<PAGE> 1
- --------------------------------------------------------------------------------
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
------------------------
FORM 10-Q
------------------------
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTER ENDED MARCH 31, 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 5,559,301
shares of Common Stock, $0.01 par value per share outstanding, as of April 30,
2000.
- --------------------------------------------------------------------------------
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<PAGE> 2
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q INDEX
FOR THE QUARTER ENDED MARCH 31, 2000
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I -- FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Statements of Financial Condition
at March 31, 2000 and December 31, 1999..................... 3
Consolidated Statements of Operations
for the Three Months Ended March 31, 2000 and 1999.......... 4
Consolidated Statements of Stockholders' Equity
for the Three Months Ended March 31, 2000................... 5
Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 2000 and 1999.......... 6
Notes to Consolidated Financial Statements.................. 7
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 10
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk... 26
PART II -- OTHER INFORMATION
ITEM 1. Legal Proceedings........................................... 28
ITEM 2. Changes in Securities....................................... 28
ITEM 3. Defaults upon Senior Securities............................. 28
ITEM 4. Submission of Matters to a Vote of Security Holders......... 28
ITEM 5. Other Information........................................... 28
ITEM 6. Exhibits and Reports on Form 8-K............................ 28
</TABLE>
FORWARD-LOOKING STATEMENTS
When used in this Form or future filings by the Company with the Securities
and Exchange Commission, in the Company's press releases or other public or
stockholder communications, or in oral statements made with the approval of an
authorized executive officer, the words or phrases "will likely result", "are
expected to", "will continue", "is anticipated", "estimate", "project",
"believe" or similar expressions are intended to identify "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. The Company wishes to caution readers that all forward-looking
statements are necessarily speculative and not to place undue reliance on any
such forward-looking statements, which speak only as of the date made, and to
advise readers that various risks and uncertainties, including regional and
national economic conditions, changes in levels of market interest rates, credit
risks of lending activities, and competitive and regulatory factors, could
affect the Company's financial performance and could cause the Company's actual
results for future periods to differ materially from those anticipated or
projected. The risks highlighted herein should not be assumed to be the only
things that could affect future performance of the Company.
The Company does not undertake, and specifically disclaims any obligation,
to publicly release the result of any revisions which may be made to any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
2
<PAGE> 3
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
(DOLLARS IN THOUSANDS) ---------- ------------
<S> <C> <C>
Assets:
Cash and cash equivalents................................... $ 88,693 $ 86,722
Loans receivable (net of allowance for estimated credit
losses of $25,731 in 2000 and $24,285 in 1999)............ 1,482,207 1,444,968
Real estate owned, net...................................... 5,525 5,587
Accrued interest receivable................................. 10,304 9,250
Investment in capital stock of Federal Home Loan Bank, at
cost...................................................... 21,345 22,236
Office property and equipment at cost, net.................. 5,557 5,939
Deferred tax asset, net..................................... 2,589 2,203
Other assets................................................ 3,945 4,248
---------- ----------
Total assets...................................... $1,620,165 $1,581,153
========== ==========
Liabilities and Stockholders' Equity:
Liabilities:
Deposits.................................................. $1,145,093 $1,086,635
FHLB advances............................................. 324,000 349,000
Senior notes.............................................. 40,000 40,000
Accounts payable and other liabilities.................... 15,079 13,214
---------- ----------
Total liabilities................................. 1,524,172 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, 5,546,801 shares in
2000 and 5,331,301 shares in 1999...................... 55 53
Capital in excess of par value -- common stock............ 41,986 40,981
Retained earnings......................................... 54,222 51,318
---------- ----------
96,263 92,352
Less:
Treasury stock, at cost -- 30,400 shares.................. (270) (48)
---------- ----------
Total stockholders' equity........................ 95,993 92,304
---------- ----------
Total liabilities and stockholders' equity........ $1,620,165 $1,581,153
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
3
<PAGE> 4
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
2000 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA) ------- -------
<S> <C> <C>
Interest revenues:
Loans..................................................... $32,913 $31,001
Investments............................................... 1,523 1,013
------- -------
Total interest revenues........................... 34,436 32,014
------- -------
Interest costs:
Deposits.................................................. 13,843 12,434
FHLB advances............................................. 4,598 3,860
Senior notes.............................................. 1,250 1,250
------- -------
Total interest costs.............................. 19,691 17,544
------- -------
Net interest income......................................... 14,745 14,470
Provision for credit losses................................. 1,500 3,000
------- -------
Net interest income after provision for credit losses..... 13,245 11,470
------- -------
Noninterest revenues:
Loan related fees......................................... 1,760 1,970
(Loss)/income from real estate operations, net.............. (59) 434
Noninterest expenses:
General and administrative expenses:
Employee............................................... 4,052 4,103
Operating.............................................. 1,513 1,540
Occupancy.............................................. 963 993
Technology............................................. 474 560
Professional........................................... 875 303
SAIF premiums and OTS assessments...................... 222 299
------- -------
Total general and administrative expenses......... 8,099 7,798
Other non-operating expense............................... 1,828 992
------- -------
Total noninterest expenses........................ 9,927 8,790
------- -------
Income before income taxes.................................. 5,019 5,084
Income tax provision........................................ 2,115 2,112
------- -------
Net income.................................................. $ 2,904 $ 2,972
======= =======
Basic earnings per share (Note 3)........................... $ 0.53 $ 0.57
======= =======
Diluted earnings per share (Note 3)......................... $ 0.39 $ 0.38
======= =======
Weighted average basic shares oustanding (Note 3)........... 5,461 5,224
======= =======
Weighted average diluted shares outstanding (Note 3)........ 7,503 7,732
======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements
4
<PAGE> 5
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMPREHENSIVE
INCOME
BALANCE AT EXERCISED ------------- BALANCE AT
DECEMBER 31, STOCK EXERCISED NET TREASURY MARCH 31,
1999 OPTIONS WARRANTS INCOME STOCK 2000
(IN THOUSANDS) ------------ --------- ---------- ------------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Number of common shares.............. 5,331 216 -- -- -- 5,547
Treasury stock....................... (5) -- -- -- (25) (30)
------- ------ --- ------ ----- -------
Total shares outstanding.... 5,326 216 -- -- (25) 5,517
======= ====== === ====== ===== =======
Common stock......................... $ 53 $ 2 $-- $ -- $ -- $ 55
Capital in excess of par value,
common stock....................... 40,981 1,005 -- -- -- 41,986
Retained earnings.................... 51,318 -- -- 2,904 -- 54,222
Treasury stock....................... (48) -- -- -- (222) (270)
======= ====== === ====== ===== =======
Total stockholders'
equity.................... $92,304 $1,007 $-- $2,904 $(222) $95,993
======= ====== === ====== ===== =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements
5
<PAGE> 6
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
2000 1999
(DOLLARS IN THOUSANDS) --------- --------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income................................................ $ 2,904 $ 2,972
Adjustments:
Deferred income tax (benefit) provision................. (386) 1,324
Provision for estimated credit losses on loans.......... 1,500 3,000
(Recovery)/provision for estimated losses on real estate
owned.................................................. (24) 45
Net loss/(gain) from sale of real estate owned.......... 22 (557)
Loan fee and discount accretion......................... (570) (1,557)
Depreciation and amortization........................... 383 1,416
FHLB dividends.......................................... (306) (197)
Increase in accrued interest receivable................. (1,054) (110)
Decrease (increase) in other assets..................... 303 (418)
Increase in accounts payable and other liabilities...... 1,865 2,278
--------- --------
Net cash provided by operating activities........... 4,637 8,196
--------- --------
Cash Flows from Investing Activities:
Loans:
New loans funded........................................ (109,865) (64,722)
Construction disbursements.............................. (58,943) (97,585)
Payoffs................................................. 126,546 115,895
Principal payments...................................... 8,435 7,937
Other, net.............................................. (4,612) 5,170
Real estate owned, net:
Sales proceeds.......................................... 320 2,579
Capitalized costs....................................... -- (21)
Purchase of FHLB stock.................................... -- (3,657)
Redemption of FHLB stock.................................. 1,197 --
Office property and equipment:
Sale proceeds........................................... 31 3
Additions............................................... (240) (356)
--------- --------
Net cash used in investing activities............... (37,131) (34,757)
--------- --------
Cash Flows from Financing Activities:
Deposit activity, net..................................... 58,458 19,151
Net (decrease) increase in FHLB advances.................. (25,000) 80,000
Net proceeds from exercise of stock options and
warrants................................................ 1,007 368
--------- --------
Net cash provided by financing activities........... 34,465 99,519
--------- --------
Net increase in cash and cash equivalents................... 1,971 72,958
Cash and cash equivalents, beginning of period.............. 86,722 45,449
--------- --------
Cash and cash equivalents, end of period.................... $ 88,693 $118,407
========= ========
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest................................................ $ 19,696 $ 16,043
Income taxes............................................ 2,500 225
Non-cash investing and financing activities:
Real estate acquired in settlement of loans............. 340 293
Loans originated to finance sales of real estate
owned.................................................. -- 1,500
Loans originated to refinance existing bank loans....... 6,085 17,926
</TABLE>
See accompanying Notes to Consolidated Financial Statements
6
<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
March 31, 2000 and December 31, 1999 and the results of its operations and its
cash flows for the three months ended March 31, 2000 and 1999. Operating results
for the three months ended March 31, 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.
