<PAGE>
As filed with the Securities and Exchange Commission on July 15, 1999
Registration No. 333-79835
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
Amendment No. 2 to
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------
Downey Financial Capital Trust I
Downey Financial Corp. (Exact name of co-registrant as
(Exact name of registrant as specified specified in its charter)
in its charter)
Delaware
Delaware (State or other jurisdiction of
(State or other jurisdiction of incorporation or organization)
incorporation or organization)
33-0858330
33-0633413 (I.R.S. Employer Identification No.)
(I.R.S. Employer Identification No.)
3501 Jamboree Road
3501 Jamboree Road Newport Beach, California 92660
Newport Beach, California 92660 (949) 854-0300
(949) 854-0300 (Address, including zip code, and
(Address, including zip code, and telephone number, including area code,
telephone number, includingarea code, of co-registrant's principal executive
of registrant's principal executive office)
office)
DANIEL D. ROSENTHAL
President and Chief Executive Officer
--------------
Downey Financial Corp.
3501 Jamboree Road
Newport Beach, California 92660
(949) 854-0300
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
--------------
Copies to:
T. HALE BOGGS, ESQ. ERIC S. HAUETER, ESQ.
Manatt, Phelps & Phillips, LLP Brown & Wood LLP
70 Willow Road 555 California Street
Menlo Park, California 94025 San Francisco, California 94104
Telephone: (650) 566-3510 Telephone: (415) 772-1200
--------------
Approximate date of commencement of proposed sale to public: As soon as
practicable after this Registration Statement becomes effective.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, check the following
box. [_]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or
interest reinvestment plans, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [_]
CALCULATION OF REGISTRATION FEE
<TABLE>
- -------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------
<CAPTION>
Proposed Maximum Proposed Maximum Amount of
Title of Each Class of Amount to be Offering Price Aggregate Offering Registration
Securities to be Registered Registered Per Unit (1) Price Fee (5)
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Capital Securities of Downey Financial 4,800,000
Capital Trust I........................... shares $25 $120,000,000 $33,360
- -------------------------------------------------------------------------------------------------------------
Junior Subordinated Debentures of Downey
Financial Corp. (2)....................... -- -- -- --
- -------------------------------------------------------------------------------------------------------------
Guarantee of Downey Financial Corp. with
respect to Capital Securities (3)......... -- -- -- --
- -------------------------------------------------------------------------------------------------------------
Total (4).................................. 4,800,000
shares $25 $120,000,000 $33,360
- -------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Estimated solely for the purpose of determining the registration fee
pursuant to Rule 457(a) under the Securities Act of 1933, as amended.
(2) The junior subordinated debentures will be purchased by Downey Financial
Capital Trust I with the proceeds from the sale of the capital securities.
These securities may later be distributed for no additional consideration
to the holders of the capital securities of Downey Financial Capital Trust
I under specific circumstances.
(3) No separate consideration will be received for the Downey Financial Corp.
guarantee.
(4) This Registration Statement is deemed to cover the junior subordinated
debentures of Downey Financial Corp., the rights of holders of junior
subordinated debentures of Downey Financial Corp. under the indenture, the
rights of holders of capital securities of Downey Financial Capital Trust
I under the trust agreement and the rights of holders of the capital
securities under the guarantee agreement entered into by Downey Financial
Corp. and specific backup undertakings as described herein, which taken
together, fully, irrevocably and unconditionally guarantee all of the
obligations of Downey Financial Capital Trust I under the capital
securities.
(5) A registration fee in the amount of $27,800 was previously paid to the SEC
in connection with the Registration Statement on Form S-3 filed with the
SEC on June 2, 1999.
Downey Financial Corp. and Downey Financial Capital Trust I hereby amend
this registration statement on such date or dates as may be necessary to delay
its effective date until they shall file a further amendment which
specifically states that this registration statement shall thereafter become
effective in accordance with Section 8(a) of the Securities Act of 1933 or
until the registration statement shall become effective on such date as the
SEC, acting pursuant to said Section 8(a), may determine.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. Downey +
+Financial Corp., the trust and the underwriters may not sell these securities +
+until the registration statement filed with the Securities and Exchange +
+Commission is effective. This prospectus is not an offer to sell these +
+securities and it is not soliciting an offer to buy these securities in any +
+state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
PROSPECTUS (Subject to Completion)
Issued July 15, 1999
$120,000,000
Downey Financial Capital Trust I
% CAPITAL SECURITIES
----------- [LOGO OF DOWNEY SAVINGS]
guaranteed by
Downey Financial Corp.
-----------
Downey Financial Capital Trust I is offering capital securities that Downey
Financial Corp. will guarantee, based on its obligations under a guarantee, a
trust agreement and an indenture.
-----------
We will apply to list the capital securities on the New York Stock Exchange
under the symbol "DFT." If approved for listing, we expect that trading of the
capital securities on the New York Stock Exchange will commence within 30 days
after initial delivery of the capital securities.
-----------
Investing in the capital securities involves risks. See "Risk Factors"
beginning on page 11.
-----------
<TABLE>
<CAPTION>
Underwriting Proceeds to
Discounts and Downey Financial
Price to Public Commissions Capital Trust I
--------------- ------------- ----------------
<S> <C> <C> <C>
Per Capital Security............. $ 25.00 $ $
Total............................ $120,000,000 $ $
</TABLE>
Because the trust will use all of the proceeds from the sale of the capital
securities to purchase junior subordinated debentures of Downey Financial
Corp., Downey Financial Corp. will pay all underwriting discounts and
commissions. If you purchase capital securities after , 1999, you should
add any accumulated distributions from that date to the price to public.
These securities are not deposits or other obligations of a bank and are not
insured by the Federal Deposit Insurance Corporation or any other government
agency.
The Securities and Exchange Commission and state securities regulators have not
approved or disapproved these securities or determined this prospectus is
truthful or complete. Any representation to the contrary is a criminal offense.
The underwriters expect to deliver the capital securities to purchasers on
, 1999.
-----------
MORGAN STANLEY DEAN WITTER
DAIN RAUSCHER WESSELS
a division of Dain
Rauscher Incorporated
A.G. EDWARDS & SONS
PRUDENTIAL SECURITIES
SUTRO & CO. INCORPORATED
, 1999
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
PROSPECTUS SUMMARY....................................................... 3
RISK FACTORS............................................................. 11
A WARNING ABOUT FORWARD-LOOKING INFORMATION.............................. 22
WHERE YOU CAN FIND MORE INFORMATION...................................... 23
DOCUMENTS INCORPORATED BY REFERENCE...................................... 23
USE OF PROCEEDS.......................................................... 24
CAPITALIZATION........................................................... 24
ACCOUNTING TREATMENT..................................................... 25
SELECTED CONSOLIDATED FINANCIAL DATA..................................... 26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS........................................................... 28
BUSINESS................................................................. 83
DESCRIPTION OF THE CAPITAL SECURITIES.................................... 104
DESCRIPTION OF JUNIOR SUBORDINATED DEBENTURES............................ 121
BOOK-ENTRY ISSUANCE...................................................... 133
DESCRIPTION OF GUARANTEE................................................. 136
RELATIONSHIP AMONG THE CAPITAL SECURITIES, THE JUNIOR SUBORDINATED
DEBENTURES AND THE GUARANTEE............................................ 138
CERTAIN FEDERAL INCOME TAX CONSEQUENCES.................................. 140
CERTAIN ERISA CONSIDERATIONS............................................. 145
UNDERWRITERS............................................................. 146
LEGAL MATTERS............................................................ 147
EXPERTS.................................................................. 147
</TABLE>
2
<PAGE>
PROSPECTUS SUMMARY
The information contained and incorporated by reference in this prospectus is
accurate only as of the date of this prospectus or the date of the document
incorporated by reference, as the case may be, regardless of the time of
delivery of this prospectus or any sale of the capital securities. In this
prospectus, "Downey," "we," "us" and "our" refer to Downey Financial Corp. and
its consolidated subsidiaries unless otherwise expressly stated or the context
otherwise requires, and "trust" refers to Downey Financial Capital Trust I.
This summary highlights selected information from this prospectus. It may not
contain all the information that is important to you. You should carefully read
this entire prospectus, as well as the documents incorporated by reference in
this prospectus, before making a decision about whether to invest in the
capital securities. You should pay special attention to the "Risk Factors" to
determine whether an investment in the capital securities is appropriate for
you.
Downey Financial Corp.
Downey is a California-based savings and loan holding company. Our principal
subsidiary is Downey Savings and Loan Association F.A., which we refer to as
the "Bank." The Bank:
. is one of the largest financial institutions headquartered in Southern
California, based on total assets;
. was formed in 1957 as a California-licensed savings and loan and
converted to a federal charter in 1995;
. at March 31, 1999, operated through more than 95 retail branches,
including 33 full-service in-store branches in California, and two loan
origination offices outside of California, one each in Arizona and
Washington; and
. experienced the best year in its 42-year history in 1998, with record
net income of $58 million and record loan production of $4.1 billion.
For the year ended December 31, 1998, we had:
. net income of $58 million, or $2.05 per share on a diluted basis, an
increase of 28% from 1997;
. asset growth of $435 million, to $6.3 billion; and
. non-performing assets of $27 million, or 0.44% of total assets, at
December 31, 1998, down from $52 million, or 0.89% of total assets, at
December 31, 1997.
At March 31, 1999, we had:
. total assets of $6.6 billion;
. total deposits of $5.2 billion; and
. total stockholders' equity of $490 million.
Banking Activities
Our primary business is banking. Our banking activities focus on:
. the origination of loans, primarily loans secured by single family
residential properties, which are either retained in our portfolio or
sold in the secondary market;
. the attraction of low-cost deposits through our retail branches;
. providing exceptional customer service; and
. providing innovative new products and services, including an increasing
focus on products offered over the Internet and on-line banking.
3
<PAGE>
The types of loans we offer include:
. adjustable rate residential mortgage loans, with rates tied primarily to
the Eleventh District Cost of Funds Index, including "subprime" loans
which carry higher interest rates;
. fixed rate residential mortgage loans;
. commercial real estate loans, including loans secured by retail
neighborhood shopping centers;
. construction loans; and
. automobile loans, through both a direct lending program and an indirect
program through preapproved auto dealers to finance customer purchases
of new and used automobiles.
We also invest in various securities--primarily short-term obligations--to
satisfy bank regulations regarding minimum levels of liquid assets.
Real Estate Investment Activities
Downey is also involved in real estate investment, which is conducted
primarily through the Bank's subsidiary, DSL Service Company. Activities
include development, construction and property management relating to our
portfolio of projects primarily within California but also in Arizona. Because
of regulatory restrictions that have been placed on real estate investment
activities, we have reduced the amount of this business in recent years. Net
income from our real estate investment and real estate joint venture activities
was $11 million in 1998.
Operating Strategy
Our operating strategy is to:
. capitalize on our strong position in our core California market and
expand our Internet business;
. broaden our new product offerings and services, including an increasing
focus on higher yielding auto and subprime residential loans;
. maintain our high lending standards and strong asset quality;
. continue to strengthen our retail franchise, including the establishment
of additional in-store branches;
. continue to focus on attracting low cost deposits from our retail
customer base;
. maintain the high quality of our service to depositors and borrowers;
and
. improve our operating efficiency.
Our principal executive offices are located at 3501 Jamboree Road, Newport
Beach, California, 92660, and our telephone number is (949) 854-0300. Our Web
site is www.downeysavings.com.
4
<PAGE>
Downey Financial Capital Trust I
The trust is a business trust formed under Delaware law, which has been
established solely for the following purposes:
. to issue and sell its capital securities to the public, which represent
an undivided beneficial interest in the assets of the trust;
. to issue and sell its common securities to Downey in a total liquidation
amount equal to at least 3% of the total capital of the trust;
. to use the proceeds from the sale of its common securities and capital
securities to acquire junior subordinated debentures from Downey; and
. to engage in other activities that are directly related to the
activities listed above.
Because the trust has been established only for the purposes listed above,
the junior subordinated debentures will be the sole assets of the trust, and
payments on the junior subordinated debentures will be the sole source of
income to the trust. There are five trustees of the trust. Three of them, the
administrative trustees, are officers of Downey. Wilmington Trust Company will
act as the property trustee of the trust and will also act as the Delaware
trustee of the trust.
The common securities will have terms substantially identical to and will
rank equal, and payments will be made thereon pro rata, with the capital
securities. However, if Downey defaults on the junior subordinated debentures,
then cash distributions and liquidation, redemption and other amounts payable
on the common securities will be subordinate to the capital securities in
priority of payment.
The trust has a term of 31 years, but may terminate earlier if specific
conditions are met. The trust's principal offices are located at 3501 Jamboree
Road, Newport Beach, California 92660, and its telephone number is (949) 854-
0300.
The Offering
Capital securities issuer........... Downey Financial Capital Trust I
Securities offered..................
The % capital securities of the
trust represent undivided
beneficial interests in the assets
of the trust. Each capital security
will entitle the holder to receive
cumulative quarterly cash
distributions as described below.
The underwriters are offering
4,800,000 capital securities having
a liquidation amount of $25 per
capital security. The capital
securities are being offered at $25
per capital security plus
accumulated distributions, if any,
from 1999.
The trust's assets.................. The trust will sell the capital
securities to the public and will
sell its common securities to
Downey. The trust will use the
proceeds from these sales to buy a
series of % junior subordinated
debentures due 2029 from Downey.
When Downey pays interest on the
junior subordinated debentures, the
trust will pay distributions on the
capital securities at the same rate
5
<PAGE>
and at the same times. The trust
will use the payments it receives
on the junior subordinated
debentures to make the
corresponding payments on the
capital securities. Downey will
guarantee payments made on the
capital securities.
Use of proceeds..................... The trust will use the proceeds
from the sale of the capital
securities and common securities to
invest in the junior subordinated
debentures of Downey. Downey
intends to use the net proceeds
from the sale of the junior
subordinated debentures to make
investments in the Bank and for
other general corporate purposes.
Distributions on the capital Holders of capital securities will
securities.......................... be entitled to receive cumulative
cash distributions at the annual
rate of % of the liquidation
amount of $25 per capital security.
Distributions will accrue from
1999, the date of
original issuance, and will be paid
quarterly in arrears on the 15th
day of March, June, September and
December of each year, beginning
September 15, 1999, unless these
payments are deferred as described
below. The amount of each quarterly
distribution will include amounts
accrued to but excluding the date
the distribution payment is due.
Deferral of distributions........... The payment of distributions may be
deferred if Downey defers payments
of interest on the junior
subordinated debentures. Downey
will have the right, on one or more
occasions, to defer payments of
interest on the junior subordinated
debentures for up to 20 consecutive
quarterly periods. In other words,
Downey may declare up to a five-
year interest payment moratorium on
the junior subordinated debentures
and may choose to do that on more
than one occasion. During the time
Downey defers interest payments,
interest on the junior subordinated
debentures will continue to accrue
and distributions on the capital
securities will continue to
accumulate and the deferred
interest and deferred distributions
will themselves accrue interest at
an annual rate of %, compounded
quarterly, to the extent permitted
by applicable law. During any
deferral period, Downey generally
would be prohibited from declaring
or paying cash distributions on its
capital stock or from repurchasing
any of its capital stock.
Redemption of the capital The trust is required to redeem all
securities.......................... of the outstanding capital
securities when the junior
subordinated debentures are repaid
at maturity. The junior
subordinated debentures are
scheduled to mature on
6
<PAGE>
, 2029. As long as Downey
obtains regulatory approval, if
required, Downey may redeem the
junior subordinated debentures
before their maturity at a
redemption price of 100% of their
principal amount plus accrued and
unpaid interest:
. on or after , 2004, in whole at
any time or from time to time in
part;
. in whole at any time within 90
days after specific special
events occur relating to changes
in tax or investment company laws
and regulations or in the
treatment of the capital
securities for bank regulatory
purposes.
If Downey redeems any junior
subordinated debentures before
their maturity, the trust will use
the cash it receives on the
redemption of the junior
subordinated debentures to redeem,
on a pro rata basis, capital
securities and common securities
having an aggregate liquidation
amount equal to the aggregate
principal amount of the junior
subordinated debentures being
redeemed. When the trust redeems
capital securities, holders will be
entitled to receive a price equal
to the aggregate liquidation amount
of the capital securities plus any
accumulated and unpaid
distributions.
Shortening of the maturity of the
junior subordinated debentures......
Downey will have the right to
shorten the maturity of the junior
subordinated debentures to a date
not earlier than , 2004,
subject to any applicable
regulatory approval. If Downey
elects to shorten the maturity of
the junior subordinated debentures,
Downey will also cause the capital
securities to be redeemed on the
earlier maturity date.
Capital securities guarantee........ In connection with the issuance of
the capital securities, Downey will
enter into a capital securities
guarantee agreement with Wilmington
Trust Company, as guarantee
trustee. Under that agreement,
Downey will guarantee, on a
subordinated basis and to the
extent described in this
prospectus, the payment of all
amounts due on the capital
securities.
Dissolution of trust and
distribution of junior subordinated
debentures.......................... Downey will have the right to
dissolve the trust at any time, as
long as Downey obtains the prior
approval of its primary federal
regulator, if that approval is
required under applicable law. If
Downey dissolves the trust, or if
the trust automatically
7
<PAGE>
dissolves because of other
specified events, the trust will
first satisfy its liabilities owed
to creditors. After the creditor
liabilities are satisfied, the
trust will distribute to the
holders of its capital securities
and common securities, on a pro
rata basis, junior subordinated
debentures with a principal amount
equal to the $25 liquidation amount
of each capital security and common
security. If the property trustee
determines that a distribution is
impractical, then holders of
capital securities and common
securities will be entitled to
receive, on a pro rata basis, an
amount equal to the $25 liquidation
amount plus accrued and unpaid
distributions. If the trust does
not have enough assets to pay this
amount to each holder of capital
securities in full, liquidating
distributions will be paid, first
to holders of capital securities on
a pro rata basis before holders of
common securities will be entitled
to receive any moneys.
Ranking of the capital securities... In general, the capital securities
will rank on a parity in right of
payment and payments thereon will
be made pro rata with the common
securities of the trust. However,
the capital securities will have a
preference under specific
circumstances with respect to cash
distributions and amounts payable
on liquidation, redemption or
otherwise over the common
securities, which will be held by
Downey.
Subordination relative to other Downey's obligations under the
obligations......................... capital securities guarantee
agreement and the junior
subordinated debentures are
unsecured and are subordinate and
junior in right of payment to
Downey's current and future
obligations to other creditors. The
terms of the junior subordinated
debentures place no limitation on
the amount of debt that Downey may
issue, including debt that is
senior to the junior subordinated
debentures. Additionally, because
Downey is a holding company,
substantially all of Downey's
assets consist of the capital stock
of its subsidiaries. All
obligations of Downey relating to
the junior subordinated debentures
will be effectively subordinated to
all existing and future liabilities
of Downey's subsidiaries, including
deposit liabilities of the Bank.
Downey may cause additional capital
securities to be issued by trusts
similar to the trust in the future,
and there is no limit on the amount
of those securities that may be
issued. In this event, Downey's
obligations under the junior
subordinated debentures to be
issued to the other trusts may rank
equal with Downey's obligation
under the junior
8
<PAGE>
subordinated debentures and
Downey's guarantees of the payments
by those trusts may rank equal with
Downey's obligations under the
capital securities guarantee
agreement.
Voting rights of the holders of Holders of capital securities will
capital securities.................. have limited voting rights relating
only to the modification of the
capital securities, the
dissolution, winding-up or
termination of the trust and other
matters described in this
prospectus.
Global certificates................. The capital securities will be
represented by one or more global
certificates registered in the name
of The Depository Trust Company or
its nominee. This means that
holders will not receive a
certificate for their capital
securities and the capital
securities will not be registered
in their names. Ownership interests
in the capital securities will be
shown on, and transfers of the
capital securities will be effected
only through, records maintained by
participants in The Depository
Trust Company. The Depository Trust
Company and the paying agent for
the capital securities will be
responsible for dividend payments
to you.
New York Stock Exchange symbol...... DFT
Recent Developments
We reported net income for the second quarter of 1999 of $15.1 million or
$0.53 per share on a diluted basis. This compares to our net income in the
second quarter of 1998 of $15.0 million or $0.53 per share on a diluted basis.
Our net income in the year-ago quarter benefited from the settlement of a
number of loan and real estate investment obligations of a former joint venture
partner. This settlement added $1.8 million to net income in the second quarter
of 1998. Excluding this settlement, our net income would have increased between
second quarters by $1.9 million or 14.4%, primarily reflecting a $1.8 million
or 15.1% increase in our net income from banking operations.
For the first six months of 1999, our net income totaled $27.4 million or
$0.97 per share on a diluted basis, down from $32.6 million or $1.15 per share
in the year-ago period. The decline primarily reflects two factors.
. First, year ago net income benefited by $4.7 million from the
settlement.
. Second, our remaining net income attributable to real estate investment
activities declined $3.0 million due to the 1999 period having a lower
level of gains from sales of real estate investments.
Excluding those two factors, our net income would have increased by $2.6
million or 11.0% for the first six months of 1999. Our banking operations
generated this adjusted increase.
Our net interest income totaled $51.2 million in the second quarter of 1999,
up $8.0 million or 18.5% from the same period last year. This improvement
between second quarters reflected increases in both our average earning assets
and in our effective interest rate spread. Our average earning assets increased
by $982 million or 17.5% between second quarters to $6.6 billion. Our effective
interest rate spread of 3.11% in the current quarter
9
<PAGE>
was up from the year-ago quarter level of 3.08%. For the first six months of
1999, our net interest income totaled $100.2 million, up $14.3 million or 16.7%
from a year ago.
Our provision for loan losses was $2.8 million in the second quarter of 1999,
up from $1.5 million from the second quarter of 1998. This increase reflects
growth in our loan portfolio during the current quarter. In contrast, during
the year-ago quarter, our loan portfolio declined. Our allowance for loan
losses was $34 million at June 30, 1999, which is up from $32 million at both
year-end 1998 and June 30, 1998. Our net charge-offs totaled $1.0 million in
the 1999 second quarter, down from $1.5 million a year ago. For the first six
months of 1999, our provision for loan losses was $5.2 million and our net
charge-offs were $2.4 million. This compares to our provision for loan losses
of $1.7 million and our net charge-offs of $2.1 million in the year-ago period,
which benefited by a $1.4 million recovery from the settlement.
Our total other income was $13.3 million in the second quarter of 1999, which
is up $1.3 million or 11.0% from a year ago. All categories of our other income
were above a year ago except for our income from real estate held for
investment. Income from real estate held for investment declined by $2.2
million, of which $1.7 million was attributable to the settlement. Our net
gains on sales of loans increased $1.6 million between second quarters due to a
higher volume of loans being sold, and our loan and deposit related fees
increased $1.2 million. For the first six months of 1999, our total other
income was $24.6 million, down $2.3 million from a year ago of which $5.3
million was attributable to the settlement.
Our operating expense totaled $35.5 million in the current quarter, compared
to $27.3 million in the second quarter of 1998. The increase was primarily due
to an increase in our general and administrative costs. Our general and
administrative costs increased $8.0 million or 29.5% because we had
significantly higher lending volumes, expanded our number of branches and had
higher expenses related to our year 2000 compliance effort. In addition, the
year-ago quarter benefited from a $1.3 million reduction to our professional
fees due to the settlement. For the first six months of 1999, our operating
expenses totaled $72.0 million, up $18.1 million from the same period of 1998,
of which $1.6 million was attributable to the settlement.
At June 30, 1999, our assets totaled $7.3 billion, which is up $1.5 billion
or 25.7% from a year ago. Our single family loan originations totaled a record
$1.677 billion in the second quarter of 1999, up 84% from the $909 million
originated in the second quarter of 1998. Of the current quarter total, $631
million represented our origination of loans for sale and $312 million
represented our origination for portfolio of subprime credits as part of our
strategy to enhance our portfolio's net yield. In addition to single family
loans, we originated $136 million of other loans in the current quarter,
including $61 million of automobile loans and $54 million of construction and
land loans.
At June 30, 1999, our deposits totaled $5.5 billion, up 5.8% from a year ago
and up $433 million or 8.6% above year-end 1998. During the quarter, we opened
four new in-store branches, bringing our total branches at quarter end to 99,
of which 37 are in-store.
Our non-performing assets were virtually unchanged during the quarter,
totaling $30 million or 0.41% of our total assets.
At June 30, 1999, the Bank had core and tangible capital ratios of 6.04% and
a risk-based capital ratio of 11.48%. These capital levels are well above the
"well capitalized" standards of 5% for core and tangible capital ratios and 10%
for risk-based capital ratios as defined by the Bank's regulators.
10
<PAGE>
RISK FACTORS
Your investment in the capital securities will involve a number of risks.
You should carefully consider the following discussion of risks, and the other
information included or incorporated by reference in this prospectus, before
buying any capital securities.
Risk Factors Relating to Downey and its Subsidiaries
Changes in market interest rates may adversely affect our performance.
Our results of operations, like that of most other financial institutions,
are primarily dependent on interest rate differentials. Changes in interest
rates will influence the growth of our loans, investments, deposits and
borrowings and will affect the rates we receive on loans and investment
securities and the amount we pay on our deposits and borrowings. In addition,
we are affected by possible interest rate spread compression which would
adversely affect our results of operations if interest rates rise. This is
primarily due to the fact that the interest rates on our adjustable-rate loans
and mortgage-backed securities adjust more slowly than the interest rates on
our liabilities. If interest rates were to increase significantly, the
economic viability and operating results of our real estate investment
activities also could be adversely affected. Interest rates are highly
sensitive to many factors that are beyond our control, like inflation,
recession, government monetary and fiscal policy and unemployment, and the
potential impact of future changes in domestic and foreign economic
conditions. Accordingly, we are unable to predict future interest rates. These
changes in interest rates may have a material adverse effect on our results of
operations, financial condition and ability to make payments on the junior
subordinated debentures and the trust's ability to make payments on the
capital securities.
Our California business focus could adversely affect our operations.
We are headquartered in Southern California, and our operations are
concentrated in Southern and Northern California. In addition, at March 31,
1999, approximately 97% of our real estate loans were secured by real estate
located in California, principally in Los Angeles, Orange, Santa Clara, San
Diego and San Mateo counties. As a result of this geographic concentration,
our results depend largely upon economic conditions in these areas. While the
California economy has recently exhibited positive economic and employment
trends, there is no assurance that these trends will continue. A deterioration
in economic conditions could have a material adverse impact on the quality of
our loan and real estate portfolios and the demand for our products and
services, which, in turn, may have a material adverse effect on our results of
operations, financial condition and ability to make payments on the junior
subordinated debentures and the trust's ability to make payments on the
capital securities. In addition, California has been, and may in the future
be, affected by earthquakes. Neither Downey nor the Bank typically require
that borrowers maintain earthquake insurance on property securing mortgage
loans. Accordingly, earthquake damage to properties securing mortgage loans or
to properties owned by Downey could have a material adverse effect on our
results of operations, financial condition and ability to make payments on the
junior subordinated debentures and the trust's ability to make payments on the
capital securities.
Loans to credit-impaired borrowers may adversely affect our performance.
Loans made to borrowers who cannot obtain financing from traditional lenders
generally entail a higher risk of delinquency and default and higher losses
than loans made to borrowers with better credit. We offer one-to-four unit
residential loans to borrowers who have or, in the case of purchases, will
have equity in their homes but whose credit rating contains exceptions which
preclude them from qualifying for the best market terms. These lower credit
grades--"A-," "B" and "C" loans--commonly referred to as subprime loans, are
characterized by lower loan-to-value ratios and higher average interest rates
than higher credit grade loans--"A" loans. If we experience higher losses than
anticipated on these loans, this event may have a material adverse effect on
our results of operations, financial condition and ability to make payments on
the junior subordinated debentures and the trust's ability to make payments on
the capital securities.
11
<PAGE>
If borrowers, guarantors and other parties fail to perform as required by the
terms of their loans, we will sustain losses.
A significant source of risk for us arises from the possibility that we will
sustain losses if borrowers, guarantors and related parties fail to perform as
required by the terms of their loans. We have adopted underwriting and loan
monitoring procedures and credit policies, including the establishment and
review of the allowance for loan losses, through which we intend to reduce
this risk by tracking loan performance, assessing the likelihood of
nonperformance and diversifying our loan portfolio. These policies and
procedures, however, may not prevent losses that may have a material adverse
effect on our results of operations, financial condition and ability to make
payments on the junior subordinated debentures and the trust's ability to make
payments on the capital securities.
Our investments in real estate may adversely affect our performance.
Our real property investments are affected by varying degrees of risk. The
yields available from our equity investments in real estate depend upon the
amount of revenues generated and expenses incurred. If our properties do not
generate revenues sufficient to meet property operating expenses, including
debt service and capital expenditures, our results of operations will be
adversely affected. In addition, our quarterly results of operations may
fluctuate significantly depending upon whether or not we realize gains or
losses on sales of real estate during the period. The performance of the
economy in each of the areas in which our properties are located affects
occupancy, market rental rates and expenses and, consequently, impacts the
revenues from our properties and their underlying values. The financial
results of major local employers also may impact on the revenues and value of
some or all of our properties.
Real estate investments entail risks similar to those our construction and
commercial lending activities present. In addition, California courts have
imposed warranty-like responsibility upon developers of new housing for
defects in structure and the housing site, including soil conditions. This
responsibility is not necessarily dependent upon a finding that the developer
was negligent. Owners of real property also may incur liabilities with respect
to environmental matters, including financial responsibility for clean-up of
hazardous waste or other conditions, under various federal and state laws.
Our business loans, motor vehicle loans, commercial real estate loans and
multi-family residential loans entail greater risk than our single family
residential loans.
Commercial real estate loans and multi-family residential loans are
generally considered to involve a higher degree of risk than single-family
residential lending because these loans typically involve larger loan balances
to a single borrower or group of related borrowers. In addition, the payment
experience on multi-family residential and commercial real estate loans
typically is dependent on the successful operation of the project--as opposed
to a desire by the borrower to continue to occupy the residence--and thus
these loans may be adversely affected to a greater extent by adverse
conditions in the real estate markets or in the economy generally.
Motor vehicle and consumer finance loans entail greater risk than do single
family residential mortgage loans since collections are dependent on the
borrower's continuing financial stability, and thus are more likely to be
affected by adverse personal circumstances.
Accordingly, there can be no assurance that our commercial business, motor
vehicle, commercial real estate and multi-family residential loans will not be
adversely affected by these and the other risks related to these loans or that
they will not have a material adverse effect on our results of operations,
financial condition and ability to make payments on the junior subordinated
debentures and the trust's ability to make payments on the capital securities.
12
<PAGE>
Our construction loans entail greater risk than our single family residential
loans.
Construction loans involve risks different from completed project lending
because we advance loan funds based upon the security of the project under
construction. If the borrower defaults on the loan, then we may have to
advance additional funds to finance the project's completion before the
project can be sold. Moreover, construction projects are affected by
uncertainties inherent in estimating:
. construction costs;
. potential delays in construction time;
. market demand; and
. the accuracy of the estimate of value on the completed project.
When providing construction loans, we require the general contractor to,
among other things, carry contractor's liability insurance equal to specific
prescribed minimum amounts, carry builder's risk insurance and have a blanket
bond against employee misappropriation. These policies and procedures,
however, may not prevent losses that may have a material adverse effect on our
results of operations, financial condition and ability to make payments on the
junior subordinated debentures and the trust's ability to make payments on the
capital securities.
Competition may adversely affect our performance.
We operate in an increasingly competitive environment. Increasing levels of
competition in the banking and financial services businesses may reduce our
market share or cause the prices we charge for our services to fall, either of
which may have a material adverse effect on our results of operations,
financial condition and ability to make payments on the junior subordinated
debentures and the trust's ability to make payments on the capital securities.
We face competition both in attracting deposits and in making loans. Our
most direct competition for deposits has historically come from other savings
institutions and from commercial banks located in our principal market areas,
including many large financial institutions based in other parts of the
country or their subsidiaries. In addition, there is additional significant
competition for investors' funds from short-term money market securities and
other corporate and government securities. Our ability to attract and retain
savings deposits depends, generally, on our ability to provide a rate of
return, liquidity and risk comparable to that offered by competing investment
opportunities and the appropriate level of customer service.
We experience competition for real estate loans principally from other
savings institutions, commercial banks, mortgage banking companies and
insurance companies. We compete for these loans principally through the
interest rates and loan fees we charge and the efficiency and quality of
services we provide to borrowers and real estate brokers.
We also experience competition in our real estate development activities,
principally from other real estate development and financing companies. Many
of these companies have greater real estate development resources than we do,
and most are not required to meet the same regulatory requirements that we
must meet in conducting and financing their real estate activities.
Governmental regulation could adversely affect our operations.
The financial services industry is extensively regulated and supervised on
both the federal and the state level. These regulations can sometimes impose
significant limitations on our operations. In addition, these regulations are
constantly evolving and may change significantly over time. Future regulatory
changes may have a material adverse effect on our results of operations,
financial condition and ability to make payments on the junior subordinated
debentures and the trust's ability to make payments on the capital securities.
Further, federal monetary policy, particularly as implemented through the
Federal Reserve System, significantly affects our
13
<PAGE>
ability to obtain credit on favorable terms. Changes in federal monetary
policy might materially change open market operations in United States
government securities, the discount rate for borrowings and reserve
requirements. This, in turn, may have a material adverse effect on our results
of operations, financial condition and ability to make payments on the junior
subordinated debentures and the trust's ability to make payments on the
capital securities.
During the past several years, Congress has considered legislation in
various forms that would require federal thrifts, like the Bank, to convert
their charters to national or state bank charters. The Economic Growth and
Paperwork Reduction Act, adopted in 1996 ("Paperwork Reduction Act"), requires
a merger of the Bank Insurance Fund ("BIF") and the SAIF into a single Deposit
Insurance Fund if Congress enacts legislation to eliminate the federal thrift
charter. While none of the "financial modernization" proposals currently being
debated in Congress would, in fact, eliminate the federal thrift charter, it
is possible that legislation will be introduced that would do so. In that
event, and in the absence of appropriate "grandfather" provisions, legislation
eliminating the thrift charter could have a material adverse effect on us and
the Bank because, among other things, the regulatory, capital and accounting
treatment for national and state banks and savings associations differ
significantly in some areas. We cannot determine whether, or in what form,
this legislation may eventually be enacted and there can be no assurance that
any legislation that is enacted would contain adequate grandfather provisions
for us and the Bank.
DSL Service Company is licensed as a real estate broker under the California
Real Estate Law and as a contractor with the Contractors State License Board.
Thus, the real estate investment activities of DSL Service Company, including
development, construction and property management activities relating to its
portfolio of projects, are governed by a variety of laws and regulations.
Changes in these laws and regulations or their interpretation by agencies and
the courts occur frequently. DSL Service Company must comply with various
federal, state and local laws, ordinances, rules and regulations concerning
zoning, building design, construction, hazardous waste and similar matters.
Environmental laws and regulations also affect the operations of DSL Service
Company, including regulations pertaining to availability of water, municipal
sewage treatment capacity, land use, protection of endangered species,
population density and preservation of the natural terrain and coastlines.
These and other requirements could become more restrictive in the future,
resulting in additional time and expense in connection with DSL Service
Company's real estate activities.
We may incur significant costs if we foreclose on environmentally
contaminated real estate.
If we foreclose on a defaulted mortgage loan to recover our investment in
the mortgage loan, then we may be exposed to environmental liabilities in
connection with the underlying real property. These liabilities could exceed
the fair value of the real property. It is also possible that hazardous
substances or wastes, contaminants, pollutants or their sources, as defined by
state and federal laws and regulations, may be discovered on properties during
our ownership or after they are sold to a third party. If they are discovered
on a property that we have acquired through foreclosure or otherwise, we may
be required to remove those substances and clean up the property. We may have
to pay for the entire cost of any removal and clean-up without the
contribution of any other third parties. These costs may also exceed the fair
value of the property. We may also be liable to tenants and other users of
neighboring properties. In addition, we may find it difficult or impossible to
sell the property before or following any clean-up. These events may have a
material adverse effect on our results of operations, financial condition and
ability to make payments on the junior subordinated debentures and the trust's
ability to make payments on the capital securities.
14
<PAGE>
With regard to environmental matters, the construction products industry is
regulated by federal, state and local laws and regulations pertaining to
several areas including human health and safety and environmental compliance.
The Comprehensive Environmental Response, Compensation and Liability Act of
1980, as amended by the Superfund Amendments and Reauthorization Act of 1986,
as well as similar laws in some states, create joint and several liability for
the cost of cleaning up or correcting releases to the environment of
designated hazardous substances. Among those who may be held jointly and
several liable are:
. those who generated the waste;
. those who arranged for disposal;
. those who owned or operated the disposal site or facility at the time of
disposal; and
. current owners.
In general, this liability is imposed in a series of governmental
proceedings initiated by the government's identification of a site for initial
listing as a "Superfund site" on the National Priorities List or a similar
state list and the government's identification of potentially responsible
parties who may be liable for cleanup costs. None of the DSL Service Company's
project sites are listed as a "Superfund site."
Year 2000 issues could adversely affect our operations.
In May 1997, the Federal Financial Institutions Examination Council issued
an interagency statement to the chief executive officers of all federally
supervised financial institutions regarding "year 2000" project awareness. It
is expected that unless financial institutions address the technology issues
relating to the coming of the year 2000, there will be major disruptions in
the operation of financial institutions. We, like most financial
organizations, have many computer systems that identify dates using only the
last two digits of the year. These systems must be prepared to distinguish
dates like 1900 from 2000.
The federal banking agencies intend to conduct year 2000 compliance
examinations, and the failure to implement a year 2000 compliance program by
December 31, 1999 may be viewed by the federal banking agencies as an unsafe
and unsound banking practice. If a savings association is deemed to be
engaging in an unsafe and unsound banking practice, a federal agency may
reclassify the savings association as being in a lower capital category and
require it to comply with specific restrictions imposed on financial
institutions so classified. We have established processes to identify,
prioritize, renovate or replace our systems that may be affected by year 2000
dates. However, we rely on third party vendors, including government entities
which may impact our efforts to successfully complete year 2000 compliance for
all systems in a timely fashion. Accordingly, there can be no assurance year
2000 matters will not have a material adverse effect on our results of
operations, financial condition and ability to make payments on the junior
subordinated debentures and the trust's ability to make payments on the
capital securities. For further information regarding our year 2000 compliance
program and its status see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Financial Condition for the Quarter Ended
March 31, 1999--Year 2000."
Risk Factors Relating to the Capital Securities
Downey's obligations under the capital securities guarantee agreement and the
junior subordinated debentures are unsecured and subordinated.
Downey's obligations under the capital securities guarantee agreement, the
junior subordinated debentures and other documents described in this
prospectus will be unsecured. In addition, Downey's obligations under the
junior subordinated debentures will be subordinate and junior in right of
payment to all existing and future debt of Downey, unless that debt is equal
with, or subordinated to, the junior subordinated debentures, and will be
effectively subordinated to all existing and future liabilities of Downey's
subsidiaries, including the deposit liabilities of the Bank. Downey's
obligations under the capital securities guarantee agreement are subordinated
to the same extent as the junior subordinated debentures. This means that
Downey cannot make any payments
15
<PAGE>
on the junior subordinated debentures or the capital securities guarantee
agreement if Downey is in default on any of its senior debt. The terms of the
junior subordinated debentures place no limitation on the amount of debt that
we can issue, including debt that ranks senior to or equal with the junior
subordinated debentures. For more information about these matters, see below
under the caption "Description of Junior Subordinated Debentures--
Subordination" and "Description of Guarantee--Status of the Guarantee."
Downey's status as a holding company causes it to be dependent on cash
dividends from its subsidiaries, particularly the Bank.
Downey is a holding company which conducts substantially all of its
operations through the Bank. As a result, our ability to make payments on the
junior subordinated debentures, and consequently the trust's ability to pay
distributions on the capital securities and Downey's ability to fulfill its
obligations under the capital securities guarantee agreement, will depend
primarily on the receipt of dividends and other distributions from the Bank.
At March 31, 1999, the Bank could pay approximately $95 million in dividends
to Downey so long as the Bank sent prior notification to the Office of Thrift
Supervision ("OTS"). The Bank's payment of dividends is affected by the Bank's
results of operations, financial condition and capital expenditures and other
cash flow requirements. In addition, the Bank's payment of dividends is
restricted by regulations. In particular, savings associations, like the Bank,
must meet their regulatory capital requirements before and after a proposed
capital distribution. For more information about regulatory capital
requirements, see below under the caption""Business-- Regulation--Regulatory
Capital Requirements."
No assurance can be given that the Bank will be able to pay dividends at past
levels, or at all, in the future.
In addition, the right of Downey to participate in any distribution of
assets of any subsidiary, including the Bank, upon the subsidiary's
liquidation or otherwise, and thus the ability of a holder of capital
securities to benefit indirectly from that distribution, will be subordinated
to the prior claims of creditors of that subsidiary, except to the extent that
any claims of Downey as a creditor of that subsidiary may be recognized. As a
result, the junior subordinated debentures will effectively be subordinated to
all existing and future liabilities and obligations of Downey's subsidiaries,
including deposit liabilities of the Bank. For more information about the risk
of the subordination of the junior subordinated debentures, see "--Downey's
obligations under the capital securities guarantee agreement and the junior
subordinated debentures are unsecured and subordinated." At March 31, 1999,
Downey's subsidiaries had outstanding debt and other liabilities, including
deposits, of approximately $6.1 billion.
The capital securities guarantee agreement covers payments only if the trust
has cash available.
The ability of the trust to pay scheduled distributions on the capital
securities, the redemption price of the capital securities and the liquidation
amount of the capital securities is solely dependent upon Downey making the
related payments on the junior subordinated debentures when due.
If Downey defaults on its obligations to pay principal or interest on the
junior subordinated debentures, the trust will not have sufficient funds to
pay distributions, the redemption price or the liquidation amount of each
capital security. In those circumstances, holders of capital securities will
not be able to rely upon the capital securities guarantee agreement for
payment of these amounts.
Instead, holders of capital securities:
. may directly sue Downey or seek other remedies to collect their pro rata
share of payments owed; or
. may rely on the property trustee to enforce the trust's rights under the
junior subordinated debentures.
16
<PAGE>
Downey may redeem the capital securities before , 2004 if special events
occur.
Generally, the junior subordinated debentures, and therefore the capital
securities, may not be redeemed before , 2004. However, if special events
occur relating to changes in tax law or the Investment Company Act of 1940 or
the treatment of the capital securities under guidelines or policies of bank
regulatory authorities, then Downey will be able, so long as it has received
any necessary regulatory approval, to redeem all of the junior subordinated
debentures at a price equal to 100% of their principal amount plus any accrued
but unpaid interest to the date fixed for redemption within 90 days following
the occurrence of a special event. If a redemption happens, the trust must use
the funds it receives to redeem all of the capital securities and common
securities. For more information about the special events, see below under the
caption "Description of the Capital Securities--Redemption."
Regarding a special event that may occur relating to changes in tax law,
Congress and the Clinton Administration have considered proposals denying
interest deductions to be claimed by an issuer for its interest payments on
instruments with characteristics similar to the junior subordinated
debentures. While Congress has not enacted that legislation, and that
legislation is not currently pending, it is possible that Congress may propose
and enact similar legislation after the date of this prospectus, which might
adversely affect the tax treatment of the junior subordinated debentures. This
type of change would be a special event relating to a change in tax law, so
Downey would be able to redeem the junior subordinated debentures. Downey's
redemption would, in turn, cause the trust to redeem all of the capital
securities.
Regarding a special event that may occur relating to changes in guidelines
or policies of bank regulatory authorities, the OTS, which supervises thrift
holding companies such as Downey, currently does not impose any capital
adequacy requirements on Downey itself. Moreover, Downey is not regulated by
the Board of Governors of the Federal Reserve System (the "Federal Reserve")
and is not required to meet the Federal Reserve's risk based capital adequacy
guidelines. Under the Federal Reserve's capital adequacy guidelines, as
currently in effect, securities similar to the capital securities would
qualify as tier 1 capital, subject to the limitations described in the next
sentence. Federal Reserve guidelines for calculation of tier 1 capital limit
the amount of cumulative preferred stock, which would include the capital
securities, which can be included in tier 1 capital to 25% of total tier 1
capital for bank holding companies. While the OTS does not currently impose
any capital adequacy requirements on Downey itself, there is no assurance that
it will not adopt these requirements after the date of this prospectus.
Likewise, if federal legislation to eliminate the thrift charter is enacted
and the Bank were converted to a commercial bank charter, Downey could become
subject to the Federal Reserve's capital adequacy guidelines for bank holding
companies. If Downey were to become required to meet the capital adequacy
guidelines and the applicable regulatory agency were to determine that the
capital securities did not qualify as tier 1 capital of Downey, or if it were
determined that proceeds realized from the sale of the junior subordinated
debentures that are invested in the Bank would no longer qualify as tier 1
capital for the Bank, Downey would be able to redeem the junior subordinated
debentures. Downey's redemption would, in turn, cause the trust to redeem all
of the capital securities.
Downey's ability to defer interest payments has tax consequences for you and
may affect the trading price of the capital securities.
As long as the junior subordinated debentures are not in default, Downey
will have the right, on one or more occasions, to defer interest payments on
the junior subordinated debentures for a period not exceeding 20 consecutive
quarterly periods, but not beyond the maturity date of the junior subordinated
debentures. Because interest payments on the junior subordinated debentures
fund the distributions on the capital securities, each deferral would result
in a corresponding deferral of distributions on the capital securities.
Downey currently does not intend to defer interest payments on the junior
subordinated debentures. However, if it does do so in the future, holders of
capital securities will be required to accrue interest income for United
States federal income tax, and possibly other, purposes in respect of their
proportionate share of the accrued but unpaid interest on the junior
subordinated debentures held by the trust, even if the holders normally
17
<PAGE>
report income when received. As a result, holders of capital securities will
be required to include the accrued interest in their gross income for United
States federal income tax purposes before receiving any cash distribution. For
more information, see below under the caption "Certain Federal Income Tax
Consequences--Interest Income and Original Issue Discount."
If Downey defers interest payments on the junior subordinated debentures,
the capital securities may trade at a price that does not reflect fully the
value of the accrued but unpaid distributions. Additionally, the market price
for the capital securities may be more volatile than that of other securities
not being subject to a right to defer interest. If holders of capital
securities dispose of the capital securities while interest payments are being
deferred, they might not receive the same return on their investment as an
investor that continues to hold the capital securities.
Holders of capital securities may receive junior subordinated debentures upon
liquidation of the trust so investing in the capital securities requires an
investment decision regarding the junior subordinated debentures;
distribution of junior subordinated debentures may have an adverse effect on
trading price.
Downey will have the right at any time to dissolve the trust. If Downey
decides to exercise its right to dissolve the trust, the trust will, after
satisfaction of liabilities to creditors of the trust as required by
applicable law, cause the junior subordinated debentures to be distributed to
holders of capital securities in liquidation of the trust. Because holders of
capital securities may receive junior subordinated debentures in liquidation
of the trust and because distributions on the capital securities are otherwise
limited to payments on the junior subordinated debentures, you are also making
an investment decision with regard to the junior subordinated debentures. We
urge you to carefully review all information included and incorporated by
reference in this prospectus regarding Downey, which is solely responsible for
payments on the junior subordinated debentures. We also urge you to review the
terms of the junior subordinated debentures. For more information, see below
under the caption "Description of the Capital Securities--Liquidation
Distribution Upon Dissolution" and "Description of Junior Subordinated
Debentures."
Under current United States federal income tax law and interpretations and
assuming, as set forth in an opinion of counsel to Downey, the trust is
classified as a grantor trust, a distribution of the junior subordinated
debentures to holders of capital securities upon a liquidation of the trust
should not be a taxable event to the holders. However, if a special event
occurs relating to changes in the tax law which would cause the trust to pay
United States federal income tax with respect to income received or accrued on
the junior subordinated debentures, the trust's distribution of the junior
subordinated debentures could be a taxable event to both the trust and holders
of capital securities. For more information about a redemption of the capital
securities relating to changes in the tax law, see below under the caption
"Description of the Capital Securities--Redemption." For more information
about the tax consequences, see below under the caption "Certain Federal
Income Tax Consequences--Distribution of Junior Subordinated Debentures to
Holders of Capital Securities."
Downey has no current intention of causing the termination of the trust and
the distribution of the junior subordinated debentures. However, there are no
restrictions on its ability to do so at any time. Downey anticipates that it
would consider exercising this right if expenses associated with maintaining
the trust were substantially greater than currently expected. This could
happen if special events occur relating to changes in tax law or the
Investment Company Act of 1940 or the treatment of capital securities under
the guidelines or policies of bank regulatory authorities. Downey cannot
predict the other circumstances under which this right would be exercised.
Downey will use its best efforts to list the junior subordinated debentures
on the New York Stock Exchange or any other exchange or organization on which
the capital securities are then listed, if they are distributed. We cannot
assure you, however, that the junior subordinated debentures would be approved
for listing or that a liquid trading market would exist for those securities.
18
<PAGE>
We also can make no assurance as to the market prices for the junior
subordinated debentures that may be distributed in exchange for the capital
securities if Downey exercises its right to terminate the trust. Accordingly,
the junior subordinated debentures that holders may receive in liquidation of
the trust may trade at a discount from the price paid to purchase the capital
securities offered in this prospectus. For more information, see below under
the caption "--There is no existing market for the capital securities."
Shortening of the maturity of the junior subordinated debentures may occur.
Downey will have the right to shorten the maturity of the junior
subordinated debentures to a date not earlier than , 2004. If Downey
shortens the maturity of the junior subordinated debentures, Downey will also
cause the capital securities to be redeemed on the earlier maturity date.
Downey does not currently require approval from the OTS or other bank
regulatory authorities to shorten the maturity of the junior subordinated
debentures. However, if regulatory approval were required, Downey will only
exercise its right to shorten the maturity date of the junior subordinated
debentures upon receiving the prior approval of the appropriate regulator. For
more information, see below under the caption "Description of the Capital
Securities-- Redemption."
Holders of capital securities will be limited in their rights to bring direct
actions against Downey and in their rights under the capital securities
guarantee agreement.
Through the capital securities guarantee agreement, Downey promises certain
payments will be made to holders of capital securities by the trust to the
extent that the trust has funds available to make those payments. Holders of
capital securities may institute a legal proceeding directly against Downey to
enforce their rights under the capital securities guarantee agreement without
first instituting a legal proceeding against the trust or any other person or
entity.
If Downey defaults on its obligation to pay amounts payable under the junior
subordinated debentures, the trust will lack funds for the payment of
distributions or amounts payable on redemption of the capital securities. The
capital securities guarantee agreement does not cover payments when the trust
does not have sufficient funds to make payments on the capital securities.
Accordingly, in the event of a default, holders of capital securities will not
be able to rely upon the capital securities guarantee agreement for payment of
these amounts. Instead, holders may institute a legal proceeding directly
against Downey for enforcement of payment of the principal of and interest on
junior subordinated debentures having a principal amount equal to the $25
liquidation amount of each capital security held. In connection with the
direct legal proceeding, Downey will be subrogated to the rights of any holder
of the capital securities under the trust agreement to the extent of any
payment made by Downey to any holder of capital securities in the direct legal
proceeding. Except as described in this prospectus, holders will not be able
to exercise directly any other remedy available to the holders of the junior
subordinated debentures or assert directly any other rights in respect of the
junior subordinated debentures. For more information, see below under the
caption "Description of Junior Subordinated Debentures--Enforcement of Certain
Rights by Holders of Capital Securities" and "Description of Guarantee."
The deductibility of interest on the junior subordinated debentures is
uncertain.
Downey's ability to deduct the interest paid on the junior subordinated
debentures will depend upon whether the junior subordinated debentures are
characterized as debt instruments for United States federal income tax
purposes, taking all the relevant facts and circumstances into account.
Downey's counsel has rendered an opinion to Downey that the junior
subordinated debentures are debt instruments for United States federal income
tax purposes. Accordingly, Downey intends to deduct interest on the junior
subordinated debentures for United States federal income tax purposes.
However, a legal opinion is not binding on the tax authorities or the courts.
If the tax authorities or the courts determine that Downey is not able to
deduct interest on the junior subordinated debentures, Downey would have
significant additional income tax liabilities. This tax liability may have a
material adverse effect on our results of operations, financial condition and
ability to make payments on the junior subordinated debentures and the trust's
ability to make payments on the capital securities.
19
<PAGE>
There are only limited covenants restricting Downey's activities.
The agreements Downey will enter into with respect to the trust and the
junior subordinated debentures do not contain covenants restricting Downey's
business or operations, except to the limited extent described in this
prospectus. As a result, these agreements will not protect holders of capital
securities in the event of a material adverse change in the financial
condition or results of operation of Downey or its subsidiaries. In addition,
these agreements do not limit the ability of Downey or any subsidiary to incur
additional indebtedness. Therefore, holders of capital securities should not
consider the provisions of these agreements in evaluating whether Downey will
be able to comply with its obligations under the junior subordinated
debentures or the capital securities guarantee agreement.
Holders of capital securities will have limited voting rights with respect to
the capital securities.
Holders of capital securities will have limited voting rights relating only
to the modification of the capital securities, the dissolution, winding-up or
liquidation of the trust, and the exercise of the trust's rights as holder of
junior subordinated debentures. In particular, Downey, as holder of the common
securities, can elect or remove any of the trustees of the trust. If, however,
Downey defaults on the junior subordinated debentures, holders of a majority
in liquidation amount of the outstanding capital securities will be able to
remove the property trustee or the Delaware trustee.
