10-K 1 pacificsecurity-10k.txt ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-k (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended July 31, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission file number 0-6673 PACIFIC SECURITY FINANCIAL, INC. -------------------------------- (Exact name of registrant as specified in its charter) Washington 91-0669906 ---------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation of organization) Identification No.) 10 North Post Street Suite 325 Spokane, Washington 99201 ------------------- ----- (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (509) 444-7700 -------------- Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on which Title of each class registered ------------------- ---------- None None Securities registered pursuant to Section 12(g) of the Act: Common stock, no par value share -------------------------------- (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports, and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (ss.229.405 of this chapter) 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 the Form 10-K or any amendment to this Form 10-K. X Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 126-2 of the Act). Yes [ ] No [X] State the aggregate market value of the voting and nonvoting common equity held by nonaffiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed fiscal year. On July 31, 2003, the registrant had outstanding 1,080,357 shares of common stock, no par value ($3 stated value) and 3,000 shares of Class A preferred stock, $100 par value. Documents incorporated by reference: none. PACIFIC SECURITY FINANCIAL, INC. FORM 10-K ANNUAL REPORT Table of Contents

PACIFIC SECURITY FINANCIAL, INC. PART I -------------------------------------------------------------------------------- ITEM 1. BUSINESS Pacific Security Companies was merged into Security Savesco, Inc. as of May 31, 1985. The name of Security Savesco, Inc., the surviving corporation, was changed to Pacific Security Companies (the Company) as of the date of the merger. Pacific Security Companies changed its name to Pacific Security Financial, Inc. in 1999. Prior to the merger, both corporations were engaged principally in real estate contract financing and owning, leasing, and selling real properties. The merged corporation has continued these activities. Total assets of the Company at July 31, 2003 and 2002, were $23,221,818 and $44,451,625, respectively, and real estate contracts and loans represent approximately 28% and 57.1% of the respective asset totals. The Company primarily originates commercial loans. The Company also originates contracts to facilitate the sale of real estate held for sale or development. Some of the Company's contracts have fixed contractual interest rates while commercial (interim and construction) loans generally have variable rates. The total amount invested in real estate contracts and loans of $6,498,089 as of July 31, 2003, is $18,953,807 less than at the end of the prior year. The percentage of contracts which were delinquent over 90 days was 17.7% as of July 31, 2003, and 5.9% as of July 31, 2002. Management continues to emphasize enforcement of the Company's credit and collection policies. In fiscal 1998, the Company's newly-formed subsidiary, Cornerstone Realty Advisors, Inc. began making short-term construction and interim loans (generally one to two years including extensions). Bank lines of credit were increased to provide additional funds for this purpose. The permanent financing to payoff these short-term loans is typically obtained from the secondary market and includes such sources as banks, savings and loan institutions, life insurance companies, credit unions, and conduits. Cornerstone Realty Advisors, Inc. was administratively dissolved in 2002, and all aspects of the company's operation were merged into the parent. The Company has continued to emphasize the development of its rental properties and commenced new projects primarily to improve the occupancy of its commercial buildings. The Company has and continues to develop land for residential development, where the land was acquired through foreclosure. These properties will be liquidated and/or developed at such time as market conditions warrant, and in the judgment of management, when the Company can maximize its return. The Company has no commitments for additional construction on these properties at this time. The Company may continue to invest in and hold real property on a long-term basis. These properties may ultimately be sold or exchanged for tax purposes in order to minimize and defer the related income taxes and to conserve funds for additional investment purposes. These plans may be modified as the result of future changes to the Internal Revenue Code. 1 PACIFIC SECURITY FINANCIAL, INC. PART I -------------------------------------------------------------------------------- ITEM 1. BUSINESS (CONTINUED) Investment in rental properties totaled $10,701,055 and $12,811,852 as of July 31, 2003 and 2002, respectively. Other real property held for sale and development totaled $4,367,608 and $4,399,921 as of July 31, 2003 and 2002, respectively. In fiscal 2001, the Company began construction of a commercial building containing approximately 13,000 square feet of rentable space, identified as Cornerstone Office Building #2. During fiscal year 2003, the Company leased approximately 2,500 square feet. With the Company's sale of certain commercial real estate, rental income has decreased to $1,403,357 in fiscal 2003 from $1,533,476 in fiscal 2002 and $2,689,799 in fiscal 2001. During the same period, interest income, including loan fees has decreased to $1,337,848 in fiscal 2003 from $3,101,696 in fiscal 2002 and $3,981,137 in fiscal 2001. The Company expects to continue originating some construction and interim commercial real estate loans as well as the development, leasing, and sale of commercial real estate in fiscal 2004. However, there are no contractual commitments other than the remaining remodeling costs associated with improvement for commercial buildings. The Company's fiscal 2004 capital expenditures may increase if demand for the rental of Company properties continues or if the Company decides to further develop any of its properties held for sale. A description of the Company's significant properties is included in Item 2. Properties As stated above, the Company's business is concentrated in originating loans collateralized by real estate, financing real estate contracts, developing real estate for sale or lease (where the properties generally have been acquired through foreclosure), and the operation of rental properties. The Company is in competition with financial institutions that originate or invest in real estate collateralized contracts and commercial property owners located primarily in or near Spokane, Washington. The Company is not dependent upon a single borrower or tenant. However, at July 31, 2003, three individual borrowers represented approximately 42%, 19%, and 14% of the gross outstanding contracts, mortgages, finance notes, and loans receivable outstanding. For the year ended July 31, 2002, three individual borrowers represented 15%, 11%, and 12% of the gross outstanding contracts, mortgages, finance notes, and loans receivable outstanding. As of July 31, 2003, the Company employed six people on a full-time equivalent in its office at 10 North Post Street, Suite 325, Spokane, Washington 99201. 2 PACIFIC SECURITY FINANCIAL, INC. PART I -------------------------------------------------------------------------------- ITEM 1. BUSINESS (CONTINUED) The management of Pacific Security Financial has commenced with a plan of restructuring for the Company. The main elements of the restructuring include paying off bank lines of credit, reducing other secured and unsecured debt, securing a debenture bond permit allowing for the renewal of bonds to qualified investors, selling Company assets including loans and properties, reducing administrative costs primarily through reductions in personnel, pursuit of all legal remedies available to protect and/or recover the Company's investments, while simultaneously working to expand the Company's lending operations. The Company intends to register as a mortgage broker/dealer in the state of Washington. As such the Company will be engaged in originating and acquiring loans secured by mortgages, deeds of trust, and real estate contracts to be sold to investors meeting certain suitability requirements or retained by the Company for investment. The Company will generally sell undivided fractional interests in the same loan in incremental units to investors, and may also resell whole loans to investors. Because the Company cannot rely solely on revenues from operations to finance its business and to meet it debt obligations, the Company has historically raised a significant portion of its additional capital through the public sale of debt securities. Any material interruption or decrease in the amount of debt securities sold by the Company would make it necessary for the Company to reduce or curtail its operations unless alternative sources of financing were available. A similar impact would result if the Company were unable to spread its debt repayment obligations by selling a mixture of long-term and short-term securities. There can be no assurance that sufficient financing will continue to be available from the public sale of debt securities or that holders of the Company's maturing debt securities will continue to reinvest in the Company. While the Company has historically financed its investments primarily through collateralized lines of credit with local banks, management believes that it is unlikely that these lines of credit will be available to the Company in the foreseeable future. It may be necessary for the Company to sell a portion of its loan portfolio or other assets at a discount to meet operating costs, including principal and interest payments on outstanding obligations. The Company currently does not maintain a website. The Company's periodic and current reports are available on the Securities and Exchange Commission's (SEC) website as soon as practicable after such material is electronically filed with or furnished to the SEC. The SEC's website address is www.sec.com. 3 PACIFIC SECURITY FINANCIAL, INC. PART I -------------------------------------------------------------------------------- ITEM 2. PROPERTIES As of July 31, 2003, the Company owns the following properties. Some of the properties are subject to real estate contracts or mortgages that are collateralized by the property. Properties located in Spokane County, Washington, unless otherwise noted:

4 PACIFIC SECURITY FINANCIAL, INC. PART I -------------------------------------------------------------------------------- ITEM 2. PROPERTIES (CONTINUED)

--------------- (1) Total obligation of $1,383,962 is secured by two commercial buildings and land as noted above. (2) Additional obligation of $3,038,272 is secured by contract sale of Broadmoor Apartments and Pier 1 Building. 5 PACIFIC SECURITY FINANCIAL, INC. PART I -------------------------------------------------------------------------------- ITEM 3. LEGAL PROCEEDINGS As of July 31, 2003, it is the opinion of management that there is no pending litigation that would have a material adverse effect on the financial condition or operations of the registrant. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS A director, Constance Guthrie, was re-elected and John F. (Jack) Bury, a replacement for Wayne E. Guthrie, was elected to the Board of Directors at the annual meeting of shareholders on April 29, 2003. The following directors continued to serve after the annual meeting: David L. Guthrie, Kevin M. Guthrie, Donald J. Migliuri, Robert N. Codd, and Julian Guthrie. Moss Adams LLP was approved as the Company's outside independent auditor by a vote of the stockholders during the fourth quarter of fiscal 2003. 6 PACIFIC SECURITY FINANCIAL, INC. PART II -------------------------------------------------------------------------------- ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (a) Principle market. There is no established market for trading in the Company's common stock. Periodically, the Company will purchase and retire its common stock, but does not solicit such transactions. (b) Stock price and dividend information. There is no market information relative to the common stock price of the Company's stock as it is not actively traded. No common stock dividends have been declared since 1990. (c) Approximate number of holders of common stock. Common no par value - 983 record holders as of July 31, 2003. (d) There is only one class of common stock outstanding. Any dividend which may be declared would be payable at the same rate on each share of common stock. At July 31, 2003, the Company also has issued 3,000 shares of Class A preferred stock owned by two holders. These shares receive cumulative dividends of 6% when declared by the Board of Directors. No dividends were declared in the fiscal year ended July 31, 2003. During the fiscal year ended July 31, 2002, dividends totaling $18,000 were declared and accrued on these shares and paid August 2, 2002. Dividends of $18,000 were paid August 3, 2001, 2000, and 1999. 7 PACIFIC SECURITY FINANCIAL, INC. PART II -------------------------------------------------------------------------------- ITEM 6. SELECTED FINANCIAL DATA The following selected financial data has been derived from the Company's audited consolidated financial statements, and should be read in conjunction with the consolidated financial statements and notes thereto.

