Back to GetFilings.com
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from
_______________ to _______________.
Commission File Number 1-13578
DOWNEY FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
Delaware 95-1953342
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
3501 Jamboree Road 92660
Newport Beach, California (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (714) 854-0300
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
Common Stock, $0.01 par value New York Stock Exchange
Pacific Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
The aggregate market value of the voting stock held by non-affiliates
of the registrant, based upon the closing sale price of its Common Stock on
February 27, 1998, on the New York Stock Exchange was $594,033,102.
At February 27, 1998, 26,755,938 shares of the Registrant's Common Stock,
$0.01 par value were outstanding.
Documents Incorporated by Reference
Portions of the Registrant's Proxy Statement to be filed with the
Securities and Exchange Commission in connection with the Annual Meeting of
Stockholders to be held April 22, 1998 are incorporated by reference in Part III
hereof.
================================================================================
DOWNEY FINANCIAL CORP.
1997 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS....................................................... 1
General....................................................... 1
Lending Activities............................................ 2
Loan and Mortgage-Backed Securities Portfolio................ 2
Residential Real Estate Lending.............................. 3
Secondary Marketing and Loan Servicing Activities............ 4
Commercial Real Estate and Multi-Family Lending.............. 5
Construction Lending......................................... 5
Commercial Lending........................................... 5
Consumer Lending............................................. 5
Investment Activities......................................... 6
Real Estate Investments....................................... 6
Sources of Funds.............................................. 6
Deposits..................................................... 6
Borrowings................................................... 7
Asset/Liability Management.................................... 7
Earnings Spread............................................... 7
Competition................................................... 8
Employees..................................................... 8
Regulation.................................................... 9
General...................................................... 9
Regulation of Downey......................................... 9
Regulation of the Bank....................................... 9
Taxation...................................................... 13
Factors That May Affect Future Results........................ 14
ITEM 2. PROPERTIES..................................................... 16
Branches...................................................... 16
Electronic Data Processing.................................... 16
ITEM 3. LEGAL PROCEEDINGS.............................................. 16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS................ 16
i
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS........................................... 17
ITEM 6. SELECTED FINANCIAL DATA........................................ 18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS..................................... 19
Overview...................................................... 19
Results of Operations......................................... 20
Net Interest Income.......................................... 20
Provision for Loan Losses.................................... 21
Other Income................................................. 21
Loan and Deposit Related Fees............................... 21
Real Estate and Joint Venture Operations Held for Investment 22
Secondary Marketing Activities ............................. 22
Net Gains (Losses) on Sales of Investment Securities........ 22
Provision for Loss on Investment in Lease Residual.......... 22
Other Category.............................................. 22
Operating Expenses........................................... 23
Provision for Income Taxes................................... 23
Financial Condition........................................... 24
Loans and Mortgage-Backed Securities......................... 24
Investment Securities........................................ 27
Investments in Real Estate and Joint Ventures................ 28
Deposits..................................................... 30
Borrowings................................................... 31
Asset/Liability Management and Market Risk................... 31
Problem Loans and Real Estate................................ 36
Non-Performing Assets....................................... 36
Delinquent Loans............................................ 38
Allowance for Losses on Loans and Real Estate............... 40
Capital Resources and Liquidity.............................. 43
Regulatory Capital Compliance................................ 44
Current Accounting Issue..................................... 44
Year 2000.................................................... 45
ITEM 8. FINANCIAL STATEMENTS........................................... 46
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURES..................................... 88
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............. 88
ITEM 11. EXECUTIVE COMPENSATION......................................... 88
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................... 88
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................. 88
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K................................................... 88
SIGNATURES............................................................... 90
ii
PART I
Certain matters discussed in this Annual Report may constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 (the "Reform Act") and, as such, may involve risks
and uncertainties. These forward-looking statements relate to, among other
things, expectations of the business environment in which Downey Financial Corp.
("Downey") operates, projections of future performance, perceived opportunities
in the market and statements regarding Downey's mission and vision. Downey's
actual results, performance, or achievements may differ significantly from the
results, performance, or achievements expressed or implied in such
forward-looking statements. For discussion of the factors that might cause such
a difference, see "Item 1. Business - Factors That May Affect Future Results" on
page 14.
ITEM 1. BUSINESS
GENERAL
Downey was incorporated in Delaware on October 21, 1994. On January 23,
1995, after obtaining necessary stockholder and regulatory approvals, Downey
acquired 100% of the issued and outstanding capital stock of Downey Savings and
Loan Association (the "Bank"), and the Bank's stockholders became the
stockholders of Downey. Downey was thereafter capitalized by the Bank and
presently operates as the Bank's holding company.
The Bank was formed in 1957 as a California-licensed savings and loan
association and conducts its business through 86 retail deposit branches (26 of
which are full-service in-store branches). Residential loans are originated by
retail loan officers who are located in 20 retail deposit branches providing
loan origination services to all the Bank's branches. Wholesale loans submitted
by mortgage brokers are originated from five loan origination centers in
California, three of which are located in or adjacent to a Bank office. The
executive offices of Downey are located at 3501 Jamboree Road, North Tower,
Newport Beach, California, 92660, and the telephone number is (714) 854-0300.
Downey's stock is traded on the New York Stock Exchange and Pacific Exchange
under trading symbol "DSL." Unless otherwise stated or indicated, references to
"Downey" or the "Bank" include their respective subsidiaries.
On March 9, 1995, the Bank completed its conversion from a
California-licensed to a federally chartered savings association and currently
operates under the name "Downey Savings and Loan Association, F.A." As a
federally chartered savings association, the Bank's activities and investments
are generally governed by the Home Owners' Loan Act, as amended ("HOLA"), and
implementing regulations and policies of the Office of Thrift Supervision (the
"OTS"). The Bank and Downey are subject to the primary regulatory and
supervisory jurisdiction of the OTS. As a federally insured depository
institution, the Bank is also subject to regulation and supervision by the
Federal Deposit Insurance Corporation ("FDIC") with respect to certain
activities and investments. The Bank is a member of the Federal Home Loan Bank
("FHLB") of San Francisco, which is one of the 12 regional banks for federally
insured depository institutions comprising the Federal Home Loan Bank System.
The Bank's savings deposits are insured through the Savings Association
Insurance Fund ("SAIF") of the FDIC, an instrumentality of the United States
government. The Bank is further subject to regulations of the Board of Governors
of the Federal Reserve System ("Federal Reserve Board") with respect to reserves
required to be maintained against deposits and certain other matters.
On January 25, 1995, Downey Affiliated Insurance Agency was incorporated as
a wholly owned subsidiary of Downey and was capitalized on February 24, 1995,
with $400,000. Operations commenced in the second quarter of 1995 at which time
representatives of Downey Affiliated Insurance Agency were available in Downey's
branches to offer annuity products. During 1996, Downey Affiliated Insurance
Agency began offering forced-placed casualty insurance policies on mortgage
loans and ceased offering annuity products.
Downey's principal business is attracting funds from the general public and
institutions, and originating and investing in loans, primarily residential real
estate mortgage loans, mortgage-backed securities ("MBSs"), and investment
securities. MBSs include securities issued or guaranteed by government-sponsored
enterprises ("Agency MBSs"), such as the Federal National Mortgage Association
("FNMA"), the Federal Home Loan Mortgage Corporation ("FHLMC") and the
Government National Mortgage Association ("GNMA"), and mortgage pass-through
securities issued by other entities. Downey's primary sources of revenue are
interest earned on mortgage loans and MBSs, income from investment securities,
gains on sales of loans and MBSs, fees earned in connection with loans and
deposits and income earned on its portfolio of loans and MBSs serviced for
investors. Downey's principal expenses are interest incurred on interest-bearing
liabilities,
1
including deposits and borrowings, and general and administrative costs.
Downey's primary sources of funds are deposits, principal and interest payments
on loans and MBSs, proceeds from sales of loans and MBSs, and borrowings.
Scheduled payments on loans and MBSs are a relatively stable source of funds,
while prepayments of loans and MBSs and flows in deposits vary widely.
Prior to 1989, the Bank conducted substantial commercial and residential
real estate development and investment activities, primarily retail neighborhood
shopping centers located in California, principally through its subsidiary, DSL
Service Company, an active wholly owned real estate subsidiary of the Bank.
Since the passage in August 1989 of the Financial Institutions Reform, Recovery,
and Enforcement Act of 1989 ("FIRREA"), the Bank's ability to engage in new real
estate development activities and retain existing real estate investments has
been curtailed dramatically, and such activities may be economically unfeasible
for the Bank because of the capital requirements for such activities. Since
FIRREA, the Bank has been engaged in significant efforts to reduce its real
estate investments and is now within allowable limits for its investment in DSL
Service Company and other equity investments.
Downey's operations are significantly influenced by general economic
conditions, the monetary and fiscal policies of the federal government and the
regulatory policies of governmental authorities. Deposit flows and the cost of
interest-bearing liabilities ("cost of funds") to Downey are influenced by
interest rates on competing investments and general market interest rates.
Similarly, Downey's loan volume and yields on loans and MBSs, and the level of
prepayments on such loans and MBSs, are affected by market interest rates, as
well as additional factors affecting the supply of and demand for housing and
the availability of funds.
LENDING ACTIVITIES
Historically, Downey's lending activities have emphasized the origination
of first mortgage loans secured by residential property and retail neighborhood
shopping centers, and, to a lesser extent, real estate loans secured by
multi-family and commercial and industrial properties, including office
buildings, land and other properties with income producing capabilities. In
addition, Downey has provided construction loan financing for residential (both
single family and multi-family) and commercial retail neighborhood shopping
center projects, including loans to joint ventures where DSL Service Company or
the Bank was a participant. Downey also originates loans to businesses through
its commercial banking operations and loans on new and used automobiles through
the purchase of motor vehicle sales contracts from auto dealers in California
and other western states. The indirect auto lending program is in addition to
automobile loans originated directly through Downey's branch network.
During 1998, Downey's primary focus will continue to be the origination of
adjustable rate single family mortgage loans, particularly subprime loans which
carry higher interest rates, and consumer loans. In addition, Downey will
continue its secondary marketing activities of selling its production of certain
fixed rate single family loans as well as certain adjustable rate mortgage
("ARM") loan products. See "Lending Activities - Secondary Marketing and Loan
Servicing Activities" on page 4.
For additional information on the composition of Downey's loan and MBS
portfolio, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - Loans and Mortgage-Backed
Securities" on page 24.
Loan and Mortgage-Backed Securities Portfolio
Loans receivable held for investment are carried at cost, adjusted for
amortization of premiums and accretion of discounts which are recognized in
interest income using the interest method. MBSs represent participating
interests in pools of first mortgage loans originated and serviced by the
issuers of the securities. MBSs held to maturity are carried at unpaid principal
balances, adjusted for unamortized premiums and unearned discounts. Premiums and
discounts on MBSs are amortized using the interest method over the remaining
period to contractual maturity, adjusted for anticipated prepayments.
Downey identifies those loans which foreseeably may be sold prior to
maturity. These loans have been classified as held for sale in the Consolidated
Balance Sheets and are recorded at the lower of amortized cost or market value.
Net unrealized losses, if any, are recognized in a valuation allowance by
charges to income.
MBSs available for sale are carried at market value. Net unrealized
gains or losses are excluded from income and reported net of income taxes as a
component of stockholders' equity until realized.
2
Residential mortgage loans originated by Downey typically have contractual
maturities at origination of 15 to 40 years. To limit the interest rate risk
associated with such maturities, Downey, among other things, principally
originates ARMs for its own loan portfolio. Fixed rate loans are primarily
originated for sale in the secondary market on a non-recourse basis for cash.
However, Downey occasionally originates for its own portfolio fixed rate loans
to facilitate the sale of real estate acquired in settlement of loans and which
meet certain yield and other approved guidelines. See "Asset/Liability
Management" on page 7. In addition, the average term of such mortgage loans
historically has been significantly shorter than their contractual maturity due
to loan payoffs as a result of home sales or refinancings and prepayments.
Residential Real Estate Lending
Downey's primary lending activity is the origination of mortgage loans
secured by single family residential properties consisting of one-to-four units
located in California. Such loans are primarily for the purchase of residences
or for the refinancing of existing mortgages at lower rates or upon different
terms. At present, Downey is primarily originating ARMs for its portfolio of
loans held for investment. See "Asset/Liability Management" on page 7. Downey
also originates residential fixed interest rate mortgage loans to meet consumer
demand, but intends to sell the majority of all such loans in the secondary
market, rather than hold such loans in its portfolio. In addition, a small
volume of residential one-to-four unit fixed rate loans are originated for
investment to facilitate the sale of real estate acquired in settlement of loans
and which meet certain yield and other approved guidelines. See "Lending
Activities - Secondary Marketing and Loan Servicing Activities" on page 4.
Downey's ARMs generally begin with an interest rate below the current
market rate ("incentive rate") and adjust to the applicable index plus a defined
spread, subject to periodic and lifetime caps, after one, three or six months.
Downey's ARMs generally provide that the maximum rate that can be charged cannot
exceed the incentive rate by more than six to nine percentage points, depending
on the type of loan and the initial rate offered. The interest rate adjustment
on Downey's ARMs which adjust semi-annually generally is limited to 1% per
adjustment period. With respect to ARMs that adjust monthly, there is a lifetime
interest rate cap, but no specified periodic interest rate adjustment cap.
Instead, monthly adjustment ARMs have a periodic cap on changes in required
monthly payments, which adjust annually. Monthly adjustment ARMs allow for
negative amortization (the addition to loan principal of accrued interest that
exceeds the required monthly loan payments). In the event that a loan incurs
significant negative amortization, there is an increased risk that the market
value of the underlying collateral on the loan would be insufficient to satisfy
fully the outstanding principal and interest. There is a limit on the amount of
negative amortization, such that the principal plus the added amount cannot
exceed 125% of the original loan amount for loans originated prior to July 1994
and 110% of the original loan amount for loans originated thereafter. Downey
permits ARMs to be assumed by qualified borrowers.
During 1997, approximately 21% of Downey's one-to-four unit residential
real estate loans were originated by retail loan representatives of Downey.
Retail loan representatives typically receive loan referrals from real estate
agents, builders, depositors and customers obtained from retail advertising and
other sources. Prior to the fourth quarter of 1997, retail loan representatives
were compensated on a commission basis. Beginning in the 1997 fourth quarter,
the compensation program was changed to a salary plus a fixed amount per loan
originated. The remainder of Downey's one-to-four unit residential real estate
loans were obtained by Downey's wholesale loan representatives but originated
through outside mortgage brokers. Wholesale loan representatives are paid on a
commission basis. Compensation for the services performed by the mortgage broker
is considered in the overall pricing of mortgage loan products. These mortgage
brokers do not operate from Downey's offices and are not employees of Downey.
Downey requires that residential real estate loans be approved at various
levels of management, depending upon the amount of the loan. On a single family
residential loan originated for portfolio, the maximum amount Downey generally
will lend is $1 million. The average loan size, however, is much lower. In 1997,
the average loan size was $237,000. Downey generally makes loans with
loan-to-value ratios (the ratio of the principal amount of the loan to the
appraised value at origination of the property securing the loan) not exceeding
80% (up to 95% for certain loans made pursuant to Downey's low and moderate
income lending program under the Community Reinvestment Act ("CRA")). Downey
will make loans with loan-to-value ratios of over 80%, but not exceeding 97% of
the value of the property, if private mortgage insurance is obtained to reduce
the effective loan-to-value ratio to between 70% to 78%, consistent with
secondary marketing requirements. In addition, Downey requires hazard insurance
for all residential real estate loans covering the lower of the loan amount or
the replacement value of the structure.
In the approval process for the loans it originates or purchases, Downey
assesses both the value of the property securing the loan and the applicant's
ability to repay the loan. Loan underwriters analyze the loan application and
the
3
property involved, and qualified staff appraisers or outside appraisers inspect
and appraise the property. All appraisers are approved by Downey's Chief
Appraiser or, with respect to Federal Housing Administration ("FHA") insured
loans, by the FHA. Appraisals performed by approved appraisers are selectively
reviewed by senior staff appraisers or approved fee review appraisers. Downey
also obtains information concerning the income, financial condition, employment
and credit history of the applicant. Typically, Downey will verify credit
information for loans originated by retail loan representatives or other Downey
employees. For loans from mortgage brokers, Downey requires the mortgage broker
to review and verify credit information and employment pursuant to Downey's
origination procedures. In addition, Downey obtains credit information and
performs certain other underwriting tests of such mortgage broker originated
loans. On its ARMs offered with incentive rates, Downey qualifies applicants for
loan programs with no negative amortization at the higher of the initial
incentive rate plus 2% or the fully indexed rate, with a minimum qualifying rate
of 7% for loans having a loan-to-value ratio of 80% or less; and qualifies
applicants at a minimum qualifying rate of 7% for loans having a loan-to-value
ratio of greater than 80%. For loan programs that include negative amortization,
Downey qualifies applicants at the lesser of the initial incentive rate plus 2%
or the fully indexed rate, with a minimum qualifying rate of 6% for loans having
a loan-to-value ratio of 80% or less; and qualifies applicants at a minimum
qualifying rate of 7% for loans having a loan-to-value ratio of greater than
80%.
Late in 1996, Downey began offering one-to-four unit residential loans to
borrowers who have or, in the case of purchases, will have equity in their homes
but whose credit rating contains certain exceptions which preclude them from
qualifying for the best market terms. These lower grade credits ("A-," "B" and
"C" loans), commonly referred to as subprime loans, are characterized by lower
loan-to-value ratios and higher average interest rates than higher credit grade
loans ("A" loans). Downey believes these lower credit grade borrowers represent
an opportunity to earn a higher net return for the risks assumed. Underwriting
guidelines have been developed for each classification of credit.
Secondary Marketing and Loan Servicing Activities
As part of its secondary marketing activities, Downey originates certain
residential real estate ARMs and loans with fixed rates with an intent of
selling such loans. Accordingly, such loans are classified as held for sale and
are carried at the lower of cost or market. These loans are secured by first
liens on one-to-four unit residential properties and have 15- to 30-year
maturities or 30-year amortization periods with balloon payments in five years,
seven years or other maturities. For additional information regarding loans held
for investment and for sale, see Notes 1 and 6 of Notes to the Consolidated
Financial Statements on pages 53 and 62, respectively. Downey utilizes various
hedging programs to manage the interest rate risk of its fixed rate mortgage
origination process. See "Asset/Liability Management" on page 7.
Management of Downey believes that servicing loans for others can be an
important asset/liability management tool because it produces operating results
which, in response to changes in market interest rates, tend to move inversely
to changes in net interest income. Because ARMs lag market interest rates, net
interest income associated with these loans is expected to decline in periods of
rising interest rates and increase in periods of falling rates. In contrast, the
value of the loan servicing portfolio normally increases as interest rates rise
(and loan prepayments decrease) and declines as interest rates fall (and loan
prepayments increase). In addition, increased levels of servicing activities can
provide additional income with minimal additional overhead costs.
Depending upon market pricing for servicing, loans are sold either
servicing retained or servicing released. When sold servicing retained, Downey
records gains or losses from the sale of loans at the time of sale, which are
determined by the difference between the net sales proceeds and the allocated
basis of the loans sold. Downey adopted, effective January 1, 1997, Statement of
Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities," ("SFAS 125"). In
accordance with SFAS 125, Downey capitalizes mortgage servicing rights ("MSRs")
acquired through either the purchase or origination of mortgage loans for sale
or securitization with servicing rights retained. The total cost of the mortgage
loans designated for sale is allocated to the MSRs and the mortgage loans
without the MSRs based on their relative fair values. MSRs are included in the
financial statements in the category of "other assets." Impairment losses are
recognized through a valuation allowance, with any associated provision recorded
as a component of loan servicing fees. At December 31, 1997, MSRs totaled $2.0
million.
Loans originated for sale may be exchanged with government agencies for
MBSs collateralized by such loans. Downey's cost for the exchange is the payment
of a monthly guaranty fee, which is expressed as a percentage of the unpaid
principal balance and which is deducted from interest income. The securities
received can be used by Downey to collateralize various types of borrowings at
rates which frequently are more favorable than rates on other types of
liabilities and also carry a lower risk-based capital requirement than whole
loans. Such MBSs available for sale are carried at fair
4
value. However, no gain or loss on the exchange is recorded in the statement of
income until the securities are sold to a third party. All changes in fair value
prior to the sale to third parties are shown as a separate component of
stockholders' equity, net of income taxes.
Commercial Real Estate and Multi-Family Lending
Downey has provided permanent loans secured by retail neighborhood shopping
centers and multi-family properties. Downey's commercial real estate lending and
multi-family activities are conducted by Downey's major loan account officers
who are compensated on a salary basis.
Commercial real estate and multi-family loans generally entail additional
risks as compared to single-family residential mortgage lending. Each loan,
including loans to facilitate the sale of real estate owned, is subject to
Downey's underwriting standards, which generally include an evaluation of the
creditworthiness and reputation of the borrower, the amount of the borrower's
equity in the project as determined on the basis of appraisal, sales and leasing
information on the property and cash flow projections. To protect the value of
the security for Downey's loan, Downey requires casualty insurance for the loan
amount or replacement cost. In addition, for non-residential loans in excess of
$500,000, Downey requires the borrower to obtain comprehensive general liability
insurance. All commercial real estate loans originated by Downey require the
approval of at least two officers, one of whom must be the originating loan
account officer and the other a designated officer with appropriate loan
approval authority.
Construction Lending
Downey has provided construction loan financing for residential (both
single family and multi-family) and commercial real estate projects (e.g.,
retail neighborhood shopping centers). Downey originates such loans principally
through its major loan officers. Construction loans generally are made at
floating rates based upon the prime or reference rate of a major commercial
bank. Generally, Downey requires a loan-to-value ratio of 75% or less on
construction lending and subjects each loan to Downey's underwriting standards.
Construction loans involve risks different from completed project lending
because loan funds are advanced upon the security of the project under
construction, and if the loan goes into default, additional funds may have to be
advanced to complete the project before it can be sold. Moreover, construction
projects are subject to uncertainties inherent in estimating construction costs,
potential delays in construction time, market demand and the accuracy of the
estimate of value upon completion. Downey requires the general contractor to,
among other things, carry contractor's liability insurance equal to certain
prescribed minimum amounts, carry builder's risk insurance and have a blanket
bond against employee misappropriation.
Commercial Lending
Downey originates commercial loans and revolving lines of credit, and
issues standby letters of credit for its middle market commercial customers. The
various credit products are offered on both a secured and unsecured basis with
interest rates being either fixed or variable. The portfolio emphasis is toward
secured, floating rate credit facilities. The activities are directed through
the Commercial Banking Group with the focus on long-term-relationship-based
customers. The retail branch network is also utilized as a source of commercial
customers, typically managed by the branch manager. The smaller branch
originated business borrowers are desirable due to their lower cost deposit
accounts which usually accompany the relationship.
Consumer Lending
Downey originates fixed rate automobile loans primarily through an indirect
lending program of Downey Auto Finance Corp. which utilizes preapproved
automobile dealers to finance consumer purchases of new and used automobiles.
This operation is centralized at Downey's headquarters and utilizes technology
to process and evaluate loan applications, including credit scoring and the
automated retrieval of consumer credit bureau files. In addition to indirect
automobile lending through Downey Auto Finance Corp., the Bank originates direct
automobile loans, home equity loans and lines of credit, and other consumer loan
products. Before making a consumer loan, Downey assesses the applicant's ability
to repay the loan and, if applicable, the value of the collateral securing the
loan. The risk involved with home equity loans and lines of credit is similar to
the risk involved with residential real estate loans. Downey offers customers a
credit card through a third party, which extends the credit and services the
loans made to Downey's customers.
5
INVESTMENT ACTIVITIES
Federal and state regulations require the Bank to maintain a specified
minimum amount of liquid assets invested in certain short-term obligations and
other securities. For additional information regarding liquidity requirements
and the Bank's compliance therewith, see "Regulation - Regulation of the Bank -
Liquidity Requirements" on page 13 and "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition - Capital
Resources and Liquidity" on page 43. As a federally chartered savings
association, the Bank is also permitted to make certain other securities
investments as prescribed under HOLA and OTS regulations. Investment decisions
are made by authorized officers of the Bank within guidelines established by the
Bank's Board of Directors. Such investments are managed in an effort to produce
the highest yield consistent with maintaining safety of principal, minimization
of interest rate risk and compliance with applicable regulations. Securities
held for investment are carried at cost, adjusted for amortization of premiums
and accretion of discounts which are recognized as interest income using the
interest method. For further information on the composition of Downey's
investment portfolio, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Investment
Securities" on page 27.
REAL ESTATE INVESTMENTS
Historically, real estate development and joint venture operations have
been a significant part of Downey's business activities. These operations have
been conducted principally through the Bank's wholly owned service corporation
subsidiary, DSL Service Company. The Bank also engaged in these activities
directly, to a limited extent, but no longer has any such investments. Since the
passage in August 1989 of FIRREA, the ability to engage in new real estate
development and joint venture activities and to retain existing real estate
investments has been curtailed dramatically, and such activities may be
economically unfeasible for the Bank because of the capital requirements imposed
on such activities. FIRREA requires, with certain limited exceptions, a savings
institution such as the Bank to exclude from its regulatory capital its
investments in, and extensions of credit to, real estate subsidiaries such as
DSL Service Company, as well as its direct equity investments, and prohibits new
direct equity investments in real estate by the Bank. Since July 1, 1996, the
Bank has been required to deduct the full amount of its investment in DSL
Service Company in calculating its applicable ratios under the core, tangible
and risk-based capital standards. Savings associations generally may invest in
service corporation subsidiaries, such as DSL Service Company, to the extent of
2% of assets, plus up to an additional 1% of assets for investments which serve
primarily community, inner-city or community development purposes. In addition,
"conforming loans" by an association to such subsidiaries and their joint
venture investments are limited to 50% of risk-based capital. "Conforming loans"
are those generally limited to 80% of appraised value, bear a market rate of
interest and require payments sufficient to amortize the principal balance of
the loan. Downey is in compliance with each of these investment limitations.
To the extent real estate investments are made by Downey or a subsidiary of
Downey other than the Bank or its subsidiaries, the above-mentioned capital
deductions and limitations do not apply as they only pertain to such investments
by savings associations or their subsidiaries.
For further information, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition -
Investments in Real Estate and Joint Ventures" on page 28.
SOURCES OF FUNDS
Deposits
Downey prefers to use deposits as the principal source of funds for
supporting its lending activities, because the cost of these funds generally is
less than that of borrowings or other funding sources with comparable
maturities. Downey's savings deposits traditionally have been obtained primarily
from the areas in Southern and Northern California surrounding the Bank's branch
offices. However, Downey also occasionally raises certain retail deposits
through Wall Street activities.
Deposit flows are affected by general economic conditions. Funds may flow
from depository institutions such as savings associations into direct vehicles
such as government and corporate securities or other financial intermediaries.
The ability of Downey to attract and retain deposits will continue to be
affected by money market conditions and prevailing interest rates. Generally,
rates set by Downey are not restricted by state or federal regulation.
6
In 1996, Downey began establishing full-service branch facilities in
selected market locations throughout Southern California. Each in-store branch
offers a full range of financial services including checking and savings
accounts as well as residential and consumer loans.
When consistent with the maintenance of appropriate capital levels, Downey
may consider opportunities to augment its retail branch system and deposit base
through selected branch or deposit acquisitions.
For further information, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition - Deposits"
on page 30.
Borrowings
Downey's principal source of funds has been and continues to be deposits
raised through its retail branch system. At various times, however, Downey has
utilized other sources to fund its loan origination and other business
activities. Downey has from time to time relied upon borrowings from the FHLB of
San Francisco as an additional source of funds. Advances are made pursuant to
several different credit programs offered by the FHLB.
In 1994, Downey initiated a program to sell commercial paper supported by
an irrevocable letter of credit issued by the FHLB of San Francisco. At December
31, 1997, the irrevocable FHLB letter of credit was $300 million. The commercial
paper provides Downey with an alternative funding source to fund asset growth in
a cost effective manner.
From time to time, Downey utilizes securities and mortgage loans sold under
agreements to repurchase as additional sources of funds. These reverse
repurchase agreements are generally short term, and are collateralized by
mortgage-backed or investment securities and mortgage loans. Downey only deals
with investment banking firms which are recognized as primary dealers in U.S.
government securities or major commercial banks in connection with such reverse
repurchase agreements. In addition, Downey limits the amounts of borrowings from
any single institution.
For further information, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition -
Borrowings" on page 31.
ASSET/LIABILITY MANAGEMENT
Savings institutions are subject to interest rate risks to the degree that
their interest-bearing liabilities, consisting principally of customer deposits,
FHLB advances and other borrowings, mature or reprice more rapidly, or on a
different basis, than their interest-earning assets, which consist predominantly
of intermediate or long-term real estate loans. While having liabilities that on
average mature or reprice more frequently than assets may be beneficial in times
of declining interest rates, such an asset/liability structure may result in
declining net earnings during periods of rising interest rates. A principal
objective of Downey is to manage the effects of adverse changes in interest
rates on Downey's interest income while maintaining asset quality and an
acceptable interest rate spread. To improve the rate sensitivity and maturity
balance of its interest-earning assets and liabilities, Downey has over the past
several years emphasized the origination of loans with adjustable interest rates
or relatively short maturities. Loans with adjustable interest rates have the
beneficial effect of allowing the yield on Downey's assets to increase during
periods of rising interest rates, although such loans have contractual
limitations on the frequency and extent of interest rate adjustments.
For further information see "Lending Activities" on page 2 and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Asset/Liability Management and Market Risk"
on page 31.
EARNINGS SPREAD
Downey's net interest income is determined by the difference (the "interest
rate spread") between the yields earned by Downey on its loans, MBSs and
investment securities ("interest-earning assets") and the interest rates paid by
Downey on its deposits and borrowings ("interest-bearing liabilities"), as well
as the relative dollar amounts of Downey's interest-earning assets and
interest-bearing liabilities.
The effective interest rate spread, which reflects the relative level of
interest-earning assets to interest-bearing liabilities, equals (i) the
difference between interest income on interest-earning assets and interest
expense on interest-bearing
7
liabilities, (ii) divided by average interest-earning assets for the period. For
information regarding net income and the components thereof and for management's
analysis of financial condition and results of operations, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
beginning on page 19. For returns on assets and other selected financial data
see "Selected Financial Data" on page 18.
COMPETITION
Downey faces competition both in attracting deposits and in making real
estate loans and other loans. Its most direct competition for deposits has
historically come from other savings institutions and from commercial banks
located in its principal market areas, including many large financial
institutions based in other parts of the country or their subsidiaries. In
addition, there is additional significant competition for investors' funds from
short-term money market securities and other corporate and government
securities. The ability of Downey to attract and retain savings deposits
depends, generally, on its ability to provide a rate of return, liquidity and
risk comparable to that offered by competing investment opportunities and the
appropriate level of customer service.
Downey experiences competition for real estate loans principally from other
savings institutions, commercial banks, mortgage banking companies and insurance
companies. Downey competes for loans principally through the interest rates and
loan fees it charges and the efficiency and quality of services it provides
borrowers and real estate brokers.
