Edgar Filing: DOWNEY FINANCIAL CORP

Securities and Exchange Commission Form 10-Q dated June 30, 2005

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UNITED STATES
SECURITITES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

___________________________

FORM 10-Q

(Mark One)

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005

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

For the transition period from __________ to __________

Commission File Number 1-13578

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

Delaware (State or other jurisdiction of incorporation or organization)	33-0633413 (I.R.S. Employer Identification No.)
3501 Jamboree Road, Newport Beach, CA (Address of principal executive office)	92660 (Zip Code)
Registrant’s telephone number, including area code	(949) 854-0300

N/A
(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No

At June 30, 2005, 27,853,783 shares of the Registrant’s Common Stock, $0.01 par value were outstanding.

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DOWNEY FINANCIAL CORP.

JUNE 30, 2005 QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION

ITEM 1. –

FINANCIAL STATEMENTS

Consolidated Balance Sheets at June 30, 2005 and 2004 and December 31, 2004

Consolidated Statements of Income for the three and six months ended June 30, 2005 and 2004

Consolidated Statements of Comprehensive Income for the three and six months ended

June 30, 2005 and 2004

Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2004

Notes To Consolidated Financial Statements

ITEM 2. –

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

ITEM 3. –

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 4. –

CONTROLS AND PROCEDURES

PART II – OTHER INFORMATION

ITEM 1. –

LEGAL PROCEEDINGS

ITEM 2. –

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

ITEM 3. –

DEFAULTS UPON SENIOR SECURITIES

ITEM 4. –

SUBMISSION OF MATTERS TO A VOTE OF SECURITIY HOLDERS

ITEM 5. –

OTHER INFORMATION

ITEM 6. –

EXHIBITS

AVAILABILITY OF REPORTS

SIGNATURES

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PART I – FINANCIAL INFORMATION

ITEM 1. – FINANCIAL STATEMENTS

DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Balance Sheets

			June 30,			December 31,			June 30,
(Dollars in Thousands, Except Per Share Data)			2005			2004			2004

Assets
Cash			$	128,670		$	119,502		$	126,361
Federal funds				30,001			-			-

	Cash and cash equivalents			158,671			119,502			126,361
U.S. Treasury securities, agency obligations and other investment
	securities available for sale, at fair value			504,965			497,009			630,785
Loans held for sale, at lower of cost or fair value				914,277			1,118,475			661,481
Mortgage-backed securities available for sale, at fair value				292			304			321
Loans held for investment				14,528,766			13,458,713			12,343,385
Allowance for loan losses				(36,380	)		(34,714	)		(33,450	)

		Loans held for investment, net		14,492,386			13,423,999			12,309,935
Investments in real estate and joint ventures				58,941			55,411			31,517
Real estate acquired in settlement of loans				2,201			2,555			2,424
Premises and equipment				105,230			106,238			107,277
Federal Home Loan Bank stock, at cost				265,849			243,613			167,797
Investment in Downey Financial Capital Trust I				-			-			3,711
Mortgage servicing rights, net				16,833			17,964			92,049
Other assets				92,482			63,738			88,689

			$	16,612,127		$	15,648,808		$	14,222,347

Liabilities and Stockholders’ Equity
Deposits			$	11,042,072		$	9,657,978		$	8,948,238
Securities sold under agreements to repurchase				-			-			239,688
Federal Home Loan Bank advances				4,002,757			4,559,622			3,556,087
Senior notes				198,004			197,924			198,179
Junior subordinated debentures				-			-			123,711
Accounts payable and accrued liabilities				126,521			108,217			88,608
Deferred income taxes				126,628			117,416			125,384

	Total liabilities			15,495,982			14,641,157			13,279,895

Stockholders’ equity
Preferred stock, par value of $0.01 per share; authorized 5,000,000 shares;
	outstanding none			-			-			-
Common stock, par value of $0.01 per share; authorized 50,000,000 shares;
	issued 28,235,022 shares at June 30, 2005, December 31, 2004 and
	June 30, 2004; outstanding 27,853,783 shares at both June 30, 2005 and
	December 31, 2004 and 27,968,283 shares at June 30, 2004			282			282			282
Additional paid-in capital				93,792			93,792			93,792
Accumulated other comprehensive income (loss)				(1,427	)		318			(5,745	)
Retained earnings				1,040,290			930,051			864,704
Treasury stock, at cost, 381,239 shares at both June 30, 2005 and
	December 31, 2004 and 266,739 shares at June 30, 2004			(16,792	)		(16,792	)		(10,581	)

	Total stockholders’ equity			1,116,145			1,007,651			942,452

			$	16,612,127		$	15,648,808		$	14,222,347

See accompanying notes to consolidated financial statements.

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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Income

		Three Months Ended						Six Months Ended
		June 30,						June 30,

(Dollars in Thousands, Except Per Share Data)		2005			2004			2005			2004

Interest income
Loans		$	189,641		$	123,313		$	362,648		$	238,843
U.S. Treasury securities and agency obligations			5,029			6,332			9,867			10,396
Mortgage-backed securities			3			3			6			6
Other investments			3,120			1,594			5,658			2,792

	Total interest income		197,793			131,242			378,179			252,037

Interest expense
Deposits			60,962			34,662			109,985			67,262
Federal Home Loan Bank advances and other borrowings			39,572			16,543			73,552			32,248
Senior notes			3,296			292			6,591			292
Junior subordinated debentures			-			3,134			-			6,268

	Total interest expense		103,830			54,631			190,128			106,070

Net interest income			93,963			76,611			188,051			145,967
Provision for loan losses			583			1,458			2,621			3,262

	Net interest income after provision for loan losses		93,380			75,153			185,430			142,705

Other income, net
Loan and deposit related fees			25,645			14,419			45,152			26,875
Real estate and joint ventures held for investment, net			1,728			7,048			4,308			7,974
Secondary marketing activities:
	Loan servicing income (loss), net		(2,529	)		13,786			(1,045	)		(459	)
	Net gains on sales of loans and mortgage-backed securities		48,848			15,675			79,463			17,047
	Net gains on sales of mortgage servicing rights		-			-			981			-
Net gains (losses) on sales of investment securities			1			(21,271	)		28			(19,159	)
Litigation award			1,767			-			1,767			-
Other			339			523			859			855

	Total other income, net		75,799			30,180			131,513			33,133

Operating expense
Salaries and related costs			39,042			37,575			78,197			73,144
Premises and equipment costs			7,891			8,200			15,891			16,408
Advertising expense			1,551			1,165			2,901			2,873
SAIF insurance premiums and regulatory assessments			927			744			1,854			1,501
Professional fees			345			356			681			724
Other general and administrative expense			8,605			9,432			16,997			17,914

	Total general and administrative expense		58,361			57,472			116,521			112,564
Net operation of real estate acquired in settlement of loans			(79	)		(237	)		(15	)		(309	)

	Total operating expense		58,282			57,235			116,506			112,255

Income before income taxes			110,897			48,098			200,437			63,583
Income taxes			46,827			20,277			84,628			26,850

	Net income	$	64,070		$	27,821		$	115,809		$	36,733

Per share information
Basic		$	2.30		$	0.99		$	4.16		$	1.31
Diluted		$	2.29		$	0.99		$	4.15		$	1.31
Cash dividends declared and paid		$	0.10		$	0.10		$	0.20		$	0.20
Weighted average shares outstanding
Basic		27,853,783			27,962,031			27,853,783			27,953,219
Diluted		27,884,276			27,990,588			27,883,058			27,985,565

See accompanying notes to consolidated financial statements.

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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

			Three Months Ended						Six Months Ended
			June 30,						June 30,

(In Thousands)			2005			2004			2005			2004

Net income			$	64,070		$	27,821		$	115,809		$	36,733

Other comprehensive income (loss), net of income taxes (benefits)
Unrealized gains (losses) on securities available for sale:
	U.S. Treasury securities, agency obligations and other investment
		securities available for sale, at fair value		728			(5,962	)		(1,715	)		(6,272	)
	Mortgage-backed securities available for sale, at fair value			1			-			1			(1	)
	Reclassification of realized amounts included in net income			-			158			(17	)		158
Unrealized gains (losses) on cash flow hedges:
	Net derivative instruments			23			1,869			(55	)		2,507
	Reclassification of realized amounts included in net income			(228	)		(3,563	)		41			(2,944	)

Total other comprehensive income (loss), net of income taxes (benefits)				524			(7,498	)		(1,745	)		(6,552	)

Comprehensive income			$	64,594		$	20,323		$	114,064		$	30,181

See accompanying notes to consolidated financial statements.

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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

			Six Months Ended
			June 30,

(In Thousands)			2005			2004

Cash flows from operating activities
Net income			$	115,809		$	36,733
Adjustments to reconcile net income to net cash used for operating activities:
	Depreciation and amortization			46,148			42,168
	Provision for losses on loans, real estate acquired in settlement of loans, investments
		in real estate and joint ventures, mortgage servicing rights and other assets		4,018			1,937
	Net gains on sales of loans and mortgage-backed securities, mortgage servicing rights,
		investment securities, real estate and other assets		(83,141	)		(4,579	)
	Interest capitalized on loans (negative amortization)			(47,860	)		(4,965	)
	Federal Home Loan Bank stock dividends			(4,875	)		(2,399	)
Loans originated and purchased for sale				(4,947,439	)		(2,206,985	)
Proceeds from sales of loans held for sale, including those sold
	as mortgage-backed securities			5,200,591			1,822,422
Other, net				(61,312	)		(48,685	)

Net cash provided by (used for) operating activities				221,939			(364,353	)

Cash flows from investing activities
Proceeds from sales of:
	U.S. Treasury securities, agency obligations and other investment securities
		available for sale		-			1,259,216
	Wholly owned real estate and real estate acquired in settlement of loans			1,752			10,446
Proceeds from maturities of U.S. Treasury securities, agency obligations
	and other investment securities available for sale			26,555			383,746
Purchase of:
	U.S. Treasury securities, agency obligations and other investment securities
		available for sale		(37,528	)		(1,613,453	)
	Loans held for investment			(29,675	)		(142,995	)
	Federal Home Loan Bank stock			(17,361	)		(42,309	)
	Premises and equipment			(7,673	)		(5,189	)
Originations of loans held for investment (net of refinances of $336,310 for the
	six months ended June 30, 2005 and $329,019 for the six months ended
	June 30, 2004)			(3,068,844	)		(4,146,060	)
Principal payments on loans held for investment and mortgage-backed
	securities available for sale			2,092,954			2,029,626
Net change in undisbursed loan funds				33,621			132,137
Investments in real estate held for investment				(869	)		(2,916	)
Other, net				2,559			922

Net cash used for investing activities				(1,004,509	)		(2,136,829	)

See accompanying notes to consolidated financial statements.

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DOWNEY FINANCIAL CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Continued)

			Six Months Ended
			June 30,

(In Thousands)			2005			2004

Cash flows from financing activities
Net increase in deposits			$	1,384,094		$	654,480
Proceeds from Federal Home Loan Bank advances and other borrowings				19,078,375			7,815,383
Repayments of Federal Home Loan Bank advances and other borrowings				(19,632,875	)		(6,134,856	)
Proceeds from the issuance of senior notes				-			198,182
Proceeds from reissuance of treasury stock and exercise of stock options				-			843
Cash dividends				(5,570	)		(5,590	)
Other, net				(2,285	)		(14,066	)

Net cash provided by financing activities				821,739			2,514,376

Net increase in cash and cash equivalents				39,169			13,194
Cash and cash equivalents at beginning of period				119,502			113,167

Cash and cash equivalents at end of period			$	158,671		$	126,361

Supplemental disclosure of cash flow information:
	Cash paid during the period for:
		Interest	$	183,597		$	105,500
		Income taxes		81,426			4,987
Supplemental disclosure of non-cash investing:
	Loans transferred to held for investment from held for sale			19,814			3,940
	Loans transferred from held for investment to held for sale			106			283
	Loans exchanged for mortgage-backed securities			480,497			1,153,683
	Real estate acquired in settlement of loans			1,141			2,508
	Loans to facilitate the sale of real estate acquired in settlement of loans			65			98

See accompanying notes to consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE (1) – Basis of Financial Statement Presentation

In the opinion of Downey Financial Corp. and subsidiaries (“Downey,” “we,” “us” and “our”), the accompanying consolidated financial statements contain all adjustments (consisting of normal recurring accruals unless otherwise disclosed in this Form 10-Q) necessary for a fair presentation of Downey’s financial condition as of June 30, 2005, December 31, 2004 and June 30, 2004, the results of operations and comprehensive income for the three months and six months ended June 30, 2005 and 2004, and changes in cash flows for the six months ended June 30, 2005 and 2004. Certain prior period amounts have been reclassified to conform to the current period presentation.

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial statements and are in compliance with the instructions for Form 10-Q and therefore do not include all information and footnotes necessary for a fair presentation of financial condition, results of operations, comprehensive income and cash flows. The information under the heading Management’s Discussion and Analysis of Financial Condition and Results of Operations presumes that the interim consolidated financial statements will be read in conjunction with Downey’s Annual Report on Form 10-K for the year ended December 31, 2004, which contains among other things, a description of the business, the latest audited consolidated financial statements and notes thereto, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2004 and for the year then ended. Therefore, only material changes in financial condition and results of operations are discussed in the remainder of Part I.

NOTE (2) – Mortgage Servicing Rights ("MSRs")

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

			Three Months Ended

			June 30,			March 31,			December 31,			September 30,			June 30,
(Dollars in Thousands)			2005			2005			2004			2004			2004

Gross balance at beginning of period			$	20,834		$	20,502		$	99,127		$	95,813		$	91,766
Additions				1,217			1,609			1,835			12,114			12,074
Amortization				(1,398	)		(1,160	)		(2,998	)		(5,190	)		(4,082	)
Sales				-			(14	)		(61,663	)		-			-
Impairment write-down				(27	)		(103	)		(15,799	)		(3,610	)		(3,945	)

	Gross balance at end of period			20,626			20,834			20,502			99,127			95,813

Allowance balance at beginning of period				1,224			2,538			16,832			3,764			22,045
Provision for (reduction of) impairment				2,596			(1,211	)		1,505			16,678			(14,336	)
Impairment write-down				(27	)		(103	)		(15,799	)		(3,610	)		(3,945	)

	Allowance balance at end of period			3,793			1,224			2,538			16,832			3,764

		Total mortgage servicing rights, net	$	16,833		$	19,610		$	17,964		$	82,295		$	92,049

As a percentage of associated mortgage loans				0.75	%		0.89	%		0.86	%		0.82	%		1.00	%
Estimated fair value ^(a)			$	16,863		$	19,665		$	17,968		$	82,401		$	92,483
Weighted average expected life (in months)				40			54			53			57			67
Custodial account earnings rate				3.45	%		3.21	%		2.69	%		2.24	%		2.10	%
Weighted average discount rate				9.12			9.13			9.03			9.27			8.97

At period end
Mortgage loans serviced for others:
	Total		$	10,287,991		$	8,043,655		$	6,672,984		$	10,568,339		$	9,279,359
	With capitalized mortgage servicing rights:^(a)
		Amount		2,249,030			2,207,403			2,100,452			10,075,028			9,242,641
		Weighted average interest rate		5.57	%		5.57	%		5.59	%		5.52	%		5.61	%
	Total loans sub-serviced without mortgage
		servicing rights:^(b)
		Term – less than six months	$	315,448		$	475,327		$	610,263		$	-		$	-
		Term – indefinite		7,698,176			5,332,613			3,931,483			459,307			-

Custodial account balances			$	237,722		$	157,624		$	143,765		$	229,704		$	238,914

^(a) The estimated fair value may exceed book value for certain asset strata and excluded loans sold or securitized prior to 1996 and loans sub-serviced without capitalized MSRs.
^(b) Servicing is performed for a fixed fee per loan each month.

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			Six Months Ended June 30,

(Dollars in Thousands)			2005			2004

Gross balance at beginning of period			$	20,502		$	95,183
Additions				2,826			18,042
Amortization				(2,558	)		(9,601	)
Sales				(14	)		-
Impairment write-down				(130	)		(7,811	)

	Gross balance at end of period			20,626			95,813

Allowance balance at beginning of period				2,538			13,008
Provision for (reduction of) impairment				1,385			(1,433	)
Impairment write-down				(130	)		(7,811	)

	Allowance balance at end of period			3,793			3,764

		Total mortgage servicing rights, net	$	16,833		$	92,049

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

The sensitivity analysis in the table below is hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 100 basis point variation in assumptions generally cannot be easily extrapolated because the relationship of the change in the assumptions to the change in fair value may not be linear. Also, in this table, the effect that a change in a particular assumption may have on the fair value is calculated without changing any other assumptions. In reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.