NOTE 2 -- RECLASSIFICATION
Certain amounts in the 1999 consolidated financial statements have been
reclassified, to conform with classifications in 2000.
7
<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 months ended March 31, 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
MARCH 31,
------------------
2000 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA) ------- -------
<S> <C> <C>
Average shares outstanding:
Basic..................................................... 5,461 5,224
Warrants.................................................. 2,486 2,503
Options(1)................................................ 258 617
Less Treasury shares(2)................................... (702) (612)
------ ------
Diluted................................................... 7,503 7,732
====== ======
Net income for the period................................... $2,904 $2,972
====== ======
Basic earnings per share.................................... $ 0.53 $ 0.57
====== ======
Diluted earnings per share.................................. $ 0.39 $ 0.38
====== ======
</TABLE>
<TABLE>
<CAPTION>
MARCH 31,
------------------
2000 1999
------- -------
<S> <C> <C>
Period-end shares outstanding:
Basic..................................................... 5,517 5,268
Warrants.................................................. 2,486 2,503
Options(3)................................................ 167 513
Less Treasury shares(2)................................... (704) (567)
------- -------
Diluted................................................... 7,466 7,717
======= =======
Stockholders' equity........................................ $95,993 $84,732
======= =======
Basic book value per share.................................. $ 17.40 $ 16.08
======= =======
Diluted book value per share................................ $ 12.86 $ 10.98
======= =======
</TABLE>
- ---------------
(1) Excludes 320,000 options outstanding for the three months ended March 31,
2000 for which the exercise price exceeded the average market price of the
Company's common stock during the period. Excludes 210,000 options
outstanding for the three months ended March 31, 1999 for which the exercise
price exceeded the average market price of the Company's common stock during
the period.
(2) Under the Diluted Method, it is assumed that the Company will use proceeds
from the proforma exercise of the Warrants and Options to acquire actual
shares currently outstanding, thus increasing Treasury shares. In this
calculation, Treasury shares were assumed to be repurchased at the average
closing stock price for the respective period.
(3) Excludes 360,000 and 210,000 options outstanding at March 31, 2000 and March
31, 1999, respectively, for which the exercise price exceeded the average
market price of the Company's common stock at period end.
8
<PAGE> 9
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 -- COMMITMENTS AND CONTINGENCIES
Other non-operating expense included $1.7 million for ongoing litigation
and/or satisfaction of judgments against the Company. On April 13, 2000, the
California Court of Appeals issued its 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 appealed from the $2.4 million
judgment in the Takaki matter on the grounds that the trial court erred in
measuring damages awarded to the plaintiffs. In an unpublished decision, the
Court of Appeals held that the Bank was entitled to a reduction for attorneys'
fees that should not have been awarded. The Court of Appeals also held that the
trial court committed errors in setting a date for calculating damages.
Nevertheless, the Court of Appeals held that the errors were "not prejudicial"
to the Bank and affirmed the basic damages award, minus the attorneys' fees. The
Bank believes that the Court of Appeals ruling is wrongly decided and intends to
file a petition for rehearing with the Court of Appeals and intends to file a
petition for review with the California Supreme Court. As there can be no
assurances that the Bank will be successful in its appeal, the Company has
recorded a liability to the level of the Court of Appeals award including post
judgment interest through April 2000. Interest will continue to accrue at 10.0%
per annum.
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.
9
<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 of $2.9 million, or $0.39 per diluted share, for the first
quarter of 2000 resulted in an annualized return on average assets ("ROA") of
.72% and an annualized return on average equity ("ROE") of 12.36% compared with
net income of $3.0 million, or $0.38 per diluted share, an annualized ROA of
.82% and an annualized ROE of 14.42% for the first quarter of 1999. Pretax
income decreased 1.28% during the first quarter of 2000, to $5.0 million from
$5.1 million in the first quarter of 1999.
In the first quarter of 2000, the Company incurred $1.8 million in other
non-operating expenses, primarily in connection with $1.7 million for ongoing
litigation and/or satisfaction of judgments against the Company, resulting in a
reduction in diluted earnings per share of $0.13. This compares to $1.0 million
of other non-operating expenses in the first quarter of 1999, of which $0.6
million related to ongoing litigation and/or satisfaction of judgments against
the Company, or a reduction in diluted earnings per share of $0.04.
Additionally, other non-operating expense in the first quarter of 2000 included
$0.1 million in connection with the early termination of its former Irvine
office, which management determined was no longer part of its operating plan.
The table below identifies the principal components of the Company's pretax
income and net income for the three months ended March 31, 2000 and March 31,
1999.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------------
2000 1999 CHANGE
(DOLLARS IN THOUSANDS) ------- ------- -------
<S> <C> <C> <C>
Net interest income..................................... $15,995 $15,720 $ 275
Provision for credit losses............................. 1,500 3,000 (1,500)
------- ------- -------
Net interest income after provision for credit
losses............................................. 14,495 12,720 1,775
Noninterest revenues, net:
Loan related fees..................................... 1,760 1,970 (210)
(Loss)/income from real estate operations, net.......... (59) 434 (493)
Noninterest expenses:
General and administrative expenses................... 8,099 7,798 301
Other non-operating expense........................... 1,828 992 836
Interest on senior notes................................ 1,250 1,250 --
------- ------- -------
Income before income taxes.............................. 5,019 5,084 (65)
Income tax provision.................................... 2,115 2,112 3
------- ------- -------
Net income.............................................. $ 2,904 $ 2,972 $ (68)
======= ======= =======
</TABLE>
The Company's net interest income before interest on senior notes and
provision for credit losses rose 1.75% to $16.0 million during the first quarter
of 2000 from $15.7 million during the first quarter of 1999. The Company's yield
on average earning assets was 8.64% during the first quarter of 2000 compared to
8.91% during the first quarter of 1999. The average cost of funds for the
Company increased to 5.41% during the first quarter of 2000 from 5.33% during
the first quarter of 1999. The Company's resulting net interest margin for the
first quarter of 2000 and 1999 was 3.70% and 4.03%, respectively. The
compression in the net interest
10
<PAGE> 11
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.
Provisions for credit losses totaled $1.5 million and $3.0 million for the
quarters ended March 31, 2000 and March 31, 1999, respectively. At March 31,
2000, the ratio of total allowance for estimated credit losses to net loans
reached 1.71%, compared to 1.65% at December 31, 1999 and 1.45% at March 31,
1999. The Company's ratio of charge-offs to annualized net loans improved to
0.01% for the first quarter of 2000 compared with a ratio of 0.04% for the first
quarter of 1999.
