================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
For the quarterly period ended JUNE 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
__________ TO __________
Commission File Number 1-13578
DOWNEY FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0633413
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3501 JAMBOREE ROAD, NEWPORT BEACH, CA 92660
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (949) 854-0300
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ---------------------------------
COMMON STOCK, $0.01 PAR VALUE NEW YORK STOCK EXCHANGE
PACIFIC EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No__
At June 30, 2002, 28,235,022 shares of the Registrant's Common Stock, $0.01
par value were outstanding.
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DOWNEY FINANCIAL CORP.
JUNE 30, 2002 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I
ITEM 1. FINANCIAL INFORMATION.............................................. 1
Consolidated Balance Sheets........................................ 1
Consolidated Statements of Income.................................. 2
Consolidated Statements of Comprehensive Income.................... 3
Consolidated Statements of Cash Flows.............................. 4
Notes to Consolidated Financial Statements......................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................. 13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......... 40
PART II
ITEM 1. LEGAL PROCEEDINGS.................................................. 41
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.......................... 41
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................... 41
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIY HOLDERS............... 41
ITEM 5. OTHER INFORMATION.................................................. 41
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................... 41
i
PART I - FINANCIAL INFORMATION
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited) (Unaudited)
June 30, December 31, June 30,
(Dollars in Thousands, Except Per Share Data) 2002 2001 2001
- -------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash .......................................................................... $ 117,788 $ 106,079 $ 110,932
Federal funds ................................................................. 16,401 37,001 35,600
- -------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents ................................................. 134,189 143,080 146,532
U.S. Treasury securities, agency obligations and other investment securities
available for sale, at fair value ......................................... 292,832 402,355 262,835
Municipal securities held to maturity, at amortized cost (estimated fair
value of $6,373 at June 30, 2002 and December 31, 2001 and
$6,534 at June 30, 2001) .................................................. 6,387 6,388 6,550
Mortgage loans purchased under resale agreements .............................. -- -- 40,000
Loans held for sale, at lower of cost or fair value ........................... 381,465 499,024 376,560
Mortgage-backed securities available for sale, at fair value .................. 58,122 118,981 5,234
Loans receivable held for investment .......................................... 9,846,446 9,514,408 9,599,419
Investments in real estate and joint ventures ................................. 40,283 38,185 19,950
Real estate acquired in settlement of loans ................................... 13,528 15,366 8,366
Premises and equipment ........................................................ 113,417 111,762 104,591
Federal Home Loan Bank stock, at cost ......................................... 114,452 113,139 110,036
Mortgage servicing rights, net ................................................ 59,771 56,895 42,142
Other assets .................................................................. 69,311 85,447 99,701
- -------------------------------------------------------------------------------------------------------------------------------
$ 11,130,203 $ 11,105,030 $ 10,821,916
===============================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits ...................................................................... $ 8,690,558 $ 8,619,566 $ 9,040,064
Federal Home Loan Bank advances and other borrowings .......................... 1,413,607 1,522,712 892,764
Accounts payable and accrued liabilities ...................................... 64,614 67,431 55,642
Deferred income taxes ......................................................... 54,118 41,425 32,727
- -------------------------------------------------------------------------------------------------------------------------------
Total liabilities ......................................................... 10,222,897 10,251,134 10,021,197
- -------------------------------------------------------------------------------------------------------------------------------
Company obligated mandatorily redeemable capital securities of subsidiary trust
holding solely junior subordinated debentures of the Company
("Capital Securities") .................................................... 120,000 120,000 120,000
STOCKHOLDERS' EQUITY
Preferred stock, par value of $0.01 per share; authorized 5,000,000 shares;
outstanding none .......................................................... -- -- --
Common stock, par value of $0.01 per share; authorized 50,000,000 shares;
outstanding 28,235,022 shares at June 30, 2002, 28,213,048 shares
at December 31, 2001 and 28,211,048 shares at June 30, 2001 ............... 282 282 282
Additional paid-in capital .................................................... 93,792 93,400 93,374
Accumulated other comprehensive income (loss) ................................. 236 (239) 2,394
Retained earnings ............................................................. 692,996 640,453 584,669
- -------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity ................................................ 787,306 733,896 680,719
- -------------------------------------------------------------------------------------------------------------------------------
$ 11,130,203 $ 11,105,030 $ 10,821,916
===============================================================================================================================
See accompanying notes to consolidated financial statements.
1
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
-----------------------------------------------------------
(Dollars in Thousands, Except Per Share Data) 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans receivable .................................................... $ 148,448 $ 203,820 $ 308,725 $ 416,582
U.S. Treasury securities and agency obligations ..................... 2,163 4,122 5,196 8,532
Mortgage-backed securities .......................................... 942 87 2,216 215
Other investments ................................................... 1,872 3,206 3,686 5,872
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest income ............................................ 153,425 211,235 319,823 431,201
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INTEREST EXPENSE
Deposits ............................................................ 60,397 114,386 128,756 229,187
Borrowings .......................................................... 14,859 17,562 29,912 43,524
Capital securities .................................................. 3,041 3,041 6,082 6,082
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest expense ........................................... 78,297 134,989 164,750 278,793
- ------------------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME ................................................. 75,128 76,246 155,073 152,408
PROVISION FOR (REDUCTION OF) LOAN LOSSES ............................ (1,106) 431 341 483
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for (reduction of) loan losses 76,234 75,815 154,732 151,925
- ------------------------------------------------------------------------------------------------------------------------------------
OTHER INCOME, NET
Loan and deposit related fees ....................................... 11,396 14,136 22,914 24,366
Real estate and joint ventures held for investment, net ............. 1,016 692 4,013 1,692
Secondary marketing activities:
Loan servicing loss, net ......................................... (15,617) (2,898) (16,205) (11,083)
Net gains on sales of loans and mortgage-backed securities ....... 6,896 8,962 23,097 11,149
Net gains on sales of mortgage servicing rights .................. 12 671 306 671
Net gains on sales of investment securities ......................... 19 114 209 239
Other ............................................................... 380 606 1,121 1,262
- ------------------------------------------------------------------------------------------------------------------------------------
Total other income, net .......................................... 4,102 22,283 35,455 28,296
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OPERATING EXPENSE
Salaries and related costs .......................................... 28,315 24,646 57,752 47,917
Premises and equipment costs ........................................ 7,754 6,042 14,887 12,085
Advertising expense ................................................. 1,582 1,127 2,626 2,303
Professional fees ................................................... 233 1,604 797 2,181
SAIF insurance premiums and regulatory assessments .................. 762 741 1,548 1,473
Other general and administrative expense ............................ 6,350 5,973 12,561 11,312
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Total general and administrative expense ......................... 44,996 40,133 90,171 77,271
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Net operation of real estate acquired in settlement of loans ........ 27 (106) (31) (108)
Amortization of excess cost over fair value of branch acquisitions .. 114 114 225 228
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Total operating expense .......................................... 45,137 40,141 90,365 77,391
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INCOME BEFORE INCOME TAXES .......................................... 35,199 57,957 99,822 102,830
Income taxes ........................................................ 14,890 24,502 42,199 43,511
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME ....................................................... $ 20,309 $ 33,455 $ 57,623 $ 59,319
====================================================================================================================================
PER SHARE INFORMATION
BASIC ............................................................... $ 0.72 $ 1.18 $ 2.04 $ 2.10
====================================================================================================================================
DILUTED ............................................................. $ 0.72 $ 1.18 $ 2.04 $ 2.09
====================================================================================================================================
CASH DIVIDENDS DECLARED AND PAID .................................... $ 0.09 $ 0.09 $ 0.18 $ 0.18
====================================================================================================================================
Weighted average diluted shares outstanding ......................... 28,284,493 28,271,014 28,277,833 28,273,099
====================================================================================================================================
See accompanying notes to consolidated financial statements.
