SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from......................to.........................
Commission file number 1-3521
WASHINGTON MUTUAL FINANCE CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-4128205
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
8900 Grand Oak Circle, Tampa, FL 33637-1050
(Address of principal executive offices) (Zip Code)
(813) 632-4500
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b)of the Act:
Name of each exchange
Title of each class on which registered
------------------- -------------------
6 7/8 % Senior Notes due May 15, 2011 New York Stock Exchange
Securities registered pursuant to Section 12 (g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K:
Not applicable
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X].
The aggregate market value of Common Stock held by non-affiliates: None
As of February 28, 2003, there were 1,000 shares of Common Stock outstanding.
Documents incorporated by reference: None
Registrant meets the conditions set forth in General Instruction (I)(1)(a) and
(b) of Form 10-K and is therefore filing this Form with the reduced disclosure
format.
WASHINGTON MUTUAL FINANCE CORPORATION
ANNUAL REPORT ON FORM 10-K
Table of Contents
Page
PART I
Item 1. Business...........................................................3
Item 2. Properties........................................................10
Item 3. Legal Proceedings.................................................10
Item 4. Submission of Matters to a Vote of Security Holders................*
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters................................12
Item 6. Five-Year Summary of Selected Financial Data......................12
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........24
Item 8. Financial Statements and Supplementary Data.......................26
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................48
PART III
Item 10. Directors and Executive Officers of the Registrant.................*
Item 11. Executive Compensation.............................................*
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters......................*
Item 13. Certain Relationships and Related Transactions.....................*
Item 14. Controls and Procedures...........................................13
PART IV
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K............................................49
* Items 4, 10, 11, 12 and 13 are not included as per conditions met by
Registrant set forth in General Instruction I(1(a) and (b) of Form
10-K.
PART I
Item 1. Business
General
Washington Mutual Finance Corporation ("WMF"), incorporated in Delaware in 1986,
as Aristar, Inc., is a holding company headquartered in Tampa, Florida whose
subsidiaries are engaged in the consumer financial services business. Washington
Mutual Finance Corporation is an indirect, wholly-owned subsidiary of Washington
Mutual, Inc. ("Washington Mutual"). When we refer to "we", "our", "us", or the
"Company" in this Form 10-K, we mean Washington Mutual Finance Corporation and
its subsidiaries, all of which are wholly-owned.
Our Company's operations consists principally of a network of 432 branch offices
located in 26 states, primarily in the southeast, southwest and California
("Consumer Finance"). These offices operate under the name Washington Mutual
Finance. Our branch offices are typically located in small- to medium-sized
communities in suburban or rural areas and are managed by individuals who
generally have considerable consumer lending experience. We make secured and
unsecured consumer installment loans, and purchase installment contracts from
local retail establishments. The consumer credit transactions are primarily for
personal, family, or household purposes. From time to time, we purchase,
servicing released, real estate secured consumer loans from national mortgage
companies and banking operations through our wholly owned subsidiary, Washington
Mutual Finance, Inc., a California corporation, which does business as Aristar
Mortgage Company ("Aristar Mortgage").
Until October 1, 2002, we also owned a consumer financial services business
("Consumer Banking"), which provided services through our industrial banking
subsidiary, First Community Industrial Bank ("FCIB"). FCIB had 10 branches in
Colorado and Utah. FCIB made consumer loans, purchased retail installment
contracts and accepted deposits insured by the Federal Deposit Insurance
Corporation. This business was sold on October 1, 2002 and, accordingly,
Consumer Banking has been accounted for, and is reported as, discontinued
operations.
Discontinued Operations
On October 1, 2002, we completed the sale of FCIB through a merger with First
State Bank, NM, formerly First State Bank of Taos, a New Mexico bank ("First
State"), wholly-owned by First State Bancorporation, a New Mexico corporation,
with First State being the surviving entity. Accordingly, Consumer Banking has
been accounted for as discontinued operations and the accompanying Consolidated
Financial Statements presented herein have been restated to report separately
the net assets and liabilities and operating results of the discontinued
operation.
Portfolio Composition
The following table provides an analysis by type of our consumer finance
receivables (excluding unearned finance charges and deferred loan fees) from
continuing operations at the dates shown:
(Dollars in thousands) December 31,
--------------------------------------------
2002 2001 2000
Notes and contracts receivable: ----------- ----------- -----------
Type:
Real estate secured loans $ 1,929,797 $ 1,738,967 $ 1,628,628
Other installment loans 1,464,234 1,410,529 1,390,697
Retail installment contracts 264,366 330,404 319,637
----------- ----------- -----------
Total $ 3,658,397 $ 3,479,900 $ 3,338,962
=========== =========== ===========
Number of accounts 886,585 984,775 997,850
Type as a percent of total receivables:
Real estate secured loans 52.8% 50.0% 48.8%
Other installment loans 40.0 40.5 41.6
Retail installment contracts 7.2 9.5 9.6
----------- ----------- -----------
100.0% 100.0% 100.0%
=========== =========== ===========
For the year ended December 31, 2002, real estate secured loans outstanding
(excluding unearned finance charges and deferred loan fees) increased $190.8
million, or 11.0% from 2001 as compared with an increase of $110.3 million, or
6.8%, from 2000 to 2001. Aristar Mortgage contributed $174.8 million toward the
real estate secured loan growth in 2002 through its bulk purchases of real
estate secured consumer loans from national mortgage companies and banking
operations. Real estate secured loans are typically secured by first or second
mortgages, and those originated by us are primarily used by the customer for
purchases of consumer goods or debt consolidation. We have focused on increasing
our percentage of real estate loans due to the better credit quality inherent in
the customer base. The underlying security in real estate secured loans reduces
our risk of loss. In addition, the larger average balance makes this loan type
more cost effective to purchase or originate and service. At December 31, 2002
and 2001, the average balance of a real estate secured loan was approximately
$28,700 and $27,600.
Over the past two years, other installment loans outstanding (excluding unearned
finance charges and deferred loan fees) has remained relatively flat, increasing
$53.7 million, or 3.8% in 2002 over 2001, and increasing $19.8 million or 1.4%
from 2000 to 2001. These results are due primarily to our focus on growing the
real estate portfolio. Other installment loans are either secured by consumer
goods or unsecured and are primarily used by the customer to make specific
purchases of consumer goods or undertake personal debt consolidation. At
December 31, 2002 and 2001, the average balance of an other installment loan was
approximately $2,800 and $2,500.
During 2002, retail installment contracts outstanding (excluding unearned
finance charges and deferred loan fees) decreased $66.0 million, or 20.0%, as
compared to an increase of $10.8 million, or 3.4% from 2000 to 2001. This
decline is due primarily to the change in consumer purchasing habits caused by
the slow economy. This loan type is generally utilized as a source of new
customers, and it has been determined that maintaining this portfolio as a small
percentage of the mix is appropriate for generating cross-selling opportunities,
while minimizing the impact on yields. Retail installment contracts are
generally acquired without recourse to the originating merchant and establish a
customer relationship for developing future loan business. These contracts
result from the sale of consumer goods and payment is secured by such goods.
Retail installment contracts are generally acquired through the originating
merchant. We had such arrangements with approximately 3,000 merchants in 2002.
At December 31, 2002 and 2001, the average balance of a retail installment
contract was approximately $900 and $930.
Consumer loans are typically fixed-rate and are originated by customer
application or acquired through periodic purchases of receivable portfolios.
Loan originations are a result of business development efforts consisting of
direct mail, telemarketing and branch office sales personnel. Consumer loans
written in 2002 had original terms generally ranging from 12 to 240 months and
averaged 64 months. Of the loans originated in 2002, approximately 74.9% of the
dollar value were unsecured or secured by consumer goods, automobiles or other
personal property, and approximately 25.1% were secured by real estate. In
addition, the Company purchases loan portfolios from its competitors and
secondary markets. In 2002, $357.4 million of loans were purchased, primarily
through Aristar Mortgage. Of these, approximately 2.3% were unsecured or secured
by consumer goods, automobiles or other personal property, and approximately
97.7% were secured by real estate.
As part of our consumer finance line of business, we make available, at the
option of our customers, various credit insurance and ancillary products. These
products include credit life insurance, credit accident and health insurance,
credit property and casualty insurance, term life protector, and involuntary
unemployment insurance. We do not sell insurance to non-customers. The credit
insurance we sell is written by unaffiliated insurance companies, and we
substantially reinsure all of these policies, and earn a reinsurance premium
thereon, except for the involuntary unemployment insurance, for which we earn a
direct commission.
Yield Written
For the years ended December 31, 2002, 2001 and 2000 the average portfolio yield
written during the year, by loan type, was as follows:
2002 2001 2000
----- ----- -----
Real estate secured loans 13.33% 13.74% 14.12%
Other installment loans 24.20 24.59 25.11
Retail installment contracts 19.84 19.95 19.86
The yield written includes the stated coupon rate of interest plus initial fees
charged at the time of loan origination. These initial finance charges are
recognized on an accrual basis, using the interest method.
Geographic Distribution
Geographic diversification of consumer finance receivables reduces the
concentration of credit risk associated with a recession in any one region. The
concentration of consumer finance receivables (excluding unearned finance
charges and deferred loan fees) by state was as follows (note that these results
are based on the state where the customer resides):
December 31,
-----------------------------------------------------------------------
2002 2001 2000
--------------------- -------------------- ---------------------
(Dollars in thousands) Amount Percent Amount Percent Amount Percent
----------- ------- ----------- ------- ----------- -------
California $ 601,936 16% $ 474,181 14% $ 388,825 12%
Texas 491,366 13 422,184 12 363,407 11
Tennessee 363,042 10 345,587 10 339,852 10
North Carolina 281,545 8 291,929 8 292,893 9
Florida 248,674 7 222,324 6 222,010 7
South Carolina 178,067 5 179,379 5 182,669 5
Virginia 160,967 4 157,217 5 161,247 5
Louisiana 143,326 4 145,127 4 146,146 4
Alabama 128,195 4 118,487 4 118,785 4
Oklahoma 113,928 3 107,086 3 102,036 3
Other 947,351 26 1,016,399 29 1,021,092 30
----------- ------- ----------- ------- ----------- -------
Total Continuing
Operations $ 3,658,397 100% $ 3,479,900 100% $ 3,338,962 100%
=========== ======= =========== ======= =========== =======
Credit Loss Experience
We closely monitor portfolio delinquency and loss rates in measuring the quality
of the portfolio and the potential for ultimate credit losses. An account is
considered delinquent when a payment is 60 days or more past due, based on the
original terms of the contract. Under our policy, non-real estate secured
delinquent accounts generally are charged off (i.e. fully reserved) when they
become 180 days contractually delinquent. Real estate secured delinquent
accounts are handled on a case-by-case basis, with foreclosure proceedings
typically beginning when the accounts are between 60 and 90 days contractually
delinquent. Within legal limitations such as bankruptcy discharges of debt,
collection efforts continue after an account has been charged off until it is
determined that the cost of collection efforts outweighs the benefits received.
We attempt to control customer delinquency through careful evaluation of each
borrower's application and credit history at the time the loan is originated or
purchased, and through appropriate collection activity. We also seek to reduce
our risk by focusing on consumer lending, making a greater number of smaller
loans than would be practical in commercial markets, and maintaining disciplined
control over the underwriting process.
We maintain an allowance for loan losses inherent in the receivables portfolio.
The allowance is based on an ongoing assessment of the probable estimated losses
inherent in the portfolio. This analysis provides a mechanism for ensuring that
estimated losses reasonably approximate actual observed losses. See discussion
in "Allowance for loan losses" in Item 7.
Funding Composition
A relatively high ratio of borrowings to invested capital is customary in
consumer finance activities due to the quality and term of the assets employed
by the business. As a result, the spread between the revenues received from
loans and interest expense is a significant factor in determining our net
income.
We fund our operations principally through net cash flows from operating
activities, short-term borrowings in the commercial paper market and issuances
of senior debt.
The Company has a commercial paper program with several investment banks which
provides $500 million in borrowing capacity. At December 31, 2002, twenty-nine
different commercial paper borrowings totaling $439.5 million were outstanding,
with an average coupon of 1.81%. We also share with Washington Mutual an $800
million three-year revolving credit facility, which provides back-up for our
commercial paper programs. The borrowing capacity is limited to the amount of
the credit facility, net of the amount of combined commercial paper outstanding.
At December 31, 2002, there was $360.5 million available under the facility.
There were no direct borrowings under the facility at any point during 2002 or
2001.
On July 31, 2002, we entered into an agreement with Westdeutsche Landesbank
Girozentrale ("WestLB") to participate in a $300 million asset-backed commercial
paper conduit program. Under this program, administered by WestLB, up to $300
million of funding will be made available through the assignment of an undivided
interest in a specified group of unsecured receivables to a special purpose,
wholly-owned consolidated subsidiary of the Company. Under the terms of the
agreement, which has a 364-day term, with an option to extend for up to two
additional 364-day periods, WestLB issues commercial paper (indirectly secured
by the receivables), on behalf of the Company. Under this agreement, we had $300
million outstanding, with an average coupon of 1.42% at December 31, 2002.
Effective January 16, 2003, we entered into a 364-day unsecured revolving credit
agreement with Washington Mutual, Inc., which provides $250.0 million in
borrowing capacity at an interest rate of LIBOR plus 0.45% and is automatically
renewable for an additional 364 days. Under the agreement, we borrowed $150.0
million on January 17, 2003. See "Subsequent Event".
Senior notes outstanding totaled $2.39 billion at December 31, 2002, with a
weighted average coupon of 7.00%.
Available Information
We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and all amendments to such reports filed pursuant to
Section 13(a) or 15(d) of the Exchange Act, available free of charge on or
through our website located at www.wamufinance.com or through the United States
Securities and Exchange Commission's website at www.sec.gov.
