UNITED STATES 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 March 31, 2000
--------------------------------------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from N/A to N/A
--------------------- ---------------------------
Commission File Number: 333-64597
---------------------------------------------------------
GOLDEN STATE HOLDINGS INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 95-4669792
- --------------------------------------------------------------------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
135 Main Street, San Francisco, CA 94105
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
415-904-1100
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
N/A
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
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. X Yes No
----- -----
The number of shares outstanding of registrant's $1.00 par value common
stock, as of the close of business on April 28, 2000: 1,000 shares.
Page 1
GOLDEN STATE HOLDINGS INC.
FIRST QUARTER 2000 REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE
--------------------- ----
Item 1. Consolidated Financial Statements
Unaudited Consolidated Balance Sheets
March 31, 2000 and December 31, 1999.......................3
Unaudited Consolidated Statements of Income
Three Months Ended March 31, 2000 and 1999.................4
Unaudited Consolidated Statements of Comprehensive Income
Three Months Ended March 31, 2000 and 1999.................5
Unaudited Consolidated Statements of Stockholder's Equity
Three Months Ended March 31, 200...........................6
Unaudited Consolidated Statements of Cash Flows
Three Months Ended March 31, 2000 and 1999.................7
Notes to Unaudited Consolidated Financial Statements.......9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.............15
Item 3. Quantitative and Qualitative Disclosures About Market
Risk......................................................34
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings.........................................35
Item 2. Changes in Securities.....................................35
Item 3. Defaults Upon Senior Securities...........................35
Item 4. Submission of Matters to a Vote of Security Holders.......35
Item 5. Other Information.........................................35
Item 6. Exhibits and Reports on Form 8-K..........................36
Signatures............................................................37
Page 2
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2000 and DECEMBER 31, 1999
(Unaudited)
(dollars in thousands, except per share data)
March 31, December 31,
ASSETS 2000 1999
------ ---- ----
Cash and due from banks $ 540,095 $ 508,812
Interest-bearing deposits in other banks 25,034 5
Short-term investment securities 76,111 84,061
----------- -----------
Cash and cash equivalents 641,240 592,878
Securities available for sale, at fair value 1,066,045 1,075,734
Securities held to maturity 164,776 185,357
Mortgage-backed securities available for sale, at fair value 13,317,692 13,764,565
Mortgage-backed securities held to maturity 2,050,733 2,149,696
Loans held for sale, net 687,329 729,062
Loans receivable, net 36,143,680 33,953,461
Investment in Federal Home Loan Bank ("FHLB") System 1,257,944 1,167,144
Premises and equipment, net 282,790 296,800
Foreclosed real estate, net 36,596 45,091
Accrued interest receivable 332,017 321,596
Intangible assets (net of accumulated amortization of $199,876
at March 31, 2000 and $183,433 at December 31, 1999) 760,640 819,561
Mortgage servicing rights 1,350,708 1,272,393
Other assets 939,634 667,793
----------- -----------
Total assets $59,031,824 $57,041,131
=========== ===========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDER'S EQUITY
-------------------------------------------------------
Deposits $23,047,919 $23,040,571
Securities sold under agreements to repurchase 5,353,602 5,481,747
Borrowings 27,397,879 25,668,626
Other liabilities 845,301 688,870
----------- -----------
Total liabilities 56,644,701 54,879,814
=========== ===========
Commitments and contingencies -- --
Minority interest 500,000 500,000
Stockholder's equity:
Common stock, $1.00 par value, 1,000 shares authorized,
issued and outstanding 1 1
Additional paid-in capital 1,544,016 1,542,171
Accumulated other comprehensive loss (297,377) (276,832)
Retained earnings (substantially restricted) 640,483 395,977
----------- -----------
Total stockholder's equity 1,887,123 1,661,317
----------- -----------
Total liabilities, minority interest and stockholder's equity $59,031,824 $57,041,131
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
Page 3
GOLDEN STATE HOLDINGS INC. AND SUBSDIARIES
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 2000 and 1999
(Unaudited)
(in thousands)
Three Months Ended March 31,
----------------------------
2000 1999
---- ----
Interest income:
Loans receivable $646,193 $567,273
Mortgage-backed securities available for sale 229,062 204,054
Mortgage-backed securities held to maturity 39,379 50,429
Loans held for sale 13,318 34,648
Securities available for sale 19,093 18,378
Securities held to maturity 2,061 3,460
Interest-bearing deposits in other banks 401 1,039
Dividends on FHLB stock 17,147 13,556
-------- --------
Total interest income 966,654 892,837
======== ========
Interest expense:
Deposits 218,792 221,996
Securities sold under agreements to repurchase 82,906 54,048
Borrowings 377,853 308,823
-------- --------
Total interest expense 679,551 584,867
-------- --------
Net interest income 287,103 307,970
Provision for loan losses -- 5,000
-------- --------
Net interest income after provision for loan losses 287,103 302,970
-------- --------
Noninterest income:
Loan servicing fees, net 44,875 35,968
Customer banking fees and service charges 48,659 44,746
Gain on sale and settlement of loans, net 6,662 15,589
Gain on sale of assets, net 419 174
Other income 9,566 9,606
-------- --------
Total noninterest income 110,181 106,083
-------- --------
Noninterest expense:
Compensation and employee benefits 107,754 102,585
Occupancy and equipment 37,371 37,955
Professional fees 8,756 13,953
Loan expense 6,043 12,178
Foreclosed real estate operations, net (2,233) (673)
Amortization of intangible assets 16,443 17,158
Merger and integration costs -- 6,082
Other expense 51,198 64,333
-------- --------
Total noninterest expense 225,332 253,571
-------- --------
Income before income taxes, minority interest and extraordinary items 171,952 155,482
Income tax (benefit) expense (82,947) 72,418
Minority interest 6,599 9,167
-------- --------
Income before extraordinary items 248,300 73,897
Extraordinary items - gain on early extinguishment of debt,
net of applicable taxes of $879 in 2000 1,206 --
-------- --------
Net income available to common stockholder $249,506 $ 73,897
======== ========
See accompanying notes to unaudited consolidated financial statements.
Page 4
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
THREE MONTHS ENDED MARCH 31, 2000 AND 1999
(Unaudited)
(in thousands)
Three Months Ended March 31,
----------------------------
2000 1999
---- ----
Net income $249,506 $ 73,897
Other comprehensive loss, net of tax:
Unrealized holding loss on securities available for sale:
Unrealized holding loss arising during the period (20,545) (15,979)
Less: reclassification adjustment for gain
included in net income -- (172)
-------- --------
Other comprehensive loss (20,545) (16,151)
-------- --------
Comprehensive income $228,961 $ 57,746
======== ========
See accompanying notes to unaudited consolidated financial statements.
Page 5
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
THREE MONTHS ENDED MARCH 31, 2000
(Unaudited)
(in thousands)
Accumulated Retained
Additional Other Earnings Total
Common Paid-in Comprehensive (Substantially Stockholder's
Stock Capital Loss Restricted) Equity
----- ------- ---- ----------- ------
Balance at December 31, 1999 $ 1 $1,542,171 $(276,832) $395,977 $1,661,317
Net income -- -- -- 249,506 249,506
Change in net unrealized holding loss
on securities available for sale -- -- (20,545) -- (20,545)
Dividends to parent -- -- -- (5,000) (5,000)
Impact of Golden State restricted
common stock -- 1,845 -- -- 1,845
--- ---------- --------- -------- ----------
Balance at March 31, 2000 $ 1 $1,544,016 $(297,377) $640,483 $1,887,123
=== ========== ========= ======== ==========
See accompanying notes to unaudited consolidated financial statements.
Page 6
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2000 AND 1999
(Unaudited)
(in thousands)
Three Months Ended March 31,
----------------------------
2000 1999
---- ----
Cash flows from operating activities:
Net Income $ 249,506 $ 73,897
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of intangible assets 16,443 17,158
(Accretion) amortization of purchase accounting premiums and discounts, net (667) 5,597
Accretion of discount on borrowings 265 245
Amortization of mortgage servicing rights 46,667 51,301
Provision for loan losses -- 5,000
Gain on sale of assets, net (419) (174)
Gain on sale of foreclosed real estate, net (4,057) (2,650)
Loss on sale and settlement of loans, net 18,926 40,738
Capitalization of originated mortgage servicing rights (25,588) (56,328)
Extraordinary items - gain on early extinguishment of debt, net (1,206) --
Depreciation and amortization of premises and equipment 11,947 8,506
Amortization of deferred debt issuance costs 1,837 1,785
FHLB stock dividends (17,147) (13,556)
Purchases and originations of loans held for sale (1,037,884) (2,920,752)
Net proceeds from the sale of loans held for sale 1,047,089 3,134,862
(Increase) decrease in other assets (208,943) 30,540
Increase in accrued interest receivable (9,183) (2,853)
Increase (decrease) in other liabilities 137,490 (98,789)
Amortization of deferred compensation expense -
Golden State restricted common stock 560 --
Minority interest 6,599 9,167
----------- -----------
Net cash provided by operating activities $ 232,235 $ 283,694
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
(Continued)
Page 7
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
THREE MONTHS ENDED MARCH 31, 2000 AND 1999
(Unaudited)
(in thousands)
Three Months Ended March 31,
----------------------------
2000 1999
---- ----
Cash flows from investing activities:
Downey Acquisition $ (379,314) $ --
Purchases of securities available for sale (5,779) (734,574)
Proceeds from maturities of securities available for sale 8,500 299,280
Purchases of securities held to maturity (652) (1,641)
Principal payments and proceeds from maturities of securities held to maturity 21,323 564
Purchases of mortgage-backed securities available for sale (38,850) (2,553,891)
Principal payments on mortgage-backed securities available for sale 455,672 1,223,668
Proceeds from sales of mortgage-backed securities available for sale -- 193,055
Principal payments on mortgage-backed securities held to maturity 98,975 187,215
Proceeds from sales of loans 2,746 6,830
Net increase in loans receivable (1,370,035) (22,342)
Purchases of loans receivable (457,486) (458,504)
Purchases of FHLB stock, net (74,820) (83,185)
Purchases of premises and equipment (6,840) (53,736)
Proceeds from disposal of premises and equipment 532 41,746
Proceeds from sales of foreclosed real estate 29,146 37,113
Purchases of mortgage servicing rights (99,394) (76,185)
----------- -----------
Net cash used in investing activities (1,816,276) (1,994,587)
----------- -----------
Cash flows from financing activities:
Net increase (decrease) in deposits 7,997 (826,517)
Proceeds from additional borrowings 8,656,278 10,254,766
Principal payments on borrowings (6,892,128) (8,428,080)
Net (decrease) increase in securities sold under agreements to repurchase (128,145) 411,896
Dividends on common stock (5,000) --
Dividends paid to minority stockholders, net of taxes (6,599) (9,127)
Tax benefit on exercise of stock options -- 934
----------- -----------
Net cash provided by financing activities 1,632,403 1,403,872
----------- -----------
Net change in cash and cash equivalents 48,362 (307,021)
Cash and cash equivalents at beginning of period 592,878 967,950
----------- -----------
Cash and cash equivalents at end of period $ 641,240 $ 660,929
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
Page 8
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation
---------------------
The accompanying unaudited consolidated financial statements were
prepared in accordance with generally accepted accounting principles for interim
financial information and the requirements of Regulation S-X, Article 10 and
therefore do not include all disclosures necessary for complete financial
statements. In the opinion of management, all adjustments have been made that
are necessary for a fair presentation of the financial position and results of
operations and cash flows as of and for the periods presented. All such
adjustments are of a normal recurring nature. The results of operations for the
three months ended March 31, 2000 are not necessarily indicative of the results
that may be expected for the entire fiscal year or any other interim period.
