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                                              SECURITIES AND EXCHANGE COMMISSION
                                                          Washington, D.C. 20549
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                                                                       FORM 10-K
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(Mark One)
|X|  Annual report  pursuant to Section 13 or 15(d) of the  Securities  Exchange
     Act of 1934 for the fiscal year ended December 31, 1998

|_|  Transition  report  pursuant  to Section  13 or 15(d) of the  Securities
     Exchange  Act of 1934 for the  transition  period  from  ______________  to
     ______________.
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                                                  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)
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3501 Jamboree Road Newport Beach, California            92660
(Address of principal executive offices)              (Zip Code)

I.R.S. Employer Identification No.:  95-1953342

Registrant's telephone number, including area code:  (949) 854-0300

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

 TITLE OF EACH CLASS                            NAME OF EACH EXCHANGE
-------------------------------                -------------------------
 Common Stock, $0.01 par value                  New York Stock Exchange
                                                Pacific Exchange

Securities registered pursuant to Section 12(g) of the Act:  None
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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 a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of Registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|

The  aggregate  market value of the voting stock held by  non-affiliates  of the
registrant,  based upon the closing  sale price of its Common  Stock on February
26, 1999, on the New York Stock Exchange was $433,528,529.

At February 26, 1999,  28,131,776 shares of the Registrant's Common Stock, $0.01
par value were outstanding.
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DOCUMENTS  INCORPORATED  BY  REFERENCE:   Portions  of  the  Registrant's  Proxy
Statement to be filed with the Securities and Exchange  Commission in connection
with  the  Annual  Meeting  of  Stockholders  to be  held  April  28,  1999  are
incorporated by reference in Part III hereof.

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<PAGE>


TABLE OF CONTENTS

ITEM                                                                      PAGE
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PART I
   1.  BUSINESS ........................................................    1
          General.......................................................    1
          Banking Activities............................................    2
             Lending Activities.........................................    2
                Loan and Mortgage-Backed Securities Portfolio...........    2
                Residential Real Estate Lending.........................    3
                Secondary Marketing and Loan Servicing Activities.......    4
                Commercial Real Estate and Multi-Family Lending.........    5
                Construction Lending....................................    5
                Commercial Lending......................................    5
                Consumer Lending........................................    6
             Investment Activities......................................    6
             Sources of Funds...........................................    6
                Deposits................................................    6
                Borrowings..............................................    7
             Asset/Liability Management.................................    7
             Earnings Spread............................................    7
          Real Estate Investment Activities.............................    8
          Competition ..................................................    8
          Employees.....................................................    9
          Regulation....................................................    9
             General....................................................    9
             Regulation of Downey.......................................    9
             Regulation of the Bank.....................................    9
             Regulation of DSL Service Company..........................   14
          Taxation......................................................   15
          Factors That May Affect Future Results........................   16
   2.  PROPERTIES.......................................................   17
          Branches......................................................   17
          Electronic Data Processing....................................   17
   3.  LEGAL PROCEEDINGS................................................   17
   4.  SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS..................   17

PART II
   5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
        STOCKHOLDER MATTERS.............................................   18
   6.  SELECTED FINANCIAL DATA................. ........................   19
   7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
        AND RESULTS OF OPERATIONS.......................................   20
          Overview......................................................   20
          Results of Operations.........................................   22
             Net Interest Income........................................   22
             Provision for Loan Losses..................................   23
             Other Income...............................................   23
                Loan and Deposit Related Fees...........................   23
                Real Estate and Joint Venture
                Operations Held for Investment..........................   24
                Secondary Marketing Activities .........................   24
                Other Category..........................................   24


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TABLE OF CONTENTS

ITEM                                                                      PAGE
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PART II----(CONTINUED)

             Operating Expenses.........................................   25
             Provision for Income Taxes.................................   25
             Business Segment Reporting.................................   25
                Banking.................................................   26
                Real Estate Investment..................................   27
          Financial Condition...........................................   28
             Loans and Mortgage-Backed Securities.......................   28
             Investment Securities......................................   32
             Investments in Real Estate and Joint Ventures..............   33
             Deposits...................................................   35
             Borrowings.................................................   36
             Asset/Liability Management and Market Risk.................   37
             Problem Loans and Real Estate..............................   42
                Non-Performing Assets...................................   42
                Delinquent Loans........................................   44
                Allowance for Losses on Loans and Real Estate...........   46
             Capital Resources and Liquidity............................   50
             Regulatory Capital Compliance..............................   51
             Current Accounting Issue...................................   51
             Year 2000..................................................   52
                Risks of the Year 2000 Issue............................   52
                State of Readiness......................................   52
                Costs to Address the Year 2000 Issue....................   53
                Contingency Plans.......................................   53
   8.  FINANCIAL STATEMENTS.............................................   54
   9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
        ACCOUNTING AND FINANCIAL DISCLOSURES............................   97

PART III
  10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...............   97
  11.  EXECUTIVE COMPENSATION...........................................   97
  12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
        MANAGEMENT......................................................   97
  13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................   97

PART IV
  14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
        ON FORM 8-K.....................................................   97
SIGNATURES   ...........................................................   99


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                                     PART I

Certain matters  discussed in this Annual Report may constitute  forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 (the "Reform Act") and, as such, may involve risks and uncertainties. These
forward-looking  statements  relate to, among other things,  expectations of the
business  environment  in which  Downey  Financial  Corp.  ("Downey")  operates,
projections of future  performance,  perceived  opportunities  in the market and
statements  regarding  Downey's  mission and vision.  Downey's  actual  results,
performance,   or  achievements  may  differ  significantly  from  the  results,
performance,  or  achievements  expressed  or  implied  in such  forward-looking
statements.  For  discussion  of the factors that might cause such a difference,
see "Item 1. Business - Factors That May Affect Future Results" on page 16.

ITEM 1. BUSINESS

                                    General

Downey was  incorporated  in Delaware on October 21, 1994.  On January 23, 1995,
after obtaining necessary stockholder and regulatory approvals,  Downey acquired
100% of the issued and  outstanding  capital  stock of Downey  Savings  and Loan
Association (the "Bank"), and the Bank's stockholders became the stockholders of
Downey. Downey was thereafter  capitalized by the Bank and presently operates as
the Bank's holding company. Unless otherwise stated or indicated,  references to
"Downey" or the "Bank" include their respective subsidiaries.

The  Bank  was  formed  in  1957  as  a  California-licensed  savings  and  loan
association and conducts its business  through 91 retail deposit branches (28 of
which are full-service  in-store branches).  Residential loans are originated by
retail loan officers who are located in 42 retail deposit branches in California
providing loan origination services to all the Bank's branches,  and two centers
outside  California,  one each in Arizona and  Washington.  Retail loan officers
also originated residential loans via the internet from a call center located in
California.  Wholesale loans  submitted by mortgage  brokers are originated from
seven loan  origination  centers in California,  five of which are located in or
adjacent to a Bank office,  and two loan origination  centers located outside of
California,  one each in Arizona and Washington. The executive offices of Downey
are located at 3501  Jamboree  Road,  North Tower,  Newport  Beach,  California,
92660, and the telephone  number is (949) 854-0300.  Downey's stock is traded on
the New York Stock Exchange and Pacific Exchange under trading symbol "DSL."

On March 9, 1995, the Bank completed its conversion  from a  California-licensed
to a federally  chartered savings  association and currently  operates under the
name  "Downey  Savings  and Loan  Association,  F.A." As a  federally  chartered
savings  association,  the  Bank's  activities  and  investments  are  generally
governed by the Home Owners'  Loan Act, as amended  ("HOLA"),  and  implementing
regulations and policies of the Office of Thrift  Supervision  (the "OTS").  The
Bank  and  Downey  are  subject  to  the  primary   regulatory  and  supervisory
jurisdiction of the OTS. As a federally insured depository institution, the Bank
is also subject to regulation and supervision by the Federal  Deposit  Insurance
Corporation  ("FDIC") with respect to certain  activities and  investments.  The
Bank is a member of the Federal Home Loan Bank ("FHLB") of San Francisco,  which
is one of the 12 regional banks for federally  insured  depository  institutions
comprising the Federal Home Loan Bank System.  The Bank's  savings  deposits are
insured through the Savings Association  Insurance Fund ("SAIF") of the FDIC, an
instrumentality of the United States government.  The Bank is further subject to
regulations of the Board of Governors of the Federal  Reserve  System  ("Federal
Reserve  Board")  with  respect to reserves  required to be  maintained  against
deposits and certain other matters.

On January 25, 1995,  Downey  Affiliated  Insurance Agency was incorporated as a
wholly owned subsidiary of Downey and was capitalized on February 24, 1995, with
$400,000.  Operations  commenced  in the  second  quarter  of 1995 at which time
representatives of Downey Affiliated Insurance Agency were available in Downey's
branches to offer annuity products.  During 1996,  Downey  Affiliated  Insurance
Agency began  offering  forced-placed  casualty  insurance  policies on mortgage
loans and ceased offering annuity products.

Downey's operations are significantly influenced by general economic conditions,
the monetary and fiscal  policies of the federal  government  and the regulatory
policies  of   governmental   authorities.   Deposit   flows  and  the  cost  of
interest-bearing  liabilities  ("cost of  funds") to Downey  are  influenced  by
interest rates on competing investments


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<PAGE>


and general market interest rates. Similarly, Downey's loan volume and yields on
loans and mortgage-backed  securities ("MBSs"),  and the level of prepayments on
such  loans  and  MBSs,  are  affected  by  market  interest  rates,  as well as
additional  factors  affecting  the  supply of and demand  for  housing  and the
availability of funds.

Downey views its business as  consisting of two business  segments--banking  and
real estate investment--each of which is discussed further below.

                               Banking Activities

Downey's  principal  business  segment is banking,  which consists of attracting
funds from the general public and institutions, and originating and investing in
loans,  primarily  residential real estate mortgage loans,  MBSs, and investment
securities. MBSs include securities issued or guaranteed by government-sponsored
enterprises  ("Agency MBSs"), such as the Federal National Mortgage  Association
("FNMA"),   the  Federal  Home  Loan  Mortgage  Corporation  ("FHLMC")  and  the
Government National Mortgage  Association  ("GNMA"),  and mortgage  pass-through
securities  issued by other  entities.  Downey's  primary sources of revenue are
interest earned on mortgage loans and MBSs,  income from investment  securities,
gains on sales of loans  and MBSs,  fees  earned in  connection  with  loans and
deposits  and income  earned on its  portfolio  of loans and MBSs  serviced  for
investors. Downey's principal expenses are interest incurred on interest-bearing
liabilities,  including deposits and borrowings,  and general and administrative
costs.  Downey's  primary sources of funds are deposits,  principal and interest
payments  on  loans  and  MBSs,  proceeds  from  sales of loans  and  MBSs,  and
borrowings.  Scheduled payments on loans and MBSs are a relatively stable source
of funds, while prepayments of loans and MBSs and flows in deposits vary widely.
Below is a detailed discussion of Downey's banking activities.

LENDING ACTIVITIES

Historically,  Downey's  lending  activities  have emphasized the origination of
first  mortgage loans secured by  residential  property and retail  neighborhood
shopping  centers,  and,  to a lesser  extent,  real  estate  loans  secured  by
multi-family  and  commercial  and  industrial   properties,   including  office
buildings,  land and other  properties with income  producing  capabilities.  In
addition,  Downey has provided construction loan financing for residential (both
single family and  multi-family)  and commercial  retail  neighborhood  shopping
center projects,  including loans to joint ventures where DSL Service Company or
the Bank was a participant.  Downey also originates loans to businesses  through
its commercial banking operations and loans on new and used automobiles  through
the purchase of motor  vehicle sales  contracts  from auto dealers in California
and other western states. The indirect auto lending program is conducted through
Downey Auto Finance Corp., a wholly-owned subsidiary of the Bank, in addition to
automobile loans originated directly through Downey's branch network.

During 1999,  Downey's  primary  focus will  continue to be the  origination  of
adjustable rate single family mortgage loans,  particularly subprime loans which
carry higher  interest  rates,  and  consumer  loans.  In addition,  Downey will
continue its secondary marketing activities of selling its production of certain
fixed rate  single  family  loans as well as certain  adjustable  rate  mortgage
("ARM") loan  products.  Given the current low  interest  rate  environment  and
customer preference for fixed rate loans, it is likely Downey may originate more
single family loans for sale in the secondary  market than for portfolio  during
1999 as was the case in  1998.  See  "Secondary  Marketing  and  Loan  Servicing
Activities" on page 4.

For  additional  information  on  the  composition  of  Downey's  loan  and  MBS
portfolio,  see "Management's Discussion and Analysis of Financial Condition and
Results  of  Operations  -  Financial  Condition  -  Loans  and  Mortgage-Backed
Securities" on page 28.

Loan and Mortgage-backed Securities Portfolio

Loans  receivable  held  for  investment  are  carried  at  cost,  adjusted  for
amortization  of premiums and  accretion of discounts  which are  recognized  in
interest  income  using  the  interest  method.  MBSs  represent   participating
interests  in pools of first  mortgage  loans  originated  and  serviced  by the
issuers of the securities. MBSs held to maturity are carried at unpaid principal
balances, adjusted for unamortized premiums and unearned discounts. Premiums and
discounts on MBSs are  amortized  using the interest  method over the  remaining
period to contractual maturity, adjusted for anticipated prepayments.


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<PAGE>


Downey  identifies those loans which  foreseeably may be sold prior to maturity.
These loans have been  classified as held for sale in the  Consolidated  Balance
Sheets and are  recorded at the lower of  amortized  cost or market  value.  Net
unrealized losses, if any, are recognized in a valuation allowance by charges to
income.

MBSs  available  for sale are carried at fair  value.  Net  unrealized  gains or
losses  are  reported  net of  income  taxes as a  separate  component  of other
comprehensive income until realized.

Residential  mortgage  loans  originated by Downey  typically  have  contractual
maturities  at  origination  of 15 to 40 years.  To limit the interest rate risk
associated  with  such  maturities,  Downey,  among  other  things,  principally
originates  ARMs for its own loan  portfolio.  Fixed  rate  loans are  primarily
originated for sale in the secondary  market on a  non-recourse  basis for cash.
However,  Downey occasionally  originates for its own portfolio fixed rate loans
to facilitate the sale of real estate  acquired in settlement of loans and which
meet  certain  yield  and  other  approved   guidelines.   See  "Asset/Liability
Management"  on page 7. In  addition,  the average term of such  mortgage  loans
historically has been significantly  shorter than their contractual maturity due
to loan payoffs as a result of home sales or refinancings and prepayments.

Residential Real Estate Lending

Downey's  primary lending  activity is the origination of mortgage loans secured
by single family residential  properties consisting of one-to-four units located
primarily in  California.  Such loans are for the purchase of  residences or for
the  refinancing of existing  mortgages at lower rates or upon different  terms.
Downey's  primary  strategy is to originate ARMs for its portfolio of loans held
for  investment.  See  "Asset/Liability  Management"  on  page  7.  Downey  also
originates  residential  fixed  interest  rate  mortgage  loans to meet consumer
demand,  but  intends to sell the  majority  of all such loans in the  secondary
market,  rather than hold such loans in its  portfolio.  Residential  fixed rate
loans may be placed in loans held for  investment  when  funded  with  long-term
funds to mitigate  interest  rate risk,  and small  volumes are  originated  for
investment to facilitate the sale of real estate acquired in settlement of loans
and which meet  certain  yield and other  approved  guidelines.  See  "Secondary
Marketing and Loan Servicing Activities" on page 4.

Downey's ARMs  generally  begin with an interest  rate below the current  market
rate  ("incentive  rate")  and  adjust to the  applicable  index  plus a defined
spread,  subject to periodic and lifetime caps,  after one, three, six or twelve
months.  Downey's  ARMs  generally  provide  that the  maximum  rate that can be
charged  cannot  exceed the incentive  rate by more than six to nine  percentage
points, depending on the type of loan and the initial rate offered. The interest
rate adjustment on Downey's ARMs which adjust semi-annually generally is limited
to 1% per adjustment period. With respect to ARMs that adjust monthly,  there is
a lifetime interest rate cap, but no specified periodic interest rate adjustment
cap. Instead, monthly adjustment ARMs have a periodic cap on changes in required
monthly  payments,  which adjust  annually.  Monthly  adjustment  ARMs allow for
negative  amortization  (the addition to loan principal of accrued interest that
exceeds the  required  monthly loan  payments).  In the event that a loan incurs
significant  negative  amortization,  there is an increased risk that the market
value of the underlying  collateral on the loan would be insufficient to satisfy
fully the outstanding principal and interest.  There is a limit on the amount of
negative  amortization,  such that the  principal  plus the added amount  cannot
exceed 125% of the original loan amount on loans having a loan-to-value ratio of
80% or less and 110% on loans  having a  loan-to-value  ratio  over 80%.  Downey
permits ARMs to be assumed by qualified borrowers.

During 1998,  approximately  87% of Downey's  one-to-four  unit residential real
estate  loans were  obtained  by Downey's  wholesale  loan  representatives  but
originated through outside mortgage brokers.  Wholesale loan representatives are
paid on a  commission  basis.  Compensation  for the  services  performed by the
mortgage  broker is considered in the overall pricing of mortgage loan products.
These  mortgage  brokers  do not  operate  from  Downey's  offices  and  are not
employees of Downey. Retail loan representatives  generated approximately 13% of
Downey's one-to-four unit residential loans during 1998 and are compensated on a
salary   basis  plus  a  fixed   amount  per  loan   originated.   Retail   loan
representatives  typically  receive  loan  referrals  from real  estate  agents,
builders,  depositors and customers  obtained from retail  advertising and other
sources, including over the internet.

Downey requires that residential real estate loans be approved at various levels
of  management,  depending  upon the  amount  of the  loan.  On a single  family
residential  loan originated for portfolio,  the maximum amount Downey generally
will lend is $1 million. The average loan size, however, is much lower. In 1998,
the average loan size


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<PAGE>


was $247,397.  Downey generally makes loans with loan-to-value ratios (the ratio
of the principal amount of the loan to the appraised value at origination of the
property  securing  the loan) not  exceeding  80%.  Downey  will make loans with
loan-to-value  ratios of over  80%,  but not  exceeding  97% of the value of the
property,  if private  mortgage  insurance  is obtained to reduce the  effective
loan-to-value  ratio to between 70% to 78%,  consistent with secondary marketing
requirements.  In addition, Downey requires hazard insurance for all residential
real estate loans covering the lower of the loan amount or the replacement value
of the structure.

In the  approval  process  for the  loans it  originates  or  purchases,  Downey
assesses  both the value of the property  securing the loan and the  applicant's
ability to repay the loan. Loan  underwriters  analyze the loan  application and
the property  involved,  and qualified  staff  appraisers or outside  appraisers
establish  the value of the  collateral  through the use of full  appraisals  or
alternative  valuation  formats  in  accordance  with  regulatory  requirements.
Appraisals  performed by approved appraisers are selectively  reviewed by senior
staff  appraisers  or  approved  fee  review  appraisers.  Downey  also  obtains
information  concerning the income,  financial condition,  employment and credit
history of the applicant.  Typically,  Downey will verify credit information for
loans originated by retail loan  representatives or other Downey employees.  For
loans from mortgage  brokers,  Downey requires the mortgage broker to review and
verify  credit  information  and  employment  pursuant to  Downey's  origination
procedures.  In addition, Downey obtains credit information and performs certain
other  underwriting  tests of such mortgage broker originated loans. On its ARMs
offered with incentive rates, Downey qualifies applicants for loan programs with
no negative  amortization at the higher of the initial incentive rate plus 2% or
the fully indexed rate, with a minimum  qualifying rate of 7% for loans having a
loan-to-value  ratio of 80% or  less;  and  qualifies  applicants  at a  minimum
qualifying  rate of 7% for loans  having a  loan-to-value  ratio of greater than
80%. For loan  programs that include  negative  amortization,  Downey  qualifies
applicants  at the  lesser of the  initial  incentive  rate plus 2% or the fully
indexed  rate,  with  a  minimum  qualifying  rate  of 6%  for  loans  having  a
loan-to-value  ratio of 80% or  less;  and  qualifies  applicants  at a  minimum
qualifying  rate of 7% for loans  having a  loan-to-value  ratio of greater than
80%.

Late in 1996,  Downey  began  offering  one-to-four  unit  residential  loans to
borrowers who have or, in the case of purchases, will have equity in their homes
but whose credit rating  contains  certain  exceptions  which preclude them from
qualifying  for the best market terms.  These lower grade credits ("A-," "B" and
"C" loans),  commonly  referred to as subprime loans, are characterized by lower
loan-to-value  ratios and higher average interest rates than higher credit grade
loans ("A" loans).  Downey believes these lower credit grade borrowers represent
an opportunity  to earn a higher net return for the risks assumed.  Underwriting
guidelines have been developed for each classification of credit.

Secondary Marketing and Loan Servicing Activities

As  part  of its  secondary  marketing  activities,  Downey  originates  certain
residential  real  estate  ARMs and loans  with  fixed  rates  with an intent of
selling such loans. Accordingly,  such loans are classified as held for sale and
are  carried at the lower of cost or market.  These  loans are  secured by first
liens on  one-to-four  unit  residential  properties  and  have  15- to  30-year
maturities or 30-year  amortization periods with balloon payments in five years,
seven years or other maturities. For additional information regarding loans held
for  investment  and for sale,  see  Notes 1 and 6 of Notes to the  Consolidated
Financial Statements on pages 61 and 70,  respectively.  Downey utilizes various
hedging  programs to manage the  interest  rate risk of its fixed rate  mortgage
origination process. See "Asset/Liability Management" on page 7.

Management  of  Downey  believes  that  servicing  loans  for  others  can be an
important asset/liability  management tool because it produces operating results
which, in response to changes in market  interest rates,  tend to move inversely
to changes in net interest  income.  Because ARMs lag market interest rates, net
interest income associated with these loans is expected to decline in periods of
rising interest rates and increase in periods of falling rates. In contrast, the
value of the loan servicing  portfolio normally increases as interest rates rise
(and loan  prepayments  decrease) and declines as interest  rates fall (and loan
prepayments increase). In addition, increased levels of servicing activities can
provide additional income with minimal additional overhead costs.

Depending  upon market pricing for  servicing,  loans are sold either  servicing
retained or servicing  released.  When sold servicing  retained,  Downey records
gains or losses from the sale of loans at the time of sale, which are determined
by the difference  between the net sales proceeds and the allocated basis of the
loans sold. Downey adopted,  effective  January 1, 1997,  Statement of Financial
Accounting  Standards  No. 125,  "Accounting  for  Transfers  and  Servicing  of
Financial  Assets  and   Extinguishments  of  Liabilities,"   ("SFAS  125").  In
accordance with


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<PAGE>


SFAS 125, Downey capitalizes mortgage servicing rights ("MSRs") acquired through
either the purchase or origination of mortgage loans for sale or  securitization
with servicing rights retained.  The total cost of the mortgage loans designated
for sale is allocated to the MSRs and the mortgage  loans without the MSRs based
on their relative fair values. MSRs are included in the financial  statements in
the  category of "other  assets."  Impairment  losses are  recognized  through a
valuation  allowance,  with any associated  provision recorded as a component of
loan servicing fees. At December 31, 1998, MSRs totaled $8 million.

Loans  originated  for sale may be exchanged with  government  agencies for MBSs
collateralized by such loans. Downey's cost for the exchange is the payment of a
monthly guaranty fee, which is expressed as a percentage of the unpaid principal
balance and which is deducted from interest income. The securities  received can
be used by Downey to  collateralize  various  types of borrowings at rates which
frequently are more favorable than rates on other types of liabilities  and also
carry a lower  risk-based  capital  requirement  than  whole  loans.  Such  MBSs
available  for sale are carried at fair value.  However,  no gain or loss on the
exchange is recorded in the statement of income until the securities are sold to
a third party.  All changes in fair value prior to the sale to third parties are
shown as a  separate  component  of other  comprehensive  income,  net of income
taxes.

Commercial Real Estate and Multi-family Lending

Downey has provided  permanent  loans  secured by retail  neighborhood  shopping
centers and multi-family properties. Downey's commercial real estate lending and
multi-family  activities are conducted by Downey's  major loan account  officers
who are compensated on a salary basis.

Commercial real estate and multi-family  loans generally entail additional risks
as compared to single-family  residential mortgage lending. Each loan, including
loans to  facilitate  the sale of real  estate  owned,  is subject  to  Downey's
underwriting   standards,   which   generally   include  an  evaluation  of  the
creditworthiness  and  reputation of the borrower,  the amount of the borrower's
equity in the project as determined on the basis of appraisal, sales and leasing
information on the property and cash flow  projections.  To protect the value of
the security for Downey's loan, Downey requires casualty  insurance for the loan
amount or replacement cost. In addition,  for non-residential loans in excess of
$500,000, Downey requires the borrower to obtain comprehensive general liability
insurance.  All  commercial  real estate loans  originated by Downey require the
approval  of at least two  officers,  one of whom must be the  originating  loan
account  officer  and the  other a  designated  officer  with  appropriate  loan
approval authority.

Construction Lending

Downey has provided  construction  loan financing for  residential  (both single
family and  multi-family)  and commercial  real estate  projects  (e.g.,  retail
neighborhood shopping centers). Downey originates such loans principally through
its major loan officers. Construction loans generally are made at floating rates
based upon the prime or reference rate of a major  commercial  bank.  Generally,
Downey requires a loan-to-value ratio of 75% or less on construction lending and
subjects each loan to Downey's underwriting standards.

Construction  loans involve  risks  different  from  completed  project  lending
because  loan  funds  are  advanced  upon  the  security  of the  project  under
construction, and if the loan goes into default, additional funds may have to be
advanced to complete the project before it can be sold.  Moreover,  construction
projects are subject to uncertainties inherent in estimating construction costs,
potential  delays in  construction  time,  market demand and the accuracy of the
estimate of value upon  completion.  Downey requires the general  contractor to,
among other things,  carry  contractor's  liability  insurance  equal to certain
prescribed  minimum  amounts,  carry builder's risk insurance and have a blanket
bond against employee misappropriation.

Commercial Lending

Downey  originates  commercial  loans and revolving lines of credit,  and issues
standby  letters of credit  for its  middle  market  commercial  customers.  The
various credit  products are offered on both a secured and unsecured  basis with
interest rates being either fixed or variable.  The portfolio emphasis is toward
secured,  floating rate credit  facilities.  The activities are directed through
the  Commercial  Banking  Group  with the focus on  long-term-relationship-based
customers.  The retail branch network is also utilized as a source of commercial
customers,


                                       5
<PAGE>


typically managed by the branch manager.  The smaller branch originated business
borrowers are desirable due to their lower cost deposit  accounts  which usually
accompany the relationship.

Consumer Lending

Downey  originates  fixed rate automobile  loans  primarily  through an indirect
lending  program  of  Downey  Auto  Finance  Corp.  which  utilizes  preapproved
automobile  dealers to finance consumer  purchases of new and used  automobiles.
This operation is centralized at Downey's  headquarters and utilizes  technology
to process and evaluate  loan  applications,  including  credit  scoring and the
automated  retrieval of consumer  credit bureau  files.  In addition to indirect
automobile lending through Downey Auto Finance Corp., the Bank originates direct
automobile loans, home equity loans and lines of credit, and other consumer loan
products. Before making a consumer loan, Downey assesses the applicant's ability
to repay the loan and, if applicable,  the value of the collateral  securing the
loan. The risk involved with home equity loans and lines of credit is similar to
the risk involved with residential real estate loans.  Downey offers customers a
credit card  through a third  party,  which  extends the credit and services the
loans made to Downey's customers.

INVESTMENT ACTIVITIES

Federal and state  regulations  require the Bank to maintain a specified minimum
amount of liquid assets  invested in certain  short-term  obligations  and other
securities.  For additional information regarding liquidity requirements and the
Bank's  compliance  therewith,  see  "Regulation  -  Regulation  of  the  Bank -
Liquidity Requirements" on page 14 and "Management's  Discussion and Analysis of
Financial  Condition and Results of  Operations - Financial  Condition - Capital
Resources  and  Liquidity"  on  page  50.  As  a  federally   chartered  savings
association,  the  Bank  is also  permitted  to make  certain  other  securities
investments as prescribed under HOLA and OTS regulations.  Investment  decisions
are made by authorized officers of the Bank within guidelines established by the
Bank's Board of Directors.  Such investments are managed in an effort to produce
the highest yield consistent with maintaining safety of principal,  minimization
of interest rate risk and compliance  with  applicable  regulations.  Securities
held for investment are carried at cost,  adjusted for  amortization of premiums
and accretion of discounts  which are  recognized  as interest  income using the
interest  method.  Securities  available  for sale are carried at market  value.
Unrealized holding gains and losses, or valuation allowances established for net
unrealized  losses,  are  excluded  from  earnings  and  reported  as a separate
component of stockholders' equity as accumulated other comprehensive income, net
of income taxes, unless the security is deemed other than temporarily  impaired.
If the security is determined to be other than temporarily impaired,  the amount
of the  impairment  is charged to  operations.  For further  information  on the
composition of Downey's investment portfolio,  see "Management's  Discussion and
Analysis of Financial  Condition and Results of Operations - Financial Condition
- Investment Securities" on page 32.

SOURCES OF FUNDS

Deposits

Downey  prefers to use deposits as the principal  source of funds for supporting
its lending  activities,  because the cost of these funds generally is less than
that of borrowings or other funding sources with comparable maturities. Downey's
savings deposits  traditionally  have been obtained  primarily from the areas in
Southern and Northern California surrounding the Bank's branch offices. However,
Downey also  occasionally  raises  certain retail  deposits  through Wall Street
activities.

Deposit flows are affected by general economic  conditions.  Funds may flow from
depository  institutions such as savings  associations into direct vehicles such
as government and corporate  securities or other financial  intermediaries.  The
ability of Downey to attract and retain deposits will continue to be affected by
money market conditions and prevailing interest rates.  Generally,  rates set by
Downey are not restricted by state or federal regulation.

In 1996, Downey began  establishing  full-service  branch facilities in selected
supermarket  locations  throughout  Southern  California.  Each in-store  branch
offers  a full  range of  financial  services  including  checking  and  savings
accounts as well as residential and consumer loans.


                                       6
<PAGE>


When consistent with the maintenance of appropriate  capital levels,  Downey may
consider  opportunities  to augment its retail  branch  system and deposit  base
through selected branch or deposit acquisitions.

For further information,  see "Management's Discussion and Analysis of Financial
Condition  and Results of  Operations - Financial  Condition - Deposits" on page
35.

Borrowings

Downey's  principal source of funds has been and continues to be deposits raised
through its retail branch system. At various times, however, Downey has utilized
other sources to fund its loan origination and other business activities. Downey
has from time to time relied upon  borrowings  from the FHLB of San Francisco as
an additional  source of funds.  Advances are made pursuant to several different
credit programs offered by the FHLB.

In 1994,  Downey  initiated a program to sell  commercial  paper supported by an
irrevocable letter of credit issued by the FHLB of San Francisco.  However, this
program  was no  longer  cost  effective  relative  to  other  sources  and  was
terminated in 1998.

From time to time,  Downey  utilizes  securities  and mortgage  loans sold under
agreements  to  repurchase  as  additional   sources  of  funds.  These  reverse
repurchase  agreements  are  generally  short term,  and are  collateralized  by
mortgage-backed or investment  securities and mortgage loans.  Downey only deals
with  investment  banking firms which are recognized as primary  dealers in U.S.
government  securities or major commercial banks in connection with such reverse
repurchase agreements. In addition, Downey limits the amounts of borrowings from
any single institution.

For further information,  see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial  Condition - Borrowings" on page
36.

ASSET/LIABILITY MANAGEMENT

Savings institutions are subject to interest rate risks to the degree that their
interest-bearing liabilities,  consisting principally of customer deposits, FHLB
advances and other borrowings, mature or reprice more rapidly, or on a different
basis,  than their  interest-earning  assets,  which  consist  predominantly  of
intermediate or long-term real estate loans.  While having  liabilities  that on
average mature or reprice more frequently than assets may be beneficial in times
of declining  interest rates,  such an  asset/liability  structure may result in
declining net earnings  during  periods of rising  interest  rates.  A principal
objective  of Downey is to manage the  effects of  adverse  changes in  interest
rates on  Downey's  interest  income  while  maintaining  asset  quality  and an
acceptable  interest rate spread.  To improve the rate  sensitivity and maturity
balance of its interest-earning assets and liabilities, Downey has over the past
several years emphasized the origination of loans with adjustable interest rates
or relatively short  maturities.  Loans with adjustable  interest rates have the
beneficial  effect of allowing the yield on Downey's  assets to increase  during
periods  of  rising  interest  rates,   although  such  loans  have  contractual
limitations on the frequency and extent of interest rate adjustments.

For further  information  see "Lending  Activities" on page 2 and  "Management's
Discussion  and  Analysis of  Financial  Condition  and Results of  Operations -
Financial Condition - Asset/Liability Management and Market Risk" on page 37.

EARNINGS SPREAD

Downey's net interest income is determined by the difference (the "interest rate
spread")  between the yields earned by Downey on its loans,  MBSs and investment
securities  ("interest-earning assets") and the interest rates paid by Downey on
its deposits and  borrowings  ("interest-bearing  liabilities"),  as well as the
relative dollar amounts of Downey's interest-earning assets and interest-bearing
liabilities.

The  effective  interest  rate spread,  which  reflects  the  relative  level of
interest-earning  assets  to  interest-bearing   liabilities,   equals  (i)  the
difference  between  interest  income on  interest-earning  assets and  interest
expense   on   interest-bearing    liabilities,    (ii)   divided   by   average
interest-earning assets for the period. For information regarding


                                       7
<PAGE>


net income and the components thereof and for management's analysis of financial
condition and results of operations,  see "Management's  Discussion and Analysis
of  Financial  Condition  and Results of  Operations"  beginning on page 20. For
returns on assets and other  selected  financial  data see  "Selected  Financial
Data" on page 19.

                       Real Estate Investment Activities

Downey's second business segment is real estate  investment,  which is primarily
performed  through DSL Service Company,  a wholly-owned  subsidiary of the Bank.
DSL Service Company is a diversified real estate  development  company which was
established  in 1966 as a neighborhood  shopping  center and  residential  tract
developer, as well as the contractor for the Bank's branch locations.  Today its
capabilities   include   development,   construction  and  property   management
activities  relating  to  a  diverse  portfolio  of  projects  primarily  within
California,  but also in Arizona.  In addition to DSL Service Company developing
its own real estate projects,  it associates with other qualified  developers to
engage in joint ventures.  The primary revenue sources of real estate investment
activities  include  net rental  income  and gains from the sale of real  estate
investments.  The  primary  expenses of real estate  investment  activities  are
interest expense and general and administrative expense.

Prior to the  passage  in  August  1989 of the  Financial  Institutions  Reform,
Recovery, and Enforcement Act of 1989 ("FIRREA"), the Bank conducted real estate
development  and joint venture  operations  directly,  in addition to operations
conducted through DSL Service Company. Since FIRREA, however, the Bank's ability
to engage in new real estate  development  and joint venture  activities  and to
retain  existing real estate  investments has been curtailed  dramatically,  and
such  activities  may be  economically  unfeasible  for the Bank  because of the
capital requirements imposed on such activities.  FIRREA requires,  with certain
limited  exceptions,  a savings institution such as the Bank to exclude from its
regulatory  capital its investments in, and extensions of credit to, real estate
subsidiaries  such  as  DSL  Service  Company,  as  well  as its  direct  equity
investments,  and prohibits new direct equity  investments in real estate by the
Bank.  Since July 1, 1996,  the Bank has been required to deduct the full amount
of its investment in DSL Service  Company in calculating  its applicable  ratios
under the core, tangible and risk-based capital standards.  Savings associations
generally may invest in service  corporation  subsidiaries,  such as DSL Service
Company,  to the extent of 2% of assets,  plus up to an  additional 1% of assets
for  investments  which  serve  primarily  community,  inner-city  or  community
development purposes. In addition,  "conforming loans" by an association to such
subsidiaries'  joint  venture  investments  are  limited  to 50%  of  risk-based
capital.  "Conforming  loans" are those  generally  limited to 80% of  appraised
value,  bear a market  rate of  interest  and  require  payments  sufficient  to
amortize the principal balance of the loan. Downey is in compliance with each of
these investment limitations.

To the extent  real estate  investments  are made by Downey or a  subsidiary  of
Downey  other than the Bank or its  subsidiaries,  the  above-mentioned  capital
deductions and limitations do not apply as they only pertain to such investments
by savings associations or their subsidiaries.

For further information,  see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial  Condition - Investments in Real
Estate and Joint Ventures" on page 33.

                                  Competition

Downey faces  competition both in attracting  deposits and in making real estate
loans and other loans. Its most direct competition for deposits has historically
come from other savings  institutions  and from commercial  banks located in its
principal  market areas,  including many large financial  institutions  based in
other  parts  of the  country  or  their  subsidiaries.  In  addition,  there is
additional  significant  competition for investors'  funds from short-term money
market securities and other corporate and government securities.  The ability of
Downey to attract and retain savings deposits depends, generally, on its ability
to provide a rate of return,  liquidity  and risk  comparable to that offered by
competing  investment  opportunities  and  the  appropriate  level  of  customer
service.

Downey  experiences  competition  for real estate loans  principally  from other
savings institutions, commercial banks, mortgage banking companies and insurance
companies.  Downey competes for loans principally through the interest rates and
loan fees it charges  and the  efficiency  and  quality of  services it provides
borrowers and real estate brokers.


                                       8
<PAGE>


                                   Employees

At December 31, 1998, Downey had approximately 1,270 full-time employees and 393
part-time  employees.  Downey  provides its  employees  with certain  health and
welfare benefits and a retirement and savings plan. Additionally,  Downey offers
qualifying employees participation in a stock purchase plan. See Notes 19 and 21
of Notes to the  Consolidated  Financial  Statements  on pages 84 and 87,  for a
further  discussion of employee benefit plans.  Employees are not represented by
any union or  collective  bargaining  group,  and Downey  considers its employee
relations to be good.

                                   Regulation

GENERAL

Savings and loan holding  companies  and savings  associations  are  extensively
regulated  under  both  federal  and state  law.  This  regulation  is  intended
primarily for the  protection of depositors and the SAIF and not for the benefit
of stockholders of Downey. The following  information  describes certain aspects
of that regulation applicable to Downey and the Bank, and does not purport to be
complete. The discussion is qualified in its entirety by reference to applicable
statutory or regulatory provisions.

REGULATION OF DOWNEY

General.  Downey  is a unitary  savings  and loan  holding  company  subject  to
regulatory  oversight  by the OTS. As such,  Downey is required to register  and
file reports with the OTS and is subject to regulation  and  examination  by the
OTS.  In  addition,  the OTS  has  enforcement  authority  over  Downey  and its
subsidiaries, which also permits the OTS to restrict or prohibit activities that
are determined to be a serious risk to the subsidiary savings association.

Activities  Restrictions.  As a unitary savings and loan holding company, Downey
generally is not subject to activity  restrictions,  provided the Bank satisfies
the  Qualified  Thrift Lender  ("QTL") test or meets the  definition of domestic
building and loan  association  pursuant to section 7701 of the Internal Revenue
Code of 1986, as amended (the  "Code").  If Downey  acquires  control of another
savings association as a separate subsidiary, it would become a multiple savings
and  loan  holding  company,  and  the  activities  of  Downey  and  any  of its
subsidiaries (other than the Bank or any other SAIF-insured savings association)
would become subject to restrictions applicable to bank holding companies unless
such other associations each also qualify as a QTL or domestic building and loan
association and were acquired in a supervisory  acquisition.  See "Regulation of
the Bank - Qualified Thrift Lender Test" on page 12.

Restrictions  on  Acquisitions.  Downey must obtain approval from the OTS before
acquiring control of any other SAIF-insured  association.  Such acquisitions are
generally  prohibited  if they  result in a multiple  savings  and loan  holding
company controlling savings associations in more than one state.  However,  such
interstate  acquisitions are permitted based on specific state  authorization or
in a supervisory acquisition of a failing savings association.