2
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
-----------------------------------------------
(In Thousands) 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------
NET INCOME ................................................................. $ 20,309 $ 33,455 $ 57,623 $ 59,319
- -----------------------------------------------------------------------------------------------------------------------------
OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAXES (BENEFITS)
Unrealized gains (losses) on securities available for sale:
U.S. Treasury securities, agency obligations and other investment
securities available for sale, at fair value .......................... 811 (152) (545) 541
Mortgage-backed securities available for sale, at fair value ........... 1,862 22 924 55
Less reclassification of realized gains included in net income ......... (11) (66) (121) (138)
Unrealized gains (losses) on cash flow hedges:
Net derivative instruments ............................................. (3,108) 2,045 (3,625) 722
Less reclassification of realized (gains) losses included in net income 1,970 (637) 3,842 527
- -----------------------------------------------------------------------------------------------------------------------------
Total other comprehensive income, net of income taxes ...................... 1,524 1,212 475 1,707
- -----------------------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME ....................................................... $ 21,833 $ 34,667 $ 58,098 $ 61,026
=============================================================================================================================
See accompanying notes to consolidated financial statements.
3
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended
June 30,
--------------------------
(In Thousands) 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ............................................................................... $ 57,623 $ 59,319
Adjustments to reconcile net income to net cash used for operating activities:
Depreciation and amortization ......................................................... 29,271 24,004
Provision for losses on loans, real estate acquired in settlement of loans, investments
in real estate and joint ventures, mortgage servicing rights and other assets ....... 16,458 11,576
Net gains on sales of loans and mortgage-backed securities, mortgage servicing rights,
investment securities, real estate and other assets ................................. (26,597) (13,600)
Net change in interest capitalized on loans (negative amortization) ................... (15,844) (34,601)
Federal Home Loan Bank stock dividends ................................................ (1,313) (3,680)
Loans originated for sale ................................................................ (2,331,790) (2,093,678)
Proceeds from sales of loans held for sale, including those sold
via mortgage-backed securities ........................................................ 2,473,447 1,955,407
Other, net ............................................................................... (2,382) (9,907)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities ..................................... 198,873 (105,160)
- -------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of:
U.S. Treasury securities, agency obligations and other investment securities
available for sale .................................................................. 88,531 18,653
Wholly owned real estate and real estate acquired in settlement of loans .............. 20,234 2,565
Proceeds from maturities of U.S. Treasury securities, agency obligations
and other investment securities available for sale .................................... 268,980 284,090
Purchase of:
U.S. Treasury securities, agency obligations and other investment securities
available for sale .................................................................. (250,355) (258,114)
Mortgage loans under resale agreements ................................................ -- (40,000)
Loans receivable held for investment .................................................. (7,302) (88,259)
Premises and equipment ................................................................ (11,226) (9,005)
Originations of loans receivable held for investment (net of refinances of $338,946 at
June 30, 2002 and $377,262 at June 30, 2001) .......................................... (1,917,550) (1,068,383)
Principal payments on loans receivable held for investment and mortgage-backed
securities available for sale ......................................................... 1,599,806 1,428,465
Net change in undisbursed loan funds ..................................................... 55,822 (12,279)
Investments in real estate held for investment ........................................... (14,806) (3,332)
Other, net ............................................................................... 2,903 2,864
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities ..................................... (164,963) 257,265
- -------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
4
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
Six Months Ended
June 30,
-------------------------------
(In Thousands) 2002 2001
- -------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits ..................................................... $ 70,992 $ 957,375
Proceeds from Federal Home Loan Bank advances and other borrowings ........... 2,213,400 1,043,200
Repayments of Federal Home Loan Bank advances and other borrowings ........... (2,322,505) (2,129,008)
Proceeds from exercise of stock options ...................................... 392 135
Cash dividends ............................................................... (5,080) (5,078)
- -------------------------------------------------------------------------------------------------------------
Net cash used for financing activities ....................................... (42,801) (133,376)
- -------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents ......................... (8,891) 18,729
Cash and cash equivalents at beginning of period ............................. 143,080 127,803
- -------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................................... $ 134,189 $ 146,532
=============================================================================================================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest ................................................................ $ 160,925 $ 284,408
Income taxes ............................................................ 18,509 40,956
Supplemental disclosure of non-cash investing:
Loans transferred to held for investment from held for sale ............... 2,015 3,179
Loans exchanged for mortgage-backed securities ............................ 2,169,126 1,534,584
Real estate acquired in settlement of loans ............................... 12,973 9,302
Loans to facilitate the sale of real estate acquired in settlement of loans 8,275 5,202
=============================================================================================================
See accompanying notes to consolidated financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE (1) - BASIS OF FINANCIAL STATEMENT PRESENTATION
In the opinion of Downey Financial Corp. and subsidiaries ("Downey," "we,"
"us" and "our"), the accompanying consolidated financial statements contain all
adjustments (consisting of only normal recurring accruals) necessary for a fair
presentation of Downey's financial condition as of June 30, 2002, December 31,
2001 and June 30, 2001, the results of operations and comprehensive income for
the three months and six months ended June 30, 2002 and 2001, and changes in
cash flows for the six months ended June 30, 2002 and 2001. Certain prior period
amounts have been reclassified to conform to the current period presentation.
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial statements and are in compliance with the
instructions for Form 10-Q and therefore do not include all information and
footnotes necessary for a fair presentation of financial condition, results of
operations, comprehensive income and cash flows. The following information under
the heading Management's Discussion and Analysis of Financial Condition and
Results of Operations is written with the presumption that the interim
consolidated financial statements will be read in conjunction with Downey's
Annual Report on Form 10-K for the year ended December 31, 2001, which contains
among other things, a description of the business, the latest audited
consolidated financial statements and notes thereto, together with Management's
Discussion and Analysis of Financial Condition and Results of Operations as of
December 31, 2001 and for the year then ended. Therefore, only material changes
in financial condition and results of operations are discussed in the remainder
of Part I.
NOTE (2) - EARNINGS PER SHARE
Earnings per share is calculated on both a basic and diluted basis. Basic
earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted from issuance of
common stock that then shared in earnings.
The following table presents a reconciliation of the components used to
derive basic and diluted earnings per share for the periods indicated.
Three Months Ended June 30,
--------------------------------------------------------------------------
2002 2001
--------------------------------------------------------------------------
Weighted Weighted
Average Average
Net Shares Per Share Net Shares Per Share
(Dollars in Thousands, Except Per Share Data) Income Outstanding Amount Income Outstanding Amount
- ----------------------------------------------------------------------------------------------------------------------------
Basic earnings per share ....... $ 20,309 28,232,787 $ 0.72 $ 33,455 28,211,048 $ 1.18
Effect of dilutive stock options -- 51,706 -- -- 59,966 --
- ----------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 20,309 28,284,493 $ 0.72 $ 33,455 28,271,014 $ 1.18
============================================================================================================================
Six Months Ended June 30,
--------------------------------------------------------------------------
2002 2001
--------------------------------------------------------------------------
Weighted Weighted
Average Average
Net Shares Per Share Net Shares Per Share
(Dollars in Thousands, Except Per Share Data) Income Outstanding Amount Income Outstanding Amount
- ----------------------------------------------------------------------------------------------------------------------------
Basic earnings per share ....... $ 57,623 28,222,918 $ 2.04 $ 59,319 28,210,364 $ 2.10
Effect of dilutive stock options -- 54,915 -- -- 62,735 0.01
- ----------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 57,623 28,277,833 $ 2.04 $ 59,319 28,273,099 $ 2.09
============================================================================================================================
6
NOTE (3) - BUSINESS SEGMENT REPORTING
The following table presents the operating results and selected financial
data by major business segments for the periods indicated.
