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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
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FORM 10-Q
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X QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE
- --- SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 1996
___ 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
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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 Offices) (Zip Code)
</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 November
14, 1996.
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q INDEX
FOR THE QUARTER ENDED SEPTEMBER 30, 1996
PART I -- FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
ITEM 1. Financial Statements
Consolidated Statements of Financial Condition at September 30, 1996
(Unaudited) and December 31, 1995......................................... 3
Consolidated Statements of Operations (Unaudited) for the Three and Nine
Months Ended September 30, 1996 and 1995.................................. 4
Consolidated Statement of Stockholders' Equity (Unaudited) for the Nine
Months Ended September 30, 1996........................................... 5
Consolidated Statements of Cash Flows (Unaudited) for the Three and Nine
Months Ended September 30, 1996 and 1995.................................. 6
Notes to Consolidated Financial Statements (Unaudited).................... 8
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................ 10
PART II -- OTHER INFORMATION
ITEM 1. Legal Proceedings......................................................... 31
ITEM 2. Changes in Securities..................................................... 31
ITEM 3. Defaults upon Senior Securities........................................... 31
ITEM 4. Submission of Matters to a Vote of Security Holders....................... 31
ITEM 5. Other Information......................................................... 31
ITEM 6. Exhibits and Reports on Form 8-K.......................................... 31
</TABLE>
2
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
(UNAUDITED) (AUDITED)
------------- ------------
(DOLLARS ARE IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents.......................................... $ 49,630 $ 14,015
Investment securities available-for-sale........................... 38,564 62,793
Loans held for investment (net of allowance for estimated credit
losses of $15,175 in 1996 and $15,192 in 1995)................... 688,372 617,328
Real estate owned (net of allowance for estimated losses of $10,914
in 1996 and $15,725 in 1995)..................................... 23,726 37,905
Investment in capital stock of Federal Home Loan Bank -- at cost... 6,676 6,312
Office property and equipment -- at cost, net...................... 4,914 9,597
Accrued interest receivable........................................ 4,963 3,583
Other assets....................................................... 10,939 2,050
--------- --------
$ 827,784 $753,583
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposit accounts................................................. $ 659,590 $698,008
Borrowings....................................................... 100,000
Senior notes..................................................... 12,222 12,006
Accounts payable and other liabilities........................... 12,530 4,603
--------- --------
784,342 714,617
Stockholders' equity
Capital stock -- $0.01 par value; authorized, 20,000,000 shares;
issued and outstanding, 2,604,675 shares...................... 26 26
Cumulative perpetual preferred stock, series A -- $0.01 par
value; $50,000 liquidation preference; authorized 10,000,000
shares; issued and outstanding 270 shares
Capital in excess of par value -- common stock................... 7,745 7,745
Capital in excess of par value -- preferred stock................ 11,592 11,592
Unrealized gains (losses) on available-for-sale securities,
net........................................................... (81) 6
Retained earnings................................................ 24,335 19,788
--------- --------
43,617 39,157
Less
Treasury stock, at cost -- 5,400 shares.......................... (48) (48)
Loan to Employee Stock Ownership Plan............................ (127) (143)
--------- --------
43,442 38,966
--------- --------
$ 827,784 $753,583
========= ========
</TABLE>
3
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------- ------------------
1996 1995 1996 1995
------- ------- ------- --------
(DOLLARS ARE IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest revenues
Loans.................................................. $16,078 $11,688 $44,875 $ 34,413
Investments............................................ 983 356 4,107 1,824
Mortgage-backed securities............................. 814 2,553
------- ------- ------- --------
17,061 12,858 48,982 38,790
------- ------- ------- --------
Interest costs
Deposits............................................... 8,072 8,745 26,304 24,560
Borrowings............................................. 1,173 61 1,294 646
Senior notes........................................... 477 1,432
------- ------- ------- --------
9,722 8,806 29,030 25,206
------- ------- ------- --------
Net interest margin inclusive of contractual interest due
on nonaccrual loans.................................... 7,339 4,052 19,952 13,584
Contractual interest due on nonaccrual loans............. (641) (420) (1,717) (1,827)
------- ------- ------- --------
Net interest margin...................................... 6,698 3,632 18,235 11,757
Provision for estimated credit losses.................... 2,800 1,700 6,489 14,445
------- ------- ------- --------
Net interest margin after provision for credit losses.... 3,898 1,932 11,746 (2,688)
Non-interest revenues.................................... 626 536 1,557 1,090
Non-interest expenses
Employee............................................... 2,366 2,370 6,968 7,518
Operating.............................................. 1,098 897 3,378 2,878
Occupancy.............................................. 713 690 2,163 2,153
Professional........................................... 512 288 1,456 1,244
SAIF premium and OTS assessment........................ 450 427 1,629 1,517
------- ------- ------- --------
5,139 4,672 15,594 15,310
------- ------- ------- --------
Real estate operations, net.............................. (597) (2,692) (551) (1,277)
Gain on sale of loans.................................... 228 68
Gain on sale of securities............................... 3,049
Gain on sale of other assets and liabilities............. 6,452 86
Other revenues (expenses)................................ (3,829) 450 (3,830) 857
------- ------- ------- --------
Net earnings (loss) before income taxes.................. (5,041) (4,446) 8 (14,125)
Income taxes benefit (expense)........................... 2,885 (32) 6,368 (617)
------- ------- ------- --------
Net earnings (loss)...................................... $(2,156) $(4,478) $ 6,376 $(14,742)
======= ======= ======= ========
Net earnings (loss) available for Common (NOTE 3)........ $(2,764) $(4,478) $ 5,029 $(14,742)
======= ======= ======= ========
Net earnings (loss) per share (NOTE 3)................... $ (1.06) $ (1.72) $ 0.98 $ (5.67)
======= ======= ======= ========
Weighted average shares (NOTE 3)......................... 2,599 2,599 5,155 2,599
======= ======= ======= ========
</TABLE>
4
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED)
<TABLE>
<CAPTION>
ACCRUED
CHANGE IN DIVIDENDS
BALANCE AT UNREALIZED NET ON BALANCE AT
DECEMBER 31, GAINS EARNINGS PREFERRED SEPTEMBER 30,
1995 (LOSSES) (LOSS) STOCK REPAYMENTS 1996
------------ ---------- -------- --------- ---------- -------------
(DOLLARS ARE IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Capital stock............................ $ 26 $ 26
Cumulative perpetual -- preferred stock
Capital in excess of par value
Common stock........................... 7,745 7,745
Preferred stock........................ 11,592 11,592
Unrealized gains (losses) on
available-for-sale securities, net..... 6 (87) (81)
Retained earnings........................ 19,788 6,376 (1,829) 24,335
Treasury stock........................... (48) (48)
Loan to employee stock ownership plan.... (143) 16 (127)
------- ---- ------ ------- --- -------
Total stockholders' equity............... $ 38,966 $(87) $6,376 $ (1,829) $ 16 $43,442
======= ==== ====== ======= === =======
</TABLE>
5
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1996 1995 1996 1995
-------- -------- -------- --------
(DOLLARS ARE IN THOUSANDS)
<S> <C> <C> <C> <C>
NET CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings (loss)................................. $ (2,156) $ (4,478) $ 6,376 $(14,742)
Adjustments
Provision (benefit) for income taxes............. (3,060) (450) (6,543) 135
Provision for estimated credit losses on loans... 2,800 1,700 6,489 14,445
Provision for estimated credit losses on real
estate owned................................... 1,000 5,100 2,711 5,100
Net gain on sale of branches..................... (6,413) (86)
Net gain on sale of securities................... (3,049)
Net recoveries from sales of real estate owned... (275) (901) (1,556) (1,225)
Net gain from sale of other assets............... (268) (68)
Loan fee and discount accretion.................. (1,071) (227) (2,452) (1,575)
Depreciation and amortization.................... 425 216 1,197 1,203
FHLB dividends................................... (107) (73) (364) (250)
Goodwill amortization............................ 12 24 36
Increase in accrued interest
receivable..................................... (705) (451) (1,368) (121)
(Increase) decrease in other assets.............. (1,783) 129 (2,845) (498)
Increase (decrease) in other liabilities......... 5,926 (755) 5,924 (1,472)
Other, net....................................... (63) (181) 403
-------- -------- -------- --------
Net cash provided (used) by operating activities.... 931 (178) 731 (1,764)
-------- -------- -------- --------
NET CASH FLOWS FROM INVESTING ACTIVITIES
Investment securities
Purchases........................................ (104,482) (111)
Maturities....................................... 128,729
Sales proceeds................................... 45,521
Mortgage-backed securities
Principal amortization........................... 2,182 33 5,157
Sales proceeds................................... 1,438
Loans
New loans funded................................. (55,710) (35,411) (165,190) (100,121)
Construction disbursements....................... (22,118) (2,769) (43,733) (5,369)
Payoffs.......................................... 25,872 5,769 56,258 18,024
Sales proceeds................................... 68,750 19,350
Principal amortization........................... 6,412 3,785 13,900 12,927
Other, net....................................... (3,509) (59) (5,042) (3,748)
Real estate owned
Sale proceeds.................................... 4,278 9,241 21,855 23,571
Capitalized costs................................ (3,014) (3,636) (8,320) (10,084)
Other, net....................................... (4) (1,082) (6) (950)
Redemption of FHLB stock............................ 1,015
Office property and equipment
Sales proceeds................................... (228) 4,551 337
Additions........................................ (127) (307) (1,134)
-------- -------- -------- --------
Net cash (used) provided by investing activities.... (47,920) (22,208) (33,004) 5,823
-------- -------- -------- --------
</TABLE>
6
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ --------------------
1996 1995 1996 1995
-------- ------- --------- --------
(DOLLARS ARE IN THOUSANDS)
<S> <C> <C> <C> <C>
NET CASH FLOWS FROM FINANCING ACTIVITIES
Payment for sale of deposits........................ $(178,884) $(16,807)
Net growth in deposits.............................. 37,626 14,834 146,756 52,543
Net change in borrowings............................ 25,000 5,890 100,000 (41,251)
Collection of ESOP loan............................. 10 8 16 16
-------- ------- --------- --------
Net cash provided (used) by financing activities.... 62,636 20,732 67,888 (5,499)
-------- ------- --------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS...... 15,647 (1,654) 35,615 (1,440)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD...... 33,983 18,277 14,015 18,063
-------- ------- --------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD............ $ 49,630 $16,623 $ 49,630 $ 16,623
======== ======= ========= ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for interest......... $ 9,069 $ 8,541 $ 27,959 $ 25,549
Non-cash investing and financing activities
Real estate acquired in settlement of loans.... $ 8,859 $ 8,282 $ 18,909 $ 30,911
Loans originated to finance property sales..... 3,835 6,023 15,565 6,469
Net change in unrealized gains (losses) on
available-for-sale securities............... 59 (87)
Transfer of held to maturity securities to
available-for-sale.......................... 30,168
Loan activity
Total commitments and permanent fundings....... $105,422 $47,811 $ 273,098 $121,767
Less:
Change in undisbursed funds on construction
commitments............................... (15,357) (3,608) (33,369) (9,808)
Loans originated to finance property
sales..................................... (3,835) (6,023) (15,565) (6,469)
Undisbursed portion of new lines of
credit.................................... (8,402) (15,241)
-------- ------- --------- --------
Net construction disbursements and loans
funded...................................... $ 77,828 $38,180 $ 208,923 $105,490
======== ======= ========= ========
</TABLE>
7
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1996
NOTE 1 -- SUMMARY OF 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 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, 1996, and December 31, 1995, and the results of its operations and
its cash flows for the nine months ended September 30, 1996 and 1995. Certain
information and note disclosures normally included in financial statements
prepared in accordance with Generally Accepted Accounting Principles ("GAAP")
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, 1996, are not necessarily indicative of the results
that may be expected for the full year ending December 31, 1996.
