<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
------------------------
FORM 10-Q
---------------
_X_ QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarter ended September 30, 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)
<TABLE>
<S> <C>
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 (Zip Code)
Offices)
</TABLE>
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, $0.01 par value per share, as of October 1,
1995.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q INDEX
FOR THE QUARTER ENDED SEPTEMBER 30, 1995
<TABLE>
<CAPTION>
PAGE
-----
<S> <C> <C>
PART I -- FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Statements of Financial Condition at September 30, 1995 (Unaudited) and
December 31, 1994............................................................................. 3
Condensed Consolidated Statements of Operations (Unaudited) for the Three and Nine Months Ended
September 30, 1995 and 1994................................................................... 4
Condensed Consolidated Statements of Stockholders' Equity (Unaudited) for the Nine Months Ended
September 30, 1995 and 1994................................................................... 5
Condensed Consolidated Statements of Cash Flows (Unaudited) for the Three and Nine Months Ended
September 30, 1995 and 1994................................................................... 6
Notes to Condensed Consolidated Financial Statements (Unaudited)............................... 7
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 8
PART II -- OTHER INFORMATION
ITEM 1. Legal Proceedings.............................................................................. 27
ITEM 2. Changes in Securities.......................................................................... 27
ITEM 3. Defaults upon Senior Securities................................................................ 27
ITEM 4. Submission of Matters to Vote of Security Holders.............................................. 27
ITEM 5. Other Materially Important Events.............................................................. 27
ITEM 6. Exhibits and Reports on Form 8-K............................................................... 27
</TABLE>
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS ARE IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1995 1994
------------- ------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
Cash and cash equivalents........................................................... $ 16,623 $ 18,063
Investment securities at amortized cost (estimated market value of $29,321
(1994))............................................................................ 30,190
Investment securities at market value............................................... 13,726
Mortgage-backed securities at amortized cost (estimated market value of $50,097
(1995) and $53,993 (1994))......................................................... 50,798 57,395
Loans receivable (net of allowance for estimated losses of $18,472 (1995) and
$21,461 (1994)).................................................................... 572,339 537,020
Real estate owned (net of allowance for estimated losses of $17,273 (1995) and
$33,517 (1994)).................................................................... 55,869 62,613
Office premises and equipment, net.................................................. 10,133 10,538
Investment in capital stock of Federal Home Loan Bank -- at cost.................... 6,229 6,995
Accrued interest receivable......................................................... 3,663 3,542
Income tax receivable............................................................... 3,080 2,630
Other assets........................................................................ 1,496 1,081
------------- ------------
$ 720,230 $ 743,793
------------- ------------
------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposit accounts.................................................................. $ 684,489 $ 649,382
Reverse repurchase agreements..................................................... 5,890 47,141
Accounts payable and other liabilities............................................ 5,144 6,078
Income taxes payable.............................................................. 365
------------- ------------
695,523 702,966
24,707 40,827
------------- ------------
Stockholders' equity................................................................ $ 720,230 $ 743,793
------------- ------------
------------- ------------
</TABLE>
The accompanying notes are 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ----------------------
1995 1994 1995 1994
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Interest revenues
Loans.......................................................... $ 11,688 $ 11,579 $ 34,413 $ 36,465
Investment securities.......................................... 356 1,546 1,824 3,507
Mortgage-backed securities..................................... 814 886 2,553 2,038
--------- --------- ---------- ----------
12,858 14,011 38,790 42,010
--------- --------- ---------- ----------
Interest costs
Deposits....................................................... (8,745) (7,901) (24,560) (22,623)
Borrowings..................................................... (61) (100) (646) (100)
--------- --------- ---------- ----------
(8,806) (8,001) (25,206) (22,723)
--------- --------- ---------- ----------
Gross interest margin............................................ 4,052 6,010 13,584 19,287
Credit losses on loans
Accrued interest on nonaccrual loans........................... (420) (1,429) (1,827) (4,678)
Loan principal................................................. (1,700) (1,314) (14,445) (2,461)
--------- --------- ---------- ----------
Net interest margin.............................................. 1,932 3,267 (2,688) 12,148
Non-interest revenues............................................ 536 296 1,583 1,493
Operating costs.................................................. (4,375) (4,839) (14,415) (15,034)
Real estate operations, net...................................... (2,989) (130) (2,172) (1,437)
Other income..................................................... 450 2,187 450 2,187
Securities gains, net............................................ 3,049
Loan sale gains, net............................................. 68
--------- --------- ---------- ----------
Pretax income (loss)............................................. (4,446) 781 (14,125) (643)
Income taxes..................................................... (32) (11) (617) (137)
--------- --------- ---------- ----------
NET EARNINGS (LOSS).............................................. $ (4,478) $ 770 $ (14,742) $ (780)
--------- --------- ---------- ----------
--------- --------- ---------- ----------
Net earnings (loss) per share.................................... $ (1.72) $ 0.30 $ (5.67) $ (0.30)
--------- --------- ---------- ----------
--------- --------- ---------- ----------
Dividends paid per share......................................... N/A N/A N/A N/A
--------- --------- ---------- ----------
--------- --------- ---------- ----------
Average shares of common stock outstanding....................... 2,599 2,599 2,599 2,599
--------- --------- ---------- ----------
--------- --------- ---------- ----------
Dividend payout ratio............................................ N/A N/A N/A N/A
--------- --------- ---------- ----------
--------- --------- ---------- ----------
</TABLE>
The accompanying notes are 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>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1995 1994
---------- ---------
<S> <C> <C>
Balance at beginning of period............................................................ $ 40,827 $ 43,949
Change in unrealized gain/(loss) on available for sale securities......................... (1,394) (33)
Net loss for the period................................................................... (14,742) (780)
Repayment of ESOP loan.................................................................... 16 13
---------- ---------
Balance at end of period.................................................................. $ 24,707 $ 43,149
---------- ---------
---------- ---------
</TABLE>
The accompanying notes are 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1995 1994 1995 1994
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net Loss.......................................................... $ (4,478) $ 770 $ (14,742) $ (780)
Adjustments
Decrease (increase) in income tax receivable.................... (450) 1,000 (849) 16,513
Depreciation and amortization................................... 228 154 1,239 473
FHLB stock dividends............................................ (73) (95) (250) (236)
Discounts on loans.............................................. 100 100
Gain on sale of REOs and apartments............................. (901) (901)
Decrease (increase) in interest receivable...................... (451) (317) (121) (222)
Amortization of loan fees....................................... (327) (203) (1,675) (917)
Decrease (increase) in other assets............................. 129 (677) (378) (702)
Increase (decrease) in other liabilities........................ (755) (604) (887) (1,864)
Provision for estimated credit losses........................... 1,700 1,300 14,400 2,300
