<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1995
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
------------------- -------------------
Commission File Number: 0-1100
HAWTHORNE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-2085671
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2381 ROSECRANS AVENUE, 2ND FLOOR 90245
EL SEGUNDO, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310)725-5000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the closing stock price of such stock as of February
29, 1996 as reported by the National Association of Securities Dealers, was
$9,046,647.
The number of shares of Common Stock, par value $0.01 per share, of the
Registrant outstanding as of February 29, 1996 was 2,599,275 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Annual Report incorporates by reference portions of the
Proxy Statement to be filed with the Securities and Exchange Commission in
connection with the Registrant's Annual Meeting of Stockholders to be held on
May 20, 1996.
<PAGE>
HAWTHORNE FINANCIAL CORPORATION
ANNUAL REPORT ON FORM 10K
PAGE
PART I.
ITEM 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
General. . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Recent Developments. . . . . . . . . . . . . . . . . . . . . 3
New Business Generation. . . . . . . . . . . . . . . . . . . 4
Financing Criteria and Standards . . . . . . . . . . . . . . 8
Regulation . . . . . . . . . . . . . . . . . . . . . . . . . 10
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . 17
ITEM 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . 19
ITEM 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . 20
ITEM 4. Submission of Matters to a Vote of Security Holders. . . . . . 21
ITEM 4A. Executive Officers . . . . . . . . . . . . . . . . . . . . . . 21
PART II.
ITEM 5. Market for Registrant's Common Stock and Related
Stockholder Matters . . . . . . . . . . . . . . . . . . . . 22
ITEM 6. Selected Financial Data. . . . . . . . . . . . . . . . . . . . 24
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . . . . 25
Operating Results. . . . . . . . . . . . . . . . . . . . . . 25
Financial Condition, Capital Resources & Liquidity
and Asset Quality. . . . . . . . . . . . . . . . . . . . . 31
Interest Rate Risk Management. . . . . . . . . . . . . . . . 49
ITEM 8. Financial Statements and Supplementary Data. . . . . . . . . . 50
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure . . . . . . . . . . . . . . . . . . . 50
PART III.
ITEM 10. Directors and Executive Officers of the Registrant . . . . . . 51
ITEM 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . 51
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management . . . . . . . . . . . . . . . . . . . . . . . . . 51
ITEM 13. Certain Relationships and Related Transactions . . . . . . . . 51
PART IV.
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . 52
<PAGE>
P A R T I.
ITEM 1. BUSINESS
GENERAL
HAWTHORNE FINANCIAL CORPORATION
Hawthorne Financial Corporation ("Hawthorne Financial" or "Company"), a
Delaware corporation organized in 1959, is a savings and loan holding company
that owns 100% of the stock of Hawthorne Savings, F.S.B. ("Hawthorne Savings"
or "Bank"). Hawthorne Savings was incorporated in 1950 and commenced operations
on May 11, 1951. The Bank's nine full service retail
offices are located in Southern California. Hawthorne Savings had 186 employees
as of January 31, 1996. The Company's executive offices are located at 2381
Rosecrans Avenue, El Segundo, California 90245, and its telephone number is
(310) 725-5000.
HAWTHORNE SAVINGS
Hawthorne Savings is a federally-chartered stock savings bank (referred to
in applicable statutes and regulations as a "savings association") incorporated
and licensed under the laws of the United States. The Bank is a member of the
Federal Home Loan Bank ("FHLB") of San Francisco, which is a member bank of the
Federal Home Loan Bank System. The Bank's deposit accounts
are insured up to the $100,000 maximum amount currently allowable under federal
laws by the Savings Association Insurance Fund ("SAIF"), which is a separate
insurance fund administered by the Federal Deposit Insurance Corporation
("FDIC"). The Bank is subject to examination and regulation by the Office of
Thrift Supervision ("OTS") and the FDIC. Hawthorne Savings is further subject
to regulations of the Board of Governors of the Federal Reserve System ("FRB")
concerning reserves required to be maintained against deposits and certain other
matters.
Hawthorne Savings is principally engaged in the business of attracting
deposits from the general public and using those deposits, together with
borrowings and other funds, to originate residential and income property real
estate loans. The Bank's principal sources of revenue are interest earned on
mortgage loans and investment securities, and fees received in connection with
various deposit account services and miscellaneous loan processing activities.
The Bank's principal expenses are interest paid on deposit accounts and the
costs necessary to operate the Bank.
The operations of a savings institution are significantly influenced by
the real estate market, general economic conditions and the related monetary
and fiscal policies of the FRB and policies of financial institution
regulatory authorities, including the FRB, the OTS and the FDIC. Deposit
flows and costs of funds are influenced by the general interest rate
environment and rates of return on competing investments. Demand for
mortgage, construction and other types of loans is affected by market
interest rates for such financing, the volume of sales and supply of housing,
the availability of funds and the regulatory environment. The value of real
estate securing loans is also directly affected by real estate market and
general economic conditions, which may change materially over time.
The Bank's operating results depend primarily on (i) the margin
("spread")between the yield from its interest-earning assets, principally
loans and investment securities, and the cost of its interest-bearing
liabilities, principally deposits, (ii) the size and relative amounts of its
interest-earning assets and its interest-bearing liabilities, and (iii) the
quality of its assets.
At December 31, 1995, Hawthorne Savings met and exceeded all three
regulatory capital requirements, based upon rules currently in effect, with
core capital to total assets of 5.80%, core capital to risk-weighted assets
of 9.01%, and total capital to risk-weighted assets of 10.27%. Based on the
foregoing, the Bank exceeded the regulatory capital requirements to qualify
as a "well capitalized" institution.
2
<PAGE>
RECENT DEVELOPMENTS
The Company's principal lending area, Southern California, has been in the
midst of a severe economic recession since 1991 characterized by, among other
things, high unemployment, declining business and real estate activity,
declining real estate values and the absence of financing for certain multi-
family and commercial real estate. The effects of the prolonged recession have
negatively impacted the ability of certain borrowers of the Company, principally
developers and owners of apartment buildings, to perform under the original
terms of their obligations and eroded the value of the Company's real estate
collateral.
Prior to 1990, the Southern California economy experienced an extended
period of significant growth fueled principally by the real estate development,
aerospace and defense industries. The expanding economy, and a corresponding
influx of immigration, prompted, among other things, a demand for housing.
Historically, the Company originated loans to finance the construction of
residential properties, principally individual single family homes,
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 for the project. In addition, the
Company generally provided a permanent loan commitment following its financing
for the construction of apartment buildings and individual single family homes.
The vast majority of loans on which the Bank's borrowers defaulted during the
1990's were originated by the Bank during the period 1986-1990, during which
time the nominal value of real estate rose sharply.
By historically focusing a substantial portion of its lending activities on
construction financing, generally involving a small number of affiliated
developers with little or no financial resources of their own, the Bank was
affected more significantly than its peers when the real estate, aerospace and
defense industries underwent significant restructuring and real estate values
fell sharply, beginning in 1991. As a result, the Company experienced enormous
credit losses from its loan portfolio during the period 1992 through 1995.
For the four years ended December 31, 1995, the Company reported cumulative
net losses of $68.9 million, with annual losses of $22.1 million (1992), $29.6
million (1993), $3.0 million (1994) and $14.2 million (1995). These losses
included cumulative provisions for credit losses on loans and foreclosed
properties of $109.3 million, with annual provisions of $54.6 million (1992),
$29.4 million (1993), $5.3 million (1994) and $20.0 million (1995).
Beginning in 1992, the Company and the Bank came under intense scrutiny
from regulators as the deterioration in real estate values resulted in a
significant number of the Bank's borrowers defaulting on their loans. In
June of 1993, the Board of Directors of the Company and the Bank recruited
Scott A. Braly as President and Chief Executive Officer of both companies.
Mr. Braly recruited a number of experienced individuals to completely
restructure the Bank and to aggressively manage the Bank's growing portfolio
of foreclosed properties and troubled loans. During the period 1992 through
1995, the Bank foreclosed on $248 million of loan principal, invested
approximately $38 million following foreclosure, principally to complete
unfinished tract developments, and sold properties representing approximately
$207 million of this accumulated investment (before credit losses).
Approximately $54 million of foreclosed properties remained unsold at the end
of 1995. During this period, the Bank's credit losses from 1992 through 1995
on loans and properties exceeded $109 million, representing the sum of actual
losses realized from property sales and provisions to establish reserves for
unsold properties and loans.
During the first quarter of 1995, continuing credit losses required the
Company to substantially increase its specific and general valuation allowances,
which rendered it "under capitalized" according to the "prompt corrective
action" regulations issued by the OTS under the Federal Deposit Insurance
Corporation Improvement Act ("FDICIA"). In June 1995 the OTS issued a Prompt
Corrective Action Directive ("PCA") to the Bank, ordering the Bank to submit a
capital restoration plan to the OTS, which plan was approved in June 1995 and,
required the Bank to increase its qualifying Tier 1 capital by $15 million to
$20 million by December 15, 1995.
In early December 1995, the Company successfully completed the sale of $27
million of "investment units" in a private placement. The investment units
consist of equal amounts of senior notes and a new class of preferred stock,
together with warrants to purchase common stock of the Company. The Company
contributed $19 million of the net proceeds of the private placement as
qualifying Tier 1 capital into the Bank upon completion of
3
<PAGE>
the private placement. With the infusion of capital into the Bank, the OTS
terminated the PCA and released the Bank from its capital plan. SEE
CAPITALIZATION.
The Company continues to make progress in reducing its portfolios of
nonperforming assets, with the investment in nonperforming assets, net of all
credit losses, declining from $139 million and $153 million at December 31, 1992
and 1993, respectively, to $95 million and $56 million at December 31, 1994
and 1995, respectively. This substantial and continuing decline in
nonperforming assets, coupled with the Bank's successful reentry into selected
real estate financing markets, returned the Company to profitability during the
fourth quarter of 1995, during which the Company reported net earnings of $0.5
million. See NEW BUSINESS GENERATION and ITEM 7. MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
NEW BUSINESS GENERATION
GENERAL
The Company's lending and deposit gathering markets are among the most
competitive in the United States. The Company's Southern California markets are
populated by the largest savings institutions and units of many of the largest
banking and non-banking concerns in the United States, as well as by a large
number of smaller insured institutions.
Financial institutions experience intense competition in making real estate
loans and attracting deposits from the general public. The competition for
funds is principally among savings institutions, commercial banks, credit
unions, thrift and loan associations, corporate and government securities and
money market mutual funds. The principal basis of competition for funds is the
interest rate paid and, to a lesser extent, convenience of access and customer
service.
Competition in making real estate loans is principally among savings
institutions, commercial banks, mortgage companies, insurance companies,
government agencies and real estate investment trusts. These institutions
compete for loans primarily through the interest rates and loan fees they charge
and the efficiency, convenience and quality of services they provide to
borrowers and their real estate brokers.
Beginning in 1995, the Company's strategy has been to generate mortgage
financings which meet or exceed established targets for return on allocated
capital, and which build upon tightly-focused segments of the Southern
California real estate markets. With respect to the Company's deposit gathering
activities, the Company will continue to focus on growth opportunities in the
South Bay communities of Los Angeles County through internal expansion, or,
subject to requisite regulatory approvals, strategic acquisitions. During its
expansion years in the 1980's, the Company acquired retail banking offices in
several disparate markets, from Ventura to San Diego counties, most of which it
has subsequently sold or exchanged. At year end 1995, the Company operated nine
branch offices as compared to the twenty-one in existence at year end 1992.
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, therefore, 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
4
<PAGE>
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.
During 1995, the Company aggressively reentered the mortgage finance
business, specializing in providing financings secured by income properties,
very expensive homes and residential construction projects. During 1995, the
Company originated $197 million of permanent loans and construction commitments,
as summarized in the table below (dollars are in thousands).
TYPE OF SECURITY AMOUNT % OF TOTAL
- ------------------------------------- ---------- -----------
Apartment buildings and commercial properties $101,600 51.6% (1)
Single family homes
Estate 53,700 27.2% (2)
Conventional 9,400 4.8%
Construction (commitments) 32,300 16.4% (3)
---------- -----------
$197,000 100.0%
---------- -----------
---------- -----------
- -----------------------------
(1) Includes $15.8 million of financings provided in connection with sales
of previously foreclosed properties.
(2) Generally defined as individual loans with principal balances of more
than $500,000 originated after 1994. This amount includes unfunded
commitments under lines of credit of $5.2 million at December 31,
1995.
(3) This amount includes unfunded commitments of $14.9 million at December
31, 1995.
The Company seeks to acquire and to maintain customer deposit accounts by
offering competitively-priced certificates of deposit and, to a far lesser
extent, checking and similar transaction-oriented accounts. The Company
competes most directly for these accounts with other savings and loan companies,
most of whom are much larger. Generally, the Company does not consistently
compete with commercial banking companies for customer accounts.
Because the Company does not have a critical mass of retail banking
facilities, and because its smaller size does not afford it the economies of
scale to advertise its basic products to the extent of its principal
competitors, the Company generally competes on price and, to a lesser extent,
on service and convenience. Historically, these limitations have been
moderated by the loyalty afforded by, and the resistance to change of, the
Company's primary customer constituency, individuals over 55 years of age.
INCOME PROPERTY FINANCING
The Company provides financing to owners and purchasers of apartment
buildings and various types of non-residential properties, such as retail
centers, office buildings, and industrial buildings. The Company generates new
financing opportunities through contact with, and submissions to it by,
independent mortgage loan brokers. The Company is able to charge premium prices
for its financings because significant opportunities exist in the marketplace to
provide financing which requires tailored terms and conditions, efficient
response and execution, and specialized real estate expertise. These attributes
derive from the Company's smaller size and flat organizational structure, its
strategy to hold all new originations in portfolio, and the real estate
experience of most of its people.
5
<PAGE>
Beginning in 1995, the Company focused upon establishing a presence in the
income property financing business in Southern California by building
relationships with a growing broker network and through advertising in selected,
business-specific publications. During 1995, the Company provided financing
secured by a variety of income properties, with about two-thirds of the year's
dollar volume being secured by apartment buildings. Over 50% of the year's
dollar volume of financings were placed in situations where the borrower had
negotiated a discounted principal payoff with their current lender. The
remainder of the year's dollar volume supported the purchase of income
properties by new owners, generally from asset management firms. For all of
1995, the Company generated new permanent financings of approximately $86
million (excluding internal financings of property sales), with an average
transaction size of $1.8 million.
The financing of income properties is subject to the risk that the cash
flows being generated by the Company's collateral, as reported by the borrower,
will decline following the funding of the loan, either because of general
economic conditions or because the Company's borrower poorly manages the
property, which could cause the borrower to default on their loan (because the
cash flows from the property are no longer sufficient to cover the payments
required by the Company's loan). The Company mitigates this risk by (1)
requiring its borrowers to demonstrate their commitment to the property through
a substantial cash equity investment therein, (2) carefully evaluating the
historical and current operations of the property, (3) investigating the rental
markets within the areas surrounding its collateral, in order to validate the
revenue and expense assumptions which contribute to the Company's assessment of
the properties' current and potential cash flows, and (4) evaluating the
operating experience of the borrower with similar properties.
Virtually all of the Company's 1995 financings were adjustable-rate, with
most transactions being priced at a margin over the FHLB Eleventh District Cost
of Funds Index ("11th DCOFI"). A minority of adjustable-rate transactions,
principally loans secured by non-residential properties, utilized the Wall
Street Journal Prime Rate or the One-Year Constant Maturity Treasury Index. The
weighted average interest rate at origination of the Company's 1995 financings
was 9.50%. At December 31, 1995, the outstanding principal balance of 1995
originations had a weighted average interest rate of 9.26%.
ESTATE FINANCING
The Company provides a variety of financings secured by very expensive homes
in Southern California, including homes located in the communities of Bel-Air,
Beverly Hills, Malibu, Newport Beach, Santa Barbara and La Jolla. Generally,
the Company's loans refinance the borrower's existing mortgage debt, rather than
financing the borrower's purchase of a home. The Company generates virtually
all of its new financing opportunities of this type, which it refers to as
"Estate Financing", through contact with, and submissions by, independent
mortgage brokers.
The Company increasingly seeks financing opportunities with respect to
which the size of the financing request is in excess of $2.0 million, the
demonstrated ability of the borrower to service the Bank's loan is difficult to
reliably measure, or the borrower's credit profile is blemished. Because one or
more of these attributes may be present in any given transaction, the Company
places its primary reliance upon the value and qualitative characteristics of
the Company's collateral in determining the terms under which the Bank will
extend credit to the borrower. In this regard, the Company generally limits its
advances to a substantially lower percentage of the value of the Bank's
collateral than is customary in conventional single family lending. For 1995
financings, the weighted average loan-to-value ratio of the Company's financings
secured by expensive homes approximated 48%. Management believes that the
substantial equity cushion required for most of the Company's transactions
significantly reduces the risk that its borrowers will default subsequent to the
funding of the loan or, if such a default does occur and the Company forecloses
upon its collateral, that the Company will incur a loss when the property is
sold.
The Company has been able to charge premium prices for financings of this
type because most of its competitors place internal limits on the dollar amount
of individual financings (without reference to the underlying attributes of the
collateral and the borrower) and because most lenders in this market are
hesitant to extend credit to individuals whose capacity to service the loan
cannot be reliably measured or where the borrower's credit profile is marred.
As suggested above, the Company compensates for the existence of one or more of
these attributes by limiting the advance it will make against its estimate of
the value of the collateral. The Company has also been successful in attracting
business where the borrower requires flexibility in structuring the terms of the
loan, where efficient and timely execution are of paramount importance, or both.
As with all of its financing businesses, the
6
<PAGE>
Company's flat organization structure, small size and portfolio retention
strategies all contribute to its success in attracting new business and in
receiving a return believed by management to be commensurate with the risk
assumed and value added to completing the transaction.
For all of 1995, the Company generated $54 million in permanent financing
and line of credit commitments secured by expensive homes, with an average
transaction size of $1.9 million. Virtually all of the Company's 1995
financings were adjustable-rate, with most transactions being priced at a margin
over the 11th DCOFI. A minority of adjustable-rate transactions utilized the
Prime Rate. The weighted average interest rate at origination of the Company's
1995 financings was 10.16%. At December 31, 1995, the outstanding principal
balance of 1995 originations had a weighted average interest rate of 10.27%.
DEVELOPMENT FINANCING
The Company conducts two separate development financing businesses, each of
which is separately targeted and resourced.
The Tract Financing group commenced operation during the fourth quarter of
1995 and provides construction financing to small-to-medium-sized builders in
Southern California. In this business, the Company believes its competitive
advantage is focused upon its efficient response and execution and, more often
than not, a pre-existing relationship with the borrower or particular knowledge
of the specific submarket and/or product type. The Company solicits new
business directly with builders and, occasionally, through independent mortgage
brokers. Most financial institutions of the Company's size or larger now
provide development financing and, therefore, this business is quite
competitive.
The SFR Financing group provides individual home construction financing to
local builders and homeowners. To date, this group has focused almost
exclusively on providing construction financing in the beach cities of the South
Bay area of Los Angeles County, with occasional financing outside the Company's
principal market area. Virtually all of the Company's business to date has been
generated through pre-existing relationships between the Company's loan officers
and local builders.
Development financing presents the Company with the risk that the actual
cost of development will substantially exceed original estimates (because the
original estimates were flawed or because of post-funding approval issues by the
local municipality that has purview over the project), or that the price of the
finished homes will not meet pre-development expectations (because the original
assessment was flawed or because of changes in real estate values generally).
The Company compensates for these risks by (1) generally limiting its advance to
a percentage of expected development costs, requiring the borrower to fund the
difference, (2) carefully evaluating the line item costs to complete the
development, utilizing its resident loan officers and staff (or, where
appropriate, third parties), (3) carefully evaluating the product type to be
built and the demand for the finished homes by reference to recent sales of
comparable homes, and (4) the development experience of, and the success or
failure of, the Company's borrower with similar projects.
The Company very rarely leverages either of these businesses with the
Estate or conventional loan groups because the permanent loan sizes would fall
beneath targets for the Estate group and the Company seeks to limit its
conventional new financing volume within any development concentration. All of
the Company's development financing is priced off of the Prime Rate, which is
the long-established index of choice of builders.
CONVENTIONAL HOME FINANCING
In addition to its other, higher-yielding financing businesses, the Company
also provides conventional permanent financing secured by single family homes.
The Company conducts this business both from its local retail banking offices
and from its corporate offices. This business is the most competitive and least
profitable of all of the Company's financing businesses. The Company lacks the
size and scale of operations to profitably penetrate this business, especially
in view of the significant capacity already in the marketplace in the form of
very large banking and non-banking companies whose principal business is to
originate conforming single-family-secured loans, many for resale in secondary
mortgage markets. The Company is organized to provide a modest volume of this
business each year, generally concentrated in and around its local retail
banking offices. Management believes that its new loan volume, coupled with
numerous other initiatives which bring either financing or resources to bear
7
<PAGE>
in the Bank's local communities, are adequate to satisfy regulatory guidelines
for conventional lending by insured institutions.
FINANCING CRITERIA AND STANDARDS
PHILOSOPHY
As described in the preceding section, the Company provides financing in a
number of tightly-defined market segments, which are distinguished by property
type, borrower profile or loan size and transaction attributes. In all
instances, the Company extends credit in situations in which it expects to be
repaid from the liquidation of its collateral prior to the maturity of its loan,
or in which it reasonably expects that its loan can be refinanced with another
lender prior to the loan's maturity. The Company does not extend credit with
the expectation that the borrower will default on their obligation, resulting in
a restructuring of the loan or foreclosure of the Company's collateral. Because
of the types of credit extended by the Company, the terms of each loan are
individually tailored to satisfy the Company's credit standards and the
borrower's financing needs. This means that the Company's loans may contain
provisions, such as prepaid interest for the term of the loan or a line of
credit facility, that fall outside the normal scope of mortgage financing
offered by the Company's competitors. In all instances, the Company places its
primary reliance upon the quantitative and qualitative attributes of the
collateral which will secure the Company's loan. In situations in which the
borrower's ability to service the Bank's loan cannot be reliably measured, or
where the borrower's credit history is blemished, the Company adjusts downward
the advance it will make, to the extent it decides to extend credit at all.
LOAN OPERATIONS
The Company maintains a staff of highly qualified professionals to manage
the day-to-day affairs of the Bank's lending operation, including staff and fee
appraisers, processors, underwriters and loan officers. The Company also houses
an experienced staff of individuals that are responsible for servicing the
Bank's permanent and construction loans following their origination.
For each loan that it funds, the Company requires, among other things, a
completed loan application, supporting financial information from the borrower,
legal and corollary agreements which support the vesting of title, a title
insurance policy, fire and extended liability coverage casualty insurance,
credit reports, contemporary loan documents and other required documents.
Though the Company may require flood insurance pursuant to federal regulations
and state laws, the Company does not require earthquake insurance coverage. The
lack of earthquake insurance coverage derives from a combination of competitive
pressure (i.e., the Bank's competitors do not require such coverage as a
condition of extending credit), the cost of such coverage, if it is even
available, and management's assessment that its collateral base is sufficiently
diverse geographically as to substantially moderate the risk of a material,
adverse result should a major earthquake again hit a section of Southern
California. The collateral for the Bank's loan is appraised either by an
approved fee appraiser or by one of the Bank's staff appraisers. All fee
appraisals are reviewed by the Bank's Chief Appraiser.
LENDING CRITERIA
As described elsewhere herein, the Bank's financing businesses, except for
its conventional financing business, do not lend themselves to detailed
requirements concerning loan-to-value ratios, lien priority, pricing terms, and
the like. However, management has established criteria which assist it in
evaluating financing opportunities, as summarized below.
INCOME PROPERTY FINANCING
Management underwrites the proposed collateral which will secure income
property financings by reference to the established and current operations of
the property. In evaluating income-producing properties, management requires
that borrowers provide, at a minimum, current rent rolls, recent operating
statements and pro forma operating statements. As appropriate, the Company's
lending personnel adjust reported results to accommodate lease expirations (from
non-residential properties), tenant turnover, necessary capital improvements and
other relevant factors. Generally, the adjusted property cash flows are
expected to produce a debt coverage
8
<PAGE>
ratio ("DCR") of not less than 150% for non-residential properties and 130% for
apartment buildings, utilizing the fully-adjusted interest rate at funding to
measure pro forma debt service (i.e., the Bank does not offer "teaser" or
discount introductory interest rates). Utilizing current market capitalization
rates, the Bank's targeted DCR's generally produce loan-to-value ratios between
70% and 80%. As a matter of policy, the Bank will not advance more than 80% of
the value of its principal collateral. Where material capital improvements are
necessary to cure deferred maintenance on the property, the Bank may, and has,
held back the necessary funds from the initial funding of the loan, which
amounts are payable to the borrower only after the agreed-upon work has been
completed. As circumstances warrant, the Bank may include minimum thresholds
for maintenance of a DCR by the borrower and working capital reserves. The Bank
will provide financing for individual transactions in an amount up to, but not
in excess of, the Bank's legal lending limit for loans-to-one borrower, which
amount approximated $8.3 million at December 31, 1995. All of the Bank's loans
secured by income properties are approved by the senior manager of the business
group and by the Chief Executive Officer.
ESTATE FINANCING
Management determines the value of the proposed collateral by reference to
current appraisals and by detailed property inspections by the Bank's senior
management. As with its other principal financing businesses, the Bank tailors
the terms and pricing of its Estate financings on a transaction-by-transaction
basis. Accordingly, the Bank offers a variety of terms and conditions,
including fixed and adjustable-rate pricing, tied to various indices; payments
which are interest-only or payments which include the amortization of loan
principal; varying adjustment frequencies for adjustable-rate loans; varying
interest rate and payment floors and caps; and varying maturity and extension
options. As described elsewhere herein, the Bank provides advances to borrowers
which, on average, have produced a loan-to-value ratio of less than 50% for
financings completed to date. Though the Bank will, as a matter of policy,
advance up to 80% of the value of the Bank's collateral, very few of the Bank's
1995 financings involved advances for more than 70% of the value of the Bank's
collateral. The Bank will provide financing for individual transactions in an
amount up to, but not in excess of, the Bank's legal lending limit for
loans-to-one borrower. All of the Bank's loans secured by expensive homes are
approved by the senior manager of the business group and by the Chief Executive
Officer.
CONSTRUCTION FINANCING
For tract developments, management underwrites each proposed development by
reference to the borrower's quantified plan, including costs to and at
completion by line item, and sales and marketing projections, and by utilizing,
where appropriate, third party sources to validate the compatibility of the
proposed development and product to be built within the immediate marketplace.