Federal law generally  provides that no "person,"  acting directly or indirectly
or through or in concert with one or more other persons,  may acquire "control,"
as that term is defined  in OTS  regulations,  of a  federally  insured  savings
association  without  giving  at least  60 days  written  notice  to the OTS and
providing the OTS an  opportunity  to disapprove  the proposed  acquisition.  In
addition,  no company may acquire  control of such an institution  without prior
OTS approval.  These provisions also prohibit,  among other things, any director
or officer of a savings and loan holding company,  or any individual who owns or
controls  more  than 25% of the  voting  shares of a  savings  and loan  holding
company,  from acquiring control of any savings  association not a subsidiary of
the savings and loan holding company,  unless the acquisition is approved by the
OTS.

REGULATION OF THE BANK

As a federally chartered,  SAIF-insured savings association, the Bank is subject
to extensive  regulation by the OTS and the FDIC.  Lending  activities and other
investments of the Bank must comply with various statutory and


                                       9
<PAGE>


regulatory   requirements.   The  Bank  is  also  subject  to  certain   reserve
requirements promulgated by the Federal Reserve Board.

The OTS, in conjunction with the FDIC,  regularly examines the Bank and prepares
reports  for  the  consideration  of  the  Bank's  Board  of  Directors  on  any
deficiencies  found in the operations of the Bank. The relationship  between the
Bank and its  depositors  and  borrowers is also  regulated by federal and state
laws,  especially in such matters as the  ownership of savings  accounts and the
form and content of mortgage documents utilized by the Bank.

The Bank must file reports with the OTS and the FDIC  concerning  its activities
and financial condition,  in addition to obtaining regulatory approvals prior to
entering into certain transactions such as mergers with or acquisitions of other
financial   institutions.   This  regulation  and   supervision   establishes  a
comprehensive  framework of activities in which an institution may engage and is
intended primarily for the protection of the SAIF and depositors. The regulatory
structure  also  gives  the  regulatory   authorities  extensive  discretion  in
connection with their  supervisory  and  enforcement  activities and examination
policies,  including  policies with respect to the  classification of assets and
the  establishment of adequate loan loss reserves for regulatory  purposes.  Any
change in such  regulations,  whether by the OTS, the FDIC or the Congress could
have a material adverse impact on Downey, the Bank and their operations.

Insurance of Deposit  Accounts.  The Bank's deposit  accounts are insured by the
SAIF, as  administered  by the FDIC, up to the maximum amount  permitted by law.
Insurance  of deposits  may be  terminated  by the FDIC upon a finding  that the
institution  has  engaged  in unsafe or  unsound  practices,  is in an unsafe or
unsound  condition to continue  operations or has violated any  applicable  law,
regulation,  rule, order or condition  imposed by the FDIC or the  institution's
primary regulator.

The FDIC charges an annual assessment for the insurance of deposits based on the
risk a particular  institution  poses to its deposit  insurance fund. Under this
system as of December 31, 1995,  SAIF members paid within a range of 23 cents to
31 cents per $100 of domestic  deposits,  depending upon the institution's  risk
classification.  This risk  classification is based on an institution's  capital
group and supervisory subgroup  assignment.  Pursuant to the Economic Growth and
Paperwork  Reduction  Act of 1996  (the  "Paperwork  Reduction  Act"),  the FDIC
imposed a special  assessment  on SAIF  members  to  capitalize  the SAIF at the
designated  reserve  level of 1.25% as of October  1, 1996.  Based on the Bank's
deposits as of March 31, 1995,  the date for measuring the amount of the special
assessment  pursuant  to the Act,  the Bank paid a special  assessment  of $24.6
million in November 1996 to  recapitalize  the SAIF. This expense was recognized
during the last quarter of fiscal 1996.

Pursuant  to the  Paperwork  Reduction  Act,  the Bank pays,  in addition to its
normal deposit insurance premium as a member of the SAIF ranging from nothing to
27 cents per $100 of domestic deposits as of October 1, 1996, an amount equal to
approximately  6.4 cents per $100 of domestic  deposits toward the retirement of
the Financing  Corporation bonds ("Fico Bonds") issued in the 1980s to assist in
the  recovery of the savings and loan  industry.  Members of the Bank  Insurance
Fund ("BIF"),  by contrast,  pay, in addition to their normal deposit  insurance
premium,  approximately  1.3  cents  per $100 of  domestic  deposits.  Under the
Paperwork  Reduction  Act,  the FDIC also is not  permitted  to  establish  SAIF
assessment rates that are lower than comparable BIF assessment rates.  Beginning
no later than  January  1, 2000,  the rate paid to retire the Fico Bonds will be
equal for  members of the BIF and the SAIF.  The  Paperwork  Reduction  Act also
provides  for the  merging of the BIF and the SAIF by  January 1, 1999  provided
there were no financial  institutions still chartered as savings associations at
that time. Although legislation to eliminate the savings association charter had
been proposed, at January 1, 1999, financial  institutions such as the Bank were
still  chartered as savings  associations.  Should the insurance funds be merged
before  January 1, 2000, the rate paid by all members of this new fund to retire
the Fico Bonds would be equal.

Regulatory  Capital  Requirements.   OTS  capital  regulations  require  savings
associations to meet three capital standards: (1) tangible capital equal to 1.5%
of total  adjusted  assets;  (2) leverage  capital (core capital) equal to 3% of
total  adjusted  assets;  and (3)  risk-based  capital  equal  to 8.0% of  total
risk-based  assets.  The Bank must meet each of these  standards  in order to be
deemed in compliance  with OTS capital  requirements.  In addition,  the OTS may
require a savings  association  to maintain  capital  above the minimum  capital
levels.

Under OTS regulations,  a savings association with a greater than "normal" level
of interest rate exposure must deduct an interest rate risk ("IRR") component in
calculating  its total capital for purposes of determining  whether it meets its
risk-based capital requirement.  Interest rate exposure is measured,  generally,
as the decline in an


                                       10
<PAGE>


institution's  net  portfolio  value that would  result  from a 200 basis  point
increase or decrease in market interest rates (whichever would result in a lower
net portfolio  value),  divided by the estimated  economic  value of the savings
association's assets. The interest rate risk component to be deducted from total
capital is equal to one-half of the difference between an institution's measured
exposure and "normal" IRR exposure  (which is defined as 2%),  multiplied by the
estimated  economic value of the  institution's  assets. In August 1995, the OTS
indefinitely delayed implementation of its IRR regulation. However, based on the
asset/liability  structure of the Bank, at December 31, 1998, the Bank would not
have been required to deduct an IRR component in  calculating  total  risk-based
capital had the IRR component of the capital regulations been in effect.

These capital  requirements are viewed as minimum standards by the OTS, and most
institutions are expected to maintain capital levels well above the minimum.  In
addition,  the OTS  regulations  provide that minimum capital levels higher than
those provided in the  regulations  may be established by the OTS for individual
savings  associations,  upon a  determination  that  the  savings  association's
capital  is or may  become  inadequate  in  view of its  circumstances.  The OTS
regulations   provide  that  higher  individual   minimum   regulatory   capital
requirements  may be appropriate in  circumstances  where,  among others:  (1) a
savings  association  has a high  degree of  exposure  to  interest  rate  risk,
prepayment  risk,  credit  risk,  concentration  of credit risk,  certain  risks
arising from nontraditional activities, or similar risks or a high proportion of
off-balance sheet risk; (2) a savings association is growing,  either internally
or through acquisitions,  at such a rate that supervisory problems are presented
that  are not  dealt  with  adequately  by OTS  regulations;  and (3) a  savings
association may be adversely  affected by activities or condition of its holding
company,  affiliates,  subsidiaries,  or other persons, or savings  associations
with which it has significant business relationships. The Bank is not subject to
any such individual minimum regulatory capital requirement.

As shown in  "Management's  Discussion  and Analysis of Financial  Condition and
Results of Operations - Financial  Condition - Regulatory Capital Compliance" on
page 51 the Bank's regulatory  capital exceeded all minimum  regulatory  capital
requirements as of December 31, 1998.

HOLA  permits  savings  associations  not in  compliance  with  the OTS  capital
standards  to  seek  an  exemption  from  certain  penalties  or  sanctions  for
noncompliance.  Such  an  exemption  will be  granted  only  if  certain  strict
requirements  are met, and must be denied  under  certain  circumstances.  If an
exemption is granted by the OTS, the savings association still may be subject to
enforcement  actions for other violations of law or unsafe or unsound  practices
or conditions.

Prompt  Corrective  Action.  The prompt corrective action regulation of the OTS,
requires certain  mandatory actions and authorizes  certain other  discretionary
actions to be taken by the OTS against a savings  association  that falls within
certain undercapitalized capital categories specified in the regulation.

The regulation  establishes  five  categories of capital  classification:  "well
capitalized,"  "adequately  capitalized,"   "undercapitalized,"   "significantly
undercapitalized" and "critically  undercapitalized." Under the regulation,  the
risk-based  capital,  leverage  capital and tangible  capital ratios are used to
determine an  institution's  capital  classification.  At December 31, 1998, the
Bank exceeded the capital  requirements of a well capitalized  institution under
applicable OTS regulations.

In  general,  the  prompt  corrective  action  regulation  prohibits  an insured
depository  institution  from declaring any dividends,  making any other capital
distribution,  or paying a management fee to a controlling  person if, following
the  distribution or payment,  the institution  would be within any of the three
undercapitalized  categories.  In addition,  adequately capitalized institutions
may accept brokered deposits only with a waiver from the FDIC and are subject to
restrictions  on  the  interest  rates  that  can  be  paid  on  such  deposits.
Undercapitalized  institutions  may not accept,  renew,  or  roll-over  brokered
deposits.

If the OTS determines that an institution is in an unsafe or unsound  condition,
or if the  institution  is  deemed  to be  engaging  in an  unsafe  and  unsound
practice, the OTS may, if the institution is well capitalized,  reclassify it as
adequately  capitalized;  if the  institution is adequately  capitalized but not
well  capitalized,   require  it  to  comply  with  restrictions  applicable  to
undercapitalized  institutions;  and, if the  institution  is  undercapitalized,
require it to comply  with  certain  restrictions  applicable  to  significantly
undercapitalized institutions.


                                       11
<PAGE>


Loans-to-One-Borrower. Savings associations generally are subject to the lending
limits  applicable  to national  banks.  With certain  limited  exceptions,  the
maximum  amount that a savings  association  or a national  bank may lend to any
borrower  (including  certain related  entities of the borrower) at one time may
not exceed 15% of the unimpaired capital and surplus of the institution, plus an
additional  10% of  unimpaired  capital and  surplus for loans fully  secured by
readily marketable collateral.  Savings associations are additionally authorized
to make  loans to one  borrower,  for any  purpose,  in an amount  not to exceed
$500,000  or, by order of the  Director  of OTS,  in an amount not to exceed the
lesser of  $30,000,000  or 30% of  unimpaired  capital  and  surplus  to develop
residential  housing,  provided:  (i) the purchase  price of each  single-family
dwelling  in  the  development  does  not  exceed  $500,000;  (ii)  the  savings
association  is in compliance  with its fully  phased-in  capital  requirements;
(iii) the loans comply with applicable loan-to-value requirements,  and (iv) the
aggregate  amount of loans  made under this  authority  does not exceed  150% of
unimpaired   capital  and   surplus.   At   December   31,   1998,   the  Bank's
loans-to-one-borrower  limit was $75  million  based upon the 15% of  unimpaired
capital and surplus measurement.

Qualified Thrift Lender Test.  Savings  associations must meet a QTL test, which
test may be met either by  maintaining a specified  level of assets in qualified
thrift  investments  as  specified  in HOLA or by meeting  the  definition  of a
"domestic  building and loan  association"  in section 7701 of the Code.  If the
Bank maintains an appropriate level of certain specified investments  (primarily
residential    mortgages   and   related    investments,    including    certain
mortgage-related  securities)  and  otherwise  qualifies  as a QTL or a domestic
building  and  loan  association,  it will  continue  to  enjoy  full  borrowing
privileges from the FHLB. The required  percentage of investments  under HOLA is
65% of  assets  while  the  Code  requires  investments  of 60%  of  assets.  An
association  must be in  compliance  with  the QTL  test  or the  definition  of
domestic  building and loan  association on a monthly basis in nine out of every
12  months.  Associations  that  fail to meet the QTL  test  will  generally  be
prohibited  from engaging in any activity not permitted for both a national bank
and a savings  association.  As of December 31, 1998, the Bank was in compliance
with its QTL requirement and met the definition of a domestic  building and loan
association.

Affiliate  Transactions.  Transactions  between  a savings  association  and its
"affiliates"  are subject to  quantitative  and qualitative  restrictions  under
Sections  23A  and 23B of the  Federal  Reserve  Act.  Affiliates  of a  savings
association include,  among other entities,  the savings  association's  holding
company  and  companies   that  are  under  common   control  with  the  savings
association.

In  general,  Sections  23A and 23B and OTS  regulations  issued  in  connection
therewith  limit the extent to which a savings  association or its  subsidiaries
may engage in certain "covered  transactions" with affiliates to an amount equal
to 10% of the  association's  capital  and  surplus,  in  the  case  of  covered
transactions  with  any one  affiliate,  and to an  amount  equal to 20% of such
capital and surplus, in the case of covered transactions with all affiliates. In
addition,  a savings  association  and its  subsidiaries  may  engage in covered
transactions   and  certain   other   transactions   only  on  terms  and  under
circumstances  that are  substantially the same, or at least as favorable to the
savings  association  or its  subsidiary,  as those  prevailing  at the time for
comparable transactions with nonaffiliated companies. A "covered transaction" is
defined to include a loan or extension of credit to an affiliate;  a purchase of
investment  securities  issued by an  affiliate;  a purchase  of assets  from an
affiliate,  with certain  exceptions;  the acceptance of securities issued by an
affiliate as collateral  for a loan or extension of credit to any party;  or the
issuance  of a  guarantee,  acceptance,  or  letter  of  credit  on behalf of an
affiliate.

In addition,  under the OTS  regulations,  a savings  association may not make a
loan or extension of credit to an affiliate unless the affiliate is engaged only
in activities  permissible for bank holding companies; a savings association may
not  purchase or invest in  securities  of an  affiliate  other than shares of a
subsidiary;  a savings  association  and its  subsidiaries  may not  purchase  a
low-quality asset from an affiliate;  and covered transactions and certain other
transactions  between a savings association or its subsidiaries and an affiliate
must be on terms and conditions  that are consistent with safe and sound banking
practices.  With  certain  exceptions,  each  loan or  extension  of credit by a
savings  association to an affiliate must be secured by collateral with a market
value  ranging from 100% to 130%  (depending on the type of  collateral)  of the
amount of the loan or extension of credit.

The OTS regulation  generally excludes all non-bank and non-savings  association
subsidiaries of savings associations from treatment as affiliates, except to the
extent  that  the  OTS or the  Federal  Reserve  Board  decides  to  treat  such
subsidiaries as affiliates. The regulation also requires savings associations to
make and retain  records  that  reflect  affiliate  transactions  in  reasonable
detail,  and  provides  that  certain  classes  of savings  associations  may be
required to give the OTS prior notice of affiliate transactions.


                                       12
<PAGE>


Capital  Distribution  Limitations.  OTS regulations impose limitations upon all
capital distributions by savings associations,  such as cash dividends, payments
to  repurchase  or otherwise  acquire its shares,  payments to  shareholders  of
another institution in a cash-out merger and other distributions charged against
capital.  The OTS recently  adopted an amendment to these  capital  distribution
limitations.  Under the new rule, a savings association in certain circumstances
may be required to file an application  and await approval from the OTS prior to
making a capital distribution, may be required to file a notice 30 days prior to
the capital  distribution,  or may be permitted to make the capital distribution
without notice or application to the OTS.

An  application  is required (1) if the savings  association is not eligible for
expedited  treatment of its other  applications  under OTS regulations;  (2) the
total amount of all of capital  distributions  (including  the proposed  capital
distribution) for the applicable  calendar year exceeds net income for that year
to date plus retained net income for the  preceding  two years;  (3) the savings
association  would not be at least  adequately  capitalized,  under  the  prompt
corrective action regulations of the OTS following the distribution;  or (4) the
savings association's  proposed capital distribution would violate a prohibition
contained  in any  applicable  statute,  regulation,  or  agreement  between the
savings association and the OTS (or the FDIC), or violate a condition imposed on
the savings association in an OTS-approved application or notice.

A notice of a capital  distribution is required if a savings  association is not
required to file an application,  but: (1) would not be well  capitalized  under
the prompt corrective action  regulations of the OTS following the distribution;
(2) the proposed capital  distribution  would reduce the amount of or retire any
part of your common or  preferred  stock or retire any part of debt  instruments
such as notes or  debentures  included in capital  (other than regular  payments
required  under a debt  instrument  approved  by the  OTS);  or (3) the  savings
association is a subsidiary of a savings and loan holding company.

If neither the savings  association nor the proposed capital  distribution  meet
any of the above listed  criteria,  no application or notice is required for the
savings  association  to make the  proposed  capital  distribution.  The OTS may
prohibit a proposed  capital  distribution  that would otherwise be permitted if
the OTS determines that the  distribution  would constitute an unsafe or unsound
practice.

Activities of  Subsidiaries.  A savings  association  seeking to establish a new
subsidiary,  acquire  control of an existing  company or conduct a new  activity
through a  subsidiary  must provide 30 days prior notice to the FDIC and the OTS
and conduct any activities of the subsidiary in accordance with  regulations and
orders of the OTS.  The OTS has the power to  require a savings  association  to
divest any subsidiary or terminate any activity  conducted by a subsidiary  that
the OTS determines to pose a serious threat to the financial  safety,  soundness
or stability of the savings  association  or to be otherwise  inconsistent  with
sound banking practices.

Year 2000 Compliance.  The Federal Financial  Institutions  Examination  Council
issued an interagency statement to the chief executive officers of all federally
supervised  financial   institutions  regarding  year  2000  project  management
awareness.  It is  expected  that  unless  financial  institutions  address  the
technology  issues relating to the coming of the year 2000,  there will be major
disruptions in the operations of financial institutions.  The statement provides
guidance  to  financial  institutions,  providers  of  data  services,  and  all
examining  personnel of the federal  banking  agencies  regarding  the year 2000
problem.  The federal  banking  agencies  intend to conduct year 2000 compliance
examinations,  and the failure to  implement a year 2000  program may be seen by
the federal  banking  agencies as an unsafe and unsound banking  practice.  If a
federal  banking agency  determines  that the Bank is operating in an unsafe and
unsound manner, the Bank may be required to submit a compliance plan. Failure to
submit  a  compliance  plan or to  implement  an  accepted  plan may  result  in
enforcement  action being taken,  which may include a cease and desist order and
fines.

Community  Reinvestment Act and the Fair Lending Laws. Savings associations have
a  responsibility  under the  Community  Reinvestment  Act  ("CRA")  and related
regulations  of the OTS to help  meet the  credit  needs  of their  communities,
including low- and moderate-income neighborhoods.  In addition, the Equal Credit
Opportunity  Act and the Fair Housing Act  (together,  the "Fair Lending  Laws")
prohibit lenders from  discriminating in their lending practices on the basis of
characteristics  specified in those statutes. An institution's failure to comply
with  the  provisions  of  CRA  could,  at  a  minimum,   result  in  regulatory
restrictions  on its  activities  and the  denial of certain  applications,  and
failure to comply with the Fair Lending Laws could result in enforcement actions
by the OTS, as well as other federal  regulatory  agencies and the Department of
Justice.


                                       13
<PAGE>


Federal  Home Loan Bank System.  The Bank is a member of the FHLB system.  Among
other  benefits,  each FHLB serves as a reserve or central  bank for its members
within its assigned  region.  Each FHLB is financed  primarily  from the sale of
consolidated  obligations  of the FHLB  system.  Each FHLB  makes  available  to
members loans (i.e.,  advances) in accordance  with the policies and  procedures
established by the Board of Directors of the individual FHLB.

As a member,  the Bank is required to own capital  stock in an FHLB in an amount
equal to the greater of: (i) 1% of its aggregate outstanding principal amount of
its residential  mortgage loans, home purchase contracts and similar obligations
at the beginning of each calendar year,  (ii) 0.3% of total assets,  or (iii) 5%
of its FHLB  advances  (borrowings).  At  December  31,  1998,  the Bank had $49
million of FHLB stock.  The Bank's required  investment in FHLB stock,  based on
December  31, 1998  financial  data,  was $52  million.  The Bank  received a $1
million  stock  dividend  and will  purchase  additional  stock  amounting to $2
million in the first quarter of 1999,  thereby  increasing the Bank's investment
to the  required  amount.  See Note 11 of Notes  to the  Consolidated  Financial
Statements on page 77.

Liquidity Requirements. Under OTS regulations, a savings association is required
to maintain an average daily balance of liquid assets  (including cash,  certain
time deposits and savings accounts,  bankers'  acceptances,  certain  government
obligations, and certain other investments) in each calendar quarter of not less
than  4%  of  either:   (i)  its  liquidity  base  (consisting  of  certain  net
withdrawable accounts plus short-term borrowings) as of the end of the preceding
calendar quarter, or (ii) the average daily balance of its liquidity base during
the preceding  quarter.  This liquidity  requirement may be changed from time to
time by the  OTS to any  amount  between  4% and  10%,  depending  upon  certain
factors,  including  economic  conditions  and  savings  flows  of  all  savings
associations.  The  Bank  maintains  liquid  assets  in  compliance  with  these
regulations.   Monetary  penalties  may  be  imposed  upon  an  institution  for
violations of liquidity requirements.

Federal  Reserve  System.  The Federal  Reserve  Board  requires all  depository
institutions  to maintain  non-interest  bearing  reserves at  specified  levels
against  their  transaction  accounts  (primarily  checking,  NOW, and Super NOW
checking  accounts) and non-personal time deposits.  The balances  maintained to
meet the reserve  requirements  imposed by the Federal Reserve Board may be used
to satisfy the liquidity  requirements  that are imposed by the OTS. At December
31, 1998, the Bank was in compliance with these requirements.

Recent  Proposed  Legislation.  Congress  has been  considering  legislation  in
various forms that would require federal  thrifts,  such as the Bank, to convert
their charters to national or state bank charters.  The Treasury  Department has
been  studying  the   development  of  a  common  charter  for  federal  savings
associations and commercial banks.  Pursuant to the Paperwork  Reduction Act, if
the thrift charter is eliminated after January 1, 1999, the Paperwork  Reduction
Act would  require  the  merger  of the BIF and the SAIF  into a single  Deposit
Insurance  Fund  on that  date.  In the  absence  of  appropriate  "grandfather"
provisions,  legislation  eliminating  the thrift  charter could have a material
adverse  effect  on the  Bank  and  Downey  because,  among  other  things,  the
regulatory,  capital,  and accounting treatment for national and state banks and
savings  associations differs in certain significant  respects.  The Bank cannot
determine  whether,  or in what form, such legislation may eventually be enacted
and there can be no assurance that any legislation that is enacted would contain
adequate grandfather provisions for the Bank and Downey.

REGULATION OF DSL SERVICE COMPANY

DSL Service  company is licensed as a real estate  broker  under the  California
Real Estate Law and as a contractor with the Contractors State License Board. As
such, the real estate  investment  activities of DSL Service Company,  including
development,  construction  and  property  management  activities  relating to a
diverse  portfolio of projects are subject to a variety of laws and regulations.
Changes in the laws and regulation,  or their interpretation by agencies and the
courts, occur frequently.  DSL Service Company must comply with various federal,
state and local  laws,  ordinances,  rules and  regulations  concerning  zoning,
building  design,  construction,  hazardous  waste,  and  similar  matters.  The
operations of DSL Service  Company are also affected by  environmental  laws and
regulations,   including  regulations   pertaining  to  availability  of  water,
municipal sewage treatment capacity, land use, protection of endangered species,
population density and preservation of the natural terrain and coastlines. These
and other requirements could become more restrictive in the future, resulting in
additional time and expense in connection with DSL Service Company's real estate
activities.


                                       14
<PAGE>


With regard to  environmental  matters,  the construction  products  industry is
regulated by federal, state and local laws and regulations pertaining to several
areas  including  human  health  and safety and  environmental  compliance.  The
Comprehensive  Environmental Response,  Compensation,  and Liability Act of 1980
("CERCLA"),  as amended by the Superfund  Amendments and  Reauthorization Act of
1986,  as well as  analogous  laws in certain  states,  create joint and several
liability for the cost of cleaning up or correcting  releases to the environment
of  designated  hazardous  substances.  Among those who may be held  jointly and
several  liable  are those who  generated  the  waste,  those who  arranged  for
disposal,  those who owned or operate the disposal  site or facility at the time
of disposal,  and current  owners.  In general,  this  liability is imposed in a
series of governmental proceedings initiated by the identification of a site for
initial  listing as a  "Superfund  site" on the  National  Priorities  List or a
similar state list and the identification of potentially responsible parties who
may be liable for cleanup  costs.  None of the DSL  Services  Company's  project
sites are listed as a "Superfund site."

In addition,  California courts have imposed  warranty-like  responsibility upon
developers  of new  housing  for  defects in  structure  and the  housing  site,
including soil conditions. This responsibility is not necessarily dependent upon
a finding that the developer was negligent.

As a licensed  entity,  DSL Service  Company is also subject to examination  and
supervision  by the  California  Department  of Real Estate and the  Contractors
State License Board.

                                    Taxation

Federal. A savings institution generally is subject to tax in the same manner as
other corporations for federal income tax purposes,  though savings institutions
have historically  enjoyed favorable treatment under the Code in determining the
deduction  allowed  for  bad  debts.  During  1996,  however,  Congress  enacted
legislation which repealed the reserve method of determining bad debt deductions
for "large thrift  institutions"  (i.e.,  thrifts with assets  greater than $500
million),  subjecting  savings  associations to rules similar to those currently
applicable  to large  commercial  banks.  The repeal was effective for tax years
beginning after 1995. Bad debt reserves  accumulated  since 1987 were subject to
recapture as taxable income over a six-year period  beginning in 1996.  However,
thrifts  were  allowed to defer  recapture  for up to two years if the amount of
mortgage  loans  originated  in 1996 and 1997  equaled or  exceeded  the average
amount of  mortgages  originated  in the six  years  prior to 1996.  Based  upon
originations  in 1996 and 1997,  the Bank  qualifies  for the two-year  deferral
under this  originations  test,  and began to recapture  its  post-1987 bad debt
reserve over a six-year  period  beginning in 1998. The bad debt  deductions for
1997 and 1998 were determined under the specific charge-off method, which allows
a tax deduction for loans determined to be wholly or partially worthless.

In  addition  to the  regular  corporate  income  tax,  corporations,  including
qualifying savings institutions, are subject to an alternative minimum tax. This
20% tax is computed with respect to the  corporation's  regular  taxable  income
(with certain  adjustments),  as increased by tax preference items ("alternative
minimum  taxable  income")  and will  apply to the extent  that it  exceeds  the
corporation's  regular tax liability.  In computing a corporation's  alternative
minimum taxable income, the corporation's  regular taxable income is required to
be  increased  by 75% of the excess of the  corporation's  current  earnings and
profits  (subject to certain  adjustments)  over the  corporation's  alternative
minimum taxable income determined prior to this adjustment and without regard to
the  alternative  tax net operating loss  deduction.  A corporation  that incurs
alternative  minimum  tax  generally  is  entitled  to take such tax as a credit
against its regular tax in subsequent years to the extent that the corporation's
regular tax  liability in such  subsequent  years  (reduced by certain other tax
credits) exceeds the corporation's so-called "tentative minimum tax" (generally,
an amount computed by multiplying the corporation's  alternative minimum taxable
income  for the year by the  then-applicable  rate for the  alternative  minimum
tax).

State.  The California  franchise tax applicable to the Bank is computed under a
formula which results in a rate higher than the rate applicable to non-financial
corporations  because it reflects an amount "in lieu" of local personal property
and business license taxes paid by such  corporations (but not generally paid by
banks or  financial  corporations  such as the Bank).  The variable tax rate was
10.84%  in 1998 and  1997.  Downey  and its  wholly  owned  subsidiaries  file a
California franchise tax return on a combined reporting basis.  Additional state
income tax returns are filed on a  separate-entity  basis in Arizona,  Colorado,
and Oregon. Additional state tax returns will be required in future years as the
Bank expands its lending business nationwide.


                                       15
<PAGE>


The Internal Revenue Service and state taxing authorities have examined Downey's
tax returns for all tax years through 1995.  Proposed  adjustments for the years
examined by the Internal Revenue Service have been protested by Downey,  and are
currently moving through the appeals  process.  Downey believes that substantial
legal authority exists for the positions taken on the tax returns and intends to
vigorously  defend  those  positions,  and that  adequate  provisions  have been
provided for the potential exposure. Tax years subsequent to 1995 remain open to
review by federal and state tax authorities.  For further information  regarding
income taxes, see Note 18 of Notes to the Consolidated  Financial  Statements on
page 81.

                     Factors That May Affect Future Results

The following  discusses  certain  factors which may affect  Downey's  financial
results and operations and should be considered in evaluating Downey.

Economic  Conditions and Geographic  Concentrations.  Downey is headquartered in
Southern  California,  and its  operations  are  concentrated  in  Southern  and
Northern  California.  As a result of this  geographic  concentration,  Downey's
results  depend  largely upon  economic  conditions  in these  areas.  While the
California economy has exhibited positive economic and employment trends,  there
is no assurance  that such trends will  continue.  A  deterioration  in economic
conditions  could have a material adverse impact on the quality of Downey's loan
and real estate portfolios and the demand for its products and services.

Interest  Rates.  Downey  anticipates  that  interest  rate  levels  will remain
generally  constant  in 1999,  but if  interest  rates vary  substantially  from
present  levels,  Downey's  results  may  differ  materially  from  the  results
currently  anticipated.  Changes in interest  rates will influence the growth of
loans,  investments  and  deposits  and affect the rates  received  on loans and
investment  securities and paid on deposits.  If interest rates were to increase
significantly,  the economic  feasibility of real estate  investment  activities
also could be adversely affected.

Government  Regulation and Monetary Policy.  The financial  services industry is
subject to extensive federal and state  supervision and regulation.  Significant
new laws or changes in, or repeals of, existing laws may cause Downey's  results
to  differ  materially.   Further,  federal  monetary  policy,  particularly  as
implemented  through the Federal  Reserve System,  significantly  affects credit
conditions for Downey, primarily through open market operations in United States
government   securities,   the  discount   rate  for   borrowings   and  reserve
requirements,  and a material change in these conditions would be likely to have
a material impact on Downey's results.

Competition.  The banking and  financial  services  business in Downey's  market
areas are highly  competitive.  The  increasingly  competitive  environment is a
result  primarily of changes in  regulation,  changes in technology  and product
delivery  systems,  and the accelerating  pace of consolidation  among financial
services providers.  Downey's results may differ if circumstances  affecting the
nature or level of competition change.

Credit Quality.  A significant  source of risk arises from the possibility  that
losses will be sustained because  borrowers,  guarantors and related parties may
fail to perform in accordance with the terms of their loans.  Downey has adopted
underwriting and loan monitoring  procedures and credit policies,  including the
establishment  and review of the  allowance  for loan  losses,  that  management
believes are  appropriate  to minimize this risk by tracking  loan  performance,
assessing  the  likelihood  of  nonperformance  and  diversifying  Downey's loan
portfolio.  Such policies and procedures,  however,  may not prevent  unexpected
losses that could materially adversely affect Downey's results.

Year 2000. Downey, like most financial organizations,  has many computer systems
that  identify  dates using only the last two digits of the year.  These systems
must be prepared to distinguish  dates such as 1900 from 2000.  Computer  system
failures due to processing errors  potentially  arising from calculations  using
Year 2000 dates are a known risk. Downey has established  processes to identify,
prioritize, renovate or replace systems that may be affected by Year 2000 dates.
However,  third party vendor  dependency,  including  government  entities,  may
impact Downey's  efforts to  successfully  complete Year 2000 compliance for all
systems in a timely fashion.  For further  information  regarding  Downey's Year
2000  compliance  program  and its  status,  see  "Management's  Discussion  and
Analysis of Financial  Condition and Results of Operations - Financial Condition
- Year 2000" on page 52.


                                       16
<PAGE>



ITEM 2. PROPERTIES

                                    Branches

The  executive  offices of both Downey and the Bank are located at 3501 Jamboree
Road,  Newport  Beach,  California  92660,  in a six-story  building  containing
approximately  320,000  square  feet.  Part of the first  floor  houses a branch
office of the Bank. Certain departments  (warehousing,  record retention,  etc.)
are located in other owned and leased  facilities in Orange County,  California.
The majority of Downey's administrative operations,  however, are located in the
headquarters building.

At December 31, 1998,  Downey owned the building and land  occupied by 54 of its
branches and owned one branch building on leased land.  Downey operates branches
in 36  locations  (including  28  in-store  locations)  with  leases or licenses
expiring at various  dates  through  November  2009,  with options to extend the
term. In 1998,  Downey purchased land and buildings for two new branch locations
opening in 1999.

The net book  value of the owned  branches,  including  the one on leased  land,
totaled $84 million at December 31,  1998,  and the net book value of the leased
branch  offices  totaled $1 million at December 31, 1998.  The net book value of
Downey's furniture and fixtures, including electronic data processing equipment,
was $18 million at December 31, 1998.

For additional information regarding Downey's offices and equipment, see Notes 1
and 10 of Notes to the Consolidated Financial Statements on page 61 and page 77,
respectively.

                           Electronic Data Processing

Downey  utilizes a mainframe  computer  system  with use of various  third-party
vendors' software for retail deposit operations, loan servicing,  accounting and
loan  origination  functions.  The net book value of  Downey's  electronic  data
processing equipment, including personal computers and software, was $11 million
at December 31, 1998.

ITEM 3. LEGAL PROCEEDINGS

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

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS

None.


                                       17
<PAGE>


                                    PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Downey's common stock is traded on the New York Stock Exchange  ("NYSE") and the
Pacific  Exchange  ("PCX") with the trading  symbol  "DSL." At February 26 1999,
Downey had approximately  1,102 stockholders of record (not including the number
of persons or entities  holding stock in nominee or street name through  various
brokerage  firms)  and  28,131,776  outstanding  shares  of  common  stock.  The
following table sets forth for the quarters  indicated the range of high and low
sale  prices per share of the  common  stock of Downey as  reported  on the NYSE
Composite Tape.

<TABLE>
<CAPTION>
                                1998                                    1997
               -----------------------------------------------------------------------------
                 4th       3rd       2nd       1st       4th       3rd       2nd       1st
               Quarter   Quarter   Quarter   Quarter   Quarter   Quarter   Quarter   Quarter
--------------------------------------------------------------------------------------------
<S>            <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>   
High ........  $26.38    $35.00    $34.50    $30.95    $27.63    $23.33    $22.50    $21.42
Low .........   17.75     23.06     30.83     23.58     23.03     20.47     17.23     17.23
End of period   25.44     23.81     32.69     30.83     27.08     23.22     22.50     18.38
============================================================================================
</TABLE>

During 1998 and 1997,  Downey paid quarterly cash dividends  totaling $0.316 and
$0.301 per share,  aggregating $8.9 million and $8.5 million,  respectively.  On
February  26,  1999,  Downey  paid a $0.08 per share  quarterly  cash  dividend,
aggregating $2.3 million.

Downey may pay additional  dividends out of funds legally available  therefor at
such times as the Board of  Directors  determines  that  dividend  payments  are
appropriate.  The Board of Directors'  policy is to consider the  declaration of
dividends on a quarterly basis.

The payment of  dividends  by the Bank to Downey is subject to OTS  regulations.
For further information regarding these regulations see "Business - Regulation -
Regulation of the Bank - Capital Distribution Limitations" on page 13.


                                       18
<PAGE>


ITEM 6. SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
(Dollars in Thousands, Except Per Share Data)                     1998          1997          1996          1995          1994
---------------------------------------------------------------------------------------------------------------------------------
<S>                                                            <C>           <C>           <C>           <C>           <C>       
FOR THE YEAR:
Total interest income ......................................   $  440,404    $  420,418    $  346,360    $  318,828    $  228,970
Total interest expense .....................................      266,057       266,260       211,765       214,238       122,601
---------------------------------------------------------------------------------------------------------------------------------
    Net interest income ....................................      174,347       154,158       134,595       104,590       106,369
    Provision for loan losses ..............................        3,899         8,640         9,137         9,293         4,211
---------------------------------------------------------------------------------------------------------------------------------
      Net interest income after provision for loan losses ..      170,448       145,518       125,458        95,297       102,158
---------------------------------------------------------------------------------------------------------------------------------
Other income, net:
    Loan and deposit related fees ..........................       15,645        10,921         7,435         5,546         5,310
    Real estate and joint ventures held for investment, net        22,363        14,222         8,241        11,192         9,530
    Net gains (losses) on sales of:
      Loans and mortgage-backed securities .................        6,462         2,675         1,543           266           114
      Investment securities ................................           68          --           4,473           (15)         --
    (Provision for) reduction of loss on investment in lease
      residual .............................................         --            --            --             207          (920)
    Other ..................................................        2,815         7,370         3,507         3,403         3,703
---------------------------------------------------------------------------------------------------------------------------------
      Total other income, net ..............................       47,353        35,188        25,199        20,599        17,737
---------------------------------------------------------------------------------------------------------------------------------
Operating expense:
    General and administrative expense .....................      115,890        99,556        86,460        74,470        75,566
    SAIF special assessment ................................         --            --          24,644          --            --
    Net operation of real estate acquired in settlement of
      loans ................................................          260         1,184         2,567         4,206         3,595
    Amortization of excess of cost over fair value of net
      assets acquired ......................................          510           532           532           530           532
---------------------------------------------------------------------------------------------------------------------------------
      Total operating expense ..............................      116,660       101,272       114,203        79,206        79,693
---------------------------------------------------------------------------------------------------------------------------------
Net income (1) .............................................       57,973        45,234        20,704        21,093        23,532

Loans originated ...........................................    4,071,262     2,329,266     1,583,784       637,490     1,810,096
Loans and mortgage-backed securities purchased .............        7,463        35,828        30,296        44,194       196,255
Loans and mortgage-backed securities sold ..................    1,740,416       557,511       166,503       102,097        45,770

Effective interest rate spread .............................         3.08%         2.83%         2.96%         2.35%         3.02%

AT DECEMBER 31:
Total assets ...............................................   $6,270,419    $5,835,825    $5,198,157    $4,656,267    $4,650,651
Total loans and mortgage-backed securities .................    5,788,365     5,366,396     4,729,846     4,169,474     4,188,539
Investments and cash equivalents ...........................      215,086       221,201       222,255       237,904       215,960
Deposits ...................................................    5,039,733     4,869,978     4,173,102     3,790,221     3,557,398
Borrowings .................................................      703,720       483,735       595,345       436,218       674,776
Stockholders' equity .......................................      480,566       430,346       391,571       384,072       366,187
Loans serviced for others ..................................    1,040,264       612,529       576,044       527,234       468,123
Allowance for loan losses as a percentage of non-performing
  loans ....................................................       140.86%        76.96%        66.84%        35.67%        49.29%
Non-performing assets as a percentage of total assets ......         0.44          0.89          1.19          2.09          1.41

SELECTED RATIOS:
Return on average assets (1) ...............................         0.98%         0.79%         0.43%         0.45%         0.62%
Return on average equity (1) ...............................        12.71         11.07          5.33          5.69          6.56
Dividend payout ratio ......................................        15.33         18.69         39.35         36.78         33.97
Capital ratios:
    Average stockholders' equity to average assets .........         7.71          7.17          8.10          7.86          9.47
    Core and tangible capital (Bank only) ..................         6.83          6.61          6.56          7.28          7.22
    Risk-based capital (Bank only) .........................        12.88         12.64         12.66         14.25         14.21

PER SHARE DATA: (2)
Earnings per share - Basic (1) .............................       $ 2.06        $ 1.61        $ 0.74        $ 0.75        $ 0.84
Earnings per share - Diluted (1) ...........................         2.05          1.61          0.74          0.75          0.84
Book value per share at end of period ......................        17.08         15.32         13.95         13.68         13.05
Stock price at end of period ...............................        25.44         27.08         17.80         13.16          8.70
Cash dividends paid ........................................        0.316         0.301         0.290         0.276         0.276
=================================================================================================================================
<FN>
(1)  Excluding the SAIF special  assessment in 1996,  net income would have been
     $34.7  million or $1.23 per share on both a basic and diluted basis and the
     returns on  average  assets and  average  equity  would have been 0.73% and
     8.95%, respectively.
(2)  Adjusted for a 5% stock dividend paid in May 1998.
</FN>
</TABLE>


                                       19
<PAGE>


ITEM 7. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

Certain  statements under this caption constitute  "forward-looking  statements"
under the Private  Securities  Litigation Reform Act of 1995 which involve risks
and  uncertainties.  Downey's 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 Downey  conducts its
operations,  fluctuations  in interest  rates,  credit  quality  and  government
regulation.  For additional  information  concerning these factors, see "Item 1.
Business - Factors that May Affect Future Results" on page 16.

