================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
For the quarterly period ended JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
__________ TO __________
Commission File Number 1-13578
DOWNEY FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0633413
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3501 JAMBOREE ROAD, NEWPORT BEACH, CA 92660
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (949) 854-0300
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ------------------------
COMMON STOCK, $0.01 PAR VALUE NEW YORK STOCK EXCHANGE
PACIFIC EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
At June 30, 1999, 28,148,409 shares of the Registrant's Common Stock, $0.01
par value were outstanding.
================================================================================
<PAGE>
DOWNEY FINANCIAL CORP.
JUNE 30, 1999 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION...................................................... 1
Consolidated Balance Sheets............................................ 1
Consolidated Statements of Income...................................... 2
Consolidated Statements of Comprehensive Income........................ 3
Consolidated Statements of Cash Flows.................................. 4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS................................. 6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.................................... 8
PART II
OTHER INFORMATION.......................................................... 33
Item 6 Exhibits and Reports on Form 8-K............................. 33
i
<PAGE>
PART I - FINANCIAL INFORMATION
<TABLE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
<CAPTION>
June 30, December 31, June 30,
(Dollars in Thousands, Except Per Share Data) 1999 1998 1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
ASSETS
Cash .................................................................... $ 56,936 $ 58,510 $ 47,744
Federal funds ........................................................... 3,900 33,751 19,001
- ------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents ........................................... 60,836 92,261 66,745
U.S. Treasury securities and agency obligations available for sale,
at fair value ....................................................... 134,091 116,061 125,019
Municipal securities being held to maturity, at amortized cost (estimated
market value of $6,845 at June 30, 1999, $6,745 at December 31,
1998, and $6,865 at June 30, 1998) .................................. 6,864 6,764 6,885
Mortgage loans purchased under resale agreements ........................ -- -- 50,000
Loans held for sale, at the lower of cost or market ..................... 360,052 447,382 212,164
Mortgage-backed securities available for sale, at fair value ............ 25,783 32,146 42,246
Loans receivable held for investment .................................... 6,432,294 5,308,837 5,073,881
Investments in real estate and joint ventures ........................... 57,460 49,447 41,880
Real estate acquired in settlement of loans ............................. 4,015 4,475 7,576
Premises and equipment .................................................. 105,957 103,979 101,809
Federal Home Loan Bank stock, at cost ................................... 64,943 49,430 48,010
Other assets ............................................................ 79,105 59,637 55,887
- ------------------------------------------------------------------------------------------------------------------
$7,331,400 $6,270,419 $5,832,102
==================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits ................................................................ $5,472,924 $5,039,733 $5,171,376
Federal Home Loan Bank advances ......................................... 1,298,438 695,012 123,347
Commercial paper ........................................................ -- -- 19,982
Other borrowings ........................................................ 8,794 8,708 12,256
Accounts payable and accrued liabilities ................................ 40,728 40,989 39,567
Deferred income taxes ................................................... 8,383 5,411 6,612
- ------------------------------------------------------------------------------------------------------------------
Total liabilities ................................................... 6,829,267 5,789,853 5,373,140
- ------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY:
Preferred stock, par value of $0.01 per share; authorized 5,000,000
shares; outstanding none ............................................ -- -- --
Common stock, par value of $0.01 per share; authorized 50,000,000
shares; outstanding 28,148,409 shares at June 30, 1999, 28,131,776
shares at December 31, 1998, and 28,104,618 shares at June 30, 1998 . 281 281 281
Additional paid-in capital .............................................. 92,385 92,166 91,814
Accumulated other comprehensive income (loss) - unrealized gains
(losses) on securities available for sale ........................... (521) 753 420
Retained earnings ....................................................... 409,988 387,366 366,447
- ------------------------------------------------------------------------------------------------------------------
Total stockholders' equity .......................................... 502,133 480,566 458,962
- ------------------------------------------------------------------------------------------------------------------
$7,331,400 $6,270,419 $5,832,102
==================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
1
<PAGE>
<TABLE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Income
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------------------
(Dollars in Thousands, Except Per Share Data) 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Loans receivable ........................................... $ 118,818 $ 105,583 $ 229,549 $ 210,928
U.S. Treasury securities and agency obligations ............ 1,798 1,846 3,415 3,675
Mortgage-backed securities ................................. 423 738 887 1,546
Other investments .......................................... 1,170 1,630 2,252 3,371
- -------------------------------------------------------------------------------------------------------------------------
Total interest income .................................. 122,209 109,797 236,103 219,520
- -------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Deposits ................................................... 58,084 62,999 113,573 124,537
Borrowings ................................................. 12,928 3,608 22,377 9,167
- -------------------------------------------------------------------------------------------------------------------------
Total interest expense ................................. 71,012 66,607 135,950 133,704
- -------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME ........................................ 51,197 43,190 100,153 85,816
PROVISION FOR LOAN LOSSES .................................. 2,798 1,462 5,179 1,734
- -------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses .... 48,399 41,728 94,974 84,082
- -------------------------------------------------------------------------------------------------------------------------
OTHER INCOME, NET:
Loan and deposit related fees .............................. 4,904 3,727 9,352 6,896
Real estate and joint ventures held for investment, net:
Net gains on sales of wholly owned real estate ........... 200 70 200 70
Reduction of losses on real estate and joint ventures .... 265 2,221 212 4,943
Operations, net .......................................... 2,304 2,712 3,522 9,505
Secondary marketing activities:
Loan servicing fees ...................................... 292 139 866 289
Net gains on sales of loans and mortgage-backed securities 4,058 2,414 8,045 3,286
Net gains on sales of investment securities ................ 191 -- 288 68
Other ...................................................... 1,045 666 2,116 1,818
- -------------------------------------------------------------------------------------------------------------------------
Total other income, net ................................ 13,259 11,949 24,601 26,875
- -------------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSE:
Salaries and related costs ................................. 21,251 15,609 42,062 30,245
Premises and equipment costs ............................... 5,068 3,908 9,803 7,790
Advertising expense ........................................ 2,571 1,552 4,770 3,135
Professional fees .......................................... 471 (29) 1,011 1,357
SAIF insurance premiums and regulatory assessments ......... 942 955 1,931 1,905
Other general and administrative expense ................... 4,979 5,248 11,954 9,021
- -------------------------------------------------------------------------------------------------------------------------
Total general and administrative expense ................. 35,282 27,243 71,531 53,453
- -------------------------------------------------------------------------------------------------------------------------
Net operation of real estate acquired in settlement of loans 121 (97) 211 158
Amortization of excess of cost over fair value of net assets
acquired ................................................. 118 134 236 266
- -------------------------------------------------------------------------------------------------------------------------
Total operating expense ................................ 35,521 27,280 71,978 53,877
- -------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES .................................... 26,137 26,397 47,597 57,080
Income taxes .................................................. 11,079 11,409 20,191 24,527
- -------------------------------------------------------------------------------------------------------------------------
NET INCOME ................................................. $ 15,058 $ 14,988 $ 27,406 $ 32,553
=========================================================================================================================
PER SHARE INFORMATION:
BASIC ......................................................... $ 0.53 $ 0.53 $ 0.97 $ 1.16
=========================================================================================================================
DILUTED ....................................................... $ 0.53 $ 0.53 $ 0.97 $ 1.15
=========================================================================================================================
CASH DIVIDENDS PAID ........................................... $ 0.090 $ 0.080 $ 0.170 $ 0.156
=========================================================================================================================
Weighted average diluted shares outstanding ................... 28,179,984 28,179,643 28,175,126 28,173,832
=========================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
<TABLE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------
(In Thousands) 1999 1998 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET INCOME ........................................................................... $15,058 $14,988 $27,406 $32,553
- ----------------------------------------------------------------------------------------------------------------------------------
OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAXES:
Unrealized gains (losses) on securities available for sale:
U.S. Treasury securities and agency obligations available for sale, at fair value (542) (7) (960) 525
Less reclassification of realized gains, net of losses included in income........ (110) -- (166) (39)
Mortgage-backed securities available for sale, at fair value .................... (174) 1 (148) (176)
- ----------------------------------------------------------------------------------------------------------------------------------
Total other comprehensive income (loss), net of income taxes ..................... (826) (6) (1,274) 310
- ----------------------------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME ................................................................. $14,232 $14,982 $26,132 $32,863
==================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
<TABLE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
<CAPTION>
Six Months Ended
June 30,
------------------------
(In Thousands) 1999 1998
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ........................................................................ $ 27,406 $ 32,553
Adjustments to reconcile net income to net cash used for operating activities:
Depreciation and amortization ................................................... 3,631 3,986
Provision for (recovery of) losses on loans, real estate acquired in settlement
of loans, investments in real estate and joint ventures and other assets ...... 5,086 (3,081)
Net gains on sales of loans and mortgage-backed securities, investment
securities, real estate and other assets ...................................... (10,591) (13,125)
Interest capitalized on loans (negative amortization) ........................... (11,387) (9,371)
Federal Home Loan Bank stock dividends .......................................... (1,327) (1,308)
Loans originated for sale ......................................................... (1,278,282) (850,600)
Proceeds from sales of loans originated for sale .................................. 450,595 513,434
Other, net ........................................................................ (6,518) (285)
- -----------------------------------------------------------------------------------------------------------------
Net cash used for operating activities ............................................... (821,387) (327,797)
- -----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from:
Sales of U.S. Treasury securities and agency obligations available for sale ..... 65,195 60,068
Sales of mortgage-backed securities available for sale .......................... 897,124 162,688
Sales of wholly owned real estate and real estate acquired in settlement of loans 2,268 3,236
Purchase of:
U.S. Treasury securities and agency obligations available for sale .............. (99,190) (27,617)
Securities under resale agreements .............................................. -- (50,000)
Loans receivable held for investment ............................................ (22,590) (6,556)
Loans receivable originated held for investment (net of refinances of
$96,983 at June 30, 1999 and $46,967 at June 30, 1998) .......................... (1,967,214) (653,936)
Principal payments on loans receivable held for investment and mortgage-backed
securities available for sale ................................................... 849,965 857,906
Net change in undisbursed loan funds .............................................. 47,719 22,564
Proceeds from (investments in) real estate held for investment .................... (8,491) 5,317
Other, net ........................................................................ (6,962) (3,064)
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities ................................. (242,176) 370,606
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
<TABLE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
<CAPTION>
Six Months Ended
June 30,
------------------------
(In Thousands) 1999 1998
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits .................................................... $ 433,191 $ 301,398
Net decrease in securities sold under agreements to repurchase .............. -- (34,803)
Proceeds from Federal Home Loan Bank advances ............................... 2,704,237 75,300
Repayments of Federal Home Loan Bank advances ............................... (2,100,811) (304,411)
Net increase (decrease) in other borrowings ................................. 86 (64,236)
Proceeds from exercise of stock options ..................................... 219 158
Cash dividends .............................................................. (4,784) (4,388)
- -----------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities ........................... 1,032,138 (30,982)
- -----------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents ........................... (31,425) 11,827
Cash and cash equivalents at beginning of year ................................. 92,261 54,918
- -----------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ..................................... $ 60,836 $ 66,745
===========================================================================================================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest .................................................................. $ 136,190 $ 133,464
Income taxes .............................................................. 16,454 28,915
Supplemental disclosure of non-cash investing:
Loans transferred to held for investment from held for sale ................. (6,857) --
Loans exchanged for mortgage-backed securities .............................. 898,237 163,716
Real estate acquired in settlement of loans ................................. 4,715 9,497
Loans to facilitate the sale of real estate acquired in settlement of loans . 3,296 9,041
===========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE (1) - BASIS OF FINANCIAL STATEMENT PRESENTATION
In the opinion of Downey Financial Corp. and subsidiaries ("Downey"), the
accompanying consolidated financial statements contain all adjustments
(consisting of only normal recurring accruals) necessary for a fair presentation
of Downey's financial condition as of June 30, 1999, December 31, 1998, and June
30, 1998, and the results of operations, and comprehensive income for the three
months and six months ended June 30, 1999, and 1998, and changes in cash flows
for the six months ended June 30, 1999, and 1998. Certain prior period amounts
have been reclassified to conform to the current period presentation.
