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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
---------
FORM 10-Q
---------
X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- -- ACT OF 1934
For the quarter ended September 30, 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
5,328,801 shares of Common Stock, $0.01 par value per share outstanding, as of
October 31, 1999.
<PAGE> 2
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q INDEX
For the quarter ended September 30, 1999
<TABLE>
PART I - FINANCIAL INFORMATION
<CAPTION>
Page
----
<S> <C> <C>
ITEM 1. Financial Statements
Consolidated Statements of Financial Condition
at September 30, 1999 and December 31, 1998 3
Consolidated Statements of Operations
for the Three and Nine Months Ended September 30, 1999 and 1998 4
Consolidated Statements of Stockholders' Equity
for Nine Months Ended September 30, 1999 5
Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 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 32
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 33
ITEM 2. Changes in Securities 33
ITEM 3. Defaults upon Senior Securities 33
ITEM 4. Submission of Matters to a Vote of Security Holders 34
ITEM 5. Other Information 34
ITEM 6. Exhibits and Reports on Form 8-K 34
</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.
<PAGE> 3
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31
1999 1998
----------- -----------
(Unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 121,217 $ 45,449
Loans receivable (net of allowance for estimated credit losses
of $22,694 in 1999 and $17,111 in 1998) 1,434,426 1,326,791
Real estate owned (net of allowance for estimated losses
of $38 in 1999 and $45 in 1998) 1,175 4,070
Investment in capital stock of Federal Home Loan Bank - at cost 20,701 13,554
Office property and equipment - at cost, net 6,101 6,513
Accrued interest receivable 9,289 8,424
Other assets 4,382 7,633
----------- -----------
TOTAL ASSETS $ 1,597,291 $ 1,412,434
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits $ 1,093,493 $ 1,019,450
FHLB advances 359,000 264,000
Senior notes 40,000 40,000
Accounts payable and other liabilities 12,636 7,560
----------- -----------
TOTAL LIABILITIES 1,505,129 1,331,010
Stockholders' Equity
Preferred stock - $0.01 par value; authorized 10,000,000 shares;
none outstanding -- --
Common stock - $0.01 par value; authorized 20,000,000
shares; outstanding 5,328,530 shares in 1999 and
5,194,996 shares in 1998 53 52
Capital in excess of par value-common stock 40,935 40,349
Retained earnings 51,222 41,150
----------- -----------
92,210 81,551
Less
Treasury stock, at cost - 5,400 shares (48) (48)
Employee stock ownership plan-loan -- (79)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 92,162 81,424
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,597,291 $ 1,412,434
=========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE> 4
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(AMOUNTS ARE IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
INTEREST REVENUES
Loans $ 32,745 $ 27,441 $ 94,956 $ 73,077
Cash and investment securities 1,786 1,483 4,269 2,938
-------- -------- -------- --------
TOTAL INTEREST REVENUES 34,531 28,924 99,225 76,015
-------- -------- -------- --------
INTEREST COSTS
Deposits 12,818 12,422 37,880 34,533
FHLB advances 4,714 2,950 13,011 5,740
Senior notes 1,250 1,250 3,750 3,764
-------- -------- -------- --------
TOTAL INTEREST COSTS 18,782 16,622 54,641 44,037
-------- -------- -------- --------
NET INTEREST INCOME 15,749 12,302 44,584 31,978
PROVISION FOR ESTIMATED CREDIT LOSSES ON LOANS 3,500 1,950 9,000 5,185
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT
LOSSES ON LOANS 12,249 10,352 35,584 26,793
-------- -------- -------- --------
NONINTEREST REVENUES
Loan related fees 1,783 1,184 5,129 2,915
Other 253 188 802 626
-------- -------- -------- --------
TOTAL NONINTEREST REVENUES 2,036 1,372 5,931 3,541
-------- -------- -------- --------
NONINTEREST EXPENSES
General and administrative expenses
Employee 3,204 3,683 10,999 10,373
Operating 1,481 1,681 4,621 4,256
Occupancy 1,059 851 3,038 2,439
Technology 459 567 1,537 1,561
Professional 796 211 1,842 979
SAIF premiums and OTS assessments 310 247 922 703
-------- -------- -------- --------
Total general and administrative expenses 7,309 7,240 22,959 20,311
-------- -------- -------- --------
Income from real estate operations, net 8 616 425 1,980
Other non-operating (income)/expense 624 10 1,624 14
-------- -------- -------- --------
TOTAL NONINTEREST EXPENSES 7,925 6,634 24,158 18,345
-------- -------- -------- --------
NET EARNINGS BEFORE INCOME TAXES 6,360 5,090 17,357 11,989
INCOME TAX PROVISION 2,686 1,632 7,285 3,526
-------- -------- -------- --------
NET EARNINGS $ 3,674 $ 3,458 $ 10,072 $ 8,463
======== ======== ======== ========
BASIC EARNINGS PER SHARE (NOTE 3) $ 0.69 $ 0.67 $ 1.91 $ 2.21
======== ======== ======== ========
DILUTED EARNINGS PER SHARE (NOTE 3) $ 0.48 $ 0.45 $ 1.30 $ 1.33
======== ======== ======== ========
WEIGHTED AVERAGE BASIC SHARES OUTSTANDING (NOTE 3) 5,312 5,189 5,275 3,838
======== ======== ======== ========
WEIGHTED AVERAGE DILUTED SHARES OUTSTANDING (NOTE 3) 7,714 7,708 7,722 6,351
======== ======== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE> 5
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(AMOUNTS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
COMPREHENSIVE
INCOME
-------------
BALANCE AT EXERCISED BALANCE AT
DECEMBER 31, STOCK EXERCISED NET SEPTEMBER 30,
1998 OPTIONS WARRANTS EARNINGS OTHER 1999
------------ --------- --------- -------- ----- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
NUMBER OF COMMON SHARES 5,195 108 26 -- -- 5,329
======== ======== ======== ========== ======== ========
Common stock $ 52 $ 1 $ -- $ -- $ -- $ 53
Capital in excess of par value
common stock 40,349 563 55 -- (32) 40,935
Retained earnings 41,150 -- -- 10,072 -- 51,222
Treasury stock (48) -- -- -- -- (48)
Employee stock ownership plan-loan (79) -- -- -- 79 --
-------- -------- -------- ---------- -------- --------
TOTAL STOCKHOLDERS' EQUITY $ 81,424 $ 564 $ 55 $ 10,072 $ 47 $ 92,162
======== ======== ======== ========== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
5
<PAGE> 6
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
--------------------------
1999 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings $ 10,072 $ 8,463
Adjustments
Provision for estimated credit losses on loans 9,000 5,185
Provision for estimated credit losses on real estate owned 80 15
Net recoveries from sales of real estate owned (757) (2,220)
Net gain from sale of other assets (7) (7)
Loan fee and discount accretion (4,409) (4,734)
Depreciation and amortization 2,016 1,258
FHLB dividends (665) (330)
Increase in accrued interest receivable (865) (2,910)
Increase in deferred tax assets, net 3,052 2,476
(Increase)/decrease in other assets (70) 1,854
Increase in other liabilities 5,076 9,797
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 22,523 18,847
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment securities -- (22,101)
Loans
New loans funded (282,642) (347,044)
Construction disbursements (266,625) (258,102)
Payoffs 414,481 263,663
Sales proceeds 3,000 --
Principal amortization and paydowns 19,051 28,239
Lines of credit activity, net (5,611) (43,860)
Other, net (59) 4,563
Real estate owned
Sale proceeds 9,858 10,827
Capitalized costs (105) (942)
Other, net -- (551)
Purchase of FHLB stock (6,482) (5,770)
Office property and equipment
Sale proceeds 60 29
Additions (1,421) (3,325)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (116,495) (374,374)
--------- ---------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
6
<PAGE> 7
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(DOLLARS ARE IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
----------------------------
1999 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Deposit activity, net $ 74,042 $ 195,431
Net FHLB advances 95,000 224,000
Net proceeds from exercise of stock options and warrants 619 438
Proceeds from stock offering -- 28,376
Offering costs -- (573)
Collection of ESOP loan 79 10
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 169,740 447,682
--------- ---------
Net increase in cash and cash equivalents 75,768 92,155
Cash and cash equivalents at beginning of period 45,449 51,620
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 121,217 $ 143,775
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
CASH PAID DURING THE PERIOD FOR
Interest $ 50,058 $ 42,598
Income taxes 4,233 2,828
NON-CASH INVESTING AND FINANCING ACTIVITIES
Real estate acquired in settlement of loans 7,563 3,847
Loans originated to finance sales of real estate owned 1,500 1,970
Net change in unrealized gains (losses) on available-for-sale securities -- 4
Loans originated to refinance existing bank loans 33,385 37,885
LOAN ACTIVITY
Total commitments $ 523,529 $ 713,000
Less:
Change in undisbursed funds on construction commitments 39,338 (97,654)
Loans originated to finance sales of real estate owned (1,500) --
New lines of credit (12,100) (10,200)
--------- ---------
Net construction disbursements and loans funded $ 549,267 $ 605,146
========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
7
<PAGE> 8
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 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
September 30, 1999 and December 31, 1998, and the results of its operations and
its cash flows for the three and nine months ended September 30, 1999 and 1998.
