UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[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 N/A to _____
Commission File Number: 1-9566
FirstFed Financial Corp.
(Exact name of registrant as specified in its charter)
Delaware 95-4087449
(State or other jurisdiction of (I. R. S. Employer Identification No.)
incorporation or organization)
401 Wilshire Boulevard
Santa Monica, California 90401-1490
Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 319-6000
Securities registered pursuant to Section 12(b) of the Act:
Common Stock $0.01 par value
(Title of Class)
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
------- ------
The approximate aggregate market value of the voting stock held by
non-affiliates of the Registrant as of June 28, 2002 was $456,096,000, based on
the closing sales price of the Registrant's common stock on the New York Stock
Exchange on such date of $29.00 per share. For purposes of the preceding
sentence only, all directors, executive officers and beneficial owners of ten
percent or more of the common stock, as well as the Company's Employee Stock
Ownership Plan ("ESOP"), are assumed to be affiliates.
The number of shares of Registrant's $0.01 par value common stock outstanding as
of February 7, 2003: 16,910,212
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Annual Meeting of Stockholders to be held
April 23, 2003 ("Proxy Statement"), (Parts II, III & IV).
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (sub-section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of the
Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No[ ]
Disclosure Regarding Forward-looking Statements
This Annual Report on Form 10-K for the year ended December 31, 2002
includes certain statements that may be deemed to be "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, (the "Securities Act") and Section 21E of the Securities and Exchange
Act of 1934, as amended (the "Exchange Act"). All statements, other than
statements of historical facts, included in this Annual Report that address
activities, events or developments that the Company expects, believes or
anticipates will or may occur in the future, including, but not limited to, such
matters as future product development, business development, competition, future
revenues, business strategies, expansion and growth of the Company's operations
and assets and other such matters are forward-looking statements. These kinds of
statements are signified by words such as "believes," "anticipates," "expects,"
"intends," "may", "could," and other similar expressions. However, these words
are not the exclusive means of identifying such statements. These statements are
based on certain assumptions and analyses made by the Company in light of its
experience and perception of historical trends, current conditions, expected
future developments and other factors it believes are appropriate in the
circumstances. Such statements are subject to a number of assumptions, risks and
uncertainties, including the risk factors discussed below, general economic and
business conditions, the business opportunities (or lack thereof) that may be
presented to and pursued by the Company, changes in law or regulations and other
factors, many of which are beyond the Company's control. Specific factors that
could cause results to differ materially from historical results or those
anticipated are: (1) the level of demand for adjustable rate mortgages, which is
affected by external factors such as interest rates, the strength of the
California economy and Southern California economy in particular; (2)
fluctuations between consumer interest rates and the cost of funds; (3) federal
and state regulation of lending, deposit and other operations, and (4)
competition for financial products and services within the Bank's market areas.
Investors are cautioned that any such statements are not guarantees of future
performance and that actual results or developments may differ materially from
those projected in the forward-looking statements.
2
FirstFed Financial Corp.
Index
Page
Part I Item 1. Business................................................................ 4
Item 2. Properties.............................................................. 24
Item 3. Legal Proceedings....................................................... 24
Item 4. Submission of Matters to a Vote of Security Holders..................... 24
Part II Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters..................................................... 24
Item 6. Selected Financial Data................................................. 25
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................... 26
Item 7a. Quantitative and Qualitative Disclosures About Market Risk.............. 38
Item 8. Financial Statements and Supplementary Data............................. 42
Notes to Consolidated Financial Statements.............................. 46
Independent Auditors' Report............................................ 74
Item 9. Changes In and Disagreements with Accountants on
Accounting and Financial Disclosure..................................... 75
Part III Item 10. Directors and Executive Officers of the Registrant...................... 75
Item 11. Executive Compensation.................................................. 75
Item 12. Security Ownership of Certain Beneficial Owners and
Management.............................................................. 75
Item 13. Certain Relationships and Related Transactions.......................... 75
Item 14. Controls and Procedures................................................. 75
Part IV Item 15. Exhibits, Consolidated Financial Statement
Schedules, and Reports on Form 8K....................................... 76
Signatures ...................................................................................... 77
Power of Attorney................................................................................ 78
Certification of Chief Executive Officer......................................................... 79
Certification of Chief Financial Officer......................................................... 80
99.1 Certification of Chief Executive Officer pursuant to 18 USC Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.......................... 81
99.2 Certification of Chief Financial Officer pursuant to 18 USC Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.......................... 82
3
PART I
ITEM 1 -- BUSINESS
General Description
FirstFed Financial Corp., a Delaware corporation ["FFC," and collectively
with its sole and wholly owned subsidiary, First Federal Bank of California (the
"Bank"), the "Company"], was incorporated on February 3, 1987. Since September
22, 1987, FFC has operated as a savings and loan holding company engaged
primarily in the business of owning the Bank. Because the Company does not
presently engage in any significant independent business operations,
substantially all earnings and performance figures herein reflect the operations
of the Bank.
The Bank was organized in 1929 as a state-chartered savings and loan
association, and, in 1935, converted to a federal mutual charter. In February
1983 the Bank obtained a federal savings bank charter, and, in December 1983,
converted from mutual to stock ownership.
The principal business of the Bank is attracting savings and checking
deposits from the general public, and using such deposits, together with
borrowings and other funds, to make real estate, business and consumer loans.
The Company's periodic and current reports are available free of charge on
its website at www.firstfedca.com as soon as reasonably practicable after such
material is electronically filed with, or furnished to, the SEC.
At December 31, 2002, the Company had assets totaling $4.3 billion,
compared to $4.7 billion at December 31, 2001 and $4.4 billion at December 31,
2000. The Company recorded net earnings of $55.2 million for 2002, compared to
net earnings of $50.3 million for 2001 and $38.5 million for 2000.
The Bank derives its revenues principally from interest on loans and
investments and loan origination fees. Its major items of expense are interest
on deposits and borrowings, and general and administrative expense.
As of February 15, 2003, the Bank operated 29 retail savings branches, all
located in Southern California. Permission to operate all full-service branches
must be granted by the Office of Thrift Supervision ("OTS"). In addition to its
retail branches, the Bank operates a call center, which conducts transactions
with deposit and loan customers by telephone.
The Bank's principal loan market is Southern California. The Bank has a
residential lending group which includes a retail lending division with two loan
offices. Additionally, the Bank has an income property lending group with two
offices and a commercial banking division with two offices.
The Bank has three wholly-owned subsidiaries: Seaside Financial
Corporation, Oceanside Insurance Agency, Inc. and Santa Monica Capital Group,
all of which are California corporations. See "Subsidiaries."
Current Operating Environment
The Company's operating results are significantly influenced by national
and regional economic conditions, monetary and fiscal policies of the federal
government, housing demand and affordability, and general levels of interest
rates.
The Bank's primary market is the Los Angeles County area of Southern
California. According to the UCLA Anderson Forecast for California, December
2002 Report ("Forecast"), "California and Los Angeles, like the rest of the
nation, entered into a recession during 2002. The forces that are slowing the
recovery here in Southern California are much the same as the forces that are
slowing the national recovery." According to the Forecast, real estate housing
prices are expected to increase during 2003 but at a slower pace than 2002. The
growth in home values in Los Angeles County are expected to decrease from a high
of 15.2% during the third quarter of 2002 to only 2.9% during the fourth quarter
of 2003.
Consistent with the favorable real estate climate in the greater Los
Angeles area, the Bank's non-performing assets remained unchanged at 0.17% of
total assets at the end of 2002, the same as at the end of 2001, and compared
favorably to 0.19% at the end of 2000.
The Bank monitors the sufficiency of the collateral supporting its loan
portfolio based on many factors including the property location, the date of
loan origination and the original loan-to-value ratio. The Bank adjusts its
general allowance for loan losses as a result of these evaluations. No provision
for loan losses was necessary during 2002, 2001 or 2000.
4
The ratio of allowances for loan losses (general valuation allowances and
valuation allowances for impaired loans) to gross loans receivable was 1.96% at
the end of 2002 compared to 1.83% at the end of 2001 and 1.95% at the end of
2000. The increase in the ratio in 2002 from 2001 was due to a reduction in
gross loans receivable. The decrease in the ratio in 2001 from 2000 was due to
growth in gross loans receivable. See "Business - Loan Loss Allowance" for
additional information.
The Bank also maintains a separate valuation allowance for impaired loans
and a repurchase liability for loans sold with recourse. See "Business - Loan
Loss Allowance" for additional information regarding valuation allowances for
these loans.
Current Interest Rate Environment. The Federal Reserve Board ("FRB")
decreased interest rates once during 2002 and eleven times during 2001. The FRB
increased interest rates three times during 2000. Through February 2003, the FRB
has not changed interest rates.
The Bank's interest rate spread typically increases in a decreasing
interest rate environment, (savings and borrowing costs decrease immediately
while the loan portfolio yield decreases more slowly). The reverse is true
during periods of increasing interest rates. The Bank's loan portfolio typically
shrinks in a decreasing interest rate environment due to payoffs of adjustable
rate loans. Furthermore, borrowers normally prefer fixed rate loans when rates
are low, which hinders the Bank's ability to originate new loans for its
portfolio.
Changes in interest rates impact the Bank's loan portfolio yield due to the
interest rate adjustment features of its loans. There is also a time lag before
changes in interest rates can be implemented with respect to the Bank's loan
portfolio due to operational and regulatory constraints. These constraints do
not allow the Bank to implement monthly changes in the primary index utilized
for the majority of its adjustable rate loan customers for a period of ninety
days.
The Bank's interest rate spread increased to 2.92% in 2002 from 2.71% in
2001 because the cost of its deposits and borrowings decreased more quickly than
the rates earned on its loan portfolio. The increase to 2.71% in 2001 from 2.37%
in 2000 was also due to the cost of its deposits and borrowings decreasing more
quickly than the rates earned on its loan portfolio. See "Asset-Liability
Management" and "Components of Earnings - Net Interest Income" in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" for
additional information.
Competition. The Bank experiences strong competition in attracting and
retaining deposits and originating real estate loans. It competes for deposits
with many of the nation's largest savings institutions and commercial banks that
have significant operations in Southern California.
The Bank also competes for deposits with credit unions, thrift and loan
associations, money market mutual funds, issuers of corporate debt securities
and the government. In addition to the rates of interest offered to depositors,
the Bank's ability to attract and retain deposits depends upon the quality and
variety of services offered, the convenience of the Bank's locations and its
financial strength as perceived by depositors.
The Bank competes for real estate loans primarily with savings
institutions, commercial banks, mortgage companies and insurance companies. The
primary factors in competing for loans are interest rates, loan fees, interest
rate caps, interest rate adjustment provisions and the quality and extent of
service to borrowers and mortgage brokers.
Environmental Concerns. In certain circumstances, such as if it actively
participates in the management or operation of a property securing its loans,
the Bank could have liability for any properties found to have pollutant or
toxic features. Environmental protection laws are strict and impose joint and
several liability on numerous parties. It is possible for the cost of cleanup of
environmental problems to exceed the value of the security property. The Bank
has adopted environmental underwriting requirements when considering loans
secured by properties which appear to have environmentally high risk
characteristics (e.g. commercial and industrial properties and construction of
all property types, which may contain friable asbestos or lead paint hazards).
The Bank also requires environmental insurance on all commercial properties
(retail, office, industrial) and on multi-family properties that may be near any
commercial influence. These requirements are intended to minimize the risk of
environmental hazard liability. The Bank's policies are also designed to avoid
the potential for liability imposed on lenders who assume the management of a
property.
Business Concentration. The Bank has no single customer or group of
customers, either as depositors or borrowers, the loss of any one or more of
which would have a material adverse effect on the Bank's operations or earnings
prospects.
5
Yields Earned and Rates Paid. Net interest income, the major component of
core earnings for the Bank, depends primarily upon the difference between the
combined average yield earned on the loan and investment security portfolios and
the combined average interest rate paid on deposits and borrowings, as well as
the relative balances of interest-earning assets and interest-bearing
liabilities. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Overview and Components of Earnings - Net Interest
Income" for further analysis and discussion.
Lending Activities
General. The Bank's primary lending activity has been the origination of
loans for the purpose of enabling borrowers to purchase, refinance or construct
improvements on residential real property. The loan portfolio primarily consists
of loans made to homebuyers and homeowners on the security of single family
dwellings and multi-family dwellings. The loan portfolio also includes loans
secured by commercial and industrial properties, consumer loans and commercial
business loans.
For an analysis of loan portfolio composition and an analysis of the types
of loans originated, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Balance Sheet Analysis - Loan Portfolio
and Loan Composition."
Origination and Sale of Loans. The Bank employs loan representatives on an
incentive compensation basis to obtain qualified applicants for loans. The Bank
also derives business from other sources such as mortgage brokers, borrower
referrals, and clients from its retail banking branches.
Loan originations and purchases were $1.3 billion in 2002, $1.5 billion in
2001, and $1.1 billion in 2000. Loan origination volume decreased during 2002
due to borrower demand for fixed rate loans at very low interest rates. Loan
origination volume has improved over the last three years due to an increase in
real estate activity in the Bank's market areas. The above amounts include loan
purchases totaling $89 thousand during 2002, $132.6 million during 2001 and
$14.1 million during 2000.
Loans sold totaled $134.2 million in 2002, $61.2 million in 2001 and $9.5
million in 2000. For the year ended December 31, 2002, $103.7 million in loans
were originated for sale compared to $64.2 million for 2001 and $10.9 million in
2000. Loans originated for sale totaled 8%, 5% and 1% of loan originations
during 2002, 2001 and 2000, respectively. The increase in loans originated for
sale is due to borrower preference for 30-year and 15-year fixed rate loans,
which were available to borrowers at lower interest rates in 2002 compared to
2001. The Bank originates 30-year and 15-year fixed rate loans only for resale
to the secondary markets.
Loans held-for-sale at December 31, 2002, 2001 and 2000 were $2.3 million,
$5.2 million and $2.2 million, respectively, constituting 0.06%, 0.13% and
0.06%, respectively, of the Bank's total loans at such dates.
Loans originated for sale are recorded at the lower of cost or fair value.
The time from origination to sale typically takes up to 30 days. During this
time period the Bank may be exposed to price adjustments as a result of
fluctuations in market interest rates.
The Bank, in prior years, has structured mortgage-backed securities with
loans from its loan portfolio for use in collateralized borrowing arrangements.
In exchange for the improvement in credit risk when the mortgage-backed
securities are formed, guarantee fees are paid to the Federal Home Loan Mortgage
Corporation ("FHLMC") or the Federal National Mortgage Association ("FNMA"). No
loans have been converted into mortgage-backed securities since 1995. The Bank
originated all loans underlying the mortgage-backed securities that it owns.
Therefore, mortgage-backed securities generally have the same experience with
respect to prepayment, repayment, delinquencies and other factors as the
remainder of the Bank's portfolio.
The portfolio of mortgage-backed securities was recorded at fair value as
of December 31, 2002, 2001 and 2000. Positive fair value adjustments for
mortgage-backed securities totaling $1.6 million and $1.9 million, net of tax,
were recorded in stockholders' equity at December 31, 2002 and 2001,
respectively. A negative fair value adjustment for mortgage-backed securities
totaling $1.9 million, net of taxes, was recorded in stockholders' equity at
December 31, 2000.
6
The Bank serviced $197.3 million in loans for other investors as of
December 31, 2002. $108.6 million of these loans were sold under recourse
arrangements. The Bank has an additional $8.1 million in loans that were formed
into mortgage-backed securities with recourse features, but were still owned by
the Bank as of December 31, 2002. Due to regulatory requirements, the Bank
maintains capital for loans sold with recourse as if those loans had not been
sold. The Bank has not entered into any new recourse arrangements since 1989.
Loans sold with recourse are analyzed in determining the adequacy of the
repurchase liability. The decrease in the principal balance of loans sold with
recourse to $108.6 million at the end of 2002 from $137.2 million at the end of
2001 and $159.8 million at the end of 2000 was due to loan amortization and
payoffs.
Interest Rates, Terms and Fees. The Bank originates residential adjustable
mortgage loans ("AMLs") with 30 and 40 year terms and interest rates which
adjust each month based upon the Federal Home Loan Bank's Eleventh District Cost
of Funds Index ("COFI"), the one year U.S. Treasury Security rate, the 12-month
average U.S. Treasury Security rate, LIBOR, starting at the end of 2002, a Three
Month Certificate of Deposit Index ("CODI"). (See "Asset-Liability Management"
in "Quantitative and Qualitative Disclosures About Market Risk.") While the
monthly payment adjusts annually, the maximum annual change in the payment is
limited to 7.5%. Any additional interest due as a result of a rising Index is
added to the principal balance of the loan ("negative amortization"). Payments
are adjusted every five years without regard to the 7.5% limitation to provide
for full amortization during the balance of the loan term. Although the interest
rates are adjusted monthly, these loans have maximum interest rates which can be
charged ranging from 400 to 750 basis points above their initial interest rate.
Generally, these loans may be assumed at any time during their term provided
that the person assuming the loan meets the Bank's credit standards and enters
into a separate written agreement with the Bank. Additionally, the new borrower
is required to pay assumption fees customarily charged for similar transactions.
The Bank also originates adjustable rate loans with initial fixed interest
rates for periods ranging from 3 to 10 years ("hybrid" loans). By policy, the
Bank will either match the fixed rate period of these hybrid loans with
borrowings for the same term or will hold unmatched fixed rate loans in its
portfolio up to 5% of total assets. Loans originated under this program totaled
$419.7 million in 2002, $1.0 billion in 2001 and $75.9 million in 2000.
Originations of adjustable rate loans with initial fixed interest rates declined
during 2002 because the rate differential between these loans and traditional
fixed rate loans was not sufficient to attract borrowers. Adjustable rate loans
with initial fixed interest rates were popular during 2001 because their initial
interest rates were competitive with longer term fixed rate loan products.
Under current portfolio loan programs, the Bank normally lends no more than
95% of a single family property's appraised value at the time of loan
origination. In addition, the Bank has special Community Reinvestment Act loan
programs in which it lends up to 97% of the property's appraised value.
The Bank generally requires that borrowers obtain private mortgage
insurance on loans in excess of 80% of the appraised property value. On certain
loans originated for the portfolio, the Bank charges premium rates and/or fees
in exchange for waiving the insurance requirement. Management believes that the
additional rates and fees that the Bank receives for these loans compensate for
the additional risk associated with this type of loan. Subsequent to the
origination of a portfolio loan, the Bank may purchase private mortgage
insurance with its own funds. Under certain mortgage insurance programs the Bank
acts as co-insurer and participates with the insurer in absorbing any future
loss. As of December 31, 2002, 2001 and 2000, loans with co-insurance totaled
$106.6 million, $140.4 million and $212.6 million, respectively. Loans
originated with an initial loan-to-value greater than 80% with no private
mortgage insurance totaled $159.7 million at December 31, 2002, $354.5 million
at December 31, 2001 and $268.2 million at December 31, 2000.
Because AML loan-to-value ratios may increase above those established at
the time of loan origination due to negative amortization, the Bank rarely lends
in excess of 90% of the appraised value on AMLs. When the Bank does lend in
excess of 90% of the appraised value, additional fees and higher rates are
charged. The amount of negative amortization recorded by the Bank increases
during periods of rising interest rates. As of December 31, 2002, negative
amortization on all loans serviced by the Bank was immaterial.
Although regulations permit a maximum loan term of 40 years for real estate
secured home loans and 30 years for other real estate loans, the majority of the
Bank's real estate loans provide for a maximum maturity period of 30 years or
less. Loans with 40-year terms constituted 6%, 4% and 7% of loan originations
during 2002, 2001 and 2000, respectively.
7
The following table shows the contractual remaining maturities of the
Bank's loans at December 31, 2002:
Loan Maturity Analysis
Maturity Period
------------------------------------------------------------------------------------------
Total 1 Year > 1 Year > 5-10 > 10-20 > 20-30 > 30
Balance or Less to 5 Years Years Years Years Years
---------- --------- ---------- --------- --------- --------- --------
(In thousands)
Interest rate sensitive loans:
AMLs.........................$ 3,700,219 $ 87,759 $ 770,733 $ 612,819 $ 1,232,556 $ 908,951 $ 87,401
Fixed rate loans............. 94,320 5,985 44,989 26,238 11,746 5,194 168
Commercial business loans.... 20,304 4,739 15,565 -- -- -- --
Construction loans........... 6,927 3,470 3,457 -- -- -- --
Consumer and other loans..... 36,880 36,331 187 362 -- -- --
--------- --------- ---------- --------- --------- --------- --------
Total..........................$ 3,858,650 $ 138,284 $ 834,931 $ 639,419 $ 1,244,302 $ 914,145 $ 87,569
========= ========= ========== ========= ========= ========= ========
Non-accrual, Past Due, Impaired and Restructured Loans
The Bank establishes allowances for delinquent interest equal to the amount
of accrued interest on all loans 90 days or more past due or in foreclosure.
This practice effectively places such loans on non-accrual status for financial
reporting purposes.
The following is a summary of non-accrual loans for which delinquent
interest allowances had been established as of December 31, for the end of each
of the periods indicated:
% of % of % of % of % of
2002 Total 2001 Total 2000 Total 1999 Total 1998 Total
------- ------ ------- ------- ------- ------ ------- ------- ------- -----
(Dollars in thousands)
Non-accrual loans:
Single family.....$ 5,705 85% $ 6,062 93% $ 5,603 89% $ 9,626 70% $ 12,270 42%
Multi-family...... 1,017 15 422 6 662 11 3,995 29 13,005 44
Commercial........ -- -- -- -- -- -- 225 1 4,040 14
Consumer.......... -- -- 16 1 -- -- -- -- -- --
------ ------ ------- ------- ------- ------ ------- ------- ------- -----
Total non-accrual
loans...........$ 6,722 100% $ 6,500 100% $ 6,265 100% $ 13,846 100% $ 29,315 100%
====== ====== ======= ======= ======= ====== ======= ======= ======= =====
The allowance for delinquent interest, based on loans past due more than 90
days or in foreclosure, totaled $372 thousand, $504 thousand, $511 thousand,
$720 thousand and $1.9 million at December 31, 2002, 2001, 2000, 1999 and 1998,
respectively.
The Bank's modified loans result primarily from temporary modifications of
principal and interest payments. Under these arrangements, loan terms are
typically reduced to no less than a monthly interest payment required under the
note. If the borrower is unable to return to scheduled principal and interest
payments at the end of the modification period, foreclosure proceedings are
initiated or the modification period may be extended. As of December 31, 2002,
the Bank had modified loans totaling $3.9 million, net of loan loss allowances
of $496 thousand. This compares with modified loans totaling $7.4 million, net
of loan loss allowances of $1.9 million as of December 31, 2001 and $9.6
million, net of loan loss allowances of $1.9 million as of December 31, 2000. No
modified loans were 90 days or more delinquent as of December 31, 2002, 2001 or
2000.
Statement of Financial Accounting Standards No. 114, "Accounting by
Creditors for Impairment of a Loan" ("SFAS No. 114"), requires the measurement
of impaired loans. SFAS No. 114 does not apply to large groups of homogeneous
loans that are collectively reviewed for impairment.
The Bank considers a loan to be impaired when management believes that the
Bank will be unable to collect all amounts due under the contractual terms of
the loan agreement. In accordance with SFAS 114, the Bank evaluates the
collectibility of commercial business loans greater than or equal to $500,000,
single-family loans greater than or equal to $750,000, and income property loans
greater than or equal to $1,500,000 for impairment purposes using its normal
loan review procedures. When a loan is determined to be impaired, the Bank
measures impairment based on either (1) the present value of expected future
cash flows, discounted at the loan's effective interest rate; (2) the loan's
observable market price, or (3) the fair value of the collateral. Estimated
impairment losses are included in the Bank's impairment allowances.
8
Valuation allowances for impaired loans totaled $496 thousand, $1.9 million
and $1.8 million as of December 31, 2002, 2001 and 2000, respectively. The
following is a summary of impaired loans, net of valuation allowances for
impairment, for the periods indicated:
Year Ended December 31,
---------------------------------
2002 2001 2000
-------- --------- --------
(In thousands)
Non-accrual loans.............................. $ -- $ 978 $ --
Modified loans................................. 1,567 6,416 8,770
-------- -------- --------
$ 1,567 $ 7,394 $ 8,770
======== ======== ========
All impaired non-accrual loans as of December 31, 2001 were single family
loans.
When a loan is considered impaired the Bank measures impairment based on
the present value of expected future cash flows (over a period not to exceed 5
years) discounted at the loan's effective interest rate. However, if the loan is
"collateral-dependent" or a probable foreclosure, impairment is measured based
on the fair value of the collateral. When the measure of an impaired loan is
less than the recorded investment in the loan, the Bank records an impairment
allowance equal to the excess of the Bank's recorded investment in the loan over
its measured value. As of December 31, 2002, December 31, 2001, and December 31,
2000, impaired loans totaling $1.6 million, $3.9 million, and $5.1 million,
respectively, had no valuation allowances established. All impaired loans were
measured using the fair value method as of December 31, 2002, December 31, 2001
and December 31, 2000, with values totaling $1.6 million, $7.4 million and $8.8
million, respectively.
The present value of an impaired loan's expected future cash flows will
change from one reporting period to the next because of the passage of time and
also may change because of revised estimates in the amount or timing of those
cash flows. The Bank records the entire change in the present value of the
expected future cash flows as an impairment valuation allowance, which may
necessitate an increase in the provision for loan losses. Similarly, the fair
value of the collateral of an impaired collateral-dependent loan may change from
one reporting period to the next. The Bank also records a change in the measure
of these impaired loans as an impairment valuation allowance, which may
necessitate an adjustment to the provision for loan losses.
The following is an analysis of the activity in the Bank's valuation
allowance for impaired loans during the periods indicated (in thousands):
Balance at December 31, 1997............................... $ 9,775
Provision for loan losses............................... 640
Net charge-offs......................................... (2,781)
--------
Balance at December 31, 1998............................... 7,634
Net charge-offs......................................... (5,038)
--------
Balance at December 31, 1999............................... 2,596
Net charge-offs......................................... (804)
--------
Balance at December 31, 2000............................... 1,792
Transfer from general valuation allowance............... 58
--------
Balance at December 31, 2001............................... 1,850
Transfer from general valuation allowance............... (1,354)
--------
Balance at December 31, 2002............................... $ 496
========
Cash payments received from impaired loans are recorded in accordance with
the contractual terms of the loan. The principal portion of the payment is used
to reduce the principal balance of the loan, whereas the interest portion is
recognized as interest income.
The average recorded investment in impaired loans during 2002, 2001 and
2000 was $5.0 million, $7.4 million and $8.8 million, respectively. The amount
of interest income recognized from impaired loans during 2002, 2001 and 2000 was
$322 thousand, $597 thousand and $706 thousand, respectively, under the cash
basis method of accounting. Interest income that was recognized under the
accrual basis method of accounting for 2002, 2001 and 2000 totaled $316
thousand, $587 thousand and $712 thousand, respectively.
9
Internal Asset Review System
In accordance with the regulations of the OTS, the Bank maintains a system
for the on-going risk grading of all assets based on an assessment of the
repayment capacities of the borrower, the collateral property, guarantors and
endorsers. The risk grading system provides a tool for risk measurement, early
problem asset identification and proper pricing for new extensions of credit.
