<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
------------------------
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER 0-1100
HAWTHORNE FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 95-2085671
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
2381 ROSECRANS AVENUE, EL SEGUNDO, CA 90245
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES) (ZIP CODE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 725-5000
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date: The Registrant had 5,194,996
shares of Common Stock, $0.01 par value per share outstanding, as of October 30,
1998.
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<PAGE> 2
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q INDEX
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
PART I -- FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
Item Financial Statements
1....
Consolidated Statements of Financial Condition at September
30, 1998 and December 31, 1997.............................. 3
Consolidated Statements of Operations for the Three Months
and Nine Months Ended September 30, 1998 and 1997........... 4
Consolidated Statement of Stockholders' Equity for the Nine
Months Ended September 30, 1998............................. 5
Consolidated Statements of Cash Flows for the Three Months
and Nine Months Ended September 30, 1998 and 1997........... 6
Notes to Consolidated Financial Statements.................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 9
Item 3. Quantitative and Qualitative Disclosure About Market Risk... 29
</TABLE>
PART II -- OTHER INFORMATION
<TABLE>
<S> <C> <C>
Item 1. Legal Proceedings........................................... 31
Item 2. Changes in Securities....................................... 31
Item 3. Defaults upon Senior Securities............................. 31
Item 4. Submission of Matters to a Vote of Security Holders......... 31
Item 5. Other Information........................................... 31
Item 6. Exhibits and Reports on Form 8-K............................ 31
</TABLE>
FORWARD-LOOKING STATEMENTS
When used in this Form 10-Q or future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or stockholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "will likely
result", "are expected to", "will continue", "is anticipated", "estimate",
"project", "believe" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company wishes to caution readers that all
forward-looking statements are necessarily speculative and not to place undue
reliance on any such forward-looking statements, which speak only as of the date
made, and to advise readers that various risks and uncertainties, including
regional and national economic conditions, changes in levels of market interest
rates, credit risks of lending activities, and competitive and regulatory
factors, could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected. The risks highlighted herein should not be assumed to
be the only things that could affect future performance of the Company.
The Company does not undertake, and specifically disclaims any obligation,
to publicly release the result of any revisions which may be made to any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
2
<PAGE> 3
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS ARE IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Cash and cash equivalents................................... $ 143,775 $ 51,620
Investment securities available-for-sale, at market......... 22,679 578
Loans receivable (net of allowance for estimated credit
losses of $16,160 in 1998 and $13,274 in 1997)............ 1,190,382 838,251
Real estate owned (net of allowance for estimated losses of
$0 in 1998 and $2,563 in 1997)............................ 2,178 9,859
Investment in capital stock of Federal Home Loan Bank -- at
cost...................................................... 13,313 7,213
Office property and equipment -- at cost, net............... 6,535 4,200
Accrued interest receivable................................. 8,166 5,298
Deferred tax asset, net..................................... 4,344 6,820
Other assets................................................ 3,692 4,358
---------- --------
$1,395,064 $928,197
========== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits.................................................. $ 994,932 $799,501
FHLB advances............................................. 264,000 40,000
Senior notes.............................................. 40,000 40,000
Accounts payable and other liabilities.................... 17,095 6,377
---------- --------
1,316,027 885,878
Stockholders' equity
Preferred stock -- $0.01 par value; authorized 10,000,000
shares; none issued and outstanding.................... -- --
Common stock -- $0.01 par value; authorized, 20,000,000
shares; issued, 5,200,396 shares in 1998 and 3,095,996
shares in 1997......................................... 52 31
Capital in excess of par value -- common stock............ 40,528 12,310
Accumulated other comprehensive income -- unrealized gain
on available-for-sale securities, net.................. 10 6
Retained earnings......................................... 38,575 30,112
---------- --------
79,165 42,459
Less
Treasury stock, at cost -- 5,400 shares................... (48) (48)
Loan to Employee Stock Ownership Plan..................... (80) (92)
---------- --------
79,037 42,319
---------- --------
$1,395,064 $928,197
========== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE> 4
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS ARE IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Interest revenues
Loans, net of nonaccrual income................... $27,441 $17,799 $73,077 $50,480
Cash and investment securities.................... 1,483 1,583 2,938 4,657
------- ------- ------- -------
Total interest revenues................... 28,924 19,382 76,015 55,137
------- ------- ------- -------
Interest costs
Deposits.......................................... 12,422 10,188 34,533 28,467
FHLB advances..................................... 2,950 598 5,740 2,322
Senior notes...................................... 1,250 489 3,764 1,468
------- ------- ------- -------
Total interest costs...................... 16,622 11,275 44,037 32,257
------- ------- ------- -------
Net interest income................................. 12,302 8,107 31,978 22,880
Provision for estimated credit losses on loans...... 1,950 1,500 5,185 3,739
------- ------- ------- -------
Net interest income after provision for credit
losses............................................ 10,352 6,607 26,793 19,141
Noninterest revenues, net........................... 1,362 1,345 3,527 2,895
Noninterest expenses
General and administrative costs
Employee....................................... 3,683 2,622 10,373 7,903
Operating...................................... 1,681 1,142 4,256 3,182
Occupancy...................................... 851 697 2,439 2,113
Technology..................................... 567 177 1,561 524
Professional................................... 211 357 979 1,088
SAIF premium and OTS assessment................ 247 208 703 1,063
------- ------- ------- -------
Total general and administrative costs.... 7,240 5,203 20,311 15,873
Income from real estate operations, net........... (616) (490) (1,980) (228)
------- ------- ------- -------
Total noninterest expenses................ 6,624 4,713 18,331 15,645
------- ------- ------- -------
Net earnings before income taxes.................... 5,090 3,239 11,989 6,391
Income tax provision (benefit)...................... 1,632 25 3,526 (1,602)
------- ------- ------- -------
Net earnings........................................ $ 3,458 $ 3,214 $ 8,463 $ 7,993
======= ======= ======= =======
Net earnings available for Common Stock (Note 3).... $ 3,458 $ 2,606 $ 8,463 $ 6,171
======= ======= ======= =======
Basic earnings per share (Note 3)................... $ 0.67 $ 0.85 $ 2.21 $ 2.19
======= ======= ======= =======
Diluted earnings per share (Note 3)................. $ 0.45 $ 0.47 $ 1.33 $ 1.21
======= ======= ======= =======
Weighted average basic shares outstanding (Note
3)................................................ 5,189 3,058 3,838 2,814
======= ======= ======= =======
Weighted average diluted shares outstanding (Note
3)................................................ 7,708 5,507 6,351 5,087
======= ======= ======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE> 5
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
COMPREHENSIVE INCOME
---------------------
BALANCE AT EXERCISED CHANGE IN BALANCE AT
DECEMBER 31, STOCK STOCK UNREALIZED NET SEPTEMBER 30,
1997 OPTIONS OFFERING GAINS EARNINGS REPAYMENTS 1998
------------ --------- -------- ---------- -------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Common stock....................... $ 31 $ 1 $ 20 $ -- $ -- $ -- $ 52
Capital in excess of par value
Common stock..................... 12,310 436 27,782 -- -- -- 40,528
Accumulated other comprehensive
income -- unrealized gain on
available-for-sale securities.... 6 -- -- 4 -- -- 10
Retained earnings.................. 30,112 -- -- -- 8,463 -- 38,575
Treasury stock..................... (48) -- -- -- -- -- (48)
Loan to employee stock ownership
plan............................. (92) -- -- -- -- 12 (80)
------- ---- ------- ---- ------ ---- -------
Total stockholders'
equity.................. $42,319 $437 $27,802 $ 4 $8,463 $ 12 $79,037
======= ==== ======= ==== ====== ==== =======
Comprehensive income............... $ 4 $8,463 $ 8,467
==== ====== =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
5
<PAGE> 6
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
1998 1997 1998 1997
--------- -------- --------- ---------
<S> <C> <C> <C> <C>
NET CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings............................................... $ 3,458 $ 3,214 $ 8,463 $ 7,993
Adjustments
Provision (benefit) for income taxes..................... 1,632 25 3,526 (1,627)
Provision for estimated credit losses on loans........... 1,950 1,500 5,185 3,739
Provision for estimated credit losses on real estate
owned.................................................. -- 50 15 811
Net recoveries from sales of real estate owned........... (545) (2,220) (1,012)
Loan fee and discount accretion.......................... (1,781) (1,040) (4,734) (2,863)
Depreciation and amortization............................ 481 453 1,258 1,357
FHLB dividends........................................... (121) (102) (330) (306)
(Increase) decrease in:
Accrued interest receivable............................ (1,095) 939 (2,910) (803)
Other assets........................................... 3,126 (382) 823 (1,393)
Decrease in other liabilities............................ 9,055 2,412 9,797 (13,444)
Other, net............................................... 6 29 (19) 23
--------- -------- --------- ---------
Net cash provided by (used in) operating activities........ 15,885 6,553 18,854 (7,525)
--------- -------- --------- ---------
NET CASH FLOWS FROM INVESTING ACTIVITIES
Investment securities
Purchases................................................ (27,681) (9) (27,698) (40,562)
Maturities............................................... 5,000 -- 5,000 795
Sales proceeds........................................... 597 10,054 597 12,468
Loans
New loans funded........................................... (130,925) (57,660) (356,660) (157,005)
Construction disbursements............................... (89,760) (46,769) (258,102) (93,878)
Advances on lines of credit.............................. (22,449) (9,321) (61,692) (14,380)
Payoffs.................................................. 115,123 64,303 263,663 145,284
Principal amortization and paydowns...................... 28,859 7,408 55,687 15,392
Other, net............................................... 2,248 (1,054) 4,563 (2,738)
Real estate owned
Sale proceeds............................................ 2,590 7,653 10,827 23,592
Capitalized costs........................................ (364) (2,018) (942) (5,910)
Other, net............................................... (602) (551)
Purchase of FHLB stock..................................... (2,337) (5,770)
Net change in office property and equipment................ (665) (164) (3,303) (375)
--------- -------- --------- ---------
Net cash used in investing activities...................... (120,366) (27,577) (374,381) (117,317)
--------- -------- --------- ---------
NET CASH FLOWS FROM FINANCING ACTIVITIES
Deposit activity, net.................................... $ 103,457 $ 21,888 $ 195,431 $ 58,468
Net change in FHLB advances.............................. 49,000 -- 224,000 (10,000)
Net proceeds from exercise of options.................... 36 31 438 282
Proceeds from stock offering............................. 28,376 -- 28,376 --
Offering costs........................................... (573) -- (573) --
Collection of ESOP loan.................................. (2) 6 10 20
--------- -------- --------- ---------
Net cash provided by financing activities................ 180,294 21,925 447,682 48,770
--------- -------- --------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ 75,813 901 92,155 (76,072)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............ 67,962 17,005 51,620 93,978
--------- -------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 143,775 $ 17,906 $ 143,775 $ 17,906
========= ======== ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid (received) during the period for:
Interest............................................... $ 15,616 $ 10,700 $ 42,598 $ 31,632
Income taxes........................................... 2,753 (149) 2,828 25
Non-cash investing and financing activities
Real estate acquired in settlement of loans............ 772 5,001 3,847 18,547
Loans originated to finance sales of real estate
owned................................................ -- 1,651 1,970 4,198
Net change in unrealized gains (losses) on
available-for-sale securities........................ 5 350 4 199
Common stock issued in lieu of cash dividends to
Preferred shareholders............................... -- 608 -- 4,273
Loan activity
Total commitments and permanent fundings............... $ 272,000 $136,645 $ 713,000 $ 325,200
Total disbursements on new loans, construction and
lines of credit...................................... 243,134 113,750 676,454 265,263
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
6
<PAGE> 7
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(AMOUNTS ARE IN THOUSANDS, EXCEPT FOR BOOK VALUE AND PER SHARE DATA)
NOTE 1 -- SUMMARY OF ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Hawthorne
Financial Corporation and its wholly-owned subsidiary, Hawthorne Savings, F.S.B.
