LINK: Downey 10-Q Analysis
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________________
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2008OR
For the transition period from __________ to __________
Commission File Number 1-13578(Exact name of registrant as specified in its charter)
N/A
(Former name, former address and former fiscal year, if changed since last report.)
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 þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non -accelerated filer, or a
smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule
12b-2 of the Exchange Act. (Check one):
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OFo TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF(State or other jurisdiction of
incorporation or organization)
33-0633413
(I.R.S. Employer Identification No.)
3501 Jamboree Road, Newport Beach, CA
(Address of principal executive office)
92660
(Zip Code)
Registrant’s telephone number, including area code (949) 854-0300Large accelerated filer þ Accelerated filer o
Non-accelerated filer o (Do not check if a smaller
reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b -2 of the Exchange Act).
Yes o No þ
At September 30, 2008, 29,080,777 shares of the Registrant’s Common Stock, $0.01 par value were outstanding.
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PART I – FINANCIAL INFORMATION
ITEM 1. – FINANCIAL STATEMENTS 1
Consolidated Balance Sheets at September 30, 2008 and 2007 and December 31, 2007 1
Consolidated Statements of Income (loss) for the three and nine months ended
September 30, 2008 and 2007 2
Consolidated Statements of Comprehensive Income (loss) for the three and nine months ended
September 30, 2008 and 2007 3
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2008 and 2007 4
Notes To Consolidated Financial Statements 6
ITEM 2. – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 27
ITEM 3. – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 75
ITEM 4. – CONTROLS AND PROCEDURES 75
PART II – OTHER INFORMATION
ITEM 1. – LEGAL PROCEEDINGS 76
ITEM 1A. – RISK FACTORS 77
ITEM 2. – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 80
ITEM 3. – DEFAULTS UPON SENIOR SECURITIES 80
ITEM 4. – SUBMISSION OF MATTERS TO A VOTE OF SECURITIY HOLDERS 80
ITEM 5. – OTHER INFORMATION 81
ITEM 6. – EXHIBITS 81
AVAILABILITY OF REPORTS 82
SIGNATURES 82
Page i Navigation Links
September 30, December 31, September 30,
(Dollars in Thousands, Except Per Share Data) 2008 2007 2007
Assets
Cash $ 451,815 $ 83,840 $ 86,072
Federal funds and interest earning due from banks 101,129 5,900 1,551
Cash and cash equivalents 552,944 89,740 87,623
U.S. Treasury, government sponsored entities and other investment
securities available for sale, at fair value 592,542 1,549,879 2,142,278
Loans held for sale, at lower of cost or fair value 7,673 103,384 90,228
Mortgage-backed securities available for sale, at fair value 104 111 112
Loans held for investment 11,511,330 11,381,327 11,744,063
Allowance for loan losses (761,824 ) (348,167 ) (142,218 )
Loans held for investment, net 10,749,506 11,033,160 11,601,845
Investments in real estate and joint ventures 15,606 68,679 58,715
Real estate acquired in settlement of loans, net 278,091 115,623 59,773
Premises and equipment, net 113,663 115,846 117,535
Federal Home Loan Bank stock, at cost 133,255 70,964 70,058
Mortgage servicing rights:
Measured at fair value 22,814 – –
Amortized – 19,512 21,849
Other assets 161,884 113,761 130,889
Income tax receivable 133,852 6,312 27,900
Deferred tax asset 19,265 122,086 8,912
$ 12,781,199 $ 13,409,057 $ 14,417,717
Liabilities and Stockholders’ Equity
Deposits $ 9,618,384 $ 10,496,041 $ 10,662,618
Securities sold under agreements to repurchase – – 566,350
Federal Home Loan Bank advances 2,110,061 1,197,100 1,308,867
Senior notes 198,593 198,445 198,398
Accounts payable and accrued liabilities 82,447 183,054 237,258
Total liabilities 12,009,485 12,074,640 12,973,491
Stockholders’ equity
Preferred stock, par value of $0.01 per share; authorized 5,000,000 shares;
outstanding none – – –
Common stock, par value of $0.01 per share; authorized 50,000,000 shares;
issued 29,080,777 shares at September 30, 2008 and 28,235,022 shares at
December 31, 2007 and September 30, 2007; outstanding 29,080,777 shares
at September 30, 2008 and 27,853,783 at December 31, 2007 and
September 30, 2007 291 282 282
Additional paid-in capital 93,835 93,792 93,792
Accumulated other comprehensive income (loss) (6,231 ) 2,768 388
Retained earnings 683,819 1,254,367 1,366,556
Treasury stock, at cost, 381,239 at December 31, 2007 and
September 30, 2007 – (16,792 ) (16,792 )
See accompanying notes to consolidated financial statements.
Total stockholders’ equity 771,714 1,334,417 1,444,226
$ 12,781,199 $ 13,409,057 $ 14,417,717
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Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in Thousands, Except Per Share Data) 2008 2007 2008 2007
Interest income
Loans $ 154,479 $ 208,314 $ 493,193 $ 690,869
U.S. Treasury and government sponsored entities securities 12,977 26,350 49,330 65,644
Mortgage-backed securities 2 3 8 9
Other investment securities 1,610 1,207 3,713 5,396
Total interest income 169,068 235,874 546,244 761,918
Interest expense
Deposits 67,726 108,514 243,047 333,977
Federal Home Loan Bank advances and other borrowings 22,010 26,088 50,601 83,494
Senior notes 3,305 3,302 9,913 9,904
Total interest expense 93,041 137,904 303,561 427,375
Net interest income
76,027 97,970 242,683 334,543
Provision for credit losses
130,291 81,562 626,035 91,684
Net interest income (loss) after provision for credit losses (54,264 ) 16,408 (383,352 ) 242,859
Other income, net
Loan and deposit related fees 8,152 8,913 24,595 27,087
Real estate and joint ventures held for investment, net (10,749 ) (7,892 ) (16,625 ) (7,527 )
Net gain on sale of real estate related contracts 69,972 – 69,972 –
Secondary marketing activities:
Loan servicing income (loss), net (56 ) (294 ) 2,724 (1,519 )
Net gains on sales of loans and mortgage-backed securities 677 2,506 6,898 20,224
Net gains on sales of investment securities – – 837 –
Other 219 (197 ) 817 (16 )
Total other income, net 68,215 3,036 89,218 38,249
Operating expense
Salaries and related costs 37,611 36,699 118,197 119,931
Premises and equipment costs 9,224 9,736 27,402 27,667
Advertising expense 1,473 1,400 2,750 4,469
Deposit insurance premiums and regulatory assessments 8,117 2,413 15,509 7,659
Professional fees 3,000 489 4,146 1,779
Impairment writedown of goodwill – – 3,149 –
Other general and administrative expense 11,802 8,275 29,256 24,271
Total general and administrative expense 71,227 59,012 200,409 185,776
Net operation of real estate acquired in settlement of loans 31,428 3,664 79,763 4,903
Total operating expense 102,655 62,676 280,172 190,679
Income (loss) before income taxes (tax benefits)
(88,704 ) (43,232 ) (574,306 ) 90,429
Income taxes (tax benefits) (7,634 ) (19,871 ) (26,620 ) 38,183
Net income (loss)
$ (81,070 ) $ (23,361 ) $ (547,686 ) $ 52,246
See accompanying notes to consolidated financial statements.
Per share information
Basic $ (2.89 ) $ (0.84 ) $ (19.64 ) $ 1.87
Diluted $ (2.89 ) $ (0.84 ) $ (19.64 ) $ 1.87
Cash dividends declared and paid $ 0.01 $ 0.12 $ 0.25 $ 0.36
Weighted average shares outstanding
Basic 27,960,478 27,853,783 27,889,608 27,853,783
Diluted 27,960,478 27,853,783 27,889,608 27,882,804
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See accompanying notes to consolidated financial statements.
Net income (loss)
$ (81,070 ) $ (23,361 ) $ (547,686 ) $ 52,246
Other comprehensive income (loss), net of income taxes (tax benefits)
Three Months Ended Nine Months Ended
September 30, September 30,
(In Thousands) 2008 2007 2008 2007
Unrealized gains (losses) on securities available for sale:
U.S. Treasury, government sponsored entities and other investment
securities available for sale, at fair value (6,054 ) 6,644 (9,113 ) 5,926
Mortgage-backed securities available for sale, at fair value – 1 – 1
Unrealized gains (losses) on cash flow hedges:
Net derivative instruments (175 ) (216 ) (390 ) 609
Reclassification of realized amounts included in net income 302 27 504 (944 )
Total other comprehensive income (loss), net of income tax benefits (5,927 ) 6,456 (8,999 ) 5,592
Comprehensive income (loss)
$ (86,997 ) $ (16,905 ) $ (556,685 ) $ 57,838
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See accompanying notes to consolidated financial statements.
Cash flows from operating activities
Nine Months Ended
September 30,
(In Thousands) 2008 2007
Net income (loss) $ (547,686 ) $ 52,246
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation 10,744 10,811
Amortization 10,963 79,541
Impairment writedown of goodwill 3,149 –
Provision for losses on loans, loan-related commitments, investments in
real estate and joint ventures, mortgage servicing rights,
real estate acquired in settlement of loans, and other assets 699,465 94,833
Net gains on sales of loans and mortgage-backed securities, mortgage servicing rights,
investment securities, real estate and other assets (84,947 ) (21,952 )
Interest capitalized on loans (negative amortization) (74,013 ) (199,382 )
Changes in fair value of mortgage servicing rights due to:
Changes in valuation model inputs or assumptions (536 ) –
Other changes 2,095 –
Federal Home Loan Bank stock dividends (3,142 ) (5,185 )
Loans originated or purchased for sale (596,374 ) (1,380,371 )
Proceeds from sales of loans held for sale, including those sold
as mortgage-backed securities 687,875 1,635,997
Other, net (157,175 ) (196,610 )
Net cash provided by (used for) operating activities (49,582 ) 69,928
Cash flows from investing activities
Proceeds from:
Sales of wholly owned real estate and real estate acquired in settlement of loans 204,122 20,560
Real estate related contracts 69,972 –
Redemption of Federal Home Loan Bank stock 2,400 95,046
Maturities or calls of U.S. Treasury, government sponsored entities
and other investment securities available for sale 14,958,610 276,200
Purchase of:
U.S. Treasury, government sponsored entities and other investment securities
available for sale (14,011,366 ) (825,030 )
Premises and equipment (8,469 ) (17,134 )
Federal Home Loan Bank stock (61,549 ) (6,967 )
Originations of loans held for investment (net of refinances of $143,307 for the
nine months ended September 30, 2008 and $572,331 for the nine months ended
September 30, 2007) (1,744,354 ) (1,209,487 )
Principal payments on loans held for investment and mortgage-backed securities
available for sale 1,120,183 3,457,620
Net change in undisbursed loan funds (38,056 ) (36,655 )
Investments in real estate held for investment (9,368 ) 2,061
Other, net 2,171 4,293
Net cash provided by investing activities $ 484,296 $ 1,760,507
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See accompanying notes to consolidated financial statements.
Cash flows from financing activities
Nine Months Ended
September 30,
(In Thousands) 2008 2007
Net decrease in deposits $ (877,657 ) $ (1,122,251 )
Proceeds from Federal Home Loan Bank advances and other borrowings 12,995,860 12,583,559
Repayments of Federal Home Loan Bank advances and other borrowings (12,086,350 ) (13,326,330 )
Cash dividends (6,962 ) (10,027 )
Other, net 3,599 7,371
Net cash provided by (used for) financing activities 28,490 (1,867,678 )
Net increase (decrease) in cash and cash equivalents 463,204 (37,243 )
Cash and cash equivalents at beginning of period 89,740 124,866
Cash and cash equivalents at end of period
$ 552,944 $ 87,623
Supplemental disclosure of cash flow information:
Interest paid $ 307,498 $ 431,774
Income taxes paid 1,599 186,100
Income tax refund (4,872 ) –
Supplemental disclosure of non-cash investing:
Loans transferred to held for investment from held for sale 7,177 26,417
Loans transferred from held for investment to held for sale 1,723 2,856
U.S. Treasury, government sponsored entities and other investment securities
available for sale, purchased and not settled – 150,000
Real estate acquired in settlement of loans 403,297 74,886
Loans to facilitate the sale of real estate acquired in settlement of loans 22,601 1,413
Page 5 Navigation LinksIn the opinion of Downey Financial Corp. and subsidiaries (“Downey,” “we,” “us” and “our”), the accompanying consolidated financial
statements contain all adjustments (consisting of normal recurring accruals unless otherwise disclosed in this Form 10-Q) necessary for a fair
presentation of Downey’s financial condition as of September 30, 2008, December 31, 2007 and September 30, 2007, the results of operations and
comprehensive income (loss) for the three months and nine months ended September 30, 2008 and 2007, and changes in cash flows for the nine months
ended September 30, 2008 and 2007. Certain prior period amounts have been reclassified to conform to the current period presentation.
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for
interim financial statements and are in compliance with the instructions for Form 10-Q and therefore do not include all information and footnotes
necessary for a fair presentation of financial condition, results of operations, comprehensive income (loss) and cash flows. The information under the
heading Management’s Discussion and Analysis of Financial Condition and Results of Operations presumes that the interim consolidated financial
statements will be read in conjunction with Downey’s Annual Report on Form 10-K for the year ended December 31, 2007, which contains among other
things, a description of the business, the latest audited consolidated financial statements and notes thereto, together with Management’s Discussion
and Analysis of Financial Condition and Results of Operations as of December 31, 2007 and for the year then ended. Therefore, only material changes
in financial condition and results of operations are discussed in the remainder of Part I.
NOTE (2) – Loans
Loans are summarized as follows:
(a) Reflected the change in fair value of the interest rate lock derivative from the date of rate lock to the date of funding. Effective January 2008, we
included the fair value of MSRs in the fair value of the interest rate lock derivatives in accordance with Staff Accounting Bulletin 109, Written Loan
Commitments Recorded at Fair Value Through Earnings.
At September 30, 2008, approximately 90% of the real estate securing Downey’s loans was located in California. As a result, the value of the
underlying collateral for a significant portion of our loans may be unfavorably impacted by adverse changes in the California economy and real estate
market.
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Loans held for investment
Loans secured by real estate:
Residential:
One-to-four units $ 10,959,601 $ 10,894,889 $ 10,712,235 $ 10,877,228 $ 11,227,561
Home equity loans and lines of credit 132,907 131,531 133,338 138,305 143,948
Five or more units 204,172 121,403 100,374 100,963 104,672
Commercial real estate 29,838 22,633 24,749 26,427 26,598
Construction 97,907 105,991 74,730 81,098 58,231
Land 10,708 10,524 10,373 49,521 50,864
Non-mortgage:
Commercial 5,305 5,505 5,305 5,000 5,000
Consumer 5,993 5,823 5,934 5,989 6,057
Total loans held for investment 11,446,431 11,298,299 11,067,038 11,284,531 11,622,931
Increase (decrease) for:
Undisbursed loan funds and net
deferred costs and premiums 64,899 65,067 96,216 96,796 121,132
Allowance for losses (761,824 ) (732,354 ) (546,751 ) (348,167 ) (142,218 )
Total loans held for investment, net $ 10,749,506 $ 10,631,012 $ 10,616,503 $ 11,033,160 $ 11,601,845
Loans held for sale
Residential one-to-four units $ 7,624 $ 85,854 $ 110,685 $ 103,320 $ 89,794
Net deferred costs and premiums (16 ) (146 ) (362 ) (109 ) 53
Capitalized basis adjustment (a) 65 (150 ) (1,070 ) 173 381
Total loans held for sale, net $ 7,673 $ 85,558 $ 109,253 $ 103,384 $ 90,228
Page 6 Navigation LinksThe combined weighted average interest rate on loans held for investment and sale was 6.26% at September 30, 2008, 7.41% at December 31, 2007,
and 7.45% at September 30, 2007. These rates exclude adjustments for non-accrual loans; amortization of net deferred costs to originate loans, premiums
and discounts, troubled debt restructuring (“TDR”) yield adjustments; and prepayment and late fees.
Most of Downey’s adjustable rate mortgages adjust the interest rate monthly and the payment amount annually. These monthly adjustable rate
mortgages allow for negative amortization, which is the addition to loan principal of accrued interest that exceeds the required monthly loan payments.
At September 30, 2008, loans subject to negative amortization represented 52% of Downey’s residential one-to-four unit adjustable rate portfolio held
for investment, of which $318 million represented the amount of negative amortization included in the loan balance. This compares to 69% and $379
million, respectively, at December 31, 2007. During the third quarter of 2008, approximately 10% of our loan interest income represented negative
amortization, down from 15% in the second quarter of 2008 and 26% from the year-ago third quarter.
A summary of activity in the allowance for loan losses for loans held for investment during the quarters indicated follows:
(a) For TDRs of residential one-to-four unit loans that are not collateral dependent, a specific valuation allowance is calculated as the difference
between the recorded investment of the original loan and the present value of the expected cash flows of the modified loan (discounted at the
effective interest rate of the original loan). This difference is recorded as a provision for credit losses in current earnings and subsequently
amortized over the expected life of the loans as an adjustment to loan yield or as a reduction of the provision if the loan is prepaid.
Real
(In Thousands) Estate Commercial Consumer Total
Balance at June 30, 2007 $ 68,794 $ 11 $ 302 $ 69,107
Provision 81,356 1 78 81,435
TDR yield adjustment (a) – – – –
Charge-offs (8,323 ) – (45 ) (8,368 )
Recoveries 40 – 4 44
Balance at September 30, 2007 141,867 12 339 142,218
Provision 218,603 24 23 218,650
TDR yield adjustment (a) (483 ) – – (483 )
Charge-offs (12,185 ) – (35 ) (12,220 )
Recoveries – – 2 2
Balance at December 31, 2007 347,802 36 329 348,167
Provision 237,052 3 32 237,087
TDR yield adjustment (a) (1,461 ) – – (1,461 )
Charge-offs (37,015 ) – (28 ) (37,043 )
Recoveries – – 1 1
Balance at March 31, 2008 546,378 39 334 546,751
Provision 258,490 1 26 258,517
TDR yield adjustment (a) (2,670 ) – – (2,670 )
Charge-offs (70,219 ) – (26 ) (70,245 )
Recoveries – – 1 1
Balance at June 30, 2008 731,979 40 335 732,354
Provision (reduction) 130,400 (5 ) 35 130,430
TDR yield adjustment (a) (3,352 ) – – (3,352 )
Charge-offs (97,586 ) – (27 ) (97,613 )
Recoveries – – 5 5
Balance at September 30, 2008 $ 761,441 $ 35 $ 348 $ 761,824
Page 7 Navigation LinksA summary of activity in the allowance for loan losses for loans held for investment for the year-to-date periods indicated follows:
(a) For TDRs of residential one-to-four unit loans that are not collateral dependent, a specific valuation allowance is calculated as the difference
between the recorded investment of the original loan and the present value of the expected cash flows of the modified loan (discounted at the
effective interest rate of the original loan). This difference is recorded as a provision for credit losses in current earnings and subsequently
amortized over the expected life of the loans as an adjustment to loan yield or as a reduction of the provision if the loan is prepaid.
During the current quarter, our provision for loan losses totaled $130.4 million, up $49.0 million from a year ago. The increase in our provision for
loan losses reflects continued weakening and uncertainty relative to the housing market and disruption in the secondary markets which have
unfavorably impacted our borrowers and the value of their loan collateral. As a result, an increase in the allowance for loan losses was deemed
appropriate. Included within the current quarter provision for loan losses was $25.7 million related to the specific allowance associated with certain
troubled debt restructurings resulting from a borrower retention program. The allowance related to the troubled debt restructurings that are not
collateral dependent is calculated as the difference between the recorded investment of the original loan and the present value of the expected cash
flows of the modified loan (discounted at the effective interest rate of the original loan). This difference is recorded as a provision for loan losses in
current earnings and subsequently amortized over the expected life of the loans as an adjustment to loan yield, thereby decreasing the allowance
balance, or as a reduction of the provision if the loan is prepaid.
Net charge-offs to average loans was 3.62% in the current quarter, higher than the 0.43% in the fourth quarter of 2007 and 0.28% in the year-ago
third quarter. The current quarter net charge-offs primarily related to residential one-to-four unit loans.
For the first nine months of 2008, the provision for loan losses totaled $626.0 million and net charge-offs were $204.9 million. This compares with a
$91.3 million provision for loan losses and net charge-offs of $10.0 million a year ago. The increase in the year-to-date provision for loan losses reflected
the same underlying weaknesses as mentioned above.
A summary of activity in the allowance for loan-related commitment losses for loans held for investment, included in accounts payable and
accrued liabilities, during the quarters indicated follows:
Real
(In Thousands) Estate Commercial Consumer Total
Balance at December 31, 2006 $ 60,611 $ 14 $ 318 $ 60,943
Provision (reduction) 91,228 (2 ) 95 91,321
TDR yield adjustment (a) – – – –
Charge-offs (10,263 ) – (81 ) (10,344 )
Recoveries 291 – 7 298
Balance at September 30, 2007 $ 141,867 $ 12 $ 339 $ 142,218
Balance at December 31, 2007 $ 347,802 $ 36 $ 329 $ 348,167
Provision (reduction) 625,942 (1 ) 93 626,034
TDR yield adjustment (a) (7,483 ) – – (7,483 )
Charge-offs (204,820 ) – (81 ) (204,901 )
Recoveries – – 7 7
Balance at September 30, 2008 $ 761,441 $ 35 $ 348 $ 761,824
Real
(In Thousands) Estate Commercial Consumer Total
Balance at June 30, 2007 $ 1,244 $ 4 $ 43 $ 1,291
Provision for (reduction of) estimated losses 125 6 (4 ) 127
Balance at September 30, 2007 1,369 10 39 1,418
Reduction of estimated losses (195 ) (7 ) (1 ) (203 )
Balance at December 31, 2007 1,174 3 38 1,215
Reduction of estimated losses (217 ) – – (217 )
Balance at March 31, 2008 957 3 38 998
Provision for (reduction of) estimated losses 357 1 (1 ) 357
Balance at June 30, 2008 1,314 4 37 1,355
Provision for (reduction of) estimated losses (139 ) 1 (1 ) (139 )
Balance at September 30, 2008 $ 1,175 $ 5 $ 36 $ 1,216
Page 8 Navigation LinksA summary of activity in the allowance for loan-related commitment losses for loans held for investment, included in accounts payable and
accrued liabilities, for the year-to-date periods indicated follows:
There were 3,355 impaired loans at September 30, 2008, compared with 1,003 at year end.
The following table presents impaired loans with specific allowances and the amount of such allowances and impaired loans without specific
allowances.
At September 30, 2008, the recorded investment in loans for which we recognized impairment totaled $1.477 billion, up from $486 million at
December 31, 2007 and $12 million at September 30, 2007. Of the current quarter total, $1.464 billion related to residential one-to-four unit loan TDRs with
an allowance for loss of $131 million and $12 million related to two construction loans with an allowance for loss of $2 million. This is up from 2007 yearend
totals of $441 million related to residential one-to-four unit loan TDRs with an allowance for loss of $39 million, $29 million related to one land loan
with an allowance for loss of $4 million, $15 million related to two construction loans with an allowance for loss of $2 million, and $1 million related to
Real
(In Thousands) Estate Commercial Consumer Total
Balance at December 30, 2006 $ 1,011 $ 3 $ 41 $ 1,055
Provision for (reduction of) estimated losses 358 7 (2 ) 363
Balance at September 30, 2007 $ 1,369 $ 10 $ 39 $ 1,418
Balance at December 31, 2007 $ 1,174 $ 3 $ 38 $ 1,215
Provision for (reduction of) estimated losses 1 2 (2 ) 1
Balance at September 30, 2008 $ 1,175 $ 5 $ 36 $ 1,216
Investment Specific Carrying
(In Thousands) Value Allowance Value
September 30, 2007:
Loans with specific allowances $ 8,201 $ (721 ) $ 7,480
Loans without specific allowances 3,316 – 3,316
Total impaired loans $ 11,517 $ (721 ) $ 10,796
December 31, 2007:
Loans with specific allowances $ 485,017 $ (45,066 ) $ 439,951
Loans without specific allowances 676 – 676
Total impaired loans $ 485,693 $ (45,066 ) $ 440,627
March 31, 2008:
Loans with specific allowances $ 778,728 $ (66,801 ) $ 711,927
Loans without specific allowances 636 – 636
Total impaired loans $ 779,364 $ (66,801 ) $ 712,563
June 30, 2008:
Loans with specific allowances $ 1,177,801 $ (102,013 ) $ 1,075,788
Loans without specific allowances – – –
Total impaired loans $ 1,177,801 $ (102,013 ) $ 1,075,788
September 30, 2008:
Loans with specific allowances $ 1,476,573 $ (133,140 ) $ 1,343,433
Loans without specific allowances – – –
Total impaired loans $ 1,476,573 $ (133,140 ) $ 1,343,433
one residential one-to-four unit loan with no allowance for loss; and up from the year-ago quarter total of $12 million with an allowance of less than $1
million. During the current quarter, the total interest recognized on the impaired portfolio was $27.0 million, compared to $19.9 million in the second
quarter of 2008 and no interest recognized in the year-ago quarter.
The aggregate amount of non-accrual loans that are in the foreclosure process, restructured, contractually past due 90 days or more as to
principal or interest, or upon which interest collection is doubtful was $1.723 billion and $364 million at September 30, 2008 and 2007, respectively.
Downey had $578 million of commitments to lend additional funds to borrowers whose loans were on non-accrual status. At September 30, 2008,
Downey’s troubled debt restructurings were $1.452 billion, of which, $831 million were on non-accrual status, compared with troubled debt
restructurings of $432 million with $432 million on non-accrual status at year end and $102 million troubled debt restructurings at September 30, 2007 all
of which are on non-accrual status.
Page 9 Navigation LinksInterest due on non-accrual loans, but excluded from interest income, was approximately $47.6 million at September 30, 2008, compared with $21.0
million at December 31, 2007 and $10.4 million at September 30, 2007.
Downey has had, and expects in the future to have, transactions in the ordinary course of business with executive officers, directors and their
associates on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other
non-related parties. In the opinion of management, those transactions neither involve more than the normal risk of collectibility nor present any
unfavorable features. At September 30, 2008, the Bank had extended loans to one director and his associates totaling $17.3 million, compared with $18.8
million and $16.7 million at December 31, 2007 and September 30, 2007, respectively. All such loans are performing in accordance with their loan terms.
Presented below is a summary of activity with respect to such loans during the quarters indicated:
Presented below is a summary of activity with respect to such loans for the year-to-date periods indicated:
NOTE (3) – Real Estate Acquired in Settlement of Loans
Real estate acquired in settlement of loans was $278 million at September 30, 2008, compared to $116 million and $60 million at December 31, 2007
and September 30, 2007, respectively.
A summary of net operation of real estate acquired in settlement of loans included in Downey’s results of operations during the quarters indicated
follows:
A summary of net operation of real estate acquired in settlement of loans included in Downey’s results of operations for the year-to-date periods
indicated follows:
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Balance at beginning of period $ 18,250 $ 18,579 $ 18,769 $ 16,713 $ 16,852
Additions – – – 2,142 –
Repayments (1,000 ) (329 ) (190 ) (86 ) (139 )
Balance at end of period $ 17,250 $ 18,250 $ 18,579 $ 18,769 $ 16,713
Nine Months Ended September 30,
(In Thousands) 2008 2007
Balance at beginning of period $ 18,769 $ 20,674
Additions – –
Repayments (1,519 ) (3,961 )
Balance at end of period $ 17,250 $ 16,713
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Net (gains) losses on sales $ 2,508 $ 760 $ 205 $ 739 $ (392 )
Net operating expense 9,591 8,667 4,099 2,726 1,998
Provision for estimated losses 19,329 14,712 19,892 1,118 2,058
Net operations of real estate acquired in
settlement of loans $ 31,428 $ 24,139 $ 24,196 $ 4,583 $ 3,664
Nine Months Ended September 30,
(In Thousands) 2008 2007
Net (gains) losses on sales $ 3,473 $ (797 )
Net operating expense 22,357 3,079
Provision for estimated losses 53,933 2,621
Net operations of real estate acquired in settlement of loans $ 79,763 $ 4,903
Page 10 Navigation LinksDowney values real estate acquired through foreclosure at fair value less cost to sell, with any subsequent losses recorded as a direct write-off to
net operations. Given the decline in home values in the residential market, we had a valuation allowance at quarter end of $11 million for our one-to-four
unit residential properties acquired through foreclosure. This valuation allowance reflects recent loss experience from sales compared to their fair value
prior to sale. As that loss experience changes over time, our estimate of this valuation allowance will be reassessed.
The following table summarizes the activity in Downey’s allowance for real estate acquired in settlement of loans for the quarters indicated.
The following table summarizes the activity in Downey’s allowance for real estate acquired in settlement of loans for the year-to-date periods
indicated.
NOTE (4) – Mortgage Servicing Rights (“MSRs”)
Effective January 1, 2008, Downey adopted the fair value provision of Statement of Financial Accounting Standards No. 156, Accounting for
Servicing of Financial Assets – an amendment of Financial Accounting Standards Board (“FASB”) Statement No. 140 (“SFAS 156”) and remeasured its
mortgage servicing rights (“MSRs”) at fair value. Downey recorded a pretax adjustment to increase MSRs by $1.5 million and a corresponding
cumulative effect adjustment of $0.9 million, after tax, to increase the 2008 beginning balance of retained earnings in stockholders’ equity. The following
table shows the adjustment recorded to the opening balance of MSRs, income taxes, and retained earnings for the remeasurement of Downey’s MSRs
at fair value.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Balance at beginning of period $ 17,592 $ 12,334 $ – $ – $ –
Provision 19,329 14,712 19,892 1,118 2,058
Charge-offs (25,850 ) (9,454 ) (7,558 ) (1,118 ) (2,058 )
Recoveries – – – – –
Balance at end of period $ 11,071 $ 17,592 $ 12,334 $ – $ –
Nine Months Ended September 30,
(In Thousands) 2008 2007
Balance at beginning of period $ – $ –
Provision 53,933 2,621
Charge-offs (42,862 ) (2,621 )
Recoveries – –
Balance at end of period $ 11,071 $ –
(Dollars in Thousands) MSRs Deferred Tax Asset Retained Earnings
Balance at December 31, 2007 $ 19,512 $ 122,086 $ 1,254,367
Remeasurement of MSRs upon adoption of SFAS 156 1,543 (651 ) 892
Balance at January 1, 2008 $ 21,055 $ 121,435 $ 1,255,259
Page 11 Navigation LinksThe following table summarizes the activity in MSRs using the fair value method and, prior to 2008, using the amortized cost method for the
periods indicated.