Assets are classified according to a nine-tiered risk grading system. The
nine risk grades are segmented into three general groups: "unclassified" (Risk
Grades 1 through 5), "criticized" (Risk Grade 6 - Special Mention), and
"classified" (Risk Grade 7 - Substandard, Risk Grade 8 - Doubtful and Risk Grade
9 - Loss). In determining the appropriate Risk Grade for an asset, consideration
is given to information on repayment prospects, including the value of and cash
flow provided by collateral and secondary support provided by the borrowers and
guarantors. Other factors considered in the assignment of a risk grade include
other cash flow sources, the stability of income sources, the type, value,
condition, and liquidity of collateral pledged, the obligor's credit history and
access to alternative financing and market influences.
All assets are subject to on-going classification through the Bank's
internal review system. For internal asset review purposes, the Bank's asset
portfolio is segregated into three distinct groups: assets subject to review by
the Loan Workout Committee (a committee of Bank officers responsible for
resolving problem asset situations), homogeneous assets and non-homogeneous
assets.
Assets Subject to Review by the Loan Workout Committee. The Loan Workout
Committee monitors and develops repayment strategies for the Bank's most complex
problem assets, such as delinquent high balance residential and income property
loans, commercial business loans and loans with collateral properties currently
managed by a court- appointed receiver.
Non-Homogeneous Assets. These are performing income property loans with
unpaid balances greater than $1.5 million, 36+ unit apartment loans, and
commercial business loans. Other non-homogeneous assets may include investments
in subsidiaries, investments in securities, and significant off-balance sheet
items. In accordance with SFAS No. 114, the Bank identifies and evaluates
non-homogeneous assets for impairment on an individual basis based on the
present value of expected future cash flows discounted at the loan's effective
interest rate, or at the loan's observable market price or at the fair value of
its collateral. For further discussion of impaired loans, see "Business -
Non-accrual, Past Due and Restructured Loans".
Homogeneous Assets. These assets are other than non-homogeneous assets and
those reviewed by the Loan Workout Committee. Generally, these assets include
residential loans, lower-balance income property loans, and consumer loans and
are collectively, rather than individually, evaluated for risk grading purposes
through the identification of risk characteristics common to specific types of
assets.
The remainder of the portfolio is segmented into groups of loans with
similar risk characteristics for evaluation and analysis under Statement of
Financial Accounting Standards No. 5, "Accounting for Contingencies" ("SFAS
No.5").
Loan Loss Allowance
The Bank maintains a general valuation allowance for loan losses due to the
inherent risks in the loan portfolio that have yet to be specifically
identified. As discussed above, the Bank's asset classification system serves as
a foundation for determining the appropriate level of the general valuation
allowance. Within the classification categories, loans are stratified based on
factors affecting the perceived level and concentration of risk, such as type of
collateral, year of origination, original loan-to-value ratio and geographic
location.
The Bank calculates the appropriate level of general valuation allowance by
applying reserve factors to the balance of assets on which the Bank has loss
exposure ("exposure base"). These reserve factors represent the expected
likelihood of default multiplied by the expected rate of loss. The expected rate
of loss is derived from the Bank's historical loss experience and adjusted for
current and anticipated conditions and trends.
The Bank reviews the general valuation allowance for adequacy at least
quarterly and evaluates the performance trends in the loan portfolio to
establish adequate reserve factors. The Bank's Asset Classification Committee,
comprised of senior Bank officers, reviews the general valuation allowance
analysis and methodology on a quarterly basis. The Board of Directors reviews
and approves the GVA policy annually.
10
The following is an analysis of the activity in the Bank's general loan
valuation allowances for the periods indicated:
Year Ended December 31,
-----------------------------------------------------------------
2002 2001 2000 1999 1998
--------- ----------- ---------- ---------- ---------
(In thousands)
Beginning general loan valuation allowances....... $ 72,919 $ 70,809 $ 69,954 $ 67,638 $ 61,237
Provision for loan losses......................... -- -- -- -- 6,560
General loan valuation allowances obtained in
acquisition................................... -- 2,050 -- -- --
Charge-offs, net of recoveries:
Single family................................. (372) (322) (767) (342) (1,497)
Multi-family.................................. 189 286 1,692 2,650 1,354
Commercial.................................... -- -- (105) 111 (32)
Non-real estate............................... 1,133 154 35 (103) 16
-------- ----------- ---------- ---------- ---------
Total net recoveries (charge-offs)................ 950 118 855 2,316 (159)
Transfers from (to) impaired valuation allowance.. 1,354 (58) -- -- --
-------- ----------- ---------- ---------- ---------
Ending general loan valuation allowances.......... $ 75,223 $ 72,919 $ 70,809 $ 69,954 $ 67,638
======== =========== ========== ========== =========
Combining activity in the general valuation allowances and the valuation in
allowances for impaired loans, the Bank recorded total net recoveries of $950
thousand, $118 thousand and $51 thousand during 2002, 2001 and 2000,
respectively. Total net charge-offs of $2.7 million and $2.9 million were
recorded during 1999 and 1998, respectively, which represented 0.09% and 0.10%
of the average loan portfolio for such periods. The low level of charge-offs
over the last five years is due to the improved condition of the Southern
California economy and real estate market since the recession of the mid-1990's.
Any increase in charge-offs would adversely impact the Bank's future loan
loss provisions and earnings.
The Bank's total general valuation allowance for loans was 1.89% of total
loans with loss exposure at December 31, 2002, 1.70% at December 31, 2001, 1.81%
at December 31, 2000, 2.15% at December 31, 1999 and 2.26% at December 31, 1998.
The following table details the general valuation allowance by loan type
for the periods indicated:
Year Ended December 31,
------------------------------------------------------------------------------------------------------
% of % of % of % of % of
2002 Total 2001 Total 2000 Total 1999 Total 1998 Total
------- ------ ------- ------- ------- ------ ------- ------- ------- -----
(Dollars in thousands)
Real estate loans:
Single family.....$ 24,952 33% $ 30,040 41% $ 37,695 53% $ 24,985 35% $ 23,061 34%
Multi-family...... 27,037 36 23,955 33 22,529 32 38,332 55 37,875 56
Commercial........ 9,938 13 7,860 11 5,797 8 6,129 9 6,034 9
Construction...... 2,281 3 3,687 5 -- -- -- -- -- --
------- ------ ------- ------- ------- ------ ------- ------- ------- -----
Total real estate
loans........... 64,208 85 65,542 90 66,021 93 69,446 99 66,970 99
------- ------ ------- ------- ------- ------ ------- ------- ------- -----
Non-real estate
loans:
Commercial........ 4,977 7 5,120 7 3,214 5 65 -- -- --
Consumer.......... 5,978 8 1,918 3 1,073 1 87 -- 72 --
Other............. 60 -- 339 -- 501 1 356 1 596 1
------- ------ ------- ------- ------- ------ ------- ------- ------- -----
Total non-real
estate loans..... 11,015 15 7,377 10 4,788 7 508 1 668 1
------- ------ ------- ------- ------- ------ ------- ------- ------- -----
Total...............$ 75,223 100% $ 72,919 100% $ 70,809 100% $ 69,954 100% $ 67,638 100%
======= ====== ======= ======= ======= ====== ======= ======= ======= =====
11
The exposure base of single-family loans declined by $463.8 million and the
proportion of higher risk loans was reduced, resulting in a $5.1 million
reduction in the general valuation allowance. The increase in the multi-family
and commercial real estate loan exposure base of $84.4 million and $56.3
million, respectively, resulted in an increase in the general valuation
allowance of $3.1 million and $2.1 million, respectively. The exposure base of
the construction loan portfolio declined by $41.3 million, generating a
reduction of $1.4 million to the general valuation allowance. The increase in
the commercial loan exposure base of $2.1 million, sustained by enhanced
experience with managing commercial loans, resulted in a decrease of $143
thousand in the general valuation allowance. The consumer loan exposure base
increased by $56.2 million, which resulted in an addition of $4.1 million to the
general valuation allowance. The remainder of the change in the general
valuation allowance for loans was attributable to changes in miscellaneous
loans.
During 2001, certain changes in the exposure base of the loan portfolio
resulted in an increase of $2.1 million in the total general valuation allowance
for loans. The exposure base of single-family loans declined by $59 million and
the proportion of higher risk loans was reduced, resulting in a $7.7 million
reduction in the general valuation allowance. The increase in the multi-family
and commercial real estate loan exposure base of $216.0 million and $117.9
million, respectively, was partially offset by the reduction in the risk
composition, resulting in an increase in general valuation allowance of $1.4
million and $2.1 million, respectively. The newly acquired construction loan
portfolio added $3.7 million to the general valuation allowance. The increase in
the commercial loan exposure base of $13.3 million and the classification of
certain loans as substandard resulted in an increase of $1.9 million in the
general valuation allowance. The consumer loan exposure base increased by $31.5
million, thus adding $845 thousand to the general valuation allowance. The
remainder of the change in the general valuation allowance for loans was
attributable to changes in other loan categories.
Depending on the economy and real estate markets in which the Bank
operates, increases in the general valuation allowance may be required in future
periods. In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's general valuation allowance.
These agencies may require the Bank to establish additional general valuation
allowances based on their judgment of the information available at the time of
their examination.
The Bank also maintains a repurchase liability for loans sold with
recourse, which is included in "Accrued Expenses and Other Liabilities" in the
Company's Statement of Financial Condition. The Bank's repurchase liability for
loans sold with recourse represents the total losses that are estimated to occur
over the remaining life of the portfolio of loans sold with recourse, discounted
to present value. During 2002, the Bank revised its current estimate of the
required repurchase liability for loans sold with recourse from $12.8 million to
$6.9 million. This reduced liability amount reflects the fact that the total
portfolio of loans sold with recourse has been experiencing significant payoffs,
and has had better credit experience than was previously estimated. The
remaining repurchase liability of $6.9 million represents approximately 6.35% of
the total portfolio of loans sold with recourse at December 31, 2002. The
activity in the repurchase liability for loans sold with recourse for 2002,
2001, 2000, 1999 and 1998 is presented below (in thousands):
Balance at December 31, 1998................................. $ 12,546
Net recoveries............................................... 278
---------
Balance at December 31, 1999................................. 12,824
Net recoveries............................................... --
---------
Balance at December 31, 2000................................. 12,824
Net recoveries............................................... --
---------
Balance at December 31, 2001................................. 12,824
Liability adjustment recorded as gain on sale of loans....... (5,924)
Net recoveries............................................... --
---------
Balance at December 31, 2002................................. $ 6,900
=========
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Asset Quality Ratios" for an analysis of the Bank's
general valuation allowances as a percentage non-performing loans and loans
receivable.
Potential Problem Loans. The Bank also had $2.1 million, $6.2 million and
$6.7 million in potential problem real estate loans as of December 31, 2002,
December 31, 2001 and December 31, 2000, respectively. These are loans that do
not meet the criteria of impaired or non-performing loans but have displayed
some past or present weakness. If the weakness is not corrected, the loan could
eventually result in a loss to the Bank.
12
The Bank's Asset Classification Committee meets at least quarterly to
review and monitor the condition of the loan portfolio. Additionally, a special
workout group of the Bank's officers meets at least monthly to resolve
delinquent loan situations and to initiate actions enforcing the Bank's rights
in security properties pending foreclosure and liquidation.
Non-performing Assets. For a further discussion of non-performing assets,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Non-Performing Assets."
Generally, loans greater than 90 days delinquent are placed into
foreclosure and a valuation allowance is established, if necessary. The Bank
acquires title to the property in most foreclosure actions in which the loan is
not reinstated by the borrower. Once real estate is acquired in settlement of a
loan, the property is recorded at fair value less estimated costs to sell.
Following the acquisition of foreclosed real estate ("REO"), the Bank
evaluates the property and establishes a plan for marketing and disposing of the
property. After inspecting the property, the Bank determines whether the
property may be disposed of in its present condition or if repairs,
rehabilitation or improvements are necessary.
The following table provides information regarding the Bank's REO activity
for the periods indicated:
Year Ended December 31,
--------------------------------------
2002 2001 2000
--------- ----------- ----------
(In thousands)
Beginning balance.............................. $ 1,485 $ 2,157 $ 2,202
Additions.................................... 1,881 5,136 5,050
Sales and other.............................. (3,047) (5,808) (5,095)
-------- ---------- ---------
Ending balance................................. $ 319 $ 1,485 $ 2,157
======== ========== =========
Other Interest-Earning Assets. The Bank owned no contractually delinquent
interest-earning assets other than loans as of December 31, 2002.
Investment Activities. It is the Bank's policy to maintain liquidity
investments at a modest level and to use available cash to originate mortgages
that normally command higher yields. Therefore, interest income on investments
generally represents less than 5% of total revenues.
The following table summarizes the total investment portfolio at historical
cost by type at the end of the periods indicated:
At or for the Year Ended December 31,
------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ---------- -----------
(Dollars in thousands)
U.S. treasury securities..........................$ 200 $ 300 $ 300 $ 300 $ 300
U.S. agency securities............................ -- 28,199 38,185 38,167 28,156
Collateralized mortgage obligations ("CMO's")..... 101,802 80,013 98,562 115,704 36,380
--------- ---------- ---------- ---------- ---------
102,002 108,512 137,047 154,171 64,836
Unrealized gain (loss) on securities available-
for-sale....................................... 1,053 1,932 (510) (2,976) (503)
---------- ---------- --------- ---------- ---------
$ 103,055 $ 110,444 $ 136,537 $ 151,195 $ 64,333
========== ========== ========= ========== =========
Weighted average yield on interest-earning
investments end of period...................... 4.77% 6.07% 5.99% 5.86% 5.38%
========== ========== ========= ========== =========
The Bank's collateralized mortgage obligations all have expected maturities
within five years.
Sources of Funds
General. The Bank's principal sources of funds are savings deposits,
advances from the FHLBSF and securities sold under agreements to repurchase.
13
Deposits. The Bank obtains deposits through three different sources: 1) its
retail branch system, 2) phone solicitations by designated employees
(telemarketing deposits), and 3) national brokerage firms.
Deposits acquired through telemarketing efforts are typically placed with
the Bank by professional money managers and represented 3%, 4% and 2% of total
deposits at December 31, 2002, 2001 and 2000, respectively. The level of
telemarketing deposits varies based on yields available to depositors on other
investment instruments and the depositors' perception of the Bank's
creditworthiness.
Deposits acquired through national brokerage firms represented 6%, 14% and
18% of total deposits at December 31, 2002, 2001 and 2000, respectively. Any
fees paid to deposit brokers are amortized over the term of the deposit. Based
on historical renewal percentages, management believes that these deposits are a
stable source of funds. Institutions meeting the regulatory capital standards
necessary to be deemed well-capitalized are not required to obtain a waiver from
the Federal Deposit Insurance Corporation ("FDIC") in order to accept brokered
deposits. See "Management's Discussion and Analysis - Capital Resources and
Liquidity."
Deposits obtained through the retail branch system were $2.3 billion at
December 31, 2002, $2.1 billion at December 31, 2001 and $1.7 billion at
December 31, 2000. Retail deposits comprised 91% of total deposits at December
31, 2002, 82% of total deposits at December 31, 2001 and 80% of total deposits
at December 31, 2000. Management attributes the increase in retail deposits
during 2002 to increased deposits from stock market investors wanting more
security for their investments. During 2001, the Bank acquired four retail
offices with deposits totaling $174.8 million as part of the purchase of two
small financial institutions. As of December 31, 2002, deposits at these
acquired branches totaled $163.7 million. The increase in retail deposits during
2000 was the result of two branch purchases during that year.
The Bank has concentrated its marketing efforts over the last several years
on the attraction and retention of non-term accounts. As a result, the
percentage of fixed-term certificates of deposit in the Bank's total deposits
has decreased from 57% as of December 31, 2000 and 52% as of December 31, 2001
to 36% as of December 31, 2002.
The following table shows the average balances and average rates paid on
deposits by deposit type for the periods indicated:
During the Year Ended December 31,
----------------------------------------------------------------------------------------------
2002 2001 2000
-------------------------- -------------------------- --------------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
----------- ----------- ----------- ----------- ---------- ------------
(Dollars in thousands)
Passbook accounts............ $ 106,591 1.47% $ 94,067 1.53% $ 81,330 1.98%
Money market deposit accounts
909,866 2.50 613,745 3.84 501,084 4.63
Interest-bearing checking
accounts................. 164,930 0.66 141,282 0.97 128,678 1.19
Non interest-bearing
checking accounts........ 234,936 -- 189,185 -- 161,863 --
Fixed term certificate
accounts................. 1,101,043 3.20 1,279,465 4.64 1,259,972 5.20
--------- --------- ---------
$ 2,517,366 2.42% $ 2,317,744 4.08% $ 2,132,927 4.70%
========= ========= =========
The following table shows the maturity distribution of jumbo certificates
of deposit ($100,000 and greater) as of December 31, 2002 (in thousands):
Maturing in:
1 month or less.............................................. $ 33,256
Over 1 month to 3 months..................................... 75,627
Over 3 months to 6 months.................................... 397
Over 6 months to 12 months................................... 56,643
Over 12 months............................................... 43,579
--------
Total...................................................... $ 209,502
========
Based on historical renewal percentages at maturity, management believes
that jumbo certificates of deposit are a stable source of funds. For additional
information with respect to deposits, see Note 8 of the Notes to Consolidated
Financial Statements.
14
The following tables set forth information regarding the amount of deposits
in the various types of savings programs offered by the Bank at the end of the
years indicated and the balances and average rates for those dates:
At December 31,
----------------------------------------------------------------------
2002 2001 2000
-------------------- --------------------- ---------------------
Amount % Amount % Amount %
----------- ------ ------------ ----- ----------- ------
(Dollars in thousands)
Variable rate non-term accounts:
Money market deposit accounts (weighted
average rate of 2.13%, 2.76% and 4.79%). $ 1,079,278 43% $ 741,978 29% $ 537,475 25%
Interest-bearing checking accounts
(weighted average rate of 0.43%, 0.72%
and 1.22%)............................. 174,802 7 162,309 7 140,151 6
Passbook accounts (weighted average rate
of 1.34%, 1.59% and 2.00%)............. 111,844 4 104,488 4 80,536 4
Non-interest bearing checking accounts..... 239,695 9 205,597 8 176,059 8
----------- ----- ------------ ----- ----------- -----
1,605,619 63 1,214,372 48 934,221 43
----------- ----- ------------ ----- ----------- -----
Fixed-rate term certificate accounts:
Under six-month term (weighted average
rate of 1.54%, 2.57% and 5.26%)........ 37,630 1 54,626 2 61,954 3
Six-month term (weighted average rate of
1.95%, 3.29% and 6.41%)................ 104,600 4 246,161 10 282,922 13
Nine-month term (weighted average rate of
2.76%, 3.98% and 6.74%)................ 101,980 4 170,190 7 240,598 11
One year to 18-month term (weighted
average rate of 2.63%, 4.45% and 6.11%)
331,308 14 469,113 18 367,603 17
Two year or 30-month term (weighted
average rate of 3.55%, 5.38% and 5.83%)
41,460 2 45,993 2 31,685 2
Over 30-month term (weighted average rate
of 4.49%, 5.31% and 5.49%)............. 94,927 4 39,938 1 31,088 1
Negotiable certificates of $100,000 and
greater, 30 day to one year terms
(weighted average rate of 2.32%, 3.84%
and 6.19%)............................. 209,502 8 306,254 12 214,976 10
----------- ----- ------------ ----- ------------ -----
921,407 37 1,332,275 52 1,230,826 57
----------- ----- ------------ ----- ------------ -----
Total deposits (weighted average rate of
1.98%, 3.02% and 4.90%)................ $ 2,527,026 100% $ 2,546,647 100% $ 2,165,047 100%
=========== ===== ============ ===== ============ =====
The cost of funds, operating margins and net earnings of the Bank
associated with brokered and telemarketing deposits are generally comparable to
the cost of funds, operating margins and net earnings of the Bank associated
with retail deposits, FHLBSF borrowings and securities sold under agreements to
repurchase. As the cost of each source of funds fluctuates from time to time,
the Bank seeks funds from the lowest cost source until the relative cost
changes. As the costs of funds, operating margins and net earnings of the Bank
associated with each source of funds are generally comparable, the Bank does not
deem the impact of a change in incremental use of any one of the specific
sources of funds at a given time to be material.
Borrowings. The Federal Home Loan Bank System functions as a source of
credit to financial institutions that are members of a regional Federal Home
Loan Bank. The Bank may apply for advances from the FHLBSF secured by the FHLBSF
capital stock owned by the Bank, certain of the Bank's mortgages and other
assets (principally obligations issued or guaranteed by the United States
government or agencies thereof). Advances can be requested for any sound
business purpose which an institution is authorized to pursue. Any institution
not meeting the qualified thrift lender test will be subject to restrictions on
its ability to obtain advances from the FHLBSF. See "Summary of Material
Legislation and Regulation - Qualified Thrift Lender Test." In granting
advances, the FHLBSF also considers a member's creditworthiness and other
relevant factors.
Total advances from the FHLBSF were $1.2 billion at December 31, 2002 at a
weighted average rate of 3.90%. This compares with advances of $1.6 billion at
December 31, 2001 and $1.6 billion at December 31, 2000 with weighted average
rates of 5.01% and 6.42%, respectively. The Bank has credit availability with
the FHLBSF, which allows it to borrow up to 50% of its assets or approximately
$2.1 billion at December 31, 2002.
15
The Bank enters into sales of securities under agreements to repurchase
(reverse repurchase agreements) which require the repurchase of the same
securities. The agreements are treated as borrowings in the Company's
Consolidated Statements of Financial Condition. There are certain risks involved
with entering into these types of transactions. In order to minimize these
risks, the Bank's policy is to enter into agreements only with well-known
national brokerage firms that meet their regulatory capital requirements.
Borrowings under reverse repurchase agreements totaled $155.3 million at
December 31, 2002 at a weighted average rate of 1.61% and were secured by
mortgage-backed securities with principal balances totaling $150.3 million.
Borrowings under reverse repurchase agreements totaled $211.0 million at
December 31, 2001 and $294.1 million at December 31, 2000 at weighted average
rates of 2.66% and 6.65%, respectively. The decrease in borrowings under
agreements to repurchase over the last three years is due to paydowns of the
underlying mortgage-backed securities.
Borrowings from all sources totaled $1.3 billion, $1.8 billion and $1.9
billion at weighted average rates of 3.63%, 4.74% and 6.46% at December 31,
2002, 2001, and 2000, respectively. Due to the high level of loan payoffs and
the growth in retail branch deposits, no additional borrowings were necessary to
fund asset growth during 2002 or 2001.
The Bank's portfolio of short-term borrowings includes short-term variable
rate credit advances and FHLB advances due in less than one year from the FHLBSF
and securities sold under agreements to repurchase. The following schedule
summarizes short term borrowings for the last three years at December 31:
Maximum
Month-End
Outstanding
Balance
During the
End of Period Period Average
--------------------------- --------------- ----------------------------
Outstanding Rate Outstanding Rate
-------------- --------- ---------------- --------
(Dollars in thousands)
2002
Short-term FHLB advances......... $ 427,000 2.25% $ 885,000 $ 611,000 4.01%
Securities sold under agreements
to repurchase................ 155,273 1.61 208,367 169,335 2.04
2001
Short-term FHLB Advances......... $ 985,000 4.86% $ 987,000 $ 900,895 5.68%
Securities sold under agreements
to repurchase................ 211,040 2.66 294,110 255,747 4.69
2000
Short-term FHLB Advances......... $ 957,000 6.58% $ 1,250,000 $ 1,065,000 6.38%
Securities sold under agreements
to repurchase................ 294,110 6.65 355,995 322,593 6.39
Other Sources of Funds
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Sources of Funds" for a discussion of other funding
sources.
Subsidiaries
The Bank has three wholly-owned subsidiaries: Seaside Financial Corporation
("Seaside"), Oceanside Insurance Agency, Inc. ("Oceanside"), and Santa Monica
Capital Group ("SMCG"), all of which are California corporations. SMCG is an
inactive corporation.
Revenues and operating results of these subsidiaries accounted for less
than 1% of consolidated revenues in 2002 and no material change is presently
foreseen.
16
Real Estate Development Activities. Seaside has not been involved in any
real estate development activity for the last several years and there are no
plans for future real estate projects. No gains or losses on real estate
development activities were recorded during 2001 or 2000. A gain of $142
thousand was recognized during 2002 on the sale of assets from a 100% owned real
estate partnership. Seaside, from time to time, will purchase individual
properties for investment and sell them for a gain. Income from this activity
totaled $285 thousand during 2001 and $590 thousand during 2000. There was no
income from the sale of investment properties during 2002.
Seaside continues to hold one condominium unit, which is rented to the Bank
for use by its employees. At December 31, 2002, Seaside's investment in the
remaining unit totaled $28 thousand. There were no loans outstanding against the
property at December 31, 2002. The unit is located in Southern California.
Trustee Activities. Seaside acts as trustee on the Bank's deeds of trust.
Trustee fees for this activity amounted to $56 thousand, $86 thousand and $65
thousand in 2002, 2001 and 2000, respectively.
Insurance Brokerage Activities. Oceanside engages in limited insurance
agent activities. Income to date from this source has been insignificant.
Oceanside operates as a licensed life insurance agent for the purpose of
receiving commissions on the sale of fixed and variable rate annuities and
mutual funds conducted in the Bank's offices by a licensed third party vendor,
Invest Financial Corporation, a registered broker-dealer. Invest conducts its
sales activities in the Bank's branch offices and the Bank receives a percentage
of the commissions on such sales through its licensed insurance agency,
Oceanside. During 2002, 2001 and 2000, Oceanside received commission income of
$456 thousand, $231 thousand and $290 thousand, respectively, from the sale of
non-insured investment products. Additionally, Oceanside receives insurance
commissions from the sale of insurance to its borrowers. Commissions received
from this activity totaled $35 thousand in 2001 and $444 thousand in 2000.
Commission rebates totaling $64 thousand were paid during 2002. The decrease in
premiums during 2002 and 2001 resulted from rebates of previously earned
commissions when interim lender-placed policies were replaced by permanent
policies obtained by borrowers.
Employees
As of December 31, 2002, the Bank had a total of 497 full time equivalent
employees, including 119 part-time employees. No employees were represented by a
collective bargaining group. At present, the Company has no employees who are
not also employees of the Bank. The Bank provides its regular full-time
employees with a comprehensive benefits program that includes basic and major
medical insurance, long-term disability coverage, sick leave, a 401(k) plan and
a profit sharing employee stock ownership plan. The Bank considers its employee
relations to be excellent.
Summary of Material Legislation and Regulations
General. FFC, as a savings and loan holding company, is registered with and
subject to regulation and examination by the OTS. The Bank, which is a federally
chartered savings bank and a member of the FHLBSF, is subject to regulation and
examination by the OTS with respect to most of its business activities,
including, among others, lending activities, capital standards, general
investment authority, deposit taking and borrowing authority, mergers and other
business combinations, establishment of branch offices, and permitted subsidiary
investments and activities. The Bank's deposits are insured by the FDIC through
the Savings Association Insurance Fund ("SAIF"). As insurer, the FDIC is
authorized to conduct examinations of the Bank. The Bank is also subject to
Federal Reserve Board regulations concerning reserves required to be maintained
against deposits.
