Securities and Exchange Commission Form 10-Q dated June 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 June 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 June 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.

JUNE 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           

45

ITEM 4. –

CONTROLS AND PROCEDURES           

45

PART II

ITEM 1. –

LEGAL PROCEEDINGS           

46

ITEM 2. –

CHANGES IN SECURITIES AND USE OF PROCEEDS           

46

ITEM 3. –

DEFAULTS UPON SENIOR SECURITIES           

46

ITEM 4. –

SUBMISSION OF MATTERS TO A VOTE OF SECURITIY HOLDERS           

46

ITEM 5. –

OTHER INFORMATION           

46

ITEM 6. –

EXHIBITS AND REPORTS ON FORM 8-K           

46

AVAILABILITY OF REPORTS           

48

SIGNATURES           

49


 

Page i
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PART I

ITEM 1. – FINANCIAL INFORMATION

DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Balance Sheets

 

June 30,

December 31,

June 30,

(Dollars in Thousands, Except Per Share Data)

2003

2002

2002


Assets

Cash

$

136,423

$

123,524

$

117,788

Federal funds

89,210

2,555

16,401


Cash and cash equivalents

225,633

126,079

134,189

Trading securities, at fair value

201,781

-

-

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

securities available for sale, at fair value

276,904

457,797

292,832

Municipal securities held to maturity, at amortized cost (estimated

fair value of $6,202 at June 30, 2003 and December 31, 2002,

and $6,373 at June 30, 2002)

6,215

6,216

6,387

Loans and securities purchased under resale agreements

60,000

-

-

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

721,929

652,052

381,465

Mortgage-backed securities available for sale, at fair value

1,736

2,253

58,122

Loans receivable held for investment

10,049,361

10,322,637

9,846,446

Investments in real estate and joint ventures

36,297

33,890

40,283

Real estate acquired in settlement of loans

9,464

12,360

13,528

Premises and equipment

113,434

113,536

113,417

Federal Home Loan Bank stock, at cost

120,517

117,563

114,452

Mortgage servicing rights, net

48,722

57,729

59,771

Other assets

75,557

76,039

69,536


$

11,947,550

$

11,978,151

$

11,130,428


Liabilities and Stockholders’ Equity

Deposits

$

8,895,452

$

9,238,350

$

8,690,558

Federal Home Loan Bank advances and other borrowings

1,675,971

1,624,084

1,413,607

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

303,921

102,533

64,709

Deferred income taxes

82,841

70,080

54,118


Total liabilities

11,078,185

11,155,047

10,342,992


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 June 30, 2003, December 31, 2002

and June 30, 2002

282

282

282

Additional paid-in capital

93,792

93,792

93,792

Accumulated other comprehensive income (loss)

1,135

(1,422

)

236

Retained earnings

786,326

742,622

693,126

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

December 31, 2002

(12,170

)

(12,170

)

-


Total stockholders’ equity

869,365

823,104

787,436


$

11,947,550

$

11,978,151

$

11,130,428


See accompanying notes to consolidated financial statements.

Page 1
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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Income

 

Three Months Ended

Six Months Ended

June 30,

June 30,


(Dollars in Thousands, Except Per Share Data)

2003

2002

2003

2002


Interest income

Loans receivable

$

130,884

$

148,448

$

273,373

$

308,725

U.S. Treasury securities and agency obligations

1,886

2,163

5,023

5,196

Mortgage-backed securities

19

942

35

2,216

Other investments

1,485

1,872

3,140

3,686


Total interest income

134,274

153,425

281,571

319,823


Interest expense

Deposits

42,369

60,397

90,219

128,756

Borrowings

14,559

14,859

29,976

29,912

Capital securities

3,041

3,041

6,082

6,082


Total interest expense

59,969

78,297

126,277

164,750


Net interest income

74,305

75,128

155,294

155,073

Provision for (reduction of) loan losses

(624

)

(1,106

)

(2,333

)

341


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

74,929

76,234

157,627

154,732


Other income, net

Loan and deposit related fees

13,649

11,396

25,627

22,914

Real estate and joint ventures held for investment, net

2,069

1,016

3,012

4,013

Secondary marketing activities:

Loan servicing loss, net

(21,692

)

(15,617

)

(35,378

)

(16,205

)

Net gains on sales of loans and mortgage-backed securities

12,652

6,896

32,415

23,097

Net gains on sales of mortgage servicing rights

18

12

23

306

Net gains on trading securities

591

-

591

-

Net gains on sales of investment securities

-

19

8

209

Litigation award

265

-

2,717

-

Other

845

380

1,331

1,121


Total other income, net

8,397

4,102

30,346

35,455


Operating expense

Salaries and related costs

33,028

28,315

67,154

57,752

Premises and equipment costs

7,971

7,754

15,684

14,887

Advertising expense

1,016

1,582

1,809

2,626

SAIF insurance premiums and regulatory assessments

825

762

1,656

1,548

Professional fees

418

233

1,046

797

Other general and administrative expense

8,111

6,350

16,004

12,561


Total general and administrative expense

51,369

44,996

103,353

90,171

Net operation of real estate acquired in settlement of loans

(111

)

27

186

(31

)


Total operating expense

51,258

45,023

103,539

90,140


Income before income taxes

32,068

35,313

84,434

100,047

Income taxes

13,553

14,938

35,702

42,294


Net income

$

18,515

$

20,375

$

48,732

$

57,753


PER SHARE INFORMATION


Basic

$

0.66

$

0.72

$

1.74

$

2.04


Diluted

$

0.66

$

0.72

$

1.74

$

2.04


Cash dividends declared and paid

$

0.09

$

0.09

$

0.18

$

0.18


Weighted average diluted shares outstanding

27,970,022

28,284,493

27,968,194

28,277,833


See accompanying notes to consolidated financial statements.

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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

 

Three Months Ended

Six Months Ended

June 30,

June 30,


(In Thousands)

2003

2002

2003

2002


Net income

$

18,515

$

20,375

$

48,732

$

57,753


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

97

811

(639

)

(545

)

Mortgage-backed securities available for sale, at fair value

(5

)

1,862

(12

)

924

Less reclassification of realized gains included in net income

-

(11

)

(5

)

(121

)

Unrealized losses on cash flow hedges:

Net derivative instruments

(4,437

)

(3,108

)

(7,735

)

(3,625

)

Less reclassification of realized losses included in net income

6,059

1,970

10,948

3,842


Total other comprehensive income, net of income taxes

1,714

1,524

2,557

475


Comprehensive income

$

20,229

$

21,899

$

51,289

$

58,228


See accompanying notes to consolidated financial statements.

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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

 

Six Months Ended

June 30,


(In Thousands)

2003

2002


Cash flows from operating activities

Net income

$

48,732

$

57,753

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

Depreciation and amortization

43,378

29,046

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

22,737

16,458

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

trading and investment securities, real estate and other assets

(35,283

)

(26,597

)

Interest capitalized on loans (negative amortization)

(5,584

)

(15,844

)

Federal Home Loan Bank stock dividends

(2,954

)

(1,313

)

Loans originated for sale

(3,768,301

)

(2,331,790

)

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

as mortgage-backed securities

3,724,399

2,473,447

Other, net

(33,039

)

(2,287

)


Net cash provided by (used for) operating activities

(5,915

)

198,873


Cash flows from investing activities

Proceeds from sales of:

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

available for sale

5,255

88,531

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

9,398

20,234

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

and other investment securities available for sale

452,630

268,980

Purchase of:

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

available for sale

(273,618

)

(250,355

)

Loans and securities under resale agreements

(60,000

)

-

Loans receivable held for investment

(667,194

)

(7,302

)

Premises and equipment

(9,022

)

(11,226

)

Originations of loans receivable held for investment (net of refinances of $ 136,471 for the

six months ended June 30, 2003 and $144,176 for the six months ended June 30, 2002)

(1,392,818

)

(2,112,320

)

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

securities available for sale

2,343,957

1,794,576

Net change in undisbursed loan funds

(6,008

)

55,822

Investments in real estate held for investment

(2,979

)

(14,806

)

Other, net

1,907

2,903


Net cash provided by (used for) investing activities

401,508

(164,963

)


See accompanying notes to consolidated financial statements.

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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Continued)

 

Six Months Ended

June 30,


(In Thousands)

2003

2002


Cash flows from financing activities

Net increase (decrease) in deposits

$

(342,898

)

$

70,992

Proceeds from Federal Home Loan Bank advances

6,016,721

2,213,400

Repayments of Federal Home Loan Bank advances and other borrowings

(5,964,834

)

(2,322,505

)

Proceeds from exercise of stock options

-

392

Cash dividends

(5,028

)

(5,080

)


Net cash used for financing activities

(296,039

)

(42,801

)


Net increase (decrease) in cash and cash equivalents

99,554

(8,891

)

Cash and cash equivalents at beginning of period

126,079

143,080


Cash and cash equivalents at end of period

$

225,633

$

134,189


Supplemental disclosure of cash flow information:

Cash paid during the period for:

Interest

$

126,592

$

160,925

Income taxes

42,550

18,509

Supplemental disclosure of non-cash investing:

Loans transferred to held for investment from held for sale

647

2,015

Loans transferred from held for investment to held for sale

3,655

-

Loans exchanged for mortgage-backed securities

3,205,813

2,169,126

Trading and investment securities purchased and not settled

205,125

-

Real estate acquired in settlement of loans

8,532

12,973

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

3,171

8,275


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 June 30, 2003, December 31, 2002 and June 30, 2002, the results of operations and comprehensive income for the three months and six months ended June 30, 2003 and 2002, and changes in cash flows for the six months ended June 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


June 30,

March 31,

December 31,

September 30,

June 30,

(Dollars in Thousands)

2003

2003

2002

2002

2002


Gross balance at beginning of period

$

92,178

$

90,584

$

83,705

$

81,100

$

74,914

Additions

15,405

14,954

18,779

9,304

10,156

Amortization

(9,951

)

(4,771

)

(4,146

)

(4,120

)

(3,253

)

Sales

-

-

(1,319

)

-

-

Impairment write-down

(7,684

)

(8,589

)

(6,435

)

(2,579

)

(717

)


