<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q/A
X QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
- ---
OF 1934
For the quarter ended March 31, 1995
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 0-1100
HAWTHORNE FINANCIAL CORPORATION
--------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-2085671
-----------------------------------------------------------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
2381 ROSECRANS AVENUE, EL SEGUNDO, CA 90245
------------------------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (310) 725-5000
--------------
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 the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date: The Registrant had 2,599,275
shares outstanding of Common stock, $1.00 par value per share, as of April 30,
1995.
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q/A INDEX
FOR THE QUARTER ENDED MARCH 31, 1995
Page
-----
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Statements of Financial Condition
at March 31, 1995 (Unaudited) and December 31, 1994 3
Condensed Consolidated Statements of Operations (Unaudited)
for the Three Months Ended March 31, 1995 and 1994 4
Condensed Consolidated Statements of Stockholders' Equity
(Unaudited) for the Three Months Ended March 31, 1995 and 1994 5
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the Three Months Ended March 31, 1995 and 1994 6
Notes to Condensed Consolidated Financial Statements (Unaudited) 8
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 29
ITEM 2. Changes in Securities 29
ITEM 3. Defaults upon Senior Securities 29
ITEM 4. Submission of Matters to Vote of Security Holders 29
ITEM 5. Other Materially Important Events 29
ITEM 6. Exhibits and Reports on Form 8-K 29
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1995 1994
---------- -----------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 15,767 $ 18,063
Investment securities at amortized cost (estimated
market value of $29,321 (1994)) 30,190
Investment securities at market value 29,997 13,726
Mortgage-backed securities at amortized cost (estimated market
value of $52,515 (1995) and $53,993 (1994)) 54,494 57,395
Loans receivable (net of allowance for estimated
losses of $26,019 (1995) and $21,461 (1994)) 540,823 537,020
Real estate owned (net of allowance for estimated
losses of $35,045 (1995) and $33,517 (1994)) 57,200 62,613
Accrued interest receivable 3,873 3,542
Investment in capital stock of Federal Home Loan Bank - at cost 7,095 6,995
Office premises and equipment - at cost, net 10,837 10,538
Income tax receivables 2,630 2,630
Other assets 1,584 1,081
------- -------
$724,300 $743,793
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposit accounts $681,421 $649,382
Reverse repurchase agreements 8,585 47,141
Accounts payable and other liabilities 4,984 6,078
Income taxes payable 365
------- -------
694,990 702,966
Stockholders' equity 29,310 40,827
------- -------
$724,300 $743,793
------- -------
------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(DOLLARS ARE IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------
1995 1994
------- ------
<S> <C> <C>
Interest revenues
Loans $11,338 $12,787
Investment securities 976 993
Mortgage-backed securities 900 426
------ ------
13,214 14,206
------ ------
Interest costs
Deposits (7,466) (7,490)
Borrowings (447)
------ ------
(7,913) (7,490)
------ ------
Gross interest margin 5,301 6,716
Credit losses on loans
Accrued interest on nonaccrual loans (730) (1,654)
Loan principal (12,745) (84)
------ ------
Net interest margin (8,174) 4,978
Non-interest revenues 683 747
Operating costs (5,121) (5,045)
Real estate operations, net 166 (1,181)
Securities gains, net 2,902
------ ------
Pretax loss (9,544) (501)
Income taxes (585) (81)
------ ------
NET LOSS $(10,129) $(582)
------ ------
------ ------
Net loss per share $(3.90) $(0.22)
------ ------
------ ------
Dividends paid per share N/A $ N/A
------ ------
------ ------
Average shares of common stock outstanding 2,599 2,599
------ ------
------ ------
Dividend payout ratio N/A N/A
------ ------
------ ------
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1995 1994
------- -------
<S> <C> <C>
Balance at beginning of period $40,827 $43,949
Change in unrealized gain/(loss) on available-for-sale securities (1,393)
Net loss for the period (10,129) (582)
Repayments of ESOP loan 5 4
------ ------
Balance at end of period $29,310 $43,371
------ ------
------- ------
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------
1995 1994
------- -------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $(10,129) $ (582)
Adjustments
Decrease in income tax receivables 8,018
Depreciation and amortization 541 158
FHLB stock dividends (100) (68)
Increase in interest receivable (331) (283)
Decrease in income taxes payable (365)
Amortization of loan fees (933) (371)
Increase in other assets (472) (856)
Decrease in other liabilities (1,050) (1,026)
Provision for estimated credit losses 12,745 84
Provision for other asset disposal 221
Other, net (34) (60)
------ ------
Net cash provided by operating activities 93 5,014
------ ------
INVESTING ACTIVITIES
Investment securities
Purchases (124)
Maturities 2,000
Sales - available-for-sale securities 12,488
Mortgage-backed securities
Principal amortization 1,462 755
Sales 1,438
Purchases (9,956)
Lending
New loans funded (24,357) (237)
Disbursements on construction loans (369) (1,157)
Principal payments by borrowers 3,860 7,527
Payoffs 7,046 11,836
Other, net (1,340) (154)
Real estate owned
Proceeds from sales of properties 7,561 14,875
Capitalized costs on properties (2,732) (2,881)
Other, net (179) (620)
Redemption of FHLB stock 802
Other, net (631) (322)
------ ------
Net cash provided by investing activities 4,123 22,468
------ ------
</TABLE>
6
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - CONTINUED
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------
1995 1994
------- -------
<S> <C> <C>
FINANCING ACTIVITIES
Net (decrease) increase in deposits 32,039 (31,364)
Net repayment of reverse repurchase agreements (38,556)
Repayment of ESOP loan 5 4
------ ------
Net cash used in financing activities (6,512) (31,360)
------ ------
NET CHANGE IN CASH AND CASH EQUIVALENTS (2,296) (3,878)
BEGINNING CASH AND CASH EQUIVALENTS 18,063 42,901
------ ------
ENDING CASH AND CASH EQUIVALENTS $ 15,767 $ 39,023
------ ------
------ ------
Supplemental disclosures of cash flow information
Cash paid during the period for
Interest $ 8,237 $ 7,555
Non-cash investing and financing activities
Real estate owned additions $ 7,837 $ 27,881
Loans originated to finance property sales 215 2,785
Transfer of held-to-maturity securities to available-for-sale 30,168
</TABLE>
The accompanying notes are an integral part of these financial statements
7
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of
Hawthorne Financial Corporation and its wholly-owned subsidiary, Hawthorne
Savings, F.S.B. ("Bank"), collectively referred to as the "Company". All
material intercompany transactions and accounts have been eliminated.
In the opinion of management, the unaudited condensed consolidated
financial statements contain all adjustments (consisting solely of normal
recurring accruals) necessary to present fairly the Company's financial
position as of March 31, 1995 and December 31, 1994 and the results of its
operations and its cash flows for the three months ended March 31, 1995 and
1994. Certain information and note disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to the rules
and regulations of the Securities and Exchange Commission ("SEC").
Operating results for the three months ended March 31, 1995 are not
necessarily indicative of the results that may be expected for the full
year ending December 31, 1995.
These unaudited condensed consolidated financial statements should be
read in conjunction with the audited consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 1994.
LOAN IMPAIRMENT
A loan is identified as impaired when it is probable that interest and
principal will not be collected according to the contractual terms of the
loan agreement. The accrual of interest is discontinued on such loans and
no income is recognized until all recorded amounts of interest and
principal are recovered in full.
2. RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") has issued Statement
of Financial Accounting Standards Number 114 "Accounting by Creditors for
Impairment of a Loan," ("SFAS 114") that requires impaired loans be
measured based on the present value of expected future cash flows
discounted at the effective interest rate of the loan, at the observable
market price of the loan, or fair value of the collateral if the loan is
collateral dependent.
FASB has issued Statement of Financial Accounting Standards Number 118
"Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures - an amendment of FASB Statement No. 114," ("SFAS 118") which
amends SFAS 114, to allow a creditor to use existing methods for
recognizing interest income on an impaired loan. To accomplish that, it
eliminates the provisions in SFAS 114 that described how a creditor should
report income on an impaired loan.
