ITEM 1. - BUSINESS
General Description
FirstFed Financial Corp., a Delaware corporation ("FFC” and, collectively with its sole and wholly-owned subsidiary, First Federal Bank of California (the "Bank"), the "Company"), was incorporated on February 3, 1987. Since September 22, 1987, FFC has operated as a savings and loan holding company engaged primarily in the business of owning the Bank. Because the Company does not presently engage in any significant independent business operations, substantially all income and performance figures herein reflect the operations of the Bank.
The Bank was organized in 1929 as a state-chartered savings and loan association, and, in 1935, converted to a federal mutual charter. In February 1983, the Bank obtained a federal savings bank charter, and, in December 1983, converted from mutual to stock ownership. Our executive offices are located at 12555 W. Jefferson Boulevard, Los Angeles, California 90066 and our telephone number is (310) 302-5600.
FFC is a savings and loan holding company and, as well as the Bank, is subject to examination and regulation by the Office of Thrift Supervision (“OTS”). Our deposits are insured through the Deposit Insurance Fund (“DIF”) of the Federal Deposit Insurance Corporation (“FDIC”), and we are subject to regulation by the FDIC. We are a member of the Federal Home Loan Bank (“FHLB”) of San Francisco, which is one of the 12 regional banks comprising the Federal Home Loan Bank System. We are also subject to certain regulations of the Board of Governors of the Federal Reserve System (“FRB”) with respect to reserves required to be maintained against deposits and certain other matters. See “-Summary of Material Legislation and Regulations”.
The Company’s periodic and current reports are available free of charge on our website at www.firstfedca.com as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”).
In 2008, our principal business was attracting checking and savings deposits from the general public and using such deposits, together with borrowings and other funds, to make real estate, business and consumer loans. Since the end of 2008, we have ceased origination of most types of loans. See “-Recent Developments” for a discussion of changes made to our business in 2009.
We derive our revenues principally from interest and fees on loans and interest on investments. Our major items of expense are interest on deposits and borrowings, and general and administrative expense.
As of December 31, 2008, we operated 39 full-service banking branches, all located in Southern California. Permission to operate full-service branches is granted by the OTS. In addition to these branches, we operate a call center that conducts transactions with deposit and loan clients by telephone, and an internet website through which clients can open accounts, transfer funds or pay bills. We offer wealth management and trust services to complement the other services offered by our retail branches and our business banking division. Revenues from wealth management and trust services have comprised less than 1% of revenues for each of the last three years. In 2008, we operated two lending offices, one in Southern California, which was open for the entire year, and one in Northern California, which was closed in July of that year.
At December 31, 2008, the Company had assets totaling $7.5 billion, compared to $7.2 billion at December 31, 2007 and $9.3 billion at December 31, 2006. Total assets increased at the end of 2008 compared to 2007 primarily because the Bank increased its cash liquidity by $337.5 million. In 2007, total assets decreased from 2006 due to loan payoffs and charge-offs, and a decline in loan originations. The Company recorded a net loss of $401.7 million for 2008, compared to net income of $92.9 million for 2007 and $129.1 million for 2006.
During 2008, the Bank originated loans in both Southern California and Northern California. Single family loans originated in Northern California comprised 43% of the total number of loans originated during 2008, compared to 33% during 2007 and 42% during 2006. The majority of the residential loans we originated during the last three years were obtained from wholesale loan brokers. Residential loans were also offered by all of our full-service branches. In addition, we have an income property lending group and a commercial banking group, both of which lend primarily in Southern California. See “-Recent Developments” for information on our current lending practices.
The Bank has three wholly-owned subsidiaries: Seaside Financial Corporation, Oceanside Insurance Agency, Inc., and Santa Monica Capital Group, all of which are California corporations. See "-Subsidiaries."
Recent Developments
To understand the impact of these recent developments on the Company, you should carefully review the detailed discussion of risk factors applicable to us contained in “Item 1A
ITEM 1A. - RISK FACTORS
Our business routinely encounters and addresses risks and uncertainties. Our business, results of operations and financial condition could be materially adversely affected by the factors described below. Discussion about the important operational risks that our businesses encounter can also be found in “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 1 - Business” of this Annual Report on Form 10-K. Below, we have described our present view of certain risks and uncertainties we face. There may be additional risks that are currently unknown or that are now considered immaterial, which may become material in the future. These additional risks could also impair our business or adversely affect our financial condition or results of operations. If any of the following risks actually occurs, our business, financial condition or results of operations could be adversely affected. In such case, the price or value of our stock could decline. The following discussion of risk factors contains “forward-looking” statements, which may be important to understanding any statement in this Annual Report on Form 10-K or elsewhere.
Our operations and activities are subject to heightened regulatory oversight and further regulatory action may be taken.
On January 26, 2009, FFC and the Bank each consented to the issuance of an Order to Cease and Desist by the OTS. See “Item 1 - Business-Recent Developments” for a detailed discussion of the terms and conditions of the Orders. Any material failure to comply with the provisions of the Orders could result in enforcement actions by the OTS, which would create a substantial risk of the Bank being seized by the FDIC in a receivership, a result of which would be that the business of our bank would cease to be owned by our holding company and the holding company would receive no compensation for the Bank. While we have taken and intend to take all such actions as may be necessary to comply with the requirements of the Orders, there can be no assurance that we will be able to comply fully with the provisions of the Orders, or to do so within the timeframes required, that compliance with the Orders will not be more time consuming or more expensive than anticipated, or that efforts to comply with the Orders will not have adverse effects on our operations and financial condition.
Our ability to service our debt, pay dividends, and otherwise satisfy our obligations as they come due is substantially dependent on capital distributions from the Bank and is further restricted by the terms of the Orders.
The primary source of our funds from which we service our debt, pay dividends and otherwise satisfy our obligations is the receipt of dividends from the Bank. The availability of dividends from the Bank is limited by various statutes and regulations. It is possible, depending upon the financial condition of the Bank, and other factors, that the applicable regulatory authorities could assert that payment of dividends or other payments, including payments to us, is an unsafe or unsound practice. In this regard, the Orders prohibit the Bank from paying dividends to us without the prior written approval of the OTS. In the event the Bank is unable to pay dividends to us, we may not be able to service our debt, pay our obligations or pay dividends on our outstanding equity securities, which would adversely affect our business, financial condition, results of operations and prospects.
The Orders also prohibit us from making any payments to third parties, including, without limitation, interest payments to service our $150.0 million in senior debt and payments to satisfy our other obligations, without the prior written approval of the OTS. If we are unable to secure OTS approval to make such payments on a timely basis, our business, financial condition, results of operations and prospects could be adversely affected. We did not receive consent from the OTS to make the aggregate $2.3 million in interest payments that was due on our senior debt on March 16, 2009. Under the indentures governing the debt, 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 debentures then outstanding may declare the entire principal of the debentures and the interest accrued thereon immediately due and payable. In addition, we may be required to pay additional interest on the debentures and the costs and expenses of collection, including reasonable compensation to the trustee, its agents, attorneys and counsel. If the outstanding debt is accelerated and we are unable to pay it, we could be forced into bankruptcy.
Our operations will likely require us to raise additional capital in the future, but that capital may not be available or may not be on terms acceptable to us when it is needed. Any additional capital infusion could severely dilute current stockholders.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. We do not believe that our existing capital resources will satisfy our capital requirements for the foreseeable future nor be sufficient to offset further losses on problem assets. Our asset quality may continue to erode and require significant additional loan loss provisions, causing continued net operating losses at the Bank. Because our capital levels have and may continue to decline, we will need to raise capital. Our ability to raise additional capital will depend on conditions in the capital markets, which are outside our control, and on our financial performance. Accordingly, we cannot be certain of our ability to raise additional capital or on terms acceptable to us. If we cannot raise additional capital when needed, our ability to operate could be materially impaired.
If we are unable to maintain capital ratios that keep us “well capitalized” under regulatory guidelines, we may be merged with or acquired by another company, or be forced to liquidate.
If the Bank ceases to be “well-capitalized” under regulatory guidelines, the Orders require that the Bank submit to the OTS a written contingency plan detailing the actions to be taken to achieve one of the following results: (1) merger with or acquisition by another federally insured institution or holding company thereof; or (2) voluntary liquidation by, among other things, filing an appropriate application with OTS in conformity with federal laws and regulations. In the event the Bank is required to merge with or be acquired by another federally insured institution or holding company thereof or to voluntarily liquidate, you would lose all or substantially all of your investment in us.
Our common stock was suspended from trading on the NYSE and is now quoted on the over-the-counter market.
On February 26, 2009, we received notice from the NYSE that our common stock would be suspended from trading on the NYSE because we were not in compliance with the continued listing standard related to average global market capitalization and were subject to delisting from the exchange. Before the opening of market on March 4, 2009, our common stock was suspended from trading on the NYSE and began being quoted on the over-the-counter market the next day. Our listing on the over-the-counter market could have an adverse effect on our financial condition and results of operations by, among other things, limiting:
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the liquidity of our common stock;
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the market price of our common stock;
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the number of institutional and other investors that will consider investing in our common stock;
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the availability of information concerning the trading prices and volumes of our common stock;
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the number of broker-dealers willing to execute trades in shares of our common stock; and
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our ability to obtain financing for the continuation of operations.
We may be subject to an increased likelihood of class action litigation and additional regulatory enforcement.
The market price of our common stock has declined substantially over the past year. This decline could result in stockholder class action lawsuits, even if the activities subject to complaint are not unlawful, and even if the lawsuits are ultimately unsuccessful. Recent events in financial markets and negative publicity may result in more regulation and legislative scrutiny of our industry practices and may expose us to increased stockholder litigation and additional regulatory enforcement actions, which would adversely affect our business.
Our single family loan portfolio consists mostly of adjustable rate loans that are subject to negative amortization and based on less than full documentation, which together may lead to greater delinquencies than other loan types and categories.
Our assets consist mostly of adjustable rate loans secured by residential real estate. A significant portion of our interest income historically has come from the accrual of interest in excess of borrower payments (negative amortization). These loans, in large part, permit negative amortization up to a specified level, and the payment on such loans adjusts periodically as provided in the loan documents. When loans incur negative amortization, if the value of the home does not increase proportionally, then the Bank’s credit risk exposure increases. Many of these adjustable rate mortgages have reached their maximum negative amortization threshold and now require an increased payment.
The “recast” of these loans to higher payment requirements has been a substantial factor in the higher delinquency levels experienced by the Bank during 2008 as many borrowers became unable to make the higher payments. Additionally, lower prevailing prices for homes made it difficult for borrowers to sell their homes and pay off their mortgages, and tightened credit standards made it difficult for borrowers to refinance their mortgages.
Of the loans outstanding as of December 31, 2008, 1,741 mortgages with principal balances totaling $802.3 million reached their maximum negative amortization and were scheduled to recast during 2008. We expect another 913 mortgages with principal balances totaling $396.0 million could reach their maximum negative amortization in 2009 and an additional 1,508 mortgages with principal balances totaling $694.3 million could reach their maximum negative amortization in 2010. This could lead to further delinquencies and foreclosures, particularly if economic conditions generally, and the California real estate and employment markets in particular, do not improve during this time frame. The Bank is currently reaching out to these borrowers encouraging them to modify their loans prior to their rescheduled recast date.
The majority of our single family loans were made under low-documentation loan programs. While we have always taken steps to mitigate the risk of unverified income and asset information, such as verification of collateral value, evaluation of credit history and limitation of the loan amount and loan-to-value ratio, there is a risk that the applicant may not in fact have been qualified for the loan granted. Any failure or neglect of borrowers to provide complete and accurate information, especially any overstatement of income or assets, could compound the potential risks of adjustable rate loans subject to negative amortization. As a result of increased delinquencies and in an effort to better manage the risks associated with our loan portfolio, the Bank stopped originating stated income/stated asset (“SISA”) loans and loans without income or asset verification (“NINA”) in October 2007 and stopped originating stated income/verified asset (“SIVA”) loans in February 2008. In addition, we have modified 22% of our formerly less-than-full documentation loans through December 31, 2008 through programs requiring full income and asset documentation.
We have reported substantial net losses during each of the last four fiscal quarters. No assurance can be given as to when or if we will return to profitability.