(a) Effective January 1, 2008, Downey adopted the fair value provision of SFAS 156 and remeasured its MSRs at fair value. Downey recorded a
pretax adjustment to increase MSRs by $1.5 million and a corresponding cumulative effect adjustment of $0.9 million, after tax, to increase the 2008
beginning balance of retained earnings in stockholders’ equity.
(b) Included minor amounts repurchased.
(c) Reflects changes in assumptions for such items as discount rates and prepayment speeds.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 2008 2008 2008 2007 2007
Balance at beginning of period $ 23,558 $ 19,425 $ 21,973 $ 22,114 $ 21,707
Remeasurement of mortgage servicing rights
to fair value (a) – – (918 ) – –
Adjusted balance at beginning of period 23,558 19,425 21,055 22,114 21,707
Additions (b) 901 1,557 1,122 945 1,394
Amortization – – – (1,085 ) (950 )
Sales – – (262 ) – –
Impairment write-down – – – (1 ) (37 )
Changes in fair value due to:
Changes in valuation model inputs or
assumptions (c) (1,038 ) 3,325 (1,751 ) – –
Other changes (d) (607 ) (749 ) (739 ) – –
Balance at end of period 22,814 23,558 19,425 21,973 22,114
Allowance balance at beginning of period – – 2,461 265 88
Remeasurement of mortgage servicing rights
to fair value (a) – – (2,461 ) – –
Adjusted balance at beginning of period – – – 265 88
Provision for impairment – – – 2,197 214
Impairment write-down – – – (1 ) (37 )
Allowance balance at end of period – – – 2,461 265
Total mortgage servicing rights, net $ 22,814 $ 23,558 $ 19,425 $ 19,512 $ 21,849
As a percentage of associated mortgage loans 0.91% 0.95% 0.80% 0.80% 0.90%
Fair value (e) $ 22,814 $ 23,558 $ 19,425 $ 20,991 $ 23,935
Weighted average expected life (in months) 67 69 50 53 69
Custodial account earnings rate 3.23% 3.75% 3.72% 4.53% 4.57%
Weighted average discount rate 11.74 11.78 11.47 11.45 11.63
At period end
Mortgage loans serviced for others:
Total $ 5,347,377 $ 5,435,529 $ 5,431,475 $ 5,525,357 $ 5,622,331
With capitalized mortgage servicing rights:(e)
Amount 2,495,492 2,471,000 2,428,098 2,436,278 2,419,432
Weighted average interest rate 5.89% 5.87% 5.88% 5.88% 5.83%
Total loans sub-serviced without mortgage
servicing rights: (f)
Term – less than six months $ 96,428 $ 103,972 $ 69,810 $ 81,123 $ 76,870
Term – indefinite 2,751,711 2,857,191 2,933,567 2,995,119 3,112,895
Custodial account balances $ 75,452 $ 67,710 $ 71,479 $ 81,778 $ 84,819
(d) Represents changes due to realization of expected cash flows over time.
(e) Excludes loans sub-serviced without capitalized mortgage servicing rights. The estimated fair values for periods presented prior to 2008 may
exceed book value for certain asset strata and excluded loans sold or securitized prior to 1996.
(f) Servicing is performed for a fixed fee per loan each month.
Page 12 Navigation LinksThe following table summarizes the activity in MSRs and its related allowance for the year-to-date periods indicated.
(a) Effective January 1, 2008, Downey adopted the fair value provision of SFAS 156 and remeasured its MSRs at fair value. Downey recorded a
pretax adjustment to increase MSRs by $1.5 million and a corresponding cumulative effect adjustment of $0.9 million, after tax, to increase the 2008
beginning balance of retained earnings in stockholders’ equity.
(b) Included minor amounts repurchased.
(c) Reflects changes in assumptions for such items as discount rates and prepayment speeds.
(d) Represents changes due to realization of expected cash flows over time.
Upon adoption in 2008 of the fair value provision of SFAS 156, Downey capitalizes MSRs at fair value for residential one-to-four unit mortgage
loans we originate and sell with servicing rights retained or acquired through purchase. Downey discloses MSRs associated with the origination and
sale of loans in the financial statements as a component of the net gains on sales of loans and mortgage-backed securities. MSR fair value adjustments
are recorded as a component of loan servicing income (loss), net. Prior to 2008, Downey capitalized MSRs at fair value except for those acquired
through purchase, which were recorded at the lower of cost or fair value. MSRs were amortized over the estimated servicing period with impairment
losses recorded through a valuation allowance with both the associated provisions and amortization recorded as a component of loan servicing income
(loss), net category.
Downey’s loan servicing portfolio normally increases in value as interest rates rise and loan prepayments decrease and declines in value as
interest rates fall and loan prepayments increase. The change in fair value for MSRs reflects changes in assumptions and changes due to the realization
of expected cash flows over time. Key assumptions used to determine the fair value of MSRs, which vary due to changes in market interest rates,
include: expected prepayment speeds, which impact the average life of the portfolio; the earnings rate on custodial accounts, which impacts the value
of custodial accounts; expected delinquencies and losses, which impact the servicing income (loss); and the discount rate used in valuing future cash
flows. Once a quarter, Downey conducts model validation procedures by obtaining three independent broker results for the fair value of MSRs and
compares them to the results of its MSR model.
Prior to 2008, under the amortization method of recording MSRs, impairment was measured on a disaggregated basis based upon the predominant
risk characteristics of the underlying mortgage loans, which include loans by loan term and coupon rate (stratified in 50 basis point increments).
Impairment losses were recognized through a valuation allowance for each impaired stratum. Certain strata may have impairment, while other strata may
not. Therefore, changes in overall fair value may not equal provisions for or reductions of the valuation allowance.
Nine Months Ended September 30,
(Dollars in Thousands) 2008 2007
Balance at beginning of period $ 21,973 $ 21,435
Remeasurement of mortgage servicing rights to fair value (a) (918 ) –
Adjusted balance at beginning of period 21,055 21,435
Additions (b) 3,580 4,661
Amortization – (2,941 )
Sales (262 ) (868 )
Impairment write-down – (173 )
Changes in fair value due to:
Changes in valuation model inputs or assumptions (c) 536 –
Other changes (d) (2,095 ) –
Balance at end of period 22,814 22,114
Allowance balance at beginning of period 2,461 239
Remeasurement of mortgage servicing rights to fair value (a) (2,461 ) –
Adjusted balance at beginning of period – 239
Provision for impairment – 199
Impairment write-down – (173 )
Allowance balance at end of period – 265
Total mortgage servicing rights, net $ 22,814 $ 21,849
Page 13 Navigation LinksThe following table summarizes the estimated changes in the fair value of MSRs for changes in those assumptions individually and in
combination associated with an immediate 100 basis point increase or decrease in market rates. The sensitivity analysis in the table below is
hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 100 basis point variation in assumptions
generally cannot be easily extrapolated because the relationship of the change in the assumptions to the change in fair value may not be linear. Also, in
this table, the effect that a change in a particular assumption may have on the fair value is calculated without changing any other assumptions. In
reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.
(a) The weighted-average expected life of the MSRs portfolio becomes 88 months.
(b) The weighted-average expected life of the MSRs portfolio becomes 34 months.
The following table presents a breakdown of the components of loan servicing income (loss), net included in Downey’s results of operations for
the periods indicated.
(a) Represents the difference between the contractual obligation to pay interest to the investor for an entire month and the actual interest received
when a loan prepays prior to the end of the month. However, loan servicing income (loss), net does not reflect interest income derived from the use of
loan repayments which is included in net interest income.
(b) Effective January 1, 2008, Downey adopted the fair value provision of SFAS 156 and remeasured its MSRs at fair value. Downey recorded a
pretax adjustment to increase MSRs by $1.5 million and a corresponding cumulative effect adjustment of $0.9 million, after tax, to increase the 2008
beginning balance of retained earnings in stockholders’ equity.
(c) Reflects changes in assumptions for such items as discount rates and prepayment speeds.
(d) Represents changes due to realization of expected cash flows over time.
Expected Custodial
Prepayment Accounts Discount
(Dollars in Thousands) Speeds Rate Rate Combination
Increase rates 100 basis points: (a)
Increase (decrease) in fair value $ 3,797 $ 1,419 $ (541 ) $ 3,795
Decrease rates 100 basis points: (b)
Increase (decrease) in fair value (7,705 ) (1,521 ) 552 (8,789 )
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Net cash servicing fees $ 1,797 $ 1,750 $ 1,765 $ 2,166 $ 1,657
Payoff and curtailment interest cost (a) (208 ) (350 ) (471 ) (544 ) (787 )
Change in fair value of mortgage servicing
rights due to:(b)
Change in valuation model inputs or
assumptions (c) (1,038 ) 3,325 (1,751 ) – –
Other changes (d) (607 ) (749 ) (739 ) – –
Amortization of mortgage servicing rights – – – (1,085 ) (950 )
Provision for impairment of mortgage
servicing rights – – – (2,197 ) (214 )
Total loan servicing income (loss), net $ (56 ) $ 3,976 $ (1,196 ) $ (1,660 ) $ (294 )
Page 14 Navigation LinksThe following table presents a breakdown of the components of loan servicing income (loss), net included in Downey’s results of operations for
the year-to-date periods indicated.
(a) Represents the difference between the contractual obligation to pay interest to the investor for an entire month and the actual interest received
when a loan prepays prior to the end of the month. However, loan servicing income (loss), net does not reflect interest income derived from the use of
loan repayments which is included in net interest income.
(b) Effective January 1, 2008, Downey adopted the fair value provision of SFAS 156 and remeasured its MSRs at fair value. Downey recorded a
pretax adjustment to increase MSRs by $1.5 million and a corresponding cumulative effect adjustment of $0.9 million, after tax, to increase the 2008
beginning balance of retained earnings in stockholders’ equity.
(c) Reflects changes in assumptions for such items as discount rates and prepayment speeds.
(d) Represents changes due to realization of expected cash flows over time.
NOTE (5) – Derivatives, Hedging Activities, Financial Instruments with Off-Balance Sheet Risk and Other Contractual Obligations (Risk
Management)
Derivatives
Downey offers short-term interest rate lock commitments to help attract potential home loan borrowers. The commitments guarantee a specified
interest rate for a loan if underwriting standards are met, but do not obligate the potential borrower. Accordingly, some commitments never become
loans and merely expire. The residential one-to-four unit interest rate lock commitments Downey ultimately expects to result in loans and sell in the
secondary market are treated as derivatives. Consequently, as derivatives, the hedging of the interest rate lock commitments does not qualify for hedge
accounting. Effective January 1, 2008, Downey adopted the Securities and Exchange Commission Staff Accounting Bulletin No. 109, Written Loan
Commitments Recorded at Fair Value Through Earnings, that specifically states the expected net future cash flows related to the associated servicing of
a loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. Associated fair
value adjustments to the notional amount of interest rate lock commitments and, beginning in 2008, the associated MSRs are recorded in current
earnings under net gains on sales of loans and mortgage-backed securities with an offset to the balance sheet in either other assets, or accounts
payable and accrued liabilities. Fair values for the notional amount of interest rate lock commitments are based on dealer quoted market prices acquired
from third parties. Fair values for the associated MSRs are determined by computing the present value of the expected net servicing income from the
portfolio by strata, determined by key characteristics of the underlying loans, primarily coupon interest rate and whether the loans have a fixed or
variable rate. The carrying amount of loans held for sale includes a basis adjustment to the loan balance at funding resulting from the change in fair
value of the interest rate lock derivative and, beginning in 2008, the associated MSRs from the date of rate lock to the date of funding. At September 30,
2008, Downey had a notional amount of interest rate lock commitments identified to sell as part of its secondary marketing activities of $26 million, with
a change in fair value resulting in a recorded gain of $0.1 million.
Downey does not generally enter into derivative transactions for purely speculative purposes.
Nine Months Ended September 30,
(In Thousands) 2008 2007
Net cash servicing fees $ 5,312 $ 4,862
Payoff and curtailment interest cost (a) (1,029 ) (3,241 )
Change in fair value of mortgage servicing rights due to:(b)
Change in valuation model inputs or assumptions (c) 536 –
Other changes (d) (2,095 ) –
Amortization of mortgage servicing rights – (2,941 )
Provision for impairment of mortgage servicing rights – (199 )
Total loan servicing income (loss), net $ 2,724 $ (1,519 )
Page 15 Navigation LinksAs part of its secondary marketing activities, Downey typically utilizes short-term loan forward sale and purchase contracts-derivatives-that
mature in less than one year to offset the impact of changes in market interest rates on the value of residential one-to-four unit interest rate lock
commitments and loans held for sale. In general, interest rate lock commitments associated with fixed rate loans require a higher percentage of loan
forward sale contracts to mitigate interest rate risk than those associated with adjustable rate loans. Contracts designated as hedges for the forecasted
sale of loans from the held for sale portfolio are accounted for as cash flow hedges because these contracts have a high correlation to the price
movement of the loans being hedged (within a range of 80% – 125%). The measurement approach for determining the ineffective aspects of the hedge is
established at the inception of the hedge. Changes in fair value of the notional amount of loan forward sale contracts not designated as cash flow
hedges and the ineffectiveness of hedge transactions are recorded in net gains on sales of loans and mortgage-backed securities. Changes in expected
future cash flows related to the fair value of the notional amount of loan forward sale contracts designated as cash flow hedges for the forecasted sale
of loans held for sale are recorded in other comprehensive income (loss), net of tax, provided cash flow hedge requirements are met. The offset to these
changes are recorded in the balance sheet as either other assets, or accounts payable and accrued liabilities. The amounts recorded in accumulated
other comprehensive income (loss) will be recognized in the income statement when the hedged forecasted transactions impact earnings. Downey
estimates that all of the related unrealized gains or losses in accumulated other comprehensive income will be reclassified into earnings within the next
three months. Fair values for the notional amount of loan forward sale contracts are based on dealer quoted market prices acquired from third parties. At
September 30, 2008, the notional amount of loan forward sale contracts amounted to $54 million, with a change in fair value resulting in a loss of $0.2
million, of which $7 million were designated as cash flow hedges. The notional amount of loan forward purchase contracts at September 30, 2008
amounted to $21 million, with a change in fair value resulting in a loss of $0.1 million.
Downey has not discontinued any designated derivative instruments associated with loans held for sale due to a change in the probability of
settling a forecasted transaction.
In connection with its interest rate risk management, Downey from time to time enters into interest rate exchange agreements (“swap contracts”)
with certain national investment banking firms or the Federal Home Loan Bank of San Francisco (“FHLB”) under terms that provide mutual payment of
interest on the outstanding notional amount of swap contracts. These swap contracts help Downey manage the effects of adverse changes in interest
rates on net interest income. Downey has interest rate swap contracts on which it pays variable interest based on the 3-month London Inter-Bank
Offered Rate (“LIBOR”) while receiving fixed interest. The swaps were designated as a hedge against changes in the fair value of certain FHLB fixed
rate advances due to changes in market interest rates. The payment and maturity dates of the swap contracts match those of the advances. This hedge
effectively converts fixed interest rate advances into debt that adjusts quarterly to movements in 3-month LIBOR. Because the terms of the swap
contracts match those of the advances, the hedge has no ineffectiveness and results are reported in interest expense. The fair value of interest rate
swap contracts is based on dealer quoted market prices acquired from third parties and represents the estimated amount Downey would receive or pay
upon terminating the contracts, taking into consideration current interest rates and the remaining contract terms. The fair value of the swap contracts is
recorded on the balance sheet in either other assets or accounts payable and accrued liabilities. With no ineffectiveness, the recorded swap contract
values will essentially act as fair value adjustments to the advances being hedged. At September 30, 2008, swap contracts with a notional amount
totaling $430 million were outstanding and had a fair value gain of $0.1 million recorded on the balance sheet in other assets and as an increase to the
advances being hedged.
The following table summarizes Downey’s interest rate swap contracts at September 30, 2008.
Weighted
Notional Average
(Dollars in Thousands) Amount Interest Rate Term
Pay – Variable (3-month LIBOR) $ (100,000 ) 2.50% March 2004 – October 2008
Receive – Fixed 100,000 3.20
Pay – Variable (3-month LIBOR) (130,000 ) 2.58 March 2004 – October 2008
Receive – Fixed 130,000 3.21
Pay – Variable (3-month LIBOR) (100,000 ) 2.73 March 2004 – November 2008
Receive – Fixed 100,000 3.26
Pay – Variable (3-month LIBOR) (100,000 ) 2.78 March 2004 – November 2008
Receive – Fixed 100,000 3.27
Page 16 Navigation LinksThe following table shows the impact from non-qualifying hedges and the ineffectiveness of cash flow hedges on net gains (losses) on sales of
loans and mortgage-backed securities (i.e., SFAS 133 effect), as well as the impact to other comprehensive income (loss) from qualifying cash flow
transactions for the periods indicated. Also shown are the notional amounts or balances for Downey’s non-qualifying and qualifying hedge
transactions.
(a) Amount represents the notional amount of the commitments or contracts reduced by an anticipated fallout factor for those commitments not
expected to fund. The notional amount for interest rate lock commitments before the reduction of expected fallout was $38 million.
The following table shows the impact from non-qualifying hedges and the ineffectiveness of cash flow hedges on net gains (losses) on sales of
loans and mortgage-backed securities (i.e., SFAS 133 effect), as well as the impact to other comprehensive income (loss) from qualifying cash flow
transactions for the year-to-date periods indicated.
These loan forward sale and swap contracts expose Downey to credit risk in the event of nonperformance by the other parties-primarily
government-sponsored enterprises such as Federal National Mortgage Association, securities firms and the FHLB. This risk consists primarily of the
termination value of agreements where Downey is in an unfavorable position. Downey manages the credit risk associated with its other parties to the
various derivative agreements through credit review, exposure limits and monitoring procedures. Downey does not anticipate nonperformance by the
other parties.
Financial Instruments with Off-Balance Sheet Risk
Downey utilizes financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Net gains (losses) on non-qualifying hedge transactions $ (1,601 ) $ 2,099 $ (69 ) $ (460 ) $ (553 )
Net gains on qualifying cash flow hedge transactions:
Unrealized hedge ineffectiveness – – – – –
Less reclassification of realized hedge ineffectiveness – – – – –
Total net gains (losses) recognized in sales of loans and
mortgage-backed securities (SFAS 133 effect) (1,601 ) 2,099 (69 ) (460 ) (553 )
Other comprehensive income (loss) 127 593 (606 ) (101 ) (189 )
Notional amount or balance at period end
Non-qualifying hedge transactions:
Interest rate lock commitments (a) $ 25,963 $ 54,095 $ 78,131 $ 53,250 $ 92,742
Associated loan forward sale contracts 47,392 57,837 94,676 57,924 94,567
Associated loan forward purchase contracts 21,000 4,000 13,000 – 10,000
Qualifying cash flow hedge transactions:
Loans held for sale, at lower of cost or fair value 7,673 85,558 109,253 103,384 90,228
Associated loan forward sale contracts 6,608 72,163 96,868 93,576 77,433
Qualifying fair value hedge transactions:
Designated FHLB advances – pay-fixed 430,000 430,000 430,000 430,000 430,000
Associated interest rate swap contracts –
pay-variable, receive-fixed 430,000 430,000 430,000 430,000 430,000
Nine Months Ended September 30,
(In Thousands) 2008 2007
Net gains on non-qualifying hedge transactions $ 429 $ 564
Net gains on qualifying cash flow hedge transactions:
Unrealized hedge ineffectiveness – –
Less reclassification of realized hedge ineffectiveness – –
Total net gains recognized in sales of loans and
mortgage-backed securities (SFAS 133 effect) 429 564
Other comprehensive income (loss) 114 (335 )
and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to originate fixed and variable rate
mortgage loans held for investment, undisbursed loan funds, lines and letters of credit, commitments to purchase loans and mortgage-backed securities
for portfolio and commitments to invest in community development funds. The contract or notional amounts of those instruments reflect the extent of
involvement Downey has in particular classes of financial instruments.
Page 17 Navigation LinksCommitments to originate fixed and variable rate mortgage loans held for investment are agreements to lend to a customer as long as there is no
violation of any condition established in the commitment. Commitments generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. Undisbursed loan funds on construction projects and unused lines of credit on home equity and commercial loans include
committed funds not disbursed. Letters of credit are conditional commitments issued by Downey to guarantee the performance of a customer to a third
party. Downey also enters into commitments to purchase loans and mortgage-backed securities, investment securities and to invest in community
development funds.
The following is a summary of commitments with off-balance sheet risk at the dates indicated.
Downey uses the same credit policies in making commitments to originate loans held for investment and lines and letters of credit as it does for
on-balance sheet instruments. For commitments to originate loans held for investment, the commitment amounts represent exposure to loss from market
fluctuations as well as credit loss. In regard to these commitments, adverse changes from market fluctuations are generally not hedged. Downey
manages the credit risk of its commitments to originate loans held for investment through credit approvals, limits and monitoring procedures. The credit
risk involved in issuing lines and letters of credit requires the same creditworthiness evaluation as that involved in extending loan facilities to
customers. Downey evaluates each customer’s creditworthiness.
Downey receives collateral to support commitments when deemed necessary. The most significant categories of collateral include real estate
properties underlying mortgage loans, liens on personal property and cash on deposit with Downey.
Downey maintains an allowance for losses to provide for inherent losses for loan-related commitments associated with undisbursed loan funds
and unused lines of credit. The allowance for losses on loan-related commitments was $1 million at September 30, 2008, December 31, 2007 and
September 30, 2007.
Other Contractual Obligations
Downey sells all loans without recourse. When a loan sold to an investor without recourse fails to perform according to the contractual terms of
the note, the investor will typically review the loan file to determine whether defects in the origination process occurred and whether such defects give
rise to a violation of a representation or warranty made to the investor in connection with the sale. If such a defect is identified, Downey may be
required to either repurchase the loan or indemnify the investor for losses sustained. If there are no such defects, Downey has no commitment to
repurchase the loan. During the first nine months of 2008, Downey recorded repurchase or indemnification losses related to defects in the origination
process of $0.7 million and repurchased $6 million of loans and $2 million of real estate acquired in settlement of loans.
The loan and servicing sale contracts may also contain provisions to refund sales price premiums to the purchaser if the related loans prepay
during a period of typically 90 days, but never more than 120 days, from the sale’s settlement date. Downey reserved less than $1 million at September
30, 2008, December 31, 2007 and September 30, 2007 to cover the estimated loss exposure related to early payoffs. However, if all the loans related to
those sales prepaid within the refund period, as of September 30, 2008, Downey’s maximum sales price premium refund would be $1.9 million.
Through the normal course of operations, Downey has entered into certain contractual obligations. Downey’s obligations generally relate to the
funding of operations through deposits and borrowings, loan servicing, as well as leases for premises and equipment. Downey has obligations under
long-term operating leases, principally for building space and land. Lease terms generally cover a five-year period, with options to extend, and are noncancelable.
Downey also has vendor contractual relationships, but the contracts are not considered to be material.
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Commitments to originate adjustable rate loans
held for investment $ 138,092 $ 362,317 $ 524,978 $ 196,471 $ 211,277
Undisbursed loan funds and unused lines of credit 267,719 277,757 265,493 306,532 310,677
Page 18 Navigation LinksAt September 30, 2008, scheduled maturities of certificates of deposit, FHLB advances and other borrowings, senior notes and future operating
minimum lease commitments were as follows:
Litigation
Judicial Proceedings
On October 29, 2004, two former traditional branch employees brought an action in Los Angeles County Superior Court, Case No. BC323796,
entitled Margie Holman and Alice A. Mesec, et al. v. Downey Savings and Loan Association. The first amended complaint seeks unspecified damages
for alleged unpaid regular and overtime wages, inadequate meal breaks, failure to pay split-shift and reporting time wages, and related claims. The
plaintiffs are seeking class action status to represent all other current and former Downey Savings and Loan Association, F.A. (“Bank”) employees who
held the position of Customer Service Supervisor and/or Customer Service Representative at the Bank’s in-store branches at any time from October 29,
2000 to date. The Bank has opposed the claim and asserted all appropriate defenses, and has provided for what is believed to be a reasonable estimate
of exposure for this matter in the event of loss. While acknowledging the uncertainties of litigation, management believes that the ultimate outcome of
this matter will not have a material adverse effect on Downey’s operations, cash flows or financial position.
Two purported shareholder class actions, one brought on behalf of Waterford Township General Employees Retirement System, Case No. CV-08-
03261, and the other brought on behalf of Stephen J. Mihalacki, Case No. SACV08-00609, were filed on May 16, 2008 and June 2, 2008, respectively, in
the United States District Court for the Central District of California against Downey Financial Corp. (“Holding Company”) and certain of its current and
former officers and certain former directors. The complaints, filed on behalf of all persons who purchased Holding Company common stock during
October 16, 2006 to March 14, 2008, seek unspecified damages for alleged violation of federal securities laws, claiming that the defendants made
misleading statements and omissions regarding Downey’s business and financial results, thereby artificially inflating the common stock price.
Specifically, the plaintiffs contend that the defendants concealed that (a) the Bank’s portfolio of option ARMs contained millions of dollars worth of
impaired and risky securities; (b) the Bank had been aggressive in acquiring loans from mortgage brokers that were highly risky; (c) the Bank had failed
to properly account for highly leveraged loans; (d) the Bank had inadequate underwriting practices, which led to large numbers of loan defaults; and (e)
the Bank had not adequately reserved for option ARM loans. A motion to consolidate the two actions was granted on August 14, 2008 with Waterford
Township General Partnership Employees Retirement System as lead plaintiff. The plaintiffs filed a consolidated complaint on September 30, 2008 and,
pursuant to a stipulation between the parties, have until November 12, 2008 to file a first amended consolidated complaint.
Related to the shareholder class actions, two purported shareholder derivative lawsuits, one entitled Michael L. McDougall v. Daniel D., Case No. 30-2008-00180029, and the other entitled Joyce Mendlin v. Maurice L. McAlister, et al., Case No. 30-2008-00087854, were
Rosenthal, et al.
filed on June 10, 2008 and July 28, 2008, respectively, in Orange County Superior Court, in California. The plaintiffs, who purport to bring the lawsuits
on behalf of the Holding Company against certain of its current and former officers, its current directors and certain former directors, allege that
commencing in October 2006, the defendants caused or allowed Downey to issue a series of press releases and other statements that significantly
overstated Downey’s business prospects and financial results; that the statements failed to disclose that Downey was more exposed to the subprime
market crisis than it had disclosed; that Downey’s portfolio of subprime and option ARM mortgage-related assets was overvalued; and that as a result,
Downey’s reported earnings and business prospects were inaccurate. The plaintiffs allege that the defendants’ action constitutes breaches of fiduciary
duty, waste of corporate assets and unjust enrichment, and seek, among other relief, unspecified damages to be paid to the Holding Company,
corporate governance reforms, and equitable and injunctive relief, including restitution and the creation of a constructive trust.
Downey has been named as a defendant in other legal actions arising in the ordinary course of business, none of which, in the opinion of
management, will have a material adverse effect on its operations, cash flows or financial position.
After 1 After 3
Within Through 3 Through 5 Beyond Total
(In Thousands) 1 Year Years Years 5 Years Balance
Certificates of deposit $ 6,865,770 $ 614,856 $ 110,554 $ – $ 7,591,180
FHLB advances 935,061 500,000 675,000 – 2,110,061
Senior notes – – – 198,593 198,593
Operating leases 5,473 7,542 2,386 344 15,745
Total other contractual obligations $ 7,806,304 $ 1,122,398 $ 787,940 $ 198,937 $ 9,915,579
Page 19 Navigation LinksOn September 5, 2008, the Holding Company and the Bank each entered into a Consent Order with the OTS, effective as of the same date. For
more information, see Note 11 of Notes to the Consolidated Financial Statements on page 24.
NOTE (6) – Income Taxes
FASB Interpretation 48: Accounting for Uncertainty in Income Taxes requires the affirmative evaluation that it is more likely than not, based on
the technical merits of a tax position, that an enterprise is entitled to economic benefits resulting from positions taken in income tax returns. If a tax
position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements.
Management has determined that there are no unrecognized tax benefits to be reported in Downey’s financial statements, and none are anticipated
during the next 12 months.
Downey’s federal tax returns have been examined by the Internal Revenue Service (“IRS”) through 2005. Tax years subsequent to 2005 remain
subject to federal examination, while state tax returns for years subsequent to 2003 are subject to examination by taxing authorities. When applicable,
Downey classifies interest (net of tax) and penalties on the underpayment of taxes as income tax expense.
SFAS 109, Accounting for Income Taxes, requires that when determining the need for a valuation allowance against a deferred tax asset,
management must assess both positive and negative evidence with regard to the realizability of the tax losses represented by that asset. To the extent
available sources of taxable income are insufficient to absorb tax losses, a valuation allowance is necessary. Sources of taxable income for this analysis
include prior years’ tax returns, the expected reversals of taxable temporary differences between book and tax income, prudent and feasible tax-planning
strategies, and future taxable income.
Downey has recorded a valuation allowance of $216 million against its deferred tax asset of $235 million as of September 30, 2008, after considering
all available evidence related to the amount of the tax asset that is more likely than not to be realized.
Downey’s deferred tax asset resulted from a significant increase in its loan loss allowance. To the extent the loan loss allowance is not allocable to
specific loans, it represents future tax benefits which would be realized when actual charge-offs are made against the allowance. Given Downey’s recent
operating losses, the valuation allowance recorded at September 30, 2008 reduces the deferred tax asset to the amount management deems more likely
than not to be realized only through the carry back of tax losses to prior years’ federal tax returns.
Since generally accepted accounting principles require Downey to spread its expected annual tax benefit across the entire year through an
effective tax rate, we expect to continue realizing a tax benefit for the remainder of 2008, but at a lower-than-normal effective tax rate, due to the effect of
the valuation allowance discussed above.