		Expected			Custodial
		Prepayment			Accounts			Discount
(Dollars in Thousands)		Speeds			Rate			Rate			Combination

Increase rates 100 basis points:^(a)
	Increase (decrease) in fair value	$	4,141		$	1,101		$	(550	)	$	4,539
	Reduction of (increase in) valuation allowance		3,062			1,073			(541	)		3,461

Decrease rates 100 basis points:^(b)
	Increase (decrease) in fair value		(7,028	)		(1,141	)		537			(8,249	)
	Reduction of (increase in) valuation allowance		(6,998	)		(1,117	)		528			(8,219	)

^(a) The weighted-average expected life of the MSRs portfolio is 57 months.
^(b) The weighted-average expected life of the MSRs portfolio is 12 months.

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

		Three Months Ended

		June 30,			March 31,			December31,			September 30,			June 30,
(In Thousands)		2005			2005			2004			2004			2004

Net cash servicing fees		$	1,753		$	1,627		$	3,595		$	6,031		$	5,615
Payoff and curtailment interest cost ^(a)			(288	)		(194	)		(968	)		(1,053	)		(2,083	)
Amortization of mortgage servicing rights			(1,398	)		(1,160	)		(2,998	)		(5,190	)		(4,082	)
(Provision for) reduction of impairment
	of mortgage servicing rights		(2,596	)		1,211			(1,505	)		(16,678	)		14,336

	Total loan servicing income (loss), net	$	(2,529	)	$	1,484		$	(1,876	)	$	(16,890	)	$	13,786

^(a) Represents the difference between the contractual obligation to pay interest to the investor for an entire month and the actual interest received when a loan prepays prior to the end of the month. This does not include the benefit of the use of repaid loan funds to increase net interest income.

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		Six Months Ended June 30,

(In Thousands)		2005			2004

Net cash servicing fees		$	3,380		$	11,319
Payoff and curtailment interest cost ^(a)			(482	)		(3,610	)
Amortization of mortgage servicing rights			(2,558	)		(9,601	)
(Provision for) reduction of impairment of mortgage servicing rights			(1,385	)		1,433

	Total loan servicing loss, net	$	(1,045	)	$	(459	)

NOTE (3) – Derivatives, Hedging Activities, Financial Instruments with Off-Balance Sheet Risk and Other Contractual Obligations (Risk Management)

Derivatives

Downey offers short-term interest rate lock commitments to help attract potential home loan borrowers. The commitments guarantee a specified interest rate for a loan if underwriting standards are met, but do not obligate the potential borrower. Accordingly, some commitments never become loans and merely expire. The residential one-to-four unit rate lock commitments Downey ultimately expects to result in loans and sell in the secondary market are treated as derivatives. Consequently, as derivatives, the hedging of the expected rate lock commitments do not qualify for hedge accounting. Associated fair value adjustments to the notional amount of the expected rate lock commitments are recorded in current earnings under net gains (losses) on sales of loans and mortgage-backed securities with an offset to the balance sheet in either other assets, or accounts payable and accrued liabilities. Fair values for the notional amount of expected rate lock commitments are based on observable market prices acquired from third parties. The carrying amount of loans held for sale includes a basis adjustment to the loan balance at funding resulting from the change in fair value of the rate lock derivative from the date of commitment to the date of funding. At June 30, 2005, Downey had a notional amount of expected rate lock commitments identified to sell as part of its secondary marketing activities of $625 million, with a change in fair value resulting in a gain of $0.1 million.

Downey does not generally enter into derivative transactions for purely speculative purposes.

Hedging Activities

As part of secondary marketing activities, Downey typically utilizes short-term forward sale and purchase contracts—derivatives—that mature in less than one year to offset the impact of changes in market interest rates on the value of residential one-to-four unit expected rate lock commitments and loans held for sale. In general, rate lock commitments associated with fixed rate loans require a higher percentage of forward sale contracts to mitigate interest rate risk than those associated with adjustable rate loans. Contracts designated as hedges for the forecasted sale of loans from the held for sale portfolio are accounted for as cash flow hedges because these contracts have a high correlation to the price movement of the loans being hedged (within a range of 80% - 125%). The measurement approach for determining the ineffective aspects of the hedge is established at the inception of the hedge. Changes in fair value of the notional amount of forward sale contracts not designated as cash flow hedges and the ineffectiveness of hedge transactions that are not perfectly correlated are recorded in net gains (losses) on sales of loans and mortgage-backed securities. Changes in expected future cash flows related to the fair value of the notional amount of forward sale contracts designated as cash flow hedges for the forecasted sale of loans held for sale are recorded in other comprehensive income, net of tax, provided cash flow hedge requirements are met. The offset to these changes are recorded in the balance sheet as either other assets, or accounts payable and accrued liabilities. The amounts recorded in accumulated other comprehensive income will be recognized in the income statement when the hedged forecasted transactions settle. Downey estimates that all of the related unrealized gains or losses in accumulated other comprehensive income will be reclassified into earnings within the next three months. Fair values for the notional amount of forward sale contracts are based on observable market prices acquired from third parties. At June 30, 2005, the notional amount of forward sale contracts amounted to $1.478 billion, with a change in fair value resulting in a loss of less than $0.1 million related to undesignated contracts and a gain of $0.7 million related to designated cash flow hedges with a notional amount of $905 million. There were no forward purchase contracts at June 30, 2005.

Downey has not discontinued any designated derivative instruments associated with loans held for sale due to a change in the probability of settling a forecasted transaction.

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In connection with its interest rate risk management, Downey from time-to-time enters into interest rate exchange agreements ("swap contracts") with certain national investment banking firms or the Federal Home Loan Bank ("FHLB") under terms that provide mutual payment of interest on the outstanding notional amount of swap contracts. These swap contracts help Downey manage the effects of adverse changes in interest rates on net interest income. Downey has interest rate swap contracts on which Downey pays variable interest based on the 3-month London Inter-Bank Offered Rate ("LIBOR") while receiving fixed interest. The swaps were designated as a hedge of changes in the fair value of certain FHLB fixed rate advances due to changes in market interest rates. The payment and maturity dates of the swap contracts match those of the advances. This hedge effectively converts fixed interest rate advances into debt that adjusts quarterly to movements in 3-month LIBOR. Because the terms of the swap contracts match those of the advances, the hedge has no ineffectiveness and results are reported in interest expense. The fair value of interest rate swap contracts is based on observable market prices acquired from third parties and represents the estimated amount Downey would receive or pay upon terminating the contracts, taking into consideration current interest rates and the remaining contract terms. The fair value of the swap contracts is recorded on the balance sheet in either other assets or accounts payable and accrued liabilities. With no ineffectiveness, the recorded swap contract values will essentially act as fair value adjustments to the advances being hedged. At June 30, 2005, swap contracts with a notional amount totaling $430 million were outstanding and had a fair value loss of $10.8 million recorded on the balance sheet in accounts payable and accrued liabilities and as a decrease to the advances being hedged.

The following table summarizes Downey’s interest rate swap contracts at June 30, 2005:

				Weighted
	Notional			Average
(Dollars in Thousands)	Amount			Interest Rate		Term

Pay – Variable (3-month LIBOR)	$	(100,000	)	3.32	%	March 2004 – October 2008
Receive – Fixed		100,000		3.20

Pay – Variable (3-month LIBOR)		(130,000	)	3.32		March 2004 – October 2008
Receive – Fixed		130,000		3.21

Pay – Variable (3-month LIBOR)		(100,000	)	3.32		March 2004 – November 2008
Receive – Fixed		100,000		3.26

Pay – Variable (3-month LIBOR)		(100,000	)	3.32		March 2004 – November 2008
Receive – Fixed		100,000		3.27

The following table shows the impact from non-qualifying hedges and the ineffectiveness of cash flow hedges on net gains (losses) on sales of loans and mortgage-backed securities (i.e., SFAS 133 effect), as well as the impact to other comprehensive income (loss) from qualifying cash flow transactions for the periods indicated. Also shown is the notional amount or balance for Downey’s non-qualifying and qualifying hedge transactions.

					Three Months Ended

					June 30,			March 31,		December 31,			September 30,		June 30,
(In Thousands)					2005			2005		2004			2004		2004

Net gains (losses) on non-qualifying hedge transactions					$	1,258		$	2,913	$	(5,030	)	$	2,595	$	3,352
Net gains (losses) on qualifying cash flow hedge transactions:
	Unrealized hedge ineffectiveness					-			-		-			-		-
	Less reclassification of realized hedge ineffectiveness					-			-		-			-		-

			Total net gains (losses) recognized in sales of loans and
				mortgage-backed securities (SFAS 133 effect)		1,258			2,913		(5,030	)		2,595		3,352
Other comprehensive income (loss)						(205	)		191		(293	)		822		(1,694	)

Notional amount or balance at period end
Non-qualifying hedge transactions:
	Expected rate lock commitments				$	624,604		$	727,899	$	367,650		$	462,441	$	541,358
	Associated forward sale contracts					572,977			633,031		368,822			448,999		374,462
	Associated forward purchase contracts					-			-		-			-		-
Qualifying cash flow hedge transactions:
	Loans held for sale, at lower of cost or fair value					914,277			1,255,104		1,118,475			845,913		661,481
	Associated forward sale contracts					905,373			1,247,969		1,115,636			838,567		652,796
Qualifying fair value hedge transactions:
	Designated FHLB advances – pay-fixed					430,000			430,000		430,000			430,000		430,000
	Associated interest rate swap contracts –
		pay-variable, receive-fixed				430,000			430,000		430,000			430,000		430,000

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				Six Months Ended June 30,

(In Thousands)				2005			2004

Net gains on non-qualifying hedge transactions				$	4,171		$	70
Net gains on qualifying cash flow hedge transactions:
	Unrealized hedge ineffectiveness				-			-
	Less reclassification of realized hedge ineffectiveness				-			-

		Total net gains recognized in sales of loans and
			mortgage-backed securities (SFAS 133 effect)		4,171			70
Other comprehensive loss					(14	)		(437	)

These forward and swap contracts expose Downey to credit risk in the event of nonperformance by the other parties—national investment banking firms, government-sponsored enterprises such as Federal National Mortgage Association and the FHLB. This risk consists primarily of the termination value of agreements where Downey is in a favorable position with an asset recorded. Downey controls the credit risk associated with these parties to the various derivative agreements through credit review, exposure limits and monitoring procedures. Downey does not anticipate nonperformance by the other parties.

Financial Instruments with Off-Balance Sheet Risk

Downey utilizes financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to originate fixed and variable rate mortgage loans held for investment, undisbursed loan funds, lines and letters of credit, commitments to purchase loans and mortgage-backed securities for portfolio and commitments to invest in community development funds. The contract or notional amounts of those instruments reflect the extent of involvement Downey has in particular classes of financial instruments.

Commitments to originate fixed and variable rate mortgage loans are agreements to lend to a customer as long as there is no violation of any condition established in the commitment. Commitments generally have fixed expiration dates or other termination clauses and some require payment of a fee. Since some commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Undisbursed loan funds on construction projects and unused lines of credit on home equity and commercial loans include committed funds not disbursed. Letters of credit are conditional commitments issued by Downey to guarantee the performance of a customer to a third party. Downey also enters into commitments to purchase loans and mortgage-backed securities, investment securities and to invest in community development funds.

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

		June 30,		March 31,		December 31,		September 30,		June 30,
(In Thousands)		2005		2005		2004		2004		2004

Commitments to originate loans held for investment:
	Adjustable	$	228,310	$	241,414	$	738,102	$	683,429	$	479,968
Undisbursed loan funds and unused lines of credit			491,375		494,210		457,815		426,055		372,464
Commitments to invest in community development
	funds ^(a)		1,832		5,445		5,129		5,771		5,226

^(a) At June 30, 2005, outstanding commitments to invest in community development funds totaled $5.9 million. Of this amount, $4.1 million was related to projects with disbursements that are likely to occur and are therefore placed on the balance sheet and recorded in other assets and other liabilities.

Downey uses the same credit policies in making commitments to originate loans held for investment and lines and letters of credit as it does for on-balance sheet instruments. For commitments to originate loans held for investment, the committed amounts represent exposure to loss from market fluctuations as well as credit loss. For these commitments, adverse changes from market fluctuations are generally not hedged. Downey controls the credit risk of its commitments to originate loans held for investment through credit approvals, limits and monitoring procedures. The credit risk involved in issuing lines and letters of credit requires the same creditworthiness evaluation as that involved in extending loan facilities to customers. Downey evaluates each customer’s creditworthiness.

Downey receives collateral to support commitments when deemed necessary. The most significant categories of collateral include real estate properties underlying mortgage loans, liens on personal property and cash on deposit with Downey.

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Other Contractual Obligations

Downey sells all loans without recourse. When a loan sold to an investor without recourse fails to perform according to the contractual terms, the investor will typically review the loan file to determine whether defects in the origination process occurred and whether such defects give rise to a violation of a representation or warranty made to the investor in connection with the sale. If such a defect is identified, Downey may be required to either repurchase the loan or indemnify the investor for losses sustained. If there are no such defects, Downey has no commitment to repurchase the loan. During the first six months of 2005, Downey recorded less than a $1 million repurchase loss related to defects in the origination process. These loan and servicing sale contracts typically contain provisions to refund sales price premiums to the purchaser if the related loans prepay during a period not to exceed 120 days from the sale settlement date. Downey had a reserve of $1 million at June 30, 2005, $7 million at December 31, 2004 and less than $1 million at June 30, 2004 to cover the estimated loss exposure related to early payoffs.

Through the normal course of business, Downey has entered into certain contractual obligations generally related to the funding of operations through deposits and borrowings, as well as leases for premises and equipment. Downey has obligations under long-term operating leases, principally for building space and land. Lease terms generally cover a five-year period, with options to extend, and are non-cancelable. Downey also has vendor contractual relationships, but the contracts are not considered to be material.

At June 30, 2005, scheduled maturities of certificates of deposit, FHLB advances, senior notes and future operating minimum lease commitments were as follows:

		Within		1 – 3		4 – 5		Over		Total
(In Thousands)		1 Year		Years		Years		5 Years		Balance

Certificates of deposit		$	6,387,443	$	907,441	$	213,752	$	-	$	7,508,636
FHLB advances and other borrowings			3,417,457		126,300		430,000		29,000		4,002,757
Senior notes			-		-		-		198,004		198,004
Operating leases			4,004		7,796		4,256		2,445		18,501

	Total other contractual obligations	$	9,808,904	$	1,041,537	$	648,008	$	229,449	$	11,727,898

Litigation

On July 23, 2004, two former in-store banking employees brought an action in Los Angeles Superior Court, Case No. BC318964, entitled "Michelle Cox and Mary Ann Tierra et al. v. Downey Savings and Loan Association." The complaint seeks unspecified damages for alleged unpaid overtime wages, inadequate meal and rest breaks, and other unlawful business practices and related claims. The plaintiffs also obtained class action status to represent all other current and former California employees who held the position of branch manager or assistant manager at in-store branches who (a) were treated as exempt and not paid overtime between July 23, 2000 and November 2002 and (b) allegedly received inadequate meal/rest periods since October 1, 2000. At a mediation in March 2005, the parties agreed to settle the lawsuit and in June 2005 the court preliminarily approved the settlement, with final approval expected later this year. Based upon the proposed settlement, management previously established a reserve for this matter and believes it constitutes a reasonable estimate of the loss exposure. Therefore, management believes that the ultimate outcome of this matter will not have a material adverse effect on its operations, cash flows or financial position.

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

NOTE (4) – Income Taxes

Downey and its wholly owned subsidiaries file a consolidated federal income tax return and various state income and franchise tax returns on a calendar year basis. The Internal Revenue Service has examined Downey’s tax returns for all tax years through 2002, while state taxing authorities have reviewed tax returns through 2000. Downey’s management believes it has adequately provided for potential exposure to issues that may be raised by tax auditors in years which remain open to review.

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NOTE (5) – Employee Stock Option Plans

Downey has a Long Term Incentive Plan (the “LTIP”), which provides for the granting of stock appreciation rights, restricted stock, performance awards and other awards. The LTIP specifies an authorization of 434,110 shares (adjusted for stock dividends and splits) of common stock to be available for issuance, of which 131,851 shares are available for future grants. Under the LTIP, options are exercisable over vesting periods specified in each grant and, unless exercised, the options terminate in five or ten years from the date of the grant. Further, under the LTIP, the option price shall at least equal or exceed the fair market value of such shares on the date the options are granted. No shares have been granted under the LTIP since 1998. At June 30, 2005, Downey had 381,239 shares of treasury stock that may be used to satisfy the exercise of options or for payment of other awards. No other stock-based compensation plan exists.