EMPLOYEES
At December 31, 1997, Downey had approximately 908 full-time employees and
377 part-time employees. Downey provides its employees with certain health and
welfare benefits and a retirement and savings plan. Additionally, Downey offers
qualifying employees participation in a stock purchase plan. See Notes 19 and 21
of Notes to the Consolidated Financial Statements on pages 77 and 79, for a
further discussion of employee benefit plans. Employees are not represented by
any union or collective bargaining group, and Downey considers its employee
relations to be good.
REGULATION
General
Savings and loan holding companies and savings associations are extensively
regulated under both federal and state law. This regulation is intended
primarily for the protection of depositors and the SAIF and not for the benefit
of stockholders of Downey. The following information describes certain aspects
of that regulation applicable to Downey and the Bank, and does not purport to be
complete. The discussion is qualified in its entirety by reference to applicable
statutory or regulatory provisions.
Regulation of Downey
General. Downey is a unitary savings and loan holding company subject to
regulatory oversight by the OTS. As such, Downey is required to register and
file reports with the OTS and is subject to regulation and examination by the
OTS. In addition, the OTS has enforcement authority over Downey and its
subsidiaries, which also permits the OTS to restrict or prohibit activities that
are determined to be a serious risk to the subsidiary savings association.
Activities Restrictions. As a unitary savings and loan holding company,
Downey generally is not subject to activity restrictions, provided the Bank
satisfies the Qualified Thrift Lender ("QTL") test or meets the definition of
domestic building and loan association pursuant to section 7701 of the Internal
Revenue Code of 1986, as amended (the "Code"). If Downey acquires control of
another savings association as a separate subsidiary, it would become a multiple
savings and loan holding company, and the activities of Downey and any of its
subsidiaries (other than the Bank or any other SAIF-insured savings association)
would become subject to restrictions applicable to bank holding companies unless
such other associations each also qualify as a QTL or domestic building and loan
association and were acquired in a supervisory acquisition. See "Regulation of
the Bank - Qualified Thrift Lender Test" on page 11.
Restrictions on Acquisitions. Downey must obtain approval from the OTS
before acquiring control of any other SAIF-insured association. Such
acquisitions are generally prohibited if they result in a multiple savings and
loan holding company controlling savings associations in more than one state.
However, such interstate acquisitions are permitted based on specific state
authorization or in a supervisory acquisition of a failing savings association.
8
Federal law generally provides that no "person," acting directly or
indirectly or through or in concert with one or more other persons, may acquire
"control," as that term is defined in OTS regulations, of a federally insured
savings association without giving at least 60 days written notice to the OTS
and providing the OTS an opportunity to disapprove the proposed acquisition. In
addition, no company may acquire control of such an institution without prior
OTS approval. These provisions also prohibit, among other things, any director
or officer of a savings and loan holding company, or any individual who owns or
controls more than 25% of the voting shares of a savings and loan holding
company, from acquiring control of any savings association not a subsidiary of
the savings and loan holding company, unless the acquisition is approved by the
OTS.
Regulation of the Bank
As a federally chartered, SAIF-insured savings association, the Bank is
subject to extensive regulation by the OTS and the FDIC. Lending activities and
other investments of the Bank must comply with various statutory and regulatory
requirements. The Bank is also subject to certain reserve requirements
promulgated by the Federal Reserve Board.
The OTS, in conjunction with the FDIC, regularly examines the Bank and
prepares reports for the consideration of the Bank's Board of Directors on any
deficiencies found in the operations of the Bank. The relationship between the
Bank and its depositors and borrowers is also regulated by federal and state
laws, especially in such matters as the ownership of savings accounts and the
form and content of mortgage documents utilized by the Bank.
The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition, in addition to obtaining regulatory
approvals prior to entering into certain transactions such as mergers with or
acquisitions of other financial institutions. This regulation and supervision
establishes a comprehensive framework of activities in which an institution may
engage and is intended primarily for the protection of the SAIF and depositors.
The regulatory structure also gives the regulatory authorities extensive
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. Any change in such regulations, whether by the OTS, the FDIC or the
Congress could have a material adverse impact on Downey, the Bank and their
respective operations.
Insurance of Deposit Accounts. The Bank's deposit accounts are insured by
the SAIF, as administered by the FDIC, up to the maximum amount permitted by
law. Insurance of deposits may be terminated by the FDIC upon a finding that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the institution's
primary regulator.
The FDIC charges an annual assessment for the insurance of deposits based
on the risk a particular institution poses to its deposit insurance fund. Under
this system as of December 31, 1995, SAIF members paid within a range of 23
cents to 31 cents per $100 of domestic deposits, depending upon the
institution's risk classification. This risk classification is based on an
institution's capital group and supervisory subgroup assignment. Pursuant to the
Economic Growth and Paperwork Reduction Act of 1996 (the "Act"), the FDIC
imposed a special assessment on SAIF members to capitalize the SAIF at the
designated reserve level of 1.25% as of October 1, 1996. Based on the Bank's
deposits as of March 31, 1995, the date for measuring the amount of the special
assessment pursuant to the Act, the Bank paid a special assessment of $24.6
million in November 1996 to recapitalize the SAIF. This expense was recognized
during the fourth quarter of 1996.
Pursuant to the Act, the Bank pays its normal deposit insurance premium as
a member of the SAIF ranging from nothing to 27 cents per $100 of domestic
deposits. In addition, the Bank also pays an amount equal to approximately 6.4
cents per $100 of domestic deposits toward the retirement of the Financing
Corporation bonds ("Fico Bonds") issued in the 1980s to assist in the recovery
of the savings and loan industry. Members of the Bank Insurance Fund ("BIF"), by
contrast, pay, in addition to their normal deposit insurance premium,
approximately 1.3 cents per $100 of domestic deposits. Under the Act, the FDIC
also is not permitted to establish SAIF assessment rates that are lower than
comparable BIF assessment rates. Beginning no later than January 1, 2000, the
rate paid to retire the Fico Bonds will be equal for members of the BIF and the
SAIF. The Act also provides for the merging of the BIF and the SAIF by January
1, 1999 provided there are no financial institutions still chartered as savings
associations at that time. Should the insurance funds be merged before January
1, 2000, the rate paid by all members of this new fund to retire the Fico Bonds
would be equal.
9
Regulatory Capital Requirements. OTS capital regulations require savings
associations to meet three capital standards: (1) tangible capital equal to 1.5%
of total adjusted assets; (2) leverage capital (core capital) equal to 3% of
total adjusted assets; and (3) risk-based capital equal to 8.0% of total
risk-based assets. The Bank must meet each of these standards in order to be
deemed in compliance with OTS capital requirements. In addition, the OTS may
require a savings association to maintain capital above the minimum capital
levels.
The OTS has proposed to amend its leverage capital requirements. Under the
proposed regulation, a savings association which is assigned a composite rating
of 1 under the Uniform Financial Institutions Rating System, would be required
to maintain a minimum leverage capital ratio equal to 3% of total adjusted
assets. All other savings associations would be required to maintain a minimum
leverage capital ratio equal to 4% of total adjusted assets.
Under OTS regulations, a savings association with a greater than "normal"
level of interest rate exposure must deduct an interest rate risk ("IRR")
component in calculating its total capital for purposes of determining whether
it meets its risk-based capital requirement. Interest rate exposure is measured,
generally, as the decline in an institution's net portfolio value that would
result from a 200 basis point increase or decrease in market interest rates
(whichever would result in a lower net portfolio value), divided by the
estimated economic value of the savings association's assets. The interest rate
risk component to be deducted from total capital is equal to one-half of the
difference between an institution's measured exposure and "normal" IRR exposure
(which is defined as 2%), multiplied by the estimated economic value of the
institution's assets. In August 1995, the OTS indicated that it intends to delay
implementation of its automatic capital deduction for interest rate risk pending
the testing of an OTS appeals process and to provide an opportunity to assess
any further guidance from the other three federal banking agencies regarding
their planned implementation of a capital deduction. This delay is still in
effect and, based on the Bank's asset/liability structure, the Bank would not
have been subject to an IRR capital requirement at December 31, 1997.
These capital requirements are viewed as minimum standards by the OTS, and
most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: (1) a
savings association has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities or similar risks or a high proportion of
off-balance sheet risk; (2) a savings association is growing, either internally
or through acquisitions, at such a rate that supervisory problems are presented
that are not dealt with adequately by OTS regulations; and (3) a savings
association may be adversely affected by activities or condition of its holding
company, affiliates, subsidiaries or other persons with which it has significant
business relationships. The Bank is not subject to any such individual minimum
regulatory capital requirement.
As shown in "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Financial Condition - Regulatory Capital Compliance"
on page 44 the Bank's regulatory capital exceeded all minimum regulatory capital
requirements as of December 31, 1997.
HOLA permits savings associations not in compliance with the OTS capital
standards to seek an exemption from certain penalties or sanctions for
noncompliance. Such an exemption will be granted only if certain strict
requirements are met, and must be denied under certain circumstances. If an
exemption is granted by the OTS, the savings association still may be subject to
enforcement actions for other violations of law or unsafe or unsound practices
or conditions.
Prompt Corrective Action. The prompt corrective action regulations adopted
by the OTS require certain mandatory actions and authorize certain other
discretionary actions to be taken by the OTS against a savings association that
falls within certain undercapitalized capital categories specified in the
regulation.
The regulations establish five categories of capital classification: "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." Under the regulations, an
institution's risk-based capital, leverage capital and tangible capital ratios
are used to determine the institution's capital classification. At December 31,
1997, the Bank exceeded the capital requirements of a well capitalized
institution under applicable OTS regulations.
10
In general, the prompt corrective action regulations prohibit an insured
depository institution from declaring any dividends, making any other capital
distribution or paying a management fee to a controlling person if, following
the distribution or payment, the institution would be within any of the three
undercapitalized categories. In addition, adequately capitalized institutions
may accept brokered deposits (as defined) only with a waiver from the FDIC and
are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew or rollover
brokered deposits.
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may, if the institution is well capitalized,
reclassify it as adequately capitalized; if the institution is adequately
capitalized but not well capitalized, require it to comply with restrictions
applicable to undercapitalized institutions; and, if the institution is
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions.
Loans-to-One-Borrower. Savings associations generally are subject to the
lending limits applicable to national banks. With certain limited exceptions,
the maximum amount that a savings association or a national bank may lend to any
borrower (including certain related entities of the borrower) at one time may
not exceed 15% of the unimpaired capital and surplus of the institution, plus an
additional 10% of unimpaired capital and surplus for loans fully secured by
readily marketable collateral. Savings associations are additionally authorized
to make loans to one borrower, for any purpose, in an amount not to exceed
$500,000 or, by order of the Director of OTS, in an amount not to exceed the
lesser of $30,000,000 or 30% of unimpaired capital and surplus to develop
residential housing, provided: (i) the purchase price of each single-family
dwelling in the development does not exceed $500,000; (ii) the savings
association is in compliance with its fully phased-in capital requirements;
(iii) the loans comply with applicable loan-to-value requirements, and (iv) the
aggregate amount of loans made under this authority does not exceed 150% of
unimpaired capital and surplus. At December 31, 1997, the Bank's
loans-to-one-borrower limit was $67.3 million based upon the 15% of unimpaired
capital and surplus measurement.
Qualified Thrift Lender Test. Savings associations must meet a QTL test,
which test may be met either by maintaining a specified level of assets in
qualified thrift investments as specified in HOLA or by meeting the definition
of a "domestic building and loan association" in section 7701 of the Code. If
the Bank maintains an appropriate level of certain specified investments
(primarily residential mortgages and related investments, including certain
mortgage-related securities) and otherwise qualifies as a QTL or a domestic
building and loan association, it will continue to enjoy full borrowing
privileges from the FHLB. The required percentage of investments under HOLA is
65% of assets while the Code requires investments of 60% of assets. An
association must be in compliance with the QTL test or the definition of
domestic building and loan association on a monthly basis in nine out of every
12 months. Associations that fail to meet the QTL test will generally be
prohibited from engaging in any activity not permitted for both a national bank
and a savings association. As of December 31, 1997, the Bank was in compliance
with its QTL requirement and met the definition of a domestic building and loan
association.
Affiliate Transactions. Transactions between a savings association and its
"affiliates" are subject to quantitative and qualitative restrictions under
Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings
association include, among other entities, the savings association's holding
company and companies that are under common control with the savings
association.
In general, Sections 23A and 23B and OTS regulations issued in connection
therewith limit the extent to which a savings association or its subsidiaries
may engage in certain "covered transactions" with affiliates to an amount equal
to 10% of the association's capital and surplus, in the case of covered
transactions with any one affiliate, and to an amount equal to 20% of such
capital and surplus, in the case of covered transactions with all affiliates. In
addition, a savings association and its subsidiaries may engage in covered
transactions and certain other transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction" is
defined to include a loan or extension of credit to an affiliate; a purchase of
investment securities issued by an affiliate; a purchase of assets from an
affiliate, with certain exceptions; the acceptance of securities issued by an
affiliate as collateral for a loan or extension of credit to any party; or the
issuance of a guarantee, acceptance, or letter of credit on behalf of an
affiliate.
In addition, under the OTS regulations, a savings association may not make
a loan or extension of credit to an affiliate unless the affiliate is engaged
only in activities permissible for bank holding companies; a savings association
may not purchase or invest in securities of an affiliate other than shares of a
subsidiary; a savings association and its subsidiaries
11
may not purchase a low-quality asset from an affiliate; and covered transactions
and certain other transactions between a savings association or its subsidiaries
and an affiliate must be on terms and conditions that are consistent with safe
and sound banking practices. With certain exceptions, each loan or extension of
credit by a savings association to an affiliate must be secured by collateral
with a market value ranging from 100% to 130% (depending on the type of
collateral) of the amount of the loan or extension of credit.
The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
such subsidiaries as affiliates. The regulation also requires savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail, and provides that certain classes of savings associations may
be required to give the OTS prior notice of affiliate transactions.
Capital Distribution Limitations. OTS regulations impose limitations upon
all capital distributions by savings associations, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. In general, the Bank may not declare or pay a cash dividend on
its capital stock if the effect thereof would cause the Bank to fail to meet one
of its regulatory capital requirements.
Under the regulation, an association that meets its capital requirements
both before and after a proposed distribution and has not been notified by the
OTS that it is in need of more than normal supervision (a "Tier 1 association")
may, after prior notice to but without the approval of the OTS, make capital
distributions during a calendar year up to the higher of: (i) 100% of its net
income to date during the calendar year plus the amount that would reduce by
one-half its surplus capital ratio at the beginning of the calendar year, or
(ii) 75% of its net income over the most recent four-quarter period. A Tier 1
association may make capital distributions in excess of the above amount if it
gives notice to the OTS and the OTS does not object to the distribution. A
savings association that meets its regulatory capital requirements both before
and after a proposed distribution but does not meet its capital requirement (a
"Tier 2 association") is authorized, after prior notice to the OTS but without
OTS approval, to make capital distributions in an amount up to 75% of its net
income over the most recent four-quarter period, taking into account all prior
distributions during the same period. Any distribution in excess of this amount
must be approved in advance by the OTS. A savings association that does not meet
its current regulatory capital requirements (a "Tier 3 association") cannot make
any capital distribution without prior approval from the OTS, unless the capital
distribution is consistent with the terms of a capital plan approved by the OTS.
At December 31, 1997, the Bank qualified as a Tier 1 association for
purposes of the capital distribution rule. The OTS may prohibit a proposed
capital distribution that would otherwise be permitted if the OTS determines
that the distribution would constitute an unsafe or unsound practice.
The OTS has proposed to amend its capital distribution regulation to
conform its requirements to the OTS prompt corrective action regulation. Under
the proposed regulation, an institution that would remain at least adequately
capitalized after making a capital distribution, and was not owned by a holding
company, would no longer be required to provide notice to the OTS prior to
making a capital distribution. "Troubled" associations and undercapitalized
associations would be allowed to make capital distributions only by filing an
application and receiving OTS approval, and such applications would be approved
under certain limited circumstances.
Activities of Subsidiaries. A savings association seeking to establish a
new subsidiary, acquire control of an existing company or conduct a new activity
through a subsidiary must provide 30 days prior notice to the FDIC and the OTS
and conduct any activities of the subsidiary in accordance with regulations and
orders of the OTS. The OTS has the power to require a savings association to
divest any subsidiary or terminate any activity conducted by a subsidiary that
the OTS determines to pose a serious threat to the financial safety, soundness
or stability of the savings association or to be otherwise inconsistent with
sound banking practices.
Community Reinvestment Act and the Fair Lending Laws. Savings associations
have a responsibility under CRA and related regulations of the OTS to help meet
the credit needs of their communities, including low- and moderate-income
neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair
Housing Act (together, the "Fair Lending Laws") prohibit lenders from
discriminating in their lending practices on the basis of characteristics
specified in those statutes. An institution's failure to comply with the
provisions of CRA could, at a minimum, result in regulatory restrictions on its
activities and the denial of certain applications, and failure to comply with
the Fair Lending Laws could result in enforcement actions by the OTS, as well as
other federal regulatory agencies and the Department of Justice.
12
Federal Home Loan Bank System. The Bank is a member of the FHLB system.
Among other benefits, each FHLB serves as a reserve or central bank for its
members within its assigned region. Each FHLB is financed primarily from the
sale of consolidated obligations of the FHLB system. Each FHLB makes available
to members loans (i.e., advances) in accordance with the policies and procedures
established by the Board of Directors of the individual FHLB.
As a member, the Bank is required to own capital stock in an FHLB in an
amount equal to the greater of: (i) 1% of its aggregate outstanding principal
amount of its residential mortgage loans, home purchase contracts and similar
obligations at the beginning of each calendar year, (ii) 0.3% of total assets,
or (iii) 5% of its FHLB advances (borrowings). At December 31, 1997, the Bank
had $44.1 million in FHLB stock. The Bank's required investment in FHLB stock,
based on December 31, 1997 financial data, was $47.4 million. The Bank received
a $0.7 million stock dividend and purchased additional stock amounting to $2.6
million in the first quarter of 1998, thereby increasing the Bank's investment
to the required amount. See Note 11 of Notes to the Consolidated Financial
Statements on page 69.
Liquidity Requirements. Under OTS regulations, a savings association is
required to maintain an average daily balance of liquid assets (including cash,
certain time deposits and savings accounts, bankers' acceptances, certain
government obligations, and certain other investments) in each calendar quarter
of not less than 4% of either: (i) its liquidity base (consisting of certain net
withdrawable accounts plus short-term borrowings) as of the end of the preceding
calendar quarter, or (ii) the average daily balance of its liquidity base during
the preceding quarter. This liquidity requirement may be changed from time to
time by the OTS to any amount between 4% and 10%, depending upon certain
factors, including economic conditions and savings flows of all savings
associations. The Bank maintains liquid assets in compliance with these
regulations. Monetary penalties may be imposed upon an institution for
violations of liquidity requirements.
Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain non-interest bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW, and Super NOW
checking accounts) and non-personal time deposits. The balances maintained to
meet the reserve requirements imposed by the Federal Reserve Board may be used
to satisfy the liquidity requirements that are imposed by the OTS. At December
31, 1997, the Bank was in compliance with these requirements.
Recent Proposed Legislation. Congress has been considering legislation in
various forms that would require federal thrifts, such as the Bank, to convert
their charters to national or state bank charters. The Treasury Department has
been studying the development of a common charter for federal savings
associations and commercial banks. In the event that the thrift charter is
eliminated by January 1, 1999, the Act would require the merger of the BIF and
the SAIF into a single Deposit Insurance Fund on that date. In the absence of
appropriate "grandfather" provisions, legislation eliminating the thrift charter
could have a material adverse effect on the Bank and Downey because, among other
things, the regulatory, capital and accounting treatment for national and state
banks and savings associations differs in certain significant respects. Downey
cannot determine whether, or in what form, such legislation may eventually be
enacted and there can be no assurance that any legislation that is enacted would
contain adequate grandfather rights for the Bank and Downey.
TAXATION
Federal. A savings institution generally is subject to tax in the same
manner as other corporations for federal income tax purposes, though savings
institutions have historically enjoyed favorable treatment under the Code in
determining the deduction allowed for bad debts. During 1996, however, Congress
enacted legislation which repealed the reserve method of determining bad debt
deductions for "large thrift institutions" (i.e., thrifts with assets greater
than $500 million), subjecting savings associations to rules similar to those
currently applicable to large commercial banks. The repeal was effective for tax
years beginning after 1995. Bad debt reserves accumulated since 1987 were
subject to recapture as taxable income over a six-year period beginning in 1996.
However, thrifts were allowed to defer recapture for up to two years if the
amount of mortgage loans originated in 1996 and 1997 equaled or exceeded the
average amount of mortgages originated in the six years prior to 1996. Based
upon originations in 1996 and 1997, the Bank qualifies for the two-year deferral
under this originations test, and thus will recapture its post-1987 bad debt
reserve over a six-year period beginning in 1998. The bad debt deductions for
1996 and 1997 were determined under the specific charge-off method, which allows
a tax deduction for loans determined to be wholly or partially worthless.
13
Prior to 1996, a savings institution which met certain definitional tests
relating to the composition of its assets and the sources of its income (a
"qualifying savings institution") was permitted to take deductions for additions
to reserves for bad debts, rather than recognizing deductions for specific loans
as they became worthless. A qualifying savings institution was allowed to make
annual additions to such reserves based upon the institution's actual loan loss
experience (the "experience method"). Alternatively, a qualifying savings
institution could elect to compute the allowable addition to its bad debt
reserve for qualifying real property loans (generally, loans secured by an
interest in improved real estate) as a percentage of the institution's taxable
income (the "percentage-of-taxable-income method").
Under applicable provisions of the Code, a savings institution organized in
stock form whose accumulated reserve for losses on qualifying real property
loans exceeds the reserve as calculated under the experience method may be
subject to recapture taxes on such reserve if it makes certain types of
distributions to its stockholders. Dividends may be paid out of retained
earnings without the imposition of any tax on the savings institution to the
extent that the amounts paid as dividends do not exceed the savings
institution's current or post-1951 accumulated earnings and profits as
calculated for federal income tax purposes. Stock redemptions, dividends paid in
excess of the savings institution's current or post-1951 accumulated earnings
and profits as calculated for tax purposes, and other distributions made with
respect to the savings institution's stock (and the taxes deemed to be
attributable thereto), however, are deemed under applicable sections of the Code
to be made from the savings institution's tax bad debt reserves to the extent
that such reserves exceed the amount that could have been accumulated under the
experience method. Thus, certain distributions to stockholders that are treated
as having been paid from the reserve for losses on qualifying real property
loans could result in a federal recapture tax. The Bank, however, has not in the
past made distributions that resulted in federal recapture tax under these rules
and does not expect to make any such distributions in the foreseeable future.
In addition to the regular corporate income tax, corporations, including
qualifying savings institutions, are subject to an alternative minimum tax. This
20% tax is computed with respect to the corporation's regular taxable income
(with certain adjustments), as increased by tax preference items ("alternative
minimum taxable income") and will apply to the extent that it exceeds the
corporation's regular tax liability. In addition, in computing a corporation's
alternative minimum taxable income, the corporation's regular taxable income is
required to be increased by 75% of the excess of the corporation's current
earnings and profits (subject to certain adjustments) over the corporation's
alternative minimum taxable income determined prior to this adjustment and
without regard to the alternative tax net operating loss deduction. A
corporation that incurs alternative minimum tax generally is entitled to take
such tax as a credit against its regular tax in subsequent years to the extent
that the corporation's regular tax liability in such subsequent years (reduced
by certain other tax credits) exceeds the corporation's so-called "tentative
minimum tax" (generally, an amount computed by multiplying the corporation's
alternative minimum taxable income for the year by the then-applicable rate for
the alternative minimum tax).
State. The California franchise tax applicable to the Bank is computed
under a formula which results in a rate higher than the rate applicable to
non-financial corporations because it reflects an amount "in lieu" of local
personal property and business license taxes paid by such corporations (but not
generally paid by banks or financial corporations such as the Bank). The
variable tax rate was 10.84% in 1997, and 11.3% for 1996. Downey and its wholly
owned subsidiaries file a California franchise tax return on a combined
reporting basis. Additional state income tax returns are filed on a
separate-entity basis in Arizona, Colorado, and Illinois for income-producing
property owned in those states.
Downey's federal income and state franchise tax returns have been audited
by the Internal Revenue Service and the California Franchise Tax Board,
respectively, for all years through 1989. Federal tax returns for years 1990
through 1995 are currently under examination. State franchise tax returns for
years subsequent to 1989 remain open to review.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The following discusses certain factors which may affect Downey's financial
results and operations and should be considered in evaluating Downey.
Economic Conditions and Geographic Concentrations. Downey is headquartered
in Southern California, and its operations are concentrated in Southern and
Northern California. As a result of this geographic concentration, Downey's
results depend largely upon economic conditions in these areas. While the
California economy has exhibited positive economic and employment trends, there
is no assurance that such trends will continue. A deterioration in economic
conditions could have a material adverse impact on the quality of Downey's loan
portfolio and the demand for its products and services.
14
Interest Rates. Downey anticipates that interest rate levels will remain
generally constant in 1998, but if interest rates vary substantially from
present levels, Downey's results may differ materially from the results
currently anticipated. Changes in interest rates will influence the growth of
loans, investments and deposits and affect the rates received on loans and
investment securities and paid on deposits.
Government Regulation and Monetary Policy. The financial services industry
is subject to extensive federal and state supervision and regulation.
Significant new laws or changes in, or repeals of, existing laws may cause
Downey's results to differ materially. Further, federal monetary policy,
particularly as implemented through the Federal Reserve System, significantly
affects credit conditions for Downey, primarily through open market operations
in United States government securities, the discount rate for borrowings and
reserve requirements, and a material change in these conditions would be likely
to have a material impact on Downey's results.
Competition. The banking and financial services business in Downey's market
areas are highly competitive. The increasingly competitive environment is a
result primarily of changes in regulation, changes in technology and product
delivery systems, and the accelerating pace of consolidation among financial
services providers. Downey's results may differ if circumstances affecting the
nature or level of competition change.
Credit Quality. A significant source of risk arises from the possibility
that losses will be sustained because borrowers, guarantors and related parties
may fail to perform in accordance with the terms of their loans. Downey has
adopted underwriting and loan monitoring procedures and credit policies,
including the establishment and review of the allowance for loan losses, that
management believes are appropriate to minimize this risk by assessing the
likelihood of nonperformance, tracking loan performance and diversifying
Downey's loan portfolio. Such policies and procedures, however, may not prevent
unexpected losses that could materially adversely affect Downey's results.
Year 2000. Like most financial organizations, Downey has many computer
systems that identify dates using only the last two digits of the year. These
systems must be prepared to distinguish dates such as 1900 from 2000. Computer
system failures due to processing errors potentially arising from calculations
using Year 2000 dates are a known risk. Downey has established processes to
identify, prioritize, renovate or replace systems that may be affected by Year
2000 dates. To date, Downey has completed an inventory of all systems and
determined which processes are most critical to supporting customer transaction
processing and providing customer services. System renovation and replacement
plans have been started and are targeted for completion by the end of 1998, with
compliance testing and installation processes to be completed during 1999.
However, third party vendor dependency, including government entities, may
impact Downey's efforts to successfully complete Year 2000 compliance for all
systems in a timely fashion.
15
ITEM 2. PROPERTIES
BRANCHES
The executive offices of both Downey and the Bank are located at 3501
Jamboree Road, Newport Beach, California 92660, in a six-story building
containing approximately 320,000 square feet. Part of the first floor houses a
branch office of the Bank. Certain departments (warehousing, record retention,
etc.) are located in other owned and leased facilities in Orange County,
California. The majority of Downey's administrative operations, however, are
located in the headquarters building.
At December 31, 1997, Downey owned the building and land occupied by 54 of
its branches and owned one building on leased land. Downey leases branches in 35
locations (including 26 in-store locations) with leases expiring at various
dates through November 2009, with options to extend the term. In 1997, Downey
purchased land and buildings for three new branch locations opening in 1998.
The net book value of the owned branches, including the one on leased land,
totaled $85.4 million at December 31, 1997, and the net book value of the leased
branch offices totaled $1.5 million at December 31, 1997. The net book value of
Downey's furniture and fixtures, including electronic data processing equipment,
was $14.9 million at December 31, 1997.
For additional information regarding Downey's offices and equipment, see
Notes 1 and 10 of Notes to the Consolidated Financial Statements on page 53 and
page 69, respectively.
ELECTRONIC DATA PROCESSING
Downey utilizes a mainframe computer system with use of various third-party
vendors' software for retail deposit operations, loan servicing, accounting and
loan origination functions. The net book value of Downey's electronic data
processing equipment, including personal computers and software, was $10.3
million at December 31, 1997.
ITEM 3. LEGAL PROCEEDINGS
Downey has been named as a defendant in legal actions arising in the
ordinary course of business, none of which, in the opinion of management, is
material.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
None.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Downey's Common Stock is traded on the New York Stock Exchange ("NYSE") and
the Pacific Exchange ("PCX") with the trading symbol "DSL." At February 27,
1998, Downey had approximately 1,078 stockholders of record (not including the
number of persons or entities holding stock in nominee or street name through
various brokerage firms) and 26,755,938 outstanding shares of common stock. The
following table sets forth for the quarters indicated the range of high and low
sale prices per share of the common stock of Downey as reported on the NYSE
Composite Tape.
1997 1996
----------------------------------- ----------------------------------
4th 3rd 2nd 1st 4th 3rd 2nd 1st
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
- -----------------------------------------------------------------------------------------
High ........ $ 29.00$ 24.50$ 23.63$ 22.50$ 18.69$ 16.03$ 15.23$ 15.23
Low ......... 24.19 21.50 18.09 18.09 15.88 12.86 12.86 13.09
End of period 28.44 24.38 23.63 19.28 18.69 16.03 13.89 14.92
During 1997 and 1996, Downey paid quarterly cash dividends totaling $0.315
and $0.304 per share, aggregating $8.5 and $8.1 million, respectively. On
February 27, 1998, Downey paid a $0.08 per share quarterly cash dividend,
aggregating $2.1 million.
Downey may pay additional dividends out of funds legally available therefor
at such times as the Board of Directors determines that dividend payments are
appropriate. The Board of Directors' policy is to consider the declaration of
dividends on a quarterly basis.
The payment of dividends by the Bank to Downey is subject to OTS
regulations. For further information regarding these regulations see "Business -
Regulation - Regulation of the Bank - Capital Distribution Limitations" on page
12.
