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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, 1999
[ ] 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
5,288,113 shares of Common Stock, $0.01 par value per share outstanding, as of
April 30, 1999.
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q INDEX
FOR THE QUARTER ENDED MARCH 31, 1999
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION Page
----
<S> <C> <C>
ITEM 1. Financial Statements
Consolidated Statements of Financial Condition
at March 31, 1999 and December 31, 1998 3
Consolidated Statements of Operations
for the Three Months Ended March 31, 1999 and 1998 4
Consolidated Statement of Stockholders' Equity
for the Three Months Ended March 31, 1999 5
Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 1999 and 1998 6
Notes to Consolidated Financial Statements 8
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk 30
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 31
ITEM 2. Changes in Securities 31
ITEM 3. Defaults upon Senior Securities 31
ITEM 4. Submission of Matters to a Vote of Security Holders 31
ITEM 5. Other Information 31
ITEM 6. Exhibits and Reports on Form 8-K 31
</TABLE>
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)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
----------- -----------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 118,407 $ 45,449
Loans receivable (net of allowance for estimated credit losses
of $19,958 in 1999 and $17,111 in 1998) 1,359,964 1,326,791
Real estate owned (net of allowance for estimated losses
of $90 in 1999 and $45 in 1998) 713 4,070
Investment in capital stock of Federal Home Loan Bank - at cost 17,408 13,554
Office property and equipment - at cost, net 6,308 6,513
Accrued interest receivable 8,534 8,424
Other assets 5,838 7,633
----------- -----------
TOTAL ASSETS $ 1,517,172 $ 1,412,434
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits $ 1,038,601 $ 1,019,450
FHLB advances 344,000 264,000
Senior notes 40,000 40,000
Accounts payable and other liabilities 9,839 7,560
----------- -----------
TOTAL LIABILITIES 1,432,440 1,331,010
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 5,273,113 shares in 1999 and
5,194,996 shares in 1998 53 52
Capital in excess of par value - common stock 40,684 40,349
Retained earnings 44,122 41,150
----------- -----------
84,859 81,551
Less
Treasury stock, at cost - 5,400 shares (48) (48)
Loan to Employee Stock Ownership Plan (79) (79)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 84,732 81,424
----------- -----------
Total Liabilities and Stockholders' Equity $ 1,517,172 $ 1,412,434
=========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS ARE IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1999 1998
------- -------
<S> <C> <C>
INTEREST REVENUES
Loans, net of nonaccrual income $31,001 $21,161
Cash and investment securities 1,004 833
------- -------
Total interest revenues 32,005 21,994
------- -------
INTEREST COSTS
Deposits 12,425 10,737
FHLB advances 3,860 917
Senior notes 1,250 1,264
------- -------
Total interest costs 17,535 12,918
------- -------
NET INTEREST INCOME 14,470 9,076
PROVISION FOR ESTIMATED CREDIT LOSSES ON LOANS 3,000 1,485
------- -------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES ON LOANS 11,470 7,591
------- -------
NONINTEREST REVENUES
Loan related fees 1,754 458
Other 214 255
------- -------
TOTAL NONINTEREST REVENUES 1,968 713
------- -------
NONINTEREST EXPENSES
General and administrative expenses
Employee 4,165 3,263
Operating 1,540 1,269
Occupancy 993 757
Technology 560 462
Professional 320 304
SAIF premiums and OTS assessments 299 225
------- -------
Total general and administrative expenses 7,877 6,280
------- -------
Income from real estate operations, net 434 333
Other non-operating expense 911 --
------- -------
Total noninterest expenses 8,354 5,947
------- -------
NET EARNINGS BEFORE INCOME TAXES 5,084 2,357
INCOME TAX PROVISION 2,112 524
------- -------
NET EARNINGS (NOTE 3) $ 2,972 $ 1,833
======= =======
BASIC EARNINGS PER SHARE (NOTE 3) $ 0.57 $ 0.58
======= =======
DILUTED EARNINGS PER SHARE (NOTE 3) $ 0.38 $ 0.32
======= =======
WEIGHTED AVERAGE BASIC SHARES OUTSTANDING (NOTE 3) 5,224 3,157
======= =======
WEIGHTED AVERAGE DILUTED SHARES OUTSTANDING (NOTE 3) 7,732 5,681
======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(AMOUNTS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
COMPREHENSIVE
INCOME
-------------
BALANCE AT EXERCISED BALANCE AT
DECEMBER 31, STOCK EXERCISED NET MARCH 31,
1998 OPTIONS WARRANTS EARNINGS OTHER 1999
----------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Number of common shares 5,195 69 9 -- -- 5,273
======== ======== ======== ======== ======== ========
Common stock $ 52 $ 1 $ -- $ -- $ -- $ 53
Capital in excess of par value-
common stock 40,349 348 19 -- (32) 40,684
Retained earnings 41,150 -- -- 2,972 -- 44,122
Treasury stock (48) -- -- -- -- (48)
Loan to employee stock ownership plan (79) -- -- -- -- (79)
-------- -------- -------- -------- -------- --------
Total stockholders' equity $ 81,424 $ 349 $ 19 $ 2,972 $ (32) $ 84,732
======== ======== ======== ======== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
5
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------
1999 1998
--------- ---------
<S> <C> <C>
NET CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings $ 2,972 $ 1,833
Adjustments
Provision for income taxes 2,112 524
Provision for estimated credit losses on loans 3,000 1,485
Provision for estimated credit losses on real
estate owned 45 15
Net recoveries from sales of real estate owned (557) (299)
Net gain from sale of other assets -- (4)
Loan fee and discount accretion (1,557) (1,364)
Depreciation and amortization 628 401
FHLB dividends (197) (105)
Increase in accrued interest receivable (110) (937)
Other assets (418) 226
Decrease in other liabilities 2,278 2,131
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 8,196 3,906
--------- ---------
NET CASH FLOWS FROM INVESTING ACTIVITIES
Investment securities
Purchases -- (8)
Loans
New loans funded (64,722) (102,431)
Construction disbursements (97,585) (61,551)
Payoffs 115,895 62,470
Principal amortization and paydowns 7,937 5,502
Lines of credit activity, net 3,994 (17,818)
Other, net 1,176 1,580
Real estate owned
Sale proceeds 2,579 3,575
Capitalized costs (21) (253)
Other, net -- 59
Purchase of FHLB stock (3,657) --
Office property and equipment
Sale proceeds 3 4
Additions (356) (765)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (34,757) (109,636)
--------- ---------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
6
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------
1999 1998
--------- ---------
<S> <C> <C>
NET CASH FLOWS FROM FINANCING ACTIVITIES
Deposit activity, net $ 19,151 $ 49,369
New FHLB advances 80,000 65,000
Net proceeds from exercise of stock options and warrants 368 369
Collection of ESOP loan -- 8
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 99,519 114,746
--------- ---------
INCREASE IN CASH AND CASH EQUIVALENTS 72,958 9,016
CASH AND CASH EQUIVALENTS
AT BEGINNING OF PERIOD 45,449 51,620
--------- ---------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 118,407 $ 60,636
========= =========
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION
CASH PAID DURING THE PERIOD FOR:
Interest $ 16,043 $ 11,202
Income taxes 225 54
NON-CASH INVESTING AND FINANCING ACTIVITIES
Real estate acquired in settlement of loans 293 1,770
Loans originated to finance sales of real estate owned 1,500 1,612
Loans originated to refinance existing Bank loans 17,926 14,367
LOAN ACTIVITY
Total commitments $ 154,975 $ 192,976
Less:
Change in undisbursed funds on construction commitments 8,936 (19,140)
Loans originated to finance sales of real estate owned (1,500) (1,612)
Undisbursed portion of new lines of credit (104) --
New lines of credit -- (8,242)
--------- ---------
Net construction disbursements and loans funded $ 162,307 $ 163,982
========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
7
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HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
(amounts in tables are in thousands, except 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, 1999 and December 31, 1998, and the results of its operations and its
cash flows for the three months ended March 31, 1999 and 1998. Operating results
for the three months ended March 31, 1999, are not necessarily indicative of the
results that may be expected for any other interim period or the full year
ending December 31, 1999.