Gross balance at end of period

89,948

92,178

90,584

83,705

81,100


Allowance balance at beginning of period

35,672

32,855

36,793

21,329

6,333

Provision for impairment

13,238

11,406

2,497

18,043

15,713

Impairment write-down

(7,684

)

(8,589

)

(6,435

)

(2,579

)

(717

)


Allowance balance at end of period

41,226

35,672

32,855

36,793

21,329


Total mortgage servicing rights, net

$

48,722

$

56,506

$

57,729

$

46,912

$

59,771


As a percentage of associated mortgage loans

0.55

%

0.67

%

0.72

%

0.64

%

0.88

%

Estimated fair value (a)

$

48,722

$

56,506

$

57,736

$

46,986

$

59,771

Weighted average expected life (in months)

31

39

43

39

61

Custodial account earnings rate

1.26

%

1.58

%

1.61

%

2.06

%

3.82

%

Weighted average discount rate

7.47

7.39

8.35

8.19

9.10


At period end

Mortgage loans serviced for others:

Total

$

8,980,037

$

8,535,480

$

8,316,236

$

7,502,157

$

6,962,403

With capitalized mortgage servicing rights:(a)

Amount

8,916,259

8,460,152

8,036,393

7,355,700

6,807,306

Weighted average interest rate

6.12

%

6.35

%

6.51

%

6.71

%

6.80

%


Custodial escrow balances

$

16,527

$

7,578

$

15,243

$

21,628

$

13,044


(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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Six Months Ended June 30,


(Dollars in Thousands)

2003

2002


Gross balance at beginning of period

$

90,584

$

65,630

Additions

30,359

25,153

Amortization

(14,722

)

(6,169

)

Sales

-

(35

)

Impairment write-down

(16,273

)

(3,479

)


Gross balance at end of period

89,948

81,100


Allowance balance at beginning of period

32,855

8,735

Provision for impairment

24,644

16,073

Impairment write-down

(16,273

)

(3,479

)


Allowance balance at end of period

41,226

21,329


Total mortgage servicing rights, net

$

48,722

$

59,771


          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

$

41,245

$

4,607

$

(405

)

$

41,579

Reduction of (increase in) valuation allowance

36,316

4,365

(405

)

36,605

Decrease rates 100 basis points: (b)

Increase (decrease) in fair value

(14,003

)

(4,292

)

729

(17,815

)

Reduction of (increase in) valuation allowance

(14,003

)

(4,292

)

729

(17,815

)


(a) The weighted-average expected life of the mortgage servicing rights portfolio is 84 months.
(b) The weighted-average expected life of the mortgage servicing rights portfolio is 31 months.

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

Three Months Ended


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Net cash servicing fees

$

5,117

$

5,016

$

4,680

$

4,382

$

4,020

Payoff and curtailment interest cost (a)

(3,620

)

(2,525

)

(2,498

)

(1,182

)

(671

)

Amortization of MSRs

(9,951

)

(4,771

)

(4,146

)

(4,120

)

(3,253

)

Provision for impairment of MSRs

(13,238

)

(11,406

)

(2,497

)

(18,043

)

(15,713

)


Total loan servicing loss, net

$

(21,692

)

$

(13,686

)

$

(4,461

)

$

(18,963

)

$

(15,617

)


(a) Represents Downey’s 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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Six Months Ended June 30,


(In Thousands)

2003

2002


Net cash servicing fees

$

10,133

$

7,474

Payoff and curtailment interest cost (a)

(6,145

)

(1,437

)

Amortization of MSRs

(14,722

)

(6,169

)

Provision for impairment of MSRs

(24,644

)

(16,073

)


Total loan servicing loss, net

$

(35,378

)

$

(16,205

)


(a) Represents Downey’s 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 notiona l 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 June 30, 2003, Downey had a notional amount of expected rate lock commitments identified to sell as part of its secondary marketing activities of $951 million, with a change in fair value resulting in a gain of $7.0 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 fr om third parties. At June 30, 2003, the notional amount of forward sale contracts amounted to $1.7 billion, with a change in fair value resulting in a loss of $7.1 million, of which $710 million were designated as cash flow hedges. The notional amount of forward purchase contracts amounted to $139 million, with an estimated fair value loss of $0.5 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


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Net gains (losses) on non-qualifying hedge transactions

$

(2,936

)

$

(139

)

$

4,287

$

(2,663

)

$

(390

)

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)

(2,936

)

(139

)

4,287

(2,663

)

(390

)

Other comprehensive loss

(1,622

)

(1,591

)

(1,272

)

(840

)

(1,138

)


Notional amount at period end

Non-qualifying hedge transactions:

Expected rate lock commitments

$

950,703

$

957,549

$

614,592

$

892,429

$

503,359

Associated forward sale contracts

985,094

913,034

624,062

1,024,586

501,292

Associated forward purchase contracts

139,000

6,000

50,000

165,000

3

Qualifying cash flow hedge transactions:

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

721,929

633,676

652,052

665,587

381,465

Associated forward sale contracts

710,099

624,002

623,975

659,305

378,238


Six Months Ended June 30,


(In Thousands)

2003

2002


Net gains (losses) on non-qualifying hedge transactions

$

(3,075

)

$

4,474

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)

(3,075

)

4,474

Other comprehensive income (loss)

(3,213

)

217


          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 have entered onto commitments to purchase loans and mortgage-backed 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.

June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Commitments to originate loans held for investment:

Adjustable

$

336,303

$

190,737

$

249,121

$

261,365

$

324,686

Fixed

235

117

716

1,459

2,112

Undisbursed loan funds and unused lines of credit

183,720

178,754

189,283

184,074

188,472

Letters of credit and other contingent liabilities

6,044

6,031

2,662

2,534

2,514

Commitments to purchase loans

40,816

5,200

-

294,476

-

Commitments to invest in affordable housing funds

2,400

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 at June 30, 2003, December 31, 2002 or June 30, 2002.

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 June 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:

June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands, Except Per Share Data)

2003

2003

2002

2002

2002


Net income:

As reported

$

18,515

$

30,217

$

39,972

$

14,568

$

20,375

Stock-based compensation expense, net of tax

-

-

(4

)

(3

)

(3

)


Pro forma

18,515

30,217

39,968

14,565

20,372

Earnings per share – Basic:

As reported

$

0.66

$

1.08

$

1.43

$

0.52

$

0.72

Pro forma

0.66

1.08

1.43

0.52

0.72

Earnings per share – Diluted:

As reported

0.66

1.08

1.43

0.52

0.72

Pro forma

0.66

1.08

1.43

0.52

0.72


Six Months Ended June 30,


(In Thousands, Except Per Share Data)

2003

2002


Net income:

As reported

$

48,732

$

57,753

Stock-based compensation expense, net of tax

-

(6

)


Pro forma

48,732

57,747

Earnings per share – Basic:

As reported

$

1.74

$

2.04

Pro forma

1.74

2.04

Earnings per share – Diluted:

As reported

1.74

2.04

Pro forma

1.74

2.04


          As of December 31, 2002, stock-based compensation would have been fully expensed over the expected life 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. 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, excluding common shares in treasury.

          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 June 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

$

18,515

27,928,722

$

0.66

$

20,375

28,232,787

$

0.72

Effect of dilutive stock options

-

41,300

-

-

51,706

-


Diluted earnings per share

$

18,515

27,970,022

$

0.66

$

20,375

28,284,493

$

0.72


 

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Six Months Ended June 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

$

48,732

27,928,722

$

1.74

$

57,753

28,222,918

$

2.04

Effect of dilutive stock options

-

39,472

-

-

54,915

-


Diluted earnings per share

$

48,732

27,968,194

$

1.74

$

57,753

28,277,833

$

2.04


          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 June 30, 2003

Net interest income (loss)

$

74,325

$

(20

)

$

-

$

74,305

Reduction of loan losses

(624

)

-

-

(624

)

Other income

5,746

2,651

-

8,397

Operating expense

50,985

273

-

51,258

Net intercompany income (expense)

40

(40

)

-

-


Income before income taxes

29,750

2,318

-

32,068

Income taxes

12,605

948

-

13,553


Net income

$

17,145

$

1,370

$

-

$

18,515


At June 30, 2003

Assets:

Loans and mortgage-backed securities

$

10,773,026

$

-

$

-

$

10,773,026

Investments in real estate and joint ventures

-

36,297

-

36,297

Other

1,165,355

8,279

(35,407

)

1,138,227


Total assets

11,938,381

44,576

(35,407

)

11,947,550


Equity

$

869,365

$

35,407

$

(35,407

)

$

869,365


Three months ended June 30, 2002

Net interest income

$

75,115

$

13

$

-

$

75,128

Reduction of loan losses

(1,106

)

-

-

(1,106

)

Other income

2,803

1,299

-

4,102

Operating expense

44,779

244

-

45,023

Net intercompany income (expense)

86

(86

)

-

-


Income before income taxes

34,331

982

-

35,313

Income taxes

14,541

397

-

14,938


Net income

$

19,790

$

585

$

-

$

20,375


At June 30, 2002

Assets:

Loans and mortgage-backed securities

$

10,286,033

$

-

$

-

$

10,286,033

Investments in real estate and joint ventures

-

40,283

-

40,283

Other

840,641

1,919

(38,448

)

804,112


Total assets

11,126,674

42,202

(38,448

)

11,130,428


Equity

$

787,436

$

38,448

$

(38,448

)

$

787,436


 

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Real Estate

(In Thousands)

Banking

Investment

Elimination

Totals


Six months ended June 30, 2003

Net interest income (loss)

$

155,299

$

(5

)

$

-

$

155,294

Reduction of loan losses

(2,333

)

-

-

(2,333

)

Other income

26,284

4,062

-

30,346

Operating expense

103,091

448

-

103,539

Net intercompany income (expense)

84

(84

)

-

-


Income before income taxes

80,909

3,525

-

84,434

Income taxes

34,259

1,443

-

35,702


Net income

$

46,650

$

2,082

$

-

$

48,732


Six months ended June 30, 2002

Net interest income

$

155,055

$

18

$

-

$

155,073

Provision for loan losses

341

-

-

341

Other income

30,865

4,590

-

35,455

Operating expense

89,674

466

-

90,140

Net intercompany income (expense)

179

(179

)

-

-


Income before income taxes

96,084

3,963

-

100,047

Income taxes

40,673

1,621

-

42,294


Net income

$

55,411

$

2,342

$

-

$

57,753


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. It is anticipated that the financial impact of SFAS 149 will 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. It is anticipated that the financial impact of SFAS 150 will not have 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 consolidated requirements apply to older entities in the first fiscal year or interim period after June 15, 2003. Certain disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. Certain of Downey’s real estate joint venture partnerships established prior to January 31, 2003 will likely require consolidation as a result of applying the provisions of FIN 46. There has been no variable interest entities established since January 31, 2003. While consolidation may require reclassification of certain financial statement items, the overall financial impact is considered immaterial.