The Company adopted SFAS 114 and 118 as of January 1, 1995, and the
effect on the Company's financial statements was insignificant.
8
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1995
FASB issued Statement of Financial Accounting Standards Number 119
"Disclosure about Derivative Financial Instruments and Fair Value of
Financial Instruments," ("SFAS 119") which requires improved disclosures
about derivative financial instruments, such as futures, forwards, options,
swaps, and other financial instruments with similar characteristics. SFAS
119 also amends existing requirements of FASB Statement No. 105,
"Disclosure of Information about Financial Instruments with Off-Balance
Sheet Risk and Financial Instruments with Concentrations of Credit Risk,"
and FASB Statement No. 107, "Disclosures about Fair Value of Financial
Instruments". The Company adopted SFAS 119 as of December 31, 1994.
3. RECLASSIFICATIONS
Certain amounts in the 1994 consolidated financial statements have
been reclassified to conform with classifications in 1995.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company reported a net loss of $10.1 million for the first quarter of
1995, compared to net losses of $2.2 million and $0.6 million for the fourth
quarter of 1994 and the first quarter of 1994, respectively. The first quarter
of 1995 was adversely impacted by additional credit loss provisions of $12.7
million associated with the Company's classified loan and property portfolios.
Most of this increase was attributable to an increase in the capitalization
rates utilized by the Company to value its portfolios of owned operating
apartment buildings and classified apartment loan collateral. These higher
capitalization rates have generally resulted from an increase, since mid-1994,
in the cost to investors financing apartment building acquisitions.
Approximately 75% of the first quarter reserve addition applied to specific
loans and properties, with the remainder used to supplement the Company's
general reserves.
Partially offsetting the credit loss provisions during the quarter were net
securities gains, net of tax adjustments, of $2.5 million on the partial
liquidation of its available-for-sale securities portfolio. The remaining
portion of the available-for-sale portfolio at March 31, 1995, was liquidated in
early May at book value. The funds from these liquidations were used to repay
wholesale borrowings.
Exclusive of these items, the quarterly results continue to be adversely
affected by the magnitude of nonperforming assets and the high cost associated
with their resolution. While the performance of the asset portfolio during the
quarter continued to demonstrate positive results from the restructuring efforts
of the past eighteen months, nonperforming assets still have a carrying value of
$84 million, or 12% of total assets.
9
<PAGE>
After experiencing several quarters of compression on its net interest
margin, the Company began to realize some benefit from the upward repricing of
its adjustable-rate asset portfolio and a modest funding advantage to the 11th
District Cost of Funds Index ("11th DCOFI"). During the first quarter of 1995,
the Company was able to increase its net loan outstandings by $11 million
through new originations totalling $25 million. These new loans, almost
exclusively adjustable-rate mortgages and with yields favorable to the existing
portfolio, will have a positive impact to operations in future periods.
At March 31, 1995, the Bank had core and risk-based capital ratios of 3.73%
and 7.44%, respectively. Under the Federal Deposit Insurance Corporation
Improvement Act ("FDICIA"), the Office of Thrift Supervision ("OTS") has issued
"prompt corrective action" regulations with specific capital ranking tiers for
thrift institutions. Progressly more stringent operational limitations and
other corrective actions are required as an institution declines in the capital
ranking tiers. With the loss recorded during the first quarter of 1995, the
Bank's capital designation has declined from "Adequately Capitalized" to "Under
Capitalized". In early May 1995, the Bank received a directive from the OTS to
formulate and present a capital plan which satisfies regulatory concerns. The
Bank will file a capital plan with the OTS by the end of May and expects a
response to its plan by the end of June. Management expects that the Bank's
capital plan will closely mirror its operative business plan for 1995 and 1996,
which has previously been reviewed with the OTS (see PROSPECTS). The OTS may
accept or reject the capital plan as filed, or require modifications to the
filed plan. If the OTS ultimately does not accept the Bank's capital plan, it
may impose restrictions on the Bank's activities or move to place the Bank into
conservatorship or receivership. Since October 1994, the Bank has been
operating pursuant to a supervisory agreement with the OTS (see SUPERVISORY
AGREEMENT), the principal provision of which requires the Bank to increase its
core and risk-based capital ratios to 6% and 11%, respectively, by June 30,
1995. The Bank has informed the OTS that it will be unable to satisfy this
provision of the agreement. Management cannot predict with certainty whether
the Bank's failure to satisfy the capital ratio provision of the supervisory
agreement will have an adverse impact upon the Bank, nor whether the OTS will
accept the Bank's capital plan or whether it will require the Bank to limit its
current activities. Management has informed the OTS that any material change to
its current operating plan, in particular its asset disposition and loan
origination strategies, would likely exacerbate the Bank's operating losses in
the short-term and extend further into the future the Bank's return to operating
profitability.
The Company had total assets of $724 million at March 31, 1995, down from
$744 million at December 31, 1994.
OPERATING RESULTS
INTEREST MARGIN
The Company's interest margin, or the difference between the yield earned
on loans, mortgage-backed securities and investment securities and the cost of
deposits and borrowings, is affected by several factors, including (1) the level
of, and relationship between, the dollar amount of interest-earning assets and
interest-bearing liabilities, (2) the relationship between repricing of the
Company's adjustable-rate loans and short-term investment securities and its
deposits and borrowings, and (3) the magnitude of the Company's nonperforming
assets.
10
<PAGE>
The table below sets forth average interest-earning assets and interest-
bearing liabilities, and their related contractual yields and costs, for the
three months ended March 31, 1995 and 1994, and for the year ended December 31,
1994, and, for the same periods, as adjusted to reflect the impact of nonaccrual
loans (dollars are in thousands).
<TABLE>
<CAPTION>
MARCH 31 , 1995 DECEMBER 31,1994 MARCH 31, 1994
------------------------ ------------------------ ------------------------
YIELD/ YIELD/ YIELD/
AMOUNT COST AMOUNT COST AMOUNT COST
-------- ------ -------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS
Loans $562,925 8.06% $608,651 7.85% $652,748 7.61%
Cash and investment securities 60,823 6.42% 97,442 4.64% 103,535 3.84%
Mortgage-backed securities 56,229 6.40% 45,810 6.47% 28,551 5.97%
------- ------- --------
679,977 7.77% 751,903 7.35% 784,834 7.05%
------- ----- ------- ----- -------- -----
INTEREST-BEARING LIABILITIES
Deposits 658,449 4.60% 763,302 3.89% 817,589 3.67%
Borrowings 29,689 6.02% 14,333 5.23%
------- ------- --------
688,138 4.66% 777,635 3.91% 817,589 3.67%
------- ----- ------- ----- -------- -----
Interest-bearing gap/
Gross interest margin (8,161) 3.12% (25,732) 3.30% (32,755) 3.22%
NONACCRUAL LOANS (37,646) (0.43%) (76,386) (0.75%) (97,713) (0.84%)
-------- ----- ------- ----- -------- -----
Adjusted interest-bearing gap/
Net interest margin $(45,807) 2.69% $(102,118) 2.55% $(130,468) 2.38%
------- ----- ------- ----- -------- -----
------- ----- ------- ----- -------- -----
</TABLE>
The table below sets forth the balances of interest-earning assets and
interest-bearing liabilities, and their contractual yields and costs, at period
end and as of the dates indicated (dollars are in thousands).
