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 September 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 (I.R.S. Employer
of incorporation or organization) Identification No.)
135 Main Street, San Francisco,CA 94105
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
415-904-1100
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
N/A
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. X YES No
----- -----
The number of shares outstanding of registrant's $1.00 par value common
stock, as of the close of business on October 31, 2002: 1,000 shares.
Page 1
GOLDEN STATE HOLDINGS INC.
THIRD QUARTER 2002 REPORT ON FORM 10-Q
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION ----
---------------------
Item 1. Consolidated Financial Statements
Unaudited Consolidated Balance Sheets
September 30, 2002 and December 31, 2001...........................3
Unaudited Consolidated Statements of Income
Nine Months Ended Septemeber 30, 2002 and 2001.....................4
Unaudited Consolidated Statements of Income
Three Months Ended September 30, 2002 and 2001.....................5
Unaudited Consolidated Statements of Comprehensive Income
Nine Months Ended September 30, 2002 and 2001......................6
Unaudited Consolidated Statements of Comprehensive Income
Three Months Ended September 30, 2002 and 2001.....................7
Unaudited Consolidated Statement of Stockholder's Equity
Nine Months Ended September 30, 2002...............................8
Unaudited Consolidated Statements of Cash Flows
NineMonths Ended September 30, 2002 and 2001.......................9
Notes to Unaudited Consolidated Financial Statements..............11
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.....................31
Critical Accounting Policies......................................31
Item 3. Quantitative and Qualitative Disclosures About Market Risk........66
Item 4. Controls and Procedures...........................................66
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings.................................................67
Item 2. Changes in Securities.............................................68
Item 3. Defaults Upon Senior Securities...................................68
Item 4. Submission of Matters to a Vote of Security Holders...............68
Item 5. Other Information.................................................68
Item 6. Exhibits and Reports on Form 8-K..................................69
Glossary of Defined Terms..................................................70
Signatures.................................................................73
Certifications.............................................................74
Page 2
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001
(Unaudited)
(dollars in thousands, except per share data)
Assets September 30, 2002 December 31, 2001
------ ------------------ -----------------
Cash and due from banks $ 795,795 $ 709,139
Interest-bearing deposits in other banks 1,302,952 103
Short-term investment securities 89,400 95,929
----------- -----------
Cash and cash equivalents 2,188,147 805,171
Securities available for sale, at fair value 109,816 116,054
Securities held to maturity 17,379 30,602
Mortgage-backed securities available for sale, at fair value 3,879,741 7,057,903
Mortgage-backed securities held to maturity 1,100,407 1,385,113
Loans held for sale, net 1,954,851 2,608,365
Loans receivable, net 36,862,720 39,335,623
Investment in FHLB System 1,105,423 1,446,607
Premises and equipment, net 260,222 276,411
Foreclosed real estate, net 11,986 18,564
Accrued interest receivable 247,413 288,308
Goodwill (net of accumulated amortization of $286,470 at both
September 30, 2002 and December 31, 2001) 563,726 590,420
Other intangible assets (net of accumulated amortization of $23,042 at
September 30, 2002 and $19,541 at December 31, 2001) 46,922 50,423
MSRs (net of valuation allowance of $274,080 at September 30, 2002
and $153,345 at December 31, 2001) 1,002,755 1,623,947
Derivative assets 233,623 349,026
Other assets 843,554 536,281
----------- -----------
Total assets $50,428,685 $56,518,818
=========== ===========
Liabilities, Minority Interest and Stockholder's Equity
-------------------------------------------------------
Deposits $25,100,210 $25,146,827
Securities sold under agreements to repurchase 1,961,157 2,363,945
Borrowings 18,413,733 24,444,541
Derivative liabilities 372,910 250,711
Other liabilities 1,231,494 1,188,005
----------- -----------
Total liabilities 47,079,504 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 1,576,362 1,569,894
Accumulated other comprehensive loss, net (139,052) (63,307)
Retained earnings (substantially restricted) 1,411,870 1,118,221
----------- -----------
Total stockholder's equity 2,849,181 2,624,789
----------- -----------
Total liabilities, minority interest and stockholder's equity $50,428,685 $56,518,818
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
Page 3
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(Unaudited)
(dollars in thousands, except per share data)
Nine Months Ended September 30,
-------------------------------
2002 2001
---- ----
Interest income:
Loans receivable $1,903,553 $2,286,425
Mortgage-backed securities available for sale 229,562 486,859
Mortgage-backed securities held to maturity 56,126 99,401
Loans held for sale 94,700 99,241
Securities available for sale 4,900 16,902
Securities held to maturity 399 22,058
Interest-bearing deposits in other banks 2,585 808
Dividends on FHLB stock 56,811 63,451
Other 14,763 --
---------- ----------
Total interest income 2,363,399 3,075,145
---------- ----------
Interest expense:
Deposits 377,583 666,343
Securities sold under agreements to repurchase 60,616 166,858
Borrowings 847,607 1,238,600
Other 2,384 --
---------- ----------
Total interest expense 1,288,190 2,071,801
---------- ----------
Net interest income 1,075,209 1,003,344
---------- ----------
Noninterest income:
Loan servicing fees, net (62,901) (35,652)
Customer banking fees and service charges 181,603 160,991
Gain on sale, settlement and transfer of loans, net 74,904 69,050
(Loss) gain on sale of assets, net (469) 21,976
Other income 14,788 43,974
---------- ----------
Total noninterest income 207,925 260,339
---------- ----------
Noninterest expense:
Compensation and employee benefits 365,449 345,993
Occupancy and equipment 123,238 119,135
Professional fees 23,999 25,185
Loan expense 10,962 12,683
Foreclosed real estate operations, net (1,366) (1,239)
Amortization of goodwill and other intangible assets 3,501 44,821
Other expense 168,782 168,052
---------- ----------
Total noninterest expense 694,565 714,630
---------- ----------
Income before income taxes, minority interest and cumulative effect of change in
accounting principle 588,569 549,053
Income tax expense 194,680 211,253
Minority interest: other 20,240 20,241
---------- ----------
Income before cumulative effect of change in accounting principle 373,649 317,559
Cumulative effect of change in accounting principle, net of applicable taxes of $1,072 in 2001 -- (1,552)
---------- ----------
Net income $ 373,649 $ 316,007
========== ==========
See accompanying notes to unaudited consolidated financial statements.
Page 4
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(Unaudited)
(dollars in thousands, except per share data)
Three Months Ended September 30,
--------------------------------
2002 2001
---- ----
Interest income:
Loans receivable $612,551 $745,411
Mortgage-backed securities available for sale 61,064 141,882
Mortgage-backed securities held to maturity 16,396 28,418
Loans held for sale 23,997 46,565
Securities available for sale 1,619 2,327
Securities held to maturity 123 5,606
Interest-bearing deposits in other banks 2,427 269
Dividends on FHLB stock 16,019 18,079
Other 2,685 --
-------- --------
Total interest income 736,881 988,557
-------- --------
Interest expense:
Deposits 116,721 201,854
Securities sold under agreements to repurchase 18,262 45,466
Borrowings 263,759 384,753
Other 929 --
-------- --------
Total interest expense 399,671 632,073
-------- --------
Net interest income 337,210 356,484
-------- --------
Noninterest income:
Loan servicing fees, net 43,685 (28,746)
Customer banking fees and service charges 62,583 55,171
Gain on sale, settlement and transfer of loans, net 19,389 47,165
(Loss) gain on sale of assets, net (8,851) 5,755
Other income 3,151 7,534
-------- --------
Total noninterest income 119,957 86,879
-------- --------
Noninterest expense:
Compensation and employee benefits 122,854 114,796
Occupancy and equipment 42,226 41,334
Professional fees 7,930 10,535
Loan expense 3,431 4,114
Foreclosed real estate operations, net (695) (386)
Amortization of goodwill and other intangible assets 1,167 14,941
Other expense 60,614 56,888
-------- --------
Total noninterest expense 237,527 242,222
-------- --------
Income before income taxes and minority interest 219,640 201,141
Income tax expense 81,073 87,544
Minority interest 6,746 6,747
-------- --------
Net income $131,821 $106,850
======== ========
See accompanying notes to unaudited consolidated financial statements.
Page 5
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(Unaudited)
(in thousands)
Nine Months Ended September 30,
-------------------------------
2002 2001
---- ----
Net income $ 373,649 $ 316,007
Other comprehensive (loss) income, net of tax:
Unrealized holding (loss) gain on securities available for sale:
Unrealized holding (loss) gain arising during the period (3,378) 148,627
Less: reclassification adjustment for gain included
in net income (1,202) (15,483)
--------- ---------
(4,580) 133,144
Amortization of market adjustment for securities
transferred from available-for-sale to held-to-maturity -- 17,912
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 (147,888) (127,349)
Less: reclassification adjustment for loss included
in net income 76,743 25,406
--------- ---------
Change in fair value of derivatives used for cash flow hedges,
net of applicable taxes of $49,133 in 2002
and $70,402 in 2001 (71,145) (101,943)
--------- ---------
Other comprehensive (loss) income (75,725) 4,466
--------- ---------
Comprehensive income $ 297,924 $ 320,473
========= =========
See accompanying notes to unaudited consolidated financial statements.
Page 6
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(Unaudited)
(in thousands)
Three Months Ended September 30,
--------------------------------
2002 2001
---- ----
Net income $131,821 $106,850
Other comprehensive loss, net of tax:
Unrealized holding (loss) gain on securities available for sale:
Unrealized holding (loss) gain arising during the period (1,193) 50,462
Less: reclassification adjustment for gain included
in net income -- (5,911)
-------- --------
(1,193) 44,551
Amortization of market adjustment for securities
transferred from available-for-sale to held-to-maturity -- 14,446
Unrealized loss on derivatives used for cash flow hedges:
Unrealized holding loss arising during the period (79,602) (98,672)
Less: reclassification adjustment for loss included
in net income 25,315 13,489
-------- --------
Change in fair value of derivatives used for cash flow hedges,
net of applicable taxes of $37,491 in 2002
and $58,828 in 2001 (54,287) (85,183)
-------- --------
Other comprehensive loss (55,480) (26,165)
-------- --------
Comprehensive income $ 76,341 $ 80,664
======== ========
See accompanying notes to unaudited consolidated financial statements.
Page 7
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2002
(Unaudited)
(dollars in thousands)
Additional Accumulated Other Comprehensive Income (Loss), 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 -- -- -- -- --
Dividends to parent -- -- -- -- --
Change in net unrealized holding gain
on securities available for sale -- -- (4,580) -- (4,580)
Change in net unrealized holding loss
on derivatives -- -- -- (71,145) (71,145)
Impact of Golden State restricted
common stock -- 3,040 -- -- --
Tax benefit on exercise of stock options -- 3,428 -- -- --
---- ---------- ------- --------- ---------
Balance at September 30, 2002 $ 1 $1,576,362 $51,472 $(190,524) $(139,052)
==== ========== ======= ========= =========
(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 373,649 373,649
Dividends to parent (80,000) (80,000)
Change in net unrealized holding gain
on securities available for sale -- (4,580)
Change in net unrealized holding loss
on derivatives -- (71,145)
Impact of Golden State restricted
common stock -- 3,040
Tax benefit on exercise of stock options -- 3,428
---------- ----------
Balance at September 30, 2002 $1,411,870 $2,849,181
========== ==========
See accompanying notes to unaudited consolidated financial statements.
Page 8
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(Unaudited)
(in thousands)
Nine Months Ended September 30,
-------------------------------
2002 2001
---- ----
Cash flows from operating activities:
Net income $ 373,649 $ 316,007
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Amortization of goodwill and other intangible assets 3,501 44,821
Amortization of purchase accounting premiums and discounts, net 7,592 8,125
Accretion of discount on borrowings 688 818
Amortization of MSRs 326,269 219,793
Loss (gain) on sale of assets, net 469 (21,976)
Gain on sale of foreclosed real estate, net (1,994) (2,438)
Loss on sale, settlement and transfer of loans, net 274,356 184,371
Capitalization of originated MSRs (349,260) (253,421)
Depreciation and amortization of premises and equipment 39,907 39,903
Amortization of deferred debt issuance costs 4,480 5,283
FHLB stock dividends (56,811) (63,451)
Purchases and originations of loans held for sale (14,701,581) (12,205,482)
Net proceeds from the sale of loans held for sale 15,046,828 10,933,006
Net gain on derivatives used to hedge MSRs (33,855) (29,491)
Provision for loss on MSRs 120,735 158,000
Increase in other assets (169,297) (289,628)
Decrease in accrued interest receivable 40,895 36,372
Increase in other liabilities 238,631 485,580
Amortization of deferred compensation expense - Golden State
restricted common stock 1,289 1,379
Gain on non-monetary exchange of Star Systems common stock -- (20,671)
Reduction in net accrued tax liability -- (25,805)
Income tax benefit (45,791) (3,370)
Minority interest: other 20,240 20,241
Dividends on restricted common stock 22 49
----------- -----------
Net cash provided by (used in) operating activities $ 1,140,962 $ (461,985)
----------- -----------
(Continued)
See accompanying notes to unaudited consolidated financial statements.
Page 9
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(Unaudited)
(in thousands)
Nine Months Ended September 30,
--------------------------------
2002 2001
---- ----
Cash flows from investing activities:
Purchases of securities available for sale $ (69,052) $ (45,616)
Proceeds from maturities of securities available for sale 78,754 654,157
Purchases of securities held to maturity (2,886) (7,541)
Principal payments and proceeds from maturities
of securities held to maturity 16,109 321,555
Purchases of mortgage-backed securities available for sale (43,644) (120,809)
Principal payments on mortgage-backed securities available for sale 3,129,403 2,263,091
Proceeds from sales of mortgage-backed securities available for sale 64,300 777,265
Principal payments on mortgage-backed securities held to maturity 284,737 344,727
Proceeds from sales of loans 48,436 72,064
Loan originations and principal collections, net 5,625,227 1,630,891
Purchases of loans receivable (3,320,012) (3,138,329)
Purchases of FHLB stock (58,484) (23,193)
Redemption of FHLB stock 399,668 --
Purchases of premises and equipment (27,257) (29,217)
Proceeds from disposal of premises and equipment 19,106 10,806
Proceeds from sales of foreclosed real estate 21,308 24,622
Proceeds from sale of Concord EFS common stock -- 29,948
Purchases of MSRs (223,079) (233,453)
Hedge receipts 86,662 14,663
Purchases of derivatives (1,230,598) (354,017)
Proceeds from sales and settlements of derivatives 1,993,381 408,377
------------ -----------
Net cash provided by investing activities 6,792,079 2,599,991
------------ -----------
Cash flows from financing activities:
Net (decrease) increase in deposits (46,346) 1,055,445
Proceeds from additional borrowings 59,593,471 87,843,153
Principal payments on borrowings (65,597,340) (89,205,993)
Net decrease in securities sold under agreements to repurchase (402,788) (1,117,147)
Principal payment of FN Holdings Notes (250) --
Principal payment of GS Holdings Notes -- (350,000)
Dividends on common stock (80,000) (135,000)
Dividends paid to minority stockholders of subsidiary, net of taxes (20,240) (20,241)
Tax benefits on exercise of stock options 3,428 1,578
------------ -----------
Net cash used in financing activities (6,550,065) (1,928,205)
------------ -----------
Net change in cash and cash equivalents 1,382,976 209,801
Cash and cash equivalents at beginning of period 805,171 783,074
------------ -----------
Cash and cash equivalents at end of period $ 2,188,147 $ 992,875
============ ===========
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 nine months
ended September 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
70 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. On October 28, 2002, Citigroup
received Federal Reserve Board approval for the Merger. On October 29, 2002, the
OTS approved the related merger of the Bank with and into Citibank (West), FSB
(in formation). The Merger is anticipated to close during the fourth quarter of
2002.
