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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, 2004
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 [ ]
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 [ ]
The approximate aggregate market value of the voting stock held by
non-affiliates of the Registrant as of June 30, 2004 was $619,287,000, based on
the closing sales price of the Registrant's common stock on the New York Stock
Exchange on such date of $41.60 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 1, 2005: 16,501,830.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Annual Meeting of Stockholders to be held
April 20, 2005 ("Proxy Statement"), (Parts II, III & IV).
Disclosure Regarding Forward-looking Statements
This Annual Report on Form 10-K for the year ended December 31, 2004
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 Consolidated Balance
Sheets and Consolidated Statements of Income................ 26
Item 7a. Quantitative and Qualitative Disclosures About Market Risk.. 39
Item 8. Financial Statements and Supplementary Data................. 43
Notes to Consolidated Financial Statements.................. 47
Report of Independent Registered Public Accounting Firm..... 73
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure......................... 75
Item 9a. Controls and Procedures..................................... 75
Part III Item 10. Directors and Executive Officers of the Registrant.......... 78
Item 11. Executive Compensation...................................... 78
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 78
Item 13. Certain Relationships and Related Transactions.............. 78
Item 14. Principal Accounting Fees and Services...................... 78
Part IV Item 15. Exhibits, Consolidated Financial Statement
Schedules, and Reports on Form 8K........................... 79
Signatures...................................................................... 80
Power of Attorney............................................................... 81
Exhibits
16 Exhibit 99.1 of Form 8-K filed September 9, 2004........................... 82
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002........................................ 83
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002........................................ 84
32.1 Certification of Chief Executive Officer pursuant to 18 USC Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.................................................................... 85
32.2 Certification of Chief Financial Officer pursuant to 18 USC Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002................................................. 86
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 income 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 executive offices of the Company
are located at 401 Wilshire Boulevard, Santa Monica, California, telephone
number (310) 319-6000.
The Company is a savings and loan holding company and as such is subject to
examination and regulation by the Office of Thrift Supervision ("OTS"). Our
deposits are insured by the Savings Association Insurance Fund ("SAIF") of the
Federal Deposit Insurance Corporation (the "FDIC"). We are regulated by the
Director of the OTS and the FDIC. We are a member of the Federal Home Loan Bank
("FHLB") of San Francisco, which is one of the 12 regional banks comprising the
Federal Home Loan Bank System. We are also subject to certain regulations of the
Board of Governors of the Federal Reserve System ("FRB") with respect to
reserves required to be maintained against deposits and certain other matters.
See "--Summary of Material Legislation and Regulations--"
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.
Our principal business is attracting checking and savings deposits from the
general public, and using such deposits, together with borrowings and other
funds, to make real estate, business and consumer loans.
At December 31, 2004, the Company had assets totaling $7.5 billion,
compared to $4.8 billion at December 31, 2003 and $4.3 billion at December 31,
2002. The Company recorded net income of $65.8 million for 2004, compared to
$64.5 million for 2003 and $55.2 million for 2002.
We derive our revenues principally from interest on loans and investments
and loan origination fees. Our major items of expense are interest on deposits
and borrowings, and general and administrative expense.
As of February 15, 2005, we operated 29 full-service banking branches, all
located in Southern California. Permission to operate full-service branches is
granted by the OTS. In addition to these branches, we operate 4 lending offices,
a call center which conducts transactions with deposit and loan customers by
telephone and an internet website through which customers can perform transfers
and pay bills.
Southern California has traditionally been our primary lending area. In
2004 we increased our level of residential originations in Northern California.
The majority of our residential loans are obtained from wholesale loan brokers.
Residential loans are also offered by all of our full-service branches. In
addition, we have an income property lending group and a commercial banking
group.
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--"
In February of 2004, the Bank received approval to begin trust operations.
We believe that the services offered by the new trust division complement the
other services currently offered.
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, local housing demand and affordability, and general levels of
interest rates.
4
According to the UCLA Anderson Forecast for California, December 2004
Report, the median home price in the state increased 21% from the previous year.
UCLA forecasters and other economists have recently warned that the residential
real estate market in the U.S. is in a "bubble", which means that market
fundamentals and actual home prices have diverged because market activity is
primarily a function of price speculation rather than careful consideration of
the economics of a situation.
At this time, no one can say with certainty that we are in a housing
bubble. There is evidence to justify the appreciation to date (availability of
reasonably-priced financing, tight housing supply in certain areas and stable
employment) and there is evidence to suggest that the market is overheated
(increasing inventories in certain areas, decreasing rents, and historically low
cap rates on apartments).
We continuously monitor the sufficiency of the collateral supporting our
real estate loan portfolio based on many factors including the property
location, the date of loan origination and the original loan-to-value ratio.
Business loans collateralized by inventory, accounts receivable and/or
other assets are monitored on a monthly or quarterly basis through the provision
of reports by the borrower. Site visits are required at loan origination and
periodically thereafter.
We adjust our general allowance for loan losses as a result of these
evaluations and the level of growth in the loan portfolio. During 2004, we
recorded a $3.0 million provision for loan losses. No provision for loan losses
was recorded during 2003 or 2002.
The ratio of allowances for loan losses (general valuation allowances and
valuation allowances for impaired loans) to gross loans receivable was 1.15% at
the end of 2004 compared to 1.70% at the end of 2003 and 1.96% at the end of
2002. The change in the ratio over the last three years is due to variations in
gross loans outstanding and changes to risk factors for various segments of the
portfolio. See "--Business - Loan Loss Allowance--" for additional information.
Consistent with the current favorable real estate climate in California,
our non-performing assets fell to 0.07% of total assets at the end of 2004 from
0.10% of total assets at the end of 2003 and 0.17% of total assets at the end of
2002.
Loans sold with recourse are separately evaluated for loan losses. See
"--Business - Loan Loss Allowance--" for additional information regarding the
repurchase liability for these loans.
Current Interest Rate Environment. The Federal Reserve Board ("FRB")
increased interest rates five times during 2004, decreased interest rates once
during 2003 and decreased interest rates once during 2002. Through February
2005, the FRB has increased interest rates once.
Typically, our interest rate spread decreases in an increasing interest
rate environment, (savings and borrowing costs increase quickly while the loan
portfolio yield increases more slowly). The reverse is true during periods of
decreasing interest rates. Our loan portfolio tends to grow in an increasing
interest rate environment due to borrower preference for adjustable rate loans.
Adjustable rate loans comprised 99% of loan originations during 2004.
Changes in interest rates impact our portfolio yield due to the interest
rate adjustment features of our loans. There is also a time lag before changes
in interest rates can be implemented with respect to our real estate loan
portfolio due to operational and regulatory constraints. These constraints do
not allow us to implement monthly changes in the indicies utilized for
adjustable rate loan customers for periods of sixty to ninety days.
Our interest rate spread decreased to 2.68% in 2004 from 3.22% in 2003 and
2.92% in 2002. The yield on our loan portfolio decreased by more than the cost
of our deposits and borrowings. Although interest rates generally increased
during 2004, interest rates earned and paid in 2004 were lower than 2003 due to
the time lags mentioned above. See "Asset-Liability Management" and "Components
of Earnings - Net Interest Income" in "--Management's Discussion and Analysis of
Consolidated Balance Sheets and Consolidated Statements of Income--" for
additional information.
Competition. We experience strong competition in attracting and retaining
deposits and originating real estate and business loans. We compete for deposits
with many of the nation's largest savings institutions and commercial banks that
have significant operations in Southern California.
5
We also compete 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,
our ability to attract and retain deposits depends upon the quality and variety
of services offered, the convenience of our locations and our financial strength
as perceived by depositors.
We compete for loans primarily with savings institutions, commercial banks,
mortgage companies and insurance companies. Commercial banks are our primary
competition for business loans. 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 actively
participating in the management or operation of properties securing its loans,
we could have liability for 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. We have
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). We also
require 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. Our policies are also designed to avoid the potential for
liability imposed on lenders who assume the management of a property.
Business Concentration. We have 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 our operations or earnings prospects.
Yields Earned and Rates Paid. Net interest income, the major component of
core income for us, 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 Consolidated Balance Sheets and
Consolidated Statements of Income - Overview and Components of Income - Net
Interest Income--" for further analysis and discussion.
Lending Activities
General. Our 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 property owners on 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 the loan portfolio composition and an analysis of the
types of loans originated, see "--Management's Discussion and Analysis of
Consolidated Balance Sheets and Consolidated Statements of Income - Balance
Sheet Analysis - Loan Portfolio and Loan Composition--"
Origination and Sale of Loans. We obtain qualified loan applicants from
mortgage brokers, borrower referrals, and the clients of our full-service
banking branches.
Loan originations were $3.9 billion in 2004, $2.3 billion in 2003, and $1.3
billion in 2002. Loan origination volume increased due to borrower preference
for adjustable rate loans in the increasing rate environment and because we
marketed our adjustable rate loans to more loan brokers. We also widened our
geographic area and introduced new products to better compete for such loans in
the current environment.
Loans sold totaled $3.3 million in 2004, $86.1 million in 2003 and $134.2
million in 2002. For the year ended December 31, 2004, $2.8 million in loans
were originated for sale compared to $84.3 million in 2003 and $103.7 million in
2002. Loans originated for sale totaled 0.07%, 4% and 8% of loan originations
during 2004, 2003 and 2002, respectively. We originate 30-year and 15-year fixed
rate loans only for resale to the secondary markets.
Loans held-for-sale at December 31, 2004, 2003 and 2002 were $0, $492
thousand and $2.3 million. 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 we may be exposed to price adjustments as a
result of fluctuations in market interest rates.
6
From time to time, mortgage-backed securities are formed with loans from
our loan portfolio. The securities are used 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 ("Fannie Mae"). Since we originated the loans underlying our
mortgage-backed securities, the mortgage-backed securities generally have the
same experience with respect to prepayment, repayment, delinquencies and other
factors as our loan portfolio.
The portfolio of mortgage-backed securities, classified as
available-for-sale, was recorded at fair value as of December 31, 2004, 2003 and
2002. Unrealized gains of $420 thousand, $965 thousand and $1.6 million, net of
tax, were recorded in stockholders' equity at December 31, 2004, 2003 and 2002,
respectively.
We serviced $102.5 million in loans for other investors as of December 31,
2004, $76.3 million of which were sold under recourse arrangements. $5.7 million
of the loans sold with recourse were formed into mortgage-backed securities and
are still owned by us as of December 31, 2004. Due to regulatory requirements,
we maintain capital for loans sold with recourse as if those loans had not been
sold. Loans sold with recourse are analyzed in determining the adequacy of the
repurchase liability. The principal balance of loans sold with recourse
decreased to $76.3 million at the end of 2004 from $91.0 million at the end of
2003 and $108.6 million at the end of 2002 due to loan amortization and payoffs.
In January of 2005, we completed a loan securitization with Fannie Mae in
which $1.3 billion in multi-family loans from our loan portfolio were formed
into mortgage-backed securities. Because we retained full recourse on the
securitized loans, the mortgage-backed securities will continue to be accounted
for as part of the loan portfolio under Statement of Financial Accounting
Standards No. 140, Accounting for and Servicing of Financial Assets and
Extinguishments of Liabilities. These mortgage-backed securities will also be
used in collateralized borrowing arrangements.
Interest Rates, Terms and Fees. We originate residential adjustable
mortgage loans ("AMLs") with 30 and 40 year terms and interest rates which
adjust each month based upon various indicies. The indices used include the
Federal Home Loan Bank's Eleventh District Cost of Funds Index ("COFI"), the
12-month average U.S. Treasury Security rate ("12MAT"), the London Interbank
Offered Rate ("LIBOR") and, the 3-month certificate of deposit Index ("CODI").
The CODI index is the monthly yield on 3-month certificate of deposits as
published by the Federal Reserve Bank and is a simple average based upon the 12
most recent months of data. Commercial business loans are generally based on
prime. Most loans originated during 2004 have interest rates which adjust
monthly based on the CODI index. CODI loans were 69% of loans originated during
2004. (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 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 Payments may also be adjusted more frequently if certain levels of negative
amortization occur. 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 our credit standards and enters into a separate written agreement with us.
Additionally, the new borrower is required to pay assumption fees customarily
charged for similar transactions.
We also originate adjustable rate loans with initial fixed interest rates
for periods ranging from 3 to 10 years ("hybrid" loans). By policy, we 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 our portfolio up to 5% of
total assets. Loans originated under this program totaled $4.5 million in 2004,
$434.3 million in 2003 and $419.7 million in 2002. Originations of adjustable
rate loans with initial fixed interest rates declined during 2004 because
management decided to focus on the origination of monthly adjustable loans.
Under current portfolio loan programs, we normally lend no more than 95% of
a single-family property's appraised value at the time of loan origination.
There are special Community Reinvestment Act loan programs in which we lend up
to 97% of the property's appraised value. Because AML loan-to-value ratios may
increase above those established at the time of loan origination due to negative
amortization, we rarely lend in excess of 90% of the appraised value on AMLs.
When we do lend in excess of 90% of the appraised value, additional fees and
higher rates are charged. The amount of negative amortization increases during
periods of rising interest rates. At December 31, 2004, 2003 and 2002, negative
amortization on all loans totaled $5.6 million, $4.0 million and $7.8 million,
respectively.
7
We generally require that borrowers obtain private mortgage insurance on
loans in excess of 80% of the appraised property value. On certain loans
originated for the portfolio, we charge premium rates and/or fees in exchange
for waiving the insurance requirement. Management believes that the additional
rates and fees that we receive for these loans compensate for the additional
risk associated with this type of loan. Subsequent to the origination of a
portfolio loan, we may purchase private mortgage insurance with our own funds.
Under certain mortgage insurance programs we act as co-insurer and participate
with the insurer in absorbing any future loss. As of December 31, 2004, 2003 and
2002, loans with co-insurance totaled $193.9 million, $52.3 million and $106.6
million, respectively. Loans with initial loan-to-value ratios greater than 80%
with no private mortgage insurance totaled $812.7 million at December 31, 2004,
$486.7 million at December 31, 2003 and $159.7 million at December 31, 2002.
Although regulations permit a maximum loan term of 40 years for real estate
secured loans, the majority of our real estate loans provide for a maximum
maturity period of 30 years or less. Loans with 40-year terms constituted 27%,
8% and 6% of loan originations during 2004, 2003 and 2002, respectively. The
increase in loans with 40-year terms was attributable to increased marketing
efforts for this product as a response to the decreased "affordability" of
houses in our market area.
The following table shows the contractual remaining maturities of our
loans at December 31, 2004:
Loan Maturity Analysis
Maturity Period
--------------------------------------------------------------------------
Total 1 Year > 1 Year > 5-10 > 10-20 > 20-30
Balance or Less to 5 Years Years Years Years > 30 Years
------- ------- -------- ------- -------- ------- -------
(In thousands)
Interest rate sensitive
loans:
AMLs....................$ 6,708,887 $ 104,646 $ 773,205 $ 542,578 $ 1,226,945 $ 2,927,801 $ 1,133,712
Fixed rate loans........ 36,487 6,169 18,500 3,997 4,981 2,726 114
Commercial business
loans.................. 58,157 16,597 41,560 -- -- -- --
Construction loans...... 19,690 5,411 14,279 -- -- -- --
Consumer and other loans 59,515 17,005 42,510 -- -- -- --
------- ------- ------- ------- -------- --------- ---------
Total.....................$ 6,882,736 $ 149,828 $ 890,054 $ 546,575 $ 1,231,926 $ 2,930,527 $ 1,133,826
========= ======= ======= ======= ========= ========= =========
Non-accrual, Past Due, Impaired and Restructured Loans
We establish 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, at each of the
periods indicated:
% of % of % of % of % of
2004 Total 2003 Total 2002 Total 2001 Total 2000 Total
------ ----- ------ ----- ------ ----- ----- ---- ----- ----
(Dollars in thousands)
Non-accrual loans:
Single family... $ 4,590 92% $ 3,326 99% $ 5,705 85% $ 6,062 93% $ 5,603 89%
Multi-family.... 391 8 -- -- 1,017 15 422 6 662 11
Commercial...... -- -- -- -- -- -- -- -- -- --
Consumer........ 4 -- 16 1 -- -- 16 1 -- --
------ ----- ------ ----- ------ ----- ----- ---- ----- ----
Total non-accrual
loans.......... $ 4,985 100% $ 3,342 100% $ 6,722 100% $ 6,500 100% $ 6,265 100%
====== ===== ====== ===== ====== ===== ===== ==== ===== ====
The allowance for delinquent interest, based on loans past due more than 90
days or in foreclosure, totaled $256 thousand, $227 thousand, $372 thousand,
$504 thousand and $511 thousand at December 31, 2004, 2003, 2002, 2001 and 2000,
respectively.
8
Our modified loans result primarily from temporary modifications of
principal and interest payments or an extension of maturity dates. 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, 2004, the Bank had modified loans totaling $1.4
million. This compares with modified loans totaling $1.5 million as of December
31, 2003 and $1.6 million as of December 31, 2002. No modified loans were 90
days or more delinquent as of December 31, 2004, 2003 or 2002.
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.
We consider a loan to be impaired when management believes that we will be
unable to collect all amounts due under the contractual terms of the loan
agreement. In accordance with SFAS 114, we annually evaluate 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, we measure 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 our impairment allowances.
Valuation allowances for impaired loans totaled $496 thousand at December
31, 2004, 2003 and 2002. The following is a summary of impaired loans, net of
valuation allowances for impairment, at the dates indicated:
At December 31,
--------------------------------
2004 2003 2002
--------- -------- -------
(In thousands)
Non-accrual loans...................... $ -- $ 1,782 $ --
Modified loans......................... 1,360 1,488 1,567
--------- -------- -------
$ 1,360 $ 3,270 $ 1,567
========= ======== =======
All impaired non-accrual loans as of December 31, 2004, December 31, 2003
and December 31, 2002 were single-family loans.
The present value of an impaired loan's expected future cash flows changes
from one reporting period to the next because of the passage of time and also
because of revised estimates in the amount or timing of those cash flows. We
record 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. We also record 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 our valuation allowance for
impaired loans during the periods indicated (in thousands):
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 to general valuation allowance....... (1,354)
-------
Balance at December 31, 2002.................... 496
Net charge-offs............................... --
-------
Balance at December 31, 2003.................... 496
Net charge-offs............................... --
--------
Balance at December 31, 2004.................... $ 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.
9
The following is a summary of information pertaining to impaired and
non-accrual loans:
At December 31,
------------------------
2004 2003
----------- ----------
(In thousands)
Impaired loans without a valuation allowance $ 1,360 $ 3,270
Impaired loans with a valuation allowance.. $ 496 $ 496
Valuation allowance related to impaired loans $ 496 $ 496
Total non-accrual loans...................... $ 4,985 $ 3,342
Year Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
(In thousands)
Average investment in impaired loans.... $ 602 $ 4,327 $ 4,982
Interest income recognized on impaired loans $ 22 $ 226 $ 322
Interest income recognized on a cash basis
on impaired loans...................... $ 16 $ 215 $ 316
Internal Asset Review System
We classify our assets according to a nine-tier risk rating system. The
nine risk grades are segmented into three general groups: "Unclassified" (Pass 1
through 5), "Criticized" (Special Mention), and "Classified" (Substandard,
Doubtful and Loss). In determining the appropriate Risk Grade for an asset,
consideration is given to a number of factors affecting the timely liquidation
of the asset, including but not limited to: the cash flow provided by the
collateral; the financial condition of borrowers, guarantors and endorsers;
collateral value; and payment history.
For internal asset review purposes, assets are segregated into two groups:
homogeneous and non-homogeneous assets.
Homogeneous Assets. These are defined as groups of assets that share
similar risk characteristics that are collectively evaluated for asset
classification purposes. Homogeneous assets include single-family residential
loans with balances less than $1.0 million, multi-family residential and
commercial real estate loans ("income property loans") with balances less than
$1.5 million, commercial business loans with balances less than $500,000,
consumer loans, and high-grade investment securities.
Non-Homogeneous Assets. These are individually reviewed for asset
classification purposes due to their relatively higher balances or complexity.
Non-homogeneous assets include single-family residential loans with balances of
$1.0 million or greater, income property loans of $1.5 million or more, and
commercial business loans of $500,000 or greater. Other non-homogeneous assets
include modified or restructured loans, real estate owned through foreclosure,
investments in subsidiaries, and significant off-balance sheet items.
Loan Loss Allowance
We maintain a general valuation allowance for loan losses due to the
inherent risks in the loan portfolio that have yet to be specifically
identified. Our loan portfolio is stratified based on factors affecting the
perceived level and concentration of risk, such as type of collateral, level of
loan documentation, the borrowers credit rating, year of origination, original
loan-to-value ratio and geographic location.