8 PACIFIC SECURITY FINANCIAL, INC. PART II -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL: This discussion contains some forward-looking statements. A forward-looking statement may contain words such as will continue to be, will be, continue to, expect to, anticipates that, to be, or can impact. Management cautions that forward-looking statements are subject to risks and uncertainties that could cause the Company's actual results to differ materially from those projected in forward-looking statements. The Company engages in financing real estate collateralized contracts and loans, originating construction and interim loans, acquiring real estate that is either held for sale or developed and leased or sold, and operating rental properties as its primary activities. In fiscal 1999, the Company expanded its lending activities associated with interim construction loans. During the past two years, the Company has also focused on the development and leasing of its rental properties as demand for the available space in these projects has increased. Much of the Company's development of the commercial office building projects has involved extensive remodeling efforts in connection with preparation of previously unoccupied space for new tenants and structural changes as required by current building codes. The Company also constructed a new building in the Cornerstone Office Park. The Company invests in real estate collateralized contracts and real property primarily within the state of Washington, with a concentration in Spokane County. The Company has concentrated its efforts on the development and sale of existing real estate projects to maximize the return from those investments. The Company originates real estate contracts to facilitate the sale of its property held for sale or development and, in fiscal year 1998, began originating loans secured by real estate, including construction and interim loans. These loans have involved properties located in the western United States. The Company has historically financed its investments in real estate and loans primarily through collateralized line of credit arrangements with local banks, real estate notes, or mortgages, and the sale of fixed rate debentures with terms ranging from one to ten years. The Company may not be able to continue using these funding sources in the future. 9 PACIFIC SECURITY FINANCIAL, INC. PART II -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS: For the years ended July 31, 2003, 2002, and 2001, the Company's net income (loss) was approximately $(2,756,000), $(176,000), and $79,000, respectively. Due to dividends on the preferred stock, the income (loss) applicable to common stockholders was approximately $(2,756,000), $(212,000), and $79,000, in fiscal 2003, 2002, and 2001, respectively. Rental revenues have decreased primarily because of sales of rental properties. Total rental income has decreased from approximately $2,690,000 in fiscal 2001 to $1,403,000 in fiscal 2003. Interest income, including loan fees and amortization of discounts on acquired real estate contracts and loans, has decreased from approximately $3,102,000 and $3,993,000 in fiscal 2002 and 2001, respectively, to approximately $1,338,000 in fiscal 2003. This decrease corresponds directly with the decrease in the Company's origination of construction and interim commercial loans. In the last half of fiscal 2002, the Company discontinued originating new commercial real property construction and interim loans through its subsidiary, Cornerstone Realty Advisors, Inc. Loan fees of $201,000 have declined as the new loan portfolio has declined in fiscal 2003. Loan fees were $741,000 and $1,053,000 in fiscal 2002 and 2001, respectively. Net interest income without loan fees was approximately $(305,000) in fiscal year 2003 compared with $356,000 and $352,000 in fiscal 2002 and 2001, respectively. The Company had a loss of approximately $458,000 from real estate sales in fiscal 2003 compared with a gain of approximately $2,022,000 in fiscal 2001 and a loss of $25,000 in fiscal 2001. The Company anticipates that it will continue to recognize gains and losses on the sale of real estate acquired through foreclosure and real estate acquired for resale as well as on the sales of rental properties and other assets. The expenses associated with rental operations have decreased to approximately $1,472,000 in fiscal 2003 from approximately $1,703,000 in fiscal 2002 and $2,396,000 in fiscal 2001. The rental activities of the Company are expected to continue to contribute to its operations, but reduced revenues due to the sales of rental properties have more than offset rental increases from renovated or newly-constructed properties. Interest expense, exclusive of interest on rental properties, net of amounts capitalized, was approximately $1,442,000, $2,005,000, and $2,588,000, in fiscal 2003, 2002, and 2001, respectively. In fiscal 2000 and through the first half of fiscal 2002, outstanding borrowings increased significantly due to advances drawn under the Company's lines of credit to fund the origination of construction and interim loans. Decreased borrowings and lower interest rates resulted in the decrease in interest expense in fiscal 2003 and 2002. 10 PACIFIC SECURITY FINANCIAL, INC. PART II -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS (CONTINUED): Salaries and commissions have decreased to approximately $1,020,000 in fiscal 2003 from $1,121,000 in fiscal 2002, and $901,000 in fiscal 2001. One-time restructuring charges exceeding $300,000 for severance payments and employee contracts were incurred in fiscal 2003 as the Company reduced personnel. General and administrative expenses in fiscal 2003 were approximately $742,000 compared with $667,000 in fiscal 2002 and $589,000 in fiscal 2001 primarily due to increases in legal fees and real estate taxes from foreclosed properties. The Company made a provision for an impaired asset of approximately $644,000 for a rental property after obtaining an appraisal in fiscal 2003. The Company incurred a $318,000 contract discount expense to induce a borrower to pay off a $3,181,000 contract receivable in fiscal 2003. The provision for loan losses decreased to approximately $807,000 in fiscal 2003 compared with approximately $1,408,000 in fiscal 2002 and $70,000 in fiscal 2001 as the slow economy resulted in some loan defaults and foreclosures. Write offs decreased to approximately $784,000 in fiscal 2003 compared with approximately $941,000 in fiscal 2002 and approximately $70,000 in fiscal 2001. The Company's effective income tax rate as a percentage of income (loss) from continuing operations before income taxes was 34% in fiscal 2003, compared to a provision of 34% and 22% in 2002 and 2001, respectively. LIQUIDITY AND CAPITAL RESOURCES: At July 31, 2003, the Company had total stockholders' equity of approximately $4,444,000 and a total liabilities to equity ratio of 4.22 to 1, which decreased from 5.16 to 1 the year before. The decrease in this ratio was primarily due to the repayment of bank borrowings in fiscal 2003. In fiscal 2003, the Company's primary sources of funds were approximately $15,198,000 in real estate contract collections and $4,822,000 from real estate sales. The primary uses of funds were approximately $1,490,000 used for acquisition and improvement of real estate projects, $156,000 used to originate new loans and acquire new contracts, $1,983,000 in net repayment of maturing debentures, approximately $15,828,000 in net repayment of bank line and other borrowings, and approximately $195,000 for net operating activities. As a shareholder of monetary assets and liabilities, the Company's performance may be significantly affected by changes in interest rates. These changes are somewhat delayed to the extent that a portion of the Company's investment in real estate contracts and established real estate leases have fixed returns, as do the Company's debentures. The interim and construction loans originated by the Company have variable interest rates and are primarily funded by variable interest rate loans so that the spread between the loans receivable interest rate and debt interest rate is maintained regardless of whether rates are increasing or decreasing. The Company will be affected by changes in the real estate market in Washington and other western states where it originates loans. 11 PACIFIC SECURITY FINANCIAL, INC. PART II -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) LIQUIDITY AND CAPITAL RESOURCES (CONTINUED): The Company's sources of liquidity traditionally have included the issuance of debentures under the auspices of the Washington State Securities Division of the Department of Financial Institutions and borrowings from various bank lenders. These sources of liquidity are limited either by the Washington State Securities Division, which has capped the amount of debentures the Company may sell or by the individual banks through covenants included in the loan agreements. An additional source of liquidity is the issuance of participation interests in certain loans originated by the Company. The total of these non-recourse participations was $475,000 at July 31, 2003, and $3,495,000 at July 31, 2002. At July 31, 2003, the Company's outstanding banking agreements totaled approximately $3,692,000 with an additional $5,583,000 due for installment contracts, mortgage notes, and notes payable. During the year ended July 31, 2003, the Company induced a borrower with a discount of $318,000 (10%) on a contract of approximately $3,181,000 to pay off and provide funds to pay off the Company's bank line on March 3, 2003. The bank continues to work with the Company on a loan that was paid down to $880,000 on March 3, 2003, and that is collateralized by a property in Eagle, Idaho, that was acquired through foreclosure in June 2003. The bank agreed to extend the loan for a period of six months to September 3, 2003, with interest only paid monthly. Subsequent to the fiscal year end on July 31, 2003, the loan was evaluated based on market and other business conditions and the maturity date was extended to June 1, 2004. Another financial institution the Company relied upon as a source of funding for its commercial real estate loans indicated they are terminating (nationally) all or nearly all, commercial warehouse lines of credit. This financial institution agreed to work with the Company to allow a current loan totaling approximately $1,858,000 to pay off as it matured. The final payoff occurred in May 2003. Management does not believe that this line of credit can be quickly replaced by another lender. This will materially impact the Company's liquidity and profitability. Due to the restrictive banking agreements, the Company has essentially stopped making new loans and has concentrated on collection efforts to pay down outstanding debt. These collection efforts include foreclosure proceedings on several loans. 12 PACIFIC SECURITY FINANCIAL, INC. PART II -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) FINANCIAL CONDITION AND LIQUIDITY (CONTINUED): The Company anticipates that cash flows from operations along with real estate and receivable sales will be sufficient to provide for the retirement of maturing debentures and mortgage obligations. The Company has begun to implement strategies for restructuring, which include liquidating a majority of the Company's assets over the course of the next year. The Company has reduced personnel during the year, incurring restructuring charges exceeding $300,000 for severance payments and employment contracts for seven employees. Six employees have continued to work for the Company after the April 30, 2003, employment contract ending date. It is management's intention that the Company will continue to own and invest in commercial real estate upon completion of the restructuring, at which time management intends to evaluate the opportunities to continue financing commercial real estate in light of market conditions and available capital. The Company's management is continuously evaluating loans for collectibility. Additional provisions for loan losses may be required as the Company analyzes each loan during its efforts to reduce outstanding loans receivable. Litigation may be required in the course of collection. In addition, the Company's position relative to bankruptcy filings by borrowers must be assessed. The borrower on a Park City, Utah, loan filed for bankruptcy protection on May 1, 2002. The Company's principal portion of this loan totaled $1,250,000 and is expected to be recovered through the sale of the foreclosed property (approximately 27 acres of land) that was acquired through a trustee's sale in December 2002. The Company completed foreclosure proceedings on three Eagle, Idaho loans totaling approximately $2,460,000 and obtained title to approximately 25 acres of land in June 2003. The Company has negotiated a sale of approximately 75% of this property pending approval of entitlements. The Company has provided an allowance for loan loss of $100,000 on a Kirkland, Washington, loan of approximately $140,000. The borrower was forced into involuntary bankruptcy by unsecured creditors. A trustee's sale of the property scheduled for May 9, 2003, was postponed. The Company is currently assessing its potential for recovery. The borrower on two loans totaling approximately $995,000 filed for bankruptcy in March 2003. The loans are collateralized by eight lots, including one partially finished house and eleven acres of land in Oakland Hills, California. The Company is currently assessing its potential for recovery and has made a $269,000 provision for loan loss on these loans. 13 PACIFIC SECURITY FINANCIAL, INC. PART II -------------------------------------------------------------------------------- ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK: Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises principally from interest rate risk in its lending and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Although the Company manages other risks, as in credit quality and liquidity risk, in the normal course of business, management considers interest rate risk to be a significant market risk and could potentially have a material effect on the Company's financial condition and results of operations. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activity. The Company's profitability can be affected by fluctuations in interest rates. Management's goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase in interest rates may adversely impact the Company's earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same speed, to the same extent, or on the same basis. In addition, real estate lending may slow in a rising interest rate environment. The Company mitigates interest rate risk on the interim and construction loans it originates by having variable interest rates on these loans tied to the variable interest rates on its borrowings to fund the loans. These loans are short-term loans (generally one to two years, including extensions). Permanent financing for these loans is obtained from the secondary market and includes such sources as banks, savings and loan institutions, life insurance companies, credit unions, and conduits. 14 PACIFIC SECURITY FINANCIAL, INC. PART II ------------------------------------------------------------------------------- ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED) The following table shows the Company's financial instruments that are sensitive to changes in interest rates, categorized by expected maturity, and the instruments' estimated fair values at July 31, 2003.