("Bank"), which are collectively referred to herein as the "Company". All
material intercompany transactions and accounts have been eliminated.
In the opinion of management, the unaudited consolidated financial
statements contain all adjustments (consisting solely of normal recurring
accruals) necessary to present fairly the Company's financial position as of
September 30, 1998 and December 31, 1997, and the results of its operations and
its cash flows for the three and nine months ended September 30, 1998 and 1997.
Operating results for the three and nine months ended September 30, 1998, are
not necessarily indicative of the results that may be expected for any other
interim period or the full year ending December 31, 1998.
Certain information and note disclosures normally included in financial
statements prepared in accordance with Generally Accepted Accounting Principles
("GAAP") have been condensed or omitted pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC"). The unaudited consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K/A for the year ended December 31, 1997.
In January 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income," which requires that all
items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. This statement
did not have a material impact on the Company's consolidated financial
statements.
NOTE 2 -- RECLASSIFICATION
Certain amounts in the 1997 consolidated financial statements have been
reclassified, where practicable, to conform with classifications in 1998.
NOTE 3 -- BOOK VALUE AND EARNINGS PER SHARE
The table below sets forth the Company's earnings per share calculations
for the three and nine months ended September 30, 1998 and 1997. The Diluted and
Basic Methods were used for all four periods as prescribed under GAAP. In the
table below, (1) Warrants refers to the warrants issued by the Company in
December 1995, which can be exercised beginning three years from the issue date
and for a period of ten years thereafter, (2) Options refers to the outstanding
stock options granted under the Company's stock option plans, and (3) Preferred
Stock refers to the Cumulative Perpetual Preferred Stock issued by the Company
in December 1995, and redeemed in December 1997, which carried an annual
dividend equal to 18% of the face amount of the Preferred Stock.
On July 10, 1998, the Company completed an offering of 2,012,500 of its
common shares (which amount includes issuance of 262,500 shares representing
exercise by the Company's underwriters of their over-allotment option) at a
price of $15.00 per share, realizing net proceeds (after offering costs) of
approximately $27.5 million. As an additional result of the completion of the
Company's offering, the exercise price of the
7
<PAGE> 8
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1998
(AMOUNTS ARE IN THOUSANDS, EXCEPT FOR BOOK VALUE AND PER SHARE DATA)
Company's Warrants was reduced to $2.128, and the number of shares of Common
Stock purchasable upon the exercise of the Warrants was increased to 2,512,188.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1998 1997 1998 1997
-------- ------- ------ -------
<S> <C> <C> <C> <C>
Average Shares Outstanding
Basic............................................. 5,189 3,058 3,838 2,814
Warrants.......................................... 2,512 2,376 2,421 2,376
Options........................................... 738 651 677 658
Less Treasury shares(1)........................... (731) (578) (585) (761)
-------- ------- ------ -------
Diluted........................................... 7,708 5,507 6,351 5,087
======== ======= ====== =======
Net Earnings
Net earnings for the period....................... $ 3,458 $ 3,214 $8,463 $ 7,993
Preferred stock dividends......................... -- (608) -- (1,822)
-------- ------- ------ -------
Net earnings available for Common Stock........... $ 3,458 $ 2,606 $8,463 $ 6,171
======== ======= ====== =======
Basic earnings per share............................ $ 0.67 $ 0.85 $ 2.21 $ 2.19
======== ======= ====== =======
Diluted earnings per share.......................... $ 0.45 $ 0.47 $ 1.33 $ 1.21
======== ======= ====== =======
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
-------------------
1998 1997
-------- -------
<S> <C> <C> <C> <C>
Period End Shares Outstanding
Basic............................................. 5,189 3,088
Warrants.......................................... 2,512 2,376
Options........................................... 738 648
Less Treasury shares(2)........................... (814) (505)
-------- -------
Diluted........................................... 7,625 5,607
======== =======
Stockholders' Equity
Basic............................................. $ 79,037 $43,273
Warrants.......................................... 5,346 5,346
Options........................................... 6,622 3,410
Less Treasury shares(2)........................... (11,968) (8,756)
-------- -------
Diluted........................................... $ 79,037 $43,273
======== =======
Basic book value per share.......................... $ 15.23 $ 14.01
======== =======
Diluted book value per share........................ $ 10.37 $ 7.72
======== =======
</TABLE>
- ---------------
(1) Under the Diluted Method, it is assumed that the Company will use proceeds
from the proforma exercise of the Warrants and Options to acquire actual
shares currently outstanding, thus increasing Treasury shares. Treasury
shares were assumed to be repurchased at the average closing stock price for
the respective period.
(2) Treasury shares were assumed to be repurchased at the average closing stock
price for the month.
8
<PAGE> 9
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company earned $3.5 million, or $0.45 per diluted share, for the
quarter ended September 30, 1998, which represented a 9% increase over the net
earnings of $3.2 million, or $0.47 per diluted share, reported for the third
quarter of 1997. For the nine months ended September 30, 1998, net earnings were
$8.5 million, or $1.33 per diluted share, as compared with net earnings of $8.0
million, or $1.21 per diluted share for the same period in 1997. Net earnings
reported for the 1997 periods were significantly enhanced by the realization of
income tax benefits. Had the pretax earnings for the three and nine months ended
September, 1997 been tax-effected consistently with the corresponding periods in
1998, net earnings would have been $2.2 million and $4.5 million, respectively.
CORE BUSINESS ACTIVITY
The Company originates real estate-secured loans throughout Southern
California, generally consisting of permanent loans collateralized by very large
homes and unique estates, permanent and construction loans secured by
multi-family residential and commercial real estate, and loans for the
construction of individual and tracts of single family residential homes and the
acquisition and development of land for the construction of such homes. The
Company funds its loans predominately with retail deposits and, to a lesser
extent, advances from the Federal Home Loan Bank of San Francisco ("FHLB"). The
interest spreads earned from this core business generally exceed the interest
spreads available on typical real estate-secured financings within the Company's
market area.
The Company's consolidated capital structure has changed significantly
during the past three years, initially as a result of its recapitalization in
December 1995, and then again in December 1997, due to its successful
refinancing of the securities issued in the 1995 recapitalization. Finally, in
July 1998, the Company completed a public offering of approximately 2.0 million
of its common shares, which raised approximately $27.5 million of net proceeds.
In addition to these positive changes to the Company's capital structure, the
Company returned to taxable status during the first quarter of 1998, following
several years in which it recorded substantial income tax benefits from
utilization of accumulated operating loss carryforwards. Together, these factors
make meaningful comparisons of consolidated operating results, and related per
share amounts, between the 1998 and 1997 periods somewhat difficult.
Because of the significant changes to the Company's capital structure and
taxable status, management believes that pretax core earnings are the most
relevant measure of the Company's underlying operating and earnings performance.
Core earnings are earnings before interest on parent company debt, income taxes,
real estate operations and non-operating items. For the third quarter of 1998,
core earnings were $5.7 million, more than 20% greater than the $4.8 million of
core earnings produced during the second quarter of 1998, and nearly 90% greater
than the core earnings of $3.0 million generated during the third quarter of
1997. For the nine months ended September 30, 1998, core earnings were $13.8
million, nearly 86% greater than the core earnings of $7.4 million realized
during the first nine months of 1997.
