<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 March 31, 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)
Delaware 95-2085671
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
2381 Rosecrans Avenue, El Segundo, CA 90245
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (310) 725-5000
---------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date: The Registrant had
3,164,096 shares of Common Stock, $0.01 par value per share, outstanding as of
April 30, 1998.
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<PAGE> 2
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q INDEX
For the quarter ended March 31, 1998
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION Page
----
<S> <C>
ITEM 1. Financial Statements
Consolidated Statements of Financial Condition
at March 31, 1998 and December 31, 1997 3
Consolidated Statements of Operations
for the Three Months Ended March 31, 1998 and 1997 4
Consolidated Statement of Stockholders' Equity
for the Three Months Ended March 31, 1998 5
Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 1998 and 1997 6
Notes to Consolidated Financial Statements 8
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 30
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 32
ITEM 2. Changes in Securities 32
ITEM 3. Defaults upon Senior Securities 32
ITEM 4. Submission of Matters to a Vote of Security Holders 32
ITEM 5. Other Information 32
ITEM 6. Exhibits and Reports on Form 8-K 32
</TABLE>
FORWARD LOOKING STATEMENTS
When used in this Form 10-Q or future filings by Hawthorne Financial
Corporation and Subsidiary (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. For an additional discussion of the risks
that could affect the Company's results of operations, readers are advised to
refer to the section captioned "Risk Factors" in the Company's 10-K.
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)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 60,636 $ 51,620
Investment securities available-for-sale, at market 586 578
Loans receivable (net of allowance for estimated credit losses
of $14,092 in 1998 and $13,274 in 1997) 950,589 838,251
Real estate owned (net of allowance for estimated losses
of $862 in 1998 and $2,563 in 1997) 6,551 9,859
Investment in capital stock of Federal Home Loan Bank - at cost 7,318 7,213
Deferred tax asset, net 6,350 6,820
Accrued interest receivable 6,235 5,298
Office property and equipment - at cost, net 4,656 4,200
Other assets 3,986 4,358
----------- -----------
$ 1,046,907 $ 928,197
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits $ 848,870 $ 799,501
FHLB advances 105,000 40,000
Senior notes 40,000 40,000
Accounts payable and other liabilities 8,508 6,377
----------- -----------
1,002,378 885,878
Stockholders' equity
Preferred stock - $0.01 per share; authorized 10,000,000 shares;
none issued and outstanding -- --
Common stock - $0.01 par value; authorized, 20,000,000
shares; issued and outstanding, 3,169,496 shares in 1998 and
3,095,996 shares in 1997 32 31
Capital in excess of par value - common stock 10,770 10,402
Accumulated other comprehensive income - unrealized gain on
available-for-sale securities 6 6
Retained earnings 33,853 32,020
----------- -----------
44,661 42,459
Less
Treasury stock, at cost - 5,400 shares (48) (48)
Loan to Employee Stock Ownership Plan (84) (92)
----------- -----------
44,529 42,319
----------- -----------
$ 1,046,907 $ 928,197
=========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
3
<PAGE> 4
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS ARE IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------
1998 1997
-------- --------
<S> <C> <C>
Interest revenues
Loans, net of nonaccrual income $ 21,161 $ 15,506
Investments 833 1,501
-------- --------
Total interest revenues 21,994 17,007
-------- --------
Interest costs
Deposits 10,737 8,892
FHLB advances 917 780
Senior notes 1,264 483
-------- --------
Total interest costs 12,918 10,155
-------- --------
Net interest income 9,076 6,852
Provision for credit losses 1,485 1,220
-------- --------
Net interest income after provision for credit losses 7,591 5,632
Noninterest revenues, net
Operating 709 732
Non-operating 4 (13)
-------- --------
Total noninterest revenues, net 713 719
Noninterest expenses
General and administrative costs
Employee 3,237 2,769
Operating 1,625 1,181
Occupancy 863 754
Professional 330 348
SAIF premium and OTS assessment 225 372
-------- --------
Total general and administrative costs 6,280 5,424
(Income) loss from real estate operations, net (333) 260
-------- --------
Total noninterest expenses 5,947 5,684
-------- --------
Net earnings before income taxes 2,357 667
Income tax (provision) benefit (524) 692
-------- --------
Net earnings $ 1,833 $ 1,359
======== ========
Net earnings available for Common Stock (NOTE 3) $ 1,833 $ 750
======== ========
Basic earnings per share (NOTE 3) $ 0.58 $ 0.29
======== ========
Diluted earnings per share (NOTE 3) $ 0.32 $ 0.16
======== ========
Weighted average basic shares outstanding (NOTE 3) 3,157 2,617
======== ========
Weighted average diluted shares outstanding (NOTE 3) 5,681 4,795
======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE> 5
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
COMPREHENSIVE INCOME
--------------------
BALANCE AT EXERCISED CHANGE IN BALANCE AT
DECEMBER 31, STOCK UNREALIZED NET MARCH 31,
1997 OPTIONS GAINS EARNINGS REPAYMENTS 1998
----------- ---------- ---------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Common stock $ 31 $ 1 $ -- $ -- $ -- $ 32
Capital in excess of par value
Common stock 10,402 368 -- -- -- 10,770
Accumulated other comprehensive income -
unrealized gain on available-for-sale
securities 6 -- -- -- 6
Retained earnings 32,020 -- -- 1,833 -- 33,853
Treasury stock (48) -- -- -- -- (48)
Loan to employee stock ownership plan (92) -- -- -- 8 (84)
-------- -------- ------ -------- -------- --------
Total stockholders' equity $ 42,319 $ 369 $ -- $ 1,833 $ 8 $ 44,529
======== ======== ====== ======== ======== ========
Comprehensive income $ -- $ 1,833 $ 1,833
====== ======== ========
