UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO _________:
Commission File Number 1-3521
WASHINGTON MUTUAL FINANCE CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-4128205
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
8900 Grand Oak Circle, Tampa, FL 33637-1050
(Address of principal executive offices) (Zip Code)
(813) 632-4500
(Registrant's telephone number, including area code)
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
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of October 31, 2002 there were 1,000 shares of Common Stock outstanding.
Registrant meets the conditions set forth in General Instruction (H)(1)(a) and
(b) of Form 10-Q and is therefore filing this Form with the reduced disclosure
format.
2
WASHINGTON MUTUAL FINANCE CORPORATION AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
TABLE OF CONTENTS
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements .................................................3
Condensed Consolidated Statements of Financial Condition -
September 30, 2002 (unaudited) and December 31, 2001 .................3
Condensed Consolidated Statements of Operations, Comprehensive Income
and Retained Earnings -
Three and Nine Months Ended September 30, 2002 and 2001 (unaudited) ..4
Condensed Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2002 and 2001 (unaudited) ............5
Notes to Condensed Consolidated Financial Statements ......................6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ....................................................12
Controls and Procedures .................................................12
Cautionary Statements ...................................................12
Overview ................................................................12
Critical Accounting Policies ............................................13
Recently Issued Accounting Standards ....................................14
Consolidated Results of Operations ......................................14
Lines of Business .......................................................17
Asset Quality ...........................................................18
Liquidity ...............................................................20
Subsequent Event ........................................................21
Capital Management ......................................................21
Item 3. Quantitative and Qualitative Disclosures About Market Risk ...........21
Item 4. Controls and Procedures ..............................................12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings ....................................................22
Item 6. Exhibits and Reports on Form 8-K .....................................22
Signature ....................................................................24
Certifications ...............................................................24
The information furnished in these interim statements reflects all adjustments
that are, in the opinion of management, necessary for a fair statement of the
results for such periods. Such adjustments are of a normal recurring nature,
unless otherwise disclosed in this Form 10-Q. The results of operations in the
interim statements are not necessarily indicative of the results that may be
expected for the full year. The interim financial information should be read in
conjunction with Washington Mutual Finance Corporation's 2001 Annual Report on
Form 10-K.
3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries
Condensed Consolidated Statements of Financial Condition
(Dollars in thousands) September 30, December 31,
2002 2001
------------- ------------
(Unaudited)
ASSETS
Consumer finance receivables, net $ 3,826,823 $ 3,729,324
Investment securities available for sale 91,447 124,214
Cash and cash equivalents 118,717 104,898
Property, equipment and leasehold improvements, net 22,692 26,510
Goodwill 42,214 42,214
Other assets 65,352 45,757
------------- ------------
TOTAL ASSETS $ 4,167,245 $ 4,072,917
============= ============
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities
Commercial paper borrowings $ 560,774 $ 351,141
Senior debt 2,540,407 2,667,181
Federal Home Loan Bank borrowings 100,000 110,000
------------- ------------
Total debt 3,201,181 3,128,322
Customer deposits 239,176 235,971
Accounts payable and other liabilities 160,859 148,967
------------- ------------
Total liabilities 3,601,216 3,513,260
------------- ------------
Stockholder's equity
Common stock: $1.00 par value;
10,000 shares authorized; 1,000
shares issued and outstanding 1 1
Paid-in capital 67,209 57,710
Retained earnings 496,025 499,149
Accumulated other comprehensive income 2,794 2,797
------------- ------------
Total stockholder's equity 566,029 559,657
------------- ------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 4,167,245 $ 4,072,917
============= ============
See Notes to Consolidated Financial Statements.
4
WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries
Condensed Consolidated Statements of Operations, Comprehensive Income and
Retained Earnings
(Unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------- -----------------------
(Dollars in thousands) 2002 2001 2002 2001
---------- ---------- ---------- ----------
Interest income:
Loan interest and fee income $ 140,524 $ 137,801 $ 410,719 $ 409,709
Investment securities income 1,554 2,396 4,750 7,855
---------- ---------- ---------- ----------
Total interest income 142,078 140,197 415,469 417,564
Interest and debt expense 42,368 47,760 128,840 146,886
---------- ---------- ---------- ----------
Net interest income before
provision for credit losses 99,710 92,437 286,629 270,678
Provision for credit losses 48,368 35,625 131,161 99,126
---------- ---------- ---------- ----------
Net interest income 51,342 56,812 155,468 171,552
---------- ---------- ---------- ----------
Noninterest income 6,654 5,931 19,405 20,608
Noninterest expense:
Personnel 21,206 21,787 65,896 69,854
Occupancy 3,520 3,605 10,609 10,699
Advertising 2,889 2,624 8,733 5,908
Goodwill amortization - 1,141 - 3,422
Other 11,611 11,052 31,148 34,040
---------- ---------- ---------- ----------
Total noninterest expense 39,226 40,209 116,386 123,923
---------- ---------- ---------- ----------
Income from continuing operations
before income taxes 18,770 22,534 58,487 68,237
Income taxes 6,662 8,173 21,028 24,746
---------- ---------- ---------- ----------
Income from continuing operations 12,108 14,361 37,459 43,491
Discontinued operations (Note 8)
Income from operations of discontinued division
(less applicable income taxes) 1,079 1,856 4,417 5,513
---------- ---------- ---------- ----------
Net income 13,187 16,217 41,876 49,004
Net unrealized gains (losses) on
securities arising during period, net of tax 479 796 (3) 2,528
---------- ---------- ---------- ----------
Comprehensive income $ 13,666 $ 17,013 $ 41,873 $ 51,532
========== ========== ========== ==========
Retained earnings:
Beginning of period $ 497,838 $ 489,811 $ 499,149 $ 481,524
Net income 13,187 16,217 41,876 49,004
Dividends (15,000) (16,000) (45,000) (40,500)
---------- ---------- ---------- ----------
End of period $ 496,025 $ 490,028 $ 496,025 $ 490,028
========== ========== ========== ==========
See Notes to Consolidated Financial Statements.