Noninterest revenues were $1.7 million for the three months ended March 31,
2000, compared to noninterest revenues of $2.4 million earned during the first
quarter of 1999. Income from real estate operations, net, decreased $0.5 million
for the quarter ended March 31, 2000 versus the quarter ended March 31, 1999, as
sales of real estate owned resulted in net recoveries during the first quarter
of 1999.
Other non-operating expense totaled $1.8 million for the three months ended
March 31, 2000, an $0.8 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 April 13, 2000, the California Court of
Appeals issued its 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 appealed from the $2.4 million judgment in the
Takaki matter on the grounds that the trial court erred in measuring damages
awarded to the plaintiffs. In an unpublished decision, the Court of Appeals held
that the Bank was entitled to a reduction for attorneys' fees that should not
have been awarded. The Court of Appeals also held that the trial court committed
errors in setting a date for calculating damages. Nevertheless, the Court of
Appeals held that the errors were "not prejudicial" to the Bank and affirmed the
basic damages award, minus the attorneys' fees. The Bank believes that the Court
of Appeals ruling is wrongly decided and intends to file a petition for review
with the California Supreme Court. As there can be no assurances that the Bank
will be successful in its appeal, the Company has recorded a liability to the
level of the Court of Appeals award including post judgment interest through
April 2000. Interest will continue to accrue at 10.0% per annum. Additionally,
other non-operating expense included $0.1 million in connection with the early
termination of its former Irvine office, which management determined was no
longer part of its operating plan.
Nonaccrual loans totaled $39.2 million at March 31, 2000 (or 2.42% of total
assets). By comparison, nonaccrual loans were $44.0 million (or 2.78% of total
assets) and $41.9 million (or 2.76% of total assets) at December 31, 1999 and
March 31, 1999, respectively. Other classified loans were $48.4 million at March
31, 2000, compared to $25.6 million at December 31, 1999 and $32.8 million at
March 31, 1999. The increase in other classified loans from December 31, 1999 to
March 31, 2000 was primarily due to classification of two loans, one income
property loan with a balance of $10.2 million and one tract loan with a balance
of $4.4 million which are both being monitored closely.
INCOME TAXES
The Company's effective tax rate was 42.14% and 41.54% during the first
quarter of 2000 and 1999, respectively.
PARENT COMPANY ITEMS
Beginning with the fourth quarter of 1999, the Company has been and 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 March 2000, the Company announced its stock repurchase program which
authorized the repurchase of up to 277,000 shares, or approximately 5% of the
outstanding common stock. As of May 12, 2000, the Company has repurchased
267,500 shares at an average price per share of $7.96.
11
<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 March 31, 2000 and 1999. In the tables, interest revenues are net
of interest associated with nonaccrual loans.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------------------------
MARCH 31, 2000 MARCH 31, 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)(2).................... $1,490,115 $32,913 8.84% $1,354,383 $31,001 9.16%
Cash and cash equivalents................. 82,768 1,215 5.87% 68,136 816 4.79%
Investment in capital stock of Federal
Home Loan Bank.......................... 21,550 308 5.72% 15,255 197 5.17%
---------- ------- ---------- -------
Total interest-earning assets............... 1,594,433 34,436 8.64% 1,437,774 32,014 8.91%
------- ----- ------- -----
Noninterest-earning assets.................. 13,302 15,762
---------- ----------
Total assets........................ $1,607,735 $1,453,536
========== ==========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Deposits.................................. $1,079,277 13,843 5.16% $ 995,652 12,434 5.06%
FHLB advances............................. 344,549 4,598 5.28% 300,444 3,860 5.14%
Senior notes.............................. 40,000 1,250 12.50% 40,000 1,250 12.50%
---------- ------- ---------- -------
Total interest-bearing
liabilities....................... 1,463,826 19,691 5.41% 1,336,096 17,544 5.33%
------- ----- ------- -----
Noninterest-bearing checking................ 29,608 20,267
Noninterest-bearing liabilities............. 20,314 14,730
Stockholders' equity........................ 93,987 82,443
---------- ----------
Total liabilities and stockholders'
equity............................ $1,607,735 $1,453,536
========== ==========
Net interest income......................... $14,745 $14,470
======= =======
Interest rate spread........................ 3.23% 3.58%
===== =====
Net interest margin including senior
notes..................................... 3.70% 4.03%
===== =====
Net interest margin excluding senior
notes..................................... 4.01% 4.37%
===== =====
</TABLE>
- ---------------
(1) Includes nonaccrual loans of $39.2 million and $44.0 million for the three
months ended March 31, 2000 and March 31, 1999, respectively.
(2) Revenues/costs include amortization of loan fees and discounts of $0.5
million and $1.5 million for the three months ended March 31, 2000 and March
31, 1999, respectively.
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 recorded net interest income of $14.7 million and $14.5 million
during the first quarter of 2000 and 1999, respectively. The Company's resulting
net interest margins for the first quarter of 2000 and 1999 were 3.70% and
4.03%, respectively. The compression in net interest margin is the result of
increased competitive rate pressures in the market place for both loans and
deposits and an increase in the payment of broker rebates on single family
residential loans.
12
<PAGE> 13
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-five years (though
such terms are subject to certain early call provisions) and carry both variable
and fixed interest rates.
As of March 31, 2000, 87.81% of the Company's loans were adjustable-rate,
with 87.89% of such loans subject to repricing no less frequently than annually.
The substantial majority of such loans are priced at a margin over various
market-sensitive indicies, including the One-year CMT, the One-month CMT, the
MTA, LIBOR and the Prime Rate. Based upon the recent rise in the effective yield
of these indicies, the Company expects that the yield on its loan portfolio will
rise moderately over the coming months to fully incorporate the recent rise in
market interest rates.
At March 31, 2000, 76.86% of the Company's 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 March 31, 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 March 31, 2000, 69.14% of the Company's borrowings from the FHLB are
fixed-rate, with remaining terms ranging from one-to-five years (though such
remaining terms are subject to early call provisions). The remaining 30.86% of
the borrowings carry an adjustable interest rate tied to the Prime Rate,
maturing in February 2003. 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, which is substantially higher than the cost of
the Company's FHLB borrowings, currently outstanding.
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 MARCH 31, 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)................................ $3,107 $(1,086) $(109) $1,912
Cash and cash equivalents.......................... 175 184 40 399
Investment in capital stock of Federal Home Loan
Bank............................................ 81 21 9 111
------ ------- ----- ------
3,363 (881) (60) 2,422
------ ------- ----- ------
Interest-bearing liabilities:
Deposits........................................... 1,045 336 28 1,409
FHLB advances...................................... 567 149 22 738
------ ------- ----- ------
1,612 485 50 2,147
------ ------- ----- ------
Change in net interest income........................ $1,751 $(1,366) $(110) $ 275
====== ======= ===== ======
</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.
13
<PAGE> 14
The Company's interest revenues increased by $2.4 million, or 7.57%, during
the three months ended March 31, 2000 as compared to the same period in 1999.
This increase was primarily attributable to a 10.02% increase in the average
balance of loans outstanding, which was partially offset by a decrease in the
weighted average yield earned thereon, which averaged 8.84% during 2000 as
compared with 9.16% in 1999. The decline in the loan portfolio yield reflected
increased competitive rate pressure in the market place, a change in the
portfolio mix, and an increase in the payment of broker rebates on single family
residential loans.
Interest costs increased by $2.1 million, or 12.24%, during the three
months ended March 31, 2000, as compared to the same period during 1999,
primarily due to a 9.56% 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, which together averaged
5.41% during the three months ended March 31, 2000, as compared with 5.33%
during the same quarter of 1999.
These changes in interest revenues and interest costs produced an increase
of $0.3 million, or 1.90%, in the Company's net interest income during the three
months ended March 31, 2000, as compared with the same quarter during 1999.
