $ 148,800 $ 121,917
============================================================================================================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest ................................................................ $ 82,061 $ 145,806
Income taxes ............................................................ 5,202 1,516
Supplemental disclosure of non-cash investing:
Loans transferred to held for investment from held for sale ............... 614 2,392
Loans exchanged for mortgage-backed securities ............................ 1,225,243 462,744
Real estate acquired in settlement of loans ............................... 4,903 5,353
Loans to facilitate the sale of real estate acquired in settlement of loans 4,336 1,615
============================================================================================================
See accompanying notes to consolidated financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE (1) - BASIS OF FINANCIAL STATEMENT PRESENTATION
In the opinion of Downey Financial Corp. and subsidiaries ("Downey," "we,"
"us" and "our"), the accompanying consolidated financial statements contain all
adjustments (consisting of only normal recurring accruals) necessary for a fair
presentation of Downey's financial condition as of March 31, 2002, December 31,
2001 and March 31, 2001 and the results of operations, comprehensive income, and
changes in cash flows for the three months ended March 31, 2002 and 2001.
Certain prior period amounts have been reclassified to conform to the current
period presentation.
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial statements and are in compliance with the
instructions for Form 10-Q and therefore do not include all information and
footnotes necessary for a fair presentation of financial condition, results of
operations, comprehensive income and cash flows. The following information under
the heading Management's Discussion and Analysis of Financial Condition and
Results of Operations is written with the presumption that the interim
consolidated financial statements will be read in conjunction with Downey's
Annual Report on Form 10-K for the year ended December 31, 2001, which contains
among other things, a description of the business, the latest audited
consolidated financial statements and notes thereto, together with Management's
Discussion and Analysis of Financial Condition and Results of Operations as of
December 31, 2001 and for the year then ended. Therefore, only material changes
in financial condition and results of operations are discussed in the remainder
of Part I.
NOTE (2) - EARNINGS PER SHARE
Earnings per share is calculated on both a basic and diluted basis. Basic
earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted from issuance of
common stock that then shared in earnings.
The following table presents a reconciliation of the components used to
derive basic and diluted earnings per share for the periods indicated.
Three Months Ended March 31,
---------------------------------------------------------------------
2002 2001
---------------------------------------------------------------------
Weighted Weighted
Average Average
Net Shares Per Share Net Shares Per Share
(Dollars in Thousands, Except Per Share Data) Income Outstanding Amount Income Outstanding Amount
-----------------------------------------------------------------------------------------------------------------------
Basic earnings per share ....... $37,314 28,213,048 $1.32 $25,864 28,209,678 $0.92
Effect of dilutive stock options -- 58,124 -- -- 65,506 0.01
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Diluted earnings per share $37,314 28,271,172 $1.32 $25,864 28,275,184 $0.91
=======================================================================================================================
6
NOTE (3) - BUSINESS SEGMENT REPORTING
The following table presents the operating results and selected financial
data by major business segments for the periods indicated.
Real Estate
(In Thousands) Banking Investment Elimination Totals
------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31, 2002
Net interest income .............................. $ 79,940 $ 5 $ -- $ 79,945
Provision for loan losses ........................ 1,447 -- -- 1,447
Other income ..................................... 28,062 3,291 -- 31,353
Operating expense ................................ 45,006 222 -- 45,228
Net intercompany income (expense) ................ 93 (93) -- --
------------------------------------------------------------------------------------------------------------
Income before income taxes ....................... 61,642 2,981 -- 64,623
Income taxes ..................................... 26,085 1,224 -- 27,309
------------------------------------------------------------------------------------------------------------
Net income .................................. $ 35,557 $ 1,757 $ -- $ 37,314
============================================================================================================
AT MARCH 31, 2002
Assets:
Loans and mortgage-backed securities ........ $10,088,113 $ -- $ -- $10,088,113
Investments in real estate and joint ventures -- 26,384 -- 26,384
Other ....................................... 819,407 4,060 (24,963) 798,504
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Total assets .............................. 10,907,520 30,444 (24,963) 10,913,001
------------------------------------------------------------------------------------------------------------
Equity ........................................... $ 767,622 $ 24,963 $ (24,963) $ 767,622
============================================================================================================
THREE MONTHS ENDED MARCH 31, 2001
Net interest income .............................. $ 76,134 $ 28 $ -- $ 76,162
Provision for loan losses ........................ 52 -- -- 52
Other income ..................................... 4,745 1,268 -- 6,013
Operating expense ................................ 36,990 260 -- 37,250
Net intercompany income (expense) ................ 97 (97) -- --
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Income before income taxes ....................... 43,934 939 -- 44,873
Income taxes ..................................... 18,625 384 -- 19,009
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Net income ................................... $ 25,309 $ 555 $ -- $ 25,864
============================================================================================================
AT MARCH 31, 2001
Assets:
Loans and mortgage-backed securities ........ $10,272,222 $ -- $ -- $10,272,222
Investments in real estate and joint ventures -- 18,690 -- 18,690
Other ....................................... 755,324 3,337 (18,471) 740,190
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Total assets .............................. 11,027,546 22,027 (18,471) 11,031,102
------------------------------------------------------------------------------------------------------------
Equity ........................................... $ 648,592 $ 18,471 $ (18,471) $ 648,592
============================================================================================================
7
NOTE (4) - MORTGAGE SERVICING RIGHTS
The following table summarizes the activity in our mortgage servicing
rights and related allowance for the periods indicated and other related
financial data.
Three Months Ended
----------------------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(Dollars in Thousands) 2002 2001 2001 2001 2001
-----------------------------------------------------------------------------------------------------------------------------------
Gross balance at beginning of period ............... $ 65,630 $ 61,651 $ 55,848 $ 49,323 $ 46,214
Additions .......................................... 14,997 15,300 10,294 13,403 5,394
Amortization ....................................... (2,916) (2,956) (2,495) (2,299) (2,063)
Sales of mortgage servicing rights ................. (35) (4,916) (582) (2,328) --
Impairment write-down .............................. (2,762) (3,449) (1,414) (2,251) (222)
-----------------------------------------------------------------------------------------------------------------------------------
Gross balance at end of period ................ 74,914 65,630 61,651 55,848 49,323
-----------------------------------------------------------------------------------------------------------------------------------
Allowance balance at beginning of period ........... 8,735 24,144 13,706 13,606 5,483
Provision for (reduction of) impairment ............ 360 (11,960) 11,852 2,351 8,345
Impairment write-down .............................. (2,762) (3,449) (1,414) (2,251) (222)
-----------------------------------------------------------------------------------------------------------------------------------
Allowance balance at end of period ............ 6,333 8,735 24,144 13,706 13,606
-----------------------------------------------------------------------------------------------------------------------------------
Total mortgage servicing rights, net .......... $ 68,581 $ 56,895 $ 37,507 $ 42,142 $ 35,717
===================================================================================================================================
Estimated fair value (1) ........................... $ 70,532 $ 58,047 $ 37,507 $ 42,142 $ 35,752
Weighted average expected life (in months) ......... 87 82 59 79 66
Custodial account earnings rate .................... 4.61% 4.36% 2.85% 3.60% 4.85%
Weighted average discount rate ..................... 9.13 9.16 9.21 9.26 9.34
===================================================================================================================================
AT PERIOD END
Mortgage loans serviced for others:
Total ......................................... $ 6,408,812 $ 5,805,811 $ 5,458,970 $ 5,056,120 $ 4,296,883
With capitalized mortgage servicing rights (1):
Amount ..................................... 6,196,137 5,379,513 5,078,088 4,456,822 3,999,380
Weighted average interest rate ............. 6.85% 6.97% 7.19% 7.29% 7.50%
===================================================================================================================================
Custodial escrow balances .......................... $ 6,103 $ 10,596 $ 15,415 $ 9,924 $ 5,281
===================================================================================================================================
(1) The estimated fair value may exceed book value for certain asset strata and
excluded loans sold or securitized prior to 1996 without capitalized
mortgage servicing rights.
Key assumptions, which vary due to changes in market interest rates and are
used to determine the fair value of our mortgage servicing rights, include:
expected prepayment speeds, which impact the average life of the portfolio; the
earnings rate on custodial accounts, which impact the value of custodial
accounts; and the discount rate used in valuing future cash flows. The table
below summarizes the estimated changes in the fair value of our mortgage
servicing rights for changes in those assumptions individually and in
combination associated with an immediate 100 basis point increase or decrease in
market rates. Also summarized is the earnings impact associated with provisions
to or reductions in the valuation allowance for mortgage servicing rights.
Impairment is measured on a disaggregated basis based upon the predominant risk
characteristics of the underlying mortgage loans such as term and coupon.
Certain stratum may have impairment, while other stratum may not. Therefore,
changes in overall fair value may not equal provisions to or reductions in the
valuation allowance.
8
The sensitivity analysis in the table below is hypothetical and should be
used with caution. As the figures indicate, changes in fair value based on a 100
basis point variation in assumptions generally cannot be easily extrapolated
because the relationship of the change in the assumptions to the change in fair
value may not be linear. Also, in this table, the effect that a change in a
particular assumption may have on the fair value is calculated without changing
any other assumption. In reality, changes in one factor may result in changes in
another, which might magnify or counteract the sensitivities.
Expected Value of
Prepayment Custodial Discount
(Dollars in Thousands) Speeds Accounts Rate Combination
--------------------------------------------------------------------------------------------------
Increase rates 100 basis points:
Fair value (1) ................................... $ 13,269 $ 4,010 $ (2,389) $ 13,920
Reduction of (increase in) valuation allowance ... 5,363 1,465 (909) 5,480
Decrease rates 100 basis points:
Fair value (2) ................................... (17,660) (4,010) 2,541 (20,312)
Reduction of (increase in) valuation allowance ... (15,711) (2,184) 728 (18,362)
==================================================================================================
(1) The weighted-average expected life is 117 months.
(2) The weighted-average expected life is 53 months.
The components of loan servicing income (loss) included in Downey's results
of operations are summarized as follows:
Three Months Ended
-------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
-----------------------------------------------------------------------------------------------------------
Income from servicing operations .......... $ 2,688 $ 2,477 $ 2,576 $ 1,752 $ 2,223
Amortization of MSRs ...................... (2,916) (2,956) (2,495) (2,299) (2,063)
(Provision for) reduction of impairment ... (360) 11,960 (11,852) (2,351) (8,345)
-----------------------------------------------------------------------------------------------------------
Total loan servicing income (loss), net $ (588) $ 11,481 $(11,771) $ (2,898) $ (8,185)
===========================================================================================================
NOTE (5) - ACCOUNTING FOR DERIVATIVES AND HEDGING ACTIVITIES
Derivatives
We offer short-term interest rate lock commitments to help us attract
potential home loan borrowers. The commitments guarantee a specified interest
rate for a loan if our underwriting standards are met, but do not obligate the
potential borrower. The residential one-to-four unit interest rate lock
commitments we ultimately expect to sell in the secondary market are treated as
derivatives. Consequently, as derivatives, the hedging of the expected rate lock
commitments do not qualify for hedge accounting. Associated fair value
adjustments are recorded in current earnings under net gains on sales of loans
and mortgage-backed securities with an offset to the balance sheet in either
other assets, or accounts payable and accrued liabilities. Fair values for
interest rate lock commitments are based on observable market prices acquired
from third parties. The carrying amount of loans held for sale includes a basis
adjustment to the loan at funding resulting from the change in the fair value of
the interest rate lock derivative from the date of commitment to the date of
funding. At March 31, 2002, we had rate lock commitments estimated to sell as
part of our secondary marketing activities of $235 million, with an estimated
fair value of $236 million, including a $2.7 million gain associated with
mortgage servicing rights.