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
operations and are in compliance with the instructions for Form 10-Q and
therefore do not include all information and footnotes necessary for a fair
presentation of financial condition, results of operations, comprehensive income
and cash flows. The following information under the heading Management's
Discussion and Analysis of Financial Condition and Results of Operations is
written with the presumption that the interim consolidated financial statements
will be read in conjunction with Downey's Annual Report on Form 10-K for the
year ended December 31, 1998, which contains among other things, a description
of the business, the latest audited consolidated financial statements and notes
thereto, together with Management's Discussion and Analysis of Financial
Condition and Results of Operations as of December 31, 1998, and for the year
then ended. Therefore, only material changes in financial condition and results
of operations are discussed in the remainder of Part I.
NOTE (2) - NET INCOME PER SHARE
Net income per share is calculated on both a basic and diluted basis. Basic
net income per share excludes dilution and is computed by dividing net income
available to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted net income per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted from the issuance of
common stock that then shared in earnings.
NOTE (3) - DERIVATIVES
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available for sale security, or a
foreign-currency-denominated forecasted transaction.
Under SFAS 133, an entity that elects to apply hedge accounting is required
to establish at the inception of the hedge the method it will use for assessing
the effectiveness of the hedging derivative and the measurement approach for
determining the ineffective aspect of the hedge. Those methods must be
consistent with the entity's approach to managing risk.
This statement is effective for all fiscal years beginning after June 15,
2000. It is not anticipated that the financial impact of this statement will
have a material impact on Downey.
As part of its secondary marketing activities, Downey utilizes forward sale
and purchase contracts to hedge the value of loans originated for sale against
adverse changes in interest rates. At June 30, 1999, these sales contracts
amounted to approximately $489 million while no purchase contracts were
outstanding. These contracts have a high correlation to the price movement of
the loans being hedged. There is no recognition of unrealized gains and losses
on these contracts in the balance sheet or statement of income. When the related
loans are sold, the deferred gains or losses from these contracts
6
<PAGE>
are recognized in the statement of income as a component of net gains or losses
on sales of loans and mortgage-backed securities.
NOTE (4) - INCOME TAXES
During the first quarter of 1998, the Internal Revenue Service ("IRS")
completed its review of Downey's federal income tax returns for years 1990
through 1995. As a result of that review, the IRS proposed additions to tax of
approximately $20 million. Of that amount, Downey has paid approximately $5
million for items not disputed. The balance of the remaining tax additions
primarily relates to the sale and leaseback of computer equipment in 1990.
Management believes that applicable federal tax authorities related to the
transaction clearly support Downey's positions and intends to vigorously defend
those positions. Management also believes that adequate tax reserves have been
established regarding the transaction.
NOTE (5) - CAPITAL SECURITIES
On July 23, 1999, subsequent to the date of these financial statements,
Downey through Downey Financial Capital Trust I (the "Trust") issued $120
million in 10.00% Capital Securities (the "Securities"). The Securities, which
were sold in a public underwritten offering, pay quarterly cumulative cash
distributions at an annual rate of 10.00% of the liquidation value of $25 per
share. The Securities represent undivided beneficial interests in the Trust,
which was established by Downey for the purpose of issuing the Securities.
Downey owns all of the issued and outstanding common securities of the Trust.
Proceeds from the offering and from the issuance of common securities were
invested by the Trust in 10.00% Junior Subordinated Deferrable Interest
Debentures due September 15, 2029 issued by Downey (the "Junior Subordinated
Debentures"), with an aggregate principal amount of $124 million. The primary
asset of the Trust is the Junior Subordinated Debentures. The obligations of the
Trust with respect to the Securities are fully and unconditionally guaranteed by
Downey, to the extent provided in the Guarantee Agreement with respect to the
Securities. Downey will use the net proceeds of $115 million from the sale of
the Junior Subordinated Debentures (net of underwriting discounts and
commissions and other offering expenses) to make investments in its primary
subsidiary, Downey Savings and Loan Association, F.A. (the "Bank"), and for
other general corporate purposes. On July 30, 1999, Downey invested $25 million
of the net proceeds as additional common stock of the Bank thereby increasing
the Bank's regulatory core / tangible capital by that amount.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain statements under this caption may constitute "forward-looking
statements" under the Private Securities Litigation Reform Act of 1995 which
involve risks and uncertainties. Downey's actual results may differ
significantly from the results discussed in such forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
economic conditions, competition in the geographic and business areas in which
Downey conducts its operations, fluctuations in interest rates, credit quality
and government regulation.
OVERVIEW FOR THE QUARTER ENDED JUNE 30, 1999
Our net income for the second quarter of 1999 totaled $15.1 million or
$0.53 per share on a diluted basis. This compares to $15.0 million or $0.53 per
share in the second quarter of 1998. 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. That settlement added $1.8
million to our net income in the second quarter of 1998. The pre-tax amount of
the settlement was $3.2 million of which:
o $1.7 million was recorded as a reduction of losses on real estate and
joint ventures;
o $0.2 million was recorded in miscellaneous other income; and o $1.3
million was recorded as a reduction to professional fees within
general and administrative expense.
Excluding that 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. This increase reflected
several factors. Net interest income increased $8.0 million or 18.5% due to
increases in both our average earning assets and in our effective interest
spread. In addition, the quarter-to-quarter improvement reflected an adjusted
increase of $3.2 million in other income, primarily reflecting increases in net
gains on sales of loans and in loan and deposit related fees. A $6.7 million
increase in adjusted general and administrative expense and a $1.3 million
increase in provision for loan losses partially offset those favorable factors.
The increase in general and administrative expense was due to significantly
higher lending volumes, branch expansion and increased expense related to our
Year 2000 compliance efforts.
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:
o First, year-ago net income benefited by $4.7 million from the
settlement. The pre-tax amount of the settlement was $8.3 million of
which:
o $1.4 million represented the recovery of a prior loan charge-off
thereby reducing provision for loan losses;
o $4.3 million was recorded as a reduction of losses on real estate
and joint ventures;
o $1.0 million was recorded in miscellaneous other income; and
o $1.6 million was recorded as a reduction to professional fees
within general and administrative expense.
o Second, our remaining net income attributable to real estate
investment activities declined $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.
For the second quarter of 1999, our return on average assets was 0.88% and
our return on average equity was 12.17%, bringing, for the first six months of
1999, our return on average assets to 0.83% and return on average equity to
11.20%.
At June 30, 1999 our assets totaled $7.3 billion, up $1.5 billion or 25.7%
from a year ago and up $1.1 billion or 16.9% from year-end 1998. Our single
family loan originations totaled a record $1.677 billion in the second quarter
of 1999, up 84% from the $909 million we originated in the second quarter of
1998. Of the current quarter total, $631 million represented originations of
loans for sale and $312 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 $136 million of other loans in
the quarter, including $61 million of automobile loans and $54 million of
construction and land loans.