Provision for real estate losses................................ 5,100 5,100
Provision for other asset disposal.............................. 403
--------- --------- --------- ---------
Net cash (used in) provided by operating activities........... (178) 1,328 1,439 14,565
--------- --------- --------- ---------
INVESTING ACTIVITIES
Investment securities
Purchases....................................................... (10,070) (111) (20,123)
Maturities...................................................... 5,000 39,000
Sales -- available for sale securities.......................... 42,472
Mortgage-backed securities
Principal amortization.......................................... 2,182 2,357 5,157 4,310
Sales........................................................... 1,438
Purchases....................................................... (10,306) (34,855)
Lending
New loans funded................................................ (35,411) (5,722) (100,121) (5,959)
Disbursements on construction loans............................. (2,769) (894) (5,369) (3,490)
Principal payments by borrowers................................. 3,785 3,346 12,927 10,982
Payoffs......................................................... 5,769 14,445 18,024 44,209
Sales........................................................... 19,282
Other, net...................................................... (59) 668 (3,748) 1,208
Real estate owned
Proceeds from sales of properties............................... 9,241 30,792 23,571 62,808
Capitalized costs on properties................................. (3,636) (6,465) (10,084) (15,640)
Other, net...................................................... (1,082) (233) (950) (2,022)
Redemption of FHLB stock.......................................... 1,015 802
Fixed asset additions............................................. (228) (2,743) (1,362) (4,872)
Fixed asset sales................................................. 4,322 744 4,322
--------- --------- --------- ---------
Net cash (used in) provided by investing activities........... (22,208) 24,497 2,885 80,680
--------- --------- --------- ---------
FINANCING ACTIVITIES
Net increase (decrease) in deposits............................... 14,834 (116,106) 35,471 (163,680)
Net repayment of reverse repurchase agreements.................... 5,890 48,335 (41,251) 48,335
Repayment of ESOP loan............................................ 8 3 16 13
--------- --------- --------- ---------
Net cash provided by (used in) financing activities........... 20,732 (67,768) (5,764) (115,332)
--------- --------- --------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS............................. (1,654) (41,943) (1,440) (20,087)
BEGINNING CASH AND CASH EQUIVALENTS................................. 18,277 64,757 18,063 42,901
--------- --------- --------- ---------
ENDING CASH AND CASH EQUIVALENTS.................................... $ 16,623 $ 22,814 $ 16,623 $ 22,814
--------- --------- --------- ---------
--------- --------- --------- ---------
Supplemental disclosures of cash flow information
Cash paid during the period for Interest.......................... $ 8,541 $ 7,925 $ 25,549 $ 9,246
Non-cash investing and financing activities
Real estate owned additions..................................... $ 8,282 $ 15,045 $ 30,911 $ 24,778
Loans originated to finance property sales...................... 6,023 2,539 6,469
Transfer of held to maturity securities to available for sale... 30,168
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 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
September 30, 1995 and December 31, 1994 and the results of its operations and
its cash flows for the nine months ended September 30, 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 nine months ended
September 30, 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 at the 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.
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 condensed consolidated financial statements have
been reclassified to conform with classifications in 1995.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company reported a net loss of $4.5 million for the third quarter of
1995, compared to net earnings of $.8 million for the third quarter of 1994. For
the nine months ended September 30, 1995 and 1994, the Company reported net
losses of $14.7 million and $.8 million, respectively. For the years ended
December 31, 1994 and 1993, respectively, the Company reported net losses of
$3.0 million and $29.6 million. The net loss for 1995 resulted from provisions
of $12.7 million in the first quarter and $6.8 million in the third quarter to
increase the Company's classified loan and property loss reserves. The 1995
provisions were attributable primarily to an increase in reserves allocated to
the Company's foreclosed apartment buildings and for its apartment loan
collateral and to continued construction-related problems associated with two
foreclosed residential developments. The higher reserve levels now maintained
for the apartments reflect management's application of capitalization rates
higher than those utilized in 1994 to value property cash flows. The higher
capitalization rates reflect the increase since mid-1994 in the cost of market
financing of apartment buildings and, in turn, the higher cash flow returns
demanded by purchasers of such buildings.
Partially offsetting the credit loss provisions during the first three
quarters of 1995 were securities gains which, net of tax adjustments, totaled
$3.0 million and which resulted from the liquidation of all of the Company's
available-for-sale securities portfolio, which totaled $42 million. During the
second quarter, the Company also sold $20 million in FNMA-qualified, single
family fixed rate mortgage loans. These sales increased the Company's capital,
provided liquidity to repay wholesale borrowings and for future loan financings,
and substantially reduced the Company's interest rate risk.
The Company continues to be burdened with the high costs associated with
foreclosed properties and nonperforming loans. At September 30, 1995,
nonperforming assets, net of reserves, totaled $70 million, or 10% of total
assets. By comparison, the related balances and ratios to total assets as of
December 31, 1994 and September 30, 1994 were $94 million and 13%, and $111
million and 15%, respectively. During July 1995, the Company commenced marketing
certain of its foreclosed apartment buildings for sale. The Company's investment
in this portfolio approximates 47% of its entire foreclosed property portfolio
and approximates 41% of all assets classified as nonperforming. The portfolio
owned at September 30, 1995 has been accumulated over a two-year period, during
which time the Company substantially increased property cash flows and invested
the funds necessary to cure deferred maintenance and to make needed capital
improvements. This portfolio currently produces cash flow returns of over 10% on
the Company's written-down investment.
The 1995 second and third quarters included the first significant new loan
production since 1992. For the three and nine-month periods ended September 30,
1995, the Company originated $48.5 million and $122.5 million, respectively, of
new loans, including construction commitments. Less than $6.5 million of these
totals were related to the financing of previously owned properties. Since 1992,
the Company has almost exclusively focused its attention on resolving its
portfolio of problem assets. With this portfolio now substantially reduced from
its levels in 1992 through 1994, the Company launched several new financing
businesses in January 1995, principally to provide financing to owners and
purchasers of existing apartment buildings and expensive, estate homes. To a
lesser extent, the Company's new loans are secured by commercial income
properties, individual homes under construction, and affordable homes within its
local markets. Generally, the Company has focused on specialized niche markets
requiring high levels of service and flexibility in structuring specific
transactions. Accordingly, the Company is compensated for its financing
activities by receiving margins on its loans well in excess of the margins
typically commanded by other lenders. The loan production to date is now of
sufficient magnitude to begin positively and measurably to impact the Company's
interest margins. These results, as well as the benefits realized from the
upward repricing
8
<PAGE>
of the Company's adjustable-rate loan portfolio, should continue to gradually
improve the Company's net interest margin during the next several quarters,
absent a significant or prolonged rise in market interest rates.
At September 30, 1995, the Bank had core and risk-based capital ratios of
3.28% and 6.39%, respectively, as compared with the minimum requirements for
such ratios at that date of 4% and 8%, 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. Progressively 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 three quarters of 1995, the Bank's capital designation has
declined from "adequately capitalized" to "under capitalized". On June 30, 1995,
the Bank and its Board of Directors stipulated and consented to the issuance of
a prompt corrective action directive (the "Directive") issued by the OTS, the
Bank's primary regulator.