Expressed as a percentage of average interest-earning assets, the Company's net
interest margin decreased to 3.70% during the three months ended March 31, 2000,
as compared with the net interest margin of 4.03% produced during the same
period during 1999.
PROVISIONS FOR ESTIMATED CREDIT LOSSES ON LOANS
Provisions for estimated credit losses were $1.5 million and $3.0 million
for the quarters ended March 31, 2000 and March 31, 1999, respectively. The
Company's total allowance for estimated credit losses to loans receivable, net
of specific allowances increased to 1.71% at March 31, 2000 compared with 1.65%
at December 31, 1999 and 1.45% at March 31, 1999. The Company's annualized ratio
of charge-offs to average loans has improved from 0.05% in the first quarter of
1999 to 0.01% in the first quarter of 2000. Additionally, the ratio of total
classified assets to Bank core capital and general allowance for estimated
credit losses has increased to 59.58% at March 31, 2000 from 49.96% at December
31, 1999 and 55.56% at March 31, 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
The Company's noninterest revenues are made up of loan related fees which
totaled $1.8 million in the first quarter of 2000, a decrease of $0.2 million
from $2.0 million recognized in the first quarter of 1999. 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 significant decrease in
loan-related fee revenues during the first three months of 2000, as compared
with the first three months 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
during 1999.
14
<PAGE> 15
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
MARCH 31,
----------------------
2000 1999 CHANGE
(DOLLARS IN THOUSANDS) ---- ---- ------
<S> <C> <C> <C>
Expenses associated with real estate operations:
Repairs, maintenance and renovation....................... $(85) $(58) $ (27)
Insurance and property taxes.............................. (2) (21) 19
---- ---- -----
(87) (79) (8)
Net (loss)/recoveries from sale of REO...................... (22) 557 (579)
Property operations, net.................................... 26 1 25
---- ---- -----
Total............................................. 4 558 (554)
---- ---- -----
Recovery/(provision) for estimated losses on real estate
owned..................................................... 24 (45) 69
---- ---- -----
(Loss)/income from real estate operations, net.............. $(59) $434 $(493)
==== ==== =====
</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 three months ended March 31, 2000, the
Company sold three properties generating net cash proceeds of $0.3 million and a
net loss of $0.02 million, as compared to sales of eight properties generating
net cash proceeds of $2.6 million and a net recovery of $0.6 million during the
three months ended March 31, 1999.
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 MARCH 31,
-----------------------------
2000 1999 CHANGE
(DOLLARS IN THOUSANDS) ------- ------- -------
<S> <C> <C> <C>
General and administrative expenses:
Employee................................................ $4,052 $4,103 $(51)
Operating............................................... 1,513 1,540 (27)
Occupancy............................................... 963 993 (30)
Technology.............................................. 474 560 (86)
Professional............................................ 875 303 572
SAIF insurance premiums and OTS assessments............. 222 299 (77)
====== ====== ====
Total general and administrative expenses....... $8,099 $7,798 $301
====== ====== ====
</TABLE>
Total general and administrative costs ("G&A") were $8.1 million for the
three months ended March 31, 2000, a 3.86% increase over the $7.8 million of G&A
incurred during the same period of 1999. The increase in G&A was primarily in
professional fees comprised of outside consultants working on operational
projects and outside lawyers representing the Company in a variety of legal
matters. 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 costs divided by net interest income before
provision and noninterest revenues, excluding REO, net). The efficiency ratio
for the first quarter of 2000 increased to 49.07% compared to 47.43% in the
first quarter of 1999.
15
<PAGE> 16
Other Non-operating Expense
Other non-operating expense totaled $1.8 million for the three months ended
March 31, 2000, an $0.8 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 April 13, 2000, the California Court of
Appeals issued its 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 appealed from the $2.4 million judgment in the
Takaki matter on the grounds that the trial court erred in measuring damages
awarded to the plaintiffs. In an unpublished decision, the Court of Appeals held
that the Bank was entitled to a reduction for attorneys' fees that should not
have been awarded. The Court of Appeals also held that the trial court committed
errors in setting a date for calculating damages. Nevertheless, the Court of
Appeals held that the errors were "not prejudicial" to the Bank and affirmed the
basic damages award, minus the attorneys' fees. The Bank believes that the Court
of Appeals ruling is wrongly decided and intends to file a petition for review
with the California Supreme Court. As there can be no assurances that the Bank
will be successful in its appeal, the Company has recorded a liability to the
level of the Court of Appeals award including post judgment interest through
April 2000. Interest will continue to accrue at 10.0% per annum. Additionally,
other non-operating expense included $0.1 million in connection with the early
termination of its former Irvine office, which management determined was no
longer part of its operating plan.
16
<PAGE> 17
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>
MARCH 31, 2000 DECEMBER 31, 1999
--------------------- ---------------------
BALANCE PERCENT BALANCE PERCENT
(DOLLARS IN THOUSANDS) ---------- ------- ---------- -------
<S> <C> <C> <C> <C>
Single family residential........................ $ 732,932 44.0% $ 683,250 41.0%
Income property:
Multi-family(1)................................ 231,973 13.9 222,616 13.4
Commercial(1).................................. 220,888 13.3 208,859 12.5
Development(2)................................. 132,825 8.0 148,092 8.9
Land(3).......................................... 55,031 3.3 59,095 3.5
Single family construction:
Single family residence(4)..................... 226,033 13.6 274,697 16.5
Tract.......................................... 19,255 1.1 24,056 1.4
Other............................................ 47,652 2.8 46,132 2.8
---------- ----- ---------- -----
Gross loans receivable(5)........................ 1,666,589 100.0% 1,666,797 100.0%
===== =====
Less:
Undisbursed funds.............................. (158,363) (196,249)
Deferred fees and credits, net................. (288) (1,295)
Allowance for estimated losses................. (25,731) (24,285)
---------- ----------
Net loans receivable............................. $1,482,207 $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> 18
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
MARCH 31, 2000
-------------------
AMOUNT %
(DOLLARS IN THOUSANDS) --------- ------
<S> <C> <C>
Single family residential(1).............................. $ 76,586 55.7%
Income property:
Multi-family............................................ 13,035 9.5
Commercial(2)........................................... 20,237 14.7
Land...................................................... 6,492 4.7
Single family construction:
Single family residence(3).............................. 21,082 15.4
Other..................................................... 7 --
-------- -----
$137,439 100.0%
======== =====
</TABLE>
- ---------------
(1) Includes unfunded commitments under lines of credit of $0.3 million.
(2) Includes unfunded commitments of $2.1 million.
(3) Includes unfunded commitments of $14.5 million.
18
<PAGE> 19
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>
MARCH 31, DECEMBER 31,
2000 1999
(DOLLARS IN THOUSANDS) ---------- ------------
<S> <C> <C>
Risk elements:
Nonaccrual loans(1)....................................... $ 39,221 $ 44,031
Real estate owned, net.................................... 5,525 5,587
---------- ----------
44,746 49,618
Performing loans classified substandard or lower.......... 48,439 25,646
---------- ----------
Total classified assets................................... $ 93,185 $ 75,264
========== ==========
Total classified loans.................................... $ 87,660 $ 69,677
========== ==========
Loans restructured and paying in accordance with modified
terms(2).................................................. $ 15,456 $ 15,394
========== ==========
Loans receivable net of specific reserves and deferred
fees...................................................... $1,507,632 $1,468,445
========== ==========
Allowance for estimated credit losses:
General................................................... $ 25,425 $ 23,476
Specific.................................................. 306 809
---------- ----------
Total allowance for estimated credit losses....... $ 25,731 $ 24,285
========== ==========
Net loan charge-offs:
Net charge-offs for quarter ended......................... $ 54 $ 1,409
Percent to net loans (annualized)......................... 0.01% 0.38%
Percent to beginning of period allowance for credit losses
(annualized)........................................... 0.89% 32.94%
Selected asset quality ratios at period end:
Total nonaccrual loans to total assets.................... 2.42% 2.78%
Total allowance for estimated credit losses to loans
receivable, net of specific reserves and deferred
fees................................................... 1.71% 1.65%
Total general allowance for estimated credit losses to
loans receivable, net of specific reserves and deferred
fees................................................... 1.69% 1.60%
Total reserves to nonaccrual loans........................ 65.61% 55.15%
Total classified assets to Bank core capital and general
loan loss reserves..................................... 59.58% 49.96%
</TABLE>
- ---------------
(1) Total troubled debt restructured loans ("TDRs") were $29.5 million and $34.9
million at March 31, 2000 and December 31, 1999, respectively. Nonaccrual
loans include TDRs of $13.8 million and $18.7 million at March 31, 2000 and
December 31, 1999, respectively.