8
<PAGE>
Our borrowings increased $1.2 billion between second quarters and
represented the primary source of funding for our asset growth. In addition to
higher borrowings, our deposits increased $302 million or 5.8% and also funded
asset growth. At quarter-end, our deposits totaled $5.5 billion. During the
quarter, we opened four new in-store branches, bringing total branches at
quarter end to 99, of which 37 are in-store. A year ago, branches totaled 90.
Our non-performing assets were virtually unchanged during the quarter
totaling $30 million or 0.41% of total assets.
At June 30, 1999, Downey's primary subsidiary, Downey Savings and Loan
Association, F.A. (the "Bank"), had core and tangible capital ratios of 6.04%
and a risk-based capital ratio of 11.48%. These capital levels are substantially
above the "well capitalized" standards of 5% for core and tangible capital and
10% for risk-based capital, as defined by regulation.
9
<PAGE>
RESULTS OF OPERATIONS FOR THE QUARTER ENDED JUNE 30, 1999
NET INTEREST INCOME
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. The 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 was up from the year-ago
quarter level of 3.08%, but down from the first quarter 1999 level of 3.23%. 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.
The following table presents for the periods indicated the total dollar
amount of:
o interest income from average interest-earning assets and the resultant
yields; and
o interest expense on average interest-bearing liabilities and the
resultant costs, expressed as rates.
The table also sets forth the net interest income, the interest rate spread
and the effective interest rate spread. The effective interest rate spread
reflects the relative level of interest-earning assets to interest-bearing
liabilities and equals:
o the difference between interest income on interest-earning assets and
interest expense on interest-bearing liabilities, divided by
o average interest-earning assets for the period.
The table also sets forth the net interest-earning balance--the difference
between the average balance of interest-earning assets and the average balance
of interest-bearing liabilities--for the periods indicated. We included
non-accrual loans in the average interest-earning assets balance. We included
interest from non-accrual loans in interest income only to the extent that we
received payments and to the extent that we believe we will recover the
remaining principal balance of the loan. We computed average balances for the
quarter using the average of each month's daily average balance during the
period indicated.
10
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
--------------------------------------------------------------
June 30,1999 June 30,1998
--------------------------------------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in Thousands) Balance Interest Rate Balance Interest Rate
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans .................................... $6,343,011 $118,818 7.49 $5,316,803 $105,583 7.94%
Mortgage-backed securities ............... 27,623 423 6.13 44,146 738 6.69
Investment securities .................... 214,077 2,968 5.56 242,071 3,476 5.76
- ---------------------------------------------------------------------------------------------------------------
Total interest-earning assets .......... 6,584,711 122,209 7.42 5,603,020 109,797 7.84
Non-interest-earning assets .................. 293,641 256,211
- ---------------------------------------------------------------------------------------------------------------
Total assets ........................... $6,878,352 $5,859,231
===============================================================================================================
Interest-bearing liabilities:
Deposits ................................. $5,328,264 $ 58,084 4.37 $5,123,428 $ 62,999 4.93%
Borrowings ............................... 996,140 12,928 5.21 219,384 3,608 6.60
- ---------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities ..... 6,324,404 71,012 4.50 5,342,812 66,607 5.00
Non-interest-bearing liabilities ............. 58,859 65,275
Stockholders' equity ......................... 495,089 451,144
- ---------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $6,878,352 $5,859,231
===============================================================================================================
Net interest income/interest rate spread ..... $ 51,197 2.92% $ 43,190 2.84%
Excess of interest-earning assets over
interest-bearing liabilities ............. $ 260,307 $ 260,208
Effective interest rate spread ............... 3.11 3.08
===============================================================================================================
Six Months Ended
--------------------------------------------------------------
June 30,1999 June 30,1998
--------------------------------------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans .................................... $6,080,936 $229,549 7.55% $5,315,150 $210,928 7.94%
Mortgage-backed securities ............... 29,111 887 6.09 46,058 1,546 6.71
Investment securities .................... 209,961 5,667 5.44 247,999 7,046 5.73
- ---------------------------------------------------------------------------------------------------------------
Total interest-earning assets .......... 6,320,008 236,103 7.47 5,609,207 219,520 7.83
Non-interest-earning assets .................. 283,754 252,454
- ---------------------------------------------------------------------------------------------------------------
Total assets ........................... $6,603,762 $5,861,661
===============================================================================================================
Interest-bearing liabilities:
Deposits ................................. $5,195,208 $113,573 4.41% $5,064,239 $124,537 4.96%
Borrowings ............................... 855,857 22,377 5.27 285,226 9,167 6.48
- ---------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities ..... 6,051,065 135,950 4.53 5,349,465 133,704 5.04
Non-interest-bearing liabilities ............. 63,099 68,802
Stockholders' equity ......................... 489,598 443,394
- ---------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $6,603,762 $5,861,661
===============================================================================================================
Net interest income/interest rate spread ..... $100,153 2.94% $ 85,816 2.79%
Excess of interest-earning assets over
interest-bearing liabilities ............. $ 268,943 $ 259,742
Effective interest rate spread ............... 3.17 3.06
===============================================================================================================
</TABLE>
11
<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:
o changes in volume--changes in volume multiplied by comparative period
rate;
o changes in rate--changes in rate multiplied by comparative period
volume; and
o changes in rate/volume--changes in rate multiplied by changes in
volume.
Interest-earning asset and interest-bearing liability balances used in the
calculations represent quarterly average balances computed using the average of
each month's daily average balance during the period indicated.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
----------------------------------------------------------------------------------
June 30, 1999 versus June 30, 1998 June 30, 1999 versus June 30, 1998
Changes Due To Changes Due To
----------------------------------------------------------------------------------
Rate/ Rate/
(In Thousands) Volume Rate Volume Net Volume Rate Volume Net
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income:
Loans ...................... $20,379 $(5,988) $(1,156) $13,235 $30,390 $(10,287) $(1,482) $18,621
Mortgage-backed securities . (276) (62) 23 (315) (568) (143) 52 (659)
Investment securities ...... (402) (120) 14 (508) (1,081) (352) 54 (1,379)
- --------------------------------------------------------------------------------------------------------------------
Change in interest income 19,701 (6,170) (1,119) 12,412 28,741 (10,782) (1,376) 16,583
- --------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits ................... 2,519 (7,148) (286) (4,915) 3,221 (13,827) (358) (10,964)
Borrowings ................. 11,747 (1,118) (1,309) 9,320 17,078 (2,198) (1,670) 13,210
- --------------------------------------------------------------------------------------------------------------------
Change in interest expense 14,266 (8,266) (1,595) 4,405 20,299 (16,025) (2,028) 2,246
- --------------------------------------------------------------------------------------------------------------------
Change in net interest income .. $ 5,435 $ 2,096 $ 476 $ 8,007 $ 8,442 $ 5,243 $ 652 $14,337
====================================================================================================================
</TABLE>
PROVISION FOR LOAN LOSSES
Provision for loan losses was $2.8 million in the current quarter, up from
$1.5 million in the year-ago quarter. This increase reflects growth in our loan
portfolio during the current quarter. In contrast, our loan portfolio declined
during the year-ago quarter. For information regarding our allowance for loan
losses, see "Financial Condition for the Quarter Ended June 30, 1999 - Problem
Loans and Real Estate - Allowance for Losses on Loans and Real Estate."
OTHER INCOME
Our other income was $13.3 million in the second quarter of 1999, up $1.3
million or 11.0% from a year-ago. All categories of our other income were above
a year ago except for 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 year-ago settlement. Our net gains on sales of loans and
mortgage-backed securities increased $1.6 million between second quarters and
our loan and deposit related fees increased $1.2 million. For the first six
months of 1999, 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.
12
<PAGE>
The following table presents a breakdown of the key components comprising
income from real estate and joint venture operations for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 1999 1999 1998 1998 1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operations, net:
Rental operations, net of expenses ................. $1,094 $ 981 $ 688 $ 894 $1,260
Equity in net income from joint ventures ........... 1,008 47 256 2,605 1,116
Interest from joint venture advances ............... 202 190 182 380 336
- ------------------------------------------------------------------------------------------------------------------
Total operations, net ............................ 2,304 1,218 1,126 3,879 2,712
Net gains on sales of wholly owned real estate ........ 200 -- 2,487 -- 70
Reduction of (provision for) losses on real estate
and joint ventures ................................ 265 (53) 214 139 2,221
- ------------------------------------------------------------------------------------------------------------------
Income from real estate and joint venture operations $2,769 $1,165 $3,827 $4,018 $5,003
==================================================================================================================
</TABLE>
OPERATING EXPENSE
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. General and administrative
costs increased $8.0 million or 29.5% due to significantly higher lending
volumes, branch expansion and increased expense related to our Year 2000
compliance efforts. 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, 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.
PROVISION FOR INCOME TAXES
Income taxes for the current quarter totaled $11.1 million, resulting in an
effective tax rate of 42.4%, compared to $11.4 million and 43.2% for the like
quarter of a year ago. For the first six months of 1999, the effective tax rate
was 42.4%, compared to 43.0% from the same period of 1998. For further
information regarding income taxes, see "Notes to Consolidated Financial
Statements - Note (4) - Income Taxes."
13
<PAGE>
BUSINESS SEGMENT REPORTING
The previous sections of the Results of Operations for the Quarter Ended
June 30, 1999 discussed our consolidated results. The purpose of this section is
to present data on the results of operations of our two business
segments--banking and real estate investment.
The following table presents net income by business segment for the periods
indicated, followed by a discussion of the results of operations of each
segment.