Operating results for the three and nine months ended September 30, 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 and nine months ended September 30, 1999 and 1998. In
the table below, "Warrants" refer to the Warrants issued by the Company in
December 1995, which are currently exercisable and which expire December 11,
2005, and "Options" refer to stock options previously granted to employees of
the Company and which were outstanding at each measurement date.
In July 1998, the Company completed an offering of 2,012,500 shares of
its Common Stock 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
<PAGE> 9
NOTE 3 - BOOK VALUE AND EARNINGS PER SHARE - CONTINUED
(AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------ ------------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
AVERAGE SHARES OUTSTANDING
Basic 5,312 5,189 5,275 3,838
Warrants 2,492 2,512 2,499 2,421
Options (1) 462 738 519 677
Less Treasury shares (2) (552) (731) (571) (585)
-------- -------- -------- --------
Diluted 7,714 7,708 7,722 6,351
======== ======== ======== ========
NET EARNINGS FOR THE PERIOD $ 3,674 $ 3,458 $ 10,072 $ 8,463
======== ======== ======== ========
BASIC EARNINGS PER SHARE $ 0.69 $ 0.67 $ 1.91 $ 2.21
======== ======== ======== ========
DILUTED EARNINGS PER SHARE $ 0.48 $ 0.45 $ 1.30 $ 1.33
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30
------------------------
1999 1998
-------- --------
<S> <C> <C>
PERIOD-END SHARES OUTSTANDING
Basic 5,323 5,189
Warrants 2,486 2,512
Options (3) 405 738
Less Treasury shares (2) (537) (814)
-------- --------
Diluted 7,677 7,625
======== ========
Stockholders' equity $ 92,162 $ 79,037
======== ========
BASIC BOOK VALUE PER SHARE $ 17.31 $ 15.23
======== ========
DILUTED BOOK VALUE PER SHARE $ 12.00 $ 10.37
======== ========
</TABLE>
- ----------------------
(1) Excludes 340,000 options outstanding for the three and nine months
ended September 30, 1999 for which the exercise price exceeded the
average market price of the Company's Common Stock during the period.
Excludes 210,000 options outstanding for the three months ended
September 30, 1998 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) Excludes 365,000 and 210,000 options outstanding at September 30, 1999
and September 30, 1998, respectively, for which the exercise price
exceeded the average market price of the Company's Common Stock during
the period.
9
<PAGE> 10
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. 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 Bank filed an appeal and 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 $2.4 million. In
May 1999, 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. The Bank believes that there is a
reasonable likelihood that its position will ultimately be upheld on appeal and
accordingly, that no amounts having a materially adverse effect on the Bank's or
the Company's financial conditions or 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.
The Bank is a defendant in an action entitled Mells v. Hawthorne, filed
in the Superior Court of the State of California, San Diego. Plaintiffs alleged
that the Bank concealed and misrepresented the severity of defects in a house
that the Bank sold to them. On September 20, 1999, a second amended judgment was
entered on behalf of the plaintiffs for $767 thousand which includes attorney's
fees and costs. In October, 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. The Bank intends to vigorously
pursue its position and believes that there is a reasonable likelihood that the
amount of the judgment will be reduced and, accordingly, that no amounts having
a materially adverse effect on the Bank's or the Company's financial condition
or operations will be paid by the Bank to the plaintiffs in this matter.
However, there can be no assurances that this will be the case.
The Company is involved in a variety of other litigation matters in the
ordinary course of its business, and anticipates that it will become involved in
new litigation matters from time to time in the future. Based on the current
assessment of these existing other matters, management does not presently
believe that any one of these existing other matters is likely to have a
material adverse impact on the Company's financial condition or result of
operations. However, the Company will incur legal and related costs in
connection with the litigation and may from time to time determine to settle
some or all of the cases, regardless of management's assessment of the Company's
legal position. The amount of legal defense costs and settlements in any period
will depend on many factors, including the status of cases (and the number of
cases that are in trial or about to be brought to trial) and the opposing
parties aggressiveness in pursuing their cases and their perception of their
legal position. Further, the inherent uncertainty of jury or judicial verdicts
makes it impossible to determine with certainty the Company's maximum cost in
any pending litigation. Accordingly, the Company's litigation costs and expenses
may vary materially from period to period, and no assurance can be given that
these costs will not be material in any particular period.
NOTE 5 - SUBSEQUENT EVENTS
In November, the Bank paid $700 thousand to settle an action related to
a foreclosure sale of one of the Bank's REO properties. The Bank's President was
also named as a defendant in the action and the Bank intends to pursue a claim
against its directors and officers insurance carrier for full reimbursement of
the settlement, however, no assurances can be given that the Bank will be
successful in recovering the amount of the settlement from the carrier. The cost
of this settlement will reduce net earnings for the 4th quarter 1999 by
approximately $406 thousand or $0.05 per share.
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Net earnings for the three months ended September 30, 1999 were $3.7
million, or $0.48 per diluted share. This compares with net earnings of $3.5
million, or $0.45 per diluted share, for the three months ended September 30,
1998. Net earnings for the first nine months of 1999 were $10.1 million, or
$1.30 per diluted share, compared to net earnings of $8.5 million, or $1.33 per
diluted share, for the first nine months of 1998.
CORE BUSINESS ACTIVITY
The Company originates real estate-secured loans throughout Southern
California, generally consisting of permanent loans collateralized by single
family (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
since 1995, 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 shares of its Common Stock which raised approximately $27.6 million
of net proceeds. In addition, 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 quarter, Bank Core Earnings were $8.4 million, 47.4% more than the $5.7
million of Bank Core Earnings produced during the third quarter of 1998. Bank
Core Earnings of $22.9 million for the first nine months of 1999 were 59.0%
higher than the Bank Core Earnings of $14.4 million during the first nine months
of 1998. This growth in Bank Core Earnings results from the continued growth in
earning assets, which was partially offset by a slight decline in the Bank's net
interest margin.