(2) TDRs not classified and not on nonaccrual.
19
<PAGE> 20
The table below sets forth information concerning the Company's gross
classified loans, by category, as of March 31, 2000.
<TABLE>
<CAPTION>
DELINQUENT LOANS OTHER
----------------------------- NONACCRUAL PERFORMING
90+ DAYS 30-89 DAYS(1) LOANS(2) LOANS TOTAL
(DOLLARS IN THOUSANDS) ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Single family residential...... $19,312 $ 733 $ -- $ 9,816 $29,861
Income property:
Commercial................... -- 10,492 -- 11,689 22,181
Development.................. -- 14,918 -- -- 14,918
Land........................... 950 145 -- 6,160 7,255
Single family construction:
Single family residence...... 771 535 2,616 382 4,304
Tract........................ 1,946 -- 2,767 4,392 9,105
Other.......................... 32 -- -- 4 36
------- ------- ------- ------- -------
Total................ $23,011 $26,823 $ 5,383 $32,443 $87,660
======= ======= ======= ======= =======
</TABLE>
- ---------------
(1) Includes $16.0 million in loans 30-89 days past due and still accruing
interest.
(2) 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 and REO when it has determined that recovery of the Company's
gross investment is not probable and when the amount of loss can be reasonably
determined. In making this determination, management considers (1) the status of
the asset, (2) the probable future status of the asset, (3) the value of the
asset or underlying collateral and (4) management's intent with respect to the
asset. In quantifying the loss, if any, associated with individual loans and
REO, management utilizes external sources of information (i.e., appraisals,
price opinions from real estate professionals, comparable sales data and
internal estimates). In establishing specific allowances, management estimates
the revenues expected to be generated from disposal of the Company's collateral
or owned property, less construction and renovation costs (if any), holding
costs and transaction costs. For tract construction and land development, the
resulting projected cash flows are discounted utilizing a market rate of return
to determine their value.
The Company maintains an allowance for estimated credit losses which is not
tied to individual loans or properties ("general 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
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),
20
<PAGE> 21
(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 March 31, 2000.
<TABLE>
<CAPTION>
LOANS
---------------------------------
PERFORMING DELINQUENT TOTAL
(DOLLARS IN THOUSANDS) ---------- ---------- -------
<S> <C> <C> <C>
Specific allowances..................................... $ -- $ 306 $ 306
General allowances...................................... 18,831 6,594 25,425
------- ------ -------
Total......................................... $18,831 $6,900 $25,731
======= ====== =======
Percentages:
Total allowance for estimated credit losses to gross
loans.............................................. 1.29% 13.85% 1.71%
Total general allowances for estimated credit losses
to net loans....................................... 1.29% 13.31% 1.69%
</TABLE>
The table below summarizes the activity of the Company's allowance for
estimated credit losses for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------
2000 1999
(DOLLARS IN THOUSANDS) ---------- ----------
<S> <C> <C>
Average loans outstanding................................... $1,490,115 $1,354,383
========== ==========
Total allowance for estimated credit losses at beginning of
period.................................................... $ 24,285 $ 17,111
Provision for estimated credit losses....................... 1,500 3,000
Charge-offs:
Single family............................................. (107) (153)
Recoveries:
Other.................................................. 53 --
---------- ----------
Net charge-offs............................................. (54) (153)
---------- ----------
Total allowance for estimated credit losses at end
of period....................................... $ 25,731 $ 19,958
========== ==========
Annualized ratio of charge-offs to average loans outstanding
during the period......................................... 0.01% 0.05%
Real estate owned:
Total allowance for estimated losses, beginning of
period................................................. $ 29 $ 45
Provision for estimated losses............................ (24) 45
Charge-offs............................................... (1) --
---------- ----------
Total allowance for estimated losses, end of
period.......................................... $ 4 $ 90
========== ==========
</TABLE>
21
<PAGE> 22
The table below summarizes the allocation of the Company's allowance for
estimated credit losses for each principal loan portfolio segment.
<TABLE>
<CAPTION>
MARCH 31, 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........................ $ 6,548 0.89% $ 7,095 1.04%
Income property:
Multi-family................................... 697 0.30% 646 0.29%
Commercial..................................... 5,334 2.41% 6,738 3.23%
Development.................................... 4,834 3.64% 2,067 1.40%
Land............................................. 1,933 3.51% 1,470 2.49%
Single family construction:
Single family residence........................ 2,993 1.32% 3,946 1.44%
Tract.......................................... 1,870 9.71% 855 3.55%
Other............................................ 972 2.04% 480 1.04%
Unallocated...................................... 550 N/A 988 N/A
------- -------
$25,731 1.54% $24,285 1.51%
======= =======
</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.
REAL ESTATE OWNED
Real estate acquired in satisfaction of loans is transferred from loans to
properties at the lower of the carrying values or the estimated fair values,
less any estimated disposal costs. The difference between the fair value of the
real estate collateral and the loan balance at the time of transfer is recorded
as a loan charge-off. Any subsequent declines in the fair value of the
properties after the date of transfer are recorded through the establishment of,
or additions to, specific allowances.
The table below summarizes the composition of the Company's real estate
owned properties for the dates indicated.
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
(DOLLARS IN THOUSANDS) --------- ------------
<S> <C> <C>
Single family residential.............................. $1,131 $1,218
Income property:
Commercial(1)........................................ 4,398 4,398
------ ------
Gross investment(2).................................... 5,529 5,616
Less allowance for estimated losses.................... 4 29
------ ------
Real estate owned, net................................. $5,525 $5,587
====== ======
</TABLE>
- ---------------
(1) In December 1999, the Bank acquired 18 lots of a tract development in La
Quinta, California with a carrying value of $4.4 million.
(2) Fair value of collateral at foreclosure, plus post-foreclosure capitalized
costs.
22
<PAGE> 23
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>
MARCH 31, 2000 DECEMBER 31, 1999
------------------------ ------------------------
BALANCE WAIR WARM BALANCE WAIR WARM
(DOLLARS IN THOUSANDS) ---------- ---- ---- ---------- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing checking................ $ 30,865 -- -- $ 28,838 -- --
Checking/NOW................................ 42,037 2.19% -- 40,563 2.17% --
Passbook.................................... 23,959 1.62% -- 23,568 1.41% --
Money market................................ 168,131 4.74% -- 155,537 4.45% --
Certificates of deposit:
7 day maturities.......................... 24,864 4.08% -- 30,631 4.08% --
Less than 6 months........................ 34,010 4.71% 1 42,082 4.78% 2
6 months to 1 year........................ 118,906 5.52% 4 147,407 5.24% 3
1 year to 2 years......................... 669,410 5.74% 8 584,488 5.46% 8
Greater than 2 years...................... 32,911 5.28% 12 33,521 5.31% 12
---------- ----------
$1,145,093 5.12% 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>
MARCH 31, 2000 DECEMBER 31, 1999
(DOLLARS IN THOUSANDS) ----------------- -----------------
ORIGINAL TERM PRINCIPAL RATE PRINCIPAL RATE
------------- --------- ---- --------- ----
<S> <C> <C> <C> <C>
36 Months......................................... $100,000 6.23% $ -- --
60 Months......................................... 175,000 5.42% 300,000 5.30%
120 Months........................................ 49,000 4.36% 49,000 4.36%
======== ========
$324,000 5.51%(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 2 months and 4 years and 6 months as of March 31, 2000 and December
31, 1999, respectively. All of the Company's FHLB advances outstanding at March
31, 2000, with the exception of one, contain options which allow the FHLB to
call the advances prior to maturity, subject to an initial non-callable period
of one-to-three years from origination.