These unaudited 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, 1995.
NOTE 2 -- RECLASSIFICATION
Certain amounts in the 1995 consolidated financial statements have been
reclassified, where practicable, to conform with classifications in 1996.
8
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
SEPTEMBER 30, 1996
(amounts are in thousands, except for book value and per share data)
NOTE 3 -- BOOK VALUE AND EARNINGS PER SHARE
The table below sets forth the Company's book value and earnings per share
calculations for September 30, 1996, using the Modified Treasury Stock Method as
prescribed under GAAP. All other calculations shown, using alternate methods,
are for informational purposes only. In the table below, (1) Warrants refers to
the warrants issued by the Company in December 1995, which have an exercise
price of $2.25 per share and can be exercised beginning three years from the
issue date and for a period of ten years from the issue date, and (2) Preferred
Stock refers to the Cumulative Perpetual Preferred Stock issued by the Company
in December 1995, which carries an annual dividend equal to 18% of the face
amount of the Preferred Stock, permits dividends thereon to be paid, under
certain circumstances, in equivalent value of the Company's common stock and has
an initial dividend payment in June 1997.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, 1996 NINE MONTHS ENDED SEPTEMBER 30, 1996
------------------------------------- -------------------------------------
MODIFIED MODIFIED
TREASURY ACTUAL SHARES, TREASURY ACTUAL SHARES,
STOCK ACTUAL WARRANTS, STOCK ACTUAL WARRANTS,
METHOD SHARES AND OPTIONS METHOD SHARES AND OPTIONS
-------- ------- -------------- -------- ------- --------------
<S> <C> <C> <C> <C> <C> <C>
SHARES OUTSTANDING
Common..................... 2,599 2,599 2,599 2,599 2,599 2,599
Warrants................... 2,376 2,376 2,376
Options.................... 700 700 700
Less Treasury shares....... (520)
------- ------- ------- ------- ------- -------
Total.............. 2,599 2,599 5,675 5,155 2,599 5,675
======= ======= ======= ======= ======= =======
STOCKHOLDERS' EQUITY
Common..................... $ 31,850 $31,850 $ 31,850 $ 31,850 $31,850 $ 31,850
Warrants................... 5,346 5,346 5,346
Options.................... 3,462 3,462 3,462
Less Treasury shares (2)... (3,456)
------- ------- ------- ------- ------- -------
Total.............. $ 31,850 $31,850 $ 40,658 $ 37,202 $31,850 $ 40,658
======= ======= ======= ======= ======= =======
NET EARNINGS (LOSS)
Net earnings for the
period.................. $ (2,156) $ 6,376
Partial reduction in
interest expense(1)..... 482
Preferred stock
dividends............... (608) (1,829)
------- -------
Adjusted earnings available
for Common.............. $ (2,764) $ 5,029
======= =======
BOOK VALUE PER SHARE......... $ 12.25 $ 12.25 $ 7.16 $ 7.22 $ 12.25 $ 7.16
======= ======= ======= ======= ======= =======
EARNINGS PER SHARE........... $ (1.06) $ (1.06) $ (1.06) $ 0.98 $ 1.75 $ 0.80
======= ======= ======= ======= ======= =======
</TABLE>
- ---------------
(1) Under the Modified Treasury Stock Method, it is assumed that the Company
will use proceeds from the proforma exercise of the Warrants and Options to
acquire 20% of the actual shares currently outstanding (Treasury shares) and
use any remaining assumed proceeds to reduce the outstanding balance of the
Company's Senior Notes. The partial reduction in interest expense of
$482,000 represents the proforma reduction in interest expense as a result
of the proforma reduction in the outstanding balance of Senior Notes. The
Modified Treasury Stock Method was not utilized for the three months ended
September 30, 1996 because the effect would have been anti-dilutive.
(2) Treasury shares were assumed to be repurchased at the average closing stock
price for the respective periods.
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
For the quarter ended September 30, 1996, the Company reported a net loss
of $2.2 million, or $1.06 per share on actual shares outstanding, compared with
a net loss of $4.5 million, or $1.72 per share, for the same period in 1995. The
net loss for the quarter ended September 30, 1996, includes an after-tax charge
of $3.8 million for the special assessment levied industry-wide to recapitalize
the Savings Association Insurance Fund ("SAIF").
For the nine months ended September 30, 1996, the Company reported net
earnings of $6.4 million, or $0.98 per share, as compared with a net loss of
$14.7 million, or $5.67 per share for the first nine months of 1995.
SPECIAL SAIF ASSESSMENT
On September 30, 1996, as a part of the omnibus appropriations package
signed by President Clinton, the government mandated a special assessment to
recapitalize the SAIF, which is a part of the Federal Deposit Insurance
Corporation ("FDIC"). The special assessment was levied against all savings
institutions in the country with deposits insured by the SAIF. Although the FDIC
deposit insurance premium rates for savings institutions will be higher than the
rates that banks will pay to the FDIC for the next several years, the
recapitalization of the SAIF will permit significant premium reductions for
thrifts and a more competitive environment between banks and savings
institutions. The Bank's current annual SAIF premium expense approximates $2.1
million.
CAPITAL RATIOS
The Bank maintained core and risk-based regulatory capital ratios of 6.3%
and 10.5%, respectively, at September 30, 1996, in excess of the regulatory
minimums which define a "well capitalized" institution.
CORE OPERATING RESULTS
The Company's core operating results continue to show significant
improvement on a quarter-to-quarter, and year-to-year basis because the
Company's net earning asset base is increasing due to its continued success in
originating a sizeable volume of high-yielding loans. The Company's net interest
margin totaled $6.7 million for the third quarter of 1996, compared with $3.6
million in the third quarter of 1995. For the third quarter of 1996, the
Company's net interest margin, as a percent to interest-earning assets, was
3.54%, compared to 2.21% in the third quarter of 1995. For the third quarter of
1996, interest-earning assets averaged $757.3 million, an increase from the
third quarter of 1995's level of $656.6 million. For the nine months ended
September 30, 1996, the Company's net interest margin was $18.2 million,
compared to $11.8 million for the same period in 1995. These results produced
net interest margins, as a percentage of interest-earning assets, for each
respective period of 3.22% and 2.36%.
In the third quarter of 1996, noninterest revenues increased slightly to
$0.6 million from $0.5 million for the same period in 1995. For the nine months
ended September 30, 1996, noninterest revenues totaled $1.6 million as compared
to $1.1 million for the same period in 1995. These amounts are exclusive of
gains on the sale of assets or other nonrecurring revenues.
Operating costs totaled $5.1 million in the third quarter of 1996,
excluding the $3.8 million after-tax charge from the SAIF special assessment.
This compares with operating costs of $4.7 million for the third quarter of
1995. For the nine months ended September 30, 1996, total operating costs
amounted to $15.6 million, which was a modest increase from operating costs of
$15.3 million for the same period in 1995.
For the third quarter of 1996, earnings from the Company's core operations
(net interest income and noninterest revenues less operating costs, before loan
loss provisions, real estate operations and non-recurring items) totaled $2.2
million, a significant improvement from the net loss from core operations of
$0.5 million reported for the same period in 1995. For the nine months ended
September 30, 1996, earnings from core operations totaled $4.2 million, as
compared to a loss from core operations of $2.5 million for the same period
10
<PAGE> 11
in 1995. The results for the third quarter of 1996 produced an efficiency ratio
of 70% as compared to an efficiency ratio of 112% for the same period in 1995.