The value of the merger consideration per share of the Golden State's
common stock is the sum of
(a) $16.40 and
(b) 0.5613 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, or a
combination, 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
----------------------------------------------------
Nine Months Ended September 30,
-------------------------------
2002 2001
---- ----
(in thousands)
Cash paid for:
Interest $1,370,115 $2,227,021
Income taxes, net 189,178 164,458
Transfer of loans to foreclosed real estate 12,647 22,990
Loans made to facilitate the sale of real estate -- 168
Reclassification of loans from loans held for sale to loans receivable -- 6,542
Reclassification of loans receivable to loans held for sale 100,095 161,073
Goodwill adjustment related to tax adjustments 13,159 --
Impact of restricted common stock 3,040 3,055
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 177,268 159,025
(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.
Nine Months Ended September 30, Three Months Ended September 30,
--------------------------------------------- --------------------------------------------
Community Mortgage Community Mortgage
Banking Banking Total Banking Banking Total
------- ------- ----- ------- ------- -----
(in thousands)
Net interest income after
provision for loan losses: (a)
2002 $ 1,033,696 $ 109,138 $ 1,142,834 $ 326,032 $ 31,243 $ 357,275
2001 1,036,087 73,592 1,109,679 357,105 37,132 394,237
Noninterest income: (b)
2002 $ 239,964 $ (2,912) $ 237,052 $ 73,794 $ 56,047 $ 129,841
2001 271,592 18,572 290,164 104,743 (3,571) 101,172
Noninterest expense: (c)
2002 $ 577,251 $ 120,794 $ 698,045 $ 199,675 $ 39,012 $ 238,687
2001 601,934 116,176 718,110 202,475 40,907 243,382
Pre-tax contribution:
2002 $ 696,409 $ (14,568) $ 681,841 $ 200,151 $ 48,278 $ 248,429
2001 705,745 (24,012) 681,733 259,373 (7,346) 252,027
Segment assets at period end: (d)
2002 $50,191,067 $4,625,912 (e) $54,816,979 $50,191,067 $4,625,912 (e) $54,816,979
2001 59,216,186 7,325,189 (e) 66,541,375 59,216,186 7,325,189 (e) 66,541,375
____________
(a) Includes $67.6 million and $106.3 million for the nine months ended
September 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 $97.3 million and $217.0 million for the nine
months ended September 30, 2002 and 2001, respectively, in interest
income and expense on intercompany loans.
Includes $20.1 million and $37.8 million for the three months ended
September 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 $25.1 million and $82.9 million for the three
months ended September 30, 2002 and 2001, respectively, in interest
income and expense on intercompany loans.
(b) Includes $29.1 million and $29.8 million for the nine months ended
September 30, 2002 and 2001, respectively, in intercompany servicing
fees. Also includes $9.9 million and $14.3 million for the three months
ended September 30, 2002 and 2001, respectively, in intercompany
servicing fees.
(c) Includes $3.5 million for each of the nine months ended September 30,
2002 and 2001, in intercompany noninterest expense. Also includes $1.2
million for each of the three months ended September 30, 2002 and 2001,
in intercompany noninterest expense.
(d) Includes $4.3 billion and $7.0 billion for 2002 and 2001, respectively,
in intercompany borrowings and $49.4 million and $49.9 million for 2002
and 2001, respectively, in intercompany deposits maintained with the
Bank.
(e) Includes $1.2 billion and $1.6 billion for 2002 and 2001, respectively,
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):
Nine Months Ended September 30, Three Months Ended September 30,
------------------------------- --------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net interest income after provision for
loan losses:
Total net interest income for reportable segments $ 1,142,834 $ 1,109,679 $ 357,275 $ 394,237
Elimination of intersegment net interest income (67,625) (106,335) (20,065) (37,753)
----------- ----------- ----------- -----------
Total $ 1,075,209 $ 1,003,344 $ 337,210 $ 356,484
=========== =========== =========== ===========
Noninterest income:
Total noninterest income for reportable segments $ 237,052 $ 290,164 $ 129,841 $ 101,172
Elimination of intersegment servicing fees (29,127) (29,825) (9,884) (14,293)
----------- ----------- ----------- -----------
Total $ 207,925 $ 260,339 $ 119,957 $ 86,879
=========== =========== =========== ===========
Noninterest expense:
Total noninterest expense for reportable segments $ 698,045 $ 718,110 $ 238,687 $ 243,382
Elimination of intersegment expense (3,480) (3,480) (1,160) (1,160)
----------- ----------- ----------- -----------
Total $ 694,565 $ 714,630 $ 237,527 $ 242,222
=========== =========== =========== ===========
Pre-tax contribution:
Total contributions for reportable segments $ 681,841 $ 681,733 $ 248,429 $ 252,027
Elimination of intersegment contributions (93,272) (132,680) (28,789) (50,886)
----------- ----------- ----------- -----------
Total $ 588,569 $ 549,053 $ 219,640 $ 201,141
=========== =========== =========== ===========
Total assets at period end:
Total assets for reportable segments $54,816,979 $66,541,375 $54,816,979 $66,541,375
Elimination of intersegment borrowings (4,338,856) (6,997,022) (4,338,856) (6,997,022)
Elimination of intersegment deposits (49,438) (49,853) (49,438) (49,853)
----------- ----------- ----------- -----------
Total $50,428,685 $59,494,500 $50,428,685 $59,494,500
=========== =========== =========== ===========
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):
September 30, 2002 December 31, 2001
------------------ -----------------
Real estate loans:
1-4 unit residential $26,324,514 $29,546,035
Multi-family residential 4,506,114 4,130,287
Commercial real estate 2,177,980 2,354,919
Land 5,515 14,055
Construction 868 2,495
----------- -----------
Total real estate loans 33,014,991 36,047,791
----------- -----------
Equity-line 878,661 639,297
Other consumer loans 220,651 283,434
Auto loans, net (a) 2,179,431 1,917,591
Commercial loans 778,058 693,114
----------- -----------
Total consumer and other loans 4,056,801 3,533,436
----------- -----------
Total loans receivable 37,071,792 39,581,227
----------- -----------
Deferred loan fees, costs, discounts and premiums, net 232,864 243,120
Allowance for loan losses (448,042) (497,298)
Purchase accounting adjustments, net 6,106 8,574
----------- -----------
Total loans receivable, net $36,862,720 $39,335,623
=========== ===========
___________
(a) $918 million, or 42% and $766 million, or 40% of this portfolio,
represents prime product as of September 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 September 30, 2002, the Company's goodwill
and other intangible assets totalled $610.6 million. Of this amount, $563.7
million represents goodwill that is no longer being amortized as of January 1,
2002 pursuant to SFAS No. 142. The remaining $46.9 million represents other
intangible assets that continue to be amortized. In addition, the Company held
MSR balances in the amount of $1.0 billion at September 30, 2002.
The following table provides details on intangible assets including MSRs:
As of September 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 $ (18,258) $ 46,193 $ 64,451 $ (15,030) $ 49,421
Core deposit intangibles 5,513 (4,784) 729 5,513 (4,511) 1,002
---------- ----------- ---------- ---------- ---------- ----------
Other intangible assets 69,964 (23,042) 46,922 69,964 (19,541) 50,423
MSRs 2,433,721 (a) (1,430,966) 1,002,755 (a) 2,728,643 (a) (1,104,696) 1,623,947 (a)
Goodwill -- -- -- 876,890 (286,470) 590,420
---------- ----------- ---------- ---------- ----------- ----------
Total amortizable
intangible assets $2,503,685 $(1,454,008) $1,049,677 $3,675,497 $(1,410,707) $2,264,790
========== =========== ========== ========== =========== ==========
Unamortizable goodwill $ 850,196 $ (286,470) $ 563,726 $ -- $ -- $ --
========== =========== ========== ========== =========== ==========
(Continued)
Page 15
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
___________
(a) After deducting $274.1 million and $153.3 million for the valuation
allowance at September 30, 2002 and December 31, 2001, respectively.
As of September 30, 2002, all of the Company's goodwill, totalling $563.7
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.
In addition, during the third quarter of 2002, the following changes to
goodwill were recorded:
(a) a $0.9 million decrease representing Federal income tax refunds
related to the 1986-1992 audits of Old Cal Fed and
(b) a $30k increase due to a California state tax refund and
pre-merger interest from the completion of the 1997 audit of
Golden State.
Intangible acquisitions during the period were as follows:
Nine Months Ended September 30,
------------------------------------------------------------------------
2002 2001
-------------------------------- ---------------------------------
Gross Weighted Gross Weighted
Carrying Average Carrying Average
Value Life (in years) Value Life (in years)
----- --------------- ----- ---------------
(dollars in thousands)
MSRs originated and purchased
during the period $572,339 3.4 $486,874 5.2
Three Months Ended September 30,
------------------------------------------------------------------------
2002 2001
-------------------------------- ---------------------------------
Gross Weighted Gross Weighted
Carrying Average Carrying Average
Value Life (in years) Value Life (in years)
----- --------------- ----- ---------------
(dollars in thousands)
MSRs originated and purchased
during the period $129,365 3.4 $227,295 5.2
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 September 30, 2002 $1,076 $ 91 $113,673 $ -- $114,840
Nine months ended September 30, 2002 3,228 273 326,269 -- 329,770
Three months ended September 30, 2001 1,076 91 72,780 13,773 87,720
Nine months ended September 30, 2001 3,228 273 219,793 41,319 264,613
Estimated amortization expense:
Three months ending December 31, 2002 1,076 91 98,616 -- 99,783
Year ending December 31,
2003 4,304 364 287,451 -- 292,119
2004 4,304 364 200,454 -- 205,122
2005 4,304 364 138,662 -- 143,330
2006 4,304 364 92,394 -- 97,062
2007 4,304 364 58,336 -- 63,004
The impact of the adoption of SFAS No. 142 on earnings was as follows:
Nine Months Ended September 30, Three Months Ended September 30,
------------------------------- --------------------------------
2002 2001 2002 2001
---- ---- ---- ----
(in thousands)
Reported net income before cumulative
effect of change in accounting principle $373,649 $317,559 $131,821 $106,850
Add back goodwill amortization, net of tax -- 40,543 -- 13,514
-------- -------- -------- --------
Adjusted net income before cumulative
effect of change in accounting principle $373,649 $358,102 $131,821 $120,364
======== ======== ======== ========
Nine Months Ended September 30, Three Months Ended September 30,
------------------------------- --------------------------------
2002 2001 2002 2001
---- ---- ---- ----
(in thousands)
Reported net income $373,649 $316,007 $131,821 $106,850
Add back goodwill amortization, net of tax -- 40,543 -- 13,514
-------- -------- -------- --------
Adjusted net income $373,649 $356,550 $131,821 $120,364
======== ======== ======== ========
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):
September 30, 2002 December 31, 2001
------------------ -----------------
Transaction Accounts:
Non-interest checking $ 2,364,211 $ 2,013,162
Interest-bearing checking 2,273,112 2,139,674
----------- -----------
Subtotal checking 4,637,323 4,152,836
Money market 5,045,218 4,614,223
Passbook savings 3,193,481 3,055,766
----------- -----------
Total transaction accounts 12,876,022 11,822,825
Certificates of deposit 9,328,273 10,618,260
----------- -----------
Total customer deposits 22,204,295 22,441,085
Custodial accounts 2,837,731 2,512,684
Accrued interest payable 32,856 46,184
Purchase accounting 103 329
----------- -----------
Total retail deposits 25,074,985 25,000,282
Brokered Deposits 25,225 146,545
----------- -----------
Total deposits $25,100,210 $25,146,827
=========== ===========
Checking deposits (including custodials) as a %
of retail deposits 29.8% 26.7%
Transaction accounts (including custodials) as a %
of retail deposits 62.7% 57.3%
Checking deposits (excluding custodials) as a %
of customer deposits 20.9% 18.5%
Transaction accounts (excluding custodials) as a %
of customer deposits 58.0% 52.7%
(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 (3,095) -- (3,095)
------- ------- -------
Balance at September 30, 2002 $11,113 $12,500 $23,613
======= ======= =======
Page 18
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(11) INCOME TAXES
------------
During the nine months ended September 30, 2002, GS Holdings recorded
gross income tax expense of $240.5 million, which was offset by a tax benefit of
$45.8 million, for net income tax expense of $194.7 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
in the second quarter. 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.
On September 11, 2002, California enacted a law requiring large banks
(those with average assets in excess of $500 million) to conform to federal law
with respect to accounting for bad debts. Prior to the law change, all banks,
regardless of size, were eligible to use the reserve method of accounting for
bad debts which enabled them to take deductions for anticipated bad debt losses
prior to the losses being incurred for California tax purposes. With the change,
large banks may now only deduct actual charge-offs net of recoveries in
determining their California taxable income. Banks that are required to conform
to the new law must include in current year taxable income 50 percent of the bad
debt reserves that existed as of the end of the prior tax year. As a concession
for requiring large banks to comply with the new law, recapture of the remaining
50 percent of the reserve is waived thereby creating a permanent tax benefit.
The Company's tax benefit resulting from the law change was $8.7 million and has
been reflected in the Company's income tax expense for the quarter ended
September 30, 2002.
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 the completion of
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
nine months ended September 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 nine months ended September 30, 2001, GS Holdings recorded net
income tax expense of $211.3 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 nine months ended September 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 September 30, 2002, there were 1,000 shares of GS Holdings common
stock issued and outstanding.
Dividends on common stock during the nine months ended September 30, 2002
and 2001 totalled $80.0 million and $135.0 million, respectively.
Page 19
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(13) EXECUTIVE AND STOCK COMPENSATION
--------------------------------
In the nine months ended September 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 nine months ended
September 30, 2001, Golden State granted to certain of the Company's employees
non-qualified stock options equivalent to 1,411,100 shares of common stock at a
weighted average price of $27.69. Golden State did not grant any options to the
Company's employees during the three months ended September 30, 2002 or 2001.
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 nine months ended September 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 nine months ended September 30, 2002, 58,834 and
486,509 options were exercised, and 11,263 and 53,860 options were cancelled or
expired, respectively, under all plans. During the three and nine months ended
September 30, 2001, 159,526 and 314,143 options were exercised and 28,247 and
49,924 options, respectively, were cancelled or expired under all plans.
At September 30, 2002 and 2001, options to acquire an equivalent of
5,059,352 and 4,718,433 shares and 659,583 and 861,916 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 nine
months ended September 30, 2002, 152,299 restricted shares were vested and 2,770
restricted shares were cancelled. During the three months ended September 30,
2002, no restricted shares were vested or cancelled. During the three and nine
months ended September 30, 2001, 28,454 and 143,499 restricted shares were
vested, respectively, and none was cancelled. At September 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 nine months ended
September 30, 2002, $0.4 million and $1.3 million, respectively, in compensation
expense was recognized related to such awards. During the three and nine months
ended September 30, 2001, $0.4 million and $1.4 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
--------------------------------------
September 30, 2002 December 31, 2001
------------------ -----------------
Commitments to extend credit
----------------------------
Unutilized consumer lines $1,806,013 $1,467,625
Unutilized commercial lines of credit 279,973 263,682
Commercial and standby letters of credit 28,138 24,953
The contracts for the Company's commitments to extend credit expire as
follows (in thousands):
September 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 $1,806,013 $525,354 $12,740 $10,574 $1,257,345
Unutilized commercial
lines of credit 279,973 202,525 60,522 10,411 6,515
Commercial and standby
letters of credit 28,138 26,541 1,597 -- --
The fair value of commitments to extend credit was not significant at
either September 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
-----------------------------------------
September 30, 2002 December 31, 2001
------------------ -----------------
(in thousands)
Commitments to originate loans $4,571,467 $3,937,422
Commitments to purchase loans 2,262,925 3,791,436
Mandatory commitments to sell loans 405,494 679,182
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):
September 30, 2002 December 31, 2001
-------------------------------------- --------------------------------------
Instruments Notional Amount Estimated Fair Value Notional Amount Estimated Fair Value
----------- --------------- -------------------- --------------- --------------------
Interest rate caps $2,000,000 $6,159 $2,000,000 $52,163
Interest rate swaptions 1,250,000 820 1,250,000 9,448
The off-balance sheet embedded options in borrowings at September 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
Page 22
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
COMMITMENTS AND CONTINGENCIES
At September 30, 2002, the Bank had pledged as collateral the securities
as detailed below (in thousands):
Mortgage-backed Mortgage-backed Commercial
Securities Securities Securities Paper
Available for Sale Available for Sale Held to Maturity Investments
------------------ ------------------ ---------------- -----------
Provide credit enhancements for certain
bond-financed real estate projects
originated by Old FNB $15,500 $ 9,909 $ 6,409 $ --
Pledged securities for principal and
interest on Bank loan securitization -- 242,688 7,261 --
Guarantee credit enhancements on
multi-family bond issues and loans
securitized by FNMA and FHLMC 1,018 143,072 32,221 --
Guarantee credit enhancements on
loans transferred as part of
securitization transactions by the Bank -- -- -- 17,379
Guarantee state and local agency
deposits, and certain deposits with the
Federal Reserve Bank 2,759 358,313 45,169 --
Secure various other obligations -- 1,715,610 731,181 --
At September 30, 2002, $23.9 billion in residential loans, $4.0 billion
in multifamily loans and $1.5 billion in commercial real estate loans were
pledged as collateral for FHLB advances.