9
<PAGE> 10
The table below isolates the principal components of the Company's core and
net earnings for the periods indicated (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ --------------------
1998 1997 1998 1997
------- ------- -------- --------
<S> <C> <C> <C> <C>
Net interest income............................... $13,552 $ 8,596 $ 35,742 $ 24,348
Provision for credit losses....................... (1,950) (1,500) (5,185) (3,739)
------- ------- -------- --------
Net interest income after provision for credit
losses.......................................... 11,602 7,096 30,557 20,609
Noninterest revenues.............................. 1,372 1,126 3,541 2,690
General and administrative costs.................. (7,240) (5,203) (20,311) (15,873)
------- ------- -------- --------
Core earnings..................................... 5,734 3,019 13,787 7,426
Other items
Real estate operations, net..................... 616 490 1,980 228
Other, net...................................... (10) 219 (14) 205
Interest on senior notes........................ (1,250) (489) (3,764) (1,468)
------- ------- -------- --------
(644) 220 (1,798) (1,035)
------- ------- -------- --------
Pretax earnings................................... 5,090 3,239 11,989 6,391
Income tax (provision) benefit.................... (1,632) (25) (3,526) 1,602
------- ------- -------- --------
Net earnings...................................... $ 3,458 $ 3,214 $ 8,463 $ 7,993
======= ======= ======== ========
</TABLE>
The growth in earning assets results directly from the continuing
successful expansion of the Company's financing businesses. During the third
quarter of 1998, the Company generated net new permanent and construction loan
commitments of $272.0 million which, net of repayments and undisbursed funds,
produced net growth of $97.1 million in the Company's retained loan portfolio
during the quarter, an annualized rate of 36%. For the nine months ended
September 30, 1998, net new loan commitments totaled $713.0 million which, net
of repayments and undisbursed funds, produced net growth of $352.1 million in
the Company's retained loan portfolio during the first nine months of 1998, an
annualized rate of 56%. By comparison, the Company recorded net new loan
commitments of $136.6 million and $325.2 million for the three and nine months
ended September 30, 1997, respectively, and net growth in the Company's retained
loan portfolio approximated $94.7 million during the first nine months of 1997.
The Company's mix of financings, and its willingness and ability to provide
customers with tailored terms and highly-efficient transaction execution when
necessary, contributes to its ability to produce relatively higher yields on the
incremental growth in its loan portfolio. Concurrently, the Company has been
successful in keeping its funding costs (excluding interest on parent company
debt) virtually unchanged during the past several quarters. As a result of
declining rates during the third quarter of 1998, partially caused by reductions
in indices used for its adjustable loan portfolio, the Company's interest margin
(before interest on parent company debt and loan loss provisions) declined
slightly, reaching 4.32% as compared with its interest margin of 4.42% realized
during the second quarter of 1998, and increasing 29 basis points over the
Company's interest margin of 4.03% realized during the third quarter of 1997.
For the nine months ended September 30, 1998, the Company's interest margin was
4.36%, as compared with its interest margin of 3.92% realized during the first
nine months of 1997, an improvement of 44 basis points or 11%.
Nonperforming assets ("NPAs"), which consist of the carrying value of
properties acquired through foreclosure and loan principal delinquent 90 days or
greater, stood at $16.6 million at September 30, 1998, down from their level of
$20.7 million at December 31, 1997. Since December 31, 1997, the Company's real
estate owned portfolio has been reduced to $2.2 million (13% of NPAs) from $9.9
million (48% of NPAs) due to sales of individual properties in the ordinary
course of business. The Company continues to experience very modest levels of
foreclosures of its collateral securing delinquent loans, with most such loans
being cured by borrowers with no concessions offered by the Company.
As previously reported, in mid-1997 the Company commenced a series of
initiatives intended to enhance its management depth, to convert its technology
platform from an outsourced, host-based system to an
10
<PAGE> 11
in-house, client server-based system, and to design and implement a plan to
ensure Year 2000 compliance. These and related initiatives were expected to
increase the Company's general and administrative costs during 1998 by about 15%
as compared with 1997. During the three and nine months ended September 30,
1998, general and administrative costs were $7.2 million and $20.3 million,
respectively, as compared with general and administrative costs of $5.2 million
and $15.9 million, respectively, for the corresponding periods during 1997. The
actual 28% growth rate in general and administrative expenses for the first nine
months of 1998, as compared with the same period in 1997, reflects the
initiatives described above plus additional compensation costs attributable to
the Company's financial performance during the first nine months of 1998.
INCOME TAXES
During the three and nine months ended September 30, 1998, the Company's
effective tax rate was 32.1% and 29.4%, respectively. During the corresponding
periods of 1997, the Company recorded income tax expense of $25,000 and tax
benefits of $1.6 million, respectively. During the past several years, the
Company has benefited from utilization of income tax benefits, principally tax
loss carryforwards, accumulated during the early 1990s. The Company expects that
these accumulated benefits will be fully utilized during 1998.
PARENT COMPANY ITEMS
The Company's capital structure has changed significantly during the past
three years. The Company's issues of Preferred Stock ($13.5 million face amount)
and Senior Notes due 2000 ($13.5 million face amount), issued in December 1995
in connection with a recapitalization of the Company and the Bank, were repaid
in full in December 1997 with the proceeds from a single, $40 million issue of
Senior Notes due 2004, which carry a coupon interest rate of 12.50% and an
effective cost of approximately 13.40% (after including the effect of issue cost
amortization). Through September 30, 1998, the Company had contributed all of
the proceeds from its current Senior Notes issue to the Bank, which has
permitted the Bank to support its recent asset growth while maintaining core and
risk-based capital ratios well above the regulatory ratios which define a
well-capitalized institution.
In July 1998, the Company completed an offering of approximately 2.0
million of its common shares, realizing net proceeds (after offering costs) of
approximately $27.5 million. The Company expects to contribute the majority of
the net proceeds from the offering to the Bank, as may be necessary over time,
to support the Bank's future asset growth while preserving the Bank's status as
a well-capitalized institution.
At September 30, 1998, the Bank maintained core and risk-based capital
ratios of 6.92% and 10.90%, respectively, which compared favorably to the
well-capitalized regulatory thresholds of 5.00% and 10.00%, respectively.
RESULTS OF OPERATIONS
NET INTEREST INCOME
The operations of the Company are substantially dependent on its net
interest income, which is the difference between the interest income received
from its interest-earning assets and the interest expense paid on its
interest-bearing liabilities. The Company's net interest margin is its net
interest income divided by its average interest-earning assets. Net interest
income and net interest margin are 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-rate
loans and short-term investment securities and its deposits and borrowings and
(3) the magnitude of the Company's noninterest-earning assets, including
nonaccrual loans and real estate owned ("REO").
11
<PAGE> 12
The following tables set forth the Company's average balance sheets, and
the related weighted average yields and costs on average interest-earning assets
(inclusive of nonaccrual loans) and interest-bearing liabilities, for the three
and nine months ended September 30, 1998 and 1997. In the tables, interest
revenues are net of interest associated with nonaccrual loans (dollars are in
thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------------------------
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
----------------------------------- ---------------------------------
WEIGHTED WEIGHTED
AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE
BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST
---------- --------- ---------- -------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets
Loans(1)(2)................ $1,146,124 $27,441 9.58% $749,531 $17,799 9.50%
Cash and cash
equivalents............. 79,961 1,105 5.53 20,636 274 5.31
Investment securities...... 17,438 258 5.92 74,989 1,206 6.43
Investment in capital stock
of
Federal Home Loan Bank..... 10,933 120 4.39 7,028 103 5.86
---------- ------- -------- -------
Total
interest-earning
assets........... 1,254,456 28,924 9.22 852,184 19,382 9.10
------- ----- ------- -----
Noninterest-earning assets... 18,042 27,332
---------- --------
Total assets....... $1,272,498 $879,516
========== ========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Interest-bearing liabilities
Deposits................... $ 938,250 12,422 5.31 $765,680 10,188 5.34
FHLB Advances.............. 215,544 2,950 5.49 40,000 598 6.00
Senior notes (3)........... 40,000 1,250 12.53 12,517 489 15.63
---------- ------- -------- -------
Total
interest-bearing
liabilities...... 1,193,794 16,622 5.58 818,197 11,275 5.53
------- ----- ------- -----
Noninterest-bearing
liabilities................ 997 8,352
Stockholders' equity......... 77,707 52,967
---------- --------
Total liabilities &
stockholders'
equity........... $1,272,498 $879,516
========== ========
Net interest income.......... $12,302 $ 8,107
======= =======
Interest rate spread......... 3.64% 3.57%
===== =====
Net interest margin.......... 3.92% 3.81%
===== =====
Net interest margin excluding
senior notes............... 4.32% 4.03%
===== =====
</TABLE>
- ---------------
(1) Includes nonaccrual loans of $23.3 million and $11.5 million for the three
months ended September 30, 1998 and September 30, 1997, respectively.
(2) Includes amortization of loan fees and discounts of $1.8 million and $1.0
million for the three months ended September 30, 1998 and September 30,
1997, respectively.
(3) Excludes issue cost amortization of $92,000 and $58,000 for the three months
ended September 30, 1998 and September 30, 1997, respectively.