17
ITEM 6. SELECTED FINANCIAL DATA
(Dollars in Thousands, Except Per Share Data) 1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------------------------------------------------
For the year:
Total interest income ..................................... $ 420,418 $ 346,360 $ 318,828 $ 228,970 $ 220,745
Total interest expense .................................... 266,260 211,765 214,238 122,601 109,973
- --------------------------------------------------------------------------------------------------------------------------------
Net interest income ................................... 154,158 134,595 104,590 106,369 110,772
Provision for loan losses ............................. 8,640 9,137 9,293 4,211 1,085
- --------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses ... 145,518 125,458 95,297 102,158 109,687
- --------------------------------------------------------------------------------------------------------------------------------
Other income, net:
Loan and deposit related fees ......................... 10,921 7,435 5,546 5,310 6,175
Real estate and joint ventures held for investment, net 14,222 8,241 11,192 9,530 4,769
Net gains (losses) on sales of:
Loans and mortgage-backed securities ................ 2,675 1,543 266 114 1,665
Investment securities ............................... -- 4,473 (15) -- --
(Provision for) reduction of loss on investment in
lease residual ...................................... -- -- 207 (920) (2,184)
Other ................................................. 7,370 3,507 3,403 3,703 4,609
- --------------------------------------------------------------------------------------------------------------------------------
Total other income, net ............................... 35,188 25,199 20,599 17,737 15,034
- --------------------------------------------------------------------------------------------------------------------------------
Operating expense:
General and administrative expense .................... 99,556 86,460 74,470 75,566 73,502
SAIF special assessment ............................... -- 24,644 -- -- --
Net operation of real estate acquired in settlement of
loans ............................................... 1,184 2,567 4,206 3,595 2,337
Amortization of excess of cost over fair value of net
assets acquired ..................................... 532 532 530 532 532
- --------------------------------------------------------------------------------------------------------------------------------
Total operating expense ............................... 101,272 114,203 79,206 79,693 76,371
- --------------------------------------------------------------------------------------------------------------------------------
Net income ................................................ 45,234 20,704 (1) 21,093 23,532 43,666 (2)
Loans originated .......................................... 2,329,266 1,583,784 637,490 1,810,096 1,104,252
Loans and mortgage-backed securities purchased ............ 35,828 30,296 44,194 196,255 19,625
Loans and mortgage-backed securities sold ................. 557,511 166,503 102,097 45,770 153,146
Effective interest rate spread ............................ 2.83% 2.96% 2.35% 3.02% 3.47%
At December 31:
Total assets .............................................. $5,835,825 $5,198,157 4,656,267 $4,650,651 $3,467,155
Total loans and mortgage-backed securities ................ 5,366,396 4,729,846 4,169,474 4,188,539 2,917,109
Investments and cash equivalents .......................... 221,201 222,255 237,904 215,960 313,989
Deposits .................................................. 4,869,978 4,173,102 3,790,221 3,557,398 3,068,929
Borrowings ................................................ 483,735 595,345 436,218 674,776 13,718
Stockholders' equity ...................................... 430,346 391,571 384,072 366,187 351,470
Loans serviced for others ................................. 612,529 576,044 527,234 468,123 503,711
Allowance for loan losses as a percentage of
non-performing loans .................................... 76.96% 66.84% 35.67% 49.29% 47.72%
Non-performing assets as a percentage of total assets ..... 0.89 1.19 2.09 1.41 2.01
Selected ratios:
Return on average assets .................................. 0.79% 0.43% (1) 0.45% 0.62% 1.25%(3)
Return on average equity .................................. 11.07 5.33 (1) 5.69 6.56 12.83 (3)
Dividend payout ratio ..................................... 18.69 39.35 36.78 33.97 12.96
Capital ratios:
Average stockholders' equity to average assets ........ 7.17 8.10 7.86 9.47 9.74
Core and tangible capital ............................. 6.61 6.56 7.28 7.22 9.45
Risk-based capital .................................... 12.64 12.66 14.25 14.21 16.93
Per Share Data: (4)
Earnings per share - Basic/Diluted ........................ $ 1.69 $ 0.77 (1) $ 0.79 $ 0.88 $ 1.64 (2)
Book value per share at end of period ..................... 16.08 14.65 14.37 13.70 13.15
Stock price at end of period .............................. 28.44 18.69 13.81 9.14 12.02
Cash dividends paid ....................................... 0.315 0.304 0.290 0.290 0.211
(1) Excluding the SAIF special assessment, net income would have been $34.7
million or $1.29 per share and the returns on average assets and average
equity would have been 0.73% and 8.95%, respectively.
(2) Includes $15.1 million, or $0.56 per share, cumulative benefit from the
adoption of SFAS 109, Accounting for Income Taxes.
(3) Excluding the SFAS 109 benefit, the returns on average assets and average
equity would have been 0.82% and 8.39%, respectively.
(4) Adjusted for a 5% stock dividend paid in May 1997.
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements under this caption constitute "forward-looking
statements" under the Reform Act which involve risks and uncertainties. Downey's
actual results may differ significantly from the results discussed in such
forward-looking statements. Factors that might cause such a difference include
but are not limited to economic conditions, competition in the geographic and
business areas in which Downey conducts its operations, fluctuations in interest
rates, credit quality and government regulation. For additional information
concerning these factors, see "Item 1. Business - Factors that May Affect Future
Results" on page 14.
OVERVIEW
Net income for 1997 totaled $45.2 million or $1.69 per share on a diluted
basis, more than double last year's $20.7 million or $0.77 per share. The 1996
results included a one-time assessment to recapitalize the Savings Association
Insurance Fund ("SAIF") which totaled $24.6 million ($14.0 million or $0.52 per
share on an after-tax basis). Excluding that assessment, net income in 1997
would have been $10.5 million or 30.2% above a year ago.
Excluding the one-time SAIF assessment, the increase in 1997 net income
primarily reflected higher net interest income. Net interest income increased
$19.6 million or 14.5% due to higher average earning assets. Also contributing
to the increase in net income between years was a $10.0 million increase in
other income and a $1.4 million decline in the net expense associated with the
operation of real estate acquired in settlement of loans. The increase in other
income reflected several factors. Favorably impacting other income were
increases of $6.0 million in income from real estate held for investment, $4.0
million in the all other category of other income representing a gain from the
sale of an asset obtained as part of the 1988 acquisition of Butterfield
Savings, $3.5 million in loan and deposit related fees and $1.1 million in net
gains from sales of loans and mortgage-backed securities. These favorable other
income items were partially offset by a decline of $4.5 million in net gains
from sales of investment securities. The favorable impact of higher net interest
and other income, and lower net expense associated with the operation of real
estate acquired in settlement of loans was partially offset by an increase of
$13.1 million in general and administrative expense. The increase in general and
administrative expense was primarily associated with branch expansion,
particularly into in-store banking, higher advertising expenditures and growth
in auto lending.
Assets increased $637.7 million or 12.3% during 1997 to $5.8 billion at
year end, following an 11.6% increase during 1996. Single family loan
originations increased from $1.25 billion in 1996 to $2.0 billion in 1997. Of
the 1997 amount, $221.2 million represented higher yielding subprime loans. In
addition to single family loans, $413.4 million of other loans were originated,
including $259.0 million of auto loans and $80.0 million of construction loans.
Asset growth was primarily funded with deposits as deposits increased
$696.9 million or 16.7% to $4.9 billion at December 31, 1997. Of the increase,
$102.6 million was generated by new branches opened in 1997.
Non-performing assets totaled $52.1 million or 0.89% of assets at December
31, 1997, down from $62.0 million or 1.19% of assets at December 31, 1996. The
decline in non-performing assets was spread throughout most categories. A
detailed review of all criticized, classified, watch and non-performing assets
is performed at least semi-annually. All assets greater than $1 million are
reviewed annually. The combined provisions for loan and real estate losses,
including real estate held for investment and acquired in settlement of loans,
totaled $6.6 million for 1997, compared to $7.5 million in 1996 and $8.9 million
in 1995.
At December 31, 1997, the Bank met and exceeded all three regulatory
capital tests, with capital-to-asset ratios of 6.61% in tangible and core
capital and 12.64% in risk-based capital. These capital levels are well above
the "well capitalized" standards defined by the federal banking regulators of 5%
for core and tangible capital and 10% for risk-based capital. For further
information, see "Business - Regulation - Regulation of the Bank - Insurance of
Deposit Accounts" on page 9, "Financial Condition - Investments in Real Estate
and Joint Ventures" on page 28 and "Regulatory Capital Compliance" on page 44.
19
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is the difference between the interest and dividends
earned on loans, mortgage-backed securities and investment securities
("interest-earning assets") and the interest paid on deposits and borrowings
("interest-bearing liabilities"). Net interest income is affected principally by
the spread between the yield on interest-earning assets and the cost of
interest-bearing liabilities and by the relative dollar amounts of such assets
and liabilities.
Net interest income was $154.2 million in 1997, up $19.6 million or 14.5%
from 1996 and $49.6 million or 47.4% greater than 1995. The 1997 improvement
over 1996 primarily reflected a 19.7% increase in average earning assets to $5.4
billion. In addition, 1997 benefited from approximately $1.3 million of higher
than usual distributions from agreements in which Downey shares in the net cash
flows of certain shopping centers which Downey currently, or in the past,
financed. These favorable items were partially offset by a decline in the
effective interest rate spread. The effective interest rate spread averaged
2.83% in 1997, down from 2.96% in 1996 but up from 2.35% in 1995. Between 1997
and 1996, the yield on earning assets increased 11 basis points, while the cost
of funding those earnings assets increased 22 basis points. The more rapid
increase in funding costs occurred as the growth in earning assets was primarily
funded with higher cost certificates of deposit and borrowings.
The following table presents for the periods indicated the total dollar
amount of interest income from average interest-earning assets and resultant
yields, the interest expense on average interest-bearing liabilities and the
resultant costs, expressed both in dollars and rates. The table also sets forth
the net earning balance (the difference between the average balance of
interest-earning assets and the average balance of interest-bearing liabilities)
for the periods indicated. Non-accrual loans are included in the average
interest-earning assets balance. Interest from non-accrual loans is included in
interest income only to the extent that payments were received and to the extent
that Downey believes it will recover the remaining principal balance of the
loan. Average balances are computed using a monthly average balance during the
period. The effective interest rate spread, which reflects a savings
association's relative level of interest-earning assets to interest-bearing
liabilities, equals (i) the difference between interest income on
interest-earning assets and interest expense on interest-bearing liabilities,
(ii) divided by average interest-earning assets for the period. The table also
sets forth the net interest income, the interest rate spread and the effective
interest rate spread.
1997 1996 1995
-------------------------------------------------------------------------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
(Dollars in Thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Loans ....................... $5,174,767 $ 404,081 7.81% $4,269,136 $ 329,746 7.72% $4,175,085 $ 300,734 7.20%
Mortgage-backed securities .. 55,045 3,633 6.60 64,957 4,317 6.65 63,772 4,311 6.76
Investment securities ....... 217,272 12,704 5.85 215,364 12,297 5.71 215,672 13,783 6.39
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning
assets ................... 5,447,084 420,418 7.72 4,549,457 346,360 7.61 4,454,529 318,828 7.16
Non-interest-earning assets ... 246,785 240,191 263,430
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets ............... $5,693,869 $4,789,648 $4,717,959
====================================================================================================================================
Interest-bearing liabilities:
Deposits .................... $4,588,320 $ 227,521 4.96% $3,892,981 $ 184,402 4.74% $3,758,948 $ 180,859 4.81%
Borrowings .................. 638,661 38,739 6.07 457,890 27,363 5.98 523,417 33,379 6.39
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing ..... 5,226,981 266,260 5.09 4,350,871 211,765 4.87 4,282,365 214,238 5.00
liabilities
Non-interest-bearing
liabilities ................. 58,415 50,590 64,880
Stockholders' equity .......... 408,473 388,187 370,714
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity .... $5,693,869 $4,789,648 $4,717,959
====================================================================================================================================
Net interest income/interest
rate spread ................. $ 154,158 2.63% $ 134,595 2.74% $ 104,590 2.16%
Excess of interest-earning
assets over interest-bearing
liabilities $ 220,103 $ 198,586 $ 172,164
Effective interest rate spread 2.83 2.96 2.35
====================================================================================================================================
20
Changes in Downey's net interest income are a function of both changes in
rates and changes in volumes of interest-earning assets and interest-bearing
liabilities. The following table sets forth information regarding changes in
interest income and expense for Downey for the years indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to: (i) change in rate (change in rate
multiplied by old volume), (ii) change in volume (change in volume multiplied by
old rate) and (iii) change in rate-volume (change in rate multiplied by change
in volume). Interest-earning asset and liability balances in the calculations
are computed using monthly average balances.
1997 versus 1996 1996 versus 1995
Change Due To Change Due To
------------------------------------------- ----------------------------------------------
Rate/ Rate/
(In Thousands) Volume Rate Volume Net Volume Rate Volume Net
- ------------------------------------------------------------------------------------------------------------------------------
Interest Income:
Loans ...................... $ 69,951 $ 3,617 $ 767 $ 74,335 $ 6,775 $ 21,747 $ 490 $ 29,012
Mortgage-backed securities . (659) (30) 5 (684) 80 (73) (1) 6
Investment securities ...... 109 295 3 407 (20) (1,468) 2 (1,486)
- ------------------------------------------------------------------------------------------------------------------------------
Change in interest income 69,401 3,882 775 74,058 6,835 20,206 491 27,532
- ------------------------------------------------------------------------------------------------------------------------------
Interest Expense:
Deposits ................... 32,937 8,639 1,543 43,119 6,449 (2,806) (100) 3,543
Borrowings ................. 10,801 412 163 11,376 (4,184) (2,094) 262 (6,016)
- ------------------------------------------------------------------------------------------------------------------------------
Change in interest expense 43,738 9,051 1,706 54,495 2,265 (4,900) 162 (2,473)
- ------------------------------------------------------------------------------------------------------------------------------
Change in net interest income . $ 25,663 $ (5,169) $ (931) $ 19,563 $ 4,570 $ 25,106 $ 329 $ 30,005
==============================================================================================================================
PROVISION FOR LOAN LOSSES
Provision for loan losses was $8.6 million in 1997, as compared to $9.1
million in 1996 and $9.3 million in 1995. The provision for loan losses in 1997
exceeded net loan charge-offs by $2.0 million primarily reflecting growth in
single family residential and automobile loans.
For further information, see "Financial Condition - Problem Loans and Real
Estate - Allowance for Losses on Loans and Real Estate" on page 40.
OTHER INCOME
Other income totaled $35.2 million in 1997, compared to $25.2 million in
1996 and $20.6 million in 1995. The increase in 1997 reflected several factors.
Favorably impacting other income were increases of $6.0 million in income from
real estate held for investment, $4.0 million in the all other category, $3.5
million in loan and deposit related fees, and $1.1 million in net gains from the
sales of loans. Partially offsetting those increases was a $4.5 million decline
in net gains from sales of investment securities. Below is a discussion of the
major other income categories.
Loan and Deposit Related Fees
Loan and deposit related fees totaled $10.9 million in 1997, compared to
$7.4 million in 1996 and $5.5 million in 1995. As depicted in the following
table, the current year reflected an increase in both loan and deposit related
fees, the latter primarily the result of higher fees from automated teller
machines.
(In Thousands) 1997 1996 1995
- --------------------------------------------------------------------
Loan related fees .................... $ 3,837 $ 2,496 $ 1,508
Deposit related fees ................. 7,084 4,939 4,038
- --------------------------------------------------------------------
Total loan and deposit related fees $10,921 $ 7,435 $ 5,546
====================================================================
21
Real Estate and Joint Venture Operations Held for Investment
Income from real estate and joint venture operations totaled $14.2 million
in 1997, compared to $8.2 million in 1996 and $11.2 million in 1995. The table
below sets forth the key components comprising income from real estate and joint
venture operations.
(In Thousands) 1997 1996 1995
- -------------------------------------------------------------------------------------------
Operations, net:
Rental operations net of expenses ..................... $ 2,317 $ 2,417 $ 3,711
Equity in net income (loss) from joint ventures ....... 3,931 55 (1,676)
Interest from joint venture advances .................. 1,880 2,071 1,702
- -------------------------------------------------------------------------------------------
Total operations, net .............................. 8,128 4,543 3,737
Net gains on sales of wholly owned real estate ........... 2,904 392 4,539
Reduction of losses on real estate and joint ventures .... 3,190 3,306 2,916
- -------------------------------------------------------------------------------------------
Income from real estate and joint venture operations $ 14,222 $ 8,241 $ 11,192
===========================================================================================
Favorably impacting income from real estate and joint venture operations
was a $5.5 million gain from an all cash sale of four California shopping
centers from one joint venture partnership relationship. The gain appears in two
categories, $3.9 million in equity in net income (loss) from joint ventures and
$1.6 million in recovery of losses on real estate and joint ventures. In
addition, net gains on sales of wholly owned real estate increased $2.5 million
in 1997.
For additional information, see "Financial Condition - Investments in Real
Estate and Joint Ventures" on page 28, "Financial Condition - Problem Loans and
Real Estate - Allowance for Losses on Loans and Real Estate" on page 40, and
Note 8 of Notes to the Consolidated Financial Statements on page 64.
Secondary Marketing Activities
Sales of loans and mortgage-backed securities originated by Downey
increased in 1997 to $557.5 million from $161.9 million in 1996 and $80.7
million in 1995. Of the current year's increase, $290.5 million represented the
sale of single family adjustable rate mortgages from the loan portfolio held for
investment. Gains associated with loan sales totaled $2.7 million in 1997,
compared to $1.5 million in 1996 and $0.3 million in 1995. The net gains include
$1.2 million in 1997 and $1.0 million in 1996 related to the capitalization of
mortgage servicing rights.
Loan servicing fees from Downey's portfolio of loans serviced for others
totaled $1.3 million for 1997, down from $1.4 million in 1996 and $1.5 million
in 1995. At December 31, 1997, Downey serviced $612.5 million of loans for
others, compared to $576.0 million at December 31, 1996, and $527.2 million at
December 31, 1995.
Net Gains (Losses) on Sales of Investment Securities
No investment securities were sold in 1997 so there were no gains or
losses. This compares to $4.5 million of net gains from the sale of investment
securities available for sale in 1996 and a loss of $15,000 in 1995.
Provision for Loss on Investment in Lease Residual
Certain mainframe computer equipment Downey leased to others was sold in
1995 upon termination of the lease resulting in a provision reduction of $0.2
million. No such activity occurred in either 1997 or 1996.
Other Category
The all other category of other income totaled $6.1 million in 1997,
compared to $2.1 million in 1996 and $1.9 million in 1995. The increase
primarily reflects a gain from the sale of an asset obtained as part of the 1988
acquisition of Butterfield Savings.
22
OPERATING EXPENSES
Operating expenses totaled $101.3 million in 1997, down $12.9 million from
1996, which included a one-time SAIF assessment of $24.6 million. Excluding that
assessment, operating expense would have increased $11.7 million or 13.1%.
Higher general and administrative costs were primarily responsible for the
increase. General and administrative expense increased $13.1 million or 15.1%
and reflected branch expansion, particularly into in-store banking, higher
advertising expenditures and growth in auto lending. The $2.8 million increase
in advertising expenditures reflects, in large part, the cost of a television
advertising campaign to increase public awareness of the Bank, and specifically
the Bank's subprime residential lending product, a key component to Downey's
strategy of increasing the loan portfolio yield. Also included in general and
administrative costs in 1997 was $1.4 million of severance paid pursuant to an
agreement with the former chief executive officer. The increase in general and
administrative expense was partially offset by a $1.4 million decline to $1.2
million in costs associated with the net operation of real estate acquired in
settlement of loans. The decline primarily reflects a $1.3 million gain from the
sale of a shopping center acquired in settlement of a loan.
(In Thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------
Salaries and related costs .......................................... $ 54,366 $ 45,811 $ 39,349
Premises and equipment costs ........................................ 15,272 12,640 11,535
Advertising expense ................................................. 6,847 4,071 2,028
Professional fees ................................................... 5,113 2,985 3,150
SAIF insurance premiums and regulatory assessments .................. 3,439 8,949 9,024
Other general and administrative expense ............................ 14,519 12,004 9,384
- ------------------------------------------------------------------------------------------------------
Total general and administrative expense ......................... 99,556 86,460 74,470
SAIF Special Assessment ............................................. -- 24,644 --
Net operation of real estate acquired in settlement of loans ........ 1,184 2,567 4,206
Amortization of excess of cost over fair value of net assets acquired 532 532 530
- ------------------------------------------------------------------------------------------------------
Total operating expense .......................................... $101,272 $114,203 $ 79,206
======================================================================================================
For information regarding the potential expense impact of the Year 2000
computer issue, see "Financial Condition - Year 2000" on page 45.
PROVISION FOR INCOME TAXES
Downey's effective tax rate for 1997 was 43.1%, similar to 43.2% in 1996
and 42.5% in 1995. See Notes 1 and 18 of Notes to the Consolidated Financial
Statements on pages 53 and 74, respectively, for a further discussion of income
taxes and an explanation of the factors which impact Downey's effective tax
rate.
23
FINANCIAL CONDITION
LOANS AND MORTGAGE-BACKED SECURITIES
Loans and mortgage-backed securities, including those held for sale,
totaled $5.4 billion, or 92.0% of assets at December 31, 1997. This represents
an increase of $636.6 million or 13.5% from the $4.7 billion at December 31,
1996.
The table below presents information regarding interest rates and fees
collected on loans originated during the periods indicated.
(Dollars in Thousands) 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------
Average interest rate on new loans .............. 6.04% 6.06% 6.99% 4.94% 5.53%
Average total loan origination fees on new loans 0.80 0.79 1.08 0.85 0.63
Total loan fees (net of costs) and discounts (net
of premiums) deferred during the year ....... $ (11,505) $ (4,525) $ 880 $ (7,861) $ 1,572
===================================================================================================================
Downey originates one-to-four unit residential adjustable rate mortgages
("ARMs") both with and without loan origination fees. In ARM transactions for
which no origination fees are charged, Downey receives a larger margin over the
index to which the loan pricing is tied than in those in which fees are charged.
In addition, such loans are subject to a prepayment fee if prepaid within the
first three years. This trend towards loans with no origination fees has
generally resulted in deferrable loan origination costs exceeding loan
origination fees except in 1995 and 1993 which included increases in interest
buydowns, or discounts, on new real estate loans.
Residential one-to-four unit ARM originations (including loans purchased
through correspondent lending relationships) were $1.7 billion during 1997,
compared to $1.1 billion and $443.8 million in 1996 and 1995, respectively.
Refinancing activities (including new loans to refinance loans originated by
Downey and other lenders) increased during 1997, constituting 38% of
originations during the year compared to 35% and 31% during 1996 and 1995,
respectively. At December 31, 1997, one-to-four unit ARMs constituted 82.7% of
the total loan and mortgage-backed securities portfolio, compared to 81.9% at
December 31, 1996. As market interest rates began to rise in 1994 and 1995,
one-to-four unit residential borrower preference changed from being
predominantly interested in ARMs tied to the one-year constant maturity Treasury
("CMT") index, a market rate index, to ARMs tied to the Federal Home Loan Bank
("FHLB") Eleventh District Cost of Funds Index ("COFI"), an index which lags the
movement in market interest rates. For the year, 79% of one-to-four unit
originations for investment represented monthly adjusting COFI ARMs which
provide for negative amortization, 18% represented COFI ARMs which reprice every
six months but do not provide for negative amortization, with the balance
represented by a variety of other pricing terms. At December 31, 1997, $2.6
billion of one-to-four unit ARMs were subject to negative amortization of which
$27.6 million represented the amount of negative amortization added to the
unpaid loan balance. For further information, see "Business - Lending Activities
- - Residential Real Estate Lending" on page 3.
Originations of commercial real estate loans totaled $7.8 million in 1997,
compared to $1.5 million in 1996 and $10.6 million in 1995. Most of the
commercial real estate lending in these years was to facilitate the sale of real
estate investments by the Bank and DSL Service Company. Originations of loans
secured by multi-family properties (including loans purchased) totaled $5.9
million in 1997, compared to $19.7 million in 1996 and $0.5 million in 1995.
During 1997, Downey originated $80.0 million of construction loans,
principally for entry level and first time move-up residential tracts. This
compares to $71.7 million in 1996 and $28.9 million in 1995. Originations of
land development loans totaled $20.3 million in 1997, compared to $10.5 million
in 1996 and $12.9 million in 1995.
Originations of non-mortgage commercial loans increased to $14.3 million in
1997 from $11.8 million in 1996 as a result of Downey's expansion into
commercial banking. For the year, 95% of such originations represented secured
loans.
In 1995, Downey augmented its direct automobile lending program with the
commencement of an indirect lending program through preapproved automobile
dealers to finance consumer purchases of new and used automobiles. These loans
are fixed rate with maturities generally up to five years. Originations of
automobile loans totaled $259.0 million in 1997, compared to $201.0 million in
1996 and $62.2 million in 1995.
24
The following table sets forth the origination, purchase and sale activity
relating to loans and mortgage-backed securities.
(In Thousands) 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------------------------
Investment Portfolio:
Loans originated:
Loans secured by real estate:
Residential:
One-to-four units:
Adjustable ............................................ $ 1,384,442 $1,026,812 $ 396,111 $1,673,822 $ 787,342
Adjustable - subprime ................................. 218,399 33,030 -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Total adjustable ..................................... 1,602,841 1,059,842 396,111 1,673,822 787,342
Fixed ................................................. 22,265 33,073 13,888 7,411 7,162
Fixed - subprime ...................................... 2,786 545 -- -- --
Five or more units:
Adjustable ............................................ 4,600 17,409 128 18,385 8,500
Fixed ................................................. -- 2,253 419 953 404
- -----------------------------------------------------------------------------------------------------------------------------------
Total residential .................................... 1,632,492 1,113,122 410,546 1,700,571 803,408
Commercial real estate .................................... 7,830 1,548 10,629 18,900 51,190
Construction .............................................. 80,014 71,678 28,931 14,785 43,958
Land ...................................................... 20,295 10,468 12,906 -- --
Non-mortgage:
Commercial ................................................ 14,336 11,835 1,115 1,605 3,500
Consumer:
Automobile .............................................. 259,040 200,966 62,234 1,869 1,871
Other consumer .......................................... 25,988 14,226 17,633 39,945 38,823
- -----------------------------------------------------------------------------------------------------------------------------------
Total loans originated ................................ 2,039,995 1,423,843 543,994 1,777,675 942,750
Real estate loans purchased (1) ............................... 35,828 223 44,194 145,117 612
- -----------------------------------------------------------------------------------------------------------------------------------
Total loans originated and purchased ....................... 2,075,823 1,424,066 588,188 1,922,792 943,362
Loan repayments ............................................... (1,130,357) (832,713) (538,217) (631,836) (759,881)
Other net changes (2), (3) .................................... (319,183) (39,978) (50,544) (38,330) (41,977)
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for investment ....... 626,283 551,375 (573) 1,252,626 141,504
Mortgage-backed securities held to maturity, net:
Purchased .................................................. -- -- -- -- 19,013
Repayments ................................................. -- -- (5,588) (11,917) (17,292)
Transferred to mortgage-backed securities available for sale -- -- (33,555) -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in mortgage-backed securities, net -- -- (39,143) (11,917) 1,721
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans and mortgage-backed
securities held for investment ....................... 626,283 551,375 (39,716) 1,240,709 143,225
- -----------------------------------------------------------------------------------------------------------------------------------
Sale Portfolio:
Residential, one-to-four units:
Originated whole loans ..................................... 289,271 159,941 93,496 32,421 161,502
Loans transferred (to) from the investment portfolio (3) ... 290,558 1,791 (100) -- 82
Originated whole loans sold (3) ............................ (467,989) (135,426) (80,725) (45,770) (152,156)
Loans exchanged for mortgage-backed securities ............. (89,522) (26,452) -- -- (990)
Other net changes .......................................... (83) (48) (10) (16) (62)
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in loans held for sale ............ 22,235 (194) 12,661 (13,365) 8,376
- -----------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities, net:
Received in exchange for loans ............................. 89,522 26,452 -- -- 990
Purchased .................................................. -- 30,073 -- 51,138 --
Transferred from mortgage-backed securities held to maturity -- -- 33,555 -- --
Sold ....................................................... (89,522) (31,077) (21,372) -- (990)
Repayments ................................................. (12,560) (15,661) (6,862) (5,263) --
Other net changes .......................................... 592 (596) 2,669 (1,789) --
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in mortgage-backed securities ..... (11,968) 9,191 7,990 44,086 --
available for sale
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase in loans and mortgage-backed securities held
for sale and available for sale ........................ 10,267 8,997 20,651 30,721 8,376
- -----------------------------------------------------------------------------------------------------------------------------------
Total net increase (decrease) in loans and mortgage-backed
securities ............................................. $ 636,500 $ 560,372 $(19,065) $1,271,430 $ 151,601
===================================================================================================================================
(1) Primarily one-to-four unit residential loans. Included in 1997 were $1.3
million of five or more unit residential loans.
(2) Primarily includes borrowings against and repayments of lines of credit and
construction loans, changes in loss allowances, loans transferred to real
estate acquired in settlement of loans or to the held for sale portfolio,
and interest capitalized on loans (negative amortization).
(3) Includes $290.5 million of one-to-four unit residential ARMs transferred
from the held for investment portfolio during 1997 and sold servicing
released.
25
The following table sets forth the composition of Downey's loan and
mortgage-backed securities portfolio at the dates indicated. At December 31,
1997, approximately 99.7% of Downey's real estate loans were secured by real
estate located in California (principally in Los Angeles, Orange, Santa Clara,
San Diego and San Mateo counties).
December 31,
-----------------------------------------------------------------------
(In Thousands) 1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------------------
Investment Portfolio:
Loans secured by real estate:
Residential:
One-to-four units:
Adjustable ................................. $ 4,190,160 $ 3,840,862 $ 3,486,774 $ 3,493,435 $ 2,127,312
Adjustable - subprime ...................... 245,749 32,715 -- -- --
Fixed ...................................... 168,315 172,328 169,738 194,845 249,274
Fixed - subprime ........................... 3,321 543 -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total one-to-four units .................. 4,607,545 4,046,448 3,656,512 3,688,280 2,376,586
Five or more units:
Adjustable ................................. 29,246 43,050 44,438 48,782 37,819
Fixed ...................................... 9,032 13,857 12,883 15,000 35,686
Commercial real estate:
Adjustable .................................... 87,604 158,656 170,498 178,377 201,406
Fixed ......................................... 114,821 101,953 100,085 116,041 139,621
Construction ..................................... 70,865 66,651 28,593 11,367 37,180
Land ............................................. 25,687 21,177 21,867 9,822 11,826
Non-mortgage:
Commercial ....................................... 26,024 22,136 12,864 12,975 8,229
Consumer:
Automobile .................................... 342,326 202,186 56,127 3,028 3,274
Other consumer ................................ 47,735 47,281 50,945 53,241 48,580
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans held for investment ............ 5,360,885 4,723,395 4,154,812 4,136,913 2,900,207
Increase (decrease) for:
Undisbursed loan funds ........................... (64,884) (49,250) (29,942) (13,872) (18,019)
Deferral of fees and discounts, net of costs ..... 18,088 11,663 7,412 7,468 (3,067)
Allowance for estimated loss ..................... (32,092) (30,094) (27,943) (25,597) (26,835)
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans held for investment, net ....... 5,281,997 4,655,714 4,104,339 4,104,912 2,852,286
- ----------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities held to maturity, net:
Adjustable ....................................... -- -- -- 19,897 25,352
Fixed ............................................ -- -- -- 19,246 25,708
- ----------------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed securities held
to maturity, net ........................... -- -- -- 39,143 51,060
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities held
for investment ............................. 5,281,997 4,655,714 4,104,339 4,144,055 2,903,346
- ----------------------------------------------------------------------------------------------------------------------------------
Sale Portfolio, Net:
Loans held for sale (all one-to-four units):
Adjustable ....................................... 1,617 1,145 238 -- --
Fixed ............................................ 33,483 11,720 12,821 398 13,763
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans held for sale ..................... 35,100 12,865 13,059 398 13,763
Mortgage-backed securities available for sale:
Adjustable ....................................... 17,751 23,620 34,355 44,086 --
Fixed ............................................ 31,548 37,647 17,721 -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed securities available .... 49,299 61,267 52,076 44,086 --
for sale
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities held
for sale and available for sale ........... 84,399 74,132 65,135 44,484 13,763
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities .... $ 5,366,396 $ 4,729,846 $ 4,169,474 $ 4,188,539 $ 2,917,109
==================================================================================================================================
26
The table below sets forth the scheduled contractual maturities of Downey's
total loan and mortgage-backed securities portfolio as of December 31, 1997.
