<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
------------------------
FORM 10-Q
------------------------
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED JUNE 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER 0-1100
------------------------
HAWTHORNE FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 95-2085671
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
2381 ROSECRANS AVENUE, EL SEGUNDO, CA 90245
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (310) 725-5000
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of Common Stock as of the latest practicable date: The Registrant had 5,286,401
shares of Common Stock, $0.01 par value per share outstanding, as of July 31,
2000.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE> 2
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q INDEX
FOR THE QUARTER ENDED JUNE 30, 2000
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I -- FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Statements of Financial Condition at June 30,
2000 and December 31, 1999.................................. 1
Consolidated Statements of Operations for the Three and Six
Months Ended June 30, 2000 and 1999......................... 2
Consolidated Statement of Stockholders' Equity for the Six
Months Ended June 30, 2000.................................. 3
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2000 and 1999................................ 4
Notes to Consolidated Financial Statements.................. 5
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 8
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk... 29
PART II -- OTHER INFORMATION
ITEM 1. Legal Proceedings........................................... 31
ITEM 2. Changes in Securities....................................... 31
ITEM 3. Defaults upon Senior Securities............................. 31
ITEM 4. Submission of Matters to a Vote of Security Holders......... 31
ITEM 5. Other Information........................................... 31
ITEM 6. Exhibits and Reports on Form 8-K............................ 31
</TABLE>
FORWARD-LOOKING STATEMENTS
When used in this Form 10-Q or future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or stockholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "will likely
result", "are expected to", "will continue", "is anticipated", "estimate",
"project", "believe" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company wishes to caution readers that all
forward-looking statements are necessarily speculative and not to place undue
reliance on any such forward-looking statements, which speak only as of the date
made, and to advise readers that various risks and uncertainties, including
regional and national economic conditions, changes in levels of market interest
rates, credit risks of lending activities, competitive and regulatory factors
and the outcome of pending litigation, 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.
i
<PAGE> 3
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
---------- ------------
(Unaudited)
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Assets:
Cash and cash equivalents................................. $ 97,892 $ 86,722
Loans receivable (net of allowance for estimated credit
losses of $27,089 in 2000 and $24,285 in 1999)......... 1,531,613 1,444,968
Real estate owned, net.................................... 5,334 5,587
Investment in capital stock of Federal Home Loan Bank, at
cost................................................... 20,105 22,236
Accrued interest receivable............................... 10,804 9,250
Office property and equipment at cost, net................ 5,267 5,939
Deferred tax asset, net................................... 3,589 2,203
Other assets.............................................. 3,352 4,248
---------- ----------
Total assets...................................... $1,677,956 $1,581,153
========== ==========
Liabilities and Stockholders' Equity:
Liabilities:
Deposits.................................................. $1,167,047 $1,086,635
FHLB advances............................................. 359,000 349,000
Senior notes.............................................. 40,000 40,000
Accounts payable and other liabilities.................... 13,681 13,214
---------- ----------
Total liabilities................................. 1,579,728 1,488,849
Stockholders' equity:
Preferred stock -- $0.01 par value; authorized 10,000,000
shares; no shares outstanding.......................... -- --
Common stock -- $0.01 par value; authorized 20,000,000
shares; issued and outstanding 5,559,301 shares in 2000
and 5,331,301 shares in 1999........................... 55 53
Capital in excess of par value -- common stock............ 42,057 40,981
Retained earnings......................................... 58,294 51,318
---------- ----------
100,406 92,352
Less:
Treasury stock, at cost -- 272,900 shares in 2000 and
5,400 shares in 1999................................... (2,178) (48)
---------- ----------
Total stockholders' equity........................ 98,228 92,304
---------- ----------
Total liabilities and stockholders' equity........ $1,677,956 $1,581,153
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
1
<PAGE> 4
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
2000 1999 2000 1999
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Interest revenues:
Loans............................................. $34,685 $31,238 $67,598 $62,219
Investments....................................... 1,690 1,442 3,213 2,475
------- ------- ------- -------
Total interest revenues................... 36,375 32,680 70,811 64,694
------- ------- ------- -------
Interest costs:
Deposits.......................................... 15,024 12,628 28,867 25,062
FHLB advances..................................... 4,594 4,437 9,192 8,297
Senior notes...................................... 1,250 1,250 2,500 2,500
------- ------- ------- -------
Total interest costs...................... 20,868 18,315 40,559 35,859
------- ------- ------- -------
Net interest income................................. 15,507 14,365 30,252 28,835
Provision for credit losses......................... 1,500 2,500 3,000 5,500
------- ------- ------- -------
Net interest income after provision for credit
losses......................................... 14,007 11,865 27,252 23,335
------- ------- ------- -------
Noninterest revenues:
Loan related fees................................. 2,134 1,925 3,894 3,895
(Loss)/income from real estate operations, net...... (90) (17) (149) 417
Noninterest expenses:
General and administrative expenses:
Employee....................................... 4,353 3,576 8,405 7,679
Operating...................................... 1,529 1,599 3,042 3,138
Occupancy...................................... 897 986 1,860 1,979
Technology..................................... 484 518 958 1,078
Professional................................... 1,231 860 2,106 1,164
SAIF premiums and OTS assessments.............. 217 313 439 612
------- ------- ------- -------
Total general and administrative
expenses................................ 8,711 7,852 16,810 15,650
Other non-operating expense....................... 196 8 2,024 1,000
------- ------- ------- -------
Total noninterest expenses................ 8,907 7,860 18,834 16,650
------- ------- ------- -------
Income before income taxes.......................... 7,144 5,913 12,163 10,997
Income tax provision................................ 3,072 2,487 5,187 4,599
------- ------- ------- -------
Net income.......................................... $ 4,072 $ 3,426 $ 6,976 $ 6,398
======= ======= ======= =======
Basic earnings per share (Note 3)................... $ 0.77 $ 0.65 $ 1.30 $ 1.22
======= ======= ======= =======
Diluted earnings per share (Note 3)................. $ 0.57 $ 0.44 $ 0.95 $ 0.83
======= ======= ======= =======
Weighted average basic shares outstanding (Note
3)................................................ 5,286 5,290 5,374 5,257
======= ======= ======= =======
Weighted average diluted shares outstanding (Note
3)................................................ 7,169 7,723 7,336 7,728
======= ======= ======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements
2
<PAGE> 5
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMPREHENSIVE
INCOME
BALANCE AT EXERCISED ------------- BALANCE AT
DECEMBER 31, STOCK EXERCISED NET TREASURY JUNE 30,
1999 OPTIONS WARRANTS INCOME STOCK 2000
------------ --------- --------- ------------- -------- -----------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Number of common shares......... 5,331 228 -- -- -- 5,559
Treasury stock.................. (5) -- -- -- (268) (273)
------- ------ ------ ------ ------- -------
Total shares
outstanding......... 5,326 228 -- -- (268) 5,286
======= ====== ====== ====== ======= =======
Common stock.................... $ 53 $ 2 $ -- $ -- $ -- $ 55
Capital in excess of par value,
common stock.................. 40,981 1,076 -- -- -- 42,057
Retained earnings............... 51,318 -- -- 6,976 -- 58,294
Treasury stock.................. (48) -- -- -- (2,130) (2,178)
------- ------ ------ ------ ------- -------
Total stockholders'
equity.............. $92,304 $1,078 $ -- $6,976 $(2,130) $98,228
======= ====== ====== ====== ======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements
3
<PAGE> 6
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------
2000 1999
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Cash Flows from Operating Activities:
Net income................................................ $ 6,976 $ 6,398
Adjustments:
Deferred income tax (benefit) provision................. (1,386) 226
Provision for estimated credit losses on loans.......... 3,000 5,500
(Recovery) provision for estimated losses on real estate
owned.................................................. (24) 80
Net gain from sale of real estate owned................. (7) (629)
Loan fee and discount accretion......................... (1,311) (3,125)
Depreciation and amortization........................... 1,067 912
FHLB dividends.......................................... (851) (417)
Increase in accrued interest receivable................. (1,554) (316)
Decrease (increase) in other assets..................... 896 (296)
Increase in accounts payable and other liabilities...... 467 1,115
--------- ---------
Net cash provided by operating activities.......... 7,273 9,448
--------- ---------
Cash Flows from Investing Activities:
Loans:
New loans funded........................................ (244,559) (172,327)
Construction disbursements.............................. (129,918) (185,876)
Payoffs................................................. 276,726 269,487
Principal payments...................................... 15,726 12,209
Other, net.............................................. (6,542) (753)
Real estate owned, net:
Sales proceeds.......................................... 688 2,947
Capitalized costs....................................... (26) (43)
Purchase of FHLB stock.................................... (630) (5,209)
Redemption of FHLB stock.................................. 3,612 --
Office property and equipment:
Sale proceeds........................................... 49 48
Additions............................................... (589) (1,213)
--------- ---------
Net cash used in investing activities.............. (85,463) (80,730)
--------- ---------
Cash Flows from Financing Activities:
Deposit activity, net..................................... $ 80,412 $ 33,914
Net increase in FHLB advances............................. 10,000 115,000
Net proceeds from exercise of stock options and
warrants................................................ 1,078 594
Treasury Stock............................................ (2,130) --
--------- ---------
Net cash provided by financing activities.......... 89,360 149,508
--------- ---------
Net increase in cash and cash equivalents................... 11,170 78,226
Cash and cash equivalents, beginning of period.............. 86,722 45,449
--------- ---------
Cash and cash equivalents, end of period.................... $ 97,892 $ 123,675
========= =========
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest................................................ $ 39,393 $ 35,590
Income taxes............................................ 3,800 4,231
Non-cash investing and financing activities:
Real estate acquired in settlement of loans............. 494 1,143
Loans originated to finance sales of real estate
owned.................................................. -- 1,500
Loans originated to refinance existing bank loans....... 19,393 21,024
</TABLE>
See accompanying Notes to Consolidated Financial Statements
4
<PAGE> 7
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
significant intercompany transactions and accounts have been eliminated in
consolidation.