Our business historically has been that of a portfolio lender, which means that our profitability depends primarily on our ability to originate loans and collect interest and principal as it comes due. When loans become non-performing or their ultimate collection is in doubt, our income is adversely affected. Our provision for loan losses for the quarters ended December 31, 2008, September 30, 2008, June 30, 2008, and March 31, 2008 were $220.0 million, $110.3 million, $90.2 million and $150.3 million, respectively. Reflecting the significant increase in non-accrual loans, our interest income over the same four quarters was $95.7 million, $99.9 million, $110.6 million and $115.6 million, respectively. This has resulted in net losses being reported for each of the last four quarters. Our ability to return to profitability will significantly depend on the stabilization and subsequent successful resolution of our loan portfolio, the timing and certainty of which cannot be predicted. No assurance can be given that we will be successful in such efforts.
If our actual loan losses exceed our allowance for credit losses, our net loss could increase or we may be unable to generate net income.
Our loan customers may not repay their loans according to their terms, and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. We have experienced, and may in the future experience, significant credit and collateral losses, which have had and may continue to have a material adverse effect on our operating results. In accordance with accounting principles generally accepted in the United States, we maintain an allowance for losses to provide for loan defaults and non-performance and a reserve for unfunded loan commitments, which when combined, we refer to as the allowance for loan losses. Our allowance for loan losses may not be adequate to cover actual losses, and future provisions for losses could have a material adverse effect on our operating results. Our allowance for loan losses is based on prior experience, as well as an evaluation of the risks in the current portfolio. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in property values and unemployment levels that may be beyond our control, and these losses may exceed current estimates.
Federal regulatory agencies, as an integral part of their examination process, review our loans and allowance for loan losses. We cannot assure you that we will not further increase the allowance for loan losses or that regulators will not require us to increase this allowance. Any of these occurrences could have a material adverse effect on our financial condition and results of operations. See “Item 1 - Business-Loan Loss Allowance“ for additional information regarding the allowance for loan losses.
Proposed federal legislation related to personal bankruptcies could increase our credit losses.
Certain pending federal legislation would allow judges in bankruptcy proceedings to modify primary home mortgages by, among other things, reducing the interest rate and the principal amount of the loan. See “Item 1 - Business-Summary of Material Legislation and Regulations-Legislative and Regulatory Initiatives“ for additional information regarding the proposed legislation. This could have a material adverse effect on our financial condition and results of operations.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to acquire deposits or borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole, if and to the extent that the recent turmoil faced by banking organizations in the domestic and worldwide credit markets continues. Our continued ability to accept deposits that are arranged through brokers is also dependent on our capital condition. If our capital were to deteriorate to the point where we were not considered to be well capitalized, then we would lose the right to accept brokered deposits unless the FDIC granted a waiver of this regulatory constraint. The OTS currently requires that we obtain its prior approval before accepting new brokered deposits or rolling over existing brokered deposits. If we are unable to accept brokered deposits or roll over existing brokered deposits for any reason, our liquidity position would be materially and adversely affected.
Changes in interest rates could adversely affect our income.
Our income depends to a great extent on the difference between the interest rates earned on interest-earning assets such as loans and investment securities, and the interest rates paid on interest-bearing liabilities such as deposits and borrowings. Our interest-earning assets and interest-bearing liabilities do not react uniformly to changes in interest rates since the two have different time periods for interest rate adjustment. Interest rates are sensitive to factors that are beyond our control, including general economic conditions and the policies of various governmental and regulatory agencies, including the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, influence the origination of loans, the prepayment of loans, and the volume of deposits. Loan originations and repayment rates tend to increase with declining interest rates and decrease with rising interest rates. On the deposit side, increasing market interest rates generally lead to interest rate increases on our deposit accounts. The impact of these changes may be greater if we do not effectively manage the relative sensitivity of our assets and liabilities to interest rate changes.
We depend on the Federal Home Loan Bank for some of our liquidity.
To some extent, we are reliant on the FHLB as a funding source for our operations. The FHLB is subject to regulation and other factors beyond our control. These factors may adversely affect the availability and pricing of advances to members such as the Bank. See “Item 1 - Business-Sources of Funds.”
Difficult economic conditions and market volatility have adversely impacted the banking industry and financial markets generally and may significantly affect our business, financial condition, or results of operations.
Our success depends, to a certain extent, upon economic and political conditions, local and national, as well as governmental monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond our control may adversely affect our asset quality, deposit levels and loan demand and, therefore, our earnings.
Declines in real estate market activity, which began in 2006 and became more dramatic in 2007 and 2008, combined with falling home prices and increasing foreclosures, unemployment and underemployment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions. The resulting write-downs to assets of financial institutions have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to seek government assistance or bankruptcy protection. Bank failures and liquidation or sales by the FDIC as receiver have also increased.
The capital and credit markets, including the fixed income markets, have been experiencing volatility and disruption for more than eighteen months. In some cases, the markets have produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers’ financial strength.
Many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers, including to other financial institutions because of concern about the stability of the financial markets and the strength of counterparties. It is difficult to predict how long these economic conditions will exist, which of our markets, products or other businesses will ultimately be most affected, and whether management’s actions will effectively mitigate these external factors. Accordingly, the decrease in funding sources and lack of available credit, lack of confidence in the financial sector, decreased consumer confidence, increased volatility in the financial markets and reduced business activity could materially and adversely affect our business, financial condition and results of operations.
As a result of the challenges presented by economic conditions, we may face the following risks:
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Inability of our borrowers to make timely repayments of their loans, or decreases in value of real estate collateral securing the payment of such loans resulting in significant credit losses, which could result in increased delinquencies, foreclosures and customer bankruptcies, any of which could have a material adverse effect on our operating results.
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Increased regulation of our industry, including heightened legal standards and regulatory requirements or expectations imposed in connection with recently enacted statutes, such as EESA and the American Recovery and Reinvestment Act (“ARRA”). Compliance with such regulation will likely increase our costs and may limit our ability to pursue business opportunities.
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Further disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations, may result in an inability to borrow on favorable terms or at all from other financial institutions.
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Further increases in FDIC insurance premiums due to the market developments which have significantly depleted the Deposit Insurance Fund and reduced the ratio of reserves to insured deposits.
The enactment of EESA and ARRA may significantly affect our financial condition, results of operations, liquidity or stock price.
EESA, which established TARP, was signed into law on October 3, 2008. As part of TARP, the Treasury established the CPP to provide up to $700 billion of funding to eligible financial institutions through the purchase of capital stock and other financial instruments for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Then, on February 17, 2009, the ARRA was signed into law as a sweeping economic recovery package intended to stimulate the economy and provide for broad infrastructure, energy, health, and education needs. There can be no assurance as to the actual impact that EESA or its programs, including the CPP, and ARRA or its programs, will have on the national economy or financial markets. A failure of these significant legislative measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.
There have been numerous actions undertaken in connection with and following EESA and ARRA by the Federal Reserve Board, Congress, the Treasury Department, federal bank regulatory agencies, the SEC and others in efforts to address the current liquidity and credit crisis in the financial industry. These measures include homeowner relief that encourages loan restructuring and modification of mortgage loans; the temporary increase in FDIC deposit insurance from $100,000 to $250,000 and unlimited FDIC insurance on non-interest bearing accounts; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector.
The purpose of these legislative and regulatory actions was to help stabilize the U.S. banking system. EESA, ARRA and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition and results of operations could be materially and adversely affected. For more information on the effect of recent legislation and regulation on us, see “ Item 1 - Business-Summary of Material Legislation and Regulations.”
Our profitability depends significantly on economic conditions in California.
Substantially all of our loans are to individuals and businesses in California. Consequently, any further decline in the economy of the state, especially in its real estate and employment markets, could have a materially adverse effect on our financial condition and results of operations.
The strength and stability of other financial institutions may adversely affect our business.
The actions and commercial soundness of other financial institutions could affect our ability to engage in routine funding transactions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to different industries and counterparties, and execute transactions with various counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose us to credit risk in the event of default by our counterparty or client. In addition, our credit risk may increase when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure that is owed to us. These losses, if they occur, could materially and adversely affect our results of operations.
Market volatility may constrain our business operations.
The capital and credit markets have been experiencing volatility and disruption for more than a year. In recent months, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers seemingly without regard to those issuers’ underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
Market volatility may further impair our stock price.
The market price for our common stock declined tremendously during 2008 and has been volatile in the past. Several factors could cause the price to fluctuate substantially in the future, including:
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announcements of developments related to our business;
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fluctuations in our results of operations;
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sales of substantial amounts of our securities into the marketplace;
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general conditions in our markets or the worldwide economy;
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a shortfall in revenues or earnings compared to securities analysts’ expectations;
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changes in analysts’ recommendations or projections; and
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disclosure of adverse regulatory developments.
Our loan portfolio is predominantly secured by real estate and thus we have risk from a further downturn in our real estate markets.
A further downturn in our real estate markets could hurt our business because many of our loans are secured by real estate. Real estate values and real estate markets are generally affected by changes in national, regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies and acts of nature, such as earthquakes and national disasters particular to California. Substantially all of our real estate collateral is located in California. If real estate values continue to further decline, the value of real estate collateral securing our loans could be significantly reduced. Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and we would be more likely to suffer losses on defaulted loans.
REO is carried at net realizable value, but this may not be what we ultimately receive upon sale, which could affect our financial condition and profitability.
Although we obtain appraisals on our REO prior to taking title to the properties and at other intervals thereafter, due to the rapid and severe deterioration in our markets, there can be no assurance that such valuations will reflect the amount which may be paid by a willing purchaser in an arms-length transaction at the time of the final sale. Moreover, we cannot provide assurance that the losses associated with the REO will not exceed the estimated amounts and adversely affect future results of our operations. The calculation for the adequacy of write-downs of our REO is based on several factors, including the appraised value of the real property, economic conditions in the property’s sub-market, comparable sales, current buyer demand, availability of financing, entitlement and development obligations and costs, and historic loss experience. All of these factors have caused significant write-downs in recent periods and can change without notice based on market and economic conditions.
Future sales of our common stock or other securities may dilute the value of our common stock, which may adversely affect the market price of our common stock.
In many situations, our Board of Directors has the authority, without any vote of our stockholders, to issue shares of our authorized but unissued securities, including shares of common stock or preferred stock. In the future, we may issue additional securities, through public or private offerings, in order to raise additional capital. Any such issuance would dilute the percentage of ownership interest of existing stockholders and may dilute the per share book value of our common stock.
Anti-takeover provisions and federal law may limit the ability of another party to acquire us, which could cause our stock price to decline.
Various provisions of our certificate of incorporation and bylaws and certain other actions we have taken could delay or prevent a third-party from acquiring us, even if doing so might be beneficial to our stockholders. These include, among other things, a stockholder rights plan and the authorization to issue “blank check” preferred stock by action of the board of directors acting alone, thus without obtaining stockholder approval. The Home Owners’ Loan Act of 1933, as amended (“HOLA”) require that, depending on the particular circumstances, either OTS approval must be obtained or notice must be furnished to the OTS and not disapproved prior to any person or entity acquiring “control” of a savings and loan holding company, such as us. These provisions may prevent a merger or acquisition that would be attractive to stockholders and could limit the price investors would be willing to pay in the future for our common stock.
Since we operate in a highly regulated industry, legislative, regulatory or accounting changes, or significant litigation, could adversely impact our business.
We are subject to extensive federal regulation, supervision and legislation. See “Item 1 - Business-Summary of Material Legislation and Regulations.” These laws and regulations change from time to time, and these changes may negatively impact us. Actions by regulatory agencies or significant litigation against us could cause us to devote time and resources to undertaking a defense; violations of law or regulations may result in penalties that affect us and our shareholders. Additionally, accounting standard setters, including the Financial Accounting Standards Board (“FASB”), SEC and other regulatory bodies, may change the financial accounting and reporting standards applicable to the preparation of our Consolidated Financial Statements. These changes can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.
We are subject to examinations and challenges by tax authorities.
In the normal course of business, the Company and its subsidiaries are routinely subject to examinations and challenges from federal and state tax authorities regarding the amount of taxes due in connection with investments we have made and the businesses in which we have engaged. Recently, federal and state taxing authorities have become increasingly aggressive in challenging tax positions taken by financial institutions. These tax positions may relate to tax compliance, sales and use, franchise, gross receipts, payroll, property and income tax issues, including tax base, apportionment and tax credit planning. The challenges made by tax authorities may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. If any such challenges are made and are not resolved in our favor, they could have a material adverse effect on our financial condition and results of operations.