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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. 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.

OVERVIEW

          Our net income for the second quarter of 2003 totaled $18.5 million or $0.66 per share on a diluted basis, down from $20.4 million or $0.72 per share in the second quarter of 2002.

          The decline in net income between second quarters reflected lower net income from our banking operations, as net income from our real estate operations increased $0.8 million to $1.4 million due primarily to a reduction in provision for losses and higher gains from sales. Net income from our banking activities declined $2.6 million, primarily reflecting:

Those unfavorable items were partially offset by:

          For the first six months of 2003, our net income totaled $48.7 million or $1.74 per share on a diluted basis, down from $57.8 million or $2.04 per share for the first six months of 2002. The decline between six-month periods primarily reflected lower net income from our banking operations. The decline reflected an increased loss from loan servicing activities and higher operating expense, partially offset by higher gains from sales of loans and mortgage-backed securities, a litigation award, higher loan and deposit related fees and a favorable change in provision for loan losses.

          For the second quarter of 2003, our return on average assets was 0.65%, down from 0.75% a year ago, while our return on average equity was 8.64%, down from 10.51% a year ago. For the first six-month periods, our return on average assets declined from 1.06% a year ago to 0.84%, while our return on average equity declined from 15.16% to 11.49%.

          Our single family loan originations, including purchases, totaled a record $3.448 billion in the second quarter of 2003, up 58.2% from the $2.179 billion we originated in the second quarter of 2002 and 44.3% above the $2.390 billion we originated in the first quarter of 2003. Of the current quarter total, $1.287 billion represented originations of loans for portfolio, of which $64 million were subprime credits. In addition to single family loans, we originated $78 million of other loans in the quarter.

          At quarter end, our assets totaled $11.9 billion, up 7.3% from a year ago, but virtually unchanged from year-end 2002. Continued low interest rates caused refinance activity to remain high, as borrowers were attracted to low fixed rate mortgages. As a result, loan repayments exceeded portfolio originations and loans held for investment declined by $273 million since year end. That decline, however, was essentially offset by increases of $202 million in trading securities and $70 million in loans held for sale.

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          Our deposits totaled $8.9 billion at June 30, 2003, up 2.4% from the year-ago level, but down 3.7% from year-end 2002. During the quarter, we opened five new in-store branches, bringing our total branches at quarter end to 170, of which 98 are in-store. A year ago, branches totaled 148, of which 78 were in-store.

          Our non-performing assets declined $9 million during the quarter to $66 million or 0.56% of total assets. The decline was primarily in our residential category, of which $5 million was associated with prime loans and $4 million with subprime loans.

          At June 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 7.20% for both tangible and core capital and 14.23% 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 $74.3 million in the current quarter, down $0.8 million or 1.1% from the same period last year. Our interest-earning assets averaged $11.0 billion during the quarter, up 4.9% 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 2.70% in the current quarter, down from 2.86% a year ago and 2.87% in the previous quarter. The decline between second quarters was due to our yield on interest-earning assets declining more than our cost of funds, as more assets repriced to current lower interest rate levels than did liabilities.

          For the first six months of 2002, net interest income totaled $155.3 million, up $0.2 million from a year ago. The increase reflected higher interest-earning asset levels, partially offset by a decline in our 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 June 30,


2003

2002


Average

Average

Average

Average

(Dollars in Thousands)

Balance

Interest

Yield/Rate

Balance

Interest

Yield/Rate


Interest-earning assets:

Loans

$

10,517,236

$

130,884

4.98

%

$

10,035,071

$

148,448

5.92

%

Mortgage-backed securities

1,802

19

4.22

80,873

942

4.66

Trading and investment securities

492,782

3,371

2.74

385,738

4,035

4.20


Total interest-earning assets

11,011,820

134,274

4.88

10,501,682

153,425

5.84

Non-interest-earning assets

408,167

392,072


Total assets

$

11,419,987

$

10,893,754


Transaction accounts:

Non-interest-bearing checking

$

402,183

$

-

-

%

$

295,568

$

-

-

%

Interest-bearing checking (a)

439,909

283

0.26

425,609

329

0.31

Money market

127,162

355

1.12

113,231

503

1.78

Regular passbook

3,896,717

13,253

1.36

2,962,758

18,543

2.51


Total transaction accounts

4,865,971

13,891

1.15

3,797,166

19,375

2.05

Certificates of deposit

4,018,803

28,478

2.84

4,763,479

41,022

3.45


Total deposits

8,884,774

42,369

1.91

8,560,645

60,397

2.83

Borrowings

1,384,203

14,559

4.22

1,299,644

14,859

4.59

Capital securities

120,000

3,041

10.14

120,000

3,041

10.14


Total deposits, borrowings and capital securities

10,388,977

59,969

2.32

9,980,289

78,297

3.15

Other liabilities

173,404

137,735

Stockholders’ equity

857,606

775,730


Total liabilities and stockholders’ equity

$

11,419,987

$

10,893,754


Net interest income/interest rate spread

$

74,305

2.56

%

$

75,128

2.69

%

Excess of interest-earning assets over

deposits, borrowings and capital securities

$

622,843

$

521,393

Effective interest rate spread

2.70

2.86


Six Months Ended June 30,


2003

2002


Average

Average

Average

Average

(Dollars in Thousands)

Balance

Interest

Yield/Rate

Balance

Interest

Yield/Rate


Interest-earning assets:

Loans

$

10,638,317

$

273,373

5.14

%

$

10,004,439

$

308,725

6.17

%

Mortgage-backed securities

1,907

35

3.67

93,624

2,216

4.73

Trading and investment securities

515,083

8,163

3.20

425,093

8,882

4.21


Total interest-earning assets

11,155,307

281,571

5.05

10,523,156

319,823

6.08

Non-interest-earning assets

405,916

395,318


Total assets

$

11,561,223

$

10,918,474


Transaction accounts:

Non-interest-bearing checking

$

393,135

$

-

-

%

$

290,362

$

-

-

%

Interest-bearing checking (a)

432,860

582

0.27

425,386

744

0.35

Money market

125,678

769

1.23

111,973

1,010

1.82

Regular passbook

3,830,620

28,082

1.48

2,702,876

33,936

2.53


Total transaction accounts

4,782,293

29,433

1.24

3,530,597

35,690

2.04

Certificates of deposit

4,147,842

60,786

2.96

5,011,329

93,066

3.75


Total deposits

8,930,135

90,219

2.04

8,541,926

128,756

3.04

Borrowings

1,491,649

29,976

4.05

1,362,761

29,912

4.43

Capital securities

120,000

6,082

10.14

120,000

6,082

10.14


Total deposits, borrowings and capital securities

10,541,784

126,277

2.42

10,024,687

164,750

3.31

Other liabilities

171,317

131,929

Stockholders’ equity

848,122

761,858


Total liabilities and stockholders’ equity

$

11,561,223

$

10,918,474


Net interest income/interest rate spread

$

155,294

2.63

%

$

155,073

2.77

%

Excess of interest-earning assets over

deposits, borrowings and capital securities

$

613,523

$

498,469

Effective interest rate spread

2.78

2.95


(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 June 30,

Six Months Ended June 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

$

7,133

$

(23,565

)

$

(1,132

)

$

(17,564

)

$

19,561

$

(51,641

)

$

(3,272

)

$

(35,352

)

Mortgage-backed securities

(921

)

(89

)

87

(923

)

(2,171

)

(498

)

488

(2,181

)

Investment securities

1,122

(1,398

)

(388

)

(664

)

1,880

(2,145

)

(454

)

(719

)


Change in interest income

7,334

(25,052

)

(1,433

)

(19,151

)

19,270

(54,284

)

(3,238

)

(38,252

)


Interest expense:

Transaction accounts:

Interest-bearing checking (a)

11

(55

)

(2

)

(46

)

13

(172

)

(3

)

(162

)

Money market

62

(187

)

(23

)

(148

)

124

(325

)

(40

)

(241

)

Regular passbook

5,845

(8,466

)

(2,669

)

(5,290

)

14,159

(14,121

)

(5,892

)

(5,854

)


Total transaction accounts

5,918

(8,708

)

(2,694

)

(5,484

)

14,296

(14,618

)

(5,935

)

(6,257

)

Certificates of deposit

(6,413

)

(7,267

)

1,136

(12,544

)

(16,036

)

(19,626

)

3,382

(32,280

)


Total interest-bearing deposits

(495

)

(15,975

)

(1,558

)

(18,028

)

(1,740

)

(34,244

)

(2,553

)

(38,537

)

Borrowings

945

(1,206

)

(39

)

(300

)

10,407

(2,542

)

(7,801

)

64

Capital securities

-

-

-

-

-

-

-

-


Change in interest expense

450

(17,181

)

(1,597

)

(18,328

)

8,667

(36,786

)

(10,354

)

(38,473

)


Change in net interest income

$

6,884

$

(7,871

)

$

164

$

(823

)

$

10,603

$

(17,498

)

$

7,116

$

221


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

Provision for Loan Losses

          During the current quarter, $0.6 million of provision for loan losses was reversed, compared to a reversal of $1.1 million in the year-ago second quarter. The current quarter reversal reflected an improvement in credit quality.

          For the first six months of 2003, $2.3 million of provision for loan losses was reversed, compared to a provision for loan losses of $0.3 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 39.

Other Income

          Our total other income was $8.4 million in the current quarter, up from $4.1 million in the year-ago second quarter. The $4.3 million increase between second quarters primarily reflected:

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Partially offsetting those items was an increase of $6.1 million in the loss on our loan servicing activity.