Employee Relations
Our number of full-time equivalent employees at December 31, 2002 was
approximately 2,300, a 13.2% decrease from December 31, 2001 due primarily to
the sale of FCIB in October, as well as efficiencies gained through the
centralization of certain branch functions. We believe that we have been
successful in attracting and retaining quality employees and that our employee
relations are good.
Factors That May Affect Future Results
From time to time, we have made and will make forward-looking statements. Our
Form 10-K and other documents that we file with the Securities and Exchange
Commission have forward-looking statements. In addition, our senior management
may make forward-looking statements orally to analysts, investors, the media and
others. Forward-looking statements can be identified by the fact that they do
not relate strictly to historical or current facts. They often include words
such as "expects," "anticipates," "intends," "plans," "believes," "estimates,"
or words of similar meaning, or future or conditional verbs such as "will,"
"would," "should," "could," or "may."
Forward-looking statements provide our expectations or predictions of future
conditions, events or results. They are not guarantees of future performance. By
their nature, forward-looking statements are subject to risks and uncertainties.
These statements speak only as of the date they are made. We do not undertake to
update forward-looking statements to reflect the impact of circumstances or
events that arise after the date the forward-looking statements were made. There
are a number of factors, many of which are beyond our control, that could cause
actual conditions, events or results to differ significantly from those
described in the forward-looking statements.
Some of these factors are described below.
A decline of collateral value may adversely affect the credit quality of our
portfolio
Approximately 53% of our consumer finance receivables outstanding were secured
by real estate at December 31, 2002. Any material decline in real estate values
reduces the ability of borrowers to use home equity to support borrowings and
increases the loan-to-value ratios of loans previously made by us, thereby
weakening collateral coverage and increasing the possibility of a loss in the
event of a borrower default. Further, delinquencies, foreclosures and losses
generally increase during economic slowdowns or recessions. Any sustained period
of such increased delinquencies, foreclosures and losses could adversely affect
our results of operations and financial condition.
An increase in our delinquency rate could adversely affect our results of
operations
Our underwriting criteria or collection methods may not afford adequate
protection against the risks inherent in the loans we make to our customers. In
the event our portfolio of consumer finance receivables experiences higher
delinquencies, foreclosures or losses than anticipated, our results of
operations or financial condition could be adversely affected.
Changes in legislation or regulation could adversely affect our business
operations
Our lending activities are subject to federal consumer protection laws such as
the Amended Truth-in-Lending Act (including the Home Ownership and Equity
Protection Act of 1994, "HOEPA"), the Fair Housing Act, the Equal Credit
Opportunity Act, the Fair Credit Reporting Act, the Real Estate Settlement
Procedures Act, the Home Mortgage Disclosure Act and the Fair Debt Collection
Practices Act and regulations promulgated thereunder. Amendments to Regulation C
implementing the Home Mortgage Disclosure Act ("HMDA") have been adopted. Prior
to the amendments, we were generally exempt from HMDA reporting. The amendments
will require us to report certain mortgage loans and will require certain
additional data that was not previously required, such as designation of HOEPA
applicability to the mortgage loan. In anticipation of the HMDA effective date
for the amendments, we instituted an implementation plan and have already begun
a pilot test of the new programming required to comply with the reporting
requirements and to insure that we are in compliance with the regulations by the
mandatory compliance date. The HMDA amendments are not expected to have a
material adverse impact on the business.
We are also under the federal regulatory oversight of the Federal Trade
Commission ("FTC") which, from time to time, promulgates rules that affect our
operations. Our operating subsidiaries are subject to state laws and regulatory
oversight which laws and regulations: (i) impose licensing obligations on us,
(ii) establish eligibility criteria for mortgage loans, (iii) prohibit
discrimination, (iv) provide for inspections and appraisals of properties, (v)
require credit reports on loan applicants, (vi) regulate assessment, collection,
foreclosure and claims handling, (vii) mandate certain disclosures and notices
to borrowers, (viii) in some cases, fix maximum interest rates, fees, loan
amounts, prepayment penalties and refinancing frequencies and (ix) regulate or
prohibit the sale of credit insurance products. Failure to comply with the state
and federal requirements can lead to termination or suspension of our ability to
make and collect loans, certain rights of rescission for mortgage loans,
individual civil liability, class action lawsuits and administrative enforcement
actions.
Although consumer finance laws have been in effect for many years, amending and
new legislation is frequently proposed. Currently there are a handful of
subprime lending bills pending in various states, cities and counties, including
Tennessee, West Virginia, Oakland, CA, Los Angeles, CA, Detroit, MI, and Toledo,
OH. In general the bills are aimed at lending practices considered to be
"predatory" as they have an adverse effect on borrowers with weakened credit
histories and lower prepayment abilities. If passed, generally the bills or
ordinances may impose additional loan disclosure requirements, restrict
prepayment penalties, prohibit frequent loan refinancings without benefit to the
borrower and increase enforcement abilities and penalties for violations. Due to
self-imposed lending guidelines, we believe that the pending state bills and
ordinances would have minimal impact on our operations if passed. There can be
no assurance that more restrictive laws, rules and regulations will not be
proposed and adopted in the future, or that existing laws and regulations will
not be interpreted in a more restrictive manner. Such occurrences could make
compliance more difficult or expensive.
Our lending practices have in the past been, and currently are, under regulatory
review by various state authorities in the normal course of their examination
functions. Additionally, the laws and regulations described above are subject to
administrative and judicial interpretation. Where the law or regulation has been
infrequently interpreted (or there are an insignificant number of
interpretations of recently enacted regulations) ambiguity with respect to
permitted conduct under these laws and regulations can result. Any ambiguity
under the regulations to which we are subject may lead to regulatory
investigations or enforcement actions and private causes of action, such as
class action lawsuits, with respect to our compliance with the applicable laws
and regulations.
We may be subject to litigation that could adversely affect our results of
operations or financial condition
In the ordinary course of our business, we are subject to claims made against us
by borrowers arising from, among other things, losses that are claimed to have
been incurred as a result of alleged failures by us to comply with various laws
and regulations applicable to our business. See Item 3 - "Legal Proceedings" for
more details. We believe that liability with respect to any currently asserted
claims or legal actions is not likely to be material to our consolidated results
of operations or financial condition. However, any claims asserted in the future
may result in legal expenses or liabilities that could have a material adverse
effect on our results of operations and financial condition.
Fluctuations in interest rates may adversely affect our profitability
Our profitability may be adversely affected during any period of rapid changes
in interest rates, as substantially all consumer loans outstanding are written
at a fixed rate. A substantial and sustained increase in interest rates could
adversely affect the spread between the rate of interest received by us on our
loans and the interest rates payable under our debt agreements. Such interest
rate increases could also affect our ability to originate loans. A significant
decline in interest rates could decrease the balance of the consumer finance
receivables portfolio by increasing the level of loan prepayments. See Item 7 -
"Asset/Liability Management" for sensitivity analysis.
Competition could adversely affect our results of operations
Competition in the consumer finance business is high. The consumer lending
market is highly fragmented and has been serviced by commercial banks, credit
unions and savings institutions, as well as by other consumer finance companies.
Many of these competitors have greater financial resources and may have
significantly lower costs of funds than we do. Even after we have made a loan to
a borrower, our competitors may seek to refinance the loan in order to offer
additional loan amounts or reduce payments. In addition, if we expand into new
geographic markets, we will face competition from lenders with established
positions in these locations. There can be no assurance that we will be able to
continue to compete successfully in these markets.
Item 2. Properties
The Company's corporate headquarters building is located in Tampa, Florida. The
current lease expires in May 2006, with an additional five-year option to renew.
Our branch offices are leased typically for terms of three to five years with
options to renew. Typical locations include shopping centers, office buildings
and storefronts, and are generally of relatively small size sufficient to
accommodate a staff of three to eight employees.
We lease 50,000 square feet of space in Pensacola, Florida, which is used for
centralized underwriting, servicing and collections activities.
See "Notes to Consolidated Financial Statements - Note 12: Leases" for
additional information on rental expense and lease commitments.
Item 3. Legal Proceedings
The Company and several of its subsidiaries and their current and former
employees are defendants in approximately 35 suits pending in the state and
federal courts of Mississippi. The lawsuits generally allege unfair lending and
insurance related practices. Similar suits are pending against other financial
services companies in Mississippi. All but three of the suits are currently in
various stages of discovery or stayed pending the outcome of motions for remand
and no immediate developments are expected in those cases.
In one of the pending cases, Carolyn Baker, et al. v. Washington Mutual Finance
Group, LLC f/k/a City Finance Company, a jury awarded just over $71 million
against one of the Company's subsidiaries, Washington Mutual Finance Group, LLC,
a Delaware limited liability company ("WMF Group"). Pursuant to a motion filed
by WMF Group, the trial court reduced the verdict to just over $53 million. WMF
Group is in the process of appealing the verdict and has posted a bond to stay
execution on the judgment pending the appellate court's ruling. WMF Group's
appellate brief and three amicus briefs were filed in November and all briefing
is expected to be completed by the end of first quarter 2003. The appeal is
based on numerous grounds, including the gross inequity between the alleged
economic losses of only $12,000 and the actual jury award.
In the case of Philisia Banks, et. al. v. City Finance Co., et. al., which was
originally scheduled for trial beginning December 16, 2002, the plaintiffs
requested further mediation. No new trial date has been set. This case is now
expected to go to trial sometime in the first or second quarter of 2003. In the
case of William Agnew, et. al. v. City Finance Company of Mississippi, Inc., et.
al., a trial is currently set for May of 2003 and a motion for summary judgment
is currently pending. Adverse verdicts could result in either case by the end of
second quarter 2003. Because of the unusual litigation environment in
Mississippi, it is difficult to predict potential outcomes and losses. However,
based upon information presently available, we believe that the total amount
that will ultimately be paid, if any, after reductions and appeals, arising from
these Mississippi lawsuits and proceedings will not have a material adverse
effect on our consolidated results of operations and financial position.
We are currently evaluating the business and legal environment in Mississippi.
During the evaluation process, we have suspended all new loan origination
activities and revolving loan advances to Mississippi residents. The moratorium
on new advances and originations went into effect September 30, 2002. Based on
the information available, we believe that the moratorium will not have a
material adverse effect on our consolidated results of operation and financial
position.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
The Company is an indirect wholly-owned subsidiary of Washington Mutual and the
Company's common stock is not traded on any national exchange or in any other
established market.
Payment of dividends is within the discretion of the Company's Board of
Directors. Provisions of certain of our debt agreements restrict the payment of
dividends to a maximum prescribed portion of cumulative earnings and contributed
capital and otherwise provide for the maintenance of minimum levels of equity
and maximum leverage ratios. Dividends will be paid when capital exceeds the
amount of debt to tangible capital (leverage ratio) deemed appropriate by
management. This leverage ratio will be managed with the intention of
maintaining the existing credit ratings on our outstanding obligations. We
declared dividends totaling $123.0 million during 2002 and $43.5 million during
2001.
Item 6. Five-Year Summary of Selected Financial Data
The selected financial data is included in Item 7 - "Management's Discussion and
Analysis of Financial Condition and Results of Operations". Please refer to Item
7, as the selected financial data should be read in conjunction with the
accompanying consolidated financial statements and related notes in Item 8 and
other financial information included in this Form 10-K. On October 1, 2002, we
sold our Consumer Banking subsidiary. Accordingly, it has been accounted for as
discontinued operations and the accompanying selected financial data has been
restated to report separately the net assets and operating results of this
discontinued operation.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Cautionary Statements
This section contains forward-looking statements, which are not historical facts
and pertain to our future operating results. These forward-looking statements
are within the meaning of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include, but are not limited to, statements
about our plans, objectives, expectations and intentions and other statements
contained in this report that are not historical facts. When used in this
report, the words "expects," "anticipates," "intends," "plans," "believes,"
"seeks," "estimates," or words of similar meaning, or future or conditional
verbs, such as "will," "would," "should," "could," or "may" are generally
intended to identify forward-looking statements. These forward-looking
statements are inherently subject to significant business, economic and
competitive uncertainties and contingencies, many of which are beyond our
control. In addition, these forward-looking statements are subject to
assumptions with respect to future business strategies and decisions that are
subject to change. Actual results may differ materially from the results
discussed in these forward-looking statements. Refer to "Business - Factors that
May Affect Future Results" for additional information on forward-looking
statements.
Controls and Procedures
An evaluation was performed under the supervision and with the participation of
the Company's management, including the Chief Executive Officer ("CEO") and the
Chief Financial Officer ("CFO"), of the effectiveness of the design and
operation of the Company's disclosure controls and procedures within 90 days
before the filing date of this annual report. Based on that evaluation, the
Company's management, including the CEO and CFO, concluded that the Company's
disclosure controls and procedures were effective. There have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls subsequent to their evaluation.
We intend to review and evaluate the design and effectiveness of our disclosure
controls and procedures on an ongoing basis and to improve our controls and
procedures over time and to correct any deficiencies that we may discover in the
future. Our goal is to ensure that our senior management has timely access to
all material financial and non-financial information concerning our business.
While we believe the present design of our disclosure controls and procedures is
effective to achieve our goal, future events affecting our business may cause us
to modify our disclosure controls and procedures.
Critical Accounting Policies
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make a
number of judgments, estimates and assumptions that affect the reported amount
of assets, liabilities, income and expenses in our Consolidated Financial
Statements and accompanying notes. We believe that the judgments, estimates and
assumptions used in the preparation of our Consolidated Financial Statements are
appropriate given the factual circumstances at the time. However, given the
sensitivity of our Consolidated Financial Statements to these critical
accounting policies, the use of other judgments, estimates and assumptions could
result in material differences in our results of operations or financial
condition.
Critical Accounting Estimates
Various elements of our accounting policies, by their nature, are inherently
subject to estimation techniques, valuation assumptions and other subjective
assessments. In particular, we have identified one policy that, due to the
judgments, estimates and assumptions inherent in this policy, is critical to an
understanding of our Consolidated financial statements. This policy relates to
the methodology for the determination of our allowance for loan losses. This
policy and judgments, estimates and assumptions are described in greater detail
in subsequent sections of "Management's Discussion and Analysis of Financial
Condition and Results of Operations".