Certain amounts for the three-month period in the prior year have been
reclassified to conform to the current period's presentation.
Golden State Holdings Inc. (the "Company" or "GS Holdings"), a wholly
owned subsidiary of Golden State Bancorp Inc. ("Golden State"), was formed to
acquire all of the assets of First Nationwide Holdings Inc. ("FN Holdings"),
including all of the common and preferred stock of California Federal Bank, A
Federal Savings Bank and its subsidiaries ("California Federal" or "Bank"), as
part of the Golden State Acquisition (as defined herein). GS Holdings is a
holding company whose only significant asset is all of the common stock of the
Bank and therefore, activities for the consolidated entity are primarily carried
out by the Bank and its operating subsidiaries.
The accompanying consolidated financial statements include the accounts
of GS Holdings, the Bank and the Bank's wholly owned subsidiaries. Unless the
context otherwise indicates, "GS Holdings" or "Company" refers to Golden State
Holdings Inc. as the surviving entity after the consummation of the Golden State
Acquisition (as defined herein), and as the surviving entity in the GS Escrow
Merger for periods after the GS Escrow Merger. On September 11, 1998, Glendale
Federal Bank, Federal Savings Bank ("Glendale Federal") merged with and into the
Bank pursuant to the Glen Fed Merger (as defined herein). Unless the context
otherwise indicates, "California Federal" or "Bank" refers to California Federal
as the surviving entity after the consummation of the Glen Fed Merger.
Minority interest represents amounts attributable to the Preferred Stock
("REIT Preferred Stock") of California Federal Preferred Capital Corporation, a
wholly owned subsidiary of the Bank, and that portion of stockholder's equity of
Auto One Acceptance Corporation ("Auto One"), a subsidiary of the Bank,
attributable to 20% of its common stock. In 1999, minority interest also
included the Bank Preferred Stock that had not yet been acquired by GS Holdings.
All significant intercompany balances and transactions have been
eliminated in consolidation. These financial statements should be read in
conjunction with the consolidated financial statements of GS Holdings included
in the Company's Annual Report on Form 10-K for the year ended December 31,
1999. All terms used but not defined elsewhere herein have meanings ascribed to
them in the Company's Annual Report on Form 10-K.
As GS Holdings' common stock is wholly owned by Golden State, earnings
per share data is not presented.
(2) Acquisitions and Divestitures
-----------------------------
GOLDEN STATE ACQUISITION
On September 11, 1998, First Nationwide (Parent) Holdings Inc. ("Parent
Holdings") and Hunter's Glen/Ford Ltd. ("Hunter's Glen") completed the merger
with Golden State, the publicly traded parent company of Glendale Federal, in a
tax-free exchange of shares (the "Golden State Merger"), accounted for under the
purchase method of accounting. Pursuant to the Golden State Merger agreement,
(a) FN Holdings contributed all of its assets (including all of the common stock
of California Federal) to GS Holdings (the "FN Holdings Asset Transfer"), (b)
Parent Holdings, which then owned all of the common stock of FN Holdings as a
result of the extinguishment of the Hunter's Glen minority interest, merged with
and into Golden State, which indirectly owned all of the common stock of
Glendale Federal, (c) FN Holdings merged with and into Golden State Financial
Corporation, which owned all of the common stock of Glendale Federal (the "FN
Holdings Merger," and together with the Golden State
Page 9
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Merger, the "Holding Company Mergers"), and (d) Glendale Federal merged with
and into California Federal (the "Glen Fed Merger"). The FN Holdings Asset
Transfer, the Holding Company Mergers and the Glen Fed Merger are referred to
collectively as the "Golden State Acquisition."
At September 11, 1998, Glendale Federal had total assets of approximately
$18.9 billion and deposits of $11.3 billion and operated 181 branches and 26
loan offices in California.
The Golden State Acquisition was accounted for as a purchase of Golden
State by Parent Holdings and, accordingly, the purchase price was allocated to
the assets acquired and liabilities assumed in the transaction based on
estimates of fair value at the date of purchase. Since the date of purchase, the
results of operations related to such assets and liabilities have been included
in the Company's consolidated statements of income.
Merger and integration costs associated with the Golden State Acquisition
totalled $6.1 million for the three months ended March 31, 1999, including
severance for terminated California Federal employees, expenses for California
Federal branch closures, and conversion and consolidation costs, as well as
transition expenses for duplicate personnel, facilities and computer systems
during the integration period. No such expenses were incurred during the first
quarter of 2000.
OTHER ACQUISITIONS AND DIVESTITURES
On February 29, 2000, Auto One acquired Downey Auto Finance Corporation,
a subsidiary of Downey Savings and Loan Association, F.A., with prime auto loans
of approximately $370 million (the "Downey Acquisition"). Intangible assets of
$7.6 million were recorded in connection with this acquisition.
On April 16, 1999, the Bank acquired twelve retail branches located in
Nevada with deposits of approximately $543 million from Norwest Bank, Nevada, a
subsidiary of Norwest Corporation, and Wells Fargo Bank, N.A. (the "Nevada
Purchase"). Intangible assets of $50.7 million were recorded in connection with
this acquisition, principally representing the deposit premium paid in the
transaction.
During April 1999, First Nationwide Mortgage Corporation ("FNMC") sold
servicing rights for approximately 49,000 loans with an unpaid principal balance
of approximately $2.0 billion, recognizing a pre-tax gain of $16.3 million (the
"Servicing Sale").
(3) Cash, Cash Equivalents, and Statements of Cash Flows
----------------------------------------------------
Cash paid for interest on deposits and other interest-bearing liabilities
during the three months ended March 31, 2000 and 1999 was $754.6 million and
$560.4 million, respectively. Net cash received for income taxes during the
three months ended March 31, 2000 and 1999 was $0.1 million and $2.1 million,
respectively.
During the three months ended March 31, 2000, noncash activity consisted
of transfers of $21.0 million from loans receivable to foreclosed real estate,
transfers of $13.6 million from loans held for sale (at lower of cost or market)
to loans receivable and $3.5 million of loans made to facilitate sales of real
estate owned.
Noncash activity during the three months ended March 31, 2000 also
included a $211.7 million reduction of the valuation allowance of the Company's
deferred tax asset representing pre-merger tax benefits, of which $161.7 million
was retained by the previous owners of FN Holdings and an increase of $1.8
million in additional paid-in capital reflecting the impact of 220,327 shares of
Golden State restricted common stock issued during the quarter under an employee
incentive plan.
During the three months ended March 31, 1999, noncash activity consisted
of transfers of $25.5 million from loans receivable to foreclosed real estate
and $.9 million of loans made to facilitate sales of real estate owned.
Page 10
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(4) Segment Reporting
-----------------
Since the Company derives a significant portion of its revenues from
interest income, and interest expense is the most significant expense, the
segments are reported below using net interest income. Because the Company also
evaluates performance based on noninterest income and noninterest expense goals,
these measures of segment profit and loss are also presented. The Company does
not allocate income taxes to the segments.
Three Months Ended March 31,
----------------------------------------------------
Community Mortgage
Banking Banking Total
------- ------- -----
Net interest income: (1)
2000 $331,419 $(21,968) $309,451
1999 349,215 (11,595) 337,620
Noninterest income: (2)
2000 $ 60,276 $ 62,061 $122,337
1999 59,655 58,147 117,802
Noninterest expense: (3)
2000 $185,682 $ 40,810 $226,492
1999 205,353 49,378 254,731
- ------------
(1) Includes $22.3 million and $29.7 million for 2000 and 1999, respectively,
in earnings credit provided to FNMC by the Bank, primarily for custodial
bank account balances generated by FNMC. Also includes $53.3 million and
$61.4 million for 2000 and 1999, respectively, in interest income and
expense on intercompany loans.
(2) Includes $12.2 million and $11.7 million for 2000 and 1999, respectively,
in intercompany servicing fees.
(3) Includes $1.2 million for each of the years 2000 and 1999 in intercompany
noninterest expense.
Page 11
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The following reconciles the above table to the amounts shown on the
consolidated financial statements for the three months ended March 31, 2000 and
1999 (in thousands):
2000 1999
---- ----
Net interest income:
Total net interest income for reportable segments $309,451 $337,620
Elimination of intersegment net interest income (22,348) (29,650)
-------- --------
Total $287,103 $307,970
======== ========
Noninterest income:
Total noninterest income for reportable segments $122,337 $117,802
Elimination of intersegment servicing fees (12,156) (11,719)
-------- --------
Total $110,181 $106,083
======== ========
Noninterest expense:
Total noninterest expense for reportable segments $226,492 $254,731
Elimination of intersegment expense (1,160) (1,160)
-------- --------
Total $225,332 $253,571
======== ========
(5) Accrued Termination and Facilities Costs
----------------------------------------
In connection with the Golden State Acquisition, the Company recorded
liabilities resulting from (a) branch consolidations due to duplicate
facilities; (b) employee severance and termination benefits due to a planned
reduction in force; and (c) expenses incurred under a contractual obligation to
terminate services provided by outside service providers (principally relating
to data processing expenses). The merger and integration plan relative to the
Golden State Acquisition was in place on September 11, 1998. Certain of these
costs were included in the allocation of purchase price and others were
recognized in net income. The table below reflects a summary of the activity in
the liability for the costs related to such plan since December 31, 1999 (in
thousands):
Branch Severance and Contract
Consolidations Termination Benefits Termination Total
-------------- -------------------- ----------- -----
Balance at December 31, 1999 $24,051 $12,770 $25 $36,846
Additional liabilities recorded 2,504 -- -- 2,504
Charges to liability account (6,591) (204) -- (6,795)
------- ------- --- -------
Balance at March 31, 2000 $19,964 $12,566 $25 $32,555
======= ======= === =======
(6) Income Taxes
------------
During the three months ended March 31, 2000, GS Holdings recorded a net
income tax benefit of $82.9 million, which included a tax benefit of $161.7
million. Based on favorable resolutions of federal income tax audits of Old
California Federal and Glendale Federal, and based on the current status of
Mafco's, including the Company's, audits for the years 1991 through 1995,
management changed its judgment about the realizability of the Company's
deferred tax asset and reduced its valuation allowance by $211.7 million during
the three-month period ended March 31, 2000. As a result of reducing the
valuation allowance, income tax expense was reduced by $161.7 million and
goodwill was reduced by $50.0 million.