</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
MARCH 31,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
NET CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings $ 1,833 $ 1,359
Adjustments
Provision (benefit) for income taxes 524 (692)
Provision for estimated credit losses on loans 1,485 1,220
Provision for estimated losses on real estate owned 15 280
Net recoveries from sales of real estate owned (299) (24)
Net gain from sale of other assets (4) --
Loan fee and discount accretion (1,364) (905)
Depreciation and amortization 401 445
FHLB dividends (105) (110)
(Increase) decrease in:
Accrued interest receivable (937) 80
Other assets 226 (2,340)
Increase (decrease) in other liabilities 2,131 (15,365)
Other, net - (43)
--------- ---------
Net cash provided by (used in ) operating activities 3,906 (16,095)
--------- ---------
NET CASH FLOWS FROM INVESTING ACTIVITIES
Investment securities
Purchases (8) (40,000)
Loans
New loans funded (110,673) (43,991)
Construction disbursements (61,551) (17,950)
Advances on lines of credit (20,491) (3,486)
Payoffs 62,470 29,194
Principal amortization 16,417 4,336
Other, net 1,580 1,224
Real estate owned
Sales proceeds 3,575 5,728
Capitalized costs (253) (2,256)
Other, net 59 --
Office property and equipment
Sales proceeds 4 --
Additions (765) (111)
--------- ---------
Net cash used in investing activities (109,636) (67,312)
--------- ---------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
6
<PAGE> 7
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended
MARCH 31,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
NET CASH FLOWS FROM FINANCING ACTIVITIES
Deposit activity, net $ 49,369 $ (9,696)
Net change in FHLB advances 65,000 15,000
Net proceeds from exercise of options 369 142
Collection of ESOP loan 8 7
--------- ---------
Net cash provided by financing activities 114,746 5,453
--------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 9,016 (77,954)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 51,620 93,978
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 60,636 $ 16,024
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for
Interest $ 11,202 $ 9,803
Income taxes 54 2
Non-cash investing and financing activities
Real estate acquired in settlement of loans 1,770 6,719
Loans originated to finance sales of real estate owned 1,612 2,192
Net change in unrealized gains (losses) on
available-for-sale securities -- (697)
Loan activity
Total commitments and permanent fundings $ 192,976 $ 74,079
Less:
Change in undisbursed funds on construction commitments (19,140) (1,958)
Loans originated to finance sales of real estate owned (1,612) (2,192)
Non-cash portion of refinanced loans -- (6,300)
Undisbursed portion of new lines of credit -- (1,688)
--------- ---------
Net construction disbursements and loans funded $ 172,224 $ 61,941
========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
7
<PAGE> 8
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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
March 31, 1998 and the results of its operations for the three months ended
March 31, 1998 and 1997, and its cash flows for the three months ended March 31,
1998 and 1997. Operating results for the three months ended March 31, 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 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 with the
same prominence as other financial statements. This statement did not have an
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
In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128, "Earnings Per Share", which establishes standards for computing and
presenting earnings per share. The table below sets forth the Company's earnings
per share calculations for the three months ended March 31, 1998 and 1997. The
Diluted and Basic Methods were used for both periods as prescribed under GAAP.
In the table below, (1) Warrants refers to the warrants issued by the Company in
December 1995, which have an exercise price of $2.25 per share and can be
exercised beginning three years from the issue date and for a period of ten
years 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.
8
<PAGE> 9
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(AMOUNTS ARE IN THOUSANDS, EXCEPT FOR BOOK VALUE AND PER SHARE DATA)
NOTE 3 - BOOK VALUE AND EARNINGS PER SHARE - CONTINUED
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------
1998 1997
-------- --------
<S> <C> <C>
SHARES OUTSTANDING
Basic 3,157 2,617
Warrants 2,376 2,376
Options 655 668
Less Treasury shares(1) (507) (866)
-------- --------
Diluted 5,681 4,795
======== ========
STOCKHOLDERS' EQUITY
Basic $ 44,529 $ 32,532
Warrants 5,346 5,346
Options 4,704 3,342
Less Treasury shares(1) (10,087) (8,745)
-------- --------
Diluted $ 44,492 $ 32,475
======== ========
NET EARNINGS
Net earnings for the period $ 1,833 $ 1,359
Preferred stock dividends -- (609)
-------- --------
Net earnings available for Common stock $ 1,833 $ 750
======== ========
BASIC BOOK VALUE PER SHARE $ 14.10 $ 12.43
======== ========
BASIC EARNINGS PER SHARE $ 0.58 $ 0.29
======== ========
DILUTED BOOK VALUE PER SHARE $ 7.83 $ 6.77
======== ========
DILUTED EARNINGS PER SHARE $ 0.32 $ 0.16
======== ========
</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.
9
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company earned $1.8 million, or $0.32 per diluted share, for the
quarter ended March 31, 1998, an increase of 35% over net earnings of $1.4
million, or $0.16 per diluted share, for the first quarter of 1997. This growth
in net earnings reflects a 19% increase in average earning assets, and a 67
basis point increase in the Bank's interest margin during the first quarter of
1998 as compared to the first quarter of 1997, as well as a $24.5 million or 59%
decline in nonperforming assets ("NPAs") from March 31, 1997 to March 31, 1998.
These positive influences were partially offset by the Company's return to
taxable status, an increase in consolidated operating costs and higher parent
company interest costs, attributable to a tripling of the Company's outstanding
indebtedness.