Initial Adoption of Accounting Policies
The Company did not adopt any new accounting policies during the year ended
December 31, 2002 that were not the result of new accounting literature issued
by a recognized accounting standard setter and that had a material impact on the
Company's financial presentation.
Five-Year Summary of Selected Financial Data
The following selected financial data is taken from our consolidated financial
statements. Accordingly, all amounts shown are from continuing operations,
unless otherwise noted. Per share information is not included because all of our
stock is owned by Washington Mutual.
As of, or For the Years Ended December 31,
-------------------------------------------------------------------
(Dollars in thousands) 2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
Net interest income $ 200,928 $ 219,127 $ 231,283 $ 205,902 $ 186,416
Noninterest income 27,624 29,212 30,914 30,094 27,817
Noninterest expense 158,438 164,011 148,164 128,941 137,323
Income from continuing
operations 44,842 53,760 71,240 65,794 46,294
Income from operations of
discontinued division (less
applicable income taxes) 4,417 7,365 7,649 7,198 6,593
Gain on disposition of discontinued
operations (less applicable
income taxes) 22,523 - - - -
Net income 71,782 61,125 78,889 72,992 52,887
Consumer finance
receivables 3,507,971 3,357,050 3,237,547 2,590,591 2,203,842
Total assets 3,847,308 3,719,740 3,574,086 2,915,364 2,477,976
Total debt 3,129,144 3,018,322 2,880,099 2,238,058 1,914,090
Total equity 517,030 559,657 539,088 475,158 419,330
Overview
On October 1, 2002, we sold FCIB, our Consumer Banking subsidiary. Accordingly,
it has been accounted for as discontinued operations and the accompanying
selected financial data has been restated to report separately the net assets
and operating results of this discontinued operation. We had net income after
discontinued operations of $71.8 million in 2002, which represents a 17%
increase from the $61.1 million reported in 2001 and a 9% decrease from the
$78.9 million reported in 2000.
The following are key highlights of our performance from continuing operations:
o Consumer finance receivables, net of unearned income and allowance,
increased 4.5% in 2002, from 2001. This reflects our ongoing strategy to
target portfolio growth, while continuing to take into account the economic
state in markets we currently serve or into which we anticipate expanding.
o Yields earned on consumer finance receivables declined to 15.61% in 2002
from 16.05% in 2001. This was due primarily to a shift in product mix
towards lower-yielding real estate secured loans and stricter underwriting
of other installment loans, which resulted in lending larger amounts at
lower allowable coupon rates.
o Net interest spread increased to 9.48% in 2002, from 9.18% in 2001. Net
interest margin increased to 10.51% in 2002, from 10.23% in 2001. Both were
due primarily to a lower average cost incurred on interest-bearing
liabilities. Net interest spread represents the difference between the
yield on interest-earning assets and the interest rate paid on borrowings.
Net interest margin represents the ratio of net interest income to average
earning assets. Interest income remained relatively flat; however, interest
expense decreased significantly due to the lower average cost of
interest-bearing liabilities.
o Operating efficiency represents the ratio of noninterest expense (excluding
the amortization of goodwill) to total revenue, which is comprised of net
interest income before provision for loan losses and noninterest income. In
2002, our operating efficiency ratio improved to 37.9% from 40.4% in 2001.
The improvement is due to higher net interest margin, coupled with reduced
noninterest expenses. See discussion in "Consolidated Results of Operations
- Noninterest Expense."
o Delinquencies (accounts contractually past-due greater than 60 days) as a
percentage of gross consumer finance receivables decreased to 3.40% at
December 31, 2002 from 3.69% in 2001. This improvement of delinquencies is
caused primarily by the following two factors: we focused specifically on
reducing delinquencies in 2002; and a portfolio that we had purchased in
2000, which experienced higher than expected delinquency rates in 2000 and
2001, was sold in February 2002.
o Net credit losses totaled $161.7 million in 2002, as compared to $125.4
million in 2001 and $101.8 million in 2000. Net credit losses as a
percentage of average consumer finance receivables (excluding unearned
finance charges and deferred loan fees) were 4.6%, 3.7% and 3.3% in 2002,
2001 and 2000.
Consolidated Results of Operations
Net Interest Income before Provision for Credit Losses
Net interest income before provision for credit losses for the year ended
December 31, 2002 increased 6.7% to $390.2 million, compared to $365.8 million
in 2001 and $339.2 million in 2000. Net interest margin for 2002 was 10.51%,
compared to 10.23% in 2001 and 10.55% in 2000.
The increase in net interest income before provision for credit losses in 2002
reflects growth in average net consumer finance receivables to $3.54 billion,
which was $133.6 million, or 3.9%, greater than the average balance for 2001.
Portfolio yield decreased by 44 basis points compared to 2001 due to the
remixing of the portfolio to a larger percentage of lower-yielding real estate
secured loans and larger balance, lower yielding unsecured loans. However, as a
result of an 83 basis point decrease in our average cost of borrowings, our net
interest spread increased from 9.18% in 2001 to 9.48% in 2002. Our average debt
outstanding increased by $44.9 million, or 1.5%, to $3.03 billion for 2002 to
support the growth in assets. Our average costs of borrowings decreased as a
result of lower rates on new senior debt issuances, coupled with lower rates
associated with our interest rate swap activities. In addition, we shifted our
strategy to meet our funding needs with commercial paper borrowings in 2002,
where our average rate paid was 283 basis points lower than 2001.
The following table reflects the average outstanding balances and related
effective yields and costs in 2002, 2001 and 2000, as described above:
(Dollars in thousands) Year Ended December 31,
---------------------------------------------------------------------
2002 2001 2000
-------------------- ------------------- -------------------
Average Average Average
Balance Rate Balance Rate Balance Rate
Interest-earning assets: ----------- ------ ----------- ------ ----------- ------
Consumer finance receivables:
Real estate secured
loans $ 1,834,680 12.54% $ 1,695,396 13.35% $ 1,425,326 13.25%
Other installment loans 1,418,219 20.71 1,390,992 20.87 1,353,295 21.48
Retail installment contracts 286,940 10.05 319,881 9.44 291,831 10.59
Total consumer ----------- ----------- -----------
finance receivables 3,539,839 15.61 3,406,269 16.05 3,070,452 16.63
Cash, cash equivalents and
investment securities 174,561 3.59 168,951 6.02 144,097 6.86
----------- ----------- -----------
Total interest-earning assets $ 3,714,400 15.05% $ 3,575,220 15.58% $ 3,214,549 16.19%
=========== =========== ===========
Interest-bearing liabilities:
Senior debt $ 2,547,009 6.23% $ 2,575,255 6.64% $ 2,180,747 7.02%
Commercial paper 484,405 2.10 411,271 4.93 420,215 6.63
----------- ----------- -----------
Total interest-bearing
liabilities $ 3,031,414 5.57% $ 2,986,526 6.40% $ 2,600,962 6.96%
=========== =========== ===========
Net interest spread 9.48% 9.18% 9.23%
Net interest margin 10.51% 10.23% 10.55%
The dollar amounts of interest income and interest expense fluctuate depending
upon changes in amounts (volume) and upon changes in interest rates of our
interest-earning assets and interest-bearing liabilities.
Changes attributable to (i) changes in volume (changes in average outstanding
balances multiplied by the prior period's rate), (ii) changes in rate (changes
in average interest rate multiplied by the prior period's volume), and (iii)
changes in rate/volume (changes in rate times the change in volume that were
allocated proportionately to the changes in volume and the changes in rate) were
as follows:
(Dollars in thousands)
Year Ended December 31, Year Ended December 31,
2002 vs. 2001 2001 vs. 2000
--------------------------------- -------------------------------------
Increase/(Decrease) Due to Increase/(Decrease) Due to
--------------------------------- -------------------------------------
Volume Rate Total Change Volume Rate Total Change
Interest income: -------- --------- ------------ --------- --------- ------------
Consumer finance
receivables $ 20,855 $ (14,935) $ 5,920 $ 53,906 $ (17,531) $ 36,375
Investment securities 202 (4,096) (3,894) 1,495 (1,212) 283
-------- --------- ------------ --------- --------- ------------
Total interest income 21,057 (19,031) 2,026 55,401 (18,743) 36,658
Interest expense:
Interest-bearing
liabilities 2,499 (24,831) (22,332) 24,674 (14,599) 10,075
-------- --------- ------------ --------- --------- ------------
Net interest income $ 18,558 $ 5,800 $ 24,358 $ 30,727 $ (4,144) $ 26,583
======== ========= ============ ========= ========= ============
Provision for Loan Losses
The provision for loan losses during 2002 was $189.3 million, compared to $146.7
million in 2001 and $108.0 million in 2000. In 2002, the provision for loan
losses was 5.35% of average consumer finance receivables (excluding unearned
finance charges and deferred loan fees), compared to 4.31% for 2001 and 3.52% in
2000. See further discussion in "Allowance for loan losses."
Noninterest Income
Noninterest income decreased to $27.6 million in 2002, compared to $29.2 million
in 2001 and $30.9 million in 2000. Noninterest income is typically comprised of
revenue earned from the sale of various credit insurance and ancillary products
to borrowers at the branch locations. These products include credit life
insurance, accident and health insurance, credit property and casualty
insurance, term life protector, and involuntary unemployment insurance. The
decreases in income from credit insurance products is primarily due to the
decision to discontinue the sale of insurance products in Mississippi as of June
2001, and to discontinue the sale of single premium credit life and accident and
health insurance on closed-end real estate loans in all other branch states as
of July 2001, in response to growing concern that the products were not fully
meeting the needs of consumers. An alternative product, intended to be more
responsive to customer needs and desires, has been developed and is being
introduced on a graduated basis in almost every branch state. The product,
monthly outstanding balance credit life insurance, provides for premiums to be
billed monthly instead of financed at the beginning of the loan.
Noninterest Expense
Noninterest expense decreased by 3.4% or $5.6 million to $158.4 million in 2002,
compared with 2001 and increased 6.9% or $10.3 million, as compared with 2000.
The decrease in noninterest expense from 2001 is attributed to continued
cost-containment efforts, begun in the second half of 2001. There were several
factors contributing to the expense improvements over prior year. Personnel
expense decreased 2.1%, due primarily to the sale of FCIB in October, as well as
efficiencies gained through the centralization of certain branch functions. Also
due to our heightened focus on cost-containment, taxes, licenses and
professional fees were approximately 30.4% below 2001. These were somewhat
offset by an increase in expenses associated with our direct mail marketing
strategy.
Operating efficiency is defined as the ratio of noninterest expense, excluding
the amortization of goodwill, to total revenue, which is comprised of net
interest income before provision for credit losses and noninterest income. In
2002, our operating efficiency ratio improved to 37.9% from 40.4% in 2001. This
improvement is due to higher interest margin and noninterest income, coupled
with reduced noninterest expenses.
Provision for Federal and State Income Taxes
The provision for income taxes from continuing operations in 2002 was $25.3
million, which represents an effective rate of 36.04%. This compares to $30.6
million, or 36.25% in 2001 and $42.8 million, or 37.53% in 2000. We are actively
managing our effective tax rate by monitoring and, where necessary, adjusting
our organizational structure.
Financial Condition
Allowance for loan losses
Activity in the Company's allowance for loan losses is as follows:
Year Ended December 31,
---------------------------------------------
(Dollars in thousands) 2002 2001 2000
------------ ----------- ------------
Balance, January 1 $ 122,850 $ 101,415 $ 95,260
Provision for loan losses 189,256 146,699 107,960
Amounts charged off:
Real estate secured loans (11,389) (7,217) (2,463)
Other installment loans (153,772) (123,723) (103,576)
Retail installment contracts (15,757) (13,064) (12,696)
------------ ----------- ------------
(180,918) (144,004) (118,735)
Recoveries:
Real estate secured loans 472 289 206
Other installment loans 16,340 15,917 14,131
Retail installment contracts 2,426 2,384 2,593
------------ ----------- ------------
19,238 18,590 16,930
------------ ----------- ------------
Net charge offs (161,680) (125,414) (101,805)
Allowances on notes purchased - 150 -
------------ ----------- ------------
Balance, December 31 $ 150,426 $ 122,850 $ 101,415
============ =========== ============
Allowance for loan losses as a percentage
of December 31 consumer finance receivables
(excluding unearned finance charges and
deferred loan fees) 4.11% 3.53% 3.04%
Net charge offs as a percentage of average
consumer finance receivables (excluding unearned
finance charges and deferred loan fees) 4.57% 3.68% 3.32%
Provision for loan losses as a percentage of
average consumer finance receivables (excluding
unearned finance charges and deferred loan fees) 5.35% 4.31% 3.52%
In order to establish our allowance for loan losses, the consumer finance
receivables portfolio is segmented into two categories: real estate secured and
non-real estate secured (other installment loans and retail installment
contracts). The determination of the level of the allowance for loan losses and,
correspondingly, the provision for credit losses for these homogeneous loan
pools rests upon various judgments and assumptions used to determine the risk
characteristics of each portfolio. These judgments are supported by analyses
that fall into three general categories: (i) economic conditions as they relate
to our current customer base and geographic distribution; (ii) a predictive
analysis of the outcome of the current portfolio (a migration analysis); and
(iii) prior loan loss experience. Additionally, every real estate secured loan
that reaches 60 days delinquency is reviewed by our credit administration
management to assess collectibility and determine a future course of action, at
times resulting in the need to foreclose on the property.