<TABLE>
<CAPTION>
MARCH 31, 1994
----------- -------------------------------------------------------
1995 DEC 31 SEPT 30 JUNE 30 MARCH 31
----------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCES
Interest-earning assets $ 672,932 $ 683,637 $ 697,814 $ 748,141 $ 774,588
Interest-bearing liabilities (690,006) (696,523) (715,578) (783,485) (799,906)
--------- --------- --------- --------- --------
Interest-bearing gap (17,074) (12,886) (17,764) (35,344) (25,318)
Nonaccrual loans (34,220) (39,396) (63,563) (75,897) (87,613)
--------- --------- --------- --------- --------
Adjusted interest-bearing gap $ (51,294) $ (52,282) $ (81,327) $(111,241) $(112,931)
--------- --------- --------- --------- --------
--------- --------- --------- --------- --------
YIELDS AND COSTS
Interest-earning assets 7.19% 6.97% 6.96% 6.87% 6.86%
Interest-bearing liabilities (4.79%) (4.40%) (4.18%) (3.82%) (3.61%)
Gross interest margin 2.28% 2.48% 2.68% 2.87% 3.14%
Nonaccrual loans (0.37%) (0.41%) (0.95%) (0.74%) (0.84%)
--------- --------- --------- --------- --------
Net interest margin 1.91% 2.07% 1.73% 2.13% 2.30%
--------- --------- --------- --------- --------
--------- --------- --------- --------- --------
</TABLE>
The dollar amount of the Company's adjusted interest-bearing gap has
improved over the past five quarters because foreclosed properties have been
sold at a rate in excess of net new defaults (new defaults are placed on
nonaccrual status when one payment is missed by a borrower). In particular, the
improvement in the Company's adjusted gap during the 1995 first quarter reflects
an increase in the rate of property disposal during the quarter (see ASSET
QUALITY).
11
<PAGE>
The Company's gross interest margin, expressed as a percentage of interest-
earning assets, has steadily declined since 1993 because of the high volume of
foreclosures and the rapid and significant rise in interest rates since early
1994. Commencing with the 1995 second quarter, the Company's gross interest
margin will begin a period of steady, sustained expansion, as its adjustable-
rate loans reprice at a rate faster than the growth in funding costs and as new
loan volume is booked at yields favorable to the existing portfolio. This
pattern is consistent with the maturity and repricing characteristics of the
Company's assets and liabilities. The Company's deposits generally have
maturities of less than one year. Accordingly, a majority of the Company's
deposits repriced during 1994 at interest rates reflective of the rise in market
interest rates experienced since January 1994. Conversely, approximately 67% of
the Company's interest-earning assets are adjustable-rate and priced at a margin
over the 11th DCOFI. The 11th DCOFI has declined from 4.36% in January 1993 to
a low of 3.63% in March 1994, before rising to 5.01% in March 1995.
During the next several quarters, management expects that the yield on the
Company's interest-earning assets will gradually rise as the 11th DCOFI
incorporates its proportionate share of the recent rise in market interest
rates. Assuming no change in current market interest rates management expects
that the Company's gross interest margin will begin to improve throughout 1995.
OPERATING COSTS
The table below sets forth the Company's operating costs for the three-
month periods indicated (dollars are in thousands). The compensatory and legal
costs directly associated with the Company's property management and disposal
operations are excluded from the table below and are included in Real Estate
Operations (see REAL ESTATE OPERATIONS).
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------------
1995 1994 CHANGE
------ ------ --------
<S> <C> <C> <C>
Employee-related $(2,574) $(2,368) $ 206
Occupancy (788) (752) 36
Operating (829) (897) (68)
Professional fees (381) (349) 32
-------- ------- ------
(4,572) (4,366) (206)
SAIF premiums and OTS
assessments (549) (679) (130)
-------- -------- ------
$(5,121) $(5,045) $ 76
-------- -------- ------
-------- -------- ------
</TABLE>
Direct compensation and commissions represent approximately 75% of all
employee-related expenses. Management believes it has a full complement of
staff currently in place to effectively complete the bank-wide restructuring.
The reduction in SAIF premiums during 1995 reflect the benefit from several
branch deposit sales which occurred during the last half of 1994.
12
<PAGE>
NON-INTEREST REVENUES
The table below sets forth the Company's non-interest revenues for the
periods indicated (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------
1995 1994 CHANGE
------ ------ --------
<S> <C> <C> <C>
Loan and escrow fees $ 96 $225 $(129)
Deposit account fees 180 175 5
Other income 407 347 60
--- --- ---
$683 $747 $ (64)
--- --- ---
--- --- ---
</TABLE>
Loan and escrow fees in 1994 were higher than current period amounts due to
prepayments on existing mortgage loans subject to refinancings
REAL ESTATE OPERATIONS
The table below sets forth the revenues and costs attributable to the
Company's real estate operations for the three-month periods indicated (dollars
are in thousands). The compensatory and legal costs directly associated with
the Company's property management and disposal operations are included in the
table below in Operating costs.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------
1995 1994 CHANGE
------ ------ --------
<S> <C> <C> <C>
EXPENSES ASSOCIATED WITH REAL ESTATE OWNED
Operating costs
Employee $(188) $ (369) $ 181
Operating (26) (49) 23
Professional (86) (199) 113
----- ------- -----
(300) (617) 317
----- ------- -----
Holding costs
Property Taxes (23) (1,450) 1,427
Repairs, maintenance and renovation (128) (216) 88
Insurance (37) (33) (4)
----- ------- -----
(488) (2,316) 1,828
----- ------- -----
NET GAINS FROM SALES OF PROPERTIES 179 848 (669)
RENTAL INCOME, NET 475 287 188
----- ------- -----
$ 166 $(1,181) $1,347
----- ------- -----
----- ------- -----
</TABLE>
Commencing in August 1993 and continuing through the first quarter of 1995,
the Company established and staffed a separate group to manage the Company's
property management, construction, property disposal and restructuring
operations. The costs included in the table above (and, therefore, excluded
from operating costs (see OPERATING COSTS)), include employee compensation,
benefits, and outside legal fees directly attributable to the assets under
management by this group.
13
<PAGE>
Through June 30, 1994, the Company expensed as incurred the cost of minor
refurbishment and renovations for individual single family homes following
foreclosure. Commencing with the 1994 third quarter, such amounts have been
capitalized as incurred, with specific reserves and the resultant carrying value
of the asset being adjusted, as appropriate. For all periods, the costs of
major construction following the foreclosure of multiple-unit for-sale housing
developments have been capitalized as incurred and appropriately reflected in
the carrying values of such assets.
Net revenues from owned properties principally include the net operating
income (collected rental revenues less operating expenses) from foreclosed
apartment buildings or receipt, following foreclosure, of similar funds held by
receivers during the period the original loan was in default.
As of March 31, 1995, the Company's portfolio of properties consisted of
over 284 individual homes, apartment buildings and land parcels. In addition,
as of that date the Company's defaulted loan portfolio was represented by 140
properties and its portfolio of performing project concentration loans secured
551 individual homes. Because of the large aggregate number of units
represented by these risk portfolios, management expects that the costs incurred
to manage the property disposal and loan restructuring operations of the
Company, plus the holding costs associated with these portfolios (other than
interest lost following a loans' default and subsequent foreclosure), will
continue to be significant for the next several quarters.
ASSET QUALITY
GENERAL
The Company's loan portfolio is exclusively concentrated in Southern
California real estate. At March 31, 1995 and 1994, respectively, 57.3% and
57.3% of the Company's loan portfolio consisted of permanent loans secured by
single family residences, 38.2% and 37.0% consisted of permanent loans secured
by multi-unit residential properties, and 4.5% and 5.7% consisted of loans to
finance commercial properties, the acquisition of land and the construction of
single family housing.
Historically, the Company actively financed the construction of residential
properties, principally small-to-medium sized tracts of detached single family
homes and condominiums, and small apartment buildings (generally, less than 37
units). With respect to for-sale housing developments, the Company typically
provided permanent financing to buyers of individual homes and condominiums
within projects for which it provided the construction financing. In addition,
the Company generally provided a permanent loan commitment following its
financing for the construction of apartment buildings.
With respect to its past construction financing activities, the Company had
long-standing customer relationships with a small group of builders and
developers within its lending markets. Many of these builders were affiliated
with one another, either by marriage or business association. A significant
portion of the Company's nonperforming loans and foreclosed properties are
associated with this group of builders and developers.