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, 1998.
NOTE 2 - RECLASSIFICATION
Certain amounts in the 1998 consolidated financial statements have
been reclassified, where practicable, to conform with classifications in 1999.
NOTE 3 - BOOK VALUE AND EARNINGS PER SHARE
The table below sets forth the Company's earnings per share
calculations for the three months ending March 31, 1999 and 1998. In the table
below, "Warrants" refers to the Warrants issued by the Company in December 1995,
which are currently exercisable and which expire December 11, 2005, and
"Options" refers to stock options previously granted to employees of the Company
and which were outstanding at each measurement date.
On July 10, 1998, the Company completed an offering of 2,012,500 of
its common shares at a price of $15.00 per share, realizing net proceeds (after
offering costs) of approximately $27.6 million. As a result of this offering,
the exercise price of the 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.
8
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NOTE 3 - BOOK VALUE AND EARNINGS PER SHARE - continued (amounts in tables are in
thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
1999 1998
------- -------
<S> <C> <C>
Average Shares Outstanding
Basic 5,224 3,157
Warrants 2,503 2,376
Options(1) 617 655
Less Treasury shares(2) (612) (507)
------- -------
Diluted 7,732 5,681
======= =======
NET EARNINGS FOR THE PERIOD $ 2,972 $ 1,833
======= =======
BASIC EARNINGS PER SHARE $ 0.57 $ 0.58
======= =======
DILUTED EARNINGS PER SHARE $ 0.38 $ 0.32
======= =======
</TABLE>
<TABLE>
<CAPTION>
MARCH 31,
-----------------------
1999 1998
-------- --------
<S> <C> <C>
PERIOD-END SHARES OUTSTANDING
Basic 5,268 3,164
Warrants 2,503 2,376
Options(3) 513 648
Less Treasury shares(2) (567) (513)
-------- --------
Diluted 7,717 5,675
======== ========
STOCKHOLDERS' EQUITY $ 84,732 $ 44,529
======== ========
BASIC BOOK VALUE PER SHARE $ 16.08 $ 14.07
======== ========
DILUTED BOOK VALUE PER SHARE $ 10.98 $ 7.85
======== ========
</TABLE>
- --------------
(1) Does not include 210,000 options outstanding at March 31, 1999 for
which the exercise price exceeded the average market price of the
Company's common stock during the period.
(2) 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. In this calculation, Treasury shares were assumed to be
repurchased at the average closing stock price for the respective
period.
(3) Does not include 210,000 options outstanding at March 31, 1999 for
which the exercise price exceeded the average market price of the
Company's common stock at period end.
NOTE 4 - COMMITMENTS AND CONTINGENCIES
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
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deed of trust ultimately proved to be inadequate. The plaintiffs alleged that
the Bank knew, or should have known, that the security that the plaintiffs
received as sellers was inadequate and should have so advised them. In June
1997, a jury found for the plaintiffs and awarded compensatory and punitive
damages totaling $9.1 million. In July 1997, the trial judge reduced the
combined award to $3.3 million. The plaintiffs accepted the reduced judgment.
The Bank filed a notice of appeal from the judgment and posted an Appeal Bond
with the Court to stay plaintiffs' enforcement of the judgment pending the
Appellate Court's decision. In July, 1998, the Appellate Court remanded the case
to the Superior Court with directions to dismiss the fraudulent concealment,
misrepresentation and punitive damages claims and to conduct a new trial
pertaining solely to damages arising from negligence, in particular to determine
whether any negligence of the Bank contributed to the plaintiffs' injury and, if
so, to apportion liability for negligence between the Bank and the plaintiffs.
On March 30, 1999, the jury returned a verdict in favor of the plaintiffs in the
amount of $2.6 million. The Bank intends to file a notice of appeal from this
judgment. The Bank believes that there is a substantial likelihood that its
position will ultimately be upheld on retrial and, accordingly, that no amounts
having a materially adverse effect on the Bank's financial condition or results
of operations will be paid by the Bank to the plaintiffs in this matter. There
can be no assurances that this will be the case, however.
In the first quarter of 1999, the Company settled two matters
involving real property sold by the Company to third parties following the
Company's acquisition of the properties through completed foreclosure prior to
1992. In each of these matters, the Company was alleged to have sold the
properties with known construction defects which were not adequately disclosed
to the purchasers. In the aggregate, these settlements involved the payment by
the Company of a total of $0.6 million.
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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company earned $3.0 million, or $0.38 per diluted share, for the
quarter ended March 31, 1999, which represented a 66.7% increase over the net
earnings of $1.8 million, or $0.32 per diluted share, for the first quarter of
1998.
Core Business Activity
The Company originates real estate-secured loans throughout Southern
California, generally consisting of permanent loans collateralized by one to
four unit residential property, 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, with advances from the Federal Home Loan Bank of San Francisco ("FHLB").
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
through the sale of senior notes ("Senior Notes"). In July 1998, the Company
completed a public offering of approximately 2.0 million of its common shares,
which raised approximately $27.6 million of net proceeds. In addition to these
positive changes to the Company's capital structure, the Company returned to
taxable status during 1998, following several years in which it realized
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 1999
and 1998 periods somewhat difficult.
Because of the significant changes to the Company's capital structure
and taxable status, management believes that pretax core earnings ("Bank Core
Earnings") are the most useful measure of the Company's underlying operating and
earnings performance. Bank Core Earnings are earnings before interest on parent
company debt, income taxes, real estate operations and non-operating items. For
the first quarter of 1999, Bank Core Earnings were $6.8 million, more than
double the $3.3 million of Bank Core Earnings produced during the first quarter
of 1998.
