<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
---------------------
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 March 31, 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)
DELAWARE 95-2085671
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
2381 Rosecrans Avenue, El Segundo, CA 90245
(Address of Principal Executive Offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (310) 725-5000
---------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes /X/ No
---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date: The Registrant had
2,599,275 shares outstanding of Common stock, $0.01 par value per share, as
of May 10, 1996.
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<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q INDEX
For the quarter ended March 31, 1996
PART I - FINANCIAL INFORMATION PAGE
----
ITEM 1. Financial Statements
Consolidated Statements of Financial Condition
at March 31, 1996 (Unaudited) and December 31, 1995 3
Consolidated Statements of Operations (Unaudited)
for the Three Months Ended March 31, 1996 and 1995 4
Consolidated Statement of Stockholders' Equity (Unaudited)
for the Three Months Ended March 31, 1996 5
Consolidated Statements of Cash Flows (Unaudited)
for the Three Months Ended March 31, 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 32
ITEM 2. Changes in Securities 32
ITEM 3. Defaults upon Senior Securities 32
ITEM 4. Submission of Matters to a Vote of Security Holders 32
ITEM 5. Other Information 32
ITEM 6. Exhibits and Reports on Form 8-K 32
2
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS ARE IN THOUSANDS)
<TABLE>
MARCH 31, DECEMBER 31,
1996 1995
(UNAUDITED) (AUDITED)
----------- ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 15,849 $ 14,015
Investment securities available for sale 94,753 62,793
Loans held for investment (net of allowance for estimated
credit losses of $15,353 in 1996 and $15,192 in 1995) 578,724 617,328
Loans held for sale (at lower of cost or market) 35,148
-------- --------
Total loans receivable 613,872 617,328
Real estate owned (net of allowance for estimated losses
of $12,317 in 1996 and $15,725 in 1995) 25,960 37,905
Accrued interest receivable 3,768 3,583
Investment in capital stock of Federal Home Loan Bank - at cost 6,476 6,312
Office property and equipment-at cost, net 6,710 9,597
Deferred tax assets 2,253
Other assets 3,449 2,050
-------- --------
$773,090 $753,583
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposit accounts $714,865 $698,008
Senior notes 12,073 12,006
Accounts payable and other liabilities 5,300 4,603
-------- --------
732,238 714,617
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 gain (loss) on available-for-sale securities, net (60) 6
Retained earnings 21,734 19,788
-------- --------
41,037 39,157
Less
Treasury stock, at cost - 5,400 shares (48) (48)
Loan to Employee Stock Ownership Plan (137) (143)
-------- --------
40,852 38,966
-------- --------
$773,090 $753,583
-------- --------
-------- --------
</TABLE>
3
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(AMOUNTS ARE IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
THREE MONTHS ENDED
MARCH 31,
---------------------
1996 1995
--------- ----------
<S> <C> <C>
Interest revenues
Loans $14,411 $ 11,338
Investments 1,013 976
Mortgage-backed securities 6 900
------- --------
15,430 13,214
------- --------
Interest costs
Deposits (8,938) (7,466)
Borrowings (471) (447)
------- --------
(9,409) (7,913)
------- --------
Net interest margin before contractual interest due
on nonaccrual loans 6,021 5,301
Contractual interest due on nonaccrual loans (629) (730)
------- --------
Net interest margin 5,392 4,571
Provision for estimated credit losses (1,200) (12,745)
------- --------
Net interest margin after provision for credit losses 4,192 (8,174)
Non-interest revenues 592 683
Non-interest expenses
Employee (2,294) (2,874)
Occupancy (723) (788)
Operating (1,049) (817)
Professional (448) (381)
SAIF premium and OTS assessment (585) (549)
Goodwill amortization (12) (12)
------- --------
(5,111) (5,421)
------- --------
Real estate operations, net 441 466
Gain on sale of loans 153
Gain on sale of securities 2,902
Gain on sale of other assets 41
------- --------
Net earnings (loss) before income taxes 308 (9,544)
Income (taxes) benefit 2,253 (585)
------- --------
Net earnings (loss) $ 2,561 $(10,129)
------- --------
------- --------
Net earnings (loss) per share (NOTE 3) $ 0.41 $ (3.90)
------- --------
------- --------
Dividends paid per share N/A N/A
------- --------
------- --------
Weighted average shares outstanding (NOTE 3) 5,155 2,599
------- --------
------- --------
Dividend payout ratio N/A N/A
------- --------
------- --------
</TABLE>
4
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED)
(DOLLARS ARE IN THOUSANDS)
<TABLE>
ACCRUED
DIVIDENDS
BALANCE AT UNREALIZED NET ON BALANCE AT
DECEMBER 31, GAINS EARNINGS PREFERRED MARCH 31,
1995 (LOSSES) (LOSS) STOCK REPAYMENTS 1996
------------ ---------- -------- --------- ---------- ----------
<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 gain (loss) on available
for sale securities 6 (66) (60)
Retained earnings 19,788 2,561 (615) 21,734
Treasury stock (48) (48)
Loans to employee stock ownership plan (143) 6 (137)
-------- ----- ------ ------ -- --------
Total stockholders' equity $38,966 $(66) $2,561 $(615) $6 $40,852
-------- ----- ------ ------ -- --------
-------- ----- ------ ------ -- --------
</TABLE>
5
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(DOLLARS ARE IN THOUSANDS)
<TABLE>
THREE MONTHS ENDED
MARCH 31,
-----------------------
1996 1995
---------- ----------
<S> <C> <C>
NET CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings (loss) $ 2,561 $(10,129)
Adjustments
Provision for income taxes (2,253) (365)
Provision for estimated credit losses on loans 1,200 12,745
Provision for estimated credit losses on real estate owned 700
Net recoveries from sales of real estate owned (743)
Net loss from sale of premises (196)
Gain on sale of investment securities (2,902)
Loan fee and discount accretion (469) (933)
Depreciation and amortization 236 529
FHLB dividends (81) (100)
Goodwill amortization 12 12
Increase in accrued interest receivable (498) (331)
Increase in other assets (1,322) (472)
Increase (decrease) in other liabilities 118 (1,050)
Other, net (90) 16
--------- ---------
Net cash (used) provided by operating activities (825) (2,980)
--------- ---------
NET CASH FLOWS FROM INVESTING ACTIVITIES
Investment securities
Purchases (89,966) (124)
Maturities 57,932
Sales 15,561
Mortgage-backed securities
Principal amortization 33 1,462
Sales 1,438
Loans
New loans funded (35,003) (24,357)
Construction disbursements (9,779) (369)
Payoffs 12,676 7,046
Sales 32,720
Principal amortization 4,138 3,860
Other, net 2,372 (1,340)
Real estate owned
Sale proceeds 10,830 7,561
Capitalized costs (2,832) (2,732)
Other, net (1) (179)
Office property and equipment
Sales 2,722
Additions (41) (631)
--------- ---------
Net cash (used) provided by investing activities (14,199) 7,196
--------- ---------
</TABLE>
6
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(DOLLARS ARE IN THOUSANDS)
<TABLE>
THREE MONTHS ENDED
MARCH 31,
---------------------
1996 1995
--------- ----------
<S> <C> <C>
NET CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits $ 16,852 $ 32,039
Net change in borrowings (38,556)
Collection of ESOP loan 6 5
-------- --------
Net cash provided (used) by financing activities 16,858 (6,512)
-------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,834 (2,296)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 14,015 18,063
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $15,849 $ 15,767
-------- --------
-------- --------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for
Interest $ 8,697 $ 8,237
Non-cash investing and financing activities
Real estate acquired in settlement of loans $ 3,646 $ 7,837
Loans originated to finance property sales 7,478 215
Net unrealized gain (loss) on available for sale securities (60) (1,393)
Transfer of held to maturity securities to available for sale 30,168
Transfer of held for investment loans to available for sale 35,148
Loan Activity
Total commitments and permanent fundings $ 64,070 $ 28,158
Less:
Change in undisbursed funds on construction commitments (10,453) (3,217)
Loans originated to finance property sales (7,478) (215)
Undisbursed portion of new lines of credit (1,357)
-------- --------
Total construction disbursements and loans funded $ 44,782 $ 24,726
-------- --------
-------- --------
</TABLE>
7
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 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
March 31, 1996, and December 31, 1995, and the results of its operations and
its cash flows for the three months ended March 31, 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 three
months ended March 31, 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
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1996
(AMOUNTS ARE IN THOUSANDS, EXCEPT 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 March 31, 1996, using the Modified Treasury Stock Method as
prescribed under GAAP. All other calculations shown, using alternate
methods, are for informational purposes only.