          For the first six months of 2003, total other income was $30.3 million, down $5.1 million from a year ago. The decline from a year ago primarily reflected an increased loss from loan servicing activities and lower income from real estate and joint ventures held for investment, partially offset by higher gains from sales of loans and mortgage-backed securities, a litigation award and higher loan and deposit related fees.

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

Loan and Deposit Related Fees

          Loan and deposit related fees totaled $13.6 million in the current quarter, up $2.3 million from a year ago. Our deposit related fees were up $1.2 million or 22.2% between second quarters, due to higher fees from both our checking accounts and automated teller machines, while our loan related fees increased $1.1 million or 17.7% from a year ago.

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

Three Months Ended


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Loan related fees:

Prepayment fees

$

4,291

$

3,413

$

3,650

$

3,523

$

4,140

Other fees

2,925

2,574

2,733

2,366

1,992

Deposit related fees:

Automated teller machine fees

2,180

2,086

2,066

2,051

1,668

Other fees

4,253

3,905

4,009

3,908

3,596


Total loan and deposit related fees

$

13,649

$

11,978

$

12,458

$

11,848

$

11,396


          For the six months of 2003, loan and deposit related fees totaled $25.6 million, up $2.7 million from the same period of 2002. The increase was primarily due to an increase in our deposit related fees of $2.5 million as a result of higher fees from both our checking accounts and automated teller machines.

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

Six Months Ended June 30,


(In Thousands)

2003

2002


Loan related fees:

Prepayment fees

$

7,704

$

8,826

Other fees

5,499

4,159

Deposit related fees:

Automated teller machine fees

4,266

3,211

Other fees

8,158

6,718


Total loan and deposit related fees

$

25,627

$

22,914


Real Estate and Joint Ventures Held for Investment

          Income from our real estate and joint ventures held for investment totaled $2.1 million in the current quarter, up $1.1 million from the year-ago quarter. The increase reflected a decline in our provision for losses on real estate and joint ventures of $0.7 million and an increase in net gains from sales of $0.3 million. Gains associated with the sale of wholly owned real estate increased $1.0 million, while gains associated with joint venture projects declined $0.7 million and is reported in the category equity in net income from 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


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Rental operations, net of expenses

$

224

$

531

$

489

$

269

$

521

Equity in net income from joint ventures

604

16

2,096

1,634

1,001

Interest from joint venture advances

388

280

303

306

304

Net gains on sales of wholly owned real estate

1,000

157

1,093

99

8

(Provision for) reduction of losses on real estate

and joint ventures

(147

)

(41

)

(151

)

99

(818

)


Total income from real estate and joint ventures

held for investment, net

$

2,069

$

943

$

3,830

$

2,407

$

1,016


          For the first six months of 2003, income from real estate and joint ventures held for investment totaled $3.0 million, down $1.0 million from the same period of 2002. The decline reflected a $0.7 million unfavorable change in provision for losses on real estate and joint ventures and a $0.2 million decline in gains from sales. While gains from wholly owned projects increased $1.1 million, gains from joint ventures declined by $1.3 million.

          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.

Six Months Ended June 30,


(In Thousands)

2003

2002


Rental operations, net of expenses

$

755

$

1,344

Equity in net income from joint ventures

620

1,746

Interest from joint venture advances

668

415

Net gains on sales of wholly owned real estate

1,157

8

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

(188

)

500


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

$

3,012

$

4,013


Secondary Marketing Activities

          A loss of $21.7 million was recorded in loan servicing from our portfolio of loans serviced for others during the current quarter, $6.1 million higher than the loss of $15.6 million in the year-ago period. Negatively impacting our loan servicing between second quarters were increases of $6.7 million in amortization of mortgage servicing rights and $3.0 million in payoff and curtailment interest costs. 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. Those two unfavorable items were partially offset by a $2.5 million reduction in the addition to the valuation allowance for mortgage servicing rights and a $1.1 million increase in net cash servicing fees.

          During the current quarter, $13.2 million was added to the valuation allowance for mortgage servicing rights. This addition reflected higher actual loan prepayments than originally projected as well as a higher projected rate at which loans we service for others are expected to prepay in the future, thereby shortening their expected average life.

          At June 30, 2003, we serviced $9.0 billion of loans for others, compared to $8.3 billion at December 31, 2002, and $7.0 billion at June 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


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Net cash servicing fees

$

5,117

$

5,016

$

4,680

$

4,382

$

4,020

Payoff and curtailment interest cost (a)

(3,620

)

(2,525

)

(2,498

)

(1,182

)

(671

)

Amortization of MSRs

(9,951

)

(4,771

)

(4,146

)

(4,120

)

(3,253

)

Provision for impairment of MSRs

(13,238

)

(11,406

)

(2,497

)

(18,043

)

(15,713

)


Total loan servicing loss, net

$

(21,692

)

$

(13,686

)

$

(4,461

)

$

(18,963

)

$

(15,617

)


(a) Represents our 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 six months of 2003, a loss of $35.4 million was recorded in loan servicing, compared to a loss of $16.2 million from the same period of 2002. The higher loss reflected a larger addition to the valuation allowance for mortgage servicing rights, increased amortization of mortgage servicing rights and higher payoff and curtailment interest losses, partially offset by an increase in net cash servicing fees.

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

Six Months Ended June 30,


(In Thousands)

2003

2002


Net cash servicing fees

$

10,133

$

7,474

Payoff and curtailment interest cost (a)

(6,145

)

(1,437

)

Amortization of MSRs

(14,722

)

(6,169

)

Provision for impairment of MSRs

(24,644

)

(16,073

)


Total loan servicing loss, net

$

(35,378

)

$

(16,205

)


(a) Represents our 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 $2.078 billion from $1.093 billion a year ago. Net gains associated with these sales totaled $12.7 million in the current quarter, up from $6.9 million a year ago. Net gains in the current quarter included the capitalization of mortgage servicing rights of $15.4 million, compared to $10.2 million a year ago. Excluding the impact of SFAS 133, a gain of 0.75% of secondary market sales was realized which compares favorably to 0.68% 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


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Mortgage servicing rights

$

15,405

$

14,954

$

18,779

$

9,304

$

10,156

All other components excluding SFAS 133 (a)

183

4,948

668

(7,612

)

(2,870

)

SFAS 133

(2,936

)

(139

)

4,287

(2,663

)

(390

)


Total net gains (losses) on sales of loans

and mortgage-backed securities

$

12,652

$

19,763

$

23,734

$

(971

)

$

6,896


Secondary marketing gain excluding SFAS

133 as a percentage of associated sales

0.75

%

1.23

%

0.94

%

0.10

%

0.68

%


(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.

          For the first six months of 2003, sales of loans and mortgage-backed securities totaled $3.703 billion, up from $2.475 billion a year ago. Net gains associated with these sales totaled $32.4 million, $9.3 million higher than the prior year amount.

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          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.

Six Months Ended June 30,


(In Thousands)

2003

2002


Mortgage servicing rights

$

30,359

$

25,153

All other components excluding SFAS 133

5,131

(6,530

)

SFAS 133

(3,075

)

4,474


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

$

32,415

$

23,097


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

0.96

%

0.76

%


Trading Securities

          Trading securities were purchased in the current quarter 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 gains on trading securities totaled $0.6 million in the current quarter.

Operating Expense

          Our operating expense totaled $51.3 million in the current quarter, up $6.2 million or 13.8% from a year ago. That increase was due primarily to higher general and administrative costs associated with an increased number of branch locations and higher loan origination activity.

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

Three Months Ended


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Salaries and related costs

$

33,028

$

34,126

$

32,695

$

29,067

$

28,315

Premises and equipment costs

7,971

7,713

7,891

7,916

7,754

Advertising expense

1,016

793

726

1,066

1,582

SAIF insurance premiums and regulatory

assessments

825

831

765

765

762

Professional fees

418

628

547

91

233

Other general and administrative expense

8,111

7,893

7,470

7,474

6,350


Total general and administrative expense

51,369

51,984

50,094

46,379

44,996

Net operation of real estate acquired in

settlement of loans

(111

)

297

(68

)

110

27


Total operating expense

$

51,258

$

52,281

$

50,026

$

46,489

$

45,023


          For the first six months of 2003, operating expenses totaled $103.5 million, up $13.4 million or 14.9% from the same period of 2002, and also reflected higher costs associated with the increased number of branch locations and higher loan origination activity.

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

Six Months Ended June 30,


(In Thousands)

2003

2002


Salaries and related costs

$

67,154

$

57,752

Premises and equipment costs

15,684

14,887

Advertising expense

1,809

2,626

SAIF insurance premiums and regulatory assessments

1,656

1,548

Professional fees

1,046

797

Other general and administrative expense

16,004

12,561


Total general and administrative expense

103,353

90,171

Net operation of real estate acquired in settlement of loans

186

(31

)


Total operating expense

$

103,539

$

90,140


 

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Provision for Income Taxes

          Income taxes for the current quarter totaled $13.6 million compared to $14.9 million a year ago. Our effective tax rate was unchanged at 42.3%, for both the second quarter and year-to-date periods. 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


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Banking net income

$

17,145

$

29,505

$

37,563

$

13,100

$

19,790

Real estate investment net income

1,370

712

2,409

1,468

585


Total net income

$

18,515

$

30,217

$

39,972

$

14,568

$

20,375


Six Months Ended June 30,


(In Thousands)

2003

2002


Banking net income

$

46,650

$

55,411

Real estate investment net income

2,082

2,342


Total net income

$

48,732

$

57,753


Banking

          Net income from our banking operations for the current quarter totaled $17.1 million, down $2.6 million or 13.4% from a year ago. The decline between second quarters reflected:

Those unfavorable items were partially offset by:

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          The following table sets forth our banking operational results and selected financial data for the quarters indicated.