Management establishes the allowance for loan losses based on estimated losses
inherent in the portfolio. There are several underlying factors in our portfolio
that support our current level of allowance for loan losses. We analyze our
reserves based on both trailing coverage and forward looking coverage. Trailing
coverage represents the percentage of coverage we currently have in the
allowance, based on the previous 12 months of losses. Forward looking coverage
represents the percentage of coverage we have in the allowance, based on
estimated losses inherent in the portfolio over the next 12 months. Our trailing
coverage is slightly lower compared to the end of 2001 and our forward looking
coverage has improved over the same period of time.
Net charge offs in 2002 increased significantly over the prior year, primarily
due to the seasoning of the portfolio which had grown significantly in prior
years, coupled with economic pressures resulting from the prolonged recession.
However, as reflected below, the delinquency trends in our portfolio are
favorable. This is a result of both strengthened underwriting capabilities and a
heightened focus on collection efforts in the branch offices and the Pensacola
facility. In the fourth quarter of 2002, these factors resulted in a decrease in
other installment loans contractually delinquent 60 days or more of $7.4
million, or 7.8%. Because other installment loans more than 60 days past due
typically result in a charge off, this significant reduction is expected to
result in lower credit losses in the first half of 2003.
From an underwriting perspective, we have focused our unsecured lending efforts
on identifying opportunities in markets with stronger economies, while
minimizing exposure in markets deemed to be in recession or unstable. For
secured lending, we have focused on reducing the loan to value ("LTV") on new
origination. LTV represents the dollars loaned as a percentage of the value of
the collateral of our real estate secured loans; lower LTV means less inherent
risk.
Based on industry-defined economic status, we have identified states that are in
or near recession, and have focused our unsecured lending efforts into
non-recessionary states, by targeting those markets for direct mail campaigns,
as well as limiting the amount of new money lent to existing borrowers in
depressed markets. As a result of our stricter underwriting standards, we have
slowed the growth of unsecured loans and continued to remix toward a higher
percentage of real estate secured loans. The increased proportion of secured
loans in the portfolio, combined with the stronger collateral position, as well
as improved unsecured guidelines, is expected to result in a relative decrease
in credit losses as the portfolio begins to season in 2003 and beyond.
When a borrower is delinquent in making a payment, the amount of effort put
forth in contacting the borrower has a direct, inverse relationship to the
likelihood that the account will eventually charge off. In light of this,
management has placed an increased emphasis on the level of resources placed
toward our collection activity. As a result of the focused, targeted contact
strategies put in place and executed upon, the delinquency levels have been
favorably impacted.
The following table sets forth, by loan type, the amount of receivables
delinquent for 60 days or more, on a contractual basis, and the ratio of that
amount to the gross consumer finance receivables outstanding in each category:
December 31,
------------------------------------------------------------------
(Dollars in thousands) 2002 2001 2000
------------------- ------------------- ------------------
Real estate secured loans $ 44,409 2.04% $ 43,236 2.17% $ 29,677 1.57%
Other installment loans 87,179 5.28 93,849 5.77 74,628 4.58
Retail installment contracts 8,874 2.92 10,668 2.82 9,302 2.55
---------- ---------- ----------
Total $ 140,462 3.40% $ 147,753 3.69% $ 113,607 2.92%
========== ========== ==========
At December 31, 2002 and 2001, the Company held foreclosed single-family
dwellings with a carrying value of approximately $8.4 million and $10.5 million.
These balances total 0.4% and 0.6% of the real estate secured loans outstanding
(net of unearned finance charges and deferred loan fees) as of December 31, 2002
and 2001.
Off-Balance Sheet Arrangements
Off balance sheet arrangements include financial guarantees, contingent
interests, derivative instruments and interests in unconsolidated entities where
portions of those entities' losses may be absorbed by the holder.
At December 31, 2002, we had three outstanding interest rate sway agreements
with a combined notional amount of $450.0 million and a total fair value of
$34.3 million. This amount is reflected as an adjustment to senior debt on the
Consolidated Statement of Financial Condition.
Other than the interest rate sway, we did not hold any such off-balance sheet
arrangements at December 31, 2002 and 2001.
Aggregate Contractual Obligations
Contractual obligations for payments under long-term debt and lease obligations
are shown as follows:
Contractual Obligations
----------------------------------------------------------------------------
Within 1 - 3 3 - 5 > 5
(Dollars in thousands) Total 1 year Years Years Years
----------- ------------ ----------- ----------- -----------
Senior debt $ 2,389,677 $ 149,921 $ 994,324 $ 747,923 $ 497,509
Operating leases 27,778 9,985 14,290 3,464 39
----------- ------------ ----------- ----------- -----------
Total $ 2,417,455 $ 159,906 $ 1,008,614 $ 751,387 $ 497,548
=========== ============ =========== =========== ===========
Asset / Liability Management
Our long-range profitability depends not only on the success of the services
offered to our customers and the credit quality of our portfolio, but also on
the extent to which earnings are not negatively affected by changes in interest
rates. Accordingly, our philosophy is to maintain an approximate match of the
interest rate sensitivity between our interest-bearing assets and liabilities.
Our consumer finance receivables are primarily fixed rate and have initial terms
generally ranging from 12 to 240 months. However, loans are generally paid off
or refinanced prior to their stated maturity. Therefore, our asset/liability
management requires a high degree of analysis and estimation. We fund our
interest-bearing assets through both internally generated equity and external
debt financing.
Liquidity
We fund our operations through a variety of corporate borrowings. The primary
source of these borrowings is corporate debt securities issued by the Company.
At December 31, 2002, seven different fixed-rate senior debt issues totaling
$2.35 billion were outstanding, with a weighted-average coupon of 7.00%. To meet
our short-term funding needs, we issue commercial paper. The Company has a
commercial paper program with several investment banks which provides $500
million in borrowing capacity. At December 31, 2002, twenty-nine different
commercial paper borrowings totaling $439.5 million were outstanding, with a
weighted-average coupon of 1.81%.
We also share, with Washington Mutual, an $800 million 3-year revolving credit
facility which provides back up for our commercial paper programs. Previously,
we shared two revolving credit facilities, which provided combined back-up of
$1.2 billion. Effective August 12, 2002 the facilities were restructured into
the existing $800 million 3-year credit facility. The borrowing capacity is
limited to the total amount of the credit facility, net of the amount of
combined commercial paper outstanding. At December 31, 2002, there was $360.5
million available under these facilities. There were no direct borrowings under
these facilities at any point during 2002 or 2001.
This revolving credit agreement, shared with Washington Mutual, has restrictive
covenants which include: a minimum consolidated net worth test; a limit on
senior debt to the borrowing base (up to 10:1); subsidiary debt (excluding bank
deposits and intercompany debt) not to exceed 30% of total debt; and a 60-day
delinquency ratio not to exceed 6% of consumer finance receivables. As of
December 31, 2002, we were in compliance with all restrictive covenants.
The following table shows selected sources (uses) of cash:
Year Ended December 31,
-------------------------------------------
(Dollars in thousands) 2002 2001 2000
----------- ----------- -----------
Operations $ 211,383 $ 205,363 $ 174,112
Net issuances and repayments of debt 112,510 139,086 640,831
Net originations and purchases
of consumer finance receivables (344,164) (275,818) (763,479)
Dividends paid (45,000) (43,500) (25,000)
Subsequent Event
Effective January 16, 2003, we entered into a 364-day unsecured revolving credit
agreement with Washington Mutual, Inc., which provides $250.0 million in
borrowing capacity at an interest rate of LIBOR plus 0.45% and is automatically
renewable for an additional 364 days. Under the agreement, we borrowed $150.0
million on January 17, 2003.
Capital Management
We establish equity leverage targets based upon the ratio of debt to tangible
equity. The debt to tangible equity ratio after discontinued operations at
December 31, 2002 was 6.57:1. The determination of our dividend payments and
resulting capital leverage is managed in a manner consistent with our desire to
maintain strong and improved credit ratings. In addition, provisions of certain
proportion of cumulative earnings and contributed capital. At December 31, 2002,
approximately $73.9 million was available under the debt agreement restriction
for future dividends.
Recently Issued Accounting Standards
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible, long-lived assets and
the associated retirement costs. This Statement is effective January 1, 2003 and
is not expected to have a material impact on our results of operations or the
financial condition of the Company.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. This Statement supercedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of, but retains the requirements relating to recognition and
measurement of an impairment loss and resolves certain implementation issues
resulting from SFAS No. 121. This Statement became effective January 1, 2002 and
did not have a material impact on our results of operations or the financial
condition of the Company.
In June 2002, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. This Statement requires that a
liability for costs associated with exit or disposition activities be recognized
when the liability is incurred and be measured at fair value and adjusted for
changes in estimated cash flows. Existing generally accepted accounting
principles provide for the recognition of such costs at the date of management's
commitment to an exit plan. Under SFAS No. 146, management's commitment to an
exit plan would not be sufficient, by itself, to recognize a liability. The
Statement is effective for exit or disposal activities initiated after December
31, 2002 and will not have a material impact on the results of operations or
financial condition of the Company.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions. This Statement amends Statements No. 72 and 144 and FASB
Interpretation No. 9. Among other topics, this Statement requires that an
unidentifiable intangible asset that is recognized in an acquisition of a
financial institution, in which the liabilities assumed exceed the identifiable
assets acquired, to be recorded as goodwill. Consequently, this unidentifiable
intangible asset will be subject to the goodwill accounting standards set forth
in SFAS No. 142, Goodwill and Other Intangible Assets, and will be evaluated for
impairment on an annual basis instead of being amortized. We do not own
intangible assets of this nature. Therefore, this Statement did not have a
material impact on the results of operations or financial condition of the
Company.
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"), Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, which expands on the accounting guidance
of SFAS No. 5, 57 and 107 and incorporates without change the provisions of FASB
Interpretation No. 34, which is being superseded. This Interpretation requires a
guarantor to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation undertaken in issuing the guarantee. In addition,
guarantors will be required to make significant new disclosures, even if the
likelihood of the guarantor making payments under the guarantee is remote. The
Interpretation's disclosure requirements are effective for the Company as of
December 31, 2002. The recognition requirements of FIN 45 are to be applied
prospectively to guarantees issued or modified after December 31, 2002. There
have been no previous significant guarantees that have been entered into by the
Company.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, which amends SFAS No. 123. This
Statement provides alternative methods of transition for a voluntary change from
the intrinsic value-based method of accounting prescribed by Accounting
Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to
Employees to the fair value-based method of accounting for stock-based employee
compensation. This Statement is effective for fiscal years ending after December
15, 2002 for transition guidance and annual disclosure provisions and did not
have a material effect on the results of its operations or financial condition
of the Company.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), Consolidation
of Variable Interest Entities. The objective of this interpretation is to
provide guidance on how to identify a variable interest entity and determine
when assets, liabilities, noncontrolling interests, and results of operations of
a variable interest entity need to be included in a company's consolidated
financial statements. A company that holds variable interests in an entity will
need to consolidate the entity if the company's interest in the variable
interest entity is such that the company will absorb a majority of the variable
interest entity's expected losses and/or receive a majority of the entity's
expected residual returns, if they occur. The provisions of this interpretation
became effective upon issuance. We have no unconsolidated investments in any
variable interest entities.
Transactions with Related Parties
Significant transactions with Washington Mutual or its subsidiaries are
identified as follows:
o Certain administrative services, including human resources and cash
management were provided, for which we paid management fees of $4.6 million
in 2002, $5.3 million in 2001 and $2.4 million in 2000. These fees are
allocated by Washington Mutual to its subsidiaries based on various
business factors, including the number of employees and total assets, and
include a reasonable market value adjustment.
o We made payments to Washington Mutual, which in turn made payments on our
behalf, pursuant to a tax allocation policy and in connection with the
retirement & savings plans. The tax payments totaled approximately $35.0
million, and retirement & savings plan payments totaled approximately $5.0
million.
o Included in accounts payable and other liabilities are net amounts due to
Washington Mutual for dividends and for operating expenses and tax
remittances paid on our behalf. At December 31, 2002 and 2001, these
amounts totaled $83.9 million and $14.3 million.
o On February 1, 2002, the Company sold, at book value, $46.3 million of
single family residence loans and $3.4 million of foreclosed single-family
dwellings to Ahmanson Obligation Company, a wholly owned subsidiary of
Washington Mutual. The loans had been acquired in 2000 from Long Beach
Mortgage Company, a wholly owned subsidiary of Washington Mutual. The loans
were reported as consumer finance receivables and the foreclosed assets
were included in other assets on the Consolidated Statements of Financial
Condition.
o Included in other assets are amounts prepaid to Washington Mutual for
pension expenses which are to be paid on our behalf. The pension-related
payments in 2002 totaled approximately $23.4 million, leaving a prepaid
balance at December 31, 2002 of $19.6 million.
o Effective January 16, 2003, we entered into a 364-day unsecured revolving
credit agreement with Washington Mutual, Inc., which provides $250.0
million in borrowing capacity at an interest rate of LIBOR plus 0.45% and
is automatically renewable for an additional 364 days. Under the agreement,
we borrowed $150.0 million on January 17, 2003. See "Subsequent Event"
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Certain of the statements contained within this section that are not historical
facts are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements are intended to
assist in the understanding of how our financial performance would be affected
by the circumstances described in this section. However, such performance
involves risks and uncertainties that may cause actual results to differ
materially from those expressed in the forward-looking statements. See Item 7 -
"Cautionary Statements."
Market risk is defined as the sensitivity of income and capital to changes in
interest rates, foreign currency exchange rates, commodity prices and other
relevant market rates or prices. The primary market risk to which we are exposed
is interest rate risk. Our risk management policy provides for the use of
certain derivatives and financial instruments in managing certain risks. We do
not enter into derivatives or other financial instruments for trading or
speculative purposes.
Increases or decreases in interest rates can cause changes in net income,
fluctuations in the fair value of assets and liabilities, and changes in
noninterest income and noninterest expense. Our interest rate risk arises
because assets and liabilities reprice, mature or prepay at different times or
frequencies as market interest rates change. Our loan volume and mix also varies
as interest rates change.
