Back to GetFilings.com
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
- --------------------------------------------------------------------------------
FORM 10-K
- --------------------------------------------------------------------------------
(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, 2000.
|X| 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 28, 2001, on the New York Stock Exchange was $923,319,826.
At February 28, 2001, 28,211,048 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 25, 2001 are
incorporated by reference in Part III hereof.
================================================================================
TABLE OF CONTENTS
ITEM PAGE
- --------------------------------------------------------------------------------
PART I
1. BUSINESS.......................................................... 1
General........................................................ 1
Banking Activities............................................. 2
Lending Activities........................................... 2
Loan and Mortgage-Backed Securities Portfolio.............. 3
Residential Real Estate Lending............................ 3
Secondary Marketing and Loan Servicing Activities.......... 5
Commercial Real Estate and Multi-Family Lending............ 6
Construction Lending....................................... 6
Commercial Lending......................................... 6
Consumer Lending........................................... 6
Investment Activities........................................ 7
Deposit Activities........................................... 7
Borrowing Activities......................................... 7
Capital Securities........................................... 8
Asset/Liability Management................................... 8
Earnings Spread.............................................. 8
Insurance Agency Activities.................................. 9
Real Estate Investment Activities.............................. 9
Competition.................................................... 9
Employees...................................................... 10
Regulation..................................................... 10
General...................................................... 10
Regulation of Downey......................................... 10
Regulation of the Bank....................................... 12
Regulation of DSL Service Company............................ 19
Taxation....................................................... 20
Factors That May Affect Future Results......................... 20
2. PROPERTIES........................................................ 22
Branches....................................................... 22
Electronic Data Processing..................................... 22
3. LEGAL PROCEEDINGS................................................. 22
4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS................... 22
PART II
5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS............................................ 23
6. SELECTED FINANCIAL DATA........................................... 24
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS...................................... 26
Overview....................................................... 26
Results of Operations.......................................... 28
Net Interest Income......................................... 28
Provision for Loan Losses................................... 30
Other Income................................................ 31
Loan and Deposit Related Fees............................ 31
Real Estate and Joint Ventures Held for Investment....... 31
Secondary Marketing Activities .......................... 32
Other Category........................................... 32
i
TABLE OF CONTENTS
ITEM PAGE
- --------------------------------------------------------------------------------
PART II----(CONTINUED)
Operating Expenses.......................................... 32
Provision for Income Taxes.................................. 32
Business Segment Reporting.................................. 33
Banking.................................................. 33
Real Estate Investment................................... 34
Financial Condition............................................ 35
Loans and Mortgage-Backed Securities........................ 35
Investment Securities....................................... 38
Investments in Real Estate and Joint Ventures............... 39
Deposits.................................................... 41
Borrowings.................................................. 43
Capital Securities.......................................... 44
Asset/Liability Management and Market Risk.................. 44
Problem Loans and Real Estate............................... 48
Non-Performing Assets.................................... 48
Delinquent Loans......................................... 50
Allowance for Losses on Loans and Real Estate............ 52
Capital Resources and Liquidity............................. 57
Regulatory Capital Compliance............................... 58
Current Accounting Issues................................... 59
Sale of Subsidiary.......................................... 61
8. FINANCIAL STATEMENTS.............................................. 62
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES........................... 108
PART III
10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................ 108
11. EXECUTIVE COMPENSATION............................................ 108
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT..................................................... 108
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................... 108
PART IV
14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K.................................................... 108
SIGNATURES ................................................................111
ii
PART I
Certain matters discussed in this Annual Report may constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 (the "Reform Act") and, as such, may involve risks
and uncertainties. These forward-looking statements relate to, among other
things, expectations of the business environment in which Downey Financial Corp.
("Downey," "we," "us" and "our") operates, projections of future performance,
perceived opportunities in the market and statements regarding Downey's mission
and vision. Downey's actual results, performance or achievements may differ
significantly from the results, performance or achievements expressed or implied
in such forward-looking statements. For discussion of the factors that might
cause such a difference, see Business--Factors That May Affect Future Results on
page 20.
ITEM 1. BUSINESS
GENERAL
We were incorporated in Delaware on October 21, 1994. On January 23, 1995,
after we obtained necessary stockholder and regulatory approvals, we acquired
100% of the issued and outstanding capital stock of Downey Savings and Loan
Association (the "Bank") and the Bank's stockholders became holders of our
stock. Downey was thereafter funded by the Bank and presently operates as the
Bank's holding company. Our stock is traded on the New York Stock Exchange and
Pacific Exchange under the trading symbol "DSL."
The Bank was formed in 1957 as a California-licensed savings and loan
association and converted to a federal charter in 1995. As of December 31, 2000,
it conducts its business through 114 retail deposit branches, including 49
full-service in-store branches. Residential loans are originated by residential
loan officers who work out of 46 of the Bank's California retail deposit
branches. Residential loan officers also originate residential loans through the
Internet from two California call centers. Wholesale loans submitted by mortgage
brokers are originated from six California loan origination centers, two of
which are located in or by a Bank office.
The Bank is regulated or affected by the following governmental entities
and laws:
o As a federally chartered savings association, the Bank's activities
and investments are generally governed by the Home Owners' Loan Act,
as amended, and regulations and policies of the Office of Thrift
Supervision (the "OTS").
o The Bank and Downey are subject to the primary regulatory and
supervisory jurisdiction of the OTS.
o As a federally insured depository institution, the Bank is regulated
and supervised by the Federal Deposit Insurance Corporation (the
"FDIC") with respect to some of its activities and investments.
o The Bank is a member of the Federal Home Loan Bank (the "FHLB") of San
Francisco, which is one of the 12 regional banks for federally insured
depository institutions comprising the Federal Home Loan Bank System.
o The Bank's savings deposits are insured through the Savings
Association Insurance Fund ("SAIF") of the FDIC, an instrumentality of
the United States government.
o The Bank is regulated by the Federal Reserve with respect to reserves
the Bank is required to maintain against deposits and other matters.
General economic conditions, the monetary and fiscal policies of the
federal government and the regulatory policies of governmental authorities
significantly influence our operations. Additionally, interest rates on
competing investments and general market interest rates influence our deposit
flows and the costs we incur on interest-bearing liabilities, which represents
our cost of funds. Similarly, market interest rates and other factors that
affect the supply of and demand for housing and the availability of funds affect
our loan volume and our yields on loans and mortgage-backed securities.
Our primary business is banking and we are also involved in real estate
investments, each of which we discuss further below.
1
BANKING ACTIVITIES
Our primary business is banking. Our banking activities focus on:
o attracting funds from the general public and institutions; and
o originating and investing in loans, primarily residential real estate
mortgage loans, investment securities and mortgage-backed securities.
These mortgage-backed securities include mortgage pass-through securities issued
by other entities and securities issued or guaranteed by government-sponsored
enterprises like the Federal National Mortgage Association, the Federal Home
Loan Mortgage Corporation and the Government National Mortgage Association.
Our primary sources of revenue from our banking business are:
o interest we earn on loans, investment securities and mortgage-backed
securities;
o fees we earn in connection with loans and deposits;
o gains on sales of our loans, investment securities and mortgage-backed
securities; and
o income we earn on loans and mortgage-backed securities we service for
investors.
Our principal expenses in connection with our banking business are:
o interest we incur on our interest-bearing liabilities, including
deposits, borrowings and capital securities; and
o general and administrative costs.
Our primary sources of funds from our banking business are:
o deposits;
o principal and interest payments on our loans and mortgage-backed
securities;
o proceeds from sales of our loans and mortgage-backed securities; and
o borrowings and capital securities.
Scheduled payments we receive on our loans and mortgage-backed securities are a
relatively stable source of funds. However, the funds we receive from deposits
and prepayment of loans and mortgage-backed securities vary widely. Below is a
detailed discussion of our banking activities.
LENDING ACTIVITIES
Historically, our lending activities have primarily emphasized our
origination of first mortgage loans secured by residential properties and retail
neighborhood shopping centers. To a lesser extent, our lending activities have
emphasized our origination of real estate loans secured by multi-family and
commercial and industrial properties, including office buildings, land and other
properties with income producing capabilities. In addition, we have provided
construction loan financing for single family and multi-family residential
properties and commercial retail neighborhood shopping center projects. These
construction loan financings have included loans to joint ventures, which were
being engaged in by DSL Service Company, a wholly owned subsidiary of the Bank,
with other participants. We also originate loans to businesses through our
commercial banking operations.
We originate automobile loans directly through our branch network. We also
conducted an indirect auto-lending program through our purchase of new or used
automobile sales contracts from auto dealers in California and other western
states. Downey Auto Finance Corp., a previous wholly owned subsidiary of the
Bank, operated this indirect auto-lending program, but was sold in February
2000. For more information, see Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition--Sale of
Subsidiary on page 61.
Our primary focus will continue to be our origination of:
o adjustable rate single family mortgage loans, including subprime loans
which carry higher interest rates; and
2
o consumer loans.
We will also continue our secondary marketing activities of originating and
selling single family loans to various investors.
For more information, see below under the caption entitled Secondary
Marketing and Loan Servicing Activities on page 5. For additional information on
the composition of our loan and mortgage-backed securities portfolio, see
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Financial Condition--Loans and Mortgage-Backed Securities on page
35.
LOAN AND MORTGAGE-BACKED SECURITIES PORTFOLIO
We carry loans receivable held for investment at cost. Our net loans
receivable are adjusted for amortization of premiums and accretion of discounts
which are recognized in interest income using the interest method. Our
investments in mortgage-backed securities represent participating interests in
pools of first mortgage loans originated and serviced by the issuers of the
securities. We carry mortgage-backed securities held to maturity at unpaid
principal balances, which are adjusted for unamortized premiums and unearned
discounts. We amortize premiums and discounts on mortgage-backed securities by
using the interest method over the remaining period to contractual maturity,
adjusted for anticipated prepayments.