We face strong competition from financial services companies and other companies that offer banking services
We conduct most of our operations in California. The banking and financial services businesses in California are highly competitive for deposits and increased competition in our primary market area may adversely impact the level of our deposits. Ultimately, we may not be able to compete successfully against current and future competitors. These competitors include commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions. In particular, our competitors include major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous locations and mount extensive promotional and advertising campaigns. Areas of competition include interest rates for deposits, efforts to obtain deposit customers and a range in quality of products and services provided, including new technology driven products and services. If we are unable to attract and retain banking customers, we may be unable to maintain or improve our level of deposits.
Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing parties to complete financial transactions that historically have involved banks at one or both ends of the transaction. For example, consumers can now pay bills and transfer funds directly without banks. The process of eliminating banks as intermediaries, known as disintermediation, could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits.
We may not be able to attract and retain skilled people.
Our success depends, in large part, on our ability to attract and retain skilled people. Competition for the best people in our businesses can be intense and we may not be able to hire people or to retain them given our current financial and market condition. The unexpected loss of services of key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, industry experience and the difficulty of promptly finding qualified replacement personnel, especially in light of our current regulatory position and financial condition.
Our information systems may experience an interruption or breach in security.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
We continually encounter technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
We are exposed to risk of environmental liabilities with respect to properties to which we take title
In the course of our business, we may foreclose and take title to REO, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean-up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we become subject to significant environmental liabilities, our business, financial condition, results of operations and prospects could be adversely affected. See also “Item 1 - Business-Environmental Concerns.”
Managing reputational risk is important to attracting and maintaining customers, investors and employees
Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable or fraudulent activities of our customers. We have policies and procedures in place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental regulation.
An investment In our common stock is not an insured deposit.
Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you could lose some or all of your investment.
ITEM 1B.
ITEM 1B. - UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. - PROPERTIES
At December 31, 2008, we owned the building and the land for nine of our branch offices, owned the building but leased the land for one office, and leased our remaining 32 offices. Properties leased by us include our current corporate and executive offices, general services and banking operations office building as well as a residential lending operations office in Los Angeles. For information concerning rental obligations, see Note 7 of the Notes to Consolidated Financial Statements.
ITEM 3.
ITEM 3. - LEGAL PROCEEDINGS
We are involved as a plaintiff or defendant in various legal actions incident to our business, none of which are believed by management to be material to us. For a discussion of the issuance of the Orders by the OTS on January 26, 2009, see “Item 1 - Business-Recent Developments.”
ITEM 4.
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
During 2008, our common stock was traded on the NYSE under the symbol "FED". On February 26, 2009, NYSE Regulation, Inc. announced that it had determined that our common stock should be suspended from trading prior to market opening on Wednesday, March 4, 2009 as a result of our failure to satisfy the continued listing standards of the NYSE. Specifically, we no longer complied with Rule 802.01B as such rule is currently in effect, which requires that a listed company’s average global market capitalization over a consecutive 30-day trading period not be less than $15 million. NYSE Regulation, Inc. announced further that it intends to apply to the SEC to delist our common stock pending completion of applicable procedures, including any appeal by us of the NYSE's decision. We do not currently intend to take any further action to appeal the delisting decision. Effective March 4, 2009, our common stock began being quoted on the over-the-counter market under the symbol “FFED.pk”.
The following table sets forth the high and low closing prices for our common stock during each quarter for the past two years.
Holders
As of March 23, 2009, 13,684,553 shares of our common stock were outstanding and held of record by 589 stockholders.
Dividends
We have no history of dividend payments on our common stock. However, we could in the future adopt a policy of paying dividends, depending on our net income, financial position and capital requirements, as well as regulatory restrictions, tax consequences and our ability to obtain a dividend from our bank subsidiary for payment to stockholders. OTS regulations limit amounts that the Bank can pay as a capital distribution to the Company. No such distribution may be made if the Bank’s net worth falls below regulatory requirements. In addition, we may not declare, make or pay any dividends or other capital distributions on our common stock without the prior written consent of the OTS as a result of the Company Order, and the Bank may not declare, make or pay any dividends or other capital distributions on its common stock without the prior written consent of the OTS as a result of the Bank Order. See “Item 1 - Business-Recent Developments” for information on the regulatory restrictions under which we currently operate and see "Item 1 - Business-Summary of Material Legislation and Regulations" for other regulatory capital considerations. No capital distributions were made by the Bank to the Company during 2008 and 2006. During 2007 and 2004, the Board of Directors of the Bank declared and paid $100.0 million and $30.0 million, respectively, of capital distribution to the Company for the purpose of repurchasing shares of our common stock.
No investments were made in the Bank by the Company during 2008, 2007 or 2006.
Recent Sales of Unregistered Securities
The Company has not sold any securities that were not registered under the Securities Act within the period covered by this Annual Report on Form 10-K.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
We did not repurchase any of our stock in 2008. For the year ended December 31, 2007, shares repurchased totaled 3,140,934 at an average price of $48.48. During the month of August 2007, the Board of Directors authorized the expansion of the Company’s stock repurchase program to permit repurchase of an additional 2,850,000 shares. The shares eligible for repurchase totaled 1,181,145 shares as of February 28, 2009.
PERFORMANCE GRAPH
Set forth as Exhibit 99.1 is a stock performance graph comparing the yearly total return on our stock over the period from December 31, 2003 through December 31, 2008 with (a) the cumulative total return on stocks included in the Industry Group 419 - Savings and Loan Index, prepared and published by Hemscott, Inc., and (b) the cumulative total return on stocks included in the NYSE Market Index, prepared and published by the NYSE.
The graph assumes $100 invested in December 31, 2003 with any dividends reinvested.
This graph represents historical stock price performance and is not necessarily indicative of any future stock price performance. We will not make or endorse any predictions as to the future stock performance.
THE FOREGOING PERFORMANCE GRAPH SHALL NOT BE DEEMED TO BE SOLICITING MATERIAL OR TO BE FILED WITH THE SEC OR INCORPORATED BY REFERENCE IN ANY DOCUMENT SO FILED.
ITEM 6.
ITEM 6. - SELECTED FINANCIAL DATA
The following table compares selected financial data for 2008 with the same data for the four prior years. The data in the following table has been derived from, and should be read in conjunction with, the Company’s Consolidated Financial Statements and the accompanying notes presented in Item 8. See also “Item 7
ITEM 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the balance sheets and statement of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements. Actual results may differ from these estimates under different assumptions or conditions.
Allowance for Loan Losses
Accounting for the allowances for loan losses involves significant judgments and assumptions by management which has a material impact on the carrying value of net loans receivable. We consider the accounting for loan valuation allowances to be a critical accounting policy. The judgments and assumptions used by management are based on historical experience and other factors, which are believed reasonable under the circumstances as described in “Item 1 - Business-Loan Loss Allowance.”
The majority of our residential loans were obtained from wholesale loan brokers. Loan origination costs for residential loans obtained from wholesale loan brokers generally include fees paid to those brokers, resulting in loan origination costs exceeding loan fees received. These excess loan origination costs are amortized as an adjustment of loan yield based on the expected lives of the related loans, including an estimate of the prepayment speeds on the portfolio.
Real Estate Owned
REO properties acquired through, or in lieu of, loan foreclosure are initially recorded at the lower of carrying value or fair market value, less estimated selling costs. Valuation adjustments at the time of foreclosure are charged to the general valuation allowance. After foreclosure, the properties continue to be carried at the lower of carrying value or fair value market value, less estimated selling costs. Any subsequent valuation adjustments, operating expense or income, and gains and losses on disposition of REO are recognized in current operations. Valuation allowances on REO are established based on our historical realization of REO losses and adjusted for current market trends.
RISKS AND UNCERTAINTIES
In the normal course of business, we encounter significant risks: economic risk, regulatory risk and operational risk, all of which are discussed in “Item 1A - Risk Factors.”
ECONOMIC RISK
There are three main components of economic risk: credit risk, collateral risk, and market risk (which includes interest rate risk).
Credit Risk
Credit risk is the risk of default in our loan portfolio that results from a borrower’s inability to make contractually required payments. Our credit risk increased substantially during 2008 due to the number of adjustable rate mortgages that reached their maximum allowable negative amortization and now require an increased payment. Many borrowers who now can not afford the increased payments are finding (1) that they cannot refinance their mortgages due to the downturn in single family home values and (2) that mortgage lenders have tightened their lending standards since the time they initially obtained their loans. Also, many borrowers are no longer able to afford their homes due to the deteriorating California economy and the increase in unemployment rates throughout the state. As a result, single family loan delinquencies increased substantially in all categories during 2008. See "-Components of Income-Loan Loss Provision" and "-Non-performing Assets."
The determination of the allowance for loan losses and the valuation of real estate collateral are based on estimates that are susceptible to changes in the economic environment and market conditions. We recorded loan loss provisions of $570.8 million, $32.4 million and $12.4 million during 2008, 2007 and 2006, respectively. A continued downturn in the current economic climate and continued job losses throughout California could increase the likelihood of additional losses due to credit risk which would create the need for additional loan loss provisions.
Collateral Risk
Collateral risk is the risk that the collateral securing our loans, primarily real estate, may decline in value, either in absolute amount or in relation to the outstanding loan balance. Single family home values declined substantially in the state of California during 2008. Negative amortization, which is added to the outstanding loan balance, increases collateral risk. A continued downturn in the California real estate market could increase the likelihood of additional charge-offs and loan loss provisions if the loan exceeds the value of the collateral.
Market Risk
Market risk is the risk of loss from unfavorable changes in market prices and interest rates. Our market risk arises primarily from the interest rate risk inherent in its lending and deposit taking activities. The FRB decreased interest rates four times during 2007 and six times during 2008. Normally we see an immediate impact on the Bank’s cost of funds. However, some depository institutions in the Bank’s market areas were experiencing liquidity problems and were paying higher than expected rates on deposits in 2008. This may cause the cost of funds to remain artificially high and may cause our net interest spread to decrease. Should there be a more long-lasting economic or market downturn or if market interest rates increase significantly, we could experience a material increase in the level of loan defaults and charge-offs, and a material loss of net interest income.
A sustained flat or inverted interest rate yield curve may hamper our ability to originate adjustable rate loans in the future and may cause additional loan prepayments.
See “Item 7A
ITEM 7A. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on our net interest income and capital, while, at the same time, adjusting our asset-liability mix to achieve the most favorable impact on income.
Our asset-liability management policy is designed to improve the balance between the maturities and repricing of interest-earning assets and interest-bearing liabilities in order to better insulate net income from interest rate fluctuations.
At the end of 2008, ­­71.3% of our loans had adjustable interest rates based on monthly changes. Of these, 25.8% were based on CODI, 14.5% were based on the 12MAT index, 28.5% were based on the COFI index and 2.5% were based on another index. Comparisons over the last several years show that changes in our cost of funds generally correlate with changes in these indices. We do not use any futures, options or swaps in our asset-liability strategy.
Assets and liabilities that are subject to repricing are considered rate sensitive. The mismatch in the repricing of rate sensitive assets and liabilities is referred to as a company's "GAP". The GAP is positive if rate-sensitive assets exceed rate-sensitive liabilities for any specified repricing term. Generally, a positive GAP benefits a company during periods of increasing interest rates. The reverse is true during periods of decreasing interest rates. The indices we use lag changes in market interest rates between 60 and 90 days while prime-based business loans re-price immediately. However, our short-term savings and borrowing costs adjust quickly causing net interest income to initially decrease during periods of rising interest rates and increase during periods of declining interest rates. The movement of interest rates, whether up or down, cannot be accurately predicted and could have a negative impact on our income.
The following table shows the interest sensitivity of our assets and liabilities by repricing period at December 31, 2008 and the consolidated GAP position as a percentage of total assets at that time:
In order to minimize the impact of rate fluctuations on income, our goal is to keep the one-year GAP at less than 20% of total assets (positive or negative). At December 31, 2008, our one-year GAP ratio was a negative $399.1 million, or 5.36% of total assets. This compares with a positive GAP ratio of 1.65% of total assets at December 31, 2007 and a positive GAP ratio of 7.49% of total assets at December 31, 2006. In past years we had a one-year positive GAP due to the high percentage of monthly adjustable rate loans in our loan portfolio, but the one-year GAP became negative at December 31, 2008 because hybrid fixed/adjustable loans comprised 86% of 2008 loan originations. These loans were partially matched with longer term FHLB advances. The positive one-year GAP at December 31, 2007 decreased from the December 31, 2006 level because hybrid fixed/adjustable loan originations comprised 50% of loan originations in 2007.