Management of Interest Rate Risk
Interest rate risk is managed within an overall asset/liability management
framework. The principal objective of asset/liability management is to manage
the sensitivity of net income to changing interest rates.
Managed risk includes the risk associated with changes in fair value of long
term fixed rate debt. In accordance with our risk management policy, such risk
is hedged by entering into pay floating interest rate exchange agreements. The
instruments designated in these fair value hedges include interest rate swaps
that qualify for the "short cut" method of accounting under SFAS No. 133. Under
the "short cut" method, we assume no ineffectiveness in a hedging relationship.
Since the terms of the interest rate swap qualify for the use of the "short cut"
method, it is not necessary to measure effectiveness and there is no charge to
earnings for changes in fair value. All changes in fair value are recorded as
adjustments to the basis of the hedged borrowings based on changes in the fair
value of the derivative instrument. When derivative instruments are terminated
prior to their maturity, or the maturity of the hedged liability, any resulting
gains or losses are included as part of the basis adjustment of the hedged item
and amortized over the remaining term of the liability. At December 31, 2002,
the unamortized deferred gain on terminated hedging transactions totaled $10.8
million. This amount is included in senior debt on the Consolidated Statement of
Financial Condition.
At December 31, 2002, we had three outstanding interest rate swap agreements
with a combined notional amount of $450.0 million and a total fair value of
$34.3 million. This amount is reflected as an adjustment to senior debt on the
Consolidated Statement of Financial Condition.
The table below indicates the sensitivity of net interest income and net income
before taxes to interest rate movements. The comparative scenarios assume that
interest rates rise or fall in even monthly increments over the next twelve
months for a total increase of 200 or decrease of 100 basis points. The interest
rate scenarios are used for analytical purposes and do not necessarily represent
management's view of future market movements.
Our net interest income and net income before taxes from continuing operations
sensitivity profiles as of year-end 2002 and 2001 are stated below:
Gradual Change in Rates
---------------------------
Net interest income change for the one-year period beginning: -100bp +200bp
---------------------------
January 1, 2003 .77% (1.48)%
January 1, 2002 .18% (.30)%
Net income before taxes change for the one-year period beginning: -100bp +200bp
---------------------------
January 1, 2003 (.50)% 1.08%
January 1, 2002 .11% (.19)%
Our net interest income and net income before taxes "at risk" position has
increased since December 31, 2001. The change reflects increased sensitivity to
interest rate movement, primarily associated with the resumption of short-term
financing needs. At December 31, 2002, the commercial paper balance outstanding
was $739.5 million (23.6% of total outstanding debt), and at December 31, 2001
the commercial paper balance outstanding was $351.1 million (11.6% of total
outstanding debt). In general, changes in rates do not have a significant impact
on our interest income, as our customers are less rate sensitive and the
majority of our borrowings are fixed rate. Assumptions are made in modeling the
sensitivity of net interest income and net income before taxes. The simulation
model captures expected prepayment behavior under changing interest rate
environments. Sensitivity of new loan volume to market interest rate levels is
included as well.
Item 8. Financial Statements and Supplementary Data
Independent Auditors' Report
To the Board of Directors and Stockholder of
Washington Mutual Finance Corporation
Tampa, Florida
We have audited the accompanying consolidated statements of financial condition
of Washington Mutual Finance Corporation and subsidiaries (the "Company") as of
December 31, 2002 and 2001, and the related consolidated statements of
operations, comprehensive income and retained earnings, and cash flows for each
of the three years in the period ended December 31, 2002. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial condition of Washington Mutual Finance
Corporation and subsidiaries as of December 31, 2002 and 2001, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Tampa, Florida
February 28, 2003
WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries
Consolidated Statements of Financial Condition
(Dollars in thousands, except par value) December 31,
--------------------------------
2002 2001
ASSETS ----------- -----------
Consumer finance receivables, net $ 3,507,971 $ 3,357,050
Investment securities available for sale 67,366 90,442
Cash and cash equivalents 124,506 94,326
Property, equipment and leasehold improvements, net 21,375 26,305
Goodwill, net 40,821 42,214
Other assets 85,269 45,658
Net assets of discontinued operations - 63,745
----------- -----------
TOTAL ASSETS $ 3,847,308 $ 3,719,740
=========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities
Commercial paper borrowings $ 739,467 $ 351,141
Senior debt 2,389,677 2,667,181
----------- -----------
Total debt 3,129,144 3,018,322
Accounts payable and other liabilities 201,134 141,761
----------- -----------
Total liabilities 3,330,278 3,160,083
----------- -----------
Commitments and contingencies
(Notes 12, 13 and 14)
Stockholder's equity
Common stock: $1.00 par value;
10,000 shares authorized; 1,000
shares issued and outstanding 1 1
Paid-in capital 67,210 57,710
Retained earnings 447,931 499,149
Accumulated other comprehensive income 1,888 2,797
----------- -----------
Total stockholder's equity 517,030 559,657
----------- -----------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 3,847,308 $ 3,719,740
=========== ===========
See Notes to Consolidated Financial Statements.
WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income
(Dollars in thousands) Year Ended December 31,
--------------------------------------------
2002 2001 2000
Interest income: ---------- ---------- ----------
Loan interest and fee income $ 552,706 $ 546,786 $ 510,411
Investment securities income 6,271 10,165 9,882
---------- ---------- ----------
Total interest income 558,977 556,951 520,293
Interest and debt expense 168,793 191,125 181,050
---------- ---------- ----------
Net interest income before
provision for loan losses 390,184 365,826 339,243
Provision for loan losses 189,256 146,699 107,960
---------- ---------- ----------
Net interest income after
provision for loan losses 200,928 219,127 231,283
---------- ---------- ----------
Noninterest income 27,624 29,212 30,914
Noninterest expense:
Personnel 88,674 90,539 87,918
Data processing and telecommunication 16,973 16,190 13,535
Occupancy 14,456 14,364 13,474
Advertising 11,743 8,358 5,309
Taxes, licenses and professional fees 10,373 14,897 12,276
Goodwill amortization - 4,563 4,563
Other 16,219 15,100 11,089
---------- ---------- ----------
Total noninterest expense 158,438 164,011 148,164
---------- ---------- ----------
Income from continuing operations
before income taxes 70,114 84,328 114,033
Income taxes 25,272 30,568 42,793
---------- ---------- ----------
Income from continuing operations 44,842 53,760 71,240
Discontinued operations (Note 6)
Income from operations of discontinued division
(less applicable income taxes of $3,042, $4,562,
and $4,737) 4,417 7,365 7,649
Gain on disposition of discontinued operations
(less applicable income taxes of $12,946) 22,523 - -
---------- ---------- ----------
Net income 71,782 61,125 78,889
Net unrealized holding (losses) gains on
securities arising during period, net of tax (909) 2,944 1,291
---------- ---------- ----------
Comprehensive income $ 70,873 $ 64,069 $ 80,180
========== ========== ==========
See Notes to Consolidated Financial Statements.
WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries
Consolidated Statements of Retained Earnings
(Dollars in thousands) Year Ended December 31,
----------------------------------------------
2002 2001 2000
Retained earnings ---------- ----------- -----------
Beginning of period $ 499,149 $ 481,524 $ 427,635
Net income 71,782 61,125 78,889
Dividends (123,000) (43,500) (25,000)
---------- ----------- -----------
End of period $ 447,931 $ 499,149 $ 481,524
========== =========== ===========
See Notes to Consolidated Financial Statements.
WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries
Consolidated Statements of Cash Flows
Year Ended December 31,
----------------------------------------------
(Dollars in thousands) 2002 2001 2000
----------- ----------- ----------
Operating activities
Income from continuing operations $ 44,842 $ 53,760 $ 71,240
Income from discontinued operations 4,417 7,365 7,649
Gain on disposition of discontinued operations 22,523 - -
----------- ----------- ----------
Net income 71,782 61,125 78,889
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for credit losses 189,256 146,699 107,960
Depreciation and amortization 8,925 18,368 19,321
Decrease (increase) in net assets of
discontinued operations - 6,192 (5,763)
Increase (decrease) in accounts payable
and other liabilities 59,029 (13,954) (47,470)
Dividends declared, but not paid (78,000) - -
(Increase) decrease in other assets (39,611) (13,067) 21,175
----------- ----------- ----------
Net cash provided by operating activities 211,381 205,363 174,112
----------- ----------- ----------
Investing activities
Disposal of operating segment 63,728 - -
Investment securities matured or sold 24,902 65,258 26,301
Investment securities purchased (232) (1,671) (77,197)
Net additions to property, equipment and leasehold
improvements (2,445) (6,868) (8,442)
Increase in consumer finance receivables (344,164) (275,818) (763,479)
----------- ----------- ----------
Net cash used in investing activities (258,211) (219,099) (822,817)
----------- ----------- ----------
Financing activities
Net increase (decrease) in commercial
paper borrowings 388,326 (332,513) 441,484
Increase in senior debt from hedging activity 24,184 26,534 -
Capital contributed by parent 9,500 - 8,750
Proceeds from issuance of senior debt - 995,065 449,347
Dividends paid (45,000) (43,500) (25,000)
Repayments of senior debt (300,000) (550,000) (250,000)
----------- ----------- ----------
Net cash provided by financing activities 77,010 95,586 624,581
----------- ----------- ----------
Net increase (decrease) in cash and cash equivalents 30,180 81,850 (24,124)
----------- ----------- ----------
Cash and cash equivalents
Beginning of period 94,326 12,476 36,600
----------- ----------- ----------
End of period $ 124,506 $ 94,326 $ 12,476
=========== =========== ==========
Supplemental disclosures of cash flow information
Interest paid $ 169,136 $ 188,365 $ 178,872
Federal and state income taxes paid
(net of refunds) $ 35,015 $ 37,559 $ 66,077
See Notes to Consolidated Financial Statements.
WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 Ownership and Operations
Washington Mutual Finance Corporation ("WMF"), incorporated in Delaware in 1986,
as Aristar, Inc., is a holding company headquartered in Tampa, Florida whose
subsidiaries are engaged in the consumer financial services business. Washington
Mutual Finance Corporation is an indirect, wholly-owned subsidiary of Washington
Mutual, Inc. ("Washington Mutual"). When we refer to "we", "our", "us", or the
"Company" in this Form 10-K, we mean Washington Mutual Finance Corporation and
its subsidiaries, all of which are wholly-owned.
Our Company's operations consist principally of a network of 432 branch offices
located in 26 states, primarily in the southeast, southwest and California
("Consumer Finance"). These offices operate under the name Washington Mutual
Finance. Our branch offices are typically located in small- to medium-sized
communities in suburban or rural areas and are managed by individuals who
generally have considerable consumer lending experience. We make secured and
unsecured consumer installment loans, and purchase installment contracts from
local retail establishments. The consumer credit transactions are primarily for
personal, family, or household purposes. From time to time, we purchase,
servicing released, real estate secured consumer loans from national mortgage
companies and banking operations through our wholly owned subsidiary Washington
Mutual Finance, Inc., a California corporation, which does business as Aristar
Mortgage Company ("Aristar Mortgage").
We also provided consumer financial services through our industrial banking
subsidiary, First Community Industrial Bank ("FCIB"), which had 10 branches in
Colorado and Utah ("Consumer Banking"). FCIB made consumer loans, purchased
retail installment contracts and accepted deposits insured by the Federal
Deposit Insurance Corporation. On October 1, 2002, we completed the sale of this
subsidiary through a merger with First State Bank, NM, formerly First State Bank
of Taos, a New Mexico bank ("First State"), wholly-owned by First State
Bancorporation, a New Mexico corporation, with First State being the surviving
entity.
Note 2 Summary of Significant Accounting Policies
Principles of Consolidation. The consolidated financial statements include the
accounts of Washington Mutual Finance Corporation and its subsidiaries, all of
which are wholly-owned, after elimination of all intercompany balances and
transactions. Certain amounts in prior years have been reclassified to conform
to the current year's presentation.
Estimates. The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Income Recognition from Finance Operations. Unearned finance charges on all
types of consumer finance receivables are recognized on an accrual basis, using
the interest method. Accrual of interest generally is suspended when payments
are more than three months contractually overdue. When the finance receivable is
secured by real estate and is well-collateralized, we continue to accrue
interest past this timeframe, until foreclosure proceedings are initiated, at
which time all interest accrued but not collected is reversed. In those cases
where the loan is not well-collateralized and collectibility is in doubt,
accrual of interest is suspended prior to the initiation of foreclosure
proceedings. Loan fees and directly related lending costs are deferred and
amortized using the interest method over the contractual life of the related
receivables.
Consumer Finance Receivables. Loans held in portfolio are recorded at the
principal amount outstanding, net of deferred loan costs or fees and any
discounts or premiums on purchased loans. Deferred costs or fees, discounts and
premiums are amortized using the interest method over the contractual term of
the loan adjusted for actual prepayments.
Derivatives. Managed risk includes the risk associated with changes in fair
value of long term fixed rate debt. In accordance with our risk management
policy, such risk is hedged by entering into pay floating interest rate swap
agreements. The instruments designated in these fair value hedges include
interest rate swaps that qualify for the "short cut" method of accounting under
SFAS No. 133. Under the "short cut" method, we assume no ineffectiveness in a
hedging relationship. Since the terms of the interest rate swap qualify for the
use of the "short cut" method, it is not necessary to measure effectiveness and
there is no charge to earnings for changes in fair value. All changes in fair
value are recorded as adjustments to the basis of the hedged borrowings based on
changes in the fair value of the derivative instrument. When derivative
instruments are terminated prior to their maturity, or the maturity of the
hedged liability, any resulting gains or losses are included as part of the
basis adjustment of the hedged item and amortized over the remaining term of the
liability.