11
<PAGE> 12
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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
---------------------- ----------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net interest income
(excluding interest expense for Senior Notes) $ 16,996 $ 13,265 $ 48,290 $ 35,422
Less provision for estimated
credit losses on loans 3,500 1,950 9,000 5,185
-------- -------- -------- --------
Net interest income after provision for
estimated credit losses on loans 13,496 11,315 39,290 30,237
Noninterest revenues 2,075 1,409 6,043 3,653
Less general and administrative costs 7,163 7,005 22,397 19,477
-------- -------- -------- --------
BANK CORE EARNINGS 8,408 5,719 22,936 14,413
-------- -------- -------- --------
Other items
Income from real estate operations, net 8 616 425 1,980
Hawthorne Financial Corp. non-operating (expense)/income, net (182) 15 (630) (626)
Other non-operating income/(expense), net (624) (10) (1,624) (14)
Interest cost on senior notes (1,250) (1,250) (3,750) (3,764)
-------- -------- -------- --------
OTHER ITEMS, NET (2,048) (629) (5,579) (2,424)
-------- -------- -------- --------
Pretax earnings 6,360 5,090 17,357 11,989
Income tax provision 2,686 1,632 7,285 3,526
-------- -------- -------- --------
NET EARNINGS $ 3,674 $ 3,458 $ 10,072 $ 8,463
======== ======== ======== ========
</TABLE>
The Bank's net interest income, excluding interest expense for Senior
Notes, increased 28.1% during the third quarter of 1999, to $17.0 million, from
the $13.3 million of net interest income during the third quarter of 1998. This
growth in net interest income resulted from a 23.1% increase in the Bank's
average interest-earning assets, which rose to $1.6 billion during the three
months ended September 30, 1999, from $1.3 billion during the three months ended
September 30, 1998. The Bank's net interest income, excluding interest expense
for Senior Notes, increased 36.3% during the nine months of 1999, to $48.3
million from $35.4 million of net interest income during the nine months of
1998. This growth in net interest income resulted from a 36.4% increase in the
Bank's average interest-earning assets, which rose to $1.5 billion during the
nine months ended September 30, 1999, from $1.1 billion during the nine months
ended September 30, 1998.
Non-interest revenues were $2.1 million and $6.0 million for the three
and nine months ended September 30, 1999, respectively, compared to non-interest
revenues of $1.4 million and $3.7 million for the three and nine months ended
September 30, 1998, respectively. The year-over-year increase in non-interest
revenues resulted primarily from a greater amount of exit and release fees and
prepayment penalties in connection with loans repaid during the 1999 period.
INCOME TAXES
During the first nine months of 1999, the Company's effective tax rate
was 42.0%. During the first nine months of 1998, the Company's effective tax
rate was 29.4%, which reflected utilization of accumulated income tax benefits,
principally tax loss carryforwards.
PARENT COMPANY ITEMS
In July 1998, the Company completed a public offering of approximately
2.0 million shares of its Common Stock, realizing net proceeds (after offering
costs) of approximately $27.6 million. Through September 30, 1999, the Company
had contributed $22.5 million of these net proceeds to the Bank and had made its
June 30, 1999 and December 31, 1998 semiannual interest payments on its Senior
Notes of approximately $2.5 million each. Accordingly, the Company will now rely
upon dividends from the Bank for its payment of interest on its Senior Notes,
the next payment of which is due in December 1999.
12
<PAGE> 13
Because the Company has contributed to the Bank 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.
RESULTS OF OPERATIONS
The following table sets forth the Company's average balance sheets,
and the related weighted average yields and costs on average interest-earning
assets and average interest-bearing liabilities, for the three months ended
September 30, 1999 and 1998 (dollars are in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------------------------------
SEPTEMBER 30, 1999 SEPTEMBER 30, 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) $1,437,346 $ 32,745 9.11% $1,146,124 $ 27,441 9.58%
Cash and cash equivalents 119,719 1,538 5.14% 79,961 1,105 5.53%
Investment securities -- -- -% 17,438 258 5.92%
Investment in capital stock of
Federal Home Loan Bank 19,282 248 5.14% 10,933 120 4.39%
---------- ---------- ---------- ----------
Total interest-earning assets 1,576,347 34,531 8.76% 1,254,456 28,924 9.22%
---------- ---- ---------- -----
Noninterest-earning assets 11,648 18,042
---------- ----------
TOTAL ASSETS $1,587,995 $1,272,498
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities
Deposits $1,058,051 12,818 4.81% $ 922,748 12,422 5.34%
FHLB advances 360,087 4,714 5.12% 215,544 2,950 5.36%
Senior notes 40,000 1,250 12.50% 40,000 1,250 12.50%
---------- ---------- ---------- ----------
Total interest-bearing liabilities 1,458,138 18,782 5.11% 1,178,292 16,622 5.60%
---------- ----- ---------- -----
Noninterest-bearing liabilities 40,295 16,499
Stockholders' equity 89,562 77,707
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,587,995 $1,272,498
========== ==========
Net interest income $ 15,749 $ 12,302
========== ==========
INTEREST RATE SPREAD 3.65% 3.63%
===== =====
NET INTEREST MARGIN INCLUDING SENIOR NOTES 4.00% 3.92%
===== =====
NET INTEREST MARGIN EXCLUDING SENIOR NOTES 4.31% 4.32%
===== =====
</TABLE>
- --------------------------
(1) Average Balance includes nonaccrual loans of $29.8 million and $23.3
million for the three months ended September 30, 1999 and September 30,
1998, respectively.
(2) Revenues/Costs includes amortization of loan fees and discounts of $1.3
million and $1.8 million for the three months ended September 30, 1999
and September 30, 1998, respectively.
13
<PAGE> 14
The table below sets forth the Company's average balance sheets, and
the related weighted average yields and costs on average interest-earning assets
and average interest-bearing liabilities, for the nine months ended September
30, 1999 and 1998 (dollars are in thousands).
<TABLE>
<CAPTION>
NINE MONTHS ENDED
--------------------------------------------------------------------------------
SEPTEMBER 30, 1999 SEPTEMBER 30, 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) $1,395,125 $ 94,956 9.08% $1,020,795 $ 73,077 9.55%
Cash and cash equivalents 98,866 3,604 4.86% 57,415 2,330 5.41%
Investment securities -- -- --% 5,635 278 6.58%
Investment in capital stock of
Federal Home Loan Bank 17,369 665 5.10% 8,659 330 5.08%
---------- ---------- ---------- ----------
Total interest-earning assets 1,511,360 99,225 8.75% 1,092,504 76,015 9.28%
---------- ---- ---------- -----
Noninterest-earning assets 12,123 18,006
---------- ----------
TOTAL ASSETS $1,523,483 $1,110,510
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities
Deposits $1,024,197 37,880 4.94% $ 861,522 34,533 5.36%
FHLB advances 335,319 13,011 5.12% 138,403 5,740 5.47%
Senior notes 40,000 3,750 12.50% 40,000 3,764 12.55%
---------- ---------- ---------- ----------
Total interest-bearing liabilities 1,399,516 54,641 5.22% 1,039,925 44,037 5.66%
---------- ----- ---------- -----
Noninterest-bearing liabilities 38,010 16,034
Stockholders' equity 85,957 54,551
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,523,483 $1,110,510
========== ==========
Net interest income $ 44,584 $ 31,978
========== ==========
INTEREST RATE SPREAD 3.53% 3.62%
===== =====
NET INTEREST MARGIN INCLUDING SENIOR NOTES 3.93% 3.90%
===== =====
NET INTEREST MARGIN EXCLUDING SENIOR NOTES 4.26% 4.36%
===== =====
</TABLE>
- --------------------------
(1) Includes nonaccrual loans of $26.4 million and $22.5 million for the
nine months ended September 30, 1999 and September 30, 1998,
respectively.