Three Months Ended


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Net interest income

$

74,325

$

80,974

$

83,338

$

76,960

$

75,115

Provision for (reduction of) loan losses

(624

)

(1,709

)

127

471

(1,106

)

Other income (loss)

5,746

20,538

31,693

(7,507

)

2,803

Operating expense

50,985

52,106

49,857

46,328

44,779

Net intercompany income

40

44

64

100

86


Income before income taxes

29,750

51,159

65,111

22,754

34,331

Income taxes

12,605

21,654

27,548

9,654

14,541


Net income

$

17,145

$

29,505

$

37,563

$

13,100

$

19,790


At period end

Assets:

Loans and mortgage-backed securities

$

10,773,026

$

10,675,557

$

10,976,942

$

11,685,037

$

10,286,033

Other

1,165,355

756,455

995,470

828,836

840,641


Total assets

11,938,381

11,432,012

11,972,412

12,513,873

11,126,674


Equity

$

869,365

$

851,650

$

823,104

$

790,807

$

787,436


          For the first six months of 2003, our net income from banking operations totaled $46.7 million, down $8.8 million from the same period a year ago. The decline reflected an increased loss from loan servicing activities and higher operating expense, partially offset by higher gains from sales of loans and mortgage-backed securities, a litigation award, higher loan and deposit related fees and a favorable change in provision for loan losses.

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

Six Months Ended June 30,


(In Thousands)

2003

2002


Net interest income

$

155,299

$

155,055

Provision for (reduction of) loan losses

(2,333

)

341

Other income

26,284

30,865

Operating expense

103,091

89,674

Net intercompany income

84

179


Income before income taxes

80,909

96,084

Income taxes

34,259

40,673


Net income

$

46,650

$

55,411


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Real Estate Investment

          Net income from our real estate investment operations totaled $1.4 million in the current quarter, compared to net income of $0.6 million a year ago. The increase primarily reflected a decline in our provision for losses on real estate and joint ventures of $0.7 million and an increase in net gains from sales of $0.3 million.

          The following table sets forth real estate investment operational results and selected financial data for the quarters indicated.

Three Months Ended


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Net interest income (loss)

$

(20

)

$

15

$

15

$

12

$

13

Other income

2,651

1,411

4,300

2,741

1,299

Operating expense

273

175

169

161

244

Net intercompany expense

40

44

64

100

86


Income before income taxes

2,318

1,207

4,082

2,492

982

Income taxes

948

495

1,673

1,024

397


Net income

$

1,370

$

712

$

2,409

$

1,468

$

585


At period end

Assets:

Investments in real estate and joint ventures

$

36,297

$

34,307

$

33,890

$

40,371

$

40,283

Other

8,279

5,641

14,174

4,090

1,919


Total assets

44,576

39,948

48,064

44,461

42,202


Equity

$

35,407

$

34,037

$

42,325

$

39,916

$

38,448


          For the first six months of 2003, our net income from real estate investment operations totaled $2.1 million, down $0.3 million from the same period of 2002. The decline primarily reflected an unfavorable change in provision for losses on real estate and joint ventures and a decline in gains from sales, which were partially offset by higher trustee and reconveyance fees.

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

Six Months Ended June 30,


(In Thousands)

2003

2002


Net interest income (loss)

$

(5

)

$

18

Other income

4,062

4,590

Operating expense

448

466

Net intercompany expense

84

179


Income before income taxes

3,525

3,963

Income taxes

1,443

1,621


Net income

$

2,082

$

2,342


          Our investments in real estate and joint ventures amounted to $36 million at June 30, 2003, $34 million at December 31, 2002, and $40 million at June 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 39.

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FINANCIAL CONDITION

Loans and Mortgage-Backed Securities

          Total loans and mortgage-backed securities, including those we hold for sale, increased $97 million during the current quarter to a total of $10.8 billion or 90.2% of assets at June 30, 2003. The increase primarily represents a higher level of loans held for sale reflecting continued borrower preference for fixed rate loans, as loans held for investment were essentially unchanged. Our annualized prepayment speed in the current quarter increased to 53%, compared to 38% a year ago and 43% 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


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Loans originated and purchased

Investment portfolio:

Residential one-to-four units:

Adjustable

$

1,280,845

$

769,461

$

1,320,491

$

1,028,635

$

1,109,982

Fixed

6,499

13,287

28,596

3,473

3,940

Other

78,407

51,155

61,109

42,576

119,970


Total for investment portfolio

1,365,751

833,903

1,410,196

1,074,684

1,233,892

Sale portfolio(a)

2,161,154

1,607,147

2,041,109

1,799,673

1,065,360


Total for investment and sale portfolios

$

3,526,905

$

2,441,050

$

3,451,305

$

2,874,357

$

2,299,252


(a) Residential one-to-four unit loans, primarily fixed.

Six Months Ended June 30,


(In Thousands)

2003

2002


Loans originated and purchased

Investment portfolio:

Residential one-to-four units:

Adjustable

$

2,050,306

$

2,098,045

Fixed

19,786

8,306

Other

129,562

165,722


Total for investment portfolio

2,199,654

2,272,073

Sale portfolio(a)

3,768,301

2,331,790


Total for investment and sale portfolios

$

5,967,955

$

4,603,863


(a) Residential one-to-four unit loans, primarily fixed.

          Originations of residential one-to-four unit loans, including loans purchased, totaled $3.448 billion in the current quarter, 44.3% higher than the $2.390 billion we originated in the first quarter of 2003, and 58.2% higher than the $2.179 billion we originated a year ago. Single family loans originated for sale increased $1.096 billion from a year ago to $2.161 billion reflecting continued borrower preference for low fixed rate loans, while single family loans originated for portfolio increased by $173 million to $1.287 billion. Of the current quarter originations for portfolio, $64 million represented subprime credits as part of our continuing strategy to enhance the portfolio’s net yield. During the current quarter, 87% of our residential one-to-four unit originations represented refinancing transactions. This is unchanged from the first quarter 2003 level but up from the year-ago second quarter level of 67%. In addition to single family loans, we originated $78 million of other loans in the current quarter.

          During the current quarter, 58% 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 36% of residential one-to-four unit loans originated for portfolio, with 55% of those tied to the Federal Home Loan Bank ("FHLB") Eleventh District Cost of Funds Index ("COFI) and the remaining 45% tied to the 12-month moving average of annual yields on actively traded U.S. Treasury securities adjusted to a constant maturity of one year ("MTA"). The remaining 6% of originations represented adjustable rate mortgages that adjust less frequently than monthly or fixed rate loans.

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          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 June 30, 2003, loans with the higher 125% limit on negative amortization represented 37% of our adjustable rate one-to-four unit residential portfolio.

          At June 30, 2003, $6.8 billion or 71% of the adjustable rate mortgages in our loan portfolio were subject to negative amortization, of which $79 million represented the amount of negative amortization included in the loan balance. The amount of negative amortization is $17 million or 18.2% below the March 31, 2003 level.

          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 $2.078 billion of loans and mortgage-backed securities in the current quarter, compared to $1.624 billion in the first quarter of 2003 and $1.093 billion a year ago. All were secured by residential one-to-four unit property, and at June 30, 2003, loans held for sale totaled $722 million.

          At June 30, 2003, our unfunded loan application pipeline totaled $3.0 billion. Within that pipeline, we had commitments to borrowers for short-term interest rate locks, not including expected fallout, of $1.6 billion, of which $1.2 billion were related to residential one-to-four unit loans being originated for sale in the secondary market. Furthermore, at June 30, 2003, we had commitments on undrawn lines and letters of credit of $121 million, loans in process of $66 million and commitments to purchase loans of $41 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


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Investment Portfolio

Loans originated:

Loans secured by real estate:

Residential one-to-four units:

Adjustable

$

468,337

$

479,506

$

589,314

$

675,280

$

868,022

Adjustable – subprime

63,903

62,268

86,613

123,263

148,876

Adjustable – fixed for 3-5 years

178,325

132,143

186,256

181,439

85,679

Adjustable – fixed for 3-5 years – subprime

-

11,683

22,810

24,851

133


Total adjustable residential one-to-four units

710,565

685,600

884,993

1,004,833

1,102,710

Fixed

5,721

11,865

28,596

3,373

3,940

Fixed – subprime

73

1,395

-

-

-

Residential five or more units (all adjustable)

17,956

4,400

2,806

-

-


Total residential

734,315

703,260

916,395

1,008,206

1,106,650

Commercial real estate

3,272

-

600

557

-

Construction

21,511

10,345

28,048

17,418

65,030

Land

-

-

-

-

37,820

Non-mortgage:

Commercial

-

125

3,710

8,000

600

Automobile

18

79

86

64

329

Other consumer

31,117

28,418

25,859

16,537

16,191


Total loans originated

790,233

742,227

974,698

1,050,782

1,226,620

Real estate loans purchased:

One-to-four units

570,985

82,746

432,289

21,485

6,459

One-to-four units – subprime

-

1,142

3,209

2,417

813

Other (a)

4,533

7,788

-

-

-


Total real estate loans purchased

575,518

91,676

435,498

23,902

7,272


Total loans originated and purchased

1,365,751

833,903

1,410,196

1,074,684

1,233,892

Loan repayments

(1,352,321

)

(1,127,612

)

(1,090,307

)

(927,653

)

(950,438

)

Other net changes (b)

(4,075

)

11,078

2,328

6,943

(45,850

)


Net increase (decrease) in loans held for investment

9,355

(282,631

)

322,217

153,974

237,604


Sale Portfolio

Residential one-to-four units:

Originated whole loans

2,161,154

1,606,085

2,038,678

1,792,091

1,060,399

Loans purchased

-

1,062

2,431

7,582

4,961

Loans transferred from (to) the investment portfolio

3,549

(541

)

(453

)

(460

)

(1,401

)

Originated whole loans sold

(250,027

)

(246,697

)

(349,605

)

(280,786

)

(132,614

)

Loans exchanged for mortgage-backed securities

(1,828,344

)

(1,377,469

)

(1,702,481

)

(1,232,826

)

(943,883

)

Other net changes

(1,116

)

(1,143

)

(898

)

(3,105

)

(594

)

Capitalized basis adjustment (c)

3,037

327

(1,207

)

1,626

6,129


Net increase (decrease) in loans held for sale

88,253

(18,376

)

(13,535

)

284,122

(7,003

)


Mortgage-backed securities, net:

Received in exchange for loans

1,828,344

1,377,469

1,702,481

1,232,826

943,883

Sold

(1,828,344

)

(1,377,469

)

(2,715,467

)

(1,283,100

)

(960,840

)

Purchased

-

-

-

1,014,098

-

Repayments

(129

)

(366

)

(2,195

)

(4,258

)

(18,950

)

Other net changes

(10

)

(12

)

(1,596

)

1,342

3,226


Net increase (decrease) in mortgage-backed

securities available for sale

(139

)

(378

)

(1,016,777

)

960,908

(32,681

)


Net increase (decrease) in loans held for sale and

mortgage-backed securities available for sale

88,114

(18,754

)

(1,030,312

)

1,245,030

(39,684

)


Total net increase (decrease) in loans and

mortgage-backed securities

$

97,469

$

(301,385

)

$

(708,095

)

$

1,399,004

$

197,920


(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.