Provision and Allowance for loan losses. The allowance for loan losses is
maintained at a level sufficient to provide for estimated credit losses based on
evaluating known and inherent risks in the consumer finance receivables
portfolio. We provide, through charges to income, an allowance for loan losses
which, based upon management's evaluation of numerous factors, including
economic conditions, a predictive analysis of the outcome of the current
portfolio and prior credit loss experience, is deemed adequate to cover
reasonably expected losses inherent in outstanding receivables. Our consumer
finance receivables are a large group of small-balance homogenous loans that are
collectively evaluated for impairment. Additionally, every real estate secured
loan that is 60 days delinquent is reviewed by our credit administration
management to assess collectibility and future course of action.
Losses on receivables are charged to the allowance for loan losses based upon
the number of days delinquent, or when collectibility becomes doubtful and the
underlying collateral, if any, is considered insufficient to liquidate the
receivable balance. Non-real estate secured, delinquent receivables are
generally charged off when they are 180 days contractually delinquent. We
typically begin foreclosure procedures on real estate secured, delinquent
receivables when they reach 60 to 90 days past due. When foreclosure is
completed and we have obtained title to the property, we establish the real
estate as an asset valued at fair value, and charge off any loan amount in
excess of that value. Recoveries on previously written-off receivables are
credited to the allowance.
Investment Securities. Debt and equity securities are classified as available
for sale and are reported at fair value, with unrealized gains and losses
excluded from earnings and reported, net of taxes, as a separate component of
stockholder's equity and comprehensive income. Gains and losses on investment
securities are recorded when realized on a specific identity basis.
Property, Equipment and Leasehold Improvements. Property, equipment and
leasehold improvements are stated at cost, net of accumulated depreciation.
Depreciation is provided for, principally, on the straight-line method over the
estimated useful life, ranging from three to ten years, or, if less, the term of
the lease. At December 31, 2002 and 2001, accumulated depreciation and
amortization totaled $34.4 million and $31.8 million.
Goodwill. Goodwill represents the excess of purchase price over the fair value
of net assets acquired by the Company. We review our goodwill periodically for
other-than-temporary impairment. Impairment loss is recognized if the carrying
amount of the goodwill is not recoverable and exceeds its fair value. As of
January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible
Assets. Under the statement, goodwill is no longer amortized but must be tested
for impairment as of the beginning of the fiscal year in which SFAS No. 142 is
adopted and at least annually thereafter. See further discussion under the
heading "Recently Issued Accounting Standards".
Real Estate Owned. Real estate owned is valued at lower of cost or fair value
less estimated costs to sell and is included in other assets. These values are
periodically reviewed and reduced, if necessary. Costs of holding real estate,
and related gains and losses on disposition, are credited or charged to
noninterest expense as incurred.
Income Taxes. We are included in the consolidated Federal income tax return
filed by Washington Mutual. Federal income taxes are paid to Washington Mutual.
Federal income taxes are allocated between Washington Mutual and its
subsidiaries in proportion to the respective contribution to consolidated income
or loss. State income tax expense represents the amount of taxes either owed by
us or that we would have paid on a separate entity basis, when we are included
in Washington Mutual's consolidated state income tax returns. Deferred income
taxes are provided on elements of income or expense that are recognized in
different periods for financial and tax reporting purposes.
Taxes on income are determined by using the asset and liability method. This
approach requires the recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, we consider expected future events other than enactments of
changes in the tax law or rates.
The Company has recorded a net deferred tax asset of approximately $42.0 million
at December 31, 2002. Realization of the asset is dependent on generating
sufficient taxable income prior to expiration of loss carryforwards available to
the Company. Although realization is not assured, management believes it is more
likely than not that all of the remaining net deferred tax asset will be
realized. The amount of the net deferred tax asset considered realizable,
however, could be reduced in the near term if estimates of future taxable income
during the carryforward period are reduced.
Statements of Cash Flows. For purposes of reporting cash flows, we consider all
highly liquid investments with a maturity of three months or less when purchased
to be cash equivalents.
Fair Value Disclosures. Quoted market prices are used, where available, to
estimate the fair value of the Company's financial instruments. Because no
quoted market prices exist for a significant portion of the Company's financial
instruments, fair value is estimated using comparable market prices for similar
instruments or using management's estimates of appropriate discount rates and
cash flows for the underlying asset or liability. A change in management's
assumptions could significantly affect these estimates. Accordingly, the
Company's fair value estimates are not necessarily indicative of the value which
would be realized upon disposition of the financial instruments.
Recently Issued Accounting Standards. In June 2001, the FASB issued SFAS No.
143, Accounting for Asset Retirement Obligations. SFAS No. 143 addresses
financial accounting and reporting for obligations associated with the
retirement of tangible, long-lived assets and the associated retirement costs.
This Statement is effective January 1, 2003 and is not expected to have a
material impact on our results of operations or the financial condition of the
Company.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. This Statement supercedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of, but retains the requirements relating to recognition and
measurement of an impairment loss and resolves certain implementation issues
resulting from SFAS No. 121. This Statement became effective January 1, 2002 and
did not have a material impact on our results of operations or the financial
condition of the Company.
In June 2002, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. This Statement requires that a
liability for costs associated with exit or disposition activities be recognized
when the liability is incurred and be measured at fair value and adjusted for
changes in estimated cash flows. Existing generally accepted accounting
principles provide for the recognition of such costs at the date of management's
commitment to an exit plan. Under SFAS No. 146, management's commitment to an
exit plan would not be sufficient, by itself, to recognize a liability. The
Statement is effective for exit or disposal activities initiated after December
31, 2002 and will not have a material impact on the results of operations or
financial condition of the Company.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions. This Statement amends Statements No. 72 and 144 and FASB
Interpretation No. 9. Among other topics, this Statement requires that an
unidentifiable intangible asset that is recognized in an acquisition of a
financial institution, in which the liabilities assumed exceed the identifiable
assets acquired, to be recorded as goodwill. Consequently, this unidentifiable
intangible asset will be subject to the goodwill accounting standards set forth
in SFAS No. 142, Goodwill and Other Intangible Assets, and will be evaluated for
impairment on an annual basis instead of being amortized. We do not own
intangible assets of this nature. Therefore, this Statement did not have a
material impact on the results of operations or financial condition of the
Company.
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"), Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, which expands on the accounting guidance
of SFAS No. 5, 57 and 107 and incorporates without change the provisions of FASB
Interpretation No. 34, which is being superseded. This Interpretation requires a
guarantor to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation undertaken in issuing the guarantee. In addition,
guarantors will be required to make significant new disclosures, even if the
likelihood of the guarantor making payments under the guarantee is remote. The
Interpretation's disclosure requirements are effective for the Company as of
December 31, 2002. The recognition requirements of FIN 45 are to be applied
prospectively to guarantees issued or modified after December 31, 2002. There
have been no previous significant guarantees that have been entered into by the
Company.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, which amends SFAS No. 123. This
Statement provides alternative methods of transition for a voluntary change from
the intrinsic value-based method of accounting prescribed by Accounting
Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to
Employees to the fair value-based method of accounting for stock-based employee
compensation. This Statement is effective for fiscal years ending after December
15, 2002 for transition guidance and annual disclosure provisions and did not
have a material effect on the results of its operations or financial condition
of the Company.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), Consolidation
of Variable Interest Entities. The objective of this interpretation is to
provide guidance on how to identify a variable interest entity and determine
when assets, liabilities, noncontrolling interests, and results of operations of
a variable interest entity need to be included in a company's consolidated
financial statements. A company that holds variable interests in an entity will
need to consolidate the entity if the company's interest in the variable
interest entity is such that the company will absorb a majority of the variable
interest entity's expected losses and/or receive a majority of the entity's
expected residual returns, if they occur. The provisions of this interpretation
became effective upon issuance. We have no unconsolidated investments in any
variable interest entities.
Note 3 Consumer Finance Receivables
Consumer finance receivables from continuing operations at December 31, 2002 and
2001 are summarized as follows:
(Dollars in thousands) 2002 2001
----------- -----------
Consumer finance receivables:
Real estate secured loans $ 2,174,108 $ 1,995,953
Other installment loans 1,651,120 1,625,388
Retail installment contracts 304,289 378,650
----------- -----------
Gross consumer finance receivables 4,129,517 3,999,991
Less: Unearned finance charges and
deferred loan fees (471,120) (520,091)
Allowance for loan losses (150,426) (122,850)
----------- -----------
Consumer finance receivables, net $ 3,507,971 $ 3,357,050
=========== ===========
The amount of gross nonaccruing consumer finance receivables was approximately
$105.7 million and $109.6 million at December 31, 2002 and 2001. The amount of
interest that would have been accrued on these consumer finance receivables from
continuing operations was approximately $16.8 million in 2002 and $15.6 million
in 2001.
Activity in the Company's allowance for loan losses is as follows:
Year Ended December 31,
-----------------------------------------------
(Dollars in thousands) 2002 2001 2000
----------- ----------- -----------
Balance, January 1 $ 122,850 $ 101,415 $ 95,260
Provision for loan losses 189,256 146,699 107,960
Amounts charged off:
Real estate secured loans (11,389) (7,217) (2,463)
Other installment loans (153,772) (123,723) (103,576)
Retail installment contracts (15,757) (13,064) (12,696)
----------- ----------- -----------
(180,918) (144,004) (118,735)
Recoveries:
Real estate secured loans 472 289 206
Other installment loans 16,340 15,917 14,131
Retail installment contracts 2,426 2,384 2,593
----------- ----------- -----------
19,238 18,590 16,930
----------- ----------- -----------
Net charge offs (161,680) (125,414) (101,805)
Allowances on notes purchased - 150 -
----------- ----------- -----------
Balance, December 31 $ 150,426 $ 122,850 $ 101,415
=========== =========== ===========
Contractual maturities, excluding unearned finance charges and deferred loan
fees, at December 31, 2002 are as follows:
Over 1 But
Within Within Over
(Dollars in thousands) 1 year 5 years 5 years Total
--------- ----------- ----------- -----------
Real estate secured loans $ 3,182 $ 251,429 $ 1,675,186 $ 1,929,797
Other installment loans 56,411 1,394,272 13,551 1,464,234
Retail installment contracts 23,553 238,592 2,221 264,366
--------- ----------- ----------- -----------
$ 83,146 $ 1,884,293 $ 1,690,958 $ 3,658,397
========= =========== =========== ===========
The weighted average contractual term of all consumer finance receivables from
continuing operations written during the years ended December 31, 2002 and 2001
was 64 months and 55 months with the majority of loans providing for a fixed
rate of interest over the contractual life of the loan. Experience has shown
that a substantial portion of consumer finance receivables will be refinanced to
lower a rate or payment or to provide additional money to the customer, or
repaid prior to contractual maturity. Therefore, the preceding information as to
contractual maturities should not be regarded as a forecast of future cash
collections.
Because we primarily lend to consumers, we did not have receivables from any
industry group that comprised 10 percent or more of total consumer finance
receivables at December 31, 2002. Geographic diversification of consumer finance
receivables reduces the concentration of credit risk associated with a recession
in any one region.
The largest concentrations of consumer finance receivables (excluding unearned
finance charges and deferred loan fees), by state were as follows:
December 31,
----------------------------------------------
2002 2001
--------------------- --------------------
(Dollars in thousands) Amount Percent Amount Percent
----------- ------- ----------- -------
California $ 601,936 16% $ 474,181 14%
Texas 491,366 13 422,184 12
Tennessee 363,042 10 345,587 10
North Carolina 281,545 8 291,929 8
Florida 248,674 7 222,324 6
South Carolina 178,067 5 179,379 5
Virginia 160,967 4 157,217 5
Louisiana 143,326 4 145,127 4
Alabama 128,195 4 118,487 4
Oklahoma 113,928 3 107,086 3
Other 947,351 26 1,016,399 29
Total Continuing ----------- ------- ----------- -------
Operations $ 3,658,397 100% $ 3,479,900 100%
=========== ======= =========== =======
Note 4 Investment Securities
At December 31, 2002 and 2001, all investment securities were classified as
available-for-sale and reported at fair value. Investment securities as of
December 31, 2002 and 2001 are as follows:
December 31, 2002
---------------------------------------------------------------
Approximate
Original Amortized Gross Unrealized Fair
(Dollars in thousands) Cost Cost Gains Losses Value
--------- --------- --------- ------ ----------
Government obligations $ 14,158 $ 14,290 $ 1,144 $ - $ 15,434
Corporate obligations 37,035 37,078 1,164 (15) 38,227
Certificates of deposit
and other 13,208 13,218 512 (25) 13,705
--------- --------- --------- ------ ----------
$ 64,401 $ 64,586 $ 2,820 $ (40) $ 67,366
========= ========= ========= ====== ==========
December 31, 2001
---------------------------------------------------------------
Approximate
Original Amortized Gross Unrealized Fair
(Dollars in thousands) Cost Cost Gains Losses Value
--------- --------- --------- ------ ----------
Government obligations $ 25,700 $ 25,920 $ 1,232 $ (1) $ 27,151
Corporate obligations 45,526 46,006 1,745 (40) 47,711
Certificates of deposit
and other 15,269 15,136 454 (10) 15,580
--------- --------- --------- ------ ----------
$ 86,495 $ 87,062 $ 3,431 $ (51) $ 90,442
========= ========= ========= ====== ==========
There were no significant realized gains or losses during 2002, 2001 or 2000.
The following table presents the maturity of the investment securities at
December 31, 2002:
Approximate
Amortized Fair
(Dollars in thousands) Cost Value
------------ -------------
Due in one year or less $ 27,002 $ 27,341
Due after one year through five years 32,690 34,794
Due after five years through ten years 3,135 3,378
Due after ten years 1,759 1,853
------------ -------------
$ 64,586 $ 67,366
============ =============
Note 5 Goodwill
The results for the year ended December 31, 2002, include the effect of adopting
SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 provides that
goodwill is no longer amortized and the value of an identifiable intangible
asset must be amortized over its useful life, unless the asset is determined to
have an indefinite useful life. Goodwill must be tested for impairment as of the
beginning of the fiscal year in which SFAS No. 142 is adopted, and at least
annually thereafter. Goodwill has been tested for impairment and it has been
determined that there are no impairment losses to be recognized in the period as
a result of the impairment analysis performed as of January 1, 2002. The
adoption of SFAS No. 142 resulted in a pretax reduction in expenses of $4.6
million year to date.
