q093009edgar.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
 
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2009
 
OR
*
TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 1-9566
FIRSTFED FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
                     
Delaware
95-4087449
 (State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
                                             
 12555 W. Jefferson Boulevard, Los Angeles, California                    90066
                    (Address of principal executive offices)                                (Zip Code)
 
(310) 302-5600
(Registrant's telephone number, including area code)

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    R                            No    *

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232,405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes    *                             No   R

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” ”accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer *                        Accelerated filer R                        Non-accelerated filer *                        Smaller reporting company *

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes    *                            No    R
 
As of November 13, 2009, 13,684,553 shares of the Registrant's $.01 par value common stock were outstanding.
 
On November 9, 2009, the Registrant received notification from Grant Thornton LLP of their resignation as the Registrant’s independent registered public accounting firm.  The Registrant is currently conducting a search for a successor accounting firm, however no successor accounting firm has been selected or engaged as of the date of this filing.  As a result of Grant Thornton LLP’s resignation, the unaudited interim consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q have not been reviewed in accordance with Statement of Auditing Standards No. 100, as required by Rule 10-01(d) of Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended.
 
The Registrant will file an amendment to this Quarterly Report on Form 10-Q as soon as practicable after the required review is completed.  As such, the unaudited interim consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q are subject to restatement.

 
Disclosure Regarding Forward-looking Statements

This Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 includes certain statements that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”) and Section 21E of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”). All statements, other than statements of historical facts, included in this Quarterly Report that address activities, events or developments that the Company expects, believes or anticipates will or may occur in the future, including, but not limited to, such matters as future product development, business development, competition, future revenues, business strategies, expansion and growth of the Company’s operations and assets and other such matters are forward-looking statements. These kinds of statements are signified by words such as “believes,” “anticipates,” “expects,” “intends,” “may”, “could,” and other similar expressions. However, these words are not the exclusive means of identifying such statements. These statements are based on certain assumptions and analyses made by the Company in light of its experience and perception of historical trends, current conditions, expected future developments and other factors it believes are appropriate in the circumstances. Such statements are subject to a number of assumptions, risks and uncertainties, including the risk factors discussed below, general economic and business conditions, the business opportunities (or lack thereof) that may be presented to and pursued by the Company, changes in law or regulations and other factors, many of which are beyond the Company’s control. Investors are cautioned that any such statements are not guarantees of future performance and that actual results or developments may differ materially from those projected in the forward-looking statements. Specific factors that could cause results to differ materially from historical results or those anticipated are: (1) the ability and willingness of borrowers to pay their mortgage loans, which is affected by external factors such as interest rates, the California real estate markets and the strength of the California economy; (2) fluctuations between consumer interest rates and the cost of funds; (3) federal and state regulation of lending, deposit and other operations, including the regulatory enforcement actions to which we and the Bank are currently, and may in the future be, subject; (4) competition for financial products and services within the Bank’s market areas; (5) operational and infrastructural risks; (6) capital market activities; (7) critical accounting estimates; and (8) other risks detailed in reports filed by the Company with the Securities and Exchange Commission. The Company does not undertake to update any forward-looking statements, except to the extent that it is obligated to do so under applicable law. Readers are advised to carefully review the detailed discussion of risk factors contained in “Item 1A – Risk Factors” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 as well as additional disclosures contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Item 7 of that Form 10-K and Item 2 of this Form 10-Q.

 
 

 

FirstFed Financial Corp.
Index
Report on Form 10-Q
For the Quarterly Period Ended September 30, 2009
       
       
     
Page
Part I.
Financial Information
       
 
Item 1.
Financial Statements
 
       
   
Consolidated Balance Sheets as of September 30, 2009, December 31, 2008 and September 30, 2008
  1
       
   
Consolidated Statements of Operations for the nine months ended September 30, 2009 and 2008
  2
       
   
Consolidated Statements of Cash Flows for the nine months ended September 30, 2009 and 2008
  3
       
   
Notes to Consolidated Financial Statements
4
       
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and
Results of Operations
 
19
       
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
38
       
 
Item 4.
Controls and Procedures
38
       
Part II.
Other Information  (omitted items are inapplicable)
       
 
Item 3.
Defaults Upon Senior Securities
39
       
  Item 4.  Submission of Matters to a Vote of Security Holders 
 40
       
 
Item 6.
Exhibits
41
       
Signatures
   
42

 

 
 

 


PART I - FINANCIAL STATEMENTS

Item 1. Financial Statements

These Financial Statements have not been reviewed by an independent registered public accounting firm.

FirstFed Financial Corp. and Subsidiary
Consolidated Balance Sheets
(In thousands, except share data)
(Unaudited)
   
September 30,
2009
   
December 31, 2008
   
September 30,
2008
 
ASSETS
                 
Cash and cash equivalents
  $ 298,661     $ 391,469     $ 62,661  
Investment securities, available-for-sale (at fair value)
          323,048       329,042  
Mortgage-backed securities, available-for-sale (at fair value)
          40,504       41,510  
Loans receivable, net of allowances for loan losses of $244,048, $326,920 and $264,092
    5,464,538       6,254,686       6,395,706  
Accrued interest and dividends receivable
    19,163       30,061       32,260  
Real estate owned (REO), net       175,725        117,664        132,957  
Office properties and equipment, net
    21,262       24,102       21,140  
Investment in Federal Home Loan Bank (FHLB) stock, at cost
    115,150       115,150       130,496  
Other assets
    56,114       153,902       209,524  
 
  $ 6,150,613     $ 7,450,586     $ 7,355,296  
                         
LIABILITIES
                       
Deposits
  $ 4,524,487     $ 4,907,356     $ 4,328,850  
FHLB advances
    1,300,000       2,085,000       2,313,000  
Senior debentures
    150,000       150,000       150,000  
Accrued expenses and other liabilities
    65,046       49,488       64,250  
 
    6,039,533       7,191,844       6,856,100  
                         
COMMITMENTS AND CONTINGENCIES
                       
                         
STOCKHOLDERS' EQUITY
                       
Common stock, par value $.01 per share; authorized 100,000,000 shares;
     issued 24,002,093 shares; outstanding 13,684,553 shares
    240       240           240  
Additional paid-in capital
    58,391       57,880       57,176  
Retained earnings
    318,336       463,759       708,532  
Unreleased shares to employee stock ownership plan
                (31 )
Treasury stock, at cost, 10,317,540 shares
    (266,040 )     (266,040 )     (266,040 )
Accumulated other comprehensive income (loss), net of taxes
    153       2,903       (681 )
      111,080       258,742       499,196  
    $ 6,150,613     $ 7,450,586     $ 7,355,296  

The accompanying notes are an integral part of these consolidated financial statements.

 
1

 
These Financial Statements have not been reviewed by an independent registered public accounting firm.

FirstFed Financial Corp. and Subsidiary
Consolidated Statements of Operations
(Dollars in thousands, except per share data)
(Unaudited)
 
   
Three months ended September 30,
   
Nine months ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Interest and dividend income:
                       
Interest on loans
  $ 73,678     $ 93,141     $ 232,407     $ 297,807  
Interest on mortgage-backed securities
          427       691       1,543  
Interest and dividends on investments
    410       6,356       6,519       17,754  
Total interest income
    74,088       99,924       239,617       317,104  
Interest expense:
                               
Interest on deposits
    25,797       32,280       92,984       105,738  
Interest on borrowings
    12,306       21,864       40,607       71,541  
Total interest expense
    38,103       54,144       133,591       177,279  
                                 
Net interest income
    35,985       45,780       106,026       139,825  
Provision for loan losses
    70,000       110,300       208,000       350,800  
Net interest loss after provision for loan losses
    (34,015 )     (64,520 )     (101,974 )     (210,975 )
                                 
Other income:
                               
Loan servicing and other fees
    296       149       1,037       3,407  
Banking service fees
    1,786       1,848       5,562       5,306  
Gain on sale of loans
    116             138       20  
Gain on sale of investment securities
                4,770        
Net gain on REO
    9,584       4,170       19,505       7,357  
Other operating income
    2,759       2,374       5,937       5,098  
Total other income
    14,541       8,541       36,949       21,188  
                                 
Non-interest expense:
                               
Salaries and employee benefits
    8,867       11,105       28,479       35,456  
Occupancy
    3,647       3,029       11,225       10,932  
Advertising
    66       284       220       619  
Amortization of core deposit intangible
          127             380  
Federal deposit insurance
    4,073       1,074       16,477       2,970  
Data processing
    589       559       1,890       1,667  
OTS assessment
    615       439       1,880       1,347  
Legal
    616       497       1,123       1,805  
Real estate owned operations
    5,726       4,277       13,285       8,541  
Other operating expense
    2,322       1,776       5,819       6,642  
Total non-interest expense
    26,521       23,167       80,398       70,359  
                                 
Loss before income taxes
    (45,995 )     (79,146 )     (145,423 )     (260,146 )
Income tax benefit
          (27,560 )           (103,267 )
Net loss
  $ (45,995 )   $ (51,586 )   $ (145,423 )   $ (156,879 )
                                 
Net loss
  $ (45,995 )   $ (51,586 )   $ (145,423 )   $ (156,879 )
Other comprehensive loss, net of taxes
          (756 )     (2,750 )     (676 )
Comprehensive loss
  $ (45,995 )   $ (52,342 )   $ (148,173 )   $ (157,555 )
                                 
Loss per share:
                               
Basic
  $ (3.36 )   $ (3.77 )   $ (10.63 )   $ (11.48 )
Diluted
  $ (3.36 )   $ (3.77 )   $ (10.63 )   $ (11.48 )
                                 
Weighted average shares outstanding:
                               
Basic
    13,678,708       13,668,576       13,677,947       13,663,059  
Diluted
    13,678,708       13,668,576       13,677,947       13,663,059  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
2

 
These Financial Statements have not been reviewed by an independent registered public accounting firm.
 