Downey measures its employee stock-based compensation arrangements under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Accordingly, no compensation expense has been recognized for the stock options, as stock options were granted at fair value at the date of grant. Had compensation expense for stock options been determined based on the fair value at the grant date for previous awards, stock-based compensation would have been fully expensed as of December 31, 2002.

NOTE (6) – Earnings Per Share

Earnings per share is calculated on both a basic and diluted basis, excluding common shares in treasury. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted from the issuance of common stock that then shared in earnings.

The following table presents a reconciliation of the components used to derive basic and diluted earnings per share for the periods indicated.

		Three Months Ended June 30,

		2005					2004

				Weighted					Weighted
				Average					Average
		Net		Shares	Per Share		Net		Shares	Per Share
(Dollars in Thousands, Except Per Share Data)		Income		Outstanding	Amount		Income		Outstanding	Amount

Basic earnings per share		$	64,070	27,853,783	$	2.30	$	27,821	27,962,031	$	0.99
Effect of dilutive stock options			-	30,493		0.01		-	28,557		-

	Diluted earnings per share	$	64,070	27,884,276	$	2.29	$	27,821	27,990,588	$	0.99

		Six Months Ended June 30,

		2005					2004

				Weighted					Weighted
				Average					Average
		Net		Shares	Per Share		Net		Shares	Per Share
(Dollars in Thousands, Except Per Share Data)		Income		Outstanding	Amount		Income		Outstanding	Amount

Basic earnings per share		$	115,809	27,853,783	$	4.16	$	36,733	27,953,219	$	1.31
Effect of dilutive stock options			-	29,275		0.01		-	32,346		-

	Diluted earnings per share	$	115,809	27,883,058	$	4.15	$	36,733	27,985,565	$	1.31

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

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NOTE (7) – Business Segment Reporting

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

						Real Estate
(In Thousands)			Banking			Investment			Elimination			Totals

Three months ended June 30, 2005
Net interest income			$	93,853		$	110		$	-		$	93,963
Provision for loan losses				583			-			-			583
Other income				73,768			2,031			-			75,799
Operating expense				58,030			252			-			58,282
Net intercompany income (expense)				(39	)		39			-			-

Income before income taxes				108,969			1,928			-			110,897
Income taxes				46,037			790			-			46,827

	Net income		$	62,932		$	1,138		$	-		$	64,070

At June 30, 2005
Assets:
	Loans and mortgage-backed securities, net		$	15,406,955		$	-		$	-		$	15,406,955
	Investments in real estate and joint ventures			-			58,941			-			58,941
	Other			1,196,756			17,833			(68,358	)		1,146,231

		Total assets		16,603,711			76,774			(68,358	)		16,612,127

Equity			$	1,116,145		$	68,358		$	(68,358	)	$	1,116,145

Three months ended June 30, 2004
Net interest income (expense)			$	76,842		$	(231	)	$	-		$	76,611
Provision for loan losses				1,458			-			-			1,458
Other income				22,724			7,456			-			30,180
Operating expense				56,908			327			-			57,235
Net intercompany income (expense)				(43	)		43			-			-

Income before income taxes				41,157			6,941			-			48,098
Income taxes				17,431			2,846			-			20,277

	Net income		$	23,726		$	4,095		$	-		$	27,821

At June 30, 2004
Assets:
	Loans and mortgage-backed securities, net		$	12,971,737		$	-		$	-		$	12,971,737
	Investments in real estate and joint ventures			-			31,517			-			31,517
	Other			1,239,475			11,845			(32,227	)		1,219,093

		Total assets		14,211,212			43,362			(32,227	)		14,222,347

Equity			$	942,452		$	32,227		$	(32,227	)	$	942,452

					Real Estate
(In Thousands)		Banking			Investment			Elimination		Totals

Six months ended June 30, 2005
Net interest income		$	187,838		$	213		$	-	$	188,051
Provision for loan losses			2,621			-			-		2,621
Other income			126,666			4,847			-		131,513
Operating expense			115,888			618			-		116,506
Net intercompany income (expense)			(77	)		77			-		-

Income before income taxes			195,918			4,519			-		200,437
Income taxes			82,776			1,852			-		84,628

	Net income	$	113,142		$	2,667		$	-	$	115,809

Six months ended June 30, 2004
Net interest income (expense)		$	146,286		$	(319	)	$	-	$	145,967
Provision for loan losses			3,262			-			-		3,262
Other income			24,415			8,718			-		33,133
Operating expense			111,607			648			-		112,255
Net intercompany income (expense)			(81	)		81			-		-

Income before income taxes			55,751			7,832			-		63,583
Income taxes			23,638			3,212			-		26,850

	Net income	$	32,113		$	4,620		$	-	$	36,733

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NOTE (8) – Current Accounting Issues

Statement of Financial Accounting Standards No. 123R

Statement of Financial Accounting Standards No. 123R, "Share-Based Payment" ("SFAS 123R"), is a revision of SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS 123R does not change the accounting guidance for share-based payment transactions with parties other than employees provided in SFAS 123 as originally issued and EITF Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services." Accounting for employee-stock-ownership-plan transaction ("ESOP’s") will continue to be accounted for in accordance with SOP 93-6, "Employers’ Accounting for Employee Stock Ownership Plans." SFAS 123R requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based compensation issued to employees, but expresses no preference for a type of valuation model. In April 2005, the Securities and Exchange commission extended compliance with SFAS 123R so that it is effective for the first interim reporting period in the next fiscal year beginning after June 15, 2005. It is not expected that SFAS 123R will have a material financial impact on Downey, unless a significant number of new option grants are made.

Statement of Financial Accounting Standards No. 153

Statement of Financial Accounting Standards No. 153, "Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29" ("SFAS 153"), requires exchanges of nonmonetary assets be measured based on the fair value of the assets exchanged. SFAS 153 eliminates the narrow exception for nonmonetary exchanges of similar productive assets and replaces it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. Previously, APB Opinion No. 29, "Accounting for Nonmonetary Transactions," required that the accounting for an exchange of a productive asset for a similar productive asset should be based on the recorded amount of the asset relinquished with no gain recognition. SFAS 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005 and is to be applied prospectively. SFAS 153 is not expected to have a material financial impact on Downey.

Statement of Financial Accounting Standards No. 154

Statement of Financial Accounting Standards No. 154, "Accounting Changes and Error Corrections" ("SFAS 154"), replaces APB No. 20, “Accounting Changes,” and FASB Statement No. 3, “Reporting Changes in Interim Financial Statements.” APB No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS 154 changes the accounting for, and reporting of, a change in accounting principle. SFAS 154 requires retrospective application to prior period’s financial statements of voluntary changes in accounting principle and changes required by new accounting standards when the standard does not include specific transition provisions, unless it is impracticable to do so. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, though early adoption is permitted as of the date this Statement was issued, which was May of 2005. SFAS 154 is not expected to have a material financial impact on Downey.

Emerging Issues Task Force Issue No. 03-1

In March of 2004, the Emerging Issues Task Force ("EITF") reached consensus on the guidance provided in EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments." Among other investments, this guidance is applicable to debt and equity securities that are within the scope of Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Paragraph 10 of EITF 03-1 specifies that an impairment would be considered other-than-temporary unless (a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment and (b) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. A company’s liquidity and capital requirements should be considered when assessing its intent and ability to hold an investment for a reasonable period of time that would allow the fair value of the investment to recover up to or beyond its cost. A pattern of selling investments prior to the forecasted fair value recovery may call into question a company’s intent. In addition, the severity and duration of the impairment should also be considered when determining whether the impairment is other-than-temporary. This guidance was effective for reporting periods beginning after June 15, 2004 with the exception of paragraphs 10 - 20 of EITF 03-1, which was to be deliberated further.

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Subsequently, the Board decided not to provide additional guidance on the meaning of other-than-temporary impairment, but directed the staff to issue proposed FASB Staff Position (“FSP”) EITF 03-1a, “Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1,” as final. The final FSP (retitled FSP FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”) will replace the guidance set forth in paragraphs 10-18 of Issue 03-1. FSP FAS 115-1 will clarify that an investor should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made. The Board decided that FSP FAS 115-1 would be effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. It is not expected to have a material financial impact on Downey.

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

Certain statements under this caption may constitute "forward-looking statements" under the Private Securities Litigation Reform Act of 1995, which involve risks and uncertainties. Forward-looking statements do not relate strictly to historical information or current facts. Some forward-looking statements may be identified by use of terms such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could" or "may." Our actual results may differ significantly from the results discussed in such forward-looking statements. Factors that might cause such a difference include, but are not limited to, economic conditions, competition in the geographic and business areas in which we conduct our operations, fluctuations in interest rates, credit quality and government regulation. We do not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements were made.

OVERVIEW

Our net income for the second quarter of 2005 totaled $64.1 million or $2.29 per share on a diluted basis, up from $27.8 million or $0.99 per share in the second quarter of 2004.

The increase in our net income between second quarters primarily reflected:

a $33.2 million increase in our net gains from sales of loans and mortgage-backed securities due to a higher volume and gain per dollar of loans sold;
a $21.3 million favorable change associated with securities gains/losses, as the year-ago quarter included a loss associated with a partial economic hedge against value changes in mortgage servicing rights (“MSRs”);
a $17.4 million or 22.6% increase in our net interest income reflecting growth in average interest-earning assets; and
a $11.2 million increase in loan and deposit related fees primarily reflecting higher loan prepayment fees.

Those favorable factors were partially offset by:

a $16.3 million unfavorable change in loan servicing activities, as the year-ago quarter included a $14.3 million recapture from the valuation allowance for MSRs compared to a $2.6 million provision in the current quarter; and
a $5.3 million decline in our income from real estate and joint ventures held for investment due primarily to lower gains from sales.

For the first six months of 2005, our net income totaled $115.8 million or $4.15 per share on a diluted basis, more than triple the $36.7 million or $1.31 per share for the first six months of 2004. The increase primarily reflected higher gains from sales of loans and mortgage-backed securities, higher net interest income, a favorable change in securities gains/losses and an increase in loan and deposit related fees. Those favorable items were partially offset by higher operating expense and a decline in our income from real estate held for investment.

For the current quarter, our return on average assets was 1.51%, up from 0.83% a year ago, while our return on average equity was 23.62%, up from 11.95% a year ago. For the first six-month periods, our return on average assets increased from 0.58% a year ago to 1.40%, while our return on average equity increased from 7.94% to 21.90%.

Our loan originations (including purchases) totaled $4.133 billion in the current quarter, up 6.8% from $3.869 billion a year ago. Loans originated for sale increased $1.487 billion to $2.766 billion, while single family loans originated for portfolio declined by $1.117 billion to $1.272 billion. Of the current quarter total originated for portfolio, $133 million represented subprime credits. At quarter end, the subprime portfolio totaled $1.3 billion, with an average loan-to-value ratio at origination of 71% and, of the total, 96% represented "Alt. A and A-" credits. In addition to single family loans, $94 million of other loans were originated in the current quarter.

At quarter end, our assets totaled $16.612 billion, up $2.390 billion or 16.8% from a year ago and up $963 million or 6.2% from year-end 2004. During the current quarter, our assets declined $281 million due primarily to a $341 million decline in loans held for sale.

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At June 30, 2005, our deposits totaled $11.042 billion, up 23.4% from the year-ago level and $1.384 billion or 14.3% since year-end 2004. During the quarter, three new traditional branches were opened. This brings our total number of branches to 172, of which 92 were in-store and four were located in Arizona. A year ago, we had 167 branches, of which 95 were in-store and three were located in Arizona.

Our non-performing assets declined $4 million during the quarter to $25 million or 0.15% of total assets. The decrease occurred in our prime residential loan category, which was partially offset by an increase in our subprime residential loan category.

At June 30, 2005, Downey Savings and Loan Association, F.A. (the "Bank"), our primary subsidiary, exceeded all regulatory capital tests, with capital-to-asset ratios of 7.31% for both tangible and core capital and 14.11% for risk-based capital. These capital levels are significantly above the “well capitalized” standards defined by the federal banking regulators of 5% for core and tangible capital and 10% for risk-based capital.

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CRITICAL ACCOUNTING POLICIES

We have established various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in Downey’s Annual Report on Form 10-K for the year ended December 31, 2004. Certain accounting policies require us to make significant estimates and assumptions which could have a material impact on the carrying value of certain assets and liabilities, and we consider these to be critical accounting policies. The estimates and assumptions are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions which could have a material impact on the future carrying value of assets and liabilities and our results of operations. Management has discussed the development and selection of these critical accounting policies with the Audit Committee of our Board of Directors.

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

The valuation of expected interest rate lock commitments. We enter into commitments to make loans that we intend to sell to investors whereby the interest rate on the loan is set prior to funding. These interest rate lock commitments are considered to be derivatives and are recorded at fair value. This value is calculated using market sources, adjusted by an anticipated fallout factor for interest rate lock commitments that are not expected to fund. Interest rate lock derivatives are accounted for individually and are not netted for balance sheet presentation. Consequently, at June 30, 2005, we had an asset recorded for interest rate lock derivatives of $0.4 million and a liability of $0.3 million. We recorded a capitalized basis adjustment at June 30, 2005 increasing loans held for sale by $0.1 million, which reflects the change in fair value of the interest rate lock derivative from the date of commitment to the date of funding. At June 30, 2004, we had a liability recorded for interest rate lock derivatives of $0.6 million and a capitalized basis adjustment decreasing loans held for sale by $0.9 million. The offset to these items was recorded in net gains on sales of loans and mortgage-backed securities. For further information, see Note 3 on page 8 of Notes to Consolidated Financial Statements.
The allowance for losses on loans and real estate. The allowance for losses on loans and real estate are maintained at an amount management deems adequate to cover inherent losses in the portfolios as of the balance sheet date. We use an internal asset review system and loan loss allowance methodology designed to provide for the detection of problem assets and an adequate allowance to cover losses. In determining the allowance for loan losses related to loans over $5 million, we evaluate the loans on an individual basis, including an analysis of the creditworthiness, cash flows and financial status of the borrower, and the condition and the estimated value of the collateral. Generally, we review all loans under $5 million by analyzing their performance and the composition of their collateral as a whole because of the relatively homogeneous nature of the loans, unless an individual loan or borrower relationship warrants separate analysis. This allowance is determined by applying against asset balances the associated factors for each major asset type that consider past loss experience and asset duration or loss statistics against current classified asset balances. These allowances totaled $38 million at June 30, 2005 and $35 million at June 30, 2004. For further information, see Allowance for Losses on Loans and Real Estate on page 42.
The valuation of MSRs. The fair value of MSRs is measured using a discounted cash flow analysis based on available market quotes, anticipated prepayment speeds, a custodial account rate and market-adjusted discount rates. Market sources are used to determine prepayment speeds, the net cost of servicing per loan, inflation rate, and default and interest rates for mortgages. MSRs are reviewed for impairment based on their fair value. We capitalize and measure MSR impairment on a disaggregated basis based on predominant risk characteristics of the underlying mortgage loans, which include fixed-rate mortgage loans by loan term and coupon rate (less than 7%, 150 basis point increments between 7% and 10%, and greater than 10%) and adjustable rate mortgages by loan term. Impairment losses are recognized through a valuation allowance for each impaired stratum, with any associated provision recorded as a component of loan servicing income (loss). At June 30, 2005, the MSR valuation allowance totaled $4 million, unchanged from June 30, 2004. For further information, see Note 2 on page 6 of Notes to Consolidated Financial Statements.
The prepayment reserves related to sales of loans and of MSRs. The gains on sales of loans and of MSRs are recorded net of reserves for anticipated prepayments. These sales contracts typically contain provisions to refund sale price premiums to the purchaser if the related loans prepay during a period not to exceed 120 days from the sale settlement date. Loan and MSR sales reserves are estimated using the prepayment experience of similar products. The estimates are updated during the 120 day period for actual payoffs. At June 30, 2005, the reserves were $1 million, compared to reserves of less than $1 million at June 30, 2004. For further information, see Note 2 on page 6 and Note 3 on page 8 of Notes to Consolidated Financial Statements and Secondary Marketing Activities on page 23.

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RESULTS OF OPERATIONS

Net Interest Income

Net interest income is the difference between the interest and dividends earned on loans, mortgage-backed securities and investment securities (“interest-earning assets”) and the interest paid on deposits and borrowings (“interest-bearing liabilities”). The spread between the yield on interest-earning assets and the cost of interest-bearing liabilities and the relative dollar amounts of these assets and liabilities principally affects net interest income.

Our net interest income totaled $94.0 million in the current quarter, up $17.4 million or 22.6% from the same period last year. The increase reflected an increase of 27.6% in average interest-earning assets to $16.540 billion in the current quarter. The effective interest rate spread averaged 2.27% in the current quarter, down from 2.36% a year ago and 2.38% in the previous quarter. The decline in our effective interest rate spread was due to a higher level of deferred loan origination costs being written-off in the current quarter related to loan repayments. Those write-offs were, in part, offset by higher loan prepayment fees recognized in other income.