Page 12
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(7) Stockholder's Equity
--------------------
COMMON STOCK
At March 31, 2000, there were 1,000 shares of GS Holdings common stock
issued and outstanding.
Dividends on common stock during the three months ended March 31, 2000
totalled $5.0 million. There were no dividends on common stock during the three
months ended March 31, 1999.
(8) Executive and Stock Compensation
--------------------------------
In connection with the Golden State Acquisition, the Bank is
administering stock option plans that provided for the granting of options of
Golden State Common Stock to employees and directors. Upon the consummation of
the merger on September 11, 1998, substantially all options outstanding became
exercisable. All pre-merger stock option plans have expired as to the granting
of additional options.
In the first quarter of 2000, Golden State granted to its employees
non-qualified stock options equivalent to 1,333,850 shares of common stock at a
weighted average price of $13.99 per share under the Golden State Bancorp Inc.
Omnibus Stock Plan (the "Stock Plan"). These shares generally vest over three
years in one-third increments on the anniversary of the grant date. The options
generally expire 10 years from the date of grant. No compensation cost was
recognized by the Company for these stock options during the three months ended
March 31, 2000, in accordance with the intrinsic value accounting methodology
prescribed in Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES, whereby compensation expense to employees is determined
based upon the excess, if any, of the market price of Golden State's common
stock at the measurement date over the exercise price of the award.
During the three months ended March 31, 2000, no Golden State stock
options were exercised and 19,250 Golden State stock options were cancelled or
expired under all plans. During the three months ended March 31, 1999, 222,533
Golden State stock options were exercised and 86,000 were cancelled or expired
under all plans. At March 31, 2000, options to acquire an equivalent of
3,875,682 Golden State shares and 1,216,082 LTW(TM)s remained outstanding under
all plans.
On January 24, 2000, Golden State awarded to certain of its employees
220,327 shares of restricted stock under the Golden State Bancorp Inc. Executive
Compensation Plan. The market value on the date of the award was $14.00 per
share. These shares generally vest over two years in one-half increments on the
anniversary of the grant date, based upon the continued service of the employee.
At March 31, 2000, a total of 277,235 restricted shares was outstanding. The
compensation expense related to these awards are recognized on a straight line
basis over the vesting period for each tranche of the award with a corresponding
increase to additional paid-in capital. During the three months ended March 31,
2000, $0.6 million in compensation expense was recognized related to such
awards. These restricted shares have full voting rights.
(9) Newly Issued Accounting Pronouncements
--------------------------------------
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS No. 133"). SFAS No. 133 was amended by
Statement of Financial Accounting Standards No. 137, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES-DEFERRAL OF THE EFFECTIVE DATE OF FASB
STATEMENT NO. 133 ("SFAS No. 137"). SFAS No. 137 mandates that SFAS No. 133
shall be effective for all fiscal quarters of all fiscal years beginning after
June 15, 2000. SFAS No. 133 requires that all derivative instruments be recorded
on the balance sheet at fair value. Changes in the fair value of derivatives are
recorded each period in current earnings or other comprehensive income,
depending on the type of hedge transaction.
Page 13
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Under SFAS No. 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 portion of the hedge. Upon
implementation, hedging relationships must be designated anew and documented
pursuant to the provisions of this statement.
For fair-value hedge transactions in which the Company is hedging changes
in the fair value of assets, liabilities or firm commitments, changes in the
fair value of the derivative instrument will generally be offset in the income
statement by changes in the hedged item's fair value. For cash-flow hedge
transactions in which the Company is hedging the variability of cash flows
related to a variable-rate asset, liability, or a forecasted transaction,
changes in the fair value of the derivative instrument will be reported in other
comprehensive income. The gains and losses on derivative instruments that are
reported in other comprehensive income will be reclassified as earnings in the
periods in which earnings are impacted by the variability of the cash flows of
the hedged item. The ineffective portion of all hedges will be recognized in
current-period earnings.
The Company has identified four instruments which will qualify as
derivatives pursuant to SFAS No. 133. The hedge instruments used to hedge the
Company's mortgage servicing rights will be reported as a fair value hedge,
while forward loan sale commitments, deferred pair-offs and interest rate swaps
qualify as cash flow hedges. On April 27, 2000, the Derivatives Implementation
Group of the FASB issued guidance indicating that interest rate lock
commitments, given by lending institutions to potential borrowers, met the net
settlement criteria described in paragraph nine of SFAS No. 133 and would
therefore be considered derivative instruments. The Bank is currently assessing
the impact of this guidance.
SFAS No. 133 applies to all entities and amends SFAS No. 107, DISCLOSURES
ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS, to include in Statement 107 the
disclosure provisions about concentrations of credit risk from Statement 105.
SFAS No. 133 supersedes FASB Statements No. 80, ACCOUNTING FOR FUTURES
CONTRACTS, No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS WITH
OFF-BALANCE SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT
RISK, and No. 119, DISCLOSURE ABOUT DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR
VALUE OF FINANCIAL INSTRUMENTS. SFAS No. 133 also nullifies or modifies the
consensuses reached in a number of issues addressed by the Emerging Issues Task
Force.
One of the qualifying criteria for hedge accounting under SFAS No. 133 is
that the hedging relationship between the hedging instrument and the hedged item
must be highly effective in achieving the offset of changes in those fair values
or cash flows that are attributable to the hedged risk, both at the inception of
the hedge and on an ongoing basis. An assessment of this effectiveness is
required at least every three months and whenever financial statements or
earnings are reported by the Bank.
The high-effectiveness requirement has been interpreted to mean that the
cumulative changes in the value of the hedging instrument since hedge inception
should be between 80% and 125% of the inverse cumulative change since hedge
inception in the fair value or cash flows of the hedged items.
Early application of all of the provisions of SFAS No. 133 is encouraged,
but is permitted only as of the beginning of any fiscal quarter that begins
after issuance of this statement. SFAS No. 133 should not be applied
retroactively to financial statements of prior periods.
SFAS No. 133 will significantly change the accounting treatment of
derivative instruments used by the Bank. Depending on the underlying risk
management strategy, these accounting changes could affect reported net income,
assets, liabilities and stockholder's equity. As a result, the Bank may choose
to reconsider its risk management strategies, since SFAS No. 133 will not
reflect the results of many of those strategies in the same manner as current
accounting practice. The Bank continues to evaluate the potential impact of
implementing SFAS No. 133. An accurate assessment of the Bank's hedge
effectiveness and hence, the net impact of adopting SFAS No. 133, will not be
possible until the FASB, which is currently both interpreting and amending SFAS
No. 133 with regard to the measurement of hedge effectiveness, concludes its
deliberations, and until after the Bank has fully implemented hedging strategies
in accordance with the FASB's amendments and interpretations.
Page 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE STATEMENTS CONTAINED IN THIS REPORT ON FORM 10-Q THAT ARE NOT PURELY
HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF
THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF
1934, INCLUDING STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS, INTENTIONS,
BELIEFS OR STRATEGIES REGARDING THE FUTURE. FORWARD-LOOKING STATEMENTS INCLUDE
THE COMPANY'S STATEMENTS REGARDING LIQUIDITY, PROVISION FOR LOAN LOSSES, CAPITAL
RESOURCES AND ANTICIPATED EXPENSE LEVELS IN "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." IN ADDITION, IN
THOSE AND OTHER PORTIONS OF THIS DOCUMENT, THE WORDS "ANTICIPATE," "BELIEVE,"
"ESTIMATE," "EXPECT," "INTEND," AND OTHER SIMILAR EXPRESSIONS, AS THEY RELATE TO
THE COMPANY OR THE COMPANY'S MANAGEMENT, ARE INTENDED TO IDENTIFY
FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS REFLECT THE CURRENT VIEWS OF THE
COMPANY WITH RESPECT TO FUTURE EVENTS AND ARE SUBJECT TO CERTAIN RISKS,
UNCERTAINTIES AND ASSUMPTIONS. IT IS IMPORTANT TO NOTE THAT THE COMPANY'S ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THOSE DESCRIBED HEREIN AS ANTICIPATED,
BELIEVED, ESTIMATED OR EXPECTED. AMONG THE FACTORS THAT COULD CAUSE RESULTS TO
DIFFER MATERIALLY ARE: (A) CHANGES IN LEVELS OF MARKET INTEREST RATES, (B)
CHANGES IN THE CALIFORNIA ECONOMY OR CALIFORNIA REAL ESTATE VALUES, (C) CHANGES
IN THE LEVEL OF MORTGAGE LOAN PREPAYMENTS, (D) CHANGES IN FEDERAL BANKING LAWS
AND REGULATIONS, (E) ACTIONS BY THE COMPANY'S COMPETITORS, AND (F) THE RISKS
DESCRIBED IN THE "RISK FACTORS" SECTION INCLUDED IN THE REGISTRATION STATEMENT
ON FORM S-1 FILED BY GS HOLDINGS WITH THE SECURITIES AND EXCHANGE COMMISSION ON
SEPTEMBER 29, 1998 (FILE NO. 333-64597) AND DECLARED EFFECTIVE ON NOVEMBER 12,
1998. THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING
STATEMENT.
OVERVIEW
The principal business of GS Holdings, through California Federal,
consists of operating retail branches that provide deposit products such as
demand, transaction and savings accounts, and investment products such as mutual
funds, annuities and insurance. In addition, it engages in mortgage banking
activities, including originating and purchasing 1-4 unit residential loans for
sale to various investors in the secondary market or for retention in its own
portfolio, and servicing loans for itself and others. To a lesser extent, the
Company originates and/or purchases commercial real estate, commercial and
consumer loans for investment. Revenues are derived primarily from interest
earned on loans, interest received on government and agency securities and
mortgage-backed securities, gains on sales of loans and other investments and
fees received in connection with loan servicing, securities brokerage and other
customer service transactions. Expenses primarily consist of interest on
customer deposit accounts, interest on short-term and long-term borrowings,
general and administrative expenses consisting of compensation and benefits,
data processing, occupancy and equipment, communications, deposit insurance
assessments, advertising and marketing, professional fees and other general and
administrative expenses.
NET INCOME
GS Holdings reported net income for the three months ended March 31, 2000
of $249.5 million compared with net income of $73.9 million for the
corresponding period in 1999. Net income for the three months ended March 31,
2000 included a tax benefit of $161.7 million and gains on the early
extinguishment of debt, net of tax, of $1.2 million. Excluding these amounts,
net income for the three months ended March 31, 2000 would have been $86.6
million.
YEAR 2000
The Company completed all major milestones in executing its comprehensive
plan to make its computer systems, applications and facilities Year 2000 ready.
This extensive planning process resulted in a smooth transition during the
rollover to the Year 2000. No significant Y2K-related events were reported, and
it was not necessary to activate any of the Company's contingency plans either
internally or with outside vendors. Special attention was provided to the
possibility of Y2K-related exceptions throughout January, February and March
2000, but no material irregularities occurred. Staffing expenses incurred during
the first quarter of 2000 were less than anticipated.