(2) Revenues/costs include amortization of loan fees and discounts of $4.4
million and $4.7 million for the nine months ended September 30, 1999
and September 30, 1998, respectively.
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 non-interest-earning assets,
including nonaccrual loans and real estate owned ("REO").
For the quarter, the decline in the Company's earning asset yield, to
8.76% from 9.22%, was closely matched by the decline in the Company's funding
costs, to 5.11% from 5.60%. As a result, the Company's net interest margin for
the third quarter of 1999 (before interest expense on the Company's Senior
Notes), remained virtually unchanged from the third quarter of 1998, declining
slightly to 4.31% from 4.32%. For the nine month periods, the same pattern was
evident, with earning asset yields declining by 53 basis points, funding costs
declining by 44 basis points, and the Bank's net interest margin (before
interest expense on the Company's Senior Notes) declining by 10 basis points (or
by 2.3%).
14
<PAGE> 15
During the third quarter of 1999, market interest rates (as measured by
the effective yields for issues of the U.S. Government, the London Interbank
Offer Rate (LIBOR), and the Prime Rate), returned to levels most recently
observed during the third quarter of 1998. However, during the intervening
period, such market interest rates declined substantially (in some instances by
as much as 1.50%), before rising again.
The substantial majority of the Company's earning assets (principally
loans) are adjustable-rate. The Company's deposits are primarily comprised of
term certificate accounts, which carry fixed interest rates and predominantly
possess original terms of from six-to-twelve months. The Company's borrowings,
which are principally derived from the Federal Home Loan Bank of San Francisco
(the "FHLB"), are for terms ranging from one-to-five years (though such terms
are subject to certain early call provisions) and carry fixed interest rates.
As of September 30, 1999, 87% of the Company's loans were
adjustable-rate, with 92% of such loans subject to repricing no less frequently
than annually. The substantial majority of such loans are priced at a margin
over various market-sensitive indicies, including the One-year CMT, the
One-month CMT, the MTA, LIBOR and the Prime Rate. Based upon the recent rise in
the effective yield of these indicies, the Company expects that the yield on its
loan portfolio will rise moderately over the coming months to fully incorporate
the recent rise in market interest rates.
The substantial majority of the Company's adjustable-rate loans were
underwritten during periods in which the market indicies utilized, approximated
the current level of such indicies. Such loans were also underwritten utilizing
the fully-indexed interest rate at the loans' inception (rather than any
introductory interest rate which may have been offered). Accordingly, current
required payments by borrowers have not changed materially since the origination
of such loans (and in many instances are lower now than they were when such
loans were originated).
At September 30, 1999, approximately 76% of the Company's deposits were
comprised of certificate accounts, the majority of which have original terms of
from six-to-twelve months. The remaining, weighted average term to maturity for
the Company's certificate accounts approximated six months at September 30,
1999. Generally, the Company's offering rates for certificate accounts move
directionally with the general level of interest rates, though typically not by
the same magnitude. Accordingly, the Company expects that the cost of its
certificate accounts will gradually rise in the coming months, as maturing and
newly-acquired accounts are priced at current, higher offering rates.
The Company's borrowings from the FHLB are fixed-rate, with remaining
terms of from one-to-four years (though such remaining terms are subject to
early call provisions). Accordingly, the recent rise in market interest rates is
expected to have no immediate impact upon the cost of the Company's currently
outstanding FHLB borrowings (though the cost of newly acquired borrowings would
reflect current market pricing, which is substantially higher than the cost of
the Company's currently outstanding FHLB borrowings).
Taken together, the Company expects that the influences described above
on its earning asset yields and funding costs will likely produce a
stable-to-rising net interest margin during the coming months, because the
Company's earning assets are expected to reprice more quickly than its
interest-bearing liabilities. However, this result could fail to materialize if
(1) the level of nonaccrual loans increases, (2) the percentage of earning
assets held in cash and equivalents increases, or (3) the composition of its
loan portfolio changes.
The following tables set 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).
15
<PAGE> 16
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
INCREASE (DECREASE) DUE TO CHANGE IN
-------------------------------------------------------------------
RATE AND NET
VOLUME RATE VOLUME CHANGE
------- ------- ------- -------
<S> <C> <C> <C> <C>
INTEREST REVENUES
Loans $ 6,972 $(1,331) $ (338) $ 5,303
Cash and cash equivalents 549 (77) (38) 434
Investment securities (258) (258) 258 (258)
Investment in capital stock of
Federal Home Loan Bank 92 20 16 128
------- ------- ------- -------
7,355 (1,646) (102) 5,607
------- ------- ------- -------
INTEREST COSTS
Deposits 1,821 (1,243) (182) 396
FHLB advances 1,978 (128) (86) 1,764
Senior notes -- -- -- --
------- ------- ------- -------
3,799 (1,371) (268) 2,160
------- ------- ------- -------
INCREASE IN NET INTEREST INCOME $ 3,556 $ (275) $ 166 $ 3,447
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
INCREASE (DECREASE) DUE TO CHANGE IN
-------------------------------------------------------------------
RATE AND NET
VOLUME RATE VOLUME CHANGE
------- ------- ------- -------
<S> <C> <C> <C> <C>
INTEREST REVENUES
Loans $26,798 $(3,599) $(1,320) $21,879
Cash and cash equivalents 1,682 (237) (171) 1,274
Investment securities (278) (278) 278 (278)
Investment in capital stock of
Federal Home Loan Bank 332 1 2 335
------- ------- ------- -------
28,534 (4,113) (1,211) 23,210
------- ------- ------- -------
INTEREST COSTS
Deposits 6,521 (2,670) (504) 3,347
FHLB advances 8,167 (370) (526) 7,271
Senior notes -- (14) -- (14)
------- ------- ------- -------
14,688 (3,054) (1,030) 10,604
------- ------- ------- -------
INCREASE IN NET INTEREST INCOME $13,846 $(1,059) $ (181) $12,606
======= ======= ======= =======
</TABLE>
The Company's interest revenues increased by $5.6 million, or 19.4%,
during the three months ended September 30, 1999 as compared to the same period
in 1998. This increase was primarily attributable to a 25.4% increase in the
average balance of loans outstanding, which was partially offset by a decrease
in the weighted average yield earned thereon, which averaged 9.11% during 1999
as compared with 9.58% in 1998.
Interest costs increased by $2.2 million, or 13.0%, during the three
months ended September 30, 1999, as compared to the same period during 1998,
primarily due to a 14.7% 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, which
together averaged 4.90% during the three months ended September 30, 1999, as
compared with 5.36% during the same quarter of 1998.
These changes in interest revenues and interest costs produced an
increase of $3.5 million, or 28.0%, in the Company's net interest income during
the three months ended September 30, 1999, as compared with the same quarter
during 1998. Expressed as a percentage of average interest-earning assets, the
Company's net interest margin
16
<PAGE> 17
increased to 4.00% during the three months ended September 30, 1999, as compared
with the net interest margin of 3.92% produced during the same period during
1998.
The Company's interest revenues increased by $23.2 million, or 30.5%,
during the first nine months of 1999 as compared to the same period in 1998.
This increase was primarily attributable to a 36.7% increase in the average
balance of loans outstanding, which was partially offset by a decrease in the
weighted average yield earned thereon, which averaged 9.08% during 1999 as
compared with 9.55% in 1998.
Interest costs increased by $10.6 million, or 24.1%, during the first
nine months of 1999, as compared to the same period during 1998, primarily due
to a 36% 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, which together averaged
5.00% during the first nine months of 1999, as compared with 5.38% during the
first nine months of 1998.