23
<PAGE> 24
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
March 31, 2000 amounted to $96.0 million and which equaled 5.92% 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........... $ 130,988 -- $ 130,988 -- $ 130,988 --
Adjustments:
General allowances........... -- -- -- -- 14,655 --
Other(1)..................... -- -- -- -- (5,565) --
---------- ---- ---------- ---- ---------- -----
Regulatory capital............. 130,988 8.09% 130,988 8.09% 140,078 12.06%
Required minimum............... 24,277 1.50 64,739 4.00 92,935 8.00
---------- ---- ---------- ---- ---------- -----
Excess capital................. $ 106,711 6.59% $ 66,249 4.09% $ 47,143 4.06%
========== ==== ========== ==== ========== =====
Adjusted assets(2)............. $1,618,479 $1,618,479 $1,161,694
========== ========== ==========
</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).
As of March 31, 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 March 31, 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
MINIMUM CAPITALIZED UNDER
CAPITAL PROMPT CORRECTIVE
ACTUAL REQUIREMENT ACTION PROVISIONS
----------------- ---------------- ------------------------
AMOUNT RATIOS AMOUNT RATIOS AMOUNT RATIOS
(DOLLARS IN THOUSANDS) -------- ------ ------- ------ ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
As of March 31, 2000
Total Capital (to Risk Weighted Assets)........ $140,078 12.06% $92,935 8.00% $116,169 10.00%
Core Capital (to Adjusted Tangible Assets)..... 130,988 8.09% 64,739 4.00% 80,924 5.00%
Tangible Capital (to Adjusted Tangible
Assets)...................................... 130,988 8.09% 24,277 1.50% N/A N/A
Tier 1 Capital (to Risk Weighted Assets)..... 130,988 11.28% N/A N/A 69,702 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>
24
<PAGE> 25
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
$1.8 million at March 31, 2000. Hawthorne Financial Corporation has no other
significant assets beyond its investment in the Bank. Beginning in December
1999, 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 expects to make 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.
The Company's liquidity position refers to the extent to which the
Company's funding sources are sufficient to meet its current and long-term cash
requirements. Federal regulations currently require a savings association to
maintain a monthly average daily balance of liquid assets (including cash,
certain time deposits, bankers' acceptances, and specified United States
Government, state or federal agency obligations) equal to 4.0% of the average
daily balance of its net withdrawable accounts and short-term borrowings during
the preceding calendar quarter. This liquidity requirement may be changed from
time to time by the OTS to any amount within the range of 4.00% to 10.00% of
such accounts and borrowings depending upon economic conditions and the deposit
flows of member associations. Monetary penalties may be imposed for failure to
meet this liquidity ratio requirement. The Company's liquidity for the
calculation period ended March 31, 2000 was 7.25%, which exceeded the applicable
minimum requirements.
The Company's current primary funding resources are deposits, principal
payments on loans, FHLB advances and cash flows from operations. Other possible
sources of liquidity available to the Company include whole loan sales,
commercial bank lines of credit, and direct access, under certain conditions, to
borrowings from the Federal Reserve System. The cash needs of the Company are
principally for the payment of interest on, and withdrawals of, deposit
accounts, the funding of loans and operating costs and expenses.
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
25
<PAGE> 26
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.
The table below sets forth information concerning repricing opportunities
for the Company's interest-earning assets and interest-bearing liabilities as of
March 31, 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>
MARCH 31, 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)......... $ 73,578 $ -- $ -- $ -- $ -- $ 73,578
Investments and FHLB stock........... 21,345 -- -- -- -- 21,345
Loans(2)............................. 991,692 327,748 39,012 30,302 119,472 1,508,226
---------- -------- --------- --------- -------- ----------
Total interest-earning
assets...................... $1,086,615 $327,748 $ 39,012 $ 30,302 $119,472 $1,603,149
========== ======== ========= ========= ======== ==========
Interest-bearing liabilities:
Deposits:
Non-certificates of deposit(3)..... $ 224,428 $ -- $ -- $ -- $ -- $ 224,428
Certificates of deposit............ 237,051 175,638 359,488 107,925 -- 880,102
FHLB advances........................ 90,000 -- 30,000 204,000 -- 324,000
Senior notes......................... -- -- -- 40,000 -- 40,000
---------- -------- --------- --------- -------- ----------
Total interest-bearing
liabilities................. $ 551,479 $175,638 $ 389,488 $ 351,925 $ -- $1,468,530
========== ======== ========= ========= ======== ==========
Interest rate sensitivity gap........ $ 535,136 $152,110 $(350,476) $(321,623) $119,472 $ 134,619
Cumulative interest rate sensitivity
gap................................ 535,136 687,246 336,770 15,147 134,619 134,619
Cumulative interest rate sensitivity
gap as a percentage of total
interest-earning assets............ 33.4% 42.9% 21.0% 0.9% 8.4% 8.4%
</TABLE>
- ---------------
(1) Excludes noninterest earning cash balances.
(2) Loans include $39.2 million of nonaccrual loans, and are exclusive of
deferred fees and loan loss reserves.
(3) Includes checking/NOW, passbook and money market accounts.
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.
26
<PAGE> 27
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.
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 March 31, 2000, based on the Company's internally generated model, it
was estimated that the Company's NPV ratio was 7.73% in the event of a 200 basis
point increase in rates, a decrease of 9.27% from basecase of 8.52%. If rates
were to decrease by 200 basis points, the Company's NPV ratio was estimated at
9.99%, an increase of 17.25% from basecase.
Presented below, as of March 31, 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
(DOLLARS IN THOUSANDS) -------------------------
$ CHANGE FROM NPV CHANGE FROM
CHANGE IN RATES $ AMOUNT BASECASE RATIO BASECASE
--------------- -------- ------------- ----- -----------
<S> <C> <C> <C> <C>
+300 bp........................................ $106,985 (30,947) 6.79% -173 bp
+200 bp........................................ 123,304 (14,628) 7.73% -79 bp
+100 bp........................................ 132,549 (5,384) 8.24% -28 bp
basecase....................................... 137,932 8.52%
- -100 bp........................................ 150,325 12,393 9.19% +67 bp
- -200 bp........................................ 166,318 28,386 9.99% +147 bp
- -300 bp........................................ 186,528 48,596 10.99% +246 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 and the ability of
the Company to analyze each individual rate index in a changing environment.
27
<PAGE> 28
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 13, 2000, the California Court of Appeals issued its 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
appealed from the $2.4 million judgment in the Takaki matter on the grounds that
the trial court erred in measuring damages awarded to the plaintiffs. In an
unpublished decision, the Court of Appeals held that the Bank was entitled to a
reduction for attorneys' fees that should not have been awarded. The Court of
Appeals also held that the trial court committed errors in setting a date for
calculating damages. Nevertheless, the Court of Appeals held that the errors
were "not prejudicial" to the Bank and affirmed the basic damages award, minus
the attorneys' fees. The Bank believes that the Court of Appeals ruling is
wrongly decided and intends to file a petition for review with the California
Supreme Court. There can be no assurances that the Bank will be successful in
its' appeal. Post judgment interest will continue to accrue at 10.0% per annum.