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 1999 1999 1998 1998 1998 (1)
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Banking .............. $13,702 $12,029 $10,791 $10,870 $12,405
Real estate investment 1,356 319 1,861 1,898 2,583
- ------------------------------------------------------------------------------------------------
Total net income .. $15,058 $12,348 $12,652 $12,768 $14,988
================================================================================================
Six Months Ended
------------------------
June 30, June 30,
1999 1998 (2)
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Banking .............. $25,731 $25,075
Real estate investment 1,675 7,478
- ------------------------------------------------------------------------------------------------
Total net income .. $27,406 $32,553
================================================================================================
<FN>
(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 $4.7 million, of which $1.9 million was in banking and $2.8 million
was in real estate investment.
</FN>
</TABLE>
Banking
Net income from our banking operations for the second quarter of 1999
totaled $13.7 million, up from $12.4 million in the second quarter of 1998. The
settlement benefited our year-ago net income by $0.5 million. The pre-tax amount
of the settlement was $0.9 million of which:
o $0.2 million was recorded in miscellaneous other income; and
o $0.7 million was recorded as a reduction to professional fees within
operating expense.
Excluding the settlement benefit from our year-ago results, our net income from
banking would have increased by $1.8 million or 15.1%.
The increase in our adjusted net income between second quarters reflected
several factors. Net interest income increased $7.9 million or 18.3% due to
increases in both our average earning assets and in our effective interest rate
spread. Other income increased an adjusted $3.8 million. The increase in
adjusted other income primarily reflected increases in net gains on sales of
loans and in loan and deposit related fees. Increases of an adjusted $7.4
million in operating expense and $1.3 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 increased expense related to our year 2000 compliance efforts.
14
<PAGE>
The table below sets forth our banking operational results and selected
financial data for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 1999 1999 1998 1998 1998
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net interest income ............. $ 51,242 $ 48,948 $ 45,953 $ 42,889 $ 43,318
Provision for loan losses ....... 2,798 2,381 1,180 985 1,520
Other income .................... 10,408 10,110 6,881 5,561 6,864
Operating expense ............... 35,112 35,839 33,057 28,270 27,077
Net intercompany income (expense) 102 82 (18) (48) 80
- -----------------------------------------------------------------------------------------------------
Income before income taxes ...... 23,842 20,920 18,579 19,147 21,665
Income taxes .................... 10,140 8,891 7,788 8,277 9,260
- -----------------------------------------------------------------------------------------------------
Net income ................... $ 13,702 $ 12,029 $ 10,791 $ 10,870 $ 12,405
=====================================================================================================
AT PERIOD END:
Assets:
Loans ........................ $6,818,129 $6,102,547 $5,788,365 $5,387,843 $5,328,291
Other ........................ 490,523 473,476 464,097 500,498 481,611
- -----------------------------------------------------------------------------------------------------
Total assets ............... 7,308,652 6,576,023 6,252,462 5,888,341 5,809,902
- -----------------------------------------------------------------------------------------------------
Equity .......................... $ 502,133 $ 490,406 $ 480,566 $ 470,815 $ 458,962
=====================================================================================================
</TABLE>
For the first six months of 1999, our net income from banking totaled $25.7
million, up $0.7 million from the same period of 1998. Our net income in the
prior-year period benefited by $1.9 million from the settlement. The pre-tax
amount of the settlement was $3.4 million of which:
o $1.4 million represented the recovery of a prior loan charge-off
thereby reducing provision for loan losses;
o $1.0 million was recorded in other income; and
o $1.0 million was recorded as a reduction to professional fees within
operating expense.
Excluding the settlement benefit from year-ago results, net income from banking
would have increased by $2.6 million or 11.0%.
The table below sets forth our banking operational results for the periods
indicated.
<TABLE>
<CAPTION>
Six Months Ended
--------------------
June 30, June 30,
(In Thousands) 1999 1998
- -------------------------------------------------------
<S> <C> <C>
Net interest income ............. $100,190 $86,125
Provision for loan losses ....... 5,179 1,753
Other income .................... 20,518 12,175
Operating expense ............... 70,951 52,627
Net intercompany income (expense) 184 (41)
- -------------------------------------------------------
Income before income taxes ...... 44,762 43,879
Income taxes .................... 19,031 18,804
- -------------------------------------------------------
Net income ................... $ 25,731 $25,075
=======================================================
</TABLE>
15
<PAGE>
Real Estate Investment
Net income from our real estate investment operations totaled $1.4 million
in the second quarter of 1999, down from $2.6 million in the year-ago quarter.
The settlement benefited year-ago net income by $1.3 million. The pre-tax amount
of the settlement was $2.3 million of which:
o $1.7 million was recorded as a reduction of loss on real estate and
joint ventures in other income; and
o $0.6 million was recorded as a reduction to professional fees within
operating expense.
Excluding the settlement, our net income from real estate investment operations
would have increased by $0.1 million or 7.8%.
The table below sets forth real estate investment operational results and
selected financial data for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 1999 1999 1998 1998 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net interest income (expense) .................. $ (45) $ 8 $ (209) $ (102) $ (128)
Reduction of loan losses ....................... -- -- -- -- (58)
Other income ................................... 2,851 1,232 3,925 4,111 5,085
Operating expense .............................. 409 618 777 679 203
Net intercompany income (expense) .............. (102) (82) 18 48 (80)
- ---------------------------------------------------------------------------------------------------------------
Income before income taxes ..................... 2,295 540 2,957 3,378 4,732
Income taxes ................................... 939 221 1,096 1,480 2,149
- ---------------------------------------------------------------------------------------------------------------
Net income .................................. $ 1,356 $ 319 $ 1,861 $ 1,898 $ 2,583
===============================================================================================================
AT PERIOD END:
Assets:
Investments in real estate and joint ventures $57,460 $52,155 $49,447 $47,918 $41,880
Other ....................................... 8,294 7,564 9,841 13,790 17,892
- ---------------------------------------------------------------------------------------------------------------
Total assets .............................. 65,754 59,719 59,288 61,708 59,772
- ---------------------------------------------------------------------------------------------------------------
Equity ......................................... $43,006 $41,650 $41,331 $39,470 $37,572
===============================================================================================================
</TABLE>
For the first six months of 1999, our net income from real estate
investment operations totaled $1.7 million, down $5.8 million from the same
period a year ago. The settlement benefited our year-ago net income by $2.8
million. The pre-tax amount of the settlement was $4.9 million of which:
o $4.3 million was recorded as a reduction of loss on real estate and
joint ventures in other income; and
o $0.6 million was recorded as a reduction to professional fees in other
expense.
Excluding the settlement benefit from year-ago results, our remaining net income
attributable to real estate investment activities declined by $3.0 million due
to the 1999 period having a lower level of gains from sales of real estate
investments.
16
<PAGE>
The table below sets forth our real estate investment operational results
for the periods indicated.
<TABLE>
<CAPTION>
Six Months Ended
--------------------
June 30, June 30,
(In Thousands) 1999 1998
- --------------------------------------------------------
<S> <C> <C>
Net interest expense ............ $ (37) $ (309)
Reduction of loan losses ........ -- (19)
Other income .................... 4,083 14,700
Operating expense ............... 1,027 1,250
Net intercompany income (expense) (184) 41
- --------------------------------------------------------
Income before income taxes ...... 2,835 13,201
Income taxes .................... 1,160 5,723
- --------------------------------------------------------
Net income ................... $1,675 $ 7,478
========================================================
</TABLE>
Our investment in real estate and joint ventures amounted to $57 million at
June 30, 1999, compared to $49 million at December 31, 1998, and $42 million at
June 30, 1998.
For information on valuation allowances associated with real estate and
joint venture loans, see "Financial Condition for the Quarter Ended June 30,
1999 - Problem Loans and Real Estate - Allowances for Losses on Loans and Real
Estate."
17
<PAGE>
FINANCIAL CONDITION FOR THE QUARTER ENDED JUNE 30, 1999
LOANS AND MORTGAGE-BACKED SECURITIES
Total loans and mortgage-backed securities, including those held for sale,
increased $716 million during the second quarter to a total of $6.8 billion or
93.0% of assets at June 30, 1999. The increase primarily occurred in the single
family loan portfolio. Of that increase, $276 million represented subprime
loans, with the majority of the remaining increase occurring in our adjustable
rate portfolio.
The following table sets forth loans originated, including purchases, for
investment and for sale during the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 1999 1999 1998 1998 1998
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Loans originated for investment:
Residential, one-to-four units:
Adjustable .......................... $ 964,408 $ 568,891 $ 436,960 $ 383,483 $309,468
Fixed ............................... 81,080 208,504 181,717 6,921 6,824
Other ................................. 136,155 131,045 111,484 102,319 88,013
- ------------------------------------------------------------------------------------------------------------
Total loans originated for investment 1,181,643 908,440 730,161 492,723 404,305
Loans originated for sale (1) ............ 631,496 646,786 740,837 571,146 592,931
- ------------------------------------------------------------------------------------------------------------
Total loans originated ................ $1,813,139 $1,555,226 $1,470,998 $1,063,869 $997,236
============================================================================================================
<FN>
(1) One-to-four unit residential loans, primarily fixed.
</FN>
</TABLE>
Originations of one-to-four unit residential loans totaled a record $1.677
billion in the second quarter of 1999, of which $1.046 billion were for
portfolio and $631 million were for sale. This was 18% higher than the $1.424
billion we originated in the first quarter of 1999, and nearly double the $909
million we originated in the year-ago quarter. Of the current quarter total,
$312 million represented originations of subprime credits as part of our
strategy to enhance the portfolio's net yield. During the current quarter, 65%
of our residential one-to-four unit originations represented refinancings of
existing loans. This is down from 76% during the previous quarter and down
slightly from 67% in the year-ago second quarter. 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.