5
WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Nine Months
Ended September 30,
------------------------
(Dollars in thousands) 2002 2001
---------- ----------
Operating activities
Income from continuing operations 37,459 43,491
Income from discontinued operations 4,417 5,513
---------- ----------
Net income $ 41,876 $ 49,004
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for credit losses 132,931 99,963
Depreciation and amortization 7,018 14,254
(Decrease) increase in accounts payable and other liabilities (3,124) 26,544
Increase in other assets (19,595) (15,269)
---------- ----------
Net cash provided by operating activities 159,106 174,496
---------- ----------
Investing activities
Investment securities purchased (232) (10,764)
Investment securities matured or sold 33,539 60,441
Net increase in consumer finance receivables (233,545) (194,788)
Net increase in property, equipment and
leasehold improvements (1,837) (6,118)
---------- ----------
Net cash used in investing activities (202,075) (151,229)
---------- ----------
Financing activities
Net increase (decrease) in commercial paper borrowings 209,633 (393,204)
Proceeds from early termination of hedging activity - 28,868
Increase in senior debt carrying value 24,450 -
Proceeds from issuance of senior debt - 995,065
Repayments of senior debt (150,000) (550,000)
Net decrease in Federal Home
Loan Bank borrowings (10,000) (46,800)
Net increase in customer deposits 3,205 41,131
Capital contributed by parent 9,500 -
Dividends paid (30,000) (40,500)
---------- ----------
Net cash provided by financing activities 56,788 34,560
---------- ----------
Net increase in cash and
cash equivalents 13,819 57,827
Cash and cash equivalents
Beginning of period 104,898 14,602
---------- ----------
End of period $ 118,717 $ 72,429
========== ==========
Supplemental disclosures of cash flow information
Cash paid for interest $ 118,252 $ 153,928
Cash paid for income taxes (net of refunds) $ 28,249 $ 22,869
See Notes to Consolidated Financial Statements.
6
WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1 Basis of Presentation
The accompanying consolidated financial statements of Washington Mutual Finance
Corporation and subsidiaries have been prepared in accordance with the
instructions to Form 10-Q and do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. These statements should be read in conjunction with the
consolidated financial statements and notes thereto included in our 2001 Annual
Report on Form 10-K filed with the Securities and Exchange Commission. Interim
results are not necessarily indicative of results for a full year.
Washington Mutual Finance Corporation is an indirect, wholly-owned subsidiary of
Washington Mutual, Inc. ("Washington Mutual"). When we refer to "we", "our",
"us", or the "Company" in this Form 10-Q, we mean Washington Mutual Finance
Corporation and its subsidiaries, all of which are wholly-owned.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Note 2 Lines of Business
We are engaged primarily in the consumer financial services business and our
operations consist principally of a network of 433 branch offices located in 24
states, primarily in the southeast, southwest and California ("Consumer
Finance"). These offices operate under the name Washington Mutual Finance. Our
branch offices are typically located in small- to medium-sized communities in
suburban or rural areas and are managed by individuals who generally have
considerable consumer lending experience. We make secured and unsecured consumer
installment loans and purchase installment contracts from local retail
establishments. The consumer credit transactions are primarily for personal,
family or household purposes. From time to time, we purchase, servicing
released, real estate secured consumer loans from national mortgage companies
and banking operations through our wholly owned subsidiary Washington Mutual
Finance, Inc., a California corporation, which does business as Aristar Mortgage
Company ("Aristar Mortgage").
We also provided consumer financial services through our industrial banking
subsidiary, First Community Industrial Bank ("FCIB"), which had 10 branches in
Colorado and Utah ("Consumer Banking"). FCIB made consumer loans, purchased
retail installment contracts and accepted deposits insured by the Federal
Deposit Insurance Corporation. On October 1, 2002, we completed the sale of this
subsidiary through a merger with First State Bank, NM, formerly First State Bank
of Taos, a New Mexico bank ("First State"), wholly-owned by First State
Bancorporation, a New Mexico corporation, with First State being the surviving
entity. See "Note 8, Discontinued Operations" for further discussion.
7
Financial highlights by line of business were as follows:
(Dollars in thousands) Three Months Ended September 30,
----------------------------------------------------------------------------
2002 2001
------------------------------------ ------------------------------------
Consumer Consumer Consumer Consumer
Finance Banking Total Finance Banking Total
Condensed income statement: ----------- ---------- ----------- ----------- ---------- -----------
Interest income $ 142,095 $ 8,430 $ 150,525 $ 140,216 $ 9,878 $ 150,094
Interest and debt expense 42,380 3,564 45,944 47,644 4,776 52,420
Provision for credit losses 48,368 1,166 49,534 35,626 295 35,921
----------- ---------- ----------- ----------- ---------- -----------
Net interest income 51,347 3,700 55,047 56,946 4,807 61,753
Noninterest income 6,819 11 6,830 6,149 16 6,165
Noninterest expense 39,395 1,725 41,120 40,409 1,972 42,381
----------- ---------- ----------- ----------- ---------- -----------
Income before income taxes 18,771 1,986 20,757 22,686 2,851 25,537
Income taxes 6,662 908 7,570 8,230 1,090 9,320
----------- ---------- ----------- ----------- ---------- -----------
Net income $ 12,109 $ 1,078 $ 13,187 $ 14,456 $ 1,761 $ 16,217
=========== ========== =========== =========== ========== ===========
(Dollars in thousands) Nine Months Ended September 30,
----------------------------------------------------------------------------
2002 2001
------------------------------------ ------------------------------------
Consumer Consumer Consumer Consumer
Finance Banking Total Finance Banking Total
Condensed income statement: ----------- ---------- ----------- ----------- ---------- -----------
Interest income $ 415,508 $ 25,566 $ 441,074 $ 417,624 $ 30,720 $ 448,344
Interest and debt expense 128,874 11,084 139,958 146,375 15,602 161,977
Provision for credit losses 131,161 1,770 132,931 99,127 836 99,963
----------- ---------- ----------- ----------- ---------- -----------
Net interest income 155,473 12,712 168,185 172,122 14,282 186,404
Noninterest income 19,884 38 19,922 21,233 67 21,300
Noninterest expense 116,869 5,292 122,161 124,516 6,024 130,540
----------- ---------- ----------- ----------- ---------- -----------
Income before income taxes 58,488 7,458 65,946 68,839 8,325 77,164
Income taxes 21,028 3,042 24,070 24,976 3,184 28,160
----------- ---------- ----------- ----------- ---------- -----------
Net income $ 37,460 $ 4,416 $ 41,876 $ 43,863 $ 5,141 $ 49,004
=========== ========== =========== =========== ========== ===========
Other disclosures:
September 30, 2002 December 31, 2001
------------------------------------ ------------------------------------
(Dollars in thousands) Consumer Consumer Consumer Consumer
Finance Banking Total Finance Banking Total
Consumer finance receivables: ----------- ---------- ----------- ----------- ---------- -----------
Real estate secured loans $ 2,167,312 $ 342,587 $ 2,509,899 $ 1,995,953 $ 361,827 $ 2,357,780
Other installment loans 1,612,754 4,648 1,617,402 1,625,388 6,949 1,632,337
Retail installment contracts 312,174 4,698 316,872 378,650 6,648 385,298
Gross consumer finance ----------- ---------- ----------- ----------- ---------- -----------
receivables 4,092,240 351,933 4,444,173 3,999,991 375,424 4,375,415
Less: Unearned finance charges
and deferred loan fees (477,870) 20 (477,850) (520,091) 22 (520,069)
Allowance for credit losses (135,328) (4,172) (139,500) (122,850) (3,172) (126,022)
Consumer finance receivables, ----------- ---------- ----------- ----------- ---------- -----------
net $ 3,479,042 $ 347,781 $ 3,826,823 $ 3,357,050 $ 372,274 $ 3,729,324
=========== ========== =========== =========== ========== ===========
Investment securities
available for sale $ 70,806 $ 20,641 $ 91,447 $ 90,442 $ 33,772 $ 124,214
Total assets $ 3,786,933 $ 380,312 $ 4,167,245 $ 3,651,843 $ 421,074 $ 4,072,917
Total equity $ 530,235 $ 35,794 $ 566,029 $ 492,572 $ 67,085 $ 559,657
8
Note 3 Commercial Paper Conduit
On July 31, 2002, we entered into an agreement with Westdeutsche Landesbank
Girozentrale ("WestLB") to participate in a $300 million asset-backed commercial
paper conduit program. Under this program, administered by WestLB, up to $300
million of funding will be made available through the assignment of an undivided
interest in a specified group of unsecured receivables to a special purpose,
wholly-owned consolidated subsidiary of the Company. Under the terms of the
agreement, which has a 364-day term, with an option to extend for up to two
additional 364-day periods, WestLB issues commercial paper (indirectly secured
by the receivables), on behalf of the Company. Under this agreement, we borrowed
$150 million on August 2, 2002 and $150 million on August 8, 2002, with an
average cost of 1.83%.