Hedging Activities
As part of our secondary marketing activities, we typically utilize
short-term forward sale and purchase contracts--derivatives--that mature in less
than one year to offset the impact of changes in market interest rates on the
value of our residential one-to-four unit interest rate lock commitments and
loans held for sale. We do not generally enter into derivative transactions for
purely speculative purposes. Contracts designated to loans held for sale are
accounted for as cash flow hedges because these contracts have a high
correlation to the price movement of the loans being hedged (within a range of
80% - 125%). The measurement approach for determining the ineffective aspects of
the hedge is established at the inception of the hedge. Changes in forward sale
contract values not designated to loans held for sale and the ineffectiveness of
hedge transactions that are not perfectly correlated are recorded in net gains
on sales of loans and mortgage-backed securities. Changes in forward sale
contract values designated as cash flow hedges for loans held for sale are
recorded in other comprehensive income, net of tax, provided cash flow hedge
requirements are met. The offset to these changes in forward
9
sale contract values are recorded in the balance sheet as either other assets,
or accounts payable and accrued liabilities. The amounts recorded in accumulated
other comprehensive income will be recognized in the income statement when the
hedged forecasted transactions settle. We estimate that all of the related
unrealized gains or losses in accumulated other comprehensive income will be
reclassified into earnings within the next three months. Fair values for forward
sale contracts are based on observable market prices acquired from third
parties. At March 31, 2002, forward sale contracts amounted to $623 million,
with an estimated fair value of $628 million, of which $392 million were
designated as cash flow hedges, and there were no forward purchase contracts.
We have not discontinued any designated derivative instruments associated
with loans held for sale due to a change in the probability of settling a
forecasted transaction.
The following table contains the amount of expected rate lock commitment
derivatives for loans originated for sale, loans held for sale and the notional
amounts for their associated hedging derivatives (i.e., forward sale contracts).
Also shown is the impact from non-qualifying hedges and the ineffectiveness of
cash flow hedges on net gains (losses) on sales of loans and mortgage-backed
securities (i.e., SFAS 133 effect), as well as the impact to other comprehensive
income (loss) from qualifying cash flow transactions.
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
-----------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Non-qualifying hedge transactions:
Expected rate lock commitments ..................... $ 235,099 $ 269,315 $ 422,606 $ 264,397 $ 336,954
Associated forward sale contracts .................. 230,660 278,319 404,177 294,284 399,720
Qualifying cash flow hedge transactions:
Loans held for sale, at lower of cost or fair value 388,468 499,024 373,489 376,560 446,264
Associated forward sale contracts .................. 392,099 508,706 369,335 358,378 371,798
=======================================================================================================================
THREE MONTHS ENDED
Net gains (losses) on non-qualifying hedge transactions $ 4,864 $ (3,834) $ (1,149) $ 726 $ (1,707)
Net gains (losses) on qualifying cash flow hedge
transactions:
Unrealized hedge ineffectiveness ................... -- -- (27) 31 (471)
Less reclassification of realized hedge
ineffectiveness ................................... -- -- 27 21 419
-----------------------------------------------------------------------------------------------------------------------
Total net gains (losses) recognized in sales of
loans and mortgage-backed securities
(SFAS 133 effect) ................................ 4,864 (3,834) (1,149) 778 (1,759)
Other comprehensive income (loss) ...................... 1,355 501 (2,477) 1,408 (159)
=======================================================================================================================
NOTE (6) - INCOME TAXES
Downey and its wholly owned subsidiaries file a consolidated federal income
tax return and various state income and franchise tax returns on a calendar year
basis. The Internal Revenue Service and state taxing authorities have examined
Downey's tax returns for all tax years through 1995 and are currently reviewing
returns filed for the 1996 and 1997 tax years. Tax years subsequent to 1997
remain open to review by federal and state tax authorities. Downey's management
believes it has adequately provided for potential exposure with regard to issues
that may be raised in the years currently under examination and open to review.
NOTE (7) - CURRENT ACCOUNTING ISSUES
Statement of Financial Accounting Standards No. 142. SFAS 142 applies to
all acquired intangible assets whether acquired singularly, as part of a group,
or in a business combination. The Statement supersedes APB Opinion No. 17,
"Intangible Assets," and carries forward provisions in Opinion 17 related to
internally developed intangible assets. The Statement changes the accounting for
goodwill from an amortization method to an impairment-only approach. Goodwill
should no longer be amortized, but instead tested for impairment at least
annually at the reporting unit level. The accounting provisions are effective
for fiscal years beginning after December 31, 2001. Our intangible assets and
goodwill are related to branch acquisitions and not within the scope of SFAS
142. However, this may change as the Financial Accounting Standards Board is
currently reconsidering the exclusion of amortization of goodwill related to
branch acquisitions and is expected to issue a final Statement in the fourth
quarter of 2002. We recognized an unidentified intangible asset for branch
acquisitions because the fair value of the liabilities assumed exceeded the fair
value of the assets acquired. For the first quarter of 2002, our amortization of
excess of cost over fair value of branch acquisitions was $0.1 million and as of
March 31, 2002, this asset totaled $3.0 million.
10
Statement of Financial Accounting Standards No. 143. Statement of Financial
Accounting Standards No. 143, "Accounting for Asset Retirement Obligations"
("SFAS 143"), addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. This Statement is effective for financial statements
issued for fiscal years beginning after June 15, 2002. It is anticipated that
the financial impact of this Statement will not have a material effect on
Downey.
Statement of Financial Accounting Standards No. 144. Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS 144"), addresses financial accounting and reporting
for the impairment or disposal of long-lived assets. This Statement supersedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of," and the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions," for the disposal of a
segment of a business. This Statement also eliminates the exception to
consolidation for a subsidiary for which control is likely to be temporary. The
provisions of this Statement are effective for financial statements issued for
fiscal years beginning after December 15, 2001, and interim periods within those
fiscal years. The provisions of this Statement generally are to be applied
prospectively. It is anticipated that the financial impact of this Statement
will not have a material effect on Downey.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain statements under this caption may constitute "forward-looking
statements" under the Private Securities Litigation Reform Act of 1995 which
involve risks and uncertainties. Our actual results may differ significantly
from the results discussed in such forward-looking statements. Factors that
might cause such a difference include, but are not limited to, economic
conditions, competition in the geographic and business areas in which we conduct
our operations, fluctuations in interest rates, credit quality and government
regulation.
OVERVIEW
Our net income for the first quarter of 2002 totaled $37.3 million or $1.32
per share on a diluted basis, up 44.3% from the $25.9 million or $0.91 per share
in the year-ago first quarter.
The increase in net income between first quarters was due to higher net
income from both of our business segments as follows:
o Banking operations contributed $10.2 million to the increase in net
income reflecting:
o a $14.3 million increase in net gains from sales of loans and
mortgage-backed securities, and mortgage servicing rights;
o a $7.6 million improvement in our loan servicing activity
primarily due to a smaller addition to the valuation allowance
for mortgage servicing rights;
o a $3.8 million increase in net interest income due to an increase
in our effective interest rate spread; and
o a $1.3 million increase in loan and deposit related fees.
Those favorable items were partially offset by:
o an $8.0 million increase in operating expenses reflecting an
increased number of branch locations and higher loan origination
activity; and
o a $1.4 million increase in provision for loan losses.
o Real estate investment activities contributed $1.2 million to the
increase in net income reflecting:
o a recapture of $1.3 million of a previously established valuation
allowance; and
o an increase of $0.3 million in net gains to a total of $0.6
million.
In addition to higher net income, our key performance measures also
improved between first quarters as follows:
o 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 expense) improved from 45.8% to 41.8%;
o our return on average assets improved from 0.94% to 1.36%; and
o our return on average equity improved from 16.28% to 19.96%.
Our single family loan originations totaled $2.259 billion in the first
quarter of 2002, up 57.1% from the $1.438 billion we originated in the first
quarter of 2001 but down 9.6% from the record $2.500 billion we originated in
the previous quarter. Of the current quarter total, $992 million represented
originations of loans for portfolio, of which $107 million represented subprime
credits. In addition to single family loans, we originated $46 million of other
loans in the quarter.
At quarter-end, our assets totaled $10.9 billion and our deposits totaled
$8.6 billion, both of which were down slightly from a year ago. During the
quarter, six new in-store branches and one new traditional branch were opened,
bringing our total branches at quarter end to 144, of which 74 are in-store. A
year ago, branches totaled 121, of which 56 were in-store.
Our non-performing assets increased $1 million during the quarter to $94
million or 0.86% of total assets. This increase was due to a rise in commercial
real estate non-accrual loans of $2 million due primarily to a shopping center
loan whose principal tenant declared bankruptcy during the quarter and ceased
paying rent.
12
At March 31, 2002, our primary subsidiary, Downey Savings and Loan
Association, F.A. (the "Bank") exceeded all regulatory capital tests, with
capital-to-asset ratios of 7.61% for both tangible and core capital and 15.39%
for risk-based capital. These capital levels are significantly above the "well
capitalized" standards defined by the federal banking regulators of 5% for core
and tangible capital and 10% for risk-based capital.
We have established various accounting policies which govern the
application of accounting principles generally accepted in the United States of
America in the preparation of our financial statements. Our significant
accounting policies are described in Downey's Annual Report on Form 10-K for the
year ended December 31, 2001. Certain accounting policies require us to make
significant estimates and assumptions which have a material impact on the
carrying value of certain assets and liabilities, and we consider these to be
critical accounting policies. The estimates and assumptions we use are based on
historical experience and other factors, which we believe to be reasonable under
the circumstances. Actual results could differ significantly from these
estimates and assumptions which could have a material impact on the carrying
value of assets and liabilities at the balance sheet dates and our results of
operations for the reporting periods.
We believe the following are critical accounting policies that require the
most significant estimates and assumptions that are particularly susceptible to
significant change in the preparation of our financial statements:
o Allowance for losses on loans and real estate. For further
information, see Financial Condition--Problem Loans and Real
Estate--Allowance for Losses on Loans and Real Estate on page 31.
o Allowance for mortgage servicing rights. For further information, see
Note 4 on page 8 of Notes to Consolidated Financial Statements.