The Bank also reviews the borrower's previous experience with construction
projects in general, and with the particular product type being proposed. The
Bank maintains an internal staff of professionals experienced in residential and
non-residential development in Southern California. In addition to underwriting
proposed developments, these individuals manage the Bank's post-origination
disbursement and inspection process, which is uniformly based upon validated
voucher submissions from builders. Generally, the Bank will advance between 75%
and 90% of the cost of the proposed development (land basis plus development
costs), with the borrower being required to provide the remaining funds.
Depending upon the particular transaction, this range of advance translates into
loan-to-value ratios of between 65% to 80%. The Bank will provide financing for
individual transactions in an amount up to, but not in excess of, the Bank's
legal lending limit for loans-to-one borrower. All of the Bank's loans secured
by tract and non-residential developments are approved by the senior manager of
the business group and by the Chief Executive Officer.
For individual home construction, management underwrites each proposed
transaction in a manner similar to that employed in the underwriting of tract
developments. Because the Bank has, to date, concentrated its individual home
construction activities within its immediate local market in the South Bay area
of Los Angeles County, management believes that it generally possesses the
market knowledge necessary to evaluate each proposal. Generally, these loans
have a term of 12 months and are priced at a margin over the prime rate.
Post-origination disbursements and inspections are managed in the same fashion
as for all of the Bank's tract financing activities. Because these transactions
solely involve the construction of individual homes, the Bank's
loans-to-one borrower limit is not a constraint. As with tract financing, the
Bank will provide between 75% to 90% of the construction funds, which translates
into loan-to-value ratios of between 65% to 80%.
9
<PAGE>
REGULATION
GENERAL
The following sections should be read in conjunction with MANAGEMENT'S
DISCUSSION and NOTES M, N, and O of the NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, which are incorporated herein by reference.
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 other permitted thrift
institution investments. At December 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 (see below) 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
10
<PAGE>
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 December 31, 1995. The FHLB of San Francisco serves as a reserve or
central bank for the member institutions within its assigned region, the
Eleventh 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.
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
Financial Institutions Reform,Recovery, and Enforcement Act of 1989 ("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, base 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-insuredinstitutions 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. If the 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.
11
<PAGE>
Also included in the budget reconciliation bill were provisions that would
eliminate the deduction for additions total 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.
Management cannot predict whether or in what form the above described
legislation 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.
LIQUIDITY
Federal regulations currently require a savings institution to maintain a
monthly average daily balance of liquid assets (including cash, certain time
deposits, bankers' acceptances and specified United States Government, state or
federal agency obligations) equal to at least 5.00% of the average daily balance
of its net withdrawable accounts and short-term borrowings during the preceding
calendar month. This liquidity requirement may be changed from time to time by
the OTS to any amount within the range of 4.00% to 10.00% of such accounts and
borrowings depending upon economic conditions and the deposit flows of
member institutions. Federal regulations also require each member institution
to maintain a monthly average daily balance of short-term liquid assets
(generally those having maturities of 12 months or less) equal to at least 1.00%
of the average daily balance of its net withdrawable accounts and short-term
borrowings during the preceding calendar month. Monetary penalties may be
imposed for failure to meet these liquidity ratio requirements. The Bank's
liquidity and short-term liquidity ratio's for the calculation period ended
December 31, 1995, were 8.50% and 5.95%, respectively, which exceed the
applicable requirements.
COMMUNITY REINVESTMENT ACT
The Community Reinvestment Act ("CRA") requires each savings institution,
as well as commercial banks and certain other lenders, to identify the
communities served by the institution and to identify the types of credit the
institution is prepared to extend within those communities. The CRA also
requires the OTS to assess an institution's performance in meeting the credit
needs of its delineated communities, as part of its examination of the
institution, and to take such assessments into consideration in reviewing
applications with respect to branches, mergers and other business combinations,
and savings and loan holding company acquisitions. An unsatisfactory CRA rating
may be the basis for denying such an application and community groups have
successfully protested applications on CRA grounds. The OTS assigns CRA ratings
of "outstanding", "satisfactory", "needs to improve" or "substantial
noncompliance". The Bank was rated "needs to improve" in its most recent CRA
examination report received in March 1995 based on the Company's decision to
cease active lending from September 1993 through July 1994.
REGULATORY CAPITAL REQUIREMENTS
FIRREA and the capital regulations of the OTS promulgated thereunder
("Capital Regulations") established three capital requirements, including a
"core capital requirement" (referred to as the "leverage limit" in the Capital
Regulations), a "tangible capital requirement" and a "risk-based capital
requirement".
Under the core capital requirement currently included in the Capital
Regulations, a savings institution must maintain "core capital" of not less than
3.0% of adjusted total assets. Under the "prompt corrective action"
12
<PAGE>
regulations (summarized below), however, an institution is generally required to
maintain "core capital" at significantly higher levels in order to be considered
to have adequate capital for regulatory purposes.
"Core Capital" generally includes common stockholders' equity,
noncumulative perpetual preferred stock, including any related surplus, and
minority interests in the equity accounts of fully consolidated subsidiaries.
The amount of an institution's core capital is, in general, calculated in
accordance with generally accepted accounting principles ("GAAP"), but with
certain exceptions. Among other exceptions, adjustments to an institution's
GAAP equity accounts that are required pursuant to FASB 115 to reflect changes
in market value of certain securities held by the institution that are
categorized as "available-for-sale" are not to be included in the calculation of
core capital for regulatory capital purposes. Intangible assets (not including
purchased mortgage servicing rights, certain mortgage servicing rights with
respect to originated loans and purchased credit card relationships) must be
deducted from core capital. With certain exceptions, equity investments,
including equity investments in real estate, and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio, must
also be deducted from capital. Core capital may include purchased mortgage
servicing rights, certain mortgage servicing rights with respect to originated
loans and purchased credit card relationships, subject to certain limitations.
The tangible capital regulations requires a savings institution to maintain
"tangible capital" in an amount not less than 1.5% of adjusted total assets.
"Tangible capital" means core capital less any intangible assets (including
supervisory goodwill), plus purchased mortgage servicing rights, and certain
mortgage servicing rights with respect to originated loans, subject to certain
limitations.
The risk-based capital requirements provide, among other things, that the
capital ratios applicable to various classes of assets are to be adjusted to
reflect the degree of credit risk deemed to be associated with such assets,
ranging from 0% for low-risk assets such as U. S. Treasury securities and GNMA
securities to 100% for various types of loans and other assets deemed to be
higher risk. Single family mortgage loans having loan-to-value ratios not
exceeding 80% and meeting certain additional criteria, as well as certain
multi-family residential property loans, qualify for a 50% risk-weighted
treatment. In addition, the asset base for computing a savings institution's
risk-based capital requirement includes off-balance sheet items, including
letters of credit, and loans or other assets sold with subordination or recourse
arrangements. Generally, the Capital Regulations require savings institutions
to maintain "total capital" equal to 8.0% of risk-weighted assets. "Total
capital" for these purposes consists of core capital and supplementary capital.
Supplementary capital includes, among other things, certain types of preferred
stock and subordinated debt and, subject to certain limitations, loans and lease
general valuation allowances. Such general valuation allowances can generally
be included up to 1.25% of risk-weighted assets. At December 31, 1995, $6.1
million of the Bank's general valuation allowance was included in supplementary
capital. A savings institution's supplementary capital may be used to satisfy
the risk-based capital requirements only to the extent of that institution's
core capital.
The OTS has adopted an amendment to its Capital Regulations that, upon
implementation, will require OTS regulated institutions to maintain additional
risk-based capital equal to half of the amount of a decline in its "net
portfolio equity" resulting from a hypothetical 200 basis point change (up or
down depending on which would result in the greater reduction in net portfolio
value) in interest rates on its assets and liabilities exceeding 2% of the
institution's estimated "economic value" of its assets. In order to preserve
the PCA capital category system (described below), the regulation requires that
the foregoing amount be subtracted from actual capital rather than requiring
that an institution's normal capital requirements be increased by that amount.
The OTS stated that implementation of this amendment to its regulations will
require additional capital to be maintained only by institutions having "above
normal" interest rate risk. An institution's "net portfolio value" is defined
for this purpose as the difference between the aggregate expected future cash
inflows from an institution's assets and the aggregate expected future cash
outflows on its liabilities, plus the net expected cash inflow from existing
off-balance sheet contracts, each discounted to present value. The estimated
"economic value" of an institution's assets is defined as the discounted present
value of the estimated future cash flows from its assets.
The OTS has deferred implementation of its above described interest rate
risk regulation. Had the OTS regulation been in effect at December 31, 1995,
the Bank would not have been required to deduct from risk-based capital an
interest rate risk exposure component.
The risk-based capital rules of the OTS, FDIC and other federal banking
agencies provide that an institution must hold capital in excess of regulatory
minimums to the extent that examiners find either (1) significant
13
<PAGE>
exposure to concentration of credit risk such as risks from higher interest
rates, prepayments, significant off-balance sheet items (especially standby
letters of credit) or credit, or risks arising from nontraditional activities or
(2) that the institution is not adequately managing these risks. For this
purpose, however, the agencies have stated that, in view of the statutory
requirements relating to permitted lending and investment activities of
savings institutions, the general concentration by such institutions in real
estate lending activities would not, by itself, be deemed to constitute an
exposure to concentration of credit risk that would require greater capital
levels.
The following table summarizes the regulatory capital requirements under FIRREA
for the Bank at December 31, 1995. 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>
Stockholders' equity (1) $ 43,539 $ 43,539 $ 43,539
Adjustments
General valuation
allowances 6,088
Core deposit intangibles (179) (179) (179)
Interest rate risk component (2)
------------ ------------ ------------ ------------ ------------ ------------
Regulatory capital 43,360 5.80% 43,360 5.80% 49,448 10.27%
Required minimum 11,213 1.50% 22,425 3.00% 38,508 8.00%
------------ ------------ ------------ ------------ ------------ ------------
Excess capital $ 32,147 4.30% $ 20,935 2.80% $ 10,940 2.27%
------------ ------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------ ------------
Adjusted assets (3) $ 747,510 $ 747,510 $ 481,347
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
- ------------------------
(1) The Bank's total stockholders' equity, exclusive of the
unrealized loss of $5,000 on available-for-sale securities, was
5.82% of its total assets at December 31, 1995. During 1995,
theCompany contributed cash of $20 million to the Bank to
improvethe capital position of the Bank, including $19 million in
December 1995, after successful completion of the
private placement, to satisfy the requirements of the PCA. See
CAPITALIZATION.
(2) At December 31, 1995, the OTS had deferred implementation of
its interest rate risk regulation. Had the regulation been in
effect at December 31, 1995, the Bank would not have been
required to deduct any amount from risk-based capital pursuant to
the interest rate risk exposure component as computed by the OTS
(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
September 30, 1995.
(3) The term "adjusted assets" refers to the term "adjusted total
assets" as defined in 12 C.F.R. Section 567.1 (a) for purposes
of tangible and core capital requirements, and for purposes of
risk-based capital requirements, refers to the term
"risk-weighted assets" as defined in 12 C.F.R. Section 567.1
(b).
14
<PAGE>
Under the FDICIA, which supplemented FIRREA, the OTS, the FDIC and the
other federal bank regulatory agencies have issued "prompt corrective action"
regulations with specific capital ranking tiers for thrift institutions and
commercial banks. Progressively more stringent operational limitations and
other corrective actions are required as an institution declines in the capital
ranking tiers. The five qualifying tiers are set forth below.
<TABLE>
<CAPTION>
Ratio of Ratio of
Ratio of Core Capital Total Capital to
Core Capital to Risk-weighted 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 assets of
2% or less
</TABLE>
The Bank's ratios at December 31, 1995 are set forth below.
Ratio of Core Capital to Total Assets (Leverage ratio) 5.80%
Ratio of Core Capital to Risk-weighted Assets 9.01%
Ratio of Total Capital to Risk-weighted Assets 10.27%
Based upon the foregoing, the Bank exceeded the requirements to qualify as
a "well capitalized" institution.
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, for supervisory
concerns.
Under the prompt corrective action regulation provisions, an institution
that is deemed to be undercapitalized must submit a capital restoration plan and
is subject to mandatory restrictions on capital distributions (including cash
dividends) and management fees, increased supervisory monitoring by the OTS,
growth restrictions, restrictions on certain expansion proposals and capital
restoration plan submission requirements. If an institution is deemed to be
significantly undercapitalized, all of the forgoing mandatory restrictions
apply, as well as a restriction on compensation paid to senior executive
officers. Furthermore, the OTS must take one or more of the following actions:
(i) require the institution to sell shares (including voting shares) or
obligations; (ii) require the institution to be acquired or merge (if one or
more grounds for the appointment of a conservator or receiver exists); (iii)
implement various restrictions on transactions with affiliates; (iv) restrict
interest rates on deposits; (v) impose further asset growth restrictions or
asset reductions; (vi) require the institution or subsidiary to alter, reduce,
or terminate activities considered risky; (vii) order a new election of
directors; (viii) dismiss directors and/or officers who have held office more
than 180 days before the institution became undercapitalized; (ix) require the
hiring of qualified executives; (x) prohibit correspondent bank deposits; (xi)
require the institution to divest or liquidate a subsidiary in danger of
insolvency or a controlling company to divest any affiliate that poses a
significant risk, or is likely to cause a significant dissipation of assets or
earnings; (xii) require a controlling company to divest the institution if it
improves the institution's financial prospects; or (xiii) require any other
action the OTS determines fulfills the purposes of the PCA provisions.
The OTS may also impose on significantly undercapitalized institutions one
or more of the mandatory restrictions applicable to critically undercapitalized
institutions. The restrictions require prior regulatory approval for any
material transaction, to extend credit on a highly leveraged transaction, to
adopt charter or bylaws amendments, to make material accounting changes, to
engage in covered transactions with affiliates, to pay excessive compensation,
or to pay higher interest on new or renewing liabilities. A critically
undercapitalized institution may not, beginning 60 days after becoming
critically undercapitalized, make any principal or interest payments on
subordinated debt not outstanding on July 15, 1991. The OTS is required, not
later than 90 days after a savings institution becomes critically
undercapitalized to either (i) appoint a conservator or receiver or (ii) take
such other actions it determines would better achieve the purpose of the PCA
provisions. In any event, the OTS is
15
<PAGE>
required to appoint a receiver within 270 days after the institution becomes
critically undercapitalized unless (i) with the concurrence of the FDIC, the OTS
determines the institution has a positive net worth, has been in substantial
compliance with an approved capital restoration plan, is profitable or has an
upward trend in earnings which the OTS finds is substantial, and is reducing the
ratio of nonperforming loans to total loans and (ii) the Director of the OTS and
the Chairman of the FDIC both certify that the institution is viable and not
expected to fail. At December 31, 1995, the Bank's regulatory capital was in
excess of the amount necessary to be "well capitalized".
SAVINGS AND LOAN HOLDING COMPANY REGULATIONS
As a saving and loan holding company, the Company is subject to certain
restrictions with respect to its activities and investments. Among other
things, the Company is generally prohibited, either directly or indirectly, from
acquiring more than 5% of the voting shares of any savings association or
savings and loan holding company which is not a subsidiary of the Company.
Similarly, OTS approval must be obtained prior to any person acquiring
control of the Company or the Bank. Control is conclusively presumed to exist
if, among other things, a person acquires more than 25% of any class of voting
stock in the institution or holding company or controls in any manner the
election of a majority of the directors of the insured institution or the
holding company.
RESTRICTION ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS
OTS regulations impose limitations on "capital distributions" by savings
association subsidiaries of holding companies, including cash dividends,
payments to repurchase or otherwise acquire an institution's shares, payments to
stockholders in a "cash-out" merger and other distributions charged against
capital. An institution that exceeds its minimum capital requirements is
permitted to make capital distributions in specified amounts based on its
regulatory capital levels without prior OTS approval unless it is deemed to be
"in need of more than normal supervision", in which case OTS approval of the
distribution may be required. The OTS retains the authority to prohibit any
capital distribution otherwise authorized under the regulation if the OTS
determines that the capital distribution would constitute an unsafe or unsound
practice. The regulation also states that the capital distribution limitations
apply to direct and indirect distributions to affiliates, including those
occurring in connection with corporation reorganizations.
Savings association subsidiaries of holding companies generally are
required to provide advance notice of any proposed dividend on the association's
stock. Any dividend declared within the notice period, or without giving the
prescribed notice, is invalid.
A savings association that meets its fully phased-in capital requirements
may make capital distributions during a calendar year of up to the greater of
(i) 200% of its net income during the calendar year, plus the amount that would
reduce by not more than one-half its "surplus capital ratio" at the beginning of
the calendar year (the amount by which the institution's actual capital exceeded
its fully phased-in capital requirements at that date) or (ii) 75% of its net
income over the most recent four-quarter period. An association that meets its
current minimum capital requirements but not its fully phased-in capital
requirements may make capital distributions up to 75% of its net income over the
most recent four-quarter period, as reduced by the amounts of any capital
distributions previously made during such period. An association that does not
meet its minimum regulatory capital requirements immediately prior to or on a
pro forma basis after giving effect to a proposed capital distribution is not
authorized to make any capital distributions unless it received prior written
approval from the OTS or the distributions are in accordance with the express
terms of an approved capital plan.
The OTS has proposed an amendment to its capital distribution regulation to
conform to its PCA regulations by replacing the current "tiered" approach
summarized above with one that would allow institutions to make capital
distributions that would not result in the association falling below the PCA
"adequately capitalized" capital category. Under this proposal, a savings
association would be able to make capital distributions (1) without notice or
application, if the association is not held by a savings and loan holding
company and received a composite CAMEL rating of 1 or 2, (2) by providing notice
to the OTS if, after the capital distribution, the association would remain at
least "adequately capitalized", or (3) by submitting an application to the OTS.
16
<PAGE>
As of December 31, 1995, the Bank was prohibited by the OTS from paying
dividends to the Company without OTS prior approval.
LOANS TO ONE BORROWER LIMITATION
With certain limited exceptions, the maximum amount that a savings
institution may lend to one borrower (including certain entities related to such
borrower) is an amount equal to 15% of the institution's unimpaired capital and
unimpaired surplus, plus an additional 10% for loans fully secured by readily
marketable collateral. Real estate is not included within the definition of
readily marketable collateral for this purpose. Under prior law (changed in
1988), a savings institution could generally lend an amount equal to its federal
regulatory capital to one borrower. The OTS recently amended its lending limit
regulations to define the term "unimpaired capital and unimpaired surplus" based
upon an institution's regulatory capital and also to include in the basic 15% of
capital lending limit, that portion of an institution's allowances for loan and
lease losses that is not includable in regulatory capital as calculated for
other regulatory purposes. OTS regulations provide that certain credit
extensions may be excepted from the described loans to one borrower limitations
including credit extensions that result from restructurings effected in
connection with an institutions efforts to salvage existing problem credit
extensions. Pursuant to the current regulation, the maximum amount which the
Company could have loaned to any one borrower (and related entities) under the
general OTS loans to one borrower limit was $8.3 million as of December 31,
1995.
OTHER LENDING STANDARDS
The OTS and the other federal banking agencies have jointly adopted uniform
rules on real estate lending and related Interagency Guidelines for Real Estate
Lending Policies. The uniform rules require that institutions adopt and
maintain comprehensive written policies for real estate lending. The policy
must reflect consideration of the Interagency Guidelines and must address
relevant lending procedures, such as loan-to-value limitations, loan
administration procedures, portfolio diversification standards and
documentation, approval and reporting requirements. Although the final rule did
not impose specific maximum loan-to-value ratios, the related Interagency
Guidelines state that such ratio limits established by individual institutions
board of directors should not exceed levels set forth in the Guidelines, which
range from a maximum of 65% for loans secured by raw land to 85% for improved
property. No limit is set for single family residence loans, but the Guidelines
state that such loans exceeding a 95% loan-to-value ratio should have private
mortgage insurance or some other form of credit enhancement. The Guidelines
further permit a limited amount of loans that do not conform to these criteria.
TAXATION
FEDERAL
Under applicable provisions of the Internal Revenue Code of 1986, as
amended ("Code"), a savings institution that meets certain definitional tests
relating to the composition of its assets and the sources of its income (a
"qualifying savings institution") is permitted to establish reserves for bad
debts. A qualifying savings institution may make annual additions thereto under
a method based on the institution's loss experience ("Experience Method").
Alternatively, a qualifying savings institution may elect, on an annual basis,
to use the percentage of taxable income method ("Percentage Method") to compute
its allowable addition to its bad debt reserve on qualifying real property loans
(generally, loans secured by an interest in improved real estate). The
Percentage Method permits the institution to deduct a specified percentage
(currently 8%) of its taxable income before such deduction, regardless of the
institution's actual bad debt experience. For periods 1992, 1993, and 1994,
however, the Company has utilized the Experience Method because that method
produced a greater deduction than did the Percentage Method. The Company
anticipates that it will use the Experience Method for its 1995 taxable year as
well.
A savings institution organized in stock form whose accumulated reserves
for losses on qualifying real property loans exceeds the allowable bad debt
reserves as calculated under the Experience Method may be subject to recapture
taxes if it makes certain types of distributions to its stockholders. While
dividends may be paid without the imposition of any tax on the savings
institution to the extent that the amounts paid do not exceed the savings
institution's current or accumulated earnings and profits as
17
<PAGE>
calculated for federal income tax purposes, stock redemptions, dividends paid in
excess of the savings institution's current or accumulated earnings and profits
as calculated for tax purposes, and other distributions made with respect to the
savings institution's stock, however, are deemed under applicable sections of
the Code to be made from the savings institution's tax bad debt reserves to the
extent that such reserves exceed the amount that could have been accumulated
under the Experience Method. The amount of tax on this excess that would be
payable upon any distribution that is treated as having been paid from the
savings institution's tax bad debt reserves is also deemed to have been paid
from those reserves. As a result, distributions to stockholders that are treated
as having been made from the savings institution's bad debt reserves could
result in a federal tax liability of up to approximately 51% of the amount of
any distributions, unless offset by net operating losses.
Corporations, including qualifying savings institutions, are subject to an
alternative minimum tax in addition to the regular corporate income tax. This
20% tax is computed based on the Company's taxable income (with certain
adjustments), as increased by its tax preference items and applies only if this
tax is larger than its regular tax. The adjustments include an addition to
taxable income of an amount equal to 75% of the excess of the Company's
"adjusted current earnings" over its regular taxable income. The tax preference
items common to savings institutions include the excess, if any, of its annual
tax bad debt deduction over the deduction that would have been available under
the experience method. The Company did not incur a minimum tax liability in
1995 (as computed for federal income tax purposes).
The IRS has completed its audit of the Company's federal tax returns for
1993 and related carry back claims. For additional information regarding
taxation, see NOTE K of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
STATE
The California franchise tax applicable to the Company is a variable-rate
tax. This rate is computed under a formula that results in a rate higher than
the rate applicable to nonfinancial corporations because it includes an amount
"in lieu" of local personal property and business license taxes paid by such
corporations (but not paid by banks or financial institutions such as the Bank).
For the taxable year 1995, the maximum rate was set at approximately 11.30%.
Under California regulations, financial corporations are permitted to claim bad
debt deductions using a reserve method, with the reserve level being determined
by past experience or current facts and circumstances.
The Company's state tax returns have been audited by the Franchise Tax
Board ("FTB") through 1992. The FTB completed its audit of the Company's 1992
state tax return during 1995 from which the Company received a tax refund of
$2.6 million in the third quarter of 1995.
18
<PAGE>
ITEM 2. PROPERTIES.
The Bank owned the land and improvements at five of its branch offices,
owned the improvements but leased the land for two of its branch offices and
leased both the land and the improvements at its remaining two branch offices as
of December 31, 1995.
Management consolidated all non-branch personnel into a leased premise
during 1994. Following the consolidation, the Company sold its two former
corporate facilities in 1994. In anticipation of their disposal, reserves of
$1.5 million were established at December 31, 1993 to reduce the Company's
carrying values for the two buildings to their fair market values.
The Bank holds the lease obligation on a discontinued branch at the Laguna
Hills location until July 30, 2001. A lease obligation reserve of $0.5 million
was established with respect to this lease in September 1994.
In February 1996, the Bank closed escrow on the sale of its Oceanside
facility (land and building) for $2.9 million. In December 1995, a valuation
allowance of $0.8 million had been established to reduce the Company's carrying
value for this facility to its fair market value.
At December 31, 1995, the Bank had aggregate net book values for office
real property and improvements owned, leasehold interests, and furniture,
fixtures and equipment of $5.0 million, $1.7 million and $2.9 million,
respectively. See NOTE H of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
The Company believes that all of the above facilities are in good condition and
are adequate for the Bank's present operations.
The principal terms and the net book values of leasehold improvements
relating to premises leased by the Bank are detailed below. None of the leases
contain any unusual terms and all are "net" or "triple net" leases.
<TABLE>
<CAPTION>
Expiration Renewal Monthly Square Book Value
Facility of Term Options Rental Feet of Leaseholds
- -------- ---------- -------- ---------- ------ ---------------
<S> <C> <C> <C> <C> <C>
El Segundo Corporate 11/30/00 One 5-Yr $ 40,092 42,202 $ 1,251,034
Torrance Branch 02/31/01 One 5-yr 16,529 7,343 253,400
Laguna Hills 07/30/01 Four 5-yr 14,477 4,125
Westlake Branch 03/31/00 None 11,828 7,600 35,871
Manhattan Beach Branch 10/31/10 Four 5-yr 4,590 4,590 58,040
Tarzana Branch 01/31/00 Five 5-yr 3,283 3,352 115,505
--------- ------------
$ 90,799 $ 1,713,850
--------- -------------
--------- -------------
</TABLE>
19
<PAGE>
ITEM 3. 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 ("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 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. The Company is vigorously
defending the case and believes the allegations to be wholly without merit.
Messrs. Glick and Gurney are stockbrokers who nominated themselves for election
to the Board of the Company at the 1995 Annual Meeting of Stockholders. Neither
person received sufficient votes to be elected as directors.
The Company is involved in a variety of litigation matters which, for the
most part, arise out of residential developments in which the Company provided
construction financing pre-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.
20
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of stockholders during the last quarter
of 1995.
ITEM 4A. EXECUTIVE OFFICERS.
The executive officers of the Company are as follows:
NAME AGE POSITION WITH THE COMPANY AND PRIOR BUSINESS EXPERIENCE
- ------------- --- -------------------------------------------------------
Scott A. Braly 42 President and Chief Executive Officer of Hawthorne
Financial and Hawthorne Savings since July 1993.
Director of Citadel Holding Corporation and
Fidelity Federal Bank from April 1992 to July
1993. President and Chief Executive Officer of
Valley Federal Savings and Loan Association from
April 1990 to April 1992. Chief Financial Officer
of Valley Federal Savings and Loan Association
from June 1989 to November 1990. Chief Financial
Officer of Bel-Air Savings from May 1985 to May
1989.