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 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. In
addition, the Company returned to taxable status during the first quarter of
1998, following several years in which it recorded income tax benefits from
utilization of accumulated operating loss carryforwards. Accordingly, the
consolidated operating results, and related per share amounts for the first
quarter of 1998 are not comparable to the results for the first quarter of 1997.
Because of these factors, the Company believes that core earnings is
a more useful measure of its underlying operating performance. Core earnings are
earnings before interest on parent company debt, income taxes, real estate
operations and nonoperating items. For the first quarter of 1998, core earnings
were $3.3 million, more than double the core earnings of $1.4 million generated
during the first quarter of 1997.
10
<PAGE> 11
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 MARCH 31,
-------------------------
1998 1997
-------- --------
<S> <C> <C>
Net interest income $ 10,340 $ 7,335
Provision for credit losses 1,485 1,220
-------- --------
Net interest income after provision for credit losses 8,855 6,115
Noninterest operating revenues 709 732
General and administrative costs (6,280) (5,424)
-------- --------
CORE EARNINGS 3,284 1,423
-------- --------
Nonrecurring gains (losses)
Real estate operations, net 333 (260)
Other, net 4 (13)
Other items
Interest on senior notes (1,264) (483)
Income tax (provision) benefit (524) 692
-------- --------
(1,451) (64)
-------- --------
NET EARNINGS $ 1,833 $ 1,359
======== ========
</TABLE>
This substantial growth in core earnings resulted from (1) a 19%
growth in average earning assets, (2) a 59% decline in NPAs, and (3) an increase
of 67 basis points in the Bank's interest margin (before loan loss provisions),
in each instance comparing the March 1998 and March 1997 quarters.
The growth in average earning assets resulted from the continuing
successful expansion of the Company's financing businesses. During the first
quarter of 1998, the Company generated new permanent and construction loan
commitments of $193.0 million, which, net of loan repayments, produced net
growth of $112.3 million in the Company's retained net loan portfolio during the
quarter, an annualized growth rate of 54%. Since March 31, 1997, net loans have
increased by $252.4 million, or 36%. The Company recorded new permanent and
construction loan commitments of $74.1 million during the first quarter of 1997.
The Company retains virtually all of its new loans for its own account, rather
than selling them into the secondary mortgage markets.
NPAs, which consist of the net carrying value of properties acquired
through foreclosure ("REO") and loan principal three or more payments
delinquent, amounted to $16.8 million at March 31, 1998, down 59% from $41.2
million at March 31, 1997. Since March 31, 1997, the Company's REO has been
reduced to $6.6 million (39% of NPAs) from $21.0 million (51% 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, which amount to an annualized rate of 0.8% of the
average loans outstanding for the quarter.
The Company's mix of financings, and its willingness and ability to
provide its customers with tailored terms and highly-efficient transaction
execution when necessary, contributes to its ability to produce yields on the
incremental growth in its loan portfolio which are higher than the average yield
on the entire portfolio. Concurrently, the Company has been successful in
keeping its funding costs (excluding parent company debt) virtually unchanged
during the past several quarters. As a result, during the first quarter of 1998,
the Bank's interest margin (before interest on parent company debt and loan loss
provisions) reached 4.34%, an increase of 67 basis points from the interest
margin of 3.67% realized during the first quarter of 1997. Net of interest on
parent company
11
<PAGE> 12
debt and loan loss provisions, the Company's consolidated interest margin was
3.18% during the first quarter of 1998, as compared with 2.82% during the first
quarter of 1997.
In late 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 in-house, client server-based system, and to
design and implement a plan to ensure Year 2000 compliance. These and related
initiatives are expected to increase the Company's consolidated general and
administrative costs during 1998 by about 15% as compared with 1997. During the
first quarter of 1998, general and administrative costs of $6.3 million were
$0.9 million, or 16%, higher than for the first quarter of 1997, which was in
line with expectations.
INCOME TAXES
During the quarter ended March 31, 1998, the Company's earnings were
reduced by an income tax provision of $0.5 million, or an estimated effective
tax rate of 22% of consolidated pretax earnings. During the first quarter of
1997, the Company recorded an income tax benefit of $0.7 million. 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
last three years. Separate issues of Preferred Stock and Senior Notes due 2000,
issued in December 1995 in connection with a recapitalization of the Company and
the Bank, were refinanced in December 1997 with proceeds from the issuance by
the Company of its Senior Notes due 2004, which carry a coupon interest rate of
12.5% and have an effective cost of approximately 13.4% (after including the
effect of issue cost amortization). Through March 31, 1998, the Company had
contributed approximately $35.0 million of the proceeds from the Senior Notes 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 under regulation of the Office of
Thrift Supervision ("OTS"). At March 31, 1998, the Bank's core and risk-based
capital ratios were 7.45% and 11.45%, respectively, which were comfortably in
excess of 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. These percentage
measures 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 nonaccrual loans and REO.