June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Investment Portfolio

Loans secured by real estate:

Residential one-to-four units:

Adjustable

$

6,444,574

$

6,711,548

$

6,739,243

$

6,746,906

$

6,590,943

Adjustable – subprime

1,119,780

1,212,905

1,297,280

1,345,644

1,357,098

Adjustable – fixed for 3-5 years

1,942,446

1,543,478

1,697,953

1,313,391

1,271,031

Adjustable – fixed for 3-5 years – subprime

70,780

80,247

81,421

64,808

48,835

Fixed

157,256

187,888

210,001

225,701

260,934

Fixed – subprime

5,602

7,266

7,412

9,629

11,982


Total residential one-to-four units

9,740,438

9,743,332

10,033,310

9,706,079

9,540,823

Residential five or more units:

Adjustable

41,004

19,048

6,964

4,693

4,952

Fixed

2,251

2,292

3,676

3,737

3,775

Commercial real estate:

Adjustable

37,524

34,530

40,373

39,553

40,200

Fixed

15,507

23,613

31,042

38,112

41,522

Construction

105,858

100,767

103,547

110,125

124,318

Land

20,090

39,962

53,538

53,885

62,182

Non-mortgage:

Commercial

6,493

14,922

15,021

17,792

17,371

Automobile

6,959

9,165

11,641

14,475

17,667

Other consumer

68,012

61,744

56,782

54,779

50,101


Total loans held for investment

10,044,136

10,049,375

10,355,894

10,043,230

9,902,911

Increase (decrease) for:

Undisbursed loan funds

(67,921

)

(72,765

)

(95,002

)

(99,309

)

(106,557

)

Net deferred costs and premiums

105,393

96,499

96,744

91,379

85,926

Allowance for losses

(32,247

)

(33,103

)

(34,999

)

(34,880

)

(35,834

)


Total loans held for investment, net

10,049,361

10,040,006

10,322,637

10,000,420

9,846,446


Sale Portfolio, Net

Loans held for sale:

Residential one-to-four units

716,477

631,261

649,964

662,292

379,796

Capitalized basis adjustment (a)

5,452

2,415

2,088

3,295

1,669


Total loans held for sale

721,929

633,676

652,052

665,587

381,465

Mortgage-backed securities available for sale:

Adjustable

1,736

1,875

2,253

3,385

58,122

Fixed

-

-

-

1,015,645

-


Total mortgage-backed securities available for sale

1,736

1,875

2,253

1,019,030

58,122


Total loans held for sale and mortgage-backed

securities available for sale

723,665

635,551

654,305

1,684,617

439,587


Total loans and mortgage-backed securities

$

10,773,026

$

10,675,557

$

10,976,942

$

11,685,037

$

10,286,033


(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 June 30, 2003, no valuation allowance was required as the fair value exceeded book value on an aggregate basis.

          At June 30, 2003, our residential one-to-four units subprime portfolio consisted of approximately 89% "A-" credit, 9% "B" credit and 2% "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 June 30, 2003, reflected an unrealized gain of $22,000. The current quarter-end unrealized gain, less the associated tax effect, is reflected within 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.

June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Federal funds

$

89,210

$

1,201

$

2,555

$

16,702

$

16,401

U.S. Treasury securities held for trading

201,781

-

-

-

-

U.S. Treasury and agency securities available for sale

276,904

214,449

457,797

264,743

290,297

Corporate bonds available for sale

-

-

-

2,500

2,535

Municipal securities held to maturity

6,215

6,215

6,216

6,387

6,387

Securities purchased under resale agreements

60,000

-

-

-

-


Total trading and investment securities

$

634,110

$

221,865

$

466,568

$

290,332

$

315,620


          The following table sets forth the maturities of our trading and investment securities and the weighted average yield of those securities at June 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

$

89,210

1.01

%

$

-

-

%

$

-

-

%

$

89,210

1.01

%

U.S. Treasury securities held for

trading

-

-

-

-

201,781

3.57

201,781

3.57

U.S. Treasury and agency securities

available for sale

-

-

233,118

2.12

43,786

1.98

276,904

2.10

Municipal securities held to maturity (a)

-

-

-

-

6,215

3.36

6,215

3.36

Securities purchased under resale

agreements

60,000

0.95

-

-

-

-

60,000

0.95


Total

$

149,210

0.99

%

$

233,118

2.12

%

$

251,782

3.29

%

$

634,110

2.32

%


(a) Yield on a fully tax-equivalent basis is 5.82%.

 

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Deposits

          At June 30, 2003, our deposits totaled $8.9 billion, up $205 million or 2.4% from the year-ago level, but down $102 million or 1.1% from the previous quarter. Compared to the year-ago period, our lower-rate transaction accounts—i.e., checking, money market and regular passbook—increased $1.1 billion or 27.5%, which was partially offset by a decrease in our certificates of deposit of $869 million or 18.2%. 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 June 30, 2003, the average deposit size of our traditional branches was $103 million, while the average size of our in-store branches was $15 million, or $18 million excluding the 20 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.

June 30, 2003

March 31, 2003

December 31, 2002

September 30, 2002

June 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

-

%

$

403,264

-

%

$

446,668

-

%

$

388,376

-

%

$

312,338

-

%

$

295,788

Interest-bearing

checking (a)

0.21

439,408

0.21

434,148

0.25

422,417

0.25

410,095

0.25

418,310

Money market

1.05

127,194

1.19

127,257

1.37

120,105

1.64

113,746

1.80

114,618

Regular passbook

1.28

4,015,045

1.45

3,872,525

1.70

3,639,798

2.04

3,413,891

2.42

3,082,356


Total transaction

accounts

1.08

4,984,911

1.20

4,880,598

1.41

4,570,696

1.71

4,250,070

1.99

3,911,072

Certificates of deposit:

Less than 2.00%

1.35

1,479,928

1.45

1,292,664

1.57

919,864

1.75

452,965

1.83

123,651

2.00-2.49

2.23

416,718

2.24

241,833

2.28

401,657

2.32

766,889

2.33

840,677

2.50-2.99

2.76

277,926

2.80

436,352

2.79

528,557

2.78

722,442

2.77

800,658

3.00-3.49

3.32

602,691

3.32

706,952

3.38

1,188,078

3.36

1,213,176

3.33

1,258,969

3.50-3.99

3.85

254,400

3.89

545,453

3.89

700,250

3.88

664,344

3.84

588,142

4.00-4.49

4.25

361,212

4.25

368,490

4.25

374,424

4.25

376,386

4.25

563,298

4.50-4.99

4.80

469,279

4.80

471,542

4.80

473,399

4.80

492,254

4.80

456,618

5.00 and greater

5.58

48,387

5.57

53,674

5.63

81,425

5.78

118,406

5.84

147,473


Total certificates

of deposit

2.74

3,910,541

2.97

4,116,960

3.19

4,667,654

3.30

4,806,862

3.41

4,779,486


Total deposits

1.81

%

$

8,895,452

2.01

%

$

8,997,558

2.31

%

$

9,238,350

2.55

%

$

9,056,932

2.77

%

$

8,690,558


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

Borrowings

          During the current quarter, our borrowings increased $375 million to $1.7 billion, due primarily to an increase in FHLB advances. This followed a decrease of $323 million during the first quarter of 2003.

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

June 30,

March 31,

December 31,

September 30,

June 30,

(Dollars in Thousands)

2003

2003

2002

2002

2002


Federal Home Loan Bank advances

$

1,672,850

$

1,300,850

$

1,624,084

$

1,687,431

$

1,413,607

Securities sold under agreements to repurchase

-

-

-

182,358

-

Other borrowings

3,121

-

-

-

-


Total borrowings

$

1,675,971

$

1,300,850

$

1,624,084

$

1,869,789

$

1,413,607


Weighted average rate on borrowings during

the quarter

4.22

%

3.91

%

4.10

%

4.35

%

4.59

%

Total borrowings as a percentage of total assets

14.03

11.37

13.56

14.94

12.70


 

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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 second 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 as a partner in real estate joint venture relationships through our wholly-owned subsidiary, DSL Service Company. It is possible that certain of our real estate joint venture partnerships will likely 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 34, Capital Resources and Liquidity—Contractual Obligations and Other Commitments on page 43 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 34, Capital Resources and Liquidity—Contractual Obligations and Other Commitments on page 43 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 CMT, LIBOR, COFI and MTA.

          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. Previously, we have not hedged our mortgage servicing rights. However, in light of the Federal Reserve’s change in bias towards weakness at their May 6, 2003 meeting and the potential for further declines in market interest rates, we purchased during the current quarter 10-year U.S. Treasury securities as a partial economic hedge against the value of our mortgage servicing rights. These securities are classified in a trading account and are carried at fair value, with any changes in fair value reflected in earnings. This partial economic hedge may be closed at any time or other financial instruments may be substituted.

          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 June 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.