Note 4 Hedging Activities
Our risk management policy provides for the use of certain derivatives and
financial instruments in managing certain interest rate risks. We do not enter
into derivatives or other financial instruments for trading or speculative
purposes.
Managed risk includes the risk associated with changes in fair value of
long-term fixed rate debt. In accordance with our risk management policy, such
risk is hedged by entering into pay floating interest rate exchange agreements.
The instruments designated in these fair value hedges include interest rate
swaps that qualify for the "short cut" method of accounting under Statement of
Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative
Instruments and Hedging Activities. Under the "short cut" method, we assume no
ineffectiveness in a hedging relationship. Since the terms of the interest rate
swap qualify for the use of the "short cut" method, it is not necessary to
measure effectiveness and there is no charge to earnings for changes in fair
value. All changes in fair value are recorded as adjustments to the basis of the
hedged borrowings based on changes in the fair value of the derivative
instrument. When derivative instruments are terminated prior to their maturity,
or the maturity of the hedged liability, any resulting gains or losses are
included as part of the basis adjustment of the hedged item and amortized over
the remaining term of the liability. At September 30, 2002, the unamortized gain
on terminated hedging transactions totaled $11.6 million. This amount is
included in senior debt on the Consolidated Statement of Financial Condition.
At September 30, 2002, we had three outstanding interest rate swap agreements
with a combined notional amount of $450.0 million and a total fair value of
$34.6 million. This amount is reflected as an adjustment to both other assets
and senior debt on the Consolidated Statement of Financial Condition.
Note 5 Legal Proceedings
The Company and several of its subsidiaries and their current and former
employees are defendants in a number of suits pending in the state and federal
courts of Mississippi. The lawsuits generally allege unfair lending and
insurance related practices. Similar suits are pending against other financial
services companies in Mississippi. In one of the pending cases, Carolyn Baker,
et al. v. Washington Mutual Finance Group, LLC f/k/a City Finance Company, a
jury awarded just over $71 million against one of the Company's subsidiaries,
Washington Mutual Finance Group, LLC, a Delaware limited liability company ("WMF
Group"). Pursuant to a motion filed by WMF Group, the trial court reduced the
verdict to just over $53 million. WMF Group is in the process of appealing the
verdict and has posted a bond to stay execution on the judgment pending the
appellate court's ruling. The appeal is still in the briefing stages. The appeal
9
will be based on numerous grounds, including the gross inequity between the
alleged economic losses of only $12,000 and the actual jury award. At least one
other case, Philisia Banks, et. al. v. City Finance Co., et. al. is expected to
go to trial before year-end and could result in an adverse verdict by year-end
or early first quarter 2003. Because of the unusual litigation environment in
Mississippi it is difficult to predict potential outcomes and losses. However,
based upon information presently available, we believe that the total amount
that will ultimately be paid, if any, after reductions and appeals, arising from
these lawsuits and proceedings will not have a material adverse effect on our
consolidated results of operations and financial position.
We are currently evaluating the business and legal environment in Mississippi.
During the evaluation process, we have suspended all new loan origination
activities and revolving loan advances to Mississippi residents. The moratorium
on new advances and originations went into effect September 30, 2002. Based on
the information available, we believe that the moratorium will not have a
material adverse effect on our consolidated results of operation and financial
position.
Note 6 Goodwill
The results for the quarter and year to date ended September 30, 2002, include
the effect of adopting SFAS No. 142, Goodwill and Other Intangible Assets. SFAS
No. 142 provides that goodwill is no longer amortized and the value of an
identifiable intangible asset must be amortized over its useful life, unless the
asset is determined to have an indefinite useful life. Goodwill must be tested
for impairment as of the beginning of the fiscal year in which SFAS No. 142 is
adopted, and at least annually thereafter. Goodwill has been tested for
impairment and it has been determined that there are no impairment losses to be
recognized in the period as a result of the impairment analysis performed as of
January 1, 2002. The adoption of SFAS No. 142 resulted in a pretax reduction in
expenses of $1.1 million for the three months ended September 30, 2002, and $3.4
million year to date.
Had the Company been accounting for its goodwill under SFAS No. 142 for all
periods presented, the Company's net income would have been as follows:
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------- ----------------------
(Dollars in thousands) 2002 2001 2002 2001
---------- ---------- ---------- ----------
Net Income:
Reported net income $ 13,187 $ 16,217 $ 41,876 $ 49,004
Add back: Goodwill previously amortized - 1,141 - 3,422
Income before income taxes, excluding ---------- ---------- ---------- ----------
amortization of goodwill 13,187 17,358 41,876 52,426
Income tax expense - (416) - (1,249)
---------- ---------- ---------- ----------
Adjusted net income $ 13,187 $ 16,942 $ 41,876 $ 51,177
========== ========== ========== ==========
Note 7 Recently Issued Accounting Standards
In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
146, Accounting for Costs Associated with Exit or Disposal Activities. This
Statement requires that a liability for costs associated with exit or
disposition activities be recognized when the liability is incurred and be
measured at fair value and adjusted for changes in estimated cash flows.
Existing generally accepted accounting principles provide for the recognition of
such costs at the date of management's commitment to exit plan. Under SFAS No.
146, management's commitment to exit plan would not be sufficient, by itself, to
10
recognize a liability. The Statement is effective for exit or disposal
activities initiated after December 31, 2002 and is not expected to have a
material impact on the results of operations or financial condition of the
Company.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions. This Statement amends Statements No. 72 and 144 and FASB
Interpretation No. 9. Among other topics, this Statement requires that an
unidentifiable intangible asset that is recognized in an acquisition of a
financial institution, in which the liabilities assumed exceed the identifiable
assets acquired, to be recorded as goodwill. Consequently, this unidentifiable
intangible asset will be subject to the goodwill accounting standards set forth
in SFAS No. 142, Goodwill and Other Intangible Assets, and will be evaluated for
impairment on an annual basis instead of being amortized. We do not own
intangible assets of this nature. Therefore, this Statement is not expected to
have a material impact on the results of operations or financial condition of
the Company.