13
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is the difference between the interest and dividends
earned on loans, mortgage-backed securities and investment securities
("interest-earning assets") and the interest paid on deposits, borrowings and
capital securities ("interest-bearing liabilities"). The spread between the
yield on interest-earning assets and the cost of interest-bearing liabilities
and the relative dollar amounts of these assets and liabilities principally
affects net interest income.
Our net interest income totaled $79.9 million in the first quarter of 2002,
up $3.8 million or 5.0% from the same period last year. The improvement between
first quarters reflected an increase in our effective interest rate spread,
which averaged 3.03% compared to 2.87% a year ago. The improvement between first
quarters was due to our cost of funds declining more rapidly than our yield on
earning assets. This is indicative of what typically happens when interest rates
decline, as there is an administrative lag in the repricing of our loans which
are primarily priced to the Federal Home Loan Bank ("FHLB") Eleventh District
Cost of Funds Index ("COFI"). Our earning assets averaged $10.5 billion during
the quarter, slightly below the year-ago level.
The following table presents for the periods indicated the total dollar
amount of:
o interest income from average interest-earning assets and the resultant
yields; and
o interest expense on average interest-bearing liabilities and the
resultant costs, expressed as rates.
The table also sets forth our net interest income, interest rate spread and
effective interest rate spread. The effective interest rate spread reflects the
relative level of interest-earning assets to interest-bearing liabilities and
equals:
o the difference between interest income on interest-earning assets and
interest expense on interest-bearing liabilities, divided by
o average interest-earning assets for the period.
The table also sets forth our net interest-earning balance--the difference
between the average balance of interest-earning assets and the average balance
of total deposits, borrowings and capital securities--for the periods indicated.
We included non-accrual loans in the average interest-earning assets balance. We
included interest from non-accrual loans in interest income only to the extent
we received payments and to the extent we believe we will recover the remaining
principal balance of the loans. We computed average balances for the quarter
using the average of each month's daily average balance during the periods
indicated.
14
Three Months Ended
-------------------------------------------------------------------------------------------
March 31, 2002 December 31, 2001 March 31, 2001
-------------------------------------------------------------------------------------------
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 ......................... $ 9,973,808 $160,277 6.43% $10,000,631 $178,335 7.13% $10,180,942 $212,762 8.36%
Mortgage-backed securities .... 106,375 1,274 4.79 36,623 449 4.90 7,761 128 6.60
Investment securities ......... 464,447 4,847 4.23 420,718 4,700 4.43 431,023 7,076 6.66
-----------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 10,544,630 166,398 6.31 10,457,972 183,484 7.02 10,619,726 219,966 8.29
Non-interest-earning assets ....... 398,488 370,537 353,887
-----------------------------------------------------------------------------------------------------------------------------------
Total assets .................. $10,943,118 $10,828,509 $10,973,613
===================================================================================================================================
Transaction accounts:
Non-interest-bearing checking . $ 285,156 $ -- -- % $ 354,231 $ -- -- % $ 246,246 $ -- -- %
Interest-bearing checking (1) . 425,162 413 0.39 414,470 424 0.41 396,484 633 0.65
Money market .................. 110,715 507 1.86 103,247 533 2.05 89,259 626 2.84
Regular passbook .............. 2,442,994 15,394 2.56 1,646,412 11,184 2.70 766,948 6,427 3.40
-----------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts .. 3,264,027 16,314 2.03 2,518,360 12,141 1.91 1,498,937 7,686 2.08
Certificates of deposit ........... 5,259,181 52,045 4.01 6,214,429 76,494 4.88 6,873,614 107,115 6.32
-----------------------------------------------------------------------------------------------------------------------------------
Total deposits ................ 8,523,208 68,359 3.25 8,732,789 88,635 4.03 8,372,551 114,801 5.56
Borrowings ........................ 1,425,878 15,053 4.28 1,114,446 12,093 4.31 1,716,077 25,962 6.14
Capital securities ................ 120,000 3,041 10.14 120,000 3,041 10.14 120,000 3,041 10.14
-----------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and
capital securities .......... 10,069,086 86,453 3.48 9,967,235 103,769 4.13 10,208,628 143,804 5.71
Other liabilities ................. 126,079 150,070 129,588
Stockholders' equity .............. 747,953 711,204 635,397
-----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity ........ $10,943,118 $10,828,509 $10,973,613
===================================================================================================================================
Net interest income/interest rate
spread ........................ $ 79,945 2.83% $ 79,715 2.89% $ 76,162 2.58%
Excess of interest-earning assets
over deposits, borrowings and
capital securities ............ $ 475,544 $ 490,737 $ 411,098
Effective interest rate spread .... 3.03 3.05 2.87
===================================================================================================================================
(1) Included amounts swept into money market deposit accounts.
15
Changes in our net interest income are a function of both changes in rates
and changes in volumes of interest-earning assets and interest-bearing
liabilities. The following table sets forth information regarding changes in our
interest income and expense for the periods indicated. For each category of
interest-earning assets and interest-bearing liabilities, we have provided
information on changes attributable to:
o changes in volume--changes in volume multiplied by comparative period
rate;
o changes in rate--changes in rate multiplied by comparative period
volume; and
o changes in rate/volume--changes in rate multiplied by changes in
volume.
Interest-earning asset and interest-bearing liability balances used in the
calculations represent quarterly average balances computed using the average of
each month's daily average balance during the period indicated.
Three Months Ended
---------------------------------------------------
March 31, 2002 Versus March 31, 2001
Changes Due To
---------------------------------------------------
Rate/
(In Thousands) Volume Rate Volume Net
-------------------------------------------------------------------------------------------
Interest income:
Loans ........................... $ (4,329) $(49,156) $ 1,000 $(52,485)
Mortgage-backed securities ...... 1,626 (35) (445) 1,146
Investment securities ........... 549 (2,578) (200) (2,229)
-------------------------------------------------------------------------------------------
Change in interest income ..... (2,154) (51,769) 355 (53,568)
-------------------------------------------------------------------------------------------
Interest expense:
Transaction accounts:
Interest-bearing checking (1) . 46 (248) (18) (220)
Money market .................. 150 (217) (52) (119)
Regular passbook .............. 14,045 (1,594) (3,484) 8,967
-------------------------------------------------------------------------------------------
Total transaction accounts .. 14,241 (2,059) (3,554) 8,628
Certificates of deposit ......... (25,159) (39,093) 9,182 (55,070)
-------------------------------------------------------------------------------------------
Total interest-bearing deposits (10,918) (41,152) 5,628 (46,442)
Borrowings ...................... (4,406) (7,180) 677 (10,909)
Capital securities .............. -- -- -- --
-------------------------------------------------------------------------------------------
Change in interest expense .... (15,324) (48,332) 6,305 (57,351)
-------------------------------------------------------------------------------------------
Change in net interest income ....... $ 13,170 $ (3,437) $ (5,950) $ 3,783
===========================================================================================
(1) Included amounts swept into money market deposit accounts.
PROVISION FOR LOAN LOSSES
Provision for loan losses was $1.4 million in the current quarter, up from
$0.1 million in the first quarter of 2001. For further information regarding our
allowance for loan losses, see Financial Condition--Problem Loans and Real
Estate--Allowance for Losses on Loans and Real Estate on page 31.
OTHER INCOME
Our total other income was $31.4 million in the first quarter of 2002, up
$25.3 million from a year ago reflecting:
o a $14.3 million increase in net gains on sales of loans and
mortgage-backed securities, and mortgage servicing rights;
o a $7.6 million improvement in our loan servicing activity primarily
due to a smaller addition to the valuation allowance for mortgage
servicing rights;
o a $2.0 million increase from real estate held for investment due
primarily to sales activity; and
o a $1.3 million increase in loan and deposit related fees.
16
LOAN AND DEPOSIT RELATED FEES
Loan and deposit related fees totaled $11.5 million in the first quarter of
2002, up $1.3 million from a year ago. Our deposit related fees increased by
$0.7 million or 18.8%, primarily due to higher fees from our checking accounts.
Our loan related fees accounted for $0.6 million of the increase between first
quarters, of which $0.2 million represented higher loan prepayment fees.
The following table presents a breakdown of loan and deposit related fees
during the periods indicated.
Three Months Ended
----------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
------------------------------------------------------------------------------------------------------------
Loan related fees:
Prepayment fees ..................... $ 4,686 $ 5,475 $ 6,384 $ 7,455 $ 4,525
Other fees .......................... 2,167 2,477 2,257 2,251 1,779
Deposit related fees:
Automated teller machine fees ....... 1,543 1,670 1,671 1,650 1,533
Other fees .......................... 3,122 3,224 2,962 2,780 2,393
------------------------------------------------------------------------------------------------------------
Total loan and deposit related fees $11,518 $12,846 $13,274 $14,136 $10,230
============================================================================================================
REAL ESTATE AND JOINT VENTURES HELD FOR INVESTMENT
Income from our real estate and joint ventures held for investment totaled
$3.0 million in the first quarter of 2002, up from $1.0 million a year ago. The
$2.0 million increase in our income from real estate held for investment was due
primarily to sales activity. Sales in the first quarter of 2002 resulted in the
recapture of $1.3 million of a previously established valuation allowance and an
increase of $0.3 million in net gains to a total of $0.6 million. Those gains
primarily relate to joint venture projects and are reported in the category of
equity in net income from joint ventures.
The table below sets forth the key components comprising our income from
real estate and joint venture operations during the periods indicated.
Three Months Ended
---------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
------------------------------------------------------------------------------------------------------------------
Rental operations, net of expenses ................... $ 823 $ 1,026 $ 259 $ 452 $ 508
Equity in net income from joint ventures ............. 745 212 12 121 391
Interest from joint venture advances ................. 111 83 101 152 132
Net gains on sales of wholly owned real estate ....... -- 127 -- -- 2
(Provision for) reduction of losses on real estate and
joint ventures .................................... 1,318 (1) 374 (33) (33)
-----------------------------------------------------------------------------------------------------------------
Income from real estate and joint ventures held for
investment, net ................................. $ 2,997 $ 1,447 $ 746 $ 692 $ 1,000
=================================================================================================================
SECONDARY MARKETING ACTIVITIES
Sales of loans and mortgage-backed securities we originated increased in
the first quarter of 2002 to $1.381 billion from $597 million a year ago. Net
gains associated with these sales totaled $16.2 million in the first quarter of
2002, up from $2.1 million a year ago. Net gains included the capitalization of
mortgage servicing rights of $15.0 million in the first quarter of 2002,
compared to $5.4 million a year ago.
A loss of $0.6 million was recorded in loan servicing from our portfolio of
loans serviced for others during the first quarter of 2002, an improvement from
a loss of $8.2 million in the year-ago period. This $7.6 million improvement
primarily reflected a smaller addition to the valuation allowance for mortgage
servicing rights, $0.4 million in the current quarter compared to $8.3 million a
year ago. At March 31, 2002, we serviced $6.4 billion of loans for others
compared to $5.8 billion at December 31, 2001 and $4.3 billion at March 31,
2001.