At September 30, 2002, loans receivable included approximately $4.3
billion of loans that had the potential to experience negative amortization.
(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.
Page 23
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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
nine months ended September 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 nine months ended September 30, 2002 was $42.8 million and $129.7
million, respectively, while $22.8 million and $43.0 million was reclassified
during the three and nine months ended September 30, 2001, respectively.
As of September 30, 2002 and 2001, approximately $147.2 million and $82.0
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 periods ending September
30, 2003 and 2002, respectively.
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.
Page 24
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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 always equal
100%. The Company keeps hedge coverage ratios at acceptable risk levels, which
may vary depending on current and expected interest rate movement and other
assets of the Company.
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 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.
Page 25
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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.
Nine Months Ended September 30, Three Months Ended September 30,
------------------------------- --------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Gain on designated derivative contracts $ 780,382 $ 214,708 $ 588,817 $ 289,309
Decrease in value of designated MSRs (746,527) (185,217) (558,901) (268,775)
--------- --------- --------- ---------
Net gain on derivatives used to hedge MSRs $ 33,855 $ 29,491 $ 29,916 $ 20,534
========= ========= ========= =========
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.
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):
Nine Months Ended September 30, Three Months Ended September 30,
------------------------------- --------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Transition adjustment upon adoption of SFAS No. 133 $ -- $ 3,834 $ -- $ --
Unrealized loss on designated forward loan
sale commitments recognized (52,744) (18,141) (14,206) (28,541)
Increase in value of warehouse loans 58,945 19,203 15,564 28,241
-------- -------- -------- --------
Net gain (loss) on derivatives used to hedge
warehouse loans $ 6,201 $ 4,896 $ 1,358 $ (300)
======== ======== ======== ========
Page 26
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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):
Nine Months Ended September 30, Three Months Ended September 30,
------------------------------- --------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Transition adjustment upon adoption of SFAS No. 133 $ -- $ (2,785) $ -- $ --
Unrealized loss on undesignated forward loan
sale commitments recognized to income (34,405) (10,394) (15,357) (20,514)
Gain on undesignated interest rate loan
commitments recognized to income 38,887 10,648 17,423 19,628
-------- -------- -------- --------
Net gain (loss) on derivatives $ 4,482 $ (2,531) $ 2,066 $ (886)
======== ======== ======== ========
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.
September 30, 2002 December 31, 2001
------------------------------- -------------------------------
Notional Notional
Amount Credit Risk (1) Amount Credit Risk (1)
------- --------------- ------ ---------------
Interest rate swaps - borrowings $ 4,159,670 $ -- $ 4,089,670 $ --
Interest rate swaps hedging MSRs 5,495,000 114,626 2,462,000 7,561
PO swaps 396,960 5,076 378,928 6,411
Interest rate floors 250,000 9,062 3,054,000 78,917
Interest rate swaptions 1,704,000 76,367 4,111,000 183,641
Forward loan sale commitments 3,719,857 -- 3,980,863 36,879
Interest rate lock commitments 2,369,136 -- 1,870,852 --
Other 400,000 2,336 -- --
----------- -------- ----------- --------
Total $18,494,623 $207,467 $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 $113.5
million and $95.2 million cash collateral held by the Bank at September
30, 2002 and December 31, 2001, respectively.
Page 27
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Derivative financial instruments used for other-than-trading purposes at
September 30, 2002 are scheduled to mature as follows (in thousands):
Notional Amounts
------------------------------------------------------------------------------------------------------
Three Months Ending
December 31, 2002 2003 2004 2005 2006 Thereafter Total
----------------- ---- ---- ---- ---- ---------- -----
Interest rate swaps -
borrowings $ 300,000 $ 500,000 $1,520,000 $ 819,670 $900,000 $ 120,000 $ 4,159,670
Interest rate swaps
hedging MSRs -- -- -- 950,000 -- 4,545,000 5,495,000
PO swaps 74,052 163,590 149,077 -- -- 10,241 396,960
Interest rate floors -- -- -- -- -- 250,000 250,000
Interest rate swaptions -- 625,000 1,079,000 -- -- -- 1,704,000
Forward loan sale
commitments 3,719,857 -- -- -- -- -- 3,719,857
Interest rate lock
commitments 2,369,136 -- -- -- -- -- 2,369,136
Other 400,000 -- -- -- -- -- 400,000
---------- ---------- ---------- ---------- -------- ---------- -----------
Total $6,863,045 $1,288,590 $2,748,077 $1,769,670 $900,000 $4,925,241 $18,494,623
========== ========== ========== ========== ======== ========== ===========
(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.
Page 28
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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
$13.5 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.
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.
ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES
In June of 2002, the FASB issued SFAS No. 146. SFAS No. 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF No. 94-3. The principal difference between SFAS
No. 146 and EITF No. 94-3 is that SFAS No. 146 requires that a liability be
recognized for a cost associated with an exit or disposal activity only when the
liability is incurred. Under EITF No. 94-3, a liability for an exit cost was
recognized at the date of an entity's commitment to an exit plan. The Board
concluded that an entity's commitment to a plan, by itself, does not create a
present obligation to others that meets the definition of a liability. SFAS No.
146 also establishes that fair value is the objective for the initial
measurement of the liability.
The provisions of SFAS No. 146 are effective for exit or disposal
activities initiated after December 31, 2002. The implementation of SFAS No. 146
is not expected to materially impact the Company's financial condition or
operating results.
Page 29
GOLDEN STATE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS
In October of 2002, the FASB issued SFAS No. 147, which addresses the
accounting for the acquisition of certain financial institutions.
The provisions of SFAS No. 147 rescind the specialized accounting
guidance in paragraph 5 of SFAS No. 72 and would require unidentifiable
intangible assets to be reclassified to goodwill if certain criteria are met.
Financial institutions meeting the conditions outlined in SFAS No. 147 will be
required to restate previously issued financial statements back to the date SFAS
No. 142 was initially applied.
The provisions of SFAS No. 147 are effective for financial statements
after September 30, 2002. Given that all goodwill and unidentifiable intangible
assets will be eliminated in purchase accounting in connection with the Merger
during the quarter ended December 31, 2002, there will be no impact to the
Company as a result of the issuance of SFAS No. 147.
Page 30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 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 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, as well as in the "Mortgage Banking
Activities" and "Allowance for Loan Losses" sections of the Company's Annual
Report on Form 10-K for the year ended December 31, 2001.
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
CITIGROUP 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. On October 28, 2002, Citigroup
received Federal Reserve Board approval for the Merger. On October 29, 2002, the
OTS approved the related merger of the Bank with and into Citibank (West), FSB
(in formation). The Merger is anticipated to close during the fourth quarter of
2002. See note 2 of the Company's Notes to Unaudited Consolidated Financial
Statements.
NET INCOME
GS Holdings reported net income of $373.6 million for the nine months
ended September 30, 2002, compared with net income of $316.0 million for the
corresponding period in 2001. Net income for the nine months ended September 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 nine months ended September 30, 2001 was
$317.6 million. The Bank's efficiency ratio was 47.74% for the nine months ended
September 30, 2002, compared to 48.73% for the comparable period in 2001.
Net interest income increased $71.9 million during the first nine 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 nine months ended September 30, 2002, $11.2 million of
interest income was received in connection with California and federal income
tax refunds. Total noninterest income declined by $52.4 million, primarily as a
result of $30.0 million in gains on the non-monetary exchange and subsequent
sale of Star Systems common stock for Concord EFS common stock in 2001 and the
decline in loan servicing fees, net, primarily due to higher MSR amortization.
Total noninterest expense declined $20.1 million and includes a $41.3 million
decrease due to the adoption of SFAS No. 142 on January 1, 2002.
GS Holdings reported net income of $131.8 million for the three months
ended September 30, 2002, compared with net income of $106.9 million for the
corresponding period in 2001. The Bank's efficiency ratio was 48.52% for the
three months ended September 30, 2002, compared to 47.66% for the comparable
period in 2001.
Net interest income decreased $19.3 million during the three months ended
September 30, 2002 as compared to the same period in 2001, primarily as a result
of reduced average earning assets more than offsetting a higher net interest
margin. Average interest-earning assets were $47.1 billion for the third quarter
of 2002, down from $56.5 billion during the same period in 2001. The net
interest margin for the current quarter was 2.88%, up 32 bps from 2.56% in the
third quarter of 2001. The improvement in net interest margin was mainly due to
declining market interest rates reducing the costs of liabilities at a faster
rate than the decline in the yield on assets. Total noninterest income increased
by $33.1 million, primarily in loan servicing fees, net due to an $87.4 million
improvement in the valuation provision on MSRs related to SFAS No. 140,
partially offset by $40.9 million in higher MSR amortization and a $24.5 million
reduction in the Company's recourse liability during the year-ago quarter which
did not recur. Total noninterest expense declined $4.7 million and includes a
$13.8 million decrease due to the cessation of goodwill amortization as required
by SFAS No. 142.
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 $41.3 million
for the three and nine months ended September 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 nine months ended September 30, 2001 was
$120.4 million and $356.6 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 nine months ended September 30, 2001 was
$120.4 million and $358.1 million, respectively.
Page 32
FINANCIAL CONDITION
During the nine months ended September 30, 2002, consolidated total
assets decreased to $50.4 billion from $56.5 billion and total liabilities
decreased to $47.1 billion from $53.4 billion at December 31, 2001.
Mortgage-backed securities, loans receivable and loans held for sale declined
$3.5 billion, $2.5 billion and $0.7 billion, respectively, during the nine
months ended September 30, 2002. 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 $46.6 million during the nine
months ended September 30, 2002, including decreases of $1.3 billion in CDs and
$121.3 million in Brokered Deposits, offset by a $1.1 billion increase in
transaction accounts and $325.0 million in custodial accounts. Total borrowings,
including securities sold under agreements to repurchase, FHLB advances and
other borrowings, declined $6.4 billion during the nine months ended September
30, 2002.
During the nine months ended September 30, 2002, stockholder's equity
increased $224.4 million to $2.8 billion. The increase in stockholder's equity
is principally the result of $373.6 million in net income for the period, $3.4
million from the exercise of Golden State common stock options and $3.0 million
due to the impact of Golden State restricted common stock. These amounts were
partially offset by $80.0 million of common stock dividends, $71.1 million in
net unrealized losses, after tax, on derivatives and $4.6 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 $107.5 million at September 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 0.21% at September 30, 2002 compared
with 0.22% at December 31, 2001.
Page 33
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2002 VERSUS NINE MONTHS ENDED SEPTEMBER
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.
Nine Months Ended September 30, 2002
------------------------------------
Average Average
Balance Interest Rate
------- -------- ----
(dollars in millions)
ASSETS
Interest-earning assets (1):
Securities, interest-bearing deposits in banks and other (2) $ 602 $ 23 4.98%
Mortgage-backed securities available for sale 5,123 230 5.97
Mortgage-backed securities held to maturity 1,217 56 6.15
Loans held for sale, net 1,986 95 6.36
Loans receivable, net:
Residential 28,267 1,284 6.06
Commercial real estate 6,578 347 7.03
Consumer 1,015 46 6.07
Automobile 2,041 194 12.71
Commercial banking 751 32 5.75
------- ------
Loans receivable, net 38,652 1,903 6.57
FHLB stock 1,255 56 6.05
------- ------
Total interest-earning assets 48,835 2,363 6.45%
Noninterest-earning assets 3,999 ------
-------
Total assets $52,834
=======
LIABILITIES, MINORITY INTEREST
AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
Deposits $24,791 377 2.04%
Securities sold under agreements to repurchase (3) 2,108 61 3.80
Borrowings (3) 21,392 848 5.28
Other 179 2 1.76
------- ------
Total interest-bearing liabilities 48,470 1,288 3.54%
Noninterest-bearing liabilities 1,179 ------
Minority interest 496
Stockholder's equity 2,689
-------
Total liabilities, minority interest
and stockholder's equity $52,834
=======
Net interest income $1,075
======
Interest rate spread (4) 2.91%
=====
Net interest margin 2.94%
=====
Return on average assets 0.94%
=====
Return on average common equity 18.53%
=====
Return on tangible common equity 24.38%
=====
Average equity to average assets 5.09%
=====
Page 34
Nine Months Ended September 30, 2001
------------------------------------
Average Average
Balance Interest Rate
------- -------- ----
(dollars in millions)
ASSETS
Interest-earning assets (1):
Securities, interest-bearing deposits in banks and other (2) $ 890 $ 40 5.96%
Mortgage-backed securities available-for-sale 9,887 487 6.57
Mortgage-backed securities held-to-maturity 1,626 99 8.15
Loans held for sale, net 1,921 99 6.89
Loans receivable, net:
Residential 31,725 1,655 6.95
Commercial real estate 6,221 384 8.23
Consumer 886 59 8.86
Automobile 1,758 152 11.58
Commercial banking 596 37 8.22
------- ------
Total loans receivable, net 41,186 2,287 7.40
FHLB stock 1,402 63 6.05
------- ------
Total interest-earning assets 56,912 3,075 7.21%
Noninterest-earning assets 3,717 ------
-------
Total assets $60,629
=======
LIABILITIES, MINORITY INTEREST
AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
Deposits $24,198 667 3.68%
Securities sold under agreements to repurchase (3) 3,872 167 5.69
Borrowings (3) 28,513 1,238 5.79
------- ------
Total interest-bearing liabilities 56,583 2,072 4.88%
Noninterest-bearing liabilities 1,198 ------
Minority interest 496
Stockholder's equity 2,352
-------
Total liabilities, minority interest
and stockholder's equity $60,629
=======
Net interest income $1,003
======
Interest rate spread (4) 2.33%
=====
Net interest margin 2.35%
=====
Return on average assets 0.70%
=====
Return on average common equity 17.91%
=====
Return on tangible common equity 28.57%
=====
Average equity to average assets 3.88%
=====
____________
(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.
Nine Months Ended September 30, 2002 vs. 2001
Increase (Decrease) Due to
---------------------------------------------
Volume Rate Net
------ ---- ---
(in millions)
INTEREST INCOME:
Securities, interest-bearing deposits in banks and other $ -- $ (17) $ (17)
Mortgage-backed securities available for sale (217) (40) (257)
Mortgage-backed securities held to maturity (22) (21) (43)
Loans held for sale, net 3 (8) (5)
Loans receivable, net (106) (277) (383)
FHLB stock (7) -- (7)
----- ----- -----
Total (349) (363) (712)
----- ----- -----
INTEREST EXPENSE:
Deposits (36) (253) (289)
Securities sold under agreements to repurchase (63) (43) (106)
Borrowings (278) (113) (391)
Other -- 2 2
----- ----- -----
Total (377) (407) (784)
----- ----- -----
Change in net interest income $ 28 $ 44 $ 72
===== ===== =====
INTEREST INCOME. Total interest income was $2.4 billion for the nine
months ended September 30, 2002, a decrease of $711.7 million from the nine
months ended September 30, 2001. Total interest-earning assets for the nine
months ended September 30, 2002 averaged $48.8 billion, compared to $56.9
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. These decreases were partially offset by a slight 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 nine months ended September 30, 2002 decreased to 6.45% from 7.21%
for the nine months ended September 30, 2001, primarily due to the repricing of
loans and mortgage-backed securities at lower rates. At September 30, 2002, 11%
of the Company's portfolio loans were tied to COFI indices, 11% 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 6% of the portfolio was in other adjustable-rate products.