Note 8 Discontinued Operations and Subsequent Event
On October 1, 2002, our subsidiary, Blazer Financial Corporation ("BFC")
completed the sale of its wholly-owned industrial banking subsidiary, First
Community Industrial Bank ("FCIB"), through a merger with First State Bank, NM,
formerly First State Bank of Taos, a New Mexico bank ("First State"),
wholly-owned by First State Bancorporation, a New Mexico corporation, with First
State being the surviving entity. BFC is a wholly-owned subsidiary of Washington
Mutual Finance Corporation. Prior to the sale, FCIB declared and paid a dividend
to BFC, in the amount of $37.5 million. The consideration paid by First State
for the merger was equal to $67.0 million in cash.
Net assets of the discontinued operations for the September 30, 2002 and
December 31, 2001 balance sheets are as follows:
(Dollars in thousands) September 30, December 31,
2002 2001
------------- ------------
ASSETS (Unaudited)
Consumer finance receivables, net $ 341,972 $ 365,713
Investment securities available for sale 18,945 38,822
Cash and cash equivalents 8,518 6,771
Property, equipment and leasehold improvements, net 137 205
Other assets 3,103 5,160
------------- ------------
TOTAL ASSETS $ 372,675 $ 416,671
============= ============
LIABILITIES
Federal Home Loan Bank borrowings $ 100,000 $ 110,000
Customer deposits 240,459 237,221
Accounts payable and other liabilities 1,453 5,705
------------- ------------
TOTAL LIABILITIES 341,912 352,926
------------- ------------
NET ASSETS OF DISCONTINUED
OPERATIONS $ 30,763 $ 63,745
============= ============
11
The operating results of discontinued operations are as follows:
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- ---------------------
(Dollars in thousands) 2002 2001 2002 2001
Interest income: --------- --------- --------- ----------
Loan interest and fee income $ 7,710 $ 9,293 $ 23,894 $ 28,745
Investment securities income 725 586 1,677 1,979
--------- --------- --------- ----------
Total interest income 8,435 9,879 25,571 30,724
Interest and debt expense 3,564 4,642 11,084 15,035
--------- --------- --------- ----------
Net interest income before
provision for credit losses 4,871 5,237 14,487 15,689
Provision for credit losses 1,166 296 1,770 837
--------- --------- --------- ----------
Net interest income 3,705 4,941 12,717 14,852
--------- --------- --------- ----------
Noninterest income 6 15 33 63
Noninterest expense:
Personnel 1,028 1,132 3,164 3,445
Occupancy 201 211 633 653
Advertising 8 0 9 6
Other 487 610 1,485 1,884
--------- --------- --------- ----------
Total noninterest expense 1,724 1,953 5,291 5,988
--------- --------- --------- ----------
Income before income taxes 1,987 3,003 7,459 8,927
Provision for federal and state income taxes 908 1,147 3,042 3,414
--------- --------- --------- ----------
Net income $ 1,079 $ 1,856 $ 4,417 $ 5,513
========= ========= ========= ==========
The above net assets and results of operations are not comparable with the
consumer banking financial highlights (see "Note 2, Lines of Business"), as the
consumer banking highlights include both BFC and FCIB.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Controls and Procedures
An evaluation was performed under the Supervision and with the participation of
the Company's management, including the President and the Chief Financial
Officer ("CFO"), of the effectiveness of the design and operation of the
Company's disclosure controls and procedures within 90 days before the filing
date of this quarterly report. Based on that evaluation, the Company's
management, including the President and CFO, concluded that the Company's
disclosure controls and procedures were effective. There have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls subsequent to their evaluation.
Cautionary Statements
This section contains forward-looking statements, which are not historical facts
and pertain to our future operating results. These forward-looking statements
are within the meaning of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include, but are not limited to, statements
about our plans, objectives, expectations and intentions and other statements
contained in this report that are not historical facts. When used in this
report, the words "expects," "anticipates," "intends," "plans," "believes,"
"seeks," "estimates," or words of similar meaning, or future or conditional
verbs, such as "will," "would," "should," "could," or "may" are generally
intended to identify forward-looking statements. These forward-looking
statements are inherently subject to significant business, economic and
competitive uncertainties and contingencies, many of which are beyond our
control. In addition, these forward-looking statements are subject to
assumptions with respect to future business strategies and decisions that are
subject to change. Actual results may differ materially from the results
discussed in these forward-looking statements due to the following factors,
among others: decline of collateral value; increase in delinquency rate; changes
in legislation or regulation; litigation; fluctuations in interest rates and
competition. These "Risk Factors" are discussed in further detail in our 2001
Annual Report on Form 10-K filed with the Securities and Exchange Commission,
which is incorporated herein by reference.
Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with the Consolidated Financial
Statements and Notes presented elsewhere in this Form 10-Q.
Overview
Net income for the three and nine months ended September 30, 2002 totaled $13.2
million and $41.9 million. This was an 18.7% and 14.5% decline from the $16.2
million and $49.0 million net income for the same periods of 2001. The major
driver of the decrease in net income is an increase in provision for credit
losses. Also attributed to this increase, return on average assets for the three
and nine months ended September 30, 2002 were down to 1.26% and 1.37%, from
1.60% and 1.65% in the same periods of 2001. See further discussion in
"Consolidated Results of Operations".
Consumer finance receivables (net of unearned finance charges and deferred loan
fees) increased $111.0 million or 2.9% from December 31, 2001. Our strategy
continues to target portfolio growth; however, our loan underwriting and
acquisition strategy will continue to take into account the state of the economy
in the markets we currently serve or in which we anticipate expanding.
13
At September 30, 2002, real estate secured loans comprised approximately 57% of
the total portfolio, as compared to 54% one year ago. As a result of this
continued shift in portfolio mix and the lower rates associated with real estate
loans, the overall yield earned on consumer finance receivables declined to
15.07% and 14.99% in the three and nine months ended September 30, 2002 from
15.48% and 15.51% in the same periods of 2001. See "Consolidated Results of
Operations."
Net interest spread for the three and nine months ended September 30, 2002
increased to 9.12% and 8.85% from 8.70% and 8.56% for the same periods of 2001.
Net interest margin for the three and nine months ended September 30, 2002
increased to 10.08% and 9.84% from 9.74% and 9.60% for the same periods of 2001.
These increases are primarily a result of lower cost borrowings, somewhat offset
by the shift in mix to lower-yielding real-estate loans, as discussed above.