LOAN LOSS PROVISIONS
During the 1996 third quarter, the Bank recorded loan loss provisions of
$2.8 million, compared to loan loss provisions of $1.7 million during the 1995
third quarter. For the first nine months of 1996, loan loss provisions totaled
$6.5 million, compared to $14.4 million for the same period during 1995.
The Bank continues to be burdened with relatively poor asset quality,
almost exclusively related to loans made prior to 1994. Since 1993, the Bank has
resolved the vast majority of its asset quality problems, through foreclosure
and liquidation of its collateral and through substantive loan restructurings
(which generally involve a comprehensive restructuring of the Bank's loan(s)
with selected borrowers). A majority of the loan loss provisions recorded during
1996 reflect the financial cost resulting from a restructuring of a small number
of large loans and multiple loans with individual borrowers originated prior to
1993, and the revaluation of the Bank's investment in the small number of
development-related loans originated prior to 1993 which remain in the Bank's
loan portfolio.
Loan loss provisions recorded during 1996 also include the continued
establishment of general valuation allowances for the Bank's 1995 and 1996 loan
originations. Since 1994, the Bank has recorded new loan commitments of $471.1
million, concentrated in loans secured by expensive homes, income-producing
properties and residential construction projects. To date, none of these loans
has resulted in the foreclosure of the Bank's collateral, and the overall
performance of these loans has met or exceeded expectations.
The Bank believes that the consistent and sustained pattern of reduced
credit loss provisions (represented by loan loss provisions and post-foreclosure
valuation adjustments on real estate owned), which have declined from $54.6
million in 1992, to $34.7 million in 1993/1994, to $20.0 million in 1995, and to
$9.2 million during the first nine months of 1996, accurately reflects the
diminishing adverse influence of the Bank's pre-1994 loan portfolio on the
Bank's operating results. At September 30, 1996, loans originated prior to 1994
had declined to approximately 50% of the Bank's net loan portfolio, and this
portfolio had declined in dollar terms by over 37% from its level at the end of
1994.
OTHER ITEMS
During the third quarter of 1996, the Bank's real estate operations, which
involve the disposal of foreclosed properties, produced a net cost of $0.6
million, compared to a net cost of $2.7 million for the same period in 1995.
Included in these net costs were provisions for estimated credit losses on real
estate owned totaling $1.0 million and $5.1 million for the quarters ended
September 30, 1996 and 1995, respectively.
Other revenues and costs are comprised of non-recurring activities to the
Bank's operations. During the third quarter of 1996, the Bank recorded a $3.8
million after-tax charge from the special SAIF assessment. For the nine months
ended September 30, 1996, in addition to the non-recurring item recorded during
the third quarter, the Bank realized a net gain of $6.4 million from the sale of
its San Diego retail branch franchise.
INCOME TAXES
During the third quarter of 1996 and the nine months ended September 30,
1996, the Company recorded income tax benefits of $2.9 million and $6.4 million,
respectively, resulting from the utilization of tax loss carryforwards, which
previously were offset by valuation allowances.
11
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ASSET QUALITY
At September 30, 1996, nonperforming assets totaled $44.5 million, net of
credit loss reserves, or 5.4% of total assets. By comparison, nonperforming
assets totaled $55.5 million (7.4% of total assets) at December 31, 1995, $70.0
million (9.7% of total assets) at September 30, 1995 and $93.9 million (12.6% of
total assets) at the end of 1994. The Bank's remaining nonperforming assets are
divided almost evenly between foreclosed properties and loans placed on
nonaccrual status. Unlike other financial institutions, the Bank places all
loans delinquent one or more payments on nonaccrual status, rather than ceasing
the accrual of interest only for loans three or more payments delinquent.
Adjusting the Bank's nonperforming asset measures for this difference,
nonperforming assets on a peer comparable basis were $33.7 million at September
30, 1996, or 4.1% of total assets.
The Bank expects that its current portfolio of foreclosed properties will
be liquidated in the ordinary course of business over the next 12 months.
Accordingly, the Bank expects that its portfolio of nonperforming assets will
continue its three-year decline over the coming quarters, with an attendant
moderation in credit loss provisions.
PARENT COMPANY ITEMS
As previously reported, the Company issued an aggregate of $27.0 million of
high-cost Senior Notes and Cumulative Perpetual Preferred Stock, and issued
Warrants to purchase the Company's common stock, in connection with a
recapitalization of the Bank in December 1995. For the three-and-nine-month
periods ended September 30, 1996, interest expense on the $13.5 million (face
amount) of Senior Notes was $0.5 million and $1.4 million, respectively, and
accrued but unpaid dividends on the $13.5 million (face amount) of Cumulative
Perpetual Preferred Stock were $0.6 million and $1.8 million, respectively.
Other parent company costs totaled $0.1 million and $0.7 million, respectively,
for the three-month and nine-month periods ended September 30, 1996.
OPERATING RESULTS
INTEREST MARGIN
The Company's net interest margin, or the difference between the interest
earned on loans and investment securities and the cost of deposits and
borrowings, 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 maturity of the Company's adjustable-rate
and fixed-rate loans and short-term investment securities and its deposits and
borrowings, (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.
12
<PAGE> 13
The table below sets forth the Company's average balance sheet, and the
related effective yields and costs on average interest-earning assets and
interest-bearing liabilities, for the nine months ended September 30, 1996 and
1995. In the table, interest revenues are net of interest associated with
nonaccrual loans (dollars are in thousands).
<TABLE>
<CAPTION>
NINE MONTHS ENDED
--------------------------------------------------------------
SEPTEMBER 30, 1996 SEPTEMBER 30, 1995
----------------------------- ----------------------------
REVENUES/ YIELD/ REVENUES/ YIELD/
AMOUNT COSTS COST AMOUNT COSTS COST
--------- --------- ------ --------- --------- -----
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets
Loans................................. $653,274 $43,158 8.81% $571,519 $32,586 7.60 %
Investments and other securities...... 102,300 4,107 5.35% 40,124 1,824 6.06 %
Mortgage-backed securities............ 53,884 2,553 6.32 %
-------- ------- -------- -------
Total interest-earning assets...... 755,574 47,265 8.34% 665,527 36,963 7.41 %
------- ----- ------- ----
Noninterest-earning assets.............. 31,401 57,407
-------- --------
Total assets............................ $786,975 $722,934
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities
Deposits.............................. $696,444 26,304 5.05% $670,842 24,560 4.89 %
Borrowings............................ 29,074 1,294 5.95% 14,105 646 6.04 %
Senior Notes.......................... 12,112 1,432 15.79%
-------- ------- -------- -------
Total interest-bearing
liabilities...................... 737,630 29,030 5.26% 684,947 25,206 4.92 %
------- ----- ------- ----
Noninterest-bearing liabilities......... 7,054 6,874
Stockholders' equity.................... 42,291 31,113
-------- --------
Total liabilities & stockholders'
equity................................ $786,975 $722,934
======== ========
Net interest margin ($)................. $18,235 $11,757
======= =======
Net interest margin (% to
interest-earning assets).............. 3.22% 2.36 %
===== ====
</TABLE>
The table below summarizes the components of the changes in the Company's
interest revenues and costs for the nine months ended September 30, 1996 and
1995 (dollars are in thousands).
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
INCREASE (DECREASE) DUE TO CHANGE IN
-------------------------------------------------
RATE AND NET
VOLUME RATE VOLUME(1) OTHER(3) CHANGE
------- ------ --------- -------- -------
<S> <C> <C> <C> <C> <C>
INTEREST REVENUES
Loans(2)....................................... $ 4,661 $5,171 $ 740 $ -- $10,572
Investments and other securities............... 2,826 (213) (330) 2,283
Mortgage-backed securities..................... (2,553) (2,553)
------ ------ ----- ----- -------
4,934 4,958 410 10,302
------ ------ ----- ----- -------
INTEREST COSTS
Deposits....................................... 937 685 26 96 1,744
Borrowings..................................... 686 (21) (22) 5 648
Senior notes................................... 1,432 1,432
------ ------ ----- ----- -------
3,055 664 4 101 3,824
------ ------ ----- ----- -------
NET MARGIN....................................... $ 1,879 $4,294 $ 406 $ (101) $ 6,478
====== ====== ===== ===== =======
</TABLE>
- ---------------
(1) Calculated by multiplying change in rate by change in volume.
(2) Interest on loans is net of interest on nonaccrual loans and includes
amortization of loan fees and discounts.
(3) Principally due to an extra day of interest expense due to leap year.
13
<PAGE> 14
The Company's net interest margin, expressed as a percentage of
interest-earning assets, has been steadily rising over the past twenty-one
months. The Company commenced operation of several new financing businesses
early in 1995, each targeted on a narrow segment of the real estate finance
markets in Southern California and designed to produce meaningful new loan
volumes with yields substantially higher than the Company's pre-1995 loan
portfolio while maintaining the Company's established credit quality standards.
The Company originated a diminimus volume of loans during 1993 and 1994. During
the nine months ended September 30, 1995, the Company originated $121.8 million
of new permanent and construction loan commitments with a weighted average
interest rate of 9.59% at origination. By comparison, new permanent and
construction loan commitments during the nine months ended September 30, 1996,
were $274.1 million, and carried a weighted average interest rate at origination
of 10.05%. At September 30, 1996, approximately $351.2 million of the loans
originated since 1994 (which amount is net of undisbursed funds of $55.6
million) remained in the Company's portfolio and had an aggregate weighted
average interest rate of 9.53%. Loans originated prior to 1995 totaled $359.6
million at September 30, 1996, and had an aggregate weighted average interest
rate of 7.76%. Most of the loans originated during 1995 and 1996 are
adjustable-rate, adjusting quarterly or more frequently, and utilize a variety
of indices, including the Eleventh District Cost of Funds Index ("11th DCOFI"),
the Prime Rate and the One-Year Constant Maturity Treasury Index. The more
frequent adjustments of, and the wider array of indices utilized by, the
Company's post-1994 originations have steadily improved the Company's
sensitivity to movements in market interest rates. At September 30, 1996,
approximately 92% of the Company's adjustable rate loans, and 71% of all loans,
had repricing intervals of six months or less. By comparison, at September 30,
1995, 86% of the Company's adjustable rate loans, and 62% of all loans, had
repricing intervals of six months or less.
