TEMPLE INLAND INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 28, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 001-08634

TEMPLE-INLAND INC.
(Exact name of Registrant as Specified in its Charter)

DELAWARE 75-1903917
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

1300 MOPAC EXPRESSWAY SOUTH
AUSTIN, TEXAS 78746
(Address of principal executive offices, including Zip code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (512) 434-5800

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]

The aggregate market value of the registrant's voting and non-voting common
equity held by non-affiliates of the registrant, based on the closing sales
price of the Common Stock on the New York Stock Exchange on June 28, 2002, was
$1,798,449,014. For purposes of this computation, all officers, directors, and 5
percent beneficial owners of the registrant (as indicated in Item 12) are deemed
to be affiliates. Such determination should not be deemed an admission that such
directors, officers, or 5 percent beneficial owners are, in fact, affiliates of
the registrant.

As of March 18, 2003, 53,797,916 shares of Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company's definitive proxy statement to be prepared in
connection with the Annual Meeting of Shareholders to be held May 2, 2003, are
incorporated by reference into Part III of this report.
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PART I

ITEM 1. BUSINESS

INTRODUCTION

Temple-Inland Inc. ("Temple-Inland" or the "Company") is a holding company
that conducts all of its operations through its subsidiaries. The business of
Temple-Inland is divided among three groups:

- the Corrugated Packaging Group, which provided 57.3 percent of
Temple-Inland's consolidated net revenues for 2002 and is operated by
Inland Paperboard and Packaging, Inc. ("Inland") and Gaylord Container
Corporation ("Gaylord"), is a vertically integrated corrugated packaging
operation that consists of:

- five linerboard mills,

- one corrugating medium mill,

- 72 box plants, and

- ten specialty converting plants, and

- the Building Products Group, which provided 17.4 percent of
Temple-Inland's consolidated net revenues for 2002 and is operated by
Temple-Inland Forest Products Corporation ("Temple-Inland FPC"), manages
the Company's forest resources of approximately 2.1 million acres of
timberland in Texas, Louisiana, Georgia, and Alabama, and manufactures a
wide range of building products, including:

- lumber,

- particleboard,

- medium density fiberboard,

- gypsum wallboard, and

- fiberboard, and

- the Financial Services Group, which provided 25.3 percent of
Temple-Inland's consolidated net revenues for 2002 and is operated by
subsidiaries of Temple-Inland Financial Services Inc. ("Financial
Services"), provides financial services in the areas of:

- consumer and commercial banking,

- mortgage banking,

- real estate, and

- insurance brokerage.

The Company's savings bank, Guaranty Bank ("Guaranty"), conducts its
business through 148 banking centers in Texas and California. Mortgage banking
is conducted through Guaranty Residential Lending, Inc. ("Residential Lending"),
a subsidiary of Guaranty that arranges financing of single-family mortgage
loans, sells loans to Guaranty or in the secondary markets by delivering whole
loans to third parties or through the delivery into a pool of mortgage loans
that are being securitized into a mortgage-backed security. Real estate
operations include development of residential subdivisions, as well as the
management and sale of income producing properties. Insurance brokerage
activities include selling a full range of insurance products.

Temple-Inland is a Delaware corporation that was organized in 1983. Its
principal subsidiaries include:

- Inland Paperboard and Packaging, Inc.,

- Gaylord Container Corporation,

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- Temple-Inland Forest Products Corporation,

- Temple-Inland Financial Services Inc.,

- Guaranty Bank, and

- Guaranty Residential Lending, Inc.

Temple-Inland's principal executive offices are located at 1300 MoPac
Expressway South, Austin, Texas 78746. Its telephone number is (512) 434-5800.
Additional information about the Company may be obtained from Temple-Inland's
home page on the Internet, the address of which is http://www.templeinland.com.
The Company provides access through its website to its annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, including
amendments to these reports, and other documents as soon as reasonably
practicable after they are filed with the Securities and Exchange Commission.

FINANCIAL INFORMATION

The results of operations including information regarding the principal
business segments are shown in the financial statements of the Company and the
notes thereto contained in Item 8 of this Annual Report on Form 10-K. Certain
statistical information concerning revenues and unit sales by product line is
contained in Item 7 of this Annual Report on Form 10-K.

NARRATIVE DESCRIPTION OF THE BUSINESS

The following chart presents the ownership structure for the significant
subsidiaries of Temple-Inland. It does not contain all the subsidiaries of
Temple-Inland, many of which are dormant or immaterial entities. A complete list
of the subsidiaries of Temple-Inland is filed as an exhibit to this annual
report on Form 10-K. All subsidiaries shown are 100 percent owned by their
immediate parent company listed in the chart, except that Inland Container
Corporation I owns approximately 90 percent of Gaylord Container Corporation.
The remaining approximately 10 percent of Gaylord is owned by a limited
liability company that is 99 percent owned by Inland Container Corporation I
with the balance owned by Inland Paperboard and Packaging, Inc.

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(CHART)

Corrugated Packaging Group. The Corrugated Packaging Group manufactures
containerboard that it converts into a complete line of corrugated packaging and
point-of-purchase displays. Approximately 16 percent of the containerboard
produced by the Corrugated Packaging Group in 2002 was sold in the domestic and
export markets. The Corrugated Packaging Group converted the remainder, and
containerboard purchased in the domestic markets, into corrugated containers at
its box plants. Following the acquisition of Gaylord Container Corporation and
Mack Packaging Company during 2002, the Company is positioned to convert more
containerboard than it manufactures.

The Corrugated Packaging Group's nationwide network of box plants produces
a wide range of products from commodity brown boxes to intricate die cut
containers that can be printed with multi-color graphics. Even though the
corrugated box business is characterized by commodity pricing, each order for
each customer is a custom order. The Corrugated Packaging Group's corrugated
boxes are sold to a variety of customers in the food, paper, glass containers,
chemical, appliance, and plastics industries, among others.

The Corrugated Packaging Group's corrugated packaging operation also
manufactures litho-laminate corrugated packaging, high graphics folding cartons,
and bulk containers constructed of multi-wall corrugated board for extra
strength, which are used for bulk shipments of various materials. The Corrugated
Packaging Group also manufactures a tear-resistant and water proof paper
packaging product under the name Tru-Tech(TM).

The Corrugated Packaging Group serves about 3,900 customers with
approximately 8,000 shipping destinations. The largest single customer accounted
for approximately 2.5 percent and the ten largest customers accounted for
approximately 16.5 percent of the 2002 corrugated packaging revenues. Costs of

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freight and customer service requirements necessitate the location of box plants
relatively close to customers. Each plant tends to service a market within a
150-mile radius of the plant.

Sales of corrugated packaging track changing population patterns and other
demographics. Historically, there has been a correlation between the demand for
corrugated packaging and real growth in the United States gross domestic
product, particularly the non-durable goods segment.

The Corrugated Packaging Group is a 50 percent owner in Premier Boxboard
Limited LLC, a joint venture that produces light-weight gypsum facing paper and
corrugating medium at a plant in Newport, Indiana.

In March 2002, the Corrugated Packaging Group acquired Gaylord Container
Corporation. The cash purchase price to acquire Gaylord was $599 million,
including $45 million in termination and change in control payments and $17
million in advisory and professional fees. Certain outstanding bank debt and
other senior secured debt obligations of Gaylord were paid or otherwise
satisfied. As a result of this acquisition, the Company has become the
third-largest manufacturer in the U.S. corrugated packaging industry. The
Company believes that this acquisition will extend its market reach, improve the
operating efficiency of its mills and packaging system, and lead to cost savings
and synergies.

The Company sold several non-strategic assets and operations obtained in
the Gaylord acquisition, including the retail bag business, which was sold in
May 2002, and the multi-wall bag business and the kraft paper mill, which were
sold in January 2003. Total proceeds from the sales of these assets were
approximately $100 million. In addition, the Company intends to sell the
chemical business obtained in the Gaylord acquisition. The Company closed
Gaylord's Antioch, California, recycle linerboard mill in the third quarter of
2002 and ceased operating two machines at the Bogalusa, Louisiana, mill. In
conjunction with closing the Antioch mill, the Corrugated Packaging Group
resumed operating the number two machine at its Orange, Texas, mill, in July
2002, the operations of which were suspended late in 2001.

The Company initially financed the Gaylord acquisition with a $900 million
bridge financing facility. During May 2002, the Company sold 4.1 million shares
of common stock at $52 per share, and issued $345 million of Upper DECS(SM)
units and $500 million of 7.875% Senior Notes due 2012. Total proceeds from
these offerings were $1.06 billion, before expenses of $28 million. The net
proceeds from these offerings were used to repay the bridge financing facility
and other borrowings.

During March 2002, the Corrugated Packaging Group acquired a box plant in
Puerto Rico for $10 million. During May 2002, the Corrugated Packaging Group
acquired the two converting operations of Mack Packaging Group, Inc. for $24
million. In fourth quarter 2002, the Corrugated Packaging Group acquired a sheet
feeder plant in Gilroy, California, from Fibre Innovations, LLC for $8 million.

Building Products Group. The Building Products Group produces lumber,
particleboard, medium density fiberboard, gypsum wallboard, and fiberboard. The
Building Products Group also manages the Company's 2.1 million acres of
timberland, which are located in Texas, Louisiana, Georgia, and Alabama.

The group sells building products throughout the continental United States
and in Canada, with the majority of sales occurring in the southern United
States. Sales of most of these products are made by account managers and
representatives to distributors, retailers, and original equipment manufacturer
accounts. Approximately 73 percent of particleboard sales are to commercial
fabricators, such as manufacturers of cabinets and furniture. The ten largest
customers accounted for approximately 27 percent of the Building Products
Group's 2002 sales. The building products business is heavily dependent upon the
level of residential housing expenditures, including the repair and remodeling
market.

The Building Products Group is a 50 percent owner in two joint ventures:
Del-Tin Fiber LLC, which produces medium density fiberboard at a facility in
Arkansas, and Standard Gypsum LP, which produces gypsum wallboard at a plant and
related quarry in Texas and a plant in Tennessee. The partner in Del-Tin Fiber
recently announced that it has written-off its interest in the venture in
connection with its intention to exit this business at its earliest reasonable
opportunity. It is uncertain what effects the partner's decision will have on
the joint venture or its operations.

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Financial Services Group. The Financial Services Group operates a savings
bank and engages in mortgage banking, real estate, and insurance brokerage
activities.

Savings Bank. Guaranty is a federally-chartered stock savings bank that
conducts its business through 148 banking centers. The 101 Texas banking centers
are concentrated in the metropolitan areas of Houston, Dallas/Fort Worth, San
Antonio, and Austin, as well as the central and eastern regions of the state.
The 47 California banking centers are concentrated in Southern California and
the Central Valley. The primary activities of Guaranty include providing deposit
products to the general public, investing in single-family adjustable-rate
mortgages, lending for the construction of real estate projects and the
financing of business operations, and providing a variety of other financial
products to consumers and businesses.

Guaranty derives its income primarily from interest earned on real estate
mortgages, commercial and business loans, consumer loans, and investment
securities, as well as fees received in connection with loans and deposit
services. Its major expenses are interest paid on consumer deposits and other
borrowings and personnel costs. The operations of Guaranty, like those of other
savings institutions, are significantly influenced by general economic
conditions; the monetary, fiscal, and regulatory policies of the federal
government; and the policies of financial institution regulatory authorities.
Deposit flows and cost of funds are influenced by interest rates on competing
investments and general market rates of interest. Lending activities are
affected by the demand for mortgage financing and for other types of loans as
well as market conditions. Guaranty primarily seeks assets with interest rates
that adjust periodically rather than assets with long-term fixed rates.

In addition to other minimum capital standards, regulations of the Office
of Thrift Supervision ("OTS") established to ensure capital adequacy of savings
institutions currently require savings institutions to maintain minimum amounts
and ratios of total and Tier I capital to risk-weighted assets and of Tier I
capital to adjusted tangible assets. Management of Guaranty believes that as of
year end, Guaranty met all capital adequacy requirements. In order to remain in
the lowest tier of Federal Deposit Insurance Corporation insurance premiums,
Guaranty must meet a leverage capital ratio of at least 5 percent of adjusted
total assets. At year end 2002, Guaranty had a leverage capital ratio of 6.5
percent of adjusted total assets.

Mortgage Banking. The mortgage banking operation of the Financial Services
Group is headquartered in Austin, Texas, and originates, warehouses, and
services FHA, VA, and conventional mortgage loans primarily on single-family
residential property. The mortgage banking operation originates mortgage loans
for sale into the secondary market through 112 offices located in 26 states and
the District of Columbia. During 2002, the Company retained the servicing rights
on approximately one-third of the loans it originated and sold the remainder to
third parties. Servicing operations are centralized in Austin, Texas. At the end
of 2002, the mortgage banking operation was servicing $10.6 billion in mortgage
loans. The mortgage banking operation produced $10.8 billion in mortgage loans
during 2002.

Real Estate. Subsidiaries of the Financial Services Group are involved in
the development of 55 residential subdivisions in Texas, California, Colorado,
Florida, Georgia, Missouri, Tennessee, and Utah. Real estate activities also
include ownership of ten commercial properties, including properties owned by
subsidiaries through joint venture interests.

Insurance Brokerage. Subsidiaries of the Financial Services Group are
engaged in the brokerage of commercial and personal lines of property, casualty,
life, and group health insurance products. One of these subsidiaries is an
insurance agency that administers the marketing and distribution of several
mortgage-related personal life, accident, and health insurance programs. This
agency also acts as the risk manager of Temple-Inland. An affiliate of the
insurance agency sells annuities through Guaranty.

RAW MATERIALS

The Company's main raw material resource is timber, with approximately 2.1
million acres of owned and leased timberland located in Texas, Louisiana,
Alabama, and Georgia. In 2002, wood fiber required for the

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Company's paper and wood products operations was produced from these lands and
as a by-product of its solid wood operations to the extent shown on the
following table:

WOOD FIBER REQUIREMENTS

The balance of the wood fiber required for these operations was purchased
from numerous landowners and other timber owners.

Linerboard and corrugating medium are the principal materials used to make
corrugated boxes. The mills at Rome, Georgia, and Orange, Texas, are solely
linerboard mills. The Ontario, California, Maysville, Kentucky, and Bogalusa,
Louisiana, mills are traditionally linerboard mills, but can be used to
manufacture corrugating medium. The New Johnsonville, Tennessee, mill is solely
a corrugating medium mill. The principal raw material used by the Rome, Georgia,
Orange, Texas, and Bogalusa, Louisiana, mills is virgin fiber. The Ontario,
California, and Maysville, Kentucky, mills use only old corrugated containers
("OCC"). The mill at New Johnsonville, Tennessee, uses a combination of virgin
fiber and OCC. In 2002, OCC represented approximately 39 percent of the total
fiber needs of the Company's containerboard operations. Following closure of the
Antioch, California, mill in September 2002, the Company's usage of OCC
decreased to approximately 33 percent. The price of OCC fluctuates due to normal
supply and demand for the raw material and for the finished product. The Company
and its competitors purchase OCC on the open market from numerous suppliers.
Price fluctuations reflect the competitiveness of these markets. The Company's
historical grade patterns produce more linerboard and less corrugating medium
than is converted at the Company's box plants. The deficit of corrugating medium
is filled through open market purchases or trades and any excess linerboard is
sold in the open market.

The Building Products Group obtains the gypsum for its wallboard operations
in Fletcher, Oklahoma, from one outside source through a long-term purchase
contract. At its gypsum wallboard plant in West Memphis, Arkansas, and the joint
venture gypsum wallboard plant in Cumberland City, Tennessee, synthetic gypsum
is used as a raw material. Synthetic gypsum is a by-product of coal-burning
electrical power plants. The Company has entered into a long-term supply
agreement for synthetic gypsum produced at a Tennessee Valley Authority
electrical plant located adjacent to the Cumberland City plant. Synthetic gypsum
acquired pursuant to this agreement supplies all the synthetic gypsum required
by the Cumberland City plant and the West Memphis plant.

In the opinion of management, the sources outlined above will be sufficient
to supply the Company's raw material needs for the foreseeable future.

ENERGY

Electricity and steam requirements at the Company's manufacturing
facilities are either supplied by a local utility or generated internally
through the use of a variety of fuels, including natural gas, fuel oil, coal,
wood bark, and in some instances, waste products resulting from the
manufacturing process. By utilizing these waste products and other wood
by-products as a biomass fuel to generate electricity and steam, the Company was
able to generate approximately 62 percent of its energy requirements at its
mills in Rome, Georgia, Bogalusa, Louisiana, and Orange, Texas, during 2002. In
most cases where natural gas or fuel oil is used as a fuel, the Company's
facilities possess a dual capacity enabling the use of either fuel as a source
of energy.

The natural gas needed to run the Company's natural gas fueled power
boilers, package boilers, and turbines is acquired pursuant to a multiple vendor
solicitation process that provides for the purchase of gas on an interruptible
basis at rates favorable to spot market rates. Prices for natural gas remained
relatively stable in 2002, following the peak energy prices experienced from
December 2000 through March 2001. Natural gas

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prices began to rise during fourth quarter 2002 and have continued to rise in
early 2003. The Company is unable to predict future prices for natural gas.

EMPLOYEES

At December 28, 2002, the Company and its subsidiaries had approximately
19,500 employees. Approximately 6,500 of these employees are covered by
collective bargaining agreements. These agreements generally run for a term of
three to six years and have varying expiration dates. The following table
summarizes certain information about the collective bargaining agreements that
cover a significant number of employees:

The Company has additional collective bargaining agreements with the
employees of various of its other box plants, mills, and building products
plants. These agreements each cover a relatively small number of employees and
are negotiated on an individual basis at each such facility.

The Company considers its relations with its employees to be good.

ENVIRONMENTAL PROTECTION

The operations conducted by the subsidiaries of the Company are subject to
federal, state, and local provisions regulating the discharge of materials into
the environment and otherwise related to the protection of the environment.
Compliance with these provisions, primarily the Federal Clean Air Act, Clean
Water Act,

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Comprehensive Environmental Response, Compensation and Liability Act of 1980
("CERCLA"), as amended by the Superfund Amendments and Reauthorization Act of
1986 ("SARA"), and Resource Conservation and Recovery Act ("RCRA"), has required
the Company to invest substantial funds to modify facilities to assure
compliance with applicable environmental regulations. Capital expenditures
directly related to environmental compliance totaled approximately $7 million
during 2002. This amount does not include capital expenditures for environmental
control facilities made as part of major mill modernizations and expansions or
capital expenditures made for another purpose that have an indirect benefit on
environmental compliance.

The Company is committed to protecting the health and welfare of its
employees, the public, and the environment and strives to maintain compliance
with all state and federal environmental regulations in a manner that is also
cost effective. In the construction of new facilities and the modernization of
existing facilities, the Company has used state of the art technology for its
air and water emissions. These forward-looking programs are intended to minimize
the impact that changing regulations have on capital expenditures for
environmental compliance.

Future expenditures for environmental control facilities will depend on new
laws and regulations and other changes in legal requirements and agency
interpretations thereof, as well as technological advances. The Company expects
the proliferation of environmental regulation to continue for the foreseeable
future. Given these uncertainties, the Company currently estimates that capital
expenditures for environmental purposes during the period 2003 through 2005 will
average approximately $13 million each year, excluding expenditures related to
the MACT programs discussed below. The estimated expenditures could be
significantly higher if more stringent laws and regulations are implemented.

On April 15, 1998, the U.S. Environmental Protection Agency (the "EPA")
issued extensive regulations governing air and water emissions from the pulp and
paper industry (the "Cluster Rule"). Compliance with various phases of the
Cluster Rule will be required at certain intervals over the next few years.
According to the EPA, the technology standards in the Cluster Rule will cut the
industry's toxic air pollutant emissions by almost 60 percent. The estimated
capital expenditures disclosed above include expenditures needed to comply with
the Cluster Rule. The Company has incurred approximately $15 million toward
Cluster Rule compliance through the end of 2002, excluding such expenditures
related to discontinued operations. Future expenditures related to Cluster Rule
compliance under High Volume Low Concentration Maximum Achievable Control
Technology ("MACT") I Rules are required to be completed in 2006 and capital
expenditures for compliance with these rules are estimated to be $9 million.

Not included in the phase I Cluster Rule was the MACT II Standard for the
control of hazardous air pollutant emissions from pulp and paper mill combustion
sources. Final promulgation of the MACT II Standard occurred on December 15,
2000, and applies to three kraft mills operated by the Company. Preliminary
estimates indicate that the Company could be required to make total capital
expenditures for monitoring both particulate matter ("PM") and gaseous hazardous
air pollutants ("HAPs") associated with the reporting and record-keeping
activities of the rule of up to $1 million over the next few years.

Future national emission standards for HAPs will apply to facilities that
are major sources of HAPs in the plywood and composite wood products ("PCWP")
industry. The proposed standard would limit emissions of HAPs including
acetaldehyde, acrolein, formaldehyde, methanol, phenol, and other HAPs. EPA
estimates that implementation of the proposed standards would reduce HAP
emissions from the PCWP source category industry-wide by approximately 11,000
tons per year. In addition, the proposed standards would reduce emissions of
volatile organic compounds ("VOCs") industry-wide by approximately 27,000 tons
per year. The estimated capital costs for the Company of these proposed
standards are approximately $23 million between 2004 and 2006.

The Company utilizes landfill operations to dispose of non-hazardous waste
at three paperboard and two building products mill operations. Based on current
costs incurred in the closure of its existing landfills, the Company expects
that it will spend, on an undiscounted basis, approximately $30 million over the
next 25 years to ensure proper closure of its remaining landfills. The Company
is involved in on-site remediation at two locations obtained in the Gaylord
acquisition and a former creosote treating facility in the Building

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Products Group. The Company expects that it will spend, on an undiscounted
basis, approximately $18 million to properly remediate these sites.

In addition to these capital expenditures, the Company incurs significant
ongoing maintenance costs to maintain compliance with environmental regulations.
The Company, however, does not believe that these capital expenditures or
maintenance costs will have a material adverse effect on the earnings of the
Company. In addition, expenditures for environmental compliance should not have
a material impact on the competitive position of the Company, because other
companies are also subject to these regulations.

COMPETITION

All of the industries in which the Company operates are highly competitive.
The level of competition in a given product or market may be affected by the
strength of the dollar and other market factors including geographic location,
general economic conditions, and the operating efficiencies of competitors.
Factors influencing the Company's competitive position vary depending on the
characteristics of the products involved. The primary factors are product
quality and performance, price, service, and product innovation.

The corrugated packaging industry is highly competitive with almost 1,500
box plants in the United States. Box plants operated by the Company's Corrugated
Packaging Group accounted for approximately 11 percent of total industry
shipments during 2002. Although corrugated packaging is dominant in the national
distribution process, the Corrugated Packaging Group's products also compete
with various other packaging materials, including products made of paper,
plastics, wood, and metals.

In the building materials markets, the Building Products Group competes
with many companies that are substantially larger and have greater resources in
the manufacturing of building materials.

The Financial Services Group competes with commercial banks, savings and
loan associations, mortgage banks, and other lenders in its mortgage banking and
savings bank activities, with real estate investment and management companies in
its real estate activities, and with insurance agencies in its property,
casualty, life, and health insurance activities. The financial services industry
is a highly competitive business, and a number of entities with which the
Company competes have greater resources.

EXECUTIVE OFFICERS OF THE REGISTRANT

Set forth below are the names, ages, and titles of the persons who serve as
executive officers of the Company:

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Kenneth M. Jastrow, II became Chairman of the Board and Chief Executive
Officer of the Company on January 1, 2000. Mr. Jastrow previously served the
Company in various capacities since 1991, including President, Chief Operating
Officer, Chief Financial Officer, and Group Vice President. He also serves as
Chairman of the Board of Financial Services, Chairman of the Board of Guaranty,
and a Director of each of Temple-Inland FPC and Inland.

Harold C. Maxwell became Executive Vice President of the Company in
February 2000 after serving as Group Vice President since May 1989. Mr. Maxwell
has served as Chairman of the Board of Temple-Inland FPC since March 1988 and
was Chief Executive Officer of Temple-Inland FPC from March 1998 to February
2003. Mr. Maxwell served as Group Vice President -- Building Products of
Temple-Inland FPC from November 1982 through March 1998.

Dale E. Stahl became Executive Vice President of the Company in May 2002
and has served as the President and Chief Executive Officer of Inland since July
2000. Mr. Stahl served as Vice President or President and Chief Operating
Officer of Gaylord Container Corporation for twelve years prior to joining the
Company in 2000. Mr. Stahl also serves as a director of AMCOL International,
Corp.

Bart J. Doney became Group Vice President of the Company in February 2000.
Mr. Doney has served Inland as Executive Vice President, Packaging since June
1998, Senior Vice President from 1996 until 1998, and Vice President, Sales and
Administration, Containerboard Division from 1990 to 1996.

Kenneth R. Dubuque became Group Vice President of the Company in February
2000. In October 1998, Mr. Dubuque was named President and Chief Executive
Officer of Guaranty. From 1996 until 1998, Mr. Dubuque served as Executive Vice
President and Manager -- International Trust and Investment of Mellon Bank
Corporation. From 1991 until 1996, he served as Chairman, President and Chief
Executive Officer of the Maryland, Virginia, and Washington, D.C., operating
subsidiary of Mellon Bank Corporation.

James C. Foxworthy became Group Vice President of the Company in February
2000. Mr. Foxworthy also serves as Executive Vice President, Paperboard of
Inland, a position he has held since June 1998. From 1995 until 1998, he served
as Senior Vice President of Inland. During the fourth quarter of 2002, Mr.
Foxworthy assumed responsibility for leading the Company's announced project to
relocate the Corrugated Packaging Group's headquarters from Indianapolis and to
consolidate and streamline corporate support functions in Austin.