As a member of the FHLB System, the Bank is required to own capital stock
in its regional FHLB, the FHLBSF, in an amount at least equal to the greater of
1% of the aggregate principal amount of its unpaid residential mortgage loans,
home purchase contracts and similar obligations at the end of each year, or 5%
of its outstanding borrowings from the FHLBSF. The Bank was in compliance with
this requirement, with an investment of $78.7 million in FHLBSF stock at
December 31, 2002.
The FHLBSF serves as a source of liquidity for the member institutions
within its assigned region, the FHLB Eleventh District. It is funded primarily
from proceeds derived from the sale of consolidated obligations of the FHLB
System. It makes advances to members in accordance with policies and procedures
established by the Federal Housing Finance Board and the Board of Directors of
the FHLBSF. At December 31, 2002, the Bank's advances from the FHLBSF amounted
to $1.2 billion, or 30% of the Company's total funding sources (deposits and
borrowings).
The FHLBs are required to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low and moderate income housing projects. These contributions have adversely
affected the level of dividends that the FHLBs have paid to its members. These
contributions also could have an adverse effect on the value of FHLB stock in
the future. For the year ended December 31, 2002, dividends paid by the FHLBSF
to the Bank totaled approximately $4.8 million.
17
Financial Services Modernization Legislation. On November 12, 1999, the
Gramm-Leach-Bliley Act of 1999 (the"Act") was signed into law. The Act made
significant changes to the operations of financial services companies. It
repealed key provisions of the "Glass-Steagall Act" by repealing prohibitions on
affiliations among banks, securities firms and insurance companies. It
authorizes a broad range of financial services to be conducted by these types of
companies within a new structure known as a "financial holding company" ("FHC").
The FHC may engage in a number of activities deemed to be new activities, such
as securities underwriting and dealing activities, insurance underwriting and
sales activities, merchant banking and equity investment activities, and
"incidental" and "complementary" non-financial activities. While the Act
specifies so-called "functional regulation," various federal and state
regulators have continued authority over certain activities of FHCs and other
regulated financial institutions. However, the Federal Reserve Board is the
principal regulator for FHCs. These changes do not directly affect the Company,
although they may dramatically affect the business activities of many of the
Company's financial institution competitors.
Other provisions of the Act also may have an impact on the Company and the
Bank. The Act limits the ability of commercial entities to obtain thrift
charters. Commencing with applications filed on and after May 5, 1999, entities
seeking control of a savings association will be required to conform their
activities to those permitted for financial holding companies. Existing thrift
holding companies that control only one insured institution (such as the
Company) are "grandfathered" with respect to their ability to continue their
activities. However, future sales of the savings institution subsidiary of such
a unitary thrift holding company will be limited to companies and entities that
limit their activities to those permitted for financial holding companies.
The Act establishes a federal right to the confidential treatment of
nonpublic personal information about consumers. These provisions of the Act
require disclosure of privacy policies to consumers and, in some circumstances,
will allow consumers to prevent disclosure of certain personal information to a
nonaffiliated third party. Compliance with the rules was mandatory starting on
July 1, 2001.
These rules affect how consumer information is transmitted through
diversified financial companies and conveyed to outside vendors. Because the
Company does not sell customer information or give customer information to
outside third parties or its affiliates except under very limited circumstances
(e.g., providing customer information to the Company's data processing provider
or to third party providers of financial services under narrow joint marketing
arrangements), the rules have not had a significant impact on the Company's
results of operations or financial condition.
The Act revised the Community Reinvestment Act (the "CRA", as discussed in
more detail below) by, among other things, requiring all insured depository
institution members of a FHC to hold at least a satisfactory CRA rating in order
to conduct new financial activities authorized by the Act.
The Act also significantly amends the Federal Home Loan Bank System, by
modifying membership requirements in regional FHLBs to permit membership to be
voluntary for both thrift and bank members. The Act changed corporate governance
of the FHLBs by eliminating the right of the Federal Housing Finance Board to
select the management of the local FHLBs, and returning that authority to the
boards of directors of the FHLBs. Additionally, the obligations of the FHLBs to
repay federal borrowings to finance the thrift bailout has been restructured
from a fixed dollar amount to a fixed percentage of the FHLBs' annual net
earnings.
Savings and Loan Holding Company Regulations. The activities of savings and
loan holding companies are governed by the Home Owners' Loan Act of 1933, as
amended. Pursuant to that statute, the Company is subject to certain
restrictions with respect to its activities and investments.
A savings and loan holding company, like FFC, which controls only one
savings association, is exempt from restrictions on the conduct of unrelated
business activities that are applicable to savings and loan holding companies
that control more than one savings association. The restrictions on multiple
savings and loan holding companies are similar to the restrictions on the
conduct of unrelated business activities applicable to bank holding companies
under the Bank Holding Company Act. The Company would become subject to these
restrictions if it were to acquire control of another savings association or if
the Bank were to fail to meet its qualified thrift lender ("QTL") test. See
"Qualified Thrift Lender Test."
The OTS may impose restrictions when it has reasonable cause to believe
that the continuation of any particular activity by a savings and loan holding
company constitutes a serious risk to the financial safety, soundness or
stability of such holding company's savings institution. Specifically, the OTS
may, as necessary, (i) limit the payment of dividends by the savings
institution; (ii) limit transactions between the savings institution and its
holding company or its affiliates; and (iii) limit any activities of the savings
institution or the holding company that create a serious risk that the
liabilities of the holding company may be imposed on the savings institution.
Any such limits will be issued in the form of a directive having the effect of a
cease-and-desist order.
18
Regulatory Capital Requirements. The capital regulations of the OTS (the
"Capital Regulations") require federally insured institutions such as the Bank
to meet certain minimum capital requirements. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Capital Resources
and Liquidity - Capital Requirements." The OTS may establish, on a case-by-case
basis, individual minimum capital requirements for a savings institution which
vary from the requirements that would otherwise apply under the Capital
Regulations.
The OTS has adopted rules based upon five capital tiers: well-capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized, and
critically undercapitalized. An institution falls into one of these
classifications depending primarily on its capital ratios. The Bank is
considered to be "well capitalized" for purposes of these capital measures.
Insurance of Accounts. The FDIC administers two separate deposit insurance
funds. The Bank Insurance Fund ("BIF") insures the deposits of commercial banks
and other institutions that were insured by the FDIC prior to the enactment of
the Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA"). The SAIF insures the deposits of savings institutions which were
insured by the Federal Savings and Loan Insurance Corporation ("FSLIC") prior to
the enactment of FIRREA. The Bank's deposits are insured by the SAIF. The FDIC
is authorized to increase deposit insurance premiums if it determines such
increases are appropriate to maintain the reserves of either the SAIF or the BIF
or to fund the administration of the FDIC. In addition, the FDIC is authorized
to levy emergency special assessments on BIF and SAIF members.
The FDIC has implemented a risk-based assessment system, under which an
institution's deposit insurance assessment is based on the probability that the
deposit insurance fund will incur a loss with respect to the institution, the
likely amount of any such loss, and the revenue needs of the deposit insurance
fund. Under the risk-based assessment system, a savings institution is
categorized into one of three capital categories: well capitalized, adequately
capitalized, and undercapitalized. A savings institution is also assigned to one
of three supervisory subgroup categories based on examinations by the OTS.
The FDIC may terminate the deposit insurance of any insured depository if
the FDIC determines, after a hearing, that the institution has engaged or is
engaging in unsafe or unsound practices, is in an unsafe or unsound condition to
continue operations or has violated any applicable law, regulation or order or
any condition imposed in writing by the FDIC. The FDIC may also suspend deposit
insurance temporarily during the hearing process if the institution has no
tangible capital. In addition, FDIC regulations provide that any insured
institution that falls below a 2% minimum leverage ratio will be subject to FDIC
deposit insurance termination proceedings unless it has submitted, and is in
compliance with, a capital plan with its primary federal regulator and the FDIC.
The OTS also imposes assessments and examination fees on savings
institutions. OTS assessments for the Bank were $708 thousand in 2002, $653
thousand in 2001 and $568 thousand in 2000.
Liquidity. In July 2001, the OTS revised its liquidity regulations to
require a savings institution to maintain sufficient liquidity to ensure its
safe and sound operation. The determination of what constitutes safe and sound
operation was left to the discretion of management. For several years it has
been the Bank's strategy to keep cash and liquid investments at a modest level
due to availability of substantial credit lines. After the repeal of the
liquidity regulation, the Bank's liquidity policy was modified to include unused
borrowing capacity in the definition of available liquidity. The Bank's current
liquidity policy requires that cash and cash equivalents, short-term investments
and unused borrowing capacity be maintained at a minimum level of 10% of the
Bank's liquidity base (defined as deposits and borrowings due within one year).
At December 31, 2002, liquidity-qualifying balances were 27.1% of the Bank's
liquidity base.
Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires
each savings institution, as well as commercial banks and certain other lenders,
to identify the communities served by the institution's offices and to identify
the types of credit the institution is prepared to extend within those
communities. The CRA also requires the OTS to assess an institution's
performance in meeting the credit needs of its identified communities as part of
its examination of the institution, and to take such assessments into
consideration in reviewing applications with respect to branches, mergers and
other business combinations, including acquisitions by savings and loan holding
companies. An unsatisfactory CRA rating may be the basis for denying such an
application and community groups have successfully protested applications on CRA
grounds. In connection with its assessment of CRA performance, the OTS assigns
CRA ratings of "outstanding," "satisfactory," "needs to improve" or "substantial
noncompliance." The Bank was rated "satisfactory" in its last CRA examination,
which was conducted in 2000. Institutions are evaluated based on: (i)
performance in lending in their assessment areas; (ii) the provision of deposit
and other community services in their assessment areas; and (iii) the investment
in housing-related and other qualified community investments. An institution
that is found to be deficient in its performance in meeting its community's
credit needs may be subject to enforcement actions, including cease and desist
orders and civil money penalties.
19
Restrictions on Dividends and Other Capital Distributions. Current OTS
regulations require that savings institutions controlled by savings and loan
holding companies (such as the Bank) file a 30-day advance notice of a proposed
capital distribution. The OTS may disapprove a notice if it finds that (a) the
savings association will be undercapitalized, significantly undercapitalized or
critically undercapitalized following the distribution, (b) the proposed capital
distribution raises safety and soundness concerns; or (c) the proposed
distribution violates a prohibition contained in an statute, regulation or
agreement between the savings institution and the OTS (or FDIC) or a condition
imposed by an OTS approval. The regulations also require a 30-day advance notice
to be filed for proposed capital distributions that would result in the savings
institution being less than well-capitalized or that involve the reduction or
retirement of the savings institution's stock. During 2002, the Bank paid a
total of $20.0 million in capital distributions to the Company. No capital
distributions were made to the Company during 2001.
Limits on Types of Loans and Investments. Federal savings institutions are
authorized, without quantitative limits, to make loans on the security of liens
upon residential real property and to invest in a variety of instruments such as
obligations of, or fully guaranteed as to principal and interest by, the United
States; stock or bonds of the FHLB; certain mortgages, obligations, or other
securities which have been sold by FHLMC or FNMA; and certain securities issued
by, or fully guaranteed as to principal and interest by, the Student Loan
Marketing Association and the Government National Mortgage Association. Certain
other types of loans or investments may be acquired subject to quantitative
limits: secured or unsecured loans for commercial, corporate, business, or
agricultural purposes, loans on the security of liens upon nonresidential real
property, investments in personal property, consumer loans and certain
securities such as commercial paper and corporate debt, and construction loans
without security.
Savings institutions are subject to the same loans-to-one borrower ("LTOB")
restrictions that are applicable to national banks, with limited provisions for
exceptions. In general, the national bank standard restricts loans to a single
borrower to no more than 15% of a bank's unimpaired capital and surplus, plus an
additional 10% if the loan is collateralized by certain readily marketable
collateral. The Bank's loans were within the LTOB limitations at December 31,
2002.
Savings institutions and their subsidiaries are prohibited from acquiring
or retaining any corporate debt security that, at the time of acquisition, is
not rated in one of the four highest rating categories by at least one
nationally recognized statistical rating organization. The Bank has no
impermissible equity investments in its investment portfolio.
Safety and Soundness Standards. OTS regulations contain "safety and
soundness" standards covering various aspects of the operations of savings
institutions. The guidelines relate to internal controls and internal audit
systems, information systems, loan documentation, credit underwriting, interest
rate exposure, asset growth, executive compensation, maximum ratios of
classified assets to capital, and minimum earnings sufficient to absorb losses
without impairing capital. If the OTS determines that a savings institution has
failed to meet the safety and soundness standards, it may require the
institution to submit to the OTS, and thereafter comply with, a compliance plan
acceptable to the OTS describing the steps the institution will take to attain
compliance with the applicable standard and the time within which those steps
will be taken.
Federal regulations contain a number of measures intended to promote early
identification of management problems at depository institutions and to ensure
that regulators intervene promptly to require corrective action by institutions.
The Bank's annual management report on the effectiveness of internal control
standards and compliance with certain designated laws will be made available in
March of 2003.
Prompt Corrective Action. The "prompt corrective action" regulations
require insured depository institutions to be classified into one of five
categories based primarily upon capital adequacy, ranging from "well
capitalized" to "critically undercapitalized." These regulations require,
subject to certain exceptions, the appropriate federal banking agency to take
"prompt corrective action" with respect to an institution which becomes
"undercapitalized" and to take additional actions if the institution becomes
"significantly undercapitalized" or "critically undercapitalized."
Only "well capitalized" institutions may obtain brokered deposits without a
waiver. An "adequately capitalized" institution can obtain brokered deposits
only if it receives a waiver from the FDIC. An "undercapitalized" institution
may not accept brokered deposits under any circumstances. The Bank met the
"well-capitalized" standards during 2002 and was eligible to accept brokered
deposits without a waiver.
Qualified Thrift Lender Test. In general, the QTL test requires that 65% of
an institution's portfolio assets be invested in "qualified thrift investments"
(primarily loans, securities and other investments related to housing), measured
on a monthly average basis for nine out of every 12 months on a rolling basis.
Any savings institution that fails to meet the QTL test must either convert to a
bank charter or become subject to national bank-type restrictions on branching,
business activities, and dividends, and its ability to obtain FHLB advances is
affected. The Bank met the QTL test at December 31, 2002, with 92% of its
portfolio assets comprised of "qualified thrift investments."
20
Transactions with Affiliates. Federal savings institutions are subject to
the provisions of Sections 23A and 23B of the Federal Reserve Act. Section 23A
restricts loans or extensions of credit to, or investments in, or certain other
transactions with, affiliates and as to the amount of advances to third parties
collateralized by the securities or obligations of affiliates. Section 23B
generally requires that transactions with affiliates must be on a
non-preferential basis. Federal savings institutions may not make any extension
of credit to an affiliate which is engaged in activities not permitted by bank
holding companies, and may not invest in securities issued by an affiliate
(except with respect to a subsidiary). The Company is an "affiliate" of the Bank
for the purposes of these provisions.
Transactions with Insiders. Federal savings institutions are subject to the
restrictions of Sections 22(g) and (h) of the Federal Reserve Act which, among
other things, restrict the amount of extensions of credit which may be made to
executive officers, directors, certain principal shareholders (collectively
"insiders"), and to their related interests. When lending to insiders, a savings
association must follow credit underwriting procedures that are not less
stringent than those applicable to comparable transactions with persons outside
the association. The amount that a savings association can lend in the aggregate
to insiders (and to their related interests) is limited to an amount equal to
the association's core capital and surplus. Insiders are also prohibited from
knowingly receiving (or knowingly permitting their related interests to receive)
any extensions of credit not authorized under these statutes.
Federal Reserve System. Federal Reserve Board regulations require savings
institutions to maintain non-interest bearing reserves against their transaction
accounts. The reserve for transaction accounts as of December 31, 2002 was 0% of
the first $5.5 million of such accounts, 3% of the next $35.6 million of such
accounts and 10% (subject to adjustment by the Federal Reserve Board between 8%
and 14%) of the balance of such accounts. The Bank is in compliance with these
requirements as of December 31, 2002.
Taxation. The Company, the Bank and its subsidiaries file a consolidated
federal income tax return on a calendar year basis using the accrual method. The
maximum marginal federal tax rate is currently 35%.
The Bank is required to use the specific charge-off method of accounting
for bad debts for federal income tax purposes all periods beginning after 1995.
Prior to that date, the Bank used the reserve method of accounting for bad
debts. The Consolidated Statements of Financial Condition at December 31, 2002
and 2001 do not include a tax liability of $5,356,000 related to the adjusted
base year bad debt reserve. The bad debt reserve was created when the Bank was
on the reserve method.
These reserves are subject to recapture if: (1) the Bank fails to qualify
as a "bank" for federal income tax purposes; (2) certain distributions are made
with respect to the stock of the Bank; (3) the bad debt reserves are used for
any purpose other than to absorb bad debt losses; or (4) there is a change in
federal tax law. Management does not expect any of these events to occur.
To the extent that distributions by the Bank to the Company that are
permitted under federal regulations exceed the Bank's earnings and profits (as
computed for federal income tax purposes), such distributions would be treated
for tax purposes as being made out of the Bank's base year reserve and would
thereby constitute taxable income to the Bank in an amount equal to the lesser
of the Bank's base year reserve or the amount which, when reduced by the amount
of income tax attributable to the inclusion of such amount in gross income, is
equal to the amount of such distribution. At December 31, 2002, the Bank's
earnings and profits (as computed for federal income tax purposes) were
approximately $392.6 million.
Prior to December 31, 2002, the Bank made additions to its state tax bad
debt reserves in amounts necessary to "fill up" to its tax reserve balance
calculated using the experience method. On September 11, 2002, the Governor of
the State of California approved legislation conforming state tax to federal tax
law with regard to the method of accounting for bad debts used by banks. This
legislation, which was effective immediately, also provided that one-half of a
bank's reserve for bad debts as of December 31, 2002 would never be subject to
state taxes. Any tax benefit resulting from this legislation will be recorded
upon agreement by the Bank and the Franchise Tax Board (the "FTB") on the Bank's
reserve balance.
At December 31, 2002, the Bank had $47.0 million in gross deferred tax
assets. No valuation allowance was established because management believes that
it is more likely than not that the deferred tax assets will be realized. Gross
deferred tax liabilities totaled $33.5 million at December 31, 2002.
21
The Bank is subject to an alternative minimum tax if such tax is larger
than the tax otherwise payable. Generally, alternative minimum taxable income is
a taxpayer's regular taxable income, increased by the taxpayer's tax preference
items for the year and adjusted by computing certain deductions utilizing a
methodology that negates the acceleration of such deductions under the regular
tax. The adjusted income is then reduced by an exemption amount and is subject
to tax at a 20% rate. No alternative minimum taxes were applicable to the Bank
for tax years 2002, 2001 or 2000.
California tax laws generally conform to federal tax laws. For California
franchise tax purposes, federal savings banks are taxed as "financial
corporations" at a rate 2% higher than that applicable to non-financial
corporations because of exemptions from certain state and local taxes. The tax
rate for 2002, 2001 and 2000 was 10.84%.
The Internal Revenue Service ("IRS") has examined the Company's
consolidated federal income tax returns for tax years up to and including 1996.
The adjustments proposed by the IRS were primarily related to temporary
differences as to the recognition of certain taxable income and expense items.
While the Company had provided for deferred taxes for federal and state
purposes, the change in the period of recognition of certain income and expense
items resulted in interest due to the IRS and the FTB. Interest accruals of
$876,000 and $300,000 were recorded during 2002 and 2001, respectively for
interest on amended returns. Interest accruals totaling $350,000 were reversed
during 2000. The balance of accrued interest payable for amended returns was
$700,000 and $300,000 as of December 31, 2002 and December 31, 2001,
respectively. There was no balance of accrued interest payable for amended
returns as of December 31, 2000.
Recent and Proposed Legislation and Regulation. In January 2001, the four
federal banking agencies jointly issued expanded examination and supervision
guidance relating to subprime lending activities. In the guidance, "subprime"
lending generally refers to programs that target borrowers with weakened credit
histories or lower repayment capacity. The guidance principally applies to
institutions with subprime lending programs with an aggregate credit exposure
equal to or greater than 25 percent of an institution's Tier 1 capital. Such
institutions would be subject to more stringent risk management standards and,
in many cases, additional capital requirements. Based on current lending
programs, management of the Bank does not expect there to be any material impact
on the conduct of its business as a result of the guidance.
In December 2001, the Federal Reserve Board published final regulations
implementing the Home Ownership and Equity Protection Act ("HOEPA"). Compliance
with the regulations was mandatory as of October 1, 2002. HOEPA imposes
additional disclosure requirements and limitations on certain mortgage loans
with rates or fees above specified levels. The regulations lower the rate levels
that trigger the application of HOEPA and include additional fees in the
calculation of the fee amount that triggers HOEPA. Currently, the loans the Bank
makes are below the rate and fee levels that trigger HOEPA.
Effective July 1, 2002, the OTS issued a number of changes to its capital
regulations. Under these new rules, a one-to-four family residential first
mortgage loan may qualify for a 50 percent risk weight if it meets certain
criteria, including a loan-to-value ("LTV") ratio below 90 percent. Currently
these loans must have an LTV ratio of 80 percent or less to qualify for the 50
percent risk weighting. The OTS has also eliminated the requirement that a
thrift institution must deduct from total capital that portion of a land loan or
a nonresidential construction loan in excess of an 80 percent LTV ratio and has
eliminated the interest rate risk component of the risk-based capital
regulations. These changes, while positive, do not have a material effect on the
Bank's operations.
On November 29, 2001 the banking agencies issued a final rule that changed
regulatory capital standards to address the treatment of recourse obligations,
residual interests and direct credit substitutes that expose banking
organizations to credit risk. The final rule treats recourse obligations and
direct credit substitutes more consistently than the agencies' prior risk-based
capital standards and adds new standards for the treatment of residual
interests, including a concentration limit for credit-enhancing interest-only
"carve-out" investment instruments. In addition, the agencies allow the use of
credit ratings and certain alternative approaches to match the risk-based
capital requirement more closely to a banking organization's relative risk of
loss for certain positions in asset securitizations. The final rule was
effective on January 1, 2002. There has been no significant impact on the Bank
as a result of this rule.
On October 26, 2001, President Bush signed into law the USA PATRIOT Act
("Patriot Act"). The Patriot Act includes numerous provisions designed to fight
international money laundering and to block terrorist access to the U.S.
financial system. Implementation of regulations to implement the Act have been
postponed by the Department of the Treasury, which has required additional time
to study certain industries for implementation of anti-money laundering
regulations. However, it is not anticipated that adoption of the regulations as
presently proposed will have a significant adverse impact on the Bank's
operations.
22
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of
2002 ("Sarbanes-Oxley"), which implemented legislative reforms intended to
address corporate and accounting fraud. Sarbanes-Oxley contains reforms of
various business practices and numerous aspects of corporate governance.
Although a number of these requirements have been implemented, a large number of
proposed and final rules are expected to be issued in 2003 and beyond. The
following is a summary of certain key provisions of Sarbanes-Oxley.
In addition to the establishment of a new accounting oversight board that
will enforce auditing, quality control and independence standards and will be
funded by fees from all publicly traded companies, Sarbanes-Oxley places
restrictions on the scope of services that may be provided by accounting firms
to their public company audit clients. Any non-audit services being provided to
a public company audit client will require pre-approval by the company's audit
committee. In addition, Sarbanes-Oxley makes certain changes to the requirements
for partner rotation after a period of time. Sarbanes-Oxley requires chief
executive officers and chief financial officers, or their equivalent, to certify
to the accuracy of periodic reports filed with the SEC, subject to civil and
criminal penalties if they knowingly or willingly violate this certification
requirement. In addition, counsel will be required to report evidence of a
material violation of the securities laws or a breach of fiduciary duty to its
chief executive officer or its chief legal officer, and, if such officer does
not appropriately respond, to report such evidence to the audit committee or
other similar committee of the board of directors or the board itself.
Under this new law, longer prison terms will apply to corporate executives
who violate federal securities laws; the period during which certain types of
suits can be brought against a company or it is officers is extended; and
bonuses issued to top executives prior to restatement of a company's financial
statements are now subject to disgorgement if such restatement was due to
corporate misconduct. Executives are also prohibited from insider trading during
retirement plan "blackout" periods, and loans to company executives (other than
loans by financial institutions permitted by federal rules or regulations) are
restricted. In addition, the legislation accelerates the time frame for
disclosures by public companies, as they must immediately disclose any material
changes in their financial condition or operations. Directors and executive
officers reporting most changes in ownership in a company's securities must now
report within two business days of the change.
Sarbanes-Oxley also increases responsibilities and codifies certain
requirements relating to audit committees of public companies and how they
interact with the company's "registered public accounting firm." Audit committee
members must be independent and are barred from accepting consulting, advisory
or other compensatory fees from the issuer. In addition, companies will be
required to disclose whether at least one member of the committee is a
"financial expert" (as such term will be defined by the SEC) and if not, why
not. A company's registered public accounting firm will be prohibited from
performing statutorily mandated audit services for a company if the company's
chief executive officer, chief financial officer, controller, chief accounting
officer or any person serving in equivalent positions had been employed by such
firm and participated in the audit of such company during the one-year period
preceding the audit initiation date. Sarbanes-Oxley also prohibits any officer
or director of a company or any other person acting under their direction from
taking any action to fraudulently influence, coerce, manipulate or mislead any
independent public or certified accountant engaged in the audit of the company's
financial statements for the purpose of rendering the financials statements
materially misleading.
Sarbanes-Oxley also requires the SEC to prescribe rules requiring inclusion
of any internal control report and assessment by management in the annual report
to stockholders. The law requires the company's registered public accounting
firm that issues the audit report to attest to and report on management's
assessment of the company's internal controls.
Although the Company anticipates that it will incur additional expense in
complying with the provisions of Sarbanes-Oxley and the resulting regulations,
management does not expect that such compliance will have a material impact on
the Company's financial condition or results of operations.
23
ITEM 2 -- PROPERTIES
At December 31, 2002, the Bank owned the building and the land for eight of
its branch offices, owned the building but leased the land for two additional
offices, and leased its remaining offices. Properties leased by the Bank include
its home and executive offices located in a 12-story office tower in downtown
Santa Monica and a general services and corporate operations office building in
Santa Monica. For information concerning rental obligations, see Note 6 of the
Notes to Consolidated Financial Statements.
ITEM 3 -- LEGAL PROCEEDINGS
The Company is involved as a plaintiff or defendant in various legal
actions incident to its business, none of which are believed by management to be
material to the Company.
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5 -- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market Information. The Company's common stock is traded on the New
York Stock Exchange ("NYSE") under the symbol "FED." Included in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" is a
chart representing the range of high and low stock prices for the Company's
common stock for each quarterly period for the last five years.
(b) Holders. As of February 7, 2003, 16,910,212 shares of Company common
stock, representing approximately 792 record stockholders, were outstanding,
which total does not include the number of stockholders whose shares are held in
street name.
(c) Dividends. As a publicly traded company, the Company has no history of
dividend payments on its common stock. However, the Company may in the future
adopt a policy of paying dividends, depending on its net earnings, financial
position and capital requirements, as well as regulatory restrictions, tax
consequences and the ability of the Company to obtain a dividend from the Bank
for payment to stockholders. OTS regulations limit amounts that the Bank can pay
as a capital distribution to the Company. No such distribution may be made if
the Bank's net worth falls below regulatory requirements. (See "Business -
Summary of Material Legislation and Regulations" for other regulatory capital
distributions.) The Board of Directors of the Bank declared and paid to the
Company $20.0 million during 2002 and $10.0 million during 2000. No capital
distributions to the Company were made during 2001. The distributions made
during 2002 were for the purpose of repurchasing 353,000 shares of Company
common stock. The distributions made during 2000 were for the purpose of
repurchasing 821,500 shares of Company common stock.
