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 June 30, 2002
------------------------------------------------
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: 000-24915
-------------------------------------------------------
Golden State Holdings Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 95-4669792
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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 July 31, 2002: 1,000 shares.
Registrant meets the conditions set forth in General Instruction H (1)
(a) and (b) of Form 10-Q and is therefore filing this Form with certain reduced
disclosures, as permitted by General Instruction H (2).
Page 1
GOLDEN STATE HOLDINGS INC.
SECOND QUARTER 2002 REPORT ON FORM 10-Q
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Unaudited Consolidated Balance Sheets
June 30, 2002 and December 31, 2001..........................3
Unaudited Consolidated Statements of Income
Six Months Ended June 30, 2002 and 2001......................4
Unaudited Consolidated Statements of Income
Three Months Ended June 30, 2002 and 2001....................5
Unaudited Consolidated Statements of Comprehensive Income
Six Months Ended June 30, 2002 and 2001......................6
Unaudited Consolidated Statements of Comprehensive Income
Three Months Ended June 30, 2002 and 2001....................7
Unaudited Consolidated Statement of Stockholder's Equity
Six Months Ended June 30, 2002 and 2001......................8
Unaudited Consolidated Statements of Cash Flows
Six Months Ended June 30, 2002 and 2001......................9
Notes to Unaudited Consolidated Financial Statements........11
Item 2. Management's Narrative Analysis of Results of Operations....31
Critical Accounting Policies................................31
Item 3. Quantitative and Qualitative Disclosures About Market Risk...*
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...........................................51
Item 2. Changes in Securities........................................*
Item 3. Defaults Upon Senior Securities..............................*
Item 4. Submission of Matters to a Vote of Security Holders..........*
Item 5. Other Information...........................................52
Item 6. Exhibits and Reports on Form 8-K............................53
Glossary of Defined Terms...............................................54
Signatures..............................................................56
* Item 3 of Part I and Items 2, 3 and 4 of Part II are not included as
per conditions met by Registrant set forth in General Instruction H
(1) (a) and (b) of Form 10-Q.
Golden State Holdings Inc. is a wholly owned subsidiary of Golden
State Bancorp Inc. For more information, refer to Golden State Bancorp
Inc.'s Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 2002.
Page 2
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2002 AND DECEMBER 31, 2001
(Unaudited)
(dollars in thousands, except per share data)
ASSETS June 30, 2002 December 31, 2001
------ ------------- -----------------
Cash and due from banks $ 770,042 $ 709,139
Interest-bearing deposits in other banks 98 103
Short-term investment securities 82,792 95,929
----------- -----------
Cash and cash equivalents 852,932 805,171
Securities available for sale, at fair value 118,231 116,054
Securities held to maturity 29,260 30,602
Mortgage-backed securities available for sale, at fair value 4,887,838 7,057,903
Mortgage-backed securities held to maturity 1,170,973 1,385,113
Loans held for sale, net 1,324,335 2,608,365
Loans receivable, net 38,626,259 39,335,623
Investment in FHLB System 1,195,657 1,446,607
Premises and equipment, net 267,200 276,411
Foreclosed real estate, net 13,565 18,564
Accrued interest receivable 269,255 288,308
Goodwill (net of accumulated amortization of $286,470
at both June 30, 2002 and December 31, 2001) 564,560 590,420
Other intangible assets (net of accumulated amortization of $21,875
at June 30, 2002 and $19,541 at December 31, 2001) 48,089 50,423
MSRs (net of valuation allowance of $280,452 at June 30, 2002 and
$153,345 at December 31, 2001) 1,539,592 1,623,947
Derivative assets 224,000 349,026
Other assets 766,602 536,281
----------- -----------
Total assets $51,898,348 $56,518,818
=========== ===========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDER'S EQUITY
-------------------------------------------------------
Deposits $24,381,991 $25,146,827
Securities sold under agreements to repurchase 2,060,144 2,363,945
Borrowings 20,708,897 24,444,541
Derivative liabilities 262,162 250,711
Other liabilities 1,213,111 1,188,005
----------- -----------
Total liabilities 48,626,305 53,394,029
----------- -----------
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 1,575,565 1,569,894
Accumulated other comprehensive loss, net (83,572) (63,327)
Retained earnings (substantially restricted) 1,280,049 1,118,221
----------- -----------
Total stockholder's equity 2,772,043 2,624,789
----------- -----------
Total liabilities, minority interest and stockholder's equity $51,898,348 $56,518,818
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
Page 3
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(UNAUDITED)
(in thousands)
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
Interest income:
Loans receivable $1,291,002 $1,541,014
Mortgage-backed securities available for sale 168,498 344,977
Mortgage-backed securities held to maturity 39,730 70,983
Loans held for sale 70,703 52,676
Securities available for sale 3,281 14,575
Securities held to maturity 276 16,452
Interest-bearing deposits in other banks 158 539
Dividends on FHLB stock 40,792 45,372
Other 12,078 --
---------- ----------
Total interest income 1,626,518 2,086,588
---------- ----------
Interest expense:
Deposits 260,862 464,489
Securities sold under agreements to repurchase 42,354 121,392
Borrowings 583,848 853,847
Other 1,455 --
---------- ----------
Total interest expense 888,519 1,439,728
---------- ----------
Net interest income 737,999 646,860
Provision for loan losses -- --
---------- ----------
Net interest income after provision for loan losses 737,999 646,860
---------- ----------
Noninterest income:
Loan servicing fees, net (106,586) (6,906)
Customer banking fees and service charges 119,020 105,820
Gain on sale, settlement and transfer of loans, net 55,515 21,885
Gain on sale of assets, net 8,382 16,221
Other income 11,637 36,440
---------- ----------
Total noninterest income 87,968 173,460
---------- ----------
Noninterest expense:
Compensation and employee benefits 242,595 231,197
Occupancy and equipment 81,012 77,801
Professional fees 16,069 14,650
Loan expense 7,531 8,569
Foreclosed real estate operations, net (671) (853)
Amortization of goodwill and other intangible assets 2,334 29,880
Other expense 108,168 111,164
---------- ----------
Total noninterest expense 457,038 472,408
---------- ----------
Income before income taxes, minority interest and cumulative effect of change
in accounting principle 368,929 347,912
Income tax expense 113,607 123,709
Minority interest 13,494 13,494
---------- ----------
Income before cumulative effect of change in accounting principle 241,828 210,709
Cumulative effect of change in accounting principle, net of applicable taxes of $1,072 in 2001 -- (1,552)
---------- ----------
Net income $ 241,828 $ 209,157
========== ==========
See accompanying notes to unaudited consolidated financial statements.
Page 4
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED JUNE 30, 2002 AND 2001
(Unaudited)
(in thousands)
Three Months Ended June 30,
---------------------------
2002 2001
---- ----
Interest income:
Loans receivable $641,843 $ 763,224
Mortgage-backed securities available for sale 75,932 163,994
Mortgage-backed securities held to maturity 18,313 33,572
Loans held for sale 28,898 32,549
Securities available for sale 1,651 3,795
Securities held to maturity 129 7,951
Interest-bearing deposits in other banks 33 120
Dividends on FHLB stock 19,953 22,326
Other 12,078 --
-------- ----------
Total interest income 798,830 1,027,531
-------- ----------
Interest expense:
Deposits 125,720 223,652
Securities sold under agreements to repurchase 21,004 53,447
Borrowings 281,038 414,044
Other 750 --
-------- ----------
Total interest expense 428,512 691,143
-------- ----------
Net interest income 370,318 336,388
Provision for loan losses -- --
-------- ----------
Net interest income after provision for loan losses 370,318 336,388
-------- ----------
Noninterest income:
Loan servicing fees, net (97,771) 19,746
Customer banking fees and service charges 60,872 54,559
Gain on sale, settlement and transfer of loans, net 20,896 16,961
Gain on sale of assets, net 10,268 15,782
Other income 5,409 7,181
-------- ----------
Total noninterest income (326) 114,229
-------- ----------
Noninterest expense:
Compensation and employee benefits 117,811 113,462
Occupancy and equipment 40,777 39,951
Professional fees 8,743 9,802
Loan expense 3,375 4,367
Foreclosed real estate operations, net 161 (455)
Amortization of goodwill and other intangible assets 1,167 14,940
Other expense 52,466 59,203
------- ----------
Total noninterest expense 224,500 241,270
------- ----------
Income before income taxes, minority interest and cumulative effect of change
in accounting principle 145,492 209,347
Income tax expense 22,320 87,526
Minority interest 6,747 6,747
-------- ----------
Income before cumulative effect of change in accounting principle 116,425 115,074
Cumulative effect of change in accounting principle, net of applicable taxes of $1,072 in 2001 -- (1,552)
-------- ----------
Net income $116,425 $ 113,522
======== ==========
See accompanying notes to unaudited consolidated financial statements.
Page 5
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(Unaudited)
(in thousands)
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
Net income $241,828 $209,157
Other comprehensive (loss) income, net of tax:
Unrealized holding (loss) gain on securities available for sale:
Unrealized holding (loss) gain arising during the period (2,185) 98,165
Less: reclassification adjustment for gain included in
net income (1,202) (9,572)
-------- --------
(3,387) 88,593
Amortization of market adjustment for securities
transferred from available-for-sale to held-to-maturity -- 3,466
Transition adjustment upon adoption of SFAS No. 133 -- (44,647)
Unrealized loss on derivatives used for cash flow hedges:
Unrealized holding loss arising during the period (68,286) (28,677)
Less: reclassification adjustment for loss included
in net income 51,428 11,917
-------- --------
Change in fair value of derivatives used for cash flow hedges, net of
applicable taxes of $11,642 in 2002 and $11,574 in 2001 (16,858) (16,760)
-------- --------
Other comprehensive (loss) income (20,245) 30,652
-------- --------
Comprehensive income $221,583 $239,809
======== ========
See accompanying notes to unaudited consolidated financial statements.
Page 6
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
THREE MONTHS ENDED JUNE 30, 2002 AND 2001
(Unaudited)
(in thousands)
Three Months Ended June 30,
---------------------------
2002 2001
---- ----
Net income $116,425 $113,522
Other comprehensive (loss) income, net of tax:
Unrealized holding gain (loss) on securities available for sale:
Unrealized holding gain (loss) arising during the period 21,537 (1,050)
Less: reclassification adjustment for gain included
in net income (435) (9,490)
-------- --------
21,102 (10,540)
Amortization of market adjustment for securities
transferred from available-for-sale to held-to-maturity -- 1,989
Unrealized (loss) gain on derivatives used for cash flow hedges:
Unrealized holding (loss) gain arising during the period (79,519) 11,748
Less: reclassification adjustment for loss included
in net income 26,670 8,689
-------- --------
Change in fair value of derivatives used for cash flow hedges, net of
applicable taxes of $36,500 in 2002 and $14,114 in 2001 (52,849) 20,437
-------- --------
Other comprehensive (loss) income (31,747) 11,886
-------- --------
Comprehensive income $ 84,678 $125,408
======== ========
See accompanying notes to unaudited consolidated financial statements.
Page 7
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
SIX MONTHS ENDED JUNE 30, 2002
(Unaudited)
(in thousands)
Additional Accumulated Other Comprehensive (Loss) Income, Net
Common Paid-in --------------------------------------------------
Stock Capital Securities Derivatives Total
----- ------- ---------- ----------- -----
Balance at December 31, 2001 $ 1 $1,569,894 $56,052 $(119,379) $(63,327)
Net income -- -- -- -- --
Change in net unrealized holding gain
on securities available for sale -- -- (3,387) -- (3,387)
Change in net unrealized holding loss
on derivatives -- -- -- (16,858) (16,858)
Dividends to parent -- -- -- -- --
Impact of Golden State restricted
common stock -- 2,600 -- -- --
Tax benefit on exercise of stock options -- 3,071 -- -- --
--- ---------- ------- --------- --------
Balance at June 30, 2002 $ 1 $1,575,565 $52,665 $(136,237) $(83,572)
=== ========== ======= ========= ========
(Continued)
See accompanying notes to unaudited consolidated financial statements.
Retained
Earnings Total
(Substantially Stockholder's
Restricted) Equity
----------- ------
Balance at December 31, 2001 $1,118,221 $2,624,789
Net income 241,828 241,828
Change in net unrealized holding gain
on securities available for sale -- (3,387)
Change in net unrealized holding loss
on derivatives -- (16,858)
Dividends to parent (80,000) (80,000)
Impact of Golden State restricted
common stock -- 2,600
Tax benefit on exercise of stock options -- 3,071
---------- ----------
Balance at June 30, 2002 $1,280,049 $2,772,043
========== ==========
See accompanying notes to unaudited consolidated financial statements.
Page 8
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(Unaudited)
(in thousands)
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
Cash flows from operating activities:
Net income $ 241,828 $ 209,157
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Amortization of goodwill and other intangible assets 2,334 29,880
Amortization of purchase accounting premiums and discounts, net 6,033 4,308
Accretion of discount on borrowings 453 573
Amortization of MSRs 212,596 147,013
Gain on sale of assets, net (8,382) (16,221)
Gain on sale of foreclosed real estate, net (1,179) (1,717)
Loss on sale, settlement and transfer of loans, net 210,001 109,487
Capitalization of originated MSRs (265,516) (131,372)
Depreciation and amortization of premises and equipment 26,586 26,084
Amortization of deferred debt issuance costs 2,983 3,676
FHLB stock dividends (40,792) (45,372)
Purchases and originations of loans held for sale (10,578,606) (7,060,801)
Net proceeds from the sale of loans held for sale 11,657,621 5,478,985
Net gain on derivatives used to hedge MSRs (3,939) (8,957)
Provision for loss on MSRs 127,107 77,000
(Increase) decrease in other assets (202,096) 370,794
Decrease in accrued interest receivable 19,053 22,601
Increase in other liabilities 118,761 332,142
Amortization of deferred compensation expense - Golden State
restricted common stock 860 992
Gain on non-monetary exchange of Star Systems common stock -- (20,671)
Reduction in net accrued tax liability -- (25,805)
Income tax benefit (37,129) (3,247)
Minority interest: other 13,494 13,494
Dividends on restricted common stock 11 35
------------ -----------
Net cash provided by (used in) operating activities 1,502,082 (487,942)
------------ -----------
(Continued)
See accompanying notes to unaudited consolidated financial statements.
Page 9
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(Unaudited)
(in thousands)
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
Cash flows from investing activities:
Purchases of securities available for sale $ (25,647) $ (21,479)
Proceeds from maturities of securities available for sale 25,269 586,733
Purchases of securities held to maturity (1,927) (4,992)
Principal payments and proceeds from maturities
of securities held to maturity 3,269 68,363
Purchases of mortgage-backed securities available for sale (43,644) (120,810)
Principal payments on mortgage-backed securities available for sale 2,134,238 1,290,937
Principal payments on mortgage-backed securities held to maturity 214,160 229,638
Proceeds from sales of mortgage-backed securities available for sale 64,300 304,365
Proceeds from sales of loans 41,222 51,358
Loan originations and principal collections, net 3,496,685 557,082
Purchases of loans receivable (2,815,296) (2,349,144)
Purchases of FHLB stock (41,136) (23,193)
Redemption of FHLB stock 292,086 --
Purchases of premises and equipment (20,223) (20,485)
Proceeds from disposal of premises and equipment 14,757 6,639
Proceeds from sales of foreclosed real estate 14,802 17,131
Proceeds from sale of Concord EFS common stock -- 29,948
Purchases of MSRs (177,458) (128,206)
Hedge receipts (payments) 51,068 (14,412)
Purchases of derivatives (833,385) (272,589)
Proceeds from sales and settlements of derivatives 1,045,738 215,420
------------ ------------
Net cash provided by investing activities 3,438,878 402,304
------------ ------------
Cash flows from financing activities:
Net (decrease) increase in deposits (764,627) 903,555
Proceeds from additional borrowings 52,313,572 59,921,714
Principal payments on borrowings (56,047,670) (59,964,993)
Principal payment of FN Holdings Notes (250) --
Net decrease in securities sold under agreements to repurchase (303,801) (596,378)
Dividends on common stock (80,000) (60,000)
Dividends paid to minority stockholders of subsidiary, net of taxes (13,494) (13,494)
Tax benefit on exercise of stock options 3,071 745
------------ ------------
Net cash (used in) provided by financing activities (4,893,199) 191,149
------------ ------------
Net change in cash and cash equivalents 47,761 105,511
Cash and cash equivalents at beginning of period 805,171 783,074
------------ ------------
Cash and cash equivalents at end of period $ 852,932 $ 888,585
============ ============
See accompanying notes to unaudited consolidated financial statements.
Page 10
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(1) BASIS OF PRESENTATION
---------------------
These financial statements are in accordance with GAAP for interim
financial information and Regulation S-X, Article 10. They are unaudited and
exclude some of the disclosures for complete financial statements. Management
believes it has made all adjustments necessary so that the financial statements
are presented fairly. The results of operations for the three and six months
ended June 30, 2002 may not indicate future results. Certain prior period
amounts have been reclassified to conform to current presentation.