                                    Overview

Net  income  for 1998  totaled a record  $58.0  million  or $2.05 per share on a
diluted basis, up 28.2% from last year's $45.2 million or $1.61 per share.

Net income in 1998  benefited by $4.8 million from the  settlement of litigation
regarding  obligations  of a prior joint  venture  partner  ("settlement").  The
pre-tax  amount  totaled  $8.4  million of which $1.4  million  represented  the
recovery of a prior loan charge-off  thereby reducing provision for loan losses;
$4.4  million  was  recorded  in income  from  real  estate  and  joint  venture
operations  of which $4.3  million was a  reduction  of loss;  $1.0  million was
recorded in  miscellaneous  other  income;  and $1.6  million was  recorded as a
reduction  to  professional  fees  within  general and  administrative  expense.
Excluding  that amount,  1998 net income would have been $53.2  million or $1.89
per share on a diluted basis, up 17.7% from a year ago.

Excluding the settlement,  the increase in 1998 net income  primarily  reflected
higher net interest income. Net interest income increased $20.2 million or 13.1%
due to increases  in both  average  earning  assets and the  effective  interest
spread.  Also  contributing  to the increase in net income  between years was an
adjusted $6.8 million  increase in other income and declines of $3.3 million and
$1.0  million in adjusted  provision  for loan losses and net  operation of real
estate acquired in satisfaction  of loans,  respectively.  The increase in other
income  reflected  several  factors.   Favorably  impacting  other  income  were
increases of $4.7 million in loan and deposit  related fees, $3.8 million in net
gains on sales of loans,  and $3.7  million in adjusted  income from real estate
held for investment. These favorable other income items were partially offset by
declines of $3.8 million in the all other category, as 1997 included a gain from
the sale of an asset  obtained as part of the 1988  acquisition  of  Butterfield
Savings,  and a $1.0 million  decline in loan  servicing  fees  primarily due to
additions made to the valuation  allowance for mortgage  servicing  rights.  The
favorable  impact of higher net interest and other income,  and lower  provision
for loan losses and cost of net operation of real estate  acquired in settlement
of loans was partially offset by higher general and administrative  expense. The
$17.9 million adjusted increase in general and administrative  expense reflected
significantly  higher lending  volumes,  branch expansion and expense related to
resolving Year 2000 compliance issues.

Assets  increased  $435 million or 7.4% during 1998 to $6.3 billion at year end,
following a 12.3% increase during 1997.  Asset growth slowed in 1998 even though
loan  originations  reached a record level, as the low interest rate environment
prevalent  during  the year  resulted  in a high  level of loan  prepayments  as
borrowers refinanced into low, fixed rate loans. Single family loan originations
increased  from $2.0  billion  in 1997 to $3.7  billion  in 1998,  of which $2.2
billion were originated for sale in the secondary  market. In addition to single
family  loans,  $396  million of other  loans were  originated,  including  $175
million of auto loans and $160 million of construction and land loans.

An increase of $220 million in  borrowings,  primarily  long-term FHLB advances,
and an  increase of $170  million in  deposits  funded  asset  growth.  Deposits
totaled $5.0 billion at December 31, 1998, up 3.5% from year-end 1997.

Non-performing  assets  totaled $27  million or 0.44% of assets at December  31,
1998, down from $52 million or 0.89% of assets at December 31, 1997. The decline
in  non-performing  assets was  primarily  in the  commercial  real  estate loan
category, as several loans were returned to accrual status following an extended
period of satisfactory payment performance. A detailed review of all criticized,
classified, watch and non-performing assets is performed at least semi-annually.
All assets greater than $1 million are reviewed annually. The combined


                                       20
<PAGE>


provisions  for loan and real  estate  losses,  including  real  estate held for
investment  and  acquired in  settlement  of loans,  resulted in a $0.9  million
reduction of expense for 1998,  primarily due to the aforementioned  settlement,
which  included  $4.3  million of  settlement  proceeds  as a  reduction  to the
provision for losses.  Excluding this item, the combined  provisions  would have
been $3.4 million in 1998, $6.6 million in 1997 and $7.5 million in 1996.

At December 31, 1998,  the Bank met and  exceeded all three  regulatory  capital
tests,  with  capital-to-asset  ratios of 6.83% in tangible and core capital and
12.88% in  risk-based  capital.  These  capital  levels are well above the "well
capitalized"  standards defined by the federal banking regulators of 5% for core
and tangible capital and 10% for risk-based  capital.  For further  information,
see  "Business -  Regulation  -  Regulation  of the Bank - Insurance  of Deposit
Accounts"  on page 10,  "Financial  Condition -  Investments  in Real Estate and
Joint Ventures" on page 33 and "Regulatory Capital Compliance" on page 51.


                                       21
<PAGE>


                             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"). Net interest income is affected principally by
the  spread  between  the  yield  on  interest-earning  assets  and the  cost of
interest-bearing  liabilities  and by the relative dollar amounts of such assets
and liabilities.

Net interest  income was $174.3  million in 1998, up $20.2 million or 13.1% from
1997 and $39.8 million or 29.5%  greater than 1996.  The 1998  improvement  over
1997  primarily  reflected  increases  in both  average  earning  assets and the
effective interest rate spread. Average earning assets increased by $217 million
or 4.0% to $5.7 billion.  The effective  interest rate spread  averaged 3.08% in
1998, up from 2.83% in 1997 and 2.96% in 1996. The 1998 effective  interest rate
spread  improved  over 1997 as the yield on  earning  assets  increased  6 basis
points,  while the cost of funding those  earnings  assets  declined by 16 basis
points.

The following  table presents for the periods  indicated the total dollar amount
of interest income from average  interest-earning  assets and resultant  yields,
the interest expense on average  interest-bearing  liabilities and the resultant
costs,  expressed  both in dollars and rates.  The table also sets forth the net
interest  income,  the  interest  rate spread and the  effective  interest  rate
spread.   The  effective   interest  rate  spread,   which  reflects  a  savings
association's  relative  level of  interest-earning  assets to  interest-bearing
liabilities,   equals   (i)  the   difference   between   interest   income   on
interest-earning  assets and interest expense on  interest-bearing  liabilities,
(ii) divided by average  interest-earning  assets for the period. The table also
sets forth the net earning balance (the  difference  between the average balance
of   interest-earning   assets  and  the  average  balance  of  interest-bearing
liabilities) for the periods  indicated.  Non-accrual  loans are included in the
average  interest-earning  assets balance.  Interest from  non-accrual  loans is
included in interest  income only to the extent that  payments were received and
to the extent that  Downey  believes it will  recover  the  remaining  principal
balance of the loan.  Average  balances are  computed  using the average of each
month's daily average balance during the period indicated.

<TABLE>
<CAPTION>
                                                    1998                            1997                            1996
                                       ---------------------------------------------------------------------------------------------
                                                             Average                         Average                         Average
                                         Average              Yield/     Average              Yield/     Average              Yield/
(Dollars in Thousands)                   Balance    Interest   Rate      Balance    Interest   Rate      Balance    Interest   Rate
------------------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>          <C>        <C>     <C>          <C>        <C>     <C>          <C>        <C>  
Interest-earning assets:
   Loans ............................. $5,345,380   $421,942   7.89%   $5,174,767   $404,081   7.81%   $4,269,136   $329,746   7.72%
   Mortgage-backed securities ........     42,075      2,780   6.61        55,045      3,633   6.60        64,957      4,317   6.65
   Investment securities .............    276,139     15,682   5.68       217,272     12,704   5.85       215,364     12,297   5.71
------------------------------------------------------------------------------------------------------------------------------------
     Total interest-earning assets ...  5,663,594    440,404   7.78     5,447,084    420,418   7.72     4,549,457    346,360   7.61
Non-interest-earning assets ..........    254,913                         246,785                         240,191                
------------------------------------------------------------------------------------------------------------------------------------
     Total assets .................... $5,918,507                      $5,693,869                      $4,789,648           
====================================================================================================================================
Interest-bearing liabilities:
   Deposits .......................... $5,102,045   $248,337   4.87%   $4,588,320   $227,521   4.96%   $3,892,981   $184,402   4.74%
   Borrowings ........................    292,044     17,720   6.07       638,661     38,739   6.07       457,890     27,363   5.98
------------------------------------------------------------------------------------------------------------------------------------
     Total interest-bearing
        liabilities ..................  5,394,089    266,057   4.93     5,226,981    266,260   5.09     4,350,871    211,765   4.87
Non-interest-bearing liabilities .....     68,181                          58,415                          50,590         
Stockholders' equity .................    456,237                         408,473                         388,187         
------------------------------------------------------------------------------------------------------------------------------------
     Total liabilities and
        stockholders' equity ......... $5,918,507                      $5,693,869                      $4,789,648   
====================================================================================================================================
Net interest income/interest rate
   spread ............................              $174,347   2.85%                $154,158   2.63%                $134,595   2.74%
Excess of interest-earning assets over 
   interest-bearing liabilities ...... $  269,505                      $  220,103                      $  198,586   
Effective interest rate spread .......                         3.08                            2.83                            2.96
====================================================================================================================================
</TABLE>


                                       22
<PAGE>


Changes in Downey's net interest  income are a function of both changes in rates
and  changes  in  volumes  of  interest-earning   assets  and   interest-bearing
liabilities.  The following table sets forth  information  regarding  changes in
interest  income  and  expense  for  Downey  for the years  indicated.  For each
category of interest-earning asset and interest-bearing  liability,  information
is provided on changes attributable to: (i) changes in volume (changes in volume
multiplied by  comparative  period rate);  (ii) changes in rate (changes in rate
multiplied by  comparative  period  volume);  and (iii)  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 average
balances computed using the average of each month's daily average balance during
the period indicated.

<TABLE>
<CAPTION>
                                              1998 versus 1997                         1997 versus 1996
                                               Changes Due To                           Changes Due To
                                   -----------------------------------------------------------------------------
                                                       Rate/                                    Rate/
(In Thousands)                    Volume      Rate    Volume     Net      Volume       Rate    Volume     Net
----------------------------------------------------------------------------------------------------------------
<S>                              <C>        <C>       <C>     <C>         <C>        <C>       <C>      <C>    
Interest Income:
   Loans ......................  $ 13,322   $ 4,394   $ 145   $ 17,861    $69,951    $ 3,617   $  767   $74,335
   Mortgage-backed securities .      (856)        4      (1)      (853)      (659)       (30)       5      (684)
   Investment securities ......     3,442      (365)    (99)     2,978        109        295        3       407
----------------------------------------------------------------------------------------------------------------
     Change in interest income     15,908     4,033      45     19,986     69,401      3,882      775    74,058
----------------------------------------------------------------------------------------------------------------
Interest Expense:
   Deposits ...................    25,474    (4,189)   (469)    20,816     32,937      8,639    1,543    43,119
   Borrowings .................   (21,019)     --      --      (21,019)    10,801        412      163    11,376
----------------------------------------------------------------------------------------------------------------
     Change in interest expense     4,455    (4,189)   (469)      (203)    43,738      9,051    1,706    54,495
----------------------------------------------------------------------------------------------------------------
Change in net interest income .  $ 11,453   $ 8,222   $ 514   $ 20,189    $25,663    $(5,169)  $ (931)  $19,563
================================================================================================================
</TABLE>

PROVISION FOR LOAN LOSSES

Provision  for loan losses was $3.9  million in 1998,  down from $8.6 million in
1997 and $9.1 million in 1996.  The decline in provision for loan losses in 1998
reflects a $1.4 million  recovery of a prior loan  charge-off as a result of the
previously  mentioned  settlement,  as well as less growth in the loan portfolio
than in 1997.

For further  information,  see  "Financial  Condition  - Problem  Loans and Real
Estate - Allowance for Losses on Loans and Real Estate" on page 46.

OTHER INCOME

Other income  totaled  $47.4  million in 1998, up from $35.2 million in 1997 and
$25.2 million in 1996. The increase in 1998 reflected several factors. Favorably
impacting other income were increases of $8.1 million in income from real estate
held for investment,  $4.7 in loan and deposit related fees, and $3.8 million in
net gains from the sale of loans and MBSs.  These favorable items were partially
offset by declines of $3.5  million in the other  category  and $1.0  million in
loan  servicing  fees.  Below is a further  discussion of the major other income
categories.

Loan and Deposit Related Fees

Loan and deposit  related  fees  totaled  $15.6  million in 1998,  up from $10.9
million in 1997 and $7.4 million in 1996.  As depicted in the  following  table,
loan  related fees  increased  by $3.4  million in 1998 due  primarily to higher
prepayment  and wire transfer fees from funding a higher volume of loans,  while
deposit related fees increased by $1.3 million.

<TABLE>
<CAPTION>
 (In Thousands)                            1998     1997    1996
-----------------------------------------------------------------
<S>                                      <C>      <C>      <C>   
Loan related fees .....................  $ 7,225  $ 3,837  $2,496
Deposit related fees ..................    8,420    7,084   4,939
-----------------------------------------------------------------
    Total loan and deposit related fees  $15,645  $10,921  $7,435
=================================================================
</TABLE>


                                       23
<PAGE>


Real Estate and Joint Venture Operations Held for Investment

Income from real estate and joint  venture  operations  totaled $22.4 million in
1998,  up from $14.2  million in 1997 and $8.2 million in 1996.  The table below
sets  forth the key  components  comprising  income  from real  estate and joint
venture operations.

<TABLE>
<CAPTION>
(In Thousands)                                                1998     1997    1996
------------------------------------------------------------------------------------
<S>                                                         <C>      <C>      <C>   
Operations, net:
    Rental operations, net of expenses ...................  $ 3,723  $ 2,317  $2,417
    Equity in net income from joint ventures .............    9,203    3,931      55
    Interest from joint venture advances .................    1,584    1,880   2,071
------------------------------------------------------------------------------------
      Total operations, net ..............................   14,510    8,128   4,543
Net gains on sales of wholly owned real estate ...........    2,557    2,904     392
Reduction of losses on real estate and joint ventures ....    5,296    3,190   3,306
------------------------------------------------------------------------------------
      Income from real estate and joint venture operations  $22,363  $14,222  $8,241
====================================================================================
</TABLE>

Favorably  impacting  1998 was $4.4  million  of  proceeds  from the  previously
mentioned settlement, of which $4.3 million was recorded as a recovery of losses
on real estate and joint  ventures.  The balance of the 1998 increase  primarily
reflected  higher gains on sale associated with  residential and shopping center
joint  venture  projects,  which  appears  within the  category of equity in net
income from joint ventures.

For  additional  information,  see  "Financial  Condition - Investments  in Real
Estate and Joint Ventures" on page 33, "Financial  Condition - Problem Loans and
Real Estate - Allowance for Losses on Loans and Real Estate" on page 46 and Note
8 of Notes to the Consolidated Financial Statements on page 73.

Secondary Marketing Activities

Sales of loans and MBSs  originated by Downey  increased in 1998 to $1.7 billion
from $558 million in 1997 and $167 million in 1996.  Net gains  associated  with
loan and MBS sales  totaled $6.5  million in 1998,  up from $2.7 million in 1997
and $1.5  million in 1996.  The net gains  include  $7.3  million in 1998,  $1.2
million  in 1997 and $1.0  million  in 1996  related  to the  capitalization  of
mortgage servicing rights.

Loan servicing fees from Downey's portfolio of loans serviced for others totaled
$0.3 million for 1998,  down from $1.3 million in 1997 and $1.4 million in 1996.
The decline in 1998 reflects an addition to the valuation allowance for mortgage
servicing  rights due to higher than expected  prepayments from the low interest
rate  environment  that existed  during the year.  At December 31, 1998,  Downey
serviced $1.0 billion of loans for others,  compared to $613 million at December
31, 1997, and $576 million at December 31, 1996.

Other Category

The all other category of other income  totaled $2.6 million in 1998,  down from
$6.1  million  in 1997 but up from $2.1  million in 1996.  Included  in the 1998
total were $1.0 million of proceeds from the  previously  mentioned  settlement.
Excluding  that  amount,  the  adjusted  decline  from 1997 would have been $4.5
million.  That  decrease  primarily  reflects that 1997 included a gain from the
sale of an  asset  obtained  as  part of the  1988  acquisition  of  Butterfield
Savings.


                                       24
<PAGE>


OPERATING EXPENSES

Operating  expenses  totaled  $116.7  million in 1998, up from $101.3 million in
1997 and $114.2  million in 1996 which  included a one-time  SAIF  assessment of
$24.6  million.  The  current  year  increase  was  due to  higher  general  and
administrative  expense,  as the  net  operation  of  real  estate  acquired  in
settlement  of loans  declined  by $0.9  million to $0.3  million.  General  and
administrative  expense  increased  $16.3  million  or  16.4%  in  1998  due  to
significantly  higher lending  volumes,  branch expansion and expense related to
Year 2000 costs.  Year 2000 related  costs  totaled $1.8 million for the current
year, up from $0.1 million in 1997.  Included within general and  administrative
expense in the current year was a $1.6 million  reduction to  professional  fees
due to proceeds from the previously mentioned  settlement,  while the prior year
included $1.4 million of expense associated with the departure of a former chief
executive.

<TABLE>
<CAPTION>
(In Thousands)                                                           1998      1997      1996
---------------------------------------------------------------------------------------------------
<S>                                                                    <C>       <C>       <C>     
Salaries and related costs ..........................................  $ 66,152  $ 54,366  $ 45,811
Premises and equipment costs ........................................    16,834    15,272    12,640
Advertising expense .................................................     5,954     6,847     4,071
Professional fees ...................................................     2,867     5,113     2,985
SAIF insurance premiums and regulatory assessments ..................     3,832     3,439     8,949
Other general and administrative expense ............................    20,251    14,519    12,004
---------------------------------------------------------------------------------------------------
    Total general and administrative expense ........................   115,890    99,556    86,460
SAIF special assessment .............................................      --        --      24,644
Net operation of real estate acquired in settlement of loans ........       260     1,184     2,567
Amortization of excess of cost over fair value of net assets acquired       510       532       532
---------------------------------------------------------------------------------------------------
    Total operating expense .........................................  $116,660  $101,272  $114,203
===================================================================================================
</TABLE>

For further information  regarding the potential expense impact of the Year 2000
compliance issue, see "Financial Condition - Year 2000" on page 52.

PROVISION FOR INCOME TAXES

Downey's  effective  tax rate for 1998 was  42.7%,  similar to 43.1% in 1997 and
43.2%  in  1996.  See  Notes 1 and 18 of  Notes  to the  Consolidated  Financial
Statements on pages 61 and 81, respectively,  for a further discussion of income
taxes and an  explanation  of the factors  which impact  Downey's  effective tax
rate.

BUSINESS SEGMENT REPORTING

The previous  sections of the Results of Operations  discussed the  consolidated
results of Downey. The purpose of this section is to present data on the results
of  operations  of  Downey's  two  business  segments - banking  and real estate
investment.  For a description  of these  business  segments and the  accounting
policies  used,  see  "Business"  on page 1, and  Notes 1 and 25 of Notes to the
Consolidated Financial Statements on pages 61 and 91, respectively.

The following  table presents by business  segment net income for 1998, 1997 and
1996, followed by a discussion of the results of operations of each segment.

<TABLE>
<CAPTION>
(In Thousands)            1998     1997     1996
-----------------------------------------------------
<S>                     <C>      <C>      <C>   
Banking ..............  $46,736  $38,662  $17,191 (1)
Real estate investment   11,237    6,572    3,513
-----------------------------------------------------
   Total net income ..  $57,973  $45,234  $20,704 (1)
=====================================================
<FN>
(1)  Excluding the SAIF special assessment, net income for Banking and the total
     would have been $31.2 million and $34.7 million, respectively.
</FN>
</TABLE>


                                       25
<PAGE>


Banking

Net income from banking  operations totaled $46.7 million in 1998, up from $38.7
million in 1997 and $17.2 million in 1996.  Net income in 1998 benefited by $1.9
million from the previously  mentioned  settlement.  Excluding that amount, 1998
net income would have been $44.8  million,  up $6.1 million or 15.8% from a year
ago.  Adjusting for the  settlement,  the increase in 1998 net income  primarily
reflected  higher net interest  income.  Net  interest  income  increased  $20.2
million  or 13.0%  due to  increases  in both  average  earning  assets  and the
effective interest rate spread.  Also contributing to the increase in net income
between years was an adjusted $3.2 million  decline in provision for loan losses
and an adjusted $3.0 million increase in other income.  The increase in adjusted
other income reflected  increases in loan and deposit related fees and net gains
on sales of loans, partially offset by a decline in loan servicing fees and that
1997 results  included a gain from the sale of an asset  obtained as part of the
1988  acquisition of Butterfield  Savings.  The favorable  impact of these items
were partially  offset by higher operating  expense.  The $16.0 million adjusted
operating  expense  increase  reflected  significantly  higher lending  volumes,
branch  expansion and expense  related  towards  resolving Year 2000  compliance
issues. The table below sets forth banking  operational  results for the periods
indicated.

<TABLE>
<CAPTION>
(In Thousands)                        1998         1997         1996
--------------------------------------------------------------------------
<S>                               <C>          <C>          <C>       
Net interest income ............  $  174,967   $  154,799   $  134,808
Provision for loan losses ......       3,918        8,522        9,026
Other income ...................      24,617       20,783       16,956
Operating expense ..............     113,954       98,803       87,275
SAIF special assessment ........        --           --         24,644
Net intercompany expense .......        (107)        (357)        (574)
--------------------------------------------------------------------------
Income before income tax expense      81,605       67,900       30,245
Income tax expense .............      34,869       29,238       13,054
--------------------------------------------------------------------------
   Net income ..................  $   46,736   $   38,662   $   17,191 (1)
==========================================================================
AT DECEMBER 31:
Assets:
   Loans .......................  $5,788,365   $5,366,396   $4,729,846
   Other .......................     463,960      449,174      446,975
--------------------------------------------------------------------------
     Total assets ..............   6,252,325    5,815,570    5,176,821
--------------------------------------------------------------------------
Equity .........................     480,566      430,346      391,571
==========================================================================
<FN>
(1)  Excluding  the SAIF  special  assessment,  net income would have been
     $31.2 million.
</FN>
</TABLE>


                                       26
<PAGE>


Real Estate Investment

Net income from real estate investment operations totaled $11.2 million in 1998,
up from  $6.6  million  in 1997 and $3.5  million  in 1996.  Net  income in 1998
benefited by $2.9 million from the previously  mentioned  settlement.  Adjusting
for the  settlement,  adjusted 1998 net income would have been $8.3 million,  up
$1.7 million or 25.8% from a year ago. The adjusted increase primarily reflected
higher gains on sale  associated  with  residential  and  shopping  center joint
venture  projects  which appears in the other income  category.  The table below
sets forth real estate investment operational results for the periods indicated.

<TABLE>
<CAPTION>
(In Thousands)                            1998      1997      1996
-------------------------------------------------------------------
<S>                                    <C>       <C>       <C>    
Net interest expense ................  $  (620)  $  (641)  $  (213)
Provision (reduction) for loan losses      (19)      118       111
Other income ........................   22,736    14,405     8,243
Operating expense ...................    2,706     2,469     2,284
Net intercompany income .............      107       357       574
-------------------------------------------------------------------
Income before income tax expense ....   19,536    11,534     6,209
Income tax expense ..................    8,299     4,962     2,696
-------------------------------------------------------------------
   Net income .......................  $11,237   $ 6,572   $ 3,513
===================================================================
AT DECEMBER 31:
Assets:
   Real estate held for investment ..  $49,447   $41,356   $46,498
   Other ............................   11,224    14,455    14,514
-------------------------------------------------------------------
     Total assets ...................   60,671    55,811    61,012
-------------------------------------------------------------------
Equity ..............................   42,577    35,556    39,676
===================================================================
</TABLE>


For a further  discussion  regarding  income  from real estate  investment,  see
"Results of Operations - Other Income - Real Estate and Joint Venture Operations
Held For  Investment" on page 24, and for information  regarding  related assets
see  "Financial  Condition - Investments  in Real Estate and Joint  Ventures" on
page 33.


                                       27
<PAGE>


                              Financial Condition

LOANS AND MORTGAGE-BACKED SECURITIES

Loans and  mortgage-backed  securities,  including those held for sale,  totaled
$5.8  billion,  or 92.3% of assets at December  31,  1998.  This  represents  an
increase of $422 million or 7.9% from the $5.4 billion at December 31, 1997. The
increase primarily represents a higher level of loans held for sale.

Loan originations  (including loans purchased)  totaled a record $4.1 billion in
1998,  up from $2.4  billion  in 1997 and $1.6  billion in 1996.  This  increase
primarily  reflected an increase in originations of one-to-four unit residential
loans. Due to the low interest rate environment  prevalent during 1998, borrower
preference  for such loans was  primarily  fixed  rate.  Therefore,  of the $3.7
billion  of  one-to-four  unit  residential  loans   originated,   approximately
two-thirds  or $2.3 billion were fixed rate,  all but $198 million of which were
originated  for sale in the  secondary  market.  In  addition,  $380  million of
subprime loans were originated in 1998, up from $221 million in 1997.

The table below presents information regarding interest rates and fees collected
on loans originated during the periods indicated.

<TABLE>
<CAPTION>
(Dollars in Thousands)                                    1998        1997        1996        1995        1994
----------------------------------------------------------------------------------------------------------------
<S>                                                    <C>         <C>          <C>           <C>       <C>      
Average interest rate on new loans .................       6.45%       6.04%       6.06%       6.99%       4.94%
Average total loan origination fees on new loans ...       0.75        0.80        0.79        1.08        0.85
Total loan fees (net of costs) and discounts (net of
    premiums) deferred during the year .............   $(30,621)   $(11,505)    $(4,525)      $ 880     $(7,861)
================================================================================================================
</TABLE>

Downey  originates   one-to-four  unit  residential  adjustable  rate  mortgages
("ARMs") both with and without loan  origination  fees. In ARM  transactions for
which no origination fees are charged,  Downey receives a larger margin over the
index to which the loan pricing is tied than in those in which fees are charged.
In addition,  such loans are  generally  subject to a prepayment  fee if prepaid
within the first three years.  This trend towards loans with no origination fees
has generally  resulted in deferrable  loan  origination  costs  exceeding  loan
origination fees except in 1995, which included  increases in interest buydowns,
or discounts, on new real estate loans.

Residential one-to-four unit ARM originations (including loans purchased through
correspondent lending  relationships) were $1.4 billion during 1998, compared to
$1.7  billion  and $1.1  billion  in 1997 and  1996,  respectively.  Refinancing
activities related to residential one-to-four unit loans (including new loans to
refinance loans  originated by Downey and other lenders)  increased during 1998,
constituting 71% of originations  during the year compared to 45% and 43% during
1997 and 1996, respectively.  As market interest rates began to rise in 1994 and
1995,  one-to-four  unit  residential  borrower  preference  changed  from being
predominantly interested in ARMs tied to the one-year constant maturity Treasury
("CMT") index,  a market rate index,  to ARMs tied to the Federal Home Loan Bank
("FHLB") Eleventh District Cost of Funds Index ("COFI"), an index which lags the
movement  in market  interest  rates.  For the  year,  74% of  one-to-four  unit
originations  for  investment  represented  monthly  adjusting  COFI ARMs  which
provide for negative amortization, 11% represented COFI ARMs which reprice every
six  months but do not  provide  for  negative  amortization,  with the  balance
represented  by a variety of other  pricing  terms.  At December 31, 1998,  $3.0
billion of one-to-four unit ARMs were subject to negative  amortization of which
$47 million represented the amount of negative  amortization added to the unpaid
loan balance.  For further  information,  see  "Business - Banking  Activities -
Lending Activities - Residential Real Estate Lending" on page 3.

Originations of commercial real estate loans (including loans purchased) totaled
$11 million in 1998, compared to $8 million in 1997 and $2 million in 1996. Most
of the commercial  real estate lending in these years was to facilitate the sale
of real estate investments by the Bank and DSL Service Company.  Originations of
loans secured by multi-family properties (including loans purchased) totaled $15
million in 1998, compared to $6 million in 1997 and $20 million in 1996.


                                       28
<PAGE>


During 1998, Downey originated $112 million of construction  loans,  principally
for entry level and first time move-up  residential tracts. This compares to $80
million in 1997 and $72 million in 1996.  Originations of land development loans
totaled $48 million in 1998,  compared to $20 million in 1997 and $10 million in
1996.

Originations  of non-mortgage  commercial  loans decreased to $6 million in 1998
from $14 million in 1997. Virtually all of such originations represented secured
loans.

In 1995,  Downey  augmented  its  direct  automobile  lending  program  with the
commencement  of an indirect  lending  program  through  preapproved  automobile
dealers to finance consumer  purchases of new and used automobiles.  These loans
are fixed rate with  maturities  generally  up to five  years.  Originations  of
automobile loans totaled $175 million in 1998,  compared to $259 million in 1997
and $201 million in 1996.


                                       29
<PAGE>


The  following  table sets forth the  origination,  purchase  and sale  activity
relating to loans and MBSs during the periods indicated.

<TABLE>
<CAPTION>
(In Thousands)                                                        1998          1997          1996        1995          1994
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                               <C>           <C>           <C>           <C>         <C>        
INVESTMENT PORTFOLIO:
Loans originated:
   Loans secured by real estate:
     Residential:
      One-to-four units:
        Adjustable ............................................   $   943,736   $ 1,384,442   $ 1,026,812   $ 396,111   $ 1,673,822
        Adjustable - subprime .................................       372,286       218,399        33,030        --            --
------------------------------------------------------------------------------------------------------------------------------------
          Total adjustable ....................................     1,316,022     1,602,841     1,059,842     396,111     1,673,822
        Fixed .................................................       192,436        22,265        33,073      13,888         7,411
        Fixed - subprime ......................................         6,020         2,786           545        --            --
      Five or more units:
        Adjustable ............................................           875         4,600        17,409         128        18,385
        Fixed .................................................        13,229          --           2,253         419           953
------------------------------------------------------------------------------------------------------------------------------------
          Total residential ...................................     1,528,582     1,632,492     1,113,122     410,546     1,700,571
     Commercial real estate ...................................        10,363         7,830         1,548      10,629        18,900
     Construction .............................................       111,534        80,014        71,678      28,931        14,785
     Land .....................................................        48,357        20,295        10,468      12,906          --
   Non-mortgage:
     Commercial ...............................................         6,376        14,336        11,835       1,115         1,605
     Automobile ...............................................       175,193       259,040       200,966      62,234         1,869
     Other consumer ...........................................        28,274        25,988        14,226      17,633        39,945
------------------------------------------------------------------------------------------------------------------------------------
        Total loans originated ................................     1,908,679     2,039,995     1,423,843     543,994     1,777,675
Real estate loans purchased (1) ...............................         7,463        35,828           223      44,194       145,117
------------------------------------------------------------------------------------------------------------------------------------
   Total loans originated and purchased .......................     1,916,142     2,075,823     1,424,066     588,188     1,922,792
Loan repayments ...............................................    (1,855,157)   (1,130,357)     (832,713)   (538,217)     (631,836)
Other net changes (2), (3) ....................................       (34,145)     (319,183)      (39,978)    (50,544)      (38,330)
------------------------------------------------------------------------------------------------------------------------------------
   Net increase (decrease) in loans held for investment .......        26,840       626,283       551,375        (573)    1,252,626
------------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities held to maturity, net:
   Repayments .................................................          --            --            --        (5,588)      (11,917)
   Transferred to mortgage-backed securities available for sale          --            --            --       (33,555)         --
------------------------------------------------------------------------------------------------------------------------------------
     Net decrease in mortgage-backed securities, net ..........          --            --            --       (39,143)      (11,917)
------------------------------------------------------------------------------------------------------------------------------------
      Net increase (decrease) in loans and mortgage-backed
         securities held for investment .......................        26,840       626,283       551,375     (39,716)    1,240,709
------------------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO:
Residential, one-to-four units:
   Originated whole loans .....................................     2,162,583       289,271       159,941      93,496        32,421
   Loans transferred from (to) the investment portfolio (3) ...        (3,056)      290,558         1,791        (100)         --
   Originated whole loans sold (3) ............................    (1,130,303)     (467,989)     (135,426)    (80,725)      (45,770)
   Loans exchanged for mortgage-backed securities .............      (608,831)      (89,522)      (26,452)       --            --
   Other net changes ..........................................        (8,111)          (83)          (48)        (10)          (16)
------------------------------------------------------------------------------------------------------------------------------------
     Net increase (decrease) in loans held for sale ...........       412,282        22,235          (194)     12,661       (13,365)
------------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities, net:
   Received in exchange for loans .............................       608,831        89,522        26,452        --            --
   Purchased ..................................................          --            --          30,073        --          51,138
   Transferred from mortgage-backed securities held to maturity          --            --            --        33,555          --
   Sold .......................................................      (610,113)      (89,522)      (31,077)    (21,372)         --
   Repayments .................................................       (15,129)      (12,560)      (15,661)     (6,862)       (5,263)
   Other net changes ..........................................          (742)          592          (596)      2,669        (1,789)
------------------------------------------------------------------------------------------------------------------------------------
     Net increase (decrease) in mortgage-backed securities
        available for sale ....................................       (17,153)      (11,968)        9,191       7,990        44,086
------------------------------------------------------------------------------------------------------------------------------------
     Net increase in loans and mortgage-backed securities held
        for sale and available for sale .......................       395,129        10,267         8,997      20,651        30,721
------------------------------------------------------------------------------------------------------------------------------------
     Total net increase (decrease) in loans and mortgage-backed
        securities ............................................   $   421,969   $   636,550   $   560,372   $ (19,065)  $ 1,271,430
====================================================================================================================================
<FN>
(1)  Primarily  one-to-four unit residential  loans.  Included in 1998 were $0.7
     million  of five  or more  unit  residential  loans  and  $0.6  million  of
     commercial  loans.  Included in 1997 were $1.3 million of five or more unit
     residential loans.
(2)  Primarily includes borrowings against and repayments of lines of credit and
     construction loans,  changes in loss allowances,  loans transferred to real
     estate  acquired in settlement of loans or to the held for sale  portfolio,
     and interest capitalized on loans (negative amortization).
(3)  Includes $290.5 million of one-to-four  unit  residential  ARMs transferred
     from the held  for  investment  portfolio  during  1997 and sold  servicing
     released.
</FN>
</TABLE>


                                       30
<PAGE>


The  following   table  sets  forth  the   composition   of  Downey's  loan  and
mortgage-backed  securities  portfolio at the dates  indicated.  At December 31,
1998,  approximately  99% of  Downey's  real estate  loans were  secured by real
estate located in California  (principally in Los Angeles,  Orange, Santa Clara,
San Diego and San Mateo counties).

<TABLE>
<CAPTION>
                                                                                    December 31,                            
                                                        -------------------------------------------------------------------
(In Thousands)                                             1998          1997          1996          1995          1994
---------------------------------------------------------------------------------------------------------------------------
<S>                                                     <C>           <C>           <C>           <C>           <C>       
INVESTMENT PORTFOLIO:
    Loans secured by real estate:
       Residential:
         One-to-four units:
            Adjustable ..............................   $3,721,728    $4,190,160    $3,840,862    $3,486,774    $3,493,435
            Adjustable - subprime ...................      580,232       245,749        32,715          --            --
            Fixed ...................................      325,454       168,315       172,328       169,738       194,845
            Fixed - subprime ........................        8,719         3,321           543          --            --
---------------------------------------------------------------------------------------------------------------------------
              Total one-to-four units ...............    4,636,133     4,607,545     4,046,448     3,656,512     3,688,280
         Five or more units:
            Adjustable ..............................       18,617        29,246        43,050        44,438        48,782
            Fixed ...................................       21,412         9,032        13,857        12,883        15,000
       Commercial real estate:
         Adjustable .................................       39,360        87,604       158,656       170,498       178,377
         Fixed ......................................      101,430       114,821       101,953       100,085       116,041
       Construction .................................      127,761        70,865        66,651        28,593        11,367
       Land .........................................       44,859        25,687        21,177        21,867         9,822
    Non-mortgage:
       Commercial ...................................       28,293        26,024        22,136        12,864        12,975
       Automobile ...................................      357,988       342,326       202,186        56,127         3,028
       Other consumer ...............................       41,894        47,735        47,281        50,945        53,241
---------------------------------------------------------------------------------------------------------------------------
            Total loans held for investment .........    5,417,747     5,360,885     4,723,395     4,154,812     4,136,913
    Increase (decrease) for:
       Undisbursed loan funds .......................     (108,414)      (64,884)      (49,250)      (29,942)      (13,872)
       Net deferred costs and premiums ..............       31,021        18,088        11,663         7,412         7,468
       Allowance for estimated loss .................      (31,517)      (32,092)      (30,094)      (27,943)      (25,597)
---------------------------------------------------------------------------------------------------------------------------
            Total loans held for investment, net ....    5,308,837     5,281,997     4,655,714     4,104,339     4,104,912
---------------------------------------------------------------------------------------------------------------------------
    Mortgage-backed securities held to maturity, net:
       Adjustable ...................................         --            --            --            --          19,897
       Fixed ........................................         --            --            --            --          19,246
---------------------------------------------------------------------------------------------------------------------------
         Total mortgage-backed securities held to
            maturity, net ...........................         --            --            --            --          39,143
---------------------------------------------------------------------------------------------------------------------------
         Total loans and mortgage-backed securities
            held for investment .....................    5,308,837     5,281,997     4,655,714     4,104,339     4,144,055
---------------------------------------------------------------------------------------------------------------------------
SALE PORTFOLIO, NET:
    Loans held for sale (all one-to-four units):
       Adjustable ...................................        7,975         1,617         1,145           238          --
       Fixed ........................................      439,407        33,483        11,720        12,821           398
---------------------------------------------------------------------------------------------------------------------------
         Total loans held for sale ..................      447,382        35,100        12,865        13,059           398
    Mortgage-backed securities available for sale:
       Adjustable ...................................       10,996        17,751        23,620        34,355        44,086
       Fixed ........................................       21,150        31,548        37,647        17,721          --
---------------------------------------------------------------------------------------------------------------------------
         Total mortgage-backed securities available
            for sale ................................       32,146        49,299        61,267        52,076        44,086
---------------------------------------------------------------------------------------------------------------------------
         Total loans and mortgage-backed securities
            held for sale and available for sale ....      479,528        84,399        74,132        65,135        44,484
---------------------------------------------------------------------------------------------------------------------------
         Total loans and mortgage-backed securities .   $5,788,365    $5,366,396    $4,729,846    $4,169,474    $4,188,539
===========================================================================================================================
</TABLE>


                                       31
<PAGE>


The table  below sets forth the  scheduled  contractual  maturities  of Downey's
total loan and mortgage-backed securities portfolio as of December 31, 1998.