The Directive was issued as a condition of acceptance by the OTS of the
Bank's capital restoration plan. The Directive requires the Bank, among other
things, (i) to comply with the terms of the revised business plan , (ii) to
achieve a capital infusion of between $15 million and $20 million by December
15, 1995, (iii) to retain an investment banking firm to assist in the
recapitalization of the Bank, (iv) to comply with all of the mandatory prompt
corrective action provisions automatically applicable to the Bank based on its
prompt corrective action capital category, and (v) to maintain its total assets
at a level not to exceed its total assets as of year end 1994. Unless otherwise
approved by the OTS, the Directive also requires that the Bank comply with an
OTS-approved time schedule specifying dates between the execution of the
Directive and December 15, 1995 by which the Bank must complete specific
intermediate steps toward achievement of the capital infusion required by the
Directive. Failure to comply with the Directive could result in a forced sale of
the Bank at a distressed price under regulatory compulsion or the appointment of
a conservator or receiver for the Bank. In addition, the Directive states that
it does not prevent the OTS from taking any other type of supervisory,
enforcement or resolution action that the OTS determines to be appropriate.
The Company has engaged an investment banking firm and has reached an
agreement with investors to purchase "investment units" being offered by the
Company in a private placement. Based upon the executed subscription agreements
that have been received by the Company, the private placement will produce net
proceeds that will be adequate, upon infusion into the Bank, to satisfy the
capital-raising provisions of the Directive and to render the Bank a
"well-capitalized" institution. However, completion of the private placement is
subject to a number of material funding conditions and there is no assurance
that these funding conditions can or will be satisfied in a manner that will
result in completion of the private placement (see PROSPECTS -- CAPITAL
RAISING).
The Company had total assets at September 30, 1995 of $720 million, down
from $744 million at December 31, 1994 and $763 million at September 30, 1994.
The Company's continuing efforts to expand its core retail deposit base have
generated positive results, with deposits totaling $684 million at September 30,
1995, an increase from $649 million at year end 1994. Deposits at September 30,
1994 were $666 million.
OPERATING RESULTS
INTEREST MARGIN
The Company's net interest margin, or the difference between the yield
earned on loans, mortgage-backed securities and investment securities and the
cost of funds to support those earning assets, is affected by several factors,
including (1) the level of, and the 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 funding sources, (3) the relationship between
market interest rates and local deposit rates offered by competing institutions,
and (4) the magnitude of the Company's nonperforming assets.
9
<PAGE>
The table below sets forth average interest-earning assets and
interest-bearing liabilities, and their related effective yields and costs, for
the nine months ended September 30, 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 in thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, 1995 DECEMBER 31, 1994 SEPTEMBER 30, 1994
-------------------- --------------------- ---------------------
YIELD/ YIELD/ YIELD/
AMOUNT COST AMOUNT COST AMOUNT COST
-------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS
Loans...................................................... $571,519 8.03%(1) $ 608,651 7.85%(1) $ 621,537 7.60%(1)
Cash and investment securities............................. 40,124 6.06% 97,442 4.64% 106,436 4.39%
Mortgage-backed securities................................. 53,844 6.32% 45,810 6.47% 42,094 6.46%
-------- --------- ---------
665,487 7.77% 751,903 7.35% 770,067 7.09%
-------- ----- --------- ----- --------- -----
INTEREST-BEARING LIABILITIES
Deposits................................................... 670,842 4.83% 763,302 3.89% 794,885 3.80%
Borrowings................................................. 14,105 6.04% 14,333 5.23% 2,685 4.95%
-------- --------- ---------
684,947 4.85% 777,635 3.91% 797,570 3.80%
-------- ----- --------- ----- --------- -----
Interest-bearing gap/Gross interest margin................. (19,460) 2.72% (25,732) 3.30% (27,503) 3.16%
NONACCRUAL LOANS............................................. (31,928) (0.37)% (76,386) (0.75)% (85,197) (0.81)%
-------- ----- --------- ----- --------- -----
Adjusted interest-bearing gap/Net interest margin.......... $(51,388) 2.36% $(102,118) 2.55% $(112,700) 2.35%
-------- ----- --------- ----- --------- -----
-------- ----- --------- ----- --------- -----
</TABLE>
- ------------------------
(1) Effective yield, inclusive of deferred fees.
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 in thousands).
<TABLE>
<CAPTION>
1995 1994
------------------------------------------------ -------------------------------
SEPT 30, JUNE 30, MARCH 31, DEC 31, SEPT 30,
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
BALANCES
Interest-earning assets...................... $ 662,029 $ 641,652 $ 672,932 $ 683,637 $ 697,814
Interest-bearing liabilities................. (690,154) (670,019) (690,006) (696,523) (715,578)
-------------- -------------- -------------- -------------- --------------
Interest-bearing gap......................... (28,125) (28,367) (17,074) (12,886) (17,764)
Nonaccrual loans............................. (17,846) (23,222) (34,220) (39,396) (63,563)
-------------- -------------- -------------- -------------- --------------
Adjusted interest-bearing gap................ $ (45,971) $ (51,589) $ (51,294) $ (52,282) $ (81,327)
-------------- -------------- -------------- -------------- --------------
-------------- -------------- -------------- -------------- --------------
YIELDS AND COSTS
Interest-earning assets...................... 8.43%(1) 7.49%(1) 7.19%(1) 6.97%(1) 6.96%(1)
Interest-bearing liabilities................. (5.10)% (5.06)% (4.79)% (4.40)% (4.18)%
Gross interest margin........................ 3.11% 2.20% 2.28% 2.48% 2.68%
Nonaccrual loans............................. (0.22)% (0.28)% (0.37)% (0.41)% (0.95)%
Net interest margin.......................... 2.89% 1.92% 1.91% 2.07% 1.73%
</TABLE>
- ------------------------
(1) Contractual yield, exclusive of deferred fees.
The amount of the Company's adjusted interest-bearing gap has steadily
improved over the past five quarters because foreclosed properties have been
sold at a rate in excess of net new defaults and, to a lesser extent, of a
change in the composition of the balance sheet as lower yielding assets were
converted to cash to support new financing activities and retire wholesale
borrowings. In particular, for the nine months ended September 30, 1995, net new
defaults amounted to $9 million, while net property sales from foreclosed assets
amounted to $24 million.
The Company's gross interest margin, expressed as a percentage of
interest-earning assets, is starting to improve. It had steadily declined since
1993 due to the high volume of foreclosures, the rapid and significant rise in
interest rates since early 1994 and its affect on funding costs, the lag in
repricing of adjustable-rate assets, and the lack of any measurable new loan
production. During the second and third quarters of 1995, new loan production
began to benefit the overall yield on earning assets and the adjustable-rate
loan portfolio, which is principally indexed to the 11th District Cost of
10
<PAGE>
Funds Index ("DCOFI"), began to reprice upward. 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. A significant portion of the liability portfolio was further
impacted by a spike in market interest rates during the first quarter of 1995.