PROVISIONS FOR ESTIMATED CREDIT LOSSES ON LOANS
For the three and nine months ended September 30, 1996, the Company
recorded loan loss provisions of $2.8 million and $6.5 million, respectively,
compared with provisions of $1.7 million and $14.4 million recorded during the
three and nine months ended September 30, 1995, respectively. The reduction in
loan loss provisions from 1995 to 1996 resulted primarily from an improvement in
asset quality. At September 30, 1996, net nonperforming assets and performing
loans classified "Substandard", "Doubtful" or "Loss" totaled $96.2 million
compared with $113.9 million at September 30, 1995. Within these totals, the net
carrying value of real estate owned totaled $23.7 million and $55.1 million,
respectively, at September 30, 1996, and 1995. The majority of the provisions
recorded in the first nine months of 1995 were attributable to an increase in
the capitalization rates utilized by the Company to value its portfolios of
owned apartment buildings and classified apartment loan collateral.
Notwithstanding the measurable improvement in the Company's asset quality
during the past twelve months, the magnitude of the Company's nonperforming
asset and classified performing loan portfolios remains substantially above peer
levels and represents a significant portion of the Company's assets. These
portfolios dilute the Company's operating results, through a combination of
funding and management costs and incremental loss provisions. Further, these
assets expose the Company to the potential for additional losses to the extent
that borrowers are unable to make their payments to the Company, requiring the
Company to pursue foreclosure of its collateral, and to the extent that the
submarkets in which the Company's collateral is located (principally the South
Bay area of Los Angeles County), or the type of property securing the Company's
loans, continue to be resistant to growth in real estate values. As a result,
management continues to diligently manage this portfolio of troubled assets and
to measure in a timely fashion adverse portfolio migration trends and the
adequacy of the Bank's reserves for future credit losses.
14
<PAGE> 15
NON-INTEREST REVENUES
The table below sets forth the Company's non-interest revenues for the
three-month and nine-month periods indicated (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ----------------------------
1996 1995 CHANGE 1996 1995 CHANGE
---- ---- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Other loan and escrow fees.............. $431 $337 $ 94 $1,032 $ 570 $462
Deposit account fees.................... 88 135 (47) 367 454 (87)
Other revenues.......................... 107 64 43 158 66 92
---- ---- ---- ------ ------ ----
$626 $536 $ 90 $1,557 $1,090 $467
==== ==== ==== ====== ====== ====
</TABLE>
Other loan and escrow fees in 1996 were higher than in 1995 due primarily
to increased loan production and loan prepayments.
OPERATING COSTS
The table below details the Company's operating costs for the three-month
and nine-month periods indicated (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ --------------------------
1996 1995 CHANGE 1996 1995 CHANGE
------ ------ ------ ------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
Employee..................................... $2,366 $2,370 $ (4) $ 6,968 $ 7,518 $(550)
Operating.................................... 1,098 897 201 3,378 2,878 500
Occupancy.................................... 713 690 23 2,163 2,153 10
SAIF insurance premium and OTS assessment.... 450 427 23 1,629 1,517 112
Professional................................. 512 288 224 1,456 1,244 212
------ ------ ---- ------- ------- -----
$5,139 $4,672 $467 $15,594 $15,310 $ 284
====== ====== ==== ======= ======= =====
</TABLE>
By the end of the 1996 third quarter, the Company had completed about
two-thirds of the hiring necessary to fully staff its various lending groups.
The remainder of the professionals to be hired are expected to be retained by
the end of 1996. These additional resources are necessary to meet the
higher-than-expected demand for the Company's financing products. During 1996,
the Company also expanded its investment in community-based organizations
focused on attracting mortgage credit and other banking services.
Based upon current activity levels, management expects that the Company's
annual operating costs will reach between $22 million and $23 million during
1997, before the benefit of any reduction to the premiums it pays to the FDIC
arising from the recent legislation to recapitalize the SAIF, which will, over
time, bring parity to the insurance premiums paid by SAIF-insured and
BIF-insured institutions.
REAL ESTATE OPERATIONS
The table below sets forth the revenues and costs attributable to the
Company's foreclosed properties 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 above in Operating Costs (dollars
are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- -------------------------
1996 1995 CHANGE 1996 1995 CHANGE
------- ------- ------ ------ ------- ------
<S> <C> <C> <C> <C> <C> <C>
Expenses associated with real estate owned
Property taxes............................ $ (87) $ (184) $ (97) $ (217) $ (553) $ 336
Repairs, maintenance and renovation....... (21) (114) 93 (120) (322) 202
Insurance................................. (62) (6) (56) (180) (95) (85)
------- ------- ------ ------- ------- ------
(170) (304) (134) (517) (970) 453
Net recoveries from sale of properties...... 275 1,524 (1,249) 1,557 2,027 (470)
Rental income, net.......................... 298 1,188 (890) 1,120 2,766 (1,646)
Provision for estimated losses on real
estate owned.............................. (1,000) (5,100) 4,100 (2,711) (5,100) 2,389
------- ------- ------ ------ ------- ------
$ (597) $(2,692) $2,095 $ (551) $(1,277) $ 726
======= ======= ====== ======= ======= ======
</TABLE>
15
<PAGE> 16
The costs included in the table above (and, therefore, excluded from
operating costs (see Operating Costs), reflect holding costs directly
attributable to the portfolio of real estate owned assets.
Net revenues from owned properties principally include the net operating
income (collected rental revenues less operating expenses and certain renovation
costs) from foreclosed apartment buildings or receipt, following foreclosure, of
similar funds held by receivers during the period the original loan was in
default. During the three and nine months ended September 30, 1996, provisions
for estimated losses on foreclosed real estate in the amounts of $1.0 million
and $2.7 million, respectively, were recorded, principally associated with a
continued decline in value on certain owned non-apartment properties and
higher-than-expected renovation costs for the Company's owned apartment
portfolio. During the nine months ended September 30, 1996, the Company sold 134
properties generating net proceeds of $37.4 million and aggregate net recoveries
of $1.6 million. During the three months ended September 30, 1996, the Company
sold 31 properties generating net proceeds of $8.1 million and aggregate net
recoveries of $0.3 million.
As of September 30, 1996, the Company's portfolio of properties consisted
of 203 individual homes, apartment buildings, and land parcels. In addition, as
of that date the Company's defaulted loan portfolio was represented by 140 homes
and its portfolio of performing project concentration loans secured 347
individual homes. See Classified Assets. 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.
OTHER NON-OPERATING REVENUES AND EXPENSES
Other non-operating revenues and expenses include gain on sale of loans,
gain on sale of securities, gain on sale of other assets and liabilities, and
other revenues and expenses. For the nine months ended September 30, 1996, other
non-operating revenues and expenses included (1) gains of $6.5 million primarily
as a result of the $185.2 million branch deposit sale, (2) assessment of $3.8
million for the recapitalization of the SAIF, (3) gains of $0.2 million as a
result of $68.9 million in loan sales, (4) legal recoveries of $0.2 million and
(5) other expenses of $0.2 million primarily due to an upward adjustment to the
deferred loan fees balance, to correct for overamortization in prior periods.
For the nine months ended September 30, 1995, other non-operating revenues
included (1) gains of $3.0 million primarily as a result of the sale of $11.5
million in marketable equity securities, (2) interest income of $0.5 million on
a California Franchise tax refund, (3) legal recoveries of $0.4 million, (4) a
gain of $0.1 million on the sale of $17.1 million in branch deposits and (5) a
gain of $0.1 million on the sale of $19.2 million in loans.
INCOME TAXES
At December 31, 1995, the Company retained accumulated income tax benefits
of $35.5 million, which principally consisted of net operating loss
carryforwards. The utilization of these net operating loss carryforwards is
limited to the demonstrated ability of the Company to generate pretax earnings
during the carryforward period, which generally runs for fifteen years from the
date the loss was generated. In accordance with Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes ("SFAS 109"), the
Company recorded an income tax benefit of $2.9 million and $6.4 million,
respectively, during the three and nine months ended September 30, 1996. Among
other things, SFAS 109 permits the recognition of an income tax benefit, and the
corresponding recording of a deferred tax asset, to the extent pretax earnings
are reasonably expected to be generated. For regulatory capital purposes, the
Office of Thrift Supervision ("OTS") limits the cumulative amount of any
deferred tax asset to the lesser of pretax earnings reasonably expected to be
generated during the succeeding twelve-month period or 10% of an institution's
tangible capital.
16
<PAGE> 17
FINANCIAL CONDITION, CAPITAL RESOURCES & LIQUIDITY AND ASSET QUALITY
ASSETS
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand, deposits at
correspondent banks and Federal funds sold. The Company maintains balances at
correspondent banks to cover daily inclearings, wire activities and other
charges. Cash and cash equivalents at September 30, 1996, were $49.6 million, an
increase from $14.0 million at December 31, 1995. This increase in cash balances
at September 30, 1996, was due to the accumulation of excess cash in the third
quarter in preparation for loan fundings during the fourth quarter. The excess
cash was made available through deposit growth as well as borrowings against the
Company's line of credit with the FHLB.