<TABLE>
<CAPTION>
                                   Within       1-2        2-3        3-5        5-10      10-15       Beyond
(In Thousands)                     1 year      years      years      years      years      years      15 years      Total
---------------------------------------------------------------------------------------------------------------------------
<S>                               <C>        <C>        <C>        <C>        <C>        <C>        <C>          <C>       
Loans secured by real estate:
    Residential:
      One-to-four units:
        Adjustable (1) ........   $ 37,087   $ 39,965   $ 43,067   $ 96,418   $314,646   $457,205   $3,321,547   $4,309,935
        Fixed (1) .............      9,520     10,251     11,039     24,687     80,353    116,342      521,388      773,580
      Five or more units:
        Adjustable ............        310        335        361        809      2,645      3,855       10,302       18,617
        Fixed .................      2,908      3,165      3,446      7,834      4,059       --           --         21,412
      Commercial real estate:
        Adjustable ............      1,294      1,395      1,505      3,371     11,025     16,067        4,703       39,360
        Fixed .................      6,051      6,596      7,191     16,386     55,780      9,426         --        101,430
      Construction - adjustable    127,761       --         --         --         --         --           --        127,761
      Land:
        Adjustable ............     32,213     11,399       --         --         --         --           --         43,612
        Fixed .................         60         66         73        170        602        276         --          1,247
Non-mortgage:
    Commercial ................     23,272      1,573      1,727      1,721       --         --           --         28,293
    Automobile ................     85,246     94,025    103,709     75,008       --         --           --        357,988
    Other consumer (2) ........      1,904      2,032      2,168        755     35,035       --           --         41,894
---------------------------------------------------------------------------------------------------------------------------
        Total loans ...........    327,626    170,802    174,286    227,159    504,145    603,171    3,857,940    5,865,129
Mortgage-backed securities, net        693     14,237        594      1,333      4,382      4,553        6,354       32,146
---------------------------------------------------------------------------------------------------------------------------
      Total loans and mortgage-
        backed securities .....   $328,319   $185,039   $174,880   $228,492   $508,527   $607,724   $3,864,294   $5,897,275
===========================================================================================================================
<FN>
(1)  Includes loans held for sale.
(2)  Includes  home equity line of credit  loans which are interest  only,  with
     balances  due  at the  end of the  term.  All or  part  of the  outstanding
     balances may be paid off at any time during the term without penalty.
</FN>
</TABLE>

At December 31, 1998,  the maximum  amount the Bank could have loaned to any one
borrower (and related entities) under regulatory limits was $75 million, or $124
million  for loans  secured by readily  marketable  collateral,  compared to $67
million and $112 million,  respectively, at December 31, 1997. The Bank does not
expect that these  regulatory  limitations  will  adversely  impact its proposed
lending activities during 1999.

INVESTMENT SECURITIES

The following table sets forth the composition of Downey's investment securities
portfolio  at the  dates  indicated.  In the 1995  fourth  quarter,  the held to
maturity U.S.  Treasury and agency  portfolio was  transferred  to available for
sale  consistent  with the "Guide to  Statement  115 on  Accounting  for Certain
Investments in Debt and Equity  Securities"  issued by the Financial  Accounting
Standards Board.

<TABLE>
<CAPTION>
                                                            December 31,
                                       ----------------------------------------------------
(In Thousands)                           1998        1997       1996       1995       1994
-------------------------------------------------------------------------------------------
<S>                                    <C>        <C>        <C>        <C>        <C>     
Federal funds ......................   $ 33,751   $  6,095   $  6,038   $  7,249   $  6,112
U.S. Treasury and agency securities:
    Held to maturity ...............       --         --         --         --      155,109
    Available for sale .............    116,061    159,398    141,999    164,880       --
Municipal bonds - held to maturity .      6,764      6,885      6,997      7,194       --
-------------------------------------------------------------------------------------------
    Total ..........................   $156,576   $172,378   $155,034   $179,323   $161,221
===========================================================================================
</TABLE>


                                       32
<PAGE>


As of December 31, 1998,  the maturities of Downey's  investment  securities and
the weighted average yield of those securities were as follows.

<TABLE>
<CAPTION>
                                                               After 1 Year
                                          1 Year or Less      Through 5 Years     After 5 Years           Total      
                                        -----------------------------------------------------------------------------
                                                 Weighted            Weighted           Weighted             Weighted
                                                  Average             Average            Average              Average
  (Dollars in Thousands)                 Amount    Yield     Amount    Yield     Amount   Yield      Amount    Yield
---------------------------------------------------------------------------------------------------------------------
<S>                                     <C>        <C>      <C>         <C>      <C>       <C>      <C>         <C>  
Federal funds .......................   $33,751    4.13%    $   --         -%    $ --         -%    $ 33,751    4.13%
  U.S. Treasury and agency securities      --         -      116,061    5.77       --         -      116,061    5.77
  Municipal bonds (1) ...............      --         -         --         -      6,764    5.28        6,764    5.28
---------------------------------------------------------------------------------------------------------------------
     Total ..........................   $33,751    4.13%    $116,061    5.77%    $6,764    5.28%    $156,576    5.40%
=====================================================================================================================
<FN>
(1) Yield on a fully tax-equivalent basis is 9.26%.
</FN>
</TABLE>

INVESTMENTS IN REAL ESTATE AND JOINT VENTURES

DSL Service  Company  participates as an owner of, or a partner in, a variety of
real estate  development  projects,  principally  retail  neighborhood  shopping
center  developments,  most of which are  located in  California.  In  addition,
Downey  Financial  Corp. owns one investment in land which it purchased from DSL
Service Company at fair value in 1995. For additional  information regarding the
location  of  these  real  estate  investments  see  Note  8  of  Notes  to  the
Consolidated   Financial  Statements  on  page  73.  Most  of  the  real  estate
development  projects have been completed and are  substantially  leased (with a
weighted average  occupancy of 83% for retail  neighborhood  shopping centers at
December 31, 1998). At December 31, 1998, the Bank had outstanding  loans of $47
million to such joint ventures.

In its joint ventures, DSL Service Company is entitled to interest on its equity
invested in the project on a priority basis after  third-party  debt, and shares
profits and losses with the developer partner,  generally on an equal basis. DSL
Service  Company has obtained  personal  guarantees  from the  principals of the
developer  partners in a number of the joint ventures and generally requires the
developer  partner to secure any  outstanding  obligations to the joint venture,
such as its portion of operating  losses,  when the partner is unable to satisfy
such obligations on a current basis.  Partnership  equity (deficit) accounts are
affected by current period results of operations,  additional  partner advances,
partnership distributions and partnership liquidations.

As of December  31,  1998,  DSL Service  Company  was  involved  with five joint
venture  partners.  Three  of  these  partners  were  operators  of four  retail
neighborhood  shopping centers, a commercial  building,  two residential housing
developments and vacant land held for sale. The other two joint venture partners
are separately  involved in the development of a new industrial  building and in
the  rehabilitation  of a large apartment  complex.  DSL Service Company has ten
wholly owned retail  neighborhood  shopping  centers  located in California  and
Arizona.


                                       33
<PAGE>


The  following  table sets forth the  condensed  balance  sheets of DSL  Service
Company's  joint ventures by property type at December 31, 1998, on a historical
cost basis. Included in the following condensed balance sheet are allowances for
losses  recorded  by  DSL  Service  Company.  These  allowances  are  determined
quarterly by means of Downey's internal asset review process. See "Problem Loans
and Real Estate - Allowance  for Losses on Loans and Real Estate" on page 46. To
the  extent the fair  market  value of the real  estate  assets is less than the
carrying value, then a provision is made to create a valuation allowance for the
difference.  If such a valuation  allowance  is needed,  it is  reflected in the
investment  accounts for the joint ventures on DSL Service  Company's books. Not
all of the joint  venture  investments  have  valuation  allowances  as the fair
market value of the associated property exceeds its carrying value.

<TABLE>
<CAPTION>
                                                                        Retail
                                                                     Neighborhood
                                                                       Shopping
(Dollars In Thousands)                                      Centers   Commercial Residential    Total
-------------------------------------------------------------------------------------------------------
<S>                                                         <C>        <C>         <C>        <C>     
Cash ...................................................    $   445    $   351     $ 1,980    $  2,776
Projects under development .............................       --          707      17,819      18,526
Completed projects .....................................     20,913      4,796       5,663      31,372
Other assets ...........................................      2,674        316         519       3,509
-------------------------------------------------------------------------------------------------------
       Total assets ....................................    $24,032    $ 6,170     $25,981    $ 56,183
=======================================================================================================
Secured notes payable to the Bank ......................    $25,195    $   903     $20,446    $ 46,544
Secured notes payable to others ........................       --        3,633        --         3,633
Other liabilities ......................................      4,418      1,936         642       6,996
Equity (deficit):
    DSL Service Company (1) ............................      2,057        464       5,362       7,883
    Allowance for losses recorded by DSL Service Company         19      1,393        --         1,412
    Other partners' (2) ................................     (7,657)    (2,159)       (469)    (10,285)
-------------------------------------------------------------------------------------------------------
       Total liabilities and equity ....................    $24,032    $ 6,170     $25,981    $ 56,183
=======================================================================================================
Number of joint venture projects .......................          4          3           3          10
=======================================================================================================
<FN>
(1)  Included in these amounts are interest-bearing  joint venture advances with
     priority interest payments from joint ventures to DSL Service Company.
(2)  The  aggregate  other  partners'  deficit of $10 million  represents  their
     equity  interest in the  accumulated  retained  earnings  (deficit)  of the
     respective joint ventures. Those results include not only the net profit on
     sales and the operating results of the real estate assets, but depreciation
     expense and funding costs as well.  Except for any secured  financing which
     has been obtained, DSL Service Company has provided all other financing. As
     part of Downey's internal asset review process, the fair value of the joint
     venture real estate  assets is compared to the secured notes payable to the
     Bank and others and DSL Service Company's equity investment.  To the extent
     the fair  value of the real  estate  assets is less than the  aggregate  of
     those amounts, a provision is made to create a valuation  allowance.  Those
     allowances  totaled $1 million at December 31, 1998.  At December 31, 1998,
     the  fair  value  of the  real  estate  assets  of  certain  joint  venture
     partnerships in which the other partners' equity was a deficit exceeded the
     amount of third party notes and DSL Service  Company's  investment  thereby
     eliminating  the need for a valuation  allowance since the sale of the real
     estate would allow DSL Service Company to realize its investment. Thus, the
     other  partners'  deficit of $10 million  exceeds  the amount of  valuation
     allowances established of $1 million.
</FN>
</TABLE>


                                       34
<PAGE>


The  following   table  sets  forth  by  property  type  Downey's  wholly  owned
investments  in real estate and related  allowances  for losses at December  31,
1998.

<TABLE>
<CAPTION>
                                                           Retail
                                       Single Family    Neighborhood
(Dollars in Thousands)                 Developments   Shopping Centers     Land          Total
------------------------------------------------------------------------------------------------
<S>                                       <C>             <C>            <C>            <C>     
Wholly Owned Properties:
Investment in wholly owned projects ...   $  --           $27,434 (1)    $20,435 (2)    $47,869
Allowance for losses ..................      --            (1,594)        (4,711)        (6,305)
------------------------------------------------------------------------------------------------
Net investment in wholly owned projects   $  --           $25,840        $15,724        $41,564
================================================================================================
Number of projects ....................      --                10             11             21
================================================================================================
<FN>                                                                     
(1)  Includes eight free-standing stores that are part of neighborhood  shopping
     centers totaling $1 million and are counted as one project.
(2)  Includes five properties totaling $20 million.
</FN>
</TABLE>

Real estate  investments  entail  risks  similar to those  presented by Downey's
construction and commercial lending activities.  In addition,  California courts
have imposed  warranty-like  responsibility  upon  developers of new housing for
defects in structure  and the housing  site,  including  soil  conditions.  This
responsibility  is not  necessarily  dependent upon a finding that the developer
was negligent.  Owners of real property also may incur  liabilities with respect
to environmental  matters,  including  financial  responsibility for clean-up of
hazardous waste or other conditions, under various federal and state laws.

DEPOSITS

Deposits  increased  $170  million or 3.5% in 1998,  and totaled $5.0 billion at
December 31, 1998.  Transaction accounts (i.e.,  checking,  regular passbook and
money market) increased $302 million or 32.3%, while higher-rate certificates of
deposits decreased $132 million or 3.4%. Of the total increase in deposits,  $49
million was  associated  with 5 new branches  opened during 1998.  The following
table sets forth the amount of deposits by classification.

<TABLE>
<CAPTION>
                                                            December 31,                          
                                    ------------------------------------------------------------
                                           1998                 1997                 1996
                                    ------------------------------------------------------------
                                             Weighted             Weighted             Weighted
                                              Average              Average              Average
(Dollars in Thousands)              Rate      Amount     Rate      Amount     Rate      Amount
------------------------------------------------------------------------------------------------
<S>                                 <C>     <C>          <C>     <C>          <C>     <C>       
Transaction accounts .............  2.30%   $1,238,062   2.15%   $  935,869   2.04%   $  831,598
Certificates of deposit:
   Less than 3.00% ...............  2.62        25,126   2.64        30,623   2.65        39,061
   3.00-3.49 .....................  3.01           593   3.02           766   3.03           723
   3.50-3.99 .....................  3.88        51,474   --            --     3.99            79
   4.00-4.49 .....................  4.39       428,316   4.31        60,095   4.39        63,577
   4.50-4.99 .....................  4.80       668,204   4.87        40,356   4.87       186,576
   5.00-5.99 .....................  5.53     2,421,333   5.63     2,896,291   5.54     2,489,852
   6.00-6.99 .....................  6.06       204,065   6.06       901,920   6.17       536,307
   7.00 and greater ..............  7.24         2,560   7.22         4,058   7.15        25,329
------------------------------------------------------------------------------------------------
     Total certificates of deposit  5.26     3,801,671   5.68     3,934,109   5.56     3,341,504
------------------------------------------------------------------------------------------------
     Total deposits ..............  4.53%   $5,039,733   5.00%   $4,869,978   4.86%   $4,173,102
================================================================================================
</TABLE>


                                       35
<PAGE>


The  following  table shows as of December  31,  1998,  certificates  of deposit
maturities by interest rate category.

<TABLE>
<CAPTION>
                              Less
                              Than     4.00%-     4.50%-      5.00%-      6.00%-      7.00%                 Percent
(Dollars in Thousands)       4.00%      4.49%      4.99%       5.99%       6.99%   and greater  Total (1)   of Total
--------------------------------------------------------------------------------------------------------------------
<S>                         <C>       <C>        <C>        <C>          <C>          <C>      <C>           <C>   
Within 3 months .........   $72,983   $ 12,948   $131,873   $  986,573   $ 21,349     $  215   $1,225,941     32.25%
3 to 6 months ...........     3,025    138,912    169,456      528,986    117,951        206      958,536     25.21
6 to 12 months ..........       769    245,387    279,597      673,641     35,247        601    1,235,242     32.50
12 to 24 months .........       403     30,618     80,316      184,869     12,165      1,538      309,909      8.15
24 to 36 months .........         3        240      1,388       22,163      5,206       --         29,000      0.76
36 to 60 months .........        10         31      4,394       24,966     12,002       --         41,403      1.09
Over 60 months  .........      --          180      1,180          135        145       --          1,640      0.04
--------------------------------------------------------------------------------------------------------------------
                            $77,193   $428,316   $668,204   $2,421,333   $204,065     $2,560   $3,801,671    100.00%
====================================================================================================================
<FN>                                                                              
(1)  Includes jumbo (over $100,000) certificates of deposit of $443 million with
     maturities  of 3 months or less,  $316  million and $413  million of 3 to 6
     month and 6 to 12 month maturities,  respectively,  and $105 million with a
     remaining term of over 12 months.
</FN>
</TABLE>

BORROWINGS

At December 31, 1998, borrowings totaled $704 million,  compared to $484 million
at December 31, 1997 and $595 million at December 31, 1996. The increase in 1998
occurred as Downey took advantage of obtaining  long-term advances from the FHLB
at  attractive  borrowing  rates.  The  following  table sets forth  information
concerning Downey's FHLB advances and other borrowings at the dates indicated.

<TABLE>
<CAPTION>
                                                                              December 31,
                                                        ---------------------------------------------------------
(Dollars in Thousands)                                    1998        1997        1996        1995        1994
-----------------------------------------------------------------------------------------------------------------
<S>                                                     <C>         <C>         <C>         <C>         <C>     
FHLB advances .......................................   $695,012    $352,458    $386,883    $220,715    $411,800
Other borrowings:
    Reverse repurchase agreements ...................       --        34,803        --        16,099      53,946
    Commercial paper ................................       --        83,811     198,113     196,602     197,839
    Industrial revenue bonds ........................       --          --          --          --         6,421
    Real estate notes ...............................      8,708      12,663      10,349       2,802       4,770
-----------------------------------------------------------------------------------------------------------------
      Total borrowings ..............................   $703,720    $483,735    $595,345    $436,218    $674,776
=================================================================================================================
Weighted average rate on borrowings during the period       6.07%       6.07%       5.98%       6.39%       5.57%
Total borrowings as a percentage of total assets ....      11.22        8.29       11.45        9.37       14.51
=================================================================================================================
</TABLE>


                                       36
<PAGE>


The  following  table sets forth  certain  information  with respect to Downey's
short-term borrowings.

<TABLE>
<CAPTION>
(Dollars in Thousands)                                                  1998        1997        1996
-------------------------------------------------------------------------------------------------------
<S>                                                                   <C>         <C>         <C>     
FHLB advances with original maturities less than one year:
    Balance at end of year ........................................   $120,000    $214,300    $279,000
    Average balance outstanding during the year ...................     38,393     328,886     174,380
    Maximum amount outstanding at any month-end during the year ...    120,000     427,100     279,000
    Weighted average interest rate during the year ................       5.96%       5.83%       5.78%
    Weighted average interest rate at the end of year .............       5.36        5.81        5.70
Securities sold under agreement to repurchase:
    Balance at end of year ........................................   $   --      $ 34,803    $   --
    Average balance outstanding during the year ...................      1,877       4,029      11,761
    Maximum amount outstanding at any month-end during the year ...     50,088      34,803      70,015
    Weighted average interest rate during the year ................       5.90%       5.61%       5.19%
    Weighted average interest rate at the end of year .............          -        6.65           -
Commercial paper sold:
    Balance at end of year ........................................   $   --      $ 83,811    $198,113
    Average balance outstanding during the year ...................     30,589     182,296     174,739
    Maximum amount outstanding at any month-end during the year ...    103,749     272,818     198,113
    Weighted average interest rate during the year ................       6.32%       5.75%       5.74%
    Weighted average interest rate at the end of year .............          -        5.61        5.45
Total short-term borrowings:
    Total average short-term borrowings outstanding during the year   $ 70,859    $515,211    $360,880
    Total weighted average rate on borrowings during the year .....       6.11%       5.80%       5.74%
=======================================================================================================
</TABLE>

As  previously  mentioned,  Downey  increased  its  intermediate  and  long-term
advances  from the  FHLB  during  1998.  At  year-end,  total  intermediate  and
long-term advances were $575 million, up from $138 million at December 31, 1997.
The weighted  average rate at year-end 1998 was 5.49%.  The following table sets
forth the associated maturities at December 31, 1998.

<TABLE>
<CAPTION>
(In Thousands)
--------------------------------------------------------------
<S>                                                   <C>     
 1999 .............................................   $ 43,105
 2000 .............................................     28,796
 2001 .............................................     16,056
 2002 .............................................     55,921
 2003 .............................................        134
 Thereafter .......................................    431,000
--------------------------------------------------------------
     Total intermediate and long-term FHLB advances   $575,012
==============================================================
</TABLE>

ASSET/LIABILITY MANAGEMENT AND MARKET RISK

Market  risk is the risk of loss  from  adverse  changes  in market  prices  and
interest rates. Downey's market risk arises primarily from interest rate risk in
its lending and deposit taking activities. This interest rate risk occurs to the
degree that interest-bearing  liabilities reprice or mature more rapidly or on a
different basis than  interest-earning  assets.  Since Downey's  earnings depend
primarily  on its 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, a principal objective of Downey is to actively
monitor  and manage the  effects of  adverse  changes in  interest  rates on net
interest income while maintaining asset quality.

Downey's  Asset/Liability  Management  Committee  ("ALCO")  is  responsible  for
implementing  the interest rate risk  management  policy which sets forth limits
established by the Board of Directors on acceptable changes in net


                                       37
<PAGE>


interest  income and net  portfolio  value  ("NPV")  from  specified  changes in
interest  rates.  NPV is defined by the OTS as the present value of expected net
cash flows from  existing  assets  minus the present  value of expected net cash
flows from  existing  liabilities  plus the present value of expected cash flows
from existing  off-balance  sheet  contracts.  ALCO reviews,  among other items,
economic  conditions,  the  interest  rate  outlook,  the demand for loans,  the
availability of deposits and borrowings, and Downey's current operating results,
liquidity,  capital and interest rate exposure. In addition, ALCO monitors asset
and liability  maturities and repricing  characteristics  on a regular basis and
performs  various  simulations  and other  analyzes to determine  the  potential
impact of various business strategies in controlling  interest rate risk and the
potential impact of those strategies upon future earnings under various interest
rate  scenarios.  Based on such  reviews,  ALCO  formulates  a strategy  that is
intended to implement the objectives set forth in Downey's business plan without
exceeding the net interest  income and NPV limits set forth in the interest rate
risk policy.

One  measure of  Downey's  exposure to  differential  changes in interest  rates
between assets and  liabilities is shown in the following table which sets forth
the repricing  frequency of Downey's major asset and liability  categories as of
December 31, 1998,  as well as certain  information  regarding the repricing and
maturity  difference  between   interest-earning   assets  and  interest-bearing
liabilities  ("GAP") in future  periods.  The  repricing  frequencies  have been
determined  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). Prepayment rates are assumed on substantially all of Downey's loan
portfolio based upon its historical  loan prepayment  experience and anticipated
future  prepayments.  Repricing  mechanisms  on certain of  Downey's  assets are
subject to  limitations,  such as caps on the  amount  that  interest  rates and
payments  on  Downey's  loans may adjust,  and  accordingly,  such assets do not
normally respond as completely or rapidly as Downey's  liabilities to changes in
market  interest  rates.  The interest rate  sensitivity of Downey's  assets and
liabilities  illustrated  in the  following  table would vary  substantially  if
different  assumptions  were  used or if  actual  experience  differed  from the
assumptions set forth.


                                       38
<PAGE>


<TABLE>
<CAPTION>
                                                                                 December 31, 1998                           
                                                   -----------------------------------------------------------------------------
                                                      Within         7 - 12         2 - 5      6 - 10        Over        Total
(Dollars in Thousands)                               6 Months        Months         Years       Years      10 Years     Balance
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>           <C>             <C>        <C>          <C>         <C>       
Interest-earning assets:
    Investment securities and FHLB stock .....(1)   $   89,945    $      --       $116,061   $    --      $   --      $  206,006
    Loans and mortgage-backed securities:        
     Mortgage-backed securities ..............(2)       16,261          4,725       10,361         745          54        32,146
     Loans secured by real estate:               
       Residential:                              
         Adjustable ..........................(2)    4,227,780        106,498        6,720        --          --       4,340,998
         Fixed ...............................(2)      483,212         36,636      171,606      68,474      35,688       795,616
       Commercial real estate ................(2)       36,528          9,454       80,983       9,087       1,919       137,971
       Construction ..........................(2)       46,122           --           --          --          --          46,122
       Land ..................................(2)       22,430             42          370         568         225        23,635
     Non-mortgage:                               
       Commercial ............................(2)       19,154           --           --          --          --          19,154
       Consumer ..............................(2)      119,718         74,288      198,717        --          --         392,723
--------------------------------------------------------------------------------------------------------------------------------
    Total loans and mortgage-backed securities       4,971,205        231,643      468,757      78,874      37,886     5,788,365
--------------------------------------------------------------------------------------------------------------------------------
     Total ...................................      $5,061,150    $   231,643     $584,818   $  78,874    $ 37,886    $5,994,371
================================================================================================================================
Deposits and borrowings:                         
    Interest-bearing deposits:                   
     Fixed maturity deposits .................(1)   $2,184,477    $ 1,235,242     $380,312   $   1,640    $   --      $3,801,671
     Transaction accounts ....................(3)    1,082,795           --           --          --          --       1,082,795
    Non-interest-bearing transaction accounts          155,267           --           --          --          --         155,267
--------------------------------------------------------------------------------------------------------------------------------
     Total deposits ..........................       3,422,539      1,235,242      380,312       1,640        --       5,039,733
--------------------------------------------------------------------------------------------------------------------------------
    Borrowings ...............................         143,575         22,305      105,142     432,698        --         703,720
--------------------------------------------------------------------------------------------------------------------------------
     Total deposits and borrowings ...........      $3,566,114    $ 1,257,547     $485,454   $ 434,338    $   --      $5,743,453
================================================================================================================================
Excess (shortfall) of interest-earning assets    
    over interest-bearing liabilities ........      $1,495,036    $(1,025,904)    $ 99,364   $(355,464)   $ 37,886    $  250,918
                                                 
Cumulative gap ...............................       1,495,036        469,132      568,496     213,032     250,918
Cumulative gap - as a % of total assets:         
    December 31, 1998 ........................           23.84%          7.48%        9.07%       3.40%       4.00%
    December 31, 1997 ........................           24.82           1.35         2.71        3.54        3.93
    December 31, 1996 ........................           16.71           2.68         0.50        1.47        3.04
================================================================================================================================
<FN>                                          
(1)  Based upon contractual maturity and repricing date.
(2)  Based upon contractual maturity, repricing date and projected repayment and
     prepayments of principal.
(3)  Subject to immediate repricing.
</FN>
</TABLE>

Downey's  six-month gap at December 31, 1998, was a positive 23.84% (i.e.,  more
interest  earning  assets  reprice  within  six  months  than   interest-bearing
liabilities).  This compares to a positive six-month gap of 24.82% and 16.71% at
December 31, 1997 and 1996,  respectively.  Downey's  primary strategy to manage
interest  rate  risk is to  emphasize  the  origination  of ARMs or  loans  with
relatively  short  maturities.  Interest rates on ARMs are primarily tied to the
CMT or COFI.  During  1998,  1997 and  1996,  Downey  originated  and  purchased
approximately  $1.5  billion,  $2.0 billion and $1.4 billion,  respectively,  of
loans  and   mortgage-backed   securities  with  adjustable  interest  rates  or
maturities of five years or less,  representing  approximately 80%, 96% and 95%,
respectively,  of  all  loans  and  mortgage-backed  securities  originated  and
purchased for  investment  during such periods.  ARM  originations  during those
three years were primarily tied to COFI rather than the CMT index.

At December 31, 1998, 98% of Downey's interest-earning assets mature, reprice or
are estimated to prepay  within five years,  compared to 99% and 97% at December
31, 1997 and 1996, respectively. At December 31, 1998, loans held for investment
with   adjustable   interest  rates   represented   85%  of  Downey's  loan  and
mortgage-backed securities portfolio. During 1999, Downey will continue to offer
residential fixed rate loan products to its customers


                                       39
<PAGE>


to meet customer demand.  Fixed rate loans are primarily  originated for sale in
the  secondary  market  and are  priced  accordingly  in  order to  create  loan
servicing income and to increase  opportunities for originating  ARMs.  However,
Downey may originate  fixed rate loans for investment when funded with long-term
funds to mitigate  interest rate risk,  and small volumes to facilitate the sale
of real estate acquired through foreclosure or that meet certain yield and other
approved  guidelines.  See "Business - Banking Activities - Lending  Activities-
Secondary Marketing and Loan Servicing Activities" on page 4.

Downey is  better  protected  against  rising  interest  rates  with a  positive
six-month GAP. However,  Downey remains subject to possible interest rate spread
compression,  which would  adversely  impact  Downey's  net  interest  income if
interest  rates rise.  This is primarily  due to the lag in the repricing of the
indices to which Downey's  adjustable-rate loans and mortgage-backed  securities
are tied, as well as the repricing  frequencies and periodic  interest rate caps
on such adjustable-rate loans and mortgage-backed securities. The amount of such
interest rate spread compression would depend upon the frequency and severity of
such interest rate  fluctuations.  The positive  six-month GAP could decrease in
future periods due to, among other things,  the continued  expansion of the auto
and consumer loan portfolios.

In  addition  to  measuring  interest  rate  risk  via  a GAP  analysis,  Downey
establishes  limits on, and measures the sensitivity of, its net interest income
and NPV to changes in interest  rates.  Changes in interest rates are defined as
instantaneous  and  sustained  movements  in  interest  rates in 100 basis point
increments.  Downey utilizes an internally maintained asset/liability management
simulation  model to make the  calculations  which,  for NPV, is calculated on a
discounted cash flow basis.  First, Downey estimates its net interest income for
the next twelve months and the current NPV assuming no change in interest  rates
from those at period end.  Once the base case has been  estimated,  calculations
are made for each of the  defined  changes in  interest  rates,  to include  any
associated  differences  in the  anticipated  prepayment  speed of loans.  Those
results are then  compared  against  the base case to  determine  the  estimated
change to net interest income and NPV due to the changes in interest rates.  The
following are the estimated  impacts to net interest income and NPV from various
instantaneous,  parallel  shifts in interest rates based upon Downey's asset and
liability  structure as of year-ends  1998 and 1997.  Since these  estimates are
based upon  numerous  assumptions,  such as the expected  maturities of Downey's
interest-bearing assets and liabilities and the shape of the period-end interest
rate yield curve,  Downey's  actual  sensitivity  to interest rate changes could
vary  significantly if actual experience  differs from those assumptions used in
making the calculations.

<TABLE>
<CAPTION>
                                                        1998                           1997
                                                Percentage Change In           Percentage Change In
Change in Interest Rates                     Net Interest  Net Portfolio    Net Interest   Net Portfolio
   (In Basis Points)                          Income(1)      Value (2)       Income (1)      Value (2)
---------------------------------------------------------------------------------------------------------
<S>                                            <C>             <C>            <C>              <C>   
             +200 .........................    (10.0)%          1.2%          (13.6)%          (9.3)%
             +100 .........................     (4.4)           2.0            (5.7)           (3.4)
             (100) ........................      2.9           (1.0)            5.5             3.2
             (200) ........................      3.9           (0.6)           12.0             9.1
=========================================================================================================
<FN>
(1)  The percentage  change in this column represents net interest income for 12
     months in a stable interest rate environment versus the net interest income
     in the various rate scenarios.
(2)  The  percentage  change in this column  represents the NPV of the Bank in a
     stable  interest  rate  environment  versus  the  NPV in the  various  rate
     scenarios.
</FN>
</TABLE>

                                       40
<PAGE>


The following table shows Downey's  financial  instruments that are sensitive to
changes  in  interest  rates,   categorized  by  expected   maturity,   and  the
instruments'  fair values at December 31,  1998.  This data differs from that in
the GAP table as it does not incorporate the repricing characteristics of assets
and liabilities.  Rather, it only reflects  contractual  maturities adjusted for
anticipated prepayments. Market risk sensitive instruments are generally defined
as on and off balance sheet derivatives and other financial instruments.

<TABLE>
<CAPTION>
                                                       Expected Maturity Date at December 31, 1998 (1)                        
                               -----------------------------------------------------------------------------------------------
                                                                                                          Total        Fair
(Dollars in Thousands)             1999         2000        2001       2002      2003      Thereafter    Balance       Value
------------------------------------------------------------------------------------------------------------------------------
<S>                            <C>          <C>          <C>        <C>        <C>        <C>          <C>          <C>       
INTEREST-SENSITIVE ASSETS:     
Investment securities .......  $   83,181   $   40,375   $ 50,448   $ 25,238   $   --     $    6,764   $  206,006   $  205,987
     Average interest rate ..        5.48%        5.74%      5.37%      6.45%         -%        5.25%        5.62%
Loans held for sale .........     447,382         --         --         --         --           --        447,382      447,468
     Average interest rate ..        6.91%           -%         -%         -%         -%           -%        6.91%
Mortgage-backed securities
   available for sale .......      12,772        9,980      2,452      1,716      1,227        3,999       32,146       32,146
     Average interest rate ..        6.71%        6.59%      7.58%      7.51%      7.44%        7.16%        6.86%
Loans held for investment:
   Loans secured by real
     estate:
     Residential:
      Adjustable ............   1,062,467      844,589    625,298    461,153    339,734      999,782    4,333,023    4,474,114
        Average interest rate        7.42%        7.43%      7.41%      7.41%      7.51%        7.38%        7.42%
      Fixed .................      79,388       59,790     46,148     36,398     29,270      105,215      356,209      368,737
        Average interest rate        8.37%        8.35%      8.27%      8.20%      8.14%        7.68%        8.11%
     Other ..................      73,969       20,833     15,368     15,974     16,631       64,953      207,728      210,172
        Average interest rate        8.87%        8.81%      8.71%      8.72%      8.72%        7.96%        8.54%
   Non-mortgage:
     Commercial .............      16,299        1,188      1,322        345       --           --         19,154       19,154
        Average interest rate        8.59%        8.59%      8.59%      8.59%         -%           -%        8.59%
     Consumer ...............     149,029      121,324    122,370       --         --           --        392,723      396,421
        Average interest rate        9.93%        9.92%      9.29%         -%         -%           -%        9.73%
Interest bearing advances to
   joint ventures ...........      25,540         --         --         --         --           --         25,540       25,540
     Average interest rate ..        3.61%           -%         -%         -%         -%           -%        3.61%
Mortgage servicing assets ...       1,630        1,471      1,282      1,095        927        1,388        7,793       11,976
------------------------------------------------------------------------------------------------------------------------------
Total interest-sensitive
   assets ...................  $1,951,657   $1,099,550   $864,688   $541,919   $387,789   $1,182,101   $6,027,704   $6,191,715
============================================================================================================================== 
INTEREST-SENSITIVE
LIABILITIES:
Deposits:
   Transaction accounts .....  $  226,130   $  184,827   $151,069   $123,477   $100,924   $  451,635   $1,238,062   $1,238,062
     Average interest rate ..        2.30%        2.30%      2.30%      2.30%      2.30%        2.30%        2.30%
   Certificates of deposit ..   3,419,719      309,909     29,000     19,863     21,540        1,640    3,801,671    3,804,269
     Average interest rate ..        5.26%        5.23%      5.69%      5.88%      5.37%        4.96%        5.26%
Borrowings ..................     165,880       31,199     16,743     56,467        733      432,698      703,720      709,223
     Average interest rate ..        5.62%        6.34%      6.28%      4.97%      8.58%        5.44%        5.51%
------------------------------------------------------------------------------------------------------------------------------
Total interest-sensitive
   liabilities ..............  $3,811,729   $  525,935   $196,812   $199,807   $123,197   $  885,973   $5,743,453   $5,751,554
==============================================================================================================================
<FN>
(1)  Expected maturities are contractual  maturities adjusted for prepayments of
     principal.  Downey uses  certain  assumptions  to estimate  fair values and
     expected  maturities.  For  assets,  expected  maturities  are  based  upon
     contractual  maturity,  projected  repayments and prepayments of principal.
     The prepayment  experience reflected herein is based on Downey's historical
     experience.  Downey's average constant prepayment rate ("CPR") is 21.1% and
     27.6%   on  its   fixed-rate   and  ARM   portfolios,   respectively,   for
     interest-earning assets (excluding investment securities, which do not have
     prepayment features). For deposit liabilities,  in accordance with standard
     industry practice and Downey's own historical experience,  "decay factors",
     used to estimate  deposit  runoff,  of 20% per year have been applied.  The
     actual maturities of these  instruments could vary  substantially if future
     prepayments differ from the Downey's historical experience.
</FN>
</TABLE>


                                       41
<PAGE>


The  following  table sets  forth the  interest  rate  spread  between  Downey's
interest-earning  assets  and  interest-bearing  liabilities  as  of  the  dates
indicated.

<TABLE>
<CAPTION>
                                                          December 31,
                                             -------------------------------------
                                             1998    1997    1996    1995    1994
----------------------------------------------------------------------------------
<S>                                          <C>     <C>     <C>     <C>     <C>  
Weighted average yield:
    Loan and mortgage-backed securities      7.72%   7.95%   7.77%   7.67%   6.24%
    FHLB stock ........................      5.44    5.88    6.45    5.16    5.69
    Investment securities .............      5.40    5.63    6.02    6.46    6.17
----------------------------------------------------------------------------------
    Earning assets yield ..............      7.65    7.87    7.71    7.60    6.24
----------------------------------------------------------------------------------
Weighted average cost:
    Deposits ..........................      4.53    5.00    4.86    4.81    4.23
    Borrowings:
      FHLB advances ...................      5.47    6.11    5.80    6.07    6.41
      Other borrowings ................      8.69    6.15    5.60    5.62    5.88
----------------------------------------------------------------------------------
    Combined borrowings ...............      5.51    6.12    5.73    5.84    6.20
----------------------------------------------------------------------------------
    Combined funds ....................      4.66    5.11    4.97    4.92    4.55
----------------------------------------------------------------------------------
Interest rate spread ..................      2.99%   2.76%   2.74%   2.68%   1.69%
==================================================================================
</TABLE>

The year-end  weighted  average yield on the loan portfolio  decreased to 7.72%,
from 7.95% as of December  31,  1997.  The  weighted  average  rate on new loans
originated during 1998, 1997 and 1996 was 6.45%, 6.04% and 6.06%,  respectively.
At December 31, 1998,  the ARM  portfolio of single  family  residential  loans,
including  mortgage-backed  securities,  totaled  $4.3  billion  with a weighted
average rate of 7.53%,  compared to $4.5 billion and $3.9 billion with  weighted
average rates of 7.58% and 7.38% at December 31, 1997 and 1996, respectively.

PROBLEM LOANS AND REAL ESTATE

Non-performing Assets

Non-performing assets consist of loans on which Downey has ceased the accrual of
interest  ("non-accrual loans") and real estate acquired in settlement of loans.
Non-performing  assets totaled $27 million at December 31, 1998, compared to $52
million at December 31, 1997, and $62 million at December 31, 1996. The decrease
in  non-performing  assets was  primarily  attributed  to  several  loans in the
commercial  real  estate loan  category  that were  returned  to accrual  status
following an extended period of satisfactory payment performance.  The effective
yield on these  loans bear a market  rate of interest  and are,  therefore,  not
considered troubled debt  restructurings.  Of the total, real estate acquired in
settlement of loans,  net of allowances,  represented $4 million at December 31,
1998,  down from $10 million at December 31,  1997,  and $16 million at December
31, 1996.


                                       42
<PAGE>


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

<TABLE>
<CAPTION>
                                                                             December 31,
                                                        ----------------------------------------------------
(Dollars in Thousands)                                    1998       1997       1996       1995       1994
------------------------------------------------------------------------------------------------------------
<S>                                                     <C>        <C>        <C>        <C>        <C>    
Non-accrual loans:                                                                                                
    One-to-four unit residential ....................   $15,571    $20,816    $22,885    $25,587    $24,012
    One-to-four unit residential - subprime .........     1,975       --         --         --         --
    Other ...........................................     4,829     20,883     22,136     52,754     28,025
------------------------------------------------------------------------------------------------------------
      Total non-accrual loans .......................    22,375     41,699     45,021     78,341     52,037
Real estate acquired in settlement of loans, net (1)      4,475      9,626     16,078     18,854     13,558
Repossessed automobiles .............................       569        795        928       --         --
------------------------------------------------------------------------------------------------------------
   Gross non-performing assets ......................   $27,419    $52,120    $62,027    $97,195    $65,595
------------------------------------------------------------------------------------------------------------
Allowance for loan losses (2):
    Amount ..........................................   $31,517    $32,092    $30,094    $27,943    $25,650
    As a percentage of non-performing loans .........    140.86%     76.96%     66.84%     35.67%     49.29%
Non-performing assets as a percentage of total assets      0.44       0.89       1.19       2.09       1.41
============================================================================================================
<FN>
(1)  Excludes  real estate  acquired in  settlement  of loans  covered under the
     Butterfield  Assistance Agreement.  All such assets were sold to the FDIC's
     Division of Resolution in December 1995.