Real Estate
(In Thousands) Banking Investment Elimination Totals
- ------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED JUNE 30, 2002
Net interest income .............................. $ 75,115 $ 13 $ -- $ 75,128
Reduction of loan losses ......................... (1,106) -- -- (1,106)
Other income ..................................... 2,803 1,299 -- 4,102
Operating expense ................................ 44,893 244 -- 45,137
Net intercompany income (expense) ................ 86 (86) -- --
- ------------------------------------------------------------------------------------------------------------------
Income before income taxes ....................... 34,217 982 -- 35,199
Income taxes ..................................... 14,493 397 -- 14,890
- ------------------------------------------------------------------------------------------------------------------
Net income .................................. $ 19,724 $ 585 $ -- $ 20,309
==================================================================================================================
AT JUNE 30, 2002
Assets:
Loans and mortgage-backed securities ........ $ 10,286,033 $ -- $ -- $ 10,286,033
Investments in real estate and joint ventures -- 40,283 -- 40,283
Other ....................................... 840,416 1,919 (38,448) 803,887
- ------------------------------------------------------------------------------------------------------------------
Total assets .............................. 11,126,449 42,202 (38,448) 11,130,203
- ------------------------------------------------------------------------------------------------------------------
Equity ........................................... $ 787,306 $ 38,448 $ (38,448) $ 787,306
==================================================================================================================
THREE MONTHS ENDED JUNE 30, 2001
Net interest income .............................. $ 76,236 $ 10 $ -- $ 76,246
Provision for loan losses ........................ 431 -- -- 431
Other income ..................................... 21,211 1,072 -- 22,283
Operating expense ................................ 38,863 1,278 -- 40,141
Net intercompany income (expense) ................ 84 (84) -- --
- ------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (benefit) ...... 58,237 (280) -- 57,957
Income taxes (benefit) ........................... 24,618 (116) -- 24,502
- ------------------------------------------------------------------------------------------------------------------
Net income (loss) ........................... $ 33,619 $ (164) $ -- $ 33,455
==================================================================================================================
AT JUNE 30, 2001
Assets:
Loans and mortgage-backed securities ........ $ 9,981,213 $ -- $ -- $ 9,981,213
Investments in real estate and joint ventures -- 19,950 -- 19,950
Other ....................................... 837,387 1,673 (18,307) 820,753
- ------------------------------------------------------------------------------------------------------------------
Total assets .............................. 10,818,600 21,623 (18,307) 10,821,916
- ------------------------------------------------------------------------------------------------------------------
Equity ........................................... $ 680,719 $ 18,307 $ (18,307) $ 680,719
==================================================================================================================
Real Estate
(In Thousands) Banking Investment Elimination Totals
- ------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 2002
Net interest income .............................. $ 155,055 $ 18 $ -- $ 155,073
Provision for loan losses ........................ 341 -- -- 341
Other income ..................................... 30,865 4,590 -- 35,455
Operating expense ................................ 89,899 466 -- 90,365
Net intercompany income (expense) ................ 179 (179) -- --
- ------------------------------------------------------------------------------------------------------------------
Income before income taxes ....................... 95,859 3,963 -- 99,822
Income taxes ..................................... 40,578 1,621 -- 42,199
- ------------------------------------------------------------------------------------------------------------------
Net income .................................. $ 55,281 $ 2,342 $ -- $ 57,623
==================================================================================================================
SIX MONTHS ENDED JUNE 30, 2001
Net interest income .............................. $ 152,370 $ 38 $ -- $ 152,408
Provision for loan losses ........................ 483 -- -- 483
Other income ..................................... 25,956 2,340 -- 28,296
Operating expense ................................ 75,853 1,538 -- 77,391
Net intercompany income (expense) ................ 181 (181) -- --
- ------------------------------------------------------------------------------------------------------------------
Income before income taxes ....................... 102,171 659 -- 102,830
Income taxes ..................................... 43,243 268 -- 43,511
- ------------------------------------------------------------------------------------------------------------------
Net income .................................. $ 58,928 $ 391 $ -- $ 59,319
==================================================================================================================
7
NOTE (4) - MORTGAGE SERVICING RIGHTS
The following table summarizes the activity in our mortgage servicing
rights and related allowance for the periods indicated and other related
financial data.
Three Months Ended
---------------------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(Dollars in Thousands) 2002 2002 2001 2001 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Gross balance at beginning of period .............. $ 74,914 $ 65,630 $ 61,651 $ 55,848 $ 49,323
Additions ......................................... 10,156 14,997 15,300 10,294 13,403
Amortization ...................................... (3,253) (2,916) (2,956) (2,495) (2,299)
Sales of mortgage servicing rights ................ -- (35) (4,916) (582) (2,328)
Impairment write-down ............................. (717) (2,762) (3,449) (1,414) (2,251)
- ------------------------------------------------------------------------------------------------------------------------------------
Gross balance at end of period ................ 81,100 74,914 65,630 61,651 55,848
- ------------------------------------------------------------------------------------------------------------------------------------
Allowance balance at beginning of period .......... 6,333 8,735 24,144 13,706 13,606
Provision for (reduction of) impairment ........... 15,713 360 (11,960) 11,852 2,351
Impairment write-down ............................. (717) (2,762) (3,449) (1,414) (2,251)
- ------------------------------------------------------------------------------------------------------------------------------------
Allowance balance at end of period ............ 21,329 6,333 8,735 24,144 13,706
- ------------------------------------------------------------------------------------------------------------------------------------
Total mortgage servicing rights, net .......... $ 59,771 $ 68,581 $ 56,895 $ 37,507 $ 42,142
====================================================================================================================================
Estimated fair value (1) .......................... $ 59,771 $ 70,532 $ 58,047 $ 37,507 $ 42,142
Weighted average expected life (in months) ........ 61 87 82 59 79
Custodial account earnings rate ................... 3.82% 4.61% 4.36% 2.85% 3.60%
Weighted average discount rate .................... 9.10 9.13 9.16 9.21 9.26
====================================================================================================================================
AT PERIOD END
Mortgage loans serviced for others:
Total ......................................... $ 6,962,403 $ 6,408,812 $ 5,805,811 $ 5,458,970 $ 5,056,120
With capitalized mortgage servicing rights (1):
Amount .................................... 6,807,306 6,196,137 5,379,513 5,078,088 4,456,822
Weighted average interest rate ............ 6.80% 6.85% 6.97% 7.19% 7.29%
====================================================================================================================================
Custodial escrow balances ......................... $ 13,044 $ 6,103 $ 10,596 $ 15,415 $ 9,924
====================================================================================================================================
Six Months Ended
June 30,
------------------------------
(In Thousands) 2002 2001
- ----------------------------------------------------------------------------------
Gross balance at beginning of period .............. $ 65,630 $ 46,214
Additions ......................................... 25,153 18,797
Amortization ...................................... (6,169) (4,362)
Sales of mortgage servicing rights ................ (35) (2,328)
Impairment write-down ............................. (3,479) (2,473)
- ----------------------------------------------------------------------------------
Gross balance at end of period ................ 81,100 55,848
- ----------------------------------------------------------------------------------
Allowance balance at beginning of period .......... 8,735 5,483
Provision for impairment .......................... 16,073 10,696
Impairment write-down ............................. (3,479) (2,473)
- ----------------------------------------------------------------------------------
Allowance balance at end of period ............ 21,329 13,706
- ----------------------------------------------------------------------------------
Total mortgage servicing rights, net .......... $ 59,771 $ 42,142
==================================================================================
(1) The estimated fair value may exceed book value for certain asset strata and
excluded loans sold or securitized prior to 1996 without capitalized
mortgage servicing rights.
Key assumptions, which vary due to changes in market interest rates and are
used to determine the fair value of our mortgage servicing rights, include:
expected prepayment speeds, which impact the average life of the portfolio; the
earnings rate on custodial accounts, which impact the value of custodial
accounts; and the discount rate used in valuing future cash flows. The table
below summarizes the estimated changes in the fair value of our mortgage
servicing rights for changes in those assumptions individually and in
combination associated with an immediate 100 basis point increase or decrease in
market rates. Also summarized is the earnings impact associated with provisions
to or reductions in the valuation allowance for mortgage servicing rights.
Impairment is measured on a disaggregated basis based upon the predominant risk
8
characteristics of the underlying mortgage loans such as term and coupon.
Certain stratum may have impairment, while other stratum may not. Therefore,
changes in overall fair value may not equal provisions to or reductions in the
valuation allowance.
The sensitivity analysis in the table below is hypothetical and should be
used with caution. As the figures indicate, changes in fair value based on a 100
basis point variation in assumptions generally cannot be easily extrapolated
because the relationship of the change in the assumptions to the change in fair
value may not be linear. Also, in this table, the effect that a change in a
particular assumption may have on the fair value is calculated without changing
any other assumption. In reality, changes in one factor may result in changes in
another, which might magnify or counteract the sensitivities.