These financial statements should be read 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, 2001. A glossary of defined terms begins on page
54 of this document. All terms used but not defined in the glossary are
clarified in the Company's Annual Report on Form 10-K.
GS Holdings, a wholly owned subsidiary of Golden State, is a holding
company whose only significant asset is all of the common and preferred stock of
the Bank. Activities for the consolidated entity are primarily carried out by
the Bank and its subsidiaries.
These unaudited consolidated financial statements include the accounts of
GS Holdings, the Bank and the Bank's wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
Minority interest: other represents amounts attributable to the REIT
Preferred Stock of California Federal Preferred Capital Corporation, a wholly
owned subsidiary of the Bank.
As GS Holdings' common stock is wholly owned by Golden State, EPS data is
not presented.
(2) PENDING MERGER
--------------
On May 21, 2002, Citigroup and Mercury Merger Sub, a wholly owned
subsidiary of Citigroup, entered into a merger agreement with Golden State
whereby Golden State will be merged with and into Mercury Merger Sub, with
Mercury Merger Sub as the surviving company. The Merger, which is expected to
close in the third quarter of 2002, is subject to regulatory and Golden State
stockholder approvals. The Special Meeting of Golden State's stockholders to
vote on the Merger is scheduled on August 22, 2002.
The value of the merger consideration per share of the Golden State's
common stock will be the sum of
(a) $16.40 and
(b) 0.5234 fractional share of Citigroup common stock for each share of Golden
State common stock delivered at closing.
Golden State's common stockholders will be entitled to elect to receive
merger consideration in the form of cash or Citigroup common stock, subject to
certain limitations.
(3) RECLASSIFICATION OF SECURITIES
------------------------------
On January 1, 2001, the Company reclassified $1.1 billion and $85.0 million
carrying value of mortgage-backed securities and U.S. government and agency
securities, respectively, from securities held to maturity to their respective
available-for-sale portfolios, as permitted upon the adoption of SFAS No. 133.
The net unrealized loss related to these securities of $30.4 million, which was
recorded in OCI upon their initial transfer to the held-to-maturity portfolio in
April 2000, was reclassified from accumulated other comprehensive loss, and the
securities were subsequently marked to market, in accordance with SFAS No. 115.
Page 11
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(4) CASH, CASH EQUIVALENTS, AND STATEMENTS OF CASH FLOWS
----------------------------------------------------
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
(in thousands)
Cash paid for: $929,970 $1,544,070
Interest 79,291 100,799
Income taxes, net
Transfer of loans to foreclosed real estate 8,535 17,812
Loans made to facilitate the sale of real estate -- 168
Reclassification of loans from loans held for sale to loans receivable -- 5,245
Reclassification of loans receivable to loans held for sale 95,521 22,351
Goodwill adjustment related to tax adjustments (25,860) --
Impact of restricted common stock 2,600 2,531
Reclassification of mortgage-backed securities from the held-to-maturity
portfolio to the available-for-sale portfolio upon the adoption of SFAS No. 133 -- 1,067,933
Reclassification of securities from the held-to-maturity portfolio to the
available-for-sale portfolio upon the adoption of SFAS No. 133 -- 84,984
Reclassification of derivative assets ($173.6 million) and derivative liabilities
($8.8 million) related to MSRs at fair value upon the adoption of SFAS No. 133 -- 164,767
Transfer of loans receivable to claims receivable 122,247 103,077
(5) REDEMPTION OF FN HOLDINGS NOTES
-------------------------------
On January 2, 2002, GS Holdings redeemed the remaining $250 thousand
principal of the FN Holdings 10 5/8% Senior Notes for a redemption price of $263
thousand, including accrued interest. The premium paid in connection with the
redemption was not material.
Page 12
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(6) SEGMENT REPORTING
-----------------
The Company derives most of its revenues from interest income, and interest
expense is the most significant expense. Therefore, net interest income after
provision for loan losses is presented for each segment. 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.
Six Months Ended June 30, Three Months Ended June 30,
--------------------------------------- ---------------------------------------
Community Mortgage Community Mortgage
Banking Banking Total Banking Banking Total
------- ------- ----- ------- ------- -----
(in thousands)
Net interest income after
provision for loan losses: (a)
2002 $ 707,665 $ 77,894 $ 785,559 $ 359,743 $ 32,507 $ 392,250
2001 673,654 41,788 715,442 341,625 33,760 375,385
Noninterest income: (b)
2002 $ 166,169 $ (58,958) $ 107,211 $ 90,579 $ (81,296) $ 9,283
2001 166,868 22,125 188,993 83,609 37,665 121,274
Noninterest expense: (c)
2002 $ 377,576 $ 81,782 $ 459,358 $ 187,293 $ 38,367 $ 225,660
2001 397,711 77,017 474,728 203,317 39,113 242,430
Pre-tax contribution:
2002 $ 496,258 $ (62,846) $ 433,412 $ 263,029 $ (87,156) $ 175,873
2001 442,811 (13,104) 429,707 221,917 32,312 254,229
Segment assets at period end: (d)
2002 $51,668,656 $4,265,407(e) $55,934,063 $51,668,656 $4,265,407(e) $55,934,063
2001 60,911,345 7,346,871(e) 68,258,216 60,911,345 7,346,871(e) 68,258,216
- -------------
(a) Includes $47.6 million and $68.6 million for the six months ended June
30, 2002 and 2001, respectively, in earnings credit provided to FNMC by
the Bank, primarily for custodial bank account balances generated by
FNMC. Also includes $72.2 million and $134.1 million for the six months
ended June 30, 2002 and 2001, respectively, in interest income and
expense on intercompany loans.
Includes $21.9 million and $39.0 million for the three months ended June
30, 2002 and 2001, respectively, in earnings credit provided to FNMC by
the Bank, primarily for custodial bank account balances generated by
FNMC. Also includes $32.3 million and $75.9 million for the three months
ended June 30, 2002 and 2001, respectively, in interest income and
expense on intercompany loans.
(b) Includes $19.2 million and $15.5 million for the six months ended June
30, 2002 and 2001, respectively, in intercompany servicing fees. Also
includes $9.6 million and $7.0 million for the three months ended June
30, 2002 and 2001, respectively, in intercompany servicing fees.
(c) Includes $2.3 million for each of the six months ended June 30, 2002 and
2001, in intercompany noninterest expense. Also includes $1.2 million for
each of the three months ended June 30, 2002 and 2001, in intercompany
noninterest expense.
(d) Includes $4.0 billion and $6.9 billion for 2002 and 2001, respectively,
in intercompany borrowings and $48.4 million and $47.8 million for 2002
and 2001, respectively, in intercompany deposits maintained with the
Bank.
(e) Includes $1.7 billion for both 2002 and 2001, in MSRs and the related
hedge.
Page 13
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 (in thousands):
Six Months Ended June 30, Three Months Ended June 30,
------------------------- ---------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net interest income after provision for loan losses:
Total net interest income for reportable segments $ 785,559 $ 715,442 $ 392,250 $ 375,385
Elimination of intersegment net interest income (47,560) (68,582) (21,932) (38,997)
----------- ----------- ----------- -----------
Total $ 737,999 $ 646,860 $ 370,318 $ 336,388
=========== =========== =========== ===========
Noninterest income:
Total noninterest income for reportable segments $ 107,211 $ 188,993 $ 9,283 $ 121,274
Elimination of intersegment servicing fees (19,243) (15,533) (9,609) (7,045)
----------- ----------- ----------- -----------
Total $ 87,968 $ 173,460 $ (326) $ 114,229
=========== =========== ============ ===========
Noninterest expense:
Total noninterest expense for reportable segments $ 459,358 $ 474,728 $ 225,660 $ 242,430
Elimination of intersegment expense (2,320) (2,320) (1,160) (1,160)
----------- ----------- ----------- -----------
Total $ 457,038 $ 472,408 $ 224,500 $ 241,270
=========== =========== =========== ===========
Pre-tax contribution:
Total contributions for reportable segments $ 433,412 $ 429,707 $ 175,873 $ 254,229
Elimination of intersegment contributions (64,483) (81,795) (30,381) (44,882)
----------- ----------- ----------- -----------
Total $ 368,929 $ 347,912 $ 145,492 $ 209,347
=========== =========== =========== ===========
Total assets at period end:
Total assets for reportable segments $55,934,063 $68,258,216 $55,934,063 $68,258,216
Elimination of intersegment borrowings (3,987,287) (6,906,614) (3,987,287) (6,906,614)
Elimination of intersegment deposits (48,428) (47,812) (48,428) (47,812)
----------- ----------- ----------- -----------
Total $51,898,348 $61,303,790 $51,898,348 $61,303,790
=========== =========== =========== ===========
Page 14
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(7) LOANS RECEIVABLE, NET
---------------------
Loans receivable, net, included the following (in thousands):
June 30, 2002 December 31, 2001
------------- -----------------
Real estate loans:
1-4 unit residential $28,219,385 $29,546,035
Multi-family residential 4,455,768 4,130,287
Commercial real estate 2,234,097 2,354,919
Land 10,651 14,055
Construction 870 2,495
----------- -----------
Total real estate loans 34,920,771 36,047,791
----------- -----------
Equity-line 802,916 639,297
Other consumer loans 237,569 283,434
Auto loans, net (a) 2,090,849 1,917,591
Commercial loans 800,038 693,114
----------- -----------
Total consumer and other loans 3,931,372 3,533,436
----------- -----------
Total loans receivable 38,852,143 39,581,227
----------- -----------
Deferred loan fees, costs, discounts and premiums, net 236,657 243,120
Allowance for loan losses (469,047) (497,298)
Purchase accounting adjustments, net 6,506 8,574
----------- -----------
Total loans receivable, net $38,626,259 $39,335,623
=========== ===========
-----------
(a) $884 million, or 42% and $766 million, or 40% of this portfolio,
represents prime product as of June 30, 2002 and December 31, 2001,
respectively.
(8) INTANGIBLE ASSETS
-----------------
Upon adopting SFAS No. 142, management reviewed the records from the
Company's various acquisitions. At June 30, 2002, the Company's goodwill and
other intangible assets totalled $612.6 million. Of this amount, $564.6 million
represents goodwill that is no longer being amortized as of January 1, 2002
pursuant to SFAS No. 142. The remaining $48.1 million represents other
intangible assets that continue to be amortized. In addition, the Company held
MSR balances in the amount of $1,539.6 million at June 30, 2002.
The following table provides details on intangible assets including MSRs:
As of June 30, 2002 As of December 31, 2001
----------------------------------------- -----------------------------------------
Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Value Amortization Value Value Amortization Value
----- ------------ ----- ----- ------------ -----
(dollars in thousands)
Amortizable intangible assets:
Unidentifiable intangibles $ 64,451 $ (17,182) $ 47,269 $ 64,451 $ (15,030) $ 49,421
Core deposit intangibles 5,513 (4,693) 820 5,513 (4,511) 1,002
---------- ----------- ---------- ---------- ----------- ----------
Other intangible assets 69,964 (21,875) 48,089 69,964 (19,541) 50,423
MSRs 2,856,885(a) (1,317,293) 1,539,592(a) 2,728,643(a) (1,104,696) 1,623,947(a)
Goodwill -- -- -- 876,890 (286,470) 590,420
---------- ----------- ---------- ---------- ----------- ----------
Total amortizable
intangible assets $2,926,849 $(1,339,168) $1,587,681 $3,675,497 $(1,410,707) $2,264,790
========== =========== ========== ========== =========== ==========
Unamortizable goodwill $ 851,030 $ (286,470) $ 564,560 $ -- $ -- $ --
========== =========== ========== ========== =========== ==========
(Continued)
Page 15
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
- ------------
(a) After deducting $280.5 million and $153.3 million for the valuation
allowance at June 30, 2002 and December 31, 2001, respectively.
As of June 30, 2002, all of the Company's goodwill, totalling $564.6
million, is included in the community-banking reporting segment. During the
second quarter of 2002, goodwill was reduced by the following:
(a) $12.7 million representing California state tax refunds and pre-merger
interest related to Old Cal Fed
(b) $12.6 million related to a reversal of a portion of the deferred tax
asset valuation allowance related to Old Cal Fed and adjustments for
sales and use tax related to Old Glen Fed and
(c) $0.6 million related to the reversal of a portion of the tax reserve
based upon the status of Glendale Federal tax audits for 1991 through
1997.
Intangible acquisitions during the period were as follows:
Six Months Ended June 30,
-------------------------------------------------------------------------
2002 2001
---------------------------------- ----------------------------------
Gross Weighted Gross Weighted
Carrying Average Carrying Average
Value Maturity (in years) Value Maturity (in years)
----- ------------------- ----- -------------------
(dollars in thousands)
MSRs originated and purchased
during the period $442,974 5.4 $259,578 6.6
Three Months Ended June 30,
--------------------------------------------------------------------------
2002 2001
---------------------------------- -----------------------------------
Gross Weighted Gross Weighted
Carrying Average Carrying Average
Value Maturity (in years) Value Maturity (in years)
----- ------------------- ----- -------------------
(dollars in thousands)
MSRs originated and purchased
during the period $198,615 5.4 $157,220 6.6
Page 16
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
In the first quarter of 2002, the Company reviewed the expected present
value of future cash flows for all reporting units with recorded goodwill and
determined that the carrying value of the goodwill was not impaired. Actual and
estimated future amortization expense is as follows:
Unidentifiable Core Deposit
Intangibles Intangibles MSRS Goodwill Total
----------- ----------- ---- -------- -----
(in thousands)
Amortization expense:
Three months ended June 30, 2002 $1,076 $ 91 $ 98,271 $ -- $ 99,438
Six months ended June 30, 2002 2,152 182 212,596 -- 214,930
Three months ended June 30, 2001 1,076 91 88,598 13,773 103,538
Six months ended June 30, 2001 2,152 182 147,013 27,546 176,893
Estimated amortization expense:
Six months ending December 31, 2002 2,152 182 173,575 -- 175,909
Year ending December 31,
2003 4,304 364 263,019 -- 267,687
2004 4,304 364 214,247 -- 218,915
2005 4,304 364 173,447 -- 178,115
2006 4,304 364 138,259 -- 142,927
2007 4,304 364 109,249 -- 113,917
The impact of the adoption of SFAS No. 142 on earnings was as follows:
Six Months Ended June 30, Three Months Ended June 30,
------------------------- ---------------------------
2002 2001 2002 2001
---- ---- ---- ----
(in thousands)
Reported net income before cumulative
effect of change in accounting principle $241,828 $210,709 $116,425 $115,074
Add back goodwill amortization, net of tax -- 27,425 -- 13,713
-------- -------- -------- --------
Adjusted net income before cumulative
effect of change in accounting principle $241,828 $238,134 $116,425 $128,787
======== ======== ======== ========
Six Months Ended June 30, Three Months Ended June 30,
------------------------- ---------------------------
2002 2001 2002 2001
---- ---- ---- ----
(in thousands)
Reported net income $241,828 $209,157 $116,425 $113,522
Add back goodwill amortization, net of tax -- 27,425 -- 13,713
-------- -------- -------- --------
Adjusted net income $241,828 $236,582 $116,425 $127,235
======== ======== ======== ========
Page 17
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(9) DEPOSITS
--------
A summary of the carrying value of deposits is as follows (dollars in
thousands):
June 30, 2002 December 31, 2001
------------- -----------------
Transaction Accounts:
Non-interest checking $ 2,238,712 $ 2,013,162
Interest-bearing checking 2,252,180 2,139,674
----------- -----------
Subtotal checking 4,490,892 4,152,836
Money market 4,831,649 4,614,223
Passbook savings 3,171,654 3,055,766
----------- -----------
Total transaction accounts 12,494,195 11,822,825
Certificates of deposit 10,053,758 10,618,260
----------- -----------
Total customer deposits 22,547,953 22,441,085
Custodial accounts 1,705,080 2,512,684
Accrued interest payable 37,721 46,184
Purchase accounting 150 329
----------- ------------
Total retail deposits 24,290,904 25,000,282
Brokered Deposits 91,087 146,545
----------- -----------
Total deposits $24,381,991 $25,146,827
=========== ===========
Checking deposits (including custodials) as a %
of retail deposits 25.5% 26.7%
Transaction accounts (including custodials) as a %
of retail deposits 58.5% 57.3%
Checking deposits (excluding custodials) as a %
of customer deposits 19.9% 18.5%
Transaction accounts (excluding custodials) as a %
of customer deposits 55.4% 52.7%
Page 18
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(10) ACCRUED TERMINATION AND FACILITIES COSTS
----------------------------------------
In connection with the Golden State Acquisition, the Company recorded
liabilities resulting from:
o branch consolidations due to duplicate facilities and
o employee severance and termination benefits due to a planned reduction in
force.