For the first six months of 2005, net interest income totaled $188.1 million, up $42.1 million from a year ago. The increase was due to higher interest-earning asset levels, partially offset by a lower effective interest rate spread.

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

interest income from average interest-earning assets and the resultant yields; and
interest expense on average interest-bearing liabilities and the resultant costs, expressed as rates.

The table also sets forth our net interest income, interest rate spread and effective interest rate spread. The effective interest rate spread reflects the relative level of interest-earning assets to interest-bearing liabilities and equals:

the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities, divided by
average interest-earning assets for the period.

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

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			Three Months Ended June 30,

			2005							2004

			Average				Average			Average			Average
(Dollars in Thousands)			Balance			Interest	Yield/Rate			Balance		Interest	Yield/Rate

Interest-earning assets:
	Loans		$	15,761,341	$	189,641	4.81	%	$	12,120,003	$	123,313	4.07	%
	Mortgage-backed securities			294		3	4.08			325		3	3.69
	Investment securities ^(a)			778,672		8,149	4.20			842,703		7,926	3.78

		Total interest-earning assets		16,540,307		197,793	4.78			12,963,031		131,242	4.05
Non-interest-earning assets				412,604						415,503

	Total assets		$	16,952,911					$	13,378,534

Transaction accounts:
	Non-interest-bearing checking		$	699,998	$	-	-	%	$	496,445	$	-	-	%
	Interest-bearing checking ^(b)			537,003		480	0.36			550,258		536	0.39
	Money market			157,761		411	1.04			144,344		376	1.05
	Regular passbook			2,289,652		6,129	1.07			3,844,436		10,283	1.08

		Total transaction accounts		3,684,414		7,020	0.76			5,035,483		11,195	0.89
Certificates of deposit				6,921,807		53,942	3.13			3,851,486		23,467	2.45

	Total deposits			10,606,221		60,962	2.31			8,886,969		34,662	1.57
FHLB advances and other borrowings ^(c)				4,827,696		39,572	3.29			3,251,957		16,543	2.05
Senior notes and junior subordinated debentures ^(d)				197,988		3,296	6.66			141,419		3,426	9.69

	Total deposits and borrowings			15,631,905		103,830	2.66			12,280,345		54,631	1.79
Other liabilities				236,109						166,886
Stockholders’ equity				1,084,897						931,303

	Total liabilities and stockholders’ equity		$	16,952,911					$	13,378,534

Net interest income/interest rate spread					$	93,963	2.12	%			$	76,611	2.26	%
Excess of interest-earning assets over deposits and borrowings			$	908,402					$	682,686
Effective interest rate spread							2.27						2.36

			Six Months Ended June 30,


Interest-earning assets:
	Loans		$	15,421,287	$	362,648	4.70	%	$	11,472,856	$	238,843	4.16	%
	Mortgage-backed securities			298		6	4.03			328		6	3.66
	Investment securities ^(a)			759,588		15,525	4.12			751,726		13,188	3.53

		Total interest-earning assets		16,181,173		378,179	4.67			12,224,910		252,037	4.12
Non-interest-earning assets				398,562						410,796

	Total assets		$	16,579,735					$	12,635,706

Transaction accounts:
	Non-interest-bearing checking		$	656,971	$	-	-	%	$	471,031	$	-	-	%
	Interest-bearing checking ^(b)			534,710		956	0.36			534,915		996	0.37
	Money market			158,126		821	1.05			142,199		740	1.05
	Regular passbook			2,462,755		13,295	1.09			3,880,975		21,145	1.10

		Total transaction accounts		3,812,562		15,072	0.80			5,029,120		22,881	0.91
Certificates of deposit				6,469,258		94,913	2.96			3,655,960		44,381	2.44

	Total deposits			10,281,820		109,985	2.16			8,685,080		67,262	1.56
FHLB advances and other borrowings ^(c)				4,809,754		73,552	3.08			2,729,433		32,248	2.38
Senior notes and junior subordinated debentures ^(d)				197,969		6,591	6.66			132,565		6,560	9.90

	Total deposits and borrowings			15,289,543		190,128	2.51			11,547,078		106,070	1.85
Other liabilities				232,652						163,118
Stockholders’ equity				1,057,540						925,510

	Total liabilities and stockholders’ equity		$	16,579,735					$	12,635,706

Net interest income/interest rate spread					$	188,051	2.16	%			$	145,967	2.27	%
Excess of interest-earning assets over deposits and borrowings			$	891,630					$	677,832
Effective interest rate spread							2.32						2.39

^(a) Yields for securities available for sale are calculated using historical cost balances and do not give effect to changes in fair value that are reflected as a component of stockholders’ equity.
^(b) Included amounts swept into money market deposit accounts.
^(c) Starting in the first quarter of 2004, the impact of swap contracts was included, with notional amounts totaling $430 million of receive-fixed, pay-3-month LIBOR variable interest, which contracts serve as a permitted hedge against a portion of our FHLB advances.
^(d) In June 2004, we issued $200 million of 6.5% 10-year senior notes. In July 2004, we redeemed our junior subordinated debentures before their maturity.

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Changes in our net interest income are a function of changes in both rates and volumes of interest-earning assets and interest-bearing liabilities. The following table sets forth information regarding changes in our interest income and expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, we have provided information on changes attributable to:

changes in volume—changes in volume multiplied by comparative period rate;
changes in rate—changes in rate multiplied by comparative period volume; and
changes in rate/volume—changes in rate multiplied by changes in volume.

Interest-earning asset and interest-bearing liability balances used in the calculations represent quarterly average balances computed using the average of each month’s daily average balance during the period indicated.

				Three Months Ended June 30,													Six Months Ended June 30,
				2005 Versus 2004													2005 Versus 2004
				Changes Due To													Changes Due To

											Rate/												Rate/
(In Thousands)				Volume			Rate				Volume			Net			Volume			Rate			Volume			Net

Interest income:
	Loans			$	37,048		$	22,515		$		6,765		$	66,328		$	82,199		$	30,953		$	10,653		$	123,805
	Mortgage-backed securities				-			-				-			-			(1	)		1			-			-
	Investment securities				(670	)		966				(73	)		223			135			2,179			23			2,337

		Change in interest income			36,378			23,481				6,692			66,551			82,333			33,133			10,676			126,142

Interest expense:
	Transaction accounts:
		Interest-bearing checking			(13	)		(44	)			1			(56	)		-			(40	)		-			(40	)
		Money market			36			(1	)			-			35			81			-			-			81
		Regular passbook			(4,142	)		(20	)			8			(4,154	)		(7,764	)		(136	)		50			(7,850	)

			Total transaction accounts		(4,119	)		(65	)			9			(4,175	)		(7,683	)		(176	)		50			(7,809	)
	Certificates of deposit				18,798			6,497				5,180			30,475			33,974			9,357			7,201			50,532

		Total interest-bearing deposits			14,679			6,432				5,189			26,300			26,291			9,181			7,251			42,723
	FHLB advances and other
		borrowings			7,772			10,054				5,203			23,029			24,014			9,518			7,772			41,304
	Senior notes and junior
		subordinated debentures			1,360			(1,064	)			(426	)		(130	)		3,237			(2,147	)		(1,059	)		31

		Change in interest expense			23,811			15,422				9,966			49,199			53,542			16,552			13,964			84,058

Change in net interest income				$	12,567		$	8,059		$		(3,274	)	$	17,352		$	28,791		$	16,581		$	(3,288	)	$	42,084

Provision for Loan Losses

Provision for loan losses totaled $0.6 million in the current quarter, down $0.9 million from the year-ago quarter. For the first six months of 2005, provision for loan losses totaled $2.6 million, compared to $3.3 million in the year-ago period. For further information, see Allowance for Losses on Loans and Real Estate on page 42.

Other Income

Our total other income was $75.8 million in the current quarter, up $45.6 million from a year ago. Contributing to the increase between second quarters was:

a $33.2 million increase in net gains from sales of loans and mortgage-backed securities;
a $21.3 million favorable change in securities gains/losses; and
a $11.2 million increase in loan and deposit related fees.

Those favorable items were partially offset by:

a $16.3 million unfavorable change in loan servicing activities; and
a $5.3 million decline in our income from real estate and joint ventures held for investment.

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For the first six months of 2005, our total other income was $131.5 million, up $98.4 million from a year ago. The increase primarily reflected higher gains from sales of loans and mortgage-backed securities, a favorable change in securities gains/losses and higher loan and deposit related fees. Those favorable items were partially offset by a decline in our income from real estate and joint ventures held for investment.

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

Loan and Deposit Related Fees

Loan and deposit related fees totaled $25.6 million in the current quarter, up $11.2 million from a year ago. The increase was primarily in our loan related fees which were up $10.5 million due to higher loan prepayment fees. Deposit related fees were up $0.7 million or 10.2%.

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

			Three Months Ended

			June 30,		March 31,		December 31,		September 30,		June 30,
(In Thousands)			2005		2005		2004		2004		2004

Loan related fees:
	Prepayment fees		$	15,743	$	10,255	$	8,284	$	6,435	$	5,090
	Other fees			2,061		1,888		2,152		2,175		2,215
Deposit related fees:
	Automated teller machine fees			2,784		2,581		2,387		2,418		2,455
	Other fees			5,057		4,783		5,013		4,800		4,659

		Total loan and deposit related fees	$	25,645	$	19,507	$	17,836	$	15,828	$	14,419

For the first six months of 2005, loan and deposit related fees totaled $45.2 million, up $18.3 million from the same period of 2004. The increase was primarily in loan prepayment fees and deposit related fees.

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

			Six Months Ended June 30,

(In Thousands)			2005		2004

Loan related fees:
	Prepayment fees		$	25,998	$	8,889
	Other fees			3,949		4,215
Deposit related fees:
	Automated teller machine fees			5,365		4,698
	Other fees			9,840		9,073

		Total loan and deposit related fees	$	45,152	$	26,875

Real Estate and Joint Ventures Held for Investment

Income from our real estate and joint ventures held for investment totaled $1.7 million in the current quarter, down $5.3 million from the year-ago quarter due primarily to lower gains from sales. Net gains from sales declined $5.1 million to $1.1 million in the current quarter, most of which related to joint venture projects and is reported within equity in net income from joint ventures.

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

			Three Months Ended

			June 30,		March 31,		December 31,		September 30,			June 30,
(In Thousands)			2005		2005		2004		2004			2004

Rental operations, net of expenses			$	300	$	456	$	153	$	113		$	172
Net gains on sales of wholly owned real estate				39		31		1		-			5,616
Equity in net income from joint ventures				906		1,458		4,563		(2	)		1,014
Interest from joint venture advances				483		635		846		254			246

	Total income from real estate and joint ventures
		held for investment, net	$	1,728	$	2,580	$	5,563	$	365		$	7,048

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For the first six months of 2005, income from real estate and joint ventures held for investment totaled $4.3 million, down $3.7 million from the same period of 2004 due primarily to lower gains from sales.

The following table sets forth the key components comprising our income from real estate and joint venture operations during the year-to-date periods indicated.

		Six Months Ended June 30,

(In Thousands)		2005		2004

Rental operations, net of expenses		$	756	$	748
Net gains on sales of wholly owned real estate			70		5,656
Equity in net income from joint ventures			2,364		1,094
Interest from joint venture advances			1,118		476

	Total income from real estate and joint ventures held for investment, net	$	4,308	$	7,974

Secondary Marketing Activities

We service loans for others and those activities generated a loss of $2.5 million in the current quarter, compared to income of $13.8 million in the year-ago quarter. The primary reason for the $16.3 million unfavorable change was that the current quarter included an addition to the impairment for MSRs of $2.6 million, whereas the year-ago quarter included a $14.3 million reduction of impairment.

Loans we service for others with capitalized MSRs totaled $2.249 billion at quarter end, up from $2.100 billion at year-end 2004, but down from $9.243 billion a year ago. The decline from a year ago reflected our sale of approximately 80% of our MSRs during the fourth quarter of 2004. In addition to the loans we serviced for others with capitalized MSRs at June 30, 2005, we serviced $8.014 billion of loans on a sub-servicing basis for which we have no risk associated with changing MSR values. On loans we sub-service, we receive a fixed fee per loan each month.

The following table presents a breakdown of the components of our loan servicing income (loss), net for the quarters indicated.

			Three Months Ended

			June 30,			March 31,			December 31,			September 30,			June 30,
(In Thousands)			2005			2005			2004			2004			2004

Net cash servicing fees			$	1,753		$	1,627		$	3,595		$	6,031		$	5,615
Payoff and curtailment interest cost ^(a)				(288	)		(194	)		(968	)		(1,053	)		(2,083	)
Amortization of mortgage servicing rights				(1,398	)		(1,160	)		(2,998	)		(5,190	)		(4,082	)
(Provision for) reduction of impairment
	of mortgage servicing rights			(2,596	)		1,211			(1,505	)		(16,678	)		14,336

		Total loan servicing income (loss), net	$	(2,529	)	$	1,484		$	(1,876	)	$	(16,890	)	$	13,786

For the first six months of 2005, a loss of $1.0 million was recorded in loan servicing, compared to a $0.5 million loss for the same period of 2004.

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

		Six Months Ended June 30,

(In Thousands)		2005			2004

Net cash servicing fees		$	3,380		$	11,319
Payoff and curtailment interest cost ^(a)			(482	)		(3,610	)
Amortization of mortgage servicing rights			(2,558	)		(9,601	)
(Provision for) reduction of impairment of mortgage servicing rights			(1,385	)		1,433

	Total loan servicing loss, net	$	(1,045	)	$	(459	)

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For further information, see Note 2 on page 6 of Notes to Consolidated Financial Statements.

Sales of loans and mortgage-backed securities we originated for sale increased from $1.139 billion a year ago to $3.093 billion in the current quarter. Net gains associated with these sales totaled $48.8 million in the current quarter, up from $15.7 million a year ago. The increase was due to a higher volume and gain per dollar of loans sold. Excluding the impact of SFAS 133, a gain of 1.54% of secondary market sales was realized, up from 1.08% a year ago. Net gains in the current quarter included the capitalization of MSRs of $1.2 million, compared to $12.1 million a year ago.

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

			Three Months Ended

			June 30,			March 31,			December 31,			September 30,			June 30,
(In Thousands)			2005			2005			2004			2004			2004

Mortgage servicing rights			$	1,217		$	1,609		$	1,835		$	12,114		$	12,074
All other components excluding SFAS 133				46,373			26,093			25,954			(72	)		249
SFAS 133				1,258			2,913			(5,030	)		2,595			3,352

	Total net gains on sales of loans
		and mortgage-backed securities	$	48,848		$	30,615		$	22,759		$	14,637		$	15,675

Secondary marketing gain excluding SFAS
	133 as a percentage of associated sales			1.54	%		1.36	%		0.87	%		0.64	%		1.08	%

For the first six months of 2005, sales of loans and mortgage-backed securities totaled $5.123 billion, up from $1.818 billion a year ago. Net gains associated with these sales totaled $79.5 million, $62.4 million higher than the prior year amount.

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

		Six Months Ended June 30,

(In Thousands)		2005			2004

Mortgage servicing rights		$	2,826		$	18,042
All other components excluding SFAS 133			72,466			(1,065	)
SFAS 133			4,171			70

	Total net gains on sales of loans and mortgage-backed securities	$	79,463		$	17,047

Secondary marketing gain excluding SFAS 133 as a percentage of associated sales			1.47	%		0.93	%

Securities Available for Sale

In the second quarter of 2004, we purchased and sold securities classified as available for sale that we acquired as a partial economic hedge against value changes in our MSRs and recognized a loss of $21.3 million. No securities were held as a partial economic hedge against value changes in our MSRs during the current quarter due to the sale of approximately 80% of our MSRs during the fourth quarter of 2004. In the current quarter, we recorded a gain of $1,000 from sales of securities as a result of normal business activity.

For the first six months of 2005, we recorded gains on sales of securities of $28,000, compared to the year-ago period loss of $19.2 million as a result of the partial economic hedge against value changes in our MSRs. For further information, see Asset/Liability Management and Market Risk on page 37.

Litigation Award

The current quarter included a $1.8 million litigation award associated with an other real estate owned asset that suffered damage from earth movement.

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Operating Expense

Our operating expense totaled $58.3 million in the current quarter, up $1.0 million or 1.8% from a year ago. The increase was primarily due to a $1.5 million or 3.9% increase in salaries and related costs.