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 June 30, 1999, $3.7 billion of the adjustable rate
mortgages in our loan portfolio were subject to negative amortization, of which
$58 million represented the amount of negative amortization included in the loan
balance.
We also continue to originate residential fixed interest rate mortgage
loans to meet consumer demand, but we intend to sell the majority of these
loans. We sold $579 million of loans in the second quarter of 1999, compared to
$777 million for the previous quarter and $554 million for the second quarter of
1998. All were secured by residential one-to-four unit property and at June 30,
1999, loans held for sale totaled $360 million.
18
<PAGE>
At June 30, 1999, we had commitments to fund loans amounting to $1.101
billion, of which $380 million were fixed rate one-to-four unit residential
loans being originated for sale in the secondary market, as well as loans in
process of $137 million and undrawn lines of credit of $82 million. We believe
our current sources of funds will enable us to meet these obligations while
exceeding all regulatory liquidity requirements.
19
<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
------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 1999 1999 1998 1998 1998
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INVESTMENT PORTFOLIO:
Loans originated:
Loans secured by real estate:
Residential:
One-to-four units:
Adjustable ...................................... $ 656,718 $ 382,562 $ 303,291 $ 283,468 $ 229,106
Adjustable - subprime ........................... 307,690 186,329 133,409 100,015 78,845
- ------------------------------------------------------------------------------------------------------------------------------
Total adjustable ............................. 964,408 568,891 436,700 383,483 307,951
Fixed ........................................... 54,671 205,758 179,786 5,351 3,980
Fixed - subprime ................................ 4,301 2,444 1,684 1,535 1,329
Five or more units:
Adjustable ...................................... -- -- -- -- --
Fixed ........................................... -- -- -- 13,229 --
- ------------------------------------------------------------------------------------------------------------------------------
Total residential ............................ 1,023,380 777,093 618,170 403,598 313,260
Commercial real estate ............................. 2,915 6,398 6,149 -- --
Construction ....................................... 45,082 30,587 45,339 17,266 19,023
Land ............................................... 8,950 29,081 9,983 23,640 6,883
Non-mortgage:
Commercial ......................................... 6,278 2,925 700 645 4,421
Automobile ......................................... 60,620 50,294 43,330 40,158 46,153
Other consumer ..................................... 12,130 11,760 5,983 7,016 10,738
- ------------------------------------------------------------------------------------------------------------------------------
Total loans originated ............................ 1,159,355 908,138 729,654 492,323 400,478
Real estate loans purchased (1) ......................... 22,288 302 507 400 3,827
- ------------------------------------------------------------------------------------------------------------------------------
Total loans originated and purchased ................. 1,181,643 908,440 730,161 492,723 404,305
Loan repayments ......................................... (506,048) (434,796) (489,912) (490,358) (498,516)
Other net changes (2) ................................... (6,958) (18,824) (8,211) 553 (11,740)
- ------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for investment 668,637 454,820 232,038 2,918 (105,951)
- ------------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO:
Residential, one-to-four units:
Originated whole loans ............................... 631,496 646,786 740,837 571,146 592,931
Loans transferred from (to) the investment portfolio . 238 (7,095) (3,822) -- 162
Originated whole loans sold .......................... (281,120) (176,139) (266,812) (354,371) (429,434)
Loans exchanged for mortgage-backed securities ....... (297,858) (600,379) (291,940) (153,175) (124,505)
Other net changes .................................... (2,637) (622) (3,794) (2,851) (1,369)
- ------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for sale ..... 50,119 (137,449) 174,469 60,749 37,785
- ------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities, net:
Received in exchange for loans ....................... 297,858 600,379 291,940 153,175 124,505
Sold ................................................. (297,858) (600,379) (293,222) (153,175) (124,505)
Repayments ........................................... (2,869) (3,235) (4,143) (4,242) (3,724)
Other net changes .................................... (305) 46 (560) 127 (13)
- ------------------------------------------------------------------------------------------------------------------------------
Net decrease in mortgage-backed securities available
for sale ......................................... (3,174) (3,189) (5,985) (4,115) (3,737)
- ------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans and mortgage-backed
securities held for sale and available for sale .. 46,945 (140,638) 168,484 56,634 34,048
- ------------------------------------------------------------------------------------------------------------------------------
Total net increase (decrease) in loans and mortgage-
backed securities ................................ $ 715,582 $ 314,182 $ 400,522 $ 59,552 $ (71,903)
==============================================================================================================================
<FN>
(1) Primarily one-to-four unit residential loans. Includes five or more unit
residential loans of $0.2 million in the three months ended June 30, 1999,
$0.4 million in the three months ended September 30, 1998, and $0.2 million
in the three months ended June 30, 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).
</FN>
</TABLE>
20
<PAGE>
The following table sets forth the composition of our loan and
mortgage-backed securities portfolios at the dates indicated. At June 30, 1999,
approximately 95% 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>
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 1999 1999 1998 1998 1998
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INVESTMENT PORTFOLIO:
Loans secured by real estate:
Residential:
One-to-four units:
Adjustable ............................. $4,118,763 $3,800,552 $3,721,728 $3,791,187 $3,892,221
Adjustable - subprime .................. 1,017,699 745,843 580,232 461,646 372,608
Fixed .................................. 550,035 507,357 325,454 153,408 155,741
Fixed - subprime ....................... 14,748 10,932 8,719 7,516 5,993
- -----------------------------------------------------------------------------------------------------------------------
Total one-to-four units ............. 5,701,245 5,064,684 4,636,133 4,413,757 4,426,563
Five or more units:
Adjustable ............................. 18,409 18,516 18,617 18,707 18,802
Fixed .................................. 6,232 7,904 21,412 22,436 8,934
Commercial real estate:
Adjustable ............................... 38,483 39,641 39,360 44,215 47,045
Fixed .................................... 111,076 111,606 101,430 112,687 114,379
Construction ............................... 178,526 147,246 127,761 92,779 95,664
Land ....................................... 71,314 74,959 44,859 39,222 29,857
Non-mortgage:
Commercial ................................. 26,884 28,182 28,293 27,710 27,298
Automobile ................................. 375,138 363,168 357,988 355,955 356,504
Other consumer ............................. 42,475 40,607 41,894 44,026 44,530
- -----------------------------------------------------------------------------------------------------------------------
Total loans held for investment .......... 6,569,782 5,896,513 5,417,747 5,171,494 5,169,576
Increase (decrease) for:
Undisbursed loan funds ..................... (146,603) (133,785) (108,414) (88,213) (85,367)
Net deferred costs and premiums ............ 43,460 33,515 31,021 24,962 21,408
Allowance for estimated loss ............... (34,345) (32,586) (31,517) (31,444) (31,736)
- -----------------------------------------------------------------------------------------------------------------------
Total loans held for investment, net ..... 6,432,294 5,763,657 5,308,837 5,076,799 5,073,881
- -----------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO, NET:
Loans held for sale (all one-to-four units):
Adjustable ................................. 5,711 -- 7,975 9,480 13,692
Fixed ...................................... 354,341 309,933 439,407 263,433 198,472
- -----------------------------------------------------------------------------------------------------------------------
Total loans held for sale ................ 360,052 309,933 447,382 272,913 212,164
Mortgage-backed securities available for sale:
Adjustable ................................. 8,822 9,887 10,996 12,795 14,575
Fixed ...................................... 16,961 19,070 21,150 25,336 27,671
- -----------------------------------------------------------------------------------------------------------------------
Total mortgage-backed securities available
for sale ............................... 25,783 28,957 32,146 38,131 42,246
- -----------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities
held for sale and available for sale ... 385,835 338,890 479,528 311,044 254,410
- -----------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities $6,818,129 $6,102,547 $5,788,365 $5,387,843 $5,328,291
=======================================================================================================================
</TABLE>
We carry loans for sale at the lower of cost or market. At June 30, 1999,
no valuation allowance was required as the market value exceeded book value on
an aggregate basis.
We carry mortgage-backed securities available for sale at fair value which,
at June 30, 1999, reflected an unrealized loss of $0.1 million. The current
quarter-end unrealized loss, less the associated tax effect of $0.1 million, is
reflected within a separate component of other comprehensive income (loss) until
realized.
21
<PAGE>
DEPOSITS
At June 30, 1999, our deposits totaled $5.5 billion, up $302 million or
5.8% from the year-ago quarter end and up $433 million or 8.6% from year-end
1998. Compared to the year-ago period, our transaction accounts--i.e., checking,
regular passbook and money market--increased $341 million or 33.4%, while
certificates of deposits decreased $40 million or 1.0%. The following table sets
forth information concerning our deposits and average rates paid at the dates
indicated.
