================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------------------------------------------------------------
FORM 10-K/A
AMENDMENT NO. 1
--------------------------------------------------------------------------------
(Mark One)
|X| Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1999.
|_| 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
(State or other jurisdiction of incorporation or organization)
--------------------------------------------------------------------------------
3501 Jamboree Road, Newport Beach, California 92660
(Address of principal executive offices) (Zip Code)
I.R.S. Employer Identification No.: 33-0633413
Registrant's telephone number, including area code: (949) 854-0300
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE
------------------------------ -------------------------
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 |_|
Indicate by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing sale price of its Common Stock on
February 29, 2000, on the New York Stock Exchange was $419,693,971.
At February 29, 2000, 28,148,409 shares of the Registrant's Common Stock,
$0.01 par value were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's Proxy
Statement to be filed with the Securities and Exchange Commission in connection
with the Annual Meeting of Stockholders to be held April 26, 2000 are
incorporated by reference in Part III hereof.
================================================================================
<PAGE>
EXPLANATORY NOTE
This amendment to Form 10-K on Form 10-K/A has been prepared to reflect a
more detailed disclosure on the allowance for loan losses and includes an
expanded:
o disclosure and analysis of the allowance for impaired loans as
described and presented in the table on page 26.
o explanation on each element of the allowance for loan losses and how
it is affected by changes in asset quality and loan portfolio as
described on pages 29-31;
o analysis to provide gross charge-off and recovery details for the past
5 years as presented in the table on page 32; and
o accounting policy description to include how each element of the
allowance is determined as described on pages 46-47.
These amended items are included in Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations and Item 8. Financial
Statements. These amended items had no effect on net income or total assets,
total liabilities or total equity as previously reported. No part of the Form
10-K for December 31, 1999 as previously filed, other than Item 7. and Item 8.,
was affected by this amendment.
<PAGE>
TABLE OF CONTENTS
ITEM PAGE
--------------------------------------------------------------------------------
PART II
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ..................................... 1
Overview ...................................................... 1
Results of Operations ......................................... 3
Net Interest Income ........................................ 3
Provision for Loan Losses .................................. 5
Other Income ............................................... 5
Loan and Deposit Related Fees ........................... 5
Real Estate and Joint Venture
Operations Held for Investment ....................... 5
Secondary Marketing Activities .......................... 6
Other Category .......................................... 6
Operating Expenses ......................................... 6
Provision for Income Taxes ................................. 6
Business Segment Reporting ................................. 7
Banking ................................................. 7
Real Estate Investment .................................. 8
Financial Condition ........................................... 10
Loans and Mortgage-Backed Securities ....................... 10
Investment Securities ...................................... 14
Investments in Real Estate and Joint Ventures .............. 15
Deposits ................................................... 17
Borrowings ................................................. 18
Capital Securities ......................................... 19
Asset/Liability Management and Market Risk ................. 19
Problem Loans and Real Estate .............................. 24
Non-Performing Assets ................................... 24
Delinquent Loans ........................................ 26
Allowance for Losses on Loans and Real Estate ........... 29
Capital Resources and Liquidity ............................ 34
Regulatory Capital Compliance .............................. 35
Current Accounting Issue ................................... 35
Year 2000 .................................................. 36
Subsequent Event ........................................... 36
8. FINANCIAL STATEMENTS ............................................. 37
SIGNATURES .............................................................. 80
i
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements under this caption constitute "forward-looking
statements" under the Private Securities Litigation Reform Act of 1995 which
involve risks and uncertainties. Our 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 we conduct
our operations, fluctuations in interest rates, credit quality and government
regulation. For additional information concerning these factors, see
Business--Factors that May Affect Future Results on page 19.
OVERVIEW
Our net income for 1999 totaled a record $63.8 million or $2.26 per share
on a diluted basis, up 10.1% from last year's record of $58.0 million or $2.05
per share. Our year-ago net income benefited from the settlement of a number of
loan and real estate investment obligations of a former joint venture partner.
That settlement added $4.8 million to our 1998 net income. The pre-tax amount of
the settlement was $8.4 million of which:
o $1.4 million represented the recovery of a prior loan charge-off
thereby reducing provision for loan losses;
o $4.4 million was recorded in income from real estate and joint venture
operations of which $4.3 million was a reduction of loss;
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.
Excluding the benefit of the settlement, our net income in 1999 would have
increased over a year ago by $10.6 million or 20.0%. This adjusted increase was
generated in both of our business segments as follows:
o Banking activities contributed $9.0 million to the increase reflecting
the following:
o net interest income increased $32.8 million or 18.8% due to an
increase in average interest-earning assets as the effective
interest rate spread declined;
o all categories of other income improved with a combined adjusted
increase of $16.1 million, primarily in net gains on sales of
loans and mortgage-backed securities of $8.3 million, loan and
deposit related fees of $4.5 million and loan servicing fees of
$1.4 million; and
o adjusted increases of $28.1 million in operating expense and $6.0
million in provision for loan losses partially offset those
favorable factors. The increase in operating expense reflected
higher general and administrative expense due to significantly
higher lending volumes and branch expansion.
o Real estate investment activities contributed $1.6 million to the
increase primarily from a higher level of gains from sales of real
estate investments.
Our assets increased a record $3.1 billion or 50.0% during 1999 to $9.4
billion at year-end, following a 7.4% increase during 1998. Assets expanded in
1999 primarily from loan growth. Our single family loan originations increased
from $3.7 billion in 1998 to a record $6.7 billion in 1999, of which $2.0
billion were originated for sale in the secondary market. Of the current year's
total, $1.2 billion represented originations for portfolio of subprime credits
as part of our continuing strategy to enhance the portfolio's net yield. In
addition to single family loans, we originated $530 million of other loans
during the year, including $234 million of automobile loans and $206 million of
construction and land loans.
We funded our asset growth with increases of $1.5 billion or 30.2% in
deposits, a record, and $1.4 billion in borrowings. In addition, we issued
during the year $120 million of 10.00% capital securities, of which $108 million
was invested as additional common stock in the Bank.
Non-performing assets totaled $39 million at December 31, 1999, up from $27
million a year ago. This increase was primarily in the subprime residential
category. When measured as a percentage of total assets, our non-performing
assets fell from 0.44% at year-end 1998 to 0.42% at year-end 1999.
1
<PAGE>
At December 31, 1999, the Bank exceeded all three regulatory capital tests,
with capital-to-asset ratios of 6.27% in tangible and core capital and 12.14% in
risk-based capital. These capital levels are significantly above the "well
capitalized" standards defined by the federal banking regulators of 5% for core
and tangible capital and 10% for risk-based capital. For further information,
see Business--Regulation--Regulation of the Bank--Insurance of Deposit Accounts
on page 12, Financial Condition--Investments in Real Estate and Joint Ventures
on page 38 and Financial Condition--Regulatory Capital Compliance on page 56.
2
<PAGE>
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is the difference between the interest and dividends
earned on loans, mortgage-backed securities and investment securities
("interest-earning assets") and the interest paid on deposits, borrowings and
capital securities ("interest-bearing liabilities"). The spread between the
yield on interest-earning assets and the cost of interest-bearing liabilities
and the relative dollar amounts of these assets and liabilities principally
affects interest income.
Our net interest income was $207.5 million in 1999, up $33.1 million or
19.0% from 1998 and $53.3 million or 34.6% greater than 1997. The 1999
improvement over 1998 primarily reflected an increase in average earning assets
as the effective interest rate spread declined. Average earning assets increased
by $1.5 billion or 27.1% to $7.2 billion. The effective interest rate spread
averaged 2.88% in 1999, down from 3.08% in 1998, but up from 2.83% in 1997. The
decline in our 1999 effective interest rate spread was due primarily to two
factors. First, the significant growth in single family adjustable rate loans
during 1999 resulted in a higher proportion of our portfolio being at low,
introductory incentive rates thereby contributing to a decline in the yield on
average earning assets between years. As these new loans reprice to
fully-indexed rates in future periods and loans with incentive rates become a
lower proportion of earning assets, this downward pressure on our earning asset
yield should lessen. Second, a higher proportion of earning assets was funded
with higher cost certificates of deposit and borrowings thereby resulting in an
increase in our cost of funds.
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 our net interest income, interest rate spread and
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 our 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
year using the average of each month's daily average balance during the period
indicated.
3
<PAGE>
<TABLE>
<CAPTION>
1999 1998 1997
----------------------------------------------------------------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
(Dollars in Thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans .............................. $6,937,342 $519,006 7.48% $5,345,380 $421,942 7.89% $5,174,767 $404,081 7.81%
Mortgage-backed securities ......... 26,361 1,638 6.21 42,075 2,780 6.61 55,045 3,633 6.60
Investment securities .............. 232,746 13,107 5.63 276,139 15,682 5.68 217,272 12,704 5.85
---------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets .... 7,196,449 533,751 7.42 5,663,594 440,404 7.78 5,447,084 420,418 7.72
Non-interest-earning assets ........... 304,779 254,913 246,785
---------------------------------------------------------------------------------------------------------------------------------
Total assets ....................... $7,501,228 $5,918,507 $5,693,869
=================================================================================================================================
Interest-bearing liabilities:
Deposits ........................... $5,697,292 $256,764 4.51% $5,102,045 $248,337 4.87% $4,588,320 $227,521 4.96%
Borrowings ......................... 1,175,704 64,161 5.46 292,044 17,720 6.07 638,661 38,739 6.07
Capital securities ................. 52,903 5,348 10.14 -- -- - -- -- -
---------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 6,925,899 326,273 4.71 5,394,089 266,057 4.93 5,226,981 266,260 5.09
Non-interest-bearing liabilities ...... 72,917 68,181 58,415
Stockholders' equity .................. 502,412 456,237 408,473
---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders'
equity ........................... $7,501,228 $5,918,507 $5,693,869
=================================================================================================================================
Net interest income/interest rate
spread ............................. $207,478 2.71% $174,347 2.85% $154,158 2.63%
Excess of interest-earning assets over
interest-bearing liabilities ....... $ 270,550 $ 269,505 $ 220,103
Effective interest rate spread ........ 2.88 3.08 2.83
=================================================================================================================================
</TABLE>
Changes in our net interest income are a function of both changes in rates
and changes in volumes of interest-earning assets and interest-bearing
liabilities. The following table sets forth information regarding changes in our
interest income and expense for the years indicated. For each category of
interest-earning assets and interest-bearing liabilities, we have provided
information on changes attributable to:
o changes in volume - changes in volume multiplied by prior period rate;
o changes in rate - changes in rate multiplied by prior 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 average balances computed using the average of each
month's daily average balance during the period indicated.
<TABLE>
<CAPTION>
1999 versus 1998 1998 versus 1997
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 ...................... $125,663 $(22,036) $(6,563) $97,064 $ 13,322 $ 4,394 $ 145 $ 17,861
Mortgage-backed securities . (1,038) (166) 62 (1,142) (856) 4 (1) (853)
Investment securities ...... (2,465) (131) 21 (2,575) 3,442 (365) (99) 2,978
---------------------------------------------------------------------------------------------------------------------
Change in interest income 122,160 (22,333) (6,480) 93,347 15,908 4,033 45 19,986
---------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits ................... 28,973 (18,399) (2,147) 8,427 25,474 (4,189) (469) 20,816
Borrowings ................. 53,612 (1,781) (5,390) 46,441 (21,019) -- -- (21,019)
Capital securities ......... -- -- 5,348 5,348 -- -- -- --
---------------------------------------------------------------------------------------------------------------------
Change in interest expense 82,585 (20,180) (2,189) 60,216 4,455 (4,189) (469) (203)
---------------------------------------------------------------------------------------------------------------------
Change in net interest income . $ 39,575 $ (2,153) $(4,291) $33,131 $ 11,453 $ 8,222 $ 514 $ 20,189
=====================================================================================================================
</TABLE>
4
<PAGE>
PROVISION FOR LOAN LOSSES
Provision for loan losses was $11.3 million in 1999, up from $3.9 million
in 1998 and $8.6 million in 1997. The increase in our provision for loan losses
in 1999 is primarily due to the significant increase during the year in our
single family residential loan portfolio. Also, 1998 benefited from a $1.4
million recovery of a prior loan charge-off as a result of the previously
mentioned settlement.
For further information, see Financial Condition--Problem Loans and Real
Estate--Allowance for Losses on Loans and Real Estate on page 51.
OTHER INCOME
Our total other income was $59.3 million in 1999, up from $47.4 million in
1998 and $35.2 million in 1997. All categories of other income were above year
ago levels except for our income from real estate held for investment. Income
from real estate held for investment declined by $3.1 million, as the year-ago
amount included $4.4 million from the previously mentioned settlement. That
decline was more than offset by increases in the other categories, the more
significant of which were $8.3 million in net gains on sales of loans and
mortgage backed securities, $4.5 million in loan and deposit related fees and
$1.4 million in loan servicing fees. Below is a further discussion of the major
other income categories.
LOAN AND DEPOSIT RELATED FEES
Loan and deposit related fees totaled $20.1 million in 1999, up from $15.6
million in 1998 and $10.9 million in 1997. As depicted in the following table,
our loan related fees increased by $3.4 million or 46.6% in 1999 due primarily
to higher prepayment and wire transfer fees from funding a higher volume of
loans, while our deposit related fees increased by $1.1 million or 12.9%.
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
--------------------------------------------------------------------------------
<S> <C> <C> <C>
Loan related fees ............................. $10,589 $ 7,225 $ 3,837
Deposit related fees .......................... 9,508 8,420 7,084
--------------------------------------------------------------------------------
Total loan and deposit related fees ....... $20,097 $15,645 $10,921
================================================================================
</TABLE>
REAL ESTATE AND JOINT VENTURE OPERATIONS HELD FOR INVESTMENT
Income from our real estate and joint ventures held for investment totaled
$19.3 million in 1999, down from $22.4 million in 1998, but up from $14.2
million in 1997. The table below sets forth the key components comprising our
income from real estate and joint venture operations.
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operations, net:
Rental operations, net of expenses ........................... $ 3,822 $ 3,723 $ 2,317
Equity in net income from joint ventures ..................... 5,352 9,203 3,931
Interest from joint venture advances ......................... 1,256 1,584 1,880
---------------------------------------------------------------------------------------------
Total operations, net ...................................... 10,430 14,510 8,128
Net gains on sales of wholly owned real estate ................... 5,206 2,557 2,904
Reduction of losses on real estate and joint ventures ............ 3,666 5,296 3,190
---------------------------------------------------------------------------------------------
Income from real estate and joint ventures held for investment $19,302 $22,363 $14,222
=============================================================================================
</TABLE>
Our income from real estate and joint ventures would have increased by $1.3
million if our 1998 results had not included $4.4 million from the previously
mentioned settlement. That adjusted increase primarily reflected an increase in
net gains from sales and declines in valuation losses.
5
<PAGE>
For additional information, see Financial Condition--Investments in Real
Estate and Joint Ventures on page 38, Financial Condition--Problem Loans and
Real Estate--Allowance for Losses on Loans and Real Estate on page 51 and Note 8
of Notes to the Consolidated Financial Statements on page 77.
SECONDARY MARKETING ACTIVITIES
Sales of loans and mortgage-backed securities we originated increased in
1999 to $2.4 billion from $1.7 billion in 1998 and $558 million in 1997. Net
gains associated with these sales totaled $14.8 million in 1999, up from $6.5
million in 1998 and $2.7 million in 1997. The net gains include $29.3 million in
1999, $7.3 million in 1998 and $1.2 million in 1997 related to the
capitalization of mortgage servicing rights.
Loan servicing fees from our portfolio of loans serviced for others totaled
$1.7 million for 1999, up from $0.3 million in 1998 and $1.3 million in 1997.
The increase in 1999 reflects both an increase in our servicing portfolio and a
decrease in the valuation allowance for mortgage servicing rights. The valuation
allowance was established during 1998 due to higher than expected prepayments
from the low interest rate environment that existed at that time. As rates began
to increase during 1999, expected prepayment rates declined permitting us to
reverse during 1999 most of the allowance established in 1998. At December 31,
1999, we serviced $2.9 billion of loans for others, compared to $1.0 billion at
December 31, 1998, and $613 million at December 31, 1997.
OTHER CATEGORY
The all other category of other income totaled $3.1 million in 1999, up
from $2.6 million in 1998, but down from $6.1 million in 1997. We included $1.0
million of proceeds from the previously mentioned settlement in the 1998 total.
Excluding that amount, the adjusted increase from 1998 would have been $1.5
million.
OPERATING EXPENSES
Our operating expenses totaled $144.9 million in 1999, up from $116.7
million in 1998 and $101.3 million in 1997. The current year increase was due to
higher general and administrative expense, as the net operation of real estate
acquired in settlement of loans declined by $0.2 million. General and
administrative expense increased $28.5 million or 24.6% in 1999 due to
significantly higher lending volumes, branch expansion and 1998 included a $1.6
million reduction to professional fees due to the previously mentioned
settlement. In addition, our year 2000 computer compliance related costs totaled
$2.7 million for 1999, up from $1.8 million in 1998 and $0.1 million in 1997.
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Salaries and related costs .......................................... $ 86,163 $ 66,152 $ 54,366
Premises and equipment costs ........................................ 20,617 16,834 15,272
Advertising expense ................................................. 8,595 5,954 6,847
Professional fees ................................................... 2,502 2,867 5,113
SAIF insurance premiums and regulatory assessments .................. 3,937 3,832 3,439
Other general and administrative expense ............................ 22,568 20,251 14,519
---------------------------------------------------------------------------------------------------
Total general and administrative expense ........................ 144,382 115,890 99,556
Net operation of real estate acquired in settlement of loans ........ 19 260 1,184
Amortization of excess of cost over fair value of net assets acquired 474 510 532
---------------------------------------------------------------------------------------------------
Total operating expense ......................................... $144,875 $116,660 $101,272
===================================================================================================
</TABLE>
PROVISION FOR INCOME TAXES
Our effective tax rate for 1999 was 42.3%, compared to 42.7% in 1998 and
43.1% in 1997. See Note 1 on page 65 and Note 18 on page 85 of Notes to the
Consolidated Financial Statements for a further discussion of income taxes and
an explanation of the factors which impact Downey's effective tax rate.
6
<PAGE>
BUSINESS SEGMENT REPORTING
The previous sections of the Results of Operations discussed our
consolidated results. The purpose of this section is to present data on the
results of operations of our two business segments--banking and real estate
investment. For a description of these business segments and the accounting
policies used, see Business on page 1 and Note 1 on page 65 and Note 26 on page
95 of Notes to the Consolidated Financial Statements.
The following table presents by business segment our net income for 1999,
1998 and 1997, followed by a discussion of the results of operations of each
segment.
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 (1) 1997
--------------------------------------------------------------------------------
<S> <C> <C> <C>
Banking net income .................................. $53,796 $46,736 $38,662
Real estate investment net income ................... 10,008 11,237 6,572
--------------------------------------------------------------------------------
Total net income ................................. $63,804 $57,973 $45,234
================================================================================
<FN>
(1) The net income impact of a settlement with a former joint venture partner
totaled $4.8 million, of which $1.9 million was in banking and $2.9 million
was in real estate investment.
</FN>
</TABLE>
BANKING
Net income from our banking operations totaled $53.8 million in 1999, up
from $46.7 million in 1998 and $38.7 million in 1997. The previously mentioned
settlement benefited our year-ago net income by $1.9 million. The pre-tax amount
of the settlement was $3.4 million of which:
o $1.4 million was recorded as a reduction to the provision for loan
losses;
o $1.0 million was recorded in miscellaneous other income; and
o $1.0 million was recorded as a reduction to professional fees within
operating expense.
Excluding the settlement from year-ago results, our 1999 net income from banking
operations would have increased $9.0 million or 20.0%.
The increase in our adjusted 1999 net income reflected several factors. Net
interest income increased $32.8 million or 18.8% due to an increase in average
earning assets as the effective interest rate spread declined. Also contributing
to the increase between years was an adjusted $16.1 million increase in other
income. The increase in adjusted other income reflected increases in all
categories, the largest being $8.3 million in net gains on sales of loans and
mortgage-backed securities, followed by $4.5 million in loan and deposit related
fees and $1.4 million in loan servicing fees. Adjusted increases of $28.1
million in operating expense and $6.0 million in provision for loan losses
partially offset the favorable impact of those items. The increase in operating
expense primarily reflected significantly higher lending volumes and branch
expansion.
7
<PAGE>
The table below sets forth banking operational results and selected
financial data for the periods indicated.
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
--------------------------------------------------------------------------------
<S> <C> <C> <C>
Net interest income .................... $ 207,784 $ 174,967 $ 154,799
Provision for loan losses .............. 11,270 3,918 8,522
Other income ........................... 39,755 24,617 20,783
Operating expense ...................... 143,081 113,954 98,803
Net intercompany income (expense) ...... 393 (107) (357)
--------------------------------------------------------------------------------
Income before income taxes ............. 93,581 81,605 67,900
Income taxes ........................... 39,785 34,869 29,238
--------------------------------------------------------------------------------
Net income .......................... $ 53,796 $ 46,736 $ 38,662
================================================================================
AT DECEMBER 31:
Assets:
Loans and mortgage-backed securities $8,746,063 $5,788,365 $5,366,396
Other ............................... 654,745 464,097 449,318
--------------------------------------------------------------------------------
Total assets ...................... 9,400,808 6,252,462 5,815,714
--------------------------------------------------------------------------------
Equity ................................. $ 532,418 $ 480,566 $ 430,346
================================================================================
</TABLE>
REAL ESTATE INVESTMENT
Net income from our real estate investment operations totaled $10.0 million
in 1999, down from $11.2 million in 1998, but up from $6.6 million in 1997. The
previously mentioned settlement benefited our year-ago net income by $2.9
million. The pre-tax amount of the settlement was $5.0 million of which:
o $4.4 million was recorded in other income of which $4.3 million
reflected a reduction of loss on real estate and joint ventures; and
o $0.6 million was recorded as a reduction to professional fees in other
expense.
Excluding the settlement from year-ago results, our 1999 net income from real
estate investment would have increased $1.6 million or 19.7% due to a higher
level of net gains from sales and declines in valuation losses.
The table below sets forth real estate investment operational results and
selected financial data for the periods indicated.
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
--------------------------------------------------------------------------------
<S> <C> <C> <C>
Net interest expense ........................... $ (306) $ (620) $ (641)
Provision for (reduction of) loan losses ....... -- (19) 118
Other income ................................... 19,523 22,736 14,405
Operating expense .............................. 1,794 2,706 2,469
Net intercompany income (expense) .............. (393) 107 357
--------------------------------------------------------------------------------
Income before income taxes ..................... 17,030 19,536 11,534
Income taxes ................................... 7,022 8,299 4,962
--------------------------------------------------------------------------------
Net income .................................. $10,008 $11,237 $ 6,572
================================================================================
AT DECEMBER 31:
Assets:
Investments in real estate and joint ventures $42,172 $49,447 $41,356
Other ....................................... 7,399 9,841 12,849
--------------------------------------------------------------------------------
Total assets .............................. 49,571 59,288 54,205
--------------------------------------------------------------------------------
Equity ......................................... $42,839 $41,331 $34,094
================================================================================
</TABLE>
8
<PAGE>
For a further discussion regarding income from real estate investment, see
Other Income--Real Estate and Joint Venture Operations Held For Investment on
page 28, and for information regarding related assets, see Financial
Condition--Investments in Real Estate and Joint Ventures on page 38.
9
<PAGE>
FINANCIAL CONDITION
LOANS AND MORTGAGE-BACKED SECURITIES
Loans and mortgage-backed securities, including those we hold for sale,
totaled $8.7 billion or 93.0% of assets at December 31, 1999. This represents an
increase of $3.0 billion or 51.1% from year-end 1998. The increase represents a
higher level of loans held for investment, primarily one-to-four unit
residential loans.
Our loan originations, including loans purchased, totaled a record $7.2
billion in 1999, up from $4.1 billion in 1998 and $2.4 billion in 1997. This
increase primarily reflected an increase in originations of one-to-four unit
residential loans. Of the $6.7 billion of one-to-four unit residential loans we
originated, approximately 70% or $4.6 billion were for portfolio, while the
balance was originated for sale in the secondary market. Our origination of
subprime loans totaled $1.2 billion in 1999, up from $380 million in 1998.
The table below presents information regarding interest rates and fees
collected on loans originated during the periods indicated.