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
June 30, 2000 and December 31, 1999, and the results of its operations and its
cash flows for the three and six months ended June 30, 2000 and 1999. Operating
results for the three and six months ended June 30, 2000, are not necessarily
indicative of the results that may be expected for any other interim period or
the full year ending December 31, 2000.
Certain information and note disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America ("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, 1999.
NEW ACCOUNTING PRONOUNCEMENTS
In December 1999, The Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements
on Selected Issues, effective December 2000. Management does not believe that
there will be a material impact on the financial position or results of
operations of the Company from adoption of this bulletin.
NOTE 2 -- RECLASSIFICATION
Certain amounts in the 1999 consolidated financial statements have been
reclassified to conform with classifications in 2000.
5
<PAGE> 8
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 -- BOOK VALUE AND EARNINGS PER SHARE
The table below sets forth the Company's earnings per share calculations
for the three and six months ended June 30, 2000 and 1999. 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.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
2000 1999 2000 1999
------- ------- ------ ------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Average shares outstanding
Basic................................................. 5,286 5,290 5,374 5,257
Warrants.............................................. 2,486 2,503 2,486 2,503
Options(1)............................................ 155 484 197 551
Less Treasury shares(2)............................... (758) (554) (721) (583)
------ ------ ------ ------
Diluted............................................... 7,169 7,723 7,336 7,728
====== ====== ====== ======
Net income for the period............................... $4,072 $3,426 $6,976 $6,398
====== ====== ====== ======
Basic earnings per share................................ $ 0.77 $ 0.65 $ 1.30 $ 1.22
====== ====== ====== ======
Diluted earnings per share.............................. $ 0.57 $ 0.44 $ 0.95 $ 0.83
====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
JUNE 30,
-----------------
2000 1999
------- -------
<S> <C> <C>
Period-end shares outstanding
Basic..................................................... 5,286 5,293
Warrants.................................................. 2,486 2,503
Options(3)................................................ 155 498
Less Treasury shares(2)................................... (771) (555)
------- -------
Diluted................................................... 7,156 7,739
======= =======
Stockholders' equity........................................ $98,228 $88,384
======= =======
Basic book value per share.................................. $ 18.58 $ 16.70
======= =======
Diluted book value per share................................ $ 13.73 $ 11.42
======= =======
</TABLE>
---------------
(1) Excludes 385,000 options outstanding for the three and six months ended June
30, 2000 for which the exercise price exceeded the average market price of
the Company's common stock during the periods. Excludes 325,000 options
outstanding for the six months ended June 30, 1999 for which the exercise
price exceeded the average market price of the Company's common stock during
the period.
(2) Under the Diluted Method, it is assumed that the Company will use proceeds
from the proforma exercise of the Warrants and Options to acquire actual
shares currently outstanding, thus increasing Treasury shares. In this
calculation, Treasury shares were assumed to be repurchased at the average
closing stock price for the respective period.
(3) Excludes 385,000 options outstanding at June 30, 2000 for which the exercise
price exceeded the average market price of the Company's common stock at
period-end.
6
<PAGE> 9
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 -- COMMITMENTS AND CONTINGENCIES
On June 28, 2000, the California Supreme Court denied the Bank's petition for
review of the Court of Appeals' decision affirming in part and reversing in part
the judgment in the Takaki vs. Hawthorne Savings and Loan Association matter
previously disclosed by the Bank. The Bank had previously accrued the full
amount of the judgment, including post judgment interest through April 2000, and
no material additional accruals were required during the second quarter as a
result of the Supreme Court's action and payment of the judgment.
The Company is involved in a variety of other litigation matters in the
ordinary course of its business, as discussed in the Annual Report on Form 10-K
for the year ended December 31, 1999. Management does not presently believe
that any of the existing litigative matters are likely to have a material
adverse impact on the Company's financial condition or results of operation.
7
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company originates real estate-secured loans throughout Southern
California. These loans generally consist of (1) permanent loans collateralized
by single family (one to four unit) residential property, (2) permanent and
construction loans secured by multi-family residential and commercial real
estate, (3) construction loans of single family residential homes and (4) 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").
RESULTS OF OPERATIONS
Net income for the three and six months ended June 30, 2000 of $4.1
million, or $0.57 per diluted share, and $7.0 million, or $0.95 per diluted
share, respectively. This net income resulted in an annualized return on average
assets ("ROA") of 1.00% and .86%, respectively, and an annualized return on
average equity ("ROE") of 16.93% and 14.67%, respectively, compared with an
annualized ROA of .90% and .86%, respectively, and an annualized ROE of 15.97%
and 15.21%, respectively, for the three and six months ended June 30, 1999.
Pretax income increased 20.82% and 10.60%, for the three and six months ended
June 30, 2000, respectively, to $7.1 million and $12.2 million from $5.9 million
and $11.0 million generated during the same periods in 1999.
The table below identifies the principal components of the Company's pretax
income and net income for the three and six months ended June 30, 2000 and 1999.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
2000 1999 2000 1999
------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Net interest income................................. $16,757 $15,615 $32,752 $31,335
Provision for credit losses......................... 1,500 2,500 3,000 5,500
------- ------- ------- -------
Net interest income after provision for credit
losses......................................... 15,257 13,115 29,752 25,835
Noninterest revenues:
Loan related fees................................. 2,134 1,925 3,894 3,895
(Loss)/income from real estate operations, net...... (90) (17) (149) 417
Noninterest expenses:
General and administrative expenses............... 8,711 7,852 16,810 15,650
Other non-operating expense....................... 196 8 2,024 1,000
Interest on senior notes............................ 1,250 1,250 2,500 2,500
------- ------- ------- -------
Income before income taxes.......................... 7,144 5,913 12,163 10,997
Income tax provision................................ 3,072 2,487 5,187 4,599
------- ------- ------- -------
Net income.......................................... $ 4,072 $ 3,426 $ 6,976 $ 6,398
======= ======= ======= =======
</TABLE>
The Company's net interest income before interest on senior notes and
provision for credit losses rose 7.31% to $16.8 million and 4.52% to $32.8
million during the three and six months ended June 30, 2000, respectively,
compared to $15.6 million and $31.3 million for the three and six months ended
June 30, 1999, respectively. The Company's yield on average earning assets was
9.01% and 8.82% for the three and six months ended June 30, 2000, respectively,
compared to 8.61% and 8.75% during the same periods in 1999. The average cost of
funds for the Company increased to 5.69% and 5.55% during the three and six
months ended June 30, 2000, respectively, compared to 5.24% and 5.28% for the
three and six months ended June 30, 1999, respectively. The Company's resulting
net interest margin for the three and six months ended June 30, 2000, was 3.84%
and 3.77%, respectively, compared to 3.78% and 3.90% during the same periods in
1999. On a year-to-date basis, the compression in the net interest margin is the
result of increased competitive rate pressures in the market place and an
increase in the payment of broker rebates on single family residential loans.