Additionally, the property trustee, the administrative trustees and Downey
may amend the trust agreement without the consent of the holders of capital
securities to ensure that the trust will be classified for United States
federal income tax purposes as a grantor trust or to ensure that the trust
will not be required to register as an investment company, even if this
adversely affects the interests of the holders. For more information, see
below under the caption "Description of the Capital Securities--Voting Rights;
Amendment of the Trust Agreement" and "--Removal of Trustees."
There is no existing market for the capital securities.
Although the trust anticipates the capital securities will be approved for
listing on the New York Stock Exchange, there is no existing market for the
capital securities. The trust cannot assure you that the capital securities,
if approved for listing, will continue to be listed on the New York Stock
Exchange. However, if approved for listing, we expect that the trading of the
capital securities on the New York Stock Exchange will commence within 30 days
after initial delivery of the capital securities. In addition, a listing does
not guarantee that a trading market for the capital securities will develop
or, if a trading market does develop, the depth of that market or the ability
of holders to sell their capital securities easily.
The trading price of the capital securities could widely fluctuate in
response to variations in operating results, general market price movements,
interest rates, developments specifically related to the consumer finance
industry, and other events or factors. In addition, the stock market has
experienced extreme price and volume fluctuations.
As discussed above, Downey will have the right to dissolve the trust and to
distribute the junior subordinated debentures to holders of capital
securities. Under those circumstances, Downey will use its best efforts to
list the junior subordinated debentures on the New York Stock Exchange or any
other exchange or organization on which the capital securities are then
listed. However, there is no existing market for junior subordinated
debentures and, if distributed to holders of capital securities, the junior
subordinated debentures will be affected by the risk factors similar to those
described in the two preceding paragraphs.
20
<PAGE>
The ability to receive distributions on the capital securities will be
affected by the capital securities being represented by a global certificate
The capital securities will be represented by one or more global
certificates registered in the name of The Depository Trust Company (the
"Depository") or its nominee. The trust's obligations, as well as the
obligations of its trustee and those of any third parties employed by the
trust or the trustees, run only to persons who are registered as holders of
capital securities. For example, once the trust makes distributions to the
registered holder, the trust has no further responsibility for the
distribution even if that holder is legally required to pass the distribution
along to you--as an indirect holder--but does not do so. As an indirect
holder, your rights relating to a global capital security will be governed by
the account rules of your financial institution and of the Depository, as well
as general laws relating to capital securities transfers.
You should be aware that when the trust issues capital securities in the
form of a global capital security:
. you cannot have capital securities registered in your own name;
. you cannot receive physical certificates for your interest in the
capital securities;
. you must look to your own bank or brokerage firm for payments on the
capital securities and protection of your legal rights relating to the
capital securities; and
. the Depository's policies will govern payments, transfers, exchanges and
other matters relating to your interest in the global capital security.
The trust and its trustees have no responsibility for any aspect of the
Depository's actions or for its records of ownership interests in the
global capital security. The trust and its trustees also do not
supervise the Depository in any way.
21
<PAGE>
A WARNING ABOUT FORWARD-LOOKING INFORMATION
Downey Financial Corp. and Downey Financial Capital Trust I have each made
forward-looking statements in this prospectus, and in documents that are
incorporated by reference in this prospectus, that are subject to risks and
uncertainties. These statements are based on the beliefs and assumptions of
management and on information currently available to management. Forward-
looking statements include the information concerning possible or assumed
future operating results and financial condition appearing under "Prospectus
Summary," "Risk Factors," "Business" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and statements preceded by,
followed by or that include the words "believes," "expects," "anticipates,"
"intends," "plans," "estimates" or similar expressions. Although we believe
that our expectations are based on reasonable assumptions, actual results may
differ materially from our expectations. Factors that could cause actual
results to differ from expectations include those described under "Risk
Factors" and the following:
. General economic or business conditions, either nationally or in
California, may be less favorable than expected, resulting in, among
other things, a deterioration in credit quality or a reduced demand for
credit;
. Because our business is concentrated in California, changes in the
economic conditions of the California market could adversely affect our
operations;
. Changes in the interest rate environment could adversely affect our
banking and real estate investment activities;
. Regulatory changes could have adverse effects on the financial services
industry;
. Competitive pressures among depository and other financial institutions
may increase significantly;
. Our competitors may have greater financial resources that enable them to
compete more successfully than we can;
. Federal monetary policy changes could have adverse effects on the
financial services industry;
. We could experience greater than anticipated losses on our loans because
borrowers, guarantors and related parties may fail to perform in
accordance with the terms of their loans; or
. Potential year 2000 noncompliance by our third party vendors and service
providers, including governmental entities, may impact our efforts to
successfully complete year 2000 compliance for all systems in a timely
fashion.
Forward-looking statements are not guarantees of performance. They involve
risks, uncertainties and assumptions. Actual results may differ from
expectations due to many factors beyond our ability to control or predict,
including those described above and under "Risk Factors." For these
statements, Downey Financial Corp. and Downey Financial Capital Trust I claim
the protection of the safe harbor for forward-looking statements contained in
the Private Securities Litigation Reform Act of 1995.
You should rely only on the information contained and incorporated by
reference in this prospectus. We have not authorized anyone to provide you
with information different from that contained or incorporated by reference in
this prospectus. Downey Financial Capital Trust I is offering to sell its
capital securities and seeking offers to buy its capital securities only in
jurisdictions where offers and sales are permitted.
22
<PAGE>
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports and proxy statements and other
information with the SEC. You may read and copy any document which Downey
Financial Corp. files at the SEC's public reference rooms in Washington, D.C.,
Chicago, Illinois and New York, New York. Please call the SEC at 1-800-SEC-
0330 for further information on the public reference rooms. Our filings with
the SEC are also available to the public over the Internet at a World Wide Web
site maintained by the SEC at http://www.sec.gov. In addition, you may inspect
our reports, proxy statements and other information at the offices of the New
York Stock Exchange.
Downey Financial Corp. and the trust have jointly filed with the SEC a
Registration Statement on Form S-3 under the Securities Act with respect to
the securities offered by this prospectus. This prospectus, which constitutes
a part of the Registration Statement, does not contain all of the information
shown in the Registration Statement. For further information with respect to
Downey Financial Corp., the trust and the securities offered by this
prospectus, reference is made to the Registration Statement and the exhibits
thereto which you may inspect at the public reference facilities of the SEC,
at the address shown above, or through the SEC's Web site.
DOCUMENTS INCORPORATED BY REFERENCE
The SEC allows us to "incorporate by reference" information into this
prospectus which means that we can disclose important information to you by
referring you to another document filed separately with the SEC. The
information incorporated by reference is considered to be a part of this
prospectus, and information that we file later with the SEC will automatically
update and supersede this information. We incorporate by reference the
documents listed below and any future filings made by us with the SEC which we
may make under Sections 13(a), 13(c), 14 or 15(d) of the Securities Exchange
Act of 1934 until we sell all of the securities offered hereby:
. Annual Report on Form 10-K for the year ended December 31, 1998;
. Quarterly Report on Form 10-Q for the quarter ended March 31, 1999; and
. Current Report on Form 8-K dated July 14, 1999.
You may request a copy of these incorporated filings, without charge,
excluding all exhibits unless specifically incorporated by reference as an
exhibit to this prospectus. You may request copies by writing or telephoning
Downey Financial Corp., 3501 Jamboree Road, Newport Beach, California 92660,
Attention: Corporate Secretary, telephone (949) 854-0300.
This prospectus does not contain or incorporate by reference any separate
financial statements of the trust. We do not consider that financial
statements of the trust are material to holders of the capital securities
because the trust is a newly formed special purpose entity, has no operating
history or independent operations and is not engaged in and does not propose
to engage in any activity other than holding the junior subordinated
debentures of Downey Financial Corp. and issuing the capital securities and
the common securities. For more information, see the information under the
captions "Prospectus Summary--Downey Financial Capital Trust I," "Description
of the Capital Securities," "Description of Junior Subordinated Debentures"
and "Description of Guarantee." In addition, we do not expect that the trust
will be filing reports under the Securities Exchange Act of 1934 with the SEC.
23
<PAGE>
USE OF PROCEEDS
All of the proceeds from the sale of capital securities will be invested by
the trust in the junior subordinated debentures. The net proceeds to Downey
from the sale of the junior subordinated debentures are estimated to be $115
million, net of estimated underwriting discounts and commissions and other
estimated offering expenses. Downey intends to use the net proceeds to make
investments in the Bank and for other general corporate purposes.
CAPITALIZATION
The following table sets forth our consolidated capitalization at March 31,
1999, and as adjusted to give effect to the issuance of the capital securities
offered by the trust. The following information should be read in conjunction
with our consolidated financial statements and notes thereto incorporated in
this prospectus by reference.
<TABLE>
<CAPTION>
March 31, 1999
---------------------
As
Actual Adjusted
---------- ----------
(Dollars in
thousands)
<S> <C> <C>
Federal Home Loan Bank advances.......................... $ 842,677 $ 842,677
Other borrowings......................................... 8,638 8,638
Downey obligated mandatorily redeemable capital
securities of subsidiary trust holding solely junior
subordinated debentures (1)............................. -- 120,000
Preferred stock, $0.01 par value: 5,000,000 shares
authorized, none issued................................. -- --
Common stock, $0.01 par value: 50,000,000 shares
authorized, 28,146,342 shares outstanding............... 281 281
Additional paid-in capital............................... 92,357 92,357
Accumulated other comprehensive income: unrealized gains
on securities available for sale........................ 305 305
Retained earnings........................................ 397,463 397,463
---------- ----------
Total stockholders' equity............................. 490,406 490,406
---------- ----------
Total capitalization................................. $1,341,721 $1,461,721
========== ==========
</TABLE>
- --------
(1) The trust will hold the junior subordinated debentures issued by Downey as
the trust's sole asset. The aggregate principal amount of the junior
subordinated debentures issued to the trust will be $123,711,350. The
capital securities are issued by the trust.
24
<PAGE>
ACCOUNTING TREATMENT
For financial reporting purposes, the trust will be treated as Downey's
subsidiary and, accordingly, the accounts of the trust will be included in our
consolidated financial statements. The capital securities will be presented as
a separate line item in our consolidated balance sheet under the caption
"Downey Obligated Mandatorily Redeemable Capital Securities of Subsidiary
Trust Holding Solely Junior Subordinated Debentures." For financial reporting
purposes, we will record distributions payable on the capital securities as an
interest expense in our consolidated statements of income.
In our future reports that we file under the Securities Exchange Act of
1934, we will include a footnote to the financial statements stating that:
. the trust is wholly owned by Downey;
. the sole assets of the trust are the junior subordinated debentures and
specifying the principal amount, interest rate and maturity date of the
junior subordinated debentures; and
. Downey's obligations under the capital securities guarantee agreement,
together with its obligations under the junior subordinated debentures
and the related indenture and the trust agreement in the aggregate,
constitute a full and unconditional guarantee on a subordinated basis by
Downey of the obligations of the trust under the capital securities.
The trust will not provide separate reports under the Securities Exchange
Act of 1934.
25
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following summary presents our selected consolidated financial data as
follows:
. the financial data as of and for the three months ended March 31, 1999
and 1998 has been derived from our unaudited consolidated quarterly
financial statements which, in the opinion of management, include all
adjustments, consisting of only normal, recurring adjustments,
considered necessary for a fair presentation; and
. the financial data as of, and for the years ended, December 31, 1998,
1997, 1996, 1995 and 1994 has been derived from our audited consolidated
financial statements.
You should read the summary selected consolidated financial data in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," included elsewhere in this prospectus and our
consolidated financial statements and related notes incorporated in this
prospectus by reference. The summary selected consolidated financial data for
the three months ended March 31, 1999 is not necessarily indicative of our
operating results or financial condition to be expected for any future period.
<TABLE>
<CAPTION>
Three Months
Ended March 31, Year Ended December 31,
----------------- ---------------------------------------------
1999 1998 1998 1997 1996 1995 1994
-------- -------- -------- -------- -------- -------- --------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Total interest income... $113,894 $109,723 $440,404 $420,418 $346,360 $318,828 $228,970
Total interest expense.. 64,938 67,097 266,057 266,260 211,765 214,238 122,601
-------- -------- -------- -------- -------- -------- --------
Net interest income.... 48,956 42,626 174,347 154,158 134,595 104,590 106,369
Provision for loan
losses................. 2,381 272 3,899 8,640 9,137 9,293 4,211
-------- -------- -------- -------- -------- -------- --------
Net interest income
after provision for
loan losses........... 46,575 42,354 170,448 145,518 125,458 95,297 102,158
-------- -------- -------- -------- -------- -------- --------
Other income, net:
Loan and deposit
related fees.......... 4,448 3,169 15,645 10,921 7,435 5,546 5,310
Real estate and joint
ventures held for
investment, net....... 1,165 9,515 22,363 14,222 8,241 11,192 9,530
Net gains (losses) on
sales of:
Loans and mortgage-
backed securities..... 3,987 872 6,462 2,675 1,543 266 114
Investment securities.. 97 68 68 -- 4,473 (15) --
(Provision for)
reduction of loss on
investment in lease
residual.............. -- -- -- -- -- 207 (920)
Other.................. 1,645 1,302 2,815 7,370 3,507 3,403 3,703
-------- -------- -------- -------- -------- -------- --------
Total other income,
net................... 11,342 14,926 47,353 35,188 25,199 20,599 17,737
-------- -------- -------- -------- -------- -------- --------
Operating expense:
General and
administrative
expense............... 36,249 26,210 115,890 99,556 86,460 74,470 75,566
SAIF special assessment
(1)................... -- -- -- -- 24,644 -- --
Net operation of real
estate acquired in
settlement of loans... 90 255 260 1,184 2,567 4,206 3,595
Amortization of excess
of cost over fair
value of net assets
acquired.............. 118 132 510 532 532 530 532
-------- -------- -------- -------- -------- -------- --------
Total operating
expense............... 36,457 26,597 116,660 101,272 114,203 79,206 79,693
-------- -------- -------- -------- -------- -------- --------
Net income (1).......... $ 12,348 $ 17,565 $ 57,973 $ 45,234 $ 20,704 $ 21,093 $ 23,532
PER SHARE DATA
Earnings per share--
Basic (1).............. $ 0.44 $ 0.63 $ 2.06 $ 1.61 $ 0.74 $ 0.75 $ 0.84
Earnings per share--
Diluted (1)............ 0.44 0.62 2.05 1.61 0.74 0.75 0.84
Book value per share at
end of period.......... 17.42 15.88 17.08 15.32 13.95 13.68 13.05
Stock price at end of
period................. 18.31 30.83 25.44 27.08 17.80 13.16 8.70
Cash dividends paid..... 0.080 0.076 0.316 0.301 0.290 0.276 0.276
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
Three Months
Ended March 31, Year Ended December 31,
---------------------- ----------------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
SELECTED FINANCIAL
RATIOS:
Effective interest rate
spread................. 3.23% 3.04% 3.08% 2.83% 2.96% 2.35% 3.02%
Return on average assets
(1).................... 0.78 1.20 0.98 0.79 0.43 0.45 0.62
Return on average equity
(1).................... 10.20 16.13 12.71 11.07 5.33 5.69 6.56
Dividend payout ratio... 18.23 12.19 15.33 18.69 39.35 36.78 33.97
Ratios of earnings to
fixed charges (2):
Excluding interest on
deposits (1).......... 3.19x 5.79x 6.22x 2.96x 2.39x 2.15x 4.11x
Including interest on
deposits (1).......... 1.33x 1.41x 1.36x 1.29x 1.18x 1.18x 1.33x
LOAN ACTIVITY:
Loans originated........ $1,554,924 $ 543,893 $4,071,262 $2,329,266 $1,583,784 $ 637,490 $1,810,096
Loans and mortgage-
backed securities
purchased.............. 302 2,729 7,463 35,828 30,296 44,194 196,255
Loans and mortgage-
backed securities
sold................... 776,518 118,897 1,740,416 557,511 166,503 102,097 45,770
BALANCE SHEET SUMMARY
(END OF PERIOD):
Total assets............ $6,594,092 $5,871,913 $6,270,419 $5,835,825 $5,198,157 $4,656,267 $4,650,651
Total loans and
mortgage-backed
securities............. 6,102,547 5,400,194 5,788,365 5,366,396 4,729,846 4,169,474 4,188,539
Investments and cash
equivalents............ 211,949 213,966 215,086 221,201 222,255 237,904 215,960
Deposits................ 5,205,282 5,108,822 5,039,733 4,869,978 4,173,102 3,790,221 3,557,398
Borrowings.............. 851,315 267,083 703,720 483,735 595,345 436,218 674,776
Stockholders' equity.... 490,406 446,086 480,566 430,346 391,571 384,072 366,187
Loans serviced for
others................. 1,566,677 625,372 1,040,264 612,529 576,044 527,234 468,123
AVERAGE BALANCE SHEET
DATA:
Assets.................. $6,329,170 $5,864,090 $5,918,507 $5,693,869 $4,789,648 $4,717,959 $3,789,709
Loans, net of unearned
income................. 5,818,860 5,313,496 5,345,380 5,174,767 4,269,136 4,175,085 3,241,390
Deposits................ 5,062,152 5,005,049 5,102,045 4,588,320 3,892,981 3,758,948 3,153,777
Stockholders' equity.... 484,108 435,645 456,237 408,473 388,187 370,714 358,748
CAPITAL RATIOS:
Average stockholders'
equity to average
assets................. 7.65% 7.43% 7.71% 7.17% 8.10% 7.86% 9.47%
Bank only--end of period
(3):
Core and tangible
capital............... 6.63 6.83 6.83 6.61 6.56 7.28 7.22
Risk-based capital..... 12.49 12.92 12.88 12.64 12.66 14.25 14.21
SELECTED ASSET QUALITY
DATA
(END OF PERIOD):
Non-accrual loans....... $ 25,085 $ 38,628 $ 22,375 $ 41,699 $ 45,021 $ 78,341 $ 52,037
Other real estate owned
and other foreclosed
assets................. 5,005 11,102 5,044 10,421 17,006 18,854 13,558
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total non-performing
assets................ 30,090 49,730 27,419 52,120 62,027 97,195 65,595
Non-performing assets as
a percentage of total
assets................. 0.46% 0.85% 0.44% 0.89% 1.19% 2.09% 1.41%
Allowance for loan
losses:
Amount................. $ 32,586 $ 31,817 $ 31,517 $ 32,092 $ 30,094 $ 27,943 $ 25,650
As a percentage of non-
performing loans...... 129.90% 82.37% 140.86% 76.96% 66.84% 35.67% 49.29%
</TABLE>
- -------
(1) In 1996, savings associations such as the Bank were assessed a one-time
charge for purposes of recapitalizing the SAIF. Excluding the SAIF special
assessment, 1996 net income would have been $34.7 million or $1.23 per
share on both a basic and diluted basis, the return on average assets
would have been 0.73%, the return on average equity would have been 8.95%
and the ratio of earnings to fixed charges would have been 3.28x excluding
interest on deposits and 1.30x including interest on deposits.
(2) For purposes of computing the ratio of earnings to fixed charges, earnings
represents income before income taxes, extraordinary items and fixed
charges. Fixed charges represents interest expense and the interest
component of rent expense and capitalized interest.
(3) For more information regarding these ratios, see "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Financial
Condition for the Quarter Ended March 31, 1999--Regulatory Capital
Compliance" and "--Financial Condition for the Year Ended December 31,
1998--Regulatory Capital Compliance."
27
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW FOR THE QUARTER ENDED MARCH 31, 1999
Our net income for the first quarter of 1999 totaled $12.3 million or $0.44
per share on a diluted basis. This compares to our net income in the first
quarter of 1998 of $17.6 million or $0.62 per share on a diluted basis.
The decline in net income between first quarters primarily reflects two
factors.
. First, year-ago net income benefited from the settlement of a number of
loan and real estate investment obligations of a former joint venture
partner. That settlement added $2.9 million to net income. The pre-tax
amount of the settlement was $5.1 million of which:
. $1.4 million represented the recovery of a prior loan charge-off
thereby reducing provision for loan loses;
. $2.6 million was recorded as a reduction of loss on real estate
and joint ventures;
. $0.8 million was recorded in miscellaneous other income; and
. $0.3 million was recorded as a reduction to professional fees
within general and administrative expense.
. Second, the remaining net income attributable to real estate investment
activities declined $3.1 million. The decline was due to there being no
sales of real estate assets in the current period compared to several
sales a year ago which resulted in pre-tax gains of $5.4 million.
Excluding those two factors, net income would have increased by $0.8
million, up 6.8% from a year ago. Our banking operations generated this
adjusted increase which reflects several factors. Net interest income
increased $6.3 million or 14.9% due to increases in both average earning
assets and the effective interest spread. In addition, the quarter-to-quarter
improvement reflected increases of $3.1 million in net gains on the sale of
loans, $1.3 million in loan and deposit related fees, and $0.4 million in loan
servicing fees. A $9.7 million increase in adjusted general and administrative
expense and a $0.7 million increase in the adjusted provision for loan losses
partially offset these positive factors. The increase in general and
administrative expense was due to significantly higher lending volumes, branch
expansion and increased expense related to year 2000 compliance efforts.
For the first quarter of 1999, our return on average assets was 0.78% and
our return on average equity was 10.20%.
At March 31, 1999, our assets totaled $6.6 billion, up $722 million or 12.3%
from a year ago. Our single family loan originations totaled a record $1.424
billion in the first quarter of 1999, more than triple the $453 million we
originated in the first quarter of 1998. Of the current quarter total, $647
million represented originations of loans for sale and $189 million
represented originations for portfolio of subprime credits as part of our
strategy to enhance the portfolio's net yield. In addition to single family
loans, we originated $131 million of other loans in the quarter including $60
million of construction and land loans and $50 million of automobile loans.
Our borrowings increased $584 million between first quarters and represented
the primary source of funding for our asset growth. That increase primarily
occurred during the fourth quarter of 1998 when we took advantage of the low
interest rate environment and borrowed $480 million of long-term Federal Home
Loan Bank ("FHLB") advances. In addition to higher borrowings, our deposits
increased $96 million or 1.9% and also funded asset growth. At quarter-end,
our deposits totaled $5.2 billion. During the quarter, we opened five new in-
store branches and closed one traditional branch, bringing total branches at
quarter end to 95 of which 33 are in-store. A year ago, branches totaled 89.
Our non-performing assets increased $3 million during the quarter to $30
million or 0.46% of total assets.
At March 31, 1999, the Bank had core and tangible capital ratios of 6.63%
and a risk-based capital ratio of 12.49%. These capital levels are well above
the "well capitalized" standards of 5% for core and tangible capital and 10%
for risk-based capital, as defined by regulation.
28
<PAGE>
RESULTS OF OPERATIONS FOR THE QUARTER ENDED MARCH 31, 1999
Net Interest Income
Our net interest income totaled $49.0 million in the first quarter of 1999,
up $6.3 million or 14.9% from the same period last year. The improvement
between first quarters reflected increases in both average earning assets and
the effective interest rate spread. Our average earning assets increased by
$440 million or 7.8% between first quarters to $6.1 billion. The effective
interest rate spread of 3.23% in the current quarter was up from both the
year-ago quarter level of 3.04% and from the fourth quarter 1998 level of
3.14%. See "Results of Operations for the Year Ended December 31, 1998--Net
Interest Income" for definitions of net interest income, interest-earning
assets and interest-bearing liabilities.
The following table presents for the periods indicated the total dollar
amount of:
. interest income from average interest-earning assets and the resultant
yields; and
. interest expense on average interest-bearing liabilities and the
resultant costs, expressed as rates.
The table also sets forth the net interest income, the interest rate spread
and the effective interest rate spread. The effective interest rate spread
reflects the relative level of interest-earning assets to interest-bearing
liabilities and equals:
. the difference between interest income on interest-earning assets and
interest expense on interest-bearing liabilities, divided by
. average interest-earning assets for the period.
The table also sets forth the net interest-earning balance--the difference
between the average balance of interest-earning assets and the average balance
of interest-bearing liabilities--for the periods indicated. We included non-
accrual loans in the average interest-earning assets balance. We included
interest from non-accrual loans in interest income only to the extent that we
received payments and to the extent that we believe we will recover the
remaining principal balance of the loan. We computed average balances for the
quarter using the average of each month's daily average balance during the
period indicated.
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------------------------------------------------
March 31, 1999 December 31, 1998 March 31, 1998
--------------------------- --------------------------- ---------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
---------- -------- ------- ---------- -------- ------- ---------- -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans.................. $5,818,860 $110,731 7.61% $5,480,840 $107,065 7.81% $5,313,496 $105,345 7.93%
Mortgage-backed
securities............ 30,599 464 6.07 35,794 580 6.48 47,970 808 6.74
Investment securities.. 205,844 2,699 5.32 307,643 4,257 5.49 253,926 3,570 5.70
---------- -------- ---- ---------- -------- ---- ---------- -------- ----
Total interest-earning
assets................ 6,055,303 113,894 7.52 5,824,277 111,902 7.69 5,615,392 109,723 7.82
Non-interest-earning
assets................ 273,867 262,408 248,698
---------- ---------- ----------
Total assets........... $6,329,170 $6,086,685 $5,864,090
========== ========== ==========
Interest-bearing
liabilities:
Deposits............... $5,062,152 $ 55,489 4.45% $5,077,632 $ 59,557 4.65% $5,005,049 $ 61,538 4.99%
Borrowings............. 715,572 9,449 5.36 466,624 6,601 5.61 351,068 5,559 6.42
---------- -------- ---- ---------- -------- ---- ---------- -------- ----
Total interest-bearing
liabilities........... 5,777,724 64,938 4.56 5,544,256 66,158 4.73 5,356,117 67,097 5.08
Non-interest-bearing
liabilities............ 67,338 67,999 72,328
Stockholders' equity.... 484,108 474,430 435,645
---------- ---------- ----------
Total liabilities and
stockholders' equity.. $6,329,170 $6,086,685 $5,864,090
========== ========== ==========
Net interest
income/interest rate
spread................. $ 48,956 2.96% $ 45,744 2.96% $ 42,626 2.74%
Excess of interest-
earning assets over
interest-bearing
liabilities............ $ 277,579 $ 280,021 $ 259,275
Effective interest rate
spread................. 3.23 3.14 3.04
</TABLE>
29
<PAGE>
Changes in our net interest income are a function of both changes in rates
and changes in volumes of interest-earning assets and interest-bearing
liabilities. The following table sets forth information regarding changes in
our interest income and expense for the periods indicated. For each category
of interest-earning assets and interest-bearing liabilities, we have provided
information on changes attributable to:
. changes in volume--changes in volume multiplied by comparative period
rate;
. changes in rate--changes in rate multiplied by comparative period
volume; and
. changes in rate-volume--changes in rate multiplied by changes in volume.
Interest-earning asset and interest-bearing liability balances used in the
calculations represent quarterly average balances computed using the average
of each month's daily average balance during the period indicated.
<TABLE>
<CAPTION>
Three Months Ended
March 31, 1999 versus March 31, 1998
Changes Due To
-----------------------------------------
Rate/
Volume Rate Volume Net
---------- --------- -------------------
(In Thousands)
<S> <C> <C> <C> <C>
Interest income:
Loans............................... $ 10,019 $ (4,231) $ (402) $ 5,386
Mortgage-backed securities.......... (292) (81) 29 (344)
Investment securities............... (676) (241) 46 (871)
--------- --------- ------- ---------
Change in interest income.......... 9,051 (4,553) (327) 4,171
--------- --------- ------- ---------
Interest expense:
Deposits............................ 702 (6,675) (76) (6,049)
Borrowings.......................... 5,392 (1,707) 205 3,890
--------- --------- ------- ---------
Change in interest expense......... 6,094 (8,382) 129 (2,159)
--------- --------- ------- ---------
Change in net interest income........ $ 2,957 $ 3,829 $ (456) $ 6,330
========= ========= ======= =========
</TABLE>
Provision for Loan Losses
Provision for loan losses was $2.4 million in the current quarter compared
to $0.3 million in the first quarter of 1998. The increase reflects higher
loan growth during the current quarter, as well as the year-ago quarter
included a $1.4 million recovery of a prior loan charge-off as a result of the
previously mentioned settlement. For information regarding our allowance for
loan losses, see "Financial Condition for the Quarter Ended March 31, 1999--
Asset Quality--Valuation Allowances."
Other Income
Total other income was $11.3 million in the first quarter of 1999, down $3.6
million or 24.0% from the year-ago quarter. The decrease between first
quarters was primarily in our income from real estate and joint ventures held
for investment which declined by $8.4 million. The majority of that decline is
attributable to our year-ago first quarter results containing $5.4 million of
gains from the sale of joint venture investments compared to none in the
current quarter, as well as $2.6 million from the previously mentioned
settlement which was reflected as a reduction to the provision for losses.
Increases of $3.1 million in net gains on sales of loans, $1.3 million in loan
and deposit related fees and $0.4 million in loan servicing fees partially
offset the decline in income from real estate and joint ventures held for
investment. The other category was essentially unchanged between first
quarters even though the year-ago quarter included $0.8 million from the
previously mentioned settlement.
30
<PAGE>
The following table presents a breakdown of the key components comprising
income from real estate and joint venture operations. The above mentioned $5.4
million joint venture gains in the year-ago quarter are included in equity in
net income from joint ventures.
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
1999 1998 1998 1998 1998
--------- ------------ ------------- -------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Operations, net:
Rental operations, net
of expenses.......... $ 981 $ 688 $ 894 $1,260 $ 881
Equity in net income
from joint ventures.. 47 256 2,605 1,116 5,226
Interest from joint
venture advances..... 190 182 380 336 686
------ ------ ------ ------ ------
Total operations,
net................ 1,218 1,126 3,879 2,712 6,793
Net gains on sales of
wholly owned real
estate................. -- 2,487 -- 70 --
Reduction of (provision
for) losses on real
estate and joint
ventures............... (53) 214 139 2,221 2,722
------ ------ ------ ------ ------
Income from real
estate and joint
venture operations... $1,165 $3,827 $4,018 $5,003 $9,515
====== ====== ====== ====== ======
</TABLE>
Operating Expense
Operating expense totaled $36.5 million in the current quarter, compared to
$26.6 million in the first quarter of 1998. The increase was due to higher
general and administrative costs which increased $10.0 million or 38.3%, as
our costs associated with the net operation of real estate acquired in
settlement of loans declined by $0.2 million. A $0.3 million reduction to
professional fees due to the previously mentioned settlement was included
within general and administrative expense in the year-ago quarter. The
increase in general and administrative expense reflected our higher lending
volumes, branch expansion and expenses related to year 2000 compliance. Year
2000 related costs totaled $0.5 million in the current quarter, up from $0.2
million a year ago.
Provision for Income Taxes
Income taxes for the current quarter totaled $9.1 million, resulting in an
effective tax rate of 42.5%, compared to $13.1 million and 42.8% for the like
quarter of a year ago.
Business Segment Reporting
The previous sections of the Results of Operations for the Quarter Ended
March 31, 1999 discussed our consolidated results. The purpose of this section
is to present data on the results of operations of our two business segments--
banking and real estate investment. For a description of these business
segments, see "Business."
31
<PAGE>
The following table presents net income by business segment for the period
indicated, followed by a discussion of the results of operations of each
segment.
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------
June
30,
March 31, December 31, September 30, 1998 March 31,
1999 1998 1998 (1) 1998 (2)
--------- ------------ ------------- ------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Banking................. $12,029 $10,791 $10,870 $12,405 $12,670
Real estate investment.. 319 1,861 1,898 2,583 4,895
------- ------- ------- ------- -------
Total net income...... $12,348 $12,652 $12,768 $14,988 $17,565
======= ======= ======= ======= =======
</TABLE>
- --------
(1) The net income impact of a settlement with a former joint venture partner
totaled $1.8 million, of which $0.5 million was in banking and $1.3
million was in real estate investment.
(2) The net income impact of a settlement with a former joint venture partner
totaled $2.9 million, of which $1.4 million was in banking and $1.5
million was in real estate investment.
Banking
Net income from banking operations for the first quarter of 1999 totaled
$12.0 million, down from $12.7 million in the first quarter of 1998. The
previously mentioned settlement benefited year-ago net income by $1.4 million.
The pre-tax amount was $2.5 million of which:
. $1.4 million represented the recovery of a prior loan charge-off thereby
reducing provision for loan losses;
. $0.8 million was recorded in other income; and
. $0.3 million was recorded as a reduction to professional fees within
operating expense.
Excluding the settlement benefit from year ago results, net income from
banking would have increased by $0.8 million or 6.8%.
32
<PAGE>
The increase in adjusted net income reflected several factors. Net interest
income increased $6.1 million or 14.3% due to increases in both average
earning assets and the effective interest rate spread. Other income increased
an adjusted $5.6 million. The increase in adjusted other income reflected
increases in net gains on sales of loans, loan and deposit related fees and
loan servicing fees. Adjusted increases of $10.0 million in operating expense
and $0.8 million in provision for loan losses partially offset the favorable
impact of these items. The increase in adjusted operating expense reflected
significantly higher lending volumes, branch expansion and expenses related to
resolving year 2000 compliance issues. The table below sets forth our banking
operational results and selected financial data for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
1999 1998 1998 1998 1998
---------- ------------ ------------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Net interest income..... $ 48,948 $ 45,953 $ 42,889 $ 43,318 $ 42,807
Provision for loan
losses................. 2,381 1,180 985 1,520 233
Other income............ 10,110 6,881 5,561 6,864 5,311
Operating expense....... 35,839 33,057 28,270 27,077 25,550
Net intercompany income
(expense).............. 82 (18) (48) 80 (121)
---------- ---------- ---------- ---------- ----------
Income before income
taxes.................. 20,920 18,579 19,147 21,665 22,214
Income taxes............ 8,891 7,788 8,277 9,260 9,544
---------- ---------- ---------- ---------- ----------
Net income............ $ 12,029 $ 10,791 $ 10,870 $ 12,405 $ 12,670
========== ========== ========== ========== ==========
At period end:
Assets:
Loans................. $6,102,547 $5,788,365 $5,387,843 $5,328,291 $5,400,194
Other................. 473,310 463,960 500,294 481,463 449,917
---------- ---------- ---------- ---------- ----------
Total assets........ 6,575,857 6,252,325 5,888,137 5,809,754 5,850,111
---------- ---------- ---------- ---------- ----------
Equity.................. 490,406 480,566 470,815 458,962 446,086
</TABLE>
33
<PAGE>
Real Estate Investment
Net income from our real estate investment operations totaled $0.3 million
in the first quarter of 1999, down from $4.9 million in the year-ago quarter.
The previously mentioned settlement benefited year-ago net income by $1.5
million. We reflected the pre-tax amount of $2.6 million as a reduction of
loss on real estate and joint ventures in the other income category. Excluding
the settlement, net income would have declined by $3.1 million. The adjusted
decline primarily reflected lower gains from the sale of real estate assets.
In the year-ago first quarter, gains totaled $5.4 million from sales
associated with residential and shopping center joint venture projects. Those
gains appear in the other income category. There were no sales in the first
quarter of 1999. The table below sets forth real estate investment operational
results and selected financial data for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------------------------------
March 31, December 31, September 30, June30, March 31,
1999 1998 1998 1998 1998
--------- ------------ ------------- ------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Net interest income
(expense).............. $ 8 $ (209) $ (102) $ (128) $ (181)
Provision for (reduction
of) loan losses........ -- -- -- (58) 39
Other income............ 1,232 3,925 4,111 5,085 9,615
Operating expense....... 618 777 679 203 1,047
Net intercompany income
(expense).............. (82) 18 48 (80) 121
------- ------- ------- ------- -------
Income before income
taxes.................. 540 2,957 3,378 4,732 8,469
Income taxes............ 221 1,096 1,480 2,149 3,574
------- ------- ------- ------- -------
Net income............ $ 319 $ 1,861 $ 1,898 $ 2,583 $ 4,895
======= ======= ======= ======= =======
At period end:
Assets:
Real estate held for
investment........... $52,155 $49,447 $47,918 $41,880 $41,123
Other................. 7,564 9,841 13,790 17,892 15,496
------- ------- ------- ------- -------
Total assets........ 59,719 59,288 61,708 59,772 56,619
------- ------- ------- ------- -------
Equity.................. 41,484 41,194 39,266 37,424 34,817
</TABLE>
Our investment in real estate and joint ventures amounted to $52 million at
March 31, 1999, compared to $49 million at December 31, 1998, and $41 million
at March 31, 1998.
For information on valuation allowances associated with real estate and
joint venture loans, see "Financial Condition for the Quarter Ended March 31,
1999--Asset Quality--Valuation Allowances."
34
<PAGE>
FINANCIAL CONDITION FOR THE QUARTER ENDED MARCH 31, 1999
Loans and Mortgage-Backed Securities
Total loans and mortgage-backed securities, including those held for sale,
increased $314 million during the first quarter to a total of $6.1 billion or
92.5% of assets at March 31, 1999. The increase primarily occurred in the
single family loan portfolio, which increased $429 million or 9.2% during the
quarter. Of that increase, $182 million represented fixed rate loans, while
subprime loans increased $168 million. In addition, our adjustable rate
portfolio increased by $79 million, the first increase in over a year. A $137
million decline in loans held for sale partially offset the increase in the
single family loan portfolio.
The following table sets forth loans originated, including purchases, for
investment and for sale.
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------------------------------
March
March 31, December 31, September 30, June 30, 31,
1999 1998 1998 1998 1998
---------- ------------ ------------- -------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Loans originated for
investment:
Residential, one-to-
four units:
Adjustable........... $ 568,891 $ 436,960 $ 383,483 $309,468 $190,490
Fixed................ 208,504 181,717 6,921 6,824 4,791
Other................. 131,045 111,484 102,319 88,013 93,672
---------- ---------- ---------- -------- --------
Total loans
originated for
investment.......... 908,440 730,161 492,723 404,305 288,953
Loans originated for
sale (1)............... 646,786 740,837 571,146 592,931 257,669
---------- ---------- ---------- -------- --------
Total loans
originated........... $1,555,226 $1,470,998 $1,063,869 $997,236 $546,622
========== ========== ========== ======== ========
</TABLE>
- --------
(1) One-to-four unit residential loans, primarily fixed.
Originations of one-to-four unit residential loans totaled $1.424 billion in
the first quarter of 1999, of which $777 million were for portfolio and $647
million were for sale. This was 5% higher than the $1.360 billion we
originated in the fourth quarter of 1998, and more than triple the $453
million we originated in the year-ago quarter. Of the current quarter total,
$189 million represented originations of subprime credits as part of our
strategy to enhance the portfolio's net yield. During the current quarter, 76%
of our residential one-to-four unit originations represented refinancings of
existing loans. This is down slightly from 77% during the 1998 fourth quarter,
but up from 70% in the year-ago first quarter. In addition to single family
loans, we originated $131 million of other loans in the current quarter
including $60 million of construction and land loans and $50 million of
automobile loans.
During the current quarter, loan originations for investment consisted
primarily of adjustable rate mortgages tied to the Eleventh District Cost of
Funds Index ("COFI"), an index which lags the movement in market interest
rates. This experience is similar to that of recent quarters. Increasingly,
the majority of adjustable rate mortgage originations reprice monthly;
however, we also originate adjustable rate mortgage loans which reprice semi-
annually and annually. With respect to adjustable rate mortgages that
primarily adjust monthly, there is a lifetime interest rate cap, but no other
specified limit on periodic interest rate adjustments. Instead, monthly
adjustment adjustable rate mortgages have a periodic cap on changes in the
required monthly payments, which payments adjust annually. Monthly adjustment
adjustable rate mortgages allow for negative amortization. Negative
amortization is the addition to loan principal of accrued interest that
exceeds the required loan payment. There is a limit on the amount of negative
amortization allowed, expressed as a percentage of principal plus the amount
added relative to the original loan amount. That limit has been 110%, but was
increased to 125% in 1998 on loans having a loan to value ratio of 80% or
less. At March 31, 1999, $3.2 billion of the adjustable rate mortgages in our
loan portfolio were subject to negative amortization, of which $53 million
represented the amount of negative amortization included in the loan balance.
35
<PAGE>
We also continue to originate residential fixed interest rate mortgage loans
to meet consumer demand, but we intend to sell the majority of these loans. We
sold $777 million of loans in the first quarter of 1999, compared to $559
million for the previous quarter and $119 million for the first quarter of
1998. All were secured by residential one-to-four unit property and at March
31, 1999, loans held for sale totaled $310 million.
At March 31, 1999, we had commitments to fund loans amounting to $807
million, of which $419 million were fixed rate one-to-four unit residential
loans being originated for sale in the secondary market, loans in process of
$123 million, undrawn lines of credit of $77 million, commitments to purchase
loans of $53 million and letters of credit of $1 million. We believe our
current sources of funds will enable us to meet these obligations while
exceeding all regulatory liquidity requirements.
36
<PAGE>
The following table sets forth the origination, purchase and sale activity
relating to loans and mortgage-backed securities during the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
1999 1998 1998 1998 1998
--------- ------------ ------------- --------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Investment Portfolio:
Loans originated:
Loans secured by real
estate:
Residential:
One-to-four units:
Adjustable........... $ 382,562 $ 303,291 $ 283,468 $ 229,106 $ 127,871
Adjustable--
subprime............ 186,329 133,409 100,015 78,845 60,017
--------- --------- --------- --------- ---------
Total adjustable.... 568,891 436,700 383,483 307,951 187,888
Fixed................ 205,758 179,786 5,351 3,980 3,319
Fixed--subprime...... 2,444 1,684 1,535 1,329 1,472
Five or more units:
Adjustable........... -- -- -- -- 875
Fixed................ -- -- 13,229 -- --
--------- --------- --------- --------- ---------
Total residential... 777,093 618,170 403,598 313,260 193,554
Commercial real
estate................ 6,398 6,149 -- -- 4,214
Construction........... 30,587 45,339 17,266 19,023 29,906
Land................... 29,081 9,983 23,640 6,883 7,851
Non-mortgage:
Commercial............. 2,925 700 645 4,421 610
Automobile............. 50,294 43,330 40,158 46,153 45,552
Other consumer......... 11,760 5,983 7,016 10,738 4,537
--------- --------- --------- --------- ---------
Total loans
originated........... 908,138 729,654 492,323 400,478 286,224
Real estate loans
purchased (1).......... 302 507 400 3,827 2,729
--------- --------- --------- --------- ---------
Total loans originated
and purchased......... 908,440 730,161 492,723 404,305 288,953
Loan repayments......... (434,796) (489,912) (490,358) (498,516) (376,371)
Other net changes (2)... (18,824) (8,211) 553 (11,740) (14,747)
--------- --------- --------- --------- ---------
Net increase (decrease)
in loans held for
investment............ 454,820 232,038 2,918 (105,951) (102,165)
--------- --------- --------- --------- ---------
Sale Portfolio:
Residential, one-to-four
units:
Originated whole
loans................. 646,786 740,837 571,146 592,931 257,669
Loans transferred from
(to) the investment
portfolio............. (7,095) (3,822) -- 162 604
Originated whole loans
sold.................. (176,139) (266,812) (354,371) (429,434) (79,686)
Loans exchanged for
mortgage-backed
securities............ (600,379) (291,940) (153,175) (124,505) (39,211)
Other net changes...... (622) (3,794) (2,851) (1,369) (97)
--------- --------- --------- --------- ---------
Net increase
(decrease) in loans
held for sale......... (137,449) 174,469 60,749 37,785 139,279
--------- --------- --------- --------- ---------
Mortgage-backed
securities, net:
Received in exchange
for loans............. 600,379 291,940 153,175 124,505 39,211
Sold................... (600,379) (293,222) (153,175) (124,505) (39,211)
Repayments............. (3,235) (4,143) (4,242) (3,724) (3,020)
Other net changes...... 46 (560) 127 (13) (296)
--------- --------- --------- --------- ---------
Net decrease in
mortgage-backed
securities available
for sale.............. (3,189) (5,985) (4,115) (3,737) (3,316)
--------- --------- --------- --------- ---------
Net increase
(decrease) in loans
and mortgage-backed
securities held for
sale and available
for sale.............. (140,638) 168,484 56,634 34,048 135,963
--------- --------- --------- --------- ---------
Total net increase
(decrease) in loans
and mortgage-backed
securities............ $ 314,182 $ 400,522 $ 59,552 $ (71,903) $ 33,798
========= ========= ========= ========= =========
</TABLE>
- --------
(1) Primarily one-to-four unit residential loans. Includes five or more unit
residential loans of $0.4 million in the three months ended September 30,
1998, $0.2 million in the three months ended June 30, 1998 and $0.1 million
in the three months ended March 31, 1998. Also includes commercial real
estate loans of $0.6 million in the three months ended June 30, 1998.
(2) Primarily includes borrowings against and repayments of lines of credit and
construction loans, changes in loss allowances, loans transferred to real
estate acquired in settlement of loans or from (to) the held for sale
portfolio, and interest capitalized on loans (negative amortization).
37
<PAGE>
The following table sets forth the composition of our loan and mortgage-
backed securities portfolios at the dates indicated. At March 31, 1999,
approximately 97% of our real estate loans were secured by real estate located
in California, principally in Los Angeles, Orange, Santa Clara, San Diego and
San Mateo counties.
<TABLE>
<CAPTION>
March 31, December 31, September 30, June 30, March 31,
1999 1998 1998 1998 1998
---------- ------------ ------------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Investment Portfolio:
Loans secured by real
estate:
Residential:
One-to-four units:
Adjustable........... $3,800,552 $3,721,728 $3,791,187 $3,892,221 $4,027,520
Adjustable--
subprime............ 745,843 580,232 461,646 372,608 303,058
Fixed................ 507,357 325,454 153,408 155,741 161,518
Fixed--subprime...... 10,932 8,719 7,516 5,993 4,672
---------- ---------- ---------- ---------- ----------
Total one-to-four
units.............. 5,064,684 4,636,133 4,413,757 4,426,563 4,496,768
Five or more units:
Adjustable........... 18,516 18,617 18,707 18,802 30,129
Fixed................ 7,904 21,412 22,436 8,934 8,748
Commercial real
estate:
Adjustable............ 39,641 39,360 44,215 47,045 73,013
Fixed................. 111,606 101,430 112,687 114,379 118,476
Construction.......... 147,246 127,761 92,779 95,664 89,989
Land.................. 74,959 44,859 39,222 29,857 32,510
Non-mortgage:
Commercial............ 28,182 28,293 27,710 27,298 25,478
Automobile............ 363,168 357,988 355,955 356,504 350,316
Other consumer........ 40,607 41,894 44,026 44,530 45,529
---------- ---------- ---------- ---------- ----------
Total loans held for
investment........... 5,896,513 5,417,747 5,171,494 5,169,576 5,270,956
Increase (decrease)
for:
Undisbursed loan
funds................ (133,785) (108,414) (88,213) (85,367) (78,888)
Net deferred costs and
premiums............. 33,515 31,021 24,962 21,408 19,581
Allowance for
estimated loss....... (32,586) (31,517) (31,444) (31,736) (31,817)
---------- ---------- ---------- ---------- ----------
Total loans held for
investment, net...... 5,763,657 5,308,837 5,076,799 5,073,881 5,179,832
---------- ---------- ---------- ---------- ----------
Sale Portfolio, Net:
Loans held for sale
(all one-to-four
units):
Adjustable............ -- 7,975 9,480 13,692 10,019
Fixed................. 309,933 439,407 263,433 198,472 164,360
---------- ---------- ---------- ---------- ----------
Total loans held for
sale................. 309,933 447,382 272,913 212,164 174,379
Mortgage-backed
securities available
for sale:
Adjustable............ 9,887 10,996 12,795 14,575 16,135
Fixed................. 19,070 21,150 25,336 27,671 29,848
---------- ---------- ---------- ---------- ----------
Total mortgage-backed
securities available
for sale............. 28,957 32,146 38,131 42,246 45,983
---------- ---------- ---------- ---------- ----------
Total loans and
mortgage-backed
securities held for
sale and available
for sale............. 338,890 479,528 311,044 254,410 220,362
---------- ---------- ---------- ---------- ----------
Total loans and
mortgage-backed
securities........... $6,102,547 $5,788,365 $5,387,843 $5,328,291 $5,400,194
========== ========== ========== ========== ==========
</TABLE>
We carry loans for sale at the lower of cost or market. At March 31, 1999,
no valuation allowance was required as the market value exceeded book value on
an aggregate basis.
38
<PAGE>
We carry mortgage-backed securities available for sale at fair value which,
at March 31, 1999, reflected an unrealized gain of $0.2 million. The current
quarter-end unrealized gain, less the associated tax effect of $0.1 million,
is reflected within a separate component of other comprehensive income until
realized.
Deposits
At March 31, 1999, our deposits totaled $5.2 billion, up $96 million or 1.9%
from the year-ago quarter end, and up $166 million or 3.3% from year-end 1998.
Compared to the year-ago period, our transaction accounts--i.e., checking,
regular passbook and money market--increased $306 million or 30.4%, while
certificates of deposits decreased $210 million or 5.1%. The following table
sets forth information concerning our deposits and average rates paid at the
dates indicated.
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998 September 30, 1998 June 30, 1998 March 31,1998
------------------- ------------------- ------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average
Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount
-------- ---------- -------- ---------- -------- ---------- -------- ---------- -------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Transaction
accounts.......... 2.34% $1,313,707 2.30% $1,238,062 2.18% $1,080,734 2.17% $1,021,428 2.10% $1,007,323
Certificates of
deposit:
Less than 3.00%... 2.60 23,324 2.62 25,126 2.63 26,686 2.63 27,290 2.63 29,543
3.00-3.49......... 3.01 323 3.01 593 3.03 449 3.02 677 3.01 581
3.50-3.99......... 3.91 47,813 3.88 51,474 3.91 40,115 -- -- -- --
4.00-4.49......... 4.39 604,692 4.39 428,316 4.16 14,754 4.13 59,708 4.20 60,410
4.50-4.99......... 4.80 1,004,947 4.80 668,204 4.88 468,922 4.90 208,774 4.89 134,194
5.00-5.99......... 5.41 2,015,702 5.53 2,421,333 5.57 3,162,420 5.60 3,072,092 5.63 2,947,539
6.00-6.99......... 6.06 192,320 6.06 204,065 6.06 382,502 6.05 778,300 6.06 925,762
7.00 and greater.. 7.24 2,454 7.24 2,560 7.25 2,798 7.24 3,107 7.21 3,470
---- ---------- ---- ---------- ---- ---------- ---- ---------- ---- ----------
Total certificates
of deposit....... 5.09 3,891,575 5.26 3,801,671 5.50 4,098,646 5.61 4,149,948 5.66 4,101,499
---- ---------- ---- ---------- ---- ---------- ---- ---------- ---- ----------
Total deposits.... 4.40% $5,205,282 4.53% $5,039,733 4.81% $5,179,380 4.93% $5,171,376 4.96% $5,108,822
==== ========== ==== ========== ==== ========== ==== ========== ==== ==========
</TABLE>
Borrowings
During the 1999 first quarter, our borrowings increased $148 million to $851
million, primarily reflecting increases in FHLB advances. This followed an
increase of $494 million during the fourth quarter of 1998 when we took
advantage of obtaining long-term advances from the FHLB at attractive
borrowing rates. The following table sets forth information concerning our
FHLB advances and other borrowings at the dates indicated.
<TABLE>
<CAPTION>
March 31, December 31, September 30, June 30, March 31,
1999 1998 1998 1998 1998
--------- ------------ ------------- -------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
FHLB advances........... $842,677 $695,012 $197,935 $123,347 $209,854
Other borrowings:
Commercial paper....... -- -- -- 19,982 44,517
Other borrowings....... 8,638 8,708 12,166 12,256 12,712
-------- -------- -------- -------- --------
Total borrowings...... $851,315 $703,720 $210,101 $155,585 $267,083
======== ======== ======== ======== ========
Weighted average rate on
borrowings during
the period............. 5.36% 5.61% 5.91% 6.60% 6.42%
Total borrowings as a
percentage of
total assets........... 12.91 11.22 3.55 2.67 4.55
</TABLE>
39
<PAGE>
Asset/Liability Management and Market Risk
Market risk is the risk of loss from adverse changes in market prices and
interest rates. Our market risk arises primarily from interest rate risk in
our lending and deposit taking activities. This interest rate risk occurs to
the degree that our interest-bearing liabilities reprice or mature more
rapidly or on a different basis than our interest-earning assets. Since our
earnings depend primarily on our net interest income, which is the difference
between the interest and dividends earned on interest-earning assets and the
interest paid on interest-bearing liabilities, one of our principal objectives
is to actively monitor and manage the effects of adverse changes in interest
rates on net interest income while maintaining asset quality. There has been
no significant change in our market risk since December 31, 1998. See
"Financial Condition for the Year Ended December 31, 1998--Asset/Liability
Management and Market Risk."
The following table sets forth the repricing frequency of our major asset
and liability categories as of March 31, 1999, as well as other information
regarding the repricing and maturity differences between interest-earning
assets and interest-bearing liabilities in future periods. We refer to these
differences as "gap." We have determined the repricing frequencies by
reference to projected maturities, based upon contractual maturities as
adjusted for scheduled repayments and "repricing mechanisms"--provisions for
changes in the interest and dividend rates of assets and liabilities. We
assume prepayment rates on substantially all of our loan portfolio based upon
our historical loan prepayment experience and anticipated future prepayments.