Within 1-2 2-3 3-5 5-10 10-15 Beyond
(In Thousands) 1 year years years years years years 15 years Total
- ------------------------------------------------------------------------------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units:
Adjustable (1) ..... $ 37,778 $ 40,730 $ 43,914 $ 98,395 $ 321,710 $ 468,703 $3,426,296 $4,437,526
Fixed (1) .......... 3,216 3,503 3,815 8,680 29,446 45,130 111,329 205,119
Five or more units:
Adjustable ......... 383 414 447 1,004 3,300 4,846 18,852 29,246
Fixed .............. 351 383 419 959 3,292 3,628 -- 9,032
Commercial real estate
Adjustable ......... 1,898 2,053 2,221 4,999 16,528 24,453 35,452 87,604
Fixed .............. 18,111 19,718 21,467 48,818 6,707 -- -- 114,821
Construction - ....... 70,865 -- -- -- -- -- -- 70,865
adjustable
Land:
Adjustable ......... 20,704 3,655 -- -- -- -- -- 24,359
Fixed .............. 55 61 67 155 551 439 -- 1,328
Non-mortgage:
Commercial .............. 23,041 1,247 1,372 364 -- -- -- 26,024
Consumer:
Automobile ........... 71,751 80,276 89,814 100,485 -- -- -- 342,326
Other consumer (2) ... 1,742 1,919 2,115 752 41,207 -- -- 47,735
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans ....... 249,895 153,959 165,651 264,611 422,741 547,199 3,591,929 5,395,985
Mortgage-backed securities,
net ..................... 934 1,004 20,454 1,796 5,912 7,750 11,449 49,299
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans and
mortgage-backed
securities ........ $ 250,829 $ 154,963 $ 186,105 $ 266,407 $ 428,653 $ 554,949 $3,603,378 $5,445,284
====================================================================================================================================
(1) Includes loans held for sale.
(2) Includes home equity line of credit loans which are interest only, with
balances due at the end of the term. All or part of the outstanding
balances may be paid off at any time during the term without penalty.
At December 31, 1997, the maximum amount the Bank could have loaned to any
one borrower (and related entities) under regulatory limits was $67.3 million,
or $112.2 million for loans secured by readily marketable collateral, compared
to $61.4 million and $102.4 million, respectively, at December 31, 1996. The
Bank does not expect that these regulatory limitations will adversely impact its
proposed lending activities during 1998.
INVESTMENT SECURITIES
The following table sets forth the composition of Downey's investment
securities portfolio at the dates indicated. In the 1995 fourth quarter, the
held to maturity U.S. Treasury and agency portfolio was transferred to available
for sale consistent with the "Guide to Statement 115 on Accounting for Certain
Investments in Debt and Equity Securities" issued by the Financial Accounting
Standards Board.
December 31,
----------------------------------------------------
(In Thousands) 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------
Federal funds ...................... $ 6,095 $ 6,038 $ 7,249 $ 6,112 $ 38,547
U.S. Treasury and agency securities:
Held to maturity ................ -- -- -- 155,109 105,265
Available for sale .............. 159,398 141,999 164,880 -- --
Municipal bonds - held to maturity . 6,885 6,997 7,194 -- --
- -------------------------------------------------------------------------------------------
Total ........................... $172,378 $155,034 $179,323 $161,221 $143,812
===========================================================================================
27
As of December 31, 1997, the maturities of Downey's investment securities
and the weighted average yield of those securities were as follows.
After 1 Year
1 Year or Less Through 5 Years After 5 Years Total
-----------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
(Dollars in Thousands) Amount Yield Amount Yield Amount Yield Amount Yield
- ---------------------------------------------------------------------------------------------------------------------------
Federal funds ....................... $ 6,095 3.51% $ -- -- % $ -- -- % $ 6,095 3.51%
U.S. Treasury and agency securities 9,999 5.85 149,399 5.73 -- -- 159,398 5.74
Municipal bonds (1) ............... -- -- -- -- 6,885 4.92 6,885 4.92
- -------------------------------------------------------------------------------------------------------------------------
Total ........................ $ 16,094 4.96% $ 149,399 5.73% $ 6,885 4.92% $ 172,378 5.63%
=========================================================================================================================
(1) Yield on a fully tax-equivalent basis is 8.64%.
INVESTMENTS IN REAL ESTATE AND JOINT VENTURES
DSL Service Company participates as an owner of, or a partner in, a variety
of real estate development projects, principally retail neighborhood shopping
center developments, most of which are located in California. In addition,
Downey Financial Corp. owns one investment in land which it purchased from DSL
Service Company at fair value in 1995. For additional information regarding the
location of these real estate investments see Note 8 of Notes to the
Consolidated Financial Statements on page 64. Most of the real estate
development projects have been completed and are substantially leased (with a
weighted average occupancy of 87% for retail neighborhood shopping centers at
December 31, 1997). At December 31, 1997, the Bank had outstanding loans of
$53.0 million to such joint ventures.
In its joint ventures, DSL Service Company is entitled to interest on its
equity invested in the project on a priority basis after third-party debt, and
shares profits and losses with the developer partner, generally on an equal
basis. DSL Service Company has obtained personal guarantees from the principals
of the developer partners in a number of the joint ventures and generally
requires the developer partner to secure any outstanding obligations to the
joint venture, such as its portion of operating losses, when the partner is
unable to satisfy such obligations on a current basis. Partnership equity
(deficit) accounts are affected by current period results of operations,
additional partner advances, partnership distributions and partnership
liquidations.
As of December 31, 1997, DSL Service Company was involved with five joint
venture partners. Four of these partners were operators of eight retail
neighborhood shopping centers, a commercial building, a residential housing
development and vacant land held for sale. The fifth partner is involved in the
rehabilitation of an apartment complex. DSL Service Company has ten wholly owned
retail neighborhood shopping centers located in California and Arizona.
The following table sets forth the condensed balance sheets of DSL Service
Company's joint ventures by property type at December 31, 1997, on a historical
cost basis. Included in the following condensed balance sheet are allowances for
losses recorded by DSL Service Company. These allowances are determined
quarterly by means of Downey's internal asset review process. See "Problem Loans
and Real Estate - Allowance for Losses on Loans and Real Estate" on page 40. To
the extent the fair market value of the real estate assets is less than the
carrying value, then a provision is made to create a valuation allowance for the
difference. If such a valuation allowance is needed, it is reflected in the
investment accounts for the joint ventures on DSL Service Company's books. Not
all of the joint venture investments have valuation allowances as the fair
market value of the associated property exceeds its carrying value.
28
Retail
Neighborhood
(Dollars In Thousands) Shopping Centers Commercial Residential Total
- ----------------------------------------------------------------------------------------------------------------
Cash ................................................... $ 382 $ 118 $ 1,203 $ 1,703
Projects under development ............................. -- 964 -- 964
Completed projects ..................................... 53,292 5,020 5,826 64,138
Other assets ........................................... 4,196 728 133 5,057
- ----------------------------------------------------------------------------------------------------------------
Total assets .................................... $ 57,870 $ 6,830 $ 7,162 $ 71,862
- ----------------------------------------------------------------------------------------------------------------
Secured notes payable to the Bank ...................... $ 46,546 $ 1,081 $ 5,365 $ 52,992
Secured notes payable to others ........................ 9,768 3,974 116 13,858
Other liabilities ...................................... 8,120 1,820 -- 9,940
Equity (deficit):
DSL Service Company (1) ............................ 5,299 38 1,747 7,084
Allowance for losses recorded by DSL Service Company 101 1,526 -- 1,627
Other partners' (2) ................................ (11,964) (1,609) (66) (13,639)
- ----------------------------------------------------------------------------------------------------------------
Total liabilities and equity .................... $ 57,870 $ 6,830 $ 7,162 $ 71,862
================================================================================================================
Number of joint venture projects ....................... 8 2 2 12
================================================================================================================
(1) Included in these amounts are interest-bearing joint venture advances with
priority interest payments from joint ventures to DSL Service Company.
(2) The aggregate other partners' deficit of $13.6 million represents their
equity interest in the accumulated retained earnings (deficit) of the
respective joint ventures. Those results include not only the net profit on
sales and the operating results of the real estate assets, but depreciation
expense and funding costs as well. Except for any secured financing which
has been obtained, DSL Service Company has provided all other financing. As
part of Downey's internal asset review process, the fair value of the joint
venture real estate assets is compared to the secured notes payable to the
Bank and others and DSL Service Company's equity investment. To the extent
the fair value of the real estate assets is less than the aggregate of
those amounts, a provision is made to create a valuation allowance. Those
allowances totaled $1.6 million at December 31, 1997. At December 31, 1997,
the fair value of the real estate assets of certain joint venture
partnerships in which the other partners' equity was a deficit exceeded the
amount of third party notes and DSL Service Company's investment thereby
eliminating the need for a valuation allowance since the sale of the real
estate would allow DSL Service Company to realize its investment. Thus, the
other partners' deficit of $13.6 million exceeds the amount of valuation
allowances established of $1.6 million.
The following table sets forth by property type Downey's wholly owned
investments in real estate and related allowances for losses at December 31,
1997.
Retail
Single Family Neighborhood
(Dollars in Thousands) Developments (1) Shopping Centers Land Total
- ----------------------------------------------------------------------------------------------------
Wholly Owned Properties:
Investment in wholly owned projects ... $ 12,164 $ 31,370 (2) $10,355 (3) $ 53,889
Allowance for losses .................. (11,767) (2,021) (5,829) (19,617)
- ----------------------------------------------------------------------------------------------------
Net investment in wholly owned projects $ 397 $ 29,349 $ 4,526 $ 34,272
====================================================================================================
Number of projects .................... 3 10 10 23
====================================================================================================
(1) These developments are joint ventures for legal purposes. However, for
financial reporting purposes, they are reported as wholly owned, as DSL
Service Company assumed operating control effective in 1993.
(2) Includes ten free-standing stores that are part of neighborhood shopping
centers totaling $1.9 million and are counted as one project.
(3) Includes three properties totaling $8.4 million.
Real estate investments entail risks similar to those presented by Downey's
construction and commercial lending activities. In addition, California courts
have imposed warranty-like responsibility upon developers of new housing for
29
defects in structure and the housing site, including soil conditions. This
responsibility is not necessarily dependent upon a finding that the developer
was negligent. Owners of real property also may incur liabilities with respect
to environmental matters, including financial responsibility for clean-up of
hazardous waste or other conditions, under various federal and state laws.
DEPOSITS
Deposits increased $696.9 million or 16.7% in 1997, and totaled $4.9
billion at December 31, 1997. Transaction accounts (i.e., checking, regular
passbook and money market) increased $104.3 million or 12.5%, while certificates
of deposits increased $592.6 million or 17.7%. Of the total increase in
deposits, $102.6 million was associated with 13 new branches opened during 1997.
The following table sets forth the amount of deposits by classification.
December 31,
--------------------------------------------------------------------
1997 1996 1995
--------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
(Dollars in Thousands) Rate Amount Rate Amount Rate Amount
- ----------------------------------------------------------------------------------------------------------
Transaction accounts ............. 2.15% $ 935,869 2.04% $ 831,598 1.87% $ 804,891
Certificates of deposit:
Less than 3.00% ............... 2.64 30,623 2.65 39,061 2.82 57,786
3.00-3.49 ..................... 3.02 766 3.03 723 3.21 1,392
3.50-3.99 ..................... -- -- 3.99 79 3.75 7,781
4.00-4.49 ..................... 4.31 60,095 4.39 63,577 4.18 99,758
4.50-4.99 ..................... 4.87 40,356 4.87 186,576 4.88 262,065
5.00-5.99 ..................... 5.63 2,896,291 5.54 2,489,852 5.52 1,863,474
6.00-6.99 ..................... 6.06 901,920 6.17 536,307 6.46 596,803
7.00 and greater .............. 7.22 4,058 7.15 25,329 7.29 96,271
- ----------------------------------------------------------------------------------------------------------
Total certificates of deposit 5.68 3,934,109 5.56 3,341,504 5.61 2,985,330
- ----------------------------------------------------------------------------------------------------------
Total deposits .............. 5.00% $4,869,978 4.86% $4,173,102 4.81% $3,790,221
==========================================================================================================
The following table shows as of December 31, 1997, certificates of deposit
maturities by interest rate category.
Less
Than 4.00% - 4.50 % - 5.00% - 6.00% - 7.00 % Percent
(Dollars in Thousands) 4.00% 4.49% 4.99% 5.99% 6.99% and greater Total of Total
- ------------------------------------------------------------------------------------------------------------------------
Within 3 months..... $ 30,125 $ 55,264 $ 29,771 $ 885,301 $ 47,856 $ 721 $1,049,038 26.67%
3 to 6 months ...... 479 4,418 2,721 640,938 193,965 445 842,966 21.43
6 to 12 months ..... 465 284 4,628 1,076,647 524,374 578 1,606,976 40.84
12 to 24 months .... 313 129 3,169 254,828 114,084 988 373,511 9.49
24 to 36 months .... -- -- 24 19,158 8,276 1,326 28,784 0.73
36 to 60 months .... 7 -- 43 19,250 13,230 -- 32,530 0.83
Over 60 months ..... -- -- -- 169 135 -- 304 0.01
- -----------------------------------------------------------------------------------------------------------------------
$ 31,389 $ 60,095 $ 40,356 $2,896,291 $ 901,920 $ 4,058 $3,934,109 (1) 100.00%
=======================================================================================================================
(1) Includes jumb$ 100,000) certificates of deposit of $281.6 million with
maturities of 3 months or less, $235.0 million and $466.8 million of 3 to 6
month and 6 to 12 month maturities, respectively, and $119.2 million with a
remaining term of over 12 months.
30
BORROWINGS
At December 31, 1997, borrowings totaled $483.7 million, compared to $595.3
million at December 31, 1996 and $436.2 million at December 31, 1995. The
decline in 1997 occurred as deposit growth exceeded asset growth. The following
table sets forth information concerning Downey's FHLB advances and other
borrowings at the dates indicated.
December 31,
----------------------------------------------------
(Dollars in Thousands) 1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------
FHLB advances ................... $352,458 $386,883 $220,715 $411,800 $ 1,800
Other borrowings:
Reverse repurchase agreements 34,803 -- 16,099 53,946 --
Commercial paper ............ 83,811 198,113 196,602 197,839 --
Industrial revenue bonds .... -- -- -- 6,421 6,496
Real estate notes ........... 12,663 10,349 2,802 4,770 5,422
- ----------------------------------------------------------------------------------------
Total borrowings ............ $483,735 $595,345 $436,218 $674,776 $ 13,718
========================================================================================
Weighted average rate on
borrowings during the period 6.07% 5.98% 6.39% 5.57% 6.53%
Total borrowings as a percentage
of total assets 8.29 11.45 9.37 14.51 0.40
========================================================================================
The following table sets forth certain information with respect to Downey's
short-term borrowings.
(Dollars in Thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------
FHLB advances with original maturities less than one year:
Balance at end of year ........................................ $214,300 $279,000 $153,400
Average balance outstanding during the year ................... 328,886 174,380 268,043
Maximum amount outstanding at any month-end during the year ... 427,100 279,000 472,000
Weighted average interest rate at the end of year ............. 5.81% 5.70% 6.07%
Weighted average interest rate during the year ................ 5.83 5.78 6.32
Securities sold under agreement to repurchase:
Balance at end of year ........................................ $ 34,803 $ - $ 16,099
Average balance outstanding during the year ................... 4,029 11,761 36,676
Maximum amount outstanding at any month-end during the year ... 34,803 70,015 52,547
Weighted average interest rate at the end of year ............. 6.65% -% 5.90%
Weighted average interest rate during the year ................ 5.61 5.19 6.21
Commercial paper sold:
Balance at end of year ........................................ $ 83,811 $198,113 $196,602
Average balance outstanding during the year ................... 182,296 174,739 191,313
Maximum amount outstanding at any month-end during the year ... 272,818 198,113 198,341
Weighted average interest rate at the end of year ............. 5.61% 5.45% 5.56%
Weighted average interest rate during the year ................ 5.75 5.74 6.38
Total short-term borrowings:
Total average short-term borrowings outstanding during the year $515,211 $360,880 $496,032
Total weighted average rate on borrowings during the year ..... 5.80% 5.74% 6.34%
======================================================================================================
ASSET/LIABILITY MANAGEMENT AND MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
interest rates. Downey's market risk arises primarily from interest rate risk in
its lending and deposit taking activities. This interest rate risk occurs to the
degree that interest-bearing liabilities reprice or mature more rapidly or on a
different basis than interest-earning assets.
31
Since Downey's earnings depend primarily on its net interest income, which
is the difference between the interest and dividends earned on interest-earning
assets and the interest paid on interest-bearing liabilities, a principal
objective of Downey is to actively monitor and manage the effects of adverse
changes in interest rates on net interest income while maintaining asset
quality.
Downey's Asset/Liability Management Committee ("ALCO") is responsible for
implementing the interest rate risk management policy which sets forth limits
established by the Board of Directors on acceptable changes in net interest
income and net portfolio value ("NPV") from specified changes in interest rates.
NPV is defined by the OTS as the present value of expected net cash flows from
existing assets minus the present value of expected net cash flows from existing
liabilities plus the present value of expected cash flows from existing
off-balance sheet contracts. ALCO reviews, among other items, economic
conditions, the interest rate outlook, the demand for loans, the availability of
deposits and borrowings, and Downey's current operating results, liquidity,
capital and interest rate exposure. In addition, ALCO monitors asset and
liability maturities and repricing characteristics on a regular basis and
performs various simulations and other analyzes to determine the potential
impact of various business strategies in controlling interest rate risk and the
potential impact of those strategies upon future earnings under various interest
rate scenarios. Based on such reviews, ALCO formulates a strategy that is
intended to implement the objectives set forth in Downey's business plan without
exceeding the net interest income and NPV limits set forth in the interest rate
risk policy.
One measure of Downey's exposure to differential changes in interest rates
between assets and liabilities is shown in the following table which sets forth
the repricing frequency of Downey's major asset and liability categories as of
December 31, 1997, as well as certain information regarding the difference
between interest-earning assets and interest-bearing liabilities in future
periods. The repricing frequencies have been determined by reference to
projected maturities, based upon contractual maturities as adjusted for
scheduled repayments and "repricing mechanisms" (provisions for changes in the
interest and dividend rates of assets and liabilities). Prepayment rates are
assumed, in each period, on substantially all of Downey's loan portfolio based
upon its historical loan prepayment experience and anticipated future
prepayments. Repricing mechanisms on certain of Downey's assets are subject to
limitations, such as caps on the amount that interest rates and payments on
Downey's loans may adjust, and accordingly, such assets do not normally respond
as completely or rapidly as Downey's liabilities to changes in market interest
rates. The interest rate sensitivity of Downey's assets and liabilities
illustrated in the following table would vary substantially if different
assumptions were used or if actual experience differed from the assumptions set
forth.
32
December 31, 1997
-----------------------------------------------------------------------------
Within 7 - 12 1 - 5 5 - 10 Over Total
(Dollars in Thousands) 6 Months Months Years Years 10 Years Balance
- -------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Investment securities and FHLB stock ..... (1) $ 67,064 $ -- $ 149,399 $ -- $ -- $ 216,463
Loans and mortgage-backed securities:
Mortgage-backed securities ............. (2) 22,420 4,438 17,770 3,216 1,455 49,299
Loans secured by real estate:
Residential:
Adjustable ......................... (2) 4,340,466 114,246 10,430 -- -- 4,465,142
Fixed .............................. (2) 58,563 19,184 83,456 33,594 19,267 214,064
Commercial real estate ............... (2) 96,340 9,505 77,692 13,761 1,593 198,891
Construction ......................... (2) 27,835 -- -- -- -- 27,835
Land ................................. (2) 10,201 41 352 536 359 11,489
Non-mortgage:
Commercial ........................... (2) 17,343 -- -- -- -- 17,343
Consumer ............................. (2) 114,309 60,335 207,689 -- -- 382,333
- -------------------------------------------------------------------------------------------------------------------------------
Total loans and mortgage-backed securities 4,687,477 207,749 397,389 51,107 22,674 5,366,396
- -------------------------------------------------------------------------------------------------------------------------------
Total .................................. $4,754,541 $ 207,749 $ 546,788 $ 51,107 $ 22,674 $5,582,859
===============================================================================================================================
Deposits and borrowings:
Interest bearing deposits:
Fixed maturity deposits ................ (1) $1,990,621 $ 1,553,704 $ 389,784 $ -- $ -- $3,934,109
Transaction accounts ................... (3) 829,317 -- -- -- -- 829,317
Non-interest bearing transaction
accounts ............................... 106,552 -- -- -- -- 106,552
- -------------------------------------------------------------------------------------------------------------------------------
Total deposits ......................... 2,926,490 1,553,704 389,784 -- -- 4,869,978
- -------------------------------------------------------------------------------------------------------------------------------
Borrowings ............................... 379,379 24,029 77,527 2,800 -- 483,735
- -------------------------------------------------------------------------------------------------------------------------------
Total deposits and borrowings .......... $3,305,869 $ 1,577,733 $ 467,311 $ 2,800 $ -- $5,353,713
===============================================================================================================================
Excess (shortfall) of interest-earning
assets over interest-bearing liabilities . $1,448,672 $(1,369,984) $ 79,477 $ 48,307 $ 22,674 $ 229,146
Cumulative gap .............................. 1,448,672 78,688 158,165 206,472 229,146
Cumulative gap - as a % of total assets:
December 31, 1997 ........................ 24.82% 1.35% 2.71% 3.54% 3.93%
December 31, 1996 ........................ 16.71 2.68 0.50 1.47 3.04
December 31, 1995 ........................ 13.64 4.96 2.58 3.16 3.47
===============================================================================================================================
(1) Based upon contractual maturity and repricing date.
(2) Based upon contractual maturity, repricing date and projected repayment and
prepayments of principal.
(3) Based upon contractual maturity or repricing date.
Downey's six-month gap at December 31, 1997, was a positive 24.82% (i.e.,
more interest earning assets reprice within six months than interest-bearing
liabilities). This compares to a positive six-month gap of 16.71% and 13.64% at
December 31, 1996 and 1995, respectively. Downey's primary strategy to manage
interest rate risk is to emphasize the origination of ARMs or loans with
relatively short maturities. Interest rates on ARMs are primarily tied to the
CMT or COFI. During 1997, 1996 and 1995, Downey originated and purchased
approximately $2.0 billion, $1.4 billion and $0.6 billion, respectively, of
loans and mortgage-backed securities with adjustable interest rates or
maturities of five years or less, representing approximately 96%, 95% and 96%,
respectively, of all loans and mortgage-backed securities originated and
purchased for investment during such periods. ARM originations during those
three years were primarily tied to COFI rather than the CMT index.
At December 31, 1997, 99% of Downey's interest-earning assets mature,
reprice or are estimated to prepay within five years, compared to 97% and 99% at
December 31, 1996 and 1995, respectively. At December 31, 1997, loans with
adjustable interest rates represented 87% of Downey's loan and mortgage-backed
securities portfolio. During 1998, Downey will continue to offer residential
fixed rate loan products to its customers to meet customer demand. Fixed rate
loans are
33
primarily originated for sale in the secondary market and are priced accordingly
in order to create loan servicing income and to increase opportunities for
originating ARMs. However, Downey occasionally originates for its own portfolio
fixed rate loans to facilitate the sale of real estate acquired through
foreclosure or that meet certain yield and other approved guidelines. See
"Business - Lending Activities - Secondary Marketing and Loan Servicing
Activities" on page 4.
Downey is better protected against rising interest rates with a positive
six-month GAP. However, Downey remains subject to possible interest rate spread
compression, which would adversely impact Downey's net interest income if
interest rates rise. This is primarily due to the lag in the repricing of the
indices to which Downey's adjustable-rate loans and mortgage-backed securities
are tied, as well as the repricing frequencies and periodic interest rate caps
on such adjustable-rate loans and mortgage-backed securities. The amount of such
interest rate spread compression would depend upon the frequency and severity of
such interest rate fluctuations. The positive six-month GAP could decrease in
future periods due to, among other things, the continued expansion of the auto
and consumer loan portfolios.
In addition to measuring interest rate risk via a GAP analysis, Downey
establishes limits on, and measures the sensitivity of, its net interest income
and NPV to changes in interest rates. Changes in interest rates are defined as
instantaneous and sustained movements in interest rates in 100 basis point
increments. Downey utilizes an internally maintained asset / liability
management simulation model to make the calculations which, for NPV, is
calculated on a discounted cash flow basis. First, Downey estimates its net
interest income for the next twelve months and the current NPV assuming no
change in interest rates from those at period end. Once the base case has been
estimated, calculations are made for each of the defined changes in interest
rates, to include any associated differences in the anticipated prepayment speed
of loans. Those results are then compared against the base case to determine the
estimated change to net interest income and NPV due to the changes in interest
rates. Following are the estimated impacts to net interest income and NPV from
various instantaneous, parallel shifts in interest rates based upon Downey's
asset and liability structure as of December 31, 1997. Since these estimates are
based upon numerous assumptions, such as the expected maturities of Downey's
interest-bearing assets and liabilities and the shape of the period-end interest
rate yield curve, Downey's actual sensitivity to interest rate changes could
vary significantly if actual experience differs from those assumptions used in
making the calculations.
Percentage Change In
Change in Interest Rates Net Interest Net Portfolio
(In Basis Points) Income (1) Value (2)
------------------------ --------------- -----------------
+200 (13.6)% (9.3)%
+100 (5.7) (3.4)
(100) 5.5 3.2
(200) 12.0 9.1
(1) The percentage change in this column represents net interest income for 12
months in a stable interest rate environment versus the net interest income
in the various rate scenarios.
(2) The percentage change in this column represents the NPV of the Bank in a
stable interest rate environment versus the NPV in the various rate
scenarios.
34
The following table shows Downey's financial instruments that are sensitive
to changes in interest rates, categorized by expected maturity, and the
instruments' fair values at December 31, 1997. This data differs from that in
the GAP table as it does not incorporate the repricing characteristics of assets
and liabilities. Rather, it only reflects contractural maturities adjusted for
anticipated prepayments. Market risk sensitive instruments are generally defined
as on and off balance sheet derivatives and other financial instruments.
Expected Maturity Date at December 31, 1997 (1)
--------------------------------------------------------------------------------------------------
Total Fair
(Dollars in Thousands) 1998 1999 2000 2001 2002 Thereafter Balance Value
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-sensitive assets:
Investment securities ......... $ 60,179 $ -- $ 75,083 $ 49,250 $ 25,066 $ 6,885 $ 216,463 $ 216,443
Average interest rate . 6.04% -% 5.68% 5.46% 6.42% 4.92% 5.79%
Loans held for sale ........... 35,100 -- -- -- -- -- 35,100 35,395
Average interest rate . 7.58% -% -% -% -% -% 7.58%
Mortgage-backed securities
held for sale ............... 11,156 9,923 8,953 2,511 2,220 14,536 49,299 49,348
Average interest rate . 6.58% 6.55% 6.53% 7.66% 7.65% 7.52% 6.95%
Loans held for investment:
Loans secured by real estate:
Residential:
Adjustable .............. 1,151,927 866,065 632,803 463,340 340,539 1,008,851 4,463,525 4,501,037
Average interest rate . 7.61% 7.64% 7.63% 7.62% 7.71% 7.54% 7.61%
Fixed ................... 41,433 30,790 22,566 17,045 13,056 55,691 180,581 185,348
Average interest rate . 9.23% 9.16% 9.09% 9.01% 8.91% 7.95% 8.76%
Other ..................... 71,222 26,383 23,710 24,696 19,346 72,858 238,215 237,429
Average interest rate . 9.17% 8.95% 8.78% 8.80% 8.92% 7.84% 8.64%
Non-mortgage:
Commercial ................ 14,759 1,075 1,197 312 -- -- 17,343 17,343
Average interest rate . 9.37% 9.37% 9.37% 9.37% -% -% 9.37%
Consumer .................. 124,387 110,891 99,825 47,230 -- -- 382,333 386,070
Average interest rate . 11.28% 11.28% 11.28% 10.01% -% -% 11.12%
Interest bearing advances to
joint ventures .............. 32,122 -- -- -- -- -- 32,122 32,122
Average interest rate . 5.76% -% -% - % -% -% 5.76%
Mortgage servicing assets ..... 440 389 334 283 238 271 1,955 7,584
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-sensitive assets $1,542,725 $1,045,516 $ 864,471 $ 604,667 $ 400,465 $1,159,092 $5,616,936 $5,668,119
====================================================================================================================================
Interest-sensitive liabilities:
Deposits:
Transaction accounts ........ $ 170,935 $ 139,714 $ 114,194 $ 93,338 $ 76,290 $ 341,398 $ 935,869 $ 935,869
Average interest rate . 2.15% 2.15% 2.15% 2.15% 2.15% 2.15% 2.15%
Certificates of deposit ..... 3,544,325 330,498 27,251 18,612 13,423 -- 3,934,109 3,947,913
Average interest rate . 5.66% 5.85% 5.89% 5.71% 6.01% -% 5.68%
Borrowings .................... 403,408 36,488 24,220 12,951 3,868 2,800 483,735 485,558
Average interest rate . 6.10% 6.25% 6.25% 6.27% 6.15% 6.00% 6.12%
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-sensitive
liabilities ................. $4,118,668 $ 506,700 $ 165,665 $ 124,901 $ 93,581 $ 344,198 $5,353,713 $5,369,340
====================================================================================================================================
(1) Expected maturities are contractual maturities adjusted for prepayments of
principal. Downey 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 reflected herein is based on Downey's historical
experience. Downey's average constant prepayment rate ("CPR") is 16.4% and
21.7% on its fixed-rate and ARM portfolios, respectively, for
interest-earning assets (excluding investment securities, which do not have
prepayment features). For deposit liabilities, in accordance with standard
industry practice and Downey's own historical experience, "decay factors",
used to estimate deposit runoff, of 20% (CPR) per year have been applied.
The actual maturities of these instruments could vary substantially if
future prepayments differ from the Downey's historical experience.
35
The following table sets forth the interest rate spread on Downey's
interest-earning assets and interest-bearing liabilities as of the dates
indicated.
December 31,
------------------------------------
1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------
Weighted average yield:
Loan and mortgage-backed securities ..... 7.95% 7.77% 7.67% 6.24% 6.48%
Investment securities ................... 5.79 6.11 6.29 6.09 4.59
- --------------------------------------------------------------------------------------
Earning assets yield .................... 7.87 7.71 7.60 6.24 6.31
- --------------------------------------------------------------------------------------
Weighted average cost:
Deposits ................................ 5.00 4.86 4.81 4.23 3.32
Borrowings:
FHLB advances ........................ 6.11 5.80 6.07 6.41 6.92
Other borrowings ..................... 6.15 5.60 5.62 5.88 5.03
- --------------------------------------------------------------------------------------
Combined borrowings ..................... 6.12 5.73 5.84 6.20 5.28
- --------------------------------------------------------------------------------------
Combined funds .......................... 5.11 4.97 4.92 4.55 3.32
- --------------------------------------------------------------------------------------
Interest rate spread ....................... 2.76% 2.74% 2.68% 1.69% 2.99%
======================================================================================
End of period effective interest rate spread 2.97% 2.89% 2.87% 1.85% 3.10%
======================================================================================
The year-end weighted average yield on the loan portfolio increased to
7.95%, compared to 7.77% as of December 31, 1996. The average yield on new loans
originated during 1997, 1996 and 1995 was 6.04%, 6.06% and 6.99%, respectively.