GS Holdings earned $1.9 billion of interest income on loans receivable
for the nine months ended September 30, 2002, a decrease of $382.9 million from
the nine months ended September 30, 2001. The average balance of loans
receivable was $38.7 billion for the nine months ended September 30, 2002,
compared to $41.2 billion for the same period in 2001. The weighted average
yield on loans receivable decreased to 6.57% for the nine months ended September
30, 2002 from 7.40% for the nine months ended September 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 nine months ended September 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 nine months ended September 30, 2002 was to
increase interest income by $35.5 million. (See "--Allowance for Loan Losses.")
Page 36
Loan production is detailed in the table below (in thousands):
Nine Months Ended September 30,
-------------------------------
2002 2001
---- ----
Loans funded:
Residential real estate loans:
Adjustable-rate $ 5,206,053 $ 5,476,707
Fixed-rate 14,491,315 12,838,798
----------- -----------
Total residential real estate loans 19,697,368 18,315,505
Commercial real estate loans 1,251,279 1,302,697
Commercial loans 973,083 764,795
Consumer nonmortgage loans 806,828 597,943
Auto loans (a) 944,804 954,862
----------- -----------
Total loans funded $23,673,362 $21,935,802
=========== ===========
Residential real estate loans purchased $ 2,392,869 $ 2,198,742
=========== ===========
____________
(a) Approximately 47% and 41% of this volume was in prime product; 53% and
59% in sub-prime product for the nine months ended September 30, 2002 and
2001, respectively.
GS Holdings earned $94.7 million of interest income on loans held for
sale for the nine months ended September 30, 2002, a decrease of $4.5 million
from the nine months ended September 30, 2001. The average balance of loans held
for sale was $2.0 billion for the nine months ended September 30, 2002, an
increase of $65.0 million 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 $14.2 billion during the
nine months ended September 30, 2002, an increase of 18% over the $12.0 billion
originated during the comparable period in 2001. The weighted average yield on
loans held for sale decreased to 6.36% for the nine months ended September 30,
2002 from 6.89% for the nine months ended September 30, 2001, primarily due to
declining market interest rates.
Interest income on mortgage-backed securities available for sale was
$229.6 million for the nine months ended September 30, 2002, a decrease of
$257.3 million from the nine months ended September 30, 2001. The average
portfolio balance decreased $4.8 billion, to $5.1 billion for the nine months
ended September 30, 2002 compared to the same period in 2001. The weighted
average yield on these assets decreased from 6.57% for the nine months ended
September 30, 2001 to 5.97% for the nine months ended September 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 $56.1
million for the nine months ended September 30, 2002, a decrease of $43.3
million from the nine months ended September 30, 2001. The average portfolio
balance decreased $0.4 billion, to $1.2 billion for the nine months ended
September 30, 2002 compared to the same period in 2001, primarily due to
repayments. The weighted average yields for the nine months ended September 30,
2002 and 2001 were 6.15% and 8.15%, 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 $22.6 million for the nine months ended September 30, 2002, a decrease
of $17.1 million from the nine months ended September 30, 2001. The average
portfolio balance was $0.6 billion and $0.9 billion for the nine months ended
September 30, 2002 and 2001, respectively. The weighted average yield was 4.98%
for the nine months ended September 30, 2002 compared to 5.96% for the nine
months ended September 30, 2001. The decrease in the volume is primarily
attributed to payments and maturities of securities. The lower weighted average
yield reflects a shift in the mix of securities, with lower average balances of
higher rate securities and the repricing of securities at lower rates during the
nine months of 2002. The weighted average yield also reflects $11.2 million of
interest income related to
Page 37
income tax refunds for which there is no corresponding earning asset; if this
amount is excluded, the weighted average yield for the nine months ended
September 30, 2002 would be 2.52%.
Dividends on FHLB stock were $56.8 million for the nine months ended
September 30, 2002, a decrease of $6.6 million from the nine months ended
September 30, 2001. The average balance outstanding was $1.3 billion and $1.4
billion for the nine months ended September 30, 2002 and 2001, respectively. The
weighted average dividend on FHLB stock was 6.05% for the nine months ended
September 30, 2002 and 2001.
INTEREST EXPENSE. Total interest expense was $1.3 billion for the nine
months ended September 30, 2002, a decrease of $783.6 million from the nine
months ended September 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.
Interest expense on deposits, including Brokered Deposits, was $377.6
million for the nine months ended September 30, 2002, a decrease of $288.8
million from the nine months ended September 30, 2001. The average balance of
deposits outstanding increased from $24.2 billion for the nine months ended
September 30, 2001 to $24.8 billion for the nine months ended September 30,
2002. Deposit interest expense attributed to changes in volume decreased despite
an increase in average volume because the volume of the average individual
deposit categories with lower or zero rates (such as transaction and custodial
accounts) increased significantly, while those with higher rates (such as CDs)
decreased. The increase in the average balance is primarily attributed to
increases in the average balances of money market accounts, custodial accounts,
and retail customer checking and savings accounts, partially offset by a decline
in CDs. The overall weighted average cost of deposits decreased to 2.04% for the
nine months ended September 30, 2002 from 3.68% for the nine months ended
September 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,
custodial, checking and savings accounts, and a lower average balance of higher
rate CDs during the first nine months of 2002.
Interest expense on securities sold under agreements to repurchase
totalled $60.6 million for the nine months ended September 30, 2002, a decrease
of $106.2 million from the nine months ended September 30, 2001. The average
balance of such borrowings for the nine months ended September 30, 2002 and 2001
was $2.1 billion and $3.9 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 3.80% for the nine months ended September 30,
2002 from 5.69% for the nine months ended September 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 $847.6 million for the nine
months ended September 30, 2002, a decrease of $391.0 million from the nine
months ended September 30, 2001. The average balance outstanding for the nine
months ended September 30, 2002 and 2001 was $21.4 billion and $28.5 billion,
respectively. The weighted average interest rate on these instruments decreased
to 5.28% for the nine months ended September 30, 2002 from 5.79% for the nine
months ended September 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 $1.1 billion for the nine
months ended September 30, 2002, an increase of $71.9 million from the nine
months ended September 30, 2001. The interest rate spread increased to 2.91% for
the nine months ended September 30, 2002 from 2.33% for the nine months ended
September 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
2.94% for the nine months ended September 30, 2002, up 59 bps from the 2.35%
reported during the nine months of 2001. Excluding the $11.2 million interest on
the California income tax refund, the interest rate spread and net interest
margin for the nine months ended September 30, 2002 would have been 2.88% and
2.91%, respectively.
Page 38
NONINTEREST INCOME. Total noninterest income, consisting primarily of
loan servicing fees, customer banking fees, gain on sale, settlement and
transfer of loans, net, (loss) gain on sale of assets, net and other income, was
$207.9 million for the nine months ended September 30, 2002, representing a
decrease of $52.4 million from the nine months ended September 30, 2001.
Loan servicing fees for the Company, were $(62.9) million for the nine
months ended September 30, 2002, compared to $(35.7) million the nine months
ended September 30, 2001. The following table details the components of loan
servicing fees, net (in thousands):
Nine Months Ended September 30,
-------------------------------
2002 2001
---- ----
Components of loan servicing fees, net:
Loan servicing fees $ 383,516 $ 337,026
Amortization of MSRs (326,269) (219,793)
Pass-through Interest Expense (33,268) (24,376)
Net gain on MSRs/MSR derivatives (SFAS No. 133) 33,855 29,491
MSR valuation provision (120,735) (158,000)
--------- ---------
Total loan servicing fees, net $ (62,901) $ (35,652)
========= =========
Portfolio run off rate (residential portfolio only) 32.9% 26.1%
MSR value run off rate (residential portfolio only) 23.5 22.3
MSR amortization rate (residential portfolio only) 24.8 19.9
As the table reflects, gross loan servicing fees increased $46.5 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 $86.3 billion at September 30, 2001 to $87.3 billion at September
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 $106.5 million in the nine months ended September
30, 2002 over the same period in 2001. Pass-through Interest Expense increased
$8.9 million or 36% year over year, also influenced by higher runoff rates.
Total loan servicing fees, net for the nine months ended September 30, 2002 and
2001 includes net pre-tax gains of $33.9 million and $29.5 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 $120.7 million and
$158.0 million during the nine months ended September 30, 2002 and 2001,
respectively. See "--Impact of SFAS No. 133" and "--Mortgage Banking Risk
Management" for further discussion.
Customer banking fees were $181.6 million for the nine months ended
September 30, 2002 compared to $161.0 million for the nine months ended
September 30, 2001. The following table details the components of customer
banking fees and service charges (in thousands):
Nine Months Ended September 30,
-------------------------------
2002 2001
---- ----
Components of customer banking fees and service charges:
Customer and electronic banking fees $119,234 $104,876
Other customer fees 2,438 1,903
Investment sales income 52,674 46,424
Insurance commissions 7,257 7,788
-------- --------
Total customer banking fees and service charges $181,603 $160,991
======== ========
Page 39
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
$2.4 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 62.7% at September 30,
2002, from 53.7% at September 30, 2001.
Gain on sale, settlement and transfer of loans, net totalled $74.9
million for the nine months ended September 30, 2002, an increase of $5.9
million from the nine months ended September 30, 2001. During the nine months
ended September 30, 2002, the Company sold $15.4 billion in single-family
mortgage loans with servicing rights retained as part of its ongoing mortgage
banking operations at gains of $58.6 million compared to $11.2 billion of such
sales at gains of $33.8 million for the corresponding period in 2001, which
included a $4.2 million gain on the sale of $136.2 million in government-insured
loans that were previously seriously delinquent and had become performing (GNMA
reperformers). 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 $10.7
million and $2.4 million, respectively, on the derivative rate locks, forward
loan sale commitments and closed loan inventory from the application of SFAS No.
133.
Net loss on sale of assets totalled $0.5 million for the nine months
ended September 30, 2002, compared to a net gain of $22.0 million for the nine
months ended September 30, 2001. The loss during the first nine months of 2002
includes a $20.2 million loss on the mark-to-market of the Company's portfolio
of IO strip and "B" tranche mortgage securities, partially offset by 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. The gain during 2001 is
primarily attributed to a $16.6 million gain on the sale of $761.8 million in
mortgage-backed securities and a $9.3 million gain on the sale of the Company's
Concord EFS stock, partially offset by a $4.1 million loss on the mark-to-market
of the Company's portfolio of IO strip securities.
Other noninterest income totalled $14.8 million for the nine months ended
September 30, 2002, a decrease of $29.2 million from the same period in 2001.
The decrease relates to 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 and $5.4
million in higher float commissions for check disbursements during the first
nine months of 2001.
NONINTEREST EXPENSE. Total noninterest expense was $694.6 million for the
nine months ended September 30, 2002, a decrease of $20.1 million compared to
the nine months ended September 30, 2001. Excluding the amortization of goodwill
and other intangible assets, noninterest expense for the nine months ended
September 30, 2002 was $691.1 million, an increase of $21.3 million over the
same period in the prior year. Noninterest expense for the nine months ended
September 30, 2002 included decreases of $41.3 million in amortization of
intangible assets, $1.7 million in loan expense and $1.2 million in professional
fees. These decreases were partially offset by increases of $19.5 million in
compensation and employee benefits, $4.1 million in occupancy and equipment and
$0.7 million in other noninterest expense.
Compensation and employee benefits expense was $365.4 million for the
nine months ended September 30, 2002, an increase of $19.5 million from the nine
months ended September 30, 2001. The increase is primarily attributed to normal
salary adjustments, and increases in incentive compensation and commissions,
primarily in volume-related operating groups.
Professional fees were $24.0 million for the nine months ended September
30, 2002, a decrease of $1.2 million from the nine months ended September 30,
2001, primarily due to an overall decrease in legal fees related to various
legal cases.
Amortization of intangible assets was $3.5 million for the nine months
ended September 30, 2002, a decrease of $41.3 million from the nine months ended
September 30, 2001, due to the adoption of SFAS No. 142 on January 1, 2002,
which requires that goodwill no longer be amortized.
Page 40
Other noninterest expense was $168.8 million for the nine months ended
September 30, 2002 compared to $168.1 million in the same period of 2001. The
increase in expenses relates to increases in a number of operating expense
categories, including data processing systems, clerical and other losses,
insurance, bank charges, charitable contributions, postage, back office
operations and courier service.
PROVISION FOR INCOME TAX. During the nine months ended September 30,
2002, GS Holdings recorded gross income tax expense of $240.5 million, which was
offset by a tax benefit of $45.8 million, for net income tax expense of $194.7
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 in the second quarter. 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.
On September 11, 2002, California enacted a law requiring large banks
(those with average assets in excess of $500 million) to conform to federal law
with respect to accounting for bad debts. Prior to the law change, all banks,
regardless of size, were eligible to use the reserve method of accounting for
bad debts which enabled them to take deductions for anticipated bad debt losses
prior to the losses being incurred for California tax purposes. With the change,
large banks may now only deduct actual charge-offs net of recoveries in
determining their California taxable income. Banks that are required to conform
to the new law must include in current year taxable income 50 percent of the bad
debt reserves that existed as of the end of the prior tax year. As a concession
for requiring large banks to comply with the new law, recapture of the remaining
50 percent of the reserve is waived thereby creating a permanent tax benefit.
The Company's tax benefit resulting from the law change was $8.7 million and has
been reflected in the Company's income tax expense for the quarter ended
September 30, 2002.
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 the completion of
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
nine months ended September 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 nine months ended September 30, 2001, GS Holdings recorded net
income tax expense of $211.3 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 nine months ended September 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.
GS Holdings' effective gross federal tax rate was 30% during the nine
months ended September 30, 2002 and 39% during the nine months ended September
30, 2001, while its federal statutory tax rate was 35% during both periods. In
2002, the difference between the effective and statutory rates was the result of
a reduction of the deferred tax asset valuation allowance. 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 3.4% and (1)% during the nine months
ended September 30, 2002 and 2001, respectively. The low effective state tax
rate during 2002 was the result of previously discussed reversal of the
California bad debt reserves and reduction in the accrued state tax liability.
The low effective state tax rate during 2001 was the result of the previously
discussed reduction in the accrued state tax liability.
Page 41
MINORITY INTEREST. During each of the nine months ended September 30,
2002 and 2001, dividends on the REIT Preferred Stock were recorded totalling
$20.2 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 nine months ended September 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.