Repricing mechanisms on a number of our assets are subject to limitations,
like caps on the amount that interest rates and payments on our loans may
adjust. Accordingly, these assets do not normally respond to changes in market
interest rates as completely or rapidly as our liabilities. The interest rate
sensitivity of our assets and liabilities illustrated in the table would vary
substantially if we used different assumptions or if actual experience
differed from the assumptions shown.
<TABLE>
<CAPTION>
March 31, 1999
------------------------------------------------------------------
Within 7-12 2-5 6-10 Over Total
6 Months Months Years Years 10 Years Balance
---------- ----------- -------- --------- -------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Investment securities
and FHLB stock........ (1) $ 111,157 $ 10,064 $ 90,169 $ -- $ -- $ 211,390
Loans and mortgage-
backed securities:
Mortgage-backed
securities........... (2) 15,047 4,638 8,542 684 46 28,957
Loans secured by real
estate:
Residential:
Adjustable.......... (2) 4,462,219 106,564 9,648 -- -- 4,578,431
Fixed............... (2) 372,615 52,856 243,085 106,924 61,709 837,189
Commercial real es-
tate................ (2) 44,942 7,486 88,244 5,771 1,896 148,339
Construction......... (2) 52,916 -- -- -- -- 52,916
Land................. (2) 41,073 34 293 448 224 42,072
Non-mortgage:
Commercial........... (2) 17,053 -- -- -- -- 17,053
Consumer............. (2) 120,240 75,286 202,064 -- -- 397,590
---------- ----------- -------- --------- -------- ----------
Total loans and
mortgage-backed
securities............ 5,126,105 246,864 551,876 113,827 63,875 6,102,547
---------- ----------- -------- --------- -------- ----------
Total interest-earning
assets............... $5,237,262 $ 256,928 $642,045 $ 113,827 $ 63,875 $6,313,937
========== =========== ======== ========= ======== ==========
Deposits and borrowings:
Interest-bearing depos-
its:
Fixed maturity
deposits............. (1) $2,328,096 $ 1,274,626 $288,853 $ -- $ -- $3,891,575
Transaction accounts.. (3) 1,152,738 -- -- -- -- 1,152,738
Non-interest-bearing
transaction accounts.. 160,969 -- -- -- -- 160,969
---------- ----------- -------- --------- -------- ----------
Total deposits........ 3,641,803 1,274,626 288,853 -- -- 5,205,282
Borrowings............. 301,471 17,744 101,100 431,000 -- 851,315
---------- ----------- -------- --------- -------- ----------
Total deposits and
borrowings........... $3,943,274 $ 1,292,370 $389,953 $ 431,000 $ -- $6,056,597
========== =========== ======== ========= ======== ==========
Excess (shortfall) of
interest-earning assets
over interest-bearing
liabilities............ $1,293,988 $(1,035,442) $252,092 $(317,173) $ 63,875 $ 257,340
Cumulative gap.......... 1,293,988 258,546 510,638 193,465 257,340
Cumulative gap--as a %
of total assets:
March 31, 1999......... 19.62% 3.92% 7.74% 2.93% 3.90%
December 31, 1998...... 23.84 7.48 9.07 3.40 4.00
March 31, 1998......... 25.50 2.57 2.70 3.65 4.07
</TABLE>
- -------
(1) Based upon contractual maturity and repricing date.
(2) Based upon contractual maturity, repricing date and projected repayment
and prepayments of principal.
(3) Subject to immediate repricing.
40
<PAGE>
Our six-month gap at March 31, 1999, was a positive 19.62%. This means that
more interest-earning assets reprice within six months than interest-bearing
liabilities. This compares to a positive six-month gap of 23.84% at
December 31, 1998, and 25.50% at March 31, 1998. We continue to pursue our
strategy of emphasizing the origination of adjustable rate mortgages. For the
twelve months ended March 31, 1999, we originated and purchased for investment
$2.0 billion of adjustable rate loans and mortgage-backed securities which
represented approximately 80% of all loans and mortgage-backed securities we
originated and purchased for investment during the period.
At March 31, 1999, 97% of our interest-earning assets mature, reprice or are
estimated to prepay within five years, down slightly from 98% at both December
31, 1998 and March 31, 1998. At March 31, 1999, loans and mortgage-backed
securities with adjustable interest rates represented 79% of our loans and
mortgage-backed securities portfolios. During the first quarter of 1999, we
continued to offer residential fixed rate loan products to our customers
primarily for sale in the secondary market. We price and originate fixed rate
mortgage loans for sale into the secondary market to increase opportunities
for originating adjustable rate mortgages and generate fee and servicing
income. We also originate fixed rate loans for portfolio to facilitate the
sale of real estate acquired in settlement of loans and which meet specific
yield and other approved guidelines.
At March 31, 1999, $5.3 billion or 86% of our total loan portfolio,
including mortgage-backed securities, consisted of adjustable rate loans,
construction loans, and loans with a due date of five years or less, compared
to $5.0 billion or 92% at December 31, 1998, and $5.1 billion or 92% at March
31, 1998.
The following table sets forth on a consolidated basis the interest rate
spread on our interest-earning assets and interest-bearing liabilities as of
the dates indicated.
<TABLE>
<CAPTION>
March 31, December 31, September 30, June 30, March 31,
1999 1998 1998 1998 1998
--------- ------------ ------------- -------- ---------
<S> <C> <C> <C> <C> <C>
Weighted average yield:
Loans and mortgage-
backed securities.... 7.59% 7.72% 7.82% 7.91% 7.94%
FHLB stock............ 5.29 5.44 5.86 5.88 5.89
Investment
securities........... 5.61 5.40 5.77 5.81 5.83
---- ---- ---- ---- ----
Earning assets
yield.............. 7.52 7.65 7.73 7.82 7.86
---- ---- ---- ---- ----
Weighted average cost:
Deposits.............. 4.40 4.53 4.81 4.93 4.96
Borrowings:
FHLB advances....... 5.30 5.47 5.85 6.18 6.17
Other borrowings.... 8.70 8.69 8.36 6.56 6.19
---- ---- ---- ---- ----
Combined borrowings... 5.33 5.51 6.00 6.26 6.17
---- ---- ---- ---- ----
Combined funds........ 4.53 4.66 4.86 4.97 5.02
---- ---- ---- ---- ----
Interest rate spread.... 2.99% 2.99% 2.87% 2.85% 2.84%
==== ==== ==== ==== ====
</TABLE>
The period end weighted average yield on our loan and mortgage-backed
securities portfolios at March 31, 1999, was 7.59%, down from 7.72% at
December 31, 1998, and 7.94% at March 31, 1998. At March 31, 1999, our single
family adjustable rate mortgage portfolio, including mortgage-backed
securities, totaled $4.6 billion with a weighted average rate of 7.35%,
compared to $4.3 billion with a weighted average rate of 7.53% at December 31,
1998, and $4.4 billion with a weighted average rate of 7.65% at March 31,
1998.
41
<PAGE>
Problem Loans and Real Estate
Non-Performing Assets
Non-performing assets consist of loans on which we have ceased the accrual
of interest, which we refer to as non-accrual loans, and real estate acquired
in settlement of loans. Non-performing assets increased during the quarter by
$3 million to $30 million at March 31, 1999 or 0.46% of total assets. The
increase primarily occurred in single family subprime credits, which totaled
0.58% of these loans. Non-performing assets at quarter end include non-accrual
loans aggregating $1 million which were not contractually past due, but were
deemed non-accrual due to our assessment of the borrower's ability to pay.
The following table summarizes our non-performing assets at the dates
indicated.
<TABLE>
<CAPTION>
March 31, December 31, September 30, June 30, March 31,
1999 1998 1998 1998 1998
--------- ------------ ------------- -------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Non-accrual loans:
Residential, one-to-
four units........... $16,579 $15,571 $15,397 $19,047 $17,736
Residential, one-to-
four units--
subprime............. 4,379 1,975 2,479 1,107 832
Other................. 4,127 4,829 20,677 20,259 20,060
------- ------- ------- ------- -------
Total non-accrual
loans.............. 25,085 22,375 38,553 40,413 38,628
Real estate acquired in
settlement of loans.... 4,686 4,475 5,423 7,576 10,414
Repossessed
automobiles............ 319 569 611 764 688
------- ------- ------- ------- -------
Gross non-performing
assets............. $30,090 $27,419 $44,587 $48,753 $49,730
======= ======= ======= ======= =======
Allowance for loan
losses (1):
Amount................ $32,586 $31,517 $31,444 $31,736 $31,817
As a percentage of
non-performing
loans................ 129.90% 140.86% 81.56% 78.53% 82.37%
Non-performing assets as
a percentage of total
assets................. 0.46 0.44 0.75 0.84 0.85
</TABLE>
- --------
(1) Allowance for loan losses does not include the allowance for real estate
and real estate acquired in settlement of loans.
At March 31, 1999, the recorded investment in loans for which we recognized
impairment totaled $13 million. The total allowance for possible losses
related to these loans was $1 million. During the first quarter of 1999, total
interest recognized on the impaired loan portfolio was $0.5 million.
Delinquent Loans
During the 1999 first quarter, our delinquencies decreased by $2 million or
4.9%. The decrease occurred primarily in our one-to-four unit residential and
automobile categories, which both declined by $2 million. An increase in the
one-to-four units subprime category of $3 million partially offset those
declines, with total subprime delinquencies equaling 0.64% of related loans.
As a percentage of total loans outstanding, total delinquencies were 0.58% at
the end of the 1999 first quarter, compared to 0.65% at year-end 1998 and
0.78% a year ago.
42
<PAGE>
The following table indicates the amounts of our past due loans at the dates
indicated.
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
---------------------------------- ----------------------------------
30-59 60-89 90+ 30-59 60-89 90+
Days Days Days (1) Total Days Days Days (1) Total
------- ------ -------- ------- ------- ------ -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real
estate:
Residential:
One-to-four units...... $ 8,463 $4,700 $13,180 $26,343 $ 9,841 $6,014 $12,832 $28,687
One-to-four units--
subprime.............. 1,177 2,281 1,385 4,843 244 784 947 1,975
Five or more units..... -- -- -- -- -- -- 155 155
Commercial real
estate................ -- -- -- -- -- -- -- --
Construction........... -- -- -- -- -- -- -- --
Land................... -- -- -- -- -- -- -- --
------- ------ ------- ------- ------- ------ ------- -------
Total real estate
loans................ 9,640 6,981 14,565 31,186 10,085 6,798 13,934 30,817
Non-mortgage:
Commercial............. -- -- -- -- -- -- -- --
Automobile............. 3,248 383 1,000 4,631 4,650 888 1,048 6,586
Other consumer......... 144 76 226 446 334 45 344 723
------- ------ ------- ------- ------- ------ ------- -------
Total loans........... $13,032 $7,440 $15,791 $36,263 $15,069 $7,731 $15,326 $38,126
======= ====== ======= ======= ======= ====== ======= =======
Delinquencies as a
percentage of total
loans.................. 0.21% 0.12% 0.25% 0.58% 0.26% 0.13% 0.26% 0.65%
<CAPTION>
September 30, 1998 June 30, 1998
---------------------------------- ----------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real
estate:
Residential:
One-to-four units...... $10,601 $4,302 $12,408 $27,311 $12,500 $5,271 $14,497 $32,268
One-to-four units--
subprime.............. 741 1,334 505 2,580 535 -- 762 1,297
Five or more units..... 155 -- -- 155 -- -- -- --
Commercial real
estate................ -- -- -- -- -- -- -- --
Construction........... -- -- -- -- -- -- -- --
Land................... -- -- -- -- -- -- -- --
------- ------ ------- ------- ------- ------ ------- -------
Total real estate
loans................ 11,497 5,636 12,913 30,046 13,035 5,271 15,259 33,565
Non-mortgage:
Commercial............. -- -- -- -- -- -- -- --
Automobile............. 5,330 1,105 990 7,425 4,795 860 819 6,474
Other consumer......... 119 143 496 758 222 208 227 657
------- ------ ------- ------- ------- ------ ------- -------
Total loans........... $16,946 $6,884 $14,399 $38,229 $18,052 $6,339 $16,305 $40,696
======= ====== ======= ======= ======= ====== ======= =======
Delinquencies as a
percentage of total
loans.................. 0.31% 0.13% 0.26% 0.70% 0.34% 0.12% 0.30% 0.76%
<CAPTION>
March 31, 1998
----------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real
estate:
Residential:
One-to-four units...... $14,532 $6,096 $14,487 $35,115
One-to-four units--
subprime.............. 287 359 186 832
Five or more units..... 222 -- -- 222
Commercial real
estate................ 241 -- -- 241
Construction........... -- -- -- --
Land................... -- -- -- --
------- ------ ------- -------
Total real estate
loans................ 15,282 6,455 14,673 36,410
Non-mortgage:
Commercial............. -- -- -- --
Automobile............. 4,005 946 716 5,667
Other consumer......... 73 57 457 587
------- ------ ------- -------
Total loans........... $19,360 $7,458 $15,846 $42,664
======= ====== ======= =======
Delinquencies as a
percentage of total
loans.................. 0.35% 0.14% 0.29% 0.78%
</TABLE>
- --------
(1) All 90 day or greater delinquencies are on non-accrual status and reported
as part of non-performing assets.
43
<PAGE>
Allowance for Losses on Loans and Real Estate
We establish valuation allowances for losses on loans and real estate on a
specific and general basis. We determine specific allowances based on the
difference between the carrying value of the asset and our net fair value. We
determine general valuation allowances based on historical loss experience,
current and anticipated levels and trends of delinquent and non-performing
loans and the economic environment in our market areas.
Allowances for losses on all assets were $41 million at March 31, 1999, $40
million at December 31, 1998 and $51 million at March 31, 1998.
Our total allowance for possible loan losses was $33 million at March 31,
1999, compared to $32 million at both December 31, 1998, and at March 31,
1998. Included in our current quarter-end total allowance was $32 million of
general loan valuation allowances, of which $3 million represents an
unallocated portion. These general loan valuation allowances may be included
as a component of risk-based capital, up to a maximum of 1.25% of our risk-
weighted assets. Net charge-offs totaled $1.3 million in the 1999 first
quarter, compared to $0.5 million in the year-ago quarter. The year-ago
quarter included a $1.4 million recovery from the previously mentioned
settlement. Adjusting year-ago results to exclude that recovery, net charge-
offs would have been down $0.6 million between first quarters. Included in the
current quarter net charge-offs were $0.1 million associated with one-to-four
unit residential loans and $1.2 million associated with automobile loans.
The following table is a summary of the activity of our allowance for loan
losses for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
--------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
1999 1998 1998 1998 1998
--------- ------------ ------------- -------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of
period................. $31,517 $31,444 $31,736 $31,817 $32,092
Provision............... 2,381 1,180 985 1,462 272
Charge-offs............. (1,520) (1,574) (1,540) (1,877) (2,381)
Recoveries (1).......... 208 467 263 334 1,834
------- ------- ------- ------- -------
Balance at end of
period................. $32,586 $31,517 $31,444 $31,736 $31,817
======= ======= ======= ======= =======
</TABLE>
- --------
(1) The first quarter of 1998 includes a $1.4 million recovery of a prior
commercial real estate loan charge-off due to the previously mentioned
settlement.
44
<PAGE>
The following table indicates our allocation of the total valuation allowance
for loan losses to the various categories of loans for the dates indicated.
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998 September 30, 1998
------------------------------- ------------------------------- -------------------------------
Gross Allowance Gross Allowance Gross Allowance
Loan Percentage Loan Percentage Loan Percentage
Portfolio to Loan Portfolio to Loan Portfolio to Loan
Allowance Balance Balance Allowance Balance Balance Allowance Balance Balance
--------- ---------- ---------- --------- ---------- ---------- --------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real
estate:
Residential:
One-to-four units..... $15,735 $5,064,684 0.31% $14,299 $4,636,133 0.31% $13,603 $4,413,757 0.31%
Five or more units.... 299 26,420 1.13 401 40,029 1.00 409 41,143 0.99
Commercial real
estate............... 2,729 151,247 1.80 2,632 140,790 1.87 3,656 156,902 2.33
Construction.......... 1,732 147,246 1.18 1,508 127,761 1.18 1,087 92,779 1.17
Land.................. 944 74,959 1.26 568 44,859 1.27 498 39,222 1.27
Non-Mortgage:
Commercial............ 202 28,182 0.72 218 28,293 0.77 204 27,710 0.74
Automobile............ 7,566 363,168 2.08 8,344 357,988 2.33 8,349 355,955 2.35
Other consumer........ 579 40,607 1.43 747 41,894 1.78 838 44,026 1.90
Not specifically
allocated............. 2,800 -- -- 2,800 -- -- 2,800 -- --
------- ---------- ---- ------- ---------- ---- ------- ---------- ----
Total loans held for
investment.......... $32,586 $5,896,513 0.55% $31,517 $5,417,747 0.58% $31,444 $5,171,494 0.61%
======= ========== ==== ======= ========== ==== ======= ========== ====
<CAPTION>
June 30, 1998 March 31, 1998
------------------------------- -------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real
estate:
Residential:
One-to-four units..... $14,143 $4,426,563 0.32% $13,960 $4,496,768 0.31%
Five or more units.... 309 27,736 1.11 399 38,877 1.03
Commercial real
estate............... 3,766 161,424 2.33 4,118 191,489 2.15
Construction.......... 1,137 95,664 1.19 1,072 89,989 1.19
Land.................. 382 29,857 1.28 415 32,510 1.28
Non-mortgage:
Commercial............ 199 27,298 0.73 192 25,478 0.75
Automobile............ 8,272 356,504 2.32 8,105 350,316 2.31
Other consumer........ 728 44,530 1.63 756 45,529 1.66
Not specifically
allocated............. 2,800 -- -- 2,800 -- --
------- ---------- ---- ------- ---------- ----
Total loans held for
investment.......... $31,736 $5,169,576 0.61% $31,817 $5,270,956 0.60%
======= ========== ==== ======= ========== ====
</TABLE>
The following table is a summary of the activity of our allowance for real
estate held for investment for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
--------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
1999 1998 1998 1998 1998
--------- ------------ ------------- -------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of
period................. $7,717 $8,151 $ 9,558 $18,140 $21,244
Provision (reduction)... 53 (214) (139) (2,221) (2,722)
Charge-offs............. -- (220) (1,268) (6,361) (382)
Recoveries.............. -- -- -- -- --
------ ------ ------- ------- -------
Balance at end of
period................. $7,770 $7,717 $ 8,151 $ 9,558 $18,140
====== ====== ======= ======= =======
</TABLE>
45
<PAGE>
In addition to losses charged against the allowance for loan losses, we have
recorded losses on real estate acquired in settlement of loans by direct
write-off to net operations of real estate acquired in settlement of loans and
against an allowance for losses specifically established for these assets. The
following table is a summary of the activity of our allowance for real estate
acquired in settlement of loans for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
1999 1998 1998 1998 1998
--------- ------------ ------------- -------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of
period................. $533 $582 $ 671 $ 898 $ 839
Provision (reduction)... 26 (14) 160 5 304
Charge-offs............. (12) (35) (249) (232) (245)
Recoveries.............. -- -- -- -- --
---- ---- ----- ----- -----
Balance at end of
period................. $547 $533 $ 582 $ 671 $ 898
==== ==== ===== ===== =====
</TABLE>
See "Financial Condition for the Year Ended December 31, 1998--Problem Loans
and Real Estate--Allowance for Losses on Loans and Real Estate" for further
information as to how we establish valuation allowances.
Capital Resources and Liquidity
Our primary sources of funds generated in the first quarter of 1999 were
principal repayments, including prepayments, but excluding our refinances on
loans and mortgage-backed securities held for investment and available for
sale of $387 million and net increases in our deposits of $166 million and
borrowings of $148 million. In addition, loans held for sale declined by $137
million.
We used these funds primarily to originate loans held for investment of $855
million, net of our refinances of $52 million.
At March 31, 1999 and December 31, 1998, the Bank's ratio of regulatory
liquidity was 4.0%, compared to 4.6% at March 31, 1998.
Stockholders' equity totaled $490 million at March 31, 1999, compared to
$481 million at December 31, 1998, and $446 million at March 31, 1998.
Regulatory Capital Compliance
The following table is a reconciliation of the Bank's stockholder's equity
to federal regulatory capital as of March 31, 1999. The core and tangible
capital ratios were 6.63% and the risk-based capital ratio was 12.49%. The
Bank's capital ratios exceed the "well capitalized" standards of 5% for core
and 10% for risk-based, as defined by regulation.
46
<PAGE>
<TABLE>
<CAPTION>
Tangible Capital Core Capital Risk-Based Capital
------------------- --------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ------- -------- ----- ---------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Stockholder's equity.... $ 480,040 $480,040 $ 480,040
Adjustments:
Deductions:
Investment in
subsidiary, primarily
real estate........... (42,477) (42,477) (42,477)
Goodwill............... (4,425) (4,425) (4,425)
Non-permitted mortgage
servicing rights...... (1,571) (1,571) (1,571)
Additions:
Unrealized gains on
securities available
for sale.............. (305) (305) (305)
General loss
allowance--investment
in DSL
Service Company....... 1,451 1,451 1,451
Loan general valuation
allowances (1)........ -- -- 32,164
---------- ------ -------- ---- ---------- -------
Regulatory capital...... 432,713 6.63% 432,713 6.63% 464,877 12.49%
Well capitalized
requirement............ 97,898 1.50 (2) 326,327 5.00 372,277 10.00 (3)
---------- ------ -------- ---- ---------- -------
Excess.................. $ 334,815 5.13% $106,386 1.63% $ 92,600 2.49%
========== ====== ======== ==== ========== =======
</TABLE>
- --------
(1) Limited to 1.25% of risk-weighted assets.
(2) Represents the minimum requirement for tangible capital, as no "well
capitalized" requirement has been established for this category.
(3) A third requirement is Tier 1 capital to risk-weighted assets of 6%, which
the Bank met and exceeded with a ratio of 11.62%.
Year 2000
Risks of the Year 2000 Issue
The year 2000 issue is the result of computer programs being written using
two digits rather than four digits to represent the calendar year--e.g., "99"
for "1999". Software so developed, and not corrected, could produce inaccurate
or unpredictable results or system failures commencing January 1, 2000, when
dates present a lower two digit year number than dates in the prior century.
These occurrences may have a material adverse effect on our financial
condition, results of operations, business or business prospects, as Downey,
like most financial organizations, is significantly impacted by the potential
year 2000 issue due to the nature of financial information. Potential impacts
to us may arise from software, computer hardware, and other equipment both
within our direct control and outside our ownership, yet with which we
electronically or operationally interface. Financial institution regulators
have intensively focused upon year 2000 exposures, issuing guidance concerning
the responsibilities of management and the board of directors. Year 2000
testing and certification is being addressed as a key safety and soundness
issue in conjunction with regulatory exams and the OTS has authority to bring
enforcement actions against any institution under its supervision which it
believes is not properly addressing year 2000 compliance issues.
State of Readiness
We have established a four-phase process to address the year 2000 issue. In
addition, our board of directors oversees the year 2000 compliance project's
progress through monthly status reports and quarterly reviews with the year
2000 project manager.
47
<PAGE>
As part of the first phase, which is now completed, we inventoried all of
our data systems to determine which are most critical to support customer
transaction processing and provide customer services. This inventory not only
included in-house systems, but those third party vendors provide as well. We
prioritized systems as being:
. mission critical;
. high risk;
. moderate risk; or
. low risk.
From this system we developed modification plans which place priority
emphasis on those systems requiring change and classified mission critical or
high risk. We contacted third party vendors during this phase to determine
their process and timeline in correcting any year 2000 compliance issues. In
addition, we also contacted our commercial loan borrowers to determine the
extent of their preparations for year 2000 and any potential impact year 2000
may have on their businesses and ability to repay loan obligations to us.
Commercial lending does not represent a significant portion of our loan
portfolio--i.e., approximately 0.3%; therefore, we believe the year 2000
preparedness of our commercial loan borrowers does not pose a significant
risk.
Phase two of the process consists of making appropriate year 2000
programming changes to our in-house systems, while phase three consists of
acceptance testing and sign-off of both our in-house and vendor provided
systems. The fourth and final phase of the year 2000 compliance project
includes installation of the system modifications into our daily operation.
The fourth phase is scheduled to occur once a system has been successfully
tested and determined to be year 2000 compliant.
By the end of 1998, we completed programming and substantially completed
acceptance testing for our in-house mainframe system. At the end of first
quarter 1999, we completed acceptance testing and installation of the in-house
mainframe system, which performs all significant loan, deposit, and general
ledger accounting processes.
For our developed PC-based systems classified mission critical, we have
completed all programming changes and acceptance testing. We expect to
complete programming and acceptance testing of all other of our developed PC-
based systems by the end of second quarter 1999, as well as the installation
of year 2000 modifications.
The timing of year 2000 acceptance testing and installation of all third
party vendor changes is dependent upon when their systems become available to
us. We have in place a process to monitor third party vendor progress in
making required year 2000 corrections and, when completed, this process
requires third party vendors to represent that their systems are year 2000
compliant. Although we request vendor representations, we do not intend to
rely solely upon them. Rather, we intend to test vendor programs or review
testing conducted by others for year 2000 compliance.
In addition to the computer systems utilized by us, we have also inventoried
other essential services that year 2000 issues may impact like
telecommunications and utilities. We are monitoring these essential service
providers to determine their progress and how they are addressing year 2000
issues. To date, no information exists to suggest these essential services
will not be year 2000 compliant.
Costs to Address the Year 2000 Issue
Currently, we estimate that year 2000 project costs will approximate $6.5
million. This cost is in addition to existing personnel who are working on the
year 2000 compliance project and includes estimates for hardware and software
renovation or replacement, as well as additions to existing staff who will be
specifically devoted to the project. Approximately 50% of the year 2000
compliance project cost represents costs to migrate to a new personal computer
environment and to replace specific older automated teller machines, both of
which we might
48
<PAGE>
otherwise have implemented or replaced during the period notwithstanding the
year 2000 issue. Thus, that portion of year 2000 costs will be amortized over
the useful life of the equipment. Of the estimated total expense,
approximately $2.4 million has been incurred to date, $0.1 million in 1997,
$1.8 million in 1998 and $0.5 million during the first three months of 1999.
The table below summarizes by year the estimated amount and anticipated timing
of the planned year 2000 expense.
<TABLE>
<CAPTION>
1997 1998 1999 2000 Thereafter Total
---- ---- ---- ---- ---------- -----
(In Millions)
<S> <C> <C> <C> <C> <C> <C>
Estimated year 2000 expense............... $0.1 $1.8 $2.8 $1.0 $0.8 $6.5
</TABLE>
As we progress in addressing the year 2000 compliance project and additional
information becomes available, estimates of costs could change. At this time,
no significant data system projects have been delayed as a result of our year
2000 compliance effort.
Contingency Plans
We believe our year 2000 compliance project should enable us to be
successful in modifying our computer systems to be year 2000 compliant. As
previously stated, we completed acceptance testing and installation with
respect to our in-house mainframe system which performs all significant loan,
deposit and general ledger accounting processes by the end of first quarter
1999. In addition to year 2000 compliance system modification plans, we have
also developed contingency plans for all other systems classified as mission
critical and high risk. Our contingency plans provide timetables to pursue
various alternatives based upon the failure of a system to be adequately
modified or sufficiently tested and validated to ensure year 2000 compliance.
However, there can be no assurance that either the compliance process or our
contingency plans will avoid partial or total system interruptions or the
costs necessary to update hardware and software would not have a material
adverse effect upon our financial condition, results of operation, business or
business prospects.
49
<PAGE>
OVERVIEW FOR THE YEAR ENDED DECEMBER 31, 1998
Our income for 1998 totaled a record $58.0 million or $2.05 per share on a
diluted basis, up 28.2% from the prior year's $45.2 million or $1.61 per
share.
The settlement of litigation regarding obligations of a prior joint venture
partner benefited net income in 1998 by $4.8 million. The pre-tax amount
totaled $8.4 million and was comprised of the following items:
. $1.4 million represented the recovery of a prior loan charge-off thereby
reducing provision for loan losses;
. $4.4 million in income from real estate and joint venture operations of
which $4.3 million was a reduction of loss;
. $1.0 million in miscellaneous other income; and
. $1.6 million as a reduction to professional fees within general and
administrative expense.
Excluding the settlement, 1998 net income would have been $53.2 million or
$1.89 per share on a diluted basis, up 17.7% from the prior year.
The increase in 1998 adjusted net income primarily reflected higher net
interest income. Net interest income increased $20.2 million or 13.1% due to
increases in both average earning assets and the effective interest spread. An
adjusted $6.8 million increase in other income and declines of $3.3 million in
adjusted provision for loan losses and $1.0 million in net operation of real
estate acquired in satisfaction of loans also contributed to the increase in
net income between years. The increase in adjusted other income reflected
increases of $4.7 million in loan and deposit related fees, $3.8 million in
net gains on sales of loans, and $3.7 million in adjusted income from real
estate held for investment. Those favorable other income items were partially
offset by declines of $4.5 million in the all other category, as 1997 included
a gain from the sale of an asset obtained as part of the 1988 acquisition of
Butterfield Savings, and a $1.0 million decline in loan servicing fees
primarily due to additions made to the valuation allowance for mortgage
servicing rights. Higher general and administrative expense partially offset
the favorable impact of higher net interest and other income, and lower
provision for loan losses and cost of net operation of real estate acquired in
settlement of loans. The $17.9 million adjusted increase in general and
administrative expense reflected significantly higher lending volumes, branch
expansion and expense related to resolving year 2000 compliance issues.
Assets increased $435 million or 7.4% during 1998 to $6.3 billion at year
end, following a 12.3% increase during 1997. Asset growth slowed in 1998 even
though our loan originations reached a record level, as the low interest rate
environment prevalent during the year resulted in a high level of loan
prepayments as borrowers refinanced into low, fixed rate loans. Single family
loan originations increased from $2.0 billion in 1997 to $3.7 billion in 1998,
of which we originated $2.2 billion for sale in the secondary market. In
addition to single family loans, we originated $396 million of other loans,
including $175 million of auto loans and $160 million of construction and land
loans.
Our asset growth was funded by an increase of $220 million in borrowings,
primarily long-term FHLB advances, and $170 million in deposits. Deposits
totaled $5.0 billion at December 31, 1998, up 3.5% from year-end 1997.
Non-performing assets totaled $27 million or 0.44% of assets at December 31,
1998, down from $52 million or 0.89% of assets at December 31, 1997. The
decline in our non-performing assets was primarily in the commercial real
estate loan category, as we returned several loans to accrual status following
an extended period of satisfactory payment performance. We perform a detailed
review of all criticized, classified, watch and non-performing assets at least
semi-annually. We review all assets greater than $1 million annually. The
combined provisions for loan and real estate losses, including real estate
held for investment and acquired in settlement of loans, resulted in a $0.9
million reduction of expense for 1998, primarily due to the aforementioned
settlement, which included $5.7 million of settlement proceeds as a reduction
to the provision for losses. Excluding this
50
<PAGE>
item, the combined provisions would have been $4.7 million in 1998, $6.6
million in 1997 and $7.5 million in 1996.
At December 31, 1998, the Bank met and exceeded all three regulatory capital
tests, with capital-to-asset ratios of 6.83% in tangible and core capital and
12.88% in risk-based capital. These capital levels are well above the "well
capitalized" standards defined by the federal banking regulators of 5% for
core and tangible capital and 10% for risk-based capital. For further
information, see "Business--Regulation--Regulation of the Bank--Insurance of
Deposit Accounts," "Financial Condition for the Year Ended December 31, 1998--
Investments in Real Estate and Joint Ventures" and "Regulatory Capital
Compliance."
51
<PAGE>
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
Net Interest Income
Net interest income is the difference between the interest and dividends
earned on loans, mortgage-backed securities and investment securities--
"interest-earning assets"--and the interest paid on deposits and borrowings--
"interest-bearing liabilities." The spread between the yield on interest-
earning assets and the cost of interest-bearing liabilities and the relative
dollar amounts of these assets and liabilities principally affects net
interest income.
Our net interest income was $174.3 million in 1998, up $20.2 million or
13.1% from 1997 and $39.8 million or 29.5% greater than 1996. The 1998
improvement over 1997 primarily reflected increases in both average earning
assets and the effective interest rate spread. Average earning assets
increased by $217 million or 4.0% to $5.7 billion. The effective interest rate
spread averaged 3.08% in 1998, up from 2.83% in 1997 and 2.96% in 1996. The
1998 effective interest rate spread improved over 1997 as our yield on earning
assets increased 6 basis points, while our cost of funding those earnings
assets declined by 16 basis points.
The following table presents for the periods indicated the total dollar
amount of:
. interest income from average interest-earning assets and the resultant
yields; and
. interest expense on average interest-bearing liabilities and the
resultant costs, expressed as rates.
The table also sets forth the net interest income, the interest rate spread
and the effective interest rate spread. The effective interest rate spread
reflects the relative level of interest-earning assets to interest-bearing
liabilities and equals:
. the difference between interest income on interest-earning assets and
interest expense on interest-bearing liabilities, divided by
. average interest-earning assets for the period.
52
<PAGE>
The table also sets forth the net earning balance--the difference between
the average balance of interest-earning assets and the average balance of
interest-bearing liabilities--for the periods indicated. We include non-
accrual loans in the average interest-earning assets balance. We include
interest from non-accrual loans in interest income only to the extent that we
received payments and to the extent that we believe we will recover the
remaining principal balance of the loan. We computed average balances using
the average of each month's daily average balance during the period indicated.
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------- --------------------------- ---------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
---------- -------- ------- ---------- -------- ------- ---------- -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans.................. $5,345,380 $421,942 7.89% $5,174,767 $404,081 7.81% $4,269,136 $329,746 7.72%
Mortgage-backed
securities............ 42,075 2,780 6.61 55,045 3,633 6.60 64,957 4,317 6.65
Investment securities.. 276,139 15,682 5.68 217,272 12,704 5.85 215,364 12,297 5.71
---------- -------- ---- ---------- -------- ---- ---------- -------- ----
Total interest-earning
assets................ 5,663,594 440,404 7.78 5,447,084 420,418 7.72 4,549,457 346,360 7.61
Non-interest-earning
assets................. 254,913 246,785 240,191
---------- ---------- ----------
Total assets........... $5,918,507 $5,693,869 $4,789,648
========== ========== ==========
Interest-bearing
liabilities:
Deposits............... $5,102,045 $248,337 4.87% $4,588,320 $227,521 4.96% $3,892,981 $184,402 4.74%
Borrowings............. 292,044 17,720 6.07 638,661 38,739 6.07 457,890 27,363 5.98
---------- -------- ---- ---------- -------- ---- ---------- -------- ----
Total interest-bearing
liabilities........... 5,394,089 266,057 4.93 5,226,981 266,260 5.09 4,350,871 211,765 4.87
Non-interest-bearing
liabilities............ 68,181 58,415 50,590
Stockholders' equity.... 456,237 408,473 388,187
---------- ---------- ----------
Total liabilities and
stockholders' equity.. $5,918,507 $5,693,869 $4,789,648
========== ========== ==========
Net interest
income/interest rate
spread................. $174,347 2.85% $154,158 2.63% $134,595 2.74%
Excess of interest-
earning assets over
interest-bearing
liabilities............ $ 269,505 $ 220,103 $ 198,586
Effective interest rate
spread................. 3.08 2.83 2.96
</TABLE>
53
<PAGE>
Changes in our net interest income are a function of both changes in rates
and changes in volumes of interest-earning assets and interest-bearing
liabilities. The following table sets forth information regarding changes in
our interest income and expense for the years indicated. For each category of
interest-earning asset and interest-bearing liability, we have provided
information on changes attributable to:
. changes in volume--changes in volume multiplied by comparative period
rate;
. changes in rate--changes in rate multiplied by comparative period
volume; and
. changes in rate-volume--changes in rate multiplied by changes in volume.
Interest-earning asset and interest-bearing liability balances used in the
calculations represent average balances computed using the average of each
month's daily average balance during the period indicated.
<TABLE>
<CAPTION>
1998 versus 1997 1997 versus 1996
Changes Due To Changes Due To
----------------------------------- ---------------------------------
Rate/ Rate/
Volume Rate Volume Net Volume Rate Volume Net
-------- ------- ------ -------- ------- ------- ------ -------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Income:
Loans.................. $ 13,322 $ 4,394 $ 145 $ 17,861 $69,951 $ 3,617 $ 767 $74,335
Mortgage-backed
securities............ (856) 4 (1) (853) (659) (30) 5 (684)
Investment securities.. 3,442 (365) (99) 2,978 109 295 3 407
-------- ------- ----- -------- ------- ------- ------ -------
Change in interest
income................ 15,908 4,033 45 19,986 69,401 3,882 775 74,058
-------- ------- ----- -------- ------- ------- ------ -------
Interest Expense:
Deposits............... 25,474 (4,189) (469) 20,816 32,937 8,639 1,543 43,119
Borrowings............. (21,019) -- -- (21,019) 10,801 412 163 11,376
-------- ------- ----- -------- ------- ------- ------ -------
Change in interest
expense............... 4,455 (4,189) (469) (203) 43,738 9,051 1,706 54,495
-------- ------- ----- -------- ------- ------- ------ -------
Change in net interest
income................. $ 11,453 $ 8,222 $ 514 $ 20,189 $25,663 $(5,169) $ (931) $19,563
======== ======= ===== ======== ======= ======= ====== =======
</TABLE>
Provision for Loan Losses
Provision for loan losses was $3.9 million in 1998, down from $8.6 million
in 1997 and $9.1 million in 1996. The decline in provision for loan losses in
1998 reflects a $1.4 million recovery of a prior loan charge-off as a result
of the previously mentioned settlement, as well as less growth in our loan
portfolio than in 1997.
For further information, see "Financial Condition for the Year Ended
December 31, 1998--Problem Loans and Real Estate--Allowance for Losses on
Loans and Real Estate."
Other Income
Other income totaled $47.4 million in 1998, up from $35.2 million in 1997
and $25.2 million in 1996. The increase in 1998 reflected several factors.
Increases of $8.1 million in income from real estate held for investment, $4.7
million in loan and deposit related fees, and $3.8 million in net gains from
the sale of loans and mortgage-backed securities ("MBSs") favorably impacted
other income. Those favorable items were partially offset by declines of $3.5
million in the other category and $1.0 million in loan servicing fees. Below
is a further discussion of the major other income categories.
54
<PAGE>
Loan and Deposit Related Fees
Loan and deposit related fees totaled $15.6 million in 1998, up from $10.9
million in 1997 and $7.4 million in 1996. As depicted in the following table,
our loan related fees increased by $3.4 million in 1998 due primarily to
higher prepayment and wire transfer fees from funding a higher volume of
loans, while our deposit related fees increased by $1.3 million.
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- ------
(In Thousands)
<S> <C> <C> <C>
Loan related fees....................................... $ 7,225 $ 3,837 $2,496
Deposit related fees.................................... 8,420 7,084 4,939
------- ------- ------
Total loan and deposit related fees................... $15,645 $10,921 $7,435
======= ======= ======
</TABLE>
Real Estate and Joint Venture Operations Held for Investment
Income from our real estate and joint venture operations totaled $22.4
million in 1998, up from $14.2 million in 1997 and $8.2 million in 1996. The
table below sets forth the key components comprising income from real estate
and joint venture operations.
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- ------
(In Thousands)
<S> <C> <C> <C>
Operations, net:
Rental operations, net of expenses.................... $ 3,723 $ 2,317 $2,417
Equity in net income from joint ventures.............. 9,203 3,931 55
Interest from joint venture advances.................. 1,584 1,880 2,071
------- ------- ------
Total operations, net............................... 14,510 8,128 4,543
Net gains on sales of wholly owned real estate.......... 2,557 2,904 392
Reduction of losses on real estate and joint ventures... 5,296 3,190 3,306
------- ------- ------
Income from real estate and joint venture
operations......................................... $22,363 $14,222 $8,241
======= ======= ======
</TABLE>
Favorably impacting 1998 was $4.4 million of proceeds from the previously
mentioned settlement, of which we recorded $4.3 million as a recovery of
losses on real estate and joint ventures. The balance of the 1998 increase
primarily reflected higher gains on sale associated with residential and
shopping center joint venture projects, which appears within the category of
equity in net income from joint ventures.
For additional information, see "Financial Condition for the Year Ended
December 31, 1998--Investments in Real Estate and Joint Ventures," "Financial
Condition for the Year Ended December 31, 1998--Problem Loans and Real
Estate--Allowance for Losses on Loans and Real Estate."
Secondary Marketing Activities
Sales of loans and MBSs we originated increased in 1998 to $1.7 billion from
$558 million in 1997 and $167 million in 1996. Net gains associated with loan
and MBS sales totaled $6.5 million in 1998, up from $2.7 million in 1997 and
$1.5 million in 1996. The net gains include $7.3 million in 1998, $1.2 million
in 1997 and $1.0 million in 1996 related to the capitalization of mortgage
servicing rights.
Loan servicing fees from our portfolio of loans serviced for others totaled
$0.3 million for 1998, down from $1.3 million in 1997 and $1.4 million in
1996. The decline in 1998 reflects an addition to the valuation allowance for
mortgage servicing rights due to higher than expected prepayments from the low
interest rate environment that existed during the year. At December 31, 1998,
we serviced $1.0 billion of loans for others, compared to $613 million at
December 31, 1997, and $576 million at December 31, 1996.
55
<PAGE>
Other Category
The all other category of other income totaled $2.6 million in 1998, down
from $6.1 million in 1997 but up from $2.1 million in 1996. We included $1.0
million of proceeds from the previously mentioned settlement in the 1998
total. Excluding that amount, the adjusted decline from 1997 would have been
$4.5 million. That decrease primarily reflects that 1997 included a gain from
the sale of an asset obtained as part of the 1988 acquisition of Butterfield
Savings.
Operating Expenses
Operating expenses totaled $116.7 million in 1998, up from $101.3 million in
1997 and $114.2 million in 1996 which included a one-time SAIF assessment of
$24.6 million. The current year increase was due to higher general and
administrative expense, as the net operation of real estate acquired in
settlement of loans declined by $0.9 million to $0.3 million. General and
administrative expense increased $16.3 million or 16.4% in 1998 due to
significantly higher lending volumes, branch expansion and expense related to
year 2000 costs. Year 2000 related costs totaled $1.8 million for 1998, up
from $0.1 million in 1997. We included a $1.6 million reduction to
professional fees due to proceeds from the previously mentioned settlement
within general and administrative expense in the current year, while we
included $1.4 million of expense associated with the departure of a former
chief executive in the prior year.
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Salaries and related costs......................... $ 66,152 $ 54,366 $ 45,811
Premises and equipment costs....................... 16,834 15,272 12,640
Advertising expense................................ 5,954 6,847 4,071
Professional fees.................................. 2,867 5,113 2,985
SAIF insurance premiums and regulatory
assessments....................................... 3,832 3,439 8,949
Other general and administrative expense........... 20,251 14,519 12,004
-------- -------- --------
Total general and administrative expense......... 115,890 99,556 86,460
SAIF special assessment............................ -- -- 24,644
Net operation of real estate acquired in settlement
of loans.......................................... 260 1,184 2,567
Amortization of excess of cost over fair value of
net assets acquired............................... 510 532 532
-------- -------- --------
Total operating expense.......................... $116,660 $101,272 $114,203
======== ======== ========
</TABLE>
For further information regarding the potential expense impact of the year
2000 compliance issue, see "Financial Condition for the Quarter Ended March
31, 1999--Year 2000."
Provision for Income Taxes
Our effective tax rate for 1998 was 42.7%, similar to 43.1% in 1997 and
43.2% in 1996.
Business Segment Reporting
The previous sections of the Results of Operations for the Year Ended
December 31, 1998 discussed our consolidated results. The purpose of this
section is to present data on the results of operations of our two business
segments--banking and real estate investment. For a description of these
business segments, see "Business."
56
<PAGE>
The following table presents by business segment net income for 1998, 1997
and 1996, followed by a discussion of the results of operations of each
segment.
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(In Thousands)
<S> <C> <C> <C>
Banking.............................................. $46,736 $38,662 $17,191(1)
Real estate investment............................... 11,237 6,572 3,513
------- ------- -------
Total net income................................... $57,973 $45,234 $20,704(1)
======= ======= =======
</TABLE>
- --------
(1) Excluding the SAIF special assessment, net income for banking would have
been $31.2 million and the total would have been $34.7 million.
Banking
Net income from our banking operations totaled $46.7 million in 1998, up
from $38.7 million in 1997 and $17.2 million in 1996. The previously mentioned
settlement benefited net income in 1998 by $1.9 million. Excluding that
amount, 1998 net income would have been $44.8 million, up $6.1 million or
15.8% from a year ago. Adjusting for the settlement, the increase in 1998 net
income primarily reflected higher net interest income. Net interest income
increased $20.2 million or 13.0% due to increases in both average earning
assets and the effective interest rate spread. An adjusted $3.2 million
decline in provision for loan losses and an adjusted $3.0 million increase in
other income also contributed to the increase in net income between years. The
increase in adjusted other income reflected increases in loan and deposit
related fees and net gains on sales of loans, partially offset by a decline in
loan servicing fees and the fact that 1997 results included a gain from the
sale of an asset obtained as part of the 1988 acquisition of Butterfield
Savings. Higher operating expense partially offset the favorable impact of
these items. The $16.0 million adjusted operating expense increase reflected
significantly higher lending volumes, branch expansion and expense related
towards resolving year 2000 compliance issues. The table below sets forth
banking operational results for the periods indicated.
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
(In Thousands)
<S> <C> <C> <C>
Net interest income...................... $ 174,967 $ 154,799 $ 134,808
Provision for loan losses................ 3,918 8,522 9,026
Other income............................. 24,617 20,783 16,956
Operating expense........................ 113,954 98,803 87,275
SAIF special assessment.................. -- -- 24,644
Net intercompany expense................. (107) (357) (574)
---------- ---------- ----------
Income before income tax expense......... 81,605 67,900 30,245
Income tax expense....................... 34,869 29,238 13,054
---------- ---------- ----------
Net income............................. $ 46,736 $ 38,662 $ 17,191(1)
========== ========== ==========
At December 31:
Assets:
Loans.................................. $5,788,365 $5,366,396 $4,729,846
Other.................................. 463,960 449,174 446,975
---------- ---------- ----------
Total assets......................... 6,252,325 5,815,570 5,176,821
---------- ---------- ----------
Equity................................... 480,566 430,346 391,571
</TABLE>
- --------
(1) Excluding the SAIF special assessment, net income would have been $31.2
million.
Real Estate Investment
Net income from our real estate investment operations totaled $11.2 million
in 1998, up from $6.6 million in 1997 and $3.5 million in 1996. The previously
mentioned settlement benefited net income in 1998 by $2.9
57
<PAGE>
million. Adjusting for the settlement, adjusted 1998 net income would have
been $8.3 million, up $1.7 million or 25.8% from 1997. The adjusted increase
primarily reflected higher gains on sale associated with residential and
shopping center joint venture projects which appears in the other income
category. The table below sets forth real estate investment operational
results for the periods indicated.
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(In Thousands)
<S> <C> <C> <C>
Net interest expense................................ $ (620) $ (641) $ (213)
Provision (reduction) for loan losses............... (19) 118 111
Other income........................................ 22,736 14,405 8,243
Operating expense................................... 2,706 2,469 2,284
Net intercompany income............................. 107 357 574
------- ------- -------
Income before income tax expense.................... 19,536 11,534 6,209
Income tax expense.................................. 8,299 4,962 2,696
------- ------- -------
Net income......................................... $11,237 $ 6,572 $ 3,513
======= ======= =======
At December 31:
Assets:
Real estate held for investment................... $49,447 $41,356 $46,498
Other............................................. 11,224 14,455 14,514
------- ------- -------
Total assets.................................... 60,671 55,811 61,012
------- ------- -------
Equity.............................................. 42,577 35,556 39,676
</TABLE>
For a further discussion regarding income from real estate investment, see
"Results of Operations for the Year Ended December 31, 1998--Other Income--
Real Estate and Joint Venture Operations Held For Investment," and for
information regarding related assets see "Financial Condition for the Year
Ended December 31, 1998--Investments in Real Estate and Joint Ventures."
58
<PAGE>
FINANCIAL CONDITION FOR THE YEAR ENDED DECEMBER 31, 1998
Loans and Mortgage-Backed Securities
Loans and mortgage-backed securities, including those we hold for sale,
totaled $5.8 billion, or 92.3% of assets at December 31, 1998. This represents
an increase of $422 million or 7.9% from the $5.4 billion at December 31,
1997. The increase primarily represents a higher level of loans held for sale.
Our loan originations, including loans purchased, totaled a record $4.1
billion in 1998, up from $2.4 billion in 1997 and $1.6 billion in 1996. This
increase primarily reflected an increase in originations of one-to-four unit
residential loans. Due to the low interest rate environment prevalent during
1998, borrower preference for these loans was primarily fixed rate. Therefore,
of the $3.7 billion of one-to-four unit residential loans we originated,
approximately two-thirds or $2.3 billion were fixed rate, all but $198 million
of which we originated for sale in the secondary market. In addition, we
originated $380 million of subprime loans in 1998, up from $221 million in
1997.
The table below presents information regarding interest rates and fees
collected on loans originated during the periods indicated.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
-------- -------- ------- ---- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Average interest rate on new
loans............................ 6.45% 6.04% 6.06% 6.99% 4.94%
Average total loan origination
fees on new loans................ 0.75 0.80 0.79 1.08 0.85
Total loan fees (net of costs) and
discounts (net of premiums)
deferred during the year......... $(30,621) $(11,505) $(4,525) $880 $(7,861)
</TABLE>
We originate one-to-four unit residential adjustable rate mortgages both
with and without loan origination fees. In adjustable rate mortgage
transactions for which we charged no origination fees, we receive a larger
margin over the index to which the loan pricing is tied than in those in which
we charge fees. In addition, a prepayment fee on these loans is generally
required if prepaid within the first three years. This trend towards loans
with no origination fees has generally resulted in deferrable loan origination
costs exceeding loan origination fees except in 1995, which included increases
in interest buydowns, or discounts, on new real estate loans.
Residential one-to-four unit adjustable rate mortgage originations,
including loans purchased, were $1.4 billion during 1998, compared to $1.7
billion in 1997 and $1.1 billion in 1996. Refinancing activities related to
residential one-to-four unit loans, including new loans to refinance loans
which we and other lenders originated, increased during 1998, constituting 71%
of originations during the year compared to 45% during 1997 and 43% during
1996. As market interest rates began to rise in 1994 and 1995, one-to-four
unit residential borrower preference changed from being predominantly
interested in adjustable rate mortgages tied to the one-year constant maturity
Treasury ("CMT") index, a market rate index, to adjustable rate mortgages tied
to COFI, an index which lags the movement in market interest rates. For the
year, 74% of one-to-four unit originations for investment represented monthly
adjusting COFI adjustable rate mortgages which provide for negative
amortization and 11% represented COFI adjustable rate mortgages which reprice
every six months but do not provide for negative amortization, with the
balance represented by a variety of other pricing terms. At December 31, 1998,
$3.0 billion of our one-to-four unit adjustable rate mortgages were subject to
negative amortization of which $47 million represented the amount of negative
amortization added to the unpaid loan balance. For further information, see
"Business--Banking Activities--Lending Activities--Residential Real Estate
Lending."
Our origination of commercial real estate loans, including loans purchased,
totaled $11 million in 1998, compared to $8 million in 1997 and $2 million in
1996. Most of our commercial real estate lending in these years was to
facilitate the sale of real estate investments by the Bank and DSL Service
Company. Originations of loans secured by multi-family properties, including
loans purchased, totaled $15 million in 1998, compared to $6 million in 1997
and $20 million in 1996.
59
<PAGE>
During 1998, we originated $112 million of construction loans, principally
for entry level and first time move-up residential tracts. This compares to
$80 million in 1997 and $72 million in 1996. Our origination of land
development loans totaled $48 million in 1998, compared to $20 million in 1997
and $10 million in 1996.
Originations of non-mortgage commercial loans decreased to $6 million in
1998 from $14 million in 1997. Virtually all of these originations represented
secured loans.
In 1995, we augmented our direct automobile lending program with the
commencement of an indirect lending program through preapproved automobile
dealers to finance consumer purchases of new and used automobiles. These loans
are fixed rate with maturities generally up to five years. Originations of
automobile loans totaled $175 million in 1998, compared to $259 million in
1997 and $201 million in 1996.