(2)  Allowance  for loan losses does not include the  allowance  for real estate
     and real estate acquired in settlement of loans.
</FN>
</TABLE>

It is Downey's  policy to take  appropriate,  timely and aggressive  action when
necessary to resolve  non-performing assets. When resolving problem loans, it is
Downey's policy to determine  collectibility  under various  circumstances which
will result in maximum  financial  benefit to Downey.  This is  accomplished  by
either working with the borrower to bring the loan current or by foreclosing and
selling  the asset.  Downey  performs  ongoing  reviews  of loans  that  display
weaknesses and maintains adequate loss allowances on the loans. For a discussion
on Downey's  internal  asset review  policy,  refer to "Allowance  for Losses on
Loans and Real Estate" on page 46.

All of Downey's  non-performing  assets at December  31,  1998,  were located in
California.

Downey evaluates the need for appraisals for non-performing assets on a periodic
basis.  A new appraisal  will  generally be obtained  when Downey  believes that
there  may have been an  adverse  change in the  property  operations  or in the
economic conditions of the geographic market of the property securing its loans.
Downey's  policy is to obtain new  appraisals  at least  annually for major real
estate  acquired in settlement of loans.  Throughout  1998,  Downey obtained new
appraisals for  non-performing  loans and real estate  acquired in settlement of
loans.

Non-Accrual  Loans.  It is  Downey's  general  policy to  account  for a loan as
non-accrual  when the loan  becomes 90 days  delinquent  or when  collection  of
interest appears doubtful.  In certain cases, loans may remain on accrual status
past 90 days when it is determined that continued  accrual is warranted  because
the loan is well-secured and in process of collection.  As of December 31, 1998,
Downey had no loans 90 days or more delinquent which remained on accrual status.
Any interest  previously  accrued with respect to non-accrual  loans is reversed
and  charged  against  interest   income.   Interest  income  is  recognized  on
non-accrual  loans to the extent that  payments  are  received and to the extent
that Downey  believes it will  recover the  remaining  principal  balance of the
loan. Such loans are restored to an accrual status only if all past due payments
are made by the borrower and the borrower has  demonstrated  the ability to make
future  payments of principal  and interest.  At December 31, 1998,  non-accrual
loans aggregating $4 million were less than 90 days delinquent relative to their
contractual   terms.   Additional   loans   aggregating   $1  million  were  not
contractually  past  due,  but  were  deemed  non-accrual  due  to  management's
assessment of the borrower's ability to pay.

Impaired Loans.  Downey considers a loan to be impaired when, based upon current
information and events, it believes it is probable that Downey will be unable to
collect  all  amounts  due  according  to the  contractual  terms  of  the  loan
agreement.  Impaired  loans are carried at either the present  value of expected
future cash flows


                                       43
<PAGE>


discounted at the loan's  effective  interest rate, or at the loan's  observable
market price or the net fair value of the collateral securing the loan. Impaired
loans  exclude  large  groups of  smaller  balance  homogeneous  loans  that are
collectively  evaluated for impairment.  For Downey, loans collectively reviewed
for impairment  include all single family loans and performing  multi-family and
non-residential loans having principal balances of less than $1 million.

In determining impairment, Downey considers large non-homogeneous loans with the
following   characteristics:   non-accrual  loans,  debt   restructurings,   and
performing loans which exhibit, among other characteristics,  high loan-to-value
ratios or delinquent taxes. Downey bases the measurement of collateral dependent
impaired  loans  on the  fair  value of the  loan's  collateral.  Non-collateral
dependent  loans are valued  based on a present  value  calculation  of expected
future cash flows,  discounted at the loan's  effective  rate.  Cash receipts on
impaired loans not performing  according to contractual terms are generally used
to reduce the carrying value of the loan, unless Downey believes it will recover
the remaining  principal balance of the loan.  Impairment losses are included in
the  allowance  for loan losses  through a charge to provision  for loan losses.
Adjustments  to  impairment  losses  due to  changes  in the  fair  value of the
collateral  of impaired  loans are included in provision  for loan losses.  Upon
disposition  of an  impaired  loan,  loss of  principal  is  recorded  through a
charge-off to the allowance for loan losses.  At December 31, 1998, the recorded
investment  in loans  for  which  impairment  has been  recognized  totaled  $13
million,  compared to $14 million at December 31, 1997. The total  allowance for
losses  related to such loans was $1 million at December 31, 1998, and 1997. For
further  information  regarding  impaired loans,  see Note 6 of the Notes to the
Consolidated Financial Statements on page 70.

Troubled Debt Restructurings. A restructuring of a debt is considered a troubled
debt  restructuring  when Downey,  for economic or legal reasons  related to the
borrower's financial  difficulties,  grants a concession to the borrower that it
would not otherwise  grant.  Troubled debt  restructurings  may include changing
repayment  terms,  reducing the stated interest rate and reducing the amounts of
principal and/or interest due or extending the maturity date. The  restructuring
of a loan is intended to recover as much of Downey's  investment as possible and
to  achieve  the  highest   yield   possible.   There  were  no  troubled   debt
restructurings on accrual status at December 31, 1998 and 1997.

Real Estate Acquired in Settlement of Loans.  Real estate acquired in settlement
of loans consists of real estate acquired  through  foreclosure or deeds in lieu
of foreclosure.

Delinquent Loans

When a borrower fails to make required  payments on a loan and does not cure the
delinquency within 60 days, Downey normally records a notice of default, subject
to  any  required  prior  notice  to the  borrower,  and  commences  foreclosure
proceedings.  If the loan is not reinstated within the time permitted by law for
reinstatement,  which is normally  five  business days prior to the date set for
the non-judicial  trustee's sale, the property may then be sold at a foreclosure
sale. If Downey has elected to pursue a non-judicial foreclosure,  Downey is not
permitted  under  applicable  California  law to  obtain a  deficiency  judgment
against the borrower, even if the security property is insufficient to cover the
balance owed. In  foreclosure  sales,  Downey  generally  acquires  title to the
property. At December 31, 1998, loans delinquent 30 days or more as a percentage
of total  loans was 0.65%,  down from 0.79% and 0.89% at  December  31, 1997 and
1996, respectively.


                                       44
<PAGE>


The  following  table  indicates  the amounts of Downey's  past due loans at the
dates indicated.

<TABLE>
<CAPTION>
                                                                                   December 31,
                                               -----------------------------------------------------------------------------------
                                                                1998                                       1997
                                               -----------------------------------------------------------------------------------
                                                 30-59     60-89       90+                  30-59     60-89       90+
(Dollars in Thousands)                           Days      Days     Days (1)     Total      Days      Days     Days (1)    Total
----------------------------------------------------------------------------------------------------------------------------------
<S>                                            <C>        <C>       <C>        <C>        <C>        <C>       <C>        <C>    
Loans secured by real estate:
    Residential:
      One-to-four units ....................   $ 9,841    $6,014    $12,832    $28,687    $12,099    $4,101    $18,579    $34,779
      One-to-four units - subprime (2) .....       244       784        947      1,975        185      --         --          185
      Five or more units ...................      --        --          155        155       --         222       --          222
    Commercial real estate .................      --        --         --         --         --        --          279        279
    Construction ...........................      --        --         --         --         --        --         --         --
    Land ...................................      --        --         --         --         --        --         --         --
----------------------------------------------------------------------------------------------------------------------------------
      Total real estate loans ..............    10,085     6,798     13,934     30,817     12,284     4,323     18,858     35,465
Non-mortgage:
    Commercial .............................      --        --         --         --         --        --         --         --
    Automobile .............................     4,650       888      1,048      6,586      4,167       981        961      6,109
    Other consumer .........................       334        45        344        723        218        54        533        805
----------------------------------------------------------------------------------------------------------------------------------
        Total loans ........................   $15,069    $7,731    $15,326    $38,126    $16,669    $5,358    $20,352    $42,379
----------------------------------------------------------------------------------------------------------------------------------
Delinquencies as a percentage of total loans      0.26%     0.13%      0.26%      0.65%      0.31%     0.10%      0.38%      0.79%
==================================================================================================================================
                                                                 1996                                       1995
                                               -----------------------------------------------------------------------------------
<S>                                            <C>        <C>       <C>        <C>        <C>        <C>       <C>        <C>    
Loans secured by real estate:
    Residential:
      One-to-four units ....................   $14,519    $5,502    $18,549    $38,570    $14,047    $6,645    $22,303    $42,995
      One-to-four units - subprime (2) .....       198      --         --          198       --        --         --         --
      Five or more units ...................      --        --         --         --           89      --          447        536
    Commercial real estate .................      --        --         --         --         --        --       30,675     30,675
    Construction ...........................      --        --         --         --         --        --         --         --
    Land ...................................      --        --          566        566       --        --        6,516      6,516
----------------------------------------------------------------------------------------------------------------------------------
      Total real estate loans ..............    14,717     5,502     19,115     39,334     14,136     6,645     59,941     80,722
Non-mortgage:
    Commercial .............................      --        --         --         --         --        --          115        115
    Automobile .............................     2,080       328        274      2,682        667       249        540      1,456
    Other consumer .........................       158        15        181        354        257       410        170        837
----------------------------------------------------------------------------------------------------------------------------------
        Total loans ........................   $16,955    $5,845    $19,570    $42,370    $15,060    $7,304    $60,766    $83,130
----------------------------------------------------------------------------------------------------------------------------------
Delinquencies as a percentage of total loans      0.36%     0.12%      0.41%      0.89%      0.36%     0.17%      1.46%      1.99%
==================================================================================================================================
                                                                 1994
                                               ----------------------------------------
<S>                                            <C>        <C>       <C>        <C>    
Loans secured by real estate:
    Residential:
      One-to-four units ....................   $15,306    $9,273    $20,584    $45,163
      Five or more units ...................      --        --          149        149
    Commercial real estate .................      --        --        1,139      1,139
    Construction ...........................      --        --         --         --
    Land ...................................      --        --          836        836
---------------------------------------------------------------------------------------
      Total real estate loans ..............    15,306     9,273     22,708     47,287
Non-mortgage:
    Commercial .............................      --        --         --         --
    Automobile .............................        22        12         24         58
    Other consumer .........................       291       171        334        796
---------------------------------------------------------------------------------------
        Total loans ........................   $15,619    $9,456    $23,066    $48,141
---------------------------------------------------------------------------------------
Delinquencies as a percentage of total loans      0.38%     0.23%      0.55%      1.16%
=======================================================================================
<FN>
(1)  All 90 day or greater  delinquencies are on non-accrual status and reported
     as part of non-performing assets.
(2)  Downey commenced one-to-four units subprime lending in the first quarter of
     1996.
</FN>
</TABLE>


                                       45
<PAGE>


Allowance for Losses On Loans and Real Estate

Valuation  allowances  for losses on loans and real estate are  established on a
specific and general basis.  Specific  allowances  are  determined  based on the
difference  between  the  carrying  value of the asset  and its net fair  value.
General valuation allowances are determined based on historical loss experience,
current and anticipated levels and trends of delinquent and non-performing loans
and the economic  environment in Downey's  market areas.  See Note 1 of Notes to
the Consolidated Financial Statements on page 61.

Downey's  Internal  Asset  Review  Department  conducts  independent  reviews to
evaluate  the risk and quality of all Downey  assets.  Downey's  Internal  Asset
Review Committee  ("IARC") is responsible for the review and  classification  of
assets. The IARC members include the Chief Internal Asset Review Officer,  Chief
Executive  Officer,  Chief Financial  Officer,  Chief Lending  Officer,  General
Counsel, Director of Compliance/Risk Management,  Credit Administrator and Chief
Appraiser.   The  IARC  meets   quarterly  to  review  and  to  determine  asset
classifications and to recommend any changes to asset valuation allowances. With
the exception of payoffs or asset sales, the  classification  of an asset,  once
established,  can be removed or upgraded  only upon  approval  of the IARC.  The
Chief Internal Asset Review Officer reports  quarterly to the Audit Committee of
the  Board of  Directors  regarding  overall  asset  quality,  the  adequacy  of
valuation allowances on classified assets and Downey's adherence to policies and
procedures regarding asset classification and valuation.

Downey adheres to an internal asset review system and loss allowance methodology
designed  to provide  for timely  recognition  of  problem  assets and  adequate
general  valuation  allowances  to cover asset  losses.  Downey's  current asset
monitoring  process includes the use of asset  classifications  to segregate the
assets, largely loans and real estate, into various risk categories. Downey uses
the various asset  classifications  as a means of measuring risk for determining
the general valuation allowances at a point in time. Downey currently uses a six
grade system to classify its assets. The current grades are Pass, Watch, Special
Mention, Substandard,  Doubtful and Loss. Substandard,  Doubtful and Loss assets
are considered  "classified assets" for regulatory purposes. A brief description
of these classifications  follows:

o    The Pass classification represents a level of credit quality which contains
     no well-defined deficiency or weakness.

o    The  Watch  classification  is used to  identify  an asset  that  currently
     contains no well-defined deficiency or weakness, but it is determined to be
     desirable to closely monitor the asset (e.g.,  loans to facilitate the sale
     of real estate acquired in settlement of loans).  This category may also be
     used for  assets  upgraded  from  lower  classifications  where  continuing
     monitoring is deemed appropriate.

o    A Special  Mention asset does not  currently  expose Downey to a sufficient
     degree of risk to  warrant an adverse  classification,  but does  possess a
     correctable  deficiency or potential weakness deserving  management's close
     attention.

o    Substandard  assets have a well-defined  weakness or  weaknesses.  They are
     characterized  by the  distinct  possibility  that Downey will sustain some
     loss if the deficiencies are not corrected.

o    An asset  classified  Doubtful  has all the  weaknesses  inherent  in those
     classified  Substandard with the added  characteristic  that the weaknesses
     make collection or liquidation in full, on the basis of currently  existing
     facts,  conditions and values,  highly questionable and improbable.  Downey
     considers  Doubtful to be a temporary  classification  until  resolution of
     pending weakness issues enables Downey to more clearly define the potential
     for loss.

o    That portion of an asset classified Loss is considered uncollectible and of
     such little value that its continuance as an asset,  without  establishment
     of a specific valuation allowance,  is not warranted. A Loss classification
     does not mean that an asset has  absolutely  no recovery or salvage  value,
     but rather it is not  reasonable  to defer writing off or providing for all
     or a portion of an  impaired  asset even  though  partial  recovery  may be
     effected in the future.  Downey will generally classify as Loss the balance
     of the asset  that is greater  than the net fair value of the asset  unless
     payment from another  source can be expected.  Therefore,  the amount of an
     asset  classified  as  Loss  reflects  the  total  of  specific   valuation
     allowances   established  for  the  particular  asset.  Specific  valuation
     allowances are not includable in  determining  the Bank's total  regulatory
     capital.


                                       46
<PAGE>


The OTS has the authority to require Downey to change its asset classifications.
If such a change  results in an asset  being  classified  in whole or in part as
Loss, a specific allowance must be established  against the amount so classified
or that  amount  must be charged  off.  OTS  guidelines  set forth  quantitative
benchmarks as a starting point for the  determination  of appropriate  levels of
general  valuation  allowances.  The  OTS  directs  its  examiners  to  rely  on
management's   estimates  of  adequate  general  valuation   allowances  if  the
association's process for determining adequate allowances is deemed to be sound.

It is  Downey's  policy to  provide  an  allowance  for losses on loans and real
estate when it is probable that the value of the asset has been impaired and the
loss can be  reasonably  estimated.  To comply  with  this  policy,  Downey  has
established  a monitoring  system that requires at least an annual review of all
assets in excess of $1 million and a semiannual  review of all assets considered
adversely  classified or criticized.  The monitoring system requires a review of
current operating  statements,  an evaluation of the property's current and past
performance,   an  evaluation  of  the  borrower's  ability  to  repay  and  the
preparation  of a  discounted  cash flow  analysis.  Based on the results of the
review, a new appraisal may be required.

Downey's  provision  for loan losses  totaled  $3.9  million in 1998,  down $4.7
million from 1997. Net loan  charge-offs  exceeded the provision for loan losses
by $0.6  million  resulting  in a decrease in the  allowance  for loan losses to
$31.5 million at December 31, 1998.  This decrease  reflects an  improvement  in
overall  loan  quality.  Included in the current  year-end  allowance  was $31.3
million of general valuation allowances of which $2.8 million was unallocated to
any specific loan category.

A summary of activity in the  allowances  for loan losses is set forth below for
the years indicated.

<TABLE>
<CAPTION>
(In Thousands)                      1998        1997        1996        1995        1994
------------------------------------------------------------------------------------------
<S>                               <C>         <C>         <C>         <C>         <C>     
Balance at beginning of period    $32,092     $30,094     $27,943     $25,650     $26,835
Provision ....................      3,899       8,640       9,137       9,293       4,211
Charge-offs ..................     (7,372)     (7,773)     (7,660)     (8,017)     (5,511)
Recoveries ...................      2,898       1,131         674       1,017         115
------------------------------------------------------------------------------------------
Balance at end of period .....    $31,517     $32,092     $30,094     $27,943     $25,650
==========================================================================================
</TABLE>


                                       47
<PAGE>


Net loan  charge-offs were $4.5 million in 1998, down from $6.6 million and $7.0
million in 1997 and 1996,  respectively.  The decline primarily reflected a $1.3
million decline in net charge-offs of one-to-four unit  residential  loans and a
$1.4 million  recovery of a prior  commercial real estate loan charge-off due to
proceeds from the previously mentioned settlement. The growth in automobile loan
net charge-offs reflects the growth in that portfolio as the ratio of automobile
net charge-offs to the average of such loans was 1.40% in 1998 compared to 1.58%
in 1997 and 1.37% in 1996. Charge-offs,  net of recoveries,  by category of loan
are as follows for the years indicated.

<TABLE>
<CAPTION>
(Dollars in Thousands)                                    1998        1997        1996        1995        1994
----------------------------------------------------------------------------------------------------------------
<S>                                                     <C>          <C>         <C>         <C>         <C>    
Loans secured by real estate:
    Residential:
       One-to-four unit (1) .........................   $   910      $2,165      $4,982      $5,165      $4,051
       Five or more unit ............................        68        --           102         469         264
    Commercial real estate ..........................    (1,610)       (261)       (250)        807         959
    Land ............................................      --          --          --             4        --
Non-mortgage:
    Commercial ......................................      --          --           115        (152)        (52)
    Automobile ......................................     4,959       4,468       1,791         398           9
    Other consumer ..................................       147         270         246         309         165
----------------------------------------------------------------------------------------------------------------
       Total net loan charge-offs ...................   $ 4,474      $6,642      $6,986      $7,000      $5,396
----------------------------------------------------------------------------------------------------------------
Net loan charge-offs as a percentage of average loans
    and mortgage-backed securities held to maturity .      0.09%       0.13%       0.16%       0.17%       0.16%
================================================================================================================
<FN>
(1)  Includes  net  charge-offs  associated  with the  January  1994  Northridge
     earthquake of $1.0 million, $1.1 million and $0.8 million in 1996, 1995 and
     1994, respectively.
</FN>
</TABLE>


                                       48
<PAGE>


The allocation of the allowance for loan losses at the dates indicated is as set
forth in the following table.

<TABLE>
<CAPTION>
                                                                       December 31,
                            -----------------------------------------------------------------------------------------------
                                           1998                            1997                           1996
                            -----------------------------------------------------------------------------------------------
                                          Gross    Allowance              Gross    Allowance             Gross    Allowance
                                           Loan   Percentage               Loan   Percentage              Loan   Percentage
                                        Portfolio  to Loan              Portfolio  to Loan             Portfolio  to Loan
(Dollars in Thousands)      Allowance    Balance   Balance  Allowance    Balance   Balance  Allowance   Balance   Balance
---------------------------------------------------------------------------------------------------------------------------
<S>                          <C>       <C>           <C>     <C>       <C>          <C>     <C>       <C>          <C>  
Loans secured by real estate:
   Residential:
     One-to-four units ...   $14,299   $4,636,133    0.31%   $14,652   $4,607,545   0.32%   $13,241   $4,046,448   0.33%
     Five or more units ..       401       40,029    1.00        314       38,278   0.82        517       56,907   0.91
   Commercial real estate      2,632      140,790    1.87      4,112      202,425   2.03      6,956      260,609   2.67
   Construction ..........     1,508      127,761    1.18        847       70,865   1.20        773       66,651   1.16
   Land ..................       568       44,859    1.27        331       25,687   1.29        466       21,177   2.20
Non-mortgage:                                                                               
   Commercial ............       218       28,293    0.77        196       26,024   0.75        236       22,136   1.07
   Automobile ............     8,344      357,988    2.33      8,016      342,326   2.34      4,303      202,186   2.13
   Other consumer ........       747       41,894    1.78        824       47,735   1.73        802       47,281   1.70
Other ....................      --           --         -       --           --        -       --           --        -
Not specifically allocated     2,800         --         -      2,800         --        -      2,800         --        -
---------------------------------------------------------------------------------------------------------------------------
   Total loans held for
     investment ..........   $31,517   $5,417,747    0.58%   $32,092   $5,360,885   0.60%   $30,094   $4,723,395   0.64%
=========================================================================================================================== 
                                           1995                            1994                        
                             ------------------------------------------------------------     
<S>                          <C>       <C>           <C>     <C>       <C>          <C>     
Loans secured by real estate:                                                                              
   Residential:                                                                                            
     One-to-four units ...   $12,254   $3,656,512    0.34%   $12,404   $3,688,280   0.34%   
     Five or more units ..       895       57,321    1.56        978       63,782   1.53    
   Commercial real estate      8,456      270,583    3.13      6,814      294,418   2.31    
   Construction ..........       335       28,593    1.17        131       11,367   1.15    
   Land ..................       973       21,867    4.45        862        9,822   8.78    
Non-mortgage:                                                                               
   Commercial ............       259       12,864    2.01        472       12,975   3.64    
   Automobile ............       849       56,127    1.51         42        3,028   1.39    
   Other consumer ........     1,122       50,945    2.20      1,094       53,241   2.05    
Other ....................      --           --         -         53       39,143   0.14    
Not specifically allocated     2,800         --         -      2,800         --             
-----------------------------------------------------------------------------------------
   Total loans held for
     investment ..........   $27,943   $4,154,812    0.67%   $25,650   $4,176,056   0.61%   
========================================================================================= 
</TABLE>

The following table is a summary of the activity in Downey's  allowance for real
estate held for  investment and  non-conforming  loans to joint ventures for the
years  indicated.  In 1998,  $4.3 million of the  provision  reduction  and $7.1
million of  charge-offs  relate to the  previously  mentioned  settlement.  Also
included in 1998 were $1.1 million of  charge-offs  due to sales of  undeveloped
land. The provision  reductions in all years  presented were due to a continuing
improvement in the real estate market which favorably  impacted the valuation of
certain  neighborhood  retail shopping center  investments and to a reduction in
the investment in certain joint venture investments.

<TABLE>
<CAPTION>
(In Thousands)                      1998        1997        1996        1995        1994
------------------------------------------------------------------------------------------
<S>                               <C>         <C>         <C>         <C>         <C>     
Balance at beginning of period    $21,244     $30,071     $34,338     $37,198     $38,674
Provision (reduction) ........     (5,296)     (3,190)     (3,306)     (2,916)     (1,400)
Charge-offs ..................     (8,231)     (5,637)     (1,035)       --           (76)
Recoveries ...................       --          --            74          56        --
------------------------------------------------------------------------------------------
Balance at end of period .....    $ 7,717     $21,244     $30,071     $34,338     $37,198
==========================================================================================
</TABLE>


                                       49
<PAGE>


In addition to losses charged against the allowance for loan losses,  Downey has
recorded  losses  on real  estate  acquired  in  settlement  of loans by  direct
write-off to net  operations of real estate  acquired in settlement of loans and
against an allowance for losses  specifically  established for such assets.  The
following  table is a summary of the  activity  of Downey's  allowance  for real
estate acquired in settlement of loans for the years indicated.

<TABLE>
<CAPTION>
(In Thousands)                    1998      1997       1996       1995       1994
-----------------------------------------------------------------------------------
<S>                              <C>      <C>        <C>        <C>        <C>    
Balance at beginning of period   $ 839    $ 1,078    $ 1,217    $   743    $   747
Provision ....................     455      1,107      1,658      2,498      2,035
Charge-offs ..................    (761)    (1,346)    (1,797)    (2,024)    (2,039)
Recoveries ...................    --         --         --         --         --
-----------------------------------------------------------------------------------
Balance at end of period .....   $ 533    $   839    $ 1,078    $ 1,217    $   743
===================================================================================
</TABLE>

CAPITAL RESOURCES AND LIQUIDITY

Downey's  sources of funds  include  deposits,  advances from the FHLB and other
borrowings,  proceeds  from  the  sale  of  real  estate,  sales  of  loans  and
mortgaged-backed securities,  payments of loans and mortgaged-backed securities,
payments  for and sales of loan  servicing  and income  from other  investments.
Repayments  on loans and  mortgage-backed  securities  and  deposit  inflows and
outflows  are  affected  significantly  by interest  rates,  real  estate  sales
activity and general economic conditions. Loan repayments increased $0.7 billion
in 1998 to $1.9 billion and were virtually  equal to new loan  originations  and
purchases  for  portfolio.  In 1997,  new loan  originations  and  purchases for
portfolio exceeded repayments by $0.9 billion.

During  1998,  aggregate  borrowings  increased  $220  million  as  Downey  took
advantage of obtaining long-term advances from the FHLB at attractive  borrowing
rates to fund  fixed-rate  loans for investment.  Downey also  experienced a net
deposit inflow of $170 million,  of which $302 million  represented  transaction
accounts partially offset by a $132 million decrease in certificates of deposit.

To the extent 1999 deposit growth falls short of satisfying ongoing  commitments
to fund maturing and withdrawable deposits, repay borrowings,  fund existing and
future  loan and  other  investment  commitments,  continue  branch  improvement
programs and  maintenance  of  regulatory  liquidity  requirements,  Downey will
utilize borrowing  arrangements with the FHLB and other sources. At December 31,
1998,  Downey had commitments to fund loans amounting to $941 million,  loans in
process of $100 million,  undrawn lines of credit of $70 million, and letters of
credit and other  contingent  liabilities  of $4 million.  Downey  believes  its
current  sources  of  funds  will  enable  it to meet  these  obligations  while
maintaining its liquidity at appropriate levels.

The  principal  measure of  liquidity  in the savings  and loan  industry is the
regulatory  ratio of cash and eligible  investments  to the sum of  withdrawable
savings and borrowings due within one year. The minimum  liquidity  ratio set by
federal  regulators was reduced in 1997 from 5% to 4%. At December 31, 1998, the
Bank's  ratio was 4.04%  compared  to 4.80% and 5.26% at  December  31, 1997 and
1996, respectively.

Downey  Financial Corp.  currently has liquid assets,  including due from Bank -
interest bearing  balances,  of $9 million and can obtain further funds by means
of dividends from subsidiaries,  subject to certain limitations,  or issuance of
further debt or equity.


                                       50
<PAGE>


REGULATORY CAPITAL COMPLIANCE

The following table is a reconciliation  of the Bank's  stockholder's  equity to
federal  regulatory  capital as of  December  31,  1998.  The core and  tangible
capital  ratios were 6.83% and the  risk-based  capital ratio was 12.88%.  These
levels are up slightly from comparable ratios of 6.61% and 12.64%, respectively,
at December 31, 1997, and continue to exceed the "well capitalized" standards of
5% for core and 10% for risk-based,  as defined by regulation.  During 1998, the
amount of the Bank's  non-includable  investment  in real estate  required to be
deducted  from  regulatory  capital  increased  by $7 million due to DSL Service
Company's growth in retained earnings.

<TABLE>
<CAPTION>
                                                         Tangible Capital        Core Capital       Risk-Based Capital
(Dollars in Thousands)                                   Amount    Ratio       Amount    Ratio      Amount       Ratio
-------------------------------------------------------------------------------------------------------------------------
<S>                                                     <C>         <C>       <C>         <C>      <C>          <C>
Stockholder's Equity ...............................    $470,504              $470,504             $470,504
Adjustments:                                                                                     
   Deductions:                                                                                   
    Investment in subsidiary, primarily real estate      (42,119)              (42,119)             (42,119)
    Goodwill .......................................      (4,543)               (4,543)              (4,543)
    Non-permitted mortgage servicing rights ........        (779)                 (779)                (779)
   Additions-:                                                                                   
    Unrealized gain on securities available for sale        (753)                 (753)                (753)
    General loss allowance - Investment in DSL .....       1,383                 1,383                1,383
    Loan general valuation allowances (1) ..........        --                    --                 31,267
-------------------------------------------------------------------------------------------------------------------------
Regulatory capital .................................     423,693    6.83%      423,693    6.83%     454,960     12.88%
Well capitalized requirement .......................      93,053    1.50 (2)   310,178    5.00      353,195     10.00 (3)
-------------------------------------------------------------------------------------------------------------------------
Excess .............................................    $330,640    5.33%     $113,515    1.83%    $101,765      2.88%
=========================================================================================================================
<FN>
(1)  Limited to 1.25% of risk-weighted assets.

(2)  Represents  the  minimum  requirement  for  tangible  capital,  as no "well
     capitalized" requirement has been established for this category.

(3)  A third requirement is Tier 1 capital to risk-weighted  assets of 6%, which
     the Bank meets and exceeds with a ratio of 12.00%.
</FN>
</TABLE>

CURRENT ACCOUNTING ISSUE

In June 1998, the FASB issued  Statement of Financial  Accounting  Standards No.
133,  "Accounting  for Derivative  Instruments  and Hedging  Activities"  ("SFAS
133").

SFAS  133  establishes   accounting  and  reporting   standards  for  derivative
instruments,   including  certain  derivative   instruments  embedded  in  other
contracts, (collectively referred to as derivatives) and for hedging activities.
It  requires  that an entity  recognize  all  derivatives  as  either  assets or
liabilities in the statement of financial position and measure those instruments
at fair value.  If certain  conditions are met, a derivative may be specifically
designated  as (a) a hedge of the  exposure  to  changes  in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction,  or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation,  an
unrecognized   firm   commitment,   an  available  for  sale   security,   or  a
foreign-currency-denominated forecasted transaction.

Under SFAS 133, an entity that elects to apply hedge  accounting  is required to
establish at the inception of the hedge the method it will use for assessing the
effectiveness  of the  hedging  derivative  and  the  measurement  approach  for
determining  the  ineffective  aspect  of  the  hedge.  Those  methods  must  be
consistent with the entity's approach to managing risk.

As part of its secondary marketing activities,  Downey utilizes forward sale and
purchase  contracts  to hedge the  value of loans  originated  for sale  against
adverse changes in interest rates. At December 31, 1998, such sales and purchase
contracts amounted to approximately $622 million and $34 million,  respectively.
These contracts have a high correlation to the price movement of the loans being
hedged.  There  is no  recognition  of  unrealized  gains  and  losses  on these
contracts in the balance  sheet or statement of income.  When the related  loans
are


                                       51
<PAGE>


sold,  the deferred  gains or losses from these  contracts are recognized in the
statement  of income as a component of net gains or losses on sales of loans and
mortgage-backed securities.

This  statement is effective for all fiscal  quarters of fiscal years  beginning
after June 15, 1999. It is not  anticipated  that the  financial  impact of this
statement will have a material impact on Downey.

YEAR 2000

Risks of the Year 2000 Issue

The Year 2000 issue is the result of computer  programs  being written using two
digits rather than four digits to represent  the calendar  year (e.g.,  "99" for
"1999").  Software so developed, and not corrected,  could produce inaccurate or
unpredictable  results or system failures commencing January 1, 2000, when dates
present a lower two digit  year  number  than dates in the prior  century.  Such
occurrences may have a material adverse effect on Downey's financial  condition,
results of  operation,  business or  business  prospects,  as Downey,  like most
financial organizations, is significantly subject to the potential impact of the
Year 2000 issue due to the nature of financial information. Potential impacts to
Downey may arise from  software,  computer  hardware,  and other  equipment both
within Downey's direct control and outside  Downey's  ownership,  yet with which
Downey  electronically  or  operationally   interfaces.   Financial  institution
regulators have intensively  focused upon Year 2000 exposures,  issuing guidance
concerning the  responsibilities of management and the board of directors.  Year
2000 testing and  certification is being addressed as a key safety and soundness
issue in conjunction  with  regulatory  exams and the OTS has authority to bring
enforcement  actions  against any  institution  under its  supervision  which it
believes is not properly addressing Year 2000 compliance issues.

State of Readiness

Downey has  established a four-phase  process to address the Year 2000 issue. In
addition,  Downey's  Board  of  Directors  oversees  the  Year  2000  compliance
project's progress through monthly status reports and quarterly reviews with the
Year 2000 project manager.

As part of the first phase,  which is now completed,  Downey  inventoried of all
data  systems  to  determine  which  are  most  critical  to  support   customer
transaction  processing and provide customer  services.  This inventory not only
included  in-house  systems,  but those provided by third party vendors as well.
Systems were prioritized as being mission critical,  high risk, moderate risk or
low risk,  from which  modification  plans were  developed  which place priority
emphasis on those systems  requiring  change and classified  mission critical or
high risk.  Third party  vendors were  contacted  during this phase to determine
their process and timeline in correcting  any Year 2000  compliance  issues.  In
addition,  commercial  loan borrowers of Downey were also contacted to determine
the extent of their  preparations  for Year 2000 and any  potential  impact Year
2000 may have on their  businesses  and  ability  to repay loan  obligations  to
Downey.  Commercial lending does not represent a significant portion of Downey's
loan portfolio (i.e.,  approximately 0.3%); therefore,  Downey believes the Year
2000  preparedness  of its commercial loan borrowers does not pose a significant
risk.

Phase two of the process  consists of making  appropriate  Year 2000 programming
changes to Downey's in-house  systems,  while phase three consists of acceptance
testing and sign-off of both Downey's in-house and vendor provided systems.  The
fourth and final phase of the Year 2000 compliance project includes installation
of the system  modifications into Downey's daily operation.  The fourth phase is
scheduled to occur once a system has been successfully  tested and determined to
be Year 2000 compliant.

In addition to phase one, phase two has been completed and phase three has begun
with  respect  to  Downey's  in-house  mainframe  system,   which  performs  all
significant  loan,  deposit  and  general  ledger  accounting  processes.  It is
expected  that  acceptance  testing of the  in-house  mainframe  system  will be
finalized and installation completed by the end of first quarter 1999.

For  Downey  developed  PC-based  systems   classified  mission  critical,   all
programming  changes and acceptance  testing have been completed.  Completion of
programming and acceptance testing of all other Downey developed


                                       52
<PAGE>


PC-based  systems is expected to be completed by the end of second quarter 1999,
as is the installation of Year 2000 modifications.

The timing of Year 2000 acceptance  testing and  installation of all third party
vendor changes is dependent  upon when such systems become  available to Downey.
Downey has in place a process to monitor  third party vendor  progress in making
required Year 2000 corrections and, when completed, requires third party vendors
to represent  that their systems are Year 2000  compliant.  Although such vendor
representations are requested,  Downey does not intend to rely solely upon them.
Rather,  Downey intends to test such vendor programs or review testing conducted
by others for Year 2000 compliance.

In  addition  to the  computer  systems  utilized  by  Downey,  Downey  has also
inventoried  other  essential  services that may be impacted by Year 2000 issues
such as  telecommunications  and utilities.  Downey is monitoring such essential
service  providers to determine  their progress and how they are addressing Year
2000 issues. To date, no information  exists to suggest such essential  services
will not be Year 2000 compliant.

Costs to Address the Year 2000 Issue

Currently  Downey  estimates that Year 2000 project costs will  approximate $6.5
million.  This cost is in addition to existing  personnel who are working on the
Year 2000  compliance  project and includes  estimates for hardware and software
renovation or  replacement,  as well as additions to existing  staff who will be
specifically  devoted  to  the  project.  Approximately  50% of  the  Year  2000
compliance  project cost represents costs to migrate to a new personal  computer
environment  and to replace  certain older automated  teller  machines,  both of
which Downey might  otherwise  have  implemented  or replaced  during the period
notwithstanding  the Year 2000 issue.  As such,  that portion of Year 2000 costs
will be amortized over the useful life of the equipment.  Of the estimated total
expense,  approximately $1.9 million has been incurred to-date,  $0.1 million in
1997 and $1.8 million in 1998. The table below  summarizes by year the estimated
amount and anticipated timing of the planned Year 2000 expense.

<TABLE>
<CAPTION>
  (In Millions)               1997    1998    1999    2000  Thereafter  Total
-----------------------------------------------------------------------------
<S>                           <C>     <C>     <C>     <C>      <C>      <C> 
Estimated Year 2000 expense   $0.1    $1.8    $2.8    $1.0     $0.8     $6.5
=============================================================================
</TABLE>

As  Downey  progresses  in  addressing  the Year  2000  compliance  project  and
additional  information  becomes available,  estimates of costs could change. At
this time, no significant  data system projects have been delayed as a result of
Downey's Year 2000 compliance effort.

Contingency Plans

Downey  believes  its  Year  2000  compliance  project  should  enable  it to be
successful  in modifying  its  computer  systems to be Year 2000  compliant.  As
previously stated,  acceptance testing and installation with respect to Downey's
in-house  mainframe  system which  performs all  significant  loan,  deposit and
general  ledger  accounting  processes is expected to be completed by the end of
first  quarter  1999. In addition to Year 2000  compliance  system  modification
plans,  Downey  has also  developed  contingency  plans  for all  other  systems
classified as mission  critical and high risk. These  contingency  plans provide
timetables to pursue various  alternatives based upon the failure of a system to
be adequately  modified or sufficiently tested and validated to ensure Year 2000
compliance.  However,  there can be no  assurance  that  either  the  compliance
process or contingency plans will avoid partial or total system interruptions or
the costs  necessary to update  hardware and software  would not have a material
adverse effect upon Downey's financial condition, results of operation, business
or business prospects.


                                       53
<PAGE>


ITEM 8.    FINANCIAL STATEMENTS

Index to Consolidated Financial Statements



     Independent Auditors' Report..........................    55
     Consolidated Balance Sheets...........................    56
     Consolidated Statements of Income.....................    57
     Consolidated Statements of Comprehensive Income.......    58
     Consolidated Statements of Stockholders' Equity.......    58
     Consolidated Statements of Cash Flows.................    59
     Notes to Consolidated Financial Statements............    61


                                       54
<PAGE>


725 South Figueroa Street
Los Angeles, CA 90017












Independent Auditors' Report


The Board of Directors and Stockholders
Downey Financial Corp.:

We have audited the accompanying consolidated balance sheets of Downey Financial
Corp.  and  subsidiaries  ("Downey")  as of December 31, 1998 and 1997,  and the
related consolidated statements of income,  comprehensive income,  stockholders'
equity  and cash  flows for each of the  years in the  three-year  period  ended
December  31,   1998.   These   consolidated   financial   statements   are  the
responsibility  of  Downey's  management.  Our  responsibility  is to express an
opinion on these consolidated financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all material  respects,  the financial  position of Downey Financial
Corp.  and  subsidiaries  as of December  31, 1998 and 1997,  and the results of
their  operations  and their cash flows for each of the years in the  three-year
period ended December 31, 1998, in conformity with generally accepted accounting
principles.