The Company's performance continues to be adversely affected by the
weakness evident in its loan portfolio and a high volume of foreclosures. These
asset quality trends reflect the continuing weakness of the Southern California
economy, and the direct translation of this weakness to local real estate
markets. These factors have been, and will continue to be, exacerbated by
several factors unique to the Company's loan portfolio, including (1) its
sizeable portfolio of land and construction loans and properties, with respect
to which development, construction and/or sales are incomplete, (2) its
portfolio of loans secured by apartment buildings, for which property cash flows
are, or may become, inadequate to meet borrowers' debt service requirements, (3)
the concentration within the Company's loan and property portfolios of multiple
permanent loans and foreclosed properties within a single integrated
development, and (4) the concentration within the Company's portfolio of loans
to one or more individuals,
14
<PAGE>
or groups of individuals, which are affiliated and with respect to which there
remain limited financial resources to fund debt service payments where property
cash flows (either from sales of homes or from income property cash flows) are,
or may become, inadequate.
LOAN IMPAIRMENT
Loan impairment is measured by estimating the expected future cash flows
and discounting them at the respective effective interest rate or by valuing the
underlying collateral for collateral dependent loans. The recorded investment
in these loans and the valuation allowance for credit losses related to loan
impairment are as follows (dollars are in thousands).
<TABLE>
<CAPTION>
1995
-------
<S> <C>
Principal amount of impaired loans $30,292
Accrued interest 732
Less loan fees/cost 702
------
Less valuation allowance 30,322
6,558
------
$23,764
------
------
</TABLE>
FAS 114, Accounting by Creditors for Impairment of a Loan, was adopted on
January 1, 1995. At that date, a valuation for credit losses related to
impaired loans was separately identified. The activity in the allowance account
for the quarter ended March 31, 1995 is as follows:
<TABLE>
<S> <C>
Valuation allowance at beginning of period $4,935
Net charges to operations for impairment 1,623
------
Valuation allowance at end of period $6,558
------
------
</TABLE>
Total cash collected on impaired loans during the three months ended March
31, 1995 was $215,000 of which $57,000 was credited to the principal balance
outstanding on such loans and $158,000 was recognized as interest income.
RISK ASSETS
15
<PAGE>
At March 31, 1995 the Company's problem asset ratios were far higher than
those of most lenders within its lending markets. The table below sets forth
the composition, measured by gross and net investment, of the Company's Risk
Asset portfolio. Risk Assets include owned properties, nonaccrual loans, and
performing loans which have been adversely classified pursuant to OTS
regulations ("Performing/Classified" loans) and guidelines. Loans categorized as
Special Mention are not classified pursuant to regulatory guidelines, but are
included in these tables as an indication of migration trends (dollars are in
thousands).
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
1995 1994 1994
--------- ------------ ---------
<S> <C> <C>
NONPERFORMING ASSETS
Properties $ 95,224 $ 99,119 $131,271
Nonaccrual loans 34,220 39,396 87,614
-------- -------- --------
129,444 138,515 218,885
OTHER LOANS
Performing loans classified Doubtful
or Substandard 69,053 61,289 73,616
-------- -------- --------
GROSS INVESTMENT IN RISK ASSETS 198,497 199,804 292,501
CREDIT LOSSES
Specific reserves and writedowns (44,905) (43,749) (68,771)
Allocated general reserves (9,679) (8,167) (16,447)
-------- -------- --------
NET INVESTMENT IN RISK ASSETS $143,913 $147,888 $207,283
-------- -------- --------
-------- -------- --------
LOANS DESIGNATED AS SPECIAL MENTION $ 68,037 $ 80,385 $58,323
-------- -------- --------
-------- -------- --------
</TABLE>
The Company currently places loans on nonaccrual status when (1) they
become one or more payment delinquent and (2) management believes that, with
respect to performing loans, continued collection of principal and interest from
the borrower is not reasonably assured.
The performance of the asset portfolio during the quarter continued to
demonstrate positive results from the restructuring efforts of the past eighteen
months. At March 31, 1995, the Company had foreclosed properties and nonaccrual
loans with a carrying value of $84 million, or 12% of total assets. At year end
1994, the carrying value of nonperforming assets was $94 million, or 13% of
total assets. By comparison, the carrying value of nonperforming assets at
March 31, 1994, was $146 million, or 17% of total assets and at December 31,
1993 was $153 million, or 17% of total assets. The migration of new loan
defaults has slowed measurably, and successful collection efforts and
disposition of foreclosures have reduced the overall levels accordingly. Loans
in default of their contractual terms and conditions, and subsequently
categorized as nonaccrual, at March 31, 1995, amounted to $34 million. This
compares favorably to the year end 1994 level of $39 million, a March 31, 1994,
balance of $88 million and a December 31, 1993 balance of $80 million. Within
the March 31, 1995 total of nonaccrual loans, $12 million in principal balances
were delinquent less than three payments.
16
<PAGE>
The table below sets forth the composition, measured by gross and net
investment, of the Company's Risk Asset portfolio as of March 31, 1995, by type
of property (dollars are in thousands).
<TABLE>
<CAPTION>
PERFORMING\CLASSIFIED %
---------------------
NONACCRUAL SPECIAL TO TOTAL
PROPERTIES LOANS SUBSTANDARD MENTION TOTAL PORTFOLIO
---------- ---------- ----------- ------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
GROSS INVESTMENT
Existing housing
Single family homes
Non-Project $ 3,452 $ 9,521 $ 9,321 $22,235 $ 44,529 18.9%
Project concentrations 13,200 10,798 22,907 19,314 66,219 59.7%
Apartment buildings 31,238 9,742 34,980 22,988 98,948 39.3%
Acquisition and Development
Construction 32,145 4,078 1,663 37,886 82.6%
Land 14,788 66 1,425 16,279 87.2%
Commercial properties 401 15 182 2,075 2,673 34.0%
------- ------- ------- ------- --------
95,224 34,220 69,053 68,037 266,534 40.4%
CREDIT LOSSES
Specific reserves and writedowns (35,319) (5,859) (3,727) (288) (45,193)
Allocated general reserves (2,705) (1,607) (5,367) (4,404) (14,083
------- ------- ------- ------- --------
NET INVESTMENT $57,200 $26,754 $59,959 $63,345 $207,258 34.8%
------- ------- ------- ------- -------- ----
------- ------- ------- ------- -------- ----
</TABLE>
SINGLE FAMILY (NON-PROJECT)
In the preceding table, non-project single family homes consist of
foreclosed properties and defaulted and performing/classified loans secured by
single family homes which are not part of an integrated development, with
respect to which the Company financed the construction of the development or
financed the purchase of homes from the developer by individuals. At March 31,
1995, the Company (1) owned 11 homes which were being actively marketed for
sale, (2) had 53 defaulted loans secured by single family (non-project) homes,
(3) had 29 loans which were performing but had been classified Substandard, and
(4) had 120 loans which were performing but had been designated Special Mention.
The Company has valued its owned single family homes at their estimated
liquidation values. The defaulted loan portfolio secured by single family homes
(non-project) has been valued, in the aggregate, consistently with the actual
recovery rates achieved through sales of foreclosed homes since 1993.
17
<PAGE>
PROJECT CONCENTRATIONS
The Company made thirty-year, fully-amortizing permanent loans to a large
number of purchasers of individual units from developers in for-sale housing
developments with respect to which the Company financed construction ("project
concentrations"). A majority of these permanent "takeout" loans were originated
during the period 1989 through 1992 and were made on terms that fell outside the
parameters normally associated with conforming or conventional single family
home loans. In some instances, as a means to pay-off a matured, troubled
construction loan, the Company made permanent loans to the developer,
collateralized individually by the remaining unsold units within the
development.
Through March 1995, management had identified 63 separate project
concentrations. The table below summarizes certain information about the
Company's project concentrations as of March 31, 1995 (dollars are in
thousands). The table includes the Company's gross investment (1) in individual
takeout loans within project concentrations, (2) related to unsold units
previously foreclosed upon, and (3) related to unsold units which secure a
construction loan outstanding at March 31, 1995, and with respect to which the
Company also made individual takeout loans.