<TABLE>
<CAPTION>
MODIFIED
TREASURY ACTUAL SHARES,
STOCK ACTUAL WARRANTS,
METHOD SHARES AND OPTIONS
-------- ------ --------------
<S> <C> <C> <C>
SHARES OUTSTANDING
Common 2,599 2,599 2,599
Warrants 2,376 2,376
Options 700 700
Less Treasury shares (520)
-------- -------- --------
Total 5,155 2,599 5,675
-------- -------- --------
-------- -------- --------
STOCKHOLDERS' EQUITY
Common $ 29,260 $ 29,260 $ 29,260
Warrants 5,346 5,346
Options 3,465 3,465
Less Treasury shares (2,655)
-------- -------- --------
Total $ 35,416 $ 29,260 $ 38,071
-------- -------- --------
-------- -------- --------
NET EARNINGS (LOSS)
Net earnings (loss) for quarter $ 2,561
Partial reduction in interest expense (1) 184
Preferred stock dividends (615)
--------
Adjusted earnings available for Common $ 2,130
--------
--------
BOOK VALUE PER SHARE $ 6.87 $ 11.26 $ 6.71
-------- -------- --------
-------- -------- --------
EARNINGS PER SHARE $ 0.41
-------- -------- --------
-------- -------- --------
</TABLE>
- ------------
(1) Under the Modified Treasury Stock Method, it is assumed that the Company
will use 20% of the proceeds from the proforma exercise of the Warrants
and Options to acquire Treasury shares and use any remaining assumed
proceeds to reduce the outstanding balance of the Company's Senior Notes.
The $184,000 represents the proforma reduction in interest expense as a
result of the proforma reduction in the outstanding balance of Senior Notes.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company reported net earnings of $2.6 million for the first quarter of
1996, compared to a net loss of $10.1 million for the first quarter of 1995.
For the years ended December 31, 1995 and 1994, respectively, the Company
reported net losses of $14.2 million and $3.0 million.
The first quarter of 1996 is the initial full reporting period following
the Company's successful completion of the sale of investment units in a
private placement ("Offering") in December 1995. Most of the proceeds from
the Offering were contributed to the Company's principal subsidiary,
Hawthorne Savings, F.S.B.
The earnings for the first quarter of 1996 resulted from several positive
factors, including (1) a continuation of the Company's success in penetrating
various specialty mortgage finance markets, which produced significant new
loan volume at substantial margins, (2) a continuing moderation in the
Company's level of nonperforming assets, including a substantial reduction in
associated loss provisions, and (3) the recognition of a portion of the
Company's accumulated tax benefits.
For the quarter, the Company realized pretax earnings of $0.3 million,
compared to a pretax loss of $9.5 million for the first quarter of 1995.
These amounts were net of provisions for possible loan losses of $1.2 million
and $12.7 million, respectively. For the three months ended March 31, 1996,
the consolidated results also included (1) net revenues of $1.1 million at
the Bank, principally associated with net recoveries from property sales, (2)
net parent company costs of $0.6 million, which were principally attributable
to the interest costs associated with the Senior Notes issued in connection
with the offering of investment units in December 1995, and (3) an income tax
benefit of $2.3 million, which represented the partial recognition of the
Company's accumulated operating loss carryforwards. For the first quarter of
1995, the consolidated net loss included (1) the pretax loss from the
Company's core operations ($12.6 million), (2) net revenues of $3.1 million,
which resulted primarily from net gains on sales of securities, and (3) a
provision for income taxes of $0.6 million.
During the first quarter of 1996, the Company originated $64.1 million of
permanent loans and construction loan commitments secured by real estate.
These new loans had a weighted average interest rate at origination of 9.66%.
By comparison, new loan originations during the first quarter of 1995 were
$28.2 million and carried a weighted average interest rate at origination of
9.37%. In addition to new loan volume in the current quarter, the Company's
core results were positively impacted by the net margin generated by
accumulated originations since the beginning of 1995, when the Company
commenced providing financing to owners and purchasers of very expensive
homes, medium-sized apartment buildings and commercial properties and
residential developments. At March 31, 1996, the Company's real estate loan
portfolio included $212.3 million of loans originated since the end of 1994,
or 33.5% of the portfolio, that carried a weighted average interest rate of
9.34% at March 31, 1996. By comparison, the principal balance of loans
outstanding at the end of the quarter that were originated prior to 1995
($422.0 million, or 66.5% of the portfolio) had a weighted average interest
rate of 7.88% at March 31, 1996.
Continuing the trend of the past two years, the Company's portfolio of
nonperforming assets declined during the quarter, to $48.3 million at March
31, 1996, compared to $55.8 million at December 31, 1995, and $84.0 million
at March 31, 1995. Though still high by comparison to its peers, the Company's
nonperforming assets represented only 6.3% of total assets at March 31, 1996,
compared to 11.0% of total assets at March 31, 1995.
In mid-April, the Company announced that it had entered into a definitive
agreement to sell the deposits from its three San Diego County retail banking
offices to Hemet Federal Savings. The Company will receive a premium of
approximately $5.6 million upon completion of the sale, which is expected
during the second quarter of 1996. These offices had deposits of $165.4
million at March 31, 1996.
10
<PAGE>
At March 31, 1996, the Bank maintained core and risk-based capital ratios
of 6.07% and 10.91%, respectively, well in excess of the minimums required
for "well-capitalized" institutions. Management expects that the net premium
to be received from the San Diego deposit sale will increase the Bank's core
and risk-based capital ratios to greater than 6.50% and 11.50%, respectively,
when that transaction is completed.
At March 31, 1996, the Company had total assets of $773.1 million, up
slightly from total assets of $753.6 million at the end of 1995 and $724.3
million at March 31, 1995. Total deposits at March 31, 1996, were $714.9
million, serviced out of 9 retail banking offices throughout Southern
California.
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.