Jack C. Sweeny became a Group Vice President of the Company in May 1996. He
also serves as President and Chief Executive Officer of Temple-Inland FPC. From
November 1982 through May 1996, Mr. Sweeny served as a Vice President of
Temple-Inland FPC and as Executive Vice President from May 1996 to February
2002.

M. Richard Warner became Vice President of the Company in June 1994 and was
named Chief Administrative Officer in May 1999. Mr. Warner also served as
General Counsel from June 1994 to August 2002, as Vice Chairman of Guaranty from
1990 to 1991, and as Treasurer and Chief Accounting Officer of the Company from
1986 to 1990.

Randall D. Levy became Chief Financial Officer of the Company in May 1999.
Mr. Levy joined Guaranty in 1989 serving in various capacities, including
Treasurer and most recently as Chief Operating Officer since 1994.

Louis R. Brill became Vice President and Controller of the Company in
December 1999 and was named Chief Accounting Officer in May 2000. Before joining
the Company in 1999, Mr. Brill was a partner of Ernst & Young LLP for 25 years.

Scott Smith became Chief Information Officer of the Company in February
2000. Prior to that, Mr. Smith was Treasurer of Guaranty from November 1993 to
December 1999 and Chief Information Officer of Financial Services from August
1995 to June 1999. Mr. Smith also served as the Chief Financial Officer of
Guaranty from June 2001 until November 2002.

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J. Bradley Johnston became General Counsel of the Company in August 2002.
Prior to that, Mr. Johnston served as General Counsel of Guaranty from January
1995 through May 1999, as General Counsel of Financial Services from May 1997
through July 2002 and Chief Administrative Officer of Financial Services and
Guaranty from May 1999 through July 2002.

Leslie K. O'Neal was named Vice President -- Benefits in August 2002 and
became Secretary of the Company in February 2000 after serving as Assistant
Secretary since 1995. Ms. O'Neal also serves as Assistant General Counsel of the
Company, a position she has held since 1985. Ms. O'Neal also serves as Secretary
of various subsidiaries of the Company.

Doyle R. Simons became Vice President -- Administration in November 2000.
Mr. Simons has served as the Director of Investor Relations for the Company
since 1994.

David W. Turpin became Treasurer of the Company in June 1991. Mr. Turpin
also serves as the Executive Vice President and Chief Financial Officer of
Lumbermen's Investment Corporation, a real estate subsidiary of the Company.

Officers are elected at the Company's Annual Meeting of Directors to serve
until their successors have been elected and have qualified or as otherwise
provided in the Company's Bylaws.

ITEM 2. PROPERTIES

The Company owns and operates manufacturing facilities throughout the
United States, five converting plants in Mexico, and a box plant in Puerto Rico.
Additional descriptions as of year-end of selected properties are set forth in
the following charts:

CONTAINERBOARD MILLS

- ---------------

* Does not include 2002 production of 200,779 tons from the Antioch,
California, mill, which was closed in third quarter 2002.

** Production for this facility is shown only since its acquisition in March.
Does not include kraft paper capacity of 62,650 tons.

*** The table shows the full capacity of this facility that is owned by a joint
venture in which a subsidiary of the Company has a 50 percent interest.
During 2002, the Company purchased 169,200 tons of medium from the venture.

11

CORRUGATED PACKAGING PLANTS*

- ---------------

* The annual capacity of the box plants is a function of the product mix,
customer requirements and the type of converting equipment installed and
operating at each plant, each of which varies from time to time.

** The Gilroy, California, Tracy, California, and Rome, Georgia, plants each
contain two corrugators.

*** Sheet or sheet feeder plants.

(1) Leased facilities.

Additionally, Inland owns a fulfillment center in Gettysburg, Pennsylvania,
a graphics resource center in Indianapolis, Indiana, that has a 100" preprint
press and also leases 50 warehouses located throughout much of the United
States. Inland owns specialty converting plants in Santa Fe Springs, California;
Harrington, Delaware; Indianapolis, Indiana; and Linden, New Jersey, and leases
specialty converting plants in Buena Park, Santa Fe Springs, Ontario, and Union
City, California.

13

BUILDING PRODUCTS

- ---------------

* Includes separate finger jointing capacity of 10 million board feet.

** Includes separate studmill capacity of 110 million board feet.

- ---------------

* The table shows the full capacity of this facility that is owned by a joint
venture in which a subsidiary of the Company has a 50 percent interest.

(1) Leased facilities.

TIMBER AND TIMBERLANDS*
(IN ACRES)

Pine Plantations............................................ 1,287,337
Natural Pine................................................ 119,016
Hardwood.................................................... 128,069
Special Use/Non-Forested.................................... 513,407
---------
Total....................................................... 2,047,829
=========

- ---------------

* Includes approximately 231,000 acres of leased land.

During 2001, the Company completed a major study of its forests, which led
to the following classifications: strategic timberland, non-strategic
timberland, and high-value land (with real estate develop-

14

ment potential). Based on the study, 1,800,000 acres has been identified as
strategic, 110,000 acres as non-strategic, and 160,000 acres as high-value with
the potential for real estate development.

Since completion of this study, the Company has sold 71,000 acres of
non-strategic land. The remaining non-strategic land will be sold over time.
During 2002, the Company sold 5,846 acres of high-value land at a total sales
price of $19 million. The remaining 1,800,000 acres of strategic timberland are
important to the Company's converting operations and play a key role in the
Company's competitiveness and ability to meet environmental certification
requirements relating to sound forest management techniques and chain of
custody.

In the opinion of management, the Company's plants, mills, and
manufacturing facilities are suitable for their purpose and adequate for the
Company's business.

Through its subsidiaries, the Company owns certain of the office buildings
in which various of its corporate offices are headquartered. This includes
approximately 150,000 square feet of space in Diboll, Texas, approximately
130,000 square feet in Indianapolis, Indiana, and 445,000 square feet of office
space in Austin, Texas. In November 2002, the Company announced a plan to
improve organizational effectiveness, reduce costs, and streamline corporate
functions that includes closing the office in Indianapolis. Upon completion of
this project, the building in Indianapolis will be sold or leased.

In connection with its timber holdings, the Company also owns mineral
rights on 388,000 acres in Texas and Louisiana and 395,830 acres in Alabama and
Georgia. Revenue derived from these mineral rights is not material.

At year end 2002, property and equipment having a net book value of
approximately $12 million were subject to liens in connection with $45 million
of debt.

ITEM 3. LEGAL PROCEEDINGS

GENERAL

The Company and its subsidiaries are involved in various legal proceedings
that have arisen from time to time in the ordinary course of business. In the
opinion of the Company's management, the possibility of a material liability
from any of these proceedings is considered to be remote and the effect of such
proceedings will not be material to the business or financial condition of the
Company and its subsidiaries.

On May 14, 1999, Inland and Gaylord were named as defendants in a
Consolidated Class Action Complaint that alleged a civil violation of Section 1
of the Sherman Act. The suit, captioned Winoff Industries, Inc. v. Stone
Container Corporation, MDL No. 1261 (E.D. Pa.), names Inland, Gaylord, and eight
other linerboard manufacturers as defendants. The complaint alleges that the
defendants, during the period from October 1, 1993, through November 30, 1995,
conspired to limit the supply of linerboard, and that the purpose and effect of
the alleged conspiracy was artificially to increase prices of corrugated
containers. The plaintiffs moved to certify a class of all persons in the United
States who purchased corrugated containers directly from any defendant during
the above period, and seek treble damages and attorneys' fees on behalf of the
purported class. The trial court granted plaintiffs' motion on September 4,
2001, but modified the proposed class to exclude those purchasers whose prices
were "not tied to the price of linerboard." The United States Court of Appeals
for the Third Circuit accepted review of the decision to certify the class and
upheld the trial court's ruling. Defendants have appealed this decision to the
United States Supreme Court. The case is currently set for trial in April 2004.
The Company believes that the plaintiffs' allegations have no merit and is
vigorously defending against the suit. The Company believes the likelihood of a
material loss from this litigation is remote and does not believe that the
outcome of this litigation should have a material adverse effect on its
financial position, results of operations, or cash flow.

On October 23, 1995, a rail tank car of nitrogen tetroxide exploded at the
Bogalusa, Louisiana plant of Gaylord Chemical Corporation, a wholly-owned,
independently-operated subsidiary of Gaylord Container Corporation. Following
the explosion, more than 160 lawsuits were filed against Gaylord, Gaylord
Chemical,

15

and third parties alleging personal injury, property damage, economic loss,
related injuries and fear of injuries. Plaintiffs sought compensatory and
punitive damages.

In 1997, the Washington Parish, Louisiana, trial court certified these
consolidated cases as a class action. By the deadline to file proof of claim
forms, 16,592 persons had filed and 3,978 persons had opted out of the Louisiana
class proceeding. All but 12 of the opt-out claimants are also plaintiffs in the
Mississippi action described below. The claims of 18 trial plaintiffs, selected
at random, are scheduled for trial in the Louisiana class action in September
2003.

Gaylord, Gaylord Chemical, and other third-parties were also named
defendants in approximately 4,000 individual actions brought by plaintiffs in
Mississippi State Court, who claim injury as a result of the same accident.
These cases were consolidated in Hinds County, Mississippi, and allege claims
and damages similar to those in Louisiana State Court.

Claims of the first 20 plaintiffs were tried to a jury in 1999. During
trial, the court dismissed with prejudice the claims of three plaintiffs. The
jury found Gaylord Chemical and a co-defendant, Vicksburg Chemical Company,
equally at fault for the accident. The jury also found that none of the 17
remaining plaintiffs whose claims went to the jury had suffered any damages,
awarded no damages to any of them, and returned a verdict in favor of all
defendants. The jury also determined that Gaylord was not responsible for the
conduct of its subsidiary, Gaylord Chemical Corporation. Plaintiffs did not
appeal the verdict or the trial court's rulings. The trial court has not set a
trial date for the next group of 20 Mississippi plaintiffs.

Gaylord and Gaylord Chemical filed suits seeking a declaratory judgment of
insurance coverage for claims arising from the October 23, 1995 accident. The
coverage action against the liability insurers was tried to a judge in December
1998, and on February 25, 1999, the trial court issued an opinion holding that
Gaylord and Gaylord Chemical have insurance coverage for the October 23, 1995,
accident under eight of the nine policies that were at issue. The judge held
that language in one policy excluded coverage. The Louisiana Court of Appeals
affirmed the trial court's finding that coverage was afforded by eight of the
nine carriers and reversed the trial court's finding that the ninth carrier's
policy did not provide coverage. Following denial of the writ, Gaylord and
Gaylord Chemical had in excess of $125 million in insurance coverage for the
October 23, 1995, accident. The insurers appealed the decision of the Court of
Appeals to the Louisiana Supreme Court, and on December 7, 2001 the Louisiana
Supreme Court denied the insurers' application for writ of certiorari to review
the Court of Appeals decision. The Supreme Court also denied the insurers'
motion to reconsider denial of the writ.

On May 4, 2001, Gaylord and Gaylord Chemical agreed in principle to settle
all claims arising out of the October 23, 1995 explosion. In exchange for
payments by its primary insurance carrier and the first five excess layers of
coverage and assignment of Gaylord's insurance coverage action against the
remaining carriers, Gaylord and Gaylord Chemical will receive full releases
and/or dismissals of all claims for damages, including punitive damages. Neither
Gaylord nor Gaylord Chemical contributed to the settlement. The settlement
agreement was fully executed on September 14, 2001, and all settlement funds
were deposited in escrow.

On December 24, 2002, counsel for the Louisiana class action plaintiffs
advised Gaylord Chemical that they would not be able to deliver all the releases
of the Gaylord entities that were promised as part of the September 2001
settlement agreement. As a result of this failure to tender the committed
releases, the motion for preliminary approval of the settlement did not proceed
as scheduled, and the parties engaged in negotiations over revised terms of
settlement. On February 18, 2003, the Court granted the settling defendants'
motion to retrieve the settlement proceeds from the escrow account and to lift
the stay of proceedings in the Louisiana action. Gaylord, Gaylord Chemical, and
their insurance carriers were reinstated as defendants in the Louisiana
class-wide trial set to begin September 3, 2003.

Inland was a party to a long-term power purchase agreement with Southern
California Edison ("Edison"). Under this agreement, Inland sold to Edison a
portion of its electrical generating capacity from a co-generation facility
operated in connection with its Ontario, California, mill. Edison was to pay
Inland for its committed generating capacity and for electricity generated and
sold to Edison. During the fourth quarter 2000 and the first quarter 2001, the
Ontario mill generated and delivered electricity to Edison but was not

16

paid. During April 2001, Inland notified Edison that the long-term power
purchase agreement was cancelled because of Edison's material breach of the
agreement. Edison has contested the right of Inland to terminate the power
purchase agreement. It has also asserted that it is entitled to recover from
Inland a portion of the payments it made during the term of the agreement.
Inland has since been paid for all power delivered to Edison. The parties are
currently in litigation, however, to determine, among other matters, whether the
agreement has been terminated and whether Inland may sell its excess generating
capacity to third parties.

In 1988, the Company formed Guaranty Bank (then known as Guaranty Federal
Savings Bank) to acquire substantially all the assets and deposit liabilities of
three thrift institutions from the Federal Savings and Loan Insurance
Corporation, as receiver of those institutions. In connection with the
acquisition, the government entered into an assistance agreement with the
Company in which various tax benefits were promised to the Company. In 1993,
Congress enacted narrowly targeted legislation to eliminate a portion of the
promised tax benefits. The Company has filed suit against the United States in
the U.S. Court of Federal Claims alleging, among other things, that the 1993
legislation breached the parties' contract and that the Company is entitled to
monetary damages. This lawsuit is currently in the discovery stage and is not
expected to be resolved for several years. The Company cannot predict the likely
outcome of this litigation.

ENVIRONMENTAL

The facilities of the Company are periodically inspected by environmental
authorities and must file periodic reports on the discharge of pollutants with
these authorities. Occasionally, one or more of these facilities may have
operated in violation of applicable pollution control standards, which could
subject the facilities to fines or penalties in the future. Management believes
that any fines or penalties that may be imposed as a result of these violations
will not have a material adverse effect on the Company's earnings or competitive
position. No assurance can be given, however, that any fines levied against the
Company in the future for any such violations will not be material.

Under CERCLA, liability for the cleanup of a Superfund site may be imposed
on waste generators, site owners and operators, and others regardless of fault
or the legality of the original waste disposal activity. While joint and several
liability is authorized under CERCLA, as a practical matter, the cost of cleanup
is generally allocated among the many waste generators. Subsidiaries of the
Company are named as a potentially responsible party in eight proceedings
relating to the cleanup of hazardous waste sites under CERCLA and similar state
laws, excluding sites to which the Company's records disclose no involvement or
as to which the Company's potential liability has finally been determined. The
Company is either designated as a de minimis potentially responsible party or
believes its financial exposure is insignificant at all but one of these sites.
The subsidiaries have conducted investigations of the sites and in certain
instances believe that there is no basis for liability and have so informed the
governmental entities. The internal investigations of the remaining sites
indicate that the portion of the remediation costs for these sites to be
allocated to the Company are approximately $2 million and should not have a
material impact on the Company. There can be no assurance that subsidiaries of
the Company will not be named as potentially responsible parties at additional
Superfund sites in the future or that the costs associated with the remediation
of those sites would not be material.

On July 22, 2002, a delivery driver for a chemical supply company
overfilled a storage tank for caustic soda at the Gaylord converting facility in
Tipton, Indiana. The excess caustic soda drained through an overflow pipe into
the city sewer system, resulting in a temporary shutdown of the city wastewater
treatment plant and killing approximately 2,000 fish in a local creek. Gaylord
removed the fish, assisted in restoring operations at the wastewater treatment
plant, and took other measures to assure no ongoing effect to human health or
the environment. The incident is being investigated by the U.S. Environmental
Protection Agency and the Indiana Department of Natural Resources, with the
cooperation of the Company. At this time, the Company is not able to predict
whether Gaylord will be subject to any monetary sanctions arising out of this
incident or the amount of any such monetary sanctions.

All litigation has an element of uncertainty and the final outcome of any
legal proceeding cannot be predicted with any degree of certainty. With these
limitations in mind, the Company presently believes that

17

any ultimate liability from the legal proceedings discussed herein would not
have a material adverse effect on the business or financial condition of the
Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company did not submit any matter to a vote of its shareholders during
the fourth quarter of its last fiscal year.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

The Common Stock of the Company is traded in the New York Stock Exchange
and The Pacific Exchange. The table below sets forth the high and low sales
price for the Common Stock during each fiscal quarter in the two most recent
fiscal years.

SHAREHOLDERS

The Company's stock transfer records indicated that as of March 18, 2003,
there were approximately 5,425 holders of record of the Common Stock.

DIVIDEND POLICY

As indicated above, the Company paid quarterly dividends during each of the
two most recent fiscal years in the amounts shown. On February 7, 2003, the
Board of Directors declared a quarterly dividend on the Common Stock of $0.34
per share payable on March 14, 2003, to shareholders of record on February 28,
2003. The quarterly dividend was $0.32 per share from the dividend paid
September 13, 1996, through the dividend paid December 13, 2002. The Board
periodically reviews its dividend policy, and the declaration of dividends will
necessarily depend upon earnings and financial requirements of the Company and
other factors within the discretion of the Board.

18

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

The following table sets forth information as of the Company's year-end
2002, with respect to compensation plans under which the Company's common stock
may be issued:

- ---------------

(1) Of this amount, at year end 412,531 shares could be issued as restricted
shares or phantom shares and the remainder of 739,152 shares could only be
issued as stock options. On February 7, 2003, the Company issued 67,900
restricted shares, 50,343 phantom shares, and 632,000 stock options at an
exercise price of $43.01.

Beginning first quarter 2003, the Company will voluntarily adopt the
prospective transition method of accounting for stock-based compensation
contained in Statement of Financial Accounting Standards No. 148, Accounting for
Stock-Based Compensation -- Transition and Disclosure, an amendment of FASB
Statement No. 123. Under the prospective transition method, the Company will
apply the fair value recognition provisions to all stock-based compensation
awards granted in 2003 and thereafter.

19

ITEM 6. SELECTED FINANCIAL DATA

- ---------------

(a) In 2002, the Company acquired Gaylord (March), a box plant in Puerto Rico
(March), certain assets of Mack Packaging Group, Inc. (May) and Fibre
Innovations LLC (November). Also in May 2002, the Company sold 4.1 million
shares of common stock and issued $345 million of Upper DECS(SM) units and
$500 million of Senior Notes due 2012. In the aggregate, these transactions
significantly increased the assets and operations of the Company and its
Corrugated Packaging Group and changed the capital structure of the
Company. The following unaudited pro

20

forma information assumes these acquisitions and related financing
transactions had occurred at the beginning of 2002 and 2001:

Adjustments made to derive this pro forma information include those related
to the effects of the purchase price allocations and financing transactions
and the reclassification of the discontinued operations. The pro forma
information does not reflect the effects of planned capacity
rationalization, cost savings or other synergies that may be realized. These
pro forma results are not necessarily an indication of what actually would
have occurred if the acquisitions had been completed on those dates and are
not intended to be indicative of future results.

In 2001, the Company acquired the corrugated packaging operations of
Chesapeake Corporation and Elgin Corrugated Box Company (May) and ComPro
Packaging LLC (October). The unaudited pro forma results of operations,
assuming these acquisitions had been effected as of the beginning of the
applicable fiscal year, would not have been materially different from those
reported.

Year 2002 amounts are not comparable to prior years due to the amortization
of goodwill and trademarks in years prior to the 2002 adoption of Statement
of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other
Intangible Assets.

(b) Segment operating income in 2001 includes a $27 million reduction in
depreciation expense resulting from a change in the estimated useful lives
of certain production equipment. Of this amount, $20 million applies to the
Corrugated Packaging Group and $7 million applies to the Building Products
Group.

(c) Other income (expense) includes (i) in 2002, an $11 million write-off of
unamortized financing fees in connection with the early repayment of a
bridge financing facility, a $6 million charge related to promissory notes
previously sold with recourse in connection with the 1998 sale of the
Company's Argentine box plant and a $7 million charge related to severance
and write-off of technology investments; (ii) in 2001, a $20 million gain
from the sale of non-strategic timberlands and $19 million in losses from
the disposition of under-performing assets and other charges; (iii) in
2000, a $15 million loss from the decision to exit the fiber cement
business; and (iv) in 1998, a $24 million loss from the disposition of the
Argentine operations and $23 million in losses and charges related to other
under-performing assets.

(d) Discontinued operations includes (i) in 2002, the non-strategic operations
obtained in the Gaylord acquisition including the retail bag business,
which was sold in May 2002, the multi-wall bag business and kraft paper
mill, which were sold in January 2003, and the chemical business; (ii) in
1999, the bleached paperboard operations, which were sold in 1999 and
includes a loss on disposal of $71 million; and (iii) in 1998, the bleached
paperboard operations for the year.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

INTRODUCTION

Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements that involve risks and
uncertainties. The actual results achieved by the Company may differ
significantly from the results discussed in the forward-looking statements.
Factors that might cause such differences include general economic, market, or
business conditions; the opportunities (or lack thereof) that may be presented
to and pursued by the Company; the availability and price of raw materials used
by the Company; competitive actions by other companies; changes in laws or
regulations; the accuracy of certain judgments and estimates concerning the
integration of Gaylord into the operations of the Company; the accuracy of
certain judgments and estimates concerning the Company's streamlining project;
and other factors, many of which are beyond the control of the Company.

21

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 2002, 2001 AND 2000

SUMMARY

Consolidated revenues were $4.5 billion in 2002, $4.1 billion in 2001 and
$4.2 billion in 2000. Income from continuing operations was $65 million in 2002,
$111 million in 2001 and $195 million in 2000. Income from continuing operations
per diluted share was $1.25 in 2002, $2.26 in 2001 and $3.83 in 2000.

BUSINESS SEGMENTS

The Company manages its operations through three business segments:
Corrugated Packaging, Building Products and Financial Services. Each of these
business segments is affected by the factors of supply and demand and changes in
domestic and global economic conditions. These conditions include changes in
interest rates, new housing starts, home repair and remodeling activities and
the strength of the U.S. dollar, some or all of which may have varying degrees
of impact on the business segments. As used herein, the term "parent company"
refers to the Company and its manufacturing business segments, the Corrugated
Packaging Group and the Building Products Group, with the Financial Services
Group reported on the equity method.

The Company acquired effective control of Gaylord Container Corporation
("Gaylord") and began consolidating the results of Gaylord on March 1, 2002. In
May 2002, the Company sold 4.1 million shares of common stock and issued $345
million of Upper DECS(SM) units and $500 million of Senior Notes due 2012. The
Company also acquired a box plant in Puerto Rico in March 2002, certain assets
of Mack Packaging Group, Inc. in May 2002 and Fibre Innovations LLC in November
2002. In the aggregate, these transactions significantly increased the assets
and operations of the Company and its Corrugated Packaging Group and changed the
capital structure of the Company. As a result, 2002 financial information is not
comparable to prior periods. None of these acquisitions resulted in the creation
of any new business segments.

THE CORRUGATED PACKAGING GROUP

The Corrugated Packaging Group manufactures linerboard and corrugating
medium that it converts into a complete line of corrugated and specialty
packaging. The Corrugated Packaging Group operations consist of five linerboard
mills, one corrugating medium mill, 72 converting plants, ten
specialty-converting plants and an interest in a gypsum facing paper joint
venture. The Corrugated Packaging Group's facilities are located throughout the
United States and in Mexico and Puerto Rico. The Corrugated Packaging Group's
revenues are principally derived from the sale of corrugated packaging products
and, to a lesser degree, from the sale of linerboard in the domestic and export
markets.

The Corrugated Packaging Group began consolidating the results of Gaylord
on March 1, 2002. Gaylord was primarily engaged in the manufacture and sale of
corrugated containers and linerboard through its 1,070,000-ton linerboard mill
in Bogalusa, Louisiana, its 425,000-ton recycle linerboard mill in Antioch,
California, and its 20 converting facilities. The Company permanently closed
Gaylord's Antioch mill in September 2002. In addition, the Company ceased
operating two machines at the Bogalusa mill in 2002. As a result of this
acquisition, the Corrugated Packaging Group is the third largest U.S.
manufacturer in the corrugated packaging industry. The Corrugated Packaging
Group also acquired a box plant in Puerto Rico in March 2002 and certain assets
of Mack Packaging Group, Inc. in May 2002 and Fibre Innovations LLC in November
2002. Due to the integration of the acquired operations, the incremental effects
on the Corrugated Packaging Group's 2002 operating income associated with these
acquisitions cannot be readily quantified but is considered to be significant.

In 2001, the Corrugated Packaging Group completed the acquisition of the
corrugated packaging operations of Chesapeake Corporation, Elgin Corrugated Box
Company and ComPro Packaging LLC. These operations consist of 13 corrugated
converting plants in eight states. These acquired operations did not contribute
significantly to the Corrugated Packaging Group's 2001 operating income.