The merger and integration plan relating 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 summarizes the activity in the liability for the costs
related to the plan (in thousands):
Severance and
Branch Termination
Consolidations Benefits Total
-------------- -------- -----
Balance at December 31, 2001 $14,208 $12,500 $26,708
Charges to liability account (2,492) -- (2,492)
------- ------- -------
Balance at June 30, 2002 $11,716 $12,500 $24,216
======= ======= =======
(11) INCOME TAXES
------------
During the six months ended June 30, 2002, GS Holdings recorded gross
income tax expense of $150.7 million, which was offset by a tax benefit of $37.1
million, for net income tax expense of $113.6 million. Based on the current
status of Mafco Holdings' audits for the years 1991 through 1995 and anticipated
reversal of deferred tax assets with established valuation allowance, management
changed its judgment about the realizability of the Company's deferred tax
assets and reduced its valuation allowance by $44 million. As a result of
reducing the valuation allowance, income tax expense was reduced by $31.4
million and goodwill was reduced by $12.6 million.
In addition, an accrued liability had been established in prior years for
the purpose of satisfying assessments that may result from issues arising during
audits with various state taxing authorities. As a result of recent
documentation received pertaining to the California audit of Glendale Federal
Bank for the years 1991 through 1997, management reduced its accrued state tax
liability by $8.7 million during the six months ended June 30, 2002. Goodwill
was reduced by $0.6 million in connection with this transaction. The Company
also recorded additional Federal tax expense of $3.1 million due to the
reduction of the state tax expense.
During the six months ended June 30, 2001, GS Holdings recorded net income
tax expense of $123.7 million, which included net tax benefits of $29.0 million.
In prior years, an accrued liability was established for the purpose of
satisfying assessments that may result from issues arising during audits with
various state taxing authorities. As a result of the completion and settlement
of audits in various state taxing jurisdictions, additional guidance on the
deductibility of covered asset losses, and the current assessment of exposure
for tax strategies employed for prior years, management reduced its accrued
state tax liability by $39.7 million. The Company also recorded additional
Federal tax expense of $13.9 million due to the reduction of the state tax
expense.
In addition, during the six months ended June 30, 2001, an income tax
benefit was recorded for $3.2 million due to the utilization of net operating
losses of a subsidiary made available as a result of the subsidiary's
liquidation into California Federal Bank.
(12) STOCKHOLDER'S EQUITY
--------------------
At June 30, 2002, there were 1,000 shares of GS Holdings common stock
issued and outstanding.
Dividends on common stock during the six months ended June 30, 2002 and
2001 totalled $80.0 million and $60.0 million, respectively.
Page 19
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(13) EXECUTIVE AND STOCK COMPENSATION
--------------------------------
In the six months ended June 30, 2002, Golden State granted to certain of
the Company's employees non-qualified stock options equivalent to 884,000 shares
of common stock at a weighted average price of $27.69 per share under the Stock
Plan, all within the first quarter. During the three and six months ended June
30, 2001, Golden State granted to certain of the Company's employees
non-qualified stock options equivalent to 560,100 and 1,411,100 shares,
respectively, of common stock at a weighted average price of $30.75 and $27.69,
respectively. 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 six months ended June 30, 2002, in accordance
with the intrinsic value accounting methodology prescribed in APB Opinion No.
25, whereby compensation expense to employees is determined based upon the
excess, if any, of the market price of the Company's common stock at the
measurement date over the exercise price of the award.
During the three and six months ended June 30, 2002, 319,909 and 427,675
options were exercised, and 9,917 and 42,597 options were cancelled or expired,
respectively, under all plans. During the three and six months ended June 30,
2001, 91,101 and 154,617 options were exercised and 4,432 and 21,677 options,
respectively, were cancelled or expired under all plans.
At June 30, 2002 and 2001, options to acquire an equivalent of 5,129,449
and 4,906,205 shares and 675,583 and 966,166 LTWTMs, respectively, remained
outstanding under all plans.
On January 22, 2002 and 2001, Golden State awarded to certain of the
Company's employees 112,760 and 99,108 shares, respectively, of restricted stock
under the Golden State Bancorp Inc. Omnibus Stock Plan. The market value on the
date of the award was $27.65 and $26.38 per share, respectively. 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. During the three
and six months ended June 30, 2002, 152,299 restricted shares were vested and
2,770 restricted shares were cancelled. During the three and six months ended
June 30, 2001, 5,911 and 115,045 restricted shares were vested, respectively,
and none was cancelled. At June 30, 2002, a total of 160,056 restricted shares
was outstanding. The compensation expense based on the stock price on the date
of these awards was recognized on a straight-line basis over the vesting period
for each service period tranche of the award with a corresponding increase to
additional paid-in capital. In addition, dividends on restricted stock are
recorded as compensation expense with a corresponding increase to additional
paid-in capital. During the three and six months ended June 30, 2002, $0.5
million and $0.9 million, respectively, in compensation expense was recognized
related to such awards. During the three and six months ended June 30, 2001,
$0.5 million and $1.0 million, respectively, in compensation expense was
recognized related to such awards. These restricted shares have full voting and
dividend rights.
(14) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
---------------------------------------------------
On September 21, 2000, the EITF issued EITF No. 99-20. This document, which
was effective on April 1, 2001, establishes guidance for
(a) recognizing interest income (including amortization of premiums or
discounts) on
(i) all credit-sensitive mortgage and asset-backed securities and
(ii) certain prepayment-sensitive securities including agency interest-
only strips and
(b) determining when these securities must be written down to fair value
because of impairment.
Existing GAAP did not provide interest recognition and impairment guidance
for securities on which cash flows change as a result of both prepayments and
credit losses and, in some cases, interest rate adjustments.
Page 20
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
On April 1, 2001, the Company identified a portfolio of securities with a
total book value of $80.7 million which are subject to the impairment provisions
of EITF No. 99-20. All of these securities had previously been reported as
available-for-sale securities, with changes in fair value reflected in OCI. As a
result of its implementation of EITF No. 99-20, the Company recorded a loss of
$1.6 million, net of income tax credits of $1.1 million, representing the
cumulative effect of a change in accounting principle.
(15) COMMITMENTS, CONTINGENCIES AND OTHER OFF-BALANCE SHEET ACTIVITIES
-----------------------------------------------------------------
CREDIT RELATED FINANCIAL INSTRUMENTS
The Company is a party to credit related financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit, standby letters of credit and commercial letters of credit. Such
commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the consolidated balance sheets.
The Company's exposure to credit loss is represented by the contractual
amount of these commitments. The Company uses the same credit policies in making
commitments as it does for on-balance sheet instruments.
Listed below are unfunded financial instruments whose contract amounts
represent credit risk (in thousands):
Contract Amounts at
----------------------------------------
June 30, 2002 December 31, 2001
------------- -----------------
COMMITMENTS TO EXTEND CREDIT
----------------------------
Unutilized consumer lines $1,722,420 $1,467,625
Unutilized commercial lines of credit 264,524 263,682
Commercial and standby letters of credit 32,042 24,953
The contracts for the Company's commitments to extend credit expire as
follows (in thousands):
June 30, 2002
-------------------------------------------------------------------------------
Contract Amount Expiring in
-------------------------------------------------------------------------------
Commitments to Extend Credit Total Less Than 1 Year 1 - 3 Years 4 - 5 Years More Than 5 Years
- ---------------------------- ----- ---------------- ----------- ----------- -----------------
Unutilized consumer lines $1,722,420 $518,546 $13,634 $11,084 $1,179,156
Unutilized commercial
lines of credit 264,524 188,270 56,199 7,865 12,190
Commercial and standby
letters of credit 32,042 31,876 166 -- --
The fair value of commitments to extend credit was not significant at
either June 30, 2002 or December 31, 2001.
Unutilized consumer lines of credit are commitments to extend credit. These
lines are either secured or nonsecured and may be cancelled by the Company if
certain conditions of the contract are not met. Many consumer line of credit
customers are not expected to fully draw down their total lines of credit and,
therefore, the total contractual amount of these lines does not necessarily
represent future cash requirements.
Unutilized commitments under commercial lines of credit are commitments for
possible future extensions of credit to existing customers. These lines of
credit are uncollateralized, usually do not contain a specified maturity date
and may not be drawn upon to the total extent to which the Company is committed.
Page 21
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Commercial and standby letters of credit are conditional commitments issued
by the Company to guarantee the performance of a customer to a third party.
Those letters of credit are primarily issued to support public and private
borrowing arrangements. All letters of credit issued have expiration dates
within three years. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Company generally holds collateral supporting those commitments in an amount
deemed to be necessary.
OFF-BALANCE SHEET COMMITMENTS TO ORIGINATE, PURCHASE AND SELL LOANS
The following is a summary of the Company's pipeline of loans in process
and mandatory forward commitments to sell loans that have not been recorded in
the Company's balance sheet as they do not meet the definition of a derivative
financial instrument. These amounts exclude commitments to extend credit which
are summarized above. For more information on derivative instruments, see note
16.
Contract Amounts at
--------------------------------------
June 30, 2002 December 31, 2001
------------- -----------------
(in thousands)
Commitments to originate loans $2,770,634 $3,937,422
Commitments to purchase loans 995,883 3,791,436
Mandatory commitments to sell loans 317,569 679,182
The Company's pipeline of loans in process includes loan applications for
both portfolio and non-portfolio loans in various stages of processing that do
not meet the definition of a derivative financial instrument. Until all required
documentation is provided and underwritten, there is no credit risk to the
Company. There is no interest rate risk until a rate commitment is extended by
the Company to a borrower. Some of these commitments will ultimately be denied
by the Company or declined by the borrower and therefore the commitment amounts
do not necessarily represent future cash requirements.
Mandatory and optional delivery forward commitments to sell loans are used
by the Company to hedge its interest rate exposure from the time a loan has a
committed rate to the time the loan is sold. These instruments involve varying
degrees of credit risk. Credit risk on these instruments is controlled through
credit approvals, limits and monitoring procedures. To the extent that
counterparties are not able to fulfill forward commitments, the Company is at
risk for any fluctuations in the market value of the mortgage loans and locked
pipeline.
OFF-BALANCE SHEET EMBEDDED DERIVATIVE OPTIONS
The Company also has off-balance sheet embedded options in borrowings as
shown in the table below (in thousands):
June 30, 2002 December 31, 2001
-------------------------------------- -------------------------------------
Instruments Notional Amount Estimated Fair Value Notional Amount Estimated Fair Value
----------- --------------- -------------------- --------------- --------------------
Interest rate caps $2,000,000 $34,913 $2,000,000 $52,163
Interest rate swaptions 1,250,000 1,750 1,250,000 9,448
Page 22
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
The off-balance sheet embedded options in borrowings at June 30, 2002 are
scheduled to expire as shown in the table below (in thousands):
Contract Amount Expiring in
------------------------------------------------------------
Instruments 2003 2004 2005 TOTAL
----------- ---- ---- ---- -----
Interest rate caps $400,000 $350,000 $1,250,000 $2,000,000
Interest rate swaptions 150,000 -- 1,100,000 1,250,000
COMMITMENTS AND CONTINGENCIES
At June 30, 2002, the Bank had pledged as collateral the securities as
detailed below (in thousands):
Securities Mortgage-backed Mortgage-backed Commercial
Available for Securities Securities Paper
Sale Available for Sale Held to Maturity Investments
---- ------------------ ---------------- -----------
Provide credit enhancements for certain
bond-financed real estate projects
originated by Old FNB $25,582 $ 10,516 $ 6,961 $ --
Pledged securities for principal and
interest on Bank loan securitization -- 265,144 6,844 --
Guarantee credit enhancements on
multi-family bond issues and loans
securitized by FNMA and FHLMC 1,027 124,948 27,779 --
Guarantee credit enhancements on
loans transferred as part of
securitization transactions by the Bank -- -- -- 29,260
Guarantee state and local agency
deposits, and certain deposits with the
Federal Reserve Bank 2,678 311,569 50,220 --
Secure various other obligations -- 1,968,602 752,127 --
At June 30, 2002, $25.2 billion in residential loans, $3.8 billion in
multifamily loans and $1.6 billion in commercial real estate loans were pledged
as collateral for FHLB advances.
At June 30, 2002, loans receivable included approximately $4.6 billion of
loans that had the potential to experience negative amortization.
Page 23
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(16) ON-BALANCE SHEET DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
--------------------------------------------------------------
INTEREST RATE RISK MANAGEMENT - RISK MANAGEMENT POLICIES - CASH FLOW
HEDGING INSTRUMENTS AND FAIR VALUE HEDGING INSTRUMENTS
The Company monitors the sensitivity of its NPV and net income under
various interest rate scenarios and manages this risk. Quarterly, the Company
simulates the NPV and net income expected to be earned over the next twelve
months. Market interest rates are projected at various levels to estimate the
impact on interest-earning assets, interest-bearing liabilities and mortgage
prepayment speeds (which affect the MSR asset). The Company may use derivatives
to reduce the volatility of NPV and net income within certain ranges of
projected changes in interest rates. The Company evaluates the effectiveness of
a derivative by measuring the cost of such an agreement in relation to the
reduction in NPV and net income volatility within an assumed range of interest
rates.
INTEREST RATE RISK MANAGEMENT - CASH FLOW HEDGING INSTRUMENTS - BALANCE
SHEET HEDGES
OBJECTIVES AND CONTEXT
----------------------
The Company uses variable-rate debt including FHLB advances and Repos as a
source of funds for lending and investment activities and other general business
purposes. Interest payments on this debt may change if interest rates change. If
interest rates increase, interest expense increases. Conversely, if interest
rates decrease, interest expense decreases.
Management hedges a significant portion of its variable-rate interest
payments to limit the effect of changing interest rates.
STRATEGIES
----------
Management enters into derivative instruments agreements to manage
fluctuations in cash flows resulting from interest rate risk. These instruments
include interest rate swaps.
The interest rate swaps change the variable-rate cash flow exposure on the
short-term FHLB advances and Repos to fixed-rate cash flows by entering into
receive-variable, pay-fixed interest rate swaps. Under the interest rate swaps,
the Company receives variable interest rate payments and makes fixed interest
rate payments, thereby creating fixed-rate FHLB advances and Repos.
RESULTS
-------
Hedges of FHLB advances and Repos were 100% effective for the three and six
months ended June 30, 2002. The Company hedges the entire amount of the change
in fair value of the liabilities with the entire amount of the change in fair
value of the derivative instruments.
Fair value changes in interest rate swap hedging instruments relating to
cash flows associated with FHLB advances and Repos are reported in OCI. These
amounts are then reclassified into interest expense as a yield adjustment in the
same period in which the related interest on the FHLB advances and Repos affects
earnings. The net amount of OCI reclassified into interest expense during the
three and six months ended June 30, 2002 was $45.1 million and $86.9 million,
respectively, while $14.7 million and $20.1 million was reclassified during the
three and six months ended June 30, 2001, respectively.
As of June 30, 2002 and 2001, approximately $96.6 million and $30.4 million
of losses reported in OCI related to the interest rate swaps were expected to be
reclassified into interest expense as a yield adjustment of the hedged FHLB
advances and Repos during the twelve month period ending June 30, 2003 and 2002,
respectively.
Page 24
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
INTEREST RATE RISK MANAGEMENT - FAIR VALUE HEDGING INSTRUMENTS - MORTGAGE
SERVICING RIGHTS HEDGES
OBJECTIVES AND CONTEXT
----------------------
The Company purchases and originates MSRs as a source of fee income. MSRs
expose the Company to the variability of their fair value due to changes in the
assumed level of prepayments and other variables. The carrying value of MSRs are
first adjusted by the calculated change in the fair value of the MSRs being
hedged and are then recorded at the lesser of their amortized cost or fair
value.
Management limits the variability in the fair value of a portion of its MSR
asset by hedging the change in fair value of the servicing rights asset
associated with fixed-rate, non-prepayment penalty loans for which it has
recorded MSRs. The Company determines appropriate coverage levels, given
anticipated or existing interest rate levels and other market considerations, as
well as the relationship of change in this asset to other assets of the Company.
STRATEGIES
----------
The Company utilizes interest rate swaps, PO swaps, interest rate floors,
and swaptions to hedge the change in value of the mortgage servicing portfolio
due to expected prepayment risk assumption changes. Although the Company hedges
the change in value of its MSRs, its hedge coverage ratio does not equal 100%.
The Company keeps hedge coverage ratios at acceptable risk levels, which may
vary depending on current and expected interest rate movement.
Interest rate swap agreements are contracts to exchange quarterly or
semi-annual floating rate payments for fixed-rate payments. The notional amount
of the contracts, on which the payments are based, are not exchanged. The
primary risks associated with interest rate swaps are the ability of the
counterparties to meet the terms of the contract and the possibility that swap
rates may not move in an inverse manner or in an amount equal to mortgage rate
movements.
PO swap agreements simulate the ownership of a PO strip, the value of which
is affected directly by prepayment rates themselves in an inverse manner to the
servicing rights, which act in a manner similar to IO strips. Under a PO swap
agreement, the counterparty to the transaction purchases a PO strip and places
the PO strip in a trust. The contracts executed prior to December 31, 1998 call
for the Company to pay floating interest to the counterparty based on:
(a) an index tied to one month LIBOR and
(b) the amortized notional balance of the swap.