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 three months ended March 31, 1996 and
1995. In the table, interest revenues are net of interest associated with
nonaccrual loans (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED,
----------------------------------------------------------------
MARCH 31, 1996 MARCH 31, 1995
-------------- --------------
REVENUES/ YIELD/ REVENUES/ YIELD/
AMOUNT COSTS COST AMOUNT COSTS COST
------ -------- ------ ------ -------- -----
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets
Loans $ 654,259 $ 13,782 8.43% $ 562,925 $10,608 7.54%
Investments and other securities 81,045 1,013 5.00% 60,823 976 6.42%
Mortgage-backed securities 11 6 6.29% 56,229 900 6.40%
--------- -------- --------- -------
Total interest-earning assets 735,315 14,801 8.05% 679,977 12,484 7.34%
-------- ------ ------- -----
Noninterest-earning assets 32,463 51,114
--------- ---------
Total assets $ 767,778 $ 731,091
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities
Deposits $ 709,050 8,938 5.07% $ 658,449 7,466 4.60%
Borrowings 12,049 471 15.72% 29,689 447 6.02%
--------- ------- --------- ------
Total interest-bearing liabilities 721,099 9,409 5.25% 688,138 7,913 4.66%
------- ------ ------ -----
Noninterest-bearing liabilities 6,445 6,371
Stockholders' equity 40,234 36,582
--------- ---------
Total liabilities & stockholders'
equity $ 767,778 $ 731,091
--------- ---------
--------- ---------
Net interest margin ($) $ 5,392 $ 4,571
------- -------
------- -------
Net interest margin (% to
interest-earning assets) 2.93% 2.69%
------ -----
------ -----
</TABLE>
<PAGE>
The table below summarizes the components of the changes in the Company's
interest revenues and costs for the three months ended March 31, 1996 and
1995 (dollars are in thousands).
<TABLE>
<CAPTION>
Three Months Ended March 31, 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) $1,721 $1,250 $ 203 $3,174
Investments and other securities 325 (216) (72) 37
Mortgage-backed securities (894) (16) 16 (894)
---------- -------- ------------- ------------ ----------
1,152 1,018 147 2,317
---------- -------- ------------- ------------ ----------
INTEREST COSTS
Deposits 574 765 59 74 1,472
Borrowings (267) 719 (428) 24
---------- -------- ------------- ------------ ----------
307 1,484 (369) 74 1,496
---------- -------- ------------- ------------ ----------
NET MARGIN $ 845 $ (466) $ 516 $ (74) $ 821
---------- -------- ------------- ------------ ----------
---------- -------- ------------- ------------ ----------
</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) Extra day of interest expense due to leap year.
The Company's net interest margin, expressed as a percentage of
interest-earning assets, has been steadily rising over the past year. This
pattern reverses the compression effect on the net interest margin
experienced during 1994 as market interest rates increased more rapidly than
the rates on the Company's adjustable-rate mortgage portfolio. The Company's
deposits generally have maturities of less than one year, with an average
maturity of approximately seven months. Accordingly, a majority of the
Company's deposits repriced during 1994 and early 1995 at interest rates
reflective of the rise in market interest rates, in particular short-term
interest rates. Conversely, approximately 65% of the Company's
interest-earning assets are adjustable-rate loans and priced at a margin over
the Eleventh District Cost of Funds ("11th DCOFI"). The 11th DCOFI had
declined from 4.36% in January 1993 to a low of 3.63% in March 1994, before
rising again to 5.06% in December 1995 and again declining to 4.87% in March
1996. Changes in the 11th DCOFI have historically lagged the repricing of
institutions' liabilities (principally deposits), which is the pattern
presently observable. Prior to 1995, more than 80% of the Company's
adjustable rate loans repriced only semi-annually or annually. However,
almost all adjustable-rate loans originated since the beginning of 1995
adjust quarterly or more frequently. Accordingly, 63% of the Company's loan
portfolio now reprices semi-annually or annually.
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-1994 loan portfolio while
maintaining the Company's established credit quality standards. During the
first quarter of 1996, the Company originated $64.1 million of new permanent
loans and construction commitments with a weighted average interest rate of
9.66%. By comparison, new loan originations and construction commitments
during the first quarter of 1995 were $28.2, and carried a weighted average
interest rate at origination of 9.37%. For the year ended December 31, 1995,
the Company originated nearly $200.0 million of new permanent loans and
construction commitments with a weighted average interest rate of 9.93%. At
March 31, 1996, approximately $212.3 million of the loans originated since
1994 remained in the Company's portfolio and had an aggregate weighted
average interest rate of 9.34%. Loans originated prior to 1995 totaled
$422.0 million at March 31, 1996 and had an aggregate weighted average
interest rate of 7.88%. Most of the loans originated during 1995 and 1996
are adjustable-rate and utilize a variety of indices, including the 11th
DCOFI, the Prime Rate and the One-Year Constant Maturity Treasury Index.
This portfolio, which represented 33% of the Company's gross loans at March 31,
1996, is expected to be substantially
12
<PAGE>
accretive to the Company's interest margin throughout 1996 and beyond to the
extent the loans remain outstanding and continue to perform in accordance
with their terms.
PROVISIONS FOR ESTIMATED CREDIT LOSSES ON LOANS
For the quarter ended March 31, 1996, the Company recorded loan loss
provisions of $1.2 million, compared with loan loss provisions of
$12.7 million recorded during the first quarter of 1995. The reduction in loan
loss provisions from 1995 to 1996 resulted primarily from an improvement in
asset quality. At March 31, 1996, nonperforming assets and performing loans
classified "Substandard, Doubtful or Loss" totaled $89.5 million compared with
$146.2 million at March 31, 1995. Within these totals, the net carrying value
of real estate owned totaled $26.0 million and $57.2 million, respectively, at
March 31, 1996 and 1995. The majority of the provisions recorded in the
first quarter 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.
NON-INTEREST REVENUES
The table below sets forth the Company's non-interest revenues for the
three month periods indicated (dollars are in thousands).
Three Months Ended March 31,
------------------------------------
1996 1995 Change
---------- ---------- ------------
Other loan and escrow fees $ 268 $ 96 $ 172
Deposit account fees 161 180 (19)
Other revenues 163 407 (244)
---------- ---------- ------------
$ 592 $ 683 $ (91)
---------- ---------- ------------
---------- ---------- ------------
Other loan and escrow fees in 1996 were higher than in 1995 due primarily
to increased loan production. Other revenues in the first quarter of 1996
included $0.2 million in legal recoveries compared to approximately
$0.4 million in legal recoveries and insurance proceeds in the first quarter of
1995.
OPERATING COSTS
The table below details the Company's operating costs for the three month
periods indicated (dollars are in thousands).
Three Months Ended March 31,
------------------------------------
1996 1995 Change
---------- ---------- ------------
Employee $ 2,294 $ 2,762 $ (468)
Occupancy 723 788 (65)
Operating 1,049 843 206
Professional 448 467 (19)
SAIF insurance premium
and OTS assessment 585 549 36
Goodwill 12 12
---------- ---------- ------------
$ 5,111 $ 5,421 $ (310)
---------- ---------- ------------
---------- ---------- ------------
The overall reduction in operating costs reflects the higher cost deferral
under GAAP associated with the Company's expanding loan origination
activities. The Company has also reduced its accruals for incentive cash
compensation, consistent with the awarding of stock options to all key
managers during the fourth quarter of 1995.
13
<PAGE>
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).
Three Months Ended March 31,
------------------------------------
1996 1995 Change
---------- ---------- ------------
EXPENSES ASSOCIATED WITH REAL ESTATE OWNED
Holding costs
Property taxes $ (41) $ (23) $ (18)
Repairs, maintenance and renovation (41) (128) 87
Insurance (36) (37) 1
---------- ---------- ------------
(118) (188) 70
NET RECOVERIES FROM SALE OF PROPERTIES 744 179 565
RENTAL INCOME, NET 515 475 40
PROVISION FOR ESTIMATED LOSSES ON
REAL ESTATE OWNED (700) (700)
---------- ---------- ------------
$ 441 $ 466 $ (25)
---------- ---------- ------------
---------- ---------- ------------
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 first quarter of 1996, a provision
for estimated losses on foreclosed real estate in the amount of $0.7 million
was recorded, principally associated with higher-than-expected renovation
costs for the Company's owned apartment portfolio. Also during the first
quarter of 1996, the Company sold 51 properties generating net proceeds of
$10.8 million and aggregate net recoveries of $0.7 million.