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.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
1. Reports on Form 8-K
No current reports on Form 8-K were filed for the three months ended
March 31, 2000
2. Other required exhibits
Exhibit 8.1 -- Hawthorne Financial Corporation Tax Sharing Agreement
Exhibit 27.1 -- Financial Data Schedule
28
<PAGE> 29
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HAWTHORNE FINANCIAL CORPORATION
Dated May 15, 2000 /s/ SIMONE LAGOMARSINO
--------------------------------------
Simone Lagomarsino
President and Chief Executive Officer
Dated May 15, 2000 /s/ KAREN C. ABAJIAN
--------------------------------------
Karen C. Abajian
Executive Vice President and
Chief Financial Officer
29
<PAGE> 1
EXHIBIT 8.1
[LOGO]
TAX SHARING AND ALLOCATION AGREEMENT
BETWEEN
HAWTHORNE FINANCIAL CORPORATION
AND
HAWTHORNE SAVINGS F.S.B.
DATED APRIL 24, 2000, SUPERCEDING THE TAX SHARING AGREEMENT DATED JUNE 16, 1999
Hawthorne Financial Corporation and Hawthorne Savings. F.S.B., a wholly
owned subsidiary of the Company, hereby enter into this agreement as of April
24, 2000, pursuant to which tax sharing and allocation of tax shall be defined.
This Agreement is effective as of the first day of the consolidated return for
the fiscal year ending December 31, 2000, by and among Hawthorne Financial
Corporation (Parent) and Hawthorne Savings F.S.B. (Subsidiary) each of whom may
be referred to as a "Member" and together referred to as an "Affiliated Group"
as defined by the Internal Revenue Code of 1986, Section 1504(a) (Code).
WHEREAS, SA No 28 of the Office of Thrift Supervision dated August 9,
1989 requires the Parent and the Subsidiary to enter into an intercompany tax
allocation agreement, and
WHEREAS, it would be to the mutual advantage of the parties hereto, and
could result in smaller federal income tax being paid by all parties, if a
consolidated federal income tax return is filed which will include any
subsidiaries and affiliates of the parties in accordance with the terms of the
Code and related income tax regulations.
WHEREAS, it is the intent and desire of the parties hereto that a
method be established for allocating the consolidated "federal income tax
liability" (as determined under Section 1.1502-2 of the Regulations) and certain
state tax liability of the Affiliated Group among its Members (as
1
<PAGE> 2
required by Section 1552(a) of the 1986 Code); for reimbursing the Parent for
payment of such tax liability; for compensating any Member for use of its "net
operating loss" or "tax credits" in arriving at such tax liability; and to
provide for the allocation and payment of any refund arising from a carry back
of net operating losses or tax credits from subsequent taxable years.
WHEREAS, it is the intention and desire of the parties hereto, that
this Agreement address and abide in all respects with OTS statutes, regulations
and the Interagency Policy Statement for Income Tax Allocation in a Holding
Company Structure issued November 23, 1998.
NOW, THEREFORE, in consideration of mutual covenants and promises
contained herein, the parties hereto agree as follows:
I. CONSOLIDATED RETURN
1. Parent and Subsidiary shall file such consents and other documents
and take such action as may be necessary to continue in filing a
consolidated tax return for the Affiliated Group.
2. Parent and Subsidiary shall cause any corporation which hereafter
becomes an affiliate of any of them and a Member of the Affiliated
Group to join in this Agreement.
3. Parent and Subsidiary shall maintain, and shall cause any
Subsidiary subsequently formed or acquired to maintain concurrent
fiscal years.
4. Parent shall make all elections under the consolidated return
regulations or required to be made for the consolidated Affiliated
Group and shall approve all elections made with respect to each
Member of the Affiliated Group.
5. A U.S. consolidated federal income tax return shall be filed by
Hawthorne Financial Corporation for the taxable year ended
December 31, 1998, and for each subsequent taxable year in respect
of which this Agreement is in effect and for which the Affiliated
Group is required or permitted to file a consolidated federal
income tax return.
6. In order to compensate Members of the Affiliated Group for the use
of net operating losses or tax credits in arriving at the
consolidated federal income tax liability of the Affiliated Group,
the Members of the Affiliated Group agree to determine and
allocate the tax liability of the Affiliated Group among
themselves in the following manner:
II. CALCULATION OF INDIVIDUAL CORPORATE INCOME TAX LIABILITY
1. Beginning with the year ended December 31, 1998, and for each tax
year thereafter, each Member of the Affiliated Group will
calculate its federal corporate income tax liability as if it were
to file a separate federal income tax return for such period.
2
<PAGE> 3
2. In so computing the individual federal income tax liability of
each Member of the Affiliated Group:
a) Except as otherwise provided herein, "separate company taxable
income" shall be determined as if Parent and each Subsidiary
were required to file a separate tax return in a manner
similar to the calculation provided in Treasury Regulation
1.1552-1(a)(2)(ii), and the term will not have the same
meaning as set forth in Section 1.1502-12 of the Treasury
Regulations;
b) Any dividends received by Parent from Subsidiaries, or by one
Subsidiary from another, will be assumed to qualify for the
100% dividend received deduction of Code Section 243, or shall
be eliminated from such calculation in accordance with
Treasury Regulation 1.1502-14(a)(1);
c) Gain or loss on inter-company transactions, whether deferred
or not, shall be treated by each Member of the Affiliated
Group in the manner required by Treasury Regulation 1.1502-13;
d) Limitations on the calculation of a deduction, the utilization
of credits, or the calculation of a liability shall be made on
a consolidated basis. Accordingly, the limitations provided in
Code Sections 170(b)(2), 172(b)(2), 38(c), 53(a) and similar
limitations shall be applied on a consolidated basis;
e) The corporate alternative minimum tax (AMT), imposed in Code
Section 55 and AMT limitations and adjustments provided in
Code Sections 56 through 59, shall be determined on a
consolidated basis;
f) The amounts in each taxable income bracket in the tax table in
Code Section 11(b) shall be allocated in any given year to
Members of the Affiliated Group as Parent shall elect. Such
election shall be made on an annual basis and shall be binding
upon all parties to this Agreement; and
g) In calculating any carry-back or carryover of net operating
losses, adjustments shall be made to such prior or subsequent
year's separate company tax liability as determined under Code
Section 172(b)(2). For purposes of this calculation, the
election under Section 172(b)(3) shall be made on a separate
company basis.
3. For California franchise tax purposes beginning with the year
ended December 31, 1998, and for each tax year thereafter, each
Member of the combined Affiliated Group will calculate its
California franchise tax liability as if it were required to file
a separate California income tax return for such period in a
manner consistent with that set forth in Section II.2. above,
except that such calculations shall be made in compliance with
applicable regulations of the Franchise Tax Board.
3
<PAGE> 4
4. For states other than California, beginning with the year ended
December 31, 1998 and for each year thereafter the state tax
liability of each Member of the Affiliated Group will be
determined as if such Member were required to file a separate
income tax return for such state for such period in a manner
consistent with that set forth in Section II.2. above, except that
such calculations shall be made in compliance with the applicable
regulations of the taxing state.
5. For purposes of Paragraphs 2 and 3 above, separate company taxable
income of each Member shall take into account only those items of
income, deduction gain and loss recorded on the books and records
of such Member.
III. LIABILITY FOR TAX PAYMENTS
1. Parent will pay the federal corporation income, California
franchise, and any state income tax liabilities of the Affiliated
Group for any year in which the Parent is a Member of the
Affiliated Group required to file consolidated combined income tax
returns. If any Subsidiary of the Affiliated Group files in states
which do not require consolidated income tax returns for the
Affiliated Group, the Subsidiary will be responsible to pay its
income tax liabilities in such states.
2. If any Subsidiary would be subject to federal corporate income or
California franchise tax if it filed a separate income or
franchise tax return, that Subsidiary shall pay to Parent that sum
which shall result from the calculations required by Section II,
above. Parent shall retain for its own account all amounts so paid
to it by the Subsidiaries.