The appropriate level of general valuation allowance is calculated by
applying reserve factors to the balance of assets on which we have loss
exposure. These reserve factors represent the expected likelihood of default
multiplied by the expected rate of loss. The expected rates of loss and default
are based on our historical loss experience and adjusted for current conditions
and trends in our lending areas.
Based on this methodology, we recorded a $3.0 million provision for loan
losses during 2004. We did not record any loan loss provision in 2003 or 2002.
10
Loans that allow for a reduced level of documentation at origination are an
increasing percentage of loans originated in our market areas. On "Stated
Income/Stated Asset" (SISA) loans, the borrower includes information on his/her
level of income and assets that is not subject to verification. "On "Stated
Income/Verified Assets" ("SIVA") loans, the borrower includes information on
his/her level of income, but his/her assets are verified. For "No Income/No
Asset" (NINA) loans, the borrower is not required to submit information on
his/her level of income or assets. The underwriting of these loans is based on
the borrower's credit score and the value of the collateral. At December 31,
2004, approximately 8%, 29% and 39% of our single family loan portfolio was
comprised of NINA, SIVA or SISA loans, respectively. This compares to 2%, 26%
and 30% of our single family loan portfolio being NINA, SIVA or SISA loans at
December 31, 2003, respectively. Our portfolios of multi-family and other real
estate loans all require full documentation by the borrowers.
The following is an analysis of the activity in our general loan valuation
allowances for the periods indicated:
Year Ended December 31,
----------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- -------- -------- --------
(In thousands)
Beginning general loan valuation allowances $ 75,238 $ 75,223 $ 72,919 $ 70,809 $ 69,954
Provision for loan losses................ 3,000 -- -- -- --
General loan valuation allowances obtained
in acquisition........................ -- -- -- 2,050 --
Charge-offs, net of recoveries:
Single family......................... 120 (52) (372) (322) (767)
Multi-family.......................... 237 14 189 286 1,692
Commercial............................ (7) -- -- -- (105)
Non-real estate....................... 87 53 1,133 154 35
--------- --------- -------- -------- --------
Total net recoveries .................... 437 15 950 118 855
Transfers from (to) impaired valuation
allowance............................. -- -- 1,354 (58) --
--------- --------- -------- -------- --------
Ending general loan valuation allowances. $ 78,675 $ 75,238 $ 75,223 $ 72,919 $ 70,809
========= ========= ======== ======== ========
We recorded total net recoveries during each of the last five years. The
lack of charge-offs over the last five years is due to the strong economy and
real estate market in Southern California.
Any increase in charge-offs would adversely impact our future loan loss
provisions and income.
Our total general loan loss allowances to gross loans receivable was 1.15%,
1.70%, 1.96%, 1.83% and 1.95% at December 31, 2004, 2003, 2002, 2001 and 2000,
respectively.
11
The following table details the general valuation allowance by loan type at
the dates indicated:
December 31,
------------------------------------------------------------------------------------
% of % of % of % of % of
2004 Total 2003 Total 2002 Total 2001 Total 2000 Total
----- ----- ----- ----- ------ ------ ----- ----- ----- ------
(Dollars in thousands)
Real estate loans:
Single family.........$ 48,271 61% $ 28,775 38% $ 24,952 33% $ 30,040 41% $ 37,695 53%
Multi-family.......... 19,570 25 24,789 33 27,037 36 23,955 33 22,529 32
Commercial............ 5,053 6 6,185 8 9,938 13 7,860 11 5,797 8
Construction.......... 508 1 2,266 3 2,281 3 3,687 5 -- --
----- ----- ----- ----- ------ ----- ----- ---- ------ ----
Total real estate loans. 73,402 93 62,015 82 64,208 85 65,542 90 66,021 93
----- ----- ------ ----- ------ ----- ------ ---- ------ ----
Non-real estate loans:
Commercial............ 2,618 3 5,595 8 4,977 7 5,120 7 3,214 5
Consumer.............. 2,655 4 7,624 10 5,978 8 1,918 3 1,073 1
Other................. -- -- 4 -- 60 -- 339 -- 501 1
----- ----- ----- ----- ------ ----- ----- ---- ----- ----
Total non-real estate
loans................. 5,273 7 13,223 18 11,015 15 7,377 10 4,788 7
----- ----- ------ ----- ------ ----- ----- ---- ----- ----
Total...................$ 78,675 100% $ 75,238 100% $ 75,223 100% $ 72,919 100% $ 70,809 100%
====== ===== ====== ==== ====== ===== ====== ==== ====== ====
During 2004, the exposure base of single-family loans increased by $2.1
billion, generating an increase in the general valuation allowance by $19.6
million. There were three changes pertaining to the calculation of the general
valuation allowance for the single-family portfolio: segregation of sub-prime
loans; refining for the geographic designation, and re-evaluated risk factors
for single-family loans made in Northern California. The exposure base for
multi-family loans increased by $279.8 million; however, the general valuation
allowance decreased by $5.2 million. The decrease in general valuation allowance
is attributable to lowered risk factors for certain geographic locations. We
also reduced the loss factors associated with anticipated loss on this product.
The exposure base for commercial real estate decreased $20.2 million, generating
a decrease in the general valuation allowance by $1.1 million. The exposure base
of the construction loan portfolio decreased by $4.5 million, while the general
valuation allowance declined by $1.8 million. The non-real estate commercial
loan exposure base increased by $47.0 million; however, the general valuation
allowance decreased by $3.0 million. The consumer loan exposure base increased
by $29.8 million; however, the general valuation allowance decreased by $5.0
million. The decrease in general valuation allowances for non-real estate
consumer and commercial loans is attributable to a decline in the expected rates
of default as we have gained experience with these product lines. The remainder
of the change in the general valuation allowance for loans was attributable to
changes in miscellaneous loans.
During 2003, the exposure base of single-family loans increased by $733.3
million and the proportion of higher risk loans was reduced, resulting in a $3.8
million increase in the general valuation allowance. The decrease in the
multi-family and commercial real estate loan exposure base of $98.7 million and
$74.0 million, respectively, resulted in a decrease in the general valuation
allowance of $2.2 million and $3.7 million, respectively. The exposure base of
the construction loan portfolio increased by $2.1 million, generating a
reduction of $15 thousand to the general valuation allowance. The increase in
the commercial loan exposure base of $14.8 million resulted in an increase of
$617 thousand in the general valuation allowance. The consumer loan exposure
base increased by $14.3 million, which resulted in an addition of $1.6 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.
Depending on the economy and real estate markets in which we operate,
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 our general valuation allowance. These
agencies may require us to establish additional general valuation allowances
based on their judgment of the information available at the time of their
examination.
12
During 2004, we revised our current estimate of the required repurchase
liability for loans sold with recourse from $5.4 million to $0. We eliminated
the repurchase liability for loans sold with recourse because we do not expect
to incur any future losses on this portfolio. No charge-offs have occurred on
these loans since 1997 and the loan balances have declined since they were
originated in the late 1980's. The activity in the repurchase liability for
loans sold with recourse for 2004, 2003, 2002, 2001 and 2000 is presented below
(in thousands):
Balance at December 31, 2000..................... $ 12,824
Balance at December 31, 2001..................... 12,824
Liability adjustment recorded as gain on sale of loans (5,924)
--------
Balance at December 31, 2002..................... 6,900
Liability adjustment recorded as gain on sale of loans (1,500)
--------
Balance at December 31, 2003..................... 5,400
Liability adjustment recorded as gain on sale of loans (5,400)
--------
Balance at December 31, 2004..................... $ -
========
See "--Management's Discussion and Analysis of Consolidated Balance Sheets
and Consolidated Statements of Income - Asset Quality Ratios--" for an analysis
of our general valuation allowances as a percentage of non-performing loans and
loans receivable.
Potential Problem Loans. We also had $2.1 million, $2.3 million and $2.1
million in potential problem real estate loans as of December 31, 2004, December
31, 2003 and December 31, 2002, 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 us.
Our Asset Classification Committee meets at least quarterly to review and
monitor the condition of the loan portfolio. Additionally, a special workout
group of our officers meets at least quarterly to resolve delinquent loan
situations and to initiate actions enforcing our 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 Consolidated Balance Sheets and
Consolidated Statements of Income - Non-Performing Assets--"
Generally, real estate loans greater than 90 days delinquent are placed
into foreclosure and a valuation allowance is established, if necessary. We
acquire 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"), we evaluate
the property and establish a plan for marketing and disposing of the property.
After inspecting the property, we determine 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 our REO activity for the
periods indicated:
Year Ended December 31,
----------------------------------
2004 2003 2002
--------- --------- --------
(In thousands)
Beginning balance...................... $ 1,324 $ 319 $ 1,485
Additions............................ -- 1,582 1,881
Sales and other...................... (1,324) (577) (3,047)
--------- --------- --------
Ending balance......................... $ -- $ 1,324 $ 319
========= ========= ========
Other Interest-Earning Assets. We owned no contractually delinquent
interest-earning assets other than loans as of December 31, 2004.
Investment Activities. It is our 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.
13
The following table summarizes the total investment portfolio at historical
cost by type at the end of the periods indicated:
At December 31,
------------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- --------- --------- --------
(Dollars in thousands)
U.S. treasury securities.................$ -- $ 200 $ 200 $ 300 $ 300
U.S. agency securities................... -- -- -- 28,199 38,185
Collateralized mortgage obligations
("CMO's")............................. 249,781 115,992 101,802 80,013 98,562
--------- --------- --------- --------- --------
249,781 116,192 102,002 108,512 137,047
Unrealized gain (loss) on securities
available-for-sale.................... 805 219 1,053 1,932 (510)
--------- --------- --------- --------- --------
$ 250,586 $ 116,411 $ 103,055 $ 110,444 $ 136,537
========= ========= ========= ========= ========
Weighted average yield on
interest-earning investments end of
period................................ 2.82% 2.92% 4.77% 6.07% 5.99%
========= ========= ========= ========= ========
Our collateralized mortgage obligations all have expected maturities within
five years.
Sources of Funds
General. Our principal sources of funds are deposits, principal and
interest payments on loans, loan sales, advances from the FHLB and securities
sold under agreements to repurchase.
Deposits. We obtain deposits through three different sources: 1) our
full-service branch system, 2) phone solicitations by designated employees
(telemarketing deposits), and 3) national brokerage firms.
Deposits obtained through the branch system were $2.5 billion, $2.5 billion
and $2.3 billion at December 31, 2004, 2003 and 2002, respectively. Branch
deposits comprised 67% of total deposits at December 31, 2004, 99% of total
deposits at December 31, 2003 and 91% of total deposits at December 31, 2002.
Deposits acquired through telemarketing efforts are typically placed with
us by professional money managers and represented 1%, 1% and 3% of total
deposits at December 31, 2004, 2003 and 2002, respectively. The level of
telemarketing deposits varies based on yields available to depositors on other
investment instruments and the depositors' perception of our creditworthiness.
Deposits acquired through national brokerage firms represented 32%, 0% and
6% of total deposits at December 31, 2004, 2003 and 2002, respectively. Any fees
paid to deposit brokers are amortized over the term of the deposit. We increased
our use of this type of deposit in 2004 to fund our increased loan growth. We
have used brokered deposits in varying amounts since 1983. 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 FDIC in
order to accept brokered deposits. See "--Management's Discussion and Analysis -
Capital Resources and Liquidity--"
The percentage of fixed-term certificates of deposit in our total deposits
was 47% at December 31, 2004, 22% at December 31, 2003 and 37% at December 31,
2002. The increase during 2004 is due to growth in our deposits acquired through
national brokerage firms. Excluding the brokered deposits, fixed-term
certificates of deposit were 22% of deposits at December 31, 2004.
14
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,
-----------------------------------------------------------------------------
2004 2003 2002
--------------------- --------------------- ---------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
--------- --------- --------- -------- -------- ---------
(Dollars in thousands)
Passbook accounts....... $ 124,923 1.03% $ 118,859 1.15% $ 106,591 1.47%
Money market deposit
accounts............. 1,383,119 1.47 1,244,294 1.72 909,866 2.50
Interest-bearing
checking accounts.... 198,084 0.31 178,173 0.32 164,930 0.66
Non interest-bearing
checking accounts.... 338,692 -- 285,653 -- 234,936 --
Fixed term certificate
accounts............. 923,939 2.16 688,492 2.30 1,101,043 3.20
--------- --------- ---------
$ 2,968,757 1.42% $ 2,515,471 1.55% $ 2,517,366 2.42%
========= ========= =========
The following tables set forth information regarding the amount of deposits
in the various types of deposit programs offered by us at the end of the years
indicated and the balances and average rates for those dates:
At December 31,
-----------------------------------------------------------
2004 2003 2002
---------------- ----------------- -----------------
Amount % Amount % Amount %
--------- ---- --------- ----- --------- -----
(Dollars in thousands)
Variable rate non-term accounts:
Money market deposit accounts
(weighted average rate of 1.61%,
1.43% and 2.13%)................. $ 1,328,230 35% $ 1,373,240 54% $ 1,079,278 43%
Interest-bearing checking accounts
(weighted average rate of 0.23%,
0.26% and 0.43%)................. 279,912 8 232,247 9 174,802 7
Passbook accounts (weighted average
rate of 1.00%, 1.10% and 1.34%).. 121,355 3 124,427 5 111,844 4
Non-interest bearing checking
accounts............................ 276,438 7 239,357 10 239,695 9
--------- ---- --------- ----- --------- -----
2,005,935 53 1,969,271 78 1,605,619 63
--------- ---- --------- ----- --------- -----
Fixed-rate term certificate
accounts:
Under six-month term (weighted
average rate of 2.06%, 1.00% and
1.54%)........................... 373,907 10 32,062 1 37,630 1
Six-month term (weighted average
rate of 1.96%, 1.06% and 1.95%).. 359,871 10 79,201 3 104,600 4
Nine-month term (weighted average
rate of 2.27%, 1.25% and 2.76%).. 526,587 14 15,126 1 101,980 4
One year to 18-month term (weighted
average rate of 1.84%, 1.53% and
2.63%)........................... 193,038 5 178,858 6 331,308 14
Two year to 30-month term (weighted
average rate of 2.40%, 2.63% and
3.55%)........................... 52,441 1 42,187 2 41,460 2
Over 30-month term (weighted
average rate of 3.71%, 3.88% and
4.49%)........................... 133,402 4 123,966 5 94,927 4
Negotiable certificates of $100,000
and greater, 30 day to one year
terms (weighted average rate of
1.97%, 1.25% and 2.32%).......... 115,984 3 97,727 4 209,502 8
--------- ---- --------- ----- --------- -----
1,755,230 47 569,127 22 921,407 37
--------- ---- --------- ----- --------- -----
Total deposits (weighted average
rate of 1.65%, 1.29% and 1.98%).. $ 3,761,165 100% $ 2,538,398 100% $ 2,527,026 100%
========= ==== ========= ===== ========= =====
15
We choose the lowest cost source of funds considering both the interest
rate and administrative cost. As the cost of each source of funds fluctuates
from time to time, we seek funds from the lowest cost source until the relative
cost changes. As the costs of funds, operating margins and net income of the
Bank associated with each source of funds are generally comparable, we do 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.
The following table shows the maturity distribution of jumbo certificates
of deposit ($100,000 and greater) as of December 31, 2004 (in thousands):
Maturing in:
1 month or less................................... $ 17,863
Over 1 month to 3 months.......................... 32,084
Over 3 months to 6 months......................... 209
Over 6 months to 12 months........................ 31,701
Over 12 months.................................... 34,127
--------
Total............................................ $115,984
========
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.
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 FHLB secured by the FHLB
capital stock owned by the Bank, certain of our 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 FHLB. See "Summary of Material Legislation and
Regulation - Qualified Thrift Lender Test" In granting advances, the FHLB also
considers a member's creditworthiness and other relevant factors.
Total advances from the FHLB were $3.0 billion at December 31, 2004 at a
weighted average rate of 2.59%. This compares with advances of $1.7 billion at
December 31, 2003 and $1.2 billion at December 31, 2002 with weighted average
rates of 2.88% and 3.90%, respectively. We have credit availability with the
FHLB, which allows us to borrow up to 60% of our total assets or approximately
$4.5 billion at December 31, 2004.
We enter 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 Balance
Sheets. There are certain risks involved with entering into these types of
transactions. In order to minimize these risks, our 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 $187.0 million at December 31, 2004 at a weighted average rate of 2.24%
and were secured by mortgage-backed securities with principal balances totaling
$80.7 million and investments totaling $116.6 million. Borrowings under reverse
repurchase agreements totaled $122.6 million at December 31, 2003 and $155.3
million at December 31, 2002 at weighted average rates of 1.12% and 1.61%,
respectively. We increased our borrowings under repurchase agreements during
2004 by pledging additional securities from our investment portfolio. The
decrease in borrowings under agreements to repurchase in 2003 and 2002 was due
to paydowns of the underlying mortgage-backed securities.
Borrowings from all sources totaled $3.2 billion, $1.8 billion and $1.3
billion at weighted average rates of 2.57%, 2.76% and 3.63% at December 31,
2004, 2003, and 2002, respectively. The increase in borrowings during 2004 was
necessary to fund asset growth. Due to the high level of loan payoffs and the
growth in branch deposits, no additional borrowings were necessary to fund asset
growth during 2003.
16
Our portfolio of short-term borrowings includes FHLB advances due in less
than one year 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)
2004
- ----
Short-term FHLB advances. $ 2,604,600 2.30% $ 2,604,600 $ 1,789,575 2.05%
Securities sold under
agreements to
repurchase............ 187,000 2.24 192,000 129,192 1.52
2003
- ----
Short-term FHLB advances. $ 1,082,000 2.16% $ 1,082,000 $ 734,000 2.25%
Securities sold under
agreements to
repurchase............ 122,622 1.12 154,021 139,568 1.27
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
Other Sources of Funds
See "--Management's Discussion and Analysis of Consolidated Balance Sheets
and Consolidated Statements of Income - Sources of Funds--" for a discussion of
other funding sources.
Subsidiaries
We have 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 2004 and no material change is presently
foreseen.
Trustee Activities. Seaside acts as trustee on our deeds of trust. Trustee
fees for this activity amounted to $41 thousand, $66 thousand and $56 thousand
in 2004, 2003 and 2002, 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 rate annuities conducted in our
branches by a licensed third party vendor, which is a registered broker-dealer.
The registered broker-dealer conducts its sales activities in our branch offices
and we receive a percentage of the commissions on such sales through Oceanside.
During 2004, 2003 and 2002, Oceanside received commission income of $178
thousand, $222 thousand and $461 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 $3 thousand in 2004 and $2 thousand in 2003.
Commission rebates totaling $64 thousand were paid during 2002. The rebates paid
during 2002 resulted from repayments of previously earned commissions when
interim lender-placed policies were replaced by permanent policies obtained by
borrowers.
17
Employees
As of December 31, 2004, we had a total of 604 full time equivalent
employees, including 121 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. We provide our regular full-time and part-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. We consider our 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 FHLB, 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. Our deposits are insured by the FDIC through the
SAIF. As insurer, the FDIC is authorized to conduct examinations of the Bank. We
are also subject to Federal Reserve Board regulations concerning reserves
required to be maintained against deposits.
The OTS also imposes assessments and examination fees on savings
institutions. OTS assessments were $751 thousand in 2004, $667 thousand in 2003
and $708 thousand in 2002.
As a member of the FHLB System, the Bank is required to own capital stock
in its regional FHLB 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 4.7% of
its outstanding borrowings from the FHLB. We were in compliance with this
requirement, with an investment of $143.4 million in FHLB stock at December 31,
2004. During 2003, the FHLB amended the redemption policy requiring 5 years
written notice to redeem stock effective 2004.
The FHLB 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 FHLB. At December 31, 2004, our advances from the FHLB amounted to $3.0
billion, or 43% 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 rate 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. The dividend yield earned on FHLB stock was 4.01%
during 2004 compared to 4.29% in 2003 and 5.45% in 2002.
Financial Services Modernization Legislation. On November 12, 1999, the
Gramm-Leach-Bliley Financial Modernization Act of 1999 (the "GLB Act") was
signed into law. The GLB Act made significant changes to the operations of
financial services companies, including provisions affecting affiliations among
banks, securities firms and insurance companies, the ability of commercial
entities to obtain thrift charters, the confidential treatment of nonpublic
personal information about consumers, and the Community Reinvestment Act (the
"CRA", as discussed in more detail below).