Subsequently, market interest rates have generally declined and have begun to be
reflected in the Company's deposit portfolio as accounts mature. At year end
1994, the Company's cost of funds was 4.40%, and increased to 4.79%, 5.06% and
5.10%, for the quarters ended March, June and September 1995, respectively. The
11th DCOFI was 4.59% at year end 1994, and increased to 5.01%, 5.18% and 5.11%
for the quarters ended March, June and September 1995, respectively. Though the
Company maintains a modest funding advantage to the 11th DCOFI, its cost of
funds increased by 70 basis points during the first nine months of 1995. This
compares unfavorably to the 11th DCOFI's rate of change for the same period,
which was 52 basis points.
During the fourth quarter of 1995, management expects that the yield on the
Company's interest-earning assets will continue gradually to rise as the 11th
DCOFI incorporates its proportionate share of the recent rise in market interest
rates, and the Company's new financing activities begin to represent an
increasing percentage of total loans. The Company's net interest margin is also
expected to improve as its cost of funds begins to level off and the Company
continues its resolution of nonperforming assets.
OPERATING COSTS
The table below sets forth the Company's operating costs for the three-month
and nine-month periods indicated. 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) (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPT. 30, NINE MONTHS ENDED SEPT. 30,
--------------------------------- ---------------------------------
1995 1994 CHANGE 1995 1994 CHANGE
--------- --------- ----------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Employee....................... $ 2,277 $ 2,211 $ 66 $ 7,320 $ 6,554 $ 766
Occupancy...................... 690 643 47 2,153 2,067 86
Operating...................... 777 1,007 (230) 2,451 3,341 (890)
Professional................... 205 324 (119) 973 1,061 (88)
--------- --------- ----------- --------- --------- -----------
3,949 4,185 (236) 12,897 13,023 (126)
SAIF insurance premium and OTS
assessment.................... 427 654 (227) 1,518 2,011 (493)
--------- --------- ----------- --------- --------- -----------
$ 4,376 $ 4,839 $ (463) $ 14,415 $ 15,034 $ (619)
--------- --------- ----------- --------- --------- -----------
--------- --------- ----------- --------- --------- -----------
</TABLE>
Direct compensation and incentives represent approximately 75% of all
employee-related expenses. Management believes it has a full complement of staff
currently in place to complete the bank-wide restructuring. The reduction in
operating expenses during the current year is principally associated with
reduced expenditures in marketing and advertising, and the benefit derived from
deferral of loan origination costs over the life of the new financing
activities. The reduction in SAIF premiums during 1995 reflects the benefit from
several branch deposit sales which occurred during the last half of 1994.
11
<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 SEPT. 30, NINE MONTHS ENDED
SEPT. 30,
--------------------------------- ---------------------------------
1995 1994 CHANGE 1995 1994 CHANGE
--------- --------- ----------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Loan and escrow fees................. $ 337 $ 157 $ 180 $ 570 $ 544 $ 26
Deposit account fees................. 135 118 17 454 419 35
Other income......................... 64 21 43 559 530 29
--------- --------- ----- --------- --------- ---
$ 536 $ 296 $ 240 $ 1,583 $ 1,493 $ 90
--------- --------- ----- --------- --------- ---
--------- --------- ----- --------- --------- ---
</TABLE>
Loan and escrow fees in 1995 were higher than in 1994 due primarily to
increased loan production.
REAL ESTATE OPERATIONS
The table below sets forth the revenues and costs attributable to the
Company's real estate operations for the periods indicated. 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 (dollars
are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPT. 30, NINE MONTHS ENDED SEPT. 30,
------------------------------- -------------------------------
1995 1994 CHANGE 1995 1994 CHANGE
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Expenses associated with real estate owned
Operating costs
Employee.................................. $ (188) $ (427) $ 239 $ (548) $ (1,384) $ 836
Operating................................. (26) (89) 63 (77) (278) 201
Professional.............................. (83) (212) 129 (271) (638) 367
--------- --------- --------- --------- --------- ---------
(297) (728) 431 (896) (2,300) 1,404
Holding costs
Property Taxes............................ (4) (348) 344 (35) (1,833) 1,798
Repairs, maintenance and renovation....... (114) (20) (94) (322) (333) 11
Real estate loss provision................ (5,100) (5,100) (5,100) (5,100)
Insurance................................. (6) (75) 69 (95) (266) 171
--------- --------- --------- --------- --------- ---------
(5,521) (1,171) (4,350) (6,448) (4,732) (1,716)
Net recoveries from property sales............ 1,524 327 1,197 2,027 2,007 20
Rental income, net............................ 1,008 714 294 2,249 1,288 961
--------- --------- --------- --------- --------- ---------
$ (2,989) $ (130) $ (2,859) $ (2,172) $ (1,437) $ (735)
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
</TABLE>
Commencing in August 1993 and continuing through the third 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.
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. Net operating
income is reduced by provisions for depreciation of owned improvements for the
1995 periods. During the third quarter, a loss provision of $5.1 million was
recorded, of which $3.6 million was allocated to specific valuation allowances
on two owned development properties, which account
12
<PAGE>
for the majority of the remaining balances. A general valuation allowance of
$1.5 million was established on non-operating apartment REOs consistent with the
letter directive received from the OTS (see RESERVES).
As of September 30, 1995, the Company's portfolio of properties consisted of
289 individual homes, apartment buildings and land parcels. In addition, as of
that date the Company's defaulted loan portfolio was represented by 82 loans and
its portfolio of performing project concentration loans secured 520 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
loan's 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 September 30, 1995 and 1994, respectively, 52% and
58% of the Company's loan portfolio consisted of permanent loans secured by
single family residences, 40% and 38% consisted of permanent loans secured by
multi-unit residential properties, and 8% and 4% 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.
The Company's performance continues to be adversely affected by the weakness
evident in its loan portfolio and a high volume of foreclosures, though
foreclosures have been declining at a steady rate over the past three quarters.
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
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, 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.
CLASSIFIED ASSETS
At September 30, 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
Classified Asset portfolio. Classified Assets include owned properties,
nonaccrual loans, and performing loans which have been adversely classified
pursuant to OTS
13
<PAGE>
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>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1995 1994 1994
------------- ------------- -------------
<S> <C> <C> <C>
NONPERFORMING ASSETS
Properties........................................................ $ 73,142 $ 99,119 $ 118,089
Nonaccrual loans.................................................. 17,846 39,396 63,563
------------- ------------- -------------
90,988 138,515 181,652
Performing loans classified Doubtful or Substandard............... 53,160 64,835 61,429
------------- ------------- -------------
GROSS INVESTMENT IN CLASSIFIED ASSETS........................... 144,148 203,350 243,081
CREDIT RESERVES
Specific reserves and writedowns.................................. (22,180) (43,749) (65,996)
Allocated general reserves........................................ (7,309) (8,167) (10,431)
------------- ------------- -------------
NET INVESTMENT IN CLASSIFIED ASSETS............................. $ 114,659 $ 151,434 $ 166,654
------------- ------------- -------------
------------- ------------- -------------
GROSS PERFORMING LOANS DESIGNATED AS SPECIAL MENTION............ $ 65,049 $ 80,385 $ 45,112
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The Company currently places loans on nonaccrual status when (1) they become
one or more payments 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 two
years. At September 30, 1995, the Company had foreclosed properties and
nonaccrual loans with a carrying value of $70 million, or 10% of total assets.