As of March 31, 1996, the Company's portfolio of properties consisted of
211 individual homes, apartment buildings, and land parcels. In addition, as
of that date the Company's defaulted loan portfolio was represented by
104 loans and its portfolio of performing project concentration loans secured
442 individual homes. See Risk 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.
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 15 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 $2.3 million during the
quarter ended March 31, 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 of pretax earnings 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 pretax earnings reasonably expected to be generated during the succeeding
12 month period or not more than 10% of an institution's tangible capital.
At March 31, 1996, the deferred tax asset recorded by the Company represented
less than 5.0% of the Bank's tangible capital.
14
<PAGE>
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 and the Federal Home Loan Bank of San Francisco ("FHLB")
to cover daily inclearings, wire activities and other charges. Cash and cash
equivalents at March 31, 1996, were $15.8 million, an increase from $14.0
million at December 31, 1995.
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>
MARCH 31, 1996
-------------------------------------------
GROSS UNREALIZED ESTIMATED
AMORTIZED ---------------- FAIR
COST GAINS LOSSES VALUE
--------- ------ ------ ---------
<S> <C> <C> <C> <C>
U.S. Government $ 94,813 $ - $ (60) $ 94,753
-------- ------ ------ --------
$ 94,813 $ - $ (60) $ 94,753
-------- ------ ------ --------
-------- ------ ------ --------
<CAPTION>
DECEMBER 31, 1995
-------------------------------------------
GROSS UNREALIZED ESTIMATED
AMORTIZED ---------------- FAIR
COST GAINS LOSSES VALUE
--------- ------ ------ ---------
U.S. Government $ 62,787 $ 11 $ (5) $ 62,793
-------- ------ ------ --------
$ 62,787 $ 11 $ (5) $ 62,793
-------- ------ ------ --------
-------- ------ ------ --------
</TABLE>
The available-for-sale amounts at March 31, 1996 and December 31, 1995,
include restricted U.S. Government securities purchased with proceeds from
the recapitalization of the Company in December 1995. These proceeds
represent prefunded interest expense associated with the Senior Notes (as
defined herein) and had a cost basis and fair value of $4.9 million and $4.8
million, respectively, at March 31, 1996.
The cost basis and estimated fair value of investment securities
available-for-sale at March 31, 1996, are summarized by contractual maturity
as follows (dollars are in thousands):
ESTIMATED
FAIR
COST BASIS VALUE
---------- ---------
Due in less than one year $ 71,586 $ 71,539
Due in one year through five years 23,227 23,214
-------- --------
$ 94,813 $ 94,753
-------- --------
-------- --------
15
<PAGE>
REAL ESTATE 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>
MARCH 31, 1996
-------------------------------
PRE-1994 POST-1993 TOTAL
--------- --------- ---------
<S> <C> <C> <C>
PERMANENT
Single family (non-project)
Estate $ - $ 54,865 $ 54,865
Other 157,449 22,120 179,569
Loan concentrations 69,308 1,057 70,365
Multi-family
2 to 4 units 32,996 11,568 44,564
5 or more units 139,355 89,777 229,132
Commercial 2,071 34,683 36,754
Land 961 3,764 4,725
RESIDENTIAL CONSTRUCTION 45,104 45,104
OTHER 19 1,705 1,724
--------- -------- --------
GROSS LOANS RECEIVABLE $ 402,159 $264,643 $666,802
--------- -------- --------
--------- -------- --------
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1996 DECEMBER 31, 1995 MARCH 31, 1995
----------------- ----------------- -----------------
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT
-------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
PERMANENT LOANS
Single family
Non-project $234,434 35.2% $257,457 39.2% $258,623 44.7%
Loan concentrations 70,365 10.6% 70,748 10.8% 80,675 13.9%
Multi-family
2 to 4 units 44,564 6.7% 41,640 6.3% 46,283 8.0%
5 or more units 229,132 34.4% 219,015 33.4% 175,667 30.4%
Commercial 36,754 5.5% 31,258 4.8% 7,453 1.3%
Land 4,725 0.7% 5,579 0.9% 1,021 0.2%
RESIDENTIAL CONSTRUCTION 45,104 6.8% 28,787 4.4% 7,530 1.3%
OTHER 1,724 0.3% 1,459 0.2% 1,342 0.2%
-------- ----- -------- ----- -------- -----
GROSS LOANS RECEIVABLE 666,802 100.0% 655,943 100.0% 578,594 100.0%
----- ----- -----
----- ----- -----
LESS
Participants' share (2,640) (2,219) (2,901)
Undisbursed loan funds (26,143) (15,208) (5,788)
Deferred loan fees and
credits, net (8,794) (5,996) (3,930)
Allowance for estimated losses (15,353) (15,192) (26,019)
-------- -------- --------
TOTAL LOANS RECEIVABLE $613,872 $617,328 $539,956
-------- -------- --------
-------- -------- --------
</TABLE>
16
<PAGE>
The Company's loan portfolio is exclusively concentrated in Southern
California real estate. At March 31, 1996 and 1995, respectively, 46% and
57% of the Company's loan portfolio consisted of permanent loans secured by
single family residences, 41% and 38% consisted of permanent loans secured by
multi-unit residential properties, and 13% and 5% consisted of loans to
finance commercial properties, the acquisition of land and the construction
of single family housing.
Historically, the Company actively financed the construction of
residential properties, principally small-to-medium sized tracts of detached
single family homes and condominiums, and small apartment buildings
(generally, less than 37 units). With respect to for-sale housing
developments, the Company typically provided permanent financing to buyers of
individual homes and condominiums within projects for which it provided the
construction financing. In addition, the Company generally provided a
permanent loan commitment following its financing for the construction of
apartment buildings.
The Company's performance continues to be adversely affected by the
weakness evident in its 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 five 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,
which are affiliated and with respect to which there remain limited financial
resources to fund debt service payments where property cash flows (either
from sales of homes or from income property cash flows) are, or may become,
inadequate.
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 fifteen
months ended March 31, 1996, the Company originated $261 million of permanent
loans and construction loan commitments.
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 products 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 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
pre-funding 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.
17
<PAGE>
RISK ASSETS
At March 31, 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 Risk
Asset portfolio. Risk Assets include owned properties, nonaccrual loans, and
performing loans which have been adversely classified pursuant to OTS
regulations ("Performing/Classified" loans) and guidelines. Loans categorized
as "Special Mention" are not classified pursuant to regulatory guidelines,
but are included in these tables as an indication of migration trends
(dollars are in thousands).