Expected Value of
Prepayment Custodial Discount
(Dollars in Thousands) Speeds Accounts Rate Combination
- ----------------------------------------------------------------------------------------------------------
Increase rates 100 basis points:
Fair value (1) ................................... $ 20,675 $ 4,532 $ (1,741) $ 22,148
Reduction of (increase in) valuation allowance ... 17,033 4,519 (1,741) 17,693
Decrease rates 100 basis points:
Fair value (2) ................................... (17,562) (4,532) 1,840 (21,278)
Reduction of (increase in) valuation allowance ... (17,562) (4,532) 1,840 (21,460)
==========================================================================================================
(1) The weighted-average expected life is 98 months.
(2) The weighted-average expected life is 36 months.
The following table presents a breakdown of the components of our loan
servicing income (loss) during the periods indicated.
Three Months Ended
---------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 2002 2002 2001 2001 2001
- -----------------------------------------------------------------------------------------------------------
Income from servicing operations .......... $ 3,349 $ 2,688 $ 2,477 $ 2,576 $ 1,752
Amortization of MSRs ...................... (3,253) (2,916) (2,956) (2,495) (2,299)
(Provision for) reduction of impairment ... (15,713) (360) 11,960 (11,852) (2,351)
- -----------------------------------------------------------------------------------------------------------
Total loan servicing income (loss), net $(15,617) $ (588) $ 11,481 $(11,771) $ (2,898)
===========================================================================================================
Six Months Ended
June 30,
--------------------------
(In Thousands) 2002 2001
- ----------------------------------------------------------------------
Income from servicing operations .......... $ 6,037 $ 3,975
Amortization of MSRs ...................... (6,169) (4,362)
Provision for impairment .................. (16,073) (10,696)
- ----------------------------------------------------------------------
Total loan servicing loss, net ........ $(16,205) $(11,083)
======================================================================
NOTE (5) - ACCOUNTING FOR DERIVATIVES AND HEDGING ACTIVITIES
DERIVATIVES
We offer short-term interest rate lock commitments to help us attract
potential home loan borrowers. The commitments guarantee a specified interest
rate for a loan if our underwriting standards are met, but do not obligate the
potential borrower. Accordingly, a certain number of commitments never become
loans and merely expire. The residential one-to-four unit rate lock commitments
we ultimately expect to result in loans and sell in the secondary market are
treated as derivatives. Consequently, as derivatives, the hedging of the
expected rate lock commitments do not qualify for hedge accounting. Associated
fair value adjustments to the notional amount of the expected rate lock
commitments are recorded in current earnings under net gains on sales of loans
and mortgage-backed securities with an offset to the balance sheet in either
other assets, or accounts payable and accrued liabilities. Fair values for the
notional amount of expected rate lock commitments are based on observable market
prices acquired from third parties. The carrying amount of loans held for sale
includes a basis adjustment to the loan balance at funding resulting from the
change in the fair value of the rate lock derivative from the date of commitment
to the date of funding. At June 30, 2002 we had a notional amount of expected
rate
9
lock commitments identified to sell as part of our secondary marketing
activities of $503 million, with an estimated fair value gain of $7.5 million,
of which $5.1 million was associated with mortgage servicing rights.
HEDGING ACTIVITIES
As part of our secondary marketing activities, we typically utilize
short-term forward sale and purchase contracts--derivatives--that mature in less
than one year to offset the impact of changes in market interest rates on the
value of our residential one-to-four unit expected rate lock commitments and
loans held for sale. We do not generally enter into derivative transactions for
purely speculative purposes. Contracts designated to loans held for sale are
accounted for as cash flow hedges because these contracts have a high
correlation to the price movement of the loans being hedged (within a range of
80% - 125%). The measurement approach for determining the ineffective aspects of
the hedge is established at the inception of the hedge. Changes in fair value of
the notional amount of forward sale contracts not designated to loans held for
sale and the ineffectiveness of hedge transactions that are not perfectly
correlated are recorded in net gains on sales of loans and mortgage-backed
securities. Changes in fair value of the notional amount of forward sale
contracts designated as cash flow hedges for loans held for sale are recorded in
other comprehensive income, net of tax, provided cash flow hedge requirements
are met. The offset to these changes in fair value of the notional amount of
forward sale contracts are recorded in the balance sheet as either other assets,
or accounts payable and accrued liabilities. The amounts recorded in accumulated
other comprehensive income will be recognized in the income statement when the
hedged forecasted transactions settle. We estimate that all of the related
unrealized gains or losses in accumulated other comprehensive income will be
reclassified into earnings within the next three months. Fair values for the
notional amount of forward sale contracts are based on observable market prices
acquired from third parties. At June 30, 2002, the notional amount of forward
sale contracts amounted to $880 million, with an estimated fair value loss of
$5.1 million, of which $378 million were designated as cash flow hedges. The
notional amount of forward purchase contracts amounted to $3.0 million, with a
negligible estimated fair value gain that partially offsets the loss on our
forward sale contracts not designated to loans held for sale.
We have not discontinued any designated derivative instruments associated
with loans held for sale due to a change in the probability of settling a
forecasted transaction.
The following table shows the impact from non-qualifying hedges and the
ineffectiveness of cash flow hedges on net gains (losses) on sales of loans and
mortgage-backed securities (i.e., SFAS 133 effect), as well as the impact to
other comprehensive income (loss) from qualifying cash flow transactions. Also
shown is the notional amount of expected rate lock commitment derivatives for
loans originated for sale, loans held for sale and the notional amounts for
their associated hedging derivatives (i.e., forward sale contracts).
Three Months Ended
-------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 2002 2002 2001 2001 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Net gains (losses) on non-qualifying hedge transactions ....... $ (390) $ 4,864 $ (3,834) $ (1,149) $ 726
Net gains (losses) on qualifying cash flow hedge transactions:
Unrealized hedge ineffectiveness .......................... -- -- -- (27) 31
Less reclassification of realized hedge ineffectiveness ... -- -- -- 27 21
- ------------------------------------------------------------------------------------------------------------------------------------
Total net gains (losses) recognized in sales of loans and
mortgage-backed securities (SFAS 133 effect) .......... (390) 4,864 (3,834) (1,149) 778
Other comprehensive income (loss) ............................. (1,138) 1,355 501 (2,477) 1,408
====================================================================================================================================
NOTIONAL AMOUNT AT PERIOD END
Non-qualifying hedge transactions:
Expected rate lock commitments ............................ $ 503,359 $ 235,099 $ 269,315 $ 422,606 $ 264,397
Associated forward sale contracts ......................... 501,292 230,660 278,319 404,177 294,284
Associated forward purchase contracts ..................... 3 -- -- 53 45
Qualifying cash flow hedge transactions:
Loans held for sale, at lower of cost or fair value ....... 381,465 388,468 499,024 373,489 376,560
Associated forward sale contracts ......................... 378,238 392,099 508,706 369,335 358,378
====================================================================================================================================
10
Six Months Ended
June 30,
--------------------------
(In Thousands) 2002 2001
- --------------------------------------------------------------------------------------------
Net gains (losses) on non-qualifying hedge transactions ....... $ 4,474 $ (981)
Net losses on qualifying cash flow hedge transactions:
Unrealized hedge ineffectiveness .......................... -- (440)
Less reclassification of realized hedge ineffectiveness ... -- 440
- --------------------------------------------------------------------------------------------
Total net gains (losses) recognized in sales of loans and
mortgage-backed securities (SFAS 133 effect) .......... 4,474 (981)
Other comprehensive income .................................... 217 1,249
============================================================================================
NOTE (6) - INCOME TAXES
Downey and its wholly owned subsidiaries file a consolidated federal income
tax return and various state income and franchise tax returns on a calendar year
basis. The Internal Revenue Service and state taxing authorities have examined
Downey's tax returns for all tax years through 1997. Tax years subsequent to
1997 remain open to review. Downey's management believes it has adequately
provided for potential exposure to issues that may be raised in the years open
to review.