Another measure of interest rate risk, which is required to be performed by OTS-regulated institutions, is an analysis specified by OTS Thrift Bulletin TB-13a, Management of Interest Rate Risk, Investment Securities, and Derivatives Activities. Under this regulation, institutions are required to establish limits on the sensitivity of their net interest income and net portfolio value to changes in interest rates. These changes in interest rates are defined as instantaneous and sustained movements in interest rates in 100 basis point increments.
The following table shows the estimated impact of a parallel shift in interest rates on our net portfolio value at December 31, 2008 and December 31, 2007:
(1)
The percentage change represents the projected change in the net portfolio value of the Bank in a stable interest rate environment versus the net portfolio value in the various rate scenarios. The OTS defines net portfolio value as the present value of expected cash flows from existing assets minus the present value of expected cash flows from existing liabilities.
(2)
Starting with the quarter ended March 31, 2008, the OTS Quarterly Interest Rate Risk Exposure Report will not display results for the minus 200 and 300 basis point scenarios.
The following table shows the contract terms and fair value of our interest-earning assets and interest-bearing liabilities as of December 31, 2008 categorized by type and expected maturity for each of the next five years and thereafter:
(1)
Expected maturities are contractual maturities adjusted for prepayments of principal. The Bank uses certain assumptions to estimate fair values and expected maturities. For assets, expected maturities are based upon contractual maturity, projected repayments and prepayments of principal. The prepayment experience used is based on the Bank’s historical experience. The Bank’s average CPR (Constant Prepayment Rate) is 12% for the adjustable single-family portfolio and 16% for its adjustable multi-family and commercial real estate portfolios. For fixed rate loans, the Bank’s average CPR for these loan types is 12% and 16%, respectively. The Bank used estimated deposit runoff based on available industry information.
ITEM 8.
ITEM 8. - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF OPERATIONS
YEARS ENDED DECEMBER 31
(Dollars in thousands, except per share data)
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE (LOSS) INCOME
YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
(Dollars in thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
(In thousands)
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
The following is a summary of the significant accounting policies of FirstFed Financial Corp. ("Company") and its wholly-owned subsidiary, First Federal Bank of California ("Bank").
Principles of Consolidation and Nature of Operations
The consolidated financial statements include the accounts of the Company and the Bank. The Bank maintains 39 retail banking offices in Southern California and one lending office in Southern California. In 2008, the Bank’s primary business consisted of attracting deposits and wholesale borrowings and using those funds to originate loans secured by mortgages on real estate, consumer loans and business loans. All inter-company balances and transactions have been eliminated in consolidation. Certain items in the 2007 and 2006 consolidated financial statements have been reclassified to conform to the 2008 presentation.
Uses of Estimates
In preparing consolidated financial statements in conformity with generally accepted accounting principles in the United States of America (“GAAP”) and general practices within the banking industry, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of real estate owned, the determination of the expected lives of residential loans used to amortize deferred origination costs and the valuation of deferred tax assets.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash, overnight investments and securities purchased under agreements to resell with maturities within 90 days of the date of purchase. The amounts advanced under agreements to resell securities (repurchase agreements) represent short-term investments. During the agreement period, the securities are maintained by the dealer under a written custodial agreement that explicitly recognizes the Bank’s interest in the securities. There were no agreements to resell securities at December 31, 2008 or 2007. The Bank had $337.3 million in overnight deposits with the Federal Reserve Bank at December 31, 2008. At December 31, 2007 and December 31, 2006, the Bank had overnight deposits with the Federal Home Loan Bank which totaled $4.3 million and $40.6 million, respectively.
Financial Instruments
GAAP requires the disclosure of the fair value of financial instruments, whether or not recognized on the Consolidated Balance Sheets, whenever it is practicable to estimate the value. A significant portion of assets and liabilities are financial instruments as defined under GAAP. Fair values, estimates and assumptions are set forth in Note 18, Fair Value of Financial Instruments.
Risks Associated with Financial Instruments
The credit risk of a financial instrument is the possibility that a loss may result from the failure of another party to perform in accordance with the terms of the contract. The most significant credit risk associated with the Bank’s financial instruments is concentrated in its loans receivable. Additionally, the Bank is subject to credit risk on certain loans sold with recourse. The Bank has established a system for monitoring the level of credit risk in the loan portfolio and for loans sold with recourse.
The market risk of a financial instrument is the possibility that future changes in market prices may reduce the value of a financial instrument or increase the contractual obligations of the Bank. The Bank’s market risk is primarily concentrated in its loans receivable. When a borrower fails to meet the contractual requirements of his or her loan agreement, the Bank is subject to the market risk of the collateral securing the loan. Likewise, the Bank is subject to the volatility of real estate prices with respect to real estate acquired by foreclosure. The Bank’s securities classified as available-for-sale are traded in active markets. The value of these securities is susceptible to the fluctuations of the market.
Interest Rate Risk
Financial instruments are subject to interest rate risk to the extent that they re-price on a frequency, degree or basis that varies from market pricing. Interest rate risk occurs to the degree that interest-earning assets re-price on a different frequency or schedule than interest-bearing liabilities. The loan portfolio tends to lag market interest rates by 60 to 90 days. The Bank closely monitors the pricing sensitivity of its financial instruments.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
Concentrations of Credit Risk
Concentrations of credit risk would exist for groups of borrowers when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The ability of the Bank’s borrowers to repay their commitments is contingent on several factors, including the economic condition in the borrowers' geographic area and the individual financial condition of the borrowers. The Bank generally requires collateral or other security to support borrower commitments on loans receivable. This collateral may take several forms. Generally, on the Bank’s mortgage loans, the collateral is the underlying mortgaged property located in California. The Bank does not have significant exposure to any individual borrower.
In 2008, the Bank’s primary product consists of adjustable rate loans secured by residential real estate. A portion of the Bank’s interest income results from interest accrued in excess of borrower payments (negative amortization). Adjustable rate loans, in large part, permit negative amortization up to a certain defined level, and the payment on such loans adjusts periodically in accordance with the terms of the loan documents. For loans with an 80% or less loan-to-value ratio at origination, the lifetime loan balance cap can range from 110% to 125% of the original loan balance. For loans with a loan-to-value ratio over 80% at origination, the lifetime loan balance cap is generally limited to 110% of the original loan balance. When there is an economic downturn and a resulting loss of income to borrowers, borrowers may be unable to make higher payments. Additionally, a downturn affecting the market value of the collateral for the Bank’s loans combined with a larger principal balance that can result from a negatively amortizing loan, may result in a loss of adequate security for such loans. A confluence of these economic conditions has had a significant effect on the Bank's net loss for 2008.
Investments and Mortgage-Backed Securities
Investment securities principally consist of U.S. Treasury and agency securities, collateralized mortgage obligations and mortgage-backed securities. Mortgage-backed securities were created when the Bank exchanged pools of its loans for mortgage-backed securities.
The Bank classifies all of its investments and mortgage-backed securities as "available-for-sale" based upon a determination that such securities might be sold at a future date or that there may be circumstances under which the Bank would sell such securities.
Securities designated as available-for-sale are recorded at fair value. Changes in the fair value of such securities available-for-sale are included in stockholders’ equity as unrealized gains (losses) on securities available-for-sale, net of taxes. Unrealized losses on available-for-sale securities, reflecting a decline in value, judged to be other than temporary, are charged to income in the Consolidated Statement of Operations. Unrealized gains or losses on available-for-sale securities are computed on a specific identification basis. Premiums and discounts on investment securities available-for-sale are amortized utilizing the interest method over the contractual term of the assets. Interest income on securities is accrued on the unpaid principal balance. The Bank did not hold any trading securities at December 31, 2008 or 2007.
Loans Receivable
The Bank’s loan portfolio is primarily comprised of single family residential loans (one-to-four units), and multi-family loans (five or more units). Loans are generally recorded at the contractual amounts owed by borrowers, less unearned loan fees and allowances for loan losses. Interest income on loans is accrued on the unpaid principal balance.
Loans Held-for-Sale
Loans that may be sold prior to maturity are classified as held-for-sale. These loans are carried at the lower of carrying value or fair value on an aggregate basis by type of asset. For loans held-for-sale, fair value is calculated on an aggregate basis as determined by current market investor yield requirements.
Impaired Loans
The Bank evaluates loans for impairment whenever the collectability of contractual principal and interest payments is questionable. A loan is impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
When a loan is considered impaired, the Bank measures impairment based on the present value of expected future cash flows (over a period not to exceed five years) discounted at the loan's effective interest rate. However, if the loan is "collateral-dependent" or a probable foreclosure, 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 Bank records an impairment allowance equal to the excess of its recorded investment in the loan over its measured value.
Cash payments received from impaired loans are recorded in accordance with the contractual terms of the loan. If the loan is not in non-accrual status, the principal portion of the payment is used to reduce the principal balance of the loan, whereas the interest portion is recognized as interest income.
Non-Accrual Loans
The Bank establishes allowances for delinquent interest equal to the amount of accrued interest on all loans 90 days or more past due based on the paid-to-date or in foreclosure. This practice effectively places such loans on non-accrual status for financial reporting purposes. Loans are returned to accrual status only when the ultimate collectability of current interest is no longer in doubt. Income is subsequently recognized only to the extent cash payments are received and the principal balance is expected to be recovered. Such loans are restored to an accrual status only when the loan is less than 90 days delinquent and not in foreclosure, and the borrower has demonstrated the ability to make future payments of principal and interest.
Allowance for Loan Losses
The Bank maintains a general valuation allowance for loan losses due to the inherent risks in the loan portfolio that have yet to be specifically identified. The Bank’s loan portfolio is stratified based on factors affecting the perceived level and concentration of risk, including the type of collateral, the extent of borrower documentation obtained, the estimated current loan-to-value ratio, whether or not the borrower faces a future payment increase, credit classification and geographic location.
The appropriate level of general valuation allowance is estimated by applying reserve factors to the various stratifications identified above. These reserve factors represent the expected likelihood of default multiplied by the expected rate of loss. The expected rates of loss and default are based on the Bank’s historical loss experience, adjusted for current conditions and trends in the Bank’s lending areas. Based on this methodology, the Bank recorded $570.8 million, $32.4 million and $12.4 million in loan loss provisions during 2008, 2007 and 2006, respectively.
The Bank has historically originated loans with a reduced level of documentation. On “Stated Income/Stated Asset” (“SISA”) loans, the borrower includes information on his/her level of income and assets that is not subject to verification by the Bank. 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 while information provided by the borrower on his/her assets is verified. For “No Income/No Asset” (“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. We stopped originating SISA loans and NINA loans in October 2007, but continued to originate SIVA loans until February 2008. All multi-family loans and other real estate loans have and do require complete customary documentation from the borrowers.
The Bank attempted to mitigate the inherent risk of making reduced documentation loans by evaluating the other credit characteristics of the loans, such as the creditworthiness of the borrower and the loan-to-value ratio based on the collateral’s appraised value at the origination date. One measure of the creditworthiness of the borrower is the borrower’s FICO score, a standardized credit scoring system developed by Fair Isaac Corporation.
The determination of the Bank’s general allowance for loan losses is based on estimates that are affected by changes in the regional or national economy and market conditions. Management believes that the general allowance for loan losses was adequate as of December 31, 2008 and 2007. Should the current economic or market downturn persist or worsen or if market interest rates increase significantly, a material increase in the level of loan defaults and charge-offs could result.
Charge-offs to the general valuation allowance are made when specific assets are considered uncollectible or are transferred to real estate owned and the fair value is less than the loan balance. Recoveries in cash are credited to the general valuation allowance.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
Loan Origination Fees and Costs
Loan origination fees and certain direct loan origination costs are deferred and recognized over the lives of the related loans as an adjustment of loan yields using the interest method. Loan origination costs for residential loans obtained from wholesale loan brokers generally include fees paid to those brokers, resulting in loan origination costs exceeding loan fees received. These excess loan origination costs are amortized as an adjustment to the loan yield based on the expected lives of the related loans, including an estimate of the prepayment speeds on the portfolio. When a loan is repaid or sold, any unamortized net deferred fee balance is included in the Consolidated Statement of Operations.