Norman A. Morales 35 Executive Vice President and Chief Financial
Officer of Hawthorne Financial and Hawthorne
Savings since February 1995. Executive Vice
President and Chief Financial Officer of SC
Bancorp and Southern California Bank from July
1987 to January 1995.
James A. Sage 57 Senior Vice President, Corporate Secretary and
General Counsel of Hawthorne Financial and
Hawthorne Savings since August 1993. Special
Litigation Consultant to Great Western Bank from
1991 to November 1993. General Counsel of Great
Western Bank from 1982 to 1991.
The above officers serve at the discretion of the Board of
Directors.
21
<PAGE>
P A R T II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
(a) MARKET PRICES OF STOCK
The common stock, par value $0.01 per share, of the Company is
traded on the National Association of Securities Dealers Automated Quotation
System-National Market System ("NASDAQ"). The following table sets forth the
high and low sales prices as reported by the NASDAQ for the common stock of the
Company for the periods indicated.
1995 HIGH LOW
- -------------- ----- --------
First quarter 5 1/2 4
Second quarter 5 1/4 2 1/4
Third quarter 3 3/4 2 1/4
Fourth quarter 5 3/4 3 3/4
1994 HIGH LOW
- -------------- ------- ------
First quarter 10 1/2 5 1/4
Second quarter 6 1/2 4
Third quarter 8 1/4 5 1/4
Fourth quarter 7 1/2 4 3/4
1993 HIGH LOW
- -------------- ------ ------
First quarter 25 1/2 14 1/2
Second quarter 18 13 3/4
Third quarter 19 1/2 13 1/2
Fourth quarter 19 8
(b) STOCKHOLDERS
At the close of business on February 29, 1996, the Company had 2,599,275
shares of common stock outstanding and had 547 stockholders of record.
22
<PAGE>
(c) PER SHARE CASH DIVIDENDS DATA
The following table sets forth the dividends per share that the Company
declared during the past three years and paid on the dates indicated. The
Company has suspended indefinitely the payment of dividends on its common stock,
effective the third quarter 1993. This action was taken in response to the
current restriction on the Bank to pay dividends to the Company. The Bank,
which is the sole source of funds with which to pay dividends to stockholders,
is currently prohibited by the OTS from paying dividends because of its
designation by the OTS as a "troubled institution" without prior regulatory
approval. The Bank's current designation is based upon its high ratio of
nonperforming assets, among other factors.
DIVIDENDS PER SHARE
-------------------
DATE 1995 1994 1993
- ---- --------- -------- -------
February 1 $ .00 $ .00 $ .25
May 1 $ .00 $ .00 $ .125
August 1 $ .00 $ .00 $ .125
November 1 $ .00 $ .00 $ .00
See NOTE O of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS and
REGULATIONS - SAVINGS AND LOAN HOLDING COMPANY REGULATIONS, with respect to
restrictions on dividend payments.
23
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data presented on the following pages for, and as of
the end of, each of the years in the five-year period ended December 31, 1995
are derived from the consolidated financial statements of the Company which have
been audited by Deloitte & Touche LLP, independent certified public accountants.
The consolidated financial statements as of December 31, 1995 and 1994 and for
the three years in the period ended December 31, 1995 and the report thereon of
Deloitte & Touche LLP are included elsewhere herein (dollars are in thousands,
except per share amounts).
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
1995 1994 1993 1992 1991
BALANCE SHEET DATA
--------- --------- ---------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Total assets $ 753,583 $ 743,793 $ 881,641 $ 991,308 $ 1,037,271
Cash and investments 76,808 61,979 108,899 140,216 118,632
Mortgage-backed securities 57,395 28,891 5,397 6,363
Loans receivable, net 617,328 537,020 623,450 765,420 847,169
Real estate owned, net 37,905 62,613 72,234 29,922 28,532
Deposits 698,008 649,382 829,809 909,657 897,963
Other borrowings 47,141 25,000
Stockholders' equity 38,966 40,827 43,949 72,616 97,342
OPERATING DATA
Net interest margin 16,508 19,128 22,106 32,819 38,466
Provision for estimated loan losses (14,895) (10,964) (21,867) (51,242) (13,757)
Non-interest revenues 1,718 1,973 3,295 3,631 2,398
Non-interest expenses (19,189) (20,187) (21,162) (18,578) (17,191)
Real estate operations, net (1,586) (1,291) (26,684) (12,828) (2,307)
Net gain (loss) from disposition
of deposits and premises (117) 2,835 (4,066)
Net earnings (loss) (14,217) (2,963) (29,610) (22,144) 8,546
Net earnings (loss) per share (5.52) (1.14) (11.39) (8.52) 3.29
YIELDS AND COSTS
At end of period (1)
Interest-earning assets 7.90% 6.97% 7.03% 7.88% 9.73%
Interest-bearing liabilities 5.17% 4.40% 3.75% 4.33% 5.91%
For the period (2)
Interest-earning assets 7.88% 6.65% 6.51% 8.89% 10.91%
Interest-bearing liabilities 5.00% 3.91% 4.12% 4.99% 7.03%
CAPITAL RATIOS
Tangible 5.80% 5.15% 4.61% 6.55% 8.51%
Core 5.80% 5.18% 4.61% 6.55% 8.51%
Risk-based 10.27% 9.36% 8.18% 10.10% 13.28%
ASSET QUALITY DATA (3)
Nonperforming assets, net ("NPAs") 55,751 94,542 152,691 139,428 132,311
NPAs to total assets 7.40% 12.71% 17.32% 14.07% 12.76%
NPAs to net loans and properties 8.51% 15.70% 22.00% 10.10% 6.40%
RATIOS
Return on average assets (1.96)% (0.36)% (3.09)% (2.15)% 0.79%
Return on average stockholders' equity (47.57)% (6.99)% (50.80)% (24.24)% 8.66%
Average stockholders' equity
to average assets 4.11 % 5.12 % 6.08 % 8.87 % 9.14%
Dividend payout ratio (4) N/A N/A N/A N/A 30.40%
</TABLE>
_______________________
(1) Contractual, exclusive of deferred fees.
(2) Effective, inclusive of deferred fees.
(3) NPAs include loans delinquent one or more payments, performing loans
placed on nonaccrual status (collectively, "nonaccrual loans") and
properties acquired through foreclosure, net of applicable writedowns
and reserves.
(4) Cash dividends of $0.50, $1.00 and $1.00 per share were paid in 1993,
1992 and 1991, respectively.
24
<PAGE>
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
OPERATING RESULTS
OVERVIEW
The Company reported a net loss of $14.2 million for 1995, or $5.52 per
share, compared with a net loss of $3.0 million, or $1.14 per share, in 1994.
The Company reported a net loss of $29.6 million, or $11.39 per share, for 1993,
which marked the Company's first year operating under new management. The net
losses for each of these three years were the result of provisions to increase
loan and property loss reserves, including provisions of $20.0 million in 1995,
$5.3 million in 1994, and $29.4 million in 1993. With the recapitalization of
the Company in December 1995, and the Company's concurrent contribution of $19
million in qualifying Tier 1 capital into the Bank, the Bank had core and risk-
based capital ratios of 5.80% and 10.27%, respectively, at December 31, 1995.
The Company's core operating results (defined for this purpose as pretax
results exclusive of loan loss provisions and net revenues or costs generated
from real estate operations, securities sales and dispositions of facilities)
declined in 1995 as compared with the previous two years. For 1995, the Company
had a core operating loss of $1.0 million, as compared with core earnings of
$0.9 million in 1994 and $4.2 million in 1993. These results reflect (1) a
decline of about 30% in the size of the Company's balance sheet since 1992, and
a related decline in the average balance of interest-earning assets for each of
the three years ended December 31, 1995, accomplished in order to maximize the
Bank's capital ratios during the period of significant credit losses, (2) a much
smaller decline in non-interest expenses, attributable to the Company's need to
substantially bolster its senior and middle management and to establish the
resources necessary to manage the Company's portfolio of troubled assets, (3)
the generally low yields associated with the Bank's pre-1994 loan portfolio, a
majority of which is priced at margins of less than 2.50% over the 11th DCOFI,
and (4) the magnitude of the Bank's non-earning assets relative to the Bank's
total assets. Notwithstanding the full-year results for 1995, the Company's
core operating results improved during the latter half of the year, principally
because the volume and yields associated with the Bank's new financing
activities began to produce margins well in excess of those contributed by the
Bank's pre-1994 assets, and because of the continuing decline in the Bank's
nonperforming assets.
During the three-year period ended December 31, 1995, the Bank's
nonperforming assets declined markedly, to $56 million (7.4% of total assets) at
year-end 1995, as compared with $95 million (12.7% of total assets) and $153
million (17.3% of total assets) at December 31, 1994 and 1993, respectively.
Total reserves stood at $30.9 million at December 31, 1995, of which $12.9
million were general valuation reserves ("GVAs") principally associated with
performing loans. In October 1995, the OTS issued a Letter Directive to the
Bank, which requires that GVAs be maintained at an aggregate level of not less
than $12.5 million. At December 31, 1995, the Bank was in compliance with the
Letter Directive. The decline in total reserves during the three-year period
ended December 31, 1995 resulted from charge-offs of previously established
reserves upon the foreclosure and subsequent liquidation of the Bank's
collateral. Though management believes that it has established loss reserves
consistent with a reasonable expectation of future losses on loans and
properties, the Bank's asset quality remains poor by comparison to its peers.
Total assets at December 31, 1995, were $754 million, a slight increase
from the Company's asset total of $744 million at December 31, 1994, but down
from their peak in 1991 of $1.1 billion. The Bank's continuing efforts to
expand its core retail deposit base have generated positive results despite a
year of uncertainty about the Company and Bank's financial condition and
negative publicity surrounding the regulatory requirements imposed on the Bank
by the OTS. Total deposits at year end 1995 were $698 million, serviced out of
9 retail savings branches, as compared to $649 million at year end 1994, which
were supported from 10 branch offices.
25
<PAGE>
INTEREST MARGIN
The Company's interest margin, or the difference between the yield 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 relationship between repricing or maturity of the Company's
adjustable-rate and fixed loans and short-term investment securities and its
deposits and borrowings, and (3) 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 each of the three years ended December 31,
1995 (dollars are in thousands). In the table, interest revenues are net of
interest associated with nonaccrual loans.
<TABLE>
<CAPTION>
1995 1994 1993
----------------------------- ---------------------------- ---------------------------
AVERAGE REVENUES/ YIELD/ AVERAGE REVENUES/ YIELD/ AVERAGE REVENUES/ YIELD/
BALANCE COSTS COST BALANCE COSTS COST BALANCE COSTS COST
--------- ---------- ------- -------- --------- ------ ------- --------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets
Loans $ 563,391 $ 45,386 8.06% $ 602,598 $ 42,085 6.98% $ 756,023 $ 52,625 6.96%
Investments and other securities 34,920 2,399 6.87% 97,442 4,523 4.64% 137,571 5,474 3.98%
Mortgage-backed securities 48,522 3,209 6.61% 45,810 2,963 6.47% 8,947 699 7.81%
--------- -------- --------- -------- --------- --------
Total interest-earning assets $ 646,833 $ 50,994 7.88% $ 745,850 $ 49,571 6.65% $ 902,541 $ 58,798 6.51%
--------- -------- ----- --------- -------- ----- --------- -------- -----
Noninterest-earning assets 80,139 81,336 55,211
--------- --------- ---------
Total assets $ 726,972 $ 827,186 $ 957,752
--------- --------- ---------
--------- --------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities
Deposits $ 677,606 33,593 4.96% 763,302 29,694 3.89% $ 887,887 36,562 4.12%
Borrowings 12,484 893 7.15% 14,333 749 5.23% 3,123 130 4.16%
--------- -------- --------- -------- --------- --------
Total interest-bearing liabilities 690,090 34,486 5.00% 777,635 30,443 3.91% 891,010 36,692 4.12%
--------- -------- ----- --------- -------- ----- --------- -------- -----
Other liabilities 6,997 7,163 8,459
Stockholders' equity 29,885 42,388 58,283
--------- --------- ---------
Total liabilities & stockholders'
equity $ 726,972 $ 827,186 $ 957,752
--------- --------- ---------
--------- --------- ---------
Net interest margin ($) $ 16,508 $ 19,128 $ 22,106
-------- -------- --------
-------- -------- --------
Net interest margin (%) 2.55% 2.56% 2.45%
----- ----- -----
----- ----- -----
</TABLE>
The table below summarizes the components of the changes in the Company's
interest revenues and costs for 1995 and 1994, as compared with the preceding
year (dollars are in thousands).
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31,
1995 AND 1994 1994 AND 1993
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO CHANGE IN DUE TO CHANGE IN
---------------------------------------------- ------------------------------------------------
RATE AND NET RATE AND NET
VOLUME RATE VOLUME (1) CHANGE VOLUME RATE VOLUME (1) CHANGE
--------- ------- ---------- --------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST REVENUES
Loans (2) $ (2,738) $ 6,459 $ (420) $ 3,301 $ (10,680) $ 175 $ (35) $ (10,540)
Investment securities (2,902) 2,171 (1,393) (2,124) (1,597) 912 (266) (951)
Mortgage-backed securities 175 67 4 246 2,880 (120) (496) 2,264
-------- ------- --------- --------- ---------- --------- --------- ----------
(5,465) 8,697 (1,809) 1,423 (9,397) 967 (797) (9,227)
-------- ------- --------- --------- ---------- --------- --------- ----------
INTEREST COSTS
Deposits (3,334) 8,147 (914) 3,899 (5,130) (2,022) 283 (6,868)
Borrowings (97) 276 (35) 144 343 76 200 619
-------- ------- --------- --------- ---------- --------- --------- ----------
(3,431) 8,423 (949) 4,043 (4,787) (1,946) 483 (6,249)
-------- ------- --------- --------- ---------- --------- --------- ----------
NET MARGIN $ (2,034) $ 274 $ (860) $ (2,620) $ (4,610) $ 2,913 $ (1,280) $ (2,978)
-------- ------- --------- --------- ---------- --------- --------- ----------
-------- ------- --------- --------- ---------- --------- --------- ----------
</TABLE>
- ----------------
(1) Calculated by multiplying change in rate by change in volume.
(2) Interest on loans is net of interest on nonaccrual loans.
26
<PAGE>
The Bank's gross interest margin, expressed as a percentage of interest-
earning assets, has leveled off 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 Bank'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 in
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 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. Changes in the 11th DCOFI have historically lagged the repricing of
institutions' liabilities (principally deposits), which is the pattern presently
observable. In addition, most of the Company's adjustable-rate loans reprice
semi-annually or annually, exacerbating the lack of repricing symmetry with
respect to the Company's interest-earning assets and interest-bearing
liabilities.
As described elsewhere herein, the Bank 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 volume with yields substantially higher than the Bank's pre-
1994 loan portfolio while maintaining the Bank's established credit quality
standards. During 1995, the Bank originated nearly $200 million of new
permanent loans and construction commitments with a weighted average yield
(excluding loan fees) of 9.93%. At December 31, 1995, $182.3 million of gross
loan principal (including gross loan commitments) and $167.4 million of net loan
principal (after deducting undisbursed loans funds) was outstanding, with a
weighted average yield (excluding loan fees) of 9.45% and 9.53%, respectively.
Most of the loans originated during 1995 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 28% of the
Bank's gross loans at year-end 1995, is expected to be substantially accretive
to the Bank's interest margin in 1996 and beyond to the extent the loans remain
outstanding and continue to perform in accordance with their terms.
PROVISIONS FOR POSSIBLE CREDIT LOSSES ON LOANS
For the three years ended December 31, 1995, the Bank recorded aggregate
loan loss provisions of $30.9 million. Including provisions to increase loss
reserves associated with foreclosed properties, aggregate loss provisions for
the three-year period totaled $54.7 million. The Bank also recorded, at the
direction of the OTS, loss provisions for loans and properties of $54.6 million
during the year ended December 31, 1992. At December 31, 1995, the Bank
maintained total reserves of $30.9 million, of which $12.9 million were GVAs.
In October 1995, the OTS issued a Letter Directive to the Bank, which requires
that the Bank maintain a total GVAs of not less than $12.5 million. The Bank
was in compliance with the Letter Directive at the end of 1995.
The table below details the Company's non-interest revenues for the years
ended December 31 (dollars are in thousands).
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Other loan and escrow fees $ 515 $ 691 $ 1,356
Deposit account fees 582 560 628
Other revenues 621 722 1,311
-------- -------- --------
$ 1,718 $ 1,973 $ 3,295
-------- -------- --------
-------- -------- --------
</TABLE>
In late 1993, the Company substantially terminated its new loan origination
and escrow activities. The Company did not commence originating new loans again
until the last half of 1994, and then did so only moderately until the second
quarter of 1995, when its new financing activities began to produce significant
volumes. Accordingly, new loan volume declined to $49 million in 1993 and $45
million in 1994 before increasing to $197 million in 1995. During the 1994
first quarter, the Company received, and recorded as revenue, payments of $0.3
million from the Resolution Trust Corporation resulting from a rent subsidy
agreement entered into as part of a branch office purchase by the Company in the
mid-1980's. During 1993, the Company recovered, and recorded as revenue, $0.6
million associated with a 1991 transaction involving the misapplication of wired
funds by a customer. Also during 1993, the Company received $0.2 million of
insurance proceeds as reimbursement for losses resulting from an employee
embezzlement in 1991.
27
<PAGE>
OPERATING COSTS
The table below details the Company's operating costs for the years ended
December 31 (dollars are in thousands).
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Employee $ 9,894 $ 8,806 $ 9,023
Occupancy 2,841 2,780 2,591
Operating 2,893 4,560 4,422
Professional 1,299 1,468 2,087
SAIF insurance premium
and OTS assessment 2,213 2,557 2,604
Goodwill amortization 49 16 435
-------- -------- --------
$ 19,189 $ 20,187 $ 21,162
-------- -------- --------
-------- -------- --------
</TABLE>
For all three years, the preceding table excludes the direct operating
costs associated with the Company's foreclosed property management and
disposition activities, which consist principally of employee compensation and
outside legal costs. Such amounts totaled $1.2 million, $3.7 million and $1.0
million during 1995, 1994 and 1993, respectively, and are included with Real
Estate Operations. See REAL ESTATE OPERATIONS.
EMPLOYEE COSTS
Since June 1993, the Company has hired, and currently retains the service
of, a full complement of senior and middle managers to effect the Company's
strategic and operational initiatives, including management and staff which have
responsibility for the Bank's financing activities, retail banking operations
and corporate staff and administrative functions. Management also substantially
restructured the Bank's retail branch network, reducing from 21 to 9 the number
of branch offices operated by the Company. These actions, largely accomplished
by late 1994, have reduced the number of employees from 210 in June 1993 to 181
at December 31, 1995, and increased the Company's base compensation from an
annualized rate of $5.8 million in June 1993 to $7.5 million at the end of 1995.
During 1994, management initiated a Bank-wide incentive compensation program for
all employees. Under this program, cash bonuses could be, and were, earned for
achievement of the Bank's principal strategic and recurring operating
initiatives. For each of the three years ended December 31, 1995, cash
incentive compensation totaled $1.7 million, $1.2 million and $0.5 million,
respectively.
During 1994, the Company restructured its employee benefit programs to
provide for comparable or improved coverage to employees at reduced costs and to
require certain employees (based upon salary level) to pay all or a portion of
the premium cost of Company-sponsored programs. During 1994, the Company froze
benefits associated with its defined benefit pension plan and ceased
contributions to the Company's Employee Stock Ownership Plan.
OCCUPANCY COSTS
Since mid-1993, the Company has (1) sold the deposits previously serviced
by 12 branch banking offices and in connection therewith sold or terminated the
lease obligations associated with 11 facilities (the Bank retains the lease
obligation with respect to one facility), (2) consolidated its non-branch
employees into a single leased facility, purchasing the leasehold improvements
and furnishings, (3) sold its two previously owned facilities, and (4)
substantially renovated its remaining branch facilities. The effect of these
initiatives has been to increase annual occupancy costs by about 10% since 1993.
28
<PAGE>
OPERATING COSTS
Operating costs include (1) data processing service charges from outside
vendors, (2) premiums for corporate liability insurance, (3) the cost of
corporate telecommunications and supplies, (4) the cost of advertising and
promotion, and (5) transaction service charges from outside vendors. Premiums
for directors and officers liability insurance and fidelity bond insurance
premiums rose significantly during 1994 and remained at those levels for 1995,
as compared with prior periods, because of the deterioration in the Company's
financial condition and an increase in the amount of coverage obtained. Other
operating costs have decreased significantly since mid-1994, principally because
of the substantial decrease in the scope of the Bank's operations (see OCCUPANCY
COSTS) and continued efficiencies gained in the operation of the Bank's
remaining facilities, supplies acquisition and data processing services. In
addition, the Company incurred approximately $0.7 million of nonrecurring costs
during 1994 associated with a detailed review of the Bank's loan files and the
loss from an employee defalcation.
PROFESSIONAL COSTS
Professional fees are paid to outside lawyers, who represent the Company in
a variety of legal matters, the Company's independent accountants, and to
various other vendors that provide employee search and miscellaneous consulting
services to the Company. Since 1992, the Company has incurred very high legal
costs due to the magnitude of its foreclosure and related actions against
borrowers. A portion of these costs ($0.3 million, $1.3 million and $0.6
million for each of the three years ended December 31, 1995) are included in
Real Estate Operations, to the extent they directly pertain to the resolution of
foreclosed properties. During 1993, the Company retained a law firm to assist
management in reviewing all of the Company's then largest and most troubled
lending transactions, and certain interrelationships among the reviewed borrower
group. The cost of this review approximated $0.4 million. Also during 1993,
the Company paid $0.2 million to settle litigation arising from a failed
residential construction development.
SAIF PREMIUMS
The Bank pays premiums to the SAIF based upon the dollar amount of deposits
it holds and the assessment rate charged by the FDIC, which is based upon the
Bank's financial condition, its capital ratios and the rating it receives in
connection with annual regulatory examinations by the OTS. Because of the
Bank's poor financial condition during the past three years, the assessment rate
charged by the FDIC has increased from $0.26 per $100 of deposits in 1993 to
$0.31 per $100 of deposits in 1994 and 1995. The increase in assessment rate
has only been partially offset by a decline in the dollar amount of deposits
held by the Bank during the last three years.
29
<PAGE>
REAL ESTATE OPERATIONS
The table below details the revenues and costs associated with the
Company's foreclosed properties for the years ended December 31 (dollars are in
thousands).
<TABLE>
<CAPTION>
1995 1994 1993
--------- --------- --------
<S> <C> <C> <C>
EXPENSES ASSOCIATED WITH REAL ESTATE OWNED
Operating costs
Employee $ (749) $ (2,028) (367)
Operating (121) (347)
Professional (280) (1,349) (591)
--------- --------- ----------
(1,150) (3,724) (958)
Holding costs
Property taxes (35) (1,965) (5,911)
Repairs, maintenance and renovation (555) (361) (1,502)
Insurance (132) (329) (233)
--------- --------- ----------
(1,872) (6,379) (8,604)
NET RECOVERIES FROM SALE OF PROPERTIES 2,547 2,980 330
RENTAL INCOME, NET 2,839 2,108 252
PROVISION FOR ESTIMATED LOSSES ON
REAL ESTATE OWNED (5,100) (18,662)
--------- --------- ----------
$ (1,586) $ (1,291) $ (26,684)
--------- --------- ----------
--------- --------- ----------
</TABLE>
Commencing in late 1993 and continuing through 1995, the Company
established and staffed a separate group to direct the Company's property
management, construction, property disposal and restructuring operations. The
costs included in the table above (and, therefore, excluded from operating costs
(see OPERATING COSTS)), include employee compensation, benefits, and outside
legal fees directly attributable to the assets under management by this group.
Commencing in early 1995, several individuals have been transferred from
their previous asset management responsibilities to the Bank's new business
groups, in response to management's launching of these businesses and the
continuing reduction in the volume of foreclosed properties under management.
Also as a result of the shrinkage in the Bank's portfolio of foreclosed
properties and the largely successful resolution of matters emanating from the
initial wave of foreclosures in 1993 and 1994, the legal costs associated with
the Bank's real estate operations have declined substantially, and now consist
principally of recurring matters such as receiverships and bankruptcy actions by
borrowers.
The decline in holding costs associated with foreclosed properties
generally mirrors the decline in the Bank's property portfolio since mid-1993.
The large expenditures for property taxes during 1993 and 1994 were attributable
to the volume of foreclosures during this period and the significant amounts of
delinquent property taxes attached to these properties. Beginning in early
1995, the Bank began to advance delinquent property taxes prior to foreclosure
of the Bank's collateral, in order to reduce the penalties associated with
nonpayment, the cost of which is generally reflected in the Bank's credit loss
reserves. With respect to foreclosed apartment buildings, which constituted
approximately 42% of the Bank's property portfolio at year end 1995, all holding
costs, including property taxes and depreciation, are included with rental
operations. With respect to foreclosed construction developments, which
constituted 29% of the Bank's property portfolio at year end 1995, all holding
costs, including property taxes, are included in the basis of the Bank's
investment. During the first half of 1995, the Bank depreciated the
improvements associated with its portfolio of foreclosed apartment buildings, on
the theory that management then expected to hold and operate this portfolio
indefinitely into the future. In mid-1995, management decided to market much of
this portfolio for sale and, accordingly, ceased depreciating the accumulated
improvements.
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.
30
<PAGE>
During the third quarter of 1995, a provision for estimated losses on
foreclosed real estate in the amount of $5.1 million was recorded. This
provision related to construction-related problems associated with two
foreclosed residential developments and the need to increase specific valuation
allowances. These developments represent the last two projects the Company has
yet to complete.
FINANCIAL CONDITION, CAPITAL RESOURCES & LIQUIDITY AND ASSET QUALITY
The table below sets forth the Company's consolidated assets, liabilities
and stockholders' equity and the percentage distribution of these items at the
dates indicated (dollars are in thousands).