INVESTMENT SECURITIES
The cost basis and estimated fair value of investment securities
available-for-sale are summarized as follows (dollars are in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
--------------------------------------------
GROSS UNREALIZED ESTIMATED
AMORTIZED ---------------- FAIR
COST GAINS LOSSES VALUE
--------- ----- ------ ---------
<S> <C> <C> <C> <C>
U.S. Government................................ $38,645 $26 $ (107) $38,564
======= === ===== =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1995
--------------------------------------------
GROSS UNREALIZED ESTIMATED
AMORTIZED ---------------- FAIR
COST GAINS LOSSES VALUE
--------- ----- ------ ---------
<S> <C> <C> <C> <C>
U.S. Government................................ $62,787 $11 $ (5) $62,793
======= === ===== =======
</TABLE>
The available-for-sale amounts at September 30, 1996 and December 31, 1995,
include U.S. Government securities purchased with proceeds from the
recapitalization of the Company in December 1995 that have been pledged as
security for the payment of interest expense associated with the Senior Notes
(as defined herein) that were issued in the recapitalization. These pledged
securities had a cost basis and fair value of $4.1 million and $4.0 million,
respectively, at September 30, 1996.
The cost basis and estimated fair value of investment securities
available-for-sale at September 30, 1996, are summarized by contractual maturity
as follows (dollars are in thousands):
<TABLE>
<CAPTION>
ESTIMATED
FAIR
COST BASIS VALUE
---------- ---------
<S> <C> <C>
Due in less than one year...................................... $ 842 $ 842
Due in one year through five years............................. 37,803 37,722
------- -------
$ 38,645 $38,564
======= =======
</TABLE>
17
<PAGE> 18
LOANS
GENERAL
The two tables below set forth the composition of the Company's loan
portfolio, and the percentage of composition by type of security, delineated by
the year of origination and in total, as of the dates indicated (dollars are in
thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
-----------------------------------
POST-1994 PRE-1995 TOTAL
--------- -------- --------
<S> <C> <C> <C>
PERMANENT
Single family (non-project)
Estate................................................ $ 98,677 $ -- $ 98,677
Other................................................. 23,092 126,295 149,387
Loan concentrations...................................... 776 62,657 63,433
Multi-family
2 to 4 units.......................................... 6,674 28,457 35,131
5 or more units....................................... 107,613 133,775 241,388
Commercial............................................... 61,737 7,772 69,509
Land..................................................... 1,200 2,121 3,321
RESIDENTIAL CONSTRUCTION................................... 91,195 91,195
OTHER...................................................... 15,805 16 15,821
-------- -------- --------
GROSS LOANS RECEIVABLE..................................... $ 406,769 $361,093 $767,862
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996 DECEMBER 31, 1995 SEPTEMBER 30, 1995
------------------ ------------------ ------------------
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT
-------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
PERMANENT LOANS
Single family
Non-project...................... $248,064 32.2% $255,956 39.0% $243,710 40.4%
Loan concentrations.............. 63,433 8.3% 67,189 10.2% 69,423 11.4%
Multi-family
2 to 4 units..................... 35,131 4.6% 44,640 6.8% 45,751 7.5%
5 or more units.................. 241,388 31.4% 216,420 33.0% 198,547 32.7%
Commercial.......................... 69,509 9.1% 31,258 4.8% 19,702 3.2%
Land................................ 3,321 0.4% 5,579 0.9% 5,536 0.9%
RESIDENTIAL CONSTRUCTION.............. 91,195 11.9% 33,347 5.1% 22,579 3.7%
OTHER................................. 15,821 2.1% 1,554 0.2% 1,305 0.2%
-------- ----- -------- ----- -------- -----
GROSS LOANS RECEIVABLE................ 767,862 100.0% 655,943 100.0% 606,553 100.0%
===== ===== =====
LESS
Participants' share................. (2,450) (2,219) (2,213)
Undisbursed loan funds.............. (53,918) (15,208) (9,375)
Deferred loan fees and credits,
net.............................. (7,947) (5,996) (4,154)
Allowance for estimated losses...... (15,175) (15,192) (18,472)
-------- -------- --------
NET LOANS RECEIVABLE.................. $688,372 $617,328 $572,339
======== ======== ========
</TABLE>
The Company's loan portfolio is exclusively concentrated in Southern
California real estate. At September 30, 1996 and 1995, respectively, 41% and
52% of the Company's loan portfolio consisted of permanent loans secured by
single family residences, 36% and 40% consisted of permanent loans secured by
multi-unit residential properties, and 23% and 8% consisted of loans to finance
commercial properties, the acquisition of land and the construction of single
family housing.
18
<PAGE> 19
Prior to 1994, 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 portfolio of loans originated prior to 1994 and a high
volume of foreclosures associated with this pre-1994 portfolio, though
foreclosures have been declining over the past several quarters. These asset
quality trends reflect the general 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 loans
secured by apartment buildings, for which property cash flows are, or may
become, inadequate to meet borrowers' debt service requirements, (2) the
concentration within the Company's loan and property portfolios of multiple
permanent loans and foreclosed properties within a single integrated
development, and (3) the concentration within the Company's portfolio of loans
to one or more individuals, or groups of individuals, who 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.
LENDING OPERATIONS
During 1995, the Company aggressively re-entered the mortgage finance
business, specializing in providing financings secured by income properties,
very expensive homes and residential construction projects. For the twenty-one
months ended September 30, 1996, the Company originated $471.1 million of
permanent and construction loan commitments. Net of undisbursed funds of $55.6
million and prepayments by borrowers, this portfolio stood at $351.2 million at
September 30, 1996, or approximately 50% of net loans receivable.
The Company's principal competitors in its pursuit of new permanent
financing business generally exclude the large, in-market banking and thrift
companies, principally because these companies do not offer products similar to
those on which the Company now focuses, including financings secured by income-
producing properties and very expensive homes. The Company's principal
competition for this business tends to come from FDIC-insured thrift and loans
(income property financings), small-to-medium sized life insurance companies and
mortgage conduits (income property financings) and large investment banking
companies (estate financing). On the other hand, competition in the conventional
permanent loan business, which is the smallest component of the Company's
business, is widespread and extremely price competitive.
To acquire new business which meets the Company's goals for profitability,
return on capital and credit quality, the Company offers prospective borrowers
efficient and effective service (e.g., quick and comprehensive response to
financing requests and timely funding), a willingness to tailor the terms and
conditions of the transaction to accomplish the borrower's objectives (while
satisfying the Company's credit standards), and a real estate orientation which
generally permits the Company to contribute proactively in helping borrowers
accomplish their near-term or long-term financial objectives. Management
believes these attributes, taken together, clearly distinguish the Company from
its competitors and permit the Company to charge a premium price for its
permanent financing products (except for the modest amount of financings
involving conventional single family loan transactions). The Company obtains its
permanent financing sourcing through independent mortgage brokers, rather than
through a captive sales force.
Unlike the Company's narrowly focused permanent financing businesses, its
pursuit of development financing opportunities is very competitive, with banks
and thrifts of all sizes generally being active in the marketplace. Generally,
pricing and underwriting standards in this market are defined around a fairly
narrow range. In this environment, the Company distinguishes itself from its
competitors by offering prospective customers efficient prefunding evaluation
and post-funding funds control, as well as an intimate knowledge of the
development process. Unlike the Company's permanent financing businesses,
development financing is generally sourced directly from builders and
developers.
19
<PAGE> 20
CLASSIFIED ASSETS
At September 30, 1996, 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 assets. Classified Assets include owned properties, nonaccrual loans,
and performing loans which have been adversely classified pursuant to OTS
regulations and guidelines ("Performing/Classified" loans) (dollars are in
thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1996 1995 1995
------------ ----------- ------------
<S> <C> <C> <C>
PROPERTIES............................................ $ 34,640 $ 53,630 $ 73,143
NONACCRUAL LOANS...................................... 25,223 21,709 17,846
Performing loans
Classified Loss, Doubtful and Substandard........... 56,900 57,049 53,160
-------- -------- --------
GROSS CLASSIFIED ASSETS............................... 116,763 132,388 144,149
LESS
Specific reserves..................................... (13,101) (18,049) (22,180)
General reserves...................................... (7,416) (8,424) (7,309)
-------- -------- --------
NET CLASSIFIED ASSETS................................. $ 96,246 $ 105,915 $114,660
======== ======== ========
NET LOANS RECEIVABLE AND PROPERTIES................... $712,098 $ 655,233 $628,208
======== ======== ========
PERCENTAGE TO NET LOANS RECEIVABLE AND PROPERTIES..... 13.5% 16.2% 18.3%
======== ======== ========
PERCENTAGE OF NET CLASSIFIED ASSETS TO CORE CAPITAL... 185.6% 244.3% 483.0%
======== ======== ========
</TABLE>
The Company currently places loans on nonaccrual status when (1) they
become one or more payments delinquent or (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 Company's loan portfolio continued to improve during
the quarter, consistent with the improvement realized since 1993. The carrying
value of nonperforming assets (i.e., foreclosed properties, loans delinquent one
or more payments and performing loans placed on nonaccrual status) declined to
$44.5 million, or 5.4% of total assets, at September 30, 1996, from $55.5
million, or 7.4% of total assets, at December 31, 1995, and $69.2 million, or
9.6% of total assets, at September 30, 1995. The carrying value of nonperforming
assets peaked at more than $150.0 million in early 1994. The reduction in
nonperforming assets reflects the continued sales of foreclosed properties and
the decrease in the rate of borrower defaults. As described above, the Company
places any loan delinquent one or more payments on nonaccrual status and
includes such amounts as loans in default for reporting purposes. At September
30, 1996, December 31, 1995 and September 30, 1995, the principal amount of
nonaccrual loans included $12.3 million, $10.4 million and $8.1 million,
respectively, of loans with respect to which payments were either current or
delinquent less than three payments.