(d) Securities authorized for issuance under equity compensation plans.
Information appearing on page 12 of the Proxy Statement is incorporated herein
by reference.
24
ITEM 6 -- SELECTED FINANCIAL DATA
Selected financial data for the Company is presented below:
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
FIVE YEAR CONSOLIDATED SUMMARY OF OPERATIONS
2002 2001 2000 1999 1998
------------ ------------- ------------- ----------- ------------
(Dollars in thousands, except per share data)
For the Year Ended December 31:
Interest income..........................$ 263,878 $ 333,932 $ 314,320 $ 260,001 $ 289,769
Interest expense......................... 128,419 201,754 206,505 161,031 186,491
Net interest income...................... 135,459 132,178 107,815 98,970 103,278
Provision for loan losses................ -- -- -- -- 7,200
Other income............................. 18,074 8,919 7,747 12,688 13,657
Non-interest expense..................... 58,212 53,174 48,265 49,159 48,924
Earnings before income taxes............. 95,321 87,923 67,297 62,499 60,811
Income taxes............................. 40,149 37,621 28,832 27,052 26,182
Earnings before extraordinary items...... 55,172 50,302 38,465 35,447 34,629
Extraordinary item loss on early
extinguishment of debt, net of taxes..... -- -- -- (2,195) --
Net earnings............................. 55,172 50,302 38,465 33,252 34,629
Basic earnings per share:
EPS before extraordinary item............ 3.22 2.92 2.23 1.84 1.63
Extraordinary item....................... -- -- -- (0.11) --
EPS after extraordinary item............. 3.22 2.92 2.23 1.73 1.63
Dilutive earnings per share:
EPS before extraordinary item............ 3.15 2.85 2.20 1.83 1.60
Extraordinary item....................... -- -- -- (0.12) --
EPS after extraordinary item............. 3.15 2.85 2.20 1.71 1.60
End of Year:
Loans receivable, net (1)................ 3,769,235 4,004,889 3,629,284 3,060,547 2,808,221
Mortgage-backed securities............... 200,585 284,079 374,405 428,641 556,679
Investment securities.................... 103,055 110,444 136,537 151,195 64,333
Total assets............................. 4,253,729 4,726,289 4,365,242 3,872,051 3,677,128
Deposits................................. 2,527,026 2,546,647 2,165,047 2,061,357 2,135,909
Borrowings............................... 1,322,273 1,808,040 1,873,110 1,532,635 1,235,172
Liabilities.............................. 3,882,088 4,400,611 4,097,800 3,640,918 3,420,128
Stockholders' equity..................... 371,641 325,678 267,442 231,133 257,000
Book value per share(2).................. 21.95 18.88 15.52 12.82 12.16
Tangible book value per share............ 21.40 18.14 14.98 12.78 12.10
Selected Ratios:
Return on average assets................. 1.24% 1.10% 0.93% 0.94% 0.88%
Return on average equity................. 15.82% 16.93% 15.85% 14.91% 14.40%
Ratio of non-performing
assets to total assets................ 0.17% 0.17% 0.19% 0.40% 0.84%
Other Data:
Number of Bank full service branches.......
29 29 25 24 24
(1) Includes loans held for sale.
(2) All per share amounts have been adjusted for the two-for-one stock split
declared June 25, 1998.
Also see summarized results of operations on a quarterly basis for 2002,
2001 and 2000 in Note 15 of the Notes to Consolidated Financial Statements.
25
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
The Company's results of operations are primarily affected by its levels of
net interest income, provisions for loan losses, non-interest income,
non-interest expense and income taxes. The Company's results are strongly
influenced by the Southern California economy in which it operates and the
direction and level of general market interest rates.
Net earnings of $55.2 million or $3.15 per diluted share were recorded in
2002, compared to net earnings of $50.3 million or $2.85 per diluted share in
2001 and net earnings of $38.5 million or $2.20 per diluted share in 2000.
The increase in net earnings from 2001 to 2002 was primarily due to an
increase in net interest income as a result of improved interest rate spreads
and income before tax of $5.9 million resulting from a revised estimate of the
Bank's repurchase liability for loans sold with recourse. The increase in net
earnings from 2000 to 2001 was primarily due to higher net interest income,
which resulted from growth in average interest-earning assets and improved
interest rate spreads.
No loan loss provision was recorded in 2002, 2001 or 2000. The Southern
California real estate market has improved over the last few years. As a result,
the Bank recorded net loan loss recoveries of $950 thousand in 2002, $118
thousand in 2001 and $51 thousand in 2000.
Certain key financial ratios for the Company are presented below:
Year Ended December 31,
-----------------------------------------
Average
Return on Return on Equity to
Average Average Average
Assets Equity Assets
----------- ----------- ------------
2002.............................................. 1.24% 15.82% 7.83%
2001.............................................. 1.10 16.93 6.52
2000.............................................. .93 15.85 5.85
1999.............................................. .94 14.91 6.29
1998.............................................. .88 14.40 6.09
Non-performing assets (primarily loans 90 days past due or in foreclosure
plus foreclosed real estate) decreased to $7.0 million or 0.17% of total assets
as of December 31, 2002 from $7.9 million or 0.17% of total assets as of
December 31, 2001 and $8.3 million or 0.19% of total assets at December 31,
2000. The decreasing amount of real estate owned over the last several years is
due to lower balances of delinquent loans and decreased foreclosures in the
improved Southern California real estate markets.
The Company repurchased common shares totaling 353,000 and 821,500 during
2002 and 2000, respectively. No shares were purchased during 2001. As of
February 7, 2003, 1,348,677 shares remain eligible for repurchase under the
Company's authorized repurchase program.
At December 31, 2002 the Bank's regulatory risk-based capital ratio was
14.53% and it's tangible and core capital ratios were 8.05%. The Bank met the
regulatory capital standards necessary to be deemed "well-capitalized" at
December 31, 2002.
The Bank's deposits are insured by the SAIF up to a maximum of $100,000 for
each insured depositor. The Bank's FDIC insurance premiums were $438 thousand
during 2002, $418 thousand during 2001 and $538 thousand during 2000. The
increase in premiums from 2001 to 2002 was the result of growth in deposits. The
decrease in premiums from 2001 to 2000 was the result of a drop in the deposit
insurance assessment rate.
26
Risks and Uncertainties
In the normal course of business, the Company encounters two significant
types of risk: economic risk and regulatory risk.
ECONOMIC RISK
There are two main components of economic risk: credit risk and market risk
(which includes interest rate risk.)
Credit Risk
Credit risk is the risk of default in the Company's loan portfolio that
results from a borrower's inability to make contractually required payments. See
"Loss Provision" and "Non-performing Assets."
The determination of the allowance for loan losses and the valuation of
real estate collateral are based on estimates that are susceptible to changes in
the economic environment and market conditions. No loan loss provision was
recorded during 2002. A downward turn in the current economic climate or real
estate market could increase the likelihood of losses due to credit risks. This
could create the need for additional loan loss provisions.
Market Risk
Market risk is the risk of loss from unfavorable changes in market prices
and interest rates. The Bank's market risk arises primarily from the interest
rate risk inherent in its lending and deposit taking activities. Should there be
an economic or market downturn or if market interest rates increase
significantly, the Bank could experience a material increase in the level of
loan defaults and charge-offs.
See "Asset-Liability Management" in "Quantitative and Qualitative
Disclosures About Market Risk" for additional information relating to market
risk.
REGULATORY RISK
Regulatory risk is the risk that the regulators will reach different
conclusions than management regarding the financial position of the Company. The
OTS examines the Bank's financial results annually. The OTS reviews the
allowance for loan losses and may require the Bank to adjust the allowance based
on information available at the time of their examination.
OTHER RISKS
Inflation
Inflation substantially impacts the financial position and operations of
financial intermediaries, such as banks and savings institutions. These entities
primarily hold monetary assets and liabilities and, as such, can experience
significant purchasing power gains and losses over relatively short periods of
time. In addition, interest rate changes during inflationary periods change the
amounts and composition of assets and liabilities held by financial
intermediaries and could result in regulatory pressure for increasing the Bank's
capital.
Pending Lawsuits
The Bank has been named as a defendant in various lawsuits, none of which
is expected to have a materially adverse effect on the Company.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the financial condition and results of
operations are based upon the consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets and liabilities at the date of the financial statements. Actual results
may differ from these estimates under different assumptions or conditions.
Accounting for the allowances for loan losses involves significant
judgments and assumptions by management which have a material impact on the
carrying value of net loans receivable. Management considers the accounting for
loan valuation allowances to be a critical accounting policy. The judgments and
assumptions used by management are based on historical experience and other
factors, which are believed reasonable under the circumstances as described in
the "Business - Loan Loss Allowance" section.
27
COMPONENTS OF EARNINGS
Net Interest Income
Net interest income is the primary component of the Company's earnings. The
chief determinants of net interest income are the dollar amounts of
interest-earning assets and interest-bearing liabilities and the interest rates
earned or paid thereon. The greater the excess of average interest-earning
assets over average interest-bearing liabilities, the more beneficial the impact
on net interest income. The excess of average interest-earning assets over
average interest-bearing liabilities was $229.2 million in 2002, $179.2 million
in 2001 and $148.2 million in 2000. The increase over the last three years was
due to accumulated earnings.
The Company's net interest income is impacted by a time lag before changes
in the cost of funds can be passed along to monthly adjustable rate loan
customers. Savings and borrowing costs adjust to market rates immediately while
it takes several months for the loan yield to adjust. This time lag decreases
the Company's net interest income during periods of rising interest rates. The
reverse is true during periods of declining interest rates. See "Asset-Liability
Management" in "Quantitative and Qualitative Disclosures About Market Risk" for
further discussion.
The following table sets forth the components of interest-earning assets
and liabilities, the excess of interest-earning assets over interest-bearing
liabilities, the yields earned and rates paid and net interest income for the
periods indicated:
At or for the Year Ended December 31,
----------------------------------------
2002 2001 2000
---------- ----------- -----------
(Dollars in thousands)
Average loans and mortgage-backed securities (1).................... $ 4,091,852 $ 4,181,554 $ 3,793,351
Average investment securities....................................... 172,996 200,807 176,476
---------- ----------- -----------
Average interest-earning assets..................................... 4,264,848 4,382,361 3,969,827
---------- ----------- -----------
Average deposits.................................................... 2,517,366 2,317,744 2,132,927
Average borrowings.................................................. 1,518,283 1,885,426 1,688,738
---------- ----------- -----------
Average interest-bearing liabilities................................ 4,035,649 4,203,170 3,821,665
---------- ----------- -----------
Excess of interest-earning assets over interest-bearing liabilities. $ 229,199 $ 179,191 $ 148,162
========== =========== ===========
Yields earned on average interest-earning assets.................... 6.08% 7.50% 7.77%
Rates paid on average interest-bearing liabilities.................. 3.16 4.79 5.40
Interest rate spread................................................ 2.92 2.71 2.37
Effective net spread................................................ 3.09 2.90 2.57
Total interest income............................................... $ 259,303 $ 328,679 $ 308,487
Total interest expense.............................................. 127,526 201,420 206,473
---------- ----------- -----------
131,777 127,259 102,014
Total other income (2).............................................. 3,682 4,919 5,801
---------- ----------- -----------
Net interest income................................................. $ 135,459 $ 132,178 $ 107,815
========== =========== ===========
(1) Non-accrual loans were included in the average dollar amount of loans
outstanding, but no income was recognized during the
period that each such loan was on non-accrual status.
(2 ) Includes dividends on FHLB stock and other miscellaneous items.
The Bank's interest rate spread increased by 21 basis points in 2002
compared to 2001 because the yield on earning assets declined by only 142 basis
points while the cost of funds fell by 163 basis points due to the low interest
rate environment throughout the year. The Bank's cost of funds is immediately
impacted by decreases in interest rates while the yield on earning assets
responds more slowly to changes in interest rates due to the three month time
lag inherent in the COFI-based adjustable rate loan portfolio. The Bank's
interest rate spread increased by 34 basis points in 2001 compared to 2000
because the yield on earning assets declined by only 27 basis points while the
cost of funds fell by 61 basis points in response to rate cuts by the Federal
Reserve Bank.
28
The table below sets forth certain information regarding changes in the
interest income and interest expense of the Bank for the periods indicated. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in average balance multiplied by old rate) and (ii) changes in rates
(changes in rate multiplied by prior year average balance):
Year Ended December 31, 2002 Year Ended December 31, 2001
Versus Versus
December 31, 2001 December 31, 2000
------------------------------------ ------------------------------------
Change Due To Change Due To
------------------------------------ ------------------------------------
Volume Rate Total Volume Rate Total
--------- --------- ---------- -------- ---------- ---------
(In thousands)
Interest Income:
Loans and mortgage-backed
securities.........................$ (6,685) $ (58,564) $ (65,249) $ 29,831 $ (9,296) $ 20,535
Investments.......................... (1,309) (2,818) (4,127) 1,379 (1,722) (343)
-------- --------- ---------- -------- ---------- ---------
Total interest income.............. (7,994) (61,382) (69,376) 31,210 (11,018) 20,192
-------- --------- ---------- -------- ---------- ---------
Interest Expense:
Deposits............................. 7,562 (41,232) (33,670) 8,229 (13,835) (5,606)
Borrowings........................... (18,628) (21,596) (40,224) 11,690 (11,137) 553
-------- --------- ---------- -------- ---------- ---------
Total interest expense............. (11,066) (62,828) (73,894) 19,919 (24,972) (5,053)
-------- --------- ---------- -------- ---------- ---------
Change in net interest income...... 3,072 1,446 4,518 11,291 13,954 25,245
-------- --------- ---------- -------- ---------- ---------
Change in other items (1).............. (1,237) (882)
---------- ---------
Total change in net interest
Income including other items......... $ 3,281 $ 24,363
========== =========
(1) Includes dividends on FHLB stock and other miscellaneous items.
Note: Changes in rate/volume (change in rate multiplied by the change in
average volume) have been allocated to the change in rate or the change in
volume based upon the respective percentages of the combined totals.
Interest Rate Spreads and Yield on Average Interest-Earning Assets
Year Ended December 31,
--------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------------- ------------------ ----------------- ------------------ ------------------
During End of During End of During End of During End of During End of
Period Period Period Period Period Period Period Period Period Period
------- ------ ------- ------- ------- ------ ------- ------- ------- -------
Weighted average
yield on loans and
mortgage-backed
securities......... 6.18% 5.98% 7.61% 6.57% 7.85% 8.15% 7.37% 7.31% 7.63% 7.48%
Weighted average
yield on
investment
portfolio (1)...... 3.65 4.41 5.16 3.52 6.11 5.63 5.41 5.69 5.29 5.14
Weighted average
yield on all
interest-earning
assets............. 6.08 5.94 7.50 6.40 7.77 8.04 7.26 7.25 7.54 7.39
Weighted average rate
paid on deposits... 2.42 1.98 4.08 3.02 4.70 4.90 4.22 4.42 4.61 4.36
Weighted average rate
paid on borrowings
and FHLB advances.. 4.39 3.63 5.67 4.74 6.29 6.46 5.59 5.88 5.81 5.66
Weighted average rate
paid on all
interest-bearing
liabilities........ 3.16 2.54 4.79 3.73 5.40 5.62 4.76 5.04 5.11 4.84
Interest rate spread
(2)................ 2.92 3.40 2.71 2.67 2.37 2.42 2.50 2.21 2.43 2.55
Effective net spread
(3)................ 3.09 2.90 2.57 2.69 2.60
(1) Dividends on FHLB stock and miscellaneous interest income were not
considered in this analysis
(2) Weighted average yield on all interest-earning assets less weighted average
rate paid on all interest-bearing liabilities
(3) Net interest income (the difference in the dollar amounts of interest earned
and paid) divided by average interest-earning assets
29
Loss Provision
The Company did not record a loan loss provision during 2002, 2001 or 2000.
No provision was recorded during the last three years because, based on analysis
performed by management, existing allowances were sufficient to cover the credit
risks inherent in the loan portfolio. Non-performing assets decreased to $7.0
million in 2002 from $7.9 million in 2001 and $8.3 million in 2000 due to
improvement in the economy and real estate markets in which the Bank operates.
The Bank has a policy of providing for general valuation allowances, unallocated
to any specific loan, but available to offset any loan losses. The allowance is
maintained at an amount that management believes adequate to cover estimable and
probable loan losses. The Company also maintains valuation allowances for
impaired loans and loans sold with recourse. See "Business - Loan Loss
Allowance." Management performs regular risk assessments of the Bank's loan
portfolio to maintain appropriate valuation allowances. Additional loan loss
provisions may be required to the extent that charge-offs are recorded against
the valuation allowance for impaired loans, the general valuation allowance, or
the valuation allowance for loans sold with recourse.
The Company recorded net loan loss recoveries of $950 thousand during 2002,
$118 thousand during 2001 and $51 thousand during 2000. The recoveries resulted
from cash payments by borrowers on loans that had been previously charged-off.
Non-interest Income
Loan servicing and other fees were $4.3 million in 2002 compared to $3.3
million in 2001 and $2.8 million in 2000. Fees earned during 2002, 2001 and 2000
include adjustments of $311 thousand, $134 thousand and $500 thousand,
respectively, to provide for impairment of the Bank's servicing asset due to
accelerated payoffs and prepayments of loans serviced for others. The increase
in fees during 2002 is due to an increase in loan prepayments fees.
Retail fees were $4.6 million in 2002 compared to $3.8 million in 2001 and
$3.1 million in 2000. The increase in retail fees is due to an increase in fee
generating deposit accounts.
Gain on sale of loans was $7.8 million in 2002, $656 thousand in 2001 and
$64 thousand in 2000. Included in gain on sale of loans for 2002 is a $5.9
million adjustment to the Bank's repurchase liability for loans sold with
recourse. The Company's repurchase liability for loans sold with recourse
represents the total losses that are estimated to occur over the remaining life
of the portfolio of loans sold with recourse, discounted to present value.
During 2002, the Bank revised its current estimate of the required repurchase
liability for loans sold with recourse from $12.8 million to $6.9 million. This
reduced liability amount reflects the fact that the total portfolio of loans
sold with recourse has been experiencing significant pay-offs, and has had
better credit experience than was previously estimated. The gain realized on
loan sales fluctuates due to changes in market pricing based on interest rate
trends. Also, the dollar amount of loans originated for sale varies based on the
availability of attractive fixed rate loan programs to borrowers compared to the
Bank's adjustable rate loan programs.
Real estate operations resulted in a net gain of $339 thousand in 2002,
$304 thousand in 2001 and $594 thousand in 2000. Real estate operations include
gain on sale of foreclosed properties, operational income and expenses during
the holding period, and recoveries of prior losses on real estate sold.
Non-interest Expense
The ratio of non-interest expense to average total assets was 1.31% for
2002 and 1.17% for both 2001 and 2000. The higher ratio during 2002 is the
result of increased compensation and legal costs and a decrease in average total
assets.
Salary and benefit costs increased 10% in 2002 compared to 2001 primarily
due to higher incentives and the additional personnel hired in the commercial
banking group. Salary and benefit costs increased 12% in 2001 compared to 2000
primarily due to higher incentives, bonuses and profit sharing costs.
Occupancy expense increased 3% in both 2002 and 2001 due to additional
occupancy costs associated with the four retail savings branches acquired in
November 2001 and an increase in repair and maintenance costs.
Other operating expenses increased 17% in 2002 compared to 2001 due to
increased amortization of core deposit intangible costs, data processing
expenses and legal expenses. Other operating expenses increased 10% in 2001
compared to 2000 due to deconversion costs associated with the institutions
acquired during 2001 and legal expenses.
30
The following table details the components of non-interest expense for the
periods indicated:
Non-Interest Expense
Year Ended December 31,
-------------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ----------- ---------- ----------
(Dollars in thousands)
Salaries and Employee Benefits:
Salaries..................................$ 20,984 $ 18,119 $ 17,354 $ 16,631 $ 16,035
Incentive compensation.................... 3,122 2,472 1,987 1,677 1,478
Payroll taxes............................. 1,827 1,652 1,486 1,607 1,455
Employee benefit insurance................ 1,386 1,203 1,320 1,220 1,069
Bonus compensation........................ 1,500 1,500 920 1,583 1,335
Profit sharing............................ 2,024 2,020 1,778 1,100 1,000
SERP...................................... 1,161 970 906 988 795
401(k).................................... 310 356 354 299 235
Other salaries and benefits............... 313 1,390 339 1,559 2,409
--------- ---------- ----------- ---------- ----------
32,627 29,682 26,444 26,664 25,811
--------- ---------- ----------- ---------- ----------
Occupancy:
Rent...................................... 4,673 4,439 4,539 4,395 5,105
Equipment................................. 1,836 1,971 2,318 2,145 1,855
Maintenance costs......................... 879 914 571 469 344
Other occupancy........................... 1,169 978 603 850 1,189
--------- ---------- ----------- ---------- ----------
8,557 8,302 8,031 7,859 8,493
--------- ---------- ----------- ---------- ----------
Other Operating Expense:
Insurance................................. 690 582 541 430 362
Amortization of core deposit intangible... 1,962 1,564 1,965 452 565
Data processing........................... 2,838 2,490 2,488 1,930 3,359
Contributions............................. 363 450 518 299 509
Professional services..................... 195 207 301 8 259
Legal expenses............................ 2,888 1,393 632 3,516 1,479
OTS assessments........................... 708 653 568 567 599
Federal deposit insurance premiums........ 438 418 538 1,236 1,241
Other operating costs..................... 5,568 5,633 4,822 4,334 4,288
--------- ---------- ----------- ---------- ----------
15,650 13,390 12,373 12,772 12,661
--------- ---------- ----------- ---------- ----------
Advertising.................................... 1,378 1,800 1,417 1,864 1,959
--------- ---------- ----------- ---------- ----------
Total........................................$ 58,212 $ 53,174 $ 48,265 $ 49,159 $ 48,924
========= ========== =========== ========== ==========
Non-interest expense as
% of average assets........................ 1.31% 1.17% 1.17% 1.30% 1.24%
========= ========== =========== ========== ==========
31
BALANCE SHEET ANALYSIS
Consolidated assets at the end of 2002 were $4.3 billion, representing an
10% decrease from $4.7 billion at the end of 2001 and a 3% decrease from $4.4
billion at the end of 2000. The reduction in assets during 2002 is attributable
to of principal repayments on loans exceeding loans originated. Loan
originations totaled $1.3 billion in 2002, $1.5 billion in 2001 and $1.1 billion
in 2000. Loan purchases totaled $89,000 during 2002, $132.6 million during 2001
and $139.5 million during 2000. Principal repayments on loans totaled $1.5
billion during 2002, $1.3 billion during 2001 and $560.5 million during 2000.
Loan Portfolio
At the end of 2002, over 58% of the Bank's loans had adjustable interest
rates based on monthly changes in the FHLBSF Eleventh District Cost of Funds
Index. As part of its asset-liability management strategy, the Bank has
maintained a high level of adjustable loans in its portfolio for several years.
Management believes that the high level of adjustable rate mortgages will help
insulate the Bank from fluctuations in interest rates, notwithstanding the
several month time lag between a change in its monthly cost of funds and a
corresponding change in its loan yields. See "Asset - Liability Management."
The Bank also originates adjustable rate loans with initial fixed interest
rates with periods ranging from 3 to 10 years. By policy, the Bank will either
match the fixed rate period of these loans with borrowings for the same term or
will hold unmatched fixed rate loans in its portfolio up to 5% of total assets.
Management believes that the limited origination of hybrid fixed-rate loans will
enhance the Company's overall return on assets and improve loan originations in
this economy. Loans originated under this limited program totaled $372.6 million
in 2002, $1.0 billion in 2001 and $75.9 million in 2000.
In 2002, 2001 and 2000, the Bank placed $1.4 million, $5.0 million and $3.9
million, respectively, in mortgages with other lenders under fee arrangements.
These loans are not included in the Bank's loan originations. In 2002, loans
made on the security of single family properties (one-to-four units) comprised
57% of the dollar amount of new loan originations. Loans made on the security of
multi-family properties (five or more units) comprised 34% of new originations.
Loans made on the security of commercial real estate properties comprised 7% of
new loan originations. Business loans originated by the commercial lending units
totaled 2% of new loan originations. Adjustable rate mortgages comprised 59% of
new loan activity during 2002 compared with 18% during 2001 and 90% during 2000.
The following table details loan originations and loan purchases by loan
type for the periods indicated:
Loan Originations and Purchased by Type
Year Ended December 31,
---------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ---------- ---------
(In thousands)
Single family (one-to-four units)......$ 728,309 $ 912,974 $ 658,808 $ 779,698 $ 594,763
Multi-family........................... 441,407 407,458 333,466 118,622 37,720
Commercial real estate................. 84,050 150,735 70,807 37,744 383
Commercial business loans.............. 17,572 16,172 11,759 7,768 1,733
Other.................................. 17,434 14,996 6,170 301 2,428
---------- ----------- ----------- ---------- ---------
Total..................................$ 1,288,772 $ 1,502,335 $ 1,081,010 $ 944,133 $ 637,027
========== =========== =========== ========== =========
Loans originated upon the sale of real estate owned totaled $375 thousand
during 2002. No loans were originated upon the sale of real estate owned during
2001 or 2000.
The Bank's loan products may provide for first year monthly payments that
are lower than the fully-indexed interest and principal due. Any interest not
fully paid by such lower first year payments is added to the principal balance
of the loan. This causes negative amortization until payments increase to cover
interest and principal repayment shortfalls. Due to negative amortization,
loan-to-value ratios may increase above those calculated at the inception of the
loan.
32
The Bank does not normally lend in excess of 90% of the appraised
collateral value on adjustable mortgage loans ("AMLs"). Where the Bank does lend
in excess of 90% of the appraised value, additional fees and rates are charged.
Mortgage insurance is required on loans in excess of 80% or premium rates and/or
fees are charged if the mortgage insurance requirement is waived. Subsequent to
the origination of a loan, the Bank may purchase private mortgage insurance with
its own funds. Loans originated with an initial loan-to-value greater than 80%
with no private mortgage insurance totaled $159.7 million at December 31, 2002
compared to $354.5 million at December 31, 2001 and $268.2 million at December
31, 2000. See "Business - Interest Rates, Terms and Fees."
Loan Composition
Loans based on the security of single family properties (one-to-four units)
comprise the largest category of the Bank's loan portfolio. The loan portfolio
also includes loans secured by multi-family and commercial and industrial
properties. At December 31, 2002, 45% of the loan portfolio consisted of first
liens on single family properties while first liens on multi-family properties
were 43% of the portfolio, and first liens on commercial properties represented
11% of the portfolio. Commercial business loans, construction loans and consumer
loans comprised the remaining 1% of the loan portfolio at December 31, 2002.