12
<PAGE> 13
The following table sets forth the Company's average balance sheet,
and the related weighted average yields and costs on average interest-earning
assets (inclusive of nonaccrual loans) and interest-bearing liabilities, for the
three months ended March 31, 1998 and 1997. In the table, interest revenues are
net of interest associated with nonaccrual loans (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------------------------
MARCH 31, 1998 MARCH 31, 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) $892,060 $ 21,161 9.49% $688,597 $ 15,506 9.01%
Cash and cash equivalents 53,506 720 5.38 58,945 738 5.01
Investment securities 574 8 5.57 45,315 653 5.76
Investment in capital stock of
Federal Home Loan Bank 7,251 105 5.79 6,847 110 6.43
-------- -------- -------- --------
Total interest-earning assets 953,391 21,994 9.23 799,704 17,007 8.51
-------- ----- -------- -----
Noninterest-earning assets 23,902 31,064
-------- --------
Total assets $977,293 $830,768
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities
Deposits $819,886 10,737 5.31 $705,507 8,892 5.11
FHLB Advances 63,988 917 5.81 51,935 780 6.09
Senior notes 40,000 1,264 12.82 12,345 483 15.87
-------- -------- -------- --------
Total interest-bearing liabilities 923,874 12,918 5.67 769,787 10,155 5.35
-------- ----- -------- -----
Noninterest-bearing liabilities 10,026 17,065
Stockholders' equity 43,393 43,916
-------- --------
Total liabilities & stockholders' equity $977,293 $830,768
======== ========
Net interest income $ 9,076 $ 6,852
======== ========
Interest rate spread 3.56% 3.16%
===== =====
Net interest margin 3.81% 3.43%
===== =====
Net interest margin excluding parent
company indebtedness 4.34% 3.67%
===== =====
</TABLE>
(1) Includes nonaccrual loans of $21.4 million and $29.0 million for the
three months ended March 31, 1998 and March 31, 1997, respectively.
(2) Includes amortization of loan fees and discounts of $1.4 million and
$0.9 million for the three months ended March 31, 1998 and March 31,
1997, respectively.
13
<PAGE> 14
ANALYSIS OF CHANGES IN NET INTEREST INCOME
The following table presents 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 MARCH 31, 1998 AND 1997
INCREASE (DECREASE) DUE TO CHANGE IN
-------------------------------------------------------------
RATE AND NET
VOLUME RATE VOLUME CHANGE
------- ------- ------- -------
INTEREST REVENUES
<S> <C> <C> <C> <C>
Loans $ 4,582 $ 828 $ 245 $ 5,655
Cash and cash equivalents (68) 55 (5) (18)
Investment securities (645) (22) 22 (645)
Investment in capital stock of
Federal Home Loan Bank 6 (10) (1) (5)
------- ------- ------- -------
3,875 851 261 4,987
------- ------- ------- -------
INTEREST COSTS
Deposits 1,442 347 56 1,845
FHLB Advances 181 (36) (8) 137
Senior notes 1,082 (93) (208) 781
------- ------- ------- -------
2,705 218 (160) 2,763
------- ------- ------- -------
INCREASE IN NET INTEREST INCOME $ 1,170 $ 633 $ 421 $ 2,224
======= ======= ======= =======
</TABLE>
The Company's interest income (net of interest due on nonaccrual
loans) increased by $5.0 million or 29.3% during the first quarter 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.
The increase in interest income during the first quarter of 1998 was
partially offset by a $2.8 million, or 27.2%, increase in interest expense, 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 an
increase in the weighted average rate paid on the Company's deposits.
As a result of the foregoing, the Company's net interest income
increased by $2.2 million, or 32.5%, from $6.9 million during the first quarter
of 1997 to $9.1 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 38 basis points, or 11.1%, from 3.43% to 3.81% during the
same respective periods.
PROVISIONS FOR CREDIT LOSSES
For the three months ended March 31, 1998, the Company recorded
provisions for credit losses of $1.5 million, compared with provisions for
credit losses of $1.2 million recorded during the three months ended March 31,
1997. At March 31, 1998, the Company's allowance for credit losses amounted to
$14.1 million, of which $9.9 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
14
<PAGE> 15
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 MARCH 31,
-------------------------------------
OPERATING 1998 1997 CHANGE
----- ----- -----
<S> <C> <C> <C>
Loan related fees $ 458 $ 466 $ (8)
Other 251 266 (15)
----- ----- -----
$ 709 $ 732 $ (23)
===== ===== =====
NON-OPERATING
Other, net $ 4 $ (13) $ 17
----- ----- -----
$ 4 $ (13) $ 17
===== ===== =====
</TABLE>
Loan related fee revenues consist of prepayment, extension,
modification, escrow and exit fees collected from customers.
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 March 31,
---------------------------------------
1998 1997 CHANGE
------ ------ ------
<S> <C> <C> <C>
Employee $3,237 $2,769 $ 468
Operating 1,625 1,181 444
Occupancy 863 754 109
Professional 330 348 (18)
SAIF premium
and OTS assessment 225 372 (147)
------ ------ ------
$6,280 $5,424 $ 856
====== ====== ======
</TABLE>
During the last half of 1997 and continuing into the first quarter of
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 17% during the
first quarter of 1998 as compared with the 1997 first quarter, in line with
expectations.
The Company has experienced an increase in operating costs primarily
as a result of its efforts related to the ongoing computer system conversions
and expenditures related to its focused efforts to expand the Company's retail
banking presence.
15
<PAGE> 16
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 MARCH 31,
-------------------------------------
1998 1997 CHANGE
----- ----- -----
<S> <C> <C> <C>
EXPENSES ASSOCIATED WITH
REAL ESTATE OWNED
Property taxes $ 3 $ 21 $ (18)
Repairs, maintenance
and renovation 15 13 2
Insurance 30 44 (14)
----- ----- -----
Total 48 78 (30)
NET RECOVERIES FROM SALE OF PROPERTIES (299) (24) (275)
PROPERTY OPERATIONS, NET (97) (74) (23)
PROVISION FOR ESTIMATED LOSSES ON REAL ESTATE OWNED 15 280 (265)
----- ----- -----
(INCOME) LOSS FROM REAL ESTATE OPERATIONS, NET $(333) $ 260 $(593)
===== ===== =====
</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. During the three months ended March 31, 1998 and March
31, 1997, the Company sold 17 properties generating net cash proceeds of $3.6
million and a net gain of $0.3 million, as compared to 40 properties generating
net cash proceeds of $5.7 million and a nominal gain, respectively.