12
<PAGE> 13
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-----------------------------------------------------------------------
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
----------------------------------- ---------------------------------
WEIGHTED WEIGHTED
AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE
BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST
---------- --------- ---------- -------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets
Loans(1)(2)................ $1,020,795 $73,077 9.55% $722,126 $50,480 9.32%
Cash and cash
equivalents............. 57,415 2,330 5.41 32,769 1,261 5.13
Investment securities...... 5,635 278 6.58 66,066 3,090 6.24
Investment in capital stock
of Federal Home Loan
Bank.................... 8,659 330 5.08 6,928 306 5.89
---------- ------- -------- -------
Total
interest-earning
assets........... 1,092,504 76,015 9.28 827,889 55,137 8.88
------- ----- ------- -----
Noninterest-earning assets... 18,006 28,908
---------- --------
Total assets....... $1,110,510 $856,797
========== ========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing liabilities
Deposits................... $ 872,849 34,533 5.29 $732,390 28,467 5.20
FHLB Advances.............. 138,403 5,740 5.54 51,433 2,322 6.04
Senior notes(3)............ 40,000 3,764 12.58 12,431 1,468 15.79
---------- ------- -------- -------
Total
interest-bearing
liabilities...... 1,051,252 44,037 5.60 796,254 32,257 5.42
------- ----- ------- -----
Noninterest-bearing
liabilities................ 4,707 12,847
Stockholders' equity......... 54,551 47,696
---------- --------
Total liabilities &
stockholders'
equity........... $1,110,510 $856,797
========== ========
Net interest income.......... $31,978 $22,880
======= =======
Interest rate spread......... 3.68% 3.46%
===== =====
Net interest margin.......... 3.90% 3.68%
===== =====
Net interest margin excluding
senior notes............... 4.36% 3.92%
===== =====
</TABLE>
- ---------------
(1) Includes nonaccrual loans of $22.5 million and $20.1 million for the nine
months ended September 30, 1998 and September 30, 1997, respectively.
(2) Includes amortization of loan fees and discounts of $4.7 million and $2.8
million for the nine months ended September 30, 1998 and September 30, 1997,
respectively.
(3) Excludes issue cost amortization of $274,000 and $175,000 for the nine
months ended September 30, 1998 and September 30, 1997, respectively.
13
<PAGE> 14
ANALYSIS OF CHANGES IN NET INTEREST INCOME
The following tables present the dollar amount of changes in interest
revenues and interest costs attributable to changes in the balances of
interest-earning assets and interest-bearing liabilities, and changes in
interest rates. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable
to: (i) changes in volume (i.e., changes in volume multiplied by old rate), (ii)
changes in rate (i.e., changes in rate multiplied by old volume) and (iii)
changes attributable to both rate and volume (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997
INCREASE (DECREASE) DUE TO CHANGE IN
-------------------------------------
RATE AND NET
VOLUME RATE VOLUME CHANGE
------ ----- -------- ------
<S> <C> <C> <C> <C>
INTEREST REVENUES
Loans................................................ $9,417 $ 147 $ 78 $9,642
Cash and cash equivalents............................ 788 11 32 831
Investment securities................................ (925) (97) 74 (948)
Investment in capital stock of Federal Home Loan
Bank.............................................. 57 (26) (14) 17
------ ----- ----- ------
9,337 35 170 9,542
------ ----- ----- ------
INTEREST COSTS
Deposits............................................. 2,296 (51) (11) 2,234
FHLB Advances........................................ 2,624 (50) (222) 2,352
Senior notes......................................... 1,074 (98) (215) 761
------ ----- ----- ------
5,994 (199) (448) 5,347
------ ----- ----- ------
Increase in Net Interest Income........................ $3,343 $ 234 $ 618 $4,195
====== ===== ===== ======
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997
INCREASE (DECREASE) DUE TO CHANGE IN
----------------------------------------
RATE AND NET
VOLUME RATE VOLUME CHANGE
------- ------ -------- -------
<S> <C> <C> <C> <C>
INTEREST REVENUES
Loans.............................................. $20,878 $1,216 $ 503 $22,597
Cash and cash equivalents.......................... 948 69 52 1,069
Investment securities.............................. (2,826) 169 (155) (2,812)
Investment in capital stock of Federal Home Loan
Bank............................................ 76 (42) (10) 24
------- ------ ------ -------
19,076 1,412 390 20,878
------- ------ ------ -------
INTEREST COSTS
Deposits........................................... 5,459 509 98 6,066
FHLB Advances...................................... 3,926 (189) (319) 3,418
Senior notes....................................... 3,255 (298) (661) 2,296
------- ------ ------ -------
12,640 22 (882) 11,780
------- ------ ------ -------
Increase in Net Interest Income...................... $ 6,436 $1,390 $1,272 $ 9,098
======= ====== ====== =======
</TABLE>
The Company's interest income (net of interest due on nonaccrual loans)
increased by $20.9 million or 37.9% during the first nine months of 1998 as
compared to the same period in 1997. This increase was primarily attributable to
increases in the average balance of loans outstanding and, to a lesser extent,
increases in the weighted average yield earned thereon.
Interest expense increased by $11.8 million or 36.6%, during the first nine
months of 1998, as compared to the same period in the prior year, which was
primarily due to an increase in the average balances of the Company's deposits
and borrowings and to a lesser extent, increases in the weighted average rate
paid on the Company's deposits.
14
<PAGE> 15
As a result of the foregoing, the Company's net interest income increased
by $9.1 million, or 39.8%, from $22.9 million during the first nine months of
1997 to $32.0 million during the comparable period in 1998, and the Company's
net interest margin (net interest income divided by average interest-earning
assets) increased by 22 basis points, or 6.0%, from 3.68% to 3.90% during the
same respective periods.
PROVISIONS FOR POSSIBLE CREDIT LOSSES ON LOANS
For the three and nine months ended September 30, 1998, the Company
recorded provisions for possible credit losses on loans of $2.0 million and $5.2
million, respectively, compared with provisions for credit losses of $1.5
million and $3.7 million, recorded during the three and nine months ended
September 30, 1997, respectively. These increases reflected the Company's
efforts to maintain adequate levels of loan reserves given the continuing
successful expansion of the Company's financing business and growing loan
portfolio. The Company has established internal guidelines for loan loss
reserves which consider the composition and size of the loan portfolio, as well
as the composition and amount of its nonperforming loans. At September 30, 1998,
the Company's allowance for credit losses amounted to $16.2 million, of which
$11.6 million was general reserves.
Although the Company maintains its allowance for credit losses at a level
which it considers to be adequate to provide for probable losses based on
presently known conditions, there can be no assurance that such losses will not
exceed the estimated amounts, thereby adversely affecting future results of
operations. The calculation of the adequacy of the allowance for credit losses,
and therefore the requisite amount of provision for credit losses, is based on
several factors, including underlying loan collateral values, delinquency trends
and historical loan loss experience, all of which can change without notice
based on market and economic conditions and other factors.
NONINTEREST REVENUES
The table below sets forth information concerning the Company's noninterest
revenues for the periods indicated (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
1998 1997 CHANGE 1998 1997 CHANGE
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Loan-related fees.............................. $1,184 $ 944 $240 $2,915 $2,063 $852
Other.......................................... 178 401 (223) 612 832 (220)
------ ------ ---- ------ ------ ----
$1,362 $1,345 $ 17 $3,527 $2,895 $632
====== ====== ==== ====== ====== ====
</TABLE>
Loan-related fees consist of prepayment, extension, modification, escrow
and exit fees collected from customers. Other non-interest revenues for the
quarter ended September 30, 1997, principally included a non-recurring benefit
from the termination of a Company-sponsored retirement plan.
NONINTEREST EXPENSES -- GENERAL AND ADMINISTRATIVE COSTS
The table below details the Company's general and administrative costs for
the periods indicated (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER
SEPTEMBER 30, 30,
------------------------ -----------------------------
1998 1997 CHANGE 1998 1997 CHANGE
------ ------ ------ -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Employee..................................... $3,570 $2,511 $1,059 $10,195 $ 7,818 $2,377
Operating.................................... 2,045 1,264 781 5,351 3,572 1,779
Occupancy.................................... 1,054 752 302 2,905 2,247 658
Professional................................. 324 468 (144) 1,157 1,173 (16)
SAIF insurance premium and OTS assessment.... 247 208 39 703 1,063 (360)
------ ------ ------ ------- ------- ------
$7,240 $5,203 $2,037 $20,311 $15,873 $4,438
====== ====== ====== ======= ======= ======
</TABLE>
15
<PAGE> 16
During the last half of 1997 and continuing into mid 1998, the Company
increased its lending staff, including retaining new senior managers for each of
its primary financing groups, in response to the substantial growth in the
volume of new business generated since the third quarter of 1997. During this
period, the Company has also hired personnel to prepare for, and to implement,
new computer-based systems during 1998. The cost of these personnel caused
employee-related costs to increase by 30% during the first nine months of 1998
as compared with the same period in 1997, which amount is also inclusive of
additional compensation costs attributable to the Company's financial
performance during the period.
The Company has also experienced an increase in operating costs primarily
as a result of its efforts related to the ongoing computer systems conversions
and expenditures related to its focused efforts to expand the Company's retail
banking presence.
NONINTEREST EXPENSES -- REAL ESTATE OPERATIONS
The table below sets forth the revenues and costs attributable to the
Company's REO for the periods indicated. The compensatory and legal costs
directly associated with the Company's property management and disposal
operations are included in the table above in NONINTEREST EXPENSES -- GENERAL
AND ADMINISTRATIVE COSTS (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ---------------------------
1998 1997 CHANGE 1998 1997 CHANGE
----- ----- ------ ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Expenses associated with real estate
operations
Property taxes..................... $ -- $ 48 $ (48) $ 3 $ 90 $ (87)
Repairs, maintenance and
renovation....................... 146 7 139 183 38 145
Insurance.......................... 50 58 (8) 91 138 (47)
----- ----- ----- ------- ------- -------
Total......................... 196 113 83 277 266 11
Net recoveries from sale of
properties............................ (826) (545) (281) (2,221) (1,013) (1,208)
Property operations, net................ 14 (108) 122 (51) (292) 241
Provision for estimated losses on real
estate owned.......................... -- 50 (50) 15 811 (796)
----- ----- ----- ------- ------- -------
(Income) loss from real estate owned,
net................................... $(616) $(490) $(126) $(1,980) $ (228) $(1,752)
===== ===== ===== ======= ======= =======
</TABLE>
The costs included in the table above (and, therefore, excluded from
operating costs (see NONINTEREST EXPENSES -- GENERAL AND ADMINISTRATIVE COSTS)),
reflect holding costs directly attributable to the Company's REO.
