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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 SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
__________ TO __________
Commission File Number 1-13578
DOWNEY FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0633413
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3501 JAMBOREE ROAD, NEWPORT BEACH, CA 92660
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (949) 854-0300
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- --------------------------
COMMON STOCK, $0.01 PAR VALUE NEW YORK STOCK EXCHANGE
PACIFIC EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
At September 30, 1999, 28,148,409 shares of the Registrant's Common Stock,
$0.01 par value were outstanding.
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DOWNEY FINANCIAL CORP.
SEPTEMBER 30, 1999 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..................................... 8
PART II
OTHER INFORMATION....................................................... 34
Item 6 Exhibits and Reports on Form 8-K.............................. 34
i
PART I - FINANCIAL INFORMATION
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, December 31, September 30,
(Dollars in Thousands, Except Per Share Data) 1999 1998 1998
- -------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash .......................................................................... $ 86,391 $ 58,510 $ 43,315
Federal funds ................................................................. 26,501 33,751 54,801
- -------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents ................................................. 112,892 92,261 98,116
U.S. Treasury securities and agency obligations available for sale,
at fair value ............................................................. 143,020 116,061 116,629
Municipal securities being held to maturity, at amortized cost (estimated
market value of $6,845 at September 30, 1999, $6,745 at December 31,
1998, and $6,865 at September 30, 1998) ................................... 6,863 6,764 6,885
Mortgage loans purchased under resale agreements .............................. -- -- 40,000
Loans held for sale, at lower of cost or market ............................... 211,067 447,382 272,913
Mortgage-backed securities available for sale, at fair value .................. 23,583 32,146 38,131
Loans receivable held for investment .......................................... 7,665,951 5,308,837 5,076,799
Investments in real estate and joint ventures ................................. 54,036 49,447 47,918
Real estate acquired in settlement of loans ................................... 5,213 4,475 5,423
Premises and equipment ........................................................ 105,492 103,979 102,030
Federal Home Loan Bank stock, at cost ......................................... 69,380 49,430 48,712
Other assets .................................................................. 103,192 59,637 57,023
- -------------------------------------------------------------------------------------------------------------------------
$8,500,689 $6,270,419 $5,910,579
=========================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits ...................................................................... $6,311,312 $5,039,733 $5,179,380
Federal Home Loan Bank advances ............................................... 1,477,207 695,012 197,935
Other borrowings .............................................................. 8,501 8,708 12,166
Accounts payable and accrued liabilities ...................................... 54,366 40,989 45,062
Deferred income taxes ......................................................... 13,358 5,411 5,221
- -------------------------------------------------------------------------------------------------------------------------
Total liabilities ......................................................... 7,864,744 5,789,853 5,439,764
- -------------------------------------------------------------------------------------------------------------------------
Company obligated mandatorily redeemable capital securities of subsidiary trust
holding solely junior subordinated debentures of the Company
("Capital Securities") .................................................... 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 28,148,409 shares at September 30, 1999 and
28,131,776 shares at December 31, 1998 and September 30, 1998 ............ 281 281 281
Additional paid-in capital .................................................... 92,385 92,166 92,166
Accumulated other comprehensive income (loss) - unrealized gains (losses)
on securities available for sale .......................................... (738) 753 1,403
Retained earnings ............................................................. 424,017 387,366 376,965
- -------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity ................................................ 515,945 480,566 470,815
- -------------------------------------------------------------------------------------------------------------------------
$8,500,689 $6,270,419 $5,910,579
=========================================================================================================================
See accompanying notes to consolidated financial statements.
1
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Income
Three Months Ended Nine Months Ended
September 30, September 30,
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(Dollars in Thousands, Except Per Share Data) 1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Loans receivable ............................................ $ 132,686 $ 103,949 $ 362,235 $ 314,877
U.S. Treasury securities and agency obligations ............. 2,063 1,813 5,478 5,488
Mortgage-backed securities .................................. 387 654 1,274 2,200
Other investments ........................................... 1,268 2,566 3,520 5,937
- -----------------------------------------------------------------------------------------------------------------------------
Total interest income .................................... 136,404 108,982 372,507 328,502
- -----------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Deposits .................................................... 67,478 64,243 181,051 188,780
Borrowings .................................................. 15,576 1,952 37,953 11,119
Capital securities .......................................... 2,307 -- 2,307 --
- -----------------------------------------------------------------------------------------------------------------------------
Total interest expense ................................... 85,361 66,195 221,311 199,899
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NET INTEREST INCOME ......................................... 51,043 42,787 151,196 128,603
PROVISION FOR LOAN LOSSES ....................................... 2,838 985 8,017 2,719
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Net interest income after provision for loan losses ......... 48,205 41,802 143,179 125,884
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OTHER INCOME, NET:
Loan and deposit related fees ............................... 5,323 4,163 14,675 11,059
Real estate and joint ventures held for investment, net:
Net gains on sales of wholly owned real estate ........... 1,037 -- 1,237 70
Reduction of losses on real estate and joint ventures .... 3,162 139 3,374 5,082
Operations, net .......................................... 1,532 3,879 5,054 13,384
Secondary marketing activities:
Loan servicing fees ...................................... 383 (420) 1,249 (131)
Net gains on sales of loans and mortgage-backed securities 4,395 1,726 12,440 5,012
Net gains on sales of investment securities ................. -- -- 288 68
Other ....................................................... 439 185 2,555 2,003
- -----------------------------------------------------------------------------------------------------------------------------
Total other income, net .................................. 16,271 9,672 40,872 36,547
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OPERATING EXPENSE:
Salaries and related costs .................................. 21,759 16,171 63,821 46,416
Premises and equipment costs ................................ 5,222 4,343 15,025 12,133
Advertising expense ......................................... 2,150 1,367 6,920 4,502
Professional fees ........................................... 553 701 1,564 2,058
SAIF insurance premiums and regulatory assessments .......... 975 977 2,906 2,882
Other general and administrative expense .................... 5,252 5,158 17,206 14,179
- -----------------------------------------------------------------------------------------------------------------------------
Total general and administrative expense ................. 35,911 28,717 107,442 82,170
- -----------------------------------------------------------------------------------------------------------------------------
Net operation of real estate acquired in settlement of loans (224) 107 (13) 265
Amortization of excess of cost over fair value of net assets
acquired ................................................. 118 125 354 391
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Total operating expense .................................. 35,805 28,949 107,783 82,826
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INCOME BEFORE INCOME TAXES ...................................... 28,671 22,525 76,268 79,605
Income taxes .................................................... 12,109 9,757 32,300 34,284
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NET INCOME .................................................. $ 16,562 $ 12,768 $ 43,968 $ 45,321
=============================================================================================================================
PER SHARE INFORMATION:
BASIC ....................................................... $ 0.59 $ 0.45 $ 1.56 $ 1.61
=============================================================================================================================
DILUTED ..................................................... $ 0.59 $ 0.45 $ 1.56 $ 1.60
=============================================================================================================================
CASH DIVIDENDS DECLARED AND PAID ............................ $ 0.090 $ 0.080 $ 0.260 $ 0.236
=============================================================================================================================
Weighted average diluted shares outstanding ................. 28,179,561 28,181,313 28,175,104 28,176,326
=============================================================================================================================
See accompanying notes to consolidated financial statements.
2
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------------
(In Thousands) 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------------------
NET INCOME ........................................................... $16,562 $12,768 $43,968 $45,321
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OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAXES:
Unrealized gains (losses) on securities available for sale:
U.S. Treasury securities and agency obligations available for
sale, at fair value ......................................... (274) 309 (1,234) 833
Less reclassification of realized gains, net of losses included
in income ................................................... -- -- (166) (39)
Mortgage-backed securities available for sale, at fair value .. 57 674 (91) 499
- -------------------------------------------------------------------------------------------------------------------
Total other comprehensive income (loss), net of income taxes ..... (217) 983 (1,491) 1,293
- -------------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME ................................................. $16,345 $13,751 $42,477 $46,614
===================================================================================================================
See accompanying notes to consolidated financial statements.
3
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Nine Months Ended
September 30,
---------------------------
(In Thousands) 1999 1998
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ......................................................................... $ 43,968 $ 45,321
Adjustments to reconcile net income to net cash used for operating activities:
Depreciation and amortization ................................................... 5,870 5,666
Provision for (recovery of) losses on loans, real estate acquired in settlement
of loans, investments in real estate and joint ventures and other assets ...... 4,611 (2,023)
Net gains on sales of loans and mortgage-backed securities, investment
securities, real estate and other assets ...................................... (16,372) (15,885)
Interest capitalized on loans (negative amortization) ........................... (18,149) (13,817)
Federal Home Loan Bank stock dividends .......................................... (2,021) (2,010)
Loans originated for sale .......................................................... (1,698,671) (1,421,746)
Proceeds from sales of loans originated for sale ................................... 758,227 867,409
Other, net ......................................................................... (4,511) 5,896
- ----------------------------------------------------------------------------------------------------------------------
Net cash used for operating activities ................................................. (927,048) (531,189)
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from:
Maturities of U.S. Treasury securities and agency obligations ................... -- 10,001
Sales of U.S. Treasury securities and agency obligations available for sale ..... 65,195 60,068
Sales of mortgage-backed securities available for sale .......................... 1,209,178 314,265
Sales of wholly owned real estate and real estate acquired in settlement of loans 3,877 5,461
Purchase of:
U.S. Treasury securities and agency obligations available for sale .............. (94,417) (25,000)
Securities under resale agreements .............................................. -- (40,000)
Federal Home Loan Bank stock .................................................... (17,929) (2,617)
Loans receivable held for investment ............................................ (28,596) (6,956)
Loans receivable originated held for investment (net of refinances of $123,932
at September 30, 1999 and $80,844 at September 30, 1998) ........................ (3,644,203) (1,132,868)
Principal payments on loans receivable held for investment and mortgage-backed
securities available for sale ................................................... 1,268,819 1,342,354
Net change in undisbursed loan funds ............................................... 43,616 24,155
Proceeds from (investments in) real estate held for investment ..................... (10,161) 1,391
Other, net ......................................................................... (9,232) (5,507)
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities ................................... (1,213,853) 544,747
- ----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
4
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
Nine Months Ended
September 30,
-------------------------
(In Thousands) 1999 1998
- -----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits .................................................. $ 1,271,579 $ 309,402
Net decrease in securities sold under agreements to repurchase ............ -- (34,803)
Proceeds from Federal Home Loan Bank advances ............................. 4,910,237 179,700
Repayments of Federal Home Loan Bank advances ............................. (4,128,042) (334,223)
Net decrease in other borrowings .......................................... (207) (84,308)
Proceeds from issuance of capital securities, net ......................... 115,063 --
Proceeds from exercise of stock options ................................... 219 510
Cash dividends ............................................................ (7,317) (6,638)
- -----------------------------------------------------------------------------------------------------------
Net cash provided by financing activities ..................................... 2,161,532 29,640
- -----------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents ..................................... 20,631 43,198
Cash and cash equivalents at beginning of year ................................ 92,261 54,918
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CASH AND CASH EQUIVALENTS AT END OF PERIOD .................................... $ 112,892 $ 98,116
===========================================================================================================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest ............................................................... $ 220,678 $ 199,529
Income taxes ........................................................... 18,910 38,684
Supplemental disclosure of non-cash investing:
Loans transferred to held for investment from held for sale ............... 48,281 --
Loans exchanged for mortgage-backed securities ............................ 1,208,333 316,891
Real estate acquired in settlement of loans ............................... 8,497 12,160
Loans to facilitate the sale of real estate acquired in settlement of loans 5,608 12,280
===========================================================================================================
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"), the
accompanying consolidated financial statements contain all adjustments
(consisting of only normal recurring accruals) necessary for a fair presentation
of Downey's financial condition as of September 30, 1999, December 31, 1998, and
September 30, 1998, the results of operations and comprehensive income for the
three months and nine months ended September 30, 1999 and 1998, and changes in
cash flows for the nine months ended September 30, 1999 and 1998. 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 generally accepted accounting principles for interim financial
operations 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, 1998, 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, 1998, 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) - NET INCOME PER SHARE
Net income per share is calculated on both a basic and diluted basis. Basic
net income per share excludes dilution and is computed by dividing net income
available to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted net income 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 the issuance of
common stock that then shared in earnings.