8
<PAGE> 11
Provisions for credit losses totaled $3.0 million and $5.5 million for the
six months ended June 30, 2000 and 1999, respectively. At June 30, 2000, the
ratio of total allowance for estimated credit losses to net loans reached 1.74%,
compared to 1.65% at December 31, 1999, and 1.43% at June 30, 1999.
Noninterest revenues were $2.0 million and $3.7 million for the three and
six months ended June 30, 2000, respectively, compared to noninterest revenues
of $1.9 million and $4.3 million earned during the three and six months ended
June 30, 1999, respectively. Real estate operations resulted in a net loss of
$0.1 million for the three and six months ended June 30, 2000, versus a net gain
of $17 thousand and a net gain of $0.4 million for the respective periods in
1999. Sales of real estate owned resulted in higher net recoveries during 1999.
Other non-operating expense totaled $2.0 million for the six months ended
June 30, 2000, a $1.0 million increase over the $1.0 million of other
non-operating expense incurred during the same period of 1999, primarily in
connection with $1.7 million for ongoing litigation and/or satisfaction of
judgments against the Company. On June 28, 2000, the California Supreme Court
denied the Bank's petition for review of the Court of Appeals' decision
affirming in part and reversing in part the judgment in the Takaki vs. Hawthorne
Savings and Loan Association matter previously disclosed by the Bank. The Bank
had previously accrued the full amount of the judgment, including post judgment
interest through April 2000, and no material additional accruals were required
during the second quarter as a result of the Supreme Court's action and payment
of the judgment.
Nonaccrual loans totaled $36.0 million at June 30, 2000 (or 2.15% of total
assets). By comparison, nonaccrual loans were $44.0 million (or 2.78% of total
assets) and $32.6 million (or 2.08% of total assets) at December 31, 1999, and
June 30, 1999, respectively. Other classified loans were $32.3 million at June
30, 2000, compared to $25.6 million at December 31, 1999, and $17.4 million at
June 30, 1999. Delinquent loans totaled $48.4 million at June 30, 2000, compared
to $24.0 million at December 31, 1999, and $30.8 million at June 30, 1999. In
July 2000, one income property loan with a balance of $10.6 million, which was
over 90 days delinquent at June 30, 2000, is now current. Seven loans totaling
$4.5 million that were past due at maturity have subsequently been extended.
INCOME TAXES
The Company's effective tax rate was 42.65% and 41.82% during the first six
months of 2000 and 1999, respectively.
PARENT COMPANY ITEMS
Beginning with the fourth quarter of 1999, the Company, as needed, will
continue to rely upon dividends from the Bank to service the semiannual interest
payments of approximately $2.5 million each, due in June and December, on its
Senior Notes, issued in December 1997.
In July 2000, the Company authorized the repurchase of up to an additional
5% of its common stock, or approximately 264,000 shares. This is in addition to
the 5% repurchase authorization announced in March 2000, for approximately
277,000 shares. As of August 11, 2000, the Company has repurchased 282,500
shares at an average price per share of $8.09.
9
<PAGE> 12
NET INTEREST INCOME
The following table sets forth the Company's average balance sheets, and
the related weighted average yields and costs on average interest-earning assets
(inclusive of nonaccrual loans) and interest-bearing liabilities, for the three
months ended June 30, 2000 and 1999. In the tables, interest revenues are net of
interest associated with nonaccrual loans.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------------------------
JUNE 30, 2000 JUNE 30, 1999
----------------------------------- -----------------------------------
WEIGHTED WEIGHTED
AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE
BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST
---------- --------- ---------- ---------- --------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning assets:
Loans receivable(1)........................... $1,519,760 $34,685 9.13% $1,392,736 $31,238 8.97%
Cash and cash equivalents..................... 75,569 1,146 6.07% 108,522 1,222 4.50%
Investment in capital stock of Federal Home
Loan Bank................................... 19,938 544 10.91% 17,527 220 5.02%
---------- ------- ---------- -------
Total interest-earning assets........... 1,615,267 36,375 9.01% 1,518,785 32,680 8.61%
------- ----- ------- ------
Noninterest-earning assets...................... 10,717 8,414
---------- ----------
Total assets............................ $1,625,984 $1,527,199
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Deposits...................................... $1,111,946 15,024 5.43% $1,018,203 12,628 4.97%
FHLB advances................................. 324,295 4,594 5.60% 344,769 4,437 5.09%
Senior notes.................................. 40,000 1,250 12.50% 40,000 1,250 12.50%
---------- ------- ---------- -------
Total interest-bearing liabilities...... 1,476,241 20,868 5.69% 1,402,972 18,315 5.24%
------- ----- ------- ------
Noninterest-bearing checking.................... $ 31,093 $ 23,221
Noninterest-bearing liabilities................. 22,431 15,220
Stockholders' equity............................ 96,219 85,786
---------- ----------
Total liabilities and stockholders'
equity................................ $1,625,984 $1,527,199
========== ==========
Net interest income............................. $15,507 $14,365
======= =======
Interest rate spread............................ 3.32% 3.37%
===== ======
Net interest margin including senior notes...... 3.84% 3.78%
===== ======
Net interest margin excluding senior notes...... 4.15% 4.11%
===== ======
</TABLE>
---------------
(1) Includes the interest on nonaccrual and non-performing loans only to the
extent that it was paid and recognized as interest income.
10
<PAGE> 13
The following table sets forth the Company's average balance sheets, and
the related weighted average yields and costs on average interest-earning assets
(inclusive of nonaccrual loans) and interest-bearing liabilities, for the six
months ended June 30, 2000 and 1999. In the tables, interest revenues are net of
interest associated with nonaccrual loans.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-------------------------------------------------------------------------
JUNE 30, 2000 JUNE 30, 1999
----------------------------------- -----------------------------------
WEIGHTED WEIGHTED
AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE
BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST
---------- --------- ---------- ---------- --------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning assets:
Loans receivable(1)........................... $1,504,938 $67,598 8.98% $1,373,666 $62,219 9.06%
Cash and cash equivalents..................... 79,168 2,362 5.97% 88,267 2,058 4.66%
Investment in capital stock of Federal Home
Loan Bank................................... 20,744 851 8.20% 16,397 417 5.09%
---------- ------- ---------- -------
Total interest-earning assets........... 1,604,850 70,811 8.82% 1,478,330 64,694 8.75%
------- ----- ------- ------
Noninterest-earning assets...................... 12,028 12,362
---------- ----------
Total assets............................ $1,616,878 $1,490,692
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Deposits...................................... $1,095,611 28,867 5.30% $1,006,990 25,062 5.02%
FHLB advances................................. 334,422 9,192 5.44% 322,729 8,297 5.11%
Senior notes.................................. 40,000 2,500 12.50% 40,000 2,500 12.50%
---------- ------- ---------- -------
Total interest-bearing liabilities...... 1,470,033 40,559 5.55% 1,369,719 35,859 5.28%
------- ----- ------- ------
Noninterest-bearing checking.................... $ 30,351 $ 21,751
Noninterest-bearing liabilities................. 21,392 15,098
Stockholders' equity............................ 95,102 84,124
---------- ----------
Total liabilities and stockholders'
equity................................ $1,616,878 $1,490,692
========== ==========
Net interest income............................. $30,252 $28,835
======= =======
Interest rate spread............................ 3.27% 3.47%
===== ======
Net interest margin including senior notes...... 3.77% 3.90%
===== ======
Net interest margin excluding senior notes...... 4.08% 4.24%
===== ======
</TABLE>
---------------
(1) Includes the interest on nonaccrual and non-performing loans only to the
extent that it was paid and recognized as interest income.
The operations of the Company are substantially dependent on its net
interest income, which is the difference between the interest income received
from its interest-earning assets and the interest expense paid on its
interest-bearing liabilities. The Company's net interest margin is its net
interest income divided by its average interest-earning assets. Net interest
income and net interest margin are affected by several factors, including (1)
the level of, and the relationship between, the dollar amount of
interest-earning assets and interest-bearing liabilities, (2) the relationship
between the repricing or maturity of the Company's adjustable-rate and
fixed-rate loans and short-term investment securities and its deposits and
borrowings, and (3) the magnitude of the Company's noninterest-earning assets,
including nonaccrual loans and real estate owned ("REO").
The Company's net interest income before provision for credit losses rose
7.95% to $15.5 million and 4.91% to $30.3 million during the three and six
months ended June 30, 2000, respectively, compared to $14.4 million and $28.8
million for the three and six months ended June 30, 1999, respectively. The
Company's resulting net interest margin for the three and six months ended June
30, 2000, was 3.84% and 3.77%, respectively, compared to 3.78% and 3.90% during
the same periods in 1999. On a year-to-date basis, the compression in the net
interest margin is the result of increased competitive rate pressures in the
market place, a change in the portfolio mix as reflected in the loan portfolio
table contained herein, and an increase in the payment of broker rebates on
single family residential loans.