Net recoveries from sales of REO represent the difference between the
proceeds received from property disposal and the carrying value of such
properties upon disposal. Property operations principally include the net
operating income (collected rental revenues less operating expenses and certain
renovation costs) from foreclosed income properties or receipt, following
foreclosure, of similar funds held by receivers during the period the original
loan was in default. During the three and nine months ended September 30, 1998,
the Company recorded gains on the sale of foreclosed properties, principally two
parcels of land. These two liquidations represented the last remaining large
real estate owned acquired whose origins pre-date 1995, and the gains realized
are not expected to be repeated.
INCOME TAXES
The Company recorded income tax provisions of $1.6 million and $3.5 million
for the three and nine months ended September 30, 1998, respectively, as
compared to tax provision of $25,000 and a tax benefit of $1.6 million, recorded
during the same periods in 1997. The effective tax rates were 32.1% and 29.4%
for the three and nine months ended September 30, 1998, which reflects the
benefit of the reduction of deferred tax valuation allowance previously
established. At September 30, 1998, $1.4 million of income tax benefits,
consisting primarily of net operating loss carryforwards and future tax
deductions, remained available
16
<PAGE> 17
for financial statement purposes. The recognition of these accumulated income
tax benefits is subject to limitations under GAAP and for regulatory capital
purposes. The primary factor affecting the timing and magnitude of recognition
of these accumulated income tax benefits is the current and future profitability
of the Company. Additionally, no more than 10% of the Bank's regulatory capital
can be represented by a deferred tax asset created pursuant to anticipated
future utilization of an institution's income tax benefits. Should the Company
cease to be profitable, or should the Company record substantial operating
losses in the future, all or a portion of the deferred tax asset established to
date may need to be reversed.
FINANCIAL CONDITION, CAPITAL RESOURCES & LIQUIDITY AND ASSET QUALITY
ASSETS
CASH AND CASH EQUIVALENTS
Cash and cash equivalents at September 30, 1998 and at December 31, 1997
consisted of the following (dollars are in thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Cash....................................... $ 22,075 $ 9,520
Federal funds sold......................... 121,700 42,100
-------- -------
$143,775 $51,620
======== =======
</TABLE>
INVESTMENT SECURITIES
The table below summarizes the cost basis and estimated fair value of
investment securities available-for-sale at September 30, 1998 and at December
31, 1997 (dollars are in thousands).
<TABLE>
<CAPTION>
GROSS UNREALIZED ESTIMATED
AMORTIZED ----------------- FAIR
COST GAINS LOSSES VALUE
--------- ------ ------- ---------
<S> <C> <C> <C> <C> <C>
September 30, 1998.......... U.S. Treasuries $22,669 10 -- $22,679
December 31, 1997........... Mutual Fund $ 572 6 -- $ 578
</TABLE>
Investment securities are classified as available-for-sale, with both a
cost basis and an estimated fair value of $22.7 million at September 30, 1998,
had a weighted average yield of 5.22%, and were due in less than one year.
17
<PAGE> 18
LOANS RECEIVABLE
GENERAL
The Company's loan portfolio consists almost exclusively of loans secured
by real estate located in Southern California. The table below sets forth the
composition of the Company's loan portfolio as of the dates indicated (dollars
are in thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
--------------------- -------------------
BALANCE PERCENT BALANCE PERCENT
---------- ------- -------- -------
<S> <C> <C> <C> <C>
Single family
Estate(1).............................. $ 311,969 21.5% $173,764 18.0%
Conventional........................... 208,681 14.4 222,865 23.0
Income property
Multi-family........................... 249,609 17.2 225,738 23.2
Commercial real estate................. 187,075 12.9 111,893 11.6
Construction........................... 54,088 3.7 7,310 0.8
Land..................................... 82,442 5.7 39,475 4.1
Single family construction
Individual residences.................. 249,611 17.2 107,989 11.2
Tract development...................... 75,989 5.2 68,653 7.1
Other.................................... 31,947 2.2 9,698 1.0
---------- ----- -------- -----
Gross loans receivable(2)................ 1,451,411 100.0% 967,385 100.0%
===== =====
Less
Undisbursed loan funds................. (238,078) (108,683)
Deferred loan fees and credits, net.... (6,791) (7,177)
Reserves............................... (16,160) (13,274)
---------- --------
Net loans receivable..................... $1,190,382 $838,251
========== ========
</TABLE>
- ---------------
(1) Generally defined as individual loans with principal balances of more than
$1.0 million originated since 1994.
(2) Gross loans receivable includes outstanding balance plus undisbursed
commitments.
The table below sets forth the approximate composition of the Company's
gross new loan commitments, net of internal refinances, for the periods
indicated in dollars and as a percentage of total loans originated (dollars are
in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
------------------- -------------------
TYPE OF SECURITY AMOUNT % AMOUNT %
---------------- --------- ------ --------- ------
<S> <C> <C> <C> <C>
Single family
Estate.................................... $ 84,200 31.0% $197,500 27.7%
Conventional.............................. 7,800 2.9 20,600 2.9
Income property
Multi-family.............................. 21,000 7.7 50,900 7.1
Commercial real estate.................... 12,600 4.6 74,200 10.4
Construction.............................. 27,400 10.1 64,200 9.0
Land........................................ 18,800 6.9 75,200 10.5
Single family construction
Individual residences..................... 69,800 25.7 178,200 25.0
Tract development......................... 29,300 10.8 37,700 5.3
Other....................................... 1,100 0.4 14,500 2.0
-------- ----- -------- -----
$272,000 100.0% $713,000 100.0%
======== ===== ======== =====
</TABLE>
18
<PAGE> 19
ASSET QUALITY
NONACCRUAL AND TROUBLED DEBT RESTRUCTURED LOANS
The Company places loans on nonaccrual status when (1) they become 30 or
more days delinquent or (2) management believes that, with respect to performing
loans, continued collection of principal and interest from the borrower is not
reasonably assured.
The following table provides information regarding the Company's nonaccrual
loans as of the dates indicated (dollars are in thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Loans past due 90 days or more............................. $14,446 $10,793
Loans past due 30-89 days.................................. 11,738 4,435
Other nonaccrual loans..................................... 1,900 168
------- -------
Total(1)......................................... $28,084 $15,396
======= =======
Reserves to loans past due 90 days or more................. 111.9% 123.0%
Reserves to total nonaccrual loans......................... 57.5% 86.2%
</TABLE>
- ---------------
(1) Includes $5.5 million and $0.5 million of troubled debt restructured loans
("TDRs") at September 30, 1998 and December 31, 1997, respectively. Excludes
$31.0 million and $29.1 million of TDRs which were performing in accordance
with their modified terms at September 30, 1998 and December 31, 1997,
respectively.
Although management of the Company has successfully reduced its
nonperforming assets in recent years, the real estate markets and the overall
economy in its market area are likely to be significant determinants of the
quality of the Company's assets in the future periods and, thus, its financial
condition and results of operations. The Company's financial condition and
results of operations may also be adversely affected to the extent the Company's
newly originated loans experience asset quality problems. In addition, in the
view of the relatively large size of many of the Company's loans, the movement
of even a few loans into the nonperforming category could have a material impact
on the Company's asset quality ratios and adversely affect its results of
operations.
19
<PAGE> 20
CLASSIFIED ASSETS
The table below sets forth information concerning the Company's classified
assets at the dates indicated. Classified assets include REO, delinquent loans
and performing loans which have been adversely classified pursuant to OTS
regulations and guidelines ("Performing/Classified" loans) (dollars are in
thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Real estate owned, net..................................... $ 2,178 $ 9,859
Nonperforming loans(1)..................................... 14,446 10,793
---------- --------
Total nonperforming assets................................. 16,624 20,652
Other delinquent loans(2).................................. 11,738 4,435
Performing loans classified substandard(3)................. 39,715 36,013
---------- --------
Total classified assets.................................... $ 68,077 $ 61,100
========== ========
Classified loans(4)........................................ $ 65,899 $ 51,241
========== ========
Loans receivable(5)........................................ $1,222,702 $851,525
========== ========
Reserves on loans
Specific................................................. $ 4,527 $ 3,878
General.................................................. 11,633 9,396
---------- --------
$ 16,160 $ 13,274
========== ========
Total reserves to loans receivable......................... 1.3% 1.6%
Total reserves to classified loans......................... 24.5% 25.9%
Total reserves to nonperforming loans...................... 111.9% 123.0%
Gross nonperforming assets to total assets................. 1.2% 2.2%
</TABLE>
- ---------------
(1) Loans 90 days or more delinquent. All such loans are on nonaccrual status.
(2) Loans 30 to 89 days delinquent. All such loans are on nonaccrual status.
(3) Includes $1.9 million and $0.2 million of performing loans on nonaccrual
status at September 30, 1998 and at December 31, 1997, respectively.
(4) Includes $28.1 million and $15.4 million of nonaccrual loans at September
30, 1998, and at December 31, 1997, respectively.
(5) Loans receivable are exclusive of the allowance for credit losses.
The carrying value of nonperforming assets (i.e., real estate owned and
loans 90 days or more delinquent) decreased to $16.6 million, or 1.2% of total
assets, at September 30, 1998, from $20.7 million, or 2.2% of total assets, at
December 31, 1997.