NOTE (7) - CURRENT ACCOUNTING ISSUES
Statement of Financial Accounting Standards No. 142. Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS
142"), applies to all acquired intangible assets whether acquired singularly, as
part of a group, or in a business combination. SFAS 142 supersedes APB Opinion
No. 17, "Intangible Assets," and carries forward provisions in Opinion 17
related to internally developed intangible assets. SFAS 142 changes the
accounting for goodwill from an amortization method to an impairment-only
approach. Goodwill should no longer be amortized, but instead tested for
impairment at least annually at the reporting unit level. The accounting
provisions are effective for fiscal years beginning after December 31, 2001. Our
intangible assets and goodwill are related to branch acquisitions and not within
the scope of SFAS 142. We recognized an unidentified intangible asset for branch
acquisitions because the fair value of the liabilities assumed exceeded the fair
value of the assets acquired. However, under a current proposal being considered
by the Financial Accounting Standards Board, assets of this nature that meet the
definition of a business combination will be accounted for using the
impairment-only approach. A final Statement regarding this proposal is expected
to be issued in the fourth quarter of 2002. If adopted as proposed, we would
stop amortizing the remaining excess of cost over fair value of branch
acquisitions and record impairment, if necessary. For the second quarter of
2002, our amortization of excess cost over fair value of branch acquisitions was
$0.1 million and as of June 30, 2002, this asset totaled $3 million. For the
first six months of 2002, our amortization was $0.2 million.
Statement of Financial Accounting Standards No. 143. Statement of Financial
Accounting Standards No. 143, "Accounting for Asset Retirement Obligations"
("SFAS 143"), addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. SFAS 143 is effective for financial statements issued
for fiscal years beginning after June 15, 2002. It is anticipated that the
financial impact of SFAS 143 will not have a material effect on Downey.
Statement of Financial Accounting Standards No. 144. Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS 144"), addresses financial accounting and reporting
for the impairment or disposal of long-lived assets. SFAS 144 supersedes SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," and the accounting and reporting provisions of APB
Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of a business segment. SFAS
144 also eliminates the exception to consolidation for a subsidiary for which
control is likely to be temporary. The provisions of SFAS 144 are effective for
financial statements issued for fiscal years beginning after December 15, 2001,
and interim periods within those fiscal years. The provisions of SFAS 144
generally are to be applied prospectively. It is anticipated that the financial
impact of SFAS 144 will not have a material effect on Downey.
Statement of Financial Accounting Standards No. 145. Statement of Financial
Accounting Standards No. 145, "Rescission of SFAS Statements No. 4, 44, and 64,
Amendment of SFAS Statement No. 13, and Technical Corrections" ("SFAS 145"),
updates, clarifies and simplifies existing accounting pronouncements. SFAS 145
rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt."
SFAS 145 amends SFAS No. 13, "Accounting for Leases," to eliminate an
inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for
11
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. The provisions of SFAS 145 related to SFAS No. 4
and SFAS No. 13 are effective for fiscal years beginning and transactions
occurring after May 15, 2002, respectively. It is anticipated that the financial
impact of SFAS 145 will not have a material effect on Downey.
Statement of Financial Accounting Standards No. 146. Statement of Financial
Accounting Standards No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities" ("SFAS 146"), requires Downey to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan. SFAS 146 replaces Emerging Issues
Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The provisions of SFAS 146 are to be
applied prospectively to exit or disposal activities initiated after December
31, 2002.
NOTE (8) - SUBSEQUENT EVENTS
New Director. On July 8, 2002, Downey Financial Corp. announced that James
H. Hunter had been elected a director of the boards of both Downey Financial
Corp. and Downey Savings and Loan Association, F.A. (the "Bank"), increasing
both Boards' membership to nine directors. James H. Hunter is Executive Vice
President of Planning and Acquisition for The Corky McMillin Companies. As of
June 30, 2002, the Bank had committed loans to The Corky McMillin Companies or
affiliates totaling $72.0 million, of which $38.7 million had been disbursed. As
of June 30, 2002, DSL Service Company, a wholly owned subsidiary of the Bank,
had committed investments in joint ventures associated with The Corky McMillin
Companies or affiliates totaling $19.8 million, of which $16.9 million had been
disbursed. All such loans and investments are performing in accordance with
their terms. The loan terms, including interest rates and collateral, are
substantially the same as those prevailing at the time for comparable
transactions with other non-related parties. In the opinion of management, those
transactions neither involve more than the normal risk of collectibility or of
return on investment, nor present any unfavorable features.
Stock Repurchase Program. On July 24, 2002, the Board of Directors of
Downey Financial Corp. authorized a share repurchase program of up to $50
million of Downey's common stock. The shares will be repurchased from
time-to-time in open market transactions. The timing, volume and price of
purchases will be made at the discretion of Downey, and will also be contingent
upon Downey's overall financial condition, as well as market conditions in
general.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain statements under this caption may constitute "forward-looking
statements" under the Private Securities Litigation Reform Act of 1995 which
involve risks and uncertainties. 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.
OVERVIEW
Our net income for the second quarter of 2002 totaled $20.3 million or
$0.72 per share on a diluted basis, compared to $33.4 million or $1.18 per share
in the second quarter of 2001.
The decline in our net income between second quarters was primarily due to
a larger addition to the valuation allowance for mortgage servicing rights. The
addition was reflected within the category of loan servicing loss and was
necessary due to the decline in long-term interest rates, which resulted in an
increase in the projected rate at which loans serviced for others are expected
to prepay, thereby shortening their expected average life. In addition, the
decline in long-term interest rates also reduced the expected value of
associated custodial accounts. The pre-tax addition during the second quarter
was $15.7 million, up from $2.4 million in the year-ago second quarter.
Excluding the valuation allowances, our net income in the current quarter would
have been $29.4 million, down $5.4 million or 15.6% from the adjusted year-ago
level. This decline reflected a decrease of $6.2 million in adjusted net income
from our banking operations, partially offset by a $0.7 million increase in net
income from real estate investment activities. Adjusted net income from banking
operations declined due to the following:
o a $6.0 million or 15.5% increase in operating expense due to higher
costs associated with the increased number of branch locations and
higher loan origination activity;
o a $5.0 million or 21.4% decline in other income primarily due to:
o a $2.7 million decline in net gains from the sales of loans and
mortgage servicing rights, as fewer loans were sold; and
o a $2.6 million decline in loan and deposit related fees due
primarily to lower loan prepayment fees.
o a $1.1 million or 1.5% decrease in net interest income due to a
decline in both the effective interest rate spread and average earning
assets.
These items were partially offset by a $1.1 million reversal of provision for
loan losses during the quarter due to improved credit quality, compared to the
year-ago quarter provision of $0.4 million.
For the first six months of 2002, our net income totaled $57.6 million or
$2.04 per share on a diluted basis, compared to $59.3 million or $2.09 per share
for the first six months of 2001. The decline between six-month periods
reflected lower net income from our banking operations and was primarily due to
higher valuation provisions associated with mortgage servicing rights.
For the second quarter of 2002, our return on average assets was 0.75% and
our return on average equity was 10.47%. For the first six months of 2002, our
return on average assets was 1.06% and our return on average equity was 15.13%.
Our single family loan originations totaled $2.179 billion in the second
quarter of 2002, up 2.7% from the $2.122 billion we originated in the second
quarter of 2001 but 3.5% below the $2.259 billion we originated in the previous
quarter. Of the current quarter total, $1.114 billion represented originations
of loans for portfolio, of which $150 million represented subprime credits. In
addition to single family loans, we originated $120 million of other loans in
the quarter.
At quarter end, our assets totaled $11.1 billion, up 2.8% from a year ago,
while our deposits totaled $8.7 billion, down 3.9% from a year ago. During the
quarter, four new in-store branches were opened, bringing our total branches at
quarter end to 148, of which 78 are in-store. A year ago, branches totaled 129,
of which 63 were in-store.
13
Our non-performing assets declined $10 million during the quarter to $83
million or 0.75% of total assets. The decline was primarily in the residential
one-to-four unit category.
At June 30, 2002, our primary subsidiary, Downey Savings and Loan
Association, F.A. (the "Bank") exceeded all regulatory capital tests, with
capital-to-asset ratios of 7.51% for both tangible and core capital and 15.16%
for risk-based capital. These capital levels are significantly above the "well
capitalized" standards defined by the federal banking regulators of 5% for core
and tangible capital and 10% for risk-based capital.