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 nine months ended September 30,
2002 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 $ -- $(746,527) $ 739,883 $ 40,499 $ -- $ -- $(33,855) $ --
Warehouse loans and
pipeline hedges 58,945 -- (11,262) (37,000) -- -- -- (10,683)
Cash flow (balance sheet)
hedges - swaps -- -- -- (120,278) 49,133 71,145 -- --
------- --------- ----------- --------- -------- -------- -------- --------
Fair Value Adjustments -
Nine Months Ended
September 30, 2002 58,945 (746,527) 728,621 (116,779) 49,133 71,145 (33,855) (10,683)
Other Activity - Nine Months
Ended September 30, 2002:
MSR hedge additions -- -- 1,230,598 -- -- -- -- --
MSR hedge sales and
maturities -- -- (2,025,869) 32,490 -- -- -- --
MSR hedge receipts
and payments -- -- (48,753) (37,910) -- -- -- --
------- --------- ----------- --------- -------- -------- -------- --------
Total Other Activity -
Nine Months Ended
September 30, 2002 -- -- (844,024) (5,420) -- -- -- --
------- --------- ----------- --------- -------- -------- -------- --------
Total Impact from
SFAS No. 133 - Nine Months
Ended September 30, 2002 $58,945 $(746,527) $ (115,403) $(122,199) $ 49,133 $ 71,145 $(33,855) $(10,683)
======= ========= =========== ========= ======== ======== ======== ========
Total Impact from
SFAS No. 133 - Nine Months
Ended September 30, 2001 $23,037 $(350,105) $ 326,296 $(284,224) $101,237 $146,590 $(29,491) $ (2,365)
======= ========= =========== ========= ======== ======== ======== ========
Page 42
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2002 VERSUS THREE MONTHS ENDED SEPTEMBER
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 September 30, 2002
-------------------------------------
Average Average
Balance Interest Rate
------- -------- ----
(dollars in millions)
ASSETS
Interest-earning assets (1):
Securities, interest-bearing deposits in banks and other (2) $ 1,094 $ 7 2.46%
Mortgage-backed securities available for-sale 4,190 61 5.83
Mortgage-backed securities held-to-maturity 1,122 16 5.85
Loans held for sale, net 1,516 24 6.33
Loans receivable, net:
Residential 27,352 402 5.87
Commercial real estate 6,628 114 6.89
Consumer 1,086 16 5.88
Automobile 2,150 70 12.83
Commercial banking 786 11 5.77
------- ----
Total loans receivable, net 38,002 613 6.44
FHLB stock 1,131 16 5.62
------- ----
Total interest-earning assets 47,055 737 6.26%
Noninterest-earning assets 3,705 ----
-------
Total assets $50,760
=======
LIABILITIES, MINORITY INTEREST
AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
Deposits $24,860 117 1.86%
Securities sold under agreements to repurchase (3) 1,950 18 3.69
Borrowings (3) 19,263 264 5.44
Other 207 1 1.76
------- ----
Total interest-bearing liabilities 46,280 400 3.43%
Noninterest-bearing liabilities 1,233 ----
Minority interest 494
Stockholder's equity 2,753
-------
Total liabilities, minority interest
and stockholder's equity $50,760
=======
Net interest income $337
====
Interest rate spread (4) 2.83%
=====
Net interest margin 2.88%
=====
Return on average assets 1.04%
=====
Return on average common equity 19.15%
=====
Return on tangible common equity 24.84%
=====
Average equity to average assets 5.42%
=====
Page 43
Three Months Ended September 30, 2001
-------------------------------------
Average Average
Balance Interest Rate
------- -------- ----
(dollars in millions)
ASSETS
Interest-earning assets (1):
Securities, interest-bearing deposits in banks and other (2) $ 571 $ 8 5.73%
Mortgage-backed securities available-for-sale 8,909 142 6.37
Mortgage-backed securities held-to-maturity 1,510 28 7.53
Loans held for sale, net 2,707 46 6.88
Loans receivable, net:
Residential 31,571 531 6.73
Commercial real estate 6,399 128 7.98
Consumer 908 19 7.99
Automobile 1,871 56 11.95
Commercial banking 647 12 7.41
------- ----
Total loans receivable, net 41,396 746 7.20
FHLB stock 1,423 18 5.04
------- ----
Total interest-earning assets 56,516 988 6.99%
Noninterest-earning assets 3,962 ----
-------
Total assets $60,478
=======
LIABILITIES, MINORITY INTEREST
AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
Deposits $24,596 202 3.26%
Securities sold under agreements to repurchase (3) 3,635 46 4.91
Borrowings (3) 27,980 384 5.45
------- ----
Total interest-bearing liabilities 56,211 632 4.45%
Noninterest-bearing liabilities 1,344 ----
Minority interest 495
Stockholder's equity 2,428
-------
Total liabilities, minority interest
and stockholder's equity $60,478
=======
Net interest income $356
====
Interest rate spread (4) 2.53%
=====
Net interest margin 2.56%
=====
Return on average assets 0.71%
=====
Return on average common equity 17.61%
=====
Return on tangible common equity 27.46%
=====
Average equity to average assets 4.01%
=====
___________
(1) Non-performing assets are included in the average balances for the
periods indicated.
(2) Includes securities, interest-bearing deposits in other banks and
securities purchased under agreements to resell.
(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 September 30, 2002 vs. 2001
Increase (Decrease) Due to
----------------------------------------------
Volume Rate Net
------ ---- ---
(in millions)
INTEREST INCOME:
Securities, interest-bearing deposits in banks and other $ 2 $ (3) $ (1)
Mortgage-backed securities available for sale (70) (11) (81)
Mortgage-backed securities held to maturity (6) (6) (12)
Loans held for sale, net (19) (3) (22)
Loans receivable, net (47) (86) (133)
FHLB stock (4) 2 (2)
----- ----- -----
Total (144) (107) (251)
----- ----- -----
INTEREST EXPENSE:
Deposits (13) (72) (85)
Securities sold under agreements to repurchase (18) (9) (27)
Borrowings (103) (18) (121)
Other -- 1 1
----- ----- -----
Total (134) (98) (232)
----- ----- -----
Change in net interest income $ (10) $ (9) $ (19)
===== ===== =====
INTEREST INCOME. Total interest income was $736.9 million for the three
months ended September 30, 2002, a decrease of $251.7 million from the three
months ended September 30, 2001. Total interest-earning assets for the three
months ended September 30, 2002 averaged $47.1 billion, compared to $56.5
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. The yield on total interest-earning assets during the three months
ended September 30, 2002 decreased to 6.26% from 6.99% for the three months
ended September 30, 2001, primarily due to the repricing of loans and
mortgage-backed securities at lower rates.
GS Holdings earned $612.6 million of interest income on loans receivable
for the three months ended September 30, 2002, a decrease of $132.9 million from
the three months ended September 30, 2001. The average balance of loans
receivable was $38.0 billion for the three months ended September 30, 2002,
compared to $41.4 billion for the same period in 2001. The weighted average
yield on loans receivable decreased to 6.44% for the three months ended
September 30, 2002 from 7.20% for the three months ended September 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 primarily 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 September 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 September 30, 2002 was to increase interest income by $14.8 million. (See
"--Allowance for Loan Losses.")
Page 45
Loan production is detailed in the table below (in thousands):
Three Months Ended September 30,
--------------------------------
2002 2001
----- ----
Loans funded:
Residential real estate loans:
Adjustable-rate $1,750,876 $1,622,486
Fixed-rate 4,121,746 5,379,189
---------- ----------
Total residential real estate loans 5,872,622 7,001,675
Commercial real estate loans 348,110 415,861
Commercial loans 324,796 241,541
Consumer nonmortgage loans 280,582 204,295
Auto loans (a) 325,110 319,396
---------- ----------
Total loans funded $7,151,220 $8,182,768
========== ==========
Residential real estate loans purchased $ 184,923 $ 475,166
========== ==========
____________
(a) Approximately 42% and 40% of this volume was in prime product; 58% and
60% in sub-prime product for the three months ended September 30, 2002
and 2001, respectively.
GS Holdings earned $24.0 million of interest income on loans held for
sale for the three months ended September 30, 2002, a decrease of $22.6 million
from the three months ended September 30, 2001. The average balance of loans
held for sale was $1.5 billion for the three months ended September 30, 2002, a
decrease of $1.2 billion from the comparable period in 2001, primarily related
to decreased originations of residential fixed-rate loans. Fixed-rate production
for sale totalled $4.0 billion during the three months ended September 30, 2002,
a decline of 20% over the $5.1 billion originated during the comparable period
in 2001. The weighted average yield on loans held for sale decreased to 6.33%
for the three months ended September 30, 2002 from 6.88% for the three months
ended September 30, 2001, primarily due to declining market interest rates.
Interest income on mortgage-backed securities available for sale was
$61.1 million for the three months ended September 30, 2002, a decrease of $80.8
million from the three months ended September 30, 2001. The average portfolio
balance decreased $4.7 billion, to $4.2 billion for the three months ended
September 30, 2002 compared to the same period in 2001. The weighted average
yield on these assets decreased from 6.37% for the three months ended September
30, 2001 to 5.83% for the three months ended September 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 $16.4
million for the three months ended September 30, 2002, a decrease of $12.0
million from the three months ended September 30, 2001. The average portfolio
balance decreased $0.4 billion, to $1.1 billion for the three months ended
September 30, 2002 compared to the same period in 2001, primarily due to
repayments. The weighted average yields for the three months ended September 30,
2002 and 2001 were 5.85% and 7.53%, 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 $6.9 million for the three months ended September 30, 2002, a decrease
of $1.3 million from the three months ended September 30, 2001. The average
portfolio balance was $1.1 billion and $0.6 billion for the three months ended
September 30, 2002 and 2001, respectively. The weighted average yield for the
three months ended September 30, 2002 was 2.46% compared to 5.73% for the three
months ended September 30, 2001. The increase in the volume is primarily due to
the impact of additional issuances of repurchase agreements and federal funds
sold during the third quarter of 2002. The decrease in the weighted average
yield reflects a shift in the mix of securities, with lower average balances of
higher rate securities held to maturity during the third quarter of 2002.
Page 46
Dividends on FHLB stock were $16.0 million for the three months ended
September 30, 2002, a decrease of $2.1 million from the three months ended
September 30, 2001. The average balance outstanding was $1.1 billion and $1.4
billion for the three months ended September 30, 2002 and 2001, respectively.
The weighted average dividend on FHLB stock increased to 5.62% for the three
months ended September 30, 2002 from 5.04% for the three months ended September
30, 2001.
INTEREST EXPENSE. Total interest expense was $399.7 million for the three
months ended September 30, 2002, a decrease of $232.4 million from the three
months ended September 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.
Interest expense on deposits, including Brokered Deposits, was $116.7
million for the three months ended September 30, 2002, a decrease of $85.1
million from the three months ended September 30, 2001. The average balance of
deposits outstanding increased from $24.6 billion for the three months ended
September 30, 2001 to $24.9 billion for the three months ended September 30,
2002. Deposit interest expense attributed to changes in volume decreased despite
an increase in average volume because the volume of the average individual
deposit categories with lower or zero rates (such as transaction and custodial
accounts) increased significantly, while those with higher rates (such as CDs)
decreased. The increase in the average balance is primarily attributed to
increases in the average balances of money market accounts, custodial accounts,
and retail customer checking and savings accounts, partially offset by a decline
in CDs. The overall weighted average cost of deposits decreased to 1.86% for the
three months ended September 30, 2002 from 3.26% for the three months ended
September 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,
custodial, checking and savings accounts, and a lower average balance of higher
rate CDs during the third quarter of 2002.
Interest expense on securities sold under agreements to repurchase
totalled $18.3 million for the three months ended September 30, 2002, a decrease
of $27.2 million from the three months ended September 30, 2001. The average
balance of such borrowings for the three months ended September 30, 2002 and
2001 was $2.0 billion and $3.6 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 3.69% for the three months ended
September 30, 2002 from 4.91% for the three months ended September 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 $263.8 million for the three
months ended September 30, 2002, a decrease of $121.0 million from the three
months ended September 30, 2001. The average balance outstanding for the three
months ended September 30, 2002 and 2001 was $19.3 billion and $28.0 billion,
respectively. The weighted average interest rate on these instruments decreased
to 5.44% for the three months ended September 30, 2002 from 5.45% for the three
months ended September 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 slight decrease in the weighted average rate
is primarily due to declining market interest rates, offset by the impact of
maturity extensions.
NET INTEREST INCOME. Net interest income was $337.2 million for the three
months ended September 30, 2002, a decrease of $19.3 million from the three
months ended September 30, 2001. The decline was the result of reduced average
earning assets more than offsetting a higher net interest margin. Average
interest-earning assets were $47.1 billion for the third quarter of 2002, down
from $56.5 billion during the same period in 2001. The interest rate spread
increased to 2.83% for the three months ended September 30, 2002 from 2.53% for
the three months ended September 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 2.88% for the three months ended September 30, 2002, up 32
bps from the 2.56% reported during the third quarter of 2001.
Page 47
NONINTEREST INCOME. Total noninterest income, consisting primarily of
loan servicing fees, customer banking fees, gain on sale, settlement and
transfer of loans, net, (loss) gain on sale of assets, net and other income, was
$120.0 million for the three months ended September 30, 2002, representing an
increase of $33.1 million from the three months ended September 30, 2001.
Loan servicing fees for the Company, were $43.7 million for the three
months ended September 30, 2002, compared to $(28.7) million the three months
ended September 30, 2001. The following table details the components of loan
servicing fees, net (in thousands):
Three Months Ended September 30,
--------------------------------
2002 2001
---- ----
Components of loan servicing fees, net:
Loan servicing fees $ 133,840 $112,734
Amortization of MSRs (113,673) (72,780)
Pass-through Interest Expense (12,770) (8,234)
Net gain on MSRs/MSR derivatives (SFAS No. 133) 29,916 20,534
MSR valuation recovery/(provision) 6,372 (81,000)
--------- --------
Total loan servicing fees, net $ 43,685 $(28,746)
========= ========
Portfolio run off rate (residential portfolio only) 38.7% 27.2%
MSR value run off rate (residential portfolio only) 27.5 24.3
MSR amortization rate (residential portfolio only) 29.3 19.1
As the table reflects, gross loan servicing fees increased $21.1 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,
decreased to $87.3 billion at September 30, 2002 from $90.7 billion at June 30,
2002 and increased from $86.3 billion at September 30, 2001. The portfolio
runoff rate, representing the percentage of the residential portfolio that has
been paid off during the year, influences MSR amortization, which increased
$40.9 million in the third quarter of 2002 over the same period in 2001.
Pass-through Interest Expense, which increased $4.5 million or 55% year over
year, was also influenced by higher runoff rates. Total loan servicing fees, net
for the third quarter of 2002 and 2001 includes net pre-tax gains of $29.9
million and $20.5 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 differed from its carrying value. As a result, in the third quarter of
2002, after determining the fair value of the MSR asset was more than its
carrying value, the Company recovered $6.4 million of the previously recorded
valuation provision. During the three months ended September 30, 2001, the
Company recorded a pre-tax valuation provision on the MSRs of $81.0 million
after determining that the fair value of the MSR asset was less than its
carrying value. See "--Impact of SFAS No. 133" and "--Mortgage Banking Risk
Management" for further discussion.
Customer banking fees were $62.6 million for the three months ended
September 30, 2002 compared to $55.2 million for the three months ended
September 30, 2001. The following table details the components of customer
banking fees and service charges (in thousands):
Three Months Ended September 30,
--------------------------------
2002 2001
---- ----
Components of customer banking fees and service charges:
Customer and electronic banking fees $41,632 $36,375
Other customer fees 921 605
Investment sales income 17,475 15,694
Insurance commissions 2,555 2,497
------- -------
Total customer banking fees and service charges $62,583 $55,171
======= =======
Page 48
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. Third 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.
Gain on sale, settlement and transfer of loans, net totalled $19.4
million for the three months ended September 30, 2002, a decrease of $27.8
million from the three months ended September 30, 2001. During the three months
ended September 30, 2002, the Company sold $3.5 billion in single-family
mortgage loans with servicing rights retained as part of its ongoing mortgage
banking operations at gains of $14.9 million compared to $5.5 billion of such
sales at gains of $19.7 million for the corresponding period in 2001, which
included a $4.2 million gain on the sale of $136.2 million in government-insured
loans that were previously seriously delinquent and had become performing (GNMA
reperformers). The overall decrease in the volume of loans sold and the related
gain is a result of a reduction in fixed-rate loan originations during the third
quarter of 2002. Gain on sale of loans during the third quarter of 2001 included
$24.5 million related to a reduction in the Company's recourse liability, which
did not recur. The results in 2002 and 2001 include an unrealized gain of $3.4
million and an unrealized loss of $1.2 million, respectively, on the derivative
rate locks, forward loan sale commitments and closed loan inventory from the
application of SFAS No. 133.
Net loss on sale of assets totalled $8.9 million for the three months
ended September 30, 2002, compared to a net gain of $5.8 million for the three
months ended September 30, 2001. The loss during the third quarter of 2002 is
due to the loss on the mark-to-market of the Company's portfolio of IO strip and
"B" tranche mortgage securities. The gain during 2001 is primarily attributed to
a $10.0 million gain on the sale of $464.0 million in mortgage-backed
securities, partially offset by a $4.1 million loss on the mark-to-market of the
Company's portfolio of IO strip securities.
Other noninterest income totalled $3.2 million for the three months ended
September 30, 2002, a decrease of $4.4 million from the three months ended
September 30, 2001, primarily attributed to the receipts in the prior year
related to an eminent domain settlement on real estate property and a CRA award,
and lower float commissions for check disbursements in 2002.