NOTE (3) - DERIVATIVES
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available for sale security, or a
foreign-currency-denominated forecasted transaction.
Under SFAS 133, an entity that elects to apply hedge accounting is required
to establish at the inception of the hedge the method it will use for assessing
the effectiveness of the hedging derivative and the measurement approach for
determining the ineffective aspect of the hedge. Those methods must be
consistent with the entity's approach to managing risk.
This statement is effective for all fiscal years beginning after June 15,
2000. It is not anticipated that the financial impact of this statement will
have a material impact on Downey.
As part of its secondary marketing activities, Downey utilizes forward sale
and purchase contracts to hedge the value of loans originated for sale against
adverse changes in interest rates. At September 30, 1999, these sales contracts
amounted to approximately $312 million while no purchase contracts were
outstanding. These contracts have a high correlation to the price movement of
the loans being hedged. There is no recognition of unrealized gains and losses
on
6
these contracts in the balance sheet or statement of income. When the related
loans are sold, the deferred gains or losses from these contracts are recognized
in the statement of income as a component of net gains or losses on sales of
loans and mortgage-backed securities.
NOTE (4) - INCOME TAXES
During the first quarter of 1998, the Internal Revenue Service ("IRS")
completed its review of Downey's federal income tax returns for years 1990
through 1995. As a result of that review, the IRS proposed additional tax of
approximately $20 million. Of that amount, Downey has paid approximately $5
million for items not disputed. The balance of the remaining additional tax
primarily relates to the sale and leaseback of computer equipment in 1990.
Management believes that applicable federal tax authorities related to the
transaction clearly support Downey's positions and intends to vigorously defend
those positions. Management also believes that adequate tax reserves have been
established regarding the transaction.
NOTE (5) - CAPITAL SECURITIES
On July 23, 1999, Downey through Downey Financial Capital Trust I (the
"Trust") issued $120 million in 10.00% capital securities. The capital
securities, which were sold in a public underwritten offering, pay quarterly
cumulative cash distributions at an annual rate of 10.00% of the liquidation
value of $25 per share and are recorded as interest expense by Downey. The
capital securities represent undivided beneficial interests in the Trust, which
was established by Downey for the purpose of issuing the capital securities.
Downey owns all of the issued and outstanding common securities of the Trust.
Proceeds from the offering and from the issuance of common securities were
invested by the Trust in 10.00% Junior Subordinated Deferrable Interest
Debentures due September 15, 2029 issued by Downey (the "Junior Subordinated
Debentures"), with an aggregate principal amount of $124 million. The sole asset
of the Trust is the Junior Subordinated Debentures. The obligations of the Trust
with respect to the securities are fully and unconditionally guaranteed by
Downey. The payment of distributions on the capital securities may be deferred
if Downey defers payments of interest on the junior subordinated debentures.
Downey will have the right, on one or more occasions, to defer payments of
interest on the junior subordinated debentures for up to 20 consecutive
quarterly periods. During the time Downey defers interest payments, interest on
the junior subordinated debentures will continue to accrue and distributions on
the capital securities will continue to accumulate and the deferred interest and
deferred distributions will themselves accrue interest at an annual rate of
10.00%, compounded quarterly, to the extent permitted by applicable law. Downey
will use the net proceeds of $115 million from the sale of the Junior
Subordinated Debentures (net of underwriting discounts and commissions and other
offering expenses) to make investments in its primary subsidiary, Downey Savings
and Loan Association, F.A. (the "Bank"), and for other general corporate
purposes. During the third quarter, Downey invested $50 million of the net
proceeds as additional common stock of the Bank thereby increasing the Bank's
regulatory core / tangible capital by that amount.
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain statements under this caption constitute "forward-looking
statements" under the Private Securities Litigation Reform Act of 1995 which
involve risks and uncertainties. Downey's 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
Downey conducts its operations, fluctuations in interest rates, credit quality
and government regulation.
OVERVIEW FOR THE QUARTER ENDED SEPTEMBER 30, 1999
Our net income for the third quarter of 1999 totaled $16.6 million or $0.59
per share on a diluted basis, up 29.7% from $12.8 million or $0.45 per share in
the third quarter of 1998.
The increase in our net income between third quarters was due to increases
in both of our business segments as follows:
o Net income from our banking operations increased $2.7 million or
24.6%. This increase primarily reflected two factors. Net interest
income increased $8.3 million or 19.4% due to an increase in average
earning assets as our effective interest rate spread declined. In
addition, the quarter-to-quarter improvement reflected an increase of
$4.9 million in other income, primarily reflecting increases in net
gains on sales of loans and in loan and deposit related fees. A $7.2
million increase in general and administrative expense and a $1.9
million increase in provision for loan losses partially offset those
favorable factors. The increase in general and administrative expense
was due to significantly higher lending volumes, branch expansion and
increased expense related to our Year 2000 compliance efforts.
o Net income from our real estate investment activities increased $1.1
million or 59.0% due primarily to higher net gains from sales of real
estate investments.
For the first nine months of 1999, our net income totaled $44.0 million or
$1.56 per share on a diluted basis, down from $45.3 million or $1.60 per share
in the year-ago period. The decline primarily reflects two factors:
o First, year-ago net income benefited by $4.7 million from the
settlement of a number of loan and real estate investment obligations
of a former joint venture partner. The pre-tax amount of the
settlement was $8.3 million of which:
o $1.4 million represented the recovery of a prior loan charge-off
thereby reducing provision for loan losses;
o $4.3 million was recorded as a reduction of losses on real estate
and joint ventures;
o $1.0 million was recorded in miscellaneous other income; and
o $1.6 million was recorded as a reduction to professional fees
within general and administrative expense.
o Second, our remaining net income attributable to real estate
investment activities declined $1.8 million due to the 1999 period
having a lower level of gains from sales of real estate investments.
Excluding those two factors, our net income would have increased by $5.2 million
or 15.4% for the first nine months of 1999. This adjusted increase was generated
by our banking operations.
For the third quarter of 1999, our return on average assets was 0.85% and
our return on average equity was 13.04%, bringing, for the first nine months of
1999, our return on average assets to 0.84% and return on average equity to
11.83%.
At September 30, 1999 our assets totaled $8.5 billion, up $2.6 billion or
43.8% from a year ago and up $2.2 billion or 35.6% from year-end 1998. Our
single family loan originations totaled a record $1.996 billion in the third
quarter of 1999, more than double the $962 million we originated in the third
quarter of 1998. Of the current quarter total, $1.576 billion represented
originations of loans for portfolio of which $390 million represented
originations for portfolio of subprime credits as part of our continuing
strategy to enhance the portfolio's net yield. In addition to single family
loans,
8
we originated $136 million of other loans in the quarter, including $67 million
of automobile loans and $46 million of construction loans.
Between third quarters, we funded our asset growth with a $1.3 billion
increase in borrowings and a $1.1 billion or 21.9% increase in deposits that
totaled $6.3 billion at quarter end. In addition, we issued during the third
quarter $120 million of 10.00% capital securities, of which $50 million was
invested as additional common stock in our primary subsidiary, Downey Savings
and Loan Association, F.A. (the "Bank"). During the quarter, we opened one new
traditional branch and three new in-store branches bringing total branches at
quarter end to 103, of which 40 are in-store. A year ago, branches totaled 91.
Our non-performing assets increased $5 million during the quarter to $35
million or 0.41% of total assets. The increase was primarily in the subprime
residential category.
At September 30, 1999, the Bank had core and tangible capital ratios of
5.98% and a risk-based capital ratio of 11.46%. These capital levels are
substantially above the "well capitalized" standards of 5.00% for core and
tangible capital and 10.00% for risk-based capital, as defined by regulation.
9
RESULTS OF OPERATIONS FOR THE QUARTER ENDED SEPTEMBER 30, 1999
NET INTEREST INCOME
Our net interest income totaled $51.0 million in the third quarter of 1999,
up $8.3 million or 19.3% from the same period last year. The improvement between
third quarters reflected an increase in our average earning assets. Our average
earning assets increased by $1.8 billion or 32.8% between third quarters to $7.5
billion. Our effective interest rate spread of 2.74% in the current quarter was
down from the year-ago quarter level of 3.05%. The decline in the effective
interest rate spread was due to our yield on earning assets declining more than
our cost of funds. The greater decline in the yield on earning assets from a
year ago was due, in part, to the significant growth in single family adjustable
rate loans in the recent two quarters which caused a higher proportion of our
portfolio to be at low, introductory incentive rates. As these new loans reprice
to fully-indexed rates in future periods and become a lower proportion of
earning assets, the downward pressure on our earning asset yield should lessen.