FirstFed Financial Corp. and Subsidiary
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
   
Nine months ended September 30,
 
   
2009
   
2008
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
    Net loss
  $ (145,423 )   $ (156,879 )
    Adjustments to reconcile net loss to
               
net cash provided by operating activities:
               
  Stock option compensation
    511       1,551  
  Excess tax benefits related to stock option awards
          (29 )
  Depreciation and amortization
    2,317       1,901  
  Provision for loan losses
    208,000       350,800  
  Yield adjustments on troubled debt restructured
    (6,219 )     (2,434 )
  Amortization of fees and premiums/discounts
    1,395       10,355  
  Decrease in interest income accrued in excess
               
       of borrower payments
    49,855       12,035  
                      Net gain on REO      (19,505      (7,357
  Gain on sale of loans
    (138 )     (20 )
  Gain on sale of investment securities
    (4,770 )      
  Deferred gain on sale of branch facility
    (1,194 )      
  FHLB stock dividends
          (4,518 )
                      Valuation allowance for deferred tax assets      2,330        —  
  Change in deferred taxes
    (1,861 )     (54,536 )
  Change in current taxes
    104,445       (45,957 )
  Decrease in interest and dividends receivable
    10,898       13,232  
  Decrease in interest payable
    (6,292 )     (7,967 )
  Amortization of core deposit intangible asset
          380  
  Increase in other assets
    (5,131 )     (10,104 )
  Increase in accrued expenses and other liabilities
    21,850       16,861  
      Total adjustments
    356,491       274,193  
      Net cash provided by operating activities
    211,068       117,314  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Loans made to customers and principal collections
               
   on loans, net
    236,442       (495,091 )
Loans purchased
    (402 )     (6,484 )
Proceeds from sale of real estate
    262,712       146,194  
Proceeds from maturities and principal payments
               
   of investment securities, available for sale
    23,215       38,597  
Principal reductions on mortgage-backed securities,
               
   available for sale
    2,793       4,763  
Purchase of investment securities, available for sale
          (51,647 )
Proceeds from sale of investment securities, available for sale
    337,515        
Purchases of FHLB stock, net
          (21,591 )
Proceeds from sale of branch facility
    2,039        
Purchases of premises and equipment
    (321 )     (5,256 )
   Net cash provided by (used in) investing activities
    863,993       (390,515 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase (decrease) in retail and commercial deposits
    719,571       (250,104 )
Net (decrease) increase  in  brokered deposits
    (1,102,440 )     422,262  
Net decrease in short term borrowings
    (455,000 )     (386,000 )
Net (decrease) increase in long term borrowings
    (330,000 )     495,000  
Proceeds from stock options exercised
          529  
Excess tax benefits related to stock option awards
          29  
Other
          172  
      Net cash (used in) provided by financing activities
    (1,167,869 )     281,888  
Net (decrease) increase in cash and cash equivalents
    (92,808 )     8,687  
Cash and cash equivalents at beginning of period
    391,469       53,974  
Cash and cash equivalents at end of period
  $ 298,661     $ 62,661  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
3

 

FirstFed Financial Corp. and Subsidiary
Notes to Consolidated Financial Statements
(Unaudited)

Explanatory Note
 
On November 9, 2009, the Registrant received notification from Grant Thornton LLP of their resignation as the Registrant’s independent registered public accounting firm.  The Registrant is currently conducting a search for a successor accounting firm, however no successor accounting firm has been selected or engaged as of the date of this filing.  As a result of Grant Thornton LLP’s resignation, the unaudited interim consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q have not been reviewed in accordance with Statement of Auditing Standards No. 100, as required by Rule 10-01(d) of Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended.

The Company will file an amendment to this Quarterly Report on Form 10-Q as soon as practicable after the required review is completed.  As such, the unaudited interim consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q are subject to restatement.

1.  Basis of Presentation
 
The unaudited consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission and in accordance with accounting principles generally accepted in the United States. In the opinion of the Company, all adjustments (which include only normal recurring adjustments) necessary to present fairly the results of operations for the periods covered have been made. Certain information and note disclosures normally included in financial statements presented in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. The Company believes that the disclosures are adequate to make the information presented not misleading.
 
These condensed financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. The results for the periods covered hereby are not necessarily indicative of the Company’s operating results for a full year.
 
2.  Subsequent Event

Management has evaluated subsequent events through November 13, 2009.

On November 6, 2009, President Barack Obama signed into law the Worker, Homeownership, and Business Assistance Act of 2009 which includes, among other things, a provision allowing all businesses - except those that received funds under the Troubled Asset Relief Program - to elect a five-year carry back of net operating losses. The Act allows taxpayers to elect to increase the present-law carry back period for an applicable net operating loss from two years up to five years for taxable years ending after December 31, 2007. A taxpayer may elect an extended carry back period for only one taxable year.
 
 
4

 
 
The following table summarizes the pro forma impact of the five-year net operating loss carry back would have on the Company’s Consolidated Balance Sheet and Consolidated Statements of Operations as of September 30, 2009:
 
   
Pro Forma Results
 
    As Reported    
5-Year Loss
Carry Back
   
Pro Forma
 
   
(Dollars in thousands, except per share data)
 
       
Other assets (income taxes receivable)
  $ 56,114     $ 76,284     $ 132,398  
Total Assets
  $ 6,150,613     $ 76,284     $ 6,226,897  
                         
Shareholders’ Equity
  $ 111,080     $ 76,284     $ 187,364  
Total Liabilities and Stockholders’ Equity
  $ 6,150,613     $ 76,284     $ 6,226,897  
                         
Loss before income taxes
  (145,423 )   $     (145,423 )
Income tax benefit
          76,284       76,284  
Net loss
  $ (145,423 )   $ 76,284     $ (69,139 )
                         
Loss per share:
                       
Basic
  $ (10.63 )   $ 5.58     $ (5.05 )
Diluted
  $ (10.63 )   $ 5.58     $ (5.05 )

The following table summarizes the Bank’s capital ratios at September 30, 2009 after giving effect to the subsequent event:

       As Reported               Pro Forma   
                               
                5-Year Loss              
       Amount    Ratio     Carry Back       Amount    Ratio   
     (Dollars in thousands)  
       
Tangible Capital
  $ 261,051   4.25 %   $ 76,284     $ 337,335   5.49 %
Core Capital
  $ 261,051   4.25 %   $ 76,284     $ 337,335   5.49 %
Tier 1 Risk-Based Capital
  $ 261,051   7.59 %   $ 76,284     $ 337,335   9.81 %
Risk-Based Capital
  $ 306,519   8.91 %   $ 76,284     $ 382,803   11.13 %

3.  Regulatory Matters and Uncertainties

To understand the impact of these regulatory matters and uncertainties on the Company, you should carefully review the detailed discussion of risk factors applicable to the Company contained in “Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 as well as additional disclosures contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Item 7 of that Form 10-K and Item 2 of this Form 10-Q.

Issuance of Cease and Desist Orders by the OTS
 
On January 26, 2009, the Company and its wholly-owned subsidiary, First Federal Bank of California (the “Bank”) each consented to the issuance of an Order to Cease and Desist (the “Company Order” and the “Bank Order,” respectively, and together, the “Orders”) by the Office of Thrift Supervision (the “OTS”).
 