Page 15
The Company has completed all activities associated with the Year 2000
project. Costs related to making the Company's computer systems, applications
and facilities Year 2000 compliant total approximately $17.3 million over the
years 1997 to 2000. Noninterest expense for the three months ended March 31,
2000 included less than $0.1 million in connection with the Company's Year 2000
efforts.
For additional information regarding the Year 2000 issue, refer to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Year 2000" in the Company's 1999 Form 10-K.
FINANCIAL CONDITION
During the three months ended March 31, 2000, consolidated total assets
increased $2.0 billion, to $59.0 billion from December 31, 1999, and total
liabilities increased from $54.9 billion to $56.6 billion.
During the three months ended March 31, 2000, stockholder's equity
increased $225.8 million to $1.9 billion. The increase in stockholder's equity
is principally the net result of $249.5 million in net income for the period,
partially offset by a $20.5 million net unrealized loss, after tax, on
securities available for sale and $5.0 million in dividends to parent.
The unrealized loss on securities available for sale is primarily a
result of a decline in the value of the Company's mortgage-backed securities
available for sale due to an increase in Treasury yields and wider spreads on
private label collateralized mortgage obligations. This unrealized loss reflects
general declines in the prices of fixed-rate instruments during the year as a
consequence of rising interest rates, which led to a slowing of prepayment
expectations and extended the expected lives of the mortgage-related securities
in the portfolio. The total accumulated unrealized loss represents a decline,
after tax, in the combined fair value of the securities available for sale and
mortgage-backed securities available for sale portfolios of approximately 2.0%.
GS Holdings' non-performing assets, consisting of non-performing loans,
net of purchase accounting adjustments, foreclosed real estate, net, and
repossessed assets, decreased to $177 million at March 31, 2000 compared with
$200 million at December 31, 1999. Total non-performing assets as a percentage
of the Bank's total assets decreased to 0.30% at March 31, 2000 from 0.35% at
December 31, 1999.
Page 16
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2000 VERSUS THREE MONTHS ENDED MARCH 31,
1999
The following table shows the Company's consolidated average balance
sheets, with the related interest income, interest expense and the average
interest rates for the periods presented. Average balances are calculated on a
daily basis.
Three Months Ended March 31, 2000
---------------------------------
Average Average
Balance Interest Rate
------- -------- ----
(dollars in millions)
ASSETS
Interest-earning assets (1):
Securities and interest-bearing deposits in banks (2) $ 1,427 $ 22 6.04%
Mortgage-backed securities available for sale 13,870 229 6.61
Mortgage-backed securities held to maturity 2,080 39 7.57
Loans held for sale, net 714 13 7.46
Loans receivable, net 35,313 646 7.32
FHLB stock 1,193 18 5.78
------- ----
Total interest-earning assets 54,597 967 7.08
----
Noninterest-earning assets 2,763
-------
Total assets $57,360
=======
LIABILITIES, MINORITY INTEREST
AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
Deposits $22,894 219 3.84
Securities sold under agreements to repurchase (3) 5,709 83 5.75
Borrowings (3) 25,773 378 5.90
------- ----
Total interest-bearing liabilities 54,376 680 5.03
----
Noninterest-bearing liabilities 838
Minority interest 495
Stockholder's equity 1,651
-------
Total liabilities, minority interest
and stockholder's equity $57,360
=======
Net interest income $287
====
Interest rate spread 2.05%
=====
Net interest margin 2.08%
=====
Return on average assets 1.74%
=====
Return on average equity 60.47%
=====
Average equity to average assets 2.88%
=====
Page 17
Three Months Ended March 31, 1999
---------------------------------------------
Average Average
Balance Interest Rate
------- -------- ----
ASSETS
Interest-earning assets (1):
Securities and interest-bearing deposits in banks (2) $ 1,444 $ 23 6.35%
Mortgage-backed securities available for sale 12,993 204 6.28
Mortgage-backed securities held to maturity 2,643 50 7.63
Loans held for sale, net 2,139 35 6.48
Loans receivable, net 30,745 567 7.38
FHLB stock 1,043 14 5.27
------- ---- 7.01
Total interest-earning assets 51,007 893
------- ----
Noninterest-earning assets 4,297
Total assets $55,304
=======
LIABILITIES, MINORITY INTEREST
AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
Deposits $24,080 222 3.74
Securities sold under agreements to repurchase 4,319 54 5.01
Borrowings 22,873 309 5.48
------- ----
Total interest-bearing liabilities 51,272 585 4.63
----
Noninterest-bearing liabilities 1,678
Minority interest 590
Stockholder's equity 1,764
-------
Total liabilities, minority interest
and stockholder's equity $55,304
=======
Net interest income $308
====
Interest rate spread 2.38%
=====
Net interest margin 2.36%
=====
Return on average assets 0.53%
=====
Return on average equity 16.75%
=====
Average equity to average assets 3.19%
=====
- ----------
(1) Non-performing assets are included in the average balances for the periods
indicated.
(2) Includes securities held to maturity, securities available for sale,
interest-bearing deposits in other banks and short-term investment
securities.
(3) Interest and average rate include the impact of interest rate swaps.
Page 18
The following table shows what portion of the changes in interest income
and interest expense were due to changes in rate and volume. For each category
of interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to volume (change in average outstanding
balance multiplied by the prior period's rate) and rate (change in average
interest rate multiplied by the prior period's volume). Changes attributable to
both volume and rate have been allocated proportionately.
Three Months Ended March 31, 2000 vs. 1999
Increase (Decrease) Due to
------------------------------------------
Volume Rate Net
------ ---- ---
INTEREST INCOME: (in millions)
Securities and interest-bearing deposits in banks $ -- $ (1) $ (1)
Mortgage-backed securities available for sale 14 11 25
Mortgage-backed securities held to maturity (11) -- (11)
Loans held for sale, net (28) 6 (22)
Loans receivable, net 84 (5) 79
FHLB stock 2 2 4
---- ---- ----
Total 61 13 74
---- ---- ----
INTEREST EXPENSE:
Deposits (8) 5 (3)
Securities sold under agreements to repurchase 20 9 29
Borrowings 42 27 69
---- ---- ----
Total 54 41 95
---- ---- ----
Change in net interest income $ 7 $(28) $(21)
==== ==== ====
The volume variances in total interest income and total interest expense
for the three months ended March 31, 2000 compared to the corresponding period
in 1999 are largely due to increased loan volume and purchases of
mortgage-backed securities during 1999, partially offset by an increase in
borrowings.
INTEREST INCOME. Total interest income was $966.7 million for the three
months ended March 31, 2000, an increase of $73.8 million from the three months
ended March 31, 1999. Total interest-earning assets for the three months ended
March 31, 2000 averaged $54.6 billion, compared to $51.0 billion for the
corresponding period in 1999, primarily as a result of increased loan volume and
purchases of mortgage-backed securities during 1999. The yield on total
interest-earning assets during the three months ended March 31, 2000 increased
to 7.08% from 7.01% for the three months ended March 31, 1999, primarily due to
a higher percentage of loans to total earning assets, purchases of
mortgage-backed securities with higher market yields during 1999 and the
repricing of variable-rate earning assets.
GS Holdings earned $646.2 million of interest income on loans receivable
for the three months ended March 31, 2000, an increase of $78.9 million from the
three months ended March 31, 1999. The average balance of loans receivable was
$35.3 billion for the three months ended March 31, 2000, compared to $30.7
billion for the same period in 1999. The weighted average rate on loans
receivable decreased to 7.32% for the three months ended March 31, 2000 from
7.38% for the three months ended March 31, 1999. The changes in the average
balance and weighted average rate reflect the impact of originations of
mortgages with low introductory interest rates during the fourth quarter of 1999
and the first quarter of 2000, offset in part by the repricing of variable-rate
loans.
GS Holdings earned $13.3 million of interest income on loans held for
sale for the three months ended March 31, 2000, a decrease of $21.3 million from
the three months ended March 31, 1999. The average balance of loans held for
sale was $0.7 billion for the three months ended March 31, 2000, a decrease of
$1.4 billion from the comparable period in 1999, primarily due to a reduction in
fixed-rate originations due to the current rising interest rate environment,
coupled with longer holding periods for loans held for sale during the three
months ended March
Page 19
31, 1999. The weighted average rate on loans held for sale increased to 7.46%
for the three months ended March 31, 2000 from 6.48% for the three months ended
March 31, 1999, primarily due to increasing market interest rates.
Interest income on mortgage-backed securities available for sale was
$229.1 million for the three months ended March 31, 2000, an increase of $25.0
million from the three months ended March 31, 1999. The average portfolio
balances increased $0.9 billion, to $13.9 billion, for the three months ended
March 31, 2000 compared to the same period in 1999. The weighted average yield
on these assets increased from 6.28% for the three months ended March 31, 1999
to 6.61% for the three months ended March 31, 2000. The increase in the volume
and the weighted average yield is primarily due to purchases of mortgage-backed
securities with higher market yields during 1999 and lower premium amortization
associated with slower prepayment of variable-rate securities during 2000.
Interest income on mortgage-backed securities held to maturity was $39.4
million for the three months ended March 31, 2000, a decrease of $11.1 million
from the three months ended March 31, 1999. The average portfolio balance
decreased $563 million, to $2.1 billion, for the three months ended March 31,
2000 compared to the same period in 1999, primarily attributed to an increase in
principal paydowns on such securities. The run-off in these securities was
replaced with the origination and purchase of whole loans instead of additional
mortgage-backed securities, evidenced by only $38.9 million in purchases during
the quarter ended March 31, 2000 compared to $2.6 billion in such purchases
during the same period in 1999. The weighted average rates for the three months
ended March 31, 2000 and 1999 were 7.57% and 7.63%, respectively.
Interest income on securities and interest-bearing deposits in other
banks was $21.6 million for the three months ended March 31, 2000, a decrease of
$1.3 million from the three months ended March 31, 1999. The average portfolio
balance was $1.4 billion for each of the three months ended March 31, 1999 and
2000. The lower weighted average rate of 6.04% for the three months ended March
31, 2000 compared to 6.35% for the three months ended March 31, 1999 reflects
interest earned in 1999 on the investment of proceeds from the assumption of the
GS Holdings Notes.
Dividends on FHLB stock were $17.1 million for the three months ended
March 31, 2000, an increase of $3.6 million from the three months ended March
31, 1999, due to an increase in the amount of such stock owned by the Company as
a result of an increase in borrowings under FHLB advances. The average balance
outstanding during the three months ended March 31, 2000 and 1999 was $1.2
billion and $1.0 billion, respectively. The weighted average dividend on FHLB
stock increased to 5.78% for the three months ended March 31, 2000 from 5.27%
for the three months ended March 31, 1999.
INTEREST EXPENSE. Total interest expense was $679.6 million for the three
months ended March 31, 2000, an increase of $94.7 million from the three months
ended March 31, 1999. The increase is primarily the result of additional
borrowings under FHLB advances and securities sold under agreements to
repurchase used to fund loans and to purchase mortgage-backed securities in
1999.
