Securities and Exchange Commission Form 10-Q dated September 30, 2003

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SECURITITES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

___________________________

FORM 10-Q

(Mark One)

[X]

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED

For the quarterly period ended September 30, 2003

OR

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

Commission File Number 1-13578

DOWNEY FINANCIAL CORP.
(Exact name of registrant as specified in its charter)

Delaware
(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) 854-0300

Securities registered pursuant to Section 12(b) of the Act:

 


Title of each class
Common Stock, $0.01 Par Value

Name of each exchange
on which registered
New York Stock Exchange
Pacific Exchange

          Securities registered pursuant to Section 12(g) of the Act:

None

          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  X    No     

          At September 30, 2003, 27,928,722 shares of the Registrant’s Common Stock, $0.01 par value were outstanding.


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DOWNEY FINANCIAL CORP.

SEPTEMBER 30, 2003 QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

 

PART I

ITEM 1. –

FINANCIAL INFORMATION           

1

Consolidated Balance Sheets          

1

Consolidated Statements of Income           

2

Consolidated Statements of Comprehensive Income          

3

Consolidated Statements of Cash Flows           

4

Notes To Consolidated Financial Statements           

6

ITEM 2. –

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS           

15

ITEM 3. –

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK           

46

ITEM 4. –

CONTROLS AND PROCEDURES           

46

PART II

ITEM 1. –

LEGAL PROCEEDINGS           

47

ITEM 2. –

CHANGES IN SECURITIES AND USE OF PROCEEDS           

47

ITEM 3. –

DEFAULTS UPON SENIOR SECURITIES           

47

ITEM 4. –

SUBMISSION OF MATTERS TO A VOTE OF SECURITIY HOLDERS           

47

ITEM 5. –

OTHER INFORMATION           

47

ITEM 6. –

EXHIBITS AND REPORTS ON FORM 8-K           

47

AVAILABILITY OF REPORTS           

49

SIGNATURES           

49


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PART I

ITEM 1. – FINANCIAL INFORMATION

DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Balance Sheets

 

September 30,

December 31,

September 30,

(Dollars in Thousands, Except Per Share Data)

2003

2002

2002


Assets

Cash

$

113,075

$

123,524

$

135,493

Federal funds

4,001

2,555

16,702


Cash and cash equivalents

117,076

126,079

152,195

U.S. Treasury securities, agency obligations and other investment

securities available for sale, at fair value

635,825

457,864

267,310

Municipal securities held to maturity, at amortized cost (estimated

fair value of $6,135 at December 31, 2002,

and $6,305 at September 30, 2002)

-

6,149

6,320

Loans held for sale, at lower of cost or fair value

335,437

652,052

665,587

Mortgage-backed securities available for sale, at fair value

1,590

2,253

1,019,030

Loans receivable held for investment

9,650,441

10,322,637

10,000,420

Investments in real estate and joint ventures

32,435

33,890

40,371

Real estate acquired in settlement of loans

7,436

12,360

15,441

Premises and equipment

111,201

113,536

113,258

Federal Home Loan Bank stock, at cost

121,813

117,563

116,041

Mortgage servicing rights, net

70,400

57,729

46,912

Other assets

75,713

76,039

75,533


$

11,159,367

$

11,978,151

$

12,518,418


Liabilities and Stockholders’ Equity

Deposits

$

8,608,068

$

9,238,350

$

9,056,932

Federal Home Loan Bank advances and other borrowings

1,263,328

1,624,084

1,869,789

Company obligated mandatorily redeemable capital securities of

subsidiary trust holding solely junior subordinated debentures

of the Company ("Capital Securities")

120,000

120,000

120,000

Accounts payable and accrued liabilities

180,869

102,533

618,210

Deferred income taxes

92,892

70,080

62,680


Total liabilities

10,265,157

11,155,047

11,727,611


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 28,235,022 shares at September 30, 2003,

December 31, 2002 and September 30, 2002

282

282

282

Additional paid-in capital

93,792

93,792

93,792

Accumulated other comprehensive income (loss)

(757

)

(1,422

)

274

Retained earnings

813,063

742,622

705,172

Treasury stock, at cost, 306,300 shares at September 30, 2003 and

December 31, 2002 and 212,300 shares at September 30, 2002

(12,170

)

(12,170

)

(8,713

)


Total stockholders’ equity

894,210

823,104

790,807


$

11,159,367

$

11,978,151

$

12,518,418


See accompanying notes to consolidated financial statements.

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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Income

 

Three Months Ended

Nine Months Ended

September 30,

September 30,


(Dollars in Thousands, Except Per Share Data)

2003

2002

2003

2002


Interest income

Loans receivable

$

119,990

$

150,987

$

393,363

$

459,712

U.S. Treasury securities and agency obligations

2,497

2,190

7,520

7,386

Mortgage-backed securities

16

287

51

2,503

Other investments

1,196

1,460

4,336

5,146


Total interest income

123,699

154,924

405,270

474,747


Interest expense

Deposits

38,010

59,598

128,229

188,354

Borrowings

14,304

15,314

44,280

45,226

Capital securities

3,040

3,040

9,122

9,122


Total interest expense

55,354

77,952

181,631

242,702


Net interest income

68,345

76,972

223,639

232,045

Provision for (reduction of) loan losses

(1,104

)

471

(3,437

)

812


Net interest income after provision for (reduction of) loan losses

69,449

76,501

227,076

231,233


Other income, net

Loan and deposit related fees

14,405

11,848

40,032

34,762

Real estate and joint ventures held for investment, net

5,864

2,407

8,876

6,420

Secondary marketing activities:

Loan servicing income (loss), net

1,550

(18,963

)

(33,828

)

(35,168

)

Net gains (losses) on sales of loans and mortgage-backed securities

23,467

(971

)

55,882

22,126

Net gains on sales of mortgage servicing rights

-

-

23

306

Net losses on trading securities

(11,040

)

-

(10,449

)

-

Net gains on sales of investment securities

-

-

8

209

Litigation award

-

-

2,717

-

Other

(747

)

913

584

2,034


Total other income (loss), net

33,499

(4,766

)

63,845

30,689


Operating expense

Salaries and related costs

34,312

29,067

101,466

86,819

Premises and equipment costs

8,291

7,916

23,975

22,803

Advertising expense

835

1,066

2,644

3,692

SAIF insurance premiums and regulatory assessments

787

765

2,443

2,313

Professional fees

798

91

1,844

888

Other general and administrative expense

7,718

7,474

23,722

20,035


Total general and administrative expense

52,741

46,379

156,094

136,550

Net operation of real estate acquired in settlement of loans

(376

)

110

(190

)

79


Total operating expense

52,365

46,489

155,904

136,629


Income before income taxes

50,583

25,246

135,017

125,293

Income taxes

21,332

10,678

57,034

52,972


Net income

$

29,251

$

14,568

$

77,983

$

72,321


PER SHARE INFORMATION


Basic

$

1.05

$

0.52

$

2.79

$

2.56


Diluted

$

1.05

$

0.52

$

2.79

$

2.56


Cash dividends declared and paid

$

0.09

$

0.09

$

0.27

$

0.27


Weighted average diluted shares outstanding

27,963,374

28,132,199

27,962,012

28,229,288


See accompanying notes to consolidated financial statements.

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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

 

Three Months Ended

Nine Months Ended

September 30,

September 30,


(In Thousands)

2003

2002

2003

2002


Net income

$

29,251

$

14,568

$

77,983

$

72,321


Other comprehensive income (loss), net of income taxes (benefits)

Unrealized gains (losses) on securities available for sale:

U.S. Treasury securities, agency obligations and other investment

securities available for sale, at fair value

536

104

(103

)

(441

)

Mortgage-backed securities available for sale, at fair value

(4

)

774

(16

)

1,698

Less reclassification of realized gains included in net income

-

-

(5

)

(121

)

Unrealized gains (losses) on cash flow hedges:

Net derivative instruments

8,786

(3,383

)

1,051

(7,008

)

Less reclassification of realized (gains) losses included in net income

(11,210

)

2,543

(262

)

6,385


Total other comprehensive income (loss), net of income taxes (benefits)

(1,892

)

38

665

513


Comprehensive income

$

27,359

$

14,606

$

78,648

$

72,834


See accompanying notes to consolidated financial statements.

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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

 

Nine Months Ended

September 30,


(In Thousands)

2003

2002


Cash flows from operating activities

Net income

$

77,983

$

72,321

Adjustments to reconcile net income to net cash used for operating activities:

Depreciation and amortization

65,989

44,966

Provision for losses on loans, real estate acquired in settlement of loans, investments

in real estate and joint ventures, mortgage servicing rights and other assets

16,979

34,912

Net gains on sales of loans and mortgage-backed securities, mortgage servicing rights,

trading and investment securities, real estate and other assets

(62,866

)

(27,677

)

Interest capitalized on loans (negative amortization)

(7,284

)

(20,917

)

Federal Home Loan Bank stock dividends

(4,250

)

(2,902

)

Loans originated for sale

(5,334,724

)

(4,131,463

)

Proceeds from sales of loans held for sale, including those sold

as mortgage-backed securities

5,673,264

4,036,188

(Increase) decrease in other, net

(61,914

)

19,854


Net cash provided by operating activities

363,177

25,282


Cash flows from investing activities

Proceeds from sales of:

U.S. Treasury securities, agency obligations and other investment securities

available for sale

15,275

88,541

Wholly owned real estate and real estate acquired in settlement of loans

21,327

26,036

Proceeds from maturities of U.S. Treasury securities, agency obligations

and other investment securities available for sale

558,474

426,205

Purchase of:

U.S. Treasury securities, agency obligations and other investment securities

available for sale

(645,822

)

(381,730

)

Mortgage-backed securities available for sale

-

(503,874

)

Loans receivable held for investment

(694,719

)

(31,204

)

Premises and equipment

(11,870

)

(15,878

)

Originations of loans receivable held for investment (net of refinances of $254,283 for the

nine months ended September 30, 2003 and $216,540 for the nine months ended

September 30, 2002)

(2,359,137

)

(3,088,235

)

Principal payments on loans receivable held for investment and mortgage-backed

securities available for sale

3,752,848

2,654,123

Net change in undisbursed loan funds

(11,764

)

53,694

Investments in real estate held for investment

(1,485

)

(15,965

)

Other, net

3,273

3,600


Net cash provided by (used for) investing activities

626,400

(784,687

)


See accompanying notes to consolidated financial statements.

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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Continued)

 

Nine Months Ended

September 30,


(In Thousands)

2003

2002


Cash flows from financing activities

Net increase (decrease) in deposits

$

(630,282

)

$

437,366

Proceeds from Federal Home Loan Bank advances

7,606,478

4,325,258

Repayments of Federal Home Loan Bank advances and other borrowings

(7,967,234

)

(3,978,181

)

Purchase of treasury stock

-

(8,713

)

Proceeds from exercise of stock options

-

392

Cash dividends

(7,542

)

(7,602

)


Net cash provided by (used for) financing activities

(998,580

)

768,520


Net increase (decrease) in cash and cash equivalents

(9,003

)

9,115

Cash and cash equivalents at beginning of period

126,079

143,080


Cash and cash equivalents at end of period

$

117,076

$

152,195


Supplemental disclosure of cash flow information:

Cash paid during the period for:

Interest

$

181,910

$

243,440

Income taxes

55,588

21,992

Supplemental disclosure of non-cash investing:

Loans transferred to held for investment from held for sale

8,406

2,475

Loans transferred from held for investment to held for sale

3,655

-

Mortgage-backed securities available for sale, purchased and not settled

-

510,224

U.S. Treasury securities, agency obligations and other investment securities

available for sale, purchased and not settled

100,000

-

Loans exchanged for mortgage-backed securities

4,808,110

3,401,952

Real estate acquired in settlement of loans

11,493

20,245

Loans to facilitate the sale of real estate acquired in settlement of loans

3,990

10,778


See accompanying notes to consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE (1) – Basis of Financial Statement Presentation

          In the opinion of Downey Financial Corp. and subsidiaries ("Downey," "we," "us" and "our"), the accompanying consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary for a fair presentation of Downey’s financial condition as of September 30, 2003, December 31, 2002 and September 30, 2002, the results of operations and comprehensive income for the three months and nine months ended September 30, 2003 and 2002, and changes in cash flows for the nine months ended September 30, 2003 and 2002. 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 accounting principles generally accepted in the United States of America 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 and cash flows. The following 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, 2002, 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, 2002 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) – Mortgage Servicing Rights

          The following table summarizes the activity in mortgage servicing rights and its related allowance for the periods indicated and other related financial data.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(Dollars in Thousands)

2003

2003

2003

2002

2002


Gross balance at beginning of period

$

89,948

$

92,178

$

90,584

$

83,705

$

81,100

Additions

21,660

15,405

14,954

18,779

9,304

Amortization

(5,051

)

(9,951

)

(4,771

)

(4,146

)

(4,120

)

Sales

-

-

-

(1,319

)

-

Impairment write-down

(13,892

)

(7,684

)

(8,589

)

(6,435

)

(2,579

)


Gross balance at end of period

92,665

89,948

92,178

90,584

83,705


Allowance balance at beginning of period

41,226

35,672

32,855

36,793

21,329

Provision for (reduction of) impairment

(5,069

)

13,238

11,406

2,497

18,043

Impairment write-down

(13,892

)

(7,684

)

(8,589

)

(6,435

)

(2,579

)


Allowance balance at end of period

22,265

41,226

35,672

32,855

36,793


Total mortgage servicing rights, net

$

70,400

$

48,722

$

56,506

$

57,729

$

46,912


As a percentage of associated mortgage loans

0.78

%

0.55

%

0.67

%

0.72

%

0.64

%

Estimated fair value (a)

$

70,401

$

48,722

$

56,506

$

57,736

$

46,986

Weighted average expected life (in months)

50

31

39

43

39

Custodial account earnings rate

1.49

%

1.26

%

1.58

%

1.61

%

2.06

%

Weighted average discount rate

8.91

7.47

7.39

8.35

8.19


At period end

Mortgage loans serviced for others:

Total

$

9,125,469

$

8,980,037

$

8,535,480

$

8,316,236

$

7,502,157

With capitalized mortgage servicing rights:(a)

Amount

9,068,209

8,916,259

8,460,152

8,036,393

7,355,700

Weighted average interest rate

5.87

%

6.12

%

6.35

%

6.51

%

6.71

%


Custodial escrow balances

$

25,732

$

16,527

$

7,578

$

15,243

$

21,628


(a) The estimated fair value may exceed book value for certain asset strata and excluded loans sold or securitized prior to 1996 and loans temporarily sub-serviced without capitalized mortgage servicing rights.
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Nine Months Ended September 30,


(Dollars in Thousands)

2003

2002


Gross balance at beginning of period

$

90,584

$

65,630

Additions

52,019

34,457

Amortization

(19,773

)

(10,289

)

Sales

-

(35

)

Impairment write-down

(30,165

)

(6,058

)


Gross balance at end of period

92,665

83,705


Allowance balance at beginning of period

32,855

8,735

Provision for impairment

19,575

34,116

Impairment write-down

(30,165

)

(6,058

)


Allowance balance at end of period

22,265

36,793


Total mortgage servicing rights, net

$

70,400

$

46,912


          Key assumptions, which vary due to changes in market interest rates and are used to determine the fair value of mortgage servicing rights, include: expected prepayment speeds, which impact the average life of the portfolio; the earnings rate on custodial accounts, which impact the value of custodial accounts; and the discount rate used in valuing future cash flows. The following table summarizes the estimated changes in the fair value of mortgage servicing rights for changes in those assumptions individually and in combination associated with an immediate 100 basis point increase or decrease in market rates. Also summarized is the earnings impact associated with provisions for or reductions of the valuation allowance for mortgage servicing rights. Impairment is measured on a disaggregated basis based upon the predominant risk characteristics of the underlying mortgage loans such as term and coupon. Certain stratum may have impairment, while other stratum may not. Therefore, changes in overall fair value may not equal provisions for or reductions of the valuation allowance.