Net charge-offs totaled $39.4 million and $119.5 million for the three and nine
months ended September 30, 2002, as compared to $31.3 million and $89.5 million
during the same periods in 2001. Charge-offs in the personal loan portfolio
increased as a result of the seasoning of the portfolio that grew significantly
in recent years, coupled with the deterioration of the economy. Charge-offs in
the real estate loan portfolio increased primarily due to the significant growth
of this portfolio over the last three years, coupled with the recent economic
downturn. Annualized net charge-offs as a percentage of average consumer finance
receivables (excluding unearned finance charges and deferred loan fees) were
4.12% in the nine months ended September 30, 2002, as compared to 3.18% in the
same period of 2001. See "Asset Quality".
Operating efficiency is defined as the ratio of noninterest expense to total
revenue (which is comprised of net interest income before provision for credit
losses and noninterest income). In the three and nine months ended September 30,
2002, our operating efficiency ratio improved to 36.91% and 38.05% from 39.72%
and 41.32% for the same periods in 2001. This improvement is due to a higher net
interest margin, coupled with reduced noninterest expenses. See "Consolidated
Results of Operations."
Critical Accounting Policies
Various elements of our accounting policies, by their nature, are inherently
subject to estimation techniques, valuation assumptions and other subjective
assessments. In particular, we have identified one policy that, due to the
judgments, estimates and assumptions inherent in this policy, is critical to an
understanding of our financial statements. This policy relates to the
methodology for the determination of our allowance for credit losses. This
policy and related judgments, estimates and assumptions are described in greater
detail in subsequent sections of Management's Discussion and Analysis and in the
notes to the financial statements included in the Company's 2001 Annual Report
on Form 10-K. In particular, Note 2 to the Consolidated Financial Statements -
"Summary of Significant Accounting Policies"- generally describes our accounting
policies. We believe that the judgments, estimates and assumptions used in the
preparation of our Consolidated Financial Statements are appropriate given the
factual circumstances at the time. However, given the sensitivity of our
Consolidated Financial Statements to this critical accounting policy, changes in
circumstances on which judgments, estimates and assumptions are based, could
result in material differences in our results of operations or financial
condition.
14
Recently Issued Accounting Standards
In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
146, Accounting for Costs Associated with Exit or Disposal Activities. This
Statement requires that a liability for costs associated with exit or
disposition activities be recognized when the liability is incurred and be
measured at fair value and adjusted for changes in estimated cash flows.
Existing generally accepted accounting principles provide for the recognition of
such costs at the date of management's commitment to exit plan. Under SFAS No.
146, management's commitment to exit plan would not be sufficient, by itself, to
recognize a liability. The Statement is effective for exit or disposal
activities initiated after December 31, 2002 and is not expected to have a
material impact on the results of operations or financial condition of the
Company.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions. This Statement amends Statements No. 72 and 144 and FASB
Interpretation No. 9. Among other topics, this Statement requires that an
unidentifiable intangible asset that is recognized in an acquisition of a
financial institution, in which the liabilities assumed exceed the identifiable
assets acquired, to be recorded as goodwill. Consequently, this unidentifiable
intangible asset will be subject to the goodwill accounting standards set forth
in SFAS No. 142, Goodwill and Other Intangible Assets, and will be evaluated for
impairment on an annual basis instead of being amortized. We do not own
intangible assets of this nature. Therefore, this Statement is not expected to
have a material impact on the results of operations or financial condition of
the Company.
Consolidated Results of Operations
Net Interest Income before Provision for Credit Losses
Net interest income before provision for credit losses for the three and nine
months ended September 30, 2002 increased 7.9% and 5.9% to $99.7 million and
$286.6 million, compared to $92.4 million and $270.7 million in the same periods
of 2001.
The increase in net interest income before provision for credit losses during
the three and nine months ended September 30, 2002 reflects growth in average
net consumer finance receivables to $3.87 billion, which was $98.1 million, or
2.6%, greater than the average balance during the same period in 2001. Partially
offsetting this portfolio growth is a 52 basis point decrease in average
portfolio yield for the nine months ended September 30, 2002, compared to the
same period of 2001. This yield compression is primarily a result of lower
written rates on both our secured and unsecured loans, although the yield on the
unsecured portfolio improved in the third quarter. In addition, the secondary
market in which we purchase second mortgages through our subsidiary Aristar
Mortgage is highly sensitive to interest rate indices. Accordingly, the yield on
our secured portfolio reflects the significant decline in rates that occurred
throughout 2001 and have continued this year. In addition, due to laws in some
states, as loan size increases, the maximum interest rate allowed by law
decreases.
Average debt outstanding remained stable, increasing only $19.6 million or 0.6%,
to $3.36 billion during the nine months ended September 30, 2002, as compared to
the same period in the prior year. As a result of improved debt management,
through lower cost borrowings, the associated interest expense decreased. The
overall cost of debt decreased 87 and 92 basis points for the three and nine
months ended September 30, 2002, as compared to the same periods in 2001.
15
The following chart reflects the average balances and related effective yields
during the three and nine months ended September 30, 2002 and 2001, as described
above:
(Dollars in thousands) Three Months Ended September 30, Nine Months Ended September 30,
----------------------------------------- ------------------------------------------
2002 2001 2002 2001
------------------- -------------------- -------------------- --------------------
Average Average Average Average
Balance Rate Balance Rate Balance Rate Balance Rate
Interest-earning assets: ----------- ----- ----------- ----- ----------- ----- ----------- -----
Consumer finance receivables:
Real estate secured loans $ 2,225,104 11.96% $ 2,065,845 12.77% $ 2,151,604 11.99% $ 2,042,252 12.80%
Other installment loans 1,429,463 20.82 1,408,339 20.69 1,415,263 20.64 1,396,333 20.91
Retail installment contracts 278,890 10.48 326,733 10.18 299,209 9.84 329,867 9.45
Total consumer ----------- ----------- ----------- -----------
finance receivables 3,933,457 15.07 3,800,917 15.48 3,866,076 14.99 3,768,452 15.51
Cash, cash equivalents and
investment securities 217,459 4.21 211,528 5.67 215,622 4.00 210,297 6.27
----------- ----------- ----------- -----------
Total interest-earning
assets $ 4,150,916 14.50% $ 4,012,445 14.96% $ 4,081,698 14.41% $ 3,978,749 15.02%
=========== =========== =========== ===========
Interest-bearing liabilities:
Senior debt $ 2,531,456 6.20% $ 2,814,215 6.55% $ 2,595,679 6.27% $ 2,546,101 6.77%
Commercial paper 548,490 2.29 196,468 3.43 428,114 2.12 449,477 5.26
Customer deposits 232,059 3.99 225,904 5.79 234,344 4.19 211,992 6.09
FHLB borrowings 100,750 4.92 113,988 4.75 101,680 4.84 132,675 5.32
----------- ----------- ----------- -----------
Total interest-bearing
liabilities $ 3,412,755 5.39% $ 3,350,575 6.26% $ 3,359,817 5.55% $ 3,340,245 6.47%
=========== =========== =========== ===========
Net interest spread 9.12% 8.70% 8.86% 8.56%
Net interest margin 10.08% 9.74% 9.84% 9.60%
The dollar amounts of interest income and interest expense fluctuate depending
upon changes in amounts (volume) and upon changes in interest rates of our
interest-earning assets and interest-bearing liabilities.