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------------------------
1995 1994 1993
----------------------- ----------------------- ------------------------
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT
-------- ------- -------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents $ 14,015 1.9% $ 18,063 2.4% $ 42,901 4.9%
Investment securities-held to maturity 30,190 4.1% 52,425 5.9%
Investment securities-available for sale 62,793 8.3% 13,726 1.8% 13,573 1.6%
Mortgage-backed securities 57,395 7.7% 28,891 3.3%
Loans receivable, net 617,328 81.9% 537,020 72.2% 623,450 70.7%
Real estate owned 37,905 5.0% 62,613 8.4% 72,234 8.2%
Other assets (1) 21,542 2.9% 22,156 3.0% 29,613 3.4%
Income tax refund receivable 2,630 0.4% 18,554 2.0%
-------- ------- -------- ------- --------- -------
Total assets $753,583 100.0% $743,793 100.0% $ 881,641 100.0%
-------- ------- -------- ------- --------- -------
-------- ------- -------- ------- --------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits $698,008 92.6% $649,382 87.3% $ 829,809 94.1%
Short-term borrowings 47,141 6.3%
Accounts payable and other liabilities 4,603 0.6% 6,443 0.9% 7,883 0.9%
Senior debt 12,006 1.6%
-------- ------- -------- ------- --------- -------
714,617 94.8% 702,966 94.5% 837,692 95.0%
Stockholders' equity 38,966 5.2% 40,827 5.5% 43,949 5.0%
-------- ------- -------- ------- --------- -------
Total liabilities and stockholders' equity $753,583 100.0% $743,793 100.0% $ 881,641 100.0%
-------- ------- -------- ------- --------- -------
-------- ------- -------- ------- --------- -------
</TABLE>
- ----------------
(1) Includes fixed assets, accrued receivable and other assets.
31
<PAGE>
The table below summarizes the principal cash flows which gave rise to the
change in the size of the Company's balance sheet during the past three years
(dollars are in thousands).
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------
1995 1994 1993 COMBINED
--------- -------- -------- ---------
<S> <C> <C> <C> <C>
BEGINNING CASH AND EQUIVALENTS $ 18,063 $ 42,901 $ 44,334 $ 44,334
ASSET CASH FLOWS
Net cash flows attributable to
Foreclosed properties (1) (2) 26,231 54,344 22,112 102,687
Securities (3) 36,935 (6,742) 9,081 39,274
Sales of loans 19,282 19,282
Loan principal payments and
payoffs 46,408 67,080 97,789 211,277
Cash flows from other assets (4) 3,613 23,854 (6,428) 21,039
--------- -------- -------- ---------
132,469 138,536 122,554 393,559
New loans, net of undisbursed
funds (2) (165,006) (27,769) (46,713) (239,488)
--------- -------- -------- ---------
Net asset cash flows (32,537) 110,767 75,841 154,071
--------- -------- -------- ---------
LIABILITY CASH FLOWS
Deposits
Net sales of deposits (17,072) (183,260) (200,332)
Other changes, net 65,698 6,107 (79,848) (8,043)
Net short-term borrowings (47,141) 47,141
Cash flows from other
liabilities (1,475) (1,687) (1,152) (4,314)
--------- -------- -------- ---------
Net liability cash flows 10 (131,699) (81,000) (212,689)
--------- -------- -------- ---------
EQUITY CASH FLOWS
Net proceeds from capital
offering 24,663 24,663
Cash flows from operations 3,816 (3,906) 3,726 3,636
--------- -------- -------- ---------
Net equity cash flows 28,479 (3,906) 3,726 28,299
--------- -------- -------- ---------
Total liability and equity
cash flows 28,489 (135,605) (77,274) (184,390)
--------- -------- -------- ---------
NET CASH FLOWS (4,048) (24,838) (1,433) (30,319)
--------- -------- -------- ---------
ENDING CASH AND EQUIVALENTS $ 14,015 $ 18,063 $ 42,901 $ 14,015
--------- -------- -------- ---------
--------- -------- -------- ---------
</TABLE>
- ----------------
(1) Proceeds from sales of properties, less post-foreclosure capitalized
costs.
(2) New loan cash flows and the net proceeds from sales of properties
exclude the financed portion of property sales where the Bank financed
the sale. For the three years ended December 31, 1995, the Bank
provided $15.8 million, $13.5 million and $11.7 million, respectively,
of financing in connection with sales of foreclosed properties,
which amounts principally related to sales of apartment buildings.
(3) Includes sales and purchases of investment securities.
(4) Includes fixed assets, FHLB stock, income tax receivable and other
assets.
32
<PAGE>
TOTAL ASSETS
Total assets increased by $9.8 million from year end 1994 to year end 1995.
This increase was primarily due to a net increase in loans receivable of $80.3
million, and was partially offset by decreases in investment securities and real
estate owned of $38.5 million and $24.7 million, respectively.
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 FHLB to cover daily inclearings, wire activities and
other charges. Cash and cash equivalents at year end 1995 were $14.0 million, a
decrease from $18.1 million at year end 1994. The Company follows a practice of
investing essentially all of its excess funds at fiscal quarter end in U.S.
Treasury bills for purposes of increasing its risk-based capital ratio, which is
affected by the composition of certain risk-weighted assets.
INVESTMENT SECURITIES
Investment securities consist of securities classified as held-to-maturity
and available-for-sale, and mortgage-backed securities. Investment securities
decreased by $38.5 million from year end 1994 to year end 1995. At year end
1994, the Company had $101.3 million in investment securities, of which $13.7
million were classified as available-for-sale. During 1995, management
initiated tactical measures to reduce the interest rate risk exposure inherent
in the balance sheet. Those measures included the liquidation of certain fixed
rate assets, both loans and investment securities, in the first and second
quarters of 1995. In December 1995, the Company, consistent with guidance
issued in November 1995 by the FASB, reclassified all of its mortgage-backed
securities from held-to-maturity to available-for-sale. These securities were
then liquidated prior to year end. All securities held in portfolio as of year
end 1994 were converted to cash during 1995 by amortization of principal on
mortgage-backed securities or by liquidation. These cash proceeds were
partially utilized to fund loan growth, and when available, reinvested in short-
term Fed funds or U.S. Treasury obligations. See NOTES C, D, and E of the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
LOAN PORTFOLIO
The Bank principally invests the proceeds generated from customer accounts
in mortgage loans secured by residential and, to a much lesser extent, non-
residential real estate. This section sets forth the composition of the Bank's
loan portfolio for each of the past five years and highlights management's
assessment of each of the Bank's individual loan portfolios.
The two tables below set forth the composition of the Company's loan
portfolio, and the percentage 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>
DECEMBER 31, 1995
---------------------------------------
PRE-1994 POST-1993 TOTAL
--------- --------- ---------
<S> <C> <C> <C>
Single family (non-project)
Estate $ $ 53,324 $ 53,324
Other 181,165 22,968 204,133
Loan concentrations 70,748 70,748
Multi-family
2 to 4 units 38,651 2,989 41,640
5 or more units 142,323 76,692 219,015
Commercial 2,100 29,158 31,258
Land 791 2,838 3,629
Construction commitments 196 30,541 30,737
Other 1,459 1,459
--------- --------- ---------
Gross Loans Receivable $ 437,433 $ 218,510 $ 655,943
--------- --------- ---------
--------- --------- ---------
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991
------------------- ----------------- ----------------- ----------------- -----------------
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT
--------- ------- -------- ------- -------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PERMANENT LOANS
Single family
Non-project $ 257,457 39.2% $ 254,856 44.7% $ 294,583 43.2% $ 450,555 53.4% $ 418,558 46.2%
Loan concentrations 70,748 10.8% 76,074 13.3% 85,807 12.6%
Multi-family
2 to 4 units 41,640 6.3% 44,390 7.8% 46,220 6.8% 50,193 6.0% 60,775 6.7%
5 or more units 219,015 33.4% 172,641 30.3% 193,468 28.4% 207,024 24.6% 200,009 22.0%
0.0%
Commercial 31,258 4.8% 7,757 1.4% 7,630 1.1% 3,332 0.4% 1,989 0.2%
Land 5,579 0.9% 3,797 0.7% 22,179 3.3% 35,957 4.3% 19,845 2.2%
RESIDENTIAL CONSTRUCTION 28,787 4.4% 9,270 1.6% 29,528 4.3% 87,274 10.4% 198,650 21.9%
COMMERCIAL 4,300 0.5% 3,500 0.4%
OTHER COLLATERALIZED LOANS 1,459 0.2% 1,654 0.3% 2,013 0.3% 3,235 0.4% 3,819 0.4%
--------- ------- -------- ------- -------- ------- -------- ------- -------- -------
GROSS LOANS RECEIVABLE 655,943 100.0% 570,439 100.0% 681,428 100.0% 841,870 100.0% 907,145 100.0%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
LESS
Participants' share (2,219) (3,072) (3,098) (4,250) (5,535)
Undisbursed loan funds (15,208) (2,795) (966) (9,750) (32,210)
Deferred loan fees and
credits, net (5,996) (6,091) (7,285) (9,484) (10,189)
Allowance for estimated
losses (15,192) (21,461) (46,629) (52,966) (12,042)
----------- ---------- ---------- ---------- ----------
TOTAL LOANS RECEIVABLE $ 617,328 $ 537,020 $ 623,450 $ 765,420 $ 847,169
----------- ---------- ---------- ---------- ----------
----------- ---------- ---------- ---------- ----------
</TABLE>
SINGLE FAMILY (NON-PROJECT)
The Company's single family loan portfolio is exclusively secured by single
family homes located within the Company's Southern California lending markets,
with a majority of the loan collateral being located within the South Bay region
of Los Angeles County. Except as described below, the Company's single family
loan portfolio has performed better than its other real estate-secured loans
(e.g., loan concentrations, apartments, residential construction, and land).
Similarly, the Company's recovery rate from the disposition of foreclosed homes
has exceeded the recovery rates achieved from the disposition of other
foreclosed real estate.
Since the end of 1993, the principal balance of loans originated prior to
1994 has declined by $113.4 million, or 38%, as the result of foreclosures of
the Bank's collateral, sales of loans and principal payments by borrowers.
During 1994 and 1995, the Bank foreclosed on the collateral for 63 single
family-secured loans, representing $17.5 million of loan principal. At December
31, 1995, the Bank owned 13 foreclosed homes and 48 loans, representing $11.0
million of loan principal, were one or more payments delinquent. During
this two-year period, the Bank sold $19.2 million of loan principal and received
principal payments of $76.7 million from borrowers.
During 1994 and 1995, the Bank originated $76.3 million of loans secured by
single family homes, of which $53.7 million were secured by very expensive homes
(Estate loans) and the remainder were secured by more conventionally-priced
homes.
In 1993, management commenced regular reviews of the collateral securing
its single family-secured loan portfolio, concentrating its efforts on larger-
balance loans and loans that exhibited attributes suggesting potential problems,
including delinquent property taxes, chronic late payments or delinquencies, and
transfers of title by the borrower not submitted for approval to or approved by
the Bank. Through December 31, 1995, one or more reviews had been performed on
$76.1 million in principal amount of such loans (excluding loans originated
during 1994 and 1995). These reviews form the basis for the classification of
loans in this portfolio. See ASSET CLASSIFICATION.
Management believes that the performance of the Company's pre-1994 single
family loan portfolio will continue to mirror the general economic environment
within its lending markets. However, management believes that the future
default and foreclosure rates of this portfolio will continue to exceed that of
its local competitors, principally because (1) of the Company's previous
underwriting practices, (2) an unusually large percentage of the loans within
this portfolio had their genesis as construction loans, and (3) a relatively
large percentage of the portfolio is concentrated in non-owner occupied single
family homes.
34
<PAGE>
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 Bank's
borrowers, the performance of this portfolio has been extremely poor.
At its 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 Bank 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.
During 1994 and 1995, the Bank's aggregate investment in its portfolio of loan
concentrations (loan principal plus foreclosed inventory before reserves)
declined by approximately $36 million, or 31%, principally as the result of
foreclosure of the Bank's collateral, sales of foreclosed units and the
acceptance of discounted payments from borrowers on several loans. During
1994 and 1995, the Bank had foreclosed upon 112 units (including unsold units
which secured the remaining construction loan), representing $20.2 million of
loan principal. At December 31, 1995, the Bank owned 58 foreclosed units and 29
loans, representing $4.1 million of loan principal, were delinquent one or
more payments. The Bank did not finance any sales of foreclosed units during
1994 and 1995.
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 Bank's collateral - are
not expected to change in the near-term.
APARTMENTS
At December 31, 1995, the Company maintained a portfolio of loans
secured by two or more units approximating $261 million, or 40% of gross loans
receivable. This total includes loan principal of approximately $42 million
that is secured by buildings with two, three or four units. Management
estimates that over 50% of the Company's permanent apartment loan portfolio
originated prior to 1994 and secured by five or more units had its genesis with
construction financing provided by the Company to the original
developer/borrower. Most of such properties were subsequently sold by the
developer and the Company's loan was assumed and remains outstanding.
Approximately 75% of the Company's apartment loan portfolio is located
within its principal South Bay lending markets, with much of the remainder being
concentrated in North San Diego County. All of the Company's apartment
collateral is located in Southern California.
Since the end of 1993, the principal balance of loans originated prior
to 1994 has declined by $58.7 million, or 24%, as the result of foreclosures of
the Bank's collateral and principal payments by borrowers. During 1994 and
1995, the Bank foreclosed on the collateral for 76 apartment-secured loans,
representing $44.0 million of loan principal. At December 31, 1995, the Bank
owned 53 foreclosed apartment buildings and 8 loans, representing $4.8 of loan
principal, were one or more payments delinquent.
In early 1994, management decided to staff a separate group within its
asset management group to manage its growing portfolio of apartment buildings
following foreclosure, with the intention of doing so indefinitely.
Accordingly, the Bank did not generally market its portfolio of buildings
following foreclosure until late 1995.
35
<PAGE>
During 1994 and 1995, the Bank originated $76.7 million of loans
secured by apartment buildings with five or more units, of which $21.8 million
was extended to purchasers of apartment buildings sold by the Bank during 1994
and 1995. Unlike the apartment collateral securing its pre-1994 originations,
which was principally located in the South Bay region of Los Angeles County, had
its genesis with construction financing provided by the Bank and was represented
by buildings with less than 20 units, the Bank's new financings are generally
secured by buildings with 50 or more units located throughout Southern
California, and are owned by experienced operators of apartment buildings.
In 1993, management commenced regular reviews of the collateral
securing its apartment loan portfolio. Through December 31, 1995, one or more
reviews had been performed on virtually all of the Bank's loan principal secured
by buildings with 5 or more units and originated prior to 1994. These reviews
form the basis for the classification of loans in this portfolio. See ASSET
CLASSIFICATION.
Management expects that the performance of the Bank's pre-1994
apartment-secured loan portfolio will continue to be uneven. This expectation
derives from management's view that (1) the underlying economics of its
collateral are not expected to improve materially in the near-term (i.e., rent
levels are expected to remain static), (2) a large number of the Bank's
borrowers are not experienced operators of apartment buildings and most lack the
financial resources to compete effectively with better capitalized operators,
and (3) the cash flows currently being generated by the Bank's collateral are
either insufficient, or barely sufficient, to service the Bank's loan in an
interest rate environment which is near cyclical lows.
RESIDENTIAL CONSTRUCTION
As described elsewhere herein, the Bank's principal business through
the early 1990's was to provide construction loans for tracts of for-sale
housing in Southern California, principally in the South Bay area of Los Angeles
County. Subsequent to mid-1993, the Bank foreclosed upon virtually all of the
units securing construction loans made by the Bank during the years 1989 through
1991. At December 31, 1995, the Bank had no residential construction loans
outstanding from this period.
During 1995, the Bank originated a total of $32.3 million of
commitments for the construction of individual homes ($25.5 million of
commitments) and small tracts of for-sale housing ($6.8 million). This activity
is managed by newly-hired professionals and the Bank's current customers include
experienced developers, none of whom had previously done business with the
Company. The Bank did not originate any construction loans during 1994.
36
<PAGE>
LOAN MATURITIES
The table below sets forth, by contractual maturity, the Company's
real estate loan portfolio at December 31, 1995. The table is based on
contractual loan maturities and does not consider amortization and prepayment of
loan principal (dollars are in thousands).
<TABLE>
<CAPTION>
MATURING IN
-------------------------------------------------------
ONE YEAR SIX YEARS TOTAL
LESS THAN THROUGH THROUGH OVER LOANS
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS RECEIVABLE
--------- ---------- --------- --------- ----------
<S> <C> <C> <C> <C> <C>
ORIGINATED PRIOR TO 1994
PERMANENT LOANS
Single family
Non-project $ 14 $ 857 $ 7,002 $ 173,292 $ 181,165
Loan concentrations 824 192 429 69,303 70,748
Multi-family
Two to four units 134 476 1,923 36,118 38,651
Five or more units 1,058 3,055 20,948 117,262 142,323
Commercial 238 1,862 2,100
Land 148 839 987
RESIDENTIAL CONSTRUCTION
SFR
Tract Development
OTHER COLLATERALIZED LOANS 1,439 6 14 1,459
--------- ---------- --------- --------- ----------
3,617 4,586 30,554 398,676 437,433
--------- ---------- --------- --------- ----------
ORIGINATED AFTER 1993
PERMANENT LOANS
Single family
Non-project 399 18,808 26,637 30,448 76,292
Loan concentrations
Multi-family
Two to four units 1,315 1,674 2,989
Five or more units 16,803 59,889 76,692
Commercial 24,051 674 4,433 29,158
Land 569 2,423 1,600 4,592
RESIDENTIAL CONSTRUCTION
SFR 19,040 2,947 21,987
Tract Development 2,000 4,800 6,800
--------- ---------- --------- --------- ----------
22,008 69,832 88,515 38,155 218,510
--------- ---------- --------- --------- ----------
$ 25,625 $ 74,418 $ 119,069 $ 436,831 655,943
--------- ---------- --------- ---------
--------- ---------- --------- ---------
LESS
Participants' share (2,219)
Undisbursed funds (15,208)
Deferred loan fees and credits, net (5,996)
Allowance for estimated losses (15,192)
---------
NET LOANS RECEIVABLE $ 617,328
---------
---------
</TABLE>
37
<PAGE>
The table below sets forth, by interest rate, the Company's fixed rate
and interest-rate sensitive real estate loans at December 31, 1995. The table
is based on contractual loan maturities and does not consider amortization and
prepayment of loan principal (dollars are in thousands).
<TABLE>
<CAPTION>
MATURING IN
-------------------------------------------------------
ONE YEAR SIX YEARS TOTAL
LESS THAN THROUGH THROUGH OVER LOANS
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS RECEIVABLE
--------- ---------- --------- --------- ----------
<S> <C> <C> <C> <C> <C>
FIXED INTEREST RATES $ 2,397 $ 19,733 $ 13,446 $ 128,304 $ 163,880
VARIABLE INTEREST RATES
11th DCOFI 2,605 25,011 81,924 306,757 416,297
Prime Rate 20,623 16,983 37,606
1 year CMT 12,691 23,699 36,390
Other 1,770 1,770
--------- ---------- --------- --------- ----------
Total variable interest rates 23,228 54,685 105,623 308,527 492,063
--------- ---------- --------- --------- ----------
TOTAL $ 25,625 $ 74,418 $ 119,069 $ 436,831 655,943
--------- ---------- --------- ---------
--------- ---------- --------- ---------
LESS
Participants' share (2,219)
Undisbursed funds (15,208)
Deferred Loan fees and credits, net (5,996)
Allowance for estimated losses (15,192)
---------
NET LOANS RECEIVABLE $ 617,328
---------
---------
</TABLE>
38
<PAGE>
The table below sets forth average balance information concerning the
Company's gross loan portfolio at December 31, 1995 (dollars are in thousands).
<TABLE>
<CAPTION>
PRINCIPAL NUMBER AVERAGE
BALANCE OF LOANS PER LOAN
--------- -------- --------
<S> <C> <C> <C>
ORIGINATED PRIOR TO 1994
PERMANENT LOANS
Single family
Non-project $ 181,165 1,393 $ 130
Loan concentrations 70,748 421 168
Multi-family
2 to 4 units 38,651 286 135
5 or more units 142,323 282 505
Commercial 2,100 9 233
Land 987 6 165
CONSTRUCTION
OTHER COLLATERALIZED LOANS 1,459 82 18
--------- -----
437,433 2,479 176
--------- -----
ORIGINATED AFTER 1993
PERMANENT LOANS
Single family
Non-project 76,292 190 402
Loan concentrations
Multi-family
2 to 4 units 2,989 13 230
5 or more units 76,692 71 1,080
Commercial 29,158 10 2,916
Land 4,592 14 328
RESIDENTIAL CONSTRUCTION
SFR 21,987 36 611
Tract 6,800 2 3,400
--------- -----
218,510 336 650
--------- -----
GROSS LOANS RECEIVABLE $ 655,943 2,815 $ 233
--------- ----- ------
--------- ----- ------
</TABLE>
RISK ASSETS
For the purpose of the following discussion, "Risk Assets" are defined
as (1) properties acquired through foreclosure, plus (2) loans delinquent one or
more payments, plus (3) performing loans placed on nonaccrual status, plus (4)
performing loans classified Loss, Doubtful and Substandard or designated Special
Mention (pursuant to OTS regulations and guidelines), less (5) applicable
writedowns and reserves.
As described elsewhere herein, the Company was an active construction
lender for many years. A majority of the construction loans made during the
period 1987 through 1991 and which did not result in foreclosure of the
Company's collateral were internally refinanced with new permanent loans. With
respect to apartment buildings and individual single family homes, the Company
generally converted the fully-disbursed construction loan into a permanent loan,
amortizing over and due in thirty years. With respect to for-sale housing
developments where the Company financed their construction, the Company
typically made permanent loans to purchasers of individual units from the
developer (loan concentrations). During this period, the Company also financed
numerous other for-sale housing developments with respect to which it did not
make any permanent loans following construction.
Generally, the risk profile associated with the types of loans made
prior to 1993 by the Company (i.e., construction loans, project concentration
loans and apartment loans) is greater than for other types of mortgage finance,
such as owner-occupied single family home loans acquired through purchase
transactions. Further, many of the concentration loans were made on terms
outside the parameters normally associated with conventional financing
(including having loan-to-value ratios greater than 80%, below-market interest
rates and subordinate financing provided
39
<PAGE>
by the developer). The recent and current character of the Company's asset
quality is a function of both broad and market-specific economic factors,
compounded by (1) the Company's underwriting standards during the years in
which the Company's Risk Assets were originated, (2) prior management's
aggressiveness in providing permanent financing to purchasers of individual
units in Company-financed construction developments, and (3) the generally poor
quality of, and internal inconsistencies within, the underlying loan
documentation supporting individual transactions. See ITEM 1. NEW BUSINESS
GENERATION for a discussion of the Company's lending activities subsequent to
1993.
The table below summarizes the Company's investment in Risk Assets as
of the dates indicated (dollars are in thousands).
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------
1995 1994 1993 1992 1991
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
PROPERTIES $ 53,630 $ 99,119 $120,417 $ 45,095 $ 28,532
NONACCRUAL LOANS 21,709 39,396 110,006 88,278 41,168
OTHER DELINQUENT LOANS 74,194 75,990
Performing loans
Classified Loss, Doubtful and
Substandard 57,026 64,664 61,630 42,487 16,544
Designated Special Mention 54,852 80,556 71,593 28,759 30,798
-------- -------- -------- -------- --------
GROSS RISK ASSETS 187,217 283,735 363,646 278,813 193,032
LESS
Writedowns (3,897) (8,726)
Specific reserves (18,049) (39,853) (58,349) (25,039) (2,422)
General reserves (11,060) (11,304) (24,870) (43,100) (11,100)
-------- -------- -------- -------- --------
NET RISK ASSETS $158,108 $228,681 $271,701 $210,674 $179,510
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
NET LOANS RECEIVABLE
AND PROPERTIES $655,233 $599,633 $695,684 $795,342 $875,701
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
PERCENTAGE TO NET LOANS
RECEIVABLE AND PROPERTIES 24.1% 38.1% 39.1% 26.5% 20.5%
----- ----- ----- ----- -----
----- ----- ----- ----- -----
</TABLE>
40
<PAGE>
ASSET CLASSIFICATION
OTS regulations require that savings institutions utilize an internal
asset classification system as a means of reporting problem and potential
problem assets for regulatory supervision purposes. The Company has
incorporated the OTS' internal classifications as a part of its credit
monitoring system. The Company currently designates its assets Pass, Special
Mention, Substandard, Doubtful or Loss. A loan is considered in default of its
terms and conditions upon the failure of a borrower to make a scheduled payment
of principal and interest. The Company's internal asset classification policy
requires that the Company's investment in foreclosed properties and nonaccrual
loans be classified Substandard, Doubtful or Loss. A brief description of these
categories follows.
A Pass asset is considered of sufficient quality to preclude
designation as Special Mention or an adverse classification. Pass assets
generally are protected by the current net worth or paying capacity of the
obligor or by the value of the asset or underlying collateral.
An asset designated Special Mention does not currently expose an
institution to a sufficient degree of risk to warrant an adverse classification.
However, it does possess credit deficiencies or potential weaknesses deserving
of management's close attention. If uncorrected, such weaknesses or deficiencies
may expose the institution to an increased risk of loss in the future.
An asset classified Substandard is inadequately protected by the
current net worth and paying capacity of the obligor or of the collateral
pledged, if any. Assets so classified have a well-defined weakness or
weaknesses. They are characterized by the distinct possibility that the
institution will sustain some loss if the deficiencies are not corrected.
Assets classified as Doubtful have all the weaknesses inherent in
those classified Substandard. In addition, these weaknesses make collection or
liquidation in full, on the basis of currently existing facts, conditions and
values, highly questionable or improbable. The Company views the Doubtful
classification as a temporary category. The Company will generally classify
assets as Doubtful when inadequate data is available or when such uncertainty
exists as to preclude a Substandard classification. Therefore, the Company will
normally tend to have a minimal amount of assets classified in this category.
Assets classified as Loss are considered uncollectible and of such
little value that their continuance as assets without establishment of a
specific reserve is not warranted. A Loss classification does not mean that an
asset has absolutely no recovery or salvage value; rather it means that it is
not practical or desirable to defer establishing a specific reserve for the
asset even though partial recovery may be effected in the future. The Company
will generally classify as Loss the portion of assets identified as exceeding
the asset's fair market value, and a specific reserve is established for such
excess.
A "classified asset" is one that has been designated Substandard,
Doubtful or Loss. All loans in default are categorized as classified assets.
Classified assets do not include Special Mention or Pass assets. All of the
foregoing standards require the application of considerable subjective judgment
by the Company.
41
<PAGE>
The table below shows the Company's gross loan portfolio, by
classification, as of December 31, 1995.