The Corrugated Packaging Group's revenues were $2.6 billion in 2002
compared with $2.1 billion in 2001 and $2.1 billion in 2000. The Corrugated
Packaging Group's revenues from the sale of corrugated packaging represented 94
percent of this group's revenues in 2002 compared with 93 percent in 2001 and 91
percent in

22

2000. The remaining revenues are derived from the sales of linerboard and other
products. The change in revenues in 2002 was principally due to the inclusion of
the acquired operations, approximately $654 million, partially offset by lower
corrugated packaging and linerboard prices and volumes. Average corrugated
packaging prices were down five percent while pro forma corrugated packaging
shipments (including Gaylord) were down three percent in 2002 compared with
2001. Corrugated packaging prices and shipments continue to be adversely
affected by the weak economy. Average linerboard prices were down seven percent
while pro forma linerboard shipments (including Gaylord) were down nine percent
in 2002 compared with 2001. Linerboard markets continue to be adversely affected
by the weak economy and increased offshore containerboard capacity. Revenues
were unchanged in 2001 as the inclusion of the acquired corrugated packaging
operations, approximately $100 million, was offset by lower corrugated packaging
volumes and lower linerboard prices. Average corrugated packaging prices were up
two percent, while corrugated packaging shipments were down three percent
compared with pro forma shipments (including the acquired operations) for 2000.
Corrugated packaging prices and shipments were adversely affected by the weak
economy. Average linerboard prices were down seven percent while linerboard
shipments were down 14 percent. Linerboard markets were adversely affected by
the weak economy and increased offshore containerboard capacity. Revenues and
volumes were also affected by the poor performance of the specialty packaging
operations. The change in revenues in 2000 was due to higher corrugated
packaging prices, up 17 percent, with essentially no change in volumes coupled
with higher linerboard prices, up 20 percent, partially offset by lower
linerboard shipments, down ten percent.

In 2001 and 2002, average corrugated packaging prices and shipments were
adversely affected by the weak economy while linerboard markets were adversely
affected by the weak economy and increased offshore containerboard capacity. It
is likely that these factors will continue to have an adverse effect on the
Corrugated Packaging Group's revenues and operating results in 2003.

Costs, which include production, distribution and administrative costs,
were $2.5 billion in 2002 compared with $2.0 billion in 2001 and $1.9 billion in
2000. The change in costs in 2002 was primarily due to the inclusion of the
acquired operations. Other factors increasing costs in 2002 included higher OCC
costs, up $26 million, higher pension costs, up $18 million, and higher
depreciation expense, up $39 million, resulting from the addition of the
acquired property and equipment. Factors decreasing costs in 2002 included lower
energy costs, down $32 million, less goodwill amortization, down $4 million, and
lower expenses associated with the specialty packaging operations. The change in
costs in 2001 was due to the inclusion of the acquired corrugated packaging
operations, higher energy costs, up $30 million, higher labor and benefit costs,
up $19 million, higher technology costs, up $14 million, and higher costs
associated with the specialty packaging operations. Factors decreasing costs in
2001 were lower OCC costs, down $35 million, and lower depreciation expense,
down $20 million, due to the lengthening of estimated useful lives of certain
production equipment beginning January 2001. The changes in costs in 2000 were
primarily due to higher energy costs, up $10 million, higher OCC costs and
increased outside purchases of corrugating medium. OCC prices continue to
fluctuate from year to year. OCC costs averaged $97 per ton in 2002 compared
with $69 per ton in 2001 and $107 per ton in 2000. At year-end 2002, OCC prices
were $81 per ton compared with $53 per ton at year-end 2001 and $67 per ton at
year-end 2000. OCC represented 39 percent of the group's fiber requirements
during 2002 compared with 38 percent in 2001 and 41 percent in 2000. Energy
costs, principally natural gas, also continue to fluctuate from year to year.
Energy costs began to rise during second quarter 2000, peaked during second
quarter 2001 and began to decline the remainder of 2001 reaching more normalized
levels by year-end 2001. Energy costs remained at these levels during most of
2002, but began to rise during fourth quarter 2002 and have continued to rise in
early 2003. It is likely that OCC and energy costs will continue to fluctuate
during 2003.

Mill production was 3.1 million tons in 2002 compared with 2.1 million tons
in 2001 and 2.3 million tons in 2000. Of the mill production, 84 percent in
2002, 83 percent in 2001 and 80 percent in 2000 was used by the corrugated
packaging operations. The remainder was sold in the domestic and export markets.
In September 2002, the 425,000-ton per year capacity recycle linerboard mill in
Antioch, California obtained in the acquisition of Gaylord was permanently
closed. Also in September 2002, the No. 2 paper machine at the Orange, Texas
linerboard mill resumed full production. This machine was shut down in December
2001 due to

23

weak market conditions. Mill production was curtailed by 451,000 tons in 2002
due to market, maintenance and operational reasons, compared with 327,000 tons
in 2001 and 315,000 tons in 2000. The Corrugated Packaging Group will likely
continue to curtail production in 2003 for these reasons. At year-end 2002, the
Corrugated Packaging Group's annual linerboard and medium mill capacity is 3.3
million tons of which approximately 67 percent is dependent on virgin fiber and
approximately 33 percent is dependent on recycled raw materials such as OCC.

In connection with the closure of the Antioch mill, the Corrugated
Packaging Group established accruals for the estimated costs of closure. These
closure accruals aggregated $41 million, which consisted of $5 million for
involuntary terminations of the work force, $6 million for contract
terminations, $13 million for environmental compliance and $17 million for
demolition and clean up. These accruals were recognized as liabilities incurred
in connection with the acquisition of Gaylord and are included in the allocation
of the purchase price. At year-end 2002, the remaining balance of the accruals
aggregated $33 million. It is expected that the majority of these accruals will
be paid in 2003. The carrying value of the Antioch mill's property and equipment
was adjusted to its estimated fair value less cost to sell. It is expected that
these assets will be sold in 2003 and 2004.

Market conditions continue to be weak for gypsum facing paper. As a result,
the Corrugated Packaging Group's Premier Boxboard Limited LLC joint venture
continues to produce corrugating medium, of which the Corrugated Packaging Group
purchased 169,200 tons in 2002, 159,400 tons in 2001 and 72,000 tons in 2000. It
is uncertain when market conditions for lightweight gypsum facing paper will
improve to levels that eliminate the venture's need to produce corrugating
medium.

Of the non-strategic assets obtained in the Gaylord acquisition, the retail
bag business, the multi-wall bag business, the kraft paper mill and other
non-strategic assets have been sold for aggregate proceeds of approximately $100
million. The only non-strategic asset that remains is the chemical business,
which is anticipated to be sold upon the resolution of its toxic tort
litigation. The operating results and cash flows of these operations are
classified as discontinued operations and are excluded from business segment
operating income. In addition, the Corrugated Packaging Group terminated 142
employees of Gaylord's corporate and divisional staff in 2002. In 2001, the
Corrugated Packaging Group sold its corrugated packaging operation in Chile at a
loss of $5 million. The Corrugated Packaging Group also restructured and
downsized its specialty packaging operations at a loss of $4 million and
recognized an impairment charge of $4 million related to its interest in a glass
bottling venture operation in Puerto Rico. These losses are included in other
operating expenses and excluded from business segment operating income.

The Corrugated Packaging Group is continuing its efforts to enhance return
on investment. These include reviewing operations that are unable to meet return
objectives and determining appropriate courses of action including the possible
consolidation and rationalization of converting facilities.

The Corrugated Packaging Group's business segment operating income was $78
million in 2002 compared with $107 million in 2001 and $207 million in 2000.

THE BUILDING PRODUCTS GROUP

The Building Products Group manufactures a variety of building products
including lumber, particleboard, medium density fiberboard (MDF), gypsum
wallboard and fiberboard. The Building Products Group operations consist of 19
facilities including a particleboard plant and an MDF plant operated under
long-term operating lease agreements and interests in a gypsum wallboard joint
venture and an MDF joint venture. The Building Products Group operates in the
United States and Canada and manages the Company's 2.1 million acres of owned
and leased timberlands located in Texas, Louisiana, Georgia and Alabama. The
Building Products Group's revenues are principally derived from the sale of its
building products and to a lesser degree from sales of timberlands.

The Building Products Group's revenues were $787 million in 2002 compared
with $726 million in 2001 and $836 million in 2000. The change in revenues in
2002 was due to higher average prices for MDF and gypsum and higher shipments of
all products, partially offset by lower average prices for particleboard and

24

lumber. Average prices for lumber were down six percent and particleboard prices
were down 13 percent while average prices for MDF were up three percent and
gypsum prices were up 25 percent. Shipments for all products were up with lumber
shipments up five percent, particleboard up 12 percent, MDF up 11 percent and
gypsum up 16 percent. In 2001, prices for lumber were down five percent,
particleboard down 14 percent, and gypsum down 39 percent, while prices for MDF
were up four percent due to improved product mix. In 2001, shipments of lumber
were up 15 percent, particleboard down 14 percent, gypsum down 13 percent and
MDF up five percent. Lumber shipments were up primarily due to the new Pineland
sawmill, which began operations in second quarter 2001. Particleboard shipments
were down due to weaker market conditions and the explosion at the Mount Jewett
facility, which closed the facility for about five months during 2001. The
change in revenues in 2000 was due to increased shipments resulting from
additional manufacturing facilities partially offset by lower average prices in
most product lines.

In 2001 and 2002, lumber prices were adversely affected by over-capacity
and increased imports. It is likely that these conditions will continue in 2003.

Other revenues include sales of high-value timberlands and deliveries under
a long-term fiber supply agreement entered into in connection with the 1999 sale
of the bleached paperboard operations. The contribution to the Building Products
Group's operating income from sales of high-value lands was $16 million in 2002
compared with $10 million in 2001 and $11 million in 2000.

Costs, which include production, distribution and administrative costs,
were $738 million in 2002 compared with $713 million in 2001 and $759 million in
2000. The change in costs in 2002 was due to higher production volumes and
higher pension costs, up $4 million, partially offset by lower energy costs,
down $12 million. Fiber costs were up three percent. The change in costs in 2001
was due to lower production volumes, lower depreciation expense, down $7
million, and the disposition of the fiber cement venture during third quarter
2000 offset by higher energy costs, up $8 million. The decrease in depreciation
expense was due to the lengthening of estimated useful lives of certain
production equipment beginning January 2001. Fiber costs were down 16 percent.
The change in costs in 2000 was due to additional manufacturing facilities, an
increase in energy costs, up $7 million, and $13 million of operating losses
from the fiber cement venture. Fiber costs were up four percent. Energy costs,
principally natural gas, continue to fluctuate from year to year. Energy costs
began to rise during second quarter 2000, peaked during second quarter 2001 and
began to decline the remainder of 2001 reaching more normalized levels by
year-end 2001. Energy costs remained at these levels during most of 2002, but
began to rise during fourth quarter 2002 and have continued to rise in early
2003. It is likely that energy costs will continue to fluctuate during 2003.

Production was curtailed to varying degrees due to market conditions in
most product lines. Production averaged from a low of 66 percent to a high of 76
percent of capacity in the various product lines in 2002 compared with a low of
66 percent to a high of 77 percent of capacity in 2001. The Building Products
Group's joint venture operations also experienced production curtailments in
2002 and 2001 due to market conditions. The Building Products Group and its
joint venture operations will likely continue to curtail production to varying
degrees due to market conditions in the various product lines in 2003.

The Building Products Group's Del-Tin Fiber LLC MDF joint venture in El
Dorado, Arkansas, continues to experience production and cost issues. In first
quarter 2001, this facility was shut down due to market conditions, higher
energy prices and reconstruction of the heat energy system of the plant.
Production at this facility resumed in second quarter 2001. In second quarter
2002, Deltic Timber Corporation, the partner in this venture, announced its
intentions to evaluate strategic alternatives for its one-half interest in the
venture. In January 2003, Deltic Timber announced its intention to exit this
business upon the earliest, reasonable opportunity provided by the market. As a
result of this decision, Deltic Timber recognized an $11 million after tax
charge. It is uncertain what effects Deltic Timber's decision will have on the
joint venture or its operations. At year-end 2002, the Building Products Group's
equity investment in the venture was $14 million, and it has agreed to fund up
to $36 million of the venture's debt service obligations as needed. In 2002, the
Building Products Group contributed $12 million to the venture. At year-end
2002, the venture had $2 million in working capital, $97 million in property and
equipment and $75 million in net long-term debt.

25

For the year 2002, the venture had $31 million in revenues and a net loss of $19
million of which the Building Products Group's share was $9 million.

In 2001, the Building Products Group performed a review of its 2.1 million
acres of timberlands and classified them into three categories: strategic, 1.8
million acres; non-strategic, 110,000 acres; and high value, 160,000 acres. In
September 2001, approximately 78,000 acres of the non-strategic timberlands were
sold for $54 million resulting in a gain of $20 million, which was included in
other income. The remaining non-strategic timberlands will be sold over time.
The high value land is located around Atlanta, Georgia and will be sold over
time. In 2002, 5,846 acres of these high value lands were sold compared with
2,462 acres in 2001.

The Building Products Group is continuing its efforts to enhance return on
investment, including reviewing operations that are unable to meet return
objectives and determining appropriate courses of action. In addition, the
Building Products Group is continuing to address production cost and market
issues at its particleboard and MDF facilities, including the Del-Tin Fiber MDF
joint venture.

The Building Products Group's business segment operating income was $49
million in 2002 compared with $13 million in 2001 and $77 million in 2000.

THE FINANCIAL SERVICES GROUP

The Financial Services Group operates a savings bank and engages in
mortgage banking, real estate and insurance brokerage activities. The savings
bank, Guaranty Bank (Guaranty), conducts its retail business through banking
centers in Texas and California. Commercial and residential lending activities
are conducted in over 35 markets in 21 states and the District of Columbia. The
mortgage banking operation originates single-family mortgages and services them
for Guaranty and unrelated third parties. Mortgage origination offices are
located in 26 states. Real estate operations include the development of
residential subdivisions and multifamily housing and the management and sale of
income producing properties, which are principally located in Texas, Colorado,
Florida, Tennessee, California and Missouri. The insurance brokerage operation
sells a full range of insurance products.

In 2002, the Financial Services Group acquired five savings bank branches
in Northern California and an insurance agency operation in Los Angeles. In
2001, the Financial Services Group acquired an asset-based loan portfolio and
two mortgage production operations. In 2000, the Financial Services Group
acquired American Finance Group, Inc. (AFG), a commercial finance company
engaged in leasing and secured lending. Pro forma results, assuming these
acquisitions had been effected at the beginning of the appropriate periods,
would not be significantly different from those presented.

Operations

The Financial Services Group revenues, consisting of interest and
noninterest income, were $1.1 billion in 2002 compared with $1.3 billion in 2001
and $1.3 billion in 2000.

Selected financial information for the Financial Services Group follows:

26

Net interest income was $374 million in 2002 compared with $395 million in
2001 and $355 million in 2000. The change in net interest income in 2002 was due
to the maintenance of an asset sensitive position, a change in the mix of
average earning assets and a competitive market for deposits. In 2002, the
Financial Services Group maintained an asset sensitive position whereby the rate
and pre-payment characteristics of its assets were more responsive to changes in
market interest rates than its liabilities. As a result, the declining interest
rate environment encountered in 2002 coupled with a change in the mix of earning
assets to lower risk, lower yield, single-family residential related earning
assets negatively affected net interest income. The change in net interest
income in 2001 was primarily due to growth and changes in the mix of average
earning assets and interest-bearing liabilities. To assist in quantifying these
matters the following table presents average balances, interest income and
expense and rates by major balance sheet categories:

- ---------------

(a) Includes nonaccruing loans.

Average earning assets increased $1.4 billion in 2002, primarily due to an
increase in securities. A mortgage-backed securities purchase program, begun in
late 2001, resulted in an increase in average U.S. government agency
mortgage-backed securities of $1.7 billion in 2002. The increase in average
securities was partially offset by a $597 million decline in average loans. The
decline in average loans was due primarily to decreases of $307 million in
average single-family mortgage loans, $215 million in average consumer and other

27

loans and $201 million in average commercial real estate loans, which were
partially offset by a $216 million increase in commercial and business loans. In
addition, average loans held for sale increased $285 million in 2002. Average
earning assets increased $816 million in 2001 primarily due to an increase in
average loans and average loans held for sale. Approximately $280 million of the
increase in average loans was the result of the first quarter 2001 acquisition
of an asset-based lending portfolio and the first quarter 2000 acquisition of
AFG. The remainder was due to internally generated growth, primarily in average
residential loans and average commercial and business loans. In addition,
average loans held for sale increased $490 million in 2001.

Average interest bearing liabilities increased $656 million in 2002
primarily due to an increase in other borrowings partially offset by a decrease
in deposits. Average other borrowings increased $1.3 billion due primarily to an
increase in average securities sold under repurchase agreements resulting from
the mortgage-backed securities purchase program partially offset by a $210
million decrease in average advances from FHLBs. The decrease in average
interest-bearing deposits of $601 million in 2002 was the result of very
competitive markets partially offset by branch and deposit acquisitions. Despite
paying rates for new deposits at an historically high interest rate spread,
non-renewed maturing deposits exceeded new deposits in 2002. See Note G to the
Financial Services Group Summarized Financial Statements for further information
regarding deposits. Average interest bearing liabilities increased $631 million
in 2001 due primarily to an increase in average other borrowings, principally
advances from FHLBs partially offset by a $476 million decrease in average
interest-bearing deposits in very competitive markets.

The following table presents the changes in net interest income
attributable to changes in volume and rates of earning assets and
interest-bearing liabilities.

- ---------------

(a) The change in interest income and expense due to both volume and rate has
been allocated to volume and rate changes in proportion to the relationship
of the absolute dollar amounts of the change in each.

The Financial Services Group is a party to various interest rate corridor
and cap agreements, which reduce the impact of increases in interest rates on
its investments in adjustable-rate mortgage-backed

28

securities that have lifetime interest rate caps. These corridor and cap
agreements do not qualify for hedge accounting and are therefore recorded at
fair value. The changes in fair value, which are not material, are included in
the determination of net interest income. The fair value of these corridor and
cap agreements at year-end 2002 and 2001 was immaterial. There were no material
changes in risk management policies as a result of applying hedge accounting in
2002. See Note M to the Financial Services Group Summarized Financial Statements
for further information regarding hedging strategies.

In 2002, net interest income was adversely affected by the maintenance of
an asset sensitive position in a declining interest rate environment coupled
with a change in the mix of earning assets to lower risk, lower yield,
single-family residential related earning assets. If interest rates continue to
decline in 2003 it is likely that net interest income will continue to be
adversely affected. However, if interest rates begin to rise in 2003, then it is
likely that net interest income would be positively affected.

The provision for loan losses was $40 million in 2002 compared with $46
million in 2001 and $39 million in 2000. The 2002 provision related primarily to
the commercial and business portfolio. This portfolio includes large
syndications, middle market lending, asset-based lending and equipment leasing.
Both the asset-based lending and equipment leasing areas continued to show
weakness in 2002. Significant provisions were required on several borrowers with
ties to air transportation, which was affected by the downturn related to the
events of September 11, 2001. The 2001 provision primarily related to a decline
in asset quality related to loans in the senior housing, commercial and
asset-based lending portfolios. The 2000 provision primarily related to large
syndications in the commercial and business portfolio.

Noninterest income includes service charges, fees and revenues from
mortgage banking, real estate and insurance activities. Noninterest income was
$370 million in 2002 compared with $308 million in 2001 and $235 million in
2000. The increase in noninterest income in 2002 was due to increases in income
from mortgage banking operations of $63 million, service charges on deposits of
$8 million and insurance operations of $3 million. These were partially offset
by declines in income from real estate operations of $9 million, loan related
fees and gains on sale of loans of $4 million and income from operating leases
of $3 million. See Mortgage Banking Activities for further information regarding
mortgage banking operations. The increase in income from insurance operations
was primarily due to an agency acquisition in first quarter 2002. The decline in
income from the real estate operations was primarily related to the decline in
lot sales as activity in residential development slowed with the downturn in the
economy. The decline in loan related fees and gains on sale of loans was
primarily due to lower loan origination activity. The Financial Services Group
is no longer originating equipment leases. As a result, the income from
operating leases is declining as the portfolio pays off. The increase in
noninterest income in 2001 was due to increased income from mortgage banking
operations of $46 million, insurance operations of $13 million, loan related
fees and gains on sale of loans of $7 million and fee-based products of $8
million. These were partially offset by a decline in income from real estate
operations of $4 million.

Noninterest expense includes compensation and benefits, real estate
operations, occupancy and data processing expenses. Noninterest expense,
including severance and asset write-offs, was $540 million in 2002 compared with
$473 million in 2001 and $362 million in 2000. The increase in noninterest
expense in 2002 was primarily due to an increase in costs associated with
mortgage banking operations of $76 million and compensation and benefits
associated with the insurance agency acquisition of $4 million. During first
quarter 2002, due to a slow down in loan demand, the Financial Services Group
took actions to lower costs and exit certain businesses and product delivery
methods that were not expected to meet return objectives in the near term. These
actions resulted in a $7 million charge related to severance for work force
reductions and the write-off of certain technology investments. This
restructuring and other cost reduction activities that occurred throughout 2002
resulted in a reduction in compensation and benefits of $8 million, professional
services of $4 million, advertising and promotional expense of $3 million and
occupancy of $3 million. The increase in noninterest expense in 2001 was
primarily due to an increase in costs associated with mortgage banking
operations of $68 million and costs related to the asset-based portfolio
acquisition and new product offerings.

See Note N to the Financial Services Group Summarized Financial Statements
for further information regarding noninterest income and noninterest expense.

29

Earning Assets

Earning assets include cash equivalents, mortgage loans held for sale,
securities and loans. At year-end 2002, cash equivalents, mortgage loans held
for sale, securities and residential loans constituted 77 percent of total
earning assets compared with 69 percent at year-end 2001 and 70 percent at
year-end 2000.

Securities, which consists principally of U.S. government agency
mortgage-backed securities, were $5.8 billion at year-end 2002 compared with
$3.4 billion at year-end 2001 and $3.3 billion at year-end 2000. The increase in
2002 was due to purchases of U.S. Government agency mortgage-backed securities
of $3.4 billion partially offset by maturities and prepayments. These purchases
are part of a mortgage-backed securities purchase program that began in late
2001. The increase in 2001 was the result of purchases and securitizations of
$948 million, partially offset by maturities and prepayments. Virtually all of
these securities held at year-end 2002 were classified as variable/no maturity.
See Note D to the Financial Services Group Summarized Financial Statements for
further information regarding securities.

Mortgage loans held for sale were $1.1 billion at year-end 2002 compared
with $958 million at year-end 2001 and $232 million at year-end 2000. The
increases in 2002 and 2001 were the result of high refinancing activities due to
the low interest rate environment and growth in the mortgage production
operations due to acquisitions in 2001.

Loans were $9.8 billion at year-end 2002 compared with $10.0 billion at
year-end 2001 and $10.5 billion at year-end 2000. The following table summarizes
the composition of the loan portfolio:

Single-family mortgages are made to owners to finance the purchase of a
home. Single-family mortgage warehouse loans provide funding to mortgage lenders
to support the flow of loans from origination to sale. Single-family
construction loans finance the development and construction of single-family
homes, condominiums and town homes, including the acquisition and development of
home lots. Multifamily and senior housing loans are for the development,
construction and lease up of apartment projects and housing for independent,
assisted and memory-impaired residents. Commercial real estate loans provide
funding for the development, construction and lease up primarily of office,
retail and industrial projects and are geographically diversified among 35
market areas in 21 states and the District of Columbia. Commercial and business
loans finance business operations and are primarily composed of large
syndications, asset-based and middle market loans and direct financing leases on
equipment. The Financial Services Group is no longer originating equipment
leases, and, as a result, this portfolio is declining as the leases pay off.
Consumer and other loans are primarily composed of loans secured by junior liens
on single-family homes.

In 2002, the Financial Services Group focused on altering the mix of loans
to reduce the overall risk in the portfolio. As a result, residential loans
represent 60 percent of the loan portfolio at year-end 2002 compared with 55
percent at year-end 2001 and 59 percent at year-end 2000. In 2002, single-family
mortgage

30

loans increased $483 million and commercial real estate loans decreased $611
million. In 2001, single-family mortgage loans decreased $972 million due to
significant repayments in the low interest rate environment and very little new
loan production. In addition, commercial and business loans increased $538
million partially due to the 2001 acquisition of an asset-based lending
portfolio.

Lending activities are subject to underwriting standards and liquidity
considerations. Specific underwriting criteria for each type of loan are
outlined in a credit policy approved by the Board of Directors of the savings
bank. In general, commercial loans are evaluated based on cash flow, collateral,
market conditions, prevailing economic trends, type and leverage capacity of the
borrower, capabilities, experience and reputation of management of the borrower
and capital and investment in a particular property, if applicable. Most small
business and consumer loans are underwritten using credit-scoring models that
consider factors including payment capacity, credit history and collateral. In
addition, market conditions, economic trends and the type of borrower are
considered. The credit policy, including the underwriting criteria for loan
categories, is reviewed on a regular basis and adjusted when warranted.

Construction and commercial and business loans by maturity date at year-end
2002 follow:

Asset Quality

Several important measures are used to evaluate and monitor asset quality.
They include the level of loan delinquencies, nonperforming loans and assets and
net loan charge-offs compared to average loans.

Accruing delinquent loans past due 30 days or more were 1.17 percent of
total loans at year-end 2002 compared with 1.07 percent at year-end 2001 and
1.67 percent at year-end 2000. Accruing delinquent loans

31

past due 90 days or more were 0.07 percent at year-end 2002 compared with none
at year-end 2001 and 0.06 percent at year-end 2000.