The Company Order requires that the Company notify, or in certain cases receive the permission of, the OTS prior to (i) declaring, making or paying any dividends or other capital distributions on its capital stock; (ii) incurring, issuing, renewing, repurchasing or rolling over any debt, increasing any current lines of credit or guaranteeing the debt of any entity; (iii) making payments (including, without limitation, principal, interest or fees of any kind) on any existing debt; (iv) making certain changes to its directors or senior executive officers; (v) entering into, renewing, extending or revising any contractual arrangement related to compensation or benefits with any of its directors or senior executive officers; and (vi) making any golden parachute payments or prohibited indemnification payments.  The Company Order also required that the Company submit to the OTS within fifteen (15) days a detailed capital plan to address how the Bank will remain “well capitalized” (as defined in 12 C.F.R. § 565.4) at each quarter-end through December 31, 2011, which the Company did submit in a timely manner.
 
 
5

 
 
The Bank Order requires that the Bank notify, or in certain cases receive the permission of, the OTS prior to (i) increasing its total assets in any quarter in excess of an amount equal to net interest credited on deposits during the quarter (other than for balance sheet increases resulting from activities to maintain liquidity); (ii) making certain changes to its directors or senior executive officers; (iii) entering into, renewing, extending or revising any contractual arrangement related to compensation or benefits with any of its directors or senior executive officers; (iv) making any golden parachute or prohibited indemnification payments; (v) paying dividends or making other capital distributions on its capital stock; (vi) entering into certain transactions with affiliates; and (vii) entering into third-party contracts outside the normal course of business.
 
On May 28, 2009, the Company and the Bank each consented to the issuance of an Amended Order to Cease and Desist (the "Company Amendment" and the "Bank Amendment," respectively, and together, the "Amendments") by the OTS. The Amendments amend and supplement the Orders to Cease and Desist that were issued by the OTS on January 26, 2009.
 
The Amendments required that the Company and the Bank submit to the OTS within thirty days a detailed capital plan to address how the Bank expected to meet and maintain a minimum Tier 1 Core Capital ratio of 7% and a minimum Total Risk-Based Capital ratio of 14% by September 30, 2009. The capital plan addressed how the Bank will meet and maintain the foregoing capital ratios and provide for the augmentation of capital to, among other things, support the Bank's business strategy and operations. The Company and the Bank did timely submit a capital plan to the OTS as required by the Amendments.  If the Bank fails to meet or maintain the foregoing capital ratios or otherwise fails to comply with the updated capital plan, the Bank must then submit to the OTS a contingency plan to accomplish either a merger with or acquisition by another federally insured institution or holding company thereof, or a voluntary liquidation of the Bank. The Bank Amendment also provides that the Bank may not accept, renew or roll over any brokered deposits, or act as a deposit broker, without the prior written approval of the Federal Deposit Insurance Corporation.
 
The Bank failed to meet these required capital ratios on September 30, 2009, and, accordingly, as required by the Bank Order, the Bank submitted to the OTS a contingency plan to accomplish either a merger of the Bank with, or an acquisition of the Bank by, another federally insured institution or holding company thereof or a voluntary liquidation of the Bank.  The FDIC may at any time commence a resolution process for the Bank that would include the marketing of the Bank or its assets to prospective buyers, culminating in a potential FDIC seizure or FDIC-assisted acquisition of the Bank.
 
Non-Payment of Interest Due March 16, June 15, 2009 and September 15, 2009 on Outstanding Company Debt; Tender Offer and Consent Solicitation for Outstanding Company Debt
 
The Company has $150.0 million in outstanding unsecured fixed/floating rate senior debentures (the “Senior Notes”). The Company Order issued by the OTS prohibits the Company from making payments (including, without limitation, principal, interest or fees of any kind) on any existing debt without the consent of the OTS.  The Company did not receive consent from the OTS to make the $2.3 million quarterly interest payments that were due on the Senior Notes on each of March 16, June 15 and September 15, 2009.

Under the indentures governing the Senior Notes, a default in the payment of any interest when it becomes due and payable that is not cured within 30 days is an “event of default.” If an event of default occurs and is continuing with respect to the debentures, the trustee or the holders of not less than 25% in aggregate principal amount of the Senior Notes then outstanding may declare the entire principal of the Senior Notes and the interest accrued thereon immediately due and payable. In addition, the Company may be required to pay additional interest on the Senior Notes and the costs and expenses of collection, including reasonable compensation to the trustee, its agents, attorneys, and counsel. The Company has not been notified of any such additional interest, costs or expenses as of November 9, 2009.
 
 
6

 
 
On June 19, 2009, the Company commenced cash tender offers and consent solicitations for its $150.0 million in Senior Notes. The terms and conditions of the tender offers and consent solicitations are described in the Offer to Purchase and Consent Solicitation Statement, dated June 19, 2009 (the “Offer to Purchase”), and the related Letter of Transmittal and Consent.
 
The tender offer and consent solicitation for each series of Senior Notes will expire at 5:00 p.m., New York City time, on November 25, 2009, unless extended or earlier terminated by the Company (the “Tender Expiration Date”). In order to be eligible to receive the purchase price of $200.00 per $1,000.00 principal amount of securities, which includes the $20.00 consent payment, holders must validly tender, and not validly withdraw, their Senior Notes prior to 5:00 p.m., New York City time, on November 25, 2009, unless extended or earlier terminated by the Company (the “Consent Payment Deadline”). Holders tendering their Senior Notes after the applicable Consent Payment Deadline but prior to the applicable Tender Expiration Date will be eligible to receive an amount equal to the purchase price less the consent payment, or $180.00 per $1,000.00 principal amount of securities. Senior Notes purchased in the tender offers will be paid for on the applicable settlement date for each tender offer, which, assuming the tender offers are not extended, will be promptly after the applicable Tender Expiration Date.
 
As of 5:00 p.m., New York City time, on November 6, 2009, the Company had received tenders and consents from holders of $50,000,000 in aggregate amount of the Senior Notes due March 15, 2016, representing 100% of such securities, $50,000,000 in aggregate amount of the Senior Notes due June 15, 2015, representing 100% of such securities, and $43,000,000 in aggregate amount of the Senior Notes due June 15, 2017, representing 86% of such securities.
 
Holders tendering their Senior Notes will be required to consent to the proposed amendments to the indentures governing the Senior Notes, which would eliminate substantially all of the restrictive covenants in the indentures, including the covenant that currently prohibits the Company from merging or selling all or substantially all of its assets unless the successor entity or purchaser is substituted as the obligor.  Holders may not tender their Senior Notes without also delivering consents and may not deliver consents without also tendering their Senior Notes.
 
Consummation of each tender offer and consent solicitation is conditioned upon satisfaction or waiver of the conditions set forth in the Offer to Purchase, including (i) the Company’s receipt of net proceeds from an offering, sale or other transaction sufficient to enable the Company to purchase the Senior Notes that are validly tendered and not withdrawn, (ii) approval by the OTS of the Company’s payment of the purchase price for the Senior Notes that are validly tendered and not withdrawn and (iii) the Company’s receipt of tenders and consents from holders of at least seventy-five percent (75%) in principal amount of each and every series of Senior Notes subject to the tender offers and consent solicitations. The Company has reserved the right to waive any condition to any tender offer and consent solicitation.
 
Suspension of Portfolio Lending and Reduction in Workforce
 
On January 26, 2009, in an effort to comply with the asset growth limitations contained in the Orders, the Company suspended lending for its own portfolio. As a result, the Company reduced the staff of the Bank by 62 persons, or approximately 10% of the Bank’s then-current workforce. The reductions came primarily from the Bank’s single family lending and commercial lending operations as well as some reduction in support areas of the Bank. As a result of these reductions, the Company paid $560 thousand for salary and benefits in accordance with the California Relocations, Terminations, and Mass Layoffs Act during the quarter ending March 31, 2009.
 
Going Concern Uncertainty
 
The ability of the Company and the Bank to continue to meet all of the requirements of the Amendments and the Orders will be affected by market conditions in the economy and other uncertainties. Declining real estate values and rising unemployment in the state of California could have a significant impact on future losses incurred on loans. In addition, there can be no assurance in the current economic environment that the Company will be able to raise capital to regain “well capitalized” status or to meet future regulatory requirements. Due to these conditions and events, substantial doubt exists in the Company’s ability to continue as a going concern.
 
 
7

 
 
The consolidated financial statements have been prepared on a going concern basis which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and do not include any adjustments to reflect possible future effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result from the outcome of any regulatory action, which would affect the ability of the Company to continue as a going concern.
 