We identify loans that may be sold before their maturity. In our balance
sheets, we classify these as loans held for sale and record them at the lower of
amortized cost or market value. We recognize net unrealized losses on these
loans, if any, in a valuation allowance by making charges to our income.
We carry mortgage-backed securities available for sale at fair value. We
report net unrealized gains or losses on these securities net of income taxes in
stockholders' equity and as a separate component of our other comprehensive
income until realized.
The residential mortgage loans we originate typically have contractual
maturities at origination of 15 to 40 years. To limit the interest rate risk
associated with these 15- to 40-year maturities, we, among other things,
principally originate adjustable rate mortgages for our own loan portfolio. We
originate fixed rate loans with the intention to sell the majority of them in
the secondary market on a non-recourse basis for cash. However, we occasionally
originate fixed rate loans for our own portfolio to facilitate the sale of real
estate we acquire in settlement of loans or which meet specific yield and other
approved guidelines. For more information, see Asset/Liability Management on
page 8. In addition, the average term of these fixed rate mortgage loans we
originate for our own portfolio historically has been significantly shorter than
their contractual maturity due to loan payoffs as a result of home sales or
refinancings and prepayments.
RESIDENTIAL REAL ESTATE LENDING
Our primary lending activity is our origination of mortgage loans secured
by single family residential properties consisting of one-to-four units located
primarily in California. We provide these mortgage loans for borrowers to
purchase residences or to refinance their existing mortgages at lower rates or
upon different terms. Our primary strategy is to originate adjustable rate
mortgages for our portfolio of loans we hold for investment. For more
information, see Asset/Liability Management on page 8. We also originate
residential fixed rate mortgage loans to meet consumer demand, but we intend to
sell the majority of these loans in the secondary market, rather than hold them
in our portfolio. We may, however, place residential fixed rate loans in our
portfolio of loans held for investment if these fixed rate loans are funded with
long-term funds to mitigate interest rate risk. In addition, we originate a
small volume of fixed rate loans for our own investment if they meet specific
yield and other approved guidelines or to facilitate our sale of real estate
acquired in settlement of loans. For more information, see Secondary Marketing
and Loan Servicing Activities on page 5.
Our adjustable rate mortgages generally:
o begin with an incentive interest rate, which is an interest rate below
the current market rate, that adjusts to the applicable index plus a
defined spread, subject to periodic and lifetime caps, after one,
three, six or twelve months;
o provide that the maximum interest rate we can charge borrowers cannot
exceed the incentive rate by more than six to nine percentage points,
depending on the type of loan and the initial rate offered; and
3
o limit interest rate adjustments to 1% per adjustment period for those
that adjust semi-annually and 2% per adjustment period for those that
adjust annually.
Most of our adjustable rate mortgages adjust monthly instead of
semi-annually. These monthly adjustable rate mortgages:
o have a lifetime interest rate cap, but no specified periodic interest
rate adjustment cap;
o have a periodic cap on changes in required monthly payments, which
adjust annually; and
o allow for negative amortization, which is the addition to loan
principal of accrued interest that exceeds the required monthly loan
payments.
Regarding negative amortization, if a loan incurs significant negative
amortization, then there is an increased risk that the market value of the
underlying collateral on the loan would be insufficient to satisfy fully the
outstanding principal and interest. We currently impose a limit on the amount of
negative amortization, so that the principal plus the added amount cannot exceed
110% of the original loan amount. In the past, the limit was 125% on loans with
an original loan-to-value ratio of 80% or less. A loan-to-value ratio is the
ratio of the principal amount of the loan to the appraised value at origination
of the property securing the loan. At year-end 2000, loans with the higher limit
on negative amortization represented about one-third of our adjustable rate
one-to-four unit residential portfolio. We permit adjustable rate mortgages to
be assumed by qualified borrowers.
During 2000, approximately 87% of our one-to-four unit residential real
estate loans were obtained by our wholesale loan representatives but originated
through outside mortgage brokers. We pay our wholesale loan representatives on a
commission basis. We consider the compensation we pay outside mortgage brokers
when we set the overall price of our mortgage loan products. These mortgage
brokers do not operate from our offices and are not our employees. Our retail
loan account representatives generated approximately 13% of our one-to-four unit
residential loans during 2000. We compensate our retail loan account
representatives located in our call centers on a salary basis plus a fixed
amount per loan they originate. Retail loan account representatives located in
our branch offices are compensated on a commission only basis. Retail loan
account representatives typically receive loan referrals from real estate
agents, builders and customers. Our call centers receive loan referrals from
retail advertising and other sources, including over the Internet.
We require that our residential real estate loans be approved at various
levels of management, depending upon the amount of the loan. On a single family
residential loan we originate for our portfolio, the maximum amount we generally
will lend is $1 million. Our average loan size, however, is much lower. In 2000,
our average loan size was $260,210. We generally make loans with loan-to-value
ratios not exceeding 80%. We will make loans with loan-to-value ratios of over
80%, but not exceeding 97% of the value of the property, if the borrower obtains
private mortgage insurance to reduce the effective loan-to-value ratio to
between 70% to 78%, consistent with secondary marketing requirements. In
addition, we require that borrowers obtain hazard insurance for all residential
real estate loans covering the lower of the loan amount or the replacement value
of the residence.
In our approval process for the loans we originate or purchase, we assess
both the value of the property securing the loan and the applicant's ability to
repay the loan. Loan underwriters analyze the loan application and the property
involved. Qualified appraisers on our staff or outside appraisers establish the
value of the collateral through the use of full appraisals or alternative
valuation formats that meet regulatory requirements. Appraisal reports prepared
by outside appraisers are selectively reviewed by our staff appraisers or by
approved fee appraisers. We also obtain information about the applicant's
income, financial condition, employment and credit history. Typically, we will
verify an applicant's credit information for loans originated by our retail loan
representatives. For loans submitted from outside mortgage brokers, we require
the mortgage broker to obtain, review and verify the applicant's credit
information and employment. In addition, in underwriting and qualifying the loan
applicant, we obtain credit information about the applicant and perform other
underwriting tests of these broker-originated loans.
On our adjustable rate mortgages we offer with incentive interest rates, we
qualify applicants:
o for loan programs with no negative amortization at the higher of:
o the initial incentive interest rate; or
o the fully indexed interest rate.
o for loan programs that include negative amortization and are owner
occupied, at the minimum qualifying interest rate of 7.50%.
4
o for loan programs that include negative amortization and are non-owner
occupied, at the minimum qualifying interest rate of 7.75%.
Late in 1996, we began offering one-to-four unit residential loans to
borrowers who have or, in the case of purchases, will have equity in their homes
but whose credit rating contains exceptions which preclude them from qualifying
for lower or better market interest rates and terms. We refer to these lower
grade credits, which we characterize as "A-," "B" and "C" loans, as subprime
loans in our loan portfolio. Our subprime loans are characterized by lower
loan-to-value ratios and higher average interest rates than higher credit grade
loans or "A" loans. We believe these lower credit grade borrowers represent an
opportunity for us to earn a higher net return for the risks we assume. We have
developed specific underwriting guidelines for each classification of subprime
credit and qualify these applicants at the fully indexed rate. For further
information, see Regulation--Regulation of the Bank--Regulatory Capital
Requirements on page 13.
SECONDARY MARKETING AND LOAN SERVICING ACTIVITIES
As part of our secondary marketing activities, we originate some
residential real estate adjustable rate mortgages and fixed rate mortgages,
which we intend to sell. Accordingly, we classify these loans as held for sale
and carry them at the lower of cost or market. These loans are secured by first
liens on one-to-four unit residential properties and generally have maturities
of 30 years or less.
Generally, we use various hedging programs to manage the interest rate risk
of our fixed rate mortgage origination process. For further information, see
Asset/Liability Management on page 8.
We believe that servicing loans for others can be an important
asset/liability management tool because it produces operating results which, in
response to changes in market interest rates, tend to move opposite to changes
in net interest income. Because adjustable rate mortgages take longer to adjust
to market interest rates, net interest income associated with these loans is
expected to decline in periods of rising interest rates and increase in periods
of falling rates. In contrast, the value of a loan servicing portfolio normally:
o increases as interest rates rise and loan prepayments decrease; and
o declines as interest rates fall and loan prepayments increase.
In addition, increased levels of servicing activities and the opportunity to
offer our other financial services in servicing loans for others can provide us
with additional income with minimal additional overhead costs.
Depending upon market pricing for servicing, we sell loans either servicing
retained or servicing released. When we sell loans servicing retained, we record
gains or losses from these loans at the time of sale. We calculate gains or
losses from our sale as the difference between the net sales proceeds and the
allocated basis of the loans sold. We capitalize mortgage servicing rights we
acquire through either our purchase or origination of mortgage loans we intend
to sell with servicing rights retained. We allocate the total cost of the
mortgage loans designated for sale to both the mortgage servicing rights and to
the mortgage loans without mortgage servicing rights based on their relative
fair values. We disclose our mortgage servicing rights in our financial
statements and include them as a component of the gain on sale of loans. We
recognize impairment losses on the mortgage servicing rights through a valuation
allowance and record any associated provision as a component of loan servicing
fees. At December 31, 2000, our mortgage servicing rights totaled $41 million.