Gain or Loss on Sale of Loans
Mortgage loans are primarily sold on a servicing-released basis and cash gains or losses are recognized immediately in the Consolidated Statement of Operations. The Bank has previously sold mortgage loans and loan participations on a servicing-retained basis with yield rates to the buyer based upon current market rates, which may differ from contractual rate earned on the loans sold. Under GAAP, servicing assets or liabilities and other retained interests are required to be recorded as an allocation of the carrying amount of the loans sold based on the estimated relative fair values of the loans sold and any retained interests, less liabilities incurred. Servicing assets are evaluated for impairment based on the asset’s fair value. The Bank estimates fair value by discounting cash flows from servicing assets using discount and prepayment rates that the Bank believes market participants would use. Servicing assets arising from the sale of loans are included in other assets and were $48 thousand and $71 thousand at December 31, 2008 and 2007, respectively. No additional servicing assets were originated in 2008, 2007 or 2006. There was no impairment of the Bank’s servicing assets during 2008, 2007, and 2006.
Core Deposit Intangible
Loans, deposits and other assets and liabilities assumed in connection with acquisitions are accounted for under the purchase method of accounting. Assets and liabilities are recorded at their fair values as of the date of the acquisition including a core deposit intangible asset. The Company amortizes intangible assets on a straight-line basis over their estimated useful lives, which is seven years. The core deposit intangible asset was fully amortized at the end of 2008.
Real Estate
Real estate owned due to settlement of loans ("REO") consists of property acquired through foreclosure proceedings. Generally, all loans greater than 90 days delinquent are placed into foreclosure. The Bank acquires title to the property in most foreclosure actions that are not reinstated by the borrower. Once real estate is acquired in settlement of a loan, the property is recorded as REO at the lower of carrying value or fair market value, less estimated selling costs. Fair value is determined by an appraisal obtained at foreclosure. The REO balance is reduced for any subsequent declines in fair value.
The recognition of gain on the sale of real estate is dependent on a number of factors relating to the nature of the property, terms of sale, and any future involvement of the Bank or its subsidiaries in the property sold. If a real estate transaction does not meet certain down payment, cash flow and loan amortization requirements, any gain would be deferred and recognized under an alternative method.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
Depreciation and Amortization
Depreciation of office properties and equipment is provided by use of the straight-line method over the estimated useful lives of the related assets, which range from three to 30 years. Amortization of leasehold improvements is provided by use of the straight-line method over the lesser of the life of the improvement or the term of the lease.
Securities Sold Under Agreements to Repurchase
The Company enters into sales of securities under agreements to repurchase (“reverse repurchase agreements”). Reverse repurchase agreements are treated as financing arrangements and, accordingly, the obligations to repurchase the securities sold are reflected as liabilities in the Consolidated Balance Sheets. The loans, mortgage-backed securities and investments collateralizing reverse repurchase agreements are delivered to several major brokerage firms who arrange the transactions. The assets collateralizing reverse repurchase agreements are reflected in the Consolidated Balance Sheets. The brokerage firms may loan such securities to other parties in the normal course of their operations and agree to return the identical securities to us at the maturity of the agreements.
Income Taxes
The Company files a consolidated Federal income tax return and a combined California franchise tax report with the Bank and the Bank’s subsidiaries. Income taxes are accounted for using the asset and liability method. In the asset and liability method, deferred tax assets and liabilities are established as of the reporting date for the realizable cumulative temporary differences between the financial reporting and tax return basis of the Company’s assets and liabilities. The tax rates applied are the statutory rates expected to be in effect when the temporary differences are realized or settled.
Stock Option Plans
The Company accounts for stock option expense in accordance with Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payments and SFAS No. 123, Accounting for Stock-Based Compensation. These pronouncements establish accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. Compensation expense related to stock options is recognized on a straight-line basis over the requisite period for each separately vesting portion of the grant.
(Loss) Earnings Per Share
The Company reports both basic and diluted net (loss) earnings per share. Basic net (loss) earnings per share is determined by dividing net (loss) earnings by the average number of shares of common stock outstanding, while diluted net (loss) earnings per share is determined by dividing net (loss) earnings by the average number of shares of common stock outstanding adjusted for the dilutive effect of common stock equivalents. When the Company is in a net loss position, all common share equivalents are anti-dilutive.
(Loss) earnings per common share have been computed based on the following:
There were 863,197, 240,484 and 134,820 anti-dilutive shares excluded from the computation of diluted (loss) earnings per share during 2008, 2007 and 2006, respectively.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
Comprehensive (Loss) Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the Consolidated Balance Sheets, such items, along with net (loss) income, are components of comprehensive (loss) income. There were $2.8 million and $2.1 million of unrealized gains on available-for-sale securities in Accumulated Other Comprehensive (Loss) Income as of December 31, 2008 and 2007, respectively. The Company adopted SFAS No. 158 as of December 31, 2006, which resulted in a $2.1 million reduction in Accumulated Other Comprehensive Income in both the 2007 and 2006 Consolidated Balance Sheets related to the Bank’s Supplemental Executive Retirement Plan.
Segment Information and Disclosures
GAAP establishes standards to report information about operating segments in annual financial statements and requires reporting of selected information about operating segments in interim reports to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major clients. The Company manages its business as one segment.
Litigation
The Company is engaged in various legal actions incident to the nature of its business. Management believes that none of the litigation will have a material effect on the Company’s Consolidated Balance Sheets and Statement of Operations.
Recent Accounting Pronouncements
In May 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard No. 162, The Hierarchy of Generally Accepted Accounting Principles. This statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of non-governmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the Unites States (“GAAP hierarchy”). This statement also clarifies that the GAAP hierarchy should be directed to entities because it is the entity (not its auditor) that is responsible for selecting accounting principles for financial statements that are presented in accordance with GAAP. The statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The Company does not expect that this statement will result in a change in current practice. Therefore, management does not expect this statement to have an impact on the Company’s financial results.
In December 2007, the FASB issued two new statements: (a) SFAS No. 141 (R) (revised 2007), Business Combinations, and (b) SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements. These statements are effective for fiscal years beginning after December 15, 2008 and the application of these standards will improve, simplify, and converge internationally the accounting for business combinations and the reporting of non-controlling interests in financial statements. The Company adopted this statement on January 1, 2009 and does not anticipate that the adoption of these standards will have any impact on its financial statements.
(a) SFAS No. 141 (R) requires an acquiring entity in a business combination to: (i) recognize all (and only) the assets acquired and the liabilities assumed in the transaction, (ii) establish an acquisition-date fair value as the measurement objective for all assets acquired and the liabilities assumed, (iii) disclose to investors and other users all of the information they will need to evaluate and understand the nature of, and the financial effect of, the business combination, and (iv) recognize and measure the goodwill acquired in the business combination or a gain from a bargain purchase.
(b) SFAS No. 160 will improve the relevance, comparability and transparency of financial information provided to investors by requiring all entities to: (i) report non-controlling (minority) interests in subsidiaries in the same manner as equity but separate from the parent’s equity, in financial statements, (ii) net income attributable to the parent and to the non-controlling interest must be clearly identified and presented on the face of the statement of income, and (iii) any changes in the parent’s ownership interest while the parent retains the controlling financial interest in its subsidiary be accounted for consistently. The Company has no minority interest in subsidiaries at the present time.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
In December 2007, the SEC issued Staff Accounting Bulletin (SAB) No. 110, Share-Based Payment, which amends SAB No. 107, Share-Based Payment, to permit public companies, under certain circumstances, to continue to use the simplified method in SAB No. 107, to estimate the expected term of their “plain vanilla” employee options. Although the Company’s stock options fit the definition of “plain vanilla” according to SAB No. 110, because it has sufficient relevant historical option exercise data to provide a reasonable basis to estimate an option’s expected term, SAB No. 110 does not apply to the Company.
In November 2007, the SEC issued SAB No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings. SAB No. 109 was effective for fiscal quarters beginning after December 15, 2007. SAB No. 109 was issued to clarify the SEC staff position that internally developed intangible assets should not be included in the fair value of derivative loan commitments and other written loan commitments that are accounted for at fair value through earnings. The Company did not have any derivative loan commitments or written loan commitments that were accounted for at fair value through earnings as of December 31, 2008. Therefore, this bulletin did not have any impact on the Company’s financial results.
In February 2007, SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115, was issued. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement was effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company has not chosen to measure additional financial instruments at fair value. Therefore, the adoption of this statement on January 1, 2008 did not have any impact on the Company’s financial results.
In September 2006, SFAS No. 157, Fair Value Measurements, was issued. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The statement clarifies that assumptions used in measuring fair value should consider the risk inherent in a particular valuation technique as well as credit and non-performance risk. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company adopted this statement on January 1, 2008 and the adoption did not have a material impact on the Company’s consolidated financial statements or the Company’s financial results.
(2) Regulatory Matters and Uncertainties
Issuance of Cease and Desist Orders by the OTS
On January 26, 2009, the Company and 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 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.
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.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2) Regulatory Matters and Uncertainties (continued)
The Bank Order also required that the Bank 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 Bank did timely submit. If the Bank fails to remain “well capitalized,” the Bank must then submit to the OTS a detailed 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 must also submit to the OTS within prescribed time periods a classified asset reduction plan, liquidity plan, business plan and loan documentation plan, and refrain from any unsafe and unsound practices that resulted in the current high level of classified assets, inadequate capital, poor earnings and reliance on wholesale funding. To date, the Bank has timely complied with the plan submission requirements set forth in the Bank Order.
In addition, since December 30, 2008, the Bank has needed the prior approval of the OTS in order to roll over existing brokered deposits or accept new brokered deposits.
Any material failure to comply with the provisions of the Orders could result in enforcement actions by the OTS. While the Company and the Bank each intend to take such actions as may be necessary to enable it to comply with the requirements of its respective Order, there can be no assurance that it will be able to comply fully with the provisions of such Order, or to do so within the timeframes required, that compliance with such Order will not be more time consuming or more expensive than anticipated, or that efforts to comply with such Order will not have adverse effects on its operations and financial condition.
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. As a result of these reductions, the Company currently expects to record approximately $560 thousand in charges for salary and benefits, to be paid in accordance with the California Relocations, Terminations and Mass Layoffs Act, during the quarter ending March 31, 2009.
Non-Payment of Interest Due March 16, 2009 on Outstanding Company Debt
The Company has $150.0 million in outstanding unsecured fixed/floating rate senior debentures as of December 31, 2008.. 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 aggregate $2.3 million in interest payments due on March 16, 2009.
Under the indentures governing the debentures, 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 debentures then outstanding may declare the entire principal of the debentures and the interest accrued thereon immediately due and payable. In addition, the Company may be required to pay additional interest on the debentures and the costs and expenses of collection, including reasonable compensation to the trustee, its agents, attorneys and counsel.
Going Concern Uncertainty
The Bank’s ability to continue meet all of the requirements of Orders and continue to be well capitalized 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 if needed to remain well-capitalized 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.
These 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.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) Investment Securities
Investment securities, available-for-sale, are recorded at fair value and summarized below for the periods indicated:
All collateralized mortgage obligations at December 31, 2008 had contractual maturities greater than five years and had expected maturities within five years. There were no sales of investment securities during 2008, 2007 or 2006. Accrued interest on investment securities was $1.5 million and $1.6 million at December 31, 2008 and 2007, respectively.
(4) Mortgage-backed Securities
Mortgage-backed securities, available-for-sale, have contractual maturities greater than six years and are summarized below at the dates indicated:
Accrued interest receivable related to mortgage-backed securities outstanding at December 31, 2008 and 2007 totaled $257 thousand and $415 thousand, respectively. There were no sales of mortgage-backed securities during 2008, 2007 or 2006.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) Loans Receivable
The following is a summary of loans receivable at the periods indicated:
The Bank has historically originated loans with reduced levels of borrower documentation at origination. On “Stated Income/Stated Asset” (“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 that is not subject to verification, but his/her assets are verified. For “No Income/No Asset” (“NINA”) loans, the borrower is not required to submit information on his/her level of income or assets. 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. Adjustments to interest rates, loan-to-values and required credit scores are made on these types of reduced documentation loans in order to compensate for any additional risks the lack of documentation may pose. At December 31, 2008, approximately 9%, 25%, and 25% of the single family loan portfolio was comprised of NINA, SIVA, or SISA loans, respectively. This compares to 12%, 32%, and 32% of the single family loan portfolio being NINA, SIVA, or SISA loans, respectively, at December 31, 2007. The multi-family portfolio and other real estate loans have and do require complete and customary documentation from the borrowers.