<TABLE>
<CAPTION>
(Dollars in Thousands) 1999 1998 1997 1996 1995
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Average interest rate on new loans ................. 5.92% 6.45% 6.04% 6.06% 6.99%
Total loan fees (net of costs) and discounts (net of
premiums) deferred during the year ............. $(53,181) $(30,621) $(11,505) $(4,525) $880
==========================================================================================================
</TABLE>
We originate one-to-four unit residential adjustable rate mortgages both
with and without loan origination fees. In adjustable rate mortgage transactions
for which we charge no origination fees, we receive a larger margin over the
index to which the loan pricing is tied than in those in which we charge fees.
In addition, a prepayment fee on these loans is generally required if prepaid
within the first three years. This trend towards loans with no origination fees
has generally resulted in deferrable loan origination costs exceeding loan
origination fees except in 1995, which included increases in interest buydowns,
or discounts, on new real estate loans.
Residential one-to-four unit adjustable rate mortgage originations,
including loans purchased, were $4.4 billion during 1999, up significantly from
$1.4 billion in 1998 and $1.7 billion in 1997. Refinancing activities related to
residential one-to-four unit loans, including new loans to refinance loans which
we and other lenders originated, constituted 63% of originations during the year
compared to 71% during 1998 and 45% during 1997. Although residential
one-to-four unit refinancing activities fell in 1999 as a percentage of
originations, in dollar terms refinancing activities increased from $2.6 billion
in 1998 to $4.2 billion in 1999 as borrowers took advantage of the lower
interest rate environment that existed, particularly in the earlier part of the
year. In addition, the majority of residential originations were adjustable rate
mortgages tied to the FHLB Eleventh District Cost of Funds Index ("COFI"), an
index which lags the movement in market interest rates. For the year, 68% of
one-to-four unit originations for investment represented monthly adjusting COFI
adjustable rate mortgages which provide for negative amortization, 14%
represented COFI adjustable rate mortgages which reprice every six months but do
not provide for negative amortization, with the balance represented by a variety
of other pricing terms. At December 31, 1999, $5.2 billion of our one-to-four
unit adjustable rate mortgages were subject to negative amortization of which
$75 million represented the amount of negative amortization added to the unpaid
loan balance. For further information, see Business--Banking Activities--Lending
Activities--Residential Real Estate Lending on page 3.
Our origination of commercial real estate loans, including loans purchased,
totaled $10 million in 1999, compared to $11 million in 1998 and $8 million in
1997. Originations of loans secured by multi-family properties, including loans
purchased, totaled $1 million in 1999, compared to $15 million in 1998 and $6
million in 1997.
During 1999, we originated $149 million of construction loans, principally
for entry level and first time move-up residential tracts. This compares to $112
million in 1998 and $80 million in 1997. Our origination of land development
loans totaled $57 million in 1999, compared to $48 million in 1998 and $20
million in 1997.
Origination of non-mortgage commercial loans increased to $25 million in
1999 from $6 million in 1998 and $14 million in 1997. The vast majority of these
originations represented secured loans.
10
<PAGE>
Origination of automobile loans totaled $234 million in 1999, compared to
$175 million in 1998 and $259 million in 1997. The majority of these
originations represent our indirect lending program that was conducted by Downey
Auto Finance Corp. whereby loans to finance the purchase of new or used
automobiles were obtained through preapproved automobile dealers. For further
information regarding Downey Auto Finance Corp., see Subsequent Event on page
57.
11
<PAGE>
The following table sets forth the origination, purchase and sale activity
relating to our loans and mortgage-backed securities during the periods
indicated.
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997 1996 1995
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INVESTMENT PORTFOLIO:
Loans originated:
Loans secured by real estate:
Residential one-to-four units:
Adjustable .............................................. $ 3,102,810 $ 943,736 $ 1,384,442 $ 1,026,812 $ 396,111
Adjustable - subprime ................................... 1,182,552 372,286 218,399 33,030 --
-----------------------------------------------------------------------------------------------------------------------------------
Total adjustable ...................................... 4,285,362 1,316,022 1,602,841 1,059,842 396,111
Fixed ................................................... 262,923 192,436 22,265 33,073 13,888
Fixed - subprime ........................................ 12,238 6,020 2,786 545 --
Residential five or more units:
Adjustable .............................................. 247 875 4,600 17,409 128
Fixed ................................................... -- 13,229 -- 2,253 419
-----------------------------------------------------------------------------------------------------------------------------------
Total residential ..................................... 4,560,770 1,528,582 1,632,492 1,113,122 410,546
Commercial real estate ................................... 10,063 10,363 7,830 1,548 10,629
Construction ............................................. 149,143 111,534 80,014 71,678 28,931
Land ..................................................... 56,851 48,357 20,295 10,468 12,906
Non-mortgage:
Commercial ............................................... 24,948 6,376 14,336 11,835 1,115
Automobile ............................................... 233,948 175,193 259,040 200,966 62,234
Other consumer ........................................... 54,489 28,274 25,988 14,226 17,633
-----------------------------------------------------------------------------------------------------------------------------------
Total loans originated .................................. 5,090,212 1,908,679 2,039,995 1,423,843 543,994
Real estate loans purchased:
One-to-four units .......................................... 36,317 4,343 32,241 233 44,194
One-to-four units - subprime ............................... 12,912 1,833 2,243 -- --
Other (1) .................................................. 440 1,287 1,344 -- --
-----------------------------------------------------------------------------------------------------------------------------------
Total loans originated and purchased ....................... 5,139,881 1,916,142 2,075,823 1,424,066 588,188
Loan repayments ............................................... (1,823,585) (1,855,157) (1,130,357) (832,713) (538,217)
Other net changes (2), (3) .................................... (36,794) (34,145) (319,183) (39,978) (50,544)
-----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for investment ....... 3,279,502 26,840 626,283 551,375 (573)
-----------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities held to maturity, net:
Repayments ................................................. -- -- -- -- (5,588)
Transferred to mortgage-backed securities available for sale -- -- -- -- (33,555)
-----------------------------------------------------------------------------------------------------------------------------------
Net decrease in mortgage-backed securities, net .......... -- -- -- -- (39,143)
-----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans and mortgage-backed
securities held for investment ...................... 3,279,502 26,840 626,283 551,375 (39,716)
-----------------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO:
Residential, one-to-four units:
Originated whole loans ..................................... 2,028,402 2,162,583 289,271 159,941 93,496
Originated whole loans - subprime .......................... 13,872 -- -- -- --
Loans transferred from (to) the investment portfolio (3) ... 42,570 (3,056) 290,558 1,791 (100)
Originated whole loans sold (3) ............................ (999,594) (1,130,303) (467,989) (135,426) (80,725)
Loans exchanged for mortgage-backed securities ............. (1,387,364) (608,831) (89,522) (26,452) --
Other net changes .......................................... (9,263) (8,111) (83) (48) (10)
-----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for sale ........... (311,377) 412,282 22,235 (194) 12,661
-----------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities, net:
Received in exchange for loans ............................. 1,387,364 608,831 89,522 26,452 --
Purchased .................................................. -- -- -- 30,073 --
Transferred from mortgage-backed securities held to maturity -- -- -- -- 33,555
Sold ....................................................... (1,387,364) (610,113) (89,522) (31,077) (21,372)
Repayments ................................................. (9,936) (15,129) (12,560) (15,661) (6,862)
Other net changes .......................................... (491) (742) 592 (596) 2,669
-----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in mortgage-backed securities
available for sale .................................... (10,427) (17,153) (11,968) 9,191 7,990
-----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans and mortgage-backed
securities held for sale and available for sale ....... (321,804) 395,129 10,267 8,997 20,651
-----------------------------------------------------------------------------------------------------------------------------------
Total net increase (decrease) in loans and
mortgage-backed securities ............................ $ 2,957,698 $ 421,969 $ 636,550 $ 560,372 $ (19,065)
===================================================================================================================================
<FN>
(1) Primarily five or more unit residential loans except for $0.6 million of
commercial real estate loans in 1998.
(2) Primarily includes borrowings against and repayments of lines of credit and
construction loans, changes in loss allowances, loans transferred to or
from real estate acquired in settlement of loans or to the held for sale
portfolio, and interest capitalized on loans (negative amortization).
(3) Included in 1999 are $49.2 million of one-to-four unit residential
adjustable rate mortgages transferred from the held for investment
portfolio and sold serving retained, and in 1997 are $290.5 million sold
servicing released.
</FN>
</TABLE>
12
<PAGE>
The following table sets forth the composition of our loan and
mortgage-backed securities portfolio at the dates indicated. At December 31,
1999, approximately 93% of our real estate loans were secured by real estate
located in California, principally in Los Angeles, Orange, Santa Clara, San
Diego and San Mateo counties.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------
(In Thousands) 1999 1998 1997 1996 1995
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INVESTMENT PORTFOLIO:
Loans secured by real estate:
Residential:
Residential one-to-four units:
Adjustable ............................... $5,644,883 $3,721,728 $4,190,160 $3,840,862 $3,486,774
Adjustable - subprime .................... 1,620,624 580,232 245,749 32,715 --
Fixed .................................... 510,516 325,454 168,315 172,328 169,738
Fixed - subprime ......................... 18,777 8,719 3,321 543 --
-------------------------------------------------------------------------------------------------------------------------
Total one-to-four units ............... 7,794,800 4,636,133 4,607,545 4,046,448 3,656,512
Residential five or more units:
Adjustable ............................... 15,889 18,617 29,246 43,050 44,438
Fixed .................................... 5,166 21,412 9,032 13,857 12,883
Commercial real estate:
Adjustable ............................... 37,419 39,360 87,604 158,656 170,498
Fixed .................................... 110,908 101,430 114,821 101,953 100,085
Construction ............................... 176,487 127,761 70,865 66,651 28,593
Land ....................................... 67,631 44,859 25,687 21,177 21,867
Non-mortgage:
Commercial ................................. 26,667 28,293 26,024 22,136 12,864
Automobile ................................. 399,789 357,988 342,326 202,186 56,127
Other consumer ............................. 49,344 41,894 47,735 47,281 50,945
-------------------------------------------------------------------------------------------------------------------------
Total loans held for investment .......... 8,684,100 5,417,747 5,360,885 4,723,395 4,154,812
Increase (decrease) for:
Undisbursed loan funds ..................... (125,159) (108,414) (64,884) (49,250) (29,942)
Net deferred costs and premiums ............ 67,740 31,021 18,088 11,663 7,412
Allowance for estimated loss ............... (38,342) (31,517) (32,092) (30,094) (27,943)
-------------------------------------------------------------------------------------------------------------------------
Total loans held for investment, net ..... 8,588,339 5,308,837 5,281,997 4,655,714 4,104,339
-------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO, NET:
Loans held for sale:
One-to-four units .......................... 122,133 447,382 35,100 12,865 13,059
One-to-four units - subprime ............... 13,872 -- -- -- --
-------------------------------------------------------------------------------------------------------------------------
Total loans held for sale ................ 136,005 447,382 35,100 12,865 13,059
Mortgage-backed securities available for sale:
Adjustable ................................. 7,700 10,996 17,751 23,620 34,355
Fixed ...................................... 14,019 21,150 31,548 37,647 17,721
-------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed securities available
for sale .............................. 21,719 32,146 49,299 61,267 52,076
-------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities
held for sale and available for sale .. 157,724 479,528 84,399 74,132 65,135
-------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities $8,746,063 $5,788,365 $5,366,396 $4,729,846 $4,169,474
=========================================================================================================================
</TABLE>
13
<PAGE>
The table below sets forth the scheduled contractual maturities of our
total loan and mortgage-backed securities portfolio as of December 31, 1999.
<TABLE>
<CAPTION>
Within 1-2 2-3 3-5 5-10 10-15 Beyond
(In Thousands) 1 Year Years Years Years Years Years 15 Years Total
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real estate:
Residential:
One-to-four units:
Adjustable (1) ........ $ 58,655 $ 63,221 $ 68,143 $152,612 $498,440 $725,099 $5,721,628 $7,287,798
Fixed (1) ............. 7,058 7,639 8,270 18,645 61,890 92,051 447,454 643,007
Five or more units:
Adjustable ............ 330 356 383 856 2,785 4,029 7,150 15,889
Fixed ................. 186 201 218 493 1,648 2,420 -- 5,166
Commercial real estate:
Adjustable ............ 1,963 2,125 2,300 5,187 17,211 8,633 -- 37,419
Fixed ................. 7,898 8,604 9,373 21,332 63,701 -- -- 110,908
Construction - adjustable 176,487 -- -- -- -- -- -- 176,487
Land:
Adjustable ............ 66,726 -- -- -- -- -- -- 66,726
Fixed ................. 10 11 12 27 94 149 602 905
Non-mortgage:
Commercial ................ 23,001 1,572 1,538 556 -- -- -- 26,667
Automobile ................ 93,642 102,568 112,346 91,233 -- -- -- 399,789
Other consumer (2) ........ 2,830 3,110 3,418 2,784 37,202 -- -- 49,344
-------------------------------------------------------------------------------------------------------------------
Total loans ............. 438,786 189,407 206,001 293,725 682,971 832,381 6,176,834 8,820,105
Mortgage-backed securities, net 534 9,158 478 1,075 3,529 2,827 4,118 21,719
-------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-
backed securities ....... $439,320 $198,565 $206,479 $294,800 $686,500 $835,208 $6,180,952 $8,841,824
===================================================================================================================
<FN>
(1) Includes loans held for sale.
(2) Includes home equity line of credit loans which are interest only, with
balances due at the end of the term. All or part of the outstanding
balances may be paid off at any time during the term without penalty.
</FN>
</TABLE>
At December 31, 1999, the maximum amount the Bank could have loaned to any
one borrower, and related entities, under regulatory limits was $100 million, or
$167 million for loans secured by readily marketable collateral, compared to $75
million or $124 million for loans secured by readily marketable collateral at
year-end 1998. The Bank does not expect that these regulatory limitations will
adversely impact its proposed lending activities during 2000.
INVESTMENT SECURITIES
The following table sets forth the composition of our investment securities
portfolio at the dates indicated.
<TABLE>
<CAPTION>
December 31,
------------------------------------------------
(In Thousands) 1999 1998 1997 1996 1995
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Federal funds .......................................... $ 1 $ 33,751 $ 6,095 $ 6,038 $ 7,249
U.S. Treasury and agency securities - available for sale 171,823 116,061 159,398 141,999 164,880
Municipal bonds - held to maturity ..................... 6,728 6,764 6,885 6,997 7,194
----------------------------------------------------------------------------------------------------------
Total investment securities ........................ $178,552 $156,576 $172,378 $155,034 $179,323
==========================================================================================================
</TABLE>
14
<PAGE>
As of December 31, 1999, the maturities of our investment securities and
the weighted average yield of those securities were as follows.
<TABLE>
<CAPTION>
After 1 Year
1 Year or Less Through 5 Years After 5 Years Total
----------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
(Dollars in Thousands) Amount Yield Amount Yield Amount Yield Amount Yield
-----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Federal funds ..................... $ 1 1.69 $ -- -% $ -- -% $ 1 1.69%
U.S. Treasury and agency securities 24,724 5.13 147,099 6.27 -- - 171,823 6.10
Municipal bonds (1) ............... 30 6.75 -- - 6,698 6.61 6,728 6.61
-----------------------------------------------------------------------------------------------------------------------
Total ........................ $24,755 5.13 $147,099 6.27 $6,698 6.61 $178,552 6.12%
=======================================================================================================================
<FN>
(1) Yield on a fully tax-equivalent basis is 11.59%.
</FN>
</TABLE>
INVESTMENTS IN REAL ESTATE AND JOINT VENTURES
DSL Service Company participates as an owner of, or a partner in, a variety
of real estate development projects, principally retail neighborhood shopping
center developments, most of which are located in California. For additional
information regarding the location of these real estate investments see Note 8
of Notes to the Consolidated Financial Statements on page 77. We have completed
and substantially leased most of the real estate development projects--with a
weighted average occupancy of 87% for retail neighborhood shopping centers at
December 31, 1999. At December 31, 1999, the Bank had outstanding loans of $35
million to these joint ventures.
In its joint ventures, DSL Service Company is entitled to interest on its
equity invested in the project on a priority basis after third-party debt and
shares profits and losses with the developer partner, generally on an equal
basis. DSL Service Company has obtained personal guarantees from the principals
of the developer partners in a number of the joint ventures and generally
requires the developer partner to secure any outstanding obligations to the
joint venture, like its portion of operating losses, when the partner is unable
to satisfy such obligations on a current basis. Partnership equity or deficit
accounts are affected by current period results of operations, additional
partner advances, partnership distributions and partnership liquidations.
As of December 31, 1999, DSL Service Company was involved with four joint
venture partners. Three of these partners were operators of four retail
neighborhood shopping centers, a commercial building, two residential housing
developments and vacant land held for sale. The other joint venture partner is
involved in the development of two new industrial buildings. DSL Service Company
has eight wholly owned retail neighborhood shopping centers located in
California and Arizona.
15
<PAGE>
The following table sets forth the condensed balance sheets of DSL Service
Company's joint ventures by property type at December 31, 1999, on a historical
cost basis. None of the joint venture investments have valuation allowances as
the fair market value of the associated property exceeds its carrying value. For
further information regarding the establishment of loss allowances, see Problem
Loans and Real Estate--Allowance for Losses on Loans and Real Estate on page 51.
<TABLE>
<CAPTION>
Retail
Neighborhood
Shopping
(Dollars in Thousands) Centers Commercial Residential Total
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cash ....................................................... $ 216 $ 162 $ 1,492 $ 1,870
Projects under development ................................. -- 1,268 11,255 12,523
Completed projects ......................................... 20,652 4,503 -- 25,155
Other assets ............................................... 2,220 495 188 2,903
---------------------------------------------------------------------------------------------------------------
Total assets ........................................ 23,088 6,428 12,935 42,451
---------------------------------------------------------------------------------------------------------------
Secured notes payable to the Bank .......................... 24,854 427 9,416 34,697
Secured notes payable to others ............................ -- 3,230 -- 3,230
Other liabilities .......................................... 4,710 54 1,411 6,175
Equity (deficit):
DSL Service Company (1) ................................ 2,065 1,618 1,032 4,715
Allowance for losses recorded by DSL Service Company (2) -- -- -- --
Other partners' (2) .................................... (8,541) 1,099 1,076 (6,366)
---------------------------------------------------------------------------------------------------------------
Total liabilities and equity ........................ $23,088 $6,428 $12,935 $42,451
---------------------------------------------------------------------------------------------------------------
Number of joint venture projects ........................... 4 3 2 9
===============================================================================================================
<FN>
(1) We included in these amounts interest-bearing joint venture advances with
priority interest payments from joint ventures to DSL Service Company.
(2) The aggregate other partners' deficit of $6 million represents their equity
interest in the accumulated retained earnings (deficit) of the respective
joint ventures. Those results include not only the net profit on sales and
the operating results of the real estate assets, but depreciation expense
and funding costs as well. Except for any secured financing which has been
obtained, DSL Service Company has provided all other financing. As part of
our internal asset review process, we compare the fair value of the joint
venture real estate assets to the secured notes payable to the Bank and
others and DSL Service Company's equity investment. To the extent the fair
value of the real estate assets is less than the aggregate of those
amounts, we make a provision to create a valuation allowance. There were no
allowances at December 31, 1999, as the fair value of the real estate
assets of the joint venture partnerships in which the other partners'
equity was a deficit exceeded the amount of third party notes and DSL
Service Company's investment thereby eliminating the need for a valuation
allowance since the sale of the real estate would allow DSL Service Company
to realize its investment.
</FN>
</TABLE>
16
<PAGE>
The following table sets forth by property type our wholly owned
investments in real estate and related allowances for losses at December 31,
1999.
<TABLE>
<CAPTION>
Retail
Neighborhood
(Dollars in Thousands) Shopping Centers Land Total
--------------------------------------------------------------------------------
<S> <C> <C> <C>
Wholly Owned Properties:
Investment in wholly owned projects $ 33,443 (1) $ 6,145 (2) $ 39,588
Allowance for losses .............. (1,069) (1,062) (2,131)
--------------------------------------------------------------------------------
Net investment in wholly owned projects $ 32,374 $ 5,083 $ 37,457
--------------------------------------------------------------------------------
Number of projects ..................... 8 8 16
================================================================================
<FN>
(1) Includes eight free-standing stores that are part of neighborhood shopping
centers totaling $1 million and which we counted as one project.
(2) Includes five properties totaling $6 million.
</FN>
</TABLE>
Real estate investments entail risks similar to those our construction and
commercial lending activities present. In addition, California courts have
imposed warranty-like responsibility upon developers of new housing for defects
in structure and the housing site, including soil conditions. This
responsibility is not necessarily dependent upon a finding that the developer
was negligent. Owners of real property also may incur liabilities with respect
to environmental matters, including financial responsibility for clean-up of
hazardous waste or other conditions, under various federal and state laws.
DEPOSITS
Our deposits increased a record $1.5 billion or 30.2% in 1999 and totaled
$6.6 billion at December 31, 1999. Our certificates of deposit increased $1.3
billion or 33.4%, while our lower-rate transaction accounts--checking, regular
passbook and money market--increased $252 million or 20.3%. Of the total
increase in our deposits, $105 million was associated with 14 new branches we
opened during 1999. The following table sets forth the amount of deposits by
classification at the dates indicated.
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------------
1999 1998 1997
-----------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
(Dollars in Thousands) Rate Amount Rate Amount Rate Amount
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Transaction accounts ............. 2.46% $1,489,939 2.30% $1,238,062 2.15% $ 935,869
Certificates of deposit:
Less than 3.00% ............... 2.47 8,717 2.62 25,126 2.64 30,623
3.00-3.49 ..................... 3.02 16 3.01 593 3.02 766
3.50-3.99 ..................... 3.92 3,786 3.88 51,474 - --
4.00-4.49 ..................... 4.32 210,127 4.39 428,316 4.31 60,095
4.50-4.99 ..................... 4.78 939,858 4.80 668,204 4.87 40,356
5.00-5.99 ..................... 5.56 3,623,632 5.53 2,421,333 5.63 2,896,291
6.00-6.99 ..................... 6.07 284,984 6.06 204,065 6.06 901,920
7.00 and greater .............. 7.32 1,702 7.24 2,560 7.22 4,058
------------------------------------------------------------------------------------------------------
Total certificates of deposit 5.39 5,072,822 5.26 3,801,671 5.68 3,934,109
------------------------------------------------------------------------------------------------------
Total deposits .............. 4.72% $6,562,761 4.53% $5,039,733 5.00% $4,869,978
======================================================================================================
</TABLE>
17
<PAGE>
The following table shows as of December 31, 1999, our certificates of
deposit maturities by interest rate category.
<TABLE>
<CAPTION>
Less
Than 4.00% - 4.50% - 5.00% - 6.00% - 7.00% Percent
(Dollars in Thousands) 4.00% 4.49% 4.99% 5.99% 6.99% and Greater Total (1) of Total
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Within 3 months ....... $10,623 $162,042 $353,922 $ 659,715 $ 8,023 $1,702 $1,196,027 23.58%
3 to 6 months ......... 722 29,121 364,185 741,513 2,549 -- 1,138,090 22.44
6 to 12 months ........ 959 13,971 178,338 1,123,934 242,797 -- 1,559,999 30.75
12 to 24 months ....... 197 4,951 37,473 1,069,074 15,137 -- 1,126,832 22.21
24 to 36 months ....... 6 28 1,101 12,964 13,495 -- 27,594 0.54
36 to 60 months ....... 12 14 4,832 16,222 2,818 -- 23,898 0.47
Over 60 months ........ -- -- 7 210 165 -- 382 0.01
--------------------------------------------------------------------------------------------------------------
Total ............. $12,519 $210,127 $939,858 $3,623,632 $284,984 $1,702 $5,072,822 100.00%
==============================================================================================================
<FN>
(1) Includes jumbo ($100,000 and over) certificates of deposit of $430 million
with maturities of 3 months or less, $371 million with maturities of 3 to 6
months and $523 million with maturities of 6 to 12 months and $388 million
with a remaining term of over 12 months.