          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.

Expected

Custodial

Prepayment

Accounts

Discount

(Dollars in Thousands)

Speeds

Rate

Rate

Combination


Increase rates 100 basis points: (a)

Increase (decrease) in fair value

$

31,646

$

4,707

$

(1,245

)

$

30,871

Reduction of (increase in) valuation allowance

19,643

3,820

(1,496

)

19,728

Decrease rates 100 basis points: (b)

Increase (decrease) in fair value

(33,679

)

(4,167

)

1,860

(37,574

)

Reduction of (increase in) valuation allowance

(33,679

)

(4,167

)

1,852

(37,574

)


(a) The weighted-average expected life of the mortgage servicing rights portfolio is 81 months.
(b) The weighted-average expected life of the mortgage servicing rights portfolio is 23 months.

          The following table presents a breakdown of the components of loan servicing income (loss) included in Downey’s results of operations for the periods indicated.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Net cash servicing fees

$

5,401

$

5,117

$

5,016

$

4,680

$

4,382

Payoff and curtailment interest cost (a)

(3,869

)

(3,620

)

(2,525

)

(2,498

)

(1,182

)

Amortization of MSRs

(5,051

)

(9,951

)

(4,771

)

(4,146

)

(4,120

)

(Provision for) reduction of impairment

of MSRs

5,069

(13,238

)

(11,406

)

(2,497

)

(18,043

)


Total loan servicing income (loss), net

$

1,550

$

(21,692

)

$

(13,686

)

$

(4,461

)

$

(18,963

)


(a) Represents contractual obligation to pay interest at the borrower’s loan rate from the date the loan is repaid until the funds are remitted to the investor. This does not include the benefit of the use of repaid loan funds to reduce borrowings and its associated interest expense, which is reported in net interest income.
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Nine Months Ended September 30,


(In Thousands)

2003

2002


Net cash servicing fees

$

15,534

$

11,856

Payoff and curtailment interest cost (a)

(10,014

)

(2,619

)

Amortization of MSRs

(19,773

)

(10,289

)

Provision for impairment of MSRs

(19,575

)

(34,116

)


Total loan servicing loss, net

$

(33,828

)

$

(35,168

)


(a) Represents contractual obligation to pay interest at the borrower’s loan rate from the date the loan is repaid until the funds are remitted to the investor. This does not include the benefit of the use of repaid loan funds to reduce borrowings and its associated interest expense, which is reported in net interest income.

NOTE (3) – Derivatives, Hedging Activities, Off-Balance Sheet Arrangements and Contractual Obligations

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 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 expected rate lock commitments do not qualify for hedge accounting. Associated fair value adjustments to the notional amount of the expected rate lock commitments are recorded in current earnings under net gains (losses) 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 expected rate lock commitments are based on observable market prices acquired from third parties. 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 rate lock derivative from the date of commitment to the date of funding. At September 30, 2003, Downey had a notional amount of expected rate lock commitments identified to sell as part of its secondary marketing activities of $382 million, with a change in fair value resulting in a gain of $7.4 million.

Hedging Activities

          As part of secondary marketing activities, Downey typically utilizes short-term 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 expected rate lock commitments and loans held for sale. Downey does not generally enter into derivative transactions for purely speculative purposes. Contracts designated as hedges for the forecasted sale of loans from our 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 forward sale contracts not designated as cash flow hedges and the in effectiveness of hedge transactions that are not perfectly correlated are recorded in net gains (losses) on sales of loans and mortgage-backed securities. Changes in fair value of the notional amount of forward sale contracts designated as cash flow hedges for loans held for sale are recorded in other comprehensive income, net of tax, provided cash flow hedge requirements are met. The offset to these changes in fair value of the notional amount of forward sale contracts are recorded in the balance sheet as either other assets, or accounts payable and accrued liabilities. The amounts recorded in accumulated other comprehensive income will be recognized in the income statement when the hedged forecasted transactions settle. 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 forward sale contracts are based on observable market prices acquired from third parties. At September 30, 2003, the notional amount of forward sale contracts amounted to $725 million, with a change in fair value resulting in a loss of $7.8 million, of which $334 million were designated as cash flow hedges. The notional amount of forward purchase contracts amounted to $35 million, with an estimated fair value gain of $0.4 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.

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          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 periods indicated. Also shown is the notional amount of expected rate lock commitment derivatives for loans originated for sale, loans held for sale and the notional amounts of their associated hedging derivatives (i.e., forward sale contracts).

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Net gains (losses) on non-qualifying hedge transactions

$

1,121

$

(2,936

)

$

(139

)

$

4,287

$

(2,663

)

Net gains (losses) 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)

1,121

(2,936

)

(139

)

4,287

(2,663

)

Other comprehensive income (loss)

(2,424

)

1,622

1,591

(1,272

)

(840

)


Notional amount at period end

Non-qualifying hedge transactions:

Expected rate lock commitments

$

381,948

$

950,703

$

957,549

$

614,592

$

892,429

Associated forward sale contracts

391,234

985,094

913,034

624,062

1,024,586

Associated forward purchase contracts

35,000

139,000

6,000

50,000

165,000

Qualifying cash flow hedge transactions:

Loans held for sale, at lower of cost or fair value

335,437

721,929

633,676

652,052

665,587

Associated forward sale contracts

334,031

710,099

624,002

623,975

659,305


Nine Months Ended September 30,


(In Thousands)

2003

2002


Net gains (losses) on non-qualifying hedge transactions

$

(1,954

)

$

1,811

Net gains (losses) 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)

(1,954

)

1,811

Other comprehensive income (loss)

789

(623

)


          These forward contracts expose Downey to credit risk in the event of nonperformance to such agreements by the other parties—primarily government-sponsored enterprises such as Federal National Mortgage Association. This risk consists primarily of the termination value of agreements where Downey is in an unfavorable position. Downey controls 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 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 of credit and letters of credit, commitments to purchase loans and mortgage-backed securities for our portfolio and commitments to invest in affordable housing funds. The contract or notional amounts of those instruments reflect the extent of involvement Downey has in particular classes of financial instruments.

          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. 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 and unused lines of credit include funds not disbursed, but committed to construction projects and home equity and commercial lines of credit. Letters of credit are conditional commitments issued by Downey to guarantee the performance of a customer to a third party. We also enter into commitments to purchase loans and mortgage-backed securities, investment securities and to invest in affordable housing funds.

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          The following is a summary of commitments and contingent liabilities with off-balance sheet risk at the dates indicated.

September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Commitments to originate loans held for investment:

Adjustable

$

414,823

$

336,303

$

190,737

$

249,121

$

261,365

Fixed

380

235

117

716

1,459

Undisbursed loan funds and unused lines of credit

178,202

183,720

178,754

189,283

184,074

Letters of credit and other contingent liabilities

2,703

6,044

6,031

2,662

2,534

Commitments to purchase loans

-

40,816

5,200

-

294,476

Commitments to purchase investment securities

100,000

-

-

-

-

Commitments to invest in affordable housing funds

3,393

2,400

2,400

2,400

2,400


          Downey uses the same credit policies in making commitments to originate loans held for investment, lines of credit and letters of credit as it does 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. Downey controls 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 for which collateral is deemed necessary. The most significant categories of collateral include real estate properties underlying mortgage loans, liens on personal property and cash on deposit with Downey.

          In connection with its interest rate risk management, Downey may enter into interest rate exchange agreements ("swap contracts") with certain national investment banking firms under terms that provide mutual payment of interest on the outstanding notional amount of the swap. These swap contracts reduce Downey’s interest rate risk between repricing assets and liabilities. No swap contracts were outstanding for any of the periods presented.

Litigation

          Downey has been named as a defendant in legal actions arising in the ordinary course of business, none of which, in the opinion of management, is material.

NOTE (4) – Income Taxes

          Downey and its wholly owned subsidiaries file a consolidated federal income tax return and various state income and franchise tax returns on a calendar year basis. The Internal Revenue Service and state taxing authorities have examined Downey’s tax returns for all tax years through 1997. Downey’s management believes it has adequately provided for potential exposure to issues that may be raised in the years subsequent to 1997, which remain open to review.

NOTE (5) – Employee Stock Option Plans

          Downey has a Long Term Incentive Plan (the "LTIP"), which provides for the granting of stock appreciation rights, restricted stock, performance awards and other awards. The LTIP specifies an authorization of 434,110 shares (adjusted for stock dividends and splits) of common stock to be available for issuance. Under the LTIP, options are exercisable over vesting periods specified in each grant and, unless exercised, the options terminate between five or ten years from the date of the grant. Further, under the LTIP, the option price shall at least equal or exceed the fair market value of such shares on the date the options are granted. No shares have been granted under the LTIP since 1998. At September 30, 2003, Downey had 306,300 shares of treasury stock that may be used to satisfy the exercise of options or for payment of other awards. No other stock based plan exists.

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          Downey measures its employee stock-based compensation arrangements under the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Accordingly, no compensation expense has been recognized for the stock option plan, as stock options were granted at fair value at the date of grant. Had compensation expense for Downey’s stock option plan been determined based on the fair value estimated using the Black-Scholes model at the grant date for previous awards, Downey’s net income and income per share would have been reduced to the pro forma amounts indicated for the periods below:

Three Months Ended September 30,


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands, Except Per Share Data)

2003

2003

2003

2002

2002


Net income:

As reported

$

29,251

$

18,515

$

30,217

$

39,972

$

14,568

Stock-based compensation expense, net of tax

-

-

-

(4

)

(3

)


Pro forma

29,251

18,515

30,217

39,968

14,565

Earnings per share – Basic:

As reported

$

1.05

$

0.66

$

1.08

$

1.43

$

0.52

Pro forma

1.05

0.66

1.08

1.43

0.52

Earnings per share – Diluted:

As reported

1.05

0.66

1.08

1.43

0.52

Pro forma

1.05

0.66

1.08

1.43

0.52


Nine Months Ended September 30,


(In Thousands, Except Per Share Data)

2003

2002


Net income:

As reported

$

77,983

$

72,321

Stock-based compensation expense, net of tax

-

(9

)


Pro forma

77,983

72,312

Earnings per share – Basic:

As reported

$

2.79

$

2.56

Pro forma

2.79

2.56

Earnings per share – Diluted:

As reported

2.79

2.56

Pro forma

2.79

2.56


          As of December 31, 2002, stock-based compensation would have been fully expensed over the vesting period of the stock options granted, if Downey had recorded stock-based compensation expense.

NOTE (6) – Earnings Per Share

          Earnings per share is calculated on both a basic and diluted basis, 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.

Three Months Ended September 30,


2003

2002


Weighted

Weighted

Average

Average

Net

Shares

Per Share

Net

Shares

Per Share

(Dollars in Thousands, Except Per Share Data)

Income

Outstanding

Amount

Income

Outstanding

Amount


Basic earnings per share

$

29,251

27,928,722

$

1.05

$

14,568

28,094,184

$

0.52

Effect of dilutive stock options

-

34,652

-

-

38,015

-


Diluted earnings per share

$

29,251

27,963,374

$

1.05

$

14,568

28,132,199

$

0.52


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Nine Months Ended September 30,


2003

2002


Weighted

Weighted

Average

Average

Net

Shares

Per Share

Net

Shares

Per Share

(Dollars in Thousands, Except Per Share Data)

Income

Outstanding

Amount

Income

Outstanding

Amount


Basic earnings per share

$

77,983

27,928,722

$

2.79

$

72,321

28,180,007

$

2.56

Effect of dilutive stock options

-

33,290

-

-

49,281

-


Diluted earnings per share

$

77,983

27,962,012

$

2.79

$

72,321

28,229,288

$

2.56


          There were no options excluded from the computation of earnings per share due to anti-dilution.

NOTE (7) – Business Segment Reporting

          The following table presents the operating results and selected financial data by major business segments for the periods indicated.

Real Estate

(In Thousands)

Banking

Investment

Elimination

Totals


Three months ended September 30, 2003

Net interest income (loss)

$

68,395

$

(50

)

$

-

$

68,345

Reduction of loan losses

(1,104

)

-

-

(1,104

)

Other income

27,023

6,476

-

33,499

Operating expense

52,126

239

-

52,365

Net intercompany income (expense)

43

(43

)

-

-


Income before income taxes

44,439

6,144

-

50,583

Income taxes

18,818

2,514

-

21,332


Net income

$

25,621

$

3,630

$

-

$

29,251


At September 30, 2003

Assets:

Loans and mortgage-backed securities

$

9,987,468

$

-

$

-

$

9,987,468

Investments in real estate and joint ventures

-

32,435

-

32,435

Other

1,161,884

4,617

(27,037

)

1,139,464


Total assets

11,149,352

37,052

(27,037

)

11,159,367


Equity

$

894,210

$

27,037

$

(27,037

)

$

894,210


Three months ended September 30, 2002

Net interest income

$

76,960

$

12

$

-

$

76,972

Provision for loan losses

471

-

-

471

Other income (loss)

(7,507

)

2,741

-

(4,766

)

Operating expense

46,328

161

-

46,489

Net intercompany income (expense)

100

(100

)

-

-


Income before income taxes

22,754

2,492

-

25,246

Income taxes

9,654

1,024

-

10,678


Net income

$

13,100

$

1,468

$

-

$

14,568


At September 30, 2002

Assets:

Loans and mortgage-backed securities

$

11,685,037

$

-

$

-

$

11,685,037

Investments in real estate and joint ventures

-

40,371

-

40,371

Other

828,836

4,090

(39,916

)

793,010


Total assets

12,513,873

44,461

(39,916

)

12,518,418


Equity

$

790,807

$

39,916

$

(39,916

)

$

790,807


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Real Estate

(In Thousands)

Banking

Investment

Elimination

Totals


Nine months ended September 30, 2003

Net interest income (loss)

$

223,694

$

(55

)

$

-

$

223,639

Reduction of loan losses

(3,437

)

-

-

(3,437

)

Other income

53,307

10,538

-

63,845

Operating expense

155,217

687

-

155,904

Net intercompany income (expense)

127

(127

)

-

-


Income before income taxes

125,348

9,669

-

135,017

Income taxes

53,077

3,957

-

57,034


Net income

$

72,271

$

5,712

$

-

$

77,983


Nine months ended September 30, 2002

Net interest income

$

232,015

$

30

$

-

$

232,045

Provision for loan losses

812

-

-

812

Other income

23,358

7,331

-

30,689

Operating expense

136,002

627

-

136,629

Net intercompany income (expense)

279

(279

)

-

-


Income before income taxes

118,838

6,455

-

125,293

Income taxes

50,327

2,645

-

52,972


Net income

$

68,511

$

3,810

$

-

$

72,321


NOTE (8) – Current Accounting Issues

Statement of Financial Accounting Standards No. 148.

          Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation – Transition and Disclosure" ("SFAS 148"), amends Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), to provide alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 to require prominent disclosure about the effects on reported net income of Downey’s accounting policy decisions with respect to stock-based employee compensation. Finally, SFAS 148 amends APB Opinion No. 28, "Interim Financial Reporting," to require disclosure about those effects in interim financial information. Presently, Downey does not intend to adopt the fair value method. For further information regarding Downey’s accounting for stock options, See Note 5 on page 10.

Statement of Financial Accounting Standards No. 149.

          Statement of Financial Accounting Standards No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS 149"), clarifies and amends financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). In general, SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The financial impact of SFAS 149 did not have a material effect on Downey.

Statement of Financial Accounting Standards No. 150.

          Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150"), establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity that have been presented either entirely as equity or between the liabilities section and the equity section of the statement of financial position. SFAS 150 clarifies that Downey’s Capital Securities be classified as a liability, whereas previously they were classified between the liabilities and equity sections. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. To-date, the financial impact of SFAS 150 has not had a material effect on Downey.

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Financial Accounting Standards Board Interpretation 46.

          Financial Accounting Standards Board Interpretation 46, "Provides Guidance to Improve Financial Reporting for SPEs, Off-Balance Sheet Structures and Similar Entities" ("FIN 46"), requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. Prior to FIN 46, a company included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 also requires disclosures about variable interest entities that the company is not required to consolidate but in which it has a significant variable interest. The consolidated requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The FASB deferred the effective date for applying the provision of FIN 46 for interests held by public entities in variable interest entities or potential variable interest entities created before February 1, 2003 until the end of the first interim or annual period after December 15, 2003. Certain disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. Downey has no business interests that require consolidation or deconsolidation as a result of applying the provisions of FIN 46.

NOTE (9) – Subsequent Events

Grocery store labor dispute.

          On October 11, 2003, grocery store workers from Albertsons, Vons, Pavillions and Ralphs went on strike or were locked out by grocery store management. As of October 31, 2003, the grocery stores continue operations. Downey operates 85 full-service, in-store branches with 85 automated teller machines ("ATMs") and 142 stand-alone ATMs in these grocery stores. At the current quarter end, $1.4 billion in deposits or 16% of total deposits are associated with these branches. These branches and ATMs remain open with no material change to deposit volumes, although ATM usage has declined somewhat due to less customer traffic in the grocery stores since the start of the labor dispute. These ATMs account for approximately one-fourth of our ATM fee income. The length and severity of the labor dispute is unknown; however, the impact to our financial results over the next quarter is expected to be minimal.

Southern California Wild Fires.

          In late October, wild fires erupted in Southern California, primarily in Los Angeles, Riverside, San Bernardino, San Diego and Ventura counties, causing partial or total destruction to numerous homes. While it is likely some homes we have financed have been damaged, we do not expect to incur any significant loss, as our borrowers are required to have fire insurance. As of the filing of this Form 10-Q, none of our branch offices have been damaged.

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ITEM 2. – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

          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 forward-looking 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 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, fluctuations in interest rates, credit quality and government regulation. 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.

OVERVIEW

          Our net income for the third quarter of 2003 totaled $29.3 million or $1.05 per share on a diluted basis, over double the $14.6 million or $0.52 per share in the third quarter of 2002.

          The increase in net income between third quarters reflected higher net income from both of our business segments. Net income from our real estate operations increased $2.2 million due primarily to higher gains from sales, while net income from our banking activities increased $12.5 million, primarily reflecting:

Those favorable items were partially offset by:

          For the first nine months of 2003, our net income totaled $78.0 million or $2.79 per share on a diluted basis, up from $72.3 million or $2.56 per share for the first nine months of 2002. Both business segments contributed to the increase. Net income from our banking activities increased $3.8 million primarily reflecting higher gains from sales of loans and mortgage-backed securities, higher loan and deposit related fees, a favorable change in provision for loan losses and a litigation award. Those favorable items were partially offset by higher operating expense, losses from trading securities, and a decline in net interest income. Net income from our real estate operations increased $1.9 million primarily reflecting higher gains from sales.

          For the third quarter of 2003, our return on average assets was 1.02%, up from 0.52% a year ago, while our return on average equity was 13.16%, up from 7.44% a year ago. For the first nine-month periods, our return on average assets increased from 0.87% a year ago to 0.90%, while our return on average equity declined from 12.54% to 12.07%.

          Our single family loan originations, including purchases, totaled $2.576 billion in the third quarter of 2003, down 9.0% from the $2.832 billion we originated in the third quarter of 2002 and 25.3% below the record $3.448 billion we originated in the second quarter of 2003. Single family loans originated for sale declined $595 million from second quarter 2003 to $1.566 billion, while single family loans originated for portfolio declined $277 million to $1.010 billion, as our purchases of loans were $570 million lower. In addition to single family loans, we originated $103 million of other loans in the quarter.

          At quarter end, our assets totaled $11.2 billion, down $1.4 billion or 10.9% from a year ago. Included in year-ago assets were $1.0 billion of 30-year fixed rate mortgage-backed securities purchased in late September of 2002, but sold in the following month due to interest rate volatility and the potential adverse impact market interest rate changes could have on the carrying value of the investment. Since year-end 2002, our assets are down $819 million. Even though mortgage interest

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rates rose during the current quarter, refinance activity continued to remain high, as loan applications submitted when interest rates were lower in the second quarter funded in the current quarter. As a result, our loan repayments continued to exceed our portfolio originations and loans held for investment declined $399 million in the quarter and were $672 million below the year-end level. In addition, our loans held for sale declined $386 million in the quarter and were $317 million below the year-end level, as our volume of new fixed rate applications fell due to the rise in mortgage interest rates during the current quarter. The decline in our loans since year end was partially offset by an increase of $173 million in investment securities, the majority of which adjust to market interest rates every three months.

          Our deposits totaled $8.6 billion at September 30, 2003, down 5.0% from the year-ago level and 6.8% from year-end 2002. During the quarter, we opened one new in-store branch, bringing our total branches at quarter end to 171, of which 99 were in-store. A year ago, branches totaled 156, of which 85 were in-store.

          Our non-performing assets declined $4 million during the quarter to $63 million or 0.56% of total assets. The decline was primarily in our subprime residential loan category.

          At September 30, 2003, our primary subsidiary, Downey Savings and Loan Association, F.A. (the "Bank") exceeded all regulatory capital tests, with capital-to-asset ratios of 8.16% for both tangible and core capital and 15.92% for risk-based capital. These capital levels are significantly above the "well capitalized" standards defined by the federal banking regulators of 5% for core and tangible capital and 10% for risk-based capital.

Critical Accounting Policies

          We 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. Our significant accounting policies are described in Downey’s Annual Report on Form 10-K for the year ended December 31, 2002. Certain accounting policies require us to make significant estimates and assumptions which 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 we use 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 carrying value of assets and liabilities at the balance sheet dates and our results of operations for the reporting periods. Management has discussed the development and selection of these critical accounting policies with the Audit Committee of our Board of Directors.

          We believe the following are critical accounting policies that require the most significant estimates and assumptions, which are particularly susceptible to significant change in the preparation of our financial statements:

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RESULTS OF OPERATIONS

Net Interest Income

          Net interest income is the difference between the interest and dividends earned on loans, mortgage-backed securities and investment securities ("interest-earning assets") and the interest paid on deposits, borrowings and capital securities ("interest-bearing liabilities"). The spread between the yield on interest-earning 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 $68.3 million in the current quarter, down $8.6 million or 11.2% from the same period last year. Our interest-earning assets averaged $11.0 billion during the quarter, up 1.2% from the year-ago level. The favorable impact of our higher interest-earning assets was more than offset by a decline in our effective interest rate spread. The effective interest rate spread averaged 2.48% in the current quarter, down from 2.83% a year ago and 2.70% in the previous quarter. The decline between third quarters was due to our yield on interest-earning assets declining more rapidly than our cost of funds. The more rapid decline in our yield on interest-earning assets primarily reflected our positive interest rate gap (i.e., more interest-earning assets reprice to market interest rates within one year than do interest-bearing liabilities). In addition, the decline in our effective interest rate spread also reflected a higher proportion of lower yielding investment securities, a higher proportion of adjustable rate mortgages tied to the 12-month moving average of annual yields on actively traded U.S. Treasury securities to a constant maturity of one year ("MTA") that are lower yielding than those tied to the Federal Home Loan Bank ("FHLB") Eleventh District Cost of Funds Index ("COFI") and a lower percentage of higher yielding subprime loans.

          For the first nine months of 2003, net interest income totaled $223.6 million, down $8.4 million from a year ago. The decline primarily reflected a lower effective interest rate spread.

          The following table presents for the periods indicated the total dollar amount of:

          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:

          The table also sets forth our net interest-earning balance—the difference between the average balance of interest-earning assets and the average balance of total deposits, borrowings and capital securities—for the quarters indicated. We included non-accrual loans in the average interest-earning assets balance. We included interest from non-accrual loans in interest income only to the extent we received payments and to the extent we believe we will recover the remaining principal balance of the loans. We computed average balances for the quarter using the average of each month’s daily average balance during the periods indicated.

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Three Months Ended September 30,


2003

2002


Average

Average

Average

Average

(Dollars in Thousands)

Balance

Interest

Yield/Rate

Balance

Interest

Yield/Rate


Interest-earning assets:

Loans

$

10,421,746

$

119,990

4.61

%

$

10,475,813

$

150,987

5.77

%

Mortgage-backed securities

1,660

16

3.86

32,601

287

3.52

Trading and investment securities

599,065

3,693

2.45

387,325

3,650

3.74


Total interest-earning assets

11,022,471

123,699

4.49

10,895,739

154,924

5.69

Non-interest-earning assets

393,442

393,252


Total assets

$

11,415,913

$

11,288,991


Transaction accounts:

Non-interest-bearing checking

$

436,087

$

-

-

%

$

301,169

$

-

-

%

Interest-bearing checking (a)

456,023

292

0.25

414,909

323

0.31

Money market

133,736

350

1.04

114,544

487

1.69

Regular passbook

4,131,975

12,874

1.24

3,222,127

18,566

2.29


Total transaction accounts

5,157,821

13,516

1.04

4,052,749

19,376

1.90

Certificates of deposit

3,699,164

24,494

2.63

4,766,674

40,222

3.35


Total deposits

8,856,985

38,010

1.70

8,819,423

59,598

2.68

Borrowings

1,322,837

14,304

4.29

1,396,414

15,314

4.35

Capital securities

120,000

3,040

10.14

120,000

3,040

10.14


Total deposits, borrowings and capital securities

10,299,822

55,354

2.13

10,335,837

77,952

2.99

Other liabilities

226,980

169,689

Stockholders’ equity

889,111

783,465


Total liabilities and stockholders’ equity

$

11,415,913

$

11,288,991


Net interest income/interest rate spread

$

68,345

2.36

%

$

76,972

2.70

%

Excess of interest-earning assets over

deposits, borrowings and capital securities

$

722,649

$

559,902

Effective interest rate spread

2.48

2.83


Nine Months Ended September 30,


2003

2002


Average

Average

Average

Average

(Dollars in Thousands)

Balance

Interest

Yield/Rate

Balance

Interest

Yield/Rate


Interest-earning assets:

Loans

$

10,566,127

$

393,363

4.96

%

$

10,161,564

$

459,712

6.03

%

Mortgage-backed securities

1,825

51

3.73

73,283

2,503

4.55

Trading and investment securities

543,076

11,856

2.92

412,504

12,532

4.06


Total interest-earning assets

11,111,028

405,270

4.86

10,647,351

474,747

5.95

Non-interest-earning assets

401,758

394,628


Total assets

$

11,512,786

$

11,041,979


Transaction accounts:

Non-interest-bearing checking

$

407,452

$

-

-

%

$

293,964

$

-

-

%

Interest-bearing checking (a)

440,581

874

0.27

421,894

1,065

0.34

Money market

128,364

1,119

1.17

112,830

1,497

1.77

Regular passbook

3,931,071

40,957

1.39

2,875,959

52,502

2.44


Total transaction accounts

4,907,468

42,950

1.17

3,704,647

55,064

1.99

Certificates of deposit

3,998,283

85,279

2.85

4,929,779

133,290

3.61


Total deposits

8,905,751

128,229

1.93

8,634,426

188,354

2.92

Borrowings

1,435,378

44,280

4.12

1,373,979

45,226

4.40

Capital securities

120,000

9,122

10.14

120,000

9,122

10.14


Total deposits, borrowings and capital securities

10,461,129

181,631

2.32

10,128,405

242,702

3.20

Other liabilities

189,872

144,514

Stockholders’ equity

861,785

769,060


Total liabilities and stockholders’ equity

$

11,512,786

$

11,041,979


Net interest income/interest rate spread

$

223,639

2.54

%

$

232,045

2.75

%

Excess of interest-earning assets over

deposits, borrowings and capital securities

$

649,899

$

518,946

Effective interest rate spread

2.68

2.91


(a) Included amounts swept into money market deposit accounts.
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          Changes 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 interest-earning assets and interest-bearing liabilities, we have provided information on changes attributable to:

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 period indicated.