NONINTEREST EXPENSE. Total noninterest expense was $237.5 million for the
three months ended September 30, 2002, a decrease of $4.7 million compared to
the three months ended September 30, 2001. Excluding the amortization of
goodwill and other intangible assets, noninterest expense for the three months
ended September 30, 2002 was $236.4 million, an increase of $9.1 million over
the same period in the prior year. Noninterest expense for the three months
ended September 30, 2002 included decreases of $13.8 million in amortization of
intangible assets, $2.6 million in professional fees and $0.7 million in loan
expense. These decreases were partially offset by increases of $8.1 million in
compensation and employee benefits, $3.7 million in other expense and $0.9
million in occupancy and equipment.
Compensation and employee benefits expense was $122.9 million for the
three months ended September 30, 2002, an increase of $8.1 million from the
three months ended September 30, 2001. The increase is primarily attributed to
an increase in incentive compensation and commissions, primarily in
volume-related operating groups, and normal salary adjustments.
Professional fees were $7.9 million for the three months ended September
30, 2002, a decrease of $2.6 million from the three months ended September 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 September 30, 2002, a decrease of $13.8 million from the three months
ended September 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 $60.6 million for the three months ended
September 30, 2002 compared to $56.9 million for the same period in 2001. The
increase in expenses relates to increases in a number of operating expense
categories, including insurance, data processing systems, bank charges, clerical
and other losses, charitable contributions, postage and retail back office
operations.
Page 49
PROVISION FOR INCOME TAX. During the three months ended September 30,
2002 and 2001, GS Holdings recorded net income tax expense of $81.1 million and
$87.5 million, respectively. The expense recorded during the three months ended
September 30, 2002 is net of an income tax benefit of $8.7 million due to
legislation passed in the third quarter of 2002. The legislation precludes banks
from using the reserve method for bad debts, and requires recognition of fifty
percent of bad debt reserves as income. As a concession for this additional
taxable income, the recapture of the remaining fifty percent of the reserve is
waived thereby creating a permanent tax benefit.
GS Holdings' effective gross federal tax rate was 35% and 37% during the
three months ended September 30, 2002 and 2001, respectively, while its federal
statutory tax rate was 35% during both periods. 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 2% and 6%
during the three months ended September 30, 2002 and 2001, respectively. The low
effective state tax rate during 2002 was the result of previously discussed
reversal of the California bad debt reserves.
MINORITY INTEREST. During each of the three months ended September 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.
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 September 30, 2002, 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 $ -- $(558,901) $ 559,425 $ 29,392 $ -- $ -- $(29,916) $ --
Warehouse loans and
pipeline hedges 15,564 -- 17,423 (29,563) -- -- -- (3,424)
Cash flow (balance sheet)
hedges - swaps -- -- -- (91,778) 37,491 54,287 -- --
------- --------- --------- --------- ------- ------- -------- -------
Fair Value Adjustments -
Three Months Ended
September 30, 2002 15,564 (558,901) 576,848 (91,949) 37,491 54,287 (29,916) (3,424)
Other Activity - Three Months
Ended September 30, 2002:
MSR hedge additions -- -- 397,213 -- -- -- -- --
MSR hedge sales and
maturities -- -- (947,738) 97 -- -- -- --
MSR hedge receipts
and payments -- -- (16,700) (18,896) -- -- -- --
------- --------- --------- --------- ------- ------- -------- -------
Total Other Activity -
Three Months Ended
September 30, 2002 -- -- (567,225) (18,799) -- -- -- --
------- --------- --------- --------- ------- ------- -------- -------
Total Impact from
SFAS No. 133 -
Three Months Ended
September 30, 2002 $15,564 $(558,901) $ 9,623 $(110,748) $37,491 $54,287 $(29,916) $(3,424)
======= ========= ========= ========= ======= ======= ======== =======
Total Impact from
SFAS No. 133 - Three
Months Ended
September 30, 2001 $28,241 $(268,775) $ 132,866 $(157,600) $58,828 $85,183 $(20,534) $ 1,186
======= ========= ========= ========= ======= ======= ======== =======
Page 50
PROBLEM AND POTENTIAL PROBLEM ASSETS
A loan is impaired when it is probable that the Company will be unable to
collect all contractual amounts due (i.e., both principal and interest), based
upon current information and events. In determining impairment, the Company
considers large non-homogeneous loans including nonaccrual loans, troubled debt
restructurings, and performing loans that exhibit, among other characteristics,
high LTV ratios, low debt-coverage ratios or other indications that the
borrowers are experiencing increased levels of financial difficulty. Loans
collectively reviewed for impairment by the Company include all single-family
loans, all auto loans, business banking loans under $100,000 and performing
multi-family and commercial real estate loans under $500,000, excluding loans
which have entered the work-out process.
The measurement of impairment may be based on:
(a) the present value of the expected future cash flows of the
impaired loan discounted at the loan's original effective interest
rate;
(b) the observable market price of the impaired loan; or
(c) the fair value of the collateral (less disposal costs) of a
collateral-dependent loan.
The excess of the recorded investment of the loan over the impaired
loan's value is recognized by recording a valuation allowance.
Cash receipts on non-performing impaired loans are generally used to
reduce the carrying value of the loan, unless the Company expects to recover the
remaining principal balance of the loan. Impairment losses are included in the
allowance for loan losses. Any loss of principal upon disposition is recorded
through a charge-off to the allowance for loan losses.
At September 30, 2002, loans that were considered to be impaired totalled
$48.6 million (of which $15.3 million were on nonaccrual status). The average
recorded investment in impaired loans during the three and nine-month periods
ended September 30, 2002 was approximately $54.2 million and $54.6 million,
respectively. For the three and nine-month periods ended September 30, 2002, GS
Holdings recognized interest income on those impaired loans of $1.0 million and
$3.0 million, respectively, which included $0.2 million and $0.5 million,
respectively, of interest income recognized using the cash basis method of
income recognition.
The following table presents the Company's non-performing loans and
impaired loans, foreclosed real estate and repossessed assets as of the dates
indicated. These categories are not mutually exclusive; certain loans are
included in more than one classification. Purchased auto loans are reflected in
the table below using each individual loan's contractual UPB.
September 30, 2002
------------------------------
Non-performing Impaired
-------------- --------
(in millions)
Real Estate:
1-4 unit residential $ 61 $ 1
Multi-family residential -- 2
Commercial and other 5 31
---- ---
Total real estate 66 34
Non-real estate 22 15
---- ---
Total loans 88 (a) $49 (b)
===
Foreclosed real estate, net 12
Repossessed assets 8
----
Total non-performing assets $108
====
Page 51
December 31, 2001
------------------------------
Non-performing Impaired
-------------- --------
(in millions)
Real Estate:
1-4 unit residential $ 75 $ 1
Multi-family residential -- 9
Commercial and other 4 32
---- ---
Total real estate 79 42
Non-real estate 22 17
---- ---
Total loans 101 (a) $59 (b)
===
Foreclosed real estate, net 19
Repossessed assets 4
----
Total non-performing assets $124
====
___________
(a) There were no loans securitized with recourse on non-performing status at
September 30, 2002 or December 31, 2001.
(b) Includes $15.3 million and $14.1 million of non-performing loans at
September 30, 2002 and December 31, 2001, respectively.
There were no accruing loans contractually past due 90 days or more at
September 30, 2002 or December 31, 2001.
The Company's and the Bank's non-performing assets, consisting of
nonaccrual loans, repossessed assets and foreclosed real estate, net, decreased
to $108 million at September 30, 2002, from $124 million at December 31, 2001.
Non-performing assets as a percentage of the Bank's total assets was 0.21% at
September 30, 2002 and 0.22% at December 31, 2001.
The following table presents non-performing real estate assets by
geographic region of the country as of September 30, 2002:
Total
Non-performing Foreclosed Non-performing
Real Estate Real Estate, Real Estate Geographic
Loans, Net (2) Net (2) Assets Concentration
-------------- ------- ------ -------------
(dollars in millions)
Region:
Northeast (1) $ 7 $ 1 $ 8 10.26%
California 37 6 43 55.13
Other regions 22 5 27 34.61
--- --- --- ------
Total $66 $12 $78 100.00%
=== === === ======
______________
(1) Consists of Connecticut, Delaware, Maine, Maryland, Massachusetts,
New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island
and Vermont.
(2) Net of purchase accounting adjustments.
At September 30, 2002, the Bank had two non-performing assets over $2
million in size with an average balance of $2.3 million and 4,195 non-performing
assets below $2 million in size, including 806 non-performing 1-4 unit
residential assets.
Page 52
ALLOWANCE FOR LOAN LOSSES
The Company's allowance absorbs losses inherent in the loan portfolio.
Management periodically evaluates the adequacy of the allowance. Provisions for
loan losses (charged to current earnings) and balances acquired through
acquisitions increase the allowance, while charge-offs (net of recoveries)
decrease it. The provision considers both specifically identified problem loans
as well as credit risks not specifically identified in the loan portfolio. The
Company recorded no provision for loan losses during the nine months ended
September 30, 2002 and 2001, respectively. Management believes that its present
allowance for loan losses is adequate and it will continue to review its loan
portfolio to determine the extent to which any changes in economic conditions
and loss experience may require further provisions in the future.
Activity in the allowance for loan losses is as follows (in thousands):
Nine Months Ended September 30, Three Months Ended September 30,
------------------------------- --------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Balance - beginning of period $497,298 $526,308 $469,047 $515,979
Provision for loan losses -- -- -- --
Net charge-offs:
1-4 unit residential (1,471) (2,735) (401) (753)
Multi-family residential and
commercial real estate 260 (109) (13) (52)
Auto loans (39,090) (7,457) (17,622) (2,368)
Consumer and other (8,931) (4,992) (2,969) (1,791)
-------- -------- -------- --------
Subtotal - net charge-offs (49,232) (15,293) (21,005) (4,964)
Reclassification (24) (130) -- (130)
-------- -------- -------- --------
Balance - end of period $448,042 $510,885 $448,042 $510,885
======== ======== ======== ========
The current period reclassification relates to loans transferred to the
held-for-sale portfolio. Net charge-offs for the nine months ended September 30,
2002 totalled $49.2 million, up $33.9 million from the nine months ended
September 30, 2001. This level of charge-offs represents 13 bps on average loans
in the nine months ended September 30, 2002, compared to 4 bps of net
charge-offs in the nine months ended September 30, 2001. The increase was
related to the Company's auto loan portfolio, but does not represent a
significant increase in portfolio delinquency rates. Total delinquency rates on
the portfolio were 6.67% at September 30, 2001 compared to 6.48% at September
30, 2002. The higher charge-offs resulted primarily from two other issues.
The Company experienced higher losses in the current quarter compared to
the previous quarter for two reasons. First, both seasonal and general economic
trends resulted in a greater number of defaults, and consequently repossessions
of vehicles. Historically, seasonal factors tend to improve beginning in the
first quarter and continuing into the second quarter. Second, prices received
for repossessed vehicles weakened. This was due to the prevalence of auto
manufacturer incentives, including zero percent financing and cash options, that
attracted buyers to new cars rather than used cars. This in turn depressed the
values of used cars due both to lessened demand and excess supply from
trade-ins. Management believes that such incentives will not be sustainable over
a long period of time, and that used car markets will return to normal
conditions in the near future.
In addition, interest income on all auto loans originated after July 1,
2001 is recorded at the gross coupon vs. an effective (or credit adjusted)
yield. Credit losses on these loans are no longer being amortized through the
net interest margin but are charged to the loan loss allowance, resulting in
higher net charge-offs. During the nine months ended September 30, 2002, net
charge-offs were $22.2 million higher as a result of this treatment. See
"--Interest Income."
Page 53
The adequacy of the allowance is based on past loan loss experience,
known and inherent risks in the loan portfolio, adverse unknown situations that
have occurred that may affect the borrower's ability to repay, the estimated
value of underlying collateral and economic conditions. Management's methodology
for assessing the adequacy of the allowance includes the evaluation of the
following three key elements: the formula allowance, specific allowances for
identified problem loans, and the unallocated allowance.
The formula allowance element considers losses embedded within the
portfolios, but which have not yet been realized. Losses are recognized when:
(a) available information indicates that it is probable that a loss
has been incurred and
(b) the amount of the loss can be reasonably estimated.
The Company has determined that borrowers are impacted by events that
result in loan default and eventual loss which occur well in advance of a
lender's knowledge of those events, and that the time-frame between the
occurrence of such events and the resulting default and loss realization is
between one and 2.5 years, depending upon the loan type. Examples of such
loss-causing events for single family mortgage and other consumer loans would be
borrower job loss, divorce, and medical crisis. An example for commercial real
estate loans would be the loss of a major tenant.
The specific allowances are established against individual loans,
including impaired loans, in accordance with SFAS No. 114. Specific allowances
are established against individual residential 1-4 mortgage loans, commercial
loans and commercial and multi-family real estate loans for which management has
performed analyses and concluded that, based on current information and events,
it is probable that the Bank will be unable to collect all amounts contractually
due. Generally, management believes that collectibility is improbable if a loan
is severely delinquent or if it has been determined that borrower cash flow is
inadequate for debt repayment. The amount of specific allowance is determined by
estimating collateral deficiency, including consideration of collateral disposal
costs. If the net book value exceeds the fair value, a specific allowance is
established equal to the excess. Loans evaluated for specific allowance are
excluded from the formula allowance analysis so as not to double-count loss
exposure.
The unallocated allowance is established for inherent losses which may
not have been identified through the formula and specific portions of the
allowance. The unallocated portion is necessarily more subjective and requires a
high degree of management judgment and experience. Management has identified
several factors that impact the potential for credit losses that are not
considered in either the formula or the specific allowance segments. These
factors consist of industry and geographic loan concentrations, changes in
underwriting processes, and trends in problem loan and loss recovery rates.
Geographic concentration is a particularly key component as there is evidence of
deterioration in some real estate markets, especially in northern California.
Statistics regarding California concentration of the Company's entire real
estate-secured portfolio at September 30, 2002 are summarized below:
% of Total Portfolio Concentration in
--------------------------------------------
California Northern CA Southern CA
---------- ----------- -----------
Residential 76% 37% 39%
Commercial Real Estate 88 28 60
Consumer (primarily Home Equity) 92 42 50
Each factor is analyzed and assigned a range of values. At this time,
management has chosen an unallocated allowance amount at the mid-point of the
range for each factor.
At September 30, 2002, the allowance for loan losses was $448 million,
consisting of a $355 million formula allowance, a $16 million specific allowance
and an $77 million unallocated allowance. Although the loan loss allowance has
been allocated by type of loan for internal valuation purposes, $432 million of
the allowance is general in nature and is available to support any losses which
may occur, regardless of type, in the Company's loan portfolio.
Page 54
A summary of the activity in the total allowance for loan losses by loan
type is as follows:
Multi-family
Residential
1 - 4 Unit and Commercial Consumer
Residential Real Estate Auto and Other Total
----------- ----------- ---- --------- -----
(in millions)
Balance - December 31, 2001 $224 $159 $ 10 $104 $497
Provision for loan losses -- (13) 13 -- --
Charge-offs -- -- (12) (3) (15)
Recoveries -- -- -- 1 1
Reclassification (4) -- -- 4 --
---- ---- ---- ---- ----
Balance - March 31, 2002 220 146 11 106 483
Provision for loan losses -- (17) 17 -- --
Charge-offs (1) -- (10) (5) (16)
Recoveries -- -- 1 1 2
---- ---- ---- ---- ----
Balance - June 30, 2002 219 129 19 102 469
Provision for loan losses -- (22) 22 -- --
Charge-offs -- -- (18) (4) (22)
Recoveries -- -- -- 1 1
---- ---- ---- ---- ----
Balance - September 30, 2002 $219 $107 $ 23 $ 99 $448
==== ==== ==== ==== ====
RISK MANAGEMENT
The Company's risk management policies are established by the Bank's
Asset/Liability Management Committee. ALCO meets monthly to formulate the Bank's
investment and risk management strategies. The basic responsibilities of ALCO
include management of net interest income and market value of portfolio equity
to measure the stability of earnings; management of liquidity to maintain
adequate funding; and the establishment of asset product priorities by
formulating performance evaluation criteria, risk evaluation techniques, and a
system to standardize the analysis and reporting of originations, competitive
trends, profitability and risk. On a quarterly basis, the Board of Directors of
the Bank is apprised of ALCO strategies adopted and their impact on operations,
and, at least annually, the Board of Directors of the Bank reviews the Bank's
interest rate risk management policy statements.