Interest expense on customer deposits, including brokered deposits, was
$218.8 million for the three months ended March 31, 2000, a decrease of $3.2
million from the three months ended March 31, 1999. The average balance of
customer deposits outstanding decreased from $24.1 billion for the three months
ended March 31, 1999 to $22.9 billion for the three months ended March 31, 2000.
The decrease in the average balance is primarily due to lower custodial account
balances as a result of lower prepayment rates on loans serviced for others.
Partially offsetting this decrease is $543 million in deposits at an average
cost of 3.71%, which were assumed in the Nevada Purchase in April 1999. The
overall weighted average cost of deposits increased to 3.84% for the three
months ended March 31, 2000 from 3.74% for the three months ended March 31,
1999, primarily due to rising market interest rates.
Interest expense on securities sold under agreements to repurchase
totalled $82.9 million for the three months ended March 31, 2000, an increase of
$28.9 million from the three months ended March 31, 1999. The average
Page 20
balance of such borrowings for the three months ended March 31, 2000 and 1999
was $5.7 billion and $4.3 billion, respectively. The increase is primarily
attributed to the funding of loans and the purchases of mortgage-backed
securities in 1999, as well as deposit run-off. The weighted average interest
rate on these instruments increased to 5.75% for the three months ended March
31, 2000 from 5.01% for the three months ended March 31, 1999, primarily due to
an increase in market rates on new borrowings in 2000 compared to 1999.
Interest expense on borrowings totalled $377.9 million for the three
months ended March 31, 2000, an increase of $69.0 million from the three months
ended March 31, 1999. The average balance outstanding for the three months ended
March 31, 2000 and 1999 was $25.8 billion and $22.9 billion, respectively. The
weighted average interest rate on these instruments increased to 5.90% for the
three months ended March 31, 2000 from 5.48% for the three months ended March
31, 1999, primarily due to higher prevailing market rates in 2000. The higher
volume reflects the increase in FHLB advances used to fund loans and the
purchases of mortgage-backed securities in 1999.
NET INTEREST INCOME. Net interest income was $287.1 million for the three
months ended March 31, 2000, a decrease of $20.9 million from the three months
ended March 31, 1999. The interest rate spread declined to 2.05% for the three
months ended March 31, 2000 from 2.38% for the three months ended March 31,
1999, primarily as a result of maturities and repayments of lower rate
interest-bearing liabilities being replaced with interest-bearing liabilities
having comparatively higher rates. The effect of higher rates on liabilities was
partially offset by higher yielding assets replenishing asset run-off in a
rising rate environment.
NONINTEREST INCOME. Total noninterest income, consisting primarily of
loan servicing fees, customer banking fees and gains on sales of assets, was
$110.2 million for the three months ended March 31, 2000, representing an
increase of $4.1 million from the three months ended March 31, 1999.
Loan servicing fees, net of amortization of mortgage servicing rights,
were $44.9 million for the three months ended March 31, 2000, compared to $36.0
million for the three months ended March 31, 1999. The single-family residential
loan servicing portfolio, excluding loans serviced for the Bank, increased from
$66.4 billion at March 31, 1999 to $76.2 billion at March 31, 2000. Incremental
loan servicing fees were partially offset by amortization of MSRs. MSR
amortization for the quarter decreased by $4.6 million from the three months
ended March 31, 1999 due to a reduction in the assumed prepayment rate,
partially offset by a higher MSR basis. Loan servicing fees benefited from the
slowdown in mortgage loan prepayments in 2000, with an average prepayment rate
on loans serviced for others of 7% in the first quarter of 2000, compared to 25%
in the comparable period in 1999.
Customer banking fees were $48.7 million for the three months ended March
31, 2000 compared to $44.7 million for the three months ended March 31, 1999.
The increase is primarily attributed to increased emphasis by management on
transaction account growth and the impact of revenues from the deposits assumed
in the Nevada Purchase.
Gain on sale and settlement of loans, net totalled $6.7 million for the
three months ended March 31, 2000, a decrease of $8.9 million from the three
months ended March 31, 1999. Gains attributed to early payoffs and settlement of
commercial loans with unamortized discounts were $2.5 million lower in 2000
compared to 1999. During the three months ended March 31, 2000, California
Federal sold $1.1 billion in single-family mortgage loans originated for sale
with servicing rights retained as part of its ongoing mortgage banking
operations compared to $3.2 billion of such sales for the corresponding period
in 1999.
NONINTEREST EXPENSE. Total noninterest expense was $225.3 million for the
three months ended March 31, 2000, a decrease of $28.2 million compared to the
three months ended March 31, 1999. The variance between the two periods is
primarily attributed to continued expense reduction efforts by the Company.
Noninterest expense for the three months ended March 31, 2000 included decreases
of $13.1 million in other noninterest expense, $6.1 million in loan expense,
$6.1 million in merger and integration costs incurred in 1999 in connection with
the Golden State Acquisition, and $5.2 million in professional fees. This
decrease was partially offset by an increase of $5.2 million in compensation
expense.
Page 21
Compensation and employee benefits expense was $107.8 million for the
three months ended March 31, 2000, an increase of $5.2 million from the three
months ended March 31, 1999. The increase is primarily attributed to normal
salary adjustments.
Merger and integration costs were $6.1 million for the three months ended
March 31, 1999, representing transition expenses, which include severance,
conversion and consolidation costs incurred in connection with the Golden State
Acquisition. Such costs were not incurred during the first quarter of 2000.
Amortization of intangible assets was $16.4 million for the three months
ended March 31, 2000, a decrease of $0.7 million from the three months ended
March 31, 1999, primarily attributed to a lower goodwill base due to a $38.2
million reduction resulting from an income tax refund received during the fourth
quarter of 1999 related to Old California Federal. This decrease was partially
offset by amortization expense related to goodwill recorded in connection with
the Downey Acquisition and the Nevada Purchase.
Other noninterest expense was $51.2 million in 2000 compared to $64.3
million in 1999. The decline in operating expenses is primarily attributed to
management's continued expense reduction efforts.
PROVISION FOR INCOME TAX. During the three months ended March 31, 2000
and 1999, GS Holdings recorded income tax (benefit) expense of $(82.9) million
and $72.4 million, respectively. Based on favorable resolutions of federal
income tax audits of Old California Federal and Glendale Federal and the current
status of Mafco's, including the Company's, audits for the years 1991 through
1995, management changed its judgment about realizability of the Company's
deferred tax asset and reduced its valuation allowance by $211.7 million during
the three-month period ended March 31, 2000. As a result of reducing the
valuation allowance, income tax expense was reduced by $161.7 million and
goodwill was reduced by $50.0 million.
GS Holdings' effective federal tax rate was (56)% and 39% during the
three months ended March 31, 2000 and 1999, respectively, while its federal
statutory tax rate was 35%. For the period ended March 31, 2000, the difference
between the effective and statutory rates was the result of the reduction in the
deferred tax asset valuation allowance, partially offset by nondeductible
goodwill amortization. For the period ended March 31, 1999, the difference
between the effective and statutory rates was primarily the result of
nondeductible goodwill amortization. GS Holdings' effective state tax rate was
8% during each of the three months ended March 31, 2000 and 1999.
MINORITY INTEREST. Dividends on the REIT Preferred Stock totalling $11.4
million were recorded during each of the three months ended March 31, 2000 and
1999. Minority interest relative to the REIT Preferred Stock is reflected net of
related income tax benefit of $4.8 million, which will inure to the Company as a
result of the deductibility of such dividends for income tax purposes.
During the three months ended March 31, 1999, minority interest also
included dividends on the Bank Preferred Stock that had not yet been acquired by
GS Holdings totalling $0.9 million and a $1.7 million benefit reversal
representing that portion of Auto One's loss attributable to the 20% interest in
the common stock of Auto One that was issued as part of the GSAC Acquisition.
PROVISION FOR LOAN LOSSES
The adequacy of the allowance for loan losses is periodically evaluated
by management to maintain the allowance at a level that is sufficient to absorb
expected loan losses. The allowance for loan losses is increased by provisions
for loan losses as well as by balances acquired through acquisitions and is
decreased by charge-offs (net of recoveries). The Company charges current
earnings with a provision for estimated credit losses on loans receivable. The
provision considers both specifically identified problem loans as well as credit
risks not specifically identified in the loan portfolio. See -- "Problem and
Potential Problem Assets" for a discussion of the methodology
Page 22
used in determining the adequacy of the allowance for loan losses. The Company
recorded no provision for loan losses during the first quarter of 2000, and a $5
million provision for loan losses during the three months ended March 31, 1999.
The decrease in the provision for loan losses during the three-month
period ended March 31, 2000 compared to the same period in 1999 reflects
management's evaluation of the adequacy of the allowance based on, among other
things, past loan loss experience and known and inherent risks in the portfolio,
evidenced in part by the continued decline in the Company's level of
non-performing assets. In addition, management's periodic evaluation of the
adequacy of the allowance for loan losses considers potential adverse situations
that have occurred but are not yet known that may affect the borrower's ability
to repay, the estimated value of underlying collateral and economic conditions.
Activity in the allowance for loan losses is as follows (in thousands):
Three Months Ended March 31,
----------------------------
2000 1999
---- ----
Balance - beginning of period $554,893 $588,533
Provision for loan losses -- 5,000
Charge-offs (12,470) (10,304)
Recoveries 765 655
Reclassification -- (670)
-------- --------
Balance - end of period $543,188 $583,214
======== ========
Although management believes that the allowance for loan losses is
adequate, it will continue to review its loan portfolio to determine the extent
to which any changes in economic conditions or loss experience may require
further provisions in the future.
PROBLEM AND POTENTIAL PROBLEM ASSETS
The Company considers a loan impaired when, based upon current
information and events, it is "probable" that it will be unable to collect all
amounts due (i.e., both principal and interest) according to the contractual
terms of the loan agreement. Any insignificant delay or insignificant shortfall
in amount of payments will not cause a loan to be considered impaired. In
determining impairment, the Company considers large non-homogeneous loans
including nonaccrual loans, troubled debt restructurings, and performing loans
that exhibit, among other characteristics, high LTV ratios, low debt-coverage
ratios or other indications that the borrowers are experiencing increased levels
of financial difficulty. Loans collectively reviewed for impairment by the
Company include all single-family loans, business banking loans under $100,000
and performing multi-family and commercial real estate loans under $500,000,
excluding loans which have entered the work-out process.
The measurement of impairment may be based on (a) the present value of
the expected future cash flows of the impaired loan discounted at the loan's
original effective interest rate, (b) the observable market price of the
impaired loan, or (c) the fair value of the collateral of a collateral-dependent
loan. The Company bases the measurement of collateral-dependent impaired loans
on the fair value of the loan's collateral, less disposal costs. The amount, if
any, by which the recorded investment of the loan exceeds the measure of the
impaired loan's value is recognized by recording a valuation allowance. Large
groups of smaller balance homogeneous loans are collectively evaluated for
impairment.