20
<PAGE> 21
The table below sets forth information concerning the Company's total
classified loans as of September 30, 1998 (dollars are in thousands).
<TABLE>
<CAPTION>
CLASSIFIED LOANS
--------------------------------------------------
OTHER PERFORMING
NONPERFORMING(1) DELINQUENCIES(2) LOANS TOTAL
---------------- ---------------- ---------- -------
<S> <C> <C> <C> <C>
Single family
Estate............................... $ 7,902 $ 7,560 $20,237 $35,699
Conventional......................... 2,446 2,346 11,760 16,552
Income property
Multi-family......................... -- 1,063 784 1,847
Commercial real estate............... 2,000 -- -- 2,000
Construction......................... -- -- -- --
Land................................... -- -- -- --
Single family construction
Individual residences................ 2,098 769 1,089 3,956
Tract development.................... -- -- 4,847 4,847
Other.................................. -- -- 998 998
------- ------- ------- -------
Total........................ $14,446 $11,738 $39,715 $65,899
======= ======= ======= =======
</TABLE>
- ---------------
(1) Loans 90 days or more delinquent. All such loans are on nonaccrual status.
(2) Loans 30 to 89 days delinquent. All such loans are on nonaccrual status.
RESERVES
Management establishes specific reserves for losses on individual loans and
REO when it has determined that recovery of the Company's gross investment is
not probable and when the amount of loss can be reasonably determined. In making
this determination, management considers (1) the 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 REO, 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 estimates the revenues expected to be
generated from the disposal of the Company's collateral or owned property, less
construction and renovation costs (if any), holding costs and transaction costs.
For tract construction and land developments, the resulting projected cash flows
are discounted utilizing a market rate of return to determine their value.
Management establishes general reserves against the Company's portfolio of
loans. Generally, such general reserves are established for each segment of the
Company's loan portfolio. 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 became nonperforming, loans
in default which proceed through foreclosure) and (4) guidelines published by
the OTS.
21
<PAGE> 22
The table below sets forth the general and specific reserves for the
Company's loan portfolio as of September 30, 1998 (dollars are in thousands).
<TABLE>
<CAPTION>
LOANS
------------------------
PERFORMING DELINQUENT TOTAL
---------- ---------- -------
<S> <C> <C> <C>
Specific reserves................................... $ 3,243 $1,284 $ 4,527
General reserves.................................... 11,308 325 11,633
------- ------ -------
Total..................................... $14,551 $1,609 $16,160
======= ====== =======
Percentages
% of total reserves to gross investment............. 1.2% 6.1% 1.3%
% of general reserves to gross investment........... 0.9% 1.2% 1.0%
</TABLE>
The table below summarizes the activity of the Company's reserves for the
periods indicated (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1998 1997 1998 1997
---------- -------- ---------- --------
<S> <C> <C> <C> <C>
Loans
Average loans outstanding............ $1,146,124 $749,531 $1,020,795 $722,126
========== ======== ========== ========
Reserve balance at beginning of
period............................. $ 14,541 $ 12,381 $ 13,274 $ 13,515
Provision for credit losses.......... 1,950 1,500 5,185 3,739
Charge-offs:
Single family
Estate.......................... (170) -- (170) --
Conventional.................... (156) (349) (891) (2,705)
Income property
Multi-family.................... (5) (279) (1,038) (1,135)
Commercial real estate.......... -- -- (200) --
Other.............................. -- -- -- (11)
Land............................... -- -- -- (150)
---------- -------- ---------- --------
Total charge-offs.......... (331) (628) (2,299) (4,001)
---------- -------- ---------- --------
Balance at end of period............. $ 16,160 $ 13,253 $ 16,160 $ 13,253
========== ======== ========== ========
Ratio of net charge-offs to average
loans outstanding during the
period............................. 0.0% 0.1% 0.2% 0.6%
Real estate owned
Reserve balance at beginning of
period.......................... $ 12 $ 9,377 $ 2,563 $ 11,871
Provision for credit losses.......... -- 50 15 811
Charge-offs.......................... (12) (305) (2,578) (3,560)
---------- -------- ---------- --------
Balance at end of period............. $ -- $ 9,122 $ -- $ 9,122
========== ======== ========== ========
</TABLE>
22
<PAGE> 23
Because the Company's loan portfolio is not homogeneous, but rather
consists 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 this portfolio. The table below summarizes the allocation of the
Company's reserves by type of collateral at the dates indicated (dollars are in
thousands).
<TABLE>
<CAPTION>
DECEMBER 31, 1997
SEPTEMBER 30, 1998 ----------------------
------------------------- PERCENT OF
PERCENT OF RESERVES TO
RESERVES TO TOTAL
TOTAL LOANS(1) LOANS(1)
BALANCE BY CATEGORY BALANCE BY CATEGORY
------- -------------- ------- -----------
<S> <C> <C> <C> <C>
Single family
Estate............................. $ 3,738 1.2% $ 1,975 1.1%
Conventional....................... 3,571 1.7% 4,696 2.1%
Income property
Multi-family....................... 1,136 0.5% 2,000 0.9%
Commercial real estate............. 3,566 1.9% 2,252 2.0%
Construction....................... 189 0.3% 10 0.1%
Land................................. 334 0.4% 162 0.4%
Single family construction
Individual residences.............. 783 0.3% 503 0.5%
Tract development.................. 950 1.3% 807 1.2%
Other................................ 464 1.5% 226 2.3%
Unallocated.......................... 1,429 --% 643 --%
------- -------
$16,160 1.1% $13,274 1.4%
======= =======
</TABLE>
- ---------------
(1) Percent of reserves to gross loan commitments, which include undisbursed
commitments.
The table below summarizes reserves at the dates indicated for each of the
REO by type of property (dollars are in thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------------ ------------------------
PERCENT OF PERCENT OF
RESERVES TO RESERVES TO
TOTAL REO TOTAL REO
PROPERTIES BY CATEGORY PROPERTIES BY CATEGORY
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Single family
Conventional............................... $-- % $1,523 19.8%
Income property
Multi-family............................... -- % 18 0.8%
Land......................................... -- % 1,022 43.2%
Unallocated
-- ------
$-- % $2,563 20.6%
== ======
</TABLE>
REAL ESTATE OWNED
Real estate acquired in satisfaction of loans is transferred from loans to
properties at estimated fair values, less any estimated disposal costs. The
difference between the fair value of the real estate collateral and the loan
balance at the time of transfer is recorded as a loan charge-off. Any subsequent
declines in the fair value of the properties after the date of transfer are
recorded through the establishment of, or additions to, specific reserves.
Recoveries and losses from the disposition of properties are also included in
NONINTEREST EXPENSES -- REAL ESTATE OPERATIONS.
23
<PAGE> 24
The table below summarizes the composition of the Company's REO at the
dates indicated (dollars are in thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Single family
Conventional............................................. $1,574 $7,695
Income property
Multi-family............................................. 604 2,362
Land....................................................... -- 2,365
------ ------
Gross investment(1)........................................ 2,178 12,422
Allowance for estimated losses............................. -- (2,563)
------ ------
Net investment............................................. $2,178 $9,859
====== ======
</TABLE>
- ---------------
(1) Fair value of collateral at foreclosure, plus post-foreclosure capitalized
costs.
SOURCES OF FUNDS
GENERAL
The Company's principal sources of funds in recent years have been deposits
obtained on a retail basis through its branch offices and, to a lesser extent,
advances from the FHLB. In addition, funds have been obtained from maturities
and repayments of loans and securities, and sales of loans, securities and other
assets, including real estate owned.
DEPOSITS
Total deposits at September 30, 1998, were $994.9 million, an increase from
$799.5 million at December 31, 1997.
The table below summarizes the balances by original term, weighted average
interest rates ("WAIR") and weighted average remaining maturities in months
("WARM") for the Company's deposits at the dates indicated (dollars are in
thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------------ ------------------------
DESCRIPTION BALANCE WAIR WARM BALANCE WAIR WARM
----------- -------- ---- ---- -------- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Transaction accounts............... $144,159 2.87% -- $105,812 2.44% --
Certificates of deposit
7 day maturities................. 37,494 4.42% -- 42,907 4.43% --
Less than 6 months............... 154,163 5.43% 3 35,418 5.57% 2
6 months to 1 year............... 555,796 5.70% 6 456,072 5.80% 8
1 year to 2 years................ 32,485 5.63% 11 146,674 5.74% 7
Greater than 2 years............. 70,835 5.82% 9 12,618 5.45% 13
-------- --------
Total.............................. $994,932 5.21% 5 $799,501 5.26% 6
======== ========
</TABLE>
24
<PAGE> 25
FHLB ADVANCES
The Company has a credit line with the FHLB with a maximum advance of up to
35% of total assets. The FHLB system functions as a source of credit to savings
institutions which are members. Advances are typically secured by the Company's
mortgage loans and the capital stock of the FHLB owned by the Company. Subject
to the FHLB's advance policies and requirements, these advances can be requested
for any business purpose in which the Company is authorized to engage. In
granting advances, the FHLB considers a member's creditworthiness and other
relevant factors. The table below sets forth certain information regarding the
Company's FHLB advances (dollars are in thousands)
<TABLE>
<CAPTION>
REMAINING
ORIGINAL TERM WEIGHTED
TERM --------------- AVERAGE
NUMBER BALANCE YEARS YEARS MONTHS RATE
------ -------- -------- ----- ------ --------
<S> <C> <C> <C> <C> <C> <C>
September 30, 1998................. 7 $264,000 5 & 10 5 7 5.18%
December 31, 1997.................. 1 40,000 1 6 5.95%
</TABLE>
Each of the Company's advances outstanding at September 30, 1998, contain
an option by the FHLB which allows them to call in the advance prior to
maturity, subject to an initial non-callable period of two to five years from
origination.