Three Months Ended September 30,

Nine Months Ended September 30,

2003 Versus 2002

2003 Versus 2002

Changes Due To

Changes Due To


Rate/

Rate/

(In Thousands)

Volume

Rate

Volume

Net

Volume

Rate

Volume

Net


Interest income:

Loans

$

(779

)

$

(30,375

)

$

157

$

(30,997

)

$

18,303

$

(81,411

)

$

(3,241

)

$

(66,349

)

Mortgage-backed securities

(272

)

27

(26

)

(271

)

(2,441

)

(455

)

444

(2,452

)

Trading and investment

securities

1,995

(1,262

)

(690

)

43

3,967

(3,527

)

(1,116

)

(676

)


Change in interest income

944

(31,610

)

(559

)

(31,225

)

19,829

(85,393

)

(3,913

)

(69,477

)


Interest expense:

Transaction accounts:

Interest-bearing checking (a)

32

(57

)

(6

)

(31

)

47

(228

)

(10

)

(191

)

Money market

82

(188

)

(31

)

(137

)

206

(513

)

(71

)

(378

)

Regular passbook

5,243

(8,527

)

(2,408

)

(5,692

)

19,262

(22,538

)

(8,269

)

(11,545

)


Total transaction accounts

5,357

(8,772

)

(2,445

)

(5,860

)

19,515

(23,279

)

(8,350

)

(12,114

)

Certificates of deposit

(9,008

)

(8,659

)

1,939

(15,728

)

(25,186

)

(28,143

)

5,318

(48,011

)


Total interest-bearing deposits

(3,651

)

(17,431

)

(506

)

(21,588

)

(5,671

)

(51,422

)

(3,032

)

(60,125

)

Borrowings

(857

)

(237

)

84

(1,010

)

40,157

(2,886

)

(38,217

)

(946

)

Capital securities

-

-

-

-

-

-

-

-


Change in interest expense

(4,508

)

(17,668

)

(422

)

(22,598

)

34,486

(54,308

)

(41,249

)

(61,071

)


Change in net interest income

$

5,452

$

(13,942

)

$

(137

)

$

(8,627

)

$

(14,657

)

$

(31,085

)

$

37,336

$

(8,406

)


(a) Included amounts swept into money market deposit accounts.

Provision for Loan Losses

          During the current quarter, $1.1 million of provision for loan losses was reversed, compared to an expense of $0.5 million in the year-ago third quarter. The current quarter reversal reflected both an improvement in our credit quality and a decline in our loan portfolio.

          For the first nine months of 2003, $3.4 million of provision for loan losses was reversed, compared to expense of $0.8 million in the year-ago period. For further information regarding our allowance for loan losses, see Financial Condition—Problem Loans and Real Estate—Allowance for Losses on Loans and Real Estate on page 40.

Other Income

          Our total other income was $33.5 million in the current quarter, compared to a loss of $4.8 million in the year-ago third quarter. The $38.3 million improvement between third quarters primarily reflected:

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Those increases were partially offset by two items. First, a loss of $11.0 million was realized from trading securities. The trading securities were sold in July and served as a partial economic hedge against mortgage servicing rights. And second, the other income category reflected a loss of $0.7 million which included a $1.1 million loss associated with computer software no longer being utilized, compared to income of $0.9 million a year ago.

          For the first nine months of 2003, our total other income was $63.8 million, up $33.2 million from a year ago. The increase from a year ago primarily reflected higher gains from sales of loans and mortgage-backed securities, higher loan and deposit related fees, a litigation award, and an increase in income from real estate and joint ventures held for investment. Those favorable items were partially offset by a loss realized from trading securities.

          Below is a further discussion of the major other income categories.

Loan and Deposit Related Fees

          Loan and deposit related fees totaled $14.4 million in the current quarter, up $2.6 million from a year ago. Our loan related fees increased $1.8 million or 29.4% from a year ago, due primarily to an increase in loan prepayment fees. Our deposit related fees were up $0.8 million or 13.9% from a year ago, due to higher fees from both our checking accounts and automated teller machines.

          The following table presents a breakdown of loan and deposit related fees for the quarters indicated.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Loan related fees:

Prepayment fees

$

4,756

$

4,291

$

3,413

$

3,650

$

3,523

Other fees

2,863

2,925

2,574

2,733

2,366

Deposit related fees:

Automated teller machine fees

2,472

2,180

2,086

2,066

2,051

Other fees

4,314

4,253

3,905

4,009

3,908


Total loan and deposit related fees

$

14,405

$

13,649

$

11,978

$

12,458

$

11,848


          For the first nine months of 2003, loan and deposit related fees totaled $40.0 million, up $5.3 million from the same period of 2002. The increase was due to an increase in our deposit related fees of $3.3 million and loan related fees of $2.0 million.

          The following table presents a breakdown of loan and deposit related fees during the year-to-date periods indicated.

Nine Months Ended September 30,


(In Thousands)

2003

2002


Loan related fees:

Prepayment fees

$

12,460

$

12,349

Other fees

8,362

6,525

Deposit related fees:

Automated teller machine fees

6,738

5,262

Other fees

12,472

10,626


Total loan and deposit related fees

$

40,032

$

34,762


Real Estate and Joint Ventures Held for Investment

          Income from our real estate and joint ventures held for investment totaled $5.9 million in the current quarter, up $3.5 million from the year-ago quarter. The increase was primarily attributed to higher net gains associated with the sale of wholly owned real estate of $2.1 million and joint venture projects of $1.7 million, which is reported in the category equity in net income from joint ventures, partially offset by an increase of $0.4 million in our provision for losses on real estate and joint ventures.

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          The following table sets forth the key components comprising our income from real estate and joint venture operations for the quarters indicated.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Rental operations, net of expenses

$

168

$

224

$

531

$

489

$

269

Equity in net income from joint ventures

3,308

604

16

2,096

1,634

Interest from joint venture advances

568

388

280

303

306

Net gains on sales of wholly owned real estate

2,160

1,000

157

1,093

99

(Provision for) reduction of losses on real estate

and joint ventures

(340

)

(147

)

(41

)

(151

)

99


Total income from real estate and joint ventures

held for investment, net

$

5,864

$

2,069

$

943

$

3,830

$

2,407


          For the first nine months of 2003, income from our real estate and joint ventures held for investment totaled $8.9 million, up $2.5 million from the same period of 2002. The increase was primarily attributed to higher net gains on sales of wholly owned projects of $3.2 million and joint ventures of $0.3 million, partially offset by an increase of $1.1 million in our provision for losses on real estate and joint ventures.

          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.

Nine Months Ended September 30,


(In Thousands)

2003

2002


Rental operations, net of expenses

$

923

$

1,613

Equity in net income from joint ventures

3,928

3,380

Interest from joint venture advances

1,236

721

Net gains on sales of wholly owned real estate

3,317

107

(Provision for) reduction of losses on real estate and joint ventures

(528

)

599


Total income from real estate and joint ventures held for investment, net

$

8,876

$

6,420


Secondary Marketing Activities

          We service loans for others and those activities generated income of $1.5 million in the current quarter, compared to a loss of $19.0 million in the year-ago period. The $20.5 million favorable change between third quarters primarily reflected a $23.1 million positive change in valuation allowances for mortgage servicing rights, as $5.1 million was recaptured in the current quarter compared to a $18.0 million addition a year ago. The recapture of valuation allowances in the current quarter reflected rising mortgage interest rates resulting in a slower projected rate at which loans we service for others are expected to prepay, thereby lengthening their average expected life. In addition to the favorable change in valuation allowances, servicing activities benefited from a $1.0 million increase in net cash servicing fees. Those two favorable items were partially offset by increases of $2.7 million in payoff and curtailment interest costs and $0.9 million in amortization of mortgage servicing rights. When a loan we service for others prepays, most of our loan servicing agreements require us to pay interest to the investor up to the date we remit funds to them. That additional interest cost is what we call payoff and curtailment interest costs. However, we benefit from the use of those proceeds from the time of repayment until we are required to remit the funds to the investor. That benefit results in a reduction of our borrowing costs within net interest income.

          At September 30, 2003, we serviced $9.1 billion of loans for others, compared to $8.3 billion at December 31, 2002, and $7.5 billion at September 30, 2002.

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          The following table presents a breakdown of the components of our loan servicing loss for the quarters indicated.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Net cash servicing fees

$

5,401

$

5,117

$

5,016

$

4,680

$

4,382

Payoff and curtailment interest cost (a)

(3,869

)

(3,620

)

(2,525

)

(2,498

)

(1,182

)

Amortization of MSRs

(5,051

)

(9,951

)

(4,771

)

(4,146

)

(4,120

)

(Provision for) reduction of impairment

of MSRs

5,069

(13,238

)

(11,406

)

(2,497

)

(18,043

)


Total loan servicing income (loss), net

$

1,550

$

(21,692

)

$

(13,686

)

$

(4,461

)

$

(18,963

)


(a) Represents contractual obligation to pay interest at the borrower’s loan rate from the date the loan is repaid until the funds are remitted to the investor. This does not include the benefit of the use of repaid loan funds to reduce borrowings and its associated interest expense, which is reported in net interest income.

          For the first nine months of 2003, a loss of $33.8 million was recorded in loan servicing, compared to a loss of $35.2 million from the same period of 2002. The improvement reflected a smaller addition to the valuation allowance for mortgage servicing rights and an increase in net cash servicing fees. Those favorable items were partially offset by increased amortization of mortgage servicing rights and higher payoff and curtailment interest costs.

          The following table presents a breakdown of the components of our loan servicing loss during the year-to-date periods indicated.

Nine Months Ended September 30,


(In Thousands)

2003

2002


Net cash servicing fees

$

15,534

$

11,856

Payoff and curtailment interest cost (a)

(10,014

)

(2,619

)

Amortization of MSRs

(19,773

)

(10,289

)

Provision for impairment of MSRs

(19,575

)

(34,116

)


Total loan servicing loss, net

$

(33,828

)

$

(35,168

)


(a) Represents contractual obligation to pay interest at the borrower’s loan rate from the date the loan is repaid until the funds are remitted to the investor. This does not include the benefit of the use of repaid loan funds to reduce borrowings and its associated interest expense, which is reported in net interest income.

          For further information regarding mortgage servicing rights, see Notes To Consolidated Financial Statements—Note (2)—Mortgage Servicing Rights on page 6.

          Sales of loans and mortgage-backed securities increased in the current quarter to $1.938 billion from $1.564 billion a year ago. Net gains associated with these sales totaled $23.5 million in the current quarter, up from a loss of $1.0 million a year ago. Net gains in the current quarter included the capitalization of mortgage servicing rights of $21.7 million, compared to $9.3 million a year ago. Excluding the impact of SFAS 133, a gain of 1.15% of secondary market sales was realized which compares favorably to 0.10% a year ago.

          The following table presents a breakdown of the components of our net gains (losses) on sales of loans and mortgage-backed securities for the quarters indicated.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Mortgage servicing rights

$

21,660

$

15,405

$

14,954

$

18,779

$

9,304

All other components excluding SFAS 133 (a)

686

183

4,948

668

(7,612

)

SFAS 133

1,121

(2,936

)

(139

)

4,287

(2,663

)


Total net gains (losses) on sales of loans

and mortgage-backed securities

$

23,467

$

12,652

$

19,763

$

23,734

$

(971

)


Secondary marketing gain excluding SFAS

133 as a percentage of associated sales

1.15

%

0.75

%

1.23

%

0.94

%

0.10

%


(a) Included a $0.2 million gain in the fourth quarter of 2002 associated with the treasury operation’s sale of $1.0 billion of mortgage-backed securities.
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          For the first nine months of 2003, sales of loans and mortgage-backed securities totaled $5.640 billion, up from $4.039 billion a year ago. Net gains associated with these sales totaled $55.9 million, $33.8 million higher than the prior year amount.

          The following table presents a breakdown of the components of our net gains on sales of loans and mortgage-backed securities during the year-to-date periods indicated.

Nine Months Ended September 30,


(In Thousands)

2003

2002


Mortgage servicing rights

$

52,019

$

34,457

All other components excluding SFAS 133

5,817

(14,142

)

SFAS 133

(1,954

)

1,811


Total net gains on sales of loans and mortgage-backed securities

$

55,882

$

22,126


Secondary marketing gain excluding SFAS 133 as a percentage of associated sales

1.03

%

0.51

%


Trading Securities

          Trading securities were purchased as a partial economic hedge against the value of our mortgage servicing rights. These securities are carried at fair value, with any changes in fair value reflected in earnings. Our losses on trading securities totaled $11.0 million in the current quarter and $10.4 million for the first nine months of 2003. No trading securities were owned as of September 30, 2003.

Operating Expense

          Our operating expense totaled $52.4 million in the current quarter, up $5.9 million or 12.6% from a year ago. The increase was primarily due to higher salaries and related costs.

          The following table presents a breakdown of key components comprising operating expense for the quarters indicated.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Salaries and related costs

$

34,312

$

33,028

$

34,126

$

32,695

$

29,067

Premises and equipment costs

8,291

7,971

7,713

7,891

7,916

Advertising expense

835

1,016

793

726

1,066

SAIF insurance premiums and regulatory

assessments

787

825

831

765

765

Professional fees

798

418

628

547

91

Other general and administrative expense

7,718

8,111

7,893

7,470

7,474


Total general and administrative expense

52,741

51,369

51,984

50,094

46,379

Net operation of real estate acquired in

settlement of loans

(376

)

(111

)

297

(68

)

110


Total operating expense

$

52,365

$

51,258

$

52,281

$

50,026

$

46,489


          For the first nine months of 2003, our operating expenses totaled $155.9 million, up $19.3 million or 14.1% from the same period of 2002, also primarily reflecting higher salaries and related costs.

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          The following table presents a breakdown of key components comprising operating expense during the year-to-date periods indicated.

Nine Months Ended September 30,


(In Thousands)

2003

2002


Salaries and related costs

$

101,466

$

86,819

Premises and equipment costs

23,975

22,803

Advertising expense

2,644

3,692

SAIF insurance premiums and regulatory assessments

2,443

2,313

Professional fees

1,844

888

Other general and administrative expense

23,722

20,035


Total general and administrative expense

156,094

136,550

Net operation of real estate acquired in settlement of loans

(190

)

79


Total operating expense

$

155,904

$

136,629


Provision for Income Taxes

          Income taxes for the current quarter totaled $21.3 million, resulting in an effective tax rate of 42.2%, compared to $10.7 million and 42.3% for the same quarter of a year ago. For the first nine months of 2003, our effective tax rate was 42.2% compared to 42.3% for the year-ago period. For further information regarding income taxes, see Notes to Consolidated Financial Statements—Note (4)—Income Taxes on page 10.

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 further information regarding business segments, see Notes To Consolidated Financial Statements—Note (7)—Business Segment Reporting on page 12.