Cash receipts on impaired loans not performing according to contractual
terms are generally used to reduce the carrying value of the loan, unless the
Company believes it will recover the remaining principal balance of the loan.
Impairment losses are included in the allowance for loan losses. Upon
disposition of an impaired loan, loss of principal, if any, is recorded through
a charge-off to the allowance for loan losses.
Page 23
At March 31, 2000, loans that were considered to be impaired totalled
$114.7 million (of which $17.2 million were on nonaccrual status). The average
recorded investment in impaired loans during the three-month period ended March
31, 2000 was approximately $127.9 million. For the three-month period ended
March 31, 2000, GS Holdings recognized interest income on those impaired loans
of $2.6 million, which included $0.8 million of interest income recognized using
the cash basis method of income recognition.
The following table presents the Company's non-performing loans,
foreclosed real estate, repossessed assets, troubled debt restructurings and
impaired loans as of the dates indicated. These categories are not mutually
exclusive; certain loans are included in more than one classification. Purchased
sub-prime auto loans are reflected as non-performing, impaired or restructured
using each individual loan's contractual unpaid principal balance.
March 31, 2000
----------------------------------------------------
Non-performing Impaired Restructured
-------------- -------- ------------
(in millions)
Real Estate:
1-4 unit residential $112 $ 1 $ 1
5+ unit residential 6 33 --
Commercial and other 7 53 --
Land -- 1 --
Construction -- -- --
---- ---- ---
Total real estate 125 88 1
Non-real estate 10 27 --
---- ---- ---
Total loans 135 (a) $115 (b) $ 1
==== ===
Foreclosed real estate, net 37
Repossessed assets 5
----
Total non-performing assets $177
====
March 31, 2000
----------------------------------------------------
Non-performing Impaired Restructured
-------------- -------- ------------
(in millions)
Real Estate:
1-4 unit residential $126 $ -- $ 2
5+ unit residential 6 34 5
Commercial and other 8 67 18
Land -- 2 --
Construction -- -- --
---- ---- ---
Total real estate 140 103 25
Non-real estate 11 21 --
---- ---- ---
Total loans 151 (a) $124 (b) $25
==== ===
Foreclosed real estate, net 45
Repossessed assets 4
----
Total non-performing assets $200
====
- -------------
(a) Includes loans securitized with recourse on non-performing status of $1.4
million and $2.0 million at March 31, 2000 and December 31, 1999,
respectively.
(b) Includes $17.2 million and $18.9 million of non-performing loans at March
31, 2000 and December 31, 1999, respectively. Also includes $9.0 million
and $13.7 million of loans classified as troubled debt restructurings at
March 31, 2000 and December 31, 1999, respectively.
There were no accruing loans contractually past due 90 days or more at
March 31, 2000 or December 31, 1999.
Page 24
The Company's non-performing assets, consisting of nonaccrual loans,
repossessed assets and foreclosed real estate, net, decreased to $177 million at
March 31, 2000, from $200 million at December 31, 1999. Non-performing assets as
a percentage of the Bank's total assets decreased to 0.30% at March 31, 2000,
from 0.35% at December 31, 1999.
The Company places a high degree of emphasis on the management of its
asset portfolio. The Company has three distinct asset management functions:
performing loan asset management, problem loan asset management and credit
review. Each of these three functions is charged with the responsibility of
reducing the risk profile within the commercial, multi-family and other asset
portfolios by applying asset management and risk evaluation techniques that are
consistent with the Company's portfolio management strategy and regulatory
requirements. In addition to these asset management functions, the Company has a
specialized credit risk management group that is charged with the development of
credit policies and performing credit risk analyses for all asset portfolios.
The following table presents non-performing real estate assets by
geographic region of the country as of March 31, 2000:
Total
Non-performing Foreclosed Non-performing
Real Estate Real Estate, Real Estate Geographic
Loans, Net (2) Net (2) Assets Concentration
-------------- ------- ------ -------------
(dollars in millions)
Region:
California $ 72 $17 $ 89 55%
Northeast (1) 15 4 19 12
Other regions 38 16 54 33
---- --- ---- ---
Total $125 $37 $162 100%
==== === ==== ===
_______________
(1) Consists of Connecticut, Massachusetts, New Hampshire, New Jersey, New York
Pennsylvania, Rhode Island, Delaware, Maine and Vermont.
(2) Net of purchase accounting adjustments.
At March 31, 2000, the Company's largest non-performing asset was
approximately $3.3 million, and it had two non-performing assets over $2 million
in size with balances averaging approximately $2.2 million. At March 31, 2000,
the Company had 1,059 non-performing assets below $2 million in size, including
1,002 non-performing 1-4 unit residential assets.
An allowance is maintained to absorb losses inherent in the loan
portfolio. The adequacy of the allowance is periodically evaluated and is based
on past loan loss experience, known and inherent risks in the loan portfolio,
adverse situations that have occurred but are not yet known that may affect the
borrower's ability to repay, the estimated value of underlying collateral and
economic conditions. Management's methodology for assessing the adequacy of the
allowance includes the evaluation of the following three key elements: the
formula allowance, specific allowances for identified problem loans and the
unallocated allowance.
The formula allowance is determined by applying loss factors against all
non-impaired loans. Loss factors may be adjusted for significant factors that,
in management's judgment, affect the collectibility of the portfolio as of the
evaluation date. Loss factors are calculated based on migration models that
estimate the probability that loans will become delinquent and ultimately result
in foreclosure over a period of between one and 2.5 years, depending on the loan
type, and the rates of loss that have been experienced on foreclosed loans. The
foreclosure migration and loss severity rates are then averaged over the past
eight years in order to capture experience across a period that management
believes approximates a business cycle. A contingency factor is then added to
provide for the modeling risk associated with imprecision in estimating inherent
loan losses.
Page 25
The specific allowances are established against individual loans,
including impaired loans in accordance with SFAS No. 114, ACCOUNTING BY
CREDITORS FOR IMPAIRMENT OF A LOAN. Specific allowances are established against
individual residential 1-4 mortgage loans, commercial loans and commercial real
estate loans for which management has performed analyses and concluded that,
based on current information and events, it is probable that the Bank will be
unable to collect all amounts due according to the contractual terms of the loan
agreement. Generally, management believes that collectibility is improbable if a
loan is severely delinquent or if it has been determined that borrower cash flow
is inadequate for debt repayment. The amount of specific allowance is determined
by an estimation of collateral deficiency, including consideration of costs that
will likely be incurred through the disposal of any repossessed collateral. In
other words, management estimates the fair value of collateral, net of the cost
of disposition of the collateral, and the fair value is compared to the net book
value of the loan. If the net book value exceeds the fair value, a specific
allowance is established in an amount equal to the excess. Loans evaluated for
specific allowance are excluded from the formula allowance analysis so as not to
double-count loss exposure.
The unallocated allowance is established for inherent losses which may
not have been identified through the more objective processes used to derive the
formula and specific portions of the allowance. The unallocated portion is
necessarily more subjective and requires a high degree of management judgment
and experience. Management has identified several factors that impact the
potential for credit losses that are not considered in either the formula or the
specific allowance segments. These factors consist of industry and geographic
loan concentrations, changes in the composition of loan portfolios through
acquisitions and new business strategies, changes in underwriting processes, and
trends in problem loan and loss recovery rates. Each factor is analyzed and
assigned a range of values. At this time, management has chosen an unallocated
allowance amount at the mid-point of the range for each factor.
At March 31, 2000, the allowance for loan losses was $543 million,
consisting of a $375 million formula allowance, a $29 million specific allowance
and a $139 million unallocated allowance.
Although the loan loss allowance has been allocated by type of loan for
internal valuation purposes, $512 million of the allowance is general in nature
and is available to support any losses which may occur, regardless of type, in
the Company's loan portfolio. A summary of the activity in the total allowance
for loan losses by loan type is as follows:
5+ Unit
Residential
1-4 Unit and Commercial Consumer
Residential Real Estate and Other Total
----------- ----------- --------- -----
(in millions)
Balance - December 31, 1999 $235 $276 $44 $555
Provision for loan losses -- (1) 1 --
Charge-offs (2) (4) (7) (13)
Recoveries -- -- 1 1
---- ---- --- ----
Balance - March 31, 2000 $233 $271 $39 $543
==== ==== === ====
Page 26
ASSET AND LIABILITY MANAGEMENT
Banks and savings associations are subject to interest rate risk to the
degree that their interest-bearing liabilities, consisting principally of
deposits, securities sold under agreements to repurchase and FHLB advances,
mature or reprice more or less frequently, or on a different basis, than their
interest-earning assets. A key element of the banking business is the monitoring
and management of liquidity risk and interest rate risk. The process of planning
and controlling asset and liability mixes, volumes and maturities to influence
the net interest spread is referred to as asset and liability management. The
objective of the Company's asset and liability management is to maximize its net
interest income over changing interest rate cycles within the constraints
imposed by prudent lending and investing practices, liquidity needs and capital
planning.
GS Holdings, through the Bank, actively pursues investment and funding
strategies intended to minimize the sensitivity of its earnings to interest rate
fluctuations. The Company measures the interest rate sensitivity of its balance
sheet through gap and duration analysis, as well as net interest income and
market value simulation. After taking into consideration both the variability of
rates and the maturities of various instruments, it evaluates strategies which
may reduce the sensitivity of its earnings to interest rate and market value
fluctuations. An important decision is the selection of interest-bearing
liabilities and the generation of interest-earning assets which best match
relative to interest rate changes. In order to reduce interest rate risk by
increasing the percentage of interest sensitive assets, the Company has
continued its emphasis on the origination of adjustable rate mortgage ("ARM")
products for its portfolio. Where possible, the Company seeks to originate real
estate and other loans that reprice frequently and that on the whole adjust in
accordance with the repricing of its liabilities. At March 31, 2000,
approximately 77% of the Company's loan portfolio consisted of ARMs.
One of the most important sources of the Bank's net income is net
interest income, which is the difference between the combined yield earned on
interest-earning assets and the combined rate paid on interest-bearing
liabilities. Net interest income is also dependent on the relative balances of
interest-earning assets and interest-bearing liabilities.
ARMs have, from time to time, been offered with low initial interest
rates as marketing inducements. In addition, most ARMs are subject to periodic
interest rate adjustment caps or floors. In a period of rising interest rates,
ARMs could reach a periodic adjustment cap while still at a rate significantly
below their contractual margin over existing market rates. Since repricing
liabilities are typically not subject to such interest rate adjustment
constraints, the Company's net interest margin would most likely be negatively
impacted in this situation. Certain ARMs now offered by the Company have a fixed
monthly payment for a given period, with any changes as a result of market
interest rates reflected in the unpaid principal balance through negative
amortization.