/s/  KPMG LLP

Los Angeles, California
January 20, 1999


                                       55
<PAGE>


DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Balance Sheets

<TABLE>
<CAPTION>
                                                                                           December 31,
                                                                                     -----------------------
(Dollars in Thousands, Except Per Share Data)                                           1998         1997
------------------------------------------------------------------------------------------------------------
<S>                                                                                  <C>          <C>       
ASSETS
Cash ............................................................................    $   58,510   $   48,823
Federal funds ...................................................................        33,751        6,095
------------------------------------------------------------------------------------------------------------
    Cash and cash equivalents ...................................................        92,261       54,918
U.S. Treasury securities and agency obligations available for sale, at fair value       116,061      159,398
Municipal securities being held to maturity, at amortized cost (estimated market     
    value of $6,745 at December 31, 1998, and $6,865 at December 31, 1997) ......         6,764        6,885
Loans held for sale, at the lower of cost or market .............................       447,382       35,100
Mortgage-backed securities available for sale, at fair value ....................        32,146       49,299
Loans receivable held for investment ............................................     5,308,837    5,281,997
Investments in real estate and joint ventures ...................................        49,447       41,356
Real estate acquired in settlement of loans .....................................         4,475        9,626
Premises and equipment ..........................................................       103,979      101,901
Federal Home Loan Bank stock, at cost ...........................................        49,430       44,085
Other assets ....................................................................        59,637       51,260
------------------------------------------------------------------------------------------------------------
                                                                                     $6,270,419   $5,835,825
============================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY                                                 
Deposits ........................................................................    $5,039,733   $4,869,978
Securities sold under agreements to repurchase ..................................          --         34,803
Federal Home Loan Bank advances .................................................       695,012      352,458
Commercial paper ................................................................          --         83,811
Other borrowings ................................................................         8,708       12,663
Accounts payable and accrued liabilities ........................................        40,989       40,579
Deferred income taxes ...........................................................         5,411       11,187
------------------------------------------------------------------------------------------------------------
    Total liabilities ...........................................................     5,789,853    5,405,479
------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY:
Common stock,  par  value of $0.01  per  share;  authorized 50,000,000 shares;     
    outstanding 28,131,776 shares at December 31, 1998, and 26,755,938
    shares at December 31, 1997 .................................................           281          268
Additional paid-in capital ......................................................        92,166       45,954
Accumulated other comprehensive income - unrealized gains
    on securities available for sale ............................................           753          110
Retained earnings ...............................................................       387,366      384,014
------------------------------------------------------------------------------------------------------------
    Total stockholders' equity ..................................................       480,566      430,346
------------------------------------------------------------------------------------------------------------
                                                                                     $6,270,419   $5,835,825
============================================================================================================
</TABLE>










See accompanying notes to consolidated financial statements.


                                       56
<PAGE>


DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Income

<TABLE>
<CAPTION>
                                                                                     Years Ended December 31,
                                                                             --------------------------------------
(Dollars in Thousands, Except Per Share Data)                                    1998          1997          1996
-------------------------------------------------------------------------------------------------------------------
<S>                                                                          <C>           <C>           <C>       
INTEREST INCOME:
    Loans receivable ....................................................      $421,942      $404,081      $329,746
    U.S. Treasury and agency securities .................................         7,078         8,300         7,765
    Mortgage-backed securities ..........................................         2,780         3,633         4,317
    Other investments ...................................................         8,604         4,404         4,532
-------------------------------------------------------------------------------------------------------------------
       Total interest income ............................................       440,404       420,418       346,360
-------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
    Deposits ............................................................       248,337       227,521       184,402
    Borrowings ..........................................................        17,720        38,739        27,363
-------------------------------------------------------------------------------------------------------------------
       Total interest expense ...........................................       266,057       266,260       211,765
-------------------------------------------------------------------------------------------------------------------
    NET INTEREST INCOME .................................................       174,347       154,158       134,595
    PROVISION FOR LOAN LOSSES ...........................................         3,899         8,640         9,137
-------------------------------------------------------------------------------------------------------------------
       Net interest income after provision for loan losses ..............       170,448       145,518       125,458
-------------------------------------------------------------------------------------------------------------------
OTHER INCOME, NET:
    Loan and deposit related fees .......................................        15,645        10,921         7,435
    Real estate and joint ventures held for investment, net:
       Net gains on sales of wholly owned real estate ...................         2,557         2,904           392
       Reduction of losses on real estate and joint ventures ............         5,296         3,190         3,306
       Operations, net ..................................................        14,510         8,128         4,543
    Secondary marketing activities:
       Loan servicing fees ..............................................           259         1,276         1,415
       Net gains on sales of loans and mortgage-backed securities .......         6,462         2,675         1,543
    Net gains on sales of investment securities .........................            68          --           4,473
    Other ...............................................................         2,556         6,094         2,092
-------------------------------------------------------------------------------------------------------------------
       Total other income, net ..........................................        47,353        35,188        25,199
-------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSE:
    Salaries and related costs ..........................................        66,152        54,366        45,811
    Premises and equipment costs ........................................        16,834        15,272        12,640
    Advertising expense .................................................         5,954         6,847         4,071
    Professional fees ...................................................         2,867         5,113         2,985
    SAIF insurance premiums and regulatory assessments ..................         3,832         3,439         8,949
    Other general and administrative expense ............................        20,251        14,519        12,004
-------------------------------------------------------------------------------------------------------------------
       Total general and administrative expense .........................       115,890        99,556        86,460
-------------------------------------------------------------------------------------------------------------------
    SAIF special assessment .............................................          --            --          24,644
    Net operation of real estate acquired in settlement of loans ........           260         1,184         2,567
    Amortization of excess of cost over fair value of net assets acquired           510           532           532
-------------------------------------------------------------------------------------------------------------------
       Total operating expense ..........................................       116,660       101,272       114,203
-------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES ..............................................       101,141        79,434        36,454
Income taxes ............................................................        43,168        34,200        15,750
-------------------------------------------------------------------------------------------------------------------
    NET INCOME ..........................................................      $ 57,973      $ 45,234      $ 20,704
===================================================================================================================
PER SHARE INFORMATION:
BASIC ...................................................................      $   2.06      $   1.61      $   0.74
===================================================================================================================
DILUTED .................................................................      $   2.05      $   1.61      $   0.74
===================================================================================================================
CASH DIVIDENDS PAID .....................................................      $  0.316      $  0.301      $  0.290
===================================================================================================================
Weighted average diluted shares outstanding .............................    28,176,243    28,140,200    28,103,291
===================================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.


                                       57
<PAGE>


DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income

<TABLE>
<CAPTION>
                                                                                    Years Ended December 31,
                                                                                 ------------------------------
(In Thousands)                                                                     1998       1997       1996
---------------------------------------------------------------------------------------------------------------
<S>                                                                              <C>        <C>        <C>    
NET INCOME ..................................................................    $57,973    $45,234    $20,704
---------------------------------------------------------------------------------------------------------------
OTHER COMPREHENSIVE  INCOME,  NET OF INCOME TAXES:
  Unrealized gains (losses) on securities available for sale:
     U.S. Treasury securities and agency obligations
       available for sale, at fair value ....................................      1,104      1,331     (2,160)
     Less reclassification of realized gains net of losses included in income        (39)      --       (2,550)
     Mortgage-backed securities available for sale, at fair value ...........       (422)       338       (344)
---------------------------------------------------------------------------------------------------------------
   Other comprehensive income (loss) ........................................        643      1,669     (5,054)
---------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME ........................................................    $58,616    $46,903    $15,650
===============================================================================================================
</TABLE>


Consolidated Statements of Stockholders' Equity

<TABLE>
<CAPTION>
                                                                        Accumulated
                                                             Additional    Other
                                                     Common    Paid-in Comprehensive  Retained
(Dollars in Thousands, Except Per Share Data)         Stock    Capital    Income      Earnings      Total
-----------------------------------------------------------------------------------------------------------
<S>                                                   <C>     <C>        <C>         <C>          <C>     
Balances at December 31, 1995 .....................   $170    $22,696    $ 3,495     $357,711     $384,072
Cash dividends, $0.290 per share ..................    --        --         --         (8,147)      (8,147)
Three-for-two stock split effected in the form of a
    stock dividend ................................     85        (89)      --           --             (4)
Unrealized loss on securities available for sale ..    --        --       (5,054)        --         (5,054)
Net income ........................................    --        --         --         20,704       20,704
-----------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 .....................    255     22,607     (1,559)     370,268      391,571
Cash dividends, $0.301 per share ..................    --        --         --         (8,454)      (8,454)
Stock dividend ....................................     13     23,012       --        (23,034)          (9)
Exercise of stock options .........................    --         335       --           --            335
Unrealized gain on securities available for sale ..    --        --        1,669         --          1,669
Net income ........................................    --        --         --         45,234       45,234
-----------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 .....................    268     45,954        110      384,014      430,346
Cash dividends, $0.316 per share ..................    --        --         --         (8,889)      (8,889)
Stock dividend ....................................     13     45,702       --        (45,732)         (17)
Exercise of stock options .........................    --         510       --           --            510
Unrealized gain on securities available for sale ..    --        --          643         --            643
Net income ........................................    --        --         --         57,973       57,973
-----------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 .....................   $281    $92,166    $   753     $387,366     $480,566
===========================================================================================================
</TABLE>









See accompanying notes to consolidated financial statements.


                                       58
<PAGE>


DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                                                 Years Ended December 31,
                                                                                        ------------------------------------------
(In Thousands)                                                                              1998           1997           1996
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                     <C>            <C>            <C>        
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income .......................................................................   $    57,973    $    45,234    $    20,704
   Adjustments activities:
     Depreciation and amortization ..................................................         7,052          9,389          8,279
     Provision (recovery) for losses on loans, real estate acquired in settlement
       of loans, investments in real estate and joint ventures and other assets .....        (1,017)         6,780          7,533
     Net gains on sales of loans and mortgage-backed securities, investment
       securities, real estate and other assets .....................................       (20,365)        (9,210)        (6,827)
     Interest capitalized on loans (negative amortization) ..........................       (18,953)       (12,885)        (9,388)
     Federal Home Loan Bank stock dividends .........................................        (2,728)        (2,638)        (2,301)
   Loans originated for sale ........................................................    (2,162,583)      (289,271)      (159,941)
   Proceeds from sales of loans originated for sale .................................     1,130,164        179,046        135,074
   Other, net .......................................................................         4,314          1,559          4,112
----------------------------------------------------------------------------------------------------------------------------------
Net cash used for operating activities ..............................................    (1,006,143)       (71,996)        (2,755)
----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Proceeds from:
     Maturities of U.S. Treasury and agency obligations .............................        10,001          9,875           --
     Sales of investment securities available for sale ..............................        60,319           --          189,541
     Sales of mortgage-backed securities available for sale .........................       608,158         88,723         31,314
     Sales of loans held for investment .............................................          --          294,469           --
     Sales of wholly owned real estate and real estate acquired in settlement
       of loans .....................................................................        14,035         15,043         10,337
   Purchase of:
     U.S. Treasury securities and agency obligations ................................       (27,617)       (25,000)      (170,455)
     Mortgage-backed securities available for sale ..................................          --             --          (30,073)
     Loans receivable held for investment ...........................................        (7,463)       (35,828)          (223)
   Loans receivable originated held for investment (net of refinances of
     $39,794, $56,366, and $90,824 at December 31, 1998, 1997 and 1996, respectively)    (1,854,801)    (1,961,710)    (1,309,663)
   Principal payments on loans receivable held for investment and
     mortgage-backed securities available for sale ..................................     1,830,492      1,086,551        757,550
   Net change in undisbursed loan funds .............................................        43,222         13,356         12,147
   Proceeds from (Investments in) real estate held for investment ...................        (4,074)         5,115         (6,454)
   Other, net .......................................................................       (10,147)       (14,086)        (7,698)
----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities ................................       662,125       (523,492)      (523,677)
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>














See accompanying notes to consolidated financial statements.


                                       59
<PAGE>


DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)

<TABLE>
<CAPTION>
                                                                                        Years Ended December 31,
                                                                                 --------------------------------------
(In Thousands)                                                                      1998         1997           1996
-----------------------------------------------------------------------------------------------------------------------
<S>                                                                              <C>          <C>           <C>       
CASH FLOWS FROM FINANCING ACTIVITIES:
   Net increase in deposits ..................................................   $ 169,755    $ 696,876     $  382,881
   Net increase (decrease) in securities sold under agreements to repurchase .     (34,803)      34,803        (16,099)
   Proceeds from Federal Home Loan Bank advances .............................     857,200      872,900      1,018,700
   Repayments of Federal Home Loan Bank advances .............................    (514,646)    (907,325)      (852,532)
   Net increase (decrease) in other borrowings ...............................     (87,766)    (111,988)         9,058
   Proceeds from exercise of stock options ...................................         510          335           --
   Cash dividends ............................................................      (8,889)      (8,454)        (8,147)
-----------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities ....................................     381,361      577,147        533,861
-----------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents .........................      37,343      (18,341)         7,429
Cash and cash equivalents at beginning of year ...............................      54,918       73,259         65,830
-----------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ...................................   $  92,261    $  54,918     $   73,259
=======================================================================================================================
Supplemental  disclosure of cash flow  information:
   Cash paid during the period for:
     Interest ................................................................   $ 266,407    $ 267,589     $  212,482
     Income taxes ............................................................      52,784       23,572         19,753
Supplemental disclosure of non-cash investing:
   Loans transferred from held for investment to held for sale ...............        --        290,558          1,791
   Loans transferred to held for investment from held for sale ...............       3,056         --             --
   Loans exchanged for mortgage-backed securities ............................     608,831       89,522         26,452
   Real estate acquired in settlement of loans ...............................      14,958       23,686         27,367
   Loans to facilitate the sale of real estate acquired in settlement of loans      14,084       21,919         23,356
=======================================================================================================================
</TABLE>


























See accompanying notes to consolidated financial statements.


                                       60
<PAGE>


DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Years Ended December 31, 1998, 1997, and 1996


(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Principles of Consolidation

     The  consolidated  financial  statements  of  Downey  Financial  Corp.  and
     subsidiaries  ("Downey") include all accounts of Downey Financial Corp. and
     the consolidated accounts of all subsidiaries, including Downey Savings and
     Loan Association,  F.A. (the "Bank"). All significant intercompany balances
     and transactions have been eliminated.

     Business

     Downey  provides a full  range of  financial  services  to  individual  and
     corporate   customers   through   subsidiaries   and  branches  located  in
     California.   Downey  is  subject  to  competition   from  other  financial
     institutions.  Downey is subject to the regulations of certain governmental
     agencies  and  undergoes   periodic   examinations   by  those   regulatory
     authorities.

     Basis of Financial Statement Presentation

     The consolidated financial statements have been prepared in conformity with
     generally  accepted  accounting  principles.  In preparing the consolidated
     financial  statements,   management  is  required  to  make  estimates  and
     assumptions  that affect the reported  amounts of assets and liabilities as
     of the dates of the balance  sheets and the results of  operations  for the
     periods. Actual results could differ significantly from those estimates.

     Material estimates that are particularly  susceptible to significant change
     in the  near-term  relate to the  determination  of the  allowance for loan
     losses and the  valuation  of real  estate.  Management  believes  that the
     allowances  established  for losses on loans and real estate are  adequate.
     While  management uses available  information to recognize  losses on loans
     and real estate,  future additions to the allowances may be necessary based
     on  changes  in  economic  conditions.  In  addition,   various  regulatory
     agencies,  as an integral part of their examination  process,  periodically
     review  Downey's  allowances  for  losses  on loans and real  estate.  Such
     agencies may require Downey to recognize  additions to the allowances based
     on their judgments about information available to them at the time of their
     examination.

     Downey  is   required   to  carry  its  loans  held  for  sale   portfolio,
     mortgage-backed  securities  available  for  sale  portfolio,  real  estate
     acquired in  settlement  of loans,  and real estate held for  investment or
     under  development  at the lower of cost or fair value or in certain cases,
     at fair value.  Fair value  estimates are made at a specific  point in time
     based upon relevant  market  information  and other  information  about the
     asset.  Such  estimates  related  to  the  mortgage-backed  and  investment
     securities  portfolios  include  published  bid  prices  or bid  quotations
     received  from  securities  dealers.  Fair value  estimates for real estate
     acquired in  settlement  of loans and real estate  held for  investment  or
     under development is determined by current  appraisals and, where no active
     market exists for a particular property, discounting a forecast of expected
     cash flows at a rate commensurate with the risk involved.

     Cash and Cash Equivalents

     For purposes of the  statements  of cash flows,  cash and cash  equivalents
     include  cash on hand,  amounts  due from  banks and  Federal  funds  sold.
     Generally, Federal funds are purchased and sold for one-day periods.


                                       61
<PAGE>


     Mortgage-backed Securities Purchased Under Resale Agreements, U.S. Treasury
     Securities and Agency Obligations,  Other Investment Securities,  Municipal
     Securities and Mortgage-backed Securities

     Downey has established  written guidelines and objectives for its investing
     activities. At the time of purchase of a mortgage-backed security purchased
     under resale agreement, U.S. Treasury security and agency obligation, other
     investment  security or a  mortgage-backed  security,  management of Downey
     designates  the security as either held to maturity,  available for sale or
     held for trading based on Downey's investment objectives, operational needs
     and intent.  Downey then monitors its investment  activities to ensure that
     those  activities  are  consistent  with  the  established  guidelines  and
     objectives.

     Held to Maturity. Securities held to maturity are carried at cost, adjusted
     for   amortization  of  premiums  and  accretion  of  discounts  which  are
     recognized in interest  income using the interest  method.  Mortgage-backed
     securities  represent  participating  interests in pools of long-term first
     mortgage loans  originated  and serviced by the issuers of the  securities.
     Mortgage-backed securities held to maturity are carried at unpaid principal
     balances,   adjusted  for  unamortized  premiums  and  unearned  discounts.
     Premiums and discounts on  mortgage-backed  securities are amortized  using
     the interest  method over the  remaining  period to  contractual  maturity,
     adjusted for anticipated prepayments.  It is the positive intent of Downey,
     and Downey has the ability, to hold these securities until maturity as part
     of its portfolio of long-term interest-earning assets. If the cost basis of
     these securities is determined to be other than temporarily  impaired,  the
     amount of the impairment is charged to operations.

     Available  for Sale.  Securities  available  for sale are carried at market
     value.  Premiums and discounts are amortized using the interest method over
     the  remaining  period  to  contractual   maturity  and,  in  the  case  of
     mortgage-backed   securities,   adjusted   for   anticipated   prepayments.
     Unrealized  holding gains and losses, or valuation  allowances  established
     for net  unrealized  losses,  are excluded  from earnings and reported as a
     separate   component  of   stockholders'   equity  as   accumulated   other
     comprehensive  income,  net of income taxes,  unless the security is deemed
     other than temporarily  impaired. If the security is determined to be other
     than  temporarily  impaired,  the  amount of the  impairment  is charged to
     operations.

     Realized  gains and losses on the sale of  securities  available  for sale,
     determined using the specific identification method and recorded on a trade
     date basis, are reflected in earnings.

     Held for Trading.  Securities held for trading are carried at market value.
     Realized and unrealized gains and losses are reflected in earnings.

     Loans Held for Sale

     Downey  identifies  those  loans  which  foreseeably  may be sold  prior to
     maturity.  These  loans  have  been  classified  as  held  for  sale in the
     Consolidated Balance Sheets and are recorded at the lower of amortized cost
     or market  value.  In  response  to  unforeseen  events  such as changes in
     regulatory  capital  requirements,  liquidity  shortfalls,  changes  in the
     availability of sources of funds,  and excess loan demand by borrowers that
     could not be controlled immediately by loan price changes,  Downey may sell
     loans which had been held for investment.  In such  occurrences,  the loans
     are transferred at amortized cost and the lower of cost or market method is
     then applied.

     Gains or Losses On Sales of Loans and Mortgage Servicing Assets

     Gains or losses on sales of loans  are  recognized  at the time of sale and
     are  determined by the  difference  between the net sales  proceeds and the
     allocated  basis of the loans sold.  Downey adopted,  effective  January 1,
     1997,  Statement of Financial Accounting Standards No. 125, "Accounting for
     Transfers  and  Servicing  of  Financial  Assets  and   Extinguishments  of
     Liabilities," ("SFAS 125"). In accordance with SFAS


                                       62
<PAGE>


     125, Downey capitalizes mortgage servicing rights ("MSRs") acquired through
     either  the  purchase  or   origination  of  mortgage  loans  for  sale  or
     securitization  with  servicing  rights  retained.  The  total  cost of the
     mortgage  loans  designated  for  sale is  allocated  to the  MSRs  and the
     mortgage  loans without the MSRs based on their  relative fair values.  The
     MSRs are  included in other  assets and as a  component  of gain on sale of
     loans.  The MSRs are  amortized  in  proportion  to and over the  estimated
     period  of net  servicing  income.  Such  amortization  is  reflected  as a
     component of loan servicing fees.

     The MSRs are  periodically  reviewed  for  impairment  based on their  fair
     value.  The fair value of the MSRs,  for the  purposes  of  impairment,  is
     measured using a discounted cash flow analysis based on Downey's  estimated
     net servicing income, market prepayment rates and market-adjusted  discount
     rates. Impairment is measured on a disaggregated basis based on predominant
     risk   characteristics   of  the  underlying   mortgage  loans.   The  risk
     characteristics  used by Downey  for the  purposes  of  capitalization  and
     impairment evaluation include loan type, interest rate tranches,  loan term
     and collateral type.  Impairment losses are recognized  through a valuation
     allowance,  with any associated  provision  recorded as a component of loan
     servicing fees.

     Derivative Financial Instruments

     As part of its secondary marketing activities, Downey utilizes forward sale
     contracts to hedge the value of loans  originated for sale against  adverse
     changes in interest rates.  These contracts have a high  correlation to the
     price  movement  of the loans  being  hedged.  There is no  recognition  of
     unrealized  gains and losses on these  contracts  in the  balance  sheet or
     statement of income. When the related loans are sold, the deferred gains or
     losses from these  contracts are recognized in the statement of income as a
     component  of net gains or  losses  on sales of loans  and  mortgage-backed
     securities.

     Loans Receivable Held for Investment

     Loans  receivable  are  recorded at cost,  net of discounts  and  premiums,
     undisbursed  loan  proceeds,  net deferred fees and costs and the allowance
     for loan losses.

     Interest  income on loans is  accrued  based on the  outstanding  principal
     amount of loans using the interest method.  Discounts and premiums on loans
     are amortized to income using the interest method over the remaining period
     to  contractual  maturity.  The  amortization  of discounts  into income is
     discontinued on loans that are contractually ninety days past due.

     Loan origination fees and related incremental direct loan origination costs
     are  deferred and  amortized  to income using the interest  method over the
     contractual  life of the  loans,  adjusted  for  actual  prepayments.  Fees
     received for a commitment to originate or purchase a loan or group of loans
     are deferred and, if the commitment is exercised,  recognized over the life
     of the  loan as an  adjustment  of  yield  or,  if the  commitment  expires
     unexercised,  recognized as income upon expiration of the  commitment.  The
     amortization  of deferred fees and costs is  discontinued on loans that are
     contractually ninety days past due.

     Accrued interest on loans that are  contractually  ninety days or more past
     due or when collection of interest appears  doubtful is generally  reversed
     and charged against interest income. Income is subsequently recognized only
     to the extent cash  payments  are  received  and the  principal  balance is
     expected to be recovered. Such loans are restored to an accrual status only
     if  the  loan  is  brought  contractually  current  and  the  borrower  has
     demonstrated the ability to make future payments of principal and interest.


                                       63
<PAGE>


     Allowance for Loan Losses

     The allowance for loan losses is maintained at an amount  management  deems
     adequate to cover estimated  losses.  Downey has implemented and adheres to
     an  internal  asset  review  system  and loan  loss  allowance  methodology
     designed  to  provide  for the  detection  of problem  assets and  adequate
     general  valuation  allowances  to cover loan losses.  In  determining  the
     allowance  for loan losses  related to  specific  major  loans,  management
     evaluates its allowance on an individual loan 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. Downey reviews
     all loans under $1 million by analyzing  their  performance and composition
     of their  collateral  as a whole,  because  of the  relatively  homogeneous
     nature of the portfolios.  Specific valuation  allowances for secured loans
     are  determined  by the excess of the recorded  investment in the loan over
     the fair  value,  where  appropriate,  of the  collateral.  In  determining
     overall  general  valuation  allowances to be maintained  and the loan loss
     allowance ratios,  management  evaluates many factors including  prevailing
     and forecasted economic conditions, regular reviews of the quality of loans
     by  Downey's   Internal  Asset  Review  Committee,   industry   experience,
     historical loss experience, year of origination, composition and geographic
     concentrations of the loan portfolio,  the borrowers'  ability to repay and
     repayment performance and estimated collateral values.

     Downey considers a loan to be impaired when, based upon current information
     and  events,  it  believes  it is  probable  that  Downey will be unable to
     collect all  amounts due  according  to the  contractual  terms of the loan
     agreement.    In   determining    impairment,    Downey   considers   large
     non-homogeneous  loans  with  the  following  characteristics:  non-accrual
     loans, debt restructurings, and performing loans which exhibit, among other
     characteristics,  high  loan-to-value  ratios or delinquent  taxes.  Downey
     bases the  measurement of collateral  dependent  impaired loans on the fair
     value of the loan's collateral.  Non-collateral  dependent loans are valued
     based on a  present  value  calculation  of  expected  future  cash  flows,
     discounted at the loan's  effective  rate.  Cash receipts on impaired loans
     not performing  according to contractual terms are generally used to reduce
     the carrying value of the loan,  unless Downey believes it will recover the
     remaining principal balance of the loan.  Impairment losses are included in
     the  allowance  for loan  losses  through  a charge to  provision  for loan
     losses.  Adjustments to impairment  losses due to changes in the fair value
     of collateral of impaired  loans are included in provision for loan losses.
     Upon  disposition  of an  impaired  loan,  loss of  principal,  if any,  is
     recorded through a charge-off to the allowance for loan losses.

     In the  opinion  of  management,  and in  accordance  with  the  loan  loss
     allowance  methodology,  the present  allowance is  considered  adequate to
     absorb estimable and probable loan losses.  Additions to the allowances are
     reflected in current operations. Charge-offs to the allowance are made when
     the loan is  considered  uncollectible  or is  transferred  to real  estate
     owned. Recoveries are credited to the allowance.

     For regulatory  capital  purposes,  the Bank's  general  allowance for loan
     losses is included to a limit of 1.25% of regulatory risk-weighted assets.

     Loan Servicing

     Downey  services  mortgage loans for  investors.  Fees earned for servicing
     loans owned by investors  are reported as income when the related  mortgage
     loan payments are collected. Loan servicing costs are charged to expense as
     incurred.

     Investment in Real Estate and Joint Ventures

     Real estate held for  investment or under  development is held at the lower
     of cost (less  accumulated  depreciation) or fair value.  Costs,  including
     interest,  of  holding  real  estate  in  the  process  of  development  or
     improvement are  capitalized,  whereas costs relating to holding  completed
     property are expensed. An


                                       64
<PAGE>


     allowance  for  losses  is  established  by a charge to  operations  if the
     carrying  value  of a  property  exceeds  its  fair  value,  including  the
     consideration of disposition costs.

     Downey  utilizes  the  equity  method  of  accounting  for  investments  in
     non-controlled joint ventures, and the consolidation method for investments
     in controlled joint ventures. All intercompany profits are eliminated.

     Income from the sale of real estate is recognized principally when title to
     the property has passed to the buyer, minimum down payment requirements are
     met,  and the terms of any notes  received  by  Downey  satisfy  continuing
     investment requirements.  At the time of sale, costs are relieved from real
     estate projects on a relative sales value basis and charged to operations.

     Real Estate Acquired in Settlement of Loans

     Real estate  acquired  through  foreclosure  is initially  recorded at fair
     value (net of an  allowance  for  estimated  selling  costs and  delinquent
     property  taxes) at the date of foreclosure,  and a valuation  allowance is
     established for any subsequent  declines in fair value.  All legal fees and
     direct costs,  including  foreclosure and other related costs, are expensed
     as incurred.

     Premises and Equipment

     Buildings,  leasehold  improvements and furniture,  fixtures, and equipment
     are  carried  at cost,  less  accumulated  depreciation  and  amortization.
     Buildings and furniture,  fixtures, and equipment are depreciated using the
     straight-line  method over the  estimated  useful lives of the assets.  The
     cost of leasehold  improvements is being amortized using the  straight-line
     method  over the shorter of the  estimated  useful life of the asset or the
     terms of the related leases.

     Impairment of Long-lived Assets

     Downey reviews long-lived assets and certain  identifiable  intangibles for
     impairment  whenever events or changes in  circumstances  indicate that the
     carrying  amount  of an asset  may not be  recoverable.  Recoverability  of
     assets to be held and used is  measured  by a  comparison  of the  carrying
     amount of an asset to future net cash flows expected to be generated by the
     asset.  If such assets are considered to be impaired,  the impairment to be
     recognized  is measured by the amount by which the  carrying  amount of the
     assets  exceed the fair value of the  assets.  Assets to be disposed of are
     reported  at the lower of the  carrying  amount or fair value less costs to
     sell.

     Securities Sold Under Agreements to Repurchase

     Downey  enters into sales of  securities  under  agreements  to  repurchase
     ("reverse  repurchase  agreements").   Reverse  repurchase  agreements  are
     treated as financing  arrangements  and,  accordingly,  the  obligations to
     repurchase  the  securities  sold are reflected as  liabilities in Downey's
     consolidated financial statements.  The securities  collateralizing reverse
     repurchase  agreements  are delivered to several major  national  brokerage
     firms who arranged the  transactions.  These  securities  are  reflected as
     assets in Downey's consolidated  financial statements.  The brokerage firms
     may loan such  securities  to other  parties in the normal  course of their
     operations  and agree to return the  identical  securities to Downey at the
     maturity of the agreements.

     Income Taxes

     Downey  applies the asset and  liability  method of  accounting  for income
     taxes. The asset and liability method recognizes  deferred income taxes for
     the  tax  consequences  of  "temporary  differences"  by  applying  enacted
     statutory tax rates  applicable to future years to differences  between the
     financial statement


                                       65
<PAGE>


     carrying amounts and the tax bases of existing assets and liabilities.  The
     effect on deferred  taxes of a change in tax rates is  recognized in income
     in the period that includes the enactment date.

     Deferred tax assets are to be  recognized  for temporary  differences  that
     will result in deductible amounts in future years and for tax carryforwards
     if, in the  opinion  of  management,  it is more  likely  than not that the
     deferred tax assets will be realized.

     Stock Option Plan

     Prior to January 1, 1996,  Downey  accounted  for its stock  option plan in
     accordance with the provisions of Accounting  Principles  Board Opinion No.
     25,  "Accounting  for Stock Issued to  Employees"  ("APB 25"),  and related
     interpretations.  As such,  compensation  expense  would be recorded on the
     date of grant only if the  current  market  price of the  underlying  stock
     exceeded the exercise price. On January 1, 1996,  Downey adopted  Statement
     of Financial  Accounting  Standards No. 123,  "Accounting  for  Stock-Based
     Compensation"  ("SFAS 123"), which permits entities to recognize as expense
     over the  vesting  period the fair value of all  stock-based  awards on the
     date of grant. Alternatively,  SFAS 123 also allows entities to continue to
     apply the  provisions  of APB 25 and  provide  pro forma net income and pro
     forma net income per share  disclosures  for employee  stock option  grants
     made in 1995 and future years as if the fair-value-based  method defined in
     SFAS 123 had been  applied.  Downey has  elected to  continue  to apply the
     provisions  of APB 25 and provide the pro forma  disclosure  provisions  of
     SFAS 123.

     Per Share Information

     Downey  adopted,  effective  December  31,  1997,  Statement  of  Financial
     Accounting  Standards No. 128,  "Earnings Per Share" ("SFAS 128"). SFAS 128
     simplifies  the standards for computing and  presenting  earnings per share
     ("EPS") as previously prescribed by Accounting Principles Board Opinion No.
     15,  "Earnings per Share." SFAS 128 replaces primary EPS with basic EPS and
     fully  diluted EPS with  diluted EPS.  Basic EPS  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 EPS 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 issuance of common stock that then shared in
     earnings.

     Current Accounting Pronouncement

     In June 1998, the FASB issued Statement of Financial  Accounting  Standards
     No. 133,  "Accounting for Derivative  Instruments  and Hedging  Activities"
     ("SFAS 133").

     SFAS 133  establishes  accounting  and reporting  standards for  derivative
     instruments,  including certain  derivative  instruments  embedded in other
     contracts,  (collectively  referred  to as  derivatives)  and  for  hedging
     activities.  It requires that an entity recognize all derivatives as either
     assets or  liabilities  in the statement of financial  position and measure
     those  instruments  at  fair  value.  If  certain  conditions  are  met,  a
     derivative may be specifically designated as (a) a hedge of the exposure to
     changes  in the  fair  value  of a  recognized  asset  or  liability  or an
     unrecognized firm commitment,  (b) a hedge of the exposure to variable cash
     flows of a forecasted  transaction,  or (c) a hedge of the foreign currency
     exposure of a net investment in a foreign  operation,  an unrecognized firm
     commitment,     an     available     for     sale     security,     or    a
     foreign-currency-denominated forecasted transaction.

     Under SFAS 133, an entity that elects to apply hedge accounting is required
     to  establish  at the  inception  of the hedge  the  method it will use for
     assessing the  effectiveness of the hedging  derivative and the measurement
     approach for determining the ineffective aspect of the hedge. Those methods
     must be consistent with the entity's approach to managing risk.


                                       66
<PAGE>


     As part of its secondary marketing activities, Downey utilizes forward sale
     and  purchase  contracts  to hedge the value of loans  originated  for sale
     against adverse changes in interest rates. At December 31, 1998, such sales
     and  purchase  contracts  amounted to  approximately  $622  million and $34
     million, respectively. These contracts have a high correlation to the price
     movement of the loans being hedged.  There is no  recognition of unrealized
     gains and losses on these  contracts  in the balance  sheet or statement of
     income.  When the related loans are sold, the deferred gains or losses from
     these contracts are recognized in the statement of income as a component of
     net gains or losses on sales of loans and mortgage-backed securities.

     This  statement  is  effective  for all  fiscal  quarters  of fiscal  years
     beginning  after June 15, 1999.  It is not  anticipated  that the financial
     impact of this statement will have a material impact on Downey.

(2)  BUSINESS COMBINATION

     During 1988, the Bank acquired  Butterfield  Savings and Loan  Association,
     FSA ("Butterfield") from the Federal Savings and Loan Insurance Corporation
     ("FSLIC") in a FSLIC assisted acquisition.

     Concurrent  with the  acquisition,  the Bank and the FSLIC  entered into an
     assistance agreement ("Butterfield Assistance Agreement") that provides for
     the  indemnification of the Bank against losses incurred on the disposal of
     certain  defined  covered assets and the  settlement of certain  unreserved
     preacquisition   liabilities  or  contingencies  reduced  by  tax  benefits
     associated with those expenses as defined.  Additionally,  the FSLIC agreed
     to provide yield  maintenance  assistance on certain  covered assets at the
     Federal  Home Loan Bank  ("FHLB")  Eleventh  District  Cost of Funds  Index
     ("COFI").  All such  amounts  received  are  nontaxable  under the Internal
     Revenue Code.

     All assets  subject to the  Butterfield  Assistance  Agreement were sold or
     repurchased  by the  Federal  Deposit  Insurance  Corporation  ("FDIC")  on
     December  29,  1995.  By its terms  the  Butterfield  Assistance  Agreement
     terminated on March 31, 1997.

     The Butterfield  Assistance  Agreement provides broad authority to the FDIC
     to conduct  audits.  A  compliance  audit was  competed by the FDIC for the
     period July 1, 1993 to June 30, 1996. A final post termination audit of the
     Butterfield Assistance Agreement by the FDIC remains to be completed.

(3)  U.S. TREASURY SECURITIES AND AGENCY OBLIGATIONS AVAILABLE FOR SALE

     The amortized cost and estimated market value of U.S.  Treasury  securities
     and agency obligations available for sale are summarized as follows:

<TABLE>
<CAPTION>
                                                  Gross      Gross     Estimated
                                   Amortized   Unrealized  Unrealized    Market
     (In Thousands)                  Cost         Gains      Losses      Value
     ---------------------------------------------------------------------------
<S>                                <C>           <C>         <C>        <C>     
     December 31, 1998 ..........  $114,882      $1,193      $   14     $116,061
     ===========================================================================
     December 31, 1997 ..........  $160,089      $  441      $1,132     $159,398
     ===========================================================================
</TABLE>


                                       67
<PAGE>


     The amortized cost and estimated market value of U.S.  Treasury  securities
     and  agency  obligations  available  for  sale at  December  31,  1998,  by
     contractual maturity, are shown below.

<TABLE>
<CAPTION>
                                                Amortized    Market
     (In Thousands)                                Cost      Value
     ---------------------------------------------------------------
<S>                                              <C>        <C>   
     Due in one year or less .................   $   --     $   --
     Due after one year through five years (1)    114,882    116,061
     ---------------------------------------------------------------
        Total ................................   $114,882   $116,061
     ===============================================================
<FN>
        (1) No investment matures beyond five years.
</FN>
</TABLE>

     Proceeds,  gross  realized  gains and losses on the sales of U.S.  Treasury
     securities  and agency  obligations  available  for sale are  summarized as
     follows:

<TABLE>
<CAPTION>
     (In Thousands)            1998      1997       1996
     -------------------------------------------------------
<S>                          <C>       <C>        <C>     
     Proceeds ............   $60,319   $   --     $189,541
     =======================================================
     Gross realized gains    $    68   $   --     $  4,578
     =======================================================
     Gross realized losses   $  --     $   --     $    105
     =======================================================
</TABLE>

     Net  unrealized  gains on  investment  securities  available  for sale were
     recognized  in  stockholders'  equity as  accumulated  other  comprehensive
     income in the amount of $1.2 million,  or $0.7 million net of income taxes,
     at December 31, 1998, compared to net unrealized losses of $0.7 million, or
     $0.4 million net of income taxes, at December 31, 1997.

(4)  LOANS AND MORTGAGE-BACKED  SECURITIES PURCHASED UNDER RESALE AGREEMENTS AND
     OTHER INVESTMENT SECURITIES HELD TO MATURITY

     Loans and Mortgage-backed Securities Purchased Under Resale Agreements

     There were no loans or  mortgage-backed  securities  purchased under resale
     agreements  at December  31, 1998 or 1997.  The average  interest  rate and
     balance was 5.67% and $73 million, respectively, during 1998, and 5.72% and
     $8 million,  respectively,  during 1997. The maximum amount  outstanding at
     any  month-end  during  1998 and 1997 was  $110  million  and $20  million,
     respectively.

     Municipal Securities Held to Maturity

     The amortized cost and estimated market value of municipal  securities held
     to maturity are summarized as follows:

<TABLE>
<CAPTION>
                                         Gross       Gross   Estimated
                           Amortized  Unrealized  Unrealized   Market
     (In Thousands)           Cost       Gains      Losses      Value
     -----------------------------------------------------------------
<S>                          <C>        <C>           <C>      <C>   
     December 31, 1998 ....  $6,764     $    --       $19      $6,745
     =================================================================
     December 31, 1997 ....  $6,885     $    --       $20      $6,865
     =================================================================
</TABLE>

     The  investment  at December  31, 1998 and 1997  represents  an  industrial
     revenue bond on which the interest  income is not subject to federal income
     taxes and matures in 2015.


                                       68
<PAGE>


(5)  MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE

     The  amortized  cost and  estimated  market  value  of the  mortgage-backed
     securities available for sale are summarized as follows:

<TABLE>
<CAPTION>
                                               Gross      Gross     Estimated
                                 Amortized  Unrealized  Unrealized    Market
     (In Thousands)                 Cost       Gains      Losses       Value
     ------------------------------------------------------------------------
<S>                               <C>          <C>        <C>        <C>    
     December 31, 1998:
        GNMA certificates .....   $ 7,027      $  309     $ --       $ 7,336
        FNMA certificates .....       145           6       --           151
        FHLMC certificates ....    13,668        --           6       13,662
        Non-agency certificates    11,164           1       168       10,997
     ------------------------------------------------------------------------
           Total ..............   $32,004      $  316     $ 174      $32,146
     ========================================================================
     December 31, 1997:                                             
        GNMA certificates .....   $ 9,623      $  459     $ --       $10,082
        FNMA certificates .....       201           9       --           210
        FHLMC certificates ....    19,659        --         163       19,496
        Non-agency certificates    18,933         583         5       19,511
     ------------------------------------------------------------------------
           Total ..............   $48,416      $1,051     $ 168      $49,299
     ========================================================================
</TABLE>

     Net unrealized gains on mortgage-backed  securities available for sale were
     recognized  in  stockholders'  equity as  accumulated  other  comprehensive
     income in the amount of $0.1 million,  or $81,400 net of income  taxes,  at
     December  31,  1998.  At  December  31,  1997,  net  unrealized  gains were
     recognized  in  stockholders'  equity as  accumulated  other  comprehensive
     income in the amount of $0.9 million, or $0.5 million net of income taxes.