11
<PAGE> 14
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 ranging 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-ten years (though such
terms are subject to certain early call provisions) and carry both variable and
fixed interest rates.
As of June 30, 2000, 88.44% of the Company's loans were adjustable-rate,
with 83.84% 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 indices, 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 indices, 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.
At June 30, 2000, 79.70% of the Company's interest-bearing deposits were
comprised of certificate accounts, the majority of which have original terms
ranging from six-to-twelve months. The remaining, weighted average term to
maturity for the Company's certificate accounts approximated six months at June
30, 2000. 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.
As of June 30, 2000, 65.18% of the Company's borrowings from the FHLB are
fixed-rate, with remaining terms ranging from one-to-ten years (though such
remaining terms are subject to early call provisions). The remaining 34.82% of
the borrowings carry an adjustable interest rate, with 80% of the adjustable
borrowings tied to the Prime Rate, maturing in February 2003. The remaining 20%
is tied to 1-month LIBOR, and matures in May 2002. Accordingly, the recent rise
in market interest rates is expected to result in a gradual rise in the cost of
the Company's currently outstanding FHLB borrowings, and the cost of any newly
acquired borrowings will reflect current market pricing.
12
<PAGE> 15
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.
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, 2000 AND 1999
INCREASE (DECREASE) DUE TO CHANGE IN
-------------------------------------------
RATE AND NET
VOLUME RATE VOLUME(1) CHANGE
------- ------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable(2).................................. $2,849 $ 548 $ 50 $3,447
Cash and cash equivalents............................ (371) 424 (129) (76)
Investment in capital stock of Federal Home Loan
Bank.............................................. 30 258 36 324
------ ------ ----- ------
2,508 1,230 (43) 3,695
------ ------ ----- ------
Interest-bearing liabilities:
Deposits............................................. 1,162 1,130 104 2,396
FHLB advances........................................ (263) 446 (26) 157
------ ------ ----- ------
899 1,576 78 2,553
------ ------ ----- ------
Change in net interest income.......................... $1,609 $ (346) $(121) $1,142
====== ====== ===== ======
</TABLE>
---------------
(1) Calculated by multiplying change in rate by change in volume.
(2) Includes the interest on non-performing loans only to the extent that it was
paid and recognized as interest income.
The Company's interest revenues increased by $3.7 million, or 11.31%,
during the three months ended June 30, 2000, as compared to the same period in
1999. This increase was primarily attributable to a 9.12% increase in the
average balance of loans outstanding.
Interest costs increased by $2.6 million, or 13.94%, during the three
months ended June 30, 2000, as compared to the same period during 1999,
primarily due to a 5.22% increase in the average balances of the Company's
deposits and borrowings, in conjunction with an increase in the weighted average
rates paid on the Company's deposits and FHLB advances. The cost of
interest-bearing liabilities averaged 5.69% during the three months ended June
30, 2000, as compared with 5.24% during the same quarter of 1999.
13
<PAGE> 16
These changes in interest revenues and interest costs produced an increase
of $1.1 million, or 7.95%, in the Company's net interest income during the three
months ended June 30, 2000, as compared with the same quarter during 1999.
Expressed as a percentage of average interest-earning assets, the Company's net
interest margin increased to 3.84% during the three months ended June 30, 2000,
as compared with the net interest margin of 3.78% produced during the same
period during 1999.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 2000 AND 1999
INCREASE (DECREASE) DUE TO CHANGE IN
----------------------------------------
RATE AND NET
VOLUME RATE VOLUME(1) CHANGE
------ ------- --------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable(2)................................. $5,946 $ (517) $ (50) $5,379
Cash and cash equivalents........................... (212) 575 (59) 304
Investment in capital stock of Federal Home Loan
Bank............................................. 110 256 68 434
------ ------- ----- ------
5,844 314 (41) 6,117
------ ------- ----- ------
Interest-bearing liabilities:
Deposits............................................ 2,206 1,470 129 3,805
FHLB advances....................................... 300 574 21 895
------ ------- ----- ------
2,506 2,044 150 4,700
------ ------- ----- ------
Change in net interest income......................... $3,338 $(1,730) $(191) $1,417
====== ======= ===== ======
</TABLE>
---------------
(1) Calculated by multiplying change in rate by change in volume.
(2) Includes the interest on non-performing loans only to the extent that it was
paid and recognized as interest income.
The Company's interest revenues increased by $6.1 million, or 9.46%, during
the six months ended June 30, 2000, as compared to the same period in 1999. This
increase was primarily attributable to a 9.56% increase in the average balance
of loans outstanding, which was partially offset by a decrease in the weighted
average yield earned thereon, which averaged 8.98% during 2000, as compared with
9.06% in 1999. The decline in the loan portfolio yield reflected increased
competitive rate pressure in the market place, a change in the portfolio mix as
reflected in the loan portfolio table contained herein, and an increase in the
payment of broker rebates on single family residential loans.
Interest costs increased by $4.7 million, or 13.11%, during the six months
ended June 30, 2000, as compared to the same period during 1999, primarily due
to a 7.32% increase in the average balances of the Company's deposits and
borrowings, in conjunction with an increase in the weighted average rates paid
on the Company's deposits and FHLB advances. The cost of interest-bearing
liabilities averaged 5.55% during the six months ended June 30, 2000, as
compared with 5.28% during the same quarter of 1999.
These changes in interest revenues and interest costs produced an increase
of $1.4 million, or 4.91%, in the Company's net interest income during the six
months ended June 30, 2000, as compared with the same period during 1999.
Expressed as a percentage of average interest-earning assets, the Company's net
interest margin decreased to 3.77% during the six months ended June 30, 2000, as
compared with the net interest margin of 3.90% produced during the same period
during 1999.
PROVISIONS FOR CREDIT LOSSES ON LOANS
Provisions for credit losses for the three and six months ended June 30,
2000, were $1.5 million and $3.0 million, respectively, a decrease of 40.0% and
45.5% over provisions of $2.5 million and $5.5 million recorded during the three
and six months ended June 30, 1999, respectively. The Company's total allowance
for estimated credit losses to loans receivable, net of specific allowances,
increased to 1.74% at June 30, 2000, compared with 1.65% at December 31, 1999
and 1.43% at June 30, 1999. The Company's annualized ratio of charge-offs to
average loans has improved from 0.60% in the second quarter of 1999 to 0.04% in
the second quarter of 2000. Additionally, the ratio of total classified assets
to Bank core capital and general allowance for
14
<PAGE> 17
estimated credit losses was 46.27% at June 30, 2000, compared to 49.96% at
December 31, 1999 and 35.43% at June 30, 1999.
Although the Company maintains its allowance for estimated 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 estimated
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
Loan Related Fees
Noninterest revenues were $2.1 million and $3.9 million for the three and
six months ended June 30, 2000, compared to noninterest revenues of $1.9 million
and $3.9 million earned during the three and six months ended June 30, 1999,
respectively. 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
Company's loan. The increase in loan-related fee revenues during the second
quarter of 2000, as compared with the second quarter of 1999, 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.
Real Estate Operations
The following table sets forth the costs and revenues attributable to the
Company's REO properties 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.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED JUNE
JUNE 30, 30,
--------------------- ----------------------
2000 1999 CHANGE 2000 1999 CHANGE
----- ---- ------ ----- ----- ------
{(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Expenses associated with real estate operations:
Repairs, maintenance and renovation............ $(106) $(71) $(35) $(191) $(151) $ (40)
Insurance and property taxes................... (7) -- (7) (9) -- (9)
----- ---- ---- ----- ----- -----
(113) (71) (42) (200) (151) (49)
Net recoveries from sale of REO.................. 29 80 (51) 7 638 (631)
Property operations, net......................... (6) 9 (15) 20 10 10
----- ---- ---- ----- ----- -----
Total.................................. 23 89 (66) 27 648 (621)
----- ---- ---- ----- ----- -----
(Provision)/recovery for estimated losses on real
estate owned................................... -- (35) 35 24 (80) 104
----- ---- ---- ----- ----- -----
(Loss)/income from real estate operations, net... $ (90) $(17) $(73) $(149) $ 417 $(566)
===== ==== ==== ===== ===== =====
</TABLE>
Net (loss)/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 six months ended June 30, 2000, the
Company sold seven properties generating net cash proceeds of $0.7 million and a
net recovery of $7 thousand, as compared to sales of eleven properties
generating net cash proceeds of $2.9 million and a net recovery of $0.6 million
during the six months ended June 30, 1999. As of June 30, 2000, the Company
holds seven properties.