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 months ended March 31, 1997, the Company recorded
$0.3 million in provisions associated with its then remaining foreclosed
residential construction projects. As of March 31, 1998, the homes within these
projects had been sold.
INCOME TAXES
The Company recorded an income tax provision of $0.5 million for the
quarter ended March 31, 1998, as compared to a $0.7 million income tax benefit
recorded during the three months ended March 31, 1997. The effective income tax
rate has been reduced to 22% to reflect the benefit of the reduction of deferred
tax valuation allowance previously established. At March 31, 1998, the Company
had approximately $2.0 million of accumulated income tax benefits, consisting
primarily of net operating loss carryforwards and future tax deductions which
had not been recognized for financial statement purposes and which are available
to be utilized to shield future earnings from income taxes, both for financial
reporting and income tax reporting 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.
16
<PAGE> 17
FINANCIAL CONDITION, CAPITAL RESOURCES & LIQUIDITY AND ASSET QUALITY
ASSETS
CASH AND CASH EQUIVALENTS
Cash and cash equivalents at March 31, 1998 and at December 31, 1997
consisted of the following (dollars are in thousands).
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
------- -------
<S> <C> <C>
Cash $12,136 $ 9,520
Federal funds sold 48,500 42,100
------- -------
$60,636 $51,620
======= =======
</TABLE>
INVESTMENT SECURITIES
The table below summarizes the cost basis and estimated fair value of
investment securities available-for-sale at March 31, 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>
MUTUAL FUND
March 31, 1998 $580 6 - $586
December 31, 1997 $572 6 - $578
</TABLE>
Investment securities with both a cost basis and an estimated fair
value of $0.6 million at March 31, 1998, had a weighted average yield of 6.39%,
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>
MARCH 31, 1998 DECEMBER 31, 1997
------------------------- -------------------------
BALANCE PERCENT BALANCE PERCENT
----------- ------- ---------- --------
<S> <C> <C> <C> <C>
SINGLE FAMILY
Estate(1) $ 216,575 19.6% $ 173,764 17.9%
Conventional 218,721 19.8 224,006 23.1
INCOME PROPERTY
Multi-family 233,520 21.2 225,738 23.3
Commercial real estate 132,171 12.0 114,293 11.8
LAND 62,999 5.7 39,475 4.1
SINGLE FAMILY CONSTRUCTION
Individual residences 151,587 13.7 112,899 11.7
Tract development 61,774 5.6 68,653 7.1
OTHER 26,596 2.4 9,698 1.0
----------- ----- ----------- ------
GROSS LOANS RECEIVABLE(2) 1,103,943 100.0% 968,526 100.0%
===== ======
LESS
Participants' share (1,088) (1,141)
Undisbursed loan funds (130,371) (108,683)
Deferred loan fees and
credits, net (7,803) (7,177)
Reserves (14,092) (13,274)
----------- ----------
NET LOANS RECEIVABLE $ 950,589 $ 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
construction commitments.
18
<PAGE> 19
The table below sets forth the approximate composition of the
Company's new loan commitments, net of internal refinances, for the period
indicated in dollars and a percentage of total loans originated (dollars are in
thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1998
----------------------
TYPE OF SECURITY AMOUNT %
- ------------------------------------- -------- ------
<S> <C> <C>
SINGLE FAMILY
Estate (1) $ 57,000 29.5%
Conventional 4,900 2.5
INCOME PROPERTY
Multi-family (2) 13,800 7.2
Commercial real estate (3) 23,500 12.2
LAND (4) 21,300 11.0
SINGLE FAMILY CONSTRUCTION
Individual residences (5) 55,500 28.8
Tract development (6) 10,200 5.3
OTHER 6,800 3.5
--------- -----
$ 193,000 100.0%
========= =====
</TABLE>
- ----------
(1) Includes unfunded commitments under lines of credit of $1.3 million at
March 31, 1998.
(2) Includes $1.6 million of financings provided in connection with sales of
previously foreclosed properties for the three months ended March 31,
1998.
(3) Includes unfunded commitments under lines of credit of $2.5 million at
March 31, 1998.
(4) Includes unfunded commitments of $0.6 million at March 31, 1998.
(5) Includes unfunded commitments of $36.1 million at March 31, 1998.
(6) Includes unfunded commitments of $9.8 million at March 31, 1998.
ASSET QUALITY
NONACCRUAL AND TROUBLED DEBT RESTRUCTURED LOANS
The Company places loans on nonaccrual status when (1) they become
one or more payments delinquent or (2) management believes that, with respect to
performing loans, continued collection of principal and interest from the
borrower is not reasonably assured.
19
<PAGE> 20
The following table provides information regarding the Company's
nonaccrual loans as of the dates indicated (dollars are in thousands).
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------- -------
<S> <C> <C>
Loans past due 90 days or more $10,223 $10,793
Loans past due 30-89 days 8,887 4,435
Other nonaccrual loans 148 168
------- -------
Total(1) $19,258 $15,396
======= =======
Reserves to loans past due 90 days or more 137.8% 123.0%
Reserves to total nonaccrual loans 73.2% 86.2%
</TABLE>
- ----------
(1) Includes $0.2 million and $0.5 million of troubled debt restructured
loans ("TDRs") at March 31, 1998 and December 31, 1997, respectively.