4.  Loss per Share
 
Basic loss per share was computed by dividing the net loss by the weighted average number of shares of common stock outstanding for the period. Loss per common share has been computed based on the following:
 
 
 
Three months ended
September 30,
 
   
2009
   
2008
 
   
(In thousands, except share data)
 
                 
    Net loss
  $ (45,995 )   $ (51,586 )
                 
    Average number of common shares outstanding
    13,678,708       13,668,576  
    Effect of dilutive stock options
           
           Average number of common shares outstanding used to calculate
                diluted loss per common share
    13,678,708       13,668,576  

 
 
   
Nine months ended
September 30,
 
   
2009
   
2008
 
   
(In thousands, except share data)
 
       
    Net loss
  $ (145,423 )   $ (156,879 )
                 
    Average number of common shares outstanding
    13,677,947       13,663,059  
    Effect of dilutive stock options
           
           Average number of common shares outstanding used to calculate
                diluted loss per common share
    13,677,947       13,663,059  

There was no dilutive effect during the third quarter or nine months ended September 30, 2009 or 2008, since the Company was in a net loss position. There were 811,042 anti-dilutive shares excluded from the weighted average shares outstanding calculation during the third quarter and nine months ended September 30, 2009 and there were 863,197 anti-dilutive shares excluded from the weighted average shares outstanding calculation during the third quarter and nine months ended September 30, 2008.
 
 
8

 

5.  Cash and Cash Equivalents
 
For purposes of reporting cash flows on the "Consolidated Statements of Cash Flows," cash and cash equivalents include cash, overnight investments and securities purchased under agreements to resell which mature within 90 days of the date of purchase.
 
6.  Loan Modifications
 
At September 30, 2009, the Bank had 2,724 modified loans with principal balances totaling $1.3 billion.

Based on the underwriting at the time of the modification, the Bank makes a determination whether or not the loan is a troubled debt restructuring (“TDR”). Modified loans are not considered TDRs when the loan terms are consistent with the Bank’s current product offerings and the borrowers meet the Bank’s current underwriting standards with regard to Fair Isaac Corporation (“FICO”) score, debt to income ratio, and loan-to-value ratio. At September 30, 2009, 2,654 of the modified loans, with balances totaling $1.2 billion, were considered TDRs and 70 loans, with balances totaling $34.9 million, were not considered TDRs.

For modified loans that are considered TDRs, the Bank calculates and records an impaired valuation allowance based on the present value of expected future cash flows discounted at the loan’s effective interest rate (based on the original contractual rate). An impaired valuation allowance is recorded when the present value of expected future cash flows is less than the recorded investment in the loan. The present value of expected future cash flows will increase from one reporting period to the next as a result of the passage of time. The Bank accomplishes the recording of this portion of the change in impairment value by amortizing the original impaired valuation allowance amount over the life of the loan as an adjustment to loan yield. The impaired valuation allowance is recomputed at the end of each reporting period if there is a significant change (increase or decrease) in the amount or timing of the expected future cash flows, or if actual cash flows are significantly different from the cash flows previously projected.

Some future payments to which the Bank is contractually entitled are not included in the expected future cash flows because of uncertainty regarding their future collection. If, as a part of the modification process, the borrower is allowed to defer making interest payments on a portion of the principal, that principal amount is assumed to be uncollectible for purposes of cash flow projections. As of September 30, 2009, the Bank had $2.2 million in deferred principal amounts that had been charged off. Similarly, for any loans that were in non-accrual status prior to modification that are brought current by capitalizing interest into the principal balances, any capitalized interest is assumed to be uncollectible and is charged off or an impaired valuation allowance is established. As of September 30, 2009, the Bank had $95.8 million in loans with capitalized interest totaling $1.8 million.

TDRs for which impaired valuation allowances are recorded based on the present value of expected future cash flows are reviewed each quarter to determine if foreclosure is probable. At September 30, 2009, the Bank had $1.2 billion of modified loans recorded based on the present value of expected future cash flows.  Impaired valuation allowances on these loans totaled $66.2 million as of September 30, 2009.

Impairment of TDRs for which foreclosure is probable is measured based on the fair value of the collateral, net of all selling costs. At September 30, 2009, the Bank had $76.6 million of modified loans that were recorded at net collateral value after charge-offs totaling $22.3 million were taken. These loans were moved to non-accrual status because foreclosure was determined to be probable. Impaired valuation allowances on these loans totaled $14.5 million as of September 30, 2009.

As of September 30, 2009, $57.7 million of modified loans that were considered TDRs were 90 days or more delinquent.

 
9

 
 
7.  Loan Loss Allowances
 
Listed below is a summary of activity in the general valuation allowance and the valuation allowance for impaired loans during the periods indicated.
 
   
 
General Valuation Allowance
   
Valuation Allowances
 For
 Impaired Loans
   
 
 
 
Total
 
   
(In thousands)
 
       
Balance at December 31, 2008:
  $ 280,185     $ 46,735     $ 326,920  
Provision for loan losses
    158,567       49,433       208,000  
Yield adjustment on troubled debt restructurings(1)
          (6,219 )     (6,219 )
Charge-offs:
                       
Single family
    (285,900 )     (2,210 )     (288,110 )
Commercial loan
    (640 )           (640 )
Consumer loans
    (690 )           (690 )
Total charge-offs
    (287,230 )     (2,210 )     (289,440 )
Recoveries
    4,787             4,787  
Net charge-offs
    (282,443 )     (2,210 )     (284,653 )
Balance at September 30, 2009:
  $ 156,309     $ 87,739     $ 244,048  

   
 
General Valuation Allowance
   
Valuation Allowances
 For
 Impaired Loans
   
 
 
 
Total
 
   
(In thousands)
 
       
Balance at December 31, 2007:
  $ 127,503     $ 555     $ 128,058  
Provision for loan losses
    306,180       44,620       350,800  
        Yield adjustment on troubled debt restructurings(1)       —        (2,434     (2,434
Charge-offs:
                       
Single family
    (207,060 )     (6,523     (213,583 )
Total charge-offs
    (207,060 )     (6,523     (213,583 )
Recoveries
    1,251             1,251  
Net charge-offs
    (205,809 )     (6,523     (212,332 )
        Transfers      (6,514      6,514        —  
Balance at September 30, 2008:
  $ 221,360     $ 42,732     $ 264,092  
                         
 
(1)
The Bank establishes an impaired loan valuation allowance for the difference between the recorded investment of the original loan at the time of modification and the expected cash flows of the modified loan (discounted at the effective interest rate of the original loan during the modification period). The difference is recorded as a provision for loan losses during the current period and subsequently amortized over the expected life of the loan as an adjustment to the loan yield or as adjustment to the loan loss provision if the loan is prepaid.
 
 
10

 
 
8.  Impaired Loans and Troubled Debt Restructurings

The Company considers a loan impaired when management believes that it is probable that the Company will not be able to collect all amounts due under the contractual terms of the loan agreement. Estimated impairment losses are recorded as separate valuation allowances and may be subsequently adjusted based upon changes in the measurement of impairment.

Impaired loans, disclosed net of valuation allowances, include non-accrual major loans (commercial business loans with an outstanding principal amount greater than or equal to $500 thousand, single family loans greater than or equal to $1.0 million, and income property loans with an outstanding principal amount greater than or equal to $1.5 million), non-accrual loans less than the major loan thresholds and delinquent greater than 180 days, modified loans which are considered troubled restructurings because they do not meet the Company’s current product offerings and underwriting standards, and major loans less than 90 days delinquent in which full payment of principal and interest is not expected to be received.

The following is a summary of impaired loans, net of valuation allowances for impairment, at the dates indicated:

   
September 30,
2009
   
December 31,
2008
   
September 30,
2008
 
   
(In thousands)
 
Troubled debt restructurings
  $ 1,093,920     $ 572,307     $ 500,139  
Non-accrual loans
    169,516       152,227       30,670  
Other impaired loans
    12,812       1,257        
    $ 1,276,248     $ 725,791     $ 530,809  

When a loan is considered impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate. However, if the loan is "collateral-dependent" or foreclosure is probable, impairment is measured based on the fair value of the collateral. When the measure of an impaired loan is less than the recorded investment in the loan, the Company records an impaired valuation allowance equal to the excess of the recorded investment in the loan over its measured value.