At December 31, 2008 and 2007, negative amortization, included in the balance of loans receivable, totaled $262.9 million and $301.7 million, respectively. The portfolio of adjustable rate single family loans with a one-year fixed payment was $2.2 billion at December 31, 2008, and $3.2 billion as of December 31, 2007. The portfolio of adjustable rate single family loans with a three-to-five year fixed payment was $706.4 million as of December 31, 2008 and $1.1 billion as of December 31, 2007.
The Bank created $1.3 billion in mortgage-backed securities with loans from its multi-family loan portfolio for use in collateralized borrowing arrangements during 2005. Because the Bank retained full recourse on the loans, the mortgage-backed securities are recorded as loans receivable in the accompanying Consolidated Balance Sheets. The principal balance of those loans totaled $501.1 million and $658.5 million at December 31, 2008 and 2007, respectively. There were no mortgage-backed securities created with loans originated by the Bank in 2008 or 2007. There were no sales of mortgage-backed securities during 2008 or 2007.
The Bank had adjustable rate loans totaling $4.7 billion and $6.0 billion at December 31, 2008 and 2007, respectively. The Bank had $1.9 billion and $656.1 million of hybrid fixed/adjustable rate loans at December 31, 2008 and 2007, respectively.
The Bank had outstanding commitments to fund $263.1 million and $175.2 million in real estate loans at December 31, 2008 and 2007, respectively. All of these loans were variable interest rate loans with initial fixed rate periods of five years. The Bank had no loans held for sale at December 31, 2008 and 2007.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) Loans Receivable (continued)
The Bank had undisbursed commercial loan funds totaling $65.8 million at December 31, 2008 and $78.5 million at December 31, 2007. Undisbursed consumer loan funds totaled $96.1 million and $107.4 million at December 31, 2008 and 2007, respectively.
Accrued interest receivable related to loans outstanding at December 31, 2008 and 2007 totaled $48.3 million and $51.3 million, respectively, and the related allowance for delinquent interest was $22.3 million and $7.8 million, respectively.
Loans delinquent greater than 90 days or in foreclosure were $403.8 million and $180.4 million at December 31, 2008 and 2007, respectively.
Loans outstanding to directors and executive officers (senior vice presidents and above) totaled $7.2 million and $5.9 million at December 31, 2008 and 2007, respectively.
Loans originated upon the sale of REO totaled $6.8 million in 2008. There were no loans originated upon the sale of REO during 2007 or 2006.
See Note 10 for loans pledged as security for borrowings as of December 31, 2008.
The following is a summary of the activity in the general loan valuation allowance and valuation allowances for impaired loans for the periods indicated:
(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.
Loans serviced for others totaled $53.8 million and $62.0 million at December 31, 2008 and 2007, respectively.
The Bank has certain loans that were sold with recourse. These loans totaled $36.6 million and $42.2 million at December 31, 2008 and 2007, respectively. The maximum potential recourse liability associated with loans sold with recourse was $14.1 million and $14.7 million at December 31, 2008 and December 31, 2007, respectively. No additional losses are expected on these loans, so there is no associated repurchase liability.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) Loans Receivable (continued)
The following is a summary of impaired loans, net of valuation allowance for impairment, at the dates indicated:
The Bank has a program to reach out to borrowers faced with loan recasts to encourage them to modify their loans before the recast date. At December 31, 2008, 1,339 loans with gross principal balances totaling $637.1 million had been modified. Of these modified loans, 1,298 loans with principal balances totaling $572.3 million, net of valuation allowances, are considered troubled debt restructurings (“TDRs”) and are included in impaired loans. Valuation allowances on these loans totaled $46.7 million. Another $18.1 million in loans were modified as of December 31, 2008 but were not considered TDRs, and had no valuation allowances. Loans on accrual status prior to modification which continue to make regular payments are considered performing loans. Loans on non-accrual status prior to modification remain on non-accrual status after modification. If the borrower makes regular payments for 6 months, the loan is returned to performing status.
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 FICO score, debt-to-income ratio, and loan-to-value ratio. At December 31, 2007, the Bank had $1.8 million in modified loans.
The Bank considers a loan impaired when management believes that it is probable that the Bank will not be able to collect all amounts due under the contractual terms of the loan. 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), modified loans, 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 information pertaining to impaired and non-accrual loans:
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) Real Estate Owned
The Bank had $117.7 million and $21.1 million of real estate owned as of December 31, 2008 and 2007, respectively. The Bank did not own any real estate held for investment as of December 31, 2008 or 2007.
The following table shows activity in real estate owned (REO) during the periods indicated:
Net gain (loss) on real estate owned is comprised of the following items for the periods indicated:
The following items are included in real estate owned operations for the periods indicated:
(7) Office Properties, Equipment and Lease Commitments
Office properties and equipment, at cost, less accumulated depreciation and amortization, are summarized as follows:
The Bank is obligated under non-cancelable operating leases for periods ranging from five to thirty years. The leases are for certain of the Bank’s branches and office facilities.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) Office Properties, Equipment and Lease Commitments (continued)
Approximately half of the leases for office facilities contain five and ten year renewal options. Minimum rental commitments at December 31, 2008 under all non-cancelable leases are as follows (in thousands):
Rent expense under these leases was $8.8 million, $7.2 million and $5.3 million for 2008, 2007 and 2006, respectively. Certain leases require the Bank to pay property taxes and insurance. Additionally, certain leases have rent escalation clauses based on specified indices.
(8) Federal Home Loan Bank Stock
The Bank’s investment in FHLB stock at December 31, 2008 and 2007 was $115.2 million and $104.4 million, respectively. The FHLB provides a central credit facility for member institutions. As a member of the FHLB system, the Bank is required to own capital stock in the FHLB in an amount at least equal to the greater of 1% of the aggregate principal amount of its unpaid home loans, home purchase contracts and similar obligations at the end of each calendar year, assuming for such purposes that at least 30% of its assets were home mortgage loans, or 4.7% of its advances (borrowings) from the FHLB. The Bank was in compliance with this requirement at December 31, 2008. The Bank’s investment in FHLB stock was pledged as collateral for advances from the FHLB at December 31, 2008 and 2007. The fair value of the Bank’s FHLB stock approximates book value due to the Bank’s ability to redeem such stock with the FHLB at par value. The Bank did not accrue any dividends on its FHLB stock at December 31, 2008 or 2007.
(9) Deposits
Deposit account balances are summarized as follows:
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) Deposits (continued)
Certificates of deposit, placed through seven major national brokerage firms, totaled $1.7 billion and $826.0 million at December 31, 2008 and 2007, respectively.
Cash payments for interest on deposits (including interest credited) totaled $144.9 million, $261.5 million and $177.5 million during 2008, 2007 and 2006, respectively. Accrued interest on deposits at December 31, 2008 and 2007 totaled $17.6 million and $19.6 million, respectively, and is included in accrued expenses and other liabilities in the accompanying Consolidated Balance Sheets.
The following table indicates the maturities and weighted average interest rates of the Bank’s deposits:
The following table shows the maturity distribution of certificates of deposit of $100,000 and greater as of December 31, 2008 (in thousands):
Interest expense on deposits is summarized as follows:
(10) Borrowings
Borrowings consist of the following:
At December 31, 2008 and 2007, accrued interest payable on borrowings totaled $166 thousand and $267 thousand, respectively, which is included in accrued expenses and other liabilities in the accompanying Consolidated Balance Sheets.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10) Borrowings (continued)
The Bank has a line of credit with a commercial bank for $5.0 million secured by mortgage-backed securities with unpaid principal balances of $5.9 million.
The Bank has a credit facility with the FHLB (advances and lines of credit) that allows borrowings up to 45% of the Bank’s assets, as computed for regulatory purposes. At December 31, 2008, the Bank’s unused borrowing capacity was $512.4 million.
The following is a summary of FHLB advance maturities at December 31, 2008 (in thousands):
Cash payments for interest on borrowings (including reverse repurchase agreements and senior debentures -see Notes 11 and 12) totaled $93.1 million, $139.6 million and $195.7 million during 2008, 2007 and 2006, respectively.
Interest expense on borrowings is comprised of the following for the years indicated:
(11) Securities Sold Under Agreements to Repurchase
The Bank enters into sales of securities under agreements to repurchase (“reverse repurchase agreements”) which require the repurchase of the same securities. Reverse repurchase agreements are treated as financing arrangements, and the obligation to repurchase securities sold is reflected as a borrowing in the Consolidated Balance Sheets. The mortgage-backed securities underlying the agreements were delivered to the dealer who arranged the transactions or its trustee.
There were no reverse repurchase agreements outstanding at December 31, 2008. At December 31, 2007, $120.0 million in reverse repurchase agreements were collateralized by loans with a fair market value totaling $111.3 million and investments with a fair market value totaling $9.3 million.
The weighted average interest rate for borrowings under reverse repurchase agreements was 5.25% at December 31, 2007.
There was no accrued interest on securities sold under agreements to repurchase at December 31, 2008. Accrued interest on securities sold under agreements to repurchase, which is included in accrued expenses and other liabilities in the accompanying Consolidated Balance Sheets, was $2.4 million at December 31, 2007.
(12) Senior Debentures
The Company has $150.0 million in unsecured fixed/floating rate senior debentures during 2008 and 2007. The first $50.0 million, completed in June 2005, is due in 2015 and has a fixed rate of 5.65% for the first five years and is adjustable afterwards at 1.55% over the three-month LIBOR. The second $50.0 million, completed in December 2005, is due in 2016 and has a fixed rate of 6.23% for the first five years and is adjustable afterwards at 1.55% over the three-month LIBOR. The third $50.0 million, completed in April 2007, is due in 2017, and has a fixed interest rate of 6.585% for the first five years and is adjustable afterwards at 1.60% over the three-month LIBOR.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(12) Senior Debentures (continued)
The debentures in each transaction are redeemable at par after the first five years. Covenants contained in the indentures prohibit the Company from selling or otherwise disposing of shares of voting stock of the Bank or permitting liens on such Bank stock other than certain permitted liens.
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 aggregate $2.3 million in interest payments due on March 16, 2009. Under the indentures governing the debentures, 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 debentures then outstanding may declare the entire principal of the debentures and the interest accrued thereon immediately due and payable. In addition, the Company may be required to pay additional interest on the debentures and the costs and expenses of collection, including reasonable compensation to the trustee, its agents, attorneys and counsel.
(13) Income Taxes
Income tax (benefit) expense consists of the following:
A reconciliation of the statutory federal corporate income tax rate to the Company’s effective income tax rate follows:
The Company, the Bank and the Bank’s subsidiaries file a consolidated federal income tax return. Each entity is responsible for paying its pro rata share of the consolidated tax liability. Substantially all of the income tax (benefit) expense belonged to the Bank during 2008, 2007, and 2006, respectively.
There were no cash payments for income taxes during 2008. Cash payments for income taxes totaled $98.8 million and $111.7 million during 2007 and 2006, respectively.
Income taxes receivable, due to the overpayment of estimated taxes, totaled $7.2 million and $9.1 million as of December 31, 2008 and 2007, respectively. Income taxes receivable, due to net operating loss carry backs, totaled $97.3 million as of December 31, 2008.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) Income Taxes (continued)
FASB Interpretation No. 48 (FIN No. 48), Accounting for Uncertainty in Income Taxes, requires the Company to determine whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The Company has concluded that neither it, nor the Bank and its subsidiaries, has any uncertain tax positions that require recognition in the financial statements as defined by FIN No. 48. Therefore, no FIN No. 48 reserve is necessary. This determination was based on tax years that remain subject to examination by the relevant tax authorities. The Internal Revenue Service (“IRS”) and the Franchise Tax Board (“FTB”) have examined the Company's consolidated federal income tax returns for tax years up to and including 2003. Therefore, years 2004 though 2007 remain open for examination. As of December 31, 2008, the Company was not under examination by the IRS or the FTB.
Our policy is to record any interest or penalties paid in connection with income taxes on the appropriate line of the Statement of Operations.
Listed below are the significant components of the net deferred tax (asset) and liability:
The valuation allowance for the Company’s deferred tax asset totaled $81.7 million for federal and $67.8 million for state as of December 31, 2008. There was no valuation allowance for the deferred tax asset at December 31, 2007.
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 future earnings that would cause the future tax benefits to be realized cannot be assured, 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. Since the state of California does not allow tax 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.