60
<PAGE>
The following table sets forth the origination, purchase and sale activity
relating to loans and MBSs during the periods indicated.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
---------- ----------- ---------- --------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Investment Portfolio:
Loans originated:
Loans secured by real
estate:
Residential:
One-to-four units:
Adjustable.......... $ 943,736 $ 1,384,442 $1,026,812 $ 396,111 $1,673,822
Adjustable--
subprime........... 372,286 218,399 33,030 -- --
---------- ----------- ---------- --------- ----------
Total adjustable... 1,316,022 1,602,841 1,059,842 396,111 1,673,822
Fixed............... 192,436 22,265 33,073 13,888 7,411
Fixed--subprime..... 6,020 2,786 545 -- --
Five or more units:
Adjustable.......... 875 4,600 17,409 128 18,385
Fixed............... 13,229 -- 2,253 419 953
---------- ----------- ---------- --------- ----------
Total residential.. 1,528,582 1,632,492 1,113,122 410,546 1,700,571
Commercial real
estate............... 10,363 7,830 1,548 10,629 18,900
Construction.......... 111,534 80,014 71,678 28,931 14,785
Land.................. 48,357 20,295 10,468 12,906 --
Non-mortgage:
Commercial............ 6,376 14,336 11,835 1,115 1,605
Automobile............ 175,193 259,040 200,966 62,234 1,869
Other consumer........ 28,274 25,988 14,226 17,633 39,945
---------- ----------- ---------- --------- ----------
Total loans
originated.......... 1,908,679 2,039,995 1,423,843 543,994 1,777,675
Real estate loans
purchased (1).......... 7,463 35,828 223 44,194 145,117
---------- ----------- ---------- --------- ----------
Total loans originated
and purchased......... 1,916,142 2,075,823 1,424,066 588,188 1,922,792
Loan repayments......... (1,855,157) (1,130,357) (832,713) (538,217) (631,836)
Other net changes (2),
(3).................... (34,145) (319,183) (39,978) (50,544) (38,330)
---------- ----------- ---------- --------- ----------
Net increase (decrease)
in loans held for
investment............ 26,840 626,283 551,375 (573) 1,252,626
---------- ----------- ---------- --------- ----------
Mortgage-backed
securities held to
maturity, net:
Repayments............. -- -- -- (5,588) (11,917)
Transferred to
mortgage-backed
securities available
for sale.............. -- -- -- (33,555) --
---------- ----------- ---------- --------- ----------
Net decrease in
mortgage-backed
securities, net...... -- -- -- (39,143) (11,917)
---------- ----------- ---------- --------- ----------
Net increase
(decrease) in loans
and mortgage-backed
securities held for
investment.......... 26,840 626,283 551,375 (39,716) 1,240,709
---------- ----------- ---------- --------- ----------
Sale Portfolio:
Residential, one-to-four
units:
Originated whole
loans................. 2,162,583 289,271 159,941 93,496 32,421
Loans transferred from
(to) the investment
portfolio (3)......... (3,056) 290,558 1,791 (100) --
Originated whole loans
sold (3).............. (1,130,303) (467,989) (135,426) (80,725) (45,770)
Loans exchanged for
mortgage-backed
securities............ (608,831) (89,522) (26,452) -- --
Other net changes...... (8,111) (83) (48) (10) (16)
---------- ----------- ---------- --------- ----------
Net increase
(decrease) in loans
held for sale........ 412,282 22,235 (194) 12,661 (13,365)
---------- ----------- ---------- --------- ----------
Mortgage-backed
securities, net:
Received in exchange
for loans............. 608,831 89,522 26,452 -- --
Purchased.............. -- -- 30,073 -- 51,138
Transferred from
mortgage-backed
securities held to
maturity.............. -- -- -- 33,555 --
Sold................... (610,113) (89,522) (31,077) (21,372) --
Repayments............. (15,129) (12,560) (15,661) (6,862) (5,263)
Other net changes...... (742) 592 (596) 2,669 (1,789)
---------- ----------- ---------- --------- ----------
Net increase
(decrease) in
mortgage-backed
securities available
for sale............. (17,153) (11,968) 9,191 7,990 44,086
---------- ----------- ---------- --------- ----------
Net increase in loans
and mortgage-backed
securities held for
sale and available
for sale............. 395,129 10,267 8,997 20,651 30,721
---------- ----------- ---------- --------- ----------
Total net increase
(decrease) in loans
and mortgage-backed
securities........... $ 421,969 $ 636,550 $ 560,372 $ (19,065) $1,271,430
========== =========== ========== ========= ==========
</TABLE>
- --------
(1) Primarily one-to-four unit residential loans. We included in 1998 $0.7
million of five or more unit residential loans and $0.6 million of
commercial loans. We included in 1997 $1.3 million of five or more unit
residential loans.
(2) Primarily includes borrowings against and repayments of lines of credit
and construction loans, changes in loss allowances, loans transferred to
real estate acquired in settlement of loans or held for sale portfolio,
and interest capitalized on loans (negative amortization).
(3) Includes $290.5 million of one-to-four unit residential adjustable rate
mortgages transferred from the held for investment portfolio during 1997
and sold servicing released.
61
<PAGE>
The following table sets forth the composition of our loan and mortgage-
backed securities portfolio at the dates indicated. At December 31, 1998,
approximately 99% of our real estate loans were secured by real estate located
in California, principally in Los Angeles, Orange, Santa Clara, San Diego and
San Mateo counties.
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Investment Portfolio:
Loans secured by real
estate:
Residential:
One-to-four units:
Adjustable............ $3,721,728 $4,190,160 $3,840,862 $3,486,774 $3,493,435
Adjustable--
subprime............. 580,232 245,749 32,715 -- --
Fixed................. 325,454 168,315 172,328 169,738 194,845
Fixed--subprime....... 8,719 3,321 543 -- --
---------- ---------- ---------- ---------- ----------
Total one-to-four
units............... 4,636,133 4,607,545 4,046,448 3,656,512 3,688,280
Five or more units:
Adjustable............ 18,617 29,246 43,050 44,438 48,782
Fixed................. 21,412 9,032 13,857 12,883 15,000
Commercial real estate:
Adjustable............. 39,360 87,604 158,656 170,498 178,377
Fixed.................. 101,430 114,821 101,953 100,085 116,041
Construction........... 127,761 70,865 66,651 28,593 11,367
Land................... 44,859 25,687 21,177 21,867 9,822
Non-mortgage:
Commercial............. 28,293 26,024 22,136 12,864 12,975
Automobile............. 357,988 342,326 202,186 56,127 3,028
Other consumer......... 41,894 47,735 47,281 50,945 53,241
---------- ---------- ---------- ---------- ----------
Total loans held for
investment........... 5,417,747 5,360,885 4,723,395 4,154,812 4,136,913
Increase (decrease) for:
Undisbursed loan
funds................. (108,414) (64,884) (49,250) (29,942) (13,872)
Net deferred costs and
premiums.............. 31,021 18,088 11,663 7,412 7,468
Allowance for estimated
loss.................. (31,517) (32,092) (30,094) (27,943) (25,597)
---------- ---------- ---------- ---------- ----------
Total loans held for
investment, net...... 5,308,837 5,281,997 4,655,714 4,104,339 4,104,912
---------- ---------- ---------- ---------- ----------
Mortgage-backed
securities held to
maturity, net:
Adjustable............. -- -- -- -- 19,897
Fixed.................. -- -- -- -- 19,246
---------- ---------- ---------- ---------- ----------
Total mortgage-backed
securities held to
maturity, net........ -- -- -- -- 39,143
---------- ---------- ---------- ---------- ----------
Total loans and
mortgage-backed
securities held for
investment........... 5,308,837 5,281,997 4,655,714 4,104,339 4,144,055
---------- ---------- ---------- ---------- ----------
Sale Portfolio, Net:
Loans held for sale (all
one-to-four units):
Adjustable............. 7,975 1,617 1,145 238 --
Fixed.................. 439,407 33,483 11,720 12,821 398
---------- ---------- ---------- ---------- ----------
Total loans held for
sale................. 447,382 35,100 12,865 13,059 398
Mortgage-backed
securities available
for sale:
Adjustable............. 10,996 17,751 23,620 34,355 44,086
Fixed.................. 21,150 31,548 37,647 17,721 --
---------- ---------- ---------- ---------- ----------
Total mortgage-backed
securities available
for sale............. 32,146 49,299 61,267 52,076 44,086
---------- ---------- ---------- ---------- ----------
Total loans and
mortgage-backed
securities held for
sale and available
for sale............. 479,528 84,399 74,132 65,135 44,484
---------- ---------- ---------- ---------- ----------
Total loans and
mortgage-backed
securities........... $5,788,365 $5,366,396 $4,729,846 $4,169,474 $4,188,539
========== ========== ========== ========== ==========
</TABLE>
62
<PAGE>
The table below sets forth the scheduled contractual maturities of our total
loan and mortgage-backed securities portfolio as of December 31, 1998.
<TABLE>
<CAPTION>
Within 1-2 2-3 3-5 5-10 10-15 Beyond
1 Year Years Years Years Years Years 15 Years Total
-------- -------- -------- -------- -------- -------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real
estate:
Residential:
One-to-four units:
Adjustable (1)........ $ 37,087 $ 39,965 $ 43,067 $ 96,418 $314,646 $457,205 $3,321,547 $4,309,935
Fixed (1)............. 9,520 10,251 11,039 24,687 80,353 116,342 521,388 773,580
Five or more units:
Adjustable............ 310 335 361 809 2,645 3,855 10,302 18,617
Fixed................. 2,908 3,165 3,446 7,834 4,059 -- -- 21,412
Commercial real estate:
Adjustable............ 1,294 1,395 1,505 3,371 11,025 16,067 4,703 39,360
Fixed................. 6,051 6,596 7,191 16,386 55,780 9,426 -- 101,430
Construction--
adjustable............ 127,761 -- -- -- -- -- -- 127,761
Land:
Adjustable............ 32,213 11,399 -- -- -- -- -- 43,612
Fixed................. 60 66 73 170 602 276 -- 1,247
Non-mortgage:
Commercial............. 23,272 1,573 1,727 1,721 -- -- -- 28,293
Automobile............. 85,246 94,025 103,709 75,008 -- -- -- 357,988
Other consumer (2)..... 1,904 2,032 2,168 755 35,035 -- -- 41,894
-------- -------- -------- -------- -------- -------- ---------- ----------
Total loans........... 327,626 170,802 174,286 227,159 504,145 603,171 3,857,940 5,865,129
Mortgage-backed
securities, net........ 693 14,237 594 1,333 4,382 4,553 6,354 32,146
-------- -------- -------- -------- -------- -------- ---------- ----------
Total loans and
mortgage-backed
securities............ $328,319 $185,039 $174,880 $228,492 $508,527 $607,724 $3,864,294 $5,897,275
======== ======== ======== ======== ======== ======== ========== ==========
</TABLE>
- --------
(1) Includes loans held for sale.
(2) Includes home equity line of credit loans which are interest only, with
balances due at the end of the term. All or part of the outstanding
balances may be paid off at any time during the term without penalty.
At December 31, 1998, the maximum amount the Bank could have loaned to any
one borrower, and related entities, under regulatory limits was $75 million,
or $124 million for loans secured by readily marketable collateral, compared
to $67 million or $112 million for loans secured by readily marketable
collateral at December 31, 1997. The Bank does not expect that these
regulatory limitations will adversely impact its proposed lending activities
during 1999.
Investment Securities
The following table sets forth the composition of our investment securities
portfolio at the dates indicated. In the 1995 fourth quarter, we transferred
the held to maturity U.S. Treasury and agency portfolio to available for sale
consistent with the "Guide to Statement 115 on Accounting for Certain
Investments in Debt and Equity Securities" issued by the Financial Accounting
Standards Board.
<TABLE>
<CAPTION>
December 31,
--------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Federal funds.................... $ 33,751 $ 6,095 $ 6,038 $ 7,249 $ 6,112
U.S. Treasury and agency
securities:
Held to maturity................ -- -- -- -- 155,109
Available for sale.............. 116,061 159,398 141,999 164,880 --
Municipal bonds--held to
maturity........................ 6,764 6,885 6,997 7,194 --
-------- -------- -------- -------- --------
Total........................... $156,576 $172,378 $155,034 $179,323 $161,221
======== ======== ======== ======== ========
</TABLE>
63
<PAGE>
As of December 31, 1998, the maturities of our investment securities and the
weighted average yield of those securities were as follows.
<TABLE>
<CAPTION>
After 1 Year
1 Year or Less Through 5 Years After 5 Years Total
---------------- ------------------ --------------- -----------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Amount Yield Amount Yield Amount Yield Amount Yield
------- -------- --------- -------- ------ -------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Federal funds........... $33,751 4.13% $ -- -- % $ -- -- % $ 33,751 4.13%
U.S. Treasury and
agency securities...... -- -- 116,061 5.77 -- -- 116,061 5.77
Municipal bonds (1)..... -- -- -- -- 6,764 5.28 6,764 5.28
------- ---- --------- ---- ------ ---- -------- ----
Total................. $33,751 4.13% $ 116,061 5.77% $6,764 5.28% $156,576 5.40%
======= ==== ========= ==== ====== ==== ======== ====
</TABLE>
- --------
(1) Yield on a fully tax-equivalent basis is 9.26%.
Investments in Real Estate and Joint Ventures
DSL Service Company participates as an owner of, or a partner in, a variety
of real estate development projects, principally retail neighborhood shopping
center developments, most of which are located in California. In addition,
Downey owns one investment in land which it purchased from DSL Service Company
at fair value in 1995. We have completed and substantially leased most of the
real estate development projects--with a weighted average occupancy of 83% for
retail neighborhood shopping centers at December 31, 1998. At December 31,
1998, the Bank had outstanding loans of $47 million to these joint ventures.
In its joint ventures, DSL Service Company is entitled to interest on its
equity invested in the project on a priority basis after third-party debt, and
shares profits and losses with the developer partner, generally on an equal
basis. DSL Service Company has obtained personal guarantees from the
principals of the developer partners in a number of the joint ventures and
generally requires the developer partner to secure any outstanding obligations
to the joint venture, like its portion of operating losses, when the partner
is unable to satisfy its obligations on a current basis. Partnership equity or
deficit accounts are affected by current period results of operations,
additional partner advances, partnership distributions and partnership
liquidations.
As of December 31, 1998, DSL Service Company was involved with five joint
venture partners. Three of these partners were operators of four retail
neighborhood shopping centers, a commercial building, two residential housing
developments and vacant land held for sale. The other two joint venture
partners are separately involved in the development of a new industrial
building and in the rehabilitation of a large apartment complex. DSL Service
Company has ten wholly owned retail neighborhood shopping centers located in
California and Arizona.
The following table sets forth the condensed balance sheets of DSL Service
Company's joint ventures by property type at December 31, 1998, on a
historical cost basis. We included allowances for losses recorded by DSL
Service Company in the following condensed balance sheet. Our internal asset
review process determines these allowances quarterly, see "--Problem Loans and
Real Estate --Allowance for Losses on Loans and Real Estate." To the extent
the fair market value of the real estate assets is less than the carrying
value, then we make a provision to create a valuation allowance for the
difference. If we need a valuation allowance, we reflect it in the investment
accounts for the joint ventures on DSL Service Company's books. Not all of the
joint venture investments have valuation allowances as the fair market value
of the associated property exceeds its carrying value.
64
<PAGE>
<TABLE>
<CAPTION>
Retail
Neighborhood
Shopping Centers Commercial Residential Total
---------------- ---------- ----------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Cash......................... $ 445 $ 351 $ 1,980 $ 2,776
Projects under development... -- 707 17,819 18,526
Completed projects........... 20,913 4,796 5,663 31,372
Other assets................. 2,674 316 519 3,509
------- ------- ------- --------
Total assets............. $24,032 $ 6,170 $25,981 $ 56,183
======= ======= ======= ========
Secured notes payable to the
Bank........................ $25,195 $ 903 $20,446 $ 46,544
Secured notes payable to
others...................... -- 3,633 -- 3,633
Other liabilities............ 4,418 1,936 642 6,996
Equity (deficit):
DSL Service Company (1).... 2,057 464 5,362 7,883
Allowance for losses
recorded by DSL Service
Company................... 19 1,393 -- 1,412
Other partners' (2)........ (7,657) (2,159) (469) (10,285)
------- ------- ------- --------
Total liabilities and
equity.................. $24,032 $ 6,170 $25,981 $ 56,183
======= ======= ======= ========
Number of joint venture
projects.................... 4 3 3 10
</TABLE>
- --------
(1) We include in these amounts interest-bearing joint venture advances with
priority interest payments from joint ventures to DSL Service Company.
(2) The aggregate other partners' deficit of $10 million represents their
equity interest in the accumulated retained earnings (deficit) of the
respective joint ventures. Those results include not only the net profit
on sales and the operating results of the real estate assets, but
depreciation expense and funding costs as well. Except for any secured
financing which has been obtained, DSL Service Company has provided all
other financing. As part of our internal asset review process, the fair
value of the joint venture real estate assets is compared to the secured
notes payable to the Bank and others and DSL Service Company's equity
investment. To the extent the fair value of the real estate assets is less
than the aggregate of those amounts, we make a provision to create a
valuation allowance. Those allowances totaled $1 million at December 31,
1998. At December 31, 1998, the fair value of the real estate assets of
some of the joint venture partnerships in which the other partners' equity
was a deficit exceeded the amount of third party notes and DSL Service
Company's investment thereby eliminating the need for a valuation
allowance since the sale of the real estate would allow DSL Service
Company to realize its investment. Thus, the other partners' deficit of
$10 million exceeds the amount of valuation allowances established of $1
million.
The following table sets forth by property type our wholly owned investments
in real estate and related allowances for losses at December 31, 1998.
<TABLE>
<CAPTION>
Retail
Single Family Neighborhood
Developments Shopping Centers Land Total
------------- ---------------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Wholly owned properties:
Investment in wholly
owned projects......... $ -- $27,434 (1) $20,435 (2) $47,869
Allowance for losses.... -- (1,594) (4,711) (6,305)
----- ------- ------- -------
Net investment in wholly
owned projects........... $ -- $25,840 $15,724 $41,564
===== ======= ======= =======
Number of projects........ -- 10 11 21
</TABLE>
- --------
(1) Includes eight free-standing stores that are part of neighborhood shopping
centers totaling $1 million and which we counted as one project.
(2) Includes five properties totaling $20 million.
65
<PAGE>
Real estate investments entail risks similar to those our construction and
commercial lending activities present. In addition, California courts have
imposed warranty-like responsibility upon developers of new housing for
defects in structure and the housing site, including soil conditions. This
responsibility is not necessarily dependent upon a finding that the developer
was negligent. Owners of real property also may incur liabilities with respect
to environmental matters, including financial responsibility for clean-up of
hazardous waste or other conditions, under various federal and state laws.
Deposits
Our deposits increased $170 million or 3.5% in 1998, and totaled $5.0
billion at December 31, 1998. Transaction accounts--checking, regular passbook
and money market--increased $302 million or 32.3%, while higher-rate
certificates of deposits decreased $132 million or 3.4%. Of the total increase
in our deposits, $49 million was associated with 5 new branches we opened
during 1998. The following table sets forth the amount of deposits by
classification.
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------
1998 1997 1996
------------------- ------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Rate Amount Rate Amount Rate Amount
-------- ---------- -------- ---------- -------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Transaction accounts.... 2.30% $1,238,062 2.15% $ 935,869 2.04% $ 831,598
Certificates of deposit:
Less than 3.00%........ 2.62 25,126 2.64 30,623 2.65 39,061
3.00-3.49.............. 3.01 593 3.02 766 3.03 723
3.50-3.99.............. 3.88 51,474 -- -- 3.99 79
4.00-4.49.............. 4.39 428,316 4.31 60,095 4.39 63,577
4.50-4.99.............. 4.80 668,204 4.87 40,356 4.87 186,576
5.00-5.99.............. 5.53 2,421,333 5.63 2,896,291 5.54 2,489,852
6.00-6.99.............. 6.06 204,065 6.06 901,920 6.17 536,307
7.00 and greater....... 7.24 2,560 7.22 4,058 7.15 25,329
---- ---------- ---- ---------- ---- ----------
Total certificates of
deposit............. 5.26 3,801,671 5.68 3,934,109 5.56 3,341,504
---- ---------- ---- ---------- ---- ----------
Total deposits....... 4.53% $5,039,733 5.00% $4,869,978 4.86% $4,173,102
==== ========== ==== ========== ==== ==========
</TABLE>
The following table shows as of December 31, 1998, certificates of deposit
maturities by interest rate category.
<TABLE>
<CAPTION>
Less
Than 4.00% - 4.50% - 5.00% - 6.00% - 7.00% Percent
4.00% 4.49% 4.99% 5.99% 6.99% And Greater Total (1) of Total
-------- -------- -------- ----------- --------- ----------- ----------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Within 3 months......... $ 72,983 $ 12,948 $131,873 $ 986,573 $ 21,349 $ 215 $ 1,225,941 32.25%
3 to 6 months........... 3,025 138,912 169,456 528,986 117,951 206 958,536 25.21
6 to 12 months.......... 769 245,387 279,597 673,641 35,247 601 1,235,242 32.50
12 to 24 months......... 403 30,618 80,316 184,869 12,165 1,538 309,909 8.15
24 to 36 months......... 3 240 1,388 22,163 5,206 -- 29,000 0.76
36 to 60 months......... 10 31 4,394 24,966 12,002 -- 41,403 1.09
Over 60 months.......... -- 180 1,180 135 145 -- 1,640 0.04
-------- -------- -------- ----------- --------- ------- ----------- ------
$ 77,193 $428,316 $668,204 $ 2,421,333 $ 204,065 $ 2,560 $ 3,801,671 100.00%
======== ======== ======== =========== ========= ======= =========== ======
</TABLE>
- --------
(1) Includes jumbo (over $100,000) certificates of deposit of $443 million
with maturities of 3 months or less, $316 million with maturities of 3 to
6 months and $413 million with maturities of 6 to 12 months, and
$105 million with a remaining term of over 12 months.
Borrowings
At December 31, 1998, borrowings totaled $704 million, compared to $484
million at December 31, 1997 and $595 million at December 31, 1996. The
increase in 1998 occurred as we took advantage of obtaining long-term advances
from the FHLB at attractive borrowing rates. The following table sets forth
information concerning our FHLB advances and other borrowings at the dates
indicated.
66
<PAGE>
<TABLE>
<CAPTION>
December 31,
------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
FHLB advances............... $695,012 $352,458 $386,883 $220,715 $411,800
Other borrowings:
Reverse repurchase
agreements............... -- 34,803 -- 16,099 53,946
Commercial paper.......... -- 83,811 198,113 196,602 197,839
Industrial revenue bonds.. -- -- -- -- 6,421
Real estate notes......... 8,708 12,663 10,349 2,802 4,770
-------- -------- -------- -------- --------
Total borrowings........ $703,720 $483,735 $595,345 $436,218 $674,776
======== ======== ======== ======== ========
Weighted average rate on
borrowings during the
period..................... 6.07% 6.07% 5.98% 6.39% 5.57%
Total borrowings as a
percentage of total
assets..................... 11.22 8.29 11.45 9.37 14.51
</TABLE>
The following table sets forth some information with respect to our short-
term borrowings.
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C>
FHLB advances with original maturities less than
one year:
Balance at end of year......................... $120,000 $214,300 $279,000
Average balance outstanding during the year.... 38,393 328,886 174,380
Maximum amount outstanding at any month-end
during the year............................... 120,000 427,100 279,000
Weighted average interest rate during the
year.......................................... 5.96% 5.83% 5.78%
Weighted average interest rate at the end of
year.......................................... 5.36 5.81 5.70
Securities sold under agreement to repurchase:
Balance at end of year......................... $ -- $ 34,803 $ --
Average balance outstanding during the year.... 1,877 4,029 11,761
Maximum amount outstanding at any month-end
during the year............................... 50,088 34,803 70,015
Weighted average interest rate during the
year.......................................... 5.90% 5.61% 5.19%
Weighted average interest rate at the end of
year.......................................... -- 6.65 --
Commercial paper sold:
Balance at end of year......................... $ -- $ 83,811 $198,113
Average balance outstanding during the year.... 30,589 182,296 174,739
Maximum amount outstanding at any month-end
during the year............................... 103,749 272,818 198,113
Weighted average interest rate during the
year.......................................... 6.32% 5.75% 5.74%
Weighted average interest rate at the end of
year.......................................... -- 5.61 5.45
Total short-term borrowings:
Total average short-term borrowings outstanding
during the year............................... $ 70,859 $515,211 $360,880
Total weighted average rate on borrowings
during the year............................... 6.11% 5.80% 5.74%
</TABLE>
As previously mentioned, we increased our intermediate and long-term
advances from the FHLB during 1998. At year-end, total intermediate and long-
term advances were $575 million, up from $138 million at December 31, 1997.
The weighted average rate on FHLB advances at year-end 1998 was 5.49%. The
following table sets forth the associated maturities at December 31, 1998.
<TABLE>
<CAPTION>
(In Thousands)
<S> <C>
1999.............................................................. $ 43,105
2000.............................................................. 28,796
2001.............................................................. 16,056
2002.............................................................. 55,921
2003.............................................................. 134
Thereafter........................................................ 431,000
--------
Total intermediate and long-term FHLB advances.................. $575,012
========
</TABLE>
67
<PAGE>
Asset/Liability Management and Market Risk
Market risk is the risk of loss from adverse changes in market prices and
interest rates. Our market risk arises primarily from interest rate risk in
our lending and deposit taking activities. This interest rate risk occurs to
the degree that interest-bearing liabilities reprice or mature more rapidly or
on a different basis than interest-earning assets. Since our earnings depend
primarily on our net interest income, which is the difference between the
interest and dividends earned on interest-earning assets and the interest paid
on interest-bearing liabilities, one of our principal objectives is to
actively monitor and manage the effects of adverse changes in interest rates
on net interest income while maintaining asset quality.
Our Asset/Liability Management Committee is responsible for implementing the
interest rate risk management policy which sets forth limits established by
the board of directors on acceptable changes in net interest income and net
portfolio value from specified changes in interest rates. The OTS defines net
portfolio value as the present value of expected net cash flows from existing
assets minus the present value of expected net cash flows from existing
liabilities plus the present value of expected cash flows from existing off-
balance sheet contracts. Our Asset/Liability Management Committee reviews,
among other items, economic conditions, the interest rate outlook, the demand
for loans, the availability of deposits and borrowings, and our current
operating results, liquidity, capital and interest rate exposure. In addition,
our Asset/Liability Management Committee monitors asset and liability
maturities and repricing characteristics on a regular basis and performs
various simulations and other analyses to determine the potential impact of
various business strategies in controlling interest rate risk and the
potential impact of those strategies upon future earnings under various
interest rate scenarios. Based on these reviews, our Asset/Liability
Management Committee formulates a strategy that is intended to implement the
objectives set forth in our business plan without exceeding the net interest
income and net portfolio value limits set forth in the interest rate risk
policy.
One measure of our exposure to differential changes in interest rates
between assets and liabilities is shown in the following table which sets
forth the repricing frequency of our major asset and liability categories as
of December 31, 1998, as well as some information regarding our gap position.
The repricing frequencies have been determined by reference to projected
maturities, based upon contractual maturities as adjusted for scheduled
repayments and "repricing mechanisms"--provisions for changes in the interest
and dividend rates of assets and liabilities. We assume prepayment rates on
substantially all of our loan portfolio based upon our historical loan
prepayment experience and anticipated future prepayments. Repricing mechanisms
on a number of our assets are subject to limitations, like caps on the amount
that interest rates and payments on our loans may adjust, and accordingly,
these assets do not normally respond as completely or rapidly as our
liabilities to changes in market interest rates. The interest rate sensitivity
of our assets and liabilities illustrated in the following table would vary
substantially if we used different assumptions or if actual experience
differed from the assumptions set forth.
68
<PAGE>
<TABLE>
<CAPTION>
December 31, 1998
------------------------------------------------------------------
Within 7-12 2-5 6-10 Over Total
6 Months Months Years Years 10 Years Balance
---------- ----------- -------- --------- -------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Investment securities
and FHLB stock........ (1) $ 89,945 $ -- $116,061 $ -- $ -- $ 206,006
Loans and mortgage-
backed securities:
Mortgage-backed
securities............ (2) 16,261 4,725 10,361 745 54 32,146
Loans secured by real
estate:
Residential:
Adjustable........... (2) 4,227,780 106,498 6,720 -- -- 4,340,998
Fixed................ (2) 483,212 36,636 171,606 68,474 35,688 795,616
Commercial real
estate............... (2) 36,528 9,454 80,983 9,087 1,919 137,971
Construction.......... (2) 46,122 -- -- -- -- 46,122
Land.................. (2) 22,430 42 370 568 225 23,635
Non-mortgage:
Commercial............ (2) 19,154 -- -- -- -- 19,154
Consumer.............. (2) 119,718 74,288 198,717 -- -- 392,723
---------- ----------- -------- --------- -------- ----------
Total loans and
mortgage-backed
securities............ 4,971,205 231,643 468,757 78,874 37,886 5,788,365
---------- ----------- -------- --------- -------- ----------
Total interest-
earning assets...... $5,061,150 $ 231,643 $584,818 $ 78,874 $ 37,886 $5,994,371
========== =========== ======== ========= ======== ==========
Deposits and borrowings:
Interest-bearing
deposits:
Fixed maturity
deposits.............. (1) $2,184,477 $ 1,235,242 $380,312 $ 1,640 $ -- $3,801,671
Transaction accounts... (3) 1,082,795 -- -- -- -- 1,082,795
Non-interest-bearing
transaction accounts.. 155,267 -- -- -- -- 155,267
---------- ----------- -------- --------- -------- ----------
Total deposits......... 3,422,539 1,235,242 380,312 1,640 -- 5,039,733
---------- ----------- -------- --------- -------- ----------
Borrowings............. 143,575 22,305 105,142 432,698 -- 703,720
---------- ----------- -------- --------- -------- ----------
Total deposits and
borrowings.......... $3,566,114 $ 1,257,547 $485,454 $ 434,338 $ -- $5,743,453
========== =========== ======== ========= ======== ==========
Excess (shortfall) of
interest-earning assets
Over interest-bearing
liabilities........... $1,495,036 $(1,025,904) $ 99,364 $(355,464) $ 37,886 $ 250,918
Cumulative gap.......... 1,495,036 469,132 568,496 213,032 250,918
Cumulative gap--as a %
of total assets:
December 31, 1998...... 23.84% 7.48% 9.07% 3.40% 4.00%
December 31, 1997...... 24.82 1.35 2.71 3.54 3.93
December 31, 1996...... 16.71 2.68 0.50 1.47 3.04
</TABLE>
- --------
(1) Based upon contractual maturity and repricing date.
(2) Based upon contractual maturity, repricing date and projected repayment
and prepayments of principal.
(3) Subject to immediate repricing.
Our six-month gap at December 31, 1998, was a positive 23.84%. This means
that more interest-earning assets reprice within six months than interest-
bearing liabilities. This compares to a positive six-month gap of 24.82% at
December 31, 1997 and 16.71% at December 31, 1996. Our primary strategy to
manage interest rate risk is to emphasize the origination of adjustable rate
mortgages or loans with relatively short maturities. Interest rates on
adjustable rate mortgages are primarily tied to the CMT or COFI. We originated
and purchased approximately $1.5 billion during 1998, $2.0 billion during 1997
and $1.4 billion during 1996, of loans and mortgage-backed securities with
adjustable interest rates or maturities of five years or less. These loans
represented approximately 80% during 1998, 96% during 1997 and 95% during
1996, of all loans and mortgage-backed securities we originated and purchased
for investment during these periods. Adjustable rate mortgage originations
during those three years were primarily tied to COFI rather than the CMT
index.
At December 31, 1998, 98% of our interest-earning assets mature, reprice or
are estimated to prepay within five years, compared to 99% at December 31,
1997 and 97% at December 31, 1996. At December 31, 1998, loans held for
investment with adjustable interest rates represented 85% of our loan and
mortgage-backed
69
<PAGE>
securities portfolio. During 1999, we will continue to offer residential fixed
rate loan products to our customers to meet customer demand. We primarily
originate fixed rate loans for sale in the secondary market and price them
accordingly to create loan servicing income and to increase opportunities for
originating adjustable rate mortgages. However, we may originate fixed rate
loans for investment when funded with long-term funds to mitigate interest
rate risk, and small volumes to facilitate the sale of real estate acquired
through foreclosure or that meet specific yield and other approved guidelines.
See "Business--Banking Activities--Lending Activities--Secondary Marketing and
Loan Servicing Activities."
We are better protected against rising interest rates with a positive six-
month gap. However, we remain subject to possible interest rate spread
compression, which would adversely impact our net interest income if interest
rates rise. This is primarily due to the lag in the repricing of the indices
to which our adjustable-rate loans and mortgage-backed securities are tied, as
well as the repricing frequencies and periodic interest rate caps on these
adjustable-rate loans and mortgage-backed securities. The amount of interest
rate spread compression would depend upon the frequency and severity of the
interest rate fluctuations. The positive six-month gap could decrease in
future periods due to, among other things, the continued expansion of the auto
and consumer loan portfolios.
In addition to measuring interest rate risk via a gap analysis, we establish
limits on, and measure the sensitivity of, our net interest income and net
portfolio value to changes in interest rates. Changes in interest rates are
defined as instantaneous and sustained movements in interest rates in 100
basis point increments. We utilize an internally maintained asset/liability
management simulation model to make the calculations which, for net portfolio
value, is calculated on a discounted cash flow basis. First, we estimate our
net interest income for the next twelve months and the current net portfolio
value assuming no change in interest rates from those at period end. Once the
base case has been estimated, we make calculations for each of the defined
changes in interest rates, to include any associated differences in the
anticipated prepayment speed of loans. We then compare those results against
the base case to determine the estimated change to net interest income and net
portfolio value due to the changes in interest rates. The following are the
estimated impacts to net interest income and net portfolio value from various
instantaneous, parallel shifts in interest rates based upon our asset and
liability structure as of year-ends 1998 and 1997. Since we base these
estimates upon numerous assumptions, like the expected maturities of our
interest-bearing assets and liabilities and the shape of the period-end
interest rate yield curve, our actual sensitivity to interest rate changes
could vary significantly if actual experience differs from those assumptions
used in making the calculations.
<TABLE>
<CAPTION>
1998 1997
Percentage Change In Percentage Change In
-------------------------- --------------------------
Change in Interest Rates Net Interest Net Portfolio Net Interest Net Portfolio
(In Basis Points) Income(1) Value(2) Income(1) Value(2)
- ------------------------ ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
+200 (10.0)% 1.2% (13.6)% (9.3)%
+100 (4.4) 2.0 (5.7) (3.4)
(100) 2.9 (1.0) 5.5 3.2
(200) 3.9 (0.6) 12.0 9.1
</TABLE>
- --------
(1) The percentage change in this column represents net interest income for 12
months in a stable interest rate environment versus the net interest
income in the various rate scenarios.
(2) The percentage change in this column represents the net portfolio value of
the Bank in a stable interest rate environment versus the net portfolio
value in the various rate scenarios.
The following table shows our financial instruments that are sensitive to
changes in interest rates, categorized by expected maturity, and the
instruments' fair values at December 31, 1998. This data differs from that in
the gap table as it does not incorporate the repricing characteristics of
assets and liabilities. Rather, it only reflects contractual maturities
adjusted for anticipated prepayments. Market risk sensitive instruments are
generally defined as on and off balance sheet derivatives and other financial
instruments.
70
<PAGE>
<TABLE>
<CAPTION>
Expected Maturity Date at December 31, 1998(1)
----------------------------------------------------------------------------------------
Total Fair
1999 2000 2001 2002 2003 Thereafter Balance Value
---------- ---------- -------- -------- -------- ---------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-sensitive
assets:
Investment securities... $ 83,181 $ 40,375 $ 50,448 $ 25,238 $ -- $ 6,764 $ 206,006 $ 205,987
Average interest
rate.................. 5.48% 5.74% 5.37% 6.45% -- % 5.25% 5.62%
Loans held for sale..... 447,382 -- -- -- -- -- 447,382 447,468
Average interest
rate.................. 6.91% -- % -- % -- % -- % -- % 6.91%
Mortgage-backed
securities available
for sale............... 12,772 9,980 2,452 1,716 1,227 3,999 32,146 32,146
Average interest
rate.................. 6.71% 6.59% 7.58% 7.51% 7.44% 7.16% 6.86%
Loans held for
investment:
Loans secured by real
estate:
Residential:
Adjustable............ 1,062,467 844,589 625,298 461,153 339,734 999,782 4,333,023 4,474,114
Average interest
rate................ 7.42% 7.43% 7.41% 7.41% 7.51% 7.38% 7.42%
Fixed................. 79,388 59,790 46,148 36,398 29,270 105,215 356,209 368,737
Average interest
rate................ 8.37% 8.35% 8.27% 8.20% 8.14% 7.68% 8.11%
Other.................. 73,969 20,833 15,368 15,974 16,631 64,953 207,728 210,172
Average interest
rate................ 8.87% 8.81% 8.71% 8.72% 8.72% 7.96% 8.54%
Non-mortgage:
Commercial............. 16,299 1,188 1,322 345 -- -- 19,154 19,154
Average interest
rate................ 8.59% 8.59% 8.59% 8.59% -- % -- % 8.59%
Consumer............... 149,029 121,324 122,370 -- -- -- 392,723 396,421
Average interest
rate................ 9.93% 9.92% 9.29% -- % -- % -- % 9.73%
Interest-bearing
advances to joint
ventures............... 25,540 -- -- -- -- -- 25,540 25,540
Average interest
rate.................. 3.61% -- % -- % -- % -- % -- % 3.61%
Mortgage servicing
assets................. 1,630 1,471 1,282 1,095 927 1,388 7,793 11,976
---------- ---------- -------- -------- -------- ---------- ---------- ----------
Total interest-sensitive
assets................. $1,951,657 $1,099,550 $864,688 $541,919 $387,789 $1,182,101 $6,027,704 $6,191,715
========== ========== ======== ======== ======== ========== ========== ==========
Interest-sensitive
liabilities:
Deposits:
Transaction accounts... $ 226,130 $ 184,827 $151,069 $123,477 $100,924 $ 451,635 $1,238,062 $1,238,062
Average interest
rate.................. 2.30% 2.30% 2.30% 2.30% 2.30% 2.30% 2.30%
Certificates of
deposit............... 3,419,719 309,909 29,000 19,863 21,540 1,640 3,801,671 3,804,269
Average interest
rate.................. 5.26% 5.23% 5.69% 5.88% 5.37% 4.96% 5.26%
Borrowings.............. 165,880 31,199 16,743 56,467 733 432,698 703,720 709,223
Average interest
rate.................. 5.62% 6.34% 6.28% 4.97% 8.58% 5.44% 5.51%
---------- ---------- -------- -------- -------- ---------- ---------- ----------
Total interest-sensitive
liabilities............ $3,811,729 $ 525,935 $196,812 $199,807 $123,197 $ 885,973 $5,743,453 $5,751,554
========== ========== ======== ======== ======== ========== ========== ==========
</TABLE>
- --------
(1) Expected maturities are contractual maturities adjusted for prepayments of
principal. We use a number of assumptions to estimate fair values and
expected maturities. For assets, we base expected maturities upon
contractual maturity, projected repayments and prepayments of principal.
The prepayment experience reflected herein is based on our historical
experience. Our average constant prepayment rate ("CPR") is 21.1% on our
fixed-rate portfolio and 27.6% on our adjustable rate mortgage portfolio
for interest-earning assets, excluding investment securities, which do not
have prepayment features. For deposit liabilities, in accordance with
standard industry practice and our own historical experience, we have
applied "decay factors," used to estimate deposit runoff, of 20% per year.
The actual maturities of these instruments could vary substantially if
future prepayments differ from our historical experience.
71
<PAGE>
The following table sets forth the interest rate spread between our
interest-earning assets and interest-bearing liabilities as of the dates
indicated.
<TABLE>
<CAPTION>
December 31,
----------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Weighted average yield:
Loan and mortgage-backed securities............. 7.72% 7.95% 7.77% 7.67% 6.24%
FHLB stock...................................... 5.44 5.88 6.45 5.16 5.69
Investment securities........................... 5.40 5.63 6.02 6.46 6.17
---- ---- ---- ---- ----
Earning assets yield.......................... 7.65 7.87 7.71 7.60 6.24
---- ---- ---- ---- ----
Weighted average cost:
Deposits........................................ 4.53 5.00 4.86 4.81 4.23
Borrowings:
FHLB advances................................. 5.47 6.11 5.80 6.07 6.41
Other borrowings.............................. 8.69 6.15 5.60 5.62 5.88
---- ---- ---- ---- ----
Combined borrowings............................. 5.51 6.12 5.73 5.84 6.20
---- ---- ---- ---- ----
Combined funds.................................. 4.66 5.11 4.97 4.92 4.55
---- ---- ---- ---- ----
Interest rate spread.............................. 2.99% 2.76% 2.74% 2.68% 1.69%
==== ==== ==== ==== ====
</TABLE>
The year-end weighted average yield on our loan portfolio decreased to 7.72%
at December 31, 1998, from 7.95% as of December 31, 1997. The weighted average
rate on new loans we originated during 1998 was 6.45%, during 1997 was 6.04%
and during 1996 was 6.06%. At December 31, 1998, our adjustable rate mortgage
portfolio of single family residential loans, including mortgage-backed
securities, totaled $4.3 billion with a weighted average rate of 7.53%,
compared to $4.5 billion with a weighted average rates of 7.58% at
December 31, 1997 and $3.9 billion with a weighted average rate of 7.38% at
December 31, 1996.
Problem Loans and Real Estate
Non-Performing Assets
Non-performing assets consist of loans on which we have ceased the accrual
of interest, which we refer to as non-accrual loans, and real estate acquired
in settlement of loans. Non-performing assets totaled $27 million at December
31, 1998, compared to $52 million at December 31, 1997, and $62 million at
December 31, 1996. The decrease in our non-performing assets was primarily
attributable to several loans in the commercial real estate loan category that
we returned to accrual status following an extended period of satisfactory
payment performance. The effective yield on these loans reflects a market rate
of interest and we, therefore, do not consider them troubled debt
restructurings. Of the total, real estate acquired in settlement of loans, net
of allowances, represented $4 million at December 31, 1998, down from $10
million at December 31, 1997, and $16 million at December 31, 1996.
72
<PAGE>
The following table summarizes our non-performing assets at the dates
indicated.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Non-accrual loans:
Residential, one-to-four
units......................... $15,571 $20,816 $22,885 $25,587 $24,012
Residential, one-to-four
units--subprime............... 1,975 -- -- -- --
Other.......................... 4,829 20,883 22,136 52,754 28,025
------- ------- ------- ------- -------
Total non-accrual loans...... 22,375 41,699 45,021 78,341 52,037
Real estate acquired in
settlement of loans (1)......... 4,475 9,626 16,078 18,854 13,558
Repossessed automobiles.......... 569 795 928 -- --
------- ------- ------- ------- -------
Gross non-performing assets.... $27,419 $52,120 $62,027 $97,195 $65,595
======= ======= ======= ======= =======
Allowance for loan losses (2):
Amount......................... $31,517 $32,092 $30,094 $27,943 $25,650
As a percentage of non-
performing loans.............. 140.86% 76.96% 66.84% 35.67% 49.29%
Non-performing assets as a per-
centage of total assets......... 0.44 0.89 1.19 2.09 1.41
</TABLE>
- --------
(1) Excludes real estate acquired in settlement of loans covered under the
assistance agreement we entered into in connection with our 1988
acquisition of Butterfield Savings. We sold these assets to the Federal
Deposit Insurance Corporation's ("FDIC") Division of Resolution in
December 1995.
(2) Allowance for loan losses does not include the allowance for real estate
and real estate acquired in settlement of loans.
It is our policy to take appropriate, timely and aggressive action when
necessary to resolve non-performing assets. When resolving problem loans, it
is our policy to determine collectibility under various circumstances which
are intended to result in our maximum financial benefit. We accomplish this by
either working with the borrower to bring the loan current or by foreclosing
and selling the asset. We perform ongoing reviews of loans that display
weaknesses and maintain adequate loss allowances on the loans. For a
discussion on our internal asset review policy, refer to "--Allowance for
Losses on Loans and Real Estate."
All of our non-performing assets at December 31, 1998 were located in
California.
We evaluate the need for appraisals for non-performing assets on a periodic
basis. We will generally obtain a new appraisal when we believe that there may
have been an adverse change in the property operations or in the economic
conditions of the geographic market of the property securing our loans. Our
policy is to obtain new appraisals at least annually for major real estate
acquired in settlement of loans. Throughout 1998, we obtained new appraisals
for non-performing loans and real estate acquired in settlement of loans.
Non-Accrual Loans. It is our general policy to account for a loan as non-
accrual when the loan becomes 90 days delinquent or when collection of
interest appears doubtful. In a number of cases, loans may remain on accrual
status past 90 days when we determine that continued accrual is warranted
because the loan is well-secured and in process of collection. As of December
31, 1998, we had no loans 90 days or more delinquent which remained on accrual
status. We reverse and charge against interest income any interest previously
accrued with respect to non-accrual loans. We recognize interest income on
non-accrual loans to the extent that we receive payments and to the extent
that we believe we will recover the remaining principal balance of the loan.
We restore these loans to an accrual status only if the borrower makes all
past due payments and the borrower has demonstrated the ability to make future
payments of principal and interest. At December 31, 1998, non-accrual loans
aggregating $4 million were less than 90 days delinquent relative to their
contractual terms. Additional loans aggregating $1 million were not
contractually past due, but were deemed non-accrual due to management's
assessment of the borrower's ability to pay.
73
<PAGE>
Impaired Loans. We consider a loan to be impaired when, based upon current
information and events, we believe it is probable that we will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. We carry impaired loans at either the present value of expected
future cash flows discounted at the loan's effective interest rate, or at the
loan's observable market price or the net fair value of the collateral
securing the loan. Impaired loans exclude large groups of smaller balance
homogeneous loans that we collectively evaluate for impairment. For us, loans
we collectively review for impairment include all single family loans and
performing multi-family and non-residential loans having principal balances of
less than $1 million.
In determining impairment, we consider large non-homogeneous loans with the
following characteristics: non-accrual loans, debt restructurings, and
performing loans which exhibit, among other characteristics, high loan-to-
value ratios or delinquent taxes. We base the measurement of collateral
dependent impaired loans on the fair value of the loan's collateral. We value
non-collateral dependent loans based on a present value calculation of
expected future cash flows, discounted at the loan's effective rate. We
generally use cash receipts on impaired loans not performing according to
contractual terms to reduce the carrying value of the loan, unless we believe
we will recover the remaining principal balance of the loan. We include
impairment losses in the allowance for loan losses through a charge to
provision for loan losses. We include adjustments to impairment losses due to
changes in the fair value of the collateral of impaired loans in provision for
loan losses. Upon disposition of an impaired loan, we record loss of principal
through a charge-off to the allowance for loan losses. At December 31, 1998,
the recorded investment in loans for which we have recognized impairment
totaled $13 million, compared to $14 million at December 31, 1997. The total
allowance for losses related to these loans was $1 million at December 31,
1998, and 1997.
Troubled Debt Restructurings. We consider a restructuring of a debt a
troubled debt restructuring when we, for economic or legal reasons related to
the borrower's financial difficulties, grant a concession to the borrower that
we would not otherwise grant. Troubled debt restructurings may include
changing repayment terms, reducing the stated interest rate and reducing the
amounts of principal and/or interest due or extending the maturity date. The
restructuring of a loan is intended to recover as much of our investment as
possible and to achieve the highest yield possible. There were no troubled
debt restructurings on accrual status at December 31, 1998 and 1997.
Real Estate Acquired in Settlement of Loans. Real estate acquired in
settlement of loans consists of real estate acquired through foreclosure or
deeds in lieu of foreclosure.
Delinquent Loans
When a borrower fails to make required payments on a loan and does not cure
the delinquency within 60 days, we normally record a notice of default to
commence foreclosure proceedings, so long as we have given any required prior
notice to the borrower. If the loan is not reinstated within the time
permitted by law for reinstatement, which is normally five business days
before the date set for the non-judicial trustee's sale, we may then sell the
property at a foreclosure sale. If we have elected to pursue a non-judicial
foreclosure, we are not permitted under applicable California law to obtain a
deficiency judgment against the borrower, even if the security property is
insufficient to cover the balance owed. At these foreclosure sales, we
generally acquire title to the property. At December 31, 1998, loans
delinquent 30 days or more as a percentage of total loans was 0.65%, down from
0.79% at December 31, 1997 and 0.89% at December 31, 1996.
74
<PAGE>
The following table indicates the amounts of our past due loans at the dates
indicated.
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------
1998 1997
---------------------------------- ----------------------------------
30-59 60-89 90+ 30-59 60-89 90+
Days Days Days (1) Total Days Days Days (1) Total
------- ------ -------- ------- ------- ------ -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real
estate:
Residential:
One-to-four units.... $ 9,841 $6,014 $12,832 $28,687 $12,099 $4,101 $18,579 $34,779
One-to-four units--
subprime (2)........ 244 784 947 1,975 185 -- -- 185
Five or more units... -- -- 155 155 -- 222 -- 222
Commercial real
estate................ -- -- -- -- -- -- 279 279
Construction........... -- -- -- -- -- -- -- --
Land................... -- -- -- -- -- -- -- --
------- ------ ------- ------- ------- ------ ------- -------
Total real estate
loans............. 10,085 6,798 13,934 30,817 12,284 4,323 18,858 35,465
Non-mortgage:
Commercial............. -- -- -- -- -- -- -- --
Automobile............. 4,650 888 1,048 6,586 4,167 981 961 6,109
Other consumer......... 334 45 344 723 218 54 533 805
------- ------ ------- ------- ------- ------ ------- -------
Total loans........ $15,069 $7,731 $15,326 $38,126 $16,669 $5,358 $20,352 $42,379
======= ====== ======= ======= ======= ====== ======= =======
Delinquencies as a
percentage of total
loans.................. 0.26% 0.13% 0.26% 0.65% 0.31% 0.10% 0.38% 0.79%
<CAPTION>
1996 1995
---------------------------------- ----------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real
estate:
Residential:
One-to-four units.... $14,519 $5,502 $18,549 $38,570 $14,047 $6,645 $22,303 $42,995
One-to-four units--
subprime (2)........ 198 -- -- 198 -- -- -- --
Five or more units... -- -- -- -- 89 -- 447 536
Commercial real
estate................ -- -- -- -- -- -- 30,675 30,675
Construction........... -- -- -- -- -- -- -- --
Land................... -- -- 566 566 -- -- 6,516 6,516
------- ------ ------- ------- ------- ------ ------- -------
Total real estate
loans............. 14,717 5,502 19,115 39,334 14,136 6,645 59,941 80,722
------- ------ ------- ------- ------- ------ ------- -------
Non-mortgage:
Commercial............. -- -- -- -- -- -- 115 115
Automobile............. 2,080 328 274 2,682 667 249 540 1,456
Other consumer......... 158 15 181 354 257 410 170 837
------- ------ ------- ------- ------- ------ ------- -------
Total loans........ $16,955 $5,845 $19,570 $42,370 $15,060 $7,304 $60,766 $83,130
======= ====== ======= ======= ======= ====== ======= =======
Delinquencies as a
percentage of total
loans.................. 0.36% 0.12% 0.41% 0.89% 0.36% 0.17% 1.46% 1.99%
<CAPTION>
1994
----------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real
estate:
Residential:
One-to-four units.... $15,306 $9,273 $20,584 $45,163
Five or more units... -- -- 149 149
Commercial real
estate................ -- -- 1,139 1,139
Construction........... -- -- -- --
Land................... -- -- 836 836
------- ------ ------- -------
Total real estate
loans............. 15,306 9,273 22,708 47,287
Non-mortgage:
Commercial............. -- -- -- --
Automobile............. 22 12 24 58
Other consumer......... 291 171 334 796
------- ------ ------- -------
Total loans........ $15,619 $9,456 $23,066 $48,141
======= ====== ======= =======
Delinquencies as a
percentage of total
loans.................. 0.38% 0.23% 0.55% 1.16%
</TABLE>
- --------
(1) All 90 day or greater delinquencies are on non-accrual status and we report
them as part of non-performing assets.
(2) We commenced one-to-four units subprime lending in the first quarter of
1996.
75
<PAGE>
Allowance for Losses on Loans and Real Estate
We establish valuation allowances for losses on loans and real estate on a
specific and general basis. We determine specific allowances based on the
difference between the carrying value of the asset and our net fair value. We
determine general valuation allowances based on historical loss experience,
current and anticipated levels and trends of delinquent and non-performing
loans and the economic environment in our market areas.
Our Internal Asset Review Department conducts independent reviews to
evaluate the risk and quality of all our assets. Our Internal Asset Review
Committee is responsible for the review and classification of assets. The
Internal Asset Review Committee members include the Chief Internal Asset
Review Officer, Chief Executive Officer, Chief Financial Officer, Chief
Lending Officer, General Counsel, Director of Compliance/Risk Management,
Credit Administrator and Chief Appraiser. The Internal Asset Review Committee
meets quarterly to review and to determine asset classifications and to
recommend any changes to asset valuation allowances. With the exception of
payoffs or asset sales, the classification of an asset, once established, can
be removed or upgraded only upon approval of the Internal Asset Review
Committee. The Chief Internal Asset Review Officer reports quarterly to the
audit committee of the board of directors regarding overall asset quality, the
adequacy of valuation allowances on classified assets and our adherence to
policies and procedures regarding asset classification and valuation.
We adhere to an internal asset review system and loss allowance methodology
designed to provide for timely recognition of problem assets and adequate
general valuation allowances to cover asset losses. Our current asset
monitoring process includes the use of asset classifications to segregate the
assets, largely loans and real estate, into various risk categories. We use
the various asset classifications as a means of measuring risk for determining
the general valuation allowances at a point in time. We currently use a six
grade system to classify our assets. The current grades are:
. pass;
. watch;
. special mention;
. substandard;
. doubtful; and
. loss.
Substandard, doubtful and loss assets are considered "classified assets" for
regulatory purposes. A brief description of these classifications follows:
. The pass classification represents a level of credit quality which
contains no well-defined deficiency or weakness.
. The watch classification is used to identify an asset that currently
contains no well-defined deficiency or weakness, but we determine it to
be desirable to closely monitor the asset--e.g., loans to facilitate the
sale of real estate acquired in settlement of loans. This category may
also be used for assets upgraded from lower classifications where
continuing monitoring is deemed appropriate.