15
<PAGE> 18
NONINTEREST EXPENSES
General and Administrative Expenses
The table below details the Company's general and administrative expenses
for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------------- ----------------------------
2000 1999 CHANGE 2000 1999 CHANGE
------- ------- ------- ------- ------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
General and administrative expenses:
Employee.......................... $4,353 $3,576 $777 $ 8,405 $ 7,679 $ 726
Operating......................... 1,529 1,599 (70) 3,042 3,138 (96)
Occupancy......................... 897 986 (89) 1,860 1,979 (119)
Technology........................ 484 518 (34) 958 1,078 (120)
Professional...................... 1,231 860 371 2,106 1,164 942
SAIF premiums and OTS
assessments.................... 217 313 (96) 439 612 (173)
------ ------ ---- ------- ------- ------
Total general and
administrative
expenses................ $8,711 $7,852 $859 $16,810 $15,650 $1,160
====== ====== ==== ======= ======= ======
</TABLE>
Total general and administrative expenses ("G&A") were $8.7 million and
$16.8 million for the three and six months ended June 30, 2000, respectively, a
10.94% and 7.41% increase over the $7.9 million and $15.7 million of G&A
incurred during the same periods in 1999. The increase in G&A for the first half
of 2000 was primarily in professional fees comprised of outside consultants
working on operational projects and legal fees attributable to loan
documentation and restructurings and ongoing litigation matters previously
disclosed. The increase in G&A and the decrease in noninterest revenues
discussed previously had a negative impact on the Company's efficiency ratio
(defined as total general and administrative expenses divided by net interest
income before provision and noninterest revenues, excluding REO, net). The
efficiency ratio for the six months ended June 30, 2000, increased to 49.23%
compared to 47.82% for the six months ended June 30, 1999.
Other Non-operating Expense
Other non-operating expense totaled $2.0 million for the six months ended
June 30, 2000, a $1.0 million increase over the $1.0 million of other
non-operating expense incurred during the same period of 1999, primarily in
connection with $1.7 million for ongoing litigation and/or satisfaction of
judgments against the Company as previously discussed (see page 7).
16
<PAGE> 19
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.
<TABLE>
<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
--------------------- ---------------------
BALANCE PERCENT BALANCE PERCENT
---------- ------- ---------- -------
{(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Single family residential........................ $ 796,620 46.4% $ 683,250 41.0%
Income property:
Multi-family(1)................................ 235,484 13.7% 222,616 13.4%
Commercial(1).................................. 201,716 11.8% 208,859 12.5%
Development(2)................................. 157,630 9.2% 148,092 8.9%
Land(3).......................................... 52,395 3.1% 59,095 3.5%
Single family construction:
Single family residence(4)..................... 219,703 12.8% 274,697 16.5%
Tract.......................................... 10,751 0.6% 24,056 1.4%
Other............................................ 41,769 2.4% 46,132 2.8%
---------- ----- ---------- -----
Gross loans receivable(5)........................ 1,716,068 100.0% 1,666,797 100.0%
===== =====
Less:
Undisbursed funds.............................. (158,358) (196,249)
Deferred fees and credits, net................. 992 (1,295)
Allowance for estimated losses................. (27,089) (24,285)
---------- ----------
Net loans receivable............................. $1,531,613 $1,444,968
========== ==========
</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) Includes the funded principal balance under recorded loan commitments, plus
outstanding but unfunded loan commitments, predominantly in connection with
construction loans.
17
<PAGE> 20
The table below sets forth the Company's loan portfolio diversification by
loan size.
<TABLE>
<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
------------------- -------------------
NO. OF GROSS NO. OF GROSS
LOANS COMMITMENT LOANS COMMITMENT
------ ---------- ------ ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Loans in excess of $10.0 million:
Single family residential............. 1 $ 13,000 1 $ 13,000
Income property:
Multi-family....................... -- -- -- --
Commercial......................... 5 56,484 3 32,622
Development........................ 2 24,750 3 33,900
Land.................................. -- -- -- --
Other................................. -- -- 1 16,000
-- ---------- -- ----------
8 94,234 8 95,522
-- ---------- -- ----------
Percentage of total gross loans....... 5.5% 5.7%
Loans between $5.0 and $10.0 million:
Single family residential............. 4 24,400 7 39,364
Income property:
Multi-family....................... -- -- 1 6,655
Commercial......................... 9 68,023 9 65,998
Development........................ 12 81,763 11 71,049
Land.................................. 1 6,501 1 6,501
Single family construction:
Single family residence............ 3 19,562 4 24,812
Tract.............................. 1 6,743 2 11,040
Other................................. 2 18,190 3 27,466
-- ---------- -- ----------
32 225,182 38 252,885
-- ---------- --------
Percentage of total gross loans....... 13.1% 15.2%
Loans less than $5 million.............. 1,396,652 1,318,390
---------- ----------
Gross loans receivable........... $1,716,068 $1,666,797
========== ==========
</TABLE>
----------
(1) Based on current credit review, management determined that a bulk sale
value would be a more conservative valuation for calculating the LTV ratio.
18
<PAGE> 21
The table below sets forth the Company's net loan portfolio composition,
excluding net deferred fees and credits, as of the dates indicated.
<TABLE>
<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
--------------------- ---------------------
BALANCE PERCENT BALANCE PERCENT
---------- ------- ---------- -------
{(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
SFR -- Permanent................................. $ 788,711 50.6% $ 674,917 45.9%
SFR -- Construction.............................. 157,485 10.1% 198,066 13.5%
Land............................................. 49,690 3.2% 50,161 3.4%
Income Property -- Permanent..................... 441,915 28.4% 434,242 29.5%
Income Property -- Construction.................. 105,031 6.7% 99,296 6.8%
Other............................................ 14,878 1.0% 13,866 0.9%
---------- ----- ---------- -----
Total.................................. $1,557,710 100.0% $1,470,548 100.0%
========== ===== ========== =====
</TABLE>
The following table sets forth the approximate composition of the Company's
gross new loan commitments, net of internal refinances, for the period
indicated, in dollars and as a percentage of total loans originated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2000 JUNE 30, 2000
------------------- -----------------
AMOUNT % AMOUNT %
--------- ------ -------- -----
{(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Single family residential(1).......................... $103,694 46.0% $180,280 49.7%
Income property:
Multi-family........................................ 18,756 8.3% 31,791 8.8%
Commercial(2)....................................... 12,227 5.4% 32,464 8.9%
Development(3)...................................... 46,545 20.6% 46,545 12.8%
Land(4)............................................... 8,894 3.9% 15,385 4.2%
Single family construction:
Single family residence(5).......................... 35,463 15.7% 56,545 15.6%
Other................................................. 16 -- 24 --
-------- ----- -------- -----
Total....................................... $225,595 100.0% $363,034 100.0%
======== ===== ======== =====
</TABLE>
---------------
(1) Includes unfunded commitments of $0.1 million as of June 30, 2000.
(2) Includes unfunded commitments of $0.4 million as of June 30, 2000.
(3) Includes unfunded commitments of $29.4 million as of June 30, 2000.
(4) Includes unfunded commitments of $0.1 million as of June 30, 2000.
(5) Includes unfunded commitments of $26.6 million as of June 30, 2000.
19
<PAGE> 22
ASSET QUALITY
Classified Assets
The table below sets forth information concerning the Company's classified
assets as of the dates indicated. Classified assets include REO, nonaccrual
loans and performing loans which have been adversely classified pursuant to OTS
regulations and guidelines ("Performing/Classified" loans).