A traditional measure of interest rate risk within the savings industry
is the interest rate sensitivity gap, which is the sum of all interest-earning
assets minus the sum of all interest-bearing liabilities to be repriced within
the same period. A gap is considered positive when the amount of interest rate
sensitive assets exceed interest rate sensitive liabilities, while the opposite
results in a negative gap. During a period of rising interest rates, a negative
gap would tend to adversely affect net interest income, and a positive gap would
tend to result in an increase in net interest income. During a period of falling
rates, the opposite would tend to occur.
Page 27
The following table sets forth the projected maturities based upon
contractual maturities as adjusted for projected prepayments and "repricing
mechanisms" (provisions for changes in the interest rates of assets and
liabilities). Prepayment rates are assumed in each period on substantially all
of the Company's loan portfolio based upon expected loan prepayments. Repricing
mechanisms on the Company's assets are subject to limitations, such as caps on
the amount that interest rates and payments on its loans may adjust.
Accordingly, such assets may not respond in the same manner or to the same
extent to changes in interest rates as the Company's liabilities. In addition,
the interest rate sensitivity of the assets and liabilities illustrated in the
table would vary substantially if different assumptions were used or if actual
experience differed from the assumptions set forth. The Company's estimated
interest rate sensitivity gap at March 31, 2000 was as follows:
Maturity/Rate Sensitivity
-------------------------------------------------------------
Within 1-5 Over 5 Noninterest
1 Year Years Years Bearing Total
------ ----- ----- ------- -----
(dollars in millions)
INTEREST-EARNING ASSETS:
Securities held to maturity, interest-bearing
deposits in other banks and short-term
investment securities(1)(2) $ 181 $ -- $ 85 $ -- $ 266
Securities available for sale (3) 1,066 -- -- -- 1,066
Mortgage-backed securities
available for sale (3) 13,318 -- -- -- 13,318
Mortgage-backed securities
held to maturity (1)(4) 2,013 19 18 -- 2,050
Loans held for sale, net (3) 687 -- -- -- 687
Loans receivable, net (1)(5) 18,979 12,533 5,030 -- 36,542
Investment in FHLB 1,258 -- -- -- 1,258
------- ------- ------ ------ -------
Total interest-earning assets 37,502 12,552 5,133 -- 55,187
Noninterest-earning assets -- -- -- 3,845 3,845
------- ------- ------ ------ -------
$37,502 $12,552 $5,133 $3,845 $59,032
======= ======= ====== ====== =======
INTEREST-BEARING LIABILITIES:
Deposits (6) $20,051 $ 2,988 $ 9 $ -- $23,048
Securities sold under agreements to
repurchase (1) 5,354 -- -- -- 5,354
FHLB advances (1) 14,442 10,836 -- -- 25,278
Other borrowings (1) 26 1,201 892 -- 2,119
------- ------- ------ ------ ------
Total interest-bearing liabilities 39,873 15,025 901 -- 55,799
Noninterest-bearing liabilities -- -- -- 846 846
Minority interest -- -- -- 500 500
Stockholder's equity -- -- -- 1,887 1,887
------- ------- ------ ------ -------
$39,873 $15,025 $ 901 $3,233 $59,032
======= ======= ====== ====== =======
Gap before interest rate swap agreements $(2,371) $(2,473) $4,232 $ (612)
Interest rate swap agreements 3,250 (2,350) (900) --
------- ------- ------ -------
Gap $ 879 $(4,823) $3,332 $ (612)
======= ======= ====== =======
Cumulative gap $ 879 $(3,944) $ (612) $ (612)
======= ======= ====== =======
Gap as a percentage of total assets 1.49% (8.17)% 5.64% (1.04)%
======= ======= ====== =======
Cumulative gap as a percentage of total assets 1.49% (6.68)% (1.04)% (1.04)%
======= ======= ====== =======
(Continued)
Page 28
_______________
(1) Based upon (a) contractual maturity, (b) instrument repricing date, if
applicable, and (c) projected repayments and prepayments of principal, if
applicable. Prepayments were estimated generally by using the prepayment
rates forecast by various large brokerage firms as of March 31, 2000. The
actual maturity and rate sensitivity of these assets could vary
substantially if future prepayments differ from prepayment estimates.
(2) Consists of $165 million of securities held to maturity, $76 million of
short-term investment securities and $25 million of interest-bearing
deposits in other banks.
(3) As securities and mortgage-backed securities available for sale and loans
held for sale may be sold within one year, they are considered to be
maturing within one year.
(4) Excludes underlying non-performing loans of $1 million.
(5) Excludes allowance for loan losses of $543 million and non-performing loans
of $134 million, net of $11 million related to specific allowances.
(6) Fixed rate deposits and deposits with fixed pricing intervals are reflected
as maturing in the year of contractual maturity or first repricing date.
Money market deposit accounts, demand deposit accounts and passbook
accounts are reflected as maturing within one year.
At March 31, 2000, GS Holdings' cumulative gap totalled $(612) million.
At December 31, 1999, GS Holdings' cumulative gap totalled $(693) million.
The Company utilizes computer modeling, under various interest rate
scenarios, to provide a dynamic view of the effects of the changes in rates,
spreads, and yield curve shifts on net interest income. However, the
maturity/rate sensitivity analysis is a static view of the balance sheet with
assets and liabilities grouped into certain defined time periods, and only
partially depicts the dynamics of the Company's sensitivity to interest rate
changes. Therefore, this analysis may not fully describe the complexity of
relationships between product features and pricing, market rates and future
management of the balance sheet mix.
The Company's risk management policies are established by the
Asset/Liability Management Committee ("ALCO") of the Bank. ALCO meets monthly to
formulate the Bank's investment and risk management strategies. The basic
responsibilities of ALCO include management of net interest income and market
value of portfolio equity to measure the stability of earnings, management of
liquidity to provide adequate funding, and the establishment of asset product
priorities by formulating performance evaluation criteria, risk evaluation
techniques and a system to standardize the analysis and reporting of
originations, competitive trends, profitability and risk. On a quarterly basis,
the Board of Directors of the Bank is apprised of ALCO strategies adopted and
their impact on operations, and, at least annually, the Board of Directors of
the Bank reviews the Bank's interest rate risk management policy statements.
LIQUIDITY
The standard measure of liquidity in the savings industry is the ratio of
cash and short-term U.S. Government securities and other specified securities to
deposits and borrowings due within one year. The OTS established a minimum
liquidity requirement for the Bank of 4.00%. California Federal has been in
compliance with the liquidity regulations during the three months ended March
31, 2000 and the year ended December 31, 1999.
Page 29
The major source of funding for GS Holdings on an unconsolidated basis is
distributions of the Bank's earnings and tax sharing payments. Net income
generated by the Bank is used to meet its cash flow needs, including paying
dividends on its preferred stock owned by the Company, and may be distributed,
subject to certain restrictions, to GS Holdings. In turn, GS Holdings uses
distributions received from the Bank primarily to meet debt service
requirements, pay any expenses it may incur, and make distributions to Golden
State, subject to certain restrictions. For more information on dividend
restrictions for the Bank and GS Holdings, refer to "Business - Regulation and
Supervision" and note 26 of the "Notes to Consolidated Financial Statements" in
the Company's 1999 Form 10-K.
On a consolidated basis, a major source of the Company's funding is
expected to be the Bank's retail deposit branch network, which management
believes will be sufficient to meet its long-term liquidity needs. The ability
of the Company to retain and attract new deposits is dependent upon the variety
and effectiveness of its customer account products, customer service and
convenience, and rates paid to customers. The Company also obtains funds from
the repayment and maturities of loans and mortgage-backed securities, while
additional funds can be obtained from a variety of other sources, including
customer and brokered deposits, loan sales, securities sold under agreements to
repurchase, FHLB advances, and other secured and unsecured borrowings. It is
anticipated that FHLB advances and securities sold under agreements to
repurchase will continue to be important sources of funding, and management
expects there to be adequate collateral for such funding requirements.
Interest on the GS Holdings Notes approximates $138.9 million per year.
Although GS Holdings expects that distributions and tax sharing payments from
the Bank will be sufficient to pay interest when due and the principal amount of
its long-term debt at maturity, there can be no assurance that earnings from the
Bank will be sufficient to make such distributions to GS Holdings. In addition,
there can be no assurance that such distributions will be permitted by the terms
of any debt instruments of GS Holdings' subsidiaries then in effect, by the
terms of any class of preferred stock issued by the Bank or its subsidiaries,
including the REIT Preferred Stock, or under applicable federal thrift laws.
The Company anticipates that cash and cash equivalents on hand, the cash
flows from assets as well as other sources of funds will provide adequate
liquidity for its operating, investing and financing needs and the Bank's
regulatory liquidity requirements for the foreseeable future. In addition to
cash and cash equivalents of $641.2 million at March 31, 2000, the Company has
substantial additional borrowing capacity with the FHLB and other sources.
The consolidated Company's primary uses of funds are the origination or
purchase of loans, the purchase of mortgage-backed securities, the funding of
maturing certificates of deposit, demand deposit withdrawals and the repayment
of borrowings. Certificates of deposit scheduled to mature during the twelve
months ending March 31, 2001 aggregate $8.8 billion. The Company may renew these
certificates, attract new replacement deposits, replace such funds with other
borrowings, or it may elect to reduce the size of the balance sheet. In
addition, at March 31, 2000, GS Holdings had FHLB advances, securities sold
under agreements to repurchase and other borrowings aggregating $19.8 billion
maturing or repricing within twelve months. The Company may elect to pay off
such debt or to replace such borrowings with additional FHLB advances,
securities sold under agreements to repurchase or other borrowings at prevailing
rates.
As presented in the accompanying unaudited consolidated statements of
cash flows, the sources of liquidity vary between periods. The primary sources
of funds during the three months ended March 31, 2000 were $8.7 billion in
proceeds from additional borrowings, $1.0 billion in proceeds from sales of
loans held for sale and $554.6 million from principal payments on
mortgage-backed securities available for sale and held to maturity. The primary
uses of funds were $6.9 billion in principal payments on borrowings, a $1.4
billion net increase in loans receivable, $1.0 billion in purchases and
originations of loans held for sale, $457.5 million in purchases of loans
receivable and $379.3 million for the Downey Acquisition.
Page 30
MORTGAGE BANKING OPERATIONS
During the three months ended March 31, 2000 and 1999, the Company,
through the Bank's wholly owned mortgage bank subsidiary, FNMC, acquired
mortgage-servicing rights on loan portfolios of $4.4 billion and $2.5 billion,
respectively. The 1-4 unit residential loans serviced for others (including
loans sub-serviced for others and excluding loans serviced for the Bank)
totalled $76.2 billion at March 31, 2000, an increase of $3.3 billion and $9.8
billion from December 31, 1999 and March 31, 1999, respectively. During the
three months ended March 31, 2000 and 1999, the Bank, through FNMC, originated
$3.1 billion and $4.7 billion, respectively, and sold (generally with servicing
retained) $1.1 billion and $3.2 billion, respectively, of 1-4 unit residential
loans. Gross revenues from mortgage loan servicing activities for the three
months ended March 31, 2000 totalled $77.8 million, an increase of $8.7 million
from the three months ended March 31, 1999. Gross loan servicing fees for the
three months ended March 31, 2000 were reduced by $45.9 million of amortization
of servicing rights to arrive at net loan servicing fees of $31.9 million.