We may exchange loans we originate for sale with government agencies for
mortgage-backed securities collateralized by these loans. Our cost for the
exchange, a monthly guaranty fee, is expressed as a percentage of the unpaid
principal balance and is deducted from interest income. We can use the
securities we receive to collateralize various types of our borrowings at rates
that frequently are more favorable than rates on other types of liabilities and
also carry a lower risk-based capital requirement than whole loans. We carry
these mortgage-backed securities available for sale at fair value. However, we
record no gain or loss on the exchange in our statement of income until the
securities are sold to a third party. Before we sell these securities to third
parties, we show all changes in fair value as a separate component of
stockholders' equity as accumulated other comprehensive income, net of income
taxes.
5
COMMERCIAL REAL ESTATE AND MULTI-FAMILY LENDING
We have provided permanent loans secured by retail neighborhood shopping
centers and multi-family properties. Our major loan officers conduct our
commercial real estate and multi-family lending activities. We compensate these
officers on a salary basis.
Commercial real estate and multi-family loans generally entail additional
risks as compared to single family residential mortgage lending. We subject each
loan, including loans to facilitate the sale of real estate we own, to our
underwriting standards, which generally include:
o our evaluation of the creditworthiness and reputation of the borrower;
and
o the amount of the borrower's equity in the project as determined on
the basis of appraisal, sales and leasing information on the property
and cash flow projections.
To protect the value of the security for our loan, we require borrowers to
maintain casualty insurance for the loan amount or replacement cost. In
addition, for non-residential loans in excess of $500,000, we require the
borrower to obtain comprehensive general liability insurance. All commercial
real estate loans we originate must be approved by at least two of our officers,
one of whom must be the originating loan account officer and the other a
designated officer with appropriate loan approval authority.
CONSTRUCTION LENDING
We have provided construction loan financing for single family and
multi-family residential properties and commercial real estate projects, like
retail neighborhood shopping centers. Our major loan officers principally
originate these loans. We generally make construction loans at floating interest
rates based upon the prime or reference rate of a major commercial bank.
Generally, we require a loan-to-value ratio of 75% or less on construction
lending and we subject each loan to our underwriting standards.
Construction loans involve risks different from completed project lending
because we advance loan funds based upon the security of the completed project
under construction. If the borrower defaults on the loan, then we may have to
advance additional funds to finance the project's completion before the project
can be sold. Moreover, construction projects are affected by uncertainties
inherent in estimating:
o construction costs;
o potential delays in construction time;
o market demand; and
o the accuracy of the estimate of value on the completed project.
When providing construction loans, we require the general contractor to,
among other things, carry contractor's liability insurance equal to specific
prescribed minimum amounts, carry builder's risk insurance and have a blanket
bond against employee misappropriation.
COMMERCIAL LENDING
We originate commercial loans and revolving lines of credit and issue
standby letters of credit for our middle market commercial customers. We offer
the various credit products on both a secured and unsecured basis with interest
rates being either fixed or variable. Our portfolio emphasis is toward secured,
floating rate credit facilities. Our commercial banking group directs these
activities and focuses on our long-term, relationship-based customers. We also
utilize our retail branch network as a source of commercial customers, with the
lending to these customers being typically managed by the branch manager. We
believe our commercial borrowers are desirable because these borrowers generally
have lower cost deposit accounts.
CONSUMER LENDING
Until its sale in February 2000, we originated fixed rate automobile loans
through an indirect lending program of Downey Auto Finance Corp. which used
preapproved automobile dealers to finance consumer purchases of new and used
automobiles. For additional information regarding Downey Auto Finance Corp., see
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Financial Condition--Sale of Subsidiary on page 61.
6
In addition, the Bank originates direct automobile loans, home equity loans
and lines of credit, and other consumer loan products. Before we make a consumer
loan, we assess the applicant's ability to repay the loan and, if applicable,
the value of the collateral securing the loan. The risk involved with home
equity loans and lines of credit is similar to the risk involved with
residential real estate loans. We offer customers a credit card through a third
party, who extends the credit and services the loans made to our customers.
INVESTMENT ACTIVITIES
Federal and state regulations require the Bank to maintain a specified
minimum amount of liquid assets invested in particular short-term obligations
and other securities. For additional information regarding liquidity
requirements and the Bank's compliance with the liquidity requirements, see
Regulation--Regulation of the Bank--Liquidity Requirements on page 19 and
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Financial Condition--Capital Resources and Liquidity on page 57. As
a federally chartered savings association, the Bank's ability to make other
securities investments is prescribed under the OTS regulations and the Home
Owners' Loan Act. The Bank's authorized officers make investment decisions
within guidelines established by the Bank's Board of Directors. The Bank manages
these investments in an effort to produce the highest yield, while at the same
time maintaining safety of principal, minimizing interest rate risk and
complying with applicable regulations.
We carry securities held to maturity at amortized cost. We adjust these
costs for amortization of premiums and accretion of discounts, which we
recognize as interest income using the interest method. We carry securities
available for sale at fair value. We exclude unrealized holding gains and
losses, or valuation allowances established for net unrealized losses, from our
earnings and report them as a separate component of our stockholders' equity as
accumulated other comprehensive income, net of income taxes, unless the security
is deemed other than temporarily impaired. If the security is determined to be
other than temporarily impaired, we charge the amount of the impairment to
operations. For further information on the composition of our investment
portfolio, see Management's Discussion and Analysis of Financial Condition and
Results of Operations--Financial Condition--Investment Securities on page 38.
DEPOSIT ACTIVITIES
We prefer to use deposits as our principal source of funds for supporting
our lending activities, because the cost of these funds generally is less than
that of borrowings or other funding sources with comparable maturities. We
traditionally have obtained our savings deposits primarily from areas
surrounding the Bank's California branch offices. However, we occasionally raise
some retail deposits through Wall Street activities.
General economic conditions affect deposit flows. Funds may flow from
depository institutions such as savings associations into direct vehicles like
government and corporate securities or other financial intermediaries. Our
ability to attract and retain deposits will continue to be affected by money
market conditions and prevailing interest rates. Generally, state or federal
regulation does not restrict interest rates we pay on deposits.
In 1996, we began establishing full-service branch facilities in selected
supermarket locations throughout California. Each in-store branch offers a full
range of financial services including checking and savings accounts as well as
residential and consumer loans.
When consistent with our maintenance of appropriate capital levels, we may
consider opportunities to augment our retail branch system and deposit base
through our acquisition of selected branches or deposits.
For further information, see Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition--Deposits on
page 41.
BORROWING ACTIVITIES
Our principal source of funds has been and continues to be deposits we
raise through our retail branch system. At various times, however, we have
utilized other sources to fund our loan origination and other business
activities. We have at times relied upon our borrowings from the FHLB of San
Francisco as an additional source of funds. The FHLB of San Francisco makes
advances to us through several different credit programs it offers.
From time to time, we obtain additional sources of funds by selling some of
our securities and mortgage loans under agreements to repurchase. These reverse
repurchase agreements are generally short-term and are
7
collateralized by our mortgage-backed or investment securities and our mortgage
loans. We only deal with investment banking firms that are recognized as primary
dealers in U.S. government securities or major commercial banks in connection
with these reverse repurchase agreements. In addition, we limit the amounts of
our borrowings from any single institution.
For further information, see Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition--Borrowings
on page 43.
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. Of the $115 million of net proceeds, we invested $108
million as additional common stock of the Bank thereby increasing the Bank's
regulatory core/tangible capital by that same amount. The balance of the net
proceeds have been used for general corporate purposes. For further information
regarding our capital securities, see Note 19 on page 93 of Notes to
Consolidated Financial Statements.
ASSET/LIABILITY MANAGEMENT
Savings institutions are affected by interest rate risks to the degree that
their interest-bearing liabilities, consisting principally of customer deposits,
FHLB advances, other borrowings and capital securities, mature or reprice on a
different basis than their interest-earning assets, which consist predominantly
of intermediate or long-term real estate loans. While having liabilities that on
average mature or reprice more frequently than assets may be beneficial in times
of declining interest rates, this asset/liability structure may result in
declining net earnings during periods of rising interest rates. One of our
principal objectives is to manage the effects of adverse changes in interest
rates on our interest income while maintaining our asset quality and an
acceptable interest rate spread. To improve the rate sensitivity and maturity
balance of our interest-earning assets and liabilities, we have emphasized the
origination of loans with adjustable interest rates or relatively short
maturities. Loans with adjustable interest rates have the beneficial effect of
allowing the yield on our assets to increase during periods of rising interest
rates, although these loans have contractual limitations on the frequency and
extent of interest rate adjustments.
For further information see Lending Activities on page 2 and Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Financial Condition--Asset/Liability Management and Market Risk on
page 44.
EARNINGS SPREAD
We determine our net interest income or the interest rate spread by
calculating the difference between:
o the yield we earn on our interest-earning assets like loans,
mortgage-backed securities and investment securities; and
o the cost we pay on our interest-bearing liabilities like deposits,
borrowings and capital securities.
Our net interest income is also determined by the relative dollar amounts of our
interest-earning assets and interest-bearing liabilities.
Our effective interest rate spread, which reflects the relative level of
our interest-earning assets to our interest-bearing liabilities, equals:
o the difference between interest income on our interest-earning assets
and interest expense on our interest-bearing liabilities, divided by
o our average interest-earning assets for the period.
For information regarding our net income and the components thereof and for
management's analysis of our financial condition and results of operations, see
Management's Discussion and Analysis of Financial Condition and Results of
Operations beginning on page 26. For information regarding the return on our
assets and other selected financial data see Selected Financial Data on page 24.