SENIOR NOTES
On December 31, 1997, the Company completed the issuance of $40.0 million
of Senior Notes due 2004. These notes bear an interest rate of 12.5%, and are
callable after December 31, 2002. Interest is required to be paid semiannually
at the stated interest rate.
STOCKHOLDERS' EQUITY; REGULATORY CAPITAL
The Company's capital consists of common stockholders' equity, which at
September 30, 1998, amounted to $79.0 million and represented 5.7% of the
Company's total assets.
The following table summarizes the regulatory capital requirements under
the Home Owners' Loan Act ("HOLA") for the Bank at September 30, 1998. As
indicated in the table, the Bank's capital levels exceed all three of the
currently applicable minimum HOLA 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).......... $ 94,752 $ 94,752 $ 94,752
Adjustments
General reserves............... -- -- 11,633
Unrealized (gains) losses,
net......................... -- -- --
---------- ---- ---------- ---- -------- -----
Regulatory capital............... 94,752 6.92% 94,752 6.92% 106,385 10.90%
Required minimum................. 20,551 1.50 41,103 3.00 78,052 8.00
---------- ---- ---------- ---- -------- -----
Excess capital................... $ 74,201 5.42% $ 53,649 3.92% $ 28,333 2.90%
========== ==== ========== ==== ======== =====
Adjusted assets(2)............... $1,370,097 $1,370,097 $975,654
========== ========== ========
</TABLE>
- ---------------
(1) Reflects capital contributions totaling $12.0 million from the parent
company made during 1998
(2) The term "adjusted assets" refers to the term "adjusted total assets", as
defined in 12 C.F.R. Section 567.1(a), for purposes of tangible and core
capital requirements, and for purposes of risk-based capital requirements,
refers to the term "risk-weighted assets", as defined in 12 C.F.R. Section
567.1(d).
25
<PAGE> 26
As of September 30, 1998, the most recent notification from the OTS
categorized the Bank as "well capitalized" under the regulatory framework for
prompt corrective action. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Bank's actual capital amounts and ratios and the capital amounts and ratios
required in order for an institution to be "well capitalized" and "adequately"
capitalized are presented in the table below (dollars are in thousands).
<TABLE>
<CAPTION>
TO BE CATEGORIZED AS
ADEQUATELY TO BE CATEGORIZED AS
CAPITALIZED WELL CAPITALIZED
UNDER PROMPT UNDER PROMPT
CORRECTIVE CORRECTIVE
ACTUAL ACTION PROVISIONS ACTION PROVISIONS
------------------ --------------------- ---------------------
AMOUNT RATIOS AMOUNT RATIOS AMOUNT RATIOS
-------- ------ --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
AS OF SEPTEMBER 30, 1998
Total Capital
(to Risk Weighted Assets)......... $106,385 10.90% $78,052 8.00% $97,565 10.00%
Core Capital
(to Adjusted Tangible Assets)..... 94,752 6.92% 41,103 3.00% 68,505 5.00%
Tangible Capital
(to Adjusted Tangible Assets)..... 94,752 6.92% 20,551 1.50% N/A N/A
Tier 1 Capital
(to Risk Weighted Assets)......... 94,752 9.70% N/A N/A 58,539 6.00%
AS OF DECEMBER 31, 1997
Total Capital
(to Risk Weighted Assets)......... $ 78,454 11.48% $54,679 8.00% $68,349 10.00%
Core Capital
(to Adjusted Tangible Assets)..... 69,900 7.55% 27,773 3.00% 46,289 5.00%
Tangible Capital
(to Adjusted Tangible Assets)..... 69,900 7.55% 13,887 1.50% N/A N/A
Tier 1 Capital
(to Risk Weighted Assets)......... 69,900 10.23% N/A N/A 41,009 6.00%
</TABLE>
The OTS has authority, after an opportunity for a hearing, to downgrade an
institution from "well capitalized" to "adequately capitalized" or to subject an
"adequately capitalized" or "undercapitalized" institution to the supervisory
actions applicable to the next lower category, if the OTS deems such action to
be appropriate as a result of supervisory concerns.
CAPITAL RESOURCES AND LIQUIDITY
The parent company had $0.7 million of cash on hand and $22.7 million in
short-term securities, at September 30, 1998. The parent company is a holding
company with no significant business operations outside of the Bank. Its
requisite obligations in relation to its debt and operations are primarily
dependent upon dividends from the Bank, the payment of which is subject to the
requirements of applicable laws and regulations.
The Company's liquidity position refers to the extent to which the
Company's funding sources are sufficient to meet its current and long-term cash
requirements. Federal regulations currently require a savings association 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 4.0% of the average
daily balance of its net withdrawable accounts and short-term borrowings during
the preceding calendar quarter. 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 associations. Monetary penalties may be imposed for failure to
meet this liquidity ratio requirement. The Company's liquidity for the
calculation period ended September 30, 1998 was 10.1%, which exceeded the
applicable minimum requirements.
26
<PAGE> 27
The Company's current primary funding resources are deposits, principal
payments on loans, FHLB advances and cash flows from operations. Other possible
sources of liquidity available to the Company include reverse repurchase
transactions involving the Company's investment securities, whole loan sales,
commercial bank lines of credit, and direct access, under certain conditions, to
borrowings from the Federal Reserve System. The cash needs of the Company are
principally for the payment of interest on and withdrawals of deposit accounts,
the funding of loans and operating costs and expenses.
YEAR 2000 COMPLIANCE
The following constitutes a "Year 2000 Readiness" disclosure under the Year
2000 Information and Readiness Disclosure Act.
The Year 2000 issue arises because many existing computer programs use only
two digits to identify a year in the date field. These programs were designed
and developed without considering the impact of the upcoming change in the
century. If a bank does not resolve problems related to the Year 2000 issue,
computer systems may incorrectly compute payment, interest or delinquency
information. In addition, because payment and other important data systems are
linked by computer, if the banks or other third parties with which the Company
conducts ongoing operations do not resolve this potential problem in time, the
Company may experience significant data processing delays, mistakes or failures.
These delays, mistakes or failures may have a significant adverse impact on the
financial condition, results of operations and cash flows of the Company.
The Company, however, has adopted, and is implementing, a plan to address
the Year 2000 issue. The plan includes the assessment of all internal systems,
programs and data processing applications (with respect to the Company,
including the new applications which are integral to the conversion of its
computer-based systems), as well as those provided to the Company by third-party
vendors. The Company has recently completed the process of converting from an
outsourced, host-based system to an in-house client-server computer system. The
Company no longer relies on any third-party provider for loan or deposit
accounting. The Company currently is performing its own Year 2000 testing by
creating a database that will roll forward systematically until the in-house
computer systems process data into what it believes is early 2000. Additionally,
in reviewing its most likely worst case scenarios, the Company has begun
establishing contingency plans that will provide for alternative methods of
conducting business for critical functions. These plans will be completed by
year end 1998.
The Company has conducted an extensive review of all of its critical third
party service providers' Year 2000 compliance efforts and identified certain
providers that require additional examination. In the process, the Company
identified six critical core data systems that are third party supported or
developed. Five of these providers have asserted that their systems are
compliant with the sixth core data system expected to be compliant by December
1998.
The Company has also has identified fifteen critical service providers
(non-data service related) of which two have asserted that they are Year 2000
compliant and seven have indicated they will be so by mid-1999. The company is
developing contingency plans for business continuity for all critical functions.
While the Company has received assurances from vendors as to compliance, such
assurances are not guarantees and may not be enforceable.
The Company, through the Bank, extends principally all of its credit on a
real estate-secured basis. The Company's primary source of repayment is by cash
flow of the borrower, although the underlying real estate collateral is the
ultimate security. The Company has approximately 2,400 loans within its
portfolio of assets and has begun Year 2000 assessments on the portfolio,
beginning with an assessment of larger commercial income property loans (greater
than $3.0 million). Within this first priority assessment group, the Company has
identified eighteen loans, totaling approximately $110.0 million, and have a
contractual maturity beyond December 31, 1999. Because these loans have an
ongoing business operations aspect, the Company believes that they may be more
susceptible to Year 2000 concerns. The Company has not yet taken steps to assess
such borrowers' Year 2000 compliance. If the borrowers fail to be Year 2000
compliant, the Company cannot at this time determine whether such noncompliance
would affect their ability to service their debt obligation. The Company
continues to assess its exposure related to larger borrowers (those with loans
over $3.0 million)
27
<PAGE> 28
that may be adversely impacted by Year 2000 issues and expects to complete its
assessment of such borrowers by June 1999.
Additionally, the Company has added a Year 2000 assessment as a component
to its internal review process of the remainder of its existing loan portfolio,
including smaller (less than $3.0 million) loans, and expects to complete its
assessment of all borrowers by June 1999. The Company cannot at this time
determine if any borrower's failure to be Year 2000 compliant will affect their
ability to service their debt obligation. In all such instances, the credit
extended to these borrowers is collateralized by real estate, which inherently
minimizes the Company's exposure. In general, the Company does not believe that
any Year 2000 issues will materially affect the Company's products, services or
competitive conditions.
Expense incurred and to be incurred by the Company to ensure Year 2000
compliance is substantially integrated and included with the expense associated
with the conversion of its computer-based systems. In addition, the Company does
not believe that the cost of addressing Year 2000 issues is a material event.
The Company anticipates incurring approximately $3.3 million in costs related to
data processing conversions and the implementation of the Company's Year 2000
plan. Approximately $1.2 million of such costs are expected to be expensed
during 1998 while approximately $2.1 million of such costs are expected to be
capitalized and expensed over a three-year period.