NOTE (7) – Employee Stock Option Plans and Restricted Grant
During 1994, the Bank adopted and Downey’s stockholders approved the Downey Savings and Loan Association 1994 Long Term Incentive Plan
(“LTIP”). The LTIP provided for the granting of stock appreciation rights, restricted stock, performance awards and other awards. The LTIP specified
an authorization of 434,110 shares (adjusted for stock dividends and splits) of the Bank’s common stock available for issuance under the LTIP. Effective
January 23, 1995, the Holding Company and the Bank executed an amendment to the LTIP by which the Holding Company adopted and ratified the
LTIP such that shares of the Holding Company shall be issued upon exercise of options or payment of other awards, for which payment is to be made
in stock, in lieu of the Bank’s common stock. The LTIP terminated in 2004; however, options granted and outstanding at termination remain exercisable
until the specific termination date of the option. At September 30, 2008, options for 23,430 shares were outstanding, all of which were exercisable at a
weighted average option price per share of $25.44, which represented at least the fair market value of such shares on the date the options were granted
and expire at December 31, 2008. No other stock based plan exists.
On September 16, 2008, in connection with the Chief Executive Officer’s commencement of employment at Downey, 1,226,994 shares of restricted
stock in Downey were granted him by the Board of Directors. At the grant date, the stock had a fair value of $3.71 per share, which resulted in
compensation expense for the current quarter of $52,000. During September 2008, all of Downey’s treasury stock of 381,239 was reissued at below cost
to satisfy part of the stock grant. As of the date of the grant, the restricted stock was unvested. The CEO shall vest in the restricted stock at a rate of
25% each year and be fully vested in the restricted stock upon the fourth anniversary of the grant date.
Page 20 Navigation LinksEarnings (loss) per share of common stock is calculated on both a basic and diluted basis based on the weighted average number of common and
common equivalent shares outstanding, excluding common shares in treasury. Basic earnings per share excludes dilution and is computed by dividing
income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share
reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or
resulted from the issuance of common stock that then shared in earnings.
The following table presents a reconciliation of the components used to derive basic and diluted earnings per share for the periods indicated.
(a) For the three months ended September 30, 2008, there was no dilutive effect from our 23,430 outstanding stock options.
The following table presents a reconciliation of the components used to derive basic and diluted earnings per share for the year-to-date periods
indicated.
(a) For the nine months ended September 30, 2008, there was no dilutive effect from our 23,430 outstanding stock options.
NOTE (9) – Fair Value of Financial Instruments
Fair value measurements for Downey’s financial instruments are determined at a specific point in time based on the assumptions that market
participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, we have
established a fair value hierarchy as required by the FASB Statement of Financial Accounting Standards No. 157, Fair Value Measurements, (“SFAS
157”). The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from sources
independent of Downey (observable inputs) and (2) Downey’s own assumptions about market participant assumptions developed based on the best
information available in the circumstances (unobservable inputs). The notion of unobservable inputs allows for situations in which there is little, if any,
market activity for the asset or liability at the measurement date. Because no active market exists for a portion of Downey’s financial instruments, fair
value estimates are subjective in nature. Additionally, the fair value estimates do not necessarily reflect the price Downey might receive if it were to sell
at one time its entire holding of a particular financial instrument.
Fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The highest priority (Level 1
inputs) is for quoted prices (unadjusted) in active markets for identical assets or liabilities, the next priority (Level 2 inputs) is for other than quoted
prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, and the lowest priority (Level 3 inputs) is for
unobservable inputs. In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The level in the fair
value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair
Three Months Ended September 30,
2008 2007
Weighted Weighted
Average Average
Net Shares Per Share Net Shares Per Share
(Dollars in Thousands, Except Per Share Data) Loss Outstanding Amount Loss Outstanding Amount
Basic loss per share $ (81,070 ) 27,960,478 $ (2.89 ) $ (23,361 ) 27,853,783 $ (0.84 )
Effect of dilutive stock options (a) – – – –
–
–
Diluted loss per share $ (81,070 ) 27,960,478 $ (2.89 ) $ (23,361 ) 27,853,783 $ (0.84 )
Nine Months Ended September 30,
2008 2007
Weighted Weighted
Average Average
Net Shares Per Share Net Shares Per Share
(Dollars in Thousands, Except Per Share Data) Loss Outstanding Amount Income Outstanding Amount
Basic earnings (loss) per share $ (547,686 ) 27,889,608 $ (19.64 ) $ 52,246 27,853,783 $ 1.87
Effect of dilutive stock options (a) – – – – 29,021 –
Diluted earnings (loss) per share $ (547,686 ) 27,889,608 $ (19.64 ) $ 52,246 27,882,804 $ 1.87
value measurement in its entirety. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment
considering factors specific to the asset or liability and could significantly affect the fair value estimate.
Page 21 Navigation LinksDowney’s valuation techniques used to measure fair value are as follows:
l Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.
l Level 2 – Valuation is based upon quoted prices for similar instruments or assets in active markets, quoted prices for identical or similar
instruments or assets in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable
in the market.
l Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These
unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability.
Valuation techniques include use of pricing models, discounted cash flow models and similar techniques.
The following table presents for each of these hierarchy levels, Downey’s assets and liabilities that are measured at fair value on a recurring basis
at the date indicated.
The following table summarizes the activity in the Level 3 fair value category for the year-to-date period indicated.
(a) Effective January 1, 2008, Downey adopted the fair value provision of SFAS 156 and remeasured its MSRs at fair value. Downey recorded a
pretax adjustment to increase MSRs by $1.5 million and a corresponding cumulative effect adjustment of $0.9 million, after tax, to increase the 2008
beginning balance of retained earnings in stockholders’ equity. Amount in Net Unrealized Gains/(Losses) column excludes changes in fair value
due to changes from the realization of expected cash flows over time.
Also, we may be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring basis in accordance with U. S.
generally accepted accounting principles. The adjustments to fair value usually result from application of lower-of-cost-or-market accounting or writedowns
of individual assets.
The following table provides a level of valuation assumptions used to determine each adjustment and the carrying value of assets measured at fair
value on a nonrecurring basis at the date and for the period indicated.
September 30,
(In Thousands) Level 1 Level 2 Level 3 2008
U.S. Treasury, government sponsored entities and other
investment securities, available for sale $ 592,481 $ – $ 61 $ 592,542
Mortgage-backed securities available for sale – – 104 104
Mortgage servicing rights – – 22,814 22,814
Net derivative assets (liabilities) – (261 ) 135 (126 )
Total $ 592,481 $ (261 ) $ 23,114 $ 615,334
Net Unrealized
Gains/(Losses) Net
At Gains/(Losses) In Other Purchases Transfers At Net
December 31, In Net Comprehensive Sales and In/out of September 30, Unrealized
(In Thousands) 2007 Income (a) Income Settlements Level 3 2008 Gains/(Losses)
U.S. Treasury, government sponsored
entities and other investment
securities, available for sale $ 61 $ – $ – $ – $ – $ 61 $ –
Mortgage-backed securities
available for sale 111 – – (7 ) – 104 –
Mortgage servicing rights 19,512 5,659 – (2,357 ) – 22,814 536
Net derivative assets (liabilities) 198 (63 ) – – – 135 135
Total $ 19,882 $ 5,596 $ – $ (2,364 ) $ – $ 23,114 $ 671
Gains/(Losses)
for the Nine
Months Ended
At September 30,
(In Thousands) Level 1 Level 2 Level 3 September 30, 2008
(a) Amount at September 30, 2008 is net of an $11 million valuation allowance related to Downey’s single family residential properties which
reflects recent loss experience from sales compared to their fair value prior to sale.
Loans held for investment $ – $ – $ 48,728 $ 48,728 $ (11,871 )
Real estate acquired in settlement of loans (a) – – 278,091 278,091 (57,406 )
Investment in real estate and joint ventures – – 13,661 13,661 (19,899 )
Total $ – $ – $ 340,480 $ 340,480 $ (89,176 )
Page 22 Navigation LinksThe following table presents the operating results and selected financial data by business segments for the periods indicated.
Real Estate
(In Thousands) Banking Investment Elimination Totals
Three months ended September 30, 2008
Net interest income $ 75,998 $ 29 $ – $ 76,027
Provision for credit losses 130,291 – – 130,291
Other income (loss) 78,820 (10,605 ) – 68,215
Operating expense 102,325 330 – 102,655
Net intercompany income (expense) 3 (3 ) – –
Loss before income tax benefits (77,795 ) (10,909 ) – (88,704 )
Income taxes (tax benefits) (8,769 ) 1,135 – (7,634 )
Net loss $ (69,026 ) $ (12,044 ) $ – $ (81,070 )
At September 30, 2008
Assets:
Loans and mortgage-backed securities, net $ 10,757,283 $ – $ – $ 10,757,283
Investments in real estate and joint ventures – 15,606 – 15,606
Other 2,004,305 11,356 (7,351 ) 2,008,310
Total assets 12,761,588 26,962 (7,351 ) 12,781,199
Equity $ 771,714 $ 7,351 $ (7,351 ) $ 771,714
Three months ended September 30, 2007
Net interest income $ 97,656 $ 314 $ – $ 97,970
Provision of credit losses 81,562 – – 81,562
Other income (loss) 10,756 (7,720 ) – 3,036
Operating expense 62,365 311 – 62,676
Net intercompany income (expense) 22 (22 ) – –
Loss before income tax benefits (35,493 ) (7,739 ) – (43,232 )
Income tax benefits (16,642 ) (3,229 ) – (19,871 )
Net loss $ (18,851 ) $ (4,510 ) $ – $ (23,361 )
At September 30, 2007
Assets:
Loans and mortgage-backed securities, net $ 11,692,185 $ – $ – $ 11,692,185
Investments in real estate and joint ventures – 58,715 – 58,715
Other 2,710,006 30,420 (73,609 ) 2,666,817
Total assets 14,402,191 89,135 (73,609 ) 14,417,717
Equity $ 1,444,226 $ 73,609 $ (73,609 ) $ 1,444,226
Real Estate
(In Thousands) Banking Investment Elimination Totals
Nine months ended September 30, 2008
Net interest income $ 242,465 $ 218 $ – $ 242,683
Provision for credit losses 626,035 – – 626,035
Other income (loss) 105,483 (16,265 ) – 89,218
Operating expense 279,204 968 – 280,172
Net intercompany income (expense) 71 (71 ) – –
Loss before income tax benefits (557,220 ) (17,086 ) – (574,306 )
Income tax benefits (25,229 ) (1,391 ) – (26,620 )
Net loss $ (531,991 ) $ (15,695 ) $ – $ (547,686 )
Nine months ended September 30, 2007
Net interest income $ 333,505 $ 1,038 $ – $ 334,543
Provision for credit losses 91,684 – – 91,684
Other income (loss) 45,056 (6,807 ) – 38,249
Operating expense 189,700 979 – 190,679
Net intercompany income (expense) 53 (53 ) – –
Income (loss) before income taxes (tax benefits) 97,230 (6,801 ) – 90,429
Income taxes (tax benefits) 41,044 (2,861 ) – 38,183
Net income (loss) $ 56,186 $ (3,940 ) $ – $ 52,246
Page 23 Navigation LinksOn September 5, 2008, the Holding Company and the Bank each entered into a Consent Order with the OTS, effective as of the same date. The
Bank Order requires the Bank to, among other things:
l meet and maintain a minimum Tier I Core Capital ratio of 7% and a minimum Total Risk-Based Capital ratio of 14% at each quarter-end;
l submit to the OTS an updated capital augmentation and strategy plan addressing how the Bank will meet and maintain the foregoing capital
ratios and that provides for the raising of new equity and a capital infusion by no later than December 31, 2008, together with an alternative
strategy to meet and maintain the Bank’s capital and ensure its safe and sound operation if the plan to raise additional capital is not successful;
l submit for OTS approval within prescribed time periods (i) a comprehensive classified asset reduction plan, (ii) a real estate owned disposition
plan, (iii) an updated business plan containing strategies for a reduction in concentration of payment option adjustable rate mortgage and stated
income loans and (iv) a plan to strengthen executive management;
l notify, or in certain cases receive the approval or non-objection of, the OTS prior to (i) increasing its total assets in any quarter in excess of an
amount equal to net interest credited on deposits during the quarter; (ii) making certain changes to its directors or senior executive officers; (iii)
entering into, renewing, extending or revising any contractual arrangement related to compensation or benefits with any director or senior
executive officer of the Bank; (iv) making any golden parachute or prohibited indemnification payments; (v) paying dividends or making other
capital distributions; and (vi) entering into certain transactions with affiliates;
l refrain from any unsafe and unsound practices regarding lending and from resuming payment option adjustable rate mortgage or stated income
lending programs; and
l comply with the OTS’ most recent report of examination with respect to the Bank.
In light of the capital directive set forth in the Bank Consent Order, the Bank is deemed to be “adequately capitalized” rather than “well
capitalized” despite exceeding all “well capitalized” regulatory ratios.
Notwithstanding that portion of the Bank Consent Order requiring the raising of new equity and a capital infusion by no later than December 31,
2008, bank regulators could take enforcement action before that date, which could include placing the Bank into receivership.
The Consent Order that the Holding Company entered into requires it to notify, or in certain cases receive the approval or non-objection of, the
OTS prior to (i) accepting or requesting that the Bank pay or make, or commit to pay or make, any dividends or other capital distributions; (ii) making
certain changes to its directors or senior executive officers; (iii) entering into, renewing, extending or revising any contractual arrangement related to
compensation or benefits with any director or senior executive officer of the Holding Company; (iv) making any golden parachute payments or
prohibited indemnification payments; and (v) incurring, issuing, renewing or rolling over any debt, increasing any current lines of credit or guaranteeing
the debt of any entity.
Liquidity
Our sources of funds include deposits, advances from the FHLB and other borrowings; proceeds from the sale of loans, available for sale
securities, and real estate; payments of loans and payments for and sales of loan servicing; and income from other investments. Interest rates, real
estate sales activity and general economic conditions significantly affect repayments on loans and deposit inflows and outflows.
In addition to its deposits, our principal source of liquidity is our ability to utilize borrowings, as needed. The Bank’s primary source of
borrowings is the FHLB. At September 30, 2008, the Bank’s FHLB borrowings totaled $2.1 billion, representing 16.5% of total assets. The Bank currently
is approved by the FHLB to borrow up to a maximum of $3.0 billion to the extent it provides qualifying collateral, providing the Bank with an additional
$0.9 billion of borrowing capacity from the FHLB as of September 30, 2008. The amount the FHLB is willing to advance differs based on the quality and
character of qualifying collateral offered by the Bank, and the advance rates for the same collateral may be adjusted upwards or downwards by the
FHLB from time to time. The Bank also is approved to borrow funds on an overnight basis from the Federal Reserve Bank of San Francisco subject to
the amount of qualifying collateral it pledges. The Bank views the Federal Reserve Bank of San Francisco as a back-up source of liquidity. As of
September 30, 2008 the Bank had no outstanding
Page 24 Navigation Linksborrowings from the Federal Reserve Bank of San Francisco and the Bank’s available qualifying collateral would have permitted it to borrow up to an
additional $1.1 billion. Neither the FHLB nor the Federal Reserve Bank of San Francisco is obligated to lend to us under these loan facilities. To the
extent deposit renewals and deposit growth are not sufficient to fund maturing and withdrawable deposits, repay maturing borrowings, fund existing
and future loans and investment securities and otherwise fund working capital needs and capital expenditures, the Bank may utilize additional
borrowing capacity from its FHLB and Federal Reserve Bank borrowing arrangements. However, if elevated levels of net deposit outflows occur, the
Bank’s usual sources of liquidity could become depleted, and the Bank would be required to raise additional capital or enter into new financing
arrangements to satisfy its liquidity needs. In the current economic environment, there are no assurances that we would be able to raise additional
capital or enter into additional financing arrangements. As a result of being “adequately capitalized” rather than “well capitalized,” the Bank is subject
to restrictions on accepting brokered deposits, which have not historically been a significant part of the Bank’s deposit base, and upper limits on
interest rates the Bank may pay on deposits.
As of September 30, 2008, we had commitments to borrowers for short-term interest rate locks, before the reduction of expected fallout, of $216
million, of which $38 million were related to residential one-to-four unit loans being originated for sale in the secondary market. We also had
undisbursed loan funds and unused lines of credit of $268 million, loan forward purchase contracts of $21 million and operating leases of $16 million.
Subsequent to September 30, 2008, we closed our wholesale lending channel which traditionally provided about 80% of our single family loan
originations and scaled back our retail loan channel. Therefore, loan origination volumes will decline in future periods. For further information, see Note
5 of Notes to the Consolidated Financial Statements on page 15.
Limitations imposed by the OTS currently prohibit the Bank from providing a dividend to the Holding Company without the prior written approval
of the OTS, and currently prohibit the Holding Company from paying a dividend without the prior non-objection of the OTS. At September 30, 2008, the
Holding Company’s liquid assets, including amounts deposited with the Bank, totaled $11 million, down from $102 million at the end of 2007 due
primarily to $80 million in capital contributions made to the Bank. In addition, the Holding Company may not issue new debt or renew existing debt
without the prior non-objection of the OTS. At this time, there is no other source of repayment of the senior notes. Absent additional capital, the
Holding Company will default on the notes within a year.
Downey’s stockholders’ equity totaled $772 million at September 30, 2008, down from $1.3 billion at December 31, 2007 and $1.4 billion at
September 30, 2007. No future dividends will be paid without the prior non-objection of the OTS.
Capital Adequacy
At September 30, 2008, the Bank was above the minimum capital ratios required by its Consent Order, with core and tangible capital ratios of
7.48% and a total risk-based capital ratio of 14.50%. In addition, the Bank’s Consent Order requires the Bank to complete a capital raising initiative by
December 31, 2008. As a direct result of these requirements, during the quarter, we sold certain non-core real estate assets to a third party resulting in
an enhancement to the Bank’s regulatory capital of $109 million and the Holding Company made a capital contribution of $30 million. These capital
enhancements were more than offset by the net loss recorded in the current quarter. Based on the Bank’s current and projected levels of capital, the
Bank anticipates that it will not be able to satisfy the Tier I Core Capital and Total Risk-Based Capital minimum ratios of its Consent Order as of
December 31, 2008, unless it raises additional capital on or prior to that date. In the current economic environment, there is a significant risk that the
Bank will not be able to raise sufficient additional capital to ensure compliance with the capital requirements of the Bank Consent Order by year-end.
For more information, see “Part II – Other Information – Item 1A. – Risk Factors – If we do not raise additional capital by December 31, 2008, it is highly
unlikely that we will be in compliance with the capital requirements of the Bank Consent Order at year-end, which could have a material adverse effect
upon us.” on page 77.
Going Concern
The circumstances described above, raise substantial doubt concerning the ability of the Holding Company and the Bank to continue as going
concerns for a reasonable period of time.
Page 25 Navigation LinksIn March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging
Activities (“SFAS 161”). This standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring
enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows.
This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application
encouraged. Downey is currently evaluating the impact, if any, that this statement will have on its disclosures related to hedging activities.
Statement of Financial Accounting Standards No. 162
In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting
Principles, (“SFAS 162”). This standard is intended to improve financial reporting by identifying the sources of accounting principles and a consistent
framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S.
GAAP for nongovernmental entities. SFAS 162 will be effective 60 days after the U.S. Securities and Commission approves the Public Company
Accounting Oversight Board’s amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting
Principles.” Adoption of SFAS 162 is not expected to have a material impact on Downey.
NOTE (13) – Subsequent Event
On October 16, 2008, the Bank closed its Wholesale Loan Department and the loan processing centers supporting that Department, and began
contracting its Retail Loan Department. For more information, see “Capital Resources and Liquidity” on page 70.
Page 26 Navigation Links
Certain statements under this caption may constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995,
which involve risks and uncertainties. Forward-looking statements do not relate strictly to historical information or current facts. Some forwardlooking
statements may be identified by use of terms such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” or
words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.” Our actual results or outcomes may
differ significantly from the results discussed in such forward-looking statements. Factors that might cause such a difference include, but are not
limited to, economic conditions, competition in the geographic and business areas in which we conduct our operations, new, changed or increased
regulatory restrictions, pending or threatened litigation, a decrease in our customers, including a decrease in our deposit base, the possible loss of
key personnel, the inability to successfully implement strategic initiatives, changes in deposit flows and loan demand, limitations on our ability to
borrow to fund our assets and operations, risk of credit losses, risk associated with residential mortgage lending, risk associated with a slowdown
in the housing market or high interest rates, fluctuations in interest rates, credit quality, the outcome of ongoing audits, taxing authorities and
government regulation and factors, identified under part II – Other Information Item 1A. Risk Factors on page77 and in our other current and
periodic reports filed from time to time with the SEC. All forward-looking statements in this document are made as of the date hereof, based on
information available to us as of the date hereof. We do not undertake to update forward-looking statements to reflect the impact of circumstances or
events that arise after the date the forward-looking statements were made, except as required by law. We are not able to make any assurances,
including but not limited to any assurances that the increased rate of sale of foreclosed homes will continue in future periods, that the rate of deposit
withdrawals will not increase in future periods, that the percentage of unsold homes in escrow or under negotiation will be representative of the
number or percentage of homes sold in future periods, we will have adequate liquidity in future periods, capital levels will exceed levels required by
our regulators in future periods or that we will be able to meet other requirements imposed by our regulators.
OVERVIEW
A net loss was recorded for the third quarter of 2008 of $81.1 million or $2.89 per share on a diluted basis, compared with a net loss of $23.4 million
or $0.84 per share in the year-ago third quarter.
The $45.5 million unfavorable change in pre-tax loss between third quarters was due primarily to:
l A $48.7 million or 59.7% increase in provision for credit losses primarily due to a higher level of delinquent loans and an increase in loss severity
from the continuing decline in housing values that provide the underlying collateral for our loans;
l A $40.0 million or 63.8% increase in operating expense, of which approximately 69% was due to higher costs related to the operation of real
estate acquired in settlement of loans, with the balance of the increase primarily associated with higher deposit insurance premiums,
professional fees and consulting fees; and
l A $21.9 million or 22.4% decline in net interest income due to both a lower level of interest-earning assets and a lower effective interest rate
spread.
These unfavorable items were partially offset by an increase in other income of $65.2 million primarily due to the sale of non-core real estate related
contracts.
For the first nine months of 2008, the net loss totaled $547.7 million or $19.64 per share on a diluted basis, compared with net income of $52.2
million or $1.87 per share on a diluted basis for the first nine months of 2007. The decline primarily reflected an increase in our provision for credit
losses, lower net interest income and higher operating expenses.
For the third quarter, our return on average assets was a negative 2.42%, and our return on average equity was a negative 39.04%. These compare
to year-ago negative returns of 0.64% on average assets and 6.36% on average equity. For the nine months ended September 30, 2008, our return on
average assets was a negative 5.51%, and our return on average equity was a negative 69.68%. These compare to year-ago positive returns of 0.46% on
average assets and 4.82% on average equity.
Page 27 Navigation LinksAt September 30, 2008, assets totaled $12.781 billion, down $1.637 billion or 11.4% from a year ago. During the current quarter, assets increased
$149 million. Our cash and cash equivalents increased $460 million during the quarter reflecting a cautionary measure relative to our liquidity given
depositor and market place concerns as various banks failed during the period. In addition, the increase in total assets reflected an increase of $118
million in loans held for investment, $54 million in Federal Home Loan Bank stock, and $33 million in other assets. Those asset increases were partially
offset by declines of $406 million in investment securities, $78 million in loans held for sale and $48 million in investments in real estate and joint
ventures. Included within loans held for investment at quarter end were $5.715 billion of single family adjustable rate mortgages subject to negative
amortization, down $527 million from June 30, 2008. These loans comprised 52% of the single family residential loan portfolio held for investment at
quarter end, compared with 74% a year ago. The amount of negative amortization included in loan balances declined $27 million during the current
quarter to $318 million or 5.6% of loans subject to negative amortization. During the current quarter, approximately 10% of loan interest income
represented negative amortization, down from 15% in the second quarter 2008 and 26% in the year-ago third quarter.
Loan originations (including purchases) totaled $804 million in the current quarter, up $110 million or 15.8% from $694 million originated a year ago
but down from $1.027 billion originated in the second quarter of 2008. Single family residential loans originated for portfolio increased $128 million or
29.6% from a year ago to $560 million, while other loans originated for portfolio increased $79 million to $96 million in the current quarter. Those
increases were partially offset by a decline in loans originated for sale, which declined $98 million or 39.8% to $147 million.
Not included in the above originations are loans for which we modify the terms of a borrower’s loan. During the current quarter, we modified $157
million of loans associated with our borrower retention program, wherein the borrower was current with their loan payments and the new interest rate
was no less than that afforded new borrowers, and an additional $149 million of loans at below market interest rates in loan workout situations. All of
the portfolio retention modifications were adjustable rate loans, which permitted negative amortization, that were modified into five-year interest-only
adjustable rate loans with interest rates that adjust semi-annually but do not permit negative amortization. Most of the other modifications were
modified for a two year period into a fixed rate interest-only product.
Deposits totaled $9.618 billion at quarter end, down $1.044 billion or 9.8% from a year ago. At quarter end, the number of branches totaled 175 (170
in California and five in Arizona). At quarter end, the average deposit size of our 85 traditional branches was $89 million, while the average deposit size
of our 90 in-store branches was $23 million. During the current quarter, borrowings increased by $487 million and represented 18% of total assets at
quarter end.
Non-performing assets increased during the quarter by $44 million to $2.002 billion and represented 15.66% of total assets, compared with 7.77%
at year-end 2007 and 2.94% a year ago. Virtually all of the increase in the current quarter was related to our single family residential lending activity.
Included in non-performing assets are loans modified pursuant to our borrower retention program. This program was initiated at the beginning of the
third quarter of 2007 to provide borrowers who are current with their loan payments a cost effective means to change from an adjustable rate loan that
permitted negative amortization to a less costly financing alternative. To the extent borrowers whose loans were modified as part of this program are
current with their loan payments and included in non-performing assets, it is relevant to distinguish those from total non-performing assets because,
unlike other loans classified as non-performing assets, these loans are paying interest at interest rates no less than those afforded new borrowers. At
September 30, 2008, 72% of such borrowers had made all loan payments due. Accordingly, the 15.66% ratio of non-performing assets to total assets
includes 3.20% related to performing troubled debt restructurings resulting in an adjusted ratio of 12.46%.
At September 30, 2008, Downey Financial Corp.’s primary subsidiary, Downey Savings and Loan Association, F.A. (the “Bank”), had core and
tangible capital ratios of 7.48%, and a total risk-based capital ratio of 14.50%. In each case, these ratios exceeded the minimum regulatory capital ratios
required to be maintained by the Bank of 7.00% for core and tangible and 14.00% for risk-based. The Bank’s regulatory capital position was enhanced
during the current quarter by $109 million from the sale of certain non-core real estate assets, and a $30 million contribution of equity from Downey
Financial Corp. (the “Holding Company”). These were more than offset by the net loss recorded in the current quarter. For more information, see Note
11 of Notes to the Consolidated Financial Statements on page 24.
Page 28 Navigation LinksIn light of the current operating environment and Downey’s recent quarterly losses, the Holding Company and the Bank have continued to work
closely with the Bank’s federal banking regulators. On September 5, 2008, the Holding Company and the Bank each entered into a Consent Order with
the OTS, effective as of the same date. The Bank Order requires the Bank to, among other things:
l meet and maintain a minimum Tier I Core Capital ratio of 7% and a minimum Total Risk-Based Capital ratio of 14% at each quarter-end;
l submit to the OTS an updated capital augmentation and strategy plan addressing how the Bank will meet and maintain the foregoing capital
ratios and that provides for the raising of new equity and a capital infusion by no later than December 31, 2008, together with an alternative
strategy to meet and maintain the Bank’s capital and ensure its safe and sound operation if the plan to raise additional capital is not successful;
l submit for OTS approval within prescribed time periods (i) a comprehensive classified asset reduction plan, (ii) a real estate owned disposition
plan, (iii) an updated business plan containing strategies for a reduction in concentration of payment option adjustable rate mortgage and stated
income loans and (iv) a plan to strengthen executive management;
l notify, or in certain cases receive the approval or non-objection of, the OTS prior to (i) increasing its total assets in any quarter in excess of an
amount equal to net interest credited on deposits during the quarter; (ii) making certain changes to its directors or senior executive officers; (iii)
entering into, renewing, extending or revising any contractual arrangement related to compensation or benefits with any director or senior
executive officer of the Bank; (iv) making any golden parachute or prohibited indemnification payments; (v) paying dividends or making other
capital distributions; and (vi) entering into certain transactions with affiliates;
l refrain from any unsafe and unsound practices regarding lending and from resuming payment option adjustable rate mortgage or stated income
lending programs; and
l comply with the OTS’ most recent report of examination with respect to the Bank.
In light of the capital directive set forth in the Bank Consent Order, the Bank is deemed to be “adequately capitalized” rather than “well
capitalized” despite exceeding all “well capitalized” regulatory ratios.
Notwithstanding that portion of the Bank Consent Order requiring the raising of new equity and a capital infusion by no later than December 31,
2008, bank regulators could take enforcement action before that date, which could include placing the Bank into receivership.
The Consent Order that the Holding Company entered into requires it to notify, or in certain cases receive the approval or non-objection of, the
OTS prior to (i) accepting or requesting that the Bank pay or make, or commit to pay or make, any dividends or other capital distributions; (ii) making
certain changes to its directors or senior executive officers; (iii) entering into, renewing, extending or revising any contractual arrangement related to
compensation or benefits with any director or senior executive officer of the Holding Company; (iv) making any golden parachute payments or
prohibited indemnification payments; and (v) incurring, issuing, renewing or rolling over any debt, increasing any current lines of credit or guaranteeing
the debt of any entity.
The circumstances described in Note 11 (page 24) and in Risk Factors (page 77), raise substantial doubt concerning the ability of the Holding
Company and the Bank to continue as going concerns for a reasonable period of time.
Page 29 Navigation LinksWe have established various accounting policies which govern the application of accounting principles generally accepted in the United States
of America in the preparation of our financial statements. Certain accounting policies require us to make significant estimates and assumptions which
could have a material impact on the carrying value of certain assets and liabilities, and we consider these to be critical accounting policies. The
estimates and assumptions are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual
results could differ significantly from these estimates and assumptions which could have a material impact on the future carrying value of assets and
liabilities and our results of operations for the reporting periods. We believe the following four critical accounting policies require the most judicious
estimates and assumptions, which are particularly susceptible to significant change in the preparation of our financial statements:
l the valuation of interest rate lock commitments;
l the allowance for credit and real estate losses;
l the valuation of mortgage servicing rights (“MSRs”); and
l the prepayment reserves related to sales of loans and MSRs.