8
INSURANCE AGENCY ACTIVITIES
Downey Affiliated Insurance Agency was incorporated on January 25, 1995, as
Downey's wholly owned subsidiary. We capitalized Downey Affiliated Insurance
Agency on February 24, 1995 with $400,000. In the 1995 second quarter, Downey
Affiliated Insurance Agency commenced operations at which time representatives
of Downey Affiliated Insurance Agency were available in our branches to offer
annuity products. During 1996, Downey Affiliated Insurance Agency began offering
forced-placed casualty insurance policies on mortgage loans and stopped offering
annuity products. The offering of forced-placed casualty insurance policies
ceased in April 1999.
REAL ESTATE INVESTMENT ACTIVITIES
In addition to our primary business of banking, which has been described
above, we are also involved in real estate investment activities, which are
conducted primarily through DSL Service Company, a wholly owned subsidiary of
the Bank. DSL Service Company is a diversified real estate development company
which was established in 1966 as a neighborhood shopping center and residential
tract developer, as well as the general contractor for the Bank's branch
locations. Today its capabilities include development, construction and property
management activities relating to its portfolio of projects primarily within
California, but also in Arizona. In addition to DSL Service Company developing
its own real estate projects, it associates with other qualified developers to
engage in joint ventures. The primary revenue sources of our real estate
investment activities include net rental income and gains from the sale of real
estate investments. The primary expenses of our real estate investment
activities are interest expense and general and administrative expense.
Before Congress passed the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA"), the Bank conducted real estate development
and joint venture operations directly, in addition to operations conducted
through DSL Service Company. Since FIRREA, however, the Bank's ability to engage
in new real estate development and joint venture activities and to retain its
existing real estate investments was curtailed dramatically. In addition, these
activities may be economically unfeasible for the Bank because of the capital
requirements FIRREA imposes on these activities. FIRREA requires, with some
limited exceptions, a savings institution like the Bank to exclude from the
Bank's regulatory capital:
o the Bank's investments in, and extensions of credit to, real estate
subsidiaries like DSL Service Company; and
o the Bank's direct equity investments in real estate development and
joint venture operations.
FIRREA also prohibits the Bank from making new investments in real estate
development and joint venture operations.
The Bank is required to deduct the full amount of its investment in DSL
Service Company in calculating its applicable ratios under the core, tangible
and risk-based capital standards. Savings associations generally may invest in
service corporation subsidiaries, like DSL Service Company, to the extent of 2%
of the association's assets, plus up to an additional 1% of assets for
investments which serve primarily community, inner-city or community development
purposes. In addition, "conforming loans" by the Bank to DSL's joint venture
partnerships are limited to 50% of the Bank's risk-based capital. "Conforming
loans" are those generally limited to 80% of appraised value, bear a market rate
of interest and require payments sufficient to amortize the principal balance of
the loan. We are in compliance with each of these investment limitations.
To the extent Downey or a subsidiary of Downey, other than the Bank or its
subsidiaries, makes real estate investments, the above-mentioned capital
deductions and limitations do not apply as they only pertain to the specific
investments by savings associations or their subsidiaries.
For further information, see Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition--Investments
in Real Estate and Joint Ventures on page 39.
COMPETITION
We face competition both in attracting deposits and in making loans. Our
most direct competition for deposits has historically come from other savings
institutions and from commercial banks located in our principal market areas,
including many large financial institutions based in other parts of the country
or their subsidiaries. In addition, we face additional significant competition
for investors' funds from short-term money market securities
9
and other corporate and government securities. Our ability to attract and retain
savings deposits depends, generally, on our ability to provide a rate of return,
liquidity and risk comparable to that offered by competing investment
opportunities and the appropriate level of customer service.
We experience competition for real estate loans principally from other
savings institutions, commercial banks, mortgage banking companies and insurance
companies. We compete for loans principally through our interest rates and loan
fees we charge and our efficiency and quality of services we provide borrowers
and real estate brokers.
EMPLOYEES
At December 31, 2000, we had approximately 1,294 full-time employees and
489 part-time employees. We provide our employees with health and welfare
benefits and a retirement and savings plan. Additionally, we offer qualifying
employees participation in our stock purchase plan. Our employees are not
represented by any union or collective bargaining group, and we consider our
employee relations to be good.
REGULATION
GENERAL
Federal and state law extensively regulates savings and loan holding
companies and savings associations. This regulation is intended primarily for
the protection of our depositors and the SAIF and not for the benefit of our
stockholders. In the following information, we describe some of the regulations
applicable to us and the Bank. We do not claim this discussion is complete and
qualify our discussion in its entirety by reference to applicable statutory or
regulatory provisions.
REGULATION OF DOWNEY
General. We are a savings and loan holding company. We are subject to
regulatory oversight by the OTS. Thus, we are required to register and file
reports with the OTS and are regulated and examined by the OTS. In addition, the
OTS has enforcement authority over us, which also permits the OTS to restrict or
prohibit our activities that it determines to be a serious risk to the Bank.
Activities Restrictions. As a savings and loan holding company with only
one savings and loan association subsidiary, we generally are not limited by OTS
activity restrictions, provided the Bank satisfies the qualified thrift lender
test or meets the definition of a domestic building and loan association in the
Internal Revenue Code. If we acquire control of another savings association as a
separate subsidiary of Downey, we would become a multiple savings and loan
holding company. As a multiple savings and loan holding company, our activities,
other than the activities of the Bank or any other SAIF-insured savings
association, would become subject to restrictions applicable to bank holding
companies unless these other savings associations were acquired in a supervisory
acquisition and each also satisfies the qualified thrift lender test or meets
the definition of a domestic building and loan association. Furthermore, if we
were in the future to sell control of the Bank to any other company, such
company would not succeed to our grandfathered status as a unitary thrift
holding company and would be subject to the same business activity restrictions
as a bank holding company. For more information, see Recent Legislation on page
11 and Regulation of the Bank--Qualified Thrift Lender Test on page 15.
On October 27, 2000, the OTS issued a proposed rule that would require some
savings and loan holding companies to notify the OTS 30 days before undertaking
certain significant new business activities. As proposed, holding companies
would have to give the OTS advance notice of:
o the incurrence of debt, when combined with all other transactions by
the company or any subsidiaries other than the thrift during the past
12 months, increases non-thrift liabilities by 5 percent or more; and
non-thrift liabilities, after the debt transaction, equal 50 percent
or more of the company's consolidated core capital;
o an asset acquisition or series of such transactions by the company or
non-thrift subsidiary during the past 12 months that involves assets
other than cash, cash equivalents and securities or other obligations
guaranteed by the U.S. Government and exceeds 15 percent of the
company's consolidated assets; and
10
o any transaction that, when combined with all other transactions during
the past 12 months, reduces the company's capital by 10 percent or
more.
Exempt from the notice requirement would be any holding company with
consolidated subsidiary thrift assets of less than 20 percent of total assets or
consolidated holding company capital of at least 10 percent. The OTS could
object to or conditionally approve an activity or transaction if it finds a
material risk to the safety and soundness and stability of the thrift. The
review period could be extended an additional 30 days if necessary.
The OTS proposal also would codify current practices and the factors
relevant to a holding company's need for capital. To determine the need for and
level of an explicit holding company capital requirement, the OTS will look at
overall risk at the thrift and the consolidated entity, their tangible and
equity capital, whether the holding company's debt-to-capital ratio is rising,
what investments or activities are funded by debt, its cash flow, how much the
holding company relies on dividends from its subsidiary thrift to service debt
or fulfill other obligations, earnings volatility and the thrift's standing in
the corporate structure.
The comment period for the proposed rule was extended to February 9, 2001.
It is not possible at this time to predict the impact of the proposed rule on
our financial condition or results of operation.
Restrictions on Acquisitions. We must obtain approval from the OTS before
acquiring control of any other SAIF-insured association. The OTS generally
prohibits these types of acquisitions if they result in a multiple savings and
loan holding company controlling savings associations in more than one state.
However, the OTS permits interstate acquisitions if the acquisition is
authorized by specific state authorization or a supervisory acquisition of a
failing savings association.
Federal law generally provides that no "person," acting directly or
indirectly or through or in concert with one or more other persons, may acquire
"control" of a federally insured savings association unless the person gives at
least 60 days written notice to the OTS. The OTS then has the opportunity to
disapprove the proposed acquisition. In addition, no company may acquire control
of this type of an institution without prior OTS approval. These provisions also
prohibit, among other things, any director or officer of a savings and loan
holding company, or any individual who owns or controls more than 25% of the
voting shares of a savings and loan holding company, from acquiring control of
any savings association not a subsidiary of the savings and loan holding
company, unless the acquisition is approved by the OTS.
Recent Legislation. On November 12, 1999, the Gramm-Leach-Bliley Act of
1999 (the "Financial Services Modernization Act") was signed into law. The
Financial Services Modernization Act repeals the two affiliation provisions of
the Glass-Steagall Act:
o Section 20, which restricted the affiliation of Federal Reserve member
banks with firms "engaged principally" in specified securities
activities; and
o Section 32, which restricts officer, director or employee interlocks
between a member bank and any company or person "primarily engaged" in
specified securities activities.
In addition, the Financial Services Modernization Act contains provisions
that expressly preempt any state law restricting the establishment of financial
affiliations, primarily related to insurance. The general effect of the law is
to establish a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms and other financial service
providers by revising and expanding the Bank Holding Company Act framework to
permit a holding company to engage in a full range of financial activities
through a new entity known as a "Financial Holding Company." "Financial
activities" is broadly defined to include not only banking, insurance and
securities activities, but also merchant banking and additional activities that
the Federal Reserve Board, in consultation with the Secretary of the Treasury,
determines to be financial in nature, related or incidental to such financial
activities, or complementary activities that do not pose a substantial risk to
the safety and soundness of depository institutions or the financial system
generally.