          The following table presents by business segment our net income for the periods indicated.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Banking net income

$

25,621

$

17,145

$

29,505

$

37,563

$

13,100

Real estate investment net income

3,630

1,370

712

2,409

1,468


Total net income

$

29,251

$

18,515

$

30,217

$

39,972

$

14,568


Nine Months Ended September 30,


(In Thousands)

2003

2002


Banking net income

$

72,271

$

68,511

Real estate investment net income

5,712

3,810


Total net income

$

77,983

$

72,321


Banking

          Net income from our banking operations for the current quarter totaled $25.6 million, up $12.5 million from a year ago. The increase between third quarters reflected:

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Those favorable items were partially offset by:

          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)

2003

2003

2003

2002

2002


Net interest income

$

68,395

$

74,325

$

80,974

$

83,338

$

76,960

Provision for (reduction of) loan losses

(1,104

)

(624

)

(1,709

)

127

471

Other income (loss)

27,023

5,746

20,538

31,693

(7,507

)

Operating expense

52,126

50,985

52,106

49,857

46,328

Net intercompany income

43

40

44

64

100


Income before income taxes

44,439

29,750

51,159

65,111

22,754

Income taxes

18,818

12,605

21,654

27,548

9,654


Net income

$

25,621

$

17,145

$

29,505

$

37,563

$

13,100


At period end

Assets:

Loans and mortgage-backed securities

$

9,987,468

$

10,773,026

$

10,675,557

$

10,976,942

$

11,685,037

Other

1,161,884

1,165,355

756,455

995,470

828,836


Total assets

11,149,352

11,938,381

11,432,012

11,972,412

12,513,873


Equity

$

894,210

$

869,365

$

851,650

$

823,104

$

790,807


          For the first nine months of 2003, our net income totaled $72.3 million, up $3.8 million from the same period a year ago. The increase reflected higher gains from sales of loans and mortgage-backed securities, higher loan and deposit related fees, a favorable change in provision for loan losses, and a litigation award. Those favorable items were partially offset by higher operating expense, losses from trading securities, and a decline in net interest income.

          The following table sets forth our banking operational results for the year-to-date periods indicated.

Nine Months Ended September 30,


(In Thousands)

2003

2002


Net interest income

$

223,694

$

232,015

Provision for (reduction of) loan losses

(3,437

)

812

Other income

53,307

23,358

Operating expense

155,217

136,002

Net intercompany income

127

279


Income before income taxes

125,348

118,838

Income taxes

53,077

50,327


Net income

$

72,271

$

68,511


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Real Estate Investment

          Net income from our real estate investment operations totaled $3.6 million in the current quarter, compared to net income of $1.5 million a year ago. The increase was primarily attributed to an increase in net gains from sales of $3.8 million.

          The following table sets forth real estate investment 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)

2003

2003

2003

2002

2002


Net interest income (loss)

$

(50

)

$

(20

)

$

15

$

15

$

12

Other income

6,476

2,651

1,411

4,300

2,741

Operating expense

239

273

175

169

161

Net intercompany expense

43

40

44

64

100


Income before income taxes

6,144

2,318

1,207

4,082

2,492

Income taxes

2,514

948

495

1,673

1,024


Net income

$

3,630

$

1,370

$

712

$

2,409

$

1,468


At period end

Assets:

Investments in real estate and joint ventures

$

32,435

$

36,297

$

34,307

$

33,890

$

40,371

Other

4,617

8,279

5,641

14,174

4,090


Total assets

37,052

44,576

39,948

48,064

44,461


Equity

$

27,037

$

35,407

$

34,037

$

42,325

$

39,916


          For the first nine months of 2003, our net income from real estate investment operations totaled $5.7 million, up $1.9 million from the same period of 2002. The increase was primarily attributed to an increase in 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)

2003

2002


Net interest income (loss)

$

(55

)

$

30

Other income

10,538

7,331

Operating expense

687

627

Net intercompany expense

127

279


Income before income taxes

9,669

6,455

Income taxes

3,957

2,645


Net income

$

5,712

$

3,810


          Our investments in real estate and joint ventures amounted to $32 million at September 30, 2003, down from $34 million at December 31, 2002, and $40 million at September 30, 2002.

          For information on valuation allowances associated with real estate and joint venture loans, see Financial Condition—Problem Loans and Real Estate—Allowances for Losses on Loans and Real Estate on page 40.

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FINANCIAL CONDITION

Loans and Mortgage-Backed Securities

          Total loans and mortgage-backed securities, including those we hold for sale, declined $786 million during the current quarter to a total of $10.0 billion or 89.5% of assets at September 30, 2003. Even though mortgage interest rates rose during the current quarter, refinance activity continued to remain high, as loan applications submitted when interest rates were lower in the second quarter funded in the current quarter. As a result, loan repayments continued to exceed portfolio originations and loans held for investment declined $399 million. In addition, loans held for sale declined $386 million as the volume of new fixed rate applications fell due to the rise in mortgage interest rates during the current quarter. Our annualized prepayment speed in the current quarter increased to 59%, compared to 36% a year ago and 53% during the previous quarter.

          The following table sets forth loans originated, including purchases, for investment and for sale for the periods indicated.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Loans originated and purchased

Investment portfolio:

Residential one-to-four units:

Adjustable by index:

COFI

$

157,322

$

250,792

$

287,913

$

345,876

$

582,271

MTA

486,146

207,342

223,987

340,410

239,142

LIBOR

88,658

74,098

35,021

3,903

-

Adjustable – fixed for 3-5 years

275,755

748,613

222,540

630,302

207,222

Fixed

1,976

6,499

13,287

28,596

3,473


Total residential one-to-four units

1,009,857

1,287,344

782,748

1,349,087

1,032,108

Other

102,618

78,407

51,155

61,109

42,576


Total for investment portfolio

1,112,475

1,365,751

833,903

1,410,196

1,074,684

Sale portfolio(a)

1,566,423

2,161,154

1,607,147

2,041,109

1,799,673


Total for investment and sale portfolios

$

2,678,898

$

3,526,905

$

2,441,050

$

3,451,305

$

2,874,357


(a) Primarily fixed rate residential one-to-four unit loans.

Nine Months Ended September 30,


(In Thousands)

2003

2002


Loans originated and purchased

Investment portfolio:

Residential one-to-four units:

Adjustable by index:

COFI

$

696,027

$

1,918,189

MTA

917,475

550,404

LIBOR

197,777

-

Adjustable – fixed for 3-5 years

1,246,908

658,087

Fixed

21,762

11,779


Total residential one-to-four units

3,079,949

3,138,459

Other

232,180

208,298


Total for investment portfolio

3,312,129

3,346,757

Sale portfolio(a)

5,334,724

4,131,463


Total for investment and sale portfolios

$

8,646,853

$

7,478,220


(a) Primarily fixed rate residential one-to-four unit loans.

          Originations of residential one-to-four unit loans, including loans purchased, totaled $2.576 billion in the current quarter, down 9.0% from the $2.832 billion we originated in the third quarter of 2002 and 25.3% below the record $3.448 billion we originated in the second quarter of 2003. Single family loans originated for sale declined $595 million from second quarter 2003 to $1.566 billion, while single family loans originated for portfolio declined $277 million to $1.010 billion, as our purchases of loans were $570 million lower. Of the current quarter originations for portfolio, $56 million represented subprime credits as part of our continuing strategy to enhance the portfolio’s net yield. During the current quarter, 85% of our residential one-to-four unit originations represented refinancing transactions. This is down from the second quarter 2003 level of 87% but up from the year-ago third quarter level of 78%. In addition to single family loans, we originated $103 million of other loans in the current quarter.

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          During the current quarter, 27% of residential one-to-four unit loans originated for portfolio, including loans purchased, represented adjustable rate loans where the initial rate is fixed for the first three or five years. At the conclusion of the initial fixed rate periods, those loans then adjust to the change in either the weekly average yield on one-year U.S. Treasury securities adjusted to a constant maturity ("CMT"), or the London Inter-Bank Offered Rate ("LIBOR"). Monthly adjustable rate mortgages that provide for negative amortization represented 64% of residential one-to-four unit loans originated for portfolio, with 76% of those tied to MTA and 24% tied to COFI. Borrowers are currently more interested in MTA adjustable rate loans, as the fully indexed rate on those loans are lower than those tied to COFI. The remaining 9% of originations primarily represented adjustable rate mortgage s that adjust less frequently than monthly or fixed rate loans.

          The 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.

September 30, 2003

June 30, 2003

March 31, 2003

December 31, 2002

September 30, 2002


% of

% of

% of

% of

% of

(Dollars in Thousands)

Amount

Total

Amount

Total

Amount

Total

Amount

Total

Amount

Total


Investment Portfolio

Residential one-to-four units:

Adjustable by index:

COFI

$

5,163,897

71

%

$

5,883,639

78

%

$

6,458,588

81

%

$

6,831,649

85

%

$

7,170,955

88

%

MTA

1,761,516

24

1,391,864

18

1,258,982

16

1,090,646

13

800,787

10

LIBOR

249,320

3

143,388

2

54,931

1

25,296

-

24,056

-

Other, primarily CMT

171,039

2

180,575

2

195,309

2

136,230

2

165,489

2


Total adjustable loans (a)

$

7,345,772

100

%

$

7,599,466

100

%

$

7,967,810

100

%

$

8,083,821

100

%

$

8,161,287

100

%


(a) Excludes residential one-to-four unit adjustable–fixed for 3-5 year loans still in their initial fixed rate period.

          Our adjustable rate mortgages:

          Most of our adjustable rate mortgages adjust the interest rate monthly and the payment amount annually. These monthly adjustable rate mortgages:

If a loan incurs significant negative amortization, the loan-to-value ratio could increase which creates an increased risk that the fair value of the underlying collateral could be insufficient to satisfy fully the outstanding principal and interest. A loan-to-value ratio is the ratio 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. We currently impose a limit on the amount of negative amortization. The principal plus the negative amortization cannot exceed 125% of the original loan amount, except for subprime loans and loans with loan-to-value ratios of greater than 80% where the borrower has obtained private mortgage insurance to reduce the effective loan-to-value ratio to between 67% and 80%. In those two instances, the principal plus negative amortization cannot exceed 110% of the original loan amount. At September 30, 2003, loans with the higher 125% limit on negative amortization represented 33% of our adjustable rate one-to-four unit residential portfolio.

          At September 30, 2003, $6.5 billion or 71% of the adjustable rate mortgages in our loan portfolio were subject to negative amortization, of which $62 million represented the amount of negative amortization included in the loan balance. The amount of negative amortization is $17 million or 21% below the June 30, 2003 level.

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          We also continue to originate residential fixed interest rate mortgage loans to meet consumer demand, but we intend to sell the majority of these loans. We sold through our secondary marketing activities $1.938 billion of loans and mortgage-backed securities in the current quarter, compared to $2.078 billion in the second quarter of 2003 and $1.564 billion a year ago. All but minor amounts were secured by residential one-to-four unit property, and at September 30, 2003, loans held for sale totaled $335 million.

          At September 30, 2003, our unfunded loan application pipeline totaled $1.8 billion. Within that pipeline, we had commitments to borrowers for short-term interest rate locks, not including expected fallout, of $907 million, of which $513 million were related to residential one-to-four unit loans being originated for sale in the secondary market. Furthermore, at September 30, 2003, we had commitments on undrawn lines and letters of credit of $127 million and loans in process of $51 million. We believe our current sources of funds will enable us to meet these obligations.

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          The 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)

2003

2003

2003

2002

2002


Investment Portfolio

Loans originated:

Loans secured by real estate:

Residential one-to-four units:

Adjustable

$

675,135

$

468,337

$

479,506

$

589,314

$

675,280

Adjustable – subprime

55,778

63,903

62,268

86,613

123,263

Adjustable – fixed for 3-5 years

275,755

178,325

132,143

186,256

181,439

Adjustable – fixed for 3-5 years – subprime

-

-

11,683

22,810

24,851


Total adjustable residential one-to-four units

1,006,668

710,565

685,600

884,993

1,004,833

Fixed

1,976

5,721

11,865

28,596

3,373

Fixed – subprime

-

73

1,395

-

-

Residential five or more units (all adjustable)

12,789

17,956

4,400

2,806

-


Total residential

1,021,433

734,315

703,260

916,395

1,008,206

Commercial real estate

575

3,272

-

600

557

Construction

12,025

21,511

10,345

28,048

17,418

Land

19,589

-

-

-

-

Non-mortgage:

Commercial

1,200

-

125

3,710

8,000

Automobile

21

18

79

86

64

Other consumer

30,107

31,117

28,418

25,859

16,537


Total loans originated

1,084,950

790,233

742,227

974,698

1,050,782

Real estate loans purchased:

One-to-four units

594

570,985

82,746

432,289

21,485

One-to-four units – subprime

619

-

1,142

3,209

2,417

Other (a)

26,312

4,533

7,788

-

-


Total real estate loans purchased

27,525

575,518

91,676

435,498

23,902


Total loans originated and purchased

1,112,475

1,365,751

833,903

1,410,196

1,074,684

Loan repayments

(1,526,563

)

(1,352,321

)

(1,127,612

)

(1,090,307

)

(927,653

)

Other net changes (b)

15,168

(4,075

)

11,078

2,328

6,943


Net increase (decrease) in loans held for investment

(398,920

)

9,355

(282,631

)

322,217

153,974


Sale Portfolio

Residential one-to-four units:

Originated whole loans

1,566,423

2,161,154

1,606,085

2,038,678

1,792,091

Loans purchased

-

-

1,062

2,431

7,582

Loans transferred from (to) the investment portfolio

(7,759

)

3,549

(541

)

(453

)

(460

)

Originated whole loans sold

(335,589

)

(250,027

)

(246,697

)

(349,605

)

(280,786

)

Loans exchanged for mortgage-backed securities

(1,602,297

)

(1,828,344

)

(1,377,469

)

(1,702,481

)

(1,232,826

)

Other net changes

(1,079

)

(1,116

)

(1,143

)

(898

)

(3,105

)

Capitalized basis adjustment (c)

(6,191

)

3,037

327

(1,207

)

1,626


Net increase (decrease) in loans held for sale

(386,492

)

88,253

(18,376

)

(13,535

)

284,122


Mortgage-backed securities, net:

Received in exchange for loans

1,602,297

1,828,344

1,377,469

1,702,481

1,232,826

Sold

(1,602,297

)

(1,828,344

)

(1,377,469

)

(2,715,467

)

(1,283,100

)

Purchased

-

-

-

-

1,014,098

Repayments

(140

)

(129

)

(366

)

(2,195

)

(4,258

)

Other net changes

(6

)

(10

)

(12

)

(1,596

)

1,342


Net increase (decrease) in mortgage-backed

securities available for sale

(146

)

(139

)

(378

)

(1,016,777

)

960,908


Net increase (decrease) in loans held for sale and

mortgage-backed securities available for sale

(386,638

)

88,114

(18,754

)

(1,030,312

)

1,245,030


Total net increase (decrease) in loans and

mortgage-backed securities

$

(785,558

)

$

97,469

$

(301,385

)

$

(708,095

)

$

1,399,004


(a) Included five or more unit residential loans.
(b) Primarily included changes in undisbursed funds for lines of credit and construction loans, changes in loss allowances, loans transferred to real estate acquired in settlement of loans or from (to) the held for sale portfolio, and the change in interest capitalized on loans (negative amortization).
(c) Reflected the change in fair value of the rate lock derivative from the date of commitment to the date of funding.
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          The following table sets forth the composition of our loan and mortgage-backed securities portfolio at the dates indicated.