Nonperforming loans consist of nonaccrual loans (loans on which interest
income is not currently recognized) and restructured loans (loans with below
market interest rates or other concessions due to the deteriorated financial
condition of the borrower). Interest payments received on nonperforming loans
are applied to reduce principal if there is doubt as to the collectibility of
contractually due principal and interest. Nonperforming loans decreased in 2002
due to payoffs and improved credit quality in the senior housing portfolio.
Nonperforming loans increased in 2001 due to loans in the senior housing and
asset-based portfolios. One of the asset-based loans was affected by the events
of September 11, 2001. The allowance as a percent of nonperforming loans was
104.80 percent at year-end 2002 compared with 83.73 percent at year-end 2001 and
179.73 percent at year-end 2000. The allowance as a percent of total loans was
1.34 percent at year-end 2002 compared with 1.39 percent at year-end 2001 and
1.12 percent at year-end 2000. Loans accounted for on a nonaccrual basis,
accruing loans that are contractually past due 90 days or more, and restructured
or other potential problem loans were less than two percent of total loans as of
the end of each of the most recent five years. The aggregate amounts and the
interest income foregone on such loans were immaterial.

The investment in impaired loans was $14 million at year-end 2002 compared
with $66 million at year-end 2001, with related allowances for loan losses of $6
million at year-end 2002 compared with $28 million at year-end 2001. The average
investment in impaired loans was $33 million in 2002 compared with $37 million
in 2001. The related amount of interest income recognized on impaired loans in
2002 and 2001 was immaterial.

Virtually all of the loans in the commercial real estate portfolio are
collateralized and performing in accordance with contractual terms. However,
many of the projects being financed are nearing completion and, as a result,
will soon require that the borrower secure permanent financing, continue
temporary financing, extend the existing borrowing or sell the property. In
addition, many of these loans contain options that permit the borrower to extend
the term of the loan if defined operating levels are achieved. In the current
economic environment, permanent financing may be difficult to secure and sales
may require significant marketing periods or may not be possible or, given the
current low variable interest rate environment, the borrower may elect to
continue temporary financing.

In addition, at year-end 2002, there are $48 million of potential problem
loans that are performing in accordance with contractual terms but for which
management has concerns about the borrower's ability to continue to comply with
repayment terms because of operating and financial difficulties. These include
direct financing aircraft leases, totaling $33 million, with an air cargo
transportation company that has indicated a need to renegotiate leases on
several aircraft, including those of the Financial Services Group. At year-end
2002, payments on these leases were current; however, no payments have been
received on these leases since mid-January 2003. The effect, if any, of lease
renegotiations on loss exposure cannot presently be determined. However, it is
likely that these leases will be classified as non-performing during first
quarter 2003. In addition, the renegotiation may result in terms that would
require classification of these assets as operating leases. If the renegotiated
leases are determined to be operating leases, they would not be included in the
loan portfolio but would be classified as other assets. Management believes it
has established an adequate allowance for loss against these direct financing
leases. The ultimate loss, if any, however, may differ from management's
estimate. These matters will be closely monitored and will likely be resolved in
2003.

Allowance for Loan Losses

The allowance for loan losses includes specific allowances, general
allowances and an unallocated allowance. Management continuously evaluates the
allowance for loan losses to confirm the level is adequate to absorb losses
inherent in the loan portfolio. The allowance is increased by charges to income
through the provision for loan losses and by the portion of the purchase price
related to credit risk on loans acquired through bulk purchases and
acquisitions, and decreased by charge-offs, net of recoveries.

Specific allowances are based on a thorough review of the financial
condition of the borrower, general economic conditions affecting the borrower,
collateral values and other factors. General allowances are based

32

on historical loss trends and management's judgment concerning those trends and
other relevant factors, including delinquency rates, current economic
conditions, loan size, industry competition and consolidation and the effect of
government regulation. The unallocated allowance provides for inherent loss
exposures not yet identified. The evaluation of the appropriate level of
unallocated allowance considers current risk factors that may not be apparent in
historical factors used to determine the specific and general allowances. These
factors include inherent delays in obtaining information, the volatility of
economic conditions, the subjective nature of individual loan evaluations,
collateral assessments and the interpretation of economic trends and the
sensitivity of assumptions used to establish general allowances for homogeneous
groups of loans.

Changes in the allowance for loan losses were:

Charge-offs increased in 2002 primarily due to certain loans in the
asset-based portfolio. Two of the borrowers were in industries related to air
transportation, which were affected by the events of September 11, 2001.
Charge-offs in 2001 were primarily related to certain large syndications.
Charge-offs in 2000 were primarily related to borrowers in the mortgage banking
industry and certain large syndications.

33

The Financial Services Group allocation of the allowance for loan losses
follows. Allocation of a portion of the allowance does not preclude its
availability to absorb losses in other categories of loans.

The allocation of the allowance did not change significantly in 2002. The
decrease in the allowance allocated to residential loans in 2002 was due to
improvements in the financial condition of several senior housing borrowers and
a reduction in the level of classified single-family mortgage loans. The
allowance allocated to the commercial real estate portfolio decreased slightly
in 2002 while the portfolio declined $611 million. The higher allowance coverage
in 2002 was due to the mature nature of the real estate properties financed by
the commercial and real estate portfolios. The increase in the allowance
allocated to residential loans in 2001 was due to an increase in nonperforming
senior housing loans. The increase in the allowance allocated to the commercial
and business portfolio was due to the growth in asset-based lending partially
offset by charge-offs of syndicated loans for which an allowance was previously
provided.

The allowance for loan losses is considered adequate based on information
currently available. However, adjustments to the allowance may be necessary due
to changes in economic conditions, assumptions as to future delinquencies or
loss rates and intent as to asset disposition options. In addition, regulatory
authorities periodically review the allowance for loan losses as a part of their
examination process. Based on their review, the regulatory authorities may
require adjustments to the allowance for loan losses based on their judgment
about the information available to them at the time of their review.

Mortgage Banking Activities

In 2001, the Financial Services Group completed acquisitions of mortgage
production operations in the upper mid-west and mid-Atlantic regions that
significantly increased its mortgage production capacity. In addition, the
mortgage loan-servicing portfolio was reduced by an $8.6 billion bulk sale of
servicing. The acquisitions and change in the size of the servicing portfolio
were designed to reposition the mortgage banking operations to be more
production focused and to minimize impairment risk associated with mortgage
servicing rights.

Mortgage loan originations were $10.8 billion in 2002 compared with $7.6
billion in 2001 and $2.1 billion in 2000. Included in total production were
loans originated for the savings bank of $1.2 billion in 2002 compared with $171
million in 2001 and virtually none in 2000. The significant increase in loans
originated for the savings bank in 2002 was the result of the Financial Services
Group's efforts to increase the level of single-family mortgage related assets.
The record mortgage loan originations in 2002 and the significant increase in
2001 compared with 2000 were due to the 2001 acquisitions and the high level of
refinance activity resulting

34

from the low interest rate environment. Higher interest rates during 2000
resulted in a significant reduction in mortgage refinancing activity,
contributing to the lower level of originations.

Mortgage servicing portfolio runoff was 33.5 percent in 2002 compared with
26.1 percent in 2001 and 13.9 percent in 2000. The changes in the runoff rates
were due to the lower interest rate environments in 2002 and 2001, leading to
high levels of refinancing, and a relatively higher interest rate environment in
2000 resulting in low levels of refinancing. As a result of the high runoff
rates, the mortgage operation recorded significant amortization of mortgage
servicing rights and impairment charges in both 2002 and 2001. Amortization of
mortgage servicing rights was $50 million in 2002 compared with $40 million in
2001. Provisions for impairment of mortgage servicing rights totaled $9 million
in 2002 compared with $6 million in 2001 resulting in valuation allowances of
$15 million at year-end 2002 compared with $6 million at year-end 2001.

In 2002, the mortgage banking operations sold $10.6 billion in loans to
secondary markets by delivering loans to third parties or by delivering loans
into mortgage-backed securities. Of the loans sold in 2002, the only retained
interest was mortgage servicing rights relating to $4.2 billion of loans. Loans
sold in 2001 and 2000 totaled $6.9 billion and $1.5 billion, respectively. Of
the loans sold in 2001 and 2000, the only retained interest was mortgage
servicing rights relating to $5.4 billion and $600 million of loans,
respectively.

The mortgage servicing portfolio was $10.6 billion at year-end 2002
compared with $11.4 billion at year-end 2001 and $19.5 billion at year-end 2000.
The decrease in 2002 was the result of significant repayments on loans serviced
for third parties. The decrease in 2001 was due to the bulk sale of servicing,
an increase in the sale of servicing with loan production and the accelerated
runoff rate. Included in the mortgage servicing portfolio were loans serviced
for the savings bank totaling $1.5 billion at year-end 2002 compared with $0.7
billion at year-end 2001 and $0.9 billion at year-end 2000.

In 2001 and 2002, the mortgage banking operations were significantly
affected by the refinancing activity associated with the declining interest rate
environment. If interest rates continue to decline in 2003, the level of
mortgage originations and the level of mortgage servicing rights impairment will
likely remain high. However, if interest rates remain constant or begin to rise
in 2003, then the level of mortgage originations and the level of mortgage
servicing rights impairment will likely decline.

CORPORATE, INTEREST AND OTHER INCOME/EXPENSE

Corporate expenses were $34 million in 2002 compared with $30 million in
2001 and $33 million in 2000. The changes in 2002 and 2001 were primarily due to
changes in pension costs.

Parent company interest expense was $133 million in 2002 compared with $98
million in 2001 and $105 million in 2000. The change in 2002 was due to an
increase in long-term debt due to the acquisition of Gaylord offset in part by a
$362 million reduction in other borrowings. In addition, the parent company
effected a number of financing transactions in 2002 that lengthened debt
maturities and reduced reliance on variable rate debt. As a result, the average
interest rate incurred on debt increased. The average interest rate on
borrowings was 6.4 percent in 2002 compared with 6.3 percent in 2001 and 7.2
percent in 2000. The change in 2001 was due to a $43 million decrease in debt
and a decrease in average interest rates, 6.3 percent in 2001 compared with 7.2
percent in 2000.

Other operating income/expense primarily consists of gains and losses on
the sale or disposition of under-performing and non-strategic assets. In 2002,
it consists of a $6 million charge related to the purchase of promissory notes
sold with recourse. In 2001, it includes a $20 million gain on the sale of
non-strategic timberlands and $13 million of losses related to under-performing
assets. It also includes a $4 million fair value adjustment of an interest rate
swap agreement before its designation as a cash flow hedge. In 2000, it consists
of a $15 million charge related to the decision to exit the fiber cement
business.

Non-operating expenses in 2002 consists of the write-off of $11 million of
unamortized financing fees related to the early repayment of the Gaylord bridge
financing facility.

35

The Company has embarked on a significant project to reorganize operations
and utilize a shared service concept to lower costs and improve efficiency.
Project TIP (Transformation-Innvovation-Performance) involves moving the
corrugated packaging operations management from Indianapolis to Austin,
consolidating business support functions throughout the Company into a shared
service function and combining and leveraging the procurement, transportation
and supply-chain processes for the entire company. The Company anticipates
estimated annual savings and cost reductions from this project of approximately
$60 million, the majority of which will begin to be realized in 2004.

PENSION EXPENSE (CREDIT)

Non-cash pension expense was $9 million in 2002 compared with non-cash
pension credits of $18 million in 2001 and $9 million in 2000. The change in
2002 was due to lower than expected returns on pension plan assets through
year-end 2001 and to the acquisition of Gaylord. The changes in 2001 and 2000
reflect the cumulative higher than expected returns on pension plan assets
through year-end 2000. See PENSION MATTERS for further information regarding
2003 pension expense.

INCOME TAXES

The effective tax rate was 39 percent in 2002 compared with 37 percent in
2001 and 39 percent in 2000. The difference between the effective tax rate and
the statutory rate is due to state income taxes, nondeductible items and losses
in certain foreign operations for which no financial benefit is recognized until
realized. The 2001 rate reflects a one time, three percent, financial benefit
realized from the sale of the corrugated packaging operation in Chile.

Based on current expectations of income and expense, it is likely that the
effective tax rate for the year 2003 will approximate 42 percent.

The Company is in the process of concluding the Internal Revenue Service's
examination of the Company's tax returns for the years 1993 through 1996
including matters related to the Company's computations of net operating losses
and minimum tax credit carry forwards for which no financial accounting benefit
has been recognized. If these computations are approved, the Company expects to
recognize a significant non-cash financial accounting benefit as a result of
reducing valuation allowances previously provided against its deferred tax
assets.

AVERAGE SHARES OUTSTANDING

Average diluted shares outstanding were 52.4 million in 2002 compared with
49.3 million in 2001 and 50.9 million in 2000. The increase of six percent in
2002 was due to the May 2002 sale of 4.1 million shares of common stock. The
decrease of three percent in 2001 was due to the effects of share repurchases
under the stock repurchase programs authorized during fourth quarter 1999 and
third quarter 2000. The dilutive effect of stock options and equity purchase
contracts was not significant in any of the years presented.

CAPITAL RESOURCES AND LIQUIDITY FOR THE YEAR 2002

The consolidated net assets invested in the Financial Services Group are
subject, in varying degrees, to regulatory rules and regulations including
restrictions on the payment of dividends to the parent company. Accordingly, the
parent company and the Financial Services Group capital resources and liquidity
are discussed separately.

PARENT COMPANY

OPERATING ACTIVITIES

Cash provided by operations was $387 million in 2002 compared with $346
million in 2001. An $89 million increase in depreciation and other non-cash
charges more than offset the $56 million decrease in net income. Depreciation
and depletion was $224 million, up $40 million, due principally to depreciation
associated with the 2002 acquisitions. Other net non-cash expenses were $73
million, up $53 million due principally to increases in non-cash pension and
postretirement expenses. Dividends received from the

36

Financial Services Group were $125 million in 2002, about the same as in 2001.
There was no significant change in working capital.

INVESTING ACTIVITIES

Cash used by investing activities was $698 million in 2002 compared with
$270 million in 2001. Cash paid for acquisitions, up $465 million, more than
offset the $72 million reduction in capital expenditures. Cash paid for
acquisitions and additional investments in joint ventures was $625 million
including $568 million to acquire Gaylord and $39 million to acquire a box plant
in Puerto Rico and the converting facilities of Mack Packaging Group, Inc. and
Fibre Innovations LLC. In addition, $12 million was contributed to the Del-Tin
joint venture. Cash received from the dispositions of Gaylord's non-strategic
assets and operations was $68 million, including $25 million related to working
capital items. In January 2003, the Company sold Gaylord's multi-wall bag
business and kraft paper mill. Aggregate proceeds from the dispositions of
Gaylord's non-strategic assets now approximate $100 million.

Capital expenditures were $112 million, down $72 million, and approximated
50 percent of 2002 depreciation and depletion. Capital expenditures are expected
to approximate $160 million in 2003 or about 75 percent of expected 2003
depreciation and depletion.

There were no capital contributions to the Financial Services Group during
2002.

FINANCING ACTIVITIES

Cash provided by financing activities was $325 million. Cash received from
financing transactions more than offset debt repayments and dividends to
shareholders.

Cash proceeds from the May 2002 offerings of common stock, senior notes and
Upper DECS(SM) units were $1,056 million before expenses of $28 million. These
proceeds were used to repay the $880 million acquisition bridge financing
facility and, coupled with the cash from operations, used to repay $362 million
in other borrowings and provide for a small increase in short-term investments.
The bridge financing facility initially provided $880 million of which $525
million was used to acquire Gaylord, $285 million was used to repay Gaylord's
assumed bank debt, $12 million was used for financing fees and the remainder was
used for other acquisition related purposes. The 4.1 million shares of common
stock were sold for $52 per share. The $500 million of 7.875% Senior Notes due
2012 were sold at 99.289 percent of par. The notes bear interest at an effective
rate of 7.98 percent.

The Upper DECS(SM) units consist of $345 million of 6.42% Senior Notes due
in 2007 and contracts to purchase common stock. The interest rate on the Upper
DECS(SM) senior notes will be reset in February 2005. The purchase contracts
represent an obligation to purchase by May 2005, shares of common stock based on
an aggregate purchase price of $345 million. The actual number of shares that
will be issued on the stock purchase date will be determined by a settlement
rate that is based on the average market price of the Company's common stock for
20 days preceding the stock purchase date. The average price per share will not
be less than $52, in which case 6.635 million shares would be issued, and will
not be higher than $63.44, in which case 5.438 million shares would be issued.
If a holder elects to purchase shares prior to May 2005, the number of shares
that would be issued will be based on a fixed price of $63.44 per share (the
settlement rate resulting in the fewest number of shares issued to the holder)
regardless of the actual market price of the shares at that time. Accordingly,
if the purchase contracts had been settled at year-end 2002, the settlement rate
would have resulted in the issuance of 5.438 million shares of common stock and
the receipt of $345 million cash. The purchase contracts also provide for
contract adjustment payments at an annual rate of 1.08 percent.

Cash dividends paid to shareholders were $67 million or $1.28 per share,
the same as in 2001. In February 2003, the Company increased the quarterly cash
dividend to $0.34 per share, or a projected annual rate of $1.36 per share.

37

LIQUIDITY AND OFF BALANCE SHEET FINANCING ARRANGEMENTS

The following table summarizes the parent company's contractual cash
obligations at year-end 2002:

The parent company's sources of short-term funding are its operating cash
flows, which include dividends received from the Financial Services Group, its
existing credit arrangements and its accounts receivable securitization program.
The parent company operates in cyclical industries, and its operating cash flows
vary accordingly. The dividends received from the Financial Services Group are
subject to regulatory approval and restrictions.

At year-end 2002, the parent company had $575 million in committed credit
agreements and a $200 million accounts receivable securitization program. Unused
borrowing capacity under its existing credit agreements was $505 million and
$140 million under the accounts receivable securitization program. In 2002, the
parent company increased its committed credit agreements by entering into a new
$400 million credit facility, canceling credit agreements scheduled to mature in
2002 and renegotiating some of its committed credit lines. Under the terms of
the new $400 million credit facility, $200 million expires in 2005, with a
provision to extend for one further year up to the full $200 million with the
consent of the lending banks. The other $200 million expires in 2007. Also in
2002, the maturity date of the accounts receivable securitization program was
extended until August 29, 2003. Most of the credit agreements contain terms and
conditions customary for such agreements including minimum levels of interest
coverage and limitations on leverage. At year-end 2002, the parent company
complied with all the terms and conditions of its credit agreements and the
accounts receivable securitization program. None of the current credit
agreements or the accounts receivable securitization program are restricted as
to availability based on the parent company's long-term debt ratings.
Approximately $32 million in joint venture and subsidiary debt guarantees and
funding obligations include rating triggers, if the long-term debt of the parent
company falls below investment grade, which if activated could result in
acceleration. The long-term debt of the parent company is currently rated
BBB/Stable by one rating agency and Baa3/Negative outlook by another rating
agency.

The following table summarizes the parent company's commercial commitments
at year-end 2002:

The parent company is a participant in three joint ventures engaged in
manufacturing and selling paper and building materials. The joint venture
partner in each of these ventures is a publicly-held company. At year-end 2002,
these ventures had $215 million in long-term debt of which the parent company
had guaranteed debt service obligations and letters of credit aggregating $124
million. Generally the guarantees would be funded by the parent company for lack
of specific performance by the joint ventures, such as non-payment of debt. One
of the joint ventures has $56 million in indebtedness that is supported by
letters of credit. The parent company and the joint venture partner have each
severally guaranteed one-half of the letter

38

of credit reimbursement obligations of the joint venture. Subsequent to
year-end, the letter of credit issuer informed the joint venture that the
letters of credit would not be renewed upon their expiration in second quarter
2003. If the existing letters of credit are not extended or substitute letters
of credit are not provided prior to the expiration date, it is likely that the
parent company could be called upon to pay $28 million to the letter of credit
bank under this guaranty. The parent company has no unconsolidated special
purpose entities. In addition the parent company has guaranteed the repayment of
$30 million of borrowings by a subsidiary of the Financial Services Group.

The parent company had an interest rate and several commodity derivative
instruments outstanding at year-end 2002. The interest rate instrument expires
in 2008, and the majority of the commodity instruments expire in 2005. These
instruments are non-exchange trade and are valued using either third-party
resources or models. At year-end 2002, the aggregate fair value of all
derivatives was a $9 million liability.

The preferred stock issued by subsidiaries of Guaranty Bank is
automatically exchanged into preferred stock of Guaranty Bank upon the
occurrence of certain regulatory events or administrative actions. If such
exchange occurs, certain preferred shares are automatically surrendered to the
parent company in exchange for senior notes of the parent company and certain
shares, at the parent company's option, are either exchanged for senior notes of
the parent company or redeemed. At year-end 2002, the outstanding preferred
stock issued by these subsidiaries totaled $305 million.

THE FINANCIAL SERVICES GROUP

OPERATING ACTIVITIES

Cash provided by operations was $1 million in 2002 compared with a use of
cash of $417 million in 2001. The change was due principally to a $543 million
decrease in loans held for sale, a $59 million decrease in originated mortgage
servicing rights partially offset by a $174 million decrease in escrowed cash
related to mortgage loans serviced.

INVESTING ACTIVITIES

Cash used for investing activities was $1,569 million in 2002 compared with
cash provided by investing activities of $520 million in 2001. An increase in
securities purchases more than offset the decrease in funds used for
acquisitions and the decrease in the sales of loans and mortgage servicing
rights. Securities purchases, net of maturities, were $2,042 million, up over
$2,000 million, due principally to the U.S. government agency mortgage-backed
securities purchase program that started in late 2001.

Cash provided by branch acquisitions totaled $364 million in 2002.

FINANCING ACTIVITIES

Cash provided by financing activities was $1,419 million in 2002.
Borrowings, which consist primarily of short- and long-term advances from
Federal Home Loan Banks and securities sold under repurchase agreements,
increased $1,719 million, primarily to fund the U.S. government agency
mortgage-backed securities purchase program.

Deposits, excluding branch and deposit acquisitions, declined $277 million
due to competitive market conditions. Dividends paid to the parent company were
$125 million in 2002, about the same as 2001.

CASH EQUIVALENTS

Cash equivalents were $438 million at year-end 2002 compared with $587
million at year-end 2001. Year-end 2001 cash equivalents were unusually large
due to the receipt on the last day of 2001 of proceeds from the sale of mortgage
loans, which were used to reduce borrowings in January 2002.

39

LIQUIDITY, OFF BALANCE SHEET FINANCING ARRANGEMENTS AND CAPITAL ADEQUACY

The following table summarizes the Financial Services Group's contractual
cash obligations at year-end 2002:

The Financial Services Group's short-term funding needs are met through
operating cash flows, attracting new retail and wholesale deposits, increasing
borrowings and converting assets to cash through sales or reverse repurchase
agreements. Assets that can be converted to cash include short-term investments,
loans, mortgage loans held for sale and securities. At year-end 2002, the
Financial Services Group had available liquidity of $1.9 billion. The maturities
of deposits in the above table are based on contractual maturities and repricing
periods. Most of the deposits that are shown to mature in 2003 consist of
transaction deposit accounts and short-term (less than one year) certificates of
deposit, most of which have historically renewed at maturity.

In addition, the Financial Services Group is the lessor in a leveraged
lease transaction that includes third-party debt totaling $28 million at
year-end 2002. The debt provides no recourse to the Financial Services Group and
is secured by the leased equipment and cash flow from the related lease. At
year-end 2002, maturities of this debt were as follows: $5 million in 2003, $11
million in 2004 and 2005 and $12 million in 2006 and 2007.

In the normal course of business, the Financial Services Group enters into
commitments to extend credit including loans, leases and letters of credit.
These commitments generally require collateral upon funding and as such carry
substantially the same risk as loans. In addition, the commitments normally
include provisions that, under certain circumstances, allow the Financial
Services Group to exit the commitment. At year-end 2002, unfunded loan, lease
and letter of credit commitments totaled $6.1 billion with expiration dates
primarily within the next three years. In addition, at year-end 2002,
commitments to originate single-family residential mortgage loans totaled $1.4
billion and commitments to sell single-family residential mortgage loans totaled
$1.4 billion.

At year-end 2002, the savings bank met or exceeded all applicable
regulatory capital requirements. The parent company expects to maintain the
savings bank's capital at a level that exceeds the minimum required for
designation as "well capitalized" under the capital adequacy regulations of the
Office of Thrift Supervision. From time to time, the parent company may make
capital contributions to or receive dividends from the savings bank. During
2002, the parent company received $125 million in dividends from the savings
bank.

At year-end 2002, preferred stock of subsidiaries was outstanding with a
liquidation preference of $305 million. These preferred stocks are automatically
exchanged into $305 million in savings bank preferred stock if federal banking
regulators determine that the savings bank is or will become undercapitalized in
the near term or upon the occurrence of certain administrative actions. If such
an exchange occurs, the parent company must issue senior notes in exchange for
the savings bank preferred stock in an amount equal to the liquidation
preference of the preferred stock exchanged. With respect to certain shares, the
parent company has the option to issue such senior notes or redeem the shares.

40

Selected financial and regulatory capital data for the savings bank
follows:

Of the subsidiary preferred stock at year-end 2002, $286 million qualifies
as core (leverage) capital and the remainder qualifies as Tier 2 (supplemental
risk-based) capital.

PENSION MATTERS

Based upon the current annual actuarial valuations, the Company's defined
benefit plans were under funded from an accounting perspective by $228 million
at year-end 2002 compared with being over funded by $38 million at year-end
2001. The 2002 change in funded status was due to decreases in the values of
plan assets due to lower investment returns coupled with an increase in the
present value of future pension benefits due to lower interest rates. As a
result of this change in the funded status, in fourth quarter 2002, the Company
recognized a non-cash after-tax charge of $123 million to other comprehensive
income, a component of shareholders' equity and recognized a $142 million
minimum pension liability.