17
The following table presents a breakdown of the components of our loan
servicing income (loss) for the periods indicated.
Three Months Ended
------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
----------------------------------------------------------------------------------------------------------
Income from servicing operations .......... $ 2,688 $ 2,477 $ 2,576 $ 1,752 $ 2,223
Amortization of MSRs ...................... (2,916) (2,956) (2,495) (2,299) (2,063)
(Provision for) reduction of impairment ... (360) 11,960 (11,852) (2,351) (8,345)
----------------------------------------------------------------------------------------------------------
Total loan servicing income (loss), net $ (588) $ 11,481 $(11,771) $ (2,898) $ (8,185)
==========================================================================================================
For further information regarding mortgage servicing rights, see Notes To
Consolidated Financial Statements--Note (4)--Mortgage Servicing Rights on page
8.
OPERATING EXPENSE
Our operating expense totaled $45.2 million in the current quarter, up $8.0
million or 21.4% from the first quarter of 2001 because of higher general and
administrative expense. That increase was primarily due to higher costs
associated with an increased number of branch locations and higher loan
origination activity.
The following table presents a breakdown of key components comprising
operating expense during the periods indicated.
Three Months Ended
-------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
--------------------------------------------------------------------------------------------------------------
Salaries and related costs ................... $ 29,437 $ 27,075 $ 24,943 $ 24,646 $ 23,271
Premises and equipment costs ................. 7,133 7,303 6,628 6,042 6,043
Advertising expense .......................... 1,044 1,168 939 1,127 1,176
Professional fees ............................ 564 839 2,432 1,604 577
SAIF insurance premiums and regulatory
assessments ............................... 786 792 786 741 732
Other general and administrative expense ..... 6,211 6,339 5,981 5,973 5,339
--------------------------------------------------------------------------------------------------------------
Total general and administrative expense .. 45,175 43,516 41,709 40,133 37,138
Net operation of real estate acquired in
settlement of loans ....................... (58) 237 110 (106) (2)
Amortization of excess of cost over fair value
of branch acquisitions ................... 111 113 116 114 114
--------------------------------------------------------------------------------------------------------------
Total operating expense .................. $ 45,228 $ 43,866 $ 41,935 $ 40,141 $ 37,250
==============================================================================================================
PROVISION FOR INCOME TAXES
Income taxes for the first quarter totaled $27.3 million, resulting in an
effective tax rate of 42.3%, compared to $19.0 million and 42.4% for the like
quarter of a year ago. For further information regarding income taxes, see Notes
To Consolidated Financial Statements--Note (6)--Income Taxes on page 10.
18
BUSINESS SEGMENT REPORTING
The previous sections of the Results of Operations discussed our
consolidated results. The purpose of this section is to present data and
discussion on the results of operations of our two business segments--banking
and real estate investment. For further information regarding business segments,
see Notes To Consolidated Financial Statements--Note (3)--Business Segment
Reporting on page 7.
The following table presents by business segment our net income for the
periods indicated.
Three Months Ended
-------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
--------------------------------------------------------------------------------------------------------
Banking net income ..................... $ 35,557 $ 38,225 $ 22,301 $ 33,619 $ 25,309
Real estate investment net income (loss) 1,757 871 (535) (164) 555
--------------------------------------------------------------------------------------------------------
Total net income .................... $ 37,314 $ 39,096 $ 21,766 $ 33,455 $ 25,864
========================================================================================================
Banking
Net income from our banking operations for the first quarter of 2002
totaled $35.6 million, up $10.2 million or 40.5% from $25.3 million in the first
quarter of 2001. The increase between first quarters primarily reflected the
following:
o a $14.3 million increase in net gains from sales of loans and
mortgage-backed securities, and mortgage servicing rights;
o a $7.6 million improvement in our loan servicing activity primarily
due to a smaller addition to the valuation allowance for mortgage
servicing rights, $0.4 million in the current quarter compared to $8.3
million a year ago;
o a $3.8 million increase in net interest income due to an increase in
our effective interest rate spread; and
o a $1.3 million increase in loan and deposit related fees.
Those favorable items were partially offset by the following:
o an $8.0 million increase in operating expenses reflecting an increased
number of branch locations and higher loan origination activity; and
o a $1.4 million increase in provision for loan losses due primarily to
a commercial real estate loan that became impaired during the quarter.
19
The table below sets forth our banking operational results and selected
financial data for the periods indicated.
Three Months Ended
-------------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
-------------------------------------------------------------------------------------------------------------
Net interest income ................... $ 79,940 $ 79,730 $ 73,473 $ 76,236 $ 76,134
Provision for loan losses ............. 1,447 1,290 791 431 52
Other income .......................... 28,062 31,397 5,987 21,211 4,745
Operating expense ..................... 45,006 43,680 40,071 38,863 36,990
Net intercompany income ............... 93 96 92 84 97
-------------------------------------------------------------------------------------------------------------
Income before income taxes ............ 61,642 66,253 38,690 58,237 43,934
Income taxes .......................... 26,085 28,028 16,389 24,618 18,625
-------------------------------------------------------------------------------------------------------------
Net income ....................... $ 35,557 $ 38,225 $ 22,301 $ 33,619 $ 25,309
=============================================================================================================
AT PERIOD END
Assets:
Loans and mortgage-backed securities $10,088,113 $10,132,413 $ 9,912,489 $ 9,981,213 $10,272,222
Other .............................. 819,407 966,942 797,775 837,387 755,324
-------------------------------------------------------------------------------------------------------------
Total assets ..................... 10,907,520 11,099,355 10,710,264 10,818,600 11,027,546
-------------------------------------------------------------------------------------------------------------
Equity ................................ $ 767,622 $ 733,896 $ 698,475 $ 680,719 $ 648,592
=============================================================================================================
Real Estate Investment
Net income from our real estate investment operations totaled $1.8 million
in the first quarter of 2002, up from $0.6 million in the year-ago quarter. The
increase was primarily attributed to higher sales activity that resulted in the
recapture of $1.3 million of a previously established valuation allowance and an
increase of $0.3 million in net gains that totaled $0.6 million in the current
quarter.
The table below sets forth real estate investment operational results and
selected financial data for the periods indicated.
Three Months Ended
----------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
-----------------------------------------------------------------------------------------------------------
Net interest income (loss) .................... $ 5 $ (15) $ (26) $ 10 $ 28
Other income .................................. 3,291 1,773 1,083 1,072 1,268
Operating expense ............................. 222 186 1,864 1,278 260
Net intercompany expense ...................... 93 96 92 84 97
-----------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (benefit) ... 2,981 1,476 (899) (280) 939
Income taxes (benefit) ........................ 1,224 605 (364) (116) 384
-----------------------------------------------------------------------------------------------------------
Net income (loss) .......................... $ 1,757 $ 871 $ (535) $ (164) $ 555
===========================================================================================================
AT PERIOD END
Assets:
Investment in real estate and joint ventures $26,384 $38,185 $38,043 $19,950 $18,690
Other ...................................... 4,060 2,003 1,629 1,673 3,337
-----------------------------------------------------------------------------------------------------------
Total assets ............................. 30,444 40,188 39,672 21,623 22,027
-----------------------------------------------------------------------------------------------------------
Equity ........................................ $24,963 $34,513 $33,642 $18,307 $18,471
===========================================================================================================
Our investment in real estate and joint ventures amounted to $26 million at
March 31, 2002, compared to $38 million at December 31, 2001 and $19 million at
March 31, 2001.
For information on valuation allowances associated with real estate and
joint venture loans, see Financial Condition--Problem Loans and Real
Estate--Allowances for Losses on Loans and Real Estate on page 31.
20
FINANCIAL CONDITION
LOANS AND MORTGAGE-BACKED SECURITIES
Total loans and mortgage-backed securities, including those we hold for
sale, declined $44 million during the first quarter to a total of $10.1 billion
or 92.4% of assets at March 31, 2002. The decrease represented a lower level of
loans held for sale and mortgage-backed securities available for sale, as loans
held for investment increased by $94 million. Given the low interest rate
environment and borrower preference for fixed rate loans, our annualized
prepayment speed in the current quarter was 39%, compared to 27% a year ago and
37% during the previous quarter.
The following table sets forth loans originated, including purchases, for
investment and for sale during the periods indicated.
Three Months Ended
--------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
-----------------------------------------------------------------------------------------------------------
Loans originated for investment:
Residential one-to-four units:
Adjustable .......................... $ 988,063 $ 884,312 $ 867,271 $ 814,696 $ 636,988
Fixed ............................... 4,366 1,788 4,445 10,849 4,117
Other ................................. 45,752 51,488 56,554 43,492 28,964
-----------------------------------------------------------------------------------------------------------
Total loans originated for investment 1,038,181 937,588 928,270 869,037 670,069
Loans originated for sale (1) ............ 1,266,430 1,613,671 1,116,589 1,296,877 796,801
-----------------------------------------------------------------------------------------------------------
Total loans originated ................ $2,304,611 $2,551,259 $2,044,859 $2,165,914 $1,466,870
===========================================================================================================
(1) Residential one-to-four unit loans, primarily fixed.
Originations of one-to-four unit residential loans totaled $2.259 billion
in the first quarter of 2002, of which $992 million or 44% were for portfolio,
with the balance for sale in the secondary market. This was 9.6% below the
$2.500 billion originated in the fourth quarter of 2001, but 57.1% higher than
the $1.438 billion we originated in the year-ago first quarter. Of the current
quarter originations for portfolio, $107 million represented originations of
subprime credits as part of our continuing strategy to enhance the portfolio's
net yield. During the current quarter, 80% of our residential one-to-four unit
originations represented refinancing transactions. This is down from 82% in the
previous quarter, but up from 71% in the year-ago first quarter. In addition to
single family loans, we originated $46 million of other loans in the current
quarter.
During the current quarter, loan originations for investment consisted
primarily of adjustable rate mortgages tied to COFI, an index which lags behind
the movement in market interest rates. This experience is similar to that of
recent quarters.
Our adjustable rate mortgages:
o generally begin with an incentive interest rate, which is an interest
rate below the current market rate, that adjusts to the applicable
index plus a defined spread, subject to periodic and lifetime caps,
after one, three, six or twelve months;
o generally provide that the maximum interest rate we can charge
borrowers cannot exceed the incentive rate by more than six to nine
percentage points, depending on the type of loan and the initial rate
offered; and
o limit interest rate adjustments, for loans that adjust both the
interest rate and payment amount simultaneously, to 1% per adjustment
period for those that adjust semi-annually and 2% per adjustment
period for those that adjust annually.