20
<PAGE> 21
The table below shows the Company's gross classified loan portfolio as of
September 30, 1996 (dollars are in thousands).
<TABLE>
<CAPTION>
CLASSIFIED LOANS
------------------------------------------
LOSS,
DOUBTFUL NONACCRUAL
& SUBSTANDARD LOANS TOTAL
------------- ---------- ---------
<S> <C> <C> <C>
Single family homes
Non-project................................ $ 6,082 $ 10,616 $ 16,698
Loan concentrations........................ 5,725 7,808 13,533
Multi-family
2 to 4 units............................... 1,822 489 2,311
5 or more units............................ 36,376 5,879 42,255
Commercial properties........................ 2,689 2,689
Land......................................... 431 431
Residential Construction
Other collateralized loans................... 4,206 4,206
------- ------- --------
$56,900 $ 25,223 $ 82,123
======= ======= ========
</TABLE>
SINGLE FAMILY (NON-PROJECT)
In the preceding table, non-project single family homes consist of
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, 1996, the Company (1) owned
16 homes which were being actively marketed for sale, (2) had 44 defaulted loans
secured by single family (non-project) homes, and (3) had 11 loans which were
performing but had been classified "Substandard". 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 Company's historical migration
and loss rates.
LOAN CONCENTRATIONS
Prior to 1994, the Company made permanent loans, amortizing over, and
maturing at the end of, thirty years, to a large number of purchasers of
individual units from developers in for-sale housing developments with respect
to which the Company financed construction. A majority of these permanent
"takeout" loans were originated during the period 1988 through 1992 and were
made on terms that fell outside the parameters normally associated with
conforming or conventional single family home loans.
Because most of these loans were made on favorable terms to foster sales of
units in developments in which unit sales were sluggish, and because the current
retail value of units in many developments has declined significantly when
compared with the stated purchase price paid by the Company's borrowers, the
performance of this portfolio has been extremely poor.
At the peak in early 1994, management had identified 63 separate loan
concentrations, involving loan principal of $90.6 million and foreclosed
inventory of $23.3 million. Approximately two-thirds of this aggregate
investment was in 13 projects, with respect to which the Company had provided
the initial takeout loans for over 50% of the units in the project or had
foreclosed upon more than 50% of the entire project prior to the sale of
completed units. At September 30, 1996, the Company's aggregate investment in
its portfolio of loan concentrations (loan principal plus foreclosed inventory
before reserves) consisted of 51 separate loan concentrations totaling $69.9
million. This represents a decrease of $44.0 million, or 39%, principally as the
result of foreclosure of the Company's collateral, sales of foreclosed units and
the acceptance of discounted
21
<PAGE> 22
payments from borrowers on several loans. At September 30, 1996, the Company
owned 81 foreclosed units and 87 loans, representing $7.8 million of loan
principal, which were delinquent one or more payments.
Management expects that the performance of this portfolio will continue to
be quite poor, principally because the underlying risk factors which have given
rise to the historically poor performance -- poorly-qualified borrowers and
significant declines in the value of the Company's collateral -- are not
expected to change in the near-term.
APARTMENT BUILDINGS
At September 30, 1996, the Company owned 25 apartment buildings, and loans
secured by 6 apartment buildings were in default. The Company's foreclosed
inventory and its defaulted loan collateral are predominantly located in the
South Bay region of Los Angeles, are between five and ten years old and average
less than 15 units in size.
Prior to late 1995, management determined to accumulate the Company's
portfolio of foreclosed apartment buildings and to operate them for their cash
flow yield. During the Company's holding period, the Company's internal property
management staff made necessary capital improvements to each property and
upgraded the quality of each buildings' tenants. In September 1995, management
commenced an aggressive sales program to liquidate the Company's then portfolio
of 71 buildings, premised upon its belief that the buildings had reached
sustainable cash flow production and had been improved to the extent required to
command a retail, as opposed to a wholesale, price in the market. Commencing in
September, 1995 and continuing through September 30, 1996, virtually all of
the Company's initial inventory of buildings had been sold, largely leaving
buildings foreclosed upon during the last three quarters in inventory at the end
of September 1996. The Company has financed all building sales involving five or
more units, generally on market terms (i.e., the 11th DCOFI plus 3.00%, with
downpayments by purchasers of between 20% and 25%). These financings have been
discounted to provide the Company with a yield to maturity equivalent to the
11th DCOFI plus 4.00%, which yield approximates the Company's marginal lending
rate for new, apartment-secured financings.
The Company records its investment in foreclosed apartment buildings at
their fair market values, generally by reference to the existing and projected
cash flows generated by the building and the application of appropriate market
capitalization ratios. Management has concluded that the maximum benefit to the
Company is obtainable through the orderly liquidation of this portfolio.
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 "Substandard", reserves have been established based
upon property-specific valuations which utilize current cash flows and estimated
stabilized cash flows and incorporate management's assessment of future event
risk.
COMMERCIAL
At September 30, 1996, the Company owned one commercial property and had
three loans which were performing but had been classified "Substandard."
RESIDENTIAL CONSTRUCTION
At September 30, 1996, the Company maintained investments in 3 residential
construction developments previously acquired through foreclosure. These
developments, when completed, will entail the construction and sale of 158
homes. At September 30, 1996, the Company had sold 123 homes in these
developments, 3 homes had been completed and had not been sold, and 73 homes
remained to be built or are model units. The cost to complete construction of
the remaining homes within these developments (approximately $6.9 million) has
been incorporated into the carrying values for each development at September 30,
1996.
LAND
At September 30, 1996, the Company's portfolio of owned land parcels
consisted of 4 properties with a net carrying value of $1.3 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.
OTHER COLLATERALIZED LOANS
At September 30, 1996, the Company had 2 other loans which were performing
but classified as "Substandard". These loans provided the financing for the
acquisition of pools of notes.
22
<PAGE> 23
CREDIT LOSSES
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, 1996, 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 valuation allowances ("GVA") against its loan and property
portfolios when sufficient information does not exist to support establishing
specific reserves. The loss factors utilized to establish general reserves are
based upon (1) the actual loss experience for similar loans and properties
within the Company's portfolio, when such loss experience is available and
representative of the assets being valued, or (2) estimates of current
liquidation values for collateral securing performing loans for a representative
sampling of each portfolio segment.
The table below sets forth the amounts and percentages of general and
specific reserves for the Company's loan and property portfolios as of September
30, 1996 (dollars are in thousands).
<TABLE>
<CAPTION>
LOANS
-------------------------
PERFORMING IN DEFAULT PROPERTIES TOTAL
---------- ---------- ---------- -------
<S> <C> <C> <C> <C>
AMOUNTS
Specific reserves................................ $ 1,710 $1,727 $ 9,664 $13,101
General reserves................................. 9,004 2,734 1,250 12,988
------- ------ ------- -------
Total reserves for estimated losses.... $ 10,714 $4,461 $ 10,914 $26,089
======= ====== ======= =======
PERCENTAGES
% of total reserves to gross investment.......... 1.6% 17.7% 31.5% 3.8%
% of general reserves to gross investment........ 1.3% 10.8% 3.6% 1.9%
</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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
1996 1995 1996 1995
------- ------- ------- --------
<S> <C> <C> <C> <C>
LOANS
Balance at beginning of period..................... $15,762 $20,690 $15,192 $ 21,461
Provision for estimated losses..................... 2,800 1,473 6,489 14,173
Transfer to property and other reserves............ (231) (884) (255) (10,291)
Charge-offs........................................ (3,156) (2,807) (6,251) (6,873)
Recoveries......................................... 2
------- ------- ------- --------
Balance at end of period........................... $15,175 $18,472 $15,175 $ 18,472
======= ======= ======= ========
PROPERTIES
Balance at beginning of period..................... $11,909 $13,507 $15,725 $ 33,517
Provision for estimated losses..................... 1,000 5,327 2,711 5,327
Transfer from loan reserves........................ 231 884 255 10,291
Charge-offs........................................ (2,226) (2,444) (7,777) (31,861)
------- ------- ------- --------
Balance at end of period........................... $10,914 $17,274 $10,914 $ 17,274
======= ======= ======= ========
</TABLE>
Because the Company's loan and property portfolios are not homogeneous, but
rather consist of discreet segments with different collateral and borrower risk
characteristics, management separately measures reserve
23
<PAGE> 24
adequacy, and establishes and maintains reserves for credit losses, for each
identifiable segment of its property and loan portfolios. The table below
summarizes credit loss reserves (dollars are in thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
----------------------------------
LOANS PROPERTIES TOTAL
------- ---------- -------
<S> <C> <C> <C>
PERMANENT
Single family homes
Non-project.............................. $ 2,033 $ 469 $ 2,502
Loan concentrations...................... 4,862 2,308 7,170
Multi-family
2 to 4 units............................. 1,440 74 1,514
5 or more units.......................... 5,033 729 5,762
Commercial.................................. 1,425 106 1,531
Land........................................ 167 1,547 1,714
RESIDENTIAL CONSTRUCTION...................... 215 5,681 5,896
------- ------- -------
$15,175 $ 10,914 $26,089
======= ======= =======
</TABLE>
REAL ESTATE OWNED
Real estate acquired in satisfaction of loans is transferred from loans to
properties at estimated fair values, less any estimated disposal costs. The
difference between the fair value of the real estate collateral and the loan
balance at the time of transfer is recorded as a loan charge-off. Any subsequent
declines in the fair value of the properties after the date of transfer are
recorded through the establishment of, or additions to, specific reserves.
Recoveries and losses from the disposition of properties are also included in
REAL ESTATE OPERATIONS.