<TABLE>
<CAPTION>
GROSS INVESTMENT/LOAN PRINCIPAL
----------------------------------------------------------
NUMBER NUMBER INDIVIDUAL CONSTRUCTION
OF LOANS OF UNITS TAKEOUTS LOAN TOTAL % TO TOTAL
-------- -------- ---------- ------------ ------- ----------
<S> <C> <C> <C> <C> <C> <C>
Performing loans 458 551 $70,225 $4,009 $74,234 75.9%
Loans in default 62 62 10,798 10,798 11.1%
Properties 46 59 9,421 3,320 12,741 13.0%
----- ---- ------- ------ ------- ------
566 672 $90,444 $7,329 $97,773 100.0%
----- ---- ------- ------ ------- ------
----- ---- ------- ------ ------- ------
</TABLE>
The table below summarizes the percentage of all units within project
concentrations for which Hawthorne retains a continuing investment.
<TABLE>
<CAPTION>
NUMBER
OF UNITS % TO TOTAL
-------- ----------
<S> <C> <C>
FINANCED BY HAWTHORNE
Sold units 595 42.5%
Unsold units 77 5.5%
----- -----
672 48.0%
Financed by others 729 52.0%
----- -----
Total number of units 1,401 100.0%
----- -----
----- -----
</TABLE>
In addition to the inherent risks associated with real estate loans,
project concentration loans pose additional risks of default, foreclosure and
loss. As illustrated in the preceding tables, approximately 24% of the number of
units originally financed by the Company are either in default or have been
foreclosed upon. Many of these units have never been sold by the developer and
have either been rented during the interim or remain vacant. The factors which
will significantly influence the ultimate recovery of the Company's gross
investment in performing project concentration loans include (1) the condition
and overall management of a development (by the homeowner's association), (2)
the selling prices which can be achieved for the units foreclosed upon, or
expected to be foreclosed upon, and resold in the current market, and their
relation to the outstanding principal balance of individual performing loans,
and (3) the extent to which the original sales of units to end buyers were
financed, in part, by the developer, minimizing the initial cash investment
required from the purchaser.
18
<PAGE>
The Company has established specific and general reserves to address the
risk factors enumerated above and the resulting uncertainties. Reserves are
established separately for each project concentration. The table below
summarizes the basis for establishing reserves for project concentrations
(dollars are in thousands).
<TABLE>
<CAPTION>
NUMBER OF GROSS
BASIS OF VALUATION DEVELOPMENTS INVESTMENT
---------------------------------------- ------------ ----------
<S> <C> <C>
Recent sales history within project 23 $62,723
% of original appraisal 36 27,138
Current appraisal/no recent sales history 4 7,912
-- ------
All project concentrations 63 $97,773
-- ------
-- ------
</TABLE>
Management considers reliable recent sales history to exist when the
Company has sold two or more units within a project for cash (financing to the
purchaser having been provided by another lender) during 1994. The per unit
values at which the Company has established its net investment for these
projects are net of expected selling costs. Where no recent sales history
exists, current appraisals, less expected selling costs, are utilized to
establish the Company's net investment. For all other projects, the significant
majority of which are not classified, percentages ranging from 65% to 90% of
original appraised value have been utilized to establish the Company's net
investment.
APARTMENT BUILDINGS
At March 31, 1995, the Company owned 55 apartment buildings and loans
secured by 22 apartment buildings were in default. With respect to these
combined portfolios, the buildings are predominantly located in the South Bay
region of Los Angeles, are between five and ten years old and average 12 units
in size. The Company's owned apartment buildings have been operated for their
current cash flow yield and potential for future appreciation since their
foreclosure. The average holding period for this portfolio approximates 12
months. The carrying value of this portfolio has been determined based upon
management's projections of the stabilized cash flow returns commanded by
investors in such properties, assuming conventional financing terms presently
available in the marketplace.
The gross investment value of the foreclosed properties portfolio at March
31, 1995, was $31 million. The Company accounts for these properties at fair
market value, by establishing and adjusting, as appropriate, specific and
general valuation allowances on these properties. During the first quarter of
1995, the Company recorded provisions for credit losses totalling $12.0 million,
the majority of which was attributable to an increase in the capitalization
rates utilized by the Company to value its portfolio of owned operating
apartment buildings and classified apartment loan collateral. These higher
capitalization rates resulted primarily from increases in the cost to finance
apartment building acquisitions. Management has recently concluded that the
maximum benefit to the Company is now for the orderly liquidation of the
foreclosed properties portfolio. These properties, now stabilized and
reflective of recovering market conditions, should be liquidated without any
material impact to earnings.
The carrying value of the defaulted apartment loan portfolio has been
determined on the same basis as for owned apartment buildings, where property-
specific information is available, or based upon the average per unit valuation
for owned buildings of similar unit size and unit mix. For performing apartment
loans classified either Substandard or designated Special Mention, reserves have
been established based upon property-specific valuations which utilize current
and stabilized cash flows and incorporate management's assessment of future
event risk.
19
<PAGE>
RESIDENTIAL CONSTRUCTION
The table below sets forth, as of March 31, 1995, the unit composition and
gross investment associated with owned developments and loans secured by the
remaining unsold units of for-sale housing developments (dollars are in
thousands).
<TABLE>
<CAPTION>
NUMBER OF UNITS
NUMBER OF ------------------------ REMAINING AT
DEVELOPMENTS ORIGINAL SOLD MARCH 31, 1995
------------ --------------- ---- --------------
<S> <C> <C> <C> <C>
OWNED
Units 6 206 (78) 128
Gross investment $32,146
Net investment 15,155
NONACCRUAL LOANS
Units 1 59 (37) 22
Gross investment $4,079
Net investment 3,048
PERFORMING/CLASSIFIED LOANS
Units 1 1 1
Gross investment $1,663
Net investment 1,414
ALL PROJECTS
--- --- ---- -------
Units 8 266 (115) 151
--- --- ---- -------
--- --- ---- -------
Gross investment $37,888
-------
-------
Net investment $19,617
-------
-------
</TABLE>
The Company's owned residential construction projects consist of 6 projects
with a total of 206 units. During the first quarter of 1995, the Company sold
33 units at minimal gains, and financed only 2 of these sales.
The Company accepted a deed-in-lieu of foreclosure in May, on the project
securing the nonaccrual construction loan. Based upon management's estimate of
the current market value of the property and existing loan loss reserves,
management does not anticipate any material loss in connection with the
completion and disposal of the project.
The project securing the only classified performing construction loan
consisted of single family residences. The loan matured in March 1995, and in
April, the Company took a deed-in-lieu of foreclosure. Construction is complete
on this property and, based on the current fair market value of the property,
management does not anticipate any material losses in connection with the
disposal of this property.
20
<PAGE>
LAND
The Company's portfolio of owned land parcels is concentrated in (1)
several tentatively mapped, unimproved land parcels entitled for multiple unit
residential developments ($12 million of gross investment), (2) one multiple lot
development ($6.4 million of gross investment) and (3) several single lot
developments. Management is presently evaluating its disposal options with
respect to several of the Company's owned land parcels (included in (1) above),
including having the Company retain ownership of the land and fund future
development. Therefore, these parcels are not being currently marketed for
sale. All of the remaining parcels are being actively marketed for sale.
The Company's investment in land has been valued by reference to comparable
land sales (where available), current appraisals and discounted cash flow land
residual analyses.
RESERVES
The Company maintains reserves against specific assets, in those instances
in which it believes that full recovery of the Company's gross investment is
unlikely. As of March 31, 1995, the Company had established specific reserves
based upon (1) management's strategy to be employed in managing and disposing of
the asset and the corresponding financial consequences, (2) current indications
of property values from (a) completed, recent sales from the Company's property
portfolio, (b) real estate brokers, and (c) potential buyers of the Company's
properties, and (3) current property appraisals. In addition, management
establishes general reserves against its loan and property portfolios when
sufficient information does not exist to support establishing specific reserves.
The loss factors utilized to establish general reserves are based upon (1) the
actual loss experience for similar loans and properties within the Company's
portfolio, when such loss experience is available and representative of the
assets being valued in, or (2) estimates of current liquidation values for
collateral serving performing loans for a representative sampling of each
portfolio segment.
During the first quarter of 1995, the OTS and the FDIC completed an
examination of the Company and the Bank. As previously mentioned, the Company
increased its reserves for potential losses on the classified loan and property
portfolios by $12.7 million during the first quarter of 1995. The increased
reserves are reflective of higher capitalization rates utilized by the Company
and the regulatory agencies to value collateral supporting apartment loans and
foreclosed properties, and were not associated with actual losses within the
portfolio.