The following is a summary of information pertaining to impaired loans at the dates indicated:

   
September 30,
2009
   
December 31,
 2008
   
September 30,
 2008
 
 
 (In thousands)
 
Impaired loans without valuation allowances
  $ 88,177     $ 18,050     $ 31,027  
Impaired loans with valuation allowances
    1,275,810       754,476       542,514  
Valuation allowances on impaired loans
    (87,739 )     (46,735 )     (42,732 )
 
 
   
Nine months ended
September 30,
 
   
2009
   
2008
 
   
(In thousands)
 
Average investment in impaired loans
  $ 844,030     $ 259,764  
Interest recognized on impaired loans
    9,451       2,961  
Interest recognized on impaired loans using the cash basis
    9,576       1,806  
 


 
11

 
 
9.  Real Estate Owned Activity

The following table shows activity in real estate owned (“REO”) during the periods indicated:

   
Nine months ended
September 30,
 
   
2009
   
2008
 
   
(In thousands)
 
  Beginning Balance
  $ 117,664     $ 21,090  
  Acquisitions
    301,268       250,705  
  Write-downs
    (16,853 )     (13,172 )
  Sales of REO
    (226,354 )     (125,666 )
  Ending Balance
  $ 175,725     $ 132,957  

Net gain on REO is comprised of the following items for the periods indicated:

   
Three months ended
September 30,
 
   
2009
   
2008
 
   
(In thousands)
 
  Gain on sale of REO
  $ 15,049     $ 12,342  
  Loss on sale of REO
          (1,518 )
  Write down on REO
    (5,465 )     (6,654 )
  Net gain on REO
  $ 9,584     $ 4,170  
                 

   
Nine months ended
September 30,
 
   
2009
   
2008
 
   
(In thousands)
 
  Gain on sale of REO
  $ 37,050     $ 22,348  
  Loss on sale of REO
    (692 )     (1,819 )
  Write down on REO
    (16,853 )     (13,172 )
  Net gain on REO
  $ 19,505     $ 7,357  
                 

The following items are included in REO operations for the periods indicated:

   
Three months ended
September 30,
 
   
2009
   
2008
 
   
(In thousands)
 
  Single family REO expense
  $ 5,743     $ 4,306  
  Single family REO income
    (17 )     (29 )
  Net REO expense
  $ 5,726     $ 4,277  
                 
   
Nine months ended
September 30,
 
      2009       2008  
   
(In thousands)
 
  Single family REO expense
  $ 13,395     $ 8,602  
  Single family REO income
    (110 )     (61 )
  Net REO expense
  $ 13,285     $ 8,541  
 
Operating costs on REO consist primarily of repair and clean up costs, property taxes, insurance, home owners’ association dues, if any, and utilities expenses during the holding period.
 
12

 
 
10.  Income Taxes

When determining the need for a valuation allowance against a deferred tax asset, management must asses both positive and negative evidence with regard to the realizability of the tax losses represented by that asset. To the extent that available sources of taxable income are insufficient to absorb tax losses, a valuation allowance is necessary. Sources of taxable income for this analysis include prior years’ tax returns, the expected reversals of taxable temporary differences between book and tax income, prudent and feasible tax planning strategies and future taxable income. The deferred tax asset related to loan loss allowances will be realized when actual charge-offs are made against the loan loss allowances.

The Company’s federal and state deferred tax assets increased significantly during 2008 due to a significant increase in its general loan valuation allowance. To the extent that the loan loss allowance is not allocable to specific loans, it represents future tax benefits which would be realized when actual charge-offs are made against the allowance. Because the Bank recorded a net loss during 2008 and the nine months ended September 30, 2009, future earnings that would cause the future tax benefits to be realized cannot be assured. Therefore, valuation allowances were recorded to reduce the deferred tax assets to the amount management deems more likely than not to be realized through the carry back of tax losses to prior years’ federal tax returns. At September 30, 2009, the Bank had $42.7 million in federal deferred tax assets net of valuation allowances. Since the state of California does not allow net operating loss carry backs, a valuation allowance was established for the entire amount of the state deferred tax assets. No expected future earnings were considered in determining the amount of the deferred tax assets.
 
11.  Fair Value Measurements

The Company has estimated fair value based on quoted market prices where available. In case where quoted market prices were not available, fair values were based on the quoted market price of a financial instruments with similar characteristics, the present value of expected future cash flows or other valuation techniques that utilize assumptions which are highly subjective and judgmental in nature. Subjective factors include, among other things, estimates of cash flows, the timing of cash flows, risk and credit quality characteristics, interest rates and liquidity premiums or discounts. Accordingly, the result may not be precise, and modifying the assumptions may significantly affect the values derived. In addition, fair values established utilizing alternative valuation techniques may or may not be substantiated by comparison with independent markets. Further, fair values may or may not be realized if a significant portion of the financial instruments were sold in a bulk transaction or a forced liquidation. Therefore, any aggregate unrealized gains or losses should not be interpreted as a forecast of future earnings or cash flows. Furthermore, the fair values disclosed should not be interpreted as the aggregated current value of the Company.

The following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:
 
Cash and cash equivalent
The carrying amounts reported in the Consolidated Balance Sheets for this item approximate fair value.

Federal Home Loan Bank Stock
The fair value of FHLB stock is defined as the carrying amount and periodically evaluated for impairment based on the ultimate recovery of par value.

Loans Receivable
The fair value of loans is estimated by discounting the future cash flows using the current rate at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. An additional liquidity discount is also incorporated to more closely align the fair value with observed market prices.

 
13

 
 
Loans held for sale
Loans held for sale are required to be measured based on the lower of cost or fair value. Market value is used to represent fair value. When management has loans held for sale, it obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions. There were no loans held for sale at September 30, 2009.
 
Impaired loans
The fair value of an impaired loan is estimated using one of several methods, including collateral value and discounted cash flows. Those impaired loans not requiring an impaired valuation allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the impaired loan at Level 2.
 
Real estate owned
REO is measured at fair value less the estimated cost to sell. The fair value of REO at September 30, 2009 was determined either by appraisals or independent valuations that were then adjusted for the cost related to liquidation of the subject property, or by sales agreement.
 
Deposits
The fair value of deposits with no stated term, such as regular passbook accounts, money market accounts and checking accounts, is defined as the carrying amounts reported in the Consolidated Balance Sheets. The fair value of deposits with stated maturity, such as certificates of deposit, is based on discounting future cash flows by the current rate offered for such deposits with similar remaining maturities.
 
Borrowings
For short-term borrowings, fair value approximates carrying value. For long-term fixed rate borrowings, fair value is based on discounting future contractual cash flows by the current interest rate paid on such borrowings with similar remaining maturities. The fair value of the $150.0 million holding company debt was determined based on the tender offer price.
 
The following table presents the carrying amounts and estimated fair values of financial instruments at September 30, 2009.
 

   
Carrying Amount
   
Fair Value
 
   
(In thousands)
 
ASSETS
           
Cash and cash equivalents
  $ 298,661     $ 298,661  
Loan receivable
    5,464,538       5,374,800  
Real estate owned
    175,725       175,725  
FHLB stock
    115,150       115,150  
                 
LIABILITIES
               
Deposits
  $ 4,524,487     $ 4,581,555  
Short-term borrowings
    600,000       600,000  
Long-term borrowings
    850,000       750,394  
 
 
14

 
 
The Financial Accounting Standards Board ("FASB") has issued an accounting standard  which defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement, and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.
 
The three levels are defined as follow:
         
 
Level 1
  
inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
     
 
Level 2
  
inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
     
 
Level 3
  
inputs to the valuation methodology are unobservable and significant to the fair value
measurement.

 
The following table represents fair value information for financial instruments measured at fair value at September 30, 2009:
 
 
 
Total
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
   
(In thousands)
 
        Non-Recurring Items:                                
        Non-accrual impaired loans
  169,516         169,516      
        Other impaired loans
    12,812             12,812        
        Real estate owned
    175,725             175,725        
       Total
  $ 358,053     $     $ 358,053     $  
 
 
 
12.  Stock Options and Restricted Stock
 
Stock Options

At September 30, 2009, the Company had options outstanding issued under its 1994 Stock Option and Appreciation Rights Plan (“1994 Plan”), a share-based compensation program. Options granted under the 1994 Plan are vested over a nine year period and have a maximum contractual term of 10 years. At September 30, 2009, the number of shares authorized for option awards under the 1994 Plan totaled 1,713,375.

Options under the share-based compensation program are granted with an exercise price equal to the market price of the Company’s stock at the date of grant. The fair value of each grant has been estimated as of the grant date using the Black-Scholes option valuation model. The expected life is estimated based on the actual weighted average life of historical exercise activity of the grantee population. The volatility factors are based on the historical volatilities of the Company’s stock, and these are used to estimate volatilities over the expected life of the options. The risk-free interest rate is the implied yield available on zero coupons (U.S. Treasury Rate) at the grant date with a remaining term equal to the expected life of the options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive stock incentive awards, and subsequent events are not indicative of the reasonableness of the original estimates of fair value calculated by the Company.

The Company recorded stock-based compensation expense related to stock options of $300 thousand and $900 thousand for the third quarter and the nine months ended September 30, 2009, respectively. For the third quarter and the nine months ended September 30, 2008, the Company recorded such stock-based compensation expense of $426 thousand and $1.4 million, respectively.
 