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
---------- ------------
{(DOLLARS IN THOUSANDS)
<S> <C> <C>
Risk elements:
Nonaccrual loans(1)....................................... $ 36,047 $ 44,031
Real estate owned, net.................................... 5,334 5,587
---------- ----------
41,381 49,618
Performing loans classified substandard or lower.......... 32,284 25,646
---------- ----------
Total classified assets................................... $ 73,665 $ 75,264
========== ==========
Total classified loans.................................... $ 68,331 $ 69,677
========== ==========
Average LTV on classified loans........................... 74% 69%
========== ==========
Loans restructured and paying in accordance with modified
terms(2).................................................. $ 15,553 $ 15,394
========== ==========
Gross loans before allowance for estimated credit losses.... $1,558,702 $1,469,253
========== ==========
Loans receivable net of specific reserves and deferred
fees...................................................... $1,556,465 $1,468,445
========== ==========
Delinquent Loans
30 - 89 days.............................................. $ 17,968 $ 9,063
90+ days.................................................. 30,441 14,916
---------- ----------
Total delinquent loans............................ $ 48,409 $ 23,979
========== ==========
Allowance for estimated credit losses:
General................................................... $ 24,852 $ 23,476
Specific.................................................. 2,237 809
---------- ----------
Total allowance for estimated credit losses....... $ 27,089 $ 24,285
========== ==========
Net loan charge-offs:
Net charge-offs for the quarter ended..................... $ 142 $ 1,409
Percent to net loans (annualized)......................... 0.04% 0.38%
Percent to beginning of period allowance for credit losses
(annualized)........................................... 2.21% 24.83%
Selected asset quality ratios at period end:
Total nonaccrual loans to total assets.................... 2.15% 2.78%
Total allowance for estimated credit losses to loans
receivable, net of specific reserves and deferred
fees................................................... 1.74% 1.65%
Total general allowance for estimated credit losses to
loans receivable, net of specific reserves and deferred
fees................................................... 1.60% 1.60%
Total reserves to nonaccrual loans........................ 75.15% 55.15%
Total classified assets to Bank core capital and general
loan loss reserves..................................... 46.27% 49.96%
</TABLE>
---------------
(1) Total troubled debt restructured loans ("TDRs") were $24.9 million and $34.9
million at June 30, 2000 and December 31, 1999, respectively. Nonaccrual
loans include TDRs of $9.3 million and $18.7 million at June 30, 2000 and
December 31, 1999, respectively.
(2) TDRs not classified and not on nonaccrual.
20
<PAGE> 23
The table below sets forth information concerning the Company's gross
classified loans, by category, as of June 30, 2000. See page 9 for further
discussion.
<TABLE>
<CAPTION>
DELINQUENT LOANS
--------------------------- OTHER
90+ NONACCRUAL PERFORMING
DAYS(1) 30-89 DAYS(2) LOANS(3) LOANS TOTAL
----------- ------------- ---------- ---------- -------
{(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Single family residential................ $17,054 $3,682 $ 131 $ 7,285 $28,152
Income property:
Multi-family........................... 348 -- -- -- 348
Commercial............................. 10,622 -- 8,538 6,462 25,622
Land..................................... 2,075 3,971 -- 2,878 8,924
Single family construction:
Single family residence................ -- 434 879 350 1,663
Tract.................................. 70 -- 3,527 -- 3,597
Other.................................... 22 -- -- 3 25
------- ------ ------- ------- -------
Total.......................... $30,191 $8,087 $13,075 $16,978 $68,331
======= ====== ======= ======= =======
</TABLE>
---------------
(1) Includes $12.7 million in classified loans 90 days past due and still
accruing interest.
(2) Includes $2.6 million in loans 30-89 days past due and still accruing
interest.
(3) Loans classified as substandard for which interest payment reserves were
established from loan funds rather than borrower funds.
ALLOWANCE FOR ESTIMATED CREDIT LOSSES
Management establishes specific allowances for estimated credit losses on
individual loans 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,
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 allowances"). General
allowances are maintained for each of the Company's principal loan segments, and
supplemented by periodic additions through provisions for credit losses. In
measuring the adequacy of the Company's general allowances, 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 Allowances.
In addition to the amount of allowance determined by applying individual
loss factors to the portfolio, the general allowance may also include an
unallocated amount. The unallocated allowance recognizes the model and
estimation risk associated with the allowance formula and specific allowances.
In addition, the unallocated allowance is based upon management's evaluation of
various conditions, the effects of which are not directly measured in the
determination of the formula and specific allowances. The evaluation of the
inherent loss with respect to these conditions is subject to a higher degree of
uncertainty because they are not identified with specific problem credits or
portfolio segments. The conditions evaluated in connection with the unallocated
21
<PAGE> 24
allowance include (1) general economic and business conditions affecting our key
lending areas, (2) credit quality trends (including trends in nonperforming
loans expected to result from existing conditions), (3) collateral values, (4)
loan volumes and concentrations, (5) seasoning of the loan portfolio, (6)
specific industry conditions within portfolio segments (7) recent loss
experience in particular segments of the portfolio, (8) duration of the current
business cycle, (9) bank regulatory examination results and (10) findings of our
internal credit examiners.
Specific allowances are established in cases where management has
identified significant conditions or circumstances related to a credit that
management believes indicate the probability that a loss has been incurred.
The table below sets forth the general and specific allowance for estimated
credit losses for the Company's loan portfolio as of June 30, 2000.
<TABLE>
<CAPTION>
LOANS
------------------------
PERFORMING DELINQUENT TOTAL
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Specific allowances............................. $ 1,181 $ 1,056 $ 2,237
General allowances.............................. 19,521 5,331 24,852
---------- ------- ----------
Total................................. $ 20,702 $ 6,387 $ 27,089
========== ======= ==========
Percentages:
Total allowance for estimated credit losses to
loans receivable before allowance for
credit losses.............................. 1.37% 13.19% 1.74%
Total general allowances for estimated credit
losses to loans receivable, net of specific
reserves................................... 1.29% 11.26% 1.60%
Loans receivable before allowance for credit
losses........................................ $1,510,293 $48,409 $1,558,702
Loans receivable net of specific reserves....... 1,509,112 47,353 1,556,465
</TABLE>
22
<PAGE> 25
The table below summarizes the activity of the Company's allowance for
estimated credit losses for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Average loans outstanding................. $1,519,760 $1,392,736 $1,504,938 $1,373,666
========== ========== ========== ==========
Total allowance for estimated credit
losses at beginning of period........... $ 25,731 $ 19,958 $ 24,285 $ 17,111
Provision for estimated credit losses..... 1,500 2,500 3,000 5,500
Charge-offs:
Single family........................... (51) (1,623) (158) (1,776)
Income property:
Commercial.............................. -- (512) -- (512)
Single family construction:
Tract................................... (147) -- (147) --
Other..................................... (15) -- (15) --
Recoveries:
Other................................... 71 -- 124 --
---------- ---------- ---------- ----------
Net charge-offs........................... (142) (2,135) (196) (2,288)
---------- ---------- ---------- ----------
Total allowance for estimated
credit losses at end of
period........................ $ 27,089 $ 20,323 $ 27,089 $ 20,323
========== ========== ========== ==========
Annualized ratio of charge-offs to average
loans outstanding during the period..... 0.04% 0.61% 0.03% 0.33%
Real estate owned:
Total allowance for estimated
losses at beginning of
period........................ $ 4 $ 90 $ 29 $ 45
Provision for estimated losses............ -- 35 -- 80
Charge-offs............................... (4) (87) (29) (87)
---------- ---------- ---------- ----------
Total allowance for estimated
losses at end of period....... $ -- $ 38 $ -- $ 38
========== ========== ========== ==========
</TABLE>
23
<PAGE> 26
The table below summarizes the allocation of the Company's allowance for
estimated credit losses for each principal loan portfolio segment.
<TABLE>
<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
------------------------- -------------------------
PERCENT OF PERCENT OF
RESERVES TO RESERVES TO
TOTAL LOANS(1) TOTAL LOANS(1)
BALANCE BY CATEGORY BALANCE BY CATEGORY
------- -------------- ------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Single family residential.................. $ 6,432 0.81% $ 7,095 1.04%
Income property:
Multi-family............................. 743 0.32% 646 0.29%
Commercial............................... 5,437 2.70% 6,738 3.23%
Development.............................. 4,615 2.93% 2,067 1.40%
Land....................................... 2,384 4.55% 1,470 2.49%
Single family construction:
Single family residence.................. 2,226 1.01% 3,946 1.44%
Tract.................................... 983 9.14% 855 3.55%
Other...................................... 873 2.09% 480 1.04%
Unallocated................................ 3,396 n/a 988 n/a
------- -------
$27,089 1.58% $24,285 1.46%
======= =======
</TABLE>
---------------
(1) Percent of allowance for estimated credit losses to gross loan commitments,
which exclude 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.
Unallocated reserves are established based on management's judgment in
order to appropriately reflect the presence of indicators of inherent losses
that are not fully reflected in the historical loss information and analysis
used in the development of allocated reserves. The factors considered in
establishing the unallocated reserve include: nonperforming, charge-off,
delinquency and portfolio growth and concentration trends and the likely impact
of known changes in the economy or other events that may affect loss
performance. The unallocated reserves are reviewed periodically to determine
whether they are at a level that management believes are adequate.