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

		Three Months Ended

		June 30,			March 31,		December 31,		September 30,		June 30,
(In Thousands)		2005			2005		2004		2004		2004

Salaries and related costs		$	39,042		$	39,155	$	38,448	$	36,629	$	37,575
Premises and equipment costs			7,891			8,000		8,801		8,771		8,200
Advertising expense			1,551			1,350		1,158		1,494		1,165
SAIF insurance premiums and regulatory
	assessments		927			927		825		825		744
Professional fees			345			336		717		387		356
Other general and administrative expense			8,605			8,392		9,238		9,909		9,432

	Total general and administrative expense		58,361			58,160		59,187		58,015		57,472
Net operation of real estate acquired in
	settlement of loans		(79	)		64		17		36		(237	)

	Total operating expense	$	58,282		$	58,224	$	59,204	$	58,051	$	57,235

For the first six months of 2005, operating expenses totaled $116.5 million, up $4.3 million or 3.8% from the same period of 2004, primarily reflecting higher salaries and related costs.

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

		Six Months Ended June 30,

(In Thousands)		2005			2004

Salaries and related costs		$	78,197		$	73,144
Premises and equipment costs			15,891			16,408
Advertising expense			2,901			2,873
SAIF insurance premiums and regulatory assessments			1,854			1,501
Professional fees			681			724
Other general and administrative expense			16,997			17,914

	Total general and administrative expense		116,521			112,564
Net operation of real estate acquired in settlement of loans			(15	)		(309	)

	Total operating expense	$	116,506		$	112,255

Provision for Income Taxes

Income taxes for the second quarter totaled $46.8 million, compared to $20.3 million a year ago. Our effective tax rate in the current quarter and first six months of 2005 was unchanged from the year-ago periods at 42.2%. For further information, see Note 4 of Notes to Consolidated Financial Statements on page 11.

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Business Segment Reporting

The previous discussion and analysis of the Results of Operations pertained to our consolidated results. This section discusses and analyzes the results of operations of our two business segments—banking and real estate investment. For further information, see Note 7 of Notes to Consolidated Financial Statements on page 13.

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

		Three Months Ended

		June 30,		March 31,		December 31,		September 30,		June 30,
(In Thousands)		2005		2005		2004		2004		2004

Banking net income		$	62,932	$	50,210	$	43,103	$	24,262	$	23,726
Real estate investment net income			1,138		1,529		3,316		248		4,095

	Total net income	$	64,070	$	51,739	$	46,419	$	24,510	$	27,821

		Six Months Ended June 30,

(In Thousands)		2005		2004

Banking net income		$	113,142	$	32,113
Real estate investment net income			2,667		4,620

	Total net income	$	115,809	$	36,733

Banking

Net income from our banking operations for the current quarter totaled $62.9 million, up $39.2 million from a year ago. The increase between second quarters primarily reflected:

a $33.2 million increase in our net gains from sales of loans and mortgage-backed securities due to a higher volume and gain per dollar of loans sold;
a $21.3 million favorable change associated with securities gains/losses, as the year-ago quarter included a loss associated with a partial economic hedge against value changes in MSRs;
a $17.0 million or 22.1% increase in our net interest income reflecting growth in average interest-earning assets; and
a $11.3 million increase in loan and deposit related fees primarily reflecting higher loan prepayment fees.

Those favorable factors were partially offset by:

a $16.3 million unfavorable change in loan servicing activities, as the year-ago quarter included a $14.3 million recapture from the valuation allowance for MSRs compared to a $2.6 million provision in the current quarter; and
a $1.1 million increase in operating expense.

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

			Three Months Ended

			June 30,			March 31,			December31,			September 30,			June 30,
(In Thousands)			2005			2005			2004			2004			2004

Net interest income			$	93,853		$	93,985		$	89,968		$	81,924		$	76,842
Provision for (reduction of) loan losses				583			2,038			(1,553	)		1,186			1,458
Other income				73,768			52,898			42,172			9,557			22,724
Operating expense				58,030			57,858			58,931			57,742			56,908
Net intercompany expense				(39	)		(38	)		(19	)		(48	)		(43	)

Income before income taxes				108,969			86,949			74,743			32,505			41,157
Income taxes				46,037			36,739			31,640			8,243			17,431

	Net income		$	62,932		$	50,210		$	43,103		$	24,262		$	23,726

At period end
Assets:
	Loans and mortgage-backed securities		$	15,406,955		$	15,728,508		$	14,542,778		$	14,257,374		$	12,971,737
	Other			1,196,756			1,155,426			1,097,534			1,374,840			1,239,475

		Total assets		16,603,711			16,883,934			15,640,312			15,632,214			14,211,212

Equity			$	1,116,145		$	1,054,336		$	1,007,651		$	965,625		$	942,452

For the first six months of 2005, net income from our banking operations totaled $113.1 million, up $81.0 million from the same period a year ago. The increase primarily reflected higher gains from sales of loans and mortgage-backed securities, higher net interest income, a favorable change in securities gains/losses and an increase in loan and deposit related fees. Those favorable items were partially offset by an unfavorable change in our loan servicing activities and higher operating expense.

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

		Six Months Ended June 30,

(In Thousands)		2005			2004

Net interest income		$	187,838		$	146,286
Provision for loan losses			2,621			3,262
Other income			126,666			24,415
Operating expense			115,888			111,607
Net intercompany expense			(77	)		(81	)

Income before income taxes			195,918			55,751
Income taxes			82,776			23,638

	Net income	$	113,142		$	32,113

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Real Estate Investment

Net income from our real estate investment operations totaled $1.1 million in the current quarter, down from $4.1 million a year ago. The decline primarily reflected lower gains from sales.

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

			Three Months Ended

			June 30,		March 31,		December 31,		September 30,		June 30,
(In Thousands)			2005		2005		2004		2004		2004

Net interest income (expense)			$	110	$	103	$	15	$	13	$	(231	)
Other income				2,031		2,816		5,858		665		7,456
Operating expense				252		366		273		309		327
Net intercompany income				39		38		19		48		43

Income before income taxes				1,928		2,591		5,619		417		6,941
Income taxes				790		1,062		2,303		169		2,846

	Net income		$	1,138	$	1,529	$	3,316	$	248	$	4,095

At period end
Assets:
	Investments in real estate and joint ventures		$	58,941	$	56,964	$	55,411	$	44,242	$	31,517
	Other			17,833		19,659		18,776		2,883		11,845

		Total assets		76,774		76,623		74,187		47,125		43,362

Equity			$	68,358	$	67,220	$	65,691	$	39,875	$	32,227

For the first six months of 2005, our net income from real estate investment operations totaled $2.7 million, down $2.0 million from the same period of 2004. The decline primarily reflected lower gains from sales.

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

		Six Months Ended June 30,

(In Thousands)		2005		2004

Net interest income (expense)		$	213	$	(319	)
Other income			4,847		8,718
Operating expense			618		648
Net intercompany income			77		81

Income before income taxes			4,519		7,832
Income taxes			1,852		3,212

	Net income	$	2,667	$	4,620

Our investments in real estate and joint ventures amounted to $59 million at June 30, 2005, up from $55 million at December 31, 2004 and $32 million at June 30, 2004.

For information on valuation allowances associated with real estate and joint venture loans, see Allowances for Losses on Loans and Real Estate on page 42.

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FINANCIAL CONDITION

Loans and Mortgage-Backed Securities

Total loans and mortgage-backed securities, including those we hold for sale, declined $322 million during the current quarter to a total of $15.4 billion or 92.7% of total assets at June 30, 2005. The decline was due primarily to a $341 million decline in loans held for sale.

Our loan originations, including loans purchased, totaled $4.133 billion in the current quarter, up 6.8% from the $3.869 billion we originated in the second quarter of 2004 but 2.8% below the $4.250 billion we originated in the first quarter of 2005. Loans originated for sale increased $1.487 billion over the year-ago quarter to $2.766 billion, while one-to-four unit residential loans originated for portfolio declined $1.117 billion to $1.272 billion. Of our current quarter originations for portfolio, $133 million represented subprime credits. Our prepayment speed, which measures the annualized percentage of loans repaid, for one-to-four unit residential loans declined from 47% a year ago to 37% in the current quarter, but was up from 30% in the first quarter of 2005. During the current quarter, 79% of our residential one-to-four unit originations represented refinance transactions. This is down slightly from 81% in the first quarter of 2005 but up from 77% in the year-ago quarter. In addition to single family loans, we originated $94 million of other loans in the current quarter.

As to our current quarter originations of adjustable one-to-four unit residential loans originated for portfolio, including loans purchased,:

72% had monthly adjustable interest rates tied primarily to the FHLB Eleventh District Cost of Funds Index (“COFI”) and generally provide for negative amortization, while essentially the remainder were tied to the 12-month moving average of annual yields on actively traded U.S. Treasury securities adjusted to a constant maturity of one year (“MTA”). This is in contrast to the year-ago quarter when COFI-related loans represented 58% and MTA-related loans represented 29%; and
Less than 1% had adjustable interest rates tied to London Inter-Bank Offered Rate (“LIBOR”) that typically adjust every six months.

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

				Three Months Ended

				June 30,		March 31,		December 31,		September 30,		June 30,
(In Thousands)				2005		2005		2004		2004		2004

Loans originated and purchased
Investment portfolio:
	Residential one-to-four units:
		Adjustable by index:
			COFI	$	920,152	$	1,904,087	$	1,846,514	$	1,903,602		$	1,390,834
			MTA		350,462		2,241		46,467		38,363			699,445
			LIBOR		1,765		10,003		33,830		130,425			299,470
		Adjustable – fixed for 3-5 years			-		-		-		-			-
		Fixed			-		-		-		482			-

		Total residential one-to-four units			1,272,379		1,916,331		1,926,811		2,072,872			2,389,749
	Other				94,100		152,084		141,238		162,069			200,017

	Total for investment portfolio				1,366,479		2,068,415		2,068,049		2,234,941			2,589,766
Sale portfolio^(a)					2,766,047		2,181,392		2,522,101		2,054,632			1,279,208

	Total for investment and sale portfolios			$	4,132,526	$	4,249,807	$	4,590,150	$	4,289,573	$		3,868,974

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

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				Six Months Ended June 30,

(In Thousands)				2005		2004

Loans originated and purchased
Investment portfolio:
	Residential one-to-four units:
		Adjustable by index:
			COFI	$	2,824,239	$	2,245,201
			MTA		352,703		1,420,583
			LIBOR		11,768		502,972
		Adjustable – fixed for 3-5 years			-		124,008
		Fixed			-		-

		Total residential one-to-four units			3,188,710		4,292,764
	Other				246,184		325,408

	Total for investment portfolio				3,434,894		4,618,172
Sale portfolio ^(a)					4,947,439		2,206,985

	Total for investment and sale portfolios			$	8,382,333	$	6,825,157

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

The following table sets forth our investment portfolio of residential one-to-four unit adjustable rate loans by index, excluding our adjustable–fixed for 3-5 year loans which are still in their initial fixed rate period, at the dates indicated.

			June 30, 2005				March 31, 2005				December 31, 2004				September 30, 2004				June 30, 2004

					% of				% of				% of				% of				% of
(Dollars in Thousands)			Amount		Total		Amount		Total		Amount		Total		Amount		Total		Amount		Total

Investment Portfolio
Residential one-to-four units:
	Adjustable by index:
		COFI	$	9,964,759	77	%	$	9,810,346	77	%	$	8,461,835	72	%	$	7,179,528	62	%	$	5,845,753	56	%
		MTA		2,185,982	17			2,068,230	16			2,224,130	19			3,362,196	29			3,563,210	35
		LIBOR		675,872	5			813,800	6			908,596	8			934,728	8			857,211	8
		Other, primarily CMT		128,281	1			148,566	1			119,475	1			108,612	1			142,796	1

	Total adjustable loans ^(a)		$	12,954,894	100	%	$	12,840,942	100	%	$	11,714,036	100	%	$	11,585,064	100	%	$	10,408,970	100	%

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

Our adjustable rate mortgages:

generally either begin with an incentive interest rate, which is an interest rate below the current market rate, that adjusts to the applicable index plus a defined spread, subject to periodic and lifetime caps, after one, three, six or twelve months, or are fixed for a period of three to five years then adjust semi-annually or annually thereafter;
generally provide that the maximum interest rate cannot exceed the incentive rate by more than six to ten percentage points, depending on the type of loan and the initial rate offered; and
limit interest rate adjustments, for loans that adjust both the interest rate and payment amount simultaneously, to 1% per adjustment for those that adjust semi-annually and 2% per adjustment for those that adjust annually.

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

have a lifetime interest rate cap, but no specified periodic interest rate adjustment cap;
have a periodic cap on changes in required monthly payments; and
allow for negative amortization, which is the addition to loan principal of accrued interest that exceeds the required monthly loan payments.

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If a loan incurs significant negative amortization, the loan-to-value ratio could increase which also increases credit risk, as the fair value of the underlying collateral could be insufficient to satisfy fully the outstanding loan obligation. A loan-to-value ratio is the proportion of the principal amount of the loan to the lower of the sales price or appraised value of the property securing the loan at origination. Our loan documents limit the amount of negative amortization that can occur. Our current practice imposes a limit on the amount of negative amortization to 110% of the original loan amount. However, our loan portfolio held for investment does contain loans previously originated with a limit of principal plus negative amortization of 125% of the original loan amount. At June 30, 2005, loans with the higher 125% limit on negative amortization represented 8% of our adjustable rate one-to-four unit residential portfolio, while those with the 110% limit represented 79%. We permit adjustable rate mortgages to be assumed by qualified borrowers.

At June 30, 2005, $12.0 billion or 87% of the adjustable rate mortgages in our loan portfolio were subject to negative amortization, of which $72 million or approximately 0.6% represented the amount of negative amortization included in the loan balance. The amount of negative amortization increased $21 million from the March 31, 2005 level. During the current quarter, approximately 15% of our loan interest income represented negative amortization, up from 11% in the first quarter of 2005 and 3% in the year-ago second quarter.

We also will continue to originate residential fixed interest rate mortgage loans to meet consumer demand, but we intend to sell the majority of these loans. We expect to sell some of our production of adjustable rate loans into the secondary market as needed to manage our balance sheet to remain in compliance with regulatory capital requirements. We sold $3.093 billion of loans and mortgage-backed securities in the current quarter, compared to $2.030 billion in the first quarter of 2005 and $1.139 billion in the year-ago second quarter. All but minor amounts were secured by residential one-to-four unit property, and at June 30, 2005, loans held for sale totaled $914 million.

At June 30, 2005, our unfunded loan application pipeline totaled $2.6 billion. Within that pipeline, we had commitments to borrowers for short-term interest rate locks, excluding expected fallout, of $1.0 billion, of which $807 million were related to residential one-to-four unit loans being originated for sale in the secondary market. Furthermore, at June 30, 2005, we had commitments on undrawn lines of credit of $409 million and loans in process of $82 million. We believe our current sources of funds will enable us to meet these obligations.

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The following table sets forth the origination, purchase and sale activity relating to our loans and mortgage-backed securities for the quarters indicated.