<TABLE>
<CAPTION>
June 30, 1999 March 31, 1999 December 31, 1998 September 30, 1998 June 30, 1998
------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average
(Dollars in Thousands) Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Transaction accounts ... 2.40% $1,362,880 2.34% $1,313,707 2.30% $1,238,062 2.18% $1,080,734 2.17% $1,021,428
Certificates of deposit:
Less than 3.00% ..... 2.58 23,239 2.60 23,324 2.62 25,126 2.63 26,686 2.63 27,290
3.00-3.49 ........... 3.01 268 3.01 323 3.01 593 3.03 449 3.02 677
3.50-3.99 ........... 3.91 44,532 3.91 47,813 3.88 51,474 3.91 40,115 - -
4.00-4.49 ........... 4.40 578,371 4.39 604,692 4.39 428,316 4.16 14,754 4.13 59,708
4.50-4.99 ........... 4.80 1,208,190 4.80 1,004,947 4.80 668,204 4.88 468,922 4.90 208,774
5.00-5.99 ........... 5.38 2,181,871 5.41 2,015,702 5.53 2,421,333 5.57 3,162,420 5.60 3,072,092
6.00-6.99 ........... 6.11 71,254 6.06 192,320 6.06 204,065 6.06 382,502 6.05 778,300
7.00 and greater .... 7.25 2,319 7.24 2,454 7.24 2,560 7.25 2,798 7.24 3,107
- ------------------------------------------------------------------------------------------------------------------------------------
Total certificates
of deposit ...... 5.05 4,110,044 5.09 3,891,575 5.26 3,801,671 5.50 4,098,646 5.61 4,149,948
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits .... 4.39% $5,472,924 4.40% $5,205,282 4.53% $5,039,733 4.81% $5,179,380 4.93% $5,171,376
====================================================================================================================================
</TABLE>
BORROWINGS
During the 1999 second quarter, our borrowings increased $456 million to
$1.3 billion, primarily reflecting increases in Federal Home Loan Bank ("FHLB")
advances. This followed an increase of $148 million during the first quarter of
1999. The following table sets forth information concerning our FHLB advances
and other borrowings at the dates indicated.
<TABLE>
<CAPTION>
June 30, March 31, December 31, September 30, June 30,
(Dollars in Thousands) 1999 1999 1998 1998 1998
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Federal Home Loan Bank advances ................ $1,298,438 $842,677 $695,012 $197,935 $123,347
Other borrowings:
Commercial paper ............................ -- -- -- -- 19,982
Other borrowings ............................ 8,794 8,638 8,708 12,166 12,256
- ----------------------------------------------------------------------------------------------------------------
Total borrowings .......................... $1,307,232 $851,315 $703,720 $210,101 $155,585
- ----------------------------------------------------------------------------------------------------------------
Weighted average rate on borrowings during
the period .................................. 5.21% 5.36% 5.61% 5.91% 6.60%
Total borrowings as a percentage of total assets 17.83 12.91 11.22 3.55 2.67
================================================================================================================
</TABLE>
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.
22
<PAGE>
The following table sets forth the repricing frequency of our major asset
and liability categories as of June 30, 1999, as well as other information
regarding the repricing and maturity differences between interest-earning assets
and interest-bearing liabilities in future periods. We refer to these
differences as "gap." We have determined the repricing frequencies by reference
to projected maturities, based upon contractual maturities as adjusted for
scheduled repayments and "repricing mechanisms"--provisions for changes in the
interest and dividend rates of assets and liabilities. We assume prepayment
rates on substantially all of our loan portfolio based upon our historical loan
prepayment experience and anticipated future prepayments. Repricing mechanisms
on a number of our assets are subject to limitations, like caps on the amount
that interest rates and payments on our loans may adjust. Accordingly, these
assets do not normally respond to changes in market interest rates as completely
or rapidly as our liabilities. The interest rate sensitivity of our assets and
liabilities illustrated in the table would vary substantially if we used
different assumptions or if actual experience differed from the assumptions
shown.
<TABLE>
<CAPTION>
June 30, 1999
----------------------------------------------------------------------------
Within 7 - 12 2 - 5 6 - 10 Over Total
(Dollars in Thousands) 6 Months Months Years Years 10 Years Balance
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Investment securities and FHLB stock ..(1) $ 75,707 $ -- $134,091 $ -- $ -- $ 209,798
Loans and mortgage-backed securities:
Mortgage-backed securities ..........(2) 13,174 4,100 6,217 1,832 460 25,783
Loans secured by real estate:
Residential:
Adjustable ......................(2) 5,050,274 55,003 76,701 -- -- 5,181,978
Fixed ...........................(2) 390,863 31,235 193,950 146,601 164,527 927,176
Commercial real estate ............(2) 44,330 8,082 83,220 8,578 2,411 146,621
Construction ......................(2) 71,112 -- -- -- -- 71,112
Land ..............................(2) 36,977 38 339 370 -- 37,724
Non-mortgage:
Commercial ........................(2) 16,480 -- -- -- -- 16,480
Consumer ..........................(2) 125,715 78,008 207,532 -- -- 411,255
- ---------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities 5,748,925 176,466 567,959 157,381 167,398 6,818,129
- ---------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets .......... $5,824,632 $ 176,466 $702,050 $ 157,381 $167,398 $7,027,927
===========================================================================================================================
Deposits and borrowings:
Interest-bearing deposits:
Fixed maturity deposits .............(1) $2,092,801 $ 1,718,981 $298,262 $ -- $ -- $4,110,044
Transaction accounts ................(3) 1,203,713 -- -- -- -- 1,203,713
Non-interest-bearing transaction accounts 159,167 -- -- -- -- 159,167
- ---------------------------------------------------------------------------------------------------------------------------
Total deposits ......................... 3,455,681 1,718,981 298,262 -- -- 5,472,924
- ---------------------------------------------------------------------------------------------------------------------------
Borrowings ............................... 766,903 16,250 89,274 434,805 -- 1,307,232
- ---------------------------------------------------------------------------------------------------------------------------
Total deposits and borrowings .......... $4,222,584 $ 1,735,231 $387,536 $ 434,805 $ -- $6,780,156
===========================================================================================================================
Excess (shortfall) of interest-earning
assets over interest-bearing liabilities . $1,602,048 $(1,558,765) $314,514 $(277,424) $167,398 $ 247,771
Cumulative gap ............................. 1,602,048 43,283 357,797 80,373 247,771
Cumulative gap - as a % of total assets:
June 30, 1999 ............................ 21.85% 0.59% 4.88% 1.10% 3.38%
December 31, 1998 ........................ 23.84 7.84 9.07 3.40 4.00
June 30, 1998 ............................ 20.62 1.74 3.24 3.92 4.29
===========================================================================================================================
<FN>
(1) Based upon contractual maturity and repricing date.
(2) Based upon contractual maturity, repricing date and projected repayment and
prepayments of principal.
(3) Subject to immediate repricing.
</FN>
</TABLE>
Our six-month gap at June 30, 1999 was a positive 21.85%. This means that
more interest-earning assets reprice within six months than interest-bearing
liabilities. This compares to a positive six-month gap of 19.62% at March 31,
1999, 23.84% at December 31, 1998, and 20.62% at June 30, 1998. We continue to
pursue our strategy of emphasizing
23
<PAGE>
the origination of adjustable rate mortgages. For the twelve months ended June
30, 1999, we originated and purchased for investment $2.6 billion of adjustable
rate loans which represented approximately 79% of all loans we originated and
purchased for investment during the period.
At June 30, 1999, 95% of our interest-earning assets mature, reprice or are
estimated to prepay within five years, down from 98% at December 31, 1998 and
99% at June 30, 1998. At June 30, 1999, loans and mortgage-backed securities
with adjustable interest rates represented 79% of our loans and mortgage-backed
securities portfolios. During the second 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 June 30, 1999, $5.9 billion or 84% 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 both December 31, 1998 and June 30, 1998.
The following table sets forth on a consolidated basis the interest rate
spread on our interest-earning assets and interest-bearing liabilities at the
dates indicated.
<TABLE>
<CAPTION>
June 30, March 31, December 31, September 30, June 30,
1999 1999 1998 1998 1998
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Weighted average yield:
Loans and mortgage-backed securities 7.47% 7.59% 7.72% 7.82% 7.91%
Federal Home Loan Bank stock ....... 5.29 5.29 5.44 5.86 5.88
Investment securities .............. 5.84 5.61 5.40 5.77 5.81
- ----------------------------------------------------------------------------------------------------------
Earning assets yield ........... 7.41 7.52 7.65 7.73 7.82
- ----------------------------------------------------------------------------------------------------------
Weighted average cost:
Deposits ........................... 4.39 4.40 4.53 4.81 4.93
Borrowings:
Federal Home Loan Bank advances .. 5.24 5.30 5.47 5.85 6.18
Other borrowings ................. 8.67 8.70 8.69 8.36 6.56
- ----------------------------------------------------------------------------------------------------------
Combined borrowings ............ 5.26 5.33 5.51 6.00 6.26
- ----------------------------------------------------------------------------------------------------------
Combined funds cost ............ 4.56 4.53 4.66 4.86 4.97
- ----------------------------------------------------------------------------------------------------------
Interest rate spread ........... 2.85% 2.99% 2.99% 2.87% 2.85%
==========================================================================================================
</TABLE>
The period end weighted average yield on our loan and mortgage-backed
securities portfolios at June 30, 1999, was 7.47%, down from 7.72% at December
31, 1998, and 7.91% at June 30, 1998. At June 30, 1999, our single family
adjustable rate mortgage portfolio, including mortgage-backed securities,
totaled $5.2 billion with a weighted average rate of 7.19%, compared to $4.3
billion with a weighted average rate of 7.53% at December 31, 1998, and $4.3
billion with a weighted average rate of 7.63% at June 30, 1998.
24
<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, real estate acquired in
settlement of loans and repossessed automobiles. Non-performing assets were
virtually unchanged during the quarter totaling $30 million or 0.41% of total
assets. Non-performing assets at quarter end include non-accrual loans
aggregating $1.3 million which were not contractually past due, but were deemed
non-accrual due to our assessment of the borrower's ability to pay.
The following table summarizes our non-performing assets at the dates
indicated.