<TABLE>
<CAPTION>
CLASSIFIED LOANS
----------------------------
SPECIAL SUB-
PASS MENTION STANDARD NONACCRUAL TOTAL
----------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Single family
Non-project $ 227,658 $11,640 $ 7,182 $10,977 $ 257,457
Loan concentrations 37,221 16,617 12,770 4,140 70,748
Multi-Family
2-4 Units 36,769 2,761 2,110 41,640
Five or more units 159,374 20,314 34,483 4,844 219,015
Commercial 29,138 2,007 113 31,258
Land 1,950 1,513 368 1,748 5,579
Residential Construction
SFR 21,987 21,987
Tract Development 6,800 6,800
Other collateralized loans 1,459 1,459
----------- ---------- ---------- ----------- ----------
Gross Loans Receivable $ 522,356 $ 54,852 $ 57,026 $ 21,709 $ 655,943
----------- ---------- ---------- ----------- ----------
----------- ---------- ---------- ----------- ----------
</TABLE>
NONACCRUAL LOANS
The Company recognizes revenue principally on the accrual basis of
accounting. In recording interest revenues from loans, the Company generally
adheres to a policy of not accruing interest for loans where payment of
principal and interest are delinquent for a period of 30 days or more. The
Company's policy is to assign nonaccrual status to a loan where either (i)
principal or interest payments are delinquent in excess of 30 days or (ii) the
full collection of interest or principal becomes uncertain, regardless of the
length of delinquency status. When a loan reaches "nonaccrual" status, any
interest accrued thereon is reversed and charged against current period
earnings. With respect to loans on nonaccrual status at December 31, 1995,
the Company recognized $1.2 million of interest revenue and deferred
recognition of $0.4 million of interest during 1995.
RESTRUCTURED LOANS
Prior to September 1993, the Company's previous management followed a
practice of aggressively modifying loans, based upon verbal or, in some cases
written, requests from borrowers. Consistent with the orientation of the
Company's past lending activities, a majority of modifications prior to mid-1993
were associated with acquisition and development loans. Many of these loans
were modified in order to avoid borrower defaults or, in the case of loans
already in default, to prolong the period prior to foreclosure. In many
instances, a single loan, or groups of loans, were modified more than once. As
illustrated in the table below, the modifications effected by the Company
generally took the form of (1) reducing the interest rate of the loan to a
market interest rate, (2) extending the maturity date of the loan, generally for
acquisition and development loans, or (3) both.
Commencing in September 1993, new management imposed new parameters to
govern the future restructuring of the Company's loans. Generally, the Company
requires a borrower to submit a written request outlining the borrower's
proposal and to provide the Company with current financial and related
information about the borrower and the Company's collateral. In making its
evaluation, the Company considers whether the proposed modification would
improve the Company's economic position relative to recovery of all or a
substantial portion of its investment in the loan.
In 1995, the Company recognized interest revenue of $1.71 million on
troubled debt restructured loans. The Company would have recognized interest
revenue of $1.93 million had the borrowers paid according to the original
contractual terms on such loans.
42
<PAGE>
During 1994 and 1995, one or more terms of 47 loans, involving loan
principal of $24.0 million outstanding at December 31, 1995, were modified as
summarized below.
- The remaining 30 performing loans within the Bank's largest loan
concentration were modified during 1995, involving principal of
$7.3 million, wherein the Bank agreed to forgive loan principal
ratably over 24 months in an amount sufficient to equalize the
amount of the Bank's loan and the current value of the Bank's
collateral, and to provide the funds necessary to repay the then
existing subordinate lienholder (who was the original seller of
units in the project) at a fraction of the face amount of such
liens. Through December 31, 1995, the Bank had forgiven $.3
million of loan principal, had provided $0.2 million of funds to
satisfy all subordinate liens, and was obligated to forgive an
additional $.3 million of loan principal. At December 31, 1995,
29 of the 30 restructured loans were performing and had performed
without incident since their restructuring.
- During 1994, the Bank modified the terms of one loan, involving
principal of $2.2 million, to permit the borrower to convert
rental units into condominiums. To facilitate the conversion,
the Bank agreed to forebear on its contractual payments through
the end of 1996, in exchange for receipt of a predetermined
dollar amount from unit sales, and to subordinate its lien to a
new first trust deed for $0.2 million. Through December 31,
1995, 14 units had been converted and sold, and the Bank's loan
had been reduced to $1.7 million. The Bank has 16 other loans
with this borrower, principally secured by apartment buildings,
involving principal of $7.3 million. All of these loans were
performing at December 31, 1995, and had performed without
incident during the two years ended December 31, 1995.
- During 1994 and 1995, the Bank modified the terms of three loans
secured by apartment buildings, involving principal of $3.7
million, with different borrowers, wherein the Bank forgave a
portion of the principal balance of its loans, in exchange for
corresponding principal payments from the borrowers. In each
instance, the interest rate on the loans was adjusted to levels
approximating then market interest rates and payments were
reamortized over 30 years. Each of these loans was performing at
December 31, 1995, and had performed without incident since its
restructuring.
- During 1994 and 1995, the Bank advanced a total of approximately
$0.5 million relating to 12 loans, involving principal of $9.8
million and different borrowers, for delinquent property taxes,
renovation to the Bank's collateral and delinquent payments.
Each of these loans was performing at December 31, 1995, and had
performed without incident since its restructuring.
- In 1995, the Bank agreed to accept reduced principal payments for
a period of one year associated with one loan, involving
principal of $1.5 million. The loan was made in connection with
the sale by the Bank in 1994 of improved lots and the modified
terms call for principal payments only to the extent of net
proceeds generated from sales of individual lots during the
restructuring period. Since the lots were sold and the loan was
made, the borrower has made principal payments of $0.5 million
and all scheduled interest payments. The loan was performing at
December 31, 1995.
43
<PAGE>
CREDIT LOSSES
Credit losses are inherent in the business of originating and retaining
real estate loans. The Company performs periodic reviews of any asset that has
been identified as having potential excess credit risk. The Company maintains
special departments with responsibility for resolving problem loans and selling
properties. Valuation allowances for estimated potential future losses are
established on a specific and general basis for loans and properties. Specific
reserves for individual assets are determined by the excess of the Company's
gross investment over the fair market value of the collateral or property.
General reserves are provided for losses inherent in the loan and property
portfolios which have yet to be specifically identified. General reserves are
based upon management's judgment of a number of factors including historical
loss experience on similar loan portfolios, composition of the loan and property
portfolios, loan delinquency experience patterns, loan classifications, and
prevailing and forecasted economic conditions.
The table below sets forth the general and specific credit losses for the
Company's loan and property portfolios as of December 31, 1995 (dollars are in
thousands).
<TABLE>
<CAPTION>
LOANS
--------------------------------
PERFORMING IN DEFAULT PROPERTIES TOTAL
----------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
AMOUNTS
Specific reserves $ 666 $ 2,760 $ 14,623 $ 18,049
General reserves 10,662 1,104 1,102 12,868
---------- ----------- ------------ -----------
Total reserves for estimated losses $ 11,328 $ 3,864 $ 15,725 $ 30,917
---------- ----------- ------------ -----------
---------- ----------- ------------ -----------
PERCENTAGES
% of total reserves to gross investment 1.9% 17.8% 29.3% 4.5%
% of general reserves to gross investment 1.7% 5.1% 2.1% 1.9%
</TABLE>
The table below summarizes the activity in the Company's reserves for the
periods indicated (dollars are in thousands).
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------------
1995 1994 1993 1992 1991
-------- --------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C>
LOANS
Balance at beginning of period $ 21,461 $ 46,629 $ 52,966 $ 10,813 $ 4,400
Provision for estimated losses 14,850 5,298 10,747 42,153 6,588
Transfer to property and other reserves (14,342) (29,577) (16,842)
Charge-offs (6,777) (889) (170)
Recoveries (72) (175)
-------- --------- ---------- --------- ---------
Balance at end of period $ 15,192 $ 21,461 $ 46,629 $ 52,966 $ 10,813
-------- --------- ---------- --------- ---------
-------- --------- ---------- --------- ---------
PROPERTIES
Balance at beginning of period $ 32,609 $ 39,457 $ 15,173 $ 2,709
Provision for estimated losses 5,100 18,662 12,464 2,709
Transfers from loan reserves 13,792 29,577 16,842
Charge-offs (35,776) (36,425) (10,953)
Recoveries (267)
-------- --------- ---------- --------- ---------
Balance at end of period $ 15,725 $ 32,609 $ 39,457 $ 15,173 $ 2,709
-------- --------- ---------- --------- ---------
-------- --------- ---------- --------- ---------
</TABLE>
44
<PAGE>
Because the Company's loan and property portfolios are not homogenous, 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 and discussion below
summarize credit loss reserves and the Company's approach to measuring credit
risk for each of its property and loan portfolios (dollars are in thousands).
<TABLE>
<CAPTION>
DECEMBER 31, 1995
---------------------------------------------
LOANS PROPERTIES TOTAL
--------- ------------ ----------
<S> <C> <C> <C>
PERMANENT
Single family residences
Non-project $ 1,866 $ 787 $ 2,653
Loan concentrations 4,256 1,541 5,797
Multi-family
2 to 4 units 530 574 1,104
5 or more units 7,828 4,806 12,634
Commercial 259 105 364
Land 361 2,043 2,404
CONSTRUCTION 92 5,869 5,961
--------- ------------ ----------
$ 15,192 $ 15,725 $ 30,917
--------- ------------ ----------
--------- ------------ ----------
</TABLE>
SINGLE FAMILY
For performing loans, general reserves are established based upon actual
portfolio migration experience (i.e., the percentage of the portfolio which has
defaulted and with respect to which the Bank's collateral has been foreclosed
upon) and estimated loss content (i.e., the estimated collateral deficiency
determined by reference to current market indicators of the properties'
liquidation value). These factors are distinguished by the classification of the
loan. For loans in default and for owned homes, general and specific reserves
are established, or charge-offs recorded, based upon the current fair market
value of the property, less selling and renovation costs, by reference to
appraisals or other indicators of the properties' current value believed by
management to be reliable, or the Bank's actual loss experience from selling
foreclosed homes since 1993.
LOAN CONCENTRATIONS
As described elsewhere herein, management has identified numerous loan
concentrations involving takeout loans made by the Bank to facilitate sales
within residential tract developments, the construction of which was financed by
the Bank. For performing loans within a concentration, management establishes
general reserves in an amount equal to the estimated collateral deficiency
observable by reference to closed unit sales during the past two years
(generally, sales of foreclosed units by the Bank) for the number of performing
loans expected to default in the future and result in foreclosure of the Bank's
collateral. For defaulted loans and foreclosed units, the Bank's actual sales
experience during the past two years is utilized to establish specific reserves
or to charge-off estimated losses.
APARTMENTS
As described elsewhere herein, management has performed one or more asset
reviews for virtually its entire pre-1994 apartment-secured loan portfolio
(i.e., loans secured by buildings with five or more units). In addition, the
Bank has foreclosed upon and sold (during 1995) a large number of buildings with
the same characteristics (location, size, age, unit mix) as those of the Bank's
remaining loan collateral. The estimated valuations derived from the foregoing
are utilized to establish loss factors, by loan classification, which are
coupled with the portfolio's migration experience to establish general reserves
for performing loans. For loans in default and for owned buildings, specific
reserves are established and, where appropriate, charge-offs are recorded, for
the estimated loss expected from foreclosure (in the case of defaulted loans)
and disposition of the building, by reference to the properties' cash flows and
the application of current market investor return and financing factors, less
transaction and renovation costs.
45
<PAGE>
CONSTRUCTION
At December 31, 1995, the Bank had investments in four foreclosed
residential tract developments. Reserves had been established, or charge-offs
had been recorded, through December 31, 1995 based upon revenues and costs to
and at completion. With respect to two of these developments, construction was
complete at the end of 1995 and most of the completed units had been sold. With
respect to one development, construction was approximately 70% complete and
approximately 60% of the total number of units in the project had been completed
and sold. With respect to one development, construction was substantially
complete at December 31, 1995 but no units had yet been sold.
POST-1994 ORIGINATIONS
As described elsewhere herein, the Bank originated nearly $200 million of
new permanent loans and construction loan commitments during 1995. Because these
loans lack the seasoning to fully assess their likely future performance
characteristics and inherent loss content, management has established general
reserves based upon estimates.
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 for the periods ended December 31 (dollars are in thousands).
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
SINGLE FAMILY RESIDENCES
Non-project $ 4,975 $ 2,791
Loan concentrations 6,419 12,056
MULTI-FAMILY
2 to 4 units 3,840 2,708
5 or more units 18,877 27,229
CONSTRUCTION 15,414 39,516
LAND 3,759 14,424
COMMERCIAL 346 395
-------- --------
GROSS INVESTMENT (1) 53,630 99,119
WRITEDOWNS (3,897)
ALLOWANCE FOR ESTIMATED LOSSES (15,725) (32,609)
-------- --------
NET INVESTMENT $ 37,905 $ 62,613
-------- --------
-------- --------
</TABLE>
- ----------------
(1) Loan principle at foreclosure, plus post-foreclosure capitalized costs,
less cumulative charge-offs.
46
<PAGE>
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, funds are generated from loan repayments and payoffs, sales
of investment securities, and, since late 1993, from sales of foreclosed
properties. Historically, the Company has not accessed the capital markets for
other types of debt instruments, and has had nominal activity in selling
seasoned, single family mortgage loans which are no longer a significant
component to the Company's operations.
DEPOSITS
The Company has several types of deposit accounts principally designed to
attract short-term deposits. The following table sets forth the distribution of
average deposits and the rates paid thereon for the periods indicated (dollars
are in thousands).
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------------
1995 1994 1993
-------------------------------- ------------------------------- -------------------------------
PERCENT PERCENT PERCENT
OF OF OF
AMOUNT RATE TOTAL AMOUNT RATE TOTAL AMOUNT RATE TOTAL
---------- ------ ------ ------- ------ ------ -------- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Noninterest-bearing
demand deposits $ 2,915 0.0% 0.4% $ - 0.0% 0.0% $ - 0.0% 0.0%
Interest-bearing demand
and savings deposits 56,836 1.1% 8.1% 60,125 1.2% 9.3% 64,008 1.8% 7.7%
Money market deposits 34,708 1.4% 5.0% 86,443 2.4% 13.3% 141,131 2.3% 17.0%
Time certificates of deposit 603,549 5.6% 86.5% 502,814 4.7% 77.4% 624,670 4.3% 75.3%
---------- ------ -------- ------ -------- ------
Total $698,008 5.0% 100.0% $649,382 4.1% 100.0% $829,809 3.8% 100.0%
---------- ------ ------ -------- ------ ------ -------- ------ ------
---------- ------ ------ -------- ------ ------ -------- ------ ------
</TABLE>
The table below sets forth the maturities of the Company's time
certificates of deposit ("TCDs") outstanding at the dates indicated (dollars are
in thousands).
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------------------
1995 1994
-------------------------- ------------------------
$100,000 $100,000
UNDER AND UNDER AND
$100,000 OVER $100,000 OVER
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Three months or less $ 54,590 $ 11,340 $ 9,814 $ 2,123
Over three months through
six months 19,904 2,781 47,111 12,671
Over six months through
twelve months 275,424 77,170 184,300 51,168
Over twelve months 123,221 39,119 144,110 52,275
---------- ---------- ---------- ---------
Total $ 473,139 $ 130,410 $ 385,335 $ 118,237
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
</TABLE>
47
<PAGE>
BORROWINGS
To supplement its funding needs, the Company enters into reverse repurchase
agreements, in which it sells securities with an agreement to repurchase the
same securities at a specific future date (overnight to 90 days). The Company
enters into such transactions only with dealers determined by management to be
financially strong and who are recognized as primary dealers in U.S. Treasury
securities by the Federal Reserve Board. See NOTE J of the NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS.
The Company considers borrowings from the FHLB system as a source for
operations. The FHLB system functions as a source of credit to savings
institutions which are members of a Federal Home Loan Bank System. See
REGULATION-Federal Home Loan Bank System. The Company may apply for advances
from the FHLB secured by the capital stock of the FHLB owned by the Company and
certain of the Company's mortgages and other assets (principally obligations
issued or guaranteed by the U.S. Government or agencies thereof). Advances can
be requested for any business purpose in which the Company is authorized to
engage. In granting advances, the FHLB considers a member's credit worthiness
and other relevant factors.
The Company currently has an approved line of credit with the FHLB for $100
million, which can be accessed for terms of up to two years.
CAPITALIZATION
During late 1995, the Company sold $27 million of "investment units" at a
price of $500,000 per unit, in a private placement ("Offering"). Each investment
unit consists of $250,000 principal amount of the Company's senior notes
("Senior Notes"), five shares of the Company's cumulative perpetual preferred
stock, series A ("Preferred Stock"), and a warrant to purchase 44,000 shares of
the Company's common stock ("Warrants"). The Company's contribution of $19
million of the net proceeds of the Offering as qualifying Tier 1 capital into
the Bank during December satisfied the PCA issued in June 1995 by the OTS. With
the infusion of capital into the Bank, the OTS terminated the PCA and released
the Bank from its capital plan. The Company's regulatory capital position is
discussed more fully under ITEM 1. REGULATION-REGULATORY CAPITAL REQUIREMENTS.
The Company recorded the Senior Notes, which have a face amount of
$13,500,000, at $11,994,000. The Senior Notes carry an annual stated interest
rate of 12% and have an annual effective rate of 16.5%, after the recording of
Original Issue Discount ("OID") of $1,506,000. The OID will be 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 $4,860,000 has been invested in U.S. Government securities and is
discussed further in NOTE N of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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.
The Company recorded the Preferred Stock, which has a liquidation value of
$13,500,000, at $12,760,000. The Preferred Stock carries a stated annual
dividend rate of 18% and will have a somewhat higher effective yield due to the
difference between the liquidation value and the recorded amount. The dividend
is cumulative, but deferred for the first 18 months. Thereafter, dividends 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.
The Warrants have been valued at $2,245,000 and entitle the holders to
purchase an aggregate of 2,376,000 shares of newly-issued common stock of the
Company at a fixed price of $2.25 per share. The Warrants are not exercisable
for the first three years following their issuance and will terminate ten years
after their issuance.
The Company incurred offering expenses of $2,336,000 which were allocated
evenly to the Senior Notes and the Preferred Stock. The $1,168,000 attributable
to the Senior Notes has been capitalized and included with Other Assets and will
be amortized over the five year term of the Senior Notes. During 1995, the
Company recorded amortization of $11,000 related to these expenses. The
$1,168,000 attributable to the Preferred Stock has been recorded as a reduction
to capital in excess of par value - Preferred Stock.
48
<PAGE>
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 certain periods of time with the majority of the
focus typically at the one-year maturity horizon. A negative gap occurs when
interest sensitive liabilities exceed interest sensitive assets. The negative
one-year maturity gap indicates, absent offsetting factors, that the Company has
more exposure to interest rate risk in an increasing interest rate environment.
In addition to utilizing gap analysis in measuring interest rate risk, the
Company performs periodic interest rate simulations. These simulations provide
the Company with an estimate of both the dollar amount and percentage change in
net interest income under various interest rate scenarios. All assets and
liabilities are subjected to tests of up to 400 basis points in increases and
decreases in interest rates. Under each interest rate scenario, the Company
projects its net interest income and the net portfolio value of its current
balance sheet. From these results, the Company can then develop alternatives to
dealing with the tolerance thresholds.
During 1995, the Company initiated certain tactical measures to reduce
interest risk exposure embedded within the balance sheet. These measures
included the sale of approximately $120 million in fixed rate assets and the
purchase of a $450 million interest rate cap on the liability base subject to
reprice within a six-month period.
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. ARMs represented 75% and 68% of
the Company's loan portfolio at December 31, 1995 and 1994, 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 interest rate environment
should benefit, in the short-term, the Company's Net Interest Margin, but the
actual dynamics of prepayments and the fact that ARMs reprice at various
intervals may alter this expected benefit.
49
<PAGE>
Interest-sensitive assets and liabilities and their weighted average
interest rates at December 31 are summarized as follows:
<TABLE>
<CAPTION>
1995 1994
--------------------------- -------------------------
BALANCE RATE BALANCE RATE
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Interest-earning assets (1)
Loans $ 637,472 8.25% $ 563,344 7.17%
Cash and investment securities 77,357 5.19% 62,898 5.73%
Mortgage-backed securities 57,395 6.38%
---------- ----------
714,829 7.90% 683,637 6.97%
---------- ---------- ---------- ---------
Interest-bearing liabilities
Deposit accounts (698,008) ( 5.16%) (649,382) ( 4.30%)
Borrowings (12,006) ( 6.19%) (47,141) ( 5.85%)
---------- ----------
(710,014) ( 5.17%) (696,523) ( 4.40%)
---------- ---------- ---------- ---------
Interest-bearing gap/stated
interest margin (17,048) 2.89% (12,886) 2.48%
Nonaccrual loans (21,709) (0.28%) (39,396) ( 0.41%)
---------- ---------- ---------- ---------
Adjusted interest-bearing gap/
effective interest margin $ (38,757) 2.61% $ (52,282) 2.07%
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
</TABLE>
- ----------------
(1) Contractual yield, exclusive of deferred fees.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Index included in Item 14 below and the Financial Statements which
begin on the first page following the Signature Page.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable
50
<PAGE>
P A R T III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required in ITEM 10 is hereby incorporated by reference to
the Company's definitive Proxy Statement to be filed with the Securities and
Exchange Commission for the 1996 Annual Meeting of Stockholders ("Proxy
Statement") under the captions "NOMINATION AND ELECTION OF DIRECTORS" and
"COMPENSATION OF EXECUTIVE OFFICERS DURING 1995."
ITEM 11. EXECUTIVE COMPENSATION.
The information required in ITEM 11 is hereby incorporated by reference to
the Proxy Statement under the captions "COMPENSATION OF EXECUTIVE OFFICERS
DURING 1995" and "REPORT ON EXECUTIVE COMPENSATION."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required in ITEM 12 is hereby incorporated by reference to
the Proxy Statement under the caption "SECURITY OWNERSHIP OF PRINCIPAL
STOCKHOLDERS AND MANAGEMENT; AFFILIATE TRANSACTIONS."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required in ITEM 13 is hereby incorporated by reference to
the Proxy Statement under the caption "SECURITY OWNERSHIP OF PRINCIPAL
STOCKHOLDERS AND MANAGEMENT; AFFILIATE TRANSACTIONS."
51
<PAGE>
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
EXHIBIT NO. DESCRIPTION OF DOCUMENT
- ----------- -----------------------
(3) Articles of Incorporation and Bylaws. The Company's Articles of
Incorporation and By laws are attached as exhibits to the Company's
Registration Statement on Form S-8 (Registration No. 33-74800)
filed on February 3, 1994.
(3.1) Amendment of Articles of Incorporation and Bylaws. The Company's
Amendment of its Articles of Incorporation and By laws are attached
as exhibits to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1995.
(10) Material Contracts. On February 27, 1985, the Board of Directors of
Hawthorne Savings adopted an Employee Stock Ownership Plan, a copy of
which is attached as an exhibit to the Company's Annual Report on Form
10-K for the year ended December 31, 1985. Mr. Braly entered into a
three-year employment agreement with the Bank which became effective
as of July 14, 1993 in connection with his employment as Chief
Executive Officer of the Company and the Bank.
(11) Statement re: Computation of Per Share Earnings. The Company's
statement regarding the computation of per share earnings is set forth
in NOTE O of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS referenced
in Item 8 of this Annual Report on Form 10-K.
(22) Subsidiaries of the Registrant. A statement of the Company's only
subsidiary is attached as an exhibit to the Company's Annual Report
on Form 10-K for the year ended 1994.
(23) Consents of Experts and Counsel. The Company's Independent
Auditors' Consent is attached hereto as Exhibit 23 on Form S-8.
(27) Financial Data Schedules. The Company's Financial Data Schedules are
attached as exhibits to the Company's Annual Report on Form 10-K for
the year ended December 31, 1980.
52
<PAGE>
FINANCIAL STATEMENT SCHEDULES
PAGE
----
INDEPENDENT AUDITORS' REPORT F-3
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition F-4
Consolidated Statements of Operations F-6
Consolidated Statements of Stockholders' Equity F-7
Consolidated Statements of Cash Flows F-8
Notes to Consolidated Financial Statements F-10
MANAGEMENT'S ASSERTION REPORT F-43
INDEPENDENT ACCOUNTANTS' REPORT F-45
REPORTS ON FORM 8-K
No current reports on Form 8-K were filed for the three months ended December
31, 1995.