For the first nine months of 1999, our net interest income totaled $151.2
million, up $22.6 million or 17.6% from a year ago.
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 the net interest income, the interest rate spread
and the 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 the net interest-earning balance--the difference
between the average balance of interest-earning assets and the average balance
of interest-bearing liabilities--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 that we
received payments and to the extent that we believe we will recover the
remaining principal balance of the loan. We computed average balances for the
quarter using the average of each month's daily average balance during the
period indicated.
10
Three Months Ended
---------------------------------------------------------------
September 30, 1999 September 30, 1998
---------------------------------------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in Thousands) Balance Interest Rate Balance Interest Rate
- ----------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Loans .................................... $7,194,888 $132,686 7.38% $5,270,387 $103,949 7.89%
Mortgage-backed securities ............... 24,557 387 6.30 40,390 654 6.48
Investment securities .................... 233,609 3,331 5.66 300,918 4,379 5.77
- ----------------------------------------------------------------------------------------------------------------
Total interest-earning assets ......... 7,453,054 136,404 7.32 5,611,695 108,982 7.77
Non-interest-earning assets .................. 327,121 252,334
- ----------------------------------------------------------------------------------------------------------------
Total assets ............................ $7,780,175 $5,864,029
================================================================================================================
Interest-bearing liabilities:
Deposits ................................. $5,947,679 $ 67,478 4.50% $5,202,075 $ 64,243 4.90%
Borrowings ............................... 1,154,230 15,576 5.35 131,097 1,952 5.91
Capital securities ....................... 91,613 2,307 10.13 -- -- --
- ----------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities .... 7,193,522 85,361 4.71 5,333,172 66,195 4.92
Non-interest-bearing liabilities ............. 78,660 67,124
Stockholders' equity ......................... 507,993 463,733
- ----------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $7,780,175 $5,864,029
================================================================================================================
Net interest income/interest rate spread ..... $ 51,043 2.61% $ 42,787 2.85%
Excess of interest-earning assets over
interest-bearing liabilities ............. $ 259,532 $ 278,523
Effective interest rate spread ............... 2.74% 3.05%
================================================================================================================
Nine Months Ended
---------------------------------------------------------------
September 30, 1999 September 30, 1998
---------------------------------------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in Thousands) Balance Interest Rate Balance Interest Rate
- ----------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Loans .................................... $6,452,253 $362,235 7.49% $5,300,229 $314,877 7.92%
Mortgage-backed securities ............... 27,593 1,274 6.16 44,169 2,200 6.64
Investment securities .................... 217,843 8,998 5.52 265,638 11,425 5.75
- ----------------------------------------------------------------------------------------------------------------
Total interest-earning assets ......... 6,697,689 372,507 7.42 5,610,036 328,502 7.81
Non-interest-earning assets .................. 298,211 252,414
- ----------------------------------------------------------------------------------------------------------------
Total assets ............................ $6,995,900 $5,862,450
================================================================================================================
Interest-bearing liabilities:
Deposits ................................. $5,446,032 $181,051 4.44% $5,110,184 $188,780 4.94%
Borrowings ............................... 955,314 37,953 5.31 233,850 11,119 6.36
Capital securities ....................... 30,538 2,307 10.13 -- -- --
- ----------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities .... 6,431,884 221,311 4.60 5,344,034 199,899 5.00
Non-interest-bearing liabilities ............. 68,286 68,242
Stockholders' equity ......................... 495,730 450,174
- ----------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $6,995,900 $5,862,450
================================================================================================================
Net interest income/interest rate spread ..... $151,196 2.82% $128,603 2.81%
Excess of interest-earning assets over
interest-bearing liabilities ............. $ 265,805 $ 266,002
Effective interest rate spread ............... 3.01% 3.06%
================================================================================================================
11
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 Nine Months Ended
------------------------------------------------------------------------------------------
September 30, 1999 versus September 30, 1998 September 30, 1999 versus September 30, 1998
Changes Due To Changes Due To
------------------------------------------------------------------------------------------
Rate/ Rate/
(In Thousands) Volume Rate Volume Net Volume Rate Volume Net
- -----------------------------------------------------------------------------------------------------------------------------
Interest income:
Loans ....................... $37,957 $(6,754) $(2,466) $28,737 $68,440 $(17,318) $(3,764) $47,358
Mortgage-backed securities .. (257) (17) 7 (267) (825) (161) 60 (926)
Investment securities ....... (980) (88) 20 (1,048) (2,055) (453) 81 (2,427)
- -----------------------------------------------------------------------------------------------------------------------------
Change in interest income 36,720 (6,859) (2,439) 27,422 65,560 (17,932) (3,623) 44,005
- -----------------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits .................... 9,208 (5,224) (749) 3,235 12,407 (18,894) (1,242) (7,729)
Borrowings .................. 15,815 (185) (2,006) 13,624 32,887 (2,130) (3,923) 26,834
Capital securities .......... -- -- 2,307 2,307 -- -- 2,307 2,307
- -----------------------------------------------------------------------------------------------------------------------------
Change in interest expense 25,023 (5,409) (448) 19,166 45,294 (21,024) (2,858) 21,412
- -----------------------------------------------------------------------------------------------------------------------------
Change in net interest income $11,697 $(1,450) $(1,991) $ 8,256 $20,266 $ 3,092 $ (765) $22,593
=============================================================================================================================
PROVISION FOR LOAN LOSSES
Provision for loan losses was $2.8 million in the current quarter, up from
$1.0 million in the year-ago quarter. This increase reflects growth in our loan
portfolio during the current quarter. In contrast, our loan portfolio was
virtually unchanged during the year-ago quarter. For information regarding our
allowance for loan losses, see "Financial Condition for the Quarter Ended
September 30, 1999 - Problem Loans and Real Estate - Allowance for Losses on
Loans and Real Estate."
OTHER INCOME
Our total other income was $16.3 million in the third quarter of 1999, up
$6.6 million or 68.2% from a year-ago. All categories of our other income were
above year-ago levels. Net gains on sales of loans increased $2.7 million
between third quarters due to a higher volume of loans being sold, while our
income from real estate held for investment increased by $1.7 million, of which
$1.4 million was attributable to net gains from sales and declines in valuation
allowances. In addition, our loan and deposit related fees increased $1.2
million, and loan servicing fees improved by $0.8 million. For the first nine
months of 1999, total other income was $40.9 million, up $4.3 million from a
year ago even though the year-ago period included $5.3 million from the
settlement.
12
The following table presents a breakdown of the key components comprising
income from real estate and joint ventures held for investment for the periods
indicated.
Three Months Ended
--------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 1999 1999 1999 1998 1998
- ------------------------------------------------------------------------------------------------------------------
Operations, net:
Rental operations, net of expenses ........ $ 975 $1,094 $ 981 $ 688 $ 894
Equity in net income from joint ventures .. (36) 1,008 47 256 2,605
Interest from joint venture advances ...... 593 202 190 182 380
- ------------------------------------------------------------------------------------------------------------------
Total operations, net ................... 1,532 2,304 1,218 1,126 3,879
Net gains on sales of wholly owned real estate 1,037 200 -- 2,487 --
Reduction of (provision for) losses on real
estate and joint ventures ................. 3,162 265 (53) 214 139
- ------------------------------------------------------------------------------------------------------------------
Income from real estate and joint ventures
held for investment ..................... $5,731 $2,769 $1,165 $3,827 $4,018
==================================================================================================================
OPERATING EXPENSE
Operating expense totaled $35.8 million in the current quarter, compared to
$28.9 million in the third quarter of 1998. The increase was due to an increase
in our general and administrative costs. General and administrative costs
increased $7.2 million or 25.1% due to significantly higher lending volumes,
branch expansion and expense related to our year 2000 compliance efforts. For
the first nine months of 1999, operating expenses totaled $107.8 million, up
$25.0 million from the same period of 1998, of which $1.6 million was
attributable to the settlement.
PROVISION FOR INCOME TAXES
Income taxes for the current quarter totaled $12.1 million, resulting in an
effective tax rate of 42.2%, compared to $9.8 million and 43.3% for the like
quarter of a year ago. For the first nine months of 1999, the effective tax rate
was 42.4%, compared to 43.1% from the same period of 1998. For further
information regarding income taxes, see "Notes To Consolidated Financial
Statements - Note (4) - Income Taxes."
13
BUSINESS SEGMENT REPORTING
The previous sections of the Results of Operations for the Quarter Ended
September 30, 1999 discussed our consolidated results. The purpose of this
section is to present data on the results of operations of our two business
segments--banking and real estate investment.
The following table presents net income by business segment for the periods
indicated, followed by a discussion of the results of operations of each
segment.
Three Months Ended
---------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 1999 1999 1999 1998 1998
- -------------------------------------------------------------------------------------------
Banking .............. $13,545 $13,702 $12,029 $10,791 $10,870
Real estate investment 3,017 1,356 319 1,861 1,898
- -------------------------------------------------------------------------------------------
Total net income . $16,562 $15,058 $12,348 $12,652 $12,768
===========================================================================================
Nine Months Ended
September 30,
--------------------------
1999 1998 (1)
- -------------------------------------------------------------------------------------------
Banking .............. $39,276 $35,945
Real estate investment 4,692 9,376
- -------------------------------------------------------------------------------------------
Total net income . $43,968 $45,321
===========================================================================================
<FN>
(1) The net income impact of a settlement with a former joint venture partner
totaled $4.7 million, of which $1.9 million was in banking and $2.8 million
was in real estate investment.
</FN>
Banking
Net income from our banking operations for the third quarter of 1999
totaled $13.5 million, up $2.7 million or 24.6% from the third quarter of 1998.