By comparison, the carrying value of nonperforming assets at December 31, 1994,
was $94 million, or 13% 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
September 1995, amounted to $18 million. This compares favorably to the year end
1994 level of $39 million, a September 30, 1994 balance of $64 million and a
December 31, 1993 balance of $80 million. Within the September 30, 1995 total of
nonaccrual loans, $8 million in principal balances were delinquent less than
three payments.
14
<PAGE>
The table below sets forth the composition, measured by gross and net
investment, of the Company's Classified Asset portfolio by type of property
(dollars are in thousand).
<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...................... $ 4,603 $ 8,187 $ 5,731 $ 16,174 $ 34,695 14.4%
Project concentrations........... 8,946 4,447 4,054 25,929 43,376 50.5%
Apartment buildings................ 34,186 3,464 42,733 19,910 100,293 36.0%
Acquisition and Development
Construction....................... 20,621 20,621 53.5%
Land............................... 4,440 1,748 454 1,006 7,648 76.7%
Commercial properties................ 346 188 2,030 2,564 12.8%
---------- ----------- ------------ --------- -----------
73,142 17,846 53,160 65,049 209,197 31.0%
CREDIT LOSSES
Specific reserves and writedowns..... (15,664) (2,787) (3,729) (22,180)
Allocated general reserves........... (1,610) (925) (4,774) (4,108) (11,417)
---------- ----------- ------------ --------- -----------
NET INVESTMENT......................... $ 55,868 $ 14,134 $ 44,657 $ 60,941 $ 175,600 26.0%
---------- ----------- ------------ --------- -----------
---------- ----------- ------------ --------- -----------
</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 September 30, 1995,
the Company (1) owned 18 homes which were being actively marketed for sale, (2)
had 36 defaulted loans secured by single family (non-project) homes, (3) had 20
loans which were performing but had been classified Substandard, and (4) had 76
loans which were performing but had been designated Special Mention. The Company
has valued its owned single family homes at their estimated net 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.
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 September 1995, management had identified 63 separate project
concentrations of the type described above. The table below summarizes certain
information about the Company's project concentrations as of September 30, 1995.
The table includes the Company's gross investment (1) in
15
<PAGE>
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 September 30, 1995, and with respect to which
the Company also made individual takeout loans (dollars are in thousands).
<TABLE>
<CAPTION>
GROSS INVESTMENT/LOAN PRINCIPAL
NUMBER OF -------------------------------------------------
LOANS OR NUMBER OF INDIVIDUAL CONSTRUCTION
PROPERTIES UNITS TAKEOUTS LOAN TOTAL % TO TOTAL
------------- ----------- ----------- ------------ --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Performing loans................. 412 520 $ 68,814 $ 3,612 $ 72,426 84.6%
Loans in default................. 33 33 4,447 4,447 5.2%
Properties....................... 67 67 6,945 1,760 8,705 10.2%
--- --- ----------- ------------ --------- -----
512 620 $ 80,206 $ 5,372 $ 85,578 100.0%
--- --- ----------- ------------ --------- -----
--- --- ----------- ------------ --------- -----
</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 15% 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.
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................................ 25 $ 53,109
% of original appraisal............................................ 34 25,543
Current appraisal/no recent sales history.......................... 4 6,926
--
-----------
All project concentrations....................................... 63 $ 85,578
--
--
-----------
-----------
</TABLE>
When determining the basis of valuation, 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 and 1995. 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.
APARTMENT BUILDINGS
At September 30, 1995, the Company owned 71 apartment buildings and loans
secured by 10 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 11 units
in size. The Company's owned apartment buildings have been operated for their
current cash flow yield and the holding period was used to stabilize rental
income and perform deferred maintenance. The average holding period for this
portfolio approximates 14 months. The carrying value of this portfolio has been
determined based upon management's projections of the stabilized cash flow
returns demanded by investors in such properties, assuming conventional
financing terms presently available in the marketplace.
16
<PAGE>
The gross investment value of the foreclosed properties portfolio at
September 30, 1995, was $34 million. The Company records these properties at
their fair market values by establishing and adjusting, as appropriate, specific
and general valuation allowances on these properties. During the first and third
quarters of 1995, the Company recorded provisions for credit losses totaling
$12.7 million and $1.5 million, respectively, 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
obtainable through orderly liquidation of this portfolio. These properties, now
stabilized and reflective of recovering market conditions, are expected to be
liquidated without any material impact to earnings. During the third quarter,
$4.5 million in net investment related to the sale of apartment buildings was
realized, resulting in a net gain of $.8 million.
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.
RESIDENTIAL CONSTRUCTION
The table below sets forth, as of September 30, 1995, the unit composition
and gross investment associated with owned developments (dollars are in
thousands).
<TABLE>
<CAPTION>
NUMBER OF UNITS REMAINING AT
NUMBER OF ---------------------- SEPT. 30,
DEVELOPMENTS ORIGINAL SOLD 1995
------------------- ----------- --------- -------------
<S> <C> <C> <C> <C>
Units......................................... 4 260 (146) 114
Gross investment.............................. $ 20,622
-------------
-------------
Net investment................................ $ 14,305
-------------
-------------
</TABLE>
The Company's owned residential construction projects consist of 4 projects
with a total of 260 units. During the first three quarters of 1995, the Company
sold 64 units at minimal gains, and financed only 2 of these sales. During the
third quarter, additional construction-related problems associated with 2 of the
projects, with a combined gross investment of $17.6 million, were identified,
resulting in an increase in reserves of $3.6 million.
LAND
The Company's portfolio of owned land parcels consists of 13 properties with
a gross investment of $4.4 million.
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 September 30, 1995, the Company had established specific
reserves based upon (1) management's strategy 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
17
<PAGE>
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 and an additional
$6.8 million during the third quarter. 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, are
due to continued construction-related problems associated with two foreclosed
residential developments, and are associated with establishing general reserves
for the portfolio of real estate owned single family residences and defaulted
loans. After completing a limited review of the Bank's reserve adequacy during
the third quarter, the OTS issued a letter directive requiring the Bank to
maintain aggregate general reserves of at least $12.5 million as of September
30, 1995. The Bank' general reserves as of that date were $13.6 million.
The table below sets forth the amounts and percentages of general and
specific credit reserves for the Company's loan and property portfolios as of
September 30, 1995 (dollars are in thousands).