53
<PAGE>
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DATED: MARCH 27, 1996 HAWTHORNE FINANCIAL CORPORATION
BY: /S/ SCOTT A. BRALY
------------------------------------------
SCOTT A. BRALY, PRESIDENT
AND CHIEF EXECUTIVE OFFICER
/S/ NORMAN A. MORALES
------------------------------------------
NORMAN A. MORALES, EXECUTIVE VICE
PRESIDENT AND CHIEF FINANCIAL OFFICER
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
SIGNATURE DATE
------------- -----
/S/ SCOTT A. BRALY March 27, 1996
- -----------------------------
SCOTT A. BRALY, PRESIDENT AND
CHIEF EXECUTIVE OFFICER
/S/ NORMAN A. MORALES March 27, 1996
- -----------------------------
NORMAN A. MORALES, EXECUTIVE
VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
/S/ MARILYN G. AMATO March 27, 1996
- -----------------------------
MARILYN G. AMATO, DIRECTOR
/S/ TIMOTHY R. CHRISMAN March 27, 1996
- -----------------------------
TIMOTHY R. CHRISMAN, CHAIRMAN
OF THE BOARD
/S/ CHARLES S. JACOBS March 27, 1996
- -----------------------------
CHARLES S. JACOBS, DIRECTOR
54
<PAGE>
/S/ HARRY RADCLIFFE March 27, 1996
- -----------------------------
HARRY RADCLIFFE, DIRECTOR
/S/ HOWARD E. RITT March 27, 1996
- -----------------------------
HOWARD E. RITT, DIRECTOR
/S/ ROBERT C. TROOST March 27, 1996
- -----------------------------
ROBERT C. TROOST, DIRECTOR
55
<PAGE>
FINANCIAL STATEMENTS AND INDEPENDENT AUDITORS' REPORT
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
AS OF DECEMBER 31, 1995 AND 1994
THREE YEARS ENDED DECEMBER 31, 1995
F-1
<PAGE>
C O N T E N T S
PAGE
----
INDEPENDENT AUDITORS' REPORT F-3
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION F-4
CONSOLIDATED STATEMENTS OF OPERATIONS F-6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-10
MANAGEMENT'S ASSERTION REPORT F-43
INDEPENDENT ACCOUNTANTS' REPORT F-45
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Hawthorne Financial Corporation
Hawthorne, California:
We have audited the accompanying consolidated statements of financial
condition of Hawthorne Financial Corporation and Subsidiary (the "Company") as
of December 31, 1995 and 1994 and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based upon our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial condition of Hawthorne Financial
Corporation and Subsidiary as of December 31, 1995 and 1994, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1995, in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
January 26, 1996
Los Angeles, California
F-3
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS ARE IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1995 1994
----------- ----------
<S> <C> <C>
Cash and cash equivalents (NOTE B) $ 14,015 $ 18,063
Investment securities-held to maturity
(estimated market value of $29,321
in 1994) (NOTES C and S) 30,190
Investment securities-available for sale (NOTE D) 62,793 13,726
Mortgage-backed securities at amortized cost
(estimated market value of $53,993 in
1994) (NOTES A and E) 57,395
Loans receivable (net of allowance for
estimated credit losses of $15,192 in 1995
and $21,461 in 1994) (NOTE F) 617,328 537,020
Real estate owned (net of allowance for
estimated losses of $15,725 in 1995
and $32,609 in 1994) (NOTE G) 37,905 62,613
Accrued interest receivable 3,583 3,542
Investment in capital stock of Federal
Home Loan Bank - at cost 6,312 6,995
Office property and equipment - at cost,
net (NOTE H) 9,597 10,538
Income tax refund receivable (NOTE K) 2,630
Other assets 2,050 1,081
----------- ----------
$ 753,583 $ 743,793
----------- ----------
----------- ----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - CONTINUED
(DOLLARS ARE IN THOUSANDS)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1995 1994
---------- -----------
<S> <C> <C>
Liabilities
Deposit accounts (NOTE I) $ 698,008 $ 649,382
Short-term borrowings (NOTE J) 47,141
Accounts payable and other liabilities 4,603 6,078
Income taxes payable (NOTE K) 365
Senior notes (NOTE N) 12,006
----------- ----------
714,617 702,966
Commitments and contingencies (NOTE R)
Stockholders' equity (NOTES N and O)
Capital stock - $0.01 par value in
1995 and $1.00 par value in 1994; authorized,
20,000,000 shares; issued and
outstanding, 2,604,675 shares 26 2,605
Cumulative perpetual preferred stock, series
A - $0.01 par value; $50,000 liquidation
preference; authorized 10,000,000 shares;
issued and outstanding 270 shares (NOTE N)
Capital in excess of par value -
common stock (NOTE N) 7,745 2,921
Capital in excess of par value -
preferred stock (NOTE N) 11,592
Unrealized gain on available-for-sale securities 6 1,393
Retained earnings 19,788 34,122
----------- ----------
39,157 41,041
Less
Treasury stock, at cost - 5,400 shares (48) (48)
Loan to Employee Stock Ownership Plan (NOTE M) (143) (166)
----------- ----------
38,966 40,827
----------- ----------
$ 753,583 $ 743,793
----------- ----------
----------- ----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS ARE IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
Interest revenues
Loans (NOTE F) $ 47,778 $ 47,751 $ 63,745
Investments 2,399 4,523 5,474
Mortgage-backed securities 3,209 2,963 699
---------- ---------- ----------
53,386 55,237 69,918
---------- ---------- ----------
Interest costs
Deposits (NOTE I) (33,593) (29,694) (36,562)
Borrowings (NOTE J) (893) (749) (130)
---------- ---------- ----------
(34,486) (30,443) (36,692)
---------- ---------- ----------
Net interest margin before contractual
interest on nonaccrual loans 18,900 24,794 33,226
Contractual interest due on nonaccrual
loans (NOTE A) (2,392) (5,666) (11,120)
---------- ---------- ----------
Net interest margin 16,508 19,128 22,106
Provision for credit losses (NOTE F) (14,895) (5,298) (10,747)
---------- ---------- ----------
Net interest margin after provision for
credit losses 1,613 13,830 11,359
Noninterest revenues 1,718 1,973 3,295
Noninterest expenses
Employee (9,894) (8,806) (9,023)
Occupancy (2,841) (2,780) (2,591)
Operating (2,893) (4,560) (4,422)
Professional (1,299) (1,468) (2,087)
SAIF premium and OTS assessment (2,213) (2,557) (2,604)
Goodwill amortization (NOTE A) (49) (16) (435)
---------- ---------- ----------
(19,189) (20,187) (21,162)
---------- ---------- ----------
Real estate operations (NOTE G) (1,586) (1,291) (26,684)
Gain on sale of securities 3,040
Other income 921
Disposition of deposits and premises
(NOTE L) (117) 2,835 (4,066)
---------- ---------- ----------
Net loss before income taxes (13,600) (2,840) (37,258)
Income taxes (NOTE K) (617) (123) 7,648
---------- ---------- ----------
Net loss $ (14,217) $ (2,963) $ (29,610)
---------- ---------- ----------
---------- ---------- ----------
Loss per share $ (5.52) $ (1.14) $ (11.39)
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
Capital stock
Balance at beginning of year $ 2,605 $ 2,605 $ 2,605
Change in par value of common stock (2,579)
---------- ---------- ----------
Balance at end of year 26 2,605 2,605
---------- ---------- ----------
Cumulative perpetual - preferred stock
Balance at beginning of year
Issuance of preferred stock
Balance at end of year ---------- ---------- ----------
---------- ---------- ----------
Capital in excess of par value -
common stock
Balance at beginning of year 2,921 2,921 2,921
Issuance of warrants 2,245
Change in par value of common stock 2,579
---------- ---------- ----------
Balance at end of year 7,745 2,921 2,921
---------- ---------- ----------
Capital in excess of par value -
preferred stock
Balance at beginning of year
Issuance of preferred stock 12,760
Offering costs (1,168)
---------- ---------- ----------
Balance at end of year 11,592
---------- ---------- ----------
Unrealized gain on marketable
equity securities
Balance at beginning of year 1,393 1,573
Unrealized gains (losses) (1,387) (180) 1,573
---------- ---------- ----------
Balance at end of year 6 1,393 1,573
---------- ---------- ----------
Retained earnings
Balance at beginning of year 34,122 37,085 67,346
Net loss (14,217) (2,963) (29,610)
Cash dividends declared (651)
Accrued dividends on preferred stock (117)
---------- --------- ----------
Balance at end of year 19,788 34,122 37,085
---------- --------- ----------
Treasury stock
Balance at beginning of year (48) (48) (48)
---------- --------- ----------
Balance at end of year (48) (48) (48)
---------- --------- ----------
Loans to employee stock ownership plan
(NOTE M)
Balance at beginning of year (166) (187) (208)
Repayments 23 21 21
---------- --------- -----------
Balance at end of year (143) (166) (187)
---------- --------- -----------
Total stockholders' equity $ 38,966 $ 40,827 $ 43,949
---------- --------- -----------
---------- --------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-7
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
NET CASH FROM OPERATING ACTIVITIES
Net loss $(14,217) $(2,963) $(29,610)
Adjustments
Provision for estimated credit losses 14,850 5,298 12,247
Provision for other credit losses 45
Disposition of deposits and premises (117) (2,835) 4,066
Deferred income taxes 3,505
Goodwill amortization 49 16 435
Depreciation and amortization 1,439 717 1,044
FHLB dividends (332) (325) (213)
Loan fee and discount accretion (2,148) (834) (2,024)
Decrease (increase) in:
Accrued interest receivable (50) 27 2,343
Income tax assets 2,630 22,767 (10,946)
Other assets (1,008) (653) (2,178)
Decrease in other liabilities (1,475) (1,687) (1,152)
Gain on sale of REOs and apartments (2,547) (2,980) (330)
Provision for real estate losses 5,100 18,662
Other, net 491 100
---------- ---------- ----------
Net cash provided (used) by
operating activities 2,710 16,548 (4,051)
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment securities
Purchases (62,898) (25,237) (98,989)
Maturities 47,000 131,564
Sales 42,472
Mortgage-backed securities
Purchases (34,855) (25,404)
Principal amortization 6,526 6,350 1,910
Sales 50,835
Loans
New loans funded (144,355) (24,677) (38,869)
Construction disbursements (20,651) (3,092) (7,844)
Payoffs 29,460 52,178 82,243
Sales 19,282
Principal amortization 16,948 14,902 15,546
Other, net 2,087
Real estate
Sale proceeds 41,282 75,612 22,112
Capitalized costs (15,741) (21,485)
Other 690 217
Redemption of FHLB stock 1,015 802 1,706
Office property and equipment
Sales 1,533 5,782
Additions (2,594) (4,892) (879)
---------- ---------- ----------
Net cash (used) provided
by investing activities (34,109) 88,605 83,096
---------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-8
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS-CONTINUED
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 48,626 (180,427) (79,848)
Net premium received from sales of deposits 3,274
Net proceeds from (repayments of) reverse
repurchase agreements (47,141) 47,141
Collection of ESOP loan 23 21 21
Cash dividends paid (651)
Increase in senior notes 12,006
Net proceeds from issuance of preferred stock 11,592
Net proceeds from issuance of warrants 2,245
---------- ---------- ----------
Net cash provided (used)
by financing activities 27,351 (129,991) (80,478)
---------- ---------- ----------
DECREASE IN CASH
AND CASH EQUIVALENTS (4,048) (24,838) (1,433)
CASH AND CASH EQUIVALENTS
AT BEGINNING OF YEAR 18,063 42,901 44,334
---------- ---------- ----------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 14,015 $ 18,063 $ 42,901
---------- ---------- ----------
---------- ---------- ----------
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION
Cash paid during the year for
Interest $ 34,815 $ 30,164 $ 36,898
Income taxes 1,000
Non-cash investing and financing items
Real estate acquired in settlement of loans 38,275 85,703 99,013
Loans originated to finance property sales 15,783 13,411 11,670
Net unrealized gain (loss) on marketable
equity securities (1,393) (180) 1,573
</TABLE>
The accompanying notes are an integral part of these statements.
F-9
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE A - SUMMARY OF ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the preparation of
the accompanying consolidated financial statements are set forth in the sections
which follow.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include accounts of Hawthorne Financial
Corporation ("Company") and its wholly-owned subsidiary, Hawthorne Savings,
F.S.B. ("Bank"). All material intercompany transactions and accounts have been
eliminated.
CASH AND CASH EQUIVALENTS
The Bank, in accordance with regulations, must maintain qualifying liquid assets
at an average monthly balance of not less than 5% of the average of all deposit
accounts and other borrowings due in less than one year, and short-term
qualifying liquid assets at an average monthly balance of not less than 1% of
the average of all deposit accounts and other borrowings due in less than one
year. Liquid assets consists primarily of cash, certificates of deposit and
overnight investments. In addition, bankers' acceptances, and certain U.S.
Government securities, corporate notes and mortgage-backed securities are liquid
assets for regulatory purposes.
In the consolidated statements of cash flows, cash and cash equivalents include
cash, amounts due from banks, interest-bearing deposits, certificates of deposit
and overnight investments.
SECURITIES
The Company classifies debt and equity securities upon acquisition into one of
three categories: held-to-maturity, available-for-sale, or trading. Debt
securities that the Company has the positive intent and ability to hold to
maturity are classified as held-to-maturity securities and reported at amortized
cost. Debt and equity securities that are bought and held principally for the
purpose of selling them in the near term are classified as trading securities
and reported at fair value, with unrealized gains and losses included in
earnings. Debt and equity securities not classified as either held-to-maturity
securities or trading securities are classified as available-for-sale securities
and reported at fair value, with unrealized gains and losses excluded from
earnings and reported in a separate component of stockholders' equity.
In November 1995, the Financial Accounting Standards Board ("FASB") issued a
"Guide to Implementation of Statement 115 on Accounting for Certain Investments
in Debt and Equity Securities: Questions and Answers" (the "Guide"). The Guide
allowed for a onetime assessment of the classification of all securities and, in
connection with such assessment, permitted the reclassification of securities
from the held-to-maturity classification to the available-for-sale as of a
single date no later than December 31, 1995, without calling into question
management's intent to hold to maturity the remaining securities classified as
held-to-maturity. On December 8, 1995, the Bank transferred $48,287,000 of
securities from held-to-maturity to available-for-sale for the purposes of
subsequently selling the securities and improving the Bank's risk-based capital
ratio. The Bank sold the securities in December 1995, which resulted in a
realized loss of $9,643.
At December 31, 1995, all debt investment securities are classified as
available-for-sale and reported at market value with unrealized gains and losses
excluded from earnings and reported as a separate component of stockholders'
equity. Investment securities include only investment grade securities.
F-10
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
LOANS RECEIVABLE
The Company defers all loan fees, net of certain direct costs associated with
originating loans, and amortizes these net deferred fees into interest revenue
as a yield adjustment over the lives of the loans.
Interest on loans is recognized in revenue as earned and is accrued only if
deemed collectible. Beginning in mid-1993, loans one or more payments delinquent
are placed on nonaccrual status, meaning that the Company stops accruing
interest on such loans and reverses any interest previously accrued but not
collected. Prior to such time, loans three or more payments delinquent were
placed on nonaccrual status. A nonaccrual loan may be restored to accrual status
when delinquent principal and interest payments are brought current and future
monthly principal and interest payments are expected to be collected.
All loans are classified as held-to-maturity as the Company has the current
intent and ability to hold its loans in portfolio until maturity.
REAL ESTATE OWNED
Properties acquired through foreclosure, or deed in lieu of foreclosure, are
carried at the estimated fair value of the property. Any subsequent declines in
fair value, if any, are accounted for through the establishment of a specific
reserve on the property. The determination of a property's fair value
incorporates (1) revenues projected to be realized from disposal of the
property, less (2) construction and renovation costs, (3) marketing and
transaction costs and (4) holding costs (e.g., property taxes, insurance and
homeowners' association dues). For multiple-unit residential construction and
land developments, these projected cash flows are discounted utilizing a market
rate of return to determine their fair value.
LOAN IMPAIRMENT
On January 1, 1995 the Bank adopted SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors for
Impairment of a Loan--Income Recognition and Disclosures." This statement amends
SFAS No. 5, "Accounting for Contingencies" and SFAS No. 15, "Accounting by
Debtors and Creditors for Troubled Debt Restructurings." This statement
prescribes that a loan is impaired when it is probable that the creditor will be
unable to collect all contractual principal and interest payments under the
terms of the loan agreement. This statement generally requires impaired loans to
be measured based on the present value of expected future cash flows discounted
at the loan's effective interest rate or, as an expedient, at the loan's
observable market price or the fair value of the collateral if the loan is
collateral-dependent. Creditors may select the measurement method on a loan by
loan basis, except that collateral dependent loans must be measured at the fair
value of the collateral if foreclosure is probable. The Company has chosen to
measure impairment based on the fair value of the underlying collateral. The
statement also prescribes measuring impairment of a restructured loan by
discounting the total expected future cash flows at the loan's effective rate of
interest in the original loan agreement. The effect of initially adopting this
statement did not have a material impact on the results of operations or the
financial position of the Bank taken as a whole.
F-11
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
ALLOWANCE FOR ESTIMATED CREDIT AND REAL ESTATE LOSSES
Management establishes specific reserves for losses on individual real estate
loans and properties when it has determined that recovery of the Company's gross
investment is not likely and when the amount of loss can be reasonably
determined. In making this determination, management considers (1) the current
status of the asset, (2) the probable future status of the asset, (3) the value
of the asset or underlying collateral, and (4) management's intent with respect
to the asset. In quantifying the loss, if any, associated with individual loans
and properties, management utilizes external sources of information (i.e.,
appraisals, price opinions from real estate professionals, comparable sales data
and internal estimates). In establishing specific reserves, management
incorporates the revenues expected to be generated from disposal of the
Company's collateral or owned property, less construction and renovation costs
(if any), holding costs and transaction costs. For multiple-unit residential
construction and land developments, the resulting projected net cash flows are
discounted utilizing a market rate of return to determine their fair value.
Management establishes general reserves against the Company's portfolio of real
estate loans and properties. Generally, such reserves are established for each
segment of the Company's loan and property portfolios, including loans secured
by, and properties represented by, single family homes, apartment buildings,
residential construction developments and land parcels. In establishing general
reserves, management incorporates (1) the recovery rate for similar properties
previously sold by the Company, (2) valuations of groups of similar assets, (3)
the probability of future adverse events (i.e., performing loans which become
nonperforming, loans in default which proceed through to foreclosure) and (4)
guidelines published by the OTS.
When a specific reserve has been established for a particular loan and the
collateral for that loan is subsequently foreclosed upon, the loan is
transferred to real estate owned at the estimated fair value of the underlying
collateral. The net carrying value of the property following foreclosure is,
therefore, the estimated fair value of the property, net of any specific
reserves which may be established after foreclosure due to a subsequent decline
in fair value. In many instances following foreclosure, these properties require
significant time for the completion of construction and their marketing and
eventual sale. During this period, estimates of future revenues and costs can,
and do, vary, requiring changes in the amount of specific reserves allocated to
individual properties.
For multiple-unit, for-sale housing developments, the actual loss incurred from
the sale of individual units is charged against previously established specific
reserves when all of the foreclosed units within the project have been sold. For
individual assets, the actual loss is charged against previously established
specific reserves when the property is sold.
Based upon periodic analysis of future recoverability, changes in specific
reserves established for the Company's property portfolio are charged to real
estate operations.
DEPRECIATION AND AMORTIZATION
Depreciation is provided in amounts sufficient to relate the cost of depreciable
assets to operations over their estimated service lives, on a straight-line
basis. Buildings are depreciated over their estimated useful lives ranging from
twenty to thirty years on a straight-line basis. Leasehold improvements are
amortized over the lives of their respective leases or the service lives of the
improvements, whichever is shorter. Costs of $1,168,000 associated with the
issuance of the senior debt have been capitalized and are being amortized over
the life of the debt, which is five years.
F-12
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
Leasehold rights arising from the acquisition of branch facilities during the
1980's of $1,166,000 were charged-off against earnings in 1993. These lease
rights were determined to have no future benefit to the Company.
INCOME TAXES
The Company and its subsidiary file a consolidated federal income tax return and
a combined state franchise tax return on a fiscal year ending September 30.
Deferred tax assets and liabilities represent the tax effects, calculated at
currently effective tax rates, of future deductible or taxable amounts
attributable to events that have been recognized on a cumulative basis in the
financial statements.
INTEREST RATE CAPS
Premiums paid for purchased interest rate cap agreements are amortized to
interest expense over the term of the caps. Unamortized premiums are included in
other assets in the statement of financial position. Amounts receivable under
cap agreements are accrued as a reduction of interest expense.
EXCESS OF COST OVER FAIR VALUE OF NET ASSETS ACQUIRED
The unamortized excess of cost over fair value of net assets acquired through
the purchase of branch facilities during the 1980's of $1,400,000 was charged-
off against earnings in 1993. The carrying amount of the excess cost over the
fair value of net assets acquired was determined to have no future benefit to
the Company. In 1994, the Company recorded excess of cost over fair value of
$244,000 as goodwill resulting from the acquisition of one branch facility. The
amount is being amortized over five years.
CURRENT ACCOUNTING PRONOUNCEMENTS
The FASB has issued SFAS No. 123 "Accounting for Stock-Based Compensation",
which encourages companies to account for stock compensation awards based on the
fair value at the date the awards are granted.
This statement does not require the application of the fair value method and
allows the continuance of the current accounting method, which requires
accounting for stock compensation awards based on their intrinsic value as of
the grant date. However, SFAS No. 123 requires pro forma disclosure of net
income and, if presented, earnings per share, as if the fair value based method
of accounting defined in this statement had been applied.
The accounting and disclosure requirements of this statement are effective for
financial statements for fiscal years beginning after December 15, 1995, though
earlier adoption is encouraged. The Company has chosen not to adopt the fair
value provisions of this statement.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
F-13
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
RECLASSIFICATIONS
Certain amounts in the 1994 and 1993 consolidated financial statements have been
reclassified to conform with classifications in 1995.
NOTE B - CASH AND CASH EQUIVALENTS
Cash and cash equivalents at December 31 consist of the following:
<TABLE>
<CAPTION>
1995 1994
--------- ---------
<S> <C> <C>
Cash $ 8,012 $ 6,763
Certificates of deposit 1,200 1,200
Overnight investments 4,803 10,100
--------- ---------
$ 14,015 $ 18,063
--------- ---------
--------- ---------
</TABLE>
Included in cash and overnight investments are $2,000 and $3,000, respectively,
which are restricted pursuant to the Capital Offering - see NOTE N.
NOTE C - INVESTMENT SECURITIES - HELD TO MATURITY
The amortized cost and estimated fair value of investment securities held to
maturity at December 31, 1994 are summarized as follows:
<TABLE>
<CAPTION>
1994
----------------------------------------------
AMORTIZED GROSS UNREALIZED ESTIMATED
------------------- FAIR
COST GAINS LOSSES VALUE
--------- ------- -------- ---------
<S> <C> <C> <C> <C>
U.S. Government agency $ 25,009 $ (773) $ 24,236
Corporate notes 5,181 (96) 5,085
--------- ------- -------- ---------
$ 30,190 $ (869) $ 29,321
--------- ------- -------- ---------
--------- ------- -------- ---------
</TABLE>
During the first quarter of 1995, and subsequent to final regulatory guidelines
relating to the inclusion of unrealized gains and losses in Tier 1 Capital
calculations, the Company reclassified its held-to-maturity securities to
available-for-sale. These securities were then sold in the second quarter of
1995. At December 31, 1995 the Company has no held-to-maturities securities in
its portfolio.
F-14
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE D - INVESTMENT SECURITIES - AVAILABLE FOR SALE
The cost basis and estimated fair value of investment securities available for
sale at December 31 are summarized as follows:
<TABLE>
<CAPTION>
1995
--------------------------------------------------------------------------
GROSS UNREALIZED ESTIMATED
AMORTIZED ---------------------------------- FAIR
COST GAINS LOSSES VALUE
-------------- --------------- -------------- --------------
<S> <C> <C> <C> <C>
U.S. Government $ 62,787 $ 11 $ (5) $ 62,793
-------------- --------------- -------------- --------------
$ 62,787 $ 11 $ (5) $ 62,793
-------------- --------------- -------------- --------------
-------------- --------------- -------------- --------------
<CAPTION>
1994
--------------------------------------------------------------------------
GROSS UNREALIZED ESTIMATED
AMORTIZED ---------------------------------- FAIR
COST GAINS LOSSES VALUE
-------------- --------------- -------------- --------------
<S> <C> <C> <C> <C>
U.S. Government agency $ 220 $ 2,606 $ 2,826
Corporate notes 404 404
Asset management fund 10,729 (233) 10,496
-------------- --------------- -------------- --------------
$ 11,353 $ 2,606 $ (233) $ 13,726
-------------- --------------- -------------- --------------
-------------- --------------- -------------- --------------
</TABLE>
Within the available-for-sale amounts at year end 1995 are restricted U.S.
Government securities purchased with proceeds from the recapitalization of the
Company in December 1995. See NOTE N. These proceeds represent prefunded
interest expense associated with the Senior Notes and had a cost basis and fair
value of $4,845,000 and $4,856,000, respectively, at December 31, 1995.
The cost basis and estimated fair value of investment securities available for
sale at December 31, 1995 are summarized by contractual maturity as follows:
<TABLE>
<CAPTION>
ESTIMATED
FAIR
COST BASIS VALUE
---------- ---------
<S> <C> <C>
Due in less than one year $ 59,560 $ 59,558
Due in one year through five years 3,227 3,235
---------- ---------
$ 62,787 $ 62,793
---------- ---------
---------- ---------
</TABLE>
F-15
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE E - MORTGAGE-BACKED SECURITIES
The amortized cost and estimated fair value of mortgage-backed securities are
summarized as follows:
<TABLE>
<CAPTION>
U.S. AGENCY SECURITIES ISSUED BY
---------------------------------------------------------------------
FHLMC FNMA GNMA TOTAL
--------- --------- ----------- ---------
<S> <C> <C> <C> <C>
DECEMBER 31, 1994
Amortized cost $38,853 $18,414 $ 128 $57,395
Gross unrealized
Gains 211 59 270
Losses (2,162) (1,510) (3,672)
--------- --------- ----------- ---------
Estimated fair value $36,902 $16,904 $ 187 $53,993
--------- --------- ----------- ---------
--------- --------- ----------- ---------
</TABLE>
During December 1995, the Company, consistent with guidance issued in November
1995 by the FASB, reclassified all of its mortgage-backed securities from held-
to-maturity to available-for-sale. These securities were then liquidated prior
to year end at a net loss of $9,643. Sales of all securities available-for-
sale, including the mortgage-backed securities, during 1995, resulted in gross
gains of $3,764,000 and gross losses of ($724,000).
NOTE F - LOANS RECEIVABLE
Loans receivable at December 31 are summarized as follows:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
REAL ESTATE LOANS
PERMANENT
Single family residence
Non-project $ 257,457 $ 254,856
Loan concentrations 70,748 76,074
Multifamily
Two to four units 41,640 44,390
Five or more units 219,015 172,641
Commercial 31,258 7,757
Land 5,579 3,797
RESIDENTIAL CONSTRUCTION
SFR 21,987 3,270
Tract development 6,800 6,000
OTHER COLLATERALIZED LOANS 1,459 1,654
----------- -----------
GROSS LOANS RECEIVABLE 655,943 570,439
LESS
Participants' share (2,219) (3,072)
Undisbursed funds (15,208) (2,795)
Deferred fees and credits, net (5,996) (6,091)
Allowance for estimated credit losses (15,192) (21,461)
----------- -----------
NET LOANS RECEIVABLE $ 617,328 $ 537,020
----------- -----------
----------- -----------
</TABLE>
F-16
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
The table below summarizes the maturities for fixed rate loans and the repricing
intervals for adjustable-rate loans as of December 31, 1995:
<TABLE>
<CAPTION>
PRINCIPAL BALANCE
------------------------------------------------------
FIXED ADJUSTABLE
INTERVAL RATE RATE TOTAL
-------------- ------------- -------------
<S> <C> <C> <C>
1 to 3 months $ 355 $ 167,239 $ 167,594
4 to 6 months 321 266,315 266,636
7 to 12 months 1,721 58,509 60,230
1 to 2 years 2,633 2,633
3 to 5 years 18,700 18,700
6 to 10 years 13,446 13,446
11 to 20 years 30,333 30,333
More than 20 years 96,371 96,371
-------------- ------------- -------------
$ 163,880 $ 492,063 $ 655,943
-------------- ------------- -------------
-------------- ------------- -------------
</TABLE>
The contractual weighted average interest rates on loans at December 31, 1995
and 1994 were 8.25% and 7.17%, respectively.
The table below summarizes nonaccrual loans at December 31, by type of
collateral:
<TABLE>
<CAPTION>
1995 1994
---------- ----------
<S> <C> <C>
PERMANENT
Single family residences
Non-project $ 10,977 $ 14,028
Loan concentrations 4,140 11,497
Multifamily 4,844 9,463
Commercial 89
RESIDENTIAL CONSTRUCTION 3,546
LAND 1,748 773
---------- ----------
$ 21,709 $ 39,396
---------- ----------
---------- ----------
</TABLE>
F-17
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
The table below summarizes the amounts of interest revenue that would have been
recognized on troubled debt restructurings had borrowers paid at the original
loan interest rate throughout each of the years below, the interest revenue that
would have been recognized based upon the modified interest rate, and the
interest revenue that was included in the consolidated statements of operations
for the periods indicated. For this purpose, troubled debt restructurings
include loans with respect to which (1) the original interest rate was changed
for a defined period of time, (2) the loan's maturity was extended, or (3)
principal or interest payments were suspended for a defined period of time.