The increase between third quarters primarily reflected two factors. Net
interest income increased $8.3 million or 19.4% due to an increase in our
average earning assets as our effective interest rate spread declined. Other
income increased $4.9 million. The increase from year-ago levels in other income
reflected increases in all categories, the largest being a $2.7 million increase
in net gains on sales of loans and a $1.2 million increase in loan and deposit
related fees. Increases of $7.2 million in operating expense and $1.9 million in
provision for loan losses partially offset the favorable impact of those items.
The increase in operating expense reflected significantly higher lending
volumes, branch expansion and increased expense related to our year 2000
compliance efforts.
14
The table below sets forth our banking operational results and selected
financial data for the periods indicated.
Three Months Ended
---------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 1999 1999 1999 1998 1998
- --------------------------------------------------------------------------------------------------------
Net interest income ............. $ 51,220 $ 51,242 $ 48,948 $ 45,953 $ 42,889
Provision for loan losses ....... 2,838 2,798 2,381 1,180 985
Other income .................... 10,503 10,408 10,110 6,881 5,561
Operating expense ............... 35,491 35,112 35,839 33,057 28,270
Net intercompany income (expense) 102 102 82 (18) (48)
- --------------------------------------------------------------------------------------------------------
Income before income taxes ...... 23,496 23,842 20,920 18,579 19,147
Income taxes .................... 9,951 10,140 8,891 7,788 8,277
- --------------------------------------------------------------------------------------------------------
Net income .................. $ 13,545 $ 13,702 $ 12,029 $ 10,791 $ 10,870
========================================================================================================
AT PERIOD END:
Assets:
Loans ....................... $7,900,601 $6,818,129 $6,102,547 $5,788,365 $5,387,843
Other ....................... 578,871 490,523 473,476 464,097 500,498
- --------------------------------------------------------------------------------------------------------
Total assets ............. 8,479,472 7,308,652 6,576,023 6,252,462 5,888,341
- --------------------------------------------------------------------------------------------------------
Equity .......................... $ 515,945 $ 502,133 $ 490,406 $ 480,566 $ 470,815
========================================================================================================
For the first nine months of 1999, our net income from banking totaled
$39.3 million, up from $35.9 million from the same period of 1998. Our net
income in the prior-year period benefited by $1.9 million from the settlement.
The pre-tax amount of the settlement was $3.4 million of which:
o $1.4 million represented the recovery of a prior loan charge-off
thereby reducing provision for loan losses;
o $1.0 million was recorded in other income; and
o $1.0 million was recorded as a reduction to professional fees within
operating expense.
Excluding the settlement benefit from year-ago results, net income from banking
would have increased by $5.2 million or 15.4%.
The table below sets forth our banking operational results for the periods
indicated.
Nine Months Ended
September 30,
--------------------
(In Thousands) 1999 1998 (1)
- --------------------------------------------------------
Net interest income ............. $151,410 $129,014
Provision for loan losses ....... 8,017 2,738
Other income .................... 31,021 17,736
Operating expense ............... 106,442 80,897
Net intercompany income (expense) 286 (89)
- --------------------------------------------------------
Income before income taxes ...... 68,258 63,026
Income taxes .................... 28,982 27,081
- --------------------------------------------------------
Net income .................. $ 39,276 $ 35,945
========================================================
<FN>
(1) The net income impact of a settlement with a former joint venture partner
totaled $1.9 million.
</FN>
15
Real Estate Investment
Net income from our real estate investment operations totaled $3.0 million
in the third quarter of 1999, up $1.1 million or 59.0% from the year-ago quarter
due primarily to higher net gains from sales of real estate investments.
The table below sets forth real estate investment operational results and
selected financial data for the periods indicated.
Three Months Ended
---------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 1999 1999 1999 1998 1998
- --------------------------------------------------------------------------------------------------------
Net interest income (expense) .... $ (177) $ (45) $ 8 $ (209) $ (102)
Provision of loan losses ......... -- -- -- -- --
Other income ..................... 5,768 2,851 1,232 3,925 4,111
Operating expense ................ 314 409 618 777 679
Net intercompany income (expense) (102) (102) (82) 18 48
- --------------------------------------------------------------------------------------------------------
Income before income taxes ....... 5,175 2,295 540 2,957 3,378
Income taxes ..................... 2,158 939 221 1,096 1,480
- --------------------------------------------------------------------------------------------------------
Net income ................... $ 3,017 $ 1,356 $ 319 $ 1,861 $ 1,898
========================================================================================================
AT PERIOD END:
Assets:
Investments in real estate and
joint ventures ............. $54,036 $57,460 $52,155 $49,447 $47,918
Other ........................ 13,204 8,294 7,564 9,841 13,790
- --------------------------------------------------------------------------------------------------------
Total assets ............... 67,240 65,754 59,719 59,288 61,708
- --------------------------------------------------------------------------------------------------------
Equity ........................... $46,023 $43,006 $41,650 $41,331 $39,470
========================================================================================================
For the first nine months of 1999, our net income from real estate
investment operations totaled $4.7 million, down from $9.4 million in the same
period a year ago. The settlement benefited our year-ago net income by $2.8
million. The pre-tax amount of the settlement was $4.9 million of which:
o $4.3 million was recorded as a reduction of loss on real estate and
joint ventures in other income; and
o $0.6 million was recorded as a reduction to professional fees in other
expense.
Excluding the settlement benefit from year-ago results, our remaining net income
attributable to real estate investment activities declined by $1.8 million due
to the 1999 period having a lower level of net gains from sales of real estate
investments.
16
The table below sets forth our real estate investment operational results
for the periods indicated.
Nine Months Ended
September 30,
-------------------
(In Thousands) 1999 1998 (1)
- -------------------------------------------------------
Net interest expense ............ $ (214) $ (411)
Reduction of loan losses ........ -- (19)
Other income .................... 9,851 18,811
Operating expense ............... 1,341 1,929
Net intercompany income (expense) (286) 89
- -------------------------------------------------------
Income before income taxes ...... 8,010 16,579
Income taxes .................... 3,318 7,203
- -------------------------------------------------------
Net income .................. $4,692 $ 9,376
=======================================================
<FN>
(1) The net income impact of a settlement with a former joint venture partner
totaled $2.8 million.
</FN>
Our investment in real estate and joint ventures amounted to $54 million at
September 30, 1999, compared to $49 million at December 31, 1998, and $48
million at September 30, 1998.
For information on valuation allowances associated with real estate and
joint venture loans, see "Financial Condition for the Quarter Ended September
30, 1999 - Problem Loans and Real Estate - Allowances for Losses on Loans and
Real Estate."
17
FINANCIAL CONDITION FOR THE QUARTER ENDED SEPTEMBER 30, 1999
LOANS AND MORTGAGE-BACKED SECURITIES
Total loans and mortgage-backed securities, including those held for sale,
increased $1.1 billion during the third quarter to a total of $7.9 billion or
92.9% of assets at September 30, 1999. The increase primarily occurred in the
single family loan portfolio. Of that increase, $340 million represented
subprime loans, with the remaining increase occurring in our adjustable rate
portfolio.
The following table sets forth loans originated, including purchases, for
investment and for sale during the periods indicated.
Three Months Ended
-----------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 1999 1999 1999 1998 1998
- ---------------------------------------------------------------------------------------------------------------
Loans originated for investment:
Residential, one-to-four units:
Adjustable ........................... $1,571,163 $ 964,408 $ 568,891 $ 436,960 $ 383,483
Fixed ................................ 4,920 81,080 208,504 181,717 6,921
Other .................................. 136,173 136,155 131,045 111,484 102,319
- ---------------------------------------------------------------------------------------------------------------
Total loans originated for investment 1,712,256 1,181,643 908,440 730,161 492,723
Loans originated for sale (1) .............. 420,389 631,496 646,786 740,837 571,146
- ---------------------------------------------------------------------------------------------------------------
Total loans originated ................. $2,132,645 $1,813,139 $1,555,226 $1,470,998 $1,063,869
===============================================================================================================
<FN>
(1) One-to-four unit residential loans, primarily fixed.
</FN>
Originations of one-to-four unit residential loans totaled a record $1.996
billion in the third quarter of 1999, of which $1.576 billion were for portfolio
and $420 million were for sale. This was 19% higher than the $1.677 billion we
originated in the second quarter of 1999, and more than double the $962 million
we originated in the year-ago quarter. Of the current quarter total, $390
million represented originations of subprime credits as part of our continuing
strategy to enhance the portfolio's net yield. During the current quarter, 59%
of our residential one-to-four unit originations represented refinancings of
existing loans. This is down from 65% during the previous quarter and 68% in the
year-ago third quarter. In addition to single family loans, we originated $136
million of other loans in the current quarter, including $67 million of
automobile loans and $46 million of construction loans.
During the current quarter, loan originations for investment consisted
primarily of adjustable rate mortgages tied to the Eleventh District Cost of
Funds Index ("COFI"), an index which lags the movement in market interest rates.
This experience is similar to that of recent quarters. The majority of
adjustable rate mortgage originations reprice monthly; however, we also
originate adjustable rate mortgage loans which reprice semi-annually and
annually. With respect to adjustable rate mortgages that primarily adjust
monthly, there is a lifetime interest rate cap, but no other specified limit on
periodic interest rate adjustments. Instead, monthly adjustment adjustable rate
mortgages have a periodic cap on changes in the required monthly payments, which
payments adjust annually. Monthly adjustment adjustable rate mortgages allow for
negative amortization. Negative amortization is the addition to loan principal
of accrued interest that exceeds the required loan payment. There is a limit on
the amount of negative amortization allowed, expressed as a percentage of
principal plus the amount added relative to the original loan amount. That limit
has been 110%, but was increased to 125% in 1998 on loans having a loan to value
ratio of 80% or less. At September 30, 1999, $4.6 billion of the adjustable rate
mortgages in our loan portfolio were subject to negative amortization, of which
$65 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 $624 million of loans in the third quarter of 1999, compared to
$579 million in the previous quarter and $508 million in the third quarter of
1998. All were secured by residential one-to-four unit property and at September
30, 1999, loans held for sale totaled $211 million.
18
At September 30, 1999, we had commitments to fund loans amounting to $1.205
billion, of which $226 million were fixed rate one-to-four unit residential
loans being originated for sale in the secondary market, as well as loans in
process of $126 million, undrawn lines of credit of $89 million and commitments
to purchase loans of $43 million. We believe our current sources of funds will
enable us to meet these obligations while exceeding all regulatory liquidity
requirements.