The contracts call for the Company to receive cash from the counterparty
based on the cash flows received from the PO strip. For PO swap agreements
executed after December 31, 1998, the agreement also requires the PO swap to be
marked to market value. A decrease in the market value of the PO swap requires
the Company to increase the amount paid to the counterparty and an increase in
the market value requires the counterparty to increase its payment to the
Company. The amounts to be paid and to be received are then netted together each
month. The nature of this instrument results in increased cash flows and
positive changes in the value of the PO swap during a declining interest rate
environment. This positive change in the value of the PO swap is highly
correlated to prepayment activity. PO swap agreements present yield curve risk
to the extent that short term interest rates (which impact the cash amount that
the Company pays on the PO swap to the counterparty) rise while long term rates
(which drive prepayment rates) stay the same. A third type of risk associated
with PO swaps is the ability of the counterparties to meet the terms of the
contract.
Interest rate floors are interest rate protection instruments that involve
payment from the seller to the buyer of an interest differential. This
differential is the difference between a long-term rate (E.G., 10-year Constant
Maturity Swaps in 2002 and 2001) and an agreed-upon rate, the strike rate,
applied to a notional principal amount. By purchasing a floor, the Company will
be paid the differential on a monthly basis by a counterparty, when the current
long-term rate falls below the strike level of the agreement. The fair value of
interest rate floor agreements is
Page 25
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
included in derivative assets or liabilities. Interest rate floors are subject
to basis risk because of differences in movements of mortgage and LIBOR rates,
market volatility and the impact of changes in the yield curve. In addition, a
credit risk associated with purchased interest rate floor agreements is the
ability of the counterparties to meet the terms of the contract.
A swaption is an over-the-counter option that provides the right, but not
the obligation, to enter into an interest rate swap agreement at predetermined
terms at a specified time in the future. Swaptions are subject to basis risk
because of differences in movements of mortgage and LIBOR rates, market
volatility and the impact of changes in the yield curve. In addition, credit
risk associated with swaptions is the ability of the counterparties to meet the
terms of the contract.
RESULTS
-------
Risk management results related to the hedging of MSRs are summarized below
and are included in the caption entitled "Loan servicing fees, net" in the
accompanying consolidated statements of income (in thousands). The net gain or
loss represents the ineffectiveness of the hedges.
Six Months Ended June 30, Three Months Ended June 30,
------------------------- ---------------------------
2002 2001 2002 2001
---- ---- ---- ----
Gain (loss) on designated derivative contracts $ 191,565 $(74,601) $ 224,062 $(108,198)
(Decrease) increase in value of designated MSRs (187,626) 83,558 (239,403) 114,750
--------- -------- --------- ---------
Net gain (loss) on derivatives used to hedge MSRs $ 3,939 $ 8,957 $ (15,341) $ 6,552
========= ======== ========= =========
INTEREST RATE RISK MANAGEMENT - FAIR VALUE HEDGING INSTRUMENTS - WAREHOUSE
LOANS
OBJECTIVES AND CONTEXT
----------------------
The Company, as part of its traditional real estate lending activities,
originates fixed-rate 1-4 unit residential loans for sale in the secondary
market. At the time of origination, management identifies loans it plans to
sell. These warehoused loans have been classified as loans held for sale, net,
in the consolidated balance sheet and are carried at fair market value, less the
values associated with servicing (for those loans which are hedged) or at the
lower of aggregate amortized cost or fair market value (for those loans which
are not hedged). These loans expose the Company to the variability of their fair
value due to changes in interest rates. If interest rates increase, the value of
the loans decreases. Conversely, if interest rates decrease, the value of the
loans increases.
Management limits the variability of a major portion of the change in fair
value of its loans held for sale by hedging substantially all of its warehoused
loans held for sale to third parties.
STRATEGIES
----------
Management employs forward loan sale hedging techniques to minimize the
interest rate and pricing risks associated with the origination and sale of such
warehoused loans.
The forward loan sales lock in the price for the sale of either specific
loans held for sale or a generic group of loans held for sale.
Page 26
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
RESULTS
-------
Risk management results related to the hedging of warehouse loans are
summarized below and are included in the caption entitled "Gain on sale,
settlement and transfer of loans, net" in the accompanying consolidated
statements of income (in thousands):
Six Months Ended June 30, Three Months Ended June 30,
------------------------- ---------------------------
2002 2001 2002 2001
---- ---- ---- ----
Transition adjustment upon adoption of SFAS No. 133 $ -- $ 3,834 $ -- $ --
Unrealized (loss) gain on designated forward loan
sale commitments recognized (38,538) 10,400 (25,020) 12,080
Increase (decrease) in value of warehouse loans 43,381 (9,038) 24,671 (10,443)
-------- ------- -------- --------
Net gain (loss) on derivatives used to hedge
warehouse loans $ 4,843 $ 5,196 $ (349) $ 1,637
======== ======= ======== ========
DERIVATIVE INSTRUMENTS NOT DESIGNATED AS HEDGING INSTRUMENTS
PURPOSE - INTEREST RATE LOCK COMMITMENTS AND FORWARD LOAN SALE COMMITMENTS
--------------------------------------------------------------------------
The Company enters into rate lock commitments to extend credit to borrowers
for generally a 30-day period for the origination and/or purchase of loans. Some
of these rate lock commitments will ultimately expire without being completed.
To the extent that a loan is ultimately granted and the borrower ultimately
accepts the terms of the loan, these rate lock commitments expose the Company to
variability in their fair value due to changes in interest rates. If interest
rates increase, the value of these rate lock commitments decreases. Conversely,
if interest rates decrease, the value of these rate lock commitments increases.
To mitigate the effect of this interest rate risk, the Company enters into
offsetting derivative contracts, primarily forward loan sale commitments. The
forward loan sale commitments lock in an interest rate and price for the sale of
loans similar to the specific rate lock loan commitments classified as
derivatives. Both the rate lock commitments and the forward loan sale
commitments are undesignated derivatives, and accordingly are marked to market
through earnings.
Risk management results related to the undesignated hedging of interest
rate lock commitments with undesignated forward loan sale commitments are
summarized below and are included in the caption entitled "Gain on sale,
settlement and transfer of loans, net" in the consolidated statements of income
(in thousands):
Six Months Ended June 30, Three Months Ended June 30,
------------------------- ---------------------------
2002 2001 2002 2001
---- ---- ---- ----
Transition adjustment upon adoption of SFAS No. 133 $ -- $(2,785) $ -- $ --
Unrealized (loss) gain on undesignated forward loan
sale commitments recognized to income (19,048) 10,120 (17,288) 11,096
Gain (loss) on undesignated interest rate loan
commitments recognized to income 21,464 (8,980) 16,025 (9,093)
-------- ------- -------- --------
Net gain (loss) on derivatives $ 2,416 $(1,645) $ (1,263) $ 2,003
======== ======= ======== ========
Page 27
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
NOTIONAL AMOUNTS OF DERIVATIVES
Information pertaining to the notional amounts of the Company's derivative
financial instruments utilized in both MSR and balance sheet hedging is as
follows (in thousands). The fair values of these derivative financial
instruments were recorded in the Company's balance sheet in accordance with SFAS
No. 133.
June 30, 2002 December 31, 2001
------------------------------ ------------------------------
Notional Notional
Amount Credit Risk (1) Amount Credit Risk (1)
------- --------------- ------ ---------------
Interest rate swaps - borrowings $ 4,509,670 $ -- $ 4,089,670 $ --
Interest rate swaps hedging MSRs 2,840,000 43,080 2,462,000 7,561
PO swaps 391,800 -- 378,928 6,411
Interest rate floors 1,021,000 26,286 3,054,000 78,917
Interest rate swaptions 4,621,000 137,058 4,111,000 183,641
Forward loan sale commitments 1,940,749 -- 3,980,863 36,879
Interest rate lock commitments 1,038,866 -- 1,870,852 --
Other 75,000 744 --
----------- -------- ----------- --------
Total $16,438,085 $207,168 $19,947,313 $313,409
=========== ======== =========== ========
- -------------
(1) Credit risk represents the amount of unrealized gain included in
derivative assets which is subject to counterparty credit risk. It
reflects the effect of master netting agreements and excludes $187.2
million and $95.2 million cash collateral held by the Bank at June 30,
2002 and December 31, 2001, respectively.
Derivative financial instruments used for other-than-trading purposes at
June 30, 2002 are scheduled to mature as follows (in thousands):
Notional Amounts
----------------------------------------------------------------------------------------------
Six Months Ending
December 31, 2002 2003 2004 2005 2006 Thereafter Total
----------------- ---- ---- ---- ---- ---------- -----
Interest rate swaps -
borrowings $ 300,000 $ 700,000 $1,670,000 $ 819,670 $900,000 $ 120,000 $ 4,509,670
Interest rate swaps
hedging MSRs -- -- -- -- -- 2,840,000 2,840,000
PO swaps 96,002 70,920 81,451 -- -- 143,427 391,800
Interest rate floors -- -- -- -- -- 1,021,000 1,021,000
Interest rate swaptions -- 3,451,000 464,000 706,000 -- -- 4,621,000
Forward loan sale
commitments 1,940,749 -- -- -- -- -- 1,940,749
Interest rate lock
commitments 1,038,866 -- -- -- -- -- 1,038,866
Other 75,000 -- -- -- -- -- 75,000
---------- ---------- ---------- ---------- -------- ---------- -----------
Total $3,450,617 $4,221,920 $2,215,451 $1,525,670 $900,000 $4,124,427 $16,438,085
========== ========== ========== ========== ======== ========== ===========
Page 28
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(17) RECENT ACCOUNTING PRONOUNCEMENTS
--------------------------------
GOODWILL AND OTHER INTANGIBLE ASSETS
On January 1, 2002, the Company adopted SFAS No. 142. SFAS No. 142
supersedes APB Opinion No. 17 and establishes new accounting standards for both
identifiable and unidentifiable intangible assets acquired in a business
combination, including goodwill, but does not address internally developed
intangible assets. It requires recognition of goodwill as an asset but does not
permit amortization of goodwill as previously required by APB Opinion No. 17.
Instead, goodwill is tested for impairment at a level referred to as a reporting
unit. A reporting unit is the same level as, or one level below, an operating
segment (as that term is used in SFAS No. 131).
Goodwill is tested for impairment annually and on an interim basis if an
event or circumstance occurs between annual tests that might reduce the fair
value of a reporting unit below its carrying value. An example of such an event
or circumstance may include an adverse change in the business climate or market,
a legal factor, an action by regulators, an introduction of competition, or a
loss of key personnel. Goodwill would also be tested for impairment on an
interim basis when:
(a) a more-likely-than-not expectation exists that a reporting unit or a
significant portion of a reporting unit will be sold or otherwise
disposed of,
(b) a significant asset group within a reporting unit is tested for
recoverability under SFAS No. 121, or
(c) a subsidiary of that reporting unit has recognized a goodwill
impairment loss.
The fair value of each reporting unit would not have to be recomputed every
year if the components of the reporting unit had not changed since the previous
fair value computation, the previous fair value amount exceeded the carrying
amount of the reporting unit by a substantial margin, and no evidence exists
indicating that the current fair value of the reporting unit may be less than
its current carrying amount.
Goodwill is tested for impairment using a two-step approach. The first step
is a comparison of the fair value of a reporting unit to its carrying amount,
including goodwill. If the fair value of the reporting unit is greater than its
carrying amount, goodwill is not considered impaired and no further work is
required. If the fair value of the reporting unit is less than its carrying
amount, the second step of the impairment test must be performed. The second
step of the impairment test is a comparison of the implied fair value of
goodwill to its carrying amount. If the implied fair value of goodwill is less
than its carrying amount, goodwill is considered impaired and an impairment loss
recognized. The impairment loss would be measured as the amount by which the
carrying amount of goodwill exceeds its implied fair value.
Acquired intangible assets other than goodwill are amortized over their
useful economic life and reviewed for impairment in accordance with SFAS No.
144.
The impact of the adoption of SFAS No. 142 increases GAAP earnings by $13.7
million per quarter in 2002.
ACCOUNTING BY CERTAIN ENTITIES (INCLUDING ENTITIES WITH TRADE RECEIVABLES)
THAT LEND TO OR FINANCE THE ACTIVITIES OF OTHERS
In December 2001, the AICPA issued SOP 01-6. SOP 01-6 is effective for
annual and interim financial statements issued for fiscal years beginning after
December 15, 2001. SOP 01-6 reconciles the specialized accounting and financial
reporting guidance established in the existing Banks and Savings Institutions
Guide, Audits of Credit Unions Guide, and Audits of Finance Companies Guide. The
SOP eliminates differences in accounting and disclosure established by the
respective guides and carries forward accounting guidance for transactions
determined to be unique to certain financial institutions. The adoption of this
pronouncement has not had a material impact on the Company's results of
operations or financial condition.
Page 29
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
RESCISSION OF SFAS NO. 4, 44, AND 64, AMENDMENT OF SFAS NO. 13, AND
TECHNICAL CORRECTIONS
SFAS No. 145 rescinds SFAS No. 4, which required all gains and losses from
extinguishment of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. As a result, the criteria
in Opinion No. 30 will now be used to classify those gains and losses. SFAS No.
64 amended SFAS No. 4, and is no longer necessary because SFAS No. 4 has been
rescinded.
The accounting, disclosure and financial statement provisions of SFAS No.
145 are effective for financial statements in fiscal years beginning after May
15, 2002. Any gain or loss on extinguishment of debt that was classified as an
extraordinary item in prior periods presented that does not meet the criteria in
Opinion No. 30 for classification as an extraordinary item shall be
reclassified.
The implementation of SFAS No. 145 is not expected to impact the Company's
financial condition or operating results.
Page 30
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS. THIS QUARTERLY REPORT CONTAINS FORWARD-LOOKING
STATEMENTS, WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995, THAT PERTAIN TO OUR FUTURE OPERATING RESULTS. WORDS SUCH AS
"ANTICIPATE," "BELIEVE," "EXPECT," "INTEND" AND OTHER SIMILAR EXPRESSIONS ARE
INTENDED TO IDENTIFY THESE STATEMENTS. FORWARD-LOOKING STATEMENTS ARE NOT
HISTORICAL FACTS AND ARE INHERENTLY SUBJECT TO SIGNIFICANT BUSINESS, ECONOMIC
AND COMPETITIVE UNCERTAINTIES AND CONTINGENCIES, MANY OF WHICH ARE BEYOND OUR
CONTROL. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE IN THE
FORWARD-LOOKING STATEMENTS DUE TO SUCH FACTORS AS (I) PORTFOLIO CONCENTRATIONS;
(II) INTEREST RATE CHANGES, INCLUDING CHANGES IN SHORT-TERM INTEREST RATES, THE
SHAPE OF THE YIELD CURVE AND THE TREASURY-EURODOLLAR SPREAD; (III) CHANGES IN
ASSET PREPAYMENT SPEEDS; (IV) CHANGES IN OUR COMPETITIVE AND REGULATORY
ENVIRONMENTS; AND (V) CHANGES IN THE AVAILABILITY OF NET OPERATING LOSS
CARRYOVERS AND DEFERRED TAX LIABILITIES. SEE "BUSINESS--FACTORS THAT MAY AFFECT
FUTURE RESULTS" IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 2001 FOR A DISCUSSION OF THESE FACTORS IN GREATER DETAIL. WE ASSUME
NO OBLIGATION TO UPDATE ANY OF OUR FORWARD-LOOKING STATEMENTS.
CRITICAL ACCOUNTING POLICIES
In preparing its consolidated financial statements, the Company is required
to make judgments and estimates that may have a significant impact upon its
financial results. The Company's valuation of its MSRs and its determination of
the adequacy of its allowance for loan losses are particularly subject to
management's judgment and estimates. The Company's accounting policies for these
two areas are discussed at length in notes 2(m) and 2(e) of the Company's Notes
to Consolidated Financial Statements included in the Company's 2001 Annual
Report on Form 10-K.
OVERVIEW
GS Holdings, formerly FN Holdings, a wholly owned subsidiary of Golden
State, is a holding company whose only significant asset is all of the common
and preferred stock of the Bank.
The Company, headquartered in San Francisco, California, provides
diversified financial services to consumers and small businesses in California
and Nevada, primarily:
(a) retail branches that provide deposit products such as demand,
transaction and savings accounts, and investment products such as
mutual funds, annuities and insurance; and
(b) mortgage banking activities, including originating and purchasing 1-4
unit residential loans for sale or retention, servicing loans for
itself and others and, to a lesser extent, originating and/or
purchasing commercial real estate, commercial and consumer loans for
investment.
The Company's revenues are derived from:
(a) interest earned on loans and securities;
(b) gains on sales of loans and other investments, fees received in
connection with loan servicing and securities brokerage; and
(c) other customer service transactions.
Expenses primarily consist of interest on customer deposit accounts and
borrowings, and general and administrative expenses including compensation and
benefits, occupancy and equipment, professional fees and other general
administrative expenses.
Page 31
PENDING MERGER
On May 21, 2002, Citigroup and Mercury Merger Sub, a wholly owned
subsidiary of Citigroup, entered into a merger agreement with the Company
whereby the Company will be merged with and into Mercury Merger Sub, with
Mercury Merger Sub as the surviving company. The Merger, which is expected to
close in the third quarter of 2002, is subject to regulatory and Golden State
stockholder approvals. See note 2 of the Company's Notes to Unaudited
Consolidated Financial Statements.