The table below sets forth the amounts and percentages of general and
specific credit losses for the Company's loan and property portfolios as of
March 31, 1995 (dollars are in thousands).
<TABLE>
<CAPTION>
LOANS
----------------------
PERFORMING NONACCRUAL PROPERTIES TOTAL
---------- ---------- ---------- -------
<S> <C> <C> <C> <C>
AMOUNTS
Writedowns $ - $ - $ 2,979 $ 2,979
Specific reserves 4,438 5,859 32,340 42,637
General reserves 14,115 1,607 2,705 18,427
------ ----- ------ ------
Total credit losses $18,553 $7,466 $38,024 $64,043
------ ----- ------ ------
------ ----- ------ ------
PERCENTAGES
% of total credit losses to
gross investment 3.5% 21.8% 39.9% 9.7%
% of general reserves to
gross investment 2.7% 4.7% 2.8% 2.8%
</TABLE>
21
<PAGE>
The tables below summarize the activity of the Company's reserves for the
periods indicated (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------------------
1995 1994
------------------- -------------------
PROPERTIES LOANS PROPERTIES LOANS
---------- ------- ---------- -------
<S> <C> <C> <C> <C>
RESERVE ACTIVITY
Beginning balance $33,517 $21,461 $39,457 $46,628
Provision for losses 12,700
Charge-offs (6,486) (128) (1,412)
Recoveries
Transfers 8,014 (8,014) 11,163 (11,163)
------ ------ ------ ------
Ending balance $35,045 $26,019 $49,208 $35,465
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
LENDING OPERATIONS
During the second half of 1994, the Bank re-entered its lending markets,
principally the South Bay area of Los Angeles County, after completely
rebuilding its lending infrastructure with new products, services, processing
systems, appraisal practices and credit management. For the first quarter of
1995, the Bank was able to increase its net loan outstanding by $11 million
through new originations totaling $25 million. This represented the Bank's
first period of significant production during the past eighteen months. The new
loan production was centered in multi-family properties (50%), single family
loans (40%), and construction financing within the South Bay market (10%). The
Company considers these three segments its pricing sources of new business (see
ASSET GENERATION).
CAPITAL
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") and implementing capital regulations require the Bank to maintain (1)
Tangible Capital of at least 1.5% of Adjusted Total Assets (as defined in the
regulations); (2) Core Capital of at least 3.0% of adjusted total assets (as
defined in the regulations); and (3) Total Risk-based Capital equal to 8.0% of
Total Risk-weighted Assets (as defined in the regulations).
22
<PAGE>
The following table summarizes the regulatory capital requirements under
FIRREA for the Bank at March 31, 1995, but does not reflect future phasing out
of certain assets, including investments in, and loans to, subsidiaries which
presently engage in activities not permitted for national banks (the impact is
immaterial). As indicated in the table, the Bank's capital levels exceed all
three of the currently applicable minimum FIRREA capital requirements (dollars
are in thousands).
<TABLE>
<CAPTION>
TANGIBLE CAPITAL CORE CAPITAL RISK-BASED CAPITAL
----------------- ---------------- ------------------
BALANCE % BALANCE % BALANCE %
--------- ---- --------- ---- ----------- ----
<S> <C> <C> <C> <C> <C> <C>
Stockholder's equity $ 26,974 $ 26,974 $ 26,974
Adjustments
General valuation
allowances 5,598
Core deposits intangibles (216)
Interest rate risk component (1)
-------- ---- -------- ---- --------
Regulatory capital (2) 26,758 3.70% 28,374 3.73% 32,572 7.44%
Required minimum 10,837 1.50% 21,680 3.00% 35,014 8.00%
-------- ---- -------- ---- -------- -----
Excess (deficient) capital $ 15,921 2.20% $ 5,994 0.73% $ (2,442) (0.56%)
-------- ---- -------- ---- -------- -----
-------- ---- -------- ---- -------- -----
Adjusted assets (3) $722,438 $722,656 $437,676
-------- ---- -------- ---- -------- -----
-------- ---- -------- ---- -------- -----
<FN>
(1) At March 31, 1995, the OTS had temporarily suspended the application of its
interest rate risk regulation but anticipated that it would become
effective again as of September 30, 1995. Had the regulation been in
effect at March 31, 1995, the Bank would have been required to deduct from
risk-based capital an interest rate risk exposure component of $3,224,000
(unaudited) as computed by the OTS as one-half of the excess of the
estimated change in the Bank's net portfolio value (determined in
accordance with OTS regulations) over a normal change in net portfolio
value (2%) assuming an immediate and sustained 200 basis point increase in
interest rates, using the Bank's reported balance sheet information as of
December 31, 1994. The Bank's risk-based capital ratio would have been
6.91% as of March 31, 1995 had the deduction been required.
(2) At periodic intervals, both the OTS and the FDIC routinely examine the Bank
as part of their legally prescribed oversight of the industry. Based on
their examinations, the regulators can direct that the Bank's financial
statements be adjusted in accordance with their findings.
(3) The term "adjusted assets" refers to the term "adjusted total assets"as
defined in 12 C.F.R. Section 567.1(a) for purposes of tangible and core
capital requirements, and for purposes of risk-based capital requirements,
refers to the term "risk-weighted assets" as defined in 12 C.F.R. Section
567.1(b)
</TABLE>
23
<PAGE>
Under the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"),
which supplemented FIRREA, the OTS has issued "prompt corrective action"
regulations with specific capital ranking tiers for thrift institutions.
Progressively more stringent operational limitations and other corrective
actions are required as an institution declines in the capital ranking tiers.
The five qualifying tiers are set forth below.
<TABLE>
<CAPTION>
RATIO OF RATIO OF
CORE CAPITAL TOTAL CAPITAL
RATIO OF TO RISK- TO RISK-
CORE CAPITAL WEIGHTED WEIGHTED
TO ASSETS ASSETS ASSETS
-------------- -------------- --------------
<S> <C> <C> <C>
Well capitalized 6% or above 5% or above 10% or above
Adequately capitalized 4% or above 4% or above 8% or above
Under capitalized Under 4% Under 4% Under 8%
Significantly undercapitalized Under 3% Under 3% Under 6%
Critically undercapitalized Ratio of tangible equity to adjusted total assets of 2% or less
</TABLE>
The Bank's ratios at March 31, 1995 are set forth below.
<TABLE>
<S> <C>
Ratio of Core Capital to Total Assets 3.73%
Ratio of Core Capital to Risk-weighted Assets (Leverage ratio) 6.16%
Ratio of Total Capital to Risk-weighted Assets 7.44%
</TABLE>
Based upon the foregoing, the Bank is classified as an under capitalized
institution.
The thrift industry is exposed to economic trends and fluctuations in real
estate values. In recent periods, those trends have been recessionary in
nature, particularly in Southern California. Accordingly, the trends have
adversely affected both the delinquencies being experienced by institutions such
as the Bank and the ability of such institutions to recoup principal and accrued
interest through acquisition and sale of the underlying collateral. No
assurances can be given that such trends will not continue in future periods,
creating increasing downward pressure on the earnings and capital of thrift
institutions.
SUPERVISORY AGREEMENT
On October 24, 1994, the Bank's Board of Directors and the OTS entered into
a Supervisory Agreement ("Agreement"). The Agreement requires that (1) the Bank
increase its core and risk-based capital ratios to a minimum of 6.0% and 11.0%,
respectively, by June 30, 1995, (2) the Bank submit its 1995 Business Plan
("Plan") to the OTS for their prior approval, and that the Plan incorporate an
infusion of capital into the Bank as prescribed in the Agreement, (3) the Bank
fully implement its Asset Review policy by April 1, 1995, in particular that the
Bank formally implement the organizational provisions of such policy, and (4)
the Bank retain qualified Compliance and Community Investment Act officers and
staff and maintain effective and comprehensive Compliance and CRA programs to
ensure the Bank's compliance with all applicable consumer protection,
nondiscrimination, fair lending and housing, public policy, and other compliance
laws and regulations, with particular emphasis on the Bank's compliance with
those areas identified as problems in the Bank's 1990, 1991 and 1992 Compliance
Examinations. The Agreement also requires the Board of Directors to adopt a
Compliance Resolution following each calendar quarter during which the Agreement
remains in effect for submission to the OTS. The Agreement contains no
24
<PAGE>
termination date. The Agreement supersedes in their entirety all previously
outstanding enforcement documents, including a Cease and Desist Order, dated
March 11, 1992, and Directive Letters dated December 29, 1992 and December 12,
1990.