For the year 2003, the Company expects to incur non-cash pension expense in
the range of $43 million. This increase in pension expense is primarily due to
the decrease in the discount rate to 6.75 percent, a planned decrease in the
expected rate of return on plan assets from 9.0 percent to 8.5 percent and an
increase in the recognition of the accumulated decline in the fair value of plan
assets. For the year 2003, the Company expects the defined benefit plans' cash
funding requirements to be in the range of $2 million.

ENVIRONMENTAL MATTERS

The Company is committed to protecting the health and welfare of its
employees, the public and the environment and strives to maintain compliance
with all state and federal environmental regulations. When constructing new
facilities or modernizing existing facilities, the Company uses state of the art
technology for controlling air and water emissions. These forward-looking
programs should minimize the effect that changing regulations have on capital
expenditures for environmental compliance.

Subsidiaries of the Company have been designated as a potentially
responsible party at eight Superfund sites, excluding sites as to which the
Company's records disclose no involvement or as to which the Company's potential
liability has been finally determined. At year-end 2002, the Company estimated
the undiscounted total costs it could incur for the remediation and toxic tort
actions at these Superfund sites to be in the range of $2 million, which has
been accrued. The Company also utilizes landfill operations to dispose of
non-hazardous waste at three paperboard and two building product mill
operations. Based on current costs incurred in the closure of its existing
landfills, the Company expects that it will spend, on an undiscounted basis,
approximately $30 million over the next 25 years to certify proper closure of
its remaining landfills. This amount is being accrued over the estimated lives
of the landfills. The Company is involved in on-site remediation at two
locations obtained in the Gaylord acquisition and a former creosote treating
facility in the

41

Building Products Group. The Company expects that it will spend, on an
undiscounted basis, approximately $18 million to properly remediate these sites.

On April 15, 1998, the U.S. Environmental Protection Agency (EPA) issued
the Cluster Rule regulations governing air and water emissions for the pulp and
paper industry. The Company has spent approximately $15 million toward Cluster
Rule compliance through year-end 2002. Future expenditures for environmental
control facilities will depend on additional Maximum Available Control
Technology (MACT) II regulations for hazardous air pollutants relating to pulp
mill combustion sources (estimated at $10 million) and the upcoming plywood and
composite wood products MACT proposal (estimated at $23 million), as well as
changing laws and regulations and technological advances. Given these
uncertainties, the Company estimates that capital expenditures for environmental
purposes excluding the MACT rules during the period 2003 through 2005 will
average in the range of $13 million each year.

ENERGY AND THE EFFECTS OF INFLATION

Inflation has had minimal effects on operating results the last three years
except for the changes in energy costs. While energy costs, principally natural
gas, decreased $44 million in 2002, they increased $38 million in 2001 and $17
million in 2000. Energy costs began to rise during second quarter 2000, peaked
during second quarter 2001 and began to decline the remainder of 2001 reaching
more normalized levels by year-end 2001. Energy costs remained at these levels
during most of 2002 but began to rise during fourth quarter 2002 and have
continued to increase in early 2003. It is likely that energy costs will
continue to fluctuate during the remainder of 2003. During the year 2002,
excluding the closed Antioch mill, the Company purchased approximately 25
million MMBtu of natural gas.

The Company's fixed assets, including timber and timberlands, are reflected
at their historical costs. If reflected at current replacement costs,
depreciation expense and the cost of timber harvested or timberlands sold would
be significantly higher than amounts reported.

LITIGATION AND RELATED MATTERS

The Company and its subsidiaries are involved in various legal proceedings
that have arisen from time to time in the ordinary course of business. The
Company believes that the possibility of a material liability from any of these
proceedings is remote and does not believe that the outcome of any of these
proceedings should have a material adverse effect on its financial position,
results of operations or cash flow.

On May 14, 1999, Inland and Gaylord were named as defendants in a
Consolidated Class Action Complaint that alleged a civil violation of Section 1
of the Sherman Act. The suit, captioned Winoff Industries, Inc. v. Stone
Container Corporation, MDL No. 1261 (E.D. Pa.), alleges that the defendants,
during the period from October 1, 1993, through November 30, 1995, conspired to
limit the supply of linerboard, and that the purpose and effect of the alleged
conspiracy was artificially to increase prices of corrugated containers. The
case is currently set for trial in April 2004. The Company believes the
likelihood of a material loss from this litigation is remote and does not
believe that the outcome of this litigation should have a material adverse
effect on its financial position, results of operations or cash flow.

Gaylord and Gaylord Chemical Corporation, a wholly-owned,
independently-operated subsidiary of Gaylord, are defendants in class action
suits in Louisiana and Mississippi related to the October 23, 1995, explosion of
a rail tank car of nitrogen tetroxide at the Bogalusa, Louisiana plant of
Gaylord Chemical. To date, the proceedings have found, among other matters, that
Gaylord Chemical and a co-defendant, Vicksburg Chemical Company, were equally at
fault for the accident and that Gaylord was not responsible for the conduct of
Gaylord Chemical. On May 4, 2001, Gaylord and Gaylord Chemical agreed in
principle to settle all claims in exchange for payments by its insurance
carriers and full releases and/or dismissals of all claims for damages,
including punitive damages, against Gaylord and Gaylord Chemical. Neither
Gaylord nor Gaylord Chemical contributed to the settlement. On December 24,
2002, counsel for the Louisiana class action plaintiffs advised Gaylord Chemical
that they would not be able to deliver all the releases of the Gaylord entities
that were promised as part of the settlement agreement. As a result of this
failure to tender the committed releases, the motion for preliminary approval of
the settlement did not proceed as scheduled,

42

and the parties engaged in negotiations over revised terms of settlement. On
February 18, 2003, the court granted the settling defendants' motion to retrieve
the settlement proceeds from the escrow account and to lift the stay of
proceedings in the Louisiana action. Gaylord, Gaylord Chemical and their
insurance carriers were reinstated as defendants in the Louisiana class-wide
trial set to begin September 3, 2003.

Inland was a party to a long-term power purchase agreement with Southern
California Edison ("Edison"). Under this agreement, Inland sold to Edison a
portion of its electrical generating capacity from a co-generation facility
operated in connection with its Ontario, California, mill. Edison was to pay
Inland for its committed generating capacity and for electricity generated and
sold to Edison. During fourth quarter 2000 and first quarter 2001, the Ontario
mill generated and delivered electricity to Edison but was not paid. During
April 2001, Inland notified Edison that the long-term power purchase agreement
was cancelled because of Edison's material breach of the agreement. Edison has
contested the right of Inland to terminate the power purchase agreement. It has
also asserted that it is entitled to recover from Inland a portion of the
payments it made during the term of the agreement. Inland has since been paid
for all power delivered to Edison. The parties are currently in litigation,
however, to determine, among other matters, whether the agreement has been
terminated and whether Inland may sell its excess generating capacity to third
parties. The Company believes the likelihood of a material loss from this
litigation is remote and does not believe that the outcome of this litigation
should have a material adverse effect on its financial position, results of
operations or cash flow.

In 1988, the Company formed Guaranty to acquire substantially all the
assets and deposit liabilities of three thrift institutions from the Federal
Savings and Loan Insurance Corporation, as receiver of those institutions. In
connection with the acquisition, the government entered into an assistance
agreement with the Company in which various tax benefits were promised to the
Company. In 1993, Congress enacted narrowly targeted legislation to eliminate a
portion of the promised tax benefits. The Company has filed suit against the
United States in the U.S. Court of Federal Claims alleging, among other things,
that the 1993 legislation breached the parties' contract and that the Company is
entitled to monetary damages. This lawsuit is currently in the discovery stage
and is not expected to be resolved for several years. The Company cannot predict
the likely outcome of this litigation.

ACCOUNTING POLICIES

CRITICAL ACCOUNTING ESTIMATES

In preparing the financial statements, the Company follows generally
accepted accounting policies, which in many cases require the Company to make
assumptions, estimates and judgments that affect the amounts reported. Many of
these policies are relatively straightforward and are included in Note A to the
summarized financial statements of the parent company and Financial Services
Group and Note 1 to the consolidated financial statements. There are, however, a
few policies that are critical because they are important in determining the
financial condition and results and are difficult to apply. Within the parent
company, they include asset impairments and pension accounting and, within the
Financial Services Group, they include the allowance for loan losses and
mortgage servicing rights. The difficulty in applying these policies arises from
the assumptions, estimates and judgments that have to be made currently about
matters that are inherently uncertain, such as future economic conditions,
operating results and valuations as well as management intentions. As the
difficulty increases, the level of precision decreases, meaning that actual
results can and probably will be different from those currently estimated. The
Company bases its assumptions, estimates and judgments on a combination of
historical experiences and other reasonable factors.

Measuring assets for impairment requires estimating intentions as to
holding periods, future operating cash flows and residual values of the assets
under review. Changes in management intentions, market conditions or operating
performance could indicate that impairment charges might be necessary. The
expected long-term rate of return on pension plan assets is an important
assumption in determining pension expense. In selecting that rate, consideration
is given to both historical returns and future returns over the next quarter
century. Differences between actual and expected returns will adjust future
pension expense. Allowances for loan losses are based on loan classifications,
historical experiences and evaluations of future cash flows and collateral
values and are subject to regulatory scrutiny. Changes in general economic
conditions or loan

43

specific circumstances will inevitably change those evaluations. Measuring for
impairment and amortizing mortgage servicing rights is largely dependent upon
the speed at which loans are repaid and market rates of return. Changes in
interest rates will affect both of these variables and could indicate that
impairments or adjustments of the rate of amortization might be necessary.

During 2000, the parent company completed an assessment of the estimated
useful lives of certain production equipment, which resulted in a revision of
estimated useful lives. These revisions ranged from a reduction of several years
to a lengthening of up to five years. Accordingly, beginning in 2001, the parent
company began computing depreciation of certain production equipment using
revised estimated useful lives. As a result of these revisions in estimated
useful lives, year 2001 depreciation expense was reduced by $27 million and net
income was increased by $16 million or $0.33 per diluted share.

NEW ACCOUNTING PRONOUNCEMENTS ADOPTED

In 2002, the Company was required to adopt a number of new accounting
pronouncements, the most significant being SFAS No. 142, Goodwill and Other
Intangible Assets, pursuant to which amortization of goodwill and other
indefinitely lived intangible assets is precluded. These assets, however, must
be measured for impairment at least annually. The cumulative effect of adopting
this statement was to reduce 2002 net income by $11 million or $0.22 per diluted
share for an $18 million goodwill impairment associated with the Corrugated
Packaging Group's pre-2001 specialty packaging acquisitions. Under this
statement, impairment is measured based upon estimated fair values generally
determined using the present value of future operating cash flows while under
the prior methodology impairment was measured based upon undiscounted future
cash flows. The effect of not amortizing goodwill and trademarks in 2001 and
2000 would have been to increase operating income by $11 million and $9 million,
respectively, and net income by $9 million, or $0.18 per diluted share, and $8
million, or $0.16 per diluted share, respectively.

The Company also adopted SFAS No. 145, Rescission of Statement of Financial
Accounting Standards No. 4, 44, and 64, Amendment of Statement of Financial
Accounting Standards No. 13 and Technical Corrections in 2002. The principal
effect of adopting this statement was that the charge-off of the unamortized
debt financing fees commensurate with the early repayment of the bridge
financing facility and other borrowings was not classified as an extraordinary
item in the determination of income from continuing operations. Other new
accounting pronouncements adopted included one related to impairments of
long-lived assets held for use and another related to the clarification of what
constitutes an acquisition of a financial institution business. The effect on
earnings or financial position of adopting these two statements was not
material.

In 2001, the Company was required to adopt a number of new accounting
pronouncements, the most important being SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended, under which derivative
instruments are required to be included on the balance sheet at fair value. The
changes in fair value are reflected in net income or other comprehensive income,
depending upon the classification of the derivative instrument. The cumulative
effect of adopting this statement was to reduce 2001 net income by $2 million or
$0.04 per diluted share and other comprehensive income by $4 million.
Additionally, as permitted by this statement, the Financial Services Group
changed the designation of its held-to-maturity securities, which are carried at
unamortized cost, to available-for-sale, which are carried at fair value. As a
result, the carrying value of these securities was adjusted to their fair value
with a corresponding after tax reduction in other comprehensive income of $16
million.

NEW ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED IN 2003

In 2003, the Company will voluntarily adopt the prospective transition
method of accounting for stock-based compensation contained in SFAS No. 148,
Accounting for Stock-Based Compensation -- Transition and Disclosure, an
amendment of FASB Statement No. 123. Under the prospective transition, the
Company will apply the fair value recognition provisions to all stock-based
compensation awards granted in 2003 and thereafter. The principal effect of
adopting this statement is that the fair value of stock options granted will be

44

charged to expense over the option-vesting period. If options are granted in
2003 at a similar level with 2002, the expected effect on earnings or financial
position of adopting this method will not be material.

Also in 2003, the Company will be required to adopt two other new
accounting pronouncements, the first being SFAS No. 143, Accounting for Asset
Retirement Obligations. This statement applies to legal obligations associated
with retirement of long-lived assets. This statement requires the recording of
an asset and a liability equal to the fair value of the estimated costs
associated with the retirement of the long-lived assets. The second
pronouncement to be adopted is SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. Under this statement, liabilities for costs
associated with an exit or disposal activity, including restructurings, are to
be recognized when the liability is incurred and can be measured at estimated
fair value. The effect on earnings or financial position of adopting these
statements is not expected to be material.

STATISTICAL AND OTHER DATA (a)

- ---------------

(a) Revenues and unit sales do not include joint venture operations.

Note: Data for the Corrugated Packaging Group for 2002 is not comparable due to
the effect of acquisitions completed in 2002 and 2001.

45

ITEM 7.A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST
RATE RISK

INTEREST RATE RISK

The Company's current level of interest rate risk is primarily due to an
asset sensitive position within the Financial Services Group and, to a lesser
degree, variable rate debt at the parent company. The following table
illustrates the estimated effect on pre-tax income of immediate, parallel and
sustained shifts in interest rates for the subsequent 12-month period at
year-end 2002, with comparative information at year-end 2001. This estimate
considers the effects of changing prepayment speeds and average balances over
the next 12 months.

Due to the current low interest rate environment, a two percent decrease in
interest rates is not presented.

The parent company's change in interest rate risk from year-end 2001 is
primarily due to a decrease in variable rate debt. During second quarter 2002,
the parent company effected a number of financing transactions that reduced
reliance on short-term borrowings.

The Financial Services Group is subject to interest rate risk to the extent
that interest-earning assets and interest-bearing liabilities repay or reprice
at different times or in differing amounts or both. The Financial Services Group
is currently in an asset sensitive position whereby the rate and repayment
characteristics of its assets are more responsive to changes in market interest
rates than are its liabilities. Postured in this way, earnings will generally be
positively affected in a rising rate environment, but will generally be
negatively affected in a falling rate environment. The effect of lower interest
rates during the year 2002 resulted in faster repayments on seasoned mortgage
loans and mortgage-backed securities and increased sensitivity to further
changes in interest rates.

Additionally, the fair value of the Financial Services Group's capitalized
mortgage servicing rights (estimated at $113 million at year-end 2002) is also
affected by changes in interest rates. The Company estimates that a one percent
decline in interest rates from current levels would decrease the fair value of
the mortgage servicing rights by approximately $27 million.

FOREIGN CURRENCY RISK

The Company's exposure to foreign currency fluctuations on its financial
instruments is not material because most of these instruments are denominated in
U.S. dollars.

COMMODITY PRICE RISK

From time to time the Company uses commodity derivative instruments to
mitigate its exposure to changes in product pricing and manufacturing costs.
These instruments cover a small portion of the Company's volume and range in
duration from three months to three years. Based on the fair value of these
instruments at year-end 2002, the potential loss in fair value resulting from a
hypothetical ten percent change in the underlying commodity prices would not be
significant.

46

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

47

PARENT COMPANY (TEMPLE-INLAND INC.)

SUMMARIZED STATEMENTS OF INCOME

See the notes to the parent company summarized financial statements.

48

PARENT COMPANY (TEMPLE-INLAND INC.)

SUMMARIZED BALANCE SHEETS

See the notes to the parent company summarized financial statements.

49

PARENT COMPANY (TEMPLE-INLAND INC.)

SUMMARIZED STATEMENTS OF CASH FLOWS

See the notes to the parent company summarized financial statements.

50

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

PARENT COMPANY (TEMPLE-INLAND INC.)

NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The summarized financial statements include the accounts of Temple-Inland
Inc. and its manufacturing subsidiaries (the parent company). The net assets
invested in Temple-Inland Financial Services are subject, in varying degrees, to
regulatory rules and restrictions including restrictions on the payment of
dividends to the parent company. Accordingly, the investment in Temple-Inland
Financial Services is reflected in the summarized financial statements on the
equity basis. Related earnings, however, are presented before tax to be
consistent with the consolidated financial statements. All material
inter-company amounts and transactions have been eliminated. These financial
statements should be read in conjunction with the Temple-Inland Inc.
consolidated financial statements and the Temple-Inland Financial Services Group
summarized financial statements.

Certain amounts have been reclassified to conform to the current year's
classification.

INVENTORIES

Inventories are stated at the lower of cost or market.

The cost of inventories amounting to $172 million at year-end 2002 and $99
million at year-end 2001, respectively, was determined by the last-in, first-out
method (LIFO). The cost of the remaining inventories was determined principally
by the average cost method, which approximates the first-in, first-out method
(FIFO). If the FIFO method of accounting had been applied to those inventories
that were determined by the LIFO method, inventories would have been $29 million
and $22 million more than reported at year-end 2002 and 2001, respectively.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost less accumulated depreciation and
depletion. Included in property and equipment are $140 million of assets that
are subject to capital leases. Depreciation, which includes amortization of
assets subject to capital leases, is generally provided on the straight-line
method based on estimated useful lives as follows:

Some machinery and production equipment is depreciated based on operating
hours or units of production because depreciation occurs primarily through use
rather than through elapsed time. Assets subject to capital lease are
depreciated over the shorter of their lease term or their estimated useful
lives.

During 2000, the parent company completed an assessment of the estimated
useful lives of certain production equipment, which resulted in a revision of
estimated useful lives. These revisions ranged from a reduction of several years
to a lengthening of up to five years. Accordingly, beginning in 2001, the parent

51

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

PARENT COMPANY (TEMPLE-INLAND INC.) -- (CONTINUED)

company began computing depreciation of certain production equipment using
revised estimated useful lives. As a result of these revisions in estimated
useful lives, year 2001 depreciation expense was reduced by $27 million and year
2001 net income was increased by $16 million or $0.33 per diluted share.

The cost of significant additions and improvements is capitalized, and the
cost of maintenance and repairs is expensed.

The parent company capitalizes interest costs incurred on major
construction projects while in progress. Capitalized interest is included in
property, plant and equipment and amortized over the estimated useful lives of
the related assets.

TIMBER AND TIMBERLANDS

Timber and timberlands are stated at cost, less accumulated cost of timber
harvested. Costs incurred to purchase timber and timberlands are capitalized
with the purchase price allocated to timber, timberlands, and where applicable,
to mineral rights based on estimated relative values, which in the case of
significant purchases, are based on third party appraisals.

The cost of timber harvested is recognized as depletion expense based on
the relationship of unamortized timber costs to the estimated volume of
recoverable timber times the amount of timber harvested. The estimated volume of
recoverable timber is determined using statistical information and other data
related to growth rates and yields gathered from physical observations, models,
and other information gathering techniques. Changes in yields are generally due
to adjustments in growth rates and similar matters and are accounted for
prospectively as changes in estimates. Timber assets are managed utilizing the
concepts of sustainable forestry -- the replacement of harvested timber through
nurtured forest plantations. Costs incurred in developing a viable seedling
plantation (up to two years of planting), such as site preparation, seedlings,
planting, fertilization, insect and wildlife control, and herbicide application,
are capitalized. All other costs, such as property taxes and costs of forest
management personnel, are expensed as incurred. Once the seedling plantation is
viable, all costs incurred to maintain the viable plantations, such as
fertilization, herbicide application, insect and wildlife control and thinning,
are expensed as incurred. Costs incurred to initially build roads are
capitalized as land improvements. Costs incurred to maintain these roads are
expensed as incurred.

The cost basis of timberland sold is determined by the area method, which
is based on the relationship of cost of timberland to total acres of timberland
times acres of timberland sold. The cost basis of timber sold is determined by
the average cost method, which is based on the relationship of unamortized cost
of timber to the estimate of recoverable timber times the amount of timber sold.

ENVIRONMENTAL LIABILITIES

When environmental assessments or remediations are probable and the costs
can be reasonably estimated, remediation liabilities are recorded on an
undiscounted basis and are adjusted as further information develops or
circumstances change. The estimated undiscounted cost to close and remediate
company-operated landfills are accrued over the estimated useful life of the
landfill.

REVENUE

Revenue is recognized upon passage of title, which generally occurs at the
time the product is delivered to the customer, the price is fixed and
determinable and collectibility is reasonably assured.

Amounts billed to customers for shipping and handling are included in net
sales and the related costs thereof are included in cost of sales.

52

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

PARENT COMPANY (TEMPLE-INLAND INC.) -- (CONTINUED)

GOODWILL

Beginning January 2002, the company adopted Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. Under
this statement, amortization of goodwill and other indefinitely lived intangible
assets is precluded; however, at least annually these assets are measured for
impairment based on estimated fair values. The company performs the annual
impairment measurement as of the beginning of the fourth quarter of each year.
Intangible assets with finite useful lives are amortized over their estimated
lives. The cumulative effect of adopting this statement was to reduce 2002
income by $11 million, or $0.22 per diluted share, for an $18 million goodwill
impairment associated with the Corrugated Packaging Group's pre-2001 specialty
packaging acquisitions.

NOTE B -- LONG-TERM DEBT

Long-term debt consists of the following:

The parent company has various debt arrangements, which are subject to
conditions and covenants customary for such agreements, including levels of
interest coverage and limitations on leverage of the parent company. At year-end
2002, the parent company was in compliance with all such conditions and
covenants.

At year-end 2002, the parent company had a $200 million accounts receivable
securitization program that expires in August 2003. Under this program, a
wholly-owned subsidiary of the parent company purchases, on

53

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

PARENT COMPANY (TEMPLE-INLAND INC.) -- (CONTINUED)

an on-going basis, substantially all of the trade receivables of the
manufacturing subsidiaries. As the parent company requires funds, the subsidiary
draws under its revolving credit arrangement, pledges the trade receivables as
collateral and remits the proceeds to the parent company. In the event of
liquidation of the subsidiary, its creditors would be entitled to satisfy their
claims from the subsidiary's assets prior to distributions back to the parent
company. At year-end 2002, the subsidiary owned $313 million in trade
receivables against which it had borrowed $40 million under this securitization
program. At year-end 2002, the unused capacity under this facility was $140
million. This subsidiary is consolidated with and included in the parent
company's summarized and consolidated financial statements.

At year-end 2002, the parent company had $575 million in committed credit
agreements. Under the terms of a $400 million credit agreement, $200 million
expires in 2005 with a provision to extend for one further year up to the full
$200 million with the consent of the lending banks. The other $200 million
expires in 2007. The remaining $175 million of credit agreements have maturities
at various dates through 2005. The credit agreements contain terms and
conditions customary for such agreements, including minimum levels of interest
coverage and limitations on leverage. At year-end 2002, unused capacity under
these facilities was $505 million. Subsequent to year-end, the company's
committed credit line was increased by $15 million for a total of $590 million.

At year-end 2002, the parent company had complied with all the terms and
conditions of the accounts receivable securitization program and its credit
agreements. At year-end 2002, property and equipment having a book value of $12
million were subject to liens in connection with $45 million of debt.

Stated maturities of the parent company's debt during the next five years
are as follows (in millions): 2003 -- $136; 2004 -- $104; 2005 -- $41;
2006 -- $102; 2007 -- $412; 2008 and thereafter -- $1,096.

Short-term borrowings of $18 million, accounts receivable securitization
debt of $40 million and current maturities of term notes of $61 million and a $9
million revolver are classified as long-term debt in accordance with the parent
company's intent and ability to refinance such obligations on a long-term basis.

Capitalized construction period interest in 2002, 2001 and 2000 was $0.4
million, $4 million and $4 million, respectively, and was deducted from interest
expense. Parent company interest paid during 2002, 2001 and 2000 was $117
million, $103 million and $108 million, respectively.

NOTE C -- JOINT VENTURES

The parent company's significant joint venture investments at year-end 2002
are: Del-Tin Fiber LLC -- a 50 percent owned venture that produces medium
density fiberboard in El Dorado, Arkansas; Standard Gypsum LP -- a 50 percent
owned venture that produces gypsum wallboard at facilities in McQueeney, Texas,
and Cumberland City, Tennessee; and, Premier Boxboard Limited LLC -- a 50
percent owned venture that produces gypsum facing paper and corrugating medium
in Newport, Indiana. The joint venture partner in each of these ventures is an
unrelated publicly-held company.

54

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

PARENT COMPANY (TEMPLE-INLAND INC.) -- (CONTINUED)

Combined summarized financial information for these joint ventures follows:

During 2002, the parent company contributed $12 million to these ventures
and received an $11 million distribution. During 2001, the parent company
contributed $15 million to these ventures and received a $1 million
distribution.

The investment in these joint ventures is included in other assets and the
equity in the net loss of these ventures is included in cost of sales. The
parent company's reported investment in joint ventures differs from the 50
percent interest in joint venture equity due to the difference between the fair
value of net assets contributed to the Premier Boxboard joint venture and the
net book value of those assets. The parent company's equity in net losses of
joint ventures differs from the 50 percent interest in joint venture net losses
because of the amortization of this difference between the fair value of net
assets contributed to the Premier Boxboard joint venture and the net book value
of those assets. When the parent company contributed the Newport, Indiana,
corrugating medium mill and its associated debt to the Premier Boxboard joint
venture near the end of second quarter 2000, the fair value of the net assets
exceeded their carrying value by $55 million. The joint venture recorded the
contributed assets at fair value. The parent company did not recognize a gain as
a result of the contribution of assets, thus creating a difference in the
carrying value of the investment and the underlying equity in the venture. This
difference is being amortized over the same period as the underlying mill assets
to reflect depreciation of the mill as if it were consolidated and carried at
historical carrying value. At year-end 2002, the unamortized basis difference
was $42 million.