19
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
------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 1999 1999 1999 1998 1998
- --------------------------------------------------------------------------------------------------------------------------
INVESTMENT PORTFOLIO:
Loans originated:
Loans secured by real estate:
Residential:
One-to-four units:
Adjustable .................................. $1,180,474 $ 656,718 $ 382,562 $ 303,291 $ 283,468
Adjustable - subprime ....................... 384,856 307,690 186,329 133,409 100,015
- --------------------------------------------------------------------------------------------------------------------------
Total adjustable ......................... 1,565,330 964,408 568,891 436,700 383,483
Fixed ....................................... 907 54,671 205,758 179,786 5,351
Fixed - subprime ............................ 3,840 4,301 2,444 1,684 1,535
Five or more units:
Adjustable .................................. -- -- -- -- --
Fixed ....................................... -- -- -- -- 13,229
- --------------------------------------------------------------------------------------------------------------------------
Total residential ........................ 1,570,077 1,023,380 777,093 618,170 403,598
Commercial real estate ......................... 750 2,915 6,398 6,149 --
Construction ................................... 46,128 45,082 30,587 45,339 17,266
Land ........................................... -- 8,950 29,081 9,983 23,640
Non-mortgage:
Commercial ..................................... 7,850 6,278 2,925 700 645
Automobile ..................................... 66,550 60,620 50,294 43,330 40,158
Other consumer ................................. 14,895 12,130 11,760 5,983 7,016
- --------------------------------------------------------------------------------------------------------------------------
Total loans originated ........................ 1,706,250 1,159,355 908,138 729,654 492,323
Real estate loans purchased (1) ..................... 6,006 22,288 302 507 400
- --------------------------------------------------------------------------------------------------------------------------
Total loans originated and purchased ............. 1,712,256 1,181,643 908,440 730,161 492,723
Loan repayments ..................................... (443,503) (506,048) (434,796) (489,912) (490,358)
Other net changes (2) (3) ........................... (35,096) (6,958) (18,824) (8,211) 553
- --------------------------------------------------------------------------------------------------------------------------
Net increase in loans held for investment ...... 1,233,657 668,637 454,820 232,038 2,918
- --------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO:
Residential, one-to-four units:
Originated whole loans ........................... 420,389 631,496 646,786 740,837 571,146
Loans transferred from (to) the investment
portfolio (3)................................... 55,138 238 (7,095) (3,822) --
Originated whole loans sold ...................... (313,589) (281,120) (176,139) (266,812) (354,371)
Loans exchanged for mortgage-backed securities ... (310,096) (297,858) (600,379) (291,940) (153,175)
Other net changes ................................ (827) (2,637) (622) (3,794) (2,851)
- --------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for sale . (148,985) 50,119 (137,449) 174,469 60,749
- --------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities, net:
Received in exchange for loans ................... 310,096 297,858 600,379 291,940 153,175
Sold ............................................. (310,096) (297,858) (600,379) (293,222) (153,175)
Repayments ....................................... (2,300) (2,869) (3,235) (4,143) (4,242)
Other net changes ................................ 100 (305) 46 (560) 127
- --------------------------------------------------------------------------------------------------------------------------
Net decrease in mortgage-backed securities
available for sale ............................ (2,200) (3,174) (3,189) (5,985) (4,115)
- --------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans and
mortgage-backed securities held for sale and
available for sale ............................ (151,185) 46,945 (140,638) 168,484 56,634
- --------------------------------------------------------------------------------------------------------------------------
Total net increase in loans and mortgage-
backed securities ............................. $1,082,472 $ 715,582 $ 314,182 $ 400,522 $ 59,552
==========================================================================================================================
<FN>
(1) Primarily one-to-four unit residential loans. Includes five or more unit
residential loans of $0.2 million in the three months ended June 30, 1999,
$0.4 million in the three months ended September 30, 1998.
(2) Primarily includes 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 interest capitalized on loans (negative amortization).
(3) Includes $55.5 million of one-to-four unit residential ARMs transferred
from the held for investment portfolio during the three months ended
September 30, 1999.
</FN>
20
The following table sets forth the composition of our loan and
mortgage-backed securities portfolios at the dates indicated. At September 30,
1999, approximately 94% of our real estate loans were secured by real estate
located in California, principally in Los Angeles, Orange, Santa Clara, San
Diego and San Mateo counties.
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 1999 1999 1999 1998 1998
- -----------------------------------------------------------------------------------------------------------------------------
INVESTMENT PORTFOLIO:
Loans secured by real estate:
Residential:
One-to-four units:
Adjustable ................................. $4,984,300 $4,118,763 $3,800,552 $3,721,728 $3,791,187
Adjustable - subprime ...................... 1,354,771 1,017,699 745,843 580,232 461,646
Fixed ...................................... 532,934 550,035 507,357 325,454 153,408
Fixed - subprime ........................... 18,027 14,748 10,932 8,719 7,516
- -----------------------------------------------------------------------------------------------------------------------------
Total one-to-four units ................. 6,890,032 5,701,245 5,064,684 4,636,133 4,413,757
Five or more units:
Adjustable ................................. 18,301 18,409 18,516 18,617 18,707
Fixed ...................................... 5,243 6,232 7,904 21,412 22,436
Commercial real estate:
Adjustable ................................... 37,647 38,483 39,641 39,360 44,215
Fixed ........................................ 111,265 111,076 111,606 101,430 112,687
Construction ................................... 190,441 178,526 147,246 127,761 92,779
Land ........................................... 61,263 71,314 74,959 44,859 39,222
Non-mortgage:
Commercial ..................................... 27,605 26,884 28,182 28,293 27,710
Automobile ..................................... 391,975 375,138 363,168 357,988 355,955
Other consumer ................................. 44,764 42,475 40,607 41,894 44,026
- -----------------------------------------------------------------------------------------------------------------------------
Total loans held for investment .............. 7,778,536 6,569,782 5,896,513 5,417,747 5,171,494
Increase (decrease) for:
Undisbursed loan funds ......................... (136,355) (146,603) (133,785) (108,414) (88,213)
Net deferred costs and premiums ................ 59,731 43,460 33,515 31,021 24,962
Allowance for estimated loss ................... (35,961) (34,345) (32,586) (31,517) (31,444)
- -----------------------------------------------------------------------------------------------------------------------------
Total loans held for investment, net ......... 7,665,951 6,432,294 5,763,657 5,308,837 5,076,799
- -----------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO, NET:
Loans held for sale (primarily one-to-four units):
Adjustable ..................................... 62,635 5,711 -- 7,975 9,480
Fixed .......................................... 148,432 354,341 309,933 439,407 263,433
- -----------------------------------------------------------------------------------------------------------------------------
Total loans held for sale .................... 211,067 360,052 309,933 447,382 272,913
Mortgage-backed securities available for sale:
Adjustable ..................................... 8,260 8,822 9,887 10,996 12,795
Fixed .......................................... 15,323 16,961 19,070 21,150 25,336
- -----------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed securities available for
sale ....................................... 23,583 25,783 28,957 32,146 38,131
- -----------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities
held for sale and available for sale ....... 234,650 385,835 338,890 479,528 311,044
- -----------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities ... $7,900,601 $6,818,129 $6,102,547 $5,788,365 $5,387,843
=============================================================================================================================
We carry loans for sale at the lower of cost or market. At September 30,
1999, no valuation allowance was required as the market value exceeded book
value on an aggregate basis.
We carry mortgage-backed securities available for sale at fair value which,
at September 30, 1999, reflected an unrealized loss of $17,000. The current
quarter-end unrealized loss, less the associated tax effect, is reflected within
a separate component of other comprehensive income (loss) until realized.
21
DEPOSITS
At September 30, 1999, our deposits totaled $6.3 billion, up $1.1 billion
or 21.9% from the year-ago quarter end and up $1.3 billion or 25.2% from
year-end 1998. Compared to the year-ago period, our transaction accounts--i.e.,
checking, regular passbook and money market increased $364 million or 33.7% and
our certificates of deposit increased $768 million or 18.7%. The following table
sets forth information concerning our deposits and average rates paid at the
dates indicated.
September 30, 1999 June 30, 1999 March 31, 1999 December 31, 1998 September 30, 1998
------------------------------------------------------------------------------------------------------------
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 2.36% $1,444,515 2.40% $1,362,880 2.34% $1,313,707 2.30% $1,238,062 2.18% $1,080,734
Certificates of
deposit:
Less than 3.00% ... 2.49 11,084 2.58 23,239 2.60 23,324 2.62 25,126 2.63 26,686
3.00-3.49 ......... 3.02 15 3.01 268 3.01 323 3.01 593 3.03 449
3.50-3.99 ......... 3.94 2,236 3.91 44,532 3.91 47,813 3.88 51,474 3.91 40,115
4.00-4.49 ......... 4.37 436,442 4.40 578,371 4.39 604,692 4.39 428,316 4.16 14,754
4.50-4.99 ......... 4.78 1,189,830 4.80 1,208,190 4.80 1,004,947 4.80 668,204 4.88 468,922
5.00-5.99 ......... 5.53 3,138,246 5.38 2,181,871 5.41 2,015,702 5.53 2,421,333 5.57 3,162,420
6.00-6.99 ......... 6.17 86,490 6.11 71,254 6.06 192,320 6.06 204,065 6.06 382,502
7.00 and greater .. 7.24 2,454 7.25 2,319 7.24 2,454 7.24 2,560 7.25 2,798
- ----------------------------------------------------------------------------------------------------------------------------------
Total certificates
of deposit ..... 5.25 4,866,797 5.05 4,110,044 5.09 3,891,575 5.26 3,801,671 5.50 4,098,646
- ----------------------------------------------------------------------------------------------------------------------------------
Total deposits . 4.59% $6,311,312 4.39% $5,472,924 4.40% $5,205,282 4.53% $5,039,733 4.81% $5,179,380
==================================================================================================================================
BORROWINGS
During the 1999 third quarter, our borrowings increased $178 million to
$1.5 billion, primarily reflecting increases in Federal Home Loan Bank ("FHLB")
advances. This followed an increase of $456 million during the second quarter of
1999. The following table sets forth information concerning our FHLB advances
and other borrowings at the dates indicated.