The Financial Services Modernization Act provides that no company may
acquire control of an insured savings association, unless that company engages,
and continues to engage, only in the financial activities permissible for a
Financial Holding Company, unless grandfathered as a unitary savings and loan
holding company. The Financial Institution Modernization Act grandfathers any
company that was a unitary savings and loan holding company on May 4, 1999 or
became a unitary savings and loan holding company pursuant to an application
pending on that date. Downey is a grandfathered unitary savings and loan holding
company and we
11
may continue to operate under present law as long as we continue to control only
the Bank and the Bank continues to meet the qualified thrift lender test.
We do not believe that the Financial Services Modernization Act will have a
material adverse effect on our operations in the near-term. However, to the
extent that the act permits banks, securities firms and insurance companies to
affiliate, the financial services industry may experience further consolidation.
The Financial Services Modernization Act is intended to grant to community banks
certain powers as a matter of right that larger institutions have accumulated on
an ad hoc basis and which unitary savings and loan holding companies, such as
Downey, already possess. Nevertheless, this act may have the result of
increasing the amount of competition that we face from larger institutions and
other types of companies offering financial products, many of which may have
greater financial resources than we do. In addition, the Financial Services
Modernization Act may have an anti-takeover effect because it may tend to limit
the range of potential acquirers of Downey to other savings and loan holding
companies and Financial Holding Companies.
REGULATION OF THE BANK
General. The OTS and the FDIC extensively regulate the Bank because the
Bank is a federally chartered, SAIF-insured savings association. The Bank must
ensure that its lending activities and its other investments comply with various
statutory and regulatory requirements. The Bank is also regulated by the Federal
Reserve.
The OTS, in conjunction with the FDIC, regularly examines the Bank and
prepares reports for the Bank's Board of Directors to consider with respect to
any deficiencies the OTS or the FDIC finds in the Bank's operations. Federal and
state laws also regulate the relationship between the Bank and its depositors
and borrowers, especially in matters regarding the ownership of savings accounts
and the form and content of mortgage documents used by the Bank.
The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition. In addition, the Bank must obtain regulatory
approvals before entering into some transactions like mergers with or
acquisitions of other financial institutions. This regulation and supervision
establishes a comprehensive framework of activities in which an institution may
engage and is intended primarily for the protection of the SAIF and our
depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in regulations, whether by the OTS, the FDIC
or the Congress, could have a material adverse impact on us, the Bank and our
operations.
Insurance of Deposit Accounts. The SAIF, as administered by the FDIC,
insures the Bank's deposit accounts up to the maximum amount permitted by law.
The FDIC may terminate insurance of deposits upon a finding that the
institution:
o has engaged in unsafe or unsound practices;
o is in an unsafe or unsound condition to continue operations; or
o has violated any applicable law, regulation, rule, order or condition
imposed by the FDIC or the institution's primary regulator.
The FDIC charges an annual assessment for the insurance of deposits based
on the risk a particular institution poses to its deposit insurance fund. Under
this system as of December 31, 2000, SAIF members paid within a range of 0 cents
to 27 cents per $100 of domestic deposits, depending upon the institution's risk
classification. This risk classification is based on an institution's capital
group and supervisory subgroup assignment.
The Bank also pays, in addition to its normal deposit insurance premium as
a member of the SAIF, an amount equal to approximately 0.0212% of insured
deposits toward the retirement of the Financing Corporation bonds (known as FICO
Bonds) issued in the 1980s to assist in the recovery of the savings and loan
industry. These assessments will continue until the FICO Bonds mature in 2017.
12
Regulatory Capital Requirements. The Bank must meet regulatory capital
standards to be deemed in compliance with OTS capital requirements. OTS capital
regulations require savings associations to meet the following three capital
standards:
o tangible capital equal to 1.5% of total adjusted assets;
o leverage capital, or "core capital," equal to 3% of total adjusted
assets for institutions such as the Bank; and
o risk-based capital equal to 8.0% of total risk-based assets.
A savings association with a greater than "normal" level of interest rate
exposure must deduct an interest rate risk component in calculating its total
capital for purposes of determining whether it meets its risk-based capital
requirement. Interest rate exposure is measured, generally, as equal to:
o the decline in an institution's net portfolio value that would result
from a 200 basis point increase or decrease in market interest rates,
whichever would result in a lower net portfolio value, divided by
o the estimated economic value of the savings association's assets.
The interest rate risk component a savings association must deduct from its
total capital is equal to:
o one-half of the difference between an institution's measured exposure
and "normal" interest rate risk exposure, which the OTS defines as 2%,
multiplied by
o the estimated economic value of the institution's assets.
In August 1995, the OTS indefinitely delayed implementation of its interest
rate risk regulation. However, based on the asset/liability structure of the
Bank, at December 31, 2000, the Bank would not have been required to deduct an
interest rate risk component in calculating its total risk-based capital had
OTS's interest rate risk regulation been in effect.
The OTS views its capital regulation requirements as minimum standards, and
it expects most institutions to maintain capital levels well above the minimum.
In addition, the OTS regulations provide that the OTS may establish minimum
capital levels higher than those provided in the regulations for individual
savings associations, upon a determination that the savings association's
capital is or may become inadequate in view of its circumstances. The OTS
regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others:
o a savings association has a high degree of exposure to interest rate
risk, prepayment risk, credit risk, concentration of credit risk,
other risks arising from nontraditional activities, or similar risks
or a high proportion of off-balance sheet risk;
o a savings association is growing, either internally or through
acquisitions, at a rate that presents supervisory issues; or
o a savings association may be adversely affected by activities or
condition of its holding company, affiliates, subsidiaries or other
persons, or savings associations with which it has significant
business relationships.
The Bank is not required to meet any individual minimum regulatory capital
requirement. At December 31, 2000, the Bank's regulatory capital exceeded all
minimum regulatory capital requirements.
As a result of a number of federally insured financial institutions
extending their risk selection standards to attract lower credit quality
accounts due to their having higher interest rates and fees, the federal banking
regulatory agencies jointly issued Interagency Guidelines on Subprime Lending in
March 1999. In addition, expanded guidelines were issued by the agencies on
January 31, 2001. Subprime lending involves extending credit to individuals with
less than perfect credit histories.
The agencies' guidelines consider subprime lending a high-risk activity
that is unsafe and unsound if the risks associated with subprime lending are not
properly controlled. Specifically, the 2001 guidelines direct examiners to
13
expect regulatory capital one and one-half to three times higher than that
typically set aside for prime assets for institutions that:
o have subprime assets equal to 25% or higher of Tier 1 capital, or
o have subprime portfolios experiencing rapid growth or adverse
performance trends, are administered by inexperienced management, or
have inadequate or weak controls.
Our subprime portfolio, pursuant to our definition, represented 250% of
Tier 1 capital as of year-end 2000. Any requirement for us to maintain
additional regulatory capital as a result of our activities in subprime lending
could have an adverse affect on our future prospects and operations and may
restrict our ability to grow. If we are unable to comply with any new capital
requirements imposed upon regulatory examination, we may be subject to the
prompt corrective action regulations of the OTS. Although we believe we maintain
appropriate controls and regulatory capital for our subprime activities, we
cannot determine whether, or to what extent, additional capital requirements
will be imposed on us after periodic examinations by the OTS.
The Home Owners' Loan Act permits savings associations not in compliance
with the OTS capital standards to seek an exemption from penalties or sanctions
for noncompliance. The OTS will grant an exemption only if the savings
association meets strict requirements. In addition, the OTS must deny the
exemption in some circumstances. If the OTS does grant an exemption, the savings
association still may be exposed to enforcement actions for other violations of
law or unsafe or unsound practices or conditions.
Prompt Corrective Action. The OTS's prompt corrective action regulation
requires the OTS to take mandatory actions and authorizes the OTS to take
discretionary actions against a savings association that falls within
undercapitalized capital categories specified in the regulation.
The regulation establishes five categories of capital classification:
o "well capitalized;"
o "adequately capitalized;"
o "undercapitalized;"
o "significantly undercapitalized;" and
o "critically undercapitalized."
The regulation uses an institution's risk-based capital, leverage capital and
tangible capital ratios to determine the institution's capital classification.
At December 31, 2000, the Bank exceeded the capital requirements of a well
capitalized institution under applicable OTS regulations.
Loans-to-One-Borrower. Savings associations generally are subject to the
lending limits applicable to national banks. With limited exceptions, the
maximum amount that a savings association or a national bank may lend to any
borrower, including some related entities of the borrower, at one time may not
exceed:
o 15% of the unimpaired capital and surplus of the institution, plus
o an additional 10% of unimpaired capital and surplus if the loans are
fully secured by readily marketable collateral.
Savings associations are additionally authorized to make loans to one
borrower, for any purpose:
o in an amount not to exceed $500,000; or
o by order of the Director of OTS, in an amount not to exceed the lesser
of $30,000,000 or 30% of unimpaired capital and surplus to develop
residential housing, provided:
o the purchase price of each single-family dwelling in the
development does not exceed $500,000;
14
o the savings association is in compliance with its capital
requirements;
o the loans comply with applicable loan-to-value requirements; and
o the aggregate amount of loans made under this authority does not
exceed 15% of unimpaired capital and surplus.
At December 31, 2000, the Bank's loans-to-one-borrower limit was $112
million based upon the 15% of unimpaired capital and surplus measurement.