<TABLE>
<CAPTION>
LOANS
-------------------------
PERFORMING NONACCRUAL PROPERTIES TOTAL
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
AMOUNTS
Specific reserves..................... $ 3,729 $ 2,787 $ 15,664 $ 22,180
General reserves...................... 11,032 925 1,610 13,567
----------- ------------ ----------- -----------
Total credit reserves............... $ 14,761 $ 3,712 $ 17,274 $ 35,747
----------- ------------ ----------- -----------
----------- ------------ ----------- -----------
PERCENTAGES
% of total credit reserves to gross
investment........................... 2.5% 20.8% 23.6% 5.3%
% of general reserves to gross
investment........................... 1.9% 5.2% 2.2% 2.0%
</TABLE>
The table below summarizes the activity of the Company's reserves for the
periods indicated (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPT. 30, NINE MONTHS ENDED SEPT. 30,
---------------------------------------------- ----------------------------------------------
1995 1994 1995 1994
---------------------- ---------------------- ---------------------- ----------------------
PROPERTIES LOANS PROPERTIES LOANS PROPERTIES LOANS PROPERTIES LOANS
----------- --------- ----------- --------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
RESERVE ACTIVITY
Beginning balance........ $ 13,507 $ 20,690 $ 51,674 $ 26,573 $ 33,517 $ 21,461 $ 39,457 $ 46,628
Provision for losses..... 5,327 1,473 1,300 5,327 14,173 2,300
Charge-offs.............. (2,444) (2,807) (3,387) (31,861) (6,873) (11,732) (493)
Recoveries............... 2
Transfers................ 884 (884) 2,411 (2,411) 10,291 (10,291) 22,973 (22,973)
----------- --------- ----------- --------- ----------- --------- ----------- ---------
Ending balance......... $ 71,274 $ 18,472 $ 50,698 $ 25,462 $ 17,274 $ 18,472 $ 50,698 $ 25,462
----------- --------- ----------- --------- ----------- --------- ----------- ---------
----------- --------- ----------- --------- ----------- --------- ----------- ---------
</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 three quarters
of 1995, the Bank was able to increase its net loans outstanding by $35.3
million through new originations (excluding loans to finance property sales)
totaling $116 million. This represented the Bank's first period of significant
production during the past two years. The new loan production was
18
<PAGE>
centered in multi-family income properties (40%), single family loans (32%),
commercial income properties (11%) and construction financing and land within
the South Bay market (17%). The Company considers these four segments its
primary 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 of at least 8.0%
of Total Risk-weighted Assets (as defined in the regulations).
The following table summarizes the regulatory capital requirements under
FIRREA for the Bank at September 30, 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 only two of the three 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........................ $ 23,773 $ 23,773 $ 23,773
Adjustments
General valuation......................... 5,827
Core deposits intangibles................. (191) (191) (191)
Interest rate risk component (1)..........
----------- --- ----------- --- ----------- -----
Regulatory capital (2)...................... 23,582 3.28% 23,582 3.28% 29,409 6.39%
Required minimum............................ 10,791 1.50% 21,583 3.00% 36,804 8.00%
----------- ----------- -----------
Excess (deficient) capital.................. 12,791 1.78% 1,999 0.28% (7,395) (1.61)%
----------- ----------- -----------
----------- ----------- -----------
Adjusted assets (3)..................... $ 719,433 $ 719,433 $ 460,054
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
- ------------------------
(1) At September 30, 1995, the OTS had temporarily suspended the application of
its interest rate risk regulation but anticipated that it would become
effective again in the near future. Had the regulation been in effect at
September 30, 1995, the Bank would not have been required to deduct from
risk-based capital any amount due to an interest rate risk exposure
component.
(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).
Under the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"),
which supplemented FIRREA, the OTS has issued "prompt corrective action"
regulations with specific capital
19
<PAGE>
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
CORE CAPITAL RATIO OF
RATIO OF TO TOTAL CAPITAL
CORE CAPITAL RISK-WEIGHTED TO RISK-WEIGHTED
TO ASSETS ASSETS ASSETS
--------------- --------------- ----------------
<S> <C> <C> <C>
Well capitalized......................... 5% or above 6% 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 under capitalized............. Ratio of tangible equity to adjusted total assets
of 2% or less
</TABLE>
The Bank's ratios at September 30, 1995 are set forth below
<TABLE>
<S> <C>
Ratio of Core Capital to Total Assets............................... 3.28%
Ratio of Core Capital to Risk-weighted Assets (Leverage ratio)...... 5.13%
Ratio of Total Capital to Risk-weighted Assets...................... 6.39%
</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.
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 8.5%
and 3.7%, respectively, as of September 1995, and 9.6% and 4.0%, 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
20
<PAGE>
securities by the Federal Reserve Board. The following table summarizes
information relating to the Company's reverse repurchase agreements for the nine
month period ended September 30, 1995 (dollars are in thousands):
<TABLE>
<CAPTION>
1995
-----------
<S> <C>
Average balance during period.................................................... $ 14,105
Average interest rate during period.............................................. 6.04%
Maximum month-end balance during period.......................................... $ 47,151
Mortgage-backed securities underlying the agreements at period ends:
Carrying value................................................................. $ 12,069
Estimated market value......................................................... $ 12,076
Outstanding reverse repurchase agreement:
Balance........................................................................ $ 5,890
Interest rate.................................................................. 6.00%
</TABLE>
The reverse repurchase agreement outstanding at September 30, 1995 matured on
October 2, 1995, and was paid off.
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 within 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. A 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 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 the net portfolio value of market equity of
the current balance sheet. From these results, the Company can then develop
alternatives for 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
21
<PAGE>
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 (and are subject to maximum periodic rate adjustment limits)
may somewhat alter this expected benefit.
In the near future, 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, purchasing an interest
rate cap. In March 1995, the Company purchased a six-month cap with a notional
amount of $450 million and 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. At the expiration date, the
cap was extended to March 1996 with a strike price of approximately 150 basis
points above current market interest rates.
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 nine months ended September 30, 1995, the Company lost $14.7 million. The
nine month loss was generated by provisions for credit losses of $12.7 million
and $6.8 million during the first and third quarters, respectively, which was
partially offset by net gains on sales of securities (net of tax adjustments) of
$3.0 million. As described more fully elsewhere herein, the Company's operating
margins have been significantly impacted by the high volume of foreclosures and
continued costs associated with the disposal of these properties. Commencing
with the 1995 second quarter, the Company's operating margins began to improve
with the continued disposition of foreclosed assets, its origination of new
financing activities, 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
qualified people to restructure the Company's existing operations, to manage its
portfolio of Classified 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 ($720 million at September 30, 1995 as
compared with $980 million at June 30, 1993).
CAPITAL-RAISING
The Company has reached agreement with investors to purchase an aggregate of
$27 million of "investment units" being offered by the Company in a private
placement (the "Offering") and consisting of senior notes, preferred stock and
warrants to purchase common stock. The private placement is scheduled to be
completed on or prior to December 15, 1995 and would produce net proceeds to the
Company that will be adequate, upon infusion into the Bank, to satisfy the
capital-raising provisions of the PCA Directive from the OTS and to render the
Bank a "well-capitalized" institution. However, as described more fully below,
completion of the Offering is subject to a number of material funding conditions
and there is no assurance that these funding conditions can or will be satisfied
in a manner that will result in completion of the Offering.
22
<PAGE>
In summary, the Offering has the following principal terms:
- The sale by the Company of $27 million of investment units.