At December 31, 1997, the ARM portfolio of single family residential loans,
including mortgage-backed securities, totaled $4.5 billion with a weighted
average rate of 7.58%, compared to $3.9 billion and $3.5 billion with weighted
average rates of 7.38% and 7.51% at December 31, 1996 and 1995, respectively.
PROBLEM LOANS AND REAL ESTATE
Non-Performing Assets
Non-performing assets consist of loans on which Downey has ceased the
accrual of interest ("non-accrual loans") and real estate acquired in settlement
of loans. Non-performing assets totaled $52.1 million at December 31, 1997,
compared to $62.0 million at December 31, 1996, and $97.2 million at December
31, 1995. The decline in non-performing assets was spread throughout all
categories and is primarily attributed to the improving California economy. Of
the total, real estate acquired in settlement of loans, net of allowances,
represented $9.6 million at December 31, 1997, compared to $16.1 million at
December 31, 1996, and $18.9 million at December 31, 1995. The 1997 decrease
reflects a reduction in the single family inventory and the sale of a shopping
center taken in satisfaction of a loan.
36
The following table summarizes the non-performing assets of Downey at the
dates indicated.
December 31,
---------------------------------------------------
(Dollars in Thousands) 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------------------------
Non-accrual loans:
One-to-four unit residential ..................... $20,816 $22,885 $25,587 $24,012 $30,784
One-to-four unit residential - subprime .......... -- -- -- -- --
Other ............................................ 20,883 22,136 52,754 28,025 25,445
- -----------------------------------------------------------------------------------------------------------
Total non-accrual loans ........................ 41,699 45,021 78,341 52,037 56,229
Real estate acquired in settlement of loans, net (1) 9,626 16,078 18,854 13,558 13,364
Repossessed automobiles ............................. 795 928 -- -- --
- -----------------------------------------------------------------------------------------------------------
Gross non-performing assets ...................... $52,120 $62,027 $97,195 $65,595 $69,593
===========================================================================================================
===========================================================================================================
Allowance for loan losses (2):
Amount ........................................... $32,092 $30,094 $27,943 $25,650 $26,835
As a percentage of non-performing loans .......... 76.96% 66.84% 35.67% 49.29% 47.72%
Non-performing assets as a percentage of total assets 0.89 1.19 2.09 1.41 2.01
===========================================================================================================
(1) Excludes real estate acquired in settlement of loans covered under the
Butterfield Assistance Agreement. All such assets were sold to the FDIC's
Division of Resolution in December 1995.
(2) Allowance for loan losses does not include the allowance for real estate
and real estate acquired in settlement of loans.
When resolving problem loans, it is Downey's policy to determine
collectibility under various circumstances which will result in maximum
financial benefit to Downey. It is also Downey's policy to take appropriate,
timely and aggressive action when necessary to resolve non-performing assets.
This is accomplished by either working with the borrower to bring the loan
current or by foreclosing and selling the asset. Downey performs ongoing reviews
of loans that display weaknesses and maintains adequate loss allowances on the
loans. For a discussion on Downey's internal asset review policy, refer to
"Allowance for Losses on Loans and Real Estate" on page 40.
All of Downey's non-performing assets at December 31, 1997, were located in
California, with the exception of one property acquired in settlement of loans
located in Arizona.
Downey evaluates the need for appraisals for non-performing assets on a
periodic basis. A new appraisal will generally be obtained when Downey believes
that there may have been an adverse change in the property operations or in the
economic conditions of the geographic market of the property securing its loans.
Downey's policy is to obtain new appraisals at least annually for major real
estate acquired in settlement of loans. Throughout 1997, Downey obtained new
appraisals for non-performing loans and real estate acquired in settlement of
loans.
Non-Accrual Loans. It is Downey's general policy to account for a loan as
non-accrual when the loan becomes 90 days delinquent or when collection of
interest appears doubtful. In certain cases, loans may remain on accrual status
past 90 days when it is determined that continued accrual is warranted because
the loan is well-secured and in process of collection. As of December 31, 1997,
Downey had no loans 90 days or more delinquent which remained on accrual status.
Any interest previously accrued with respect to non-accrual loans is reversed
and charged against interest income. Interest income is recognized on
non-accrual loans to the extent that payments are received and to the extent
that Downey believes it will recover the remaining principal balance of the
loan. Such loans are restored to an accrual status only if all past due payments
are made by the borrower and the borrower has demonstrated the ability to make
future payments of principal and interest. At December 31, 1997, non-accrual
loans aggregating $2.0 million were less than 90 days delinquent relative to
their contractual terms. Additional loans aggregating $17.8 million were not
contractually past due, but were deemed non-accrual due to management's
assessment of the borrower's ability to pay.
Impaired Loans. Impaired loans are carried on Downey's accounting records
at either the present value of expected future cash flows discounted at the
loan's effective interest rate, or at the loan's observable market price or the
fair value of
37
the collateral securing the loan. Impaired loans exclude large groups of smaller
balance homogeneous loans that are collectively evaluated for impairment. For
Downey, loans collectively reviewed for impairment include all single family
loans and performing multi-family and non-residential loans having principal
balances of less than $1 million.
Downey considers a loan to be impaired when, based upon current information
and events, it believes it is probable that Downey will be unable to collect all
amounts due according to the contractual terms of the loan agreement. In
determining impairment, Downey considers large non-homogeneous loans with the
following characteristics: non-accrual loans, debt restructurings, and
performing loans which exhibit, among other characteristics, high loan-to-value
ratios or delinquent taxes. Downey bases the measurement of collateral dependent
impaired loans on the fair value of the loan's collateral. Non-collateral
dependent loans are valued based on a present value calculation of expected
future cash flows, discounted at the loan's effective rate. Cash receipts on
impaired loans not performing according to contractual terms are generally used
to reduce the carrying value of the loan, unless Downey believes it will recover
the remaining principal balance of the loan. Impairment losses are included in
the allowance for loan losses through a charge to provision for loan losses.
Adjustments to impairment losses due to changes in the fair value of the
collateral of impaired loans are included in provision for loan losses. Upon
disposition of an impaired loan, loss of principal is recorded through a
charge-off to the allowance for loan losses. At December 31, 1997, the recorded
investment in loans for which impairment has been recognized totaled $13.8
million, compared to $46.7 million at December 31, 1996 (all of which were on
non-accrual status). The total allowance for losses related to such loans was
$1.3 million at December 31, 1997, and $4.4 million at December 31, 1996. For
further information regarding impaired loans, see Note 6 of the Notes to the
Consolidated Financial Statements on page 62.
Troubled Debt Restructurings. A restructuring of a debt is considered a
troubled debt restructuring when Downey, for economic or legal reasons related
to the borrower's financial difficulties, grants a concession to the borrower
that it would not otherwise grant. Troubled debt restructurings may include
changing repayment terms, reducing the stated interest rate and reducing the
amounts of principal and/or interest due or extending the maturity date. The
restructuring of a loan is intended to recover as much of Downey's investment as
possible and to achieve the highest yield possible. There were no troubled debt
restructurings on accrual status at December 31, 1997 and 1996.
Real Estate Acquired in Settlement of Loans. Real estate acquired in
settlement of loans consists of real estate acquired through foreclosure or
deeds in lieu of foreclosure.
Delinquent Loans
When a borrower fails to make required payments on a loan and does not cure
the delinquency within 60 days, Downey normally records a notice of default,
subject to any required prior notice to the borrower, and commences foreclosure
proceedings. If the loan is not reinstated within the time permitted by law for
reinstatement, which is normally five business days prior to the date set for
the non-judicial trustee's sale, the property may then be sold at a foreclosure
sale. If Downey has elected to pursue a non-judicial foreclosure, Downey is not
permitted under applicable California law to obtain a deficiency judgment
against the borrower, even if the security property is insufficient to cover the
balance owed. In foreclosure sales, Downey generally acquires title to the
property. At December 31, 1997, loans delinquent 30 days or more as a percentage
of total loans was 0.79%, down from 0.90% and 1.99% at December 31, 1996 and
1995, respectively.
38
The following table indicates the amounts of Downey's past due loans at the
dates indicated.
December 31,
------------------------------------------------------------------------------------
1997 1996
------------------------------------------------------------------------------------
30-59 60-89 90+ 30-59 60-89 90+
(Dollars in Thousands) Days Days Days (1) Total Days Days Days (1) Total
- --------------------------------------------------------------------------------------- -----------------------------------------
Loans secured by real estate:
Residential:
One-to-four units ..................... $12,099 $ 4,101 $18,579 $34,779 $14,519 $ 5,502 $18,549 $38,570
One-to-four units - subprime (2) ...... 185 -- -- 185 198 -- -- 198
Five or more units .................... -- 222 -- 222 -- -- -- --
Commercial real estate .................. -- -- 279 279 -- -- -- --
Construction ............................ -- -- -- -- -- -- -- --
Land .................................... -- -- -- -- -- -- 566 566
- --------------------------------------------------------------------------------------- -----------------------------------------
Total real estate loans ............... 12,284 4,323 18,858 35,465 14,717 5,502 19,115 39,334
Non-mortgage:
Commercial .............................. -- -- -- -- -- -- -- --
Consumer:
Automobile ............................ 4,167 981 961 6,109 2,080 328 274 2,682
Other consumer ........................ 218 54 533 805 158 15 181 354
- --------------------------------------------------------------------------------------- -----------------------------------------
Total loans ......................... $16,669 $ 5,358 $20,352 $42,379 $16,955 $ 5,845 $19,570 $42,370
======================================================================================= =========================================
Delinquencies as a percentage of total loans 0.31% 0.10% 0.38% 0.79% 0.36% 0.12% 0.41% 0.90%
======================================================================================= =========================================
1995 1994
---------------------------------------- -----------------------------------------
Loans secured by real estate:
Residential:
One-to-four units ..................... $14,047 $ 6,645 $22,303 $42,995 $15,306 $ 9,273 $20,584 $45,163
Five or more units .................... 89 -- 447 536 -- -- 149 149
Commercial real estate .................. -- -- 30,675 30,675 -- -- 1,139 1,139
Construction ............................ -- -- -- -- -- -- -- --
Land .................................... -- -- 6,516 6,516 -- -- 836 836
- --------------------------------------------------------------------------------------- -----------------------------------------
Total real estate loans ............... 14,136 6,645 59,941 80,722 15,306 9,273 22,708 47,287
Non-mortgage:
Commercial .............................. -- -- 115 115 -- -- -- --
Consumer:
Automobile ............................ 667 249 540 1,456 22 12 24 58
Other consumer ........................ 257 410 170 837 291 171 334 796
- --------------------------------------------------------------------------------------- -----------------------------------------
Total loans ......................... $15,060 $ 7,304 $60,766 $83,130 $15,619 $ 9,456 $23,066 $48,141
======================================================================================= =========================================
Delinquencies as a percentage of total loans 0.36% 0.18% 1.46% 1.99% 0.37% 0.23% 0.55% 1.15%
======================================================================================= =========================================
1993
----------------------------------------
Loans secured by real estate:
Residential:
One-to-four units ..................... $15,058 $ 5,565 $29,160 $49,783
Five or more units .................... 58 205 183 446
Commercial real estate .................. -- -- 20,882 20,882
Construction ............................ -- -- -- --
Land .................................... -- -- -- --
- ---------------------------------------------------------------------------------------
Total real estate loans ............... 15,116 5,770 50,225 71,111
Non-mortgage:
Commercial .............................. -- -- -- --
Consumer:
Automobile ............................ 39 7 131 177
Other consumer ........................ 635 249 479 1,363
- ---------------------------------------------------------------------------------------
Total loans ......................... $15,790 $ 6,026 $50,835 $72,651
=======================================================================================
Delinquencies as a percentage of total loans 0.54% 0.21% 1.74% 2.49%
=======================================================================================
(1) All 90 day or greater delinquencies are on non-accrual status and reported
as part of non-performing assets.
(2) Downey commenced one-to-four subprime lending in the first quarter of 1996.
39
Allowance for Losses on Loans and Real Estate
Valuation allowances for losses on loans and real estate are established on
a specific and general basis. Specific allowances are determined based on the
difference between the carrying value of the asset and its fair value. General
valuation allowances are determined based on historical loss experience, current
and anticipated levels and trends of delinquent and non-performing loans and the
economic environment in Downey's market areas. See Note 1 of Notes to the
Consolidated Financial Statements on page 53.
Downey's Internal Asset Review Department conducts independent reviews to
evaluate the risk and quality of all Downey assets. Downey's Internal Asset
Review Committee ("IARC") is responsible for the review and classification of
assets. The IARC members include the Chief Internal Asset Review Officer, Chief
Executive Officer, Chief Financial Officer, Chief Lending Officer, General
Counsel, Director of Compliance/Risk Management, Credit Administrator and Chief
Appraiser. The IARC meets quarterly to review and to determine asset
classifications and to recommend any changes to asset valuation allowances. With
the exception of payoffs or asset sales, the classification of an asset, once
established, can be removed or upgraded only upon approval of the IARC. The
Chief Internal Asset Review Officer reports quarterly to the Audit Committee of
the Board of Directors regarding overall asset quality, the adequacy of
valuation allowances on classified assets and Downey's adherence to policies and
procedures regarding asset classification and valuation.
Downey adheres to an internal asset review system and loss allowance
methodology designed to provide for timely recognition of problem assets and
adequate general valuation allowances to cover asset losses. Downey's current
asset monitoring process includes the use of asset classifications to segregate
the assets, largely loans and real estate, into various risk categories. Downey
uses the various asset classifications as a means of measuring risk for
determining the general valuation allowances at a point in time. Downey
currently uses a six grade system to classify its assets. The current grades are
Pass, Watch, Special Mention, Substandard, Doubtful and Loss. Substandard,
Doubtful and Loss assets are considered "classified assets" for regulatory
purposes. A brief description of these classifications follows:
The Pass classification represents a level of credit quality which contains
no well-defined deficiency or weakness.
o The Watch classification is used to identify an asset that currently
contains no well-defined deficiency or weakness, but it is determined to be
desirable to closely monitor the asset (e.g., loans to facilitate the sale
of real estate acquired in settlement of loans). This category may also be
used for assets upgraded from lower classifications where continuing
monitoring is deemed appropriate.
o A Special Mention asset does not currently expose Downey to a sufficient
degree of risk to warrant an adverse classification, but does possess a
correctable deficiency or potential weakness deserving management's close
attention.
o Substandard assets have a well-defined weakness or weaknesses. They are
characterized by the distinct possibility that Downey will sustain some
loss if the deficiencies are not corrected.
o An asset classified Doubtful has all the weaknesses inherent in those
classified Substandard with the added characteristic that the weaknesses
make collection or liquidation in full, on the basis of currently existing
facts, conditions and values, highly questionable and improbable. Downey
considers Doubtful to be a temporary classification until resolution of
pending weakness issues enables Downey to more clearly define the potential
for loss.
o That portion of an asset classified Loss is considered uncollectible and of
such little value that its continuance as an asset, without establishment
of a specific valuation allowance, is not warranted. A Loss classification
does not mean that an asset has absolutely no recovery or salvage value,
but rather it is not reasonable to defer writing off or providing for all
or a portion of an impaired asset even though partial recovery may be
effected in the future. Downey will generally classify as Loss the balance
of the asset that is greater than the fair value of the asset unless
payment from another source can be expected. Therefore, the amount of an
asset classified as Loss reflects the total of specific valuation
allowances established for the particular asset. Specific valuation
allowances are not includable in determining the Bank's total regulatory
capital.
The OTS has the authority to require Downey to change its asset
classifications. If such a change results in an asset being classified in whole
or in part as Loss, a specific allowance must be established against the amount
so classified or that amount must be charged off. OTS guidelines set forth
quantitative benchmarks as a starting point for the determination of appropriate
levels of general valuation allowances. The OTS directs its examiners to rely on
management's estimates of
40
adequate general valuation allowances if the association's process for
determining adequate allowances is deemed to be sound.
It is Downey's policy to provide an allowance for losses on loans and real
estate when it is probable that the value of the asset has been impaired and the
loss can be reasonably estimated. To comply with this policy, Downey has
established a monitoring system that requires at least an annual review of all
assets in excess of $1 million and a semiannual review of all assets considered
adversely classified or criticized. The monitoring system requires a review of
current operating statements, an evaluation of the property's current and past
performance, an evaluation of the borrower's ability to repay and the
preparation of a discounted cash flow analysis. Based on the results of the
review, a new appraisal may be required.
Downey's provision for loan losses totaled $8.6 million in 1997, down $0.5
million from 1996. The provision for loan losses exceeded net loan charge-offs
by $2.0 million resulting in an increase in the allowance for loan losses to
$32.1 million at December 31, 1997. This increase reflected the growth in single
family residential and automobile loans. Included in the current year-end
allowance of $32.1 million was $31.7 million of general valuation allowances of
which $2.8 million was unallocated to any specific loan category and is
maintained due to the uncertain, but improving, economy of California.
A summary of activity in the allowances for loan losses is set forth below
for the years indicated.
(In Thousands) 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------
Balance at beginning of period $ 30,094 $ 27,943 $ 25,650 $ 26,835 $ 28,425
Provision .................... 8,640 9,137 9,293 4,211 1,085
Charge-offs .................. (7,773) (7,660) (8,017) (5,511) (2,675)
Recoveries ................... 1,131 674 1,017 115 22
Transfers .................... -- -- -- -- (22)
- -----------------------------------------------------------------------------------------
Balance at end of period ..... $ 32,092 $ 30,094 $ 27,943 $ 25,650 $ 26,835
=========================================================================================
Net loan charge-offs were $6.6 million in 1997, down from $7.0 million in
both 1996 and 1995. The decline primarily reflected a $2.8 million decline in
net charge-offs of one-to-four unit residential loans, partially offset by an
increase of $2.7 million in automobile loans. The growth in automobile loan net
charge-offs reflects the growth in that portfolio as the ratio of automobile net
charge-offs to the average of such loans was 1.58% in 1997 compared to 1.37% in
1996. Charge-offs, net of recoveries, by category of loan are as follows for the
years indicated.
(Dollars in Thousands) 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four unit (1) .............................. $ 2,165 $ 4,982 $ 5,165 $ 4,051 $ 1,431
Five or more unit ................................. -- 102 469 264 320
Commercial real estate .............................. (261) (250) 807 959 617
Land ................................................ -- -- 4 -- --
Non-mortgage:
Commercial .......................................... -- 115 (152) (52) --
Consumer:
Automobile ........................................ 4,468 1,791 398 9 51
Other consumer .................................... 270 246 309 165 234
- -------------------------------------------------------------------------------------------------------------------
Total net loan charge-offs ........................ $ 6,642 $ 6,986 $ 7,000 $ 5,396 $ 2,653
===================================================================================================================
Net loan charge-offs as a percentage of average loans and
mortgage-backed securities held to maturity ......... 0.13% 0.16% 0.17% 0.16% 0.09%
===================================================================================================================
(1) Includes net charge-offs associated with the January 1994 Northridge
earthquake of $1.0 million, $1.1 million and $0.8 million in 1996, 1995 and
1994, respectively.
41
The allocation of the allowance for loan losses at the dates indicated is
as set forth in the following table.
December 31,
-----------------------------------------------------------------------------------------------------
1997 1996 1995
----------------------------------- -------------------------------- --------------------------------
Gross Allowance Gross Allowance Gross Allowance
Loan Percentage Loan Percentage Loan Percentage
Portfolio to Loan Portfolio to Loan Portfolio to Loan
(Dollars in Thousands) Allowance Balance Balance Allowance Balance Balance Allowance Balance Balance
- ------------------------------------------------------------------------------------------------------------------------------------
Loans secured by real estate:
Residential:
One-to-four units ...... $14,652 $4,607,545 0.32% $13,241 $4,046,448 0.33% $12,254 $3,656,512 0.34%
Five or more units ..... 314 38,278 0.82 517 56,907 0.91 895 57,321 1.56
Commercial real estate ... 4,112 202,425 2.03 6,956 260,609 2.67 8,456 270,583 3.13
Construction ............. 847 70,865 1.20 773 66,651 1.16 335 28,593 1.17
Land ..................... 331 25,687 1.29 466 21,177 2.20 973 21,867 4.45
Non-mortgage:
Commercial ............... 196 26,024 0.75 236 22,136 1.07 259 12,864 2.01
Consumer:
Automobile ............. 8,016 342,326 2.34 4,303 202,186 2.13 849 56,127 1.51
Other consumer ......... 824 47,735 1.73 802 47,281 1.70 1,122 50,945 2.20
Other ....................... -- -- -- -- -- -- -- -- --
Not specifically allocated .. 2,800 -- -- 2,800 -- -- 2,800 -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans held for
investment ........... $32,092 $5,360,885 0.60%$ 30,094 $4,723,395 0.64%$ 27,943 $ 4,154,812 0.67%
==================================================================================================================================
1994 1993
----------------------------------- --------------------------------
Loans secured by real estate:
Residential:
One-to-four units ...... $12,404 (1) $3,688,280 0.34% $ 7,598 $2,376,586 0.32%
Five or more units ..... 978 63,782 1.53 1,052 73,505 1.43
Commercial real estate ... 6,814 294,418 2.31 10,551 341,027 3.09
Construction ............. 131 11,367 1.15 372 37,180 1.00
Land ..................... 862 9,822 8.78 608 11,826 5.14
Non-mortgage:
Commercial ............... 472 12,975 3.64 339 8,229 4.12
Consumer:
Automobile ............. 42 3,028 1.39 53 3,274 1.62
Other consumer ......... 1,094 53,241 2.05 1,362 48,580 2.80
Other ....................... 53 39,143 0.14 -- 51,060 --
Not specifically allocated .. 2,800 (1) -- -- 4,900 -- --
- -------------------------------------------------------------------------------------------------
Total loans held for
investment ........... $25,650 $4,176,056 0.61 $26,835 $2,951,267 0.91%
=================================================================================================
(1) At March 31, 1994, $2.1 million was reallocated from the "not specifically
allocated" category to the "one-to-four unit residential" category for the
potential Northridge earthquake loss exposure. During 1994, $1.2 million in
loss provision was recorded to further increase the loss allowance
associated with the Northridge earthquake.
42
The following table is a summary of the activity of Downey's allowance for
real estate held for investment and non-conforming loans to joint ventures for
the years indicated. The $3.2 million, $3.3 million and $2.9 million provision
reductions in 1997, 1996 and 1995 respectively, were due to a continuing
improvement in the real estate market which favorably impacted the valuation of
certain neighborhood retail shopping center investments and to a reduction in
the investment in certain joint ventures. Charge-offs in 1997 amounted to $5.6
million related to the sale of four properties held for investment.
(In Thousands) 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------
Balance at beginning of period $ 30,071 $ 34,338 $ 37,198 $ 38,674 $ 34,921
Provision (reduction) ........ (3,190) (3,306) (2,916) (1,400) 4,128
Charge-offs .................. (5,637) (1,035) -- (76) (355)
Recoveries ................... -- 74 56 -- --
Transfers .................... -- -- -- -- (20)
- -----------------------------------------------------------------------------------------
Balance at end of period ..... $ 21,244 $ 30,071 $ 34,338 $ 37,198 $ 38,674
=========================================================================================
In addition to losses charged against the allowance for loan losses, Downey
has recorded losses on real estate acquired in settlement of loans by direct
write-off to net operations of real estate acquired in settlement of loans and
against an allowance for losses specifically established for such assets. The
following table is a summary of the activity of Downey's allowance for real
estate acquired in settlement of loans for the years indicated.
(In Thousands) 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------
Balance at beginning of period $ 1,078 $ 1,217 $ 743 $ 747 $ 255
Provision .................... 1,107 1,658 2,498 2,035 1,360
Charge-offs .................. (1,346) (1,797) (2,024) (2,039) (890)
Recoveries ................... -- -- -- -- --
Transfers .................... -- -- -- -- 22
- ------------------------------------------------------------------------------------
Balance at end of period ..... $ 839 $ 1,078 $ 1,217 $ 743 $ 747
====================================================================================
CAPITAL RESOURCES AND LIQUIDITY
Downey's sources of funds include deposits, advances from the FHLB and
other borrowings, proceeds from the sale of real estate, sales of loans and
mortgaged-backed securities, payments of loans and mortgaged-backed securities,
payments for and sales of loan servicing and income from other investments.
Repayments on loans and mortgage-backed securities and deposit inflows and
outflows are affected significantly by interest rates, real estate sales
activity and general economic conditions. Loan repayments totaled $1.1 billion
for 1997, compared to $0.8 billion in 1996. These repayments were more than
offset by new loan originations and purchases for portfolio of $2.1 billion and
$1.4 billion, respectively.
During 1997, Downey experienced a net deposit inflow of $696.9 million, of
which $104.3 million represented transaction accounts with the balance of the
increase in certificates of deposit. Aggregate borrowings decreased $111.6
million as deposit growth exceeded new loan fundings.
Downey expects to meet its 1998 funding needs primarily from deposit
growth. If those sources fall short of satisfying ongoing commitments to fund
maturing and withdrawable deposits, repay borrowings, fund existing and future
loan and other investment commitments, continue branch improvement programs and
maintenance of regulatory liquidity requirements, Downey will utilize borrowing
arrangements with the FHLB and other sources. At December 31, 1997, Downey had
commitments to fund loans amounting to $125.4 million, stand-by letters of
credit of $0.5 million, undrawn lines of credit of $69.8 million and loans in
process of $56.3 million. Downey believes its current sources of funds will
enable it to meet these obligations while maintaining its liquidity at
appropriate levels.
The principal measure of liquidity in the savings and loan industry is the
regulatory ratio of cash and eligible investments to the sum of withdrawable
savings and borrowings due within one year. The minimum liquidity ratio set by
federal regulators was reduced in 1997 from 5% to 4%. At December 31, 1997, the
Bank's ratio was 4.80% compared to 5.26% and 5.03% at December 31, 1996 and
1995, respectively.
43
REGULATORY CAPITAL COMPLIANCE
The following table is a reconciliation of the Bank's stockholder's equity
to federal regulatory capital as of December 31, 1997. The core and tangible
capital ratios were 6.61% and the risk-based capital ratio was 12.64%. These
levels are little changed from comparable ratios of 6.56% and 12.66%,
respectively, at December 31, 1996, but continue to exceed the "well
capitalized" standards of 5% for core and tangible and 10% for risk-based, as
defined by regulation. During 1997, the amount of the Bank's non-includable
investment in real estate required to be deducted from regulatory capital
declined by $8.1 million primarily as a result of dividends paid to the Bank by
DSL Service Company.
Tangible Capital Core Capital Risk-Based Capital
------------------ ----------------- -------------------
(Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------------------------------
Stockholder's Equity ............................... $ 421,230 $ 421,230 $ 421,230
Adjustments:
Deductions:
Investment in subsidiary, primarily real estate (35,585) (35,585) (35,585)
Goodwill ....................................... (5,053) (5,053) (5,053)
Core deposit premium ........................... (214) (214) (214)
Non-permitted mortgage servicing rights ........ (195) (195) (195)
Additions:
Unrealized gain on securities available for sale (110) (110) (110)
General loss allowance - Investment in DSL ..... 1,606 1,606 1,606
Loan general valuation allowances (1) .......... -- -- 31,713
- ----------------------------------------------------------------------------------------------------------------------
Regulatory capital ................................. 381,679 6.61% 381,679 6.61% 413,392 12.64%
Well capitalized requirement ....................... 86,614 1.50 (2) 288,715 5.00 326,959 10.00 (3)
- ----------------------------------------------------------------------------------------------------------------------
Excess ............................................. $ 295,065 5.11%$ $ 92,964 1.61% $ 86,433 2.64%
======================================================================================================================
(1) Limited to 1.25% of risk-weighted assets.
(2) Represents the minimum requirement for tangible capital, as no "well
capitalized" requirement has been established for this category.
(3) A third requirement is Tier 1 capital to risk-weighted assets of 6%, which
the Bank meets and exceeds with a ratio of 11.67%.
CURRENT ACCOUNTING ISSUE
In September 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS 131").
SFAS 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. SFAS 131 supersedes FASB Statement No. 14,
"Financial Reporting for Segments of a Business Enterprise," but retains the
requirement to report information about major customers. It amends FASB
Statement No. 94, "Consolidation of All Majority-Owned Subsidiaries," to remove
the special disclosure requirements for previously unconsolidated subsidiaries.
SFAS 131 requires that a public business enterprise report financial and
descriptive information about its reportable operating segments. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. Generally, financial information is required to be reported on the
basis that it is used internally for evaluating segment performance and deciding
how to allocate resources to segments.
SFAS 131 requires that a public business enterprise report a measure of
segment profit or loss, certain specific revenue and expense items, and segment
assets. It requires reconciliations of total segment revenues, total segment
profit or loss, total segment assets, and other amounts disclosed for segments
to corresponding amounts in the enterprise's general-purpose financial
statements. It requires that all public business enterprises report information
about the revenues derived from the enterprise's products or services (or groups
of similar products and services), about the countries in which the enterprise
earns revenues and holds assets, and about major customers regardless of whether
that information is used in making operating decisions. However, SFAS 131 does
not require an enterprise to report information that is not
44
prepared for internal use if reporting it would be impracticable.
SFAS 131 also requires that a public business enterprise report descriptive
information about the way that the operating segments were determined, the
products and services provided by the operating segments, differences between
the measurements used in reporting segment information and those used in the
enterprise's general-purpose financial statements, and changes in the
measurement of segment amounts from period to period.
SFAS 131 is effective for financial statements for periods beginning after
December 15, 1997. In the initial year of application, comparative information
for earlier years is to be restated. SFAS 131 need not be applied to interim
financial statements in the initial year of its application, but comparative
information for interim periods in the initial year of application is to be
reported in financial statements for interim periods in the second year of
application.
YEAR 2000
Like most financial organizations, Downey has many computer systems that
identify dates using only the last two digits of the year. These systems must be
prepared to distinguish dates such as 1900 from 2000. Computer system failures
due to processing errors potentially arising from calculations using Year 2000
dates are a known risk.
Downey has established processes to identify, prioritize, renovate or
replace systems that may be affected by Year 2000 dates. To date, Downey has
completed an inventory of all systems and determined which processes are most
critical to supporting customer transaction processing and providing customer
services. System renovation and replacement plans have been started and are
targeted for completion by the end of 1998, with compliance testing and
installation processes to be completed during 1999.
Downey believes that this process is designed to be successful and will be
utilizing current technology in seeking to assure Year 2000 compliant systems.
However, third party vendor dependency, including government entities, may
impact Downey's efforts to successfully complete Year 2000 compliance for all
systems in a timely fashion. Downey is requiring that third party vendors
represent their products to be Year 2000 compliant and has planned a program to
test for compliance. Contingency plans are being developed in the event that a
vendor is not able to provide a Year 2000 compliant solution.