The GLB Act also significantly amended 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 GLB 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 income.
There continues to be ongoing discussions in Congress as to whether the
regulator of the FHLBs should be changed and if so, to which regulatory agency.
Recently, the FHFB required the FHLBanks to register a class of their equity
securities with the SEC. The FHFB also recently required all the FHLBanks to
submit a "retained earnings" policy, the purpose of which is to cause the
FHLBanks to retain more of their earning versus paying dividends. Because of the
level of our borrowings from the FHLB, the outcome of these changes will effect
the cost and availability of borrowings and the dividends we receive on our FHLB
stock.
18
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 and
maintain that association as a separate entity or if we 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.
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 Consolidated Balance Sheets and Consolidated Statements of Income -
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. We are 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. Our 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.
Liquidity. The OTS requires a savings institution to maintain sufficient
liquidity to ensure its safe and sound operation. The determination of what
constitutes safe and sound operation is left to the discretion of management.
For several years it has been our strategy to keep cash and liquid investments
at a modest level due to availability of substantial credit lines. Our liquidity
policy includes unused borrowing capacity in the definition of available
liquidity. Our 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 our liquidity base (defined as deposits and borrowings due
within one year). At December 31, 2004, liquidity-qualifying balances were
14.99% of our liquidity base.
19
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." We were rated "satisfactory" in its last CRA examination, which
was conducted in 2003. 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.
Restrictions on Dividends and Other Capital Distributions. Current OTS
regulations require that savings institutions controlled by savings and loan
holding companies (such as ourselves) 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 a 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 2004 and 2002, the Bank
paid a total of $30.0 million and $20.0 million, respectively, in capital
distributions to the Company. No capital distributions were made to the Company
during 2003.
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 Fannie Mae; 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. Our loans were within the LTOB limitations at December 31, 2004.
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. We have no impermissible
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 income 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.
Our annual management report on the effectiveness of internal control standards
and compliance with certain designated laws will be made available in March of
2005.
20
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. We met the
"well-capitalized" standards during 2004 and were 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. We
met the QTL test at December 31, 2004, with 98.1% of the portfolio assets
comprised of "qualified thrift investments".
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 no 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. All of the Bank's
loans to insiders are made in strict compliance with these regulations.
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, 2004 was 0% of
the first $7.0 million of such accounts, 3% of the next $47.6 million of such
accounts and 10% (subject to adjustment by the Federal Reserve Board between 8%
and 14%) of the balance of such accounts. We are in compliance with these
requirements as of December 31, 2004.
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%.
We are required to use the specific charge-off method of accounting for bad
debts for Federal income tax purposes. Prior to 1995, we used the reserve method
of accounting for bad debts. The Consolidated Balance Sheets at December 31,
2004 and 2003 do not include a tax liability of $5,356,000 related to the
adjusted base year bad debt reserve that was created when we were on the reserve
method. The base year reserve is subject to recapture if: (1) we fail 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 exceed our
cumulative income and profits (as computed for federal income tax purposes),
such distributions would be treated for tax purposes as being made out of our
base year reserve and would thereby constitute taxable income to ourselves in an
amount equal to the lesser of our 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,
2004, our cumulative income and profits (as computed for federal income tax
purposes) were approximately $530.3 million.
21
We are required to use the specific charge-off method for state tax
purposes for all periods beginning after 2002. Prior to 2002, we made additions
to our state tax bad debt reserves in amounts necessary to "fill up" to a tax
reserve balance calculated using the experience method. A change in California
tax law during 2002 eliminated the bad debt reserve method for California tax
purposes and conformed state tax law to federal tax law with regard to the
method of accounting for bad debts used by banks. After a review of our bad debt
reserves by the California Franchise Tax Board, we recorded a reduction in tax
expense of approximately $1.6 million, or $0.09 per diluted share, net of
federal income tax expense in 2003.
At December 31, 2004, we had $52.8 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 $28.3 million at December 31, 2004.
We are 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 2004, 2003 or 2002.
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 2004, 2003 and 2002 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 2000.
The adjustments proposed by the IRS were primarily related to timing 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 Franchise Tax Board ("FTB"). Interest
accruals of $260 thousand and $0 were recorded during 2004 and 2003,
respectively for interest on amended returns. During 2004, interest payments
totaling $252 thousand were paid in settlement for tax years 1999 and 2000. The
balance of accrued interest payable for amended returns was $408 thousand and
$400 thousand as of December 31, 2004 and December 31, 2003, respectively.
Recent Legislation. 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. While many of the Sarbanes-Oxley reforms took effect in 2002, a
large number of the provisions of Sarbanes-Oxley were implemented upon adoption
of final rules and regulations during 2003 and 2004. Sarbanes-Oxley, among other
things, places additional responsibilities on management and the boards of
directors of public companies. The Company has incurred and expects to continue
to incur costs associated with compliance with the provisions of Sarbanes-Oxley
and other related changes to federal securities and corporate governance laws.
The Company expects to experience an increase in the cost of its professional
fees, including but not limited to, accounting and compliance. However,
management does not anticipate that such compliance costs will have a material
impact on the Company's balance sheets or statements of income.
Financial Privacy. In accordance with the GLB Act, federal banking
regulators adopted rules that limit the ability of savings banks and other
financial institutions to disclose non-public information about consumers to
nonaffiliated third parties. These limitations require disclosure of privacy
policies to consumers and, in some circumstances, allow consumers to prevent
disclosure of certain personal information to a nonaffiliated third party. The
privacy provisions of the GLB Act affect how consumer information is transmitted
through diversified financial companies and conveyed to outside vendors.
Anti-Money Laundering Initiatives and the USA Patriot Act. A major focus of
governmental policy on financial institutions in recent years has been aimed at
combating money laundering and terrorist financing. The USA PATRIOT Act of 2001
(the "USA Patriot Act") substantially broadened the scope of United States
anti-money laundering laws and regulations by imposing significant new
compliance and due diligence obligations, creating new crimes and penalties and
expanding the extra-territorial jurisdiction of the United States. The United
States Treasury Department has issued a number of implementing regulations which
apply to various requirements of the USA Patriot Act to financial institutions
such as the Bank. These regulations impose obligations on financial institutions
to maintain appropriate policies, procedures and controls to detect, prevent and
report money laundering and terrorist financing and to verify the identity of
their customers. Failure of a financial institution to maintain and implement
adequate programs to combat money laundering and terrorist financing, or to
comply with all of the relevant laws or regulations, could have serious legal
and reputational consequences for the institution.
22
Legislative Initiatives. From time to time, various legislative and
regulatory initiatives are introduced in Congress and state legislatures, as
well as by regulatory agencies. Such initiatives may include proposals to expand
or contract the powers of savings and loan holding companies and depository
institutions or proposals to substantially change the financial institution
regulatory system. Such legislation could change banking statutes and the
operating environment of the Company in substantial and unpredictable ways. If
enacted, such legislation could increase or decrease the cost of doing business,
limit or expand permissible activities or affect the competitive balance among
banks, savings associations, credit unions, and other financial institutions.
The Company cannot predict whether any such legislation will be enacted, and, if
enacted, the effect that it, or any implementing regulations, would have on the
consolidated balance sheets or consolidated statements of income of the Company.
A change in statutes, regulations or regulatory policies applicable to the Bank
could have a material effect on the business of the Company.
23
ITEM 2 -- PROPERTIES
At December 31, 2004, we owned the building and the land for nine of our
branch offices, owned the building but leased the land for two additional
offices, and leased our remaining offices. Properties leased by us include our
corporate and executive offices located in an office tower in downtown Santa
Monica, a general services and banking operations office building in Santa
Monica and a residential lending operations office in Los Angeles. 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 Consolidated Balance Sheets and Consolidated
Statements of Income" is a table 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 January 21, 2005, 16,498,754 shares of Company common
stock, representing approximately 721 stockholders were on record. This 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 income, 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 we can pay as a
capital distribution to the Company. No such distribution may be made if our 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 $30.0 million
and $20.0 million during 2004 and 2002, respectively. No capital distributions
to the Company were made during 2003. The distributions made during 2004 and
2002 were for the purpose of repurchasing shares of Company common stock.
(d) Securities authorized for issuance under equity compensation plans.
Information appearing on page 11 of the Proxy Statement is incorporated herein
by reference.
24
ITEM 6 -- SELECTED FINANCIAL DATA
Selected financial data for the Company is presented below:
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
FIVE YEAR CONSOLIDATED SUMMARY OF OPERATIONS
2004 2003 2002 2001 2000
---------- ---------- ----------- ----------- ----------
(Dollars in thousands, except per share data)
For the Year Ended December 31:
Interest income...................$ 262,722 $ 235,881 $ 263,878 $ 333,932 $ 314,320
Interest expense.................. 101,190 88,342 128,419 201,754 206,505
Net interest income............... 161,532 147,539 135,459 132,178 107,815
Provision for loan losses......... 3,000 -- -- -- --
Other income...................... 21,296 16,741 18,074 8,919 7,747
Non-interest expense.............. 66,372 55,589 58,212 53,174 48,265
income before income taxes........ 113,456 108,691 95,321 87,923 67,297
Income taxes...................... 47,614 44,216 40,149 37,621 28,832
Net income........................ 65,842 64,475 55,172 50,302 38,465
Basic earnings per share............ 3.95 3.80 3.22 2.92 2.23
Dilutive earnings per share......... 3.85 3.70 3.15 2.85 2.20
End of Year:
Loans receivable, net (1)......... 6,837,945 4,374,112 3,769,235 4,004,889 3,629,284
Mortgage-backed securities, at
fair value...................... 97,059 135,176 200,585 284,079 374,405
Investment securities, at fair
value.......................... 250,586 116,411 103,055 110,444 136,537
Total assets...................... 7,468,983 4,825,022 4,253,729 4,726,289 4,365,242
Deposits.......................... 3,761,165 2,538,398 2,527,026 2,546,647 2,165,047
Borrowings........................ 3,191,600 1,816,622 1,322,273 1,808,040 1,873,110
Liabilities....................... 6,991,509 4,388,455 3,882,088 4,400,611 4,097,800
Stockholders' equity.............. 477,474 436,567 371,641 325,678 267,442
Book value per share.............. 28.94 25.61 21.95 18.88 15.52
Tangible book value per share..... 28.62 25.18 21.40 18.14 14.98
Selected Ratios:
Return on average assets.......... 1.12% 1.43% 1.24% 1.10% 0.93%
Return on average equity.......... 14.54% 15.97% 15.82% 16.93% 15.85%
Ratio of non-performing
assets to total assets......... 0.07% 0.10% 0.17% 0.17% 0.19%
Effective net spread.............. 2.78% 3.35% 3.09% 2.90% 2.57%
Ratio of non-interest expense to
average assets................... 1.13% 1.24% 1.31% 1.17% 1.30%
Other Data:
Number of retail banking offices... 29 29 29 29 25
Number of lending only offices.....
Number of lending only offices 4 2 2 2 2
(1) Includes loans held for sale.
Also see summarized results of operations on a quarterly basis for 2004,
2003 and 2002 in Note 15 of the Notes to Consolidated Financial Statements.
25
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIATED BALANCE SHEETS
AND CONSOLIDATED STATEMENTS OF INCOME
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the balance sheets and statements of income
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.
The majority of our residential loans are obtained from wholesale loan
brokers. Loan origination costs for residential loans obtained from wholesale
loan brokers will generally include fees paid to those brokers, resulting in
loan origination costs exceeding loan fees received. These excess loan
origination costs re amortized as an adjustment of loan yield based on the
expected lives of the related loans, including an estimate of the prepayment
speeds on the portfolio.
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 three main components of economic risk: credit risk, collateral
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. We recorded a $3.0 million loss
provision during 2004. No loan loss provisions were recorded in 2003 and 2002. A
downward turn in the current economic climate could increase the likelihood of
losses due to credit risks. This could create the need for additional loan loss
provisions above those required for loan growth.
Collateral Risk
Collateral risk is the risk that the collateral securing our loans,
primarily real estate, declines in value. A downward turn in the real estate
market could increase the likelihood of losses if the loan exceeds the value of
the collateral. 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. Our 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,
we 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.
26
REGULATORY RISK
Regulatory risk is the risk that regulations will change or the regulators
will reach different conclusions than management regarding the financial
position of the Company. The OTS examines our financial results annually. The
OTS reviews the allowance for loan losses and may require us 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 our
capital.
Pending Lawsuits
We have been named as a defendant in various lawsuits, none of which is
expected to have a materially adverse effect on the Company.
OVERVIEW
Our results of operations are primarily affected by our levels of net
interest income, provisions for loan losses, non-interest income, non-interest
expense and income taxes. Our results are strongly influenced by the California
economy in which we operate and the direction and level of general market
interest rates.
Net income of $65.8 million or $3.85 per diluted share were recorded in
2004, compared to net income of $64.5 million or $3.70 per diluted share in 2003
and net income of $55.2 million or $3.15 per diluted share in 2002.
Net income increased from 2003 to 2004 due to higher net interest income,
higher prepayment fees and a $5.4 million reduction in the repurchase liability
for loans sold with recourse. Operating expenses increased primarily due to
costs associated with loan originations. The increase in net income from 2002 to
2003 was primarily due to higher net interest income, higher prepayment fees and
lower operating expenses due to a reduction in legal costs. In addition, during
2003, there was a $1.6 million reduction in net tax provision resulting from a
change in the California tax law relating to bad debts.
Consolidated assets at the end of 2004 were $7.5 billion, representing a
55% increase from $4.8 billion at the end of 2003 and a 76% increase from $4.3
billion at the end of 2002. The increase in assets during 2004 is attributable
to increased loan origination activity. Loan originations totaled $3.9 billion
in 2004, $2.3 billion in 2003 and $1.3 billion in 2002.
The Company recorded $3.0 million in loan loss provision in 2004. No loss
provision was recorded in 2003 or 2002. We recorded net loan recoveries of $437
thousand, $15 thousand and $950 thousand during 2004, 2003 and 2002,
respectively.
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
--------- --------- ----------
2004..................................... 1.12% 14.54% 7.69%
2003..................................... 1.43 15.97 8.98
2002..................................... 1.24 15.82 7.83
2001..................................... 1.10 16.93 6.52
2000..................................... .93 15.85 5.85
Non-performing assets (primarily loans 90 days past due or in foreclosure
plus foreclosed real estate) were $5.0 million or .07% of total assets as of
December 31, 2004 compared to $4.7 million or 0.10% of total assets as of
December 31, 2003 and $7.0 million or 0.17% of total assets at December 31,
2002. The decrease in non-performing assets over the last several years is
attributable to lower balances of delinquent loans and the strength of the
California real estate market. See --"Non-Performing Assets--"
27
As of February 1, 2005, 1,472,079 shares remain eligible for repurchase
under the Company's authorized repurchase program. The Company repurchased
common shares totaling 696,900, 33,800 and 353,000 during 2004, 2003 and 2002,
respectively.
At December 31, 2004 our regulatory risk-based capital ratio was 11.96% and
our tangible and core capital ratios were 5.99%. We met the regulatory capital
standards necessary to be deemed "well-capitalized" at December 31, 2004. See
- --"Capital Requirements--"
COMPONENTS OF INCOME
Net Interest Income
Net interest income is the primary component of our income. 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 $292.3 million in 2004, $262.9 million in 2003
and $229.2 million in 2002.
Our 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 quickly while it takes
several months for loan yields to adjust. This time lag decreases our 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:
Year Ended December 31,
------------------------------------
2004 2003 2002
--------- ---------- ---------
(Dollars in thousands)
Average loans and mortgage-backed securities (1)....... $ 5,325,910 $ 4,194,404 $ 4,091,852
Average investment securities.......................... 252,708 113,624 172,996
--------- --------- ---------
Average interest-earning assets........................ 5,578,618 4,308,028 4,264,848
--------- --------- ---------
Average deposits....................................... 2,968,757 2,515,471 2,517,366
Average borrowings..................................... 2,317,518 1,529,630 1,518,283
--------- --------- ---------
Average interest-bearing liabilities................... 5,286,275 4,045,101 4,035,649
--------- --------- ---------
Excess of interest-earning assets over interest-bearing
liabilities............................................ $ 292,343 $ 262,927 $ 229,199
========= ========= =========
Yields earned on average interest-earning assets....... 4.59 % 5.40 % 6.08 %
Rates paid on average interest-bearing liabilities..... 1.91 2.18 3.16
Interest rate spread................................... 2.68 3.22 2.92
Effective net spread................................... 2.78 3.35 3.09
Total interest income.................................. $ 256,059 $ 232,634 $ 259,303
Total interest expense................................. 100,968 88,183 127,526
--------- --------- ---------
155,091 144,451 131,777
Total other income (2)................................. 6,441 3,088 3,682
--------- --------- ---------
Net interest income.................................... $ 161,532 $ 147,539 $ 135,459
========= ========= =========
(1) Non-accrual loans are included in the average dollar amount of loans
outstanding; however, no income is included for the period that each
such loan was on non-accrual status.
(2) Includes dividends on FHLB stock and other miscellaneous items.
Our interest rate spread decreased by 54 basis points in 2004 compared to
2003 as the yield on earning assets declined by 81 basis points while the cost
of funds fell by only 27 basis points. The yield on the loan portfolio was
impacted by lower interest rates from 2003 and early 2004. The rates paid on
savings and borrowings also decreased in 2004 compared to 2003, but they
decreased to a lesser extent because they were more impacted by increasing
interest rates throughout most of 2004.
Our interest rate spread increased by 30 basis points in 2003 compared to
2002 as the yield on earning assets declined by only 68 basis points while the
cost of funds fell by 98 basis points due to the declining short term interest
rates throughout the year. The time lag inherent in our adjustable real estate
loan portfolio ranges from one to three months.
28
The table below sets forth certain information regarding changes in our
interest income and interest expense 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, 2004 Year Ended December 31, 2003
Versus Versus
December 31, 2003 December 31, 2002
-------------------------------- -------------------------------
Change Due To Change Due To
-------------------------------- -------------------------------
Volume Rate Total Volume Rate Total
-------- -------- -------- ------- -------- --------
(In thousands)
Interest Income:
Loans and mortgage-backed
securities................... $ 56,132 $ (37,250) $ 18,882 $ 6,163 $ (29,014) $ (22,851)
Investments.................... 3,728 815 4,543 (1,770) (2,048) (3,818)
-------- -------- -------- ------- -------- --------
Total interest income........ 59,860 (36,435) 23,425 4,393 (31,062) (26,669)
-------- -------- -------- ------- -------- --------
Interest Expense:
Deposits....................... 6,647 (3,446) 3,201 (46) (21,822) (21,868)
Borrowings..................... 21,531 (11,947) 9,584 496 (17,971) (17,475)
-------- -------- -------- ------- -------- --------
Total interest expense....... 28,178 (15,393) 12,785 450 (39,793) (39,343)
-------- -------- -------- ------- -------- --------
Change in net interest income $ 31,682 $ (21,042) 10,640 $ 3,943 $ 8,731 12,674
======== ======== -------- ======= ======== --------
Change in other items (1)........ 3,353 (594)
-------- --------
Total change in net interest
Income including other items... $ 13,993 $ 12,080
======== ========
(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 Effective Net Spreads
Year Ended December 31,
-------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
-------------- -------------- --------------- -------------- --------------
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......... 4.68% 4.98% 5.49% 5.09% 6.18% 5.98% 7.61% 6.57% 7.85% 8.15%
Weighted average
yield on
investment
portfolio (1)...... 2.79 2.62 2.20 2.64 3.65 4.41 5.16 3.52 6.11 5.63
Weighted average
yield on all
interest-earning
assets............. 4.59 4.89 5.40 5.02 6.08 5.94 7.50 6.40 7.77 8.04
Weighted average
rate paid on
deposits........... 1.42 1.65 1.55 1.29 2.42 1.98 4.08 3.02 4.70 4.90
Weighted average
rate paid on
borrowings and
FHLB advances...... 2.53 2.57 3.21 2.76 4.39 3.63 5.67 4.74 6.29 6.46
Weighted average
rate paid on all
interest-bearing
liabilities........ 1.91 2.07 2.18 2.12 3.16 2.54 4.79 3.73 5.40 5.62
Interest rate spread
(2)................ 2.68 2.82 3.22 2.90 2.92 3.40 2.71 2.67 2.37 2.42
Effective net spread
(3)................ 2.78 3.35 3.09 2.90 2.57
(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 (excluding dividends on FHLB stock and other
miscellaneous items) divided by average interest-earning assets.