Changes attributable to (i) changes in volume (changes in average outstanding
balances multiplied by the prior period's rate), (ii) changes in rate (changes
in average interest rate multiplied by the prior period's volume), and (iii)
changes in rate/volume (changes in rate times the change in volume that were
allocated proportionately to the changes in volume and the changes in rate) were
as follows:
(Dollars in thousands) Three Months Ended September 30, Nine Months Ended September 30,
2002 vs. 2001 2002 vs. 2001
-------------------------------------- ----------------------------------------
Increase/(Decrease) Due to Increase/(Decrease) Due to
Volume Rate Total Change Volume Rate Total Change
Interest income: ---------- ----------- ------------ ---------- ------------ ------------
Consumer finance
receivables $ 4,995 $ (3,855) $ 1,140 $ 10,974 $ (14,815) $ (3,841)
Investment securities 62 (771) (709) 160 (3,589) (3,429)
---------- ----------- ------------ ----------- ------------ ------------
Total interest income 5,057 (4,626) 431 11,134 (18,404) (7,270)
Interest expense:
Interest-bearing
liabilities 837 (7,313) (6,476) 815 (22,834) (22,019)
---------- ----------- ------------ ----------- ------------ ------------
Net interest income $ 4,220 $ 2,687 $ 6,907 $ 10,319 $ 4,430 $ 14,749
========== =========== ============ =========== ============ ============
16
Provision for Credit Losses
The provision for credit losses for the three and nine months ended September
30, 2002 was $48.4 million and $131.2 million compared to $35.6 million and
$99.1 million in the same periods of 2001. For the nine months ended September
30, 2002, the annualized provision for credit losses from continuing operation
was 5.0% of average consumer finance receivables (excluding unearned finance
charges and deferred loan fees), as compared to 3.9% during the same period of
2001. See further discussion in "Allowance for Credit Losses."
Noninterest Income
Noninterest income increased 12.2% to $6.7 million for the three months ended
September 30, 2002, compared to $5.9 million during the same period in 2001.
Noninterest income decreased 5.8% to $19.4 million for the nine months ended
September 30, 2002, compared to $20.6 million for the same period in 2001.
Noninterest income is comprised of revenue earned from the sale of various
credit insurance and ancillary products to borrowers at the branch locations.
These products include credit life insurance, accident and health insurance,
credit property and casualty insurance, term life protector, accidental death
and dismemberment insurance (discontinued on February 1, 2002), involuntary
unemployment insurance, auto single interest and appliance warranty programs
(discontinued in all states but Florida on January 1, 2002 and in Florida on
June 1, 2002). Additionally, group debtor life insurance was included as one of
our ancillary products in 2001. However, it was discontinued on July 2, 2001.
The decrease in 2002 in year-to-date income from credit insurance products is
due primarily to the decision to discontinue the sale of insurance products in
Mississippi as of June 2001, to discontinue the sale of single premium credit
life and accident and health insurance on closed-end real estate loans in all
other branch states as of July 2001, and to discontinue the sale of accidental
death and dismemberment insurance and appliance warranty programs during 2002.
These decisions were made in response to growing concern that the products were
not fully meeting the needs of consumers. An alternative product, intended to be
more responsive to customer needs and desires, has been developed and is being
introduced on a graduated basis in almost every branch state. The product,
monthly outstanding balance credit life insurance, provides for premiums to be
billed monthly instead of financed at the beginning of the loan. The product has
already been introduced in sixteen branch states through the third quarter of
2002, and is anticipated to be in each of our major branch states by the end of
the first quarter of 2003. Also contributing to the decline in income from
credit insurance products is a decrease in the number of loans originated during
the nine months ended September 30, 2002, as compared to the same period in
2001.
Noninterest Expense
Noninterest expense for the three and nine months ended September 30, 2002
decreased 2.4% and 6.1% to $39.2 million and $116.4 million, as compared to
$40.2 million and $123.9 million for the same periods in 2001. The decrease in
noninterest expense is attributed to continued cost-containment efforts, begun
in the second half of 2001. There were several factors contributing to the
expense improvements over prior year. Year to date personnel expense decreased
5.7%, due to the consolidation of 50 branches in December 2001, as well as the
centralization of certain funding and posting functions from sales offices to
the customer care center in Pensacola during 2002. The centralization effort was
identified as one of our cost-containment initiatives and has enabled us to
reduce headcount by approximately 240 employees company-wide, during 2002. In
2001, data processing and telecommunication charges associated with introducing
a company-wide network in our branch locations caused our other operating
17
expenses to be high. Due to the near-completion of the network, coupled with
recent cost-containment efforts, data processing and telecommunication charges
for the nine months ended September 30, 2002 are approximately 20.2% below the
same period for 2001. These were somewhat offset by an increase in expenses
associated with our direct mail marketing strategy.
Lines of Business
Through October 1, we were managed along two major lines of business: Consumer
Finance and Consumer Banking (see "subsequent event"). Following is an overview
of the performance of each line of business in the three and nine months ended
September 30, 2002:
Consumer Finance
o Net income decreased 16.2% and 14.6% to $12.1 million and $37.5 million for
the three and nine months ended September 30, 2002 from $14.5 million and
$43.9 million in the same periods of 2001.
o The Consumer Finance receivables portfolio (net of unearned finance charges
and deferred loan fees) increased $134.5 million or 3.9% during the nine
months ended September 30, 2002.
o Net interest margin increased as a result of lower cost of funds, as well
as improved yields on personal loans and sales finance loans. See
discussion in "Consolidated Results of Operations".
Consumer Banking
o Net income decreased 38.8% and 14.1% to $1.1 million and $4.4 million for
the three and nine months ended September 30, 2002, compared to $1.8
million and $5.1 million during the same periods of 2001.
o The Consumer Banking receivables portfolio decreased $23.5 million or 6.3%
during the nine months ended September 30, 2002.
o Net interest margin decreased as a result of an overall decline in earned
yields due to the adjustable-rate nature of much of the receivables
portfolio.