Commercial loan borrowers of Downey may also be impacted by Year 2000
issues. Downey has embarked on an awareness program to bring these issues to the
borrower's attention and to determine the extent of their preparations for Year
2000. In addition, lending guidelines will take into consideration how Year 2000
issues will impact their business and possibly their ability to repay loan
obligations to Downey.
Downey currently estimates that the Year 2000 project may cost
approximately $5 million. This cost is in addition to existing personnel who may
participate in the project and includes estimates for hardware and software
renovation or replacement, as well as additions to existing staff who will be
specifically devoted to the project. Approximately 55% of the cost represents
costs to migrate to a new personal computer environment and to replace certain
older automated teller machines, both of which Downey might otherwise have
implemented/replaced during the period notwithstanding the Year 2000 issue. As
such, that portion of the Year 2000 costs are projected to be amortized over the
useful life of the equipment. Of the estimated $5 million total cost,
approximately $0.1 million was incurred in 1997, with approximately $1.5 million
to be expensed in each of 1998 and 1999, approximately $1.0 million in 2000,
with the balance in subsequent years. As Downey progresses in addressing the
Year 2000 issue, estimates of costs could change, including failure of any third
party vendor to provide Year 2000 compliant solutions in a timely fashion.
45
ITEM 8. FINANCIAL STATEMENTS
Index to Consolidated Financial Statements
Page
Independent Auditors' Report.............................. 47
Consolidated Balance Sheets............................... 48
Consolidated Statements of Income......................... 49
Consolidated Statements of Comprehensive Income........... 50
Consolidated Statements of Stockholders' Equity........... 50
Consolidated Statements of Cash Flows..................... 51
Notes to Consolidated Financial Statements................ 53
46
Independent Auditors' Report
The Board of Directors and Stockholders
Downey Financial Corp.:
We have audited the accompanying consolidated balance sheets of Downey Financial
Corp. and subsidiaries ("Downey") as of December 31, 1997 and 1996, and the
related consolidated statements of income, comprehensive income, stockholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 1997. These consolidated financial statements are the
responsibility of Downey'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 generally accepted auditing
standards. 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 Downey Financial
Corp. and subsidiaries as of December 31, 1997 and 1996, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ KPMG Peat Marwick LLP
Los Angeles, California
January 14, 1998
47
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31,
(Dollars in Thousands, Except Per Share Data) 1997 1996
- ------------------------------------------------------------------------------------------------------------
ASSETS
Cash ........................................................................... $ 48,823 $ 67,221
Federal funds .................................................................. 6,095 6,038
- ------------------------------------------------------------------------------------------------------------
Cash and cash equivalents .................................................. 54,918 73,259
U.S. Treasury and agency obligations and other investment securities
available for sale, at fair value .......................................... 159,398 141,999
Municipal securities being held to maturity, at amortized cost (estimated market
value of $6,865 at December 31, 1997, and $6,975 at December 31, 1996) ..... 6,885 6,997
Loans held for sale, at the lower of cost or market ............................ 35,100 12,865
Mortgage-backed securities available for sale, at fair value ................... 49,299 61,267
Loans receivable held for investment ........................................... 5,281,997 4,655,714
Investments in real estate and joint ventures .................................. 41,356 46,498
Real estate acquired in settlement of loans .................................... 9,626 16,078
Premises and equipment ......................................................... 101,901 96,643
Federal Home Loan Bank stock, at cost .......................................... 44,085 41,447
Other assets ................................................................... 51,260 45,390
- ------------------------------------------------------------------------------------------------------------
$ 5,835,825 $ 5,198,157
============================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits ....................................................................... $ 4,869,978 $ 4,173,102
Government securities sold under agreements to repurchase ...................... 34,803 --
Federal Home Loan Bank advances ................................................ 352,458 386,883
Commercial paper ............................................................... 83,811 198,113
Other borrowings ............................................................... 12,663 10,349
Accounts payable and accrued liabilities ....................................... 40,579 28,357
Deferred income taxes .......................................................... 11,187 9,782
- ------------------------------------------------------------------------------------------------------------
Total liabilities .......................................................... 5,405,479 4,806,586
- ------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY:
Common stock, par value of $0.01 per share; authorized 50,000,000 shares;
outstanding 26,755,938 shares at December 31, 1997, and 25,459,079
shares at December 31, 1996 ................................................ 268 255
Additional paid-in capital ..................................................... 45,954 22,607
Unrealized gains (losses) on securities available for sale ..................... 110 (1,559)
Retained earnings .............................................................. 384,014 370,268
- ------------------------------------------------------------------------------------------------------------
Total stockholders' equity ................................................. 430,346 391,571
- ------------------------------------------------------------------------------------------------------------
$ 5,835,825 $ 5,198,157
============================================================================================================
See accompanying notes to consolidated financial statements.
48
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Income
Years ended December 31,
------------------------------------------
(Dollars in Thousands, Except Per Share Data) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Loans receivable .................................................... $ 404,081 $ 329,746 $ 300,098
U.S. Treasury and agency securities ................................. 8,300 7,765 11,122
Mortgage-backed securities .......................................... 3,633 4,317 4,311
Other investments ................................................... 4,404 4,532 2,661
Yield maintenance on covered assets, net ............................ -- -- 636
- ---------------------------------------------------------------------------------------------------------------------
Total interest income ........................................... 420,418 346,360 318,828
- ---------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Deposits ............................................................ 227,521 184,402 180,859
Borrowings .......................................................... 38,739 27,363 33,379
- ---------------------------------------------------------------------------------------------------------------------
Total interest expense .......................................... 266,260 211,765 214,238
- ---------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME ................................................. 154,158 134,595 104,590
PROVISION FOR LOAN LOSSES ........................................... 8,640 9,137 9,293
- ---------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses ............. 145,518 125,458 95,297
- ---------------------------------------------------------------------------------------------------------------------
OTHER INCOME, NET:
Loan and deposit related fees ....................................... 10,921 7,435 5,546
Real estate and joint ventures held for investment, net:
Net gains on sales of wholly owned real estate .................... 2,904 392 4,539
Reduction of loss on real estate and joint ventures ............... 3,190 3,306 2,916
Operations, net ................................................... 8,128 4,543 3,737
Secondary marketing activities:
Loan servicing fees ............................................... 1,276 1,415 1,460
Net gains on sales of loans and mortgage-backed securities ........ 2,675 1,543 266
Net gains (losses) on sales of investment securities ................ -- 4,473 (15)
Reduction of loss on investment in lease residual ................... -- -- 207
Other ............................................................... 6,094 2,092 1,943
- ---------------------------------------------------------------------------------------------------------------------
Total other income, net ......................................... 35,188 25,199 20,599
- ---------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSE:
Salaries and related costs .......................................... 54,366 45,811 39,349
Premises and equipment costs ........................................ 15,272 12,640 11,535
Advertising expense ................................................. 6,847 4,071 2,028
Professional fees ................................................... 5,113 2,985 3,150
SAIF insurance premiums and regulatory assessments .................. 3,439 8,949 9,024
Other general and administrative expense ............................ 14,519 12,004 9,384
- ---------------------------------------------------------------------------------------------------------------------
Total general and administrative expense .......................... 99,556 86,460 74,470
- ---------------------------------------------------------------------------------------------------------------------
SAIF Special Assessment ............................................. -- 24,644 --
Net operation of real estate acquired in settlement of loans ........ 1,184 2,567 4,206
Amortization of excess of cost over fair value of net assets acquired 532 532 530
- ---------------------------------------------------------------------------------------------------------------------
Total operating expense ......................................... 101,272 114,203 79,206
- ---------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES ............................................. 79,434 36,454 36,690
Income taxes ........................................................... 34,200 15,750 15,597
- ---------------------------------------------------------------------------------------------------------------------
NET INCOME .......................................................... $ 45,234 $ 20,704 $ 21,093
=====================================================================================================================
PER SHARE INFORMATION:
Basic .................................................................. $ 1.69 $ 0.77 $ 0.79
=====================================================================================================================
DILUTED ................................................................ $ 1.69 $ 0.77 $ 0.79
=====================================================================================================================
CASH DIVIDENDS PAID .................................................... $ 0.315 $ 0.304 $ 0.290
=====================================================================================================================
Weighted average shares outstanding .................................... 26,800,190 26,765,039 26,731,528
=====================================================================================================================
See accompanying notes to consolidated financial statements.
49
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Years ended December 31,
-------------------------------
(Dollars in Thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------
NET INCOME ..................................................................... $ 45,234 $ 20,704 $ 21,093
- ------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of income taxes: Unrealized gains
(losses) on securities available for sale:
U.S. Treasury and agency obligations and other investment securities
available for sale, at fair value ....................................... 1,331 (4,710) 2,985
Mortgage-backed securities available for sale, at fair value .............. 338 (344) 1,566
- ------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) ........................................... 1,669 (5,054) 4,551
- ------------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME ........................................................... $ 46,903 $ 15,650 $ 25,644
==================================================================================================================
Consolidated Statements of Stockholders' Equity
Unrealized
Additional Gain (Loss)
Common Paid-in on Securities Retained
(Dollars in Thousands, Except Per Share Data) Stock Capital Available for Sale Earnings Total
- ----------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1994 ..................... $ 162 $ 3,720 $ (1,056) $ 363,361 $ 366,187
Cash dividends, $0.290 per share .................. -- -- -- (7,759) (7,759)
Stock dividend .................................... 8 18,976 -- (18,984) --
Unrealized gain on securities available for sale .. -- -- 4,551 -- 4,551
Net income ........................................ -- -- -- 21,093 21,093
- ----------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1995 ..................... 170 22,696 3,495 357,711 384,072
Cash dividends, $0.304 per share .................. -- -- -- (8,147) (8,147)
Three-for-two stock split effected in the form of a
stock dividend ................................. 85 (89) -- -- (4)
Unrealized loss on securities available for sale .. -- -- (5,054) -- (5,054)
Net income ........................................ -- -- -- 20,704 20,704
- ----------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 ..................... 255 22,607 (1,559) 370,268 391,571
Cash dividends, $0.315 per share .................. -- -- -- (8,454) (8,454)
Stock dividend .................................... 13 23,012 -- (23,034) (9)
Exercise of stock options ......................... -- 335 -- -- 335
Unrealized gain on securities available for sale .. -- -- 1,669 -- 1,669
Net income ........................................ -- -- -- 45,234 45,234
- ----------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 ..................... $ 268 $ 45,954 $ 110 $ 384,014 $ 430,346
======================================================================================================================
See accompanying notes to consolidated financial statements.
50
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended December 31,
--------------------------------------------
(In Thousands) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................................... $ 45,234 $ 20,704 $ 21,093
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization ............................................ 9,389 8,279 7,390
Provision for losses on loans, leases, real estate acquired in settlement
of loans, investments in real estate and joint ventures and other assets 6,780 7,533 8,693
Net gains on sales of loans and mortgage-backed securities, investment
securities, real estate and other assets ............................... (9,210) (6,827) (4,799)
Interest capitalized on loans (negative amortization) .................... (12,885) (9,388) (2,600)
Federal Home Loan Bank dividends ......................................... (2,638) (2,301) (1,808)
Loans originated for sale .................................................... (289,271) (159,941) (93,496)
Proceeds from sales of loans originated for sale ............................. 179,046 135,074 80,972
Other, net ................................................................... 1,559 4,112 (11,643)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities ........................... (71,996) (2,755) 3,802
- ----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from:
Maturities of U.S. Treasury and agency obligations ......................... 9,875 -- 30,000
Sales of loans held for investment ......................................... 294,469 -- --
Sales of investment securities available for sale .......................... -- 189,541 --
Sales of mortgage-backed securities available for sale ..................... 88,723 31,314 21,135
Sales of wholly owned real estate and real estate acquired in settlement of 15,043 10,337 45,393
loans
Purchase of:
U.S. Treasury and agency obligations and other investment securities ....... (25,000) (170,455) (42,089)
Mortgage-backed securities available for sale .............................. -- (30,073) --
Loans receivable held for investment ....................................... (35,828) (223) (44,194)
Loans receivable originated held for investment (net of refinances of
$56,366, $90,824, and $50,039 during 1997, 1996 and 1995, respectively) .... (1,961,710) (1,309,663) (493,955)
Principal payments on loans receivable held for investment and mortgage-backed
securities held to maturity and available for sale ......................... 1,086,551 757,550 501,367
Net change in undisbursed loan funds ......................................... 13,356 12,147 11,605
Investments in real estate held for investment ............................... 5,115 (6,454) (1,377)
Other, net ................................................................... (14,086) (7,698) (13,214)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities ........................... (523,492) (523,677) 14,671
- ----------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
51
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
Years Ended December 31,
---------------------------------------
(In Thousands) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits ..................................................... $ 696,876 $ 382,881 $ 232,823
Net increase (decrease) in securities sold under agreements to repurchase .... 34,803 (16,099) --
Proceeds from Federal Home Loan Bank advances ................................ 872,900 1,018,700 844,800
Repayments of Federal Home Loan Bank advances ................................ (907,325) (852,532) (1,035,885)
Net increase (decrease) in other borrowings .................................. (111,988) 9,058 (47,473)
Proceeds from exercise of stock options ...................................... 335 -- --
Cash dividends ............................................................... (8,454) (8,147) (7,759)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities ........................... 577,147 533,861 (13,494)
- ----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents ........................... (18,341) 7,429 4,979
Cash and cash equivalents at beginning of year ................................. 73,259 65,830 60,851
- ----------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ..................................... $ 54,918 $ 73,259 $ 65,830
============================================================================================================================
Supplemental disclosure of cash flow information: Cash paid during the period
for:
Interest ................................................................... $ 267,589 $ 212,482 $ 215,696
Income taxes ............................................................... 23,572 19,753 13,965
Supplemental disclosure of non-cash investing:
Loans transferred from held for investment to held for sale .................. 290,558 1,791 --
U.S Treasury and agency obligations transferred from held to maturity to
available for sale .......................................................... -- -- 164,880
Loans exchanged for mortgage-backed securities ............................... 89,522 26,452 --
Mortgage-backed securities transferred from held to maturity to available for -- -- 33,555
sale
Real estate acquired in settlement of loans .................................. 23,686 27,367 36,991
Loans to facilitate the sale of real estate acquired in settlement of loans .. 21,919 23,356 13,777
============================================================================================================================
See accompanying notes to consolidated financial statements.
52
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1997, 1996 and 1995
(1) Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements of Downey Financial Corp. and
subsidiaries ("Downey") include all accounts of Downey Financial Corp. and
the consolidated accounts of all subsidiaries, including Downey Savings and
Loan Association, F.A. (the "Bank"). All significant intercompany balances
and transactions have been eliminated.
Business
Downey provides a full range of financial services to individual and
corporate customers through subsidiaries and branches located in
California. Downey is subject to competition from other financial
institutions. Downey is subject to the regulations of certain governmental
agencies and undergoes periodic examinations by those regulatory
authorities.
Basis of Financial Statement Presentation
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. In preparing the consolidated
financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities as
of the dates of the balance sheets and the results of operations for the
periods. Actual results could differ significantly 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 and the valuation of real estate. Management believes that the
allowances established for losses on loans and real estate are adequate.
While management uses available information to recognize losses on loans
and real estate, future additions to the allowances may be necessary based
on changes in economic conditions. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review Downey's allowances for losses on loans and real estate. Such
agencies may require Downey to recognize additions to the allowances based
on their judgments about information available to them at the time of their
examination.
Downey is required to carry its available for sale mortgage-backed
securities portfolio, real estate acquired in settlement of loans, and real
estate held for investment or under development at the lower of cost or
fair value or in certain cases, at fair value. Fair value estimates are
made at a specific point in time based upon relevant market information and
other information about the asset. Such estimates related to the
mortgage-backed and investment securities portfolios include published bid
prices or bid quotations received from securities dealers. Fair value
estimates for real estate acquired in settlement of loans and real estate
held for investment or under development is determined by current
appraisals and, where no active market exists for a particular property,
discounting a forecast of expected cash flows at a rate commensurate with
the risk involved.
Cash and Cash Equivalents
For purposes of the statements of cash flows, cash and cash equivalents
include cash on hand, amounts due from banks and Federal funds sold.
Generally, Federal funds are purchased and sold for one-day periods.
Mortgage-Backed Securities Purchased Under Resale Agreements, U.S. Treasury
and Agency Obligations, Other Investment Securities, Municipal Securities
and Mortgage-Backed Securities
Downey has established written guidelines and objectives for its investing
activities. At the time of purchase of a mortgage-backed security purchased
under resale agreement, U.S. Treasury and agency obligation, other
53
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
investment security or a mortgage-backed security, management of Downey
designates the security as either held to maturity, available for sale or
held for trading based on Downey's investment objectives, operational needs
and intent. Downey then monitors its investment activities to ensure that
those activities are consistent with the established guidelines and
objectives.
Held to Maturity
Securities held to maturity are carried at cost, adjusted for amortization
of premiums and accretion of discounts which are recognized in interest
income using the interest method. Mortgage-backed securities represent
participating interests in pools of long-term first mortgage loans
originated and serviced by the issuers of the securities. Mortgage-backed
securities held to maturity are carried at unpaid principal balances,
adjusted for unamortized premiums and unearned discounts. Premiums and
discounts on mortgage-backed securities are amortized using the interest
method over the remaining period to contractual maturity, adjusted for
anticipated prepayments. It is the positive intent of Downey, and Downey
has the ability, to hold these securities until maturity as part of its
portfolio of long-term interest earning assets. If the cost basis of these
securities is determined to be other than temporarily impaired, the amount
of the impairment is charged to operations.
Available for Sale
Securities available for sale are carried at market value. Unrealized
holding gains and losses, or valuation allowances established for net
unrealized losses, are excluded from earnings and reported as a separate
component of stockholders' equity and comprehensive income, net of income
taxes, unless the security is deemed permanently impaired. If the security
is determined to be other than temporarily impaired, the amount of the
impairment is charged to operations.
Realized gains and losses on the sale of securities available for sale,
determined using the specific identification method and recorded on a trade
date basis, are reflected in earnings.
Held for Trading
Securities held for trading are carried at market value. Realized and
unrealized gains and losses are reflected in earnings.
Loans Held for Sale
Downey identifies those loans which foreseeably may be sold prior to
maturity. These loans have been classified as held for sale in the
Consolidated Balance Sheets and are recorded at the lower of amortized cost
or market value. In response to unforeseen events such as changes in
regulatory capital requirements, liquidity shortfalls, changes in the
availability of sources of funds, and excess loan demand by borrowers that
could not be controlled immediately by loan price changes, Downey may sell
loans which had been held for investment. In such occurrences, the loans
are transferred at amortized cost and the lower of cost or market method is
then applied.
Gains or Losses on Sales of Loans and Mortgage Servicing Assets
Gains or losses on sales of loans are recognized at the time of sale and
are determined by the difference between the net sales proceeds and the
allocated basis of the loans sold. Downey adopted, effective January 1,
1997, Statement of Financial Accounting Standards No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," ("SFAS 125"). In accordance with SFAS 125, Downey capitalizes
mortgage servicing rights ("MSRs") acquired through either the purchase or
origination of mortgage loans for sale or securitization with servicing
rights retained. The total cost of the mortgage loans designated for sale
is allocated to the MSRs and the mortgage loans without the MSRs based on
their relative fair values. The MSRs are included in other assets and as a
component of gain on sale of loans. The MSRs are amortized in proportion to
and over the
54
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
estimated period of net servicing income. Such amortization is reflected as
a component of loan servicing fees.
The MSRs are periodically reviewed for impairment based on their fair
value. The fair value of the MSRs, for the purposes of impairment, is
measured using a discounted cash flow analysis based on Downey's estimated
net servicing income, market prepayment rates and market-adjusted discount
rates. Impairment is measured on a disaggregated basis based on predominant
risk characteristics of the underlying mortgage loans. The risk
characteristics used by Downey for the purposes of capitalization and
impairment evaluation include loan type, interest rate tranches, loan term
and collateral type. Impairment losses are recognized through a valuation
allowance, with any associated provision recorded as a component of loan
servicing fees.
Derivative Financial Instruments
As part of its secondary marketing activities, Downey utilizes forward sale
contracts to hedge the value of loans originated for sale against adverse
changes in interest rates. These contracts have a high correlation to the
price movement of the loans being hedged. There is no recognition of
unrealized gains and losses on these contracts in the balance sheet or
statement of income. When the related loans are sold, the deferred gains or
losses from these contracts are recognized in the statement of income as a
component of net gains or losses on sales of loans and mortgage-backed
securities.
Loans Receivable Held for Investment
Loans receivable are recorded at cost, net of discounts and premiums,
undisbursed loan proceeds, net deferred fees and costs and the allowance
for loan losses.
Interest income on loans is accrued based on the outstanding principal
amount of loans using the interest method. Discounts and premiums on loans
are amortized to income using the interest method over the remaining period
to contractual maturity. The amortization of discounts into income is
discontinued on loans that are contractually ninety days past due.
Loan origination fees and related incremental direct loan origination costs
are deferred and amortized to income using the interest method over the
contractual life of the loans, adjusted for actual prepayments. Fees
received for a commitment to originate or purchase a loan or group of loans
are deferred and, if the commitment is exercised, recognized over the life
of the loan as an adjustment of yield or, if the commitment expires
unexercised, recognized as income upon expiration of the commitment. The
amortization of deferred fees and costs is discontinued on loans that are
contractually ninety days past due.
Accrued interest on loans that are contractually ninety days or more past
due or when collection of interest appears doubtful is generally reversed
and charged against interest income. Income is subsequently recognized only
to the extent cash payments are received and the principal balance is
expected to be recovered. Such loans are restored to an accrual status only
if the loan is brought contractually current and the borrower has
demonstrated the ability to make future payments of principal and interest.
Allowance for Loan Losses
The allowance for loan losses is maintained at an amount management deems
adequate to cover estimated losses. Downey has implemented and adheres to
an internal asset review system and loan loss allowance methodology
designed to provide for the detection of problem assets and adequate
general valuation allowances to cover loan losses. In determining the
allowance for loan losses related to specific major loans, management
evaluates its allowance on an individual loan basis, including an analysis
of the creditworthiness, cash flows and financial status of the borrower,
and the condition and the estimated value of the collateral. Downey reviews
all loans under $1 million by analyzing their performance and composition
of their collateral as a whole, because of the relatively homogeneous
nature of the portfolios. Specific valuation allowances for secured loans
are determined by the excess of
55
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
the recorded investment in the loan over the fair value, where appropriate,
of the collateral. In determining overall general valuation allowances to
be maintained and the loan loss allowance ratios, management evaluates many
factors including prevailing and forecasted economic conditions, regular
reviews of the quality of loans by Downey's Internal Asset Review
Committee, industry experience, historical loss experience, year of
origination, composition and geographic concentrations of the loan
portfolio, the borrowers' ability to repay and repayment performance and
estimated collateral values.
Downey considers a loan to be impaired when, based upon current information
and events, it believes it is probable that Downey will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. In determining impairment, Downey considers large
non-homogeneous loans with the following characteristics: non-accrual
loans, debt restructurings, and performing loans which exhibit, among other
characteristics, high loan-to-value ratios or delinquent taxes. Downey
bases the measurement of collateral dependent impaired loans on the fair
value of the loan's collateral. Non-collateral dependent loans are valued
based on a present value calculation of expected future cash flows,
discounted at the loan's effective rate. Cash receipts on impaired loans
not performing according to contractual terms are generally used to reduce
the carrying value of the loan, unless Downey believes it will recover the
remaining principal balance of the loan. Impairment losses are included in
the allowance for loan losses through a charge to provision for loan
losses. Adjustments to impairment losses due to changes in the fair value
of collateral of impaired loans are included in provision for loan losses.
Upon disposition of an impaired loan, loss of principal, if any, is
recorded through a charge-off to the allowance for loan losses.
In the opinion of management, and in accordance with the loan loss
allowance methodology, the present allowance is considered adequate to
absorb estimable and probable loan losses. Additions to the allowances are
reflected in current operations. Charge-offs to the allowance are made when
the loan is considered uncollectible or is transferred to real estate
owned. Recoveries are credited to the allowance.
For regulatory capital purposes, the Bank's general allowance for loan
losses is included to a limit of 1.25% of regulatory risk-weighted assets.
Loan Servicing
Downey services mortgage loans for investors. Fees earned for servicing
loans owned by investors are reported as income when the related mortgage
loan payments are collected. Loan servicing costs are charged to expense as
incurred.
Investment in Real Estate and Joint Ventures
Real estate held for investment or under development is held at the lower
of cost (less accumulated depreciation) or fair value. Costs, including
interest, of holding real estate in the process of development or
improvement are capitalized, whereas costs relating to holding completed
property are expensed. An allowance for losses is established by a charge
to operations if the carrying value of a property exceeds its fair value,
including the consideration of disposition costs.
Downey utilizes the equity method of accounting for investments in
non-controlled joint ventures, and the consolidation method for investments
in controlled joint ventures. All intercompany profits are eliminated.
Income from the sale of real estate is recognized principally when title to
the property has passed to the buyer, minimum down payment requirements are
met, and the terms of any notes received by Downey satisfy continuing
investment requirements. At the time of sale, costs are relieved from real
estate projects on a relative sales value basis and charged to operations.
56
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Real Estate Acquired in Settlement of Loans
Real estate acquired through foreclosure is initially recorded at fair
value (net of an allowance for estimated selling costs and delinquent
property taxes) at the date of foreclosure, and a valuation allowance is
established for any subsequent declines in fair value. All legal fees and
direct costs, including foreclosure and other related costs, are expensed
as incurred.
Premises and Equipment
Buildings, leasehold improvements and furniture, fixtures, and equipment
are carried at cost, less accumulated depreciation and amortization.
Buildings and furniture, fixtures, and equipment are depreciated using the
straight-line method over the estimated useful lives of the assets. The
cost of leasehold improvements is being amortized using the straight-line
method over the shorter of the estimated useful life of the asset or the
terms of the related leases.
Impairment of Long-Lived Assets
Downey reviews long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying
amount of an asset to future net cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the
assets exceed the fair value of the assets. Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs to
sell.
Securities Sold Under Agreements to Repurchase
Downey 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 Downey's
consolidated financial statements. The securities collateralizing reverse
repurchase agreements are delivered to several major national brokerage
firms who arranged the transactions. These securities are reflected as
assets in Downey'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 Downey at the
maturity of the agreements.
Income Taxes
Downey applies the asset and liability method of accounting for income
taxes. The asset and liability method recognizes deferred income taxes for
the tax consequences of "temporary differences" by applying enacted
statutory tax rates applicable to future years to differences between the
financial statement carrying amounts and the tax bases of existing assets
and liabilities. The effect on deferred taxes of a change in tax rates is
recognized in income in the period that includes the enactment date.
Deferred tax assets are to be recognized for temporary differences that
will result in deductible amounts in future years and for tax carryforwards
if, in the opinion of management, it is more likely than not that the
deferred tax assets will be realized.
Stock Option Plan
Prior to January 1, 1996, Downey accounted for its stock option plan in
accordance with the provisions of Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25"), and related
interpretations. As such, compensation expense would be recorded on the
date of grant only if the current market price of the underlying stock
exceeded the exercise price. On January 1, 1996, Downey adopted Statement
of
57
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), which permits entities to recognize as expense
over the vesting period the fair value of all stock-based awards on the
date of grant. Alternatively, SFAS 123 also allows entities to continue to
apply the provisions of APB 25 and provide pro forma net income and pro
forma net income per share disclosures for employee stock option grants
made in 1995 and future years as if the fair-value-based method defined in
SFAS 123 had been applied. Downey has elected to continue to apply the
provisions of APB 25 and provide the pro forma disclosure provisions of
SFAS 123.
Per Share Information
Downey adopted, effective December 31, 1997, Statement of Accounting
Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS 128 simplifies
the standards for computing and presenting earnings per share ("EPS") as
previously prescribed by Accounting Principles Board Opinion No. 15,
"Earnings per Share." SFAS 128 replaces primary EPS with basic EPS and
fully diluted EPS with diluted EPS. Basic EPS excludes dilution and is
computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding for the period.
Diluted EPS reflects the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into
common stock or resulted from issuance of common stock that then shared in
earnings.
Current Accounting Pronouncement
In September 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131").
SFAS 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements
and requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. It
also establishes standards for related disclosures about products and
services, geographic areas and major customers. SFAS 131 supersedes FASB
Statement No. 14, "Financial Reporting for Segments of a Business
Enterprise," but retains the requirement to report information about major
customers. It amends FASB Statement No. 94, "Consolidation of All
Majority-Owned Subsidiaries," to remove the special disclosure requirements
for previously unconsolidated subsidiaries.
SFAS 131 requires that a public business enterprise report financial and
descriptive information about its reportable operating segments. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. Generally, financial information is required to be reported on
the basis that it is used internally for evaluating segment performance and
deciding how to allocate resources to segments.
SFAS 131 requires that a public business enterprise report a measure of
segment profit or loss, certain specific revenue and expense items, and
segment assets. It requires reconciliations of total segment revenues,
total segment profit or loss, total segment assets, and other amounts
disclosed for segments to corresponding amounts in the enterprise's
general-purpose financial statements. It requires that all public business
enterprises report information about the revenues derived from the
enterprise's products or services (or groups of similar products and
services), for the countries in which the enterprise earns revenues and
holds assets, and about major customers regardless of whether that
information is used in making operating decisions. However, SFAS 131 does
not require an enterprise to report information that is not prepared for
internal use if reporting it would be impracticable.
SFAS 131 also requires that a public business enterprise report descriptive
information about the way that the operating segments were determined, the
products and services provided by the operating segments, differences
between the measurements used in reporting segment information and those
used in the enterprise's general-purpose financial statements, and changes
in the measurement of segment amounts from period to period.
SFAS 131 is effective for financial statements for periods beginning after
December 15, 1997. In the initial
58
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
year of application, comparative information for earlier years is to be
restated. SFAS 131 need not be applied to interim financial statements in
the initial year of its application, but comparative information for
interim periods in the initial year of application is to be reported in
financial statements for interim periods in the second year of application.
(2) Business Combination
During 1988, the Bank acquired Butterfield Savings and Loan Association,
FSA ("Butterfield") from the Federal Savings and Loan Insurance Corporation
("FSLIC") in a FSLIC assisted acquisition.
Concurrent with the acquisition, the Bank and the FSLIC entered into an
assistance agreement ("Butterfield Assistance Agreement") that provides for
the indemnification of the Bank against losses incurred on the disposal of
certain defined covered assets and the settlement of certain unreserved
preacquisition liabilities or contingencies reduced by tax benefits
associated with those expenses as defined. Additionally, the FSLIC agreed
to provide yield maintenance assistance on certain covered assets at the
Federal Home Loan Bank ("FHLB") Eleventh District Cost of Funds Index
("COFI"). All such amounts received are nontaxable under the Internal
Revenue Code.
During 1995, the estimated losses on covered assets which were covered by
the Butterfield Assistance Agreement totaled $12.9 million. The yield
maintenance on covered assets totaled $0.6 million for 1995, and is
included in interest income. The remaining covered assets which consist
primarily of real estate of $9.2 million and loans receivable of $2.5
million were repurchased by the Federal Deposit Insurance Corporation
("FDIC") on December 29, 1995, as it exercised its right under the
Butterfield Assistance Agreement.