The following table sets forth the composition of the Bank's portfolio of
loans and mortgage-backed securities for each of the last five years:
Year Ended December 31,
----------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ---------- ----------- ----------- -----------
(In thousands)
REAL ESTATE LOANS First trust deed
residential loans:
One-to-four units......................$ 1,723,690 $ 2,121,899 $ 2,158,940 $ 1,813,783 $ 1,564,392
Five or more units..................... 1,646,430 1,525,749 1,308,440 1,123,308 1,127,228
----------- ---------- ----------- ----------- -----------
Residential loans................. 3,370,120 3,647,648 3,467,380 2,937,091 2,691,620
OTHER REAL ESTATE LOANS
Commercial and industrial.............. 419,273 358,159 217,619 183,194 181,772
Construction........................... 6,927 38,060 -- -- --
Land................................... 203 1,481 -- -- --
Second trust deeds..................... 5,965 9,472 8,543 13,489 15,357
----------- ---------- ----------- ----------- -----------
Real estate loans.................... 3,802,488 4,054,820 3,693,542 3,133,774 2,888,749
NON-REAL ESTATE LOANS:
Manufactured housing................... -- -- 391 613 893
Deposit accounts....................... 1,185 1,267 576 683 1,002
Commercial business loans.............. 19,582 18,882 12,600 8,140 1,259
Consumer loans......................... 35,395 19,546 6,555 593 621
----------- ---------- ----------- ----------- -----------
Loans receivable..................... 3,858,650 4,094,515 3,713,664 3,143,803 2,892,524
LESS:
General valuation allowance............ 75,223 72,919 70,809 69,954 67,638
Impaired loan valuation allowance...... 496 1,850 1,792 2,596 7,634
Unearned loan fees..................... 13,696 14,857 11,779 10,706 9,031
----------- ---------- ----------- ----------- -----------
Net loans receivable (1)............. 3,769,235 4,004,889 3,629,284 3,060,547 2,808,221
FHLMC AND FNMA MORTGAGE-BACKED
SECURITES (at fair value):
Secured by single family dwellings..... 192,395 272,419 360,210 412,469 539,079
Secured by multi-family dwellings...... 8,190 11,660 14,195 16,172 17,600
----------- ---------- ----------- ----------- -----------
Mortgage-backed securities........ 200,585 284,079 374,405 428,641 556,679
----------- ---------- ----------- ----------- -----------
TOTAL $ 3,969,820 $ 4,288,968 $ 4,003,689 $ 3,489,188 $ 3,364,900
=========== ========== =========== =========== ===========
(1) Includes loans held-for-sale.
33
Loans Sold with Recourse
The Bank has loss exposure on certain loans sold with recourse. These loans
are substantially all secured by multi-family properties. Loans sold with
recourse totaled $108.6 million as of December 31, 2002, $137.2 million as of
December 31, 2001 and $159.8 million as of December 31, 2000. Although no longer
owned by the Bank, these loans are evaluated for the purposes of computing the
repurchase liability and measuring risk exposure for regulatory capital. Under
the Bank's current policy, it no longer enters into loans sold with recourse
agreements.
ASSET QUALITY
Asset Quality Ratios
The following table sets forth certain asset quality ratios of the Bank for
the periods indicated:
Year Ended December 31,
--------------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ----------- ----------- ---------- -----------
Non-performing loans to loans gross receivable
(1)......................................... 0.17% 0.16% 0.17% 0.42% 1.00%
Non-performing assets to total assets (2)....... 0.17% 0.17% 0.19% 0.40% 0.84%
Loan loss allowances to non-performing loans (3) 1,126% 1,151% 1,160% 528% 243%
General loss allowances to gross loans
receivable (4).............................. 1.96% 1.83% 1.95% 2.31% 2.60%
(1) Non-performing loans are net of valuation allowances related to those
loans. Loans receivable are before deducting unrealized loan fees,
general valuation allowances and valuation allowances for impaired loans.
(2) Non-performing assets are net of valuation allowances related to those
assets.
(3) The Bank's loan loss allowances, including any valuation allowances for
non-performing loans, impaired loans and the general valuation allowance.
Non-performing loans are before deducting valuation allowances related to
those loans.
(4) The Bank's general valuation allowances plus the allowance for impaired
loans as a percentage of loans receivable before deducting unrealized
loan fees, general valuation allowances and valuation allowances for
impaired loans.
34
NON-PERFORMING ASSETS
Non-performing assets, as defined by the Bank, include loans delinquent
over 90 days or in foreclosure, real estate acquired in settlement of loans, and
other loans less than 90 days delinquent but for which collectibility is
questionable.
The table below details the amounts of non-performing assets by type of
collateral. Also shown is the ratio of non-performing assets to total assets.
Non-Performing Assets
December 31,
-----------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------------ ------------------ ----------------- ----------------- -------------------
$ % $ % $ % $ % $ %
------- ------- ------- ------- ------- ------ ------ ------ ------ --------
(Dollars in thousands)
Real estate owned:
Single family..........$ 519 7.37%$ 1,671 21.08%$ 2,507 30.21%$ 1,069 6.93%$ 3,946 12.84%
Multi-family........... -- -- 164 2.06 -- -- 1,483 9.62 1,309 4.26
Less: general
valuation allowance.. (200) (2.84) (350) (4.41) (350) (4.22) (350) (2.27) (500) (1.63)
------ ------- ------- ------- ------- ------ ------ ------ ------ ------
Total real estate owned 319 4.53 1,485 18.73 2,157 25.99 2,202 14.28 4,755 15.47
Non-performing loans:
Single family.......... 5,705 81.03 6,062 76.46 5,603 67.51 9,626 62.41 12,270 39.92
Multi-family........... 1,017 14.44 422 5.32 662 7.98 3,995 25.90 13,005 42.31
Commercial and 1.46
industrial........... -- -- -- -- -- -- 225 4,040 13.14
Other.................. -- -- 16 .21 -- -- -- -- -- --
Less: valuation
allowance............ -- -- (57) (.72) (123) (1.48) (625) (4.05) (3,332) (10.84)
------ ------- ------- ------- ------- ------ ------ ------ ------ ------
Total non-performing
loans................ 6,722 95.47 6,443 81.27 6,142 74.01 13,221 85.72 25,983 84.53
------ ------- ------- ------- ------- ------ ------ ------ ------ ------
Total..................$ 7,041 100.00 $ 7,928 100.00 $ 8,299 100.00 $ 15,423 100.00 $ 30,738 100.00
====== ======= ======= ======= ======= ====== ====== ====== ====== ======
Ratio of
non-performing
assets to total
assets............... 0.17% 0.17% 0.19% 0.40% 0.84%
======= ======= ====== ====== ======
The decrease in non-performing loans over the last several years is due to
reductions in delinquent loans and non-performing loans due to continued
strength in the Southern California real estate markets.
Single family non-performing loans are primarily due to factors such as
layoffs and declining personal income. Multi-family and commercial
non-performing loans are attributable primarily to factors such as declines in
occupancy rates, increased operating costs and decreased real estate values. The
Bank actively monitors the status of all non-performing loans.
Impaired loans totaled $1.6 million, $7.4 million and $8.8 million, net of
related allowances of $496 thousand, $1.9 million and $1.8 million as of
December 31, 2002, 2001 and 2000, respectively. See "Business - Non-accrual,
Past Due, Impaired and Restructured Loans" for further discussion of impaired
loans.
The Bank's modified loans result primarily from temporary modifications of
principal and interest payments. Under these arrangements, loan terms are
typically reduced to no less than a required monthly interest payment. Any loss
of revenues under the modified terms would be immaterial to the Bank. If the
borrower is unable to return to scheduled principal and interest payments at the
end of the modification period, foreclosure procedures are initiated, or, in
certain circumstances, the modification period is extended. As of December 31,
2002, the Bank had modified loans totaling $3.9 million, net of loan loss
allowances of $496 thousand. This compares with $7.4 million and $9.6 million,
net of allowances, as of December 31, 2001 and December 31, 2000 respectively.
Modified loans included as impaired loans totaled $1.6 million, $6.4 million and
$8.8 million, net of valuation allowances, as of December 31, 2002, 2001 and
2000, respectively. No modified loans were 90 days or more delinquent as of
December 31, 2002, 2001 or 2000.
35
CAPITAL RESOURCES AND LIQUIDITY
Liquidity Requirements
In July 2001, the OTS removed the regulation that required a savings
institution to maintain an average daily balance of liquid assets of at least
four percent of its liquidity base, and retained a provision requiring a savings
institution to maintain sufficient liquidity to ensure its safe and sound
operation. The determination of what constitutes safe and sound operation was
left to the discretion of management.
For several years it has been the Bank's strategy to keep cash and liquid
investments at a modest level due to availability of substantial credit lines.
After the repeal of the liquidity regulation, the Bank's liquidity policy was
modified to include unused borrowing capacity in the definition of available
liquidity. The Bank's current liquidity policy requires that cash and cash
equivalents, short-term investments and unused borrowing capacity be maintained
at a minimum level of 10% of the Bank's liquidity base (defined as deposits and
borrowings due within one year.) As of December 31, 2002, liquidity-qualifying
balances were 27.1% of the Bank's liquidity base.
External Sources of Funds
External sources of funds include savings deposits, loan sales, advances
from the FHLB and reverse repurchase agreements ("reverse repos"). For purposes
of funding asset growth, the source or sources of funds with the lowest total
cost for the desired term are generally selected. The incremental source of
funds used most often during the last three years was advances from the FHLB.
Deposits obtained from national brokerage firms ("brokered deposits") are
considered a source of funds similar to a borrowing. In evaluating brokered
deposits as a source of funds, the cost of these deposits, including commission
fees, is compared to other funding sources. Brokered deposits were $161.3
million at December 31, 2002. This compares to $356.8 million at December 31,
2001 and $381.2 million at December 31, 2000. Utilization of brokered deposits
decreased during 2002 due to high levels of loan payoffs and growth in retail
branch deposits.
Deposits at retail savings offices were $2.3 billion at December 31, 2002,
$2.1 billion as of December 31, 2001 and $1.7 billion at December 2000.
Management attributes the increase in retail deposits over the last two years to
increased deposits from stock market investors wanting more security for their
investments due to variability in the stock market. During 2001, the Bank
acquired four retail offices with deposits totaling $174.8 million as part of
the purchase of two small banks. As of December 31, 2002, deposits at these
acquired branches totaled $163.7 million.
The Bank also solicits deposits through telemarketing efforts.
Telemarketing deposits are obtained by the Bank's employees via telephone, from
depositors outside of the Bank's normal service areas. Telemarketing deposits
decreased by 36% to $64.6 million at the end of 2002. This compares with $100.7
million at the end of 2001 and $49.1 million at the end of 2000. The level of
telemarketing deposits varies based on the activity of investors, who are
typically professional money managers. The availability of telemarketing
deposits also varies based on the investors' perception of the Bank's
creditworthiness. During 2002, the balance of telemarketing deposits decreased
as a result of cash flows from loan payoffs and growth in retail deposits.
Reverse repurchase agreements are short term borrowings secured by
mortgage-backed securities. These borrowings decreased to $155.3 million at the
end of 2002 from $211.0 million at the end of 2001 and $294.1 million at the end
of 2000. Borrowings under reverse repurchase agreements have decreased over the
last three years due to prepayments of the underlying mortgage collateral. The
Bank has not securitized any mortgage loans for use in collateralized borrowings
for several years.
FHLB advances were $1.2 billion at the end of 2002 compared to $1.6 billion
at the end of both 2001 and 2000. Due to high levels of loan payoffs and the
growth in retail branch deposits, borrowings from the FHLB decreased during
2002.
Loan sales were $134.2 million in 2002. This compares to $61.2 million
during 2001 and $9.5 million during 2000. Loan sales increased during 2002 and
2001 due to the increased demand by clients for 30-year and 15-year fixed rate
mortgages which are originated by the Bank only for sale.
36
Internal Sources of Funds
Internal sources of funds include scheduled loan principal payments, loan
payoffs, and positive cash flows from operations. Principal payments were $1.5
billion in 2002 compared to $1.3 billion in 2001 and $560.5 million in 2000.
Principal payments include both amortization and prepayments and are a function
of real estate activity and the general level of interest rates. The increase in
prepayments during 2002 compared to 2001 was due to the low level of interest
rates available on 30-year and 15-year fixed rate loans available to customers.
Capital Requirements
Current OTS regulatory capital standards require that the Bank maintain
tangible capital of at least 1.5% of total assets, core capital of 4.0% of total
assets, and risk-based capital of 8.0% of total assets, risk-weighted. Among
other things, failure to comply with these capital standards will result in
restrictions on asset growth and necessitate the preparation of a capital plan,
subject to regulatory approval. Generally, any institution with a risk-based
capital ratio in excess of 10% and a core capital ratio greater than 5% is
considered "well-capitalized" for regulatory purposes. Institutions who maintain
this capital level can utilize brokered deposits at their discretion
Additionally, if they achieve a sufficient ranking on their regulatory
examination, they may be assessed lower deposit insurance premiums.
Management presently intends to maintain its capital position at levels
above those required by regulators to ensure operating flexibility and growth
capacity for the Bank. The Bank's capital position is actively monitored by
management. The Bank met the regulatory capital standards to be deemed
"well-capitalized" for purposes of the various regulatory measures of capital
including the prompt corrective action regulations.
To be considered "well capitalized" for purposes of the prompt corrective
action requirements the Bank must maintain the capital ratios as set forth in
the table below:
December 31, 2002
-----------------
Amount %
------- ------
(Dollars in thousands)
Core capital requirement.......................... $212,143 5.00%
Bank's core capital............................... 341,680 8.05
-------- ------
Excess core capital............................. $129,537 3.05%
======== ======
Tier 1 risk-based capital requirement............. $154,607 6.00%
Bank's tier 1 risk-based capital.................. 341,680 13.26
-------- ------
Excess tier 1 risk-based capital................ $187,073 7.26%
======== ======
Risk-based capital requirement.................... $257,678 10.00%
Bank's risk-based capital......................... 374,421 14.53
-------- ------
Excess risk-based capital....................... $116,743 4.53%
======== ======
37
ITEM 7A -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ASSET-LIABILITY MANAGEMENT
The Bank's primary objective in managing interest rate risk is to minimize
the adverse impact of changes in interest rates on the Bank's net interest
income and capital, while, at the same time, adjusting the Bank's
asset-liability mix to achieve the most favorable impact on earnings.
The Bank's asset-liability management policy is designed to improve the
balance between the maturities and repricings of interest-earning assets and
interest-bearing liabilities in order to better insulate net earnings from
interest rate fluctuations. Under this program, the Bank emphasizes the funding
of monthly adjustable mortgages with short term savings and borrowings and
matching the maturities of these assets and liabilities. The Bank also
originates adjustable rate loans with initial fixed interest rates for periods
ranging from 3 to 10 years. By policy, the Bank will either match the fixed rate
period of these loans with borrowings for the same term or will hold unmatched
fixed rate loans in its portfolio up to 5% of total assets.
The majority of the Bank's assets are monthly adjustable rate mortgages
with interest rates that fluctuate based on changes in the FHLB Eleventh
District Cost of Funds. These mortgages constitute over 58% of the loan
portfolio at the end of 2002. Comparisons over the last several years show that
a change in the Bank's cost of funds generally correlates with changes in the
Index. The Bank does not use any futures, options or swaps in its
asset-liability strategy.
Assets and liabilities that are subject to repricing are considered rate
sensitive. The mis-match in the repricing of rate sensitive assets and
liabilities is referred to as a company's "GAP." The GAP is positive if
rate-sensitive assets exceed rate-sensitive liabilities for any specified
repricing term. Generally, a positive GAP benefits a company during periods of
increasing interest rates. The reverse is true during periods of decreasing
interest rates. The indices used by the Bank lag changes in interest rates by up
to three months (COFI has a three month lag while all other indices have two).
However, the Bank's short-term savings and borrowing costs adjust immediately
causing net interest income to initially decrease during periods of rising
interest rates and increase during periods of declining interest rates.
The following chart shows the interest sensitivity of the Company's assets
and liabilities by repricing period at December 31, 2002 and the consolidated
GAP position as a percentage of total assets at that time:
INTEREST-SENSITIVITY GAP
--------------------------------------------------------------------------
Balances Balances Balances
Balances Repricing Repricing Repricing
Total Repricing Within 1-3 Within 4-10 After
Balance Within 1 Year Years Years 10 Years
------------ ------------ ----------- ----------- ------------
(Dollars in thousands)
Interest-earning assets:
FHLB interest-earning deposits............... $ 9,925 $ 9,925 $ -- $ -- $ --
Investment securities........................ 103,055 18,639 40,389 44,027 --
Mortgage-backed securities................... 200,585 200,310 181 79 15
Loans receivable............................. 3,858,650 3,014,346 589,612 250,850 3,842
---------- ------------ --------- ----------- ----------
Total interest-earning assets.............. $ 4,172,215 $ 3,243,220 $ 630,182 $ 294,956 $ 3,857
========== ============ ========= =========== ==========
Interest-bearing liabilities:
Demand accounts.............................. $ 1,605,619 $ 1,605,619 $ -- $ -- $ --
Fixed rate term certificates................. 921,407 794,671 116,202 9,451 1,083
FHLB advances.............................. 1,167,000 427,000 445,000 295,000 --
Reverse repurchase agreements.............. 155,273 155,273 -- -- --
---------- ------------ --------- ----------- ----------
Total interest-bearing liabilities........ $ 3,849,299 $ 2,982,563 $ 561,202 $ 304,451 $ 1,083
========== ============ ========= =========== ==========
Interest-sensitivity GAP....................... $ 322,916 $ 260,657 $ 68,980 $ (9,495) $ 2,774
========== ============ ========= =========== ==========
Interest-sensitivity GAP as a percentage of
total assets............................... 6.13% 1.62% (0.22)% 0.07%
============ ========= =========== ==========
Cumulative interest-sensitivity GAP............ $ 260,657 $ 329,637 $ 320,142 $ 322,916
============ ========= =========== ==========
Cumulative interest-sensitivity GAP as a
percentage of total assets................. 6.13% 7.74% 7.53% 7.59%
============ ========= =========== ==========
38
In order to minimize the impact of rate fluctuations on earnings,
management's goal is to keep the one-year GAP at less than 20% of total assets
(positive or negative). At December 31, 2002, the Company's one-year GAP ratio
was a positive $260.7 million or 6.13% of total assets. This compares with a
negative GAP ratio of 6.1% of total assets at December 31, 2001 and a positive
GAP ratio of 11.8% of total assets at December 31, 2000. The change to a
positive GAP at December 31, 2002 from a negative GAP at December 31, 2001 is
due to the fact that the Bank extended the maturities of its FHLB advances in
order to match the fixed rate period of its hybrid loans.
Another measure of interest rate risk, that is required to be performed by
OTS-regulated institutions, is an analysis specified by OTS Thrift Bulletin
TB-13a, "Management of Interest Rate Risk, Investment Securities, and
Derivatives Activities". Under this regulation institutions are required to
establish limits on the sensitivity of their net interest income and net
portfolio value to changes in interest rates. Such changes in interest rates are
defined as instantaneous and sustained movements in interest rates in 100 basis
point increments.
The following table shows the estimated impact of a parallel shift in
interest rates on the Bank's portfolio value at December 31, 2002 and December
31, 2001:
Percentage
Change in Interest Rates Change in Net Portfolio Value(1)
-----------------------------
(In Basis Points) 2002 2001
------- ------
+300.......................... (7)% (16)%
+200.......................... (3)% (11)%
+100.......................... (.49)% (6)%
--100......................... --% 6%
--200......................... --%(2) --%(2)
--300......................... --%(2) --%(2)
(1) The percentage change represents the projected change in the net portfolio
value of the Bank in a stable interest rate environment versus the net
portfolio value in the various rate scenarios. The OTS defines net
portfolio value as the present value of expected cash flows from existing
assets minus the present value of expected cash flows from existing
liabilities.
(2) A downward shift in interest rates of 200 basis points or 300 basis points
for both December 31, 2002 and December 31, 2001 levels would result in
negative interest rates in many cases. Therefore, modeling the impact of
such declines as of December 31, 2002 and December 31, 2001 is not
meaningful or practical
39
The following table shows the fair value and contract terms of the Bank's
interest-earning assets and interest-bearing liabilities as of December 31, 2002
categorized by type and expected maturity for each of the next five years and
thereafter:
Expected Maturity Date as of December 31, (1)
--------------------------------------------------------------------------------------------------------
Total
2003 2004 2005 2006 2007 Thereafter Balance Fair Value
--------- ---------- ---------- -------- --------- --------- --------- -----------
(Dollars in thousands)
Interest-earning assets:
Loans receivable:
Adjustable rate loans:
Single family........ $ 543,633 $ 433,890 $ 280,022 $ 156,308 $ 89,317 $ 133,228 $ 1,636,398 $ 1,665,635
Average interest
rate................. 5.89% 5.78% 5.64% 5.57% 5.53% 5.47% 5.73%
Multi-family......... 337,266 320,688 272,430 241,432 127,350 312,152 1,611,318 1,659,295
Average interest
rate................. 5.85% 5.86% 5.85% 6.15% 5.74% 5.60% 5.84%
Commercial and
industrial........... 88,641 86,442 68,310 55,363 27,916 56,711 383,383 401,772
Average interest
rate................. 6.94% 6.92% 6.87% 7.05% 6.64% 6.37% 6.83%
Fixed rate loans:
Single family........ 8,976 6,485 4,318 1,784 690 432 22,685 23,290
Average interest
rate................ 7.49% 6.74% 6.35% 6.31% 6.30% 6.29% 6.91%
Multi-family......... 9,623 7,920 6,646 6,328 1,499 1,979 33,995 35,969
Average interest
rate................ 7.79% 7.64% 7.54% 7.33% 7.74% 7.89% 7.62%
Commercial and
industrial........... 11,020 11,064 6,115 4,298 2,571 2,572 37,640 39,916
Average interest
rate................ 7.90% 7.79% 7.55% 7.89% 7.76% 8.11% 7.82%
Commercial business
loans................ 4,739 5,033 5,344 5,188 -- -- 20,304 20,595
Average interest
rate................ 6.02% 6.02% 6.02% 6.02% -- -- 6.02%
Construction loans... 3,470 3,457 -- -- -- -- 6,927 7,150
Average interest
rate................ 8.75% 8.75% -- -- -- -- 8.75%
Consumer loans....... 36,331 40 44 49 54 362 36,880 36,891
Average interest
rate................ 5.50% 10.10% 10.10% 10.10% 10.10% 10.10% 5.57%
Other loans.......... 18,869 21,393 16,309 8,613 3,936 -- 69,120 69,410
Average interest
rate................ 4.84% 4.96% 4.96% 4.96% 4.96% -- 4.93%
Mortgage-backed
securities:
Adjustable: 67,594 43,761 29,473 19,809 13,282 26,216 200,135 200,135
Average interest
rate................ 3.76% 3.76% 3.76% 3.76% 3.76% 3.76% 3.76%
Fixed: 176 112 69 42 25 26 450 450
Average interest
rate................ 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00%
Investment securities,
overnight
investments and
interest-bearing
deposits: 28,564 19,790 20,599 23,184 20,843 -- 112,980 112,980
Average interest
rate................ 3.57% 5.00% 5.04% 5.06% 5.07% -- 4.66%
--------- ---------- ---------- -------- --------- --------- --------- ---------
Total interest-earning
assets............... $ 1,158,902 $ 960,075 $ 709,679 $ 522,398 $ 287,483 $ 533,678 $ 4,172,215 $ 4,273,488
========= ========== ========== ======== ========= ========= ========= =========
Interest-bearing
liabilities:
Deposits:
Checking accounts.... $ 414,497 $ -- $ -- $ -- $ -- $ -- $ 414,497 $ 414,497
Average interest
rate................ 0.24% -- -- -- -- -- 0.24%
Savings accounts..... 1,191,122 -- -- -- -- -- 1,191,122 1,191,122
Average interest
rate................ 2.05% -- -- -- -- -- 2.05%
Certificate accounts. 794,671 52,397 63,805 2,623 6,022 1,889 921,407 934,359
Average interest
rate................ 2.47% 3.67% 4.34% 4.54% 4.43% 3.44% 1.98%
Borrowings:
FHLB advances........ 427,000 285,000 160,000 175,000 85,000 35,000 1,167,000 1,214,044
Average interest
rate................ 2.25% 4.74% 4.24% 5.57% 4.56% 5.88% 3.90%
Reverse repurchase
agreements........... 155,273 -- -- -- -- -- 155,273 155,285
Average interest
rate................ 1.61% -- -- -- -- -- 1.61%
--------- -------- -------- -------- --------- -------- --------- ---------
Total interest-bearing
liabilities.......... $ 2,982,563 $ 337,397 $ 223,805 $ 177,623 $ 91,022 $ 36,889 $ 3,849,299 $ 3,909,307
========= ======== ======== ======== ========= ======== ========= =========
(1) Expected maturities are contractual maturities adjusted for prepayments of
principal. The Bank uses certain assumptions to estimate fair values and
expected maturities. For assets, expected maturities are based upon
contractual maturity, projected repayments and prepayments of principal.
The prepayment experience used is based on the Bank's historical
experience. The Bank's average CPR (Constant Prepayment Rate) is 36% for
the single family portfolio and 24% for its multi-family and commercial
real estate portfolios. For fixed rate loans, the Bank's average CPR is 60%
and 30% respectively. The Bank used estimated deposit runoff based on
available industry information.
40
STOCK PRICES
The common stock of FirstFed Financial Corp. is traded on the New York
Stock Exchange under the trading symbol "FED". The quarterly high and low
information presented below is based on information supplied by the New York
Stock Exchange.
The Company has never declared or paid a cash dividend to its stockholders.
As of February 7, 2003, there remain 1,348,677 shares eligible for
repurchase under the Company's stock repurchase program. The Company repurchased
353,000 and 821,500 shares of its common stock during 2002 and 2000. No shares
were repurchased during 2001.
PRICE RANGE OF COMMON STOCK
First Quarter Second Quarter Third Quarter Fourth Quarter
High Low High Low High Low High Low
2002 $27.00 $24.58 $29.90 $26.26 $28.89 $23.89 $29.15 $23.92
2001 32.06 26.25 31.00 28.00 36.30 24.00 25.95 21.90
2000 16.63 11.88 14.56 11.69 23.00 14.06 33.13 21.31
1999 18.00 15.56 20.00 15.31 17.81 15.00 18.50 12.81
1998(1) 21.19 15.94 26.41 20.41 26.94 14.75 18.56 14.13
(1) All amounts have been adjusted for the two-for-one stock split declared
June 25, 1998.
41
ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share data)
December 31, December 31,
2002 2001
---------------- ------------------
ASSETS
Cash and cash equivalents...................................... $ 45,199 $ 174,171
Investment securities, available-for-sale (at fair value)
(Note 2)..................................................... 103,055 110,444
Mortgage-backed securities, available-for-sale (at fair value:
$151,775 and $224,114 pledged) (Notes 3 and 10)............. 200,585 284,079
Loans receivable, held-for-sale (fair value of $2,300 and
$5,250) (Note 4)............................................ 2,293 5,246
Loans receivable, net (Notes 4 and 9).......................... 3,766,942 3,999,643
Accrued interest and dividends receivable...................... 17,752 22,076
Real estate, net (Note 5)...................................... 347 1,515
Office properties and equipment, net (Note 6).................. 10,342 10,822
Investment in Federal Home Loan Bank (FHLB) stock, at cost (Notes
7 and 9)..................................................... 78,728 91,713
Other assets................................................... 28,486 26,580
-------------- ---------------
$ 4,253,729 $ 4,726,289
============== ===============
LIABILITIES
Deposits (Note 8).............................................. $ 2,527,026 $ 2,546,647
FHLB advances (Notes 7 and 9) ................................. 1,167,000 1,597,000
Securities sold under agreements to repurchase (Note 10)....... 155,273 211,040
Accrued expenses and other liabilities......................... 32,789 45,924
-------------- ---------------
3,882,088 4,400,611
-------------- ---------------
COMMITMENTS AND CONTINGENT LIABILITIES
(Notes 1, 4, 6 and 13)
STOCKHOLDERS' EQUITY (Notes 12 and 13)
Common stock, par value $.01 per share; Authorized 100,000,000 shares; issued
23,395,202, and 23,362,196 shares, outstanding 16,931,306 and 17,251,300
shares.