These changes in interest revenues and interest costs produced an
increase of $12.6 million, or 39.4%, in the Company's net interest income during
the first nine months of 1999 as compared with the same period during 1998.
Expressed as a percentage of average interest-earning assets, the Company's net
interest margin increased to 3.93% during the first nine months of 1999, as
compared with the net interest margin of 3.90% produced during the same period
during 1998.
PROVISIONS FOR ESTIMATED CREDIT LOSSES ON LOANS
For the three and nine months ended September 30, 1999, the Company
recorded provisions for estimated credit losses on loans of $3.5 million and
$9.0 million, respectively, an increase of 79.5% and 73.6% over provisions of
$2.0 million and $5.2 million recorded during the three and nine months ended
September 30, 1998, respectively. The provisions for estimated credit losses
during the nine months of 1999 were recorded to the Company's general valuation
reserve, compared to a provision of $2.7 million to specific valuation reserve
and $2.5 million to general valuation reserve during the first nine months of
1998. The increase in the level of loan loss provisions reflects management's
intention to increase the ratio of the Company's general valuation 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 amount of construction loans in the Company's loan portfolio
directed at financing real estate development. At September 30, 1999, the
Company's general reserves totaled 1.45% of net loans compared to 0.89% and
0.97% at December 31, 1998, and September 30, 1998, respectively.
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 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 SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
------------------------------------ ------------------------------------
1999 1998 CHANGE 1999 1998 CHANGE
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
NONINTEREST REVENUES
Loan-related fees $1,783 $1,184 $ 599 $5,129 $2,915 $2,214
Other 253 188 65 802 626 176
------ ------ ------ ------ ------ ------
TOTAL NONINTEREST REVENUES $2,036 $1,372 $ 664 $5,931 $3,541 $2,390
====== ====== ====== ====== ====== ======
</TABLE>
Loan-related fees primarily consist of fees collected from borrowers
(1) for the early repayment of their loans, (2) for the extension of the
maturity of loans (predominantly short-term construction loans, with respect to
which extension options are often 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
17
<PAGE> 18
Company's loan. The significant increase in loan-related fee revenues during the
first nine months of 1999, as compared with the first nine months 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 requiring
exit fees due upon repayment. The increase in prepayments was due to the sharp
drop in market interest rates that occurred during the last half of 1998,
resulting in an increase in the volume of prepayments and refinancings during
the first half of 1999.
NONINTEREST EXPENSES - GENERAL AND ADMINISTRATIVE EXPENSES
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 nine months of 1999, the Company employed
an average of 271 full-time equivalents. By comparison, the Company employed an
average of 233 full-time equivalents during the first nine months 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.
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.
General and administrative expenses were $7.3 million during the three
months ended September 30, 1999, which is $0.5 million less than the general and
administrative costs during the second quarter of 1999, and is 1.4% more than
the general and administrative costs during the third quarter of 1998, which
were $7.2 million. For the nine months ended September 30, 1999, general and
administrative costs were $23.0 million, representing a 13.3% increase over
general and administrative costs of $20.3 million for the same period in 1998.
The growth in general and administrative expenses during the third quarter of
1999, as compared with the same quarter in 1998, resulted from increases of $0.6
million in professional fees which was somewhat offset by a reduction of
employee related costs of $0.5 million.
Professional fees increased $0.9 million during the first nine months
of 1999 as compared with 1998, primarily due to increased legal fees.
Non-operating expenses increased to $1.6 million compared to $14 thousand due to
$1.3 million in connection with actual or proposed legal settlements; see
further discussion under "Legal Matters". Employee related costs, occupancy and
operating expenses also increased year-over-year, as a direct consequence of the
growth in staff. In addition, during the first nine months of 1999, the Company
paid $ 0.3 million, which is included in other non-operating expenses, for the
remaining cost 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.
LEGAL MATTERS
The Company and the Bank are involved in a variety of litigation
matters in the ordinary course of its business. A majority of these actions
involve allegations with respect to properties acquired by the Bank through
foreclosure and subsequently sold by the Bank. The Bank was found liable in two
cases that went to trial in 1999; see "Legal Proceedings" for a discussion of
these two cases. The amount of legal defense costs and settlements in any period
will depend on many factors, including the status of cases (and in the number of
cases that are in trial or about to be brought to trial) and the opposing
parties aggressiveness in pursuing their cases and their perception of their
legal position. For the nine months ended September 30, 1999, legal expenses
totaled $0.9 million compared to $0.5 million during the first nine months of
1998. Additionally, other non-operating expenses included $1.3 million in
connection with actual or proposed legal settlements during the first nine
months of 1999.
As set forth in Note 5, SUBSEQUENT EVENTS, the Bank agreed to pay the
sum of $700 thousand to settle an action related to a foreclosure sale of one of
the Bank's REO properties. The cost of this settlement will reduce net earnings
for the 4th quarter by approximately $406 thousand, or $0.05 per share.
18
<PAGE> 19
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 SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
--------------------------------- ---------------------------------
1999 1998 CHANGE 1999 1998 CHANGE
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
EXPENSES ASSOCIATED WITH REAL ESTATE
OPERATIONS
Property taxes, repairs, maintenance,
renovations, and insurance $ 82 $ 196 $ (114) $ 233 $ 277 $ (44)
REVENUES ASSOCIATED WITH REAL ESTATE
OPERATIONS
Net recoveries from sale of REO and
property operations 90 812 (722) 738 2,272 (1,534)
PROVISION FOR ESTIMATED LOSSES ON
REAL ESTATE OWNED -- -- -- 80 15 65
------- ------- ------- ------- ------- -------
INCOME FROM REAL ESTATE $ 8 $ 616 $ (608) $ 425 $ 1,980 $(1,555)
======= ======= ======= ======= ======= =======
</TABLE>
Net recoveries from sales of REO properties 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 nine months ended September 30, 1999,
the Company sold seventeen properties generating net cash proceeds of $9.9
million and a net recovery of $0.8 million, as compared to sales of eighty
properties generating net cash proceeds of $10.8 million and a net recovery of
$2.2 million during the nine months ended September 30, 1998.
INCOME TAXES
The Company recorded income tax provisions of $2.7 million and $7.3
million for the three and nine months ended September 30, 1999, respectively, as
compared to income tax provisions of $1.6 million and $3.5 million, during the
same periods in 1998. 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. The Company's
effective tax rate was 42.2% and 42.0%, respectively, for the three and nine
months ended September 30, 1999 and 32.1% and 29.4%, for the same periods in
1998.
19
<PAGE> 20
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>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
---------------------------- --------------------------------
BALANCE PERCENT BALANCE PERCENT
------------ ------- ------------ -------
<S> <C> <C> <C> <C>
Single family $ 636,036 38.2% $ 576,032 35.9%
Income property
Multi-family (1) 226,308 13.6 250,876 15.6
Commercial (1) 207,484 12.5 222,558 13.9
Development (2) 140,986 8.5 78,425 4.9
Land (3) 86,543 5.2 69,581 4.3
Single family construction
Single residence (4) 288,823 17.3 275,888 17.2
Tract 36,546 2.2 85,942 5.3
Other 41,013 2.5 46,615 2.9
------------ ----- ------------ ------------
GROSS LOANS RECEIVABLE (5) 1,663,739 100.0% 1,605,917 100.0%
===== ====
LESS
Undisbursed funds (204,282) (256,096)
Deferred fees and credits, net (2,337) (5,919)
Allowance for estimated losses (22,694) (17,111)
------------ ------------
NET LOANS RECEIVABLE $ 1,434,426 $ 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 loans repaid with the
proceeds of these construction loans, within 12 months.
(4) Predominantly loans for the construction of individual and custom
homes.