NET INCOME
GS Holdings reported net income of $241.8 million for the six months ended
June 30, 2002, compared with net income of $209.2 million for the corresponding
period in 2001. Net income for the six months ended June 30, 2001 includes a
loss of $1.6 million, net of tax, from the cumulative effect of change in
accounting principle. Net income before the cumulative effect of change in
accounting principle for the six months ended June 30, 2001 was $210.7 million.
The Bank's efficiency ratio was 47.34% for the six months ended June 30, 2002,
compared to 49.30% for the comparable period in 2001.
Net interest income increased $91.1 million during the first six months of
2002 as compared to the year-ago period, primarily as a result of declining
market interest rates reducing the costs of liabilities at a faster rate than
the decline in the yield on assets. Lower-costing liabilities were the result of
the replacement of higher-rate borrowings and deposits with lower-rate
borrowings and deposits as these instruments came due or were repaid. In
addition, during the six months ended June 30, 2002, $11.2 million of interest
income was received in connection with a California income tax refund. Total
noninterest income declined by $85.5 million, primarily in loan servicing fees,
net due to higher MSR amortization and an increased MSR valuation provision.
Total noninterest expense declined $15.4 million and includes a $27.5 million
decrease due to the adoption of SFAS No. 142 on January 1, 2002.
GS Holdings reported net income of $116.4 million for the three months
ended June 30, 2002, compared with net income of $113.5 million for the
corresponding period in 2001. Net income for the three months ended June 30,
2001 includes a loss of $1.6 million, net of tax, from the cumulative effect of
change in accounting principle. Net income before the cumulative effect of
change in accounting principle for the three months ended June 30, 2001 was
$115.1 million. The Bank's efficiency ratio was 47.06% for the three months
ended June 30, 2002, compared to 46.27% for the comparable period in 2001.
Net interest income increased $33.9 million during the three months ended
June 30, 2002 as compared to the same period in 2001, primarily as a result of
declining market interest rates reducing the costs of liabilities at a faster
rate than the decline in the yield on assets. Lower-costing liabilities were the
result of the replacement of higher-rate borrowings and deposits with lower-rate
borrowings and deposits as these instruments came due or were repaid. In
addition, during the three months ended June 30, 2002, $11.2 million of interest
income was received in connection with a California income tax refund. Total
noninterest income declined by $114.6 million, primarily in loan servicing fees,
net due to higher MSR amortization and an increased MSR valuation provision.
Total noninterest expense declined $16.8 million and includes a $13.8 million
decrease due to the adoption of SFAS No. 142 on January 1, 2002.
As noted above, the Company adopted SFAS No. 142 effective January 1, 2002,
which requires that goodwill no longer be amortized. The effect of the adoption
was to reduce goodwill amortization by $13.8 million and $27.5 million for the
three and six months ended June 30, 2002, respectively, compared to the same
period a year ago. Excluding the effect of the adoption of SFAS No. 142, net
income for the three and six months ended June 30, 2001 was $127.2 million and
$236.6 million, respectively. Excluding the effect of the adoption of SFAS No.
142, income before the cumulative effect of change in accounting principle for
the three and six months ended June 30, 2001 was $128.8 million and $238.1
million, respectively.
Page 32
FINANCIAL CONDITION
During the six months ended June 30, 2002, consolidated total assets
decreased to $51.9 billion from $56.5 billion and total liabilities decreased to
$48.6 billion from $53.4 billion at December 31, 2001. Mortgage-backed
securities, loans held for sale and loans receivable declined $2.4 billion, $1.3
billion and $0.7 billion, respectively, during the six month period. This shift
in mortgage-backed securities and loans is primarily due to high repayment rates
in light of the declining interest rate environment. Deposits decreased $764.8
million during the six months ended June 30, 2002, including decreases of $807.6
million in custodial accounts, $564.5 million in CDs and $55.5 million in
Brokered Deposits, offset by a $671.4 million increase in transaction accounts.
Total borrowings, including securities sold under agreements to repurchase, FHLB
advances and other borrowings, declined $4.0 billion during the six months ended
June 30, 2002.
During the six months ended June 30, 2002, stockholder's equity increased
$147.3 million to $2.8 billion. The increase in stockholder's equity is
principally the result of $241.8 million in net income for the period, $3.1
million from the exercise of stock options and $2.6 million due to the impact of
Golden State restricted common stock. These amounts are partially offset by
$80.0 million in dividends to parent, $16.9 million in net unrealized losses,
after tax, on derivatives and $3.4 million in net unrealized losses, after tax,
on securities available for sale.
GS Holdings' non-performing assets, consisting of non-performing loans, net
of purchase accounting adjustments, foreclosed real estate, net, and repossessed
assets, decreased to $104.6 million at June 30, 2002 compared with $124.1
million at December 31, 2001. Total non-performing assets as a percentage of the
Bank's total assets was 0.20% at June 30, 2002 compared with 0.22% at December
31, 2001.
Page 33
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2002 VERSUS SIX MONTHS ENDED JUNE 30, 2001
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.
Six Months Ended June 30, 2002
------------------------------------
Average Average
Balance Interest Rate
------- -------- ----
(dollars in millions)
ASSETS
Interest-earning assets (1):
Securities, interest-bearing deposits in banks and other (2) $ 351 $ 16 8.99%
Mortgage-backed securities available for sale 5,598 168 6.02
Mortgage-backed securities held to maturity 1,266 40 6.28
Loans held for sale, net 2,226 71 6.35
Loans receivable, net:
Residential 28,732 883 6.15
Commercial real estate 6,552 233 7.10
Consumer 978 30 6.18
Automobile 1,986 124 12.65
Commercial banking 733 21 5.74
------- ------
Loans receivable, net 38,981 1,291 6.63
FHLB stock 1,318 41 6.24
------- ------
Total interest-earning assets 49,740 1,627 6.55%
Noninterest-earning assets 4,149 ------
-------
Total assets $53,889
=======
LIABILITIES, MINORITY INTEREST
AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
Deposits $24,756 261 2.12%
Securities sold under agreements to repurchase (3) 2,189 42 3.85
Borrowings (3) 22,474 584 5.22
Other 165 2 1.76
------- ------
Total interest-bearing liabilities 49,584 889 3.60%
Noninterest-bearing liabilities 1,151 ------
Minority interest 497
Stockholder's equity 2,657
-------
Total liabilities, minority interest
and stockholder's equity $53,889
=======
Net interest income $ 738
======
Interest rate spread (4) 2.95%
=====
Net interest margin 2.96
=====
Return on average assets 0.90%
=====
Return on average common equity 18.21%
=====
Return on tangible common equity 24.14%
=====
Average equity to average assets 4.93%
=====
Page 34
Six Months Ended June 30, 2001
------------------------------------
Average Average
Balance Interest Rate
------- -------- ----
(dollars in millions)
ASSETS
Interest-earning assets (1):
Securities and interest-bearing deposits in banks (2) $ 1,051 $ 32 6.01%
Mortgage-backed securities available for sale 10,385 345 6.64
Mortgage-backed securities held to maturity 1,685 71 8.43
Loans held for sale, net 1,523 53 6.92
Loans receivable, net:
Residential 31,803 1,124 7.07
Commercial real estate 6,130 256 8.36
Consumer 875 40 9.31
Automobile 1,700 96 11.38
Commercial banking 570 25 8.69
------- ------
Total loans receivable, net 41,078 1,541 7.51
FHLB stock 1,391 45 6.58
------- ------
Total interest-earning assets 57,113 2,087 7.31%
Noninterest-earning assets 3,593 ------
-------
Total assets $60,706
=======
LIABILITIES, MINORITY INTEREST
AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
Deposits $23,997 465 3.90%
Securities sold under agreements to repurchase (3) 3,992 121 6.05
Borrowings (3) 28,784 854 5.96
Other 1 -- --
------- ------
Total interest-bearing liabilities 56,774 1,440 5.09%
Noninterest-bearing liabilities 1,121 ------
Minority interest 497
Stockholder's equity 2,314
-------
Total liabilities, minority interest
and stockholder's equity $60,706
=======
Net interest income $ 647
======
Interest rate spread (4) 2.22%
=====
Net interest margin 2.25%
=====
Return on average assets 0.69%
=====
Return on average common equity 18.08%
=====
Return on tangible common equity 29.19%
=====
Average equity to average assets 3.81%
=====
- ----------------
(1) Non-performing assets are included in the average balances for the periods
indicated.
(2) Includes securities, interest-bearing deposits in other banks, securities
purchased under agreements to resell, interest income on California income
tax refund and other interest income.
(3) Interest and average rate include the impact of interest rate swaps.
(4) Interest rate spread represents the difference between the average rates of
total interest-earning assets and total interest-bearing liabilities.
Page 35
The following table shows the changes in interest income and expense 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.
Six Months Ended June 30, 2002 vs. 2001
Increase (Decrease) Due to
------------------------------------------------
VOLUME RATE NET
------ ---- ---
INTEREST INCOME: (in millions)
Securities, interest-bearing deposits in banks and other $ (13) $ (3) $ (16)
Mortgage-backed securities available for sale (147) (30) (177)
Mortgage-backed securities held to maturity (15) (16) (31)
Loans held for sale, net 22 (4) 18
Loans receivable, net (40) (210) (250)
FHLB stock (2) (2) (4)
----- ----- -----
Total (195) (265) (460)
----- ----- -----
INTEREST EXPENSE:
Deposits 30 (234) (204)
Securities sold under agreements to repurchase (46) (33) (79)
Borrowings (161) (109) (270)
Other 1 1 2
----- ----- -----
Total (176) (375) (551)
----- ----- -----
Change in net interest income $ (19) $ 110 $ 91
===== ===== =====
INTEREST INCOME. Total interest income was $1.6 billion for the six months
ended June 30, 2002, a decrease of $460.1 million from the six months ended June
30, 2001. Total interest-earning assets for the six months ended June 30, 2002
averaged $49.7 billion, compared to $57.1 billion for the corresponding period
in 2001. The decrease in interest-earning assets is primarily a result of a
decline in mortgage-backed securities, principally due to management's decision
to sharply reduce purchases, and net loan run off, as well as decreased
securities volume. These decreases were partially offset by an increase in loans
held for sale due to heightened borrower refinancing activity in the declining
interest rate environment. The yield on total interest-earning assets during the
six months ended June 30, 2002 decreased to 6.55% from 7.31% for the six months
ended June 30, 2001, primarily due to the repricing of loans and mortgage-backed
securities available for sale at lower rates. At June 30, 2002, 11% of the
Company's portfolio loans were tied to COFI indices, 12% to Treasury-based
indices and 49% were "hybrid" ARMs - fixed for three to ten years and then
adjusting annually. Twenty-three percent of the portfolio was fixed. The
remaining 5% of the portfolio was in other adjustable-rate products.
GS Holdings earned $1.3 billion of interest income on loans receivable for
the six months ended June 30, 2002, a decrease of $250.0 million from the six
months ended June 30, 2001. The average balance of loans receivable was $39.0
billion for six months ended June 30, 2002, compared to $41.1 billion for the
same period in 2001. The weighted average yield on loans receivable decreased to
6.63% for the six months ended June 30, 2002 from 7.51% for the six months ended
June 30, 2001. The decrease in the average balance reflects the sharp run off of
residential loans during a period of high refinancing activity. The decrease in
the weighted average yield reflects the repricing of variable-rate loans, a
decrease in the prime rate on commercial banking loans and comparatively lower
market interest rates during the six months ended June 30, 2002, partially
offset by a higher yield on auto loans purchased after July 1, 2001, which are
recorded on a gross-coupon basis, rather than a credit-adjusted yield basis. The
impact of this change on net interest income during the six months ended June
30, 2002 was to increase interest income by $20.7 million.
Page 36
Loan production is detailed in the table below (in thousands):
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
Loans funded:
Residential real estate loans:
Adjustable-rate $ 3,455,177 $ 3,854,221
Fixed-rate 10,369,569 7,459,609
----------- -----------
Total residential real estate loans 13,824,746 11,313,830
Commercial real estate loans 903,169 886,836
Commercial loans 648,287 523,254
Consumer nonmortgage loans 526,246 393,648
Auto loans (a) 619,694 635,466
----------- -----------
Total loans funded $16,522,142 $13,753,034
=========== ===========
Residential real estate loans purchased $ 2,207,946 $ 1,723,576
=========== ===========
------------
(a) Approximately 50% and 41% of this volume was in prime product; 50% and
59% in sub-prime product for the six months ended June 30, 2002 and
2001, respectively.
GS Holdings earned $70.7 million of interest income on loans held for sale
for the six months ended June 30, 2002, an increase of $18.0 million from the
six months ended June 30, 2001. The average balance of loans held for sale was
$2.2 billion for the six months ended June 30, 2002, an increase of $0.7 billion
from the comparable period in 2001, primarily attributed to increased
originations of residential fixed-rate loans as a result of heightened borrower
refinancing activity in the declining interest rate environment. Fixed-rate
production for sale totalled $10.2 billion during the six months ended June 30,
2002, an increase of 46.5% over the $6.9 billion originated during the
comparable period in 2001. The weighted average yield on loans held for sale
decreased to 6.35% for the six months ended June 30, 2002 from 6.92% for the six
months ended June 30, 2001, primarily due to declining market interest rates.
Interest income on mortgage-backed securities available for sale was $168.5
million for the six months ended June 30, 2002, a decrease of $176.5 million
from the six months ended June 30, 2001. The average portfolio balance decreased
$4.8 billion, to $5.6 billion for the six months ended June 30, 2002 compared to
the same period in 2001. The weighted average yield on these assets decreased
from 6.64% for the six months ended June 30, 2001 to 6.02% for the six months
ended June 30, 2002. The decrease in the volume is primarily attributed to
management's decision to sharply reduce purchases, coupled with high repayments
and sales of mortgage-backed securities. The decrease in the weighted average
yield primarily reflects the repricing of variable-rate securities at lower
rates.
Interest income on mortgage-backed securities held to maturity was $39.7
million for the six months ended June 30, 2002, a decrease of $31.3 million from
the six months ended June 30, 2001. The average portfolio balance decreased $0.4
billion, to $1.3 billion for the six months ended June 30, 2002 compared to the
same period in 2001, primarily due to repayments. The weighted average yields
for the six months ended June 30, 2002 and 2001 were 6.28% and 8.43%,
respectively. The decrease in the weighted average yield is primarily the result
of the repricing of variable-rate securities at lower rates.
Interest income on securities, interest-bearing deposits in banks and other
was $15.8 million for the six months ended June 30, 2002, a decrease of $15.8
million from the six months ended June 30, 2001. The average portfolio balance
was $0.4 billion and $1.1 billion for the six months ended June 30, 2002 and
2001, respectively. The weighted average yield was 8.99% for the six months
ended June 30, 2002 compared to 6.01% for the six months ended June 30, 2001.
The decrease in the volume is primarily attributed to payments and maturities of
securities. The increase in the weighted average yield reflects $11.2 million of
interest income related to a California income tax refund for which there is no
corresponding earning asset; if this amount is excluded, the weighted average
yield for the six months ended June 30, 2002 would be 2.61%. The weighted
average yield also
Page 37
reflects a shift in the mix of securities, with lower average balances of higher
rate securities held to maturity during the first six months of 2002.
Dividends on FHLB stock were $40.8 million for the six months ended June
30, 2002, a decrease of $4.6 million from the six months ended June 30, 2001.
The average balance outstanding was $1.3 billion and $1.4 billion for the six
months ended June 30, 2002 and 2001, respectively. The weighted average dividend
on FHLB stock declined to 6.24% for the six months ended June 30, 2002 from
6.58% for the six months ended June 30, 2001.
INTEREST EXPENSE. Total interest expense was $888.5 million for the six
months ended June 30, 2002, a decrease of $551.2 million from the six months
ended June 30, 2001. The decrease is primarily due to declining market interest
rates and a reduction in borrowings under FHLB advances and securities sold
under agreements to repurchase, partially offset by additional deposits.
Interest expense on deposits, including Brokered Deposits, was $260.9
million for the six months ended June 30, 2002, a decrease of $203.6 million
from the six months ended June 30, 2001. The average balance of deposits
outstanding increased from $24.0 billion for the six months ended June 30, 2001
to $24.8 billion for the six months ended June 30, 2002. The increase in the
average balance is primarily attributed to increases in the average balances of
money market accounts, retail customer checking accounts, custodial accounts and
savings account balances, partially offset by a decline in CDs. The overall
weighted average cost of deposits decreased to 2.12% for the six months ended
June 30, 2002 from 3.90% for the six months ended June 30, 2001, primarily due
to declining market interest rates and a shift in the mix of deposits, with
higher average balances of lower rate money market, checking, custodial and
savings accounts, and a lower average balance of higher rate CDs during the
first half of 2002.