29
Loss Provision
The Company recorded $3.0 million in loan loss provision during 2004. The
loan loss provision was attributable to the significant growth in the loan
portfolio. The Company did not record any provision for loan loss during 2003 or
2002. No provision was recorded during 2003 and 2002 because, based on analysis
performed by management, existing allowances were sufficient to cover credit
risks inherent in the loan portfolio. Non-performing assets were $5.0 million at
December 31, 2004 compared to $4.7 million at December 31, 2003 and $7.0 million
at December 31, 2002. We have 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 our 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 repurchase liability for loans sold with recourse.
The Company recorded net loan recoveries of $437 thousand during 2004, $15
thousand during 2003 and $950 thousand during 2002. 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 $9.5 million in 2004 compared to $8.0
million in 2003 and $4.3 million in 2002. The increase in fees during 2004
compared to 2003 was primarily due to an increase in loan prepayment fees. Loan
prepayment fees grew to $8.0 million in 2004 compared to $6.0 million in 2003,
because a greater number of loans subject to prepayment fees were paid off by
borrowers.
Banking service fees were $5.6 million in 2004 compared to $5.1 million in
2003 and $4.6 million in 2002. The increase in these fees is due to an increase
in fee-generating deposit accounts.
Gain on sale of loans was $5.4 million in 2004, $2.4 million in 2003 and
$7.8 million in 2002. Loan sales were $3.3 million, $86.1 million and $134.2
million during 2004, 2003 and 2002, respectively. The gain realized on cash loan
sales was $34 thousand, $944 thousand and $1.9 million in 2004, 2003 and 2002,
respectively. Cash gains fluctuate 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 our adjustable rate loan programs. In addition to cash
gains, gain on sale of loans includes adjustments from prior years' sales.
During 2004, we revised our current estimate of the required repurchase
liability for loans sold with recourse from $5.4 million to $0. During 2003, we
revised our current estimate of the required repurchase liability for loans sold
with recourse from $ 6.9 million to $5.4 million. This reduced liability amount
reflects the fact that the portfolio of loans sold with recourse has been
experiencing significant pay-offs, and has had better credit experience than
previously estimated. As a result, included in gain on sale of loans for 2004 is
a $5.4 million adjustment to our repurchase liability for loans sold with
recourse and 2003 results include an adjustment of $1.5 million. We do not
expect to incur any future losses on loans sold with recourse.
Real estate operations resulted in a net gain of $308 thousand in 2004,
$780 thousand in 2003 and $339 thousand in 2002. Real estate operations include
gain on sale of foreclosed properties, operational income and expense during the
holding period, and recoveries of prior losses on real estate sold.
Non-interest Expense
The ratio of non-interest expense to average total assets was 1.13% for
2004, 1.24% for 2003 and 1.31% for 2002. The decrease during 2004 compared to
2003 is due to an increase in average total assets. The decrease during 2003
compared to 2002 is the result of lower legal costs.
Salary and benefit costs increased 22% in 2004 compared to 2003 primarily
due to higher compensation and incentive costs attributable to our significant
loan growth and the additional staffing of our business banking unit. Salary and
benefit costs increased 3% in 2003 compared to 2002 primarily due to normal
salary adjustments and incentive costs.
Occupancy expense increased 6% in 2004 compared to 2003 due to expansion of
our loan divisions in Southern and Northern California. Occupancy expense
decreased 5% in 2003 compared to 2002 due to a reduction in depreciation expense
for certain assets that became fully depreciated in 2003.
Other operating costs increased 34% in 2004 compared to 2003 due to higher
operating costs (delivery, telephone and supplies) associated with the expansion
of our loan divisions.
30
The following table details the components of non-interest expense for the
periods indicated:
Non-Interest Expense
Year Ended December 31,
---------------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- ---------- ---------- ---------
(Dollars in thousands)
Salaries and Employee Benefits:
Salaries..........................$ 25,992 $ 21,565 $ 20,984 $ 18,119 $ 17,354
Incentive compensation............ 4,217 3,480 3,122 2,472 1,987
Payroll taxes..................... 2,334 1,883 1,827 1,652 1,486
Employee benefit insurance........ 1,629 1,016 1,386 1,203 1,320
Bonus compensation................ 1,500 1,275 1,500 1,500 920
Profit sharing.................... 2,530 2,030 2,024 2,020 1,778
SERP.............................. 1,381 1,287 1,161 970 906
401(k)............................ 500 540 310 356 354
Other salaries and benefits....... 824 408 313 1,390 339
--------- --------- --------- ---------- ---------
40,907 33,484 32,627 29,682 26,444
--------- --------- --------- ---------- ---------
Occupancy:
Rent.............................. 4,836 4,690 4,673 4,439 4,539
Equipment......................... 1,826 1,378 1,836 1,971 2,318
Maintenance costs................. 861 904 879 914 571
Other occupancy................... 1,168 1,199 1,169 978 603
--------- --------- --------- ---------- ---------
8,691 8,171 8,557 8,302 8,031
--------- --------- --------- ---------- ---------
Other Operating Expense:
Insurance......................... 746 648 690 582 541
Amortization of core deposit
intangible...................... 1,995 1,995 1,962 1,564 1,965
Data processing................... 2,587 2,905 2,838 2,490 2,488
Contributions..................... 502 409 363 450 518
Professional services............. 292 201 195 207 301
Legal expenses.................... 1,686 1,103 2,888 1,393 632
OTS assessments................... 751 667 708 653 568
Federal deposit insurance premiums 388 394 438 418 538
Other operating costs............. 7,122 5,297 5,568 5,633 4,822
--------- --------- --------- ---------- ---------
16,069 13,619 15,650 13,390 12,373
--------- --------- --------- ---------- ---------
Advertising............................ 705 315 1,378 1,800 1,417
--------- --------- --------- ---------- ---------
Total................................$ 66,372 $ 55,589 $ 58,212 $ 53,174 $ 48,265
========= ========= ========= ========== =========
Non-interest expense as
% of average assets................ 1.13% 1.24% 1.31% 1.17% 1.17%
========= ========= ========= ========== =========
31
BALANCE SHEET ANALYSIS
Consolidated assets at the end of 2004 were $7.5 billion, representing a
55% increase from $4.8 billion at the end of 2003 and a 76% increase from $4.3
billion at the end of 2002. The increase in assets during 2004 is attributable
to increased loan origination activity. Loan originations totaled $3.9 billion
in 2004, $2.3 billion in 2003 and $1.3 billion in 2002. Principal repayments on
loans totaled $1.4 billion during 2004, $1.7 billion during 2003 and $1.5
billion during 2002.
Real Estate Loan Portfolio
At the end of 2004, 45% of our loans had adjustable interest rates based on
monthly changes in the CODI, 24% were based on the 12MAT Index and 19% were
based on the COFI index. As part of our asset-liability management strategy, we
have maintained a high level of adjustable loans in our portfolio for several
years. During 2004, we focused on marketing adjustable loans based on the CODI.
At December 31, 2004, CODI loans comprised 69% of the loan originations.
Management believes that the high level of adjustable rate mortgages will help
insulate us 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--"
We also originate adjustable rate loans with initial fixed interest rates
with periods ranging from 3 to 10 years. By policy, we 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 these hybrid fixed-rate loans will
enhance the Company's overall return on assets. However, loans originated under
the hybrid programs totaled $4.5 million in 2004 compared to $434.3 million in
2003 and $419.7 million in 2002 because management decided to focus on the
origination of monthly adjustable loans.
The following table summarizes loan originations and purchases by loan type for
the periods indicated:
Loan Originations and
Purchases by Loan Type
Year ended December 31,
-----------------------------------
2004 2003 2002
----------- ---------- -----------
(In thousands)
Fixed.............................................. $ 19,609 $ 64,120 $ 110,154
Hybrid............................................. 4,484 434,314 419,690
Adjustable:
12MAT.............................................. 988,123 817,217 303,443
CODI............................................... 2,678,739 745,507 20,082
COFI............................................... 109,331 158,868 383,852
LIBOR.............................................. 9,832 2,350 20,887
Prime.............................................. 70,691 53,154 30,664
---------- ---------- ----------
Total........................................... $ 3,880,809 $ 2,275,530 $ 1,288,772
========== ========== ==========
32
The following table details loan originations and loan purchases by
property type for the periods indicated:
Loan Originations and Purchases by Property Type
Year Ended December 31,
------------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- --------- --------- ----------
(In thousands)
Single family (one-to-four
units)....................... $ 3,095,010 $ 1,712,584 $ 728,309 $ 912,974 $ 658,808
Multi-family.................. 647,326 470,426 441,407 407,458 333,466
Commercial real estate........ 66,010 35,237 84,050 150,735 70,807
Commercial business loans..... 43,226 31,581 17,572 16,172 11,759
Other......................... 29,237 25,702 17,434 14,996 6,170
--------- --------- --------- --------- ---------
Total......................... $ 3,880,809 $ 2,275,530 $ 1,288,772 $ 1,502,335 $ 1,081,010
========= ========= ========= ========= =========
No loans were originated upon the sale of real estate owned during 2004 and
2003. Loans originated upon the sale of real estate owned totaled $375 thousand
during 2002.
Our loan products may provide for initial monthly payments that are
calculated based on pay rates 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, as well as shortfalls
resulting from a 7.5% annual payment cap, 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.
We do not normally lend in excess of 90% of the appraised collateral value
on adjustable mortgage loans ("AMLs"). Where we do 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, we may purchase private mortgage insurance with our own funds. Loans
originated with an initial loan-to-value greater than 80% with no private
mortgage insurance totaled $812.7 million at December 31, 2004 compared to
$486.7 million at December 31, 2003 and $159.7 million at December 31, 2002. See
"--Business - Interest Rates, Terms and Fees--"
Loan Composition
Loans based on the security of single-family properties (one-to-four units)
comprise the largest category of our loan portfolio. The loan portfolio also
includes loans secured by multi-family and commercial and industrial properties.
At December 31, 2004, 67% of the loan portfolio consisted of first liens on
single-family properties while first liens on multi-family properties were 27%
of the portfolio, and first liens on commercial properties represented 5% of the
portfolio. Commercial business loans, construction loans, consumer loans and
other loans comprised the remaining 1% of the loan portfolio at December 31,
2004.
33
The following table sets forth the composition of our portfolio of loans
and mortgage-backed securities at December 31, for each of the last five years:
December 31,
-----------------------------------------------------------
2004 2003 2002 2001 2000
--------- -------- -------- --------- ---------
(In thousands)
REAL ESTATE LOANS
First trust deed residential loans:
One-to-four units................$ 4,585,962 $ 2,456,971 $ 1,723,690 $ 2,121,899 $ 2,158,940
Five or more units............... 1,825,564 1,547,771 1,646,430 1,525,749 1,308,440
--------- --------- --------- --------- ---------
Residential loans............ 6,411,526 4,004,742 3,370,120 3,647,648 3,467,380
OTHER REAL ESTATE LOANS
Commercial and industrial........ 324,805 345,273 419,273 358,159 217,619
Construction..................... 20,902 9,053 6,927 38,060 --
Land............................. -- -- 203 1,481 --
Second trust deeds............... 5,466 7,281 5,965 9,472 8,543
--------- --------- --------- ---------- ---------
Real estate loans............... 6,762,699 4,366,349 3,802,488 4,054,820 3,693,542
NON-REAL ESTATE LOANS
Manufactured housing............. -- -- -- -- 391
Deposit accounts................. 491 649 1,185 1,267 576
Commercial business loans........ 58,869 34,424 19,582 18,882 12,600
Consumer loans................... 60,677 49,738 35,395 19,546 6,555
--------- -------- -------- --------- ---------
Loans receivable................ 6,882,736 4,451,160 3,858,650 4,094,515 3,713,664
LESS:
General valuation allowance...... 78,675 75,238 75,223 72,919 70,809
Impaired loan valuation allowance 496 496 496 1,850 1,792
Deferred loan origination
(costs) fees.................... (34,380) 1,314 13,696 14,857 11,779
--------- -------- -------- --------- ---------
Net loans receivable (1)........ 6,837,945 4,374,112 3,769,235 4,004,889 3,629,284
FHLMC AND Fannie Mae MORTGAGE-BACKED SECURITES
(at fair value):
Secured by single family
dwellings....................... 91,308 128,465 192,395 272,419 360,210
Secured by multi-family dwellings 5,751 6,711 8,190 11,660 14,195
--------- -------- -------- --------- ---------
Mortgage-backed securities... 97,059 135,176 200,585 284,079 374,405
--------- -------- -------- --------- ---------
TOTAL $ 6,935,004 $ 4,509,288 $ 3,969,820 $ 4,288,968 $ 4,003,689
========= ========= ========= ========= =========
(1) Includes loans held-for-sale.
Net deferred loan origination costs were $34.4 million at December 31,
2004. Net deferred loan origination fees were $1.3 million at December 31, 2003
and $13.7 million at December 31, 2002. The change to net deferred loan costs
from net deferred loan fees was attributable to the high volume of wholesale
loans originated during 2004 and 2003. Wholesale single family loans typically
have loan deferred origination costs in excess of deferred loan origination
income due to commissions paid to mortgage loan brokers.
Loans Sold with Recourse
Loans sold with recourse are primarily secured by multi-family properties.
Loans sold with recourse totaled $76.3 million as of December 31, 2004, $91.0
million as of December 31, 2003 and $108.6 million as of December 31, 2002.
Although no longer owned by us, these loans are evaluated for the purposes of
computing the repurchase liability and measuring risk exposure for regulatory
capital.
In January of 2005, we completed a multi-family loan securitization with
Fannie Mae in which $1.3 billion in loans from our loan portfolio were formed
into mortgage-backed securities. Because we retained full recourse on the
securitized loans, the mortgage-backed securities will continue to be accounted
for as part of our loan portfolio under SFAS No. 133. These loans will be
evaluated for risk along with the remainder of our multi-family loan portfolio.
34
ASSET QUALITY
Asset Quality Ratios
The following table sets forth certain asset quality ratios at the dates
indicated:
December 31,
----------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
Non-performing loans to gross
loans receivable (1)........ 0.07% 0.08% 0.17% 0.16% 0.17%
Non-performing assets to total
assets (2).................. 0.07% 0.10% 0.17% 0.17% 0.19%
Loan loss allowances to
non-performing loans (3).... 1,588% 2,266% 1,126% 1,151% 1,160%
General loss allowances to
gross loans receivable (4).. 1.15% 1.70% 1.96% 1.83% 1.95%
(1) 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) Our loan loss allowances, including general valuation allowances and
valuation allowances for impaired loans.
(4) Our 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.
NON-PERFORMING ASSETS
Non-performing assets, as defined by ourselves, 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,
---------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
--------------- --------------- --------------- --------------- ---------------
$ % $ % $ % $ % $ %
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
(Dollars in thousands)
Real estate owned:
Single family.......... $ -- --% $ 1,324 28% $ 519 7% $ 1,671 21% $ 2,507 30%
Multi-family........... -- -- -- -- -- -- 164 2 -- --
Less: general
valuation allowance.. -- -- -- -- (200) (2) (350) (4) (350) (4)
----- ----- ------ ----- ------ ---- ------ ----- ------ -----
Total real estate owned -- -- 1,324 28 319 5 1,485 19 2,157 26
Non-performing loans:
Single family.......... 4,590 92 3,326 71 5,705 81 6,062 75 5,603 66
Multi-family........... 391 8 -- -- 1,017 14 422 5 662 8
Commercial and
industrial........... -- -- -- -- -- -- -- -- -- --
Other.................. 4 -- 16 1 -- -- 16 1 -- --
----- ----- ------ ----- ------ ---- ------ ----- ------ -----
Total non-performing
loans................ 4,985 100 3,342 72 6,722 95 6,500 81 6,265 74
----- ----- ------ ----- ------ ---- ------ ----- ------ -----
Total..................$ 4,985 100% $ 4,666 100% $ 7,041 100% $ 7,985 100% $ 8,422 100%
===== ===== ====== ===== ====== ==== ====== ===== ====== =====
Ratio of
non-performing
assets to total
assets............... 0.07% 0.10% 0.17% 0.17% 0.19%
====== ====== ====== ====== ======
The decrease in non-performing loans and real estate owned over the last several
years is due to continued strength in the California real estate markets.
35
Single-family non-performing loans are primarily due to factors such as
unemployment and declining personal income. Multi-family and commercial
non-performing loans are attributable primarily to factors such as declines in
occupancy rates, employment rates and rental rates. We actively monitor the
status of all non-performing loans.
Impaired loans totaled $1.4 million, $3.3 million and $1.6 million, net of
related allowances of $496 thousand, $496 thousand and $496 thousand as of
December 31, 2004, 2003 and 2002, respectively. See "--Business - Non-accrual,
Past Due, Impaired and Restructured Loans--" for further discussion of impaired
loans.
Our modified loans result primarily from temporary modifications of
principal and interest payments or an extension of maturity dates. 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 us. 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, 2004, we had modified loans totaling $1.4 million.
This compares with $1.5 million and $1.6 million as of December 31, 2003 and
December 31, 2002, respectively. No modified loans were 90 days or more
delinquent as of December 31, 2004, 2003 or 2002.
CAPITAL RESOURCES AND LIQUIDITY
Liquidity Requirements
As permitted by the OTS, management determines the level of liquidity
required for safe and sound operation. Our strategy is to keep cash and liquid
investments at a modest level due to the availability of credit lines. These
credit lines are considered in our definition of available liquidity. Our
liquidity policy requires that cash and cash equivalents, short-term investments
and unused borrowing capacity be maintained at a minimum level of 10% of our
liquidity base (defined as deposits and borrowings due within one year). As of
December 31, 2004, liquidity-qualifying balances were 14.99% of our liquidity
base.
External Sources of Funds
External sources of funds include 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 FHLB advances.
Deposits are accepted from full-service banking branches, national deposit
brokers ("brokered deposits") and telemarketing sources. The cost of funds,
operating margins and our net income associated with brokered and telemarketing
deposits are generally comparable to the cost of funds, operating margins and
our net income associated with deposits, FHLB borrowings and repurchase
agreements. As the cost of each source of funds fluctuates from time to time,
based on market rates of interest offered by us and other depository
institutions, we select funds from the lowest cost source until the relative
costs change. As the cost of funds, operating margins and net income associated
with each source of funds are generally comparable, we do not deem the impact of
its use of any one of the specific sources of funds at a given time to be
material.
Deposits at full-service banking branches were $2.5 billion at December 31,
2004, $2.5 billion as of December 31, 2003 and $2.3 billion at December 31,
2002.
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. We had $1.2 billion in brokered
deposits at December 31, 2004. There were none at December 31, 2003 and $161.3
million at December 31, 2002. Utilization of brokered deposits increased during
2004 due to funds required to fund loan originations.
36
Telemarketing deposits were $45.1 million at the end of 2004, $15.6 million
at the end of 2003 and $64.6 million at the end of 2002. These deposits are
normally large deposits from pension plans, managed trusts and other financial
institutions. 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 rates offered and the investors'
perception of our creditworthiness.
Loan sales were $3.3 million in 2004. This compares to $86.1 million during
2003 and $134.2 million during 2002. Loan sales decreased during 2004 and 2003
because management focused on the origination of monthly adjustable loans for
portfolio growth.
FHLB advances were $3.0 billion at the end of 2004, $1.7 billion at the end
of 2003 and $1.2 billion at the end of 2002. Borrowings from the FHLB increased
during 2004 in order to fund loan originations.
Reverse repurchase agreements are short-term borrowings secured by
mortgage-backed and investment securities. These borrowings increased to $187.0
million at the end of 2004 from $122.6 million at the end of 2003 and $155.3
million at the end of 2002. The increase during 2004 occurred because we pledged
additional securities from our investment portfolio. These borrowings are
expected to increase during 2005, because $1.3 billion in additional
mortgage-backed securities were formed with loans from our loan portfolio in
January of 2005.
Internal Sources of Funds
Internal sources of funds include loan principal payments, loan payoffs,
and positive cash flows from operations. Principal payments were $1.4 billion in
2004 compared to $1.7 billion in 2003 and $1.5 billion in 2002. Principal
payments include both scheduled principal paydowns and prepayments which are a
function of real estate activity and the general level of interest rates.
The Company anticipates that it will have sufficient funds available to
fund current loan origination activity. At December 31, 2004, the Company has a
credit facility with the FHLB in the form of advances and lines of credit which
allow borrowings of up to 60% of our assets as computed for regulatory purposes.