</FN>
</TABLE>
BORROWINGS
At December 31, 1999, borrowings totaled $2.1 billion, up significantly
from $704 million at year-end 1998 and $484 million at year-end 1997. The
increase in 1999 primarily reflected increases in advances from the FHLB. The
following table sets forth information concerning our FHLB advances and other
borrowings at the dates indicated.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------
(Dollars in Thousands) 1999 1998 1997 1996 1995
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Federal Home Loan Bank advances ..................... $2,122,407 $695,012 $352,458 $386,883 $220,715
Other borrowings: ................................... --
Reverse repurchase agreements ................... -- -- 34,803 -- 16,099
Commercial paper ................................ -- -- 83,811 198,113 196,602
Real estate notes ............................... 373 8,708 12,663 10,349 2,802
--------------------------------------------------------------------------------------------------------------
Total borrowings .............................. $2,122,780 $703,720 $483,735 $595,345 $436,218
==============================================================================================================
Weighted average rate on borrowings during the period 5.46% 6.07% 6.07% 5.98% 6.39%
Total borrowings as a percentage of total assets .... 22.56 11.22 8.29 11.45 9.37
==============================================================================================================
</TABLE>
18
<PAGE>
The following table sets forth certain information with respect to our
short-term borrowings.
<TABLE>
<CAPTION>
(Dollars in Thousands) 1999 1998 1997
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
FHLB advances with original maturities less than one year:
Balance at end of year ............................................. $1,590,500 $120,000 $214,300
Average balance outstanding during the year ........................ 616,199 38,393 328,886
Maximum amount outstanding at any month-end during the year ........ 1,590,500 120,000 427,100
Weighted average interest rate during the year ..................... 5.42% 5.96% 5.83%
Weighted average interest rate at the end of year .................. 5.88 5.36 5.81
Securities sold under agreement to repurchase:
Balance at end of year ............................................. $ -- $ -- $ 34,803
Average balance outstanding during the year ........................ 1,987 1,877 4,029
Maximum amount outstanding at any month-end during the year ........ 24,875 50,088 34,803
Weighted average interest rate during the year ..................... 5.42% 5.90% 5.61%
Weighted average interest rate at the end of year .................. -- -- 6.65
Commercial paper sold:
Balance at end of year ............................................. $ -- $ -- $ 83,811
Average balance outstanding during the year ........................ -- 30,589 182,296
Maximum amount outstanding at any month-end during the year ........ -- 103,749 272,818
Weighted average interest rate during the year ..................... -% 6.32% 5.75%
Weighted average interest rate at the end of year .................. -- -- 5.61
Total short-term borrowings:
Total average short-term borrowings outstanding during the year .... $ 618,186 $ 70,859 $515,211
Total weighted average rate on short-term borrowings during the year 5.42% 6.11% 5.80%
===========================================================================================================
</TABLE>
At year-end 1999, total intermediate and long-term advances were $532
million, down from $575 million at December 31, 1998. The weighted average rate
on our intermediate and long-term FHLB advances at year-end 1999 was 5.44%. The
following table sets forth the associated maturities at December 31, 1999.
<TABLE>
<CAPTION>
(In Thousands)
---------------------------------------------------------------
<S> <C>
2000 .............................................. $ 28,796
2001 .............................................. 16,056
2002 .............................................. 55,921
2003 .............................................. 134
2004 .............................................. --
Thereafter ........................................ 431,000
---------------------------------------------------------------
Total intermediate and long-term FHLB advances $531,907
===============================================================
</TABLE>
CAPITAL SECURITIES
On July 23, 1999, we issued $120 million in capital securities through
Downey Financial Capital Trust I. The capital securities pay quarterly
cumulative cash distributions at an annual rate of 10.00% of the liquidation
value of $25 per share. Interest expense, including the amortization of deferred
issuance costs, on our capital securities was $5.3 million for 1999. For further
information regarding our capital securities, see Note 19 on page 87 of Notes To
Consolidated Financial Statements.
ASSET/LIABILITY MANAGEMENT AND MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
interest rates. Our market risk arises primarily from interest rate risk in our
lending and deposit taking activities. This interest rate risk occurs to the
degree that interest-bearing liabilities reprice or mature more rapidly or on a
different basis than interest-earning assets. Since our earnings depend
primarily on our net interest income, which is the difference between
19
<PAGE>
the interest and dividends earned on interest-earning assets and the interest
paid on interest-bearing liabilities, one of our principal objectives is to
actively monitor and manage the effects of adverse changes in interest rates on
net interest income while maintaining asset quality.
Our Asset/Liability Management Committee is responsible for implementing
the interest rate risk management policy which sets forth limits established by
the Board of Directors on acceptable changes in net interest income and net
portfolio value from specified changes in interest rates. The OTS defines net
portfolio value as the present value of expected net cash flows from existing
assets minus the present value of expected net cash flows from existing
liabilities plus the present value of expected cash flows from existing
off-balance sheet contracts. Our Asset/Liability Management Committee reviews,
among other items, economic conditions, the interest rate outlook, the demand
for loans, the availability of deposits and borrowings, and our current
operating results, liquidity, capital and interest rate exposure. In addition,
our Asset/Liability Management Committee monitors asset and liability maturities
and repricing characteristics on a regular basis and performs various
simulations and other analyses to determine the potential impact of various
business strategies in controlling interest rate risk and the potential impact
of those strategies upon future earnings under various interest rate scenarios.
Based on these reviews, our Asset/Liability Management Committee formulates a
strategy that is intended to implement the objectives set forth in our business
plan without exceeding the net interest income and net portfolio value limits
set forth in our interest rate risk policy.
One measure of our exposure to differential changes in interest rates
between assets and liabilities is shown in the following table which sets forth
the repricing frequency of our major asset and liability categories as of
December 31, 1999, as well as information regarding our gap position. Our gap
position represents the repricing and maturity difference between our
interest-earning assets and interest-bearing liabilities in future periods. The
repricing frequencies have been determined by reference to projected maturities,
based upon contractual maturities as adjusted for scheduled repayments and
"repricing mechanisms"--provisions for changes in the interest and dividend
rates of assets and liabilities. We assume prepayment rates on substantially all
of our loan portfolio based upon our historical loan prepayment experience and
anticipated future prepayments. Repricing mechanisms on a number of our assets
are subject to limitations, such as caps on the amount that interest rates and
payments on our loans may adjust, and accordingly, these assets do not normally
respond as completely or rapidly as our liabilities to changes in market
interest rates. The interest rate sensitivity of our assets and liabilities
illustrated in the following table would vary substantially if we used different
assumptions or if actual experience differed from the assumptions set forth.
20
<PAGE>
<TABLE>
<CAPTION>
December 31, 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) $ 109,021 $ 24,754 $ 147,099 $ 70 $ -- $ 280,944
Loans and mortgage-backed securities:
Mortgage-backed securities ..............(2) 12,628 4,691 2,328 1,670 402 21,719
Loans secured by real estate:
Residential:
Adjustable ..........................(2) 6,840,189 379,900 122,151 -- -- 7,342,240
Fixed ...............................(2) 148,075 28,589 179,994 136,315 157,625 650,598
Commercial real estate ................(2) 44,005 8,437 85,298 6,223 1,824 145,787
Construction ..........................(2) 86,151 -- -- -- -- 86,151
Land ..................................(2) 37,004 14 113 150 614 37,895
Non-mortgage:
Commercial ............................(2) 17,259 -- -- -- -- 17,259
Consumer ..............................(2) 139,096 83,679 221,639 -- -- 444,414
------------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities 7,324,407 505,310 611,523 144,358 160,465 8,746,063
------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets............ $7,433,428 $ 530,064 $ 758,622 $ 144,428 $160,465 $9,027,007
==============================================================================================================================
Deposits, borrowings and capital securities:
Interest-bearing deposits:
Fixed maturity deposits .................(1) $2,334,117 $ 1,559,999 $1,178,324 $ 382 $ -- $5,072,822
Transaction accounts ....................(3) 1,307,689 -- -- -- -- 1,307,689
Non-interest-bearing transaction accounts 182,250 -- -- -- -- 182,250
------------------------------------------------------------------------------------------------------------------------------
Total deposits .......................... 3,824,056 1,559,999 1,178,324 382 -- 6,562,761
Borrowings ............................... 1,606,689 12,790 72,301 431,000 -- 2,122,780
Capital securities ....................... -- -- -- -- 120,000 120,000
------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and
capital securities .................... $5,430,745 $ 1,572,789 $1,250,625 $ 431,382 $120,000 $8,805,541
==============================================================================================================================
Excess (shortfall) of interest-earning assets
over interest-bearing liabilities ........ $2,002,683 $(1,042,725) $ (492,003) $(286,954) $ 40,465 $ 221,466
Cumulative gap ............................... 2,002,683 959,958 467,955 181,001 221,466
Cumulative gap - as a % of total assets:
December 31, 1999 ........................ 21.29% 10.20% 4.97% 1.92% 2.35%
December 31, 1998 ........................ 23.84 7.48 9.07 3.40 4.00
December 31, 1997 ........................ 24.82 1.35 2.71 3.54 3.93
==============================================================================================================================
<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 December 31, 1999, was a positive 21.29%. This means
that more interest-earning assets reprice within six months than
interest-bearing liabilities. This compares to a positive six-month gap of
23.84% at December 31, 1998 and 24.82% at December 31, 1997. Our primary
strategy to manage interest rate risk is to emphasize the origination of
adjustable rate mortgages or loans with relatively short maturities. Interest
rates on adjustable rate mortgages are primarily tied to COFI. We originated and
purchased approximately $4.7 billion during 1999, $1.5 billion during 1998 and
$2.0 billion during 1997, of loans and mortgage-backed securities with
adjustable interest rates or maturities of five years or less. These loans
represented approximately 92% during 1999, 80% during 1998 and 96% during 1997,
of all loans and mortgage-backed securities originated and purchased for
investment during these periods.
At December 31, 1999, 97% of our interest-earning assets mature, reprice or
are estimated to prepay within five years, compared to 98% at December 31, 1998
and 99% at December 31, 1997. At December 31, 1999, loans held for investment
with adjustable interest rates represented 87% of our loan and mortgage-backed
21
<PAGE>
securities portfolio. During 2000, we will continue to offer residential fixed
rate loan products to our customers to meet customer demand. We primarily
originate fixed rate loans for sale in the secondary market and price them
accordingly to create loan servicing income and to increase opportunities for
originating adjustable rate mortgages. However, we may originate fixed rate
loans for investment when funded with long-term funds to mitigate interest rate
risk and small volumes to facilitate the sale of real estate acquired through
foreclosure or that meet certain yield and other approved guidelines. See
Business--Banking Activities--Lending Activities--Secondary Marketing and Loan
Servicing Activities on page 5.
We are better protected against rising interest rates with a positive
six-month gap. However, we remain subject to possible interest rate spread
compression, which would adversely impact our net interest income if interest
rates rise. This is primarily due to the lag in the repricing of the indices to
which our adjustable rate loans and mortgage-backed securities are tied, as well
as the repricing frequencies and periodic interest rate caps on these adjustable
rate loans and mortgage-backed securities. The amount of such interest rate
spread compression would depend upon the frequency and severity of such interest
rate fluctuations.
In addition to measuring interest rate risk via a gap analysis, we
establish limits on, and measure the sensitivity of, our net interest income and
net portfolio value to changes in interest rates. Changes in interest rates are
defined as instantaneous and sustained movements in interest rates in 100 basis
point increments. We utilize an internally maintained asset/liability management
simulation model to make the calculations which, for net portfolio value, is
calculated on a discounted cash flow basis. First, we estimate our net interest
income for the next twelve months and the current net portfolio value assuming
no change in interest rates from those at period end. Once the base case has
been estimated, we make calculations for each of the defined changes in interest
rates, to include any associated differences in the anticipated prepayment speed
of loans. We then compare those results against the base case to determine the
estimated change to net interest income and net portfolio value due to the
changes in interest rates. The following are the estimated impacts to net
interest income and net portfolio value from various instantaneous, parallel
shifts in interest rates based upon our asset and liability structure as of
year-ends 1999 and 1998. Since we base these estimates upon numerous
assumptions, like the expected maturities of our interest-bearing assets and
liabilities and the shape of the period-end interest rate yield curve, our
actual sensitivity to interest rate changes could vary significantly if actual
experience differs from those assumptions used in making the calculations.
<TABLE>
<CAPTION>
1999 1998
-------------------------------------------------------------
Percentage Change in Percentage Change in
-------------------------------------------------------------
Change in Interest Rates Net Interest Net Portfolio Net Interest Net Portfolio
(In Basis Points) Income(1) Value (2) Income (1) Value (2)
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
+200 ............. (13.8)% (9.7)% (10.0)% 1.2%
+100 ............. (6.8) (1.5) (4.4) 2.0
(100) ............ 3.9 (2.2) 2.9 (1.0)
(200) ............ 7.1 (4.3) 3.9 (0.6)
-----------------------------------------------------------------------------------------------
<FN>
(1) The percentage change in this column represents net interest income for 12
months in a stable interest rate environment versus the net interest income
in the various rate scenarios.
(2) The percentage change in this column represents the net portfolio value of
the Bank in a stable interest rate environment versus the net portfolio
value in the various rate scenarios.
</FN>
</TABLE>
22
<PAGE>
The following table shows our financial instruments that are sensitive to
changes in interest rates, categorized by expected maturity, and the
instruments' fair values at December 31, 1999. This data differs from that in
the gap table as it does not incorporate the repricing characteristics of assets
and liabilities. Rather, it only reflects contractual maturities adjusted for
anticipated prepayments. Market risk sensitive instruments are generally defined
as on and off balance sheet derivatives and other financial instruments.
<TABLE>
<CAPTION>
Expected Maturity Date at December 31, 1999 (1)
-------------------------------------------------------------------------------------------------
Total Fair
(Dollars in Thousands) 2000 2001 2002 2003 2004 Thereafter Balance Value
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST-SENSITIVE ASSETS:
Investment securities .......... $ 127,147 $ 12,343 $ 85,539 $ 22,218 $ 26,999 $ 6,698 $ 280,944 $ 280,926
Average interest rate ....... 5.51% 6.32% 5.98% 6.70% 6.79% 6.61% 5.93%
Loans held for sale ............ 136,005 -- -- -- -- -- 136,005 136,298
Average interest rate ....... 8.10% -% -% -% -% -% 8.10%
Mortgage-backed securities
Available for sale .......... 10,516 1,495 1,333 1,185 1,053 6,137 21,719 21,719
Average interest rate ....... 6.96% 7.41% 7.40% 7.38% 7.37% 7.36% 7.17%
Loans held for investment:
Loans secured by real estate:
Residential:
Adjustable ............... 1,359,513 1,194,967 970,704 758,010 589,064 2,447,691 7,319,949 7,308,374
Average interest rate .. 7.49% 7.47% 7.45% 7.44% 7.43% 7.43% 7.45%
Fixed .................... 59,418 52,803 47,383 42,566 38,059 296,655 536,884 533,673
Average interest rate .. 7.93% 7.92% 7.91% 7.90% 7.90% 7.89% 7.90%
Other ..................... 143,649 20,366 43,735 21,177 13,153 27,753 269,833 276,140
Average interest rate .... 8.72% 8.30% 8.27% 8.20% 8.00% 7.87% 8.45%
Non-mortgage:
Commercial ................ 12,516 25 2,316 2,402 -- -- 17,259 17,912
Average interest rate .... 9.28% 9.55% 9.72% 10.06% -% -% 9.45%
Consumer .................. 175,179 141,875 78,534 48,826 -- -- 444,414 453,425
Average interest rate .... 9.11% 9.08% 9.07% 9.12% -% -% 9.09%
Interest bearing advances to
joint ventures .............. 15,613 -- -- -- -- -- 15,613 15,613
Average interest rate ....... 4.64% -% -% -% -% -% 4.64%
Mortgage servicing assets ...... 6,803 6,240 5,578 4,916 4,294 6,432 34,263 47,363
-------------------------------------------------------------------------------------------------------------------------------
Total interest-sensitive assets $2,046,359 $1,430,114 $1,235,122 $901,300 $672,622 $2,791,366 $9,076,883 $9,091,443
-------------------------------------------------------------------------------------------------------------------------------
INTEREST-SENSITIVE
LIABILITIES:
Deposits:
Transaction accounts ........ $ 272,134 $ 222,430 $181,803 $148,597 $121,456$ 543,519 $1,489,939 $1,489,939
Average interest rate ..... 2.46% 2.46% 2.46% 2.46% 2.46% 2.46% 2.46%
Certificates of deposit ..... 3,894,116 1,126,832 27,594 19,943 3,955 382 5,072,822 5,025,389
Average interest rate ..... 5.29% 5.72% 5.83% 5.42% 5.08% 5.71% 5.39%
Borrowings ..................... 1,619,480 16,245 55,921 134 -- 431,000 2,122,780 2,055,493
Average interest rate ....... 5.89% 5.87% 4.77% 5.76% -% 5.42% 5.77%
Capital securities ............. -- -- -- -- -- 120,000 120,000 102,000
Average interest rate ....... -% -% -% -% -% 10.14% 10.14%
-------------------------------------------------------------------------------------------------------------------------------
Total interest-sensitive
liabilities ................. $5,785,730 $1,365,507 $265,318 $168,674 $125,411 $1,094,901 $8,805,541 $8,672,821
-------------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Expected maturities are contractual maturities adjusted for prepayments of
principal. We use a number of assumptions to estimate fair values and
expected maturities. For assets, we base expected maturities upon
contractual maturity, projected repayments and prepayments of principal.
The prepayment experience reflected herein is based on our historical
experience. Our average constant prepayment rate ("CPR") is 10.9% on our
fixed-rate and 19.2% on our adjustable rate mortgage portfolio for
interest-earning assets, excluding investment securities, which do not have
prepayment features. For deposit liabilities, in accordance with standard
industry practice and our own historical experience, we have applied "decay
factors," used to estimate deposit runoff, of 20% per year. The actual
maturities of these instruments could vary substantially if future
prepayments differ from our historical experience.
</FN>
</TABLE>
23
<PAGE>
The following table sets forth the interest rate spread between our
interest-earning assets and interest-bearing liabilities at the dates indicated.
<TABLE>
<CAPTION>
December 31,
-------------------------------------
1999 1998 1997 1996 1995
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Weighted average yield:
Loans and mortgage-backed securities 7.67% 7.72% 7.95% 7.77% 7.67%
Federal Home Loan Bank stock ....... 5.60 5.44 5.88 6.45 5.16
Investment securities .............. 6.12 5.40 5.63 6.02 6.46
-----------------------------------------------------------------------------------
Earning assets yield ............. 7.62 7.65 7.87 7.71 7.60
-----------------------------------------------------------------------------------
Weighted average cost:
Deposits ........................... 4.72 4.53 5.00 4.86 4.81
Borrowings:
Federal Home Loan Bank advances .. 5.77 5.47 6.11 5.80 6.07
Other borrowings ................. 7.88 8.69 6.15 5.60 5.62
-----------------------------------------------------------------------------------
Combined borrowings .......... 5.99 5.51 6.12 5.73 5.84
Capital securities ................. 10.00 - - - -
-----------------------------------------------------------------------------------
Combined funds cost .............. 5.05 4.66 5.11 4.97 4.92
-----------------------------------------------------------------------------------
Interest rate spread ......... 2.57% 2.99% 2.76% 2.74% 2.68%
===================================================================================
</TABLE>
The year-end weighted average yield on our loan portfolio decreased to
7.67% at December 31, 1999, from 7.72% at year-end 1998. The weighted average
rate on new loans originated during 1999 was 5.92%, compared to 6.45% during
1998 and 6.04% during 1997. Although interest rates increased during 1999, we
experienced a decline in rates on new loans primarily due to the higher
proportion of residential one-to-four unit adjustable rate loans originated at
low introductory rates than in prior years. At December 31, 1999, our adjustable
rate mortgage portfolio of single family residential loans, including
mortgage-backed securities, totaled $7.3 billion with a weighted average rate of
7.52%, compared to $4.3 billion with a weighted average rate of 7.53% at
December 31, 1998 and $4.5 billion with a weighted average rate of 7.58% at
December 31, 1997.
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 totaled
$39 million at December 31, 1999, compared to $27 million at December 31, 1998,
and $52 million at December 31, 1997. The increase in our non-performing assets
during 1999 was primarily attributed to one-to-four unit residential subprime
loans. When measured as a percentage of total assets, our non-performing assets
fell to 0.42% at year-end 1999 compared to 0.44% at year-end 1998 and 0.89% at
year-end 1997.
24
<PAGE>
The following table summarizes our non-performing assets at the dates
indicated.
<TABLE>
<CAPTION>
December 31,
------------------------------------------------
(Dollars in Thousands) 1999 1998 1997 1996 1995
-------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-accrual loans:
Residential, one-to-four units .................. $15,590 $15,571 $20,816 $22,885 $25,587
Residential, one-to-four units - subprime ....... 13,914 1,975 -- -- --
Other ........................................... 3,477 4,829 20,883 22,136 52,754
-------------------------------------------------------------------------------------------------------
Total non-accrual loans ....................... 32,981 22,375 41,699 45,021 78,341
Real estate acquired in settlement of loans ......... 5,899 4,475 9,626 16,078 18,854
Repossessed automobiles ............................. 314 569 795 928 --
-------------------------------------------------------------------------------------------------------
Total non-performing assets ...................... $39,194 $27,419 $52,120 $62,027 $97,195
=======================================================================================================
Allowance for loan losses (1):
Amount .......................................... $38,342 $31,517 $32,092 $30,094 $27,943
As a percentage of non-performing loans ......... 116.25% 140.86% 76.96% 66.84% 35.67%
Non-performing assets as a percentage of total assets 0.42 0.44 0.89 1.19 2.09
=======================================================================================================
<FN>
(1) Allowance for loan losses does not include the allowance for real estate
and real estate acquired in settlement of loans.
</FN>
</TABLE>
It is our policy to take appropriate, timely and aggressive action when
necessary to resolve non-performing assets. When resolving problem loans, it is
our policy to determine collectibility under various circumstances which are
intended to result in our maximum financial benefit. We accomplish this by
either working with the borrower to bring the loan current or by foreclosing and
selling the asset. We perform ongoing reviews of loans that display weaknesses
and maintain adequate loss allowances on the loans. For a discussion on our
internal asset review policy, refer to Allowance for Losses on Loans and Real
Estate on page 51.
All but $4.3 million of our non-performing assets at December 31, 1999 were
located in California.
We evaluate the need for appraisals for non-performing assets on a periodic
basis. We will generally obtain a new appraisal when we believe that there may
have been an adverse change in the property operations or in the economic
conditions of the geographic market of the property securing our loans. Our
policy is to obtain new appraisals at least annually for major real estate
acquired in settlement of loans. Throughout 1999, we obtained new appraisals for
non-performing loans and real estate acquired in settlement of loans.
Non-Accrual Loans. It is our general policy to account for a loan as
non-accrual when the loan becomes 90 days delinquent or when collection of
interest appears doubtful. In a number of cases, loans may remain on accrual
status past 90 days when we determine that continued accrual is warranted
because the loan is well-secured and in process of collection. As of December
31, 1999, we had no loans 90 days or more delinquent which remained on accrual
status. We reverse and charge against interest income any interest previously
accrued with respect to non-accrual loans. We recognize interest income on
non-accrual loans to the extent that we receive payments and to the extent that
we believe we will recover the remaining principal balance of the loan. We
restore these loans to an accrual status only if all past due payments are made
by the borrower and the borrower has demonstrated the ability to make future
payments of principal and interest. At December 31, 1999, non-accrual loans
aggregating $9 million were less than 90 days delinquent relative to their
contractual terms. Additional loans aggregating $1 million were not
contractually past due, but were deemed non-accrual due to management's
assessment of the borrower's ability to pay.
Impaired Loans. We consider a loan to be impaired when, based upon current
information and events, we believe it is probable that we will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. We carry impaired loans at either the present value of expected
future cash flows discounted at the loan's effective interest rate, or at the
loan's observable market price or the net fair value of the collateral securing
the loan. Impaired loans exclude large groups of smaller balance homogeneous
loans that we
25
<PAGE>
collectively evaluate for impairment. For us, loans we collectively review for
impairment include all single family loans and performing multi-family and
non-residential loans having principal balances of less than $1 million.