June 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:

Trading securities

$

201,781

$

-

$

-

$

-

$

-

$

201,781

Investment securities and FHLB stock(a)

455,904

61,857

35,018

67

-

552,846

Loans and mortgage-backed securities:(b)

Loans secured by real estate:

Residential:

Adjustable

8,110,597

312,786

1,406,217

-

-

9,829,600

Fixed

628,668

28,803

84,762

11,118

1,596

754,947

Commercial real estate

29,245

4,736

11,267

5,654

-

50,902

Construction

50,388

-

-

-

-

50,388

Land

6,975

7

51

610

-

7,643

Non-mortgage loans:

Commercial

4,039

-

-

-

-

4,039

Consumer

68,801

1,663

3,307

-

-

73,771

Mortgage-backed securities

1,736

-

-

-

-

1,736


Total loans and mortgage-backed securities

8,900,449

347,995

1,505,604

17,382

1,596

10,773,026


Total interest-earning assets

$

9,558,134

$

409,852

$

1,540,622

$

17,449

$

1,596

$

11,527,653


Transaction accounts:

Non-interest-bearing checking

$

403,264

$

-

$

-

$

-

$

-

$

403,264

Interest-bearing checking(c)

439,408

-

-

-

-

439,408

Money market (d)

127,194

-

-

-

-

127,194

Regular passbook (d)

4,015,045

-

-

-

-

4,015,045


Total transaction accounts

4,984,911

-

-

-

-

4,984,911

Certificates of deposit(a)

1,900,122

614,520

1,395,899

-

-

3,910,541


Total deposits

6,885,033

614,520

1,395,899

-

-

8,895,452

Borrowings

465,821

60,000

691,150

459,000

-

1,675,971

Capital securities

-

-

-

-

120,000

120,000


Total deposits, borrowings and

capital securities

$

7,350,854

$

674,520

$

2,087,049

$

459,000

$

120,000

$

10,691,423


Excess (shortfall) of interest-earning assets over

deposits, borrowings and capital securities

$

2,207,280

$

(264,668

)

$

(546,427

)

$

(441,551

)

$

(118,404

)

$

836,230

Cumulative gap

2,207,280

1,942,612

1,396,185

954,634

836,230

Cumulative gap–as a percentage of total assets:

June 30, 2003

18.47

%

16.26

%

11.69

%

7.99

%

7.00

%

December 31, 2002

16.80

12.54

9.33

5.80

4.83

June 30, 2002

21.95

12.73

9.31

5.45

4.42


(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 June 30, 2003 was a positive 18.47%. 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 21.95% a year ago.

          We continue to pursue our strategy of emphasizing the origination of adjustable rate mortgages. For the twelve months ended June 30, 2003, we originated and purchased for investment $4.6 billion of adjustable rate loans which represented approximately 99% of all loans we originated and purchased for investment during the period.

          At June 30, 2003, December 31, 2002 and June 30, 2002, essentially all of our interest-earning assets mature, reprice or are estimated to prepay within five years. At June 30, 2003, $9.9 billion or 98% 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 $9.7 billion or 97% a year ago. During the second 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.

June 30,

March 31,

December 31,

September 30,

June 30,

2003

2003

2002

2002

2002


Weighted average yield: (a)

Loans and mortgage-backed securities

5.24

%

5.53

%

5.83

%

6.00

%

6.01

%

Federal Home Loan Bank stock

4.80

5.31

5.24

2.87

5.56

Trading and investment securities

2.32

2.34

3.07

3.12

3.44


Interest-earning assets yield

5.08

5.46

5.72

5.90

5.93


Weighted average cost:

Deposits

1.81

2.01

2.31

2.55

2.77

Borrowings:

Federal Home Loan Bank advances

3.68

4.50

3.88

3.95

4.32

Other borrowings

6.63

-

-

2.02

-


Total borrowings

3.68

4.50

3.88

3.76

4.32

Capital securities

10.00

10.00

10.00

10.00

10.00


Combined funds cost

2.20

2.42

2.63

2.84

3.07


Interest rate spread

2.88

%

3.04

%

3.09

%

3.06

%

2.86

%


(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 5.24% at June 30, 2003, down from 5.83% at December 31, 2002 and 6.01% at June 30, 2002. At June 30, 2003, our adjustable rate mortgage portfolio of single family residential loans, including mortgage-backed securities, totaled $9.8 billion with a weighted average rate of 5.16%, compared to $9.9 billion with a weighted average rate of 5.75% at December 31, 2002, and $9.4 billion with a weighted average rate of 5.91% at June 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 $9 million during the current quarter to $66 million or 0.56% of total assets. The decline was primarily in the residential category, of which $5 million was associated with prime loans and $4 million was associated with subprime loans.

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

June 30,

March 31,

December 31,

September 30,

June 30,

(Dollars in Thousands)

2003

2003

2002

2002

2002


Non-accrual loans:

Residential one-to-four units

$

29,758

$

34,426

$

34,504

$

36,068

$

33,827

Residential one-to-four units – subprime

26,568

30,086

32,263

36,304

31,540

Other

646

683

681

823

4,305


Total non-accrual loans

56,972

65,195

67,448

73,195

69,672

Troubled debt restructure – below market rate (a)

-

-

-

203

203

Real estate acquired in settlement of loans

9,464

10,205

12,360

15,441

13,528

Repossessed automobiles

3

-

6

15

16


Total non-performing assets

$

66,439

$

75,400

$

79,814

$

88,854

$

83,419


Allowance for loan losses:

Amount

$

32,247

$

33,103

$

34,999

$

34,880

$

35,834

As a percentage of non-performing loans

56.60

%

50.78

%

51.89

%

47.52

%

51.28

%

Non-performing assets as a percentage of total assets

0.56

0.66

0.67

0.71

0.75


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

Delinquent Loans

          Loans delinquent 30 days or more as a percentage of total loans declined to 0.69% at June 30, 2003, from 0.80% at March 31, 2003, and 0.91% a year ago. The decline 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.

June 30, 2003

March 31, 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

$

17,488

$

5,482

$

23,500

$

46,470

$

18,566

$

7,771

$

26,054

$

52,391

One-to-four units – subprime

4,785

4,350

18,302

27,437

7,835

6,943

17,496

32,274

Five or more units

-

-

-

-

-

-

-

-

Commercial real estate

-

-

-

-

-

-

-

-

Construction

-

-

-

-

-

-

-

-

Land

-

-

-

-

-

-

-

-


Total real estate loans

22,273

9,832

41,802

73,907

26,401

14,714

43,550

84,665

Non-mortgage:

Commercial

-

-

428

428

-

-

428

428

Automobile

94

18

44

156

158

23

15

196

Other consumer

77

16

174

267

141

70

240

451


Total delinquent loans

$

22,444

$

9,866

$

42,448

$

74,758

$

26,700

$

14,807

$

44,233

$

85,740


Delinquencies as a percentage of total loans

0.21

%

0.09

%

0.39

%

0.69

%

0.25

%

0.14

%

0.41

%

0.80

%


December 31, 2002

September 30, 2002


Loans secured by real estate:

Residential:

One-to-four units

$

19,881

$

8,066

$

27,333

$

55,280

$

17,835

$

10,454

$

25,487

$

53,776

One-to-four units – subprime

8,971

5,944

23,831

38,746

11,606

6,565

22,275

40,446

Five or more units

-

-

-

-

-

-

-

-

Commercial real estate

-

-

-

-

-

-

-

-

Construction

-

-

-

-

-

-

-

-

Land

-

-

-

-

-

-

-

-


Total real estate loans

28,852

14,010

51,164

94,026

29,441

17,019

47,762

94,222

Non-mortgage:

Commercial

-

-

466

466

-

1,235

548

1,783

Automobile

98

13

4

115

126

9

26

161

Other consumer

48

47

211

306

147

36

249

432


Total delinquent loans

$

28,998

$

14,070

$

51,845

$

94,913

$

29,714

$

18,299

$

48,585

$

96,598


Delinquencies as a percentage of total loans

0.26

%

0.13

%

0.47

%

0.86

%

0.28

%

0.17

%

0.45

%

0.90

%


June 30, 2002


Loans secured by real estate:

Residential:

One-to-four units

$

20,531

$

6,461

$

27,472

$

54,464

One-to-four units – subprime

10,694

3,308

24,228

38,230

Five or more units

-

-

-

-

Commercial real estate

-

-

-

-

Construction

-

-

-

-

Land

-

-

-

-


Total real estate loans

31,225

9,769

51,700

92,694

Non-mortgage:

Commercial

-

-

428

428

Automobile

190

13

54

257

Other consumer

314

132

180

626


Total delinquent loans

$

31,729

$

9,914

$

52,362

$

94,005


Delinquencies as a percentage of total loans

0.31

%

0.10

%

0.50

%

0.91

%


(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 takes into consideration loss that is imbedded within the portfolio but has 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 $33 million at June 30, 2003, compared to $36 million at December 31, 2002, and $38 million a year ago.

          In the current quarter, we reversed $0.6 million of provision for loan losses and net loan charge-offs totaled $0.2 million, resulting in a decrease in the allowance for loan losses to $32 million at June 30, 2003. The current quarter decline in the allowance reflected decreases of $0.7 million in the general valuation allowances due to change of mix in the loan portfolio and $0.1 million in allocated allowances to $4.6 million due to declines in various loan categories. 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


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Balance at beginning of period

$

33,103

$

34,999

$

34,880

$

35,834

$

37,307

Provision (reduction)

(624

)

(1,709

)

127

471

(1,106

)

Charge-offs

(236

)

(191

)

(118

)

(1,450

)

(387

)

Recoveries

4

4

110

25

20


Balance at end of period

$

32,247

$

33,103

$

34,999

$

34,880

$

35,834


          Since year-end 2002, our allowance for loan losses declined by $2.8 million, from decreases in the general valuation allowances of $2.0 million and allocated allowances of $0.8 million.

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

Six Months Ended June 30,


(In Thousands)

2003

2002


Balance at beginning of period

$

34,999

$

36,120

Provision (reduction)

(2,333

)

341

Charge-offs

(427

)

(663

)

Recoveries

8

36


Balance at end of period

$

32,247

$

35,834


 

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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

Six Months Ended


June 30,

March 31,

December 31,

September 30,

June 30,

          June 30,          

(Dollars in Thousands)

2003

2003

2002

2002

2002

2003

2002


Gross loan charge-offs

Loans secured by real estate:

Residential:

One-to-four units

$

130

$

17

$

-

$

113

$

197

$

147

$

322

One-to-four units – subprime

39

82

17

69

63

121

80

Five or more units

-

-

-

-

-

-

-

Commercial real estate

-

-

-

1,188

-

-

-

Construction

-

-

-

-

-

-

-

Land

-

-

-

-

-

-

-

Non-mortgage:

Commercial

-

20

-

-

-

20

-

Automobile

8

10

16

3

33

18

85

Other consumer

59

62

85

77

94

121

176


Total gross loan charge-offs

236

191

118

1,450

387

427

663


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

5

21

16

2

21

Other consumer

3

3

3

4

4

6

6


Total gross loan recoveries

4

4

110

25

20

8

36


Net loan charge-offs

Loans secured by real estate:

Residential:

One-to-four units

130

17

(102

)

113

197

147

313

One-to-four units – subprime

39

82

17

69

63

121

80

Five or more units

-

-

-

-

-

-

-

Commercial real estate

-

-

-

1,188

-

-

-

Construction

-

-

-

-

-

-

-

Land

-

-

-

-

-

-

-

Non-mortgage:

Commercial

-

20

-

-

-

20

-

Automobile

7

9

11

(18

)

17

16

64

Other consumer

56

59

82

73

90

115

170


Total net loan charge-offs

$

232

$

187

$

8

$

1,425

$

367

$

419

$

627


Net loan charge-offs as a

percentage of average loans

0.01

%

0.01

%

-

%

0.05

%

0.01

%

0.01

%

0.01

%


 

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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.