11
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The table below isolates the principal components of the Bank's Core
Earnings and the Company's net earnings for the periods indicated (dollars are
in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1999 1998
------- -------
<S> <C> <C>
Net interest income $15,720 $10,340
Less provision for estimated credit losses on loans 3,000 1,485
------- -------
Net interest income after provision for estimated credit losses on loans 12,720 8,855
Noninterest revenues 1,968 713
Less general and administrative costs 7,877 6,280
------- -------
BANK CORE EARNINGS 6,811 3,288
------- -------
Income from real estate operations, net 434 333
Other expenses
Other non-operating expenses, net 911 --
Interest cost on Senior Notes 1,250 1,264
------- -------
Total other expenses, net 2,161 1,264
------- -------
PRETAX EARNINGS 5,084 2,357
Income tax provision 2,112 524
------- -------
NET EARNINGS $ 2,972 $ 1,833
======= =======
</TABLE>
The Bank's net interest income increased 52.4% during the first
quarter of 1999, to $15.7 million, from the $10.3 million of net interest income
generated during the first quarter of 1998. This growth in net interest income
resulted from a commensurate increase in the Bank's average interest-earning
assets, which rose to $1.4 billion during the three months ended March 31, 1999,
from $953.4 million during the three months ended March 31, 1998. Because the
Company has contributed substantially all of the net proceeds raised during 1998
from its sale of common stock, the Company and the Bank will not have excess
capital during 1999 to the same extent excess capital was available during 1998.
Accordingly, management does not expect that growth in the Company's assets will
approach the percentage growth achieved during 1998, absent the issuance of
additional debt or equity securities by the Company or the Bank. The Company and
the Bank have no present intention of issuing debt or equity securities in 1999.
Noninterest revenues were $2.0 million during the first quarter of
1999, as compared with $0.7 million during the three months ended March 31,
1998. The year-over-year increase in noninterest revenues results primarily from
the Company's receipt of exit and release fees and prepayment penalties in
connection with loans repaid during the quarter.
General and administrative expenses were $7.9 million during the
three months ended March 31, 1999, a 25.4% increase over operating expenses of
$6.3 million incurred during the first quarter of 1998. The growth in operating
expenses during the first quarter of 1999, as compared with the same quarter in
1998, resulted from significant increases to staff, in particular in the
Company's lending and technology groups, to accommodate the significant
expansion in each of the Company's lending businesses and in anticipation of the
Company's now-completed technology platform conversion. Occupancy and operating
expenses also increased year-over-year, as a direct consequence of the growth in
staff.
During the three months ended March 31, 1999, the Company settled two
matters involving real estate owned, sold by the Company to third parties prior
to 1992. In each of these matters, the Company was alleged to have sold the
properties with known construction defects which were not adequately disclosed
to the purchasers. In
12
<PAGE> 13
the aggregate, these settlements involved the payment by the Company of a total
of $0.6 million, which is included with other non-operating expense. Also during
the first quarter of 1999, the Company accrued for the estimated remaining cost
($0.3 million) of a long-term lease in connection with one of its former branch
offices, which management determined was no longer part of the Company's
operating plant.
INCOME TAXES
During the first quarter of 1999, the Company's effective tax rate
was 41.5%. During the first quarter of 1998, the Company's effective tax rate
was 22.2%, which reflected continued utilization of accumulated income tax
benefits, principally tax loss carryforwards. Such accumulated income tax
benefits were fully utilized by December 31, 1998.
PARENT COMPANY ITEMS
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 $27.6 million. Through March 31, 1999, the Company had contributed
$22.5 million of these net proceeds to the Bank and had made its December 1998
semi-annual interest payment of approximately $2.5 million on its Senior Notes.
Accordingly, approximately $2.6 million of the offering proceeds remained with
the Company at March 31, 1999, which are expected to be utilized to make the
June 1999 semi-annual interest payment of approximately $2.5 million on its
Senior Notes. Thereafter, the Company will rely upon dividends from the Bank for
its payment of interest on the Senior Notes.
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 the 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").
During the first quarter of 1999, the Bank's net interest margin rose
slightly to 4.37% from its effective interest margin of 4.34% realized during
the first quarter of 1998. During the first quarter of 1999, the Company
received, and recorded as revenue, approximately $1.5 million of interest in
connection with several loans previously on non-accrual status which were repaid
in full during the quarter. Adjusted for this non-recurring revenue, the Bank's
interest margin for the first quarter of 1999, was 3.92%. This tempering of the
Bank's recurring effective interest margin resulted from a decline in the yield
earned on the Bank's loans, which are predominantly adjustable-rate and priced
off of market-sensitive indices (e.g., Prime Rate, One-year CMT, Six-month
LIBOR), which was occasioned by the sharp drop in market interest rates since
the middle of 1998. The lower yield on the Bank's loans was partially offset by
a decline in the Bank's funding costs, which averaged 5.02% during the first
quarter of 1999, as compared with 5.29% during the first quarter of 1998.
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The following table sets 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 months ended March 31, 1999 and 1998. In the tables, interest revenues are
net of interest associated with nonaccrual loans (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------------------------------------------------------------------
MARCH 31, 1999 MARCH 31, 1998
------------------------------------------ --------------------------------------------
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) $1,354,383 $31,001 9.16% $892,060 $21,161 9.49%
Cash and cash equivalents 68,136 807 4.74% 53,506 720 5.38%
Investment securities -- -- --% 574 8 5.57%
Investment in capital stock of
Federal Home Loan Bank 15,255 197 5.17% 7,251 105 5.79%
---------- ------- -------- -------
Total interest-earning assets 1,437,774 32,005 8.90% 953.391 21,994 9.23%
------- ----- ------- -----
Noninterest-earning assets 15,762 23,902
---------- --------
Total assets $1,453,536 $977,293
========== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities
Deposits $1,015,919 12,425 4.96% $819,886 10,737 5.31%
FHLB advances 300,444 3,860 5.14% 63,988 917 5.81%
Senior notes 40,000 1,250 12.50% 40,000 1,264 12.64%
---------- ------- -------- -------
Total interest-bearing liabilities 1,356,363 17,535 5.24% 923,874 12,918 5.67%
------- ----- ------- -----
Noninterest-bearing liabilities 14,730 10,026
Stockholders' equity 82,443 43,393
---------- --------
Total liabilities and
stockholders' equity 1,453,536 $977,293
========== ========
Net interest income $14,470 $ 9,076
======= =======
INTEREST RATE SPREAD 3.66% 3.56%
===== =====
NET INTEREST MARGIN INCLUDING
SENIOR NOTES 4.03% 3.81%
===== =====
NET INTEREST MARGIN EXCLUDING
SENIOR NOTES 4.37% 4.34%
===== =====
</TABLE>
- -------------
(1) Includes nonaccrual loans of $42.1 million and $21.4 million for the
three months ended March 31, 1999 and March 31, 1998, respectively.
(2) Includes amortization of loan fees and discounts of $1.6 million and
$1.4 million for the three months ended March 31, 1999 and March 31,
1998, respectively.