At December 31, 2004, this amounted to approximately $4.5 billion. At December
31, 2004 the Company had $3.0 billion in advances from the FHLB. Certificates of
deposits which have contractual maturities of one year or less from December 31,
2004, totaled $1.6 billion. The Company's other sources of liquidity include
principal and interest payments on loans, proceeds from loan sales and other
borrowings, such as reverse repurchase transactions. The Company could also
choose to pay higher rates to maintain maturing deposits, which could result in
an increased cost of funds. Historically, the Company has retained a significant
portion of maturing deposits. While management anticipates that there may be
some outflow of these deposits upon maturity due to the current competitive rate
environment, they are not expected to have a material impact on the long-term
liquidity position of the Company.
The table below details the amounts of the Company's contractual
obligations by maturity at December 31, 2004.
Payments due by period
----------------------------------------------------------------
Less than More than
Total 1 year 1 - 3 years 3 - 5 years 5 years
---------- ---------- ---------- --------- ----------
(In thousands)
Fixed-rate term certificates.... $1,755,230 $ 1,643,035 $ 95,155 $ 17,040 $ --
FHLB advances................... 3,004,600 2,604,600 365,000 15,000 20,000
Reverse repurchase agreements... 187,000 187,000 -- -- --
Operating lease obligations..... 19,030 4,968 9,041 3,613 1,408
--------- --------- ---------- --------- ---------
Total........................... $4,965,860 $ 4,439,603 $ 469,196 $ 35,653 $ 21,408
========= ========= ========== ========= =========
37
Capital Requirements
Current OTS regulatory capital standards require that we 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 risk-weighted assets. 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 ourselves. Our capital position is actively monitored by
management. We 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.
The following table summarizes the capital ratios of the "well capitalized"
category and our regulatory capital position at December 31, 2004 as compared to
such ratios. As indicated in the table, our capital levels exceeded the three
minimum capital ratios of the "well capitalized" category:
Amount %
----------- ------
(Dollars in thousands)
Core capital requirement................. $ 373,111 5.00%
Bank's core capital...................... 446,662 5.99
--------- -----
Excess core capital.................... $ 73,551 .99%
========= =====
Tier 1 risk-based capital requirement.... $ 250,378 6.00%
Bank's tier 1 risk-based capital......... 446,662 10.70
-------- -----
Excess tier 1 risk-based capital....... $ 196,284 4.70%
======== =====
Risk-based capital requirement........... $ 417,297 10.00%
Bank's risk-based capital................ 499,151 11.96
-------- -----
Excess risk-based capital.............. $ 81,854 1.96%
========= =====
Recent Accounting Pronouncements
In December 2004, SFAS Statement No. 123 (revised), Share-Based Payment,
was issued. Statement 123 (revised) requires a public entity to measure the cost
of employee services received in exchange for an award of equity instruments
based on the grant-date fair value of the award (with limited exceptions). That
cost will be recognized over the period which an employee is required to provide
service in exchange for the award-the requisite service period (usually the
vesting period). No compensation cost is recognized for equity instruments for
which employees do not render the requisite service. Employee share purchase
plans will not result in recognition of compensation cost if certain conditions
are met; those conditions are much the same as the related conditions in
Statement 123.
A public entity will initially measure the cost of employee services
received in exchange for an award of liability instruments based on its current
fair value; the fair value of that award will be re-measured subsequently at
each reporting date through the settlement date. Changes in fair value during
the requisite service period will be recognized as compensation cost over that
period. The grant-date fair value of employee share options and similar
instruments will be estimated using option-pricing models adjusted for the
unique characteristics of those instruments (unless) observable market prices
for the same or similar instruments are available). If an equity award is
modified after the grant date, incremental compensation cost will be recognized
in an amount equal to the excess of the fair value of the modified award over
the fair value of the original award immediately before the modification. The
Statement is effective for the Company on July 1, 2005.
SFAS Statement No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued in May 2003. This
Statement establishes standards for the classification and measurement of
certain financial instruments with characteristics of both liabilities and
equity. The Statement also includes required disclosures for financial
instruments within its scope. For the Company, the Statement was effective for
instruments entered into or modified after May 31, 2003 and otherwise will be
effective as of January 1, 2004, except for mandatorily redeemable financial
instruments. For certain mandatorily redeemable financial instruments, the
Statement is effective for the Company on January 1, 2005. The effective date
has been deferred indefinitely for certain other types of mandatorily redeemable
financial instruments. The Company currently does not have any financial
instruments that are within the scope of this Statement.
38
ITEM 7A -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ASSET-LIABILITY MANAGEMENT
Our primary objective in managing interest rate risk is to minimize the
adverse impact of changes in interest rates on our net interest income and
capital, while, at the same time, adjusting our asset-liability mix to achieve
the most favorable impact on income.
Our 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 income from
interest rate fluctuations. Under this program, we emphasize the funding of
monthly adjustable mortgages with short-term savings and borrowings and match
the repricing of these assets and liabilities. We also originate adjustable rate
loans with initial fixed interest rates for periods ranging from 3 to 10 years.
By policy, we 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.
At the end of 2004, 45% of our loans had adjustable interest rates based on
monthly changes in the CODI, 24% were based on the 12MAT Index and 19% were
based on the COFI. Comparisons over the last several years show that changes in
our cost of funds generally correlate with changes in these indices. We do not
use any futures, options or swaps in our 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 we use lag changes in interest rates from 60 to 90
days while prime-based business loans re-price immediately. However, our
short-term savings and borrowing costs adjust quickly causing net interest
income to initially decrease during periods of rising interest rates and
increase during periods of declining interest rates. The movement of interest
rates, whether up or down, cannot be accurately predicted and could have a
negative impact on our income.
The following table shows the interest sensitivity of our assets and
liabilities by repricing period at December 31, 2004 and the consolidated GAP
position as a percentage of total assets at that time:
INTEREST-SENSITIVITY GAP
-----------------------------------------------------------
Balances Balances Balances Balances
Repricing Repricing Repricing Repricing
Total Within Within Within After
Balance 1 Year 1-3 Years 4-10 Years 10 Years
--------- ---------- -------- --------- ---------
(Dollars in thousands)
Interest-earning assets:
FHLB and other interest-earning
deposits............................ $ 29,914 $ 29,914 $ -- $ -- $ --
Investment securities, at fair value. 250,586 249,710 808 68 --
Mortgage-backed securities, at fair
value............................... 97,059 97,010 43 6 --
Loans receivable..................... 6,882,736 6,717,547 144,320 18,512 2,357
--------- ---------- -------- --------- ---------
Total interest-earning assets...... $ 7,260,295 $ 7,094,181 $ 145,171 $ 18,586 $ 2,357
========= ========== ======== ========= =========
Interest-bearing liabilities:
Demand accounts...................... $ 2,005,935 $ 2,005,935 $ -- $ -- $ --
Fixed rate term certificates......... 1,755,230 1,642,919 95,155 16,626 530
FHLB advances........................ 3,004,600 2,604,600 365,000 35,000 --
Reverse repurchase agreements........ 187,000 187,000 -- -- --
--------- ---------- -------- --------- ---------
Total interest-bearing liabilities. $ 6,952,765 $ 6,440,454 $ 460,155 $ 51,626 $ 530
========= ========== ======== ========= =========
Interest-sensitivity GAP............... $ 307,530 $ 653,727 $ (314,984)$ (33,040) $ 1,827
========= ========== ======== ========= =========
Interest-sensitivity GAP as a
percentage of total assets.......... 8.75% (4.22)% (0.44)% 0.02%
========== ======== ========= =========
Cumulative interest-sensitivity GAP.... $ 653,727 $ 338,743 $ 305,703 $ 307,530
========== ======== ========= =========
Cumulative interest-sensitivity GAP as
a percentage of total assets........ 8.75% 4.54% 4.09% 4.12%
========== ======== ========= =========
39
In order to minimize the impact of rate fluctuations on income,
management's goal is to keep the one-year GAP at less than 20% of total assets
(positive or negative). At December 31, 2004, our one-year GAP ratio was a
positive $654 million or 8.75% of total assets. This compares with a positive
GAP ratio of 13.8% of total assets at December 31, 2003 and a positive GAP ratio
of 6.1% of total assets at December 31, 2002. The positive one-year GAP at
December 31, 2004 decreased from December 31, 2003 because we funded one month
adjustable loans with liabilities due in one year or less. The change to a
positive one-year GAP at December 31, 2003 from a negative GAP at December 31,
2002 resulted from the early payoff of loans with initial fixed periods and the
increased origination of monthly adjustable rate 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 our net portfolio value at December 31, 2004 and December 31,
2003:
Percentage
Change in Interest Rates Change in Net Portfolio Value(1)
(In Basis Points) 2004 2003
---- ----
+300.................... (5)% (14)%
+200.................... (4)% (11)%
+100.................... (3)% (8)%
--100................... (1)% 9 %
--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, 2004 and December 31, 2003 levels would
result in negative interest rates in many cases. Therefore, modeling the
impact of such declines as of December 31, 2004 and December 31, 2003 is
not meaningful or practical.
40
The following table shows the contract terms and fair value of our
interest-earning assets and interest-bearing liabilities as of December 31, 2004
categorized by type and expected maturity for each of the next five years and
thereafter:
Expected Maturity Date as of December 31, (1)
-------------------------------------------------------------------------------------
Total Fair
2005 2006 2007 2008 2009 Thereafter Balance Value
-------- ------- -------- ------ ------- -------- -------- ---------
(Dollars in thousands)
Interest-earning
assets:
Loans receivable:
Adjustable rate
loans:
Single family.... $1,232,648 $1,347,949 $ 963,174 $ 501,079 $ 257,456 $ 274,365 $ 4,576,671 $ 4,619,960
Average
interest rate..... 5.04% 5.04% 5.04% 5.04% 5.04% 5.04% 5.04%
Multi-family..... 527,577 454,803 333,703 194,452 143,919 163,273 1,817,727 1,820,991
Average
interest rate..... 4.75% 4.61% 4.44% 4.41% 4.37% 4.44% 4.56%
Commercial and
industrial...... 109,819 82,687 48,089 28,558 17,068 23,270 309,491 315,807
Average
interest rate..... 6.02% 5.92% 5.49% 5.41% 5.35% 5.01% 5.74%
Fixed rate loans:
Single family.... 5,526 2,403 923 260 71 27 9,210 9,390
Average
interest rate..... 6.97% 6.47% 6.21% 6.15% 6.13% 6.12% 6.73%
Multi-family..... 6,796 2,363 542 270 203 76 10,250 10,571
Average
interest rate..... 7.60% 7.53% 8.04% 8.00% 7.98% 8.04% 7.63%
Commercial and
industrial........ 9,959 4,454 2,257 701 252 87 17,710 18,342
Average
interest rate..... 7.46% 7.80% 7.61% 7.84% 8.17% 7.95% 7.59%
Non-mortgage
loans:
Commercial
business loans... 18,433 19,398 20,413 1,749 -- -- 59,993 59,845
Average
interest rate..... 5.11% 5.11% 5.11% 5.11% -- -- 5.11%
Construction
loans........... 6,009 6,540 7,118 621 -- -- 20,288 21,476
Average
interest rate..... 8.50% 8.50% 8.50% 8.50% -- -- 8.50%
Consumer loans.... 18,886 19,853 20,870 1,787 -- -- 61,396 61,641
Average
interest rate..... 5.00% 5.00% 5.01% 5.01% -- -- 5.00%
Mortgage-backed
securities:
Adjustable: 40,403 23,420 13,789 8,094 4,737 6,513 96,956 97,681
Average
interest rate..... 2.81% 2.81% 2.81% 2.81% 2.81% 2.81% 2.81%
Fixed: 55 28 14 6 -- -- 103 103
Average
interest rate..... 8.00% 8.00% 8.00% 8.00% -- -- 8.00%
Investment
securities,
overnight
investments and
interest-bearing
deposits: 35,885 5,342 5,520 5,705 5,897 222,151 280,500 281,301
Average
interest rate..... 0.49% 3.29% 3.30% 3.31% 3.32% 3.45% 3.07%
-------- ------- -------- ------ ------- -------- -------- ---------
Total interest-
earning assets.... $2,011,996 $1,969,240 $1,416,412 $743,282 $429,603 $689,762 $7,260,295 $7,317,108
========= ========= ========== ======= ======= ======= ========= =========
Interest-bearing
liabilities:
Deposits:
Checking accounts $ 556,350 $ -- $ -- $ -- $ -- $ -- $ 556,350 $ 556,350
Average
interest rate..... 0.10% -- -- -- -- -- 0.10%
Savings accounts.. 1,449,585 -- -- -- -- -- 1,449,585 1,449,585
Average
interest rate..... 1.59% -- -- -- -- -- 1.59%
Certificate
accounts.......... 1,642,919 70,175 24,980 8,959 6,221 1,976 1,755,230 1,754,787
Average
interest rate..... 2.15% 2.75% 3.45% 3.20% 3.70% 3.49% 2.21%
Borrowings:
FHLB advances.... 2,604,600 280,000 85,000 10,000 5,000 20,000 3,004,600 3,003,161
Average
interest rate..... 2.30% 4.30% 4.56% 5.43% 5.49% 6.20% 2.59%
Reverse
repurchase
agreements........ 187,000 -- -- -- -- -- 187,000 186,325
Average
interest rate..... 2.24% -- -- -- -- -- 2.24%
-------- ------ ------- ------ ------ ------ -------- ---------
Total interest-
bearing liabilities.. $6,440,454 $350,175 $ 109,980 $ 18,959 $11,221 $ 21,976 $6,952,765 $6,950,208
========= ======= ======= ====== ====== ====== ========= =========
(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 48% for the adjustable single-family portfolio
and 36% for its adjustable multi-family and commercial real estate portfolios.
For fixed rate loans, the Bank's average CPR is 72% and 48% respectively. The
Bank used estimated deposit runoff based on available industry information.
41
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 1, 2005, there remain 1,472,079 shares eligible for
repurchase under the Company's stock repurchase program. The Company repurchased
696,900, 33,800 and 353,000 shares of its common stock at average per share
prices of $40.25, $28.53 and $25.02 during 2004, 2003 and 2002, respectively.
PRICE RANGE OF COMMON STOCK
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
High Low High Low High Low High Low
---- --- ---- --- ---- --- ---- ---
2004 $46.38 $40.40 $46.15 $38.16 $49.16 $41.23 $54.30 $48.50
2003 31.30 26.41 35.57 29.86 41.50 34.77 49.05 39.93
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
42
ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
December 31, December 31,
2004 2003
------------- ---------------
ASSETS
Cash and cash equivalents.................................. $ 68,343 $ 54,318
Investment securities, available-for-sale (at fair value)
($116,644 and $11,347 pledged) (Notes 2 and 10)......... 250,586 116,411
Mortgage-backed securities, available-for-sale (at fair
value) ($80,687 and $114,360 pledged) (Notes 3 and 10). 97,059 135,176
Loans receivable, held-for-sale (fair value of $0 and
$494) (Note 4).......................................... -- 492
Loans receivable, net of allowance for loan losses of
$79,171 and $75,734 (Notes 4 and 9)...................... 6,837,945 4,373,620
Accrued interest and dividends receivable.................. 24,115 16,941
Real estate owned, net (Note 5)............................ -- 1,324
Real estate held for investment (Note 5)................... 986 --
Office properties and equipment, net (Note 6).............. 15,881 10,568
Investment in Federal Home Loan Bank (FHLB) stock, at cost
(Notes 7 and 9).......................................... 143,425 87,775
Other assets............................................... 30,643 28,397
------------- ---------------
$ 7,468,983 $ 4,825,022
============= ===============
LIABILITIES
Deposits (Note 8).......................................... $ 3,761,165 $ 2,538,398
FHLB advances (Notes 7 and 9) ............................. 3,004,600 1,694,000
Securities sold under agreements to repurchase (Note 10)... 187,000 122,622
Accrued expenses and other liabilities..................... 38,744 33,435
------------- ---------------
6,991,509 4,388,455
------------- ---------------
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 23,693,350 and
23,543,339 shares, outstanding 16,498,754 and 17,045,643
shares................................................... 237 235
Additional paid-in capital................................. 40,977 37,733
Retained earnings.......................................... 549,202 483,360
Unreleased shares to employee stock
ownership plan .......................................... (53) (125)
Treasury stock, at cost, 7,194,596 and 6,497,696 shares.... (113,776) (85,727)
Accumulated other comprehensive income, net of taxes....... 887 1,091
------------- ---------------
477,474 436,567
------------- ---------------
$ 7,468,983 $ 4,825,022
============= ===============
The accompanying notes are in integral part of these consolidated financial statements
43
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except per share data)
2004 2003 2002
------------ ------------ -----------
Interest and dividend income:
Interest on loans............................. $ 247,892 $ 224,779 $ 243,716
Interest on mortgage-backed securities........ 3,312 5,328 9,154
Interest and dividends on investments......... 11,518 5,774 11,008
------------ ------------ -----------
Total interest income...................... 262,722 235,881 263,878
------------ ------------ -----------
Interest expense:
Interest on deposits (Note 8)................. 42,159 39,104 60,808
Interest on borrowings (Notes 9 and 10)....... 59,031 49,238 67,611
------------ ------------ -----------
Total interest expense..................... 101,190 88,342 128,419
------------ ------------ -----------
Net interest income............................... 161,532 147,539 135,459
Provision for loan losses (Note 4)............ 3,000 -- --
------------ ------------ -----------
Net interest income after provision for loan losses 158,532 147,539 135,459
------------ ------------ -----------
Non-interest income:
Loan servicing and other fees................. 9,545 7,990 4,325
Banking service fees.......................... 5,639 5,095 4,604
Gain on sale of loans......................... 5,434 2,444 7,806
Real estate operations, net (Note 5).......... 308 780 339
Other operating income........................ 370 432 1,000
------------ ------------ -----------
Total other income......................... 21,296 16,741 18,074
------------ ------------ -----------
Non-interest expense:
Salaries and employee benefits (Note 13)...... 40,907 33,484 32,627
Occupancy (Note 6)............................ 8,691 8,171 8,557
Advertising................................... 705 315 1,378
Amortization of core deposit intangible....... 1,995 1,995 1,962
Federal deposit insurance..................... 388 394 438
Legal......................................... 1,686 1,103 2,888
Other operating expense....................... 12,000 10,127 10,362
------------ ------------ -----------
Total non-interest expense................. 66,372 55,589 58,212
------------ ------------ -----------
Income before income taxes........................ 113,456 108,691 95,321
Income taxes (Note 11)............................ 47,614 44,216 40,149
------------ ------------ -----------
Net income........................................ $ 65,842 $ 64,475 $ 55,172
============ ============ ===========
Earnings per share: (Notes 12 and 15)
Basic......................................... $ 3.95 $ 3.80 $ 3.22
============ ============ ===========
Diluted....................................... $ 3.85 $ 3.70 $ 3.15
============ ============ ===========
Weighted average shares outstanding:
Basic......................................... 16,679,927 16,986,725 17,149,712
============ ============ ===========
Diluted....................................... 17,090,227 17,407,459 17,506,129
============ ============ ===========
The accompanying notes are in integral part of these consolidated financial statements
44
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(In thousands, except share data)
Accumulated
Retained Unreleased Other
Earnings Shares Comprehensive
Additional (Substantially to ESOP Income, Net
Common Paid-In Restricted) (Notes 12 Treasury of Taxes
Stock Capital (Note 12) and 13) Stock (Notes 2 and 3) Total
------- -------- ----------- -------- ------- ------------- -------
Balance, December 31,
2001.................... $ 234 $ 34,670 $ 363,713 $ -- $ (75,930) $ 2,991 $ 325,678
Comprehensive income:
Net income............. -- -- 55,172 -- -- -- 55,172
Change in net
unrealized gain on
securities
available for
sale, net of
reclassification
adjustment and tax
effect............. -- -- -- -- -- (790) (790)
-------
Total
comprehensive
income........... 54,382
Exercise of employee
stock options......... -- 407 -- -- -- -- 407
Net decrease in
unreleased shares to -- -- -- (597) -- -- (597)
the ESOP..............
Benefit from stock
option tax adjustment. -- 603 -- -- -- -- 603
Common stock repurchased
(353,000) shares...... -- -- -- -- (8,832) -- (8,832)
------- -------- ----------- -------- ------- ------------- -------
Balance, December 31,
2002................... 234 35,680 418,885 (597) (84,762) 2,201 371,641
Comprehensive income:
Net income............. -- -- 64,475 -- -- -- 64,475
Change in net
unrealized gain on
securities
available for
sale, net of
reclassification
adjustment and tax
effect............. -- -- -- -- -- (1,110) (1,110)
-------
Total
comprehensive
income........... 63,365
Exercise of employee
stock options......... 1 1,828 -- -- -- -- 1,829
Net increase in
unreleased shares to -- -- -- 472 -- -- 472
the ESOP..............