September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Investment Portfolio

Loans secured by real estate:

Residential one-to-four units:

Adjustable

$

6,328,674

$

6,444,574

$

6,711,548

$

6,739,243

$

6,746,906

Adjustable – subprime

987,509

1,119,780

1,212,905

1,297,280

1,345,644

Adjustable – fixed for 3-5 years

1,809,803

1,942,446

1,543,478

1,697,953

1,313,391

Adjustable – fixed for 3-5 years – subprime

57,910

70,780

80,247

81,421

64,808

Fixed

123,413

157,256

187,888

210,001

225,701

Fixed – subprime

4,790

5,602

7,266

7,412

9,629


Total residential one-to-four units

9,312,099

9,740,438

9,743,332

10,033,310

9,706,079

Residential five or more units:

Adjustable

79,778

41,004

19,048

6,964

4,693

Fixed

2,213

2,251

2,292

3,676

3,737

Commercial real estate:

Adjustable

37,860

37,524

34,530

40,373

39,553

Fixed

14,580

15,507

23,613

31,042

38,112

Construction

90,233

105,858

100,767

103,547

110,125

Land

18,931

20,090

39,962

53,538

53,885

Non-mortgage:

Commercial

5,235

6,493

14,922

15,021

17,792

Automobile

5,085

6,959

9,165

11,641

14,475

Other consumer

70,593

68,012

61,744

56,782

54,779


Total loans held for investment

9,636,607

10,044,136

10,049,375

10,355,894

10,043,230

Increase (decrease) for:

Undisbursed loan funds

(52,841

)

(67,921

)

(72,765

)

(95,002

)

(99,309

)

Net deferred costs and premiums

97,445

105,393

96,499

96,744

91,379

Allowance for losses

(30,770

)

(32,247

)

(33,103

)

(34,999

)

(34,880

)


Total loans held for investment, net

9,650,441

10,049,361

10,040,006

10,322,637

10,000,420


Sale Portfolio, Net

Loans held for sale:

Residential one-to-four units

335,594

716,477

631,261

649,964

662,292

Other consumer

582

-

-

-

-

Capitalized basis adjustment (a)

(739

)

5,452

2,415

2,088

3,295


Total loans held for sale

335,437

721,929

633,676

652,052

665,587

Mortgage-backed securities available for sale:

Adjustable

1,590

1,736

1,875

2,253

3,385

Fixed

-

-

-

-

1,015,645


Total mortgage-backed securities available for sale

1,590

1,736

1,875

2,253

1,019,030


Total loans held for sale and mortgage-backed

securities available for sale

337,027

723,665

635,551

654,305

1,684,617


Total loans and mortgage-backed securities

$

9,987,468

$

10,773,026

$

10,675,557

$

10,976,942

$

11,685,037


(a) Reflected the change in fair value of the rate lock derivative from the date of commitment to the date of funding.

          We carry loans for sale at the lower of cost or fair value. At September 30, 2003, no valuation allowance was required as the fair value exceeded book value on an aggregate basis.

          At September 30, 2003, our residential one-to-four units subprime portfolio consisted of approximately 90% "A-" credit, 9% "B" credit and 1% "C" credit loans. The average loan-to-value ratio at origination for these loans was approximately 74%.

          We carry mortgage-backed securities available for sale at fair value which, at September 30, 2003, reflected an unrealized gain of $16,000. The current quarter-end unrealized gain, less the associated tax effect, is reflected as a separate component of other comprehensive income until realized.

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Trading and Investment Securities

          The following table sets forth the composition of our trading and investment securities portfolios at the dates indicated.

September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Federal funds

$

4,001

$

89,210

$

1,201

$

2,555

$

16,702

U.S. Treasury securities held for trading

-

201,781

-

-

-

U.S. Treasury and agency securities available for sale

635,759

276,904

214,449

457,797

264,743

Corporate bonds and other investment

securities available for sale

66

67

67

67

2,567

Municipal securities held to maturity

-

6,148

6,148

6,149

6,320

Securities purchased under resale agreements

-

60,000

-

-

-


Total trading and investment securities

$

639,826

$

634,110

$

221,865

$

466,568

$

290,332


          The following table sets forth the maturities of our investment securities and their weighted average yields at September 30, 2003.

After 1 Year

1 Year or Less

Through 5 Years

After 5 Years

Total


Weighted

Weighted

Weighted

Weighted

Average

Average

Average

Average

(Dollars in Thousands)

Amount

Yield

Amount

Yield

Amount

Yield

Amount

Yield


Federal funds

$

4,001

1.00

%

$

-

-

%

$

-

-

%

$

4,001

1.00

%

U.S. Treasury, agency, and other

securities available for sale (a)

-

-

147,755

2.17

488,070

2.78

635,825

2.64


Total investment securities

$

4,001

1.00

%

$

147,755

2.17

%

$

488,070

2.78

%

$

639,826

2.63

%


(a) Includes within the category of maturities after five years, $450 million with yields that adjust every three months based on movements of the 3-month LIBOR.
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Deposits

          At September 30, 2003, our deposits totaled $8.6 billion, down $449 million or 5.0% from the year-ago level, and down $287 million or 3.2% from the previous quarter. Compared to the year-ago period, our certificates of deposit declined $1.3 billion or 26.3%, which was partially offset by an increase in our lower-rate transaction accounts—i.e., checking, money market and regular passbook—of $814 million or 19.2%. As depositors seemed more interested in liquidity given the relatively low level of interest rates, they continued to move monies from certificates of deposit to transaction accounts, primarily regular passbook accounts. At September 30, 2003, the average deposit size of our 72 traditional branches was $100 million, while the average deposit size of our 99 in-store branches was $14 million, or $16 million excluding the 14 new in-store branches opened within the past 12 months.

          The following table sets forth information concerning our deposits and weighted average rates paid at the dates indicated.

September 30, 2003

June 30, 2003

March 31, 2003

December 31, 2002

September 30, 2002


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

-

%

$

411,839

-

%

$

403,264

-

%

$

446,668

-

%

$

388,376

-

%

$

312,338

Interest-bearing

checking (a)

0.21

453,547

0.21

439,408

0.21

434,148

0.25

422,417

0.25

410,095

Money market

1.05

136,981

1.05

127,194

1.19

127,257

1.37

120,105

1.64

113,746

Regular passbook

1.18

4,062,067

1.28

4,015,045

1.45

3,872,525

1.70

3,639,798

2.04

3,413,891


Total transaction

accounts

0.99

5,064,434

1.08

4,984,911

1.20

4,880,598

1.41

4,570,696

1.71

4,250,070

Certificates of deposit:

Less than 2.00%

1.24

1,533,630

1.35

1,479,928

1.45

1,292,664

1.57

919,864

1.75

452,965

2.00-2.49

2.22

374,684

2.23

416,718

2.24

241,833

2.28

401,657

2.32

766,889

2.50-2.99

2.75

233,258

2.76

277,926

2.80

436,352

2.79

528,557

2.78

722,442

3.00-3.49

3.32

560,853

3.32

602,691

3.32

706,952

3.38

1,188,078

3.36

1,213,176

3.50-3.99

3.80

133,807

3.85

254,400

3.89

545,453

3.89

700,250

3.88

664,344

4.00-4.49

4.27

241,388

4.25

361,212

4.25

368,490

4.25

374,424

4.25

376,386

4.50-4.99

4.83

423,728

4.80

469,279

4.80

471,542

4.80

473,399

4.80

492,254

5.00 and greater

5.60

42,286

5.58

48,387

5.57

53,674

5.63

81,425

5.78

118,406


Total certificates

of deposit

2.56

3,543,634

2.74

3,910,541

2.97

4,116,960

3.19

4,667,654

3.30

4,806,862


Total deposits

1.64

%

$

8,608,068

1.81

%

$

8,895,452

2.01

%

$

8,997,558

2.31

%

$

9,238,350

2.55

%

$

9,056,932


(a) Included amounts swept into money market deposit accounts.

Borrowings

          During the current quarter, our borrowings declined $413 million to $1.3 billion, due primarily to a decrease in FHLB advances. This followed an increase of $375 million during the second quarter of 2003.

          The following table sets forth information concerning our FHLB advances and other borrowings at the dates indicated.

September 30,

June 30,

March 31,

December 31,

September 30,

(Dollars in Thousands)

2003

2003

2003

2002

2002


Federal Home Loan Bank advances

$

1,259,150

$

1,672,850

$

1,300,850

$

1,624,084

$

1,687,431

Securities sold under agreements to repurchase

-

-

-

-

182,358

Other borrowings

4,178

3,121

-

-

-


Total borrowings

$

1,263,328

$

1,675,971

$

1,300,850

$

1,624,084

$

1,869,789


Weighted average rate on borrowings during

the quarter

4.29

%

4.22

%

3.91

%

4.10

%

4.35

%

Total borrowings as a percentage of total assets

11.32

14.03

11.37

13.56

14.94


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Capital Securities

          On July 23, 1999, we issued $120 million in capital securities through Downey Financial Capital Trust I. The capital securities pay quarterly cumulative cash distributions at an annual rate of 10.00% of the liquidation value of $25 per share. Interest expense on our capital securities, including the amortization of deferred issuance costs, was $3.0 million for the third quarter of both 2003 and 2002. These securities may be called at our option at $25 per share beginning in July of 2004.

Off-Balance Sheet Arrangements

          We 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 the recently issued Financial Accounting Standards Board Interpretation 46. The financial impact of this interpretation is expected to be immaterial. For further information, see Note 8 of Notes to the Consolidated Financial Statements on page 13.

          We enter into derivative financial instruments as part of our interest rate risk management process, primarily related to our sale of loans in the secondary market. The associated fair value changes to the notional amount of the derivative instrument are recorded on-balance sheet. For further information regarding our derivative instruments, see Asset/Liability Management and Market Risk on page 35, Capital Resources and Liquidity—Contractual Obligations and Other Commitments on page 44 and Note 3 of Notes to the Consolidated Financial Statements on page 8.

          We also 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 of credit and letters of credit, and commitments to purchase loans and mortgage-backed securities for our portfolio. The contract or notional amounts of these instruments reflect the extent of involvement we have in particular classes of financial instruments. For further information regarding these commitments, see Asset/Liability Management and Market Risk on page 35, Capital Resources and Liquidity—Contractual Obligations and Other Commitments on page 44 and Note 3 of Notes to the Consolidated Financial Statements on page 8.

          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 troubled loans or problem assets by means of unconsolidated special purpose entities.

Transactions with Related Parties

          There are no 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.

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Asset/Liability Management and Market Risk

          Market risk is the risk of loss 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. This interest rate risk primarily occurs to the degree that our interest-bearing liabilities reprice or mature on a different basis—generally more rapidly—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 while maintaining asset quality. Our primary strategy to manage interest rate risk is to emphasize the origination of adjustable rate mortgages or loans with relatively short maturities. Interest rates on adjustable rate mortgages are primarily tied to COFI, MTA, LIBOR and CMT.

          In addition to the market risk associated with our lending and deposit taking activities, we also have market risk associated with our secondary marketing activities. Changes in mortgage interest rates, primarily fixed rate mortgages, 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 use of forward sale and purchase contracts with government-sponsored enterprises and whole loan sale contracts with various parties. These contracts are typically obtained at 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. 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. Although we continue to hedge as previously done, SFAS 133, as applied to our risk management strategies, may increase or decrease reported net income and stockholders’ equity, depending on levels of 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. We generally do not enter into hedging type contracts for speculative purposes.

          Changes in mortgage interest rates also impact the value of our mortgage servicing rights. Rising interest rates typically result in slower prepayment speeds on the loans being serviced for others which increase the value of mortgage servicing rights. Declining interest rates typically result in faster prepayment speeds which decrease the value of mortgage servicing rights. Generally, we have not hedged our mortgage servicing rights. However, in light of the Federal Reserve’s change in bias towards weakness and the potential for further declines in market interest rates, we purchased during the second quarter of 2003 10-year U.S. Treasury securities as a partial economic hedge against the value of our mortgage servicing rights. These securities were classified in a trading account and were carried at fair value, with any changes in fair value reflected in earnings. This partial economic hedge was closed in July of 2003 as interest rates began to rise.

          There has been no significant change in our market risk since December 31, 2002.

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          One 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, 2003, as well as other information regarding the repricing and maturity differences between our interest-earning assets and total deposits, borrowings and capital securities 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. We assume prepayment rates on substantially all of our loan portfolio based upon our historical loan prepayment experience and anticipated future prepayments. 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 do not normally 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, 2003


Within

7 – 12

1 – 5

6 – 10

Over

Total

(Dollars in Thousands)

6 Months

Months

Years

Years

10 Years

Balance


Interest-earning assets:

Investment securities and FHLB stock(a)

$

732,196

$

23,209

$

6,168

$

66

$

-

$

761,639

Loans and mortgage-backed securities:(b)

Loans secured by real estate:

Residential:

Adjustable

7,621,021

497,010

1,335,781

-

-

9,453,812

Fixed

250,869

24,206

64,266

6,728

1,178

347,247

Commercial real estate

31,740

2,785

11,586

3,957

427

50,495

Construction

42,817

-

-

-

-

42,817

Land

12,990

7

51

610

-

13,658

Non-mortgage loans:

Commercial

2,731

-

-

-

-

2,731

Consumer

72,478

2,036

604

-

-

75,118

Mortgage-backed securities

1,590

-

-

-

-

1,590


Total loans and mortgage-backed securities

8,036,236

526,044

1,412,288

11,295

1,605

9,987,468


Total interest-earning assets

$

8,768,432

$

549,253

$

1,418,456

$

11,361

$

1,605

$

10,749,107


Transaction accounts:

Non-interest-bearing checking

$

411,839

$

-

$

-

$

-

$

-

$

411,839

Interest-bearing checking(c)

453,547

-

-

-

-

453,547

Money market (d)

136,981

-

-

-

-

136,981

Regular passbook (d)

4,062,067

-

-

-

-

4,062,067


Total transaction accounts

5,064,434

-

-

-

-

5,064,434

Certificates of deposit(a)

1,623,170

490,814

1,429,650

-

-

3,543,634


Total deposits

6,687,604

490,814

1,429,650

-

-

8,608,068

Borrowings

53,178

60,000

691,150

459,000

-

1,263,328

Capital securities

-

-

-

-

120,000

120,000


Total deposits, borrowings and

capital securities

$

6,740,782

$

550,814

$

2,120,800

$

459,000

$

120,000

$

9,991,396


Excess (shortfall) of interest-earning assets over

deposits, borrowings and capital securities

$

2,027,650

$

(1,561

)

$

(702,344

)

$

(447,639

)

$

(118,395

)

$

757,711

Cumulative gap

2,027,650

2,026,089

1,323,745

876,106

757,711

Cumulative gap–as a percentage of total assets:

September 30, 2003

18.17

%

18.16

%

11.86

%

7.85

%

6.79

%

December 31, 2002

16.80

12.54

9.33

5.80

4.83

September 30, 2002

25.35

19.18

12.72

9.27

8.35


(a) Based upon contractual maturity and repricing date.
(b) Based upon contractual maturity, repricing date and projected repayment and prepayments of principal.
(c) Included amounts swept into money market deposit accounts and is subject to immediate repricing.
(d) Subject to immediate repricing.
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          Our six-month gap at September 30, 2003 was a positive 18.17%. This means that more interest-earning assets mature or reprice within six months than total deposits, borrowings and capital securities. This compares to a positive six-month gap of 16.80% at December 31, 2002 and 25.35% a year ago.