Excludes $31.4 million and $29.1 million of TDRs which were performing
in accordance with their modified terms at March 31, 1998 and December
31, 1997, respectively.
During the past several years, the Company's lending areas, which are
concentrated in Southern California, experienced adverse economic conditions,
including declining real estate values. These factors adversely affected the
ability of certain borrowers to repay loans according to their stated terms.
Although management believes the level of allowance for estimated credit losses
on loans is adequate to absorb losses inherent in the loan portfolio, continuing
weakness in the local economy may result in increasing loan losses that cannot
be reasonably predicted at December 31, 1997.
20
<PAGE> 21
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>
MARCH 31, DECEMBER 31,
1998 1997
-------- --------
<S> <C> <C>
Real estate owned, net $ 6,551 $ 9,859
Nonperforming loans(1) 10,223 10,793
-------- --------
GROSS NONPERFORMING ASSETS 16,774 20,652
Other delinquent loans(2) 8,887 4,435
Performing loans classified loss,
doubtful and substandard(3) 34,307 36,013
-------- --------
GROSS CLASSIFIED ASSETS $ 59,968 $ 61,100
======== ========
CLASSIFIED LOANS(4) $ 53,417 $ 51,241
======== ========
LOANS RECEIVABLE(5) $964,681 $851,525
======== ========
RESERVES ON LOANS
Specific $ 4,172 $ 3,878
General 9,920 9,396
-------- --------
$ 14,092 $ 13,274
======== ========
Total reserves to loans receivable 1.5% 1.6%
Total reserves to classified loans 26.4% 25.9%
Total reserves to nonperforming loans 137.8% 123.0%
Gross nonperforming assets to total assets 1.6% 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 $0.1 million and $0.2 million of performing loans on nonaccrual
status at March 31, 1998, and December 31, 1997, respectively.
(4) Includes $19.3 million and $15.4 million of nonaccrual loans at March
31, 1998, and at December 31, 1997, respectively.
(5) Loans receivable are exclusive of the allowance for credit losses.
The carrying value of NPA (i.e., real estate owned and loans 90 days
or more delinquent) decreased to $16.8 million, or 1.6% of total assets, at
March 31, 1998, from $20.7 million, or 2.2% of total assets, at December 31,
1997. The carrying value of NPA peaked at $151.2 million in December 1993.
21
<PAGE> 22
The table below sets forth information concerning the company's
total classified loans as of March 31, 1998 (dollars are in thousands).
<TABLE>
<CAPTION>
CLASSIFIED LOANS
------------------------------------------------------------------
OTHER PERFORMING
NONPERFORMING (1) DELINQUENCIES(2) LOANS (3) TOTAL
----------------- ---------------- -------------- --------
<S> <C> <C> <C> <C>
SINGLE FAMILY
Estate $ 7,904 $ 4,235 $ 8,569 $20,708
Conventional 2,276 2,028 13,880 18,184
INCOME PROPERTY
Multi-family -- 2,230 4,177 6,407
Commercial real estate -- -- 2,000 2,000
LAND 43 394 -- 437
SINGLE FAMILY CONSTRUCTION
Individual residences -- -- 831 831
Tract development -- -- 3,661 3,661
OTHER -- -- 1,189 1,189
------- ------- ------- -------
Total $10,223 $ 8,887 $34,307 $53,417
======= ======= ======= =======
</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 $0.1 million of performing loans 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.
22
<PAGE> 23
The table below sets forth the general and specific reserves for the
Company's loan and REO portfolios as of March 31, 1998 (dollars are in
thousands).
<TABLE>
<CAPTION>
LOANS
-------------------------------- REAL ESTATE
PERFORMING DELINQUENT OWNED TOTAL
---------- ---------- ------- --------
<S> <C> <C> <C> <C>
Specific reserves $ 3,310 $ 862 $ 836 $ 5,008
General reserves 9,447 473 26 9,946
------- ------- ------- -------
Total $12,757 $ 1,335 $ 862 $14,954
======= ======= ======= =======
PERCENTAGES
% of total reserves to gross investment 1.3% 7.0% 11.6% 1.5%
% of general reserves to gross investment 1.0% 2.5% 0.4% 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
MARCH 31,
-------------------------------
1998 1997
--------- ---------
<S> <C> <C>
LOANS
Average loans outstanding $ 892,060 $ 688,597
========= =========
Reserve balance at beginning of period $ 13,274 $ 13,515
Provision for credit losses 1,485 1,220
Charge-offs:
Single family - conventional (467) (413)
Income property
Multi-family -- (515)
Commercial real estate (200) --
Land -- (150)
--------- ---------
Total charge-offs (667) (1,078)
--------- ---------
Balance at end of period $ 14,092 $ 13,657
========= =========
Ratio of net charge-offs to average loans
outstanding during the period 0.1% 0.2%
REAL ESTATE OWNED
Reserve balance at beginning of period $ 2,563 $ 11,871
Provision for credit losses 15 280
Charge-offs (1,716) (2,492)
--------- ---------
Balance at end of period $ 862 $ 9,659
========= =========
</TABLE>
23
<PAGE> 24
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>
MARCH 31, 1998 DECEMBER 31, 1997
------------------------------ -----------------------------
PERCENT OF PERCENT OF
RESERVES TO RESERVES TO
TOTAL LOANS TOTAL LOANS
BALANCE BY CATEGORY BALANCE BY CATEGORY
------------ ----------- --------- -----------
<S> <C> <C> <C> <C>
SINGLE FAMILY
Estate $ 2,311 1.1% $ 1,975 1.1%
Conventional 4,216 1.9% 4,696 2.1%
INCOME PROPERTY
Multi-family 2,398 1.0% 2,000 0.9%
Commercial real estate 2,539 1.9% 2,252 2.0%
LAND 329 0.5% 162 0.4%
SINGLE FAMILY CONSTRUCTION
Individual residences 463 0.3% 503 0.4%
Tract development 1,006 1.6% 817 1.2%
OTHER 264 1.0% 226 2.3%
UNALLOCATED 566 -- % 643 -- %
---------- --------
$ 14,092 1.3% $ 13,274 1.4%
========== ========
</TABLE>
The table below summarizes reserves at the dates indicated for each
of the REO by type of property (dollars are in thousands).