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
1996 1995 1995
--------- ------------ ---------
<S> <C> <C> <C>
PROPERTIES $ 38,277 $ 53,630 $ 95,224
NONACCRUAL LOANS 27,627 21,709 34,220
Performing loans
Classified Loss, Doubtful and Substandard 47,170 57,049 69,053
Designated Special Mention 67,686 54,851 68,037
-------- -------- --------
GROSS RISK ASSETS 180,760 187,239 266,534
LESS
Specific reserves (15,179) (18,049) (45,193)
General reserves (11,321) (11,160) (14,083)
-------- -------- --------
NET RISK ASSETS $154,260 $158,030 $207,258
-------- -------- --------
-------- -------- --------
NET LOANS RECEIVABLE
AND PROPERTIES $639,832 $655,233 $566,842
-------- -------- --------
-------- -------- --------
PERCENTAGE TO NET LOANS RECEIVABLE
AND PROPERTIES
Net risk assets 24.1% 24.1% 36.6%
---- ---- ----
---- ---- ----
Net classified assets 14.0% 16.2% 25.8%
---- ---- ----
---- ---- ----
PERCENTAGE OF NET CLASSIFIED ASSETS TO
CORE CAPITAL 192.1% 244.3% 515.4%
----- ----- -----
----- ----- -----
</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 in
default and performing loans placed on nonaccrual status) declined to $48.3
million, or 6.2% of total assets, at March 31, 1996, from $55.8 million, or
7.4% of total assets, at December 31, 1995 and $84.0 million, or 11.6% of
total assets, at March 31, 1995. The carrying value of nonperforming assets
peaked at nearly $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 in-migration of performing loans to default. 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 March 31, 1996, December 31, 1995 and March 31, 1995, the
principal amount of nonaccrual loans included $14.4 million, $10.4 million
and $16.5 million, respectively, of loans with respect to which payments were
either current or delinquent less than three payments.
18
<PAGE>
The table below shows the Company's gross loan portfolio, by
classification, as of March 31, 1996 (dollars are in thousands).
<TABLE>
CLASSIFIED LOANS
-----------------------
SPECIAL NONACCRUAL
PASS MENTION SUBSTANDARD LOANS TOTAL
--------- -------- ----------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Single family homes
Non-project $ 206,513 $10,802 $ 5,194 $11,925 $234,434
Loan concentrations 30,540 26,068 8,446 5,311 70,365
Multi-family
2 to 4 units 40,169 1,673 1,430 1,292 44,564
5 or more units 164,280 25,904 31,597 7,351 229,132
Commercial properties 34,664 1,978 112 36,754
Land 1,325 1,261 391 1,748 4,725
Residential construction
SFR 29,215 29,215
Tract development 15,889 15,889
Other collateralized loans 1,724 1,724
--------- ------- ----------- ------- --------
$ 524,319 $67,686 $ 47,170 $27,627 $666,802
--------- ------- ----------- ------- --------
--------- ------- ----------- ------- --------
</TABLE>
SINGLE FAMILY (NON-PROJECT)
In the preceding table, non-project single family homes consist of and
defaulted performing/classified and nonclassified loans secured by single
family homes which are not part of an integrated development with respect to
which the Company financed the construction of the development or financed
the purchase of homes from the developer by individuals. At March 31, 1996,
the Company (1) owned 9 homes which were being actively marketed for sale,
(2) had 49 defaulted loans secured by single family (non-project) homes, (3)
had 15 loans which were performing but had been classified "Substandard", and
(4) had 49 loans which were performing but had been designated "Special
Mention". The Company has valued its owned single family homes at their
estimated net liquidation values. The defaulted loan portfolio secured by
single family homes (non-project) has been valued, in the aggregate,
consistently with the 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 March 31, 1996 the Company's aggregate investment in its
portfolio of loan concentrations (loan principal plus foreclosed inventory
before reserves) consisted of 53 separate loan concentrations totaling $76.1
million. This represents a decrease of $37.8 million, or 35%, principally as
the result of foreclosure of the Company's collateral, sales of foreclosed
units and the acceptance of discounted payments from borrowers on several
19
<PAGE>
loans. At March 31, 1996, the Company owned 55 foreclosed units and 32 loans,
representing $5.3 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 March 31, 1996, the Company owned 38 apartment buildings, and loans
secured by 21 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.
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. These properties, which are now stabilized and reflective
of stabilizing market conditions, are expected to be liquidated within the
next several quarters without any material impact on earnings.
The carrying value of the defaulted apartment loan portfolio has been
determined on the same basis as for owned apartment buildings, where
property-specific information is available, or based upon the average per
unit valuation for owned buildings of similar unit size and unit mix. For
performing apartment loans either classified "Substandard" or designated
"Special Mention", 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.
RESIDENTIAL CONSTRUCTION
At March 31, 1996, the Company maintained investments in 5 residential
construction developments previously acquired through foreclosure. These
developments, when completed, will entail the construction and sale of 259
homes. At March 31, 1996, the Company had sold 160 homes in these
developments, 33 homes had been completed and had not been sold, and 66 homes
remained to be built or are model units. The cost to complete construction
of the remaining homes within these developments ($11.2 million) has been
incorporated into the carrying values for each development at March 31, 1996.
LAND
At March 31, 1996, the Company's portfolio of owned land parcels consisted
of 5 properties with a net carrying value of $0.7 million. The Company also
had 3 classified loans totaling $3.3 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.
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 March 31, 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") GVAs
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.
20
<PAGE>
The table below sets forth the amounts and percentages of general and
specific reserves for the Company's loan and property portfolios as of March 31,
1996 (dollars are in thousands).
<TABLE>
LOANS
-----------------------
PERFORMING IN DEFAULT PROPERTIES TOTAL
---------- ---------- ---------- --------
<S> <C> <C> <C> <C>
AMOUNTS
Specific reserves $ 500 $ 3,229 $ 11,450 $ 15,179
General reserves 9,614 2,010 867 12,491
---------- --------- ---------- --------
Total reserves for estimated losses $ 10,114 $ 5,239 $ 12,317 $ 27,670
---------- --------- ---------- --------
---------- --------- ---------- --------
PERCENTAGES
% of total reserves to gross investment 1.5% 19.0% 32.2% 3.9%
% of general reserves to gross investment 1.4% 7.3% 2.3% 1.7%
</TABLE>
The table below summarizes the activity of the Company's reserves for the
periods indicated (dollars are in thousands).
THREE MONTHS ENDED MARCH 31,
------------------------------
1996 1995
----------- ------------
LOANS
Balance at beginning of period $ 15,192 $ 21,461
Provision for estimated losses 1,200 12,700
Transfer to property and other reserves 400 (8,014)
Charge-offs (1,439) (128)
Recoveries
----------- -----------
Balance at end of period $ 15,353 $ 26,019
----------- -----------
----------- -----------
PROPERTIES
Balance at beginning of period $ 15,725 $ 33,517
Provision for estimated losses 700
Transfer from loan reserves (400) 8,014
Charge-offs (3,708) (6,489)
Recoveries
----------- -----------
Balance at end of period $ 12,317 $ 35,042
----------- -----------
----------- -----------
21
<PAGE>
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
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).
MARCH 31, 1996
-------------------------------------------
LOANS PROPERTIES TOTAL
----------- ----------- -----------
PERMANENT
Single family homes
Non-project $ 1,645 $ 451 $ 2,096
Loan concentrations 3,980 1,313 5,293
Multi-family
2 to 4 units 1,019 609 1,628
5 or more units 7,953 2,851 10,804
Commercial 288 105 393
Land 10 933 943
RESIDENTIAL CONSTRUCTION 458 6,055 6,513
----------- ------------ -----------
$ 15,353 $ 12,317 $ 27,670
----------- ------------ -----------
----------- ------------ -----------
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 March 31, 1996 and 1995 and at December 31, 1995 (dollars are in
thousands).
MARCH 31, DECEMBER 31, MARCH 31,
1996 1995 1995
------------ ------------ -----------
SINGLE FAMILY RESIDENCES
Non-project $ 2,191 $ 4,975 $ 3,452
Loan concentrations 5,778 6,419 13,200
MULTI-FAMILY
2 to 4 units 2,175 3,840 1,298
5 or more units 10,940 18,877 30,209
COMMERCIAL 346 346 395
LAND 1,609 3,759 13,387
RESIDENTIAL CONSTRUCTION 15,238 15,414 32,146
------------ ----------- -----------
GROSS INVESTMENT (1) 38,277 53,630 94,087
WRITEDOWNS (2,331)
ALLOWANCE FOR ESTIMATED LOSSES (12,317) (15,725) (35,693)
------------ ----------- -----------
NET INVESTMENT $ 25,960 $ 37,905 $ 56,063
------------ ----------- -----------
------------ ----------- -----------
- ------------
(1) Loan principal at foreclosure, plus post-foreclosure capitalized
costs, less cumulative charge-offs.