Qualified Thrift Lender Test. The OTS requires savings associations to meet
a qualified thrift lender test. The qualified thrift lender test may be met
either by maintaining a specified level of assets in qualified thrift
investments as specified in the Home Owners' Loan Act or by meeting the
definition of a "domestic building and loan association." Qualified thrift
investments are primarily residential mortgages and related investments,
including some mortgage-related securities. The required percentage of
investments under the Home Owners' Loan Act is 65% of assets while the Internal
Revenue Code requires investments of 60% of assets. An association must be in
compliance with the qualified thrift lender test or the definition of domestic
building and loan association on a monthly basis in nine out of every 12 months.
Associations failing to meet the qualified thrift lender test are generally
allowed only to engage in activities permitted for both national banks and
savings associations.
The FHLB also relies on the qualified thrift lender test. A savings
association will only enjoy full borrowing privileges from an FHLB if the
savings association is a qualified thrift lender. As of December 31, 2000, the
Bank was in compliance with its qualified thrift lender test requirement and met
the definition of a domestic building and loan association.
Affiliate Transactions. Transactions between a savings association and its
"affiliates" are quantitatively and qualitatively restricted under the Federal
Reserve Act. Affiliates of a savings association include, among other entities,
the savings association's holding company and companies that are under common
control with the savings association.
In general, a savings association or its subsidiaries are limited in their
ability to engage in "covered transactions" with affiliates:
o to an amount equal to 10% of the association's capital and surplus, in
the case of covered transactions with any one affiliate; and
o to an amount equal to 20% of the association's capital and surplus, in
the case of covered transactions with all affiliates.
In addition, a savings association and its subsidiaries may engage in covered
transactions and other specified transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction"
includes:
o a loan or extension of credit to an affiliate;
o a purchase of investment securities issued by an affiliate;
o a purchase of assets from an affiliate, with some exceptions;
o the acceptance of securities issued by an affiliate as collateral for
a loan or extension of credit to any party; or
o the issuance of a guarantee, acceptance or letter of credit on behalf
of an affiliate.
15
In addition, under the OTS regulations:
o a savings association may not make a loan or extension of credit to an
affiliate unless the affiliate is engaged only in activities
permissible for bank holding companies;
o a savings association may not purchase or invest in securities of an
affiliate other than shares of a subsidiary;
o a savings association and its subsidiaries may not purchase a
low-quality asset from an affiliate;
o covered transactions and other specified transactions between a
savings association or its subsidiaries and an affiliate must be on
terms and conditions that are consistent with safe and sound banking
practices; and
o with some exceptions, each loan or extension of credit by a savings
association to an affiliate must be secured by collateral with a
market value ranging from 100% to 130%, depending on the type of
collateral, of the amount of the loan or extension of credit.
The OTS regulations generally exclude all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve decides to treat these
subsidiaries as affiliates. The regulations also require savings associations to
make and retain records that reflect affiliate transactions in reasonable detail
and provides that specified classes of savings associations may be required to
give the OTS prior notice of affiliate transactions.
Capital Distribution Limitations. OTS regulations impose limitations upon
all capital distributions by savings associations, like cash dividends, payments
to repurchase or otherwise acquire its shares, payments to shareholders of
another institution in a cash-out merger and other distributions charged against
capital. The OTS recently adopted an amendment to these capital distribution
limitations. Under the new rule, a savings association in some circumstances
may:
o be required to file an application and await approval from the OTS
before it makes a capital distribution;
o be required to file a notice 30 days before the capital distribution;
or
o be permitted to make the capital distribution without notice or
application to the OTS.
The OTS regulations require a savings association to file an application if:
o it is not eligible for expedited treatment of its other applications
under OTS regulations;
o the total amount of all of capital distributions, including the
proposed capital distribution, for the applicable calendar year
exceeds its retained net income for that year to date plus retained
net income for the preceding two years;
o it would not be at least adequately capitalized, under the prompt
corrective action regulations of the OTS following the distribution;
or
o the association's proposed capital distribution would violate a
prohibition contained in any applicable statute, regulation or
agreement between the savings association and the OTS, or the FDIC, or
violate a condition imposed on the savings association in an
OTS-approved application or notice.
In addition, a savings association must give the OTS notice of a capital
distribution if the savings association is not required to file an application,
but:
o would not be well capitalized under the prompt corrective action
regulations of the OTS following the distribution;
o the proposed capital distribution would reduce the amount of or retire
any part of the savings association's common or preferred stock or
retire any part of debt instruments like notes or debentures
16
included in capital, other than regular payments required under a debt
instrument approved by the OTS; or
o the savings association is a subsidiary of a savings and loan holding
company.
If neither the savings association nor the proposed capital distribution
meet any of the above listed criteria, the OTS does not require the savings
association to submit an application or give notice when making the proposed
capital distribution. The OTS may prohibit a proposed capital distribution that
would otherwise be permitted if the OTS determines that the distribution would
constitute an unsafe or unsound practice.
Privacy. Under the Financial Services Modernization Act, federal banking
regulators are required to adopt rules that will limit the ability of banks and
other financial institutions to disclose non-public information about consumers
to nonaffiliated third parties. Federal banking regulators issued final rules on
May 10, 2000. Pursuant to those rules, financial institutions must provide:
o initial notices to customers about their privacy policies, describing
the conditions under which they may disclose nonpublic personal
information to nonaffiliated third parties and affiliates;
o annual notices of their privacy policies to current customers; and
o a reasonable method for customers to "opt out" of disclosures to
nonaffiliated third parties.
The rules were effective November 13, 2000, but compliance is optional until
July 1, 2001. These privacy provisions will affect how consumer information is
transmitted through diversified financial companies and conveyed to outside
vendors. Although it is not possible at this time to assess the impact of the
privacy provisions on our financial condition or results of operations, we do
not believe that the Privacy provisions will have a material adverse impact on
our operations in the near term.
Consumer Protection Rules - Sale of Insurance Products. In December 2000,
pursuant to the requirements of the Financial Services Modernization Act, the
federal bank and thrift regulatory agencies adopted consumer protection rules
for the sale of insurance products by depository institutions. The rule is
effective on April 1, 2001. The final rule applies to any depository institution
or any person selling, soliciting, advertising or offering insurance products or
annuities to a consumer at an office of the institution or on behalf of the
institution. Before an institution can complete the sale of an insurance product
or annuity, the regulation requires oral and written disclosure that such
product:
o is not a deposit or other obligation of, or guaranteed by, the
depository institution or its affiliate;
o is not insured by the FDIC or any other agency of the United States,
the depository institution or its affiliate; and
o has certain risks in investment, including the possible loss of value.
Finally, the depository institution may not condition an extension of
credit:
o on the consumer's purchase of an insurance product or annuity from the
depository institution or from any of its affiliates, or
o on the consumer's agreement not to obtain, or a prohibition on the
consumer from obtaining, an insurance product or annuity from an
unaffiliated entity.
The rule also requires formal acknowledgement from the consumer that
disclosures were received.
In addition, to the extent practicable, a depository institution must keep
insurance and annuity sales activities physically segregated from the areas
where retail deposits are routinely accepted from the general public.
17
Safeguarding Confidential Customer Information. In January 2000, the
banking agencies adopted guidelines requiring financial institutions to
establish an information security program to:
o identify and assess the risks that may threaten customer information;
o develop a written plan containing policies and procedures to manage
and control these risks;
o implement and test the plan; and
o adjust the plan on a continuing basis to account for changes in
technology, the sensitivity of customer information, and internal or
external threats to information security.
Each institution may implement a security program appropriate to its size and
complexity and the nature and scope of its operations.
The guidelines outline specific security measures that institutions should
consider in implementing a security program. A financial institution must adopt
those security measures determined to be appropriate. The guidelines require the
board of directors to oversee an institution's efforts to develop, implement and
maintain an effective information security program and approve written
information security policies and programs. The guidelines are effective July 1,
2001.
Activities of Subsidiaries. A savings association seeking to establish a
new subsidiary, acquire control of an existing company or conduct a new activity
through a subsidiary must provide 30 days prior notice to the FDIC and the OTS
and conduct any activities of the subsidiary in compliance with regulations and
orders of the OTS. The OTS has the power to require a savings association to
divest any subsidiary or terminate any activity conducted by a subsidiary that
the OTS determines to pose a serious threat to the financial safety, soundness
or stability of the savings association or to be otherwise inconsistent with
sound banking practices.
Community Reinvestment Act and the Fair Lending Laws. Savings associations
have a responsibility under the Community Reinvestment Act and related
regulations of the OTS to help meet the credit needs of their communities,
including low- and moderate-income neighborhoods. In addition, the Equal Credit
Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in
their lending practices on the basis of characteristics specified in those
statutes. An institution's failure to comply with the provisions of the
Community Reinvestment Act could, at a minimum, result in regulatory
restrictions on its activities and the denial of applications. In addition, an
institution's failure to comply with the Equal Credit Opportunity Act and the
Fair Housing Act could result in the OTS, other federal regulatory agencies as
well as the Department of Justice taking enforcement actions.
Federal Home Loan Bank System. The Bank is a member of the FHLB system.
Among other benefits, each FHLB serves as a reserve or central bank for its
members within its assigned region. Each FHLB is financed primarily from the
sale of consolidated obligations of the FHLB system. Each FHLB makes available
loans or advances to its members in compliance with the policies and procedures
established by the Board of Directors of the individual FHLB.
As an FHLB member, the Bank is required to own capital stock in an FHLB in
an amount equal to the greater of:
o 1% of its aggregate outstanding principal amount of its residential
mortgage loans, home purchase contracts and similar obligations at the
beginning of each calendar year;
o 5% of its FHLB advances or borrowings; or
o $500.
The Bank's required investment in FHLB stock, based on December 31, 2000
financial data, was $99 million. At December 31, 2000, the Bank had $106 million
of FHLB stock.