14
<PAGE> 15
The following table sets forth 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
(1) changes in volume (i.e., changes in volume multiplied by old rate), (2)
changes in rate (i.e., changes in rate multiplied by old volume) and (3) changes
attributable to both rate and volume (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1999 AND 1998
INCREASE (DECREASE) DUE TO CHANGE IN
-----------------------------------------------------
RATE AND NET
VOLUME RATE VOLUME CHANGE
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Interest Revenues
Loans $ 10,967 $ (742) $ (385) $ 9,840
Cash and cash equivalents 197 (86) (24) 87
Investment securities (8) -- -- (8)
Investment in capital stock of
Federal Home Loan Bank 116 (11) (13) 92
-------- -------- -------- --------
11,272 (839) (422) 10,011
-------- -------- -------- --------
INTEREST COSTS
Deposits 2,568 (710) (170) 1,688
FHLB Advances 3,389 (95) (351) 2,943
Senior notes -- (14) -- (14)
-------- -------- -------- --------
5,957 (819) (521) 4,617
-------- -------- -------- --------
INCREASE IN NET INTEREST INCOME $ 5,315 $ (20) $ 99 $ 5,394
======== ======== ======== ========
</TABLE>
The Company's interest revenues increased by $10.0 million, or 45.5%,
during the first three months of 1999 as compared to the same period in 1998.
This increase was primarily attributable to an increase in the average balance
of loans outstanding, which was partially offset by a decrease in the weighted
average yield earned thereon.
Interest costs increased by $4.6 million, or 35.7%, during the first
three months of 1999, as compared to the same period during 1998, primarily due
to an increase in the average balances of the Company's deposits and borrowings,
which was partially offset by a decrease in the weighted average rates paid on
the Company's deposits and FHLB advances.
These changes in interest revenues and interest costs produced an
increase of $5.4 million, or 59.4%, in the Company's net interest income during
the first quarter of 1999 as compared with the same quarter during 1998.
Expressed as a percentage of average interest-earning assets, the Company's
effective net interest margin increased to 4.03% during the first quarter of
1999, as compared with the effective net interest margin of 3.81% produced
during the first quarter of 1998.
Provisions for Estimated Credit Losses on Loans
For the three months ended March 31, 1999, the Company recorded
provisions for estimated credit losses on loans of $3.0 million, an increase of
100.0% over provisions of $1.5 million recorded during the three months ended
March 31, 1998. The sharp increase in the level of loan loss provisioning
reflects management's intention to increase the ratio of the Company's general
loan loss reserves to 1.50% of net loans by the end of 1999, a level deemed by
management to be prudent in view of the significant growth in the Company's loan
portfolio since 1997, the relative lack of seasoning of many of the Company's
loans, and the significant portion of the Company's loans which are directed at
financing real estate development.
Although the Company maintains its allowance for credit losses at a
level which it considers to be adequate to provide for potential 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
15
<PAGE> 16
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,
---------------------------------
1999 1998 CHANGE
------- ------- -------
<S> <C> <C> <C>
OPERATING
Loan related fees $ 1,754 $ 458 $ 1,296
Other 214 251 (37)
------- ------- -------
TOTAL NONINTEREST REVENUES - OPERATING 1,968 709 1,259
------- ------- -------
NON-OPERATING
Other, net -- 4 (4)
------- ------- -------
TOTAL NONINTEREST REVENUES - NON-OPERATING -- 4 (4)
------- ------- -------
TOTAL NONINTEREST REVENUES $ 1,968 $ 713 $ 1,255
======= ======= =======
</TABLE>
Loan-related fees primarily consist of fees collected (1) from
certain borrowers for the early repayment of their loans, (2) when the Company
agrees to extend the maturity of loans (predominantly short-term construction
loans, with respect to which extension options are included in the original term
of the Company's loan), and (3) in connection with certain loans which contain
exit or release fees payable to the Company upon the maturity or repayment of
the Company's loan. The significant increase in loan-related fee revenues during
the first quarter of 1999, as compared with the first quarter of 1998, was
occasioned by the prepayment of a larger number of loans to which prepayment
penalties were attached, and the repayment of a small number of loans which
possessed exit fees due upon the loans' repayment.
NONINTEREST EXPENSES - GENERAL AND ADMINISTRATIVE EXPENSES
The table below details the Company's general and administrative
expenses for the periods indicated (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------
1999 1998 CHANGE
------ ------ ------
<S> <C> <C> <C>
GENERAL AND ADMINISTRATIVE EXPENSES
Employee $4,165 $3,263 $ 902
Operating 1,540 1,269 271
Occupancy 993 757 236
Technology 560 462 98
Professional 320 304 16
SAIF insurance premiums and OTS assessments 299 225 74
------ ------ ------
TOTAL GENERAL AND ADMINISTRATIVE EXPENSES $7,877 $6,280 $1,597
====== ====== ======
</TABLE>
As the Company's business activities have grown and expanded,
additional personnel have been hired into the Company's various business and
staff support groups. During the first quarter of 1999, the Company employed an
average of 278 full-time equivalents. By comparison, the Company employed an
average of 209 full-time equivalents during the first quarter of 1998. The
corresponding year-over-year growth in employee-related expenses, which consist
primarily of base salaries, incentive compensation and the Company's share of
benefit expenses, was substantially less than the growth in the dollar amount of
the Company's net interest margin.
16
<PAGE> 17
The year-over-year growth in operating and occupancy expenses
approximates, and is directly tied to, the growth in the number of full-time
equivalents employed by the Company.
As previously reported, the Company completed the conversion of its
computer-based systems to an in-house platform during 1998. This platform
conversion was integrated into the Company's overall plan to address Year 2000
data processing issues. To date, the Company has (1) completed its own Year 2000
testing by creating a database that rolled forward systematically until the
in-house computer systems processed data into what it believed was early 2000,
(2) established contingency plans that will provide for alternative methods of
conducting business for critical functions, (3) completed an extensive review of
all of its third party service providers' Year 2000 compliance, and (4)
completed its evaluation of the potential Year 2000-related risk associated with
certain of its real estate loan collateral. The expense incurred and to be
incurred by the Company to ensure Year 2000 compliance is substantially
integrated and was included with the expense associated with the now-completed
conversion of the Company's technology platform. The Company does not anticipate
any material additional expenses in 1999 related to Year 2000 software or
hardware. Year 2000 testing occurs on a continual basis upon receipt of all new
releases of Year 2000-compliant software and hardware.
NONINTEREST EXPENSES - REAL ESTATE OPERATIONS
The table below sets forth the costs and revenues 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 General and Administrative Expenses (dollars are in
thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------
1999 1998 CHANGE
----- ----- -----
<S> <C> <C> <C>
EXPENSES ASSOCIATED WITH REAL ESTATE OPERATIONS
Property taxes $ -- $ 3 $ (3)
Repairs, maintenance and renovation 58 15 43
Insurance 21 30 (9)
----- ----- -----
TOTAL 79 48 31
----- ----- -----
REVENUES ASSOCIATED WITH REAL ESTATE OPERATIONS
Net recoveries from sale of REO 557 299 258
Property operations, net 1 97 (96)
----- ----- -----
TOTAL 558 396 162
----- ----- -----
PROVISION FOR ESTIMATED LOSSES ON REAL ESTATE OWNED 45 15 30
----- ----- -----
INCOME FROM REAL ESTATE $ 434 $ 333 $ 101
===== ===== =====
</TABLE>
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-producing 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, 1999, the
Company sold eight properties generating net cash proceeds of $2.6 million and a
net recovery of $0.6 million, as compared to sales of 17 properties generating
net cash proceeds of $3.6 million and a net recovery of $0.3 million during the
three months ended March 31, 1998.