Expected maturities are contractual maturities adjusted for prepayments of principal. The Company uses certain assumptions to estimate fair values and expected maturities. For assets, expected maturities are based upon contractual maturity, projected repayments, and prepayment of principal. 15 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA INDEPENDENT AUDITOR'S REPORT Board of Directors and Stockholders Pacific Security Financial, Inc. and Subsidiaries Spokane, Washington We have audited the accompanying consolidated balance sheets of Pacific Security Financial, Inc. and subsidiaries as of July 31, 2003 and 2002, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years ended July 31, 2003, 2002, and 2001. These consolidated financial statements are the responsibility of the Corporation'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 auditing standards generally accepted in the United States of America. 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 Pacific Security Financial, Inc. and subsidiaries as of July 31, 2003 and 2002, and the results of their operations and cash flows for the years ended July 31, 2003, 2002, and 2001, in conformity with accounting principles generally accepted in the United States of America. Spokane, Washington August 29, 2003 16 PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET --------------------------------------------------------------------------------

See accompanying notes. 17 PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET --------------------------------------------------------------------------------

See accompanying notes 18 PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS --------------------------------------------------------------------------------

See accompanying notes. 19 PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS --------------------------------------------------------------------------------

See accompanying notes. 20 PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY --------------------------------------------------------------------------------

See accompanying notes. 21 PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS -------------------------------------------------------------------------------

See accompanying notes. 22 PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS --------------------------------------------------------------------------------

See accompanying notes. 23 PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS --------------------------------------------------------------------------------