- The investment units will consist of equal amounts of Senior Notes and a
new class of preferred stock, to be denominated "Cumulative Perpetual
Preferred Stock, Series A", and Warrants to purchase common stock of the
Company.
- The Senior Notes will carry a 12% interest rate and have a final maturity
of five years from the date of issuance. The first three years' interest
will be prefunded from the proceeds of the Offering. Thereafter, interest
will be payable either in cash or in an equivalent value (determined in
accordance with the provisions of the relevant agreement) in common stock
of the Company. The Senior Notes provide for retirement in equal
semi-annual installments payable in cash or in an equivalent value in
common stock, commencing December 1998.
- The Cumulative Perpetual Preferred Stock will carry a dividend rate of
18%. Dividends will accumulate for the first eighteen months following
issuance and, thereafter, will be payable either in cash or in an
equivalent value (determined in accordance with the provisions of the
relevant agreement) in common stock of the Company.
- At the maximum of $27 million in subscriptions, the Warrants will entitle
the holders to purchase approximately 2.4 million shares of newly-issued
common stock of the Company at a fixed price of $2.25 per share. The
Warrants are not exercisable for the first three years following their
issuance and will terminate ten years after their issuance.
- Certain members of senior management will purchase approximately 5% of the
Offering on the same terms as have been negotiated with other purchasers
in the Offering. Concurrently, members of senior management will be
granted stock options to purchase 360,000 shares of the Company's common
stock over a specified period, consistent with the stock option plan
previously approved by the Company's shareholders. Outstanding options
previously granted to such persons will be canceled.
The structure and principal terms of the Offering were developed to (1)
fully satisfy the capital-raising provisions of the PCA Directive, (2) permit
the Bank to continue the orderly resolution of troubled assets and (3) maximize
the common ownership retention by the Company's current shareholders.
Assuming the Offering closes with the purchase by investors of $27 million
of investment units, the Company would contribute qualifying core capital to the
Bank of at least $19 million, which amount is net of the costs of the Offering
and prefunded interest required to be escrowed on the Senior Notes.
A number of conditions (the "Funding Conditions") must be satisfied prior to
completion of the Offering. The Funding Conditions include requirements that the
Company achieve certain minimum thresholds for each of the following:
- Consolidated tangible net worth as of November 30, 1995
- Consolidated nonperforming assets, as defined, as of November 30, 1995
- Consolidated general valuation allowances as of November 30, 1995
- Net proceeds received from sales of foreclosed properties for the period
August 1, 1995 through November 30, 1995
Though management believes that the Funding Conditions are achievable, it
can provide no assurances in this regard.
In addition to the Funding Conditions, investors have requested that the OTS
confirm certain matters in writing prior to completion of the Offering (the
"Regulatory Conditions") concerning the
23
<PAGE>
disposition of the PCA Directive, the Bank's required capital ratios following
the completion of the Offering and the disposition of the Bank's current,
operative capital plan. The OTS has not yet communicated which of these matters,
if any, it will confirm to investors.
The purchasers of investment units in the Offering retain the sole right to
waive compliance with, or satisfaction of, any of the Funding Conditions or the
Regulatory Conditions. No assurance can be given that, should one or more of the
Funding Conditions or the Regulatory Conditions not be satisfied, the purchasers
will agree to grant the necessary waiver(s) to complete the Offering.
CLASSIFIED ASSETS
Notwithstanding the significant progress made in disposing of foreclosed
properties during 1994 and the first three quarters of 1995, the Company's
portfolios of Classified 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 and
1995, 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 $76 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 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.
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 OVERVIEW), 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
Classified 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.
24
<PAGE>
Should the Company not be permitted to engage in certain higher margin
business activities, 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.
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.
On August 8, 1995, the FDIC substantially reduced the deposit insurance
premium assessment rate to be paid by commercial banks and other institutions
whose deposits are insured by the Bank Insurance Fund (the "BIF") but did not
reduce the rates for savings institutions, such as the Bank, whose deposits are
insured by the FDIC's Savings Association Insurance Fund (the "SAIF"). Following
this reduction, the FDIC estimates that BIF-insured institutions will pay an
average assessment rate of .044%, compared to the current average rate for
SAIF-insured institutions of .237%. (The FDIC has established the Bank's deposit
insurance premium at the level of 0.3% of deposits for 1995.) The FDIC action
was taken in recognition of the fact that the BIF has reached its statutorily
prescribed ratio of reserves to deposits insured, whereas the SAIF is not
currently expected to do so for at least several more years.
The deposit rate premium disparity between BIF-insured institutions and
SAIF-insured institutions resulting from the BIF premium reduction could place
SAIF-insured institutions at a significant competitive disadvantage due to their
higher premium costs and worsen the financial condition of the SAIF by leading
to a shrinkage in its deposit base. A number of proposals to permit SAIF deposit
insurance premiums to be reduced to levels at or near those paid by BIF-insured
institutions are under
25
<PAGE>
discussion by various of the affected parties, relevant government agencies and
in Congress. Separate bills approved, respectively, by the United States House
of Representatives and Senate have common elements that would provide for a
one-time surcharge on SAIF-insured institutions in an amount sufficient
(expected to be approximately 85 basis points on SAIF-insured deposits) to
enable the SAIF to attain its required reserve level and require that a portion
of the insurance premiums paid by banks to the BIF be used to pay the interest
bonds that were issued to finance the resolution of failed thrift institutions.
Should this legislation be enacted, the Bank's contribution to the
recapitalization of the SAIF would approximate $6.0 million. If this
contribution is required to be made by the Bank in the next several months, it
is likely that the Bank's regulatory capital ratios would only satisfy those
required for an "adequately capitalized" institution, even after completion of
the private placement (see CAPITAL-RAISING). The House of Representatives bill
contains the following additional elements: elimination of the separate federal
thrift institution charter, coupled with the requirement that each
federally-chartered thrift institution convert to a national bank, a
state-chartered bank or a state-chartered savings and loan association by
January 1, 1998; merger of the BIF and the SAIF as of that date; elimination of
the OTS as a separate regulatory agency; treatment of thrift holding companies
as bank holding companies for federal regulatory purposes and elimination of the
ability of qualifying thrift institutions under current law to take tax
deductions for additions to their bad debt reserves established for federal
income tax purposes. Companion legislation that has been approved by the House
Ways and Means Committee would provide that such tax bad debt reserves relating
to deductions taken prior to 1988 would not be required to be "recaptured"
(i.e., restored to income and taxed at current tax rates) solely by reason of
conversion of the qualifying thrift institution to bank charter, but would
require recapture of such reserves to the extent they relate to post-1987
additions to the institution's tax bad debt reserve unless the institution
continues each year to meet a specified residential loan origination test. The
Company cannot predict whether or in what form any of these proposals will be
adopted or the effect that such adoption will have on the Company's operations.