. A special mention asset does not currently expose us to a sufficient
degree of risk to warrant an adverse classification, but does possess a
correctable deficiency or potential weakness deserving management's
close attention.
. Substandard assets have a well-defined weakness or weaknesses. They are
characterized by the distinct possibility that we will sustain some loss
if we do not correct the deficiencies.
. An asset classified doubtful has all the weaknesses inherent in those
classified substandard with the added characteristic that the weaknesses
make collection or liquidation in full, on the basis of currently
existing facts, conditions and values, highly questionable and
improbable. We consider doubtful to be a temporary classification until
resolution of pending weakness issues enables us to more clearly define
the potential for loss.
76
<PAGE>
. That portion of an asset classified loss is considered uncollectible and
of so little value that its continuance as an asset, without
establishment of a specific valuation allowance, is not warranted. A
loss classification does not mean that an asset has absolutely no
recovery or salvage value, but rather it is not reasonable to defer
writing off or providing for all or a portion of an impaired asset even
though partial recovery may be effected in the future. We will generally
classify as loss the balance of the asset that is greater than the net
fair value of the asset unless we can expect payment from another
source. Therefore, the amount of an asset classified as loss reflects
the total of specific valuation allowances established for the
particular asset. Specific valuation allowances are not includable in
determining the Bank's total regulatory capital.
The OTS has the authority to require us to change our asset classifications.
If the change results in an asset being classified in whole or in part as
loss, a specific allowance must be established against the amount so
classified or that amount must be charged off. OTS guidelines set forth
quantitative benchmarks as a starting point for the determination of
appropriate levels of general valuation allowances. The OTS directs its
examiners to rely on management's estimates of adequate general valuation
allowances if the Bank's process for determining adequate allowances is deemed
to be sound.
Our policy is to provide an allowance for losses on loans and real estate
when it is probable that the value of the asset has been impaired and the loss
can be reasonably estimated. To comply with this policy, we have established a
monitoring system that requires at least an annual review of all assets in
excess of $1 million and a semiannual review of all assets considered
adversely classified or criticized. The monitoring system requires a review of
current operating statements, an evaluation of the property's current and past
performance, an evaluation of the borrower's ability to repay and the
preparation of a discounted cash flow analysis. Based on the results of the
review, we may require a new appraisal.
Our provision for loan losses totaled $3.9 million in 1998, down $4.7
million from 1997. Net loan charge-offs exceeded the provision for loan losses
by $0.6 million resulting in a decrease in the allowance for loan losses to
$31.5 million at December 31, 1998. This decrease reflects an improvement in
overall loan quality. Included in the current year-end allowance was $31.3
million of general valuation allowances of which $2.8 million was not
allocated to any specific loan category.
A summary of activity in the allowances for loan losses is shown below for
the years indicated.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period.... $32,092 $30,094 $27,943 $25,650 $26,835
Provision......................... 3,899 8,640 9,137 9,293 4,211
Charge-offs....................... (7,372) (7,773) (7,660) (8,017) (5,511)
Recoveries........................ 2,898 1,131 674 1,017 115
------- ------- ------- ------- -------
Balance at end of period.......... $31,517 $32,092 $30,094 $27,943 $25,650
======= ======= ======= ======= =======
</TABLE>
77
<PAGE>
Net loan charge-offs were $4.5 million in 1998, down from $6.6 million in
1997 and $7.0 million in 1996. The decline primarily reflected a $1.3 million
decline in net charge-offs of one-to-four unit residential loans and a $1.4
million recovery of a prior commercial real estate loan charge-off due to
proceeds from the previously mentioned settlement. The growth in automobile
loan net charge-offs reflects the growth in that portfolio as the ratio of
automobile net charge-offs to the average of these loans was 1.40% in 1998
compared to 1.58% in 1997 and 1.37% in 1996. Charge-offs, net of recoveries,
by category of loan are as follows for the years indicated.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------- ------ ------ ------ ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Loans secured by real estate:
Residential:
One-to-four units (1)............. $ 910 $2,165 $4,982 $5,165 $4,051
Five or more units................ 68 -- 102 469 264
Commercial real estate.............. (1,610) (261) (250) 807 959
Land................................ -- -- -- 4 --
Non-mortgage:
Commercial.......................... -- -- 115 (152) (52)
Automobile.......................... 4,959 4,468 1,791 398 9
Other consumer...................... 147 270 246 309 165
------- ------ ------ ------ ------
Total net loan charge-offs........ $ 4,474 $6,642 $6,986 $7,000 $5,396
======= ====== ====== ====== ======
Net loan charge-offs as a percentage
of average loans and mortgage-backed
securities held to maturity.......... 0.09% 0.13% 0.16% 0.17% 0.16%
</TABLE>
- --------
(1) Includes net charge-offs associated with the January 1994 Northridge
earthquake of $1.0 million in 1996, $1.1 million in 1995 and $0.8 million
in 1994.
78
<PAGE>
The allocation of the allowance for loan losses at the dates indicated is as
shown in the following table.
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------- ------------------------------- -------------------------------
Gross Allowance Gross Allowance Gross Allowance
Loan Percentage Loan Percentage Loan Percentage
Portfolio to Loan Portfolio to Loan Portfolio to Loan
Allowance Balance Balance Allowance Balance Balance Allowance Balance Balance
--------- ---------- ---------- --------- ---------- ---------- --------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real
estate:
Residential:
One-to-four units.... $14,299 $4,636,133 0.31% $14,652 $4,607,545 0.32% $13,241 $4,046,448 0.33%
Five or more units... 401 40,029 1.00 314 38,278 0.82 517 56,907 0.91
Commercial real
estate................ 2,632 140,790 1.87 4,112 202,425 2.03 6,956 260,609 2.67
Construction........... 1,508 127,761 1.18 847 70,865 1.20 773 66,651 1.16
Land................... 568 44,859 1.27 331 25,687 1.29 466 21,177 2.20
Non-mortgage:
Commercial............. 218 28,293 0.77 196 26,024 0.75 236 22,136 1.07
Automobile............. 8,344 357,988 2.33 8,016 342,326 2.34 4,303 202,186 2.13
Other consumer......... 747 41,894 1.78 824 47,735 1.73 802 47,281 1.70
Other................... -- -- -- -- -- -- -- -- --
Not specifically
allocated.............. 2,800 -- -- 2,800 -- -- 2,800 -- --
------- ---------- ---- ------- ---------- ---- ------- ---------- ----
Total loans held for
investment.......... $31,517 $5,417,747 0.58% $32,092 $5,360,885 0.60% $30,094 $4,723,395 0.64%
======= ========== ==== ======= ========== ==== ======= ========== ====
<CAPTION>
1995 1994
------------------------------- -------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real
estate:
Residential:
One-to-four units.... $12,254 $3,656,512 0.34% $12,404 $3,688,280 0.34%
Five or more units... 895 57,321 1.56 978 63,782 1.53
Commercial real
estate................ 8,456 270,583 3.13 6,814 294,418 2.31
Construction........... 335 28,593 1.17 131 11,367 1.15
Land................... 973 21,867 4.45 862 9,822 8.78
Non-mortgage:
Commercial............. 259 12,864 2.01 472 12,975 3.64
Automobile............. 849 56,127 1.51 42 3,028 1.39
Other consumer......... 1,122 50,945 2.20 1,094 53,241 2.05
Other................... -- -- -- 53 39,143 0.14
Not specifically
allocated.............. 2,800 -- -- 2,800 -- --
------- ---------- ---- ------- ---------- ----
Total loans held for
investment.......... $27,943 $4,154,812 0.67% $25,650 $4,176,056 0.61%
======= ========== ==== ======= ========== ====
</TABLE>
The following table is a summary of the activity in our allowance for real
estate held for investment and non-conforming loans to joint ventures for the
years indicated. In 1998, $4.3 million of the provision reduction and $7.1
million of charge-offs relate to the previously mentioned settlement. We also
included $1.1 million of charge-offs due to sales of undeveloped land in 1998.
The provision reductions in all years presented were due to a continuing
improvement in the real estate market which favorably impacted the valuation
of some neighborhood retail shopping center investments and to a reduction in
the investment in some joint venture investments.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period.... $21,244 $30,071 $34,338 $37,198 $38,674
Provision (reduction)............. (5,296) (3,190) (3,306) (2,916) (1,400)
Charge-offs....................... (8,231) (5,637) (1,035) -- (76)
Recoveries........................ -- -- 74 56 --
------- ------- ------- ------- -------
Balance at end of period.......... $ 7,717 $21,244 $30,071 $34,338 $37,198
======= ======= ======= ======= =======
</TABLE>
79
<PAGE>
In addition to losses charged against the allowance for loan losses, we have
recorded losses on real estate acquired in settlement of loans by direct
write-off to net operations of real estate acquired in settlement of loans and
against an allowance for losses specifically established for these assets. The
following table is a summary of the activity of our allowance for real estate
acquired in settlement of loans for the years indicated.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
----- ------- ------- ------- -------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period....... $ 839 $ 1,078 $ 1,217 $ 743 $ 747
Provision............................ 455 1,107 1,658 2,498 2,035
Charge-offs.......................... (761) (1,346) (1,797) (2,024) (2,039)
Recoveries........................... -- -- -- -- --
----- ------- ------- ------- -------
Balance at end of period............. $ 533 $ 839 $ 1,078 $ 1,217 $ 743
===== ======= ======= ======= =======
</TABLE>
Capital Resources and Liquidity
Our sources of funds include deposits, advances from the FHLB and other
borrowings, proceeds from the sale of real estate, sales of loans and
mortgaged-backed securities, payments of loans and mortgaged-backed
securities, payments for and sales of loan servicing and income from other
investments. Interest rates, real estate sales activity and general economic
conditions affect significantly repayments on loans and mortgage-backed
securities and deposit inflows and outflows. Loan repayments increased $0.7
billion in 1998 to $1.9 billion and were virtually equal to new loan
originations and purchases for portfolio. In 1997, new loan originations and
purchases for portfolio exceeded repayments by $0.9 billion.
During 1998, aggregate borrowings increased $220 million as we took
advantage of obtaining long-term advances from the FHLB at attractive
borrowing rates to fund fixed-rate loans for investment. We also experienced a
net deposit inflow of $170 million, of which $302 million represented
transaction accounts partially offset by a $132 million decrease in
certificates of deposit.
To the extent 1999 deposit growth falls short of satisfying ongoing
commitments to fund maturing and withdrawable deposits, repay borrowings, fund
existing and future loan and other investment commitments, continue branch
improvement programs and maintenance of regulatory liquidity requirements, we
will utilize borrowing arrangements with the FHLB and other sources. At
December 31, 1998, we had commitments to fund loans amounting to $941 million,
loans in process of $100 million, undrawn lines of credit of $70 million and
letters of credit and other contingent liabilities of $4 million. We believe
our current sources of funds will enable us to meet these obligations while
maintaining our liquidity at appropriate levels.
The principal measure of liquidity in the savings and loan industry is the
regulatory ratio of cash and eligible investments to the sum of withdrawable
savings and borrowings due within one year. Federal regulators reduced the
minimum liquidity ratio in 1997 from 5% to 4%. At December 31, 1998, the
Bank's ratio was 4.04% compared to 4.80% at December 31, 1997 and 5.26% at
December 31, 1996.
80
<PAGE>
Regulatory Capital Compliance
The following table is a reconciliation of the Bank's stockholder's equity
to federal regulatory capital as of December 31, 1998. The core and tangible
capital ratios were 6.83% and the risk-based capital ratio was 12.88%. These
levels are up slightly from comparable ratios of 6.61% for core and tangible
capital and 12.64% for risk-based capital at December 31, 1997, and continue
to exceed the "well capitalized" standards of 5% for core and 10% for risk-
based, as defined by regulation. During 1998, the amount of the Bank's non-
includable investment in real estate required to be deducted from regulatory
capital increased by $7 million due to DSL Service Company's growth in
retained earnings.
<TABLE>
<CAPTION>
Risk-
Tangible Capital Core Capital Based Capital
------------------- --------------- ---------------
Amount Ratio Amount Ratio Amount Ratio
---------- ------- -------- ----- -------- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Stockholder's equity.... $ 470,504 $470,504 $470,504
Adjustments:
Deductions:
Investment in
subsidiary, primarily
real estate.......... (42,119) (42,119) (42,119)
Goodwill.............. (4,543) (4,543) (4,543)
Non-permitted mortgage
servicing rights..... (779) (779) (779)
Additions:
Unrealized gain on
securities available
for sale............. (753) (753) (753)
General loss
allowance--investment
in DSL Service
Company.............. 1,383 1,383 1,383
Loan general valuation
allowances (1)....... -- -- 31,267
---------- -------- --------
Regulatory capital...... 423,693 6.83% 423,693 6.83% 454,960 12.88%
Well capitalized
requirement............ 93,053 1.50 (2) 310,178 5.00 353,195 10.00 (3)
---------- ------ -------- ---- -------- -----
Excess.................. $ 330,640 5.33% $113,515 1.83% $101,765 2.88%
========== ====== ======== ==== ======== =====
</TABLE>
- --------
(1) Limited to 1.25% of risk-weighted assets.
(2) Represents the minimum requirement for tangible capital, as no "well
capitalized" requirement has been established for this category.
(3) A third requirement is Tier 1 capital to risk-weighted assets of 6%, which
the Bank met and exceeded with a ratio of 12.00% at December 31, 1998.
Current Accounting Issue
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including a number of derivative instruments embedded in other
contracts, collectively referred to as derivatives, and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. If specific conditions are met, a derivative may be
specifically designated as:
. a hedge of the exposure to changes in the fair value of a recognized
asset or liability or an unrecognized firm commitment;
. a hedge of the exposure to variable cash flows of a forecasted
transaction; or
. a hedge of the foreign currency exposure of a net investment in a
foreign operation, an unrecognized firm commitment, an available for
sale security, or a foreign-currency-denominated forecasted transaction.
81
<PAGE>
Under SFAS 133, an entity that elects to apply hedge accounting is required
to establish at the inception of the hedge the method it will use for
assessing the effectiveness of the hedging derivative and the measurement
approach for determining the ineffective aspect of the hedge. Those methods
must be consistent with the entity's approach to managing risk.
As part of our secondary marketing activities, we utilize forward sale and
purchase contracts to hedge the value of loans originated for sale against
adverse changes in interest rates. At December 31, 1998, these sales contracts
amounted to approximately $622 million and purchase contracts amounted to
approximately $34 million. These contracts have a high correlation to the
price movement of the loans being hedged. There is no recognition of
unrealized gains and losses on these contracts in the balance sheet or
statement of income. When the related loans are sold, we recognize the
deferred gains or losses from these contracts in our statement of income as a
component of net gains or losses on sales of loans and mortgage-backed
securities.
This statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000. We do not anticipate that the financial impact
of this statement will have a material impact on us.
82
<PAGE>
BUSINESS
GENERAL
We were incorporated in Delaware on October 21, 1994. On January 23, 1995,
after we obtained necessary stockholder and regulatory approvals, we acquired
100% of the issued and outstanding capital stock of the Bank and the Bank's
stockholders became holders of our stock. Downey was thereafter funded by the
Bank and presently operates as the Bank's holding company. Our stock is traded
on the New York Stock Exchange and Pacific Exchange under the trading symbol
"DSL."
The Bank was formed in 1957 as a California-licensed savings and loan
association and converted to a federal charter in 1995. As of March 31, 1999,
it conducts its business through 95 retail deposit branches, including 33
full-service in-store branches. Residential loans are originated by retail
loan officers who work out of 43 of the Bank's California retail deposit
branches and two loan origination centers outside of California, one each in
Arizona and Washington. Retail loan officers also originate residential loans
through the Internet from four California call centers. Wholesale loans
submitted by mortgage brokers are originated from the Arizona and Washington
loan origination centers and ten California loan origination centers, eight of
which are located in or by a Bank office.
The Bank is regulated or affected by the following governmental entities and
laws as follows:
. As a federally chartered savings association, the Bank's activities and
investments are generally governed by the Home Owners' Loan Act, as
amended, and implementing regulations and policies of the OTS.
. The Bank and Downey are subject to the primary regulatory and
supervisory jurisdiction of the OTS.
. As a federally insured depository institution, the Bank is regulated and
supervised by the FDIC with respect to some of its activities and
investments.
. The Bank is a member of the FHLB of San Francisco, which is one of the
12 regional banks for federally insured depository institutions
comprising the Federal Home Loan Bank System.
. The Bank's savings deposits are insured through the SAIF of the FDIC, an
instrumentality of the United States government.
. The Bank is regulated by the Federal Reserve with respect to reserves
the Bank is required to maintain against deposits and other matters.
Downey Affiliated Insurance Agency was incorporated on January 25, 1995, as
Downey's wholly owned subsidiary. We capitalized Downey Affiliated Insurance
Agency on February 24, 1995 with $400,000. In the 1995 second quarter, Downey
Affiliated Insurance Agency commenced operations at which time representatives
of Downey Affiliated Insurance Agency were available in our branches to offer
annuity products. During 1996, Downey Affiliated Insurance Agency began
offering forced-placed casualty insurance policies on mortgage loans and
stopped offering annuity products. The offering of forced-placed casualty
insurance policies ceased in April 1999.
General economic conditions, the monetary and fiscal policies of the federal
government and the regulatory policies of governmental authorities
significantly influence our operations. Additionally, interest rates on
competing investments and general market interest rates influence our deposit
flows and the costs we incur for interest-bearing liabilities, which
represents our cost of funds. Similarly, market interest rates and other
factors that affect the supply of and demand for housing and the availability
of funds affect our loan volume and our yields on loans and mortgage-backed
securities.
Our primary business is banking and we are also involved in real estate
investment, each of which we discuss further below.
83
<PAGE>
BANKING ACTIVITIES
Our primary business is banking. Our banking activities focus on:
. attracting funds from the general public and institutions; and
. originating and investing in loans, primarily residential real estate
mortgage loans, investment securities and mortgage-backed securities.
These mortgage-backed securities include mortgage pass-through securities
issued by other entities and securities issued or guaranteed by government-
sponsored enterprises like the Federal National Mortgage Association, the
Federal Home Loan Mortgage Corporation and the Government National Mortgage
Association.
Our primary sources of revenue from our banking business are:
. interest we earn on loans and mortgage-backed securities;
. income from investment securities;
. gains on sales of our loans and mortgage-backed securities;
. fees we earn in connection with loans and deposits; and
. income we earn on our portfolio of loans and mortgage-backed securities
we service for investors.
Our principal expenses in connection with our banking business are:
. interest we incur on our interest-bearing liabilities, including
deposits and borrowings; and
. general and administrative costs.
Our primary sources of funds from our banking business are:
. deposits;
. principal and interest payments on our loans and mortgage-backed
securities;
. proceeds from sales of our loans and mortgage-backed securities; and
. borrowings.
Scheduled payments we receive on loans and mortgage-backed securities are a
relatively stable source of our funds. However, the funds we receive from
deposits and prepayment of loans and mortgage-backed securities vary widely.
Below is a detailed discussion of our banking activities.
Lending Activities
Historically, our lending activities have primarily emphasized our
origination of first mortgage loans secured by residential properties and
retail neighborhood shopping centers. To a lesser extent, our lending
activities have emphasized our origination of real estate loans secured by
multi-family and commercial and industrial properties, including office
buildings, land and other properties with income producing capabilities. In
addition, we have provided construction loan financing for single-family and
multi-family residential properties and commercial retail neighborhood
shopping center projects. These construction loan financings have included
loans to joint ventures, which were being engaged in by DSL Service Company or
the Bank with other participants. We also originate loans to businesses
through our commercial banking operations.
We originate our automobile loans directly through our branch network. We
also conduct an indirect auto-lending program through our purchase of new or
used automobile sales contracts from auto dealers in California and other
western states. Downey Auto Finance Corp., a wholly owned subsidiary of the
Bank, operates this indirect auto-lending program.
Our primary focus will continue to be our origination of:
. adjustable rate single family mortgage loans, particularly subprime
loans which carry higher interest rates; and
. consumer loans.
84
<PAGE>
We will also continue our secondary marketing activities of selling:
. our production of some fixed rate single family loans; and
. some adjustable rate mortgage loan products.
Given the current low interest rate environment and customer preference for
fixed rate loans, it is likely we may originate more single family loans for
sale in the secondary market than for our portfolio during 1999, as was the
case in 1998. For more information, see below under the caption entitled
"Business--Secondary Marketing and Loan Servicing Activities." For additional
information on the composition of our loan and mortgage-backed securities
portfolio, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Financial Condition for the Year Ended December 31,
1998--Loans and Mortgage-Backed Securities" and "--Financial Condition for the
Quarter Ended March 31, 1999--Loans and Mortgage-Backed Securities."
Loan and Mortgage-Backed Securities Portfolio
We carry loans receivable at cost. Our net loans receivable are adjusted for
amortization of premiums and accretion of discounts which are recognized in
interest income using the interest method. Our investments in mortgage-backed
securities represent participating interests in pools of first mortgage loans
originated and serviced by the issuers of the securities. We carry mortgage-
backed securities held to maturity at unpaid principal balances, which are
adjusted for unamortized premiums and unearned discounts. We amortize premiums
and discounts on mortgage-backed securities by using the interest method over
the remaining period to contractual maturity, adjusted for anticipated
prepayments.
We identify loans that may be sold before their maturity. In our balance
sheets, we classify these loans as held for sale and record them at the lower
of amortized cost or market value. We recognize net unrealized losses on these
loans, if any, in a valuation allowance by making charges to our income.
We carry mortgage-backed securities available for sale at fair value. We
report net unrealized gains or losses on these securities net of income taxes
and as a separate component of our other comprehensive income until realized.
The residential mortgage loans we originate typically have contractual
maturities at origination of 15 to 40 years. To limit the interest rate risk
associated with these 15- to 40-year maturities, we, among other things,
principally originate adjustable rate mortgages for our own loan portfolio. We
originate fixed-rate loans and sell the majority of them in the secondary
market on a non-recourse basis for cash. However, we occasionally originate
fixed rate loans for our own portfolio to facilitate our sale of real estate
we acquire in settlement of loans and which meet specific yield and other
approved guidelines. For more information, see "Business--Asset/Liability
Management." In addition, the average term of these fixed rate mortgage loans
we originate for our own portfolio historically has been significantly shorter
than their contractual maturity due to loan payoffs as a result of home sales
or refinancings and prepayments.
Residential Real Estate Lending
Our primary lending activity is our origination of mortgage loans secured by
single family residential properties consisting of one-to-four units located
primarily in California. We provide these mortgage loans for borrowers to
purchase residences or to refinance their existing mortgages at lower rates or
upon different terms. Our primary strategy is to originate adjustable rate
mortgages for our portfolio of loans we hold for investment. For more
information, see "Business--Asset/Liability Management." We also originate
residential fixed interest rate mortgage loans to meet consumer demand, but we
intend to sell the majority of all these loans in the secondary market, rather
than hold these loans in our portfolio. We may, however, place residential
fixed rate loans in our portfolio of loans held for investment if fixed rate
loans are funded with long-term funds to mitigate interest rate risk. In
addition, we originate a small volume of fixed rate loans for our own
investment if they meet specific yield and other approved guidelines or to
facilitate our sale of real estate acquired in settlement of
85
<PAGE>
loans. For more information, see "Business--Lending Activities--Secondary
Marketing and Loan Servicing Activities."
Our adjustable rate mortgages generally:
. begin with an incentive interest rate, which is an interest rate below
the current market rate, that adjusts to the applicable index plus a
defined spread, subject to periodic and lifetime caps, after one, three,
six or twelve months;
. provide that the maximum interest rate we can charge borrowers cannot
exceed the incentive rate by more than six to nine percentage points,
depending on the type of loan and the initial rate offered; and
. limit interest rate adjustments to 1% per adjustment period for those
that adjust semi-annually.
Most of our adjustable rate mortgages adjust monthly instead of semi-
annually. These monthly adjustable rate mortgages:
. have a lifetime interest rate cap, but no specified periodic interest
rate adjustment cap;
. have a periodic cap on changes in required monthly payments, which
adjust annually; and
. allow for negative amortization, which is the addition to loan principal
of accrued interest that exceeds the required monthly loan payments.
Regarding negative amortization, if a loan incurs significant negative
amortization, then there is an increased risk that the market value of the
underlying collateral on the loan would be insufficient to satisfy fully the
outstanding principal and interest. We impose a limit on the amount of
negative amortization, so that the principal plus the added amount cannot
exceed:
. 125% of the original loan amount on loans having a loan-to-value ratio
of 80% or less; and
. 110% on loans having a loan-to-value ratio over 80%.
A loan-to-value ratio is the ratio of the principal amount of the loan to
the appraised value at origination of the property securing the loan. We
permit adjustable rate mortgages to be assumed by qualified borrowers.
During first quarter 1999, approximately 83% of our one-to-four unit
residential real estate loans were obtained by our wholesale loan
representatives but originated through outside mortgage brokers. We pay our
wholesale loan representatives on a commission basis. We consider the
compensation we pay these mortgage brokers when we set the overall price of
our mortgage loan products. These mortgage brokers do not operate from our
offices and are not our employees. Our retail loan representatives generated
approximately 17% of our one-to-four unit residential loans during first
quarter 1999. We compensate our retail loan representatives on a salary basis
plus a fixed amount per loan they originate. Retail loan representatives
typically receive loan referrals from real estate agents, builders, depositors
and customers obtained from our retail advertising and other sources,
including over the Internet.
We require that our residential real estate loans be approved at various
levels of management, depending upon the amount of the loan. On a single-
family residential loan we originate for our portfolio, the maximum amount we
generally will lend is $1 million. Our average loan size, however, is much
lower. During first quarter 1999, our average loan size was $241,577. We
generally make loans with loan-to-value ratios not exceeding 80%. We will make
loans with loan-to-value ratios of over 80%, but not exceeding 97% of the
value of the property, if borrowers obtain private mortgage insurance to
reduce the effective loan-to-value ratio to between 70% to 78%, consistent
with secondary marketing requirements. In addition, we require that borrowers
obtain hazard insurance for all residential real estate loans covering the
lower of the loan amount or the replacement value of the structure.
In our approval process for the loans we originate or purchase, we assess
both the value of the property securing the loan and the applicant's ability
to repay the loan. Loan underwriters analyze the loan application
86
<PAGE>
and the property involved. Qualified appraisers on our staff or outside
appraisers establish the value of the collateral through the use of full
appraisals or alternative valuation formats that meet regulatory requirements.
Our senior staff or approved fee review appraisers selectively review
appraisals performed by these approved appraisers. We also obtain information
about the applicant's income, financial condition, employment, and credit
history. Typically, we will verify an applicant's credit information for loans
originated by our retail loan representatives or our other employees. For
loans from mortgage brokers, we require the mortgage broker to review and
verify the applicant's credit information and employment. In addition, we
obtain credit information about the applicant and perform other underwriting
tests of these mortgage broker originated loans.
On our adjustable rate mortgages we offer with incentive interest rates, we
qualify applicants:
. for loan programs with no negative amortization and having a loan-to-
value ratio of 80% or less, at the higher of:
. the initial incentive interest rate plus 2%; or
. the fully indexed interest rate, with a minimum qualifying rate of
7%.
. for loan programs with no negative amortization and having a loan-to-
value ratio of greater than 80%, at a minimum qualifying interest rate
of 7%.
. for loan programs that include negative amortization and having a loan
to value ratio of 80% or less, at the lesser of:
. the initial incentive interest rate plus 2%; or
. the fully indexed interest rate, with a minimum qualifying rate of
6%.
. for loan programs that include negative amortization and having a loan
to value ratio of greater than 80%, at the minimum qualifying interest
rate of 7%.
Late in 1996, we began offering one-to-four unit residential loans to
borrowers who have or, in the case of purchases, will have equity in their
homes but whose credit rating contains exceptions which preclude them from
qualifying for the best market terms. These lower grade credits or "A-," "B"
and "C" loans are commonly referred to as subprime loans and are characterized
by lower loan-to-value ratios and higher average interest rates than higher
credit grade loans or "A" loans. We believe these lower credit grade borrowers
represent an opportunity for us to earn a higher net return for the risks we
assume. We have developed underwriting guidelines for each classification of
credit.
Secondary Marketing and Loan Servicing Activities
As part of our secondary marketing activities, we originate some residential
real estate adjustable rate mortgages and fixed rate mortgages, which we
intend to sell. Accordingly, we classify these loans as held for sale and
carry them at the lower of cost or market. These loans are secured by first
liens on one-to-four unit residential properties and have:
. 15- to 30-year maturities; or
. 30-year amortization periods with balloon payments in five or seven
years; or
. other maturities.
We use various hedging programs to manage the interest rate risk of our fixed
rate mortgage origination process. For more information, see "Business--
Asset/Liability Management."
We believe that servicing loans for others can be an important
asset/liability management tool because it produces operating results which,
in response to changes in market interest rates, tend to move opposite to
changes in net interest income. Because adjustable rate mortgages take longer
to adjust to market interest rates,
87
<PAGE>
net interest income associated with these loans is expected to decline in
periods of rising interest rates and increase in periods of falling rates. In
contrast, the value of a loan servicing portfolio normally:
. increases as interest rates rise, and loan prepayments decrease; and
. declines as interest rates fall, and loan prepayments increase.
In addition, increased levels of servicing activities can provide us with
additional income with minimal additional overhead costs.
Depending upon market pricing for servicing, we sell loans that are either
servicing retained or servicing released. When we sell loans that are
servicing retained, we record gains or losses from our sale of these loans at
the time of sale. We calculate gains or losses from our sale as the difference
between the net sales proceeds and the allocated basis of the loans sold.
Effective January 1, 1997, we adopted Statement of Financial Accounting
Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities," ("SFAS 125") which governs the accounting
treatment of mortgage servicing rights. As required by SFAS 125, we capitalize
mortgage servicing rights we acquire through either our purchase or
origination of mortgage loans we intend to sell with servicing rights
retained. We allocate the total cost of the mortgage loans designated for sale
to both the mortgage servicing rights and to the mortgages loans without
mortgage servicing rights based on their relative fair values. We include our
mortgage servicing rights in our financial statements in the category of
"other assets." We recognize impairment losses on mortgage servicing rights
through a valuation allowance, and record any associated provision as a
component of loan servicing fees. At March 31, 1999, our mortgage servicing
rights totaled $16 million.
We may exchange loans we originate for sale with government agencies for
mortgage-backed securities collateralized by these loans. Our cost for the
exchange is our payment of a monthly guaranty fee, which is expressed as a
percentage of the unpaid principal balance and which we deduct from interest
income. We can use the securities we receive to collateralize various types of
our borrowings at rates that frequently are more favorable than rates on other
types of liabilities and also carry a lower risk-based capital requirement
than whole loans. We carry these mortgage-backed securities available for sale
at fair value. However, we record no gain or loss on the exchange in our
statement of income until the securities are sold to a third party. Before we
sell these securities to third parties, we show all changes in fair value as a
separate component of our comprehensive income, net of income taxes.
Commercial Real Estate and Multi-Family Lending
We have provided permanent loans secured by retail neighborhood shopping
centers and multi-family properties. Our major loan officers conduct our
commercial real estate lending and multi-family activities. We compensate
these officers on a salary basis.
Commercial real estate and multi-family loans generally entail additional
risks as compared to single-family residential mortgage lending. We subject
each loan, including loans to facilitate the sale of real estate we own, to
our underwriting standards, which generally include:
. our evaluation of the creditworthiness and reputation of the borrower;
and
. the amount of the borrower's equity in the project as determined on the
basis of appraisal, sales and leasing information on the property and
cash flow projections.
To protect the value of the security for our loan, we require borrowers to
maintain casualty insurance for the loan amount or replacement cost. In
addition, for non-residential loans in excess of $500,000, we require the
borrower to obtain comprehensive general liability insurance. All commercial
real estate loans we originate must be approved by at least two of our
officers, one of whom must be the originating loan account officer and the
other a designated officer with appropriate loan approval authority.
88
<PAGE>
Construction Lending
We have provided construction loan financing for single family and multi-
family residential properties and commercial real estate projects, like retail
neighborhood shopping centers. Our major loan officers principally originate
these loans. We generally make construction loans at floating rates based upon
the prime or reference rate of a major commercial bank. Generally, we require
a loan-to-value ratio of 75% or less on construction lending and we subject
each loan to our underwriting standards.
Construction loans involve risks different from completed project lending
because we advance loan funds based upon the security of the project under
construction. If the borrower defaults on the loan, then we may have to
advance additional funds to finance the project's completion before the
project can be sold. Moreover, construction projects are affected by
uncertainties inherent in estimating:
. construction costs;
. potential delays in construction time;
. market demand; and
. the accuracy of the estimate of value on the completed project.
When providing construction loans, we require the general contractor to, among
other things, carry contractor's liability insurance equal to specific
prescribed minimum amounts, carry builder's risk insurance and have a blanket
bond against employee misappropriation.
Commercial Lending
We originate commercial loans and revolving lines of credit, and issue
standby letters of credit for our middle market commercial customers. We offer
the various credit products on both a secured and unsecured basis with
interest rates being either fixed or variable. Our portfolio emphasis is
toward secured, floating rate credit facilities. Our commercial banking group
directs these activities and focuses on our long-term-relationship-based
customers. We also utilize our retail branch network as a source of commercial
customers, with the lending to these customers being typically managed by the
branch manager. We believe our commercial borrowers are desirable because
these borrowers generally have lower cost deposit accounts.
Consumer Lending
We originate fixed rate automobile loans primarily through an indirect
lending program of Downey Auto Finance Corp. which uses preapproved automobile
dealers to finance consumer purchases of new and used automobiles. Downey Auto
Finance Corp. has centralized this operation at our headquarters and uses
technology to process and evaluate loan applications, including credit scoring
and the automated retrieval of consumer credit bureau files. In addition to
indirect automobile lending through Downey Auto Finance Corp., the Bank
originates direct automobile loans, home equity loans and lines of credit, and
other consumer loan products. Before we make a consumer loan, we assess the
applicant's ability to repay the loan and, if applicable, the value of the
collateral securing the loan. The risk involved with home equity loans and
lines of credit is similar to the risk involved with residential real estate
loans. We offer customers a credit card through a third party, who extends the
credit and services the loans made to our customers.
Investment Activities
Federal and state regulations require the Bank to maintain a specified
minimum amount of liquid assets invested in particular short-term obligations
and other securities. For additional information regarding liquidity
requirements and the Bank's compliance with the liquidity requirements, see
"Regulation--Regulation of the Bank--Liquidity Requirements" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Financial Condition for the Year Ended December 31, 1998--Capital Resources
and Liquidity", and "--Financial Condition for the Quarter Ended March 31,
1999--Capital Resources and Liquidity." As a federally chartered savings
association, the Bank's ability to make other securities investments
89
<PAGE>
is prescribed under the OTS regulations and the Home Owners' Loan Act. The
Bank's authorized officers make investment decisions within guidelines
established by the Bank's Board of Directors. The Bank manages these
investments in an effort to produce the highest yield, while at the same time
maintaining safety of principal, minimizing our interest rate risk and
complying with applicable regulations.
We carry securities held for investment at cost. We adjust these costs for
amortization of premiums and accretion of discounts, which we recognize as
interest income using the interest method. We carry securities available for
sale at market value. We exclude unrealized holding gains and losses, or
valuation allowances established for net unrealized losses, from our earnings
and report them as a separate component of our stockholders' equity as
accumulated other comprehensive income, net of income taxes, unless the
security is deemed other than temporarily impaired. If the security is
determined to be other than temporarily impaired, we charge the amount of the
impairment to operations. For further information on the composition of our
investment portfolio, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Financial Condition for the Year Ended
December 31, 1998--Investment Securities."
Sources of Funds
Deposits
We prefer to use deposits as our principal source of funds for supporting
our lending activities, because the cost of these funds generally is less than
that of borrowings or other funding sources with comparable maturities. We
traditionally have obtained our savings deposits primarily from areas
surrounding the Bank's Southern and Northern California branch offices.
However, we occasionally raise some retail deposits through Wall Street
activities.
General economic conditions affect deposit flows. Funds may flow from
depository institutions like savings associations into direct vehicles like
government and corporate securities or other financial intermediaries. Our
ability to attract and retain deposits will continue to be affected by money
market conditions and prevailing interest rates. Generally, state or federal
regulation does not restrict interest rates we pay on deposits.
In 1996, we began establishing full-service branch facilities in selected
supermarket locations throughout Southern California. Each in-store branch
offers a full range of financial services including checking and savings
accounts as well as residential and consumer loans.
When consistent with our maintenance of appropriate capital levels, we may
consider opportunities to augment our retail branch system and deposit base
through our acquisition of selected branches or deposits.
For further information, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition for the
Year Ended December 31, 1998--Deposits" and "--Financial Condition for the
Quarter Ended March 31, 1999--Deposits."
Borrowings
Our principal source of funds has been and continues to be deposits we raise
through our retail branch system. At various times, however, we have utilized
other sources to fund our loan origination and other business activities. We
have at times relied upon our borrowings from the FHLB of San Francisco as an
additional source of funds. The FHLB makes advances to us through several
different credit programs it offers.
In 1994, we initiated a program to sell commercial paper supported by an
irrevocable letter of credit issued by the FHLB of San Francisco. However, we
terminated this program in 1998 because it was no longer cost effective
compared to other funding sources.
From time to time, we obtain additional sources of funds by selling some of
our securities and mortgage loans under agreements to repurchase. These
reverse repurchase agreements are generally short-term, and are
90
<PAGE>
collateralized by our mortgage-backed or investment securities and our
mortgage loans. We only deal with investment banking firms that are recognized
as primary dealers in U.S. government securities or major commercial banks in
connection with these reverse repurchase agreements. In addition, we limit the
amounts of our borrowings from any single institution.
For further information, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition for the
Year Ended December 31, 1998--Borrowings" and "--Financial Condition for the
Quarter Ended March 31, 1999--Borrowings."
Asset/Liability Management
Savings institutions are affected by interest rate risks to the degree that
their interest-bearing liabilities, consisting principally of customer
deposits, FHLB advances and other borrowings, mature or reprice more rapidly,
or on a different basis, than their interest-earning assets, which consist
predominantly of intermediate or long-term real estate loans. While having
liabilities that on average mature or reprice more frequently than assets may
be beneficial in times of declining interest rates, this asset/liability
structure may result in declining net earnings during periods of rising
interest rates. One of our principal objectives is to manage the effects of
adverse changes in interest rates on our net interest income while maintaining
our asset quality and an acceptable interest rate spread. To improve the rate
sensitivity and maturity balance of our interest-earning assets and
liabilities, we have over the past several years emphasized the origination of
loans with adjustable interest rates or relatively short maturities. Loans
with adjustable interest rates have the beneficial effect of allowing the
yield on our assets to increase during periods of rising interest rates,
although these loans have contractual limitations on the frequency and extent
of interest rate adjustments.
For further information see "Business--Lending Activities" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Financial Condition for the Year Ended December 31, 1998--Asset/Liability
Management and Market Risk" and "--Financial Condition for the Quarter Ended
March 31, 1999--Asset/Liability Management and Market Risk."
Earnings Spread
We determine our net interest income by calculating the difference or the
interest rate spread, between:
. the yields we earn on our interest-earning assets like loans, mortgage-
backed securities and investment securities; and
. the interest we pay on our interest-bearing liabilities like deposits
and borrowings.
Our net interest income is also determined by the relative dollar amounts of
our interest-earning assets and interest-bearing liabilities.
Our effective interest rate spread, which reflects the relative level of our
interest-earning assets to our interest-bearing liabilities, equals:
. the difference between interest income on our interest-earning assets
and interest expense on our interest-bearing liabilities divided by
. our average interest-earning assets for the period.
For information regarding our net income and its components and for
management's analysis of our financial condition and results of operations,
see "Management's Discussion and Analysis of Financial Condition and Results
of Operations." For returns on our assets and other selected financial data
see "Selected Consolidated Financial Data."
91
<PAGE>
REAL ESTATE INVESTMENT ACTIVITIES
In addition to our primary business of banking, which has been described
above, we are also involved in real estate investment activities, which is
conducted primarily through DSL Service Company, a wholly owned subsidiary of
the Bank. DSL Service Company is a diversified real estate development company
which was established in 1966 as a neighborhood shopping center and
residential tract developer, as well as the general contractor for the Bank's
branch locations. Today its capabilities include development, construction and
property management activities relating to its portfolio of projects primarily
within California, but also in Arizona. In addition to DSL Service Company
developing its own real estate projects, it associates with other qualified
developers to engage in joint ventures. The primary revenue sources of our
real estate investment activities include net rental income and gains from the
sale of real estate investments. The primary expenses of our real estate
investment activities are interest expense and general and administrative
expense.
Before Congress passed the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 ("FIRREA"), the Bank conducted real estate development
and joint venture operations directly, in addition to operations conducted
through DSL Service Company. Since FIRREA, however, the Bank's ability to
engage in new real estate development and joint venture activities and to
retain its existing real estate investments has been curtailed dramatically.
In addition, these activities may be economically unfeasible for the Bank
because of the capital requirements FIRREA imposes on these activities. FIRREA
requires, with some limited exceptions, a savings institution like the Bank to
exclude from the Bank's regulatory capital:
. the Bank's investments in, and extensions of credit to, real estate
subsidiaries like DSL Service Company; and
. the Bank's direct equity investments in real estate development and
joint venture operations.
FIRREA also prohibits the Bank from making new investments in real estate
development and joint venture operations.
Since July 1, 1996, the Bank has been required to deduct the full amount of
its investment in DSL Service Company in calculating its applicable ratios
under the core, tangible and risk-based capital standards. Savings
associations generally may invest in service corporation subsidiaries, like
DSL Service Company, to the extent of 2% of the association's assets, plus up
to an additional 1% of assets for investments which serve primarily community,
inner-city or community development purposes. In addition, "conforming loans"
by an association to DSL's joint venture partnerships are limited to 50% of
the association's risk-based capital. "Conforming loans" are those generally
limited to 80% of appraised value, bear a market rate of interest and require
payments sufficient to amortize the principal balance of the loan. We are in
compliance with each of these investment limitations.
To the extent Downey or a subsidiary of Downey, other than the Bank or its
subsidiaries, makes real estate investments, the above-mentioned capital
deductions and limitations do not apply as they only pertain to the specific
investments by savings associations or their subsidiaries.
For further information, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition for the
Year Ended December 31, 1998--Investments in Real Estate and Joint Ventures."
COMPETITION
We face competition both in attracting deposits and in making loans. Our
most direct competition for deposits has historically come from other savings
institutions and from commercial banks located in our principal market areas,
including many large financial institutions based in other parts of the
country or their subsidiaries. In addition, we face additional significant
competition for investors' funds from short-term money market securities and
other corporate and government securities. Our ability to attract and retain
savings deposits depends, generally, on our ability to provide a rate of
return, liquidity and risk comparable to that offered by competing investment
opportunities and the appropriate level of customer service.
92
<PAGE>
We experience competition for real estate loans principally from other
savings institutions, commercial banks, mortgage banking companies and
insurance companies. We compete for loans principally through our interest
rates and loan fees we charge and our efficiency and quality of services we
provide borrowers and real estate brokers.
EMPLOYEES
At March 31, 1999, we had approximately 1,369 full-time employees and 425
part-time employees. We provide our employees with health and welfare benefits
and a retirement and savings plan. Additionally, we offer qualifying employees
participation in our stock purchase plan. Our employees are not represented by
any union or collective bargaining group, and we consider our employee
relations to be good.
REGULATION
General
Federal and state law extensively regulates savings and loan holding
companies and savings associations. This regulation is intended primarily for
the protection of our depositors and the SAIF and not for the benefit of our
stockholders. In the following information, we describe some of the
regulations applicable to Downey and the Bank. We do not claim this discussion
is complete and qualify our discussion in its entirety by reference to
applicable statutory or regulatory provisions.
Regulation of Downey
General
Downey is a savings and loan holding company that holds only one savings and
loan association. Downey is subject to regulatory oversight by the OTS. Thus,
Downey is required to register and file reports with the OTS and is regulated
and examined by the OTS. In addition, the OTS has enforcement authority over
us, which also permits the OTS to restrict or prohibit our activities that it
determines to be a serious risk to the Bank.
Activities Restrictions
As a savings and loan holding company that holds only one savings and loan
association, Downey generally is not limited by OTS activity restrictions,
provided the Bank:
. satisfies the OTS's qualified thrift lender test; or
. meets the definition of a domestic building and loan association in
section 7701 of the Internal Revenue Code of 1986, as amended.
If Downey acquires control of another savings association as a separate
subsidiary, it would become a multiple savings and loan holding company. As a
multiple savings and loan holding company, our activities, other than the
activities of the Bank or any other SAIF-insured savings association, would
become subject to restrictions applicable to bank holding companies unless
these other savings associations were acquired in a supervisory acquisition
and each also:
. satisfies the qualified thrift lender test; or
. meets the definition of a domestic building and loan association.
For more information, see "Regulation of the Bank--Qualified Thrift Lender
Test."
Restrictions on Acquisitions
Downey must obtain approval from the OTS before acquiring control of any
other SAIF-insured association. The OTS generally prohibits these types of
acquisitions if they result in a multiple savings and loan holding
93
<PAGE>
company controlling savings associations in more than one state. However, the
OTS permits interstate acquisitions if the acquisition is:
. authorized by specific state authorization; or
. a supervisory acquisition of a failing savings association.
Federal law generally provides that no "person," acting directly or
indirectly or through or in concert with one or more other persons, may
acquire "control," as that term is defined in OTS regulations, of a federally
insured savings association without:
. giving at least 60 days written notice to the OTS; and
. providing the OTS an opportunity to disapprove the proposed acquisition.
In addition, no company may acquire control of this type of an institution
without prior OTS approval. These provisions also prohibit, among other
things, any director or officer of a savings and loan holding company, or any
individual who owns or controls more than 25% of the voting shares of a
savings and loan holding company, from acquiring control of any savings
association not a subsidiary of the savings and loan holding company, unless
the acquisition is approved by the OTS.
Regulation of the Bank
As a federally chartered, SAIF-insured savings association, the Bank is
extensively regulated by the OTS and the FDIC. The Bank must ensure that its
lending activities and its other investments comply with various statutory and
regulatory requirements. The Bank is also regulated by the Federal Reserve.
The OTS, in conjunction with the FDIC, regularly examines the Bank and
prepares reports for the Bank's Board of Directors to consider with respect to
any deficiencies the OTS or the FDIC finds in the Bank's operations. Federal
and state laws also regulate the relationship between the Bank and its
depositors and borrowers, especially in matters regarding the ownership of
savings accounts and the form and content of mortgage documents the Bank uses.
The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition. In addition the Bank must obtain
regulatory approvals before it enters into some transactions like mergers with
or acquisitions of other financial institutions. This regulation and
supervision establishes a comprehensive framework of activities in which an
institution may engage and is intended primarily for the protection of the
SAIF and our depositors. The regulatory structure also gives the regulatory
authorities extensive discretion in connection with their supervisory and
enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in regulations, whether by
the OTS, the FDIC or the Congress, could have a material adverse impact on us,
the Bank and our operations.
Insurance of Deposit Accounts
The SAIF, as administered by the FDIC, insures the Bank's deposit accounts
up to the maximum amount permitted by law. The FDIC may terminate insurance of
deposits upon a finding that the institution:
. has engaged in unsafe or unsound practices;
. is in an unsafe or unsound condition to continue operations; or
. has violated any applicable law, regulation, rule, order or condition
imposed by the FDIC or the institution's primary regulator.
The FDIC charges an annual assessment for the insurance of deposits based on
the risk that a particular institution poses to its deposit insurance fund.
Under this system as of December 31, 1995, SAIF members paid within a range of
23 cents to 31 cents per $100 of domestic deposits, depending upon the
institution's risk
94
<PAGE>
classification. This risk classification is based on an institution's capital
group and supervisory subgroup assignment. Under the Paperwork Reduction Act,
the FDIC imposed a special assessment on SAIF members to capitalize the SAIF
at the designated reserve level of 1.25% as of October 1, 1996. Based on the
Bank's deposits as of March 31, 1995, the date for measuring the amount of the
special assessment as stated in the Act, the Bank paid a special assessment of
$24.6 million in November 1996 to recapitalize the SAIF. This expense was
recognized during the last quarter of 1996.
Under the Paperwork Reduction Act, the Bank pays, in addition to its normal
deposit insurance premium as a member of the SAIF, which ranges currently from
0 to 27 cents per $100 of domestic deposits, an amount equal to 6.10 cents per
$100 of domestic deposits on an annual basis as of the first quarter of 1999
toward the retirement of financing corporation bonds issued in the 1980s to
assist in the recovery of the savings and loan industry. Members of the BIF,
by contrast, pay, in addition to their normal deposit insurance premium,
approximately 1.22 cents per $100 of domestic deposits on an annual basis as
of the first quarter of 1999.
The Paperwork Reduction Act also provides:
. that the FDIC is not permitted to establish SAIF assessment rates that
are lower than comparable BIF assessment rates;
. that beginning no later than January 1, 2000, the rate paid to retire
the financing corporation bonds will be equal for members of the BIF and
the SAIF; and
. for the merging of the BIF and the SAIF by January 1, 1999, provided
that there are no financial institutions still chartered as savings and
loans by January 1, 1999.
Although legislation to eliminate the savings association charter had been
proposed in prior sessions of Congress, that legislation was not enacted.
Therefore, at January 1, 1999, financial institutions like the Bank are still
chartered as savings associations, and the current "financial modernization"
proposals do not contain provisions that would eliminate the federal
association charter. Should the insurance funds be merged before January 1,
2000, however, the rate paid by all members of this new fund to retire the
financing corporation bonds would be equal.
Regulatory Capital Requirements
OTS capital regulations require savings associations to meet three capital
standards:
. tangible capital equal to 1.5% of total adjusted assets;
. leverage capital, or "core capital," equal to 3% of total adjusted
assets for institutions such as the Bank; and
. risk-based capital equal to 8.0% of total risk-based assets.
The Bank must meet each of these standards to be deemed in compliance with OTS
capital requirements. In addition, the OTS may require a savings association
to maintain capital above the minimum capital levels.
Under OTS regulations, a savings association with a greater than "normal"
level of interest rate exposure must deduct an interest rate risk component in
calculating its total capital for purposes of determining whether it meets its
risk-based capital requirement. Interest rate exposure is measured, generally,
as equal to:
. the decline in an institution's net portfolio value that would result
from a 200 basis point increase or decrease in market interest rates,
whichever would result in a lower net portfolio value, divided by
. the estimated economic value of the savings association's assets.
The interest rate risk component a savings association must deduct from its
total capital is equal to:
. one-half of the difference between an institution's measured exposure
and "normal" interest rate risk exposure, which the OTS defines as 2%,
multiplied by
. the estimated economic value of the institution's assets.
95
<PAGE>
In August 1995, the OTS indefinitely delayed implementation of its interest
rate risk regulation. However, based on the asset/liability structure of the
Bank, at March 31, 1999, the Bank would not have been required to deduct an
interest rate risk component in calculating its total risk-based capital had
OTS's interest rate risk regulation been in effect.
The OTS views its capital regulation requirements as minimum standards, and
it expects most institutions to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that the OTS may establish
minimum capital levels higher than those provided in the regulations for
individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its
circumstances. The OTS regulations provide that higher individual minimum
regulatory capital requirements may be appropriate in circumstances where,
among others:
. a savings association has a high degree of exposure to interest rate
risk, prepayment risk, credit risk, concentration of credit risk, other
risks arising from nontraditional activities, or similar risks or a high
proportion of off-balance sheet risk;
. a savings association is growing, either internally or through
acquisitions, at a rate that supervisory problems are presented that are
not dealt with adequately by OTS regulations; and
. a savings association may be adversely affected by activities or
condition of its holding company, affiliates, subsidiaries, or other
persons, or savings associations with which it has significant business
relationships.
The Bank is not required to meet any individual minimum regulatory capital
requirement and the Bank's regulatory capital exceeded all minimum regulatory
capital requirements as of March 31, 1999.
The Home Owners' Loan Act permits savings associations not in compliance
with the OTS capital standards to seek an exemption from penalties or
sanctions for noncompliance. The OTS will grant an exemption only if the
savings association meets strict requirements. In addition, the OTS must deny
the exemption in some circumstances. If the OTS does grant an exemption, the
savings association still may be exposed to enforcement actions for other
violations of law or unsafe or unsound practices or conditions.
Prompt Corrective Action
The OTS's prompt corrective action regulation requires the OTS to take
mandatory actions and authorizes the OTS to take discretionary actions against
a savings association that falls within undercapitalized capital categories
specified in the regulation.
The regulation establishes five categories of capital classification:
. "well capitalized;"
. "adequately capitalized;"
. "undercapitalized;"
. "significantly undercapitalized;" and
. "critically undercapitalized."
The regulation uses an institution's risk-based capital, leverage capital and
tangible capital ratios to determine the institution's capital classification.
At March 31, 1999, the Bank exceeded the capital requirements of a well
capitalized institution under applicable OTS regulations.
In general, the prompt corrective action regulation prohibits an insured
depository institution from:
. declaring any dividends;
. making any other capital distribution; or
. paying a management fee to a controlling person,
96
<PAGE>
if, following the distribution or payment, the institution would be within any
of the three undercapitalized categories. In addition, adequately capitalized
institutions may accept brokered deposits only with a waiver from the FDIC and
are restricted with respect to the interest rates that can be paid on these
deposits. Undercapitalized institutions may not accept, renew, or roll-over
brokered deposits.