The parent company provides marketing and management services to these
ventures. Fees for such services were $5 million during each of 2002, 2001 and
2000, and are reported as a reduction of cost of sales

55

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

PARENT COMPANY (TEMPLE-INLAND INC.) -- (CONTINUED)

and selling expense. The parent company purchases, at market rates, finished
products from one of these joint ventures. These purchases aggregated $56
million, $58 million and $29 million during 2002, 2001 and 2000, respectively.

The parent company's partner in the Del-Tin joint venture has announced its
intentions to exit this venture upon the earliest, reasonable opportunity
provided by the market. It is uncertain what effects this will have on this
venture or its operations. At year-end 2002, the parent company's investment in
this venture was $14 million and the parent company has agreed to fund up to $36
million of the venture's debt service obligations as needed. The parent
company's equity in the year 2002 net loss of this venture was $9 million. The
parent company contributed $12 million to this venture during 2002. Marketing
fees received from the venture during the year 2002 totaled $1 million.
Summarized financial information for this venture as of and for the year-ended
2002 follows (in millions):

Working capital............................................. $ 2
Property and equipment...................................... 97
Long-term debt, net of sinking fund reserves................ 75
Equity...................................................... 29

Revenues.................................................... $ 31
Operating loss.............................................. (13)
Net loss.................................................... (19)

NOTE D -- ACQUISITIONS

On February 28, 2002, the company completed tender offers in which it
acquired 86.3 percent of Gaylord Container Corporation's outstanding common
stock for $56 million cash and 99.3 percent of its 9 3/8% Senior Notes, 98.5
percent of its 9 3/4% Senior Notes and 83.6 percent of its 9 7/8% Senior
Subordinated Notes for $462 million cash plus accrued interest of $10 million.
On April 5, 2002, the company acquired the remainder of Gaylord's outstanding
common stock for $9 million cash. The results of Gaylord's operations have been
included in the company's income statement since the beginning of March 2002.

Gaylord is primarily engaged in the manufacture and sale of corrugated
containers. As a result of this acquisition, the company has become the
third-largest U.S. manufacturer in the corrugated packaging industry. The
company believes that this acquisition will improve its market reach, improve
the operating efficiency of its mill and packaging system and lead to cost
savings and synergies.

The cash purchase price to acquire Gaylord was $599 million including $45
million in termination and change of control payments and $17 million in
advisory and professional fees. Proceeds from a $900 million credit agreement
(the bridge financing facility) were used to fund the cash purchase and to pay
off the assumed bank debt of $285 million. The company paid $12 million in fees
to the lending institutions for this facility, which was funded from the bridge
financing facility. During May 2002, the parent company sold 4.1 million shares
of common stock at $52 per share and issued $345 million of Upper DECS(SM) units
and $500 million of 7.875% Senior Notes due 2012. Total proceeds from these
offerings were $1,056 million, before expenses of $28 million. The net proceeds
from these offerings were used to repay the bridge financing facility and other
borrowings. As a result of the early repayment of these borrowings, $11 million
of unamortized debt financing fees were charged to other expense during the
second quarter 2002.

The purchase price is being allocated to the assets acquired and
liabilities assumed based on their estimated fair values at the date of
acquisition. The allocation of the purchase price is based upon independent
appraisals and other valuations and will reflect finalized management
intentions. It is expected that the final allocations will be completed during
first quarter 2003. The final allocations will probably differ from those

56

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

PARENT COMPANY (TEMPLE-INLAND INC.) -- (CONTINUED)

currently assumed. Changes, if any, to the fair value of property and equipment
will affect the amount of depreciation to be reported. Goodwill from this
acquisition is allocated to the Corrugated Packaging Group. It is anticipated
that all of the goodwill will be deductible for income tax purposes. The
preliminary allocation of the purchase price follows (in millions):

Assets acquired
Current assets............................................ $ 190
Property and equipment.................................... 559
Assets of discontinued operations......................... 142
Other assets.............................................. 27
Goodwill.................................................. 201
------
Total Assets........................................... $1,119
------
Liabilities assumed
Current liabilities....................................... $ 135
Liabilities of discontinued operations.................... 18
Bank debt................................................. 285
Senior and Subordinated Notes and other secured debt...... 68
Other long-term liabilities............................... 14
------
Total Liabilities...................................... $ 520
------
Net assets acquired......................................... $ 599
======

During September 2002, the parent company permanently closed the Antioch,
California recycle linerboard mill obtained in the acquisition of Gaylord. The
parent company established accruals for the estimated costs to be incurred in
connection with this closure. The allocation of the purchase price includes
these accruals, aggregating $41 million. As a result, these costs will not
affect current operating income. Activity related to these accruals for the year
2002 follows:

During March 2002, the parent company acquired a box plant in Puerto Rico
for $10 million cash. During May 2002, the parent company acquired the two
converting operations of Mack Packaging Group, Inc. for $24 million, including
$20 million cash and $4 million related to the present value of a minimum
earn-out arrangement. The purchase prices were allocated to the acquired assets
and liabilities based on their fair values with $2 million assigned to goodwill,
all of which is allocated to the Corrugated Packaging Group.

During November 2002, the parent company acquired Fibre Innovations LLC for
$8 million cash. The purchase price will be allocated to the acquired assets and
liabilities based on their fair values.

57

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

PARENT COMPANY (TEMPLE-INLAND INC.) -- (CONTINUED)

The following unaudited pro forma information assumes these acquisitions
and related financing transactions had occurred at the beginning of 2002 and
2001:

Adjustments made to derive this pro forma information include those related
to the effects of the purchase price allocations and financing transactions
described above and the reclassification of the discontinued operations
described in Note E. The pro forma information does not reflect the effects of
planned capacity rationalization, cost savings or other synergies that may be
realized. These pro forma results are not necessarily an indication of what
actually would have occurred if the acquisitions had been completed on those
dates and are not intended to be indicative of future results.

During May 2001, the parent company completed the acquisitions of the
corrugated packaging operations of Chesapeake Corporation and Elgin Corrugated
Box Company. These operations consist of 11 corrugated converting plants in
eight states. The aggregate purchase price of $135 million was allocated to the
acquired assets and liabilities based on their fair values with $36 million
allocated to goodwill. During October 2001, the parent company completed the
acquisition of ComPro Packaging LLC. These operations consist of two corrugated
converting plants. The aggregate purchase price of $9 million was allocated to
the acquired assets and liabilities based on fair values with $9 million
allocated to goodwill. The operating results of these packaging operations are
included in the accompanying summarized financial statements from their
acquisition dates. The unaudited pro forma results of operations, assuming these
acquisitions had been effected as of the beginning of the applicable fiscal
year, would not have been materially different from those reported.

NOTE E -- DISCONTINUED OPERATIONS

In conjunction with the acquisition of Gaylord, the parent company
announced that it intended to sell several non-strategic assets and operations
obtained in the acquisition including the retail bag business, the multi-wall
bag business and kraft paper mill and the chemical business. The assets and
liabilities of the discontinued operations have been adjusted to their estimated
realizable values and are identified in the balance sheet as discontinued
operations. Through first quarter 2003, differences between estimated net
realizable value and their actual value will be reflected as an adjustment to
goodwill. The operating results and cash flows of these operations are
classified as discontinued operations and are excluded from income from
continuing operations and business segment information for the Corrugated
Packaging Group. The retail bag business was sold during May 2002. The
multi-wall bag business and kraft paper mill were sold during January 2003.
Aggregate proceeds from all of these sales approximate $100 million.

At year-end 2002, the discontinued operations consist of Gaylord's chemical
business, multi-wall bag business and kraft paper mill and accruals related to
the 1999 sale of the bleached paperboard operations. At year-end 2002, the
assets and liabilities of discontinued operations includes $25 million of
working capital, $45 million of property and equipment and $20 million of
environmental and other long-term obligations. Revenues from discontinued
operations for the year 2002 were $142 million.

During 2001, the eucalyptus fiber project in Mexico, which was to be a
source of hardwood fiber for the bleached paperboard mill that was sold in
December 1999, was sold at a price that approximated its carrying value.

58

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

PARENT COMPANY (TEMPLE-INLAND INC.) -- (CONTINUED)

NOTE F -- OTHER OPERATING (INCOME) EXPENSE

In connection with the 1998 sale of the parent company's Argentine box
plant, the parent company received $11 million in promissory notes repayable in
U.S. dollars, which were subsequently sold with recourse to a financial
institution. During May 2002, the borrower notified the financial institution
that Argentine legislation enacted as a result of that country's currency crisis
requires the borrower to repay these promissory notes in Argentine pesos at a
specified exchange rate, which is less favorable to the parent company than the
market exchange rate. During 2002, the parent company purchased these notes from
the financial institution at their unpaid principal balance of $6 million. Based
on current exchange rates, these notes and related prepaid interest totaling $7
million have a U.S. dollar value of $1 million. The difference of $6 million was
charged to other operating expense in 2002. During fourth quarter 2002, the
parent company received $2 million from the borrower, a portion of which applies
to principal and interest related to the promissory notes and the remainder
applies to accounts receivable, which were written off in 2001. Any additional
payments on these notes and accounts receivable will be recognized as other
income when received in U.S. dollars.

In connection with the 2001 sale of a box plant in Chile, the parent
company recognized a one-time benefit of $8 million, which is reflected as a
reduction of income tax expense.

In connection with its 2000 decision to exit the fiber cement business, the
parent company retained $53 million of assets that are leased to a third party.
The lease agreement provides for payments of $3.4 million per year and expires
in 2020. At year-end 2002, these assets have a carrying amount of $45 million
and are included in other assets.

NOTE G -- COMMITMENTS AND CONTINGENCIES

The parent company leases timberlands, equipment and facilities under
operating lease agreements. Future minimum rental commitments under
non-cancelable operating leases having a remaining term in excess of one year,
exclusive of related expenses, are as follows (in millions): 2003 -- $42;
2004 -- $34; 2005 -- $27; 2006 -- $21; 2007 -- $22; 2008 and
thereafter -- $184. Total rent expense was $53 million, $49 million and $46
million during 2002, 2001, and 2000, respectively.

The parent company also leases two manufacturing facilities under capital
lease agreements with municipalities, which expire in 2022 and 2025. These
capital lease obligations total $188 million and have been offset by the parent
company's purchase of an equal amount of bonds issued by these municipalities
that are funded with identical terms and secured by the payments due under the
capital lease obligations.

At year-end 2002, the parent company has unconditional purchase
obligations, principally for gypsum and timber, aggregating $24 million that
will be paid over the next five years. The parent company also has

59

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

PARENT COMPANY (TEMPLE-INLAND INC.) -- (CONTINUED)

acquired rights to timber and timberlands under agreements that require the
parent company to pay the owners $61 million in 2004, which could be extended to
2006 under certain conditions. This obligation is included in other long-term
liabilities.

In connection with its joint venture operations, the parent company has
guaranteed debt service and other obligations and letters of credit aggregating
$124 million at year-end 2002. Generally the guarantees would be funded by the
parent company for lack of specific performance by the joint ventures, such as
non-payment of debt.

The preferred stock issued by subsidiaries of Guaranty Bank is
automatically exchanged into preferred stock of Guaranty Bank upon the
occurrence of certain regulatory events or administrative actions. If such
exchange occurs, certain preferred shares are automatically surrendered to the
parent company in exchange for senior notes of the parent company and certain
shares, at the parent company's option, are either exchanged for senior notes of
the parent company or redeemed. At year-end 2002, the outstanding preferred
stock issued by these subsidiaries totaled $305 million. See Note K of the
Financial Services Group summarized financial statements for further
information.

The parent company has $575 million in committed credit agreements and a
$200 million accounts receivable securitization program. The credit agreements
contain terms and conditions customary for such agreements, including minimum
levels of interest coverage and limitations on leverage. At year-end 2002, the
parent company has complied with all the terms and conditions of its credit
agreements and the accounts receivable securitization program. None of the
current credit agreements or the accounts receivable securitization program are
restricted as to availability based on the ratings of the parent company's
long-term debt. Approximately $32 million in joint venture and subsidiary debt
guarantees and funding obligations include rating triggers (parent company debt
rated below investment grade), which if activated would result in acceleration.
The long-term debt of the parent company is currently rated BBB/Stable by one
rating agency and Baa3/Negative outlook by another rating agency. Several supply
and lease agreements include similar rating triggers, which if activated would
result in a variety of remedies including restructuring of the agreements.

In connection with the 1999 sale of the bleached paperboard mill, the
parent company agreed, subject to certain limitations, to indemnify the
purchaser from certain liabilities including environmental liabilities and
contingencies associated with the parent company's operation and ownership of
the mill.

During 2002 and 2001, the parent company sold, with recourse to financial
institutions, $2 million and $6 million, respectively, of notes receivable.

NOTE H -- DERIVATIVE INSTRUMENTS

The parent company uses interest rate agreements in the normal course of
business to manage and reduce the risk inherent in interest rate fluctuations by
entering into contracts with major U.S. securities firms. Interest rate swap
agreements are considered hedges of interest cash flows anticipated from
specific borrowings and amounts paid and received under the swap arrangements
are recognized as adjustments to interest expense. The parent company has an
interest rate swap agreement to pay fixed rate interest at 6.55 percent and
receive variable interest (currently 1.32 percent) on $50 million notional
amount of indebtedness. This agreement matures in 2008. For the year 2002,
interest expense increased by $2 million as a result of this interest rate swap.
There was no hedge ineffectiveness on the interest rate swap for the year 2002.

The parent company also uses, to a limited degree, fiber-based derivative
instruments to mitigate its exposure to changes in anticipated cash flows from
sale of products and manufacturing costs. The parent company's fiber-based
derivative contracts have notional amounts that represent less than five percent
of the parent company's annual sales of linerboard and purchases of OCC. For the
year 2002, operating income

60

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

PARENT COMPANY (TEMPLE-INLAND INC.) -- (CONTINUED)

decreased by $0.9 million as a result of the linerboard and OCC derivatives. The
net loss recognized in earnings that represents hedge ineffectiveness was
insignificant for the year 2002.

At year-end 2002, the aggregate fair value of these derivative instruments
was a $9 million liability, consisting of a $1 million liability related to the
linerboard and OCC derivatives and an $8 million liability for the interest rate
swap derivative.

As of year-end 2002, approximately $0.5 million of income on derivative
instruments recorded in accumulated other comprehensive loss are expected to be
re-classified to earnings during the next twelve months in conjunction with the
hedged cash flow.

61

FINANCIAL SERVICES GROUP

SUMMARIZED STATEMENTS OF INCOME

See the notes to Financial Services Group summarized financial statements.

62

FINANCIAL SERVICES GROUP

SUMMARIZED BALANCE SHEETS

See the notes to the Financial Services Group summarized financial statements.

63

FINANCIAL SERVICES GROUP

SUMMARIZED STATEMENTS OF CASH FLOWS

See the notes to the Financial Services Group summarized financial statements.

64

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS

NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

Temple-Inland Financial Services Group (the group) operates a savings bank
and engages in mortgage banking, real estate and insurance brokerage activities.
The savings bank, Guaranty Bank (Guaranty), conducts its retail business through
banking centers in Texas and California. Commercial lending activities
(including single-family mortgage warehouse and construction lending,
multifamily and senior housing lending, commercial real estate lending and
commercial and business lending) are conducted in over 35 market areas in 21
states and the District of Columbia. The mortgage banking operation originates
single-family mortgages and services them for Guaranty and unrelated third
parties. Mortgage origination offices are located in 26 states. Real estate
operations include the development of residential subdivisions and multifamily
housing and the management and sale of income producing properties, which are
principally located in Texas, Colorado, Florida, Tennessee, California and
Missouri. The insurance brokerage operation sells a full range of insurance
products. The assets and operations of this group are subject, in varying
degrees, to regulatory rules and restrictions, including restrictions on the
payment of dividends to the parent company. All material intercompany amounts
and transactions have been eliminated. These financial statements should be read
in conjunction with the company's consolidated financial statements.

Certain amounts have been reclassified to conform to the current year's
classification.

USE OF ESTIMATES

The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions. These estimates and assumptions affect the amounts reported in the
financial statements and accompanying notes, including disclosures related to
contingencies. Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include cash on hand and other short-term liquid
instruments with original maturities of three months or less.

LOANS HELD FOR SALE

Loans held for sale consist primarily of single-family residential loans
collateralized by the underlying property and are intended for sale in the
secondary market either directly or indirectly through securitization
transactions. The group enters into forward sales agreements to hedge changes in
fair value of loans held for sale due to changes in interest rates. Loans held
for sale with forward sales agreements designated as fair value hedges are
recorded at cost, adjusted for changes in fair value after the date of hedge
designation. Loans held for sale without designated fair value hedges are
recorded at the lower of aggregate cost or fair value. Fair value adjustments
and realized gains and losses are classified as noninterest income.

LOANS

Loans are stated at unpaid principal balances, net of deferred loan costs
or fees and any discounts or premiums on purchased loans. Deferred fees or
costs, as well as premiums and discounts on loans, are amortized to income using
the interest method over the remaining period to contractual maturity and
adjusted for anticipated or actual prepayments. Any unamortized loan fees or
costs, premiums, or discounts are taken to income in the event a loan is repaid
or sold.

Interest on loans is credited to income as earned. The accrual of interest
ceases when collection of principal or interest becomes doubtful or when payment
has not been received for 90 days or more unless the

65

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

asset is both well secured and in the process of collection. When interest
accrual ceases, uncollected interest previously credited to income is reversed.
Thereafter, interest income is accrued only if and when, in management's
opinion, projected cash proceeds are deemed sufficient to repay both principal
and interest or when it otherwise becomes well secured and in the process of
collection. Loans for which interest is not being accrued are referred to as
non-accrual loans.

Management reviews all non-homogeneous loans in non-accrual status to
determine whether a loan is impaired. Loans are considered impaired when it is
probable that the group will be unable to collect all amounts contractually due,
including scheduled interest payments.

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses represents management's estimate of credit
losses inherent in the loan portfolio as of the balance sheet date. Management's
periodic evaluation of the adequacy of the allowance is based on the group's
past loan loss experience, known and inherent risks in the portfolio, adverse
situations that may have affected the borrower's ability to repay, estimated
value of any underlying collateral, and current economic conditions.

Loans are assigned a risk rating to distinguish levels of credit risk and
loan quality. These risk ratings are categorized as pass or criticized grade
with the resultant allowance for loan losses based on this distinction. Certain
loan portfolios are considered to be performance based and are graded by
analyzing performance through assessment of delinquency status.

The allowance for loan losses includes specific allowances for impaired
loans, general allowances for pass graded loans and pools of criticized loans
with common risk characteristics and an unallocated allowance based on analysis
of other economic factors. Specific allowances on impaired loans are measured by
comparing the basis in the loan to: 1) estimated present value of total expected
future cash flows, discounted at the loan's effective rate, 2) the loan's
observable market price, or 3) the fair value of the collateral if the loan is
collateral dependent.

The group uses general allowances for pools of loans with relatively
similar risks based on management's assessment of homogeneous attributes, such
as product types, markets, aging and collateral. The group uses information on
historic trends in delinquencies, charge-offs and recoveries to identify
unfavorable trends. The analysis considers adverse trends in the migration of
classifications to be an early warning of potential problems that would indicate
a need to increase loss allowances over historic levels.

The unallocated allowance for loan losses is determined based on
management's assessment of general economic conditions as well as specific
economic factors in individual markets. The evaluation of the appropriate level
of unallocated allowance considers current risk factors that may not be
reflected in the historical trends used to determine the allowance on criticized
and pass graded loans. These factors may include inherent delays in obtaining
information regarding a borrower's financial condition or changes in their
unique business conditions; the subjective nature of individual loan
evaluations, collateral assessments and the interpretation of economic trends;
volatility of economic or customer-specific conditions affecting the
identification and estimation of losses for larger non-homogeneous loans; and
the sensitivity of assumptions used to establish general allowances for
homogeneous groups of loans. In addition, the unallocated allowance recognizes
that ultimate knowledge of the loan portfolios may be incomplete.

When available information confirms the specific loans or portions thereof
that are uncollectible, these amounts are charged off against the allowance for
loan losses. The existence of some or all of the following criteria will
generally confirm that a loss has been incurred: the loan is significantly
delinquent and the borrower has not evidenced the ability or intent to bring the
loan current; the group has no recourse to the borrower or, if it does, the
borrower has insufficient assets to pay the debt; or the fair value of the loan

66

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

collateral is significantly below the current loan balance and there is little
or no near-term prospect for improvement.

FORECLOSED ASSETS

Foreclosed assets include properties acquired through loan foreclosure and
are recorded at the lower of the related loan balance or fair value of the
foreclosed asset; less estimated selling costs, which represents the new
recorded basis of the property. If the fair value is less than the loan balance
at the time of foreclosure, a loan charge-off is recorded. Subsequently,
properties are evaluated and any additional declines in value are recorded by a
charge to earnings. The amount the group ultimately recovers from foreclosed
assets may differ substantially from the net carrying value of these assets
because of future market factors beyond the group's control or because of
changes in the group's strategy for sale or development of the property.
Foreclosed assets are included in "Real estate."

SECURITIES

The group determines the appropriate classification of securities at the
time of purchase and confirms the designation of these securities as of each
balance sheet date. Securities are classified as held-to-maturity and stated at
amortized cost when the group has both the intent and ability to hold the
securities to maturity. Otherwise, securities are classified as
available-for-sale and are stated at fair value with any unrealized gains and
losses, net of tax, reported in other comprehensive income, a component of
shareholder's equity, until realized.

Interest on securities is credited to income as earned. The cost of
securities classified as held-to-maturity or available-for-sale is adjusted for
amortization of premiums and accretion of discounts by a method that
approximates the interest method over the estimated lives of the securities.
Gains or losses on securities sold are recognized based on the
specific-identification method.

TRANSFERS AND SERVICING OF FINANCIAL ASSETS

The group sells loans to secondary markets by delivering whole loans to
third parties or through the delivery into a pool of mortgage loans that are
being securitized into a mortgage-backed security. The group may sell the loans
and related servicing rights or retain the right to service the loans. If the
servicing rights are not sold, they are considered a retained interest. The
group does not retain any other interest in loans sold. These transactions are
accounted for as sales in accordance with Statement of Financial Accounting
Standards (SFAS) No. 140 Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities. Upon the sale of loans through either
of these methods, the group removes the loan from the balance sheet and records
a gain or loss. Sales proceeds of loans held for sale in the statement of cash
flows include loans sold to secondary markets and loans delivered into
mortgage-backed securities.

A servicing asset is recorded when the right to service mortgage loans for
others is acquired through a purchase or retained upon sale of loans. Purchased
mortgage servicing rights are recorded at cost. If the mortgage servicing right
is retained upon sale, the group recognizes a mortgage servicing asset related
to the mortgage loan sold based on the current market value of servicing rights
for other mortgage loans with the same or similar characteristics such as loan
type, size, escrow and geographic location, being traded in the market. Mortgage
servicing rights are amortized in proportion to, and over the period of,
estimated net servicing revenues.

Periodically, the group reviews the mortgage servicing rights for
impairment. The group stratifies its pools of mortgage servicing rights based on
predominant risk characteristics such as loan type and interest rate. The group
then determines fair value of the mortgage servicing rights of each stratum and
compares fair value to amortized cost for the stratum to determine if impairment
exists. If the fair value of a stratum is less than the

67

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

amortized cost of the stratum, an impairment loss is recognized by provision for
impairment that is charged to earnings and the establishment of a valuation
allowance for each individual stratum. Recoveries in fair value up to the amount
of the amortized costs of the stratum are recognized by a credit to earnings and
a reduction in the valuation allowance. Fair values in excess of the amortized
cost for a given stratum are not recognized. Amortization expense and changes to
the valuation allowance are included in "Loan origination, marketing and
servicing fees, net" in the summarized statements of income.

The fair value of mortgage servicing rights are calculated internally using
discounted cash flow models and are supported by third party valuations and, if
available, quoted market prices for comparable mortgage servicing rights. The
most significant assumptions made in estimating the fair value of mortgage
servicing rights are anticipated loan repayments and discount rates. Anticipated
loan prepayments are affected by changes in market mortgage interest rates.
Other assumptions include the cost to service, foreclosure costs, ancillary
income and float rates. Additionally, product-specific risk characteristics such
as adjustable-rate mortgage loans, and credit quality as well as whether a loan
is conventionally or government insured, also affect the mortgage servicing
rights valuation.

The group stratifies its mortgage servicing rights based on the predominant
characteristics of the underlying financial asset. The following is a summary of
the mortgage servicing right strata used by the group to assess impairment:

REAL ESTATE

Real estate consists primarily of land and commercial properties held for
development and sale and is carried at the lower of cost or fair value. In
addition, certain properties are held for the production of income. Interest on
indebtedness and property taxes, as well as improvements and other development
costs, are generally capitalized during the development period. The cost of land
sold is determined using the relative sales value method.

PREMISES AND EQUIPMENT

Land is carried at cost. Premises, furniture and equipment and leasehold
improvements are carried at cost, less accumulated depreciation and amortization
computed principally by the straight-line method.

GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill represents the excess of purchase price over the fair value of net
assets acquired by the group. Other indefinite lived intangible assets represent
an investment in a trademark. In accordance with SFAS No. 142, Goodwill and
Other Intangible Assets, the amortization of goodwill and other indefinite lived
intangible assets ceased effective January 1, 2002. Amortization of goodwill and
other indefinite lived intangible assets was $8 million in 2001 and $7 million
in 2000. Goodwill and other indefinite lived intangible assets are assessed for
impairment during the fourth quarter of each year.

In addition, the group has core deposit intangibles and other intangible
assets with finite lives that are amortized using the straight-line method over
their estimated useful lives, 5 to 10 years.

68

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

SECURITIES SOLD UNDER REPURCHASE AGREEMENTS

The group enters into agreements under which it sells securities subject to
an obligation to repurchase the same or similar securities. Under these
arrangements, the group transfers legal control over the assets but still
retains effective control through an agreement that both entitles and obligates
the group to repurchase the assets. As a result, securities sold under
repurchase agreements are accounted for as financing arrangements and not as a
sale and subsequent repurchase of securities. The obligation to repurchase the
securities is reflected as a liability in the balance sheet while the dollar
amount of securities underlying the agreements remains in the respective asset
classification. The securities sold under repurchase agreements are classified
as pledged.

OTHER REVENUE RECOGNITION

Loan servicing fees represent a participation in interest collections on
loans serviced for investors and are normally based on a stipulated percentage
of the outstanding monthly principal balance of such loans. Loan servicing fees
are credited to income as monthly principal and interest payments are collected
from mortgagors. Expenses of loan servicing are charged to income as incurred.

Real estate operations revenue consists of income from commercial
properties and gains on sales of real estate. Income from commercial properties
is recognized in income as earned. Gains from sales of real estate are
recognized in noninterest income when a sale is consummated, the buyer's initial
and continuing investments are adequate, any receivables are not subject to
future subordination, and the usual risks and rewards of ownership have been
transferred to the buyer in accordance with the provisions of SFAS No. 66,
Accounting for Sales of Real Estate. When it is determined that the earnings
process is not complete, gains are deferred for recognition in future periods as
earned.

Insurance commissions and fees are recognized in income as earned.

INCOME TAXES

The group is included in the consolidated income tax return filed by the
parent company. Under an agreement with the parent company, the group provides a
current income tax provision that takes into account the separate taxable income
of the group. Deferred income taxes are recorded by the group.

Effective with the first quarter 2003, the agreement with the parent
company was amended to require the group to accrue taxes as if the group was
filing a separate tax return. As a result, the group's tax expense is expected
to increase beginning in 2003 to an amount approximating the federal statutory
income tax rate.

DERIVATIVE FINANCIAL INSTRUMENTS

Beginning January 2001, the group adopted SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended. The statement
requires derivative instruments be recorded on the balance sheet at fair value
with changes in fair value reflected in net income or other comprehensive
income, depending upon the classification of the derivative instrument. The
cumulative effect of adopting this statement was to reduce 2001 net income by $1
million. This loss resulted from recording the fair value of derivative
instruments that do not qualify for hedge accounting treatment.

As permitted by SFAS No. 133, the group reassessed the classification of
its securities. As a result of that reassessment, on January 1, 2001, the group
transferred $864 million in securities from held-to-maturity to
available-for-sale. This transfer resulted in a $16 million after-tax reduction
in other comprehensive income, a component of shareholder's equity.

69

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

HEDGING ACTIVITIES

The operations of the group are subject to a risk of interest rate
fluctuation to the extent that interest-earning assets and interest-bearing
liabilities mature or reprice at different times or in differing amounts. The
group is also subject to repayment risk inherent in a portion of its
single-family adjustable-rate mortgage assets. Also, substantial portions of the
group's investments in adjustable-rate mortgage-backed securities have annual or
lifetime caps that subject the group to interest rate risk should rates rise
above certain levels. To optimize net interest income while maintaining
acceptable levels of interest rate and liquidity risk, the group, from time to
time, will enter into various derivative contracts for purposes other than
trading. To qualify for hedge accounting, the derivatives and related hedged
items must be designated as a hedge. The hedge must be effective in reducing the
designated risk. The effectiveness of the derivatives is evaluated on an initial
and ongoing basis using quantitative measures of correlation.

RECENT ACCOUNTING PRONOUNCEMENTS

Beginning with acquisitions of certain financial institutions effected
after October 1, 2002, the group will be required to apply the provisions of
SFAS No. 147, Acquisitions of Certain Financial Institutions -- an amendment of
SFAS No. 72 and 144 and SFAS Board Interpretations No. 9. The principal effect
of this statement is the clarification of what constitutes the acquisition of a
business and that such acquisitions should be accounted for in accordance with
the provisions of SFAS No. 141, Business Combinations, and SFAS No. 142,
Goodwill and Other Intangible Assets. It also includes within the scope of SFAS
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets,
intangible assets customarily recognized in acquisitions of financial
institutions. No acquisitions have occurred in the group to which SFAS No. 147
would apply.

NOTE B -- ACQUISITIONS

During September 2002, the group acquired $374 million in deposits and a
five-branch network in Northern California for a purchase price of $9 million.
The purchase price was allocated to the acquired assets and liabilities based on
their estimated fair values with $12 million allocated to goodwill.

During February 2002, the group acquired an insurance agency for $6 million
cash and a potential earn-out payment of $2 million based on revenue growth. The
purchase price was allocated to acquired assets and liabilities based on their
fair values with $4 million allocated to goodwill.

During third quarter 2001, the group acquired mortgage loan production and
processing offices for $63 million cash. The purchase price was allocated to the
acquired assets and liabilities based on their estimated fair values with $8
million allocated to goodwill.

On February 1, 2001, the group acquired certain assets (primarily
asset-based loans), totaling $300 million for $301 million cash. The purchase
price was allocated to the acquired assets and liabilities based on their
estimated fair values with $1 million allocated to goodwill.

On March 1, 2000, the group acquired all of the outstanding stock of
American Finance Group, Inc. (AFG) for $32 million cash. AFG, an industrial and
commercial equipment leasing and financing operation, had total assets
(primarily financing leases, loans, and equipment under operating leases) of
$161 million and total liabilities (primarily debt) of $132 million, of which
$128 million was repaid after acquisition. The purchase price was allocated to
the acquired assets and liabilities based on their estimated fair values with $1
million allocated to goodwill.

The acquisitions were accounted for using the purchase method of accounting
and, accordingly, the acquired assets and liabilities were adjusted to their
estimated fair values at the date of the acquisitions. The operating results of
the acquisitions are included in the accompanying financial statements from the

70

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

acquisition dates. The unaudited pro forma results of operations, assuming the
acquisitions had been effected as of the beginning of the applicable fiscal
year, would not have been materially different from those reported.

NOTE C -- LOANS

The outstanding principal balances of loans receivable consisted of the
following:

Single-family mortgages are made to owners to finance the purchase of a
home. Single-family mortgage warehouse provides funding to mortgage lenders to
support the flow of loans from origination to sale. Single-family construction
finances the development and construction of single-family homes, condominiums
and town homes, including the acquisition and development of home lots.
Multifamily and senior housing loans are for the development, construction and
lease of apartment projects and housing for independent, assisted and
memory-impaired residents.

The commercial real estate portfolio provides funding for the development,
construction and lease up primarily of office, retail and industrial projects
and is geographically diversified among over 35 market areas in 21 states and
the District of Columbia. The commercial and business portfolio finances
business operations and primarily includes asset-based and middle-market loans
and direct financing leases on equipment. The consumer and other portfolio is
primarily composed of loans secured by second liens on single-family homes.

Direct finance leveraged leases with a net book value of $33 million are
included in the commercial and business portfolio. The group is the lessor in
these leveraged lease agreements entered into in 2000 under which two commercial
aircraft having an estimated remaining economic life of 20 years were leased for
a term of seven years. The group's equity investment represented 50 percent of
the purchase price; the remaining 50 percent was furnished by third party
financing in the form of long-term debt totaling $28 million at year-end 2002,
that provides for no recourse against the group and is secured by a first lien
on the aircraft and cash flows from the related lease. At the end of the lease
term, the equipment is turned back to the group. The residual value at that time
is estimated to be 42 percent of cost.

Accruing loans past due 90 days or more were $7 million at year-end 2002.
There were no accruing loans past due 90 days or more at year-end 2001. The
recorded investment in nonaccrual loans was $126 million and $166 million at
year-end 2002 and 2001, respectively.

The recorded investment in impaired loans was $14 million at year-end 2002
and $66 million at year-end 2001, with a related allowance for loan losses of $6
million and $28 million, respectively. The average recorded

71

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

investment in impaired loans during the years ended 2002 and 2001 was
approximately $33 million and $37 million, respectively. The related amount of
interest income recognized on impaired loans for the years ended 2002 and 2001
was immaterial.

At year-end 2002, the group had unfunded commitments on outstanding loans
totaling approximately $4.2 billion and commitments to originate loans of $1.6
billion. To meet the needs of its customers, the group also issues standby and
other letters of credit. The credit risk in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The group holds collateral to support letters of credit when deemed necessary.
At year-end 2002, the group had issued letters of credit totaling $280 million.
Of this amount, $274 million was standby letters of credit with a
weighted-average term of approximately three years that represent an obligation
of the group to guarantee payment of a specified financial obligation or to make
payments based on another entity's failure to perform under an obligating
agreement. The portion of these amounts to be ultimately funded is uncertain.

Activity in the allowance for loan losses was as follows:

72

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE D -- SECURITIES

The amortized cost and fair values of securities consisted of the
following:

Securities are classified according to their contractual maturities without
consideration of principal amortization, potential prepayments or call options.
Accordingly, actual maturities may differ from contractual maturities.

73

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

The mortgage loans underlying mortgage-backed securities have adjustable
interest rates and generally have contractual maturities ranging from 15 to 40
years with principal and interest installments due monthly. The actual
maturities of mortgage-backed securities may differ from the contractual
maturities of the underlying loans because issuers or mortgagors may have the
right to call or prepay their securities or loans.

Certain mortgage-backed securities and other securities are guaranteed
directly or indirectly by U.S. government agencies. Other mortgage-backed
securities not guaranteed by U.S. government agencies are senior-tranche
securities considered investment grade quality by third-party rating agencies.
The collateral underlying these securities is primarily single-family
residential properties.

The group held $443 million and $614 million of securitized loans at
year-end 2002 and 2001, respectively. Included in these amounts are $57 million
and $123 million of mortgage loans that were securitized during 2002 and 2001,
respectively. These loans that were re-characterized to mortgage-backed
securities were recorded at the carrying value of the mortgage loans at the time
of securitization. The market value of the securities generated through these
securitization activities are obtained through active market quotes.

At year-end 2000, the carrying values of available-for-sale mortgage-backed
securities, debt securities and equity securities were $2.2 billion, $3 million,
and $175 million, respectively. The carrying value of held-to-maturity
mortgage-backed securities at year-end 2000 was $864 million.

NOTE E -- REAL ESTATE

Real estate is summarized as follows:

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FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE F -- PREMISES AND EQUIPMENT

Premises and equipment are summarized as follows:

The group leases equipment and facilities under operating lease agreements.
Future minimum rental payments, net of related sublease income and exclusive of
related expenses, under non-cancelable operating leases with a remaining term in
excess of one year are as follows (in millions): 2003 -- $17; 2004 -- $14;
2005 -- $11; 2006 -- $5; 2007 -- $3; 2008 and thereafter -- $6. Total rent
expense under these lease agreements was $21 million, $19 million and $15
million for 2002, 2001 and 2000, respectively.

NOTE G -- DEPOSITS

Deposits consisted of the following:

Scheduled maturities of time deposits at year-end 2002 are as follows:

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FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

At year-end 2002, maturities of time deposits were as follows (in
millions): 2003 -- $3,805; 2004 -- $856; 2005 -- $222; 2006 -- $226;
2007 -- $147; 2008 and thereafter -- $2.

NOTE H -- FEDERAL HOME LOAN BANK ADVANCES

Pursuant to collateral agreements with the Federal Home Loan Bank of Dallas
(FHLB), advances are secured by a blanket floating lien on the savings bank's
and mortgage bank's assets and by securities on deposit at the FHLB.

At year-end 2002, maturities of short- and long-term advances were as
follows (in millions): 2003 -- $1,083; 2004 -- $609; 2005 -- $446; 2006 -- $420;
2007 -- $828.

Information concerning short-term Federal Home Loan Bank Advances is
summarized as follows:

NOTE I -- SECURITIES SOLD UNDER REPURCHASE AGREEMENTS

Securities sold under repurchase agreements were delivered to
brokers/dealers who retained such securities as collateral for the borrowings
and have agreed to resell the same securities back to the group at the
maturities of the agreements. The agreements generally mature within 45 days.

Information concerning borrowings under repurchase agreements is summarized
as follows:

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FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

At year-end 2002, the carrying value of held-to-maturity and
available-for-sale securities sold under repurchase agreements was $2.6 billion
and $349 million, respectively. The market value of the held-to-maturity
securities sold under repurchase agreements was $2.7 billion at year-end 2002.

Accrued interest payable on securities sold under repurchase agreements
included in other liabilities was $2 million and $1 million at year-end 2002 and
2001, respectively.

NOTE J -- OTHER BORROWINGS

Other borrowings, which represent borrowings of the real estate and
insurance operations, consisted of the following:

Borrowings under bank credit facility are guaranteed by the parent company.

At year-end 2002, maturities of other borrowings were as follows (in
millions): 2003 -- $4; 2004 -- $142; 2005 -- $4; 2006 -- $2; 2007 -- $2; 2008
and thereafter -- $27.

NOTE K -- PREFERRED STOCK ISSUED BY SUBSIDIARIES

Guaranty has two subsidiaries that qualify as real estate investment
trusts, Guaranty Preferred Capital Corporation (GPCC) and Guaranty Preferred
Capital Corporation II (GPCC II). Both are authorized to issue floating rate and
fixed rate preferred stock. These preferred stocks have a liquidation preference
of $1,000 per share, dividends that are non-cumulative and payable when
declared, and are automatically exchanged into Guaranty preferred stock under
similar terms and conditions if federal banking regulators determine that
Guaranty is, or will become, undercapitalized in the near term or an
administrative body takes an action that will prevent GPCC or GPCC II from
paying full quarterly dividends or redeeming any preferred stock. If such an
exchange occurs, the parent company must, for all affected GPCC preferred
stockholders and may, at its option, for all affected GPCC II preferred
stockholders, issue its senior notes in exchange for the Guaranty preferred
stock in an amount equal to the liquidation preference, plus certain
adjustments, of the preferred stock exchanged. If the parent company elects to
not issue its senior notes to all affected GPCC II preferred stockholders, it
must redeem all their exchanged Guaranty preferred stock for cash in an amount
equal to the liquidation preference, plus certain adjustments. The terms of the
senior notes are similar to those of the Guaranty preferred stock exchanged
except that the rate on the senior notes received by the former GPCC preferred
stockholders is fixed instead of floating. At year-end 2002, the liquidation
preference of the outstanding preferred stock issued by the Guaranty
subsidiaries totaled $305 million and is reported as "Preferred stock issued by
subsidiaries" on the balance sheet. Dividends paid on this preferred stock were
$13 million, $19 million and $18 million in 2002, 2001 and 2000, respectively,
and are included in interest expense on borrowed funds.

In 1997, GPCC issued an aggregate of 150,000 shares of floating rate
preferred stock for an aggregate consideration of $150 million cash. GPCC issued
an additional 75,000 shares in 1998 for an aggregate

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NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

consideration of $75 million cash. The weighted average rate paid to preferred
shareholders was 3.27 percent and 5.82 percent during 2002 and 2001,
respectively. Prior to May 2007, at the option of GPCC, these shares may be
redeemed in whole or in part for $1,000 per share cash plus certain adjustments.

In 2000, GPCC II issued 35,000 shares of floating rate preferred stock and
45,000 shares of 9.15 percent fixed rate preferred stock for an aggregate
consideration of $80 million cash. The weighted average rate paid to floating
rate-preferred shareholders was 4.25 percent and 6.83 percent during 2002 and
2001, respectively. Prior to May 2007, at the option of GPCC II, these shares
may be redeemed in whole or in part for $1,000 per share cash plus certain
adjustments.

NOTE L -- MORTGAGE LOAN SERVICING

The group services mortgage loans that are owned primarily by independent
investors. The group serviced approximately 106,300 and 129,700 mortgage loans
aggregating $10.7 billion and $11.6 billion as of year-end 2002 and 2001,
respectively.

The group is required to advance, from group funds, escrow and foreclosure
costs on loans it services. The majority of these advances are recoverable,
except for certain amounts for loans serviced for GNMA. A reserve has been
established for unrecoverable advances. Market risk is assumed related to the
disposal of certain foreclosed VA loans. No significant losses were incurred
during 2002, 2001 or 2000 in connection with this risk.

Capitalized mortgage servicing rights, net of accumulated amortization,
were as follows:

Amortization expense related to mortgage servicing rights totaled $50
million, $40 million and $34 million for 2002, 2001 and 2000, respectively. The
valuation allowance was increased $9 million in 2002

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FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

and $6 million in 2001 and reduced $1 million in 2000. Changes in the valuation
allowance are included in amortization expense.

The estimated fair value of the capitalized mortgage servicing rights at
year-end 2002 was $113 million. Fair value was determined using internally
generated cash flow models. The assumptions used therein were supported by
comparisons to third party valuations, observable market data and generally
accepted valuation techniques. The most significant assumptions used in valuing
the capitalized mortgage servicing rights were prepayment speeds and discount
rates.

The group recognizes a mortgage servicing right related to the mortgage
loan sold based on the current market value of servicing rights for other
mortgage loans with the same or similar characteristics such as loan type, size,
escrow and geographic location, being traded in the market.

At year-end 2002, key economic assumptions and the sensitivity of the
current fair value for all capitalized mortgage servicing rights to immediate
changes in those assumptions were as follows (dollars in millions):

- ---------------

(a) Public Securities Act

(b) Constant Prepayment Rate

These sensitivity illustrations are hypothetical. As figures indicate,
changes in fair value based on a variation in assumptions generally cannot be
extrapolated because the relationship of the change in assumption to the change
in fair value may not be linear. Also, in the table, the effect of a variation
in a particular assumption on the fair value of the retained interest is
calculated without changing any other assumption. In reality, changes in one
factor may result in changes in another, which may magnify or counteract the
sensitivities.

The mortgage banking operations were in compliance with the minimum net
worth requirements of its investors who have established such net worth
requirements for approved loan servicers, sellers and custodians for year-end
2002 and 2001. The mortgage banking operations do not issue independent audited
financial statements and, instead, substitute the audited financial statements
of its parent, Guaranty; therefore, a net worth calculation is also required for
Guaranty by the Government National Mortgage Association (GNMA).

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FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

The minimum net worth requirements of the major secondary market investors and
actual net worth amounts for the mortgage banking operations are presented
below:

If, at any time, the mortgage banking operations fail to maintain the
minimum net worth values stated above, it would be at risk of losing the right
to sell loans to and/or service loans for the investors named above, which would
have a material impact on the stability of the mortgage banking operations.

NOTE M -- DERIVATIVE INSTRUMENTS

Guaranty is a party to various interest rate corridor agreements, which
reduce the impact of increases in interest rates on its investments in
adjustable-rate mortgage-backed securities that have lifetime interest rate
caps. Under these agreements with notional amounts totaling $73 million and $167
million at year-end 2002 and 2001, respectively, Guaranty simultaneously
purchased and sold caps whereby it receives interest if the variable rate based
on the FHLB Eleventh District Cost of Funds (EDCOF) Index (2.54 percent at
year-end 2002) exceeds an average strike rate of 8.93 percent and pays interest
if the same variable rate exceeds a strike rate of 11.75 percent. These
agreements mature through 2003. Guaranty did not receive or pay any amounts
under this agreement in 2002, 2001 or 2000.

Guaranty is also a party to an interest rate cap agreement to reduce the
impact of interest rate increases on certain adjustable rate investments with
lifetime caps. Under this agreement, with a notional amount of $29 million,
Guaranty would receive payments if the EDCOF exceeds the strike rate of 10
percent. This agreement matures in 2004. Guaranty did not receive or pay any
amounts under this agreement in 2002, 2001 or 2000.

These corridor and cap agreements do not qualify for hedge accounting and
are therefore recorded at fair value. Changes in the fair value of the interest
rate corridor and interest rate cap agreements, which are not material, are
included in the determination of net interest income. The amounts related to
these agreements subject to credit risk are the streams of payments receivable
by Guaranty under the terms of the contracts not the notional amounts used to
express the volumes of these transactions. Guaranty minimizes its exposure to
credit risk by entering into contracts with major U.S. securities firms. At
year-end 2002, fair value of these corridor and cap agreements was immaterial.

The mortgage banking operation enters into forward sales commitments to
deliver mortgage loans to third parties. These forward sales commitments hedge
volatility of interest rates between the time a mortgage loan commitment is made
and the subsequent funding and sale of the loan to a third party. During the
time these forward sale commitments are hedging a mortgage loan commitment, both
commitments are considered derivative financial instruments and are recorded at
fair value with changes in their fair value recorded in income. Upon origination
of a mortgage loan, the forward sale commitment is designated as a fair-value
hedge of the mortgage loan held for sale and changes in the fair value of both
the forward sale commitment and the mortgage loan held for sale are recorded in
income. Hedge ineffectiveness related to the fair value hedge is recorded in
income and was immaterial in 2002 and 2001. At year-end 2002, the mortgage
banking operation

80

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

had commitments to originate or purchase mortgage loans totaling approximately
$1.4 billion and commitments to sell mortgage loans of approximately $1.4
billion. To the extent mortgage loans at the appropriate rates are not available
to fulfill the sales commitments, the group is subject to market risk resulting
from interest rate fluctuations.

NOTE N -- NONINTEREST INCOME AND NONINTEREST EXPENSE

Noninterest income and expense consisted of the following:

81

FINANCIAL SERVICES GROUP

NOTES TO SUMMARIZED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE O -- REGULATORY CAPITAL MATTERS

Guaranty is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on
Guaranty's financial statements. The payment of dividends from Guaranty to the
company is subject to proper regulatory notification or approval.

Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, Guaranty must meet specific capital guidelines that involve
quantitative measures of Guaranty's assets, liabilities and certain
off-balance-sheet items such as unfunded loan commitments, as calculated under
regulatory accounting practices. Capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors. At year-end 2002, Guaranty met or exceeded all of
its capital adequacy requirements.

At year-end 2002, the most recent notification from regulators categorized
Guaranty as "well capitalized." The following table sets forth Guaranty's actual
capital amounts and ratios along with the minimum capital amounts and ratios
Guaranty must maintain in order to meet capital adequacy requirements and to be
categorized as "well capitalized."

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TEMPLE-INLAND INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

See the notes to the consolidated financial statements.

83

TEMPLE-INLAND INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

See the notes to the consolidated financial statements

84

TEMPLE-INLAND INC. AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEETS

See the notes to the consolidated financial statements.

85

TEMPLE-INLAND INC. AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEETS

See the notes to the consolidated financial statements.
86

TEMPLE-INLAND INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

See the notes to the consolidated financial statements.

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TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The consolidated financial statements include the accounts of Temple-Inland
Inc. and its manufacturing and financial services subsidiaries (the company).
Investments in joint ventures and other subsidiaries in which the company has
between a 20 percent and 50 percent equity ownership are reflected using the
equity method. All material intercompany amounts and transactions have been
eliminated.

The consolidated net assets invested in financial services activities are
subject, in varying degrees, to regulatory rules and restrictions including
restrictions on the payment of dividends to the parent company. Accordingly,
included as an integral part of the consolidated financial statements are
separate summarized financial statements and notes for the company's
manufacturing and financial services groups, as well as the significant
accounting policies unique to each group.

The preparation of the consolidated financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions. These estimates and assumptions affect the amounts reported in
the financial statements and accompanying notes, including disclosures related
to contingencies. Actual results could differ from these estimates.

The company's fiscal year ends on the Saturday closest to December 31,
which from time to time means that a fiscal year will include 53 weeks instead
of 52 weeks. Fiscal years 2002, 2001, and 2000, which ended on December 28,
December 29, and December 30, respectively, each consisted of 52 weeks.

Balance sheets of the company's international operations where the
functional currency is other than the U.S. dollar are translated into U.S.
dollars at year-end exchange rates. Adjustments resulting from financial
statement translation are reported as a component of shareholders' equity. For
other international operations where the functional currency is the U.S. dollar,
inventories, property, plant and equipment values are translated at the
historical rate of exchange, while other assets and liabilities are translated
at year-end exchange rates. Translation adjustments for these operations are
included in earnings and are not material. Income and expense items are
translated into U.S. dollars at average rates of exchange prevailing during the
year. Gains and losses resulting from foreign currency transactions are included
in earnings and are not material.

Certain amounts have been reclassified to conform to current year's
classifications.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include cash on hand and other short-term liquid
instruments with original maturities of three months or less. At year-end 2002,
$6 million of cash was subject to withdrawal restrictions.

CAPITALIZED SOFTWARE

The company capitalizes purchased software costs as well as the direct
costs, both internal and external, associated with software developed for
internal use. These capitalized costs are amortized using the straight-line
method over estimated useful lives ranging from three to seven years. Carrying
values of capitalized software at year-end 2002 and 2001 were $72 million and
$90 million, respectively. Amortization of these capitalized costs was $22
million in 2002, $15 million in 2001, and $7 million in 2000.