Most of our adjustable rate mortgages adjust the interest rate monthly and
the payment annually. These monthly adjustable rate mortgages:
o have a lifetime interest rate cap, but no specified periodic interest
rate adjustment cap;
o have a periodic cap on changes in required monthly payments; and
o allow for negative amortization, which is the addition to loan
principal of accrued interest that exceeds the required monthly loan
payments.
21
If a loan incurs significant negative amortization, the loan-to-value ratio
could increase which indicates an increased risk that the fair value of the
underlying collateral on the loan would be insufficient to satisfy fully the
outstanding principal and interest. A loan-to-value ratio is the ratio of the
principal amount of the loan to the lower of the sales price or appraised value
of the property securing the loan at origination. We currently impose a limit on
the amount of negative amortization. The principal plus the added amount cannot
exceed 125% of the original loan amount, except for subprime loans and loans
with loan-to-value ratios of 80% or greater wherein the borrower has obtained
private mortgage insurance to reduce the effective loan-to-value ratio to
between 70% and 78%. In those two instances, the principal plus negative
amortization cannot exceed 110% of the original loan amount.
At March 31, 2002, $6.7 billion of the adjustable rate mortgages in our
loan portfolio were subject to negative amortization, of which $166 million
represented the amount of negative amortization included in the loan balance.
We also continue to originate residential fixed interest rate mortgage
loans to meet consumer demand, but we intend to sell the majority of these
loans. We sold $1.381 billion of loans in the first quarter of 2002, compared to
$1.472 billion in the previous quarter and $597 million in the first quarter of
2001. All were secured by residential one-to-four unit property, and at March
31, 2002, loans held for sale totaled $388 million.
At March 31, 2002, our unfunded loan application pipeline totaled $1.3
billion. Within that pipeline, we had commitments to borrowers for short-term
interest rate locks of $660 million, of which $289 million were related to
residential one-to-four unit loans being originated for sale in the secondary
market. Furthermore, we had commitments on undrawn lines and letters of credit
of $89 million and loans in process of $56 million. We believe our current
sources of funds will enable us to meet these obligations.
22
The following table sets forth the origination, purchase and sale activity
relating to our loans and mortgage-backed securities during the periods
indicated.
Three Months Ended
---------------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
----------------------------------------------------------------------------------------------------------------------------------
INVESTMENT PORTFOLIO
Loans originated:
Loans secured by real estate:
Residential one-to-four units:
Adjustable ......................................... $ 880,729 $ 801,751 $ 767,246 $ 620,539 $ 501,945
Adjustable - subprime .............................. 107,334 82,561 100,025 106,148 135,043
----------------------------------------------------------------------------------------------------------------------------------
Total adjustable ................................. 988,063 884,312 867,271 726,687 636,988
Fixed .............................................. 4,336 1,577 3,294 7,455 4,117
Fixed - subprime ................................... -- 211 1,103 3,394 --
Residential five or more units:
Adjustable ......................................... -- -- -- -- --
Fixed .............................................. -- -- -- 125 --
----------------------------------------------------------------------------------------------------------------------------------
Total residential ................................ 992,399 886,100 871,668 737,661 641,105
Commercial real estate .............................. -- 133 -- -- --
Construction ........................................ 13,672 32,025 27,649 23,154 18,888
Land ................................................ 18,542 5,153 4,870 6,219 --
Non-mortgage:
Commercial .......................................... 1,361 4,006 8,440 4,970 165
Automobile .......................................... 376 275 957 1,502 2,091
Other consumer ...................................... 11,801 9,896 7,965 7,522 7,570
----------------------------------------------------------------------------------------------------------------------------------
Total loans originated ............................. 1,038,151 937,588 921,549 781,028 669,819
Real estate loans purchased:
One-to-four units ..................................... 30 -- 48 88,009 --
One-to-four units - subprime .......................... -- -- -- -- --
Other (1) ............................................. -- -- 6,673 -- 250
----------------------------------------------------------------------------------------------------------------------------------
Total real estate loans purchased ................... 30 -- 6,721 88,009 250
----------------------------------------------------------------------------------------------------------------------------------
Total loans originated and purchased ............ 1,038,181 937,588 928,270 869,037 670,069
Loan repayments .......................................... (942,811) (945,582) (968,918) (1,095,547) (705,116)
Other net changes (2) .................................... (936) (12,036) (24,333) 5,813 32,585
----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for investment .. 94,434 (20,030) (64,981) (220,697) (2,462)
----------------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO
Residential one-to-four units:
Originated whole loans ................................ 1,264,559 1,610,470 1,115,345 1,296,270 796,216
Loans purchased ....................................... 1,871 3,201 1,244 607 585
Loans transferred to the investment portfolio ......... (614) (3,167) (1,108) (787) (2,392)
Originated whole loans sold ........................... (156,206) (181,632) (129,237) (292,552) (134,352)
Loans exchanged for mortgage-backed securities ........ (1,225,243) (1,290,355) (991,232) (1,071,840) (462,744)
Other net changes ..................................... (789) (404) (530) (649) (3,179)
Capitalized basis adjustment (3) ...................... 5,866 (12,578) 2,447 (753) 558
----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for sale ...... (110,556) 125,535 (3,071) (69,704) 194,692
----------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities, net:
Received in exchange for loans ........................ 1,225,243 1,290,355 991,232 1,071,840 462,744
Sold .................................................. (1,225,243) (1,290,355) (991,232) (1,071,840) (462,744)
Purchased ............................................. -- 115,597 -- -- --
Repayments ............................................ (26,553) (773) (686) (647) (4,417)
Other net changes ..................................... (1,625) (405) 14 39 56
----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in mortgage-backed securities
available for sale ................................. (28,178) 114,419 (672) (608) (4,361)
----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for sale and
mortgage-backed securities available for sale ...... (138,734) 239,954 (3,743) (70,312) 190,331
----------------------------------------------------------------------------------------------------------------------------------
Total net increase (decrease) in loans and
mortgage-backed securities ......................... $ (44,300) $ 219,924 $ (68,724) $ (291,009) $ 187,869
==================================================================================================================================
(1) Included one commercial loan for the three months ended September 30, 2001
and two residential five or more unit loans for the three months ended
March 31, 2001.
(2) Primarily included borrowings against and repayments of lines of credit and
construction loans, changes in loss allowances, loans transferred to real
estate acquired in settlement of loans or from (to) the held for sale
portfolio, and the change in interest capitalized on loans (negative
amortization).
(3) Reflected the change in fair value from date of interest rate lock
commitment to date of origination.
23
The following table sets forth the composition of our loan and
mortgage-backed securities portfolio at the dates indicated.
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT PORTFOLIO
Loans secured by real estate:
Residential one-to-four units:
Adjustable ................................... $ 7,574,205 $ 7,364,677 $ 7,191,929 $ 7,097,270 $ 7,215,128
Adjustable - subprime ........................ 1,423,661 1,491,416 1,588,573 1,683,302 1,748,715
Fixed ........................................ 295,228 334,384 375,533 408,757 437,197
Fixed - subprime ............................. 13,099 15,303 17,421 18,256 16,941
------------------------------------------------------------------------------------------------------------------------------------
Total residential one-to-four units ....... 9,306,193 9,205,780 9,173,456 9,207,585 9,417,981
Residential five or more units:
Adjustable ................................... 5,920 6,055 6,199 13,359 13,462
Fixed ........................................ 4,230 5,124 5,290 5,464 5,453
Commercial real estate:
Adjustable ................................... 40,650 40,900 41,987 47,236 47,583
Fixed ........................................ 69,691 71,609 100,493 110,513 114,586
Construction ................................... 78,202 84,942 99,161 99,261 96,564
Land ........................................... 36,303 22,028 21,121 21,283 21,230
Non-mortgage:
Commercial ..................................... 21,182 22,017 22,762 21,648 21,312
Automobile ..................................... 20,902 24,529 29,109 32,594 36,590
Other consumer ................................. 48,067 50,908 53,243 56,096 58,610
------------------------------------------------------------------------------------------------------------------------------------
Total loans held for investment .............. 9,631,340 9,533,892 9,552,821 9,615,039 9,833,371
Increase (decrease) for:
Undisbursed loan funds ......................... (65,813) (61,280) (62,880) (59,940) (59,206)
Net deferred costs and premiums ................ 80,622 77,916 79,540 78,621 80,010
Allowance for losses ........................... (37,307) (36,120) (35,043) (34,301) (34,059)
------------------------------------------------------------------------------------------------------------------------------------
Total loans held for investment, net ......... 9,608,842 9,514,408 9,534,438 9,599,419 9,820,116
------------------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO, NET
Loans held for sale:
Residential one-to-four units .................. 392,928 509,317 371,237 376,755 445,706
Residential one-to-four units - subprime ....... -- 33 -- -- --
Capitalized basis adjustment (1) ............... (4,460) (10,326) 2,252 (195) 558
------------------------------------------------------------------------------------------------------------------------------------
Total loans held for sale .................... 388,468 499,024 373,489 376,560 446,264
Mortgage-backed securities available for sale:
Adjustable ..................................... 73,792 101,562 4,562 5,234 5,835
Fixed .......................................... 17,011 17,419 -- -- 7
------------------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed securities available for
sale ...................................... 90,803 118,981 4,562 5,234 5,842
------------------------------------------------------------------------------------------------------------------------------------
Total loans held for sale and mortgage-backed
securities available for sale ............. 479,271 618,005 378,051 381,794 452,106
------------------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities ... $ 10,088,113 $ 10,132,413 $ 9,912,489 $ 9,981,213 $ 10,272,222
====================================================================================================================================
(1) Reflected the change in fair value from date of interest rate lock
commitment to date of origination.
We carry loans for sale at the lower of cost or fair value. At March 31,
2002, no valuation allowance was required as the fair value exceeded book value
on an aggregate basis.
At March 31, 2002, our residential one-to-four units subprime portfolio
consisted of approximately 80% "A-" credit, 17% "B" credit and 3% "C" credit
loans. At March 31, 2002, the average loan-to-value ratio at origination for
these loans was approximately 75%.
We carry mortgage-backed securities available for sale at fair value which,
at March 31, 2002, reflected an unrealized loss of $2.9 million. The current
quarter-end unrealized loss, less the associated tax effect, is reflected within
a separate component of other comprehensive income (loss) until realized.
24
DEPOSITS
At March 31, 2002, our deposits totaled $8.6 billion, down slightly from
both the year-ago level and year-end 2001. Compared to the year-ago period, our
certificates of deposit declined $2.1 billion or 29.9%, which was partially
offset by an increase in our lower-rate transaction accounts--i.e., checking,
regular passbook and money market--of $2.0 billion, more than double the
year-ago level. Within transaction accounts, approximately 99% of the increase
was in our passbook accounts, as depositors moved monies from certificates of
deposit because they seemed more interested in liquidity given the relatively
low level of interest rates. At March 31, 2002, the average deposit size of our
traditional branches was $105 million, while the average size of our in-store
branches was $17 million, or $21 million excluding the 18 new in-store branches
opened within the past 12 months.