          We continue to pursue our strategy of emphasizing the origination of adjustable rate mortgages for our investment portfolio. For the twelve months ended September 30, 2003, we originated and purchased for investment $4.7 billion of adjustable rate loans which represented approximately 99% of all loans we originated and purchased for investment during the period.

          At September 30, 2003, December 31, 2002 and September 30, 2002, essentially all of our interest-earning assets mature, reprice or are estimated to prepay within five years. At September 30, 2003, $9.5 billion or 99% 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, compared to $10.1 billion or 98% at December 31, 2002, and $9.8 billion or 97% 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 price and originate fixed rate mortgage loans for sale into the secondary market to increase opportunities to originate adjustable rate mortgages and to generate fees and servicing income. We also originate fixed rate loans for portfolio to facilitate the sale of real estate acquired in settlement of loans and which meet specific yield and other approved guidelines.

          The following table sets forth the interest rate spread between our interest-earning assets and interest-bearing liabilities at the dates indicated.

September 30,

June 30,

March 31,

December 31,

September 30,

2003

2003

2003

2002

2002


Weighted average yield: (a)

Loans and mortgage-backed securities

4.98

%

5.24

%

5.53

%

5.83

%

6.00

%

Federal Home Loan Bank stock

4.34

4.80

5.31

5.24

2.87

Trading and investment securities

2.63

2.32

2.34

3.07

3.12


Interest-earning assets yield

4.84

5.08

5.46

5.72

5.90


Weighted average cost:

Deposits

1.64

1.81

2.01

2.31

2.55

Borrowings:

Federal Home Loan Bank advances

4.42

3.68

4.50

3.88

3.95

Other borrowings

6.63

6.63

-

-

2.02


Total borrowings

4.43

3.68

4.50

3.88

3.76

Capital securities

10.00

10.00

10.00

10.00

10.00


Combined funds cost

2.09

2.20

2.42

2.63

2.84


Interest rate spread

2.75

%

2.88

%

3.04

%

3.09

%

3.06

%


(a) Excludes adjustments for non-accrual loans, and amortization of net deferred costs to originate loans, premiums and discounts.

          The period-end weighted average yield on our loan portfolio declined to 4.98% at September 30, 2003, down from 5.83% at December 31, 2002 and 6.00% at September 30, 2002. At September 30, 2003, our adjustable rate mortgage portfolio of single family residential loans, including mortgage-backed securities, totaled $9.4 billion with a weighted average rate of 4.89%, compared to $9.9 billion with a weighted average rate of 5.75% at December 31, 2002, and $9.6 billion with a weighted average rate of 5.94% at September 30, 2002.

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Problem Loans and Real Estate

Non-Performing Assets

          Non-performing assets consist of loans on which we have ceased accruing interest (which we refer to as non-accrual loans), loans restructured at a below market rate, real estate acquired in settlement of loans and repossessed automobiles. Our non-performing assets declined $4 million during the current quarter to $63 million or 0.56% of total assets. The decline was primarily in our subprime residential loan category.

          The following table summarizes our non-performing assets at the dates indicated.

September 30,

June 30,

March 31,

December 31,

September 30,

(Dollars in Thousands)

2003

2003

2003

2002

2002


Non-accrual loans:

Residential one-to-four units

$

32,430

$

29,758

$

34,426

$

34,504

$

36,068

Residential one-to-four units – subprime

22,101

26,568

30,086

32,263

36,304

Other

576

646

683

681

823


Total non-accrual loans

55,107

56,972

65,195

67,448

73,195

Troubled debt restructure – below market rate (a)

-

-

-

-

203

Real estate acquired in settlement of loans

7,436

9,464

10,205

12,360

15,441

Repossessed automobiles

15

3

-

6

15


Total non-performing assets

$

62,558

$

66,439

$

75,400

$

79,814

$

88,854


Allowance for loan losses:

Amount

$

30,770

$

32,247

$

33,103

$

34,999

$

34,880

As a percentage of non-performing loans

55.84

%

56.60

%

50.78

%

51.89

%

47.52

%

Non-performing assets as a percentage of total assets

0.56

0.56

0.66

0.67

0.71


(a) Represented one residential one-to-four unit loan.

Delinquent Loans

          Loans delinquent 30 days or more as a percentage of total loans was 0.71% at September 30, 2003, similar to 0.69% at June 30, 2003, but down from 0.90% a year ago. The decline from a year ago primarily occurred in our residential one-to-four units category.

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          The following table indicates the amounts of our past due loans at the dates indicated.

September 30, 2003

June 30, 2003


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

$

14,942

$

5,246

$

26,259

$

46,447

$

17,488

$

5,482

$

23,500

$

46,470

One-to-four units – subprime

5,582

4,813

12,961

23,356

4,785

4,350

18,302

27,437

Five or more units

-

-

-

-

-

-

-

-

Commercial real estate

-

-

-

-

-

-

-

-

Construction

-

-

-

-

-

-

-

-

Land

-

-

-

-

-

-

-

-


Total real estate loans

20,524

10,059

39,220

69,803

22,273

9,832

41,802

73,907

Non-mortgage:

Commercial

-

-

428

428

-

-

428

428

Automobile

24

20

36

80

94

18

44

156

Other consumer

42

29

112

183

77

16

174

267


Total delinquent loans

$

20,590

$

10,108

$

39,796

$

70,494

$

22,444

$

9,866

$

42,448

$

74,758


Delinquencies as a percentage of total loans

0.21

%

0.10

%

0.40

%

0.71

%

0.21

%

0.09

%

0.39

%

0.69

%


March 31, 2003

December 31, 2002


Loans secured by real estate:

Residential:

One-to-four units

$

18,566

$

7,771

$

26,054

$

52,391

$

19,881

$

8,066

$

27,333

$

55,280

One-to-four units – subprime

7,835

6,943

17,496

32,274

8,971

5,944

23,831

38,746

Five or more units

-

-

-

-

-

-

-

-

Commercial real estate

-

-

-

-

-

-

-

-

Construction

-

-

-

-

-

-

-

-

Land

-

-

-

-

-

-

-

-


Total real estate loans

26,401

14,714

43,550

84,665

28,852

14,010

51,164

94,026

Non-mortgage:

Commercial

-

-

428

428

-

-

466

466

Automobile

158

23

15

196

98

13

4

115

Other consumer

141

70

240

451

48

47

211

306


Total delinquent loans

$

26,700

$

14,807

$

44,233

$

85,740

$

28,998

$

14,070

$

51,845

$

94,913


Delinquencies as a percentage of total loans

0.25

%

0.14

%

0.41

%

0.80

%

0.26

%

0.13

%

0.47

%

0.86

%


September 30, 2002


Loans secured by real estate:

Residential:

One-to-four units

$

17,835

$

10,454

$

25,487

$

53,776

One-to-four units – subprime

11,606

6,565

22,275

40,446

Five or more units

-

-

-

-

Commercial real estate

-

-

-

-

Construction

-

-

-

-

Land

-

-

-

-


Total real estate loans

29,441

17,019

47,762

94,222

Non-mortgage:

Commercial

-

1,235

548

1,783

Automobile

126

9

26

161

Other consumer

147

36

249

432


Total delinquent loans

$

29,714

$

18,299

$

48,585

$

96,598


Delinquencies as a percentage of total loans

0.28

%

0.17

%

0.45

%

0.90

%


(a) All 90 day or greater delinquencies are on non-accrual status and reported as part of non-performing assets.
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Allowance for Losses on Loans and Real Estate

          We maintain a valuation allowance for losses on loans and real estate to provide for losses inherent in those portfolios. Management evaluates the adequacy of the allowance quarterly to maintain the allowance at levels sufficient to provide for inherent losses.

          We use an internal asset review system and loss allowance methodology to provide for timely recognition of problem assets and adequate general valuation allowances to cover asset losses. The amount of the allowance is based upon the total of general valuation allowances, allocated allowances and an unallocated allowance. General valuation allowances relate to assets with no well-defined deficiency or weakness and take into consideration losses that are imbedded within the portfolio but have not yet been realized. Allocated allowances relate to assets with well-defined deficiencies or weaknesses. Included in these allowances are those amounts associated with assets where it is probable that the value of the asset has been impaired and the loss can be reasonably estimated. If we determine our carrying value of the 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 unallocated allowance is more subjective and is reviewed quarterly to take into consideration estimation errors and economic trends that are not necessarily captured in determining the general valuation and allocated allowances.

          Allowances for losses on all assets were $32 million at September 30, 2003, compared to $36 million at December 31, 2002, and $37 million a year ago.

          In the current quarter, we reversed $1.1 million of provision for loan losses and net loan charge-offs totaled $0.4 million, resulting in a decrease in the allowance for loan losses to $31 million at September 30, 2003. The current quarter decline in the allowance reflected decreases of $1.2 million in the general valuation allowances due to a decline in the loan portfolio and $0.3 million in allocated allowances to $4.4 million due to an improvement in credit quality. There was no change in our unallocated allowance of $2.8 million.

          The following table summarizes the activity in our allowance for loan losses for the quarters indicated.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Balance at beginning of period

$

32,247

$

33,103

$

34,999

$

34,880

$

35,834

Provision (reduction)

(1,104

)

(624

)

(1,709

)

127

471

Charge-offs

(378

)

(236

)

(191

)

(118

)

(1,450

)

Recoveries

5

4

4

110

25


Balance at end of period

$

30,770

$

32,247

$

33,103

$

34,999

$

34,880


          Since year-end 2002, our allowance for loan losses declined by $4.2 million, from decreases in the general valuation allowances of $3.1 million and allocated allowances of $1.1 million.

          The following table summarizes the activity in our allowance for loan losses during the year-to-date periods indicated.

Nine Months Ended September 30,


(In Thousands)

2003

2002


Balance at beginning of period

$

34,999

$

36,120

Provision (reduction)

(3,437

)

812

Charge-offs

(805

)

(2,113

)

Recoveries

13

61


Balance at end of period

$

30,770

$

34,880


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          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)

2003

2003

2003

2002

2002

2003

2002


Gross loan charge-offs

Loans secured by real estate:

Residential:

One-to-four units

$

203

$

130

$

17

$

-

$

113

$

350

$

435

One-to-four units – subprime

85

39

82

17

69

206

149

Five or more units

-

-

-

-

-

-

-

Commercial real estate

-

-

-

-

1,188

-

1,188

Construction

-

-

-

-

-

-

-

Land

-

-

-

-

-

-

-

Non-mortgage:

Commercial

-

-

20

-

-

20

-

Automobile

35

8

10

16

3

53

88

Other consumer

55

59

62

85

77

176

253


Total gross loan charge-offs

378

236

191

118

1,450

805

2,113


Gross loan recoveries

Loans secured by real estate:

Residential:

One-to-four units

-

-

-

102

-

-

9

One-to-four units – subprime

-

-

-

-

-

-

-

Five or more units

-

-

-

-

-

-

-

Commercial real estate

-

-

-

-

-

-

-

Construction

-

-

-

-

-

-

-

Land

-

-

-

-

-

-

-

Non-mortgage:

Commercial

-

-

-

-

-

-

-

Automobile

1

1

1

5

21

3

42

Other consumer

4

3

3

3

4

10

10


Total gross loan recoveries

5

4

4

110

25

13

61


Net loan charge-offs

Loans secured by real estate:

Residential:

One-to-four units

203

130

17

(102

)

113

350

426

One-to-four units – subprime

85

39

82

17

69

206

149

Five or more units

-

-

-

-

-

-

-

Commercial real estate

-

-

-

-

1,188

-

1,188

Construction

-

-

-

-

-

-

-

Land

-

-

-

-

-

-

-

Non-mortgage:

Commercial

-

-

20

-

-

20

-

Automobile

34

7

9

11

(18

)

50

46

Other consumer

51

56

59

82

73

166

243


Total net loan charge-offs

$

373

$

232

$

187

$

8

$

1,425

$

792

$

2,052


Net loan charge-offs as a

percentage of average loans

0.01

%

0.01

%

0.01

%

-

%

0.05

%

0.01

%

0.03

%


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          The following table indicates our allocation of the allowance for loan losses to the various categories of loans at the dates indicated.

September 30, 2003

June 30, 2003

March 31, 2003


Gross

Allowance

Gross

Allowance

Gross

Allowance

Loan

Percentage

Loan

Percentage

Loan

Percentage

Portfolio

to Loan

Portfolio

to Loan

Portfolio

to Loan

(Dollars in Thousands)

Allowance

Balance

Balance

Allowance

Balance

Balance

Allowance

Balance

Balance


Loans secured by real estate:

Residential:

One-to-four units

$

17,174

$

8,261,890

0.21

%

$

17,447

$

8,544,276

0.20

%

$

17,553

$

8,442,914

0.21

%

One-to-four units – subprime

6,123

1,050,209

0.58

7,315

1,196,162

0.61

7,965

1,300,418

0.61

Five or more units

615

81,991

0.75

324

43,255

0.75

160

21,340

0.75

Commercial real estate

1,160

52,440

2.21

1,171

53,031

2.21

1,226

58,143

2.11

Construction

1,082

90,233

1.20

1,256

105,858

1.19

1,197

100,767

1.19

Land

235

18,931

1.24

250

20,090

1.24

498

39,962

1.25

Non-mortgage:

Commercial

461

5,235

8.81

504

6,493

7.76

564

14,922

3.78

Automobile

42

5,085

0.83

94

6,959

1.35

82

9,165

0.89

Other consumer

1,078

70,593

1.53

1,086

68,012

1.60

1,058

61,744

1.71

Not specifically allocated

2,800

-

-

2,800

-

-

2,800

-

-


Total loans held for investment

$

30,770

$

9,636,607

0.32

%

$

32,247

$

10,044,136

0.32

%

$

33,103

$

10,049,375

0.33

%


December 31, 2002

September 30, 2002


Loans secured by real estate:

Residential:

One-to-four units

$

18,562

$

8,647,197

0.21

%

$

17,951

$

8,285,998

0.22

%

One-to-four units – subprime

8,642

1,386,113

0.62

8,873

1,420,081

0.62

Five or more units

80

10,640

0.75

63

8,430

0.75

Commercial real estate

1,364

71,415

1.91

1,448

77,665

1.86

Construction

1,223

103,547

1.18

1,292

110,125

1.17

Land

636

53,538

1.19

665

53,885

1.23

Non-mortgage:

Commercial

586

15,021

3.90

634

17,792

3.56

Automobile

100

11,641

0.86

127

14,475

0.88

Other consumer

1,006

56,782

1.77

1,027

54,779

1.87

Not specifically allocated

2,800

-

-

2,800

-

-


Total loans held for investment

$

34,999

$

10,355,894

0.34

%

$

34,880

$

10,043,230

0.35

%


          At September 30, 2003, the recorded investment in loans for which we recognized impairment totaled $13 million, unchanged from December 31, 2002 and September 30, 2002. The allowance for losses related to these loans was $1 million at September 30, 2003, December 31, 2002 and September 30, 2002. During the current quarter, total interest recognized on the impaired loan portfolio was $0.3 million.