In determining impairment, we consider large non-homogeneous loans with the
following characteristics: non-accrual loans, debt restructurings and performing
loans which exhibit, among other characteristics, high loan-to-value ratios or
delinquent taxes. We base the measurement of collateral dependent impaired loans
on the fair value of the loan's collateral. We value non-collateral dependent
loans based on a present value calculation of expected future cash flows,
discounted at the loan's effective rate. We generally use cash receipts on
impaired loans not performing according to contractual terms to reduce the
carrying value of the loan, unless we believe we will recover the remaining
principal balance of the loan. We include impairment losses in the allowance for
loan losses through a charge to provision for loan losses. We include
adjustments to impairment losses due to changes in the fair value of the
collateral of impaired loans in provision for loan losses. Upon disposition of
an impaired loan, we record loss of principal through a charge-off to the
allowance for loan losses. At December 31, 1999, the recorded investment in
loans for which we have recognized impairment totaled $13 million, unchanged
from December 31, 1998. The total allowance for losses related to these loans
was $1 million for both December 31, 1999 and 1998. For further information
regarding impaired loans, see Note 6 of the Notes to the Consolidated Financial
Statements on page 74.
A summary of the activity in the allowance for loan losses associated with
impaired loans is shown below for the years indicated. We have recorded
provisions and reductions to the allowance associated with changes in
classification of loans as impaired and reductions due to loan principal
payments.
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997 1996 1995 (1)
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of period .................. $ 810 $1,301 $ 4,402 $5,292 $ --
Provision for (reduction of) impaired loan losses (13) (491) (3,101) (890) 5,292
Charge-offs ..................................... -- -- -- -- --
Recoveries ...................................... -- -- -- -- --
--------------------------------------------------------------------------------------------------
Balance at end of period ........................ $ 797 $ 810 $ 1,301 $4,402 $5,292
==================================================================================================
<FN>
(1) The allowance for impaired loans started in January 1995 to meet the
requirements from the issuance of SFAS 114, Accounting by Creditors for
Impairment of a Loan.
</FN>
</TABLE>
Troubled Debt Restructurings. We consider a restructuring of a debt a
troubled debt restructuring when we, for economic or legal reasons related to
the borrower's financial difficulties, grant a concession to the borrower that
we would not otherwise grant. Troubled debt restructurings may include changing
repayment terms, reducing the stated interest rate or reducing the amounts of
principal and/or interest due or extending the maturity date. The restructuring
of a loan is intended to recover as much of our investment as possible and to
achieve the highest yield possible. There were no troubled debt restructurings
on accrual status at either December 31, 1999 or 1998.
Real Estate Acquired in Settlement of Loans. Real estate acquired in
settlement of loans consists of real estate acquired through foreclosure or
deeds in lieu of foreclosure and totaled $6 million at December 31, 1999.
DELINQUENT LOANS
When a borrower fails to make required payments on a loan and does not cure
the delinquency within 60 days, we normally record a notice of default to
commence foreclosure proceedings, so long as we have given any required prior
notice to the borrower. If the loan is not reinstated within the time permitted
by law for reinstatement, which is normally five business days prior to the date
set for the non-judicial trustee's sale, we may then sell the property at a
foreclosure sale. If we have elected to pursue a non-judicial foreclosure, we
are not permitted under applicable California law to obtain a deficiency
judgment against the borrower, even if the security property is insufficient to
cover the balance owed. At these foreclosure sales, we generally acquire title
to the property.
At December 31, 1999, loans delinquent 30 days or more as a percentage of
total loans was 0.58%, down from 0.65% at year-end 1998 and 0.79% at year-end
1997. Although total loan delinquencies declined in 1999,
26
<PAGE>
subprime residential loan delinquencies increased from 0.34% at year-end 1998 to
1.15% at year-end 1999. A higher incidence of delinquency is expected on these
subprime loans as, by definition, these borrowers have a history of
delinquencies and that is why higher interest rates are charged on these loans
to compensate for that risk. In addition, the loan-to-value ratio on these loans
is generally lower thereby providing more equity protection against loss.
27
<PAGE>
The following table indicates the amounts of our past due loans at the
dates indicated.
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------------
1999 1998
----------------------------------------------------------------------------
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 .................... $ 8,630 $3,889 $12,793 $25,312 $ 9,841 $6,014 $12,832 $28,687
One-to-four units - subprime (2) ..... 7,867 3,069 7,935 18,871 244 784 947 1,975
Five or more units ................... -- -- -- -- -- -- 155 155
Commercial real estate ................. -- -- -- -- -- -- -- --
Construction ........................... -- -- -- -- -- -- -- --
Land ................................... -- -- -- -- -- -- -- --
--------------------------------------------------------------------------------------------------------------------------
Total real estate loans .............. 16,497 6,958 20,728 44,183 10,085 6,798 13,934 30,817
Non-mortgage:
Commercial ............................. -- -- -- -- -- -- -- --
Automobile ............................. 4,758 674 717 6,149 4,650 888 1,048 6,586
Other consumer ......................... 679 42 114 835 334 45 344 723
--------------------------------------------------------------------------------------------------------------------------
Total loans .......................... $21,934 $7,674 $21,559 $51,167 $15,069 $7,731 $15,326 $38,126
==========================================================================================================================
Delinquencies as a percentage of total loans 0.25% 0.09% 0.24% 0.58% 0.26% 0.13% 0.26% 0.65%
==========================================================================================================================
1997 1996
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans secured by real estate:
Residential:
One-to-four units .................... $12,099 $4,101 $18,579 $34,779 $14,519 $5,502 $18,549 $38,570
One-to-four units - subprime (2) ..... 185 -- -- 185 198 -- -- 198
Five or more units ................... -- 222 -- 222 -- -- -- --
Commercial real estate ................. -- -- 279 279 -- -- -- --
Construction ........................... -- -- -- -- -- -- -- --
Land ................................... -- -- -- -- -- -- 566 566
--------------------------------------------------------------------------------------------------------------------------
Total real estate loans .............. 12,284 4,323 18,858 35,465 14,717 5,502 19,115 39,334
Non-mortgage:
Commercial ............................. -- -- -- -- -- -- -- --
Automobile ............................. 4,167 981 961 6,109 2,080 328 274 2,682
Other consumer ......................... 218 54 533 805 158 15 181 354
--------------------------------------------------------------------------------------------------------------------------
Total loans .......................... $16,669 $5,358 $20,352 $42,379 $16,955 $5,845 $19,570 $42,370
==========================================================================================================================
Delinquencies as a percentage of total loans 0.31% 0.10% 0.38% 0.79% 0.36% 0.12% 0.41% 0.89%
==========================================================================================================================
1995
-------------------------------------
<S> <C> <C> <C> <C>
Loans secured by real estate:
Residential:
One-to-four units .................... $14,047 $6,645 $22,303 $42,995
One-to-four units - subprime (2) ..... -- -- -- --
Five or more units ................... 89 -- 447 536
Commercial real estate ................. -- -- 30,675 30,675
Construction ........................... -- -- -- --
Land ................................... -- -- 6,516 6,516
-----------------------------------------------------------------------------------
Total real estate loans .............. 14,136 6,645 59,941 80,722
Non-mortgage:
Commercial ............................. -- -- 115 115
Automobile ............................. 667 249 540 1,456
Other consumer ......................... 257 410 170 837
-----------------------------------------------------------------------------------
Total loans .......................... $15,060 $7,304 $60,766 $83,130
===================================================================================
Delinquencies as a percentage of total loans 0.36% 0.18% 1.46% 1.99%
===================================================================================
<FN>
(1) All 90 day or greater delinquencies are on non-accrual status and we report
them as part of non-performing assets. (2) We commenced one-to-four units
subprime lending in the first quarter of 1996.
</FN>
</TABLE>
28
<PAGE>
ALLOWANCE FOR LOSSES ON LOANS AND REAL ESTATE
We maintain a valuation allowance for losses on loans and real estate to
provide for losses inherent in those portfolios. The adequacy of the allowance
is evaluated quarterly by management to maintain the allowance at levels
sufficient to provide for inherent losses. A key component to our evaluation is
our internal asset review process.
Our Internal Asset Review Department conducts independent reviews to
evaluate the risk and quality of all our assets. Our Internal Asset Review
Committee is responsible for the review and classification of assets. The
Internal Asset Review Committee members include the Chief Internal Asset Review
Officer, Chief Executive Officer, Chief Operating Officer, Chief Financial
Officer, Chief Lending Officer, General Counsel, Director of Compliance/Risk
Management, Credit Administrator and Chief Appraiser. The Internal Asset Review
Committee meets quarterly to review and to determine asset classifications and
to recommend any changes to asset valuation allowances. With the exception of
payoffs or asset sales, the classification of an asset, once established, can be
removed or upgraded only upon approval of the Internal Asset Review Committee.
The Chief Internal Asset Review Officer reports quarterly to the Audit Committee
of the Board of Directors regarding overall asset quality, the adequacy of
valuation allowances on classified assets and our adherence to policies and
procedures regarding asset classification and valuation.
We adhere to an internal asset review system and loss allowance methodology
designed to provide for timely recognition of problem assets and adequate
general valuation allowances to cover asset losses. Our current asset monitoring
process includes the use of asset classifications to segregate the assets,
largely loans and real estate, into various risk categories. We use the various
asset classifications as a means of measuring risk for determining the valuation
allowance at a point in time. We currently use a six grade system to classify
our assets. The current grades are:
o pass;
o watch;
o special mention;
o substandard;
o doubtful; and
o loss.
We consider substandard, doubtful and loss assets "classified assets" for
regulatory purposes. A brief description of these classifications follows:
o The pass classification represents a level of credit quality which
contains no well-defined deficiency or weakness.
o The watch classification is used to identify an asset that currently
contains no well-defined deficiency or weakness, but it is determined
to be desirable to closely monitor the asset--e.g., loans to
facilitate the sale of real estate acquired in settlement of loans.
This category may also be used for assets upgraded from lower
classifications where continuing monitoring is deemed appropriate.
o A special mention asset does not currently expose us to a sufficient
degree of risk to warrant an adverse classification, but does possess
a correctable deficiency or potential weakness deserving management's
close attention.
o Substandard assets have a well-defined weakness or weaknesses. They
are characterized by the distinct possibility that we will sustain
some loss if we do not correct the deficiencies.
o An asset classified doubtful has all the weaknesses inherent in those
classified substandard with the added characteristic that the
weaknesses make collection or liquidation in full, on the basis of
currently existing facts, conditions and values, highly questionable
and improbable. We consider doubtful to be a temporary classification
until resolution of pending weakness issues enables us to more clearly
define the potential for loss.
o That portion of an asset classified as loss is considered
uncollectible and of so little value that its continuance as an asset,
without establishment of a specific valuation allowance, is not
warranted. A
29
<PAGE>
loss classification does not mean that an asset has absolutely no
recovery or salvage value, but rather it is not reasonable to defer
writing off or providing for all or a portion of an impaired asset
even though partial recovery may be effected in the future. We will
generally classify as loss the balance of the asset that is greater
than the net fair value of the asset unless we can expect payment from
another source. Therefore, the amount of an asset classified as loss
reflects the total of specific valuation allowances established for
the particular asset. Specific valuation allowances are not includable
in determining the Bank's total regulatory capital.
The OTS has the authority to require us to change our asset
classifications. If the change results in an asset being classified in whole or
in part as loss, a specific allowance must be established against the amount so
classified or that amount must be charged off. OTS guidelines set forth
quantitative benchmarks as a starting point for the determination of appropriate
levels of general valuation allowances. The OTS directs its examiners to rely on
management's estimates of adequate general valuation allowances if the Bank's
process for determining adequate allowances is deemed to be sound.
Our policy is to provide an allowance for losses on loans and real estate
when it is probable that the value of the asset has been impaired and the loss
can be reasonably estimated. To comply with this policy, we have established a
monitoring system that requires at least an annual review of all assets in
excess of $1 million and a semiannual review of all assets considered adversely
classified or criticized. The monitoring system requires a review of current
operating statements, an evaluation of the property's current and past
performance, an evaluation of the borrower's ability to repay and the
preparation of a discounted cash flow analysis. Based on the results of the
review, we may require a new appraisal.
We utilize the asset classifications from our internal asset review process
in the following manner to determine the amount of our allowances:
o General valuation allowances: This element relates to assets with no
well-defined deficiency or weakness (i.e., assets classified pass or
watch) and takes into consideration loss that is imbedded within the
portfolio but has not yet been realized. Generally, we believe that
borrowers are impacted by events well in advance of a lender's
knowledge that may ultimately result in loan default and eventual
loss. Examples of such loss-causing events would be borrower job loss,
divorce or medical crisis in the case of single family residential and
consumer loans, or loss of a major tenant in the case of commercial
real estate loans. General valuation allowances are determined by
applying factors that take into consideration past loss experience and
asset duration for each major asset type to the associated asset
balance.
o Allocated allowances: This element relates to assets with well-defined
deficiencies or weaknesses (i.e., assets classified special mention,
substandard, doubtful or loss). We calculate on an ongoing basis loss
by credit classification for each major asset type. Factors based upon
those loss statistics are applied against current classified asset
balances to determine the amount of allocated allowances. Included in
these allowances are those amounts associated with assets where it is
probable that the value of the asset has been impaired and the loss
can be reasonably estimated. If we determine the net fair value of the
asset exceeds our carrying value, a specific allowance is recorded for
the amount of that difference.
o Unallocated allowance: This element is more subjective and is reviewed
quarterly to take into consideration estimation errors and economic
trends that are not necessarily captured in determining the general
valuation and allocated allowances.
Our provision for loan losses was $11.3 million in 1999, up $7.4 million
from 1998. The provision for loan losses exceeded net loan charge-offs by $6.8
million resulting in an increase in the allowance for loan losses to $38.3
million at December 31, 1999. The allowance increase reflected an increase of
$6.2 million in general valuation allowances to $30.6 million due primarily to
the increase during the year in the overall one-to-four unit residential loan
portfolio, while allocated allowances increased $0.6 million to $4.9 million due
primarily to an increase in loans classified substandard. There was no change in
the unallocated allowance. During 1998, our provision for loan losses was less
than net loan charge-offs by $0.6 million resulting in a decrease in the
allowance for loan losses to $31.5 million at December 31, 1998. The decline in
the allowance reflected a decline of $1.6 million in allocated allowances to
$4.3 million due to a decline in loans classified substandard. The decline in
allocated allowances more than offset an increase in general valuation
allowances. General valuation
30
<PAGE>
allowances increased $1.0 million to $24.4 million due to increases during 1998
in most major loan categories. There was no change in the unallocated allowance.
A summary of activity in the allowance for loan losses is shown below for
the years indicated.
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997 1996 1995
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $ 31,517 $ 32,092 $ 30,094 $ 27,943 $ 25,650
Provision for loan losses .... 11,270 3,899 8,640 9,137 9,293
Charge-offs .................. (5,535) (7,372) (7,773) (7,660) (8,017)
Recoveries ................... 1,090 2,898 1,131 674 1,017
-------------------------------------------------------------------------------------
Balance at end of period ..... $ 38,342 $ 31,517 $ 32,092 $ 30,094 $ 27,943
=====================================================================================
</TABLE>
31
<PAGE>
Net loan charge-offs were $4.4 million in 1999, down from $4.5 million in
1998 and $6.6 million in 1997. Net charge-offs in 1998 included a $1.4 million
recovery from the previously mentioned settlement. Excluding that recovery, net
loan charge-offs would have declined by $1.5 million in 1999 primarily
reflecting declines of $1.0 million in net charge-offs of automobile loans and
$0.3 million in net charge-offs of one-to-four unit residential loans. The
decline in automobile loan net charge-offs reflects an improvement in the credit
quality of the portfolio combined with improved collection methods. The ratio of
automobile net charge-offs to the average of these loans was 1.05% in 1999,
compared to 1.40% in 1998 and 1.58% in 1997. Gross charge-offs, gross recoveries
and net charge-offs by category of loan are as follows for the years indicated.
<TABLE>
<CAPTION>
(Dollars in Thousands) 1999 1998 1997 1996 1995
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Gross loan charge-offs:
Loans secured by real estate:
Residential:
One-to-four units (1) ........................ $ 580 $ 1,035 $2,389 $5,098 $5,165
Five or more units ........................... -- 68 -- 102 469
Commercial real estate .......................... -- -- -- -- 1,662
Land ............................................ -- -- -- -- 4
Non-mortgage:
Commercial ...................................... -- -- -- 115 --
Automobile ...................................... 4,795 6,118 5,109 2,096 400
Other consumer .................................. 160 151 275 249 317
-----------------------------------------------------------------------------------------------------------
Total gross loan charge-offs ................. 5,535 7,372 7,773 7,660 8,017
-----------------------------------------------------------------------------------------------------------
Gross loan recoveries:
Loans secured by real estate:
Residential:
One-to-four units ............................ -- 125 224 116 --
Five or more units ........................... -- -- -- -- --
Commercial real estate .......................... 250 1,610 261 250 855
Land ............................................ -- -- -- -- --
Non-mortgage:
Commercial ...................................... -- -- -- -- 152
Automobile ...................................... 831 1,159 641 305 2
Other consumer .................................. 9 4 5 3 8
-----------------------------------------------------------------------------------------------------------
Total gross loan recoveries .................. 1,090 2,898 1,131 674 1,017
-----------------------------------------------------------------------------------------------------------
Net loan charge-offs:
Loans secured by real estate:
Residential:
One-to-four units ............................ 580 910 2,165 4,982 5,165
Five or more units ........................... -- 68 -- 102 469
Commercial real estate .......................... (250) (1,610) (261) (250) 807
Land ............................................ -- -- -- -- 4
Non-mortgage:
Commercial ...................................... -- -- -- 115 (152)
Automobile ...................................... 3,964 4,959 4,468 1,791 398
Other consumer .................................. 151 147 270 246 309
-----------------------------------------------------------------------------------------------------------
Total net loan charge-offs ................... $4,445 $ 4,474 $6,642 $6,986 $7,000
===========================================================================================================
Net loan charge-offs as a percentage of average loans 0.06% 0.08% 0.13% 0.16% 0.17%
===========================================================================================================
<FN>
(1) Includes amounts associated with the January 1994 Northridge earthquake of
$1.0 million in 1996 and $1.1 million in 1995.
</FN>
</TABLE>
32
<PAGE>
The allocation of the allowance for loan losses at the dates indicated is
as shown in the following table.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------------------
1999 1998 1997
-------------------------------------------------------------------------------------------------
Gross Allowance Gross Allowance Gross Allowance
Loan Percentage Loan Percentage Loan Percentage
Portfolio to Loan Portfolio 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 ......... $12,913 $6,155,399 0.21% $11,244 $4,047,182 0.28% $13,396 $4,358,475 0.31%
One-to-four units--subprime 9,876 1,639,401 0.60 3,055 588,951 0.52 1,256 249,070 0.50
Five or more units ........ 184 21,055 0.87 401 40,029 1.00 314 38,278 0.82
Commercial real estate ...... 2,439 148,327 1.64 2,632 140,790 1.87 4,112 202,425 2.03
Construction ................ 2,075 176,487 1.18 1,508 127,761 1.18 847 70,865 1.20
Land ........................ 843 67,631 1.25 568 44,859 1.27 331 25,687 1.29
Non-mortgage:
Commercial .................. 334 26,667 1.25 218 28,293 0.77 196 26,024 0.75
Automobile .................. 6,259 399,789 1.57 8,344 357,988 2.33 8,016 342,326 2.34
Other consumer .............. 619 49,344 1.25 747 41,894 1.78 824 47,735 1.73
Not specifically allocated ..... 2,800 -- -- 2,800 -- -- 2,800 -- --
----------------------------------------------------------------------------------------------------------------------------------
Total loans held for
investment ............. $38,342 $8,684,100 0.44% $31,517 $5,417,747 0.58% $32,092 $5,360,885 0.60%
==================================================================================================================================
1996 1995
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Loans secured by real estate:
Residential:
One-to-four units ......... $12,960 $4,013,190 0.32% $12,254 $3,656,512 0.34%
One-to-four--subprime ..... 281 33,258 0.84 -- -- --
Five or more units ........ 517 56,907 0.91 895 57,321 1.56
Commercial real estate ...... 6,956 260,609 2.67 8,456 270,583 3.13
Construction ................ 773 66,651 1.16 335 28,593 1.17
Land ........................ 466 21,177 2.20 973 21,867 4.45
Non-mortgage:
Commercial .................. 236 22,136 1.07 259 12,864 2.01
Automobile .................. 4,303 202,186 2.13 849 56,127 1.51
Other consumer .............. 802 47,281 1.70 1,122 50,945 2.20
Not specifically allocated ..... 2,800 -- -- 2,800 -- --
------------------------------------------------------------------------------------------------
Total loans held for
investment ............. $30,094 $4,723,395 0.64% $27,943 $4,154,812 0.67%
================================================================================================
</TABLE>
The following table is a summary of the activity in our allowance for real
estate held for investment for the years indicated. The provision reductions in
all years were, in general, due to a continuing improvement in the real estate
market which favorably impacted the valuation of certain neighborhood shopping
center investments and to a reduction in the investment in certain joint venture
investments. In 1998, $4.3 million of the provision reduction and $7.1 million
of charge-offs related to the previously mentioned settlement.
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997 1996 1995
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $ 7,717 $21,244 $30,071 $34,338 $37,198
Reduction of real estate losses (3,666) (5,296) (3,190) (3,306) (2,916)
Charge-offs ................... (1,920) (8,231) (5,637) (1,035) --
Recoveries .................... -- -- -- 74 56
-------------------------------------------------------------------------------------
Balance at end of period ...... $ 2,131 $ 7,717 $21,244 $30,071 $34,338
=====================================================================================
</TABLE>
33
<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. As of
September 30, 1999, we are no longer maintaining an allowance for real estate
acquired in settlement of loans as we record the related individual assets at
the lower of cost or fair value. The following table is a summary of the
activity of our allowance for real estate acquired in settlement of loans for
the years indicated.
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997 1996 1995
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of period ................ $ 533 $ 839 $ 1,078 $ 1,217 $ 743
Provision for (reduction of) real estate losses (45) 455 1,107 1,658 2,498
Charge-offs ................................... (488) (761) (1,346) (1,797) (2,024)
--------------------------------------------------------------------------------------------------
Balance at end of period ...................... $-- $ 533 $ 839 $ 1,078 $ 1,217
==================================================================================================
</TABLE>
CAPITAL RESOURCES AND LIQUIDITY
Our sources of funds include deposits, advances from the FHLB and other
borrowings, proceeds from the sale of real estate, sales of loans and
mortgage-backed securities, payments of loans and mortgage-backed securities,
payments for and sales of loan servicing and income from other investments.
Interest rates, real estate sales activity and general economic conditions
affect significantly repayments on loans and mortgage-backed securities and
deposit inflows and outflows.
Our primary sources of funds generated during 1999 were from:
o principal repayments--including prepayments, but excluding our
refinances of our existing loans--on loans and mortgage-backed
securities of $1.7 billion;
o a net deposit inflow of $1.5 billion, of which certificate of deposits
represented $1.3 billion of the total;
o a net increase in borrowings of $1.4 billion; and
o net proceeds related to the issuance of capital securities of $115
million.
We used these funds primarily to originate loans held for investment of $4.9
billion.
To the extent 2000 deposit growth falls short of satisfying ongoing
commitments to fund maturing and withdrawable deposits, repay borrowings, fund
existing and future loan and other investment commitments, continue branch
improvement programs and maintenance of regulatory liquidity requirements, we
will utilize borrowing arrangements with the FHLB and other sources. At December
31, 1999, we had commitments to fund loans amounting to $607 million,
undisbursed loan funds and unused lines of credit of $209 million, commitments
to purchase investment securities of $15 million, commitments to purchase loans
and mortgage-backed securities of $14 million, and other contingent liabilities
of $2 million. We believe our current sources of funds will enable us to meet
these obligations while maintaining our liquidity at appropriate levels.
The principal measure of liquidity in the savings and loan industry is the
regulatory ratio of cash and eligible investments to the sum of withdrawable
savings and borrowings due within one year. Federal regulators reduced the
minimum liquidity ratio in 1997 from 5% to 4%. At December 31, 1999, the Bank's
ratio was 4.2% compared to 4.0% at December 31, 1998, and 4.8% at December 31,
1997.
Downey currently has liquid assets, including due from Bank--interest
bearing balances, of $13 million and can obtain further funds by means of
dividends from subsidiaries, subject to certain limitations, or issuance of
further debt or equity.