The following table sets forth information concerning our deposits and
weighted average rates paid at the dates indicated.
March 31, 2002 December 31, 2001 September 30, 2001 June 30, 2001 March 31, 2001
---------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average
(Dollars in Thousands) Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount
---------------------------------------------------------------------------------------------------------------------------------
Transaction accounts:
Non-interest-bearing
checking .......... -- % $ 312,962 -- % $ 263,165 -- % $ 327,335 -- % $ 328,338 -- % $ 335,404
Interest-bearing
checking (1) ...... 0.25 436,612 0.35 423,776 0.42 403,134 0.42 401,126 0.42 416,636
Money market ....... 1.82 112,646 2.01 108,747 2.29 97,548 2.79 89,949 2.87 91,733
Regular passbook ... 2.57 2,789,500 2.46 2,131,048 2.96 1,308,959 3.44 986,488 3.38 807,503
---------------------------------------------------------------------------------------------------------------------------------
Total transaction
accounts ........ 2.05 3,651,720 1.92 2,926,736 2.00 2,136,976 2.11 1,805,901 1.92 1,651,276
Certificates of
deposit:
Less than 3.00% ..... 2.45 1,467,532 2.41 970,854 2.41 39,217 2.48 27,473 2.14 7,620
3.00-3.49 ........... 3.29 1,080,673 3.20 458,511 3.26 379,901 3.36 8,342 3.45 26
3.50-3.99 ........... 3.84 527,613 3.84 532,634 3.83 508,383 3.83 82,191 3.81 20,748
4.00-4.49 ........... 4.23 830,142 4.22 892,517 4.22 888,123 4.29 387,442 4.38 7,279
4.50-4.99 ........... 4.76 495,530 4.76 555,885 4.73 815,711 4.74 691,800 4.72 293,442
5.00-5.99 ........... 5.21 356,605 5.30 921,510 5.36 1,883,498 5.50 2,791,697 5.62 2,288,745
6.00 and greater .... 6.32 189,075 6.37 1,360,919 6.46 2,216,973 6.59 3,245,218 6.64 4,439,139
---------------------------------------------------------------------------------------------------------------------------------
Total certificates
of deposit ...... 3.66 4,947,170 4.54 5,692,830 5.24 6,731,806 5.82 7,234,163 6.21 7,056,999
---------------------------------------------------------------------------------------------------------------------------------
Total deposits .. 2.98% $8,598,890 3.65% $8,619,566 4.46% $8,868,782 5.08% $9,040,064 5.40% $8,708,275
=================================================================================================================================
(1) Included amounts swept into money market deposit accounts.
BORROWINGS
During the current quarter, our borrowings declined $202 million to $1.3
billion, due to a decrease in FHLB advances. This followed an increase of $595
million during the fourth quarter of 2001.
The following table sets forth information concerning our FHLB advances and
other borrowings at the dates indicated.
March 31, December 31, September 30, June 30, March 31,
(Dollars in Thousands) 2002 2001 2001 2001 2001
-------------------------------------------------------------------------------------------------------------------------
Federal Home Loan Bank advances ................ $1,320,386 $1,522,705 $ 927,398 $ 892,670 $1,457,046
Other borrowings ............................... -- 7 29 94 145
-------------------------------------------------------------------------------------------------------------------------
Total borrowings ............................ $1,320,386 $1,522,712 $ 927,427 $ 892,764 $1,457,191
-------------------------------------------------------------------------------------------------------------------------
Weighted average rate on borrowings during
the period ................................. 4.28% 4.31% 5.01% 5.67% 6.14%
Total borrowings as a percentage of total assets 12.10 13.71 8.65 8.25 13.21
=========================================================================================================================
25
CAPITAL SECURITIES
On July 23, 1999, we issued $120 million in capital securities through
Downey Financial Capital Trust I. The capital securities pay quarterly
cumulative cash distributions at an annual rate of 10.00% of the liquidation
value of $25 per share. Interest expense on our capital securities, including
the amortization of deferred issuance costs, was $3.0 million for the first
quarter of 2002.
ASSET/LIABILITY MANAGEMENT AND MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
interest rates. Our market risk arises primarily from interest rate risk in our
lending and deposit taking activities. This interest rate risk primarily occurs
to the degree that our interest-bearing liabilities reprice or mature on a
different basis--generally more rapidly--than our interest-earning assets. Since
our earnings depend primarily on our net interest income, which is the
difference between the interest and dividends earned on interest-earning assets
and the interest paid on interest-bearing liabilities, one of our principal
objectives is to actively monitor and manage the effects of adverse changes in
interest rates on net interest income while maintaining asset quality. Our
primary strategy to manage interest rate risk is to emphasize the origination of
adjustable rate mortgages or loans with relatively short maturities. Interest
rates on adjustable rate mortgages are primarily tied to COFI.
In addition to the market risk associated with our lending and deposit
taking activities, we also have market risk associated with our secondary
marketing activities. Changes in mortgage interest rates, primarily fixed rate
mortgages, impact the fair value of loans held for sale as well as our
off-balance sheet commitments where we have committed to an interest rate with a
potential borrower for a loan we intend to sell (known as an interest rate lock
derivative). Our objective is to hedge against fluctuations in interest rates
through use of forward sale and purchase contracts with government-sponsored
enterprises and whole loan sale contracts with various parties. These contracts
are typically obtained at the time the interest rate lock commitments are made.
Therefore, as interest rates fluctuate, the changes in the fair value of our
interest rate lock commitments and loans held for sale tend to be offset by
changes in the fair value of the hedge contracts. Although we continue to hedge
as previously done, SFAS 133, as applied to our risk management strategies, may
increase or decrease reported net income and stockholders' equity, depending on
levels of interest rates and other variables affecting the fair values of
derivative instruments and hedged items, but will have no effect on the overall
economics of the transactions.
Changes in mortgage interest rates also impact the value of our mortgage
servicing rights. Rising interest rates typically result in slower prepayment
speeds on the loans being serviced for others which increase the value of
mortgage servicing rights. Declining interest rates typically result in faster
prepayment speeds which decrease the value of mortgage servicing rights.
Currently, we do not hedge our mortgage servicing rights against that risk.
We currently do not enter into hedging contracts for speculative purposes.
There has been no significant change in our market risk since December 31,
2001.
26
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 March
31, 2002, as well as other information regarding the repricing and maturity
differences between our interest-earning assets and total deposits, borrowings
and capital securities in future periods. We refer to these differences as
"gap." We have determined the repricing frequencies by reference to projected
maturities, based upon contractual maturities as adjusted for scheduled
repayments and "repricing mechanisms"--provisions for changes in the interest
and dividend rates of assets and liabilities. We assume prepayment rates on
substantially all of our loan portfolio based upon our historical loan
prepayment experience and anticipated future prepayments. Repricing mechanisms
on a number of our assets are subject to limitations, such as caps on the amount
that interest rates and payments on our loans may adjust, and accordingly, these
assets do not normally respond to changes in market interest rates as completely
or rapidly as our liabilities. The interest rate sensitivity of our assets and
liabilities illustrated in the following table would vary substantially if we
used different assumptions or if actual experience differed from the assumptions
set forth.
March 31, 2002
---------------------------------------------------------------------------------
Within 7 - 12 1 - 5 6 - 10 Over Total
(Dollars in Thousands) 6 Months Months Years Years 10 Years Balance
----------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Investment securities and FHLB stock ..(1) $ 264,684 $ 17,893 $ 125,707 $ 68 $ -- $ 408,352
Loans and mortgage-backed securities: (2)
Loans secured by real estate:
Residential:
Adjustable ....................... 7,671,717 192,364 1,191,558 -- -- 9,055,639
Fixed ............................ 429,818 33,307 154,616 61,581 21,417 700,739
Commercial real estate ............. 39,457 11,508 50,708 2,234 1,584 105,491
Construction ....................... 38,205 -- -- -- -- 38,205
Land ............................... 17,492 9 66 781 -- 18,348
Non-mortgage loans:
Commercial ......................... 10,805 -- -- -- -- 10,805
Consumer ........................... 52,568 4,415 11,100 -- -- 68,083
Mortgage-backed securities ........... 40,224 35,830 6,501 4,387 3,861 90,803
----------------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities 8,300,286 277,433 1,414,549 68,983 26,862 10,088,113
----------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets ........ $8,564,970 $ 295,326 $1,540,256 $ 69,051 $ 26,862 $10,496,465
===================================================================================================================================
Transaction accounts:
Non-interest-bearing checking ......... $ 312,962 $ -- $ -- $ -- $ -- $ 312,962
Interest-bearing checking .............(3) 436,612 -- -- -- -- 436,612
Money market ..........................(4) 112,646 -- -- -- -- 112,646
Regular passbook ......................(4) 2,789,500 -- -- -- -- 2,789,500
----------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts ........... 3,651,720 -- -- -- -- 3,651,720
Certificates of deposit ...................(1) 2,823,767 1,276,030 847,373 -- -- 4,947,170
----------------------------------------------------------------------------------------------------------------------------------
Total deposits ........................ 6,475,487 1,276,030 847,373 -- -- 8,598,890
Borrowings ................................ 123,255 56,781 710,350 430,000 -- 1,320,386
Capital securities ........................ -- -- -- -- 120,000 120,000
----------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and
capital securities ................. $6,598,742 $ 1,332,811 $1,557,723 $ 430,000 $120,000 $10,039,276
===================================================================================================================================
Excess (shortfall) of interest-earning
assets over deposits, borrowings and
capital securities .................... $1,966,228 $(1,037,485) $ (17,467) $(360,949) $(93,138) $ 457,189
Cumulative gap ............................ 1,966,228 928,743 911,276 550,327 457,189
Cumulative gap - as a % of total assets:
March 31, 2002 ........................ 18.02% 8.51% 8.35% 5.04% 4.19%
December 31, 2001 ..................... 12.01 4.76 7.91 4.71 3.86
March 31, 2001 ........................ 19.74 3.99 6.45 3.63 3.31
===================================================================================================================================
(1) Based upon contractual maturity and repricing date.
(2) Based upon contractual maturity, repricing date and projected repayment and
prepayments of principal.
(3) Included amounts swept into money market deposit accounts and is subject to
immediate repricing.
(4) Subject to immediate repricing.
27
Our six-month gap at March 31, 2002 was a positive 18.02%. 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
12.01% at December 31, 2001 and 19.74% at March 31, 2001. We continue to pursue
our strategy of emphasizing the origination of adjustable rate mortgages. For
the twelve months ended March 31, 2002, we originated and purchased for
investment $3.7 billion of adjustable rate loans which represented approximately
99% of all loans we originated and purchased for investment during the period.