3. If any Subsidiary would be entitled to a refund of federal or
state corporate income tax if it filed a separate federal or state
income tax return, or if currently generated losses or credits of
any Subsidiary reduce the current tax liability of the
consolidated Affiliated Group, Parent shall pay to that Subsidiary
an amount equal to the amount of the refund to which it would be
entitled or the amount of the reduction in current consolidated
tax liability, as applicable. In the event that a Subsidiary's
separate company taxable income is a loss in any given year as
calculated under paragraph II, and the consolidated Affiliated
Group is unable to utilize the loss to reduce its current tax
liability, the Parent will first offset this loss against prior
years' taxable income. If the loss is greater than prior years'
profits, the excess will be carried forward against future years'
taxable income, but Parent shall not be required to make any
payment to any Subsidiary on account thereof until such tax loss
is used to offset otherwise taxable income.
4. With the exception of payments provided for under subparagraphs 2
and 3 of this paragraph III, neither Parent nor any Subsidiary
shall pay or credit any amount to the other hereunder, even though
the federal or state corporate income tax liability of the
Affiliated Group may have been reduced by reason of the inclusion
of a particular
4
<PAGE> 5
Subsidiary as a Member of the Group. Parent will not forgive the
Subsidiary for any deferred tax liabilities.
5. Payments to Parent by any Subsidiary must not include any deferred
tax liability incurred by Subsidiary. Payments shall not include
any deferred tax liabilities incurred by any Member.
IV. RESTRICTION ON AMOUNT OF TAX LIABILITY
Without regard for anything to the contrary in this Agreement, the
Subsidiary shall not be treated any less favorably than if it had filed its
taxes on a separate entity basis.
V. METHOD AND TIME OF PAYMENT
Payments by Parent of consolidated estimated tax for the consolidated
Affiliated Group at the normal quarterly due dates will be reimbursed by the
Subsidiaries at those quarterly due dates. Each Subsidiary shall make/receive
these quarterly payments/receipts of estimated tax liability/repayment on
account to/from Parent based on the Subsidiary's separate company taxable income
calculated under paragraph II, above, as of the close of the appropriate
quarter. As soon as the Group's consolidated tax liability for the year is
determined, each Subsidiary shall make/receive payment to/from Parent pursuant
to paragraph III, above, less amounts already paid for estimated tax. All
payments to/from Parent shall be made no later than the due date for each tax
payment.
The parties agree that it is their express intent that this Agreement
shall at all times be construed in a manner consistent with any law or
regulation applicable to any Member as now or hereafter in effect relating to
thrift and loan associations, the insurance of their accounts, thrift and loan
holding companies or mortgage companies. Anything to the contrary herein
notwithstanding, (1) Subsidiary shall not pay to Parent an amount greater than
the tax which Subsidiary would have been required to pay had it always filed
separate tax returns; (2) any payments made pursuant to paragraphs V and VI of
this Agreement shall be made only with reference to the time taxes are actually
paid or refunds or credits are actually received, it being understood that at no
time shall advance payments be made by any Member with respect to the foregoing
to any other Member; and (3) any funds (i) received by Parent from another
Member for the payment of taxes or (ii) from any taxing authority by reason of
any refund, credit or overpayment and properly allocable to another Member,
shall at all times be held by Parent in a segregated account solely as agent for
such Member and shall at no time be commingled with any other funds.
VI. ADJUSTMENT OF TAX LIABILITY
If the consolidated tax liability is adjusted for any taxable period,
whether by means of an amended return, claim for refund, or after a tax audit by
any taxing authority, the liability of the Group and its Members shall be
re-computed by Parent to give effect to such adjustments. In the
5
<PAGE> 6
case of a refund, Parent shall make payment to each Subsidiary for its share of
the refund, determined in the same manner as in paragraph II above, within seven
(7) business days after the refund is received by Parent. In the case of an
increase in tax liability, each Subsidiary shall pay to Parent its allocable
share of such increased tax liability within seven (7) business days after
receiving notice of such liability from Parent, but in no event later than the
due date for tax payment.
VII. EARNINGS AND PROFITS ADJUSTMENTS
This Agreement is not intended to establish the method by which the
earnings and profits of each Member of the Group will be determined. Parent
reserves the right to elect the method for allocating tax liability for the
purposes of determining earnings and profits as set forth in Income Tax
Regulations Sections I.1552.1(a) and I.1502.33(d).
VIII. PROCEDURAL MATTERS
a) Parent shall prepare and file consolidated returns, and any other
returns, documents or statements required to be filed with the
Internal Revenue Service with respect to the determination of the
tax liability of Parent and the Subsidiaries for all taxable
periods commencing with the tax period applicable as of the date
of the execution of this Agreement. Parent shall have the right in
its sole discretion: (i) to determine (a) the manner in which such
returns shall be prepared and filed, including without limitation,
the manner in which any item of income, gain, loss, deduction or
credit shall be reported; (b) whether any extensions of the
statute of limitations may be granted; (c) the elections that will
be made pursuant to the Code on behalf of any Subsidiaries of the
consolidated Group; and (d) the manner in which any costs and
expenses attributable to tax return preparation and any other
related matters (including any matter referred to in (ii), (iii)
or (iv) below) shall be allocated among Members of the Group; (ii)
to contest, compromise or settle any adjustment or deficiency
proposed, asserted or assessed as a result of any audit of any
such returns; (iii) to file, prosecute, compromise or settle any
claim for refund; and (iv) to determine whether any refunds to
which the consolidated Group may be entitled shall be paid by way
of refund or credited against the tax liability of the
consolidated Group.
b) Each of Parent and the Subsidiaries, to the extent such
information is available, shall promptly notify each other and the
Members of the Group of any tax liability or refund issue, and
shall cooperate fully with one another in all efforts by Parent to
contest, compromise or settle the same.
IX. MISCELLANEOUS
a) COOPERATION. All material, including but not limited to, returns,
supporting schedules, workpapers, correspondence and other
documents relating to the consolidated return, shall be made
available to any party to this Agreement during
6
<PAGE> 7
regular business hours. In the event of the termination of this
Agreement, the parties will use their best efforts to make
available to the others, upon written request, its officers and
employees in connection with any tax proceedings.
b) ENTIRE AGREEMENT. This Agreement contains the entire agreement of
the parties and there are no agreements, representations, or
warranties not contained herein. This Agreement may not be
modified or amended except by written instrument executed with the
same formality as this Agreement.
c) SUCCESSORS ASSIGNS. The provisions and terms of this Agreement
shall be binding on and inure to the benefit of any successor, by
merger, acquisition of assets or otherwise, of any of the parties
hereto.
d) NEW MEMBERS. If, at any time, any other company becomes a Member
of the Group, the parties hereto agree that such Member may become
a party to this Agreement by executing a duplicate copy of this
Agreement. Unless otherwise specified, such Member shall have all
the rights and obligations of a Subsidiary under this Agreement.
e) DURATION. Unless earlier terminated as herein provided, this
Agreement shall remain in effect with respect to any tax year for
which consolidated Federal income tax returns are filed by the
Group.
Notwithstanding the termination of this Agreement, its provisions
will remain in effect with respect to any period of time during
the tax year in which termination occurs, for which the income of
the terminating party must be included in the consolidated return.
The preceding sentence shall not be construed, however, to require
a Subsidiary to contribute to consolidated tax liability for any
period for which it files a separate return. Allocations of
consolidated tax liability shall be made hereunder only for
periods covered by a consolidated Federal income tax return.
f) TERMINATION. This Agreement may be terminated by any party hereto
upon thirty (30) days prior written notice to the other parties.
g) LAW GOVERNING. This Agreement has been made in and shall be
construed and enforced in accordance with the laws of the State of
California, as such laws may from time to time be amended or
revised.
7
<PAGE> 8
IN WITNESS WHEREOF, the parties hereto have caused their names to be
subscribed and executed by their respective authorized officers on the dates
indicated, effective as of the date first written above.
Submitted for Approval to the Boards of Directors on April 24, 2000.
/s/ SIMONE LAGOMARSINO /s/ EILEEN LYON
- ------------------------- -------------------------
SIMONE LAGOMARSINO EILEEN LYON
President/CEO SVP/General Counsel
Hawthorne Financial Corporation Hawthorne Savings F.S.B.
8
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