Banks are subject to interest rate risk to the degree that their
interest-bearing liabilities mature or reprice more or less frequently, or on a
different basis, than their interest-earning assets. A key element of the
banking business is the monitoring and management of interest rate risk and
liquidity risk. The process of planning and controlling asset and liability
mixes, volumes, and maturities to influence the net interest spread is referred
to as asset and liability management. The objective of the Company's asset and
liability management is to maximize the net interest income over changing
interest rate cycles within the constraints imposed by prudent lending and
investing practices, liquidity needs, and capital planning.
ASSET AND LIABILITY MANAGEMENT
GS Holdings, through the Bank, actively pursues investment and funding
strategies to minimize the sensitivity of its earnings to interest rate
fluctuations. The Company measures the interest rate sensitivity of its balance
sheet through gap and duration analysis, as well as net interest income and
market value simulation. After taking into consideration both the variability of
rates and the maturities of various instruments, it evaluates strategies which
may reduce the sensitivity of its earnings to interest rate and market value
fluctuations. In order to reduce interest rate risk by increasing the percentage
of interest-rate-sensitive assets, the Company continues to emphasize the
origination of ARM products for its portfolio. Where possible, the Company seeks
to originate real estate and other loans that on the whole adjust in accordance
with the repricing of its liabilities. At September 30, 2002, 77% of the
Company's net loan portfolio consisted of ARMs.
Page 55
One of the most important sources of the Bank's net income is net
interest income, which is the difference between the combined yield earned on
interest-earning assets and the combined rate paid on interest-bearing
liabilities. Net interest income is also dependent on the relative balances of
interest-earning assets and interest-bearing liabilities.
ARMs have, from time to time, been offered with low initial interest
rates as marketing inducements. In addition, most ARMs are subject to periodic
interest rate adjustment caps or floors. In a period of rising interest rates,
ARMs could reach a periodic adjustment cap while still at a rate significantly
below their contractual margin over existing market rates. Since repricing
liabilities are typically not subject to such interest rate adjustment
constraints, the Company's net interest margin would most likely be negatively
impacted in this situation. In order to reduce the negative impact of assets
with periodic rate caps in a rising interest rate environment, the Bank issued
liabilities whose rates are capped against rising rates. Certain ARMs now
offered by the Company have a fixed monthly payment for a given period, with any
changes as a result of market interest rates reflected in the UPB through
negative amortization.
Conversely, in a period of falling rates, ARMs can be subject to
repayments as borrowers convert from floating-rate mortgages to low fixed-rate
mortgages. As the ARMs reprice downward or are converted to low fixed-rate
mortgages, the yield on interest-earning assets is reduced, thereby negatively
impacting the net interest margin. The Bank seeks to manage this risk by
structuring the maturity and repricing of its liabilities to best offset the
impact on the net interest margin.
A traditional measure of interest-rate risk within the savings industry
is the interest rate sensitivity gap, which is the sum of all interest-earning
assets minus the sum of all interest-bearing liabilities to be repriced within
the same period. A gap is considered positive when the amount of
interest-rate-sensitive assets exceeds interest-rate-sensitive liabilities,
while the opposite results in a negative gap. During a period of rising interest
rates, a negative gap would tend to adversely affect net interest income, and a
positive gap would tend to result in an increase in net interest income. During
a period of falling rates, the opposite would tend to occur.
Page 56
The following table sets forth the projected contractual maturities
adjusted for projected prepayments and "repricing mechanisms" (provisions for
changes in the interest rates of assets and liabilities). Prepayment rates are
assumed on substantially all of the Company's loan portfolio based upon expected
loan prepayments. Repricing mechanisms on the Company's assets are subject to
limitations, such as caps on the amount that interest rates and payments on its
loans may adjust. Accordingly, such assets may not respond in the same manner or
to the same extent to changes in interest rates as the Company's liabilities. In
addition, the interest rate sensitivity of the assets and liabilities
illustrated in the table would vary substantially if different assumptions were
used or if actual experience differed from the assumptions set forth. The
Company's estimated interest rate sensitivity gap at September 30, 2002 was as
follows:
Maturity/Rate Sensitivity
--------------------------------------------------------------
Within 1 - 5 Over 5 Noninterest
1 Year Years Years Bearing Total
------ ----- ----- ------- -----
(dollars in millions)
INTEREST-EARNING ASSETS:
Interest-bearing deposits in other banks $ 1,392 $ -- $ -- $ -- $ 1,392
and short-term investment
securities (1) (2)
Securities held to maturity (1) 17 -- -- -- 17
Securities available for sale (3) 110 -- -- -- 110
Mortgage-backed securities
available for sale (3) 3,880 -- -- -- 3,880
Mortgage-backed securities
held to maturity (1) (4) 1,085 14 1 -- 1,100
Loans held for sale, net (3) 1,955 -- -- -- 1,955
Loans receivable, net (1) (5) 22,925 12,348 1,950 -- 37,223
Investment in FHLB 1,105 -- -- -- 1,105
------- ------- ------ ------ -------
Total interest-earning assets 32,469 12,362 1,951 -- 46,782
Noninterest-earning assets -- -- -- 3,647 3,647
------- ------- ------ ------ -------
$32,469 $12,362 $1,951 $3,647 $50,429
======= ======= ====== ====== =======
INTEREST-BEARING LIABILITIES:
Deposits (6) $22,603 $ 2,496 $ 1 $ -- $25,100
Securities sold under agreements to
repurchase (1) 1,888 73 -- -- 1,961
FHLB advances (1) 11,733 4,919 -- -- 16,652
Other borrowings (1) 871 891 -- -- 1,762
------- ------- ------ ------ -------
Total interest-bearing liabilities 37,095 8,379 1 -- 45,475
Noninterest-bearing liabilities -- -- -- 1,605 1,605
Minority interest -- -- -- 500 500
Stockholder's equity -- -- -- 2,849 2,849
------- ------- ------ ------ -------
$37,095 $ 8,379 $ 1 $4,954 $50,429
======= ======= ====== ====== =======
Gap before interest rate swap agreements $(4,626) $ 3,983 $1,950 $ 1,307
Interest rate swap agreements 3,510 (3,440) (70) --
------- ------- ------ -------
Gap (1,116) 543 1,880 $ 1,307
------- ------- ------ =======
Cumulative gap $(1,116) $ (573) $1,307
======= ======= ======
Gap as a percentage of total assets (2.2)% 1.1% 3.7% 2.6%
======= ======= ====== =======
Cumulative gap as a percentage of total assets (2.2)% (1.1)% 2.6% 2.6%
======= ======= ====== =======
(Continued)
Page 57
_________________
(1) Based upon:
(a) contractual maturity,
(b) instrument repricing date, if applicable, and
(c) projected repayments and prepayments of principal, if applicable.
Prepayments were estimated generally by using the prepayment rates
forecast by various large brokerage firms as of September 30, 2002. The
actual maturity and rate sensitivity of these assets could vary
substantially if future prepayments differ from prepayment estimates.
(2) Consists of $89.4 million of short-term investment securities and $1.3
billion of interest-bearing deposits in other banks.
(3) As securities and mortgage-backed securities available for sale and loans
held for sale may be sold within one year, they are considered to be
maturing within one year.
(4) Excludes underlying non-performing securities of $0.8 million.
(5) Excludes allowance for loan losses of $448 million and non-performing
loans of $88 million.
(6) Fixed-rate deposits and deposits with fixed pricing intervals are
reflected as maturing in the year of contractual maturity or first
repricing date. Money market deposit accounts, demand deposit accounts
and passbook accounts are reflected as maturing within one year.
At September 30, 2002, GS Holdings' cumulative gap totalled $1.3 billion.
At December 31, 2001, GS Holdings' cumulative gap totalled $518 million.
The Company utilizes computer modeling, under various interest rate
scenarios, to provide a dynamic view of the effects of the changes in rates,
spreads, and yield curve shifts on net interest income. However, the
maturity/rate sensitivity analysis is a static view of the balance sheet with
assets and liabilities grouped into certain defined time periods, and only
partially depicts the dynamics of the Company's sensitivity to interest rate
changes. Therefore, this analysis may not fully describe the complexity of
relationships between product features and pricing, market rates and future
management of the balance sheet mix.
Page 58
The Company's performance is highly dependent on the structure of the
balance sheet and the relationship between assets and liabilities. Differences
in maturity, coupon rates and rate indices between assets and liabilities have
the potential to create variability in earnings.
The following table sets forth the Company's balance sheet composition by
index (in thousands):
September 30, 2002 December 31, 2001
------------------ -----------------
Balance Sheet Composition by Index:
Securities
Fixed $ 2,725,829 $ 5,348,504
COFI 848,569 1,140,414
Treasury 1,231,291 1,516,419
Other ARMs 212,364 483,136
Unrealized gain/(loss) 89,639 97,070
Purchase accounting (349) 4,129
----------- -----------
Total securities 5,107,343 8,589,672
----------- -----------
Loans
Fixed 8,617,795 9,149,482
Hybrid ARMs 18,120,000 18,649,980
COFI 4,153,266 5,092,248
Treasury 4,271,674 5,340,633
Other ARMs 2,141,921 1,592,005
Purchase accounting 6,106 8,573
Allowance for loan losses (448,042) (497,298)
----------- -----------
Total loans 36,862,720 39,335,623
----------- -----------
Other interest-earning assets 4,452,626 4,151,004
Noninterest-earning assets 4,005,996 4,442,519
----------- -----------
Total assets $50,428,685 $56,518,818
=========== ===========
Deposits $25,100,210 $25,146,827
Borrowings:
Fixed with maturities < 1 year 8,230,256 9,416,480
Fixed with maturities > 1 year 6,482,839 10,155,390
Adjustable 5,557,000 7,063,000
Purchase accounting 72 2,524
Accrued interest payable 104,723 171,092
----------- -----------
Total borrowings 20,374,890 26,808,486
----------- -----------
Noninterest-bearing liabilities 1,604,404 1,438,716
Minority interest and stockholder's equity 3,349,181 3,124,789
----------- -----------
Total liabilities and equity $50,428,685 $56,518,818
=========== ===========
Page 59
MORTGAGE BANKING ACTIVITIES
The following table provides detailed information related to FNMC's MSRs:
September 30, 2002 December 31, 2001
------------------ -----------------
(dollars in thousands)
Residential Mortgage Servicing Portfolio:
Total UPB residential loans serviced $110,489,364 $112,262,916
Total number of residential loans serviced 959,625 997,276
Total UPB residential loans serviced for others $ 87,268,885 $ 85,218,280
Total number of residential loans serviced for others 819,999 838,234
Portfolio Characteristics:
Weighted average contractual servicing fee earned 42bps 42bps
Average loan balance $ 106 $ 102
Weighted average note rate 7.11% 7.36%
Per loan servicing cost (in whole dollars) $ 49 $ 47
Secured by California properties 42.08% 45.67%
Nine Months Ended September 30, Three Months Ended September 30,
------------------------------- --------------------------------
2002 2001 2002 2001
---- ---- ---- ----
(in thousands)
Mortgage loans sold $15,385,092 $11,191,653 $3,464,789 $5,548,272
Mortgage loans sold (servicing retained) $15,364,620 $11,191,080 $3,464,789 $5,548,169
Number of Loans Loan Principal Msr Basis
--------------- -------------- ---------
(whole numbers) (in thousands)
Residential Mortgage Servicing Portfolio:
Balance - December 31, 2001 (a) 838,234 $ 85,218,280 $1,620,916
Originated servicing 205,331 14,450,666 349,260
Flow purchases 47,017 6,949,539 185,277
Bulk purchases 15,184 2,252,897 37,797
Runoff (285,767) (21,602,497) (324,808)
Fair value adjustment (SFAS No. 133) -- -- (746,527)
Valuation provision -- -- (120,735)
-------- ------------ ----------
Balance - September 30, 2002 (a) 819,999 $ 87,268,885 $1,001,180
======== ============ ==========
___________
(a) Excludes $1.6 million at September 30, 2002 and $3.0 million at December
31, 2001 of MSRs on non-single family residential portfolios.
Page 60
The table below summarizes mortgage servicing acquisitions during the
nine and three months ended September 30, 2002 and 2001:
Number of loans Loan Principal MSR Basis
------------------- ------------------ ------------------
Nine Months Ended September 30,
----------------------------------------------------------------------------
2002 2001 2002 2001 2002 2001
---- ---- ---- ---- ---- ----
(whole numbers) (in millions) (in millions)
------------------- ------------------ ------------------
Residential Mortgage
Servicing portfolio:
Purchased servicing rights 62,201 62,803 $9,202.4 $8,709.1 $223.1 $231.6
Number of loans Loan Principal MSR Basis
------------------- ------------------ ------------------
Three Months Ended September 30,
----------------------------------------------------------------------------
2002 2001 2002 2001 2002 2001
---- ---- ---- ---- ---- ----
(whole numbers) (in millions) (in millions)
------------------- ------------------ ------------------
Residential Mortgage
Servicing portfolio:
Purchased servicing rights 12,564 27,612 $1,850.8 $3,892.8 $45.6 $105.2
Page 61
MORTGAGE BANKING RISK MANAGEMENT
In 2002, mortgage rates have declined to levels not seen in over
thirty-five years. As a result, prepayments of mortgages are occurring at an
unprecedented level. This results in reduced servicing fee income due to
increased amortization and also results in lower market value of MSRs. To reduce
the sensitivity of its earnings to interest rate and market value fluctuations,
the Company hedges the change in value of its MSRs based on changes in the
benchmark interest rate, LIBOR. However, its hedge coverage ratio does not
always equate to 100%. The Company does not hedge certain components of its
portfolio, primarily ARMs and loans with prepayment penalties. In addition, the
Company hedges only certain components of risk, which have not generally
included the mortgage rate spread to other market interest rates. The Company
works to reduce its exposure to changes between mortgage and LIBOR rates in a
variety of ways, including changing the hedge ratio and the mix of the
instruments used to hedge its MSRs. However, because its instruments are
predominantly based on LIBOR rates, there is significant exposure to future
spread changes.
The Company owned several derivative instruments at September 30, 2002,
which were used to hedge the change in value of the mortgage servicing portfolio
due to expected prepayment risk assumption changes caused by changes in rates.
These derivative instruments included interest rate swap agreements, Constant
Maturity Swap interest rate floor contracts, swaptions and PO swaps. MSR
derivatives used to hedge the change in value due to prepayment risk are
comprised of the following (dollars in thousands):
Notional Fair Value at
Derivative Amount Contract Provisions Maturity September 30, 2002
---------- ------ ------------------- -------- -----------------------
Assets Liabilities
------ -----------
Interest rate swap agreements $5,495,000 Weighted average pay rate of 1.80% 2005 - 2012 $114,767 $(141)
Receive rates between 2.97% and 4.73%
Interest rate floor contracts (a) 250,000 Strike rates between 5.96% and 6.19% 2007 9,062 --
Swaption contracts (b) 1,704,000 Strike rates between 4.40% and 4.85% 2003 - 2004 76,367 --
PO swap agreements 396,960 Index tied to LIBOR based on cash
flow from a PO strip 2002 - 2028 5,473 (397)
Other 400,000 Strike rate between 5.50% and 6.00% 2002 2,336 --
---------- -------- -----
Total $8,245,960 $208,005 $(538)
========== ======== =====
____________
(a) Premiums paid to counterparties in exchange for the right to receive cash
payments when the 10-year Constant Maturity Swap rate falls below the
strike rate are recorded as part of the MSR derivative asset on the
balance sheet.
(b) Premiums paid to counterparties in exchange for the right to enter into
an interest rate swap are recorded as part of the MSR derivative asset on
the balance sheet.
Servicing fee income for the nine months ended September 30, 2002
included a $120.7 million charge to increase the valuation allowance on MSRs.