June 30, 2003

March 31, 2003

December 31, 2002


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

$

17,447

$

8,544,276

0.20

%

$

17,553

$

8,442,914

0.21

%

$

18,562

$

8,647,197

0.21

%

One-to-four units – subprime

7,315

1,196,162

0.61

7,965

1,300,418

0.61

8,642

1,386,113

0.62

Five or more units

324

43,255

0.75

160

21,340

0.75

80

10,640

0.75

Commercial real estate

1,171

53,031

2.21

1,226

58,143

2.11

1,364

71,415

1.91

Construction

1,256

105,858

1.19

1,197

100,767

1.19

1,223

103,547

1.18

Land

250

20,090

1.24

498

39,962

1.25

636

53,538

1.19

Non-mortgage:

Commercial

504

6,493

7.76

564

14,922

3.78

586

15,021

3.90

Automobile

94

6,959

1.35

82

9,165

0.89

100

11,641

0.86

Other consumer

1,086

68,012

1.60

1,058

61,744

1.71

1,006

56,782

1.77

Not specifically allocated

2,800

-

-

2,800

-

-

2,800

-

-


Total loans held for investment

$

32,247

$

10,044,136

0.32

%

$

33,103

$

10,049,375

0.33

%

$

34,999

$

10,355,894

0.34

%


September 30, 2002

June 30, 2002


Loans secured by real estate:

Residential:

One-to-four units

$

17,951

$

8,285,998

0.22

%

$

17,291

$

8,122,908

0.21

%

One-to-four units – subprime

8,873

1,420,081

0.62

8,697

1,417,915

0.61

Five or more units

63

8,430

0.75

65

8,727

0.74

Commercial real estate

1,448

77,665

1.86

2,905

81,722

3.55

Construction

1,292

110,125

1.17

1,459

124,318

1.17

Land

665

53,885

1.23

769

62,182

1.24

Non-mortgage:

Commercial

634

17,792

3.56

596

17,371

3.43

Automobile

127

14,475

0.88

250

17,667

1.42

Other consumer

1,027

54,779

1.87

1,002

50,101

2.00

Not specifically allocated

2,800

-

-

2,800

-

-


Total loans held for investment

$

34,880

$

10,043,230

0.35

%

$

35,834

$

9,902,911

0.36

%


          At June 30, 2003, the recorded investment in loans for which we recognized impairment totaled $13 million, unchanged from December 31, 2002, but down from $17 million a year ago. The allowance for losses related to these loans was $1 million at both June 30, 2003 and December 31, 2002, and $2 million a year ago. During the second 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


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Balance at beginning of period

$

720

$

725

$

747

$

2,203

$

2,356

Reduction

(4

)

(5

)

(22

)

(268

)

(153

)

Charge-offs

-

-

-

(1,188

)

-

Recoveries

-

-

-

-

-


Balance at end of period

$

716

$

720

$

725

$

747

$

2,203


          For the first six months of 2003, total interest recognized on the impaired loan portfolio was $0.6 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.

Six Months Ended June 30,


(In Thousands)

2003

2002


Balance at beginning of period

$

725

$

759

Provision (reduction)

(9

)

1,444

Charge-offs

-

-

Recoveries

-

-


Balance at end of period

$

716

$

2,203


          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


June 30,

March 31,

December 31,

September 30,

June 30,

(In Thousands)

2003

2003

2002

2002

2002


Balance at beginning of period

$

949

$

908

$

1,752

$

1,851

$

1,033

Provision (reduction)

147

41

151

(99

)

818

Charge-offs

-

-

(995

)

-

-

Recoveries

-

-

-

-

-


Balance at end of period

$

1,096

$

949

$

908

$

1,752

$

1,851


          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.

Six Months Ended June 30,


(In Thousands)

2003

2002


Balance at beginning of period

$

908

$

2,690

Provision (reduction)

188

(500

)

Charge-offs

-

(339

)

Recoveries

-

-


Balance at end of period

$

1,096

$

1,851


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 second 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 June 30, 2003, our FHLB borrowings totaled $1.7 billion, representing 14% 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 $3.1 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 June 30, 2003, we had commitments to borrowers for short-term rate locks, not including expected fallout, of $1.6 billion, undisbursed loan funds and unused lines and letters of credit of $187 million, operating leases of $17 million, commitments to purchase loans of $41 million, other contingent liabilities of $3 million and commitments to invest in affordable housing funds of $2 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.

          Another measure of liquidity in the savings and loan industry is the ratio of cash and eligible investments to the sum of withdrawable savings and borrowings due within one year. The Bank’s ratio was 5.8% at June 30, 2003, 5.4% at December 31, 2002 and 4.3% a year ago.

          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 June 30, 2003, the holding company’s liquid assets, including due from Bank—interest bearing balances, totaled $68 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 June 30, 2003, $38 million of the original authorization remains available for future purchases.

          Stockholders’ equity totaled $869 million at June 30, 2003, up from $823 million at December 31, 2002 and $787 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.

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          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 34 and Note 3 of Notes to the Consolidated Financial Statements on page 8.

          At June 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

$

2,514,642

$

825,480

$

570,419

$

-

$

3,910,541

FHLB advances and other borrowings

525,821

564,850

126,300

459,000

1,675,971

Secondary marketing activities:

Non-qualifying hedge transactions:

Expected rate lock commitments

950,703

-

-

-

950,703

Associated forward sale contracts

985,094

-

-

-

985,094

Associated forward purchase contracts

139,000

-

-

-

139,000

Qualifying cash flow hedge transactions:

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

721,929

-

-

-

721,929

Associated forward sale contracts

710,099

-

-

-

710,099

Commitments to originate loans held for investment:

Adjustable

336,303

-

-

-

336,303

Fixed

235

-

-

-

235

Undisbursed loan funds and unused lines of credit

57,578

10,343

-

115,799

183,720

Operating leases

4,317

7,139

3,791

2,108

17,355

Letters of credit and other contingent liabilities

-

-

-

6,044

6,044

Commitments to purchase loans

40,816

-

-

-

40,816

Commitments to invest in affordable housing funds

-

-

-

2,400

2,400


Total obligations and commitments

$

6,986,537

$

1,407,812

$

700,510

$

585,351

$

9,680,210


Regulatory Capital Compliance

          Our core and tangible capital ratios were both 7.20% and our risk-based capital ratio was 14.23% at June 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 June 30, 2003.

Tangible Capital

Core Capital

Risk-Based Capital


(Dollars in Thousands)

Amount

Ratio

Amount

Ratio

Amount

Ratio


Stockholder’s equity

$

917,824

$

917,824

$

917,824

Adjustments:

Deductions:

Investment in subsidiary, primarily real estate

(34,806

)

(34,806

)

(34,806

)

Loans to subsidiary joint ventures

(19,415

)

(19,415

)

(19,415

)

Excess cost over fair value of branch acquisitions

(3,150

)

(3,150

)

(3,150

)

Non-permitted mortgage servicing rights

(4,872

)

(4,872

)

(4,872

)

Unrealized gains on securities available for sale

(1,135

)

(1,135

)

(1,135

)

Additions:

General loss allowance – investment in DSL

Service Company

390

390

390

Allowance for loan losses,

net of specific allowances (a)

-

-

31,704


Regulatory capital

854,836

7.20

%

854,836

7.20

%

886,540

14.23

%

Well capitalized requirement

178,063

1.50

(b)

593,544

5.00

622,880

10.00

(c)


Excess

$

676,773

5.70

%

$

261,292

2.20

%

$

263,660

4.23

%


(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 13.72%.

 

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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 34.

 

ITEM 4. – CONTROLS AND PROCEDURES

          Within 90 days of the date of this report, 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 Exchange Act Rule 13a-15. 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 required to be included in Downey’s periodic Securities and Exchange Commission 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 Rule 13a-14 of the Exchange Act 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 Securities and Exchange Commission’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

          On April 23, 2003, Downey held its annual meting of shareholders to elect three Class 2 Directors for terms of three years each and to ratify the Board of Directors’ appointment of KPMG LLP as auditors for the year ending December 31, 2003. The number of votes cast at the meeting as to each matter acted upon was as follows:

1.

Election of Directors:

Nominees

Votes For

Votes Withheld

Unvoted


Cheryl E. Olson

22,225,715

406,355

5,296,652

Lester C. Smull

18,974,357

3,657,713

5,296,652

Michael B. Abrahams

22,225,676

406,394

5,296,652

The Directors whose terms continued and the years their terms expire are as follows:

Continuing Directors

Year Term Expires


Dr. Paul Kouri

2004

Brent McQuarrie

2004

James H. Hunter

2004

Gerald E. Finnell

2005

Maurice L. McAlister

2005

Daniel D. Rosenthal

2005

2.

Ratification of appointment of KPMG LLP as auditors for the year ending December 31, 2003:

Votes For

Votes Against

Abstain

Unvoted


21,893,941

328,421

409,708

5,296,652


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.


 

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(A)          Exhibits (Continued)

Exhibit

Number

Description


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).

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.


 

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(A)          Exhibits (Continued)

Exhibit

Number

Description


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 April 16, 2003, with respect to a press release reporting its results of operations during the three months ended March 31, 2003.

          2) Form 8-K filed May 15, 2003, with respect to a press release reporting monthly selected financial data for the thirteen months ended April 30, 2003.

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

 

 

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

 

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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: July 31, 2003

Daniel D. Rosenthal

President and Chief Executive Officer

/s/ Thomas E. Prince


Date: July 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