 
15

 
There were no options granted under the 1994 Plan during the nine months ended September 30, 2009. The weighted average fair value of options granted under the 1994 Plan during the first quarter of 2008 was $10.91 using the following assumptions: expected volatility of 24%; risk-free interest rate of 3.15%; and an expected average life of 5.9 years.

The following is a summary of stock option transactions for the nine months ended September 30, 2009:

 
 
 
 
Stock Options:
 
 
 
Shares
   
Weighted
Average Exercise
Price
   
Weighted
Average Remaining Contractual Term
(years)
   
Aggregate Intrinsic
Value
(In thousands)
 
                         
Outstanding at January 1, 2009
    848,807     $ 42.32              
Granted
                       
Exercised
                       
Forfeited
    (43,610 )     52.58              
Outstanding at September 30, 2009
    805,197     $ 41.76       4.80     $  
Exercisable at September 30, 2009
    446,928     $ 33.33       5.93     $  

There were no options exercised during the third quarter or the nine months ended September 30, 2009.  The total intrinsic value of options exercised during the first nine months of 2008 was $445 thousand.  Cash received from options exercised during the first nine months of 2008 was $529 thousand. No options were exercised during the third quarter of 2008.

As of September 30, 2009, the unearned compensation cost related to non-vested stock options totaled $1.8 million to be recognized over a weighted average period of 3.2 years.

Restricted Stock

On April 26, 2007, the stockholders of the Company adopted the 2007 Non-employee Directors Restricted Stock Plan (“2007 Plan”). Under the 2007 Plan, the Company may grant up to 200,000 shares to non-employee directors of the Company. Of each grant, 50% of the restricted shares will vest on the one-year anniversary date of the issuance and the remaining 50% will vest on the third-year anniversary date of the issuance. Upon retirement of a non-employee director, any non-vested shares of stock shall automatically vest.

The Company recorded stock-based compensation expense of $79 thousand related to restricted stock for the nine months ended September 30, 2009. For the nine months ended September 30, 2008, the Company recorded such stock-based compensation expense of $305 thousand, net of tax.

There were no restricted shares issued to non-employee directors during the nine months ended September 30, 2009. The Company issued 1,670 shares of restricted stock to each of the seven non-employee directors during the first quarter of 2008.
 
 
16

 
 
The following is a summary of transactions in the Company’s non-vested restricted stock as of September 30, 2009.

 
 
 
 
 
Non-vested Stock:
 
 
 
 Number of Shares
   
Weighted
Average
Grant
Date Fair
Value
 
             
Outstanding at January 1, 2009
    14,390     $ 41.92  
Granted
             
Vested
    (8,545 )   $ 45.93  
Forfeited
             
Outstanding at September 30, 2009
    5,845     $ 36.07  

The total fair value of the restricted stock awards that vested during the nine months ended September 30, 2009 was $14 thousand.

As of September 30, 2009, the total unrecognized compensation cost related to non-vested restricted awards totaled $185 thousand to be recognized over a weighted average period of 9 months.
 
13.  Supplementary Executive Retirement Plan

The following table sets forth the net periodic benefit cost attributable to the Company’s Supplementary Executive Retirement Plan:

   
Pension Benefits
 
   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(Dollars in thousands)
 
                         
Service cost
  $ 63     $ 86     $ 189     $ 258  
Interest cost
    221       257       663       771  
Amortization of net loss
          190             570  
Net periodic benefit cost
  $ 284     $ 533     $ 852     $ 1,599  
 
Weighted Average Assumptions
               
Discount rate
 
6.25%
 
6.25%
 
6.25%
 
6.25%
Rate of compensation increase
 
4.00%
 
4.00%
 
4.00%
 
4.00%
Expected return on plan assets
 
N/A
 
N/A
 
N/A
 
N/A

14.  Recent Accounting Pronouncements
 
In July 2009, the FASB Accounting Standards CodificationTM (Codification) became the single source of authoritative non-SEC U.S. generally accepted accounting principles (GAAP) for non-governmental entities. The Codification is effective for financial statements for interim and annual periods ending after September 15, 2009. For periods ending after September 15, 2009 any references to specific accounting guidance must be Codification references.
 
 
17

 
 
In June 2009, the FASB issued an accounting standard to improve how enterprises account for and disclose their involvement with variable interest entities (VIEs), which are special-purpose entities, and other entities whose equity at risk is insufficient or lack certain characteristics. Among other things, the standard changes how an entity determines whether it is the primary beneficiary of a VIE and whether that VIE should be consolidated. The standard requires an entity to provide significantly more disclosures about its involvement with VIEs. As a result, the Company must comprehensively review its involvements with VIEs and potential VIEs, including entities previous considered to be qualifying special purpose entities, to determine the effect on its consolidated financial statements and related disclosures. The standard is effective as of the beginning of a reporting entity’s first annual reporting period that begins after November 15, 2009 and for interim periods within the first annual reporting period. Earlier application is prohibited. The Company does not believe that the adoption of this guidance will have a significant effect on its consolidated financial statements.
 
In June 2009, the FASB issued an accounting standard that changes the derecognition guidance for transferors of financial assets, including entities that sponsor securitizations, to align that guidance with other guidance. The standard also eliminates the exemption from consolidation for qualifying special-purpose entities (QSPEs). As a result, all existing QSPEs need to be evaluated to determine whether the QSPE should be consolidated. The standard is effective as of the beginning of a reporting entity’s first annual reporting period beginning after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. The recognition and measurement provisions of this standard must be applied to transfers that occur on or after the effective date. Early application is prohibited. The standard also requires additional disclosures about transfers of financial assets that occur both before and after the effective date. The Company does not believe that this guidance will have a significant effect on its financial statements.
 
In May 2009, the FASB issued an accounting standard to incorporate the accounting and disclosure requirements for subsequent events into U.S. generally accepted accounting principles. This standard introduces new terminology, defines a date through which management must evaluate subsequent events, and lists the circumstances under which an entity must recognize and disclose events or transactions occurring after the balance-sheet date. The Company adopted this standard as of June 30, 2009, which was the required effective date. The Company evaluated its September 30, 2009 financial statements for subsequent events through November 13, 2009, the date the financial statements were available to be issued. A subsequent event is disclosed in Note 2 of the Notes to these Consolidated Financial Statements.
 
In April 2009, the FASB issued accounting standards to require disclosures about fair value of financial instruments for interim reporting periods of publicly-traded companies as well as in annual financial statements. This standard also amended existing guidance to require those disclosures in summarized financial information at interim reporting periods. This standard is effective for interim periods ending after June 15, 2009. Fair value information for the Company is presented in Note 11 of the Notes to these Consolidated Financial Statements.
 
 
18

 
 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following narrative is written with the presumption that the users have read the 2008 Annual Report on Form 10-K of FirstFed Financial Corp. (the “Company”), which contains the latest audited financial statements and notes thereto, together with Management's Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2008 and for the year then ended. Therefore, only material changes in the consolidated balance sheets and consolidated statements of operations are discussed herein.

The Securities and Exchange Commission (“SEC”) maintains a website which contains reports, proxy statements, and other information pertaining to registrants that file electronically with the SEC, including the Company. The internet address is: www.sec.gov. In addition, the Company’s periodic and current reports are available free of charge on the Company’s website at www.firstfedca.com as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.

Consolidated Balance Sheets
 
At September 30, 2009, the Company, the holding company for First Federal Bank of California and its subsidiaries ("Bank"), had consolidated stockholders’ equity of $111.1 million compared to $258.7 million at December 31, 2008 and $499.2 million at September 30, 2008. Stockholders’ equity decreased from December 31, 2008 to September 30, 2009 due to a $145.4 million loss recorded during the nine months ended September 30, 2009.
 
The Bank’s risk-based capital ratio was 8.91% at September 30, 2009 and its core and tangible capital ratios were 4.25%. These capital ratios are below the levels required by the Bank’s federal regulators to be considered “well capitalized”. The Company and the Bank are operating under Amended Orders to Cease and Desist (“Amendments”) issued by the Office of Thrift Supervision (“OTS”) on May 28, 2009. As required by the Amendments, the Company and the Bank have submitted a detailed capital plan to the OTS addressing how the Bank expected to meet and maintain a Tier 1 Core Capital ratio of 7% and a minimum Total Risk-Based Capital Ratio of 14% by September 30, 2009. The capital plan addressed how the Bank will meet and maintain the foregoing capital ratios and provides for the augmentation of capital to, among other things, support the Bank's business strategy and operations. The Bank failed to meet these required capital ratios, and, accordingly, as required by the Bank Order, the Bank submitted to the OTS a contingency plan to accomplish either a merger of the Bank with, or an acquisition of the Bank by, another federally insured institution or holding company thereof or a voluntary liquidation of the Bank.
 