<TABLE>
MARCH 31, 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 $ 36 0.7% $ 1,523 19.8%
INCOME PROPERTY
Multi-family -- -- % 18 0.8%
LAND 800 36.8% 1,022 43.2%
UNALLOCATED 26 -- % -- -- %
------ --------
$ 862 11.6% $ 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.
24
<PAGE> 25
The table below summarizes the composition of the Company's REO at
the dates indicated (dollars are in thousands).
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
-------- --------
<S> <C> <C>
SINGLE FAMILY
Conventional $ 4,995 7,695
INCOME PROPERTY
Multi-family 247 2,362
LAND 2,171 2,365
-------- --------
GROSS INVESTMENT (1) 7,413 12,422
ALLOWANCE FOR ESTIMATED LOSSES (862) (2,563)
-------- --------
NET INVESTMENT $ 6,551 $ 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 and securities sold under agreements to
repurchase ("reverse repurchase agreements"). 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 March 31, 1998, were $848.9 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>
MARCH 31, 1998 DECEMBER 31, 1997
-------------------------------------------- ------------------------------------
DESCRIPTION BALANCE WAIR WARM BALANCE WAIR WARM
- ------------------------------- ----------------- ----------- --------- ------------ -------- -----
<S> <C> <C> <C> <C> <C> <C>
Transaction accounts $ 121,111 2.54% -- $ 105,812 2.44% --
Certificates of deposit
7 day maturities 42,006 4.43% -- 42,907 4.43% --
Less than 6 months 33,501 5.51% 3 35,418 5.57% 2
6 months to 1 year 525,828 5.77% 6 456,072 5.80% 8
1 year to 2 years 115,665 5.74% 7 146,674 5.74% 7
Greater than 2 years 10,759 5.41% 12 12,618 5.45% 13
----------- ----------
Total $ 848,870 5.22% 5 $ 799,501 5.26% 6
=========== ==========
</TABLE>
25
<PAGE> 26
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.
At March 31, 1998, the Company had two FHLB advances outstanding
totaling $105.0 million with an original and remaining weighted average term of
three years and four months and three years and one month, respectively. These
advances are securitized by mortgage collateral and have a weighted average rate
of 5.59%.
SENIOR NOTES
On December 31, 1997, the Company completed the issuance of $40.0
million of Senior Notes due 2004. The Notes carry 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
The Company's capital consists of common stockholders' equity, which
at March 31, 1998, amounted to $44.5 million and represented 4.3% 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 March 31, 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 (2) $ 77,773 $ 77,773 $ 77,773
Adjustments
General valuation allowances -- -- 9,539
Unrealized (gains) losses, net (6) (6) (6)
----------- ----- ----------- ----- ----------- -------
Regulatory capital 77,767 7.45% 77,767 7.45% 87,306 11.45%
Required minimum 15,667 1.50% 31,334 3.00% 61,021 8.00%
----------- ----- ----------- ----- ----------- -------
Excess capital $ 62,100 5.95% $ 46,433 4.45% $ 26,285 3.45%
=========== ===== =========== ===== =========== =======
Adjusted assets (1) $ 1,044,473 $ 1,044,473 $ 762,760
=========== =========== ===========
</TABLE>
- ----------
(1) 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).
(2) Reflects a capital contribution of $4.5 million from the parent company
made in March 1998.
26
<PAGE> 27
As of March 31, 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 TO BE CATEGORIZED AS
ADEQUATELY CAPITALIZED WELL CAPITALIZED
UNDER PROMPT CORRECTIVE UNDER PROMPT CORRECTIVE
ACTUAL ACTION PROVISIONS ACTION PROVISIONS
----------------------- ---------------------- ----------------------
AMOUNT RATIOS AMOUNT RATIOS AMOUNT RATIOS
----------- -------- ------------- ------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
AS OF MARCH 31, 1998
Total Capital
(to Risk Weighted Assets) $87,306 11.45% $61,021 8.00% $76,276 10.00%
Core Capital
(to Adjusted Tangible Assets) 77,767 7.45% 31,334 3.00% 52,224 5.00%
Tangible Capital
(to Adjusted Tangible Assets) 77,767 7.45% 15,667 1.50% N/A N/A
Tier 1 Capital
(to Risk Weighted Assets) 77,767 10.20% N/A N/A 45,766 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 $5.7 million of cash on hand at March 31,
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 March 31, 1998 was 7.7%, which exceeded the applicable
minimum requirements.
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
27
<PAGE> 28
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.
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.