Benefit from stock
option tax adjustment. -- 225 -- -- -- -- 225
Common stock
repurchased (33,800)
shares................ -- -- -- -- (965) -- (965)
------- -------- ----------- -------- ------- ------------- -------
Balance, December 31,
2003.................... 235 37,733 483,360 (125) (85,727) 1,091 436,567
Comprehensive income:
Net income............ -- -- 65,842 -- -- -- 65,842
Change in net
unrealized gain on
securities
available for
sale, net of
reclassification
adjustment and tax
effect............. -- -- -- -- -- (204) (204)
-------
Total
comprehensive
income........... 65,638
Exercise of employee
stock options......... 2 1,979 -- -- -- -- 1,981
Net increase in
unreleased shares to -- (52) -- 72 -- -- 20
the ESOP..............
Benefit from stock
option tax adjustment. -- 1,317 -- -- -- -- 1,317
Common stock
repurchased
(696,900) shares...... -- -- -- -- (28,049) -- (28,049)
------- -------- ----------- -------- ------- ------------- -------
Balance, December 31,
2004.................... $ 237 $ 40,977 $ 549,202 $ (53) $ (113,776) $ 887 $ 477,474
======= ======== =========== ======== ======== ============= =======
The accompanying notes are in integral part of these consolidated financial statements
45
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(In thousands)
2004 2003 2002
--------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................................ $ 65,842 $ 64,475 $ 55,172
Adjustments to reconcile net income to
net cash provided by operating activities:
Net change in loans held-for-sale............... 492 1,801 2,953
Depreciation and amortization................... 1,335 1,371 1,652
Provision for loan losses....................... 3,000 -- --
Valuation adjustments on real estate sold....... -- (68) (265)
Amortization of fees and discounts.............. 14,215 2,009 3,926
Gain on sale of loans........................... (5,434) (2,444) (7,806)
Decrease in servicing asset..................... 105 240 737
FHLB stock dividends............................ (3,863) (3,260) (4,950)
Increase (decrease) in taxes payable............ 1,175 6,617 (1,976)
(Increase) decrease in interest and dividends
receivable..................................... (7,174) 811 4,324
Increase (decrease) in interest payable......... 7,356 (3,298) (5,895)
Amortization of core deposit intangible asset... 1,995 1,995 1,962
(Increase) decrease in other assets............. (8,147) (8,043) 5,248
(Increase) decrease in accrued expenses and
other liabilities............................. 4,441 774 (7,240)
--------- ---------- ----------
Total adjustments............................. 9,496 (1,495) (7,330)
--------- ---------- ----------
Net cash provided by operating activities..... 75,338 62,980 47,842
--------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Loans made to customers and principal
collections on loans ......................... (2,430,543) (589,905) 232,998
Loans purchased................................. (422) (500) (89)
Net change in unearned loan fees................ (49,314) (13,758) (5,104)
Proceeds from sales of real estate owned........ 1,324 884 3,500
Proceeds from maturities and principal reductions
on investment securities, available-for-sale.. 64,379 134,037 87,120
Principal reductions on mortgage-backed
securities, available-for-sale................ 37,178 64,330 83,010
Purchases of investment securities,
available-for-sale............................ (198,494) (148,847) (80,855)
Redemptions (purchases) of FHLB stock, net...... (51,787) (5,787) 17,585
Purchases of premises and equipment............. (6,648) (1,597) (1,172)
--------- ---------- ----------
Net cash provided by (used in) investing
activities.................................... (2,634,327) (561,143) 336,993
--------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits............. 1,222,767 11,372 (19,621)
Net increase (decrease) in short term borrowings 1,586,978 622,349 (613,767)
Net Increase (decrease) in long term borrowings. (212,000) (128,000) 128,000
Purchases of treasury stock..................... (28,049) (965) (8,832)
Other........................................... 3,318 2,526 413
--------- ---------- ----------
Net cash provided by (used in) financing
activities.................................... 2,573,014 507,282 (513,807)
--------- ---------- ----------
Net increase (decrease) in cash and cash
equivalents................................... 14,025 9,119 (128,972)
Cash and cash equivalents at beginning of period 54,318 45,199 174,171
--------- ---------- ----------
Cash and cash equivalents at end of period...... $ 68,343 $ 54,318 $ 45,199
========= ========== ==========
The accompanying notes are in integral part of these consolidated financial statements
46
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 and Nature of Operations
The consolidated financial statements include the accounts of the Company
and its subsidiary, the Bank. We maintain 29 full-service banking branches and
four loan offices. Our primary business consists of attracting 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 2002 and 2003 consolidated financial statements have been
reclassified to conform to the 2004 presentation.
Uses of Estimates
In preparing consolidated financial statements in conformity with generally
accepted accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of the
date of the balance sheet and reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. Material
estimates that are particularly susceptible to significant change in the near
term relate to the determination of the allowance for loan losses, the
determination of the expected lives of residential loans used to amortize
deferred origination costs and the valuation of deferred tax assets.
Cash and Cash Equivalents
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 Balance Sheet, whenever it is practicable to
estimate the value. A significant portion of our 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 our
financial instruments is concentrated in our loans receivable. Additionally, we
are subject to credit risk on certain loans sold with recourse. We have
established a system for monitoring the level of credit risk in the 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 ourselves. Our market risk is
concentrated in our portfolios of loans receivable. When a borrower fails to
meet the contractual requirements of his or her loan agreement, we are subject
to the market risk of the collateral securing the loan. Likewise, we are subject
to the volatility of real estate prices with respect to real estate acquired by
foreclosure. Our securities classified as available-for-sale are traded in
active markets. The value of these securities is susceptible to the fluctuations
of the market.
47
(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.
Interest rate risk occurs to the degree that interest-earning assets reprice on
a different frequency or schedule than interest-bearing liabilities. The loan
portfolio tends to lag market interest rates by 60 to 90 days. We closely
monitor the pricing sensitivity of our 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 our 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 our mortgage loans, the collateral will be the
underlying mortgaged property. Our lending activities are concentrated in
California. We do not have significant exposure to any individual customer.
Securities Purchased under Agreements to Resell
The company invests in securities purchased under agreements to resell
("repurchase agreements"). We obtain 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. We deal only with nationally
recognized investment banking firms as the counterparties to these agreements.
The Company's investment in repurchase agreements consisted solely of securities
purchased under agreements to resell identical securities.
Investments and Mortgage-Backed Securities
Investment securities principally consist of U.S. Treasury and agency
securities, collateralized mortgage obligations and mortgage-backed securities.
Mortgage-backed securities are created when we exchange pools of our own loans
for mortgage-backed securities.
We classify all of our 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
we 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 income in the Consolidated Statements of Income. 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. Interest income on securities is accrued on the unpaid principal
balance.
We did not hold any trading securities at December 31, 2004 or 2003.
48
(1) Summary of Significant Accounting Policies (continued)
Loans Held-for-Investment
Our 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 loan fees and allowances for loan losses. Interest income on loans is
accrued on the unpaid principal balance.
Loans Held-for-Sale
Loans that may foreseeably be sold prior to maturity are classified 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
We evaluate 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, we measure 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, we record an impairment allowance
equal to the excess of our 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
We establish 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 due to the
inherent risks in the loan portfolio that have yet to be specifically
identified. The Bank's loan portfolio is stratified based on factors affecting
the perceived level and concentration of risk, such as type of collateral, level
of loan documentation, the borrowers credit rating, year of origination,
original loan-to-value ratio and geographic location.
The appropriate level of general valuation allowance is calculated by
applying reserve factors to the balance of assets on which the Bank has loss
exposure. These reserve factors represent the expected likelihood of default
multiplied by the expected rate of loss. The expected rates of loss and default
are based on the Bank's historical loss experience and adjusted for current
conditions and trends in the Bank's lending areas.
Based on this methodology, the Bank recorded $3.0 million in provision for
loan losses during 2004. The Bank did not record a loan loss provision during
2003 and 2002.
Loans that require a reduced level of documentation at origination are an
increasing percentage of the Bank's loan portfolio. On "Stated Income/Stated
Asset" (SISA) loans, the borrower includes information on his/her level of
income and assets that is not subject to verification by the Bank. On "Stated
Income/Verified Assets" ("SIVA") loans, the borrower includes information on
his/her level of income, but his/her assets are verified. For "No Income/No
Asset" (NINA) loans, the borrower is not required to submit information on
his/her level of income or assets. The Bank's portfolios of multi-family and
other real estate loans all require full documentation by the borrowers.
49
(1) Summary of Significant Accounting Policies (continued)
The Bank attempts to mitigate the inherent risk of making reduced
documentation loans by evaluating the other credit characteristics of the loans,
such as the creditworthiness of the borrower and the loan to value ratio based
on the collateral's appraised value at the origination date. One measure of the
creditworthiness of the borrower is the borrower's FICO score, which is a
standardized credit scoring system developed by Fair Isaac & Co.
General allowances are provided for all loans, regardless of any specific
allowances provided. The determination of our general allowance for loan losses
is based on estimates that are affected by changes in the regional or national
economy and market conditions. Management believes, based on economic and market
conditions, that the general allowance for loan losses is adequate as of
December 31, 2004 and 2003. Should there be an economic or market downturn or if
market interest rates increase significantly, a material increase in the level
of loan defaults and charge-offs could result.
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. Loan origination costs for residential
loans obtained from wholesale loan brokers will generally include fees paid to
those brokers, resulting in loan origination costs exceeding loan fees received.
These excess loan origination costs are amortized as an adjustment of loan yield
based on the expected lives of the related loans, including an estimate of the
prepayment speeds on the portfolio. When a loan is repaid or sold, any
unamortized net deferred fee balance is included in our statement of operations.
Gain or Loss on Sale of Loans
Mortgage loans are primarily sold on a servicing released basis and we
recognize cash gains or losses immediately in our Statement of Operations and
Comprehensive Income. We have 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 earned
on 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. We estimate
fair values by discounting servicing assets cash flows using discount and
prepayment rates that we believe market participants would use. Servicing assets
arising from the sale of loans are included in other assets and were $192,000
and $296,000 at December 31, 2004 and 2003, respectively. No additional
servicing assets were originated in 2004, 2003 or 2002.
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. The Company adopted SFAS No.
142 effective January 1, 2002. Under the provisions of SFAS No. 142, the Company
amortizes these intangible assets on a straight-line basis over their estimated
useful lives, which is seven years. The balance of core deposit intangible at
December 31, 2004 was $5,333,000. There was no impairment of the Company's core
deposit intangible as of December 31, 2004.
The following is a projection of estimated amortization of the core deposit
intangible at December 31, for the periods indicated (in thousands):
2005............................. $ 2,005
2006............................. 2,005
2007............................. 1,323
---------
$ 5,333
=========
Real Estate
Our 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. We
acquire 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.
50
(1) Summary of Significant Accounting Policies (continued)
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 Company or its subsidiaries in the property sold. If a real
estate transaction does not meet certain down payment, cash flow and loan
amortization requirements, any gain would be 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 and investments 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 its subsidiaries. Income taxes are
accounted for 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 Company'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 SFAS
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.
51
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:
Year Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
(In thousands, except per share data)
Net income as reported.................. $ 65,842 $ 64,475 $ 55,172
Deduction:
Total stock-based compensation expense
determined under fair-value-based method
for all rewards, net of tax............ (740) (606) (976)
---------- ---------- ----------
Pro forma net income.................. $ 65,102 $ 63,869 $ 54,196
========== ========== ==========
Earnings per share:
Basic:
As reported........................... $ 3.95 $ 3.80 $ 3.22
Pro forma............................. $ 3.90 $ 3.76 $ 3.16
Diluted:
As reported........................... $ 3.85 $ 3.70 $ 3.15
Pro forma............................. $ 3.82 $ 3.68 $ 3.11
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 2004, 2003 and 2002, respectively: no dividend
yield in any year; expected volatility of 32%, 34% and 34%; risk free interest
rates of 4.2%, 3.8% and 5.1%; and expected average lives of 5.5 years for 2004
and 5.5 years for 2003 and 6 years for 2002. The weighted-average fair value of
options granted during the year are $15.82, $11.31 and $12.68 for 2004, 2003 and
2002, respectively. The Company has elected to recognize forfeitures in the year
they occur.
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.
52
(1) Summary of Significant Accounting Policies (continued)
Earnings per common share have been computed based on the following:
Year Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
(In thousands, except share data)
Net income.............................. $ 65,842 $ 64,475 $ 55,172
========== ========== ==========
Average number of common shares outstanding 16,679,927 16,986,725 17,149,712
Effect of dilutive options.............. 410,300 420,734 356,417
---------- ---------- ----------
Average number of common shares outstanding
used to calculate diluted earnings per
common share........................... 17,090,227 17,407,459 17,506,129
========== ========== ==========
The number of anti-dilutive shares excluded from the weighted average
shares outstanding within the diluted EPS calculation was 0, 0, and 118,100
during 2004, 2003 and 2002, respectively.
Comprehensive Income
Accounting principles generally require that the recognized revenue,
expenses, gains and losses be included in net income. Although certain changes
in assets and liabilities, such as unrealized gains and losses on
available-for-sale securities, are reported as a separate component of the
equity section of the consolidated balance sheets, such items, along with net
income, are components of comprehensive income.
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 as amended. A
derivative is considered either an asset or liability in the balance sheets 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 income
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 income and
subsequently reclassified into income when the hedged risk affects income. For a
derivative not designated as a hedging instrument, changes in fair value are
recognized in income in the period of change. As of December 31, 2004, the
Company had no commitments to originate loans held for sale, and had no loan
sale commitments that would qualify as derivatives under SFAS No. 133.
Litigation
The Company is engaged in various legal actions incident to the nature of
its business. Management is of the opinion that none of the litigation will have
a material effect on the Company's Consolidated Balance Sheets and Statements of
Income.
Recent Accounting Pronouncements
In December 2004, SFAS Statement No. 123 (revised), Share-Based Payment,
was issued. Statement 123 (revised) requires a public entity to measure the cost
of employee services received in exchange for an award of equity instruments
based on the grant-date fair value of the award (with limited exceptions). That
cost will be recognized over the period which an employee is required to provide
service in exchange for the award-the requisite service period (usually the
vesting period). No compensation cost is recognized for equity instruments for
which employees do not render the requisite service. Employee share purchase
plans will not result in recognition of compensation cost if certain conditions
are met; those conditions are much the same as the related conditions in
Statement 123.
53
(1) Summary of Significant Accounting Policies (continued)
A public entity will initially measure the cost of employee services
received in exchange for an award of liability instruments based on its current
fair value; the fair value of that award will be re-measured subsequently at
each reporting date through the settlement date. Changes in fair value during
the requisite service period will be recognized as compensation cost over that
period. The grant-date fair value of employee share options and similar
instruments will be estimated using option-pricing models adjusted for the
unique characteristics of those instruments (unless) observable market prices
for the same or similar instruments are available). If an equity award is
modified after the grant date, incremental compensation cost will be recognized
in an amount equal to the excess of the fair value of the modified award over
the fair value of the original award immediately before the modification. The
Statement is effective for the Company on July 1, 2005.
SFAS Statement No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued in May 2003. This
Statement establishes standards for the classification and measurement of
certain financial instruments with characteristics of both liabilities and
equity. The Statement also includes required disclosures for financial
instruments within its scope. For the Company, the Statement was effective for
instruments entered into or modified after May 31, 2003 and otherwise will be
effective as of January 1, 2004, except for mandatorily redeemable financial
instruments. For certain mandatorily redeemable financial instruments, the
Statement is effective for the Company on January 1, 2005. The effective date
has been deferred indefinitely for certain other types of mandatorily redeemable
financial instruments. The Company currently does not have any financial
instruments that are within the scope of this Statement.
(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. There were no
agreements to resell securities as of December 31, 2004. The Bank had $5,000,000
in agreements to resell securities at December 31, 2003. These agreements are
classified as cash and cash equivalents in the accompanying Consolidated Balance
Sheets.
The Bank also had overnight deposits on hand with the Federal Home Loan
Bank which totaled $29,814,000 and $11,836,000, respectively, at December 31,
2004 and December 31, 2003.
Investment securities, available-for-sale, are recorded at fair value and
summarized below for the periods indicated:
At December 31, 2004
---------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Cost Gains Losses Value
--------- --------- ---------- --------
(In thousands)
Collateralized Mortgage Obligations... $ 249,781 $ 1,121 $ (316) $ 250,586
========= ========= ========== ========
54
(2) Investment Securities (continued)
At December 31, 2003
------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Cost Gains Losses Value
--------- --------- ---------- --------
(In thousands)
United States Government and
Federal agency obligations..........$ 200 $ -- $ -- $ 200
Collateralized Mortgage Obligations... 115,992 313 (94) 116,211
-------- ---------- ---------- --------
$ 116,192 $ 313 $ (94) $ 116,411
======== ========== ========== ========
Collateralized Mortgage Obligations as of December 31, 2004 all have
contractual maturities greater than 10 years and have expected maturities within
five years. There were no sales of investment securities during 2004, 2003 or
2002. Accrued interest on investments was $739,000 and $332,000 at December 31,
2004 and 2003, respectively.
(3) Mortgage-backed Securities
Mortgage-backed securities, available-for-sale, all have contractual
maturities greater than 10 years and are summarized below at the dates
indicated:
At December 31, 2004
--------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Cost Gains Losses Value
--------- --------- ---------- --------
(In thousands)
Fannie Mae...........................$ 5,752 $ 43 $ -- $ 5,795
FHLMC................................ 90,582 682 -- 91,264
-------- ---------- ----------- -------
$ 96,334 $ 725 $ -- $ 97,059
======== ========== =========== =======
At December 31, 2003
--------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Cost Gains Losses Value
--------- --------- ---------- --------
(In thousands)
Fannie Mae...........................$ 6,711 $ 84 $ -- $ 6,795
FHLMC................................ 126,800 1,581 -- 128,381
-------- ---------- ----------- --------
$ 133,511 $ 1,665 $ -- $ 135,176
======== ========== =========== ========
There were no mortgage-backed securities created with loans originated by
the Bank in 2004, 2003 or 2002. There were no sales of mortgage-backed
securities during 2004, 2003 or 2002.
Accrued interest receivable related to mortgage-backed securities
outstanding at December 31, 2004 and 2003 totaled $478,000 and $691,000,
respectively.
55
(4) Loans Receivable
The following is a summary of loans receivable at the periods indicated:
At December 31,
------------------------
2004 2003
----------- ----------
(In thousands)
Real estate loans:
First trust deed residential loans:
One-to-four units ........................ $ 4,585,962 $ 2,456,971
Five or more units ..................... 1,825,564 1,547,771
----------- ----------
Residential loans ........................ 6,411,526 4,004,742
Other real estate loans:
Commercial and industrial ................ 324,805 345,273
Construction ............................. 20,902 9,053
Land ..................................... -- --
Second trust deeds ....................... 5,466 7,281
----------- ----------
Real estate loans ........................... 6,762,699 4,366,349
Non-real estate loans:
Deposit accounts ........................... 491 649
Commercial business loans .................. 58,869 34,424
Consumer ................................... 60,677 49,738
----------- ----------
Loans receivable ......................... 6,882,736 4,451,160
Less:
General loan valuation allowance ........... 78,675 75,238
Valuation allowances for impaired loans .... 496 496
Deferred loan origination (costs) fees ...... (34,380) 1,314
----------- ----------
Subtotal ................................. 6,837,945 4,374,112
Less:
Loans held-for-sale......................... -- 492
----------- ----------
Loans receivable, net.......................... $ 6,837,945 $ 4,373,620
=========== ==========
Loans serviced for others totaled $102,546,000 and $145,475,000 at December
31, 2004 and 2003, respectively.
The Bank had outstanding commitments to fund $681,320,000 and $246,996,000
in real estate loans at December 31, 2004 and December 31, 2003, respectively.
Of these totals, $681,320,000 and $246,511,000 had variable interest rates. The
Bank had outstanding commitments to sell real estate loans of $0 and $977,000,
respectively at December 31, 2004 and December 31, 2003.
The Bank had undisbursed loan funds totaling $76,884,000 and $58,608,000 in
commercial business loans at December 31, 2004 and December 31, 2003,
respectively and undisbursed loan funds totaling $141,862,000 and $122,791,000
in consumer loans at December 31, 2004 and December 31, 2003, respectively.
Accrued interest receivable related to loans outstanding at December 31,
2004 and 2003 totaled $21,502,000 and $15,189,000, respectively.