CRITICAL ACCOUNTING POLICIES
We have established various accounting policies which govern the
application of accounting principles generally accepted in the United States of
America in the preparation of our financial statements. Our significant
accounting policies are described in Downey's Annual Report on Form 10-K for the
year ended December 31, 2001. Certain accounting policies require us to make
significant estimates and assumptions which have a material impact on the
carrying value of certain assets and liabilities, and we consider these to be
critical accounting policies. The estimates and assumptions we use are based on
historical experience and other factors, which we believe to be reasonable under
the circumstances. Actual results could differ significantly from these
estimates and assumptions which could have a material impact on the carrying
value of assets and liabilities at the balance sheet dates and our results of
operations for the reporting periods.
We believe the following are critical accounting policies that require the
most significant estimates and assumptions that are particularly susceptible to
significant change in the preparation of our financial statements:
o Allowance for losses on loans and real estate. For further
information, see Financial Condition--Problem Loans and Real
Estate--Allowance for Losses on Loans and Real Estate on page 35.
o Allowance for mortgage servicing rights. For further information, see
Note 4 on page 8 of Notes to Consolidated Financial Statements.
14
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is the difference between the interest and dividends
earned on loans, mortgage-backed securities and investment securities
("interest-earning assets") and the interest paid on deposits, borrowings and
capital securities ("interest-bearing liabilities"). The spread between the
yield on interest-earning assets and the cost of interest-bearing liabilities
and the relative dollar amounts of these assets and liabilities principally
affects net interest income.
Our net interest income totaled $75.1 million in the second quarter of
2002, down $1.1 million or 1.5% from the same period last year. The decrease
between second quarters reflected both a lower effective interest rate spread
and lower interest-earning asset levels. The effective interest rate spread
averaged 2.86% in the current quarter, below 2.89% of a year ago. The decrease
between second quarters was due to our yield on interest-earning assets
declining more rapidly than the decline in our cost of funds. This is indicative
of what typically happens when interest rates decline, as there is an
administrative lag in the repricing of our loans which are primarily priced to
the Federal Home Loan Bank (the "FHLB") Eleventh District Cost of Funds Index
("COFI") and is reflective of the faster decline in COFI earlier in 2002. Our
interest-earning assets averaged $10.5 billion during the quarter, slightly
below the year-ago level.
For the first six months of 2002, net interest income totaled $155.1
million, up $2.7 million or 1.7% from a year ago. The increase reflected a
higher effective interest rate spread as our earning asset levels remained
relatively stable.
The following table presents for the periods indicated the total dollar
amount of:
o interest income from average interest-earning assets and the resultant
yields; and
o interest expense on average interest-bearing liabilities and the
resultant costs, expressed as rates.
The table also sets forth our net interest income, interest rate spread and
effective interest rate spread. The effective interest rate spread reflects the
relative level of interest-earning assets to interest-bearing liabilities and
equals:
o the difference between interest income on interest-earning assets and
interest expense on interest-bearing liabilities, divided by
o average interest-earning assets for the period.
The table also sets forth our net interest-earning balance--the difference
between the average balance of interest-earning assets and the average balance
of total deposits, borrowings and capital securities--for the periods indicated.
We included non-accrual loans in the average interest-earning assets balance. We
included interest from non-accrual loans in interest income only to the extent
we received payments and to the extent we believe we will recover the remaining
principal balance of the loans. We computed average balances for the quarter
using the average of each month's daily average balance during the periods
indicated.
15
Three Months Ended June 30,
-------------------------------------------------------------------------------
2002 2001
-------------------------------------------------------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in Thousands) Balance Interest Rate Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Loans ........................................... $10,035,071 $ 148,448 5.92% $10,057,634 $ 203,820 8.11%
Mortgage-backed securities ...................... 80,873 942 4.66 5,651 87 6.16
Investment securities ........................... 385,738 4,035 4.20 501,169 7,328 5.86
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets ................. 10,501,682 153,425 5.84 10,564,454 211,235 8.00
Non-interest-earning assets ......................... 391,884 362,519
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets .................................... $10,893,566 $10,926,973
====================================================================================================================================
Transaction accounts:
Non-interest-bearing checking ................... $ 295,568 $ -- -- % $ 296,370 $ -- -- %
Interest-bearing checking (1) ................... 425,609 329 0.31 408,931 499 0.49
Money market .................................... 113,231 503 1.78 89,960 629 2.80
Regular passbook ................................ 2,962,758 18,543 2.51 875,580 7,515 3.44
- ------------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts .................... 3,797,166 19,375 2.05 1,670,841 8,643 2.07
Certificates of deposit ............................. 4,763,479 41,022 3.45 7,102,427 105,743 5.97
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits .................................. 8,560,645 60,397 2.83 8,773,268 114,386 5.23
Borrowings .......................................... 1,299,644 14,859 4.59 1,241,535 17,562 5.67
Capital securities .................................. 120,000 3,041 10.14 120,000 3,041 10.14
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and capital securities 9,980,289 78,297 3.15 10,134,803 134,989 5.34
Other liabilities ................................... 137,644 128,086
Stockholders' equity ................................ 775,633 664,084
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity ...... $10,893,566 $10,926,973
====================================================================================================================================
Net interest income/interest rate spread ............ $ 75,128 2.69% $ 76,246 2.66%
Excess of interest-earning assets over
deposits, borrowings and capital securities ..... $ 521,393 $ 429,651
Effective interest rate spread ...................... 2.86 2.89
====================================================================================================================================
Six Months Ended June 30,
-------------------------------------------------------------------------------
2002 2001
-------------------------------------------------------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in Thousands) Balance Interest Rate Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Loans ........................................... $10,004,439 $ 308,725 6.17% $10,119,289 $ 416,582 8.23%
Mortgage-backed securities ...................... 93,624 2,216 4.73 6,706 215 6.41
Investment securities ........................... 425,093 8,882 4.21 466,097 14,404 6.23
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets ................. 10,523,156 319,823 6.08 10,592,092 431,201 8.14
Non-interest-earning assets ......................... 395,186 358,203
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets .................................... $10,918,342 $10,950,295
====================================================================================================================================
Transaction accounts:
Non-interest-bearing checking ................... $ 290,362 $ -- -- % $ 271,308 $ -- -- %
Interest-bearing checking (1) ................... 425,386 744 0.35 402,707 1,132 0.57
Money market .................................... 111,973 1,010 1.82 89,610 1,254 2.82
Regular passbook ................................ 2,702,876 33,936 2.53 821,264 13,943 3.42
- ------------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts .................... 3,530,597 35,690 2.04 1,584,889 16,329 2.08
Certificates of deposit ............................. 5,011,329 93,066 3.75 6,988,021 212,858 6.14
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits .................................. 8,541,926 128,756 3.04 8,572,910 229,187 5.39
Borrowings .......................................... 1,362,761 29,912 4.43 1,478,807 43,524 5.94
Capital securities .................................. 120,000 6,082 10.14 120,000 6,082 10.14
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits, borrowings and capital securities 10,024,687 164,750 3.31 10,171,717 278,793 5.53
Other liabilities ................................... 131,862 128,837
Stockholders' equity ................................ 761,793 649,741
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity ...... $10,918,342 $10,950,295
====================================================================================================================================
Net interest income/interest rate spread ............ $ 155,073 2.77% $ 152,408 2.61%
Excess of interest-earning assets over
deposits, borrowings and capital securities ..... $ 498,469 $ 420,375
Effective interest rate spread ...................... 2.95 2.88
====================================================================================================================================
(1) Included amounts swept into money market deposit accounts.
16
Changes in our net interest income are a function of both changes in rates
and changes in volumes of interest-earning assets and interest-bearing
liabilities. The following table sets forth information regarding changes in our
interest income and expense for the periods indicated. For each category of
interest-earning assets and interest-bearing liabilities, we have provided
information on changes attributable to:
o changes in volume--changes in volume multiplied by comparative period
rate;
o changes in rate--changes in rate multiplied by comparative period
volume; and
o changes in rate/volume--changes in rate multiplied by changes in
volume.
Interest-earning asset and interest-bearing liability balances used in the
calculations represent quarterly average balances computed using the average of
each month's daily average balance during the period indicated.