(5) The funded principal balance under recorded loan commitments, plus
undisbursed funds associated with such loan commitments.
The following table sets forth the approximate composition of the
Company's gross new loan commitments, net of internal refinances, for the
periods indicated, in dollars and as a percentage of total loans originated
(dollars are in thousands).
20
<PAGE> 21
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1999
----------------------------- -----------------------------
TYPES OF COLLATERAL AMOUNT % AMOUNT %
- -------------------------- -------- ----- -------- -----
<S> <C> <C> <C> <C>
Single family (1) $ 89,900 54.3% $215,300 41.1%
Income property
Multi-family 3,500 2.1 18,000 3.4
Commercial (2) 17,000 10.3 50,700 9.7
Development (3) 13,300 8.0 53,200 10.2
Land (4) 14,300 8.6 39,400 7.5
Single family construction
Single residence (5) 24,700 14.9 129,500 24.7
Tract (6) 3,000 1.8 9,700 1.9
Other (7) -- -- 7,700 1.5
-------- ----- -------- -----
$165,700 100.0% $523,500 100.0%
======== ===== ======== =====
</TABLE>
- --------------------
(1) Includes unfunded commitments of $0.2 million as of September 30, 1999.
(2) Includes unfunded commitments of $2.0 million as of September 30, 1999.
(3) Includes unfunded commitments of $25.9 million as of September 30,
1999.
(4) Includes unfunded commitments of $9.2 million as of September 30, 1999.
(5) Includes unfunded commitments of $67.1 million as of September 30,
1999.
(6) Includes unfunded commitments of $4.4 million as of September 30, 1999.
(7) Includes unfunded commitments of $5.5 million as of September 30, 1999.
ASSET QUALITY
Nonaccrual and Troubled Debt Restructured Loans
The Company generally places a loan on nonaccrual status when (1) it
becomes 30 or more days delinquent or (2) management believes that, with respect
to a performing loan, continued collection of principal and interest from the
borrower is not reasonably assured.
The following table provides information regarding the Company's
nonaccrual loans as of the dates indicated (dollars are in thousands).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
NONACCRUAL LOANS
Loans past due 90 days or more $13,502 $13,042
Loans past due 30-89 days (1) 8,091 20,002
Other nonaccrual loans 4,800 14,644
------- -------
TOTAL (2) $26,393 $47,688
======= =======
RATIO OF TOTAL NONACCRUAL LOANS TO
Total assets 1.7% 3.4%
Net loans receivable 1.8% 3.6%
Core capital plus General Reserves 17.4% 39.5%
</TABLE>
- ---------------------
(1) Excludes a $2.2 million loan that was delinquent and accruing at
September 30, 1999, which was paid in full on October 1, 1999.
(2) Includes $10.0 million and $2.7 million of troubled debt restructured
loans ("TDRs") at September 30, 1999 and December 31, 1998,
respectively. Excludes $26.4 million and $31.6 million of TDRs which
were performing in accordance with their modified terms at September
30, 1999 and December 31, 1998, respectively.
21
<PAGE> 22
Nonperforming assets ("NPAs"), which consist of the carrying value of
properties acquired through foreclosure and loan principal delinquent three or
more payments, were at $14.7 million at September 30, 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 $26.4
million and $13.5 million, respectively, at September 30, 1999, or 1.7% and
0.8%, 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>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Real estate owned, net $ 1,175 $ 4,070
Total nonaccrual loans 26,393 47,688
---------- ----------
Gross nonaccrual assets 27,568 51,758
Performing loans classified substandard or lower (1) 65,938 45,397
---------- ----------
Gross classified assets $ 93,506 $ 97,155
========== ==========
Gross classified loans $ 92,331 $ 93,085
========== ==========
Gross loans receivable $1,457,120 $1,343,902
========== ==========
Bank core capital $ 130,622 $ 108,673
========== ==========
Bank risk-based capital $ 143,332 $ 119,400
========== ==========
Ratio of classified assets to:
Loans receivable 6.4% 7.2%
========== ==========
Core capital 71.6% 89.4%
========== ==========
Risk-based capital 65.2% 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.
22
<PAGE> 23
The table below sets forth information concerning the Company's gross
classified loans, by category, as of September 30, 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 $11,527 $ 3,789 $ 2,500 $26,909 $44,725
Income property -- -- -- 196 196
Multi-family -- -- -- 21,529 21,529
Commercial -- -- -- -- --
Development -- 6,508 2,300 9,310 18,118
Land -- -- -- -- --
Single family construction
Single residence -- -- -- 5,512 5,512
Tract 1,946 -- -- 1,946
Other 29 2 -- 274 305
------- ------- ------- ------- -------
TOTAL $13,502 $10,299 $ 4,800 $63,730 $92,331
======= ======= ======= ======= =======
</TABLE>
- ---------------------
(1) Loans which have been restructured and are paying as agreed.
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 development, 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.
23
<PAGE> 24
The table below sets forth the general and specific allowance for
estimated credit losses for the Company's loan portfolio as of September 30,
1999 (dollars are in thousands).
<TABLE>
<CAPTION>
LOANS
-------------------------------
PERFORMING DELINQUENT TOTAL
---------- ---------- -----
<S> <C> <C> <C>
Specific reserves $ 494 $ 1,074 $ 1,568
General reserves 20,004 1,122 21,126
------- ------- -------
TOTAL $20,498 $ 2,196 $22,694
======= ======= =======
PERCENTAGES
% of total reserves to gross loans 1.43% 9.22% 1.56%
% of general reserves to net loans 1.40% 4.94% 1.45%
</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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
----------------------------- -----------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
LOANS
Average loans outstanding $ 1,437,346 $ 1,146,124 $ 1,395,125 $ 1,020,795
=========== =========== =========== ===========
Total allowance for estimated credit
losses at beginning of period $ 20,323 $ 14,541 $ 17,111 $ 13,274
Provision for estimated credit losses 3,500 1,950 9,000 5,185
Charge-offs
Single family(1) (80) (326) (1,856) (1,061)
Income property
Multi-family (186) (5) (186) (1,038)
Commercial -- (512) (200)
Other (863) (863)
----------- ----------- ----------- -----------
Total charge-offs (1,129) (331) (3,417) (2,299)
----------- ----------- ----------- -----------
TOTAL ALLOWANCE FOR ESTIMATED CREDIT
LOSSES AT END OF PERIOD $ 22,694 $ 16,160 $ 22,694 $ 16,160
=========== =========== =========== ===========
Ratio of charge-offs to average loans
outstanding during the period 0.08% 0.03% 0.24% 0.23%
REAL ESTATE OWNED
Total allowance for estimated losses
at beginning of period $ 38 $ 12 $ 45 $ 2,563
Provision for estimated losses -- -- 80 15
Charge-offs -- (12) (87) (2,578)
----------- ----------- ----------- -----------
Total allowance for estimated losses
at end of period $ 38 $ -- $ 38 $ --
=========== =========== =========== ===========
</TABLE>
- ---------------------
(1) In April 1999, the Bank sold a single family loan which
resulted in a charge-off of $1.5 million.
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).
24
<PAGE> 25
<TABLE>
<CAPTION>
SEPTEMBER 30, 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 $ 4,687 0.74% $ 7,836 1.36%
Income Property
Multi-family 736 0.33% 1,063 0.42%
Commercial 5,548 2.67% 4,334 1.95%
Development 2,302 1.63% 354 0.45%
Land 2,800 3.24% 293 0.42%
Single family construction
Single residence 2,479 0.86% 789 0.29%
Tract 816 2.23% 1,092 1.27%
Other 3,326 8.11% 1,350 2.90%
------- -------
$22,694 1.56% $17,111 1.28%
======= =======
</TABLE>
- ---------------------
(1) Percent of allowance for estimated credit losses to gross loan
commitments, which include the undisbursed portion of such
commitments. The change in the percentage of reserves to total
loans by category is a result of different levels of
classified assets within each category. Also in June 1999, the
Bank changed its reserve methodology to individually risk
weight a vast majority of certain types of loans.