<TABLE>
<CAPTION>
PRINCIPAL ORIGINAL MODIFIED RECOGNIZED
BALANCE INTEREST INTEREST INTEREST
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1995
Permanent loans $ 24,029 $ 1,929 $ 1,707 $ 1,707
----------- ---------- ---------- ----------
$ 24,029 $ 1,929 $ 1,707 $ 1,707
----------- ---------- ---------- ----------
----------- ---------- ---------- ----------
YEAR ENDED DECEMBER 31, 1994
Construction loans 824 113 64 64
Permanent loans 9,404 933 633 626
----------- ---------- ---------- ----------
$ 10,228 $ 1,046 $ 697 $ 690
----------- ---------- ---------- ----------
----------- ---------- ---------- ----------
YEAR ENDED DECEMBER 31, 1993
Construction loans 22,601 2,857 1,981 240
Permanent loans 18,347 1,870 1,286 748
----------- ---------- ---------- ----------
$ 40,948 $ 4,727 $ 3,267 $ 988
----------- ---------- ---------- ----------
----------- ---------- ---------- ----------
</TABLE>
The table below summarizes the activity within the allowance for estimated
credit losses on loans for the years ended December 31:
<TABLE>
<CAPTION>
1995 1994 1993
-------------- ------------- -------------
<S> <C> <C> <C>
Balance at beginning of year $ 21,461 $ 46,629 $ 52,966
Provision for credit losses 14,850 5,298 10,747
Charge-offs (6,777) (889) (170)
Recoveries (72)
Transfers to allowance for
real estate losses
and other losses (14,342) (29,577) (16,842)
-------------- ------------- -------------
$ 15,192 $ 21,461 $ 46,629
-------------- ------------- -------------
-------------- ------------- -------------
</TABLE>
F-18
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
The Bank is a federally-chartered savings bank engaged in attracting deposits
from the general public and using those deposits together with borrowings and
other funds to originate residential real estate loans in areas near its nine
offices in Southern California. The Southern California region has continued to
experience adverse economic conditions, including declining real estate values.
These factors have adversely affected the ability of certain borrowers to repay
loans according to their stated terms. Although management believes the level
of allowance for estimated credit losses on loans is adequate to absorb losses
inherent in the loan portfolio, continuing weakness in the local economy may
result in increasing loan losses that cannot be reasonably predicted at December
31, 1995.
At December 31, 1995, the Company classified $13,159,000 of its loans as
impaired with a specific loss reserve of $3,426,000 and a general reserve of
$1,115,000, and $50,157,000 of its loans impaired with no specific loss reserve
and a general reserve of $5,095,000 determined in accordance with SFAS No. 114.
It is generally the Company's policy to place loans on nonaccrual status when
they are 30 days past due. Thereafter, interest income is no longer recognized
until the loan becomes current again. As such, interest income is recognized on
impaired loans to the extent they are not past due by 30 days or more. Interest
income of $4,356,000 was recognized during the year ended December 31, 1995.
The average recorded investment in impaired loans during the year ended December
31, 1995 was approximately $78,600,000.
NOTE G - REAL ESTATE OWNED
Real estate owned at December 31 is summarized as follows:
<TABLE>
<CAPTION>
1995 1994
----------- ------------
<S> <C> <C>
Single family residences
Non-project $ 4,975 $ 2,791
Loan concentrations 6,419 12,056
Multifamily 22,717 29,937
Commercial 346 395
Construction 15,414 39,516
Land 3,759 14,424
----------- ------------
Gross investment 53,630 99,119
Writedowns (3,897)
Allowance for estimated losses (15,725) (32,609)
----------- ------------
Net investment $ 37,905 $ 62,613
----------- ------------
----------- ------------
</TABLE>
The table below summarizes the allowance for estimated losses on real estate
owned for the years ended December 31:
<TABLE>
<CAPTION>
1995 1994 1993
------------ ------------- -------------
<S> <C> <C> <C>
Balance at beginning of year $ 32,609 $ 39,457 $ 15,173
Provision for estimated losses 5,100 18,662
Transfers from allowance for
estimated credit losses 13,792 29,577 16,842
Charge-offs (35,776) (36,425) (10,953)
Recoveries (267)
------------ ------------- -------------
Balance at end of year $ 15,725 $ 32,609 $ 39,457
------------ ------------- -------------
------------ ------------- -------------
</TABLE>
F-19
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
Real estate operations for the years ended December 31 are summarized as
follows:
<TABLE>
<CAPTION>
1995 1994 1993
------------ ------------- -------------
<S> <C> <C> <C>
Expenses associated with real
estate owned
Operating costs
Employee $ (749) $ (2,028) $ (367)
Operating (121) (347)
Professional (280) (1,349) (591)
------------ ------------- -------------
(1,150) (3,724) (958)
Property taxes (35) (1,965) (5,911)
Repairs, maintenance and
renovation (555) (361) (1,502)
Insurance (132) (329) (233)
Depreciation (474)
------------ ------------- -------------
(1,872) (6,379) (9,078)
Net gains from sales of
properties 2,547 2,980 330
Rental income, net 2,839 2,108 726
Provision for estimated losses (5,100) (18,662)
------------ ------------- -------------
$ (1,586) $ (1,291) $ (26,684)
------------ ------------- -------------
------------ ------------- -------------
</TABLE>
NOTE H - OFFICE PROPERTY AND EQUIPMENT - AT COST
Office property and equipment at December 31 consists of the following:
<TABLE>
<CAPTION>
1995 1994
------------ -------------
<S> <C> <C>
Office buildings $ 4,520 $ 4,911
Furniture and equipment 4,611 3,901
Leasehold improvements 2,249 1,944
------------ -------------
11,380 10,756
Less
Accumulated depreciation and amortization (3,225) (2,693)
Allowance for estimated loss on disposal
of offices (753)
------------ -------------
7,402 8,063
Land 2,195 2,475
------------ -------------
$ 9,597 $ 10,538
------------ -------------
------------ -------------
</TABLE>
F-20
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE I - DEPOSITS
The table below summarizes the balances of and weighted average interest rates
("WAIR") for the Company's deposits at December 31:
<TABLE>
<CAPTION>
1995 1994
-------------------- --------------------
WAIR BALANCE WAIR BALANCE
----- --------- ----- ----------
<S> <C> <C> <C> <C>
Money market savings and checking 1.42% 34,708 2.40% $ 86,443
Checking/NOW accounts 0.22% 29,156 0.92% 32,798
Passbook 1.82% 30,595 1.50% 27,327
Certificates of deposit
3.00% or less 650 5,308
3.01% - 4.00% 8,086 107,304
4.01% - 5.00% 133,168 233,735
5.01% - 6.00% 321,296 102,868
6.01% - 7.00% 128,055 42,157
7.01% - 8.00% 12,244 10,710
8.01% - 9.00% 50 621
9.01% or more 111
--------- ---------
5.04% $ 698,008 4.20% $ 649,382
------ --------- ------ ---------
------ --------- ------ ----------
</TABLE>
Interest expense on deposits, by type of account, for the years ended December
31 is summarized as follows:
<TABLE>
<CAPTION>
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Checking $ 485 $ 523 $ 1,450
Passbook 1,228 3,217 3,827
Certificates of deposit 31,880 25,954 31,285
--------- --------- ---------
$ 33,593 $ 29,694 $ 36,562
--------- --------- ---------
--------- --------- ---------
</TABLE>
Brokered deposits at December 31, 1995 mature as follows:
AMOUNT
--------
1996 $ 1,433
1997 99
-------
$ 1,532
-------
-------
The Company had public fund deposits of $199,000 and $496,000 in December 31,
1995 and 1994, respectively, from government agencies that are partially
collateralized by real estate loans having unpaid principal balances of
$2,314,000 and $2,862,000 at December 31, 1995 and 1994, respectively.
F-21
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE J - SHORT-TERM BORROWINGS
To supplement its funding needs, the Company entered into reverse repurchase
agreements, in which it sells securities with an agreement to repurchase the
same securities at a specific future date (overnight to 90 days). The Company
enters into such transactions only with dealers determined by management to be
financially strong and who are recognized as primary dealers in U.S. Treasury
securities by the Federal Reserve Board. The following schedule summarizes
information relating to the Company's reverse repurchase agreements for the
periods presented:
<TABLE>
<CAPTION>
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Average balance during the year $ 10,694 $ 14,333 $ 3,939
Average interest rate during the year 6.06% 5.23% 3.30%
Maximum month-end balance during the year 38,575 48,365 24,088
Mortgage-backed and agency securities
underlying the agreements at year end:
Carrying value 55,855
Estimated market value 52,506
Outstanding reverse repurchase agreements
Balance 47,141
Interest rate 5.85%
</TABLE>
The Company also borrows from the FHLB System as an additional source of funds
for operations. The FHLB system functions as a source of credit to savings
institutions which are members of a Federal Home Loan Bank. The Company may
apply for advances from the FHLB secured by the capital stock of the FHLB owned
by the Company and certain of the Company's mortgages and other assets
(principally obligations issued or guaranteed by the United States Government or
agencies thereof). Advances can be requested for any business purpose in which
the Company is authorized to engage. In granting advances, the FHLB considers a
member's credit worthiness and other relevant factors.
The company last obtained an advance from the FHLB in September 1995 for $15
million, which was repaid at maturity in December 1995. The Bank had pledged
real estate loans with an unpaid principal balance of $75,292,000 at December
31, 1995 to be used as collateral for advances from the FHLB.
F-22
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE K - INCOME TAXES
Provision (benefit) for income taxes for the years ended December 31 consists of
the following:
<TABLE>
<CAPTION>
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Current
Federal $ 615 $ (6,333) $ (11,153)
State 2 2
----------- ----------- -----------
617 (6,331) (11,153)
----------- ----------- -----------
Deferred
Federal 6,454 3,505
State
----------- ----------- -----------
6,454 3,505
----------- ------------ -----------
$ 617 $ 123 $ (7,648)
----------- ------------ -----------
----------- ------------ -----------
</TABLE>
The components of the net deferred income tax liability (asset) at December 31
are summarized as follows:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Deferred income tax liabilities
Loan fees $ 3,391 $ 3,429
Unrealized gain on securities 979
FHLB stock 1,187 1,081
Depreciation 719 771
Accrued interest 114
Other 493 919
----------- -----------
5,790 7,293
----------- -----------
Deferred income tax assets
Bad debts (10,637) (11,398)
State NOL carryforward (1,545) (1,932)
Federal AMT credit carryforward (936) (936)
Federal NOL carryforward (7,440) (348)
Delinquent interest (450) (450)
Reserve for loss on assets (337)
Other (1,166) (3,533)
----------- -----------
(22,174) (18,934)
----------- -----------
Valuation allowance (16,384) (11,641)
----------- -----------
Net deferred income tax assets $ 0 $ 0
----------- -----------
----------- -----------
</TABLE>
F-23
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
At September 30, 1995, the Company had (1) a federal net operating loss
carryforward of $1,024,000 expiring in 2009 and an estimated federal net
operating loss carryforward of $21,900,000 expiring in 2010, (2) state net
operating loss carryforwards of $2,099,000 and $2,241,000 expiring in 1997 and
1999, respectively and an estimated net operating loss carryforward of
$9,300,000 expiring in 2000, and (3) a federal alternative minimum tax credit
carryover of $936,000 which can be carried forward indefinitely.
The income tax (receivable) liability at December 31 consists of the following:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Current
Federal $ $ 365
State (2,630)
----------- -----------
(2,265)
----------- -----------
Deferred
Federal
Income tax asset (12,066) (6,548)
Valuation allowance 12,066 6,548
State
Income tax asset (4,318) (5,093)
Valuation allowance 4,318 5,093
----------- -----------
$ 0 $ 0
----------- -----------
----------- -----------
</TABLE>
During 1994, the Company received refundable federal income taxes of $22,767,000
stemming from carryback claims filed in 1994 for the tax years 1992, 1991, and
1990.
The table below summarizes the differences between the statutory income tax rate
and the Company's effective tax rate for the years ended December 31:
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Federal income tax (benefit) rate (35.00%) (35.00%) (35.00%)
Addition (reduction) in rate resulting from
Valuation allowance 40.00 69.20 14.80
Goodwill amortization and charge-off (1.20) (30.00) 1.40
California franchise tax, net of
federal income taxes
Other 0.70 0.10 (1.70)
-------- -------- --------
4.50% 4.30% 20.50%
-------- -------- --------
-------- -------- --------
</TABLE>
F-24
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE L - DISPOSITION OF DEPOSITS AND PREMISES
During 1995 and 1994, the Company sold certain of its branch deposits and sold
or closed the related branch facilities, consolidated deposits from certain
branches and sold the related facilities, and sold its two owned corporate
office buildings. The table below sets forth the composition of the net gain
realized from these transactions:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------
1995 1994 1993
--------- ----------- ----------
<S> <C> <C> <C>
Deposits sold $ 17,072 $ 186,534
--------- ----------- ----------
--------- ----------- ----------
Net premium received from sales of deposits 265 3,274
Loss on disposition of premises
Proceeds received 743 5,782
Net book value at disposition (922) (5,721)
Provision for loss on disposition (203) (500) (1,500)
--------- ----------- -----------
Net loss from disposition of premises (382) (439) (1,500)
Writeoff of intangibles (2,566)
--------- ----------- -----------
Net gain (loss) $ (117) $ 2,835 $ (4,066)
--------- ----------- -----------
--------- ----------- -----------
</TABLE>
During 1995, one branch was sold with deposits of $17,072,000. The Company
received a premium of $265,000 on these deposits as well as $743,000 for the
premises resulting in a gain of $86,000. Also during 1995, an agreement was
reached to sell a branch office facility at year end. The reserve for estimated
loss on this facility was $753,000. The sale was completed at no additional
loss to the Company in February 1996.
The table above also includes the sale of the Company's two owned corporate
headquarters buildings during 1994. These sales were financed by the Company
and the resulting financings have been discounted in order to produce a market
yield over the contractual terms of the loans. Including the discounted
financings, these two sales produced net proceeds of $2,319,000 compared with a
net book value at disposition of $1,902,000.
During 1994, reserves were established for the estimated future net lease
obligations associated with closed branch facilities. During 1993, reserves
were established for the estimated loss associated with the disposition,
completed during 1994, of the Company's owned corporate buildings. During 1993,
the Company wrote-off the remaining balance of intangible assets associated with
certain deposits and branch facilities acquired during the 1980's, based upon
management's conclusion that such intangibles retained no further value. The
branch deposits and related facilities to which these intangibles related were
sold during 1994.
F-25
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE M - EMPLOYEE BENEFIT PLANS
The Company has an Employee Stock Ownership Plan ("ESOP") that previously
covered substantially all employees over 21 years of age who met minimum service
requirements. The company froze the ESOP effective December 15, 1995. As part
of the freezing of the ESOP, all accounts under it became fully vested and
nonforfeitable as of December 15, 1995. The ESOP owns 173,447 shares of the
Company's common stock. As of December 31, 1995, the Company had a loan
receivable from the ESOP of $143,000 collateralized by 9,833 shares of common
stock owned by ESOP.
In place of the ESOP, the Company is establishing a 401(k) plan to be effective
April 1, 1996. The Bank will make a matching contribution equal to 100% of the
amount each participant elects to defer up to a maximum of 3% of the
participant's compensation for the calendar quarter. All individuals employed
on March 1, 1996 will be eligible to participate. Thereafter, the employee must
be employed for 6 months, have at least 500 hours, and be over 21 years of age.
The Company has a retirement income plan ("Retirement Plan") that previously
covered substantially all employees over 21 years of age who met minimum service
requirements. The Company does not have an accumulated post-retirement benefit
obligation associated with the Retirement Plan at December 31, 1995, as the
assets of the Retirement Plan exceeded the vested benefits of participants. At
that date, participant's benefits were fixed at their levels as of May 1989.
During 1993, the Company's Board of Directors established a stock option plan
("Option Plan") for the purpose of rewarding exemplary performance by key
employees of the Company and the Bank and to assist in the recruiting and
retaining key employees. The Option Plan was approved by stockholders in May
1994 and provides for the issuance of a maximum of 455,000 shares of common
stock of the Company. Participants that are granted options will have the right
to purchase a number of shares of common stock covered by the option for a fixed
period of time at a price determined at the time of grant.
Options to purchase 247,500 shares were granted during 1994 at prices ranging
from $13.48 to $14.75. Subsequent to the initial grants, the Board of Directors
approved a reduction of the option price for all outstanding options to the then
market price for the Company's common stock of $7.22. During 1995, these grants
were canceled and replaced with options to purchase 700,000 shares. 360,000 of
these options were issued to the senior executives at an exercise price of
$4.65. The remaining 340,000 shares were issued to other executives at an
exercise price of $5.26 per share.
NOTE N - CAPITAL OFFERING
The Company sold $27 million of "investment units" at a price of $500,000 per
unit in a private placement offering (the "Offering"), each investment unit
consisting of $250,000 principal amount of the Company's senior notes ("Senior
Notes"), five shares of the Company's cumulative preferred stock, series A
("Preferred Stock"), and a warrant to purchase 44,000 shares of the Company's
common stock ("Warrants"). The Company's contribution of $19 million of the net
proceeds of the Offering as qualifying Tier 1 capital into the Bank during
December satisfied the capital-raising provisions of a Prompt Correction Action
Directive ("PCA") issued in June by the OTS and enabled the Bank to meet the
quantitative requirements to be categorized as a "well-capitalized" institution.
Upon completion of the offering, the Company recorded the Senior Notes, with a
face amount of $13,500,000, at $11,994,000. The Senior Notes carry an annual
stated interest rate of 12% and have an annual effective yield of 16.5% after
the recording of Original Issue Discount ("OID") of $1,506,000. The OID will be
accreted using the constant yield method
F-26
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
over the five year term of the Senior Notes. During 1995, the Company recorded
$12,000 of OID as part of its interest expense. Interest, which is required to
be paid semi-annually at the stated interest rate, has been prefunded for 3
years out of the proceeds of the Offering. Of this $4,860,000 in prefunded
interest, $4,845,000 has since been invested in U.S. Government securities,
$10,000 was used to purchase interest on the securities and was recorded with
other assets, and $5,000 is still in cash. See NOTES B and D. Thereafter,
interest will be payable either in cash or in an equivalent value (determined in
accordance with the relevant agreement) in common stock of the Company.
The Company also recorded the receipt of $12,760,000 from the issuance of 270
shares of Preferred Stock with a par value of $.01 as capital in excess of par
value - preferred stock. The Preferred Stock requires quarterly dividends at an
annual rate of 18% on the $13,500,000 liquidating value of the stock. This
dividend is cumulative, but deferred for the first 18 months. Thereafter,
dividends will be payable either in cash or in an equivalent value (determined
in accordance with the provisions of the relevant agreement) in common stock of
the Company.
The Warrants are valued at $2,245,000 and entitle the holders to purchase 2.4
million shares of newly-issued common stock of the Company at a fixed price of
$2.25 per share. The Warrants are not exercisable for the first three years
following their issuance and will terminate ten years after their issuance.
The Company incurred offering expenses of $2,336,000 which were attributable
evenly to the Senior Notes and the Preferred Stock. The $1,168,000 attributable
to the Senior Notes has been capitalized and included with other assets and will
be amortized over the five year term of the Senior Notes. During 1995, the
Company recorded amortization of $11,000 related to these capitalized expenses.
The $1,168,000 attributable to the Preferred Stock has been recorded as a
reduction to capital in excess of par value - Preferred Stock.
NOTE O - STOCKHOLDERS' EQUITY
Retained earnings, which include bad debt deductions of approximately
$21,700,000 for federal income tax purposes at December 31, 1995, are restricted
and may be used only for the absorption of losses on loans and real estate
acquired through foreclosure. They are not subject to federal income tax unless
used for other purposes. The Company has not provided for federal income tax on
these amounts, since it is not contemplated that such amounts will be used for
purposes other than to absorb such losses.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989,
("FIRREA") and the capital regulations of the OTS promulgated thereunder (the
"Capital Regulations") established three capital requirements - a "leverage
limit," a "tangible capital requirement" and a "risk-based capital requirement."
These capital standards established by FIRREA are required, with certain
exceptions, to be no less stringent than the capital standards applicable to
national banks. The OTS may also establish, on a case-by-case basis, individual
minimum capital requirements for a savings institution which vary from the
requirements that would otherwise apply under the Capital Regulations.
The leverage limit currently included in the Capital Regulations requires a
savings institutions to maintain "core capital" of not less than 3.0% of
adjusted total assets. "Core Capital" generally includes common stockholders'
equity (including common stock, paid in capital, and permanent noncumulative
preferred stock) less intangible assets (other than certain mortgage servicing
rights and purchased credit card relationships).
The tangible capital requirement adopted by the OTS requires a savings
institution to maintain "tangible capital" in an amount not less than 1.5% of
adjusted total assets. "Tangible capital" means core capital less any
intangible assets (including supervisory goodwill), plus certain mortgage
service rights, subject to certain limitations.
F-27
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
The risk-based capital requirements provide, among other things, that the
capital ratios applicable to various classes of assets are to be adjusted to
reflect the degree of credit risk deemed to be associated with such assets. In
addition, the asset base for computing a savings institution's risk-based
capital requirement includes certain off-balance sheet items. Generally, the
Capital Regulations require savings institutions to maintain "total capital"
equal to 8.0% of risk-weighted assets. "Total Capital" for these purposes
consists of core capital and supplementary capital. Supplementary capital
includes, among other things and subject to certain limitations, general loan
valuation allowances. Such general valuation allowances can generally be
included up to 1.25% of risk-weighted assets. The Bank's supplementary capital
included $6,088,000 of general valuation allowances at December 31, 1995. A
savings institution's supplementary capital may be used to satisfy the risk-
based capital requirement only to the extent of that institution's core capital.
In measuring an association's compliance with all three standards under the
Capital Regulations, savings associations must deduct their investments in, and
advances to, subsidiaries engaged in activities not permissible for national
banks from their capital. In computing an association's total capital for
purposes of the risk-based capital standard, similar capital deduction and
phase-in provisions generally apply to: (a) other equity investments in equity
securities (not meeting the definition of a subsidiary) and in real estate and
(b) that portion of land loans and nonresidential construction loans in excess
of an 80% loan-to-value ratio. Under FIRREA, the Federal Deposit Insurance
Corporation ("FDIC") may suspend deposit insurance for an association that has
no tangible capital (computed by considering qualifying supervisory goodwill).
Any savings association that is not in compliance with its regulatory capital
requirements must, within 60 days from the date the savings association falls
out of compliance, submit a capital plan acceptable to the OTS demonstrating how
the savings association will meet applicable capital standards. The OTS places
an asset growth restriction on all institutions failing any of the three capital
standards pending review of their capital plans and consideration of future
growth restrictions.
The OTS may treat the failure of any savings association to maintain capital at
or above the minimum required levels or to comply with an approved capital plan
as an "unsafe and unsound practice." In general, unsafe and unsound practices
are subject to a number of enforcement actions, including the appointment of a
conservator or receiver.
An OTS regulated institution is required to maintain additional risk-based
capital equal to half of the amount by which a decline in its "net portfolio
equity" that would result from a hypothetical 200 basis point change (up or down
depending on which would result in the greater reduction in net portfolio value)
in interest rates on its assets and liabilities exceeds 2% of the institution's
estimated "economic value" or its assets. In order to preserve the prompt
corrective action capital category system (described below) the regulation
requires that the foregoing amount be subtracted from actual capital rather than
requiring that an institution's normal capital requirements be increased by that
amount. The OTS states that implementation of this amendment to its regulations
will require additional capital to be maintained only by institutions having
"above normal" interest rate risk. An institution's "net portfolio value" is
defined for this purpose as the difference between the aggregate expected future
cash outflows on its liabilities, plus the net expected cash inflows from
existing off-balance sheet contracts, each discounted to present value. The
estimated "economic value" of an institution's assets is defined as the
discounted present value of the estimated future cash flows from its assets. At
December 31, 1995, the OTS had temporarily suspended the implementation of its
interest rate risk regulation. Had the regulation been in effect at December
31, 1995, the Bank would not have been required to deduct from risk-based
capital any amount due to an interest rate risk exposure component using the
Bank's reported balance sheet information as of September 30, 1995.
FIRREA and the capital regulations require the Bank to maintain (1) Tangible
Capital of at least 1.5% of Adjusted Total Assets (as defined in the
regulations); (2) Core Capital of at least 3.0% of Adjusted Total Assets (as
defined in
F-28
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
the regulations); and (3) Total Risk-based Capital equal to 8.0% of Total
Risk-weighted Assets (as defined in the regulations).
The following table summarizes the regulatory capital requirements under FIRREA
for the Bank at December 31, 1995. 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>
Stockholders' equity (1) $ 43,539 $ 43,539 $ 43,539
Adjustments
General valuation
allowances 6,088
Core deposit intangibles (179) (179) (179)
Interest rate risk component (2)
------------ ------------ ------------ ------------ ------------ ------------
Regulatory capital 43,360 5.80% 43,360 5.80% 49,448 10.27%
Require minimum 11,213 1.50% 22,425 3.00% 38,508 8.00%
------------ ------------ ------------ ------------ ------------ ------------
Excess capital $ 32,147 4.30% $ 20,935 2.80% $ 10,940 2.27%
------------ ------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------ ------------
Adjusted assets (3) $ 747,510 $ 747,510 $ 481,347
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
____________________
(1) The Bank's total stockholders' equity, exclusive of the unrealized
loss of $5,000 on available-for-sale securities, was 5.82% of its
total assets at December 31, 1995. The Company contributed cash of
$20 million to the Bank during 1995 to improve the capital position of
the Bank, including $19 million in December 1995 after successful
completion of the private placement, to satisfy the requirements of
the PCA Directive. SEE CAPITALIZATION.
(2) At December 31, 1995, the OTS had temporarily suspended the
application of its interest rate risk regulation. Had the regulation
been in effect at December 31, 1995, 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 September 30, 1995.
(3) The term "adjusted assets" refers to the term "adjusted total assets"
as defined in 12 C.F.R. Section 567.1(a) for purposes of tangible and
core capital requirements, and for purposes of risk-based capital
requirements, refers to the term "risk-weighted assets" as defined in
12 C.F.R. Section 567.1(b).
F-29
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
Under the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"),
which supplemented FIRREA, the OTS has issued "prompt corrective action"
regulations with specific capital ranking tiers for thrift institutions.