Interest expense on securities sold under agreements to repurchase totalled
$42.4 million for the six months ended June 30, 2002, a decrease of $79.0
million from the six months ended June 30, 2001. The average balance of such
borrowings for the six months ended June 30, 2002 and 2001 was $2.2 billion and
$4.0 billion, respectively. The decrease in the average balance is primarily the
result of maturities, which were not renewed in light of the decline in
interest-earning assets. The weighted average interest rate on these instruments
decreased to 3.85% for the six months ended June 30, 2002 from 6.05% for the six
months ended June 30, 2001, primarily due to maturities of higher fixed-rate
borrowings and the repricing of variable-rate borrowings at lower rates.
Interest expense on borrowings totalled $583.8 million for the six months
ended June 30, 2002, a decrease of $270.0 million from the six months ended June
30, 2001. The average balance outstanding for the six months ended June 30, 2002
and 2001 was $22.5 billion and $28.8 billion, respectively. The weighted average
interest rate on these instruments decreased to 5.22% for the six months ended
June 30, 2002 from 5.96% for the six months ended June 30, 2001. The decrease in
the average volume is primarily the result of maturities, which were not renewed
in light of the decline in interest-earning assets, while the decrease in the
weighted average rate is primarily due to declining market interest rates.
NET INTEREST INCOME. Net interest income was $738.0 million for the six
months ended June 30, 2002, an increase of $91.1 million from the six months
ended June 30, 2001. The interest rate spread increased to 2.95% for the six
months ended June 30, 2002 from 2.22% for the six months ended June 30, 2001,
primarily as a result of declining market interest rates reducing costs of
liabilities at a faster rate than the decline in the yield on assets.
Lower-costing liabilities were the result of the replacement of higher-rate
borrowings and deposits with lower-rate borrowings and deposits as these
instruments came due or were repaid. The net interest margin increased to 2.96%
for the six months ended June 30, 2002, up 71 bps from the 2.25% reported during
the first half of 2001. Excluding the $11.2 million interest on the California
income tax refund, the interest rate spread and net interest margin for the six
months ended June 30, 2002 would be 2.90% and 2.91%, respectively.
NONINTEREST INCOME. Total noninterest income, consisting primarily of loan
servicing fees, customer banking fees, gain on sale, settlement and transfer of
loans, net, gain on sale of assets, net and other income, was $88.0 million for
the six months ended June 30, 2002, representing a decrease of $85.5 million
from the six months ended June 30, 2001.
Page 38
Loan servicing fees for the Company, were $(106.6) million for the six
months ended June 30, 2002, compared to $(6.9) million the six months ended June
30, 2001. The following table details the components of loan servicing fees, net
(in thousands):
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
Components of loan servicing fees, net:
Loan servicing fees $ 249,676 $ 224,292
Amortization of MSRs (212,596) (147,013)
Pass-through Interest Expense (20,498) (16,142)
Net gain on MSRs/MSR derivatives (SFAS No. 133) 3,939 8,957
MSR valuation provision (127,107) (77,000)
--------- ---------
Total loan servicing fees, net $(106,586) $ (6,906)
========= =========
Portfolio run off rate (residential portfolio only) 30.0% 25.6%
MSR value run off rate (residential portfolio only) 21.8 21.2
MSR amortization rate (residential portfolio only) 22.9 20.3
As the table reflects, gross loan servicing fees increased $25.4 million
from year-ago levels, which is primarily attributable to the growth of the
Company's servicing portfolio and higher ancillary fees. The single-family
residential loan servicing portfolio, excluding loans serviced for the Bank,
increased from $83.3 billion at June 30, 2001 to $90.7 billion at June 30, 2002.
The portfolio runoff rate, representing the percentage of the residential
portfolio that has been paid off during the year, influences MSR amortization,
which increased $65.6 million in the six months ended June 30, 2002 over the
same period in 2001. MSR amortization was also affected by a higher average MSR
balance for the six months ended June 30, 2002 compared to the same period in
2001. Pass-through Interest Expense increased $4.4 million or 27.0% year over
year, also influenced by higher runoff rates. Total loan servicing fees, net for
the six months ended June 30, 2002 and 2001 includes net pre-tax gains of $3.9
million and $9.0 million, respectively, from the impact of SFAS No. 133
pertaining to the MSR fair value hedges. After recording these gains in
accordance with SFAS No. 133, the Company determined that the fair value of the
MSR asset was less than its carrying value and recorded pre-tax valuation
provisions on the MSRs of $127.1 million and $77.0 million during the six months
ended June 30, 2002 and 2001, respectively.
Customer banking fees were $119.0 million for the six months ended June 30,
2002 compared to $105.8 million for the six months ended June 30, 2001. The
following table details the components of customer banking fees and service
charges (in thousands):
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
Components of customer banking fees and service charges:
Customer and electronic banking fees $ 77,602 $ 68,501
Other customer fees 1,517 1,298
Investment sales income 35,199 30,730
Insurance commissions 4,702 5,291
-------- --------
Total customer banking fees and service charges $119,020 $105,820
======== ========
The increase is primarily attributed to increased emphasis by management on
transaction account growth and higher fee income on mutual fund, annuity and
other investment and insurance product sales through CFI. 2002 also includes a
$1.6 million reclassification to reflect gross revenues from customer check
printing fees rather than net revenues. The offset is included in the "other
expense" line of the income statement. Transaction accounts (including custodial
accounts) as a percentage of retail deposits increased to 58.5% at June 30,
2002, from 53.3% at June 30, 2001.
Page 39
Gain on sale, settlement and transfer of loans, net totalled $55.5 million
for the six months ended June 30, 2002, an increase of $33.6 million from the
six months ended June 30, 2001. During the six months ended June 30, 2002, the
Company sold $11.9 billion in single-family mortgage loans with servicing rights
retained as part of its ongoing mortgage banking operations at gains of $43.7
million compared to $5.6 billion of such sales for the corresponding period in
2001 at gains of $14.1 million. The overall increase in the volume of loans sold
and the related gain is a result of the significant increase in fixed-rate loan
originations due to the overall decline in market interest rates and increased
mortgage refinancing. The results in 2002 and 2001 include unrealized gains of
$7.3 million and $3.6 million, respectively, on the derivative rate locks,
forward loan sale commitments and closed loan inventory from the application of
SFAS No. 133.
Gain on sale of assets, net totalled $8.4 million for the six months ended
June 30, 2002, compared to a net gain of $16.2 million for the six months ended
June 30, 2001. The gain during the first half of 2002 includes a $14.2 million
gain on the sale of a real estate partnership interest, a $3.4 million gain on
the sale of the Santa Barbara branch and a $2.0 million gain on the sale of
$62.3 million in mortgage-backed securities, partially offset by an $11.3
million loss on the mark-to-market of the Company's portfolio of IO strip and
"B" tranche mortgage securities pursuant to EITF No. 99-20. The gain during 2001
is primarily attributed to a $9.3 million gain on the sale of the Company's
Concord EFS stock and a gain of $6.6 million on the sale of $298 million in
mortgage-backed securities.
Other noninterest income for the six months ended June 30, 2001 included a
gain of $20.7 million on the non-monetary exchange of Star Systems common stock
for 634,520 shares of Concord EFS common stock as a result of Concord's
acquisition of Star Systems in February 2001.
NONINTEREST EXPENSE. Total noninterest expense was $457.0 million for the
six months ended June 30, 2002, a decrease of $15.4 million compared to the six
months ended June 30, 2001. Excluding the amortization of goodwill and other
intangible assets, noninterest expense for the six months ended June 30, 2002
was $454.7 million, an increase of $12.2 million over the same period in the
prior year. Noninterest expense for the six months ended June 30, 2002 included
decreases of $27.5 million in amortization of intangible assets, $3.0 million in
other noninterest expense and $1.0 million in loan expense. These decreases were
partially offset by increases of $11.4 million in compensation expense, $3.2
million in occupancy and equipment expense and $1.4 million in professional
fees.
Compensation and employee benefits expense was $242.6 million for the six
months ended June 30, 2002, an increase of $11.4 million from the six months
ended June 30, 2001. The increase is primarily attributed to an increase in
staff (from 8,015 FTE at June 30, 2001 to 8,185 at June 30, 2002) and temporary
personnel, primarily in volume-related operating groups, as well as normal
salary adjustments.
Professional fees were $16.1 million for the six months ended June 30,
2002, an increase of $1.4 million from the six months ended June 30, 2001,
primarily due to an overall increase in legal fees related to various legal
cases.
Amortization of intangible assets was $2.3 million for the six months ended
June 30, 2002, a decrease of $27.5 million from the six months ended June 30,
2001, due to the adoption of SFAS No. 142 on January 1, 2002, which requires
that goodwill no longer be amortized.
Other noninterest expense was $108.2 million for the six months ended June
30, 2002 compared to $111.2 million in the same period of 2001. The decrease in
expenses relates to decreases in a number of operating expense categories,
including retail back office operations, marketing, judgments and settlements,
employee travel expense and telephone.
PROVISION FOR INCOME TAX. During the six months ended June 30, 2002, GS
Holdings recorded gross income tax expense of $150.7 million, which was offset
by a tax benefit of $37.1 million, for net income tax expense of $113.6 million.
Based on the current status of Mafco Holdings' audits for the years 1991 through
1995 and anticipated reversal of deferred tax assets with established valuation
allowance, management changed its judgment about the realizability of the
Company's deferred tax assets and reduced its valuation allowance by $44
million. As a result of reducing the valuation allowance, income tax expense was
reduced by $31.4 million and goodwill was reduced by $12.6 million.
Page 40
In addition, an accrued liability had been established in prior years for
the purpose of satisfying assessments that may result from issues arising during
audits with various state taxing authorities. As a result of recent
documentation received pertaining to the California audit of Glendale Federal
Bank for the years 1991 through 1997, management reduced its accrued state tax
liability by $8.7 million during the six months ended June 30, 2002. Goodwill
was reduced by $0.6 million in connection with this transaction. The Company
also recorded additional Federal tax expense of $3.1 million due to the
reduction of the state tax expense.
During the six months ended June 30, 2001, GS Holdings recorded net income
tax expense of $123.7 million, which included net tax benefits of $29.0 million.
In prior years, an accrued liability was established for the purpose of
satisfying assessments that may result from issues arising during audits with
various state taxing authorities. As a result of the completion and settlement
of audits in various state taxing jurisdictions, additional guidance on the
deductibility of covered asset losses, and the current assessment of exposure
for tax strategies employed for prior years, management reduced its accrued
state tax liability by $39.7 million. The Company also recorded additional
Federal tax expense of $13.9 million due to the reduction of the state tax
expense.
In addition, an income tax benefit was recorded for $3.2 million due to the
utilization of net operating losses of a subsidiary made available as a result
of the subsidiary's liquidation into California Federal Bank.
GS Holdings' effective gross federal tax rate was 27% during the six months
ended June 30, 2002 and 41% during the six months ended June 30, 2001, while its
federal statutory tax rate was 35% during both periods. In 2002, the difference
between the effective and statutory rates was primarily the result of a
reduction of the valuation allowance, partially offset by an increase in federal
tax recorded in conjunction with the reduction in the accrued state tax
liability. In 2001, the difference between the effective and statutory rates was
primarily the result of non-deductible goodwill amortization and additional
federal tax liability recorded in conjunction with a reduction in the accrued
state tax liability. GS Holdings' effective state tax rate was 3% and (5)%
during the six months ended June 30, 2002 and 2001, respectively. The low
effective state tax rate during 2002 and 2001 was the result of the previously
discussed reduction in the accrued state tax liability.
MINORITY INTEREST. During each of the six months ended June 30, 2002 and
2001, dividends on the REIT Preferred Stock were recorded totalling $13.5
million, net of income tax benefit, which will inure to the Company as a result
of the deductibility of such dividends for income tax purposes.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. Cumulative effect of
change in accounting principle for the six months ended June 30, 2001 includes a
write-down of $1.6 million, net of income taxes of $1.1 million, on certain
securities as a result of the Company's implementation of EITF No. 99-20 on
April 1, 2001. See note 14 of the Company's Notes to Unaudited Consolidated
Financial Statements.
Page 41
IMPACT OF SFAS NO. 133. On January 1, 2001, the Company adopted SFAS No.
133. The pronouncement impacted several other areas of the financial statements.
The table summarizes the activity during the six months ended June 30, 2002 and
2001 below (debit/(credit); in thousands):
Assets Liabilities and Equity Pre-tax Earnings
-------------------------------- ------------------------------ ----------------------
Loans Taxes- Loan (Gain)/Loss
Held Residential Derivative Derivative Other Servicing on Sale of
For Sale MSRS Assets Liabilities Liabilities OCI Fees, Net Loans
-------- ---- ------ ----------- ----------- --- --------- -----
Fair value adjustments:
MSRs and MSR hedges $ -- $(187,626) $ 180,458 $ 11,107 $ -- $ -- $(3,939) $ --
Warehouse loans and
pipeline hedges 43,381 -- (28,685) (7,437) -- -- -- (7,259)
Cash flow (balance sheet)
hedges - swaps -- -- -- (28,500) 11,642 16,858 -- --
------- --------- ----------- --------- ------- ------- ------- -------
Fair Value Adjustments - Six
Months Ended June 30, 2002 43,381 (187,626) 151,773 (24,830) 11,642 16,858 (3,939) (7,259)
Other Activity - Six Months
Ended June 30, 2002:
MSR hedge additions -- -- 833,385 -- -- -- -- --
MSR hedge sales and
maturities -- -- (1,078,131) 32,393 -- -- -- --
MSR hedge receipts
and payments -- -- (32,053) (19,014) -- -- -- --
------- --------- ----------- --------- ------- ------- ------- -------
Total Other Activity - Six
Months Ended June 30, 2002 -- -- (276,799) 13,379 -- -- -- --
------- --------- ----------- --------- ------- ------- ------- -------
Total Impact from
SFAS No. 133 - Six Months
Ended June 30, 2002 $43,381 $(187,626) $ (125,026) $ (11,451) $11,642 $16,858 $(3,939) $(7,259)
======= ========= =========== ========= ======= ======= ======= =======
Total Impact from
SFAS No. 133 - Six Months
Ended June 30, 2001 $(5,204) $ (81,330) $ 193,430 $(126,624) $42,409 $61,407 $(8,957) $(3,551)
======= ========= =========== ========= ======= ======= ======= =======
Page 42
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2002 VERSUS THREE MONTHS ENDED JUNE 30, 2001
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 June 30, 2002
---------------------------------------
Average Average
Balance Interest Rate
------- -------- ----
(dollars in millions)
ASSETS
Interest-earning assets (1):
Securities, interest-bearing deposits in banks and other (2) $ 439 $ 14 12.65%
Mortgage-backed securities available for-sale 5,093 76 5.96
Mortgage-backed securities held-to-maturity 1,204 18 6.08
Loans held for sale, net 1,758 29 6.57
Loans receivable, net:
Residential 28,453 435 6.11
Commercial real estate 6,634 116 7.00
Consumer 1,011 15 6.06
Automobile 2,032 65 12.74
Commercial banking 765 11 5.75
------- ----
Total loans receivable, net 38,895 642 6.60
FHLB stock 1,247 20 6.42
------- ----
Total interest-earning assets 48,636 799 6.57%
----
Noninterest-earning assets 4,040
-------
Total assets $52,676
=======
LIABILITIES, MINORITY INTEREST
AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
Deposits $24,702 126 2.04%
Securities sold under agreements to repurchase (3) 2,143 21 3.89
Borrowings (3) 21,341 281 5.27
Other 168 1 1.77
------- ----
Total interest-bearing liabilities 48,354 429 3.55%
----
Noninterest-bearing liabilities 1,127
Minority interest 499
Stockholder's equity 2,696
-------
Total liabilities, minority interest
and stockholder's equity $52,676
=======
Net interest income $370
====
Interest rate spread (4) 3.02%
=====
Net interest margin 3.04%
=====
Return on average assets 0.88%
=====
Return on average common equity 17.27%
=====
Return on tangible common equity 22.74%
=====
Average equity to average assets 5.12%
=====
Page 43
Three Months Ended June 30, 2001
---------------------------------------
Average Average
Balance Interest Rate
------- -------- ----
(dollars in millions)
ASSETS
Interest-earning assets (1):
Securities and interest-bearing deposits in banks (2) $ 811 $ 12 5.85%
Mortgage-backed securities available for sale 10,005 164 6.56
Mortgage-backed securities held to maturity 1,631 34 8.24
Loans held for sale, net 1,927 33 6.76
Loans receivable, net:
Residential 31,939 554 6.94
Commercial real estate 6,225 128 8.22
Consumer 890 19 8.70
Automobile 1,762 50 11.36
Commercial banking 590 12 8.24
------- ------
Total loans receivable, net 41,406 763 7.38
FHLB stock 1,402 22 6.39
------- ------
Total interest-earning assets 57,182 1,028 7.19%
Noninterest-earning assets 3,722 ------
-------
Total assets $60,904
=======
LIABILITIES, MINORITY INTEREST
AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
Deposits $24,334 224 3.69%
Securities sold under agreements to repurchase (3) 3,819 53 5.55
Borrowings (3) 28,755 415 5.75
Other 3 -- --
------- ------
Total interest-bearing liabilities 56,911 692 4.86%
Noninterest-bearing liabilities 1,143 ------
Minority interest 499
Stockholder's equity 2,351
-------
Total liabilities, minority interest
and stockholder's equity $60,904
=======
Net interest income $ 336
======
Interest rate spread (4) 2.33%
=====
Net interest margin 2.36%
=====
Return on average assets 0.75%
=====
Return on average common equity 19.31%
=====
Return on tangible common equity 30.54%
=====
Average equity to average assets 3.86%
=====
- ----------
(1) Non-performing assets are included in the average balances for the periods
indicated.