During the nine-month period, mortgage rates declined significantly
(approximately 130 bps) and estimates of future prepayment speeds accelerated
substantially. In addition, the relationship between mortgage rates and the
LIBOR rates on the instruments most commonly used to hedge MSRs moved in a
manner that increased the effective hedge ratio and reduced the amount of
impairment required to be recorded. Based on the benchmark mortgage rate the
Bank uses for its internal estimates, the spread between mortgage and LIBOR
rates widened from approximately 114 bps at December 31, 2001 to approximately
140 bps at September 30, 2002. These spread levels represent historically wide
spreads. All of the widening occurred in the three months ended September 30,
2002, when mortgage rates declined approximately 81 bps and LIBOR rates declined
approximately 110 bps. As a result, during the three months ended September 30,
2002, the Company was
Page 62
effectively 100% hedged and recorded a small recovery (approximately $6.4
million) of its previously recorded valuation allowance. The Company estimates
that the spread widening increased the gain in the value of the hedges and the
offsetting writedown of the MSRs by approximately $100 million. The hedge ratio
during the nine-month period ranged from approximately 60% to approximately
100%.
If mortgage rates were to remain constant and LIBOR rates were to
increase such that the spread to mortgage rates was similar to that at June 30,
2002, the hedges at September 30, 2002 would lose an estimated $100 million and
the servicing would only gain an estimated $30 million, resulting in a net
pre-tax loss of $70 million. To the extent that mortgage rates also increase,
but not as much as LIBOR rates, recorded losses may be reduced because estimated
hedge ratios are less than 100% or because other factors used in the valuation
change in a manner that increases the value of the servicing.
Because mortgage rates have decreased in 2002 to lows not seen in over
thirty-five years, prepayments of mortgages are occurring at an unprecedented
level despite significant opportunities to refinance in 2001. These
unprecedented prepayments could exceed estimates of prepayments used in the
valuation of the servicing resulting in additional recorded losses in the
future.
When developing MSR values, there is no demonstrable liquid market for
MSRs with the same size and other characteristics as the Company's MSR asset.
Management must therefore turn to other methods to estimate fair value.
Management regularly reviews its process for determining MSR fair value and
believes that the process it has been using has led to reasonable estimates of
value.
LIQUIDITY
The ratio of cash and short-term U.S. Government securities and other
specified securities to deposits and borrowings due within one year measures the
Company's liquidity. The OTS requires that California Federal maintain
sufficient liquidity to ensure its safe and sound operation. Effective March 15,
2001, the OTS eliminated the previously imposed minimum liquidity requirement of
4%. California Federal has been in compliance with the liquidity regulations
during the nine months ended September 30, 2002 and the year ended December 31,
2001.
The major source of funding for GS Holdings on an unconsolidated basis is
distributions of the Bank's earnings and tax sharing payments. Net income
generated by the Bank is used to meet its own cash flow needs, including paying
dividends on its preferred stock owned by GS Holdings, and may be distributed,
subject to certain restrictions, to the Company. In turn, GS Holdings uses
distributions received from the Bank primarily to meet debt service
requirements, pay any expenses it may incur and make distributions to Golden
State, subject to certain restrictions. For more information on dividend
restrictions for the Bank and GS Holdings, refer to "Business - Regulation and
Supervision" and note 24 of the "Notes to Consolidated Financial Statements" in
the Company's 2001 Annual Report on Form 10-K.
On a consolidated basis, a major source of the Company's funding is
expected to be the Bank's retail deposit branch network, which management
believes will be sufficient to meet its long-term liquidity needs. The Company
must retain and attract new deposits, which depends upon the variety and
effectiveness of its customer account products, service and convenience, and
rates paid to customers. Any decline in retail deposit funding would adversely
impact the Company's liquidity. The Company also obtains funds from the
repayment and maturity of loans and mortgage-backed securities, as well as
deposit inflows, loan sales, securities sold under agreements to repurchase,
FHLB advances, and other secured and unsecured borrowings. The Company
anticipates that FHLB advances and securities sold under agreements to
repurchase will continue to be important sources of funding, and management
expects there to be adequate collateral for such funding requirements. A decline
in the Bank's credit rating would adversely affect the Bank's ability to borrow
and/or the related borrowing costs, thus impacting the Company's liquidity. In
addition, if the Company were to default on a borrowing, all principal and
accrued interest would become due and payable, thus negatively affecting the
Company's liquidity.
Page 63
The consolidated Company's primary uses of funds are the origination or
purchase of loans, mortgage-backed securities, maturing CDs, demand deposit
withdrawals, repayment of borrowings and dividends to common shareholders. CDs
scheduled to mature during the twelve months ending September 30, 2003 aggregate
$6.9 billion. The Company may renew these certificates, attract new replacement
deposits, replace such funds with other borrowings, or reduce the size of the
balance sheet. In addition, at September 30, 2002, the Company had FHLB
advances, securities sold under agreements to repurchase and other borrowings
aggregating $9.2 billion and $14.5 billion maturing or repricing within the next
three and twelve months, respectively. The Company may elect to pay off such
debt or to replace such borrowings with additional FHLB advances, securities
sold under agreements to repurchase or other borrowings at prevailing rates.
Interest expense on the GS Holdings Notes approximates $107.3 million per
year. The Company expects the GS Holdings Notes to be redeemed within 30 days
after the consummation of the Citigroup Merger. Although GS Holdings expects
that distributions and tax sharing payments from the Bank will cover future
interest and principal payments, there is no guarantee. In addition, there is no
assurance that Bank distributions will be permitted by the terms of any GS
Holdings' debt instruments, any class of preferred stock issued by the Bank or
its subsidiaries, including the REIT Preferred Stock, or under applicable
federal thrift laws then in effect.
The Company anticipates that cash and cash equivalents on hand and its
sources of funds will provide adequate liquidity for its operating, investing
and financing needs and the Bank's regulatory liquidity requirements for the
foreseeable future. In addition to cash and cash equivalents of $2.2 billion at
September 30, 2002, the Company has substantial additional borrowing capacity
with the FHLB and other sources amounting to $8.9 billion.
As presented in the accompanying unaudited consolidated statements of
cash flows, the sources of liquidity vary between periods. The primary sources
of funds during the nine months ended September 30, 2002 were $59.6 billion in
proceeds from additional borrowings, $15.0 billion in proceeds from sales of
loans held for sale, $5.6 billion in net loan originations and principal
collections, $3.4 billion in principal payments on mortgage-backed securities
available for sale and held to maturity and $2.0 billion in proceeds from sales
and settlements of derivatives. The primary uses of funds were $65.6 billion in
principal payments on borrowings, $14.7 billion in purchases and originations of
loans held for sale, $3.3 billion in purchases of loans receivable and $1.2
billion in purchases of derivatives.
CAPITAL MANAGEMENT
OTS capital regulations require the Bank to satisfy three minimum capital
requirements: tangible capital, core (leverage) capital, and risk-based capital.
TANGIBLE CAPITAL. Tangible capital is the sum of the Bank's common
stockholder's equity (including retained earnings), noncumulative perpetual
preferred stock and minority interest in equity accounts of fully consolidated
subsidiaries, less disallowed intangibles. Tangible capital must be at least
1.5% of adjusted total assets.
CORE CAPITAL. Core capital generally is the sum of tangible capital plus
certain other qualifying intangibles. Under the leverage requirement, a savings
association is required to maintain core capital equal to a minimum of 4% of
adjusted total assets.
RISK-BASED CAPITAL. Risk-based capital equals the sum of core capital
plus supplementary capital. Risk-based capital must be at least 8% of
risk-weighted assets.
RISK-WEIGHTED ASSETS. Risk-weighted assets equal assets plus the credit
risk equivalent of certain off-balance sheet items, multiplied by the
appropriate risk weight.
SUPPLEMENTARY CAPITAL. Supplementary capital includes certain permanent
capital instruments, such as qualifying cumulative perpetual preferred stock, as
well as some forms of term capital instruments, such as qualifying subordinated
debt. Supplementary capital may not exceed 100% of core capital for purposes of
the risk-based requirement.
Page 64
MINIMUM REQUIREMENTS. These capital requirements discussed above are
viewed as minimum standards by the OTS. In addition, the OTS regulations provide
that minimum capital levels higher than those provided in the regulations may be
established by the OTS for individual savings associations, depending upon their
circumstances. The Bank is not subject to any such individual regulatory capital
requirement that is higher than the minimum. These capital requirements are
currently applicable to the Bank but not to GS Holdings.
At September 30, 2002, the Bank's tangible, core and risk-based capital
ratios of 8.18%, 8.18% and 15.23%, respectively, exceeded the minimum regulatory
capital requirements. The following is a reconciliation of the Bank's
stockholder's equity to regulatory capital as of September 30, 2002:
Tangible Core Risk-based
Capital Capital Capital
------- ------- -------
(dollars in millions)
Stockholder's equity of the Bank $4,356 $4,356 $4,356
Minority interest - REIT Preferred Stock 500 500 500
Unrealized holding gain on securities, net (53) (53) (53)
Unrealized holding loss on derivative instruments, net 191 191 191
Non-allowable capital:
Non-qualifying loan servicing rights (94) (94) (94)
Intangible assets (611) (611) (611)
Goodwill Litigation Assets (159) (159) (159)
Investment in non-includable subsidiaries (68) (68) (68)
Supplemental capital:
Qualifying subordinated debentures -- -- 55
General loan loss allowance -- -- 367
Assets required to be deducted:
Equity in subsidiaries -- -- (7)
Low-level recourse deduction -- -- (9)
------ ------ ------
Regulatory capital of the Bank 4,062 4,062 4,468
Minimum regulatory capital requirement 745 1,987 2,347
------ ------ ------
Excess above minimum capital requirement $3,317 $2,075 $2,121
====== ====== ======
Regulatory capital of the Bank 8.18% 8.18% 15.23%
Minimum regulatory capital requirement 1.50% 4.00% 8.00%
---- ---- -----
Excess above minimum capital requirement 6.68% 4.18% 7.23%
==== ==== =====
The amount of adjusted total assets used for the tangible and leverage
capital ratios is $49.7 billion. Risk-weighted assets used for the risk-based
capital ratio amounted to $29.3 billion.
Under the prompt corrective action regulations mandated by the FDICIA,
the OTS must take certain actions against savings associations that fall within
certain undercapitalized capital categories. The regulation establishes five
categories of capital classification: "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized," and
"critically undercapitalized." Under the regulation, three ratios determine an
association's capital classification:
o the ratio of total capital to risk-weighted assets,
o the ratio of core capital to risk-weighted assets and
o the leverage capital ratio.
Page 65
The Bank met the capital requirements of a "well capitalized" institution
under the FDICIA prompt corrective action standards as of September 30, 2002.
The Bank is not subject to any enforcement action or other regulatory
proceedings with respect to the prompt corrective action regulation. Management
believes there have been no conditions or events since September 30, 2002 that
would change the Bank's capital classification.
At September 30, 2002, the Bank's capital levels were sufficient for it
to be considered "well capitalized," as presented below.
Risk-based
Leverage -------------------------
Capital Tier 1 Total Capital
-------- ------ -------------
Regulatory capital of the Bank 8.18% 13.82% 15.23%
"Well capitalized" ratio 5.00% 6.00% 10.00%
---- ----- -----
Excess above "well capitalized" ratio 3.18% 7.82% 5.23%
==== ===== =====
OTS capital regulations allow a savings association to include a net
deferred tax asset in regulatory capital, subject to certain limitations. To the
extent that the realization of a deferred tax asset depends on a savings
association's future taxable income, such deferred tax asset is limited for
regulatory capital purposes to the lesser of the amount that can be realized
within one year or 10 percent of core capital. At September 30, 2002, none of
the net tax benefit was determined to be attributable to the amount of taxable
income that may be realized in periods beyond one year. Accordingly, no amount
has been excluded from the Bank's regulatory capital at September 30, 2002.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in reported market risks faced by GS
Holdings since the Company's report in Item 7A of its Form 10-K for the year
ended December 31, 2001.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
Exchange Act reports is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms, and that such information
is accumulated and communicated to the Company's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure.
Within 90 days prior to the date of this report, the Company carried out
an evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer along with the
Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-14. Based upon the foregoing, the Company's Chief
Executive Officer along with the Company's Chief Financial Officer concluded
that the Company's disclosure controls and procedures are effective. There have
been no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls subsequent to the date
the Company completed its evaluation.
Page 66
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 was remanded back to
the Claims Court for a damages trial under the lost profits theory, and the
trial concluded on October 22, 2002, with post-trial briefing to end on November
15, 2002, sometime after which the Claims Court will issue its ruling. 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. On August 2, 2002, the Claims Court determined that the Bank's
total reliance damages were $380.8 million. On August 19, 2002, the Government
filed with the Claims Court a motion for reconsideration of this damage award,
which the Claims Court has not yet acted upon.
Page 67
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.
An agreement to settle all claims on a California class basis has been
reached with the plaintiffs' counsel. The trial court granted preliminary
approval of the settlement and the final hearing on the settlement is scheduled
for February 2003. It is anticipated that the cost of the settlement will not be
material.
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 2. CHANGES IN SECURITIES.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
Page 68
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 69
GLOSSARY OF DEFINED TERMS
AICPA - American Institute of Certified Public Accountants
ALCO - Asset/Liability Management Committee
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
CALIFORNIA FEDERAL GOODWILL LITIGATION ASSET - an asset, related to California
Federal Goodwill Litigation, arising out of the purchase of the Old
California Federal.
CD - Certificate of deposit
CFI - Cal Fed Investments
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.
CRA - Community Reinvestment Act
EITF - Emerging Issues Task Force
EITF NO. 94-3 - Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)
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
GLENDALE GOODWILL LITIGATION ASSET - an asset, related to the Glendale Goodwill
Litigation, arising out of the purchase of Glendale Federal.
GNMA - Government National Mortgage Association
GOLDEN STATE - Golden State Bancorp Inc.
Page 70
GLOSSARY OF DEFINED TERMS (CONTINUED)
GOLDEN STATE ACQUISITION - FN Holdings Asset Transfer, Holding Company Mergers
and Glen Fed Merger, collectively
GOLDEN STATE COMMON STOCK - Golden State common stock, par value $1.00
GOLDEN STATE MERGER - the merger, completed on September 11, 1998, between
Golden State, the publicly traded parent company of Glendale Federal, and
First Nationwide Holdings Inc. and Hunter's Glen/Ford, Ltd.
GOODWILL LITIGATION ASSETS - the California Federal Goodwill Litigation Asset
and the Glendale Goodwill Litigation Asset, collectively
GOVERNMENT - United States Government
GSB - Golden State Bancorp Inc.
GSB INVESTMENTS - GSB Investments Corp.
GS HOLDINGS - Golden State Holdings Inc.
GS HOLDINGS NOTES - On August 6, 1998, GS Escrow Corp, which subsequently
merged into GS Holdings, issued $2 billion of fixed and floating rate
notes.
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
LIBOR - London Interbank Offered Rate
LTV - Loan-to-value
LTWTM - Litigation Tracking WarrantsTM
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
NOL - net operating loss
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.
Page 71
GLOSSARY OF DEFINED TERMS (CONTINUED)
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. 72 - Accounting for Certain Acquisitions of Banking or Thrift
Institutions
SFAS NO. 114 - Accounting by Creditors for Impairment of a Loan
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
SFAS NO. 146 - Accounting for Costs Associated with Exit or Disposal Activities
SFAS NO. 147 - Acquisitions of Certain Financial Institutions
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
UPB - Unpaid principal balance
VERDUGO - Verdugo Trustee Service Corporation
Page 72
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)
November 4, 2002
Page 73
CERTIFICATIONS
CERTIFICATION BY CHAIRMAN AND CHIEF EXECUTIVE OFFICER
I, Gerald J. Ford, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Golden State
Holdings Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weakness in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Gerald J. Ford
----------------------------------------
By: Gerald J. Ford
Chairman and Chief Executive Officer
November 4, 2002
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CERTIFICATION BY CHIEF FINANCIAL OFFICER
I, Richard H. Terzian, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Golden State
Holdings Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weakness in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Richard H. Terzian
----------------------------------------
By: Richard H. Terzian
Chief Financial Officer
November 4, 2002
Page 75