34
<PAGE>
REGULATORY CAPITAL COMPLIANCE
The following table is a reconciliation of the Bank's stockholder's equity
to federal regulatory capital as of December 31, 1999. The core and tangible
capital ratios were 6.27% and the risk-based capital ratio was 12.14%. These
levels are down slightly from comparable ratios of 6.83% for core and tangible
capital and 12.88% for risk-based capital at December 31, 1998, but continue to
exceed the "well capitalized" standards of 5.00% for core and 10.00% for
risk-based, as defined by regulation. During 1999, the amount of the Bank's
non-includable investment in real estate required to be deducted from regulatory
capital increased by $4 million due primarily to DSL Service Company's growth in
retained earnings.
<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 ................................. $636,213 $636,213 $636,213
Adjustments:
Deductions:
Investment in subsidiary, primarily real estate .. (45,498) (45,498) (45,498)
Goodwill ......................................... (4,070) (4,070) (4,070)
Non-permitted mortgage servicing rights .......... (3,426) (3,426) (3,426)
Additions:
Unrealized losses on securities available for sale 1,568 1,568 1,568
General loss allowance - Investment in DSL
Service Company ............................... 1,122 1,122 1,122
General loan valuation allowances (1) ............ -- -- 37,954
------------------------------------------------------------------------------------------------------------------------------
Regulatory capital ................................... 585,909 6.27% 585,909 6.27% 623,863 12.14%
Well capitalized requirement ......................... 140,191 1.50 (2) 467,304 5.00 513,693 10.00 (3)
------------------------------------------------------------------------------------------------------------------------------
Excess ............................................... $445,718 4.77% $118,605 1.27% $110,170 2.14%
==============================================================================================================================
<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 11.41%.
</FN>
</TABLE>
CURRENT ACCOUNTING ISSUE
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including a number of derivative instruments embedded in other
contracts, collectively referred to as derivatives, and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If specific conditions are met, a derivative may be specifically
designated as:
o a hedge of the exposure to changes in the fair value of a recognized
asset or liability or an unrecognized firm commitment;
o a hedge of the exposure to variable cash flows of a forecasted
transaction; or
o 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.
35
<PAGE>
As part of our secondary marketing activities, we utilize forward sale and
purchase contracts to hedge the value of loans originated for sale against
adverse changes in interest rates. At December 31, 1999, sales contracts
amounted to approximately $210 million. These contracts have a high correlation
to the price movement of the loans being hedged. There is no recognition of
unrealized gains and losses on these contracts in the balance sheet or statement
of income. When the related loans are sold, we recognize the deferred gains or
losses from these contracts in our statement of income as a component of net
gains or losses on sales of loans and mortgage-backed securities.
This statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000. We do not anticipate that the financial impact of
this statement will have a material impact on us.
YEAR 2000
Downey was successful in its four phase approach to the year 2000 computer
compliance project. The year-end transition from 1999 to year 2000 has not
presented any issues to date. Although considered unlikely, Downey could be
affected by third party systems that were not as well prepared. Management will
continue to monitor the situation and take action as necessary to remediate any
problems which might occur and ensure all business processes continue to
function properly.
We estimate that year 2000 project costs will approximate $6.3 million.
This cost is in addition to existing personnel who have been working on the year
2000 compliance 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
$4.6 million was incurred through 1999.
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 $2.7 $0.9 $0.8 $6.3
================================================================================
</TABLE>
SUBSEQUENT EVENT
On January 21, 2000, the Bank signed a definitive agreement to sell its
indirect automobile finance subsidiary, Downey Auto Finance Corp., to Auto One
Acceptance Corp., a subsidiary of California Federal Bank. The sale closed on
February 29, 2000. Downey Auto Finance Corp.'s loan portfolio totaled $366
million at December 31, 1999. The proceeds from the sale will provide additional
capital to further the growth of our residential lending business.
36
<PAGE>
ITEM 8. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Report................................ 38
Consolidated Balance Sheets................................. 39
Consolidated Statements of Income........................... 40
Consolidated Statements of Comprehensive Income............. 41
Consolidated Statements of Stockholders' Equity............. 41
Consolidated Statements of Cash Flows....................... 42
Notes to Consolidated Financial Statements.................. 44
37
<PAGE>
355 South Grand Avenue
Los Angeles, CA 90071
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Downey Financial Corp.:
We have audited the accompanying consolidated balance sheets of Downey Financial
Corp. and subsidiaries ("Downey") as of December 31, 1999 and 1998, and the
related consolidated statements of income, comprehensive income, stockholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 1999. These consolidated financial statements are the
responsibility of Downey's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Downey Financial
Corp. and subsidiaries as of December 31, 1999 and 1998, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1999, in conformity with generally accepted accounting
principles.
/s/ KPMG LLP
Los Angeles, California
January 21, 2000
38
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-----------------------
(Dollars in Thousands, Except Per Share Data) 1999 1998
-----------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash ............................................................................ $ 121,146 $ 58,510
Federal funds ................................................................... 1 33,751
-----------------------------------------------------------------------------------------------------------
Cash and cash equivalents ................................................... 121,147 92,261
U.S. Treasury securities and agency obligations available for sale, at fair value 171,823 116,061
Municipal securities held to maturity, at amortized cost (estimated market value
of $6,710 at December 31, 1999, and $6,745 at December 31, 1998) ............ 6,728 6,764
Loans held for sale, at lower of cost or market ................................. 136,005 447,382
Mortgage-backed securities available for sale, at fair value .................... 21,719 32,146
Loans receivable held for investment ............................................ 8,588,339 5,308,837
Investments in real estate and joint ventures ................................... 42,172 49,447
Real estate acquired in settlement of loans ..................................... 5,899 4,475
Premises and equipment .......................................................... 107,978 103,979
Federal Home Loan Bank stock, at cost ........................................... 102,392 49,430
Other assets .................................................................... 103,338 59,637
-----------------------------------------------------------------------------------------------------------
$9,407,540 $6,270,419
===========================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits ........................................................................ $6,562,761 $5,039,733
Federal Home Loan Bank advances ................................................. 2,122,407 695,012
Other borrowings ................................................................ 373 8,708
Accounts payable and accrued liabilities ........................................ 45,682 40,989
Deferred income taxes ........................................................... 23,899 5,411
-----------------------------------------------------------------------------------------------------------
Total liabilities ........................................................... 8,755,122 5,789,853
-----------------------------------------------------------------------------------------------------------
Company obligated mandatorily redeemable capital securities of subsidiary trust
holding solely junior subordinated debentures of the Company
("Capital Securities") ...................................................... 120,000 --
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 December 31, 1999, and 28,131,776
shares at December 31, 1998 ................................................. 281 281
Additional paid-in capital ...................................................... 92,385 92,166
Accumulated other comprehensive income (loss) - unrealized gains (losses)
on securities available for sale ............................................ (1,568) 753
Retained earnings ............................................................... 441,320 387,366
-----------------------------------------------------------------------------------------------------------
Total stockholders' equity .................................................. 532,418 480,566
-----------------------------------------------------------------------------------------------------------
$9,407,540 $6,270,419
===========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
39
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------
(Dollars in Thousands, Except Per Share Data) 1999 1998 1997
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME:
Loans receivable .................................................... $519,006 $421,942 $404,081
U.S. Treasury securities and agency obligations ..................... 8,025 7,078 8,300
Mortgage-backed securities .......................................... 1,638 2,780 3,633
Other investments ................................................... 5,082 8,604 4,404
-----------------------------------------------------------------------------------------------------------------
Total interest income ............................................ 533,751 440,404 420,418
-----------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Deposits ............................................................ 256,764 248,337 227,521
Borrowings .......................................................... 64,161 17,720 38,739
Capital securities .................................................. 5,348 -- --
-----------------------------------------------------------------------------------------------------------------
Total interest expense ........................................... 326,273 266,057 266,260
-----------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME ................................................. 207,478 174,347 154,158
PROVISION FOR LOAN LOSSES ............................................... 11,270 3,899 8,640
-----------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses ................. 196,208 170,448 145,518
-----------------------------------------------------------------------------------------------------------------
OTHER INCOME, NET:
Loan and deposit related fees ....................................... 20,097 15,645 10,921
Real estate and joint ventures held for investment, net:
Net gains on sales of wholly owned real estate ................... 5,206 2,557 2,904
Reduction of losses on real estate and joint ventures ............ 3,666 5,296 3,190
Operations, net .................................................. 10,430 14,510 8,128
Secondary marketing activities:
Loan servicing fees .............................................. 1,672 259 1,276
Net gains on sales of loans and mortgage-backed securities ....... 14,806 6,462 2,675
Net gains on sales of investment securities ......................... 288 68 --
Other ............................................................... 3,113 2,556 6,094
-----------------------------------------------------------------------------------------------------------------
Total other income, net .......................................... 59,278 47,353 35,188
-----------------------------------------------------------------------------------------------------------------
OPERATING EXPENSE:
Salaries and related costs .......................................... 86,163 66,152 54,366
Premises and equipment costs ........................................ 20,617 16,834 15,272
Advertising expense ................................................. 8,595 5,954 6,847
Professional fees ................................................... 2,502 2,867 5,113
SAIF insurance premiums and regulatory assessments .................. 3,937 3,832 3,439
Other general and administrative expense ............................ 22,568 20,251 14,519
-----------------------------------------------------------------------------------------------------------------
Total general and administrative expense ......................... 144,382 115,890 99,556
-----------------------------------------------------------------------------------------------------------------
Net operation of real estate acquired in settlement of loans ........ 19 260 1,184
Amortization of excess of cost over fair value of net assets acquired 474 510 532
-----------------------------------------------------------------------------------------------------------------
Total operating expense .......................................... 144,875 116,660 101,272
-----------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES .............................................. 110,611 101,141 79,434
Income taxes ............................................................ 46,807 43,168 34,200
-----------------------------------------------------------------------------------------------------------------
NET INCOME .......................................................... $ 63,804 $ 57,973 $ 45,234
=================================================================================================================
PER SHARE INFORMATION:
BASIC ............................................................... $ 2.27 $ 2.06 $ 1.61
=================================================================================================================
DILUTED ............................................................. $ 2.26 $ 2.05 $ 1.61
=================================================================================================================
CASH DIVIDENDS DECLARED AND PAID .................................... $ 0.350 $ 0.316 $ 0.301
=================================================================================================================
Weighted average diluted shares outstanding ......................... 28,175,537 28,176,243 28,140,200
=================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
40
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
(In Thousands) 1999 1998 1997
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
NET INCOME ..................................................................... $63,804 $57,973 $45,234
---------------------------------------------------------------------------------------------------------------
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 ....................................... (1,874) 1,104 1,331
Less reclassification of realized gains, net of losses included in income . (166) (39) --
Mortgage-backed securities available for sale, at fair value .............. (281) (422) 338
---------------------------------------------------------------------------------------------------------------
Total other comprehensive income (loss), net of income taxes ................ (2,321) 643 1,669
---------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME ........................................................... $61,483 $58,616 $46,903
===============================================================================================================
</TABLE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated
Additional Other
Common Paid-in Comprehensive Retained
(Dollars in Thousands, Except Per Share Data) Stock Capital Income (Loss) Earnings Total
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1996 .................. $255 $22,607 $(1,559) $370,268 $391,571
Cash dividends, $0.301 per share ............... -- -- -- (8,454) (8,454)
Stock dividend ................................. 13 23,012 -- (23,034) (9)
Exercise of stock options ...................... -- 335 -- -- 335
Unrealized gain on securities available for sale -- -- 1,669 -- 1,669
Net income ..................................... -- -- -- 45,234 45,234
-----------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 .................. 268 45,954 110 384,014 430,346
Cash dividends, $0.316 per share ............... -- -- -- (8,889) (8,889)
Stock dividend ................................. 13 45,702 -- (45,732) (17)
Exercise of stock options ...................... -- 510 -- -- 510
Unrealized gain on securities available for sale -- -- 643 -- 643
Net income ..................................... -- -- -- 57,973 57,973
-----------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 .................. 281 92,166 753 387,366 480,566
Cash dividends, $0.350 per share ............... -- -- -- (9,850) (9,850)
Exercise of stock options ...................... -- 219 -- -- 219
Unrealized loss on securities available for sale -- -- (2,321) -- (2,321)
Net income ..................................... -- -- -- 63,804 63,804
-----------------------------------------------------------------------------------------------------------
Balances at December 31, 1999 .................. $281 $92,385 $(1,568) $441,320 $532,418
===========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
41
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
(In Thousands) 1999 1998 1997
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................................... $ 63,804 $ 57,973 $ 45,234
Adjustments to reconcile net income to net cash used for operating activities:
Depreciation and amortization ............................................. 8,631 7,052 9,389
Provision for (recovery of) losses on loans, real estate acquired in
settlement of loans, investments in real estate and joint ventures and
other assets ............................................................ 7,640 (1,017) 6,780
Net gains on sales of loans and mortgage-backed securities, investment
securities, real estate and other assets ................................ (27,086) (20,365) (9,210)
Interest capitalized on loans (negative amortization) ..................... (29,429) (18,953) (12,885)
Federal Home Loan Bank stock dividends .................................... (2,941) (2,728) (2,638)
Loans originated for sale .................................................... (2,042,274) (2,162,583) (289,271)
Proceeds from sales of loans originated for sale ............................. 935,485 1,130,164 179,046
Other, net ................................................................... 967 4,314 1,559
---------------------------------------------------------------------------------------------------------------------------
Net cash used for operating activities .......................................... (1,085,203) (1,006,143) (71,996)
---------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from:
Maturities of U.S. Treasury securities and agency obligations ............. -- 10,001 9,875
Sales of U.S. Treasury securities and agency obligations available for sale 67,195 60,319 --
Sales of mortgage-backed securities available for sale .................... 1,386,151 608,158 88,723
Sales of loans held for investment ........................................ 50,856 -- 294,469
Sales of wholly owned real estate and real estate acquired in settlement
of loans ................................................................ 25,863 14,035 15,043
Purchase of:
U.S. Treasury securities and agency obligations available for sale ........ (126,403) (25,000) (25,000)
Federal Home Loan Bank stock .............................................. (50,021) (2,617) --
Loans receivable held for investment ...................................... (49,669) (7,463) (35,828)
Loans receivable originated held for investment (net of refinances of
$145,316, at December 31, 1999, $120,638 at December 31, 1998 and $56,366
at December 31, 1997) ................................................... (4,938,395) (1,854,801) (1,961,710)
Principal payments on loans receivable held for investment and mortgage-backed
securities available for sale ............................................. 1,688,205 1,830,492 1,086,551
Net change in undisbursed loan funds ......................................... 38,154 43,222 13,356
Proceeds from (investments in) real estate held for investment ............... (10,712) (4,074) 5,115
Other, net ................................................................... (14,655) (10,147) (14,086)
---------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities ............................ (1,933,431) 662,125 (523,492)
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
42
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
(In Thousands) 1999 1998 1997
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits ..................................................... $ 1,523,028 $ 169,755 $ 696,876
Net increase (decrease) in securities sold under agreements to repurchase .... -- (34,803) 34,803
Proceeds from Federal Home Loan Bank advances ................................ 7,166,737 857,200 872,900
Repayments of Federal Home Loan Bank advances ................................ (5,739,342) (514,646) (907,325)
Net decrease in other borrowings ............................................. (8,335) (87,766) (111,988)
Proceeds from issuance of capital securities, net ............................ 115,063 -- --
Proceeds from exercise of stock options ...................................... 219 510 335
Cash dividends ............................................................... (9,850) (8,889) (8,454)
---------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities ....................................... 3,047,520 381,361 577,147
---------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents ............................ 28,886 37,343 (18,341)
Cash and cash equivalents at beginning of year .................................. 92,261 54,918 73,259
---------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ...................................... $ 121,147 $ 92,261 $ 54,918
===========================================================================================================================
Supplemental disclosure of cash flow information: Cash paid during the period
for:
Interest ................................................................... $ 325,769 $ 266,407 $ 267,589
Income taxes ............................................................... 22,064 52,784 23,572
Supplemental disclosure of non-cash investing:
Loans transferred from held for investment to held for sale .................. 55,754 -- 290,558
Loans transferred to held for investment from held for sale .................. 13,184 3,056 --
Loans exchanged for mortgage-backed securities ............................... 1,387,364 608,831 89,522
Real estate acquired in settlement of loans .................................. 11,263 14,958 23,686
Loans to facilitate the sale of real estate acquired in settlement of loans .. 6,501 14,084 21,919
===========================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
43
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1999, 1998 and 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements of Downey Financial Corp. and
subsidiaries ("Downey") include all accounts of Downey Financial Corp. and
the consolidated accounts of all subsidiaries, including Downey Savings and
Loan Association, F.A. (the "Bank"). All significant intercompany balances
and transactions have been eliminated.
Business
Downey provides a full range of financial services to individual and
corporate customers through subsidiaries and branches located in
California. Downey is subject to competition from other financial
institutions. Downey is subject to the regulations of certain governmental
agencies and undergoes periodic examinations by those regulatory
authorities.
Basis of Financial Statement Presentation
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. In preparing the consolidated
financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities as
of the dates of the balance sheets and the results of operations for the
periods. Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change
in the near-term relate to the determination of the allowance for loan
losses and the valuation of real estate. Management believes that the
allowances established for losses on loans and real estate are adequate.
While management uses available information to recognize losses on loans
and real estate, future additions to the allowances may be necessary based
on changes in economic conditions. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review Downey's allowances for losses on loans and real estate. Such
agencies may require Downey to recognize additions to the allowances based
on their judgments about information available to them at the time of their
examination.
Downey is required to carry its loans held for sale portfolio,
mortgage-backed and investment securities available for sale portfolio,
real estate acquired in settlement of loans and real estate held for
investment or under development at the lower of cost or fair value or in
certain cases, at fair value. Fair value estimates are made at a specific
point in time based upon relevant market information and other information
about the asset. Such estimates related to the mortgage-backed and
investment securities portfolios include published bid prices or bid
quotations received from securities dealers. Fair value estimates for real
estate acquired in settlement of loans and real estate held for investment
or under development is determined by current appraisals and, where no
active market exists for a particular property, discounting a forecast of
expected cash flows at a rate commensurate with the risk involved.
Cash and Cash Equivalents
For purposes of the statements of cash flows, cash and cash equivalents
include cash on hand, amounts due from banks and Federal funds sold.
Generally, Federal funds are purchased and sold for one-day periods.
44
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Mortgage-backed Securities Purchased Under Resale Agreements, U.S. Treasury
Securities and Agency Obligations, Other Investment Securities, Municipal
Securities and Mortgage-backed Securities
Downey has established written guidelines and objectives for its investing
activities. At the time of purchase of a mortgage-backed security purchased
under resale agreement, U.S. Treasury security and agency obligation, other
investment security, municipal security or a mortgage-backed security,
management of Downey designates the security as either held to maturity,
available for sale or held for trading based on Downey's investment
objectives, operational needs and intent. Downey then monitors its
investment activities to ensure that those activities are consistent with
the established guidelines and objectives.
Held to Maturity. Securities held to maturity are carried at cost, adjusted
for amortization of premiums and accretion of discounts which are
recognized in interest income using the interest method. Mortgage-backed
securities represent participating interests in pools of long-term first
mortgage loans originated and serviced by the issuers of the securities.
Mortgage-backed securities held to maturity are carried at unpaid principal
balances, adjusted for unamortized premiums and unearned discounts.
Premiums and discounts on mortgage-backed securities are amortized using
the interest method over the remaining period to contractual maturity,
adjusted for anticipated prepayments. It is the positive intent of Downey,
and Downey has the ability, to hold these securities until maturity as part
of its portfolio of long-term, interest-earning assets. If the cost basis
of these securities is determined to be other than temporarily impaired,
the amount of the impairment is charged to operations.
Available for Sale. Securities available for sale are carried at fair
value. Premiums and discounts are amortized using the interest method over
the remaining period to contractual maturity and, in the case of
mortgage-backed securities, adjusted for anticipated prepayments.
Unrealized holding gains and losses, or valuation allowances established
for net unrealized losses, are excluded from earnings and reported as a
separate component of stockholders' equity as accumulated other
comprehensive income, net of income taxes, unless the security is deemed
other than temporarily impaired. If the security is determined to be other
than temporarily impaired, the amount of the impairment is charged to
operations.
Realized gains and losses on the sale of securities available for sale,
determined using the specific identification method and recorded on a trade
date basis, are reflected in earnings.
Held for Trading. Securities held for trading are carried at market value.
Realized and unrealized gains and losses are reflected in earnings.
Loans Held for Sale
Downey identifies those loans which foreseeably may be sold prior to
maturity. These loans have been classified as held for sale in the
Consolidated Balance Sheets and are recorded at the lower of amortized cost
or market value. In response to unforeseen events such as changes in
regulatory capital requirements, liquidity shortfalls, changes in the
availability of sources of funds and excess loan demand by borrowers that
could not be controlled immediately by loan price changes, Downey may sell
loans which had been held for investment. In such occurrences, the loans
are transferred at amortized cost and the lower of cost or market method is
then applied.
Gains or Losses On Sales of Loans and Mortgage Servicing Assets
Gains or losses on sales of loans are recognized at the time of sale and
are determined by the difference between the net sales proceeds and the
allocated basis of the loans sold. Effective January 1, 1997, Downey began
capitalizing mortgage servicing rights ("MSRs") acquired through either the
purchase or origination of mortgage loans for sale or securitization with
servicing rights retained. The total
45
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
cost of the mortgage loans designated for sale is allocated to the MSRs and
the mortgage loans without the MSRs based on their relative fair values.
The MSRs are included in other assets and as a component of gain on sale of
loans. The MSRs are amortized in proportion to and over the estimated
period of net servicing income. Such amortization is reflected as a
component of loan servicing fees.
The MSRs are periodically reviewed for impairment based on their fair
value. The fair value of the MSRs, for the purposes of impairment, is
measured using a discounted cash flow analysis based on Downey's estimated
net servicing income, market prepayment rates and market-adjusted discount
rates. Impairment is measured on a disaggregated basis based on predominant
risk characteristics of the underlying mortgage loans. The risk
characteristics used by Downey for the purposes of capitalization and
impairment evaluation include loan type, interest rate tranche, loan term
and collateral type. Impairment losses are recognized through a valuation
allowance, with any associated provision recorded as a component of loan
servicing fees.
Derivative Financial Instruments
As part of its secondary marketing activities, Downey utilizes forward sale
contracts to hedge the value of loans originated for sale against adverse
changes in interest rates. 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 are recognized in the statement of income as a
component of net gains or losses on sales of loans and mortgage-backed
securities.
Loans Receivable Held for Investment
Loans receivable are recorded at cost, net of discounts and premiums,
undisbursed loan proceeds, net deferred fees and costs and the allowance
for loan losses.
Interest income on loans is accrued based on the outstanding principal
amount of loans using the interest method. Discounts and premiums on loans
are amortized to income using the interest method over the remaining period
to contractual maturity. The amortization of discounts into income is
discontinued on loans that are contractually ninety days past due.
Loan origination fees and related incremental direct loan origination costs
are deferred and amortized to income using the interest method over the
contractual life of the loans, adjusted for actual prepayments. Fees
received for a commitment to originate or purchase a loan or group of loans
are deferred and, if the commitment is exercised, recognized over the life
of the loan as an adjustment of yield or, if the commitment expires
unexercised, recognized as income upon expiration of the commitment. The
amortization of deferred fees and costs is discontinued on loans that are
contractually ninety days past due.
Accrued interest on loans that are contractually ninety days or more past
due or when collection of interest appears doubtful is generally reversed
and charged against interest income. Income is subsequently recognized only
to the extent cash payments are received and the principal balance is
expected to be recovered. Such loans are restored to an accrual status only
if the loan is brought contractually current and the borrower has
demonstrated the ability to make future payments of principal and interest.
Allowance for Loan Losses
The allowance for loan losses is maintained at an amount management deems
adequate to cover inherent losses. Downey has implemented and adheres to an
internal asset review system and loan loss allowance methodology designed
to provide for the detection of problem assets and an adequate allowance to
cover loan losses. In determining the allowance for loan losses related to
specific major loans (loans over
46
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
$1 million), management evaluates its allowance on an individual loan
basis, including an analysis of the creditworthiness, cash flows and
financial status of the borrower, and the condition and the estimated value
of the collateral. Downey reviews all loans under $1 million by analyzing
their performance and composition of their collateral as a whole, because
of the relatively homogeneous nature of the portfolios. Given the above
evaluations, the amount of the allowance is based upon the summation of
general valuation allowances, allocated allowances and an unallocated
allowance. General valuation allowances relate to loans with no
well-defined deficiency or weakness and are determined by applying against
such loans factors for each major loan category that consider past loss
experience and loan duration. Allocated allowances relate to loans with
well-defined deficiencies or weaknesses and are generally determined by
loss factors that consider past loss experience for such loans or are
determined by the excess of the recorded investment in the loan over the
fair value of the collateral, where appropriate. The unallocated allowance
is more subjective and is reviewed quarterly to take into consideration
estimation errors and other factors such as prevailing and forecasted
economic conditions.