234 234
Additional paid-in capital........................................ 35,680 34,670
Retained earnings - substantially restricted...................... 418,885 363,713
Unreleased shares to employee stock
ownership plan ................................................. (597) --
Treasury stock, at cost, 6,463,896 and 6,110,896 shares........... (84,762) (75,930)
Accumulated other comprehensive earnings, net of taxes............ 2,201 2,991
-------------- ---------------
371,641 325,678
-------------- ---------------
$ 4,253,729 $ 4,726,289
============== ===============
See accompanying notes to consolidated financial statements
42
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE EARNINGS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(Dollars in thousands, except per share data)
2002 2001 2000
-------------- -------------- --------------
Interest income:
Interest on loans....................................... $ 243,716 $ 298,942 $ 274,720
Interest on mortgage-backed securities.................. 9,154 19,803 24,448
Interest and dividends on investments................... 11,008 15,187 15,152
-------------- -------------- -------------
Total interest income................................ 263,878 333,932 314,320
-------------- -------------- -------------
Interest expense:
Interest on deposits (Note 8)........................... 60,808 94,568 100,174
Interest on borrowings (Notes 9 and 10)................. 67,611 107,186 106,331
-------------- -------------- -------------
Total interest expense............................... 128,419 201,754 206,505
-------------- -------------- -------------
Net interest income.......................................... 135,459 132,178 107,815
Provision for loan losses (Note 4)...................... -- -- --
-------------- -------------- -------------
Net interest income after provision for loan losses.......... 135,459 132,178 107,815
-------------- -------------- -------------
Non-interest income:
Loan servicing and other fees........................... 4,325 3,319 2,804
Retail office fees...................................... 4,604 3,791 3,050
Gain on sale of loans................................... 7,806 656 64
Real estate operations, net (Note 5).................... 339 304 594
Other operating income.................................. 1,000 849 1,235
-------------- -------------- -------------
Total other income................................... 18,074 8,919 7,747
-------------- -------------- -------------
Non-interest expense:
Salaries and employee benefits (Note 13)................ 32,627 29,682 26,444
Occupancy (Note 6)...................................... 8,557 8,302 8,031
Advertising............................................. 1,378 1,800 1,417
Amortization of core deposit intangible................. 1,962 1,564 1,965
Federal deposit insurance............................... 438 418 538
Legal................................................... 2,888 1,393 632
Other operating expense................................. 10,362 10,015 9,238
-------------- -------------- -------------
Total non-interest expense........................... 58,212 53,174 48,265
-------------- -------------- -------------
Earnings before income taxes................................. 95,321 87,923 67,297
Income taxes (Note 11)....................................... 40,149 37,621 28,832
-------------- -------------- -------------
Net earnings................................................. $ 55,172 $ 50,302 $ 38,465
============== ============== =============
Other comprehensive earnings (loss):
Unrealized earnings (loss) on mortgage-backed
securities and securities available-for-sale, net of taxes (790) 5,149 6,122
-------------- -------------- -------------
Comprehensive earnings....................................... $ 54,382 $ 55,451 $ 44,587
============== ============== =============
Earnings per share: (Notes 12 and 15)
Basic................................................... $ 3.22 $ 2.92 $ 2.23
============== ============== =============
Diluted................................................. $ 3.15 $ 2.85 $ 2.20
============== ============== =============
Weighted average shares outstanding:
Basic................................................... 17,149,712 17,234,591 17,251,618
============== ============== =============
Diluted................................................. 17,506,129 17,645,647 17,456,895
============== ============== =============
See accompanying notes to consolidated financial statements
43
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(Dollars in thousands, except share data)
Accumulated
Retained Unreleased Other
Earnings Shares to Comprehensive
Additional (Substantially ESOP Earnings
Common Paid-In Restricted) (Notes 12 Treasury (Loss), Net of
Stock Capital (Note 12) and 13) Stock Taxes (Notes 2 Total
and 3)
--------- ---------- -------------- ---------- --------- --------------- --------
Balance, December 31, 1999......... $ 233 $ 31,561 $ 274,946 $ (1,759) $ (65,568) $ (8,280) $231,133
Exercise of employee stock options. -- 793 -- -- -- -- 793
Net decrease in unreleased shares
to the ESOP.................... -- 186 -- 918 -- -- 1,104
Unrealized gain on securities
available-for-sale, net of taxes -- -- -- -- -- 6,122 6,122
Common stock repurchased (821,500)
shares.......................... -- -- -- -- (10,175) -- (10,175)
Net earnings 2000.................. -- -- 38,465 -- -- -- 38,465
--------- ---------- ----------- --------- --------- ----------- --------
Balance, December 31, 2000......... 233 313,411 (841) (75,743) (2,158) 267,442
Exercise of employee stock options. 1 764 -- -- -- -- 765
Net decrease in unreleased shares
to the ESOP.................... -- 1,179 -- 841 -- -- 2,020
Unrealized gain on securities
available-for-sale, net of taxes -- -- -- -- -- 5,149 5,149
Restricted common stock forfeited.. -- 187 -- -- (187) -- --
Net earnings 2001.................. -- -- 50,302 -- -- -- 50,302
--------- ---------- ----------- --------- -------- ----------- -------
Balance, December 31, 2001......... 234 34,670 363,713 -- (75,930) 2,991 325,678
Exercise of employee stock options. -- 407 -- -- -- -- 407
Net decrease in unreleased shares
to the ESOP.................... -- -- -- (597) -- -- (597)
Benefit from stock option tax
adjustment...................... -- 603 -- -- -- -- 603
Unrealized loss on securities
available-for-sale, net of taxes -- -- -- -- -- (790) (790)
Common stock repurchased (353,000)
shares.......................... -- -- -- -- (8,832) -- (8,832)
Net earnings 2002.................. -- -- 55,172 -- -- -- 55,172
--------- --------- ----------- --------- -------- ------------- -------
Balance, December 31, 2002......... $ 234 $ 35,680 $ 418,885 $ (597) $ (84,762) $ 2,201 $371,641
========= ========= =========== ========= ======== ============= =======
See accompanying notes to consolidated financial statements
44
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(In thousands)
2002 2001 2000
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings................................................. $ 55,172 $ 50,302 $ 38,465
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Net change in loans held-for-sale.......................... 2,953 (3,000) 57
Depreciation and amortization.............................. 1,652 1,919 1,874
Valuation adjustments on real estate sold.................. (265) (525) (491)
Amortization of fees and discounts......................... 3,926 5,913 1,703
Decrease in servicing asset................................ 737 375 905
Change in taxes payable.................................... (1,976) (1,738) (323)
(Increase) decrease in interest and dividends receivable... 4,324 7,392 (6,663)
Increase (decrease) in interest payable.................... (5,895) (13,855) 11,298
Amortization of core deposit intangible asset.............. 1,962 1,564 1,964
Increase in other assets................................... (13,784) (5,505) (5,179)
Increase (decrease) in accrued expenses and
other liabilities........................................ (7,240) (1,575) 325
----------- ------------ ------------
Total adjustments........................................ (13,606) (9,035) 5,470
----------- ------------ ------------
Net cash provided by operating activities................ 41,566 41,267 43,935
----------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Loans made to customers and principal
collections on loans .................................... 232,998 (96,132) (434,026)
Loans purchased under recourse arrangements................ -- -- (240)
Loans purchased............................................ (89) (132,625) (14,077)
Proceeds from sales of real estate owned................... 3,500 4,968 5,290
Proceeds from maturities and principal payments of
investment securities, available-for-sale................ 87,120 48,962 20,589
Principal reductions on mortgage-backed securities,
available-for-sale....................................... 83,010 96,770 62,332
Purchases of investment securities,
available-for-sale....................................... (80,855) (19,964) (3,547)
Redemptions (purchases) of FHLB stock...................... 17,585 (4,025) (4,079)
Other...................................................... -- (4,105) (1,205)
Net cash from acquisitions................................. -- 17,680 32,866
----------- ------------ ------------
Net cash provided by (used in) investing activities...... 343,269 (88,471) (336,097)
----------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits........................ (19,621) 206,824 (64,767)
Net increase (decrease) in short term borrowings........... (675,767) (65,070) 340,475
Increase in long term borrowings........................... 190,000 -- --
Purchases of treasury stock................................ (8,832) -- (10,175)
Other...................................................... 413 1,944 2,499
----------- ------------ ------------
Net cash provided by (used in) financing activities (513,807) 143,698 268,032
----------- ------------ ------------
Net increase (decrease) in cash and cash equivalents....... (128,972) 96,494 (24,130)
Cash and cash equivalents at beginning of period........... 174,171 77,677 101,807
----------- ------------ ------------
Cash and cash equivalents at end of period................. $ 45,199 $ 174,171 $ 77,677
=========== ============ ============
See accompanying notes to consolidated financial statements
45
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
The following is a summary of the significant accounting policies of
FirstFed Financial Corp. ("Company") and its wholly-owned subsidiary First
Federal Bank of California ("Bank").
The preparation of the Company's financial statements in conformity with
Generally Accepted Accounting Principles in the United States of America
("GAAP") requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosures of contingent assets
and liabilities at the date of the financial statements and the reported
operations of the Company for the periods presented. Actual results may differ
from those estimates calculated by management.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiary, the Bank. The Bank maintains 29 full-service savings
branches in Southern California. The Bank's primary business consists of
attracting retail deposits and wholesale borrowings and using those funds to
originate loans secured by mortgages on real estate, consumer loans and business
loans. All significant inter-company balances and transactions have been
eliminated in consolidation. Certain items in the 2000 and 2001 consolidated
financial statements have been reclassified to conform to the 2002 presentation.
Statement of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include
cash, overnight investments and securities purchased under agreements to resell
with maturities within 90 days of the date of purchase.
Financial Instruments
GAAP requires the disclosure of the fair value of financial instruments,
whether or not recognized on the Statement of Financial Condition, whenever it
is practicable to estimate the value. A significant portion of the Bank's assets
and liabilities are financial instruments as defined under GAAP. Fair values,
estimates and assumptions are set forth in Note 16, Fair Value of Financial
Instruments.
Risks Associated with Financial Instruments
The credit risk of a financial instrument is the possibility that a loss
may result from the failure of another party to perform in accordance with the
terms of the contract. The most significant credit risk associated with the
Bank's financial instruments is concentrated in its loans receivable.
Additionally, the Bank is subject to credit risk on certain loans sold with
recourse. The Bank has established a system for monitoring the level of credit
risk in its loan portfolio and for loans sold with recourse.
The market risk of a financial instrument is the possibility that future
changes in market prices may reduce the value of a financial instrument or
increase the contractual obligations of the Bank. The Bank's market risk is
concentrated in its portfolios of loans receivable. When a borrower fails to
meet the contractual requirements of his or her loan agreement, the Bank is
subject to the market risk of the collateral securing the loan. Likewise, the
Bank is subject to the volatility of real estate prices with respect to real
estate acquired by foreclosure. The Bank's securities classified as
available-for-sale are traded in active markets. The value of these securities
is susceptible to the fluctuations of the market.
46
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
Interest Rate Risk
Financial instruments are subject to interest rate risk to the extent that
they reprice on a frequency, degree or basis that varies from market pricing.
The Bank is subject to interest rate risk to the degree that its
interest-earning assets reprice on a different frequency or schedule than its
interest-bearing liabilities. A majority of the Bank's loans receivable and
mortgage-backed securities reprice based on the Federal Home Loan Bank of San
Francisco ("FHLBSF") Eleventh District Cost of Funds Index (the "Index"). The
repricing of the Index tends to lag market interest rates. The Bank closely
monitors the pricing sensitivity of its financial instruments.
Concentrations of Credit Risk
Concentrations of credit risk would exist for groups of borrowers when they
have similar economic characteristics that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic or other
conditions. The ability of the Bank's borrowers to repay their commitments is
contingent on several factors, including the economic condition in the
borrowers' geographic area and the individual financial condition of the
borrowers. The Company generally requires collateral or other security to
support borrower commitments on loans receivable. This collateral may take
several forms. Generally, on the Bank's mortgage loans, the collateral will be
the underlying mortgaged property. The Bank's lending activities are primarily
concentrated in Southern California. The Bank does not have significant exposure
to any individual customer.
Securities Purchased under Agreements to Resell
The Bank invests in securities purchased under agreements to resell
("repurchase agreements"). The Bank obtains collateral for these agreements,
which normally consists of U.S. treasury securities or mortgage-backed
securities guaranteed by agencies of the U.S. government. The collateral is held
in the custody of a trustee, who is not a party to the transaction. The duration
of these agreements is typically 1 to 30 days. The Bank deals only with
nationally recognized investment banking firms as the counterparties to these
agreements. The Bank's investment in repurchase agreements consisted solely of
securities purchased under agreements to resell identical securities.
Investments and Mortgage-Backed Securities
The Bank's investment in securities principally consists of U.S. Treasury
and agency securities and mortgage-backed securities. The Bank creates
mortgage-backed securities when it exchanges pools of its own loans for
mortgage-backed securities.
The Bank classifies all of its investments and mortgage-backed securities
as "available-for-sale" based upon a determination that such securities might be
sold at a future date or that there may be foreseeable circumstances under which
the Bank would sell such securities.
Securities designated as available-for-sale are recorded at fair value.
Changes in the fair value of such securities available-for-sale are included in
stockholders' equity as unrealized gains (losses) on securities
available-for-sale, net of taxes. Unrealized losses on available-for-sale
securities, reflecting a decline in value judged to be other than temporary, are
charged to earnings in the Consolidated Statements of Operations and
Comprehensive Earnings. Unrealized gains or losses on available-for-sale
securities are computed on a specific identification basis. Premiums and
discounts on investment securities available for sale are amortized utilizing
the interest method over the contractual term of the assets.
The Bank did not hold any trading securities at December 31, 2002 or 2001.
47
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
Loans Held-for-Investment
The Bank's loan portfolio is primarily comprised of single family
residential loans (one-to-four units), and multi-family loans (five or more
units). Loans are generally recorded at the contractual amounts owed by
borrowers, less unearned interest and allowances for loan losses.
Loans Held-for-Sale
The Bank identifies loans that foreseeably may be sold prior to maturity
and classifies them as held-for-sale. These loans are carried at the lower of
amortized cost or fair value on an aggregate basis by type of asset. For loans,
fair value is calculated on an aggregate basis as determined by current market
investor yield requirements.
Impaired Loans
The Bank evaluates loans for impairment whenever the collectibility of
contractual principal and interest payments is questionable. A loan is impaired
when, based on current circumstances and events, a creditor will be unable to
collect all amounts contractually due under a loan agreement. Large groups of
smaller balance homogenous loans that are collectively evaluated for impairment
are not subject to the evaluation of impairment on an individual basis.
When a loan is considered impaired, the Bank measures impairment based on
the present value of expected future cash flows (over a period not to exceed 5
years) discounted at the loan's effective interest rate. However, if the loan is
"collateral-dependent" or a probable foreclosure, impairment is measured based
on the fair value of the collateral. When the measure of an impaired loan is
less than the recorded investment in the loan, the Bank records an impairment
allowance equal to the excess of the Bank's recorded investment in the loan over
its measured value.
Cash payments received from impaired loans are recorded in accordance with
the contractual terms of the loan. The principal portion of the payment is used
to reduce the principal balance of the loan, whereas the interest portion is
recognized as interest income.
Non-Accrual Loans
The Bank establishes allowances for delinquent interest equal to the amount
of accrued interest on all loans 90 days or more past due or in foreclosure.
This practice effectively places such loans on non-accrual status for financial
reporting purposes. Loans are returned to accrual status only when the ultimate
collectibility of current interest is no longer in doubt.
Allowances for Loan Losses
The Bank maintains a general valuation allowance for loan losses for the
inherent risk in the loan portfolio which has yet to be specifically identified.
The allowance is not allocated to any specific loan. The allowance is maintained
at an amount that management believes adequate to cover estimable and probable
loan losses based on a risk analysis of the current portfolio. Additionally,
management performs periodic reviews of the loan portfolio to identify potential
problems and to establish impairment allowances if losses are expected to be
incurred. Additions to the allowances are charged to earnings. The regulatory
agencies periodically review the allowances for loan losses and may require the
Bank to adjust the allowances based on information available to them at the time
of their examination.
48
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
General allowances are provided for all loans, regardless of any specific
allowances provided. The determination of the Bank's general allowance for loan
losses is based on estimates that are affected by changes in the regional or
national economy and market conditions. The Bank's management believes, based on
economic and market conditions, that the general allowance for loan losses is
adequate as of December 31, 2002 and 2001. Should there be an economic or market
downturn or if market interest rates increase significantly, the Bank could
experience a material increase in the level of loan defaults and charge-offs.
Loan Origination Fees and Costs
Loan origination fees and certain direct loan origination costs are
deferred and recognized over the lives of the related loans as an adjustment of
loan yields using the interest method. When a loan is repaid or sold, any
unamortized net deferred fee balance is credited to income.
Gain or Loss on Sale of Loans
The Bank primarily sells its mortgage loans on a servicing released basis
and recognizes cash gains or losses immediately in its Statement of Operations
and Comprehensive Earnings. The Bank has previously sold mortgage loans and loan
participations on a servicing retained basis with yield rates to the buyer based
upon the current market rates which may differ from the contractual rate of the
loans sold. Under GAAP, servicing assets or liabilities and other retained
interests are required to be recorded as an allocation of the carrying amount of
the loans sold based on the estimated relative fair values of the loans sold and
any retained interests, less liabilities incurred. Servicing assets are
evaluated for impairment based on the asset's fair value. The Bank estimates
fair values by discounting servicing assets cash flows using discount and
prepayment rates that it believes market participants would use. Servicing
assets arising from the sale of loans are included in other assets and were
$536,000 and $1,087,000 at December 31, 2002 and 2001, respectively. No
additional servicing assets were recorded in 2002, 2001 or 2000.
Core Deposit Intangible
Loans, deposits and other assets and liabilities assumed in connection with
acquisitions are accounted for under the purchase method of accounting. Assets
and liabilities are recorded at their fair values as of the date of the
acquisition and the excess cost over fair values of the assets and liabilities
is classified as a core deposit intangible asset. This asset is being amortized
over its estimated useful life. The Company adopted SFAS No. 142 effective
January 1, 2002. Under the provisions of SFAS No. 142, the Company amortizes
these intangible assets over their estimated useful lives. The balance of core
deposit intangible at December 31, 2002 was $9,323,000. There was no impairment
of the Company's core deposit intangible as of December 31, 2002.
The following is a projection of estimated amortization of the core deposit
intangible at December 31, for the periods indicated (in thousands):
2003...................................$ 2,005
2004................................... 2,005
2005................................... 2,005
2006................................... 2,005
2007 and thereafter.................... 1,303
-----------
$ 9,323
===========
49
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
Real Estate
The Bank's real estate acquired in settlement of loans ("REO") consists of
property acquired through foreclosure proceedings or by deed in lieu of
foreclosure. Generally, all loans greater than 60 days delinquent are placed
into foreclosure and, if necessary, a valuation allowance is established. The
Bank acquires title to the property in most foreclosure actions that are not
reinstated by the borrower. Once real estate is acquired in settlement of a
loan, the property is recorded as REO at fair market value, less estimated
selling costs. Fair value is determined by an appraisal obtained at foreclosure.
The REO balance is adjusted for any subsequent declines in fair value through a
valuation allowance.
The recognition of gain on the sale of real estate is dependent on a number
of factors relating to the nature of the property, terms of sale, and any future
involvement of the Bank or its subsidiaries in the property sold. If a real
estate transaction does not meet certain down payment, cash flow and loan
amortization requirements, gain is deferred and recognized under an alternative
method.
Depreciation and Amortization
Depreciation of office properties and equipment is provided by use of the
straight-line method over the estimated useful lives of the related assets.
Amortization of leasehold improvements is provided by use of the straight-line
method over the lesser of the life of the improvement or the term of the lease.
Securities Sold Under Agreements to Repurchase
The Company enters into sales of securities under agreements to repurchase
("reverse repurchase agreements"). Reverse repurchase agreements are treated as
financing arrangements and, accordingly, the obligations to repurchase the
securities sold are reflected as liabilities in the consolidated financial
statements. The mortgage-backed securities collateralizing reverse repurchase
agreements are delivered to several major brokerage firms who arrange the
transactions. These securities are reflected as assets in the Company's
consolidated financial statements. The brokerage firms may loan such securities
to other parties in the normal course of their operations and agree to return
the identical securities to the Company at the maturity of the agreements.
Income Taxes
The Company files a consolidated federal income tax return and a combined
California franchise tax report with the Bank and its subsidiaries. The Bank
accounts for income taxes using the asset and liability method. In the asset and
liability method, deferred tax assets and liabilities are established as of the
reporting date for the realizable cumulative temporary differences between the
financial reporting and tax return basis of the Bank's assets and liabilities.
The tax rates applied are the statutory rates expected to be in effect when the
temporary differences are realized or settled.
Stock Option Plans
The Company applies the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations including FASB
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation, an interpretation of APB Opinion No. 25, issued in March 2000, to
account for its fixed-plan stock options. Under this method, compensation
expense is recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. SFAS No. 123, Accounting for
Stock-Based Compensation, established accounting and disclosure requirements
using a fair-value-based method of accounting for stock-based employee
compensation plans. As allowed by SFAS No. 123, the Company has elected to
continue to apply the intrinsic-value-based method of accounting described
above, and has adopted only the disclosure requirements of SFAS No. 123. The
following table illustrates the effect on net income if the fair-value-based
method had been applied to all outstanding and unvested awards in each period.
50
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
Years Ended December 31,
------------------------------------------
2002 2001 2000
----------- ------------ -----------
(In thousands, except per share data)
Net income as reported............................ $ 55,172 $ 50,302 $ 38,465
Deduction total stock-based employee compensation
expense determined under fair-value-based method
for all rewards, net of tax..................... (976) (978) (773)
----------- ----------- -----------
Pro forma net income............................ $ 54,196 $ 49,324 $ 37,692
=========== =========== ===========
Earnings per share:
Basic:
As reported..................................... $ 3.22 $ 2.92 $ 2.23
Pro forma....................................... $ 3.16 $ 2.86 $ 2.18
Diluted:
As reported..................................... $ 3.15 $ 2.85 $ 2.20
Pro forma....................................... $ 3.11 $ 2.80 $ 2.17
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 2002, 2001 and 2000, respectively: no dividend
yield in any year; expected volatility of 34%, 38% and 37%; risk free interest
rates of 5.1%, 5.1% and 6.7%; and expected average lives of 6 years in all three
periods. The weighted-average grant date fair value of options granted during
the year are $12.68, $9.45 and $23.75 for 2002, 2001 and 2000, respectively. The
Company has elected to recognize forfeitures in the year they occur.
Pro forma net earnings and earnings per share reflect only options granted
since 1995. Therefore, the full impact of calculating compensation cost for
stock options under SFAS No. 123 is not reflected in the pro forma net earnings
per share amounts presented above because compensation cost is reflected over
the options' vesting period and compensation cost for options granted prior to
January 1, 1995 is not considered.
Cash Flows
Cash and cash equivalents include short-term, highly liquid investments
that generally have an original maturity date of three months or less. Non-cash
investing transactions during 2001 include the acquisition of $158,654,000 of
loans and other assets and the assumption of $176,334,000 in deposits and other
liabilities and the recognition of $3,573,000 of intangible assets. A net total
of $17,680,000 in cash was received in the acquisition of two small institutions
during 2001. Non-cash investing transactions during 2000 include the acquisition
of $125,171,000 of loans and the assumption of $168,457,000 in deposits and the
recognition of $10,420,000 of intangible assets. A net total of $32,866,000 in
cash was received related to the acquisition of certain branches during 2000.
Earnings Per Share
The Company reports both basic and diluted net earnings per share. Basic
net earnings per share is determined by dividing net earnings by the average
number of shares of common stock outstanding, while diluted net earnings per
share is determined by dividing net earnings by the average number of shares of
common stock outstanding adjusted for the dilutive effect of common stock
equivalents.
51
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
Comprehensive Earnings
GAAP establishes standards for reporting and presentation of comprehensive
earnings and its components in a full set of financial statements. Comprehensive
earnings consists of net earnings and net unrealized gains (losses) on
securities available-for-sale and is presented in the consolidated statements of
operations and comprehensive earnings and consolidated statements of
stockholders' equity. Accounting standards require only additional disclosures
in the consolidated statements; it does not affect the Company's financial
position or results of operations.
Segment Information and Disclosures
GAAP establishes standards to report information about operating segments
in annual financial statements and requires reporting of selected information
about operating segments in interim reports to stockholders. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. The Company manages its business as one segment.
Derivative Instruments
The Company accounts for derivative instruments in accordance with SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." A
derivative is considered either an asset or liability in the statement of
financial condition and measured at fair value. If a derivative is designated as
a hedging instrument the changes in fair value of the derivative are either (a)
recognized in earnings in the period of change together with the offsetting gain
or loss on the hedged item or (b) reported as a component of other comprehensive
earnings and subsequently reclassified into earnings when the hedged risk
affects earnings. For a derivative not designated as a hedging instrument,
changes in fair value are recognized in earnings in the period of change. As of
December 31, 2002, the Company has approximately $13,630,000 of commitments to
originate loans, which will be held for sale, and approximately $3,590,000 of
loan sale commitments that qualify as derivatives under SFAS No. 133. The
commitments are recorded at fair value at December 31, 2002.
Recent Accounting Pronouncements
On July 30, 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 146, Accounting for Costs
Associated with Exit or Disposal Activities ("SFAS No. 146"). SFAS No. 146 will
be effective for exit or disposal activities initiated after December 31, 2002,
with early adoption encouraged. Management does not expect implementation of
SFAS No. 146 to have a material impact on its consolidated financial statements.
On October 1, 2002, the FASB issued Statement No. 147, Acquisitions of
Certain Financial Institutions ("SFAS No. 147"), which requires most financial
services companies to subject all their goodwill to annual impairment tests
instead of amortizing some of it (the so-called Statement 72 goodwill). SFAS No.
147 applies to all new and past financial-institution acquisitions, including
"branch acquisitions" that qualify as acquisitions of a business, but excluding
acquisitions between mutual institutions. All acquisitions within the scope of
the new Statement will now be governed by the requirements in Statements 141 and
142. Statement 147 did not have a material impact on the Company's consolidated
financial statements.
52
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34. This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The disclosure requirements are effective for financial
statements of interim and annual periods ending after December 15, 2002. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002 and are not
expected to have a material effect on the Company's financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123. This Statement amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement No. 123 to require prominent disclosures in both annual and interim
financial statements.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51. This Interpretation
addresses the consolidation by business enterprises of variable interest
entities as defined in the Interpretation. The Interpretation applies
immediately to variable interests in variable interest entities created after
January 31, 2003, and to variable interests in variable interest entities
obtained after January 31, 2003. The Interpretation requires certain disclosures
in financial statements issued after January 31, 2003 if it is reasonably
possible that the Company will consolidate or disclose information about
variable interest entities when the Interpretation becomes effective. The
application of this Interpretation is not expected to have a material effect on
the Company's financial statements as the Company has no variable interest
entities.