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 1999 1999 1999 1998 1998
- ---------------------------------------------------------------------------------------------------------------------------
Federal Home Loan Bank advances ..................... $1,477,207 $1,298,438 $842,677 $695,012 $197,935
Other borrowings .................................... 8,501 8,794 8,638 8,708 12,166
- ---------------------------------------------------------------------------------------------------------------------------
Total borrowings ................................ $1,485,708 $1,307,232 $851,315 $703,720 $210,101
===========================================================================================================================
Weighted average rate on borrowings during the period 5.35% 5.21% 5.36% 5.61% 5.91%
Total borrowings as a percentage of total assets .... 17.48 17.83 12.91 11.22 3.55
===========================================================================================================================
CAPITAL SECURITIES
On July 23, 1999, we issued $120 million in capital securities through the
Trust. The capital securities pay quarterly cumulative cash distributions at an
annual rate of 10.00% of the liquidation value of $25 per share. Interest
expense including the amortization of deferred issuance costs on our capital
securities was $2.3 million for the third quarter of 1999. For further
information regarding our capital securities, see "Notes To Consolidated
Financial Statements - Note (5) - Capital Securities."
22
ASSET/LIABILITY MANAGEMENT AND MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
interest rates. Our market risk arises primarily from interest rate risk in our
lending and deposit taking activities. This interest rate risk occurs to the
degree that our interest-bearing liabilities reprice or mature more rapidly or
on a different basis 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. There has been no significant
change in our market risk since December 31, 1998.
The following table sets forth the repricing frequency of our major asset
and liability categories as of September 30, 1999, as well as other information
regarding the repricing and maturity differences between interest-earning assets
and interest-bearing liabilities 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, like caps on the amount
that interest rates and payments on our loans may adjust. 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 table would vary substantially if we used
different assumptions or if actual experience differed from the assumptions
shown.
23
September 30, 1999
--------------------------------------------------------------------------------
Within 7 - 12 2 - 5 6 - 10 Over Total
(Dollars in Thousands) 6 Months Months Years Years 10 Years Balance
- ---------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Investment securities and FHLB stock ..(1) $ 102,714 $ -- $ 143,050 $ -- $ -- $ 245,764
Loans and mortgage-backed securities:
Mortgage-backed securities .........(2) 12,762 4,264 4,423 1,721 413 23,583
Loans secured by real estate:
Residential:
Adjustable ....................(2) 6,045,848 296,839 111,412 -- -- 6,454,099
Fixed .........................(2) 182,058 29,236 184,272 141,815 169,732 707,113
Commercial real estate ...........(2) 41,425 9,440 86,555 7,072 1,845 146,337
Construction .....................(2) 85,727 -- -- -- -- 85,727
Land .............................(2) 34,763 38 338 351 -- 35,490
Non-mortgage:
Commercial .......................(2) 17,062 -- -- -- -- 17,062
Consumer .........................(2) 131,042 82,293 217,855 -- -- 431,190
- ---------------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities 6,550,687 422,110 604,855 150,959 171,990 7,900,601
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets ......... $6,653,401 $ 422,110 $ 747,905 $ 150,959 $ 171,990 $8,146,365
- ---------------------------------------------------------------------------------------------------------------------------------
Deposits, borrowings and capital securities:
Interest-bearing deposits:
Fixed maturity deposits ............(1) $2,134,836 $ 1,749,919 $ 982,042 $ -- $ -- $4,866,797
Transaction accounts ...............(3) 1,250,405 -- -- -- -- 1,250,405
Non-interest-bearing transaction accounts 194,110 -- -- -- -- 194,110
- ---------------------------------------------------------------------------------------------------------------------------------
Total deposits ....................... 3,579,351 1,749,919 982,042 -- -- 6,311,312
- ---------------------------------------------------------------------------------------------------------------------------------
Borrowings .............................. 953,893 14,624 82,403 434,788 -- 1,485,708
Capital securities ...................... -- -- -- -- 120,000 120,000
- ---------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and
capital securities ................ $4,533,244 $ 1,764,543 $1,064,445 $ 434,788 $ 120,000 $7,917,020
=================================================================================================================================
Excess (shortfall) of interest-earning assets
over interest-bearing liabilities ....... $2,120,157 $(1,342,433) $ (316,540) $(283,829) $ 51,990 $ 229,345
Cumulative gap .............................. 2,120,157 777,724 461,184 177,355 229,345
Cumulative gap - as a % of total assets:
September 30, 1999 ...................... 24.94% 9.15% 5.43% 2.09% 2.70%
December 31, 1998 ....................... 23.84 7.48 9.07 3.40 4.00
September 30, 1998 ...................... 19.11 0.97 3.59 4.20 4.49
=================================================================================================================================
<FN>
(1) Based upon contractual maturity and repricing date.
(2) Based upon contractual maturity, repricing date and projected repayment and
prepayments of principal.
(3) Subject to immediate repricing.
</FN>
Our six-month gap at September 30, 1999 was a positive 24.94%. This means
that more interest-earning assets reprice within six months than
interest-bearing liabilities. This compares to a positive six-month gap of
23.84% at December 31, 1998, and 19.11% at September 30, 1998. We continue to
pursue our strategy of emphasizing the origination of adjustable rate mortgages.
For the twelve months ended September 30, 1999, we originated and purchased for
investment $3.8 billion of adjustable rate loans which represented approximately
84% of all loans we originated and purchased for investment during the period.
At September 30, 1999, 96% of our interest-earning assets mature, reprice
or are estimated to prepay within five years, down from 98% at December 31, 1998
and 99% at September 30, 1998. At September 30, 1999, loans and mortgage-backed
securities with adjustable interest rates represented 85% of our loans and
mortgage-backed securities portfolios. During the third quarter of 1999, we
continued to offer residential fixed rate loan products to our customers
24
primarily for sale in the secondary market. We price and originate fixed rate
mortgage loans for sale into the secondary market to increase opportunities for
originating adjustable rate mortgages and generate fee and servicing income. We
also originate fixed rate loans for portfolio to facilitate the sale of real
estate acquired in settlement of loans and which meet specific yield and other
approved guidelines.
At September 30, 1999, $7.1 billion or 89% 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
$5.0 billion or 92% at December 31, 1998 and $5.0 billion or 91% at September
30, 1998.
The following table sets forth on a consolidated basis the interest rate
spread on our interest-earning assets and interest-bearing liabilities at the
dates indicated.
September 30, June 30, March 31, December 31, September 30,
1999 1999 1999 1998 1998
- ----------------------------------------------------------------------------------------------------------
Weighted average yield:
Loans and mortgage-backed securities 7.33% 7.47% 7.59% 7.72% 7.82%
Federal Home Loan Bank stock ....... 5.24 5.29 5.29 5.44 5.86
Investment securities .............. 5.85 5.84 5.61 5.40 5.77
- ----------------------------------------------------------------------------------------------------------
Earning assets yield ............ 7.28 7.41 7.52 7.65 7.73
- ----------------------------------------------------------------------------------------------------------
Weighted average cost:
Deposits ........................... 4.59 4.39 4.40 4.53 4.81
Borrowings:
Federal Home Loan Bank advances . 5.45 5.24 5.30 5.47 5.85
Other borrowings ................ 8.68 8.67 8.70 8.69 8.36
- ----------------------------------------------------------------------------------------------------------
Combined borrowings ........... 5.46 5.26 5.33 5.51 6.00
Capital securities ................. 10.13 -- -- -- --
- ----------------------------------------------------------------------------------------------------------
Combined funds cost ............. 4.84 4.56 4.53 4.66 4.86
- ----------------------------------------------------------------------------------------------------------
Interest rate spread ............ 2.44% 2.85% 2.99% 2.99% 2.87%
==========================================================================================================
The period end weighted average yield on our loan and mortgage-backed
securities portfolios at September 30, 1999, was 7.33%, down from 7.72% at
December 31, 1998, and 7.82% at September 30, 1998. At September 30, 1999, our
single family adjustable rate mortgage portfolio, including mortgage-backed
securities, totaled $6.4 billion with a weighted average rate of 7.10%, compared
to $4.3 billion with a weighted average rate of 7.53% at December 31, 1998, and
$4.3 billion with a weighted average rate of 7.56% at September 30, 1998.
PROBLEM LOANS AND REAL ESTATE
Non-Performing Assets
Non-performing assets consist of loans on which we have ceased the accrual
of interest, which we refer to as non-accrual loans, real estate acquired in
settlement of loans and repossessed automobiles. Non-performing assets increased
during the quarter by $5 million to $35 million at September 30, 1999, or 0.41%
of total assets. The majority of the increase during the quarter was due to
subprime residential assets. Non-performing assets at quarter end include
non-accrual loans aggregating $1.3 million which were not contractually past
due, but were deemed non-accrual due to our assessment of the borrower's ability
to pay.
25
The following table summarizes our non-performing assets at the dates
indicated.
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 1999 1999 1999 1998 1998
- ---------------------------------------------------------------------------------------------------------------
Non-accrual loans:
Residential, one-to-four units .......... $16,318 $15,522 $16,579 $15,571 $15,397
Residential, one-to-four units - subprime 9,719 6,010 4,379 1,975 2,479
Other ................................... 3,563 4,281 4,127 4,829 20,677
- ---------------------------------------------------------------------------------------------------------------
Total non-accrual loans .............. 29,600 25,813 25,085 22,375 38,553
Real estate acquired in settlement of loans . 5,213 4,015 4,686 4,475 5,423
Repossessed automobiles ..................... 335 256 319 569 611
- ---------------------------------------------------------------------------------------------------------------
Total non-performing assets ............. $35,148 $30,084 $30,090 $27,419 $44,587
===============================================================================================================
Allowance for loan losses (1):
Amount .................................. $35,962 $34,345 $32,586 $31,517 $31,444
As a percentage of non-performing loans . 121.49% 133.05% 129.90% 140.86% 81.56%
Non-performing assets as a percentage of
total assets ............................ 0.41 0.41 0.46 0.44 0.75
===============================================================================================================
<FN>
(1) Allowance for loan losses does not include the allowance for real estate
and real estate acquired in settlement of loans.