DERIVATIVES

The company uses, to a limited degree, derivative instruments to mitigate
its exposure to risk, including those associated with changes in product
pricing, manufacturing costs and interest rates related to borrowings and
investments in securities, as well as mortgage production activities. The
company does not use derivatives

88

TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

for trading purposes. Changes in the fair value of derivative instruments
designated as cash flow hedges are deferred and recorded in other comprehensive
income. These deferred gains or losses are recognized in income when the
transactions being hedged are completed. The ineffective portion of these
hedges, which is not material, is recognized in income. Changes in the fair
value of derivative instruments designated as fair value hedges are recognized
in income, as are changes in the fair value of the hedged item. Changes in the
fair value of derivative instruments that are not designated as hedges for
accounting purposes are recognized in income.

Beginning January 2001, the company adopted Statement of Financial
Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and
Hedging Activities, as amended. The cumulative effect of adopting this statement
was to reduce 2001 net income by $2 million, or $0.04 per diluted share, and
other comprehensive income, a component of shareholders' equity, by $4 million.
As permitted by this statement, the company also changed the designation of its
January 2001 portfolio of held-to-maturity securities, which were carried at
unamortized costs, to available-for-sale, which are carried at fair value. As a
result, the $864 million carrying value of these securities was adjusted to
their fair value with a corresponding after-tax reduction of $16 million in
other comprehensive income.

FAIR VALUE OF FINANCIAL INSTRUMENTS

In the absence of quoted market prices, the fair value of financial
instruments is estimated. These estimated fair value amounts are significantly
affected by the assumptions used, including the discount rate and estimates of
future cash flow. Where these estimates approximate carrying value, no separate
disclosure of fair value is shown.

GOODWILL

Beginning January 2002, the company adopted SFAS No. 142, Goodwill and
Other Intangible Assets. Under this statement, amortization of goodwill and
other indefinitely lived intangible assets is precluded; however, at least
annually these assets are measured for impairment based on estimated fair
values. The company performs the annual impairment measurement as of the
beginning of the fourth quarter of each year. Intangible assets with finite
useful lives are amortized over their estimated lives. The cumulative effect of
adopting this statement was to reduce 2002 income by $11 million, or $0.22 per
diluted share, for an $18 million goodwill impairment associated with the
Corrugated Packaging Group's pre-2001 specialty packaging acquisitions.

The effects of not amortizing goodwill and trademarks in periods prior to
the adoption of this statement follows:

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TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

IMPAIRMENT OF LONG-LIVED ASSETS

Beginning January 2002, the company adopted SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. The effect on earnings or
financial position of adopting this statement was not material.

Long-lived assets held for use are reviewed for impairment when events or
circumstances indicate that its carrying value may not be recoverable.
Impairment exists if the carrying amount of the long-lived asset is not
recoverable from the undiscounted cash flows expected from its use and eventual
disposition. The amount of the impairment loss is determined by comparing the
carrying value of the long-lived asset to its fair value. In the absence of
quoted market prices, fair value is generally based on the present value of
future cash flows expected from the use and eventual disposition of the
long-lived asset. Assets held for disposal are recorded at the lower of carrying
value or estimated fair value less costs to sell.

INCOME TAXES

Deferred income taxes are provided for temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for tax purposes computed using current tax rates.

STOCK-BASED COMPENSATION

The company uses the intrinsic value method in accounting for its
stock-based employee compensation plans.

Beginning first quarter 2003, the company will voluntarily adopt the
prospective transition method of accounting for stock-based compensation
contained in SFAS No. 148, Accounting for Stock-Based Compensation -- Transition
and Disclosure, an amendment of FASB Statement No. 123. Under the prospective
transition method, the company will apply the fair value recognition provisions
to all stock-based compensation awards granted in 2003 and thereafter. The
principal effects of adopting this statement are that the fair value of stock
options granted will be charged to expense over the option vesting period. If
options are granted in 2003 at a similar level with 2002, the expected effect on
earnings or financial position of the adoption of this method will not be
material.

OTHER NEW ACCOUNTING PRONOUNCEMENTS

Beginning second quarter 2002, the company adopted SFAS No. 145, Rescission
of Financial Accounting Standards Board Statements No. 4, 44, and 64, Amendment
of Financial Accounting Standards No. 13 and Technical Corrections. The
principal effect of adopting this statement was that the charge-off of the $11
million of unamortized debt financing fees commensurate with the early repayment
of the bridge financing facility and other borrowings was not classified as an
extraordinary item in the determination of income from continuing operations.

Beginning third quarter, 2002, the company adopted SFAS No. 147,
Acquisitions of Certain Financial Institutions -- an amendment of Financial
Accounting Standards No. 72 and 144 and Financial Accounting Standards Board
Interpretations No. 9. The effect on earnings or financial position of adopting
this statement was not material.

PENDING ACCOUNTING PRONOUNCEMENTS

Beginning first quarter 2003, the company will be required to adopt SFAS
No. 143, Accounting for Asset Retirement Obligations. The company has not yet
determined the effects on earnings or financial position of adopting this
statement but it expects that the effects will not be material.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Beginning first quarter 2003, the company will be required to adopt SFAS
No. 146, Accounting for Costs Associated with Exit or Disposal Activities. The
company expects that the effect of adopting this statement will not be material.

NOTE 2 -- CAPITAL STOCK

The company has a Shareholder Rights Plan in which one-half of a preferred
stock purchase right (Right) was declared as a dividend for each common share
outstanding. Each Right entitles shareholders to purchase, under certain
conditions, one one-hundredth of a share of newly issued Series A Junior
Participating Preferred Stock at an exercise price of $200. Rights will be
exercisable only if a person or group acquires beneficial ownership of 20
percent or more of the company's common shares or commences a tender or exchange
offer, upon consummation of which such person or group would beneficially own 25
percent or more of the company's common shares. The company will generally be
entitled to redeem the Rights at $0.01 per Right at any time until the 10th
business day following public announcement that a 20 percent position has been
acquired. The Rights will expire on February 20, 2009.

In connection with the issuance of the Upper DECS(SM) units the company
issued contracts to purchase common stock. The purchase contracts represent an
obligation to purchase by May 2005 shares of common stock based on an aggregate
purchase price of $345 million. The actual number of shares that will be issued
on the stock purchase date will be determined by a settlement rate that is based
on the average market price of the company's common stock for 20 days preceding
the stock purchase date. The average price per share will not be less than $52,
in which case 6.635 million shares would be issued, and will not be higher than
$63.44, in which case 5.438 million shares would be issued. If a holder elects
to purchase shares prior to May 2005, the number of shares that would be issued
will be based on a fixed price of $63.44 per share (the settlement rate
resulting in the fewest number of shares issued to the holder) regardless of the
actual market price of the shares at that time. Accordingly, if the purchase
contracts had been settled at year-end 2002, the settlement rate would have
resulted in the issuance of 5.438 million shares of common stock and the receipt
of $345 million cash. The purchase contracts are considered to be equity
instruments as they can only be settled with shares of common stock and
therefore were included as a component of shareholders' equity based on their
fair value. Subsequent changes in fair value are not recognized. At the date of
issuance the purchase contracts had no value. The purchase contracts also
provide for contract adjustment payments at an annual rate of 1.08 percent. The
$10 million present value of the contract adjustment payments was recorded as a
liability with a corresponding offset to shareholders' equity at the time the
Upper DECS(sm) were issued. The accretion of this contract adjustment liability
is recorded as a component of interest expense. Accretion charged to interest
expense for the year 2002 was $0.4 million.

See Note 6 for information about additional shares of common stock that
could be issued under terms of the company's stock-based compensation programs.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3 -- FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts and the estimated fair values of financial instruments
were as follows:

Differences between fair value and carrying amounts are primarily due to
instruments that provide fixed interest rates or contain fixed interest rate
elements. Inherently, such instruments are subject to fluctuations in fair value
due to subsequent movements in interest rates. All other financial instruments
are excluded from the above table because they are either carried at fair value
or have fair values that approximate their carrying amount due to their
short-term nature. The fair value of mortgage-backed and other securities
held-to-maturity and off-balance-sheet instruments are based on quoted market
prices. Other financial instruments are valued using discounted cash flows. The
discount rates used represent current rates for similar instruments.

At year-end 2002, the company has guaranteed certain joint venture
obligations principally related to fixed-rate debt instruments totaling $124
million and sold with recourse promissory notes totaling $8 million. It is not
practicable to estimate the fair value of these guarantees or contingencies.

NOTE 4 -- TAXES ON INCOME

Taxes on income from continuing operations consisted of the following:

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TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Earnings from operations consisted of the following:

The difference between the consolidated effective income tax rate and the
federal statutory income tax rate includes the following:

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TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Significant components of the company's consolidated deferred tax assets
and liabilities are as follows:

The valuation allowance represents accruals for deductions and credits that
are uncertain and, accordingly, have not been recognized for financial reporting
purposes.

The primary reason for the decrease in the net deferred tax liability was
due to changes in other comprehensive income attributed to the increase in the
minimum pension liability.

Cash income tax payments, net of refunds received, were $19 million, $29
million, and $88 million during 2002, 2001 and 2000, respectively.

The company has foreign net operating loss carryforwards of $46 million
that will expire from 2005 through 2011. Alternative minimum tax credits may be
carried forward indefinitely. In accordance with generally accepted accounting
principles, the company has not provided deferred taxes on approximately $31
million of pre-1988 tax bad debt reserves.

The exercise of employee stock options generated a tax benefit of less than
$1 million in each of the years 2002, 2001 and 2000. This tax benefit was
credited to additional paid-in capital and reduced current taxes payable.

The IRS is currently examining the company's consolidated tax returns for
the years 1993 through 1996. The resolution of these examinations is not
expected to have a material adverse effect on the company's financial condition
or results of operations.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 5 -- EMPLOYEE BENEFIT PLANS

The company has defined contribution or defined benefit plans covering
substantially all employees. The company also provides, as a postretirement
benefit, medical and insurance coverage to eligible hourly and salaried
employees who begin drawing retirement benefits immediately after termination of
employment with the company. Amounts charged to expense for these plans were:

The company's defined benefit plans covering salaried and nonunion hourly
employees provide benefits based on compensation and years of service, while
union hourly plans are based on negotiated benefits and years of service. The
company's policy is to fund amounts on an actuarial basis in order to accumulate
assets sufficient to meet the benefits to be paid in accordance with the
requirements of ERISA. Contributions to the plans are made to trusts for the
benefit of plan participants. The annual measurement date of the benefit
obligations, fair value of plan assets and the funded status of defined benefit
and postretirement plans is September 30.

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TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The changes in benefit obligation, plan assets and the funded status of
defined benefit plan and the postretirement plans follows:

- ---------------

(a) At year-end 2002 and 2001, the pension plan assets included company stock
with market values of $17 million (2 percent of plan assets) and $18 million
(3 percent of plan assets), respectively.

For plans that are under funded at year-end 2002 and 2001, the projected
benefit obligation was $917 million and $477 million, respectively, and the fair
value of plan assets was $632 million and $412 million, respectively. For plans
with accumulated benefit obligations in excess of plan assets at year-end 2002
and 2001, the accumulated benefit obligation was $862 million and $75 million,
respectively, and the fair value of plan assets was $632 million and $51
million, respectively.

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TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Net periodic cost (credit)for defined benefit and postretirement plans
include the following:

Significant assumptions used for the defined benefit and postretirement
plans follow:

For the year 2003, the company expects to incur net periodic non-cash
pension expense in the range of $43 million. The increase in pension expense is
primarily due to the current year decrease in the discount rate to 6.75 percent,
a year 2003 decrease in the assumed expected rate of return of plan assets to
8.5 percent and a year 2003 increase in the recognition of the accumulated
decline in the fair value of plan assets.

For estimating postretirement benefits, a 10 percent annual rate of
increase in the per capita cost of covered health care benefits was assumed for
2003. The rate was assumed to decrease gradually to 4.5 percent by 2008 and
remain at that level thereafter.

Assumed health care cost trend rates have a significant effect on the
amounts reported for the postretirement benefits. A one-percentage point change
in assumed health care cost trend rates would have the following effects:

NOTE 6 -- STOCK-BASED COMPENSATION

The company has established stock-based compensation plans for key
employees and directors. These plans permit stock-based compensation awards in
the form of restricted or phantom shares of common stock and nonqualified and/or
incentive options to purchase shares of common stock.

Under the restricted stock and phantom stock plans, at year-end 2002,
awards of 251,170 shares of common stock were outstanding and another 412,531
shares were available for future awards. Restricted shares generally vest over a
four- to six-year period while phantom shares generally vest after three years
of employment. The fair value of the shares awarded, generally the market value
of the underlying stock on the date of grant, is charged to expense over the
vesting period. This stock-based compensation expense was $1 million, $1 million
and $2 million for the years 2002, 2001 and 2000, respectively.

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TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Options granted after 1995 generally have a ten-year term and become
exercisable in steps from one to five years. Options are granted with an
exercise price equal to the market value at the date of grant. The company
accounts for stock options under the recognition and measurement provisions of
APB Opinion No. 25, Accounting for Stock Issued to Employees and related
interpretations. The company has adopted the disclosure only provisions of SFAS
No. 123, Accounting for Stock Based Compensation. As a result, no stock-based
compensation expense is recognized for stock options, as there is no intrinsic
value at the date of grant.

A summary of stock option activity follows:

Exercise prices for options outstanding at year-end 2002 range from $27 to
$75. The weighted average remaining contractual life of these options is eight
years. An additional 739,152, 1,664,552, and 755,956 shares of common stock were
available for grants at year-end 2002, 2001 and 2000, respectively.

The fair value of the options granted in 2002, 2001 and 2000 was estimated
on the date of grant using the Black-Scholes option-pricing model using the
following assumptions:

98

TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Pro forma net income and diluted earnings per share, assuming that the
company had accounted for its employee stock options using the fair value method
based upon the Black-Scholes option-pricing model described above and amortized
the fair value to expense over the option vesting period follows:

The pro forma disclosures may not be indicative of future amounts due to
changes in assumptions caused by changing circumstances and because the options
vest over several years with additional future option grants expected.

NOTE 7 -- EARNINGS PER SHARE

Numerators and denominators used in computing earnings per share are as
follows:

99

TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 8 -- ACCUMULATED OTHER COMPREHENSIVE INCOME

The components of and changes in other comprehensive income are as follows:

NOTE 9 -- CONTINGENCIES

There are pending against the company and its subsidiaries lawsuits, claims
and environmental matters arising in the regular course of business. The outcome
of individual matters cannot be predicted with certainty. In the opinion of
management, recoveries and claims, if any, by plaintiffs or claimants resulting
from the foregoing litigation will not have a material adverse effect on the
operations or financial position of the company.

NOTE 10 -- SEGMENT INFORMATION

The company has three reportable segments: corrugated packaging, building
products and financial services. The Corrugated Packaging Group manufactures
containerboard and corrugated packaging. The Building Products Group
manufactures a variety of building materials and manages the company's timber
resources. The Financial Services Group operates a savings bank and engages in
mortgage banking, real estate and insurance brokerage activities.

These segments are managed as separate business units. The company
evaluates performance based on operating income before other income/expense,
corporate expenses and income taxes. Parent Company interest expense is not
allocated to the business segments. The accounting policies of the segments are
the

100

TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

same as those described in the accounting policy notes to the financial
statements. Corporate and other includes corporate expenses, other income
(expense) and discontinued operations.

- ---------------

(a) Includes other expenses of $13 million of which $7 million is related to
the severance and write-off of technology investments, which applies to the
financial services segment, and $6 million is related to the repurchase of
notes sold with recourse, which applies to the corrugated packaging
segment.

(b) Operating income includes $27 million reduction in depreciation expense
resulting from a change in the estimated useful lives of certain production
equipment, of which $20 million applies to the corrugated packaging segment
and $7 million applies to the building products segment.

(c) Includes other expense of $19 million, of which $15 million applies to the
corrugated packaging segment and $4 million to corporate, and other income
of $20 million, which applies to the building products segment.

(d) Includes other expense of $15 million, which applies to the building
products segment.

101

TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table includes revenues and property and equipment based on
the location of the operation:

102

TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 11 -- SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

Selected quarterly financial results for the years 2002 and 2001 are
summarized below.

- ---------------

(a) Includes a $7 million charge related to severance and write off of
technology investments.

(b) Includes an $11 million charge related to the charge off of unamortized
debt financing fees and a $6 million charge related to promissory notes
previously sold with recourse.

103

TEMPLE-INLAND INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

- ---------------

(a) The effect of not amortizing goodwill and trademarks during each quarter of
2001 would have been approximately $2 million or $0.04 per diluted share.

(b) Includes a $20 million pre-tax gain from sale of non-strategic timberlands;
a $3 million pre-tax loss related to the disposal of two specialty
packaging operations; a $4 million impairment pre-tax charge related to an
interest in a glass bottling venture in Puerto Rico; a $4 million pre-tax
loss related to the sale of a box plant in Chile; and a $4 million pre-tax
charge related to the fair value adjustment of an interest rate swap
agreement. In connection with the sale of the box plant in Chile, a
one-time tax benefit of $8 million was recognized.

NOTE 12 -- OTHER INFORMATION

The allowance for doubtful accounts was $13 million, $11 million and $10
million at year-end 2002, 2001 and 2000, respectively. The provision for bad
debts was $5 million, $8 million, and $6 million in 2002, 2001 and 2000,
respectively. Bad debt charge-offs, net of recoveries were $4 million, $7
million and $5 million in 2002, 2001 and 2000, respectively. The allowance for
doubtful accounts associated with acquisitions during the year 2002 was $1
million.

The unrealized gain on available-for-sale mortgage-backed securities was
$24 million, $26 million and $17 million at year-end 2002, 2001 and 2000,
respectively. The unrealized gain decreased by $2 million for the year 2002 and
increased by $9 million and $36 million for the years 2001 and 2000,
respectively.

104

MANAGEMENT REPORT ON FINANCIAL STATEMENTS

Management has prepared and is responsible for the company's financial
statements, including the notes thereto. They have been prepared in accordance
with generally accepted accounting principles and necessarily include amounts
based on judgments and estimates by management. All financial information in
this annual report is consistent with that in the financial statements.

The company maintains internal accounting control systems and related
policies and procedures designed to provide reasonable assurance that assets are
safeguarded, that transactions are executed in accordance with management's
authorization and properly recorded, and that accounting records may be relied
upon for the preparation of financial statements and other financial
information. The design, monitoring and revision of internal accounting control
systems involve, among other things, management's judgment with respect to the
relative cost and expected benefits of specific control measures. The company
also maintains an internal auditing function that evaluates and formally reports
on the adequacy and effectiveness of internal accounting controls, policies and
procedures.

The company's financial statements have been examined by Ernst & Young LLP,
independent auditors, who have expressed their opinion with respect to the
fairness of the presentation of the statements.

The Audit Committee of the Board of Directors, composed solely of outside
directors, meets with the independent auditors and internal auditors to evaluate
the effectiveness of the work performed by them in discharging their respective
responsibilities and to assure their independent and free access to the
committee.

KENNETH M. JASTROW, II
Chairman of the Board and
Chief Executive Officer

LOUIS R. BRILL
Chief Accounting Officer

105

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders of Temple-Inland Inc.:

We have audited the accompanying consolidated balance sheets of
Temple-Inland Inc. as of December 28, 2002 and December 29, 2001, and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the three years in the period ended December 28, 2002. These
financial statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Temple-Inland
Inc. and subsidiaries at December 28, 2002 and December 29, 2001, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 28, 2002, in conformity with accounting
principles generally accepted in the United States.

As discussed in Note 1 to the consolidated financial statements, in 2002
the Company changed its method of accounting for goodwill and other intangible
assets.

Ernst & Young LLP
Austin, Texas
January 31, 2003

106

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

The Company has had no changes in or disagreements with its independent
auditors to report under this item.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item is incorporated herein by reference
from the Company's definitive proxy statement, involving the election of
directors, to be filed pursuant to Regulation 14A with the Securities and
Exchange Commission not later than 120 days after the end of the fiscal year
covered by this Form 10-K (the "Definitive Proxy Statement"). Information
required by this item concerning executive officers is included in Part I of
this report.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference from the
Company's Definitive Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is incorporated by reference from the
Company's Definitive Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is incorporated by reference from the
Company's Definitive Proxy Statement.

ITEM 14. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures.

The Company's chief executive officer and its chief financial officer,
based on their evaluation of the Company's disclosure controls and procedures
(as defined in Exchange Act Rule 13a-14(c)) as of a date within 90 days prior to
the filing of this Annual Report on Form 10-K, have concluded that the Company's
disclosure controls and procedures are adequate and effective for the
information required to be disclosed by us in the reports we file or submit
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is
recorded, processed, summarized, and reported within the time periods specified
in the Securities and Exchange Commission's ("SEC") rules and forms.

(b) Changes in internal controls.

There were no significant changes in the Company's internal controls or in
other factors that could significantly affect the Company's internal controls
subsequent to the date of their evaluation described above.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) Documents Filed as Part of Report.

1. Financial Statements

The financial statements of the Company and its consolidated subsidiaries
are included in Part II, Item 8 of this Annual Report on Form 10-K.

107

2. Financial Statement Schedule

All schedules are omitted as the required information is either
inapplicable or the information is presented in the Consolidated Financial
Statements and notes thereto in Item 8 above.

3. Exhibits

108

- ---------------

* Management contract or compensatory plan or arrangement.

(1) Incorporated by reference to Registration Statement No. 2-87570 on Form S-1
filed by the Company with the Commission.

(2) Incorporated by reference to Post-effective Amendment No. 2 to Registration
Statement No. 2-88202 on Form S-8 filed by the Company with the Commission.

(3) Incorporated by reference to Post-Effective Amendment No. 1 to Registration
Statement No. 33-25650 on Form S-8 filed by the Company with the
Commission.

(4) Incorporated by reference to Registration Statement No. 33-27286 on Form
S-8 filed by the Company with the Commission.

(5) Incorporated by reference to Registration Statement No. 33-8362 on Form S-1
filed by the Company with the Commission.

(6) Incorporated by reference to the Company's Form 10-K for the year ended
December 31, 1988.

(7) Incorporated by reference to the Company's Registration Statement on Form
8A filed with the Commission on February 19, 1999.

(8) Incorporated by reference to the Company's Form 8-K filed with the
Commission on December 27, 1990.

(9) Incorporated by reference to Registration Statement No. 33-40003 on Form
S-3 filed by the Company with the Commission.

109

(10) Incorporated by reference to Registration Statement No. 33-43978 on Form
S-3 filed by the Company with the Commission.

(11) Incorporated by reference to Registration Statement No. 33-50880 on Form
S-3 filed by the Company with the Commission.

(12) Incorporated by reference to the Company's Definitive Proxy Statement in
connection with the Annual Meeting of Shareholders held May 6, 1994, and
filed with the Commission on March 21, 1994.

(13) Incorporated by reference to the Company's Form 10-Q for the quarter ended
September 28, 2002.

(14) Incorporated by reference to the Company's Definitive Proxy Statement in
connection with the Annual Meeting of Shareholders held May 2, 1997, and
filed with the Commission on March 17, 1997.

(15) Incorporated by reference to the Company's Form 8-K filed with the
Commission on June 2, 1998.

(16) Incorporated by reference to the Company's Definitive Proxy Statement in
connection with the Annual Meeting of Shareholders held May 7, 1999, and
filed with the Commission on March 26, 1999

(17) Incorporated by reference to the Company's Definitive Proxy Statement in
connection with the Annual Meeting of Shareholders held May 4, 2001, and
filed with the Commission on March 23, 2001

(18) Incorporated by reference to the Company's Form 10-K for the year ended
December 30, 2000.

(19) Incorporated by reference to the Company's Form 10-Q for the quarter ended
June 30, 2001.

(20) Incorporated by reference to the Schedule TO filed by the Company on
January 22, 2002, in connection with the proposed acquisition of Gaylord
Container Corporation.

(21) Incorporated by reference to exhibit 4.2 to the Company's Form 8-K filed
with the Commission on May 3, 2002.

(22) Incorporated by reference to exhibit 4.1 to the Company's Form 8-K filed
with the Commission on May 3, 2002.

(23) Filed herewith.

(b) Reports on Form 8-K.

The Company filed the following Current Reports on Form 8-K during the
fourth quarter of the fiscal year ended December 28, 2002:

1. Current Report dated October 15, 2002 furnishing materials under
Item 9 of Form 8-K related to the Company's quarterly earnings call.

2. Current Report dated October 31, 2002 furnishing information under
Item 9 of Form 8-K related to unauthorized comments made to the media by a
mill manager.

3. Current Report dated November 21, 2002 furnishing a press release
under Item 9 of Form 8-K related to the Company's plan to streamline its
operations.

110

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this
registration statement to be signed on its behalf by the undersigned thereunto
authorized, on March 19, 2003.

TEMPLE-INLAND INC.
(Registrant)

By: /s/ KENNETH M. JASTROW, II
------------------------------------
Kenneth M. Jastrow, II
Chairman of the Board and
Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.

111

112

CERTIFICATIONS

I, Kenneth M. Jastrow, II, Chief Executive Officer of Temple-Inland Inc.,
certify that:

1. I have reviewed this annual report on Form 10-K of Temple-Inland Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.

/s/ KENNETH M. JASTROW, II
--------------------------------------
Kenneth M. Jastrow, II
Chief Executive Officer

Date: March 19, 2003

113

CERTIFICATIONS

I, Randall D. Levy, Chief Financial Officer of Temple-Inland Inc., certify that:

1. I have reviewed this annual report on Form 10-K of Temple-Inland Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.

/s/ RANDALL D. LEVY
--------------------------------------
Randall D. Levy
Chief Financial Officer

Date: March 19, 2003

114

INDEX TO EXHIBITS

- ---------------

* Management contract or compensatory plan or arrangement.