(2) Investment Securities
The amounts advanced under agreements to resell securities (repurchase
agreements) represent short-term investments. During the agreement period the
securities are maintained by the dealer under a written custodial agreement that
explicitly recognizes the Bank's interest in the securities. The Bank had no
agreements to resell securities at December 31, 2002 and $123,000,000 in
agreements to resell securities at December 31, 2001. These agreements are
classified as cash and cash equivalents in the accompanying Consolidated
Statements of Financial Condition. Securities purchased under agreements to
resell averaged $54,054,000 and $62,860,000 during 2002 and 2001, and the
maximum amounts outstanding at any month end during 2002 and 2001 were
$83,000,000 and $123,000,000 respectively.
The Bank also had overnight deposits on hand with the Federal Home Loan
Bank of San Francisco which totaled $9,925,000 and $18,814,000, respectively, at
December 31, 2002 and December 31, 2001.
Investment securities, available-for-sale, are recorded at fair value and
summarized below for the periods indicated:
At December 31, 2002
------------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
United States Government and
Federal agency obligations.................$ 200 $ 3 $ -- $ 203
Collateralized Mortgage Obligations......... 101,802 1,151 (101) 102,852
--------- ----------- ----------- --------
$ 102,002 $ 1,154 $ (101) $ 103,055
========= =========== =========== ========
53
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2) Investment Securities (continued)
At December 31, 2001
-----------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
United States Government and
Federal agency obligations.................$ 28,499 $ 3 $ (34) $ 28,468
Collateralized Mortgage Obligations......... 80,013 1,973 (10) 81,976
---------- --------- ------------ ---------
$ 108,512 $ 1,976 $ (44) $ 110,444
========== ========= ============ =========
Related maturity data for U.S. government and agency securities,
available-for-sale, is summarized below for the period indicated:
At December 31, 2002
----------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
Maturing within 2 years......................$ 200 $ 3 $ -- $ 203
--------- ---------- --------- -------
$ 200 $ 3 $ -- $ 203
========= ========== ========= =======
Collateralized Mortgage Obligations as of December 31, 2002 all have
expected maturities within five years. There were no sales of investment
securities during 2002, 2001 or 2000. Accrued interest on investments was
$428,000 and $1,275,000 at December 31, 2002 and 2001, respectively.
(3) Mortgage-backed Securities
Mortgage-backed securities, available-for-sale, are due through the year
2032 and are summarized below for the periods indicated:
At December 31, 2002
-----------------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
FNMA...............................$ 8,203 $ 114 $ -- $ 8,317
FHLMC.............................. 189,638 2,630 -- 192,268
--------- ------------- ------------- ---------
$ 197,841 $ 2,744 $ -- $ 200,585
========= ============= ============= =========
At December 31, 2001
-----------------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
FNMA...............................$ 11,657 $ 173 $ -- $ 11,830
FHLMC.............................. 269,195 3,054 -- 272,249
--------- ------------- ------------ ---------
$ 280,852 $ 3,227 $ -- $ 284,079
========= ============= ============ =========
There were no mortgage-backed securities created with loans originated by
the Bank in 2002, 2001 or 2000. There were no sales of mortgage-backed
securities during 2002, 2001 or 2000.
Accrued interest receivable related to mortgage-backed securities
outstanding at December 31, 2002 and 2001 totaled $1,293,000 and $2,461,000
respectively.
54
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) Loans Receivable
The following is a summary of loans receivable for the periods indicated:
At December 31,
----------------------------
2002 2001
------------ ------------
(In thousands)
Real estate loans: First trust deed residential loans:
One-to-four units .................................. $ 1,723,690 $ 2,121,899
Five or more units ............................... 1,646,430 1,525,749
------------ ------------
Residential loans .................................. 3,370,120 3,647,648
Other real estate loans:
Commercial and industrial .......................... 419,273 358,159
Construction ....................................... 6,927 38,060
Land ............................................... 203 1,481
Second trust deeds ................................. 5,965 9,472
------------ ------------
Real estate loans ..................................... 3,802,488 4,054,820
Non-real estate loans:
Deposit accounts ..................................... 1,185 1,267
Commercial business loans ............................ 19,582 18,882
Consumer ............................................. 35,395 19,546
------------ ------------
Loans receivable ................................... 3,858,650 4,094,515
Less:
General loan valuation allowance ..................... 75,223 72,919
Valuation allowances for impaired loans .............. 496 1,850
Unearned loan fees .................................... 13,696 14,857
------------ ------------
Subtotal ........................................... 3,769,235 4,004,889
Less:
Loans held-for-sale.................................. 2,293 5,246
------------ ------------
Loans receivable, net.................................... $ 3,766,942 $ 3,999,643
============ ============
Loans serviced for others totaled $197,250,000, $257,629,000 and
$322,315,000 at December 31, 2002, 2001 and 2000, respectively.
The Bank had outstanding commitments to fund $239,127,000 and $105,045,000
in real estate loans at December 31, 2002 and December 31, 2001, respectively.
Of these totals, $225,497,000 and $95,770,000 had variable interest rates and
$13,630,000 and $9,275,000 had fixed interest rates. The Bank had outstanding
commitments to sell real estate loans of $3,590,000 and $5,955,000, respectively
at December 31, 2002 and December 31, 2001, respectively.
Accrued interest receivable related to loans outstanding at December 31,
2002 and 2001 totaled $15,349,000 and $17,664,000, respectively.
Loans delinquent greater than 90 days or in foreclosure were $6,722,000 and
$6,500,000 at December 31, 2002 and 2001, respectively, and the related
allowance for delinquent interest was $372,000 and $504,000, respectively.
Loans made to directors and executive officers (defined for this purpose as
senior vice presidents and above) totaled $5,041,000 and $3,386,000 at December
31, 2002 and 2001, respectively.
See Note 9 for loans that were pledged as security for borrowings.
55
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4) Loans Receivable (continued)
The following is a summary of the activity in the general loan valuation
allowance and the valuation allowance for impaired loans for the periods
indicated:
Valuation
Allowance
General for
Valuation Impaired
Allowance Loans Total
------------ ----------- -----------
(In thousands)
Balance at December 31, 1998................................. $ 67,638 $ 7,634 $ 75,272
Charge-offs................................................ (1,362) (5,038) (6,400)
Recoveries................................................. 3,678 -- 3,678
----------- ----------- ----------
Balance at December 31, 1999................................. 69,954 2,596 72,550
Charge-offs................................................ (1,443) (804) (2,247)
Recoveries................................................. 2,298 -- 2,298
----------- ----------- ----------
Balance at December 31, 2000................................. 70,809 1,792 72,601
Balance obtained from acquisition.......................... 2,050 -- 2,050
Transfers.................................................. (58) 58 --
Charge-offs................................................ (369) -- (369)
Recoveries................................................. 487 -- 487
----------- ----------- ----------
Balance at December 31, 2001................................. 72,919 1,850 74,769
Transfers.................................................. 1,354 (1,354) --
Charge-offs................................................ (372) -- (2,206)
Recoveries................................................. 1,322 -- 3,156
----------- ----------- ----------
Balance at December 31, 2002................................. $ 75,223 $ 496 $ 75,719
=========== =========== ==========
The Bank has loss exposure on certain loans sold with recourse. The dollar
amount of loans sold with recourse totaled $108,606,000 and $137,204,000 at
December 31, 2002 and 2001, respectively. The maximum potential recourse
liability totaled $23,325,000 and $27,274,000 at December 31, 2002 and December
31, 2001, respectively.
The Bank maintains a repurchase liability for loans sold with recourse.
This liability is included in accrued expenses and other liabilities in the
Consolidated Statements of Financial Condition and was $6,900,000 and
$12,824,000 at December 31, 2002 and December 31, 2001, respectively.
The following is a summary of impaired loans, net of valuation allowances
for impairment, for the periods indicated:
At December 31,
-----------------------
2002 2001
---------- ---------
(In thousands)
Non-accrual loans............................................ $ -- $ 978
Modified loans............................................... 1,567 6,416
--------- ---------
$ 1,567 $ 7,394
========= =========
56
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) Loans Receivable (continued)
The Bank considers a loan to be impaired when management believes that the
Bank will be unable to collect all amounts due under the contractual terms of
the loan agreement. In accordance with SFAS 114, the Bank evaluates the
collectibility of commercial business loans greater than or equal to $500,000,
single-family loans greater than or equal to $750,000, and income property loans
greater than or equal to $1,500,000 for impairment purposes using its normal
loan review procedures. When a loan is determined to be impaired, the Bank
measures impairment based on either (1) the present value of expected future
cash flows, discounted at the loan's effective interest rate; (2) the loan's
observable market price, or (3) the fair value of the collateral. Estimated
impairment losses are included in the Bank's impairment allowances.
As of December 31, 2002, the Bank's total recorded investment in impaired
loans identified in accordance with SFAS 114 was $1,567,000 (after deducting
$496,000 of impairment allowances attributable to such loans). As of December
31, 2001, the total recorded investment in impaired loans was $7,394,000 (net of
$1,850,000 of impairment allowances).
As of December 31, 2002 and December 31, 2001, impaired loans totaling
$1,567,000 and $3,929,000, respectively, had no valuation allowances
established.
The Average recorded investment in impaired loans during the years ended
December 31, 2002 and 2001 was $2,588,000 and $7,429,000, respectively. Interest
income recognized for these same periods was $322,000 and $597,000,
respectively, under the cash basis method of accounting; and was $316,000 and
$587,000, respectively, under the accrual basis of accounting. There were no
commitments to lend additional funds to borrowers whose loan terms had been
modified for any of these periods.
(5) Real Estate
The following is a summary of real estate for the periods indicated:
At December 31,
---------------------------
2002 2001
----------- ------------
(In thousands)
Real estate acquired by (or deed in lieu of) foreclosure ("REO") $ 519 $ 1,835
Valuation allowance............................................. (200) (350)
----------- -----------
319 1,485
Real estate held-for-investment................................. 28 30
----------- -----------
Real estate, net.............................................. $ 347 $ 15
=========== ===========
Listed below is a summary of the activity in the general valuation
allowance for real estate owned for the periods indicated (in thousands):
Balance at December 31, 1998.......................................... $ 500
Recovery of losses on REO............................................. (54)
Charge-offs........................................................... (96)
-------
Balance at December 31, 1999.......................................... 350
Provision for losses on REO........................................... --
Charge-offs........................................................... --
-------
Balance at December 31, 2000.......................................... 350
Provision for losses on REO........................................... --
Charge-offs........................................................... --
-------
Balance at December 31, 2001.......................................... 350
Reversal of valuation allowance....................................... (150)
Charge-offs........................................................... --
-------
Balance at December 31, 2002.......................................... $ 200
=======
57
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) Real Estate (continued)
The following table summarizes real estate operations, net:
For the Years Ended December 31,
------------------------------------
2002 2001 2000
----------- -------- ---------
(In thousands)
Net income (loss) from operations:
Gain on sales of REO........................................ $ 765 $ 1,501 $ 949
Other REO operations........................................ (426) (1,197) (355)
---------- -------- --------
Real estate operations, net ............................. $ 339 $ 304 $ 594
========== ======== ========
The Bank acquired $1,881,000, $5,135,000 and $5,050,000 of real estate in
settlement of loans during 2002, 2001 and 2000, respectively.
(6) Office Properties, Equipment and Lease Commitments
Office properties and equipment, at cost, less accumulated depreciation and
amortization, are summarized as follows:
At December 31,
-----------------------
2002 2001
---------- ---------
(In thousands)
Land............................................................... $ 3,861 $ 3,361
Office buildings................................................... 5,348 5,615
Furniture, fixtures and equipment.................................. 16,815 15,101
Leasehold improvements............................................. 10,478 10,386
Other.............................................................. 541 56
--------- --------
37,043 34,519
Less accumulated depreciation and amortization..................... 26,701 23,697
--------- --------
$ 10,342 $ 10,822
========= ========
The Bank is obligated under non-cancelable operating leases for periods
ranging from five to thirty years. The leases are for certain of the Bank's
office facilities. Approximately half of the leases for office facilities
contain five and ten year renewal options. Minimum rental commitments at
December 31, 2002 under all non-cancelable leases are as follows (in thousands):
2003....................................$ 4,324
2004.................................... 3,868
2005.................................... 3,629
2006.................................... 3,369
2007.................................... 3,157
Thereafter.............................. 21,887
---------
$ 40,234
=========
Rent payments under these leases were $4,665,000, $4,309,000 and $4,278,000
for 2002, 2001 and 2000, respectively. Certain leases require the Bank to pay
property taxes and insurance. Additionally, certain leases have rent escalation
clauses based on specified indices.
58
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) Federal Home Loan Bank Stock
The Bank's investment in FHLB stock at December 31, 2002 and 2001 was
$78,728,000 and $91,713,000, respectively. The FHLB provides a central credit
facility for member institutions. As a member of the FHLB system, the Bank is
required to own capital stock in the FHLBSF in an amount at least equal to the
greater of 1% of the aggregate principal amount of its unpaid home loans, home
purchase contracts and similar obligations at the end of each calendar year,
assuming for such purposes that at least 30% of its assets were home mortgage
loans, or 5% of its advances (borrowings) from the FHLB. The Bank was in
compliance with this requirement at December 31, 2002. The Bank's investment in
FHLB stock was pledged as collateral for advances from the FHLB at December 31,
2002 and 2001. The fair value of the Bank's FHLB stock approximates book value
due to the Bank's ability to redeem such stock with the FHLB at par value.
Accrued dividends on FHLB stock totaled $1,054,000 and $1,173,000 at December
31, 2002 and December 31, 2001, respectively.
(8) Deposits
Deposit account balances are summarized as follows:
At December 31,
---------------------------------------------
2002 2001
-------------------- --------------------
Amount % Amount %
----------- ----- ----------- -----
(Dollars in thousands)
Variable rate non-term accounts:
Money market deposit accounts (weighted average
rate of 2.13% and 2.76%)................... $ 1,079,278 43% $ 741,978 29%
Interest-bearing checking accounts (weighted
average rate of 0.43% and 0.72%)........... 174,802 7 162,309 7
Passbook accounts (weighted average rate of 1.34%
and 1.59%)................................. 111,844 4 104,488 4
Non-interest bearing checking accounts......... 239,695 9 205,597 8
----------- ----- ----------- ----
1,605,619 63 1,214,372 48
----------- ----- ----------- ----
Fixed-rate term certificate accounts:
Under six-month term (weighted average rate of
1.54% and 2.57%)........................... 37,630 1 54,626 2
Six-month term (weighted average rate of 1.95% and
3.29%)..................................... 104,600 4 246,161 10
Nine-month term (weighted average rate of 2.76% and
3.98%)..................................... 101,980 4 170,190 7
One year to 18-month term (weighted average rate of
2.63% and 4.45%)........................... 331,308 14 469,113 18
Two year or 30-month term (weighted average rate of
3.55% and 5.38%)........................... 41,460 2 45,993 2
Over 30-month term (weighted average rate of
4.49% and 5.31%)........................... 94,927 4 39,938 1
Negotiable certificates of $100,000 and greater, 30
day to one year terms (weighted average rate of
2.32% and 3.84%)........................... 209,502 8 306,254 12
----------- ----- ----------- ----
921,407 37 1,332,275 52
----------- ----- ----------- ----
Total deposits (weighted average rate of 1.98% and
3.02%)..................................... $ 2,527,026 100% $ 2,546,647 100%
=========== ===== =========== ====
59
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) Deposits (continued)
Certificates of deposit, placed through four major national brokerage
firms, totaled $161,273,000 and $356,819,000 at December 31, 2002 and 2001,
respectively.
Cash payments for interest on deposits (including interest credited)
totaled $65,830,000, $96,482,000 and $97,624,000 during 2002, 2001 and 2000,
respectively. Accrued interest on deposits at December 31, 2002 and 2001 totaled
$3,899,000 and $8,921,000, respectively, and is included in accrued expenses and
other liabilities in the accompanying Consolidated Statements of Financial
Condition.
Certificates of deposit of $100,000 or more amounted to $209,502,000 and
$306,254,000 at December 31, 2002 and December 31, 2001, respectively.
The following table indicates the maturities and weighted average interest
rates of the Bank's deposits at December 31, 2002:
Non-Term There-
Accounts 2003 2004 2005 2006 after Total
--------- -------- ------- ------- ------ ------ -----------
(Dollars in thousands)
Deposits at
December 31, 2002....... $1,605,619 $794,671 $52,397 $63,805 $2,623 $7,911 $2,527,026
========== ======== ======= ======= ====== ====== ==========
Weighted average
interest rates.......... 1.57% 2.47% 3.67% 4.34% 4.54% 4.28% 1.98%
Interest expense on deposits is summarized as follows:
For the Years Ended December 31,
------------------------------------------
2002 2001 2000
----------- ----------- ------------
(In thousands)
Passbook accounts................................................... $ 1,559 $ 1,443 $ 1,611
Money market deposits and interest-bearing checking accounts........ 24,024 24,929 24,709
Certificate accounts................................................ 35,225 68,196 73,854
---------- ----------- ----------
$ 60,808 $ 94,568 $ 100,174
========== =========== ==========
60
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) Federal Home Loan Bank Advances
Federal Home Loan Bank (FHLB) advances consist of the following at December
31, for the years indicated:
2002 2001
----------- -----------
(In thousands)
Advances from the FHLB of San Francisco with a weighted average interest
rate of 3.90% and 5.01%, respectively, secured by FHLB stock and certain
real estate loans with unpaid principal balances of approximately $3.0
billion at December 31, 2002,
advances mature through 2010............................... $1,167,000 $1,597,000
---------- ----------
$1,167,000 $1,597,000
At December 31, 2002 and 2001, accrued interest payable on FHLB advances
totaled $125,000 and $219,000, respectively, which is included in accrued
expenses and other liabilities in the accompanying Consolidated Statements of
Financial Condition.
The Bank has a credit facility with the FHLB in the form of advances and
lines of credit which allow borrowings up to 50% of the Bank's assets, as
computed for regulatory purposes, or approximately $2,126,865,000 at December
31, 2002, with terms up to 30 years.
The following is a summary of FHLB advance maturities at December 31, 2002
(in thousands):
2003...................................$ 427,000
2004................................... 285,000
2005................................... 160,000
2006................................... 175,000
2007................................... 85,000
2008................................... 10,000
2009................................... 5,000
2010................................... 20,000
---------
$ 1,167,000
=========
Cash payments for interest on borrowings (including reverse repurchase
agreements see Note 10) totaled $67,579,000, $118,194,000 and $77,621,000 during
2002, 2001 and 2000, respectively.
Interest expense on borrowings is comprised of the following for the years
indicated:
For the Years Ended December 31,
----------------------------------------
2002 2001 2000
----------- ----------- ----------
(In thousands)
FHLB Advances............................................... $ 63,253 $ 94,506 $ 85,603
Reverse Repurchase Agreements............................... 3,453 12,346 21,041
Other....................................................... 905 334 (313)
----------- ---------- ----------
$ 67,611 $ 107,186 $ 106,331
=========== ========== ==========
Other interest expense in 2002, 2001 and 2000 includes the additional
accruals and reversals of accrued interest due to the IRS and FTB. See Note 11.
61
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10) Securities Sold Under Agreements to Repurchase
The Bank enters into sales of securities under agreements to repurchase
(reverse repurchase agreements) which require the repurchase of the same
securities. Reverse repurchase agreements are treated as financing arrangements,
and the obligation to repurchase securities sold is reflected as a borrowing in
the Consolidated Statements of Financial Condition. The mortgage-backed
securities underlying the agreements were delivered to the dealer who arranged
the transactions or its trustee.
At December 31, 2002, $155,273,000 in reverse repurchase agreements were
collateralized by mortgages totaling $5,557,000 and mortgage-backed securities
with principal balances totaling $150,331,000 and fair values totaling
$152,398,000. At December 31, 2001, $211,040,000 in reverse repurchase
agreements were collateralized by mortgage-backed securities with principal
balances totaling $221,618,000 and fair values totaling $224,114,000.
The weighted average interest rates for borrowings under reverse repurchase
agreements were 1.61% and 2.66%, respectively, at December 31, 2002 and December
31, 2001.
Securities sold under agreements to repurchase averaged $169,335,000 and
$255,747,000 during 2002 and 2001, respectively, and the maximum amounts
outstanding at any month-end during 2002 and 2001 were $208,367,000 and
$294,110,000 respectively.
The following is a summary of maturities at December 31, 2002 (in
thousands):
Up to 30 days..........................$ 18,257
30 to 90 days.......................... 60,000
Over 90 to 182 days.................... 77,016
-------
$ 155,273
=======
Accrued interest on securities sold under agreements to repurchase which is
included in accrued expenses and other liabilities in the accompanying
Consolidated Statements of Financial Condition was $673,000 and $1,452,000 at
December 31, 2002 and 2001, respectively.
(11) Income Taxes
Income taxes (benefit) consist of the following:
2002 2001 2000
---------- ---------- ---------
(In thousands)
Current:
Federal................................................. $ 32,615 $ 30,305 $ 20,764
State................................................... 10,866 9,889 8,391
-------- -------- -------
43,481 40,194 29,155
-------- -------- -------
Deferred:
Federal................................................. (2,920) (2,492) 722
State................................................... (412) (81) (1,045)
-------- -------- -------
(3,332) (2,573) (323)
-------- -------- -------
Total:
Federal................................................. 29,695 27,813 21,486
State................................................... 10,454 9,808 7,346
-------- -------- -------
$ 40,149 $ 37,621 $ 28,832
======== ======== =======
62
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(11) Income Taxes (continued)
A reconciliation of the statutory federal corporate income tax rate to the
Company's effective income tax rate follows:
At December 31,
---------------------------------------
2002 2001 2000
------------ ---------- ---------
Statutory federal income tax rate ................... 35.0% 35.0% 35.0%
Increase in taxes resulting from:
State franchise tax, net of federal income tax benefit 7.1 7.2 7.3
Core deposit intangibles............................. -- -- 0.3
Other, net........................................... -- 0.6 0.2
---------- ---------- ---------
Effective rate....................................... 42.1% 42.8% 42.8%
========== ========== =========
Cash payments for income taxes totaled $44,257,000, $43,100,000 and
$28,300,000 during 2002, 2001 and 2000, respectively. The Company received cash
refunds totaling $667,000 during 2000. No refunds were received during 2001 or
2002.
Current income taxes receivable were $6,706,000 and $4,377,000 at December
31, 2002 and December 31, 2001, respectively. Current income taxes payable at
December 31, 2000 were $530,000.
Listed below are the significant components of the net deferred tax (asset)
and liability:
At December 31,
--------------------------
2002 2001
----------- -----------
(In thousands)
Components of the deferred tax asset:
Bad debts....................................................... $ (35,307) $ (34,501)
Pension expense................................................. (4,421) (3,901)
State taxes..................................................... (4,093) (3,903)
Other........................................................... (3,129) (2,575)
--------- ----------
Total deferred tax asset...................................... (46,950) (44,880)
--------- ----------
Components of the deferred tax liability:
Loan fees....................................................... 10,304 11,978
Loan sales...................................................... 217 477
FHLB stock dividends............................................ 21,085 20,411
Tax effect of unrealized gain on
securities available-for-sale................................ 1,597 2,170
Other........................................................... 312 313
--------- ---------
Total deferred tax liability.................................. 33,515 35,349
--------- ---------
Net deferred tax asset............................................ $ (13,435) $ (9,531)
========= =========
The Company provides for recognition and measurement of deductible
temporary differences to the extent that it is more likely than not that the
deferred tax asset will be realized. The Company did not have a valuation
allowance for the deferred tax asset at December 31, 2002 or 2001, as it is more
likely than not that the deferred tax asset will be realized through loss
carrybacks and the timing of future reversals of existing temporary differences.
63
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(11) Income Taxes (continued)
The Internal Revenue Service ("IRS") has examined the Company's
consolidated federal income tax returns for tax years up to and including 1996.
The adjustments proposed by the IRS were primarily related to temporary
differences as to the recognition of certain taxable income and expense items.
While the Company had provided for deferred taxes for federal and state
purposes, the change in the period of recognition of certain income and expense
items resulted in interest due to the IRS and FTB. Interest accruals of $876,000
and $300,000 were recorded during 2002 and 2001, respectively for interest on
amended returns. Interest accruals totaling $350,000 were reversed during 2000.
The balance of accrued interest payable for amended returns was $700,000 and
$300,000 as of December 31, 2002 and December 31, 2001, respectively. There was
no balance of accrued interest payable for amended returns as of December 31,
2000.
The Bank is required to use the specific charge-off method of accounting
for bad debts for federal income tax purposes for all periods beginning after
1995. Prior to that date, the Bank used the reserve method of accounting for bad
debts. The Consolidated Statements of Financial Condition at December 31, 2002
and 2001 do not include a liability of $5,356,000 related to the adjusted base
year bad debt reserve. This reserve was created when the Bank was on the reserve
method. During 2002, legislation was passed which requires the Bank to use the
specific charge-off method of accounting for bad debts for state tax purposes.
(12) Stockholders' Equity and Earnings Per Share
The Company's stock charter authorizes 5,000,000 shares of serial preferred
stock. As of December 31, 2002, no preferred shares had been issued.
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations for the years indicated:
For the Year Ended December 31, 2002 For the Year Ended December 31, 2001 For the Year Ended December 31, 2000
------------------------------------ ------------------------------------ ------------------------------------
Weighted Weighted Weighted
Average Average Average
Shares Per Shares Per Shares Per
Earnings Outstanding Share Earnings Outstanding Share Earnings Outstanding Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
--------- ----------- ------- ---------- ------------ -------- ----------- ----------- -------
(Dollars in thousands, except per share amounts)
Basic EPS:
Net earnings.......$ 55,172 17,149,712 $ 3.22 $ 50,302 17,234,591 $ 2.92 $ 38,465 17,251,618 $ 2.23
Diluted EPS:
Net earnings.......$ 55,172 17,149,712 $ 3.22 50,302 17,234,591 2.92 38,465 17,251,618 $ 2.23
Options-common
stock equivalents -- 356,417 -- -- 411,056 -- -- 205,277 --
------- ---------- ------- -------- ---------- ------- -------- ---------- ------
Net earnings.......$ 55,172 17,506,129 $ 3.15 $ 50,302 17,645,647 $ 2.85 $ 38,465 17,456,895 $ 2.20
======= ========== ======= ======== ========== ======= ======== ========== ======
The number of anti-dilutive shares excluded from the weighted average
shares outstanding within the diluted EPS calculation was 118,100, 104,900, and
zero during 2002, 2001 and 2000, respectively.
64
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(12) Stockholders' Equity and Earnings Per Share (continued)
Regulatory Capital
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory - and possibly additional discretionary - actions
by regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about asset risk weightings,
and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to risk
weighted assets (as defined). Management believes that the Bank meets all
capital adequacy requirements to which it is subject as of December 31, 2002.
As of December 31, 2002, the most recent notification from the OTS
indicated that the Bank was well capitalized under the regulatory framework for
prompt corrective action. There are no conditions or events since December 31,
2002 that management believes have changed the Bank's classification.