The nature of these judgments, estimates and assumptions are described in greater detail in Downey’s Annual Report on Form 10-K for the year ended
December 31, 2007 in the “Critical Accounting Policies” section of Management’s Discussion and Analysis and in Note 1 to the Consolidated Financial
Statements – “Summary of Significant Accounting Policies.”
In addition to those critical accounting policies addressed in Downey’s Annual Report on Form 10-K for the year ended December 31, 2007, we
have added:
l the calculation of our income tax provision and related tax accruals as they could have a material impact on the future value of assets and
liabilities and our results of operations. Accrued income taxes represent the estimated amounts due or to be received from the various taxing
jurisdictions where we have established a business presence. The balance also includes, when appropriate, a contingent reserve for potential
taxes, interest and penalties related to uncertain tax positions. On a quarterly basis, management evaluates the contingent tax accruals to
determine if they are sufficient based on a probability assessment of potential outcomes. The determination is based on facts and
circumstances, including the interpretation of existing law, new judicial or regulatory guidance and the status of tax audits. The provision for
income taxes is based on amounts reported in the consolidated statements of income which are adjusted to reflect the permanent and temporary
differences in the tax and financial accounting for certain assets and liabilities. Deferred income taxes represent the tax effect of the basis
differences in tax and financial reporting arising from temporary differences in accounting treatment. On a quarterly basis, management
evaluates its deferred tax assets to determine if these tax benefits are expected to be realized in future periods. This determination is based on
facts and circumstances, including our current and future tax outlook. To the extent a deferred tax asset is not considered “more likely than not”
to be realized, a valuation allowance is established. At September 30, 2008, we recorded a valuation allowance of $216 million against our
deferred tax assets of $235 million.
l the valuation of real estate acquired in settlement of loans. Real estate acquired through foreclosure is recorded at fair value less cost to sell on
the date of foreclosure and any subsequent fair value changes are recorded in net operations, with a corresponding charge to the asset value.
Fair value is measured based on the lower of the sales price, an appraisal or the list price and an additional loss allowance may be established
based on current market trends. List prices are determined based on Management’s estimate of value and take into consideration sources of
value such as a broker’s price opinion, internal appraisal review and market trends. At September 30, 2008, it was deemed necessary to maintain
an allowance for losses of $11 million against our single family residential real estate acquired in settlement of loans based on recent loss
experience from sales compared to their fair values prior to sale. For further information, see Note 3 on page 10 of Notes to the Consolidated
Financial Statements and Problem Loans and Real Estate on page 60.
Management has discussed the development and selection of these critical accounting policies with the Audit Committee of our Board of
Directors.
Page 30 Navigation LinksNet interest income is the difference between the interest and dividends earned on loans, mortgage-backed securities and investment securities
(“interest-earning assets”) and the interest paid on deposits and borrowings (“interest-bearing liabilities”). The spread between the yield on interestearning
assets and the cost of interest-bearing liabilities and the relative dollar amounts of these assets and liabilities principally affects net interest
income.
Our net interest income totaled $76.0 million in the third quarter of 2008, down $21.9 million or 22.4% from a year ago, reflecting a $1.828 billion or
13.0% decline in average interest-earning assets to $12.214 billion and a decline in our effective interest rate spread. The average effective interest rate
spread was 2.49% in the current quarter, down 0.30% from a year ago and 0.24% from the second quarter of 2008. The decline in the current quarter
effective interest spread from a year ago primarily reflected the negative impact of a higher proportion of non-performing assets. The decline in our
effective interest spread from the second quarter of 2008 reflected both a higher level of non-performing assets as well as an increase in non-interest
bearing cash related assets for liquidity purposes funded with interest-bearing liabilities.
For the first nine months of 2008, net interest income totaled $242.7 million, down $91.9 million or 27.5% from the year-ago period. The decline was
due to lower interest-earning assets and a lower effective interest rate spread in the current period.
The following table presents for the periods indicated the total dollar amount of:
l interest income from average interest-earning assets and resultant yields; and
l interest expense on average interest-bearing liabilities and resultant costs, expressed as rates.
The table also sets forth our net interest income, interest rate spread and effective interest rate spread. The effective interest rate spread reflects the
relative level of interest-earning assets to interest-bearing liabilities and equals:
l the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities, divided by
l average interest-earning assets for the period.
Page 31 Navigation LinksThe table also sets forth the difference between the average balance of interest-earning assets and the average balance of total deposits and
borrowings for the quarters indicated. While we included non-accrual loans in the average interest-earning assets balance, interest from non-accrual
loans has not been included in interest income unless we received payments and we believe the remaining principal balance of the loans will be
recovered. We computed average balances for the quarter using the average of each month’s daily average balance during the periods indicated.
(a) Yields for securities available for sale are calculated using historical cost balances and are not adjusted for changes in fair value that are
reflected as a separate component of stockholders’ equity.
(b) Included amounts swept into money market deposit accounts.
(c) The impact of swap contracts was included, with notional amounts totaling $430 million of receive-fixed, pay-3-month London Inter-Bank Offered
Rate (“LIBOR”) variable interest, which contracts serve as a permitted hedge against a portion of our FHLB advances.
Three Months Ended September 30,
2008 2007
Average Average Average Average
(Dollars in Thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
Average balance sheet data
Interest-earning assets:
Loans:
Loan prepayment fees $ 463 0.02% $ 8,542 0.29%
Write-off of deferred costs and
premiums from loan payoffs (3,391 ) (0.13 ) (16,315 ) (0.55 )
All other 157,407 5.84 216,087 7.22
Total loans $ 10,783,449 154,479 5.73 $ 11,973,516 208,314 6.96
Mortgage-backed securities 105 2 4.78 113 3 5.77
Investment securities (a) 1,430,431 14,587 4.06 2,068,187 27,557 5.29
Total interest-earnings assets 12,213,985 $ 169,068 5.54% 14,041,816 $ 235,874 6.72%
Non-interest-earning assets 1,158,650 485,648
Total assets $ 13,372,635 $ 14,527,464
Transaction accounts:
Non-interest-bearing checking (b) $ 766,544 $ – -% $ 730,179 $ – -%
Interest-bearing checking (b) 400,758 1,142 1.13 470,516 340 0.29
Money market 108,361 280 1.03 139,808 367 1.04
Regular passbook 864,663 1,952 0.90 1,117,084 2,660 0.94
Total transaction accounts 2,140,326 3,374 0.63 2,457,587 3,367 0.54
Certificates of deposit 7,564,088 64,352 3.38 8,455,461 105,147 4.93
Total deposits 9,704,414 67,726 2.78 10,913,048 108,514 3.94
FHLB advances and other borrowings (c) 2,538,497 22,010 3.45 1,766,933 26,088 5.86
Senior notes 198,565 3,305 6.66 198,381 3,302 6.66
Total deposits and borrowings 12,441,476 93,041 2.98 12,878,362 137,904 4.25
Other liabilities 100,624 179,944
Stockholders’ equity 830,535 1,469,158
Total liabilities and stockholders’ equity $ 13,372,635 $ 14,527,464
Net interest income/interest rate spread $ 76,027 2.56% $ 97,970 2.47%
Excess of interest-earning assets over
deposits and borrowings $ (227,491) $ 1,163,454
Effective interest rate spread 2.49 2.79
Page 32 Navigation Links
(a) Yields for securities available for sale are calculated using historical cost balances and are not adjusted for changes in fair value that are
reflected as a separate component of stockholders’ equity.
(b) Included amounts swept into money market deposit accounts.
(c) The impact of swap contracts was included, with notional amounts totaling $430 million of receive-fixed, pay-3-month LIBOR variable interest,
which contracts serve as a permitted hedge against a portion of our FHLB advances.
Nine Months Ended September 30,
2008 2007
Average Average Average Average
(Dollars in Thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
Average balance sheet data
Interest-earning assets:
Loans:
Loan prepayment fees $ 3,632 0.04% $ 47,937 0.50%
Write-off of deferred costs and
premiums from loan payoffs (15,669 ) (0.19 ) (66,454 ) (0.69 )
All other 505,230 6.21 709,386 7.37
Total loans $ 10,854,805 493,193 6.06 $ 12,829,398 690,869 7.18
Mortgage-backed securities 108 8 5.45 127 9 5.85
Investment securities (a) 1,520,402 53,043 4.66 1,781,837 71,040 5.33
Total interest-earnings assets 12,375,315 $ 546,244 5.89% 14,611,362 $ 761,918 6.95%
Non-interest-earning assets 874,532 478,398
Total assets $ 13,249,847 $ 15,089,760
Transaction accounts:
Non-interest-bearing checking (b) $ 704,296 $ – -% $ 762,050 $ – -%
Interest-bearing checking (b) 436,960 2,208 0.67 481,867 1,117 0.31
Money market 126,724 982 1.04 145,141 1,128 1.04
Regular passbook 973,320 6,687 0.92 1,183,810 8,423 0.95
Total transaction accounts 2,241,300 9,877 0.59 2,572,868 10,668 0.55
Certificates of deposit 7,793,586 233,170 4.00 8,742,787 323,309 4.94
Total deposits 10,034,886 243,047 3.24 11,315,655 333,977 3.95
FHLB advances and other borrowings (c) 1,832,461 50,601 3.69 1,909,513 83,494 5.85
Senior notes 198,520 9,913 6.66 198,334 9,904 6.66
Total deposits and borrowings 12,065,867 303,561 3.36 13,423,502 427,375 4.26
Other liabilities 135,922 219,667
Stockholders’ equity 1,048,058 1,446,591
Total liabilities and stockholders’ equity $ 13,249,847 $ 15,089,760
Net interest income/interest rate spread $ 242,683 2.53% $ 334,543 2.69%
Excess of interest-earning assets over
deposits and borrowings $ 309,448 $ 1,187,860
Effective interest rate spread 2.61 3.05
Page 33 Navigation LinksChanges in our net interest income are a function of changes in both rates and volumes of interest-earning assets and interest-bearing liabilities.
The following table sets forth information regarding changes in our interest income and expense for the periods indicated. For each category of interestearning
assets and interest-bearing liabilities, we have provided information on changes attributable to:
l changes in volume: changes in volume multiplied by comparative period rate;
l changes in rate: changes in rate multiplied by comparative period volume; and
l changes in rate/volume: changes in rate multiplied by changes in volume.
Interest-earning asset and interest-bearing liability balances used in the calculations represent quarterly average balances computed using the average
of each month’s daily average balance during the periods indicated.
Provision for Credit Losses
During the current quarter, our provision for credit losses totaled $130.3 million, up $48.7 million from a year ago. The increase in our provision for
credit losses reflects continued weakening and uncertainty relative to the housing market and disruption in the secondary markets which have
unfavorably impacted our borrowers and the value of their loan collateral.
For the first nine months of 2008, the provision for credit losses totaled $626.0 million, compared with $91.7 million a year ago. For further
information, see Allowance for Credit and Real Estate Losses on page 65.
Other Income
Other income totaled $68.2 million in the current quarter, up $65.2 million from a year ago primarily due to a $70.0 million gain from the sale of
certain non-core real estate contracts. Offsetting contributors to this increase between third quarters was:
l A $2.9 million unfavorable change in income from investments in real estate and joint ventures; and
l A $1.8 million decline in net gains on sale of loans and mortgage-backed securities, reflecting a decline in loans sold, partially offset by a higher
gain per dollar of loan sold.
Three Months Ended September 30, Nine Months Ended September 30,
2008 Versus 2007 2008 Versus 2007
Changes Due To Changes Due To
Rate/ Rate/
(In Thousands) Volume Rate Volume Net Volume Rate Volume Net
Interest income:
Loans $ (20,705 ) $ (36,786 ) $ 3,656 $ (53,835 ) $ (106,333 ) $ (107,959 ) $ 16,616 $ (197,676 )
Mortgage-backed securities (1 ) – – (1 ) (1 ) – – (1 )
Investment securities (8,523 ) (6,429 ) 1,982 (12,970 ) (10,395 ) (8,909 ) 1,307 (17,997 )
Change in interest income (29,229 ) (43,215 ) 5,638 (66,806 ) (116,729 ) (116,868 ) 17,923 (215,674 )
Interest expense:
Transaction accounts:
Interest-bearing checking (50 ) 1,001 (149 ) 802 (104 ) 1,318 (123 ) 1,091
Money market (82 ) (5 ) – (87 ) (147 ) – 1 (146 )
Regular passbook (605 ) (133 ) 30 (708 ) (1,492 ) (297 ) 53 (1,736 )
Total transaction accounts (737 ) 863 (119 ) 7 (1,743 ) 1,021 (69 ) (791 )
Certificates of deposit (11,133 ) (33,159 ) 3,497 (40,795 ) (35,019 ) (61,833 ) 6,713 (90,139 )
Total interest-bearing deposits (11,870 ) (32,296 ) 3,378 (40,788 ) (36,762 ) (60,812 ) 6,644 (90,930 )
FHLB advances and other
borrowings 11,563 (10,887 ) (4,754) (4,078 ) (3,373 ) (30,765 ) 1,245 (32,893 )
Senior notes 3 – – 3 9 – – 9
Change in interest expense (304 ) (43,183 ) (1,376 ) (44,863 ) (40,126 ) (91,577 ) 7,889 (123,814 )
Change in net interest income $ (28,925 ) $ (32 ) $ 7,014 $ (21,943 ) $ (76,603 ) $ (25,291 ) $ 10,034 $ (91,860 )
Page 34 Navigation LinksFor the first nine months of 2008, other income totaled $89.2 million, up $51.0 million or 133.3% from a year ago. The increase primarily reflected the
current period gain from the sale of certain non-core real estate contracts, partially offset by unfavorable changes in net gains from sales of loans and
mortgage-backed securities and income from real estate and joint ventures held for investment.
Below is a further detailed discussion of the major other income categories.
Loan and Deposit Related Fees
Our loan and deposit related fees totaled $8.2 million in the current quarter, down $0.8 million from a year ago. The decline was primarily related to
lower automated teller machine fees.
The following table presents a breakdown of loan and deposit related fees during the quarters indicated.
For the first nine months of 2008, loan and deposit related fees totaled $24.6 million, down $2.5 million from the same period of 2007. The decline
was primarily related to lower automated teller machine fees of $1.4 million or 20.3% and loan related fees of $1.0 million or 44.2%.
The following table presents a breakdown of loan and deposit related fees during the year-to-date periods indicated.
Real Estate and Joint Ventures Held for Investment
A loss of $10.7 million was recorded from our real estate and joint ventures held for investment, compared to a loss of $7.9 million a year ago. The
$2.8 million unfavorable change is primarily related to current quarter net losses from sales of wholly owned real estate of $2.4 million. Both the current
quarter and the year-ago quarter included writedowns associated with declines in the value of single family lots in which we are a joint venture partner.
In the current quarter, the writedown is recorded in provision for losses on real estate and joint ventures, whereas in the year-ago quarter the writedown
appears in deficit in net loss from joint ventures.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Loan related fees $ 445 $ 377 $ 422 $ 467 $ 572
Deposit related fees:
Automated teller machine fees 1,747 1,859 1,997 2,285 2,287
Other fees 5,960 5,968 5,820 6,215 6,054
Total loan and deposit related fees $ 8,152 $ 8,204 $ 8,239 $ 8,967 $ 8,913
Nine Months Ended September 30,
(In Thousands) 2008 2007
Loan related fees $ 1,244 $ 2,233
Deposit related fees:
Automated teller machine fees 5,603 7,032
Other fees 17,748 17,822
Total loan and deposit related fees $ 24,595 $ 27,087
Page 35 Navigation LinksThe following table sets forth the key components comprising our income from real estate and joint venture operations during the quarters
indicated.
For the first nine months of 2008, a loss of $16.6 million was recorded from real estate and joint ventures held for investment, compared to a loss of
$7.5 million a year ago. The unfavorable change primarily reflected an increase in the writedowns of single family lots in which we are a joint venture
partner, partially offset by net gains from sales.
The following table sets forth the key components comprising our income from real estate and joint venture operations during the year-to-date
periods indicated.
Secondary Marketing Activities
We service loans for others and those activities generated a loss of $0.1 million in the current quarter, down from a loss of $0.3 million in the yearago
quarter. This primarily reflected a $0.6 million favorable change in payoff and curtailment interest cost, partially offset by a $0.5 million unfavorable
change from the measurement of MSRs to fair value. Payoff and curtailment interest costs represent the difference between the contractual obligation
to pay interest to the investor for an entire month and the actual interest received when a loan prepays prior to the end of the month. Loan servicing
income (loss), net does not reflect the interest income we derive from the use of those loan repayments as it is included in net interest income.
Effective January 1, 2008, we adopted the fair value provision of Statement of Financial Accounting Standards No. 156, Accounting for Servicing
of Financial Assets – an amendment of FASB Statement No. 140 (“SFAS 156”) and remeasured our MSRs at fair value. For further information regarding
the adoption of SFAS 156 and our MSRs, see Note 4 of Notes to Consolidated Financial Statements on page 11.
At September 30, 2008, MSRs totaled $23 million or 0.91% of the $2.495 billion of associated loans serviced for others, up $1 million from the year
ago balance accounted for under the amortized cost method. In addition to the loans we serviced for others with capitalized MSRs, at September 30,
2008, we serviced $2.848 billion of loans on a sub-servicing basis where we receive a fixed fee per loan, with no risk associated with changing MSR
values.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Net rental operations and income from community
development funds $ (127 ) $ 133 $ 331 $ (49 ) $ 576
Net gains (losses) on sales of wholly owned real estate
estate (2,388 ) 6,129 – – –
Equity (deficit) in net income (loss) from
joint ventures (181 ) (79 ) (945 ) 681 (8,492 )
(Provision for) reduction of losses on real estate
and joint ventures (8,053 ) (11,454 ) 9 10 24
Total income (loss) from real estate and
joint ventures held for investment, net $ (10,749 ) $ (5,271 ) $ (605 ) $
642
$ (7,892 )
Nine Months Ended September 30,
(In Thousands) 2008 2007
Net rental operations and income from community development funds $ 337 $ 1,170
Net gains on sales of wholly owned real estate 3,741 22
Deficit in net loss from joint ventures (1,205 ) (8,390 )
Provision for losses on real estate and joint ventures (19,498 ) (329 )
Total loss from real estate and joint ventures held for investment, net $ (16,625 ) $ (7,527 )
Page 36 Navigation LinksThe following table presents a breakdown of the components of our loan servicing income (loss), net for the quarters indicated.
(a) Represents the difference between the contractual obligation to pay interest to the investor for an entire month and the actual interest received
when a loan prepays prior to the end of the month. However, loan servicing activities do not include the benefit of the use of total loan repayments
to increase net interest income.
(b) Effective January 1, 2008, Downey adopted the fair value provision of SFAS 156 and remeasured its MSRs at fair value. Downey recorded a
pretax adjustment to increase MSRs by $1.5 million and a corresponding cumulative effect adjustment of $0.9 million, after tax, to increase the 2008
beginning balance of retained earnings in stockholders’ equity.
(c) Reflects changes in assumptions for such items as discount rates and prepayment speeds.
(d) Represents changes due to realization of expected cash flows over time.
For the first nine months of 2008, income of $2.7 million was recorded from loan servicing activities, compared to a loss of $1.5 million for the same
period of 2007. The favorable change primarily reflected a reduction in payoff and curtailment interest costs and a favorable change in the fair value of
MSRs in the current period versus the amortization of MSRs a year ago.
The following table presents a breakdown of the components of our loan servicing income (loss), net during the year-to-date periods indicated.
(a) Represents the difference between the contractual obligation to pay interest to the investor for an entire month and the actual interest received
when a loan prepays prior to the end of the month. However, loan servicing activities do not include the benefit of the use of total loan repayments
to increase net interest income.
(b) Effective January 1, 2008, Downey adopted the fair value provision of SFAS 156 and remeasured its MSRs at fair value. Downey recorded a
pretax adjustment to increase MSRs by $1.5 million and a corresponding cumulative effect adjustment of $0.9 million, after tax, to increase the 2008
beginning balance of retained earnings in stockholders’ equity.
(c) Reflects changes in assumptions for such items as discount rates and prepayment speeds.
(d) Represents changes due to realization of expected cash flows over time.
Our net gains on sales of loans and mortgage-backed securities totaled $0.7 million in the current quarter, down $1.8 million from a year ago,
reflecting a decline in loans sold, partially offset by a higher gain per dollar of loan sold. The current quarter included a $1.6 million loss due to the
SFAS 133 impact of valuing derivatives associated with the sale of loans, compared with a SFAS 133 loss of $0.6 million in the year-ago quarter.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Net cash servicing fees $ 1,797 $ 1,750 $ 1,765 $ 2,166 $ 1,657
Payoff and curtailment interest cost (a) (208 ) (350 ) (471 ) (544 ) (787 )
Changes in fair value of mortgage servicing
rights due to: (b)
Change in valuation model inputs or
assumptions (c) (1,038 ) 3,325 (1,751 ) – –
Other changes (d) (607 ) (749 ) (739 ) – –
Amortization of mortgage servicing rights – – – (1,085 ) (950 )
Provision for impairment of mortgage
servicing rights – – – (2,197 ) (214 )
Total loan servicing income (loss), net $ (56 ) $ 3,976 $ (1,196 ) $ (1,660 ) $ (294 )
Nine Months Ended September 30,
(In Thousands) 2008 2007
Net cash servicing fees $ 5,312 $ 4,862
Payoff and curtailment interest cost (a) (1,029 ) (3,241 )
Change in fair value of mortgage servicing rights due to: (b)
Changes in valuation model inputs or assumptions (c) 536 –
Other changes (d) (2,095 ) –
Amortization of mortgage servicing rights – (2,941 )
Reduction of impairment of mortgage servicing rights – (199 )
Total loan servicing income (loss), net $ 2,724 $ (1,519 )
Excluding the impact of SFAS 133, a gain was realized equal to 1.03% on secondary market sales of $221 million, compared with the year-ago gain of
0.91% on secondary market sales of $337 million.
Page 37 Navigation LinksThe following table presents a breakdown of the components of our net gains on sales of loans and mortgage-backed securities for the quarters
indicated.
For the first nine months of 2008, our sales of loans and mortgage-backed securities totaled $685 million, down from $1.622 billion a year ago. Net
gains associated with these sales totaled $6.9 million in the current period, or $13.3 million lower than the prior year amount. Excluding the impact of
SFAS 133, a gain equal to 0.94% per dollar of loan sold was realized in the current year, down from the year-ago gain of 1.21%.
The following table presents a breakdown of the components of our net gains on sales of loans and mortgage-backed securities during the yearto-
date periods indicated.
Operating Expense
Operating expense totaled $102.7 million in the current quarter, up $40.0 million or 63.8% from a year ago. The increase primarily reflected an
increase of $27.8 million in net operations of real estate acquired in the settlement of loans due to a higher number of foreclosed properties and general
and administrative expense of $12.2 million or 20.7%. The increase in general and administrative expense between third quarters was primarily a result of
increases of:
l $5.7 million in deposit insurance premiums and regulatory assessments due, in part, to a special credit received in the year-ago period and higher
premium rates in the current quarter;
l $3.5 million in other expense due primarily to a search fee related to executive search fees and higher consulting fees;
l $2.5 million in professional fees; and
l $0.9 million in salaries and related costs due, in part, to the year-ago reversal of certain management incentive plan accruals.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Mortgage servicing rights $ 901 $ 1,557 $ 1,122 $ 945 $ 1,394
All other components excluding SFAS 133 1,377 916 596 (393 ) 1,665
SFAS 133 (1,601 ) 2,099 (69 ) (460 ) (553 )
Total net gains on sales of loans and
mortgage-backed securities $ 677 $ 4,572 $ 1,649 $ 92 $ 2,506
Secondary marketing gain excluding SFAS
133 as a percentage of associated sales 1.03% 1.05% 0.75% 0.31% 0.91%
Nine Months Ended September 30,
(In Thousands) 2008 2007
Mortgage servicing rights $ 3,580 $ 4,661
All other components excluding SFAS 133 2,889 14,999
SFAS 133 429 564
Total net gains on sales of loans and mortgage-backed securities $ 6,898 $ 20,224
Secondary marketing gain excluding SFAS 133 as a percentage of associated sales 0.94% 1.21%
Page 38 Navigation LinksThe following table presents a breakdown of key components comprising operating expense for the quarters indicated.
For the first nine months of 2008, operating expense totaled $280.2 million, up $89.5 million or 46.9% from a year ago. The increase primarily
reflected higher net operations of real estate acquired in the settlement of loans, deposit insurance premiums, other general and administrative expense
category, a goodwill impairment charge during the first quarter of 2008, and professional fees. Those increases were partially offset by a decline in
salaries and related costs and advertising expense.
The following table presents a breakdown of key components comprising operating expense during the year-to-date periods indicated.
Provision for Income Taxes
A tax benefit of $7.6 million was recorded in the current quarter, reflecting an effective tax rate of 8.6%, compared with the year-ago effective tax
rate of 46.0%. For the first nine months of 2008, the effective tax rate benefit was 4.6%, compared with an effective tax rate of 42.2% a year ago. For
further information, see Note 6 of Notes to Consolidated Financial Statements on page 20.
Business Segment Reporting
The previous discussion and analysis of the Results of Operations pertained to our consolidated results. This section discusses and analyzes the
results of operations of our two business segments: banking and real estate investment. For more information, see Note 10 of Notes to Consolidated
Financial Statements on page 23.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Salaries and related costs $ 37,611 $ 40,884 $ 39,702 $ 38,882 $ 36,699
Premises and equipment costs 9,224 9,181 8,997 10,257 9,736
Advertising expense 1,473 816 461 1,443 1,400
Deposit insurance premiums and regulatory
assessments 8,117 3,689 3,703 2,516 2,413
Professional fees 3,000 843 303 916 489
Impairment writedown of goodwill – – 3,149 – –
Other general and administrative expense 11,802 8,974 8,480 8,732 8,275
Total general and administrative expense 71,227 64,387 64,795 62,746 59,012
Net operation of real estate acquired in
settlement of loans 31,428 24,139 24,196 4,583 3,664
Total operating expense $ 102,655 $ 88,526 $ 88,991 $ 67,329 $ 62,676
Nine Months Ended September 30,
(In Thousands) 2008 2007
Salaries and related costs $ 118,197 $ 119,931
Premises and equipment costs 27,402 27,667
Advertising expense 2,750 4,469
Deposit insurance premiums and regulatory assessments 15,509 7,659
Professional fees 4,146 1,779
Impairment writedown of goodwill 3,149 –
Other general and administrative expense 29,256 24,271
Total general and administrative expense 200,409 185,776
Net operation of real estate acquired in settlement of loans 79,763 4,903
Total operating expense $ 280,172 $ 190,679
Page 39 Navigation LinksThe following table presents by business segment our net income (loss) for the periods indicated.
The following table presents by business segment our net income for the year-to-date periods indicated.
Banking
A net loss of $69.0 million was recorded in the current quarter related to our banking operations, compared with a loss of $18.9 million a year ago.
The unfavorable change between second quarters primarily reflected:
l A $48.7 million increase in provision for credit losses;
l A $40.0 million increase in operating expense, of which approximately 69% was due to higher costs related to the operation of real estate
acquired in settlement of loans, with the balance of the increase associated with higher deposit insurance premiums, professional fees and
consulting fees; and
l A $21.7 million or 22.2% decline in net interest income due to a lower level of interest-earning assets and a lower effective interest rate spread.
These unfavorable items were partially offset by an increase in other income of $68.1 million primarily due to the sale of non-core real estate related
contracts.
The following table sets forth our banking operational results and selected financial data for the quarters indicated.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Banking net loss $ (69,026 ) $ (215,707 ) $ (247,258 ) $ (109,282 ) $ (18,851 )
Real estate investment net income (loss) (12,044 ) (3,212 ) (439 ) 437 (4,510 )
Total net loss $ (81,070 ) $ (218,919 ) $ (247,697 ) $ (108,845 ) $ (23,361 )
Nine Months Ended September 30,
(In Thousands) 2008 2007
Banking net income (loss) $ (531,991 ) $ 56,186
Real estate investment net loss (15,695 ) (3,940 )
Total net income (loss) $ (547,686 ) $ 52,246
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Net interest income $ 75,998 $ 82,866 $ 83,601 $ 89,059 $ 97,656
Provision for credit losses 130,291 258,874 236,870 218,447 81,562
Other income 78,820 17,224 9,439 7,424 10,756
Operating expense 102,325 88,207 88,672 67,038 62,365
Net intercompany income 3 22 46 15 22
Loss before income taxes (tax benefits) (77,795 ) (246,969 ) (232,456 ) (188,987 ) (35,493 )
Income taxes (tax benefits) (8,769 ) (31,262 ) 14,802 (79,705 ) (16,642 )
Net loss $ (69,026 ) $ (215,707 ) $ (247,258 ) $ (109,282 ) $ (18,851 )
At period end
Assets:
Loans and mortgage-backed securities, net $ 10,757,283 $ 10,716,676 $ 10,725,865 $ 11,136,655 $ 11,692,185
Other 2,004,305 1,902,632 2,392,047 2,258,746 2,710,006
For the first nine months of 2008, our net loss from our banking operations totaled $532.0 million, compared to income of $56.2 million a year ago.
The unfavorable change primarily reflected a higher provision for credit losses, lower net interest income and higher operating expense, partially offset
by higher other income.
Total assets 12,761,588 12,619,308 13,117,912 13,395,401 14,402,191
Equity $ 771,714 $ 858,937 $ 1,090,484 $ 1,334,417 $ 1,444,226
Page 40 Navigation LinksThe following table sets forth our banking operational results for the year-to-date periods indicated.
Real Estate Investment
A net loss of $12.0 million was recorded in the current quarter from our real estate investment operations, compared to a net loss of $4.5 million a
year ago. The unfavorable change primarily reflects net losses from the sale of wholly owned real estate in the current quarter.
The following table sets forth real estate investment operational results and selected financial data for the quarters indicated.
For the first nine months of 2008, a net loss of $15.7 million was recorded related to our real estate investment operations, compared to a loss of
$3.9 million a year ago. The unfavorable change primarily reflected an increase in the writedowns of single family lots in which we are a joint venture
partner, partially offset by higher net gains from sales.
The following table sets forth our real estate investment operational results for the year-to-date periods indicated.