(2) Includes securities, interest-bearing deposits in other banks, securities
purchased under agreements to resell, interest income on California income
tax refund and other interest income.
(3) Interest and average rate include the impact of interest rate swaps.
(4) Interest rate spread represents the difference between the average rates of
total interest-earning assets and total interest-bearing liabilities.
Page 44
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 June 30, 2002 vs. 2001
Increase (Decrease) Due to
-------------------------------------------------
Volume Rate Net
------ ---- ---
INTEREST INCOME: (in millions)
Securities, interest-bearing deposits in banks and other $ (4) $ 6 $ 2
Mortgage-backed securities available for sale (74) (14) (88)
Mortgage-backed securities held to maturity (8) (7) (15)
Loans held for sale, net (3) (1) (4)
Loans receivable, net 24 (146) (122)
FHLB stock (2) -- (2)
----- ----- -----
Total (67) (162) (229)
----- ----- -----
INTEREST EXPENSE:
Deposits 2 (100) (98)
Securities sold under agreements to repurchase (20) (13) (33)
Borrowings (89) (44) (133)
Other -- 1 1
----- ----- -----
Total (107) (156) (263)
----- ----- -----
Change in net interest income $ 40 $ (6) $ 34
===== ===== =====
INTEREST INCOME. Total interest income was $798.8 million for the three
months ended June 30, 2002, a decrease of $228.7 million from the three months
ended June 30, 2001. Total interest-earning assets for the three months ended
June 30, 2002 averaged $48.6 billion, compared to $57.2 billion for the
corresponding period in 2001. The decrease in interest-earning assets is
primarily a result of a decline in mortgage-backed securities, principally due
to management's decision to sharply reduce purchases, and net loan run off, as
well as decreased securities volume and loans held for sale. The yield on total
interest-earning assets during the three months ended June 30, 2002 decreased to
6.57% from 7.19% for the three months ended June 30, 2001, primarily due to the
repricing of loans and mortgage-backed securities available for sale at lower
rates.
GS Holdings earned $641.8 million of interest income on loans receivable
for the three months ended June 30, 2002, a decrease of $121.4 million from the
three months ended June 30, 2001. The average balance of loans receivable was
$38.9 billion for three months ended June 30, 2002, compared to $41.4 billion
for the same period in 2001. The weighted average yield on loans receivable
decreased to 6.60% for the three months ended June 30, 2002 from 7.38% for the
three months ended June 30, 2001. The decrease in the average balance reflects
the sharp run off of residential loans during a period of high refinancing
activity resulting in a shift in the mix of loans, with a higher percentage of
higher rate loans during the second quarter of 2002. The decrease in the
weighted average yield reflects the repricing of variable-rate loans, a decrease
in the prime rate on commercial banking loans and comparatively lower market
interest rates during the three months ended June 30, 2002, partially offset by
a higher yield on auto loans purchased after July 1, 2001, which are recorded on
a gross-coupon basis, rather than a credit-adjusted yield basis. The impact of
this change on net interest income during the three months ended June 30, 2002
was to increase interest income by $11.9 million.
Page 45
Loan production is detailed in the table below (in thousands):
Three Months Ended June 30,
---------------------------
2002 2001
---- ----
Loans funded:
Residential real estate loans:
Adjustable-rate $1,525,246 $2,253,890
Fixed-rate 4,073,907 4,968,232
---------- ----------
Total residential real estate loans 5,599,153 7,222,122
Commercial real estate loans 462,597 555,456
Commercial loans 352,402 297,011
Consumer nonmortgage loans 289,429 215,374
Auto loans (a) 339,191 310,038
---------- ----------
Total loans funded $7,042,772 $8,600,001
========== ==========
Residential real estate loans purchased $1,080,339 $ 558,081
========== ==========
------------
(a) Approximately 49% and 36% of this volume was in prime product; 51% and
64% in sub-prime product for the three months ended June 30, 2002 and
2001, respectively.
GS Holdings earned $28.9 million of interest income on loans held for sale
for the three months ended June 30, 2002, a decrease of $3.7 million from the
three months ended June 30, 2001. The average balance of loans held for sale was
$1.8 billion for the three months ended June 30, 2002, a decrease of $0.2
billion from the comparable period in 2001, primarily attributed to increased
originations of residential fixed-rate loans as a result of heightened borrower
refinancing activity in the declining interest rate environment. Fixed-rate
production for sale totalled $4.0 billion during the three months ended June 30,
2002, a decline of 14.7% over the $4.7 billion originated during the comparable
period in 2001. The weighted average yield on loans held for sale decreased to
6.57% for the three months ended June 30, 2002 from 6.76% for the three months
ended June 30, 2001, primarily due to declining market interest rates.
Interest income on mortgage-backed securities available for sale was $75.9
million for the three months ended June 30, 2002, a decrease of $88.1 million
from the three months ended June 30, 2001. The average portfolio balance
decreased $4.9 billion, to $5.1 billion for the three months ended June 30, 2002
compared to the same period in 2001. The weighted average yield on these assets
decreased from 6.56% for the three months ended June 30, 2001 to 5.96% for the
three months ended June 30, 2002. The decrease in the volume is primarily
attributed to management's decision to sharply reduce purchases, coupled with
high repayments and sales of mortgage-backed securities. The decrease in the
weighted average yield primarily reflects the repricing of variable-rate
securities at lower rates.
Interest income on mortgage-backed securities held to maturity was $18.3
million for the three months ended June 30, 2002, a decrease of $15.3 million
from the three months ended June 30, 2001. The average portfolio balance
decreased $0.4 billion, to $1.2 billion for the three months ended June 30, 2002
compared to the same period in 2001, primarily due to repayments. The weighted
average yields for the three months ended June 30, 2002 and 2001 were 6.08% and
8.24%, respectively. The decrease in the weighted average yield is primarily the
result of the repricing of variable-rate securities at lower rates.
Interest income on securities, interest-bearing deposits in banks and other
was $13.9 million for the three months ended June 30, 2002, an increase of $2.0
million from the three months ended June 30, 2001. The average portfolio balance
was $0.4 billion and $0.8 billion for the three months ended June 30, 2002 and
2001, respectively. The weighted average yield of 12.65% for the three months
ended June 30, 2002 compared to 5.85% for the three months ended June 30, 2001.
The decrease in the volume is primarily attributed to payments and maturities of
securities. The increase in weighted average yield reflects $11.2 million of
interest income related to a California income tax refund for which there is no
corresponding earning asset; if this amount is excluded, the weighted average
yield for the three months ended June 30, 2002 would be 2.44%. The weighted
average yield also reflects a
Page 46
shift in the mix of securities, with lower average balances of higher rate
securities held to maturity during the second quarter of 2002.
Dividends on FHLB stock were $20.0 million for the three months ended June
30, 2002, a decrease of $2.4 million from the three months ended June 30, 2001.
The average balance outstanding was $1.2 billion and $1.4 billion for the three
months ended June 30, 2002 and 2001, respectively. The weighted average dividend
on FHLB stock increased to 6.42% for the three months ended June 30, 2002 from
6.39% for the three months ended June 30, 2001.
INTEREST EXPENSE. Total interest expense was $428.5 million for the three
months ended June 30, 2002, a decrease of $262.6 million from the three months
ended June 30, 2001. The decrease is primarily due to declining market interest
rates and a reduction in borrowings under FHLB advances and securities sold
under agreements to repurchase, partially offset by a slight increase in average
deposits.
Interest expense on deposits, including Brokered Deposits, was $125.7
million for the three months ended June 30, 2002, a decrease of $97.9 million
from the three months ended June 30, 2001. The average balance of deposits
outstanding increased from $24.3 billion for the three months ended June 30,
2001 to $24.7 billion for the three months ended June 30, 2002. The increase in
the average balance is primarily attributed to increases in the average balances
of money market accounts, retail customer checking and savings accounts,
partially offset by a decline in CDs and custodial accounts. The overall
weighted average cost of deposits decreased to 2.04% for the three months ended
June 30, 2002 from 3.69% for the three months ended June 30, 2001, primarily due
to declining market interest rates and a shift in the mix of deposits, with
higher average balances of lower rate money market, checking and savings
accounts, and a lower average balance of higher rate CDs during the second
quarter of 2002.
Interest expense on securities sold under agreements to repurchase totalled
$21.0 million for the three months ended June 30, 2002, a decrease of $32.4
million from the three months ended June 30, 2001. The average balance of such
borrowings for the three months ended June 30, 2002 and 2001 was $2.1 billion
and $3.8 billion, respectively. The decrease in the average balance is primarily
the result of maturities, which were not renewed in light of the decline in
interest-earning assets. The weighted average interest rate on these instruments
decreased to 3.89% for the three months ended June 30, 2002 from 5.55% for the
three months ended June 30, 2001, primarily due to maturities of higher
fixed-rate borrowings and the repricing of variable-rate borrowings at lower
rates.
Interest expense on borrowings totalled $281.0 million for the three months
ended June 30, 2002, a decrease of $133.0 million from the three months ended
June 30, 2001. The average balance outstanding for the three months ended June
30, 2002 and 2001 was $21.3 billion and $28.8 billion, respectively. The
weighted average interest rate on these instruments decreased to 5.27% for the
three months ended June 30, 2002 from 5.75% for the three months ended June 30,
2001. The decrease in the average volume is primarily the result of maturities,
which were not renewed in light of the decline in interest-earning assets, while
the decrease in the weighted average rate is primarily due to declining market
interest rates.
NET INTEREST INCOME. Net interest income was $370.3 million for the three
months ended June 30, 2002, an increase of $33.9 million from the three months
ended June 30, 2001. The interest rate spread increased to 3.02% for the three
months ended June 30, 2002 from 2.33% for the three months ended June 30, 2001,
primarily as a result of declining market interest rates reducing costs of
liabilities at a faster rate than the decline in the yield on assets.
Lower-costing liabilities were the result of the replacement of higher-rate
borrowings and deposits with lower-rate borrowings and deposits as these
instruments came due or were repaid. The net interest margin increased to 3.04%
for the three months ended June 30, 2002, up 68 bps from the 2.36% reported
during the second quarter of 2001. Excluding the $11.2 million interest on the
California income tax refund, the interest rate spread and net interest margin
for the three months ended June 30, 2002 would be 2.93% and 2.95%, respectively.
NONINTEREST INCOME. Total noninterest income, consisting primarily of loan
servicing fees, customer banking fees, gain on sale, settlement and transfer of
loans, net, gain on sale of assets, net and other income, was $(0.3) million for
the three months ended June 30, 2002, representing a decrease of $114.6 million
from the three months ended June 30, 2001.
Page 47
Loan servicing fees for the Company, were $(97.8) million for the three
months ended June 30, 2002, compared to $19.7 million the three months ended
June 30, 2001. The following table details the components of loan servicing
fees, net (in thousands):
Three Months Ended June 30,
---------------------------
2002 2001
---- ----
Components of loan servicing fees, net:
Loan servicing fees $ 124,304 $111,050
Amortization of MSRs (98,271) (88,598)
Pass-through Interest Expense (8,463) (9,258)
Net (loss) gain on MSRs/MSR derivatives (SFAS No. 133) (15,341) 6,552
MSR valuation provision (100,000) --
--------- --------
Total loan servicing fees, net $ (97,771) $ 19,746
========= ========
Portfolio run off rate (residential portfolio only) 26.4% 30.5%
MSR value run off rate (residential portfolio only) 19.8 25.5
MSR amortization rate (residential portfolio only) 20.7 23.5
As the table reflects, gross loan servicing fees increased $13.3 million
from year-ago levels, which is primarily attributable to the growth of the
Company's servicing portfolio and higher ancillary fees. The single-family
residential loan servicing portfolio, excluding loans serviced for the Bank,
increased from $88.5 billion at March 31, 2002 to $90.7 billion at June 30,
2002. MSR amortization, which increased $9.7 million in the second quarter of
2002 over the same period in 2001, is affected by a higher average MSR balance
for the three months ended June 30, 2002 over the same period in 2001, partially
offset by a lower portfolio runoff rate, representing the percentage of the
residential portfolio that has been paid off during the year. Pass-through
Interest Expense decreased $0.8 million or 9% year over year, also influenced by
lower runoff rates. Total loan servicing fees, net for the second quarter of
2002 and 2001 includes net pre-tax (loss) gain of $(15.3) million and $6.6
million, respectively, from the impact of SFAS No. 133 pertaining to the MSR
fair value hedges. After recording these (losses) gains in accordance with SFAS
No. 133, the Company determined that the fair value of the MSR asset was less
than its carrying value and recorded a pre-tax valuation provision on the MSRs
of $100.0 million during the three months ended June 30, 2002.
Customer banking fees were $60.9 million for the three months ended June
30, 2002 compared to $54.6 million for the three months ended June 30, 2001. The
following table details the components of customer banking fees and service
charges (in thousands):
Three Months Ended June 30,
---------------------------
2002 2001
---- ----
Components of customer banking fees and service charges:
Customer and electronic banking fees $40,019 $35,392
Other customer fees 805 678
Investment sales income 17,819 15,968
Insurance commissions 2,229 2,521
------- -------
Total customer banking fees and service charges $60,872 $54,559
======= =======
The increase is primarily attributed to increased emphasis by management on
transaction account growth and higher fee income on mutual fund, annuity and
other investment and insurance product sales through CFI. Second quarter 2002
also includes a $0.8 million reclassification to reflect gross revenues from
customer check printing fees rather than net revenues. The offset is included in
the "other expense" line of the income statement.
Page 48
Gain on sale, settlement and transfer of loans, net totalled $20.9 million
for the three months ended June 30, 2002, an increase of $3.9 million from the
three months ended June 30, 2001. During the three months ended June 30, 2002,
California Federal sold $5.0 billion in single-family mortgage loans with
servicing rights retained as part of its ongoing mortgage banking operations at
gains of $22.1 million compared to $4.2 billion of such sales for the
corresponding period in 2001 at gains of $10.5 million. The overall increase in
the volume of loans sold and the related gain is a result of the significant
increase in fixed-rate loan originations due to the overall decline in market
interest rates and increased mortgage refinancing. The results in 2002 and 2001
include a $1.6 million unrealized loss and a $3.6 million unrealized gain,
respectively, on the derivative rate locks, forward loan sale commitments and
closed loan inventory from the application of SFAS No. 133.
Gain on sale of assets, net totalled $10.3 million for the three months
ended June 30, 2002, compared to a net gain of $15.8 million for the three
months ended June 30, 2001. The gain during the second quarter of 2002 includes
a $14.2 million gain on the sale of a real estate partnership interest and a
$3.4 million gain on the sale of the Santa Barbara branch, partially offset by
an $8.1 million loss on the mark-to-market of the Company's portfolio of IO
strip and "B" tranche mortgage securities pursuant to EITF No. 99-20. The gain
during 2001 is primarily attributed to a $9.3 million gain on the sale of the
Company's Concord EFS stock and a gain of $6.6 million on the sale of $298
million in mortgage-backed securities.
NONINTEREST EXPENSE. Total noninterest expense was $224.5 million for the
three months ended June 30, 2002, a decrease of $16.8 million compared to the
three months ended June 30, 2001. Excluding the amortization of goodwill and
other intangible assets, noninterest expense for the three months ended June 30,
2002 was $223.3 million, a decrease of $3.0 million over the same period in the
prior year. Noninterest expense for the three months ended June 30, 2002
included decreases of $13.8 million in amortization of intangible assets, $6.7
million in other expense, $1.1 million in professional fees and $1.0 million in
loan expense. These decreases were partially offset by increases of $4.3 million
in compensation and employee benefits expense, $0.8 million in occupancy and
equipment expense and $0.6 million in foreclosed real estate operations, net.
Compensation and employee benefits expense was $117.8 million for the three
months ended June 30, 2002, an increase of $4.3 million from the three months
ended June 30, 2001. The increase is primarily attributed to an increase in
staff (from 8,015 FTE at June 30, 2001 to 8,185 at June 30, 2002) and temporary
personnel, primarily in volume-related operating groups, and normal salary
adjustments.
Professional fees were $8.7 million for the three months ended June 30,
2002, a decrease of $1.1 million from the three months ended June 30, 2001,
primarily due to an overall decrease in legal fees related to various legal
cases.
Amortization of intangible assets was $1.2 million for the three months
ended June 30, 2002, a decrease of $13.8 million from the three months ended
June 30, 2001, due to the adoption of SFAS No. 142 on January 1, 2002, which
requires that goodwill no longer be amortized.