The table below summarizes the composition of the Company's property
portfolio at September 30, 1996 and 1995 and at December 31, 1995 (dollars are
in thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1996 1995 1995
------------- ------------ -------------
<S> <C> <C> <C>
SINGLE FAMILY RESIDENCES
Non-project........................ $ 2,621 $ 4,975 $ 4,603
Loan concentrations................ 7,335 6,419 8,946
MULTI-FAMILY
2 to 4 units....................... 1,338 3,840 2,728
5 or more units.................... 5,469 18,877 32,211
COMMERCIAL........................... 346 346 346
LAND................................. 2,877 3,759 3,687
RESIDENTIAL CONSTRUCTION............. 14,654 15,414 20,622
-------- -------- --------
GROSS INVESTMENT(1)................ 34,640 53,630 73,143
ALLOWANCE FOR ESTIMATED LOSSES....... (10,914) (15,725) (17,274)
-------- -------- --------
NET INVESTMENT....................... $ 23,726 $ 37,905 $ 55,869
======== ======== ========
</TABLE>
- ---------------
(1) Loan principal at foreclosure, plus post-foreclosure capitalized costs, less
cumulative charge-offs.
OFFICE PROPERTY AND EQUIPMENT
At September 30, 1996, the Company's office property and equipment of $4.9
million was down from $9.6 million at December 31, 1995. The decrease was
primarily due to $3.7 million in sales of branch facilities, of which $2.2
million related to the sale of the Company's Oceanside branch office facility in
February 1996 and $1.5 million related to the sale of the Company's Rancho
Bernardo and Vista branch facilities in June 1996, in conjunction with the sale
of deposits at the Company's three San Diego branches. A gain
24
<PAGE> 25
of $6.4 million was recorded on the sale of these deposits and facilities and is
included in gain on sale of other assets and liabilities.
LIABILITIES
GENERAL
The Company derives funds principally from deposits and, to a lesser
extent, from borrowings from the FHLB. In addition, recurring cash flows are
generated from loan repayments and payoffs and, since late 1993, from sales of
foreclosed properties. In addition to the Company's recurring sources of funds,
the Company has generated funds by identifying certain of its securities and
seasoned real estate loans as available-for-sale, and selling such assets in the
open market. During 1995 and 1996, the Company sold $88.1 million of loan
principal secured primarily by single family homes originated prior to 1994 and
$93.3 million of securities. Generally, the Company no longer originates the
types of loans which have been, or will be, sold and the proceeds therefrom have
been redeployed in the Company's current financing activities.
DEPOSITS
Total deposits at September 30, 1996, were $659.6 million, a decrease from
$698.0 million at December 31, 1995, and $684.5 million at September 30, 1995.
In June 1996 the Company sold the deposits housed in its three San Diego County
branches. At the time of the sale, these branches had total deposits of $185.2
million. The Company funded the transfer of deposits with a combination of
borrowings from the FHLB (see Borrowings) and excess liquidity, which had been
accumulated through loan sales totaling $68.9 million and deposit growth at the
Company's remaining six branches.
The table below summarizes the balances, weighted average interest rates
("WAIR") and weighted average remaining maturities in months ("WARM") for the
Company's deposits (dollars are in thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996 DECEMBER 31, 1995
---------------------- ----------------------
DESCRIPTION BALANCE WAIR WARM BALANCE WAIR WARM
----------- ------- ---- ---- ------- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Transaction accounts......................... $ 71,781 1.32% -- $ 94,459 1.19% --
Certificates of Deposit
7 day maturities........................... 59,655 4.71% 60,552 4.78%
Less than 6 months......................... 43,892 5.32% 3 28,053 4.69% 2
6 months to 1 year......................... 338,741 5.45% 5 356,013 5.74% 5
1 year to 2 years.......................... 104,098 5.88% 13 90,432 5.85% 9
Greater than 2 years....................... 41,423 5.92% 14 68,499 6.08% 16
-------- ---- --- -------- ---- --
Total.............................. $659,590 5.02% 6 $698,008 5.04% 5
======== ==== === ======== ==== ==
</TABLE>
BORROWINGS
A primary alternative funding source for the Company is a $200.0 million
credit line with the FHLB. The FHLB system functions as a source of credit to
savings institutions which are members of a Federal Home Loan Bank System.
Advances are typically secured by the Company's mortgage loans and the capital
stock of the FHLB owned by the Company. Subject to the FHLB of San Francisco's
advance policies and requirements, these advances can be requested for any
business purpose in which the Company is authorized to engage. In granting
advances, the FHLB considers a member's credit worthiness and other relevant
factors.
The balance and rate of the Company's FHLB advances at September 30, 1996,
are summarized as follows (dollars are in thousands).
<TABLE>
<CAPTION>
TERM PRINCIPAL RATE
---- --------- ----
<S> <C> <C>
4 Months................................................... $ 25,000 5.82%
5 Months................................................... 25,000 5.95%
9 Months................................................... 25,000 5.99%
12 Months.................................................. 25,000 6.24%
-------- ----
$100,000 6.00%
======== ====
</TABLE>
25
<PAGE> 26
SENIOR NOTES
The Company has Senior Notes, which have a face amount of $13.5 million,
and a current, amortized fair value of $12.2 million at September 30, 1996. The
Senior Notes carry an annual stated interest rate of 12% and have an annual
effective rate of approximately 16.5%, after the recording of original issue
discount ("OID") of $1.5 million. The OID is accreted using the constant yield
method over the five year term of the Senior Notes. Interest, which is required
to be paid semi-annually at the stated interest rate, has been prefunded for
three years out of the proceeds of the Company's recapitalization in December
1995. This prefunded interest of $4.9 million was invested in U.S. Government
securities. Thereafter, interest will be payable either in cash or, in certain
circumstances as permitted by the relevant agreements, in an equivalent value
(determined in accordance with the provisions of the relevant agreement) in
common stock of the Company.
CAPITAL
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") and the capital regulations of the OTS thereunder 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, 1996. As indicated in the table, the Bank's
capital levels exceed all three of the currently applicable minimum FIRREA
capital requirements (dollars are in thousands).
<TABLE>
<CAPTION>
RISK-BASED
TANGIBLE CAPITAL CORE CAPITAL CAPITAL
---------------- ---------------- -----------------
BALANCE % BALANCE % BALANCE %
-------- ----- -------- ----- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Stockholders' equity............. $ 51,813 $ 51,813 $ 51,813
Adjustments
General valuation allowances... 7,082
Unrealized (gains) losses...... 54 54 54
Interest rate risk
component(1)................
-------- ----- -------- ----- -------- ------
Regulatory capital............... 51,867 6.30% 51,867 6.30% 58,949 10.49%
Required minimum................. 12,348 1.50% 24,697 3.00% 44,954 8.00%
-------- ----- -------- ----- -------- ------
Excess capital................... $ 39,519 4.80% $ 27,170 3.30% $ 13,995 2.49%
======== ===== ======== ===== ======== ======
Adjusted assets(2)............... $823,255 $823,255 $561,937
======== ======== ========
</TABLE>
- ---------------
(1) At September 30, 1996, the OTS had temporarily suspended the application of
its interest rate risk regulation. Had the regulation been in effect at
September 30, 1996, the Bank would have been required to deduct from
riskbased capital $232, due to an interest rate risk exposure component
as computed by the OTS as one-half of the excess of the estimated change in
the Bank's net portfolio value (determined in accordance with OTS
regulations) over a normal change in net portfolio value (2%) assuming an
immediate and sustained 200 basis point increase in interest rates, using
the Bank's reported balance sheet information as of June 30, 1996.
(2) 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).
26
<PAGE> 27
Under the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"),
which supplemented FIRREA, the OTS has issued "prompt corrective action"
regulations with specific capital ranking tiers for thrift institutions.
Progressively more stringent operational limitations and other corrective
actions are required as an institution declines in the capital ranking tiers.
Principal elements of the five qualifying tiers are set forth below.
<TABLE>
<CAPTION>
RATIO OF RATIO OF
RATIO OF CORE CAPITAL TOTAL CAPITAL
CORE CAPITAL TO RISK-WEIGHTED TO RISK-WEIGHTED
TO TOTAL 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 undercapitalized....... Ratio of tangible equity to adjusted total assets of 2% or less
</TABLE>
The Bank's ratios at September 30, 1996 are set forth below.
<TABLE>
<S> <C>
Ratio of Core Capital to Total Assets (Leverage ratio).............. 6.30%
Ratio of Core Capital to Risk-weighted Assets....................... 9.23%
Ratio of Total Capital to Risk-weighted Assets...................... 10.49%
</TABLE>
At September 30, 1996, the Company's capital ratios exceeded the capital
ratio requirements for the Company to qualify as a "well capitalized"
institution.
The OTS has authority, after an opportunity for a hearing, to downgrade an
institution from "well-capitalized" to "adequately capitalized" or to subject an
"adequately capitalized" or "undercapitalized" institution to the supervisory
actions applicable to the next lower category, if the OTS deems such action to
be appropriate as a result of supervisory concerns.
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
Company 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 Company's liquidity position refers to the extent to which the
Company'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 11.12%
and 6.01%, respectively, as of September 30, 1996, and 8.50% and 5.95%,
respectively, as of December 31, 1995.
27
<PAGE> 28
The Company's current primary funding resources are deposit accounts,
principal payments on loans, proceeds from property sales, advances from the
FHLB and cash flows from operations. Other possible sources of liquidity
available to the Company include reverse repurchase transactions involving the
Company's investment securities, whole loan sales, 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.
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. 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 focuses on measuring absolute dollar amounts of interest-earning assets
and interest-bearing liabilities that are subject to repricing within periods of
time, with the majority of the focus typically at the one-year maturity horizon.
A "negative gap" occurs when the interest sensitive liabilities maturing or
repricing in a given period exceed the interest sensitive assets maturing or
repricing in that same period. The negative one-year maturity gap indicates,
absent offsetting factors, that the Company has more exposure to interest rate
risk in an increasing interest rate environment.