Nine Months Ended September 30,
(In Thousands) 2008 2007
Net interest income $ 242,465 $ 333,505
Provision for credit losses 626,035 91,684
Other income 105,483 45,056
Operating expense 279,204 189,700
Net intercompany income 71 53
Income (loss) before income taxes (tax benefits) (557,220 ) 97,230
Income taxes (tax benefits) (25,229 ) 41,044
Net income (loss) $ (531,991 ) $ 56,186
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Net interest income $ 29 $ 65 $ 124 $ 236 $ 314
Other income (loss) (10,605 ) (5,159 ) (501 ) 803 (7,720 )
Operating expense 330 319 319 291 311
Net intercompany expense (3 ) (22 ) (46 ) (15 ) (22 )
Income (loss) before income taxes (tax benefits) (10,909 ) (5,435 ) (742 ) 733 (7,739 )
Income taxes (tax benefits) 1,135 (2,223 ) (303 ) 296 (3,229 )
Net income (loss) $ (12,044 ) $ (3,212 ) $ (439 ) $ 437 $ (4,510 )
At period end
Assets:
Investments in real estate and joint ventures $ 15,606 $ 63,182 $ 71,196 $ 68,679 $ 58,715
Other 11,356 8,224 15,848 19,023 30,420
Total assets 26,962 71,406 87,044 87,702 89,135
Equity $ 7,351 $ 58,395 $ 73,607 $ 74,046 $ 73,609
Nine Months Ended September 30,
(In Thousands) 2008 2007
Net interest income $ 218 $ 1,038
Our investments in real estate and joint ventures amounted to $16 million at September 30, 2008, down from $69 million at December 31, 2007, and
$59 million at September 30, 2007.
For information on valuation allowances associated with real estate and joint venture loans, see Allowance for Credit and Real Estate Losses on
page 65.
Other loss (16,265 ) (6,807 )
Operating expense 968 979
Net intercompany expense (71 ) (53 )
Loss before income tax benefits (17,086 ) (6,801 )
Income taxes (tax benefits) (1,391 ) (2,861 )
Net income (loss) $ (15,695 ) $ (3,940 )
Page 41 Navigation LinksTotal loans and mortgage-backed securities, including those we hold for sale, increased $41 million during the current quarter to $10.8 billion or
84.2% of total assets at September 30, 2008. During the quarter, loans held for investment increased $119 million while loans held for sale declined $78
million.
Our loan originations, including loans purchased, totaled $804 million in the current quarter, up $110 million or 15.8% from the $694 million we
originated in the year-ago third quarter but 21.8% less than the $1.027 billion we originated in the second quarter of 2008. Loans originated for sale
declined $98 million or 39.8% from a year ago to $147 million, while single family loans originated for portfolio increased $128 million or 29.6% to $560
million. Our prepayment speed, which measures the annualized percentage of loans repaid, for residential one-to-four unit loans held for investment
declined from 27% a year ago to 9% in the current quarter and was down from 13% in the second quarter of 2008. During the current quarter, 42% of our
residential one-to-four unit originations represented refinance transactions, including new loans to refinance existing loans which we or other lenders
originated. This is down from 61% in the second quarter of 2008 and down from 79% in the year-ago third quarter.
Not included in the above originations are loans in which we modified the terms of the notes for borrowers. During the current quarter, we
modified $157 million of loans associated with our borrower retention program. This program provided borrowers who were current with their loan
payments with the opportunity to change from an adjustable rate loan subject to negative amortization to less costly financing alternatives, albeit at
new interest rates that were no less than those offered new borrowers. The majority of these modifications were modified into adjustable rate loans
whereby the interest rate adjusts semi-annually but does not permit negative amortization. An additional $149 million of loans were modified at below
market interest rates in loan workout situations.
We originate residential one-to-four unit mortgage loans both with and without loan origination fees. In mortgage transactions for which we
charge no origination fees, we receive a higher interest rate than those for which we charge origination fees. These loans generally result in deferrable
loan origination costs exceeding loan origination fees. A prepayment fee on these loans may be required if these loans are prepaid within the first three
years.
Originations of adjustable rate residential one-to-four unit loans for portfolio, including loans purchased, totaled $553 million in the current
quarter, up from $432 million in the year-ago quarter but down from $748 million in the second quarter of 2008. Of the current quarter total:
l 94% were adjustable rate loans – fixed for 3-5 years, compared with 74% in the year-ago quarter;
l 3% were adjustable rate loans tied to either the LIBOR index, which typically adjust every six months, or the Constant Maturity Treasury
(“CMT”) index unchanged from the year-ago quarter; and
l 3% were adjustable rate loans tied to either the FHLB Eleventh District Cost of Funds Index (“COFI”) or the 12-month moving average of yields
on actively traded U.S. Treasury securities adjusted to a constant maturity of one year (“MTA”) index and generally have rates that adjust
monthly and provide for negative amortization, compared with 23% in the year-ago quarter. Effective July 2008, we no longer offer to borrowers
loans that provide for negative amortization.
Page 42 Navigation LinksThe following table sets forth loans originated, including purchases, for investment and for sale during the periods indicated.
(a) Originations for the quarter ending September 30, 2007 are net of $1.0 million of cancelled loans that were originated in the previous quarter.
(b) All residential one-to-four unit loans.
The following table sets forth loans originated, including purchases, for investment and for sale during the year-to-date periods indicated.
(a) Primarily residential one-to-four unit loans.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Loans originated and purchased
Investment portfolio:
Residential one-to-four units:
Adjustable by index:
COFI $ 16,587 $ 1,515 $ 7,170 $ 77,163 $ 101,698
MTA (a) 354 1,706 740 4,953 (177 )
LIBOR 8,070 6,562 490 2,102 5,968
CMT 7,169 3,677 1,285 7,572 6,415
Adjustable – fixed for 3-5 years 521,273 734,242 424,939 302,705 317,770
Fixed 6,805 2,876 702 – 588
Total residential one-to-four units 560,258 750,578 435,326 394,495 432,262
Other 95,953 64,765 3,382 31,682 16,743
Total for investment portfolio 656,211 815,343 438,708 426,177 449,005
Sale portfolio (b) 147,292 211,726 237,356 192,053 244,831
Total for investment and sale portfolios $ 803,503 $ 1,027,069 $ 676,064 $ 618,230 $ 693,836
Nine Months Ended September 30,
(In Thousands) 2008 2007
Loans originated and purchased
Investment portfolio:
Residential one-to-four units:
Adjustable by index:
COFI $ 25,272 $ 257,201
MTA 2,800 7,621
LIBOR 15,122 383,069
CMT 12,131 66,543
Adjustable – fixed for 3-5 years 1,680,454 1,018,805
Fixed 10,383 873
Total residential one-to-four units 1,746,162 1,734,112
Other 164,100 49,119
Total for investment portfolio 1,910,262 1,783,231
Sale portfolio (a) 596,374 1,380,371
Total for investment and sale portfolios $ 2,506,636 $ 3,163,602
Page 43 Navigation LinksThe following table sets forth our investment portfolio of residential one-to-four unit adjustable rate loans by index, excluding our adjustable-
fixed for 3-5 year loans which are still in their initial fixed rate period, at the dates indicated.
(a) Excludes residential one-to-four unit adjustable-fixed for 3-5 year loans still in their initial fixed rate period.
Our adjustable rate mortgage loans generally:
l either begin with an incentive interest rate (“start rate”), which is an interest rate below the current market rate, that adjusts to the applicable
index plus a defined margin, subject to periodic and lifetime caps, after one, three, six or twelve months, or have a fixed interest rate for a period
of three to five years then adjust semi-annually or annually thereafter;
l provide that the maximum interest rate cannot exceed the start rate by more than six to twelve percentage points, depending on the type of loan
and the initial rate offered; and
l limit interest rate adjustments, for loans that adjust both the interest rate and payment amount simultaneously, to 1% per adjustment for those
that adjust semi-annually and 2% per adjustment for those that adjust annually.
Our adjustable rate loans subject to negative amortization, which are no longer offered to borrowers, have an interest rate that adjusts monthly
and a minimum monthly loan payment that adjusts annually. The start rate for these loans is lower than the fully-indexed rate and is the rate at which we
earned interest for the loan only during the first month. After the first month, interest accrues at the fully-indexed rate. The start rate, however, is used
to calculate the minimum monthly loan payment for the first twelve months. The borrower is required to make at least the minimum monthly payment,
but retains the option to make a larger payment to reduce loan principal and avoid negative amortization (the addition to loan principal of accrued
interest that exceeds the minimum monthly loan payment). If the borrower chooses to make the minimum monthly loan payment, and the interest accrual
based on the fully-indexed rate results in monthly interest due exceeding the payment amount, the loan balance will increase by the difference. These
payment options were clearly defined in the loan documents signed by the borrower at funding and are explained again on the borrower’s monthly
statement.
More particularly, our adjustable rate loans subject to negative amortization:
l typically limit the maximum loan balance to 110% of the original loan amount if the original loan-to-value ratio (a loan-to-value ratio is the
proportion of the principal amount of the loan to the lower of the sales price or appraised value of the property securing the loan at origination)
is greater than 75%, and to 115% if the loan-to-value ratio is 75% or less;
l have a lifetime interest rate cap, but no periodic cap on interest rate adjustments; and
l include a payment cap that limits the change in minimum monthly loan payments to 7.5% per year, unless the loan is recast (i.e., a new monthly
loan payment is calculated using the fully-indexed interest rate and provides for amortization of the loan balance over the remaining term of the
loan). A loan is recast every five years and additionally when the loan balance reaches the maximum level of loan balance permitted.
The maximum home loan we currently make for our own portfolio, except for a limited amount related to Community Reinvestment Act (“CRA”)
activities and loans to facilitate the sale of real estate acquired in settlement of loans, is equal to 80% of a property’s appraised value. If a loan incurs
negative amortization, the loan-to-value ratio could rise, which increases credit risk, and the fair value of the underlying collateral could be insufficient
to satisfy fully the outstanding loan obligation in the event of a loan default. A loan-to-value ratio is the proportion of the principal amount of the loan
to the lower of the sales price or appraised value of the property securing the loan at origination.
September 30, 2008 June 30, 2008 March 31, 2008 December 31, 2007 September 30, 2007
% of % of % of % of % of
(Dollars in Thousands) Amount Total Amount Total Amount Total Amount Total Amount Total
Loan Investment Portfolio
Residential one-to-four units:
Adjustable by index:
COFI $ 5,342,617 75% $ 5,599,857 75% $ 5,893,818 74% $ 6,383,837 75% $ 6,899,483 76%
MTA 950,163 13 1,047,051 14 1,163,661 15 1,256,672 15 1,398,540 15
LIBOR 255,208 4 250,271 3 274,555 3 444,483 5 586,143 7
Other, primarily CMT 579,518 8 588,571 8 595,695 8 394,829 5 204,513 2
Total adjustable loans (a) $ 7,127,506 100% $ 7,485,750 100% $ 7,927,729 100% $ 8,479,821 100% $ 9,088,679 100%
Page 44 Navigation LinksOur loan portfolio held for investment contains loans previously originated with a limit on the maximum loan balance of 125% of the original loan
amount. At September 30, 2008, loans with the higher 125% limit on the maximum loan balance represented 2% of our one-to-four unit residential loan
portfolio, while those with the 115% limit represented 4% and those with the 110% limit represented 46% of that portfolio. We permit adjustable rate
mortgage loans to be assumed by qualified borrowers.
While start rates of our loan products fluctuate with the market, we do not use them to qualify a loan applicant. Rather, we qualify an applicant for
adjustable rate mortgage loans using a fully-amortizing payment calculated from the higher of the fully-indexed rate or, currently, for our:
l lower risk applicants:
l 6.00% for owner occupied; or
l 6.25% for non-owner occupied.
l higher risk applicants:
l 7.00% for owner occupied; or
l 7.25% for non-owner occupied.
At September 30, 2008, $5.7 billion or 52% of our total residential one-to-four unit loans held for investment were subject to negative amortization.
The amount of negative amortization included in the loan balance declined $27 million during the quarter to $318 million or 5.6% of loans subject to
negative amortization. During current quarter, approximately 10% of our loan interest income represented negative amortization, down from 15% in the
second quarter of 2008 and 26% in year-ago third quarter. At origination, these loans had a weighted average loan-to-value ratio of 73%. In addition,
$4.4 billion or 40% of our residential one-to-four unit loans held for investment represented loans requiring interest only payments over the initial terms
of the loans, generally the first three to five years.
Page 45 Navigation LinksThe following table sets forth our investment portfolio of residential one-to-four unit adjustable rate loans subject to negative amortization and
with interest only payments, along with negative amortization included in the loan balance, loan to value ratio information and weighted average age of
the loans, at the dates indicated.
(a) Based on current loan balance relative to the lower of the appraised value or sales price at time of origination. (b) Loans with interest only
payments include loans modified with previously capitalized interest due to negative amortization.
Our adjustable rate loans subject to negative amortization require a payment recast every five years and additionally when the loan balance
reaches the maximum permissible level of negative amortization, while interest only loans require a payment recast when the initial fixed rate or interest
only period expires. At payment recast, the fully-indexed interest rate is used to calculate a new monthly loan payment that provides for full
amortization of the loan balance over the remaining term of the loan. Generally, the new loan payment is significantly higher and therefore default risk
typically increases. We have other adjustable rate loans that also are subject to payment recasts but the new loan payments are not likely to be as
Negative Loan to Current Weighted
Amortization Value Loan to Average
Loan % of Included in the Ratio at Value Age
(Dollars in Thousands) Balance Total Loan Balance Origination Ratio (a) (Months)
Loan Investment Portfolio
Residential one-to-four units subject to negative amortization:
At September 30, 2008:
With negative amortization:
Balance less than or equal to original loan amount $ 126,949 2% $ 1,063 71% 69% 42
Balance greater than original loan amount 4,925,666 86 316,439 74 79 37
Total with negative amortization 5,052,615 88 317,502 74 79 37
Not utilizing negative amortization 662,451 12 – 70 64 69
Total loans subject to negative amortization $ 5,715,066 100% $ 317,502 73% 77% 41
As a percentage of total residential one-to-four unit loans 52%
Total loans with interest only payments (b) $ 4,373,160 70% 71% 21
As a percentage of total residential one-to-four unit loans 40%
At December 31 2007:
With negative amortization:
Balance less than or equal to original loan amount $ 189,508 3% $ 1,253 70% 69% 37
Balance greater than original loan amount 6,501,649 86 377,411 74 78 29
Total with negative amortization 6,691,157 89 378,664 74 78 30
Not utilizing negative amortization 839,433 11 – 69 65 55
Total loans subject to negative amortization $ 7,530,590 100% $ 378,664 73% 77% 32
As a percentage of total residential one-to-four unit loans 69%
Total loans with interest only payments $ 2,745,117 70% 70% 16
As a percentage of total residential one-to-four unit loans 25%
At September 30, 2007:
With negative amortization:
Balance less than or equal to original loan amount $ 213,427 3% $ 1,358 70% 69% 36
Balance greater than original loan amount 7,104,531 86 386,626 74 78 27
Total with negative amortization 7,317,958 89 387,984 74 78 28
Not utilizing negative amortization 937,431 11 – 69 65 50
Total loans subject to negative amortization $ 8,255,389 100% $ 387,984 73% 76% 30
As a percentage of total residential one-to-four unit loans 74%
Total loans with interest only payments $ 2,456,416 69% 69% 13
As a percentage of total residential one-to-four unit loans 22%
severe as those associated with loans subject to negative amortization or interest only payments because the original loan payments already include
principal amortization.
Page 46 Navigation LinksThe following table sets forth projected first-time loan payment recasts for our investment portfolio of residential one-to-four unit adjustable rate
loans subject to negative amortization and loans with interest only payments for the fourth quarter of 2008 and annually thereafter through 2012. To
determine projected first-time loan payment recasts, we assumed that borrowers will continue to utilize negative amortization at the same rate as they
did in the preceding 12 months and no loans prepay. Therefore, the projected recast amounts may be overstated as some portion of these loans is likely
to prepay or be modified as part of our borrower retention or loan workout programs. For example, at the end of the second quarter of 2008, we
forecasted that $460 million of loans subject to negative amortization and loans with interest only payments would recast for the first-time during the
second quarter of 2008, of which $283 million did recast while:
l $61 million did not recast during the quarter as borrowers reduced their utilization of negative amortization;
l $53 million were modified during the quarter as part of our borrower retention program;
l $36 million were foreclosed upon;
l $16 million were modified as part of our loan workout program; and
l $11 million were paid off.
(a) Represents fully-amortizing adjustable rate loans.
Projected First-Time Loan Recasts at September 30, 2008 for
4th Quarter Year Ended Year Ended Year Ended Year Ended
(Dollars in Thousands) 2008 2009 2010 2011 2012
Loan Investment Portfolio
Residential one-to-four units:
Loans subject to negative amortization $ 287,489 $ 1,244,001 $ 1,412,573 $ 888,950 $ 430,995
Loans with interest only payments 1,905 152,819 32,397 1,437,642 1,270,105
All other loans (a) 394 87,283 45,591 302,689 50,908
Total $ 289,788 $ 1,484,103 $ 1,490,561 $ 2,629,281 $ 1,752,008
As a percentage of total residential
one-to-four unit loans 3% 14% 14% 24% 16%
Page 47 Navigation LinksAt September 30, 2008, 15% of our residential one-to-four unit loans were originated in 2008, with an additional 15% in 2007, and 25% in 2006,
which are relatively new and unseasoned. The following table sets forth our investment portfolio of residential one-to-four unit loans by year of
origination segregated by those subject to negative amortization, those with interest only payments and all others at the dates indicated. From year to
year, loans may change categories due to modification.
(a) Represents fully-amortizing adjustable rate loans and fixed rate loans.
Loans by Year of Origination
(Dollars in Thousands) 2004 and Prior 2005 2006 2007 2008 Balance
Loan Investment Portfolio
Residential one-to-four units:
At September 30, 2008:
Loans subject to negative amortization $ 1,486,305 $ 2,181,840 $ 1,599,568 $ 410,262 $ 37,091 $ 5,715,066
Hybrid adjustable rate loans:
Interest only payments 108,108 54,633 832,998 1,015,074 1,261,526 3,272,339
Fully amortizing 84,355 73,238 60,069 78,270 332,004 627,936
Total hybrid adjustable rate loans 192,463 127,871 893,067 1,093,344 1,593,530 3,900,275
Non-hybrid interest only loans 221,647 514,022 189,100 140,168 35,884 1,100,821
All other loans (a) 145,253 29,910 15,333 34,699 18,244 243,439
Total residential one-to-four units $ 2,045,668 $ 2,853,643 $ 2,697,068 $ 1,678,473 $ 1,684,749 $ 10,959,601
As a percentage of total residential
one-to-four unit loans 19% 26% 25% 15% 15% 100%
2004 and Prior 2005 2006 2007 2008 Balance
At September 30, 2007:
Loans subject to negative amortization $ 2,438,438 $ 3,512,669 $ 1,980,013 $ 324,269 $ – $ 8,255,389
Hybrid adjustable rate loans:
Interest only payments 147,222 51,784 918,761 887,577 – 2,005,344
Fully amortizing 82,773 2,326 51,250 51,861 – 188,210
Total hybrid adjustable rate loans 229,995 54,110 970,011 939,438 – 2,193,554
Non-hybrid interest only loans 43,109 14,001 133,086 260,876 – 451,072
All other loans (a) 160,497 10,936 16,826 139,287 – 327,546
Total residential one-to-four units $ 2,872,039 $ 3,591,716 $ 3,099,936 $ 1,663,870 $ – $ 11,227,561
As a percentage of total residential
one-to-four unit loans 25% 32% 28% 15% -% 100%
Page 48 Navigation LinksAt September 30, 2008, 90% of our residential one-to-four unit loans were concentrated and secured by properties located in California. The
following table sets forth the major geographic distribution of our investment portfolio of residential one-to-four unit loans at the dates indicated.
The following table sets forth our investment portfolio of residential one-to-four unit loans by the Fair Isaac Corporation credit score model
(“FICO”) of the borrower at origination at the dates indicated.
September 30,
2008 2007
% of % of
(Dollars in Thousands) Amount Total Amount Total
Loan Investment Portfolio
Residential one-to-four units:
California county:
Los Angeles $ 2,103,692 19% $ 2,053,395 19%
San Diego 1,213,173 11 1,287,091 12
Santa Clara 1,162,620 11 915,134 8
Orange 911,994 8 894,280 8
Alameda 557,382 5 569,392 5
Riverside 483,644 4 565,185 5
Contra Costa 471,255 4 493,200 4
San Mateo 356,430 3 298,290 3
San Bernardino 312,356 3 350,286 3
Sacramento 277,404 3 340,490 3
All other counties 2,038,234 19 2,172,137 19
Total California 9,888,184 90 9,938,880 89
Arizona 431,332 4 480,301 4
All other states 640,085 6 808,380 7
Total residential one-to-four units $ 10,959,601 100% $ 11,227,561 100%
September 30, 2008 June 30, 2008 March 31, 2008 December 31, 2007 September 30, 2007
% of % of % of % of % of
(Dollars in Thousands) Amount Total Amount Total Amount Total Amount Total Amount Total
Loan Investment Portfolio
Residential one-to-four units:
FICO score at Origination:
620 or below $ 341,495 3% $ 361,879 3% $ 384,320 4% $ 407,764 4% $ 443,748 4%
621 to 659 2,238,634 20 2,348,417 22 2,463,700 23 2,573,185 24 2,697,313 24
660 to 719 3,990,707 37 4,034,572 37 4,046,287 38 4,122,326 38 4,232,819 38
720 and above 4,262,804 39 4,020,953 37 3,683,490 34 3,630,721 33 3,705,685 33
Not available 125,961 1 129,068 1 134,438 1 143,232 1 147,996 1
Total residential one-to-four units $ 10,959,601 100% $ 10,894,889 100% $ 10,712,235 100% $ 10,877,228 100% $ 11,227,561 100%
Weighted average FICO score for
loan investment portfolio of
residential one-to-four units 704 702 698 697 696
Page 49 Navigation LinksThe following table sets forth our investment portfolio of residential one-to-four unit loans by original loan-to-value ratio at the dates indicated.
For this table, the loan-to-value ratios have been updated to reflect the current loan balance and, if private mortgage insurance has been removed, a
current appraisal.
(a) Primarily related to Community Reinvestment Act activities.
September 30, 2008 June 30, 2008 March 31, 2008 December 31, 2007 September 30, 2007
% of % of % of % of % of
(Dollars in Thousands) Amount Total Amount Total Amount Total Amount Total Amount Total
Loan Investment Portfolio
Residential one-to-four units:
80% or below:
60% or less $ 1,600,167 15% $ 1,590,553 15% $ 1,504,295 14% $ 1,539,989 14% $ 1,628,047 14%
61% to 70% 2,185,379 20 2,111,314 19 1,972,543 18 1,931,397 18 1,966,339 18
71% to 80% 6,722,658 61 6,711,241 61 6,717,851 63 6,866,261 63 7,067,710 63
Total 80% or below 10,508,204 96 10,413,108 95 10,194,689 95 10,337,647 95 10,662,096 95
81% to 85%:
With private mortgage insurance:
MGIC 8,255 8,928 8,923 7,805 7,782
RMIC 36,871 38,260 40,032 42,231 42,630
UGI 24,270 27,507 29,176 31,131 32,290
All others 1,096 1,260 1,448 1,452 1,786
Total with private mortgage
insurance 70,492 1 75,955 1 79,579 1 82,619 1 84,488 1
Without private mortgage insurance 2,971 – 2,991 – 2,805 – 1,728 – 1,145 –
Total 81% to 85% 73,463 1 78,946 1 82,384 1 84,347 1 85,633 1
86% to 89%:
With private mortgage insurance:
MGIC 19,167 20,134 20,552 19,563 21,252
RMIC 85,076 94,284 104,558 107,673 111,908
UGI 41,271 45,249 50,402 53,423 55,757
All others 4,319 4,351 4,941 4,959 6,051
Total with private mortgage
insurance 149,833 1 164,018 2 180,453 2 185,618 2 194,968 2
Without private mortgage insurance 5,195 – 4,457 – 4,532 – 4,624 – 4,355 –
Total 86% to 89% 155,028 1 168,475 2 184,985 2 190,242 2 199,323 2
90% and above:
With private mortgage insurance
MGIC 16,658 18,864 19,348 19,981 22,614
RMIC 104,696 113,895 126,184 132,823 140,568
UGI 58,670 62,172 66,047 73,066 77,989
All others 6,482 6,622 7,179 7,398 8,587
Total with private mortgage
insurance 186,506 2 201,553 2 218,758 2 233,268 2 249,758 2
Without private mortgage insurance (a) 33,808 – 30,114 – 28,534 – 28,778 – 27,786 –
Total 90% and above 220,314 2 231,667 2 247,292 2 262,046 2 277,544 2
Not available 2,592 – 2,693 – 2,885 – 2,946 – 2,965 –
Total residential one-to-four units $ 10,959,601 100% $ 10,894,889 100% $ 10,712,235 100% $ 10,877,228 100% $ 11,227,561 100%
Weighted average loan-to-value ratio
for loan investment portfolio of
residential one-to-four units 72 72 72 72 73
In addition to the other credit risks already identified, 74% of our residential one-to-four unit loans held for investment at September 30, 2008 were
underwritten based on borrower stated income and asset verification and an additional 5% were underwritten with no verification of either borrower
income or assets. In April 2008, we changed our guidelines to no longer permit stated income programs for portfolio loans.
Page 50 Navigation LinksCredit risks are mitigated primarily by various minimum borrower credit requirements and maximum loan-to-value ratio limitations. For example, at
September 30, 2008, the average loan-to-value ratio at origination of our residential one-to-four unit loan portfolio was 72%. However, even with these
requirements and limitations, our risk mitigation strategy is limited by potential defects in the underwriting process as well as potential changes in the
loan-to-value ratio due to negative amortization and declines in home values after the loans were originated. For example, while residential property
values increased in the past thereby further reducing our exposure to credit risk, home value declines emerged in 2006 and are continuing in most
markets in which we lend. The uncertainty of future home value changes may materially impact the risk associated with our loan portfolio since 55% of
these loans were originated after 2005.
We originated $3 million of home equity loans and lines of credit in the current quarter, unchanged from both the second quarter of 2008 and yearago
third quarter. During the current quarter, we originated $83 million of residential five or more unit loans, compared to $24 million in the second
quarter of 2008 and none in the year-ago third quarter. During the current quarter we originated less than $1 million of construction loans, down from
$36 million in the second quarter of 2008 and $12 million in the year-ago third quarter. Consumer loan originations totaled $1 million in the current
quarter, up from less than $1 million in the second quarter of 2008 but down from $2 million in the year-ago third quarter.
At September 30, 2008, our unfunded loan application pipeline totaled $423 million. Within that pipeline, we had commitments to borrowers for
short-term interest rate locks, before the reduction of expected fallout, of $216 million, of which $38 million were related to residential one-to-four unit
loans being originated for sale in the secondary market. Furthermore, we had commitments for undrawn lines of credit of $205 million and loans in
process of $63 million. We believe our current sources of funds will be adequate relative to these obligations.
Page 51 Navigation LinksThe following table sets forth the origination, purchase and sale activity relating to our loans and mortgage-backed securities for the quarters
indicated.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Investment Portfolio
Loans originated:
Loans secured by real estate:
Residential one-to-four units:
Adjustable $ 32,180 $ 13,460 $ 9,685 $ 92,109 $ 113,585
Adjustable – fixed for 3-5 years 521,273 734,242 424,939 302,386 318,089
Fixed 6,805 2,876 702 – 588
Total residential one-to-four units 560,258 750,578 435,326 394,495 432,262
Home equity loans and lines of credit 3,325 3,322 2,019 2,268 3,048
Residential five or more units – adjustable 82,970 24,345 – – –
Total residential 646,553 778,245 437,345 396,763 435,310
Commercial real estate 8,180 – – – –
Construction 271 36,478 275 28,524 11,551
Land 197 161 41 103 135
Non-mortgage:
Commercial – – 305 – 300
Consumer 1,010 459 742 787 1,709
Total loans originated 656,211 815,343 438,708 426,177 449,005
Loan repayments (297,790 ) (412,751 ) (552,942 ) (747,862 ) (979,625 )
Other net changes (a) (239,927 ) (388,083 ) (302,423 ) (247,000 ) (71,735 )
Increase (decrease) in loans held for investment, net 118,494 14,509 (416,657 ) (568,685 ) (602,355 )
Sale Portfolio
Residential one-to-four unit loans:
Originated 143,610 210,055 236,568 190,816 240,423
Purchased 3,682 1,671 788 1,237 4,408
Loans transferred to the investment portfolio (4,254 ) (1,077 ) (123 ) (579 ) (6,669 )
Originated whole loans sold (16,548 ) (398 ) (1,505 ) (1,999 ) (93,774 )
Loans exchanged for mortgage-backed securities (b) (204,613 ) (234,715 ) (227,482 ) (173,909 ) (243,546 )
Capitalized basis adjustment (c) 215 920 (1,243 ) (208 ) 2,103
Other net changes (d) 23 (151 ) (1,134 ) (2,202 ) (469 )
Increase (decrease) in loans held for sale, net (77,885 ) (23,695 ) 5,869 13,156 (97,524 )
Mortgage-backed securities, net:
Received in exchange for loans (b) 204,613 234,715 227,482 173,909 243,546
Sold (b) (204,613 ) (234,715 ) (227,482 ) (173,909 ) (243,546 )
Repayments (2 ) (3 ) (2 ) (1 ) (2 )
Other net changes – – – –
–
Decrease in mortgage-backed securities
available for sale (2 ) (3 ) (2 ) (1 ) (2 )
Increase (decrease) in loans held for sale and
mortgage-backed securities available for sale (77,887 ) (23,698 ) 5,867 13,155 (97,526 )
Total increase (decrease) in loans and
mortgage-backed securities, net $ 40,607 $ (9,189 ) $ (410,790 ) $ (555,530 ) $ (699,881 )
(a) Primarily included changes in undisbursed funds for lines of credit and construction loans, in loss allowances, in net deferred costs and
premiums, in interest capitalized on loans (negative amortization), and from loans transferred to real estate acquired in settlement of loans or from
(to) the held for sale portfolio.