Downey considers a loan to be impaired when, based upon current information
and events, it believes it is probable that Downey will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. In determining impairment, Downey considers large
non-homogeneous loans with the following characteristics: non-accrual
loans, debt restructurings and performing loans which exhibit, among other
characteristics, high loan-to-value ratios or delinquent taxes. Downey
bases the measurement of collateral dependent impaired loans on the fair
value of the loan's collateral. Non-collateral dependent loans are valued
based on a present value calculation of expected future cash flows,
discounted at the loan's effective rate. Cash receipts on impaired loans
not performing according to contractual terms are generally used to reduce
the carrying value of the loan, unless Downey believes it will recover the
remaining principal balance of the loan. Impairment losses are included in
the allowance for loan losses through a charge to provision for loan
losses. Adjustments to impairment losses due to changes in the fair value
of collateral of impaired loans are included in provision for loan losses.
Upon disposition of an impaired loan, loss of principal, if any, is
recorded through a charge-off to the allowance for loan losses.
In the opinion of management, and in accordance with the loan loss
allowance methodology, the present allowance is considered adequate to
absorb estimable and probable loan losses. Additions to the allowances are
reflected in current operations. Charge-offs to the allowance are made when
the loan is considered uncollectible or is transferred to real estate
owned. Recoveries are credited to the allowance.
For regulatory capital purposes, the Bank's general allowance for loan
losses is included to a limit of 1.25% of regulatory risk-weighted assets.
Loan Servicing
Downey services mortgage loans for investors. Fees earned for servicing
loans owned by investors are reported as income when the related mortgage
loan payments are collected. Loan servicing costs are charged to expense as
incurred.
Investment in Real Estate and Joint Ventures
Real estate held for investment or under development is held at the lower
of cost (less accumulated depreciation) or fair value. Costs, including
interest, of holding real estate in the process of development or
improvement are capitalized, whereas costs relating to holding completed
property are expensed. An allowance for losses is established by a charge
to operations if the carrying value of a property exceeds its fair value,
including the consideration of disposition costs.
Downey utilizes the equity method of accounting for investments in
non-controlled joint ventures and the consolidation method for investments
in controlled joint ventures. All intercompany profits are eliminated.
47
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Income from the sale of real estate is recognized principally when title to
the property has passed to the buyer, minimum down payment requirements are
met and the terms of any notes received by Downey satisfy continuing
investment requirements. At the time of sale, costs are relieved from real
estate projects on a relative sales value basis and charged to operations.
Real Estate Acquired in Settlement of Loans
Real estate acquired through foreclosure is initially recorded at fair
value (net of an allowance for estimated selling costs and delinquent
property taxes) at the date of foreclosure, and a writedown is recorded or
a valuation allowance is established for any subsequent declines in fair
value. All legal fees and direct costs, including foreclosure and other
related costs, are expensed as incurred.
Premises and Equipment
Buildings, leasehold improvements and furniture, fixtures, and equipment
are carried at cost, less accumulated depreciation and amortization.
Buildings and furniture, fixtures, and equipment are depreciated using the
straight-line method over the estimated useful lives of the assets. The
cost of leasehold improvements is being amortized using the straight-line
method over the shorter of the estimated useful life of the asset or the
terms of the related leases.
Impairment of Long-lived Assets
Downey reviews long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying
amount of an asset to future net cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the
assets exceed the fair value of the assets. Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs to
sell.
Securities Sold Under Agreements to Repurchase
Downey enters into sales of securities under agreements to repurchase
("reverse repurchase agreements"). Reverse repurchase agreements are
treated as financing arrangements and, accordingly, the obligations to
repurchase the securities sold are reflected as liabilities in Downey's
consolidated financial statements. The securities collateralizing reverse
repurchase agreements are delivered to several major national brokerage
firms who arranged the transactions. These securities are reflected as
assets in Downey's consolidated financial statements. The brokerage firms
may loan such securities to other parties in the normal course of their
operations and agree to return the identical securities to Downey at the
maturity of the agreements.
Income Taxes
Downey applies the asset and liability method of accounting for income
taxes. The asset and liability method recognizes deferred income taxes for
the tax consequences of "temporary differences" by applying enacted
statutory tax rates applicable to future years to differences between the
financial statement carrying amounts and the tax bases of existing assets
and liabilities. The effect on deferred taxes of a change in tax rates is
recognized in income in the period that includes the enactment date.
Deferred tax assets are to be recognized for temporary differences that
will result in deductible amounts in future years and for tax carryforwards
if, in the opinion of management, it is more likely than not that the
deferred tax assets will be realized.
48
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Stock Option Plan
Downey records compensation expense on the date of grant only if the
current market price of the underlying stock exceeded the exercise price
rather than recognizing as expense over the vesting period the fair value
of all stock-based awards on the date of grant. However, Downey provides
pro forma net income and pro forma net income per share disclosures for
employee stock option grants made since 1995 as if the fair-value of all
stock-based awards as of the grant date are recognized as expense over the
vesting period.
Per Share Information
Two earnings per share ("EPS") measures are presented. Basic EPS excludes
dilution and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding
for the period. Diluted EPS 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 issuance of common stock
that then shared in earnings.
Current Accounting Pronouncement
In June 1998, the FASB 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.
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. Sales contracts amounted to
approximately $210 million at December 31, 1999. 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 are recognized in the
statement of income as a component of net gains or losses on sales of loans
and mortgage-backed securities.
This statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000. It is not anticipated that the financial
impact of this statement will have a material impact on Downey.
49
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(2) BUSINESS COMBINATION
During 1988, the Bank acquired Butterfield Savings and Loan Association,
FSA ("Butterfield") from the Federal Savings and Loan Insurance Corporation
("FSLIC") in a FSLIC assisted acquisition.
Concurrent with the acquisition, the Bank and the FSLIC entered into an
assistance agreement ("Butterfield Assistance Agreement") that provides for
the indemnification of the Bank against losses incurred on the disposal of
certain defined covered assets and the settlement of certain unreserved
preacquisition liabilities or contingencies reduced by tax benefits
associated with those expenses as defined. Additionally, the FSLIC agreed
to provide yield maintenance assistance on certain covered assets at the
Federal Home Loan Bank ("FHLB") Eleventh District Cost of Funds Index
("COFI"). All such amounts received are nontaxable under the Internal
Revenue Code.
All assets subject to the Butterfield Assistance Agreement were sold or
repurchased by the Federal Deposit Insurance Corporation ("FDIC") on
December 29, 1995. By its terms the Butterfield Assistance Agreement
terminated on March 31, 1997.
The Butterfield Assistance Agreement provides broad authority to the FDIC
to conduct audits. A compliance audit was competed by the FDIC for the
period July 1, 1993 to June 30, 1996. A final post termination audit of the
Butterfield Assistance Agreement by the FDIC remains to be completed.
(3) U.S. TREASURY SECURITIES AND AGENCY OBLIGATIONS AVAILABLE FOR SALE
The amortized cost and estimated market value of U.S. Treasury securities
and agency obligations available for sale are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In Thousands) Cost Gains Losses Value
---------------------------------------------------------------------------
<S> <C> <C> <C> <C>
December 31, 1999 .......... $174,223 $ -- $2,400 $171,823
===========================================================================
December 31, 1998 .......... $114,882 $1,193 $ 14 $116,061
===========================================================================
</TABLE>
The amortized cost and estimated market value of U.S. Treasury securities
and agency obligations available for sale at December 31, 1999, by
contractual maturity, are shown below.
<TABLE>
<CAPTION>
Amortized Market
(In Thousands) Cost Value
---------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less ........................... $ 25,000 $ 24,724
Due after one year through five years (1) ......... 149,223 147,099
---------------------------------------------------------------------------
Total .......................................... $174,223 $171,823
===========================================================================
<FN>
(1) No investment matures beyond five years.
</FN>
</TABLE>
50
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Proceeds, gross realized gains and losses on the sales of U.S. Treasury
securities and agency obligations available for sale are summarized as
follows:
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
---------------------------------------------------------------------------
<S> <C> <C> <C>
Proceeds ................................. $67,195 $60,319 $ --
===========================================================================
Gross realized gains ..................... $ 288 $ 68 $ --
===========================================================================
Gross realized losses .................... $ -- $ -- $ --
===========================================================================
</TABLE>
Net unrealized losses on investment securities available for sale were
recognized in stockholders' equity as accumulated other comprehensive
income in the amount of $2.4 million, or $1.4 million net of income taxes,
at December 31, 1999, compared to net unrealized gains of $1.2 million, or
$0.7 million net of income taxes, at December 31, 1998.
(4) LOANS AND MORTGAGE-BACKED SECURITIES PURCHASED UNDER RESALE AGREEMENTS AND
OTHER INVESTMENT SECURITIES HELD TO MATURITY
Loans and Mortgage-backed Securities Purchased Under Resale Agreements
There were no outstanding loans or mortgage-backed securities purchased
under resale agreements at December 31, 1999 or 1998. The average interest
rate and balance of such transactions was 5.16% and $4 million,
respectively, during 1999 and 5.67% and $73 million, respectively, during
1998. There was no amount outstanding at any month-end during 1999 compared
to the maximum amount outstanding at any month-end during 1998 of $110
million.
Municipal Securities Held to Maturity
The amortized cost and estimated market value of municipal securities held
to maturity are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In Thousands) Cost Gains Losses Value
---------------------------------------------------------------------------
<S> <C> <C> <C> <C>
December 31, 1999 ........... $6,728 $ -- $18 $6,710
===========================================================================
December 31, 1998 ........... $6,764 $ -- $19 $6,745
===========================================================================
</TABLE>
All but $30,000 of the investment at December 31, 1999 and all the
investment in 1998 represents an industrial revenue bond on which the
interest income is not subject to federal income taxes and matures in 2015.
51
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(5) MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE
The amortized cost and estimated market value of the mortgage-backed
securities available for sale are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In Thousands) Cost Gains Losses Value
---------------------------------------------------------------------------
<S> <C> <C> <C> <C>
December 31, 1999:
GNMA certificates ..... $ 5,112 $100 $ 1 $ 5,211
FNMA certificates ..... 125 3 -- 128
FHLMC certificates .... 8,936 -- 257 8,679
Non-agency certificates 7,897 10 204 7,701
---------------------------------------------------------------------------
Total .............. $22,070 $113 $462 $21,719
===========================================================================
December 31, 1998:
GNMA certificates ..... $ 7,027 $309 $-- $ 7,336
FNMA certificates ..... 145 6 -- 151
FHLMC certificates .... 13,668 -- 6 13,662
Non-agency certificates 11,164 1 168 10,997
---------------------------------------------------------------------------
Total .............. $32,004 $316 $174 $32,146
===========================================================================
</TABLE>
Net unrealized losses on mortgage-backed securities available for sale were
recognized in stockholders' equity as accumulated other comprehensive
income in the amount of $0.4 million, or $0.2 million net of income taxes,
at December 31, 1999. At December 31, 1998, net unrealized gains were
recognized in stockholders' equity as accumulated other comprehensive
income in the amount of $0.1 million, or $81,400 net of income taxes.
Proceeds, gross realized gains and losses on the sales of mortgage-backed
securities available for sale are summarized as follows:
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
---------------------------------------------------------------------------
<S> <C> <C> <C>
Proceeds ............................. $1,386,151 $608,158 $88,723
===========================================================================
Gross realized gains ................. $ 14,017 $ 3,490 $ 728
===========================================================================
Gross realized losses ................ $ 2,504 $ 3,814 $ 928
===========================================================================
</TABLE>
52
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(6) LOANS RECEIVABLE
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
December 31,
---------------------------
(In Thousands) 1999 1998
-------------------------------------------------------------------------------------
<S> <C> <C>
Held for investment:
Loans secured by real estate:
Residential:
One-to-four units ............................. $6,155,399 $4,047,182
One-to-four units - subprime .................. 1,639,401 588,951
Five or more units ............................ 21,055 40,029
Commercial real estate .......................... 148,327 140,790
Construction .................................... 176,487 127,761
Land ............................................ 67,631 44,859
Non-mortgage:
Commercial ...................................... 26,667 28,293
Automobile ...................................... 399,789 357,988
Other consumer .................................. 49,344 41,894
-------------------------------------------------------------------------------------
Total loans receivable held for investment .... 8,684,100 5,417,747
Less:
Undisbursed loan funds .......................... (125,159) (108,414)
Net deferred costs and premiums ................. 67,740 31,021
Allowance for estimated losses .................. (38,342) (31,517)
-------------------------------------------------------------------------------------
Total loans receivable held for investment, net $8,588,339 $5,308,837
=====================================================================================
Held for sale:
Loans secured by residential one-to-four units ..... $ 136,005 $ 447,382
=====================================================================================
</TABLE>
Over 93% of the real estate securing Downey's loans is located in
California.
53
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
A summary of activity in the allowance for loan losses for loans receivable
held for investment during 1999, 1998 and 1997 follows:
<TABLE>
<CAPTION>
Not
Real Other Specifically
(In Thousands) Estate Commercial Automobile Consumer Allocated Total
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 ........... $21,953 $ 236 $ 4,303 $ 802 $2,800 $30,094
Provision for (reduction of) loan losses 207 (40) 8,181 292 -- 8,640
Charge-offs ............................ (2,389) -- (5,109) (275) -- (7,773)
Recoveries ............................. 485 -- 641 5 -- 1,131
--------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 ........... 20,256 196 8,016 824 2,800 32,092
Provision for (reduction of) loan losses (1,480) 22 5,287 70 -- 3,899
Charge-offs ............................ (1,103) -- (6,118) (151) -- (7,372)
Recoveries ............................. 1,735 -- 1,159 4 -- 2,898
--------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 ........... 19,408 218 8,344 747 2,800 31,517
Provision for loan losses .............. 9,252 116 1,879 23 -- 11,270
Charge-offs ............................ (580) -- (4,795) (160) -- (5,535)
Recoveries ............................. 250 -- 831 9 -- 1,090
--------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 ........... $28,330 $ 334 $ 6,259 $ 619 $2,800 $38,342
==============================================================================================================
</TABLE>
Net charge-offs represented 0.06%, 0.08% and 0.13% of average loans for
1999, 1998 and 1997, respectively.
All impaired loans at December 31, 1999 and 1998 were secured by commercial
real estate. The following table presents impaired loans with specific
allowances and the amount of such allowances and impaired loans without
specific allowances.
<TABLE>
<CAPTION>
Net Specific Net
(In Thousands) Carrying Value Allowance Balance
---------------------------------------------------------------------------
<S> <C> <C> <C>
December 31, 1999:
Loans with specific allowances .. $ -- $ -- $ --
Loans without specific allowances 13,049 -- 13,049
---------------------------------------------------------------------------
Total impaired loans ............ $13,049 $ -- $13,049
===========================================================================
December 31, 1998:
Loans with specific allowances .. $ -- $ -- $ --
Loans without specific allowances 13,302 -- 13,302
---------------------------------------------------------------------------
Total impaired loans ............ $13,302 $ -- $13,302
===========================================================================
</TABLE>
The average recorded investment in impaired loans during 1999 totaled $13
million, $14 million in 1998 and $15 million in 1997. During 1999, total
interest recognized on the impaired loan portfolio was $1.9 million,
compared to $2.0 million in both 1998 and 1997.
The combined weighted average interest yield on loans receivable held for
investment and sale was 7.67% and 7.73% as of December 31, 1999 and 1998,
respectively, and averaged 7.48%, 7.89% and 7.81% during 1999, 1998 and
1997, respectively.
54
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
The aggregate amount of non-accrual loans receivable that are contractually
past due 90 days or more as to principal or interest, in the foreclosure
process, restructured, or upon which interest collection is doubtful were
$33 million and $22 million as of December 31, 1999 and 1998, respectively.
There were no troubled debt restructurings on accrual status as of December
31, 1999 and 1998.
Interest due on non-accrual loans, but excluded from interest income, was
approximately $1.1 million for 1999, $0.5 million for 1998 and $1.8 million
for 1997.
Downey has had, and expects in the future to have, transactions in the
ordinary course of business with executive officers, directors and their
associates ("related parties") on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for
comparable transactions with other non-related parties. Those transactions
neither involve more than the normal risk of collectibility nor present any
unfavorable features. At December 31, 1999 and 1998, the Bank had extended
loans to a director and his associates totaling $27 million and $26
million, respectively. All such loans are performing in accordance with
their loan terms. Presented below is a summary of activity with respect to
such loans for the years ending December 31, 1999 and 1998:
<TABLE>
<CAPTION>
(In Thousands) 1999 1998
---------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of period ................... $25,763 $27,094
Additions ........................................ 4,149 --
Repayments ....................................... (3,255) (1,331)
---------------------------------------------------------------------------
Balance at end of period ......................... $26,657 $25,763
===========================================================================
</TABLE>
(7) LOAN SERVICING
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of mortgage
loans serviced for others was $2.9 billion and $1.0 billion at December 31,
1999 and 1998, respectively.
Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in demand deposits, were $5 million and $3 million
at December 31, 1999 and 1998, respectively.
Mortgage servicing rights of $29.3 million, $7.3 million and $1.2 million
related to loans sold with servicing rights retained were capitalized in
1999, 1998 and 1997, respectively. Mortgage servicing rights have been
written down to their fair value of $34.3 million, $7.8 million and $2.0
million at December 31, 1999, 1998 and 1997, respectively. Amortization of
mortgage servicing rights was $3.1 million in 1999, $0.7 million in 1998
and $0.3 million in 1997.
A summary of activity in the allowance for mortgage servicing rights during
1999, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
---------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of period ............. $ 464 $ 206 $ 101
Additions .................................. 195 1,350 249
Reductions ................................. (446) (581) (144)
Impairment write-down ...................... (210) (511) --
---------------------------------------------------------------------------
Balance at end of period ................... $ 3 $ 464 $ 206
===========================================================================
</TABLE>
55
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(8) INVESTMENTS IN REAL ESTATE AND JOINT VENTURES
Investments in real estate and joint ventures are summarized as follows:
<TABLE>
<CAPTION>
December 31,
---------------------
(In Thousands) 1999 1998
----------------------------------------------------------------------------------------
<S> <C> <C>
Gross investments in real estate ............................. $46,715 $57,084
Accumulated depreciation ..................................... (7,127) (9,215)
Allowance for estimated losses ............................... (2,131) (6,305)
----------------------------------------------------------------------------------------
Investments in real estate ................................ 37,457 41,564
----------------------------------------------------------------------------------------
Investments in and interest bearing advances to joint ventures 4,715 9,295
Joint venture valuation allowance ............................ -- (1,412)
----------------------------------------------------------------------------------------
Investments in joint ventures ............................. 4,715 7,883
----------------------------------------------------------------------------------------
Total investments in real estate and joint ventures ....... $42,172 $49,447
=======================================================================================
</TABLE>
The table set forth below describes the type, location and amount invested
in real estate and joint ventures, net of specific valuation allowances of
$1 million and general valuation allowances of $1 million, at December 31,
1999:
<TABLE>
<CAPTION>
(In Thousands) California Arizona Other Total
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Shopping centers ...................................... $ 28,750 $6,758 $-- $35,508
Office buildings ...................................... 713 450 -- 1,163
Residential ........................................... 1,032 -- -- 1,032
Land .................................................. 4,956 176 459 5,591
-------------------------------------------------------------------------------------------------
Total real estate before general valuation allowance $ 35,451 $7,384 $459 $43,294
=================================================================================================
General valuation allowance ........................... (1,122)
-------------------------------------------------------------------------------------------------
Net investment in real estate and joint ventures ...... $ 42,172
=================================================================================================
</TABLE>
56
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
A summary of real estate and joint venture operations included in Downey's
results of operations follows:
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Wholly owned operations:
Rental operations:
Rental income .................................. $ 4,950 $ 5,189 $ 4,689
Costs and expenses ............................. (1,128) (1,466) (2,372)
---------------------------------------------------------------------------------------------
Net rental operations ........................ 3,822 3,723 2,317
Net gains on sales of real estate ................. 5,206 2,557 2,904
Reduction of losses on real estate ................ 2,266 5,081 985
---------------------------------------------------------------------------------------------
Total wholly owned operations .................. 11,294 11,361 6,206
---------------------------------------------------------------------------------------------
Joint venture operations:
Equity in net income from joint ventures .......... 5,352 9,203 3,931
Reduction of losses provided by DSL Service Company 1,400 215 2,205
---------------------------------------------------------------------------------------------
Net joint venture operations ................... 6,752 9,418 6,136
Interest from joint venture advances ................. 1,256 1,584 1,880
---------------------------------------------------------------------------------------------
Total joint venture operations .................... 8,008 11,002 8,016
---------------------------------------------------------------------------------------------
Total .......................................... $19,302 $22,363 $14,222
=============================================================================================
</TABLE>
Activity in the allowance for losses on real estate and investments in
joint ventures for 1999, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
Real Estate Commercial Residential
Held for Real Estate Real Estate Investments
or Under Held for Held for In Joint
(In Thousands) Development Investment Investment Ventures Total
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1996 ................ $ 5,337 $ 5,116 $11,841 $ 7,777 $30,071
Provision for (reduction of) estimated losses 492 (1,403) (74) (2,205) (3,190)
Charge-offs ................................. -- (1,692) -- (3,945) (5,637)
Recoveries .................................. -- -- -- -- --
--------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 ................ 5,829 2,021 11,767 1,627 21,244
Provision for (reduction of) estimated losses 33 (427) (4,687) (215) (5,296)
Charge-offs ................................. (1,151) -- (7,080) -- (8,231)
Recoveries .................................. -- -- -- -- --
--------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 ................ 4,711 1,594 -- 1,412 7,717
Reduction of estimated losses ............... (1,741) (525) -- (1,400) (3,666)
Charge-offs ................................. (1,908) -- -- (12) (1,920)
Recoveries .................................. -- -- -- -- --
--------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 ................ $ 1,062 $ 1,069 $ -- $ -- $ 2,131
==============================================================================================================
</TABLE>
57
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Condensed financial information of joint ventures reported on the equity
method is as follows:
Condensed Combined Balance Sheets - Joint Ventures
<TABLE>
<CAPTION>
December 31,
---------------------
(In Thousands) 1999 1998
-------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash ...................................................... $ 1,870 $ 2,776
Projects under development ................................ 12,523 18,526
Completed projects ........................................ 25,155 31,372
Other assets .............................................. 2,903 3,509
-------------------------------------------------------------------------------------
$42,451 $ 56,183
=====================================================================================
LIABILITIES AND EQUITY
Liabilities:
Notes payable to the Bank .............................. $34,697 $ 46,544
Notes payable to others ................................ 3,230 3,633
Other .................................................. 6,175 6,996
Equity (deficit):
DSL Service Company (1) ................................ 4,715 7,883
Allowance for losses recorded by DSL Service Company (2) -- 1,412
Other partners' (2) .................................... (6,366) (10,285)
-------------------------------------------------------------------------------------
Net deficit .......................................... (1,651) (990)
-------------------------------------------------------------------------------------
$42,451 $ 56,183
=====================================================================================
<FN>
(1) Included in these amounts are interest-bearing joint venture advances
with priority interest payments from joint ventures to DSL Service
Company.
(2) The aggregate other partners' deficit of $6 million and $10 million at
December 31, 1999 and 1998, respectively, represents their equity
interest in the accumulated retained earnings (deficit) of the
respective joint ventures. Those results include not only the net
profit on sales and the operating results of the real estate assets,
but depreciation expense and funding costs as well. Except for any
secured financing which has been obtained, DSL Service Company has
provided all other financing. As part of Downey's internal asset
review process, the fair value of the joint venture real estate assets
is compared to the secured notes payable to the Bank and others and
DSL Service Company's investment. To the extent the fair value of the
real estate assets is less than the aggregate of those amounts, a
provision is made to create a valuation allowance. There were no
allowances at December 31, 1999, and $1 million at December 31, 1998.