26
<PAGE>
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has been served with a complaint in a purported class and
derivative action filed against it and the directors of the Company (ARTHUR
GLICK AND WILLIAM GURNEY V. HAWTHORNE FINANCIAL CORPORATION, ET AL., filed in
the United States District Court for the Central District of California, October
11, 1995, Case No. 95-6855ER). The complaint asserts causes of action based on
allegedly faulty disclosures in the Company's periodic filings with the
Securities and Exchange Commission, alleged corporate waste by Company officers
and alleged breaches of fiduciary duty by the individual director defendants in
connection therewith. The matter has been referred to counsel and will be
defended vigorously.
ITEM 2. CHANGES IN SECURITIES -- None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES -- None
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
A Special Meeting of Stockholders of the Company was held on August 31,
1995. At the Special Meeting, the stockholders voted on the following two
proposals, both of which were approved by the votes indicated:
1. APPROVAL TO INCREASE THE AMOUNT OF AUTHORIZED COMMON STOCK TO 20
MILLION SHARES. Votes in the affirmative were 1,835,072, votes against the
proposal were 345,257, and votes abstaining were 10,083.
2. APPROVAL TO AUTHORIZE PREFERRED STOCK, WITH 10 MILLION SHARES
AVAILABLE FOR ISSUANCE. Votes in the affirmative were 1,536,300, votes
against the proposal were 438,074, votes abstaining were 6,459 and broker
non-votes were 209,579.
ITEM 5. OTHER MATERIALLY IMPORTANT EVENTS -- None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
1. Reports on Form 8-K -- None
2. Other required exhibits
a. Amendment of Certificate of Incorporation, Exhibit 3
b. Financial data schedules, Exhibit 27
27
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HAWTHORNE FINANCIAL CORPORATION
Dated: November 14, 1995 /s/ SCOTT A. BRALY
---------------------------------------
Scott A. Braly
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Dated: November 14, 1995 /s/ NORMAN A. MORALES
---------------------------------------
Norman A. Morales
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
28
<PAGE>
[DELAWARE SEAL & SIGNATURE OF SECRETARY OF STATE]
CERTIFICATE OF AMENDMENT
OF
CERTIFICATE OF INCORPORATION
HAWTHORNE FINANCIAL CORPORATION, a corporation organized and existing
under and by virtue of the General Corporation Law of the State of Delaware,
DOES HEREBY CERTIFY:
FIRST: That at a meeting of the Board of Directors of Hawthorne
Financial Corporation resolutions were duly adopted setting forth a proposed
amendment to the Certificate of Incorporation of said corporation, declaring
said amendment to be advisable and calling a meeting of the stockholders of said
corporation for consideration thereof. The resolution setting forth the
proposed amendment is as follows:
RESOLVED, that the Certificate of Incorporation of this corporation
be amended by changing the Article numbered "FOURTH" so that, as
amended said Article shall be and read as follows:
"FOURTH": The total number of shares of all classes of capital stock
which this Corporation shall have authority to issue is thirty million
(30,000,000), of which twenty million (20,000,000) shares shall be
Common Stock, par value $.01 per share, and ten million (10,000,000)
shares shall be Preferred Stock, par value $.01 per share.
The shares of Preferred Stock may be issued from time to time in one
or more series. The Board of Directors of this Corporation shall have
authority to fix by resolution or resolutions the designations and the
powers, preferences and relative, participating, optional or other
special rights and qualifications, limitations or restrictions
thereof, including without limitation the voting rights, the
dividend rate, conversion rights, redemption price and liquidation
preference, of any series of shares of Preferred Stock, to fix the
number of shares constituting any such series and to increase or
decrease the number of shares of any such shares (but not below the
number of shares thereof then outstanding). In case the number of
shares of any such series shall be so decreased, the shares
constituting such decrease shall resume the status which they had
prior to the adoption of the resolution or resolutions originally
fixing the number of shares of such series.
The holders of the capital stock shall be entitled to one vote for
each share held at all meetings of the stockholders of the
Corporation. At all elections of directors of the Corporation each
holder of shares of capital stock of the Corporation entitled to be
voted thereat shall be entitled to as many votes as shall equal the
number of shares of stock of such holder multiplied by the number of
directors to be elected, and each stockholder may cast all of such
votes for a single director or may distribute them among the total
number of directors to be voted for, or among any two or more of such
directors, as such stockholder may see fit.
<PAGE>
No stockholder of the Corporation shall by reason of his holding
shares of any class have any pre-emptive or preferential right to
purchase or subscribe to any shares of any class of the Corporation,
now or hereafter to be authorized, or any notes, debentures, bonds,
or other securities convertible into or carrying options or warrants
to purchase shares of any class, now or hereafter to be authorized,
whether or not the issuance of any shares, or such notes,
debentures, bonds or other securities, would adversely affect the
dividend or voting rights of such stockholder."
SECOND: That thereafter, pursuant to a resolution of its Board of
Directors, a special meeting of the stockholders of said corporation was duly
called and held, upon notice in accordance with Section 222 of the General
Corporation Law of the State of Delaware, and the necessary number of shares as
required by statute were voted in favor of the amendment.
THIRD: That said amendment was duly adopted in accordance with
the provisions of Section 242 of the General Corporation Law of the State of
Delaware.
IN WITNESS WHEREOF, said HAWTHORNE FINANCIAL CORPORATION, has caused this
certificate to be signed by Scott A. Braly, its Chief Executive Officer and
President and James D. Sage, its Senior Vice President and Corporate Secretary,
this 21st day of September, 1995.
By: [SCOTT BRALY]
-------------------------------------
Chief Executive Officer and
President
Attest: [JAMES D. SAGE]
---------------------------------
Senior Vice President and
Corporate Secretary
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> SEP-30-1995
<CASH> 10,323
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 6,300
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 50,798
<INVESTMENTS-MARKET> 50,097
<LOANS> 590,811
<ALLOWANCE> 18,472
<TOTAL-ASSETS> 720,230
<DEPOSITS> 684,489
<SHORT-TERM> 5,890
<LIABILITIES-OTHER> 5,144
<LONG-TERM> 0
<COMMON> 2,599
0
0
<OTHER-SE> 22,108
<TOTAL-LIABILITIES-AND-EQUITY> 720,230
<INTEREST-LOAN> 34,413
<INTEREST-INVEST> 4,377
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 38,790
<INTEREST-DEPOSIT> 24,560
<INTEREST-EXPENSE> 25,206
<INTEREST-INCOME-NET> 13,584
<LOAN-LOSSES> 14,445
<SECURITIES-GAINS> 3,049
<EXPENSE-OTHER> 14,415
<INCOME-PRETAX> (14,125)
<INCOME-PRE-EXTRAORDINARY> (14,125)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (14,742)
<EPS-PRIMARY> (5.67)
<EPS-DILUTED> 0
<YIELD-ACTUAL> 2.36
<LOANS-NON> 17,846
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 53,160
<ALLOWANCE-OPEN> 21,461
<CHARGE-OFFS> 6,873
<RECOVERIES> 2
<ALLOWANCE-CLOSE> 18,472
<ALLOWANCE-DOMESTIC> 18,472
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