At March 31, 2002, 99% of our interest-earning assets mature, reprice or
are estimated to prepay within five years, unchanged from December 31, 2001 and
up slightly from 98% at March 31, 2001. At March 31, 2002, loans held for
investment and mortgage-backed securities with adjustable interest rates
represented 92% of those portfolios. During the first quarter of 2002, we
continued to offer residential fixed rate loan products to our customers
primarily for sale in the secondary market. We price and originate fixed rate
mortgage loans for sale into the secondary market to increase opportunities to
originate adjustable rate mortgages and to generate fees and servicing income.
We also originate fixed rate loans for portfolio to facilitate the sale of real
estate acquired in settlement of loans and which meet specific yield and other
approved guidelines.
At March 31, 2002, $9.4 billion or 93% of our total loan portfolio,
including mortgage-backed securities, consisted of adjustable rate loans,
construction loans, and loans with a due date of five years or less, compared to
$9.3 billion or 91% at December 31, 2001, and $9.4 billion or 91% at March 31,
2001.
The following table sets forth the interest rate spread between our
interest-earning assets and interest-bearing liabilities at the dates indicated.
March 31, December 31, September 30, June 30, March 31,
2002 2001 2001 2001 2001
-------------------------------------------------------------------------------------------------------
Weighted average yield:
Loans and mortgage-backed securities 6.45% 7.15% 7.68% 8.24% 8.56%
Federal Home Loan Bank stock ....... 5.30 5.31 6.00 6.00 5.51
Investment securities .............. 3.43 3.54 5.18 5.38 6.00
-------------------------------------------------------------------------------------------------------
Interest-earning assets yield .... 6.35 6.98 7.59 8.12 8.46
-------------------------------------------------------------------------------------------------------
Weighted average cost:
Deposits ........................... 2.98 3.65 4.46 5.08 5.40
Borrowings:
Federal Home Loan Bank advances .. 4.63 3.73 4.70 5.36 5.94
Other borrowings ................. -- 7.88 7.88 7.88 7.88
-------------------------------------------------------------------------------------------------------
Total borrowings ............. 4.63 3.73 4.70 5.36 5.94
Capital securities ................. 10.00 10.00 10.00 10.00 10.00
-------------------------------------------------------------------------------------------------------
Combined funds cost .............. 3.28 3.74 4.55 5.16 5.53
-------------------------------------------------------------------------------------------------------
Interest rate spread ......... 3.07% 3.24% 3.04% 2.96% 2.93%
=======================================================================================================
The period-end weighted average yield on our loan portfolio declined to
6.45% at March 31, 2002, down from 7.15% at December 31, 2001 and 8.56% at March
31, 2001. At March 31, 2002, our adjustable rate mortgage portfolio of single
family residential loans, including mortgage-backed securities, totaled $9.1
billion with a weighted average rate of 6.35%, compared to $9.0 billion with a
weighted average rate of 7.11% at December 31, 2001, and $9.0 billion with a
weighted average rate of 8.65% at March 31, 2001.
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 increased $1 million during the current
quarter to $94 million or 0.86% of total assets. This increase was primarily due
to a $2 million rise in commercial real estate non-accrual loans as a result of
a shopping center loan whose principal tenant declared bankruptcy during the
quarter and ceased paying rent. Non-performing assets at quarter end included
non-accrual loans aggregating $4 million which were not contractually past due,
but were deemed non-accrual due to management's assessment of the borrower's
ability to pay.
28
The following table summarizes our non-performing assets at the dates
indicated.
March 31, December 31, September 30, June 30, March 31,
(Dollars in Thousands) 2002 2001 2001 2001 2001
-----------------------------------------------------------------------------------------------------------------
Non-accrual loans:
Residential one-to-four units ................... $43,934 $43,210 $29,266 $22,494 $16,965
Residential one-to-four units - subprime ........ 33,169 31,166 31,076 25,737 26,353
Other ........................................... 4,589 2,668 2,927 3,054 3,367
-----------------------------------------------------------------------------------------------------------------
Total non-accrual loans ....................... 81,692 77,044 63,269 51,285 46,685
Troubled debt restructure - below market rate (1) ... 203 203 204 204 205
Real estate acquired in settlement of loans ......... 11,917 15,366 11,870 8,366 11,634
Repossessed automobiles ............................. 19 19 28 37 15
-----------------------------------------------------------------------------------------------------------------
Total non-performing assets ..................... $93,831 $92,632 $75,371 $59,892 $58,539
=================================================================================================================
Allowance for loan losses:
Amount .......................................... $37,307 $36,120 $35,043 $34,301 $34,059
As a percentage of non-performing loans ......... 45.55% 46.76% 55.21% 66.62% 72.64%
Non-performing assets as a percentage of total assets 0.86 0.83 0.70 0.55 0.53
=================================================================================================================
(1) Represents a residential single one-to-four unit loan.
Delinquent Loans
Loans delinquent 30 days or more declined during the first quarter to 1.05%
at March 31, 2002, from 1.10% at December 31, 2001, but were above the 0.73% of
a year ago. The decline during the current quarter primarily occurred in our
residential one-to-four units category.
29
The following table indicates the amounts of our past due loans at the
dates indicated.
March 31, 2002 December 31, 2001
---------------------------------------------------------------------------------------------
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 .......... $ 19,454 $ 6,360 $ 34,724 $ 60,538 $ 19,170 $ 12,797 $ 33,449 $ 65,416
One-to-four units - subprime 13,653 4,175 25,797 43,625 13,159 9,104 20,958 43,221
Five or more units ......... -- -- -- -- -- -- -- --
Commercial real estate ....... -- -- -- -- -- -- -- --
Construction ................. -- -- -- -- -- -- -- --
Land ......................... -- -- -- -- -- -- -- --
----------------------------------------------------------------------------------------------------------------------------------
Total real estate loans .... 33,107 10,535 60,521 104,163 32,329 21,901 54,407 108,637
Non-mortgage:
Commercial ................... -- -- 637 637 -- -- 1,163 1,163
Automobile ................... 138 14 79 231 174 85 46 305
Other consumer ............... 142 57 185 384 356 62 173 591
----------------------------------------------------------------------------------------------------------------------------------
Total delinquent loans ..... $ 33,387 $ 10,606 $ 61,422 $105,415 $ 32,859 $ 22,048 $ 55,789 $110,696
==================================================================================================================================
Delinquencies as a percentage of
total loans .................. 0.33% 0.11% 0.61% 1.05% 0.33% 0.22% 0.55% 1.10%
==================================================================================================================================
September 30, 2001 June 30, 2001
---------------------------------------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units .......... $18,515 $ 8,165 $25,131 $51,811 $15,190 $ 7,262 $17,291 $39,743
One-to-four units - subprime 11,212 8,569 21,649 41,430 11,402 6,513 20,772 38,687
Five or more units ......... -- -- -- -- -- -- 248 248
Commercial real estate ....... -- -- -- -- -- -- -- --
Construction ................. -- -- -- -- -- -- -- --
Land ......................... -- -- -- -- -- -- -- --
----------------------------------------------------------------------------------------------------------------------------------
Total real estate loans .... 29,727 16,734 46,780 93,241 26,592 13,775 38,311 78,678
Non-mortgage:
Commercial ................... -- -- 1,290 1,290 -- -- 1,290 1,290
Automobile ................... 269 54 80 403 112 63 32 207
Other consumer ............... 253 38 264 555 287 28 185 500
----------------------------------------------------------------------------------------------------------------------------------
Total delinquent loans ..... $30,249 $16,826 $48,414 $95,489 $26,991 $13,866 $39,818 $80,675
==================================================================================================================================
Delinquencies as a percentage of
total loans .................. 0.30% 0.17% 0.49% 0.96% 0.27% 0.14% 0.40% 0.81%
==================================================================================================================================
March 31, 2001
-----------------------------------------
Loans secured by real estate:
Residential:
One-to-four units .......... $14,166 $ 6,961 $15,490 $36,617
One-to-four units - subprime 11,223 6,651 17,860 35,734
Five or more units ......... -- -- 508 508
Commercial real estate ....... -- -- -- --
Construction ................. -- -- -- --
Land ......................... -- -- -- --
------------------------------------------------------------------------------
Total real estate loans .... 25,389 13,612 33,858 72,859
Non-mortgage:
Commercial ................... -- 1,290 -- 1,290
Automobile ................... 230 55 74 359
Other consumer ............... 189 31 190 410
------------------------------------------------------------------------------
Total delinquent loans ..... $25,808 $14,988 $34,122 $74,918
==============================================================================
Delinquencies as a percentage of
total loans .................. 0.25% 0.15% 0.33% 0.73%
==============================================================================
(1) All 90 day or greater delinquencies are on non-accrual status and reported
as part of non-performing assets.
30
Allowance for Losses on Loans and Real Estate
We maintain a valuation allowance for losses on loans and real estate to
provide for losses inherent in those portfolios. The adequacy of the allowance
is evaluated quarterly by management to maintain the allowance at levels
sufficient to provide for inherent losses.
We adhere to an internal asset review system and loss allowance methodology
designed to provide for timely recognition of problem assets and an adequate
valuation allowance to cover asset losses. The amount of the allowance is based
upon the summation of general valuation allowances, allocated allowances and an
unallocated allowance. General valuation allowances relate to assets with no
well-defined deficiency or weakness and takes into consideration loss that is
imbedded within the portfolio but has not yet been realized. Allocated
allowances relate to assets with well-defined deficiencies or weaknesses.
Included in both these allowances are those amounts associated with assets where
it is probable that the recorded value of the asset declined and the loss can be
reasonably estimated. If we determine the carrying value of our asset exceeds
its net fair value and no alternative payment source exists, then a specific
allowance is recorded for the amount of that difference. The unallocated
allowance is more subjective and is reviewed quarterly to take into
consideration estimation errors and economic trends that are not necessarily
captured in determining the general valuation and allocated allowances.
Allowances for losses on all assets were $38 million at March 31, 2002,
compared to $39 million at December 31, 2001, and $37 million at March 31, 2001.
Our provision for loan losses was $1.4 million in the current quarter and
exceeded our net loan charge-offs by $1.2 million resulting in an increase in
the allowance for loan losses to $37.3 million at March 31, 2002. The current
quarter allowance increase reflected an increase of $1.2 million in allocated
allowances due primarily to a commercial real estate loan that became impaired
during the quarter. There were no changes in our general valuation allowances or
our unallocated allowance of $2.8 million.
The following table summarizes the activity in our allowance for loan
losses during the periods indicated.
Three Months Ended
-----------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
--------------------------------------------------------------------------------------------
Balance at beginning of period $ 36,120 $ 35,043 $ 34,301 $ 34,059 $ 34,452
Provision .................... 1,447 1,290 791 431 52
Charge-offs .................. (276) (316) (198) (326) (508)
Recoveries ................... 16 103 149 137 63
--------------------------------------------------------------------------------------------
Balance at end of period ..... $ 37,307 $ 36,120 $ 35,043 $ 34,301 $ 34,059
============================================================================================
31
The following table presents by category of loan gross charge-offs, gross
recoveries and net charge-offs during the periods indicated.