These valuation allowances are less than the other partners' deficit
as the fair value of the real estate assets of certain joint venture
partnerships in which the other partners' equity was a deficit
exceeded the amount of third party notes and DSL Service Company's
investment thereby eliminating the need for a valuation allowance
since the sale of the real estate would allow DSL Service Company to
realize its investment and provide a profit to the partners.
</FN>
</TABLE>
58
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Condensed Combined Statements of Operations - Joint Ventures
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Real estate sales:
Sales ......................................... $ 40,096 $ 59,095 $ 82,696
Cost of sales ................................. (31,770) (39,261) (72,255)
------------------------------------------------------------------------------------------
Net gains on sales ........................... 8,326 19,834 10,441
------------------------------------------------------------------------------------------
Rental operations:
Rental income ................................. 5,825 6,252 8,280
Operating expenses ............................ (2,192) (2,409) (1,729)
Interest, depreciation and other expenses ..... (4,236) (5,271) (9,130)
------------------------------------------------------------------------------------------
Net loss on rental operations ................ (603) (1,428) (2,579)
------------------------------------------------------------------------------------------
Net income ........................................ 7,723 18,406 7,862
Less other partners' share of net income .......... 2,371 9,203 3,931
------------------------------------------------------------------------------------------
DSL Service Company's share of net income ......... 5,352 9,203 3,931
Reduction of losses provided by DSL Service Company 1,400 215 2,205
------------------------------------------------------------------------------------------
DSL Service Company's share of net income ......... $ 6,752 $ 9,418 $ 6,136
==========================================================================================
</TABLE>
(9) REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS
The type and amount of real estate acquired in settlement of loans is
summarized as follows:
<TABLE>
<CAPTION>
December 31,
------------------
(In Thousands) 1999 1998
------------------------------------------------------------------------------
<S> <C> <C>
One-to-four unit residential ............................ $4,973 $ 4,708
One-to-four unit residential - subprime ................. 926 300
------------------------------------------------------------------------------
Total real estate acquired in settlement of loans .... 5,899 5,008
Allowance for estimated losses .......................... -- (533)
------------------------------------------------------------------------------
Total real estate acquired in settlement of loans, net $5,899 $ 4,475
==============================================================================
</TABLE>
A summary of net operation of real estate acquired in settlement of loans
included in Downey's results of operations follows:
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net gains on sales (1) ......................................... $(704) $(1,417) $(1,299)
Net operating expense .......................................... 768 1,222 1,376
Provision for (reduction of) estimated losses .................. (45) 455 1,107
--------------------------------------------------------------------------------------------------
Net operations of real estate acquired in settlement of loans $ 19 $ 260 $ 1,184
==================================================================================================
<FN>
(1) Includes $1.1 million in 1997 associated with the sale of a shopping
center.
</FN>
</TABLE>
59
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Activity in the allowance for estimated losses on real estate acquired
through foreclosure for 1999, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
--------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of period ................. $ 533 $ 839 $ 1,078
Provision for (reduction of) real estate losses (45) 455 1,107
Charge-offs .................................... (488) (761) (1,346)
--------------------------------------------------------------------------------
Balance at end of period ....................... $-- $ 533 $ 839
================================================================================
</TABLE>
(10) PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------
(In Thousands) 1999 1998
---------------------------------------------------------------------------
<S> <C> <C>
Land .......................................... $ 23,653 $ 24,471
Building and improvements ..................... 90,591 88,384
Furniture, fixtures and equipment ............. 64,693 52,080
Construction in progress ...................... 18 196
Other ......................................... 62 62
---------------------------------------------------------------------------
Total premises and equipment ............... 179,017 165,193
Accumulated depreciation and amortization ..... (71,039) (61,214)
---------------------------------------------------------------------------
Total premises and equipment, net .......... $107,978 $103,979
===========================================================================
</TABLE>
Downey has commitments under long term operating leases, principally for
building space and land. Lease terms generally cover a five-year period.
Rental expense was $2.1 million in 1999, $1.7 million in 1998 and $1.4
million in 1997. The following table summarizes future minimum rental
commitments under noncancelable leases.
<TABLE>
<CAPTION>
(In Thousands)
---------------------------------------------------------------------------
<S> <C>
2000 ............................................................ $2,117
2001 ............................................................ 1,917
2002 ............................................................ 1,227
2003 ............................................................ 857
2004 ............................................................ 507
Thereafter (1) .................................................. 432
---------------------------------------------------------------------------
Total future lease commitments .................................. $7,057
===========================================================================
<FN>
(1) There are no lease commitments beyond the year 2009 though options to
renew at that time are available.
</FN>
</TABLE>
(11) FEDERAL HOME LOAN BANK STOCK
The Bank's required investment in FHLB stock, based on December 31, 1999
financial data, was $104 million. The investment in FHLB stock amounted to
$102 million and $49 million at December 31, 1999 and 1998, respectively.
The Bank received a $1 million stock dividend and will purchase additional
stock amounting to $1 million in the first quarter of 2000 thereby
increasing the Bank's investment to the required amount.
60
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(12) OTHER ASSETS
Other assets are summarized as follows:
<TABLE>
<CAPTION>
December 31,
-------------------
(In Thousands) 1999 1998
---------------------------------------------------------------------------
<S> <C> <C>
Accounts receivable ................................ $ 3,338 $ 4,151
Accrued interest receivable:
Loans ........................................... 43,240 27,949
Mortgage-backed securities ...................... 123 182
Investment securities ........................... 3,360 2,618
Prepaid expenses ................................... 12,362 10,172
Excess of purchase price over fair value of assets
acquired and liabilities assumed, net ........... 4,070 4,543
Mortgage servicing rights, net ..................... 34,263 7,793
Repossessed automobiles, net ....................... 314 569
Other .............................................. 2,268 1,660
---------------------------------------------------------------------------
Total other assets .............................. $103,338 $59,637
===========================================================================
</TABLE>
(13) DEPOSITS
Deposits are summarized as follows:
<TABLE>
<CAPTION>
December 31,
--------------------------------------------
1999 1998
--------------------------------------------
Weighted Weighted
Average Average
(Dollars in Thousands) Rate Amount Rate Amount
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Transaction accounts (1) ......... 2.46% $1,489,939 2.30% $1,238,062
Certificates of deposit:
Less than 3.00% ............... 2.47 8,717 2.62 25,126
3.00-3.49 ..................... 3.02 16 3.01 593
3.50-3.99 ..................... 3.92 3,786 3.88 51,474
4.00-4.49 ..................... 4.32 210,127 4.39 428,316
4.50-4.99 ..................... 4.78 939,858 4.80 668,204
5.00-5.99 ..................... 5.56 3,623,632 5.53 2,421,333
6.00-6.99 ..................... 6.07 284,984 6.06 204,065
7.00 and greater .............. 7.32 1,702 7.24 2,560
------------------------------------------------------------------------------------
Total certificates of deposit 5.39 5,072,822 5.26 3,801,671
------------------------------------------------------------------------------------
Total deposits .............. 4.72% $6,562,761 4.53% $5,039,733
====================================================================================
<FN>
(1) Included in these amounts is $182 million and $155 million of
non-interest bearing accounts at December 31, 1999 and 1998,
respectively.
</FN>
</TABLE>
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was $1.7 billion and $1.3 billion at December 31,
1999 and 1998, respectively.
61
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
At December 31, 1999, scheduled maturities of certificates of deposit are
as follows:
<TABLE>
<CAPTION>
Weighted
(Dollars in Thousands) Average Rate Amount
---------------------------------------------------------------------------
<S> <C> <C>
2000 .............................................. 5.28% $3,894,116
2001 .............................................. 5.72 1,126,832
2002 .............................................. 5.83 27,594
2003 .............................................. 5.42 19,943
2004 .............................................. 5.08 3,955
Thereafter ........................................ 5.71 382
---------------------------------------------------------------------------
Total ........................................... 5.39% $5,072,822
===========================================================================
</TABLE>
The weighted average cost of deposits averaged 4.51%, 4.87% and 4.96%
during 1999, 1998 and 1997, respectively.
As of December 31, 1999 and 1998 public funds of approximately $3 million
and $5 million, respectively, are secured by mortgage loans with a carrying
value of approximately $5 million and $7 million at December 31, 1999 and
1998, respectively.
Interest expense on deposits by type is summarized as follows:
<TABLE>
<CAPTION>
(In Thousands) 1999 1998 1997
---------------------------------------------------------------------------
<S> <C> <C> <C>
Transaction accounts .................. $ 32,376 $ 22,866 $ 18,239
Certificate accounts .................. 224,388 225,471 209,282
---------------------------------------------------------------------------
Total deposit interest expense ..... $256,764 $248,337 $227,521
===========================================================================
</TABLE>
Accrued interest on deposits, which is included in accounts payable and
accrued liabilities, was $2 million at both December 31, 1999 and 1998.
(14) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase are summarized as follows:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1999 1998 1997
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at year end ....................................... $ -- $ -- $34,803
Average balance outstanding during the year ............... 1,987 1,877 4,029
Maximum amount outstanding at any month-end during the year 24,875 50,088 34,803
Weighted average interest rate during the year ............ 5.42% 5.90% 5.61%
Weighted average interest rate at year end ................ - - 6.65
As of year end secured by:
U.S. Treasury note ..................................... $ -- $ -- $34,798
===============================================================================================
</TABLE>
The securities collateralizing these transactions were delivered to major
national brokerage firms who arranged the transactions. Securities sold
under agreements to repurchase generally mature within 30 days of the
various dates of sale.
62
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(15) FEDERAL HOME LOAN BANK ADVANCES
FHLB advances are summarized as follows:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1999 1998 1997
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at year end ....................................... $2,122,407 $695,012 $352,458
Average balance outstanding during the year ............... 1,169,474 247,521 444,408
Maximum amount outstanding at any month-end during the year 2,122,407 695,012 550,736
Weighted average interest rate during the year ............ 5.44% 5.85% 6.02%
Weighted average interest rate at year end ................ 5.77 5.47 6.11
As of year end secured by:
Loans receivable ....................................... $2,395,599 $789,588 $368,480
Mortgage-backed securities ............................. -- -- 25,527
====================================================================================================
</TABLE>
In addition to the collateral securing existing advances, Downey had an
additional $621 million in loans available as collateral for any future
advances as of December 31, 1999.
FHLB advances have the following maturities at December 31, 1999:
<TABLE>
<CAPTION>
(In Thousands)
---------------------------------------------------------------------------
<S> <C>
2000 ........................................................ $1,619,296
2001 ........................................................ 16,056
2002 ........................................................ 55,921
2003 ........................................................ 134
2004 ........................................................ --
Thereafter .................................................. 431,000
---------------------------------------------------------------------------
Total ..................................................... $2,122,407
===========================================================================
</TABLE>
(16) COMMERCIAL PAPER
Commercial paper borrowings are summarized as follows:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1999 1998 1997
----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at year end ....................................... $ -- $ -- $ 83,811
Average balance outstanding during the year ............... -- 30,589 182,296
Maximum amount outstanding at any month-end during the year -- 103,749 272,818
Weighted average interest rate during the year ............ - 6.32% 5.75%
Weighted average interest rate at end of year ............. -- - 5.61
As of year end secured by:
FHLB Letter of Credit .................................. $ -- $ -- $300,000
==============================================================================================
</TABLE>
The commercial paper program was discontinued during 1998.
63
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(17) OTHER BORROWINGS
Other borrowings are summarized as follows:
<TABLE>
<CAPTION>
December 31,
--------------
(Dollars In Thousands) 1999 1998
------------------------------------------------------------------------------------------
<S> <C> <C>
Long-term notes payable to banks, secured by real estate and mortgage
loans with a carrying value of $769 at December 31, 1999, bearing an
interest
rate of 7.88% ....................................................... $373 $8,708
==========================================================================================
</TABLE>
Other borrowings have the following maturities at December 31, 1999:
<TABLE>
<CAPTION>
(In Thousands)
---------------------------------------------------------------------------
<S> <C>
2000 ............................................................. $184
2001 ............................................................. 189
---------------------------------------------------------------------------
Total ............................................................ $373
===========================================================================
</TABLE>
(18) INCOME TAXES
Income taxes (benefits) are summarized as follows:
<TABLE>
<CAPTION>
December 31,
---------------------------------
(In Thousands) 1999 1998 1997
---------------------------------------------------------------------------
<S> <C> <C> <C>
Federal:
Current ......................... $18,382 $38,474 $26,681
Deferred ........................ 19,821 (5,848) (886)
---------------------------------------------------------------------------
$38,203 $32,626 $25,795
===========================================================================
State:
Current ......................... $ 8,186 $10,955 $ 7,373
Deferred ........................ 418 (413) 1,032
---------------------------------------------------------------------------
$ 8,604 $10,542 $ 8,405
===========================================================================
Total:
Current ......................... $26,568 $49,429 $34,054
Deferred ........................ 20,239 (6,261) 146
---------------------------------------------------------------------------
Total ........................ $46,807 $43,168 $34,200
===========================================================================
</TABLE>
Current income taxes payable were $12 million and $8 million at December
31, 1999 and 1998, respectively.
64
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Deferred tax liabilities (assets) are comprised of the following temporary
differences between the financial statement carrying amounts and the tax
bases of assets:
<TABLE>
<CAPTION>
December 31,
----------------------
(In Thousands) 1999 1998
------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax liabilities:
Tax reserves in excess of base year .................. $ 21,904 $ 16,438
Mortgage servicing rights, net of allowances ......... 14,818 --
FHLB stock dividends ................................. 8,197 5,607
Deferred loan fees ................................... 5,344 (1,564)
Depreciation on premises and equipment ............... 2,737 3,812
Capitalized interest ................................. -- 978
Installment sales .................................... -- 268
Accrual to cash adjustment ........................... -- 164
SAIF insurance premiums .............................. -- 86
------------------------------------------------------------------------------------
53,000 25,789
------------------------------------------------------------------------------------
Deferred tax assets:
Loan valuation allowances, net of bad debt charge-offs (18,017) (14,447)
California franchise tax ............................. (3,959) (3,704)
Real estate and joint venture valuation allowances ... (2,180) (4,010)
Deferred compensation ................................ (1,895) (1,924)
Other deferred income items .......................... (1,217) (721)
Unrealized gains (losses) on investment securities ... (1,183) 568
Mark to market adjustment on loans held for sale ..... (357) (923)
Equity in joint ventures ............................. (293) 4,783
------------------------------------------------------------------------------------
(29,101) (20,378)
Deferred tax assets valuation allowance .................. -- --
------------------------------------------------------------------------------------
Net deferred tax liability ............................... $ 23,899 $ 5,411
====================================================================================
</TABLE>
A reconciliation of income taxes (benefits) to the expected statutory
federal corporate income taxes follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------------------------------------------------------------
(Dollars in Thousands) Amount Percent Amount Percent Amount Percent
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Expected statutory income taxes ............... $38,714 35.0% $35,399 35.0% $27,802 35.0%
California franchise tax, net of federal income
tax benefit ................................ 7,606 6.9 6,880 6.8 5,461 6.9
Increase (decrease) resulting from:
Amortization of goodwill ................... 166 0.2 253 0.3 291 0.4
Interest on municipal bonds ................ (105) (0.1) (107) (0.1) (103) (0.1)
Other ...................................... 426 0.3 743 0.7 749 0.9
--------------------------------------------------------------------------------------------------------------------
Income taxes .................................. $46,807 42.3% $43,168 42.7% $34,200 43.1%
====================================================================================================================
</TABLE>
The Small Business Job Protection Act of 1996 repealed the reserve method
of accounting for bad debts by savings institutions for years beginning
after 1995. Under prior law, savings associations calculated additions to
reserves using either a percentage-of-taxable-income or historical loan
loss experience. The new law allows deductions for bad debts only when such
debts are actually charged off against income (the "specific charge-off"
method). Downey calculated its bad debt deduction for 1999, 1998 and 1997
under the specific charge-off method.
65
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Downey made income tax payments, net of refunds, amounting to $22.1
million, $52.8 million and $23.6 million in 1999, 1998 and 1997,
respectively.
Downey and its wholly owned subsidiaries file a consolidated federal income
tax return and various state income and franchise tax returns on a calendar
year basis. The Internal Revenue Service and state taxing authorities have
examined Downey's tax returns for all tax years through 1995 and are
currently reviewing returns filed for the 1996 tax year. Adjustments
proposed by the Internal Revenue Service have been protested by Downey and
are currently moving through the government appeals process. Downey
believes it has established appropriate liabilities for any resultant
deficiencies. Tax years subsequent to 1996 remain open to review by federal
and state tax authorities.
(19) CAPITAL SECURITIES
On July 23, 1999, Downey, through Downey Financial Capital Trust I (the
"Trust"), issued $120 million in 10.00% capital securities. The capital
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 and are recorded as interest expense by
Downey. The capital securities represent undivided beneficial interests in
the Trust, which was established by Downey for the purpose of issuing the
capital 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 sole 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. The payment
of distributions on the capital securities may be deferred if Downey defers
payments of interest on the junior subordinated debentures. Downey will
have the right, on one or more occasions, to defer payments of interest on
the junior subordinated debentures for up to 20 consecutive quarterly
periods. During the time Downey defers interest payments, interest on the
junior subordinated debentures will continue to accrue and distributions on
the capital securities will continue to accumulate and the deferred
interest and deferred distributions will themselves accrue interest at an
annual rate of 10.00%, compounded quarterly, to the extent permitted by
applicable law. Downey invested $108 million of the $115 million of net
proceeds from the sale of the Junior Subordinated Debentures (net of
underwriting discounts and commissions and other offering expenses) as
additional common stock of the Bank thereby increasing the Bank's
regulatory core / tangible capital by that amount. The balance of the net
proceeds have been used for general corporate purposes.
66
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(20) STOCKHOLDERS' EQUITY
Regulatory Capital
Downey is not subject to any regulatory capital requirements. However, the
Bank is subject to regulation by the Office of Thrift Supervision ("OTS")
which has adopted regulations ("Capital Regulations") that contain a
capital standard for savings institutions. The Bank is in compliance with
the Capital Regulations at December 31, 1999 and 1998.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------- ----------------------- ---------------------------
(Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1999
Risk-based capital
(to risk-weighted assets) $623,863 12.14% $410,955 8.00% $513,693 10.00%
Core capital
(to adjusted assets) .... 585,909 6.27 280,382 3.00 467,304 5.00
Tangible capital
(to adjusted assets) .... 585,909 6.27 140,191 1.50 -- - (1)
Tier I capital
(to risk-weighted assets) 585,909 11.41 -- - (1) 308,216 6.00
------------------------------------------------------------------------------------------------------------------
1998
Risk-based capital
(to risk-weighted assets) $454,960 12.88% $282,556 8.00% $353,195 10.00%
Core capital
(to adjusted assets) .... 423,693 6.83 186,107 3.00 310,178 5.00
Tangible capital
(to adjusted assets) .... 423,693 6.83 93,053 1.50 -- - (1)
Tier I capital
(to risk-weighted assets) 423,693 12.00 -- - (1) 211,917 6.00
------------------------------------------------------------------------------------------------------------------
<FN>
(1) Ratio is not specified under capital regulations.
</FN>
</TABLE>
Capital Distributions
The OTS rules impose certain limitations regarding stock repurchases and
redemptions, cash-out mergers and any other distributions charged against
an institution's capital accounts. The payment of dividends by the Bank is
subject to OTS regulations. Inasmuch as the Bank is owned by a holding
company, the Bank is required to provide the OTS with a notice before
payment of any dividend. Prior OTS approval is required, however, to the
extent the Bank would not be considered well capitalized under the prompt
corrective action regulations of the OTS following the distribution or the
amount of the dividend exceeds the Bank's retained net income for that year
to date plus retained net income for the preceding two years.
As of December 31, 1999, the Bank had the capacity to declare a dividend
totaling $110 million without obtaining prior OTS approval.
Stock Dividend
On April 22, 1998, the Board of Directors declared a five percent stock
dividend on Downey's common
67
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
stock payable on May 22, 1998 to stockholders of record on May 7, 1998. The
stock dividend resulted in the issuance of 1,337,271 shares and the par
value of the common stock remained at $0.01. Accordingly, $13,000 and $45.7
million were transferred from retained earnings to common stock and
additional paid-in-capital, respectively. On April 23, 1997, the Board of
Directors declared a five percent stock dividend on Downey's common stock
payable on May 22, 1997 to stockholders of record on May 8, 1997. The stock
dividend resulted in the issuance of 1,272,542 shares and the par value of
the common stock remained at $0.01. Accordingly, $13,000 and $23.0 million
were transferred from retained earnings to common stock and additional
paid-in-capital, respectively. All share and per share data, including
stock option plan information, have been restated to reflect this
distribution.
Employee Stock Option Plans
During 1994, the Bank adopted and the stockholders approved the Downey
Savings and Loan Association 1994 Long Term Incentive Plan (the "LTIP").
The LTIP provides for the granting of stock appreciation rights, restricted
stock, performance awards and other awards. The LTIP specifies an
authorization of 434,110 shares (adjusted for stock dividends and splits)
of the Bank's common stock available for issuance under the LTIP. Effective
January 23, 1995, Downey Financial Corp. and the Bank executed an amendment
to the LTIP by which Downey Financial Corp. adopted and ratified the LTIP
such that shares of Downey Financial Corp. shall be issued upon exercise of
options or payment of other awards, for which payment is to be made in
stock, in lieu of the Bank's common stock.
During 1999, no shares were granted under the LTIP, while in 1998, 120,335
shares were granted.
Options outstanding under the LTIP at December 31, 1999 and 1998 are
summarized as follows:
<TABLE>
<CAPTION>
Outstanding Options
----------------------
Number Average
of Option
Shares Price
---------------------------------------------------------------------------
<S> <C> <C>
December 31, 1996 ............................... 343,159 $12.82
Options granted ................................. -- -
Options canceled and exercised .................. (199,273) 12.40
---------------------------------------------------------------------------
December 31, 1997 ............................... 143,886 13.40
Options granted ................................. 120,335 25.44
Options canceled and exercised .................. (44,770) 13.28
---------------------------------------------------------------------------
December 31, 1998 ............................... 219,451 20.03
Options granted ................................. -- -
Options canceled and exercised .................. (18,701) 13.18
---------------------------------------------------------------------------
December 31, 1999 .............................. 200,750 $20.66
===========================================================================
</TABLE>
Under the LTIP, options are exercisable over vesting periods specified in
each grant and, unless exercised, the options terminate between five or ten
years from the date of the grant. Further, under the LTIP, the option price
shall at least equal or exceed the fair market value of such shares on the
date the options are granted.
At December 31, 1999, 100,344 options were exercisable at a weighted
average option price per share of $16.30, with 127,722 shares available for
future grants under the LTIP. At December 31, 1998 and 1997, exercisable
options of 78,439 and 76,692, respectively, were exercisable at a weighted
average option price per share of $13.26 and $13.21, respectively.
68
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Downey measures its employee stock-based compensation arrangements under
the provisions of APB 25. Accordingly, no compensation expense has been
recognized for the stock option plan. Had compensation expense for Downey's
stock option plan been determined based on the fair value at the grant date
for previous awards, Downey's net income and income per share would have
been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
(In Thousands, Except Per Share Data) 1999 1998 1997
---------------------------------------------------------------------------
<S> <C> <C> <C>
Net income:
As reported ...................... $63,804 $57,973 $45,234
Pro forma ........................ 63,611 57,954 45,195
Earnings per share - Basic:
As reported ...................... $ 2.27 $ 2.06 $ 1.61
Pro forma ........................ 2.26 2.06 1.61
Earnings per share - Diluted:
As reported ...................... 2.26 2.05 1.61
Pro forma ........................ 2.26 2.05 1.61
===========================================================================
</TABLE>
The weighted average fair value at date of grant of options granted was
$7.77 during 1998. The fair value of options at date of grant was estimated
using the Black-Scholes model with the following weighted average
assumptions:
<TABLE>
<CAPTION>
1999 (1) 1998 1997 (1)
---------------------------------------------------------------------------
<S> <C> <C> <C>
Expected life (years) .................... - 3.11 -
Interest rate ............................ -% 4.65% -%
Volatility ............................... - 40.31 -
Dividend yield ........................... - 1.23 -
===========================================================================
<FN>
(1) No options were granted during the period.