<TABLE>
<CAPTION>
June 30, March 31, December 31, September 30, June 30,
(Dollars in Thousands) 1999 1999 1998 1998 1998
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-accrual loans:
Residential, one-to-four units .................. $15,522 $16,579 $15,571 $15,397 $19,047
Residential, one-to-four units - subprime ....... 6,010 4,379 1,975 2,479 1,107
Other ........................................... 4,281 4,127 4,829 20,677 20,259
- --------------------------------------------------------------------------------------------------------------------------
Total non-accrual loans ....................... 25,813 25,085 22,375 38,553 40,413
Real estate acquired in settlement of loans ......... 4,015 4,686 4,475 5,423 7,576
Repossessed automobiles ............................. 256 319 569 611 764
- --------------------------------------------------------------------------------------------------------------------------
Total non-performing assets ..................... $30,084 $30,090 $27,419 $44,587 $48,753
==========================================================================================================================
Allowance for loan losses (1):
Amount .......................................... $34,345 $32,586 $31,517 $31,444 $31,736
As a percentage of non-performing loans ......... 133.05% 129.90% 140.86% 81.56% 78.53%
Non-performing assets as a percentage of total assets 0.41 0.46 0.44 0.75 0.84
==========================================================================================================================
<FN>
(1) Allowance for loan losses does not include the allowance for real estate
and real estate acquired in settlement of loans.
</FN>
</TABLE>
At June 30, 1999, the recorded investment in loans for which we recognized
impairment totaled $13 million. The total allowance for possible losses related
to these loans was $1 million. During the second quarter of 1999, total interest
recognized on the impaired loan portfolio was $0.5 million, increasing the
year-to-date total to $1.0 million.
Delinquent Loans
During the 1999 second quarter, our delinquencies decreased by $3 million
or 8.5%. This decrease primarily occurred in our residential one-to-four units
category, which declined by $5 million. Partially offsetting that decline was a
$2 million increase in our residential one-to-four units-subprime category, with
total subprime delinquencies equaling 0.64% of related loans. As a percentage of
total loans outstanding, total delinquencies were 0.48% at the end of the 1999
second quarter, compared to 0.65% at year-end 1998 and 0.76% a year ago.
25
<PAGE>
The following table indicates the amounts of our past due loans at the
dates indicated.
<TABLE>
<CAPTION>
June 30, 1999 March 31, 1999
----------------------------------------------------------------------------------------
30-59 60-89 90+ 30-59 60-89 90+
(Dollars in Thousands) Days Days Days (1) Total Days Days Days (1) Total
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real estate:
Residential:
One-to-four units .............. $ 5,834 $3,812 $11,910 $21,556 $ 8,463 $4,700 $13,180 $26,343
One-to-four units - subprime ... 2,328 1,235 3,092 6,655 1,177 2,281 1,385 4,843
Five or more units ............. -- -- -- -- -- -- -- --
Commercial real estate ........... -- -- -- -- -- -- -- --
Construction ..................... -- -- -- -- -- -- -- --
Land ............................. -- -- -- -- -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total real estate loans ........ 8,162 5,047 15,002 28,211 9,640 6,981 14,565 31,186
Non-mortgage:
Commercial ....................... -- -- -- -- -- -- -- --
Automobile ....................... 3,133 489 895 4,517 3,248 383 1,000 4,631
Other consumer ................... 169 36 233 438 144 76 226 446
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans .................... $11,464 $5,572 $16,130 $33,166 $13,032 $7,440 $15,791 $36,263
==================================================================================================================================
Delinquencies as a percentage of total
loans .............................. 0.17% 0.08% 0.23% 0.48% 0.21% 0.12% 0.25% 0.58%
==================================================================================================================================
December 31, 1998 September 30, 1998
---------------------------------------------------------------------------------------
<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 $10,601 $4,302 $12,408 $27,311
One-to-four units - subprime ... 244 784 947 1,975 741 1,334 505 2,580
Five or more units ............. -- -- 155 155 155 -- -- 155
Commercial real estate ........... -- -- -- -- -- -- -- --
Construction ..................... -- -- -- -- -- -- -- --
Land ............................. -- -- -- -- -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total real estate loans ........ 10,085 6,798 13,934 30,817 11,497 5,636 12,913 30,046
Non-mortgage:
Commercial ....................... -- -- -- -- -- -- -- --
Automobile ....................... 4,650 888 1,048 6,586 5,330 1,105 990 7,425
Other consumer ................... 334 45 344 723 119 143 496 758
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans .................... $15,069 $7,731 $15,326 $38,126 $16,946 $6,884 $14,399 $38,229
==================================================================================================================================
Delinquencies as a percentage of total
loans .............................. 0.26% 0.13% 0.26% 0.65% 0.31% 0.13% 0.26% 0.70%
==================================================================================================================================
June 30, 1998
-----------------------------------------
<S> <C> <C> <C> <C>
Loans secured by real estate:
Residential:
One-to-four units .............. $12,500 $5,271 $14,497 $32,268
One-to-four units - subprime ... 535 -- 762 1,297
Five or more units ............. -- -- -- --
Commercial real estate ........... -- -- -- --
Construction ..................... -- -- -- --
Land ............................. -- -- -- --
- -----------------------------------------------------------------------------------
Total real estate loans ........ 13,035 5,271 15,259 33,565
Non-mortgage:
Commercial ....................... -- -- -- --
Automobile ....................... 4,795 860 819 6,474
Other consumer ................... 222 208 227 657
- -----------------------------------------------------------------------------------
Total loans .................... $18,052 $6,339 $16,305 $40,696
===================================================================================
Delinquencies as a percentage of total
loans .............................. 0.34% 0.12% 0.30% 0.76%
===================================================================================
<FN>
(1) All 90 day or greater delinquencies are on non-accrual status and reported
as part of non-performing assets.
</FN>
</TABLE>
26
<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 $43 million at June 30, 1999, $40
million at December 31, 1998, and $42 million at June 30, 1998.
Our total allowance for possible loan losses was $34 million at June 30,
1999, up from $32 million at both year-end 1998 and June 30, 1998. Included in
our current quarter-end total allowance was $34 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 $1.0 million in the 1999 second quarter, down from $1.5
million in the year-ago quarter. Included in the current quarter net charge-offs
were $0.2 million associated with one-to-four unit residential loans and $0.8
million associated with automobile loans. For the first six months of 1999, our
net charge-offs were $2.4 million, compared to net charge-offs of $2.1 million
in the year-ago period. The year-ago period included a $1.4 million recovery
from the settlement. Adjusting year-ago results to exclude that recovery, net
charge-offs would have been down $1.1 million between six-month periods.
The following table is a summary of the activity of our allowance for loan
losses during the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
--------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 1999 1999 1998 1998 1998
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $32,586 $31,517 $31,444 $31,736 $31,817
Provision .................... 2,798 2,381 1,180 985 1,462
Charge-offs .................. (1,280) (1,520) (1,574) (1,540) (1,877)
Recoveries ................... 241 208 467 263 334
- ---------------------------------------------------------------------------------------------------------
Balance at end of period ..... $34,345 $32,586 $31,517 $31,444 $31,736
=========================================================================================================
</TABLE>
27
<PAGE>
The following table indicates our allocation of the total valuation
allowance for loan losses to the various categories of loans at the dates
indicated.
<TABLE>
<CAPTION>
June 30, 1999 March 31, 1999 December 31, 1998
---------------------------------------------------------------------------------------------------
Gross Allowance Gross Allowance Gross Allowance
Loan Percentage Loan Percentage Loan Percentage
Portfolio to Loan Portfoli to Loan Portfolio to Loan
(Dollars in Thousands) Allowance Balance Balance Allowance Balance Balance Allowance Balance Balance
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real estate:
Residential:
One-to-four units ...... $16,896 $5,701,245 0.30% $15,735 $5,064,684 0.31% $14,299 $4,636,133 0.31%
Five or more units ..... 285 24,641 1.16 299 26,420 1.13 401 40,029 1.00
Commercial real estate ... 2,808 149,559 1.88 2,729 151,247 1.80 2,632 140,790 1.87
Construction ............. 2,082 178,526 1.17 1,732 147,246 1.18 1,508 127,761 1.18
Land ..................... 900 71,314 1.26 944 74,959 1.26 568 44,859 1.27
Non-Mortgage:
Commercial ............... 193 26,884 0.72 202 28,182 0.72 218 28,293 0.77
Automobile ............... 7,832 375,138 2.09 7,566 363,168 2.08 8,344 357,988 2.33
Other consumer ........... 549 42,475 1.29 579 40,607 1.43 747 41,894 1.78
Not specifically allocated .. 2,800 -- -- 2,800 -- -- 2,800 -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans held for
investment ............. $34,345 $6,569,782 0.52% $32,586 $5,896,513 0.55% $31,517 $5,417,747 0.58%
- ----------------------------------------------------------------------------------------------------------------------------------
September 30, 1998 June 30, 1998
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Loans secured by real estate:
Residential:
One-to-four units ...... $13,603 $4,413,757 0.31% $14,143 $4,426,563 0.32%
Five or more units ..... 409 41,143 0.99 309 27,736 1.11
Commercial real estate ... 3,656 156,902 2.33 3,766 161,424 2.33
Construction ............. 1,087 92,779 1.17 1,137 95,664 1.19
Land ..................... 498 39,222 1.27 382 29,857 1.28
Non-Mortgage:
Commercial ............... 204 27,710 0.74 199 27,298 0.73
Automobile ............... 8,349 355,955 2.35 8,272 356,504 2.32
Other consumer ........... 838 44,026 1.90 728 44,530 1.63
Not specifically allocated .. 2,800 -- -- 2,800 -- --
- ----------------------------------------------------------------------------------------------
Total loans held for
investment ............. $31,444 $5,171,494 0.61% $31,736 $5,169,576 0.61%
- ----------------------------------------------------------------------------------------------
</TABLE>
The following table is a summary of the activity of our allowance for real
estate held for investment during the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 1999 1999 1998 1998 1998
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $7,770 $7,717 $8,151 $ 9,558 $18,140
Provision (reduction) ........ (265) 53 (214) (139) (2,221)
Charge-offs .................. (116) -- (220) (1,268) (6,361)
Recoveries ................... -- -- -- -- --
- ----------------------------------------------------------------------------------------------------
Balance at end of period ..... $7,389 $7,770 $7,717 $ 8,151 $ 9,558
====================================================================================================
</TABLE>
28
<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 during the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 1999 1999 1998 1998 1998
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $ 547 $ 533 $ 582 $ 671 $ 898
Provision (reduction) ........ 9 26 (14) 160 5
Charge-offs .................. (47) (12) (35) (249) (232)
Recoveries ................... -- -- -- -- --
- ---------------------------------------------------------------------------------------------
Balance at end of period ..... $ 509 $ 547 $ 533 $ 582 $ 671
=============================================================================================
</TABLE>
CAPITAL RESOURCES AND LIQUIDITY
Our primary sources of funds generated in the second 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 $463 million, and net increases in our borrowings of $456 million and
deposits of $268 million.