Management and the Board of Directors have informed the OTS and the FDIC
that the Company will not achieve its required capital ratios by June 30, 1995.
As previously stated, the Company will be submitting a capital plan by the end
of May to the OTS. The OTS may accept the capital plan, it may reject it, or it
may request modifications. Absent on acceptable capital plan, the OTS may
impose additional corrective actions against the Company, inclusive of a forced
receivership and liquidation. Raising the required additional capital is
expected to result in a substantial dilution of existing stockholder interests.
Consistent with its 1994 Business Plan, a Chief Compliance Officer and Community
Investment Officer were retained by mid-year. See PROSPECTS for a further
discussion of the strategic elements management expects to be incorporated into
the Company's 1995 Business Plan
CAPITAL RESOURCES AND LIQUIDITY
The Bank's liquidity position refers to the extent to which the Bank's
funding sources are sufficient to meet its current and long-term cash
requirements. Federal regulations currently require a savings institution to
maintain a monthly average daily balance of liquid and short-term liquid assets
equal to at least 5.0% and 1.0%, respectively, of the average daily balance of
its net withdrawable accounts and short-term borrowings during the preceding
calendar month. The Bank had liquidity and short-term liquidity ratios of 12%
and 6%, respectively, as of March 31, 1995, and 14% and 12%, respectively, as of
December 31, 1994.
The Bank's current primary funding resources are deposit accounts,
principal payments on loans, proceeds from property sales and cash flows from
operations. Other possible sources of liquidity available to the Bank include
reverse repurchase transactions involving the Bank's investment securities,
mortgage-backed securities or whole loans, FHLB advances, commercial bank lines
of credit, and direct access, under certain conditions, to borrowings from the
Federal Reserve System. The cash needs of the Bank are principally for the
payment of interest on and withdrawals of deposit accounts, the funding of
loans, operating costs and expenses, and holding and refurbishment costs on
foreclosed properties.
To supplement its funding needs, the Company enters into reverse repurchase
agreements, in which it sells securities with an agreement to repurchase the
same securities at a specific future date (overnight to 90 days). The Company
enters into such transactions only with dealers determined by management to be
financially strong and who are recognized as primary dealers in U.S. Treasury
securities by the Federal Reserve Board. The following table summarizes
information relating to the Company's reverse repurchase agreements as of March
31, 1995 (dollars are in thousands):
<TABLE>
<CAPTION>
1995
--------
<S> <C>
Average balance during period $29,000
Average interest rate during period 6.07%
Maximum month-end balance during period 47,141
Mortgage-backed securities
underlying the agreements at period end:
Carrying value 9,046
Estimated market value 8,829
Outstanding reverse repurchase agreements
Balance 8,585
Interest rate 6.10%
</TABLE>
25
<PAGE>
Reverse repurchase agreements outstanding March 31, 1995 matured on April
6, 1995, and were rolled over for an additional 30 days.
INTEREST RATE RISK MANAGEMENT
The objective of interest rate risk management is to stabilize the
Company's net interest income ("NII") while limiting the change in its net
portfolio value ("NPV") from interest rate fluctuations. The Company seeks to
achieve this objective by matching its interest sensitive assets and
liabilities, and maintaining the maturity and repricing of these assets and
liabilities at appropriate levels given the interest rate environment. When the
amount of rate sensitive liabilities exceeds rate sensitive assets, the net
interest income will generally be negatively impacted during a rising rate
environment as has been the situation during the past eighteen months. The speed
and velocity of the repricing of assets and liabilities will also contribute to
the effects on net interest income.
The Company utilizes two methods for measuring interest rate risk. Gap
analysis is the first method, with a focus on measuring absolute dollar amounts
subject to repricing given certain periods of time. A negative gap occurs when
interest sensitive liabilities exceed interest sensitive assets, with the
majority of the focus typically at the one-year maturity horizon. The negative
one-year maturity gap indicates, absent offsetting factors, that the Company has
more exposure to interest rate risk in an increasing interest rate environment.
This is the situation in which the Company has operated in during the past year.
In addition to utilizing gap analysis in measuring interest rate risk, the
Company performs a monthly interest rate simulation. This simulation provides
the Company with an estimate of both the dollar amount and percentage change in
net interest income under various interest rate scenarios. All assets and
liabilities are subjected to tests of up to 400 basis points in increases and
decreases in interest rates. Under each interest rate scenario, the Company
projects its net interest income and net portfolio value of market equity of the
current balance sheet. From these results, the Company can then develop
alternatives to dealing with the tolerance thresholds.
A principal mechanism used by the Company in the past for interest rate
risk management was the origination of ARMs tied to the 11th DCOFI. The basic
premise was that the Company's actual cost of funds would parallel the 11th
DCOFI, and as such, the net interest margins would generate the desired
operating results.
ARMs tied to 11th DCOFI are slower in responding to current interest rate
environments than other types of variable rate loans because the index is a
compilation of the average rates paid by member institutions of the 11th
District of the FHLB. This index typically lags market rate changes in both
directions. If interest rates on deposit accounts increase due to market
conditions and competition, it may be anticipated that the Company will, absent
offsetting factors, experience a decline in the percentage of net interest
income to average interest-earning assets (the "Net Interest Margin"). A
contributing factor would be the lag in upward pricing of the ARMs tied to the
11th DCOFI. However, the lag inherent in the 11th DCOFI will also cause the ARMs
to remain at a higher rate for a longer period after interest rates on deposits
begin to decline. The 11th DCOFI lag during a falling rate environment should
benefit, in the short-term, the Company's Net Interest Margin, but the actual
dynamics of prepayments and the fact that ARMs reprice at various intervals may
somewhat alter this expected benefit.
Effective September 30, 1995, the Office of Thrift Supervision ( the "OTS")
will require that institutions complete an Interest Rate Risk Exposure Report.
This report will measure an institution's interest rate risk given the effect of
large interest rate movements. If, based upon the results of this calculation,
the institution's interest rate risk falls outside of the permitted range, the
institution will be required to deduct certain amounts from its risk-based
capital. In response to this OTS requirement, the Company has implemented a
strategy to reduce its interest rate exposure. This strategy includes, among
other things, an interest rate cap. In March 1995, the Company purchased a six-
month cap with a notional amount of $450 million with a strike price of
approximately 110 basis points above current market rates. This cap was
intended to reduce the impact of a sharp increase in interest rates on the
Company's liabilities, which tend to reprice faster than the Company's loan
portfolio.
26
<PAGE>
PROSPECTS
FINANCIAL
For the three-year period ended December 31, 1994, the Company reported
cumulative net losses of $55 million, reducing its equity capital by 58%. For
the three months ended March 31, 1995, the Company lost $9.4 million. The
quarter loss was generated by provisions for credit losses of $12.0 million,
which was partially offset by net earnings of $0.1 million from its core savings
and loan business, $0.2 million in earnings from real estate operations, and net
gains on sales of securities (net of tax adjustments) of $2.5 million. As
described more fully elsewhere herein, the Company's operating margins have been
significantly impacted because of the high volume of foreclosures and the rapid
and significant rise in interest rates since early 1994. Commencing with the
1995 second quarter, the Company's operating margins will begin to improve with
the continued disposition of foreclosed assets and favorable repricing of its
adjustable-rate loan portfolio. Conversely, since mid-1993, operating costs
have increased from their pre-1993 levels as new management has (1) aggressively
pursued the retention of highly qualified people to restructure the Company's
existing operations, to manage its portfolio of Risk Assets and to establish new
lines of business, (2) made significant investments in the Company's remaining
facilities, (3) made significant investments to improve the Company's
information management systems, and (4) spent heavily to promote the Company's
products and services. As a consequence, the Company's current level of fixed
costs cannot be profitably spread over its diminished asset base ($725 million
at March 31, 1995 as compared with $980 million at June 30, 1993).