18
Liquidity Requirements. Under OTS regulations, a savings association is
required to maintain an average daily balance of liquid assets. These liquid
assets include cash, some time deposits and savings accounts, bankers'
acceptances, some government obligations and other investments. The OTS requires
a savings association to maintain an average daily balance of liquid assets in
each calendar quarter of not less than 4% of either:
o its liquidity base, which consists of some net withdrawable accounts
plus short-term borrowings, as of the end of the preceding calendar
quarter; or
o the average daily balance of its liquidity base during the preceding
quarter.
The OTS may change this liquidity requirement from time to time to any
amount between 4% and 10%, depending upon factors, including economic conditions
and savings flows of all savings associations. The Bank maintains liquid assets
in compliance with these regulations. The OTS may impose monetary penalties upon
an institution for violations of liquidity requirements.
Federal Reserve System. The Federal Reserve requires all depository
institutions to maintain non- interest-bearing reserves at specified levels
against their transaction accounts and non-personal time deposits. These
transaction accounts include checking, NOW and Super NOW checking accounts. The
balances a savings association maintains to meet the reserve requirements
imposed by the Federal Reserve may be used to satisfy the liquidity requirements
that are imposed by the OTS. At December 31, 2000, the Bank was in compliance
with these requirements.
REGULATION OF DSL SERVICE COMPANY
DSL Service Company is licensed as a real estate broker under the
California Real Estate Law and as a contractor with the Contractors State
License Board. Thus, the real estate investment activities of DSL Service
Company, including development, construction and property management activities
relating to its portfolio of projects, are governed by a variety of laws and
regulations. Changes in the laws and regulations or their interpretation by
agencies and the courts occur frequently. DSL Service Company must comply with
various federal, state and local laws, ordinances, rules and regulations
concerning zoning, building design, construction, hazardous waste and similar
matters. Environmental laws and regulations also affect the operations of DSL
Service Company, including regulations pertaining to availability of water,
municipal sewage treatment capacity, land use, protection of endangered species,
population density and preservation of the natural terrain and coastlines. These
and other requirements could become more restrictive in the future, resulting in
additional time and expense in connection with DSL Service Company's real estate
activities.
With regard to environmental matters, the construction products industry is
regulated by federal, state and local laws and regulations pertaining to several
areas including human health and safety and environmental compliance. The
Comprehensive Environmental Response, Compensation and Liability Act of 1980, as
amended by the Superfund Amendments and Reauthorization Act of 1986, as well as
analogous laws in some states, create joint and several liability for the cost
of cleaning up or correcting releases to the environment of designated hazardous
substances. Among those who may be held jointly and severally liable are:
o those who generated the waste;
o those who arranged for disposal;
o those who owned or operated the disposal site or facility at the time
of disposal; and
o current owners.
In general, this liability is imposed in a series of governmental
proceedings initiated by the government's identification of a site for initial
listing as a "Superfund site" on the National Priorities List or a similar state
list and the government's identification of potentially responsible parties who
may be liable for cleanup costs. None of the DSL Service Company's project sites
are listed as a "Superfund site."
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.
19
As a licensed entity, DSL Service Company is also examined and supervised
by the California Department of Real Estate and the Contractors State License
Board.
TAXATION
Federal. A savings institution is taxed like other corporations for federal
income tax purposes, though savings institutions have historically enjoyed
favorable treatment under the Internal Revenue Code in determining their
deductions for bad debts.
Savings institutions are required to comply with income tax statutes and
regulations similar to those applicable to large commercial banks. The Bank's
bad debt deduction is determined under the specific charge-off method, which
allows the Bank to take an income tax deduction for these loans only when they
have been determined to be wholly or partially worthless.
In addition to the regular corporate income tax, corporations might be
required to pay an alternative minimum tax. This tax is computed at 20% of the
corporation's regular taxable income, after taking some adjustments into
account. This alternative tax applies to corporations to the extent that it
exceeds a corporation's regular tax liability.
A corporation that incurs alternative minimum tax generally is entitled to
take this tax as a credit against its regular tax in later years to the extent
that the corporation's regular tax liability in these later years exceeds the
corporation's alternative minimum tax.
State. The Bank uses California's financial corporation income tax rate to
compute its California franchise tax liability. This rate is higher than the
California non-financial corporation income tax rate because the financial
corporation income tax rate reflects an amount "in lieu" of local personal
property and business license taxes that are paid by non-financial corporations,
but not by banks or other financial corporations. The financial corporation
income tax rate was 10.84% for both 2000 and 1999.
The Bank files a California franchise tax return on a combined reporting
basis. Other state income and franchise tax returns are filed on a
separate-entity basis in Arizona, Colorado, Idaho, Oregon and Utah. The Bank
anticipates that additional state income and franchise tax returns will be
required in future years as its lending business is expanded nationwide.
The Internal Revenue Service and state taxing authorities have examined our
tax returns for all tax years through 1995 and are currently reviewing returns
filed for the 1996 tax year. The Bank made a payment of $10.7 million during
2000 to settle federal tax claims related to the sale and leaseback of computer
equipment in 1990. This amount had been previously reflected in the Bank's tax
accrual, and therefore had no adverse impact upon current year earnings. In
addition, the Bank's management believes it has adequately provided for
potential exposure with regard to other issues in the years currently under
examination. Our tax years subsequent to 1996 remain open to review by federal
and state tax authorities.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The following discusses certain factors which may affect our financial
results and operations and should be considered in evaluating Downey.
Economic Conditions and Geographic Concentrations. Downey is headquartered
in and its operations are concentrated in California. As a result of this
geographic concentration, our results depend largely upon economic conditions in
the state. Leading business forecasters and economists predict that economic
growth may slow substantially from 2000. A significant contributor to the
projected 2001 slowdown is California's current energy crisis. The expected hike
in energy rates could impede growth by reducing business investment and consumer
spending within the state. Other issues facing the state's economy are potential
job losses as California "dot.com" companies continue to reduce their workforce.
A deterioration in economic conditions could have a material adverse impact on
the quality of our loan and real estate portfolios and the demand for our
products and services.
Interest Rates. We anticipate that short-term interest rate levels will
likely decline in 2001, and if interest rates vary substantially from present
levels, our results may differ materially from current levels. Changes in
interest rates will influence the growth of loans, investments and deposits and
affect the rates received on loans and investment securities and paid on
deposits. Changes in interest rates also affect the value of our recorded
20
mortgage servicing rights on loans we service for others, generally increasing
in value as interest rates rise and declining as interest rates fall. If
interest rates were to increase significantly, the economic feasibility of real
estate investment activities also could be adversely affected.
Government Regulation and Monetary Policy. The financial services industry
is subject to extensive federal and state supervision and regulation.
Significant new laws or changes in, or repeals of, existing laws may cause our
results to differ materially. Further, federal monetary policy, particularly as
implemented through the Federal Reserve System, significantly affects credit
conditions for Downey, primarily through open market operations in United States
government securities, the discount rate for borrowings and reserve
requirements, and a material change in these conditions would be likely to have
a material impact on our results.
Competition. The banking and financial services business in our market
areas is highly competitive. The increasingly competitive environment is a
result primarily of changes in regulation, changes in technology and product
delivery systems, and the accelerating pace of consolidation among financial
services providers. Our results may differ if circumstances affecting the nature
or level of competition change.
Credit Quality. A significant source of risk arises from the possibility
that losses will be sustained because borrowers, guarantors and related parties
may fail to perform in accordance with the terms of their loans. We have adopted
prudent underwriting and loan quality monitoring systems, procedures and credit
policies, including the establishment and review of the allowance for loan
losses, that management believes are appropriate to minimize this risk by
tracking loan performance, assessing the likelihood of nonperformance and
diversifying our loan portfolio. Such policies and procedures, however, may not
prevent unexpected losses that could materially adversely affect our results.
21
ITEM 2. PROPERTIES
BRANCHES
The corporate offices of Downey, the Bank and DSL Service Company are
located at 3501 Jamboree Road, Newport Beach, California 92660. Part of that
corporate facility houses a branch office of the Bank. Certain departments
(warehousing, record retention, etc.) are located in other owned and leased
facilities in Orange County, California. The majority of our administrative
operations, however, are located in our corporate headquarters.
At December 31, 2000, we had 114 branches. We owned the building and land
occupied by 56 of our branches and we owned one branch building on leased land.
We operate branches in 57 locations (including 49 in-store locations) with
leases or licenses expiring at various dates through October 2010, with options
to extend the term.
The net book value of our owned branches, including the one on leased land,
totaled $82 million at December 31, 2000 and the net book value of our leased
branch offices totaled $2 million at December 31, 2000. The net book value of
our furniture and fixtures, including electronic data processing equipment, was
$20 million at December 31, 2000.
For additional information regarding our offices and equipment, see Note 1
on page 69 and Note 9 on page 85 of Notes to Consolidated Financial Statements.
ELECTRONIC DATA PROCESSING
We utilize a mainframe computer system with use of various third-party
vendors' software for retail deposit operations, loan servicing, accounting and
loan origination functions, including our operations conducted over the
Internet. The net book value of our electronic data processing equipment,
including personal computers and software, was $12 million at December 31, 2000.
ITEM 3. LEGAL PROCEEDINGS
We have 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
No matters were submitted to shareholders during the fourth quarter of
2000.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the New York Stock Exchange ("NYSE") and the
Pacific Exchange ("PCX") with the trading symbol "DSL." At February 28, 2001, we
had approximately 873 stockholders of record (not including the number of
persons or entities holding stock in nominee or street name through various
brokerage firms) and 28,211,048 outstanding shares of common stock.