Three Months Ended
---------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(Dollars in Thousands) 2002 2001 2001 2001 2001
----------------------------------------------------------------------------------------------------------------
GROSS LOAN CHARGE-OFFS
Loans secured by real estate:
Residential:
One-to-four units ............................. $ 125 $ 108 $ 25 $ 115 $ 282
One-to-four units - subprime .................. 17 70 60 92 122
Five or more units ............................ -- -- -- -- --
Commercial real estate .......................... -- -- -- -- --
Construction .................................... -- -- -- -- --
Land ............................................ -- -- -- -- --
Non-mortgage:
Commercial ...................................... -- -- -- -- --
Automobile ...................................... 52 51 26 72 48
Other consumer .................................. 82 87 87 47 56
----------------------------------------------------------------------------------------------------------------
Total gross loan charge-offs .................. 276 316 198 326 508
----------------------------------------------------------------------------------------------------------------
GROSS LOAN RECOVERIES
Loans secured by real estate:
Residential:
One-to-four units ............................. 9 1 86 121 59
One-to-four units - subprime .................. -- 100 61 5 --
Five or more units ............................ -- -- -- -- --
Commercial real estate .......................... -- -- -- 1 --
Construction .................................... -- -- -- -- --
Land ............................................ -- -- -- -- --
Non-mortgage:
Commercial ...................................... -- -- -- -- --
Automobile ...................................... 5 -- -- 4 --
Other consumer .................................. 2 2 2 6 4
----------------------------------------------------------------------------------------------------------------
Total gross loan recoveries ................... 16 103 149 137 63
----------------------------------------------------------------------------------------------------------------
NET LOAN CHARGE-OFFS
Loans secured by real estate:
Residential:
One-to-four units ............................. 116 107 (61) (6) 223
One-to-four units - subprime .................. 17 (30) (1) 87 122
Five or more units ............................ -- -- -- -- --
Commercial real estate .......................... -- -- -- (1) --
Construction .................................... -- -- -- -- --
Land ............................................ -- -- -- -- --
Non-mortgage:
Commercial ...................................... -- -- -- -- --
Automobile ...................................... 47 51 26 68 48
Other consumer .................................. 80 85 85 41 52
----------------------------------------------------------------------------------------------------------------
Total net loan charge-offs .................... $ 260 $ 213 $ 49 $ 189 $ 445
================================================================================================================
Net loan charge-offs as a percentage of average loans 0.01% 0.01% -% 0.01% 0.02%
================================================================================================================
32
The following table indicates our allocation of the allowance for loan
losses to the various categories of loans at the dates indicated.
March 31, 2002 December 31, 2001 September 30, 2001
----------------------------------------------------------------------------------------------------
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 ...... $18,566 $7,869,433 0.24% $19,033 $7,699,061 0.25% $16,598 $7,567,462 0.22%
One-to-four
units-subprime ....... 9,755 1,436,760 0.68 9,633 1,506,719 0.64 10,385 1,605,994 0.65
Five or more units ..... 76 10,150 0.75 84 11,179 0.75 86 11,489 0.75
Commercial real estate ... 3,367 110,341 3.05 1,848 112,509 1.64 2,262 142,480 1.59
Construction ............. 920 78,202 1.18 1,005 84,942 1.18 1,164 99,161 1.17
Land ..................... 446 36,303 1.23 274 22,028 1.24 262 21,121 1.24
Non-mortgage:
Commercial ............... 511 21,182 2.41 573 22,017 2.60 650 22,762 2.86
Automobile ............... 292 20,902 1.40 277 24,529 1.13 196 29,109 0.67
Other consumer ........... 574 48,067 1.19 593 50,908 1.16 640 53,243 1.20
Not specifically allocated .. 2,800 -- -- 2,800 -- -- 2,800 -- --
-----------------------------------------------------------------------------------------------------------------------------------
Total loans held for
investment ............. $37,307 $9,631,340 0.39% $36,120 $9,533,892 0.38% $35,043 $9,552,821 0.37%
===================================================================================================================================
June 30, 2001 March 31, 2001
----------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units ...... $15,139 $7,506,027 0.20% $14,599 $7,652,325 0.19%
One-to-four
units-subprime ....... 10,826 1,701,558 0.64 11,071 1,765,656 0.63
Five or more units ..... 141 18,823 0.75 142 18,915 0.75
Commercial real estate ... 2,703 157,749 1.71 2,709 162,169 1.67
Construction ............. 1,171 99,261 1.18 1,142 96,564 1.18
Land ..................... 263 21,283 1.24 261 21,230 1.23
Non-mortgage:
Commercial ............... 422 21,648 1.95 424 21,312 1.99
Automobile ............... 175 32,594 0.54 234 36,590 0.64
Other consumer ........... 661 56,096 1.18 677 58,610 1.16
Not specifically allocated .. 2,800 -- -- 2,800 -- --
------------------------------------------------------------------------------------------------
Total loans held for
investment ............. $34,301 $9,615,039 0.36% $34,059 $9,833,371 0.35%
================================================================================================
At March 31, 2002, the recorded investment in loans for which we recognized
impairment totaled $17 million, up from $13 million at December 31, 2001. The
allowance for losses related to these loans increased from $1 million at
December 31, 2001, to $2 million at March 31, 2002. During the first quarter of
2002, total interest recognized on the impaired loan portfolio was $0.3 million.
The following table summarizes the activity in our allowance for loan
losses associated with impaired loans during the periods indicated.
Three Months Ended
-------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2001 2001
---------------------------------------------------------------------------------------------
Balance at beginning of period $ 759 $ 1,210 $ 782 $ 798 $ 800
Provision (reduction) ........ 1,597 (451) 428 (16) (2)
Charge-offs .................. -- -- -- -- --
Recoveries ................... -- -- -- -- --
---------------------------------------------------------------------------------------------
Balance at end of period ..... $ 2,356 $ 759 $ 1,210 $ 782 $ 798
=============================================================================================
33
The following table summarizes the activity in our allowance for real
estate and joint ventures held for investment during the periods indicated.
Three Months Ended
-----------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
(In Thousands) 2002 2001 2001 2000 2001
--------------------------------------------------------------------------------------------
Balance at beginning of period $ 2,690 $ 2,689 $ 3,063 $ 3,030 $ 2,997
Provision (reduction) ........ (1,318) 1 (374) 33 33
Charge-offs .................. (339) -- -- -- --
Recoveries ................... -- -- -- -- --
--------------------------------------------------------------------------------------------
Balance at end of period ..... $ 1,033 $ 2,690 $ 2,689 $ 3,063 $ 3,030
============================================================================================
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.
Our primary sources of funds generated in the first quarter of 2002 were
from:
o principal repayments--including prepayments, but excluding refinances
of our existing loans--on loans and mortgage-backed securities of $786
million;
o maturities and sales of U.S. Treasury securities, agency obligations
and other investment securities available for sale of $225 million;
and
o a net decrease of our loans held for sale of $111 million.
We used these funds for the following purposes:
o to originate and purchase loans held for investment, excluding
refinances of our existing loans, of $851 million;
o to paydown our borrowings by $202 million; and
o to purchase U.S. Treasury securities, agency obligations and other
investment securities available for sale of $75 million.
Our principal source of liquidity is our ability to utilize borrowings, as
needed. Our primary source of borrowings is the FHLB. At March 31, 2002, our
FHLB borrowings totaled $1.3 billion, representing 12.1% of total assets. We
currently are approved by the FHLB to borrow up to 40% of total assets to the
extent we provide qualifying collateral and hold sufficient FHLB stock. That
approved limit would have permitted us, as of quarter end, to borrow an
additional $3.0 billion. To the extent deposit growth over the remainder of 2002
falls short of satisfying ongoing commitments to fund maturing and withdrawable
deposits, repay maturing borrowings, fund existing and future loans, make
investments, and continue branch improvement programs, we will utilize our FHLB
borrowing arrangement or possibly other sources. As of March 31, 2002, we had
commitments to borrowers for short-term rate locks of $660 million, undisbursed
loan funds and unused lines and letters of credit of $145 million, and other
contingent liabilities of $3 million. We believe our current sources of funds
enable us to meet these obligations while maintaining our liquidity at
appropriate levels.
Another measure of liquidity in the savings and loan industry is the ratio
of cash and eligible investments to the sum of withdrawable savings and
borrowings due within one year. At March 31, 2002, the Bank's ratio was 3.9%,
compared to 4.3% at December 31, 2001 and 4.6% at March 31, 2001.
The holding company currently has liquid assets, including due from
Bank--interest-bearing balances, of $22 million and can obtain further funds by
means of dividends from subsidiaries, subject to certain limitations, or
issuance of further debt or equity.
Stockholders' equity totaled $768 million at March 31, 2002, up from $734
million at December 31, 2001 and $649 million at March 31, 2001.
34
REGULATORY CAPITAL
Our core and tangible capital ratios were both 7.61% and our risk-based
capital ratio was 15.39%. The Bank's capital ratios exceed the "well
capitalized" standards of 5.00% for core capital and 10.00% for risk-based
capital, as defined by regulation.
The following table is a reconciliation of the Bank's stockholder's equity
to federal regulatory capital as of March 31, 2002.
Tangible Capital Core Capital Risk-Based Capital
--------------------- -------------------- ---------------------
(Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio
----------------------------------------------------------------------------------------------------------------
Stockholder's equity ........................ $860,022 $860,022 $860,022
Adjustments:
Deductions:
Investment in subsidiary, primarily real
estate ................................ (24,094) (24,094) (24,094)
Excess cost over fair value of branch
acquisitions .......................... (3,039) (3,039) (3,039)
Non-permitted mortgage servicing rights . (6,858) (6,858) (6,858)
Additions:
Unrealized losses on securities available
for sale .............................. 1,288 1,288 1,288
General loss allowance - investment in
DSL Service Company ................... 46 46 46
Allowance for loan losses,
net of specific allowances (1) ........ -- -- 35,631
----------------------------------------------------------------------------------------------------------------
Regulatory capital .......................... 827,365 7.61% 827,365 7.61% 862,996 15.39%
Well capitalized requirement ................ 163,051 1.50 (2) 543,504 5.00 560,615 10.00 (3)
----------------------------------------------------------------------------------------------------------------
Excess ...................................... $664,314 6.11% $283,861 2.61% $302,381 5.39%
================================================================================================================
(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 14.76%.
35
PART II -- OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K
(A) Exhibits.
(B) Form 8-K filed January 17, 2002.
SIGNATURES: Pursuant to the requirements of Section 13 or 15 (d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
DOWNEY FINANCIAL CORP.
Date: May 1, 2002 /s/ DANIEL D. ROSENTHAL
----------------------------------------------------
Daniel D. Rosenthal
President and Chief Executive Officer
Date: May 1, 2002 /s/ THOMAS E. PRINCE
----------------------------------------------------
Thomas E. Prince
Executive Vice President and Chief Financial Officer
36