(b) These transactions typically involve creation of an MBS by a government sponsored entity (GSE) from loans sold by, and delivered by, us to the
GSE. While the GSE is obligated to provide us with the MBS in exchange for the sold loans, the GSE typically fulfills this commitment through
delivery of the MBS directly to the third-party purchaser based on a forward sales commitment made by us to that third party. The sales of both the
loans and MBS are settled typically on a same-day basis such that we do not retain the MBS. If the MBS were to be retained with an intent to sell, we
would classify the security as held for trading and record changes in fair value in our consolidated statement of income.
(c) Reflected the change in fair value of the interest rate lock derivative from the date of rate lock to the date of funding. Effective January 2008, we
included the fair value of MSRs in the fair value of interest rate lock derivatives in accordance with Staff Accounting Bulletin 109, Written Loan
Commitments Recorded at Fair Value Through Earnings.
(d) Primarily included repayments and the change in net deferred costs and premiums.
Page 52 Navigation LinksThe following table sets forth the composition of our loan and mortgage-backed securities portfolios at the dates indicated.
(a) Reflected the change in fair value of the interest rate lock derivative from the date of rate lock to the date of funding. Effective January 2008, we
included the fair value of MSRs in the fair value of the interest rate lock derivatives in accordance with Staff Accounting Bulletin 109, Written Loan
Commitments Recorded at Fair Value Through Earnings.
We carry loans for sale at the lower of cost or fair value. At September 30, 2008, no valuation allowance was required as the fair value exceeded
book value on an aggregate basis.
We carry mortgage-backed securities available for sale at fair value which, at September 30, 2008, was essentially equal to our cost basis.
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Investment Portfolio
Loans secured by real estate:
Residential one-to-four units:
Adjustable $ 6,989,861 $ 7,343,057 $ 7,781,332 $ 8,302,538 $ 8,999,273
Adjustable – fixed for 3-5 years 3,916,019 3,504,702 2,884,877 2,528,287 2,180,099
Fixed 53,721 47,130 46,026 46,403 48,189
Total residential one-to-four units 10,959,601 10,894,889 10,712,235 10,877,228 11,227,561
Home equity loans and lines of credit 132,907 131,531 133,338 138,305 143,948
Residential five or more units:
Adjustable 193,914 120,565 99,522 100,098 103,798
Fixed 10,258 838 852 865 874
Commercial real estate:
Adjustable 28,796 21,562 23,651 23,837 23,966
Fixed 1,042 1,071 1,098 2,590 2,632
Construction 97,907 105,991 74,730 81,098 58,231
Land 10,708 10,524 10,373 49,521 50,864
Non-mortgage:
Commercial 5,305 5,505 5,305 5,000 5,000
Consumer 5,993 5,823 5,934 5,989 6,057
Total loans held for investment 11,446,431 11,298,299 11,067,038 11,284,531 11,622,931
Increase (decrease) for:
Undisbursed loan funds (64,674 ) (74,228 ) (51,595 ) (60,057 ) (48,063 )
Net deferred costs and premiums 129,573 139,295 147,811 156,853 169,195
Allowance for losses (761,824 ) (732,354 ) (546,751 ) (348,167 ) (142,218 )
Total loans held for investment, net 10,749,506 10,631,012 10,616,503 11,033,160 11,601,845
Sale Portfolio
Loans held for sale:
Residential one-to-four units 7,624 85,854 110,685 103,320 89,794
Net deferred costs and premiums (16 ) (146 ) (362 ) (109 ) 53
Capitalized basis adjustment (a) 65 (150 ) (1,070 ) 173 381
Total loans held for sale, net 7,673 85,558 109,253 103,384 90,228
Mortgage-backed securities available for sale:
Adjustable 104 106 109 111 112
Fixed – – – – –
Total mortgage-backed securities available for sale 104 106 109 111 112
Total loans held for sale and mortgage-backed
securities available for sale 7,777 85,664 109,362 103,495 90,340
Total loans and mortgage-backed securities, net $ 10,757,283 $ 10,716,676 $ 10,725,865 $ 11,136,655 $ 11,692,185
Page 53 Navigation LinksThe following table sets forth the composition of our investment securities portfolios at the dates indicated.
The fair value of temporarily impaired investment securities, the amount of unrealized losses and the length of time these unrealized losses existed
as of September 30, 2008 are presented in the following table. The $7 million unrealized loss on investment securities that have been in a loss position
for less than 12 months is due to changes in market interest rates and is not considered to be other than temporary. We have the intent and ability to
hold the securities until that temporary impairment is eliminated.
The following table sets forth the maturities of our investment securities and their weighted average yields at September 30, 2008.
(a) At September 30, 2008, 41% of our investment securities had step-up provisions that stipulate increases in the coupon rate ranging from 0.25% to
1.43% at various specified dates ranging from February 2011 to February 2020. In addition, at September 30, 2008, all of these investment
securities contained call provisions from June 2008 to November 2022. Yields for investment securities available for sale are calculated using
historical cost balances and are not adjusted for changes in fair value that are reflected as a separate component of stockholders’ equity.
Deposits
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Federal funds and interest earning due from banks $ 101,129 $ 11,060 $ – $ 5,900 $ 1,551
Investment securities available for sale:
U.S. Treasury – – – – –
Government sponsored entities 592,481 998,396 1,603,039 1,549,818 2,142,216
Other 61 61 61 61 62
Total investment securities $ 693,671 $ 1,009,517 $ 1,603,100 $ 1,555,779 $ 2,143,829
Less than 12 months 12 months or longer Total
Unrealized Unrealized Unrealized
(In Thousands) Fair Value Losses Fair Value Losses Fair Value Losses
Investment securities available for sale:
U.S. Treasury $ – $ – $ – $ – $ – $ –
Government sponsored entities 243,234 6,766 – – 243,234 6,766
Total temporarily impaired securities $ 243,234 $ 6,766 $ – $ – $ 243,234 $ 6,766
Amount Due as of September 30, 2008
In 1 Year After 1 Year After 5 Years After
(Dollars in Thousands) or Less Through 5 Years Through 10 Years 10 Years Total
Federal funds and interest earning due
from banks $ 101,129 $ – $ – $ – $ 101,129
Weighted average yield 0.77% -% -% -% 0.77%
Investment securities available for sale:
U.S. Treasury – – – – –
Weighted average yield -% -% -% -% -%
Government sponsored entities (a) – 349,247 98,124 145,110 592,481
Weighted average yield -% 5.09% 4.40% 4.68% 4.87%
Other – – – 61 61
Weighted average yield -% -% -% 6.25% 6.25%
Total investment securities $ 101,129 $ 349,247 $ 98,124 $ 145,171 $ 693,671
Weighted average yield 0.77% 5.09% 4.40% 4.68% 4.27%
At September 30, 2008, our deposits totaled $9.6 billion, down $1.0 billion or 9.8% from the year-ago level and $878 million or 8.4% from year-end
2007. Compared with the year-ago period, certificates of deposit declined $719 million or 8.7% and our transaction accounts (i.e., checking, money
market and regular passbook) declined $325 million or 13.8%. Within our transaction accounts, regular passbook accounts declined $290 million and
checking accounts declined $148 million while money market increased $113 million. Of the decline in checking, $8 million was in custodial accounts
related to loan servicing, which reflected the concurrent decline in loan prepayments.
Page 54 Navigation LinksAt September 30, 2008, our total number of branches was 175, of which 170 were located in California and five were located in Arizona. The
average deposit size of our 85 traditional branches was $89 million, while the average deposit size of our 90 in-store branches was $23 million.
The following table sets forth information concerning our deposits and weighted average rates paid at the dates indicated.
(a) Included amounts swept into money market deposit accounts.
Borrowings
At September 30, 2008, our borrowings totaled $2.3 billion, up $235 million from a year ago and up $913 million from year-end 2007. During the
current quarter, borrowings increased by $487 million and represented 18% of total assets at quarter end. This increase is largely due to additional
FHLB advances of $585 million, partially offset by the decline in securities sold under agreements to repurchase of $98 million.
The following table sets forth information concerning our FHLB advances and other borrowings at the dates indicated.
(a) Included the impact of interest rate swap contracts, with notional amounts totaling $430 million of receive-fixed, pay-3-month LIBOR variable
September 30, 2008 June 30, 2008 March 31, 2008 December 31, 2007 September 30, 2007
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average
(Dollars in Thousands) Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount
Transaction accounts:
Non-interest-bearing
checking (a) -% $ 628,492 -% $ 664,895 -% $ 673,717 -% $ 645,730 -% $ 679,148
Interest-bearing
checking (a) 0.27 365,930 0.27 443,801 0.29 467,051 0.27 464,980 0.27 462,973
Money market 2.26 251,160 1.47 185,036 1.04 137,745 1.04 134,640 1.04 138,256
Regular passbook 0.89 781,622 0.93 1,002,450 0.93 1,033,302 0.95 1,035,964 0.95 1,071,728
Total transaction
accounts 0.67 2,027,204 0.58 2,296,182 0.54 2,311,815 0.55 2,281,314 0.55 2,352,105
Certificates of deposit:
Less than 2.00% 1.26 22,805 1.27 26,765 1.28 26,374 1.25 21,915 1.28 20,070
2.00-2.49 2.45 464,836 2.45 475,931 2.44 118,716 2.31 148 2.33 163
2.50-2.99 2.94 1,532,295 2.92 1,927,169 2.90 370,206 2.83 6,889 2.83 8,068
3.00-3.49 3.15 1,880,018 3.23 1,715,721 3.29 1,094,117 3.28 72,288 3.28 87,110
3.50-3.99 3.84 1,147,577 3.76 776,072 3.75 894,761 3.86 43,481 3.84 49,390
4.00-4.49 4.17 1,552,749 4.24 557,160 4.23 618,422 4.29 306,302 4.26 189,990
4.50-4.99 4.68 924,106 4.80 1,845,236 4.81 4,061,873 4.85 6,026,108 4.91 5,225,991
5.00-5.49 5.05 66,787 5.07 260,735 5.09 747,306 5.10 1,736,673 5.11 2,728,452
5.50 and greater 6.06 7 6.06 7 6.06 699 6.00 923 5.82 1,279
Total certificates
of deposit 3.57 7,591,180 3.67 7,584,796 4.33 7,932,474 4.85 8,214,727 4.93 8,310,513
Total deposits 2.96% $ 9,618,384 2.95% $ 9,880,978 3.47% $ 10,244,289 3.92% $ 10,496,041 3.96% $ 10,662,618
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 2008 2008 2008 2007 2007
Securities sold under agreements to repurchase $ – $ 97,838 $ 103,000 $ – $ 566,350
Federal Home Loan Bank advances (a) 2,110,061 1,525,034 1,434,602 1,197,100 1,308,867
Senior notes 198,593 198,543 198,494 198,445 198,398
Total borrowings $ 2,308,654 $ 1,821,415 $ 1,736,096 $ 1,395,545 $ 2,073,615
Weighted average rate on borrowings during
the quarter (a) 3.68% 3.73% 4.74% 5.80% 5.94%
Total borrowings as a percentage of total assets 18.06 14.42 13.22 10.41 14.38
interest, which contracts serve as a permitted hedge against a portion of our FHLB advances.
Page 55 Navigation LinksWe consolidate majority-owned subsidiaries that we control. We account for other affiliates, including joint ventures, in which we do not exhibit
significant control or have majority ownership, by the equity method of accounting. For those relationships in which we own less than 20%, we
generally carry them at cost. In the course of our business, we participate in real estate joint ventures through our wholly-owned subsidiary, DSL
Service Company. Our real estate joint ventures do not require consolidation as a result of applying the provisions of Financial Accounting Standards
Board Interpretation 46 (revised December 2003).
We utilize financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These
financial instruments include commitments to originate fixed and variable rate mortgage loans held for investment, undisbursed loan funds, lines and
letters of credit, commitments to purchase loans and mortgage-backed securities for our portfolio and commitments to invest in community
development funds. The contract or notional amounts of these instruments reflect the extent of involvement we have in particular classes of financial
instruments. For further information, see Asset/Liability Management and Market Risk on page 56 and Note 5 of Notes to the Consolidated Financial
Statements on page 15.
We use the same credit policies in making commitments to originate or purchase loans, lines of credit and letters of credit as we do for on-balance
sheet instruments. For commitments to originate loans held for investment, the contract amounts represent exposure to loss from market fluctuations as
well as credit loss. In regard to these commitments, adverse changes from market fluctuations are generally not hedged. We control the credit risk of our
commitments to originate loans held for investment through credit approvals, limits and monitoring procedures.
We do not dispose of loans or assets by means of unconsolidated special purpose entities.
Transactions with Related Parties
There are no significant related party transactions required to be disclosed in accordance with FASB Statement No. 57, Related Party Disclosures.
Loans to our executive officers and directors were made in the ordinary course of business and were made on substantially the same terms as
comparable transactions.
Asset/Liability Management and Market Risk
Market risk is the risk of loss or reduced earnings from adverse changes in market prices and interest rates. Our market risk arises primarily from
interest rate risk in our lending and deposit taking activities. Interest rate risk primarily occurs to the degree that our interest-bearing liabilities reprice or
mature on a different basis and frequency than our interest-earning assets. Since our earnings depend primarily on our net interest income, which is the
difference between the interest and dividends earned on interest-earning assets and the interest paid on interest-bearing liabilities, our principal
objectives are to actively monitor and manage the effects of adverse changes in interest rates on net interest income. Our primary strategy in managing
interest rate risk is to emphasize the origination for investment of adjustable rate mortgage loans or loans with relatively short maturities. Interest rates
on adjustable rate mortgage loans are primarily tied to COFI, MTA, LIBOR and CMT. We also may execute swap contracts to change interest rate
characteristics of our interest-earning assets or interest-bearing liabilities to better manage interest rate risk.
In addition to the interest rate risk associated with our lending for investment and deposit-taking activities, we also have market risk associated
with our secondary marketing activities. Changes in mortgage interest rates, primarily fixed rate mortgage loans, impact the fair value of loans held for
sale as well as our interest rate lock commitment derivatives, where we have committed to an interest rate with a potential borrower for a loan we intend
to sell. Our objective is to hedge against fluctuations in interest rates through the use of loan forward sale and purchase contracts with governmentsponsored
enterprises and whole loan sale contracts with various other parties. These contracts are typically obtained at or about the time the interest
rate lock commitments are made. Therefore, as interest rates fluctuate, the changes in the fair value of our interest rate lock commitments and loans held
for sale tend to be offset by changes in the fair value of the hedge contracts. We continue to hedge as previously done before the issuance of SFAS
133. As applied to our risk management strategies, SFAS 133 may increase or decrease reported net income and stockholders’ equity, depending on
interest rates and other variables affecting the fair values of derivative instruments and hedged items, but will have no effect on the overall economics
of the transactions. The method used for assessing the effectiveness of a hedging derivative, as well as the measurement approach for determining the
ineffective aspects of the hedge, is established at the inception of the hedge. We generally do not enter into derivative contracts for speculative
purposes.
Page 56 Navigation LinksChanges in mortgage interest rates also impact the value of our MSRs. Rising interest rates typically result in slower prepayment speeds on the
loans being serviced for others which increase the value of MSRs. Declining interest rates typically result in faster prepayment speeds which decrease
the value of MSRs. Over time, we may use derivatives or securities to provide an economic hedge against value changes in our MSRs.
Page 57 Navigation LinksOne measure of our exposure to differential changes in interest rates between assets and liabilities is shown in the following table which sets forth
the repricing frequency of our major asset and liability categories as of September 30, 2008, as well as other information regarding the repricing and
maturity differences between our interest-earning assets and total deposits and borrowings in future periods. We refer to these differences as “gap.”
We have determined the repricing frequencies by reference to projected maturities, based upon contractual maturities as adjusted for scheduled
repayments and “repricing mechanisms”-provisions for changes in the interest and dividend rates of assets and liabilities. Prepayment rates on
substantially our entire loan portfolio are based upon anticipated future prepayment behavior as derived from external models of loans with similar
characteristics. Repricing mechanisms on a number of our assets are subject to limitations, such as caps on the amount that interest rates and payments
on our loans may adjust, and accordingly, these assets may not respond to changes in market interest rates as completely or rapidly as our liabilities.
The interest rate sensitivity of our assets and liabilities illustrated in the following table would vary substantially if we used different assumptions or if
actual experience differed from the assumptions set forth.
September 30, 2008
After 6 Months After 1 Year After 5 Years
Within Through 12 Through 5 Through 10 Beyond Total
(Dollars in Thousands) 6 Months Months Years Years 10 Years Balance
Interest-earning assets:
Investment securities and stock (a) $ 447,116 $ 11,291 $ 368,519 $ – $ – $ 826,926
Loans and mortgage-backed securities: (b)
Loans secured by real estate:
Residential one-to-four units:
Adjustable 6,387,381 423,273 3,475,101 – – 10,285,755
Fixed 7,750 2,187 15,038 13,732 19,958 58,665
Home equity loans and lines of credit 131,471 51 347 220 – 132,089
Residential five or more units:
Adjustable 69,242 14,845 68,308 30,145 – 182,540
Fixed 281 364 2,609 6,220 144 9,618
Commercial real estate 15,382 3,250 4,701 3,551 – 26,884
Construction 45,053 – – – – 45,053
Land 7,463 – – – – 7,463
Non-mortgage loans:
Commercial 3,451 – – – – 3,451
Consumer 5,661 – – – – 5,661
Mortgage-backed securities 104 – – – – 104
Total loans and mortgage-backed securities, net 6,673,239 443,970 3,566,104 53,868 20,102 10,757,283
Total interest-earning assets $ 7,120,355 $ 455,261 $ 3,934,623 $ 53,868 $ 20,102 $ 11,584,209
Transaction accounts:
Non-interest-bearing checking (c) $ 628,492 $ – $ – $ – $ – $ 628,492
Interest-bearing checking (d) 365,930 – – – – 365,930
Money market (e) 251,160 – – – – 251,160
Regular passbook (e) 781,622 – – – – 781,622
Total transaction accounts 2,027,204 – – – – 2,027,204
Certificates of deposit (f) 5,138,288 1,727,482 725,410 – – 7,591,180
Total deposits 7,165,492 1,727,482 725,410 – – 9,618,384
FHLB advances and other borrowings (g) 960,061 – 1,150,000 – – 2,110,061
Senior notes – – – 198,593 – 198,593
Total deposits and borrowings $ 8,125,553 $ 1,727,482 $ 1,875,410 $ 198,593 $ – $ 11,927,038
Excess (shortfall) of interest-earning assets
over deposits and borrowings $ (1,005,198 ) $ (1,272,221 ) $ 2,059,213 $ (144,725 ) $ 20,102 $ (342,829 )
Cumulative gap (1,005,198 ) (2,277,419 ) (218,206 ) (362,931 ) (342,829 )
Cumulative gap – as a percentage of total assets:
September 30, 2008 (7.86 )% (17.82 )% (1.71 )% (2.84 )% (2.68 )%
December 31, 2007 3.59 (2.96 ) 7.85 6.46 6.50
(a) Includes FHLB stock and is based on contractual maturity and repricing/call date.
(b) Based on contractual maturity, repricing date and projected repayment of principal. Prepayment rate based on speeds in September 2008
blended for entire portfolio.
(c) Even though no interest is paid on these accounts, they are classified as repricing within six months, which increases negative gap.
(d) Includes amounts swept into money market deposit accounts and is subject to immediate repricing.
(e) Subject to immediate repricing.
(f) Based on contractual maturity.
(g) Excludes embedded interest rate caps with a notional amount of $50 million and a three-month LIBOR strike rate equal to 5.50%.
September 30, 2007 5.89 (2.27 ) 9.36 8.07 8.11
Page 58 Navigation LinksOur six-month gap at September 30, 2008 was a negative 7.86%. This means more deposits and borrowings mature or reprice within six months
than total interest-earning assets. This compares to our positive six-month gap of 3.59% at December 31, 2007 and 5.89% a year ago, which reflected
more interest-earning assets repricing within six months than total deposits and borrowings. The change since year-end 2007 from a positive to
negative gap is primarily due to an increase of adjustable rate loans with interest rates fixed for the first 3 to 5 years without a commensurate increase in
the maturities for our FHLB advances and certificates of deposit.
We continue to emphasize the origination of adjustable rate mortgages for our investment portfolio, which includes our adjustable – fixed for 3-5
years loans that carry a fixed interest rate for a period of three to five years then adjust semi-annually or annually thereafter. For the twelve months
ended September 30, 2008, we originated and purchased for investment $2.3 billion of adjustable rate loans, of which $2.0 billion or 85% were adjustable
– fixed for 3-5 years loans, which represented essentially all of the loans we originated and purchased for investment during the period.
At September 30, 2008, December 31, 2007 and September 30, 2007 essentially all of our interest-earning assets mature, reprice or are estimated to
prepay within five years. Essentially all of our loans held for investment and mortgage-backed securities portfolios consisted of adjustable rate loans
and loans with a due date of five years or less, and totaled $11.4 billion at September 30, 2008 compared with $11.2 billion at December 31, 2007 and $11.6
billion a year ago. During the current quarter, we continued to offer residential fixed rate loan products to our customers primarily for sale in the
secondary market. We originate fixed rate loans primarily for sale in the secondary market and price them accordingly to create loan servicing income
and to increase opportunities for originating adjustable rate mortgage loans. However, we may originate fixed rate loans for investment if these loans
meet specific yield, interest rate risk and other approved guidelines, or to facilitate the sale of real estate acquired through foreclosure.
The following table sets forth the interest rate spread between our interest-earning assets and interest-bearing liabilities at the dates indicated.
(a) Excludes adjustments for non-accrual loans, amortization of net deferred costs to originate loans, premiums and discounts, troubled debt
restructuring (“TDR”) yield adjustments, prepayment and late fees.
(b) Excludes FHLB stock dividends and includes the yield on investment securities accounted for on a trade-date basis but for which interest income
will not be recognized until settlement. Yields for investment securities available for sale are calculated using historical cost balances and are not
adjusted for changes in fair value that are reflected as a separate component of stockholders’ equity.
(c) Included the impact of interest rate swap contracts, with notional amounts totaling $430 million of receive-fixed, pay-3-month LIBOR variable
interest, which contracts serve as a permitted hedge against a portion of our FHLB advances.
The period-end weighted average yield on our loans and mortgage-backed securities was 6.26% at September 30, 2008, down from 7.41% at
December 31, 2007 and 7.45% a year ago. At September 30, 2008, our adjustable rate mortgage portfolio of single family residential loans, including
mortgage-backed securities, totaled $10.9 billion with a weighted average rate of 6.24%, compared with $10.8 billion with a weighted average rate of
7.29% at December 31, 2007, and $11.2 billion with a weighted average rate of 7.41% at September 30, 2007.
September 30, June 30, March 31, December 31, September 30,
2008 2008 2008 2007 2007
Weighted average yield:
Loans and mortgage-backed securities (a) 6.26% 6.57% 7.10% 7.41% 7.45%
Investment securities (b) 4.27 4.88 5.01 5.09 5.50
Interest-earning assets yield 6.14 6.44 6.84 7.14 7.15
Weighted average cost:
Deposits 2.96 2.95 3.47 3.92 3.96
Borrowings:
Securities sold under agreements to repurchase – 2.40 2.92 – 5.14
Federal Home Loan Bank advances (c) 3.81 3.35 3.49 5.61 5.96
Senior notes 6.50 6.50 6.50 6.50 6.50
Total borrowings 4.04 3.64 3.80 5.74 5.79
Combined funds cost 3.17 3.06 3.52 4.14 4.26
Interest rate spread 2.97% 3.38% 3.32% 3.00% 2.89%
Page 59 Navigation LinksNon-performing assets consist of loans on which we have ceased accruing interest (which we refer to as non-accrual loans), loans restructured at
an interest rate below market and real estate acquired in settlement of loans. At the beginning of the third quarter of 2007, we initiated our borrower
retention program to provide borrowers who are current with their loan payments a cost effective means to change from an adjustable rate loan subject
to negative amortization to a less costly financing alternative. Those loans are considered TDRs and have been placed on non-accrual status even
though the interest rates following modification were no less than those offered new borrowers. The reason for this is because the modified interest rate
was lower than the interest rate on the original loan and the loan was not re-underwritten to prove that the new interest rate was, in fact, a market
interest rate for a borrower with similar credit quality. Interest income is recorded as these borrowers make their loan payments and, in the current
quarter, $8.7 million was recognized including $1.1 million of amortization of associated impairment allowance. If these borrowers perform pursuant to
the modified terms for six consecutive months, the loans will be placed back on accrual status and, while still reported as TDRs, they will no longer be
classified as non-performing assets because the borrower will have demonstrated an ability to perform in accordance with the loan modification and the
interest rate was no less than those afforded new borrowers at the time of modification.
Our non-performing assets totaled $2.002 billion at September 30, 2008, up from $1.042 billion at December 31, 2007 and $424 million at September
30, 2007. Virtually all of the $44 million increase in non-performing assets during the current quarter came from our single family residential loans which,
in turn, reflected the following:
l A $169 million increase in TDR loans modified in loan workout situations and borrower retention program loans where at least one payment due
has not been made; and
l A $30 million net increase in single family residential real estate acquired in settlement of loans.
Those increases were partially offset by declines in performing TDR loans modified as part of our previously disclosed borrower retention program of
$139 million and in our non-TDR loans of $5 million. At September 30, 2008, $621 million of TDR loans for which we have received six consecutive
months of successful loan payments were removed from non-performing assets and placed on accrual status, of which $578 million were associated
with our borrower retention program and $43 million were associated with loans modified in loan workout situations.
Our non-performing assets as a percentage of total assets were 15.66% at September 30, 2008, up from 7.77% at year-end 2007 and 2.94% a year
ago. To the extent borrowers whose loans were modified pursuant to the borrower retention program are current with their loan payments and included
in non-performing assets, it is relevant to distinguish those from total non-performing assets because, these loans are paying interest at interest rates
no less than those offered new borrowers. At September 30, 2008, $409 million or 72% of such borrowers had made all loan payments due. Accordingly,
the 15.66% ratio of non-performing assets to total assets includes 3.20% related to performing TDRs, resulting in an adjusted ratio of 12.46%.
Page 60 Navigation LinksThe following table summarizes our non-performing assets at the dates indicated.
(a) Represents TDRs associated with loans modified pursuant to our borrower retention program and all payments due have been made. These loans
are considered TDRs and have been placed on non-accrual status even though the interest rate following modification was no less than that offered
new borrowers at the time of loan modification. These TDR loans will be on non-accrual status until six consecutive months of successful payment
history has been established, at which time they will be removed from non-accrual status and from non-performing assets; however, they will
continue to be reported as TDRs. While these loans are on non-accrual status, interest income is recognized only when paid by borrowers on a cash
basis.
(b) Amount is net of a valuation allowance of $11 million at September 30, 2008 and $18 million at June 30, 2008, which reflects recent loss
experience from sales compared to their fair value prior to sale.
(c) Represents loans where the borrower has made six consecutive months of successful loan payments and the loan has been placed on accrual
status, including $578 million associated with our borrower retention program and $43 million related to loans modified in loan workout
situations.
We evaluate the need for property valuations of non-performing assets on a periodic basis. We generally will obtain a new property valuation
when we believe there may have been an adverse change in the property operations or in the economic conditions of the geographic market of the
property securing our loans. Our policy is to obtain new property valuations at least annually for all real estate acquired in settlement of loans, but in a
declining real estate market such as the recent market, we typically obtain new property valuations more frequently.
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 2008 2008 2008 2007 2007
Non-accrual loans:
Residential one-to-four units:
Performing troubled debt restructurings (a) $ 408,976 $ 548,096 $ 589,304 $ 400,562 $ 96,984
Other troubled debt restructurings 410,260 240,775 110,368 31,218 5,173
All other 888,644 894,104 658,334 448,516 253,259
Residential five or more units 2,900 – – – –
Construction 12,195 12,790 14,869 15,933 7,808
Land – – – 29,080 –
Other 448 566 487 837 511
Total non-accrual loans 1,723,423 1,696,331 1,373,362 926,146 363,735
Real estate acquired in settlement of loans (b) 278,091 261,536 189,127 115,623 59,773
Total non-performing assets $ 2,001,514 $ 1,957,867 $ 1,562,489 $ 1,041,769 $ 423,508
Allowance for loan losses:
Amount $ 761,824 $ 732,354 $ 546,751 $ 348,167 $ 142,218
As a percentage of non-accrual loans 44.20% 43.17% 39.81% 37.59% 39.10%
Non-performing assets as a percentage of total assets:
Performing troubled debt restructurings (a) 3.20 4.34 4.49 2.99 0.67
All other non-performing assets 12.46 11.16 7.41 4.78 2.27
Total non-performing assets 15.66% 15.50% 11.90% 7.77% 2.94%
Performing troubled debt restructurings excluded
from non-performing assets (c) $ 620,903 $ 354,842 $ 49,141 $ – $ –
Page 61 Navigation LinksAt September 30, 2008, 90% of our non-performing assets were located in California, compared with 86% a year ago. The following table
summarizes by major geographical area our residential one-to-four unit non-performing assets at the dates indicated.
Troubled Debt Restructurings
We consider a restructuring of a debt a TDR when we, for economic or legal reasons related to the borrower’s financial difficulties, grant a
concession to the borrower that we would not otherwise grant. TDRs may include changing repayment terms, reducing the stated interest rate,
reducing the amounts of principal and/or interest due or extending the maturity date. The restructuring of a loan is intended to recover as much of our
investment as possible and to achieve the highest yield possible. During the current quarter, the total interest recognized on the impaired portfolio was
$27.0 million. At September 30, 2008, we had $1.452 billion of principal balance for TDRs of which $1.150 billion related to the borrower retention
program, $290 million related to other residential one-to-four unit loans and $12 million related to two construction loans. Of those TDRs related to our
borrower retention program, $578 million have demonstrated six consecutive months of successful payment history, were accruing interest and were no
longer reported as a non-performing asset at September 30, 2008. During the current quarter, $8.7 million of interest income was recognized from TDR
loan payments, including $1.1 million of amortization of the associated impairment allowance. There are $43 million of TDR loans modified in loan
workout situations that are currently accruing interest and were no longer reported as a non-performing assets at September 30, 2008.