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may:
. if the institution is well capitalized, reclassify it as adequately
capitalized;
. if the institution is adequately capitalized but not well capitalized,
require it to comply with restrictions applicable to undercapitalized
institutions; and
. if the institution is undercapitalized, require it to comply with
specific restrictions applicable to significantly undercapitalized
institutions.
Loans-to-One-Borrower
Savings associations generally are subject to the lending limits applicable
to national banks. With limited exceptions, the maximum amount that a savings
association or a national bank may lend to any borrower, including some
related entities of the borrower, at one time may not exceed:
. 15% of the unimpaired capital and surplus of the institution, plus
. for loans fully secured by readily marketable collateral, an additional
10% of unimpaired capital and surplus.
Savings associations are additionally authorized to make loans to one
borrower, for any purpose:
. in an amount not to exceed $500,000; or
. by order of the Director of OTS, in an amount not to exceed the lesser
of $30,000,000 or 30% of unimpaired capital and surplus to develop
residential housing, provided:
. the purchase price of each single-family dwelling in the development
does not exceed $500,000;
. the savings association is in compliance with its capital
requirements;
. the loans comply with applicable loan-to-value requirements; and
. the aggregate amount of loans made under this authority does not
exceed 150% of unimpaired capital and surplus.
At March 31, 1999, the Bank's loans-to-one-borrower limit was $76 million
based upon the 15% of unimpaired capital and surplus measurement.
Qualified Thrift Lender Test
The OTS requires savings associations to meet a qualified thrift lender
test, which may be met as follows:
. either by maintaining a specified level of assets in qualified thrift
investments as specified in the Home Owners' Loan Act; or
. by meeting the definition of a "domestic building and loan association"
in section 7701 of the Internal Revenue Code.
The required percentage of investments under the Home Owners' Loan Act is 65%
of assets while the Internal Revenue Code requires investments of 60% of
assets. An association must be in compliance with the qualified thrift lender
test or the definition of domestic building and loan association on a monthly
basis in nine out of every 12 months. Associations failing to meet the
qualified thrift lender test are generally allowed only to engage in
activities permitted for both national banks and savings associations.
97
<PAGE>
In connection with the qualified thrift lender test, the Bank will continue
to enjoy full borrowing privileges from the FHLB if the Bank:
. maintains an appropriate level of these specified investments, which are
primarily residential mortgages and related investments, including some
mortgage-related securities, and otherwise qualifies as a qualified
thrift lender; or
. meets the definition of a domestic building and loan association.
As of March 31, 1999, the Bank was in compliance with its qualified thrift
lender test requirement and met the definition of a domestic building and loan
association.
Affiliate Transactions
Transactions between a savings association and its "affiliates" are
quantitatively and qualitatively restricted under Sections 23A and 23B of the
Federal Reserve Act. Affiliates of a savings association include, among other
entities, the savings association's holding company and companies that are
under common control with the savings association.
In general, Sections 23A and 23B and OTS regulations issued in connection
with these sections limit the extent to which a savings association or its
subsidiaries may engage in "covered transactions" with affiliates:
. to an amount equal to 10% of the association's capital and surplus, in
the case of covered transactions with any one affiliate; and
. to an amount equal to 20% of the association's capital and surplus, in
the case of covered transactions with all affiliates.
In addition, a savings association and its subsidiaries may engage in
covered transactions and other specified transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction"
includes:
. a loan or extension of credit to an affiliate;
. a purchase of investment securities issued by an affiliate;
. a purchase of assets from an affiliate, with some exceptions;
. the acceptance of securities issued by an affiliate as collateral for a
loan or extension of credit to any party; or
. the issuance of a guarantee, acceptance, or letter of credit on behalf
of an affiliate.
In addition, under the OTS regulations:
. a savings association may not make a loan or extension of credit to an
affiliate unless the affiliate is engaged only in activities permissible
for bank holding companies;
. a savings association may not purchase or invest in securities of an
affiliate other than shares of a subsidiary;
. a savings association and its subsidiaries may not purchase a low-
quality asset from an affiliate;
. covered transactions and other specified transactions between a savings
association or its subsidiaries and an affiliate must be on terms and
conditions that are consistent with safe and sound banking practices;
and
. with some exceptions, each loan or extension of credit by a savings
association to an affiliate must be secured by collateral with a market
value ranging from 100% to 130%, depending on the type of collateral, of
the amount of the loan or extension of credit.
98
<PAGE>
The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve decides to treat
these subsidiaries as affiliates. The regulation also requires savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail, and provides that specified classes of savings associations
may be required to give the OTS prior notice of affiliate transactions.
Capital Distribution Limitations
OTS regulations impose limitations upon all capital distributions by savings
associations, like cash dividends, payments to repurchase or otherwise acquire
its shares, payments to shareholders of another institution in a cash-out
merger and other distributions charged against capital. The OTS recently
adopted an amendment to these capital distribution limitations. Under the new
rule, a savings association in some circumstances may:
. be required to file an application and await approval from the OTS
before it makes a capital distribution;
. be required to file a notice 30 days before the capital distribution; or
. be permitted to make the capital distribution without notice or
application to the OTS.
The OTS regulations require the savings association to file an application
if:
. it is not eligible for expedited treatment of its other applications
under OTS regulations;
. the total amount of all of capital distributions, including the proposed
capital distribution, for the applicable calendar year exceeds its net
income for that year to date plus retained net income for the preceding
two years;
. it would not be at least adequately capitalized, under the prompt
corrective action regulations of the OTS following the distribution; or
. the association's proposed capital distribution would violate a
prohibition contained in any applicable statute, regulation, or
agreement between the savings association and the OTS, or the FDIC, or
violate a condition imposed on the savings association in an OTS-
approved application or notice.
In addition, a savings association must give the OTS notice of a capital
distribution if the savings association is not required to file an
application, but:
. would not be well capitalized under the prompt corrective action
regulations of the OTS following the distribution;
. the proposed capital distribution would reduce the amount of or retire
any part of the savings association's common or preferred stock or
retire any part of debt instruments like notes or debentures included in
capital, other than regular payments required under a debt instrument
approved by the OTS; or
. the savings association is a subsidiary of a savings and loan holding
company.
If neither the savings association nor the proposed capital distribution
meet any of the above listed criteria, the OTS does not require the savings
association to submit an application or give notice when making the proposed
capital distribution. The OTS may prohibit a proposed capital distribution
that would otherwise be permitted if the OTS determines that the distribution
would constitute an unsafe or unsound practice.
Activities of Subsidiaries
A savings association seeking to establish a new subsidiary, acquire control
of an existing company or conduct a new activity through a subsidiary must
provide 30 days prior notice to the FDIC and the OTS and conduct any
activities of the subsidiary in compliance with regulations and orders of the
OTS. The OTS has the power to require a savings association to divest any
subsidiary or terminate any activity conducted by a subsidiary that the OTS
determines to pose a serious threat to the financial safety, soundness or
stability of the savings association or to be otherwise inconsistent with
sound banking practices.
99
<PAGE>
Year 2000 Compliance
The Federal Financial Institutions Examination Council issued an interagency
statement to the chief executive officers of all federally supervised
financial institutions regarding year 2000 project management awareness. It is
expected that unless financial institutions address the technology issues
relating to the coming of the year 2000, there will be major disruptions in
the operations of financial institutions. The statement provides guidance to
financial institutions, providers of data services, and all examining
personnel of the federal banking agencies regarding the year 2000 problem. The
federal banking agencies intend to conduct year 2000 compliance examinations,
and our failure to implement a year 2000 program may be seen by the federal
banking agencies as an unsafe and unsound banking practice. If a federal
banking agency determines that the Bank is operating in an unsafe and unsound
manner, the Bank may be required to submit a compliance plan. The Bank's
failure to submit a compliance plan or to implement an accepted plan may
result in enforcement action being taken, which may include a cease and desist
order and fines.
Community Reinvestment Act and the Fair Lending Laws
Savings associations have a responsibility under the Community Reinvestment
Act and related regulations of the OTS to help meet the credit needs of their
communities, including low- and moderate-income neighborhoods. In addition,
the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders
from discriminating in their lending practices on the basis of characteristics
specified in those statutes. An institution's failure to comply with the
provisions of the Community Reinvestment Act could, at a minimum, result in
regulatory restrictions on its activities and the denial of applications. In
addition, an institution's failure to comply with the Equal Credit Opportunity
Act and the Fair Housing Act could result in the OTS, other federal regulatory
agencies as well as the Department of Justice taking enforcement actions.
Federal Home Loan Bank System
The Bank is a member of the FHLB system. Among other benefits, each FHLB
serves as a reserve or central bank for its members within its assigned
region. Each FHLB is financed primarily from the sale of consolidated
obligations of the FHLB system. Each FHLB makes available loans or advances to
its members in compliance with the policies and procedures established by the
Board of Directors of the individual FHLB.
As an FHLB member, the Bank is required to own capital stock in an FHLB in
an amount equal to the greater of:
. 1% of its aggregate outstanding principal amount of its residential
mortgage loans, home purchase contracts and similar obligations at the
beginning of each calendar year;
. 0.3% of total assets; or
. 5% of its FHLB advances or borrowings.
At March 31, 1999, the Bank had $50 million of FHLB stock. The Bank's
required investment in FHLB stock, based on December 31, 1998 financial data,
was $52 million. The Bank has subsequently purchased additional stock, thereby
increasing the Bank's investment to the required amount.
Liquidity Requirements
Under OTS regulations, a savings association is required to maintain an
average daily balance of liquid assets. These liquid assets include cash, some
time deposits and savings accounts, bankers' acceptances, some government
obligations, and other investments. The OTS requires a savings association to
maintain an average daily balance of liquid assets in each calendar quarter of
not less than 4% of either:
. its liquidity base, which consists of some net withdrawable accounts
plus short-term borrowings, as of the end of the preceding calendar
quarter; or
. the average daily balance of its liquidity base during the preceding
quarter.
100
<PAGE>
The OTS may change this liquidity requirement from time to time to any
amount between 4% and 10%, depending upon factors, including economic
conditions and savings flows of all savings associations. The Bank maintains
liquid assets in compliance with these regulations. The OTS may impose
monetary penalties upon an institution for violations of liquidity
requirements.
Federal Reserve System
The Federal Reserve requires all depository institutions to maintain non-
interest-bearing reserves at specified levels against their transaction
accounts and non-personal time deposits. These transaction accounts include
checking, NOW, and Super NOW checking accounts. The balances a savings
association maintains to meet the reserve requirements imposed by the Federal
Reserve may be used to satisfy the liquidity requirements that are imposed by
the OTS. At March 31, 1999, the Bank was in compliance with these
requirements.
Recent Proposed Legislation
During the past several years, Congress has considered legislation in
various forms that would require federal thrifts, like the Bank, to convert
their charters to national or state bank charters. The Paperwork Reduction Act
requires a merger of the BIF and the SAIF into a single deposit insurance fund
if Congress enacts legislation to eliminate the federal thrift charter. While
none of the "financial modernization" proposals currently being debated in
Congress would, in fact, eliminate the federal thrift charter, it is possible
that legislation will be introduced that would do so. In that event, and in
the absence of appropriate "grandfather" provisions, legislation eliminating
the thrift charter could have a material adverse effect on us and the Bank
because, among other things, the regulatory, capital and accounting treatment
for national and state banks and savings associations differ significantly in
some areas. We cannot determine whether, or in what form, this legislation may
eventually be enacted and there can be no assurance that any legislation that
is enacted would contain adequate grandfather provisions for us and the Bank.
Regulation of DSL Service Company
DSL Service Company is licensed as a real estate broker under the California
Real Estate Law and as a contractor with the Contractors State License Board.
Thus, the real estate investment activities of DSL Service Company, including
development, construction and property management activities relating to its
portfolio of projects, are governed by a variety of laws and regulations.
Changes in the laws and regulations or their interpretation by agencies and
the courts occur frequently. DSL Service Company must comply with various
federal, state and local laws, ordinances, rules and regulations concerning
zoning, building design, construction, hazardous waste, and similar matters.
Environmental laws and regulations also affect the operations of DSL Service
Company, including regulations pertaining to availability of water, municipal
sewage treatment capacity, land use, protection of endangered species,
population density and preservation of the natural terrain and coastlines.
These and other requirements could become more restrictive in the future,
resulting in additional time and expense in connection with DSL Service
Company's real estate activities.
With regard to environmental matters, the construction products industry is
regulated by federal, state and local laws and regulations pertaining to
several areas including human health and safety and environmental compliance.
The Comprehensive Environmental Response, Compensation, and Liability Act of
1980, as amended by the Superfund Amendments and Reauthorization Act of 1986,
as well as analogous laws in some states, create joint and several liability
for the cost of cleaning up or correcting releases to the environment of
designated hazardous substances. Among those who may be held jointly and
severally liable are:
. those who generated the waste;
. those who arranged for disposal;
. those who owned or operate the disposal site or facility at the time of
disposal; and
. current owners.
101
<PAGE>
In general, this liability is imposed in a series of governmental
proceedings initiated by the government's identification of a site for initial
listing as a "Superfund site" on the National Priorities List or a similar
state list and the government's identification of potentially responsible
parties who may be liable for cleanup costs. None of the DSL Service Company's
project sites are listed as a "Superfund site."
In addition, California courts have imposed warranty-like responsibility
upon developers of new housing for defects in structure and the housing site,
including soil conditions. This responsibility is not necessarily dependent
upon a finding that the developer was negligent.
As a licensed entity, DSL Service Company is also examined and supervised by
the California Department of Real Estate and the Contractors State License
Board.
Taxation
Federal
A savings institution generally is taxed in the same manner as other
corporations for federal income tax purposes, though savings institutions have
historically enjoyed favorable treatment under the Internal Revenue Code in
determining their deductions for bad debts. During 1996, however, Congress
enacted legislation that repealed the reserve method of determining bad debt
deductions for large thrift institutions or thrifts with assets greater than
$500 million. As a result, savings associations are required to comply with
rules similar to those currently applicable to large commercial banks.
Congress made the repeal effective for tax years beginning after 1995.
Accordingly, bad debt reserves accumulated by savings institutions since 1987
were subject to recapture as taxable income over a six-year period beginning
in 1996. However, Congress allowed thrifts to defer recapture for up to two
years if the amount of mortgage loans the thrift originated in 1996 and 1997
equaled or exceeded the average amount of mortgages the thrift originated in
the six years before 1996. Based upon the Bank's mortgage originations in 1996
and 1997, the Bank qualifies for the two-year deferral under this test, and
began to recapture its post-1987 bad debt reserve over a six-year period
beginning in 1998. The Bank's bad debt deductions for 1997 and 1998 were
determined under the specific charge-off method, which allows the Bank to take
a tax deduction for loans determined to be wholly or partially worthless.
In addition to the regular corporate income tax, corporations, including
qualifying savings institutions, might be required to pay an alternative
minimum tax. This 20% tax is computed with respect to the corporation's
regular taxable income, with some adjustments, as increased by tax preference
items and called "alternative minimum taxable income." This alternative
minimum income tax applies to corporations to the extent that the
corporation's alternative minimum taxable income exceeds the corporation's
regular tax liability. In computing a corporation's alternative minimum
taxable income, the corporation's regular taxable income is required to be
increased by 75% of:
. the excess of the corporation's current earnings and profits, as
adjusted, over
. the corporation's alternative minimum taxable income determined before
this adjustment and without regard to the alternative tax net operating
loss deduction.
A corporation that incurs alternative minimum tax generally is entitled to
take this tax as a credit against its regular tax in later years to the extent
that the corporation's regular tax liability in these later years, as reduced
by some other tax credits, exceeds the corporation's so-called "tentative
minimum tax." This tentative minimum tax is an amount computed by multiplying
the corporation's alternative minimum taxable income for the year by the then-
applicable rate for the alternative minimum tax.
State
The Bank uses a formula to compute its applicable California franchise tax.
This formula results in a rate higher than the rate applicable to non-
financial corporations because the rate reflects an amount "in lieu" of local
personal property and business license taxes paid by non-financial
corporations, but not generally paid by
102
<PAGE>
banks or financial corporations like the Bank. The Bank's variable tax rate
has been 10.84% since 1997. We file a California franchise tax return on a
combined reporting basis. We file additional state income tax returns on a
separate-entity basis in Arizona, Colorado, and Oregon. As the Bank expands
its lending business nationwide, the Bank may be required to file additional
state tax returns.
The Internal Revenue Service and state taxing authorities have examined our
tax returns for all tax years through 1995. We have protested proposed
adjustments for the years examined by the Internal Revenue Service, and are
currently moving through the appeals process. We believe that substantial
legal authority exists for the positions we have taken on the tax returns and
we intend to vigorously defend those positions. In addition we have made
adequate provisions for the potential exposure. Our tax years subsequent to
1995 remain open to review by federal and state tax authorities.
103
<PAGE>
DESCRIPTION OF THE CAPITAL SECURITIES
In this prospectus, unless the context requires otherwise, we use the terms
set forth below as follows:
. the "Indenture" means the Junior Subordinated Indenture between Downey
and Wilmington Trust Company, as trustee (the "Indenture Trustee"),
under which the junior subordinated debentures will be issued;
. the "Trust Agreement" means the Amended and Restated Trust Agreement
relating to the trust among Downey, as Depositor, Wilmington Trust
Company, as property trustee (the "Property Trustee"), Wilmington Trust
Company, as Delaware trustee (the "Delaware Trustee"), and the
administrative trustees (the "Administrative Trustees") named therein
(collectively, with the Property Trustee and Delaware Trustee, the
"Issuer Trustees"); and
. the "Guarantee Agreement" means the capital securities guarantee
agreement relating to the capital securities between Downey and
Wilmington Trust Company, as guarantee trustee (the "Guarantee
Trustee").
The capital securities and the common securities will be issued under the
terms of the Trust Agreement. The Trust Agreement will be qualified as an
indenture under the Trust Indenture Act of 1939, as amended (the "Trust
Indenture Act"). The Administrative Trustees will be officers of Downey.
The Property Trustee is the independent trustee whose sole responsibility is
to fulfill the obligations specified in the Trust Indenture Act and the Trust
Agreement. The terms of the capital securities will include those stated in
the Trust Agreement and those made part of the Trust Agreement by the Trust
Indenture Act. We do not purport to represent that this summary of terms and
provisions of the capital securities and the Trust Agreement is complete. It
is qualified in its entirety by reference to all the provisions of the Trust
Agreement, including the definitions of terms in the Trust Agreement, and the
Trust Indenture Act. Wherever particular defined terms of the Trust Agreement
are referred to in this prospectus, the defined terms are incorporated in this
prospectus. As used under this caption "Description of the Capital
Securities," all references to "Downey" mean Downey Financial Corp. excluding,
unless otherwise expressly stated or the context otherwise requires, its
subsidiaries. The form of the Trust Agreement has been filed as an exhibit to
the registration statement, together with all amendments and exhibits thereto
(the "Registration Statement"), of which this prospectus forms a part, and
copies of the Trust Agreement may be obtained as described under "Where You
Can Find More Information."
General
Under the terms of the Trust Agreement, the Administrative Trustees on
behalf of the trust will issue the capital securities and the common
securities, which we refer to collectively as the "Trust Securities." The
capital securities will be limited to $120,000,000 aggregate Liquidation
Amount, as defined below. The capital securities will represent undivided
beneficial interests in the assets of the trust. The holders of the capital
securities will be entitled to a preference in some circumstances with respect
to Distributions, as defined below, and amounts payable on redemption or
liquidation over the common securities of the trust, which will be held by
Downey, as well as other benefits as described in the Trust Agreement.
The capital securities will rank equally in right of payment with, and
payments will be made thereon pro rata with, the common securities of the
trust, except as described below under "--Subordination of Common Securities."
Legal title to the junior subordinated debentures will be held by the Property
Trustee in trust for the benefit of the holders of the Trust Securities. The
Guarantee Agreement executed by Downey for the benefit of the holders of the
capital securities will be a guarantee on a subordinated basis and will not
guarantee payment of Distributions or amounts payable on redemption of the
capital securities or on liquidation of the capital securities if the trust
does not have funds on hand available to make these payments. See "Description
of Guarantee."
104
<PAGE>
Distributions
Payment of Distributions. Holders of the capital securities will be entitled
to receive cumulative cash distributions accruing from the date of original
issuance and payable quarterly in arrears on the 15th day of March, June,
September and December of each year, unless there is a deferral as described
below. These payments, which we refer to as "Distributions," will commence on
September 15, 1999, at the annual rate of % of the Liquidation Amount of $25
per capital security. Each date on which Distributions are payable is referred
to as a "Distribution Date." The amount of each Distribution due with respect
to the capital securities will include amounts accrued to but excluding the
Distribution Date. The distribution payable on any Distribution Date will be
payable to registered holders of the capital securities at the close of
business on the immediately preceding regular record date, which will be the
15th day, whether or not a Business Day, immediately preceding the
Distribution Date.
The amount of Distributions payable for any period will be computed on the
basis of a 360-day year of twelve 30-day months. For any period less than a
full quarterly period, Distributions will be computed on the basis of the
actual number of days elapsed in a 30-day month. If any date on which
Distributions are payable on the capital securities is not a Business Day,
then payment of the Distributions payable on that date will be made on the
next Business Day, and without any interest or other payment in respect of
that delay, with the same force and effect as if made on the date the payment
was originally payable. As used in this prospectus, a "Business Day" shall
mean any day other than a Saturday or a Sunday, or a day on which banking
institutions in the City of New York are authorized or required by law or
executive order to remain closed.
The funds of the trust available for distribution to holders of its capital
securities will be limited to payments by Downey under the junior subordinated
debentures in which the trust will invest the proceeds from the issuance and
sale of its capital securities. For further information, see "Description of
Junior Subordinated Debentures." If Downey does not make interest payments on
the junior subordinated debentures, the Property Trustee will not have funds
available to pay Distributions on the capital securities. The payment of
Distributions, if and to the extent the trust has funds available for the
payment of Distributions, will be guaranteed on a subordinated basis by
Downey. For a more complete discussion of Downey's guarantee, see "Description
of Guarantee."
Extension Period. So long as no Debenture Event of Default, as defined
below, has occurred and is continuing, Downey will have the right under the
Indenture to defer the payment of interest on the junior subordinated
debentures at any time and from time to time for a period not exceeding 20
consecutive quarterly periods with respect to each period (each, an "Extension
Period"). However, no Extension Period may extend beyond the Stated Maturity,
as defined below, of the junior subordinated debentures or end on any date
other than an interest payment date for the junior subordinated debentures. As
a consequence of that election, the trust will defer quarterly Distributions
on the capital securities during any Extension Period. During an Extension
Period, interest on the junior subordinated debentures will continue to accrue
and Distributions on the capital securities will continue to accumulate in
each case with interest thereon to the extent permitted by law, compounded
quarterly, at the rate per annum of %. Because interest will continue to
accrue during an Extension Period, holders of capital securities will be
required to accrue interest income for United States federal income tax
purposes. For a more complete discussion of the tax consequences pertaining to
holders of capital securities, see "Certain Federal Income Tax Consequences--
Interest Income and Original Issue Discount." The term "Distributions" as used
in this prospectus shall include this interest on the deferred Distributions
and any other Additional Amounts, as defined below. During any Extension
Period, Downey may not itself and shall not allow any of its subsidiaries to:
. declare or pay any dividends or distributions on, or redeem, purchase,
acquire or make a liquidation payment with respect to, any of Downey's
capital stock, which includes common and preferred stock;
. make any payment of principal of or interest or premium, if any, on or
repay, repurchase or redeem any debt securities of Downey that rank on a
parity with or junior to the junior subordinated debentures in right of
payment;
105
<PAGE>
. redeem, purchase or acquire less than all of the junior subordinated
debentures or the capital securities; or
. make any guarantee payments with respect to any guarantee by Downey of
the debt securities of any subsidiary of Downey if the guarantee ranks
on parity with or junior to the junior subordinated debentures in right
of payment.
Notwithstanding the foregoing, during an Extension Period Downey and its
subsidiaries will be allowed to make:
. any dividend in a form of stock, warrants, options or other rights where
the dividend or the stock issuable upon the exercise of the warrants,
options or other rights is the same stock as that on which the dividend
is being paid or ranks on a parity with or junior to that stock in right
of payment;
. any declaration of a dividend in connection with the implementation of a
stockholders' rights plan or the issuance of stock under any
stockholders' rights plan in the future, or the redemption or repurchase
of any rights pursuant thereto;
. payments under the Guarantee Agreement; and
. purchases of common stock related to the issuance of common stock or
rights under any of Downey's benefit plans for its directors, officers
or employees.
Before the termination of any Extension Period, Downey may further extend
the Extension Period, provided that the Extension Period does not exceed 20
consecutive quarters or extend beyond the Stated Maturity.
If Downey shortens the Stated Maturity of the junior subordinated debentures
as described below under "Description of Junior Subordinated Debentures--
General" at any time while an Extension Period is in effect, and if the Stated
Maturity, as so shortened, would end before the last day of the Extension
Period, the Extension Period will be deemed to end on the Stated Maturity. If
the junior subordinated debentures are called for redemption on any date
before the end of an Extension Period, the Extension Period will be deemed to
end on that Redemption Date, as defined below, as to all of the capital
securities.
Upon the termination of any Extension Period and the payment of all amounts
then due, and so long as no Debenture Event of Default has occurred and is
continuing, Downey may elect to begin a new Extension Period. Each Extension
Period must end on a Distribution Date, and all deferred Distributions will be
payable on that Distribution Date to the persons in whose names the capital
securities are registered at the close of business on the immediately
preceding record date.
The Administrative Trustees will give notice of Downey's election to begin
or extend an Extension Period to the holders of the capital securities as
described below under "Description of Junior Subordinated Debentures--Option
to Defer Interest Payments."
Except as described above, there is no limitation on the number of times
that Downey may elect to begin an Extension Period. Downey has no current
intention of exercising its right to defer payments of interest by extending
the interest payment period on the junior subordinated debentures. Downey must
give the Issuer Trustees notice of its election of any Extension Period at
least one Business Day before the earlier of:
. the date the Distributions on the capital securities would have been
payable but for the election to begin or extend the Extension Period,
. the date the Administrative Trustees are required to give notice to the
New York Stock Exchange or any applicable stock exchange or automated
quotation system on which the capital securities are then listed or
quoted or to holders of the capital securities of the record date, or
. the date the Distributions are payable,
but, in any event not less than one Business Day before the applicable record
date.
106
<PAGE>
Redemption
Upon the repayment or redemption at any time, in whole or in part, of any
junior subordinated debentures, the proceeds from the repayment or redemption
shall be applied by the Property Trustee to redeem a Like Amount, as defined
below, of the Trust Securities. The Property Trustee will redeem the Trust
Securities upon not less than 30 nor more than 60 days' notice of a date of
redemption (the "Redemption Date"), at the Redemption Price, as defined below.
For a more complete discussion of the redemption procedures for the junior
subordinated debentures, see "Description of Junior Subordinated Debentures--
Redemption." If less than all of the junior subordinated debentures are to be
repaid or redeemed on a Redemption Date, then the proceeds from the repayment
or redemption shall be allocated to the redemption of the capital securities
and common securities pro rata, except as described below under "--Events of
Default; Notice."
Downey will have the right to redeem the junior subordinated debentures at a
redemption price equal to the accrued and unpaid interest on the junior
subordinated debentures to be redeemed to the date fixed for redemption, plus
100% of the principal amount of the junior subordinated debentures as follows:
. on or after , 2004, in whole at any time, or in part from time to
time; or
. before , 2004, in whole but not in part, within 90 days following
the occurrence and during the continuance of a Tax Event, an Investment
Company Event or a Capital Treatment Event, each as defined below.
However, Downey's right to redeem the junior subordinated debentures
upon the occurrence of a Tax Event, Investment Company Event or Capital
Treatment Event will not go into effect if there is available to Downey
or the trust the opportunity to eliminate, within the 90-day period, the
relevant event by taking some ministerial action, such as filing a form
or making an election or pursuing some reasonable measure that will have
no adverse effect on Downey, the trust or the holders of the capital
securities and will involve no material cost, and in that case Downey
will pursue this measure instead of redemption. See "Description of
Junior Subordinated Debentures--Redemption" for a further discussion of
the redemption procedures of the junior subordinated debentures.
If a Tax Event, Capital Treatment Event or an Investment Company Event has
occurred and is continuing and Downey does not elect to redeem the junior
subordinated debentures and thereby cause a mandatory redemption of the Trust
Securities, the Trust Securities will remain outstanding and, in the case of a
Tax Event, Downey will be obligated to pay Additional Sums, as defined below,
if any, on the junior subordinated debentures.
Additionally, if a Tax Event, Capital Treatment Event or an Investment
Company Event has occurred and is continuing and Downey does not elect to
liquidate the trust and cause the junior subordinated debentures to be
distributed to holders of the Trust Securities in liquidation of the trust as
described below, then the Trust Securities will remain outstanding and, in the
case of a Tax Event, Downey will be obligated to pay Additional Sums, if any,
on the junior subordinated debentures.
A "Tax Event" means the receipt by Downey and the trust of an opinion of
nationally recognized independent tax counsel, which may include outside
counsel to Downey for this offering, experienced in these matters to the
effect that as a result of:
. any amendment to, or change (including any announced prospective change)
in, the laws (or any regulations thereunder) of the United States or any
political subdivision or taxing authority thereof or therein, or
. any official or administrative pronouncement or action or judicial
decision interpreting or applying such laws or regulations,
107
<PAGE>
which amendment or change is effective or which prospective change, action,
pronouncement or decision is announced on or after the original issuance date
of the capital securities, there is more than an insubstantial risk that:
. the trust is, or will be within 90 days of the date of the opinion,
subject to United States federal income tax with respect to income
received or accrued on the junior subordinated debentures;
. interest payable by Downey on the junior subordinated debentures is not,
or within 90 days of the date of the opinion will not be, deductible by
Downey, in whole or in part, for United States federal income tax
purposes; or
. the trust is, or will be within 90 days of the date of the opinion,
subject to more than a de minimis amount of other taxes, duties or other
governmental charges.
See "Certain Federal Income Tax Consequences--Possible Tax Law Changes
Affecting the Capital Securities" below for a discussion of some legislative
proposals that, if adopted, could give rise to a Tax Event, which may permit
Downey to cause a redemption of the junior subordinated debentures, and
therefore the capital securities, before , 2004. In addition, for a
further discussion see "Risk Factors--Risk Factors Relating to the Capital
Securities--Downey may redeem the capital securities before , 2004 if
special events occur."
An "Investment Company Event" means the receipt by Downey and the trust of
an opinion of nationally recognized independent counsel, which may include
outside counsel to Downey for this offering, experienced in these matters to
the effect that, as the result of any change in law or regulation or any
written change in interpretation or application of law or regulation by any
legislative body, court, governmental agency or regulatory authority, which
change is effective or which written change is announced on or after the
original issuance date of the capital securities, there is more than an
insubstantial risk that the trust is or will be considered an "investment
company" that is required to be registered under the Investment Company Act of
1940, as amended.
A "Capital Treatment Event" means the receipt by Downey and the trust of an
opinion of nationally recognized independent counsel, which may include
outside counsel to Downey for this offering, experienced in these matters to
the effect that, as a result of any amendment to, or change, including any
announced prospective change, in the laws or any regulations thereunder of the
United States or any political subdivision thereof or therein, or as a result
of any official or administrative pronouncement or action or judicial decision
interpreting or applying such laws or regulations, which amendment or change
is effective or which prospective change, pronouncement, action or decision is
announced on or after the original issuance date of the capital securities,
there is more than an insubstantial risk that:
. Downey will not be entitled to treat the capital securities, or any
substantial portion thereof, as "tier 1 capital," or the then equivalent
thereof, for purposes of the holding company capital adequacy guidelines
of the primary federal regulator of Downey, as then in effect and
applicable to Downey, in which case the legal opinion shall also state
that Downey is subject to those holding company capital adequacy
guidelines; or
. The Bank will not be entitled to treat the net proceeds from the sale of
the junior subordinated debentures that are invested in the Bank, or any
substantial portion thereof, as "tier 1 capital," or the then equivalent
thereof, for purposes of the capital adequacy guidelines of the primary
federal regulator of the Bank, as then in effect and applicable to the
Bank, assuming for this purpose that at least 50% of the net proceeds
are invested in the Bank by Downey in the form of a capital contribution
or through the purchase of the common stock of the Bank.
"Additional Sums" means the additional amounts as may be necessary in order
that the amount of Distributions including any Additional Amounts, as defined
below, due and paid or payable by the trust on the outstanding Trust
Securities shall not be reduced as a result of any additional taxes, duties
and other governmental charges to which the trust has become subject as a
result of a Tax Event.
"Additional Amounts" means, with respect to the Trust Securities of a given
liquidation amount and for a given period, the amount of Additional Interest,
as defined below, paid or payable by Downey on a Like Amount of junior
subordinated debentures for such period.
108
<PAGE>
"Additional Interest" means the interest, if any, that shall accrue on any
interest on the junior subordinated debentures the payment of which has not
been made on the applicable Interest Payment Date, as defined below under
"Description of Junior Subordinated Debentures," or other date when due,
including without limitation any interest which is deferred as the result of
an Extension Period, and which shall accrue at the rate per annum specified or
determined as specified in the junior subordinated debentures.
"Like Amount" means:
. With respect to a redemption of Trust Securities, Trust Securities
having a Liquidation Amount equal to the principal amount of the junior
subordinated debentures to be contemporaneously redeemed, allocated pro
rata to the common securities and the capital securities based upon the
relative Liquidation Amounts of the outstanding capital securities and
common securities, subject to the preferential rights of the capital
securities if a Debenture Event of Default has occurred and is
continuing; and
. With respect to a distribution of junior subordinated debentures to
holders of Trust Securities in connection with a dissolution or
liquidation of the trust, junior subordinated debentures having a
principal amount equal to the Liquidation Amount of the Trust Securities
of the holder to whom such junior subordinated debentures are
distributed.
"Liquidation Amount" means the stated amount of $25 per Trust Security.
"Redemption Price" means, with respect to any Trust Security, the
Liquidation Amount of such Trust Security, plus accumulated and unpaid
Distributions to the Redemption Date.
Redemption Procedures
The trust shall redeem capital securities on each Redemption Date at the
Redemption Price. The trust shall pay the Redemption Price with the applicable
proceeds from the contemporaneous redemption of the junior subordinated
debentures. The trust shall redeem the capital securities and pay the
Redemption Price on each Redemption Date only to the extent that the trust has
funds on hand for the payment of the Redemption Price. For a description of
factors affecting the redemption of the Trust Securities, see "--Subordination
of Common Securities" and "Description of Guarantee." The trust may not redeem
fewer than all of the outstanding Trust Securities unless it has paid all
accumulated and unpaid Distributions on all Trust Securities for all quarterly
distribution periods terminating on or before the relevant Redemption Date.
If the trust gives a notice of redemption in respect of the capital
securities, then, by 12:00 noon, Eastern time, on the Redemption Date, to the
extent funds are available, the Property Trustee will irrevocably deposit with
the Depository funds sufficient to pay the aggregate Redemption Price and will
give the Depository irrevocable instructions and authority to pay the
Redemption Price to the holders of the capital securities. For a description
of the Depository procedures, see "Book-Entry Issuance." With respect to Trust
Securities not held in book-entry form, the Property Trustee, to the extent
funds are available, will irrevocably deposit with the paying agent for those
Trust Securities, by 12:00 noon, Eastern time, on the Redemption Date, funds
sufficient to pay the aggregate Redemption Price and will give the paying
agent irrevocable instructions and authority to pay the Redemption Price to
the holders of the Trust Securities upon their surrender of the certificates
evidencing the Trust Securities.
Notwithstanding the foregoing, Distributions payable on any Distribution
Date falling on or before the Redemption Date shall be payable to the
registered holders of the capital securities at the close of business on the
relevant record dates for the related Distribution Dates. Thus, if a
Redemption Date falls on a Distribution Date, the Distribution payable on that
date will be paid to the person who was the holder of record on the relevant
record date. If the trust has given notice of redemption and the Property
Trustee has deposited funds as required, then upon the date that the Property
Trustee makes the deposit, all of the rights of the holders of the capital
securities to be redeemed will cease except as follows and those capital
securities will cease to be outstanding.
109
<PAGE>
The only right a holder of capital securities to be redeemed will still have
is the right to receive the applicable Redemption Price, and any Distributions
payable on or before the Redemption Date, but without interest for any period
from and after the Redemption Date. If any date fixed for redemption of the
capital securities is not a Business Day, then the trust will pay the
Redemption Price payable on that date on the next succeeding Business Day, and
without any interest or other payment in respect of any delay. If the trust or
Downey, under the terms of the Guarantee Agreement, improperly withholds or
refuses payment of the Redemption Price in respect of capital securities
called for redemption, Distributions on the capital securities will continue
to accrue, at the then applicable rate, from the Redemption Date originally
established by the trust for the capital securities to the date the Redemption
Price is actually paid, in which case the actual payment date will be the date
fixed for redemption for purposes of calculating the Redemption Price. For a
discussion of Downey's obligations under the Guarantee Agreement, see
"Description of Guarantee."
If allowed under applicable law, including, without limitation, United
States federal securities law, and further provided that Downey is not then
exercising its rights to defer interest payments on the junior subordinated
debentures, Downey or its subsidiaries, other than the trust, may at any time
and from time to time purchase outstanding capital securities by tender, in
the open market or by private agreement.
If less than all of the outstanding Trust Securities issued by the trust are
to be redeemed on a Redemption Date, then the aggregate Redemption Price for
the Trust Securities to be redeemed shall be allocated pro rata to the capital
securities and common securities based upon the relative Liquidation Amounts
of the capital securities and common securities then outstanding. The
particular capital securities to be redeemed shall be selected not more than
60 days before the Redemption Date by the Property Trustee from the
outstanding capital securities not previously called for redemption, by a
method that the Property Trustee deems fair and appropriate and which may
provide for the selection for redemption of portions, equal to $25 or an
integral multiple of $25, of the Liquidation Amount of capital securities of a
denomination larger than $25. The Property Trustee shall promptly notify the
Securities Registrar in writing of the capital securities selected for
redemption and, in the case of any capital securities selected for partial
redemption, the Liquidation Amount to be redeemed. For all purposes of the
Trust Agreement, unless the context otherwise requires, all provisions
relating to the redemption of capital securities shall relate to the portion
of the aggregate Liquidation Amount of capital securities which has been or is
to be redeemed.
In the event of any redemption, neither the trust nor the Property Trustee
shall be required to:
. issue, register the transfer of or exchange capital securities during a
period beginning at the opening of business 15 days before the date of
mailing of a notice of redemption of any capital securities called for
redemption and ending at the close of business on the day of the
mailing; or
. register the transfer or exchange any capital securities so selected for
redemption, except, in the case of any capital securities being redeemed
in part, any portion of the capital securities not to be redeemed.
Notice of any redemption will be mailed at least 30 days but not more than
60 days before the Redemption Date to each holder of Trust Securities to be
redeemed at the holder's registered address. Unless Downey defaults in payment
of the Redemption Price on the junior subordinated debentures, on and after
the Redemption Date interest will cease to accrue on the junior subordinated
debentures or portions of the junior subordinated debentures called for
redemption and, unless payment of the Redemption Price in respect of the
capital securities is withheld or refused and not paid either by the trust or
Downey as required by the Guarantee Agreement, Distributions will cease to
accumulate on the capital securities or portions of the capital securities
called for redemption.
Subordination of Common Securities
Payment of Distributions on, and the Redemption Price of, the capital
securities and common securities shall be made pro rata based on the
Liquidation Amounts of the outstanding capital securities and common
securities.
110
<PAGE>
However, no payment of any Distribution, including Additional Amounts, if
applicable, on, or applicable Redemption Price of, any of the common
securities, and no other payment on account of the redemption, liquidation or
other acquisition of the common securities, shall be made if:
. a Debenture Event of Default shall have occurred and be continuing as a
result of any failure by Downey to pay any amounts in respect of the
junior subordinated debentures when due; or
. the trust is dissolved or liquidated and funds held by the trust are
insufficient to pay in full the aggregate Liquidation Amount, plus
accrued and unpaid Distributions, payable on the Trust Securities or, in
the event of the distribution of junior subordinated debentures to
holders of capital securities upon such dissolution or liquidation, the
holders of capital securities do not receive the full amount of junior
subordinated debentures to which they are entitled.
The payments with respect to the common securities will be allowed, however,
if:
. payment in full in cash of all accumulated and unpaid Distributions,
including Additional Amounts, if applicable, on all of the outstanding
capital securities for all Distribution periods terminating on or prior
thereto, and in the case of payment of the applicable Redemption Price,
the full payment in cash of the Redemption Price on all of the
outstanding capital securities then called for redemption, shall have
been made or provided for; or
. the trust is dissolved or liquidated and the full Liquidation Amount on
all outstanding capital securities plus accumulated and unpaid
Distributions thereon shall have been made or duly provided for in cash
or, in the event of the distribution of junior subordinated debentures
to holders of capital securities upon the dissolution or liquidation,
the distribution to each holder of capital securities of the junior
subordinated debentures to which such holder is entitled shall have been
made or duly provided for.
All funds available to the Property Trustee shall first be applied to the
payment in full in cash of all Distributions on, or the Redemption Price or
Liquidation Amount, plus accrued and unpaid Distributions, of the capital
securities then due and payable, including Additional Amounts, if applicable,
or, in the event of the distribution of junior subordinated debentures upon
dissolution or liquidation of the trust, the junior subordinated debentures
available to the Property Trustee shall first be distributed to holders of
capital securities.
In the case of any Event of Default under the Trust Agreement resulting from
a Debenture Event of Default, Downey as holder of the common securities will
be deemed to have waived any right to act with respect to the Event of Default
until all Events of Default with respect to the capital securities have been
cured, waived or otherwise eliminated. Until all Events of Default with
respect to the capital securities have been so cured, waived or otherwise
eliminated, the Property Trustee shall act solely on behalf of the holders of
the capital securities and not on behalf of Downey as holder of the common
securities and only the holders of the capital securities will have the right
to direct the Property Trustee to act on their behalf.
Liquidation Distribution Upon Dissolution
The amount payable on the Trust Securities if the trust is liquidated or
dissolved is $25 per Trust Security plus accumulated and unpaid Distributions
thereon to the date of payment. Downey has the right to make the payment to
holders of the Trust Securities by distributing a Like Amount of the junior
subordinated debentures to them as described below.
Downey will have the right, at any time before the 30th day before the
Stated Maturity, to dissolve the trust and cause a Like Amount of the junior
subordinated debentures to be distributed to holders of the Trust Securities.
Before exercising this right, Downey must receive all required regulatory
approvals and an opinion of nationally recognized independent tax counsel,
which may include outside counsel to Downey for this offering, experienced in
these matters to the effect that the holders of the Trust Securities will not
recognize income, gain or loss for United States federal income tax purposes
as a result of the dissolution of the trust and distribution of the junior
subordinated debentures and will be subject to federal income tax with respect
to the junior
111
<PAGE>
subordinated debentures on the same amounts, in the same manner and at the
same times as would have been the case if the holders had remained holders of
Trust Securities. For a more complete discussion of the distribution of the
junior subordinated debentures, see "--Distribution of Junior Subordinated
Debentures." Downey might exercise its right to dissolve the trust under
circumstances where a Tax Event, a Capital Treatment Event, an Investment
Company Event or other undesirable event could be avoided simply by dissolving
the trust and causing the junior subordinated debentures to be distributed to
the holders of the Trust Securities.
In addition, under the terms of the Trust Agreement, the trust shall
automatically dissolve upon expiration of its term and shall earlier dissolve
on the first to occur of:
1. specific events of bankruptcy, dissolution or liquidation of Downey or
any other holder of the common securities;
2. redemption of all of the capital securities as described under "--
Redemption;" or
3. the entry of an order for the dissolution of the trust, Downey or any
other holder of the common securities by a court of competent
jurisdiction.
If an early dissolution occurs as described in the second preceding
paragraph or in clause 1 or 3 above, the Issuer Trustees shall liquidate the
trust as expeditiously as the Issuer Trustees determine to be possible by
distributing, after satisfaction of liabilities to creditors of the trust as
provided by applicable law, to the holders of the Trust Securities a Like
Amount of the junior subordinated debentures. However, if this distribution is
determined by the Property Trustee not to be practical, the holders will be
entitled to receive out of the assets of the trust available for distribution
to holders, after satisfaction of liabilities to creditors of the trust as
provided by applicable law, an amount equal to the aggregate of the
Liquidation Amount plus accrued and unpaid Distributions thereon to the date
of payment. The amount due and payable upon liquidation of the trust, whether
payable in cash or out of the assets of the trust, is called the "Liquidation
Distribution." If the Liquidation Distribution can be paid only in part
because the trust has insufficient assets available to pay in full the
aggregate Liquidation Distribution, then the amounts payable directly by the
trust on the capital securities shall be paid on a pro rata basis, based upon
Liquidation Amounts. Downey, as the holder of the common securities, will be
entitled to receive distributions upon the trust's liquidation pro rata with
the holders of the capital securities, except that if a Debenture Event of
Default has occurred and is continuing as a result of any failure by Downey to
pay any amounts due in respect of the junior subordinated debentures when due
or if funds available to the trust are insufficient to pay in full the
Liquidation Distribution on all of the outstanding capital securities, the
capital securities shall have a priority over the common securities to the
extent described above under "--Subordination of Common Securities."
After the liquidation date fixed for any distribution of junior subordinated
debentures for Trust Securities, the following will happen:
. the Trust Securities will no longer be deemed to be outstanding;
. certificates representing a Like Amount of junior subordinated
debentures will be issued to holders of Trust Securities certificates,
upon surrender of such certificates to the Administrative Trustees or
their agent for exchange;
. Downey shall use its best efforts to have the junior subordinated
debentures listed on the New York Stock Exchange or on another exchange,
interdealer quotation system or self-regulatory organization on which
the capital securities are then listed;
. any Trust Securities certificates not so surrendered for exchange will
be deemed to represent a Like Amount of junior subordinated debentures,
accruing interest from the last Distribution Date on which a
Distribution was made on the Trust Securities certificates until the
certificates are surrendered for exchange as described above; and
. all rights of securityholders holding Trust Securities will cease,
except the right of the securityholders to receive a Like Amount of
junior subordinated debentures upon surrender of Trust Securities
certificates and to receive accrued and unpaid interest on the junior
subordinated debentures.
112
<PAGE>
We can give no assurance as to the market prices for the junior subordinated
debentures that may be distributed in exchange for the capital securities if a
dissolution and liquidation of the trust were to occur. Accordingly, the
junior subordinated debentures that holders of capital securities may receive
on dissolution and liquidation of the trust may trade at a discount to the
price paid to purchase the capital securities offered by this prospectus. For
more information about these risks, see "Risk Factors--Risk Factors Relating
to the Capital Securities--Holders of capital securities may receive junior
subordinated debentures upon liquidation of the trust so investing in capital
securities requires an investment decision regarding the junior subordinated
debentures; distribution of junior subordinated debentures may have an adverse
effect on trading price" and "--There is no existing market for the capital
securities."
Under current United States federal income tax law and interpretations and
assuming, as shown in an opinion of counsel to Downey, the trust is treated as
a grantor trust, a distribution of the junior subordinated debentures should
not be a taxable event to holders of the capital securities. Should there be a
change in law, a change in legal interpretation, a Tax Event or other
circumstances, however, the distribution could be a taxable event to the trust
and to holders of capital securities. For a discussion of possible tax
consequences, see "Certain Federal Income Tax Consequences."
If Downey elects to dissolve the trust and thereby causes the junior
subordinated debentures to be distributed to holders of the capital securities
in liquidation of the trust, Downey shall continue to have the right to
shorten the maturity of the junior subordinated debentures, subject to a
number of conditions which are discussed under "Description of Junior
Subordinated Debentures--General."
Events of Default; Notice
Any one of the following events that has occurred and is continuing
constitutes an "Event of Default" under the Trust Agreement with respect to
the capital securities, regardless of the reason for the Event of Default and
whether it shall be voluntary or involuntary or be effected by operation of
law or by any judgment, decree or order of any court or any order, rule or
regulation of any administrative or governmental body:
1. the occurrence of a Debenture Event of Default (see "Description of
Junior Subordinated Debentures-- Debenture Events of Default");
2. default by the trust in the payment of any Distribution when it becomes
due and payable, and continuation of such default for a period of 30
days;
3. default by the trust in the payment of any Redemption Price of any Trust
Security when it becomes due and payable;
4. default in the performance, or breach, in any material respect, of any
covenant or warranty of any of the Issuer Trustees in the Trust
Agreement (other than a default or breach in the performance of a
covenant or warranty which is addressed in clause 2 or 3 above), and
continuation of such default or breach for a period of 60 days after
there has been given, by registered or certified mail, to the defaulting
Issuer Trustee and the trust by the holders of at least 25% in aggregate
Liquidation Amount of the outstanding capital securities, a written
notice specifying such default or breach and requiring it to be remedied
and stating that such notice is a "Notice of Default" under the Trust
Agreement; or
5. the occurrence of specific events of bankruptcy or insolvency with
respect to the Property Trustee and the failure by Downey to appoint a
successor Property Trustee within 60 days after the occurrence.
Within five Business Days after the occurrence of any Event of Default
actually known to the Property Trustee, the Property Trustee shall transmit
notice of the Event of Default to the holders of the capital securities, the
Administrative Trustees and Downey, as Depositor, unless the Event of Default
shall have been cured or waived. Downey, as Depositor, and the Administrative
Trustees will be required to file annually with the Property Trustee a
certificate as to whether or not they are in compliance with all the
conditions and covenants applicable to them under the Trust Agreement.
113
<PAGE>
If a Debenture Event of Default has occurred and is continuing as a result
of any failure by Downey to pay any amounts in respect of the junior
subordinated debentures when due, the capital securities shall have a
preference over the common securities as described under "--Subordination of
Common Securities" and "--Liquidation Distribution Upon Dissolution." Upon a
Debenture Event of Default, either the Indenture Trustee or the holders of not
less than 25% in aggregate principal amount of the junior subordinated
debentures then outstanding may declare all of the junior subordinated
debentures to be due and payable immediately by giving notice in writing to
Downey. If the Indenture Trustee or the holders of not less than 25% in
principal amount of the outstanding junior subordinated debentures fail to
declare the principal of all of the junior subordinated debentures due and
payable upon a Debenture Event of Default, the holders of at least 25% in
Liquidation Amount of the capital securities then outstanding shall have the
right to declare the principal amount of the junior subordinated debentures
immediately due and payable. In either event, payment of principal and
interest on the junior subordinated debentures shall remain subordinated to
the extent provided in the Indenture. In addition, holders of the capital
securities have the right in specific circumstances to bring a Direct Action,
as defined below and discussed under "Description of Junior Subordinated
Debentures--Enforcement of Specified Rights by Holders of Capital Securities."
The holders of a majority in aggregate outstanding principal amount of the
junior subordinated debentures may rescind and annul the declaration and its
consequences if all defaults, other than the non-payment of the principal and
interest of the junior subordinated debentures which has become due solely by
the acceleration, have been cured or waived as provided in the Indenture and a
sum sufficient to pay all overdue installments of interest, including any
Additional Interest, and principal due otherwise than by acceleration has been
deposited with the Indenture Trustee. The holders of a majority in aggregate
Liquidation Amount of the capital securities may similarly waive any past
default under the Indenture, except a default in the payment of principal or
interest, unless the default has been cured or waived and a sum sufficient to
pay all matured installments of interest and principal due otherwise than by
acceleration has been deposited with the Indenture Trustee, or a default in
respect of a covenant or provision which under the Indenture cannot be
modified or amended without the consent of the holder of each outstanding
junior subordinated debenture.
Removal of Trustees
Unless an Event of Default shall have occurred and be continuing, any of the
Property Trustee, the Delaware Trustee or the Administrative Trustees may be
removed at any time by Downey as the holder of the common securities. If an
Event of Default has occurred and is continuing, the holders of a majority in
Liquidation Amount of the outstanding capital securities may remove the
Property Trustee or the Delaware Trustee or both of them. In no event will the
holders of the capital securities have the right to vote to appoint, remove or
replace the Administrative Trustees, which voting rights are vested
exclusively in Downey as the holder of the common securities. No resignation
or removal of an Issuer Trustee and no appointment of a successor trustee
shall be effective until the acceptance of appointment by the successor
trustee has been made in compliance with the provisions of the Trust
Agreement.
Co-Trustees and Separate Property Trustee
Unless an Event of Default shall have occurred and be continuing, at any
time or times, for the purpose of meeting the legal requirements of the Trust
Indenture Act or of any jurisdiction in which any part of the Trust Property
may at the time be located, Downey, as the holder of the common securities,
and the Administrative Trustees by agreed action of the majority of the
Administrative Trustees shall have the power to appoint one or more persons
either to act as a co-trustee, jointly with the Property Trustee, of all or
any part of the Trust Property, or to act as separate trustee of any Trust
Property, in either case with the powers as may be provided in the instrument
of appointment, and to vest in the person or persons in that capacity any
property, title, right or power deemed necessary or desirable, subject to the
provisions of the Trust Agreement. If Downey does not join in the appointment
within 15 days of the receipt by it of a request to do so, or in case an Event
of Default has occurred and is continuing, the Property Trustee alone shall
have power to make the appointment.