On October 1, 2002, we completed the sale of our wholly-owned subsidiary, First
Community Industrial Bank ("FCIB"), through a merger with First State Bank, NM.
See "Note 6 - Discontinued Operations". There was goodwill in the amount of $1.4
million, associated with the discontinued operation, that was written down, at
the time of the sale.
Had the Company been accounting for its goodwill under SFAS No. 142 for all
periods presented, the Company's net income would have been as follows:
Year Ended December 31,
----------------------------------------
(Dollars in thousands) 2002 2001 2000
--------- ---------- ---------
Net income from continuing operations:
Reported net income from continuing operations $ 44,842 $ 53,760 $ 71,240
Add back: Goodwill previously amortized - 4,563 4,563
--------- ---------- ---------
Income from continuing operations before income
taxes, excluding amortization of goodwill 44,842 58,323 75,803
Income tax expense - (1,665) (1,665)
--------- ---------- ---------
Adjusted net income from continuing operations $ 44,842 $ 56,658 $ 74,138
========= ========== =========
Note 6 Discontinued Operations
On October 1, 2002, our subsidiary, Blazer Financial Corporation ("BFC")
completed the sale of its wholly-owned industrial banking subsidiary, First
Community Industrial Bank ("FCIB"), through a merger with First State Bank, NM,
formerly First State Bank of Taos, a New Mexico bank ("First State"),
wholly-owned by First State Bancorporation, a New Mexico corporation, with First
State being the surviving entity. FCIB was a wholly-owned subsidiary of BFC and
was included in the Consumer Banking segment. BFC is a wholly-owned subsidiary
of Washington Mutual Finance Corporation. Prior to the sale, FCIB declared and
paid a dividend to BFC, in the amount of $37.5 million. The consideration paid
by First State for the merger was equal to $67.0 million in cash.
Net assets of the discontinued operations for the December 31, 2001 balance
sheet are as follows:
(Dollars in thousands) December 31,
2001
ASSETS ------------
Consumer finance receivables, net $ 372,274
Investment securities available for sale 33,772
Cash and cash equivalents 11,821
Property, equipment and leasehold
improvements, net 205
Other assets 99
------------
TOTAL ASSETS $ 418,171
============
LIABILITIES
Federal Home Loan Bank borrowings $ 110,000
Customer deposits 237,220
Accounts payable and other liabilities 7,206
------------
TOTAL LIABILITIES 354,426
------------
NET ASSETS OF DISCONTINUED
OPERATIONS $ 63,745
============
The operating results of discontinued operations are as follows:
Nine
Months
Ended Year Ended
September 30, December 31,
------------- -----------------------
(Dollars in thousands) 2002 2001 2000
Interest income: ------------- --------- ---------
Loan interest and fee income $ 23,894 $ 37,753 $ 38,641
Investment securities income 1,677 2,538 2,472
------------- --------- ---------
Total interest income 25,571 40,291 41,113
Interest and debt expense 11,084 19,396 21,113
------------- --------- ---------
Net interest income before
provision for credit losses 14,487 20,895 20,000
Provision for credit losses 1,770 1,124 (717)
------------- --------- ---------
Net interest income 12,717 19,771 20,717
------------- --------- ---------
Noninterest income 33 92 163
Noninterest expense:
Personnel 3,164 4,508 4,901
Data processing and telecommunication 615 1,021 872
Occupancy 584 778 768
Advertising 8 13 59
Taxes, licenses and professional fees 37 67 148
Goodwill amortization 0 0 0
Other 883 1,549 1,746
------------- --------- ---------
Total noninterest expense 5,291 7,936 8,494
------------- --------- ---------
Income before income taxes 7,459 11,927 12,386
Provision for income taxes 3,042 4,562 4,737
------------- --------- ---------
Net income $ 4,417 $ 7,365 $ 7,649
============= ========= =========
Note 7 Commercial Paper Borrowings
The Company has a commercial paper program with several investment banks which
provides $500 million in borrowing capacity. Commercial paper borrowings at
December 31, 2002 and 2001 totaled $439.5 million and $351.1 million. Interest
expense in 2002, 2001 and 2000 related to commercial paper was $9.3 million,
$19.0 million and $26.2 million.
On July 31, 2002, we entered into an agreement with Westdeutsche Landesbank
Girozentrale ("WestLB") to participate in a $300 million asset-backed commercial
paper conduit program. Under this program, administered by WestLB, up to $300
million of funding will be made available through the assignment of an undivided
interest in a specified group of unsecured receivables to a special purpose,
wholly-owned consolidated subsidiary of the Company. Under the terms of the
agreement, which has a 364-day term, with an option to extend for up to two
additional 364-day periods, WestLB issues commercial paper (indirectly secured
by the receivables), on behalf of the Company. Under this agreement, we had $300
million outstanding, with an average coupon of 1.42% at December 31, 2002. This
program has restrictive covenants which include various financial reporting and
management requirements, as well as a $9.0 million minimum net worth
requirement. As of December 31, 2002, we were in compliance with all restrictive
covenants.
We also share with Washington Mutual, an $800 million 3-year revolving credit
facility, which provides back-up for our commercial paper programs. Previously,
we shared two revolving credit facilities, which provided combined back-up of
$1.2 billion. Effective August 12, 2002 the facilities were restructured into
the existing $800 million 3-year credit facility. The borrowing capacity is
limited to the amount of the credit facility, net of the amount of combined
commercial paper outstanding. At December 31, 2002, there was $360.5 million
available under the facility. There were no direct borrowings under these
facilities at any point during 2002 or 2001.
This revolving credit agreement, shared with Washington Mutual, has restrictive
covenants which include: a minimum consolidated net worth test; a limit on
senior debt to the borrowing base (up to 10:1); subsidiary debt (excluding bank
deposits and intercompany debt) not to exceed 30% of total debt; and a 60-day
delinquency ratio not to exceed 6% of consumer finance receivables. As of
December 31, 2002, we were in compliance with all restrictive covenants.
Effective January 16, 2003, we entered into a 364-day unsecured revolving credit
agreement with Washington Mutual, Inc., which provides $250.0 million in
borrowing capacity at an interest rate of LIBOR plus 0.45% and is automatically
renewable for an additional 364 days. Under the agreement, we borrowed $150.0
million on January 17, 2003. See "Note 15 - Subsequent Event".
Additional information concerning total commercial paper borrowings, including
the commercial paper conduit, is as follows:
Year Ended December 31,
-------------------------------------------
(Dollars in thousands) 2002 2001 2000
----------- ----------- -----------
Outstanding during the year
Maximum amount at any month end $ 739,467 $ 703,912 $ 683,654
Average amount 484,405 411,271 420,215
Average yield 2.10% 4.93% 6.63%
Average interest rates include the effect of commitment fees.
Note 8 Senior Debt
Senior debt at December 31, 2002 and 2001 was comprised of the following senior
notes and debentures (unsecured):
(Dollars in thousands) 2002 2001
------------ ------------
6.0%, due May 15, 2002 $ - $ 149,960
6.30%, due October 1, 2002 - 149,927
6.50%, due November 15, 2003 149,921 149,771
5.85%, due January 27, 2004 199,940 199,875
7.375%, due September 1, 2004 299,620 299,392
8.25%, due June 15, 2005 494,764 473,734
7.25%, due June 15, 2006 249,253 249,036
6.25%, due June 15, 2006 498,670 498,275
6.875%, due June 15, 2011 497,509 497,211
------------ ------------
Total senior debt $ 2,389,677 $ 2,667,181
============ ============
Aggregate maturities of senior debt at December 31, 2002 are as follows: $149.9
million in 2003; $499.6 million in 2004; $494.8 million in 2005; $747.9 million
in 2006; $497.5 million in 2007 and thereafter.
Interest expense related to senior debt outstanding in 2002, 2001 and 2000 was
$158.5 million, $170.8 million, and $154.3 million.
The increase in senior debt related to hedging activities in 2002 totaled $20.9
million. This was comprised of $24.2 million total fair value offset by $3.3
million amortization of deferred gain on terminated hedging transactions. See
"Note 9 - Hedging Activities".
Note 9 Hedging Activities
SFAS No. 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. We did not enter into any agreements,
which met the definition of a derivative instrument at any time during 2002.
Our risk management policy provides for the use of certain derivatives and
financial instruments in managing certain risks. We do not enter into
derivatives or other financial instruments for trading or speculative purposes.
Managed risk includes the risk associated with changes in fair value of
long-term fixed rate debt. In accordance with our risk management policy, such
risk is hedged by entering into pay floating interest rate exchange agreements.
The instruments designated in these fair value hedges include interest rate
swaps that qualify for the "short cut" method of accounting under SFAS No. 133.
Under the "short cut" method, we assume no ineffectiveness in a hedging
relationship. Since the terms of the interest rate swap qualify for the use of
the "short cut" method, it is not necessary to measure effectiveness and there
is no charge to earnings for changes in fair value. All changes in fair value
are recorded as adjustments to the basis of the hedged borrowings based on
changes in the fair value of the derivative instrument. When derivative
instruments are terminated prior to their maturity, or the maturity of the
hedged liability, any resulting gains or losses are included as part of the
basis adjustment of the hedged item and amortized over the remaining term of the
liability. At December 31, 2002, the unamortized deferred gain on terminated
hedging transactions totaled $10.8 million. This amount is included in senior
debt on the Consolidated Statement of Financial Condition.
At December 31, 2002, we had three outstanding interest rate swap agreements
with a combined notional amount of $450.0 million and a total fair value of
$34.3 million. This amount is reflected as an adjustment to senior debt on the
Consolidated Statement of Financial Condition.
Note 10 Income Taxes
The components of income tax expense (benefit) are as follows:
Year Ended December 31,
------------------------------------------
(Dollars in thousands) 2002 2001 2000
---------- ---------- ----------
Current
Federal $ 31,673 $ 37,689 $ 39,775
State 1,560 (71) (1,588)
Deferred (7,961) (7,050) 4,606
---------- ---------- ----------
$ 25,272 $ 30,568 $ 42,793
========== ========== ==========
The provisions for income taxes differ from the amounts determined by
multiplying pre-tax income by the statutory federal income tax rate of 35% for
2002, 2001 and 2000. A reconciliation between these amounts is as follows:
Year Ended December 31,
--------------------------------------------------------------------------
(Dollars in thousands) 2002 2001 2000
---------------------- ---------------------- -----------------------
% of % of % of
Pretax Pretax Pretax
Income Income Income
from from from
Continuing Continuing Continuing
Amount Operations Amount Operations Amount Operations
--------- ---------- --------- ---------- -------- ----------
Income taxes at statutory rates $ 24,540 35.00% $ 29,515 35.00% $ 39,911 35.00%
Increase (reduction) in taxes
resulting from:
State income taxes, net of
Federal benefit 964 1.37 1,008 1.20 2,877 2.52
Other (232) (.33) 45 .05 5 .01
--------- ---------- --------- ---------- -------- ----------
$ 25,272 36.04% $ 30,568 36.25% $ 42,793 37.53%
========= ========== ========= ========== ======== ==========
Deferred taxes result from temporary differences in the recognition of certain
items for tax and financial reporting purposes. The significant components of
the Company's net deferred tax asset (liability) were as follows:
December 31,
---------------------------------
(Dollars in thousands) 2002 2001
----------- ------------
Deferred tax assets:
Credit loss reserves $ 50,952 $ 35,671
Unearned insurance commissions 5,435 7,090
State taxes 1,515 1,145
Employee benefits accruals 1,269 2,943
Other 883 899
----------- ------------
Total deferred tax assets 60,054 47,748
----------- ------------
Deferred tax liabilities:
Amortization of intangibles (10,809) (10,314)
Loan interest and fee income (4,565) (930)
Basis differences on premises and equipment (1,402) (1,187)
Other (1,232) (1,066)
----------- ------------
Total deferred tax liabilities (18,008) (13,497)
----------- ------------
Net deferred tax asset $ 42,046 $ 34,251
=========== ============
Note 11 Retirement and Savings Plans
Substantially all of our employees participate in a noncontributory defined
contribution pension plan maintained by Washington Mutual ("the Plan").
Accumulated plan benefits and annual pension cost are derived from an allocation
formula based on our total participants and the Plan's total participants.
Pension cost for our participants for the years ended December 31, 2002, 2001,
and 2000 was approximately $3.8 million, $2.2 million, and $1.0 million. The
significant increase in 2002 was due to actuarial adjustments to funding of the
pension plan. Due to our participation in a multi-employer defined benefit plan,
information as to separate Company participant assets and vested benefits is not
presented.
Our employees also participate in an employee savings plan maintained by
Washington Mutual, which allows employees to defer part of their pre-tax
compensation until retirement. Company contributions equal 100% of the
contributions made by employees up to 3% of salary plus annual discretionary
amounts, if any, as determined by management. Our cost is based on the actual
contribution related to our participating employees. Total expense was
approximately $3.4 million, $3.6 million and $3.4 million for the years ended
December 31, 2002, 2001 and 2000.
The Company's employees who retired prior to July 1, 1997 also participate in
Washington Mutual's defined benefit postretirement plan ("the Benefit Plan")
which covers a portion of the costs of medical and life insurance coverage to
eligible employees and dependents based on age and length of service.
Medical coverage options are the same as available to active employees. The
accumulated postretirement benefit obligation and related expense are derived
from an allocation formula based on our total participants and the Benefit
Plan's total participants.
The net postretirement medical and life insurance expense allocated to us for
the years ended December 31, 2002, 2001 and 2000 was approximately $141,000,
$194,000 and $184,000.