     Proceeds,  gross realized gains and losses on the sales of  mortgage-backed
     securities available for sale are summarized as follows:

<TABLE>
<CAPTION>
     (In Thousands)            1998       1997      1996
     ----------------------------------------------------
<S>                          <C>        <C>       <C>    
     Proceeds ............   $608,158   $88,723   $31,314
     ====================================================
     Gross realized gains    $  3,490   $   728   $   809
     ====================================================
     Gross realized losses   $  3,814   $   928   $   221
     ====================================================
</TABLE>


                                       69
<PAGE>


(6)  LOANS RECEIVABLE

     Loans receivable are summarized as follows:

<TABLE>
<CAPTION>
                                                                       December 31,
                                                                --------------------------
     (In Thousands)                                                1998           1997
     -------------------------------------------------------------------------------------
<S>                                                             <C>            <C>       
     Held for investment:
        Loans secured by real estate:
           Residential:
             One-to-four units .............................    $4,047,182     $4,358,475
             One-to-four units - subprime ..................       588,951        249,070
             Five or more units ............................        40,029         38,278
           Commercial real estate ..........................       140,790        202,425
           Construction ....................................       127,761         70,865
           Land ............................................        44,859         25,687
        Non-mortgage:
           Commercial ......................................        28,293         26,024
           Automobile ......................................       357,988        342,326
           Other consumer ..................................        41,894         47,735
     -------------------------------------------------------------------------------------
             Total loans receivable held for investment ....     5,417,747      5,360,885
        Less:
           Undisbursed loan funds ..........................      (108,414)       (64,884)
           Net deferred costs and premiums .................        31,021         18,088
           Allowance for estimated losses ..................       (31,517)       (32,092)
     -------------------------------------------------------------------------------------
             Total loans receivable held for investment, net    $5,308,837     $5,281,997
     =====================================================================================
     Held for sale:
        Loans secured by residential one-to-four units .....    $  447,382     $   35,100
     =====================================================================================
</TABLE>

     Over  99%  of the  real  estate  securing  Downey's  loans  is  located  in
     California.


                                       70
<PAGE>


     A summary of activity in the allowance for loan losses for loans receivable
     held for investment during 1998, 1997 and 1996 follows:

<TABLE>
<CAPTION>
                                                                                               Not
                                                   Real                            Other  Specifically
     (In Thousands)                               Estate  Commercial  Automobile  Consumer  Allocated    Total
     -----------------------------------------------------------------------------------------------------------
<S>                                              <C>         <C>       <C>         <C>        <C>       <C>    
     Balance at December 31, 1995 ...........    $22,913     $ 259     $   849     $1,122     $2,800    $27,943
     Provision for (reduction of) loan losses      3,874        92       5,245        (74)      --        9,137
     Charge-offs ............................     (5,200)     (115)     (2,096)      (249)      --       (7,660)
     Recoveries .............................        366      --           305          3       --          674
     -----------------------------------------------------------------------------------------------------------
     Balance at December 31, 1996 ...........     21,953       236       4,303        802      2,800     30,094
     Provision for (reduction of) loan losses        207       (40)      8,181        292       --        8,640
     Charge-offs ............................     (2,389)     --        (5,109)      (275)      --       (7,773)
     Recoveries .............................        485      --           641          5       --        1,131
     -----------------------------------------------------------------------------------------------------------
     Balance at December 31, 1997 ...........     20,256       196       8,016        824      2,800     32,092
     Provision for (reduction of) loan losses     (1,480)       22       5,287         70       --        3,899
     Charge-offs ............................     (1,103)     --        (6,118)      (151)      --       (7,372)
     Recoveries .............................      1,735      --         1,159          4       --        2,898
     -----------------------------------------------------------------------------------------------------------
     Balance at December 31, 1998 ...........    $19,408     $ 218     $ 8,344     $  747     $2,800    $31,517
     ===========================================================================================================
</TABLE>

     Net  charge-offs  represented  0.09%,  0.13% and 0.16% of average loans for
     1998, 1997 and 1996, respectively.

     All impaired loans at December 31, 1998 and 1997 were secured by commercial
     real estate.  The following  table  presents  impaired  loans with specific
     allowances  and the amount of such  allowances,  and impaired loans without
     specific allowances.

<TABLE>
<CAPTION>
                                              Net         Specific       Net
     (In Thousands)                      Carrying Value   Allowance    Balance
     -------------------------------------------------------------------------
<S>                                         <C>          <C>          <C>  
     December 31, 1998:
        Loans with specific allowances ..   $  --        $  --        $  --
        Loans without specific allowances    13,302         --         13,302
     -------------------------------------------------------------------------
        Total impaired loans ............   $13,302      $  --        $13,302
     =========================================================================
     December 31, 1997:                                             
        Loans with specific allowances ..   $  --        $  --        $  --
        Loans without specific allowances    13,798         --         13,798
     -------------------------------------------------------------------------
        Total impaired loans ............   $13,798      $  --        $13,798
     =========================================================================
</TABLE>
                                                                 
     The average  recorded  investment in impaired loans during 1998 totaled $14
     million and $15 million in 1997. During 1998, total interest  recognized on
     the impaired loan portfolio,  on a cash basis, was $2.0 million,  unchanged
     from 1997.

     The combined  weighted  average interest yield on loans receivable held for
     investment  and sale was 7.73% and 7.96% as of December  31, 1998 and 1997,
     respectively,  and averaged  7.89%,  7.81% and 7.72% during 1998,  1997 and
     1996, respectively.


                                       71
<PAGE>


     The aggregate amount of non-accrual loans receivable that are contractually
     past due 90 days or more as to principal or  interest,  in the  foreclosure
     process,  restructured,  or upon which interest collection is doubtful were
     $22 million and $42 million as of December 31, 1998 and 1997, respectively.
     There were no troubled debt restructurings on accrual status as of December
     31, 1998 and 1997.

     Interest due on  non-accrual  loans but excluded from  interest  income was
     approximately $0.5 million for 1998, $1.8 million for 1997 and $4.1 million
     for 1996.

     Downey has had,  and  expects in the  future to have,  transactions  in the
     ordinary  course of business with executive  officers,  directors and their
     associates  ("related parties") on substantially the same terms,  including
     interest  rates  and  collateral,  as  those  prevailing  at the  time  for
     comparable  transactions with other non-related parties. Those transactions
     neither involve more than the normal risk of collectibility nor present any
     unfavorable  features. At December 31, 1998 and 1997, the Bank had extended
     loans  to  certain  directors,  executive  officers  and  their  associates
     totaling  $26 million  and $27  million,  respectively.  All such loans are
     performing  in  accordance  with their  loan  terms.  Presented  below is a
     summary  of  activity  with  respect  to such  loans for the  years  ending
     December 31, 1998 and 1997:

<TABLE>
<CAPTION>
     (In Thousands)                      1998        1997
     ------------------------------------------------------
<S>                                    <C>         <C>      
     Balance at beginning of period    $27,094     $28,835 
     Additions ....................       --         3,857 
     Repayments ...................     (1,331)     (5,598)
     ------------------------------------------------------
     Balance at end of period .....    $25,763     $27,094 
     ======================================================
</TABLE>
     
(7)  LOAN SERVICING

     Mortgage  loans  serviced for others are not  included in the  accompanying
     consolidated  balance  sheets.  The unpaid  principal  balances of mortgage
     loans serviced for others was $1.0 billion and $613 million at December 31,
     1998 and 1997, respectively.

     Custodial escrow balances  maintained in connection with the foregoing loan
     servicing,  and included in demand deposits, were $3 million and $2 million
     at December 31, 1998 and 1997, respectively.

     Mortgage  servicing  rights of $7.3 million,  $1.2 million and $1.0 million
     related to loans sold with servicing  rights  retained were  capitalized in
     1998,  1997 and 1996,  respectively.  Mortgage  servicing  rights have been
     written  down to their fair value of $7.8  million,  $2.0  million and $1.2
     million at December 31, 1998, 1997 and 1996, respectively.  Amortization of
     mortgage  servicing  rights was $0.7 million in 1998,  $0.3 million in 1997
     and $0.2 million in 1996.

     A summary of activity in the allowance for mortgage servicing rights during
     1998, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
     (In Thousands)                     1998      1997     1996
     -----------------------------------------------------------
<S>                                    <C>       <C>      <C>   
     Balance at beginning of period    $  206    $ 101    $--   
     Additions ....................     1,350      249      129 
     Reductions ...................      (581)    (144)     (28)
     Impairment write-down ........      (511)    --       --   
     -----------------------------------------------------------
     Balance at end of period .....    $  464    $ 206    $ 101 
     ===========================================================
</TABLE>
     

                                       72
<PAGE>


(8)  INVESTMENTS IN REAL ESTATE AND JOINT VENTURES

     Investments in real estate and joint ventures are summarized as follows:

<TABLE>
<CAPTION>
                                                                           December 31,
                                                                       --------------------
     (In Thousands)                                                      1998        1997
     --------------------------------------------------------------------------------------
<S>                                                                    <C>        <C>     
     Gross investments in real estate .............................    $57,084    $ 63,321
     Accumulated depreciation .....................................     (9,215)     (9,432)
     Allowance for estimated losses ...............................     (6,305)    (19,617)
     --------------------------------------------------------------------------------------
        Investments in real estate (1) ............................     41,564      34,272
     --------------------------------------------------------------------------------------
     Investments in and interest bearing advances to joint ventures      9,295       8,711
     Joint venture valuation allowance ............................     (1,412)     (1,627)
     --------------------------------------------------------------------------------------
        Investments in joint ventures .............................      7,883       7,084
     --------------------------------------------------------------------------------------
        Total investments in real estate and joint ventures .......    $49,447    $ 41,356
     ======================================================================================
<FN>
     (1)  Includes  $0.4  million at December 31,  1997,  associated  with three
          single family housing  developments which are joint ventures for legal
          purposes.  They are reported as wholly owned for  financial  reporting
          purposes  because  DSL  Service  Company  assumed   operating  control
          effective in the fourth quarter of 1993.
</FN>
</TABLE>

     The table set forth below describes the type, location, and amount invested
     in real estate and joint ventures,  net of specific valuation allowances of
     $6 million and general valuation  allowances of $1 million, at December 31,
     1998:

<TABLE>
<CAPTION>
     (In Thousands)                                            California  Arizona  Other    Total
     -----------------------------------------------------------------------------------------------
<S>                                                             <C>        <C>       <C>    <C>     
     Shopping centers ......................................    $14,675    $14,532   $--    $29,207 
     Office buildings ......................................        695        281    --        976 
     Residential ...........................................      5,362       --      --      5,362 
     Land ..................................................     14,761        176    459    15,396 
     -----------------------------------------------------------------------------------------------
        Total real estate before general valuation allowance    $35,493    $14,989   $459   $50,941 
     -----------------------------------------------------------------------------------------------
     General valuation allowance ...........................                                 (1,494)                            
     -----------------------------------------------------------------------------------------------
     Net investment in real estate and joint ventures ......                                $49,447                             
     ===============================================================================================
</TABLE>
     

                                       73
<PAGE>


     A summary of real estate and joint venture operations  included in Downey's
     results of operations follows:

<TABLE>
<CAPTION>
     (In Thousands)                                              1998        1997       1996
     -----------------------------------------------------------------------------------------
<S>                                                            <C>         <C>        <C>     
     Wholly owned operations:
        Rental operations:
           Rental income ..................................    $ 5,189     $ 4,689    $ 4,649 
           Costs and expenses .............................     (1,466)     (2,372)    (2,232)
     -----------------------------------------------------------------------------------------
             Net rental operations ........................      3,723       2,317      2,417 
        Net gains on sales of real estate .................      2,557       2,904        392 
        Reduction of losses on real estate ................      5,081         985      1,263 
     -----------------------------------------------------------------------------------------
           Total wholly owned operations ..................     11,361       6,206      4,072 
     -----------------------------------------------------------------------------------------
     Joint venture operations:                                                                
        Equity in net income from joint ventures ..........      9,203       3,931         55 
        Reduction of losses provided by DSL Service Company        215       2,205      2,043 
     -----------------------------------------------------------------------------------------
           Net joint venture operations ...................      9,418       6,136      2,098 
     Interest from joint venture advances .................      1,584       1,880      2,071 
     -----------------------------------------------------------------------------------------
        Total joint venture operations ....................     11,002       8,016      4,169 
     -----------------------------------------------------------------------------------------
           Total ..........................................    $22,363     $14,222    $ 8,241 
     =========================================================================================
</TABLE>
     
     Activity  in the  allowance  for losses on real estate and  investments  in
     joint ventures for 1998, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
                                                    Real Estate  Commercial   Residential
                                                     Held for   Real Estate   Real Estate  Investments
                                                     or Under     Held for      Held for     In Joint
     (In Thousands)                                 Development  Investment    Investment    Ventures       Total
     --------------------------------------------------------------------------------------------------------------
<S>                                                  <C>          <C>           <C>          <C>           <C>     
     Balance at December 31, 1995 ................   $ 5,967      $ 6,683       $11,859      $ 9,829       $34,338 
     Provision for (reduction of) estimated losses        50       (1,567)          254       (2,043)       (3,306)
     Charge-offs .................................      (680)        --            (272)         (83)       (1,035)
     Recoveries ..................................      --           --            --             74            74 
     --------------------------------------------------------------------------------------------------------------
     Balance at December 31, 1996 ................     5,337        5,116        11,841        7,777        30,071 
     Provision for (reduction of) estimated losses       492       (1,403)          (74)      (2,205)       (3,190)
     Charge-offs .................................      --         (1,692)         --         (3,945)       (5,637)
     Recoveries ..................................      --           --            --           --            --   
     --------------------------------------------------------------------------------------------------------------
     Balance at December 31, 1997 ................     5,829        2,021        11,767        1,627        21,244 
     Provision for (reduction of) estimated losses        33         (427)       (4,687)        (215)       (5,296)
     Charge-offs .................................    (1,151)        --          (7,080)        --          (8,231)
     Recoveries ..................................      --           --            --           --            --   
     --------------------------------------------------------------------------------------------------------------
     Balance at December 31, 1998 ................   $ 4,711      $ 1,594       $  --        $ 1,412       $ 7,717 
     ==============================================================================================================
</TABLE>
     

                                       74
<PAGE>


     Condensed  financial  information of joint ventures  reported on the equity
     method is as follows:

     Condensed Combined Balance Sheets - Joint Ventures

<TABLE>
<CAPTION>
                                                                        December 31,
                                                                   ---------------------
     (In Thousands)                                                   1998        1997
     -----------------------------------------------------------------------------------
<S>                                                                <C>         <C>               
     ASSETS
     Cash ......................................................   $  2,776    $  1,703          
     Projects under development ................................     18,526         964          
     Completed projects ........................................     31,372      64,138          
     Other assets ..............................................      3,509       5,057          
     -----------------------------------------------------------------------------------
                                                                   $ 56,183    $ 71,862          
     ===================================================================================
     LIABILITIES AND EQUITY                                                                      
     Liabilities:                                                                                
        Notes payable to the Bank ..............................   $ 46,544    $ 52,992          
        Notes payable to others ................................      3,633      13,858          
        Other ..................................................      6,996       9,940          
     Equity (deficit):                                                                           
        DSL Service Company (1) ................................      7,883       7,084          
        Allowance for losses recorded by DSL Service Company (2)      1,412       1,627          
        Other partners' (2) ....................................    (10,285)    (13,639)         
     -----------------------------------------------------------------------------------
          Net deficit ..........................................       (990)     (4,928)         
     -----------------------------------------------------------------------------------
                                                                   $ 56,183    $ 71,862          
     ===================================================================================
<FN> 
     (1)  Included in these amounts are interest-bearing  joint venture advances
          with priority  interest  payments  from joint  ventures to DSL Service
          Company.

     (2)  The aggregate other  partners'  deficit of $10 million and $14 million
          at December 31, 1998 and 1997,  respectively,  represents their equity
          interest  in  the  accumulated  retained  earnings  (deficit)  of  the
          respective  joint  ventures.  Those  results  include not only the net
          profit on sales and the operating  results of the real estate  assets,
          but  depreciation  expense and funding  costs as well.  Except for any
          secured  financing  which has been obtained,  DSL Service  Company has
          provided  all other  financing.  As part of  Downey's  internal  asset
          review process, the fair value of the joint venture real estate assets
          is compared to the  secured  notes  payable to the Bank and others and
          DSL Service Company's investment.  To the extent the fair value of the
          real estate  assets is less than the  aggregate  of those  amounts,  a
          provision is made to create a valuation  allowance.  Those  allowances
          totaled $1  million  and $2 million  at  December  31,  1998 and 1997,
          respectively.  At December 31, 1998, the fair value of the real estate
          assets  of  certain  joint  venture  partnerships  in which  the other
          partners'  equity was a deficit  exceeded  the  amount of third  party
          notes and DSL Service  Company's  investment  thereby  eliminating the
          need for a valuation allowance since the sale of the real estate would
          allow DSL  Service  Company to realize  its  investment  and provide a
          profit to the  partners.  Thus,  the other  partners'  deficit  of $10
          million and $14 million at December  31, 1998 and 1997,  respectively,
          exceeds the amount of aforementioned  valuation allowances established
          of  $1  million  and  $2  million  at  December  31,  1998  and  1997,
          respectively.
</FN>
</TABLE>


                                       75
<PAGE>


     Condensed Combined Statements of Operations - Joint Ventures

<TABLE>
<CAPTION>
     (In Thousands)                                           1998        1997        1996
     ---------------------------------------------------------------------------------------
<S>                                                        <C>         <C>         <C>      
     Real estate sales:
         Sales .........................................   $ 59,095    $ 82,696    $  2,901 
         Cost of sales .................................    (39,261)    (72,255)     (1,401)
     ---------------------------------------------------------------------------------------
          Net gains on sales ...........................     19,834      10,441       1,500 
     ---------------------------------------------------------------------------------------
     Rental operations:                                                                     
         Rental income .................................      6,252       8,280      13,674 
         Operating expenses ............................     (2,409)     (1,729)     (1,781)
         Interest, depreciation and other expenses .....     (5,271)     (9,130)    (14,784)
     ---------------------------------------------------------------------------------------
          Net loss on rental operations ................     (1,428)     (2,579)     (2,891)
     ---------------------------------------------------------------------------------------
     Net income (loss) .................................     18,406       7,862      (1,391)
     Less other partners' share of net income (loss) ...      9,203       3,931      (1,446)
     ---------------------------------------------------------------------------------------
     DSL Service Company's share of net income .........      9,203       3,931          55 
     Reduction of losses provided by DSL Service Company        215       2,205       2,043 
     ---------------------------------------------------------------------------------------
     DSL Service Company's share of net income .........   $  9,418    $  6,136    $  2,098 
     =======================================================================================
</TABLE>
     
(9)  REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS

     The type and  amount of real  estate  acquired  in  settlement  of loans is
     summarized as follows:

<TABLE>
<CAPTION>
                                                                     December 31,
                                                                  -------------------
     (In Thousands)                                                1998        1997
     --------------------------------------------------------------------------------
<S>                                                               <C>        <C>             
     One-to-four unit residential ............................    $5,008     $ 9,295         
     Commercial shopping centers .............................      --           477    
     Land ....................................................      --           693    
     --------------------------------------------------------------------------------
        Total real estate acquired in settlement of loans ....     5,008      10,465    
     Allowance for estimated losses ..........................      (533)       (839)   
     --------------------------------------------------------------------------------
        Total real estate acquired in settlement of loans, net    $4,475     $ 9,626    
     ================================================================================
</TABLE>

     A summary of net  operation of real estate  acquired in settlement of loans
     included in Downey's results of operations follows:

<TABLE>
<CAPTION>
     (In Thousands)                                                       1998       1997       1996
     -------------------------------------------------------------------------------------------------
<S>                                                                     <C>        <C>         <C>           
     Net gains on sales (1) .........................................   $(1,417)   $(1,299)    $ (389)       
     Net operating expense ..........................................     1,222      1,376      1,298    
     Provision for estimated losses .................................       455      1,107      1,658    
     -------------------------------------------------------------------------------------------------
        Net operations of real estate acquired in settlement of loans   $   260    $ 1,184     $2,567    
     =================================================================================================
<FN> 
     (1)  Includes $1.1 million in 1997  associated  with the sale of a shopping
          center.
</FN>
</TABLE>


                                       76
<PAGE>


     Activity in the  allowance  for  estimated  losses on real estate  acquired
     through foreclosure for 1998, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
     (In Thousands)                    1998      1997       1996
     -------------------------------------------------------------
<S>                                   <C>      <C>        <C>     
     Balance at beginning of period   $ 839    $ 1,078    $ 1,217 
     Provision ....................     455      1,107      1,658 
     Charge-offs ..................    (761)    (1,346)    (1,797)
     -------------------------------------------------------------
     Balance at end of period .....   $ 533    $   839    $ 1,078 
     =============================================================
</TABLE>
     
(10) PREMISES AND EQUIPMENT

     Premises and equipment are summarized as follows:

<TABLE>
<CAPTION>
                                                       December 31,
                                                  ----------------------
     (In Thousands)                                 1998         1997
     -------------------------------------------------------------------
<S>                                               <C>          <C>      
     Land ....................................    $ 24,471     $ 23,413 
     Building and improvements ...............      88,384       86,444 
     Furniture, fixtures and equipment .......      52,080       46,970 
     Construction in progress ................         196          705 
     Other ...................................          62           76 
     -------------------------------------------------------------------
        Total premises and equipment .........     165,193      157,608 
     Accumulated depreciation and amortization     (61,214)     (55,707)
     -------------------------------------------------------------------
        Total premises and equipment, net ....    $103,979     $101,901 
     ===================================================================
</TABLE>
     
     Downey has commitments  under long term operating  leases,  principally for
     building space and land.  Lease terms generally  cover a five-year  period.
     Rental  expense  was $1.7  million in 1998,  $1.4  million in 1997 and $0.8
     million in 1996.  The following  table  summarizes  future  minimum  rental
     commitments under noncancelable leases.

<TABLE>
<CAPTION>
     (In Thousands)
     ----------------------------------------------------------
<S>                                                      <C>   
     1999 ............................................   $1,662
     2000 ............................................    1,364
     2001 ............................................    1,022
     2002 ............................................      586
     2003 ............................................      465
     Thereafter (1) ..................................      398
     ----------------------------------------------------------
        Total future lease commitments                   $5,497
     ==========================================================
 <FN>                                        
     (1)  There are no lease commitments  beyond the year 2009 though options to
          renew at that time are available.
</FN>
</TABLE>

(11) FEDERAL HOME LOAN BANK STOCK

     The Bank's  required  investment in FHLB stock,  based on December 31, 1998
     financial  data, was $52 million.  The investment in FHLB stock amounted to
     $49 million and $44  million at December  31, 1998 and 1997,  respectively.
     The Bank received a $1 million stock dividend and will purchase  additional
     stock  amounting  to $2  million  in the  first  quarter  of  1999  thereby
     increasing the Bank's investment to the required amount.


                                       77
<PAGE>


(12) OTHER ASSETS

     Other assets are summarized as follows:

<TABLE>
<CAPTION>
                                                          December 31,
                                                       -----------------
     (In Thousands)                                      1998      1997
     -------------------------------------------------------------------
<S>                                                    <C>       <C>             
     Accounts receivable ...........................   $ 4,151   $ 3,798         
     Accrued interest receivable:                                            
        Loans ......................................    27,949    27,279     
        Mortgage-backed securities .................       182       281     
        Investment securities ......................     2,618     2,824     
     Prepaid expenses ..............................    10,172     8,598     
     Excess of purchase price over fair value of                             
        assets acquired and liabilities assumed, net     4,543     5,054     
     Core deposit premium ..........................      --         214     
     Mortgage servicing rights, net ................     7,793     1,955     
     Repossessed automobiles, net ..................       569       795     
     Other .........................................     1,660       462     
     -------------------------------------------------------------------
        Total other assets .........................   $59,637   $51,260     
     ===================================================================
</TABLE>

(13) DEPOSITS

     Deposits are summarized as follows:

<TABLE>
<CAPTION>
                                                            December 31,
                                          ---------------------------------------------
                                                  1998                    1997
                                          ---------------------------------------------
                                          Weighted                Weighted
                                           Average                 Average
     (Dollars in Thousands)                 Rate       Amount       Rate       Amount
     ----------------------------------------------------------------------------------
<S>                                         <C>      <C>            <C>      <C>           
     Transaction accounts (1) .........     2.30%    $1,238,062     2.15%    $  935,869    
     Certificates of deposit:                                                              
        Less than 3.00% ...............     2.62         25,126     2.64         30,623    
        3.00-3.49 .....................     3.01            593     3.02            766    
        3.50-3.99 .....................     3.88         51,474        -           --      
        4.00-4.49 .....................     4.39        428,316     4.31         60,095    
        4.50-4.99 .....................     4.80        668,204     4.87         40,356    
        5.00-5.99 .....................     5.53      2,421,333     5.63      2,896,291    
        6.00-6.99 .....................     6.06        204,065     6.06        901,920    
        7.00 and greater ..............     7.24          2,560     7.22          4,058    
     ----------------------------------------------------------------------------------
          Total certificates of deposit     5.26      3,801,671     5.68      3,934,109    
     ----------------------------------------------------------------------------------
          Total deposits ..............     4.53%    $5,039,733     5.00%    $4,869,978    
     ==================================================================================
<FN> 
     (1)  Included  in  these  amounts  is $155  million  and  $107  million  of
          non-interest   bearing   accounts  at  December  31,  1998  and  1997,
          respectively
</FN>
</TABLE>


                                       78
<PAGE>


     The  aggregate  amount  of jumbo  certificates  of  deposit  with a minimum
     denomination  of $100,000 was $1.3 billion and $1.1 billion at December 31,
     1998 and 1997, respectively.

     At December 31, 1998,  scheduled  maturities of certificates of deposit are
     as follows:

<TABLE>
<CAPTION>
                                                       Weighted
     (Dollars in Thousands)                          Average Rate     Amount
     -------------------------------------------------------------------------
<S>                                                       <C>       <C>             
     1999 ............................................    5.26      $3,419,719      
     2000 ............................................    5.23         309,909      
     2001 ............................................    5.69          29,000      
     2002 ............................................    5.88          19,863      
     2003 ............................................    5.37          21,540      
     Thereafter ......................................    4.96           1,640
     -------------------------------------------------------------------------
        Total ........................................    5.26      $3,801,671
     =========================================================================
</TABLE>
                                                              
     The  weighted  average  cost of deposits  averaged  4.87%,  4.96% and 4.74%
     during 1998, 1997 and 1996, respectively.

     As of December 31, 1998 and 1997,  public funds of approximately $5 million
     and $6 million, respectively, are secured by mortgage loans with a carrying
     value of approximately $7 million and $9 million, respectively.

     Interest expense on deposits by type is summarized as follows:

<TABLE>
<CAPTION>
     (In Thousands)                       1998      1997      1996
     ---------------------------------------------------------------
<S>                                     <C>       <C>       <C>     
     Transaction accounts ............  $ 22,866  $ 18,239  $ 16,087
     Certificate accounts ............   225,471   209,282   168,315
     ---------------------------------------------------------------
        Total deposit interest expense  $248,337  $227,521  $184,402
     ===============================================================
</TABLE>
     
     Accrued  interest on  deposits,  which is included in accounts  payable and
     accrued liabilities, was $2 million at both December 31, 1998 and 1997.

(14) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

     Securities sold under agreements to repurchase are summarized as follows:

<TABLE>
<CAPTION>
     (Dollars in Thousands)                                         1998      1997      1996
     -----------------------------------------------------------------------------------------
<S>                                                               <C>       <C>       <C>       
     Balance at year end .......................................  $  --     $34,803   $  --     
     Average balance outstanding during the year ...............    1,877     4,029    11,761   
     Maximum amount outstanding at any month-end during the year   50,088    34,803    70,015   
     Weighted average interest rate during the year ............     5.90%     5.61%     5.19%  
     Weighted average interest rate at year end ................     --        6.65      --     
     As of year end secured by:                                                                 
        U.S. Treasury note .....................................  $  --     $34,798   $  --     
     =========================================================================================
</TABLE>
     
     The securities  collateralizing  these transactions were delivered to major
     national brokerage firms who


                                       79
<PAGE>


     arranged the  transactions.  Securities sold under agreements to repurchase
     generally mature within 30 days of the various dates of sale.

(15) FEDERAL HOME LOAN BANK ADVANCES

     FHLB advances are summarized as follows:

<TABLE>
<CAPTION>
     (Dollars in Thousands)                                         1998       1997       1996
     --------------------------------------------------------------------------------------------
<S>                                                               <C>        <C>        <C>      
     Balance at year end .......................................  $695,012   $352,458   $386,883 
     Average balance outstanding during the year ...............   247,521    444,408    266,252 
     Maximum amount outstanding at any month-end during the year   695,012    550,736    397,147 
     Weighted average interest rate during the year ............      5.85%      6.02%      5.85%
     Weighted average interest rate at year end ................      5.47       6.11       5.80 
     As of year end secured by:                                                                  
        Loans receivable .......................................  $789,588   $368,480   $345,463 
        Mortgage-backed securities .............................      --       25,527     31,651 
        FHLB stock .............................................      --         --       41,447 
     ============================================================================================
</TABLE>
     
     In addition to the collateral  securing  existing  advances,  Downey had an
     additional  $227 million in loans  available as  collateral  for any future
     advances as of December 31, 1998.

     FHLB advances have the following maturities at December 31, 1998:

<TABLE>
<CAPTION>
     (In Thousands)
     ----------------------------------------------------------------------
<S>                                                                <C>     
     1999 .......................................................  $163,105
     2000 .......................................................    28,796
     2001 .......................................................    16,056
     2002 .......................................................    55,921
     2003 .......................................................       134
     Thereafter .................................................   431,000
     ----------------------------------------------------------------------
        Total ...................................................  $695,012
     ======================================================================
</TABLE>

(16) COMMERCIAL PAPER

     Commercial paper borrowings are summarized as follows:

<TABLE>
<CAPTION>
     (Dollars in Thousands)                                         1998       1997       1996
     --------------------------------------------------------------------------------------------
<S>                                                               <C>        <C>        <C>         
     Balance at year end .......................................  $   --     $ 83,811   $198,113    
     Average balance outstanding during the year ...............    30,589    182,296    174,739    
     Maximum amount outstanding at any month-end during the year   103,749    272,818    198,113    
     Weighted average interest rate during the year ............      6.32%      5.75%      5.74%   
     Weighted average interest rate at end of year .............         -       5.61       5.45    
                                                                                                    
     As of year end secured by:                                                                     
        FHLB Letter of Credit ..................................   $  --     $300,000   $200,000    
     ============================================================================================
</TABLE>
     
     The commercial paper program was discontinued during 1998.


                                       80
<PAGE>


(17) OTHER BORROWINGS

     Other borrowings are summarized as follows:

<TABLE>
<CAPTION>
                                                                                 December 31,
                                                                               ---------------
     (Dollars In Thousands)                                                     1998     1997
     -----------------------------------------------------------------------------------------
<S>                                                                            <C>     <C>       
     Long-term  notes  payable to banks,  secured by real estate and mortgage                    
        loans with a carrying value of $13,319 at December 31, 1998,  bearing                    
        interest rates from 7.50% to 9.21%  .................................  $8,708  $12,663   
     =========================================================================================
</TABLE>
     
     Other borrowings have the following maturities at December 31, 1998:

<TABLE>
<CAPTION>
     (In Thousands)                                                       
     ----------------------------------------------------------------------   
<S>                                                                  <C>      
     1999 ........................................................   $2,775   
     2000 ........................................................    2,403   
     2001 ........................................................      687   
     2002 ........................................................      546   
     2003 ........................................................      599   
     Thereafter ..................................................    1,698   
     ----------------------------------------------------------------------   
        Total ....................................................   $8,708   
     ======================================================================
</TABLE>
     
(18) INCOME TAXES

     Income taxes are summarized as follows:

<TABLE>
<CAPTION>
     (In Thousands)                                   1998       1997      1996
     ---------------------------------------------------------------------------
<S>                                                 <C>        <C>       <C>     
     Federal:                                                                    
          Current ...............................   $38,474    $26,681   $ 8,310 
          Deferred ..............................    (5,848)      (886)    3,317 
     ---------------------------------------------------------------------------
                                                    $32,626    $25,795   $11,627 
     ===========================================================================
     State:                                                                      
          Current ...............................   $10,955    $ 7,373   $ 2,602 
          Deferred ..............................      (413)     1,032     1,521 
     ---------------------------------------------------------------------------
                                                    $10,542    $ 8,405   $ 4,123 
     ===========================================================================
     Total:                                                                      
          Current ...............................   $49,429    $34,054   $10,912 
          Deferred ..............................    (6,261)       146     4,838 
     ---------------------------------------------------------------------------
             Total ..............................   $43,168    $34,200   $15,750 
     ===========================================================================
</TABLE>
     
     Current  income  taxes  payable were $8 million and $11 million at December
     31, 1998 and 1997, respectively.


                                       81
<PAGE>


     Deferred tax liabilities  (assets) are comprised of the following temporary
     differences  between the financial  statement  carrying amounts and the tax
     bases of assets:

<TABLE>
<CAPTION>
                                                                     December 31,
                                                                 --------------------
     (In Thousands)                                                1998       1997
     --------------------------------------------------------------------------------
<S>                                                              <C>        <C>         
     Deferred tax liabilities:                                                          
         Tax reserves in excess of base year ..................  $ 16,438   $ 21,095    
         Deferred loan fees ...................................      --       19,498    
         Equity in joint ventures .............................     4,783      7,260    
         FHLB stock dividends .................................     5,607      5,600    
         Installment sales ....................................       268      5,011    
         Depreciation on premises and equipment ...............     3,812      4,497    
         Capitalized interest .................................       978      1,530    
         Accrual to cash adjustment ...........................       164        259    
         Unrealized gains on investment securities (1) ........       568         86    
         SAIF insurance premiums ..............................        86         62    
         Other deferred income items ..........................        18         54    
     --------------------------------------------------------------------------------
                                                                   32,722     64,952    
     --------------------------------------------------------------------------------
     Deferred tax assets:                                                               
         Loan valuation allowances, net of bad debt charge-offs   (14,447)   (32,875)   
         Real estate and joint venture valuation allowances ...    (4,010)   (15,190)   
         California franchise tax .............................    (3,704)    (2,941)   
         Deferred compensation ................................    (1,924)    (1,899)   
         Deferred loan fees ...................................    (1,564)      --      
         Mark to market adjustment on loans held for sale .....      (923)      (217)   
         Interest expense on deferred gain ....................      --         (131)   
         Other deferred expense items .........................      (739)      (512)   
     --------------------------------------------------------------------------------
                                                                  (27,311)   (53,765)   
     Deferred tax assets valuation allowance ..................      --         --      
     --------------------------------------------------------------------------------
     Net deferred tax liability ...............................  $  5,411   $ 11,187    
     ================================================================================
<FN> 
     (1)  Generally  accepted  accounting  principles  require the tax effect of
          unrealized  gains and losses on  securities  available  for sale to be
          reported  as  a  separate   component  of   stockholders'   equity  as
          accumulated other comprehensive income.
</FN>
</TABLE>

     A  reconciliation  of income taxes  (benefits)  to the  expected  statutory
     federal corporate income taxes follows:

<TABLE>
<CAPTION>
                                                              1998                 1997                 1996
                                                       ------------------------------------------------------------
     (Dollars in Thousands)                             Amount    Percent    Amount    Percent    Amount    Percent
     --------------------------------------------------------------------------------------------------------------
<S>                                                    <C>         <C>      <C>         <C>      <C>         <C>   
     Expected statutory income taxes ...............   $35,399     35.0%    $27,802     35.0%    $12,759     35.0% 
     California franchise tax, net of federal income                                                               
        tax benefit ................................     6,880      6.8       5,461      6.9       2,680      7.4  
     Increase (decrease) resulting from:                                                                           
        Amortization of goodwill ...................       253      0.3         291      0.4         295      0.8  
        Interest on municipal bonds ................      (107)    (0.1)       (103)    (0.1)       (103)    (0.3) 
        Other ......................................       743      0.7         749      0.9         119      0.3  
     --------------------------------------------------------------------------------------------------------------
     Income taxes ..................................   $43,168     42.7%    $34,200     43.1%    $15,750     43.2% 
     ==============================================================================================================
</TABLE>
     

                                       82
<PAGE>


     The Small  Business Job  Protection Act of 1996 repealed the reserve method
     of accounting  for bad debts by savings  institutions  for years  beginning
     after 1995. Under prior law, savings  associations  calculated additions to
     reserves  using either a  percentage-of-taxable-income  or historical  loan
     loss experience. The new law allows deductions for bad debts only when such
     debts are actually  charged off against income (the  "specific  charge-off"
     method).  Downey  calculated its bad debt deduction for 1998, 1997 and 1996
     under the specific charge-off method.

     Downey  made  income  tax  payments,  net of  refunds,  amounting  to $52.8
     million,  $23.6  million,  and  $19.8  million  in  1998,  1997  and  1996,
     respectively.

     Downey and its wholly owned subsidiaries file a consolidated federal income
     tax return and various state income and franchise tax returns on a calendar
     year basis. The Internal Revenue Service and state taxing  authorities have
     examined  Downey's tax returns for all tax years through 1995.  Adjustments
     totaling $15 million  proposed by the Internal  Revenue Service relating to
     the sale and leaseback of computer equipment in 1990 have been protested by
     Downey,  and are currently  moving through the government  appeals process.
     Downey believes that  substantial  legal authority exists for the positions
     taken on the tax returns and intends to vigorously  defend those positions,
     and that adequate provisions have been provided for the potential exposure.
     Tax years subsequent to 1995 remain open to review by federal and state tax
     authorities.


                                       83
<PAGE>


(19) STOCKHOLDERS' EQUITY

     Regulatory Capital

     Downey is not subject to any regulatory capital requirements.  However, the
     Bank is subject to regulation by the Office of Thrift  Supervision  ("OTS")
     which  has  adopted  regulations  ("Capital  Regulations")  that  contain a
     capital standard for savings  institutions.  The Bank is in compliance with
     the Capital Regulations at December 31, 1998 and 1997.

<TABLE>
<CAPTION>
                                                                                   To Be Well
                                                                                Capitalized Under
                                                             For Capital        Prompt Corrective
                                           Actual         Adequacy Purposes     Action Provisions
                                      ----------------   -------------------   --------------------
     (Dollars in Thousands)            Amount    Ratio    Amount    Ratio       Amount    Ratio
     ----------------------------------------------------------------------------------------------
<S>                                   <C>        <C>     <C>        <C>        <C>        <C>            
     1998                                                                                                       
         Risk-based capital                                                                                     
           (to risk-weighted assets)  $454,960   12.88%  $282,556   8.00%      $353,195   10.00%         
         Core capital                                                                                    
           (to adjusted assets) ....   423,693    6.83    186,107   3.00        310,178    5.00          
         Tangible capital                                                                                
           (to adjusted assets) ....   423,693    6.83     93,053   1.50           --         - (1)      
         Tier I capital                                                                                  
           (to risk-weighted assets)   423,693   12.00       --        - (1)    211,917    6.00          
     ==============================================================================================
     1997                                                                                                
         Risk-based capital                                                                              
           (to risk-weighted assets)  $413,392   12.64%  $261,567   8.00%      $326,959   10.00%         
         Core capital                                                                                    
           (to adjusted assets) ....   381,679    6.61    173,229   3.00        288,715    5.00          
         Tangible capital                                                                                
           (to adjusted assets) ....   381,679    6.61     86,614   1.50           --         - (1)      
         Tier I capital                                                                                  
           (to risk-weighted assets)   381,679   11.67       --        - (1)    196,175    6.00          
     ==============================================================================================
<FN>                                                                                    
     (1)  Ratio is not specified under capital regulations.
</FN>
</TABLE>

     Capital Distributions

     The OTS rules impose certain  limitations  regarding stock  repurchases and
     redemptions,  cash-out mergers and any other distributions  charged against
     an institution's capital accounts.  The payment of dividends by the Bank is
     subject to OTS regulations.  Safe-harbor  amounts of capital  distributions
     can be made after  providing  notice to the OTS, but without  needing prior
     approval.  For  institutions,  such as the Bank,  that meet  their  capital
     requirements,  the  safe-harbor  amount  is the  greater  of (a) 75% of net
     income  for the  prior  four  quarters,  or (b) the sum of (1) the  current
     year's  net  income  and (2) the  amount  that  causes  the  excess  of the
     institution's  total  capital-to-risk  weighted  assets ratio over 8% to be
     only one-half of such excess at the beginning of the year. Institutions can
     distribute amounts in excess of the safe-harbor amounts only with the prior
     approval of the OTS.