114
<PAGE>
Merger or Consolidation of Issuer Trustees
Any Person, as defined in the Trust Agreement, into which the Property
Trustee or the Delaware Trustee may be merged or converted or with which it
may be consolidated, or any Person resulting from any merger, conversion or
consolidation to which the Property Trustee or Delaware Trustee shall be a
party, or any Person succeeding to all or substantially all the corporate
trust business of the Property Trustee or Delaware Trustee, shall be the
successor of the Property Trustee or Delaware Trustee, as the case may be,
under the Trust Agreement, provided the Person shall be otherwise qualified
and eligible.
Mergers, Consolidations, Amalgamations or Replacements of the Trust
The trust may not merge with or into, consolidate, amalgamate or be replaced
by, or convey, transfer or lease its properties and assets as an entirety or
substantially as an entirety to any Person, except as described below. The
trust may, at the request of Downey, with the consent of the Administrative
Trustees and without the consent of the holders of the capital securities, the
Property Trustee or the Delaware Trustee, merge with or into, consolidate,
amalgamate or be replaced by or convey, transfer or lease its properties and
assets as an entirety or substantially as an entirety to a trust organized
under the laws of any state. Downey will only be allowed to make this request
if:
. the successor trust either (a) expressly assumes all of the obligations
of the trust with respect to the Trust Securities or (b) substitutes for
the Trust Securities other securities having substantially the same
terms as the common securities (the "Successor Common Securities") and
the capital securities (the "Successor Capital Securities") so long as
the Successor Common Securities are subordinated in right of payment to
the Successor Capital Securities to the same extent and in the same
manner as the common securities are subordinated in right of payment to
the capital securities;
. Downey expressly appoints a trustee of the successor trust possessing
the same powers and duties as the Property Trustee as the holder of the
junior subordinated debentures;
. the Successor Capital Securities are listed or traded, or any Successor
Capital Securities will be listed upon notification of issuance, on any
national securities exchange or other organization on which the capital
securities are then listed or traded, if any;
. the merger, consolidation, amalgamation, replacement, conveyance,
transfer or lease does not cause the capital securities or the Successor
Capital Securities, as the case may be, to be downgraded by any
nationally recognized statistical rating organization which gives
ratings to the capital securities or the Successor Capital Securities,
as the case may be;
. the merger, consolidation, amalgamation, replacement, conveyance,
transfer or lease does not adversely affect the rights, preferences and
privileges of the holders of the capital securities or the Successor
Capital Securities, as the case may be, in any material respect;
. the successor trust has a purpose identical to that of the trust;
. before the merger, consolidation, amalgamation, replacement, conveyance,
transfer or lease, Downey has received an opinion from nationally
recognized independent counsel, which may include outside counsel to
Downey for this offering, experienced in the following matters to the
effect that:
. the merger, consolidation, amalgamation, replacement, conveyance,
transfer or lease does not adversely affect the rights, preferences
and privileges of holders of the capital securities or the Successor
Capital Securities, as the case may be, in any material respect; and
. following the merger, consolidation, amalgamation, replacement,
conveyance, transfer or lease, neither the trust nor any successor
trust will be required to register as an investment company under
the Investment Company Act or will be classified as other than a
grantor trust for United States federal income tax purposes; and
. Downey owns all of the Successor Common Securities of the successor
trust and guarantees the obligations of the successor trust under the
Successor Capital Securities at least to the extent provided by the
Guarantee Agreement and under the Successor Common Securities at least
to the extent provided by Downey's guarantee of the common securities.
115
<PAGE>
Notwithstanding the foregoing, the trust shall not, except with the consent
of holders of 100% in Liquidation Amount of the outstanding capital
securities, consolidate, amalgamate, merge with or into, or be replaced by or
convey, transfer or lease its properties and assets as an entirety or
substantially as an entirety to any other Person or permit any other Person to
consolidate, amalgamate, merge with or into, or replace it if the
consolidation, amalgamation, merger, replacement, conveyance, transfer or
lease would cause the trust or the successor entity to be classified as other
than a grantor trust for United States federal income tax purposes.
Voting Rights; Amendment of the Trust Agreement
Except as provided below and under "--Removal of Trustees" and "Description
of Guarantee--Amendments and Assignment" and as otherwise required by law and
the Trust Agreement, the holders of the capital securities will have no voting
rights.
The Trust Agreement may be amended from time to time by Downey, the Property
Trustee and the Administrative Trustees, without the consent of holders of the
Trust Securities, if the Trust Agreement is being amended to:
1. cure any ambiguity, correct or supplement any provisions in the Trust
Agreement that may be inconsistent with any other provision, or to make
any other provisions with respect to matters or questions arising under
the Trust Agreement, which shall not be inconsistent with the other
provisions of the Trust Agreement; or
2. modify, eliminate or add to any provisions of the Trust Agreement to
such extent as shall be necessary to ensure that the trust will be
classified for United States federal income tax purposes as a grantor
trust at all times that any Trust Securities are outstanding or to
ensure that the trust will not be required to register as an "investment
company" under the Investment Company Act.
In the case of clause 1 above, the amendment will only be allowed if the
action shall not adversely affect in any material respect the interests of any
holder of Trust Securities, and any amendments of the Trust Agreement shall
become effective when notice of the amendments are given to the holders of the
Trust Securities.
In other cases, the Trust Agreement may be amended by the Administrative
Trustees and the Property Trustee with:
. the consent of holders representing not less than a majority of the
aggregate Liquidation Amount of the outstanding Trust Securities; and
. the receipt by the Issuer Trustees of an opinion of nationally
recognized independent counsel, which may include outside counsel to
Downey for this offering, experienced in these matters to the effect
that the amendment or the exercise of any power granted to the Issuer
Trustees in accordance with the terms of the amendment will not affect
the trust's status as a grantor trust for United States federal income
tax purposes or the trust's exemption from registration as an investment
company under the Investment Company Act.
However, the Trust Agreement may only be amended with the unanimous consent
of each holder of Trust Securities, if it is being amended to:
. change the amount or timing of any Distribution on the Trust Securities,
or the amount or timing of any payment of the Redemption Price of, or
the amount or timing of any payment or distribution of funds or
property, including junior subordinated debentures, payable or
distributable upon liquidation or dissolution of the trust or otherwise
adversely affect the amount or change the time of any Distribution
required to be made in respect of the Trust Securities or the amount of
funds or property, including junior subordinated debentures, required to
be paid or distributed in respect of the Trust Securities; or
. restrict the right of a holder of Trust Securities to institute suit for
the enforcement of any of the foregoing payments on or after the date it
is due.
116
<PAGE>
So long as any junior subordinated debentures are held by the Property
Trustee, the Issuer Trustees shall not:
. direct the time, method and place of conducting any proceeding for any
remedy available to the Indenture Trustee, or execute any trust or power
conferred on the Indenture Trustee or the Property Trustee with respect
to the junior subordinated debentures;
. waive any past default that is waivable under the Indenture;
. exercise any right to rescind or annul a declaration that the principal
of and interest on all the junior subordinated debentures shall be due
and payable; or
. consent to any amendment, modification or termination of the Indenture
or the junior subordinated debentures, where their consent shall be
required;
without, in each case, obtaining the prior approval of the holders of a
majority in aggregate Liquidation Amount of all outstanding capital
securities; provided, however, that where a consent under the Indenture would
require the consent of each holder of junior subordinated debentures affected
thereby, no consent shall be given by the Property Trustee without the prior
consent of each holder of the outstanding capital securities.
The Issuer Trustees shall not revoke any action previously authorized or
approved by vote of the holders of the capital securities except by subsequent
vote of the holders of the capital securities. The Property Trustee shall
notify each holder of capital securities of any notice of default with respect
to the junior subordinated debentures. In addition to obtaining the foregoing
approvals of the holders of the capital securities, before taking any of the
foregoing actions, the Issuer Trustees shall obtain an opinion of nationally
recognized independent counsel, which may include outside counsel to Downey
for this offering, experienced in these matters to the effect that the trust
will not be classified as other than a grantor trust for United States federal
income tax purposes on account of that action.
Any required approval from holders of the capital securities may be given at
a meeting of the holders convened for that purpose or may be given by written
consent. The Property Trustee will cause a notice of any meeting at which
holders of the capital securities are entitled to vote to be given to each
holder of record of the capital securities in the manner described in the
Trust Agreement.
No vote or consent of holders of the capital securities will be required for
the trust to redeem and cancel the capital securities in compliance with the
Trust Agreement.
Notwithstanding that holders of the capital securities will be entitled to
vote or consent under any of the circumstances described above, any of the
capital securities that are owned by Downey, the Issuer Trustees or any
affiliate of Downey or any Issuer Trustee, shall, for purposes of any vote or
consent, be treated as if they were not outstanding.
Expenses
In the Indenture, Downey will agree to pay all costs, expenses, obligations
and liabilities, other than with respect to the Trust Securities, of the
trust, including those relating to the organization of the trust, the fees and
expenses of the Issuer Trustees, costs and expenses relating to the operation
of the trust, those relating to the offering of the capital securities and the
fees and expenses of the Property Trustee in connection with any enforcement
of the rights of the holders of the capital securities or the junior
subordinated debentures. The foregoing obligations of Downey under the
Indenture are for the benefit of, and will be enforceable by, any person to
whom any of those costs, expenses, obligations, taxes or liabilities are owed,
which person is referred to as a "Creditor," whether or not the Creditor has
received notice. Any Creditor may enforce the obligations of Downey described
in this paragraph and Downey will irrevocably waive any right or remedy to
require that the Creditor take action against the trust or any other person
before proceeding against Downey.
117
<PAGE>
Global Capital Securities
The capital securities will be represented by one or more global
certificates registered in the name of the Depository or its nominee (a
"Global Capital Security"). Beneficial interests in the Global Capital
Securities will be shown on, and transfers of the Global Capital Securities
will be effected only through, records maintained by participants in the
Depository, which are referred to as the "Participants." Except as described
below, capital securities in certificated form will not be issued in exchange
for interests in the Global Capital Security. For more information, see "Book-
Entry Issuance."
Unless and until a Global Capital Security is exchanged in whole or in part
for the individual capital securities represented thereby, it may not be
transferred except as a whole by:
. the Depository to a nominee of the Depository;
. a nominee of the Depository to the Depository or another nominee of the
Depository; or
. the Depository or any nominee to a successor depository or any nominee
of that successor.
The Depository may discontinue providing its services as securities
depository with respect to the Global Capital Security at any time.
A Global Capital Security shall be exchangeable for capital securities
registered in the names of persons other than the Depository or its nominee
only if:
. the Depository notifies Downey that it is unwilling or unable to
continue as depository for the Global Capital Security or at any time
the Depository ceases to be a clearing agency registered under the
Securities Exchange Act if so required by applicable law or regulation,
and no successor Depository shall have been appointed within 90 days of
such notification or of Downey becoming aware of the Depository ceasing
to be so registered, as the case may be; or
. Downey in its sole discretion determines that such Global Capital
Security shall be so exchangeable.
Any Global Capital Security that is exchangeable as described in the
preceding sentence shall be exchangeable for definitive certificates
registered in those names as the Depository shall direct. It is expected that
the Depository's instructions will be based upon directions received by the
Depository from its Participants with respect to ownership of beneficial
interests in the Global Capital Security. If the capital securities are issued
in definitive form, the capital securities will be in denominations of $25 and
integral multiples of $25 and may be transferred or exchanged at the offices
of the Property Trustee described below.
Upon the issuance of a Global Capital Security, and the deposit of the
Global Capital Security with or on behalf of the Depository, the Depository
for the Global Capital Security or its nominee will credit, on its book-entry
registration and transfer system, the respective aggregate Liquidation Amounts
of the individual capital securities represented by the Global Capital
Security to the accounts of Participants. These accounts shall be designated
by the dealers, underwriters or agents with respect to the capital securities.
Ownership of beneficial interests in a Global Capital Security will be limited
to Participants or persons that may hold interests through Participants.
Ownership of beneficial interests in the Global Capital Security will be shown
on, and the transfer of that ownership will be effected only through, records
maintained by the Depository or its nominee, with respect to interests of
Participants, and the records of Participants, with respect to interests of
persons who hold through Participants. The laws of some states may require
that some purchasers of securities take physical delivery of securities in
definitive form. The foregoing limits and these laws may impair the ability to
transfer beneficial interests in a Global Capital Security.
So long as the Depository for a Global Capital Security, or its nominee, is
the registered owner of the Global Capital Security, the Depository or its
nominee, as the case may be, will be considered the sole owner or holder of
the capital securities represented by the Global Capital Security for all
purposes under the Trust Agreement. Except as provided above, owners of
beneficial interests in a Global Capital Security will not be entitled to have
118
<PAGE>
any of the individual capital securities represented by the Global Capital
Security registered in their names, will not receive or be entitled to receive
physical delivery of any capital securities in definitive form and will not be
considered the owners or holders of the capital securities under the Trust
Agreement. Accordingly, each person owning a beneficial interest in the Global
Capital Security must rely on the procedures of the Depository and, if the
person is not a Participant, on the procedures of the Participant through
which the person owns its interest, to exercise any rights of a holder under
the Trust Agreement.
Distributions on the capital securities registered in the name of the
Depository or its nominee will be made to the Depository or its nominee, as
the case may be, as the registered owner of the Global Capital Security
representing the capital securities. None of Downey, the Property Trustee, any
paying agent or the securities registrar for the capital securities will have
any responsibility or liability for any aspect of the records relating to or
payments made on account of beneficial ownership interests of the Global
Capital Security representing the capital securities or for maintaining,
supervising or reviewing any records relating to beneficial ownership
interests.
Disbursements of Distributions to Participants shall be the responsibility
of the Depository. Downey expects that the Depository or its nominee, upon
receipt of any payment of the Liquidation Amount or Distributions in respect
of a Global Capital Security, will credit Participants' accounts with payments
in amounts proportionate to their respective beneficial interests in the
aggregate Liquidation Amount of the Global Capital Security as shown on the
records of the Depository or its nominee. Downey also expects that payments by
Participants to owners of beneficial interests in the Global Capital Security
held through Participants will be governed by standing instructions and
customary practices, as is now the case with securities held for the accounts
of customers in "street name." Payments to owners of beneficial interests will
be the responsibility of the relevant Participants.
Payment and Paying Agent
Payments in respect of the capital securities shall be made to the
Depository, which shall credit the relevant accounts at the Depository on the
applicable Distribution Dates and Redemption Dates, or, if any of the capital
securities are not held by the Depository, payments of Distributions shall be
made at the Property Trustee's option either by check mailed to the address of
the holder entitled thereto as the address shall appear on the register or by
wire transfer. The paying agent shall initially be the Property Trustee and
any co-paying agent chosen by the Property Trustee and acceptable to the
Administrative Trustees and Downey. The paying agent shall be permitted to
resign as paying agent upon 30 days' written notice to Downey, the Property
Trustee and the Administrative Trustees. If the Property Trustee shall no
longer be the paying agent, then the Administrative Trustees shall appoint a
successor, which shall be a bank or trust company acceptable to the Property
Trustee and Downey, to act as paying agent.
Registrar
The Property Trustee will act as registrar for the capital securities.
Registration of transfers of the capital securities will be effected without
charge by or on behalf of the trust, but the registrar may require payment of
a sum sufficient to cover any tax or other governmental charges that may be
imposed in connection with any transfer or exchange.
Downey will agree in the Trust Agreement that, if capital securities are
issued in certificated form, it will at all times maintain a paying agent and
transfer agent for the capital securities in the Borough of Manhattan, the
City of New York.
Information Concerning the Property Trustee
The Property Trustee, other than upon the occurrence and during the
continuance of an Event of Default, undertakes to perform only the duties that
are specifically provided in the Trust Agreement and, after an Event
119
<PAGE>
of Default, must exercise the same degree of care and skill as a prudent
person would exercise or use in the conduct of his or her own affairs. In all
other instances, the Property Trustee is under no obligation to exercise any
of the powers vested in it by the Trust Agreement at the request of any holder
of capital securities unless it is offered reasonable indemnity against the
costs, expenses and liabilities that might be incurred thereby. If no Event of
Default has occurred and is continuing and the Property Trustee is required to
decide between alternative causes of action, construe ambiguous provisions in
the Trust Agreement or is unsure of the application of any provision of the
Trust Agreement, and the matter is not one on which holders of the capital
securities are entitled under the Trust Agreement to vote, then the Property
Trustee shall take the action that is directed by Downey and if not so
directed, shall take the action as it deems advisable and in the best
interests of the holders of the Trust Securities and will have no liability
therefor except for liability resulting from its own bad faith, negligence or
willful misconduct.
Miscellaneous
The Administrative Trustees are authorized and directed to conduct the
affairs of and to operate the trust in such a way that the trust will not be
deemed to be an "investment company" required to be registered under the
Investment Company Act or classified as an association taxable as a
corporation for United States federal income tax purposes, and so that the
junior subordinated debentures will be treated as indebtedness of Downey for
United States federal income tax purposes. In this connection, Downey and the
Administrative Trustees are authorized to take any action, not inconsistent
with applicable law, the certificate of trust or the Trust Agreement, that
Downey and the Administrative Trustees determine in their discretion to be
necessary or desirable for the foregoing purposes, as long as the action does
not materially adversely affect the interests of the holders of the capital
securities.
The holders of the capital securities have no preemptive or similar rights.
The trust may not borrow money or incur debt or mortgage or pledge any of
its assets.
Governing Law
The Trust Agreement will be governed by and construed under the laws of the
State of Delaware.
120
<PAGE>
DESCRIPTION OF JUNIOR SUBORDINATED DEBENTURES
Concurrently with the issuance of the capital securities, the trust will
invest the proceeds therefrom, together with the consideration paid by Downey
for the common securities, in junior subordinated debentures to be issued by
Downey. The junior subordinated debentures will be issued under the Indenture.
The following summary of the terms and provisions of the junior subordinated
debentures and the Indenture does not purport to be complete, and is qualified
in its entirety by reference to the Indenture, which has been filed as an
exhibit to the Registration Statement of which this prospectus forms a part,
and to the Trust Indenture Act. Copies of the junior subordinated debentures
and the Indenture may be obtained as described under "Where You Can Find More
Information." The Indenture is qualified under the Trust Indenture Act.
Whenever particular defined terms of the Indenture are referred to in this
prospectus, the defined terms are incorporated herein by reference. As used
under this caption "Description of Junior Subordinated Debentures," all
references to "Downey" mean Downey Financial Corp. excluding, unless otherwise
expressly stated or the context otherwise requires, its subsidiaries.
General
The Indenture provides that Downey may issue junior subordinated debt
securities (the "Debt Securities") thereunder from time to time in one or more
series and permits Downey to establish the terms of each series of Debt
Securities at the time of issuance. The junior subordinated debentures to be
issued to the trust will constitute a separate series of Debt Securities under
the Indenture, limited to $123,711,350 million aggregate principal amount. The
Indenture will not limit the aggregate amount of Debt Securities that may be
issued by Downey under the Indenture nor will it limit the incurrence or
issuance of other debt by Downey or any of its subsidiaries. The junior
subordinated debentures will be unsecured and will be subordinated to the
extent described below.
The junior subordinated debentures will bear interest at the rate of % per
annum, payable quarterly in arrears on the 15th day of March, June, September
and December of each year (each, an "Interest Payment Date"), commencing
September 15, 1999, to the registered holders of the junior subordinated
debentures as of the close of business on the relevant record date, which will
be the 15th day, whether or not a Business Day, immediately preceding the
Distribution Date. The amount of each interest payment due with respect to the
junior subordinated debentures will include amounts accrued to but excluding
the relevant Interest Payment Date. It is anticipated that, until the
liquidation, if any, of the trust, each junior subordinated debenture will be
held in the name of the Property Trustee in trust for the benefit of the
holders of the capital securities. The amount of interest payable for any
period will be computed on the basis of a 360-day year of twelve 30-day
months. Interest for any period of less than a full quarterly period will be
computed upon the basis of the actual number of days elapsed in a 30-day
month. If any date on which interest is payable on the junior subordinated
debentures is not a Business Day, then payment of the interest payable on that
date will be made on the next Business Day, and without any interest or other
payment in respect of any delay. Accrued interest that is not paid on the
applicable Interest Payment Date will bear additional interest on the amount
of the accrued interest, to the extent permitted by law, at the rate of % per
annum, compounded quarterly. The term "interest" as used herein shall include
quarterly interest payments and Additional Interest, Additional Sums and
Additional Expenses, if any.
The junior subordinated debentures will mature on , 2029 (this date, as
it may be shortened as hereinafter described, the "Stated Maturity"). This
date may be shortened at any time by Downey to any date not earlier than ,
2004, provided that the shortened date must fall on an Interest Payment Date.
Downey may exercise its right to shorten the maturity of the junior
subordinated debentures under circumstances where, for example, a Tax Event,
Capital Treatment Event, Investment Company Event or other undesirable event
could be avoided simply by shortening the maturity of the junior subordinated
debentures. If Downey elects to shorten the Stated Maturity of the junior
subordinated debentures, then it shall give notice to the Indenture Trustee,
and the Indenture Trustee shall give notice of the shortening to the holders
of the junior subordinated debentures no less than 60 days before the
effectiveness of the shortening. If Downey elects to shorten the Stated
Maturity of the junior subordinated debentures, Downey will also cause the
capital securities to be redeemed on the earlier maturity date.
121
<PAGE>
The Stated Maturity may be shortened only if Downey shall have received an
opinion of nationally recognized independent counsel, which may include
outside counsel to Downey for this offering, experienced in these matters to
the effect that:
. The holders of the capital securities and the junior subordinated
debentures will not recognize income, gain or loss for United States
federal income tax purposes as a result of the shortening of the Stated
Maturity and will be subject to United States federal income tax on the
same amounts, in the same manner and at the same times as would have
been the case if the shortening of the Stated Maturity had not occurred;
and
. The shortening of the Stated Maturity will not cause the trust to be
classified as other than a grantor trust for the United States federal
income tax purposes.
The junior subordinated debentures will be unsecured and will be subordinate
in right of payment to all Senior and Subordinated Debt of Downey. Because
Downey is a holding company, the right of Downey to participate in any
distribution of assets of any subsidiaries upon the subsidiaries' liquidation
or reorganization or otherwise, and thus the ability of holders of the capital
securities and junior subordinated debentures to benefit indirectly from the
distribution, is subordinated to the prior claims of creditors of that
subsidiary, except to the extent that Downey may itself be a creditor with
recognized claims against the subsidiary, in which case the claims of Downey
would still be effectively subordinate to any security interest in, or
mortgages or other liens on, the assets of the subsidiary and would be
subordinate to any indebtedness of the subsidiary senior to that held by
Downey. In that regard, if a receiver or conservator is appointed for the
Bank, then the Federal Deposit Insurance Act recognizes a priority in favor of
depositors, including the FDIC as subrogee or transferee, over general
creditors. Thus, in the event of a conservatorship or receivership of the
Bank, claims for customer deposits would have a priority over any claims
Downey may itself have as a creditor of the Bank. Accordingly, the junior
subordinated debentures will be effectively subordinated to all existing and
future liabilities of the subsidiaries of Downey, including deposit
liabilities of the Bank, and holders of junior subordinated debentures should
look only to the assets of Downey for payments on the junior subordinated
debentures. The Indenture does not limit the incurrence or issuance of other
secured or unsecured debt of Downey, including Senior and Subordinated Debt.
See "Risk Factors--Risk Factors Relating to the Capital Securities" and "--
Subordination" below for a discussion of the effects of subordination.
Option to Defer Interest Payments
So long as no Debenture Event of Default has occurred and is continuing,
Downey will have the right under the Indenture at any time during the term of
the junior subordinated debentures to defer the payment of interest at any
time and from time to time for a period not exceeding 20 consecutive quarters
with respect to each period, provided that no Extension Period may extend
beyond the Stated Maturity. During an Extension Period, interest on the junior
subordinated debentures will continue to accrue, with interest thereon at the
rate of % per annum, compounded quarterly, to the extent permitted by law. No
Extension Period shall end other than on an Interest Payment Date. At the end
of an Extension Period, Downey must pay all interest then accrued and unpaid,
together with interest thereon at the annual rate of %, compounded quarterly,
to the extent permitted by applicable law. During an Extension Period, because
interest will continue to accrue, holders of junior subordinated debentures
will be required to accrue interest income for United States federal income
tax purposes as discussed under "Certain Federal Income Tax Consequences--
Interest Income and Original Issue Discount." During any Extension Period,
Downey will be restricted from making specific payments as described below
under "--Restrictions on Specified Payments."
Before the termination of any Extension Period, Downey may further extend
the Extension Period, provided that the Extension Period does not exceed 20
consecutive quarters or extend beyond the Stated Maturity. If Downey shortens
the Stated Maturity at any time while an Extension Period is in effect, and if
the Stated Maturity, as so shortened, would end before the last day of the
Extension Period, the Extension Period will be deemed to end on the Stated
Maturity. If the junior subordinated debentures are called for redemption on
any
122
<PAGE>
date before the end of an Extension Period, the Extension Period will be
deemed to end on that Redemption Date as to all of the junior subordinated
debentures.
Upon the termination of any Extension Period and the payment of all amounts
then due, Downey may elect to begin a new Extension Period subject to the
above requirements. Each Extension Period must end on an Interest Payment
Date, and all deferred interest will be payable on that Interest Payment Date
to the persons in whose names the junior subordinated debentures are
registered at the close of business on the immediately preceding record date.
Except as discussed above, there is no limitation on the number of times
Downey may elect to begin an Extension Period. No interest shall be due and
payable during an Extension Period, except at the end of the Extension Period.
Downey must give the Property Trustee, the Administrative Trustees and the
Indenture Trustee notice of its election or extension of any Extension Period
at least one Business Day before the earlier of:
. the date the Distributions on the capital securities or the interest on
the junior subordinated debentures would have been payable except for
the election to begin or extend such Extension Period;
. the date the Administrative Trustees are or the Indenture Trustee is
required to give notice to the New York Stock Exchange or any applicable
stock exchange or automated quotation system on which the capital
securities or the junior subordinated debentures are then listed or
quoted or to the holders of the capital securities or the junior
subordinated debentures of the record date; or
. the date the interest is payable,
but in any event not less than one Business Day before the applicable record
date.
The Indenture Trustee shall give notice of Downey's election to begin or
extend an Extension Period to the holders of the junior subordinated
debentures.
Distributions on the capital securities will be deferred by the trust during
any Extension Period as discussed under "Description of the Capital
Securities--Distributions." For a description of related United States federal
income tax consequences and special considerations applicable to the junior
subordinated debentures during the Extension Period, see "Certain Federal
Income Tax Consequences."
Redemption
The junior subordinated debentures will be redeemable before the Stated
Maturity at the option of Downey at a redemption price equal to the accrued
and unpaid interest on the junior subordinated debentures so redeemed to the
date fixed for redemption, plus 100% of the principal amount of the junior
subordinated debentures so redeemed as follows:
1. on or after , 2004, in whole at any time or in part from time to
time; or
2. before , 2004, in whole but not in part, within 90 days following
the occurrence and during the continuance of a Tax Event, an Investment
Company Event or a Capital Treatment Event. However, Downey's right to
redeem the junior subordinated debentures upon the occurrence of a Tax
Event, Investment Company Event or Capital Treatment Event will not go
into effect if there is available to Downey or the trust the opportunity
to eliminate, within the 90-day period, the relevant event by taking
some ministerial action, such as filing a form or making an election or
pursuing some other reasonable measure that will have no adverse effect
on Downey, the trust or the holders of the capital securities and will
involve no material cost, and in that case Downey will pursue this
measure instead of redemption.
123
<PAGE>
Notwithstanding the foregoing, installments of interest on the junior
subordinated debentures which are due and payable on Interest Payment Dates
falling on or before a redemption date shall be payable to the registered
holders as of the close of business on the relevant record dates. Notice of
any redemption will be mailed at least 30 days but not more than 60 days
before the redemption date to each holder of junior subordinated debentures to
be redeemed at the holder's registered address. Unless Downey defaults in
payment of the redemption price, on and after the redemption date interest
will cease to accrue on the junior subordinated debentures or portions of the
junior subordinated debentures called for redemption.
If Downey redeems less than all of the outstanding junior subordinated
debentures, the junior subordinated debentures, or portions of the junior
subordinated debentures to be redeemed, will be selected by the Indenture
Trustee. The Indenture Trustee will select the junior subordinated debentures
to be redeemed from the outstanding junior subordinated debentures not
previously called for redemption. The Indenture Trustee may use any method it
deems fair and appropriate and which may provide for the selection for
redemption of a portion of the principal amount of any junior subordinated
debentures, which must be in a principal amount of $25 or integral multiples
of $25.
Downey may not redeem fewer than all of the outstanding junior subordinated
debentures unless it has paid or contemporaneously pays all accrued and unpaid
interest on all junior subordinated debentures for all quarterly interest
payment periods terminating on or before the relevant redemption date.
The junior subordinated debentures will not be subject to any sinking fund.
Restrictions on Specified Payments
Downey will not make the payments described below if at any time Downey does
the following or the following events occur:
. failure by Downey to pay any principal of or interest on junior
subordinated debentures when due, including any Additional Interest or
Additional Sums;
. there shall have occurred any event of which Downey has actual knowledge
that (a) constitutes or with the giving of notice or the lapse of time,
or both, would constitute a Debenture Event of Default with respect to
the junior subordinated debentures, other than a Debenture Event of
Default referred to in the preceding bullet point, and (b) in respect of
which Downey shall not have taken reasonable steps to cure;
. Downey shall have given notice of its election of an Extension Period as
provided in the Indenture with respect to the junior subordinated
debentures and such Extension Period, or any extension of an Extension
Period, shall be continuing; or
. while the junior subordinated debentures are held by the trust, Downey
shall be in default with respect to its payment of any obligation under
the Guarantee Agreement.
If any of the above events occurs and is continuing, then Downey may not and
shall not allow any of its subsidiaries to:
. declare or pay any dividends or distributions on, or redeem, purchase,
acquire or make a liquidation payment with respect to, any of Downey's
capital stock, which includes common and preferred stock;
. make any payment of principal of or interest or premium, if any, on or
repay, repurchase or redeem any debt securities of Downey that rank on a
parity with or junior to the junior subordinated debentures in right of
payment;
. redeem, purchase or acquire less than all of the junior subordinated
debentures or the capital securities; or
. make any guarantee payments with respect to any guarantee by Downey of
the debt securities of any subsidiary of Downey if such guarantee ranks
on parity with or junior to the junior subordinated debentures in right
of payment.
124
<PAGE>
Notwithstanding the foregoing, during an Extension Period Downey and its
subsidiaries will be allowed to make:
. any dividend in a form of stock, warrants, options or other rights where
the dividend or the stock issuable upon the exercise of the warrants,
options or other rights is the same stock as that on which the dividend
is being paid or ranks on a parity with or junior to that stock in right
of payment;
. any declaration of a dividend in connection with the implementation of a
stockholders' rights plan or the issuance of stock under any
stockholders' rights plan in the future, or the redemption or repurchase
of any rights pursuant thereto;
. payments under the Guarantee Agreement; and
. purchases of common stock related to the issuance of common stock or
rights under any of Downey's benefit plans for its directors, officers
or employees.
Debenture Events of Default
The Indenture provides that any one or more of the following described
events with respect to the junior subordinated debentures that has occurred
and is continuing constitutes a "Debenture Event of Default" with respect to
the junior subordinated debentures:
. failure for 30 days to pay any interest, including any Additional
Interest or Additional Sums, on the junior subordinated debentures when
due, subject to the deferral of any due date as the result of an
Extension Period;
. failure to pay any principal of the junior subordinated debentures when
due, whether at maturity, upon redemption, by declaration or otherwise;
. default in the performance, or breach, in any material respect, of any
covenant contained in the Indenture or the junior subordinated
debentures (other than a covenant contained in the Indenture for the
benefit of a series of Debt Securities other than the junior
subordinated debentures) for 90 days after written notice to Downey from
the Indenture Trustee or to Downey and the Indenture Trustee by the
holders of at least 25% in aggregate outstanding principal amount of the
junior subordinated debentures;
. the dissolution, winding up or termination of the trust, except in
connection with the distribution of the junior subordinated debentures
to holders of Trust Securities in liquidation or dissolution of the
trust in accordance with the terms of the Trust Agreement; or
. specified events in bankruptcy, insolvency or reorganization of Downey.
The holders of not less than a majority in aggregate outstanding principal
amount of the junior subordinated debentures will have the right to direct the
time, method and place of conducting any proceeding for any remedy available
to the Indenture Trustee. The Indenture Trustee or the holders of not less
than 25% in aggregate outstanding principal amount of the junior subordinated
debentures may declare the principal of and accrued and unpaid interest on the
junior subordinated debentures due and payable immediately upon a Debenture
Event of Default. If the Indenture Trustee or the holders of the junior
subordinated debentures fail to make this declaration, the holders of at least
25% in aggregate Liquidation Amount of the capital securities shall have the
right. The holders of a majority in aggregate outstanding principal amount of
the junior subordinated debentures may annul the declaration and waive the
default if all defaults, other than the non-payment of the principal and
interest of the junior subordinated debentures which have become due solely by
the above-mentioned acceleration, have been cured or waived and a sum
sufficient to pay all matured installments of interest and principal due
otherwise than by acceleration has been deposited with the Indenture Trustee.
Should the holders of the junior subordinated debentures fail to annul the
declaration and waive the default, the holders of a majority in aggregate
Liquidation Amount of the capital securities shall have this right.
125
<PAGE>
The holders of a majority in aggregate outstanding principal amount of
junior subordinated debentures may, on behalf of the holders of all the junior
subordinated debentures, waive any past default, except a default in the
payment of principal or interest, unless the default has been cured and a sum
sufficient to pay all matured installments of interest and principal due
otherwise than by acceleration has been deposited with the Indenture Trustee,
or a default in respect of a covenant or provision which under the Indenture
cannot be modified or amended without the consent of the holder of each
outstanding junior subordinated debenture.
In case a Debenture Event of Default shall occur and be continuing, the
Indenture Trustee will have the right to declare the principal of and the
interest on the junior subordinated debentures, and any other amounts payable
under the Indenture, to be forthwith due and payable and to enforce its other
rights as a creditor with respect to the junior subordinated debentures.
Downey will be required to file annually with the Indenture Trustee a
certificate as to whether or not Downey is in compliance with all the
conditions and covenants applicable to it under the Indenture.
Subordination
The Indenture provides that the junior subordinated debentures will be
subordinate and junior in right of payment to all Senior and Subordinated Debt
to the extent provided in the Indenture. Upon any payment or distribution of
assets of Downey to creditors upon any liquidation, dissolution, winding up,
reorganization, assignment for the benefit of creditors, marshaling of assets
or any bankruptcy, insolvency, receivership or similar proceedings in
connection with any insolvency or bankruptcy proceeding of Downey, the holders
of Senior and Subordinated Debt will first be entitled to receive payment in
full of all Senior and Subordinated Debt before the holders of junior
subordinated debentures will be entitled to receive or retain any payment in
respect of the junior subordinated debentures.
The Indenture also provides that Downey may not make payments of principal
of or interest on the junior subordinated debentures if:
. any Senior and Subordinated Debt is not paid when due and any applicable
grace period after the default has ended and the default has not been
cured or waived or ceased to exist; or
. the maturity of any Senior and Subordinated Debt has been accelerated
because of a default, and the acceleration has not been rescinded.
Upon the occurrence of any of the events described in the two preceding
paragraphs, any payment or distribution on the junior subordinated debentures
that would otherwise be payable in respect of the junior subordinated
debentures but for the subordination provisions will be paid or delivered
directly to the holders of Downey's Senior and Subordinated Debt until all of
Downey's Senior and Subordinated Debt has been paid in full. Upon the
occurrence of any of the events described in the two preceding paragraphs, if
the Indenture Trustee or any holder of junior subordinated debentures receives
any payment or distribution on account of the junior subordinated debentures
before all of Downey's Senior and Subordinated Debt is paid in full, then that
payment or distribution will be paid over or delivered and transferred to
Downey, or if Downey is in bankruptcy to a bankruptcy trustee, which will then
be obligated to pay the holders of its Senior and Subordinated Debt at the
time outstanding.
The rights of the holders of the junior subordinated debentures will be
subrogated to the rights of the holders of Downey's Senior and Subordinated
Debt to the extent of any payment Downey makes to the holders of its Senior
and Subordinated Debt that otherwise would have been made to the holders of
the junior subordinated debentures but for the subordination provisions.
"Debt" means with respect to any Person, whether recourse is to all or a
portion of the assets of such Person and whether or not contingent:
1. every obligation of the Person for money borrowed;
126
<PAGE>
2. every obligation of the Person evidenced by bonds, debentures, notes or
other similar instruments, including obligations incurred in connection
with the acquisition of property, assets or businesses;
3. every reimbursement obligation of the Person with respect to letters of
credit, bankers' acceptances or similar facilities issued for the
account of the Person;
4. every obligation of the Person issued or assumed as the deferred
purchase price of property or services (but excluding trade accounts
payable or accrued liabilities arising in the ordinary course of
business);
5. every capital lease obligation of the Person;
6. all indebtedness of the Person for claims in respect of derivative
products, including interest rate, foreign exchange rate and commodity
forward contracts, options and swaps and similar arrangements; and
7. every obligation of the type referred to in clauses 1 through 6 of
another Person and all dividends of another Person the payment of which,
in either case, the Person in question has guaranteed or for which the
person in question is responsible or liable, directly or indirectly, as
obligor or otherwise.
"Senior and Subordinated Debt" means the principal of, and premium, and
interest, if any, including interest accruing on or after the filing of any
petition in bankruptcy or for reorganization relating to Downey whether or not
such claim for post-petition interest is allowed in such proceeding, on Debt
of Downey, whether incurred on or before the date of the Indenture or
thereafter incurred, unless, in the instrument creating or evidencing the same
or under which the same is outstanding, it is expressly provided that such
Debt is not superior in right of payment to, or ranks on parity in right of
payment with or junior in right of payment to, the junior subordinated
debentures or to other Debt which by its express terms ranks on parity with,
or junior to, the junior subordinated debentures in right of payment. However,
Senior and Subordinated Debt shall not be deemed to include:
. any Debt of Downey which, when incurred and without respect to any
election under section 1111(b) of the United States Bankruptcy Code of
1978, as amended, or any successor provision thereto, was without
recourse to Downey;
. any Debt of Downey to any of its subsidiaries;
. any Debt to any employee of Downey;
. any other debt securities issued under the Indenture;
. any Debt between or among Downey and any of its affiliates, including
all other debt securities and guarantees in respect of those debt
securities issued to any other trust, or trustee of any other trust,
partnership, limited liability company or other entity affiliated with
Downey which is a financing vehicle of Downey (a "Financing Entity") in
connection with the issuance by that Financing Entity of preferred
securities or other securities that rank on parity in right of payment
with, or junior in right of payment to, the capital securities or
Downey's guarantee of which ranks on a parity in right of payment with,
or junior in right of payment to, Downey's guarantee under the Guarantee
Agreement;
. trade accounts payable or accrued liabilities arising in the ordinary
course of business; and
. any liabilities for federal, state, local or other taxes.
By reason of the subordination provisions described above, in the event of
bankruptcy, insolvency, receivership or similar proceedings involving Downey,
holders of Senior and Subordinated Debt may receive more, ratably, and holders
of junior subordinated debentures may receive less, ratably, than other
creditors of Downey. The subordination provisions will not prevent the
occurrence of any Debenture Event of Default.
The Indenture places no limitation on the amount of additional Senior and
Subordinated Debt that may be incurred by Downey. Downey may from time to time
incur additional indebtedness constituting Senior and Subordinated Debt.
127
<PAGE>
Additional Expenses
If at any time while the Property Trustee is the holder of the junior
subordinated debentures, the trust shall be required to pay any taxes, duties,
assessments or governmental charges of whatever nature, other than withholding
taxes, imposed by the United States or any other taxing authority, then, in
any such case, we will pay as additional interest on the junior subordinated
debentures any additional amounts ("Additional Expenses") that are required so
that the net amounts received and retained by the trust after paying those
taxes, duties, assessments or governmental charges will not be less than the
amounts the trust would have received if those taxes, duties, assessments or
governmental charges had not been imposed.
Denominations, Registration and Transfer
The junior subordinated debentures will initially be registered in the name
of the trust and delivered to and held by the Property Trustee. If the junior
subordinated debentures are distributed to holders of the capital securities,
it is anticipated that the junior subordinated debentures will be represented
by a global certificate or certificates registered in the name of the
Depository or its nominee (a "Global Subordinated Debenture"). It is likewise
anticipated that the depository arrangements for any Global Subordinated
Debenture will be substantially similar to those in effect for the capital
securities as described above under "Description of the Capital Securities--
Global Capital Securities" and under "Book-Entry Issuance" below. Accordingly,
beneficial interests in the Global Subordinated Debenture will be shown on,
and transfers of the Global Subordinated Debenture will be effected only
through, records maintained by the Depository. Except as described below,
junior subordinated debentures in certificated form will not be issued in
exchange for the Global Subordinated Debenture.
Unless and until a Global Subordinated Debenture is exchanged in whole or in
part for the individual capital securities represented thereby, it may not be
transferred except as a whole by:
. the Depository to a nominee of the Depository;
. a nominee of the Depository to the Depository or another nominee of the
Depository; or
. the Depository or any nominee to a successor depository or any nominee
of that successor.
The Depository may discontinue providing its services as securities
depository with respect to the Global Subordinated Debenture at any time.
A Global Subordinated Debenture shall be exchangeable for junior
subordinated debentures registered in the names of persons other than the
Depository or its nominee only if:
. the Depository notifies Downey that it is unwilling or unable to
continue as depository for the Global Subordinated Debenture or at any
time the Depository ceases to be a clearing agency registered under the
Securities Exchange Act if so required by applicable law or regulation,
and no successor depository shall have been appointed within 90 days of
such notification or of Downey becoming aware of the Depository's
ceasing to be so registered, as the case may be;
. Downey in its sole discretion determines that the Global Subordinated
Debenture shall be so exchangeable; or
. a Debenture Event of Default shall have occurred and be continuing.
Any Global Subordinated Debenture that is exchangeable as described in the
preceding sentence shall be exchangeable for definitive certificates
registered in the names as the Depository shall direct. It is expected that
the instructions will be based upon directions received by the Depository from
its Participants with respect to ownership of beneficial interests in the
Global Subordinated Debenture. If junior subordinated debentures are issued in
definitive form, the junior subordinated debentures will be in denominations
of $25 and integral multiples of $25 and may be transferred or exchanged at
the offices described below.
128
<PAGE>
For so long as the Property Trustee is the holder of the junior subordinated
debentures, all payments on junior subordinated debentures will be made to the
Property Trustee. Payments on junior subordinated debentures represented by a
Global Subordinated Debenture will be made to the Depository, as the
depository for the junior subordinated debentures. For junior subordinated
debentures issued in certificated form, principal and interest will be
payable, the transfer of the junior subordinated debentures will be
registrable, and junior subordinated debentures will be exchangeable for
junior subordinated debentures of other denominations of a like aggregate
principal amount, at the office or agency of Downey maintained for that
purpose, which initially shall be the office of the Indenture Trustee which on
the date of this prospectus is located at Rodney Square North, 1100 Market
Street, Wilmington, Delaware or at the offices of any other paying agent or
transfer agent appointed by Downey, provided that payment of interest may be
made at the option of Downey by check mailed to the address of the persons
entitled thereto or by wire transfer to those persons. Downey will agree that,
if the junior subordinated debentures are distributed to holders of capital
securities upon liquidation or dissolution of the trust and any such junior
subordinated debentures are not in the form of Global Subordinated Debentures,
it will at all times maintain a paying agent and transfer agent for the junior
subordinated debentures in the Borough of Manhattan, the City of New York. For
a description of the Depository and the terms of the depository arrangements
relating to payments, transfers, voting rights, redemptions and other notices
and other matters, see "Book-Entry Issuance."
Downey will appoint the Indenture Trustee as securities registrar under the
Indenture. Junior subordinated debentures in certificated form may be
presented for exchange, and may be presented for registration of transfer, and
shall, if so required by Downey or the securities registrar, have the form of
transfer endorsed thereon, or a satisfactory written instrument of transfer,
duly executed, at the office of the securities registrar. Downey will not
impose a service charge for the transfer or exchange but may require payment
of any transfer tax or other governmental charge which may be imposed in
connection with any transfer or exchange. Downey may at any time rescind the
designation of any transfer agent or approve a change in the location through
which any transfer agent acts. Downey may at any time designate additional
transfer agents with respect to the junior subordinated debentures.
In the event of any redemption, neither Downey nor the Indenture Trustee
shall be required to:
. issue, register the transfer of or exchange junior subordinated
debentures during a period beginning at the opening of business 15
calendar days before the day of mailing of a notice of redemption of any
junior subordinated debentures called for redemption and ending at the
close of business on the day of mailing of the relevant notice of
redemption; or
. transfer or exchange any junior subordinated debentures so selected for
redemption in whole or in part, except, in the case of any junior
subordinated debentures being redeemed in part, any portion of the
junior subordinated debentures not to be redeemed.
Any moneys deposited with the Indenture Trustee or any Paying Agent, or then
held by Downey in trust, for the payment of the principal of or interest on
the junior subordinated debentures and remaining unclaimed for two years after
the principal or interest has become due and payable shall, at the request of
Downey, be repaid to Downey and the holder of those junior subordinated
debentures shall thereafter look, as a general unsecured creditor, only to
Downey for payment thereof.
Modification of Indenture
From time to time Downey and the Indenture Trustee may, without the consent
of the holders of the junior subordinated debentures, amend, waive or
supplement the Indenture for specified purposes, including:
. to evidence the succession of another party to Downey and the assumption
by that party of the covenants of Downey under the Indenture and under
the junior subordinated debentures;
. to add to the covenants of Downey for the benefit of the holders of the
junior subordinated debentures;
. to add any additional Events of Default for the benefit of the holders
of the junior subordinated debentures;
129
<PAGE>
. to cure any ambiguity, to correct or supplement any provision of the
Indenture which may be defective or inconsistent with any other
provision in the Indenture, or to make any other provisions regarding
matters or questions arising under the Indenture, provided that any
actions under this clause shall not adversely affect the interests of
any holders of junior subordinated debentures or capital securities in
any material respect for so long as they remain outstanding; or
. to comply with the requirements of the SEC to effect or maintain the
qualification of the Indenture under the Trust Indenture Act.
The Indenture also contains provisions permitting Downey and the Indenture
Trustee, with the consent of the holders of not less than a majority in
principal amount of the outstanding junior subordinated debentures, to modify
the Indenture in a manner affecting the rights of the holders of the junior
subordinated debentures. However, Downey and the Indenture Trustee may not
modify the Indenture without the consent of the holder of each outstanding
junior subordinated debenture, except to the extent permitted in connection
with the deferral of Interest Payment Dates during an Extension Period, or the
shortening of the Stated Maturity, if the modification will:
. change the Stated Maturity of the junior subordinated debentures, or
reduce the principal amount of the junior subordinated debentures, or
reduce the rate or extend the time of payment of interest thereon, or
reduce the amount payable upon redemption, or change the place of
payment where, or the currency in which, any amount is payable or impair
the right to institute suit for the enforcement of any payment on or
after the date it is due and payable;
. reduce the percentage of principal amount of junior subordinated
debentures, the holders of which are required to consent to any
modification of or for waivers under the Indenture; or
. modify the provisions of the Indenture with respect to the subordination
of the junior subordinated debentures, including the definitions
relating thereto, in a manner adverse to the holders of the junior
subordinated debentures.
With respect to the above modifications, so long as any of the capital
securities remain outstanding, neither Downey, the Indenture Trustee, nor the
holders of the outstanding junior subordinated debentures may make
modifications to the Indenture that adversely affect the holders of the
capital securities in any material respect, and no termination of the
Indenture may occur, and no waiver of any Debenture Event of Default or
compliance with any covenant under the Indenture may be effective, without the
prior consent of the holders of at least a majority of the aggregate
Liquidation Amount of the capital securities then outstanding unless and until
the principal of the junior subordinated debentures and all accrued and unpaid
interest thereon have been paid in full and other conditions are satisfied.
Where a consent under the Indenture would require the consent of each holder
of junior subordinated debentures, no consent shall be given by the Property
Trustee without the prior consent of each holder of capital securities then
outstanding. In addition, Downey and the Indenture Trustee may execute,
without the consent of any holder of junior subordinated debentures, any
supplemental Indenture for the purpose of creating any new series of Debt
Securities.
Enforcement of Specified Rights by Holders of Capital Securities
If a Debenture Event of Default has occurred and is continuing and that
event is attributable to the failure of Downey to pay principal of or interest
on the junior subordinated debentures on the date that interest or principal
is otherwise payable, a holder of capital securities may institute a legal
proceeding directly against Downey for enforcement of payment to the holder of
the principal of or interest on the junior subordinated debentures having a
principal amount equal to the aggregate Liquidation Amount of the capital
securities held by the holder (a "Direct Action"). Downey may not amend the
Indenture to remove the foregoing right to bring a Direct Action without the
prior written consent of the holders of all of the capital securities
outstanding. In connection with a Direct Action, Downey will be subrogated to
the rights of any holders of the capital securities to the extent of any
payment made by Downey to any holders of the junior subordinated debentures in
the Direct Action.
130
<PAGE>
The holders of the capital securities will not be able to exercise directly
any remedies other than those discussed in the preceding paragraph available
to the holders of the junior subordinated debentures unless there shall have
been an Event of Default under the Trust Agreement as discussed under
"Description of the Capital Securities--Events of Default; Notice."
Consolidation, Merger, Sale of Assets and Other Transactions
The Indenture provides that Downey shall not consolidate or merge with or
into any other Person or convey, transfer or lease its properties and assets
as an entirety or substantially as an entirety to any Person, and no Person
shall consolidate with or merge into Downey or convey, transfer or lease its
properties and assets as an entirety or substantially as an entirety to
Downey, unless:
. either Downey shall be the continuing Person, in the case of a merger,
or the successor Person, if other than Downey, formed by the
consolidation or into which Downey is merged or which acquires by
conveyance, transfer or lease the properties and assets of Downey as an
entirety or substantially as an entirety is organized under the laws of
the United States or any state or the District of Columbia, and the
successor Person expressly assumes, by execution of a supplemental
indenture in form satisfactory to the Indenture Trustee, all of Downey's
obligations under the junior subordinated debentures, the Guarantee
Agreement, the guarantee agreement in respect of the common securities
and the Indenture and the due and punctual performance and observance of
every obligation in the junior subordinated debentures, Guarantee
Agreement, guarantee agreement in respect of the common securities and
the Indenture to be performed or observed by Downey;
. immediately after giving effect thereto, no Debenture Event of Default
with respect to the junior subordinated debentures, and no event which,
after notice or lapse of time or both, would become a Debenture Event of
Default with respect to the junior subordinated debentures, shall have
occurred and be continuing; and
. other conditions as described in the Indenture are met.
The provisions of the Indenture do not afford holders of the junior
subordinated debentures protection in the event of a highly leveraged or other
transaction involving Downey that may adversely affect holders of the junior
subordinated debentures.
Satisfaction and Discharge
The Indenture provides that when, among other things, all junior
subordinated debentures not previously delivered to the Indenture Trustee for
cancellation:
. have become due and payable,
. will become due and payable at their Stated Maturity within one year, or
. are to be called for redemption within one year under arrangements
satisfactory to the Indenture Trustee,
and, in each of the foregoing cases, Downey deposits or causes to be deposited
with the Indenture Trustee funds, in trust, for the purpose and in an amount
in the currency in which the junior subordinated debentures are payable
sufficient to pay and discharge the entire indebtedness on the junior
subordinated debentures not previously delivered to the Indenture Trustee for
cancellation, for the principal and interest to the date of the deposit or to
the Stated Maturity or the relevant Redemption Date, as the case may be, then
the Indenture will cease to be of further effect, except as to Downey's
obligations to pay all other sums due under the Indenture and to provide the
officers' certificates and opinions of counsel described therein, and a
limited number of other provisions which the Indenture provides will survive,
and Downey will be deemed to have satisfied and discharged the Indenture.
131
<PAGE>
Covenants of Downey
Downey will covenant in the Indenture, as to the junior subordinated
debentures, that Downey will pay to the trust any applicable Additional Sums
if and so long as:
. the trust is the holder of all the junior subordinated debentures; and
. a Tax Event in respect of the trust has occurred and is continuing.
Downey will also covenant, as to the junior subordinated debentures:
. to maintain, directly or indirectly, 100% ownership of the common
securities of the trust, provided that successors which are permitted
under the Indenture may succeed to Downey's ownership of the common
securities;
. to use its reasonable efforts, consistent with the terms and provisions
of the Trust Agreement, to cause the trust to remain classified as a
grantor trust and not as an association taxable as a corporation for
United States federal income tax purposes;
. not to voluntarily terminate, wind-up or liquidate the trust, except
having received prior to the termination, winding up or liquidation all
required regulatory approvals, and except
. in connection with a distribution of junior subordinated debentures
to the holders of the capital securities in liquidation of the
trust; or
. in connection with specified mergers, consolidations, or
amalgamations permitted by the Trust Agreement; and
. to pay the costs, expenses, obligations and liabilities as described
under "Description of Junior Subordinated Debentures--Additional
Expenses" and "Description of the Capital Securities--Expenses."
Governing Law
The Indenture and the junior subordinated debentures will be governed by and
construed under the laws of the State of New York.
Information Concerning the Indenture Trustee
The Indenture Trustee shall have all the duties and responsibilities
specified with respect to an indenture trustee under the Trust Indenture Act.