Note 12 Leases
The Company leases office space, computers, office equipment and automobiles,
generally for terms of five or fewer years.
Under operating leases that have initial or remaining noncancelable lease terms
in excess of one year, approximate aggregate annual minimum rentals are $9.2
million in 2003; $7.4 million in 2004; $5.2 million in 2005; $2.3 million in
2006; and $0.8 million in 2007 and thereafter. Rent expense from continuing
operations for the years ended December 31, 2002, 2001 and 2000 was $11.5
million, $11.7 million and $11.6 million.
Our corporate headquarters building is located in Tampa, Florida. We currently
lease our headquarters office facilities at a monthly base rent of $66 thousand
per month, with annual increases approximating 3.5% per year. The current lease
expires in May 2006, with an additional five-year option to renew.
Note 13 Contingencies
The Company and several of its subsidiaries and their current and former
employees are defendants in approximately 35 suits pending in the state and
federal courts of Mississippi. The lawsuits generally allege unfair lending and
insurance related practices. Similar suits are pending against other financial
services companies in Mississippi. All but three of the suits are currently in
various stages of discovery or stayed pending the outcome of motions for remand
and no immediate developments are expected in those cases.
In one of the pending cases, Carolyn Baker, et al. v. Washington Mutual Finance
Group, LLC f/k/a City Finance Company, a jury awarded just over $71 million
against one of the Company's subsidiaries, Washington Mutual Finance Group, LLC,
a Delaware limited liability company ("WMF Group"). Pursuant to a motion filed
by WMF Group, the trial court reduced the verdict to just over $53 million. WMF
Group is in the process of appealing the verdict and has posted a bond to stay
execution on the judgment pending the appellate court's ruling. WMF Group's
appellate brief and three amicus briefs were filed in November and all briefing
is expected to be completed by the end of first quarter 2003. The appeal is
based on numerous grounds, including the gross inequity between the alleged
economic losses of only $12,000 and the actual jury award.
In the case of Philisia Banks, et. al. v. City Finance Co., et. al., which was
originally scheduled for trial beginning December 16, 2002, the plaintiffs
requested further mediation. No new trial date has been set. This case is now
expected to go to trial sometime in the first or second quarter of 2003. In the
case of William Agnew, et. al. v. City Finance Company of Mississippi, Inc., et.
al., a trial is currently set for May of 2003 and a motion for summary judgment
is currently pending. Adverse verdicts could result in either case by the end of
second quarter 2003. Because of the unusual litigation environment in
Mississippi it is difficult to predict potential outcomes and losses. However,
based upon information presently available, we believe that the total amount
that will ultimately be paid, if any, after reductions and appeals, arising from
these Mississippi lawsuits and proceedings will not have a material adverse
effect on our consolidated results of operations and financial position.
We are currently evaluating the business and legal environment in Mississippi.
During the evaluation process, we have suspended all new loan origination
activities and revolving loan advances to Mississippi residents. The moratorium
on new advances and originations went into effect September 30, 2002. Based on
the information available, we believe that the moratorium will not have a
material adverse effect on our consolidated results of operation and financial
position.
Note 14 Transactions with Related Parties
Significant transactions with Washington Mutual or its subsidiaries are
identified as follows:
o Certain administrative services, including human resources and cash
management were provided, for which we paid management fees of $4.6 million
in 2002, $5.3 million in 2001 and $2.4 million in 2000. These fees are
allocated by Washington Mutual to its subsidiaries based on various
business factors, including the number of employees and total assets, and
include a reasonable market value adjustment.
o We made payments to Washington Mutual, which in turn made payments on our
behalf, pursuant to a tax allocation policy and in connection with the
retirement & savings plans. The tax payments totaled approximately $35.0
million, and retirement & savings plan payments totaled approximately $5.0
million.
o Included in accounts payable and other liabilities are net amounts due to
Washington Mutual for operating expenses and tax remittances paid on our
behalf. At December 31, 2002 and 2001, these amounts totaled $83.9 million
and $14.3 million.
o On February 1, 2002, the Company sold, at book value, $46.3 million of
single family residence loans and $3.4 million of foreclosed single-family
dwellings to Ahmanson Obligation Company, a wholly owned subsidiary of
Washington Mutual. The loans had been acquired in 2000 from Long Beach
Mortgage Company, a wholly owned subsidiary of Washington Mutual. The loans
were reported as consumer finance receivables and the foreclosed assets
were included in other assets on the Consolidated Statements of Financial
Condition.
o Included in other assets are amounts prepaid to Washington Mutual for
pension expenses which are to be paid on our behalf. The pension-related
payments in 2002 totaled approximately $23.4 million, leaving a prepaid
balance at December 31, 2002 of $19.6 million.
o Effective January 16, 2003, we entered into a 364-day unsecured revolving
credit agreement with Washington Mutual, Inc., which provides $250.0
million in borrowing capacity at an interest rate of LIBOR plus 0.45% and
is automatically renewable for an additional 364 days. Under the agreement,
we borrowed $150.0 million on January 17, 2003. See "Note 15 - Subsequent
Event".
Note 15 Subsequent Event
Effective January 16, 2003, we entered into a 364-day unsecured revolving credit
agreement with Washington Mutual, Inc., which provides $250.0 million in
borrowing capacity at an interest rate of LIBOR plus 0.45% and is automatically
renewable for an additional 364 days. Under the agreement, we borrowed $150.0
million on January 17, 2003.
Note 16 Approximate Fair Values of Financial Instruments
A summary of the approximate fair values of our financial instruments, as
compared to their carrying values, is set forth in the following table:
December 31, 2002 December 31, 2001
--------------------------- ---------------------------
(Dollars in thousands) Carrying Approximate Carrying Approximate
Value Fair Value Value Fair Value
----------- ----------- ----------- -----------
Consumer finance receivables $ 3,658,397 $ 3,671,001 $ 3,479,900 $ 3,471,743
Investment securities 67,366 67,366 90,442 90,442
Commercial paper borrowings 739,467 740,162 351,141 351,247
Senior Debt 2,389,677 2,601,835 2,667,181 2,785,907
In estimating the fair value disclosures for financial instruments, we used the
following methods and assumptions:
Consumer finance receivables. The approximate fair value of consumer
finance receivables was estimated by discounting the future cash flows
using current rates at which similar loans would be made with similar
maturities to borrowers with similar credit ratings. The fair value was
not adjusted for the value of potential loan renewals from existing
borrowers.
Investment securities. Fair values for investment securities are based
on quoted market prices. If quoted market prices were not available,
fair values were estimated based on quoted market prices of comparable
instruments.
Cash and cash equivalents. The carrying amount reported in the
statement of financial condition for cash and cash equivalents
approximates its fair value given its highly liquid nature.
Debt. The carrying amount reported in the statement of financial
condition for commercial paper borrowings approximates its fair value
given its brief maximum term. The approximate fair value for senior
debt was estimated using rates currently available for debt with
similar terms and remaining maturities.
Accounts payable and other liabilities. The carrying amounts reported
in the statement of financial condition for accounts payable and other
liabilities approximate their fair value, given the settlement on
demand nature of these items.
Note 17 Selected Quarterly Financial Data (Unaudited)
A summary of the quarterly results of operations for the years ended December
31, 2002 and 2001 is set forth below. On October 1, 2002, we sold our Consumer
Banking subsidiary. Accordingly, it has been accounted for as discontinued
operations and the accompanying selected quarterly financial data has been
restated to report separately the net consumer finance receivables and operating
results of this discontinued operation.
As of and for the Quarter Ended
----------------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
---------------------- ---------------------- ---------------------- ----------------------
(Dollars in thousands) 2002 2001 2002 2001 2002 2001 2002 2001
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net interest income before
provision for credit losses $ 92,266 $ 87,400 $ 94,653 $ 90,841 $ 99,710 $ 92,437 $ 103,555 $ 95,148
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Provision for credit losses 39,599 31,332 43,194 32,169 48,368 35,625 58,095 47,573
Other operating income 5,790 7,750 7,589 7,747 6,994 6,369 7,251 7,346
Other operating expenses 39,526 42,605 38,262 39,648 39,566 39,506 41,084 37,689
Goodwill amortization
expense - 1,141 - 1,140 - 1,141 - 1,141
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income from continuing operations
before income taxes 18,931 20,072 20,786 25,631 18,770 22,534 11,627 16,091
Income taxes 6,867 7,274 7,499 9,299 6,662 8,173 4,244 5,822
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income from continuing
operations 12,064 12,798 13,287 16,332 12,108 14,361 7,383 10,269
Income from operations of discontinued
division (less applicable
income taxes) 1,572 1,799 1,766 1,858 1,079 1,856 - 1,852
Gain on disposition of discontinued
operations (less applicable
income taxes) - - - - - - 22,523 -
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income $ 13,636 $ 14,597 $ 15,053 $ 18,190 $ 13,187 $ 16,217 $ 29,906 $ 12,121
========== ========== ========== ========== ========== ========== ========== ==========
Consumer finance
receivables, net (from
continuing operations) $3,309,770 $3,262,062 $3,444,445 $3,293,989 $3,479,042 $3,335,783 $3,507,971 $3,357,050
========== ========== ========== ========== ========== ========== ========== ==========
Consumer finance
receivables, net (from
discontinued operations) $ 362,065 $ 378,850 $ 360,878 $ 376,164 $ 347,781 $ 375,779 $ - $ 372,274
========== ========== ========== ========== ========== ========== ========== ==========
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Index of Documents filed as a part of this Report:
1. Financial Statements
Included in Part II of this Report:
PAGE
Report of Independent Certified Public Accountants...............26
Washington Mutual Finance Corporation and Subsidiaries:
Consolidated Statements of Financial Condition
at December 31, 2002 and 2001.................................27
Consolidated Statements of Operations and Comprehensive Income
for the Years Ended December 31, 2002, 2001 and 2000..........28
Consolidated Statements of Retained Earnings
for the Years Ended December 31, 2002, 2001 and 2000..........29
Consolidated Statements of Cash Flows
for the Years Ended December 31, 2002, 2001 and 2000..........30
Notes to Consolidated Financial Statements.....................31
2. Financial Statement Schedules
All schedules are omitted because of the absence of the conditions
under which they are required or because the required information
is set forth in the financial statements or related notes.
3. Exhibits
Included in Part IV of this Report:
Exhibit
Number
(3) (a) Certificate of Incorporation of Washington Mutual Finance
Corporation. as presently in effect. (i)
(b) By-Laws of Washington Mutual Finance Corporation as presently
in effect. (ii)
(4) (a) Indenture dated as of October 1, 1997 between Aristar, Inc.
and First Union National Bank, as trustee. (iii)
(b) Indenture dated as of November 15, 1997 between Aristar, Inc.
and First Union National Bank, as trustee. (iv)
(c) Indenture dated as of June 23, 1999 between Aristar, Inc. and
Harris Trust and Savings Bank, as trustee. (iv)
(d) The registrant hereby agrees to furnish the Securities and
Exchange Commission upon request with copies of all
instruments defining rights of holders of long-term debt of
Washington Mutual Finance Corporation and its consolidated
subsidiaries.
(10) (a) Income Tax Allocation Agreement between Aristar, Inc. and
Washington Mutual, as successor to Great Western Financial
Corporation (as amended effective August 31, 1999). (iv)
(b) Three-Year Credit Agreement by and among Washington Mutual
and Washington Mutual Finance Corporation and JPMorgan Chase
Bank, as Administrative Agent. (iv)
(12) Statement Re: Computation of Ratios
(23) Independent Auditors' Consent.
(i) Incorporated by reference to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1987, Commission
file number 1-3521.
(ii) Incorporated by reference to Registrant's Current Report on
Form 8-K dated October 6, 1997, Commission file number
1-3521.
(iii) Incorporated by reference to Registrant's Report on Form
424B2 dated November 6, 1997, Commission file number 1-3521.
(iv) Incorporated by reference to Washington Mutual, Inc.'s Annual
Report on Form 10-K for the year ended December 31, 2002,
Commission File No. 1-14667.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the period covered
by this Report.
Signatures
Pursuant to the requirements of the Section 13 of the Securities Exchange Act of
1934, the Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
WASHINGTON MUTUAL FINANCE CORPORATION
/s/ Craig J. Chapman
-------------------------------------
Craig J. Chapman
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Company and in
the capacities indicated on March 27, 2003.
/s/ Craig J. Chapman /s/ Edward S. Robertson
- ------------------------------------ -----------------------------------------
Craig J. Chapman Edward S. Robertson
Chief Executive Officer and Director Senior Vice President and Chief Financial
(Principal Executive Officer) Officer (Principal Financial Officer)
/s/ Craig A. Stein
-----------------------------------------
Craig A. Stein
Vice President and Controller
(Principal Accounting Officer)
/s/ Craig E. Tall /s/ Fay L. Chapman
- ------------------------------------ -----------------------------------------
Craig E. Tall Fay L. Chapman
Director Director
/s/ William A. Longbrake
-----------------------------------------
William A. Longbrake
Director
CERTIFICATIONS
I, Craig J. Chapman, certify that:
1) I have reviewed this annual report on Form 10-K of Washington Mutual
Finance Corporation;
2) Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3) Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employee who have a significant role in the registrant's internal
controls; and
6) The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective action with regard to significant deficiencies and material
weaknesses.
Date: March 27, 2003
By: /s/ Craig J. Chapman
-----------------------------------------
Craig J. Chapman
Chief Executive Officer of
Washington Mutual Finance Corporation
I, Edward S. Robertson, certify that:
1) I have reviewed this annual report on Form 10-K of Washington Mutual
Finance Corporation;
2) Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3) Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employee who have a significant role in the registrant's internal
controls; and
6) The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective action with regard to significant deficiencies and material
weaknesses.
Date: March 27, 2003
By: /s/ Edward S. Robertson
-----------------------------------------
Edward S. Robertson
Chief Financial Officer of Washington
Mutual Finance Corporation