The following table sets forth for the quarters indicated the range of high
and low sale prices per share of our common stock as reported on the NYSE
Composite Tape.
2000 1999
-----------------------------------------------------------------------
4th 3rd 2nd 1st 4th 3rd 2nd 1st
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------
High ........ $60.88 $40.94 $33.00 $21.44 $22.94 $24.13 $23.00 $25.75
Low ......... 33.13 29.94 20.44 18.75 19.06 19.81 18.13 18.25
End of period 55.00 39.50 28.98 21.25 20.19 20.13 21.94 18.31
===========================================================================================
During 2000, we paid quarterly cash dividends totaling $0.36 per share,
aggregating $10.1 million compared to $0.35 per share, aggregating $9.9 million
during 1999. On February 23, 2001, we paid a $0.09 per share quarterly cash
dividend, aggregating $2.5 million.
We may pay additional dividends out of funds legally available therefor at
such times as the Board of Directors determines that dividend payments are
appropriate. The Board of Directors' policy is to consider the declaration of
dividends on a quarterly basis.
The payment of dividends by the Bank to Downey is subject to OTS
regulations. For further information regarding these regulations see
Business--Regulation--Regulation of the Bank--Capital Distribution Limitations
on page 16.
23
ITEM 6. SELECTED FINANCIAL DATA
(Dollars in Thousands, Except Per Share Amounts) 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME STATEMENT DATA:
Total interest income .......................................... $ 784,360 $ 533,751 $ 440,404 $ 420,418 $ 346,360
Total interest expense ......................................... 521,885 326,273 266,057 266,260 211,765
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income ........................................ 262,475 207,478 174,347 154,158 134,595
Provision for loan losses ...................................... 3,251 11,270 3,899 8,640 9,137
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses ........ 259,224 196,208 170,448 145,518 125,458
- ------------------------------------------------------------------------------------------------------------------------------------
Other income, net:
Loan and deposit related fees .............................. 30,089 20,097 15,645 10,921 7,435
Real estate and joint ventures held for investment, net .... 8,798 19,302 22,363 14,222 8,241
Secondary marketing activities:
Loan servicing fees ...................................... (3,628) 1,672 259 1,276 1,415
Net gains on sales of loans and mortgage-backed securities 3,297 14,806 6,462 2,675 1,543
Net gains (losses) on sales of investment securities ....... (106) 288 68 -- 4,473
Gain on sale of subsidiary (1) ............................. 9,762 -- -- -- --
Other ...................................................... 2,342 3,113 2,556 6,094 2,092
- ------------------------------------------------------------------------------------------------------------------------------------
Total other income, net .................................. 50,554 59,278 47,353 35,188 25,199
- ------------------------------------------------------------------------------------------------------------------------------------
Operating expense:
General and administrative expense ......................... 136,189 144,382 115,890 99,556 86,460
SAIF special assessment (2) ................................ -- -- -- -- 24,644
Net operation of real estate acquired in settlement of loans 818 19 260 1,184 2,567
Amortization of excess of cost over fair value of net assets
acquired.................................................. 462 474 510 532 532
- ------------------------------------------------------------------------------------------------------------------------------------
Total operating expense .................................. 137,469 144,875 116,660 101,272 114,203
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (1) (2) ............................................. $ 99,251 $ 63,804 $ 57,973 $ 45,234 $ 20,704
PER SHARE DATA:
Earnings per share--Basic (1) (2) .............................. $ 3.52 $ 2.27 $ 2.06 $ 1.61 $ 0.74
Earnings per share--Diluted (1) (2) ............................ 3.51 2.26 2.05 1.61 0.74
Book value per share at end of period .......................... 22.15 18.91 17.08 15.32 13.95
Stock price at end of period ................................... 55.00 20.19 25.44 27.08 17.80
Cash dividends paid ............................................ 0.36 0.35 0.32 0.30 0.29
SELECTED FINANCIAL RATIOS:
Effective interest rate spread ................................. 2.66% 2.88% 3.08% 2.83% 2.96%
Return on average assets (1) (2) ............................... 0.97 0.85 0.98 0.79 0.43
Return on average equity (1) (2) ............................... 17.17 12.70 12.71 11.07 5.33
Dividend payout ratio .......................................... 10.22 15.44 15.33 18.69 39.35
LOAN ACTIVITY:
Loans originated ............................................... $ 5,218,368 $7,132,486 $4,071,262 $2,329,266 $1,583,784
Loans and mortgage-backed securities purchased ................. 18,828 49,669 7,463 35,828 30,296
Loans and mortgage-backed securities sold ...................... 1,662,600 2,386,958 1,740,416 557,511 166,503
BALANCE SHEET SUMMARY (END OF PERIOD):
Total assets ................................................... $10,893,863 $9,407,540 $6,270,419 $5,835,825 $5,198,157
Loans and mortgage-backed securities ........................... 10,084,353 8,746,063 5,788,365 5,366,396 4,729,846
Investments and cash equivalents ............................... 439,968 299,698 215,086 221,201 222,255
Deposits ....................................................... 8,082,689 6,562,761 5,039,733 4,869,978 4,173,102
Borrowings ..................................................... 1,978,572 2,122,780 703,720 483,735 595,345
Capital securities ............................................. 120,000 120,000 -- -- --
Stockholders' equity ........................................... 624,636 532,418 480,566 430,346 391,571
Loans serviced for others ...................................... 3,964,462 2,923,778 1,040,264 612,529 576,044
AVERAGE BALANCE SHEET DATA:
Assets ......................................................... $10,217,371 $7,501,228 $5,918,507 $5,693,869 $4,789,648
Loans .......................................................... 9,514,978 6,937,342 5,345,380 5,174,767 4,269,136
Deposits ....................................................... 7,290,850 5,697,292 5,102,045 4,588,320 3,892,981
Stockholders' equity ........................................... 577,979 502,412 456,237 408,473 388,187
24
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
(Dollars in Thousands, Except Per Share Amounts) 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS:
Average stockholders' equity to average assets ................. 5.66% 6.70% 7.71% 7.17% 8.10%
Bank only--end of period (3):
Core and tangible capital .................................. 6.42 6.27 6.83 6.61 6.56
Risk-based capital ......................................... 12.94 12.14 12.88 12.64 12.66
SELECTED ASSET QUALITY DATA (END OF PERIOD):
Total non-performing assets .................................... $ 54,974 $ 39,194 $ 27,419 $ 52,120 $ 62,027
Non-performing assets as a percentage of total assets .......... 0.50% 0.42% 0.44% 0.89% 1.19%
Allowance for loan losses:
Amount ..................................................... $ 34,452 $ 38,342 $ 31,517 $ 32,092 $ 30,094
As a percentage of non-performing loans .................... 76.63% 116.25% 140.86% 76.96% 66.84%
====================================================================================================================================
(1) In 2000, a $5.6 million after-tax gain was recognized from the sale of
Downey Auto Finance Corp. Excluding the gain, 2000 net income would have
been $93.6 million or $3.33 per share on a basic basis and $3.32 per share
on a diluted basis, the return on average assets would have been 0.92% and
the return on average equity would have been 16.20%.
(2) In 1996, savings associations such as the Bank were assessed a one-time
charge for purposes of recapitalizing the SAIF. Excluding the SAIF special
assessment, 1996 net income would have been $34.7 million or $1.23 per
share on both a basic and diluted basis, the return on average assets would
have been 0.73% and the return on average equity would have been 8.95%.
(3) For more information regarding these ratios, see Management's Discussion
and Analysis of Financial Condition and Results of Operations--Financial
Condition--Regulatory Capital Compliance on page 58.
25
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 20.
OVERVIEW
Our net income for 2000 totaled a record $99.2 million or $3.51 per share
on a diluted basis. Included in the results was a $5.6 million after-tax gain
from the sale of our indirect automobile finance subsidiary in February 2000.
Excluding the gain, our net income for the year would have been $93.6 million or
$3.32 per share on a diluted basis, up 46.8% from $63.8 million or $2.26 per
share in 1999.
The increase in our adjusted net income between years was due to higher net
income from our banking operations, as net income from our real estate
investment activities declined $5.6 million to $4.4 million due primarily to
lower net gains from sales of properties. On an adjusted basis, net income from
our banking operations increased $35.4 million or 65.8% to $89.2 million due to
the following:
o net interest income increased $54.4 million or 26.2% due to an
increase in average interest-earning assets as our effective interest
rate spread declined;
o provision for loan losses declined by $8.0 million due primarily to
lower growth in our loan portfolio than a year ago and the sale of our
indirect automobile finance subsidiary; and
o operating expense declined by $7.1 million due to lower general and
administrative costs primarily associated with residential lending
activities and the sale of our indirect automobile finance subsidiary.
Our efficiency ratio (the percentage of our net interest income and
other income excluding income from real estate investment activities
and investment securities gains or losses used to cover our general
and administrative costs) improved from 58.4% in 1999 to 46.2% in
2000.
Those favorable items were partially offset by a $8.1 million decline in other
income, as an increase of $10.0 million in loan and deposit related fees were
unable to offset the following:
o a $11.5 million decline in net gains on sales of loans and
mortgage-backed securities due to a lower volume of loans being sold;
and
o a $3.6 million loss in loan servicing fees compared to income of $1.7
million in 1999. Our current year loss resulted from a $6.1 million
addition to the valuation allowance for mortgage servicing rights due
to an increase in expected prepayments from the drop in late 2000 in
mortgage interest rates.
For 2000, our return on average assets was 0.97% and our return on average
equity was 17.17%. Excluding the gain on sale of subsidiary, our