Total assets decreased to $6.2 billion at September 30, 2009 from $7.5 billion at December 31, 2008 and $7.4 billion at September 30, 2008 primarily due to loan payoffs and the sale of the Bank’s investment securities and mortgage-backed securities during the second quarter of 2009. Loan originations decreased to $108.0 million during the nine months ended September 30, 2009 compared to $1.3 billion during the nine months ended September 30, 2008. The Bank curtailed its lending efforts in January of 2009 based on the original Order to Cease and Desist issued by the OTS on January 26, 2009.
 
The net loss during the third quarter of 2009 was due primarily to a $70.0 million provision for loan losses relating to the Bank’s single family loan portfolio. The Bank’s estimate of losses on single family loans is based on the continued weakness in the California real estate market and the increase in unemployment in California. However, the loan loss provision decreased compared to the third quarter of last year because fewer loans are facing payment recast, newly delinquent single family loans have decreased and 51% of the Bank’s non-performing assets have already been adjusted to fair market value less estimated selling costs.

The Bank estimates that 129 loans with balances totaling approximately $56.1 million remain scheduled to recast during 2009. Another 771 loans, with balances totaling $344.0 million, are scheduled to recast during 2010. In comparison, there were 1,960 loans with balances totaling approximately $907.3 million that were scheduled to recast during the year 2008 alone. The total portfolio of loans scheduled to recast has fallen from $2.1 billion at September 30, 2008 to $824.1 million at September 30, 2009.
 
Single family loans less than 90 days delinquent were $74.7 million at September 30, 2009 compared to $109.2 million at June 30, 2009, $208.2 million at December 31, 2008 and $212.1 million at September 30, 2008.  Management believes that the decline in single family loan delinquencies is the result of several factors including the success of the Bank’s loan modification programs, improving real estate prices and home sales in California and the overall lowering of interest rates upon which the Bank’s adjustable mortgages are based.
 
 
19

 
 
Non-performing assets increased to $567.7 million or 9.23% of total assets at September 30, 2009 compared to $521.5 million or 7.00% at December 31, 2008 and $579.1 million or 7.87% at September 30, 2008. The increase in non-performing assets over the last year was due to single family REO which grew to $175.7 million at September 30, 2009 from $117.7 million at December 31, 2008 and $133.0 million at September 30, 2008. The increase in single family REO resulted from: (1) the highest level of unemployment in California since 1940, (2) the inability of borrowers to afford their loan payments after recast, (3) the inability of borrowers to refinance their loans due to tighter credit and more stringent underwriting standards by mortgage lenders and (4) the continued overall weakness in the California real estate market. It is Bank’s policy to record REO based on fair market value less estimated selling costs.
 
Non-performing assets also included non-accrual loans, which were mostly comprised of single family loans over the last year. Single family non-accrual loans were $389.2 million at September 30, 2009 compared to $403.8 million at December 31, 2008 and $445.2 million at September 30, 2008. Single family non-accrual loans at September 30, 2009, December 31, 2008 and September 30, 2008 included $95.8 million, $14.8 million and $7.0 million in loans which were current, but for which the Bank had capitalized interest into the loan balance as part of the modification process. It is the Bank’s policy that these loans remain in non-accrual loans until the loans have performed by making all contractual payments required by their loan for six months.
 
Despite the inclusion of loans with capitalized interest, single family non-accrual loans decreased due to the Bank’s proactive efforts to modify loans before they reach their maximum allowed negative amortization or are otherwise subject to recast. Continued increases in the California unemployment rate could have a negative effect on this trend. Non-accrual loans at September 30, 2009, December 31, 2008 and September 30, 2008 included $113.9 million, $134.9 million and $18.9 million, respectively, of severely delinquent non-accrual loans which were written down to net collateral value less estimated costs to liquidate.
 
With its modification program, the Bank has been focusing on modifying loans for the last seven quarters to lessen the number of loans at risk for foreclosure due to payment recast. Modified loans totaled $1.2 billion net of valuation allowances as of September 30, 2009. Of these modified loans, $1.2 billion net of valuation allowances were considered troubled debt restructurings (“TDRs”). The other $34.9 million in adjustable rate mortgages modified as of September 30, 2009 were not considered TDRs and therefore no valuation allowances were established. Modified loans totaled $590.4 million as of December 31, 2008 and $516.3 million as of September 30, 2008.
 
Because substantially all loans are collateralized by properties located in California, the Company continuously monitors the California economy and real estate market and the sufficiency of the collateral supporting its real estate loan portfolio. The Company considers several factors in evaluating the real estate collateral including the property location, the date of loan origination, the original loan-to-value ratio and the current loan-to-value ratio.
 
In a press release dated October 7, 2009, the California Association of Realtors (CAR) projected that, at the end of 2009, the median price of an existing home in the state of California will have fallen by 21.8% from the 2008 level. A minor increase of 3.3% is projected for 2010 unless there is a heavier than expected wave of foreclosures which causes the inventory of unsold homes to increase. CAR projects that sales of existing single family homes for the year 2009 will be 22.8% higher than in 2008 due to affordable home prices, tax credits for first-time homebuyers and low interest rates. However, sales activity is projected to decrease by 2.3% during 2010 due to continued challenges in the California labor market, the inability of homebuyers to secure financing and concerns about the reliability of real estate values. The UCLA Forecast for California, September 2009 Report, projects that the California economy will start growing in 2011, but not enough to drive the unemployment rate below 10% until the end of 2011 because the California economy will likely not produce enough jobs for new entrants to the labor force over the next couple of years.
 
 
20

 
 
Lending Activities
 
The following table shows the components of the loan portfolio by type at the dates indicated:
 
   
September 30,
2009
   
December 31,
2008
   
September 30,
2008
 
   
(In thousands)
 
REAL ESTATE LOANS:
                 
First trust deed residential loans
                 
One-to-four units
  $ 3,654,209     $ 4,378,731     $ 4,521,889  
Five or more units
    1,835,117       1,936,286       1,857,634  
Residential loans
    5,489,326       6,315,017       6,379,523  
                         
OTHER REAL ESTATE LOANS:
                       
Commercial and industrial
    130,529       148,841       149,901  
Second trust deeds
    2,607       4,201       2,021  
Other
    4,169       1,953       4,212  
Real estate loans
    5,626,631       6,470,012       6,535,657  
                         
 
NON-REAL ESTATE LOANS:
                       
Deposit accounts
    1,108       1,354       1,330  
Commercial business loans
    51,398       79,378       92,605  
Consumer loans
    33,590       33,661       32,139  
Loans receivable
    5,712,727       6,584,405       6,661,731  
                         
LESS:
                       
General valuation allowances
    156,309       280,185       221,360  
Valuation allowances for impaired loans
    87,739       46,735       42,732  
Deferred loan origination costs, net
    4,141       2,799       1,933  
Loans receivable, net
  $ 5,464,538     $ 6,254,686     $ 6,395,706  

The following table summarizes total loan originations by type for the periods indicated:

   
Nine months ended
September 30,
 
   
2009
   
2008
 
   
(In thousands)
 
Single family real estate
  $ 29,508     $ 767,313  
Single family loans purchased
    402       6,484  
Multi-family and commercial real estate
    68,248       450,763  
Other
    9,808       31,676  
     Total
  $ 107,966     $ 1,256,236  

Loan originations decreased by 91% during the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 due to the Bank’s suspension of lending for the its own portfolio.
 
The following table summarizes single family loan fundings by borrower documentation type for the periods indicated:
 
   
Nine months ended
September 30,
 
   
2009
   
2008
 
   
(In thousands)
 
Verified Income/Verified Asset
  $ 29,508     $ 761,944  
Stated Income/Verified Asset
          5,369  
     Total
  $ 29,508     $ 767,313  
 
 
21

 
 
On Verified Income/Verified Asset loans (VIVA), the borrower includes information on his/her income and assets, which is then verified. On Stated Income/Stated Assets (SISA) loans, the borrower includes information on his/her level of income and assets that is not subject to verification. On Stated Income/Verified Assets (SIVA) loans, the borrower includes information on his/her level of income and that information is not subject to verification, although information provided by the borrower on his/her assets is verified. For No Income/No Assets (NINA) loans, the borrower is not required to submit information on his/her level of income or assets. However, all single family loans, including NINA loans, require credit reports and appraisals. The Bank required higher credit scores, higher rates and lower loan-to-value ratios on NINA loans.
 
The Bank stopped originating NINA and SISA loans in October 2007 and ceased originating SIVA loans in February 2008. All multi-family loans and other real estate loans have always required complete and customary documentation from the borrowers.
 