Other noninterest expense was $52.5 million for the three months ended June
30, 2002 compared to $59.2 million for the same period in 2001. The decrease in
expenses relates to decreases in a number of operating expense categories,
including marketing, retail back office operations, judgments and settlements,
employee travel expense and telephone.
PROVISION FOR INCOME TAX. During the three months ended June 30, 2002 and
2001, GS Holdings recorded net income tax expense of $22.3 million and $87.5
million, respectively. The expense recorded during the three months ended June
30, 2002 is net of income tax benefit of $31.4 million from the reduction of the
valuation allowance and $5.7 million from the reduction of the accrued state tax
liability. The expense recorded during the three months ended June 30, 2001 is
net of income tax benefit of $3.2 million recognized due to the utilization of
net operating losses of a subsidiary made available as a result of the
subsidiary's liquidation into California Federal Bank.
Page 49
GS Holdings' effective gross federal tax rate was 15% and 36% during the
three months ended June 30, 2002 and 2001, respectively, while its federal
statutory tax rate was 35% during both periods. In 2002, the difference between
the effective and statutory rates was primarily the result of a reduction of the
valuation allowance, partially offset by an increase in federal tax recorded in
conjunction with the reduction in the accrued state tax liability. In 2001, the
difference between the effective and statutory rates was primarily the result of
nondeductible goodwill amortization. GS Holdings' effective state tax rate was
0% and 6% during the three months ended June 30, 2002 and 2001, respectively.
The effective state tax rate declined during 2002 as a result of a reduction of
the accrued state tax liability.
MINORITY INTEREST. During each of the three months ended June 30, 2002 and
2001, dividends on the REIT Preferred Stock were recorded totalling $6.7
million, net of income tax benefit, which will inure to the Company as a result
of the deductibility of such dividends for income tax purposes.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. Cumulative effect of
change in accounting principle for the three months ended June 30, 2001 includes
a write-down of $1.6 million, net of income taxes of $1.1 million, on certain
securities as a result of the Company's implementation of EITF No. 99-20 on
April 1, 2001. See note 12 of the Company's Notes to Unaudited Consolidated
Financial Statements.
IMPACT OF SFAS NO. 133. On January 1, 2001, the Company adopted SFAS No.
133. The pronouncement impacted several other areas of the financial statements
for the three months ended June 30, 2002 and 2001, as summarized below
(debit/(credit); in thousands):
Assets Liabilities and Equity Pre-tax Earnings
-------------------------------- ------------------------------ ----------------------
Loans Taxes- Loan (Gain)/Loss
Held Residential Derivative Derivative Other Servicing on Sale of
For Sale MSRS Assets Liabilities Liabilities OCI Fees, Net Loans
-------- ---- ------ ----------- ----------- --- --------- -----
Fair value adjustments:
MSRs and MSR hedges $ -- $(239,403) $ 209,777 $ 14,285 $ -- $ -- $15,341 $ --
Warehouse loans and
pipeline hedges 24,671 -- (13,407) (12,876) -- -- -- 1,612
Cash flow (balance sheet)
hedges - swaps -- -- -- (89,349) 36,500 52,849 -- --
-------- --------- --------- --------- -------- -------- ------- -------
Fair Value Adjustments - Three
Months Ended June 30, 2002 24,671 (239,403) 196,370 (87,940) 36,500 52,849 15,341 1,612
Other Activity - Three Months
Ended June 30, 2002:
MSR hedge additions -- -- 416,498 -- -- -- -- --
MSR hedge sales and
maturities -- -- (569,501) (1,229) -- -- -- --
MSR hedge receipts
and payments -- -- (13,670) (17,455) -- -- -- --
-------- --------- --------- --------- -------- -------- ------- -------
Total Other Activity - Three
Months Ended June 30, 2002 -- -- (166,673) (18,684) -- -- -- --
-------- --------- --------- --------- -------- -------- ------- -------
Total Impact from
SFAS No. 133 - Three
Months Ended June 30, 2002 $ 24,671 $(239,403) $ 29,697 $(106,624) $ 36,500 $ 52,849 $15,341 $ 1,612
======== ========= ========= ========= ======== ======== ======= =======
Total Impact from
SFAS No. 133 - Three
Months Ended June 30, 2001 $(10,443) $ 114,750 $ (11,233) $ 25,109 $(14,114) $(20,437) $(6,552) $(3,640)
======== ========= ========= ========= ======== ======== ======= =======
Page 50
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
CALIFORNIA FEDERAL GOODWILL LITIGATION
The Bank is the plaintiff in a lawsuit against the Government, the
California Federal Goodwill Litigation. In the California Federal Goodwill
Litigation, the Bank alleged, among other things, that the Government breached
certain contractual commitments regarding the computation of its regulatory
capital for which the Bank sought damages and restitution. The Bank's claims
arose from changes, mandated by FIRREA, with respect to the rules for computing
Old California Federal's regulatory capital.
In late 1997, a Claims Court Judge ruled in favor of the Bank's motion for
partial summary judgment as to the Government's liability to the Bank for breach
of contract, and a formal order in that regard was subsequently issued. In late
1998, a second Claims Court Judge ruled that California Federal could not meet
its burden for proving lost profits damages and ordered that the case proceed to
trial on the damage issue of restitution and reliance.
On April 16, 1999, the Claims Court issued its decision on the damages
claim against the Government in the California Federal Goodwill Litigation,
ruling that the Government must compensate the Bank in the sum of approximately
$23 million. The summary judgment liability decision by the first Claims Court
Judge was appealed by the Government, and the damage award by the second Claims
Court Judge was appealed by the Bank.
On April 3, 2001, the Court of Appeals for the Federal Circuit upheld the
summary judgment liability decision and the approximately $23 million damage
award, but it also ruled that the Bank be allowed to present evidence regarding
damages incurred under the lost profits theory. The case has been remanded back
to the Claims Court for a damages trial under the lost profits theory, and trial
is currently expected to begin in the first week of September 2002. In
preparation for this trial, the Bank has had prepared a supplemental expert
report, which contains alternate damage calculations based upon different
assumptions, with the higher calculation being $587 million in lost profits and
the lower calculation being $288 million in lost profits. The Government has had
prepared reports from four different experts, all of which challenge, for a
variety of reasons, the calculations in the Bank's expert report and which
essentially contend that the Bank is not entitled to any damages other than the
approximately $23 million previously awarded by the Claims Court and affirmed by
the Federal Circuit.
GLENDALE GOODWILL LITIGATION
By virtue of the Glen Fed Merger, the Bank is also a plaintiff in a claim
against the United States in a second lawsuit, the Glendale Goodwill Litigation.
In the Glendale Goodwill Litigation, Glendale Federal sued the Government
contending that FIRREA's treatment of supervisory goodwill constituted a breach
by the Government of its 1981 contract with the Bank, under which the Bank had
merged with a Florida thrift and was permitted to include the goodwill resulting
from the merger in its regulatory capital. In 1992, the Claims Court found in
favor of Glendale Federal's position, ruling that the Government breached its
express contractual commitment to permit Glendale Federal to include supervisory
goodwill in its regulatory capital and that Glendale Federal is entitled to seek
financial compensation.
The trial began in February 1997 and concluded in September 1998. On April
9, 1999, the Claims Court issued its decision in the Glendale Goodwill
Litigation, ruling that the Government must compensate the Bank in the sum of
$908.9 million. This decision was appealed by the Government and the Bank.
On February 16, 2001, the Court of Appeals for the Federal Circuit vacated
the trial court's award of damages and remanded the case back to the trial court
for determination of total reliance damages to which the Bank might be entitled.
Oral argument before the trial court took place on June 26, 2001, and on August
2, 2002, the Claims Court ruled that the Bank's total reliance damages were
$380.8 million.
Page 51
BARTOLD V. GLENDALE FEDERAL BANK ET AL.
On September 18, 1995, four plaintiffs commenced an action in Superior
Court of California, County of Orange, alleging that the defendants Glendale
Federal, to which the Bank is a successor by merger, and Verdugo, a wholly owned
subsidiary of the Bank, failed timely to record their release of the mortgage
interest following payoffs of residential mortgage loans and, in at least some
instances, improperly required borrowers to pay fees for these releases. The
plaintiffs' complaint seeks relief for the named plaintiffs, as well as
purportedly for all others similarly situated in California and throughout the
United States and the general public, on causes of action for violation of
California Civil Code Section 2941 and California Business and Professions Code
Section 17200, breach of contract, fraud and unjust enrichment. The plaintiffs
seek statutory damages of $300 for each supposed, separate violation of Section
2941 by Glendale Federal and Verdugo, restitution, punitive damages, injunctive
relief and attorney's fees, among other things.
In October 1997, the trial court granted summary judgment for the
defendants. In September 2000, the California Court of Appeals reversed this
decision and remanded for further proceedings, including further development of
class certification issues. On March 2, 2001, the trial court held that a
California class had been certified. On June 7, 2001, the trial court dismissed
two of the four causes of action against the Bank, holding that the OTS
pre-empted the California courts from regulating the Bank's procedures for
reconveying deeds. The California Court of Appeal denied plaintiff's petition
for review of the trial court's decision.
In September 2001, the California state legislature amended California
Civil Code Section 2941 (Assembly Bill 1090) clarifying the legislature's intent
that loan servicers had 39 days from loan pay off to deliver reconveyance
documents and that trustees had 21 days from the time of receiving the
reconveyance documents to record or cause to be recorded the reconveyance. This
amendment specifically abrogated the contrary September 2000 holding of the
California Court of Appeal in this litigation.
The Bank believes that it has additional meritorious defenses to
plaintiffs' claims and intends to continue to contest the remaining claims in
the lawsuit vigorously.
OTHER LITIGATION
In addition to the matters described above, GS Holdings and its
subsidiaries are involved in other legal proceedings and 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 5. OTHER INFORMATION.
None.
Page 52
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
Quarterly 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 3.2 of the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1998.)
99.1 Certification of Periodic Report by Principal Executive Officer.
99.2 Certification of Periodic Report by Principal Financial Officer.
(b) Reports on Form 8-K:
None.
Page 53
GLOSSARY OF DEFINED TERMS
AICPA - American Institute of Certified Public Accountants
APB - Accounting Principles Board
APB OPINION NO. 17 - Intangible Assets
APB OPINION NO. 25 - Accounting for Stock Issued to Employees
APB OPINION NO. 30 - Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions
ARM - Adjustable-rate mortgage
BANK - California Federal Bank
BPS - basis points
BROKERED DEPOSITS - Issued CDs through direct placement programs and national
investment banking firms
CAL FED ACQUISITION - Agreement and Plan of Merger among FN Holdings, Cal Fed
Bancorp Inc. and California Federal Bank, A Federal Savings Bank. FN
Holdings acquired 100% of the outstanding stock of Cal Fed and Old
California Federal, and First Nationwide merged with and into Old
California Federal in January 1997.
CALIFORNIA FEDERAL - California Federal Bank
CALIFORNIA FEDERAL GOODWILL LITIGATION - California Federal Bank v. United
States, Civil Action 92-138
CD - Certificate of deposit
CITIGROUP - Citigroup Inc.
CLAIMS COURT - United States Court of Federal Claims
COFI - Cost of Funds Index (tied to the FHLB's 11th District cost of funds)
COMPANY - Golden State Holdings Inc.
EITF - Emerging Issues Task Force
EITF NO. 99-20 - Recognition of Interest Income and Impairment on Purchased
and Retained Beneficial Interests in Securitized Financial Assets
EPS - earnings per share
FASB - Financial Accounting Standards Board
FDICIA - Federal Deposit Insurance Corporation Improvement Act
FEDERAL CIRCUIT - U.S. Court of Appeals for the Federal Circuit
FHLB - Federal Home Loan Bank of San Francisco
FHLB SYSTEM - Federal Home Loan Bank System
FIRREA - Financial Institutions Reform, Recovery and Enforcement Act of 1989 and
its implementing regulations.
FN HOLDINGS - First Nationwide Holdings Inc.
FN HOLDINGS ASSET TRANSFER - FN Holdings contributed all of its assets
(including all of the common stock of the Bank) to GS Holdings in September
1998.
FN HOLDINGS NOTES - FN Holdings 12 1/4% Senior Notes, the FN Holdings 9 1/8%
Senior Sub Notes and the FN Holdings 10 5/8% Notes, collectively
FNMC - First Nationwide Mortgage Corporation
FTE - Full-time equivalent staff
GAAP -accounting principles generally accepted in the United States of America
GLEN FED MERGER - Glendale Federal Bank merged with and into the Bank
GLENDALE FEDERAL - Glendale Federal Bank, Federal Savings Bank
GLENDALE GOODWILL LITIGATION - Glendale Federal Bank v. United States, No.
90-772C
GNMA - Government National Mortgage Association
GOLDEN STATE - Golden State Bancorp Inc.
GOLDEN STATE ACQUISITION - FN Holdings Asset Transfer, Holding Company Mergers
and Glen Fed Merger, collectively
GOVERNMENT - United States Government
GS HOLDINGS - Golden State Holdings Inc.
HOLDING COMPANY MERGERS - FN Holdings merged with and into Golden State
Financial Corporation, which owned all of the common stock of Glendale
Federal.
HUNTER'S GLEN - Hunter's Glen/Ford, Ltd.
IO - Interest only
IRS - Internal Revenue Service
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GLOSSARY OF DEFINED TERMS (CONTINUED)
LIBOR - London Interbank Offered Rate
LTW(TM) - Litigation Tracking Warrants(TM)
MERCURY MERGER SUB - Mercury Merger Sub, Inc., a subsidiary of Citigroup
MERGER - The merger of Golden State with and into Mercury Merger Sub, with
Mercury Merger Sub as the surviving entity
MERGER AGREEMENT - the Agreement and Plan of Merger that provides for, among
other things, the Merger
MSR - Mortgage servicing rights
notional amount - the amount on which calculations, payments, and the value of a
derivative is based. Notional amounts do not represent direct credit
exposures.
NPV - Net portfolio value
OCI - Other comprehensive income
OLD CALIFORNIA FEDERAL - California Federal Bank, A Federal Savings Bank prior
to the Cal Fed Acquisition.
OTS - Office of Thrift Supervision
PASS-THROUGH INTEREST EXPENSE - represents interest that FNMC pays to the
investor(s) for loans serviced by FNMC, which are paid off by the
borrower(s) before the end of the month. FNMC pays the shortfall of
interest on the respective loans as a result of the contractual agreement
between the servicer (FNMC) and the investor(s) (I. E., GNMA)
PO - Principal only
PREFERRED CAPITAL CORPORATION - California Federal Preferred Capital Corporation
REIT - Real Estate Investment Trust
REIT PREFERRED STOCK - 9 1/8% Noncumulative Exchangeable Preferred Stock,
Series A, issued by California Federal Preferred Capital Corporation in
January 1996.
REPOS - short-term securities sold under agreements to repurchase
SEC - United States Securities and Exchange Commission
SECURITYHOLDERS - consists of Mafco Holdings Inc., GSB Investments Corp.,
MacAndrews & Forbes Holdings Inc., Hunter's Glen/Ford, Ltd. and Gerald Ford
SECURITYHOLDERS AGREEMENT - dated as of May 21, 2002, by and among Citigroup
Inc., Golden State Bancorp Inc., Mafco Holdings Inc., GSB Investments Corp.,
MacAndrews & Forbes Holdings Inc., Hunter's Glen/Ford, Ltd. and Gerald Ford,
pursuant to which the Securityholders, among other things, have agreed to
vote certain shares of Company Common Stock beneficially owned by them,
constituting approximately 31.5% of the outstanding shares of Golden State
Common Stock, in favor of the Merger and against competing business
combination proposals.
SFAS - Statement of Financial Accounting Standards
SFAS NO. 4 - Reporting Gains and Losses from Extinguishment of Debt
SFAS NO. 13 - Accounting for Leases
SFAS NO. 44 - Accounting for Intangible Assets of Motor Carriers
SFAS NO. 64 - Extinguishment of Debt Made to Satisfy Sinking-Fund Requirements
SFAS NO. 115 - Accounting for Certain Investments in Debt and Equity Securities
SFAS NO. 121 - Accounting for the Impairment of Long-lived Assets and for Long-
lived Assets to be Disposed of
SFAS NO. 131 - Disclosures about Segments of an Enterprise and Related
Information
SFAS NO. 133 - Accounting for Derivative Instruments and Hedging Activities
SFAS NO. 142 - Accounting for Goodwill and Intangible Assets
SFAS NO. 144 - Accounting for the Impairment or Disposal of Long-Lived Assets
SFAS NO. 145 - Rescission of SFAS No. 4, 44, and 64, Amendment of SFAS No. 13,
and Technical Corrections
SOP - Statement of Position
SOP 01-6 - Accounting by Certain Entities (Including Entities With Trade
Receivables) That Lend to or Finance the Activities of Others
STOCK PLAN - Golden State Bancorp Inc. Omnibus Stock Plan
THE MERGER - Mercury Merger Sub merges with and into Golden State, with Mercury
Merger Sub as the surviving entity
VERDUGO - Verdugo Trustee Service Corporation
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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)
August 9, 2002
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