Since 1995, the Company has been utilizing interest rate floors to
mitigate the risk of interest margin compression on its new loans in a
decreasing interest rate environment. Typically, these floors represent the rate
at underwriting. Additionally, on most new income property loans, the Company
utilizes interest rate caps. These caps apply to the term of the loan and are
usually five points above the rate at underwriting or at an amount that would
still allow for one-to-one debt service coverage at the maximum rate, thereby
reducing the likelihood of borrower default in a rising interest rate
environment. The risk to the Company that is associated with interest rate caps
is that interest rates will exceed the maximum loan rates on such loans, and
while the Company's cost of funds continues to rise, the interest income derived
from these loans will be fixed, resulting in an overall compression on net
interest income.
28
<PAGE> 29
The following table sets forth information concerning sensitivity of
the Company's interest-earning assets and interest-bearing liabilities as of
March 31, 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) $ 48,500 $ -- $ -- $ -- $ -- $ 48,500
Investments and FHLB Stock 7,904 -- -- -- -- 7,904
Loans (2) 563,802 197,599 42,159 40,094 128,830 972,484
---------- ---------- ---------- ---------- ---------- ----------
Total interest-earning assets $ 620,206 $ 197,599 $ 42,159 $ 40,094 $ 128,830 $1,028,888
========== ========== ========== ========== ========== ==========
INTEREST-BEARING LIABILITIES
Deposits
Transaction accounts $ 121,111 $ -- $ -- $ -- $ -- $ 121,111
Certificates of deposit 223,919 169,390 306,514 27,936 -- 727,759
FHLB advances 40,000 -- -- 65,000 -- 105,000
Senior Notes -- -- -- -- 40,000 40,000
---------- ---------- ---------- ---------- ---------- ----------
Total interest-bearing liabilities $ 385,030 $ 169,390 $ 306,514 $ 92,936 $ 40,000 $ 993,870
========== ========== ========== ========== ========== ==========
Interest rate sensitivity gap $ 235,176 $ 28,209 $ (264,355) $ (52,842) $ 88,830 $ 35,018
Cumulative interest rate
sensitivity gap 235,176 263,385 (970) (53,812) 35,018 35,018
Cumulative interest rate
sensitivity gap as a percentage
of total interest-earning assets 22.9% 25.6% (0.1%) (5.2%) 3.4% 3.4%
</TABLE>
- ----------
(1) Excludes noninterest-earning cash balances.
(2) Loans include $19.3 million of nonaccrual loans.
29
<PAGE> 30
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.
Presented below, as of March 31, 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 $ 80,749 $ (7,478) (8.48%)
+200 bp 84,861 (3,366) (3.82%)
0 bp 88,227 -- --%
- -200 bp 91,771 3,544 4.02%
- -400 bp 95,553 7,326 8.30%
</TABLE>
30
<PAGE> 31
The Bank's overall improvement in its sensitivity to changes in market rates
from the period ended December 31, 1997 to March 31, 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.
31
<PAGE> 32
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 plaintiffs accepted the reduced
judgment. The Bank has filed a Notice of Appeal from the judgment and
has posted an Appeal Bond with the court to stay plaintiffs
enforcement of the judgment pending the Appellate Court's decision.
Based upon its view that the law in California is unambiguous that
there is no duty which attaches to escrow providers to advise parties
to an escrow, the Bank believes that its position will ultimately be
upheld on appeal and accordingly, that no amounts will be paid by the
Bank to the plaintiffs in this matter. There can be no assurances
that this will be the case, however. The defendant's appellate brief
and the plaintiffs' appellate brief have been filed with the Court.
The defendant's reply brief was filed April 6, 1998. After the
plaintiffs' reply, hearing for oral arguments will be scheduled by
the Court.
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 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
The Company filed a Form 8-K on March 26, 1998, announcing
the extension of Exchange Offer for Senior Notes.
The Company filed a Form 8-K on February 23, 1998, announcing
Exchange Offer of Senior Notes.
The Company filed a Form 8-K on January 28, 1998, announcing
financial results for the year ended December 31, 1997.
2. Other required exhibits - None
32
<PAGE> 33
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HAWTHORNE FINANCIAL CORPORATION
Dated May 13, 1998 /s/ NORMAN A. MORALES
-----------------------------
Norman A. Morales
Executive Vice President and
Chief Financial Officer
Dated May 13, 1998 /s/ JULIE A. MOODY
-----------------------------
Julie A. Moody
Vice President and
Controller
33
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 12,136
<INT-BEARING-DEPOSITS> 839,675
<FED-FUNDS-SOLD> 48,500
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 586
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 950,589
<ALLOWANCE> 14,092
<TOTAL-ASSETS> 1,046,907
<DEPOSITS> 848,870
<SHORT-TERM> 105,000
<LIABILITIES-OTHER> 8,508
<LONG-TERM> 40,000
0
0
<COMMON> 32
<OTHER-SE> 44,497
<TOTAL-LIABILITIES-AND-EQUITY> 1,046,907
<INTEREST-LOAN> 21,161
<INTEREST-INVEST> 833
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 21,994
<INTEREST-DEPOSIT> 10,737
<INTEREST-EXPENSE> 2,181
<INTEREST-INCOME-NET> 9,076
<LOAN-LOSSES> 1,485
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 5,947
<INCOME-PRETAX> 2,357
<INCOME-PRE-EXTRAORDINARY> 2,357
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,833
<EPS-PRIMARY> 0.58
<EPS-DILUTED> 0.32
<YIELD-ACTUAL> 9.23
<LOANS-NON> 19,258
<LOANS-PAST> 10,223
<LOANS-TROUBLED> 37,441
<LOANS-PROBLEM> 34,307
<ALLOWANCE-OPEN> 13,274
<CHARGE-OFFS> 667
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 14,092
<ALLOWANCE-DOMESTIC> 14,092
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