Three Months Ended June 30, Six Months Ended June 30,
2002 Versus 2001 2002 Versus 2001
Changes Due To Changes Due To
----------------------------------------------------------------------------------------------
Rate/ Rate/
(In Thousands) Volume Rate Volume Net Volume Rate Volume Net
- ------------------------------------------------------------------------------------------------------------------------------------
Interest income:
Loans ........................... $ (457) $(55,038) $ 123 $(55,372) $ (4,728) $(104,313) $ 1,184 $(107,857)
Mortgage-backed securities ...... 1,158 (21) (282) 855 2,786 (56) (729) 2,001
Investment securities ........... (1,687) (2,086) 480 (3,293) (1,267) (4,665) 410 (5,522)
- ------------------------------------------------------------------------------------------------------------------------------------
Change in interest income ..... (986) (57,145) 321 (57,810) (3,209) (109,034) 865 (111,378)
- ------------------------------------------------------------------------------------------------------------------------------------
Interest expense:
Transaction accounts:
Interest-bearing checking (1) . 20 (183) (7) (170) 64 (428) (24) (388)
Money market .................. 164 (231) (59) (126) 313 (446) (111) (244)
Regular passbook .............. 17,914 (2,035) (4,851) 11,028 31,945 (3,632) (8,320) 19,993
- ------------------------------------------------------------------------------------------------------------------------------------
Total transaction accounts .. 18,098 (2,449) (4,917) 10,732 32,322 (4,506) (8,455) 19,361
Certificates of deposit ......... (34,822) (44,579) 14,680 (64,721) (60,210) (83,083) 23,501 (119,792)
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits (16,724) (47,028) 9,763 (53,989) (27,888) (87,589) 15,046 (100,431)
Borrowings ...................... 813 (3,368) (148) (2,703) (3,440) (9,941) (231) (13,612)
Capital securities .............. -- -- -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Change in interest expense .... (15,911) (50,396) 9,615 (56,692) (31,328) (97,530) 14,815 (114,043)
- ------------------------------------------------------------------------------------------------------------------------------------
Change in net interest income ....... $ 14,925 $ (6,749) $(9,294) $ (1,118) $ 28,119 $ (11,504) $ (13,950) $ 2,665
====================================================================================================================================
(1) Included amounts swept into money market deposit accounts.
PROVISION FOR LOAN LOSSES
During the second quarter, $1.1 million of provision for loan losses was
reversed due to an improvement in credit quality, while in the year-ago quarter
the provision for loan losses totaled $0.4 million. The allowance for loan
losses was $36 million at June 30, 2002, essentially unchanged from year-end
2001. Net charge-offs totaled $0.4 million in the second quarter of 2002, up
slightly from $0.2 million a year ago.
For the first six months of 2002, provision for loan losses declined to
$0.3 million from $0.5 million a year ago, and net charge-offs were unchanged at
$0.6 million. The decline in provision for loan losses was primarily due to the
current period improvement in credit quality. For further information regarding
our allowance for loan losses, see Financial Condition--Problem Loans and Real
Estate--Allowance for Losses on Loans and Real Estate on page 35.
17
OTHER INCOME
Our total other income was $4.1 million in the second quarter of 2002, down
$18.2 million from a year ago reflecting:
o a $12.7 million increase in the loss on our loan servicing activity
from the year-ago quarter primarily due to a larger addition to the
valuation allowance for mortgage servicing rights, as their fair value
dropped in the current quarter due to an approximate 60 basis point
decline in long-term interest rates;
o a $2.7 million decrease in net gains on sales of loans and
mortgage-backed securities and mortgage servicing rights as fewer
loans were sold; and
o a $2.7 million decline in loan and deposit related fees, primarily due
to a $3.3 million decline in loan prepayment fees.
Partially offsetting those declines was a $0.3 million increase in income from
real estate held for investment.
For the first six months of 2002, total other income was $35.5 million, up
$7.2 million from a year ago, primarily reflecting an $11.9 million increase in
net gains on sales of loans and mortgage-backed securities, and a $2.3 million
increase in income from real estate and joint ventures held for investment.
Those favorable items were partially offset by a $5.1 million increase in the
loss from loan servicing and a $1.5 million decrease in loan and deposit related
fees. Below is a further discussion of the major other income categories.
LOAN AND DEPOSIT RELATED FEES
Loan and deposit related fees totaled $11.4 million in the second quarter
of 2002, down $2.7 million from a year ago. Our loan related fees were down $3.5
million between second quarters, of which $3.3 million represented a decline in
loan prepayment fees. This was partially offset by a $0.8 million or 18.8%
increase in our deposit related fees, primarily due to higher fees from our
checking accounts.
The following table presents a breakdown of loan and deposit related fees
during the periods indicated.
Three Months Ended
----------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 2002 2002 2001 2001 2001
- ------------------------------------------------------------------------------------------------------------
Loan related fees:
Prepayment fees ...................... $ 4,140 $ 4,686 $ 5,475 $ 6,384 $ 7,455
Other fees ........................... 1,992 2,167 2,477 2,257 2,251
Deposit related fees:
Automated teller machine fees ........ 1,668 1,543 1,670 1,671 1,650
Other fees ........................... 3,596 3,122 3,224 2,962 2,780
- ------------------------------------------------------------------------------------------------------------
Total loan and deposit related fees $11,396 $11,518 $12,846 $13,274 $14,136
============================================================================================================
For the six months of 2002, loan and deposit related fees totaled $22.9
million, down $1.5 million from the same period of 2001. The decrease reflected
a $3.2 million decline in loan prepayment fees, as deposit related fees were up
$1.5 million.
The following table presents a breakdown of loan and deposit related fees
during the periods indicated.
Six Months Ended
June 30,
-----------------------
(In Thousands) 2002 2001
- -------------------------------------------------------------------
Loan related fees:
Prepayment fees ...................... $ 8,826 $11,980
Other fees ........................... 4,159 4,030
Deposit related fees:
Automated teller machine fees ........ 3,211 3,183
Other fees ........................... 6,718 5,173
- -------------------------------------------------------------------
Total loan and deposit related fees $22,914 $24,366
===================================================================
18
REAL ESTATE AND JOINT VENTURES HELD FOR INVESTMENT
Income from our real estate and joint ventures held for investment totaled
$1.0 million in the second quarter of 2002, up $0.3 million from a year ago. The
increase reflected increases of $0.9 million in net gains from sales and $0.2
million in interest from joint venture advances. The gains primarily relate to
joint venture projects and are reported in the category of equity in net income
from joint ventures. Those favorable items were partially offset by an increase
of $0.8 million in the provision for losses on real estate and joint ventures
due to a decline in the fair value of a shopping center.
The following table sets forth the key components comprising our income
from real estate and joint venture operations during the periods indicated.
Three Months Ended
--------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 2002 2002 2001 2001 2001
- -----------------------------------------------------------------------------------------------------------------------
Rental operations, net of expenses ..................... $ 521 $ 823 $ 1,026 $ 259 $ 452
Equity in net income from joint ventures ............... 1,001 745 212 12 121
Interest from joint venture advances ................... 304 111 83 101 152
Net gains on sales of wholly owned real estate ......... 8 -- 127 -- --
(Provision for) reduction of losses on real estate and
joint ventures ...................................... (818) 1,318 (1) 374 (33)
- -----------------------------------------------------------------------------------------------------------------------
Total income from real estate and joint ventures held
for investment, net ............................... $ 1,016 $ 2,997 $ 1,447 $ 746 $ 692
=======================================================================================================================
For the first six months of 2002, income from real estate and joint
ventures held for investment totaled $4.0 million, up $2.3 million from the same
period of 2001 due primarily to sales activity.
The following table sets forth the key components comprising our income
from real estate and joint venture operations during the periods indicated.
Six Months Ended
June 30,
--------------------
(In Thousands) 2002 2001
- -------------------------------------------------------------------------------------------------
Rental operations, net of expenses ......................................... $ 1,344 $ 960
Equity in net income from joint ventures ................................... 1,746 512
Interest from joint venture advances ....................................... 415 284
Net gains on sales of wholly owned real estate ............................. 8 2
(Provision for) reduction of losses on real estate and joint ventures ...... 500 (66)
- -------------------------------------------------------------------------------------------------
Total income from real estate and joint ventures held for investment, net $ 4,013 $ 1,692
=================================================================================================
SECONDARY MARKETING ACTIVITIES
Sales of loans and mortgage-backed securities decreased in the second
quarter of 2002 to $1.093 billion from $1.364 billion a year ago. Net gains
associated with these sales totaled $6.9 million in the current quarter, down
$2.1 million from a year ago. Net gains in the current quarter included the
capitalization of mortgage servicing rights totaling $10.2 million, compared to
$13.4 million a year ago.