					Three Months Ended

					June 30,			March 31,			December 31,			September 30,			June 30,
(In Thousands)					2005			2005			2004			2004			2004

Investment Portfolio
Loans originated:
	Loans secured by real estate:
		Residential one-to-four units:
			Adjustable		$	1,135,573		$	1,719,398		$	1,672,606		$	1,788,864		$	2,114,055
			Adjustable – subprime			132,491			171,573			214,370			228,110			198,731
			Adjustable – fixed for 3-5 years			-			-			-			-			-
			Adjustable – fixed for 3-5 years – subprime			-			-			-			-			-

				Total adjustable residential one-to-four units		1,268,064			1,890,971			1,886,976			2,016,974			2,312,786
			Fixed			-			-			-			284			-
			Fixed – subprime			-			-			-			-			-
		Residential five or more units – adjustable				-			-			625			2,695			9,029

				Total residential		1,268,064			1,890,971			1,887,601			2,019,953			2,321,815
		Commercial real estate				-			-			-			875			1,070
		Construction				35,483			21,172			17,464			4,858			8,165
		Land				9,514			35,211			2,100			-			25,953
	Non-mortgage:
		Commercial				-			-			-			1,000			-
		Automobile				-			-			-			-			-
		Other consumer				49,103			95,701			121,049			152,641			155,305

			Total loans originated			1,362,164			2,043,055			2,028,214			2,179,327			2,512,308
Real estate loans purchased:
	One-to-four units					4,170			23,609			36,169			51,476			71,006
	One-to-four units – subprime					145			1,751			3,666			4,138			5,957
	Other ^(a)					-			-			-			-			495

		Total real estate loans purchased				4,315			25,360			39,835			55,614			77,458

			Total loans originated and purchased			1,366,479			2,068,415			2,068,049			2,234,941			2,589,766
Loan repayments						(1,385,603	)		(1,043,649	)		(1,088,690	)		(1,123,307	)		(1,294,340	)
Other net changes ^(b)						38,402			24,343			(966,506	)		(10,423	)		(50,177	)

	Increase in loans held for investment, net					19,278			1,049,109			12,853			1,101,211			1,245,249

Sale Portfolio
Originated whole loans:
	Residential one-to-four units					2,741,341			2,171,625			2,499,648			2,016,218			1,273,042
	Non-mortgage loans					-			-			-			-			-
Loans purchased						24,706			9,767			22,453			38,414			6,166
Loans transferred from (to) the investment portfolio ^(b)						(9,842	)		(9,866	)		981,282			-			(3,940	)
Originated whole loans sold						(2,881,687	)		(1,760,376	)		(2,865,724	)		(1,560,485	)		(508,482	)
Loans exchanged for mortgage-backed securities						(211,086	)		(269,411	)		(331,777	)		(310,741	)		(630,547	)
Capitalized basis adjustment ^(c)						1,516			2,656			(7,053	)		3,901			(2,261	)
Other net changes						(5,775	)		(7,766	)		(26,267	)		(2,875	)		(1,582	)

	Increase (decrease) in loans held for sale					(340,827	)		136,629			272,562			184,432			132,396

Mortgage-backed securities, net:
	Received in exchange for loans					211,086			269,411			331,777			310,741			630,547
	Sold					(211,086	)		(269,411	)		(331,777	)		(310,741	)		(630,547	)
	Repayments					(6	)		(6	)		(6	)		(6	)		(6	)
	Other net changes					2			(2	)		(5	)		-			-

		Decrease in mortgage-backed securities
			available for sale			(4	)		(8	)		(11	)		(6	)		(6	)

		Increase (decrease) in loans held for sale and
			mortgage-backed securities available for sale			(340,831	)		136,621			272,551			184,426			132,390

		Total increase (decrease) in loans and
			mortgage-backed securities, net		$	(321,553	)	$	1,185,730		$	285,404		$	1,285,637		$	1,377,639

^(a) Included five or more unit residential loans.
^(b) Primarily included changes in undisbursed funds for lines of credit and construction loans, changes in loss allowances, loans transferred to real estate acquired in settlement of loans or from (to) the held for sale portfolio, and the change in interest capitalized on loans (negative amortization). During the fourth quarter of 2004, we transferred to our sale portfolio and sold approximately $1 billion of our loans held for investment.
^(c) Reflected the change in fair value of the rate lock derivative from the date of commitment to the date of funding.

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The following table sets forth the composition of our loan and mortgage-backed securities portfolio at the dates indicated.

				June 30,			March 31,			December 31,			September 30,			June 30,
(In Thousands)				2005			2005			2004			2004			2004

Investment Portfolio
Loans secured by real estate:
	Residential one-to-four units:
		Adjustable		$	11,600,453		$	11,498,211		$	10,425,738		$	10,422,234		$	9,342,177
		Adjustable – subprime			1,244,386			1,269,695			1,231,911			1,140,995			1,043,557
		Adjustable – fixed for 3-5 years			823,518			885,029			1,017,958			1,152,604			1,302,726
		Adjustable – fixed for 3-5 years – subprime			14,583			16,495			19,415			22,882			28,938
		Fixed			56,630			60,361			65,371			70,524			76,913
		Fixed – subprime			2,705			3,014			3,126			3,688			4,028

			Total residential one-to-four units		13,742,275			13,732,805			12,763,519			12,812,927			11,798,339
	Residential five or more units:
		Adjustable			89,408			92,554			95,163			95,555			102,176
		Fixed			1,208			1,371			1,424			1,808			1,840
	Commercial real estate:
		Adjustable			25,935			25,409			28,384			37,641			37,075
		Fixed			3,314			4,255			4,294			4,838			5,465
	Construction				93,016			77,428			67,519			72,599			80,608
	Land				65,377			59,470			25,569			25,764			26,770
Non-mortgage:
	Commercial				4,496			4,766			4,997			5,990			5,083
	Automobile				320			542			858			1,297			1,911
	Other consumer				325,096			313,177			283,798			235,113			179,793

		Total loans held for investment			14,350,445			14,311,777			13,275,525			13,293,532			12,239,060
Increase (decrease) for:
	Undisbursed loan funds				(85,377	)		(67,869	)		(49,089	)		(50,709	)		(62,478	)
	Net deferred costs and premiums				263,698			265,913			232,277			202,874			166,803
	Allowance for losses				(36,380	)		(36,713	)		(34,714	)		(34,551	)		(33,450	)

		Total loans held for investment, net			14,492,386			14,473,108			13,423,999			13,411,146			12,309,935

Sale Portfolio
Loans held for sale:
	Residential one-to-four units				914,164			1,256,507			1,122,534			842,853			662,321
	Non-mortgage				-			-			-			63			64
	Capitalized basis adjustment ^(a)				113			(1,403	)		(4,059	)		2,997			(904	)

		Total loans held for sale			914,277			1,255,104			1,118,475			845,913			661,481
Mortgage-backed securities available for sale:
	Adjustable				292			296			304			315			321
	Fixed				-			-			-			-			-

		Total mortgage-backed securities available for sale			292			296			304			315			321

		Total loans held for sale and mortgage-backed
			securities available for sale		914,569			1,255,400			1,118,779			846,228			661,802

		Total loans and mortgage-backed securities, net		$	15,406,955		$	15,728,508		$	14,542,778		$	14,257,374		$	12,971,737

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

We carry loans for sale at the lower of cost or fair value. At June 30, 2005, no valuation allowance was required as the fair value exceeded book value on an aggregate basis.

At June 30, 2005, our residential one-to-four units subprime portfolio totaled $1.3 billion and consisted of 96% “Alt. A and A-” credit, 3% “B” credit and 1% “C” credit loans. The average loan-to-value ratio at origination for these loans was 71%.

We carry mortgage-backed securities available for sale at fair value which, at June 30, 2005, was essentially equal to our cost basis.

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Investment Securities

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

			June 30,		March 31,		December 31,		September 30,		June 30,
(In Thousands)			2005		2005		2004		2004		2004

Federal funds			$	30,001	$	10,003	$	-	$	-	$	-
Investment securities available for sale:
	U.S. Treasury			-		-		-		248,047		238,906
	Agency			504,900		511,638		496,944		484,766		391,813
	Other			65		65		65		65		66

		Total investment securities	$	534,966	$	521,706	$	497,009	$	732,878	$	630,785

The fair value of temporarily impaired securities, the amount of unrealized losses and the length of time these unrealized losses existed as of June 30, 2005 are presented in the following table. The $0.2 million unrealized loss on the security that has been in a loss position for 12 months or longer is due to changes in market interest rates. We have the intent and ability to hold the security until that temporary impairment is eliminated.

			Less than 12 months				12 months or longer				Total

					Unrealized				Unrealized				Unrealized
(In Thousands)			Fair Value		Losses		Fair Value		Losses		Fair Value		Losses

Investment securities available for sale:
	U.S. Treasury		$	-	$	-	$	-	$	-	$	-	$	-
	Agency			410,420		2,136		44,423		226		454,843		2,362
	Other			-		-		-		-		-		-

		Total temporarily impaired securities	$	410,420	$	2,136	$	44,423	$	226	$	454,843	$	2,362

The following table sets forth the maturities of our investment securities and their weighted average yields at June 30, 2005.

				As of June 30, 2005 Amount Due

				In 1 Year			After 1 Year			After 5 Years			After
(Dollars in Thousands)				or Less			Through 5 Years			Through 10 Years			10 Years			Total

Federal funds				$	30,001		$	-		$	-		$	-		$	30,001
	Weighted average yield				3.25	%		-	%		-	%		-	%		3.25	%
Investment securities available for sale:
	U.S. Treasury				-			-			-			-			-
		Weighted average yield			-	%		-	%		-	%		-	%		-	%
	Agency ^(a)				2,487			46,386			447,470			8,557			504,900
		Weighted average yield			2.94	%		3.74	%		4.03	%		3.94	%		4.00	%
	Other				-			-			-			65			65
		Weighted average yield			-	%		-	%		-	%		6.25	%		6.25	%

		Total investment securities		$	32,488		$	46,386		$	447,470		$	8,622		$	534,966
			Weighted average yield		3.23	%		3.74	%		4.03	%		3.96	%		3.96	%

^(a) At June 30, 2005, virtually all of our securities had step-up provisions that stipulate increases in the coupon rate ranging from 0.25% to 4.00% at various specified times over a range from May 2005 to September 2014. Yields for securities available for sale are calculated using historical cost balances and do not give effect to changes in fair value that are reflected as a component of stockholders’ equity.

Deposits

At June 30, 2005, our deposits totaled $11.0 billion, up $2.1 billion or 23.4% from the year-ago level and up $733 million or 7.1% since March 31, 2005. Compared to the year-ago period, our certificates of deposit increased $3.3 billion or 78.5%, which was partially offset by a decrease in our transaction accounts—i.e., checking, money market and regular passbook—of $1.2 billion or 25.5%. As short-term market interest rates have continued to rise over the past year, our customers have moved monies from regular passbook accounts into certificates of deposit.

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During the quarter, three new traditional branches were opened. This brings our total number of branches to 172, of which 92 were in-store and four were located in Arizona. A year ago, we had 167 branches, of which 95 were in-store and three were located in Arizona. At June 30, 2005, the average deposit size of our 80 traditional branches was $110 million, while the average deposit size of our 92 in-store branches was $24 million.

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

				June 30, 2005				March 31, 2005				December 31, 2004				September 30, 2004				June 30, 2004

				Weighted				Weighted				Weighted				Weighted				Weighted
				Average				Average				Average				Average				Average
(Dollars in Thousands)				Rate		Amount		Rate		Amount		Rate		Amount		Rate		Amount		Rate		Amount

Transaction accounts:
	Non-interest-bearing
		checking		-	%	$	715,152	-	%	$	672,531	-	%	$	601,588	-	%	$	506,981	-	%	$	483,566
	Interest-bearing
		checking ^(a)		0.31			513,559	0.31			538,842	0.33			534,775	0.34			525,124	0.35			532,682
	Money market			1.05			159,402	1.05			159,241	1.05			158,519	1.05			150,716	1.05			146,756
	Regular passbook			1.06			2,145,323	1.09			2,465,789	1.12			2,813,078	1.08			3,144,606	1.10			3,578,383

		Total transaction
			accounts	0.74			3,533,436	0.79			3,836,403	0.85			4,107,960	0.86			4,327,427	0.90			4,741,387
Certificates of deposit:
	Less than 2.00%			1.68			218,223	1.62			446,819	1.59			912,234	1.46			1,131,677	1.33			1,480,511
	2.00-2.49			2.45			1,222,193	2.40			2,232,900	2.38			3,003,000	2.37			2,711,948	2.39			1,463,613
	2.50-2.99			2.79			429,479	2.81			474,212	2.80			495,119	2.77			363,305	2.71			263,753
	3.00-3.49			3.22			3,341,993	3.17			2,494,034	3.19			327,552	3.28			200,480	3.28			211,428
	3.50-3.99			3.72			1,568,814	3.80			171,466	3.84			94,611	3.85			93,163	3.83			87,374
	4.00-4.49			4.21			266,015	4.23			196,138	4.26			257,369	4.25			262,531	4.27			240,864
	4.50-4.99			4.83			429,941	4.83			425,732	4.83			424,937	4.83			425,352	4.83			423,229
	5.00 and greater			5.60			31,978	5.59			31,373	5.62			35,196	5.62			35,450	5.62			36,079

		Total certificates
			of deposit	3.27			7,508,636	2.94			6,472,674	2.66			5,550,018	2.58			5,223,906	2.49			4,206,851

			Total deposits	2.46	%	$	11,042,072	2.14	%	$	10,309,077	1.89	%	$	9,657,978	1.80	%	$	9,551,333	1.65	%	$	8,948,238

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

Borrowings

During the current quarter, our borrowings declined $1.1 billion to $4.2 billion, due to a decrease in FHLB advances. This followed a $534 million increase in borrowings during the first quarter of 2005.

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

		June 30,			March 31,			December 31,			September 30,			June 30,
(Dollars in Thousands)		2005			2005			2004			2004			2004

Securities sold under agreements to repurchase		$	-		$	-		$	-		$	251,875		$	239,688
Federal Home Loan Bank advances			4,002,757			5,093,874			4,559,622			4,418,729			3,556,087
Senior notes			198,004			197,964			197,924			197,886			198,179
Junior subordinated debentures ^(a)			-			-			-			-			123,711

	Total borrowings	$	4,200,761		$	5,291,838		$	4,757,546		$	4,868,490		$	4,117,665

Weighted average rate on borrowings during
	the quarter ^(b)		3.42	%		3.03	%		2.67	%		2.40	%		2.37	%
Total borrowings as a percentage of total assets			25.29			31.33			30.40			31.13			28.95

^(a) On July 23, 2004, we redeemed our junior subordinated debentures before their maturity.
^(b) Included the impact of swap contracts, with notional amounts totaling $430 million of receive-fixed, pay-3-month LIBOR variable interest, which contracts serve as a permitted hedge against a portion of our FHLB advances.

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Off-Balance Sheet Arrangements

We consolidate majority-owned subsidiaries that we control. We account for other affiliates, including joint ventures, in which we do not exhibit significant control or have majority ownership, by the equity method of accounting. For those relationships in which we own less than 20%, we generally carry them at cost. In the course of our business, we participate in real estate joint ventures through our wholly-owned subsidiary, DSL Service Company. Our real estate joint ventures do not require consolidation as a result of applying the provisions of Financial Accounting Standards Board Interpretation 46 (revised December 2003).

We also utilize financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers and to reduce our own exposure to fluctuations in interest rates. These financial instruments include commitments to originate fixed and variable rate mortgage loans held for investment, undisbursed loan funds, lines and letters of credit, commitments to purchase loans and mortgage-backed securities for our portfolio and commitments to invest in community development funds. The contract or notional amounts of these instruments reflect the extent of involvement we have in particular classes of financial instruments. For further information, see Asset/Liability Management and Market Risk on page 37 and Note 3 of Notes to the Consolidated Financial Statements on page 8.

We use the same credit policies in making commitments to originate or purchase loans, lines of credit and letters of credit as we do for on-balance sheet instruments. For commitments to originate loans held for investment, the contract amounts represent exposure to loss from market fluctuations as well as credit loss. In regard to these commitments, adverse changes from market fluctuations are generally not hedged. We control the credit risk of our commitments to originate loans held for investment through credit approvals, limits and monitoring procedures.

We do not dispose of troubled loans or problem assets by means of unconsolidated special purpose entities.

Transactions with Related Parties

There are no related party transactions required to be disclosed in accordance with FASB Statement No. 57, Related Party Disclosures. Loans to our executive officers and directors were made in the ordinary course of business and were made on substantially the same terms as comparable transactions.

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Asset/Liability Management and Market Risk

Market risk is the risk of loss from adverse changes in market prices and interest rates. Our market risk arises primarily from interest rate risk in our lending and deposit taking activities. Interest rate risk primarily occurs to the degree that our interest-bearing liabilities reprice or mature on a different basis than our interest-earning assets. Since our earnings depend primarily on our net interest income, which is the difference between the interest and dividends earned on interest-earning assets and the interest paid on interest-bearing liabilities, our principal objectives are to actively monitor and manage the effects of adverse changes in interest rates on net interest income. Our primary strategy to manage interest rate risk is to emphasize the origination for investment of adjustable rate mortgages or loans with relatively short maturities. Interest rates on adjustable rate mortgages are primarily tied to COFI, MTA, LIBOR and CMT. We also may execute swap contracts to change interest rate characteristics of our interest-earning assets or interest-bearing liabilities to better manage interest rate risk.

In addition to the interest rate risk associated with our lending for investment and deposit taking activities, we also have market risk associated with our secondary marketing activities. Changes in mortgage interest rates, primarily fixed rate mortgages, impact the fair value of loans held for sale as well as our interest rate lock commitment derivatives, where we have committed to an interest rate with a potential borrower for a loan we intend to sell. Our objective is to hedge against fluctuations in interest rates through use of forward sale and purchase contracts with national investment banking firms and government-sponsored enterprises and whole loan sale contracts with various parties. These contracts are typically obtained at the time the interest rate lock commitments are made. Therefore, as interest rates fluctuate, the changes in the fair value of our interest rate lock commitments and loans held for sale tend to be offset by changes in the fair value of the hedge contracts. We continue to hedge as previously done before the issuance of SFAS 133. As applied to our risk management strategies, SFAS 133 may increase or decrease reported net income and stockholders’ equity, depending on interest rates and other variables affecting the fair values of derivative instruments and hedged items, but will have no effect on the overall economics of the transactions. The method used for assessing the effectiveness of a hedging derivative, as well as the measurement approach for determining the ineffective aspects of the hedge, is established at the inception of the hedge. We generally do not enter into derivative contracts for speculative purposes.