Progressively more stringent operational limitations and other corrective
actions are required as an institution declines in the capital ranking tiers.
The five qualifying tiers are set forth below.
<TABLE>
<CAPTION>
RATIO OF RATIO OF
RATIO OF CORE CAPITAL TO TOTAL CAPITAL TO
CORE CAPITAL RISK-WEIGHTED 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 December 31, 1995 are set forth below.
Ratio of Core Capital to Total Assets (Leverage ratio) 5.80%
Ratio of Core Capital to Risk-weighted Assets 9.01%
Ratio of Total Capital to Risk-weighted Assets 10.27%
At December 31, 1995, the Bank's capital ratios exceeded the capital ratio
requirements for the Bank to qualify as a "well capitalized" institution.
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.
NOTE P - REGULATORY MATTERS
In early 1993, the OTS completed its annual examination of the Bank, and issued
its report thereon, dated March 5, 1993. In their report, the OTS concluded
that the Bank's future viability was threatened by inadequacies in the Board of
Directors and management, deteriorating asset quality and moderate-to-high
interest rate risk. The Board of Directors was advised to restructure itself
and to strengthen management, to commence actions to improve loan underwriting
controls, to improve the internal asset review system, to reduce large
concentrations of construction and land loans to certain developer borrowers and
to improve the internal audit department. The OTS also communicated its
intention to consider assessing civil money penalties against current and former
Directors of the
F-30
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
Bank arising from the perceived noncompliance with the previously issued cease
and desist order and letter directive. In connection with the OTS' examination,
additional provisions for loan and real estate losses were recorded, in the
aggregate amount of $54,617,000, as of September 30, 1992.
On March 31, 1993, the Company's and the Bank's President and Chief Executive
Officer, Vernon Herbst retired. In July 1993, the Board of Directors of the
Company and the Bank hired a new President and Chief Executive Officer, Scott A.
Braly. Mr. Braly was approved by the OTS prior to commencing his employment.
During the period from August through December 1993, a full complement of senior
management was hired covering each of the Bank's line and staff units, and
previous management was either terminated or reassigned. Subsequent to the OTS'
1992/1993 examination, two new non-management Directors were appointed by the
Boards of Directors of the Bank and the Company.
On June 30, 1995, the Bank and its Board of Directors stipulated and consented
to the issuance of a prompt corrective action directive ("PCA Directive") issued
by the OTS, the Bank's primary regulator. The PCA Directive was issued as a
condition of acceptance by the OTS of the Bank's capital restoration plan. The
Directive required the Bank, among other things, (i) to comply with the terms of
the revised business plan, (ii) to achieve a capital infusion of between $15
million and $20 million by December 15, 1995, (iii) to retain an investment
banking firm to assist in the recapitalization of the Bank, (iv) to comply with
all of the mandatory prompt corrective action provisions automatically
applicable to the Bank based on its prompt corrective action capital category,
and (v) to maintain its total assets at a level not to exceed its total assets
as of year end 1994. Unless otherwise approved by the OTS, the Directive also
required that the Bank comply with an OTS-approved time schedule specifying
dates between the execution of the Directive and December 15, 1995 by which the
Bank must complete specific intermediate steps toward achievement of the capital
infusion required by the Directive. Failure to comply with the Directive could
have resulted in a forced sale of the Bank at a distressed price under
regulatory compulsion or the appointment of a conservator or receiver for the
Bank. In addition, the Directive stated that it does not prevent the OTS from
taking any other type of supervisory, enforcement or resolution action that the
OTS determines to be appropriate.
In early December 1995, the Company successfully completed the sale of $27
million of "investment units" by the Company in a private placement. The
investment units consist of equal amounts of senior notes and a new class of
preferred stock, together with warrants to purchase common stock of the Company.
The Company's contribution of $19 million of the net proceeds of the private
placement as qualifying Tier 1 capital into the Bank during December satisfied
the PCA Directive. With the infusion of capital into the Bank, the OTS
terminated the PCA Directive and released the Bank from its capital plan - SEE
NOTE N.
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 FIRREA. The SAIF
insures the deposits of savings institutions and other institutions that were
insured by the FSLIC prior to enactment of FIRREA. The FDIC is authorized to
increase deposit insurance premiums, if it determines such increases are
appropriate, to maintain the reserves of either the SAIF or the BIF or to fund
the administration of the FDIC. In addition, the FDIC is authorized to levy
emergency special assessments on BIF and SAIF members.
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% (subject to a statutory minimum
of $2,000 in annual
F-31
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
assessments) to .27% of insured deposits, with an historical low average of
approximately .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 .23% to .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. If the 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 the Congress and signed by the President.
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
shareholders in excess of current or accumulated earnings and profits, or
redemptions, or in the event of liquidations or certain mergers or other
corporate transactions.
Management cannot predict whether or in what form the above described
legislation 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 shareholders 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.
NOTE Q - DERIVATIVE FINANCIAL INSTRUMENTS
The Company has only limited involvement with derivative financial instruments
and does not use them for trading purposes. They are used to manage well-
defined interest rate risks.
Interest rate cap agreements are used to reduce the potential impact of
increases in interest rates on repriceable liabilities. At December 31, 1995,
the Company was a party to one interest rate cap agreement, with a notional
amount of $450,000,000 and an expiration in March 1996. The Company had not
entered into any other derivative instrument contracts at December 31, 1995.
The agreement entitles the Company to receive from the counterparty,
F-32
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
on a quarterly basis, the amount, if any, of the excess of the 3 month LIBOR
rate over 7.34%. The Company amortizes the cost of this cap over its life.
The unamortized premium at December 31, 1995 was $23,000.
The Company is exposed to credit losses in the event of nonperformance by the
counterparties to its interest rate caps but has no off-balance-sheet credit
risk of accounting loss. The Company anticipates that the counterparty will be
able to fully satisfy its obligation under the contract. The Company does not
obtain collateral or other security to support financial instruments subject to
credit risk but monitors the credit standing of counterparties.
NOTE R - COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company had a number of lawsuits and claims pending December 31, 1995.
Management and its legal counsel do not believe that disposition of such
lawsuits and pending claims will have a material adverse effect upon the
Company's consolidated financial position or results of operations.
LENDING COMMITMENTS
At December 31, 1995, the Company had outstanding commitments to originate
loans of $27,639,000 and had commitments to fund the undisbursed portion of
existing construction loans of $14,899,000.
ERRORS AND OMISSIONS INSURANCE
The Company had a mortgagee's errors and omissions insurance policy as of
December 31, 1995. The Company did not have errors and omissions insurance on
other aspects of its operation.
LEASES
The Company has entered into agreements to lease certain office facilities under
operating leases which expire at various dates to the year 2009. The leases
generally provide that the Company pay property taxes, insurance and other
items. Current rental commitments for the remaining terms of these
noncancelable leases are as follows:
AMOUNT
---------
1996 $ 1,142
1997 1,128
1998 1,134
1999 1,140
Thereafter 2,165
---------
$ 6,709
---------
---------
Lease expense for office facilities was $966,000, $767,000, and $809,000 for the
years ended December 31, 1995, 1994 and 1993, respectively.
F-33
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE S - ESTIMATED FAIR VALUE INFORMATION
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, "Disclosures about
Fair Value of Financial Instruments." The estimated fair value amounts have
been determined by the Company using available market information and
appropriate valuation methodologies. However, considerable judgment is required
to interpret market data to develop the estimates of fair value. Accordingly,
the estimates presented herein are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of different market
assumptions and or estimation methodologies may have a material effect on the
estimated fair value amounts.
<TABLE>
<CAPTION>
1995 1994
-------------------------- --------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Assets
Cash and cash equivalents $ 14,015 $ 14,015 $ 18,063 $ 18,063
Investment securities 62,787 62,793 43,916 43,047
Mortgage-backed securities 57,395 53,993
Loans receivable 617,328 627,090 537,020 504,465
----------- ----------- ----------- -----------
$ 694,130 $ 703,898 $ 656,394 $ 619,568
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Liabilities
Deposits
Money market savings and checking $ 34,708 $ 34,675 $ 86,443 $ 86,289
Passbook 30,595 30,557 27,327 27,293
Checking 26,241 26,220 32,798 32,771
Certificates of deposits 603,549 590,080 502,814 465,775
Noninterest bearing demands 2,915 2,915
Reverse repurchase agreements 47,141 46,906
----------- ----------- ----------- -----------
$ 698,008 $ 684,447 $ 696,523 $ 659,034
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
The methods and assumptions used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value are
explained below.
For cash and cash equivalents, the carrying amount is considered to be their
estimated fair value.
For investment securities and mortgage-backed securities, fair values are based
on quoted market prices obtained from an independent pricing service (NOTES A, D
and E).
The carrying amount of loans receivable is their contractual amounts outstanding
reduced by net deferred loan origination fees and the allowance for loan losses
(NOTE F). Variable rate loans consist primarily of loans whose interest rates
float with changes in either a specified bank's reference rate or the FHLB
eleventh district cost of funds index.
The fair value of both variable and fixed rate loans was estimated by
discounting the remaining contractual cash flows using the estimated current
rate at which similar loans would be made to borrowers with similar credit risk
characteristics over the same remaining maturities, reduced by net deferred loan
origination fees and the allocable
F-34
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
portion of the allowance for the loan losses. The estimated current rate for
discounting purposes was not adjusted for any change in borrowers' credit risks
since the origination of such loans. Rather, the allocable portion of the
allowance for loan losses is considered to provide for such changes in
estimating fair value.
The fair value of nonaccrual loans (NOTE F) has been estimated at their carrying
amount as it is practicable to reasonably assess the credit risk adjustment that
would be applied in the market place for such loans.
The withdrawable amounts for checking accounts are considered to be stated at
their estimated fair value. The fair value of passbook accounts and fixed-
maturity certificates of deposits is estimated using the rates currently offered
for deposits of similar remaining maturities.
The fair value of reverse repurchase agreements is estimated using the rates
currently offered on similar collateral.
The fair value of the interest rate cap is based upon the quoted termination
price as of the reporting date, as provided by independent dealers in these
instruments. As such, the interest rate cap had no fair value at year end.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 1995. Although management is not
aware of any factors that would significantly affect the estimated fair value
amounts, such amounts have not been comprehensively revalued for purposes of
these financial statements since that date and, therefore, current estimates of
fair value may differ significantly from the amounts presented above.
F-35
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLARS AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE T - SEPARATE PARENT COMPANY FINANCIAL STATEMENTS
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1995 1994
---------- ----------
<S> <C> <C>
ASSETS
Cash at the Bank $ 1,829 $ 1,069
Investment securities 4,856
Loans receivable 876
Real estate owned 753
Investment in subsidiary 43,534 38,438
Other assets 1,216 24
---------- ----------
$ 51,435 $ 41,160
---------- ----------
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and other liabilities $ 463 $ 333
Senior debt 12,006
---------- ----------
$ 12,469 $ 333
Stockholders' equity
Capital stock 26 2,605
Cumulative perpetual preferred stock, series A
Capital in excess of par value - common stock 7,745 2,921
Capital in excess of par value - preferred stock 11,592
Unrealized gain on available-for-sale securities 6 1,393
Retained earnings - partially restricted 19,788 34,122
---------- ----------
39,157 41,041
Less
Treasury stock, at cost - 5,400 shares (48) (48)
Loan to Bank ESOP (143) (166)
---------- ----------
38,966 40,827
---------- ----------
$ 51,435 $ 41,160
---------- ----------
---------- ----------
</TABLE>
F-36
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLARS AMOUNTS IN TABLES ARE IN THOUSANDS)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------
1995 1994 1993
--------- ---------- ----------
<S> <C> <C> <C>
Interest revenues
Interest income
Loans $ 49 $ 79 $ 91
Investments 13
From subsidiary 12 30 70
--------- ---------- ----------
Total interest revenues 74 109 161
Interest costs (92)
Provision for credit losses (648)
--------- ---------- ----------
Net interest margin (18) 109 (487)
Noninterest revenues 49 96 276
Operating costs (515) (471) (853)
Real estate operations, net (102)
Loss on sale of loans (89)
--------- ---------- ----------
Pretax loss before equity in
loss of subsidiary (675) (266) (1,064)
Income taxes (37)
--------- ---------- ----------
Loss before equity in
loss of subsidiary (712) (266) (1,064)
Equity in loss of subsidiary (13,505) (2,697) (28,546)
--------- ---------- ----------
Net loss $ (14,217) $ (2,963) $ (29,610)
--------- ---------- ----------
--------- ---------- ----------
</TABLE>
F-37
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLARS AMOUNTS IN TABLES ARE IN THOUSANDS)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating actvities
Net loss $ (14,217) $ (2,963) $ (29,610)
Adjustments
Equity in undistributed loss of subsidiary 13,505 2,697 28,546
Depreciation and amortization 112
Provision for credit losses 648
Increase in interest receivable (13)
Loss on sale of REOs 80
Decrease (increase) in other assets (1,178) 12
Increase (decrease) in accounts payable and other liabilities 14 (169) (252)
----------- ----------- -----------
Net cash used in operating activities (1,697) (435) (656)
----------- ----------- -----------
Cash flows from investing activities
Purchases of securities (4,845)
Sales of loans receivable 760
Collection of loans receivable 16 76 98
Net proceeds from real estate owned 671 (3) (11)
----------- ----------- -----------
Net cash provided (used) in investing activities (3,398) 73 87
----------- ----------- -----------
Cash flows from financing activities
Net collection of ESOP loan 23 21 21
Cash dividend paid (651)
Cash contribution to subsidiary (20,000) (750)
Net proceeds from issuance of senior notes 11,994
Net proceeds from issuance of preferred stock 12,760
Net proceeds from issuance of warrants 1,078
----------- ----------- -----------
Net cash provided (used) in financing activities 5,855 (729) (630)
----------- ----------- -----------
Increase (decrease) in cash 760 (1,091) (1,199)
Cash at beginning of year 1,069 2,160 3,359
----------- ----------- -----------
Cash at end of year $ 1,829 $ 1,069 $ 2,160
----------- ----------- -----------
----------- ----------- -----------
Non-cash investing and financing items
Real estate acquired in settlement of loans $ 1,398
Net unrealized gain (loss) on available-for-sale securities $ 11 $ (180) 1,573
</TABLE>
F-38
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLARS AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE U - QUARTERLY INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------
MAR 31, JUNE 30, SEP 30, DEC 31,
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1995
Interest revenues $ 13,214 $ 12,718 $ 12,858 $ 14,596
Interest costs (7,913) (8,487) (8,806) (9,280)
---------- ---------- ---------- ----------
Net interest margin before contractual
interest on nonaccrual loans 5,301 4,231 4,052 5,316
Contractual interest on nonaccrual loans (730) (677) (420) (565)
---------- ---------- ---------- ----------
Net interest margin 4,571 3,554 3,632 4,751
Provision for credit losses (12,745) (1,700) (450)
---------- ---------- ---------- ----------
Net interest margin after provision
for credit losses (8,174) 3,554 1,932 4,301
Noninterest revenues 683 364 536 135
Operating costs (5,121) (4,919) (4,375) (4,774)
Real estate operations, net 166 651 (2,989) 586
Other income 2,902 215 450 277
---------- ---------- ---------- ----------
(9,544) (135) (4,446) 525
Income taxes (585) (32)
---------- ---------- ---------- ----------
Net earnings (loss) $ (10,129) $ (135) $ (4,478) $ 525
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Earnings (loss) per share (1) $ (3.90) $ (0.05) $ (1.72) $ 0.13
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
- ----------------------
(1) Calculated using the modified Treasury method.
F-39
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLARS AMOUNTS IN TABLES ARE IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------
MAR 31, JUNE 30, SEP 30, DEC 31,
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1994
Interest revenues $ 14,206 $ 13,793 $ 14,011 $ 13,227
Interest costs (7,490) (7,232) (8,001) (7,720)
---------- ---------- ---------- ----------
Net interest margin before contractual
interest on nonaccrual loans 6,716 6,561 6,010 5,507
Contractual interest on nonaccrual loans (1,654) (1,595) (1,429) (988)
---------- ---------- ---------- ----------
Net interest margin 5,062 4,966 4,581 4,519
Provision for credit losses (84) (1,063) (1,314) (2,837)
---------- ---------- ---------- ----------
Net interest margin after provision 4,978 3,903 3,267 1,682
for credit losses
Noninterest revenues 748 373 297 555
Operating costs (5,045) (5,151) (5,089) (4,902)
Real estate operations (1,182) (125) (131) 147
Disposition of deposits and premises 77 2,437 321
---------- ---------- ---------- ----------
(501) (923) 781 (2,197)
Income taxes (81) (45) (11) 14
---------- ---------- ---------- ----------
Net earnings (loss) $ (582) $ (968) $ 770 $ (2,183)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Earnings (loss) per share $ (0.22) $ (0.37) $ 0.30 $ (0.85)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
F-40
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLARS AMOUNTS IN TABLES ARE IN THOUSANDS)
NOTE V - CONSOLIDATING SCHEDULES
<TABLE>
<CAPTION>
HAWTHORNE HAWTHORNE
SAVINGS FINANCIAL ELIMINATIONS CONSOLIDATED
----------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents $ 14,009 $ 1,829 $ (1,823) $ 14,015
Investment securities 57,937 4,856 62,793
Investment in subsidiary 43,534 (43,534)
Loans receivable, net 617,316 12 617,328
Real estate owned, net 37,905 37,905
Accrued interest receivable 3,570 13 3,583
FHLB stock 6,312 6,312
Office property and equipment 9,597 9,597
Other assets 859 1,203 (12) 2,050
----------- ----------- ----------- -----------
$ 747,505 $ 51,435 $ (45,357) $ 753,583
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits $ 699,831 $ - $ (1,823) $ 698,008
Accounts payable and other liabilities 4,140 463 4,603
Senior debt 12,006 12,006
----------- ----------- ----------- -----------
703,971 12,469 (1,823) 714,617
Stockholders' equity
Capital stock 150 26 (150) 26
Preferred Stock
Capital in excess of par
value - common stock 765 7,745 (765) 7,745
Capital in excess of par
value - preferred stock 11,592 11,592
Unrealized gain (loss) on available for
for sale securities 6 6
Retained earnings 42,619 19,788 (42,619) 19,788
----------- ----------- ----------- -----------
43,534 39,157 (43,534) 39,157
Less
Treasury stock (48) (48)
Loan to Bank ESOP (143) (143)
----------- ----------- ----------- -----------
43,534 38,966 (43,534) 38,966
----------- ----------- ----------- -----------
$ 747,505 $ 51,435 $ (45,357) $ 753,583
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
F-41
<PAGE>
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1995
(DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)
<TABLE>
<CAPTION>
HAWTHORNE HAWTHORNE
SAVINGS FINANCIAL ELIMINATIONS CONSOLIDATED
---------- ---------- ---------- ------------
<S> <C> <C> <C> <C>
Interest revenues
Loans $ 47,818 $ 49 $ (89) $ 47,778
Investments 2,386 25 (12) 2,399
Mortgage-backed securities 3,209 3,209
------------ ------------ ------------ ------------
53,413 74 (101) 53,386
Interest costs
Deposits (33,605) 12 (33,593)
Borrowings (801) (92) (893)
------------ ------------ ------------ ------------
(34,406) (92) 12 (34,486)
Net interest margin before contractual
interest on nonaccrual loans 19,007 (18) (89) 18,900
Contractual interest on nonaccrual loans (2,392) (2,392)
------------ ------------ ------------ ------------
Net interest margin 16,615 (18) (89) 16,508
Loan provision for credit losses (14,895) (14,895)
------------ ------------ ------------ ------------
Net interest margin after provision
for credit losses 1,720 (18) (89) 1,613
Noninterest revenues 1,730 49 (61) 1,718
Operating costs
Employee (9,807) (87) (9,894)
Occupancy (2,841) (2,841)
Operating (2,725) (229) 61 (2,893)
Professional (1,100) (199) (1,299)
SAIF Premium and OTS assessment (2,213) (2,213)
Goodwill amortization (49) (49)
------------ ------------ ------------ ------------
(15,285) (484) (89) (15,858)
Real estate operations (1,484) (102) (1,586)
Gain on sale of securities 3,040 3,040
Other, net 804 (89) 89 804
------------ ------------ ------------ ------------
(12,925) (675) - (13,600)
Pretax loss before income taxes
and equity in loss of subsidiary (12,925) (675) (13,600)
Income taxes (580) (37) (617)
------------ ------------ ------------ ------------
Loss before equity in loss
of subsidiary (13,505) (712) (14,217)
Equity in loss of subsidiary (13,505) 13,505
------------ ------------ ------------ ------------
NET EARNINGS (LOSS) $ (13,505) $ (14,217) $ 13,505 $ (14,217)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
F-42
<PAGE>
MANAGEMENT'S ASSERTION REPORT
January 26, 1996
To our Stockholders:
FINANCIAL STATEMENTS
The management of Hawthorne Financial Corporation ("Company") and its
subsidiary, Hawthorne Savings, F.S.B. is responsible for the preparation,
integrity, and fair presentation of its published financial statements and all
other information presented in this annual report. The financial statements
have been prepared in accordance with generally accepted accounting principles
("GAAP") and, as such, include amounts based on judgments and estimates made by
management.
The financial statements have been audited by an independent accounting firm,
which was given unrestricted access to all financial records and related data,
including minutes of all meetings of stockholders, the Board of Directors and
committees of the Board. Management believes that all representations to the
independent auditors during their audit were valid and appropriate.
INTERNAL CONTROL
Management is responsible for establishing and maintaining an effective internal
control structure over financial reporting, presented in conformity with both
GAAP and the Office of Thrift Supervisors ("OTS") instructions for the Thrift
Financial Report ("TFR"). The structure contains monitoring mechanisms, and
actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any structure of internal
control, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even an effective internal control
structure can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the
effectiveness of an internal control structure may vary over time.
Management assessed the Company's internal control structure over financial
reporting presentation in conformity with both GAAP and TFR instructions as of
December 31, 1995. The assessment was based on criteria for effective internal
control over financial reporting described in INTERNAL CONTROL - INTEGRATED
FRAMEWORK issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on this assessment, management believes that the Company
maintained an effective internal control structure over financial reporting
presented in conformity with both GAAP and TFR instructions, as of December 31,
1995.
The Audit Committee of the Board of Directors is comprised entirely of outside
directors who are independent of management; it includes members with banking or
related management experience, has access to its own outside counsel, and does
not include any large customers of the Company. The Audit Committee is
responsible for recommending to the Board of Directors the selection of
independent auditors. It meets periodically with management, the independent
auditors, and the internal auditors to ensure that they are carrying out their
responsibilities. The Audit Committee is also responsible for performing an
oversight role by reviewing the Company's financial reports. The independent
auditors and the internal auditors have full and free access to the Audit
Committee, with or without the presence of management, to discuss the adequacy
of the internal control structure for financial reporting and any other matter
which they believe should be brought to the attention of the Audit Committee.
F-43
<PAGE>
COMPLIANCE WITH LAWS AND REGULATIONS
Management is also responsible for ensuring the compliance with federal laws and
regulations concerning loans to insiders and federal and state laws and
regulations concerning dividend restrictions, both of which are designated by
the FDIC as safety and soundness standards.
Management assessed its compliance with the designated safety and soundness laws
and regulations and has maintained records of its determinations and assessments
as required by the OTS. Based on this assessment, Management believes that the
Company has complied, in all material respects, with the designated safety and
soundness laws and regulations for the year ended December 31, 1995.
/S/ SCOTT BRALY /s/ NORMAN MORALES
- -------------------------------- --------------------------------
Scott A. Braly Norman A. Morales
President and Executive Vice President and
Chief Executive Officer Chief Financial Officer
F-44
<PAGE>
INDEPENDENT ACCOUNTANTS' REPORT
To the Audit Committee
Hawthorne Financial Corporation
Hawthorne, California
We have examined management's assertion that, as of December 31, 1995,
Hawthorne Financial Corporation ("the Company") and its subsidiary, Hawthorne
Savings, F.S.B. maintained an effective internal control structure over
financial reporting presented in conformity with both generally accepted
accounting principles and the Office of the Thrift Supervision Instructions for
Thrift Financial Reports included in the accompanying management's assertion
report.
Our examination was made in accordance with standards established by the
American Institute of Certified Public Accountants, and, accordingly, included
obtaining an understanding of the internal control structure over financial
reporting, and such other procedures as we considered necessary in the
circumstances. We believe that our examination provides a reasonable basis for
our opinion.
Because of inherent limitations in any internal control structure, errors
or irregularities may occur and not be detected. Also, projections of any
evaluation of the internal control structure over financial reporting to future
periods are subject to the risk that the internal control structure may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies may deteriorate.
In our opinion, management's assertion that, as of December 31, 1995, the
Company maintained an effective internal control structure over financial
reporting presented in conformity with both generally accepted accounting
principles and the Office of Thrift Supervision Instructions for Thrift
Financial reports is fairly stated, in all material respects, based on the
criteria established in INTERNAL CONTROL - INTEGRATED FRAMEWORK issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
DELOITTE & TOUCHE LLP
January 26, 1996
Los Angeles, California
F-45
<PAGE>
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement (No.
33-74800) of Hawthorne Financial Corporation on Form S-8 of our report dated
january 26, 1996, appearing in the Annual Report on Form 10-K of Hawthorne
Financial Corporation for the year ended December 31, 1995.
DELIOTTE & TOUCHE LLP
March 26, 1996
Los Angeles, California
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> DEC-31-1995
<CASH> 5,763
<INT-BEARING-DEPOSITS> 8,252
<FED-FUNDS-SOLD> 4,803
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 62,793
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 632,520
<ALLOWANCE> 15,192
<TOTAL-ASSETS> 753,583
<DEPOSITS> 698,008
<SHORT-TERM> 0
<LIABILITIES-OTHER> 4,603
<LONG-TERM> 12,006
0
0
<COMMON> 26
<OTHER-SE> 38,940
<TOTAL-LIABILITIES-AND-EQUITY> 753,583
<INTEREST-LOAN> 47,778
<INTEREST-INVEST> 5,608
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 53,386
<INTEREST-DEPOSIT> 33,593
<INTEREST-EXPENSE> 34,486
<INTEREST-INCOME-NET> 16,508
<LOAN-LOSSES> 14,895
<SECURITIES-GAINS> 3,040
<EXPENSE-OTHER> 20,775
<INCOME-PRETAX> (13,600)
<INCOME-PRE-EXTRAORDINARY> (13,600)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (14,217)
<EPS-PRIMARY> (5.52)
<EPS-DILUTED> 0
<YIELD-ACTUAL> 2.20
<LOANS-NON> 21,709
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 21,461
<CHARGE-OFFS> 6,777
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 15,192
<ALLOWANCE-DOMESTIC> 15,192
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