The Bank is required to use the specific charge-off method of accounting for bad debts for Federal income tax purposes. Prior to 1995, the Bank used the reserve method of accounting for bad debts. The Consolidated Balance Sheet at December 31, 2008 does not include a tax liability of $5.4 million related to the adjusted base year bad debt reserve that was created when the Bank was on the reserve method. The base year reserve is subject to recapture if: (1) the Bank fails to qualify as a “bank” for federal income tax purposes; (2) certain distributions are made with respect to the stock of the Bank; (3) the bad debt reserves are used for any purpose other than to absorb bad debt losses; or (4) there is a change in federal tax law. Management does not expect any of these events to occur.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(14) Stockholders’ Equity
The Company’s stock charter authorizes 5,000,000 shares of serial preferred stock with a par value of $0.01 per share. As of December 31, 2008, no preferred shares have been issued.
Regulatory Capital
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital levels are also subject to qualitative judgments by the regulators about asset risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined). Management believes that the Bank meets all capital adequacy requirements to which it is subject as of December 31, 2008.
On January 26, 2009 the Company and the Bank consented to the Company Order and the Bank Order, respectively, issued by the Office of Thrift Supervision. The Orders require that the Company submit a detailed capital plan to address how the Bank will remain “well capitalized” at each quarter end through December 31, 2011. The Orders place growth restrictions on the Company and require that the Company receive permission before paying dividends, distributing capital, incurring new debt or making payments on existing debt, including interest payments. The Orders further require the Bank to submit to the OTS, within various prescribed time periods, a capital plan, a classified asset reduction plan, a liquidity plan, a business plan and a loan documentation plan.
The following table summarizes the Bank’s regulatory capital and required capital as of the dates indicated:
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(14) Stockholders’ Equity (continued)
The payment of dividends is subject to certain federal income tax consequences. Specifically, the Bank is capable of paying dividends to the Company in any year without incurring tax liability only if such dividends do not exceed both the tax basis current year income and profits and accumulated tax income and profits as of the beginning of the year.
In order to declare dividends under the Orders, the Bank must receive prior written approval of the OTS. The Bank must submit a written request to the OTS at least 45 days prior to the anticipated date of the proposed dividend payment.
The Company may loan up to $6.0 million to the Employee Stock Ownership Plan ("ESOP") under a line of credit loan. At December 31, 2008, there was no outstanding loan to the ESOP. At December 31, 2007, the outstanding loan to the ESOP totaled $236 thousand. Interest on any outstanding loan balance is due December 31 of each year. Interest varies based on the Bank’s monthly cost of funds. The average rates paid during 2008 and 2007 were 3.85% and 4.65%, respectively.
The Company currently maintains the Second Amended and Restated Rights Agreement (as amended, the "Rights Plan") expiring November 2018, which is designed to protect stockholders from attempts to acquire control of the Company at an inadequate price. Under the Rights Plan, the owner of each share of Company stock received a dividend of one right ("Right") to purchase one one-thousandth of a share of a new series of preferred stock for its estimated long term value of $100. In the event of certain acquisitions of 15% or more of the voting stock or a tender offer for 15% or more of the voting stock of the Company, each holder of a Right who exercises such Right will receive shares of the Company with a market value equal to two times the exercise price of the Right. Also, in the event of certain business combination transactions following the acquisition by a person of 15% or more of the Company stock, each Right holder will have the right to receive upon exercise of the Right common stock of the surviving company in such transaction having a market value of two times the exercise price of the Right. The Company may redeem the Rights at any time prior to such acquisition or tender offer should the Board of Directors deem redemption to be in its stockholders' best interests.
During 2007, the Board of Directors authorized the expansion of the Company’s stock repurchase program to permit repurchase of an additional 2,850,000 shares. No shares were repurchased during the year ended December 31, 2008. Shares repurchased during the year ended December 31, 2007 totaled 3,140,934 at an average price of $48.48. Shares eligible for repurchase totaled 1,181,145 shares as of February 28, 2009.
(15) Employee Benefit Plans
The Bank maintains a qualified defined contribution plan established under Section 401(k) of the Internal Revenue Code, as amended (the “401(k) Plan”). Participants are permitted to make contributions on a pre-tax basis, a portion of which is matched by the Bank. The 401(k) Plan expense was $635 thousand, $535 thousand and $652 thousand for 2008, 2007 and 2006, respectively.
The Bank has an Amended and Restated Supplementary Executive Retirement Plan (as amended, "SERP"), which is unfunded and covers the individuals currently employed by the Bank as its Chief Executive Officer and Chief Operating Officer. The pension expense for the SERP was $2.1 million, $1.6 million and $1.5 million in 2008, 2007 and 2006, respectively. The expected annual benefits under the SERP will be $287 thousand in 2009, $981 thousand in 2010 and 2011, $1.0 million in 2012, and $1.4 million in 2013 and $7.1 million for the next five years thereafter. In connection with the Bank’s adoption of SFAS No. 158 in 2006, the Bank recorded a $3.7 million increase to its SERP liability, which resulted in a $2.1 million, net of tax, reduction in Accumulated Other Comprehensive Earnings on the Consolidated Balance Sheets. Also, related to the adoption of SAB No. 108, the Bank reversed a $275 thousand excess SERP accrual with a $160 thousand, net of tax, increase to Retained Earnings as of January 1, 2006. The Bank’s SERP liability at December 31, 2006 was $11.7 million prior to the SAB No. 108 and SFAS No. 158 adjustments, and was $15.2 million after the adjustments. The Bank’s SERP liability at December 31, 2008 was $14.3 million.
As of December 31, 2008 the adjustment to Accumulated Other Comprehensive Earnings on the Consolidated Balance Sheets for SERP totaled $264 thousand.
The discount rate used in determining the actuarial value of benefit obligations was 6.25% as of December 31, 2008 and 2007. The rate of increase in future compensation levels used in determining the pension cost for the SERP was 4.0% at both December 31, 2008 and 2007. The plan had no assets as of December 31, 2008 or 2007.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(15) Employee Benefit Plans (continued)
The following table sets forth the funded status of the SERP and amounts recognized in the Company's financial statements for the years indicated:
The projected benefit obligation, accumulated benefit obligation, and fair value of assets were $14.3 million, $14.3 million and $0, respectively, at December 31, 2008 and $16.3 million, $13.8 million, and $0, respectively, at December 31, 2007.
The Bank’s ESOP is a profit sharing plan for all eligible employees and officers who have completed one year of continuous service. The ESOP is accounted for in accordance with AICPA Statement of Position 93-6, Employers’ Accounting for Employee Stock Ownership Plans. The number of shares to be released to ESOP participants each year is determined based on the contribution made by the Bank divided by the average market price of the Company’s stock for the year.
At December 31, 2008, the ESOP held 4.41% of the outstanding stock of the Company. Profit sharing expense was $145 thousand for the year ended December 31, 2008 and $1.5 million for the years ended December 31, 2007 and 2006. The amount of the contribution made by the Bank is determined each year by the Board of Directors, but is not to exceed 15% of the participants' aggregated compensation. The Bank does not offer post-retirement benefits under this plan.
At December 31, 2008 and 2007, total allocated ESOP shares were 573,140 and 559,712 shares, respectively. At December 31, 2008, there were no unallocated ESOP shares. Total unallocated ESOP shares were 34,410 shares at December 31, 2007. The fair value of unallocated ESOP shares totaled $1.7 million at December 31, 2007.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(15) Employee Benefit Plans (continued)
Stock Option Plan
On January 1, 2006, the Company adopted the fair value provisions of SFAS No. 123R, Share-Based Payments, using the modified prospective transition method. Prior to January 1, 2006, the Company used the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, issued in March 2000, to account for its fixed-plan stock options. Under this method, compensation expense was recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, prior to January 1, 2006, the Company had adopted only the disclosure requirements of SFAS No. 123.
The fair value recognition requirement applies only to new awards or awards modified after January 1, 2006. Additionally, the fair value of existing unvested awards at the date of adoption is recorded as compensation expense over the period which an employee is required to provide service in exchange for the award, which, for the Company, is the vesting period of the options. The results from prior periods have not been restated. As a result of adopting this statement, the Company recorded stock-based compensation expense for employees of $1.8 million, net of tax, and $1.7 million, net of tax, in 2008 and 2007, respectively. The deferred tax benefit recognized for stock-based compensation expense was $267 thousand in 2006. This deferred tax benefit related to non-qualified shares issued to directors. Due to the implementation of the restricted stock plan described below, no options were issued to directors during 2008 and 2007, and therefore no deferred tax benefit was recognized in 2008 and 2007.
At December 31, 2008, the Company had options outstanding issued under two share-based compensation programs, the 1994 Stock Option and Appreciation Rights Plan (“1994 Plan”) and the 1997 Non-employee Directors Stock Incentive Plan (“Directors 1997 Plan”). At December 31, 2008, the number of shares authorized for option awards under the 1994 Plan totaled 1,669,765. The Directors 1997 Plan was terminated in connection with the implementation of the restricted stock plan. No new grants will be made under the Directors 1997 Plan.
Under the 1994 Plan, the Company may grant options to employees of the Bank for up to 3,000,000 shares of common stock, subject to limitations set forth under the 1994 Plan. Options under each plan are granted with an exercise price equal to the market price of the Company’s stock at the date of grant. Options granted under the 1994 Plan usually vest over a six year period and have a maximum contractual term of 10 years. The Directors 1997 Plan provided for the issuance of up to 400,000 shares of common stock to non-employee directors of the Company. Options previously granted to non-employee directors under the Directors 1997 Plan vest in one year and have a maximum contractual term of 10 years.
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.
Options under all of the share-based compensation programs 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 option grant in 2008, 2007 and 2006 was estimated on the date of the grant using the Black-Scholes option valuation model. The expected life was estimated based on the actual weighted average life of historical exercise activity of the grantee population. The volatility factors were based on the historical volatilities of the Company’s stock, and these were used to estimate volatilities over the expected life of the options. The risk-free interest rate was 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 made by the Company. The following weighted average assumptions were used for grants in 2008, 2007 and 2006, respectively: no dividend yield in any year; expected volatility of 24%, 27% and 30%; risk-free interest rates of 3.15%, 4.9% and 4.5%; and expected average lives of 5.9 years, 6.0 years and 6.6 years. The weighted-average fair values of options granted during the year were $10.91, $25.28 and $24.05 for 2008, 2007, and 2006, respectively. Forfeitures were recognized in the year of occurrence. It is the Company’s policy that shares issued upon the exercise of stock options come from authorized, but previously un-issued, shares.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(15) Employee Benefit Plans (continued)
The following table summarizes information about stock option activity during the periods indicated:
As of December 31, 2008, the unrecognized cost related to non-vested share-based compensation plans was $2.7 million, to be recognized over a weighted-average period of 3.9 years.
A summary of the Company’s non-vested shares as of December 31, 2008 is presented below:
Additional information with respect to stock options outstanding at December 31, 2008 follows:
The total intrinsic value of options exercised during 2008 was $445 thousand. The aggregate intrinsic value of options exercised was $5.3 million and $3.3 million in 2007 and 2006, respectively. There was no aggregate intrinsic value of stock options outstanding and no aggregate intrinsic value of shares exercisable at December 31, 2008. Cash proceeds received from options exercised in 2008, 2007 and 2006 were $529 thousand, $2.5 million and $1.6 million, respectively.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(15) Employee Benefit Plans (continued)
Restricted Stock Plan
On April 26, 2006, 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 second-year anniversary date of the issuance. The Company issued 1,670 shares and 900 shares of restricted stock to each of the seven outside directors during the first quarter of 2008 and 2007, respectively. Of the 5,400 shares issued in 2007, 2,700 shares vested during the second quarter of 2008.
The following is a summary of the Company’s non-vested restricted stock as of December 31, 2008:
The total fair value of the restricted stock awards that vested for the year ended December 31, 2008 was $97 thousand.
Stock-based compensation expense recorded in connection with the 2007 Plan totaled $236 thousand, net of tax, for the year ended December 31, 2008 and $193 thousand, net of tax, for the year ended December 31, 2007. As of December 31, 2008, the total unrecognized compensation cost related to non-vested restricted awards totaled $105 thousand, to be recognized over a weighted average period of one year.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(16) Parent Company Financial Information
The following condensed parent company financial information should be read in conjunction with the other Notes to the Consolidated Financial Statements.
CONDENSED BALANCE SHEETS
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(17) Quarterly Results of Operations (unaudited)
Summarized below are the Company's results of operations on a quarterly basis for 2008, 2007, and 2006:
(18) Fair Value of Financial Instruments
SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosure of the estimated fair value of financial instruments. 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.