The following table summarizes the Bank's regulatory capital and required
capital for the years indicated:
December 31, 2002
-----------------------------------------------------------------
Tier 1
Tangible Core Risk-based Risk-based
Capital Capital Capital Capital
------------- ------------ -------------- -------------
(Dollars in thousands)
Actual capital:
Amount....................................$ 341,680 $ 341,680 $ 341,680 $ 374,421
Ratio..................................... 8.05% 8.05% 13.26% 14.53%
FIRREA minimum required capital:
Amount....................................$ 63,643 $ 169,715 $ -- $ 206,142
Ratio..................................... 1.50% 4.00% --% 8.00%
FIRREA well capitalized required capital:
Amount....................................$ -- $ 212,143 $ 154,607 $ 257,678
Ratio..................................... --% 5.00% 6.00% 10.00%
December 31, 2001
-----------------------------------------------------------------
Tier 1 Risk-based
Tangible Core Risk-based Capital
Capital Capital Capital
------------- ------------ -------------- -------------
(Dollars in thousands)
Actual capital:
Amount....................................$ 302,448 $ 302,448 $ 302,448 $ 336,556
Ratio..................................... 6.42% 6.42% 11.24% 12.51%
FIRREA minimum required capital:
Amount....................................$ 70,617 $ 188,522 $ -- $ 215,184
Ratio..................................... 1.50% 4.00% --% 8.00%
FIRREA well capitalized required capital:
Amount....................................$ -- $ 235,391 $ 161,388 $ 268,980
Ratio..................................... --% 5.00% 6.00% 10.00%
65
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(12) Stockholders' Equity and Earnings Per Share (continued)
The payment of dividends is subject to certain federal income tax
consequences. Specifically, the Bank is capable of paying dividends to the
Company in any year without incurring tax liability only if such dividends do
not exceed both the tax basis current year earnings and profits and accumulated
tax earnings and profits as of the beginning of the year.
Thirty days' prior notice to the OTS of the intent to declare dividends is
required for the declaration of such dividends by the Bank. The OTS generally
allows a savings institution which meets its fully phased-in capital
requirements to distribute without OTS approval dividends up to 100% of the
institution's net income for the applicable calendar year plus retained net
income for the two prior calendar years. However, the OTS has the authority to
preclude the declaration of any dividends or adopt more stringent amendments to
its capital regulations.
The Company may loan up to $6,000,000 to the Employee Stock Ownership Plan
("ESOP") under a line of credit loan. At December 31, 2002, the outstanding loan
to the ESOP totaled $553,000. There was no balance outstanding at December 31,
2001. Interest on any outstanding loan balance is due each December 31. Interest
varies based on the Bank's monthly cost of funds. The average rates paid during
2002 and 2001 were 2.93% and 4.79%, respectively.
The Company maintains a Shareholder Rights Plan ("Rights Plan") which is
designed to protect shareholders from attempts to acquire control of the Company
at an inadequate price. Under the Rights Plan, the owner of each share of
Company stock received a dividend of one right ("Right") to purchase one
one-thousandth of a share of a new series of preferred stock for its estimated
long term value of $200. In the event of certain acquisitions of 15% or more of
the voting stock or a tender offer for 15% or more of the voting stock of the
Company, each holder of a Right who exercises such Right will receive shares of
the Company with a market value equal to two times the exercise price of the
Right. Also, in the event of certain business combination transactions following
the acquisition by a person of 15% or more of the Company stock, each Rights
holder will have the right to receive upon exercise of the Right common stock of
the surviving company in such transaction having a market value of two times the
exercise price of the Right. The Company may redeem the Rights at any time prior
to such acquisition or tender offer should the Board of Directors deem
redemption to be in its stockholders' best interests.
(13) Employee Benefit Plans
The Bank maintains a qualified defined contribution plan established under
Section 401 (k) of the Internal Revenue Code, as amended (the "401(k) Plan").
Participants are permitted to make contributions on a pre-tax basis, a portion
of which is matched by the Bank. The 401(k) Plan expense was $310,000, $356,000
and $354,000 for 2002, 2001 and 2000, respectively.
The Bank has a Supplementary Executive Retirement Plan ("SERP") which
covers any individual employed by the Bank as its Chief Executive Officer or
Chief Operating Officer. The pension expense for the SERP was $1,161,000,
$970,000 and $906,000 in 2002, 2001 and 2000, respectively. The SERP is
unfunded.
The discount rates used in determining the actuarial value of benefit
obligations were 6.50% and 7.00%, respectively, as of December 31, 2002 and
2001. The rate of increase in future compensation levels used in determining the
pension cost for the SERP was 4.0% as of December 31, 2002 and 2001. The plan
had no assets at December 31, 2002 or 2001.
66
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) Employee Benefit Plans (continued)
The following table sets forth the funded status of the SERP and amounts
recognized in the Company's Statements of Financial Condition for the years
indicated:
At December 31,
----------------------
2002 2001
---------- --------
(In thousands)
Change in Benefit Obligation
Projected benefit obligation, beginning of the year.................. $ 7,885 $ 6,594
Service cost......................................................... 380 304
Interest cost........................................................ 581 468
Benefits paid........................................................ (287) (287)
Actuarial loss....................................................... 602 806
-------- --------
Projected benefit obligation, end of the year........................ $ 9,161 $ 7,885
======== ========
Change in Plan Assets
Funded status........................................................ $ (9,161) $ (7,885)
Unrecognized transition obligation................................... -- --
Unrecognized prior service cost...................................... 284 419
Unrecognized (gain)/loss............................................. 1,956 1,419
-------- --------
Net amount recognized................................................ $ (6,921) $ (6,047)
======== ========
Components of Net Periodic Benefit Cost
Service cost......................................................... $ 380 $ 304
Interest cost........................................................ 581 467
Amortization of unrecognized transition obligation................... 65 62
Amortization of unrecognized prior service cost...................... 135 135
-------- --------
Pension cost......................................................... $ 1,161 $ 968
======== ========
The projected benefit obligation, accumulated benefit obligation, and fair
value of assets were $9,161,000, $7,255,000, and $0 respectively, at December
31, 2002 and $7,885,000, $6,131,000, and $0, respectively, at December 31, 2001.
The Bank has a profit sharing plan (the "ESOP") for all salaried employees
and officers who have completed one year of continuous service. At December 31,
2002, the ESOP held 5.20% of outstanding stock of the Company. Profit sharing
expense for the years ended December 31, 2002, 2001 and 2000 was $2,024,000,
$2,020,000 and $1,778,000, respectively. The amount of the contribution made by
the Bank is determined each year by the Board of Directors, but is not to exceed
15% of the participants' aggregated compensation. The Bank does not offer
post-retirement benefits under this plan.
Stock Compensation Plans
At December 31, 2002, the Company had two stock-based compensation
programs, which are described below. The Company applies APB Opinion 25 and
related interpretations in accounting for its plans. Accordingly, no
compensation cost has been recognized for its stock compensation plans.
Stock Option Programs
Under the 1994 Stock Option and Stock Appreciation Rights Plan (the "1994
Plan"), the Company may grant options to employees of the Bank for up to
3,000,000 shares of common stock, subject to limitations set forth under the
1994 Plan. Under the 1994 Plan, the exercise price of each option equals the
market value of the Company's stock on the date of the grant, and an option's
maximum term is 10 years. Options typically begin to vest on the second
anniversary date of the grant.
67
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) Employee Benefit Plans (continued)
The Company also has a stock option plan for outside directors, the 1997
Non-employee Directors Stock Incentive Plan (the "Directors Stock Plan"). The
Directors Stock Plan provides for the issuance of up to 400,000 shares of common
stock to non-employee directors of the Company. The exercise price of each
option equals the market value of the Company's stock on the date of the grant,
and an option's maximum term is 10 years plus one month. Options typically vest
100% on the one year anniversary date of the grant.
The following table summarizes information about stock option activity
during the periods indicated:
At December 31,
-------------------------------------
Options Outstanding 2002 2001 2000
---------- --------- ----------
(Weighted average option prices) (In shares)
Beginning of year ($15.51, $12.84 and $12.54) 819,915 796,538 653,742
Granted ($26.75, $31.44 and $13.13)............................. 134,900 127,050 219,275
Exercised ($10.98, $12.22 and $7.04)............................ (33,006) (62,489) (30,656)
Canceled ($20.53, $18.12 and $13.77)............................ (64,127) (41,184) (45,823)
--------- --------- ---------
End of Year ($17.08, $15.51 and $12.84)......................... 857,682 819,915 796,538
========= ========= =========
Shares exercisable at December 31, ($13.41, $11.53 and $11.22).. 407,401 309,808 252,121
========= ========= =========
Additional information with respect to stock options outstanding at
December 31, 2002 follows:
Price Ranges
-------------------------------------------------------------
($5.63 - $14.23) ($14.24 - $22.84) ($22.85- $31.45)
Options outstanding:
Number of outstanding shares.......................... 400,606 230,376 226,700
Weighted-average contractual life .................... 4.71 5.61 8.60
Weighted-average exercise price ...................... $10.62 $16.65 $28.92
Options exercisable:
Number of exercisable shares.......................... 257,506 117,895 32,000
Weighted-average exercise price ...................... $9.60 $16.83 $31.44
Restricted Stock Plan
The Company's 1991 Restricted Stock Plan (the "Restricted Stock Plan")
expired November 20, 2000 pursuant to its terms. Under the Restricted Stock
Plan, the Company issued shares of restricted stock to employees of the Company,
including officers and directors. All shares issued under the Plan to current
employees have been vested. The remaining 43,406 shares which were available for
issuance under the Plan, consisting of previously issued shares reacquired by
the Company, are no longer authorized for issuance under the Plan due to the
Plan's termination. Accordingly, these shares are included in the Company's
treasury stock for 2001.
68
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(14) Parent Company Financial Information
The following condensed parent company financial information should be read
in conjunction with the other Notes to the Consolidated Financial Statements.
CONDENSED STATEMENTS OF FINANCIAL CONDITION
At December 31,
------------------------
2002 2001
--------- -----------
(In thousands)
Assets:
Cash.................................................................... $ 17,947 $ 6,263
Fixed assets............................................................ 259 419
Investment in subsidiary................................................ 353,739 319,276
-------- -----------
$ 371,945 $ 325,958
======== ===========
Liabilities and Stockholders' Equity:
Other liabilities....................................................... 304 280
Stockholders' equity.................................................... 371,641 325,678
-------- -----------
$ 371,945 $ 325,958
======== ===========
Years Ended December 31,
------------------------------------
CONDENSED STATEMENTS OF OPERATIONS AND 2002 2001 2000
COMPREHENSIVE EARNINGS ---------- --------- ---------
(In thousands)
Dividends received from Bank.................................. $ 20,000 $ -- $ 10,000
Equity in undistributed net earnings of subsidiary ........... 35,254 52,007 29,263
Other expense, net............................................ (82) (1,705) (798)
---------- -------- ---------
Net earnings.................................................. 55,172 50,302 38,465
========== ======== =========
Other comprehensive earnings (loss), net of taxes............. (790) 5,149 6,122
---------- -------- ---------
Comprehensive earnings........................................ $ 54,382 $ 55,451 $ 44,587
========== ======== =========
69
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(14) Parent Company Financial Information (continued)
Years Ended December 31,
------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS 2002 2001 2000
---------- --------- ---------
(In thousands)
Net Cash Flows from Operating Activities:
Net earnings................................................ $ 55,172 $ 50,302 $ 38,465
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Equity in undistributed net
net earnings of subsidiary............................. (35,254) (52,007) (29,263)
Depreciation expense...................................... 160 184 89
Other..................................................... 1,035 1,581 --
--------- --------- ---------
Net cash provided by operating activities................. 21,113 60 9,291
--------- --------- ---------
Cash Flows from Investing Activities:
Increase in fixed assets.................................. -- (112) (580)
--------- --------- ---------
Net cash provided by (used in) investing activities....... -- (112) (580)
--------- --------- ---------
Cash Flows from Financing Activities:
Purchase of treasury stock................................ (8,832) -- (10,175)
(Increase) decrease in unreleased shares.................. (597) 841 918
Other..................................................... -- 1,943 988
--------- --------- ---------
Net cash provided by (used in) financing activities........... (9,429) 2,784 (8,269)
--------- --------- ---------
Net increase in cash.......................................... 11,684 2,732 442
Cash at beginning of period................................... 6,263 3,531 3,089
--------- --------- ---------
Cash at end of period......................................... $ 17,947 $ 6,263 $ 3,531
========= ========= =========
70
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(15) Quarterly Results of Operations: (unaudited)
Summarized below are the Company's results of operations on a quarterly
basis for 2002, 2001 and 2000:
Provision Non- Basic Diluted
Interest Interest for Loan Other Interest Net Earnings Earnings
Income Expense Losses Income Expense Earnings per Share per Share
---------- --------- ---------- -------- --------- ---------- ---------- ----------
(In thousands, except per share data)
First quarter
2002................. $ 70,776 $ 36,788 $ -- $ 2,699 $ 15,311 $ 12,368 $ 0.72 $ 0.70
2001................. 88,017 55,865 -- 2,007 12,533 12,373 0.72 0.70
2000................. 71,102 45,122 -- 1,725 12,245 8,835 0.50 0.49
Second quarter
2002................. $ 65,923 $ 32,943 $ -- $ 2,494 $ 14,233 $ 12,287 $ 0.71 $ 0.70
2001................. 87,443 53,881 -- 1,641 13,195 12,592 0.73 0.71
2000................. 76,455 50,288 -- 2,418 12,570 9,351 0.54 0.54
Third quarter
2002................. $ 64,741 $ 31,312 $ -- $ 8,711 $ 14,107 $ 16,226 $ 0.94 $ 0.92
2001................. 81,837 49,397 -- 3,019 13,738 12,427 0.72 0.70
2000................. 81,980 55,290 -- 1,950 12,276 9,497 0.55 0.54
Fourth quarter
2002................. $ 62,438 $ 27,376 $ -- $ 4,170 $ 14,561 $ 14,291 $ 0.84 $ 0.83
2001................. 76,635 42,611 -- 2,252 13,708 12,910 0.75 0.73
2000................. 84,783 55,805 -- 1,654 11,174 10,782 0.63 0.62
Total year
2002................. $ 263,878 $ 128,419 $ -- $ 18,074 $ 58,212 $ 55,172 $ 3.22 $ 3.15
2001................. 333,932 201,754 -- 8,919 53,174 50,302 2.92 2.85
2000................. 314,320 206,505 -- 7,747 48,265 38,465 2.23 2.20
(16) Fair Value of Financial Instruments
The following table presents fair value information for financial
instruments for which a market exists.
At December 31,
----------------------------------------------------------------
2002 2001
------------------------------ ------------------------------
Carrying Carrying Value
Value Fair Value Fair Value
----------- --------------- ------------- -------------
(In thousands)
Mortgage-backed securities $ 200,585 $ 200,585 $ 284,079 $ 284,079
U.S. Government securities .................... 203 203 28,468 28,468
Collateralized mortgage obligations ........... 102,852 102,852 81,976 81,976
Loans held-for-sale ........................... 2,293 2,300 5,246 5,250
71
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(16) Fair Value of Financial Instruments (continued)
The following table presents fair value information for financial
instruments shown in the Company's Consolidated Statements of Financial
Condition for which there is no readily available market. The fair values for
these financial instruments were calculated by discounting expected cash flows.
Because these financial instruments have not been evaluated for possible sale
and because management does not intend to sell these financial instruments, the
Company does not know whether the fair values shown below represent values at
which the respective financial instruments could be sold.
At December 31,
------------------------------------------------------------------
2002 2001
------------------------------ --------------------------------
Calculated Calculated
Historical Fair Value Historical Fair Value
Cost Amount Cost Amount
----------- --------------- ------------- ---------------
(In thousands)
ASSETS
Adjustable loans:
Single family ............................... $ 1,636,398 $ 1,665,635 $ 2,091,298 $ 2,119,245
Multi-family ................................ 1,611,318 1,659,295 1,513,077 1,540,775
Commercial ................................. 383,383 401,772 335,245 347,592
Fixed rate loans:
Single family 22,685 23,290 26,859 27,579
Multi-family ................................ 33,995 35,969 17,716 18,520
Commercial ................................. 37,640 39,916 26,138 27,653
Consumer loans................................. 36,880 36,891 20,797 21,206
Commercial business loans...................... 20,304 20,595 18,882 18,992
Construction loans............................. 6,927 7,150 38,060 38,571
Non-performing loans .......................... 6,722 6,722 6,443 6,443
LIABILITIES
Fixed-term certificate accounts ............... 921,407 934,359 1,332,275 1,347,368
Non-term deposit accounts ..................... 1,605,619 1,605,619 1,214,372 1,214,372
Borrowings .................................... 1,322,273 1,369,329 1,808,040 1,847,196
GAAP specifies that fair values should be calculated based on the value of
one unit. The estimates do not necessarily reflect the price the Company might
receive if it were to sell the entire holding of a particular financial
instrument at one time.
Fair value estimates are based on the following methods and assumptions,
some of which are subjective in nature. Changes in assumptions could
significantly affect the estimates.
Cash and Cash Equivalents
The carrying amounts reported in the Consolidated Statements of Financial
Condition for this item approximate fair value.
Investment Securities and Mortgage-Backed Securities
Fair values are based on bid prices published in financial newspapers or
bid quotations received from national securities dealers.
72
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(16) Fair Value of Financial Instruments (continued)
Loans Receivable
The portfolio is segregated into those loans with adjustable rates of
interest and those with fixed rates of interest. Fair values are based on
discounting future cash flows by the current rate offered for such loans with
similar remaining maturities and credit risk. The amounts so determined for each
loan category are reduced by the Bank's allowance for loans losses which thereby
takes into consideration changes in credit risk. At December 31, 2002, the Bank
had outstanding commitments to fund $239,127,000 in real estate mortgage loans,
$3,037,000 in construction loans and $87,000 in non-mortgage loans. All loan
commitments were substantially at fair value.
Non-performing Loans
The carrying amounts reported in the Consolidated Statements of Financial
Condition for this item approximate fair value.
Deposits
The fair value of deposits with no stated term, such as regular passbook
accounts, money market accounts and checking accounts, is defined by SFAS No.
107 as the carrying amounts reported in the Consolidated Statements of Financial
Condition. The fair value of deposits with a stated maturity, such as
certificates of deposit, is based on discounting future cash flows by the
current rate offered for such deposits with similar remaining maturities.
Borrowings
For short-term borrowings, fair value approximates carrying value. The fair
value of long term borrowings is based on their interest rate characteristics.
For variable rate borrowings, fair value is based on carrying values. For fixed
rate borrowings, fair value is based on discounting future contractual cash
flows by the current interest rate paid on such borrowings with similar
remaining maturities.
73
Independent Auditors' Report
The Board of Directors
FirstFed Financial Corp.:
We have audited the accompanying consolidated statements of financial condition
of FirstFed Financial Corp. and subsidiary (Company) as of December 31, 2002 and
2001 and the related consolidated statements of operations and comprehensive
earnings, stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 2002. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with 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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of FirstFed Financial
Corp. and subsidiary as of December 31, 2002 and 2001 and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2002 in conformity with accounting principles generally
accepted in the United States of America.
KPMG LLP
Los Angeles, California
January 29, 2003
74
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers appearing on pages 4
through 7 of the Proxy Statement for the Annual Meeting of Stockholders' to be
held April 23, 2003 (the "Proxy Statement") is incorporated herein by reference.
ITEM 11 -- EXECUTIVE COMPENSATION
Information regarding executive compensation appearing on pages 8 through
15 of the Proxy Statement is incorporated herein by reference.
ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and
management appearing on pages 2 and 3 of the Proxy Statement incorporated herein
by reference. Information regarding securities authorized for issuance under
equity compensation plans appearing on page 12 of the Proxy Statement is
incorporated herein by reference.
ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions
appearing on pages 10 through 11 of the Proxy Statement is incorporated herein
by reference.
ITEM 14 -- CONTROLS AND PROCEDURES
(a) Under the supervision and with the participation of the Company's
management, including its principal executive officer and principal
accounting officer, the Company conducted an evaluation of its disclosure
controls and procedures, as such term is defined under Rule 13a-14(c)
promulgated under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), within 90 days of the filing date of this report. Based on
their evaluation, the Company's principal executive officer and principal
accounting officer concluded that the Company's disclosure controls and
procedures are effective.
(b) There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced in paragraph (a) above.
75
PART IV
ITEM 15 -- EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8K
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
EXHIBIT
NUMBER
-------------
(3.1)Restated Certificate of Incorporation filed as Exhibit 3.1 to Form 10-K
for the fiscal year ended December 31, 1999 and incorporated by reference.
(3.2)By-laws filed as Exhibit (1)(a) to Form 8-A dated September 4,1987 and
incorporated by reference.
(4.1)Amended and Restated Rights Agreement dated as of September 25, 1998,
filed as Exhibit 4.1 to Form 8-A/A, dated September 25, 1998 and
incorporated by reference.
(10.1)Deferred Compensation Plan filed as Exhibit 10.3 to Form 10-K for the
fiscal year ended December 31, 1983 and incorporated by reference.
(10.2)Supplemental Executive Retirement Plan dated January 16, 1986 filed as
Exhibit 10.5 to Form 10-K for the fiscal year ended December 31, 1992 and
incorporated by reference.
(10.3)Change of Control Agreement effective September 26, 1996 filed as Exhibit
10.4 to Form 10-Q for the Quarter ended September 30, 1996 and Amendment
filed as Exhibit 10.3 10.4 for change of control to Form 10-Q for the
Quarter ended September 30, 2000 and incorporated by reference.
(10.4)1997 Non-employee Directors Stock Incentive Plan filed as Exhibit 1 to
Form S-8 dated August 12, 1997 and Amendment filed as Exhibit 10.5 to Form
10-Q for the Quarter ended September 30, 2000, and incorporated by
reference. (21) Registrant's sole subsidiary is First Federal Bank of
California, a federal savings bank. (23) Independent Auditors' consent.
(24) Power of Attorney (included at page 78).
(99.1) Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 for Babette E. Heimbuch.
(99.2) Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 for Douglas J. Goddard.
This 2002 Annual Report on Form 10-K and the Proxy Statement have already
been furnished to each stockholder of record who is entitled to receive copies
thereof. Copies of these items will be furnished without charge upon request in
writing by any stockholder of record on March 7, 2003 and any beneficial owner
of Company stock on such date who has not previously received such material and
who so represents in good faith and in writing to:
Corporate Secretary
FirstFed Financial Corp.
401 Wilshire Boulevard
Santa Monica, California 90401
Other exhibits will be supplied to any such stockholder at a charge equal
to the Company's cost of copying, postage, and handling.
(b) Reports on Form 8-K
The Company filed reports on Form 8-K during the quarter ended December 31,
2002 on the following dates: October 25, 2002, November 15, 2002, November 19,
2002, and December 18, 2002. The November 15, 2002 8-K announced the expansion
of the Company's stock repurchase program. The remaining reports are related to
the release of the Company's third quarter earnings and the disclosure of
certain other financial data.
76
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
FIRSTFED FINANCIAL CORP.,
a Delaware corporation
Dated this 26th day of February 2003
By: /s/ Babette E. Heimbuch
-----------------------
Babette E. Heimbuch
Chief Executive Officer
77
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes Babette E.
Heimbuch and Douglas J. Goddard, and each of them or either of them, as
attorney-in-fact to sign on his or her behalf as an individual and in every
capacity stated below, and to file all amendments to the Registrant's Form 10-K,
and the Registrant hereby confers like authority to sign and file in its behalf.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has be signed by the following persons on behalf of the Registrant and in
the capacities indicated on the 26th day of February 2003.
SIGNATURE TITLE
Chairman of the Board and
/s/ Babette E. Heimbuch Chief Executive Officer (Principal Executive Officer)
- ----------------------------------------
Babette E. Heimbuch
/s/ James P. Giraldin Director, President and Chief Operating Officer
- ----------------------------------------
James P. Giraldin
/s/ Douglas J. Goddard Executive Vice President and Chief Financial Officer
- ----------------------------------------
Douglas J. Goddard (Principal Financial Officer)
/s/ Brenda J. Battey Senior Vice President and Controller
- ----------------------------------------
Brenda J. Battey (Principal Accounting Officer)
/s/ Christopher M. Harding Director
- ----------------------------------------
Christopher M. Harding
/s/ James L. Hesburgh Director
- ----------------------------------------
James L. Hesburgh
/s/ William G. Ouchi Director
- ----------------------------------------
William G. Ouchi
/s/ William P. Rutledge Director
- ----------------------------------------
William P. Rutledge
/s/ Charles F. Smith Director
- ----------------------------------------
Charles F. Smith
/s/ Steven L. Soboroff Director
- ----------------------------------------
Steven L. Soboroff
/s/ John R. Woodhull Director
- ----------------------------------------
John R. Woodhull
78
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Babette Heimbuch, certify that:
(1) I have reviewed this annual report on Form 10-K of FirstFed Financial
Corp.;
(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 officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(i) 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;
(ii) 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
(iii)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 officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons fulfilling
the equivalent function):
(i) 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
(ii) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
(6) The registrant's other certifying officers and I have indicated in this
annual report whether or not 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 actions with regard to significant deficiencies and material
weaknesses.
Dated this 26th day of February 2003
By: /s/ Babette E. Heimbuch
------------------------
Babette E. Heimbuch
Chief Executive Officer
79
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Douglas Goddard, certify that:
(1) I have reviewed this annual report on Form 10-K of FirstFed Financial
Corp.;
(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 officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(i) 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;
(ii) 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
(iii) 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 officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons fulfilling the
equivalent function):
(i) 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
(ii) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
(6) The registrant's other certifying officers and I have indicated in this
annual report whether or not 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 actions with regard to significant deficiencies and material
weaknesses.
Dated this 26th day of February 2003.
By: /s/ Douglas Goddard
--------------------
Douglas Goddard
Chief Financial Officer
80
EXHIBIT 99.1
Exhibit 99.1
CEO CERTIFICATION
The undersigned, as Chief Executive Officer hereby certifies, to the best of her
knowledge and belief, that:
(1) the Form 10-K of FirstFed Financial Corp. (the "Company") for the
annual period ended December 31, 2003 (the "Report ") accompanying
this certification fully complies with the requirements of Section
13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m
or 78o(d)); and
(2) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company for such period.
This certification is made solely for purposes of complying with the provisions
of Section 906 of the Sarbanes-Oxley Act of 2003, 18 U.S.C. Section 1350.
FIRSTFED FINANCIAL CORP.
Registrant
Date: February 26, 2003
By: /s/ Babette E. Heimbuch
------------------------
Babette E. Heimbuch
Chief Executive Officer
81
EXHIBIT 99.2
Exhibit 99.2
CFO CERTIFICATION
The undersigned, as Chief Financial Officer hereby certifies, to the best of his
knowledge and belief, that:
(1) the Form 10-K of FirstFed Financial Corp. (the "Company") for the
annual period ended December 31, 2003 (the "Report ") accompanying
this certification fully complies with the requirements of Section
13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m
or 78o(d)); and
(2) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company for such period.
This certification is made solely for purposes of complying with the provisions
of Section 906 of the Sarbanes-Oxley Act of 2003, 18 U.S.C. Section 1350.
FIRSTFED FINANCIAL CORP.
Registrant
Date: February 26, 2003
By: /s/ Douglas J. Goddard
----------------------
Douglas J. Goddard
Chief Financial Officer and
Executive Vice President
82