22
<PAGE>
OFFICE PROPERTY AND EQUIPMENT
At March 31, 1996, the Company's office property and equipment of $6.7
million was down from $9.6 million at March 31, 1995. The decrease was
primarily due to $2.9 million in sales of branch facilities, of which $2.2
million related to the sale of the Company's Oceanside branch in February
1996. The deposits at this branch will be sold as part of the Company's
San Diego County branch sale in June 1996. A nominal gain was recorded on
the sale of this facility and is included in gain on sale of other assets.
LIABILITIES
GENERAL
The Company derives funds principally from deposits and, to a far lesser
extent, from short-term reverse repurchase agreements and 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 generates
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 $51.9 million of loan principal secured primarily by
single family homes originated prior to 1994 and $91.5 million of securities.
At March 31, 1996, an additional $35.1 million of seasoned real estate loans
were held-for-sale. 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 March 31, 1996, were $714.9 million, an increase from
$698.0 million at December 31, 1995 and $681.4 million at March 31, 1995. In
April 1996 the Company entered into a definitive agreement to sell its three
San Diego County branches. At March 31, 1996, these branches had total
deposits of $165.4 million. The Company expects to fund the transfer of
deposits with a combination of borrowings from the FHLB (See BORROWINGS) and
excess liquidity. The transaction is expected to be completed during the
second quarter of 1996.
BORROWINGS
To supplement its funding needs, the Company may enter into reverse
repurchase agreements, in which certain securities are sold with an agreement
to repurchase the same securities at a specific future date (overnight to
90 days). The Company will enter into such transactions only with dealers
determined by management to be financially strong and who are recognized as
primary dealers in U.S. Treasury securities by the Federal Reserve Board.
An additional source of liquidity for the Company is the Bank's
$150.0 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 mortgages underlying a
company's loans and the capital stock of the FHLB owned by the company.
Subject to the FHLB of San Francisco's policies and requirements, these
advances can be requested for any business purpose in which a company
is authorized to engage. In granting advances, the FHLB considers a member's
credit worthiness and other relevant factors.
The Company has Senior Notes, which have a face amount of $13.5 million,
and a recorded market value of $12.1 million at March 31, 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 Offering. This
prefunded interest of $4.9 million has been invested in U.S. Government
securities. Thereafter, interest will be payable either in cash or, 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).
23
<PAGE>
The following table summarizes the regulatory capital requirements under
FIRREA for the Bank at March 31, 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>
Tangible Capital Core Capital Risk-based Capital
---------------------- --------------------- ----------------------
Balance % Balance % Balance %
----------- ---------- ------------ -------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Stockholder's equity $ 46,740 $ 46,740 $ 46,740
Adjustments
General valuation allowances 6,107
Core deposit intangibles (167) (167) (167)
Interest rate risk component (1)
----------- ---------- ------------ -------- ------------- ---------
Regulatory capital 46,573 6.07% 46,573 6.07% 52,680 10.91%
Required minimum 11,518 1.50% 23,035 3.00% 38,645 8.00%
----------- ---------- ------------ -------- ------------- ---------
Excess capital $ 35,055 4.57% $ 23,538 3.07% $ 14,035 2.91%
----------- ---------- ------------ -------- ------------- ---------
----------- ---------- ------------ -------- ------------- ---------
Adjusted assets (2) $ 767,841 $ 767,841 $ 483,063
----------- ------------ -------------
----------- ------------ -------------
</TABLE>
__________________
(1) At March 31, 1996, the OTS had temporarily suspended the application
of its interest rate risk regulation. Had the regulation been in
effect at March 31, 1996, the Bank would not have been required to
deduct from risk-based capital any amount 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 December 31, 1995.
(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).
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 March 31, 1996 are set forth below.
Ratio of Core Capital to Total Assets (Leverage ratio) 6.07%
Ratio of Core Capital to Risk-weighted Asset 9.64%
Ratio of Total Capital to Risk-weighted Assets 10.91%
At March 31, 1996, the Bank's capital ratios exceeded the capital ratio
requirements for the Bank to qualify as a "well capitalized" institution.
24
<PAGE>
The OTS also 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 Bank and the ability of such institutions to recoup principal and
accrued interest through acquisition and sale of the underlying collateral.
No assurances can be given that such trends will not continue in future
periods, creating increasing downward pressure on the earnings and capital of
thrift institutions.
CAPITAL RESOURCES AND LIQUIDITY
The Bank's liquidity position refers to the extent to which the Bank's
funding sources are sufficient to meet its current and long-term cash
requirements. Federal regulations currently require a savings institution to
maintain a monthly average daily balance of liquid and short-term liquid
assets equal to at least 5.0% and 1.0%, respectively, of the average daily
balance of its net withdrawable accounts and short-term borrowings during the
preceding calendar month. The Bank had liquidity and short-term liquidity
ratios of 9.64% and 6.29%, respectively, as of March 31, 1996, and 8.50% and
5.95%, respectively, as of December 31, 1995.
The Bank's current primary funding resources are deposit accounts,
principal payments on loans, proceeds from property sales, and cash flows
from operations. Other possible sources of liquidity available to the Bank
include reverse repurchase transactions involving the Bank's investment
securities, whole loan sales, FHLB advances, commercial bank lines of credit,
and direct access, under certain conditions, to borrowings from the Federal
Reserve System. The cash needs of the Bank are principally for the payment
of interest on and withdrawals of deposit accounts, the funding of loans,
operating costs and expenses, and holding and refurbishment costs on
foreclosed properties.
The Company has been seeking new sources of liquidity to finance its core
operations and to provide funds for the June, 1996 sale of the Company's
three San Diego County branches. Deposits at these branches totaled
approximately $165.4 million at March 31, 1996. Additionally, the Company's
lending activities are expected to increase substantially over the remainder
of the year. As a result, the Company has had to explore additional sources
of liquidity. During the first quarter of 1996 the Company successfully
completed a whole loan sale of $37.2 million at a nominal gain to the
Company. Additionally, at March 31, 1996 the Company had negotiated the
sale of an additional $35.1 million of fixed rate loans secured by single
family homes. This transaction was completed on April 30, 1996. The loans
sales will provide the Company with additional cash for use in operations or
to finance the branch sales in June. Access to additional funds of $150.0
million are available through borrowings from the FHLB.
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 is the first method, with a focus on measuring absolute dollar
amounts 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
25
<PAGE>
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 simulation. 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 90% for the three
months ended March 31, 1996. ARMs represented 74% and 75% of the Company's
loan portfolio at March 31, 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 (and are subject to maximum periodic rate
adjustment limits) may somewhat alter this expected benefit (dollars are in
thousands).