Based on the $24.4 million increase in delinquent loans, from $24.0
million at December 31, 1999 to $48.4 million at June 30, 2000, and other
factors discussed elsewhere herein, management believes that the unallocated
reserve of $3.4 million as of June 30, 2000 is appropriate.
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 a write-down of the
asset.
The table below summarizes the composition of the Company's real estate
owned properties for the dates indicated.
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
-------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Single family(1)....................................... $ 946 $1,218
Income property:
Commercial(2)........................................ 4,388 4,398
------ ------
Gross investment(3).................................... 5,334 5,616
Less allowance for estimated losses.................... -- 29
------ ------
Real estate owned, net................................. $5,334 $5,587
====== ======
</TABLE>
---------------
(1) As of June 30, 2000, the Company holds six properties.
(2) In December 1999, the Bank acquired 18 lots of a tract development in La
Quinta, California with a carrying value of $4.4 million.
(3) Fair value of collateral at foreclosure, plus post-foreclosure capitalized
costs.
24
<PAGE> 27
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.
<TABLE>
<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
-------------------------- --------------------------
BALANCE WAIR WARM BALANCE WAIR WARM
---------- ---- ---- ---------- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing checking.... $ 30,877 -- -- $ 28,838 -- --
Checking/NOW.................... 41,487 2.16% -- 40,563 2.17% --
Passbook........................ 24,250 1.65% -- 23,568 1.41% --
Money market.................... 164,887 4.85% -- 155,537 4.45% --
Certificates of deposit:
7 day maturities.............. 27,207 4.06% -- 30,631 4.08% --
Less than 6 months............ 20,991 4.86% 1 42,082 4.78% 2
6 months to 1 year............ 149,035 5.97% 3 147,407 5.24% 3
1 year to 2 years............. 679,478 6.04% 7 584,488 5.46% 8
Greater than 2 years.......... 28,835 5.32% 10 33,521 5.31% 12
---------- ----------
$1,167,047 5.39% 5 $1,086,635 4.86% 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.
<TABLE>
<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
----------------- -----------------
ORIGINAL TERM PRINCIPAL RATE PRINCIPAL RATE
------------- --------- ---- --------- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
24 Months............................................. $ 25,000 6.59% $ -- --
36 Months............................................. 100,000 6.73% -- --
60 Months............................................. 135,000 5.92% 300,000 5.30%
120 Months............................................ 99,000 5.19% 49,000 4.36%
-------- --------
$359,000 5.99%(1) $349,000 5.16%(1)
======== ========
</TABLE>
---------------
(1) Weighted average interest rate.
The weighted average remaining term of the Company's FHLB advances was 4
years and 11 months and 4 years and 6 months as of June 30, 2000 and December
31, 1999, respectively. All of the Company's FHLB advances outstanding at June
30, 2000, with the exception of one, contain options which allow the FHLB to
25
<PAGE> 28
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 ("1997 Senior Notes") in a private placement, which included registration
rights. The 1997 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
June 30, 2000 amounted to $98.2 million and which equaled 5.85% of the Company's
total assets.
As indicated in the table below, the Bank's capital levels exceeded minimum
regulatory capital requirements.
<TABLE>
<CAPTION>
TANGIBLE CAPITAL CORE CAPITAL RISK-BASED CAPITAL
------------------ ----------------- -------------------
BALANCE % BALANCE % BALANCE %
---------- ---- ---------- ---- ---------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Stockholders' equity............. $ 134,350 $ 134,350 $ 134,350
Adjustments:
General reserves............... -- -- 15,121
Other(1)....................... -- -- (5,565)
---------- ---- ---------- ---- ---------- -----
Regulatory capital............... 134,350 8.01% 134,350 8.01% 143,906 11.99%
Required minimum................. 25,145 1.50 67,054 4.00 96,001 8.00
---------- ---- ---------- ---- ---------- -----
Excess capital................... $ 109,205 6.51% $ 67,296 4.01% $ 47,905 3.99%
========== ==== ========== ==== ========== =====
Adjusted assets(2)............... $1,676,356 $1,676,356 $1,200,012
========== ========== ==========
</TABLE>
---------------
(1) Includes the portion of non-residential construction loans and land loans
which exceed a loan-to-value ratio of 80%.
(2) The term "adjusted assets" refers to the term "adjusted total assets", as
defined in 12 C.F.R. Section 567.1(a), for purposes of tangible and core
capital requirements, and for purposes of risk-based capital requirements,
refers to the term "risk-weighted assets", as defined in 12 C.F.R. Section
567.1(d).
26
<PAGE> 29
As of June 30, 2000, the Bank is categorized as "well capitalized" under
the regulatory framework for prompt corrective action. To be categorized as well
capitalized, an institution must maintain minimum total risk-based, Tier 1
risk-based and Tier 1 leverage ratios as set forth in the following table. There
are no conditions or events subsequent to June 30, 2000 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.
<TABLE>
<CAPTION>
MINIMUM TO BE WELL
CAPITALIZED UNDER
MINIMUM PROMPT
CAPITAL CORRECTIVE ACTION
ACTUAL REQUIREMENT PROVISIONS
----------------- ---------------- ------------------
AMOUNT RATIOS AMOUNT RATIOS AMOUNT RATIOS
-------- ------ ------- ------ -------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 2000
Total Capital (to Risk Weighted Assets)......... $143,906 11.99% $96,001 8.00% $120,001 10.00%
Core Capital (to Adjusted Tangible Assets)...... 134,350 8.01% 67,054 4.00% 83,818 5.00%
Tangible Capital (to Adjusted Tangible
Assets)....................................... 134,350 8.01% 25,145 1.50% N/A N/A
Tier 1 Capital (to Risk Weighted Assets)........ 134,350 11.20% N/A N/A 72,001 6.00%
As of December 31, 1999
Total Capital (to Risk Weighted Assets)......... $139,815 12.50% $89,468 8.00% $111,835 10.00%
Core Capital (to Adjusted Tangible Assets)...... 127,160 8.05% 63,174 4.00% 78,967 5.00%
Tangible Capital (to Adjusted Tangible
Assets)....................................... 127,160 8.05% 23,690 1.50% N/A N/A
Tier 1 Capital (to Risk Weighted Assets)........ 127,160 11.37% N/A N/A 67,101 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
$2.9 million at June 30, 2000. Hawthorne Financial Corporation has no other
significant assets beyond its investment in the Bank. From time-to-time, the
Company is 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. The Company made its June 2000 semiannual interest
payment on its 1997 Senior Notes. 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 1997 Senior Notes. In April 2000, Hawthorne Financial Corporation
received a dividend of $1.5 million to fund the stock repurchase as disclosed
previously herein. In July 2000, the Company authorized the repurchase of up to
an additional 5% of its common stock, or approximately 264,000 shares. This is
in addition to the 5% repurchase authorization announced in March 2000, for
approximately 277,000 shares. As of August 11, 2000, the Company has
repurchased 282,500 shares at an average price per share of $8.09.
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 June 30, 2000 was 6.54%, which exceeded the applicable
minimum requirements.
The Company's current primary funding resources are deposits, principal
payments on loans, FHLB advances and cash flows from operations. Other possible
sources of liquidity available to the Company include whole loan sales,
commercial bank lines of credit, and direct access, under certain conditions, to
borrowings
27
<PAGE> 30
from the Federal Reserve System. The cash needs of the Company are principally
for the payment of interest on, and withdrawals of, deposit accounts, the
funding of loans and operating costs and expenses.
INTEREST RATE RISK MANAGEMENT
The objective of interest rate risk management is to stabilize the
Company's net interest income ("NII") while limiting the change in its Net
Portfolio Value ("NPV") from interest rate fluctuations. The Company seeks to
achieve this objective by matching its interest sensitive assets and
liabilities, and maintaining the maturity and repricing of these assets and
liabilities at appropriate levels given the interest rate environment. When the
amount of rate-sensitive liabilities exceeds rate-sensitive assets within
specified periods, the NII generally will be negatively impacted by increasing
interest rates and positively impacted by decreasing interest rates during such
periods. Conversely, when the amount of rate-sensitive assets exceeds the amount
of rate-sensitive liabilities within specified periods, net interest income
generally will be positively impacted by increasing interest rates and
negatively impacted by decreasing interest rates during such periods. The speed
and velocity of the repricing of assets and liabilities will also contribute to
the effects on NII.