18
Asset Quality
Consumer Finance Receivables
Consumer finance receivables consisted of the following:
September 30, December 31,
(Dollars in thousands) 2002 2001
------------- ------------
Consumer finance receivables:
Real estate secured loans $ 2,509,899 $ 2,357,780
Other installment loans 1,617,402 1,632,337
Retail installment contracts 316,872 385,298
------------- ------------
Gross consumer finance receivables 4,444,173 4,375,415
Less: Unearned finance charges and
deferred loan fees (477,850) (520,069)
Allowance for credit losses (139,500) (126,022)
------------- ------------
Consumer finance receivables, net $ 3,826,823 $ 3,729,324
============= ============
Allowance for Credit Losses
Activity in the allowance for credit losses was as follows:
Nine Months Ended September 30,
-------------------------------
(Dollars in thousands) 2002 2001
------------- ------------
Balance, beginning of period $ 126,022 $ 104,587
Provision for credit losses from
continuing operations 131,161 99,126
Provision for credit losses from
discontinued operations 1,770 837
------------ ------------
Total provision for credit losses 132,931 99,963
Amounts charged-off:
Real estate secured loans (7,789) (4,948)
Other installment loans (114,711) (89,161)
Retail installment contracts (12,061) (9,763)
------------- ------------
(134,561) (103,872)
Recoveries:
Real estate secured loans 368 220
Other installment loans 12,829 12,230
Retail installment contracts 1,911 1,925
------------- ------------
15,108 14,375
------------- ------------
Net charge-offs (119,453) (89,497)
------------- ------------
Allowances on notes purchased $ - 150
------------- ------------
Balance, end of period $ 139,500 $ 115,203
============= ============
In order to establish our allowance for credit losses, the consumer finance
receivables portfolio is segmented into two categories: real estate secured and
non-real estate secured (other installment loans and retail installment
contracts). The determination of the level of the allowance for credit losses
and, correspondingly, the provision for credit losses for these homogeneous loan
pools rests upon various judgments and assumptions used to determine the risk
characteristics of each portfolio. These judgments are supported by analyses
that fall into three general categories: (i) economic conditions as they relate
to our current customer base and geographic distribution; (ii) a predictive
analysis of the outcome of the current portfolio (a migration analysis); and
19
(iii) prior loan loss experience. Additionally, every real estate secured loan
that reaches 60 days delinquency is reviewed by our credit administration
management to assess collectibility and determine a future course of action, at
times resulting in the need to foreclose on the property.
Management establishes the allowance for credit losses based on estimated losses
inherent in the portfolio. There are several underlying factors in our portfolio
that support our current level of allowance for credit losses. We analyze our
reserves based on both trailing coverage and forward looking coverage. Trailing
coverage represents the percentage of coverage we currently have in the
allowance, based on the previous 12 months of losses. Forward looking coverage
represents the percentage of coverage we have in the allowance, based on
estimated losses inherent in the portfolio over the next 12 months. Our trailing
coverage is slightly lower compared to the same period last year, and our
forward looking coverage has improved when comparing the same period of time.
Loan to value ("LTV") represents dollars loaned as a percentage of the value of
the collateral of our real estate secured loans. Lower LTV means lower risk. Our
active management of the real estate secured portfolio has focused on reducing
the LTV on new originations, which has resulted in a reduction of the LTV for
the overall portfolio. This has been partially offset by an increase in LTV of
acquired loans through the Aristar Mortgage channel. This increase reflects our
improved underwriting criteria utilized in selecting these accounts for
purchase.
Based on industry-defined economic status, we have identified states that are in
or near recession, and have focused our unsecured lending efforts into
non-recessionary states. As a result of our stricter underwriting standards, we
have slowed the growth of unsecured loans, while increasing the weighted average
credit score of the portfolio, and continued to remix toward a higher percentage
of real estate secured loans. The increased proportion of secured loans in the
portfolio, coupled with the stronger collateral position, as well as improved
unsecured guidelines, is expected to result in a relative decrease in credit
losses as the portfolio continues to season in 2002 and beyond.
Our allowance for credit losses as of September 30, 2002 was $139.5 million, an
increase of $13.5 million, or 10.7% as compared to December 31, 2001. Based on
our historical data and strengthened underwriting criteria, management considers
the allowance for credit losses adequate to cover losses inherent in the
portfolio at September 30, 2002. No assurance can be given that we will not, in
any particular period, sustain credit losses that are sizable in relation to the
amount reserved, or that subsequent evaluation of the portfolio, in light of the
factors then prevailing, including economic conditions and our ongoing
examination process and that of our regulators, will not require significant
increases in the allowance for credit losses.
The following table sets forth, by loan type, the amount of receivables
delinquent for 60 days or more, on a contractual basis, and the ratio of that
amount to gross consumer finance receivables outstanding in each category:
(Dollars in thousands) September 30, 2002 December 31, 2001
------------------ -----------------
Real estate secured loans $ 42,963 1.72% $ 48,386 2.06%
Other installment loans 94,590 5.85 93,987 5.76
Retail installment contracts 9,842 3.12 10,734 2.79
--------- ----- --------- -----
$ 147,395 3.32% $ 153,107 3.51%
========= ===== ========= =====
20
Liquidity
We fund our operations through a variety of corporate borrowings. The primary
source of these borrowings is corporate debt securities issued by the Company.
At September 30, 2002, eight different fixed-rate senior debt issues totaling
$2.49 billion were outstanding, with a weighted-average coupon rate of 6.96%.
To meet our short-term funding needs, we typically issue commercial paper. We
have a commercial paper program with several investment banks which provides
$500 million in borrowing capacity. At September 30, 2002, under this program,
seventeen different commercial paper borrowings totaling $260.8 million were
outstanding, with an average cost of 1.90%. Additionally, on July 31, 2002, we
entered into an agreement with Westdeutsche Landesbank Girozentrale ("WestLB")
to participate in a $300 million asset-backed commercial paper conduit program.
Under this program, administered by WestLB, up to $300 million of funding will
be made available through the assignment of an undivided interest in a specified
group of unsecured receivables to a special purpose, wholly-owned consolidated
subsidiary of the Company. Under the terms of the agreement, which has a 364-day
term, with an option to extend for up to two additional 364-day periods, WestLB
issues commercial paper (indirectly secured by the receivables), on behalf of
the Company. Under this agreement, we borrowed $150 million on August 2, 2002
and $150 million on August 8, 2002, with an average cost of 1.83%. Under the two
programs, combined, we had commercial paper outstanding of $560.8 million at
September 30, 2002.
We also share, with Washington Mutual, an $800 million 3-year revolving credit
facility, which provides back-up for our commercial paper programs. Previously,
we shared two revolving credit facilities, which provided combined back-up of
$1.2 billion. Effective August 12, 2002 the facilities were restructured into
the existing $800 million 3-year credit facility. The borrowing capacity is
limited to the amount of the credit facility, net of the amount of combined
commercial paper outstanding. At September 30, 2002, there was $239.2 million
available under the facility. There were no direct borrowings under this
facility or the previously existing facilities at any point during 2002 or 2001.
First Community Industrial Bank ("FCIB") raised funds through customer deposits
and borrowings with the Federal Home Loan Bank. At September 30, 2002, the
banking subsidiary's outstanding debt totaled $340.5 million, with a
weighted-average cost of 4.54%. See "Subsequent Event".
21
Subsequent Event
On October 1, 2002, our subsidiary, Blazer Financial Corporation ("BFC")
completed the sale of its subsidiary, FCIB, to First State Bank, NM, formerly
First State Bank of Taos, a New Mexico bank ("First State").