As all assets subject to the Butterfield Assistance Agreement have been
sold or repurchased by the FDIC, Downey and the FDIC terminated the
Butterfield Assistance Agreement on March 31, 1997.
(3) U.S. Treasury and Agency Obligations and Other Investment Securities
Available for Sale
The amortized cost and estimated market value of U.S. Treasury and agency
obligations and other investment securities available for sale are
summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In Thousands) Cost Gains Losses Value
---------------------------------------------------------------------------
December 31, 1997 ........ $160,089 $ 441 $ 1,132 $159,398
===========================================================================
December 31, 1996 ........ $145,025 $ 317 $ 3,343 $141,999
===========================================================================
The amortized cost and estimated market value of U.S. Treasury and agency
obligations and other securities available for sale at December 31, 1997,
by contractual maturity, are shown below.
Amortized Market
(In Thousands) Cost Value
----------------------------------------------------------------
Due in one year or less ................. $ 9,990 $ 9,999
Due after one year through five years (1) 150,099 149,399
----------------------------------------------------------------
Total ................................. $160,089 $159,398
================================================================
(1) No investment matures beyond five years.
59
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Proceeds, gross realized gains and losses on the sales of U.S. Treasury and
agency obligations and other investment securities available for sale are
summarized as follows:
(In Thousands) 1997 1996 1995
------------------------------------------------------
Proceeds ................ $ -- $189,541 $ --
======================================================
Gross realized gains .... $ -- $ 4,578 $ --
======================================================
Gross realized losses ... $ -- $ 105 $ --
======================================================
Net unrealized losses on investment securities available for sale were
recognized in stockholders' equity in the amount of $0.7 million, or $0.4
million net of income taxes, at December 31, 1997, compared to net
unrealized losses of $3.0 million, or $1.7 million net of income taxes, at
December 31, 1996.
(4) Loans and Mortgage-Backed Securities Purchased Under Resale Agreements,
U.S. Treasury and Agency Obligations and Other Investment Securities Held
to Maturity
Loans and Mortgage-Backed Securities Purchased Under Resale Agreements
There were no loans or mortgage-backed securities purchased under resale
agreements at December 31, 1997 or 1996. The average interest rate and
balance was 5.72% and $8.0 million, respectively, during 1997, and 5.52%
and $18.1 million, respectively, during 1996. The maximum amount
outstanding at any month-end during 1997 and 1996 was $20.0 million and
$40.0 million, respectively.
U.S. Treasury and Agency Obligations and Other Investment Securities
The loss on sale during 1995 of $15,000 was realized upon the in-substance
maturity of $15.0 million in U.S. Treasury obligations.
Municipal Securities Held to Maturity
The amortized cost and estimated market value of municipal securities held
to maturity are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In Thousands) Cost Gains Losses Value
------------------------------------------------------------------------
December 31, 1997 ..... $6,885 $ -- $ 20 $6,865
========================================================================
December 31, 1996 ..... $6,997 $ -- $ 22 $6,975
========================================================================
The investment at December 31, 1997 and 1996 represents an industrial
revenue bond on which the interest income is not subject to federal income
taxes.
60
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(5) Mortgage-Backed Securities Available for Sale
The amortized cost and estimated market value of the mortgage-backed
securities available for sale are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In Thousands) Cost Gains Losses Value
-------------------------------------------------------------------------
December 31, 1997:
GNMA certificates ..... $ 9,623 $ 459 $ -- $10,082
FNMA certificates ..... 201 9 -- 210
FHLMC certificates .... 19,659 -- 163 19,496
Non-agency certificates 18,933 583 5 19,511
-------------------------------------------------------------------------
Total ............... $48,416 $ 1,051 $ 168 $49,299
=========================================================================
December 31, 1996:
GNMA certificates ..... $11,669 $ 241 $ 6 $11,904
FNMA certificates ..... 225 9 -- 234
FHLMC certificates .... 23,475 -- 351 23,124
Non-agency certificates 25,607 596 198 26,005
-------------------------------------------------------------------------
Total ............... $60,976 $ 846 $ 555 $61,267
=========================================================================
Net unrealized gains on mortgage-backed securities available for sale were
recognized in stockholders' equity in the amount of $0.9 million, or $0.5
million net of income taxes, at December 31, 1997. At December 31, 1996,
net unrealized gains were recognized in stockholders' equity in the amount
of $0.3 million, or $0.2 million net of income taxes.
Proceeds, gross realized gains and losses on the sales of mortgage-backed
securities available for sale are summarized as follows:
(In Thousands) 1997 1996 1995
------------------------------------------------------
Proceeds ............... $88,723 $31,314 $21,135
======================================================
Gross realized gains ... $ 728 $ 809 $ 46
======================================================
Gross realized losses .. $ 928 $ 221 $ 283
======================================================
61
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(6) Loans Receivable
Loans receivable are summarized as follows:
December 31,
--------------------------
(In Thousands) 1997 1996
-----------------------------------------------------------------------------
Held for investment:
Loans secured by real estate:
Residential:
One-to-four units ........................ $ 4,358,475 $ 4,013,190
One-to-four units - subprime ............. 249,070 33,258
Five or more units ....................... 38,278 56,907
Commercial real estate ..................... 202,425 260,609
Construction ............................... 70,865 66,651
Land ....................................... 25,687 21,177
Non-mortgage:
Commercial ................................. 26,024 22,136
Consumer:
Automobile ............................... 342,326 202,186
Other consumer ........................... 47,735 47,281
-----------------------------------------------------------------------------
5,360,885 4,723,395
Less:
Undisbursed loan funds ..................... (64,884) (49,250)
Net deferred costs and premiums ............ 18,088 11,663
Allowance for estimated losses ............. (32,092) (30,094)
-----------------------------------------------------------------------------
Loans receivable held for investment ..... $ 5,281,997 $ 4,655,714
-----------------------------------------------------------------------------
Held for sale:
Loans secured by residential one-to-four units $ 35,100 $ 12,865
=============================================================================
Over 99% of the real estate securing Downey's loans is located in
California.
Downey has had, and expects in the future to have, transactions in the
ordinary course of business with executive officers, directors and their
associates ("related parties") on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for
comparable transactions with other non-related parties. Those transactions
neither involve more than the normal risk of collectibility nor present any
unfavorable features. At December 31, 1997 and 1996, the Bank had extended
loans to certain directors, executive officers and their associates
totaling $27.1 million and $28.8 million, respectively. All such loans are
performing in accordance with their loan terms. Presented below is a
summary of activity with respect to such loans for the years ending
December 31, 1997 and 1996:
(In Thousands) 1997 1996
-----------------------------------------------------
Balance at beginning of period $ 28,835 $ 29,681
Additions .................... 3,857 --
Repayments ................... (5,598) (846)
-----------------------------------------------------
Balance at end of period ..... $ 27,094 $ 28,835
=====================================================
62
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
A summary of activity in the allowance for loan losses for loans receivable
held for investment during 1997, 1996 and 1995 follows:
Not
Real Other Specifically
(In Thousands) Estate Commercial Automobile Consumer Allocated Total
---------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 ........... $ 21,189 $ 472 $ 42 $ 1,094 $ 2,800 $ 25,597
Provision for (reduction of) loan losses 8,116 (365) 1,205 337 -- 9,293
Charge-offs ............................ (7,247) -- (401) (316) -- (7,964)
Recoveries ............................. 855 152 3 7 -- 1,017
---------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 ........... 22,913 259 849 1,122 2,800 27,943
Provision for (reduction of) loan losses 3,874 92 5,245 (74) -- 9,137
Charge-offs ............................ (5,200) (115) (2,096) (249) -- (7,660)
Recoveries ............................. 366 -- 305 3 -- 674
---------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 ........... 21,953 236 4,303 802 2,800 30,094
Provision for (reduction of) loan losses 207 (40) 8,181 292 -- 8,640
Charge-offs ............................ (2,389) -- (5,109) (275) -- (7,773)
Recoveries ............................. 485 -- 641 5 -- 1,131
---------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 ........... $ 20,256 $ 196 $ 8,016 $ 824 $ 2,800 $ 32,092
===============================================================================================================
Net charge-offs represented 0.13%, 0.16% and 0.17% of average loans for
1997, 1996 and 1995, respectively.
All impaired loans at December 31, 1997 and 1996 were secured by commercial
real estate. The following table presents impaired loans with specific
allowances and the amount of such allowances, and impaired loans without
specific allowances.
Net Specific Net
(In Thousands) Carrying Value Allowance Balance
-------------------------------------------------------------------------------
December 31, 1997:
Loans with specific allowances .. $ -- $ -- $ --
Loans without specific allowances 13,798 -- 13,798
-------------------------------------------------------------------------------
Total impaired loans ............ $13,798 $ -- $13,798
===============================================================================
December 31, 1996:
Loans with specific allowances .. $ 2,967 $ (276) $ 2,691
Loans without specific allowances 43,763 -- 43,763
-------------------------------------------------------------------------------
Total impaired loans ............ $46,730 $ (276) $46,454
===============================================================================
The average recorded investment in impaired loans during 1997 totaled $15.1
million and $45.8 million in 1996. During 1997, total interest recognized
on the impaired loan portfolio, on a cash basis, was $2.0 million, compared
to $3.5 million in 1996.
The combined weighted average interest yield on loans receivable held for
investment and sale was 7.96% and 7.77% as of December 31, 1997 and 1996,
respectively, and averaged 7.81%, 7.72% and 7.20% during 1997, 1996 and
1995, respectively.
The aggregate amount of non-accrual loans receivable that are contractually
past due 90 days or more as
63
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
to principal or interest, in the foreclosure process, restructured, or upon
which interest collection is doubtful were $41.7 million and $45.0 million
as of December 31, 1997 and 1996, respectively. There were no troubled debt
restructurings on accrual status as of December 31, 1997 and 1996.
Interest due on non-accrual loans but excluded from interest income was
approximately $1.8 million for 1997, $4.1 million for 1996 and $6.1 million
for 1995.
(7) Loan Servicing
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of mortgage
loans serviced for others was $612.5 million and $576.0 million at December
31, 1997 and 1996, respectively.
Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in demand deposits, were $2.1 million and $2.0
million at December 31, 1997 and 1996, respectively.
Mortgage servicing rights of $1.2 million and $1.0 million related to loans
sold with servicing rights retained were capitalized in 1997 and 1996,
respectively, and $0.4 million related to purchased servicing rights was
capitalized in 1995. Mortgage servicing rights have been written down to
their fair value of $2.0 million, $1.2 million and $0.4 million at December
31, 1997, 1996 and 1995, respectively. Amortization of mortgage servicing
rights was $295,000 in 1997, $179,000 in 1996 and $48,000 in 1995.
Starting in 1996, a valuation reserve was provided for mortgage servicing
rights. The allowance for mortgage servicing rights during 1997 and 1996
are summarized as follows:
(In Thousands) 1997 1996
-----------------------------------------------
Balance at beginning of period $ 101 $--
Additions .................... 249 129
Reductions ................... (144) (28)
-----------------------------------------------
Balance at end of period ..... $ 206 $ 101
===============================================
64
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(8) Investments in Real Estate and Joint Ventures
Investments in real estate and joint ventures are summarized as follows:
December 31,
--------------------
(In Thousands) 1997 1996
-------------------------------------------------------------------------------------
Gross investments in real estate ............................. $ 63,321 $ 66,745
Accumulated depreciation ..................................... (9,432) (11,094)
Allowance for estimated losses ............................... (19,617) (22,294)
-------------------------------------------------------------------------------------
Investments in real estate (1) ............................ 34,272 33,357
-------------------------------------------------------------------------------------
Investments in and interest bearing advances to joint ventures 8,711 20,918
Joint venture valuation allowance ............................ (1,627) (7,777)
-------------------------------------------------------------------------------------
Investments in joint ventures ............................. 7,084 13,141
-------------------------------------------------------------------------------------
Total investments in real estate and joint ventures ....... $ 41,356 $ 46,498
=====================================================================================
(1) Includes $0.4 million and $0.6 million at December 31, 1997 and 1996,
respectively, associated with three single family housing developments
which are joint ventures for legal purposes. They are reported as
wholly owned for financial reporting purposes because DSL Service
Company assumed operating control effective in the fourth quarter of
1993.
The table set forth below describes the type, location, and amount invested
in real estate and joint ventures, net of specific valuation allowances of
$19.5 million and general valuation allowances of $1.7 million, at December
31, 1997:
(In Thousands) California Arizona Other Total
-------------------------------------------------------------------------------------------------
Shopping centers ..................................... $18,061 $17,954 $ -- $36,015
Office buildings ..................................... 573 -- -- 573
Residential .......................................... 2,250 -- -- 2,250
Land ................................................. 3,490 309 459 4,258
-------------------------------------------------------------------------------------------------
Total real estate before general valuation allowance $24,374 $18,263 $ 459 $43,096
=================================================================================================
General valuation allowance (1,740)
------
Net investment in real estate and joint ventures $41,356
======
65
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
A summary of real estate and joint venture operations included in Downey's
results of operations follows:
(In Thousands) 1997 1996 1995
----------------------------------------------------------------------------------------
Wholly owned operations:
Rental operations:
Rental income .................................. $ 4,689 $ 4,649 $ 5,837
Costs and expenses ............................. (2,372) (2,232) (2,126)
----------------------------------------------------------------------------------------
Net rental operations ....................... 2,317 2,417 3,711
Net gains on sales of real estate ................. 2,904 392 4,539
Reduction of losses on real estate ................ 985 1,263 2,085
----------------------------------------------------------------------------------------
Total wholly owned operations .................. 6,206 4,072 10,335
----------------------------------------------------------------------------------------
Joint venture operations:
Equity in net income (loss) from joint ventures ... 3,931 55 (1,676)
Reduction of losses provided by DSL Service Company 2,205 2,043 831
----------------------------------------------------------------------------------------
Net joint venture operations ................... 6,136 2,098 (845)
Interest from joint venture advances ................ 1,880 2,071 1,702
----------------------------------------------------------------------------------------
Total joint venture operations .................... 8,016 4,169 857
----------------------------------------------------------------------------------------
Total .......................................... $ 14,222 $ 8,241 $ 11,192
========================================================================================
Activity in the allowance for losses on real estate and investments in
joint ventures for 1997, 1996 and 1995 is as follows:
Real Estate Commercial Residential Investments
Held for Real Estate Real Estate In
or Under Held for Held for Joint
(In Thousands) Development Investment Investment Ventures Total
----------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 ................ $ 6,173 $ 8,093 $ 12,328 $ 10,604 $ 37,198
Reduction of estimated losses ............... (206) (1,410) (469) (831) (2,916)
Charge-offs ................................. -- -- -- -- --
Recoveries .................................. -- -- -- 56 56
----------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 ................ 5,967 6,683 11,859 9,829 34,338
Provision for (reduction of) estimated losses 50 (1,567) 254 (2,043) (3,306)
Charge-offs ................................. (680) -- (272) (83) (1,035)
Recoveries .................................. -- -- -- 74 74
----------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 ................ 5,337 5,116 11,841 7,777 30,071
Provision for (reduction of) estimated losses 492 (1,403) (74) (2,205) (3,190)
Charge-offs ................................. -- (1,692) -- (3,945) (5,637)
Recoveries .................................. -- -- -- -- --
----------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 ................ $ 5,829 $ 2,021 $ 11,767 $ 1,627 $ 21,244
================================================================================================================
66
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Condensed financial information of joint ventures reported on the equity
method is as follows:
Condensed Combined Balance Sheets - Joint Ventures
December 31,
----------------------
(In Thousands) 1997 1996
------------------------------------------------------------------------------------
Assets
Cash ...................................................... $ 1,703 $ 1,778
Projects under development ................................ 964 13,039
Completed projects ........................................ 64,138 91,049
Other assets .............................................. 5,057 6,310
------------------------------------------------------------------------------------
$ 71,862 $ 112,176
====================================================================================
Liabilities and Equity
Liabilities:
Notes payable to the Bank .............................. $ 52,992 $ 77,598
Notes payable to others ................................ 13,858 28,562
Other .................................................. 9,940 11,152
Equity (deficit):
DSL Service Company (1) ................................ 7,084 13,141
Allowance for losses recorded by DSL Service Company (2) 1,627 7,777
Other partners' (2) .................................... (13,639) (26,054)
------------------------------------------------------------------------------------
Net deficit .......................................... (4,928) (5,136)
------------------------------------------------------------------------------------
$ 71,862 $ 112,176
====================================================================================
(1) Included in these amounts are interest-bearing joint venture advances
with priority interest payments from joint ventures to DSL Service
Company.
(2) The aggregate other partners' deficit of $13.6 million and $26.1
million at December 31, 1997 and 1996, respectively, represents their
equity interest in the accumulated retained earnings (deficit) of the
respective joint ventures. Those results include not only the net
profit on sales and the operating results of the real estate assets,
but depreciation expense and funding costs as well. Except for any
secured financing which has been obtained, DSL Service Company has
provided all other financing. As part of Downey's internal asset
review process, the fair value of the joint venture real estate assets
is compared to the secured notes payable to the Bank and others and
DSL Service Company's equity investment. To the extent the fair value
of the real estate assets is less than the aggregate of those amounts,
a provision is made to create a valuation allowance. Those allowances
totaled $1.6 million and $7.8 million at December 31, 1997 and 1996,
respectively. At December 31, 1997, the fair value of the real estate
assets of certain joint venture partnerships in which the other
partners' equity was a deficit exceeded the amount of third party
notes and DSL Service Company's investment thereby eliminating the
need for a valuation allowance since the sale of the real estate would
allow DSL Service Company to realize its investment. Thus, the
aforementioned other partners' deficit of $13.6 million and $26.1
million at December 31, 1997 and 1996, respectively, exceeds the
amount of aforementioned valuation allowances established of $1.6
million and $7.8 million at December 31, 1997 and 1996, respectively.
67
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Condensed Combined Statements of Operations - Joint Ventures
(In Thousands) 1997 1996 1995
--------------------------------------------------------------------------------------
Real estate sales:
Sales .......................................... $ 82,696 $ 2,901 $ --
Cost of sales .................................. (72,255) (1,401) --
--------------------------------------------------------------------------------------
Net gains on sales ........................... 10,441 1,500 --
--------------------------------------------------------------------------------------
Rental operations:
Rental income .................................. 8,280 13,674 16,587
Operating expenses ............................. (1,729) (1,781) (3,574)
Interest, depreciation and other expenses ...... (9,130) (14,784) (16,365)
--------------------------------------------------------------------------------------
Net loss on rental operations ................ (2,579) (2,891) (3,352)
--------------------------------------------------------------------------------------
Net income (loss) ................................. 7,862 (1,391) (3,352)
Less other partners' share of net income (loss) ... 3,931 (1,446) (1,676)
--------------------------------------------------------------------------------------
DSL Service Company's share of net income (loss) .. 3,931 55 (1,676)
Reduction of losses provided by DSL Service Company 2,205 2,043 831
--------------------------------------------------------------------------------------
DSL Service Company's share of net income (loss) .. $ 6,136 $ 2,098 $ (845)
======================================================================================
(9) Real Estate Acquired in Settlement of Loans
The type and amount of real estate acquired in settlement of loans is
summarized as follows:
December 31,
---------------------
(In Thousands) 1997 1996
---------------------------------------------------------------------------
One-to-four unit residential ...................... $ 9,295 $ 12,690
Commercial shopping centers ....................... 477 3,754
Land .............................................. 693 712
---------------------------------------------------------------------------
10,465 17,156
Allowance for estimated losses .................... (839) (1,078)
---------------------------------------------------------------------------
Total real estate acquired in settlement of loans $ 9,626 $ 16,078
===========================================================================
A summary of net operation of real estate acquired in settlement of loans
included in Downey's results of operations follows:
(In Thousands) 1997 1996 1995
-----------------------------------------------------------------------------------------------
Net gains on sales (1) ........................................ $(1,299) $ (389) $ (25)
Net operating expense ......................................... 1,376 1,298 1,733
Provision for estimated losses ................................ 1,107 1,658 2,498
-----------------------------------------------------------------------------------------------
Net operations of real estate acquired in settlement of loans $ 1,184 $ 2,567 $ 4,206
===============================================================================================
(1) Includes $1.1 million in 1997 associated with the sale of a shopping
center.
68
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Activity in the allowance for estimated losses on real estate acquired
through foreclosure for 1997, 1996 and 1995 is as follows:
(In Thousands) 1997 1996 1995
--------------------------------------------------------------
Balance at beginning of period $ 1,078 $ 1,217 $ 743
Provision .................... 1,107 1,658 2,498
Charge-offs .................. (1,346) (1,797) (2,024)
--------------------------------------------------------------
Balance at end of period ..... $ 839 $ 1,078 $ 1,217
==============================================================
(10) Premises and Equipment
Premises and equipment are summarized as follows:
December 31,
----------------------
(In Thousands) 1997 1996
------------------------------------------------------------------
Land .................................... $ 23,413 $ 21,287
Building and improvements ............... 86,444 84,612
Furniture, fixtures and equipment ....... 46,970 39,828
Construction in progress ................ 705 37
Other ................................... 76 91
------------------------------------------------------------------
157,608 145,855
Accumulated depreciation and amortization (55,707) (49,212)
------------------------------------------------------------------
Total premises and equipment .......... $ 101,901 $ 96,643
==================================================================
Downey has commitments under long term operating leases, principally for
building space and land. Lease terms generally cover a five-year period.
Rental expense was $1.4 million in 1997, $0.8 million in 1996 and $0.7
million in 1995. The following table summarizes future minimum rental
commitments under noncancelable leases.
(In Thousands)
-----------------------------------------
1998 ........................... $1,418
1999 ........................... 1,194
2000 ........................... 757
2001 ........................... 534
2002 ........................... 126
Thereafter (1) ................. 193
------
Total future lease commitments $4,222
------
(1) There are no lease commitments beyond the year 2009 though options to
renew at that time are available.
(11) Federal Home Loan Bank Stock
The Bank's required investment in FHLB stock, based on December 31, 1997
financial data, was $47.4 million. The investment in FHLB stock amounted to
$44.1 million and $41.4 million at December 31, 1997 and 1996,
respectively. The Bank received a $0.7 million stock dividend and purchased
additional stock amounting to $2.6 million in the first quarter of 1998
thereby increasing the Bank's investment to the required amount.
69
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(12) Other Assets
Other assets are summarized as follows:
December 31,
-----------------
(In Thousands) 1997 1996
----------------------------------------------------------------------
Accounts receivable .............................. $ 3,798 $ 2,465
Accrued interest receivable:
Loans .......................................... 27,279 24,259
Mortgage-backed securities ..................... 281 356
Investment securities .......................... 2,824 2,186
Prepaid expenses ................................. 8,598 7,261
Excess of purchase price over fair value of assets
acquired and liabilities assumed, net .......... 5,054 5,586
Core deposit premium ............................. 214 513
Mortgage servicing rights ........................ 1,945 1,175
Repossessed automobiles, net ..................... 795 928
Other ............................................ 472 661
----------------------------------------------------------------------
Total other assets ............................. $51,260 $45,390
======================================================================
(13) Deposits
Deposits are summarized as follows:
December 31,
-------------------------------------------
1997 1996
-------------------------------------------
Weighted Weighted
Average Average
(Dollars in Thousands) Rate Amount Rate Amount
-------------------------------------------------------------------------------
Transaction accounts (1) ....... 2.15% $ 935,869 2.04% $ 831,598
Certificates of deposit:
Less than 3.00% ............... 2.64 30,623 2.65 39,061
3.00-3.49 ..................... 3.02 766 3.03 723
3.50-3.99 ..................... -- -- 3.99 79
4.00-4.49 ..................... 4.31 60,095 4.39 63,577
4.50-4.99 ..................... 4.87 40,356 4.87 186,576
5.00-5.99 ..................... 5.63 2,896,291 5.54 2,489,852
6.00-6.99 ..................... 6.06 901,920 6.17 536,307
7.00 and greater .............. 7.22 4,058 7.15 25,329
-------------------------------------------------------------------------------
Total certificates of deposit 5.68 3,934,109 5.56 3,341,504
-------------------------------------------------------------------------------
Total deposits .............. 5.00% $4,869,978 4.86% $4,173,102
===============================================================================
(1) Included in these amounts is $106.5 million and $81.0 million of
non-interest bearing accounts at December 31, 1997 and 1996,
respectively
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was $1.1 billion and $0.8 billion at December 31,
1997 and 1996, respectively.
70
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At December 31, 1997, scheduled maturities of certificates of deposit are
as follows:
Weighted
(Dollars in Thousands) Average Rate Amount
------------------------------------------------------
1998 ........................ 5.66% $3,498,980
1999 ........................ 5.82 373,511
2000 ........................ 5.87 28,784
2001 ........................ 5.74 15,096
2002 ........................ 5.92 17,434
Thereafter .................. 6.01 304
------------------------------------------------------
Total ..................... 5.68% $3,934,109
======================================================
The weighted average cost of deposits averaged 4.96%, 4.74% and 4.81%
during 1997, 1996 and 1995, respectively.
As of December 31, 1997 and 1996, public funds of approximately $6.2
million and $1.8 million, respectively, are secured by mortgage loans with
a carrying value of approximately $9.3 million and $2.6 million,
respectively.
Interest expense on deposits by type is summarized as follows:
(In Thousands) 1997 1996 1995
-----------------------------------------------------------------
Transaction accounts ........... $ 18,239 $ 16,087 $ 14,028
Certificate accounts ........... 209,282 168,315 166,831
-----------------------------------------------------------------
Total deposit interest expense $227,521 $184,402 $180,859
=================================================================
Accrued interest on deposits, which is included in accounts payable and
accrued liabilities, was $2.3 million at both December 31, 1997 and 1996.
(14) Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase are summarized as follows:
(Dollars in Thousands) 1997 1996 1995
-------------------------------------------------------------------------------------------
Balance at year end ....................................... $34,803 $ -- $16,099
Average balance outstanding during the year ............... 4,029 11,761 36,676
Maximum amount outstanding at any month-end during the year 34,803 70,015 52,547
Weighted average interest rate during the year ............ 5.61% 5.19% 6.21%
Weighted average interest rate at year end ................ 6.65 -- 5.90
Secured by:
U.S. Treasury note ..................................... $34,798 $ -- $ --
Mortgage-backed securities ............................. -- -- 17,342
===========================================================================================
The securities collateralizing these transactions were delivered to major
national brokerage firms who arranged the transactions. Securities sold
under agreements to repurchase generally mature within 30 days of the
various dates of sale.
71
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(15) Federal Home Loan Bank Advances
FHLB advances are summarized as follows:
(Dollars in Thousands) 1997 1996 1995
----------------------------------------------------------------------------------------------
Balance at year end ....................................... $352,458 $386,883 $220,715
Average balance outstanding during the year ............... 444,408 266,252 284,003
Maximum amount outstanding at any month-end during the year 550,736 397,147 473,800
Weighted average interest rate during the year ............ 6.02% 5.85% 6.30%
Weighted average interest rate at year end ................ 6.11 5.80 6.07
Secured by:
Loans receivable ........................................ $368,480 $345,463 $276,375
Mortgage-backed securities .............................. 25,527 31,651 10,523
FHLB stock .............................................. -- 41,447 39,146
==============================================================================================
In addition to the collateral securing existing advances, Downey had an
additional $1.2 billion in loans available as collateral for any future
advances as of December 31, 1997.
FHLB advances have the following maturities at December 31, 1997:
(In Thousands)
------------------------------------------
1998 ........................ $272,131
1999 ........................ 36,488
2000 ........................ 24,220
2001 ........................ 12,951
2002 ........................ 3,868
Thereafter .................. 2,800 (1)
------------------------------------------
Total ..................... $352,458
==========================================
(1) Includes a $1.8 million advance which carries a penalty-free
prepayment option beginning in April 1996 and every six months
thereafter.
72
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(16) Commercial Paper
Commercial paper borrowings are summarized as follows:
(Dollars in Thousands) 1997 1996 1995
----------------------------------------------------------------------------------------------
Balance at year end ....................................... $ 83,811 $198,113 $196,602
Average balance outstanding during the year ............... 182,296 174,739 191,313
Maximum amount outstanding at any month-end during the year 272,818 198,113 198,341
Weighted average interest rate during the year ............ 5.75% 5.74% 6.38%
Weighted average interest rate at end of year ............. 5.61 5.45 5.56
Secured by:
FHLB Letter of Credit (1) ............................... $300,000 $200,000 $200,000
==============================================================================================
(1) This letter of credit is secured by loans receivable of $348 million
at December 31, 1997.
Commercial paper borrowings at December 31, 1997 bear interest rates
ranging from 5.57% to 5.68% and mature within six months of year end.
(17) Other Borrowings
Other borrowings are summarized as follows:
December 31,
------------------
(Dollars In Thousands) 1997 1996
-------------------------------------------------------------------------------------------
Long-term notes payable to banks, secured by real estate and mortgage
loans with a carrying value of $17,725 at December 31, 1997, bearing
interest
rates from 7.50% to 9.21% ......................................... $12,663 $10,349
===========================================================================================
Other borrowings have the following maturities at December 31, 1997:
(In Thousands)
-----------------------------------------
1998 ........................ $ 2,224
1999 ........................ 2,415
2000 ........................ 2,211
2001 ........................ 1,106
2002 ........................ 927
Thereafter .................. 3,780
-----------------------------------------
Total ..................... $12,663
=========================================
73
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(18) Income Taxes
Income taxes are summarized as follows:
(In Thousands) 1997 1996 1995
--------------------------------------------------------------------
Federal:
Current ...................... $ 26,681 $ 8,310 $ 11,538
Deferred ..................... (886) 3,317 17
--------------------------------------------------------------------
$ 25,795 $ 11,627 $ 11,555
====================================================================
State:
Current ...................... $ 7,373 $ 2,602 $ 2,144
Deferred ..................... 1,032 1,521 1,898
--------------------------------------------------------------------
$ 8,405 $ 4,123 $ 4,042
====================================================================
Total:
Current ...................... $ 34,054 $ 10,912 $ 13,682
Deferred ..................... 146 4,838 1,915
--------------------------------------------------------------------
Total ..................... $ 34,200 $ 15,750 $ 15,597
====================================================================
Current income taxes payable were $11.0 million and $0.6 million at
December 31, 1997 and 1996, respectively.
74
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Deferred tax liabilities (assets) are comprised of the following temporary
differences between the financial statement carrying amounts and the tax
bases of assets:
December 31,
--------------------
(In Thousands) 1997 1996
---------------------------------------------------------------------------------
Deferred tax liabilities:
Tax reserves in excess of base year .................. $ 21,095 $ 22,652
Deferred loan fees ................................... 19,498 22,049
Equity in joint ventures ............................. 7,260 2,250
FHLB stock dividends ................................. 5,600 4,777
Installment sales .................................... 5,011 5,927
Depreciation on premises and equipment ............... 4,497 1,012
Capitalized interest ................................. 1,530 1,730
Accrual to cash adjustment ........................... 259 422
Unrealized gains on investment securities (1) ........ 86 --
SAIF insurance premiums .............................. 62 2,544
Other deferred income items .......................... 54 118
---------------------------------------------------------------------------------
64,952 63,481
---------------------------------------------------------------------------------
Deferred tax assets:
Loan valuation allowances, net of bad debt charge-offs (32,875) (31,573)
Real estate and joint venture valuation allowances ... (15,190) (16,150)
California franchise tax ............................. (2,941) (1,475)
Deferred compensation ................................ (1,899) (2,244)
Mark to market adjustment on securities held for sale (217) (20)
Interest expense on deferred gain .................... (131) (107)
Unrealized losses on investment securities (1) ....... -- (1,177)
Alternative minimum tax credit carryforward .......... -- (734)
Other deferred expense items ......................... (512) (219)
---------------------------------------------------------------------------------
(53,765) (53,699)
Deferred tax assets valuation allowance .................. -- --
---------------------------------------------------------------------------------
Net deferred tax liability ............................... $ 11,187 $ 9,782
=================================================================================
(1) Generally accepted accounting principles require the tax effect of
unrealized gains and losses on securities available for sale to be
reported as a separate component of stockholders' equity.