The factors enumerated above will result in a continuation of operating
losses. Based upon current projections, which assume (1) no change in the
current level of market interest rates, (2) significant new asset generation
(see below) initiated in early in 1995, and (3) the current level of operating
costs, the Company will not be profitable until the end of 1995, at the
earliest.
RISK ASSETS
Notwithstanding the significant progress made in disposing of foreclosed
properties during 1994 and the first quarter of 1995, the Company's portfolios
of Risk Assets remain at very significant and highly dilutive levels. As
previously reported, management does not expect that these portfolios will be
reduced to levels approaching those normally associated with "healthy" financial
institutions until at least the end of 1995 or early 1996. To date, recoveries
from property sales have comported with the reserves previously established
since 1993 and virtually all of the Company's multiple unit, for-sale housing
projects have experienced multiple unit sales during 1994 (without being
financed by the Company), providing a solid, empirical basis for the current
carrying values of such projects. However, management cannot predict with
certainty the future performance of the Company's remaining portfolio of
performing loans, much of which has been classified. Accordingly, additional
provisions for credit losses may be required in the future should the
performance of its loan portfolio deteriorate further.
BRANCH RESTRUCTURING
During the 1994 third quarter, management largely completed its
restructuring of the Company's retail branch network. The Company now operates
9 savings branches with average deposits of $75 million per branch. At
September 30, 1993, the Company operated 21 branches, with average deposits per
branch of $44 million.
During the next several quarters, deposit growth is expected to be
generated from the Company's existing locations. The Company has initiated
certain activities that are intended to increase its core deposit base, while
reducing its average cost of funds. These initiatives will include introducing
greater emphasis on building upon lower
27
<PAGE>
costing transactional accounts, such as checking, savings, NOW and money market
accounts. The Company will also seek to shorten the average maturity of
certificates of deposits as general interest rates continue to moderate.
ASSET GENERATION
The Company reestablished its real estate financing operation very late in
1994 and competes with numerous financial intermediaries for new loans. The
Company's new financing programs are targeted to owners and purchasers of
medium-sized apartment buildings, single family development sites and expensive
single family residences. In addition, the Company continues to offer
competitive loan programs to all home buyers within its immediate market areas.
Internal projections call for the Company's aggregate financing volume to grow
gradually throughout 1995. Management contemplates that new loan originations
will be held in portfolio rather than being sold in the secondary mortgage
markets.
REGULATORY
As described elsewhere herein (see SUPERVISORY AGREEMENT), the Bank remains
under the intense scrutiny of the OTS and the FDIC. Until such time as the Bank
(1) receives an infusion of capital sufficient to meet current and future
balance sheet requirements, (2) satisfies the OTS that the operating and
compliance deficiencies accumulated prior to 1993 have been adequately and
permanently addressed, (3) achieves a further significant reduction to its
portfolios of Risk Assets, and (4) can demonstrate sustainable profitability,
management believes that regulatory scrutiny of its business activities,
including lending programs, and branch and entity acquisitions, will continue to
be intense. Such scrutiny could result in the OTS not permitting the Company to
proceed with one or more of the strategic initiatives described above.
Should the Company not be permitted to engage in certain higher margin
business activities (with respect to which the Company has, or will have,
demonstrated competence), future balance sheet growth will either fall short of
management's targets or consist of lower margin assets. In this event, the
Company's future profitability will not only be retarded but may in fact be
pushed out indefinitely into the future.
28
<PAGE>
GENERAL REGULATION
The OTS has enforcement authority over savings institutions and their
holding companies, including, among other things, the ability to assess civil
money penalties, to issue cease and desist orders, to initiate removal and
prohibition orders against officers, directors and certain other persons, and
the authority to appoint a conservator or receiver. In general, these
enforcement actions may be initiated for violations of laws and regulations,
violations of cease and desist orders and "unsafe or unsound" conditions or
practices, which are not limited to cases of inadequate capital. FIRREA
requires, except under certain circumstances, public disclosure of final
enforcement actions by the OTS.
The FDIC has authority to recommend that the OTS take any authorized
enforcement action with respect to any federally insured savings institution.
If the OTS does not take the recommended action or provide an acceptable plan
for addressing the FDIC's concerns within 60 days after receipt of a
recommendation from the FDIC, the FDIC may take such action if the FDIC board of
directors determines that the institution is in an unsafe or unsound condition
or that failure to take such action will result in the continuation of unsafe or
unsound practices in conducting the business of the institution. The FDIC may
also take action prior to the expiration of the 60-day time period in exigent
circumstances after notifying the OTS.
The FDIC may terminate the deposit insurance of any insured depository if
the FDIC determines, after a hearing, that the institution has engaged or is
engaging in unsafe or unsound practices, which, as with OTS authority, are not
limited to cases of capital inadequacy, is in an unsafe or unsound condition to
continue operations or has violated any applicable law, regulation or order or
any condition imposed in writing by the FDIC. In addition, FDIC regulations
provide that any insured institution that falls below a 2% minimum leverage
ratio will be subject to FDIC deposit insurance termination proceedings unless
it has submitted, and is in compliance with, a capital plan with its primary
federal regulator and the FDIC. The FDIC may also suspend deposit insurance
temporarily during the hearing process if the institution has no tangible
capital. The FDIC is additionally authorized by statute to appoint itself as
conservator or receiver of an insured institution (in addition to the powers of
the institution's primary federal regulatory authority) in cases, among others
and upon compliance with certain procedures, of unsafe or unsound conditions or
practices or willful violations of cease and desist orders.
29
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings - None
ITEM 2. Changes in Securities - None
ITEM 3. Defaults upon Senior Securities - None
ITEM 4. Submission of Matters to Vote of Security Holders - None
ITEM 5. Other Materially Important Events - None
ITEM 6. Exhibits and Reports on Form 8-K - None
30
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to signed on its behalf by the
undersigned thereunto duly authorized.
HAWTHORNE FINANCIAL CORPORATION
Dated August 2, 1995 /s/ SCOTT A. BRALY
----------------- -----------------------------
Scott A. Braly
President and
Chief Executive Officer
Dated August 2, 1995 /s/ NORMAN A. MORALES
--------------- -----------------------------
Norman A. Morales
Executive Vice President
and Chief Financial Officer
31
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> MAR-31-1995
<CASH> 7,967
<INT-BEARING-DEPOSITS> 678,903
<FED-FUNDS-SOLD> 7,800
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 29,997
<INVESTMENTS-CARRYING> 54,494
<INVESTMENTS-MARKET> 52,515
<LOANS> 540,823
<ALLOWANCE> 26,019
<TOTAL-ASSETS> 724,300
<DEPOSITS> 681,421
<SHORT-TERM> 8,585
<LIABILITIES-OTHER> 4,984
<LONG-TERM> 0
<COMMON> 2,599
0
0
<OTHER-SE> 26,711
<TOTAL-LIABILITIES-AND-EQUITY> 724,300
<INTEREST-LOAN> 10,808
<INTEREST-INVEST> 1,876
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 12,484
<INTEREST-DEPOSIT> 7,466
<INTEREST-EXPENSE> 7,913
<INTEREST-INCOME-NET> 4,571
<LOAN-LOSSES> 12,745
<SECURITIES-GAINS> 2,902
<EXPENSE-OTHER> 5,121
<INCOME-PRETAX> (9,544)
<INCOME-PRE-EXTRAORDINARY> (9,544)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,129)
<EPS-PRIMARY> (3.90)
<EPS-DILUTED> 0
<YIELD-ACTUAL> 7.77
<LOANS-NON> 34,220
<LOANS-PAST> 0
<LOANS-TROUBLED> 2,884
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 21,461
<CHARGE-OFFS> 128
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 26,019
<ALLOWANCE-DOMESTIC> 26,019
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