A decline in long-term interest rates generally results in an
acceleration of mortgage loan prepayments. Higher than anticipated levels of
prepayments generally cause the accelerated amortization of mortgage servicing
rights ("MSRs"), and generally will result in a reduction in the market value of
MSRs and in the Company's servicing fee income. To reduce the sensitivity of its
earnings to interest rate and market value fluctuations, the Company hedged the
change in value of its MSRs based on changes in interest rates ("MSR Hedge").
The Company owned several derivative instruments at March 31, 2000 which
were used to hedge against prepayment risk in its mortgage servicing portfolio.
These derivative instruments included Constant Maturity Swap interest rate floor
contracts, swaptions, principal only swaps, and prepayment-linked swaps. The
estimated fair value of all derivatives used to hedge prepayment risk was $24.1
million at March 31, 2000. The interest rate floor contracts had a notional
amount of $820 million, strike rates between 5.70% and 7.13%, mature in the
years 2004 and 2005, and had an estimated fair value of $12.7 million at March
31, 2000. Premiums paid to counterparties in exchange for cash payments when the
10-year Constant Maturity Swap rate falls below the strike rate are recorded as
part of the MSR asset on the balance sheet. The swaption contracts had a
notional amount of $986 million, strike rates between 6.75% and 7.88%, expire in
the years 2002 and 2003, and had an estimated fair value of $24.3 million at
March 31, 2000. Premiums paid to counterparties in exchange for the right to
enter into an interest rate swap are recorded as part of the MSR asset on the
balance sheet. Principal only swap agreements had notional amounts of $200.5
million and an estimated fair value of $(12.9) million at March 31, 2000. There
were no prepayment-linked swaps at March 31, 2000.
The following is a summary of activity in MSRs and the MSR Hedge for the
three months ended March 31, 2000 (in millions):
Total MSR
MSRs MSR Hedge Balance
---- --------- -------
Balance at December 31, 1999 $1,232 $40 $1,272
Additions - purchases 97 -- 97
Originated servicing 26 -- 26
Swaption sales (4) (8) (12)
Premiums paid -- 11 11
Payments made to counterparties, net 3 -- 3
Amortization (43) (3) (46)
------ --- ------
Balance at March 31, 2000 $1,311 $40 $1,351
====== === ======
Page 31
Capitalized MSRs are amortized in proportion to, and over the period of,
estimated net servicing income. SFAS No. 125 requires enterprises to measure the
impairment of MSRs based on the difference between the carrying amount of the
MSRs and their current fair value. At March 31, 2000 and December 31, 1999, no
allowance for impairment of the MSRs was necessary.
CAPITAL RESOURCES
OTS capital regulations require savings associations to satisfy three
minimum capital requirements: tangible capital, core (leverage) capital, and
risk-based capital.
TANGIBLE CAPITAL. Tangible capital is the sum of common stockholder's
equity (including retained earnings), noncumulative perpetual preferred stock
and minority interest in equity accounts of fully consolidated subsidiaries,
less disallowed intangibles. Tangible capital must be at least 1.5% of adjusted
total assets.
CORE CAPITAL. Core capital generally is the sum of tangible capital plus
certain other qualifying intangibles. Under the leverage requirement, a savings
association is required to maintain core capital equal to a minimum of 4% of
adjusted total assets.
RISK-BASED CAPITAL. Risk-based capital equals the sum of core capital
plus supplementary capital. Risk-based capital must be at least 8% of
risk-weighted assets.
RISK-WEIGHTED ASSETS. Risk-weighted assets equal assets plus the credit
risk equivalent of certain off-balance sheet items, multiplied by the
appropriate risk weight.
SUPPLEMENTARY CAPITAL. Supplementary capital includes certain permanent
capital instruments, such as qualifying cumulative perpetual preferred stock, as
well as some forms of term capital instruments, such as qualifying subordinated
debt. Supplementary capital may not exceed 100% of core capital for purposes of
the risk-based requirement.
MINIMUM REQUIREMENTS. These capital requirements discussed above are
viewed as minimum standards by the OTS, and most associations are expected to
maintain capital levels well above the minimum. In addition, the OTS regulations
provide that minimum capital levels higher than those provided in the
regulations may be established by the OTS for individual savings associations,
depending upon their circumstances. These capital requirements are currently
applicable to the Bank but not to GS Holdings. The Bank is not subject to any
such individual regulatory capital requirement that is higher than the minimum.
Page 32
At March 31, 2000, the Bank's regulatory capital levels exceeded the
minimum regulatory capital requirements, with tangible, core and risk-based
capital ratios of 5.98%, 5.98% and 12.96%, respectively. The following is a
reconciliation of the Bank's stockholder's equity to regulatory capital as of
March 31, 2000:
Tangible Core Risk-based
Capital Capital Capital
------- ------- -------
(dollars in millions)
Stockholder's equity of the Bank $3,765 $3,765 $3,765
Minority interest - REIT Preferred Stock 500 500 500
Unrealized holding loss on securities available for sale, net 296 296 296
Non-allowable capital:
Intangible assets (761) (761) (761)
Goodwill Litigation Assets (159) (159) (159)
Investment in non-includable subsidiaries (58) (58) (58)
Excess deferred tax asset (82) (82) (82)
Supplemental capital:
Qualifying subordinated debentures -- -- 93
General loan loss allowance -- -- 383
Assets required to be deducted:
Land loans with more than 80% LTV ratio -- -- (4)
Equity in subsidiaries -- -- (6)
Low-level recourse deduction -- -- (11)
------ ------ ------
Regulatory capital of the Bank 3,501 3,501 3,956
Minimum regulatory capital requirement 878 2,340 2,442
------ ------ ------
Excess above minimum capital requirement $2,623 $1,161 $1,514
====== ====== ======
Regulatory capital of the Bank 5.98% 5.98% 12.96%
Minimum regulatory capital requirement 1.50 4.00 8.00
------ ------ ------
Excess above minimum capital requirement 4.48% 1.98% 4.96%
====== ====== ======
The amount of adjusted total assets used for the tangible and leverage
capital ratios is $58.5 billion. Risk-weighted assets used for the risk-based
capital ratio amounted to $30.5 billion.
The Bank is also subject to the "prompt corrective action" standards
prescribed in FDICIA and related OTS regulations, which, among other things,
define specific capital categories based on an association's capital ratios. The
capital categories, in declining order, are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized," and
"critically undercapitalized." Under the regulation, the ratio of total capital
to risk-weighted assets, core capital to risk-weighted assets and the leverage
capital ratio are used to determine an association's capital classification. The
Bank met the capital requirements of a "well capitalized" institution under the
FDICIA prompt corrective action standards as of March 31, 2000. The Bank is not
presently subject to any enforcement action or other regulatory proceeding with
respect to the prompt corrective action regulation.
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At March 31, 2000, the Bank's capital levels were sufficient for it to be
considered "well capitalized," as presented below.
Risk-based
Leverage --------------------------
Capital Tier 1 Total Capital
------- ------ -------------
Regulatory capital of the Bank 5.98% 11.44% 12.96%
"Well capitalized" ratio 5.00 6.00 10.00
---- ----- -----
Excess above "well capitalized" ratio 0.98% 5.44% 2.96%
==== ===== =====
OTS capital regulations allow a savings association to include a net
deferred tax asset in regulatory capital, subject to certain limitations. To the
extent that the realization of a deferred tax asset depends on a savings
association's future taxable income, such deferred tax asset is limited for
regulatory capital purposes to the lesser of the amount that can be realized
within one year or 10 percent of core capital. At March 31, 2000, $82.2 million
of the net tax benefit was determined to be attributable to the amount of
taxable income that may be realized in periods beyond one year. Accordingly,
such amount has been excluded from the Bank's regulatory capital at March 31,
2000.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in reported market risks faced by GS
Holdings since the Company's report in Item 7A of its Form 10-K for the year
ended December 31, 1999.
Page 34
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
GOODWILL LITIGATION AGAINST THE GOVERNMENT
On April 9, 1999, the Claims Court issued its decision on a claim by the
Bank against the United States Government (the "Government") in the lawsuit,
GLENDALE FEDERAL BANK, FEDERAL SAVINGS BANK V. UNITED STATES, Civil Action No.
90-772-C (the "Glendale Goodwill Litigation"), ruling that the Government must
compensate the Bank in the sum of $908.9 million. This decision has been
appealed by the Government and the Bank. All appellate briefs have been filed by
both the Government and the Bank and oral argument on the appeal will be
scheduled in conjunction with the argument in the California Federal Goodwill
Litigation (as defined herein) in mid 2000.
On April 16, 1999, the Claims Court issued its decision on a claim by the
Bank against the Government in the lawsuit, CALIFORNIA FEDERAL BANK V. UNITED
STATES, Civil Action No. 92-138C (the "California Federal Goodwill Litigation"),
ruling that the Government must compensate the Bank in the sum of $23.0 million.
The summary judgment liability decision by the first Claims Court Judge has been
appealed by the Government and the damage award by the second Claims Court Judge
has been appealed by the Bank. All appellate briefs have been filed and it is
anticipated that oral argument in the Federal Circuit Court of Appeals will take
place in conjunction with the appellate argument in the Glendale Goodwill
Litigation in mid 2000.
In each of the Glendale Goodwill Litigation and the California Federal
Goodwill Litigation, it is alleged, among other things, that the United States
breached certain contractual commitments regarding the computation of its
regulatory capital for which each of Glendale Federal and California Federal
seek damages and restitution. The claims arose from changes made by the
Financial Institutions Reform, Recovery and Enforcement Act of 1989 and its
implementing regulations ("FIRREA") with respect to the rules for computing
regulatory capital.
OTHER LITIGATION
In addition to the matters described above, GS Holdings and its
subsidiaries are involved in other legal proceedings on claims incidental to the
normal conduct of their business. Although it is impossible to predict the
outcome of any outstanding legal proceedings, management believes that such
legal proceedings and claims, individually or in the aggregate, will not have a
material effect on GS Holdings or the Bank.
ITEM 2. CHANGES IN SECURITIES.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
Page 35
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
3.1 Certificate of Incorporation of the Registrant, as amended.
(Incorporated by reference to Exhibit 3.1 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 1998).
3.2 By-laws of the Registrant, as amended. (Incorporated by
reference to Exhibit 3.3 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1998).
27.1 Financial Data Schedule.
(b) Reports on Form 8-K:
None.
Page 36
SIGNATURES
Pursuant to the requirements 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.
Golden State Holdings Inc.
/s/ Richard H. Terzian
---------------------------------------
By: Richard H. Terzian
Executive Vice President
and Chief Financial Officer
(Principal Financial Officer)
/s/ Renee Nichols Tucei
---------------------------------------
By: Renee Nichols Tucei
Executive Vice President and Controller
(Principal Accounting Officer)
May 10, 2000
Page 37