75
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
A reconciliation of income taxes (benefits) to the expected statutory
federal corporate income taxes follows:
1997 1996 1995
---------------------------------------------------------------
(Dollars in Thousands) Amount Percent Amount Percent Amount Percent
-----------------------------------------------------------------------------------------------------------------
Expected statutory income taxes ............... $ 27,802 35.0% $ 12,759 35.0% $ 12,842 35.0%
California franchise tax, net of federal income
tax benefit ............................... 5,461 6.9 2,680 7.4 2,640 7.2
Increase (decrease) resulting from:
Non-taxable federal financial assistance .. -- -- -- -- (223) (0.6)
Amortization of goodwill .................. 291 0.4 295 0.8 295 0.8
Interest on municipal bonds ............... (103) (0.1) (103) (0.3) (21) (0.1)
Interest expense on deferred gain ......... 58 0.1 -- -- -- --
Other ..................................... 691 0.8 119 0.3 64 0.2
-----------------------------------------------------------------------------------------------------------------
Income taxes .................................. $ 34,200 43.1% $ 15,750 43.2% $ 15,597 42.5%
=================================================================================================================
The Small Business Job Protection Act of 1996 repealed the reserve method
of accounting for bad debts by savings institutions for years beginning
after 1995. Under prior law, savings associations calculated additions to
reserves using either a percentage-of-taxable-income or historical loan
loss experience. The new law allows deductions for bad debts only when such
debts are actually charged off against income (the "specific charge-off"
method). Downey calculated its bad debt deduction for 1997 and 1996 under
the specific charge-off method.
Downey made income tax payments, net of refunds, amounting to $23.6
million, $19.8 million, and $14.0 million in 1997, 1996 and 1995,
respectively.
Downey and its wholly owned subsidiaries file a consolidated federal income
tax return and a combined California franchise tax report on a calendar
year basis. Downey's federal and state tax returns have been examined by
the Internal Revenue Service and the Franchise Tax Board of California,
respectively, for all prior years through 1989. Federal income tax returns
for years 1990 through 1995 are currently under examination. State
franchise tax returns for years subsequent to 1989 remain open to review.
76
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(19) Stockholders' Equity
Regulatory Capital
Downey is not subject to any regulatory capital requirements. However, the
Bank is subject to regulation by the Office of Thrift Supervision ("OTS")
which has adopted regulations ("Capital Regulations") that contain a
capital standard for savings institutions. The Bank is in compliance with
the Capital Regulations at December 31, 1997 and 1996.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------- ------------------- ------------------
(Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio
---------------------------------------------------------------------------------------------------
1997
Risk-based capital
(to risk-weighted assets) $ 413,392 12.64% $ 261,567 8.00% $ 326,959 10.00%
Core capital
(to adjusted assets) .... 381,679 6.61 173,229 3.00 288,715 5.00
Tangible capital
(to adjusted assets) .... 381,679 6.61 86,614 1.50 -- -- (1)
Tier I capital
(to risk-weighted assets) 381,679 11.67 -- -- (1) 196,175 6.00
===================================================================================================
1996
Risk-based capital
(to risk-weighted assets) $ 366,079 12.66% $ 231,376 8.00% $ 289,220 10.00%
Core capital
(to adjusted assets) .... 336,921 6.56 153,976 3.00 256,627 5.00
Tangible capital
(to adjusted assets) .... 336,921 6.56 76,988 1.50 -- -- (1)
Tier I capital
(to risk-weighted assets) 336,921 11.65 -- -- (1) 173,532 6.00
===================================================================================================
(1) Ratio is not specified under capital regulations.
Capital Distributions
The OTS rules impose certain limitations regarding stock repurchases and
redemptions, cash-out mergers and any other distributions charged against
an institution's capital accounts. The payment of dividends by the Bank is
subject to OTS regulations. Safe-harbor amounts of capital distributions
can be made after providing notice to the OTS, but without needing prior
approval. For institutions, such as the Bank, that meet their capital
requirements, the safe-harbor amount is the greater of (a) 75% of net
income for the prior four quarters, or (b) the sum of (1) the current
year's net income and (2) the amount that causes the excess of the
institution's total capital-to-risk weighted assets ratio over 8% to be
only one-half of such excess at the beginning of the year. Institutions can
distribute amounts in excess of the safe-harbor amounts only with the prior
approval of the OTS.
As of December 31, 1997, the Bank had the capacity to declare dividends
totaling $75.4 million under the safe-harbor limitations.
77
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Stock Dividend
On April 23, 1997, the Board of Directors declared a five percent stock
dividend on Downey's common stock payable on May 22, 1997 to stockholders
of record on May 8, 1997. The stock dividend resulted in the issuance of
1,272,542 shares and the par value of the common stock remained at $0.01.
Accordingly, $13,000 and $23,012,000 were transferred from retained
earnings to common stock and additional paid-in-capital, respectively. All
share and per share data, including stock option plan information, have
been restated to reflect this distribution.
Employee Stock Option Plans
During 1994, the Bank adopted and the stockholders approved the Downey
Savings and Loan Association 1994 Long Term Incentive Plan (the "LTIP").
The LTIP provides for the granting of stock appreciation rights, restricted
stock, performance awards and other awards. The LTIP specifies an
authorization of 413,438 shares (adjusted for stock dividends and splits)
of the Bank's common stock available for issuance under the LTIP. Effective
January 23, 1995, Downey Financial Corp. and the Bank executed an amendment
to the LTIP by which Downey Financial Corp. adopted and ratified the LTIP
such that shares of Downey Financial Corp. shall be issued upon exercise of
options or payment of other awards, for which payment is to be made in
stock, in lieu of the Bank's common stock.
During 1997, no options were granted under the LTIP, compared to 15,750 in
1996.
Options outstanding under the LTIP at December 31, 1997 and 1996 are
summarized as follows:
Outstanding Options
--------------------
Number Average
of Option
Shares Price
------------------------------------------------------
December 31, 1995 ............ 343,353 $ 13.38
Options granted .............. 15,750 16.19
Options canceled and exercised (32,288) 13.90
------------------------------------------------------
December 31, 1996 ............ 326,815 13.46
Options granted .............. -- --
Options canceled and exercised (189,786) 13.02
------------------------------------------------------
December 31, 1997 ............ 137,029 $ 14.07
=======================================================
Under the LTIP, options are exercisable in cumulative annual installments
commencing one year after the date of the grant and, unless exercised, the
options terminate five years from the date of the grant. Further, under the
LTIP, the option price shall at least equal or exceed the fair market value
of such shares on the date the options are granted.
At December 31, 1997, 73,037 options were exercisable at a weighted average
option price per share of $13.87, with 236,428 shares available for future
grants under the LTIP. At December 31, 1996, 139,776 options were
exercisable at a weighted average option price per share of $13.24.
78
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Downey measures its employee stock-based compensation arrangements under
the provisions of APB 25. Accordingly, no compensation expense has been
recognized for the stock option plan. Had compensation expense for Downey's
stock option plan been determined based on the fair value at the grant date
for awards in 1997, 1996 and 1995, Downey's net income and income per share
would have been reduced to the pro forma amounts indicated below:
(In Thousands, Except Per Share Data) 1997 1996 1995
------------------------------------------------------------------------
Net income:
As reported .................... $ 45,234 $ 20,704 $ 21,093
Pro forma ...................... 45,195 20,673 20,192
Income per share - Basic/Diluted:
As reported .................... $ 1.69 $ 0.77 $ 0.79
Pro forma ...................... 1.69 0.77 0.79
========================================================================
The weighted average fair value at date of grant of options granted during
1996 and 1995 was $4.09 and $3.01 per option, respectively. The fair value
of options at date of grant was estimated using the Black-Scholes model
with the following weighted average assumptions:
1997 (1) 1996 1995
----------------------------------------------------
Expected life (years) .... -- 3.79 3.74
Interest rate ............ -- % 6.08% 5.60%
Volatility ............... -- 24.58 24.92
Dividend yield ........... -- 1.88 2.17
====================================================
(1) No options were granted.
(20) Earnings Per Share
A reconciliation of the components used to derive basic and diluted
earnings per share for 1997, 1996 and 1995 follows:
Net Weighted Average Per-Share
Dollars in Thousands, Except Per Share Data) Income Shares Outstanding Amount
-----------------------------------------------------------------------------------------
1997:
Basic earnings per share ............... $ 45,234 26,739,577 $ 1.69
Effect of dilutive stock options ....... -- 60,613 --
----------------------------------------------------------------------------------------
Diluted earnings per share ............. $ 45,234 26,800,190 $ 1.69
========================================================================================
1996:
Basic earnings per share ............... $ 20,704 26,731,528 $ 0.77
Effect of dilutive stock options ....... -- 33,511 --
----------------------------------------------------------------------------------------
Diluted earnings per share ............. $ 20,704 26,765,039 $ 0.77
========================================================================================
1995:
Basic earnings per share ............... $ 21,093 26,731,528 $ 0.79
Effect of dilutive stock options ....... -- -- --
----------------------------------------------------------------------------------------
Diluted earnings per share ............. $ 21,093 26,731,528 $ 0.79
========================================================================================
79
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(21) Employee Benefit Plans
Retirement and Savings Plan
In August 1993, Downey amended its profit sharing plan so that it qualifies
as a profit sharing and savings plan under Section 401(k) of the Internal
Revenue Code ("the Plan"), covering substantially all salaried employees.
Under the Plan, employee contributions are partially matched by Downey.
Downey's matching contribution is equal to 25% of an employee's pretax
contributions which do not exceed 4% of the employee's annual compensation.
In addition, Downey makes an annual retirement contribution based on the
employee's age and salary. Downey's contributions to the Plan totaled $1.5
million for 1997, compared to $1.3 million in 1996 and $1.2 million in
1995.
Group Benefit Plan
Downey provides certain health and welfare benefits for active employees
under a cafeteria plan ("the Benefit Plan") as defined by section 125 of
the Internal Revenue Code. Under the Benefit Plan, employees make
appropriate selections as to the type of benefits and the amount of
coverage desired. The benefits are provided through insurance companies and
other health organizations and are funded by contributions from Downey,
employees and retirees and include deductibles, co-insurance provisions and
other limitations. Downey's expense for health and welfare benefits was
$2.5 million, $3.1 million and $2.7 million in 1997, 1996 and 1995,
respectively.
(22) Commitments and Contingencies
Litigation
Downey has been named as a defendant in legal actions arising in the
ordinary course of business, none of which, in the opinion of management,
is material.
Financial Instruments with Off-Balance-Sheet Risk
Downey is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers
and to reduce its own exposure to fluctuations in interest rates. These
financial instruments include commitments to originate fixed and variable
rate mortgage loans, letters of credit, lines of credit and loans in
process. The contract or notional amounts of those instruments reflect the
extent of involvement Downey has in particular classes of financial
instruments.
Downey uses the same credit policies in making commitments to originate
loans, lines of credit and letters of credit as it does for
on-balance-sheet instruments. For commitments to originate fixed rate
loans, the contract amounts represent exposure to loss from market
fluctuations as well as credit loss. Downey controls the credit risk of its
commitments to originate fixed rate loans through credit approvals, limits
and monitoring procedures.
80
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following is a summary of commitments and contingent liabilities:
December 31,
-------------------
(In Thousands) 1997 1996
------------------------------------------------------------------------------------
Commitments to originate loans and mortgage-backed securities:
Adjustable .............................................. $ 90,136 $131,767
Fixed ................................................... 35,225 12,339
Commitments to sell loans and mortgage-backed securities ..... 50,893 12,353
Unused lines of credit ....................................... 69,810 72,646
Loans in process ............................................. 56,325 40.535
Standby letters of credit and other contingent liabilities ... 3,080 --
====================================================================================
Commitments to originate fixed and variable rate mortgage loans are
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a
fee. Since some of the commitments may expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements. The credit risk involved in issuing lines and letters of
credit requires the same creditworthiness evaluation as that involved in
extending loan facilities to customers. Downey evaluates each customer's
creditworthiness on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party.
Downey receives collateral to support commitments for which collateral is
deemed necessary. The most significant categories of collateral include
real estate properties underlying mortgage loans, liens on personal
property, and cash on deposit with Downey. At December 31, 1997, the extent
of collateral supporting mortgage and other loans varied from nothing to
100% of the maximum credit exposure.
In connection with its interest rate risk management, Downey occasionally
enters into interest rate exchange agreements ("swap contracts") with
certain national investment banking firms under terms that provide mutual
payment of interest on the outstanding notional amount of the swap. The
effect of these swaps serve to reduce Downey's interest rate risk between
repricing assets and liabilities, At December 31, 1997, no swap contracts
were outstanding.
(23) Risk Management
Derivative financial instruments are utilized to minimize the effect of
future fluctuations in the interest rates as part of its secondary
marketing activities. Downey utilizes forward sale contracts to hedge the
value of loans originated for sale against adverse changes in interest
rates. At December 31, 1997, such contracts amounted to $31 million.
(24) Fair Value of Financial Instruments
Fair value estimates are made at a specific point in time based upon
relevant market information and other information about the financial
instrument. The estimates do not necessarily reflect the price Downey might
receive if it were to sell at one time its entire holding of a particular
financial instrument. Because no active market exists for a significant
portion of Downey's financial instruments, fair value estimates are based
upon the following methods and assumptions, some of which are subjective in
nature. Changes in assumptions could significantly affect the estimates.
81
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Cash, Federal Funds Sold, and Securities Purchased Under Resale Agreements
The carrying amounts reported in the balance sheet for these items
approximate fair value.
Investment Securities Including U.S. Treasuries and Mortgage-Backed
Securities
Fair value is based upon bid prices published in financial newspapers or
bid quotations received from securities dealers.
Loans Receivable
For residential mortgage loans, fair value is estimated based upon market
prices obtained from readily available market quote systems. The remaining
portfolio was segregated into those loans with variable rates of interest
and those with fixed rates of interest. For non-residential variable rate
loans which reprice frequently, fair values approximate carrying values.
For non-residential fixed rate loans, fair values are based on discounting
future contractual cash flows using the current rate offered for such loans
with similar remaining maturities and credit risk. The amounts so
determined for each category of loan are reduced by the associated
allowance for loan losses which thereby takes into consideration changes in
credit risk.
Interest-Bearing Advances to Joint Ventures
The carrying amounts approximate fair value as the interest earned is based
upon a variable rate.
Deposits
The fair value of deposits with no stated maturity such as regular passbook
accounts, money market accounts, and checking accounts, is the carrying
amount reported in the balance sheet. The fair value of deposits with a
stated maturity such as certificates of deposit is based on discounting
future contractual cash flows by the current rate offered for such deposits
with similar remaining maturities.
Borrowings
For short-term borrowings, fair value approximates carrying value. The fair
value of long-term borrowings is based on their interest rate
characteristics. For variable rate borrowings, fair values approximate
carrying values. For fixed rate borrowings, fair value is based on
discounting future contractual cash flows by the current rate paid on such
borrowings with similar remaining maturities.
Off-Balance-Sheet Financial Instruments
The fair value of commitments to extend credit and standby letters of
credit are estimated using the fees currently charged to enter into similar
agreements taking into consideration the remaining terms of the agreements
and the creditworthiness of the counterparties. The fair value of loans in
process is determined in the same manner as described for loans receivable.
The fair value of commitments to sell loans and mortgage-backed securities
is based upon bid quotations received from securities dealers. The fair
value of loans serviced for others is determined by computing the present
value of the expected net servicing income from the portfolio.
82
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Based on the above methods and assumptions, the following table presents
the estimated fair value of Downey's financial instruments:
December 31,1997 December 31,1996
----------------------- ----------------------
Carrying Estimated Carrying Estimated
(In Thousands) Amount (1) Fair Value Amount (1) Fair Value
------------------------------------------------------------------------------------------------------------------
ASSETS:
Cash ......................................................... $ 48,823 $ 48,823 $ 67,221 $ 67,221
Federal funds ................................................ 6,095 6,095 6,038 6,038
U.S. Government and agency obligations and other
investment securities available for sale ................... 159,398 159,398 141,999 141,999
Municipal securities held to maturity ........................ 6,885 6,865 6,997 6,975
Loans held for sale .......................................... 35,100 35,395 12,865 12,919
Mortgage-backed securities available for sale ................ 49,299 49,348 61,267 61,316
Loans receivable held for investment: Loans secured by
real estate:
Residential:
Adjustable ............................................ 4,463,525 4,501,037 3,910,895 3,888,656
Fixed ................................................. 180,581 185,348 186,402 194,029
Other .................................................... 238,215 237,429 291,791 297,361
Non-mortgage loans:
Commercial ............................................... 17,343 17,343 21,796 21,807
Consumer ................................................. 382,333 386,070 244,830 245,333
Interest-bearing advances to joint ventures .................. 32,122 32,122 57,563 57,563
MSRs and loan servicing portfolio ............................ 1,955 7,584 1,180 6,943
LIABILITIES:
Deposits:
Transaction accounts ....................................... 935,869 935,869 831,598 831,598
Certificates of deposit .................................... 3,934,109 3,947,913 3,341,504 3,351,342
Borrowings ................................................... 483,735 485,558 595,345 596,346
OFF-BALANCE SHEET INSTRUMENTS:
Commitments to sell loans and mortgage-backed securities ..... 50,893 50,893 12,353 12,353
Standby letters of credit .................................... 480 480 -- --
Unused lines of credit ....................................... 69,810 69,810 72,646 72,646
Commitments to originate loans and mortgage-backed securities:
Adjustable .............................................. 90,136 90,136 131,767 131,767
Fixed ................................................... 35,225 35,225 12,339 12,339
==================================================================================================================
(1) The carrying amount of loans is stated net of undisbursed loan funds,
unearned fees and discounts and allowances for losses.
83
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(25) Selected Quarterly Financial Data (Unaudited)
Selected quarterly financial data are presented below by quarter for the
years ended December 31, 1997 and 1996:
December 31, September 30, June 30, March 31,
(In Thousands, Except Per Share Data) 1997 1997 1997 1997
---------------------------------------------------------------------------------------------------
Total interest income ........................ $110,457 $109,101 $103,276 $ 97,584
Total interest expense ....................... 69,254 71,547 65,993 59,466
-------------------------------------------------------------------------------------------------
Net interest income ........................ 41,203 37,554 37,283 38,118
Provision for loan losses .................... 3,034 1,578 1,873 2,155
-------------------------------------------------------------------------------------------------
Net interest income after provision for loan 38,169 35,976 35,410 35,963
losses
Total other income ........................... 10,826 8,018 5,353 10,991
Total operating expense ...................... 24,339 25,477 26,280 25,176
-------------------------------------------------------------------------------------------------
Income before income taxes ................... 24,656 18,517 14,483 21,778
Income taxes ................................ 10,619 7,960 6,173 9,448
-------------------------------------------------------------------------------------------------
Net income ................................... $ 14,037 $ 10,557 $ 8,310 $ 12,330
==================================================================================================
Net income per share
Basic ...................................... $ 0.53 $ 0.39 $ 0.31 $ 0.46
Diluted .................................... $ 0.53 $ 0.39 $ 0.31 $ 0.46
==================================================================================================
Market range:
High bid ................................... $ 29.00 $ 24.50 $ 23.63 $ 22.50
Low bid .................................... 24.19 21.50 18.09 18.09
End of period .............................. 28.44 24.38 23.63 19.28
==================================================================================================
December 31, September 30, June 30, March 31,
1996 1996 1996 1996
---------------------------------------------------------------------------------------------------
Total interest income ........................ $ 92,922 $ 87,950 $ 83,149 $ 82,339
Total interest expense ....................... 57,364 52,915 50,034 51,452
-------------------------------------------------------------------------------------------------
Net interest income ........................ 35,558 35,035 33,115 30,887
Provision for loan losses .................... 1,674 4,092 2,200 1,171
-------------------------------------------------------------------------------------------------
Net interest income after provision for loan 33,884 30,943 30,915 29,716
losses
Total other income ........................... 6,203 5,172 4,002 9,822
Total operating expense ...................... 24,670 47,464 21,107 20,962
-------------------------------------------------------------------------------------------------
Income (loss) before income taxes ............ 15,417 (11,349) 13,810 18,576
Income taxes (benefit) ....................... 6,671 (4,879) 5,946 8,012
-------------------------------------------------------------------------------------------------
Net income (loss) ............................ $ 8,746 $ (6,470) (1) $ 7,864 $ 10,564
==================================================================================================
Net income (loss) per share
Basic ...................................... $ 0.32 $ (0.24) $ 0.30 $ 0.39
Diluted .................................... $ 0.32 $ (0.24) $ 0.30 $ 0.39
==================================================================================================
Market range:
High bid ................................... $ 18.69 $ 16.03 $ 15.23 $ 15.23
Low bid .................................... 15.88 12.86 12.86 13.09
End of period .............................. 18.69 16.03 13.89 14.92
==================================================================================================
(1) Net income totaled $7.6 million or $0.28 per share before an after-tax
charge of $14.0 million or $0.52 per share for a government-mandated
industry-wide one-time assessment to all institutions who are insured
by the Federal Deposit Insurance Corporation as part of its Savings
Association Insurance Fund.
84
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(26) Parent Company Financial Information
Downey Financial Corp. was incorporated in Delaware on October 21, 1994. On
January 23, 1995, after obtaining necessary stockholder and regulatory
approvals, Downey Financial Corp. acquired 100% of the issued and
outstanding capital stock of the Bank, and the Bank's stockholders became
stockholders of Downey Financial Corp. The transaction was accounted for in
a manner similar to a pooling-of-interests under generally accepted
accounting principles. Downey Financial Corp. was thereafter funded by a
$15 million dividend from the Bank. Condensed financial statements of
Downey Financial Corp. only are as follow:
CONDENSED BALANCE SHEETS
December 31,
-------------------
(In Thousands) 1997 1996
-----------------------------------------------------------
ASSETS
Cash ................................ $ 11 $ --
-----------------------------------------------------------
Due from Bank - interest bearing .... 6,635 7,333
Investment in subsidiaries:
Bank .............................. 421,230 382,932
Downey Affiliated Insurance Agency 182 162
Real estate held for investment ..... 551 704
Other assets ........................ 1,862 558
-----------------------------------------------------------
$430,471 $391,689
===========================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses $ 125 $ 118
-----------------------------------------------------------
Total liabilities ................. 125 118
-----------------------------------------------------------
Stockholders' equity ................ 430,346 391,571
-----------------------------------------------------------
$430,471 $391,689
===========================================================
85
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
CONDENSED STATEMENTS OF INCOME
Years Ended December 31,
-------------------------------
(In Thousands) 1997 1996 1995
----------------------------------------------------------------------------------------------------------
INCOME:
Dividends from the Bank .............................................. $ 8,891 $ 8,406 $ 16,940
Interest income ...................................................... 380 382 603
Other income ......................................................... 57 82 --
----------------------------------------------------------------------------------------------------------
Total income ....................................................... 9,328 8,870 17,543
----------------------------------------------------------------------------------------------------------
EXPENSE:
Provision for losses on real estate .................................. 153 -- 171
General and administrative expense ................................... 805 883 909
----------------------------------------------------------------------------------------------------------
Total expense ...................................................... 958 883 1,080
----------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND EQUITY IN UNDISTRIBUTED NET INCOME OF
SUBSIDIARIES ......................................................... 8,370 7,987 16,463
Income tax benefit ..................................................... 215 168 194
----------------------------------------------------------------------------------------------------------
INCOME BEFORE EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES ....... 8,585 8,155 16,657
Equity in undistributed net income of subsidiaries ..................... 36,649 12,549 4,436
----------------------------------------------------------------------------------------------------------
NET INCOME ........................................................... 45,234 20,704 21,093
OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAXES: UNREALIZED
gains (losses) on securities available for sale:
U.S. Treasury and agency obligations and other investment securities
available for sale, at fair value ............................... 1,331 (4,710) 2,985
Mortgage-backed securities available for sale, at fair value ....... 338 (344) 1,566
----------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) ............................... 1,669 (5,054) 4,551
----------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME ................................................. $ 46,903 $ 15,650 $ 25,644
==========================================================================================================
86
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31,
--------------------------------
(In Thousands) 1997 1996 1995
-----------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................... $ 45,234 $ 20,704 $ 21,093
Equity in undistributed net income of subsidiaries ....... (36,649) (12,549) (4,436)
Provision for losses on real estate ...................... 153 -- 171
Increase in other assets ................................. (1,304) (296) (262)
Increase (decrease) in liabilities ....................... 7 (69) 187
------------------------------------------------------------------------------------------------
Net cash provided by operating activities .............. 7,441 7,790 16,753
------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contribution to Downey Affiliated Insurance Agency -- -- (400)
(Issuance) decrease of note to the Bank - interest bearing 698 346 (7,679)
Purchase of real estate from subsidiary .................. -- -- (900)
------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities ... 698 346 (8,979)
------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of stock options ................................ 335 -- --
Dividends on common stock ................................ (8,454) (8,147) (7,759)
Other .................................................... (9) (4) --
------------------------------------------------------------------------------------------------
Net cash used for financing activities ................. (8,128) (8,151) (7,759)
------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents ....... 11 (15) 15
Cash and cash equivalents at beginning of year ............. -- 15 --
------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................. $ 11 $ -- $ 15
================================================================================================
87
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Downey Financial Corp. intends to file with the Securities and Exchange
Commission a definitive proxy statement (the "Proxy Statement") pursuant to
Regulation 14A, which will involve the election of directors, within 120 days of
the end of the year covered by this Form 10-K. Information regarding directors
of Downey Financial Corp. will appear under the caption "Election of Directors"
in the Proxy Statement for the Annual Meeting of Stockholders to be held on
April 22, 1998, and is incorporated herein by reference. Information regarding
executive officers of Downey Financial Corp. will appear under the caption
"Executive Officers" in the Proxy Statement and is incorporated herein by this
reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation will appear under the caption
"Executive Compensation" in the Proxy Statement and is incorporated herein by
this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information to be included under the captions "Securities Ownership of
Certain Beneficial Owners and Management" in the Proxy Statement is incorporated
herein by this reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information to be included under the caption "Certain Relationships and
Related Transactions" in the Proxy Statement is incorporated herein by this
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements.
These documents are listed in the Index to Consolidated Financial
Statements under Item 8.
2. Financial Statement Schedules.
Financial Statement Schedules have been omitted because they are not
applicable or the required information is shown in the Consolidated
Financial Statements or Notes thereto.
(b) Reports on Form 8-K during the last quarter of 1997.
None.
(c) Exhibits.
88
Exhibit
Number Description
3.1 (1) Certificate of Incorporation of Downey Financial Corp.
3.3 (2) Bylaws of Downey Financial Corp.
10.1 Downey Savings and Loan Association, F.A. Employee Stock Purchase
Plan (Amended and Restated as of January 1, 1996).
10.2 Amendment No. 1, Downey Savings and Loan Association, F.A.
Employee Stock Purchase Plan. Amendment No. 1, Effective and
Adopted January 22, 1997.
10.3 Downey Savings and Loan Association, F.A. Employees' Retirement
and Savings Plan (October 1, 1997 Restatement).
10.4 Amendment No. 1, Downey Savings and Loan Association, F.A.
Employees' Retirement and Savings Plan (October 1, 1997
Restatement) Amendment No. 1, Effective and Adopted January 28,
1998.
10.5 Trust Agreement for Downey Savings and Loan Association, F.A.
Employees' Retirement and Savings Plan, Effective October 1, 1997
between Downey Savings and Loan Association, F.A. and Fidelity
Management Trust Company.
10.6 (1) Downey Savings and Loan Association 1994 Long-Term Incentive Plan
(as amended).
10.7 (2) Asset Purchase Agreement among Butterfield Savings and Loan
Association, FSA, Mortgage Investment, Inc., Property Management
Service, Inc. and Butterfield Capital Corporation, dated
September 1, 1988.
10.8 (2) Assistance Agreement between and among the Federal Savings and
Loan Insurance Corporation, Butterfield Savings and Loan
Association, FSA and Downey Savings and Loan Association, dated
September 29, 1988 (confidential treatment requested due to
contractual prohibition against disclosure).
10.9 (2) Merger of Butterfield Savings and Loan Association, FSA, into
Downey Savings and Loan Association, dated September 29, 1989.
10.10 (2) Founder Retirement Agreement of Maurice L. McAlister, dated
December 21, 1989.
10.11 (2) Founder Retirement Agreement of Gerald H. McQuarrie, dated
December 21, 1989.
10.13 (2) Employment Agreement and Nonqualified Stock Option Agreement of
Stephen W. Prough, dated June 14, 1994.
10.14 (3) First Addendum to Employment Agreement of Stephen W. Prough dated
June 14, 1994, as amended June 30, 1995.
10.15 (4) Severance Agreement and General Release, dated February 6, 1997,
by and among Downey Financial Corp., Downey Savings and Loan
Association, F.A. and Stephen W. Prough.
22. (2) Subsidiaries
23.1 Consent of Independent Auditors.
(1) Filed as part of Downey's report on Form S-8 filed February 3, 1995.
(2) Filed as part of Downey's report on Form 8-B/A filed January 17, 1995.
(3) Filed as part of Downey's report on Form 10-K filed March 12, 1996.
(4) Filed as part of Downey's report on Form 10-K filed March 14, 1997.
Downey Financial Corp. will furnish any or all of the non-confidential
exhibits upon payment of a reasonable fee. Please send request for exhibits
and/or fee information to:
Downey Financial Corp.
3501 Jamboree Road
Newport Beach, California 92660
Attention: Corporate Secretary
89
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.
DOWNEY FINANCIAL CORP.
By: /s/ JAMES W. LOKEY
-------------------------------------
James W. Lokey
President and Chief Executive Officer
DATED: March 16, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ MAURICE L. McALISTER Chairman of the Board
- --------------------------
Maurice L. McAlister Director March 16, 1998
/s/ CHERYL E. JONES Vice Chairman of the Board
- --------------------------
Cheryl E. Jones Director March 16, 1998
/s/ JAMES W. LOKEY President and
- --------------------------
James W. Lokey Chief Executive Officer March 16, 1998
/s/ THOMAS E. PRINCE Executive Vice President,
- --------------------------
Thomas E. Prince Chief Financial Officer March 16, 1998
(Principal Financial and
Accounting Officer)
Director
- --------------------------
Brent McQuarrie
/s/ DR. PAUL KOURI
- --------------------------
Dr. Paul Kouri Director March 16, 1998
/s/ LESTER C. SMULL
- --------------------------
Lester C. Smull Director March 16, 1998
/s/ DR. DENNIS J. AIGNER
- --------------------------
Dr. Dennis J. Aigner Director March 16, 1998
/s/ SAM YELLEN
- --------------------------
Sam Yellen Director March 16, 1998