INCOME TAXES
The Company recorded an income tax provision of $2.1 million for the
three months ended March 31, 1999, as compared to an income tax provision of
$0.5 million, during the same period in 1998. The Company returned to taxable
status during 1998, following several years in which it realized substantial
income tax benefits from
17
<PAGE> 18
utilization of accumulated operating loss carryforwards. The Company's effective
tax rate was 41.5% and 22.2%, respectively, for the three months ended March 31,
1999 and 1998.
FINANCIAL CONDITION, CAPITAL RESOURCES & LIQUIDITY AND ASSET QUALITY
ASSETS
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, 1999 DECEMBER 31, 1998
------------------------------ -----------------------------
BALANCE PERCENT BALANCE PERCENT
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
SINGLE FAMILY $ 578,558 35.6% $ 576,032 35.9%
INCOME PROPERTY
Multi-family(1) 243,980 15.0 250,876 15.5
Commercial(1) 219,999 13.5 222,558 13.9
Development(2) 121,626 7.5 78,425 4.9
LAND(3) 73,289 4.5 69,581 4.3
SINGLE FAMILY CONSTRUCTION
Single residence(4) 283,789 17.5 275,888 17.2
Tract 68,566 4.2 85,942 5.4
OTHER 35,351 2.2 46,615 2.9
----------- ------------ ----------- ------------
GROSS LOANS RECEIVABLE(5) 1,625,158 100.0% 1,605,917 100.0%
============ ============
LESS
Undisbursed funds (240,658) (256,096)
Deferred fees and
credits, net (4,578) (5,919)
Allowance for estimated losses (19,958) (17,111)
----------- ------------
NET LOANS RECEIVABLE $ 1,359,964 $ 1,326,791
=========== ============
</TABLE>
- -----------
(1) Predominantly term loans secured by improved properties, with respect
to which the properties' cash flows are sufficient to service the
Company's loan.
(2) Predominantly loans to finance the construction of income-producing
improvements. Also includes loans to finance the renovation of
existing improvements.
(3) The Company expects that a majority of these loans will be converted
into construction loans, and the land-secured loan repaid with the
proceeds of these construction loans, within 12 months.
(4) Predominantly loans for the construction of individual, custom homes,
and the acquisition of land for the construction of such homes.
(5) The funded principal balance under recorded loan commitments, plus
undisbursed funds associated with such loan commitments.
18
<PAGE> 19
The table below sets forth the approximate composition of the
Company's gross new loan commitments, net of internal refinances, for the period
indicated, in dollars and as a percentage of total loans originated (dollars are
in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1999
--------------------
TYPE OF COLLATERAL AMOUNT %
- -------------------------- -------- -------
<S> <C> <C>
SINGLE FAMILY(1) $ 41,400 26.7%
INCOME PROPERTY
Multi-family 8,900 5.7
Commercial 14,700 9.5
Development(2) 27,300 17.6
LAND(3) 14,600 9.4
SINGLE FAMILY CONSTRUCTION
Single residence(4) 47,100 30.5
OTHER 1,000 0.6
======== =====
$155,000 100.0%
======== =====
</TABLE>
- ------------
(1) Includes unfunded commitments under lines of credit of $0.1 million.
(2) Includes unfunded commitments of $14.3 million.
(3) Includes unfunded commitments of $4.5 million.
(4) Includes unfunded commitments of $30.3 million.
ASSET QUALITY
Nonaccrual and Troubled Debt Restructured Loans
The Company generally 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>
MARCH 31, DECEMBER 31,
1999 1998
------- -------
<S> <C> <C>
NONACCRUAL LOANS
Loans past due 90 days or more $13,365 $13,042
Loans past due 30-89 days 9,914 20,002
Other nonaccrual loans 18,637 14,644
======= =======
TOTAL(1) $41,916 $47,688
======= =======
RATIO OF TOTAL NONACCRUAL LOANS TO:
Total assets 2.8% 3.4%
Net loans receivable 3.1% 3.6%
Core capital plus General Reserves 30.9% 39.5%
</TABLE>
- ----------
(1) Includes $4.2 million and $2.7 million of troubled debt restructured
loans ("TDRs") at March 31, 1999 and December 31, 1998, respectively.
Excludes $30.3 million and $31.6 million of TDRs which were
performing in accordance with their modified terms at March 31, 1999
and December 31, 1998, respectively.
19
<PAGE> 20
Nonperforming assets ("NPAs"), which consist of the carrying value of
properties acquired through foreclosure and loan principal delinquent three or
more payments, stood at $14.1 million at March 31, 1999 (or 0.9% of total
assets). By comparison, NPAs were $17.1 million (or 1.2% of total assets) at
December 31, 1998.
The dollar amounts of nonaccrual and nonperforming loans have
steadily declined over the past several years, reaching their current level of
$41.9 million and $13.4 million, respectively, at March 31, 1999, or 2.8% and
0.9%, respectively, of total assets, their lowest level since the 1980's.
Because a portion of the Company's lending involves greater potential risk than
conventional lending, and because certain of the Company's loans are large
relative to the Company's and the Bank's capital, management expects that the
dollar amount of the Company's nonaccrual and nonperforming loans is likely to
be more volatile than that of its competitors. Accordingly, the Company's
earnings may be measurably affected by periodic changes in the dollar amounts of
nonaccrual and nonperforming loans.
Classified Assets
The table below sets forth information concerning the Company's
classified assets as of 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,
1999 1998
---------- ----------
<S> <C> <C>
Real estate owned, net $ 713 $ 4,070
Total nonaccrual loans 41,916 47,688
---------- ----------
GROSS NONACCRUAL ASSETS 42,629 51,758
Performing loans classified substandard or lower (1) 32,784 45,397
---------- ----------
GROSS CLASSIFIED ASSETS $ 75,413 $ 97,155
========== ==========
GROSS CLASSIFIED LOANS $ 74,700 $ 93,085
========== ==========
GROSS LOANS RECEIVABLE $1,379,922 $1,343,902
========== ==========
CORE CAPITAL $ 120,588 $ 108,673
========== ==========
RISK-BASED CAPITAL $ 133,440 $ 119,400
========== ==========
RATIO OF CLASSIFIED ASSETS TO:
Loans receivable 5.5% 7.2%
========== ==========
Core capital 62.5% 89.4%
========== ==========
Risk-based capital 56.5% 81.4%
========== ==========
</TABLE>
- -------------
(1) Includes $18.1 million in loans at December 31, 1998, of which $13.1
million were past due for maturity but current with respect to
interest and, if applicable, principal payments. All $18.1 million of
loans were renewed, paid current or paid off during the first quarter
of 1999.
20
<PAGE> 21
The table below sets forth information concerning the Company's gross
classified loans, by category, as of March 31, 1999 (dollars are in thousands).