The creditworthiness of the borrower is based on the borrower’s FICO score, prior use of and repayment of credit, job history and stability. The average borrower FICO score and average loan-to-value (“LTV”) ratio on single family loan originations were 758 and 64.7%, respectively, during the nine months ended September 30, 2009, compared to 754 and 65.9%, respectively, for the comparable 2008 period.

At September 30, 2009, 64.4% of the Bank’s loan portfolio was invested in adjustable rate products. Loans with interest rates that adjust monthly based on the 3-Month Certificate of Deposit Index (“CODI”) comprised 12.3% of the loan portfolio. Loans with interest rates that adjust monthly based on the 12-month average U.S. Treasury Security rate (“12MAT”) comprised 25.7% of the loan portfolio. Loans with interest rates that adjust monthly based on the Federal Home Loan Bank (“FHLB”) Eleventh District Cost of Funds Index (“COFI”) comprised 25.9% of the loan portfolio. Loans with interest rates that adjust monthly based on the London Inter-Bank Offering Rate (“LIBOR”) and other indices comprised 0.5% of the loan portfolio.

The following table summarizes total loan fundings by type of index for the periods indicated:

   
Nine months ended
September 30,
 
   
2009
   
2008
 
   
     (In thousands)
 
12MAT
  $ 24,032     $ 17,808  
COFI
    54,959       57,634  
Other
    9,808       37,611  
Hybrid and Fixed
    19,167       1,143,183  
                                    Total
  $ 107,966     $ 1,256,236  

The following table shows the composition of the Bank’s single family loan portfolio by borrower documentation type at the dates indicated:

   
September 30,
2009
   
December 31,
2008
   
September 30,
2008
 
Documentation Type:
       
(In thousands)
       
Verified Income/Verified Asset
  $ 2,660,809     $ 2,383,688     $ 2,192,511  
Stated Income/Verified Asset (1)
    457,519       867,098       1,004,974  
Stated Income/Stated Asset (1)
    396,318       830,818       977,700  
No Income/No Asset (1)
    139,563       297,127       346,704  
    Total
  $ 3,654,209     $ 4,378,731     $ 4,521,889  

(1)  As part of the loan modification process, an aggregate of $1.0 billion of loans originated in these low documentation categories have become fully documented.

In the past, when the Bank originated loans with low documentation requirements, the Bank attempted to mitigate the inherent risk of making reduced documentation loans by evaluating the other characteristics of the loan, such as the creditworthiness of the borrower and the LTV ratio based on the collateral’s appraised value at the origination date. The underwriting of these loans was based on the borrower’s credit score and credit history, intended occupancy, reasonableness of stated income and the value of the collateral.  If the loans have been modified, the Bank obtains and verifies the borrower’s income.

 
22

 
 
The following table shows the composition of the Bank’s single family loan portfolio by borrower documentation type with weighted average LTV ratio and FICO score at the dates indicated:

   
September 30, 2009
   
December 31, 2008
   
September 30, 2008
 
   
LTV Ratio
   
FICO Score
   
LTV Ratio
   
FICO Score
   
LTV Ratio
   
FICO Score
 
Verified Income/Verified Asset
    67.7 %     714       67.3 %     713       67.4 %     710  
Stated Income/Verified Asset
    66.1       710       68.4       711       69.2       711  
Stated Income/Stated Asset
    70.2       708       72.4       711       72.6       711  
No Income/No Asset
    60.1       724       64.2       726       65.0       726  
    Total Weighted Average
    67.4 %     713       68.2 %     713       68.6 %     712  


The following table shows the composition of the Bank’s single family loan portfolio at the dates indicated by the FICO score of the borrower at origination:

     
September 30, 2009
   
December 31, 2008
   
September 30, 2008
 
FICO Score at Origination:
         
(In thousands)
       
<620
    $ 21,987     $ 24,481     $ 24,606  
        620-659       264,479       330,096       352,102  
        660-719       1,443,248       1,784,932       1,927,844  
>720
      1,886,685       2,198,022       2,175,160  
Not Available
      37,810       41,200       42,177  
Total
    $ 3,654,209     $ 4,378,731     $ 4,521,889  

The following table shows the composition of the Bank’s single family loan portfolio at the dates indicated by original LTV ratio:

   
September 30, 2009
   
December 31, 2008
   
September 30, 2008
 
Original LTV Ratio:
       
(In thousands)
       
<65%
  $ 850,185     $ 949,119     $ 922,295  
        65-70%     476,456       535,765       539,725  
        70-75%     520,526       606,856       617,812  
        75-80%     1,638,678       2,047,508       2,161,945  
        80-85%     31,099       46,797       53,881  
        85-90%     103,385       153,273       182,318  
>90%
    33,880       39,413       43,913  
Total
  $ 3,654,209     $ 4,378,731     $ 4,521,889  
 
 
23

 
 
The following table shows the composition of the Bank’s single family loan portfolio at September 30, 2009 by estimated current LTV ratio:

   
Loan Balance
   
% of Portfolio
   
Average Current
LTV Ratio
 
Current LTV Ratio
Price Adjusted (1):
 
(In thousands)
             
<65%
  $ 593,012       16.2 %     42.7 %
65  -  70%
    129,198       3.5       67.5  
70  -  75%
    208,874       5.7       73.2  
75  -  80%
    189,075       5.2       77.9  
80  -  85%
    226,937       6.2       82.9  
85  -  90%
    264,467       7.2       87.3  
>90%
    1,900,119       52.0       111.1  
Partially charged off
    133,218       3.7       100.0  
Not in MSAs
    9,309       0.3       N/A  
    Total
  $ 3,654,209       100.0 %     79.9 %

(1)  The current estimated loan to value ratio is based on Federal Housing Finance Agency (“FHFA”) June 2009 data. The FHFA housing price index provides a broad measure of the housing price movements by Metropolitan Statistical Area (“MSA”). In evaluating the potential for loan losses within the bank’s portfolio, the Bank considers both the fact that FHFA data cannot reflect price movements for the most recent three months, and that individual areas within an MSA will perform worse than the average for the larger area. The Bank therefore also looks at sales data that is available by zip code, as well as the Bank’s experience with marketing foreclosed properties in estimating the loan loss allowance that is required.

The Bank generally required that borrowers obtain private mortgage insurance on loans in excess of 80% of the appraised property value. Prior to April 2006, on certain loans originated for the portfolio, the Bank charged premium rates and/or fees in exchange for waiving the insurance requirement. Management believes that the additional rates and fees that the Bank received for these loans compensated for the additional risk associated with this type of loan. In certain of these cases when the Bank waived the insurance requirement, the Bank purchased private mortgage insurance with own funds. At September 30, 2009, 63% of loans with mortgage insurance were insured by the Republic Mortgage Insurance Company (RMIC), and 37% were insured by the Mortgage Guaranty Insurance Corporation (MGIC). Under certain mortgage insurance programs, the Bank continues to act as co-insurer and participate with the insurer in absorbing any future loss.

As of September 30, 2009, December 31, 2008 and September 30, 2008, loans with co-insurance totaled $70.6 million, $110.4 million, and $133.3 million, respectively. Loans with initial loan-to-value ratios greater than 80% with no private mortgage insurance totaled $97.8 million at September 30, 2009, $129.1 million at December 31, 2008 and $146.8 million at September 30, 2008.

The following table shows the composition of the Bank’s single family loan portfolio by geographic distribution at the dates indicated:

    September 30,     December 31,     September 30,  
    2009     2008     2008  
    (Dollars in thousands)  
Los Angeles County
  $ 1,107,597       30.3 %   $ 1,233,889       28.2 %   $ 1,224,568       27.1 %
Bay Area
    635,366       17.4       768,262       17.5       785,080       17.4  
Central California Coast
    495,458       13.6       598,268       13.7       612,533       13.5  
Orange County
    417,113       11.4       479,464       10.9       478,161       10.6  
San Diego Area
    359,058       9.8       441,631       10.1       471,140       10.4  
San Bernardino/Riverside
    225,537       6.2       296,624       6.8       321,616       7.1  
Sacramento Valley
    144,048       3.9       197,861       4.6       222,163       4.9  
San Joaquin Valley
    136,221       3.7       194,741       4.4       227,129       5.0  
Other
    133,811       3.7       167,991       3.8       179,499       4.0  
   Total
  $ 3,654,209       100.0 %   $ 4,378,731       100.0 %   $ 4,521,889       100.0 %

 
24

 

The following table shows the composition of the Bank’s single family loan portfolio by year of origination as of September 30, 2009 (dollars in thousands):

2003 and Prior
  $ 266,780       7.3 %
2004
    468,873       12.8  
2005
    1,076,142       29.4  
2006
    677,979       18.6  
2007
    300,003       8.2  
2008