Loans delinquent greater than 90 days or in foreclosure were $4,985,000 and
$3,342,000 at December 31, 2004 and 2003, respectively, and the related
allowance for delinquent interest was $256,000 and $227,000, respectively.
Loans made to directors and executive officers (defined for this purpose as
senior vice presidents and above) totaled $4,435,000 and $4,993,000 at December
31, 2004 and 2003, respectively.
See Note 9 for loans that were pledged as security for borrowings as of
December 31,
2004.
56
(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, 2001...................... $ 72,919 $ 1,850 $ 74,769
Transfers....................................... 1,354 (1,354) --
Charge-offs..................................... (372) -- (372)
Recoveries...................................... 1,322 -- 1,322
--------- --------- --------
Balance at December 31, 2002...................... 75,223 496 75,719
Charge-offs..................................... (103) -- (103)
Recoveries...................................... 118 -- 118
--------- --------- --------
Balance at December 31, 2003...................... 75,238 496 75,734
Provision for loan losses....................... 3,000 -- 3,000
Charge-offs..................................... (19) -- (19)
Recoveries...................................... 456 -- 456
--------- --------- --------
Balance at December 31, 2004...................... $ 78,675 $ 496 $ 79,171
========= ========= ========
The Bank has certain loans that were sold with recourse. These loans
totaled $76,338,000 and $91,003,000 at December 31, 2004 and 2003, respectively.
The maximum potential recourse liability associated with loans sold with
recourse totaled $18,320,000 and $20,476,000 at December 31, 2004 and December
31, 2003, respectively. Because no additional losses are expected, the
repurchase liability associated with these loans was eliminated during 2004.
The following is a summary of impaired loans, net of valuation allowances
for impairment, for the periods indicated:
At December 31,
--------------------
2004 2003
-------- -------
(In thousands)
Non-accrual loans................................. $ -- $ 1,782
Modified loans.................................... 1,360 1,488
-------- -------
$ 1,360 $ 3,270
======== =======
The Bank considers a loan impaired when management believes that it is
probable that the Bank will not be able to collect all amounts due under the
contractual terms of the loan. Estimated impairment losses are recorded as
separate valuation allowances and may be subsequently adjusted based upon
changes in the measurement of impairment. Impaired loans, disclosed net of
valuation allowances, include non-accrual major loans (commercial business loans
with an outstanding principal amount greater than or equal to $500 thousand and
single-family loans greater than or equal to $750 thousand, and income property
loans with an outstanding principal amount greater than or equal to $1.5
million), modified loans, and major loans less than 90 days delinquent in which
full payment of principal and interest is not expected to be received.
57
(4) Loans Receivable (continued)
As of December 31, 2004, the Bank's total recorded investment in impaired
loans identified in accordance with SFAS 114 was $1,360,000 (after deducting
$496,000 of impairment allowances attributable to such loans). As of December
31, 2003, the total recorded investment in impaired loans was $3,270,000 (net of
$496,000 of impairment allowances).
The following is a summary of information pertaining to impaired and
non-accrual loans:
At December 31,
------------------------
2004 2003
----------- ----------
(In thousands)
Impaired loans without a valuation allowance . $ 1,360 $ 3,270
Impaired loans with a valuation allowance.. $ 496 $ 496
Valuation allowance related to impaired loans. $ 496 $ 496
Total non-accrual loans...................... $ 4,985 $ 3,342
Years Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
(In thousands, except per share data)
Average investment in impaired loans.... $ 602 $ 4,327 $ 4,982
Interest income recognized on impaired loans $ 22 $ 226 $ 322
Interest income recognized on a cash basis
on impaired loans...................... $ 16 $ 215 $ 316
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 owned at the dates indicated:
At December 31,
-----------------------
2004 2003
--------- ----------
(In thousands)
Real estate acquired by (or deed in lieu of) $ -- $ 1,324
foreclosure ("REO").................................
Valuation allowance................................. -- --
--------- ----------
Real estate, net.................................. $ -- $ 1,324
========= ==========
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, 2001............................. $ 350
Reversal of valuation allowance.......................... (150)
-------
Balance at December 31, 2002............................. 200
Reversal of valuation allowance.......................... (200)
-------
Balance at December 31, 2003............................. --
-------
Balance at December 31, 2004............................. $ --
=======
At December 31, 2004, the Bank had $986,000 in real estate held for
investment. These properties were acquired from borrowers in settlement of
judgments.
58
(5) Real Estate (continued)
The following table summarizes real estate operations, net:
For the Years Ended December 31,
---------------------------------
2004 2003 2002
-------- -------- --------
(In thousands)
Net income from operations:
Gain on sale of REO and real estate held for
investment..................................... $ 496 $ 884 $ 765
Other REO operations............................. (188) (104) (426)
-------- -------- --------
Real estate operations, net .................. $ 308 $ 780 $ 339
======== ======== ========
The Bank acquired $0, $1,582,000 and $1,881,000 of real estate in
settlement of loans during 2004, 2003 and 2002, 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,
---------------------
2004 2003
--------- --------
(In thousands)
Land................................................... $ 6,713 $ 3,861
Office buildings....................................... 6,568 5,333
Furniture, fixtures and equipment...................... 17,195 14,773
Leasehold improvements................................. 9,102 8,634
Other.................................................. 646 1,160
--------- --------
40,224 33,761
Less accumulated depreciation and amortization......... 24,343 23,193
--------- --------
$ 15,881 $ 10,568
========= ========
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, 2004 under all non-cancelable leases are as follows (in thousands):
2005.............................$ 4,968
2006............................. 4,694
2007............................. 4,347
2008............................. 3,008
2009............................. 605
Thereafter....................... 1,408
---------
$ 19,030
=========
Rent expense under these leases was $4,836,000, $4,690,000 and $4,673,000
for 2004, 2003 and 2002, respectively. Certain leases require the Bank to pay
property taxes and insurance. Additionally, certain leases have rent escalation
clauses based on specified indices.
59
(7) Federal Home Loan Bank Stock
The Bank's investment in FHLB stock at December 31, 2004 and 2003 was
$143,425,000 and $87,775,000, 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 FHLB 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 4.7% of its advances (borrowings) from the FHLB. The Bank was in
compliance with this requirement at December 31, 2004. The Bank's investment in
FHLB stock was pledged as collateral for advances from the FHLB at December 31,
2004 and 2003. 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.
During 2003, the FHLB amended the redemption policy requiring 5 years written
notice to redeem stock effective 2004. Accrued dividends on FHLB stock totaled
$1,310,000 and $711,000 at December 31, 2004 and December 31, 2003,
respectively.
(8) Deposits
Deposit account balances are summarized as follows:
At December 31,
----------------- -----------------
2004 2003
----------------- -----------------
Amount % Amount %
--------- ----- --------- ----
(Dollars in thousands)
Variable rate non-term accounts:
Money market deposit accounts (weighted average
rate of 1.61% and 1.43%).................. $ 1,328,230 35% $ 1,373,240 54%
Interest-bearing checking accounts (weighted
average rate of 0.23% and 0.26%).......... 279,912 8 232,247 9
Passbook accounts (weighted average rate of
1.00% 121,355 3 124,427 5
and 1.10%).............................
Non-interest bearing checking accounts....... 276,438 7 239,357 10
--------- ----- --------- ----
2,005,935 53 1,969,271 78
--------- ----- --------- ----
Fixed-rate term certificate accounts:
Under six-month term (weighted average rate of
2.06% and 1.00%).......................... 373,907 10 32,062 1
Six-month term (weighted average rate of 1.96%
and 1.06%)................................ 359,871 10 79,201 3
Nine-month term (weighted average rate of 2.27%
and 1.25%)................................ 526,587 14 15,126 1
One year to 18-month term (weighted average rate
of 1.84% and 1.53%)....................... 193,038 5 178,858 6
Two year to 30-month term (weighted average rate
of 2.40% and 2.63%)....................... 52,441 1 42,187 2
Over 30-month term (weighted average rate of
3.71% and 3.88%).......................... 133,402 4 123,966 5
Negotiable certificates of $100,000 and greater,
30 day to one year terms (weighted average
rate of 1.97% and 1.25%)................ 115,984 3 97,727 4
--------- ----- --------- ----
1,755,230 47 569,127 22
--------- ----- --------- ----
Total deposits (weighted average rate of 1.65%
and 1.29%)................................ $ 3,761,165 100% $ 2,538,398 100%
========= ===== ========= ====
Certificates of deposit, placed through four major national brokerage
firms, totaled $1,192,657,000 and $0 at December 31, 2004 and 2003,
respectively.
Cash payments for interest on deposits (including interest credited)
totaled $35,308,000, $42,108,000 and $65,830,000 during 2004, 2003 and 2002,
respectively. Accrued interest on deposits at December 31, 2004 and 2003 totaled
$7,746,000 and $895,000, respectively, and is included in accrued expenses and
other liabilities in the accompanying Consolidated Balance Sheets.
60
(8) Deposits (continued)
Certificates of deposit of $100,000 or more with 30 day to one year terms
amounted to $115,984,000 and $97,727,000 at December 31, 2004 and December 31,
2003, respectively.
The following table indicates the maturities and weighted average interest
rates of the Bank's deposits:
Non-Term There-
Accounts 2005 2006 2007 after Total
--------- --------- ---------- ---------- --------- --------
(Dollars in thousands)
Deposits at
December 31, 2004......$ 2,005,935 $ 1,643,035 $ 70,175 $ 24,980 $ 17,040 $ 3,761,165
Weighted average
Interest rates......... 1.16% 2.15% 2.75% 3.45% 3.43% 1.65%
Interest expense on deposits is summarized as follows:
For the Years Ended December 31,
-------------------------------------
2004 2003 2002
---------- --------- ----------
(In thousands)
Passbook accounts....................................... $ 1,287 $ 1,370 $ 1,559
Money market deposits and interest-bearing checking
accounts.............................................. 20,953 21,920 24,024
Certificate accounts.................................... 19,919 15,814 35,225
---------- --------- ----------
$ 42,159 $ 39,104 $ 60,808
========== ========= ==========
(9) Federal Home Loan Bank Advances
FHLB advances consist of the following at December 31:
2004 2003
--------- ---------
(In thousands)
Advances from the FHLB of San Francisco with
a weighted average interest rate of 2.59% and
2.88%, respectively, secured by FHLB stock
and certain real estate loans with unpaid
principal balances of approximately $4.4
billion at December 31, 2004,
advances mature through 2010......................... $3,004,600 $1,694,000
========== ==========
At December 31, 2004 and 2003, accrued interest payable on FHLB advances
totaled $213,000 and $134,000, respectively, which is included in accrued
expenses and other liabilities in the accompanying Consolidated Balance Sheets.
The Bank has a credit facility with the FHLB in the form of advances and
lines of credit which allows borrowings up to 60% of the Bank's assets, as
computed for regulatory purposes, or approximately $4,481,399 at December 31,
2004, with terms up to 30 years.
The following is a summary of FHLB advance maturities at December 31, 2004
(in thousands):
2005............................ $2,604,600
2006............................ 280,000
2007............................ 85,000
2008............................ 10,000
2009............................ 5,000
Thereafter....................... 20,000
---------
$3,004,600
=========
61
(9) Federal Home Loan Bank Advances (continued)
Cash payments for interest on borrowings (including reverse repurchase
agreements - see Note 10) totaled $58,248,000, $49,393,000 and $67,579,000
during 2004, 2003 and 2002, respectively.
Interest expense on borrowings is comprised of the following for the years
indicated:
For the Years Ended December 31,
------------------------------------
2004 2003 2002
--------- -------- ----------
(In thousands)
FHLB advances.................................... $ 56,789 $ 47,299 $ 63,253
Reverse repurchase agreements.................... 1,964 1,800 3,453
Other............................................ 278 139 905
--------- -------- ----------
$ 59,031 $ 49,238 $ 67,611
========= ======== ==========
Other interest expense in 2003 and 2002 includes the additional accruals
and reversals of accrued interest due to the Internal Revenue Service and
Franchise Tax Board. See Note 11.
(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 Balance Sheets. The mortgage-backed securities underlying the
agreements were delivered to the dealer who arranged the transactions or its
trustee.
At December 31, 2004, $187,000,000 in reverse repurchase agreements were
collateralized by mortgage-backed securities totaling $80,687,000 and CMO's
totaling $116,644,000. At December 31, 2003, $122,622,000 in reverse repurchase
agreements were collateralized by mortgage-backed securities totaling
$114,360,000 and CMO's with principal balances totaling $11,347,000.
The weighted average interest rates for borrowings under reverse
repurchase agreements were 2.24% and 1.12%, respectively, at December 31, 2004
and December 31, 2003.
Securities sold under agreements to repurchase averaged $129,192,000 and
$139,568,000 during 2004 and 2003, respectively, and the maximum amounts
outstanding at any month-end during 2004 and 2003 were $192,000,000 and
$154,021,000 respectively.
The following is a summary of maturities at December 31, 2004 (in
thousands):
Up to 30 days.................... $ 12,000
30 to 90 days.................... --
Over 90 to 182 days.............. 175,000
--------
$187,000
========
Accrued interest on securities sold under agreements to repurchase which is
included in accrued expenses and other liabilities in the accompanying
Consolidated Balance Sheets was $796,000 and $370,000 at December 31, 2004 and
2003, respectively.
62
(11) Income Taxes
Income taxes (benefit) consist of the following:
2004 2003 2002
-------- ------- --------
(In thousands)
Current:
Federal....................................... $ 42,297 $ 32,136 $ 32,615
State......................................... 13,747 13,842 10,866
-------- ------- --------
56,044 45,978 43,481
-------- ------- --------
Deferred:
Federal....................................... (6,842) 2,694 (2,920)
State......................................... (1,588) (4,456) (412)
-------- ------- --------
(8,430) (1,762) (3,332)
-------- ------- --------
Total:
Federal....................................... 35,455 34,830 29,695
State......................................... 12,159 9,386 10,454
-------- ------- --------
$ 47,614 $ 44,216 $ 40,149
======== ======= ========
A reconciliation of the statutory federal corporate income tax rate to the
Company's effective income tax rate follows:
Year Ended December 31,
--------------------------------
2004 2003 2002
--------- ------- --------
Statutory federal income tax rate .......... 35.0% 35.0% 35.0%
Increase in taxes resulting from:
State franchise tax, net of federal income tax 7.0 5.6 7.1
benefit.....................................
Other, net.................................. -- 0.1 --
--------- ------- --------
Effective rate.............................. 42.0% 40.7% 42.1%
========= ======= ========
Cash payments for income taxes totaled $53,471,000, $38,727,000 and
$44,257,000 during 2004, 2003 and 2002, respectively.
There were no income taxes receivable at December 31, 2004 or December 31,
2003.
63
(11) Income Taxes (continued)
Listed below are the significant components of the net deferred tax (asset)
and liability:
At December 31,
-----------------------
2004 2003
---------- ---------
(In thousands)
Components of the deferred tax asset:
Bad debts........................................... $ (36,064) $ (36,965)
Pension expense..................................... (5,565) (4,763)
State taxes......................................... (4,303) (2,745)
Core deposit intangible asset....................... (2,535) (2,147)
Other............................................... (4,374) (3,443)
---------- ---------
Total deferred tax asset.......................... (52,841) (50,063)
---------- ---------
Components of the deferred tax liability:
Loan fees........................................... 3,346 11,002
FHLB stock dividends................................ 23,820 21,776
Tax effect of unrealized gain on
securities available-for-sale.................... 644 792
Other............................................... 451 491
---------- ---------
Total deferred tax liability...................... 28,261 34,061
---------- ---------
Net deferred tax asset................................ $ (24,580) $ (16,002)
========== =========
The Company did not have a valuation allowance for the deferred tax asset
at December 31, 2004 or 2003, as it is more likely than not that the deferred
tax asset will be realized.
The Internal Revenue Service ("IRS") has examined the Company's
consolidated federal income tax returns for tax years up to and including 2000.
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 Franchise Tax Board ("FTB").
Interest accruals of $260,000 and $0 were recorded during 2004 and 2003,
respectively for interest on amended returns. During 2004, interest payments
totaling $252,000 were paid in settlement for tax years 1999 and 2000. The
balance of accrued interest payable for amended returns was $408,000 and
$400,000 as of December 31, 2004 and December 31, 2003, respectively.
The Bank is required to use the specific charge-off method of accounting
for bad debts for Federal income tax purposes. Prior to 1995, the Bank used the
reserve method of accounting for bad debts. The Consolidated Balance Sheets at
December 31, 2004 and 2003 do not include a tax liability of $5,356,000 related
to the adjusted base year bad debt reserve that was created when we were on the
reserve method. The base year reserve is subject to recapture if: (1) we fail 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.
64
(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, 2004, no preferred shares had been issued.
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, 2004.
As of December 31, 2004, 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,
2004 that management believes have changed the Bank's classification.
The following table summarizes the Bank's regulatory capital and required
capital as of the dates indicated:
December 31, 2004
-----------------------------------------------------
Tier 1
Tangible Core Risk-based Risk-based
Capital Capital Capital Capital
---------- ---------- ------------ -----------
(Dollars in thousands)
Actual capital:
Amount.............................$ 446,662 $ 446,662 $ 446,662 $ 499,151
Ratio............................. 5.99% 5.99% 10.70% 11.96%
FIRREA minimum required capital:
Amount.............................$ 111,933 $ 298,489 $ -- $ 333,838
Ratio.............................. 1.50% 4.00% --% 8.00%
FIRREA well capitalized required capital:
Amount.............................$ -- $ 373,111 $ 250,378 $ 417,297
Ratio.............................. --% 5.00% 6.00% 10.00%
December 31, 2003
-----------------------------------------------------
Tier 1
Tangible Core Risk-based Risk-based
Capital Capital Capital Capital
---------- ---------- ------------ -----------
(Dollars in thousands)
Actual capital:
Amount.............................$ 408,524 $ 408,524 $ 408,524 $ 443,867
Ratio.............................. 8.48% 8.48% 14.66% 15.92%
FIRREA minimum required capital:
Amount.............................$ 72,254 $ 192,678 $ -- $ 223,005
Ratio.............................. 1.50% 4.00% --% 8.00%
FIRREA well capitalized
required capital:
Amount.............................$ -- $ 240,848 $ 167,254 $ 278,757
Ratio.............................. --% 5.00% 6.00% 10.00%
65
(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 income and profits and accumulated
tax income 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, 2004, the outstanding loan
to the ESOP totaled $45,000. At December 31, 2003, the outstanding loan to the
ESOP totaled $104,000. 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 2004 and 2003 were 1.91% and 2.18%, 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 $500,000, $540,000
and $310,000 for 2004, 2003 and 2002, 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 $1,381,000,
$1,287,000 and $1,161,000 in 2004, 2003 and 2002, respectively. The SERP is
unfunded. The expected contribution to the SERP during 2005 is $287,000.
The discount rates used in determining the actuarial value of benefit
obligations were 5.75% and 6.00%, respectively, as of December 31, 2004 and
2003. The rate of increase in future compensation levels used in determining the
pension cost for the SERP was 4.0% as of December 31, 2004 and 4.0% as of 2003.
The plan had no assets at December 31, 2004 or 2003.
66
(13) Employee Benefit Plans (continued)
The following table sets forth the funded status of the SERP and amounts
recognized in the Company's financial statements for the years indicated:
At December 31,
---------------------
2004 2003
--------- --------
(In thousands)
Change in Benefit Obligation
Projected benefit obligation, beginning of the year..... $ 10,185 $ 9,161
Service cost............................................ 488 447
Interest cost........................................... 607 586
Benefits paid........................................... (286) (287)
Actuarial gain.......................................... 754 278
--------- --------
Projected benefit obligation, end of the year........... $ 11,748 $ 10,185
========= ========
Change in Plan Assets
Benefits Paid........................................... $ (286) $ --
Employer contributions.................................. 286 --
Funded status........................................... (11,748) (10,185)
Unrecognized transition obligation...................... -- --
Unrecognized prior service cost......................... 15 149
Unrecognized loss....................................... 2,717 2,115
--------- --------
Net amount recognized................................... $ (9,016) $ (7,921)
========= ========
Components of Net Periodic Benefit Cost
Service cost............................................ $ 488 $ 447
Interest cost........................................... 607 586
Amortization of net loss................................ 151 119
Amortization of unrecognized prior service cost......... 135 135
--------- --------
Pension cost............................................ $ 1,381 $ 1,287
========= ========
The projected benefit obligation, accumulated benefit obligation, and fair
value of assets were $11,748,000, $9,944,000, and $0 respectively, at December
31, 2004 and $10,185,000, $8,604,000, and $0, respectively, at December 31,
2003.