See accompanying notes. 24 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Pacific Security Financial, Inc. (formerly Pacific Security Companies) and subsidiaries (the Company) is incorporated under the laws of the state of Washington. The Company is engaged in the business of owning, selling, and leasing real properties and in financing contracts and loans, collateralized by real estate. Most of the Company's real estate activities are concentrated within the state of Washington. The Company's commercial real estate loans are originated on properties located in the western United States. FINANCIAL CONDITION OF LIQUIDITY: As a result of the weakening national economy, the Company experienced increasing levels of delinquent loans arising from its lending to borrowers primarily engaged in construction and real estate development around the western United States. This has resulted in a reduction in the Company's earning assets, which may materially impact the Company's profitability. This has also resulted in one of the Company's lenders limiting borrowing capacity to $880,000 from $4.75 million. Another financial institution the Company relied upon as a source of funding for its commercial real estate loans has terminated (nationally) all or nearly all, commercial warehouse lines of credit similar to the borrowing relationship they had entered into with us in the past. This financial institution agreed to work with the Company to allow all loan commitments to pay off as they mature, which occurred by May 31, 2003. Therefore, the Company does not have access to an $11.0 million line of credit provided by this institution going forward. Management does not currently believe that this line of credit can be quickly replaced by another lender. This event has materially impacted the Company's liquidity and profitability. The Washington State Securities Division has approved the Company's application to issue debentures under the Washington State Debenture Act. Approval required significant conditions, which may adversely impact the Company's liquidity and profitability. The state of Washington has mandated as a condition for issuance of the permit that the Company reduce total debentures outstanding by $500,000 by August 29, 2004. The requirement to do so will materially impact the Company's liquidity. The result of these actions has impacted the Company's ability to meet long-term debt retirement projections. Without additional sources of liquidity with which to originate further loans, the liquidity needed to retire the debentures is a significant problem. Therefore, the Company will continue strategies for reorganizing or liquidating the Company over the next year. In either case, implementation of the different alternatives will result in the orderly sale of some or all of the Company's assets. 25 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A summary of the significant accounting policies followed by the Company is presented below: CONSOLIDATION: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Pacific Realty Management and Cornerstone Realty Advisors, Inc., which were formed in fiscal years 2000 and 1998, respectively. All significant intercompany accounts and transactions have been eliminated. Cornerstone Realty Advisors, Inc. was dissolved as of March 31, 2002, with commercial lending activities folded back into the parent company. Pacific Realty Management was an inactive corporation that was dissolved on December 23, 2002. CASH AND CASH EQUIVALENTS: The Company deposits all cash and cash equivalents with high quality financial institutions. At times, the deposits may exceed the federal insured limit. The Company considers highly liquid debt instruments, if any, purchased with a remaining maturity of three months or less to be cash equivalents. CONTRACTS, MORTGAGES, FINANCE NOTES, AND LOANS RECEIVABLE: The Company's contracts, finance notes, and loans receivable consist primarily of short-term construction and real estate development loans. Contracts, mortgages, finance notes, and loans receivable are stated at the unpaid principal balance, plus accrued interest, less acquisition discounts, unearned loan fees, and an allowance for estimated uncollectible amounts, as necessary. Management evaluates receivables which may not be fully collectible to determine if a provision for loss is necessary based on the present value of expected future cash flows from the receivables in the ordinary course of business or from amounts recoverable through foreclosures and the subsequent resale of the collateral. Contracts, mortgages, finance notes, and loans receivable are determined to be delinquent when the contractual payments are 30 days past due. Contracts, mortgages, finance notes, and loans receivable are placed on nonaccrual status when collection of principal or interest is considered doubtful. Interest income previously accrued on these loans that are 90 days past due, but not yet received, is reversed in the current period to the extent that it is considered uncollectible. Interest subsequently recovered is credited to income in the period collected. 26 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is based on management's evaluation of each specific loan. A loan is considered impaired when, based on current information such as adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, current economic conditions, and independent appraisals, it is probable that the Company will be unable to collect, on a timely basis, all principal and interest according to the contractual terms of the loan's original agreement. The amount of the impairment is measured using cash flows discounted at the loan's effective interest rate, except when it is determined that the sole source of repayment for the loan is the operation or liquidation of the underlying collateral. In such cases, the current value of the collateral, reduced by anticipated selling costs, is used in place of discounted cash flows. Generally, when a loan is deemed impaired, current period interest previously accrued but not collected is reversed against current period interest income. Income on such impaired loans is then recognized only to the extent that cash in excess of any amounts charged off to the allowance for loan losses is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest. Contracts, mortgages, finance notes, and loans receivable are charged off when management believes there has been permanent impairment of their carrying values. DISCOUNTS ON CONTRACTS: The Company amortizes discounts on purchased contracts using the effective yield method over the expected term of the contracts. LOAN ORIGINATION FEES: Loan origination fees, net of direct origination costs, are deferred and recognized as interest income using the effective interest yield method over the contractual term of each loan. INVESTMENT IN RENTAL PROPERTIES: Rental properties, including land, buildings and improvements, and furniture and equipment, are recorded at cost. Expenditures for maintenance and repairs are charged to operations as incurred. Depreciation is provided on the straight-line method over estimated useful lives as summarized below: Building and improvements 15-40 years Furniture and equipment 5-10 years Upon sale or retirement of depreciable properties, the related cost and accumulated depreciation are removed from the accounts and any resultant gain or loss is reflected in operations. 27 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INTEREST CAPITALIZATION: All costs associated with self-constructed assets, including interest, incurred during the construction period, are capitalized. Interest costs of approximately $66,000 and $46,000 were capitalized during the years ended July 31, 2003 and 2002, respectively. PROPERTY HELD FOR SALE OR DEVELOPMENT: The Company acquires real estate through direct acquisition and foreclosures and records these assets at the lower of fair value, less estimated costs to sell, or cost. Losses on properties held for sale or development are recognized if the anticipated cash flows from disposition, less estimated selling costs, are estimated to be less than the carrying value of the related asset. The Company evaluates its real estate assets for impairment in value whenever events or circumstances indicate that the carrying value of an asset may not be recoverable. In performing the review, if expected future undiscounted cash flows from the use of the asset or the fair value, less selling costs, from the disposition of the asset is less than its carrying value, an impairment loss is recognized. INTANGIBLE ASSETS: A covenant not to compete of $125,000 was amortized on a straight-line basis over a five-year term of the related agreement. At July 31, 2002, this asset was recorded as other assets on the consolidated balance sheet with a balance of $13,559. The covenant not to compete was fully amortized as of July 31, 2003. FURNITURE AND EQUIPMENT: Furniture and equipment are stated at cost and are depreciated using the straight-line method over their estimated useful lives of 4 to 5 and 5 to 10 years, respectively. Accumulated depreciation associated with furniture and equipment was $281,590 and $259,714 at July 31, 2003 and 2002, respectively. Upon sale or retirement, the cost and related accumulated depreciation are removed from the accounts and any resultant gain or loss is reflected in operations. SALES OF REAL ESTATE: Profit on sale of real estate is recognized when the buyers' initial and continuing investment is adequate to demonstrate (1) a commitment to fulfill the terms of the transaction, (2) that collectibility of the remaining sales price due is reasonably assured, and (3) the Company maintains no continuing involvement or obligation in relation to the property sold and has transferred all the risk and rewards of ownership to the buyer. Receipts on sales of real estate investments are accounted for as customer deposits until the principal payments received on the sales contracts exceed the minimum guidelines for gain recognition. Losses arising from sales of real estate are recognized immediately upon sale. 28 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RECOGNITION OF RENTAL INCOME: Rental income on cancelable operating leases is recognized as it becomes receivable in accordance with the provisions of the lease. Rental income on noncancelable operating leases which contain fixed escalation clauses is recognized on the straight-line method over the term of the lease. The difference between income earned and lease payments received from the tenants is included in the other assets on the consolidated balance sheet. INCOME TAXES: The Company recognizes deferred tax assets and liabilities for the expected future income tax consequences of events that have been recognized in the financial statements. Under this method, deferred tax liabilities and assets are determined based on the temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse. INCOME OR LOSS PER SHARE: Income (loss) per share - basic is computed by dividing income (loss) applicable to common stockholders by the weighted-average number of common shares outstanding during the period. Income (loss) per share - diluted is computed by dividing income (loss) applicable to common stockholders by the weighted-average number of common shares outstanding increased by the additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The Company did not have any potentially dilutive common shares outstanding during the years ended July 31, 2003, 2002, and 2001; therefore, diluted earnings per share amounts are identical to basic earnings per share. INTEREST RATE RISK: The results of operations of the Company may be materially and adversely affected by changes in prevailing economic conditions, including rapid changes in interest rates. The Company's financial assets (primarily contracts, mortgages, finance notes, and loans receivable) and liabilities (primarily notes payable to banks, installment contracts, mortgage notes, notes payable, and debenture bonds) are subject to interest rate risk. Management is aware of the sources of interest rate risk and endeavors to actively monitor and manage its interest rate risk, although there can be no assurance regarding the management of interest rate risk in future periods. OFF-BALANCE-SHEET INSTRUMENTS: The Company has outstanding commitments to extend credit to commercial borrowers. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. The Company has also entered into nonrecourse participation agreements with other lenders to reduce its credit risk on certain commercial loans. The use of participations enables the Company to diversify its portfolio among its borrowers and lenders and mitigate significant geographical and credit concentration. 29 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RECENT ACCOUNTING PRONOUNCEMENTS: In June 2002, FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company has elected to early adopt SFAS No. 146. The effect of adoption of this Statement is included in these statements. In October 2002, FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions - an amendment of FASB Nos. 72 and 144 and FASB Interpretation No. 9. SFAS No. 147 concluded that for a transaction that is a business combination, the unidentified intangible asset that is required to be recognized under paragraph 5 of SFAS No. 72 represents goodwill that should be accounted for under SFAS No. 147. The statement also concluded that SFAS No. 141 provides sufficient guidance for assigning amounts to assets acquired and liabilities assumed; therefore, the specialized industry guidance in Interpretation No. 9 and paragraph 4 of SFAS No. 72 is no longer necessary. Finally, SFAS No. 147 clarifies that a branch acquisition that meets the definition of a business should be accounted for as a business combination, otherwise the transaction should be accounted for as an acquisition of net assets that does not result in the recognition of goodwill. This statement was effective on October 1, 2002. The Company's adoption of SFAS No. 147 did not have a material impact on the Company's financial position or results of operations. In December 2002, FASB issued SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure - an amendment to FASB Statement No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures about the method of accounting for stock-based employee compensation and the effect of the method used on reporting results. As the Company has no stock-based compensation plans, this statement had no impact on the Company's financial position or results of operations. The FASB issued SFAS No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. This statement, which was issued in April 2003, amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement is effective for contracts entered into or modified after June 30, 2003. The Company's adoption of SFAS No. 149 did not have a material impact on the Company's financial position or results of operations. 30 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED): The FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement, which was issued in May 2003, establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company's adoption of SFAS No. 150 did not have a material impact on the Company's financial position or results of operations. ESTIMATES: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expense during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures, or in satisfaction of loans as well as the impairment of investments in rental properties. Management believes that the allowance for loan losses and impairment of rental properties is adequate. While management uses currently available information to recognize losses on loans and real estate held for sale and development or investment in rental properties, future additions to the allowance or impairment valuation may be necessary based on changes in economic conditions. RECLASSIFICATIONS: Certain amounts in the 2002 and 2001 financial statements have been reclassified to conform with the current year's presentation. These reclassifications had no effect on retained earnings or net income (loss) as previously reported. 31 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 2 - CONTRACTS, MORTGAGES, FINANCE NOTES, AND LOANS RECEIVABLE The components of contracts, mortgages, finance notes, and loans receivable at July 31, 2003 and 2002, are as follows: 2003 2002 ------------ ------------ Contracts, mortgages, and finance notes receivable $ 4,644,946 $ 9,121,087 Originated loans receivable 2,574,581 18,823,391 Undisbursed portion of loans receivable (91,985) (1,825,566) ------------ ------------ 7,127,542 26,118,912 Unearned loan fees, net (20,353) (81,161) Allowance for loan losses (609,100) (585,855) ------------ ------------ CONTRACTS, MORTGAGES, FINANCE NOTES, AND LOANS RECEIVABLE, NET $ 6,498,089 $ 25,451,896 ============ ============ At July 31, 2003, three individual borrowers represented approximately 42%, 19%, and 14% of the gross outstanding receivable. For the year ended July 31, 2002, three individual borrowers represented 15%, 11%, and 12% of the gross outstanding receivable. Outstanding commitments to extend credit to borrowers is $91,985 at July 31, 2003. The Company does not have any other commitments to extend credit. At July 31, 2003 and 2002, the aging of the gross amounts due on contracts, mortgages, finance notes, and loans receivable was as follows: 2003 2002 ----------- ----------- Current $ 5,869,714 $20,429,239 31 to 60 days -- 2,864,281 61 to 90 days -- 1,290,000 Over 90 days 1,257,828 1,535,392 ----------- ----------- $ 7,127,542 $26,118,912 =========== =========== The Company had no loans past due 90 days or more and still accruing interest. 32 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 2 - CONTRACTS, MORTGAGES, FINANCE NOTES, AND LOANS RECEIVABLE (CONTINUED) Management of the Company provides an allowance for losses based upon estimates of the cash flows to be collected on the receivable or the fair value of the underlying collateral, net of selling costs on an individual loan basis. An allowance of $609,100 and $585,855 was provided at July 31, 2003 and 2002, respectively. The receivables are collateralized primarily by residential and commercial real estate located in the western United States. These estimates can be affected by changes in the economic environment in the western United States and the resultant effect on real estate values. As a result of changing economic conditions, the amount of the allowance for loan losses could change in the near-term. ALLOWANCE FOR LOAN LOSSES: Write offs include $58,774, $60,000, and $70,000 in 2003, 2002, and 2001, respectively, for impairment of real estate owned against the provision for loan loss. Year Ended July 31, ------------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Beginning balance $ 585,855 $ 119,460 $ 119,460 Provision for loan loss 807,159 1,407,712 70,000 Write offs (783,914) (941,317) (70,000) ----------- ----------- ----------- ENDING BALANCE $ 609,100 $ 585,855 $ 119,460 =========== =========== =========== NOTE 3 - INVESTMENTS IN RENTAL PROPERTIES Following is a summary of investments in rental properties at July 31, 2003 and 2002: 2003 2002 ------------ ------------ Land $ 1,412,585 $ 2,071,033 Buildings and improvements 13,605,327 14,234,991 Furniture and equipment 743,997 641,457 ------------ ------------ 15,761,909 16,947,481 Impairment on rental properties (643,680) -- Less accumulated depreciation (4,417,174) (4,135,629) ------------ ------------ $ 10,701,055 $ 12,811,852 ------------ ------------ Depreciation expense was $471,440, $538,096, and $783,704 for the years ended July 31, 2003, 2002, and 2001, respectively. 33 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 3 - INVESTMENTS IN RENTAL PROPERTIES (CONTINUED) The Company leases office space in certain of the above buildings under operating leases. Most of the lease agreements contain renewal options and escalation provisions associated with inflation over the term of the lease. The following is a schedule by years of minimum future rentals on noncancelable operating leases as of July 31, 2003: Year Ending July 31, 2004 $ 850,800 2005 689,429 2006 603,773 2007 535,458 2008 240,170 Thereafter 386,007 ---------- $3,305,637 ========== These properties are primarily located in the greater Spokane, Washington, geographical area. Losses on investments in rental properties are recognized if the anticipated undiscounted cash flows from operations or the sale of the rental property, net of selling costs, are estimated to be less than the carrying value of the related asset. These estimates can be affected by changes in the economic environment of the Spokane, Washington, area and the resultant effect on the real estate rental and property values. As a result of changing economic conditions, these estimates could change in the near-term. Management determined that an impairment of value had occurred on a rental property office building after obtaining an appraisal and updating it with additional information. An impairment expense of $643,680 was recorded in the fiscal year ended July 31, 2003, to reduce the carrying value of this office building. 34 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 4 - BUSINESS SEGMENT REPORTING Information about the Company's separate continuing business segments as of and for the years ended July 31, 2003, 2002, and 2001, is as follows: Real Estate Commercial Rental, and Lending Receivales Operations Operations Total ---------- ---------- ----- 2003 Revenue $ 632,434 $ 1,673,653 $ 2,306,087 Income (loss) before income tax (1,533,701) (2,642,677) (4,176,378) Identifiable assets, net 5,881,571 17,340,247 23,221,818 Depreciation and amortization 4,739 504,773 509,512 Capital expenditures 2,382 1,487,602 1,489,984 2002 Revenue $ 2,507,279 $ 4,177,182 $ 6,684,461 Income (loss) before income tax (485,102) 218,151 (266,951) Identifiable assets, net 19,052,050 25,399,575 44,451,625 Depreciation and amortization 4,969 581,022 585,991 Capital expenditures 40,414 1,154,827 1,195,241 2001 Revenue 3,582,771 3,106,737 6,689,508 Income (loss) before income tax 1,088,890 (988,002) 100,888 Identifiable assets, net 22,792,656 25,962,003 48,754,659 Depreciation and amortization 3,709 823,273 826,982 Capital expenditures 20,449 2,047,956 2,068,405 The Company has determined that its reportable business segments are those that are based on its method of disaggregated internal reporting. The Company's reportable business segments are its commercial loan origination business and its rental and receivable operations. The commercial loan origination business, operated as Cornerstone Realty Advisors, Inc. from 1998 to March 31, 2002, originates commercial construction loans throughout the western United States. The rental and receivable operations represent the selling and leasing of real properties and the financing of contracts and loans collateralized by real estate. 35 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 5 - MARKETABLE SECURITIES The Company had no investments in marketable securities at July 31, 2003 and 2002. Investments in marketable securities at July 31, 2000, consisted of debt securities of $41,724, which matured in 1998, but were not fully paid by the issuer until 2001 due to the issuer's reorganization. No gain or loss was recognized on this security. NOTE 6 - NOTES PAYABLE TO BANKS (LINES OF CREDIT) Notes payable to banks consisted of the following at July 31, 2003 and 2002:

The prime rate and the BARR referenced on the above notes were 4.00% and 4.75% on July 31, 2003 and 2002, respectively The following assets were pledged as collateral on these notes payable at July 31, 2003 and 2002:

36 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 7 - INSTALLMENT CONTRACTS, MORTGAGE NOTES, AND NOTES PAYABLE Installment contracts, mortgage notes, and notes payable consist of the following at July 31, 2003 and 2002:

Scheduled future maturities of installment contracts, mortgage notes, and notes payable are as follows: Year Ending July 31, 2004 $1,604,766 2005 218,802 2006 219,915 2007 3,020,583 2008 184,622 Thereafter 334,578 ---------- $5,583,266 ========== NOTE 8 - DEBENTURE BONDS The Company has issued unsecured investment bonds (debentures) to residents of the state of Washington under the Securities Act of Washington. The proceeds have been primarily used in making funds available for contracts and loans and the development, improvement, and acquisition of commercial real property. The outstanding debentures have original maturities ranging from one to ten years, and the interest rates vary depending upon the maturity. 37 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 8 - DEBENTURE BONDS (CONTINUED) Outstanding debentures by interest rate categories were as follows at July 31, 2003 and 2002: Debenture Interest Rate 2003 2002 ---------- ----------- 5.00% $ -- $ 136,008 5.25% -- 34,561 5.75% -- 49,736 6.00% 263,661 257,566 6.50% 140,838 138,652 6.75% 78,276 84,153 7.00% 113,846 128,938 7.25% 210,602 209,598 7.50% 10,561 176,822 7.75% 791,594 1,176,651 8.00% 293,416 287,808 8.25% 1,259,783 1,380,740 8.50% 1,696,554 2,134,065 8.75% 369,016 364,362 9.00% 1,908,723 2,045,523 9.25% 474,400 438,738 9.50% 896,110 923,363 10.00% 10,826 21,577 10.50% 8,977 8,093 ---------- ---------- $8,527,183 $9,996,954 ========== ========== The weighted-average annual interest rate on outstanding debentures at July 31, 2003 and 2002, was 8.47% and 8.36%, respectively. Estimated future contractual maturities of outstanding debentures are as follows: Year Ending July 31, 2004 $2,808,723 2005 2,626,034 2006 1,727,803 2007 892,318 2008 472,305 ---------- $8,527,183 38 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 8 - DEBENTURE BONDS (CONTINUED) The Company's permit for the sale of debenture securities is effective from August 29, 2003, to August 29, 2004. This permit is conditional upon maintaining compliance with the Washington Securities Act, including special permit conditions, such as the maintenance of minimum net worth and liquidity levels. In addition, the Company is required to reduce outstanding debentures by $500,000 by August 29, 2004. Failure to comply with these requirements may jeopardize the Company's ability to issue debentures. NOTE 9 - INCOME TAXES The components of income tax expense consists of the following for the years ended July 31:

39 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 9 - INCOME TAXES (CONTINUED) The net deferred tax liabilities consist of the following components at July 31:

The effective tax rate differs from the statutory federal rate for the years presented as follows:

Operating loss carryforward as of July 31, 2003, for income tax purposes were as follows: Expiration Date 2023 $3,227,239 ---------- 40 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 10 - EMPLOYEE BENEFIT PLAN The Company provides a retirement savings plan (the Plan), authorized under Section 401(k) of the Tax Reform Act of 1986, as amended. Under the terms of the Plan, employees are eligible to contribute up to 18% of their compensation, subject to annual limitations, to the Plan. The Company may contribute 3% of gross salary for all eligible employees. Contributions are made directly to a qualified individual retirement account or annuity in the employee's name. The Company is required to make nondiscriminatory contributions for each employee who (1) has reached the age of 21; (2) has performed services for the Company during the last year of service in which he or she has completed 1,000 hours of service; (3) is not covered by a collective bargaining agreement; and (4) is not a nonresident alien. The Company's Plan contribution was approximately $30,000, $34,000, and $25,000 during the years ended July 31, 2003, 2002, and 2001, respectively. NOTE 11 - PREFERRED STOCK On February 18, 1999, at the Annual Meeting of the Stockholders, a motion was passed to amend the Company's articles of incorporation to eliminate the mandatory redemption provisions of the Class A Preferred stock. Accordingly, the remaining 3,000 outstanding shares of preferred stock, with a face amount of $300,000, were reclassified to stockholders' equity. In addition, 10 million no par value shares of preferred stock were authorized, but none were issued. Each share of Class A preferred stock is entitled to one vote on each matter voted on at a stockholders' meeting. The preferred stockholders have liquidation rights equal to the par value plus accumulated and unpaid dividends. The liquidation preference of the Class A preferred stock was $318,000 on July 31, 2003, 2002, and 2001. There were no changes to the 3,000 outstanding shares of preferred stock during the years ending July 31, 2003, 2002, and 2001. The 6% annual dividends on the Class A preferred stock are cumulative. No dividends were declared or recorded during the year ended July 31, 2003. Dividends of $18,000 were declared on the preferred stock during July 2002, which were accrued as of July 31, 2002, and reflected in the consolidated statement of stockholders' equity for the year ending July 31, 2002, and paid August 2, 2002. No dividends were declared during the year ended July 31, 2001; however, dividends of $18,000 were declared and paid during August 2001 and are reflected in the consolidated statement of stockholders' equity for the year ending July 31, 2002. NOTE 12 - COMMON STOCK The Company has authorized a second class of common stock, Class B. This class has authorized 30,000, no par value shares and entitles the holder to 50 votes on each matter in all proceedings in which actions are taken by the stockholders, including the election of directors. Otherwise, the common stock is identical to the original class in all respects and for all purposes. 41 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 13 - RELATED PARTY TRANSACTIONS NOTE RECEIVABLE: A certain former stockholder was indebted to the Company by a note secured by real estate bearing interest at 8.75% (prime plus 4.00% adjusted annually) in the outstanding amounts (including interest) of $-0- and $167,098 at July 31, 2003 and 2002, respectively. INSTALLMENT CONTRACTS, MORTGAGE NOTES, AND NOTES PAYABLE: At July 31, 2003 and 2002, the Company had a related party payable of $-0- and $28,158, respectively. The payable had a monthly payment of $4,789, bearing interest at 7.00%, and matured in 2003. DEBENTURE BONDS: Included in debenture bonds at July 31, 2003 and 2002, is approximately $80,000 and $142,000, respectively, that is payable to related parties. These debentures bear interest at the prevailing market rate on the date of issuance. ACCRUED EXPENSES AND OTHER LIABILITIES: At July 31, 2003 and 2002, the following demand notes were payable to related parties:

INTEREST INCOME AND EXPENSE: The approximate amount of related party interest income and expense included in the accompanying consolidated statement of operations during the years ended July 31, 2003, 2002, and 2001, is as follows: 2003 2002 2001 ---- ---- ---- Interest income $ 7,000 $18,000 $24,000 Interest expense 12,000 14,000 22,000 42 PACIFIC SECURITY FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 13 - RELATED PARTY TRANSACTIONS (CONTINUED) PARTICIPATIONS: The former president of Cornerstone Realty Advisors, Inc., a wholly-owned subsidiary of the Company that was folded into the parent company in 2002, had directly invested in certain loans through participation agreements during 2002. The former president had no direct investments in loan participating agreements at July 31, 2003. The total of such participations was $150,000 at July 31, 2002. NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the value of each class of financial instruments for which it is practicable to estimate that value. Potential income tax ramifications related to the realization of unrealized gains and losses that would be incurred in an actual sales and/or settlement have not been taken into consideration. CASH AND CASH EQUIVALENTS: Due to the nature of these financial instruments, carrying value approximates fair value. DEBENTURE BONDS, CONTRACTS RECEIVABLE, AND INSTALLMENT CONTRACTS PAYABLE: Fair values are determined using future cash flows discounted at a rate of interest currently offered for debt or receivables with similar remaining maturities and credit risks. At July 31, 2003 and 2002, the carrying values of these financial instruments approximated their fair values. NOTES PAYABLE TO BANKS: Fair value approximates the carrying value because the notes bear variable interest rates. LIMITATIONS: The fair value estimates are made at a discrete point in time based on relevant market information and information about the financial instruments. Because no market exists for many of these financial instruments, fair value estimates are based on judgments regarding current economic conditions and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Accordingly the estimates presented herein are not necessarily indicative of what the Company could realize in a current market exchange. 43 PACIFIC SECURITY FINANCIAL, INC. PART II -------------------------------------------------------------------------------- ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES DISCLOSURE CONTROLS AND PROCEDURES: Based on an evaluation of the Company's disclosure controls and procedures as of the end of the period covered by this annual report, the Company's president and treasurer have determined that the Company's current disclosure controls and procedures are effective. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING: There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the fourth quarter of fiscal year ended July 31, 2003, that have materially affected, or are reasonably likely to materially affect the Company's internal control over financial reporting. 44 PACIFIC SECURITY FINANCIAL, INC. PART III -------------------------------------------------------------------------------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT IDENTIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS: The following information as of July 31, 2003, is provided with respect to each director and executive officer of the Company:

FAMILY RELATIONSHIP: Kevin M. Guthrie, David L. Guthrie, and Julian Guthrie are the children of Wayne E. Guthrie and Constance Guthrie. Constance M. Guthrie is the wife of Wayne E. Guthrie. BUSINESS EXPERIENCE: Wayne E. Guthrie was Chairman of the Board Emeritus of Pacific Security Financial, Inc., a Washington corporation. Mr. Guthrie had over 50 years experience in areas of construction, financing of real estate and personal property, and real estate investments. He died August 4, 2003. David L. Guthrie became Chairman of the Board in 2002 and has been president of Pacific Security Financial, Inc. since 1999 and vice president since 1989. Mr. Guthrie was formerly a financial consultant with Merrill Lynch in Spokane, Washington. Mr. Guthrie is a NASD licensed securities sales person (registered representative) and broker-dealer (general securities principal). He is a licensed real estate broker in the state of Washington and has obtained the CCIM designation (certified commercial investment member) awarded by the commercial real estate investment institute. 45 PACIFIC SECURITY FINANCIAL, INC. PART III -------------------------------------------------------------------------------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) BUSINESS EXPERIENCE (CONTINUED): Kevin M. Guthrie was vice president of Pacific Security Financial, Inc. from 1985 to 2002. Mr. Guthrie has served as property manager for the Company since 1976. Mr. Guthrie resigned as an officer and terminated employment with the Company on October 15, 2002, to work for a Spokane property management firm that manages the Company's rental properties located in Spokane. Donald J. Migliuri has been treasurer of Pacific Security Financial, Inc. since 1990 and secretary since 1991. Mr. Migliuri was a Certified Public Accountant and has served as an accounting officer with various diversified financial services companies for over 20 years. He also is a Certified Management Accountant (CMA) and has a Masters Degree in Business Administration. Constance M. Guthrie has not been employed outside the home during the past ten years. Robert N. Codd retired August 1, 2002, after being employed by Pacific Security Financial, Inc. in its leasing and real estate activities. He was employed by the Company from 1970 to 1979 and was rehired in November 1992. Prior to being rehired, he was a commercial realtor and property manager. Julian Guthrie is a reporter for the San Francisco Chronicle. She covered general news for the paper for two years and in 1998 was named education reporter, responsible for covering all education issues in the Bay Area. Before that, she was senior editor of a lifestyle magazine in San Francisco and also worked as a freelance writer for the Chronicle, covering breaking business, political, and lifestyle stories. She currently lives in San Francisco. Jack Bury is a practicing attorney in Spokane, Washington. Mr. Bury graduated from the Gonzaga University School of Law. Since 1974 he has been employed by the law firm of Murphy, Bantz & Bury, P.S. where he is currently the sole shareholder and president of that professional service corporation. Mr. Bury's law firm represents the Company in corporate and certain other legal matters. Mr. Bury owns no shares in the Company's common or preferred stock. William L. Jenkins became vice president in August 2003. He is a Certified Public Accountant and has a Masters Degree in Business Administration. He joined the Company on October 9, 2000, after working as an accountant and senior treasury analyst since 1986 at two financial institutions. COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934: Section 16(a) of the Securities Exchange Act of 1934 requires the Company's executive officers and directors, and persons who beneficially own more than ten percent (10%) of a registered class of the Company's equity securities (Reporting Persons), to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors, and greater than ten percent (10%) beneficial owners are required by Securities and Exchange Commission regulation to furnish the Company with copies of all Section 16(a) forms filed by them. 46 PACIFIC SECURITY FINANCIAL, INC. PART III -------------------------------------------------------------------------------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934 (CONTINUED): Based solely on its review of copies of such forms furnished to the Company, the Company believes that during the fiscal years ended July 31, 2003 and 2002, all Section 16(a) filing requirements applicable to Reporting Persons were complied with, except that David L. Guthrie has one delinquent Form 4 filing and Kevin M. Guthrie had two delinquent Form 4 filings. 47 PACIFIC SECURITY FINANCIAL, INC. PART III -------------------------------------------------------------------------------- ITEM 11. EXECUTIVE COMPENSATION REMUNERATION OF DIRECTORS AND OFFICERS: The following table lists, on an accrual basis, for each of the three years ended July 31, 2003, the remuneration paid by the Company to any officers or directors in excess of $100,000 and to all officers and directors as a group who were officers or directors of the Company at any time during the year ended July 31, 2003:

The Company has no qualified or nonqualified stock option plan as of July 31, 2003. * Includes severance payments 48 PACIFIC SECURITY FINANCIAL, INC. PART III -------------------------------------------------------------------------------- ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS: Set forth below is certain information concerning parties, excluding management, who are known by the Company to directly own more than five percent of any class of the Company's voting shares on July 31, 2003: none. SECURITY OWNERSHIP OF MANAGEMENT: The following table sets forth as of July 31, 2003, information concerning the direct ownership of each class of equity securities by all directors and all directors and officers of the Company as a group: Amount of Shares and Nature of Beneficial Percent of Title of Class Name of Beneficial Owner Ownership Class ---------------- ----------------------------- --------- --------- Common stock Wayne E. Guthrie 142,521.5 13.19% Common stock Constance Guthrie 142,521.5 13.19% Common stock Kevin Guthrie 222,718.0 20.62% Common stock David Guthrie 222,718.0 20.62% Common stock Julian Guthrie 196,838.4 18.22% --------- ------- Common stock All directors and officers as a group 927,317.4 85.84% --------- ------- Preferred stock Wayne E. or Constance Guthrie 2,000 66.70% Preferred stock Constance Guthrie 1,000 33.30% --------- ------- Preferred stock All directors and officers as a group 3,000 100.00% --------- ------- ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS Transactions with Company officers, directors, and stockholders and other related parties are summarized in Note 13 to the consolidated financial statements included herein. 49 PACIFIC SECURITY FINANCIAL, INC. PART III -------------------------------------------------------------------------------- ITEM 14. PRINCIPLE ACCOUNTING FEES AND SERVICES AUDIT FEES: Audit fees billed or expected to be billed to the Company by Moss Adams for the audit of the Company's financial statements for the year ended July 31, 2003, and for reviews of the Company's financial statements included in the Company's quarterly reports on Form 10-Q totaled $41,908. Audit fees billed or expected to be billed to the Company by Moss Adams for the audit of the Company's financial statements for the year ended July 31, 2002, and for reviews of the Company's financial statements included in the Company's quarterly reports on Form 10-Q totaled $43,317. TAX FEES: Fees billed or expected to be billed to the Company by Moss Adams for tax-related services provided during 2003 totaled $4,895. Fees billed or expected to be billed to the Company by Moss Adams for tax-related services provided during 2002 totaled $5,345. FINANCIAL INFORMATION SYSTEMS DESIGN AND IMPLEMENTATION FEES: No fees were billed or are expected to be billed to the Company by Moss Adams for services provided during 2003 or 2002 for the design and implementation of financial information systems. ALL OTHER FEES: No fees were billed or are expected to be billed to the Company by Moss Adams for other services during 2003 or 2002. The Company's Board of Directors has considered whether the provisions of the services performed by Moss Adams LLP are compatible with maintaining their independence. All services are approved by the Chairman of the Board prior to the commencement of the engagement. 50 PACIFIC SECURITY FINANCIAL, INC. PART IV -------------------------------------------------------------------------------- ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) Financial Statements: The consolidated financial statements of Pacific Security Financial, Inc. are included in Part II, Item 8 of this annual report. (2) Financial Statement Schedules Schedule III - Real estate and accumulated depreciation. Schedule IV - Mortgage loans on real estate. (3) Exhibits 31.1 Certification of President pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Treasurer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of President pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Treasurer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K filed during the quarter None (c) See Item 15(a)(3) above. (d) See Item 15(a)(2) above. 51 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (CONTINUED) INDEPENDENT ACCOUNTANT'S REPORT ON FINANCIAL STATEMENT SCHEDULES To the Board of Directors and Stockholders Pacific Security Financial, Inc. and Subsidiaries Spokane, Washington Our audits of the consolidated financial statements referred to in our report dated August 29, 2003, of Pacific Security Financial, Inc. (formerly Pacific Security Companies) and its subsidiaries, which report and consolidated financial statements are included herein in this Annual Report on Form 10-K, also included an audit of the financial statement schedules listed in Item 15 of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Spokane, Washington August 29, 2003 52 PACIFIC SECURITY FINANCIAL, INC. SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION --------------------------------------------------------------------------------

(1) Total obligation of $1,383,962 is secured by two commercial buildings and land as noted above. (2) Total obligation of $3,038,272 is secured by contract sale of Broadmoor Apartments and Pier 1 Building. 53 PACIFIC SECURITY FINANCIAL, INC. SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION -------------------------------------------------------------------------------- Real estate: Balance at beginning of period $ 16,947,480 Additions during period: Purchases and capitalized costs, net 2,417,403 Deductions during period: Cost of real estate sold (3,602,975) Impairment of rental properties (643,680) ------------ BALANCE AT CLOSE OF PERIOD $ 15,118,228 ------------ Accumulated depreciation: Balance at beginning of period $ 4,135,629 Depreciation for the year 477,956 Charges to accumulated depreciation related to real estate investments sold, net of other adjustments (196,411) ------------ BALANCE AT CLOSE OF PERIOD $ 4,417,174 ============

54 PACIFIC SECURITY FINANCIAL, INC. SCHEDULE IV MORTGAGE LOANS ON REAL ESTATE --------------------------------------------------------------------------------

55 PACIFIC SECURITY FINANCIAL, INC. SIGNATURES -------------------------------------------------------------------------------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Pacific Security Financial, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PACIFIC SECURITY FINANCIAL, INC. (Registrant) Dated: October 27, 2003 By: /s/ David L. Guthrie -------------------- David L. Guthrie Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, which include the Chief Executive Officer, the Chief Financial Officer, and the Board of Directors, on behalf of the Registrant and in the capacities and on the dates indicated:

PACIFIC SECURITY COMPANIES 10-K