Real Estate Acquired in Settlement of Loans
Real estate acquired in settlement of loans consists of real estate acquired through foreclosure or deeds in lieu of foreclosure and totaled $278
million at September 30, 2008. Of this amount, $266 million, net of a $11 million valuation allowance which reflects recent loss experience from sales
compared to their fair value prior to sale, was for 1,080 residential one-to-four unit properties, $8 million represented one property consisting of raw land
for approximately 545 single family lots and $4 million represented one property consisting of 113 single family lots. We generally require private
mortgage insurance on loans in excess of 80% of their appraised value. In the current quarter, subsequent to our acquiring real estate in the settlement
of loans, we collected $6.0 million in private mortgage insurance to mitigate any losses incurred.
September 30, 2008 September 30, 2007
Non- Non- % of Non- Non- % of
Performing Performing Related Performing Performing Related
(Dollars in Thousands) Loans REO Assets Assets Loans REO Assets Assets
Loan Investment Portfolio
Residential one-to-four units:
California county:
Los Angeles $ 238,654 $ 21,673 $ 260,327 12.2% $ 26,170 $ 2,835 $ 29,005 1.4%
San Diego 237,981 45,079 283,060 22.5 38,817 10,269 49,086 3.8
Santa Clara 89,249 12,257 101,506 8.6 8,458 1,631 10,089 1.1
Orange 125,587 13,183 138,770 15.0 13,963 619 14,582 1.6
Alameda 72,096 17,112 89,208 15.5 8,915 2,329 11,244 2.0
Riverside 109,688 16,318 126,006 25.2 25,372 2,930 28,302 5.0
Contra Costa 83,095 21,427 104,522 21.2 8,874 3,286 12,160 2.5
San Mateo 39,387 3,687 43,074 12.0 3,079 1,368 4,447 1.5
San Bernardino 66,353 8,687 75,040 23.4 10,662 755 11,417 3.3
Sacramento 69,599 18,655 88,254 29.8 17,910 4,001 21,911 6.4
All other counties 388,589 80,430 469,019 22.1 56,945 15,503 72,448 3.3
Total California 1,520,278 258,508 1,778,786 17.5 219,165 45,526 264,691 2.7
Arizona 66,278 9,149 75,427 17.1 9,197 1,086 10,283 2.1
All other states 121,324 9,893 131,217 20.2 27,477 5,837 33,314 4.1
Valuation allowance – (11,071 ) (11,071 ) (1.0 ) – – – –
Total residential
one-to-four units $ 1,707,880 $ 266,479 $ 1,974,359 17.6% $ 255,839 $ 52,449 $ 308,288 2.7%
Page 62 Navigation LinksThe following table summarizes the activity of our number of residential one-to-four unit properties acquired in settlement of loans and the loss
given default on those sold for the quarters indicated.
(a) Reflects the difference between the net sales proceeds and loan principal balance at foreclosure adjusted for associated deferred costs and fees,
premiums and discounts, and collection of mortgage insurance as a percentage of their loan principal balance at foreclosure. The ratio does not
include the cost to carry or real estate related costs, such as property taxes, which are expensed as incurred.
At September 30, 2008, 169 properties or 15.6% of our one-to-four unit residential properties were in escrow to be sold and offers were being
negotiated on an additional 91 properties.
Delinquent Loans
At September 30, 2008, loans delinquent 30 days or more as a percentage of total loans was 12.41%, up from 6.05% at December 31, 2007 and
3.30% a year ago. The increase from the year-ago quarter occurred primarily in our residential one-to-four unit loan classification. As a percentage of its
loan category, delinquent residential one-to-four units increased from 3.41% at September 30, 2007 to 12.91% at September 30, 2008, reflecting the
continued weakness in the residential real estate market. A higher incidence of delinquency is expected when the minimum payments reset on our
adjustable rate loans subject to negative amortization or interest only payments, whereby the interest rate is fixed for the first three to five years. For
example, we had loans subject to negative amortization or with interest only payments that have not been modified within our loans held for investment,
which recasted for the first time in 2007 or 2008 of $1.2 billion, of which 47.65% were delinquent 30 days or more at September 30, 2008. The increase in
delinquency is considered when we analyze the adequacy of our credit loss allowance.
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 2008 2008 2008 2007 2007
Number of residential one-to-four unit
properties acquired in settlement of loans
Count at beginning of period 888 575 326 162 90
New 596 522 316 212 109
Sold (404 ) (209 ) (67 ) (48 ) (37 )
Count at end of period 1,080 888 575 326 162
Loss given default (a) 35.9% 31.8% 22.3 % 22.2% 8.1%
Page 63 Navigation LinksThe following table indicates the amounts of our past due loans at the dates indicated.
September 30, 2008 June 30, 2008
30-59 60-89 90+ 30-59 60-89 90+
(Dollars in Thousands) Days Days Days (a) Total Days Days Days (a) Total
Loans secured by real estate:
Residential:
One-to-four units $ 274,844 $ 200,502 $ 940,731 $ 1,416,077 $ 269,429 $ 209,610 $ 796,358 $ 1,275,397
Home equity loans and lines of credit – 569 365 934 212 – 490 702
Five or more units – – – – – – – –
Commercial real estate – – – – – – – –
Construction – 4,136 – 4,136 – – – –
Land – – – – – – – –
Total real estate loans 274,844 205,207 941,096 1,421,147 269,641 209,610 796,848 1,276,099
Non-mortgage:
Commercial – – – – – – – –
Consumer 32 5 83 120 17 5 76 98
Total delinquent loans $ 274,876 $ 205,212 $ 941,179 $ 1,421,267 $ 269,658 $ 209,615 $ 796,924 $ 1,276,197
Delinquencies as a percentage
of total loans 2.40% 1.79% 8.22% 12.41% 2.37% 1.84% 7.00% 11.21%
March 31, 2008 December 31, 2007
Loans secured by real estate:
Residential:
One-to-four units $ 226,100 $ 160,775 $ 576,130 $ 963,005 $ 205,737 $ 134,715 $ 313,528 $ 653,980
Home equity loans and lines of credit 131 – 422 553 – 450 776 1,226
Five or more units – – – – – – – –
Commercial real estate – – – – – – – –
Construction – – – – – – – –
Land – – – – 33,580 – – 33,580
Total real estate loans 226,231 160,775 576,552 963,558 239,317 135,165 314,304 688,786
Non-mortgage:
Commercial – – – – – – – –
Consumer 19 9 65 93 21 12 61 94
Total delinquent loans $ 226,250 $ 160,784 $ 576,617 $ 963,651 $ 239,338 $ 135,177 $ 314,365 $ 688,880
Delinquencies as a percentage
of total loans 2.02% 1.44% 5.16% 8.62% 2.10% 1.19% 2.76% 6.05%
September 30, 2007
Loans secured by real estate:
Residential:
One-to-four units $ 129,329 $ 75,757 $ 180,422 $ 385,508
Home equity loans and lines of credit 212 195 444 851
Five or more units – – – –
Commercial real estate – – – –
Construction – – – –
Land – – – –
(a) All 90 day or greater delinquencies are on non-accrual status and reported as part of non-performing assets.
Total real estate loans 129,541 75,952 180,866 386,359
Non-mortgage:
Commercial – – – –
Consumer 22 6 67 95
Total delinquent loans $ 129,563 $ 75,958 $ 180,933 $ 386,454
Delinquencies as a percentage
of total loans 1.11% 0.65% 1.54% 3.30%
Page 64 Navigation LinksWe maintain a valuation allowance for credit and real estate losses to provide for losses inherent in those portfolios at the balance sheet date. The
allowance for credit losses includes an allowance for loan losses reported as a reduction of loans held for investment and the allowance for loan-related
commitments reported in accounts payable and accrued liabilities. Management evaluates the adequacy of the allowance quarterly to maintain the
allowance at levels sufficient to provide for inherent losses at the balance sheet date.
We use an internal asset review system and loss allowance methodology designed to provide for timely recognition of problem assets and an
adequate allowance to cover asset and loan-related commitment losses. The amount of the allowance is based upon the total of general valuation
allowances, allocated allowances and specific allowances. General valuation allowances relate to assets and loan-related commitments with no welldefined
deficiency or weakness and take into consideration losses that are embedded within the portfolio but have not yet been realized. Allocated
allowances relate to assets segregated into different classifications with well-defined deficiencies or weaknesses. Loans evaluated individually that are
deemed to be impaired are separated from our other credit loss analysis in accordance with FASB Statement No. 114, Accounting by Creditors for
Impairment of a Loan. If we determine the carrying value of our asset exceeds the net fair value and no alternative payment source exists, then a specific
allowance is recorded for the amount of that difference.
The OTS has the authority to require us to change our asset classifications. If the change results in an asset being classified in whole or in part as
loss, a specific allowance must be established against the amount so classified or that amount must be charged off. The OTS generally directs its
examiners to rely on management’s estimates of adequate general valuation allowances if the Bank’s process for determining adequate allowances is
deemed to be sound.
Provision for credit losses totaled $130.3 million in the third quarter of 2008, compared with $81.6 million a year ago.
At September 30, 2008, the allowance for credit losses was $763 million, comprised of $762 million for loan losses and $1 million for loan-related
commitments. That compares to an allowance for credit losses of $349 million at year-end 2007, comprised of $348 million for loan losses and $1 million
for loan-related commitments. Loan-related commitments are reported on the balance sheet in the category accounts payable and accrued liabilities. The
allowance for credit losses increased $29 million this quarter, of which $24 million was related to specific allowances associated with certain troubled
debt restructurings pursuant to our borrower retention program. These specific allowances totaled $117 million at quarter end and will be accreted into
interest income over the remaining life of the modified loans as long as they remain on accrual status. The balance of the increase in the allowance for
credit losses was primarily due to loan workout modifications.
Downey’s allowance methodology incorporates assumptions related to default probabilities, loss severities and loss horizons based on historical
experience, current market conditions, and the unique characteristics of each borrower, loan and underlying collateral. On a comparative basis, these
factors individually increase or decrease the amount of the allowance for loan losses from prior periods. In the current quarter, loss severities continued
to increase and loss horizons continued to shorten. Further, as a result of deteriorating conditions facing the residential housing market, borrower
equity continues to decline. Partially offsetting this unfavorable trend was a small decrease in default probabilities due to lower mortgage interest rates
and a lower proportion of option ARM loans in our portfolio that have a higher loss experience.
Page 65 Navigation LinksThe following table summarizes the activity in our allowance for losses on loans and loan-related commitments for the quarters indicated.
(a) For TDRs of residential one-to-four unit loans that are not collateral dependent, a specific valuation allowance is calculated as the difference
between the recorded investment of the original loan and the present value of the expected cash flows of the modified loan (discounted at the
effective interest rate of the original loan). This difference is recorded as a provision for credit losses in current earnings and subsequently
amortized over the expected life of the loans as an adjustment to loan yield or as a reduction of the provision if the loan is prepaid.
The following table summarizes the activity in our allowance for losses on loans and loan-related commitments for the year-to-date periods
indicated.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Allowance for loan losses
Balance at beginning of period $ 732,354 $ 546,751 $ 348,167 $ 142,218 $ 69,107
Provision 130,430 258,517 237,087 218,650 81,435
TDR yield adjustment (a) (3,352 ) (2,670 ) (1,461 ) (483 ) –
Charge-offs (97,613 ) (70,245 ) (37,043 ) (12,220 ) (8,368 )
Recoveries 5 1 1 2 44
Balance at end of period $ 761,824 $ 732,354 $ 546,751 $ 348,167 $ 142,218
Allowance for loan-related commitments
Balance at beginning of period $ 1,355 $ 998 $ 1,215 $ 1,418 $ 1,291
Provision (reduction) (139 ) 357 (217 ) (203 ) 127
Balance at end of period $ 1,216 $ 1,355 $ 998 $ 1,215 $ 1,418
Total allowance for credit losses
Balance at beginning of period $ 733,709 $ 547,749 $ 349,382 $ 143,636 $ 70,398
Provision 130,291 258,874 236,870 218,447 81,562
TDR yield adjustment (a) (3,352 ) (2,670 ) (1,461 ) (483 ) –
Charge-offs (97,613 ) (70,245 ) (37,043 ) (12,220 ) (8,368 )
Recoveries 5 1 1 2 44
Balance at end of period $ 763,040 $ 733,709 $ 547,749 $ 349,382 $ 143,636
Nine Months Ended September 30,
(In Thousands) 2008 2007
Allowance for loan losses
Balance at beginning of period $ 348,167 $ 60,943
Provision 626,034 91,321
TDR yield adjustment (a) (7,483 ) –
Charge-offs (204,901 ) (10,344 )
Recoveries 7 298
Balance at end of period $ 761,824 $ 142,218
Allowance for loan-related commitments
Balance at beginning of period $ 1,215 $ 1,055
Provision 1 363
Balance at end of period $ 1,216 $ 1,418
Total allowance for credit losses
Balance at beginning of period $ 349,382 $ 61,998
(a) For TDRs of residential one-to-four unit loans that are not collateral dependent, a specific valuation allowance is calculated as the difference
between the recorded investment of the original loan and the present value of the expected cash flows of the modified loan (discounted at the
effective interest rate of the original loan). This difference is recorded as a provision for credit losses in current earnings and subsequently
amortized over the expected life of the loans as an adjustment to loan yield or as a reduction of the provision if the loan is prepaid.
Provision 626,035 91,684
TDR yield adjustment (a) (7,483 ) –
Charge-offs (204,901 ) (10,344 )
Recoveries 7 298
Balance at end of period $ 763,040 $ 143,636
Page 66 Navigation LinksNet charge-offs of loans totaled $97.6 million in the current quarter, compared to $8.3 million a year ago. The current quarter net charge-offs
primarily related to residential one-to-four unit loans, with an annualized net charge-off ratio associated with these loans increasing to 3.62% from 0.28%
a year ago.
For the first nine months of 2008, the provision for credit losses totaled $626.0 million and net charge-offs were $204.9 million. This compares with
a $91.7 million provision for credit losses and net charge-offs of $10.0 million a year ago.
The following table presents gross charge-offs, gross recoveries and net charge-offs by category of loan for the periods indicated.
Three Months Ended Nine Months Ended
September 30, June 30, March 31, December 31, September 30, September 30,
(Dollars in Thousands) 2008 2008 2008 2007 2007 2008 2007
Gross loan charge-offs
Loans secured by real estate:
Residential:
One-to-four units $ 97,586 $ 70,219 $ 26,207 $ 12,188 $ 4,301 $ 194,012 $ 6,221
Home equity loans and lines
of credit – – 169 – – 169 –
Five or more units – – – – – – –
Commercial real estate – – – – – – –
Construction – – – (3 ) – – 20
Land – – 10,639 – 4,022 10,639 4,022
Non-mortgage:
Commercial – – – – – – –
Consumer 27 26 28 35 45 81 81
Total gross loan charge-offs 97,613 70,245 37,043 12,220 8,368 204,901 10,344
Gross loan recoveries
Loans secured by real estate:
Residential:
One-to-four units – – – – 40 – 291
Home equity loans and lines
of credit – – – – – – –
Five or more units – – – – – – –
Commercial real estate – – – – – – –
Construction – – – – – – –
Land – – – – – – –
Non-mortgage:
Commercial – – – – – – –
Consumer 5 1 1
2
4 7
7
Total gross loan recoveries 5 1 1 2 44 7
298
Net loan charge-offs (recoveries)
Loans secured by real estate:
Residential:
One-to-four units 97,586 70,219 26,207 12,188 4,261 194,012 5,930
Home equity loans and lines – – 169 – –
of credit – – – – – 169 –
Five or more units – – – – – – –
Commercial real estate – – – – – – –
Construction – – – (3 ) – – 20
Land – – 10,639 – 4,022 10,639 4,022
Non-mortgage:
Commercial – – – – – – –
Consumer 22 25 27 33 41 74 74
Total net loan charge-offs $ 97,608 $ 70,244 $ 37,042 $ 12,218 $ 8,324 $ 204,894 $ 10,046
Net loan charge-offs
as a percentage of average loans 3.62% 2.60% 1.35% 0.43% 0.28% 2.52 % 0.10%
Page 67 Navigation LinksThe following table indicates our allocation of the allowance for loan losses to the various categories of loans at the dates indicated.
The following table indicates our allowance for loan losses as a percentage of loan category balance for the various categories of loans at the
dates indicated.
The following table indicates by loan category the percentage mix of our total loans held for investment at the dates indicated.
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 2008 2008 2008 2007 2007
Loans secured by real estate:
Residential:
One-to-four units $ 755,010 $ 727,073 $ 542,248 $ 339,424 $ 134,947
Home equity loans and lines of credit 853 828 767 1,019 850
Five or more units 1,934 1,306 1,005 976 965
Commercial real estate 290 226 247 297 298
Construction 2,569 2,348 1,916 1,857 1,726
Land 785 198 195 4,229 3,081
Non-mortgage:
Commercial 35 40 39 36 12
Consumer 348 335 334 329 339
Total for loans held for investment $ 761,824 $ 732,354 $ 546,751 $ 348,167 $ 142,218
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 2008 2008 2008 2007 2007
Loans secured by real estate:
Residential:
One-to-four units 6.89% 6.67% 5.06% 3.12% 1.20%
Home equity loans and lines of credit 0.64 0.63 0.58 0.74 0.59
Five or more units 0.95 1.08 1.00 0.97 0.92
Commercial real estate 0.97 1.00 1.00 1.12 1.12
Construction 2.62 2.22 2.56 2.29 2.96
Land 7.33 1.88 1.88 8.54 6.06
Non-mortgage:
Commercial 0.66 0.73 0.74 0.72 0.24
Consumer 5.81 5.75 5.63 5.49 5.60
Total for loans held for investment 6.66% 6.48% 4.94% 3.09% 1.22%
September 30, June 30, March 31, December 31, September 30,
(Dollars in Thousands) 2008 2008 2008 2007 2007
Loans secured by real estate:
Residential:
One-to-four units 95.75% 96.43% 96.80% 96.40% 96.60%
Home equity loans and lines of credit 1.16 1.16 1.20 1.23 1.24
Five or more units 1.78 1.08 0.91 0.89 0.90
Commercial real estate 0.26 0.20 0.22 0.23 0.23
Construction 0.86 0.94 0.68 0.72 0.50
Land 0.09 0.09 0.09 0.44 0.44
Non-mortgage:
Commercial 0.05 0.05 0.05 0.04 0.04
Consumer 0.05 0.05 0.05 0.05 0.05
Total for loans held for investment 100.00% 100.00% 100.00% 100.00% 100.00%
Page 68 Navigation LinksIn determining impairment, we consider large non-homogeneous loans that are on non-accrual, have been restructured or are performing but
exhibit, among other characteristics, high loan-to-value ratios or delinquent taxes. We base the measurement of collateral dependent impaired loans on
the fair value of the loan’s collateral net of costs to sell. We value non-collateral dependent loans based on a present value calculation of expected
future cash flows discounted at the loan’s effective rate or the loan’s observable market price. We generally use cash receipts on impaired loans not
performing according to contractual terms to reduce the carrying value of the loan, unless we believe we will recover the remaining principal balance of
the loan, in which case we may recognize interest income. We include impairment losses in the allowance for loan losses through a charge to provision
for credit losses. We include adjustments to impairment losses due to changes in the fair value of the collateral of impaired loans in provision for credit
losses. For TDRs of residential one-to-four unit loans, we include adjustments to impairment losses due to the change in cash flow as an adjustment to
loan yield. Upon disposition of an impaired loan, we record loss of principal through a charge-off to the allowance for loan losses.
At September 30, 2008, the recorded investment in loans for which we recognized impairment totaled $1.477 billion, up from $486 million at
December 31, 2007 and $12 million at September 30, 2007. Of the current quarter total, $1.464 billion related to residential one-to-four unit loan TDRs with
an allowance for loss of $131 million and $12 million related to two construction loans with an allowance for loss of $2 million. This is up from 2007 yearend
totals of $441 million related to residential one-to-four unit loan TDRs with an allowance for loss of $39 million, $29 million related to one land loan
with an allowance for loss of $4 million, $15 million related to two construction loans with an allowance for loss of $2 million, and $1 million related to
one residential one-to-four unit loan with no allowance for loss; and up from the year-ago quarter total of $12 million with an allowance of less than $1
million. During the current quarter, the total interest recognized on the impaired portfolio was $27.0 million, compared to $19.9 million in the second
quarter of 2008 and no interest recognized in the year-ago quarter.
The following table summarizes the activity in our allowance for credit losses associated with impaired loans for the quarters indicated.
(a) For TDRs of residential one-to-four unit loans that are not collateral dependent, a specific valuation allowance is calculated as the difference
between the recorded investment of the original loan and the present value of the expected cash flows of the modified loan (discounted at the
effective interest rate of the original loan). This difference is recorded as a provision for credit losses in current earnings and subsequently
amortized over the expected life of the loans as an adjustment to loan yield or as a reduction of the provision if the loan is prepaid.
The following table summarizes the activity in our allowance for credit losses associated with impaired loans for the year-to-date periods
indicated.
(a) For TDRs of residential one-to-four unit loans that are not collateral dependent, a specific valuation allowance is calculated as the difference
between the recorded investment of the original loan and the present value of the expected cash flows of the modified loan (discounted at the
effective interest rate of the original loan). This difference is recorded as a provision for credit losses in current earnings and subsequently
amortized over the expected life of the loans as an adjustment to loan yield or as a reduction of the provision if the loan is prepaid.
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Balance at beginning of period $ 102,013 $ 66,801 $ 45,066 $ 721 $ 1,238
Provision (reduction) 34,888 38,052 33,900 48,602 (412 )
TDR yield adjustment (a) (3,352 ) (2,670 ) (1,461 ) (483 ) –
Charge-offs (409 ) (170 ) (10,704 ) (3,917 ) (105 )
Recoveries – – – 143 –
Balance at end of period $ 133,140 $ 102,013 $ 66,801 $ 45,066 $ 721
Nine Months Ended September 30,
(In Thousands) 2008
2007
Balance at beginning of period $ 45,066 $ 601
Provision 106,840 772
TDR yield adjustment (a) (7,483 ) –
Charge-offs (11,283 ) (652 )
Recoveries – –
Balance at end of period $ 133,140 $ 721
Page 69 Navigation LinksThe following table summarizes the activity in our allowance for real estate and joint ventures held for investment for the quarters indicated.
The following table summarizes the activity in our allowance for real estate and joint ventures held for investment for the year-to-date periods
indicated.
The following table summarizes the activity in our allowance for real estate acquired in settlement of loans for the quarters indicated.
The following table summarizes the activity in our allowance for real estate acquired in settlement of loans for the year-to-date periods indicated.
We value real estate acquired through foreclosure at fair value less cost to sell, with any subsequent losses recorded as a direct write-off to net
operations. Given the decline in home values in the residential market, we had a valuation allowance at quarter end of $11 million for our one-to-four unit
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Balance at beginning of period $ 11,867 $ 413 $ 422 $ 432 $ 456
Provision (reduction) 8,053 11,454 (9 ) (10 ) (24 )
Charge-offs – – – – –
Recoveries – – – – –
Balance at end of period $ 19,920 $ 11,867 $ 413 $ 422 $ 432
Nine Months Ended September 30,
(In Thousands) 2008 2007
Balance at beginning of period $ 422 $ 103
Provision 19,498 329
Charge-offs – –
Recoveries – –
Balance at end of period $ 19,920 $ 432
Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(In Thousands) 2008 2008 2008 2007 2007
Balance at beginning of period $ 17,592 $ 12,334 $ – $ – $ –
Provision 19,329 14,712 19,892 1,118 2,058
Charge-offs (25,850 ) (9,454 ) (7,558 ) (1,118 ) (2,058 )
Recoveries – – – – –
Balance at end of period $ 11,071 $ 17,592 $ 12,334 $ – $ –
Nine Months Ended September 30,
(In Thousands) 2008 2007
Balance at beginning of period $ – $ –
Provision 53,933 2,621
Charge-offs (42,862 ) (2,621 )
Recoveries – –
Balance at end of period $ 11,071 $ –
residential properties acquired through foreclosure. This valuation allowance reflects recent loss experience from sales compared to their fair value prior
to sale. As that loss experience changes over time, our estimate of this valuation allowance will be reassessed.
Capital Resources and Liquidity
Our sources of funds include deposits, advances from the FHLB and other borrowings; proceeds from the sale of loans, available for sale
securities, and real estate; payments of loans and payments for and sales of loan servicing; and income from other investments. Interest rates, real
estate sales activity and general economic conditions significantly affect repayments on loans and deposit inflows and outflows.
Page 70 Navigation LinksOur primary sources of funds generated in the third quarter of 2008 were from:
l maturities or calls of $14.2 billion of U.S. Treasury, government sponsored entities and other investment securities available for sale;
l a net increase of $487 million in borrowings;
l principal repayments of $274 million on loans held for investment, including prepayments but excluding refinances of our existing loans; and
l Sales of wholly owned real estate, real estate acquired in settlement of loans and real estate related contracts of $195 million.
We used these funds to:
l purchase $13.7 billion of government sponsored entities investment securities available for sale;
l originate and purchase $613 million of loans held for investment, excluding refinances of our existing loans; and
l absorb a $263 million reduction in deposits, primarily higher cost certificates of deposit.
In addition to its deposits, our principal source of liquidity is our ability to utilize borrowings, as needed. The Bank’s primary source of
borrowings is the FHLB. At September 30, 2008, the Bank’s FHLB borrowings totaled $2.1 billion, representing 16.5% of total assets. The Bank currently
is approved by the FHLB to borrow up to a maximum of $3.0 billion to the extent it provides qualifying collateral, providing the Bank with an additional
$0.9 billion of borrowing capacity from the FHLB as of September 30, 2008. The amount the FHLB is willing to advance differs based on the quality and
character of qualifying collateral offered by the Bank, and the advance rates for the same collateral may be adjusted upwards or downwards by the
FHLB from time to time. The Bank also is approved to borrow funds on an overnight basis from the Federal Reserve Bank of San Francisco subject to
the amount of qualifying collateral it pledges. The Bank views the Federal Reserve Bank of San Francisco as a back-up source of liquidity. As of
September 30, 2008 the Bank had no outstanding borrowings from the Federal Reserve Bank of San Francisco and the Bank’s available qualifying
collateral would have permitted it to borrow up to an additional $1.1 billion. Neither the FHLB nor the Federal Reserve Bank of San Francisco is
obligated to lend to us under these loan facilities. To the extent deposit renewals and deposit growth are not sufficient to fund maturing and
withdrawable deposits, repay maturing borrowings, fund existing and future loans and investment securities and otherwise fund working capital needs
and capital expenditures, the Bank may utilize additional borrowing capacity from its FHLB and Federal Reserve Bank borrowing arrangements.
However, if elevated levels of net deposit outflows occur, the Bank’s usual sources of liquidity could become depleted, and the Bank would be required
to raise additional capital or enter into new financing arrangements to satisfy its liquidity needs. In the current economic environment, there are no
assurances that we would be able to raise additional capital or enter into additional financing arrangements. As a result of being deemed to be
“adequately capitalized” rather than “well capitalized,” the Bank is subject to restrictions on accepting brokered deposits, which have not historically
been a significant part of the Bank’s deposit base, and upper limits on interest rates the Bank may pay on deposits. For further information, see Note 11
of Notes to the Consolidated Financial Statements on page 24.
As of September 30, 2008, we had commitments to borrowers for short-term interest rate locks, before the reduction of expected fallout, of $216
million, of which $38 million were related to residential one-to-four unit loans being originated for sale in the secondary market. We also had
undisbursed loan funds and unused lines of credit of $268 million, loan forward purchase contracts of $21 million and operating leases of $16 million.
For further information, see Note 5 of Notes to the Consolidated Financial Statements on page 15.
Subsequent to September 30, 2008, we closed our Wholesale Loan Department and the loan processing centers supporting that Department, and
began contracting our Retail Loan Department. The Wholesale lending channel has traditionally provided about 80% of our single family loan
originations. Therefore, loan origination volumes will decline in future periods.
Page 71 Navigation LinksLimitations imposed by the OTS currently prohibit the Bank from providing a dividend to the Holding Company without the prior written approval
of the OTS, and currently prohibit the Holding Company from paying a dividend without the prior non-objection of the OTS. At September 30, 2008, the
Holding Company’s liquid assets, including amounts deposited with the Bank, totaled $11 million, down from $102 million at the end of 2007 due
primarily to $80 million in capital contributions made to the Bank. In addition, the Holding Company may not issue new debt or renew existing debt
without the prior non-objection of the OTS. At the moment there is no other source of repayment of the senior notes. Absent additional capital, the
Holding Company will default on the notes within a year.
Subsequent to the end of the quarter, Moody’s Investors Service and Standards & Poor’s Ratings Services lowered their ratings for the Holding
Company and the Bank on August 12, 2008 and September 11, 2008, respectively. For further information, see Risk Factors, on page 77.
Downey’s stockholders’ equity totaled $772 million at September 30, 2008, down from $1.3 billion at December 31, 2007 and $1.4 billion at
September 30, 2007. No future dividends will be paid without the prior non-objection of the OTS.
Contractual Obligations and Other Commitments
Through the normal course of operations, we have entered into contractual obligations and other commitments. Our obligations generally relate to
funding of our operations through deposits and borrowings as well as leases for premises and equipment, and our commitments generally relate to our
lending operations.
We have obligations under long-term operating leases, principally for building space and land. Lease terms generally cover a five-year period,
with options to extend, and are non-cancelable. Currently, we have no material contractual vendor obligations.
We have executed interest rate swap contracts to change interest rate characteristics of a portion of our FHLB advances to better manage interest
rate risk. The contracts have notional amounts totaling $430 million of receive-fixed, pay 3-month LIBOR variable interest and serve as a permitted fair
value hedge.
Our commitments to originate fixed and variable rate mortgage loans are agreements to lend to a customer as long as there is no violation of any
condition established in the commitment. Undisbursed loan funds on construction projects and unused lines of credit on home equity and commercial
loans include committed funds not disbursed. Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to
a third party.
Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some commitments expire
without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The credit risk involved in issuing
lines and letters of credit requires the same creditworthiness evaluation as that involved in extending loan facilities to customers. We evaluate each
customer’s creditworthiness.
We receive collateral to support commitments when deemed necessary. The most significant categories of collateral include real estate properties
underlying mortgage loans, liens on personal property and cash on deposit with us.