          The following table summarizes the activity in our allowance for loan losses associated with impaired loans for the quarters indicated.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Balance at beginning of period

$

716

$

720

$

725

$

747

$

2,203

Reduction

(5

)

(4

)

(5

)

(22

)

(268

)

Charge-offs

-

-

-

-

(1,188

)

Recoveries

-

-

-

-

-


Balance at end of period

$

711

$

716

$

720

$

725

$

747


          For the first nine months of 2003, total interest recognized on the impaired loan portfolio was $0.8 million.

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          The following table summarizes the activity in our allowance for loan losses associated with impaired loans for the year-to-date periods indicated.

Nine Months Ended September 30,


(In Thousands)

2003

2002


Balance at beginning of period

$

725

$

759

Provision (reduction)

(14

)

1,176

Charge-offs

-

(1,188

)

Recoveries

-

-


Balance at end of period

$

711

$

747


          The following table summarizes the activity in our allowance for real estate and joint ventures held for investment for the quarters indicated.

Three Months Ended


September 30,

June 30,

March 31,

December 31,

September 30,

(In Thousands)

2003

2003

2003

2002

2002


Balance at beginning of period

$

1,096

$

949

$

908

$

1,752

$

1,851

Provision (reduction)

340

147

41

151

(99

)

Charge-offs

-

-

-

(995

)

-

Recoveries

-

-

-

-

-


Balance at end of period

$

1,436

$

1,096

$

949

$

908

$

1,752


          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.

Nine Months Ended September 30,


(In Thousands)

2003

2002


Balance at beginning of period

$

908

$

2,690

Provision (reduction)

528

(599

)

Charge-offs

-

(339

)

Recoveries

-

-


Balance at end of period

$

1,436

$

1,752


Capital Resources and Liquidity

          Our sources of funds include deposits, advances from the FHLB and other borrowings; proceeds from the sale of loans, mortgage-backed securities and real estate; payments of loans and mortgage-backed securities 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 mortgage-backed securities and deposit inflows and outflows.

          Our primary sources of funds generated in the third quarter of 2003 were from:

          We used these funds for the following purposes:

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          Our principal source of liquidity is our ability to utilize borrowings, as needed. Our primary source of borrowings is from the FHLB. At September 30, 2003, our FHLB borrowings totaled $1.3 billion, representing 11% of total assets. We currently are approved by the FHLB to borrow up to 40% of total assets to the extent we provide qualifying collateral and hold sufficient FHLB stock. That approved limit would have permitted us, as of quarter end, to borrow an additional $3.2 billion. To the extent deposit growth over the remainder of 2003 falls short of satisfying ongoing commitments to fund maturing and withdrawable deposits, repay maturing borrowings, fund existing and future loans, make investments, and continue branch improvement programs, we may utilize our FHLB borrowing arrangement or possibly other sources. As of September 30, 2003, we had commitments to borrowers for short-term rate locks, not including expected fallout, of $907 million, undisbursed loan funds and unused lines and letters of credit of $178 million, commitments to purchase investment securities of $100 million, operating leases of $19 million, other contingent liabilities of $3 million and commitments to invest in affordable housing funds of $3 million. We believe our current sources of funds, including repayments of existing loans, enable us to meet our obligations while maintaining liquidity at appropriate levels.

          The holding company currently has adequate liquid assets to meet its obligations and can obtain further funds by means of dividends from subsidiaries, subject to certain limitations, or issuance of further debt or equity. At September 30, 2003, the holding company’s liquid assets, including due from Bank—interest bearing balances, totaled $69 million.

          On July 24, 2002, the Board of Directors of Downey authorized a share repurchase program of up to $50 million of our common stock. To fund this program, the Bank paid a special $50 million dividend during the third quarter of 2002 to the holding company. The shares are being repurchased from time-to-time in open market transactions. The timing, volume and price of purchases will be made at our discretion, and will also be contingent upon our overall financial condition, as well as market conditions in general. To-date, a total of 306,300 shares have been repurchased at an average price of $39.73. There have been no shares repurchased since the fourth quarter of 2002 and, at September 30, 2003, $38 million of the original authorization remains available for future purchases.

          Stockholders’ equity totaled $894 million at September 30, 2003, up from $823 million at December 31, 2002 and $791 million a year ago.

Contractual Obligations and Other Commitments

          Through the normal course of operations, we have entered into certain 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.

          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 and unused lines of credit include funds not disbursed, but committed to construction projects and home equity and commercial lines of credit. 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 for which collateral is deemed necessary. The most significant categories of collateral include real estate properties underlying mortgage loans, liens on personal property and cash on deposit with us.

          We enter into derivative financial instruments as part of our interest rate risk management process, primarily related to our sale of loans in the secondary market. For further information regarding our derivative instruments, see Asset/Liability Management and Market Risk on page 35 and Note 3 of Notes to the Consolidated Financial Statements on page 8.

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          At September 30, 2003, scheduled maturities of certificates of deposit and FHLB advances, secondary marketing activities, loans held for investment, future operating minimum lease commitments and other contractual obligations were as follows:

Within

1 – 3

4 – 5

Over

Total

(In Thousands)

1 Year

Years

Years

5 Years

Balance


Certificates of deposit

$

2,113,984

$

878,606

$

551,044

$

-

$

3,543,634

FHLB advances and other borrowings

113,178

570,150

121,000

459,000

1,263,328

Capital securities (a)

-

-

-

120,000

120,000

Secondary marketing activities:

Non-qualifying hedge transactions:

Expected rate lock commitments

381,948

-

-

-

381,948

Associated forward sale contracts

391,234

-

-

-

391,234

Associated forward purchase contracts

35,000

-

-

-

35,000

Qualifying cash flow hedge transactions:

Loans held for sale, at lower of cost or fair value

335,437

-

-

-

335,437

Associated forward sale contracts

334,031

-

-

-

334,031

Commitments to originate loans held for investment:

Adjustable

414,823

-

-

-

414,823

Fixed

380

-

-

-

380

Undisbursed loan funds and unused lines of credit

37,381

14,368

-

126,453

178,202

Operating leases

4,540

8,129

4,720

1,996

19,385

Letters of credit and other contingent liabilities

123

-

-

2,580

2,703

Commitments to purchase investment securities

100,000

-

-

-

100,000

Commitments to invest in affordable housing funds

-

-

-

3,393

3,393


Total obligations and commitments

$

4,262,059

$

1,471,253

$

676,764

$

713,422

$

7,123,498


(a) These securities may be called at our option beginning in July of 2004.

Regulatory Capital Compliance

          Our core and tangible capital ratios were both 8.16% and our risk-based capital ratio was 15.92% at September 30, 2003. The Bank’s capital ratios exceed the "well capitalized" standards of 5.00% for core capital and 10.00% for risk-based capital, as defined by regulation.

          The following table is a reconciliation of the Bank’s stockholder’s equity to federal regulatory capital as of September 30, 2003.

Tangible Capital

Core Capital

Risk-Based Capital


(Dollars in Thousands)

Amount

Ratio

Amount

Ratio

Amount

Ratio


Stockholder’s equity

$

941,538

$

941,538

$

941,538

Adjustments:

Deductions:

Investment in subsidiary, primarily real estate

(26,646

)

(26,646

)

(26,646

)

Excess cost over fair value of branch acquisitions

(3,150

)

(3,150

)

(3,150

)

Non-permitted mortgage servicing rights

(7,040

)

(7,040

)

(7,040

)

Additions:

Unrealized losses on securities available for sale

757

757

757

General loss allowance – investment in DSL

Service Company

730

730

730

Allowance for loan losses,

net of specific allowances (a)

-

-

30,254


Regulatory capital

906,189

8.16

%

906,189

8.16

%

936,443

15.92

%

Well capitalized requirement

166,596

1.50

(b)

555,320

5.00

588,287

10.00

(c)


Excess

$

739,593

6.66

%

$

350,869

3.16

%

$

348,156

5.92

%


(a) Limited to 1.25% of risk-weighted assets.
(b) Represents the minimum requirement for tangible capital, as no "well capitalized" requirement has been established for this category.
(c) A third requirement is Tier 1 capital to risk-weighted assets of 6.00%, which the Bank met and exceeded with a ratio of 15.40%.
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ITEM 3. – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

          For information regarding quantitative and qualitative disclosures about market risk, see Financial Condition—Asset/Liability Management and Market Risk on page 35.

 

ITEM 4. – CONTROLS AND PROCEDURES

          As of September 30, 2003, 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 that Downey’s disclosure controls and procedures are effective in timely alerting them to material information relating to Downey, which is required to be included in Downey’s periodic SEC filings. There has been no significant changes in Downey’s internal controls 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, including subsidiaries, is made known to management, including the Chief Executive Officer and Chief Financial Officer, in a timely manner.

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PART II – OTHER INFORMATION

ITEM 1 – Legal Proceedings

          We have been named as a defendant in legal actions arising in the ordinary course of business, none of which, in the opinion of management, is material.

ITEM 2 – Changes in 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.

ITEM 5 – Other Information

          None.

ITEM 6 – Exhibits and Reports on Form 8-K

(A)          Exhibits

Exhibit

Number

Description


3.1 (b)

Certificate of Incorporation of Downey Financial Corp.

3.2 (a)

Bylaws of Downey Financial Corp.

4.1 (d)

Junior Subordinated Indenture dated as of July 23, 1999 between Downey Financial Corp. and Wilmington

Trust Company as Indenture Trustee.

4.2 (d)

10% Junior Subordinated Debenture due September 15, 2029, Principal Amount $123,711,350.

4.3 (d)

Certificate of Trust of Downey Financial Capital Trust I, dated as of May 25, 1999.

4.4 (d)

Trust Agreement of Downey Financial Capital Trust I, dated May 25, 1999.

4.5 (d)

Amended and Restated Trust Agreement of Downey Financial Capital Trust I, between Downey Financial

Corp., Wilmington Trust Company and the Administrative Trustees named therein, dated as of July 23, 1999.

4.6 (d)

Certificate Evidencing Common Securities of Downey Financial Capital Trust I, 10% Common Securities.

4.7 (d)

Certificate Evidencing Capital Securities of Downey Financial Capital Trust I, 10% Capital Securities (Global

Certificate).

4.8 (d)

Common Securities Guarantee Agreement of Downey Financial Corp. (Guarantor), dated July 23, 1999.

4.9 (d)

Capital Securities Guarantee Agreement of Downey Financial Corp. and Wilmington Trust Company, dated as

of July 23, 1999.

10.1 (c)

Downey Savings and Loan Association, F.A. Employee Stock Purchase Plan (Amended and Restated as of

January 1, 1996).


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(A)          Exhibits (Continued)

Exhibit

Number

Description


10.2 (c)

Amendment No. 1, Downey Savings and Loan Association, F.A. Employee Stock Purchase Plan. Amendment

No. 1, Effective and Adopted January 22, 1997.

10.3 (c)

Downey Savings and Loan Association, F.A. Employees’ Retirement and Savings Plan (October 1, 1997

Restatement).

10.4 (c)

Amendment No. 1, Downey Savings and Loan Association, F.A. Employees’ Retirement and Savings Plan

(October 1, 1997 Restatement) Amendment No. 1, Effective and Adopted January 28, 1998.

10.5 (c)

Trust Agreement for Downey Savings and Loan Association, F.A. Employees’ Retirement and Savings Plan,

Effective October 1, 1997 between Downey Savings and Loan Association, F.A. and Fidelity Management

Trust Company.

10.6 (b)

Downey Savings and Loan Association 1994 Long-Term Incentive Plan (as amended).

10.10 (a)

Founder Retirement Agreement of Maurice L. McAlister, dated December 21, 1989.

10.11 (e)

Amendment No. 1, Founders Retirement Agreement of Maurice L. McAlister, dated December 21, 1989.

Amendment No. 1, Effective and Adopted July 26, 2000.

10.13 (f)

Deferred Compensation Program.

10.14 (f)

Director Retirement Benefits.

10.15 (g)

Director Retirement Benefits Agreement of Sam Yellen, dated January 15, 2003.

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.


(a) Filed as part of Downey’s Registration Statement on Form 8-B/A filed January 17, 1995.
(b) Filed as part of Downey’s Registration Statement on Form S-8 filed February 3, 1995.
(c) Filed as part of Downey’s report on Form 10-K filed March 16, 1998.
(d) Filed as part of Downey’s report on Form 10-Q filed November 2, 1999.
(e) Filed as part of Downey’s report on Form 10-Q filed August 2, 2000.
(f) Filed as part of Downey’s report on Form 10-K filed March 7, 2001.
(g) Filed as part of Downey’s report on Form 10-K filed March 6, 2003.

(B)          Reports on Form 8-K

          1) Form 8-K filed July 17, 2003, with respect to a press release reporting its results of operations during the three and six months ended June 30, 2003.

          2) Form 8-K filed August 18, 2003, with respect to a press release reporting monthly selected financial data for the thirteen months ended July 31, 2003.

          3) Form 8-K filed September 16, 2003, with respect to a press release reporting monthly selected financial data for the thirteen months ended August 31, 2003.

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AVAILABILITY OF REPORTS

          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 available free of charge from our internet site, www.downeysavings.com, by clicking on "Investor Relations" located on our home page and proceeding to "Corporate Filings."

          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 Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

DOWNEY FINANCIAL CORP.

/s/ Daniel D. Rosenthal


Date: October 31, 2003

Daniel D. Rosenthal

President and Chief Executive Officer

/s/ Thomas E. Prince


Date: October 31, 2003

Thomas E. Prince

Executive Vice President and Chief Financial Officer


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NAVIGATION   LINKS

FORM 10-Q COVER

PART I

ITEM 1. – FINANCIAL INFORMATION

ITEM 2. – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 3. – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITME 4. – CONTROLS AND PROCEDURES

PART II – OTHER INFORMATION

ITEM 1. – Legal Proceedings

ITEM 2. – Changes in 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 and Reports on Form 8-K

AVAILABILITY OF REPORTS

SIGNATURES