</FN>
At September 30, 1999, the recorded investment in loans for which we
recognized impairment totaled $13 million. The total allowance for possible
losses related to these loans was $1 million. During the third quarter of 1999,
total interest recognized on the impaired loan portfolio was $0.4 million,
increasing the year-to-date total to $1.4 million.
Delinquent Loans
During the 1999 third quarter, our delinquencies as a percentage of total
loans outstanding increased from 0.48% to 0.55%, but remained below 0.65% at
year-end 1998 and 0.70% a year ago. This increase primarily occurred in our
residential one-to-four units category and our residential one-to-four
units-subprime category.
26
The following table indicates the amounts of our past due loans at the
dates indicated.
September 30, 1999 June 30, 1999
-----------------------------------------------------------------------------------
30-59 60-89 90+ 30-59 60-89 90+
(Dollars in Thousands) Days Days Days (1) Total Days Days Days (1) Total
- ----------------------------------------------------------------------------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units ................... $11,306 $3,441 $12,804 $27,551 $ 5,834 $3,812 $11,910 $21,556
One-to-four units - subprime ........ 3,669 3,278 3,697 10,644 2,328 1,235 3,092 6,655
Five or more units .................. -- -- -- -- -- -- -- --
Commercial real estate ................. -- -- -- -- -- -- -- --
Construction ........................... -- -- -- -- -- -- -- --
Land ................................... -- -- -- -- -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total real estate loans ............. 14,975 6,719 16,501 38,195 8,162 5,047 15,002 28,211
Non-mortgage:
Commercial ............................. -- -- -- -- -- -- -- --
Automobile ............................. 4,548 367 571 5,486 3,133 489 895 4,517
Other consumer ......................... 161 33 175 369 169 36 233 438
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans ......................... $19,684 $7,119 $17,247 $44,050 $11,464 $5,572 $16,130 $33,166
==================================================================================================================================
Delinquencies as a percentage of total loans 0.25% 0.09% 0.22% 0.55% 0.17% 0.08% 0.23% 0.48%
==================================================================================================================================
March 31, 1999 December 31, 1998
-----------------------------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units ................... $ 8,463 $4,700 $13,180 $26,343 $ 9,841 $6,014 $12,832 $28,687
One-to-four units - subprime ........ 1,177 2,281 1,385 4,843 244 784 947 1,975
Five or more units .................. -- -- -- -- -- -- 155 155
Commercial real estate ................. -- -- -- -- -- -- -- --
Construction ........................... -- -- -- -- -- -- -- --
Land ................................... -- -- -- -- -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total real estate loans ............. 9,640 6,981 14,565 31,186 10,085 6,798 13,934 30,817
Non-mortgage:
Commercial ............................. -- -- -- -- -- -- -- --
Automobile ............................. 3,248 383 1,000 4,631 4,650 888 1,048 6,586
Other consumer ......................... 144 76 226 446 334 45 344 723
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans ......................... $13,032 $7,440 $15,791 $36,263 $15,069 $7,731 $15,326 $38,126
==================================================================================================================================
Delinquencies as a percentage of total loans 0.21% 0.12% 0.25% 0.58% 0.26% 0.13% 0.26% 0.65%
==================================================================================================================================
September 30, 1998
---------------------------------------
Loans secured by real estate:
Residential:
One-to-four units ................... $10,601 $4,302 $12,408 $27,311
One-to-four units - subprime ........ 741 1,334 505 2,580
Five or more units .................. 155 -- -- 155
Commercial real estate ................. -- -- -- --
Construction ........................... -- -- -- --
Land ................................... -- -- -- --
- ---------------------------------------------------------------------------------------
Total real estate loans ............. 11,497 5,636 12,913 30,046
Non-mortgage:
Commercial ............................. -- -- -- --
Automobile ............................. 5,330 1,105 990 7,425
Other consumer ......................... 119 143 496 758
- ---------------------------------------------------------------------------------------
Total loans ......................... $16,946 $6,884 $14,399 $38,229
=======================================================================================
Delinquencies as a percentage of total loans 0.31% 0.13% 0.26% 0.70%
=======================================================================================
<FN>
(1) All 90 day or greater delinquencies are on non-accrual status and reported
as part of non-performing assets.
</FN>
27
Allowance for Losses on Loans and Real Estate
We establish valuation allowances for losses on loans and real estate on a
specific and general basis. We determine specific allowances based on the
difference between the carrying value of the asset and our net fair value. We
determine general valuation allowances based on historical loss experience,
current and anticipated levels and trends of delinquent and non-performing
loans, and the economic environment in our market areas.
Allowances for losses on all assets were $39 million at September 30, 1999,
$40 million at December 31, 1998, and $41 million at September 30, 1998.
Our total allowance for possible loan losses was $36 million at September
30, 1999, up from $32 million at year-end and $31 million at September 30, 1998.
Virtually all of our current quarter-end allowance represented general loan
valuation allowances, of which $3 million represents an unallocated portion.
These general loan valuation allowances may be included as a component of
risk-based capital, up to a maximum of 1.25% of our risk-weighted assets. Net
charge-offs totaled $1.2 million in the 1999 third quarter, down from $1.3
million in the year-ago quarter. Included in the current quarter net charge-offs
were $0.1 million associated with one-to-four unit residential loans and $1.1
million associated with automobile loans. For the first nine months of 1999, our
net charge-offs were $3.6 million, compared to net charge-offs of $3.4 million
in the year-ago period. The year-ago period included a $1.4 million recovery
from the settlement. Adjusting year-ago results to exclude that recovery, net
charge-offs would have been down $1.2 million between nine-month periods.
The following table is a summary of the activity of our allowance for loan
losses during the periods indicated.
Three Months Ended
--------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 1999 1999 1999 1998 1998
- ------------------------------------------------------------------------------------------------------
Balance at beginning of period $34,345 $32,586 $31,517 $31,444 $31,736
Provision .................... 2,838 2,798 2,381 1,180 985
Charge-offs .................. (1,423) (1,280) (1,520) (1,574) (1,540)
Recoveries ................... 202 241 208 467 263
- ------------------------------------------------------------------------------------------------------
Balance at end of period ..... $35,962 $34,345 $32,586 $31,517 $31,444
======================================================================================================
28
The following table indicates our allocation of the total valuation
allowance for loan losses to the various categories of loans at the dates
indicated.
September 30, 1999 June 30, 1999 March 31, 1999
------------------------------------------------------------------------------------------------
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 .......... $19,496 $6,890,032 0.28% $16,896 $5,701,245 0.30% $15,735 $5,064,684 0.31%
Five or more units ......... 276 23,544 1.17 285 24,641 1.16 299 26,420 1.13
Commercial real estate ........ 2,463 148,912 1.65 2,808 149,559 1.88 2,729 151,247 1.80
Construction .................. 2,242 190,441 1.18 2,082 178,526 1.17 1,732 147,246 1.18
Land .......................... 764 61,263 1.25 900 71,314 1.26 944 74,959 1.26
Non-mortgage:
Commercial .................... 227 27,605 0.82 193 26,884 0.72 202 28,182 0.72
Automobile .................... 7,099 391,975 1.81 7,832 375,138 2.09 7,566 363,168 2.08
Other consumer ................ 595 44,764 1.33 549 42,475 1.29 579 40,607 1.43
Not specifically allocated ........ 2,800 -- -- 2,800 -- -- 2,800 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans held for investment $35,962 $7,778,536 0.46% $34,345 $6,569,782 0.52% $32,586 $5,896,513 0.55%
====================================================================================================================================
December 31, 1998 September 30, 1998
--------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units .......... $14,299 $4,636,133 0.31% $13,603 $4,413,757 0.31%
Five or more units ......... 401 40,029 1.00 409 41,143 0.99
Commercial real estate ........ 2,632 140,790 1.87 3,656 156,902 2.33
Construction .................. 1,508 127,761 1.18 1,087 92,779 1.17
Land .......................... 568 44,859 1.27 498 39,222 1.27
Non-mortgage:
Commercial .................... 218 28,293 0.77 204 27,710 0.74
Automobile .................... 8,344 357,988 2.33 8,349 355,955 2.35
Other consumer ................ 747 41,894 1.78 838 44,026 1.90
Not specifically allocated ........ 2,800 -- -- 2,800 -- --
- --------------------------------------------------------------------------------------------------
Total loans held for investment $31,517 $5,417,747 0.58% $31,444 $5,171,494 0.61%
==================================================================================================
The following table is a summary of the activity of our allowance for real
estate and joint ventures held for investment during the periods indicated.
Three Months Ended
---------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 1999 1999 1999 1998 1998
- ------------------------------------------------------------------------------------------------
Balance at beginning of period $ 7,389 $7,770 $7,717 $8,151 $ 9,558
Provision (reduction) ........ (3,162) (265) 53 (214) (139)
Charge-offs .................. (1,792) (116) -- (220) (1,268)
Recoveries ................... -- -- -- -- --
- ------------------------------------------------------------------------------------------------
Balance at end of period ..... $ 2,435 $7,389 $7,770 $7,717 $ 8,151
================================================================================================
29
In addition to losses charged against the allowance for loan losses, we
have recorded losses on real estate acquired in settlement of loans by direct
write-off to net operations of real estate acquired in settlement of loans and
against an allowance for losses specifically established for these assets. As of
September 30, 1999, we are no longer maintaining an allowance for real estate
acquired in settlement of loans as the related individual assets are recorded at
the lower of cost or fair value. The following table is a summary of the
activity of our allowance for real estate acquired in settlement of loans during
the periods indicated.
Three Months Ended
-----------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 1999 1999 1999 1998 1998
- -------------------------------------------------------------------------------------------------
Balance at beginning of period $ 509 $ 547 $ 533 $ 582 $ 671
Provision (reduction) ........ (136) 9 26 (14) 160
Charge-offs .................. (373) (47) (12) (35) (249)
Recoveries ................... -- -- -- -- --
- -------------------------------------------------------------------------------------------------
Balance at end of period ..... $-- $ 509 $ 547 $ 533 $ 582
=================================================================================================
CAPITAL RESOURCES AND LIQUIDITY
Our primary sources of funds generated in the third quarter of 1999 were:
o a net increase of $838 million in deposits;
o principal repayments (including prepayments but excluding our
refinances of our existing loans) on loans and mortgage-backed
securities of $419 million;
o a net increase of $178 million in borrowings;
o a net decrease of $149 million of loans held for sale; and
o net proceeds of $115 million from the issuance of capital securities.