<TABLE>
<CAPTION>
DELINQUENT LOANS OTHER
---------------------- NONACCRUAL PERFORMING
90+ DAYS 30-89 DAYS LOANS(1) LOANS TOTAL
-------- ---------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
SINGLE FAMILY $ 9,660 $ 9,911 $14,252 $11,688 $45,511
INCOME PROPERTY
Multi-family 225 -- -- 1,243 1,468
Commercial 3,480 -- -- 9,367 12,847
Development -- -- -- 2,190 2,190
SINGLE FAMILY CONSTRUCTION
Single residence -- -- -- 1,451 1,451
Tract -- -- 3,437 5,701 9,138
OTHER -- 3 948 1,144 2,095
------- ------- ------- ------- -------
TOTAL $13,365 $ 9,914 $18,637 $32,784 $74,700
======= ======= ======= ======= =======
</TABLE>
- --------------
(1) Loans which have been restructured, such that interest payments are
made from the proceeds of the Company's loan without periodic
payments by the borrower.
ALLOWANCE FOR ESTIMATED LOSSES
Management establishes specific allowances for estimated 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 allowances, management estimates
the revenues expected to be generated from disposal of the Company's collateral
or owned property, less construction and renovation costs (if any), holding
costs and transaction costs. For tract construction and land developments, the
resulting projected cash flows are discounted utilizing a market rate of return
to determine their value.
The Company maintains an allowance for estimated credit losses which
is not tied to individual loans or properties ("General Reserves"). General
Reserves are maintained for each of the Company's principal loan segments, and
supplemented by periodic additions through provisions for estimated credit
losses. In measuring the adequacy of the Company's General Reserves, management
considers (1) the Company's historical loss experience for each loan portfolio
segment and in total, (2) the historical migration of loans within each
portfolio segment and in total (i.e., from performing to nonperforming, from
nonperforming to REO), (3) observable trends in the performance of each loan
portfolio segment (4) observable trends in the region's economy and in its real
property markets, and (5) guidelines published by the OTS for maintaining
General Reserves.
Because a significant majority of the Company's loans have been
originated since 1994, a period during which the Southern California region has
experienced substantial and sustained economic growth, and property values have
risen sharply, the Company's loan portfolio lacks substantial seasoning and the
Company has little historical experience to aid management in measuring the
impact of a pronounced and sustained economic downturn on the performance of the
Company's loan portfolio. For these reasons, and because of the generally higher
risk profile and individual size of many of the Company's loans, in each
instance when compared with conventional home lenders, management has determined
to increase the level of General Reserves during 1999, to an amount which
represents 1.50% of net loans by the end of 1999.
21
<PAGE> 22
The table below sets forth the general and specific allowance for
estimated credit losses for the Company's loan portfolio as of March 31, 1999
(dollars are in thousands).
<TABLE>
<CAPTION>
LOANS
-------------------------
PERFORMING DELINQUENT TOTAL
---------- ---------- -------
<S> <C> <C> <C>
Specific reserves $ 3,366 $ 1,452 $ 4,818
General reserves 14,845 295 15,140
------- ------- -------
Total $18,211 $ 1,747 $19,958
======= ======= =======
PERCENTAGES
% of total reserves to gross loans 1.3% 7.5% 1.4%
% of general reserves to net loans 1.1% 1.4% 1.1%
</TABLE>
The table below summarizes the activity of the Company's allowance
for estimated credit losses for the periods indicated (dollars are in
thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------------
1999 1998
----------- -----------
<S> <C> <C>
LOANS
Average loans outstanding $ 1,354,383 $ 892,060
=========== ===========
Total allowance for estimated credit losses at beginning of period $ 17,111 $ 13,274
Provision for estimated credit losses 3,000 1,485
Charge-offs:
Single family (153) (467)
Income property
Commercial -- (200)
----------- -----------
Total charge-offs (153) (667)
----------- -----------
Total allowance for estimated credit losses at end of period $ 19,958 $ 14,092
=========== ===========
Ratio of charge-offs to average loans
outstanding during the period 0.01% 0.07%
REAL ESTATE OWNED
Total allowance for estimated losses at beginning of period $ 45 $ 2,563
Provision for estimated losses 45 15
Charge-offs -- (1,716)
----------- -----------
Total allowance for estimated losses at end of period $ 90 $ 862
=========== ===========
</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 maintains
an allowance for estimated credit losses, for each identifiable segment of the
Company's loan portfolio. The table below summarizes the allocation of the
Company's allowance for estimated credit losses for each principal loan
portfolio segment (dollars are in thousands).
<TABLE>
<CAPTION>
MARCH 31, 1999 DECEMBER 31, 1998
------------------------ -------------------------
PERCENT OF PERCENT OF
RESERVES TO RESERVES TO
TOTAL LOANS(1) TOTAL LOANS(1)
BALANCE BY CATEGORY BALANCE BY CATEGORY
------- ----------- ------- -----------
<S> <C> <C> <C> <C>
SINGLE FAMILY $ 7,644 1.3% $ 7,836 1.4%
INCOME PROPERTY
Multi-family 1,105 0.5% 1,063 0.4%
Commercial 4,441 2.0% 4,334 1.9%
Development 815 0.7% 354 0.5%
LAND 347 0.5% 293 0.4%
SINGLE FAMILY CONSTRUCTION
Single residence 1,086 0.4% 789 0.3%
Tract 1,776 2.6% 1,092 1.3%
OTHER 2,744 7.8% 1,350 2.9%
------- -------
$19,958 1.2% $17,111 1.1%
======= =======
</TABLE>
- -----------
(1) Percent of allowance for estimated credit losses to gross loan
commitments, which include the undisbursed portion of such
commitments.
REAL ESTATE OWNED
Real estate acquired in satisfaction of loans is transferred from
loans to properties at the lower of the carrying values or the 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 allowances. Recoveries and losses from the disposition
of properties are also included in NONINTEREST EXPENSES - REAL ESTATE
OPERATIONS.
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,
1999 1998
------ ------
<S> <C> <C>
SINGLE FAMILY $ 590 $2,509
INCOME PROPERTY
Multi-family 213 213
Commercial -- 1,393
------ ------
GROSS INVESTMENT(1) 803 4,115
LESS ALLOWANCE FOR ESTIMATED LOSSES 90 45
------ ------
NET REAL ESTATE OWNED $ 713 $4,070
====== ======
</TABLE>
- ---------------
(1) Fair value of collateral at foreclosure, plus post-foreclosure
capitalized costs.
23
<PAGE> 24
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
The table below summarizes the Company's deposit portfolio by
original term, weighted average interest rates ("WAIR") and weighted average
remaining maturities in months ("WARM") as of the dates indicated (dollars are
in thousands).