The Company utilizes two methods for measuring interest rate risk, 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.
28
<PAGE> 31
The table below sets forth information concerning repricing opportunities
for the Company's interest-earning assets and interest-bearing liabilities as of
June 30, 2000. The amounts of assets and liabilities shown within a particular
period were determined in accordance with the contractual maturities, except
that adjustable-rate products 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.
<TABLE>
<CAPTION>
JUNE 30, 2000
------------------------------------------------------------------------
OVER THREE OVER SIX OVER ONE
THREE THROUGH THROUGH YEAR OVER
MONTHS SIX TWELVE THROUGH FIVE
OR LESS MONTHS MONTHS FIVE YEARS YEARS TOTAL
---------- ---------- --------- ---------- -------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Cash and cash
equivalents(1)........... $ 83,025 $ -- $ -- $ -- $ -- $ 83,025
Investments and FHLB
stock.................... 20,105 -- -- -- -- 20,105
Loans(2).................... 981,006 393,524 34,370 28,496 120,314 1,557,710
---------- -------- --------- --------- -------- ----------
Total
interest-earning
assets............ $1,084,136 $393,524 $ 34,370 $ 28,496 $120,314 $1,660,840
========== ======== ========= ========= ======== ==========
Interest-bearing liabilities:
Deposits:
Non-certificates of
deposit................ $ 230,624 $ -- $ -- $ -- $ -- $ 230,624
Certificates of
deposit................ 215,188 239,213 350,243 100,902 -- 905,546
FHLB advances............... -- 30,000 125,000 204,000 -- 359,000
Senior notes................ -- -- -- 40,000 -- 40,000
---------- -------- --------- --------- -------- ----------
Total
interest-bearing
liabilities....... $ 445,812 $269,213 $ 475,243 $ 344,902 $ -- $1,535,170
========== ======== ========= ========= ======== ==========
Interest rate sensitivity
gap...................... $ 638,324 $124,311 $(440,873) $(316,406) $120,314 $ 125,670
Cumulative interest rate
sensitivity gap.......... 638,324 762,635 321,762 5,356 125,670 125,670
Cumulative interest rate
sensitivity gap as a
percentage of total
interest-earning
assets................... 38.4% 45.9% 19.4% 0.3% 7.6% 7.6%
</TABLE>
---------------
(1) Excludes noninterest earning cash balances.
(2) Loans include $36.0 million of nonaccrual loans, and are exclusive of
deferred fees and loan loss reserves.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company realizes income principally from the differential or spread
between the interest earned on loans, investments, other interest-earning assets
and the interest paid on deposits and borrowings. The Company, like other
financial institutions, is subject to interest rate risk ("IRR") to the degree
that its interest-earning assets reprice differently than its interest-bearing
liabilities. The Company's primary objective in managing interest rate risk is
to minimize the adverse impact of changes in interest rates on the Company's net
interest income and capital, while structuring the Company's asset-liability mix
to obtain the maximum yield-cost spread on that structure.
A sudden and substantial increase in interest rates may adversely impact
the Company's income to the extent that the interest rates borne by the assets
and liabilities do not change at the same speed, to the same extent, or on the
same basis. The Company has adopted formal policies and practices to monitor its
interest rate risk exposure. As a part of this effort, the Company uses the Net
Portfolio Value ("NPV") methodology to gauge interest rate risk exposure.
29
<PAGE> 32
Using an internally generated model, the Company monitors interest rate
sensitivity by estimating the change in NPV over a range of interest rate
scenarios. NPV is the discounted present value of the difference between
incoming cashflows on interest-earning assets and other assets, and the outgoing
cashflows on interest-bearing liabilities and other liabilities. The NPV ratio
is defined as the NPV for a given rate scenario divided by the market value of
the assets in the same scenario. The Sensitivity Measure is the decline in the
NPV ratio, in basis points, caused by a 200 basis point increase or decrease in
interest rates, whichever produces the largest decline. The higher an
institution's Sensitivity Measure, the greater its exposure to IRR. The OTS also
produces a similar analysis using its own model, based upon data submitted on
the Bank's quarterly Thrift Financial Report ("TFR").
At June 30, 2000, based on the Company's internally generated model, it was
estimated that the Company's NPV ratio was 7.95% in the event of a 200 basis
point increase in rates, a decrease of 13.59% from basecase of 9.20%. If rates
were to decrease by 200 basis points, the Company's NPV ratio was estimated at
10.10%, an increase of 9.78% from basecase.
Presented below, as of June 30, 2000, is an analysis of the Company's IRR
as measured in the NPV for instantaneous and sustained parallel shifts of 100,
200, and 300 basis point increments in market interest rates.
<TABLE>
<CAPTION>
NET PORTFOLIO VALUE
-------------------------
CHANGE $ CHANGE FROM NPV CHANGE FROM
IN RATES $ AMOUNT BASECASE RATIO BASECASE
-------- -------- ------------- ----- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
+300 bp................................ $110,024 (46,096) 6.75% -245 bp
+200 bp................................ 131,755 (24,365) 7.95% -125 bp
+100 bp................................ 146,263 (9,857) 8.71% -49 bp
basecase............................... 156,120 9.20%
-100 bp................................ 162,566 6,446 9.48% +28 bp
-200 bp................................ 176,368 20,248 10.10% +90 bp
-300 bp................................ 192,539 36,419 10.80% +160 bp
</TABLE>
Management believes that the NPV methodology overcomes three shortcomings
of the typical maturity gap methodology. First, it does not use arbitrary
repricing intervals and accounts for all expected cash flows, weighing each by
its appropriate discount factor. Second, because the NPV method projects cash
flows of each financial instrument under different rate environments, it can
incorporate the effect of embedded options on an association's IRR exposure.
Third, it allows interest rates on different instruments to change by varying
amounts in response to a change in market interest rates, resulting in more
accurate estimates of cash flows.
On a quarterly basis, the results of the internally generated model are
reconciled to the results of the OTS model. Historically the OTS has valued the
NPV higher, but the changes in NPV as a result of the rate increases and
decreases are directionally consistent between the two models. The difference
between the two models resides in the prepayment assumptions, the ability of the
Company to analyze each individual rate index in a changing environment, and the
ability of the Company's model to include caps and floors on loans in the rate
shock analyses.
30
<PAGE> 33
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On June 28, 2000, the California Supreme Court denied the Bank's petition
for review of the Court of Appeals' decision affirming in part and reversing in
part the judgment in the Takaki vs. Hawthorne Savings and Loan Association
matter previously disclosed by the Bank. The Bank had previously accrued the
full amount of the judgment, including post judgment interest through April
2000, and no material additional accruals were required during the second
quarter as a result of the Supreme Court's action and payment of the judgment.
The Company is involved in a variety of other litigation matters in the
ordinary course of its business, as discussed in the Annual Report on Form 10-K
for the year ended December 31, 1999. Management does not presently believe
that any of the existing litigative matters are likely to have a material
adverse impact on the Company's financial condition or results of operation.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of the Company was held on May 20, 2000.
At the Annual Meeting the following seven nominees were elected until the 2001
Annual Meeting of Stockholders and their successors have been duly elected and
qualified as directors.
<TABLE>
<CAPTION>
NUMBER OF SHARES
---------------------
DIRECTOR FOR WITHHELD
-------- --------- --------
<S> <C> <C>
Marilyn Garton Amato................................... 4,630,614 194,748
Gary W. Brummett....................................... 4,645,076 180,286
Timothy R. Chrisman.................................... 4,642,787 182,575
Simone Lagomarsino..................................... 4,639,755 185,607
Anthony W. Liberati.................................... 4,643,476 181,886
Harry F. Radcliffe..................................... 4,643,576 181,786
Howard E. Ritt......................................... 4,642,927 182,435
</TABLE>
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 six months ended June 30,
2000
2. Other required exhibits:
Exhibit 10.1 -- Deferred Compensation Loan Agreement between Company and
Karen Abajian*
Exhibit 10.2 -- Form of Change in Control Employment Agreement*
Exhibit 10.3 -- Form of Change in Control Employment Agreement between
Company and Simone Lagomarsino*
Exhibit 27.1 -- Financial Data Schedule
* Denotes management compensation agreement.
31
<PAGE> 34
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 August 14, 2000 /s/ SIMONE LAGOMARSINO
--------------------------------------
Simone Lagomarsino
President and Chief Executive Officer
Dated August 14, 2000 /s/ KAREN C. ABAJIAN
--------------------------------------
Karen C. Abajian
Executive Vice President and Chief
Financial Officer
32