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 within
specified periods, the NII generally will be negatively impacted by increasing
interest rates and positively impacted by decreasing interest rates during such
periods. Conversely, when the amount of rate-sensitive assets exceeds the amount
of rate-sensitive liabilities within specified periods, net interest income
generally will be positively impacted by increasing interest rates and
negatively impacted by decreasing interest rates during such periods. The speed
and velocity of the repricing of assets and liabilities will also contribute to
the effects on NII.
The Company utilizes two methods for measuring interest rate risk, gap
analysis and interest rate simulations. Gap analysis focuses on measuring
absolute dollar amounts subject to repricing within certain periods of time,
particularly the one-year maturity horizon.
Interest rate simulations provide the Company with an estimate of both the
dollar amount and percentage change in NII 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 NPV of its
current balance sheet. From these results, the Company can then develop
alternatives to dealing with the tolerance thresholds.
The Company's interest rate risk strategy emphasizes the management of
asset and liability balances within repricing categories in order to limit the
Bank's exposure to earnings variations as well as variations in the value of
assets and liabilities due to changes in interest rates over time. The Company
does not currently utilize off balance sheet hedging instruments in order to
hedge it's interest rate exposure. Instead, the Company hedges such exposure
internally through the use of core deposit accounts and FHLB advances together
with an emphasis on investing in shorter-term or adjustable-rate assets.
28
<PAGE> 29
The following table sets forth information concerning sensitivity of the
Company's interest-earning assets and interest-bearing liabilities as of
September 30, 1998. The amounts of assets and liabilities shown within a
particular period were determined in accordance with the contractual maturities
of the assets and liabilities, except that adjustable-rate loans are included in
the period in which they are first scheduled to adjust and not in the period in
which they mature. Such assets and liabilities are classified by the earlier of
maturity or repricing date (dollars are in thousands).
<TABLE>
<CAPTION>
OVER THREE OVER SIX OVER ONE
THREE THROUGH THROUGH YEAR OVER
MONTHS SIX TWELVE THROUGH FIVE
OR LESS MONTHS MONTHS FIVE YEARS YEARS TOTAL
-------- ---------- --------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS
Cash and cash
equivalents(1)............ $143,775 $ -- $ -- $ -- $ -- $ 143,775
Investments and FHLB Stock... 35,992 -- -- -- -- 35,992
Loans(2)..................... 783,250 248,083 32,193 29,088 120,719 1,213,333
-------- -------- --------- --------- -------- ----------
Total
interest-earning
assets............. $963,017 $248,083 $ 32,193 $ 29,088 $120,719 $1,393,100
======== ======== ========= ========= ======== ==========
INTEREST-BEARING LIABILITIES
Deposits
Transaction accounts...... $144,149 $ -- $ -- $ -- $ -- $ 144,149
Certificates of deposit... 37,504 154,163 555,796 103,320 -- 850,783
FHLB advances................ -- -- -- 215,000 49,000 264,000
Senior Notes................. -- -- -- -- 40,000 40,000
-------- -------- --------- --------- -------- ----------
Total
interest-bearing
liabilities........ $181,653 $154,163 $ 555,796 $ 318,320 $ 89,000 $1,298,932
======== ======== ========= ========= ======== ==========
Interest rate sensitivity
gap....................... $781,364 $ 93,920 $(523,603) $(289,232) $ 31,719 $ 94,168
Cumulative interest rate
sensitivity gap........... 781,364 875,284 351,681 62,449 94,168 94,168
Cumulative interest rate
sensitivity gap as a
percentage of total
interest-earning assets... 56.1% 62.8% 25.2% 4.5% 6.8% 6.8%
</TABLE>
- ---------------
(1) Excludes noninterest-earning cash balances.
(2) Loans include $28.1 million of nonaccrual loans, and are exclusive of loan
loss reserves.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Bank seeks to control its interest rate risk exposure in a manner that
will allow for adequate levels of earnings and capital over a range of possible
interest rate environments. The Bank has adopted formal policies and practices
to monitor and manage interest rate risk exposure. As part of this effort, the
Bank uses the market value ("MV") methodology, a type of sensitivity analysis,
to gauge interest rate risk exposure.
Generally, MV is the discounted present value of the difference between
incoming cash flows on interest-earning assets and other assets and outgoing
cash flows on interest-bearing liabilities and other liabilities. The
application of the methodology attempts to quantify interest rate risk as the
change in the MV which would result from changes in market interest rates in
theoretical increments of 100 basis points, up to 400 basis points in either
direction.
At December 31, 1997, it was estimated that the Bank's MV would decrease
8.8% and 18.0% in the event of 200 and 400 basis point increases in market
interest rates, respectively. The Bank's MV at the same date would increase 9.3%
and 19.4% in the event of 200 and 400 basis point decreases in market rates,
respectively.
29
<PAGE> 30
Presented below, as of June 30, 1998, is an analysis of the Bank's MV
interest rate risk as measured by changes in MV for instantaneous and sustained
parallel shifts of 200 and 400 basis point increments in market interest rates
(dollars are in thousands).
<TABLE>
<CAPTION>
MARKET VALUE
------------------------------
CHANGE IN RATES $ AMOUNT $ CHANGE % CHANGE
- --------------- -------- -------- --------
<S> <C> <C> <C>
+400 bp.... $113,909 $(10,971) (8.79%)
+200 bp.... 124,139 (741) (0.59%)
0 bp....... 124,880 -- --%
- -200 bp.... 117,885 (6,995) (5.60%)
- -400 bp.... 114,205 (10,675) (8.55%)
</TABLE>
The Bank's overall improvement in its sensitivity to changes in market
rates from the period ended December 31, 1997 to June 30, 1998, is principally
attributable to an increase in its interest-earning assets with repricing
frequencies of three months or less, which have been supported by longer term
interest-bearing liabilities. The effect of these two actions has been a
moderation in the Bank's sensitivity to significant changes in market rates.
30
<PAGE> 31
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Bank is a defendant in an action entitled Takaki vs. Hawthorne Savings
and Loan Association, filed in the Superior Court of the State of California,
Los Angeles, as Case No. YC021815. The plaintiffs were owners of real property
which they sold in early 1992 to a third party. The Bank provided escrow
services in connection with the transaction. A substantial portion of the
consideration paid to the plaintiffs took the form of a deed of trust secured by
another property then owned by an affiliate of the purchaser. The value of the
collateral securing this deed of trust ultimately proved to be inadequate. The
plaintiffs alleged that the Bank knew, or should have known, that the security
for the plaintiffs' loan was inadequate and should have so advised them. In late
June 1997, a trial jury found for the plaintiffs and awarded compensatory and
punitive damages totaling $9.1 million. In late July 1997, the trial judge
reduced the combined award to $3.3 million. The trial court's judgment was
appealed. On July 21, 1998 the Court of Appeal reversed the jury's findings on
two of the three causes of action alleged by the plaintiffs, upholding only the
trial jury's finding that the Bank's escrow department was negligent in failing
to provide copies of escrow amendments to the plaintiff's real estate broker. In
rendering its opinion, the Court of Appeals also reversed the jury's findings of
compensatory and punitive damages, with instructions to the trial court to retry
the matter to determine the amount of damages, if any, attributable to the Bank
on the sole issue of negligence. A hearing to schedule a new trial date will be
held in November, 1998. Management believes that the amount of damages, if any,
attributable to the Bank in this matter will be insignificant.
The Company is involved in a variety of other litigation matters. In the
opinion of management, none of these cases will have a materially adverse effect
on the Bank's or the Company's financial condition or results of operations.
ITEM 2. CHANGES IN SECURITIES -- NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES -- NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS -- NONE
ITEM 5. OTHER INFORMATION -- NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
1. Reports on Form 8-K -- None
2. Other required exhibits -- Exhibit 27.1 -- Financial Data Schedule
31
<PAGE> 32
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HAWTHORNE FINANCIAL CORPORATION
Dated November 13, 1998 /s/ NORMAN A. MORALES
--------------------------------------
Norman A. Morales
Executive Vice President and
Chief Financial Officer
Dated November 13, 1998 /s/ H. MELISSA LANFRE
--------------------------------------
H. Melissa Lanfre
Vice President and
Principal Accounting Officer
32
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000046267
<NAME> HAWTHORNE FINANCIAL CORPORATION
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 143,775
<INT-BEARING-DEPOSITS> 978,170
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 22,679
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 1,190,382
<ALLOWANCE> 16,160
<TOTAL-ASSETS> 1,395,064
<DEPOSITS> 994,932
<SHORT-TERM> 264,000
<LIABILITIES-OTHER> 17,095
<LONG-TERM> 40,000
0
0
<COMMON> 52
<OTHER-SE> 78,985
<TOTAL-LIABILITIES-AND-EQUITY> 1,395,064
<INTEREST-LOAN> 73,077
<INTEREST-INVEST> 2,938
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 76,015
<INTEREST-DEPOSIT> 34,533
<INTEREST-EXPENSE> 44,037
<INTEREST-INCOME-NET> 31,978
<LOAN-LOSSES> 5,185
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 20,311
<INCOME-PRETAX> 11,989
<INCOME-PRE-EXTRAORDINARY> 8,463
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,463
<EPS-PRIMARY> 2.21
<EPS-DILUTED> 1.33
<YIELD-ACTUAL> 9.28
<LOANS-NON> 28,084
<LOANS-PAST> 14,446
<LOANS-TROUBLED> 36,450
<LOANS-PROBLEM> 39,715
<ALLOWANCE-OPEN> 13,274
<CHARGE-OFFS> 2,299
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 16,160
<ALLOWANCE-DOMESTIC> 16,160
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