<TABLE>
<CAPTION>
MARCH 31, 1999 DECEMBER 31, 1998
---------------------------------------- --------------------------------------------
PRODUCT TYPE BALANCE WAIR WARM BALANCE WAIR WARM
- ----------------------------- ----------- ---------- -------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Non-interest bearing checking $ 21,131 -- -- $ 20,275 -- --
Checking/NOW 39,321 2.02% -- 35,596 2.03% --
Passbook 27,268 2.13% -- 25,723 2.10% --
Money market 143,030 4.58% -- 104,137 4.53% --
Certificates of deposit
7 day maturities 35,124 4.08% -- 36,091 4.08% --
Less than 6 months 15,616 4.71% 1 5,688 4.60% 2
6 months to 1 year 197,400 4.95% 3 207,964 5.25% 3
1 year to 2 years 519,372 5.37% 6 537,815 5.51% 7
Greater than 2 years 40,339 5.32% 17 46,161 5.40% 16
---------- ----------
$1,038,601 4.80% 4 $1,019,450 4.98% 5
========== ======= ====== ========== ========== ==========
</TABLE>
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>
MARCH 31, 1999 DECEMBER 31, 1998
------------------------- ------------------------
ORIGINAL TERM PRINCIPAL RATE PRINCIPAL RATE
- ---------------------- --------- ----------- --------- ---------
<S> <C> <C> <C> <C>
6 Months $ 20,000 4.87% $ - -
60 Months 275,000 5.25% 215,000 5.36%
120 Months 49,000 4.36% 49,000 4.36%
========= =========
$ 344,000 5.10%(1) $ 264,000 5.18%(1)
========= =========
</TABLE>
- --------------
(1) Weighted average
The weighted average remaining term of the Company's FHLB advances
was 4 years and 8 months and 5 years and 3 months as of March 31, 1999 and
December 31, 1998, respectively. All of the Company's FHLB advances outstanding
at March 31, 1999, with the exception of one, contain options which allow the
FHLB to call the advances prior to maturity, subject to an initial non-callable
period of two-to-five years from origination.
24
<PAGE> 25
SENIOR NOTES
On December 31, 1997, the Company completed the issuance of $40.0
million of Senior Notes due 2004. These Senior Notes bear an interest payable
semiannually at a 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 AND REGULATORY CAPITAL
The Company's capital consists of common stockholders' equity, which
at March 31, 1999 amounted to $84.7 million and which equaled 5.6% of the
Company's total assets.
The following table summarizes the regulatory capital requirements
under the Home Owners' Loan Act ("HOLA") for the Bank as of March 31, 1999. 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) $ 120,588 $ 120,588 $ 120,588
Adjustments
General reserves -- -- 13,664
Other(2) -- -- (812)
----------- --------- ----------- -------- ----------- -------------
Regulatory capital 120,588 7.96% 120,588 7.96% 133,440 12.23%
Required minimum 22,724 1.50 60,597 4.00 87,267 8.00
----------- --------- ----------- -------- ----------- -------------
Excess capital $ 97,864 6.46% $ 59,991 3.96% $ 46,173 4.23%
=========== ========= =========== ======== =========== =============
Adjusted assets(3) $ 1,514,932 $ 1,514,932 $ 1,090,842
=========== =========== ===========
</TABLE>
- --------------
(1) Reflects capital contributions totaling $7.5 million from the parent
company made during 1999.
(2) Includes the portion of non-residential construction loans which
exceed a loan-to-value of 80%.
(3) The term "adjusted assets" refers to the term "adjusted total
assets", as defined in 12 C.F.R. Section 567.1(a), for purposes of
tangible and core capital requirements, and for purposes of
risk-based capital requirements, refers to the term "risk-weighted
assets", as defined in 12 C.F.R. Section 567.1(d).
25
<PAGE> 26
As of March 31, 1999, 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 Bank'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, 1999
Total Capital
(to Risk Weighted Assets) $133,440 12.23% $ 87,267 8.00% $109,084 10.00%
Core Capital
(to Adjusted Tangible Assets) 120,588 7.96% 60,597 4.00% 75,747 5.00%
Tangible Capital
(to Adjusted Tangible Assets) 120,588 7.96% 22,724 1.50% N/A N/A
Tier 1 Capital
(to Risk Weighted Assets) 120,588 11.05% N/A N/A 65,451 6.00%
AS OF DECEMBER 31, 1998
Total Capital
(to Risk Weighted Assets) $119,400 11.10% $ 86,090 8.00% $107,612 10.00%
Core Capital
(to Adjusted Tangible Assets) 108,673 7.65% 56,804 4.00% 71,005 5.00%
Tangible Capital
(to Adjusted Tangible Assets) 108,673 7.65% 21,302 1.50% N/A N/A
Tier 1 Capital
(to Risk Weighted Assets) 108,673 10.10% N/A N/A 64,567 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
Hawthorne Financial Corporation maintained cash and cash equivalents
of $3.3 million at March 31, 1999. Hawthorne Financial Corporation has no other
significant assets beyond its investment in the Bank. As discussed elsewhere in
this report, the Company expects to make its June 1999 semi-annual interest
payment on its Senior Notes from its current liquidity. Thereafter, the Company
will be dependent upon the Bank for dividends in order to make these semi-annual
interest payments. The ability of the Bank to provide dividends to Hawthorne
Financial Corporation is governed by applicable regulations of the OTS. Based
upon these regulations, the Bank's supervisory rating, and the Bank's current
and projected earnings rate, management fully expects the Bank to maintain the
ability to provide dividends to Hawthorne Financial Corporation, as necessary,
for the payment of interest on the Company's Senior Notes.
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
26
<PAGE> 27
Company's liquidity for the calculation period ended March 31, 1999 was 7.47%,
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 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 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, as well
as, those provided to the Company by third-party vendors. In 1998, the Company
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 has completed
its own Year 2000 testing by creating a database that rolled forward
systematically until the in-house computer systems processed data into what it
believed was early 2000.In addition, the Company has identified the following
worst case scenarios that could occur as a result of the calendar date change:
(1) loss of electrical power, (2) loss of communication systems, (3) loss of
water, (4) failure of a security system, (5) failure of a critical third party
system and (6) large deposit account withdrawals or advances on existing lines
of credit. The Company has developed contingency plans that provide for
alternative methods of conducting business for critical functions in the event
one or more of these circumstances occurs. These plans will be refined
throughout 1999.
The Company has conducted an extensive review of all of its critical
third party software service providers' Year 2000 compliance efforts. In the
process, the Company identified five critical core data systems that are third
party supported or developed. All of these providers have asserted that their
systems are compliant.
The Company has also identified twenty-one critical service providers
(non-data service related) of which twelve have asserted that they are Year 2000
compliant. If any of the remaining nine, who are not compliant, have not
committed to a date of compliance by July 1999, then the Company will proceed
under its contingency plans. While the Company has received assurances from
vendors as to compliance, such assurances are not guarantees and may not be
enforceable.
The Company's loan portfolio consists almost entirely of real estate
secured loans. While the financial condition of any borrower is susceptible to
Year 2000 problems, the Company believes that its credit risk relating to Year
2000 issues is greater with commercial mortgage loans where the borrowers have
an ongoing business. In September 1998, the Company began reviewing all of its
commercial mortgage loans maturing after December 31, 1999 to identify those
with borrowers having ongoing business operations at the property securing the
Company's loans. As a result of this review, as of March 31, 1999, the Company
had identified 39 borrowers with aggregate outstanding loans of approximately
$150.0 million maturing after December 31, 1999, which would fit into this
higher risk profile. The Company is in the process of contacting each of these
borrowers in an attempt to assess their Year 2000 compliance. If the borrowers
are non-compliant, the Company will have difficulty in assessing whether
27
<PAGE> 28
such non-compliance will adversely affect the borrowers' ability to service
their loans. Further, the financial condition of these borrowers (and all
borrowers) may be adversely affected if their major customers or providers of
critical goods and services (including telephone, gas, water and electricity)
are not Year 2000 compliant.