In addition to utilizing gap analysis in measuring interest rate risk, the
Company performs periodic interest rate simulations. These simulations provide
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 its 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. Loans having adjustable rate characteristics were 87% of the
Company's total dollar originations during 1995 and 77% for the nine months
ended September 30, 1996. ARMs represented 77% and 75% of the Company's loan
portfolio at September 30, 1996, and December 31, 1995, respectively.
ARMs tied to 11th DCOFI are slower in responding to current interest rate
environments than other types of variable rate loans because the index is a
compilation of the average rates paid by member institutions of the 11th
District of the FHLB. This index typically lags market rate changes in both
directions. If interest rates on deposit accounts increase due to market
conditions and competition, it may be anticipated that the Company will, absent
offsetting factors, experience a decline in the percentage of net interest
income to average interest-earning assets (the "Net Interest Margin"). A
contributing factor would be the lag in upward pricing of the ARMs tied to the
11th DCOFI. However, the lag inherent in the 11th DCOFI will also cause the ARMs
to remain at a higher rate for a longer period after interest rates on deposits
begin to decline. The 11th DCOFI lag during a falling rate environment should
benefit, in the short-term, the Company's Net Interest Margin, but the actual
dynamics of prepayments and the fact that ARMs reprice at various intervals
28
<PAGE> 29
(and are subject to maximum periodic rate adjustment limits) may alter this
expected benefit (dollars are in thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996 DECEMBER 31, 1995 SEPTEMBER 30, 1995
------------------ ------------------ ------------------
BALANCE RATE BALANCE RATE BALANCE RATE
--------- ------ --------- ------ --------- -----
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets
Loans(1)......................... $ 712,587 8.63% $ 637,472 8.22% $ 594,116 8.00%
Cash and investment securities... 86,829 5.50 77,357 4.60 17,114 4.99
Mortgage-backed securities....... 50,799 6.57
--------- --------- ---------
799,416 8.29 714,829 7.82 662,029 7.81
--------- ------ --------- ------ --------- -----
Interest-bearing liabilities
Deposit accounts................. (659,590) (5.02) (698,008) (5.04) (684,489) (5.09)
Borrowings....................... (100,000) (6.00) (5,890) (5.87)
Senior notes..................... (12,222) (16.50) (12,006) (16.50)
--------- --------- ---------
(771,812) (5.33) (710,014) (5.23) (690,379) (5.10)
--------- ------ --------- ------ --------- -----
Interest-bearing gap/stated
interest margin.................. 27,604 3.15 4,815 2.63 (28,350) 2.50
Nonaccrual loans................... (25,223) (0.27) (21,709) (0.25) (17,846) (0.22)
--------- ------ --------- ------ --------- -----
Adjusted interest-bearing gap.... $ 2,381 2.88% $ (16,894) 2.38% $ (46,196) 2.28%
========= ====== ========= ====== ========= =====
</TABLE>
- ---------------
(1) Contractual yield, exclusive of the amortization of loan fees deferred at
origination.
PROSPECTS
The Company successfully completed its recapitalization by the sale of
investment units in December 1995, from which the majority of the proceeds ($19
million) were contributed to the Bank as additional Tier 1 capital. As a result,
the Bank reported core and risk-based capital ratios at December 31, 1995, of
5.80% and 10.27%, respectively, which defined the Bank as a "well-capitalized"
institution for regulatory capital purposes. With the net earnings reported for
the nine months ended September 30, 1996, the Bank's core and risk-based capital
ratios increased to 6.30% and 10.49%, respectively.
As described more fully elsewhere herein, the Company has been successful
since early 1995 in establishing itself as a provider of financings secured by
very expensive homes, income properties and residential construction
developments. These post-1994 financings account for about one-half of the
Company's total loans at September 30, 1996, and carry margins well in excess of
those associated with the Company's pre-1995 loans. Management expects that the
Company will continue to be successful in further penetrating its target loan
markets and will be able to price its financings at a premium to more generic
mortgages because of its service levels, portfolio retention strategy and
internal real estate expertise. Accordingly, management expects that its
post-1994 loan portfolio will continue to grow as a percentage of total loans
and will contribute to the gradual growth in the Company's total assets and
interest margin.
Management further expects, however, that the magnitude of the Company's
Risk Assets will continue to dilute the margins generated from the Company's new
financing activities. Though the Company has been successful in gradually
reducing the adverse impact to earnings of nonperforming assets, and the
prospective risk to earnings from performing, classified loans, the relationship
of these portfolios to total assets and to the Company's capital remain well
above peer levels. During the remainder of 1996, management will continue to
employ the strategies which have, to date, been successful in reducing these
portfolios, including (1) aggressively pursuing foreclosure of the Company's
collateral in those circumstances where the borrower defaults on their
obligation, (2) considering restructurings of individual loans, or groups of
loans, only in limited circumstances in which the borrowers have the financial
means and demonstrated intention of satisfying their obligations to the Company,
and (3) liquidating the Company's inventory of foreclosed properties in an
orderly fashion utilizing retail sales strategies.
29
<PAGE> 30
GENERAL REGULATION
The President has signed legislation which repealed the tax rules formerly
applicable to bad debt reserves of thrift institutions for taxable years
beginning after December 31, 1995. The Company will thereupon be required to
change its tax method of accounting for bad debts from the reserve method
formerly permitted under section 593 of the Internal Revenue Code (the "Code")
to the "specific charge-off" method effective for its tax year beginning October
1, 1996. Under the specific charge-off method, tax deductions may be taken for
bad debts only as to the extent that the loans become wholly or partially
worthless. The enacted legislation requires thrift institutions, such as the
Company, which have previously utilized the section 593 reserve method to
recapture (i.e., include in taxable income) over a six-year period a portion of
their existing bad debt reserves equal to their "applicable excess reserves."
The Company does not believe that the recapture of its bad debt reserves, if
any, would be material. Under these provisions, the remainder of the Company's
bad debt reserve balance as of September 30, 1996 (approximately $22.5 million)
will in future years be subject to recapture in whole or in part upon the
occurrence of certain events such as a distribution to stockholders in excess of
the Company's current and accumulated earnings and profits, a redemption of
shares, or upon a partial or complete liquidation of the Company. The Company
does not intend to make distributions to its stockholders that would result in
recapture of any portion of its bad debt reserves.
30
<PAGE> 31
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
On September 6, 1996, the Company and the Bank were named as defendants in
a class action lawsuit entitled Stanley D. Mosler and Eileen C. Mosler vs.
Hawthorne Savings and Loan Association, Hawthorne Financial Corporation, et.
al., filed in the Superior Court of the State of California as Case No. BC154729
(the "Action"). The plaintiffs had previously filed an individual action
alleging the same matters contained in the class action complaint. Plaintiffs
contend they were entitled to a notice of availability of foreclosure
counseling, which they allege they did not receive, before the Bank foreclosed.
Plaintiffs contend that the alleged failure to provide counseling notices and
the underbidding by the Bank of the loan amount at foreclosure resulted in
damages to the purported class in an amount in excess of $40 million. The
Company has been named and alleged to have liability based upon its relationship
as trustee on the Deed of Trust securing the Bank's loans. The Company and the
Bank have filed responsive pleadings to the complaint alleging that the
complaint is defective on its face and that the plaintiffs are not proper
representatives of the purported class. The hearings on the Company's motion are
scheduled to be heard November 26, 1996.
The Company is involved in a variety of other litigation matters which, for
the most part, arise out of matters and events which were alleged to have
occurred prior to 1994. Many of these lawsuits either allege construction
defects or allege improper servicing of the loan. In the opinion of management,
none of these cases will have a material adverse effect on the Bank's or the
Company's financial condition.
ITEM 2. Changes in Securities - None
ITEM 3. Defaults upon Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security Holders - None
ITEM 5. Other Information - None
ITEM 6. Exhibits and Reports on Form 8-K
1. Reports on Form 8-K - None
2. Other required exhibits - None
31
<PAGE> 32
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, 1996 /s/ NORMAN A. MORALES
--------------------------
Norman A. Morales
Executive Vice President
and
Chief Financial Officer
Dated November 14, 1996 /s/ JESSICA VLACO
--------------------------
Jessica Vlaco
Senior Vice President and
Principal Accounting
Officer
32
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<CASH> 10,430
<INT-BEARING-DEPOSITS> 655,889
<FED-FUNDS-SOLD> 39,200
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 38,564
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 688,372
<ALLOWANCE> 15,175
<TOTAL-ASSETS> 827,784
<DEPOSITS> 659,590
<SHORT-TERM> 112,222
<LIABILITIES-OTHER> 12,530
<LONG-TERM> 0
0
11,592
<COMMON> 26
<OTHER-SE> 31,824
<TOTAL-LIABILITIES-AND-EQUITY> 827,784
<INTEREST-LOAN> 43,158
<INTEREST-INVEST> 4,107
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 47,265
<INTEREST-DEPOSIT> 26,304
<INTEREST-EXPENSE> 29,030
<INTEREST-INCOME-NET> 18,235
<LOAN-LOSSES> 6,489
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 15,594
<INCOME-PRETAX> 8
<INCOME-PRE-EXTRAORDINARY> 8
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,376
<EPS-PRIMARY> 1.75
<EPS-DILUTED> .8
<YIELD-ACTUAL> 8.34
<LOANS-NON> 25,223
<LOANS-PAST> 0
<LOANS-TROUBLED> 38,661
<LOANS-PROBLEM> 56,900
<ALLOWANCE-OPEN> 15,192
<CHARGE-OFFS> 6,251
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 15,175
<ALLOWANCE-DOMESTIC> 15,175
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