Changes in mortgage interest rates also impact the value of our MSRs. Rising interest rates typically result in slower prepayment speeds on the loans being serviced for others which increase the value of MSRs. Declining interest rates typically result in faster prepayment speeds which decrease the value of MSRs. We may use securities or derivatives, or a combination of both, to provide an economic hedge against value changes in our MSRs. In addition, the dollar amount used as an economic hedge may vary due to changes in the volume of MSRs or their sensitivity to changes in market interest rates.

There has been no significant change in our market risk since December 31, 2004.

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One measure of our exposure to differential changes in interest rates between assets and liabilities is shown in the following table which sets forth the repricing frequency of our major asset and liability categories as of June 30, 2005, as well as other information regarding the repricing and maturity differences between our interest-earning assets and total deposits and borrowings in future periods. We refer to these differences as “gap.” We have determined the repricing frequencies by reference to projected maturities, based upon contractual maturities as adjusted for scheduled repayments and “repricing mechanisms”—provisions for changes in the interest and dividend rates of assets and liabilities. We assume prepayment rates on substantially all of our loan portfolio based upon our historical loan prepayment experience and anticipated future prepayments. Repricing mechanisms on a number of our assets are subject to limitations, such as caps on the amount that interest rates and payments on our loans may adjust, and accordingly, these assets do not normally respond to changes in market interest rates as completely or rapidly as our liabilities. The interest rate sensitivity of our assets and liabilities illustrated in the following table would vary substantially if we used different assumptions or if actual experience differed from the assumptions set forth.

					June 30, 2005

					Within			7 – 12			1 – 5			6 – 10			Over			Total
(Dollars in Thousands)					6 Months			Months			Years			Years			10 Years			Balance

Interest-earning assets:
	Investment securities and stock^(a)				$	366,584		$	115,291		$	318,940		$	-		$	-		$	800,815
	Loans and mortgage-backed securities:^(b)
		Loans secured by real estate:
			Residential:
				Adjustable		14,120,821			239,932			453,923			-			-			14,814,676
				Fixed		120,655			10,427			30,633			4,491			754			166,960
			Commercial real estate			18,894			313			8,698			351			-			28,256
			Construction			41,975			-			-			-			-			41,975
			Land			30,516			7			647			-			-			31,170
		Non-mortgage loans:
			Commercial			985			-			-			-			-			985
			Consumer			322,412			96			133			-			-			322,641
		Mortgage-backed securities				292			-			-			-			-			292

	Total loans and mortgage-backed securities, net					14,656,550			250,775			494,034			4,842			754			15,406,955

		Total interest-earning assets			$	15,023,134		$	366,066		$	812,974		$	4,842		$	754		$	16,207,770

Transaction accounts:
	Non-interest-bearing checking				$	715,152		$	-		$	-		$	-		$	-		$	715,152
	Interest-bearing checking^(c)					513,559			-			-			-			-			513,559
	Money market ^(d)					159,402			-			-			-			-			159,402
	Regular passbook ^(d)					2,145,323			-			-			-			-			2,145,323

		Total transaction accounts				3,533,436			-			-			-			-			3,533,436
Certificates of deposit^(e)						4,896,708			1,490,735			1,121,193			-			-			7,508,636

	Total deposits					8,430,144			1,490,735			1,121,193			-			-			11,042,072
FHLB advances and other borrowings						3,402,457			15,000			556,300			29,000			-			4,002,757
Senior notes						-			-			-			198,004			-			198,004
Impact of swap contracts hedging borrowings						430,000			-			(430,000	)		-			-			-

	Total deposits and borrowings				$	12,262,601		$	1,505,735		$	1,247,493		$	227,004		$	-		$	15,242,833

Excess (shortfall) of interest-earning assets over
	deposits and borrowings				$	2,760,533		$	(1,139,669	)	$	(434,519	)	$	(222,162	)	$	754		$	964,937
Cumulative gap						2,760,533			1,620,864			1,186,345			964,183			964,937
Cumulative gap – as a percentage of total assets:
	June 30, 2005					16.62	%		9.76	%		7.14	%		5.80	%		5.81	%
	December 31, 2004					17.05			9.25			6.96			5.54			5.55
	June 30, 2004					20.33			12.58			4.79			6.35			4.98

^(a) Includes FHLB stock and is based upon contractual maturity and repricing date.
^(b) Based upon contractual maturity, repricing date and projected repayment and prepayments of principal reported.
^(c) Included amounts swept into money market deposit accounts and is subject to immediate repricing.
^(d) Subject to immediate repricing.
^(e) Based upon contractual maturity and repricing date.

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Our six-month gap at June 30, 2005 was a positive 16.62%. This means that more interest-earning assets mature or reprice within six months than total deposits and borrowings. This compares to our positive six-month gap of 17.05% at December 31, 2004 and 20.33% a year ago.

We continue to emphasize the origination of adjustable rate mortgages for our investment portfolio and plan to sell the originations in excess of our balance sheet needs into the secondary market to the extent we can do so profitably. For the twelve months ended June 30, 2005, we originated and purchased for investment $7.7 billion of adjustable rate loans which represented essentially all of the loans we originated and purchased for investment during the period.

At June 30, 2005, December 31, 2004 and June 30, 2004 essentially all of our interest-earning assets mature, reprice or are estimated to prepay within five years. At June 30, 2005, $14.3 billion or essentially all of our loans held for investment and mortgage-backed securities portfolios consisted of adjustable rate loans and loans with a due date of five years or less, compared to $13.2 billion or 99% at December 31, 2004, and $12.2 billion or 99% a year ago. During the current quarter, we continued to offer residential fixed rate loan products to our customers primarily for sale in the secondary market. We price and originate fixed rate mortgage loans for sale into the secondary market to increase opportunities to originate adjustable rate mortgages and to generate fees and servicing income. We also occasionally originate a small number of fixed rate loans for portfolio to facilitate the sale of real estate acquired in settlement of loans and which meet specific yield and other approved guidelines.

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

				June 30,		March 31,		December 31,		September 30,		June 30,
				2005		2005		2004		2004		2004

Weighted average yield: ^(a)
	Loans and mortgage-backed securities			5.42	%	5.00	%	4.67	%	4.46	%	4.37	%
	Federal Home Loan Bank stock			4.44		4.26		3.89		3.90		4.42
	Investment securities ^(b)			3.96		3.86		3.88		3.96		3.61

		Interest-earning assets yield		5.36		4.95		4.63		4.43		4.34

Weighted average cost:
	Deposits			2.46		2.14		1.89		1.80		1.65
	Borrowings:
		Securities sold under agreements to repurchase		-		-		-		1.60		0.60
		Federal Home Loan Bank advances ^(c)		3.57		3.08		2.77		2.32		2.06
		Senior notes		6.50		6.50		6.50		6.50		6.50
		Junior subordinated debentures ^(d)		-		-		-		-		10.00

			Total borrowings	3.71		3.21		2.93		2.45		2.43

		Combined funds cost		2.80		2.50		2.23		2.02		1.90

			Interest rate spread	2.56	%	2.45	%	2.40	%	2.41	%	2.44	%

^(a) Excludes adjustments for non-accrual loans, and amortization of net deferred costs to originate loans, premiums and discounts.
^(b) Yields for securities available for sale are calculated using historical cost balances and do not give effect to changes in fair value that are reflected as a component of stockholders’ equity.
^(c) Included the impact of swap contracts, with notional amounts totaling $430 million of receive-fixed, pay-3-month LIBOR variable interest, which contracts serve as a permitted hedge against a portion of our FHLB advances.
^(d) On July 23, 2004, we redeemed our junior subordinated debentures before maturity.

The period-end weighted average yield on our loan portfolio increased to 5.42% at June 30, 2005, up from 4.67% at December 31, 2004 and 4.37% at June 30, 2004. At June 30, 2005, our adjustable rate mortgage portfolio of single family residential loans, including mortgage-backed securities, totaled $14.7 billion with a weighted average rate of 5.37%, compared to $13.9 billion with a weighted average rate of 4.61% at December 31, 2004, and $12.4 billion with a weighted average rate of 4.30% at June 30, 2004.

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Problem Loans and Real Estate

Non-Performing Assets

Non-performing assets consist of loans on which we have ceased accruing interest (which we refer to as non-accrual loans), loans restructured at a below market rate, real estate acquired in settlement of loans and repossessed automobiles. Our non-performing assets declined $4 million during the current quarter to $25 million or 0.15% of total assets. The decrease occurred in our prime residential loan category, which was partially offset by an increase in our subprime residential loan category.

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

			June 30,			March 31,			December 31,			September 30,			June 30,
(Dollars in Thousands)			2005			2005			2004			2004			2004

Non-accrual loans:
	Residential one-to-four units		$	12,004		$	16,835		$	20,470		$	23,091		$	24,445
	Residential one-to-four units – subprime			10,599			8,798			10,696			12,870			12,615
	Other			456			466			468			464			475

		Total non-accrual loans		23,059			26,099			31,634			36,425			37,535
Real estate acquired in settlement of loans				2,201			2,783			2,555			2,819			2,424
Repossessed automobiles				-			-			-			-			9

	Total non-performing assets		$	25,260		$	28,882		$	34,189		$	39,244		$	39,968

Allowance for loan losses:
	Amount		$	36,380		$	36,713		$	34,714		$	34,551		$	33,450
	As a percentage of non-performing loans			157.77	%		140.67	%		109.74	%		94.86	%		89.12	%
Non-performing assets as a percentage of total assets				0.15			0.17			0.22			0.25			0.28

Delinquent Loans

Loans delinquent 30 days or more as a percentage of total loans was 0.27% at June 30, 2005, unchanged from March 31, 2005 and down from 0.40% a year ago. The declines primarily occurred in our residential one-to-four units category.

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

			June 30, 2005												March 31, 2005

			30-59			60-89			90+						30-59			60-89			90+
(Dollars in Thousands)			Days			Days			Days ^(a)			Total			Days			Days			Days ^(a)			Total

Loans secured by real estate:
	Residential:
		One-to-four units	$	14,311		$	3,620		$	11,144		$	29,075		$	14,341		$	4,837		$	12,562		$	31,740
		One-to-four units – subprime		3,136			3,043			5,566			11,745			2,474			1,961			5,487			9,922
		Five or more units		-			-			-			-			-			-			-			-
	Commercial real estate			-			-			-			-			-			-			-			-
	Construction			-			-			-			-			-			-			-			-
	Land			-			-			-			-			-			-			-			-

		Total real estate loans		17,447			6,663			16,710			40,820			16,815			6,798			18,049			41,662
Non-mortgage:
	Commercial			-			-			428			428			-			-			428			428
	Automobile			-			-			-			-			11			-			-			11
	Other consumer			373			11			28			412			169			11			38			218

		Total delinquent loans	$	17,820		$	6,674		$	17,166		$	41,660		$	16,995		$	6,809		$	18,515		$	42,319

Delinquencies as a percentage of total loans				0.12	%		0.04	%		0.11	%		0.27	%		0.11	%		0.04	%		0.12	%		0.27	%


			December 31, 2004												September 30, 2004

Loans secured by real estate:
	Residential:
		One-to-four units	$	13,446		$	4,089		$	16,949		$	34,484		$	9,858		$	6,480		$	16,283		$	32,621
		One-to-four units – subprime		3,756			2,143			5,998			11,897			4,650			3,818			5,940			14,408
		Five or more units		-			-			-			-			-			-			-			-
	Commercial real estate			-			-			-			-			-			-			-			-
	Construction			-			-			-			-			-			-			-			-
	Land			-			-			-			-			-			-			-			-

		Total real estate loans		17,202			6,232			22,947			46,381			14,508			10,298			22,223			47,029
Non-mortgage:
	Commercial			-			-			428			428			-			-			428			428
	Automobile			22			2			-			24			1			-			-			1
	Other consumer			31			44			40			115			30			43			36			109

		Total delinquent loans	$	17,255		$	6,278		$	23,415		$	46,948		$	14,539		$	10,341		$	22,687		$	47,567

Delinquencies as a percentage of total loans				0.13	%		0.04	%		0.16	%		0.33	%		0.11	%		0.07	%		0.16	%		0.34	%


			June 30, 2004

Loans secured by real estate:
	Residential:
		One-to-four units	$	11,844		$	6,333		$	18,004		$	36,181
		One-to-four units – subprime		3,935			2,427			7,854			14,216
		Five or more units		-			-			-			-
	Commercial real estate			-			-			-			-
	Construction			-			-			-			-
	Land			-			-			-			-

		Total real estate loans		15,779			8,760			25,858			50,397
Non-mortgage:
	Commercial			-			-			428			428
	Automobile			-			11			8			19
	Other consumer			309			13			39			361

		Total delinquent loans	$	16,088		$	8,784		$	26,333		$	51,205

Delinquencies as a percentage of total loans				0.13	%		0.07	%		0.20	%		0.40	%

^(a) All 90 day or greater delinquencies are on non-accrual status and reported as part of non-performing assets.

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Allowance for Losses on Loans and Real Estate

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

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

Allowances for losses on all assets were $38 million at June 30, 2005, compared to $36 million at December 31, 2004, and $35 million a year ago.

In the current quarter, our provision for loan losses was $0.6 million and net loan charge-offs totaled $0.9 million, resulting in a decrease in the allowance for loan losses from $37 million to $36 million at June 30, 2005. The current quarter decrease in the allowance reflected a decrease of $0.4 million in the general valuation allowance due to a decrease in the loan portfolio. There was no change in our unallocated allowance of $2.8 million.

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

		Three Months Ended

		June 30,			March 31,			December 31,			September 30,			June 30,
(In Thousands)		2005			2005			2004			2004			2004

Balance at beginning of period		$	36,713		$	34,714		$	34,551		$	33,450		$	32,072
Provision (reduction)			583			2,038			(1,553	)		1,186			1,458
Charge-offs			(925	)		(46	)		(107	)		(94	)		(86	)
Recoveries			9			7			1,823			9			6

	Balance at end of period	$	36,380		$	36,713		$	34,714		$	34,551		$	33,450

Since year-end 2004, our allowance for loan losses increased by $1.7 million, reflecting an increase in the general valuation allowances of $2.1 million and a decline in allocated allowances of $0.4 million.

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

		Six Months Ended June 30,

(In Thousands)		2005			2004

Balance at beginning of period		$	34,714		$	30,330
Provision			2,621			3,262
Charge-offs			(971	)		(182	)
Recoveries			16			40

	Balance at end of period	$	36,380		$	33,450

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The following table presents gross charge-offs, gross recoveries and net charge-offs by category of loan for the periods indicated.

			Three Months Ended															Six Months Ended

			June 30,			March 31,			December 31,			September 30,			June 30,			June 30,
(Dollars in Thousands)			2005			2005			2004			2004			2004			2005			2004

Gross loan charge-offs
Loans secured by real estate:
	Residential:
		One-to-four units	$	879		$	-		$	78		$	56		$	27		$	879		$	72
		One-to-four units – subprime		-			-			-			-			-			-			-
		Five or more units		-			-			-			-			-			-			-
	Commercial real estate			-			-			-			-			-			-			-
	Construction			-			-			-			-			-			-			-
	Land			-			-			-			-			-			-			-
Non-mortgage:
	Commercial			-			-			-			-			-			-			-
	Automobile			1			8			2			7			3			9			13
	Other consumer			45			38			27			31			56			83			97

		Total gross loan charge-offs		925			46			107			94			86			971			182

Gross loan recoveries
Loans secured by real estate:
	Residential:
		One-to-four units		-			-			-			-			-			-			-
		One-to-four units – subprime		-			-			-			-			1			-			26
		Five or more units		-			-			-			-			-			-			-
	Commercial real estate			-			-			1,819			-			-			-			-
	Construction			-			-			-			-			-			-			-
	Land			-			-			-			-			-			-			-
Non-mortgage:
	Commercial			-			-			-			-			-			-			-
	Automobile			-			-			2			3			2			-			7
	Other consumer			9			7			2			6			3			16			7

		Total gross loan recoveries		9			7			1,823			9			6			16			40

Net loan charge-offs
Loans secured by real estate:
	Residential:
		One-to-four units		879			-			78			56			27			879			72
		One-to-four units – subprime		-			-			-			-			(1	)		-			(26	)
		Five or more units		-			-			-			-			-			-			-
	Commercial real estate			-			-			(1,819	)		-			-			-			-
	Construction			-			-			-			-			-			-			-
	Land			-			-			-			-			-			-			-
Non-mortgage:
	Commercial			-			-			-			-			-			-			-
	Automobile			1			8			-			4			1			9			6
	Other consumer			36			31			25			25			53			67			90

		Total net loan charge-offs	$	916		$	39		$	(1,716	)	$	85		$	80		$	955		$	142

Net loan charge-offs as a
	percentage of average loans			0.02	%		-	%		(0.05	)%		-	%		-	%		0.01	%		-	%

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

			June 30,		March 31,		December 31,		September 30,		June 30,
(Dollars in Thousands)			2005		2005		2004		2004		2004

Loans secured by real estate:
	Residential:
		One-to-four units	$	20,577	$	21,700	$	20,452	$	20,562	$	19,547
		One-to-four units – subprime		6,877		6,355		6,130		5,997		5,569
		Five or more units		680		704		724		730		780
	Commercial real estate			350		297		492		561		1,096
	Construction			1,083		917		797		855		951
	Land			855		781		352		321		333
Non-mortgage:
	Commercial			446		446		451		461		460
	Automobile			5		8		13		19		37
	Other consumer			2,707		2,705		2,503		2,245		1,877
Not specifically allocated				2,800		2,800		2,800		2,800		2,800

		Total for loans held for investment	$	36,380	$	36,713	$	34,714	$	34,551	$	33,450

The following table indicates our allowance for loan losses as a percentage of loan category balance for the various categories of loans at the dates indicated.