We used these funds primarily to originate loans held for investment of
$1.1 billion (net of our refinances of $45 million).
Both at June 30, 1999 and at December 31, 1998, the Bank's ratio of
regulatory liquidity was 4.0%, compared to 4.4% at June 30, 1998.
Stockholders' equity totaled $502 million at June 30, 1999, compared to
$481 million at December 31, 1998, and $459 million at June 30, 1998.
29
<PAGE>
REGULATORY CAPITAL COMPLIANCE
The following table is a reconciliation of the Bank's stockholder's equity
to federal regulatory capital as of June 30, 1999. The core and tangible capital
ratios were 6.04% and the risk-based capital ratio was 11.48%. The Bank's
capital ratios exceed the "well capitalized" standards of 5% for core and 10%
for risk-based, as defined by regulation. For information regarding a capital
contribution to the Bank by Downey subsequent to June 30, 1999, see "Notes to
Consolidated Financial Statements - Note (5) - Capital Securities."
<TABLE>
<CAPTION>
Tangible Capital Core Capital Risk-Based Capital
----------------- ----------------- ------------------
(Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Stockholder's equity ................................ $491,767 $491,767 $491,767
Adjustments:
Deductions:
Investment in subsidiary, primarily real estate . (48,724) (48,724) (48,724)
Goodwill ........................................ (4,307) (4,307) (4,307)
Non-permitted mortgage servicing rights ......... (2,299) (2,299) (2,299)
Additions:
Unrealized gains on securities available for sale 521 521 521
General loss allowance - Investment in DSL
Service Company ............................... 1,485 1,485 1,485
General loan valuation allowances (1) ........... -- -- 33,932
- -------------------------------------------------------------------------------------------------------------------------
Regulatory capital .................................. 438,443 6.04% 438,443 6.04% 472,375 11.48%
Well capitalized requirement ........................ 108,868 1.50 362,894 5.00 411,364 10.00
- -------------------------------------------------------------------------------------------------------------------------
Excess .............................................. $329,575 4.54% $ 75,549 1.04% $ 61,011 1.48%
=========================================================================================================================
<FN>
(1) Limited to 1.25% of risk-weighted assets.
(2) Represents the minimum requirement for tangible capital, as no "well
capitalized" requirement has been established for this category.
(3) A third requirement is Tier 1 capital to risk-weighted assets of 6.00%,
which the Bank met and exceeded with a ratio of 10.66%.
</FN>
</TABLE>
YEAR 2000
Risks of the Year 2000 Issue
The year 2000 issue is the result of computer programs being written using
two digits rather than four digits to represent the calendar year--e.g., "99"
for "1999". Software so developed, and not corrected, could produce inaccurate
or unpredictable results or system failures commencing January 1, 2000, when
dates present a lower two digit year number than dates in the prior century.
These occurrences may have a material adverse effect on our financial condition,
results of operations, business or business prospects, as Downey, like most
financial organizations, is significantly impacted by the potential year 2000
issue due to the nature of financial information. Potential impacts to us may
arise from software, computer hardware, and other equipment both within our
direct control and outside our ownership, yet with which we electronically or
operationally interface. Financial institution regulators have intensively
focused upon year 2000 exposures, issuing guidance concerning the
responsibilities of management and the board of directors. Year 2000 testing and
certification is being addressed as a key safety and soundness issue in
conjunction with regulatory exams and the Office of Thrift Supervision has
authority to bring enforcement actions against any institution under its
supervision which it believes is not properly addressing year 2000 compliance
issues.
State of Readiness
We have established a four-phase process to address the year 2000 issue. In
addition, our board of directors oversees the year 2000 compliance project's
progress through monthly status reports and quarterly reviews with the year 2000
project manager.
30
<PAGE>
As part of the first phase, which is completed, we inventoried all of our
data systems to determine which are most critical to support customer
transaction processing and provide customer services. This inventory not only
included in-house systems, but those provided by third party vendors as well. We
prioritized systems as being:
o mission critical;
o high risk;
o moderate risk; or
o low risk.
From this system we developed modification plans which place priority
emphasis on those systems requiring change and classified mission critical or
high risk. We contacted third party vendors during this phase to determine their
process and timeline in correcting any year 2000 compliance issues. In addition,
we also contacted our commercial loan borrowers to determine the extent of their
preparations for year 2000 and any potential impact year 2000 may have on their
businesses and ability to repay loan obligations to us. Commercial lending does
not represent a significant portion of our loan portfolio--i.e., substantially
less than 1.0%; therefore, we believe the year 2000 preparedness of our
commercial loan borrowers does not pose a significant risk.
Phase two of the process consisted of making appropriate year 2000
programming changes to our in-house systems, while phase three consists of
acceptance testing and sign-off of both our in-house and vendor provided
systems. The fourth and final phase of the year 2000 compliance project includes
installation of the system modifications into our daily operation. The fourth
phase is scheduled to occur once a system has been successfully tested and
determined to be year 2000 compliant.
By the end of 1998, we completed programming and substantially completed
acceptance testing for our in-house mainframe system. At the end of first
quarter 1999, we completed acceptance testing and installation of the in-house
mainframe system, which performs all significant loan, deposit, and general
ledger accounting processes.
For our developed PC-based systems classified mission critical, we have
completed all programming changes, acceptance testing and installation. We
completed programming and acceptance testing of all other of our developed
PC-based systems by the end of the second quarter, with installation of year
2000 modifications scheduled for completion during third quarter 1999.
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 otherwise have implemented or replaced during the period
notwithstanding the year 2000 issue. Thus, that portion of year 2000 costs will
be amortized over the useful life of the equipment. Of the estimated total
expense, approximately $3.2 million has been incurred to date, $0.1 million in
1997, $1.8 million in 1998 and $1.3 million during the first six months of 1999.
31
<PAGE>
The table below summarizes by year the estimated amount and anticipated timing
of the planned year 2000 expense.
<TABLE>
<CAPTION>
(In Millions) 1997 1998 1999 2000 Thereafter Total
- ----------------------------------------------------------------------------------
<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 have completed acceptance testing and installation with
respect to our in-house mainframe system which performs all significant loan,
deposit and general ledger accounting processes, as well as our developed
PC-based systems classified mission critical. Also, programming and acceptance
testing of all other of our developed PC-based systems has been completed, with
installation scheduled for third 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 operations, business or business prospects.
32
<PAGE>
PART II - OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K
(A) Exhibits
27 Financial Data Schedule.
(B) There were no reports on Form 8-K filed for the six months ended June 30,
1999.
SIGNATURES: Pursuant to the requirements of Section 13 or 15 (d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
DOWNEY FINANCIAL CORP.
Date: August 2, 1999 /s/ Daniel D. Rosenthal
----------------------------------------------------
Daniel D. Rosenthal
President and Chief Executive Officer
Date: August 2, 1999 /s/ Thomas E. Prince
----------------------------------------------------
Thomas E. Prince
Executive Vice President and Chief Financial Officer
33
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 9,130
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 3,900
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 159,874
<INVESTMENTS-CARRYING> 6,864
<INVESTMENTS-MARKET> 6,845
<LOANS> 6,792,346
<ALLOWANCE> 34,345
<TOTAL-ASSETS> 7,331,400
<DEPOSITS> 5,472,924
<SHORT-TERM> 783,153
<LIABILITIES-OTHER> 49,111
<LONG-TERM> 524,079
0
0
<COMMON> 281
<OTHER-SE> 501,852
<TOTAL-LIABILITIES-AND-EQUITY> 7,331,400
<INTEREST-LOAN> 229,549
<INTEREST-INVEST> 6,554
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 236,103
<INTEREST-DEPOSIT> 113,573
<INTEREST-EXPENSE> 22,377
<INTEREST-INCOME-NET> 100,153
<LOAN-LOSSES> 5,179
<SECURITIES-GAINS> 288
<EXPENSE-OTHER> 71,978
<INCOME-PRETAX> 47,597
<INCOME-PRE-EXTRAORDINARY> 27,406
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 27,406
<EPS-BASIC> .97
<EPS-DILUTED> .97
<YIELD-ACTUAL> 7.42
<LOANS-NON> 25,813
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 405
<ALLOWANCE-OPEN> 31,517
<CHARGE-OFFS> 2,800
<RECOVERIES> 449
<ALLOWANCE-CLOSE> 34,345
<ALLOWANCE-DOMESTIC> 34,345
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 2,800
</TABLE>