A loss of $15.6 million was recorded in loan servicing from our portfolio
of loans serviced for others during the second quarter of 2002, a deterioration
from a loss of $2.9 million in the year-ago period. This increased loss
primarily reflected a larger addition to the valuation allowance for mortgage
servicing rights, $15.7 million in the current quarter, compared to $2.4 million
a year ago. The current quarter valuation addition was associated with the
deterioration in fair value of mortgage servicing rights due to the approximate
60 basis point decline in long-term interest rates, which resulted in an
increase in the projected rate at which loans serviced for others are expected
to prepay, thereby shortening the expected average life. In addition, the
decline in long-term interest rates also reduced the expected value of custodial
accounts. At June 30, 2002, we serviced $7.0 billion of loans for others,
compared to $5.8 billion at December 31, 2001 and $5.1 billion at June 30, 2001.
19
The following table presents a breakdown of the components of our loan
servicing income (loss) during the periods indicated.
Three Months Ended
------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 2002 2002 2001 2001 2001
- ----------------------------------------------------------------------------------------------------------------
Income from servicing operations .......... $ 3,349 $ 2,688 $ 2,477 $ 2,576 $ 1,752
Amortization of MSRs ...................... (3,253) (2,916) (2,956) (2,495) (2,299)
(Provision for) reduction of impairment ... (15,713) (360) 11,960 (11,852) (2,351)
- ----------------------------------------------------------------------------------------------------------------
Total loan servicing income (loss), net $(15,617) $ (588) $ 11,481 $(11,771) $ (2,898)
================================================================================================================
For the first six months of 2002, net gains on sales of loans and
mortgage-backed securities totaled $23.1 million, up $11.9 million from the same
period of 2001. For the first six months of 2002, a loss of $16.2 million was
recorded in loan servicing, compared to a loss of $11.1 million from the same
period of 2001 due to the larger addition to the valuation allowance for
mortgage servicing rights.
The following table presents a breakdown of the components of our loan
servicing income (loss) during the periods indicated.
Six Months Ended
June 30,
------------------------
(In Thousands) 2002 2001
- --------------------------------------------------------------
Income from servicing operations . $ 6,037 $ 3,975
Amortization of MSRs ............. (6,169) (4,362)
Provision for impairment ......... (16,073) (10,696)
- --------------------------------------------------------------
Total loan servicing loss, net $(16,205) $(11,083)
==============================================================
For further information regarding mortgage servicing rights, see Notes To
Consolidated Financial Statements--Note (4)--Mortgage Servicing Rights on page
8.
OPERATING EXPENSE
Our operating expense totaled $45.1 million in the current quarter, up $5.0
million or 12.4% from the second quarter of 2001 because of higher general and
administrative expense. That increase was primarily due to higher costs
associated with an increased number of branch locations and higher loan
origination activity.
The following table presents a breakdown of key components comprising
operating expense during the periods indicated.
Three Months Ended
--------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 2002 2002 2001 2001 2001
- -------------------------------------------------------------------------------------------------------------
Salaries and related costs ................. $ 28,315 $ 29,437 $ 27,075 $ 24,943 $ 24,646
Premises and equipment costs ............... 7,754 7,133 7,303 6,628 6,042
Advertising expense ........................ 1,582 1,044 1,168 939 1,127
Professional fees .......................... 233 564 839 2,432 1,604
SAIF insurance premiums and regulatory
assessments ............................. 762 786 792 786 741
Other general and administrative expense ... 6,350 6,211 6,339 5,981 5,973
- -------------------------------------------------------------------------------------------------------------
Total general and administrative expense 44,996 45,175 43,516 41,709 40,133
Net operation of real estate acquired in
settlement of loans ..................... 27 (58) 237 110 (106)
Amortization of excess cost over fair value
of branch acquisitions ................. 114 111 113 116 114
- -------------------------------------------------------------------------------------------------------------
Total operating expense ................ $ 45,137 $ 45,228 $ 43,866 $ 41,935 $ 40,141
=============================================================================================================
20
For the first six months of 2002, operating expenses totaled $90.4 million,
up $13.0 million or 16.8% from the same period of 2001 and also reflected higher
costs associated with the increased number of branch locations and higher loan
origination activity.
The following table presents a breakdown of key components comprising
operating expense during the periods indicated.
Six Months Ended
June 30,
------------------------
(In Thousands) 2002 2001
- --------------------------------------------------------------------------------------------
Salaries and related costs ....................................... $ 57,752 $ 47,917
Premises and equipment costs ..................................... 14,887 12,085
Advertising expense .............................................. 2,626 2,303
Professional fees ................................................ 797 2,181
SAIF insurance premiums and regulatory assessments ............... 1,548 1,473
Other general and administrative expense ......................... 12,561 11,312
- --------------------------------------------------------------------------------------------
Total general and administrative expense ..................... 90,171 77,271
Net operation of real estate acquired in settlement of loans ..... (31) (108)
Amortization of excess cost over fair value of branch acquisitions 225 228
- --------------------------------------------------------------------------------------------
Total operating expense ...................................... $ 90,365 $ 77,391
============================================================================================
PROVISION FOR INCOME TAXES
Income taxes for the second quarter totaled $14.9 million, compared to
$24.5 million for the like quarter of a year ago. Our effective tax rate was
unchanged at 42.3% for each of the current year and year-ago periods. For
further information regarding income taxes, see Notes to Consolidated Financial
Statements--Note (6)--Income Taxes on page 11.
BUSINESS SEGMENT REPORTING
The previous discussion and analysis of the Results of Operations pertained
to our consolidated results. This section discusses and analyzes the results of
operations of our two business segments--banking and real estate investment. For
further information regarding business segments, see Notes To Consolidated
Financial Statements--Note (3)--Business Segment Reporting on page 7.
The following table presents by business segment our net income for the
periods indicated.
Three Months Ended
----------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
(In Thousands) 2002 2002 2001 2001 2001
- -----------------------------------------------------------------------------------------------------------
Banking net income ..................... $ 19,724 $ 35,557 $ 38,225 $ 22,301 $ 33,619
Real estate investment net income (loss) 585 1,757 871 (535) (164)
- -----------------------------------------------------------------------------------------------------------
Total net income .................... $ 20,309 $ 37,314 $ 39,096 $ 21,766 $ 33,455
===========================================================================================================
Six Months Ended
June 30,
---------------------
2002 2001
- --------------------------------------------------------
Banking net income .............. $55,281 $58,928
Real estate investment net income 2,342 391
- --------------------------------------------------------
Total net income ............. $57,623 $59,319
========================================================
BANKING
Net income from our banking operations for the second quarter of 2002
totaled $19.7 million, down $13.9 million or 41.3% from $33.6 million in the
second quarter of 2001. The decrease between second quarters primarily reflected
a larger addition to the valuation allowance for mortgage servicing rights. The
addition was reflected within the category of loan servicing loss and was
necessary due to the approximate 60 basis point decline in long-term interest
rates, which resulted in an increase in the projected rate at which loans
serviced for others are expected to prepay, thereby shortening their expected
21
average life. In addition, the decline in long-term interest rates also reduced
the expected value of associated custodial accounts. The pre-tax addition during
the second quarter was $15.7 million, up from $2.4 million in the year-ago
second quarter. Excluding the valuation allowances, our net income from our
banking operations in the current quarter would have been $28.8 million, down
$6.2 million or 17.6% from the adjusted year-ago level. Adjusted net income from
banking operations decreased due to the following:
o a $6.0 million or 15.5% increase in operating expense due to higher
costs associated with the increased number of branch locations and
higher loan origination activity;
o a $5.0 million or 21.4% decrease in other income primarily due to:
o a $2.7 million decrease in net gains from the sales of loans and
mortgage servicing rights, as fewer loans were sold; and
o a $2.6 million decrease in loan and deposit related fe