     As of December  31, 1998,  the Bank had the  capacity to declare  dividends
     totaling $88 million under the safe-harbor limitations.


                                       84
<PAGE>



     Stock Dividend

     On April 22,  1998,  the Board of Directors  declared a five percent  stock
     dividend on Downey's  common stock payable on May 22, 1998 to  stockholders
     of record on May 7, 1998.  The stock  dividend  resulted in the issuance of
     1,337,271  shares and the par value of the common stock  remained at $0.01.
     Accordingly,   $13,000  and  $45,702,000  were  transferred  from  retained
     earnings to common stock and additional paid-in-capital,  respectively. All
     share and per share data,  including  stock option plan  information,  have
     been restated to reflect this distribution.

     Employee Stock Option Plans

     During  1994,  the Bank  adopted and the  stockholders  approved the Downey
     Savings and Loan  Association  1994 Long Term  Incentive Plan (the "LTIP").
     The LTIP 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 the Bank's common stock available for issuance under the LTIP. Effective
     January 23, 1995, Downey Financial Corp. and the Bank executed an amendment
     to the LTIP by which Downey  Financial Corp.  adopted and ratified the LTIP
     such that shares of Downey Financial Corp. shall be issued upon exercise of
     options  or  payment of other  awards,  for which  payment is to be made in
     stock, in lieu of the Bank's common stock.

     During 1998,  options to purchase  120,335  shares were  granted  under the
     LTIP, while in 1997 no options were granted.

     Options  outstanding  under  the  LTIP at  December  31,  1998 and 1997 are
     summarized as follows:

<TABLE>
<CAPTION>
                                                     Outstanding Options
                                                    --------------------
                                                      Number     Average
                                                        of       Option
                                                      Shares      Price
     -------------------------------------------------------------------
<S>                                                 <C>           <C>    
     December 31, 1995 ...........................   360,523      $12.74  
     Options granted .............................    16,538       15.42  
     Options canceled and exercised ..............   (33,902)      13.23  
     -------------------------------------------------------------------
     December 31, 1996 ...........................   343,159       12.82  
     Options granted .............................      --             - 
     Options canceled and exercised ..............  (199,273)      12.40  
     -------------------------------------------------------------------
     December 31, 1997 ...........................   143,886       13.40  
     Options granted .............................   120,335       25.44  
     Options canceled and exercised ..............   (44,770)      13.28  
     -------------------------------------------------------------------
     December 31, 1998 ...........................   219,451      $20.03  
     ===================================================================
</TABLE>
     
     Under the LTIP,  options are exercisable over vesting periods  specified in
     each grant and, unless exercised, the options terminate between five or ten
     years from the date of the grant. Further, under the LTIP, the option price
     shall at least equal or exceed the fair market  value of such shares on the
     date the options are granted.

     At December 31, 1998, 78,439 options were exercisable at a weighted average
     option price per share of $13.26,  with 127,722 shares available for future
     grants under the LTIP. At December 31, 1997 and 1996,  exercisable  options
     of 76,692 and 146,768, respectively, were exercisable at a weighted average
     option price per share of $13.21 and $12.61, respectively.


                                       85
<PAGE>


     Downey measures its employee  stock-based  compensation  arrangements under
     the provisions of APB 25.  Accordingly,  no  compensation  expense has been
     recognized for the stock option plan. Had compensation expense for Downey's
     stock option plan been determined based on the fair value at the grant date
     for awards in 1998 and 1996, Downey's net income and income per share would
     have been reduced to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
     (In Thousands, Except Per Share Data)             1998      1997     1996
     ---------------------------------------------------------------------------
<S>                                                  <C>       <C>       <C>    
     Net income:
          As reported ............................   $57,973   $45,234   $20,704
          Pro forma ..............................    57,954    45,195    20,673
     Earnings per share - Basic:
          As reported ............................     $2.06     $1.61     $0.74
          Pro forma ..............................      2.06      1.61      0.74
     Earnings per share - Diluted:
          As reported ............................      2.05      1.61      0.74
          Pro forma ..............................      2.05      1.61      0.74
     ===========================================================================
</TABLE>

     The  weighted  average  fair value at date of grant of options  granted was
     $7.77 and $3.71 per option  during  1998 and 1996,  respectively.  The fair
     value of options  at date of grant was  estimated  using the  Black-Scholes
     model with the following weighted average assumptions:

<TABLE>
<CAPTION>
                                                      1998    1997 (1)    1996
     --------------------------------------------------------------------------
<S>                                                  <C>        <C>      <C> 
     Expected life (years) .......................    3.11       -        3.79
     Interest rate ...............................    4.65%      -%       6.08%
     Volatility ..................................   40.31       -       24.58
     Dividend yield ..............................    1.23       -        1.88
     ==========================================================================
<FN>
     (1)  No options were granted during the period.
</FN>
</TABLE>

(20) EARNINGS PER SHARE

     A  reconciliation  of the  components  used to  derive  basic  and  diluted
     earnings per share for 1998, 1997 and 1996 follows:

<TABLE>
<CAPTION>
                                                       Net    Weighted Average  Per-Share
     (Dollars in Thousands, Except Per Share Data)   Income  Shares Outstanding   Amount
     ------------------------------------------------------------------------------------
<S>                                                  <C>         <C>              <C>        
     1998:                                                                   
        Basic earnings per share .................   $57,973     28,111,855       $2.06      
        Effect of dilutive stock options .........      --           64,388        0.01      
     ------------------------------------------------------------------------------------
        Diluted earnings per share ...............   $57,973     28,176,243       $2.05      
     ====================================================================================
     1997:                                                                         
        Basic earnings per share .................   $45,234     28,076,556       $1.61      
        Effect of dilutive stock options .........      --           63,644           -     
     ------------------------------------------------------------------------------------
        Diluted earnings per share ...............   $45,234     28,140,200       $1.61      
     ====================================================================================
     1996:                                                                         
        Basic earnings per share .................   $20,704     28,068,104       $0.74      
        Effect of dilutive stock options .........      --           35,187           -     
     ------------------------------------------------------------------------------------
        Diluted earnings per share ...............   $20,704     28,103,291       $0.74      
     ====================================================================================
</TABLE>
                                                                              

                                       86
<PAGE>


(21) EMPLOYEE BENEFIT PLANS

     Retirement and Savings Plan

     In August 1993, Downey amended its profit sharing plan so that it qualifies
     as a profit  sharing and savings plan under Section  401(k) of the Internal
     Revenue Code ("the Plan"),  covering  substantially all salaried employees.
     Under the Plan,  employee  contributions  are partially  matched by Downey.
     Downey's  matching  contribution  is equal to 25% of an  employee's  pretax
     contributions which do not exceed 4% of the employee's annual compensation.
     In addition,  Downey makes an annual retirement  contribution  based on the
     employee's age and salary.  Downey's contributions to the Plan totaled $1.9
     million  for 1998,  compared  to $1.5  million in 1997 and $1.3  million in
     1996.

     During 1995, Downey approved the implementation of a Deferred  Compensation
     Plan for key management employees and directors.  The Deferred Compensation
     Plan  is  considered  to  be  an  essential   element  in  a  comprehensive
     competitive benefits package designed to attract and retain individuals who
     contribute  to the success of Downey.  Participants  are  eligible to defer
     compensation  on a  pre-tax  basis,  including  director  fees,  and earn a
     competitive interest rate on the amounts deferred. Currently, 82 management
     employees  and six directors  are eligible to  participate  in the program.
     During 1998,  17  management  employees  and one director  elected to defer
     compensation pursuant to the plan. Downey's expense related to the Deferred
     Compensation  Plan  has  been  less  than  $0.1  million  each  year  since
     inception.

     Group Benefit Plan

     Downey provides  certain health and welfare  benefits for active  employees
     under a cafeteria  plan ("the  Benefit  Plan") as defined by section 125 of
     the  Internal  Revenue  Code.  Under  the  Benefit  Plan,   employees  make
     appropriate  selections  as to the  type  of  benefits  and the  amount  of
     coverage desired. The benefits are provided through insurance companies and
     other health  organizations  and are funded by  contributions  from Downey,
     employees and retirees and include deductibles, co-insurance provisions and
     other  limitations.  Downey's  expense for health and welfare  benefits was
     $3.1  million,  $2.5  million  and $3.1  million  in 1998,  1997 and  1996,
     respectively.

(22) COMMITMENTS AND CONTINGENCIES

     Litigation

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

     Financial Instruments With Off-balance-sheet Risk

     Downey is a party to 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,  letters  of  credit,  lines of credit  and loans in
     process.  The contract or notional amounts of those instruments reflect the
     extent  of  involvement  Downey  has in  particular  classes  of  financial
     instruments.

     Downey uses the same credit  policies in making  commitments  to  originate
     loans,   lines  of   credit   and   letters   of  credit  as  it  does  for
     on-balance-sheet  instruments.  For  commitments  to  originate  fixed rate
     loans,  the  contract  amounts  represent  exposure  to  loss  from  market
     fluctuations as well as credit loss. Downey controls the credit risk of its
     commitments to originate fixed rate loans through credit approvals,  limits
     and monitoring procedures.


                                       87
<PAGE>


     The following is a summary of commitments and contingent liabilities:

<TABLE>
<CAPTION>
                                                                         December 31,
                                                                      ------------------
     (In Thousands)                                                     1998      1997
     -----------------------------------------------------------------------------------
<S>                                                                   <C>       <C>         
     Commitments to originate loans and mortgage-backed securities:
         Adjustable ................................................  $390,556  $ 90,136    
         Fixed .....................................................   550,339    35,225    
     Commitments to sell loans and mortgage-backed securities ......   621,753    50,893    
     Commitments to purchase mortgage-backed securities ............    34,000     7,600    
     Undisbursed loan funds and unused lines of credit .............   169,738   126,135    
     Standby letters of credit and other contingent liabilities ....     3,851     3,080    
     ===================================================================================
</TABLE>
     
     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 contract.  Commitments  generally have fixed
     expiration dates or other termination  clauses and may require payment of a
     fee. Since some of the commitments may 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.  Downey  evaluates each customer's
     creditworthiness on a case-by-case basis. Undisbursed loan funds and unused
     lines  of  credit  include  home  equity  lines of  credit  and  funds  not
     disbursed,  but committed to  construction  and  commercial  lending by the
     Bank.

     Standby letters of credit are conditional commitments issued by the Bank to
     guarantee the performance of a customer to a third party.

     Downey receives  collateral to support  commitments for which collateral is
     deemed  necessary.  The most significant  categories of collateral  include
     real  estate  properties  underlying  mortgage  loans,  liens  on  personal
     property, and cash on deposit with Downey. At December 31, 1998, the extent
     of  collateral  supporting  mortgage and other loans varied from nothing to
     100% of the maximum credit exposure.

     In connection with its interest rate risk management,  Downey  occasionally
     enters into interest  rate  exchange  agreements  ("swap  contracts")  with
     certain national  investment  banking firms under terms that provide mutual
     payment of interest on the  outstanding  notional  amount of the swap.  The
     effect of these swaps serve to reduce  Downey's  interest rate risk between
     repricing assets and  liabilities.  At December 31, 1998, no swap contracts
     were outstanding.

(23) RISK MANAGEMENT

     Derivative  financial  instruments  are  utilized to minimize the effect of
     future  fluctuations  in interest rates as part of its secondary  marketing
     activities.  Downey utilizes  forward sale and purchase  contracts to hedge
     the value of loans  originated for sale against adverse changes in interest
     rates. At December 31, 1998, such sales and purchase  contracts amounted to
     $622 million and $34 million, respectively.


                                       88
<PAGE>


(24) FAIR VALUE OF FINANCIAL INSTRUMENTS

     Fair  value  estimates  are made at a  specific  point in time  based  upon
     relevant  market  information  and other  information  about the  financial
     instrument. The estimates do not necessarily reflect the price Downey might
     receive if it were to sell at one time its entire  holding of a  particular
     financial  instrument.  Because no active  market  exists for a significant
     portion of Downey's financial  instruments,  fair value estimates are based
     upon the following methods and assumptions, some of which are subjective in
     nature. Changes in assumptions could significantly affect the estimates.

     Cash, Federal Funds Sold, and Securities Purchased Under Resale Agreements

     The  carrying  amounts  reported  in the  balance  sheet  for  these  items
     approximate fair value.

     Investment   Securities   Including  U.S.  Treasuries  and  Mortgage-backed
     Securities

     Fair value is based upon bid prices  published in financial  newspapers  or
     bid quotations received from securities dealers.

     Loans Receivable

     For residential  mortgage loans,  fair value is estimated based upon market
     prices obtained from readily available market quote systems.  The remaining
     portfolio was  segregated  into those loans with variable rates of interest
     and those with fixed rates of interest.  For non-residential  variable rate
     loans which reprice  frequently,  fair values approximate  carrying values.
     For non-residential  fixed rate loans, fair values are based on discounting
     future contractual cash flows using the current rate offered for such loans
     with  similar  remaining   maturities  and  credit  risk.  The  amounts  so
     determined  for  each  category  of  loan  are  reduced  by the  associated
     allowance for loan losses which thereby takes into consideration changes in
     credit risk.

     Interest-bearing Advances to Joint Ventures

     The carrying amounts approximate fair value as the interest earned is based
     upon a variable rate.

     Mortgage Servicing Rights

     The fair value of MSRs related to loans  serviced for others is  determined
     by computing the present  value of the expected net  servicing  income from
     the portfolio.

     Deposits

     The fair value of deposits with no stated maturity such as regular passbook
     accounts,  money market accounts,  and checking  accounts,  is the carrying
     amount  reported in the balance  sheet.  The fair value of deposits  with a
     stated  maturity such as  certificates  of deposit is based on  discounting
     future contractual cash flows by the current rate offered for such deposits
     with similar remaining maturities.

     Borrowings

     For short-term borrowings, fair value approximates carrying value. The fair
     value  of   long-term   borrowings   is  based  on  their   interest   rate
     characteristics.  For variable  rate  borrowings,  fair values  approximate
     carrying  values.  For  fixed  rate  borrowings,  fair  value  is  based on
     discounting  future contractual cash flows by the current rate paid on such
     borrowings with similar remaining maturities.


                                       89
<PAGE>


     Off-balance-sheet Financial Instruments

     Outstanding  commitments  to sell  loans  and  mortgage-backed  securities,
     commitments  to purchase  mortgage-backed  securities,  standby  letters of
     credit  and  other   contingent   liabilities,   unused  lines  of  credit,
     commitments  to  originate   loans  and   mortgage-backed   securities  are
     essentially  carried at zero which  approximates fair value. See Note 22 on
     page 87, for  information  concerning the notional amount of such financial
     instruments.

     Based on the above methods and  assumptions,  the following  table presents
     the estimated fair value of Downey's financial instruments:

<TABLE>
<CAPTION>
                                                                             December 31,1998        December 31,1997
                                                                          ----------------------------------------------
                                                                           Carrying    Estimated   Carrying    Estimated
     (In Thousands)                                                       Amount (1)  Fair Value  Amount (1)  Fair Value
     -------------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>         <C>         <C>         <C>       
     ASSETS:
     Cash ..............................................................  $   58,510  $   58,510  $   48,823  $   48,823     
     Federal funds .....................................................      33,751      33,751       6,095       6,095     
     U.S. Government and agency obligations and other                                                                        
         investment securities available for sale ......................     116,061     116,061     159,398     159,398     
     Municipal securities held to maturity .............................       6,764       6,745       6,885       6,865     
     Loans held for sale ...............................................     447,382     447,468      35,100      35,395     
     Mortgage-backed securities available for sale .....................      32,146      32,146      49,299      49,348     
     Loans receivable held for investment: Loans secured by real estate:                                                     
           Residential:                                                                                                      
             Adjustable ................................................   4,333,023   4,474,114   4,463,525   4,501,037     
             Fixed .....................................................     356,209     368,737     180,581     185,348     
           Other .......................................................     207,728     210,172     238,215     237,429     
         Non-mortgage loans:                                                                                                 
           Commercial ..................................................      19,154      19,154      17,343      17,343     
           Consumer ....................................................     392,723     396,421     382,333     386,070     
     Interest-bearing advances to joint ventures .......................      25,540      25,540      32,122      32,122     
     MSRs and loan servicing portfolio .................................       7,793      11,976       1,955       7,584     
                                                                                                                          
     LIABILITIES:                                                                                                            
     Deposits:                                                                                                               
         Transaction accounts ..........................................   1,238,062   1,238,062     935,869     935,869     
         Certificates of deposit .......................................   3,801,671   3,804,269   3,934,109   3,947,913     
     Borrowings ........................................................     703,720     709,223     483,735     485,558     
     =================================================================================================================== 
<FN> 
     (1)  The carrying amount of loans is stated net of undisbursed  loan funds,
          unearned fees and discounts and allowances for losses.
</FN>
</TABLE>


                                       90
<PAGE>


(25) BUSINESS SEGMENT REPORTING

     Downey  views  its  business  as  consisting  of  two  reportable  business
     segments--banking  and real estate investment.  The accounting  policies of
     the  segments  are the  same as  those  described  in  Note 1,  Summary  of
     Significant  Accounting  Policies on page 61. Downey evaluates  performance
     based  on the net  income  generated  by  each  segment.  Internal  expense
     allocations  between  segments  are  independently  negotiated  and,  where
     possible,  service  and  price  is  measured  against  comparable  services
     available in the external marketplace.

     The following describes the two business segments.

     Banking

     The principal business activities of this segment are attracting funds from
     the general  public and  institutions,  and  originating  and  investing in
     loans,  primarily  residential real estate mortgage loans,  mortgage-backed
     securities, and investment securities.

     This segment's  primary  sources of revenue are interest earned on mortgage
     loans and mortgage-backed  securities,  income from investment  securities,
     gains on sales of loans  and  mortgage-backed  securities,  fees  earned in
     connection  with loans and deposits and income  earned on its  portfolio of
     loans and mortgage-backed securities serviced for investors.

     This segment's principal expenses are interest incurred on interest-bearing
     liabilities,   including   deposits   and   borrowings,   and  general  and
     administrative costs.

     Real Estate Investment

     Real  estate   development  and  joint  venture  operations  are  conducted
     principally through the Bank's wholly owned service corporation subsidiary,
     DSL Service Company. However, Downey Financial Corp. owns one investment in
     land which it purchased from DSL Service Company at fair value in 1995.

     DSL Service Company participates as an owner of, or a partner in, a variety
     of  real  estate  development  projects,  principally  retail  neighborhood
     shopping center developments, most of which are located in California. Most
     of the  real  estate  development  projects  have  been  completed  and are
     substantially leased.

     In its joint  ventures,  DSL Service Company is entitled to interest on its
     equity invested in the project on a priority basis after  third-party debt,
     and shares profits and losses with the developer  partner,  generally on an
     equal basis.  Partnership equity (deficit) accounts are affected by current
     period  results of operations,  additional  partner  advances,  partnership
     distributions and partnership liquidations.

     This segment's  primary  sources of revenue are net rental income and gains
     from the sale of real estate investment  assets.  This segment's  principal
     expenses are interest expense and general and administrative expense.


                                       91
<PAGE>



     Operating Results and Assets

     The following presents the operating results and selected financial data by
     major business segments for 1998, 1997 and 1996:

<TABLE>
<CAPTION>
                                                         Real Estate
     (In Thousands)                            Banking    Investment Elimination    Totals
     ---------------------------------------------------------------------------------------
<S>                                          <C>           <C>        <C>         <C>         
     YEAR ENDED DECEMBER 31 1998:
     Net interest income (expense) .......   $  174,967    $  (620)   $   --      $  174,347  
     Provision (reduction) for loan losses        3,918        (19)       --           3,899  
     Other income ........................       24,617     22,736        --          47,353  
     Operating expense ...................      113,954      2,706        --         116,660  
     Net intercompany income (expense) ...         (107)       107        --            --    
     ---------------------------------------------------------------------------------------
     Income before income tax expense ....       81,605     19,536        --         101,141  
     Income tax expense ..................       34,869      8,299        --          43,168  
     ---------------------------------------------------------------------------------------
         Net income ......................   $   46,736    $11,237    $   --      $   57,973  
     =======================================================================================
     ASSETS AT DECEMBER 31 1998:                                                              
         Loans ...........................   $5,788,365    $  --      $   --      $5,788,365  
         Real estate held for investment .         --       49,447        --          49,447  
         Other ...........................      463,960     11,224     (42,577)      432,607  
     ---------------------------------------------------------------------------------------
            Total assets .................    6,252,325     60,671     (42,577)    6,270,419
     ---------------------------------------------------------------------------------------
     Equity ..............................   $  480,566    $42,577    $(42,577)   $  480,566  
     =======================================================================================
     YEAR ENDED DECEMBER 31 1997:                                                             
     Net interest income (expense) .......   $  154,799    $  (641)   $   --      $  154,158  
     Provision for loan losses ...........        8,522        118        --           8,640  
     Other income ........................       20,783     14,405        --          35,188  
     Operating expense ...................       98,803      2,469        --         101,272  
     Net intercompany income (expense) ...         (357)       357        --            --    
     ---------------------------------------------------------------------------------------
     Income before income tax expense ....       67,900     11,534        --          79,434  
     Income tax expense ..................       29,238      4,962        --          34,200  
     ---------------------------------------------------------------------------------------
         Net income ......................   $   38,662    $ 6,572    $   --      $   45,234  
     =======================================================================================
     ASSETS AT DECEMBER 31 1997:                                                              
         Loans ...........................   $5,366,396    $  --      $   --      $5,366,396  
         Real estate held for investment .         --       41,356        --          41,356  
         Other ...........................      449,174     14,455     (35,556)      428,073  
     ---------------------------------------------------------------------------------------
            Total assets .................    5,815,570     55,811     (35,556)    5,835,825  
     ---------------------------------------------------------------------------------------
     Equity ..............................   $  430,346    $35,556    $(35,556)   $  430,346  
     =======================================================================================
     YEAR ENDED DECEMBER 31 1996:                                                             
     Net interest income (expense) .......   $  134,808    $  (213)   $   --      $  134,595  
     Provision for loan losses ...........        9,026        111        --           9,137  
     Other income ........................       16,956      8,243        --          25,199  
     Operating expense ...................       87,275      2,284        --          89,559  
     SAIF special assessment .............       24,644       --          --          24,644  
     Net intercompany income (expense) ...         (574)       574        --            --    
     ---------------------------------------------------------------------------------------
     Income before income tax expense ....       30,245      6,209        --          36,454  
     Income tax expense ..................       13,054      2,696        --          15,750  
     ---------------------------------------------------------------------------------------
         Net income ......................   $   17,191    $ 3,513    $   --      $   20,704  
     =======================================================================================
     ASSETS AT DECEMBER 31 1996:                                                              
         Loans ...........................   $4,729,846    $  --      $   --      $4,729,846  
         Real estate held for investment .         --       46,498        --          46,498  
         Other ...........................      446,975     14,514     (39,676)      421,813  
     ---------------------------------------------------------------------------------------
            Total assets .................    5,176,821     61,012     (39,676)    5,198,157  
     ---------------------------------------------------------------------------------------
     Equity ..............................   $  391,571    $39,676    $(39,676)   $  391,571  
     =======================================================================================
</TABLE>
     

                                       92
<PAGE>


(26) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

     Selected  quarterly  financial data are presented  below by quarter for the
     years ended December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                           December 31,  September 30,   June 30,     March 31,
     (In Thousands, Except Per Share Data)                     1998          1998          1998         1998
     ----------------------------------------------------------------------------------------------------------
<S>                                                          <C>           <C>           <C>           <C>      
     Total interest income ................................  $111,902      $108,982      $109,797      $109,723 
     Total interest expense ...............................    66,158        66,195        66,607        67,097 
     ----------------------------------------------------------------------------------------------------------
        Net interest income ...............................    45,744        42,787        43,190        42,626 
     Provision for loan losses ............................     1,180           985         1,462           272 
     ----------------------------------------------------------------------------------------------------------
        Net interest income after provision for loan losses    44,564        41,802        41,728        42,354 
     Total other income ...................................    10,806         9,672        11,949        14,926 
     Total operating expense ..............................    33,834        28,949        27,280        26,597 
     ----------------------------------------------------------------------------------------------------------
     Income before income taxes ...........................    21,536        22,525        26,397        30,683 
     Income  taxes ........................................     8,884         9,757        11,409        13,118 
     ----------------------------------------------------------------------------------------------------------
     Net income ...........................................  $ 12,652      $ 12,768      $ 14,988      $ 17,565 
     ==========================================================================================================
     Net income per share:                                                                                      
        Basic .............................................  $   0.45      $   0.45      $   0.53      $   0.63 
        Diluted ...........................................  $   0.45      $   0.45      $   0.53      $   0.62 
     ========================================================================================================== 
     Market range:                                                                                              
        High bid ..........................................  $  26.38      $  35.00      $  34.50      $  30.95 
        Low bid ...........................................     17.75         23.06         30.83         23.58 
        End of period .....................................     25.44         23.81         32.69         30.83 
     ==========================================================================================================
</TABLE>

<TABLE>
<CAPTION>
                                                           December 31,  September 30,   June 30,     March 31,
                                                               1997          1997          1997         1997
     ----------------------------------------------------------------------------------------------------------
<S>                                                          <C>           <C>           <C>            <C>      
     Total interest income ................................  $110,457      $109,101      $103,276       $97,584  
     Total interest expense ...............................    69,254        71,547        65,993        59,466  
     ----------------------------------------------------------------------------------------------------------
        Net interest income ...............................    41,203        37,554        37,283        38,118  
     Provision for loan losses ............................     3,034         1,578         1,873         2,155  
     ----------------------------------------------------------------------------------------------------------
        Net interest income after provision for loan losses    38,169        35,976        35,410        35,963  
     Total other income ...................................    10,826         8,018         5,353        10,991  
     Total operating expense ..............................    24,339        25,477        26,280        25,176  
     ----------------------------------------------------------------------------------------------------------
     Income before income taxes ...........................    24,656        18,517        14,483        21,778  
     Income taxes .........................................    10,619         7,960         6,173         9,448  
     ----------------------------------------------------------------------------------------------------------
     Net income ...........................................  $ 14,037      $ 10,557      $  8,310       $12,330  
     ==========================================================================================================
     Net income per share:                                                                                       
        Basic .............................................  $   0.50      $   0.37      $   0.30       $  0.44  
        Diluted ...........................................  $   0.50      $   0.37      $   0.30       $  0.44  
     ==========================================================================================================
     Market range:                                                                                               
        High bid ..........................................  $  27.63      $  23.33      $  22.50       $ 21.42  
        Low bid ...........................................     23.03         20.47         17.23         17.23  
        End of period .....................................     27.08         23.22         22.50         18.38  
     ==========================================================================================================
</TABLE>


                                       93
<PAGE>


(27) PARENT COMPANY FINANCIAL INFORMATION

     Downey Financial Corp. was incorporated in Delaware on October 21, 1994. On
     January 23, 1995,  after  obtaining  necessary  stockholder  and regulatory
     approvals,   Downey  Financial  Corp.  acquired  100%  of  the  issued  and
     outstanding  capital stock of the Bank, and the Bank's  stockholders became
     stockholders of Downey Financial Corp. The transaction was accounted for in
     a  manner  similar  to  a  pooling-of-interests  under  generally  accepted
     accounting  principles.  Downey Financial Corp. was thereafter  funded by a
     $15 million  dividend  from the Bank.  Condensed  financial  statements  of
     Downey Financial Corp. only are as follows:

     Condensed Balance Sheets

<TABLE>
<CAPTION>
                                                December 31,
                                            --------------------
     (In Thousands)                           1998        1997
     -----------------------------------------------------------
<S>                                         <C>         <C>            
     ASSETS
     Cash ................................  $      5    $     11       
     Due from Bank - interest bearing ....     8,521       6,635       
     Investment in subsidiaries:                                       
        Bank .............................   470,504     421,230       
        Downey Affiliated Insurance Agency       213         182       
     Real estate held for investment .....       458         551       
     Other assets ........................     1,124       1,862       
     -----------------------------------------------------------
                                            $480,825    $430,471       
     ===========================================================
     LIABILITIES AND STOCKHOLDERS' EQUITY                              
     Accounts payable and accrued expenses  $    259    $    125       
     -----------------------------------------------------------
        Total liabilities ................       259         125       
     -----------------------------------------------------------
     Stockholders' equity ................   480,566     430,346       
     -----------------------------------------------------------
                                            $480,825    $430,471       
     ===========================================================
</TABLE>
                                                    

                                       94
<PAGE>


     Condensed Statements of Income
     and Other Comprehensive Income

<TABLE>
<CAPTION>
                                                                            Years Ended December 31,
                                                                         ------------------------------
     (In Thousands)                                                        1998       1997       1996
     --------------------------------------------------------------------------------------------------
<S>                                                                      <C>        <C>        <C>      
     INCOME:
        Dividends from the Bank .......................................  $ 9,537    $ 8,891    $ 8,406  
        Interest income ...............................................      374        380        382  
        Other income ..................................................       60         57         82  
     --------------------------------------------------------------------------------------------------
           Total income ...............................................    9,971      9,328      8,870  
     --------------------------------------------------------------------------------------------------
     EXPENSE:                                                                                           
        Provision for losses on real estate ...........................       24        153       --    
        General and administrative expense ............................      793        805        883  
     --------------------------------------------------------------------------------------------------
           Total expense ..............................................      817        958        883  
     --------------------------------------------------------------------------------------------------
     INCOME BEFORE INCOME TAXES AND EQUITY IN UNDISTRIBUTED                                             
        NET INCOME OF SUBSIDIARIES ....................................    9,154      8,370      7,987  
     Income tax benefit ...............................................      157        215        168  
     --------------------------------------------------------------------------------------------------
     INCOME BEFORE EQUITY IN UNDISTRIBUTED NET INCOME                                                   
        OF SUBSIDIARIES ...............................................    9,311      8,585      8,155  
     Equity in undistributed net income of subsidiaries ...............   48,662     36,649     12,549  
     --------------------------------------------------------------------------------------------------
        NET INCOME ....................................................   57,973     45,234     20,704  
                                                                                                        
     OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAXES:                                            
        Unrealized gains (losses) on securities available for sale:                                     
           U.S. Treasury and agency obligations and other investment                                    
             securities available for sale, at fair value .............    1,104      1,331     (2,160) 
           Less reclassification of realized gains net of losses                                        
             included in income .......................................      (39)      --       (2,550) 
           Mortgage-backed securities available for sale, at fair value     (422)       338       (344) 
     --------------------------------------------------------------------------------------------------
        Other comprehensive income (loss) .............................      643      1,669     (5,054) 
     --------------------------------------------------------------------------------------------------
        COMPREHENSIVE INCOME ..........................................  $58,616    $46,903    $15,650  
     ==================================================================================================
</TABLE>


                                       95
<PAGE>


     Condensed Statements of Cash Flows
<TABLE>
<CAPTION>
                                                                            Years Ended December 31,
                                                                        -------------------------------
     (In Thousands)                                                        1998       1997      1996
     --------------------------------------------------------------------------------------------------
<S>                                                                     <C>        <C>        <C>           
     CASH FLOWS FROM OPERATING ACTIVITIES:
        Net income ...................................................  $ 57,973   $ 45,234   $ 20,704      
        Equity in undistributed net income of subsidiaries ...........   (48,662)   (36,649)   (12,549)     
        Provision for losses on real estate ..........................        24        153       --        
        Increase (decrease) in liabilities ...........................       134          7        (69)     
        Other, net ...................................................       807     (1,304)      (296)     
     --------------------------------------------------------------------------------------------------
           Net cash provided by operating activities .................    10,276      7,441      7,790      
     --------------------------------------------------------------------------------------------------
     CASH FLOWS FROM INVESTING ACTIVITIES:                                                           
        (Increase) decrease in due from Bank - interest bearing ......    (1,886)       698        346      
     --------------------------------------------------------------------------------------------------
           Net cash provided by (used for) investing activities ......    (1,886)       698        346      
     --------------------------------------------------------------------------------------------------
     CASH FLOWS FROM FINANCING ACTIVITIES:                                                           
        Exercise of stock options ....................................       510        335       --        
        Dividends on common stock ....................................    (8,889)    (8,454)    (8,147)     
        Other ........................................................       (17)        (9)        (4)     
     --------------------------------------------------------------------------------------------------
           Net cash used for financing activities ....................    (8,396)    (8,128)    (8,151)     
     --------------------------------------------------------------------------------------------------
     Net increase (decrease) in cash and cash equivalents ............        (6)        11        (15)     
     Cash and cash equivalents at beginning of year ..................        11       --           15      
     --------------------------------------------------------------------------------------------------
     CASH AND CASH EQUIVALENTS AT END OF PERIOD ......................  $      5   $     11   $   -- 
     ==================================================================================================
</TABLE>
     

                                       96
<PAGE>


ITEM 9.  CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
         FINANCIAL DISCLOSURES

None.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Downey  Financial  Corp.  intends  to file  with  the  Securities  and  Exchange
Commission a definitive  proxy  statement  (the "Proxy  Statement")  pursuant to
Regulation 14A, which will involve the election of directors, within 120 days of
the end of the year covered by this Form 10-K.  Information  regarding directors
of Downey Financial Corp. will appear under the caption  "Election of Directors"
in the Proxy  Statement  for the Annual  Meeting of  Stockholders  to be held on
April 28, 1999, and is incorporated herein by reference.  Information  regarding
executive  officers of Downey  Financial  Corp.  will  appear  under the caption
"Executive  Officers" in the Proxy Statement and is incorporated  herein by this
reference.

ITEM 11. EXECUTIVE COMPENSATION

Information  regarding  executive  compensation  will  appear  under the caption
"Executive  Compensation"  in the Proxy Statement and is incorporated  herein by
this reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information to be included under the captions  "Securities  Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement is incorporated  herein
by this reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information to be included under the caption "Certain  Relationships and Related
Transactions" in the Proxy Statement is incorporated herein by this reference.

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)  1.  Financial  Statements.  These  documents  are  listed  in the  Index to
         Consolidated Financial Statements under Item 8.

     2.  Financial Statement Schedules.  Financial Statement Schedules have been
         omitted because they are not  applicable or the required information is
         shown in the Consolidated Financial Statements or Notes thereto.

(b)  Reports on Form 8-K during the last quarter of 1998.

         The Registrant  filed  with the Commission two Current  Reports on Form
         8-K,  the  first  dated  November  20,  1998,  with  respect  to senior
         management   transition  and  the  second   dated  December  17,  1998,
         announcing a new director.


                                       97
<PAGE>


(c)  Exhibits.

     EXHIBIT
     NUMBER                              DESCRIPTION

     3.1  (1) Certificate of Incorporation of Downey Financial Corp.
     3.3  (2) Bylaws of Downey Financial Corp.
     10.1 (3) Downey Savings and Loan Association,  F.A. Employee Stock Purchase
              Plan (Amended and Restated as of January 1, 1996).
     10.2 (3) Amendment  No.  1,  Downey  Savings  and  Loan  Association,  F.A.
              Employee  Stock  Purchase  Plan.  Amendment  No. 1, Effective  and
              Adopted January 22, 1997.
     10.3 (3) Downey Savings and Loan Association,  F.A.  Employees'  Retirement
              and Savings Plan (October 1, 1997 Restatement).
     10.4 (3) Amendment  No.  1,  Downey  Savings  and  Loan  Association,  F.A.
              Employees'   Retirement   and   Savings   Plan  (October  1,  1997
              Restatement) Amendment No. 1, Effective and  Adopted  January  28,
              1998.
     10.5 (3) Trust  Agreement for  Downey  Savings and Loan  Association,  F.A.
              Employees'  Retirement  and  Savings  Plan,  Effective  October 1,
              1997  between  Downey  Savings  and  Loan  Association,  F.A.  and
              Fidelity Management Trust Company.
     10.6 (1) Downey Savings and Loan Association 1994 Long-Term  Incentive Plan
              (as amended).
     10.7 (2) Asset  Purchase  Agreement  among  Butterfield  Savings  and  Loan
              Association, FSA, Mortgage Investment, Inc.,  Property  Management
              Service, Inc. and Butterfield Capital Corporation, dated September
              1, 1988.
     10.8 (2) Assistance  Agreement  between and  among the Federal  Savings and
              Loan   Insurance   Corporation,   Butterfield   Savings  and  Loan
              Association,  FSA and  Downey Savings and Loan Association,  dated
              September  29,  1988  (confidential  treatment  requested  due  to
              contractual prohibition against disclosure).
     10.9 (2) Merger of  Butterfield  Savings and Loan  Association,  FSA,  into
              Downey Savings and Loan Association, dated September 29, 1989.
     10.10(2) Founder  Retirement  Agreement  of   Maurice L.  McAlister,  dated
              December 21, 1989.
     10.11(2) Founder   Retirement  Agreement  of  Gerald  H.  McQuarrie,  dated
              December 21, 1989.
     10.12    Employment Agreement of James W. Lokey dated February 6, 1998.
     10.13    Severance Agreement and General  Release,  dated November 20, 1998
              by  and  among,  Downey  Financial  Corp.  Downey Savings and Loan
              Association, F.A., and James W. Lokey.
     22.  (2) Subsidiaries.
     23.1     Consent of Independent Auditors.
     27       Financial Data Schedule.

(1)  Filed as part of Downey's report on Form S-8 filed February 3, 1995.
(2)  Filed as part of Downey's report on Form 8-B/A filed January 17, 1995.
(3)  Filed as part of Downey's report on Form 10-K filed March 14, 1997.

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

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


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<PAGE>


                                   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.



                                By:    /s/ DANIEL D. ROSENTHAL              
                                       ------------------------------
                                           Daniel D. Rosenthal
                                President and Chief Executive Officer
                                              Director

DATED:  March 16, 1999

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  Registrant and
in the capacities and on the dates indicated.

        Signature                    Title                        Date
        ---------                    -----                        ----  
/s/ MAURICE L. McALISTER     Chairman of the Board            March 16, 1999
------------------------            Director
    Maurice L. McAlister                                                       

/s/ CHERYL E. OLSON        Vice Chairman of the Board         March 16, 1999
------------------------            Director
    Cheryl E. Olson                                           

/s/ DANIEL D. ROSENTHAL          President and                March 16, 1999
------------------------     Chief Executive Officer
    Daniel D. Rosenthal             Director                  
                                                   

/s/ THOMAS E. PRINCE        Executive Vice President,         March 16, 1999
-----------------------      Chief Financial Officer
    Thomas E. Prince        (Principal Financial and          
                               Accounting Officer)                 
                                                                    
                             
/s/ BRENT MCQUARRIE                 Director                  March 16, 1999
-----------------------
    Brent McQuarrie                                           

/s/ DR. PAUL KOURI                  Director                  March 16, 1999
-----------------------
    Dr. Paul Kouri     

/s/ LESTER C. SMULL                 Director                  March 16, 1999
-----------------------
    Lester C. Smull                                

/s/ SAM YELLEN                      Director                  March 16, 1999
-----------------------
    Sam Yellen                                   


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