			June 30,			March 31,			December 31,			September 30,			June 30,
(Dollars in Thousands)			2005			2005			2004			2004			2004

Loans secured by real estate:
	Residential:
		One-to-four units		0.16	%		0.17	%		0.18	%		0.18	%		0.18	%
		One-to-four units – subprime		0.55			0.49			0.49			0.51			0.52
		Five or more units		0.75			0.75			0.75			0.75			0.75
	Commercial real estate			1.20			1.00			1.51			1.32			2.58
	Construction			1.16			1.18			1.18			1.18			1.18
	Land			1.31			1.31			1.38			1.25			1.24
Non-mortgage:
	Commercial			9.92			9.36			9.03			7.70			9.05
	Automobile			1.56			1.48			1.52			1.46			1.94
	Other consumer			0.83			0.86			0.88			0.95			1.04

		Total for loans held for investment		0.25	%		0.26	%		0.26	%		0.26	%		0.27	%

The following table indicates by loan category the percentage mix of our total loans held for investment at the dates indicated.

			June 30,			March 31,			December 31,			September 30,			June 30,
(Dollars in Thousands)			2005			2005			2004			2004			2004

Loans secured by real estate:
	Residential:
		One-to-four units		86.97	%		86.95	%		86.69	%		87.60	%		87.60	%
		One-to-four units – subprime		8.79			9.01			9.45			8.78			8.80
		Five or more units		0.63			0.66			0.73			0.73			0.85
	Commercial real estate			0.20			0.21			0.25			0.32			0.35
	Construction			0.65			0.54			0.51			0.55			0.66
	Land			0.46			0.41			0.19			0.19			0.22
Non-mortgage:
	Commercial			0.03			0.03			0.04			0.05			0.04
	Automobile			-			-			0.01			0.01			0.01
	Other consumer			2.27			2.19			2.13			1.77			1.47

		Total for loans held for investment		100.00	%		100.00	%		100.00	%		100.00	%		100.00	%

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At June 30, 2005, there were no loans for which we recognized impairment. This was down from $3 million at December 31, 2004 and $12 million a year ago. There was no allowance for losses related to impaired loans at quarter end. There was less than a $1 million allowance for losses related to impaired loans at December 31, 2004 and $1 million at June 30, 2004. During the current quarter, there was no interest recognized on the impaired loan portfolio. The year-to-date total interest recognized on the impaired loan portfolio was less than $1 million.

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

		Three Months Ended

		June 30,		March 31,			December 31,		September 30,			June 30,
(In Thousands)		2005		2005			2004		2004			2004

Balance at beginning of period		$	-	$	193		$	41	$	699		$	704
Provision (Reduction)			-		(193	)		152		(658	)		(5	)
Charge-offs			-		-			-		-			-
Recoveries			-		-			-		-			-

	Balance at end of period	$	-	$	-		$	193	$	41		$	699

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

		Six Months Ended June 30,

(In Thousands)		2005			2004

Balance at beginning of period		$	193		$	709
Reduction			(193	)		(10	)
Charge-offs			-			-
Recoveries			-			-

	Balance at end of period	$	-		$	699

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

		Three Months Ended

		June 30,		March 31,		December 31,		September 30,		June 30,
(In Thousands)		2005		2005		2004		2004		2004

Balance at beginning of period		$	1,436	$	1,436	$	1,436	$	1,436	$	1,436
Provision			-		-		-		-		-
Charge-offs			-		-		-		-		-
Recoveries			-		-		-		-		-

	Balance at end of period	$	1,436	$	1,436	$	1,436	$	1,436	$	1,436

The following table summarizes the activity in our allowance for real estate and joint ventures held for investment for the year-to-date periods indicated.

		Six Months Ended June 30,

(In Thousands)		2005		2004

Balance at beginning of period		$	1,436	$	1,436
Provision			-		-
Charge-offs			-		-
Recoveries			-		-

	Balance at end of period	$	1,436	$	1,436

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Capital Resources and Liquidity

Our sources of funds include deposits, advances from the FHLB and other borrowings; proceeds from the sale of loans, mortgage-backed securities and real estate; payments of loans and mortgage-backed securities and payments for and sales of loan servicing; and income from other investments. Interest rates, real estate sales activity and general economic conditions significantly affect repayments on loans and mortgage-backed securities and deposit inflows and outflows.

Our primary sources of funds generated in the second quarter of 2005 were from:

principal repayments of $1.216 billion—including prepayments, but excluding refinances of our existing loans—on loans and mortgage-backed securities;
an increase of $733 million in deposits; and
a net decline of $341 million in our loans held for sale.

We used these funds to:

originate and purchase $1.197 billion of loans held for investment, excluding refinances of our existing loans; and
repay $1.098 billion in FHLB advances and other borrowings.

Our principal source of liquidity is our ability to utilize borrowings, as needed. Our primary source of borrowings is the FHLB. At June 30, 2005, our FHLB borrowings totaled $4.0 billion, representing 24.1% of total assets. We currently are approved by the FHLB to borrow up to 50% of total assets to the extent we provide qualifying collateral and hold sufficient FHLB stock. That approved limit would have permitted us, as of quarter end, to borrow an additional $4.3 billion. To the extent deposit growth over the remainder of 2005 falls short of satisfying ongoing commitments to fund maturing and withdrawable deposits, repay maturing borrowings, fund existing and future loans and make investments, we may utilize the additional capacity from our FHLB borrowing arrangement or other sources. As of June 30, 2005, we had commitments to borrowers for short-term rate locks, excluding expected fallout, of $1.0 billion, undisbursed loan funds and unused lines of credit of $491 million, operating leases of $19 million and commitments to invest in community development funds of $2 million. We believe our current sources of funds, including repayments of existing loans, enable us to meet our obligations while maintaining liquidity at appropriate levels.

The holding company currently has adequate liquid assets to meet its obligations and can obtain further funds by means of dividends from subsidiaries, subject to certain limitations, or issuance of further debt or equity. At June 30, 2005, the holding company’s liquid assets, including due from Bank—interest bearing balances, totaled $41 million.

Stockholders’ equity totaled $1.1 billion at June 30, 2005, up from $1.0 billion at December 31, 2004 and $942 million a year ago.

Contractual Obligations and Other Commitments

Through the normal course of operations, we have entered into certain contractual obligations and other commitments. Our obligations generally relate to funding of our operations through deposits and borrowings as well as leases for premises and equipment, and our commitments generally relate to our lending operations. We have obligations under long-term operating leases, principally for building space and land. Lease terms generally cover a five-year period, with options to extend, and are non-cancelable. Currently, we have no material contractual vendor obligations.

We executed interest rate swap contracts to change interest rate characteristics of a portion of our FHLB advances to better manage interest rate risk. The contracts have notional amounts totaling $430 million of receive-fixed, pay 3-month LIBOR variable interest and serve as a permitted fair value hedge.

Our commitments to originate fixed and variable rate mortgage loans are agreements to lend to a customer as long as there is no violation of any condition established in the commitment. Undisbursed loan funds on construction projects and unused lines of credit on home equity and commercial loans include committed funds not disbursed. Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party.

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Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The credit risk involved in issuing lines and letters of credit requires the same creditworthiness evaluation as that involved in extending loan facilities to customers. We evaluate each customer’s creditworthiness.

We receive collateral to support commitments when deemed necessary. The most significant categories of collateral include real estate properties underlying mortgage loans, liens on personal property and cash on deposit with us.

We enter into derivative financial instruments as part of our interest rate risk management process, including forward sale and purchase contracts related to our sale of loans in the secondary market. The associated fair value changes to the notional amount of the derivative instruments are recorded on-balance sheet. The total notional amount of our derivative financial instruments do not represent future cash requirements. For further information, see Asset/Liability Management and Market Risk on page 37 and Note 3 of Notes to the Consolidated Financial Statements on page 8.

We sell all loans without recourse. When a loan sold to an investor without recourse fails to perform according to the contractual terms, the investor will typically review the loan file to determine whether defects in the origination process occurred and whether such defects give rise to a violation of a representation or warranty made to the investor in connection with the sale. If such a defect is identified, we may be required to either repurchase the loan or indemnify the investor for losses sustained. If there are no such defects, we have no commitment to repurchase the loan. During the first six months of 2005, we recorded less than a $1 million repurchase loss related to defects in the origination process. These loan and servicing sale contracts typically contain provisions to refund sales price premiums to the purchaser if the related loans prepay during a period not to exceed 120 days from the sale settlement date. We reserved $1 million at June 30, 2005, $7 million at December 31, 2004 and less than $1 million at June 30, 2004 to cover the estimated loss exposure related to early payoffs. See Note 3 of Notes to the Consolidated Financial Statements on page 8.

At June 30, 2005, scheduled maturities of obligations and commitments were as follows:

			Within		1 – 3		4 – 5		Over		Total
(In Thousands)			1 Year		Years		Years		5 Years		Balance

Certificates of deposit			$	6,387,443	$	907,441	$	213,752	$	-	$	7,508,636
FHLB advances				3,417,457		126,300		430,000		29,000		4,002,757
Senior notes				-		-		-		198,004		198,004
Secondary marketing activities:
	Non-qualifying hedge transactions:
		Expected rate lock commitments		624,604		-		-		-		624,604
		Associated forward sale contracts		572,977		-		-		-		572,977
	Qualifying cash flow hedge transactions:
		Loans held for sale, at lower of cost or fair value		914,277		-		-		-		914,277
		Associated forward sale contracts		905,373		-		-		-		905,373
Qualifying fair value hedge transactions:
	Designated FHLB advances – pay-fixed			-		-		430,000		-		430,000
	Associated interest rate swap contracts –
		pay-variable, receive-fixed		-		-		430,000		-		430,000
Commitments to originate adjustable loans held
	for investment			228,310		-		-		-		228,310
Undisbursed loan funds and unused lines of credit				42,130		39,161		-		410,084		491,375
Operating leases				4,004		7,796		4,256		2,445		18,501
Commitments to invest in community
	development funds			-		-		-		1,832		1,832

		Total obligations and commitments	$	13,096,575	$	1,080,698	$	1,508,008	$	641,365	$	16,326,646

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Regulatory Capital Compliance

At June 30, 2005, our core and tangible capital ratios were both 7.31% and our risk-based capital ratio was 14.11%. The Bank’s capital ratios compare favorably with the “well capitalized” standards of 5.00% for core capital and 10.00% for risk-based capital, as defined by regulation.

The following table is a reconciliation of the Bank’s stockholder’s equity to federal regulatory capital as of June 30, 2005.

				Tangible Capital						Core Capital					Risk-Based Capital

(Dollars in Thousands)				Amount			Ratio			Amount			Ratio		Amount			Ratio

Stockholder’s equity				$	1,280,041					$	1,280,041				$	1,280,041
Adjustments:
	Deductions:
		Investment in subsidiary, primarily real estate			(68,060	)					(68,060	)				(68,060	)
		Excess cost over fair value of branch acquisitions			(3,150	)					(3,150	)				(3,150	)
		Non-permitted mortgage servicing rights			(1,683	)					(1,683	)				(1,683	)
	Additions:
		Unrealized losses on securities available for sale			1,427						1,427					1,427
		General loss allowance – investment in DSL
			Service Company		730						730					730
		Allowance for loan losses,
			net of specific allowances ^(a)		-						-					35,941

Regulatory capital					1,209,305		7.31	%			1,209,305		7.31	%		1,245,246		14.11	%
Well capitalized requirement					248,027		1.50		^(b)		826,755		5.00			882,223		10.00		^(c)

Excess				$	961,278		5.81	%		$	382,550		2.31	%	$	363,023		4.11	%

^(a) Limited to 1.25% of risk-weighted assets.
^(b) Represents the minimum requirement for tangible capital, as no “well capitalized” requirement has been established for this category.
^(c) A third requirement is Tier 1 capital to risk-weighted assets of 6.00%, which the Bank met and exceeded with a ratio of 13.71%.

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ITEM 3. – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For information regarding quantitative and qualitative disclosures about market risk, see Asset/Liability Management and Market Risk on page 37.

ITEM 4. – CONTROLS AND PROCEDURES

As of June 30, 2005, Downey carried out an evaluation, under the supervision and with the participation of Downey’s management, including Downey’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Downey’s disclosure controls and procedures pursuant to Securities and Exchange Commission (“SEC”) rules. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that Downey’s disclosure controls and procedures were effective as of the end of the period covered by this report. There have been no significant changes during the most recent quarter in Downey’s internal controls over financial reporting or in other factors that could significantly affect these controls subsequent to the evaluation date.

Disclosure controls and procedures are defined in SEC rules as controls and other procedures designed to ensure that information required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Downey’s disclosure controls and procedures were designed to ensure that material information related to Downey, including subsidiaries, is made known to management, including the Chief Executive Officer and Chief Financial Officer, in a timely manner.

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PART II – OTHER INFORMATION

ITEM 1. – Legal Proceedings

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

ITEM 2. – Unregistered Sales of Equity Securities and Use of Proceeds

None.

ITEM 3. – Defaults Upon Senior Securities

None.

ITEM 4. – Submission of Matters to a Vote of Security Holders

On April 27, 2005, Downey held its annual meeting of shareholders to elect three Class 1 Directors for terms of three years each and to ratify the Board of Directors’ appointment of KPMG LLP as auditors for the year ending December 31, 2005. The number of votes cast at the meeting as to each matter acted upon was as follows:

1.	Election of Directors:

		Nominees	Votes For	Votes Withheld	Unvoted

		Gerald E. Finnell	24,377,647	367,620	3,108,516
		Maurice L. McAlister	17,919,388	6,825,879	3,108,516
		Daniel D. Rosenthal	18,700,146	6,045,121	3,108,516

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

		Continuing Directors	Year Term Expires

		James H. Hunter	2007
		Brent McQuarrie	2007
		Jane Wolfe	2007
		Lester C. Smull	2006
		Michael B. Abrahams	2006
		Cheryl E. Olson	2006

2.	Ratification of appointment of KPMG LLP as auditors for the year ending December 31, 2005:

		Votes For	Votes Against	Abstain	Unvoted

		24,492,316	246,456	6,495	3,108,516

ITEM 5. – Other Information

None.

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ITEM 6. – Exhibits

Exhibit

Number

Description

31.1

Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002.

31.2

Certification of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002.

32.1

Certification of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

32.2

Certification of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

AVAILABILITY OF REPORTS

Corporate governance guidelines, charters for the audit, compensation, and nominating and corporate governance committees of the Board of Directors and codes of business conduct and ethics are available free of charge from our internet site, www.downeysavings.com by clicking on “Investor Relations” on our home page and proceeding to “Corporate Governance.” Annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports are posted on our internet site as soon as reasonably practical after we file them with the SEC and available free of charge under “Corporate Filings” on our “Investor Relations” page.

We will furnish any or all of the non-confidential exhibits upon payment of a reasonable fee. Please send request for exhibits and/or fee information to:

Downey Financial Corp.
3501 Jamboree Road
Newport Beach, California 92660
Attention: Corporate Secretary

SIGNATURES

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

DOWNEY FINANCIAL CORP.

/s/ Daniel D. Rosenthal

Date: August 3, 2005

Daniel D. Rosenthal

President and Chief Executive Officer

/s/ Thomas E. Prince

Date: August 3, 2005

Thomas E. Prince

Chief Operating Officer and Chief Financial Officer

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