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>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Single family $ 1,213 $ 2,509
Income property
Multi-family -- 213
Commercial -- 1,393
------- -------
GROSS INVESTMENT (1) 1,213 4,115
Less allowance for estimated losses (38) (45)
------- -------
NET REAL ESTATE OWNED $ 1,175 $ 4,070
======= =======
</TABLE>
- ---------------------
(1) Fair value of collateral at foreclosure, plus post-foreclosure
capitalized costs.
In August 1999, the Bank acquired a property with a carrying value of $6.24
million, which was sold for $6.27 million. The Bank made a loan in connection
with the sale of the property and recorded $32 thousand in deferred profit,
which will be recognized upon maturity in August 2000.
25
<PAGE> 26
LIABILITIES
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>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
----------------------------------------- ------------------------------------------
PRODUCT TYPE BALANCE WAIR WARM BALANCE WAIR WARM
- ----------------------------- ---------- ----- ---- ---------- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Non-interest bearing checking $ 27,196 0.00% -- $ 20,275 0.00%
Checking/NOW 38,839 2.11% -- 35,596 2.03% --
Passbook 23,883 1.59% -- 25,723 2.10% --
Money market 166,687 4.35% -- 104,137 4.53% --
Certificates of deposit
7 day maturities 32,173 4.08% -- 36,091 4.08% --
Less than 6 months 57,242 5.17% 2 5,688 4.60% 2
6 months to 1 year 168,356 5.07% 4 207,964 5.25% 3
1 year to 2 years 543,535 5.23% 7 537,815 5.51% 7
Greater than 2 years 35,582 5.22% 14 46,161 5.40% 16
---------- ----------
$1,093,493 4.71% 5 $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 based on qualifying collateral. The FHLB system
functions as a source of credit to savings institutions which are members.
Advances are 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>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------------- -------------------------
ORIGINAL TERM PRINCIPAL RATE PRINCIPAL RATE
--------- ---- --------- ----
<S> <C> <C> <C> <C>
60 Months $310,000 5.24% $215,000 5.36%
120 Months 49,000 4.36% 49,000 4.36%
--------- ---------
$359,000 5.12% (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 6 months and 5 years and 3 months as of September 30, 1999 and December 31,
1998, respectively. All of the Company's FHLB advances
26
<PAGE> 27
outstanding at September 30, 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 one-to-three years from origination.
SENIOR NOTES
On December 31, 1997, the Company issued $40.0 million of Senior Notes
due 2004. These Senior Notes bear 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
September 30, 1999 amounted to $92.2 million and which equaled 5.8% 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 September 30, 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) $ 130,622 $ 130,622 $ 130,622
Adjustments
General reserves -- -- 14,036
Other (2) -- -- (1,326)
------------- ------------- ------------- ------------- ------------- -------------
Regulatory capital 130,622 8.19% 130,622 8.19% 143,332 12.86%
Required minimum 23,931 1.50 63,800 4.00 89,200 8.00
------------- ------------- ------------- ------------- ------------- -------------
Excess capital $ 106,691 6.69% $ 66,822 4.19% $ 54,132 4.86%
============= ============= ============= ============= ============= =============
Adjusted assets (3) $ 1,595,388 $ 1,595,388 $ 1,114,457
============= ============= =============
</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).
27
<PAGE> 28
As of September 30, 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 SEPTEMBER 30, 1999
Total Capital
(to Risk Weighted Assets) $143,332 12.86% $ 89,200 8.00% $111,446 10.00%
Core Capital
(to Adjusted Tangible Assets) 130,622 8.19% 63,800 4.00% 79,769 5.00%
Tangible Capital
(to Tangible Assets) 130,622 8.19% 23,931 1.50% N/A N/A
Tier 1 Capital
(to Risk Weighted Assets) 130,622 11.72% N/A N/A 66,867 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 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
$.9 million at September 30, 1999. Hawthorne Financial Corporation has no other
significant assets beyond its investment in the Bank. As discussed elsewhere in
this report, the Company paid its June 1999 semiannual interest payment on its
Senior Notes from its current liquidity. The Company will be dependent upon the
Bank for dividends in order to make future semiannual 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 Company's liquidity for the
calculation period ended September 30, 1999 was 10.46%, which exceeded the
applicable minimum requirements.
28
<PAGE> 29
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 refers to the inability of some computers to read
the Year 2000 correctly. To conserve storage space, many older computers were
programmed to read dates using only the last two digits of the century. When the
Year 2000 arrives, these computers may interpret "00" as the year 1900. 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.
In 1997, the Company adopted a plan to address Year 2000 issues and
also created a Year 2000 committee. The Year 2000 project was divided into five
phases: the Awareness phase, the Assessment phase, the Renovation phase, the
Validation phase, and the Implementation phase. All phases have been
successfully completed.
In 1998, the Company completed the process of converting from an
outsourced, host-based computer system to an in-house client-server computer
system. This loan/deposit accounting software was certified as Year 2000
compliant and was tested by the vendor. The Company also tested the system by
creating a database that rolled forward systematically until it processed data
into what it believed was early 2000. The test results were predictable and no
issues were noted.
The Company has also addressed the Year 2000 efforts of other critical
third party vendors and service providers. Year 2000 compliance certifications
have been obtained from these critical vendors/service providers and testing has
been performed in accordance with the Company's testing plan. The systems that
have been tested include, but are not limited to, the following: (1) deposit
system; (2) loan payment system; (3) loan origination system; (4) accounting
system; (5) ATMs; (6) wire transfer system; and (7) direct deposit interfaces.
Year 2000 testing occurs on a continual basis upon receipt of all new releases
of Year 2000 compliant hardware and software.
While the Company anticipates a smooth transition into the Year 2000,
there is no way to guarantee that the Company has eliminated every conceivable
problem that might affect its systems or those controlled by third parties.
Accordingly, the Company has developed a comprehensive contingency plan
outlining emergency procedures should key services be disrupted. 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, (6) failure of an operating
system, (7) failure of a critical third party electronic data interface, (8)
equipment failure, and (9) large deposit account withdrawals. The Company's
contingency plan provides for alternative methods of conducting business for
critical functions in the event one or more of these circumstances occurs.
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 critical service providers
(non-data service related) of which seventeen have asserted that they are Year
2000 compliant. Two providers have indicated that they will be Year 2000 ready
by the end of the year and one provider has not committed to a date of
compliance. Contingency plans have been developed for those who have not yet
submitted compliance statements. While the Company has received assurances from
providers as to compliance, such assurances are not guarantees and may not be
enforceable. With respect to equipment, Year 2000 testing of servers and PC's in
workstations has been successfully completed.
29
<PAGE> 30
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
borrowers having ongoing business operations as property securing the Company's
loans. As a result of this review, as of September 30, 1999, the Company had
identified seven borrowers with aggregate outstanding loans of approximately
$45.2 million maturing after December 31, 1999, which would fit into this higher
risk profile. The Company performs quarterly evaluations on these borrowers to
monitor their compliance status. If the borrowers are non-compliant, the Company
will have difficulty in assessing whether such non-compliance will adversely
affect the borrowers' ability to service the 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 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 planned conversion of its computer-based systems. The
Company incurred approximately $3.8 million in costs related to its data
processing conversion and implementation of the Year 2000 plan. Approximately
$1.2 million and $0.4 million of these costs were expensed during 1998 and 1999,
respectively. The Company capitalized $2.1 million of these costs which are
amortized over a three year period and expensed the remaining $0.1 million of
these costs during 1999. The Company does not anticipate any material additional
expenses in 1999 related to Year 2000 software or 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,
namely, 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 300 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, prepayment penalties, 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.