<TABLE>
<CAPTION>
March 31, 1996 December 31, 1995 March 31, 1995
-------------------- ---------------------- -------------------
Balance Rate Balance Rate Balance Rate
---------- --------- ------------ --------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets
Loans (1) $ 636,044 8.39% $ 637,472 8.25% $ 569,336 7.36%
Cash and investment securities 109,762 4.98% 77,357 5.19% 49,102 6.36%
Mortgage-backed securities 54,494 6.26%
---------- ------------ ----------
745,806 7.89% 714,829 7.90% 672,932 7.19%
---------- --------- ------------ --------- ---------- --------
Interest-bearing liabilities
Deposit accounts (713,377) (5.07%) (698,008) (5.16%) (682,415) (4.77%)
Borrowings (12,073)(12.00%) (12,006) (6.19%) (8,585) (6.04%)
---------- ------------ ----------
(725,450) (5.19%) (710,014) (5.17%) (691,000) (4.79%)
---------- --------- ------------ --------- ---------- --------
Interest-bearing gap/stated
interest margin 20,356 2.84% 4,815 2.89% (18,068) 2.28%
Nonaccrual loans (27,627) (0.31%) (21,709) (0.28%) (34,220) (0.37%)
---------- --------- ------------ --------- ---------- --------
Adjusted interest-bearing gap $ (7,271) 2.53% $ (16,894) 2.61% $ (52,288) 1.91%
---------- --------- ------------ --------- ---------- --------
---------- --------- ------------ --------- ---------- --------
</TABLE>
__________________
(1) Contractual yield, exclusive of the amortization of loan fees
deferred at origination.
26
<PAGE>
PROSPECTS
For the four-year period ended December 31, 1995, the Company reported
cumulative net losses of $68.9 million. These losses were principally the
result of cumulative credit loss provisions of $109.3 million. These
provisions were necessary to absorb the losses associated with the
foreclosure during this period of the collateral securing $247.7 million of
loan principal, the significant majority of which was sold during 1994 and
1995.
The magnitude of the losses incurred by the Company during this period
caused the OTS and the Federal Deposit Insurance Corporation ("FDIC") to
question the Company's viability as a going concern, in the process imposing
several directives upon the Company, including a Prompt Corrective Action
Directive ("PCA Directive") in June 1995, which required, among other things,
that the Company recapitalize the Bank by December 1995.
As previously reported, the Company successfully completed the sale of
investment units in December 1995, the majority of the proceeds from which
($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 three months ended March 31, 1996, the Bank's core
and risk-based capital ratios increased to 6.07% and 10.91%, respectively.
Upon the completion of the deposit sale discussed elsewhere herein,
management expects that the Bank's core and risk-based capital ratios will
further increase to in excess of 6.50% and 11.50%, respectively, at June 30,
1996.
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-third of the
Company's total loans at March 31, 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 expects 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 borrower has 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.
GENERAL REGULATION
The Company is registered with the OTS as a savings and loan holding
company and is subject to regulation and examination as such by the OTS. The
Bank is a member of the FHLB and its deposits are insured by the FDIC. The
Bank is subject to examination and regulation by the OTS and the FDIC with
respect to most of its business activities, including, among others, lending
activities, capital standards, general investment authority, deposit-taking
and borrowing authority, mergers and other business combinations,
establishments of branch offices, and permitted subsidiary investment and
activities.
Saving institutions regulated by the OTS are subject to a qualified thrift
lender ("QTL") test which requires an institution to maintain at least 65% of
its portfolio assets (as defined) in "qualified thrift investments."
Qualified thrift investments include, in general, loans, securities and other
investments that are related to housing and certain
27
<PAGE>
other permitted thrift institution investments. At March 31, 1995, the Bank
was in compliance with its QTL test requirements. A savings institution's
failure to remain a QTL may result in (1) limitations on new investments and
activities, (2) imposition of branching restrictions, (3) loss of FHLB
borrowing privileges, and (4) limitations on the payment of dividends.
The Bank is further subject to regulations of the Board of Governors of
the Federal Reserve System concerning non-interest bearing services required
to be maintained against deposits and certain other matters. Financial
institutions, including the Bank, may also be subject, under certain
circumstances, to potential liability under various statues and regulations
applicable to property owners generally, including statutes and regulations
relating to the environmental condition of real property and potential
liability for the costs of remediation thereof.
The description of the statutes and regulations applicable to the Company
and the Bank set forth below and elsewhere herein do not purport to be
complete descriptions of such statutes and regulations and their effects on
the Company and the Bank. Such descriptions also do not purport to identify
every statute and regulation that may apply to the Company or Bank.
The OTS' enforcement authority over savings institutions and their holding
companies includes, among other things, the ability to assess civil money
penalties, to issue cease and desist orders, to initiate removal and
prohibition orders against officers, directors, and certain other persons,
and to appoint a conservator or receiver for savings institutions under
appropriate circumstances. In general, these enforcement actions may be
initiated for violations of laws and regulations, violations of cease and
desist orders and "unsafe or unsound" conditions or practices, which are not
limited to cases of inadequate capital.
The FDIC has authority to recommend that the OTS take any authorized
enforcement action with respect to any federally insured savings institution.
If the OTS does not take the recommended action or provide an acceptable
plan for addressing the FDIC's concerns within 60 days after the receipt of
the recommendation from the FDIC, the FDIC may take such action if the FDIC
Board of Directors determines that the institution is in an unsafe or unsound
condition or that failure to take such action will result in the continuation
of unsafe or unsound practices in conducting the business of the institution.
The FDIC may also take action prior to the expiration of the 60-day time
period in exigent circumstances after notifying the OTS.
The FDIC may terminate the deposit insurance of any insured depository if
the FDIC determines, after a hearing, that the institution has engaged or is
engaging in unsafe or unsound practices which, as with the OTS' enforcement
authority, are not limited to cases of capital inadequacy, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation or order or any condition imposed in writing by the FDIC. In
addition, FDIC regulations provide that any insured institution that falls
below a 2% minimum leverage ratio will be subject to FDIC deposit insurance
termination proceedings unless it has submitted, and is in compliance with, a
capital plan with its primary federal regulator and the FDIC. The FDIC may
also suspend deposit insurance temporarily during the hearing process if the
institution has no tangible capital. The FDIC is additionally authorized by
statute to appoint itself as conservator or receiver of an insured
institution (in addition to the powers of the institution's primary federal
regulatory authority) in cases, among others and upon compliance with certain
procedures, of unsafe or unsound conditions or practices or willful
violations of cease and desist orders.
As a member of the FHLB system, the Bank is required to own capital stock
in its regional FHLB, the FHLB of San Francisco, in a minimum amount
determined at the end of each year based on the greater of (i) 1.00% of the
aggregate principal amount of its unpaid residential mortgage loans, home
purchase contracts and similar obligations, (ii) 5.00% of its outstanding
borrowings from the FHLB of San Francisco, or (iii) 0.3% of its total assets.
The Bank was in compliance with this requirement, with an investment of $6.3
million in FHLB stock, at March 31, 1996. The FHLB of San Francisco serves as
a reserve or central bank for the member institutions within its assigned
region, the 11th FHLB District. It makes advances to members in accordance
with policies and procedures established by the Federal Housing Finance Board
and the Board of Directors of the FHLB of San Francisco.
28
<PAGE>
The FDIC administers two separate deposit insurance funds. The Bank
Insurance Fund ("BIF") insures the deposits of commercial banks and other
institutions that were insured by the FDIC prior to the enactment of the
FIRREA. The SAIF insures the deposits of savings institutions that were
insured by the Federal Savings and Loan Insurance Corporation ("FSLIC") prior
to enactment of FIRREA. The FDIC is authorized to increase insurance premiums
payable by institutions of either fund if it determines that such increases
are appropriate to maintain the reserves of that fund or to pay the costs of
administration of the FDIC. In addition, the FDIC is authorized to levy
emergency special assessments on BIF and SAIF members.