Capital Management
We establish equity leverage targets based upon the ratio of debt (including
customer deposits) to tangible equity. The debt to tangible equity ratio at
September 30, 2002 of 6.57:1 is consistent with the ratio of 6.50:1 at December
31, 2001. The determination of our dividend payments and resulting capital
leverage is managed in a manner consistent with our desire to maintain strong
and improved credit ratings. In addition, provisions of certain of our debt
agreements restrict the payment of dividends to a maximum prescribed proportion
of cumulative earnings and contributed capital. At September 30, 2002,
approximately $132.6 million was available under the debt agreement restriction
for future dividends. We declared dividends in the amount of $15.0 million and
$45.0 million during the three and nine months ended September 30, 2002. The
$15.0 million declared during the third quarter will be paid early in the fourth
quarter. All other amounts have been paid. Due to the rapid growth in our
consumer finance receivables portfolio during the second quarter of 2002, and in
order for us to maintain strong credit ratings, Washington Mutual contributed
capital totaling $9.5 million.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The table below indicates the sensitivity of net interest income and net income
before taxes to interest rate movements. The comparative scenarios assume that
interest rates rise or fall in even monthly increments over the next twelve
months for a total increase of 200 or decrease of 100 basis points. The interest
rate scenarios are used for analytical purposes and do not necessarily represent
management's view of future market movements.
Our net interest income and net income before taxes sensitivity profiles as of
September 30, 2002 and December 31, 2001 are stated below:
Gradual Change in Rates
-----------------------
Net interest income change for the one year period beginning: -100bp +200bp
--------- ----------
October 1, 2002 .32% (1.70)%
January 1, 2002 .20% (.34)%
Net income before taxes change for the one year period beginning: -100bp +200bp
--------- --------
October 1, 2002 .86% (4.61)%
January 1, 2002 .55% (.92)%
Our net interest income and net income before taxes "at risk" position has
increased since December 31, 2001. The change reflects increased sensitivity to
interest rate movement, primarily associated with the resumption of short-term
financing needs. At September 30, 2002, the commercial paper balance outstanding
was $560.8 million (17.5% of total outstandingdebt), and at December 31, 2001
the commercial paper balance outstanding was $351.1 million (11.2% of total
outstanding debt). In general, changes in rates do not have a significant impact
on our income, as our customers are less rate sensitive and the majority of our
borrowings are fixed rate. Assumptions are made in modeling the sensitivity of
net interest income and net income before taxes. The simulation model captures
expected prepayment behavior under changing interest rate environments.
Sensitivity of new loan volume to market interest rate levels is included as
well.
22
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company and several of its subsidiaries and their current and former
employees are defendants in a number of suits pending in the state and federal
courts of Mississippi. The lawsuits generally allege unfair lending and
insurance related practices. Similar suits are pending against other financial
services companies in Mississippi. In one of the pending cases, Carolyn Baker,
et al. v. Washington Mutual Finance Group, LLC f/k/a City Finance Company, a
jury awarded just over $71 million against one of the Company's subsidiaries,
Washington Mutual Finance Group, LLC, a Delaware limited liability company ("WMF
Group"). Pursuant to a motion filed by WMF Group, the trial court reduced the
verdict to just over $53 million. WMF Group is in the process of appealing the
verdict and has posted a bond to stay execution on the judgment pending the
appellate court's ruling. The appeal is still in the briefing stages. The appeal
will be based on numerous grounds, including the gross inequity between the
alleged economic losses of only $12,000 and the actual jury award. At least one
other case, Philisia Banks, et. al. v. City Finance Co., et. al. is expected to
go to trial before year-end and could result in an adverse verdict by year-end
or early first quarter 2003. Because of the unusual litigation environment in
Mississippi it is difficult to predict potential outcomes and losses. However,
based upon information presently available, we believe that the total amount
that will ultimately be paid, if any, after reductions and appeals, arising from
these lawsuits and proceedings will not have a material adverse effect on our
consolidated results of operations and financial position.
We are currently evaluating the business and legal environment in Mississippi.
During the evaluation process, we have suspended all new loan origination
activities and revolving loan advances to Mississippi residents. The moratorium
on new advances and originations went into effect September 30, 2002. Based on
the information available, we believe that the moratorium will not have a
material adverse effect on our consolidated results of operation and financial
position.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit
Number
(3) (a) Certificate of Incorporation of Washington Mutual Finance
Corporation. as presently in effect. (i)
(b) By-Laws of Washington Mutual Finance Corporation as presently
in effect. (iii)
(4) (a) Indenture dated as of July 1, 1995 between Aristar, Inc. and
The Bank of New York, as trustee. (ii)
(b) Indenture dated as of October 1, 1997 between Aristar, Inc.
and First Union National Bank, as trustee. (iii)
(c) Indenture dated as of November 15, 1997 between Aristar, Inc.
and First Union National Bank, as trustee. (iv)
(d) Indenture dated as of June 23, 1999 between Aristar, Inc. and
Harris Trust and Savings Bank, as trustee.(iv)
(e) The registrant hereby agrees to furnish the Securities and
Exchange Commission upon request with copies of all instruments
defining rights of holders of long-term debt of Washington
Mutual Finance Corporation and its consolidated subsidiaries.
(99) (a) Certification of the President. (filed herewith)
(b) Certification of the Chief Financial Officer. (filed herewith)
23
(i) Incorporated by reference to Registrant's Annual Report on Form
10-K for the year ended December 31, 1987, Commission file
number 1-3521.
(ii) Incorporated by reference to Registrant's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1995, Commission
file number 1-3521.
(iii) Incorporated by reference to Registrant's Current Report on
Form 8-K dated October 6, 1997, Commission file number 1-3521.
(iv) Incorporated by reference to Registrant's Report on Form 424B2
dated November 6, 1997, Commission file number 1-3521.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the period covered by this Report.
24
SIGNATURE
Pursuant to the requirements of Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on November 14, 2002.
WASHINGTON MUTUAL FINANCE CORPORATION
By: /s/ CRAIG A. STEIN
------------------------------------
Craig A. Stein
Vice President,Controller and Acting
Chief Financial Officer
(Principal Accounting Officer)
CERTIFICATIONS
I, Daniel J. Gilbert, certify that:
1) I have reviewed this quarterly report on Form 10-Q of Washington Mutual
Finance Corporation;
2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing
the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employee who have a significant role in the registrant's internal
controls; and
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6) The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective action with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002
By: /s/ DANIEL J. GILBERT
------------------------------
Daniel J. Gilbert
President of Washington
Mutual Finance Corporation
I, Craig A. Stein, certify that:
1) I have reviewed this quarterly report on Form 10-Q of Washington Mutual
Finance Corporation
2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employee who have a significant role in the registrant's internal
controls; and
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective action with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002
By: /s/ CRAIG A. STEIN
------------------------------
Craig A. Stein
Acting Chief Financial Officer of
Washington Mutual Finance
Corporation