</FN>
</TABLE>
(21) EARNINGS PER SHARE
A reconciliation of the components used to derive basic and diluted
earnings per share for 1999, 1998 and 1997 follows:
<TABLE>
<CAPTION>
Net Weighted Average Per Share
(Dollars in Thousands, Except Per Share Data) Income Shares Outstanding Amount
-----------------------------------------------------------------------------------------
<S> <C> <C> <C>
1999:
Basic earnings per share ................. $63,804 28,144,851 $2.27
Effect of dilutive stock options ......... -- 30,686 0.01
-----------------------------------------------------------------------------------------
Diluted earnings per share ............... $63,804 28,175,537 $2.26
=========================================================================================
1998:
Basic earnings per share ................. $57,973 28,111,855 $2.06
Effect of dilutive stock options ......... -- 64,388 0.01
-----------------------------------------------------------------------------------------
Diluted earnings per share ............... $57,973 28,176,243 $2.05
=========================================================================================
1997:
Basic earnings per share ................. $45,234 28,076,556 $1.61
Effect of dilutive stock options ......... -- 63,644 -
-----------------------------------------------------------------------------------------
Diluted earnings per share ............... $45,234 28,140,200 $1.61
=========================================================================================
</TABLE>
69
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(22) EMPLOYEE BENEFIT PLANS
Retirement and Savings Plan
In August 1993, Downey amended its profit sharing plan so that it qualifies
as a profit sharing and savings plan under Section 401(k) of the Internal
Revenue Code ("the Plan"), covering substantially all salaried employees.
Under the Plan, employee contributions are partially matched by Downey.
Downey's matching contribution is equal to 25% of an employee's pretax
contributions which do not exceed 4% of the employee's annual compensation.
In addition, Downey makes an annual retirement contribution based on
Downey's net income and the employee's age, vested years of service and
salary. Downey's contributions to the Plan totaled $1.9 million for 1999,
compared to $1.9 million in 1998 and $1.5 million in 1997.
During 1995, Downey approved the implementation of a Deferred Compensation
Plan for key management employees and directors. The Deferred Compensation
Plan is considered to be an essential element in a comprehensive
competitive benefits package designed to attract and retain individuals who
contribute to the success of Downey. Participants are eligible to defer
compensation on a pre-tax basis, including director fees, and earn a
competitive interest rate on the amounts deferred. Currently, 74 management
employees and seven directors are eligible to participate in the program.
During 1999, 25 management employees and one director elected to defer
compensation pursuant to the plan. Downey's expense related to the Deferred
Compensation Plan has been less than $0.1 million each year since
inception.
Group Benefit Plan
Downey provides certain health and welfare benefits for active employees
under a cafeteria plan ("the Benefit Plan") as defined by section 125 of
the Internal Revenue Code. Under the Benefit Plan, employees make
appropriate selections as to the type of benefits and the amount of
coverage desired. The benefits are provided through insurance companies and
other health organizations and are funded by contributions from Downey,
employees and retirees and include deductibles, co-insurance provisions and
other limitations. Downey's expense for health and welfare benefits was
$3.6 million, $3.1 million and $2.5 million in 1999, 1998 and 1997,
respectively.
(23) COMMITMENTS AND CONTINGENCIES
Litigation
Downey has been named as a defendant in legal actions arising in the
ordinary course of business, none of which, in the opinion of management,
is material.
Financial Instruments With Off-balance-sheet Risk
Downey is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers
and to reduce its own exposure to fluctuations in interest rates. These
financial instruments include commitments to originate fixed and variable
rate mortgage loans, letters of credit, lines of credit and loans in
process. The contract or notional amounts of those instruments reflect the
extent of involvement Downey has in particular classes of financial
instruments.
Downey uses the same credit policies in making commitments to originate
loans, lines of credit and letters of credit as it does for
on-balance-sheet instruments. For commitments to originate fixed rate
loans, the contract amounts represent exposure to loss from market
fluctuations as well as credit loss. Downey controls the credit risk of its
commitments to originate fixed rate loans through credit approvals, limits
and monitoring procedures.
70
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
The following is a summary of commitments and contingent liabilities:
<TABLE>
<CAPTION>
December 31,
--------------------
(In Thousands) 1999 1998
--------------------------------------------------------------------------------------
<S> <C> <C>
Commitments to sell loans and mortgage-backed securities ..... $210,092 $621,753
Commitments to purchase investment securities ................ 15,000 --
Commitments to purchase loans and mortgage-backed securities . 13,992 34,000
Commitments to originate loans and mortgage-backed securities:
Adjustable ............................................... 422,145 390,556
Fixed .................................................... 184,695 550,339
Undisbursed loan funds and unused lines of credit ............ 209,414 169,738
Standby letters of credit and other contingent liabilities ... 2,423 3,851
======================================================================================
</TABLE>
Commitments to originate fixed and variable rate mortgage loans are
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a
fee. Since some of the commitments may expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements. The credit risk involved in issuing lines and letters of
credit requires the same creditworthiness evaluation as that involved in
extending loan facilities to customers. Downey evaluates each customer's
creditworthiness on a case-by-case basis. Undisbursed loan funds and unused
lines of credit include home equity lines of credit and funds not
disbursed, but committed to construction and commercial lending by the
Bank.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party.
Downey receives collateral to support commitments for which collateral is
deemed necessary. The most significant categories of collateral include
real estate properties underlying mortgage loans, liens on personal
property and cash on deposit with Downey. At December 31, 1999, the extent
of collateral supporting mortgage and other loans varied from nothing to
100% of the maximum credit exposure.
In connection with its interest rate risk management, Downey occasionally
enters into interest rate exchange agreements ("swap contracts") with
certain national investment banking firms under terms that provide mutual
payment of interest on the outstanding notional amount of the swap. The
effect of these swaps serve to reduce Downey's interest rate risk between
repricing assets and liabilities. At December 31, 1999, no swap contracts
were outstanding.
(24) RISK MANAGEMENT
Derivative financial instruments are utilized to minimize the effect of
future fluctuations in interest rates 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 December 31, 1999, sales contracts amounted to $210 million.
71
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(25) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates are made at a specific point in time based upon
relevant market information and other information about the financial
instrument. The estimates do not necessarily reflect the price Downey might
receive if it were to sell at one time its entire holding of a particular
financial instrument. Because no active market exists for a significant
portion of Downey's financial instruments, fair value estimates are based
upon the following methods and assumptions, some of which are subjective in
nature. Changes in assumptions could significantly affect the estimates.
Cash, Federal Funds Sold and Securities Purchased Under Resale Agreements
The carrying amounts reported in the balance sheet for these items
approximate fair value.
Investment Securities Including U.S. Treasuries and Mortgage-backed
Securities
Fair value is based upon bid prices published in financial newspapers or
bid quotations received from securities dealers.
Loans Receivable
For residential mortgage loans, fair value is estimated based upon market
prices obtained from readily available market quote systems. The remaining
portfolio was segregated into those loans with variable rates of interest
and those with fixed rates of interest. For non-residential variable rate
loans which reprice frequently, fair values approximate carrying values.
For non-residential fixed rate loans, fair values are based on discounting
future contractual cash flows using the current rate offered for such loans
with similar remaining maturities and credit risk. The amounts so
determined for each category of loan are reduced by the associated
allowance for loan losses which thereby takes into consideration changes in
credit risk.
Interest-bearing Advances to Joint Ventures
The carrying amounts approximate fair value as the interest earned is based
upon a variable rate.
Federal Home Loan Bank Stock
The carrying amounts approximate fair value.
Mortgage Servicing Rights
The fair value of MSRs related to loans serviced for others is determined
by computing the present value of the expected net servicing income from
the portfolio.
Deposits
The fair value of deposits with no stated maturity such as regular passbook
accounts, money market accounts and checking accounts, is the carrying
amount reported in the balance sheet. The fair value of deposits with a
stated maturity such as certificates of deposit is based on discounting
future contractual cash flows by the current rate offered for such deposits
with similar remaining maturities.
Borrowings
For short-term borrowings, fair value approximates carrying value. The fair
value of long-term borrowings is based on their interest rate
characteristics. For variable rate borrowings, fair values approximate
72
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
carrying values. For fixed rate borrowings, fair value is based on
discounting future contractual cash flows by the current rate paid on such
borrowings with similar remaining maturities.
Capital Securities
Fair value is based upon closing stock price published in financial
information services or newspapers.
Off-balance-sheet Financial Instruments
Outstanding commitments to sell loans and mortgage-backed securities,
commitments to purchase mortgage-backed securities, standby letters of
credit and other contingent liabilities, unused lines of credit,
commitments to originate loans and mortgage-backed securities are
essentially carried at zero which approximates fair value. See Note 23 on
page 91, for information concerning the notional amount of such financial
instruments.
Based on the above methods and assumptions, the following table presents
the estimated fair value of Downey's financial instruments:
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
--------------------------------------------------
Carrying Estimated Carrying Estimated
(In Thousands) Amount (1) Fair Value Amount (1) Fair Value
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ASSETS:
Cash ........................................... $ 121,146 $ 121,146 $ 58,510 $ 58,510
Federal funds .................................. 1 1 33,751 33,751
U.S. Government and agency obligations and other
investment securities available for sale ... 171,823 171,823 116,061 116,061
Municipal securities held to maturity .......... 6,728 6,710 6,764 6,745
Loans held for sale ............................ 136,005 136,298 447,382 447,468
Mortgage-backed securities available for sale .. 21,719 21,719 32,146 32,146
Loans receivable held for investment:
Loans secured by real estate:
Residential:
Adjustable ............................. 7,319,949 7,308,374 4,333,023 4,474,114
Fixed .................................. 536,884 533,673 356,209 368,737
Other .................................... 269,833 276,140 207,728 210,172
Non-mortgage loans:
Commercial ............................... 17,259 17,912 19,154 19,154
Consumer ................................. 444,414 453,425 392,723 396,421
Interest-bearing advances to joint ventures .... 15,613 15,613 25,540 25,540
Federal Home Loan Bank stock ................... 102,392 102,392 49,430 49,430
MSRs and loan servicing portfolio .............. 34,263 47,363 7,793 11,976
LIABILITIES:
Deposits:
Transaction accounts ....................... 1,489,939 1,489,939 1,238,062 1,238,062
Certificates of deposit .................... 5,072,822 5,025,389 3,801,671 3,804,269
Borrowings ..................................... 2,122,780 2,055,493 703,720 709,223
Capital securities ............................. 120,000 102,000 -- --
======================================================================================================
<FN>
(1) The carrying amount of loans is stated net of undisbursed loan funds,
unearned fees and discounts and allowances for losses.
</FN>
</TABLE>
73
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(26) BUSINESS SEGMENT REPORTING
Downey views its business as consisting of two reportable business
segments--banking and real estate investment. The accounting policies of
the segments are the same as those described in Note 1, Summary of
Significant Accounting Policies on page 65. Downey evaluates performance
based on the net income generated by each segment. Internal expense
allocations between segments are independently negotiated and, where
possible, service and price is measured against comparable services
available in the external marketplace.
The following describes the two business segments.
Banking
The principal business activities of this segment are attracting funds from
the general public and institutions and originating and investing in loans,
primarily residential real estate mortgage loans, mortgage-backed
securities and investment securities.
This segment's primary sources of revenue are interest earned on mortgage
loans and mortgage-backed securities, income from investment securities,
gains on sales of loans and mortgage-backed securities, fees earned in
connection with loans and deposits and income earned on its portfolio of
loans and mortgage-backed securities serviced for investors.
This segment's principal expenses are interest incurred on interest-bearing
liabilities, including deposits and borrowings, and general and
administrative costs.
Real Estate Investment
Real estate development and joint venture operations are conducted
principally through the Bank's wholly owned service corporation subsidiary,
DSL Service Company. However, Downey Financial Corp. owned one investment
in land which it purchased from DSL Service Company at fair value in 1995
and sold in 1999.
DSL Service Company participates as an owner of, or a partner in, a variety
of real estate development projects, principally retail neighborhood
shopping center developments, most of which are located in California. Most
of the real estate development projects have been completed and are
substantially leased.
In its joint ventures, DSL Service Company is entitled to interest on its
equity invested in the project on a priority basis after third-party debt
and shares profits and losses with the developer partner, generally on an
equal basis. Partnership equity (deficit) accounts are affected by current
period results of operations, additional partner advances, partnership
distributions and partnership liquidations.
This segment's primary sources of revenue are net rental income and gains
from the sale of real estate investment assets. This segment's principal
expenses are interest expense and general and administrative expense.
74
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Operating Results and Assets
The following presents the operating results and selected financial data by
major business segments for 1999, 1998 and 1997:
<TABLE>
<CAPTION>
Real Estate
(In Thousands) Banking Investment Elimination Totals
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31 1999:
Net interest income (expense) .......... $ 207,784 $ (306) $ -- $ 207,478
Provision for loan losses .............. 11,270 -- -- 11,270
Other income ........................... 39,755 19,523 -- 59,278
Operating expense ...................... 143,081 1,794 -- 144,875
Net intercompany income (expense) ...... 393 (393) -- --
---------------------------------------------------------------------------------------------------
Income before income tax expense ....... 93,581 17,030 -- 110,611
Income tax expense ..................... 39,785 7,022 -- 46,807
---------------------------------------------------------------------------------------------------
Net income ......................... $ 53,796 $10,008 $ -- $ 63,804
===================================================================================================
ASSETS AT DECEMBER 31 1999:
Loans and mortgage-backed securities $8,746,063 $ -- $8,746,063
Real estate held for investment .... -- 42,172 42,172
Other .............................. 654,745 7,399 (42,839) 619,305
---------------------------------------------------------------------------------------------------
Total assets .................... 9,400,808 49,571 (42,839) 9,407,540
---------------------------------------------------------------------------------------------------
Equity ................................. $ 532,418 $42,839 $ (42,839) $ 532,418
===================================================================================================
YEAR ENDED DECEMBER 31 1998:
Net interest income (expense) .......... $ 174,967 $ (620) $ -- $ 174,347
Provision (reduction) for loan losses .. 3,918 (19) -- 3,899
Other income ........................... 24,617 22,736 -- 47,353
Operating expense ...................... 113,954 2,706 -- 116,660
Net intercompany income (expense) ...... (107) 107 -- --
---------------------------------------------------------------------------------------------------
Income before income tax expense ....... 81,605 19,536 -- 101,141
Income tax expense ..................... 34,869 8,299 -- 43,168
---------------------------------------------------------------------------------------------------
Net income ......................... $ 46,736 $11,237 $ -- $ 57,973
===================================================================================================
ASSETS AT DECEMBER 31 1998:
Loans and mortgage-backed securities $5,788,365 $ -- $ -- $5,788,365
Real estate held for investment .... -- 49,447 -- 49,447
Other .............................. 464,097 9,841 (41,331) 432,607
---------------------------------------------------------------------------------------------------
Total assets .................... 6,252,462 59,288 (41,331) 6,270,419
---------------------------------------------------------------------------------------------------
Equity ................................. $ 480,566 $41,331 $ (41,331) $ 480,566
===================================================================================================
YEAR ENDED DECEMBER 31 1997:
Net interest income (expense) .......... $ 154,799 $ (641) $ -- $ 154,158
Provision for loan losses .............. 8,522 118 -- 8,640
Other income ........................... 20,783 14,405 -- 35,188
Operating expense ...................... 98,803 2,469 -- 101,272
Net intercompany income (expense) ...... (357) 357 -- --
---------------------------------------------------------------------------------------------------
Income before income tax expense ....... 67,900 11,534 -- 79,434
Income tax expense ..................... 29,238 4,962 -- 34,200
---------------------------------------------------------------------------------------------------
Net income ......................... $ 38,662 $ 6,572 $ -- $ 45,234
===================================================================================================
ASSETS AT DECEMBER 31 1997:
Loans and mortgage-backed securities $5,366,396 $ -- $ -- $5,366,396
Real estate held for investment .... -- 41,356 -- 41,356
Other .............................. 449,318 12,849 (34,094) 428,073
---------------------------------------------------------------------------------------------------
Total assets .................... 5,815,714 54,205 (34,094) 5,835,825
---------------------------------------------------------------------------------------------------
Equity ................................. $ 430,346 $34,094 $ (34,094) $ 430,346
===================================================================================================
</TABLE>
75
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(27) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Selected quarterly financial data are presented below by quarter for the
years ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
December 31, September 30, June 30, March 31,
(In Thousands, Except Per Share Data) 1999 1999 1999 1999
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total interest income ................................ $161,244 $136,404 $122,209 $113,894
Total interest expense ............................... 104,962 85,361 71,012 64,938
-------------------------------------------------------------------------------------------------------------
Net interest income ............................... 56,282 51,043 51,197 48,956
Provision for loan losses ............................ 3,253 2,838 2,798 2,381
-------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 53,029 48,205 48,399 46,575
Total other income ................................... 18,406 16,271 13,259 11,342
Total operating expense .............................. 37,092 35,805 35,521 36,457
-------------------------------------------------------------------------------------------------------------
Income before income taxes ........................... 34,343 28,671 26,137 21,460
Income taxes ........................................ 14,507 12,109 11,079 9,112
-------------------------------------------------------------------------------------------------------------
Net income ........................................... $ 19,836 $ 16,562 $ 15,058 $ 12,348
=============================================================================================================
Net income per share:
Basic ............................................. $ 0.71 $ 0.59 $ 0.53 $ 0.44
Diluted ........................................... 0.70 0.59 0.53 0.44
=============================================================================================================
Market range:
High bid .......................................... $ 22.94 $ 24.13 $ 23.00 $ 25.75
Low bid ........................................... 19.06 19.81 18.13 18.25
End of period ..................................... 20.19 20.13 21.94 18.31
=============================================================================================================
</TABLE>
<TABLE>
<CAPTION>
December 31, September 30, June 30, March 31,
1998 1998 1998 1998
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total interest income ................................ $111,902 $108,982 $109,797 $109,723
Total interest expense ............................... 66,158 66,195 66,607 67,097
-------------------------------------------------------------------------------------------------------------
Net interest income ............................... 45,744 42,787 43,190 42,626
Provision for loan losses ............................ 1,180 985 1,462 272
-------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 44,564 41,802 41,728 42,354
Total other income ................................... 10,806 9,672 11,949 14,926
Total operating expense .............................. 33,834 28,949 27,280 26,597
-------------------------------------------------------------------------------------------------------------
Income before income taxes ........................... 21,536 22,525 26,397 30,683
Income taxes ......................................... 8,884 9,757 11,409 13,118
-------------------------------------------------------------------------------------------------------------
Net income ........................................... $ 12,652 $ 12,768 $ 14,988 $ 17,565
=============================================================================================================
Net income per share:
Basic ............................................. $ 0.45 $ 0.45 $ 0.53 $ 0.63
Diluted ........................................... 0.45 0.45 0.53 0.62
=============================================================================================================
Market range:
High bid .......................................... $ 26.38 $ 35.00 $ 34.50 $ 30.95
Low bid ........................................... 17.75 23.06 30.83 23.58
End of period ..................................... 25.44 23.81 32.69 30.83
=============================================================================================================
</TABLE>
76
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
(28) PARENT COMPANY FINANCIAL INFORMATION
Downey Financial Corp. was incorporated in Delaware on October 21, 1994. On
January 23, 1995, after obtaining necessary stockholder and regulatory
approvals, Downey Financial Corp. acquired 100% of the issued and
outstanding capital stock of the Bank, and the Bank's stockholders became
stockholders of Downey Financial Corp. The transaction was accounted for in
a manner similar to a pooling-of-interests under generally accepted
accounting principles. Downey Financial Corp. was thereafter funded by a
$15 million dividend from the Bank. Condensed financial statements of
Downey Financial Corp. only are as follows:
Condensed Balance Sheets
<TABLE>
<CAPTION>
December 31,
--------------------
(In Thousands) 1999 1998
-------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash .................................................................... $ 7 $ 5
Due from Bank - interest bearing ........................................ 12,686 8,521
Investment in subsidiaries:
Bank ................................................................. 636,213 470,504
Downey Financial Capital Trust I ..................................... 3,711 --
Downey Affiliated Insurance Agency ................................... 204 213
Real estate held for investment ......................................... -- 458
Other assets ............................................................ 5,016 1,124
-------------------------------------------------------------------------------------------------
$657,837 $480,825
=================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Junior subordinated debentures .......................................... $123,711 $ --
Accounts payable and accrued expenses ................................... 1,708 259
-------------------------------------------------------------------------------------------------
Total liabilities .................................................... 125,708 259
-------------------------------------------------------------------------------------------------
Company obligated mandatorily redeemable capital securities of subsidiary
trust holding solely junior subordinated debentures of the Company ... 123,711 --
Stockholders' equity .................................................... 532,418 480,566
-------------------------------------------------------------------------------------------------
$657,837 $480,825
=================================================================================================
</TABLE>
77
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Condensed Statements of Income
and Other Comprehensive Income
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------
(In Thousands) 1999 1998 1997
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INCOME:
Dividends from the Bank ............................................. $ 5,011 $ 9,537 $ 8,891
Interest income ..................................................... 1,635 374 380
Other income ........................................................ 104 60 57
-------------------------------------------------------------------------------------------------------------
Total income ..................................................... 6,750 9,971 9,328
-------------------------------------------------------------------------------------------------------------
EXPENSE:
Interest expense .................................................... 5,353 -- --
Provision for (reduction of) losses on real estate .................. (1,720) 24 153
General and administrative expense .................................. 896 793 805
-------------------------------------------------------------------------------------------------------------
Total expense .................................................... 4,529 817 958
-------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND EQUITY IN UNDISTRIBUTED
NET INCOME OF SUBSIDIARIES .......................................... 2,221 9,154 8,370
Income tax benefit ..................................................... 1,162 157 215
-------------------------------------------------------------------------------------------------------------
INCOME BEFORE EQUITY IN UNDISTRIBUTED NET INCOME
OF SUBSIDIARIES ..................................................... 3,383 9,311 8,585
Equity in undistributed net income of subsidiaries ..................... 60,421 48,662 36,649
-------------------------------------------------------------------------------------------------------------
NET INCOME .......................................................... 63,804 57,973 45,234
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 ........................................ (1,874) 1,104 1,331
Less reclassification of realized gains, net of losses
included in income ............................................. (166) (39) --
Mortgage-backed securities available for sale, at fair value ..... (281) (422) 338
-------------------------------------------------------------------------------------------------------------
Total other comprehensive income (loss), net of income taxes ........ (2,321) 643 1,669
-------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME ................................................ $61,483 $58,616 $46,903
=============================================================================================================
</TABLE>
78
<PAGE>
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(Continued)
Condensed Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------
(In Thousands) 1999 1998 1997
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................ $ 63,804 $ 57,973 $ 45,234
Equity in undistributed net income of subsidiaries .... (60,421) (48,662) (36,649)
Provision for (recovery of) losses on real estate ..... (1,720) 24 153
Increase in liabilities ............................... 1,449 134 7
Other, net ............................................ 1,022 807 (1,304)
--------------------------------------------------------------------------------------------------
Net cash provided by operating activities .......... 4,134 10,276 7,441
--------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contribution to the Bank ...................... (107,600) -- --
(Increase) decrease in due from Bank - interest bearing (4,165) (1,886) 698
Sales of wholly owned real estate ..................... 2,201 -- --
--------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities (109,564) (1,886) 698
--------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of junior subordinated debentures ............ 115,063 -- --
Exercise of stock options ............................. 219 510 335
Dividends on common stock ............................. (9,850) (8,889) (8,454)
Other ................................................. -- (17) (9)
--------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities 105,432 (8,396) (8,128)
--------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents ..... 2 (6) 11
Cash and cash equivalents at beginning of year ........... 5 11 --
--------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............... $ 7 $ 5 $ 11
==================================================================================================
</TABLE>
(29) SUBSEQUENT EVENT
On January 21, 2000, the Bank signed a definitive agreement to sell during
the first quarter of 2000 its indirect automobile finance subsidiary,
Downey Auto Finance Corp., to Auto One Acceptance Corp., a subsidiary of
California Federal Bank. The proceeds of the sale will provide additional
capital to further the growth of our residential lending business.
79
<PAGE>
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.
By: /s/ THOMAS E. PRINCE
-------------------------
Thomas E. Prince
Executive Vice President
Chief Financial Officer
(Principal Financial and Accounting Officer)
DATED: September 15, 2000
80
<PAGE>