FDIC deposit insurance premiums are assessed pursuant to a "risk-based"
system under which institutions are classified on the basis of capital
ratios, supervisory evaluations by their primary federal regulatory agency
and other information determined by the FDIC to be relevant. Each of nine
resulting subgroups of institutions is assigned a deposit insurance premium
assessment rate which, for SAIF-insured institutions, currently ranges from
0.23% to 0.31%. The Bank's current deposit insurance premium assessment rate,
which is based on the FDIC's evaluation of the relevant factors applicable to
the Bank as of a date prior to the completion of the Bank's recapitalization,
is 0.31%.
The SAIF and the BIF are each required by statute to attain and thereafter
to maintain a reserve to deposits ratio of 1.25%. The BIF has reached the
required reserve level, whereas, based upon projections by the FDIC, the SAIF
is not expected to reach its targeted ratio until at least the year 2002, or
later. This disparity arises from the BIF's greater premium revenues and the
requirement that a substantial portion of the SAIF premiums be used to repay
bonds (commonly referred to as the "FICO Bonds") that were issued by a
specially created federal corporation for the purpose of funding failed
thrift institutions. In November 1995, the FDIC reduced its deposit insurance
premiums for BIF member institutions to a range of 0.00% of deposits plus a
statutory minimum of $2,000 in annual assessment per institution to 0.27%,
with an historical low average of approximately 0.04%, effective beginning
with the semiannual period commencing January 1, 1996. The FDIC maintained
the range of deposit insurance premiums assessable against SAIF member
institutions at 0.23% to 0.31%.
The deposit premium rate disparity between BIF-insured institutions and
SAIF-insured institutions places SAIF-insured institutions at a significant
competitive disadvantage due to their higher premium costs and may worsen the
financial condition of the SAIF by leading to a shrinkage in its deposit
base. A number of proposals for assisting the SAIF in attaining its required
reserve level, and thereby permitting SAIF deposit insurance premiums to be
reduced to levels at or near those paid by BIF-insured institutions, have
been under discussion in Congress and among various of the affected parties
and relevant government agencies. Congress proposed, as part of the budget
reconciliation bill submitted to and vetoed by the President, a one-time,
special assessment on all savings institutions to recapitalize the SAIF. The
proposal would have required SAIF-insured institutions to pay a one-time
special assessment on January 1, 1996 (estimated to be between approximately
80 and 90 basis points on deposits) and would provide for a pro rata sharing
by all federally insured institutions of the obligation, now borne entirely
by SAIF-insured institutions, to repay the above-mentioned FICO Bonds.
Subsequent efforts to enact similar legislation have not been successful to
date. If such proposed legislation were ultimately to become law, the special
assessment would be reported in the Bank's Statement of Operations in the
quarter during which the budget reconciliation bill (or such other bill to
which such legislation may be attached) is finally agreed to by Congress and
signed by the President.
29
<PAGE>
Also included in the budget reconciliation bill were provisions that would
eliminate the deduction for additions to tax bad debt reserves available to
qualifying thrift institutions under existing provisions of the Internal
Revenue Code. The bill would also generally have required "recapture" (i.e.,
inclusion in taxable income) of the balance of such reserve accounts to the
extent they exceed a base year amount (generally the balance of reserves as
of December 31, 1987, reduced proportionately for any reduction in an
institution's loan portfolio) in ratable installments over a six-year period.
The legislation would also, as under existing law, have required recapture of
reserves, including the base year amounts, in the event of certain
distributions to stockholders in excess of current or accumulated earnings
and profits, or redemptions, or in the event of liquidations or certain
mergers or other corporate transactions. Subsequent proposed legislation
contains similar provisions.
Management cannot predict whether or in what form legislation of the types
described above will be enacted or the effect of such legislation, if
adopted, on the Bank's operations and financial condition. Management
believes, however, that certain of the provisions of such proposed
legislation could benefit the Bank and its stockholders through eliminating
one source of financial uncertainty facing thrift institutions in the current
environment and by providing greater operating flexibility to pursue its
business strategies. A significant increase in SAIF premiums or a significant
surcharge to recapitalize the SAIF, however, would have an adverse effect on
the operating expenses and results of operations of the Bank and the Company
during the period thereof and would reduce the Bank's regulatory capital on
at least a temporary basis.
30
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
The Company and the directors of the Company, excluding Mr.
Herbst, have been named as defendants in a class and derivative
action entitled ARTHUR GLICK AND WILLIAM GURNEY, ON BEHALF OF
THEMSELVES AND ALL OTHERS SIMILARLY SITUATED VS. HAWTHORNE
FINANCIAL CORPORATION, ET.AL., filed in the United States
District Court of California, Case No. 95-6855-ER (the
"Action"). The Action was originally filed on October 12, 1995,
and has since been amended by the plaintiffs. The Action
alleges, among other things, that the directors, in particular
Mr. Braly, fraudulently failed timely and accurately to disclose
in the Company's periodic public reports the magnitude of credit
losses associated with the Bank's foreclosed property and
troubled loan portfolios during the period May 1994 through May
1995, thereby purportedly inflating the Company's share price
until additional credit losses were recorded during the first
half of 1995, after which the Company's share price declined, to
the purported detriment of the plaintiffs, among others. On
February 26, 1996, the Court granted the Company's Motion to
Dismiss the Action, concluding that the Action failed to set
forth sufficient facts in support of the allegations included
therein. The Court allowed the plaintiffs to amend the Action to
seek to add sufficient additional facts to support their
allegations. The plaintiffs filed an amended complaint with the
Court in early March. Since filing the amended complaint, the
plaintiffs have initiated settlement discussions with the
Company. While these discussions have not been finalized, the
Company believes a favorable resolution will be reached in the
near future.
The Company is involved in a variety of other litigation matters
which, for the most part, arise out of residential developments
in which the Company provided construction financing prior to 1994.
Most 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
The Company filed a Form 8-K on February 7, 1996 disclosing
certain information regarding the Offering completed by the
Company on December 12, 1995.
2. Other required exhibits - None
31
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HAWTHORNE FINANCIAL CORPORATION
Dated May 14, 1996 /s/ NORMAN A. MORALES
--------------------------------
Norman A. Morales
Executive Vice President and
Chief Financial Officer
Dated May 14, 1996 /s/ JESSICA VLACO
--------------------------------
Jessica Vlaco
Senior Vice President and
Principal Accounting Officer
32
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> MAR-31-1996
<CASH> 9,849
<INT-BEARING-DEPOSITS> 711,191
<FED-FUNDS-SOLD> 6,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 94,753
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 613,872
<ALLOWANCE> 15,353
<TOTAL-ASSETS> 773,090
<DEPOSITS> 714,865
<SHORT-TERM> 12,073
<LIABILITIES-OTHER> 5,300
<LONG-TERM> 0
0
11,592
<COMMON> 26
<OTHER-SE> 29,234
<TOTAL-LIABILITIES-AND-EQUITY> 773,090
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<INTEREST-TOTAL> 14,801
<INTEREST-DEPOSIT> 8,938
<INTEREST-EXPENSE> 9,409
<INTEREST-INCOME-NET> 5,392
<LOAN-LOSSES> 1,200
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<EXPENSE-OTHER> 5,111
<INCOME-PRETAX> 308
<INCOME-PRE-EXTRAORDINARY> 308
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,561
<EPS-PRIMARY> .41
<EPS-DILUTED> .41
<YIELD-ACTUAL> 8.05
<LOANS-NON> 27,627
<LOANS-PAST> 0
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<LOANS-PROBLEM> 47,170
<ALLOWANCE-OPEN> 15,192
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<RECOVERIES> 0
<ALLOWANCE-CLOSE> 15,353
<ALLOWANCE-DOMESTIC> 15,353
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