We used these funds primarily to originate loans held for investment of
$1.7 billion (net of our refinances of $27 million).
At September 30, 1999, the Bank's ratio of regulatory liquidity was 4.1%,
compared to 4.0% at both December 31, 1998 and September 30, 1998.
Stockholders' equity totaled $516 million at September 30, 1999, compared
to $481 million at December 31, 1998 and $471 million at September 30, 1998.
Downey Financial Corp. had liquid assets, including due from Bank -
interest-bearing balances of $73 million at September 30, 1999, compared to $9
million at year-end 1998. The increase primarily reflected the $115 million of
net proceeds from the issuance of capital securities less the $50 million
contributed to the Bank as additional capital. Further capital contributions to
the Bank are anticipated. Downey Financial Corp. can obtain additional funds by
means of dividends from subsidiaries, subject to certain limitations, or
issuance of further debt or equity.
30
REGULATORY CAPITAL COMPLIANCE
The following table is a reconciliation of the Bank's stockholder's equity
to federal regulatory capital as of September 30, 1999. The core and tangible
capital ratios were 5.98% and the risk-based capital ratio was 11.46%. The
Bank's capital ratios exceed the "well capitalized" standards of 5.00% for core
and 10.00% for risk-based, as defined by regulation. For information regarding a
capital contribution to the Bank by Downey, see "Notes To Consolidated Financial
Statements - Note (5) - Capital Securities."
Tangible Capital Core Capital Risk-Based Capital
-------------------- ------------------ ----------------------
(Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------------------------------------
Stockholder's equity $557,925 $557,925 $557,925
Adjustments:
Deductions:
Investment in subsidiary, primarily real estate . (49,578) (49,578) (49,578)
Goodwill ........................................ (4,188) (4,188) (4,188)
Non-permitted mortgage servicing rights ......... (3,044) (3,044) (3,044)
Additions:
Unrealized gains on securities available for sale 738 738 738
General loss allowance - Investment in DSL
Service Company ............................... 1,408 1,408 1,408
General loan valuation allowances (1) ........... -- -- 35,522
- ----------------------------------------------------------------------------------------------------------------------------
Regulatory capital ..................................... 503,261 5.98% 503,261 5.98% 538,783 11.46%
Well capitalized requirement ........................... 126,308 1.50 (2) 421,027 5.00 469,987 10.00 (3)
- ----------------------------------------------------------------------------------------------------------------------------
Excess ................................................. $376,953 4.48% $ 82,234 0.98% $ 68,796 1.46%
- ----------------------------------------------------------------------------------------------------------------------------
<FN>
(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 10.71%.
</FN>
YEAR 2000
Risks of the Year 2000 Issue
The year 2000 issue is the result of computer programs being written using
two digits rather than four digits to represent the calendar year--e.g., "99"
for "1999". Software so developed, and not corrected, could produce inaccurate
or unpredictable results or system failures commencing January 1, 2000, when
dates present a lower two digit year number than dates in the prior century.
These occurrences may have a material adverse effect on our financial condition,
results of operations, business or business prospects, as Downey, like most
financial organizations, is significantly impacted by the potential year 2000
issue due to the nature of financial information. Potential impacts to us may
arise from software, computer hardware, and other equipment both within our
direct control and outside our ownership, yet with which we electronically or
operationally interface. Financial institution regulators have intensively
focused upon year 2000 exposures, issuing guidance concerning the
responsibilities of management and the board of directors. Year 2000 testing and
certification is being addressed as a key safety and soundness issue in
conjunction with regulatory exams; and the Office of Thrift Supervision has
authority to bring enforcement actions against any institution under its
supervision which it believes is not properly addressing year 2000 compliance
issues.
State of Readiness
We have established a four-phase process to address the year 2000 issue. In
addition, our board of directors oversees the year 2000 compliance project's
progress through monthly status reports and quarterly reviews with the year 2000
project manager.
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As part of the first phase, which is completed, we inventoried all of our
data systems to determine which are most critical to support customer
transaction processing and provide customer services. This inventory not only
included in-house systems, but those provided by third party vendors as well. We
prioritized systems as being:
o mission critical;
o high risk;
o moderate risk; or
o low risk.
From this system, we developed modification plans which place priority
emphasis on those systems requiring change and classified mission critical or
high risk. We contacted third party vendors during this phase to determine their
process and timeline in correcting any year 2000 compliance issues. In addition,
we also contacted our commercial loan borrowers to determine the extent of their
preparations for year 2000 and any potential impact year 2000 may have on their
businesses and ability to repay loan obligations to us. Commercial lending does
not represent a significant portion of our loan portfolio--i.e., substantially
less than 1.0%; therefore, we believe the year 2000 preparedness of our
commercial loan borrowers does not pose a significant risk.
Phase two of the process consisted of making appropriate year 2000
programming changes to our in-house systems, while phase three consists of
acceptance testing and sign-off of both our in-house and vendor provided
systems. The fourth and final phase of the year 2000 compliance project includes
installation of the system modifications into our daily operation. The fourth
phase is scheduled to occur once a system has been successfully tested and
determined to be year 2000 compliant.
By the end of 1998, we completed programming and substantially completed
acceptance testing for our in-house mainframe system. At the end of first
quarter 1999, we completed acceptance testing and installation of the in-house
mainframe system, which performs all significant loan, deposit and general
ledger accounting processes.
For our developed PC-based systems classified mission critical, we have
completed all programming changes, acceptance testing and installation. We
completed programming and acceptance testing of all other of our developed
PC-based systems by the end of the second quarter, with installation of year
2000 modifications completed during the third quarter of 1999.
Year 2000 acceptance testing and installation of all third party vendor
changes is substantially completed. There are no outstanding mission critical
systems requiring installation. Any new systems released during the remainder of
1999 will require third party vendors to represent that their systems are year
2000 compliant. In addition to these representations, we will test vendor
programs or review testing conducted by others for year 2000 compliance.
In addition to the computer systems utilized by us, we have also
inventoried other essential services that year 2000 issues may impact like
telecommunications and utilities. We are monitoring these essential service
providers to determine their progress and how they are addressing year 2000
issues. To date, no information exists to suggest these essential services will
not be available.
Costs to Address the Year 2000 Issue
Currently, we estimate that year 2000 project costs will approximate $6.3
million. This cost is in addition to existing personnel who are working on the
year 2000 compliance project and includes estimates for hardware and software
renovation or replacement, as well as additions to existing staff who will be
specifically devoted to the project. Approximately 50% of the year 2000
compliance project cost represents costs to migrate to a new personal computer
environment and to replace specific older automated teller machines, both of
which we might otherwise have implemented or replaced during the period
notwithstanding the year 2000 issue. Thus, that portion of year 2000 costs will
be amortized over the useful life of the equipment. Of the estimated total
expense, approximately $3.7 million has been incurred to date, $0.1 million in
1997, $1.8 million in 1998 and $1.8 million during the first nine months of
1999.
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The table below summarizes by year the estimated amount and anticipated
timing of the planned year 2000 expense.
(In Millions) 1997 1998 1999 2000 Thereafter Total
- ----------------------------------------------------------------------------
Estimated Year 2000 expense $0.1 $1.8 $2.6 $1.0 $0.8 $6.3
- ----------------------------------------------------------------------------
As we progress in addressing the year 2000 compliance project and
additional information becomes available, estimates of costs could change. At
this time, no significant data system projects have been delayed as a result of
our year 2000 compliance effort.
Contingency Plans
We believe our year 2000 compliance project should enable us to be
successful in modifying our computer systems to be year 2000 compliant. As
previously stated, we have completed acceptance testing and installation with
respect to our in-house mainframe system which performs all significant loan,
deposit and general ledger accounting processes, as well as our developed
PC-based systems classified mission critical. Also, programming and acceptance
testing of all other of our developed PC-based systems and installation has been
completed. In addition to year 2000 compliance system modification plans, we
have also developed contingency plans for all other systems classified as
mission critical and high risk. Our contingency plans provide timetables to
pursue various alternatives based upon the failure of a system to be adequately
modified or sufficiently tested and validated to ensure year 2000 compliance.
However, there can be no assurance that either the compliance process or our
contingency plans will avoid partial or total system interruptions or the costs
necessary to update hardware and software would not have a material adverse
effect upon our financial condition, results of operations, business or business
prospects.
33
PART II - OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K
(A) Exhibits
4.1 Junior Subordinated Indenture dated as of July 23, 1999 between Downey
Financial Corp. and Wilmington Trust Company as Indenture Trustee.
4.2 10% Junior Subordinated Debenture due September 15, 2029 Principal Amount
$123,711,350.
4.3 Certificate of Trust of Downey Financial Capital Trust I, dated as of May
25, 1999.
4.4 Trust Agreement of Downey Financial Capital Trust I, dated May 25, 1999.
4.5 Amended and Restated Trust Agreement of Downey Financial Capital Trust I,
between Downey Financial Corp., Wilmington Trust Company and the
Administrative Trustees named therein, dated as of July 23, 1999.
4.6 Certificate Evidencing Common Securities of Downey Financial Capital Trust
I, 10% Common Securities.
4.7 Certificate Evidencing Capital Securities of Downey Financial Capital Trust
I, 10% Capital Securities (Global Certificate).
4.8 Common Securities Guarantee Agreement of Downey Financial Corp.
(Guarantor), dated July 23, 1999.
4.9 Capital Securities Guarantee Agreement of Downey Financial Corp. and
Wilmington Trust Company, dated as of July 23, 1999.
27 Financial Data Schedule.
(B) Reports on Form 8-K during last quarter ended September 30, 1999.
The Registrant filed with the Commission two Current Reports on Form 8-K.
The first, dated July 14, 1999, was the Company's press announcement of
second quarter 1999 earnings. The second, dated July 15, 1999, reported
that on June 2, 1999, litigation had been filed against sixteen large banks
located in California, including the Bank.
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: November 2, 1999 /s/ Daniel D. Rosenthal
----------------------------------------------------
Daniel D. Rosenthal
President and Chief Executive Officer
Date: November 2, 1999 /s/ Thomas E. Prince
----------------------------------------------------
Thomas E. Prince
Executive Vice President and Chief Financial Officer
34