We enter into derivative financial instruments as part of our interest rate risk management process, including loan forward sale and purchase
contracts related to our sale of loans in the secondary market. The associated fair value changes to the notional amount of the derivative instruments
are recorded on-balance sheet. The total notional amount of our derivative financial instruments does not represent future cash requirements. At
September 30, 2008, Downey had a notional amount of interest rate lock commitments identified to sell as part of its secondary marketing activities of
$26 million, with a change in fair value resulting in a recorded gain of $0.1 million, compared with a notional amount of interest rate lock commitments of
$93 million with a change in fair value resulting in a recorded loss of less than $0.1 million at September 30, 2007. For further information, see
Asset/Liability Management and Market Risk on page 56 and Note 5 of Notes to the Consolidated Financial Statements on page 15.
We sell all loans without recourse. When a loan sold to an investor without recourse fails to perform according to the contractual terms, the
investor will typically review the loan file to determine whether defects in the origination process occurred and whether such defects give rise to a
violation of a representation or warranty we made to the investor in connection with the sale. If such a defect is identified, we may be required to either
repurchase the loan or indemnify the investor for losses sustained. If there are no such defects, we have no commitment to repurchase the loan. During
the first nine months of 2008, we repurchased $6 million of loans and $2 million of real estate acquired in settlement of loans and recorded $0.7 million of
repurchase or indemnification losses related to defects in the origination process.
Page 72 Navigation LinksThese loan and servicing sale contracts may also contain provisions to refund sale price premiums to the purchaser if the related loans prepay
during a period typically 90 days, but not to exceed 120 days from the sale’s settlement date. We reserved less than $1 million at September 30, 2008,
December 31, 2007 and September 30, 2007 to cover the estimated loss exposure related to early payoffs. However, if all the loans related to those sales
prepaid within the refund period, as of September 30, 2008, our maximum sales price premium refund would be $1.9 million. See Note 5 of Notes to the
Consolidated Financial Statements on page 15.
Servicing loans for others includes managing foreclosed loans through the sale of the properties. Advances made for principal and interest
remittances as well as foreclosure costs are recorded in the balance sheet as other assets and are expected to ultimately be recovered from the related
investor.
At September 30, 2008, scheduled maturities of obligations and commitments, excluding accrued interest, were as follows:
(a) Amount represents the notional amount of the commitments or contracts. The notional amount for interest rate lock commitments before the
reduction of expected fallout was $38 million.
After 1 After 3
Within Through 3 Through 5 Beyond Total
(In Thousands) 1 Year Years Years 5 Years Balance
Certificates of deposit $ 6,865,770 $ 614,856 $ 110,554 $ – $ 7,591,180
Securities sold under agreements to repurchase – – – – –
FHLB advances 935,061 500,000 675,000 – 2,110,061
Senior notes – – – 198,593 198,593
Secondary marketing activities:
Non-qualifying hedge transactions:
Interest rate lock commitments (a) 25,963 – – – 25,963
Associated loan forward sale contracts (a) 47,392 – – – 47,392
Associated loan forward purchase contracts 21,000 21,000
Qualifying cash flow hedge transactions:
Loans held for sale, at lower of cost or fair value 7,673 – – – 7,673
Associated loan forward sale contracts (a) 6,608 – – – 6,608
Qualifying fair value hedge transactions:
Designated FHLB advances – pay-fixed 430,000 – – – 430,000
Associated interest rate swap contracts –
pay-variable, receive-fixed (a) 430,000 – – – 430,000
Commitments to originate adjustable rate loans held
for investment 138,092 – – – 138,092
Undisbursed loan funds and unused lines of credit 30,381 35,694 22,372 179,272 267,719
Operating leases 5,473 7,542 2,386 344 15,745
Page 73 Navigation LinksAt September 30, 2008, the Bank was above the minimum capital ratios required by its Consent Order, with core and tangible capital ratios of
7.48% and a total risk-based capital ratio of 14.50%. For further information, see Note 11 of Notes to the Consolidated Financial Statements on page 24.
The following table is a reconciliation of the Bank’s stockholder’s equity to federal regulatory capital as of September 30, 2008.
(a) Limited to 1.25% of risk-weighted assets.
(b) From orders issued by the OTS, the Bank is required to maintain minimum capital ratios for core and tangible capital of 7.00% and risk-based
capital of 14.00%, both of which were exceeded at quarter end.
(c) Represents the minimum requirement for tangible capital, as no “well capitalized” requirement has been established for this category.
(d) A third requirement is Tier 1 capital to risk-weighted assets of 6.00%, which the Bank met and exceeded with a ratio of 13.17%.
Tangible Capital Core Capital Risk-Based Capital
(Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio
Stockholder’s equity $ 958,298 $ 958,298 $ 958,298
Adjustments:
Deductions:
Investment in real estate subsidiary (7,038 ) (7,038 ) (7,038 )
Non-permitted mortgage servicing rights (2,281 ) (2,281 ) (2,281 )
Additions:
Unrealized losses on investment securities
available for sale 6,231 6,231 6,231
Allowance for credit losses, net of specific
allowances (a) – – 96,015
Regulatory capital 955,210 7.48% 955,210 7.48% 1,051,225 14.50%
Well capitalized requirement (b) 191,650 1.50 (c) 638,833 5.00 725,109 10.00 (d)
Excess $ 763,560 5.98% $ 316,377 2.48% $ 326,116 4.50%
Page 74 Navigation LinksFor information regarding quantitative and qualitative disclosures about market risk, see Asset/Liability Management and Market Risk on page 56.
ITEM 4. – CONTROLS AND PROCEDURES
As of September 30, 2008, Downey carried out an evaluation, under the supervision and with the participation of Downey’s management,
including Downey’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Downey’s disclosure
controls and procedures pursuant to Securities and Exchange Commission (“SEC”) rules. Based upon that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded Downey’s disclosure controls and procedures were effective as of the end of the period covered by this report. There
have been no significant changes during the most recent quarter in Downey’s internal controls over financial reporting or in other factors that could
significantly affect these controls subsequent to the evaluation date.
Disclosure controls and procedures are defined in SEC rules as controls and other procedures designed to ensure that information required to be
disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
Downey’s disclosure controls and procedures were designed to ensure that material information related to Downey is made known to management,
including the Chief Executive Officer and Chief Financial Officer, in a timely manner.
Page 75 Navigation LinksOn October 29, 2004, two former traditional branch employees brought an action in Los Angeles County Superior Court, Case No. BC323796,
entitled Margie Holman and Alice A. Mesec, et al. v. Downey Savings and Loan Association. The first amended complaint seeks unspecified damages
for alleged unpaid regular and overtime wages, inadequate meal breaks, failure to pay split-shift and reporting time wages, and related claims. The
plaintiffs are seeking class action status to represent all other current and former Bank employees who held the position of Customer Service Supervisor
and/or Customer Service Representative at the Bank’s in-store branches at any time from October 29, 2000 to date. The Bank has opposed the claim and
asserted all appropriate defenses, and has provided for what is believed to be a reasonable estimate of exposure for this matter in the event of loss.
While acknowledging the uncertainties of litigation, management believes that the ultimate outcome of this matter will not have a material adverse effect
on Downey’s operations, cash flows or financial position.
Two purported shareholder class actions, one brought on behalf of Waterford Township General Employees Retirement System, Case No. CV-08-
03261, and the other brought on behalf of Stephen J. Mihalacki, Case No. SACV08-00609, were filed on May 16, 2008 and June 2, 2008, respectively, in
the United States District Court for the Central District of California against the Holding Company and certain of its current and former officers and
certain former directors. The complaints, filed on behalf of all persons who purchased Holding Company common stock during October 16, 2006 to
March 14, 2008, seek unspecified damages for alleged violation of federal securities laws, claiming that the defendants made misleading statements and
omissions regarding Downey’s business and financial results, thereby artificially inflating the common stock price. Specifically, the plaintiffs contend
that the defendants concealed that (a) the Bank’s portfolio of option ARMs contained millions of dollars worth of impaired and risky securities; (b) the
Bank had been aggressive in acquiring loans from mortgage brokers that were highly risky; (c) the Bank had failed to properly account for highly
leveraged loans; (d) the Bank had inadequate underwriting practices, which led to large numbers of loan defaults; and (e) the Bank had not adequately
reserved for option ARM loans. A motion to consolidate the two actions was granted on August 14, 2008 with Waterford Township General Employees
Retirement System as lead plaintiff. The plaintiffs filed a consolidated complaint on September 30, 2008 and, pursuant to a stipulation between the
parties, have until November 12, 2008 to file a first amended consolidated complaint.
Related to the shareholder class actions, two purported shareholder derivative lawsuits, one entitled Michael L. McDougall v. Daniel D., Case No. 30-2008-00180029, and the other entitled Joyce Mendlin v. Maurice L. McAlister, et al., Case No. 30-2008-00087854, were
Rosenthal, et al.
filed on June 10, 2008 and July 28, 2008, respectively, in Orange County Superior Court, in California. The plaintiffs, who purport to bring the lawsuits
on behalf of the Holding Company against certain of its current and former officers, its current directors and certain former directors, allege that
commencing in October 2006, the defendants caused or allowed Downey to issue a series of press releases and other statements that significantly
overstated Downey’s business prospects and financial results; that the statements failed to disclose that Downey was more exposed to the subprime
market crisis than it had disclosed; that Downey’s portfolio of subprime and option ARM mortgage-related assets was overvalued; and that as a result,
Downey’s reported earnings and business prospects were inaccurate. The plaintiffs allege that the defendants’ action constitutes breaches of fiduciary
duty, waste of corporate assets and unjust enrichment, and seek, among other relief, unspecified damages to be paid to the Holding Company,
corporate governance reforms, and equitable and injunctive relief, including restitution and the creation of a constructive trust.
Downey has been named as a defendant in other legal actions arising in the ordinary course of business, none of which, in the opinion of
management, will have a material adverse effect on its operations, cash flows or financial position.
Consent Orders
On September 5, 2008, the Holding Company and the Bank each entered into a Consent Order with the OTS, effective as of the same date. For
more information, see Note 11 of Notes to the Consolidated Financial Statements on page 24.
Page 76 Navigation LinksDowney’s 2007 Form 10-K presents, on pages 22 to 27, a comprehensive set of risk factors that may impact Downey’s future results. Given recent
developments, we are adding the following:
If we do not raise additional capital by December 31, 2008, it is highly unlikely that we will be in compliance with the capital requirements
of the Bank Consent Order at year-end, which could have a material adverse effect upon us.
The Bank Consent Order requires the Bank to maintain a minimum Tier I Core Capital ratio of 7% and a minimum Total Risk-Based Capital ratio of
14% at each quarter-end. While the Bank was in compliance with this requirement at September 30, 2008, based on the Bank’s current and projected
levels of capital, the Bank anticipates that it will not be able to satisfy the Tier I Core Capital and Total Risk-Based Capital minimum ratios of its Consent
Order as of December 31, 2008, unless it raises additional capital on or prior to that date. In the current economic environment, there is a significant risk
that the Bank will not be able to raise sufficient additional capital to ensure compliance with the capital requirements of the Bank Consent Order by
year-end. If the Bank does not comply with the Consent Order, without a waiver by the OTS or amendment of the Consent Order, the Bank could be
subject to further regulatory enforcement action, including, without limitation, the issuance of additional cease and desist orders (which may, among
other things, further restrict the Bank’s business activities, the imposition of civil money penalties against the Bank, and placing the Bank into a
conservatorship or receivership). Notwithstanding that portion of the Bank Consent Order requiring the raising of new equity and a capital infusion by
no later than December 31, 2008, bank regulators could take enforcement action before that date, which could include placing the Bank into
receivership. If the Bank is placed into a conservatorship or receivership, it is highly likely that this will lead to a complete loss of all value of the
Holding Company’s ownership interest in the Bank, and the Holding Company subsequently may be exposed to significant claims by the Federal
Deposit Insurance Corporation or OTS. In addition, further restrictions will be placed on the Bank following a determination that the Bank is
undercapitalized, significantly undercapitalized, or critically undercapitalized, with increasingly greater restrictions being imposed as the level of
undercapitalization increases. Further, the failure to comply with the Consent Order could result in the termination of the Bank’s federal deposit
insurance, subject to a number of other conditions.
The Consent Orders that the Bank and the Holding Company entered into with the OTS restrict the Bank’s operations and may adversely
affect our ability to pay dividends or service our debt; and there is substantial doubt concerning the ability of the Holding Company and the Bank
to continue as going concerns for a reasonable period of time.
The ability of the Holding Company to pay regular quarterly dividends to its stockholders and to pay interest on its debt depends to a large extent
upon the dividends it receives from the Bank. The Consent Orders entered into by the Bank and the Holding Company with the OTS prohibit the Bank
from paying dividends to the Holding Company without the prior approval of the OTS, and which further prohibits the Holding Company from paying
dividends without the prior non-objection of the OTS.
At September 30, 2008, the Holding Company’s liquid assets, including amounts deposited with the Bank, totaled $11 million. However, in the
longer term, the Holding Company’s ability to service its senior debt depends on its ability to receive dividends from the Bank and, when the notes
mature, on its ability to renew or refinance the senior debt. However, pursuant to the Holding Company’s Consent Order, the OTS has prohibited the
Holding Company from issuing or renewing debt without its prior approval. We cannot predict whether the OTS will approve payments of dividends by
the Bank to the Holding Company, or will object to the payment of future Holding Company dividends, or how long these restrictions will remain in
effect. At the moment, there is no other source of repayment of the senior notes. Absent additional capital, the Holding Company will default on the
notes within a year.
As a result of the circumstances described above and in the other Risk Factors herein, there is substantial doubt concerning the ability of the
Holding Company and the Bank to continue as going concerns for a reasonable period of time.
Difficult market conditions have adversely affected our industry.
Downey is particularly exposed to downturns in the U.S. housing market. Dramatic declines in the housing market over the past year, with falling
home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans
and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities, major commercial and
investment banks, and regional financial institutions such as Downey. Reflecting concern about the stability of the financial markets generally and the
strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers,
Page 77 Navigation Linksincluding to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer
delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting
economic pressure on consumers and lack of confidence in the financial markets have adversely affected our business, financial condition and results
of operations. For example, on October 16, 2008, we announced the closing of our Wholesale Loan Department, the loan processing centers supporting
that Department, and a contraction of our Retail Loan Department, which affected approximately 200 employees. We do not expect that the difficult
conditions in the financial markets are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects
of these difficult market conditions on us and others in the financial institutions industry. In particular, we may face the following risks in connection
with these events:
l We expect to face increased regulation of our industry. Compliance with such regulation may increase our costs and limit our ability to pursue
business opportunities.
l Our ability to assess the creditworthiness of our customers may be impaired if the models and approaches we use to select, manage and
underwrite our customers become less predictive of future behaviors.
l The process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts
of economic conditions and how these economic predictions might impair the ability of our borrowers to repay their loans, which may no longer
be capable of accurate estimation which may, in turn, impact the reliability of the process.
l Our ability to borrow from other financial institutions on favorable terms or at all could be adversely affected by further disruptions in the capital
markets or other events, including actions by rating agencies and deteriorating investor expectations.
l Competition in our industry could intensify as a result of the increasing consolidation of financial services companies in connection with
current market conditions.
l We may be required to pay significantly higher Federal Deposit Insurance Corporation premiums because market developments have
significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.
l Our liquidity could be negatively impacted by an inability to access the capital markets, unforeseen or extraordinary demands on cash, or
regulatory restrictions, which could, among other things, materially and adversely affect our business prospects and financial condition, result
in the loss of servicing rights (and the value of those rights) and negatively impact our debt ratings.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and disruption for more than a year. In recent weeks, the volatility and disruption
has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain
issuers without regard to those issuers’ underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can
be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial
condition and results of operations.
There can be no assurance that recently enacted legislation and other measures undertaken by the Treasury, the Federal Reserve and other
governmental agencies will help stabilize the U.S. financial system, improve the housing market or be of specific benefit to Downey.
On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 or “EESA,” which, among other measures,
authorized the Treasury Secretary to establish the Troubled Asset Relief Program (“TARP”). EESA gives broad authority to Treasury to purchase,
manage, modify, sell and insure the troubled mortgage related assets that triggered the current economic crisis as well as other “troubled assets.” EESA
includes additional provisions directed at bolstering the economy, including
l Authority for the Federal Reserve to pay interest on depository institution balances;
l Mortgage loss mitigation and homeowner protection;
l Temporary increase in FDIC insurance coverage from $100,000 to $250,000 through December 31, 2009; and
l Authority to the SEC to suspend mark-to-market accounting requirements for any issuer or class of category of transactions.
Page 78 Navigation LinksPursuant to the TARP, the U.S. Treasury has the authority to, among other things, purchase up to $700 billion (of which $250 billion is currently
available) of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and
providing liquidity to the U.S. financial markets. Shortly following the enactment of EESA, the Treasury announced the creation of specific TARP
programs to purchase mortgage-backed securities and whole mortgage loans. In addition, under the TARP, the Treasury has created a capital purchase
program, pursuant to which it proposes to provide access to capital to financial institutions through a standardized program to acquire preferred stock
(accompanied by warrants) from eligible financial institutions that will serve as Tier I capital.
EESA also contains a number of significant employee benefit and executive compensation provisions, some of which apply to employee benefit
plans generally, and others which impose on financial institutions that participate in the TARP program restrictions on executive compensation.
EESA followed, and has been followed by, numerous actions by the Federal Reserve, Congress, Treasury, the SEC and others to address the
current liquidity and credit crisis that has followed the subprime meltdown that commenced in 2007. These measures include homeowner relief that
encourage loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment
banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds;
the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; coordinated international efforts to
address illiquidity and other weaknesses in the banking sector;
In addition, the IRS has issued an unprecedented wave of guidance in response to the credit crisis, including a relaxation of limits on the ability of
financial institutions that undergo an “ownership change” to utilize their pre-change net operating losses and net unrealized built-in losses. The
relaxation of these limits may make significantly more attractive the acquisition of financial institutions whose tax basis in their loan portfolios
significantly exceeds the fair market value of those portfolios.
On October 14, 2008, the FDIC announced the establishment of a temporary liquidity guarantee program to provide insurance for all non-interest
bearing transaction accounts and guarantees of certain newly issued senior unsecured debt issued by financial institutions (such as the Bank), bank
holding companies and savings and loan holding companies (such as the Holding Company). Financial institutions are automatically covered by this
program commencing October 14, 2008. Any eligible entity that opts out of the Program on or before December 5, 2008, will not pay any assessment
under the Program. Any eligible entity that does not opt out on or before December 5, 2008, will be required to pay related assessment fees. Under the
program, newly issued senior unsecured debt issued on or before June 30, 2009 will be insured in the event the issuing institution subsequently fails, or
its holding company files for bankruptcy. The debt includes all newly issued unsecured senior debt (e.g., promissory notes, commercial paper and interbank
funding). The aggregate coverage for an institution may not exceed 125% of its debt outstanding on September 30, 2008 that was scheduled to
mature before June 30. 2009. The guarantee will extend to June 30, 2012 even if the maturity of the debt is after that date. Many details of the program
still remain to be worked out.
There can be no assurance as to the actual impact that EESA and such related measures undertaken to alleviate the credit crisis will have
generally on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced The failure of such
measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely
affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.
Finally, there can be no assurance regarding the specific impact that such measures may have on Downey-or whether (or to what extent)
Downey will be able to benefit from such programs and, in particular, whether Downey will be eligible to obtain capital from the Treasury under the
TARP program.
Downey’s access to liquidity may be negatively impacted if market conditions and regulatory restrictions persist or if further ratings
downgrades occur.
While Downey actively manages its liquidity risk and maintains liquidity at least sufficient to cover all maturing debt obligations or other
forecasted funding requirements, Downey’s liquidity may be affected by an inability to access the capital markets or by unforeseen or extraordinary
demands on cash. This situation may arise due to circumstances beyond Downey’s control, and is subject to the Holding Company’s and the Bank’s
credit ratings as assigned by nationally recognized statistical rating organizations. Recent disruptions in the capital markets have substantially limited
the ability of mortgage originators, including Downey, to sell mortgage loans to the capital markets through whole loan sales or securitization. As a
result, Downey has experienced a general loss of liquidity in most secondary markets for its loans.
Page 79 Navigation LinksDowney cannot forecast if or when market liquidity conditions will improve from current stresses, although it is Downey’s expectation that the
existing turmoil in the financial and credit markets may continue to affect its performance at least throughout 2008.
On August 12, 2008, Moody’s Investors Service downgraded the Holding Company’s senior unsecured debt rating to “B3” from “B1.” In
addition, the Bank’s financial strength was downgraded to “E+” from “D” and its long term deposit rating was downgraded to “B1” from “Ba2.” Its
short term deposit rating remains “Not Prime.” On September 11, 2008, Standard & Poor’s Ratings Services lowered its senior unsecured credit rating on
the Holding Company to “B-” from “B+/Watch Neg” and its counterparty credit rating on the Holding Company to “B-/Negative/C” from “B+/Watch
Neg/C.” In addition, the Bank’s counterparty and deposit ratings were lowered to “B/Negative/C” from “BB-/Watch Neg/B.”
In addition, the Holding Company may not issue new debt or renew existing debt without prior non-objection of the OTS.
Current market conditions have also limited the Bank’s liquidity sources principally to secured funding outlets such as the FHLB and, as back-up,
the Federal Reserve Bank of San Francisco, and to FDIC-insured deposits originated through the Bank’s branch network. Other sources of funding,
such as medium-term notes and uninsured institutional deposits, may not be available to the Bank. There can be no assurance that actions by the FHLB
or the Federal Reserve Bank would not reduce or eliminate our borrowing capacity or that we would be able to continue to attract deposits at
competitive rates. Such events could have a material adverse impact on our results of operations and financial condition.
Future regulatory actions may also adversely impact our ability to raise funds through deposits. For example, as a result of the September 5, 2008
Consent Order, the Bank is required to meet and maintain specific capital levels, it is deemed “adequately capitalized” under OTS regulations even
though it exceeds minimum regulatory capital ratios that would otherwise qualify it to be “well capitalized.” As a result, the Bank is subject to
restrictions on accepting brokered deposits and upper limits on interest rates the Bank may pay on deposits.
After the end of the second quarter, the Bank experienced elevated levels of deposit withdrawals. More recently, in response to steps taken by
management to address the situation, the deposit flows have seemed to stabilize more to historical levels. If the Bank’s deposit levels remain stabilized
at historical levels, we believe our current sources of funds, including deposits; advances from the FHLB and other borrowings; proceeds from the sale
of loans and real estate; payments of loans and payments for and sales of loan servicing; and income from other investments would enable us to meet
our obligations while maintaining liquidity at appropriate levels. However, if elevated levels of net deposit outflows occur, the Bank’s usual sources of
liquidity could become depleted, and the Bank would be required to raise additional capital or enter into new financing arrangements to satisfy its
liquidity needs. In the current economic environment, there are no assurances that we would be able to raise additional capital or enter into additional
financing or other arrangements.
ITEM 2. – Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3. – Defaults Upon Senior Securities
None.
ITEM 4. – Submission of Matters to a Vote of Security Holders
None.
Page 80 Navigation LinksThe following disclosure would otherwise be filed on Form 8-K under the heading “Item 5.02. Departure of Directors or Certain Officers; Election
of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers.” On August 27, 2008, the Company’s Board of
Directors determined to move certain members of the Board from one Class of directors to another Class. In connection with this determination,
effective as of August 27, 2008:
l Brent McQuarrie resigned as a Class 2 director and was immediately appointed by the Board as a Class 3 director;
l James H. Hunter resigned as a Class 3 director and was immediately appointed by the Board as a Class 1 director; and
l Jane Wolfe resigned as a Class 3 director and was immediately appointed by the Board as a Class 1 director.
Following these changes to the Board, and the appointment of Thomas E. Prince to the Board effective July 21, 2008, Paul M. Homan to the Board
effective August 18, 2008, and Charles R. Rinehart to the Board effective September 23, 2008, the Company’s Board is comprised as follows:
Class 1, 2 and 3 directors will continue to hold office until the Company’s 2011, 2009 and 2010 Annual Meetings of Stockholders, respectively, and
until their respective successors are duly elected and qualified.
ITEM 6. – Exhibits
Class 1 Class 2 Class 3
Gary W. Brummett Michael B. Abrahams Michael D. Bozarth
James H. Hunter Thomas E. Prince Paul M. Homan
Jane Wolfe Lester C. Smull Brent McQuarrie
Charles R. Rinehart
Exhibit
Number Description
10.1 Employment Agreement (which also includes the Change in Control Agreement), dated as of September 26,
2008, by and between the Bank and Charles R. Rinehart (incorporated by reference to Exhibit 10.1 of the
Company’s Current Report on Form 8-K, filed with the SEC on October 2, 2008).
10.2 OTS Order to Cease and Desist with the Company dated September 5, 2008 (incorporated by reference to
Exhibit 10.1 of the Company’s Current Report on Form 8-K, filed with the SEC on September 5, 2008)
10.3 Stipulation and Consent to Issuance of Order to Cease and Desist with the Company dated September 5, 2008
(incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K, filed with the SEC
on September 5, 2008)
10.4 OTS Order to Cease and Desist with the Bank dated September 5, 2008 (incorporated by reference to Exhibit
10.3 of the Company’s Current Report on Form 8-K, filed with the SEC on September 5, 2008)
10.5 Stipulation and Consent to Issuance of Order to Cease and Desist with the Bank dated September 5, 2008 on
(incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K, filed with the SEC
September 5, 2008)
31.1
Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
32.1
Certification of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
Page 81 Navigation LinksCorporate governance guidelines, charters for the audit, compensation, and nominating and corporate governance committees of the Board of
Directors and codes of business conduct and ethics are available free of charge from our internet site, http://www.downeysavings.com by clicking on
“Investor Relations” on our home page and proceeding to “Corporate Governance.” Annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and all amendments to those reports are posted on our internet site as soon as reasonably practical after we file them with
the SEC and available free of charge under “Corporate Filings” on our “Investor Relations” page.
We will furnish any or all of the non-confidential exhibits upon payment of a reasonable fee. Please send request for exhibits and/or fee
information to:
Downey Financial Corp.
3501 Jamboree Road
Newport Beach, California 92660
Attention: Corporate Secretary
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DOWNEY FINANCIAL CORP.
/s/ Charles R. Rinehart
Date: November 10, 2008 Charles R. Rinehart
Chief Executive Officer
/s/ Brian E. Côté
Date: November 10, 2008 Brian E. Côté
Chief Financial Officer
Page 82 Navigation LinksITEM 1. – FINANCIAL STATEMENTS
l CONSOLIDATED BALANCE SHEETS (unaudited)
l CONSOLIDATED STATEMENTS OF INCOME (LOSS) (unaudited)
l CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (unaudited)
l CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
l NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
l NOTE (1) – Basis of Financial Statement Presentation
l NOTE (2) – Loans
l NOTE (3) – Real Estate Acquired in Settlement of Loans
l NOTE (4) – Mortgage Servicing Rights (“MSRs”)
l NOTE (5) – Derivatives, Hedging Activities, Financial Instruments with Off-Balance Sheet Risk and Other Contractual Obligations (Risk
Management)
l NOTE (6) – Income Taxes
l NOTE (7) – Employee Stock Option Plans and Restricted Stock Grant
l NOTE (8) – Earnings (Loss) Per Share
l NOTE (9) – Fair Value of Financial Instruments
l NOTE (10) – Business Segment Reporting
l NOTE (11) – Regulatory Consent Orders, Liquidity and Capital Adequacy
l NOTE (12) – Recently Issued Accounting Standards
l NOTE (13) – Subsequent Event
ITEM 2. – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
l OVERVIEW
l CRITICAL ACCOUNTING POLICIES
l RESULTS OF OPERATIONS
l Net Interest Income
l Provision for Credit Losses
l Other Income
l Loan and Deposit Related Fees
l Real Estate and Joint Ventures Held for Investment
l Secondary Marketing Activities
l Operating Expense
l Provision for Income Taxes
l Business Segment Reporting
l Banking
l Real Estate Investment
l FINANCIAL CONDITION
l Loans and Mortgage-Backed Securities
l Investment Securities
l Deposits
l Borrowings
l Off-Balance Sheet Arrangements
l Transactions with Related Parties
l Asset/Liability Management and Market Risk
l Problem Loans and Real Estate
l Non-Performing Assets and TDRs
l Delinquent Loans
l Allowance for Credit and Real Estate Losses
l Capital Resources and Liquidity
l Contractual Obligations and Other Commitments
l Regulatory Capital Compliance
ITEM 3. – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. – CONTROLS AND PROCEDURES
PART II – OTHER INFORMATION
ITEM 1. – Legal Proceedings
ITEM 1A. – Risk Factors
ITEM 2. – Unregistered Sales of Equity Securities and Use of Proceeds
ITEM 3. – Defaults Upon Senior Securities
ITEM 4. – Submission of Matters to a Vote of Security Holders
ITEM 5. – Other Information
ITEM 6. – Exhibits
l 31.1 Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002l 31.2 Certification of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002l 32.1 Certification of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002l 32.2 Certification of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002AVAILABILITY OF REPORTS
SIGNATURES
NAVIGATION LINKS
FORM 10-Q COVER
PART I – FINANCIAL INFORMATION
AVAILABILITY OF REPORTS
ITEM 5. – Other Information
ITEM 1A. – Risk Factors
PART II – OTHER INFORMATION
ITEM 1. – Legal Proceedings
Judicial Proceedings
ITEM 3. – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Regulatory Capital Compliance
Allowance for Credit and Real Estate Losses
Problem Loans and Real Estate
Non-Performing Assets and TDRs
Off-Balance Sheet Arrangements
Investment Securities
FINANCIAL CONDITION
Loans and Mortgage-Backed Securities
RESULTS OF OPERATIONS
Net Interest Income
CRITICAL ACCOUNTING POLICIES
ITEM 2. – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
NOTE (12) – Recently Issued Accounting Standards
Statement of Financial Accounting Standards No. 161
NOTE (11) – Regulatory Consent Orders, Liquidity and Capital Adequacy
NOTE (10) – Business Segment Reporting
NOTE (8) – Earnings (Loss) Per Share
Consent Orders
Derivative Hedging Activities
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE (1) – Basis of Financial Statement Presentation
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss) (unaudited)
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Income (Loss) (unaudited)
PART I – FINANCIAL INFORMATION
ITEM 1. – FINANCIAL STATEMENTS
DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited)
DOWNEY FINANCIAL CORP.
September 30, 2008 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
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Delaware
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DOWNEY FINANCIAL CORP.