30
<PAGE> 31
The following table sets forth information concerning sensitivity of
the Company's interest-earning assets and interest-bearing liabilities as of
September 30, 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>
SEPTEMBER 30, 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) $ 100 $ -- $ -- $ -- $ -- $ 100
Investments and FHLB Stock 20,701 -- -- -- -- 20,701
Loans(2) 957,368 296,904 41,399 45,252 118,534 1,459,457
---------- ---------- ---------- ---------- ---------- ----------
TOTAL INTEREST-EARNING ASSETS $ 978,169 $ 296,904 $ 41,399 $ 45,252 $ 118,534 $1,480,258
========== ========== ========== ========== ========== ==========
INTEREST-BEARING LIABILITIES
Deposits
Transaction accounts $ 232,846 $ -- $ -- $ -- $ -- $ 232,846
Certificates of deposit 270,959 195,566 273,285 97,078 -- 836,888
FHLB advances -- -- 310,000 49,000 359,000
Senior notes -- -- -- 40,000 40,000
---------- ---------- ---------- ---------- ---------- ----------
TOTAL INTEREST-BEARING LIABILITIES $ 503,805 $ 195,566 $ 273,285 $ 407,078 $ 89,000 $1,468,734
========== ========== ========== ========== ========== ==========
Interest rate sensitivity gap $ 474,364 $ 101,338 $ (231,886) $ (361,826) $ 29,534 $ 11,524
Cumulative interest rate
sensitivity gap 474,364 575,702 343,816 (18,010) 11,524 11,524
Cumulative interest rate
sensitivity gap as a percentage
of total interest earning assets 32.0% 38.9% 23.2% (1.2%) 0.8% 0.8%
</TABLE>
- ---------------------
(1) Excludes noninterest earning cash balances.
(2) Loans include $26.4 million of nonaccrual loans, and are
exclusive of loan loss reserves.
31
<PAGE> 32
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 a Net Portfolio Value analysis (NPV), which in essence
"marks-to-market" the balance sheet under various interest rate scenarios to
determine how the Bank's NPV changes in response to changes in interest rates.
Net Portfolio Value is calculated as 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 NPV which would result from changes in market
interest rates in theoretical increments of 100 basis points, up to 300 basis
points in either direction.
Presented below, as of September 30, 1999, is an analysis of the Bank's
interest rate risk as measured by changes in NPV for instantaneous and sustained
parallel shifts of 100, 200 and 300 basis points in market interest rates, in
either direction. These results reflect that the Bank has "minimal interest rate
risk exposure" based on the OTS guidelines (dollars are in thousands).
<TABLE>
<CAPTION>
NET PORTFOLIO VALUE
---------------------------------
CHANGE $ CHANGE FROM NPV % CHANGE FROM
IN RATES $ AMOUNT BASECASE RATIO BASECASE
- -------- -------- ------------- ----- -------------
<S> <C> <C> <C> <C>
+300 bp $137,161 (10,490) 8.68% -0.52%
+200 bp 144,296 (3,355) 9.06% -0.13%
+100 bp 147,309 (342) 9.21% 0.01%
basecase 147,651 -- 9.20% --
-100 bp 149,384 1,733 9.25% 0.05%
-200 bp 143,201 (4,450) 8.80% -0.40%
-300 bp 138,592 (9,059) 8.46% -0.74%
</TABLE>
32
<PAGE> 33
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. 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 Bank filed an appeal and 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 $2.4 million. In May 1999, 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. The Bank believes that there is a reasonable likelihood that
its position will ultimately be upheld on appeal and accordingly, that
no amounts having a materially adverse effect on the Bank's or the
Company's financial conditions or 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.
The Bank is a defendant in an action entitled Mells v.
Hawthorne, filed in the Superior Court of the State of California, San
Diego. Plaintiffs alleged that the Bank concealed and misrepresented
the severity of defects in a house that the Bank sold to them. On
September 20, 1999, a second amended judgment was entered on behalf of
the plaintiffs for $767 thousand which includes attorney's fees and
costs. In October, 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. The
Bank intends to vigorously pursue its position and believes that there
is a reasonable likelihood that the amount of the judgment will be
reduced and, accordingly, that no amounts having a materially adverse
effect on the Bank's or the Company's financial condition or operations
will be paid by the Bank to the plaintiffs in this matter. However,
there can be no assurances that this will be the case.
The Company is involved in a variety of other litigation
matters in the ordinary course of its business, and anticipates that it
will become involved in new litigation matters from time to time in the
future. Based on the current assessment of these existing other
matters, management does not presently believe that any one of these
existing other matters is likely to have material adverse impact on the
Company's financial condition or result of operations. However, the
Company will incur legal and related costs in connection with the
litigation and may from time to time determine to settle some or all of
the cases, regardless of management's assessment of the Company's legal
position. The amount of legal defense costs and settlements in any
period will depend on many factors, including the status of cases (and
the number of cases that are in trial or about to be brought to trial)
and the opposing parties aggressiveness in pursuing their cases and
their perception of their legal position. Further, the inherent
uncertainty of jury or judicial verdicts makes it impossible to
determine with certainty the Company's maximum cost in any pending
litigation. Accordingly, the Company's litigation costs and expenses
may vary materially from period to period, and no assurance can be
given that these costs will not be material in any particular period.
ITEM 2. CHANGES IN SECURITIES - None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None
33
<PAGE> 34
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
No current reports on Form 8-K were filed for the three months
ended September 30, 1999
2. Other required exhibits - Exhibit 27.1 - Financial Data
Schedule
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HAWTHORNE FINANCIAL CORPORATION
Dated November 15, 1999 /s/ SCOTT A. BRALY
-------------------------------
Scott A. Braly
President and
Chief Executive Officer
Dated November 15, 1999 /s/ SIMONE LAGOMARSINO
-------------------------------
Simone Lagomarsino
Executive Vice President and
Chief Financial Officer
34
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000046267
<NAME> HAWTHORNE FINANCIAL CORP.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 121,217
<INT-BEARING-DEPOSITS> 100
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 1,457,120
<ALLOWANCE> 22,694
<TOTAL-ASSETS> 1,597,291
<DEPOSITS> 1,093,493
<SHORT-TERM> 0
<LIABILITIES-OTHER> 12,636
<LONG-TERM> 399,000
0
0
<COMMON> 53
<OTHER-SE> 92,109
<TOTAL-LIABILITIES-AND-EQUITY> 1,597,291
<INTEREST-LOAN> 94,956
<INTEREST-INVEST> 4,269
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 99,225
<INTEREST-DEPOSIT> 37,880
<INTEREST-EXPENSE> 54,641
<INTEREST-INCOME-NET> 44,584
<LOAN-LOSSES> 9,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 24,158
<INCOME-PRETAX> 17,357
<INCOME-PRE-EXTRAORDINARY> 17,357
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,072
<EPS-BASIC> 1.91
<EPS-DILUTED> 1.30
<YIELD-ACTUAL> 8.75
<LOANS-NON> 26,393
<LOANS-PAST> 0
<LOANS-TROUBLED> 36,441
<LOANS-PROBLEM> 65,938
<ALLOWANCE-OPEN> 17,111
<CHARGE-OFFS> 3,417
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 22,694
<ALLOWANCE-DOMESTIC> 22,694
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