Investment Securities and Mortgage-backed securities
Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 includes securities that have quoted prices in active markets for identical assets. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Examples of such instruments, which would generally be classified within level 2 of the valuation hierarchy, include certain collateralized mortgage and debt obligations and certain high-yield debt securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy. The Company did not have any level 1 or level 3 securities as of December 31, 2008.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(18) Fair Value of Financial Instruments (continued)
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.
Loans held for sale
Loans held for sale are required to be measured based on the lower of cost or fair value. Under SFAS No. 157, 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. At December 31, 2008, the Company had no loans held for sale.
Impaired loans
Impaired Loans. SFAS No. 157 applies to loans measured for impairment in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”, including impaired loans measured at an observable market price (if available), and at the fair value of the loan’s collateral (if the loan is collateral dependent) less selling cost. 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. When a discounted cash flow has been used to determine the fair value, we record the impaired loan at Level 3.
Real estate owned
Certain assets such as real estate owned (REO) are measured at fair value less the estimated cost to sell. The Company believes that using fair value as a basis for measuring REO follows the provisions of SFAS No. 157. The fair value of REO at December 31, 2008 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 tern, 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.
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(18) Fair Value of Financial Instruments (continued)
The following table presents the carrying amounts and estimated fair values of financial instruments at December 31,
SFAS No. 157, Fair Value Measurements, 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:
The following table represents fair value information for financial instruments measured at fair value at December 31, 2008:
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(18) Fair Value of Financial Instruments (continued)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
FirstFed Financial Corp. and Subsidiary
We have audited the accompanying consolidated balance sheets of FirstFed Financial Corp. (a Delaware Corporation) and Subsidiary (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in stockholders' equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FirstFed Financial Corp. and Subsidiary as of December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company consented to the issuance of an Order to Cease and Desist by the Office of Thrift Supervision (the “OTS”), and the Company has experienced a significant net loss in 2008 which has resulted in a reduction in the Company’s available regulatory capital. A capital plan outlining the Company’s plans for maintaining its required levels of regulatory capital has been submitted to the OTS. Failure to maintain its required levels of regulatory capital would require the Company to submit a contingency plan to the OTS to accomplish either a merger with or acquisition by another federally insured institution or a voluntary liquidation of the Company. These matters, among others discussed more fully in Note 2, raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent on many factors, including acceptance of the capital plan by the OTS. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of FirstFed Financial Corp. and Subsidiary’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 30, 2009 expressed an unqualified opinion on the effectiveness of FirstFed Financial Corp. and Subsidiary’s internal control over financial reporting.
/s/ Grant Thornton LLP
Woodland Hills, California
March 30,
ITEM 9.
ITEM 9. - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Management’s Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of the Company’s management, including its principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of its disclosure controls and procedures, as defined under Rule 13a-15(e) and 15d-15(e) under the Exchange Act, as of December 31, 2008.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. In order to evaluate the effectiveness of internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, management has conducted an assessment, including testing, using the criteria in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of the company’s assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and that receipts and expenditures are being made only in accordance with authorizations of a company’s management and the directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the company’s financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Based on its assessment, management has concluded that the Company maintained effective internal control over financial reporting as of December 31, 2008, based on criteria in Internal Control - Integrated Framework issued by the COSO.
Grant Thornton LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this Annual Report on Form 10-K, has issued a report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008. The report of Grant Thornton LLP is included in this Annual Report on Form 10-K.
Changes in Internal Controls Over Financial Reporting
There were no changes in the Company’s internal control over financial reporting identified in management’s evaluation during the fourth quarter of the period covered by this Annual Report on Form 10-K that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B. - OTHER INFORMATION
None
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
FirstFed Financial Corp. and Subsidiary
We have audited FirstFed Financial Corp. (a Delaware Corporation) and Subsidiary’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). FirstFed Financial Corp. and Subsidiary’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on FirstFed Financial Corp. and Subsidiary’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, FirstFed Financial Corp. and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of FirstFed Financial Corp. and Subsidiary as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2008 and our report dated March 30, 2009 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Woodland Hills, California
March 30,
PART III
ITEM 10.
ITEM 10. - DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information regarding directors, executive officers and corporate governance is set forth in the Company’s definitive proxy statement, which will be filed with the SEC within 120 days of December 31, 2008 (the “Proxy Statement”), under the captions “Election of Directors,” “Corporate Governance,” “Other Corporate Governance Matters,” “Information Relating to Executive Officers,” and “Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated herein by reference.
On May 15, 2008, we filed with the NYSE the Annual CEO Certification regarding the Company's compliance with the NYSE's corporate governance listing standards as required by Section 303A.12(a) of the NYSE Listed Company Manual. In addition, we have filed as exhibits to this Annual Report on Form 10-K the applicable certifications of our Chief Executive Officer and our Chief Financial Officer required under Section 302 of the Sarbanes-Oxley Act of 2002 regarding the quality of the Company's public disclosures.
ITEM 11.
ITEM 11. - EXECUTIVE COMPENSATION
Information regarding executive compensation is set forth in the Proxy Statement under the captions “Compensation Discussion and Analysis,” “Corporate Governance - Compensation Committee Interlocks and Insider Participation” and “Report of the Compensation Committee of FirstFed Financial Corp.“ and the tables related thereto and is incorporated herein by reference.
ITEM 12.
ITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information regarding security ownership of certain beneficial owners and management is set forth in the Proxy Statement under the captions “Security Ownership of Certain Beneficial Owners” and “Security Ownership of Management” and is incorporated herein by reference.
ITEM 13.
ITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information regarding certain relationships and related transactions, and director independence is set forth in the Proxy Statement under the caption “Transactions with Related Persons” and is incorporated herein by reference.
ITEM 14.
ITEM 14. -PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding principal accounting fees and services is set forth in the Proxy Statement under the caption “Independent Public Accountants - Fees” and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
The following documents are filed as a part of this Annual Report on Form 10-K:
(1) Financial Statements (included in this Annual Report on Form 10-K under Item 8)
(2) Exhibits as shown below
EXHIBIT
NUMBER
(3.1)
Restated Certificate of Incorporation filed as Exhibit 3.1 to Form 10-K for the fiscal year ended December 31, 1999 and
incorporated by reference.
(3.2)
Amended and Restated Bylaws filed as Exhibit 3(ii) to Form 8-K dated June 27, 2008 and incorporated by reference.
(4.1)
Second Amended and Restated Rights Agreement dated as of October 23, 2008, filed on October 28, 2008 as Exhibit 4.1 to Form 8-K and
incorporated by reference.
(10.1)*
Amended and Restated Supplemental Executive Retirement Plan dated October 23, 2008 filed as Exhibit 10.1 to Form 8-K dated
October 23, 2008 and incorporated by reference.
(10.2)*
Change of Control Agreement effective September 26, 1996 filed as Exhibit 10.4 to Form 10-Q for the quarter ended September 30, 1996
and Amendment filed as Exhibit 10.4 for quarter ended September 30, 2000 and incorporated by reference.
(10.3)
Non-employee Directors Stock Incentive Plan filed on August 12, 1997 as Exhibit 4.1 to Form S-8 dated August 12, 1997and
Amendment filed as Exhibit 10.5 to Form 10-Q for the quarter ended September 30, 2000 and incorporated by reference.
(10.4)
Non-employee Directors Restricted Stock Plan filed as Appendix A to Schedule 14A, Proxy Statement for the Annual Stockholders’
Meeting held on April 26, 2006 and incorporated by reference.
(10.5)
Order to Cease and Desist with the Company dated January 26, 2009 filed as Exhibit 10.1 to Form 8-K dated January 26, 2009 and
incorporated by reference.
(10.6)
Stipulation and Consent to Issuance of Order to Cease and Desist with the Company dated January 26, 2009 filed as Exhibit 10.2 to
Form 8-K dated January 26, 2009 and incorporated by reference.
(10.7)
Order to Cease and Desist with the Bank dated January 26, 2009 filed as Exhibit 10.3 to Form 8-K dated January 26, 2009 and
incorporated by reference.
(10.8)
Stipulation and Consent to Issuance of Order to Cease and Desist with the Bank dated January 26, 2009 filed as Exhibit 10.4 to
Form 8-K dated January 26, 2009 and incorporated by reference.
(21)
Registrant's sole subsidiary is First Federal Bank of California, a federal savings bank.
(23)
Independent Auditors’ consent.
(31.1)
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(31.2)
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(32.1)
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(32.2)
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
* Indicates management contract or compensatory plan or arrangement.
This 2008 Annual Report on Form 10-K and the Proxy Statement for our 2009 Annual Meeting of Stockholders will be furnished to each stockholder of record as of March 5, 2009 who is entitled to receive copies thereof. Copies of these items will be furnished without charge upon request in writing by any stockholder of record as of such date and any beneficial owner of Company stock on such date who has not previously received such material and who so represents in good faith and in writing to:
Corporate Secretary
FirstFed Financial Corp.
12555 West Jefferson Boulevard
Los Angeles, California 90066
Other exhibits will be supplied to any such stockholder at a charge equal to the Company's cost of copying, postage, and handling.
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.
FIRSTFED FINANCIAL CORP.,
a Delaware corporation
Dated this 30th day of March, 2009
By: /s/ Babette E. Heimbuch
Babette E. Heimbuch
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has be signed by the following persons on behalf of the Registrant and in the capacities indicated on the 30th day of March, 2009.
SIGNATURE
TITLE
/s/ Babette E. Heimbuch
Chairman of the Board and
Babette E. Heimbuch
Chief Executive Officer (Principal Executive Officer)
/s/ James P. Giraldin
Director, President and Chief Operating Officer
James P. Giraldin
/s/ Douglas J. Goddard
Executive Vice President and Chief Financial Officer
Douglas J. Goddard
(Principal Financial Officer)
/s/ Brenda J. Battey
Senior Vice President and Controller
Brenda J. Battey
(Principal Accounting Officer)
/s/ Gisselle Acevedo
Director
Gisselle Acevedo
/s/ Brian E. Argrett
Director
Brian E. Argrett
/s/ Nicholas C. Biase
Director
Nicholas C. Biase
/s/ Jesse Casso, Jr.
Director
Jesse Casso, Jr.
/s/ Christopher M. Harding
Director
Christopher M. Harding
/s/ William G. Ouchi
Director
William G. Ouchi
/s/ William P. Rutledge
Director
William P. Rutledge
/s/ Steven L. Soboroff
Director
Steven L. Soboroff
EXHIBIT 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Babette E. Heimbuch, certify that:
(1)
I have reviewed this annual report on Form 10-K of FirstFed Financial Corp.;
(2)
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
(3)
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
(4)
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
(5)
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Dated this 30th day of March, 2009
By: /s/ Babette E. Heimbuch
Babette E. Heimbuch
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Douglas J. Goddard, certify that:
(1)
I have reviewed this annual report on Form 10-K of FirstFed Financial Corp.;
(2)
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
(3)
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
(4)
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
(5)
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Dated this 30th day of March, 2009
By: /s/ Douglas J. Goddard
Douglas J. Goddard
Chief Financial Officer
EXHIBIT 32.1
CEO CERTIFICATION
The undersigned, as Chief Executive Officer hereby certifies, to the best of her knowledge and belief, that:
(1)
the Annual Report on Form 10-K of FirstFed Financial Corp. (the "Company") for the fiscal year ended December 31, 2008 (the "Report ") accompanying this certification fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78m or 78o(d)); and
(2)
the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company for such period.
FIRSTFED FINANCIAL CORP.
Registrant
Dated this 30th day of March, 2009
By: /s/ Babette E. Heimbuch
Babette E. Heimbuch
Chief Executive Officer
This certification is made solely for purposes of complying with the provisions of Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date of hereof, regardless of any general incorporation language into such filing.
EXHIBIT 32.2
CFO CERTIFICATION
The undersigned, as Chief Financial Officer hereby certifies, to the best of his knowledge and belief, that:
(1)
the Annual Report on Form 10-K of FirstFed Financial Corp. (the "Company") for the fiscal year ended December 31, 2008 (the "Report ") accompanying this certification fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78m or 78o(d)); and
(2)
the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company for such period.
FIRSTFED FINANCIAL CORP.
Registrant
Dated this 30th day of March, 2009
By: /s/ Douglas J. Goddard
Douglas J. Goddard
Chief Financial Officer and
Executive Vice President
This certification is made solely for purposes of complying with the provisions of Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date of hereof, regardless of any general incorporation language into such filing.