The Indenture Trustee, other than during the occurrence and continuance of a
Debenture Event of Default, undertakes only to perform those duties as are
specifically described in the Indenture and, after a Debenture Event of
Default, must exercise the same degree of care as a prudent person would
exercise or use in the conduct of his or her own affairs. Except as discussed
in the foregoing, the Indenture Trustee is under no obligation to exercise any
of the powers vested in it by the Indenture at the request of any holder of
junior subordinated debentures, unless the holder offers it reasonable
indemnity against the costs, expenses and liabilities which it might incur.
The Indenture Trustee is not required to expend or risk its own funds or
otherwise incur financial liability in the performance of its duties if the
Indenture Trustee reasonably believes that repayment or adequate indemnity is
not reasonably assured to it.
132
<PAGE>
BOOK-ENTRY ISSUANCE
The capital securities will be issued in the form of one or more fully
registered securities in book-entry form registered in the name of the
Depository or its nominee. So long as the junior subordinated debentures are
held by the Property Trustee, the junior subordinated debentures will not be
issued in book-entry form, but will be evidenced by one or more certificates
held by, and registered in the name of, the Property Trustee. However, if the
junior subordinated debentures are distributed to holders of capital
securities upon dissolution or liquidation of the trust, Downey anticipates
that the junior subordinated debentures will be issued in fully registered
book-entry form. The following discussion is relevant only with respect to
capital securities and junior subordinated debentures in book-entry form which
are evidenced by one or more global certificates registered in the name of the
Depository or its nominee as described below.
The Depository will act as securities depository for all capital securities
while they are in book-entry form and, if applicable, junior subordinated
debentures issued in book-entry form (collectively, the "Global Securities").
The Global Securities will be issued only as fully-registered securities
registered in the name of Cede & Co., the Depository's nominee. One or more
fully-registered global certificates will be issued for the capital securities
and the junior subordinated debentures and will be deposited with the
Depository.
The Depository has advised Downey as follows: The Depository is a limited
purpose trust company organized under the New York Banking Law, a "banking
organization" within the meaning of the New York Banking Law, a member of the
Federal Reserve System, a "clearing corporation" within the meaning of the New
York Uniform Commercial Code, and a "clearing agency" registered as required
by the provisions of Section 17A of the Exchange Act.
The Depository holds securities that its Participants deposit with the
Depository. The Depository also facilitates the settlement among Participants
of securities transactions, like transfers and pledges, in deposited
securities through electronic computerized book-entry changes in Participants'
accounts, thereby eliminating the need for physical movement of securities
certificates. "Direct Participants" include securities brokers and dealers,
banks, trust companies, clearing corporations and other organizations. The
Depository is owned by a number of its Direct Participants and by the New York
Stock Exchange, Inc., the American Stock Exchange, Inc. and the National
Association of Securities Dealers, Inc. Access to the Depository system is
also available to other parties like securities brokers and dealers, banks and
trust companies that clear through or maintain custodial relationships with
Direct Participants, either directly or indirectly ("Indirect Participants").
The rules applicable to the Depository and its Participants are on file with
the SEC.
Parties who purchase capital securities or junior subordinated debentures
within the Depository system must make the purchase by or through Direct
Participants, which will receive a credit for the capital securities or junior
subordinated debentures on the Depository's records. The ownership interest of
each actual purchaser of each capital security and each junior subordinated
debenture ("Beneficial Owner") will in turn be recorded on the Direct and
Indirect Participants' records. Beneficial Owners will not receive written
confirmation from the Depository of their purchases, but Beneficial Owners are
expected to receive written confirmations providing details of the
transactions, as well as periodic statements of their holdings, from the
Direct or Indirect Participants through which the Beneficial Owners purchased
capital securities or junior subordinated debentures. Transfers of ownership
interests in the capital securities or junior subordinated debentures are to
be accomplished by entries made on the books of Participants acting on behalf
of Beneficial Owners. Beneficial Owners will not receive certificates
representing their ownership interests in capital securities or junior
subordinated debentures, except under the limited circumstances referred to
below.
The Depository will have no knowledge of the actual Beneficial Owners of the
capital securities or junior subordinated debentures. The Depository's records
reflect only the identity of the Direct Participants to whose accounts the
capital securities or junior subordinated debentures are credited, which may
or may not be the Beneficial Owners. The Participants will remain responsible
for keeping account of their holdings on behalf of their customers.
133
<PAGE>
Conveyance of notices and other communications by:
. the Depository to Direct Participants,
. Direct Participants to Indirect Participants, and
. Direct Participants and Indirect Participants to Beneficial Owners,
and the voting rights of Direct Participants, Indirect Participants and
Beneficial Owners will be governed by arrangements among them, subject to any
statutory or regulatory requirements as may be in effect from time to time.
Redemption notices will be sent to Cede & Co. as the registered holder of
the Global Securities. If less than all of the Global Securities are being
redeemed, the Depository will determine by lot or pro rata the amount of the
Global Securities of each Direct Participant to be redeemed.
Although voting with respect to the capital securities and the junior
subordinated debentures is generally limited to the holders of record of the
capital securities or junior subordinated debentures, as applicable, in those
instances in which a vote is required, neither the Depository nor Cede & Co.
will itself consent or vote with respect to capital securities or junior
subordinated debentures. Under its usual procedures, the Depository would mail
an omnibus proxy to the relevant trustee as soon as possible after the record
date. The omnibus proxy assigns Cede & Co.'s consenting or voting rights to
those Direct Participants to whose accounts the capital securities or junior
subordinated debentures are credited on the record date, and identified in a
listing attached to the omnibus proxy.
Payments on the capital securities or the junior subordinated debentures
will be made by the relevant trustee or paying agent to the Depository. The
Depository's practice is to credit Direct Participants' accounts on the
relevant payment date in any amount determined by each Direct Participants'
holdings shown on the Depository's records unless the Depository has reason to
believe that it will not receive payments on the payment date. Payments by
Participants to Beneficial Owners will be governed by standing instructions
and customary practices and will be the responsibility of the Participants and
not of the Depository, the relevant trustee, the trust or Downey, subject to
any statutory or regulatory requirements as may be in effect from time to
time. Payments to the Depository is the responsibility of the relevant
trustee, disbursement of these payments to Direct Participants is the
responsibility of the Depository, and disbursement of these payments to the
Beneficial Owners is the responsibility of Direct and Indirect Participants.
The Depository may discontinue providing its services as securities
depositary with respect to the capital securities or the junior subordinated
debentures at any time by giving reasonable notice to the relevant trustee and
Downey. In that event, or in the other limited circumstances described above
under "Description of the Capital Securities-Global Capital Securities" and
"Description of the Junior Subordinated Debentures--Denominations,
Registration and Transfer" and "--Global Subordinated Debentures," definitive
certificates representing the capital securities or junior subordinated
debentures are required to be printed and delivered.
The information in this section and elsewhere in this prospectus concerning
the Depository and the Depository's book-entry system has been obtained from
sources that the trust and Downey believe to be accurate, but the trust and
Downey assume no responsibility for the accuracy of the information. Neither
the trust nor Downey has any responsibility for the performance by the
Depository or its Participants of their individual obligations as described in
this prospectus or under the rules and procedures governing their operations.
Management of the Depository is aware that some computer applications,
systems, and the like for processing data that are dependent upon calendar
dates, including dates before, on, and after January 1, 2000, may encounter
"year 2000 problems." The Depository has informed its Participants and other
members of the financial community that it has developed and is implementing a
program so that its applications and systems, as the same relate to the timely
payment of distributions to securityholders, book-entry deliveries, and
settlement of trades within the Depository, continue to function
appropriately. This program includes a technical assessment and a remediation
plan, each of which the Depository has indicated is complete. Additionally,
the Depository's plan includes a testing phase, which the Depository expects
to be completed within appropriate time frames.
134
<PAGE>
However, the Depository's ability to perform properly its services is also
dependent upon other parties, including but not limited to issuers and their
agents, as well as third party vendors from whom the Depository licenses
software and hardware, and third party vendors upon whom the Depository relies
for information or the provision of services, including telecommunication and
electrical utility service providers, among others. The Depository has
informed its Participants and other members of the financial community that it
is contacting, and will continue to contact, third party vendors from whom the
Depository acquires services to:
. impress upon them the importance of these services being year 2000
compliant; and
. determine the extent of their efforts for year 2000 remediation (and, as
appropriate, testing) of their services.
In addition, the Depository is in the process of developing contingency
plans as it deems appropriate.
According to the Depository, the foregoing information with respect to the
Depository has been provided for informational purposes only and is not
intended to serve as a representation, warranty, or contract modification of
any kind.
If problems associated with the year 2000 problem were to occur with respect
to the Depository and the services described above, payments to holders would
be delayed or otherwise adversely affected.
135
<PAGE>
DESCRIPTION OF GUARANTEE
The Guarantee Agreement will be executed and delivered by Downey
concurrently with the issuance of the capital securities for the benefit of
the holders of the capital securities. Wilmington Trust Company will act as
Guarantee Trustee under the Guarantee Agreement for the purposes of compliance
with the Trust Indenture Act, and the Guarantee Agreement will be qualified as
an indenture under the Trust Indenture Act. The following summary of
provisions of the Guarantee Agreement does not purport to be complete and is
qualified in its entirety by reference to the provisions of the Guarantee
Agreement, including the definitions therein of terms, and the Trust Indenture
Act. The form of the Guarantee Agreement has been filed as an exhibit to the
Registration Statement of which this prospectus forms a part, and copies of
the Guarantee Agreement may be obtained as described under "Where You Can Find
More Information." As used under this caption "Description of Guarantee," all
references to "Downey" mean Downey Financial Corp. excluding, unless otherwise
expressly stated or the context otherwise requires, its subsidiaries.
General
Downey will irrevocably and unconditionally agree to pay in full on a
subordinated basis, to the extent described below, the Guarantee Payments, as
defined below, to the holders of the capital securities, as and when due,
regardless of any defense, right of set-off or counterclaim that the trust may
have or assert other than the defense of payment. The following payments with
respect to the capital securities, to the extent not paid by or on behalf of
the trust (the "Guarantee Payments"), will be guaranteed by Downey under the
Guarantee Agreement:
. any accrued and unpaid Distributions required to be paid on the capital
securities, to the extent that the trust has funds on hand available
therefor at that time;
. the Redemption Price with respect to any capital securities called for
redemption, to the extent that the trust has funds on hand available
therefor at that time; and
. upon a voluntary or involuntary termination, winding up or liquidation
of the trust (unless the junior subordinated debentures are distributed
to the holders of the capital securities), the lesser of (a) the
Liquidation Distribution and (b) the amount of assets of the trust
remaining available for distribution to holders of the capital
securities after satisfaction of liabilities to creditors of the trust
as required by applicable law.
Downey's obligation to make a Guarantee Payment may be satisfied by direct
payment of the required amounts by Downey to the holders of the capital
securities or by causing the trust to pay those amounts to the holders of the
capital securities.
Downey's guarantee (the "Guarantee") under the Guarantee Agreement will be
an irrevocable guarantee on a subordinated basis of the trust's obligations
under the capital securities, but will apply only to the extent the trust has
funds sufficient to make those payments, and is not a guarantee of collection.
If Downey does not make payments on the junior subordinated debentures held
by the trust, the trust will not be able to pay amounts due on the capital
securities and will not have funds available to pay amounts due on the capital
securities. The Guarantee Agreement does not limit the incurrence or issuance
of other secured or unsecured debt of Downey, including Senior and
Subordinated Debt.
Status of the Guarantee
The Guarantee will constitute an unsecured obligation of Downey and will
rank subordinate and junior in right of payment to all Senior and Subordinated
Debt in the same manner as the junior subordinated debentures.
The Guarantee will constitute a guarantee of payment and not of collection.
For example, the guaranteed party may institute a legal proceeding directly
against Downey to enforce its rights under the Guarantee
136
<PAGE>
Agreement without first instituting a legal proceeding against any other
person or entity. The Guarantee will be held by the Guarantee Trustee for the
benefit of the holders of the capital securities. The Guarantee will not be
discharged except by payment of the Guarantee Payments in full to the extent
not paid by the trust or upon distribution to the holders of the capital
securities of the junior subordinated debentures.
Amendments and Assignment
Except with respect to any changes which do not adversely affect the rights
of holders of the capital securities in any material respect, in which case no
consent will be required, the Guarantee Agreement may not be amended without
the prior approval of the holders of not less than a majority of the aggregate
Liquidation Amount of the outstanding capital securities. All guarantees and
agreements contained in the Guarantee Agreement shall bind the successors,
assigns, receivers, trustees and representatives of Downey and shall inure to
the benefit of the holders of the capital securities then outstanding.
Events of Default
An event of default under the Guarantee Agreement will occur upon the
failure of Downey to perform any of its payment obligations thereunder, or to
perform any of its non-payment obligations thereunder if the default remains
uncured for 90 days after Downey receives notice of the default. The foregoing
notice and cure conditions do not apply, however, with respect to Downey's
default in payment of any guarantee payment. The holders of not less than a
majority in aggregate Liquidation Amount of the outstanding capital securities
will have the right to direct the time, method and place of conducting any
proceeding for any remedy available to the Guarantee Trustee in respect of the
Guarantee Agreement or to direct the exercise of any trust or power conferred
upon the Guarantee Trustee under the Guarantee Agreement. Any holder of the
capital securities may institute a legal proceeding directly against Downey to
enforce its rights under the Guarantee Agreement without first instituting a
legal proceeding against the trust, the Guarantee Trustee or any other person
or entity.
Downey, as guarantor, will be required to file annually with the Guarantee
Trustee a certificate as to whether or not Downey is in compliance with all
the conditions applicable to it under the Guarantee Agreement.
Information Concerning the Guarantee Trustee
The Guarantee Trustee, other than during the occurrence and continuance of a
default by Downey in performance of its obligations under the Guarantee
Agreement, undertakes to perform only those duties as are specifically
provided in the Guarantee Agreement and, after default with respect to the
Guarantee Agreement, must exercise the same degree of care and skill as a
prudent person would exercise or use in the conduct of his or her own affairs.
Except as discussed in this paragraph, the Guarantee Trustee is under no
obligation to exercise any of the powers vested in it by the Guarantee
Agreement at the request of any holder of the capital securities unless it is
offered reasonable indemnity against the costs, expenses and liabilities that
it might incur.
Termination of the Guarantee Agreement
The Guarantee Agreement will terminate and be of no further force and effect
upon full payment of the Redemption Price of the capital securities, upon full
payment of the amounts payable upon liquidation of the trust or upon
distribution of junior subordinated debentures to the holders of the capital
securities upon the dissolution of the trust. The Guarantee Agreement will
continue to be effective or will be reinstated, as the case may be, if at any
time any holder of the capital securities must restore payment of any sums
paid under the capital securities or the Guarantee Agreement.
Governing Law
The Guarantee Agreement will be governed by and construed under the laws of
the State of New York.
137
<PAGE>
RELATIONSHIP AMONG THE CAPITAL SECURITIES, THE
JUNIOR SUBORDINATED DEBENTURES AND THE GUARANTEE
Full and Unconditional Guarantee
Payments of Distributions and other amounts due on the capital securities,
to the extent the trust has funds available for the payment of those amounts,
will be irrevocably guaranteed by Downey on a subordinated basis as and to the
extent described under "Description of Guarantee." Taken together, Downey's
obligations under the junior subordinated debentures, the Indenture, the Trust
Agreement, and the Guarantee Agreement will provide, in the aggregate, a full,
irrevocable and unconditional guarantee on a subordinated basis of payments of
distributions and other amounts due on the capital securities. No single
document standing alone or operating in conjunction with fewer than all of the
other documents constitutes the same guarantee. It is only the combined
operation of those documents that has the effect of providing a full,
irrevocable and unconditional guarantee of the trust's obligations under the
capital securities. If and to the extent that Downey does not make payments on
the junior subordinated debentures, the trust will not pay Distributions or
other amounts due holders of the capital securities. Neither the Guarantee
Agreement nor any of the other documents described above covers payment of
Distributions or other amounts payable on the capital securities when the
trust does not have sufficient funds to pay those amounts. In that event, the
remedy of a holder of the capital securities is to institute a legal
proceeding directly against Downey for enforcement of payment. The obligations
of Downey under the Guarantee Agreement will be subordinate and junior in
right of payment to all Senior and Subordinated Debt to the same extent as the
junior subordinated debentures.
Sufficiency of Payments
As long as payments of interest and other payments are made when due on the
junior subordinated debentures, those payments will be sufficient to cover
Distributions and other payments due on the capital securities, primarily
because:
. the aggregate principal amount of the junior subordinated debentures
will be equal to the aggregate Liquidation Amount of the capital
securities and common securities;
. the interest rate and interest and other payment dates on the junior
subordinated debentures will match the distribution rate and
Distribution Dates and other payment dates for the capital securities;
. Downey shall pay for all and any costs, expenses and liabilities of the
trust except the trust's payment obligations to holders of the capital
securities; and
. the Trust Agreement further provides that the trust will not engage in
any activity that is not consistent with its limited purposes.
In connection with any Direct Action, Downey will be subrogated to the
rights of any holder of Trust Securities to the extent of any payment made by
Downey to any holder of the Trust Securities in the Direct Action.
Enforcement Rights of Holders of the Capital Securities under the Guarantee
Holders of capital securities may institute a legal proceeding directly
against Downey to enforce their rights under the Guarantee Agreement without
first instituting a legal proceeding against the Guarantee Trustee, the trust
or any other person or entity.
Downey's default or the event of default under any Senior or Subordinated
Debt would not constitute a default or Debenture Event of Default with respect
to the junior subordinated debentures. However, in the event of payment
defaults under, or acceleration of any Senior or Subordinated Debt, the
subordination provisions of the Indenture provide that no payments may be made
in respect of the junior subordinated debentures until the Senior and
Subordinated Debt has been paid in full or any payment default thereunder has
been cured or waived or the acceleration has been rescinded.
138
<PAGE>
Limited Purpose of the Trust
The capital securities evidence beneficial interests in the assets of the
trust, and the trust exists for the sole purpose of issuing the Trust
Securities and investing the proceeds in junior subordinated debentures. A
principal difference between the rights of a holder of the capital securities
and the rights of a holder of a junior subordinated debenture is that a holder
of a junior subordinated debenture will be entitled to receive from Downey the
principal of and interest accrued on junior subordinated debentures held,
while a holder of the capital securities will be entitled to receive
Distributions from the trust.
Rights upon Dissolution
Upon any voluntary or involuntary dissolution, winding-up or liquidation of
the trust, other than a dissolution involving the distribution of the junior
subordinated debentures to the holders of the capital securities, the holders
of the capital securities will be entitled to receive, out of assets held by
the trust, the Liquidation Distribution in cash, as discussed under
"Description of the Capital Securities--Liquidation Distribution Upon
Dissolution." Upon any voluntary or involuntary liquidation or bankruptcy of
Downey, the Property Trustee, as holder of the junior subordinated debentures,
would be a subordinated creditor of Downey, subordinated in right of payment
to all Senior and Subordinated Debt as described in the Indenture, but
entitled to receive payment in full of principal and interest, before any
stockholders of Downey receive payments or distributions. Since Downey is the
guarantor under the Guarantee Agreement and will pay for all costs, expenses
and liabilities of the trust, other than the trust's payment obligations to
the holders of its capital securities, the position of a holder of the capital
securities and the position of a holder of junior subordinated debentures
relative to other creditors and to shareholders of Downey in the event of
liquidation or bankruptcy of Downey are expected to be substantially the same.
139
<PAGE>
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
General
The following is a summary of the material United States federal income tax
consequences associated with the purchase, ownership and disposition of
capital securities held as capital assets by a holder who purchased original
capital securities upon initial issuance. We do not purport to deal with all
aspects of federal income taxation that might be relevant to particular
holders in light of their personal investment circumstances or status, nor do
we discuss the federal income tax consequences to some types of holders
subject to special treatment under the federal income tax laws. These holders
include banks, thrifts, real estate investment trusts, regulated investment
companies, insurance companies, dealers in securities or currencies, tax-
exempt investors, United States Alien Holders engaged in a U.S. trade or
business or persons that will hold the capital securities as a position in a
"straddle," as part of a "synthetic security" or "hedge," as part of a
"conversion transaction" or other integrated investment, or as other than a
capital asset. This summary also does not address the tax consequences to
persons that have a functional currency other than the U.S. dollar or the tax
consequences to shareholders, partners or beneficiaries of a holder of capital
securities. Further, we do not include any description of any alternative
minimum tax consequences or the tax laws of any state or local government or
of any foreign government that may be applicable to the capital securities.
This summary is based on the Internal Revenue Code of 1986, as amended (the
"Code"), Treasury Regulations thereunder and the administrative and judicial
interpretations of the Code and the Treasury Regulations, as of the date
hereof, all of which might change, possibly on a retroactive basis. This
discussion is based upon opinions issued by Manatt, Phelps & Phillips, LLP
("Tax Counsel"). An opinion of Tax Counsel is not binding on the IRS or the
courts. No rulings have been or are expected to be sought from the IRS with
respect to any of the transactions described herein and we cannot assure that
the IRS will not take contrary positions. Moreover, we cannot assure that the
IRS will not challenge the opinions expressed herein or, if challenged, that
the IRS would not be successful. Tax Counsel has reviewed this summary and is
of the opinion that, to the extent that it constitutes matters of law or
purports to describe particular provisions of the federal income tax laws, it
is a correct summary in all material respects of the matters discussed herein.
Classification of the Junior Subordinated Debentures
Tax counsel has rendered its opinion that the junior subordinated debentures
will be classified for federal income tax purposes as indebtedness of Downey.
Downey, the trust and the holders of the capital securities, by acceptance of
a beneficial interest in a capital security, will agree to treat the junior
subordinated debentures as indebtedness of Downey and the capital securities
as evidence of a beneficial ownership interest in the junior subordinated
debentures for all federal income tax purposes. We cannot assure, however,
that the IRS will not challenge this position or, if challenged, that the IRS
will not be successful. The remainder of this discussion assumes that the
junior subordinated debentures will be classified as indebtedness of Downey
for federal income tax purposes.
Enron Corporation filed a petition in the United States Tax Court (Docket
No. 6149-98) challenging the IRS' proposed disallowance of the deduction of
interest expense on securities Enron Corporation issued in 1993 and 1994 that
are similar to, although different in a number of respects from, the junior
subordinated debentures. It has been reported to Tax Counsel that the IRS is
not currently pursuing this issue in the pending Enron case.
More recently, the IRS issued a technical advice memorandum (PLR 199910046),
that addresses whether instruments that are similar in some respects to the
junior subordinated debentures constituted debt or equity for federal income
tax purposes. The IRS concluded that the instruments constituted debt. A
technical advice memorandum may not be used or cited as a legal precedent, but
it does provide some indication of the views of the IRS National Office on the
issues addressed therein. While PLR 199910046 is supportive of Tax Counsel's
opinion and our intended reporting position referred to above, the
characterization action of instruments like the junior subordinated debentures
continues to be an area of some controversy.
140
<PAGE>
Classification of the Trust
Tax Counsel has rendered its opinion that, under current law and assuming
full compliance with the terms of the Trust Agreement and the Indenture, and
other documents, and based on specific facts and assumptions contained in the
opinion, the trust will be classified for federal income tax purposes as a
grantor trust and not as an association taxable as a corporation. Accordingly,
for federal income tax purposes, each holder of capital securities generally
will be considered the owner of an undivided interest in the junior
subordinated debentures, and each holder will be required to include in its
gross income any interest, or original issue discount ("OID") accrued, with
respect to its allocable share of those junior subordinated debentures.
Interest Income and Original Issue Discount
Under recently issued Treasury Regulations (the "Treasury Regulations")
applicable to debt instruments issued on or after August 13, 1996, a "remote"
contingency that stated interest will not be timely paid will be ignored in
determining whether a debt instrument is issued with OID. Downey believes that
the likelihood of its exercising its option to defer payments of interest is
"remote" since exercising that option would, among other things, prevent
Downey from declaring dividends on any class of its equity securities.
Accordingly, Tax Counsel has rendered its opinion that the junior subordinated
debentures will not be considered to be issued with OID and, accordingly,
stated interest on the junior subordinated debentures generally will be
taxable to a holder as ordinary income at the time it is paid or accrued
according to the holder's method of tax accounting. The IRS has not addressed
the Treasury Regulations in any rulings or other interpretations, and it is
possible that the IRS could take a position contrary to the interpretation
described herein.
Under the Treasury Regulations, if Downey were to exercise its option to
defer payments of interest, the junior subordinated debentures would at that
time be treated as issued with OID, and all stated interest on the junior
subordinated debentures would thereafter be treated as OID as long as the
junior subordinated debentures remain outstanding. In this event, all of a
holder's taxable interest income with respect to the junior subordinated
debentures would thereafter be accounted for on an economic accrual basis
regardless of the holder's method of tax accounting, and actual distributions
of stated interest would not be reported as taxable income. Consequently, a
holder of capital securities would be required to include in gross income OID
even though Downey would not make actual cash payments during an Extension
Period. Moreover, under the Treasury Regulations, if the option to defer the
payment of interest was determined not to be "remote," the junior subordinated
debentures would be treated as having been originally issued with OID. In this
event, all of a holder's taxable interest income with respect to the junior
subordinated debentures would be accounted for on an economic accrual basis
regardless of the holder's method of tax accounting, and actual distributions
of stated interest would not be reported as taxable income.
Because income on the capital securities will constitute interest or OID,
corporate holders of the capital securities will not be entitled to a
dividends-received deduction with respect to any income recognized with
respect to the capital securities.
Distribution of Junior Subordinated Debentures to Holders of Capital
Securities
Downey will have the right at any time to liquidate the trust and cause the
junior subordinated debentures to be distributed to the holders of the capital
securities under specific circumstances. Under current law, this distribution,
for federal income tax purposes, would be treated as a nontaxable event to
each holder, and each holder would receive an aggregate tax basis in the
junior subordinated debentures equal to the holder's aggregate tax basis in
its capital securities. A holder's holding period in the junior subordinated
debentures so received in liquidation of the trust would include the period
during which the holder held the capital securities. If, however, the trust
were characterized for federal income tax purposes as an association taxable
as a corporation at the time of its dissolution, the distribution of the
junior subordinated debentures may constitute a taxable event to the trust and
to holders of capital securities and a holder's holding period in junior
subordinated debentures would begin on the date the holder received the junior
subordinated debentures.
141
<PAGE>
Under specific circumstances discussed under "Description of the Capital
Securities," the junior subordinated debentures may be redeemed for cash and
the proceeds of the redemption distributed to holders in redemption of their
capital securities. Under current law, a redemption would, for federal income
tax purposes, constitute a taxable disposition of the redeemed capital
securities, and a holder would recognize a gain or loss as if he had sold the
redeemed capital securities for cash. See "--Sales or Redemptions of Capital
Securities."
Sales or Redemptions of Capital Securities
A holder that sells capital securities, including a redemption of the
capital securities either on the Stated Maturity Date or upon an optional
redemption of the junior subordinated debentures by Downey, will recognize
gain or loss equal to the difference between its adjusted tax basis in capital
securities and the amount realized on the sale of capital securities, other
than with respect to accrued and unpaid interest which has not yet been
included in income, which will be treated as ordinary income. A holder's
adjusted tax basis in the capital securities generally will be its initial
purchase price increased by OID, if any, previously includable in the holder's
gross income to the date of disposition and decreased by payments, if any,
received on the capital securities in respect of OID. This gain or loss
generally will be a capital gain or loss and generally will be a long-term
capital gain or loss if the capital securities have been held for more than
one year. For individuals the maximum tax on long term capital gains on most
assets is 20% for amounts properly taken into account after January 1, 1998.
The capital securities may trade at a price that does not accurately reflect
the value of accrued but unpaid interest with respect to the underlying junior
subordinated debentures. A holder who uses the accrual method of accounting
for tax purposes--and a cash method holder, if the junior subordinated
debentures are deemed to have been issued with OID--who disposes of his
capital securities between record dates for payments of distributions thereon
will be required to include accrued but unpaid interest on the junior
subordinated debentures through the date of disposition in income as ordinary
income--i.e., interest or, if applicable, OID--and to add this amount to his
adjusted tax basis in his pro rata share of the underlying junior subordinated
debentures deemed disposed of. To the extent the selling price is less than
the holder's adjusted tax basis, which will include all accrued but unpaid
interest, a holder will recognize a capital loss. Except for limited
exceptions, capital losses cannot be applied to offset ordinary income for
federal income tax purposes.
Possible Tax Law Changes Affecting the Capital Securities
In the recent past, President Clinton proposed legislation that would, among
other things, have denied an issuer a deduction for United States federal
income tax purposes for the payment of interest on instruments with
characteristics similar to the junior subordinated debentures. This
legislation was not enacted. We cannot assure, however, that legislation
enacted after the date hereof would not adversely affect the tax treatment of
the junior subordinated debentures, resulting in a Tax Event. The occurrence
of a Tax Event may result in the redemption of the junior subordinated
debentures for cash, in which event the holders of the capital securities
would receive cash in redemption of their capital securities.
United States Alien Holders
For purposes of this discussion, a "United States Alien Holder" is any
corporation, individual, partnership, estate or trust that is not a U.S.
Holder for federal income tax purposes.
A "U.S. Holder" is a holder of capital securities who or which is:
. a citizen or individual resident (or is treated as a citizen or
individual resident) of the United States for federal income tax
purposes;
. a corporation or partnership created or organized in or under the laws
of the United States, any state of the United States or the District of
Columbia; or
142
<PAGE>
. an estate the income of which is includable in its gross income for
federal income tax purposes without regard to its source. A trust is a
U.S. Holder if, and only if:
. a court within the United States is able to exercise primary
supervision over the administration of the trust; and
. one or more United States trustees have the authority to control all
substantial decisions of the trust.
Under present federal income tax laws:
. payments by the trust or any of its paying agents to any holder of a
capital security who or which is a United States Alien Holder will not
be subject to federal withholding tax; provided that:
. the beneficial owner of the capital security does not actually or
constructively own 10% or more of the total combined voting power of
all classes of stock of Downey entitled to vote;
. the beneficial owner of the capital security is not a controlled
foreign corporation that is related to Downey through stock
ownership; and
. either:
. the beneficial owner of the capital security certifies to the
trust or its agent, under penalties of perjury, that it is not a
U.S. holder and provides its name and address; or
. a securities clearing organization, bank or other financial
institution that holds customers' securities in the ordinary
course of its trade or business (a "Financial Institution"), and
holds the capital security in such capacity, certifies to the
trust or its agent, under penalties of perjury, that such
statement has been received from the beneficial owner by it or by
a Financial Institution between it and the beneficial owner and
furnishes the trust or its agent with a copy of the statement;
and
. a United States Alien Holder of a capital security will not be subject
to federal withholding tax on any gain realized upon the sale or other
disposition of a capital security.
The IRS recently issued regulations which will be effective for payments
made after December 31, 2000, making modifications to the certification
procedures applicable to United States Alien Holders. In general, these
regulations unify certification procedures and forms and clarify and modify
reliance standards. A United States Alien Holder should consult with its own
advisor regarding the effect of the new Treasury Regulations.
As discussed above, changes in legislation or other events affecting the
federal income tax treatment of the junior subordinated debentures are
possible, and could adversely affect the ability of Downey to deduct the
interest payable on the junior subordinated debentures. Moreover, legislation
or other events could adversely affect United States Alien Holders by
characterizing income derived from the junior subordinated debentures as
dividends, generally subject to a 30% income tax, on a withholding basis, when
paid to a United States Alien Holder, rather than as interest which, as
discussed above, is generally exempt from income tax in the hands of a United
States Alien Holder.
Information Reporting to Holders
Generally, income on the capital securities will be reported to holders on
Form 1099, which forms should be mailed to holders of capital securities by
January 31 following each calendar year.
Backup Withholding
Payments made on, and proceeds from the sale of, the capital securities may
be subject to a "backup" withholding tax of 31% unless the holder complies
with specific identification requirements. Any withheld amounts will be
allowed as a credit against the holder's federal income tax, provided the
holder provides the required information to the IRS.
143
<PAGE>
THE UNITED STATES FEDERAL INCOME TAX DISCUSSION ABOVE IS INCLUDED FOR
GENERAL INFORMATION ONLY AND MAY NOT BE APPLICABLE DEPENDING UPON A HOLDER'S
PARTICULAR SITUATION. HOLDERS SHOULD CONSULT THEIR TAX ADVISORS WITH RESPECT
TO THE TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF
THE CAPITAL SECURITIES, INCLUDING THE TAX CONSEQUENCES UNDER STATE, LOCAL,
FOREIGN AND OTHER TAX LAWS AND THE POSSIBLE EFFECTS OF CHANGES IN UNITED
STATES FEDERAL OR OTHER TAX LAWS.
144
<PAGE>
CERTAIN ERISA CONSIDERATIONS
Downey, which is the obligor with respect to the junior subordinated
debentures held by the trust, the Property Trustee and their affiliates may be
considered "parties in interest" within the meaning of the Employee Retirement
Income Security Act of 1974, as amended ("ERISA") or "disqualified persons,"
within the meaning of Section 4975 of the Code, with respect to many
individual retirement accounts that are subject to Section 408 of the Code or
employee benefit plans that are subject to ERISA or to Section 4975 of the
Code (collectively as "Plans"). Any purchaser proposing to acquire capital
securities with assets of any Plan should consult with its counsel. The
purchase and/or holding of capital securities by a Plan that is subject to the
fiduciary responsibility provisions of ERISA or the prohibited transaction
provisions of Section 4975 of the Code, including individual retirement
arrangements and other Plans described in Section 4975(e)(1) of the Code, and
with respect to which Downey, the Property Trustee or any affiliate is a
service provider or otherwise is a party in interest or a disqualified person
may constitute or result in a prohibited transaction under ERISA or Section
4975 of the Code, unless the acquisition of the capital securities fall within
an applicable exemption, like Prohibited Transaction Class Exemption ("PTCE")
84-14, an exemption for specific transactions determined by an independent
qualified professional asset manager, PTCE 91-38, an exemption for specific
transactions involving bank collective investment funds, PTCE 90-1, an
exemption for specific transactions involving insurance company pooled
separate accounts, PTCE 95-60, an exemption for specific transactions
involving specific insurance company general accounts or PTCE 96-23, an
exemption for specific transactions determined by an in-house asset manager.
In addition, a Plan fiduciary considering the purchase of capital securities
should be aware that, under regulations issued by the Department of Labor
concerning what constitutes the assets of a Plan (the "Plan Assets
Regulation"), the assets of the trust may be considered "plan assets" for
ERISA purposes if Plans acquire the capital securities, unless an exception
under those regulations applies. It is anticipated that the capital securities
will qualify for the exception for "publicly-offered securities" because they
will be sold in an offering registered under the Securities Act and will be
registered under the Securities Exchange Act within the period required under
the Plan Assets Regulation; it is expected that they will be held by 100 or
more investors at the conclusion of the offering; and Downey believes that the
capital securities will be "freely transferable." If the capital securities
qualify for this exception, ownership of the capital securities by Plans would
not cause the assets of the trust to constitute plan assets.
The discussion herein of ERISA is general in nature and is not intended to
be all inclusive. Any fiduciary of a Plan, governmental plan or church plan
considering an investment in the capital securities should consult with its
legal advisors regarding the consequence of an investment.
145
<PAGE>
UNDERWRITERS
Under the terms and conditions of an underwriting agreement dated the date
of this prospectus, the underwriters named below, for whom Morgan Stanley &
Co. Incorporated, Dain Rauscher Wessels, a division of Dain Rauscher
Incorporated, A.G. Edwards & Sons, Inc., Prudential Securities Incorporated
and Sutro & Co. Incorporated are acting as representatives, have severally
agreed to purchase, and the trust has agreed to sell to them, severally, the
respective number of capital securities indicated below.
<TABLE>
<CAPTION>
Number of
Capital
Name Securities
---- ----------
<S> <C>
Morgan Stanley & Co. Incorporated...................................
Dain Rauscher Wessels, a division of Dain Rauscher Incorporated.....
A.G. Edwards & Sons, Inc............................................
Prudential Securities Incorporated..................................
Sutro & Co. Incorporated............................................
---------
Total............................................................. 4,800,000
=========
</TABLE>
The underwriters are offering the capital securities subject to their
acceptance of the capital securities from the trust and subject to prior sale.
The underwriting agreement provides that the obligations of the several
underwriters to pay for and accept delivery of the capital securities are
subject to conditions, including the delivery of legal opinions by their
counsel. The underwriters are obligated to purchase all the capital securities
if any capital securities are purchased.
The underwriters initially propose to offer part of the capital securities
directly to the public at the public offering price appearing on the cover
page of this prospectus. The underwriters may also offer the capital
securities to securities dealers at a price that represents a concession not
in excess of $. per capital security. Any underwriter may allow, and
dealers may reallow, a concession not in excess of $. per capital security
to other securities dealers. After the initial offering of the capital
securities, the offering price and other selling terms may from time to time
be changed by the representatives.
Because the proceeds from the sale of the capital securities will be used to
purchase the junior subordinated debentures issued by Downey, the underwriting
agreement provides that Downey will pay to the underwriters as compensation
for their services $. per capital security or $ in the aggregate.
Downey's offering expenses, not including underwriting discounts and
commissions, are estimated to be $ .
Downey and the trust have agreed that, without the prior written consent of
Morgan Stanley & Co. Incorporated on behalf of the underwriters, they will
not, during the period beginning on the date of the underwriting agreement and
continuing through and including the date which is 30 days after the date of
the underwriting agreement:
. offer, pledge, sell, contact to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase or otherwise transfer or dispose of,
directly or indirectly, any debt securities or preferred stock of Downey
or any securities of the trust or any similar trust or other entity
affiliated with Downey, or any securities convertible into or
exchangeable or exercisable for any debt securities or preferred stock
of Downey or any securities of the trust or any similar trust or other
entity affiliated with Downey; or
. enter into any swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of any
preferred stock or debt securities of Downey or any securities of the
trust or any similar trust or other entity affiliated with Downey,
146
<PAGE>
whether any transaction described above is to be settled by delivery of
securities of Downey, the trust or any similar trust or other entity, any
other securities, in cash or otherwise, except for the issuance of the capital
securities to the underwriters, the issuance of the common securities to
Downey or the issuance of the junior subordinated debentures to the trust in
connection with this offering.
Before this offering, there has been no public market for the capital
securities. The trust has applied to list the capital securities on the New
York Stock Exchange. To meet one of the requirements for listing the capital
securities on the New York Stock Exchange, the underwriters intend to sell
capital securities to a minimum of 400 beneficial holders in lots of 100
capital securities or more. If the listing is approved, trading of the capital
securities on the New York Stock Exchange is expected to begin within a 30-day
period after the date of this prospectus. The representatives have advised
Downey that they presently intend to make a market in the capital securities
before the commencement of trading on the New York Stock Exchange. The
representatives are not obligated to make a market in the capital securities,
however, and may discontinue market making activities at any time without
notice. No assurance can be given as to the liquidity of any trading market
for the capital securities.
Downey, the trust and the underwriters have agreed to indemnify each other
against some liabilities, including liabilities under the Securities Act.
To facilitate the offering of the capital securities, the underwriters may
engage in transactions that stabilize, maintain or otherwise affect the price
of the capital securities. Specifically, the underwriters may over-allot in
connection with the offering, creating a short position in the capital
securities for their own account. In addition, to cover over-allotments or to
stabilize the price of the capital securities, the underwriters may bid for,
and purchase, capital securities in the open market. Finally, the underwriting
syndicate may reclaim selling concessions allowed to an underwriter or a
dealer for distributing the capital securities in the offering, if the
syndicate repurchases previously distributed capital securities in
transactions to cover syndicate short positions, in stabilization transactions
or otherwise. Any of these activities may stabilize or maintain the market
price of the capital securities above independent market levels. The
underwriters are not required to engage in these activities, and may end any
of these activities at any time.
LEGAL MATTERS
Matters of Delaware law relating to the validity of the capital securities,
the enforceability of the Trust Agreement and the formation of the trust will
be passed upon by Richards, Layton & Finger, P.A., Wilmington, Delaware,
special counsel to Downey and the trust. The validity of the Guarantee
Agreement, the Indenture and the junior subordinated debentures will be passed
upon for Downey by Manatt, Phelps & Phillips, LLP, Menlo Park, California,
counsel to Downey. Brown & Wood llp, San Francisco, California will act as
counsel to the underwriters. Manatt, Phelps & Phillips, LLP and Brown & Wood
llp will rely on the opinions of Richards, Layton & Finger, P.A. as to matters
of Delaware law. Matters relating to United States federal income tax
considerations will be passed upon for Downey by Manatt, Phelps & Phillips,
LLP.
EXPERTS
Our consolidated financial statements as of December 31, 1998 and 1997, and
for each of the years in the three-year period ended December 31, 1998 have
been incorporated by reference herein and in the Registration Statement in
reliance upon the report of KPMG LLP, independent auditors, incorporated
herein by reference, and upon the authority of said firm as experts in
accounting and auditing.
147
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 14. Other Expenses of Issuance and Distribution
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee................ $ 33,360
NASD fees and expenses............................................. 22,500
New York Stock Exchange fees....................................... 47,800
Trustees' fees and expenses........................................ 11,000
Legal fees and expenses............................................ 225,000
Blue Sky fees and expenses......................................... 10,000
Accounting fees and expenses....................................... 40,000
Rating agency fees................................................. 65,000
Printing expenses.................................................. 150,000
Miscellaneous expenses............................................. 25,000
--------
Total............................................................ $629,660
========
</TABLE>
All of the above items except the registration fee are estimated.
Item 15. Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law (the "DGCL") contains
detailed provisions on indemnification of directors and officers against
expenses, judgments, fines and amounts paid in settlement, actually and
reasonably incurred in connection with legal proceedings. Section 102(b)(7) of
the DGCL permits a provision in the certificate of incorporation of each
corporation organized thereunder, like Downey, eliminating or limiting, with
certain exceptions, the personal liability of a director of the corporation or
its stockholders for monetary damages for breach of fiduciary duty as a
director.
Our bylaws provide that we shall indemnify and hold harmless to the fullest
extent authorized by the DGCL each person who is or was a director or officer
of Downey against all expense, liability and loss, including attorneys' fees,
judgments, fines, ERISA excise taxes or penalties and amounts paid or to be
paid in settlement, reasonably incurred or suffered by the director or
officer. The indemnification shall continue as to a person who has ceased to
be a director or officer; provided, however, that, except as otherwise
provided in our bylaws, we shall indemnify any person seeking indemnification
in connection with a proceeding initiated by that person only if our board of
directors authorized the proceeding. The right to indemnification conferred in
our bylaws is a contract right and includes the right to have us pay the
expenses incurred in defending the proceeding in advance of its final
disposition. However, if the DGCL requires the payment of expenses incurred in
advance of the final disposition of a proceeding, we shall make payment only
upon delivery to us of an undertaking, by or on behalf of the director or
officer, to repay all amounts so advanced if it shall ultimately be determined
that the director or officer is not entitled to be indemnified under the
bylaws or otherwise. Our bylaws create a right to indemnification whether or
not the proceeding to which the indemnification relates arose in whole or in
part before adoption of the indemnification provisions of our bylaws.
The rights of indemnification provided in our bylaws are not exclusive of
any other rights which may be available under Delaware law, any insurance or
other agreement, by vote of shareholders or disinterested directors or
otherwise. In addition, our bylaws authorize us to maintain insurance on
behalf of any person who is or was a director or officer of Downey or another
entity at our expense, whether or not we would have the power to provide
indemnification to the person under the DGCL. We currently maintain directors'
and officers' liability insurance. The indemnification provisions may, in some
instances, cover acts of directors and officers that may not be covered by
insurance.
These provisions require indemnification even in cases in which the conduct
giving rise to the request for indemnification may have been negligent,
grossly negligent or reckless. Although equitable remedies may be available in
some instances, these indemnification provisions cover any expenses or damages
resulting from these suits.
II-1
<PAGE>
Our certificate of incorporation provides for the elimination, except in
limited circumstances, of the liability of our directors for monetary damages
for breach of fiduciary duty to Downey and its shareholders. Under our
certificate of incorporation, a director shall not be personally liable to
Downey or its shareholders for monetary damages for breach of fiduciary duty
as a director, except for liability:
. for any breach of the director's duty of loyalty to Downey or its
shareholders;
. for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. for unlawful payment of dividends or unlawful stock purchase or
redemption; or
. for any transaction from which the director derived an improper personal
benefit.
The underwriting agreement with respect to the offering of securities
registered hereunder will also provide for indemnification of Downey and its
officers and directors who signed this registration statement by the
underwriters, against certain liabilities including liabilities under the
Securities Act of 1933.
The Amended and Restated Trust Agreement also provides that we shall
indemnify the Property Trustee, the Delaware Trustee, the Administrative
Trustee, or any of their affiliates, or any officers, directors, shareholders,
employees, representatives, or agents of the Property Trustee, the Delaware
Trustee and the Administrative Trustee, each, a "Fiduciary Indemnified
Person," for, and hold each Fiduciary Indemnified Person harmless, to the
fullest extent permitted by applicable law, against, any loss, damage,
liability, tax, penalty, expense or claim of any kind or nature whatsoever a
Fiduciary Indemnified Person incurred by reason of the creation, operation or
dissolution of the trust or any act or omission the Fiduciary Indemnified
Person performed or omitted in good faith on behalf of the trust and in a
manner the Fiduciary Indemnified Person reasonably believed to be within the
scope of authority conferred on the Fiduciary Indemnified Person by the
Amended and Restated Trust Agreement. However, no Fiduciary Indemnified Person
shall be entitled to be indemnified in respect of any loss, damage or claim
the Fiduciary Indemnified Person incurred by reason of gross negligence, or
ordinary negligence in the case of the Property Trustee, bad faith or willful
misconduct with respect to the acts or omissions.
Item 16. Exhibits
(a) Exhibits
<TABLE>
<C> <S>
1.1 Form of Underwriting Agreement.*
4.1 Form of Junior Subordinated Indenture between Downey Financial Corp. and
Wilmington Trust Company, as Trustee (includes Form of Junior
Subordinated Debenture).*
4.2 Certificate of Trust of Downey Financial Capital I.*
4.3 Trust Agreement of Downey Financial Capital I dated as of May 25, 1999.*
4.4 Form of Amended and Restated Trust Agreement of Downey Financial Capital
I.*
4.5 Form of Capital Securities Certificate of Downey Financial Capital I.*
4.6 Form of Capital Securities Guarantee Agreement.*
5.1 Opinion and Consent of Manatt, Phelps & Phillips, LLP.*
5.2 Opinion and Consent of Richards, Layton & Finger, P.A.*
8.1 Opinion and Consent of Manatt, Phelps & Phillips, LLP, counsel to Downey
Financial Corp., as to certain federal income tax matters.+
12.1 Statement of Computation of Ratio of Earnings to Fixed Charges.*
</TABLE>
II-2
<PAGE>
<TABLE>
<C> <S>
23.1 Consent of KPMG LLP.
23.2 Consent of Manatt, Phelps & Phillips, LLP (included in Exhibit 5.1
above).*
23.3 Consent of Richards, Layton & Finger, P.A. (included in Exhibit 5.2
above).*
23.4 Consent of Manatt, Phelps & Phillips, LLP (included in Exhibit 8.1
above).*
24.1 A power of attorney is set forth on the signature page of the
Registration Statement.*
25.1 Form T-1 Statement of Eligibility of Wilmington Trust Company to act as
trustee under the Subordinated Indenture.*
25.2 Form T-1 Statement of Eligibility of Wilmington Trust Company to act as
trustee under the Amended and Restated Trust Agreement.*
25.3 Form T-1 Statement of Eligibility of Wilmington Trust Company to act as
trustee under the Capital Securities Guarantee Agreement.*
</TABLE>
- --------
* Previously filed as an exhibit to the Registration Statement on Form S-3
filed with the SEC on June 2, 1999.
+ Previously filed as an exhibit to Amendment No. 1 to the Registration
Statement on Form S-3 filed with the SEC on July 6, 1999 which superseded
and replaced Exhibit 8.1 filed as an exhibit to the Registration Statement
on Form S-3 filed with the SEC on June 2, 1999.
Item 17. Undertakings
The undersigned Registrants hereby undertake as follows:
(a) That, for purposes of determining any liability under the Securities
Act of 1933, each filing of Downey's annual report pursuant to Section
13(a) or Section 15(d) of the Securities Exchange Act of 1934 (and, where
applicable, each filing of an employee benefit plan's annual report
pursuant to Section 15(d) of the Securities Exchange Act of 1934) that is
incorporated by reference in the registration statement shall be deemed to
be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
(b) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and
controlling persons of the Registrants pursuant to the foregoing
provisions, or otherwise, the Registrants have been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrants of expenses incurred
or paid by a director, officer or controlling person of the Registrants in
the successful defense of any action, suit or proceeding) is asserted by
such director, officer, trustee or controlling person in connection with
the securities being registered, the Registrants will, unless in the
opinion of their counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question
whether such indemnification by it is against public policy as expressed in
the Act and will be governed by the final adjudication of such issue.
(c) That for purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed as
part of a registration statement in reliance upon Rule 430A and contained
in the form of prospectus filed by the Registrants pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be
part of the registration statement as of the time it was declared
effective.
(d) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Amendment No. 2
to the Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Newport Beach, State of California,
on July 14, 1999.
Downey Financial Corp.
By: /s/ Daniel D. Rosentha___________l
Daniel D. Rosenthal
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 2 to the Registration Statement has been signed by the following persons
in the capacities indicated and on July 14, 1999.
<TABLE>
<CAPTION>
Signature Title
--------- -----
<S> <C>
/s/ Daniel D. Rosenthal President, Chief Executive Officer and Director
______________________________________ (Principal Executive Officer)
Daniel D. Rosenthal
/s/ Thomas E. Prince Executive Vice President and Chief Financial
______________________________________ Officer (Principal Financial and Accounting
Thomas E. Prince Officer)
* Director
______________________________________
Michael Abrahams
* Director
______________________________________
Paul Kouri
* Director
______________________________________
Maurice McAlister
* Director
______________________________________
Brent McQuarrie
* Director
______________________________________
Cheryl E. Olson
* Director
______________________________________
Lester C. Smull
* Director
______________________________________
Sam Yellen
</TABLE>
*By: /s/ Thomas E. Prince
-------------------------------
Thomas E. Prince
Attorney-in-fact
II-4
<PAGE>
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Amendment No. 2
to the Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Newport Beach, State of California,
on July 14, 1999.
Downey Financial Capital Trust I
/s/ Daniel D. Rosenthal
By: _________________________________
Daniel D. Rosenthal, Trustee
/s/ Thomas E. Prince
By: _________________________________
Thomas E. Prince, Trustee
/s/ Paul G. Woollatt
By: _________________________________
Paul G. Woollatt, Trustee
II-5
<PAGE>
Index to Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S> <C>
1.1 Form of Underwriting Agreement.*
4.1 Form of Junior Subordinated Indenture between Downey Financial
Corp. and Wilmington Trust Company, as Trustee (includes Form of
Junior Subordinated Debenture).*
4.2 Certificate of Trust of Downey Financial Capital I.*
4.3 Trust Agreement of Downey Financial Capital I dated as of May
25, 1999.*
4.4 Form of Amended and Restated Trust Agreement of Downey Financial
Capital I.*
4.5 Form of Capital Securities Certificate of Downey Financial
Capital I.*
4.6 Form of Capital Securities Guarantee Agreement.*
5.1 Opinion and Consent of Manatt, Phelps & Phillips, LLP.*
5.2 Opinion and Consent of Richards, Layton & Finger, P.A.*
8.1 Opinion and Consent of Manatt, Phelps & Phillips, LLP, counsel
to Downey Financial Corp., as to certain federal income tax
matters.+
12.1 Statement of Computation of Ratio of Earnings to Fixed Charges.*
23.1 Consent of KPMG LLP.
23.2 Consent of Manatt, Phelps & Phillips, LLP (included in Exhibit
5.1 above).*
23.3 Consent of Richards, Layton & Finger, P.A. (included in Exhibit
5.2 above).*
23.4 Consent of Manatt, Phelps & Phillips, LLP (included in Exhibit
8.1 above).*
24.1 A power of attorney is set forth on the signature page of the
Registration Statement.*
25.1 Form T-1 Statement of Eligibility of Wilmington Trust Company to
act as trustee under the Subordinated Indenture.*
25.2 Form T-1 Statement of Eligibility of Wilmington Trust Company to
act as trustee under the Amended and Restated Trust Agreement.*
25.3 Form T-1 Statement of Eligibility of Wilmington Trust Company to
act as trustee under the Capital Securities Guarantee
Agreement.*
</TABLE>
- --------
* Previously filed as an exhibit to the Registration Statement on Form S-3
filed with the SEC on June 2, 1999.
+ Previously filed as an exhibit to Amendment No. 1 to the Registration
Statement on Form S-3 filed with the SEC on July 6, 1999 which superseded
replaced Exhibit 8.1 filed as an exhibit to the Registration Statement on
Form S-3 filed with the SEC on June 2, 1999.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Downey Financial Corp.:
We consent to incorporation by reference in the registration statement (No.
333-79835) on Amendment No. 2 to Form S-3 of Downey Financial Corp. of our
report dated January 20, 1999, relating to the consolidated balance sheets of
Downey Financial Corp. and subsidiaries as of December 31, 1998 and 1997, and
the related consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1998, which report appears in the December 31, 1998
annual report on Form 10-K of Downey Financial Corp. and to the reference to
our firm under the heading "Experts" in the prospectus.
/s/ KPMG LLP
KPMG LLP
Los Angeles, California
July 15, 1999