The Bank has a profit sharing plan (the "ESOP") for all eligible employees
and officers who have completed one year of continuous service. The ESOP is
accounted for in accordance with SOP 93-6. At December 31, 2004, the ESOP held
4.46% of the outstanding stock of the Company. Profit sharing expense for the
years ended December 31, 2004, 2003 and 2002 was $2,530,000, $2,030,000 and
$2,024,000, 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.
At December 31, 2004 and 2003 total allocated ESOP shares were 695,245 and
767,486 shares, respectively. At December 31, 2004 and 2003 total unallocated
ESOP shares were 1,162 and 3,426 shares, respectively. The fair value of
unallocated ESOP shares totaled $60,000 and $149,000 at December 31, 2004 and
2003, respectively.
Stock Compensation Plans
At December 31, 2004, 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.
67
(13) Employee Benefit Plans (continued)
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 SFAS
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.
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 the maximum
term of an option is 10 years. Options typically begin to vest on the second
anniversary date of the grant.
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 the maximum term of an option 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:
--------------------------------
Options Outstanding 2004 2003 2002
--------- --------- --------
(Weighted average option prices) (In shares)
Beginning of Year ($19.68, $17.08 and $15.51).............. 808,248 857,682 819,915
Granted ($42.24, $29.55 and $26.75)................. 131,785 150,510 134,900
Exercised ($13.20, $12.73 and $10.98)............... (150,011) (149,664) (33,006)
Canceled ($30.67, $26.89 and $20.53)................ (64,564) (50,280) (64,127)
--------- --------- --------
End of Year ($48.07, $19.68 and $17.08).................... 725,458 808,248 857,682
========= ========= ========
Shares exercisable at December 31, ($17.39, $15.50
and $13.41)....................................... 354,398 352,004 407,401
========= ========= ========
Additional information with respect to stock options outstanding at
December 31, 2004 follows:
Price Ranges
-----------------------------------------------------
($6.94 - $16.13) ($16.14 - $27.05) ($27.06 - $43.00)
Options outstanding:
Number of outstanding shares................. 276,671 173,312 275,475
Weighted-average contractual life ........... 3.83 5.63 7.96
Weighted-average exercise price ............. $13.28 $23.07 $35.44
Options exercisable:
Number of exercisable shares................. 207,778 115,880 30,740
Weighted-average exercise price ............. $12.75 $22.08 $31.06
68
(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 BALANCE SHEETS
At December 31,
----------------------
2004 2003
--------- ---------
(In thousands)
Assets:
Cash....................................................... $ 23,607 $ 18,990
Other assets............................................... 908 449
Investment in subsidiary................................... 453,074 417,236
--------- ---------
$ 477,589 $ 436,675
========= =========
Liabilities and Stockholders' Equity:
Other liabilities.......................................... 115 108
Stockholders' equity....................................... 477,474 436,567
--------- ---------
$ 477,589 $ 436,675
========= =========
Year Ended December 31,
----------------------------------
CONDENSED STATEMENTS OF INCOME AND 2004 2003 2002
-------- -------- ---------
COMPREHENSIVE INCOME (In thousands)
Dividends received from Bank....................... $ 30,000 $ -- $ 20,000
Equity in undistributed net income of subsidiary .. 36,077 64,605 35,254
Other expense, net................................. (235) (130) (82)
-------- -------- ---------
Net Income......................................... 65,842 64,475 55,172
Change in other comprehensive income, net of taxes. (204) (1,110) (790)
-------- -------- ---------
Comprehensive Income............................... $ 65,638 $ 63,365 $ 54,382
======== ======== =========
Year Ended December 31,
--------------------------------
CONDENSED STATEMENTS OF CASH FLOWS 2004 2003 2002
-------- -------- -------
(In thousands)
Net Cash Flows from Operating Activities:
Net income....................................... $ 65,842 $ 64,475 $ 55,172
Adjustments to reconcile net income to
net cash provided by operating activities:
Equity in undistributed
net income of subsidiary.................... (36,077) (64,605) (35,254)
Depreciation expense........................... -- 62 160
Other.......................................... (415) (646) 25
-------- -------- -------
Net cash provided (used) by operating activities 29,350 (714) 20,103
-------- -------- -------
Cash Flows from Investing Activities:
Decrease in fixed assets....................... -- 197 --
-------- -------- -------
Net cash used in investing activities.......... -- 197 --
-------- -------- -------
Cash Flows from Financing Activities:
Purchase of treasury stock..................... (28,049) (965) (8,832)
(Increase) decrease in unreleased shares....... 72 472 (597)
Exercise of stock options...................... 3,244 2,053 1,010
-------- -------- -------
Net cash provided by (used in) financing activities (24,733) 1,560 (8,419)
-------- -------- -------
Net increase in cash............................... 4,617 1,043 11,684
Cash at beginning of period........................ 18,990 17,947 6,263
-------- -------- -------
Cash at end of period.............................. $ 23,607 $ 18,990 $ 17,947
======== ======== =======
69
(15) Quarterly Results of Operations (unaudited)
Summarized below are the Company's results of operations on a quarterly
basis for 2004, 2003 and 2002:
Diluted
Provision Basic Earnings
Interest Interest for Loan Other Non-Interest Net Earnings per
Income Expense Losses Income Expense Income per Share Share
------- -------- -------- ------ ------- -------- ------- --------
(In thousands, except per share data)
First quarter
2004............$ 58,517 $ 20,804 $ -- $ 3,461 $ 15,282 $ 14,977 $ 0.88 $ 0.86
2003............ 60,839 23,324 -- 3,348 14,116 15,478 0.92 0.89
2002............ 70,776 36,788 -- 2,699 15,311 12,368 0.72 0.70
Second quarter
2004............$ 61,360 $ 21,373 $ -- $ 4,040 $ 15,351 $ 16,553 $ 0.99 $ 0.96
2003............ 59,412 22,350 -- 3,393 13,429 15,633 0.92 0.90
2002............ 65,923 32,943 -- 2,494 14,233 12,287 0.71 0.70
Third quarter
2004............$ 64,999 $ 26,133 $ -- $ 9,326 $ 17,694 $ 17,872 $ 1.09 $ 1.06
2003............ 58,344 21,814 -- 5,590 13,522 18,203 1.07 1.04
2002............ 64,741 31,312 -- 8,711 14,107 16,226 0.94 0.92
Fourth quarter
2004............$ 77,846 $ 32,880 $ 3,000 $ 4,469 $ 18,045 $ 16,440 $ 1.00 $ 0.97
2003............ 57,286 20,854 -- 4,410 14,522 15,161 0.89 0.87
2002............ 62,438 27,376 -- 4,170 14,561 14,291 0.84 0.83
Total year
2004............$ 262,722 $ 101,190 $ 3,000 $ 21,296 $ 66,372 $ 65,842 $ 3.95 $ 3.85
2003............ 235,881 88,342 -- 16,741 55,589 64,475 3.80 3.70
2002............ 263,878 128,419 -- 18,074 58,212 55,172 3.22 3.15
(16) Fair Value of Financial Instruments
The following table presents fair value information for financial
instruments for which a market exists:
At December 31,
--------------------------------------------------------
2004 2003
--------------------------- -------------------------
Carrying Carrying
Value Fair Value Value Fair Value
---------- ------------- ---------- ----------
(In thousands)
Mortgage-backed securities ............ $ 97,059 $ 97,059 $ 135,176 $ 135,176
U.S. Government securities ............ -- -- 200 200
Collateralized mortgage obligations ... 250,586 250,586 116,211 116,211
Loans held-for-sale ................... -- -- 492 494
70
(16) Fair Value of Financial Instruments (continued)
The following table presents fair value information for financial
instruments shown in the Company's Consolidated Balance Sheets 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,
-----------------------------------------------------------
2004 2003
---------------------------- ---------------------------
Calculated Calculated
Historical Fair Value Historical Fair Value
Cost Amount Cost Amount
------------ ------------ ----------- ------------
(In thousands)
ASSETS
Adjustable loans:
Single family ....................... $ 4,576,671 $ 4,619,960 $ 2,439,962 $ 2,527,181
Multi-family ........................ 1,817,727 1,820,991 1,526,186 1,582,830
Commercial ......................... 309,491 315,807 314,524 336,909
Fixed rate loans:
Single family ....................... 9,210 9,390 13,665 14,610
Multi-family ........................ 10,250 10,571 21,585 23,459
Commercial ......................... 17,710 18,342 30,749 33,807
Commercial business loans.............. 59,993 59,845 34,424 35,372
Construction loans..................... 20,288 21,476 9,053 9,370
Consumer loans......................... 61,396 61,641 57,670 49,998
Non-performing loans .................. 4,985 4,985 3,342 3,342
LIABILITIES
Fixed-term certificate accounts ....... 1,755,230 1,754,787 569,127 578,754
Non-term deposit accounts ............. 2,005,935 2,005,935 1,969,271 1,969,271
Borrowings ............................ 3,191,600 3,189,486 1,816,622 1,843,890
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 Balance Sheets 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.
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, 2004, the Bank
had outstanding commitments to fund $681,320,000 in real estate mortgage loans,
and undisbursed funds totaling $76,884,000 in commercial business loans and
$141,862,000 in consumer loans, respectively. All loan commitments are
substantially at fair value. There is no value associated with the Bank's
commitment to originate these loans.
71
(16) Fair Value of Financial Instruments (continued)
Non-performing Loans
The carrying amounts reported in the Consolidated Balance Sheets for these
assets 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 Balance Sheets. 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. For
long-term 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.
72
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
FirstFed Financial Corp. and Subsidiary
We have audited the consolidated balance sheet of FirstFed Financial Corp. and
subsidiary as of December 31, 2004, and the related consolidated statements of
income, stockholders' equity, and cash flows for the year ended December 31,
2004. These financial statements are the responsibility of management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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 audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of FirstFed Financial
Corp. and subsidiary as of December 31, 2004, and the consolidated results of
their operations and their consolidated cash flows for the year ended December
31, 2004, in conformity with accounting principles generally accepted in the
United States of America.
We have also audited, in accordance with standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of FirstFed
Financial Corp. and subsidiary's internal control over financial reporting as of
December 31, 2004, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 24, 2005 expressed an unqualified
opinion thereon.
Grant Thornton LLP
Los Angeles, California
February 24, 2005
73
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
FirstFed Financial Corp.:
We have audited the accompanying consolidated balance sheet of FirstFed
Financial Corp and subsidiary as of December 31, 2003, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the years in the two-year period ended December 31, 2003.
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 the standards of the Public Company
Accounting Oversight Board (United States). 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, 2003, and the results of their
operations and their cash flows for each of the years in the two-year period
ended December 31, 2003, in conformity with U.S. generally accepted accounting
principles.
KPMG LLP
Los Angeles, California
January 28, 2004
74
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Effective September 2, 2004, based on a recommendation of the Audit Committee of
our Board of Directors, we dismissed our independent public accountants, KPMG
LLP. KPMG LLP's reports on our financial statements for the past two fiscal
years ended December 31, 2003 did not contain an adverse opinion or disclaimer
of opinion and were not qualified or modified as to uncertainty, audit scope or
accounting principles. During the two fiscal years ended December 31, 2003 and
during the subsequent interim period through the date of dismissal, September 2,
2004, there were not any disagreements between us and KPMG LLP on any matters of
accounting principles or practices, financial statement disclosure or auditing
scope or procedure, or any reportable events as defined under Item 304(a)(1)(v)
of Regulation S-K promulgated by the Securities and Exchange Commission.
A copy of a letter addressed to the Securities and Exchange Commission from KPMG
LLP stating that it agrees with the above statements is incorporated by
reference into this Form 10-K as Exhibit 16.
Also effective September 2, 2004, based upon a recommendation of the Audit
Committee of our Board of Directors, we engaged the firm of Grant Thornton LLP
to be our independent registered public accounting firm. We did not consult
Grant Thornton LLP prior to September 2, 2004 with respect to the application of
accounting principles to a specified transaction, either completed or proposed,
or the type of audit opinion that might be rendered on our financial statements,
or concerning any disagreement or reportable event with KPMG LLP.
Item 9A. Controls and Procedures
- -------- -----------------------
Management's Evaluation of Disclosure 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 to alert them to any material information relating
to the Company (including its consolidated subsidiaries) that must be
included in the Company's periodic Securities and Exchange Commission
filings.
(b) There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in the Company's
internal controls or in other factors that could significantly affect these
controls subsequent to the date of the evaluation referenced in paragraph
(a) above.
(c) The Company intends to review and evaluate the design and effectiveness of
its disclosure controls and procedures from time to time in order to
improve its controls and procedures. If any deficiencies are discovered in
the future, corrective action will be taken in order to ensure that senior
management has timely access to all material financial and non-financial
information concerning the Company's business. While management believes
that the Company's disclosure controls and procedures are currently
effective to achieve these results, future events affecting the Company's
business may cause management to modify its disclosure controls and
procedures.
Management's Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal
control over financial reporting for the Company. In order to evaluate the
effectiveness of internal control over financial reporting, as required by
Section 404 of the Sarbanes-Oxley Act, management has conducted an assessment,
including testing, using the criteria in Internal Control - Integrated
Framework, issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). The Company's system of internal control over financial
reporting is designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. Because of
its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
75
Based on its assessment, management has concluded that the Company maintained
effective internal control over financial reporting as of December 31, 2004,
based on criteria in Internal Control - Integrated Framework issued by the COSO.
Management's assessment of the effectiveness of the Company's internal control
over financial reporting as of December 31, 2004, has been audited by Grant
Thornton LLP, an independent registered public accounting firm, as stated in
their report which is included herein.
Management's Certifications
The certifications of the Company's Chief Executive Officer and Chief Financial
Officer required by the Sarbanes-Oxley Act have been included as Exhibits 31 and
32 in the Company's Form 10-K. In addition, in 2004, the Company's Chief
Executive Officer provided to the New York Stock Exchange the annual CEO
certification regarding the Company's compliance with the New York Stock
Exchange's corporate governance listing standards.
76
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM ON MANAGEMENT'S ASSESSMENT OF THE EFFECTIVENESS OF
INTERNAL CONTROL OVER FINANCIAL REPORTING AND THE EFFECTIVENESS
OF INTERNAL CONTROL OVER FINANCIAL REPORTING
Board of Directors and Stockholders
FirstFed Financial Corp. and Subsidiary
We have audited management's assessment, included in the accompanying FirstFed
Financial Corp. and subsidiary's "Management's Report on Internal Control over
Financial Reporting," that FirstFed Financial Corp. and subsidiary maintained
effective internal control over financial reporting as of December 31, 2004,
based on criteria established in Internal Control--Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
FirstFed Financial Corp. and subsidiary's management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the Company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that FirstFed Financial Corp. and
subsidiary maintained effective internal control over financial reporting as of
December 31, 2004, is fairly stated, in all material respects, based on criteria
established in COSO. Also in our opinion, FirstFed Financial Corp. and
subsidiary maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2004, based on criteria established in
COSO.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet of
FirstFed Financial Corp. and subsidiary as of December 31, 2004, and the related
consolidated statements of income, stockholders' equity, and cash flows for the
year ended December 31, 2004 and our report dated February 24, 2005 expressed an
unqualified opinion.
Grant Thornton LLP
Los Angeles, California
February 24, 2005
77
PART III
ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers appearing on page 5
of the Proxy Statement for the Annual Meeting of Stockholders' to be held April
20, 2005 (the "Proxy Statement") is incorporated herein by reference.
ITEM 11 -- EXECUTIVE COMPENSATION
Information regarding executive compensation appearing on page 8 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, 3 and 11 of the Proxy Statement incorporated
herein by reference. Information regarding securities authorized for issuance
under equity compensation plans appearing on page 11 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 page 11 of the Proxy Statement is incorporated herein by reference.
ITEM 14 --PRINCIPAL ACCOUNTING FEES AND SERVICES
Information regarding principal accounting fees and services appearing on
page 15 of the Proxy Statement is incorporated herein by reference.
78
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.
(16) Letter from KPMG LLP dated September 8, 2004.
(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).
(31.1) Certification of Babette E. Heimbuch, Chairman, President and Chief
Executive Officer of the Company, pursuant to Rule 13a-14(a) of the
Exchange Act.
(31.2) Certification of Douglas J. Goddard, Executive Vice President and Chief
Financial Officer of the Company, pursuant to Rule 13a-14(a) of the
Exchange Act.
(32.1) Certification of Babette E. Heimbuch, Chairman, President and Chief
Executive Officer of the Company, pursuant to 18 U.S.C. Section 1350.
(32.1) Certification of Douglas J. Goddard, Executive Vice President and Chief
Financial Officer of the Company, pursuant to 18 U.S.C. Section 1350.
This 2004 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 1, 2005 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 last quarter of the year
ended December 31, 2004 on the following dates: October 7, 2004, October 29,
2004, November 19, 2004, and December 20, 2004. The reports are related to the
release of the Company's third quarter earnings and the disclosure of certain
other financial data.
79
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 24th day of February, 2005
By: /s/ Babette E. Heimbuch
-----------------------
Babette E. Heimbuch
Chief Executive Officer
80
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 24th day of February, 2005.
SIGNATURE TITLE
Chairman of the Board and
Chief Executive Officer (Principal Executive
/s/ Babette E. Heimbuch Officer)
- ---------------------------------
Babette E. Heimbuch
Director, President and Chief Operating
/s/ James P. Giraldin Officer
- ---------------------------------
James P. Giraldin
Executive Vice President and Chief Financial
/s/ Douglas J. Goddard Officer
- --------------------------------- (Principal Financial Officer)
Douglas J. Goddard
/s/ Brenda J. Battey Senior Vice President and Controller
- --------------------------------- (Principal Accounting Officer)
Brenda J. Battey
/s/ Jesse Casso, Jr. Director
- ---------------------------------
Jesse Casso, Jr.
/s/ Christopher M. Harding Director
- ---------------------------------
Christopher M. Harding
/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
81
Exhibit 16
Exhibit 99.1 of Form 8-K filed September 9, 2004
Exhibit 99.1
September 8, 2004
Securities and Exchange Commission
Washington, D.C. 20549
Ladies and Gentlemen:
We were previously principal accountants for FirstFed Financial Corp. and, under
the date of January 28, 2004, we reported on the consolidated financial
statements of FirstFed Financial Corp. as of and for the years ended December
31, 2003 and 2002. On September 2, 2004, our appointment as principal
accountants was terminated. We have read FirstFed Financial Corp.'s statements
included under Item 4.01(b) of its Form 8-K dated September 8, 2004, and we
agree with the statements contained in paragraph (b), except that we are not in
a position to agree or disagree with FirstFed Financial Corp.'s statements that
the change was approved by the Board of Directors.
Very truly yours,
KPMG LLP
82
Exhibit 31.1
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 consolidated balance sheets, consolidated statements of income
and cash flows of the registrant as of, and for, the periods presented in
this annual report;
(4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the
registrant and have:
(i) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed
under our supervision, to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles;
(iii)Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures,
as of the end of the period covered by this report based on such
evaluation; and
(iv) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's fourth fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the registrant's
internal control over financial reporting;
(5) The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
(i) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(ii) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting; and
(6) The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
control over financial reporting or in other factors that could
significantly affect internal control over financial reporting subsequent to
the date of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.
Dated this 24th day of February, 2005
By: /s/ Babette E. Heimbuch
-----------------------
Babette E. Heimbuch
Chief Executive Officer
83
Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Douglas J. 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 consolidated balance sheets, consolidated statements of income
and cash flows of the registrant as of, and for, the periods presented in
this annual report;
(4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the
registrant and have:
(i) Designed such disclosure controls and procedures or caused such
disclosure controls and procedures to be designed under our
supervision, 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) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles;
(iii)Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(iv) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
fourth fiscal quarter that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting;
(5) The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
(i) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(ii)Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting; and
(6) The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
control over financial reporting or in other factors that could
significantly affect internal control over financial reporting subsequent to
the date of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.
Dated this 24th day of February, 2005.
By: /s/ Douglas J. Goddard
-----------------------
Douglas J. Goddard
Chief Financial Officer
84
EXHIBIT 32.1
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, 2004 (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 consolidated balance sheets and consolidated statements of
income 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 24, 2005
By: /s/ Babette E. Heimbuch
-----------------------
Babette E. Heimbuch
Chief Executive Officer
85
EXHIBIT 32.2
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, 2004 (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 consolidated balance sheets and consolidated statements of
income 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 24, 2005
By: /s/ Douglas J. Goddard
----------------------
Douglas J. Goddard
Chief Financial Officer and
Executive Vice President
86