The Company installed Y2K compliant software and hardware as part of
the conversion completed in 1998. The expense incurred and to be incurred by the
Company to ensure Year 2000 compliance is substantially integrated and was
included with the expense associated with the conversion of its computer-based
systems. The Company does not anticipate any material additional expenses in
1999 related to Y2K software or hardware. Y2K testing occurs on a continual
basis upon receipt of all new releases of Y2K compliant software and hardware.
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 its interest rate exposure. Instead, the Company utilizes interest rate
floors, penalties, prepayment and exit fees on its new loans to mitigate the
risk of interest margin compression. Additionally, the Company hedges such
exposure internally by extending the duration of interest-bearing liabilities
through the use of FHLB advances, to better match the repricing sensitivity of
the interest-earning 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
March 31, 1999. 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>
MARCH 31, 1999
-----------------------------------------------------------------------------------------
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) $ 300 $ -- $ -- $ -- $ -- $ 300
Investments and FHLB Stock 17,408 -- -- -- -- 17,408
Loans(2) 666,783 239,466 313,204 46,933 118,114 1,384,500
----------- ----------- ----------- ----------- ----------- -----------
Total interest-
earning assets $ 684,491 $ 239,466 $ 313,204 $ 46,933 $ 118,114 $ 1,402,208
=========== =========== =========== =========== =========== ===========
INTEREST-BEARING LIABILITIES
Deposits
Transaction accounts $ 230,752 $ -- $ -- $ -- $ -- $ 230,752
Certificates of deposit 267,381 239,291 248,497 52,680 -- 807,849
FHLB advances -- 20,000 -- 275,000 49,000 344,000
Senior Notes -- -- -- -- 40,000 40,000
----------- ----------- ----------- ----------- ----------- -----------
Total interest-bearing
liabilities $ 498,133 $ 259,291 $ 248,497 $ 327,680 $ 89,000 $ 1,422,601
=========== =========== =========== =========== =========== ===========
Interest rate sensitivity gap $ 186,358 $ (19,825) $ 64,707 $ (280,747) $ 29,114 $ (20,393)
Cumulative interest rate
sensitivity gap 186,358 166,533 231,240 (49,507) (20,393) (20,393)
Cumulative interest rate
sensitivity gap
as a percentage
of total interest-
earning assets 13.3% 11.9% 16.5% (3.5%) (1.5%) (1.5%)
</TABLE>
- -------------
(1) Excludes noninterest-earning cash balances.
(2) Loans include $41.9 million of nonaccrual loans, and are exclusive of
loan loss reserves.
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, 1998, according to the Bank's internal interest rate
risk exposure model analysis, it was estimated that the Bank's MV would decrease
4% and 15% 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 1% and 5% in
the event of 200 and 400 basis point decreases in market rates, respectively.
Presented below, as of March 31, 1999, 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>
AS A % OF PRESENT
CHANGE MARKET VALUE VALUE OF ASSETS
--------------------------------- ---------------------
IN RATES $ AMOUNT $ CHANGE % CHANGE RATIO CHANGE
- ----------- --------- --------- --------- ------- ---------
<S> <C> <C> <C> <C> <C>
+400 bp $ 84,124 $(59,231) (41.32)% 5.82% -354bp
+200 bp 122,432 (20,923) (14.60)% 8.18% -118bp
0 bp 143,355 -- -- 9.36% --
- -200 bp 142,337 (1,017) (0.71)% 9.09% -27bp
- -400 bp 141,271 (2,084) (1.45)% 8.84% -52bp
</TABLE>
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 that the plaintiffs received as sellers was
inadequate and should have so advised them. In June 1997, a jury
found for the plaintiffs and awarded compensatory and punitive
damages totaling $9.1 million. In July 1997, the trial judge reduced
the combined award to $3.3 million. The plaintiffs accepted the
reduced judgment. The Bank filed a notice of appeal from the judgment
and posted an Appeal Bond with the Court to stay plaintiffs'
enforcement of the judgment pending the Appellate Court's decision.
In July, 1998, the Appellate Court remanded the case to the Superior
Court with directions to dismiss the fraudulent concealment,
misrepresentation and punitive damages claims and to conduct a new
trial pertaining solely to damages arising from negligence, in
particular to determine whether any negligence of the Bank
contributed to the plaintiffs' injury and, if so, to apportion
liability for negligence between the Bank and the plaintiffs. On
March 30, 1999, the jury returned a verdict in favor of the
plaintiffs in the amount of $2.6 million. The Bank intends to file a
notice of appeal from this judgment. The Bank believes that there is
a substantial likelihood that its position will ultimately be upheld
on retrial and, accordingly, that no amounts having a materially
adverse effect on the Bank's financial condition or results of
operations will be paid by the Bank to the plaintiffs in this matter.
There can be no assurances that this will be the case, however.
In the first quarter of 1999, the Company settled two
matters involving real property sold by the Company to third parties
following the Company's acquisition of the properties through
completed foreclosure prior to 1992. In each of these matters, the
Company was alleged to have sold the properties with known
construction defects which were not adequately disclosed to the
purchasers. In the aggregate, these settlements involved the payment
by the Company of a total of $0.6 million.
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
The Company filed a Form 8-K on March 10, 1999, announcing
financial results for the year ended December 31, 1998.
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 May 14, 1999 /s/ SCOTT A. BRALY
----------------------------------------
Scott A. Braly
President and
Chief Executive Officer
Dated May 14, 1999 /s/ SIMONE LAGOMARSINO
----------------------------------------
Simone Lagomarsino
Executive Vice President and
Chief Financial Officer
32
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000046267
<NAME> HAWTHORNE FINANCIAL CORPORATION
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 118,407
<INT-BEARING-DEPOSITS> 300
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 1,359,964
<ALLOWANCE> 19,958
<TOTAL-ASSETS> 1,517,172
<DEPOSITS> 1,038,601
<SHORT-TERM> 20,000
<LIABILITIES-OTHER> 9,839
<LONG-TERM> 364,000
0
0
<COMMON> 53
<OTHER-SE> 84,679
<TOTAL-LIABILITIES-AND-EQUITY> 1,517,172
<INTEREST-LOAN> 31,001
<INTEREST-INVEST> 1,004
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 32,005
<INTEREST-DEPOSIT> 12,425
<INTEREST-EXPENSE> 17,535
<INTEREST-INCOME-NET> 14,470
<LOAN-LOSSES> 3,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 8,354
<INCOME-PRETAX> 5,084
<INCOME-PRE-EXTRAORDINARY> 5,084
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,972
<EPS-PRIMARY> 0.57
<EPS-DILUTED> 0.38
<YIELD-ACTUAL> 8.90
<LOANS-NON> 41,916
<LOANS-PAST> 0
<LOANS-TROUBLED> 30,273
<LOANS-PROBLEM> 32,784
<ALLOWANCE-OPEN> 17,111
<CHARGE-OFFS> 153
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 19,958
<ALLOWANCE-DOMESTIC> 19,958
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
